-----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, OZz3TmauX0HcM3bnIjZc947s4ZaLDoQfCRs6RiNqXCEg3ZYrAMiVS5bP/oUFSyrB 1lLUT0eNO/NXg+wN4ycBoQ== 0000950135-97-004809.txt : 19971201 0000950135-97-004809.hdr.sgml : 19971201 ACCESSION NUMBER: 0000950135-97-004809 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970831 FILED AS OF DATE: 19971128 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-K SEC ACT: SEC FILE NUMBER: 000-10824 FILM NUMBER: 97730199 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-K 1 GENOME THERAPEUTICS CORPORATION 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE FISCAL YEAR ENDED: AUGUST 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]. FOR THE TRANSITION PERIOD FROM TO . COMMISSION FILE NUMBER: 0-10824 GENOME THERAPEUTICS CORP. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MASSACHUSETTS 04-2297484 (STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NUMBER) OR ORGANIZATION) 100 BEAVER STREET, WALTHAM, MASSACHUSETTS 02154 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER: (781) 398-2300 SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT: COMMON STOCK, $.10 PAR VALUE (TITLE OF CLASS) 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of November 24, 1997 was approximately $123,461,072. The number of shares outstanding of the registrant's common stock as of November 24, 1997 was 18,211,543. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's proxy statement for use at its Special Meeting of Shareholders in lieu of an Annual Meeting to be held on January 26, 1998 are incorporated by reference into Part III. ================================================================================ 2 PART I ITEM 1. BUSINESS OVERVIEW Genome Therapeutics Corp. ("GTC" or the "Company") is a leader in the field of genomics-based drug discovery -- the identification and functional characterization of genes. The Company has over ten years of experience in positional cloning, having served as one of the primary researchers under genome programs sponsored by the United States government, and has developed numerous techniques and tools that are widely used in this field. GTC's commercial gene discovery strategy capitalizes on its pioneering work in genomics by applying its high-throughput sequencing technology and positional cloning, its experience and skills in pathogen functional genomics and its bioinformatics capabilities. The two areas of focus are: the discovery and characterization of (i) genes of pathogens that are responsible for many serious diseases and (ii) human disease genes. The Company believes that its genomic discoveries may lead to the development of novel therapeutics, vaccines and diagnostic products by it and its strategic partners. The Company has entered into several corporate collaborations in connection with its pathogen and human gene discovery programs. SCIENTIFIC BACKGROUND Human disease is caused by a variety of factors, including genetic defects, pathogens and environmental factors, with many of the most common life-threatening and chronic diseases believed to have a genetic basis. Genes, which define the inherited characteristics of an organism, are found in all living cells (e.g., human, animal and pathogen cells). Each gene codes for a specific protein that performs a specific function in the body, such as the production of insulin. In humans, a defect in a gene, or the absence of a critical gene, may lead to overproduction, underproduction, improper function or absence of a protein resulting in the onset of disease or an undesirable physical condition. Genetic defects can be inherited or can accumulate during the lifetime of an individual. Human diseases caused by pathogens also have a genetic foundation in that specific genes in the pathogen are required for that organism to survive and infect its human host. The genetic content of an organism consists of DNA, a chemically complex material comprised of four different nucleotides (adenine, guanine, cytosine, and thymine) which are the building blocks of DNA. The sequence in which these nucleotides are linked together in a molecule of DNA determines the informational content of genes. The entire genetic content of an organism, including humans, is referred to as its genome. The human genome consists of 23 pairs of chromosomes. These chromosomes contain approximately 100,000 human genes distributed over approximately three billion nucleotides. Human genes are found in the chromosomes as coding regions of DNA ("exons") interrupted by non-coding regions of DNA ("introns"). The number of exons found in human genes can be quite large as can be the distance between exons. The function of the majority of human DNA is unknown. The DNA sequence of a human gene is transcribed into a messenger RNA molecule ("mRNA") which is processed to contain only the exon sequences. The information in the mRNA molecule is, in turn, translated into a protein product. Genomes of pathogens are significantly less complex than the human genome and generally consist of a single chromosome containing several thousand genes distributed over millions of nucleotides. The majority of DNA in pathogens typically is comprised of genes as uninterrupted DNA sequences. Proteins expressed by genes are the targets of most current drugs. As a result, the identification of human disease genes and the protein product of these genes may lead to new therapeutics and diagnostic tests. In the case of diseases caused by pathogens, the identification of the biologically important genes of the pathogen may lead to the development of new drugs and vaccines to combat the pathogen. Moreover, because of the simpler nature of the genomes of pathogens relative to the human genome, efforts to identify and characterize pathogen genes may lead to product development candidates more quickly than human gene discovery efforts. The two principal technologies currently being used to discover genes are sequencing and positional cloning. 2 3 SEQUENCING Sequencing is the process of identifying genes through the determination of the order or sequence of nucleotides in DNA fragments. In recent years, high-throughput procedures, such as those being employed by the Company, have been developed which now enable sequencing to be performed on a larger scale and with greater speed than was previously possible. There are generally two ways of applying high-throughput sequencing to discover genes: random discovery and targeted discovery. In random discovery, high-throughput sequencing is used to identify the genes in a genome without regard to the function of the genes. In targeted discovery, high-throughput sequencing is used to identify the genes in a specific chromosomal region or tissue after the region or the tissue has been implicated in or associated with a specific disease. High-throughput sequencing offers a practical way of randomly identifying all of the genes in a pathogen because the genomes of pathogens consist of relatively small numbers of uninterrupted gene sequences. In contrast, the human genome is very large with only small portions of the DNA containing genes which are present as interrupted DNA sequences. As a result, although high-throughput sequencing of the DNA in a particular chromosomal region is used in human gene discovery, sequencing of all of the DNA in the human genome is not a practical means to identify large numbers of human genes. Instead, several groups are randomly discovering large numbers of human genes by sequencing expressed copies of genes, which contain only exons and are called cDNA, which they synthesize from mRNA. Although random discovery permits the rapid identification of pathogen and human genes, it generally does not provide an understanding of the function of a gene or of the gene's role in a particular disease. Any determination of function of randomly discovered genes is dependent on the detection of structural similarities, or homology, existing between the protein product of such sequenced genes and genes with a known function or the analysis of the signaling pathways both upstream and downstream from such sequenced genes. Targeted gene discovery by high-throughput sequencing of human DNA typically is applied as part of positional cloning (described below) after a specific chromosomal region has been identified which is believed to contain a particular gene. In this targeted gene discovery procedure, the entire chromosomal region is sequenced in an effort to identify, from all the genes present in that region, the one gene located in that region which is responsible for causing the specific disease. Another type of targeted gene discovery involves the use of high-throughput sequencing of cDNA to identify genes believed to cause or maintain a particular disease. In this procedure, which is referred to as "comparative gene expression," mRNA present in healthy and diseased tissues is converted into cDNA and then sequenced to identify the genes whose protein product is present in each. Candidate genes responsible for causing or maintaining the disease are identified by comparing which genes are expressing or producing their protein product and at what level this expression is occurring in both the healthy and diseased tissue. POSITIONAL CLONING Positional cloning is the process of analyzing disease inheritance patterns to identify the genes responsible for causing human disease. The first step in positional cloning is the identification of individual families or genetically homogeneous populations in which the occurrence of the disease in individuals within such families or populations is substantially higher than in the general population. Blood samples are collected from individuals within the family or population to provide DNA to be used to identify the region on a particular chromosome where the disease-causing gene is located. This process is referred to as "genetic linkage mapping." In genetic linkage mapping, DNA probes are used to detect genetic markers, regions of DNA that vary in sequence content from person to person. The position of these genetic markers on a chromosome, as detected by the DNA probes, constitutes a genetic linkage map of the chromosome. The chromosomal regions which are initially examined are those regions which have been identified as containing genes that are likely candidates for causing or predisposing an individual to the disease. Because only a limited number of human 3 4 genes have been mapped to date, most genetic mapping is done genome-wide with a set of DNA probes that span the genome. By following the inheritance patterns of genetic markers and looking for the coinheritance of the genetic markers and the disease, the gene responsible for causing or predisposing an individual to that disease can be located within a specific chromosomal region. Using additional DNA probes, the chromosomal region containing the targeted disease gene can be narrowed to a region consisting of approximately 1,000,000 to 3,000,000 nucleotides in size containing between approximately 30 to 100 genes. Next, libraries comprised of large DNA fragments are examined to find those fragments which contain pieces of DNA from the relevant chromosomal region. The aligning of these DNA fragments so that their resulting order represents how these DNA fragments are related to each other in the relevant chromosomal region is called physical mapping. The physical map of the relevant chromosomal region can then be used to identify the genes which are contained within the region. These genes can be identified in two ways. First, "exon trapping" is used, whereby individual exons within this chromosomal region can be isolated and then used to obtain a complete copy of the gene from a cDNA library. Alternatively or in combination with exon trapping, the DNA of the chromosomal region can be sequenced using high-throughput procedures and, through the use of special computer software, the exons which are contained within the chromosomal region can be predicted. This sequencing information is then used to search cDNA libraries for DNA fragments which contain these presumed exons. Each gene identified through this process is a candidate for causing the disease. By determining the sequence of these genes in individuals with the disease and comparing it to the sequence of that gene from healthy individuals, the gene involved in the disease can be identified. DNA sequence differences, which are only found in individuals who have inherited the disease, identify the gene which is believed to be responsible for causing the disease. COMPANY TECHNOLOGY The Company applies its proprietary technologies and know-how in high-throughput sequencing, positional cloning and functional genomics in its gene discovery programs. In its pathogen programs, the Company uses its high- throughput sequencing capabilities to sequence the genomes of pathogens. In its human gene discovery programs, the Company combines its proprietary positional cloning capabilities, together with its high-throughput sequencing capabilities, in its efforts to identify human genes associated with disease. Both the Company's pathogen and human genomics programs utilize substantial bioinformatics skills to identify genes, tentatively assign them a likely function, and possibly select genes as targets for drug and vaccine development. In its pathogen program, the Company has fully developed functional genomics and drug discovery skills, including drug discovery target validation (via gene "knock-outs") and high-throughput drug discovery assay development. HIGH-THROUGHPUT SEQUENCING AND FINISHING GTC has an automated process using DNA sequencers and computers to sequence and analyze genes in its discovery research programs. Using its technology, the Company has randomly sequenced the genomes of several pathogens and various chromosomal regions of the human genome. GTC's sequencing production currently generates approximately .5 billion nucleotides of raw sequence annually. Finishing is the "end game" of high-throughput sequencing. It is the process of producing a complete genome once the majority of the sequence has been generated by the high-throughput shotgun process. Finishing is necessary because shotgun sequencing is a random process; the individual clones that are sequenced contain small randomly selected fragments of the complete genome. These fragments are assembled using sophisticated computer software which identifies overlapping regions of sequence and arranges the fragments into large contiguous sequence regions called "contigs". As more sequence is generated, the fragments assemble into larger contigs covering more of the genome. At an appropriate point in a sequencing project, the process moves from a random to a directed sequencing approach in order to specifically target and obtain sequence for the missing regions and, thereby, "finish" the genome sequence. 4 5 The Company has developed a proprietary quality control process to assure a high-quality sequenced genome. Sequence quality is expressed in terms of the probability of error at any given base location in the sequence. The integrated computational and biochemical techniques used in the finishing process, when coupled with the sequence quality measurements generated by the high-throughput sequencing process, allow the Company to specify the required quality of the end-product sequence and then direct the process to achieve the desired quality level. Finishing is also very important in the later stages of human gene discovery where the identification of disease-associated mutations requires gene sequences of much higher quality than in the early stages of gene identification. The quality of the sequence must be such as to allow the detection of two different nucleotides in a given position. POSITIONAL CLONING The Company has over 10 years of experience in various aspects of positional cloning. GTC was one of the pioneers in the use of genetic linkage mapping and developed numerous techniques and tools that are widely used in the positional cloning field. GTC has considerable experience in identifying genetic markers for specific chromosomal regions. This ability is needed when additional genetic markers are required to narrow the size of the chromosomal region believed to contain the disease gene. The Company also has several libraries of large DNA fragments arranged in a format which facilitates the isolation of DNA fragments from a specific chromosomal region. These libraries are used to develop physical maps of chromosomal regions thought to contain disease genes. In addition, the Company uses specialized tools to trap the exons present in large DNA fragments. These tools are used to isolate exons from the genes present in chromosomal regions believed to contain disease genes. BIOINFORMATICS The process of identifying and characterizing genes generates vast amounts of data which must be organized and managed. Such data result from genetic linkage and physical mapping, DNA sequencing and biological experiments performed on identified genes. The use of computers, software and databases to track, process, store, retrieve and analyze data generated by genomic research is referred to as "bioinformatics," which is an emerging subspecialty of genomics and a key capability of any participant in the field. Because of its early work in large-scale genetic linkage analysis, GTC was one of the first companies to develop significant bioinformatics capabilities. The Company continually refines its bioinformatics systems. The Company currently is focusing these efforts in four areas: upgrading and standardizing its bioinformatics hardware and software; developing enhanced data management systems; expanding its software engineering capabilities; and expanding its resources in computational molecular biology. These enhancements are expected to result in more effective data management by allowing for higher-throughput sequencing, providing for smooth integration of laboratory automation, supporting more rapid analyses and comparison of genomic data and facilitating the identification of gene targets for the development of therapeutic, vaccine and diagnostic products. As part of its enhancement of its bioinformatics capabilities, the Company continues to increase the number of its bioinformatics personnel. FUNCTIONAL GENOMICS (PATHOGEN) Once the genome of a pathogen has been sequenced, the Company uses its bioinformatics expertise and the information in its proprietary and public databases to identify and locate the genes within the genome and assign features to the genes which helps identify their likely function. Relying on these assigned functions and using the criteria for the product to be developed (drug or vaccine; narrow or broad spectrum), the Company examines sequences from the genomes of various pathogens in its proprietary and public databases and from human cDNAs and the entire genome of Saccharomyces cerevisiae (bakers yeast) to select genes as potential targets for drug or vaccine development 5 6 The criteria used for selecting gene targets against which small molecules (drugs) will be developed include such features as essentiality, uniqueness, and assayability. The gene should be essential for the survival of the organism. The gene or its protein product should have novel biochemistry or special characteristics to make it unique to the organism(s) against which the drug is to be active. In order to reduce possible side effects, such genes should be absent or have little homology to genes found in humans. The gene or its protein product should have general features which make it possible to construct high-throughput screening assays. If protein or polypeptide vaccines are to be developed, then the criteria used for selecting gene targets include such features as whether the protein product is likely to be secreted or found on the cell surface or in the membrane of the organism or shows homology to a major antigen in other organisms. For small molecule targets, the transition from bioinformatics to functional genomics begins by demonstrating that the gene is essential for the viability or virulence of the organism. That is, the gene must be required for the survival of the organism on a culture plate (in vitro) or in an animal model (in vivo). To determine the essentiality of a gene, the Company has developed high-throughput techniques for either directly or randomly inactivating, i.e. "knocking-out", specific genes within the genome of a pathogen. After targets have been validated for their biological relevance, the Company then develops screening assays for these targets. These assays include conventional biochemical assays in which the gene target is over-expressed in a recombinant host and the protein product is purified and used to develop a non-cellular, high-throughput assay. Assay systems for gene targets of unknown function include the construction of an over or under-expressing strain for use in high-throughput bio- or genetic whole cell assays. For vaccine targets, functional genomics begins with the demonstration that the gene product is not subject to significant antigenic variation between strains or under different growth conditions. Gene targets are then over-expressed in a recombinant host, and the resulting protein product is purified for testing in an appropriate animal model. FUNCTIONAL GENOMICS (HUMAN) In many cases, the protein products of a gene or genes causing a human disease are pharmaceutically not suitable as drug discovery targets. Therefore, new targets need to be identified, based on a thorough understanding of the gene's function, including interaction with other proteins and genes. Thus, in order to bridge the gap between gene discovery and drug discovery target identification, the Company mobilized a group which solely focuses on Functional Genomics. This department is developing new technologies to accelerate the functional analysis of important disease genes, including high-throughput signaling pathway analyses in mammalian and non-mammalian systems, gene knock-outs and transgenics. This will be complemented with high-throughput drug discovery assay development skills which are already implemented in the Company's pathogen functional genomics program. The Company's integrated approach to gene function and signal pathway analysis is supported by multiple technology platforms. These include: a) Rapid analysis of differential gene expression profiles. Such analysis can be applied to identify genes differentially expressed in normal vs. disease states, or, using cellular model systems developed by the Company, of genes differentially expressed in response to conditional and controlled expression of specific disease genes. b) Functional expression cloning of signaling molecules, associated with and regulating specific disease pathways. This approach takes advantage of recent advances in retroviral gene transfer technologies to search for regulatory components of signaling pathways encoded by complex cDNA libraries. c) High-throughput protein-protein interaction screening, to identify critical interactors and regulators of disease gene-encoded protein products and their downstream signaling mediators. The Company employs various in vitro and cell-based technologies to identify physiologically relevant and novel protein-protein interactions. These include yeast and mammalian cell-based screening assays. The Company's high-throughput DNA sequencing, automation, and bioinformatics capabilities provide critical support to 6 7 the gene identification process, data analysis and management, and the development of signal pathway databases. The identification of novel disease pathway-associated signaling molecules represents a critical step towards the selection of novel candidate therapeutic targets. Candidate targets are validated by multiple approaches, including antisense and gene "knock-out" technologies. High-throughput drug discovery assay development skills, which are already implemented in the Company's pathogen programs, will be applied to specific validated targets towards the identification of novel therapeutic agents. GTC STRATEGY The Company's objective is to use its sequencing, positional cloning, functional genomics and bioinformatics capabilities to identify and validate gene targets for the development of novel therapeutic, vaccine and diagnostic products in collaboration with pharmaceutical and biotechnology company partners. The Company is using the following strategies to achieve this objective: SEQUENCING OF PATHOGENS Over the past four years, the Company has devoted a significant portion of its resources to, and obtained considerable experience in, sequencing the genomes of pathogens. The Company has randomly sequenced the genomes of several disease-causing pathogens. The Company plans to continue to identify and characterize genes of these and other pathogens for which the Company believes new or improved therapeutic, vaccine or diagnostic products represent a significant commercial opportunity. In particular, the Company plans to focus its efforts on pathogens where the incidence of antibiotic resistance or other factors limit the use or efficacy of currently available therapies, creating a need for novel antibiotics and vaccines. The Company believes its pathogen gene discovery programs will lead to product development candidates more quickly than human gene discovery efforts. DISCOVERY OF HUMAN DISEASE GENES In the human gene discovery area, the Company plans to build on its decade of experience and knowledge in positional cloning, genotyping, sequencing and bioinformatics capabilities by obtaining exclusive rights to collections of DNA samples from relevant family resources in order to map, identify and characterize genes responsible for selected human diseases. The Company actively seeks collaborations with clinicians and academic researchers to obtain these rights. The Company believes that access to these family and other resources will bolster its existing human gene discovery programs and enable it to initiate additional programs directed at human genes associated with significant diseases. STRATEGIC COLLABORATIONS The Company continues to seek strategic collaborations with pharmaceutical and biotechnology companies for the development and commercialization of products based on the Company's genomic discoveries. This strategy is designed to provide the Company access to the scientific and product development expertise of its partners and permit the Company to benefit from the commercialization of products based on the Company's gene discoveries without incurring the substantial costs required for pharmaceutical product development and commercialization. The Company generally expects to license (either exclusively or non-exclusively) to its partners most rights to therapeutic products and vaccines (and, depending upon the gene, diagnostic products) which may be developed from the particular genetic database licensed-out by the Company. In exchange, the Company generally expects to receive a combination of up-front license fees, research funding, milestone payments and royalty payments on product sales. Through August 1997, the Company has entered into three collaborations, two of which relates to pathogens and one which relates to asthma genetics. The collaboration with Astra is for the development of therapeutic, diagnostic and vaccine products effective against gastrointestinal infections and other diseases caused by H. pylori, and the one with Schering-Plough is providing for the use by Schering-Plough of the genomic sequence of Staph. aureus to 7 8 identify new gene targets for the development of antibiotics and vaccines effective against drug resistant infectious organisms. GOVERNMENT GRANTS AND CONTRACTS The Company has served as one of the primary researchers under genomic programs sponsored by the United States government programs. These programs strengthened the Company's genomics technology base and increased the number and enhanced the expertise of its scientific personnel. From January 1991 through August 1997, the United States government awarded the Company grants and contracts providing for aggregate payments over their terms of approximately $37 million. However, as of the end of fiscal 1997, the Company has substantially reduced its reliance on government grants and contracts as it implements its commercial strategy. NON-EXCLUSIVE DATABASE SUBSCRIPTIONS In May 1997, the Company introduced to the market a database of genomic information from over a dozen pathogens and fungi, PathoGenome(TM). This database is available through non-exclusive subscriptions to pharmaceutical and other drug discovery companies. Together with the sequence modules, GTC will offer some functional genomics modules which would allow for exclusive collaborations. As of August 31, 1997, the Company had subscribed one customer to the PathoGenome(TM) database; however, subsequent to the fiscal year end, the company added two additional subscribers to the PathoGenome(TM) database. DRUG DEVELOPMENT PROGRAMS In order to maximize the commercial utilization of novel drug discovery targets derived from GTC's genomics approach, the Company's alliance strategy with pharmaceutical companies will be complemented with internal drug discovery programs. These internal drug discovery efforts were initially focused in the Pathogen area, since GTC has extensive expertise in this field based on its existing pharmaceutical alliances. The non-exclusive business strategy of the PathoGenome(TM) database allows GTC to choose its own drug discovery targets. The Company's internal programs include drug discovery target validation through gene knock-outs, protein expression and purification, development of high-throughput assays, and -- via external collaborations -- lead compounds identification and lead optimization. In the second phase of the Company's drug development program, the expertise from the Pathogen drug discovery efforts will be transferred to select targets derived from its Human Genetics and Functional Genomics Program. GENE DISCOVERY PROGRAMS The Company is currently conducting gene discovery programs directed at both pathogen genes and human disease genes. The factors the Company considers in determining whether to initiate these programs include the projected commercial potential, the effectiveness of current therapies, the likelihood of attracting a pharmaceutical or biotechnology company as a collaborator, the status of competitive programs and anticipated development costs. PATHOGEN PROGRAMS Antibiotics are the standard therapy for bacterial and fungal infections. During the twelve month period ended August 1997, approximately 300 million prescriptions for antibiotics were written in the United States for such infections and approximately $7 billion was expended in the United States for oral and injectable antibiotics. The approximately 100 antibiotics in use in the United States today are primarily variations of a small number of original antibiotic compounds. In the past decade, a growing number of infections have been caused by pathogens which are becoming resistant to an increasing number of currently available antibiotics. This problem of growing resistance to antibiotics is particularly problematic in the approximately 6,500 acute care hospitals in the United States in which approximately 2.1 million patients each year develop infections. Examples of pathogens that have exhibited resistance to a number of current antibiotics include Staph., M. tuberculosis, Streptococcus pneumonia, and Enterococcus. To date, the primary response of pharmaceutical 8 9 companies to the resistance problem has been to modify existing antibiotics. However, in many cases, the pathogens that are the targets of these antibiotics have further mutated, often quite rapidly, and thereby developed resistance to the modified antibiotics. The Company believes that the development of novel antibiotics and vaccines based on new pathogen targets identified using genomic information may be less prone to the rapid development of resistance than antibiotics that are only modified versions of existing drugs. Helicobacter pylori. H. pylori is the pathogen believed responsible for causing 90% of duodenal peptic ulcers, the most common type of ulcer, and 70% of gastric peptic ulcers. Peptic ulcer disease is a chronic inflammatory condition of the stomach and duodenum. Although frequently asymptomatic, all persons infected by H. pylori have chronic gastric inflammation (gastritis). It is estimated that approximately 4.5 million people suffer from active peptic ulcers each year, and approximately 500,000 new cases are diagnosed annually in the United States. Approximately 600,000 patients are hospitalized each year in the United States for peptic ulcer disease. Serious complications occur in approximately one-third of these cases, including intestinal obstruction, upper gastrointestinal hemorrhage and perforation. Further, each year over 6,000 deaths in the United States are directly caused by ulcer disease, and peptic ulcers are a contributing factor in an additional 11,000 deaths. Approximately 10% of the population in the United States will develop peptic ulcer disease during their lifetimes. Studies have also linked H. pylori with the development of certain stomach cancers and coronary heart disease. The most common medication for treating peptic ulcers are anti-secretory drugs, such as H2 antagonists (e.g., Tagamet(TM) and Zantac(TM)), and proton pump inhibitors (e.g., Prilosec(TM)). Although anti-secretory drugs reduce ulcer symptoms by inhibiting gastric acid secretion, they do not eradicate the H. pylori which is the primary cause of the disease. In 1994, the market for such drugs for the treatment of ulcers totaled approximately $7 billion worldwide. An approach being developed to treat recurrent peptic ulcer disease recognizes the role of H. pylori and involves the administration of antibiotics, often in combination with bismuth or anti-secretory drugs. The most effective antibiotic treatments may be complicated by the need to treat for prolonged periods with multiple drugs, by side effects and problems with patient compliance, by relapses if treatment is interrupted, and by the development of antibiotic-resistant strains of the bacteria. Using its sequencing technology, the Company completed the random sequencing of the genome of a clinical isolate of H. pylori in December 1994. Under its agreement with Astra, the Company is identifying the genes critical to the survival of H. pylori and proteins on the surface of the bacterium that are believed to be likely targets for therapeutic products and vaccines, respectively. See "Collaborative Agreements -- Pharmaceutical Company Collaborations." Staphylococcus aureus. Staph. is the most common cause of skin, wound and blood infections. Staph. infections are typically treated with antibiotics. The percentage of Staph. isolates resistant to penicillin and certain other antibiotics increased from 2.4% in 1975 to 29% by 1991. Moreover, clinical isolates of Staph. exist which are resistant to all known antibiotics other than vancomycin. Vancomycin resistance has appeared in Enterococcus, a pathogen related to Staph., which has raised the possibility that untreatable strains of Staph. could appear. Using its high-throughput sequencing capabilities, the Company has randomly sequenced the genome of a clinical isolate of methicillin-resistant Staph. Under its agreement with Schering-Plough, the Company is using the sequence of Staph. aureus to identify and validate gene targets for the development of new small molecules to treat pathogens which have become resistant to current antibiotics. HUMAN GENE DISCOVERY PROGRAMS GTC has initiated a variety of programs to identify human genes that are responsible for various diseases. In some of these programs, the Company is using positional cloning strategies, while in others it is employing a multi-faceted approach incorporating positional cloning and comparative gene expression. The Company's current primary human gene discovery programs are directed at asthma, cancer, osteoporosis and neuropsychiatric disorders. Asthma. Asthma is a significant health problem that affects approximately 5% of the U.S. population. Both twin and family studies suggest a strong genetic component in the etiology of the disease. Despite a clear genetic contribution to the disease, no consistent mode of inheritance has been observed, suggesting that 9 10 multiple genetic factors as well as environmental influences play a role. The Company has initiated a research program to use positional cloning strategies to identify genes involved in the etiology of asthma. Newly identified asthma genes will facilitate the development of superior diagnostics and novel therapeutic agents. This program is being conducted in collaboration with a leading academic asthma research center which provides access to appropriate family resources and clinical insight to asthma pathophysiology. Osteoporosis. Osteoporosis is a major health problem that affects roughly 50% of post-menopausal women and nearly 25% of elderly men. In the U.S. alone, there are in excess of 1.3 million osteoporotic bone fractures per year. As defined by low bone mineral density, both twin and family studies suggest a strong genetic component to the disease. The Company has initiated a research program to identify genes involved in the etiology of osteoporosis. Given the complex nature of this disorder, and the lack of information about biochemical defects involved, the Company is using a multi-faceted approach including positional cloning and comparative gene expression strategies to identify osteoporosis genes. The Company expects the identification of genes regulating bone density and disease progression will significantly influence the development of diagnostic tests and the discovery of novel therapeutic agents. Atherosclerosis. The Company's atherosclerosis programs focuses on identifying genes which regulate high density lipoproteins (HDL). Epediomiological studies in man and animal experimentation have established that HDL is a major risk factor for atherosclerosis. Although there is strong evidence for genetic determinants, genes that regulate HDL levels have not yet been identified. In addition, there currently are no effective drugs for raising HDL levels. Given these opportunities, the company is using positional cloning to identify genes regulating HDL levels for the purpose of defining new atherosclerotic drug discovery targets. Cancer Program. The Company's strategy is to identify novel signaling molecules in cellular pathways that control tumor cell survival and are linked to the most commonly mutated cancer genes known to date, such as the p53 tumor suppressor gene. Multiple technology platforms are used to paint a comprehensive picture of such cancer gene signaling pathways. These include tools for the development of biological model systems, differential gene expression profiling, functional expression cloning, and protein-protein interaction analysis. The identification of cancer pathway signaling molecules is expected to provide an important resource of new therapeutic targets whose inhibition selectively sensitizes tumor cells to cell death, and, thus, the development of novel anticancer agents that may be administered either alone or in combination with currently known chemotherapeutic agents to inhibit tumor growth. Other Programs. The Company is also conducting preliminary research on schizophrenia and manic depressive illness. These neuropsychiatric disorders affect large numbers of people in the U.S. and throughout the world and are believed to have a genetic basis. The Company is currently evaluating various family resources for research on these diseases and may expand its research in this area. COLLABORATIVE AGREEMENTS An important part of the Company's strategy is to pursue strategic collaborations with pharmaceutical and biotechnology companies for the development and commercialization of products based on the Company's genomic discoveries. The Company also plans to continue to seek government grants and research contracts related to the Company's technology and research programs. PHARMACEUTICAL COMPANY COLLABORATIONS Astra. In August 1995, the Company entered into a collaboration agreement with Astra to develop pharmaceutical, vaccine and diagnostic products effective against gastrointestinal infections or any other disease caused by H. pylori. The Company granted Astra exclusive access to the Company's H. pylori genomic sequence database and exclusive worldwide rights to make, use and sell products based on the Company's H. pylori technology. The agreement also provides for a four-year research collaboration to further develop and annotate the Company's H. pylori genomic sequence database, identify therapeutic and vaccine targets and 10 11 develop appropriate biological assays. This research is being directed by a Joint Management Committee and a Joint Research Committee, each consisting of representatives from both parties. Under this agreement, Astra agreed to pay the Company a minimum of approximately $11 million and, subject to the achievement of certain product development milestones, up to approximately $22 million (and possibly a greater amount if more than one product is developed under the agreement) in license fees, expense allowances, research funding and milestone payments. Of such fees, $500,000 are creditable against any future royalties payable to GTC by Astra under the agreement. The Company received approximately $10.7 million in license fees, expense allowances and research funding under the Astra agreement through August 31, 1997. For the Company's fiscal years ended August 31, 1995, 1996 and 1997, revenue recognized by the Company under its agreement with Astra accounted for approximately 31%, 21% and 15%, respectively, of the Company's total revenue. Astra is obligated to provide funding for the research program for a minimum of two and one-half years. On July 21, 1997, Astra elected to extend the research program to at least September 1998. The Company will also be entitled to receive royalties on Astra's sale of any products (i) protected by the claims of patents licensed exclusively to Astra by the Company pursuant to the agreement, or (ii) the discovery of which was enabled in a significant manner by the genomic database licensed to Astra by the Company. GTC has the right under certain circumstances to convert Astra's license to a nonexclusive license in the event Astra is not actively pursuing commercialization of the licensed technology. Schering-Plough. In December 1995, the Company entered into a collaboration and license agreement with Schering-Plough providing for the use by Schering-Plough of the genomic sequence of Staph. aureus 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 has agreed to pay the Company a minimum of $13.3 million in an up-front license fee, 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 $30.2 million in research funding and milestone payments. The Company received approximately $11.9 million in an up-front license fee, research funding and milestone payments through August 31, 1997. For the Company's fiscal years ended August 31, 1996 and 1997, revenue recognized by the Company under its agreement with Schering-Plough accounted for approximately 37% and 17%, respectively, of the Company's total revenue. The agreement grants Schering-Plough exclusive worldwide rights to make, use and sell pharmaceutical and vaccine products based on the genomic sequence databases licensed to Schering-Plough by the Company and on the technology developed in the course of the research program. GTC has also granted Schering- Plough a right of first negotiation if during the term of the research plan GTC desires to enter into a collaboration with a third party with respect to the development or sale of any compounds which are targeted against, as their primary indication, the pathogen that is the principal subject of the Company's agreement with Schering-Plough. 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, GTC retained the rights to make, use, and sell diagnostic products developed based on the Company's genomic database licensed to Schering-Plough or the technology developed in the course of the research program. In December 1996, the Company entered into its second research collaboration and license agreement with Schering-Plough. This agreement calls for the use of genomics to discover new therapeutics for treating 11 12 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 rights to develop and commercialize diagnostic products that may result from this collaboration. Under this agreement, Schering-Plough agreed to pay an initial 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. The company received approximately $5.8 million in up-front license fees, research funding and expense allowances through August 31, 1997. For the Company's fiscal year ended August 31, 1997, revenue recognized under this agreement with Schering-Plough accounted for approximately 23% of the Company's total revenue. Government Collaborations Since 1989, the Company has been awarded a number of grants and contracts by various agencies of the United States government pursuant to the government's genomics programs. The scope of the research covered by the grants and contracts encompasses technology development, sequencing production, technology automation projects and positional cloning projects. Under the government grants, the Company has, subject to certain rights of the government described below, exclusive ownership rights to any commercial applications of inventions first reduced to practice under the grants, including all gene discoveries and technology improvements created or discovered. The Company is strongly encouraged under certain of the government grants to make data and materials resulting from the research public within 180 days from the date such data and materials are developed. Under the Company's government research contracts, the government has ownership rights in the data, clones, genes and other material derived from the material furnished to the Company by the government, and the Company has ownership rights in other inventions developed solely by the Company under the contracts. The government also retains certain rights, described below under the caption "Patents and Proprietary Technology", to the inventions first reduced to practice by the Company under the government grants and contracts. The Company currently has two principal government research contracts, one with the National Institute of Neurological Disorders and Stroke relating to the preparation of DNA samples for sequencing, the isolation of DNA fragments and genotyping, and one with the NIMH relating to the identification of genes responsible for manic depressive illness. See "Patent and Proprietary Technology" and "Human Gene Discovery Programs -- Other Programs." The Company's government grants and research contracts include both cost-plus-fixed-fee arrangements and fixed price contracts. Under cost-plus-fixed-fee arrangements, the Company receives reimbursement of its direct costs associated with the research, a portion of its indirect or overhead costs as well as fees in excess of such costs. The amount of overhead reimbursement varies with each contract. Under fixed price contracts, the Company agrees to perform a particular research plan for an agreed upon payment. From January 1991 through August 1997, the United States government awarded the Company grants and contracts providing for aggregate payments over their terms of approximately $37 million. These grants and research contracts are typically funded annually and are subject to the appropriation by the United States Congress of funding in each year. In addition, funding under these grants and contracts may be discontinued or reduced at any time by the United States Congress. For the Company's fiscal year ended August 31, 1997, 12 13 the Company recognized revenue under its government collaborations of $4.5 million which accounted for approximately 23% of the Company's total revenue. 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 access 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 fee 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. For the Company's fiscal year ended August 31, 1997, revenue recognized under this agreement with Bayer accounted for approximately 3% of the Company's total revenue. PATENTS AND PROPRIETARY TECHNOLOGY The Company's commercial success will be dependent in part on its ability to obtain patent protection on genes, or products based on genes, discovered by it. The current criteria for obtaining patent protection for partially sequenced genes and for genes whose biological functions have not been characterized are unclear. The Company's current strategy is to apply for patent protection upon the identification of a novel gene or novel gene fragment and pursue claims to these gene sequences as well as equivalent sequences, such as substantially homologous sequences. Where the biological function of a gene or gene fragment has not been characterized at the time of filing a patent application, the Company intends to supplement such patent filing as soon as additional information with respect to the biological function of such gene or gene fragment is available. However, there can be no assurance that the Company will be able to obtain patent protection on such genes or gene fragments, and even if such patents are issued, the scope of the coverage or protection provided by any such patents is uncertain. In addition, there can be no assurance that any patents, if issued, will provide protection against any competitors, will provide the Company with competitive advantages, will provide protection for any therapeutic, vaccine or diagnostic products based on the Company's gene discoveries or will not be successfully challenged by others. Furthermore, others have filed and are likely to file in the future patent applications which have not yet been published covering genes or protein sequences similar or identical to the Company's. No assurance can be given that any such patent application will not have priority over patent applications filed by the Company or that any patent applications filed by the Company will result in issued patents. There have been, and continue to be, intensive discussions on the scope of patent protection for both gene fragments and full-length genes. In November 1995, the PTO scheduled a hearing and requested public comment on the patenting of a complete genome of an organism as well as the patenting of human gene fragments. Although the PTO canceled the hearings and request for comments, they may be rescheduled at a future date. There can be no assurance that these or other proposals will not result in changes in, or interpretations of, the patent laws which will adversely affect the Company's patent position. The PTO issued new Utility Guidelines in July 1995 that address the requirements for demonstrating utility, particularly in inventions relating to human therapeutics. While the guidelines do not require clinical efficacy data for issuance of patents for human therapeutics, the guidelines have been issued only recently and there can be no assurance that the PTO's interpretations of such guidelines, and any changes to such interpretations will not delay or adversely affect the Company's or its collaborators' ability to obtain patent protection. The biotechnology patent situation outside the United States is even more uncertain and is currently undergoing review and revision in many countries. The Company has filed patent applications and will continue to do so with respect to a number of full length genes and corresponding proteins and partial genes resulting from its pathogens program. The Company plans to file foreign counterparts of these U.S. applications within the appropriate time frames. These applications seek to protect these full length and partial gene sequences and corresponding proteins, as well as 13 14 equivalent sequences, such as substantially homologous sequences, and products derived therefrom and uses therefor. These applications also identify possible biological functions for the genes and gene fragments based in part on a comparison to genes or gene fragments included in public databases but do not contain any laboratory or clinical data with respect to such biological functions. Under the Company's government grants and contracts, the government has a statutory right to practice or have practiced, and, under certain circumstances (including inaction on the part of the Company or its licensees to achieve practical application of the invention or a need to alleviate public health or safety concerns not reasonably satisfied by the Company or its licensees), to grant to other parties licenses under any inventions first reduced to practice under the government grants and contracts. In addition, under the Company's government research contracts, the government has ownership rights in the data, clones, genes and other material derived from the material furnished to the Company by the government, and the Company has ownership rights in other technology developed solely by the Company under the contracts. Under the Company's CRADA with the NIH, any inventions or discoveries made in whole or in part by NIH researchers are the property, either solely or jointly with the Company, of NIH, and the Company has the right to negotiate with the NIH to obtain an exclusive license to such inventions and discoveries. The Company is also strongly encouraged under certain government grants to make data and materials resulting from the research public within 180 days from the date such data and materials are developed. If this requirement results in premature publication of the Company's discoveries and inventions, the Company's ability to obtain patent protection for such discoveries and inventions may be adversely affected. The Company also relies on trade secret protection for its confidential and proprietary information. There can be no assurance that the Company can maintain adequate protection for its trade secrets or other proprietary information. In addition, while the Company has entered into proprietary information agreements with its employees, consultants and advisors, there can be no assurance that these agreements will provide meaningful protection for the Company's proprietary information in the event of unauthorized use or disclosure of such information. Moreover, there can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets or disclose such technology, or that the Company can meaningfully protect its trade secrets. COMPETITION The Company faces intense competition both with respect to its human gene and pathogen gene discovery programs. There is a finite number of genes in the human genome and the Company believes virtually all of such genes will be identified albeit largely without known function. The Company also believes that the primary genes that cause or predispose individuals to most common diseases will eventually be identified and characterized. In addition, the Company believes that the genomes of many commercially important pathogens will be sequenced within the next three years. Competitors of the Company include pharmaceutical and biotechnology companies both in the United States and abroad. In addition, significant research to identify and sequence genes is being conducted by universities, other non-profit research institutions and United States and foreign government-sponsored entities. A number of commercial, scientific and governmental entities are attempting to sequence human genes and the genomes of other organisms. Other entities are utilizing positional cloning to identify and characterize human disease genes. Certain of the Company's competitors' human gene programs are more advanced than the Company's and any one of these companies or other entities may discover and establish a competitive advantage in one or more pathogen development programs which the Company has commenced. The Company also faces competition in its human gene discovery programs in gaining access to family DNA samples for use in positional cloning. The Company believes that its ability to compete is dependent, in part, upon its ability to create and maintain advanced technology, the speed with which it can identify and characterize the genes involved in human diseases, the Company's ability to rapidly sequence the genomes of selected pathogens, its collaborators' ability to develop and commercialize therapeutic, vaccine and diagnostic products based upon the Company's gene discoveries, as well as its ability to attract and retain qualified personnel, obtain patent 14 15 protection or otherwise develop proprietary technology or processes and secure sufficient capital resources for the expected substantial time period between technological conception and commercial sales of products based upon the Company's gene discoveries. Many of the Company's competitors have greater research and product development capabilities and financial, scientific, marketing and human resources than the Company. These competitors may succeed in identifying or sequencing genes or developing products earlier than the Company or its collaborators, obtaining authorization from the FDA for such products more rapidly than the Company or its collaborators or developing products that are more effective than those proposed to be developed by the Company or its collaborators. Any potential products based on genes identified by the Company will face competition both from companies developing gene-based products and from companies developing other forms of diagnosis or treatment for the particular diseases targeted by the Company. There can be no assurance that products developed by others will not render the products which the Company or its collaborators may seek to develop obsolete or uneconomical or result in diagnoses, treatments or cures superior to any products developed by the Company or its collaborators, or that any product developed by the Company or its strategic collaboration partners will be preferred to any existing or newly developed technologies. GOVERNMENT REGULATION Regulation by governmental entities in the United States and other countries will be a significant factor in the development, manufacturing and marketing of any products which may be developed by the Company or its collaborators. The nature and the extent to which such regulation may apply to the Company or its collaborators will vary depending on the nature of any such products. Virtually all of the Company's or its collaborators' pharmaceutical products will require regulatory approval by governmental agencies prior to commercialization. In particular, human therapeutic and vaccine products are subject to rigorous preclinical and clinical testing and other approval procedures by the FDA in the United States and similar health authorities in foreign countries. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of such products. The process of obtaining these approvals and the subsequent compliance with appropriate federal and foreign statutes and regulations are time consuming and require the expenditure of substantial resources. The FDA regulates human therapeutic products in one of three broad categories: drugs, biologics, or medical devices. Products based on the Company's technologies could potentially fall into all three categories. Generally, in order to gain FDA pre-market approval of a new drug or biological product, a company first must conduct pre-clinical studies in the laboratory and in animal model systems to gain preliminary information on an agent's efficacy and to identify any safety problems. The results of these studies are submitted as a part of an investigational new drug application ("IND"), which the FDA must review before human clinical trials of a drug or biologic can commence. In order to commercialize any products, the Company or its collaborators will be required to sponsor and file an IND and will be responsible for initiating and overseeing the clinical studies to demonstrate the safety, efficacy and potency that are necessary to obtain FDA approval of any such products. Clinical trials are normally done in three phases and are likely to take a number of years to complete. After completion of clinical trials of a new product, FDA marketing approval must be obtained. If the product is classified as a new drug, the Company or its collaborators will be required to file a New Drug Application ("NDA") and receive approval before commercial marketing of the drug. If the product is classified as a biologic (e.g., a vaccine), the Company or its collaborator will be required to file a product license application and an establishment license application ("ELA") and receive approval of both before commercial marketing of the product can take place. The testing and approval processes require substantial time and effort and there can be no assurance that any approvals will be granted on a timely basis, if at all. Even if FDA regulatory clearances are obtained, a marketed product is subject to continual review, and later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions. In addition, biologic products may be subject to batch certification and lot release requirements. To the extent that any of the Company's products involve recombinant DNA technology, additional layers of government regulation and review are possible. For 15 16 marketing outside the United States, the Company will also be subject to FDA export regulations and foreign regulatory requirements governing human clinical trials and marketing approval for pharmaceutical products. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country. The Company or its collaborators may also develop diagnostic products based upon the human or pathogen genes that the Company identifies. The Company believes that the diagnostic products to be developed by the Company or its collaborators are likely to be regulated by the FDA as devices rather than drugs or biologics. The nature of the FDA requirements applicable to such diagnostic devices depends on their classification by the FDA. A diagnostic device developed by the Company or a collaborator would most likely be classified as a Class III device, requiring pre-market approval. Obtaining pre-market approval involves the costly and time-consuming process, comparable to that for new drugs or biologics, of conducting pre-clinical studies, obtaining an investigational device exemption to conduct clinical tests, filing a pre-market approval application, and obtaining FDA approval. Again, there can be no assurance that any approval will be granted on a timely basis, if at all. The Company's research and development activities involve the controlled use of hazardous materials, chemicals and various radioactive materials. The Company is subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of such materials and certain waste products. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state, federal and local laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result and any liability could exceed the resources of the Company. MANUFACTURING AND MARKETING The Company does not generally expect to directly manufacture or market products in the near term. However, the Company may, in the future, consider taking such actions if it believes they are appropriate under the circumstances. The Company has no recent experience in developing pharmaceutical products or in manufacturing or marketing products. The Company may not have the resources to develop or manufacture or market by itself any products based on genes identified by it. In the event the Company decides to establish a manufacturing facility, the Company will require substantial additional funds and will be required to hire and train significant additional personnel and comply with the extensive "good manufacturing practice" regulations applicable to such a facility. In addition, if any products produced at the Company's facilities were regulated as biologics, the Company would be required to file and obtain approval of an ELA for its facilities. HUMAN RESOURCES As of August 31, 1997, the Company had 211 full-time employees, of whom 187 were engaged in research and development activities, and 24 in general and administrative functions. Thirty-nine of the Company's employees hold Ph.D. degrees and 55 others hold other advanced degrees. None of the Company's employees are covered by a collective bargaining agreement, and the Company considers its relations with its employees to be good. FACILITIES The Company's executive offices and its research and development activities are conducted at facilities located at 100 Beaver Street and 1365 Main Street, Waltham Massachusetts. The Company's executive offices and laboratories are located at 100 Beaver Street, Waltham Massachusetts, where the Company has leased approximately 80,000 square feet of space expiring November 15, 2006 with options to extend for two consecutive five-year periods. The Company has additional labs at 1365 Main Street where the Company has leased approximately 14,000 square feet of space under a lease expiring December 31, 1997. The Company plans to consolidate its operations at its Beaver Street facility during fiscal 1998 at an estimated cost of $6,500,000 which consists of office and laboratory renovations. As of August 31, 1997, the Company had 16 17 incurred approximately $847,000 of capital improvements and plans to spend an estimated $5,653,000 during fiscal 1998 on this renovation project. During fiscal 1997, the Company incurred aggregate rental costs, excluding maintenance, taxes and utilities, for all facilities of approximately $949,000. The aggregate minimum rental cost to be paid in fiscal 1998 is expected to be approximately $1,015,000. ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The Company's common stock is traded on the NASDAQ National Market System (ticker symbol "GENE"). The table below sets forth the range of high and low quotations for each fiscal quarter of the Company during 1997 and 1996 as furnished by the National Association of Securities Dealers Quotation System.
1997 1996 -------------- -------------- HIGH LOW HIGH LOW ------ ----- ------ ----- First Quarter................. 10 1/2 7 3/8 8 1/2 6 5/8 Second Quarter................ 12 1/2 8 5/8 15 7 Third Quarter................. 10 1/8 5 7/8 15 8 1/2 Fourth Quarter................ 8 7/8 6 1/2 12 1/8 6 1/8
As of November 24, 1997, there were approximately 1,305 shareholders of record of the Company's Common Stock. The Company has not paid any dividends since its inception and presently anticipates that all earnings, if any, will be retained for development of the Company's business and that no dividends on its Common Stock will be declared in the foreseeable future. Any future dividends will be subject to the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, the operating and financial condition of the Company, its capital requirements and general business conditions. 17 18 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FOR THE YEAR ENDED AUGUST 31, 1993 1994 1995 1996 1997 - ------------------------------- ----------- ----------- ----------- ----------- ------------ Revenues: Collaborative research, licenses, subscription fees and service.......... $ 1,114,864 $ 251,529 $ 3,870,620 $12,548,724 $ 11,550,786 Government research.......... 5,021,975 6,077,346 7,014,280 6,795,393 4,454,828 Royalties.................... 139,713 148,458 90,541 127,112 647,150 Interest income.............. 173,788 141,584 231,662 1,785,164 2,965,866 Total........................ $ 6,450,340 $ 6,618,917 $11,207,103 $21,256,393 $ 19,618,630 Net income (loss).............. $(3,481,857) $(1,078,718) $ 585,204 $ 1,920,710 $(11,302,391) Net income (loss) per common share........................ $ (0.33) $ (0.10) $ 0.05 $ 0.11 $ (0.64) Weighted average common and common equivalent shares..... 10,668,628 11,097,224 12,961,734 18,129,794 17,617,614 Cash, cash equivalents, restricted cash and long and short-term marketable securities................... $ 3,915,306 $ 4,311,854 $ 9,011,247 $53,768,562 $ 47,843,597 Working capital................ 3,264,454 3,244,260 5,498,782 25,904,641 35,868,618 Total assets................... 5,288,691 5,910,682 11,528,674 63,279,017 60,688,379 Shareholders' equity........... 3,676,333 4,224,555 7,238,503 54,312,758 43,946,197
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company is a leader in the field of genomics-based drug discovery -- the identification and functional characterization of genes. The Company has over ten years of experience in positional cloning, having served as one of the primary researchers under genome programs sponsored by the United States government, and has developed numerous techniques and tools that are widely used in the field. The Company's commercial gene discovery strategy capitalizes on its pioneering work in genomics by applying its high-throughput sequencing technology and positional cloning, its experience and skills in functional genomics and its bioinformatics capabilities. The two areas of focus are: the discovery and characterization of (i) genes of pathogens that are responsible for many serious diseases and (ii) human disease genes. The Company believes that its genomic discoveries may lead to the development of novel therapeutics, vaccines and diagnostic products by it and its strategic partners. The Company has entered into several corporate collaborations in connection with its pathogen and human gene discovery programs. The Company does not anticipate revenues from product sales on a sustained basis until such time that products based on the Company's research efforts are commercialized, if at all. The Company's product development strategy is to form collaborations with pharmaceutical and biotechnology companies generating revenues from licensing fees, sponsored research and milestone payments. Additionally, the Company will sell non-exclusive access to its proprietary genome sequence database, PathoGenome(TM). These collaborations are expected to result in the discovery and commercialization of novel therapeutics, vaccines and diagnostics, generating royalty payments to the Company from product sales downstream. 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 upon product revenues for many years. For the past several years, the Company's primary sources of revenue have been government research grants and contracts and collaborative agreements with pharmaceutical company partners. As of August 31, 1997, the Company had three collaborative research agreements and one subscriber to its proprietary genome sequence database, PathoGenome(TM). In September 1997, subsequent to fiscal year end, the Company entered into its fourth collaborative research agreement and added two additional subscribers to its PathoGenome(TM) database. The Company entered into corporate collaborations with Astra Hassle AB ("Astra") relating to H. 18 19 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 September 1997, subsequent to the fiscal year end, the Company entered into its third research collaboration with Schering-Plough to use genomics to discover and develop new pharmaceutical products to treat fungal infections. In May 1997, the Company sold its first subscription to its proprietary genome sequence database, PathoGenome(TM) to Bayer AG ("Bayer"). Under the agreement, Bayer will receive nonexclusive access to the Company's PathoGenome(TM) database and associated information relating to microbial organisms. In September 1997, subsequent to the fiscal year end, the Company sold two additional subscriptions to its PathoGenome(TM) database to Bristol-Myers Squibb and Schering-Plough. For fiscal 1995, 1996, and 1997, the Company expended $7,892,000, $14,074,000 and $26,524,000, respectively, on research and development, of which $6,414,000, $6,150,000 and $4,455,000, respectively, was sponsored by the United States government. As of August 31, 1997, the Company had outstanding approximately $2,968,000 of government research grants and contracts under which services were yet to be performed. These grants and contracts call for services to be performed over the next 30 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 Congress. As of August 31, 1997, the funded portion of these grants and contracts was $2,416,000. For fiscal 1995, 1996 and 1997, revenue recognized pursuant to United States government grants and research contracts accounted for approximately 63%, 32% and 23%, 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 programs in order to pursue its strategy of attaining additional corporate partnerships 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 has incurred significant losses, since inception, with an accumulated deficit of approximately $44,556,000 at August 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 collaborative agreements and government research grants and contracts. 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 REVENUE Total revenues decreased 8% from $21,256,000 in fiscal 1996 to $19,619,000 in fiscal 1997 and increased 90% from $11,207,000 in fiscal 1995 to $21,256,000 in fiscal 1996. Collaborative research, licenses and subscription fees decreased 8% from $12,549,000 in fiscal 1996 to $11,551,000 in fiscal 1997 due to lower license fees and milestone payments received in fiscal 1997 under the Company's collaborative research agreements with Astra and Schering-Plough. Collaborative research, licenses and subscription fees increased 224% from $3,871,000 in fiscal 1995 to $12,549,000 in fiscal 1996 primarily due to revenue received in fiscal 1996 under the Company's collaborative research agreements with Astra and Schering-Plough of $4,539,000 and $7,868,000, respectively, consisting of milestone payments, license fees and sponsored research. Government research revenue decreased 34% from $6,795,000 in fiscal 1996 to $4,455,000 in fiscal 1997 and decreased 3% from $7,014,000 in fiscal 1995 to $6,795,000 in fiscal 1996. The decrease in government 19 20 research revenue in both fiscal 1996 and 1997 was primarily attributable to a shift in personnel from government research programs to Company sponsored research and development programs, in particular, the microbial genetic database program, PathoGenome(TM). 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. 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 continues to focus its resources in company-sponsored research and development programs in order to obtain additional corporate partnerships. The Company had royalty revenue of $91,000, $127,000 and $647,000 in fiscal 1995, 1996 and 1997, respectively, from the Company's rennin patent. In October 1996, the Company assigned its rights to the rennin patent to Pfizer, Inc. for $671,000 and no further royalties will be received. Interest income increased 66% from $1,785,000 in fiscal 1996 to $2,966,000 in fiscal 1997 and increased 671% from $232,000 in fiscal 1995 to $1,785,000 in fiscal 1996 reflecting the increase in funds available for investment as a result of (i) proceeds received from the sale of Common Stock through a public offering in February 1996, (ii) the sale of Common Stock in a private placement in March 1995 and (iii) payments received under the Company's collaborative agreements. COST AND EXPENSES Total cost and expenses, excluding noncash charges for stock option grants, increased 81% from $17,015,000 in fiscal 1996 to $30,842,000 in fiscal 1997 and increased 61% from $10,596,000 in fiscal 1995 to $17,015,000 in fiscal 1996. 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 $7,924,000 in fiscal 1996 to $22,069,000 in fiscal 1997 and increased 436% from $1,478,000 in fiscal 1995 to $7,924,000 in fiscal 1996. The increase in research and development expenses in both fiscal 1996 and fiscal 1997 was primarily attributable to increases in both personnel and laboratory expenses associated with the Company's expansion of its pathogen, microbial genetic database, human gene discovery and functional genomics research programs. The increase 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 fungal, osteoporosis, atherosclerosis, oncology and functional genomics projects. The cost of government research decreased 28% from $6,150,000 in fiscal 1996 to $4,455,000 in fiscal 1997 and decreased 4% from $6,414,000 in fiscal 1995 to $6,150,000 in fiscal 1996. The decrease in cost of government research in both fiscal 1996 and fiscal 1997 was due primarily to a decrease in government research revenue. Cost of government research, as a percentage of government research revenue, was 100%, 91% and 91% in fiscal 1997, 1996 and 1995, respectively. Selling, general and administrative expenses increased 35% from $2,727,000 in fiscal 1996 to $3,686,000 in fiscal 1997 and increased 4% from $2,618,000 in fiscal 1995 to $2,727,000 in fiscal 1996. The increase in selling, general and administrative expenses in fiscal 1997 was primarily due to increases in payroll and related expenses and legal fees. The increase in legal fees in fiscal 1997 was directly attributable to the Company's new collaborative agreements with Schering-Plough, Bayer and Bristol-Myers Squibb. The increase in selling, general and administrative expenses in fiscal 1996 was primarily due to increases in payroll and related expenses and consulting fees. Interest expense increased 195% from $214,000 in fiscal 1996 to $631,000 in fiscal 1997 and increased 150% from $86,000 in fiscal 1995 to $214,000 in fiscal 1996. The increase in interest expense for each period was attributable to increases 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 20 21 shareholder approval, and the per share exercise price of the options. Additionally, in March 1997, the Company granted options valued at approximately $51,000 to certain consultants in lieu of cash for services. The Company recorded $79,000, $2,320,000 and $26,000 as compensation expense in fiscal 1997, 1996 and 1995, respectively. LIQUIDITY AND CAPITAL RESOURCES Since September 1, 1992, the Company's primary sources of cash have been revenue from government grants and contract, revenue from collaborative research agreements and subscription fees, borrowings under equipment lending facilities and capital leases and proceeds from sale of equity securities. In fiscal 1995, the Company received net proceeds of approximately $2,403,000 from the private sale of common stock and warrants and the exercise of stock options. In August 1995, the Company entered into a collaborative research agreement with Astra under which it received $3,500,000. In fiscal 1996, the Company received approximately $11,671,000 in collaborative payments from its collaborative 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 $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 from the exercise of stock options and warrants during fiscal 1996. In fiscal 1997, the Company received payments of $13,496,000 from its collaborative partners consisting of an up-front license fee, subscription fee, expense allowance, milestone payments and sponsored research funding. As of August 31, 1997, the Company had cash, cash equivalents, restricted cash and long and short-term marketable securities of approximately $47,844,000. 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, debt service coverage and minimum restricted cash balances. At August 31, 1997, the Company had approximately $6,420,000 available under these arrangements for future borrowings and had an outstanding balance of approximately $10,744,000 which is repayable over the five year period ending August 2002. Under one of these arrangements, the Company received a $2,500,000 advance in July 1997 to finance office and laboratory renovations at its Beaver Street facility of which approximately $1,653,000 had not been expended at August 31, 1997. The Company's operating activities used cash of approximately $4,757,000 in fiscal 1997 and provided cash of approximately $2,976,000 and $2,693,000 in fiscal 1996 and 1995, respectively. The Company primarily used cash in fiscal 1997 to fund the Company's operating loss which was partially offset by increases in deferred revenue, accounts payable and accrued liabilities. Net cash provided in fiscal 1995 and 1996 was comprised primarily of deferred revenue, accounts payable, accrued liabilities and operating income. The Company's investing activities provided cash of approximately $2,257,000 and $5,600 in fiscal 1997 and 1995, respectively, and used cash of approximately $40,258,000 in fiscal 1996. The Company used cash primarily for purchases of marketable securities and to a lesser extent the purchase of equipment and leasehold improvements. In addition, the Company financed $1,340,000, $4,724,000 and $5,843,000 of property and equipment in fiscal 1995, 1996 and 1997, respectively, under equipment financing arrangements. Capital expenditures totaled $6,138,000 during fiscal 1997 consisting of laboratory, computer and office equipment. The Company currently estimates that it will acquire approximately $6,200,000 in capital equipment in fiscal 1998 consisting of primarily computer and laboratory equipment which it intends to finance under existing and new financing arrangements. The Company also plans to consolidate its operations at its Beaver Street facility during fiscal 1998 at an estimated cost of $6,500,000 which consists of office and 21 22 laboratory renovations. As of August 31, 1997, the Company had incurred approximately $847,000 of capital improvements and plans to spend an estimated $5,653,000 during fiscal 1998 on this renovation project. The Company plans to utilize existing and new capital lease and equipment financing arrangements to finance substantially all of these capital improvements. Financing activities provided cash of approximately $422,000, $42,075,000 and $2,074,000 in fiscal 1997, 1996 and 1995, respectively, primarily from the sale of equity securities and the exercise of stock options and warrants, net of payments of capital lease obligations. At August 31, 1997, the Company had net operating loss and tax credit carryforwards of approximately $49,065,000 and $1,128,000, respectively. 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 10K 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial statements and supplementary data required by Item 8 are set forth at the pages indicated in Item 14(a) below. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Pursuant to General Instruction G(3) to Form 10-K, the information required for Part III (Items 10, 11, 12 and 13) is incorporated herein by reference from the Company's proxy statement for the Special Meeting of Shareholders in Lieu of an Annual Meeting to be held on January 26, 1998. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (1) AND (2) See "Index to Consolidated Financial Statements and Financial Statement Schedules" appearing on page F-1. 22 23 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Public Accountants.................................................................... F-2 Consolidated Balance Sheets as of August 31, 1996 and 1997.................................................. F-3 Consolidated Statements of Operations for the Years Ended August 31, 1995, 1996 and 1997................... F-4 Consolidated Statements of Shareholders' Equity for the Years Ended August 31, 1995, 1996 and 1997.......... F-5 Consolidated Statements of Cash Flows for the Years Ended August 31, 1995, 1996 and 1997.................... F-6 Notes to Consolidated Financial Statements.................................................................. F-7
F-1 24 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Genome Therapeutics Corp.: We have audited the accompanying consolidated balance sheets of Genome Therapeutics Corp. and subsidiaries (a Massachusetts corporation) as of August 31, 1996 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended August 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Genome Therapeutics Corp. and subsidiaries as of August 31, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1997, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP - ----------------------- Boston, Massachusetts October 10, 1997 F-2 25 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
AUGUST 31, --------------------------- 1996 1997 ----------- ----------- ASSETS Current Assets: Cash and cash equivalents................................................. $10,679,287 $ 8,602,698 Marketable securities..................................................... 17,429,488 34,814,601 Accounts receivable....................................................... 1,338,418 55,142 Interest receivable....................................................... 1,296,657 1,280,611 Unbilled costs and fees................................................... 345,773 140,320 Note receivable from officer.............................................. -- 160,000 Prepaid expenses and other current assets................................. 552,903 408,240 ----------- ----------- Total current assets............................................... 31,642,526 45,461,612 ----------- ----------- Equipment and Leasehold Improvements, at cost: Laboratory and scientific equipment....................................... 6,403,221 11,855,630 Equipment and furniture................................................... 581,533 792,342 Leasehold improvements.................................................... 1,939,545 1,964,981 Construction-in-progress.................................................. 77,027 1,111,526 ----------- ----------- 9,001,326 15,724,479 Less -- Accumulated depreciation............................................ 3,266,068 5,352,999 ----------- ----------- 5,735,258 10,371,480 Restricted Cash............................................................. 195,500 301,500 Long-Term Marketable Securities............................................. 25,464,287 4,124,798 Other Assets................................................................ 241,446 428,989 ----------- ----------- $63,279,017 $60,688,379 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts payable.......................................................... $ 864,279 $ 1,288,391 Accrued expenses.......................................................... 1,731,220 2,373,788 Deferred revenue.......................................................... 1,035,504 2,335,695 Current maturities of long-term obligations............................... 2,106,882 3,595,120 ----------- ----------- Total current liabilities.......................................... 5,737,885 9,592,994 ----------- ----------- Long-Term Obligations, net of current maturities............................ 3,228,374 7,149,188 ----------- ----------- Commitments and Contingencies (Note 4) Shareholders' Equity: Common stock, $.10 par value -- Authorized -- 34,375,000 shares Issued and outstanding -- 17,460,966 and 17,782,929 shares at August 31, 1996 and 1997, respectively............................................ 1,746,097 1,778,293 Series B restricted stock, $.10 par value -- Authorized -- 625,000 shares Issued and outstanding -- none.......................................... -- -- Additional paid-in capital................................................ 86,067,176 86,942,034 Accumulated deficit....................................................... (33,253,515) (44,555,906) Deferred compensation..................................................... (247,000) (218,224) ----------- ----------- Total shareholders' equity......................................... 54,312,758 43,946,197 ----------- ----------- $63,279,017 $60,688,379 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-3 26 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED AUGUST 31, -------------------------------------------- 1995 1996 1997 ----------- ----------- ------------ Revenues: Collaborative research, licenses and subscription fees.......................................... $ 3,870,620 $12,548,724 $ 11,550,786 Government research.............................. 7,014,280 6,795,393 4,454,828 Royalties........................................ 90,541 127,112 647,150 Interest income.................................. 231,662 1,785,164 2,965,866 ----------- ----------- ------------ Total revenues........................... 11,207,103 21,256,393 19,618,630 ----------- ----------- ------------ Costs and Expenses: Research and development......................... 1,478,247 7,924,113 22,068,996 Cost of government research...................... 6,414,148 6,150,234 4,454,828 Selling, general and administrative.............. 2,617,787 2,726,855 3,686,385 Interest expense................................. 85,759 214,264 631,442 Noncash charge for stock option grants........... 25,958 2,320,217 79,370 ----------- ----------- ------------ Total costs and expenses................. 10,621,899 19,335,683 30,921,021 ----------- ----------- ------------ Net income (loss)........................ $ 585,204 $ 1,920,710 $(11,302,391) =========== =========== ============ Net Income (Loss) per Common Share: Primary.......................................... $ 0.05 $ 0.11 $ (.64) =========== =========== ============ Fully diluted.................................... $ 0.04 $ -- $ -- =========== =========== ============ Weighted Average Number of Common and Common Equivalent Shares Outstanding: Primary.......................................... 12,961,734 18,129,794 17,617,614 =========== =========== ============ Fully diluted.................................... 13,036,741 -- -- =========== =========== ============
The accompanying notes are an integral part of these consolidated financial statements. F-4 27 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL TOTAL ----------------------- PAID-IN ACCUMULATED DEFERRED SHAREHOLDERS' SHARES AMOUNT CAPITAL DEFICIT COMPENSATION EQUITY ---------- ---------- ----------- ------------ ------------ ------------- BALANCE, AUGUST 31, 1994................. 11,778,946 $1,177,894 $38,833,865 $(35,759,429) $ (27,775) $ 4,224,555 Exercise of stock options........... 244,166 24,417 394,982 -- -- 419,399 Amortization of deferred compensation...... -- -- -- -- 25,958 25,958 Sale of common stock and warrants...... 1,453,023 145,302 1,838,085 -- -- 1,983,387 Net income........... -- -- -- 585,204 -- 585,204 ---------- ---------- ----------- ------------ ----------- ------------ BALANCE, AUGUST 31, 1995................. 13,476,135 1,347,613 41,066,932 (35,174,225) (1,817) 7,238,503 Exercise of stock options, including tax effects....... 496,756 49,676 1,151,079 -- -- 1,200,755 Exercise of warrants.......... 38,075 3,808 106,643 -- -- 110,451 Deferred compensation from grant of stock options..... -- -- 2,565,400 -- (2,565,400) -- Amortization of deferred compensation...... -- -- -- -- 2,320,217 2,320,217 Sale of common stock............. 3,450,000 345,000 41,177,122 -- -- 41,522,122 Net income........... -- -- -- 1,920,710 -- 1,920,710 ---------- ---------- ----------- ------------ ----------- ------------ BALANCE, AUGUST 31, 1996................. 17,460,966 1,746,097 86,067,176 (33,253,515) (247,000) 54,312,758 Exercise of stock options........... 321,963 32,196 824,264 -- -- 856,460 Deferred compensation from grant of stock options..... -- -- 50,594 -- (50,594) -- Amortization of deferred compensation...... -- -- -- -- 79,370 79,370 Net loss............. -- -- -- (11,302,391) -- (11,302,391) ---------- ---------- ----------- ------------ ----------- ------------ BALANCE, AUGUST 31, 1997................. 17,782,929 $1,778,293 $86,942,034 $(44,555,906) $ (218,224) $ 43,946,197 ========== ========== =========== ============ =========== ============
The accompanying notes are an integral part of these consolidated financial statements. F-5 28 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED AUGUST 31, ---------------------------------------------- 1995 1996 1997 ----------- ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)..................................... $ 585,204 $ 1,920,710 $(11,302,391) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities-- Depreciation and amortization....................... 350,230 887,907 2,382,286 Loss on disposal of fixed assets.................... -- -- 227,864 Deferred compensation............................... 25,958 2,320,217 79,370 Changes in assets and liabilities-- Accounts receivable.............................. 77,544 (1,057,514) 1,283,276 Interest receivable.............................. (47,186) (1,216,768) 16,046 Unbilled costs and fees.......................... (29,960) (86,768) 205,453 Loan to officer.................................. -- -- (160,000) Prepaid expenses and other current assets........ (27,754) (502,763) 144,663 Accounts payable................................. 124,568 454,997 424,112 Accrued expenses................................. 897,974 (5,349) 642,568 Deferred contract revenue........................ 736,057 261,456 1,300,191 ----------- ------------ ------------ Total adjustments.............................. 2,107,431 1,055,415 6,545,829 ----------- ------------ ------------ Net cash provided by (used in) operating activities................................... 2,692,635 2,976,125 (4,756,562) ----------- ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of marketable securities.................... (5,332,248) (49,553,183) (20,575,625) Proceeds from the sale of marketable securities....... 6,000,000 9,000,000 24,530,000 Purchases of equipment and leasehold improvements..... (97,016) (164,211) (1,370,028) (Increase) decrease in restricted cash................ (689,797) 588,971 (106,000) (Increase) decrease in other assets................... 124,687 (129,233) (220,850) ----------- ------------ ------------ Net cash provided by (used in) investing activities................................... 5,626 (40,257,656) 2,257,497 ----------- ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options, including tax benefits............................................ 419,399 1,200,755 856,460 Proceeds from the exercise of warrants................ -- 110,451 -- Proceeds from sale of common stock and warrants....... 1,983,387 41,522,122 -- Proceeds from long-term obligations................... -- -- 2,500,000 Payments on long-term obligations..................... (329,025) (758,694) (2,933,984) ----------- ------------ ------------ Net cash provided by financing activities...... 2,073,761 42,074,634 422,476 ----------- ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.... 4,772,022 4,793,103 (2,076,589) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............ 1,114,162 5,886,184 10,679,287 ----------- ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR.................. $ 5,886,184 $ 10,679,287 8,602,698 =========== ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid during the year......................... $ 85,759 $ 214,264 631,442 =========== ============ ============ Income taxes paid during the year..................... $ 6,824 $ 43,240 36,612 =========== ============ ============ SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Property and equipment acquired under capital leases.............................................. $ 1,340,611 $ 4,723,678 $ 5,843,037 =========== ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-6 29 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Genome Therapeutics Corp. (the Company) is a leader in the field of genomics-based drug discovery -- the identification and functional characterization of genes. The Company has over ten years of experience in positional cloning, having served as one of the primary researchers under genome programs sponsored by the United States government, and has developed numerous techniques and tools that are widely used in this field. GTC's commercial gene discovery strategy capitalizes on its pioneering work in genomics by applying its high-throughput sequencing technology and positional cloning, its experience and skills in pathogen functional genomics and its bioinformatics capabilities. The two areas of focus are: the discovery and characterization of (i) genes of pathogens that are responsible for many serious diseases and (ii) human disease genes. The accompanying consolidated financial statements reflect the application of certain accounting policies described in this note and elsewhere in the accompanying notes to the consolidated financial statements. (a) Revenue Recognition Research and contract revenues are derived from government grants and contract arrangements as well as collaborative agreements with pharmaceutical companies. Research revenues are recognized as earned under government 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 and royalties are recognized as earned. Unbilled costs and fees represent revenue recognized prior to billing. Deferred revenue represents amounts received prior to revenue recognition. Subscription fee revenues from the PathoGenome(TM) database are recognized ratably over the life of the subscription agreement. (b) Equipment and Leasehold Improvements Equipment and leasehold improvements are depreciated over their estimated useful lives using the straight-line method. The estimated useful life for leasehold improvements is the lesser of the term of the lease or the estimated useful life of the assets. Equipment and all other depreciable assets' useful lives vary from three to seven years. The majority of the Company's equipment and leaseholds are financed through capital leases. Construction-in-progress primarily consists of renovations and expansions of the Company's headquarters. (c) 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 year. In March 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (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 ending August 31, 1998. For the years ended August 31, F-7 30 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1995, 1996 and 1997, basic earnings per share would have been $.05, $.12 and $(.64), respectively. Diluted earnings per share would have been $.04, $.11 and $(.64), respectively, for the same periods. (d) Concentration of Credit Risk SFAS No. 105, Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. The Company has no significant off-balance-sheet or concentration of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. The Company maintains its cash and cash equivalents and marketable securities balances with several nonaffiliated institutions. The Company had revenues from the following significant customers:
PERCENTAGE OF NUMBER OF TOTAL REVENUES SIGNIFICANT ------------------- CUSTOMERS A B C --------- --- --- --- Year Ended August 31, 1995...................................... 2 31% 63% --% 1996...................................... 3 21 32 37 1997...................................... 3 15 23 41
The Company had the following significant accounts receivable balances from the following customers:
PERCENTAGE OF ACCOUNTS NUMBER OF RECEIVABLE SIGNIFICANT -------------- CUSTOMERS A B --------- ----- ----- As of August 31, 1996........................................... 2 25% 75% 1997........................................... 1 100% --%
(e) 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. (f) Financial Instruments The estimated fair value of the Company's financial instruments, which include cash equivalents, marketable securities, accounts receivable and long-term debt, approximates carrying value. (g) Loan to Officer On December 6, 1996, the Company loaned $160,000 to an officer of the Company. The loan bears interest at prime plus 1% and is due August 31, 1998. (h) Reclassifications The Company has reclassified certain prior year information to conform with the current year's presentation. F-8 31 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (2) CASH EQUIVALENTS AND MARKETABLE SECURITIES The Company applies SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. At August 31, 1997, 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 gains or losses on its marketable securities. Marketable securities consist of commercial paper and U.S. Government debt securities. The aggregate fair value and costs of the investments at August 31, 1996 and 1997 were as follows:
1996 1997 ------------------------- ------------------------- AMORTIZED MARKET AMORTIZED MARKET MATURITY COST VALUE COST VALUE ---------------------------------- ----------- ----------- ----------- ----------- Less than one year-- Corporate and other debt securities................... $17,429,488 $17,413,011 $34,814,601 $34,806,434 Greater than one year-- U.S. Government and agency securities................... $ 2,998,931 $ 2,988,420 $ 654,529 $ 657,406 Corporate and other debt securities (average maturity of 1.7 and 1.5 years in 1996 and 1997, respectively)...... 22,465,356 22,296,279 3,470,269 3,462,547 ----------- ----------- ----------- ----------- $25,464,287 $25,284,699 $ 4,124,798 $ 4,119,953 =========== =========== =========== ===========
The Company has $195,500 and $301,500 in restricted cash at August 31, 1996 and 1997, respectively, in connection with certain long-term obligations (see Note 5). (3) INCOME TAXES The Company applies SFAS No. 109, Accounting for Income Taxes, which requires the Company to recognize deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS No. 109 requires deferred tax assets and liabilities to be adjusted when the tax rates or other provisions of the income tax laws change. At August 31, 1997, the Company had net operating loss and tax credit carryforwards of approximately $49,065,000 and $1,128,000, respectively, available to reduce federal taxable income and federal income taxes, respectively, if any. Net operating loss carryforwards and 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 the ownership interest of significant shareholders over a three-year period in excess of 50%. In the years ended August 31, 1995 and 1996, the Company utilized approximately $1,100,000 and $4,398,000, respectively, of net operating loss carryforwards to offset taxable income. In the year ended August 31, 1997, the Company did not utilize any loss carryforwards. F-9 32 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The net operating loss carryforwards and tax credits expire approximately as follows:
NET OPERATING RESEARCH INVESTMENT LOSS TAX CREDIT TAX CREDIT EXPIRATION DATE CARRYFORWARDS CARRYFORWARDS CARRYFORWARDS --------------- ------------- ------------- ------------- 1997........................................ $ -- $ 80,000 $103,000 1998........................................ 6,886,000 208,000 90,000 1999........................................ 5,039,000 273,000 143,000 2000........................................ 3,829,000 84,000 75,000 2001........................................ 4,812,000 24,000 3,000 2002-2011................................... 28,498,000 8,000 37,000
The components of the deferred tax assets recognized in the Company's balance sheet at the respective dates are as follows:
AUGUST 31, ----------------------------- 1996 1997 ------------ ------------ Net operating loss carryforwards........................ $ 11,997,000 $ 17,743,000 Research and development credits........................ 677,000 677,000 Investment tax credits.................................. 451,000 451,000 Other, net.............................................. 1,173,000 1,856,000 ------------ ------------ 14,298,000 20,727,000 Valuation allowance..................................... (14,298,000) (20,727,000) ------------ ------------ $ -- $ -- ============ ============
The valuation allowance has been provided due to the uncertainty surrounding the realization of the deferred tax assets. (4) COMMITMENTS (a) Lease Commitments At August 31, 1997, the Company has operating leases for office and laboratory facilities, the last of which expires on November 15, 2006. Minimum lease payments and facilities charges under the leases at August 31, 1997 are as follows: Year Ending August 31, 1998.......................................... $ 1,285,061 1999.......................................... 1,171,325 2000.......................................... 1,171,325 2001.......................................... 1,171,325 2002.......................................... 1,219,780 Thereafter.................................... 5,174,025 ----------- $11,192,841 ===========
Rental expense was approximately $411,000, $472,000 and $949,000 in the years ended August 31, 1995, 1996 and 1997, respectively. Rental expense for fiscal 1997 includes the expansion of laboratory and office space at its primary facility. F-10 33 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (b) Research and Development Commitments The Company has entered three research and development alliances with companies and research institutions. These agreements provide for the funding of research activities by the Company and the possibility of royalties and, in some cases, license fees. At August 31, 1997, the Company's obligations under these arrangements totaled $1,715,000, of which $1,161,000 and $554,000 was payable for the fiscal years ending August 31, 1998 and 1999, respectively. (c) Employment Agreements The Company has employment agreements with certain executive officers which provide for bonuses, as defined, and severance benefits upon termination of employment as defined. (5) LONG-TERM OBLIGATIONS On February 28, 1997, the Company entered into an equipment line of credit under which it can finance up to $6,000,000 of laboratory, computer and office equipment. Borrowings are payable in 48 monthly installments at a variable interest rate of prime (8.5% as of August 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 2). 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 $2,920,000 available under this equipment line of credit at August 31, 1997. On July 31, 1997, the Company entered into a financing arrangement under which it can finance up to $6,000,000 of laboratory and office renovations at its Beaver Street facility. The principal amount of the loan will be repaid over 48 consecutive months commencing July 1, 1998 at the prevailing 12 month Eurodollar rate (12-month Eurodollar rate was 6% as of August 31, 1997) plus 1 1/2%. The Company is required to maintain certain financial ratios pertaining to minimum cash balances, debt to net worth and tangible net worth. At August 31, 1997, the Company borrowed $2,500,000 under this arrangement; of which approximately $1,653,000 has not been utilized to finance the Company's purchases, and is included in cash and cash equivalents. The Company has approximately $3,500,000 available under this financing arrangement at August 31, 1997. The Company is required to maintain certain restricted cash balances, upon the occurrence of certain events, as defined. The Company has entered into capital lease arrangements under which it financed approximately $9,214,000 of 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 2). 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 debt service coverage. The Company has no additional borrowing capacity under these capital lease agreements at August 31, 1997. Additionally, in connection with its facilities lease, the Company issued a $100,000 note payable in September 1994 to its lessor to finance leasehold improvements. The note bears interest at 9% and is payable in 60 monthly payments of $2,076. F-11 34 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Long-term obligations at August 31, 1997 are as follows: Year Ending August 31, 1998................................................... $ 4,388,053 1999................................................... 4,134,793 2000................................................... 1,857,887 2001................................................... 1,416,028 2002................................................... 616,420 ----------- Total minimum payments............................ 12,413,181 Less -- Amount representing interest................... 1,668,873 ----------- Present value of total minimum payments.............. 10,744,308 Less -- Current portion................................ 3,595,120 ----------- $ 7,149,188 ===========
(6) SHAREHOLDERS' EQUITY (a) Public Offering In February 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. In March 1996, the Company sold an additional 450,000 shares of its common stock in the underwriter's overallotment, resulting in proceeds of approximately $5,515,000, net of issuance costs. (b) Private Placement On March 20, 1995, the Company completed a private placement of 850,000 shares of common stock at $2.43 per share, resulting in proceeds of approximately $2,000,000, net of issuance costs. In connection with the private placement, the Company issued warrants to purchase 1,020,000 shares of common stock at an exercise price of $2.43 per share. These warrants were exercised on July 18, 1995 through a cashless exercise and resulted in the net issuance of 603,023 shares of common stock. The net issuance represents the excess fair market value of the shares purchasable pursuant to the warrants on the date of exercise over the total exercise price of such warrants. (c) Stock Options The Company has granted stock options to key employees and consultants under its 1988, 1991 and 1993 Stock Option Plans. In February 1996, the Company's stockholders approved the 1995 Stock Option Plan (the 1995 Plan) covering 750,000 options. The purchase price and vesting schedule applicable to each option grant are determined by the stock option and compensation committee of the Board of Directors. In addition, under separate agreements not covered by any plan, the Company has granted certain key employees and certain directors of the Company, options to purchase common stock. On November 16, 1995 and December 21, 1995, the Board of Directors of the Company granted, and the shareholders approved on February 16, 1996, nonqualified stock options outside the 1995 Plan for the purchase of an aggregate of 380,000 shares of common stock to four members of the Board of Directors and the Company's Chief Executive Officer. The options were granted with an exercise price of $7.25 and $8.87 per share, respectively, the fair market value on the date of grant, and vest at the end of five years or in earlier installments based upon the average closing price of the Company's common stock, as defined. On January 2, 1996, the Board of Directors of the Company granted, and the shareholders approved on February 16, 1996, stock options for the purchase of 60,000 shares of common stock to an employee. The F-12 35 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) options were granted with an exercise price of $9.56 per share, the fair market value on the date of grant, and vest over a four-year period. On July 11, 1996 and March 12, 1997, the Board of Directors of the Company granted nonqualified stock options outside the 1995 Plan for the purchase of 600,000 and 150,000 shares of common stock, respectively, to two executives of the Company. The options were granted with an exercise price of $7.44 and $9.06 per share, respectively, the fair market value on the date of grant and vest at the end of seven years or in earlier installments based upon the average closing price of the Company's common stock, as defined. During fiscal 1997, the Board of Directors of the Company granted nonqualified stock options outside of the 1995 Plan for the purchase of an aggregate 65,000 shares of common stock to a director of the company and two consultants. The options were granted with an exercise price equal to the fair market price at the date of grant and vest over a four-year period. In accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the Company computed the fair value of the options granted to the consultants at $50,594 using the Black-Scholes option pricing model. Of this amount, $5,270 was charged to operations for the year ended August 31, 1997 and the remaining amount will be amortized over the remaining vesting periods of the options. The Company records deferred compensation when stock options are granted at an exercise price per share that is less than the fair market value on the date of the grant for options granted to non-employees. Deferred compensation for employees is recorded in an amount equal to the excess of the fair market value per share over the exercise price times the number of options granted. In 1996 and 1997, the Company recorded $2,565,400 and $50,594, respectively, of deferred compensation for certain options described above. Deferred compensation is being recognized as an expense over the estimated vesting period of the underlying options. Compensation expense included in the statements of operations was approximately $26,000, $2,320,000 and $79,000 for the years ended August 31, 1995, 1996 and 1997, respectively. There were 154,430 common shares available for future grant at August 31, 1997 under the 1995 Plan. The following is a summary of all stock option activity:
NUMBER OF EXERCISE WEIGHTED SHARES PRICE RANGE AVERAGE --------- -------------- -------- Outstanding, August 31, 1994................... 3,499,702 $ .20 - $ 8.00 $1.87 Granted...................................... 355,275 $2.03 - $ 5.34 3.12 Exercised.................................... (244,166) $ .81 - $ 4.00 1.72 Canceled..................................... (70,624) $ .81 - $ 5.25 1.60 --------- -------------- ----- Outstanding, August 31, 1995................... 3,540,187 $ .20 - $ 8.00 $2.01 Granted...................................... 1,361,775 $1.56 - $14.50 $7.96 Exercised.................................... (496,756) $ .20 - $ 8.00 2.16 Canceled..................................... (56,992) $1.56 - $ 7.25 2.25 --------- -------------- ----- Outstanding, August 31, 1996................... 4,348,214 $ .20 - $14.50 $3.85 Granted...................................... 797,950 $6.19 - $ 9.69 8.58 Exercised.................................... (321,963) $ .88 - $ 7.25 2.66 Canceled..................................... (178,513) $1.56 - $14.50 6.86 --------- -------------- ----- Outstanding, August 31, 1997................... 4,645,688 $ .20 - $14.50 $4.63 ========= ============== ===== Exercisable.................................. 2,795,938 $ .20 - $14.50 $2.78 ========= ============== =====
F-13 36 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (d) Pro Forma Disclosure of Stock-Based Compensation The Company applies SFAS No. 123, Accounting for Stock-Based Compensation, which requires the measurement of the fair value of stock options or warrants granted to employees to be included in the consolidated statement of operations or, alternatively, disclosed in the notes to consolidated financial statements. The Company has determined that it will continue to account for stock-based compensation for employees and non-employee directors under Accounting Principles Board Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123. The Company records the fair market value of stock options and warrants granted to nonemployees in the consolidated statement of operations. The Company has computed the pro forma disclosures required under SFAS No. 123 for stock options granted in 1996 and 1997 using the Black-Scholes option pricing model. The weighted average assumptions used for 1996 and 1997 are as follows:
1996 1997 -------------- -------------- Risk-free interest rate..................... 6.13% - 6.52% 6.20% - 6.73% Expected life............................... 7 years 7 years Expected volatility......................... 65% 65%
The total value of the options granted to employees during fiscal 1996 and fiscal 1997 was computed as $5,691,880 and $3,857,026, respectively. Of these amounts, $811,018 and $2,951,660 would be charged to operations for the years ended August 31, 1996 and 1997, respectively. The remaining amount, approximately $3,067,000, would be amortized over the remaining vesting periods. The pro forma effect of these option grants for the years ended August 31, 1996 and 1997 is as follows:
1996 1997 -------------------------- ---------------------------- AS REPORTED PRO FORMA AS REPORTED PRO FORMA ----------- ----------- ------------ ------------ Net income (loss)................ $ 1,920,710 $ 1,109,692 $(11,302,391) $(14,254,051) ========= ========= =========== =========== Net income (loss) per share...... $ 0.11 $ 0.06 $ (0.64) $ (0.81) ========= ========= =========== ===========
The weighted average remaining contractual life of options outstanding at August 31, 1997 was 7.12 years. The resulting pro forma compensation expense may not be representative of the amount to be expected in future years, as the pro forma expense may vary based on the number of options granted. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions, including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. (e) Warrants In connection with the sales of common stock in March and May 1994, the Company issued three-year warrants for the purchase of 30,075 shares of common stock at $3.09 per share and 8,000 shares of common stock at $2.19 per share, respectively. These warrants were exercised during the year ended August 31, 1996. In connection with the Company's public offering described in Note 6(a), the Company issued two-year warrants to its underwriters for the purchase of 224,250 shares of common stock at $15.60 per share. These warrants are outstanding and exercisable as of August 31, 1997. F-14 37 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (7) INCENTIVE SAVINGS PLAN 401(k) The Company maintains an incentive savings plan (the Plan) for the benefit of all employees. On October 1, 1996, the Company changed its matching contribution from 50% of the first 2% of salary and 25% of the next 4% of salary, limited to the first $50,000 of annual salary to 100% of the first 2% of salary and 50% of the next 2% of salary, limited to the first $100,000 of annual salary. The Company contributed $43,533, $58,354 and $165,778 to the Plan for the years ended August 31, 1995, 1996 and 1997, respectively. (8) COLLABORATION AGREEMENTS (a) Astra Hassle AB In August 1995, the Company entered into a collaboration agreement with Astra Hassle AB (Astra) to develop pharmaceutical, vaccine and diagnostic products effective against gastrointestinal infection or any other disease caused by H. pylori. The Company granted Astra exclusive access to the Company's H. plyori genomic sequence database and exclusive worldwide rights to make, use and sell products based on the Company's H. pylori technology. The agreement also provides for a four-year research collaboration to further develop and annotate the Company's H. pylori genomic sequence database, identify therapeutic and vaccine targets and develop appropriate biological assays. This research is being directed by a Joint Management Committee and a Joint Research Committee, each consisting of representatives from both parties. Under this agreement, Astra agreed to pay the Company a minimum of approximately $11 million and, subject to the achievement of certain product development milestones, up to approximately $22 million (and possibly a greater amount if more than one product is developed under the agreement) in license fees, expense allowances, research funding and milestone payments. Of such fees, $500,000 is creditable against any future royalties payable to the Company by Astra under the agreement. Astra is obligated to provide funding for the research program for a minimum of two and one-half years. On July 21, 1997, Astra elected to extend the research program to at least September 1998. The Company will also be entitled to receive royalties on Astra's sale of products (i) protected by the claims of patents licensed exclusively to Astra by the Company pursuant to the agreement, or (ii) the discovery of which was enabled in a significant manner by the genomic database licensed to Astra by the Company. The Company has the right, under certain circumstances, to convert Astra's license to a nonexclusive license in the event Astra is not actively pursuing commercialization of the technology. The Company has recognized $3,500,000, $4,539,496 and $2,859,262 in revenue under the agreement in the years ended August 31, 1995, 1996 and 1997, respectively. The revenue in the year ended August 31, 1995 consisted of a nonrefundable license fee and capital allowance. The revenue in the years ended August 31, 1996 and 1997 consisted of milestone payments and collaborative research revenues. The Company has recorded $650,504 and $502,996 of deferred revenue under this agreement at August 31, 1996 and 1997, respectively. (b) 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 genomic sequence of a specified pathogen. The Company is sequencing 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 nonexclusive 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 F-15 38 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 has agreed to pay the Company a minimum of $13.3 million for an up-front license fee, 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 $30.2 million in research funding and milestone payments. The agreement grants Schering-Plough exclusive worldwide rights to make, use and sell pharmaceutical and vaccine products based on the genomic sequence databases licensed to Schering-Plough by the Company 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 that are targeted against, as their primary indication, the pathogen that is the principal subject of the Company's agreement with Schering-Plough. 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 genomic database licensed to Schering-Plough or the technology developed in the course of the research program. The Company has recognized $7,867,579 and $3,364,810 in revenue in the years ended August 31, 1996 and 1997, respectively, under this collaborative agreement. The revenue in the year ended August 31, 1996 consisted of a license fee, collaborative research revenue and milestone payments. The revenue in the year ended August 31, 1997 consisted of collaborative research revenue. The Company recorded $382,421 and $17,610 as deferred revenue at August 31, 1996 and 1997, respectively. In December 1996, the Company entered into its second research collaboration and license agreement with Schering-Plough. 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 rights to develop and commercialize diagnostic products that may result from this collaboration. Under this agreement, Schering-Plough agreed to pay an initial 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 on 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 milestones. The Company has recognized $4,603,805 in revenue in the year ended August 31, 1997 under this agreement, which consisted of a license fee, expense allowance and collaborative research revenues. The Company recorded $1,399,803 as deferred revenue at August 31, 1997. F-16 39 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (9) DATABASE SUBSCRIPTIONS In May 1997, the Company entered into a license agreement with Bayer AG, (Bayer) to provide Bayer with nonexclusive access 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, an annual subscription fee and royalties on any molecules developed as a result of access to the information provided by the PathoGenome(TM) database. The Company retains all rights associated with protein therapeutic, diagnostic and vaccine use of bacterial genes or gene products. The Company has recognized $666,667 in revenue under this agreement in the year ended August 31, 1997 consisting of license and subscription fees. The Company recorded $333,333 as deferred revenue at August 31, 1997 under this agreement. (10) HARVARD LICENSE AGREEMENT On November 12, 1993, the Company entered into an agreement with Harvard College for an exclusive worldwide license for commercial applications of their patented multiplex sequencing technology. Under this agreement, the Company has paid a nonrefundable license fee of $100,000, of which $50,000 can be credited against future royalties. In addition, the Company must pay minimum royalties ranging from $5,000 in 1995 to $35,000 in 1998 and beyond. The Company may terminate this agreement upon 90 days notice. The Company recorded a $115,000, $135,000 and $20,000 expense under this agreement in the years ended August 31, 1995, 1996 and 1997, respectively, primarily relating to the collaborative agreements with Astra and Schering-Plough, as well as the subscription agreement with Bayer. In 1997, the Company discontinued use of its multiplex sequencing technology; however, the Company will continue to incur royalty expense for future sales, if any, on products developed using the multiplex sequencing technology. (11) ACCRUED EXPENSES Accrued expenses consist of the following:
AUGUST 31, ------------------------- 1996 1997 ---------- ---------- Payroll and related expenses................................ $ 893,303 $1,130,296 Professional fees........................................... 77,918 321,626 Facilities.................................................. 34,276 157,228 Employee relocation......................................... 137,622 106,764 License and other fees...................................... 335,434 355,434 All other................................................... 252,667 302,440 ---------- ---------- $1,731,220 $2,373,788 ========== ==========
(12) SUBSEQUENT EVENTS (a) Bristol-Myers Squibb On September 16, 1997, the Company entered into a license agreement with Bristol-Myers Squibb to provide Bristol-Myers Squibb with nonexclusive access 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 Bristol-Myers Squibb with periodic data updates, analysis tools and software support. Under the agreement, Bristol-Myers Squibb has agreed to pay annual subscription fees, F-17 40 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) milestones and royalties on any molecules developed as a result of access to the information provided by PathoGenome(TM). The Company retains rights associated with therapeutic, diagnostic and vaccine use of bacterial genes or gene products. (b) Schering-Plough On September 24, 1997, the Company entered into a research collaboration and license agreement with Schering Corporation and Schering-Plough Ltd. (collectively Schering-Plough) to use genomics to discover and develop new pharmaceutical products to treat fungal infection. Under the agreement, the Company will employ its bioinformatics, high-throughput sequencing and functional genomics capabilities to identify and validate genes and associated proteins as drug discovery targets that can be utilized by Schering-Plough to develop novel antifungal treatments. Schering-Plough will receive exclusive access to the genomic information developed in the collaboration related to two fungal pathogens, Candida albicans and Aspergillus fumigatus. Schering-Plough will also receive exclusive worldwide right to make, use and sell products based on the technology developed in the course of the research program. In return, Schering-Plough has agreed to fund a research program for a minimum number of years with an option to extend. If all milestones are met and the research program continues for its full term, total payments to the Company will approximate $30.7 million, excluding royalties. Of the total potential payments, approximately $7.7 million represents license fees and research payments and $23 million represents milestone payments based on achievement of research and product development milestones. In a separate agreement, the Company entered into a license agreement with Schering-Plough to provide Schering-Plough with nonexclusive access 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 Schering-Plough with periodic data updates, analysis tools and software support. Under the agreement, Schering-Plough has agreed to pay annual subscription fees and royalties on any molecules developed as a result of access to the information provided by PathoGenome(TM) database. The Company retains certain rights to use the bacterial genes or gene products as therapeutics, diagnostics and vaccines. F-18 41 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Genome Therapeutics Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 26, 1997. GENOME THERAPEUTICS CORP. /s/ ROBERT J. HENNESSEY ------------------------------------- Robert J. Hennessey Chief Executive Officer SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated as of November 27, 1996.
SIGNATURE TITLE --------- ----- /s/ ROBERT J. HENNESSEY Chairman, President, - ------------------------------------------ Chief Executive Officer Robert J. Hennessey /s/ PHILIP LEDER Director - ------------------------------------------ Philip Leder /s/ LAWRENCE LEVY Director - ------------------------------------------ Lawrence Levy /s/ DONALD J. MCCARREN Director - ------------------------------------------ Donald J. McCarren /s/ STEVEN M. RAUSCHER Director - ------------------------------------------ Steven M. Rauscher /s/ FENEL M. ELOI Sr. Vice President, Treasurer - ------------------------------------------ Chief Financial Officer Fenel M. Eloi (Principal Financial and Accounting Officer)
42 EXHIBIT INDEX 3.2 Amendment dated January 24, 1983 to Restated Articles of Organization(3) 3.3 Amendment dated January 17, 1984 to Restated Articles of Organization(4) 3.4 Amendment dated October 20, 1987 to the By-laws(8) 3.5 Amendment dated December 9, 1987 to Restated Articles of Organization(9) 3.6 Amendment dated October 16, 1989 to the By-laws(11) 3.7 Amendment dated January 24, 1994 to Restated Articles of Organization(15) 3.8 Amendment dated August 31, 1994 to Restated Articles of Organization(15) 4 Series B Restricted Stock Purchase Plan(3) 10.1 Research Agreement with The Dow Chemical Company dated May 21, 1980(1) 10.2 Research Agreement with The Dow Chemical Company dated August 19, 1981(1) 10.3 1981 Amended Stock Option Plan and Form of Stock Option Certificate(1) 10.4 Incentive Stock Option Plan and Form of Stock Option Certificate(1) 10.5 1984 Stock Option Plan and Form of Stock Option Certificate(5) 10.6 Collaborative Research Incentive Savings Plan(6) 10.7 Amendment dated November 4, 1986 to the Collaborative Research Incentive Savings Plan dated March 1, 1985(7) 10.8 Stock Option Agreement with Mr. Lawrence Levy(8) 10.9 Form of Amendment to the 1981 Incentive Stock Option Plan(8) 10.10 Stock Option Agreement with Mr. Mark Friedman(10) 10.11 1988 Stock Option Plan and Form of Stock Option Certificate(10) 10.12 Stock Option Agreement with Dr. Rothchild(11) 10.13 Agreement with Health Sciences Research Institute (Hoken Kagaku Kenkyojyo)(12) 10.14 1991 Stock Option Plan and Form of Stock Option Certificate(13) 10.15 Lease dated November 17, 1992 relating to certain property in Waltham, Massachusetts(14) 10.16 Lease dated June 3, 1993 relating to certain property in Waltham, Massachusetts(14) 10.17 License Agreement with President and Fellows of Harvard College(14) 10.18 Agreement with Becton Dickinson and Company(14) 10.19 Employment Agreement with Robert J. Hennessey(14) 10.20 Agreement with Immuno-Cor Inc. dated September 13, 1993(14) 10.21 Agreement with DIANON Systems, Inc.(14) 10.22 Lease Amendment dated August 1, 1994 relating to certain property in Waltham, MA(15) 10.23 Consulting Agreement with Dr. Philip Leder(15) 10.24 1993 Stock Option Plan and Form of Stock Option Certificate(15) 10.25 Stock and Warrant Purchase Agreement among the Company and certain purchasers named therein dated March 20, 1995(16) 10.26 Registration Rights Agreement among the Company and certain purchasers named therein dated March 20, 1995(16) 10.27 Form of Warrant Certificate issued pursuant to the Stock and Warrant Purchase Agreement(16) 10.28 Agreement between the Company and Astra Hassle AB dated August 31, 1995.(17)* 10.29 Collaboration and License Agreement between the Company, Schering Corporation and Schering-Plough Ltd., dated as of December 6, 1995.(20)*
43 10.30 Form of director Stock Option Agreement and schedule of director options granted(18) 10.31 United States government grant from the National Institutes of Health, National Institute of Arthritis and Musculoskeletal and Skin Diseases for Cloning the Gene Responsible for FSH Muscular Dystrophy dated September 30, 1994, as amended.(17) 10.32 United States government grant from the National Center for Human Genome Research for Genome Sequencing Center dated August 16, 1994, as amended.(17) 10.33 United States government grant from the National Center for Human Genome Research for High Resolution Physical Map of Chromosome 10 dated April 13, 1995, as amended.(17) 10.34 United States government contract from the National Institute of Neurological Disorders and Stroke, NIH for Large Scale Automated DNA Sequencing of Human Genes Involved in Neurological Disorders dated November 30, 1993, as amended.(17) 10.35 Cooperative agreement from the United States Department of Energy for Microbial Genome Sequencing dated December 21, 1994, as amended.(17) 10.36 Credit Agreement between the Company and Silicon Valley Bank dated June 1, 1995, as amended.(17) 10.37 Lease amendment dated November 15, 1996 to certain property in Watham, MA(21) 10.38 Collaboration and License Agreement between the Company, Schering Corporation and Schering-Plough Ltd., dated as of December 20, 1996(22)* 10.39 Credit agreement between the Company and Fleet National Bank dated February 28, 1997(23) 10.40 Credit agreement between the Company and Sumitomo Bank, Limited dated July 31, 1997(24) 11.1 Calculation of Shares Used in Determining Net Income (Loss) Per Share(24) 23. Consent of Arthur Andersen LLP Independent Public Accounts(24) 27. Financial Data Schedule(24)
- --------------- * Confidential treatment requested with respect to a portion of this Exhibit. 44 FOOTNOTES (1) Filed as exhibits to the Company's Registration Statement on Form S-1 (No. 2-75230) and incorporated herein by reference. (2) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 27, 1982 and incorporated herein by reference. (3) Filed as exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended February 26, 1983 and incorporated herein by reference. (4) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 25, 1984 and incorporated herein by reference. (5) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1984 and incorporated herein by reference. (6) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1985 and incorporated herein by reference. (7) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1986 and incorporated herein by reference. (8) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1987 and incorporated herein by reference. (9) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 28, 1987 and incorporated herein by reference. (10) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988 and incorporated herein by reference. (11) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989 and incorporated herein by reference. (12) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1990 and incorporated herein by reference. (13) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992 and incorporated herein by reference. (14) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference. (15) Filed as an Exhibit of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1994 and incorporated herein by reference. (16) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1995 and incorporated herein by reference. (17) Filed as an Exhibit to the Company's Annual Report on Form 10-K/A3 for the year ended August 31, 1995 and incorporated herein by reference. (18) Filed as an Exhibit to the Company Registration Statement on Forms S-8 (File No. 33-61191) and incorporated herein by reference. (19) Filed as an Exhibit to the Company's amended Annual Report on Form 10-K/A for the fiscal year ended August 31, 1995 and incorporated herein by reference. (20) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 25, 1995 and incorporated herein by reference. (21) Filed as an Exhibit to the Company's 10-K for fiscal year ended August 31, 1996. (22) Filed as an Exhibit to the Company's 10-Q/A for the quarter ended March 1, 1997. (23) Filed as an Exhibit to the Company's 10-Q for the quarter ended May 31, 1997. (24) Filed herewith. EX-10.40 2 CREDIT AGREEMENT 1 EXHIBIT 10.40 LOAN AGREEMENT AMONG GENOME THERAPEUTICS CORP., COLLABORATIVE SECURITIES CORP. AND THE SUMITOMO BANK, LIMITED JULY 31, 1997 2 TABLE OF CONTENTS
PAGE ARTICLE I. DEFINITIONS 1 Section 1.1. Definitional Provisions 1 ARTICLE II. LOAN 1 Section 2.1. Term Note 1 Section 2.2. Use of Proceeds 4 Section 2.3. Payments 4 Section 2.4. Prepayments 5 Section 2.5. Indemnification; Increased Costs 5 Section 2.6. Investment Account and Custodian Account 7 Section 2.7. Change In Legality 7 ARTICLE III. REPRESENTATIONS AND WARRANTIES 8 Section 3.1. Organization 8 Section 3.2. Power, Authority, Consents 8 Section 3.3. No Violation of Law or Agreements 9 Section 3.4. Due Execution, Validity, Enforceability 9 Section 3.5. Judgments, Actions, Proceedings 9 Section 3.6. No Defaults, Compliance With Laws 9 Section 3.7. No Materially Adverse Contracts, Etc. 10 Section 3.8. Financial Statements. 10 Section 3.9. Title to Properties; Leases 11 Section 3.10. Priority of Liens 11 Section 3.11. Patents, Copyrights, Licenses, Etc 11 Section 3.12. Tax Returns 11 Section 3.13. Regulation U; Margin Stock 11 Section 3.14. Full Disclosure 12 Section 3.15. ERISA 12 Section 3.16. Environmental Compliance 12 Section 3.17. Other Regulations 14 Section 3.18. Compliance with Securities Laws 14 Section 3.19. Solvency 14 Section 3.20. Subsidiaries or Affiliates 14 Section 3.21. Pending Litigation 14 Section 3.22. Compliance with Investment Policy 14 Section 3.23. Nuclear Regulatory Compliance 14 ARTICLE IV. CONDITIONS PRECEDENT 14 Section 4.1. Conditions Precedent to the Effectiveness of this Agreement 14 ARTICLE V. AFFIRMATIVE COVENANTS 16 Section 5.1 Books and Records 16 Section 5.2. Inspections and Audits 16 Section 5.3. Perform Obligations 16 Section 5.4. Fees and Expenses 17 Section 5.5. Maintenance of Existence; Conduct of Business 17
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PAGE Section 5.6. Insurance 17 Section 5.7. Certain Taxes 18 Section 5.8. Use of Proceeds 18 Section 5.9. Further Assurances With Respect To Accounts 19 Section 5.10. Financial Covenants 19 Section 5.11 Deposits Into Custodian Account 19 ARTICLE VI. DELIVERY OF FINANCIAL REPORTS,DOCUMENTS AND OTHER INFORMATION 20 Section 6.1. Annual Financial Statements 20 Section 6.2. Quarterly Financial Statements 20 Section 6.3. 10Q and 10K Filings 20 Section 6.4. ash and Covenant Reports 21 Section 6.5. Other Information 21 Section 6.6. No Default Certificate 21 Section 6.7. Notices 21 ARTICLE VII. NEGATIVE COVENANTS 22 Section 7.1. Liens 22 Section 7.2. Changes in Business; Merger or Consolidation; Disposition of Assets 23 Section 7.3. Change of Office Address 24 Section 7.4. Violation of Agreement 24 ARTICLE VIII. EVENTS OF DEFAULT 24 Section 8.1. Events of Default 24 ARTICLE IX. MISCELLANEOUS PROVISIONS 26 Section 9.1. Indemnity; Additional Fees 26 Section 9.2. Survival of Agreements and Representations 27 Section 9.3. Modifications, Consents and Waivers 27 Section 9.4. Entire Agreement 27 Section 9.5. Remedies Cumulative 27 Section 9.6. Further Assurances 27 Section 9.7. Notices 27 Section 9.8. Construction; Governing Law 29 Section 9.9. Waiver of Jury Trial 29 Section 9.10. Jurisdiction 29 Section 9.11. Relationship of the Borrowers and the Bank 30 Section 9.12. Severability 30 Section 9.13. Ending Effect; Assignment 30 Section 9.14. Counterparts 31 Section 9.15. Joint and Several Obligations 31 APPENDIX A TO LOAN AGREEMENT -- DEFINITIONS A-1 Exhibit 2.1 Form of Note Exhibit 2.1(a) Form of Borrower's Request
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PAGE Exhibit 2.6 Form of Irrevocable Instructions and Power of Attorney Schedule 3.5 Judgments, Actions, Proceedings Schedule 3.9 Title to Properties; Leases Schedule 3.11 Pending Litigation on Intellectual Property Rights Schedule 3.15 ERISA Schedule 3.16 Environmental Compliance Schedule 3.20 Subsidiary or Affiliate Schedule 3.21 Pending Litigation Claims Schedule 5.6 Insurance In Effect Schedule 8.1(j) Borrowers' Cash Investment Policies
5 LOAN AGREEMENT THIS LOAN AGREEMENT (the "Agreement") is made as of July 31, 1997 by and among GENOME THERAPEUTICS CORP., a Massachusetts corporation ("Genome"), COLLABORATIVE SECURITIES CORP., a Massachusetts corporation ("Collaborative", and jointly and severally together with Genome, the "Borrowers"), and THE SUMITOMO BANK, LIMITED, a Japanese banking corporation (the "Bank"). The Borrowers and the Bank hereby agree as follows: ARTICLE I DEFINITIONS SECTION 1.1 DEFINITIONAL PROVISIONS. (a) Capitalized terms used in this Agreement and defined in APPENDIX A hereto, which APPENDIX A is attached to this Agreement and by this reference made a part hereof, shall have the respective meanings specified in such APPENDIX A. (a) All terms defined in APPENDIX A shall have such defined meanings when used in any certificate or any other document made or delivered pursuant to this Agreement unless otherwise defined in such other document or certificate. (a) All accounting terms not specifically defined in this Agreement or in APPENDIX A hereto shall be construed in accordance with generally accepted accounting principles as in effect in the United States of America on the date of this Agreement. ARTICLE II LOAN SECTION 2.1 TERM NOTE. (a) Subject to the terms and conditions of this Agreement, the Bank shall loan to the Borrowers from time to time between the Closing Date through the Advance Termination Date upon three (3) Business Days prior written notice to the Bank in the form of EXHIBIT 2.1(a) hereto, an aggregate principal amount of up to Six Million Dollars ($6,000,000) (the "Loan"). The Bank will make an initial Disbursement to the Borrowers on the Closing Date in the amount of Two Million Five Hundred Thousand Dollars ($2,500,000). The Borrowers may request additional Disbursements hereunder following the Closing Date in principal amounts of not less than $500,000, provided that the aggregate of the principal amount of all Disbursements (including the one being requested) shall not exceed $6,000,000. The obligation of the Borrowers to repay the Loan and to pay interest and all other costs and charges payable hereunder is joint and several and will be evidenced by a promissory note in the form of EXHIBIT 2.1 (the "Note") dated the Closing Date and payable to the order of the Bank in the original principal amount of Six Million Dollars ($6,000,000). (a) The Loan shall bear interest, and the Borrowers shall pay interest on the outstanding principal balance of the Loan from the date of each Disbursement to the Borrowers until the Maturity Date, at the following rates per annum: (i) with respect to any portion of such Loan which is a Eurodollar Rate Loan Portion, interest at a rate per annum on such Eurodollar Rate Loan Portion equal (at all times during each applicable Interest Period) to the Reserve Adjusted Eurodollar Rate for such applicable Interest Period plus the Applicable Margin; and (i) with respect to each portion of such Loan which is not a Eurodollar Rate Loan Portion, interest at a rate per annum on each such Loan Portion equal to the Prime Rate. Except for the initial Disbursement to be made hereunder on the Closing Date, not later than 12:00 noon (Chicago time) on the third Business Day prior to the funding of the Loan, the Borrowers shall provide written notice ("Eurodollar Notice") to the Bank of the dollar amount of any Disbursement which will be a Eurodollar Rate Loan Portion for the initial Interest Period. In the event that the Borrowers fail to provide the Eurodollar Notice in accordance with the preceding sentence or if an Event of Default has occurred and is continuing , then the outstanding principal balance of the Loan shall bear interest at the Prime Rate until such time as Borrowers have given an Election Notice in accordance with Section 2.1(c) below. Computations of interest will be on the basis of a 360 day year, for actual days elapsed with respect to interest accruing. (a) The Borrowers, upon written notice (the "Election Notice") given to the Bank by not later than 12:00 noon (Chicago time) on the third Business Day prior to the expiration of the Interest Period for any Eurodollar Rate Loan Portion in the case of any continuation of a Eurodollar Rate Loan Portion as such, and not later than 12:00 Noon (Chicago time) on the conversion date in the case of any conversion into a Prime Rate Loan Portion, may elect: (1) to continue such portion or any part thereof as a Eurodollar 6 Rate Loan Portion for the next succeeding Interest Period; or (2) to convert such portion or any part thereof to a Prime Rate Loan Portion; or (3) a combination thereof, effective the last day of such Interest Period. At the end of each applicable Interest Period, in the absence of a timely effective Election Notice to continue the applicable Loan Portion as a Eurodollar Rate Loan Portion, such Loan Portion shall bear interest at the Prime Rate. Notwithstanding anything herein to the contrary, if at the end of an applicable Interest Period for a Eurodollar Rate Loan Portion, an Event of Default has occurred and is continuing, then the Borrower shall have no right to give an Election Notice, and the Bank may ignore any attempt by the Borrower to give an Election Notice. (a) An Election Notice with respect to any Eurodollar Rate Loan Portion shall contain the following information: (i) the dollar amount (if any) which is to be continued as a Eurodollar Rate Loan Portion; and (i) with respect to the dollar amount to be continued as a Eurodollar Rate Loan Portion, the new Interest Period. Notwithstanding anything herein to the contrary, the outstanding Loan balance may not at any time be comprised of more than five (5) Eurodollar Rate Loan Portions at the same time without the Bank's consent, which shall be in the Bank's sole and absolute discretion. Once received by the Bank, any Election Notice will be irrevocable for the applicable Eurodollar Rate Loan Portion for the applicable Interest Period. The Borrowers hereby authorize the Bank to record on schedule(s) annexed to the Note (a) the date and amount of each Loan Portion; (b) the term of the Interest Period for each Eurodollar Rate Loan Portion; (c) the interest rate or rates for each Prime Rate Loan Portion and the effective date(s) of all changes in such rates; and (d) the date and amount of each principal and interest payment on each Loan Portion made by the Borrowers, and the Borrowers agree that all such notations shall constitute PRIMA FACIE evidence of the matters noted absent manifest error, provided that the failure of the Bank to record such information shall not reduce or affect the obligations of the Borrowers hereunder or under the Note. (a) In the event that on the date for determining the Reserve Adjusted Eurodollar Rate to be paid by the Borrowers in respect of any Interest Period, the Bank determines in good faith (which determination will be conclusive and binding on the Borrower) that 7 by reason of circumstances affecting the London Interbank Eurodollar market, either Eurodollar rates are not offered in the London Interbank Eurodollar market or adequate and fair means do not exist for ascertaining the Reserve Adjusted Eurodollar Rate for such Interest Period, the Bank shall promptly give to the Borrowers telephonic notice (confirmed as soon as practicable in writing) of such determination. During the existence of such circumstances, any existing Eurodollar Rate Loan Portion in respect of which such circumstances exist will convert to a Prime Rate Loan Portion at the end of the applicable Interest Period. SECTION 2.2 USE OF PROCEEDS. The proceeds of the Loan shall be used by the Borrowers for the purpose of funding or replenishing working capital reserves, funding capital expenditures for enhancement of research and development facilities and acquisition of laboratory equipment and for general corporate purposes. SECTION 2.3 PAYMENTS. (a) The Borrowers will pay interest hereunder as set forth in Section 2.1. The Borrowers will repay the principal amount of the Loan in forty-eight (48) equal consecutive monthly installments of principal (each installment being in an amount sufficient to amortize the outstanding principal balance of the Loan over a period of forty-eight (48) months), payable on the first Business Day of each calendar month commencing with the first payment due on July 1, 1998 and continuing until the Maturity Date, on which date the Borrowers shall make a final payment in an amount equal to all the then unpaid principal of the Loan and all unpaid interest thereon. Notwithstanding the foregoing, repayment of the Loan and all accrued and unpaid interest thereon may be accelerated upon the occurrence and continuance of an Event of Default. (a) The Borrowers shall make all payments hereunder in U.S. Dollars and in immediately available funds at the Bank's office at 233 S. Wacker Drive, Suite 5400, Chicago, Illinois 60606 (or at such other office as the Bank may notify the Borrowers in writing) via wire transfer to Sumitomo Bank, Limited, Chicago Branch, ABA 071001850, through the Federal Reserve Bank of Chicago, Reference: Genome Therapeutics Corp. Payments not made prior to 12:00 noon (Chicago time) on the date of payment will be deemed paid on the next Business Day. Payments which fall due on a day which is not a Business Day will be payable on the next Business Day, with interest to accrue to such date of payment. All payments hereunder and under the Note shall be made without set-off or counterclaim and in such amounts as may be necessary in order that all such payments shall not be less than the amounts otherwise specified to be paid under this Agreement or the Note, as the case may be. 8 (a) Any installment of interest only or of principal and interest paid more than five (5) days late or any other amount payable hereunder which is not paid when due, will bear (and the Borrowers shall pay) interest (to the extent permitted by law) from such due date until such unpaid amount has been paid in full (whether before or after judgment) at a rate per annum equal to three and one-half percent (3.5%) in excess of the rate then applicable to each Loan Portion until the end of any Interest Period then applicable to such Loan Portion and thereafter at a rate per annum equal to three and one-half percent (3.5%) in excess of the Prime Rate ("Default Rate"). (a) In partial consideration for the Bank making the Loan to the Borrowers, the Borrowers shall pay to Bank: (i) a loan disbursement fee ("Loan Fee") in an amount equal to one and one-eighth percent (1.125%) of each Disbursement amount being made, such Loan Fee to be due and payable at the time of funding such Disbursement, and (ii) during the period that the Bank has any lending commitment hereunder, a commitment fee ("Commitment Fee") in an amount equal to one quarter of one percent (0.25%) per annum of any portion of the Loan not disbursed to the Borrowers, with such Commitment Fee to be due and payable, in arrears, on the last Business Day of each calendar quarter and calculated on the actual daily amount of the undisbursed portion of the Loan, provided that when any Disbursement occurs, the Commitment Fee which has accrued on the portion of the unutilized Loan being disbursed shall be credited against the Loan Fee payable with respect to such Disbursement, and only the net amount of such Loan Fee shall be payable at the time of such Disbursement. From and after the Closing Date, Borrowers hereby authorize Bank to deduct and pay any and all Loan Fees (including such fee for the initial Disbursement made on the Closing Date), all Commitment Fees and any and all other reasonable fees and expenses of the Bank from the available proceeds of the Loan. SECTION 2.4 PREPAYMENTS. Subject to this Section 2.4, the Borrowers may, upon five (5) Business Days' prior notice to the Bank, prepay the outstanding amount of the Loan in whole or in part. In the event that the Borrowers prepay or are required to prepay any Eurodollar Rate Loan Portion by acceleration or otherwise or fails to draw down or convert to a Eurodollar Rate Loan Portion after giving notice thereof, the Borrowers agree to reimburse the Bank for its expenses, funding losses and loss of anticipated profits due to such prepayment or failure to draw. The Borrowers and the Bank hereby agree that such expenses, funding losses and loss of anticipated profits shall consist of the sum of: (a) Principal amount of each such Eurodollar Rate Loan Portion times (([number of days between the date of prepayment 9 and the last day in the applicable Interest Period] divided by 360), times the applicable Interest Differential); plus (a) All actual out-of-pocket expenses (other than those taken into account in the calculation of the Interest Differential) incurred by the Bank (excluding allocations of any expense internal to the Bank) and reasonably attributable to such payment or prepayment. Notwithstanding the foregoing, no prepayment fee shall be payable (and no credit or rebate shall be required) if the product of the foregoing formula is not a positive number. The Loan is not in a nature of a revolving loan; therefore, amounts prepaid or repaid under the Note may not be reborrowed. SECTION 2.5 INDEMNIFICATION; INCREASED COSTS. If after the date of this Agreement the Bank reasonably determines that any Regulatory Change, or compliance by the Bank with any request or directive (whether or not having the force of law) of any governmental authority, central bank or comparable agency charged with the interpretation or administration of any applicable law, rule or regulation which is effective or issued after the date hereof: (a) Subjects the Bank to any tax, duty or other charge with respect to the Loan or the Note, or changes the basis of taxation of payments to the Bank of the principal of or interest on the Loan or any other amounts due under this Agreement in respect of the Loan except for changes in the rate of tax on the overall net income of the Bank or its lending office imposed by the Commonwealth of Massachusetts or the jurisdictions in which the Bank's principal executive office or applicable lending office is located) (such non-excluded amounts, "Taxes"); or (a) Imposes, modifies or deems applicable any reserve (including, without limitation, any reserve imposed by the Board of Governors of the Federal Reserve System), special deposit, liquidity, capital maintenance, capital adequacy, capital ratio (including, but without limitation thereto, any request by or requirement of any regulatory body or official which affects the manner in which the Bank allocates capital resources to its obligations hereunder), for the account of, or credit extended by, the Bank or imposes on the Bank any other condition affecting the Loan, or the Note; and the result of any of the foregoing is to (A) impose a cost on or increase the cost to the Bank of making or maintaining the Loan, or (B) cause an increase in any capital requirement arising out of the making or maintenance of the Loan or any obligation to the Borrower hereunder or (C) reduce the amount of any sum received or 10 receivable by the Bank under this Agreement or under the Note, by an amount deemed by the Bank to be material, then, within ten (10) days after demand by the Bank, the Borrowers shall pay for the account of the Bank such additional amount or amounts as will compensate the Bank for such increased cost or reduction as such cost or reduction is incurred by the Bank. If the Bank makes any claim for compensation under this Section 2.5, the Borrowers may immediately elect by written notice (or telephonic notice confirmed as soon as practicable in writing) to the Bank to prepay the Loan (but subject to payment of any other amounts due under Section 2.4 and this Section 2.5, including any increased cost or reduction incurred through the date of such prepayment or conversion). The Bank shall promptly notify the Borrowers of any event of which it has knowledge, occurring after the date hereof, which will entitle the Bank to compensation pursuant to this Section 2.5. The Bank shall provide to the Borrowers a certificate claiming compensation under this Section 2.5, setting forth the additional amount or amounts to be paid to it hereunder and showing in reasonable detail the Bank's calculation thereof which shall be presumed to be correct absent manifest error. In determining such amount, the Bank may use any reasonable averaging and attribution methods. The Bank shall exercise reasonable efforts to promptly provide the Borrowers with notice of the imposition, or overtly threatened exercise of, any Regulatory Change set forth in this Section 2.5 of which the Bank has actual knowledge, provided, however, that the failure by the Bank to so provide such notice will not relieve the Borrowers of any of their obligations hereunder. The Bank agrees that it will use reasonable efforts to reduce or eliminate any claim for compensation pursuant to this Section 2.5, including designating a different lending office for the Loans, if such designation will avoid the need for or reduce the amount of any such compensation, PROVIDED that the Bank will not be obligated to take any actions that would, in the sole opinion of the Bank, be disadvantageous to the Bank in any material respect (it being understood that the incurrence of any unreimbursed cost or expense by the Bank that would not have been incurred but for such action is material). SECTION 2.6 INVESTMENT ACCOUNT AND CUSTODIAN ACCOUNT. (a) Prior to the occurrence of a Trigger Event, the Borrowers shall hold at all times Cash and Cash Equivalents, which are not subject to any Lien or claim of any Person other than the Bank, in an amount not less than an amount equal to the then outstanding principal balance due under the Loan plus three (3) months interest thereon at the then applicable rate provided for herein, in a custodial account (the "Investment Account") with an institution approved by the Bank (such institution being referred to herein as the "Custodian"). The initial Custodian will be Oppenheimer & Co., 11 Inc. The amounts held in the Investment Account shall be subject to the investment control of the Borrowers. The Custodian in respect of the Investment Account cannot be changed or a new Investment Account opened without the Bank's prior written approval, which approval shall not be unreasonably withheld. The Borrowers shall deliver to the Custodian the Irrevocable Instructions and Power of Attorney in the form of EXHIBIT 2.6 (the "Irrevocable Instructions and Power of Attorney"). (a) On or before the Closing Date, the Borrowers, for the benefit and on behalf of the Bank, shall establish and maintain or cause to be established and maintained in the name of the Borrowers an account (the "Custodian Account") with Sumitomo Bank of New York Trust Company (the "Bailee") under the Custodian Agreement and the Collateral Bailment Agreement. Pursuant to the Restricted Account and Security Agreement by and between the Bank and the Borrowers, the Borrowers have granted to the Bank a security interest in all of its right, title and interest in the Custodian Account, all deposits or investments held therein and all proceeds thereof to secure payment and performance of the Borrowers' obligations hereunder. On or before the Closing Date, the Borrowers shall cause to be deposited in the Custodian Account the sum of One Thousand Dollars ($1,000). So long as the Borrowers are indebted to the Bank hereunder and until payment in full of the Note and the Borrowers' full and complete performance of its obligations hereunder, the Custodian Account shall at all times have a Restricted Account Balance of not less than One Thousand Dollars ($1,000). The terms and conditions of the Restricted Account and Security Agreement, the Collateral Bailment Agreement, and the Custodian Agreement are incorporated herein by reference. SECTION 2.7 CHANGE IN LEGALITY. (a) In the event that at any time the Bank shall have reasonably determined (which determination shall be presumed to be correct until the contrary shall have been established) that by reason of a change in any law or regulation or in the interpretation thereof by any governmental authority charged with the interpretation thereof affecting the Bank or the Eurodollar market and applicable to any Eurodollar Rate Loan Portion, the making or continuation of a loan at the applicable Reserve Adjusted Eurodollar Rate plus the Applicable Margin has become unlawful, the Bank shall forthwith give written notice (or telephonic notice, confirmed as soon as practicable in writing) to the Borrowers and the obligation of the Bank to make or maintain such Eurodollar Rate Portion at the applicable Reserve Adjusted Eurodollar Rate plus the Applicable Margin shall terminate and the Borrowers shall forthwith upon receipt of notice of such determination prepay such Eurodollar Rate Loan Portion without premium or penalty (subject to Sections 2.4 and 2.5), together with all interest accrued on the amount 12 prepaid to the date of prepayment. A certificate, setting forth (x) each event which the Bank shall have determined makes the continuation of such Eurodollar Rate Loan Portion unlawful and (y) any additional amounts payable by the Borrowers under Sections 2.4 and 2.5 (and the basis therefor and the Bank's computation thereof) upon prepayment of such Eurodollar Rate Loan Portion, shall be furnished to the Borrowers by the Bank and shall be presumed correct absent manifest error. (a) In the event that the Borrowers are obligated to prepay a Eurodollar Rate Loan Portion pursuant to clause (a) of this Section 2.7, the Borrowers shall have the right, upon written notice (or telephonic notice confirmed as soon as practicable in writing) to the Bank, in lieu of such prepayment, to elect to convert such Eurodollar Rate Portion to a Prime Rate Loan Portion, effective on the date on which such prepayment would otherwise be required to have been made, provided that on the effective date of conversion the Borrowers also shall pay all interest accrued on the amount converted to the date of conversion and such additional amounts, if any, payable by the Borrowers under Section 2.4 and 2.5, as specified in the certificate furnished the Borrowers pursuant to said clause (a). ARTICLE III REPRESENTATIONS AND WARRANTIES Each of the Borrowers hereby represents and warrants to the Bank that: SECTION 3.1 ORGANIZATION. It is a corporation duly organized, validly existing and in good standing under the laws of the Commonwealth of Massachusetts; it has the power to own its assets, to transact the business in which it is presently engaged and in which it proposes to be engaged and is duly qualified and in good standing in each jurisdiction in which the failure to qualify to do business would materially adversely affect its financial condition and business operations. SECTION 3.2 POWER, AUTHORITY, CONSENTS. (a) It has the power to execute, deliver and to perform its obligations under the Loan Documents. (a) It has the power to borrow hereunder and has taken all necessary action to authorize the borrowing hereunder on the terms and conditions of this Agreement. (a) It has taken all necessary corporate action to authorize the execution, delivery and performance of the Loan Documents. (a) No consent or approval of any Person, no waiver of any Lien or right of distraint or other similar right and no consent, license, approval, authorization or declaration of any governmental authority, bureau or agency is or will be required in connection with the execution and delivery of the Loan Documents by it or the performance by it of its obligations thereunder or the validity, enforcement or priority of the Loan Documents, or any Lien created and granted thereunder, except such consents as have been obtained and copies of which have been delivered to the Bank. SECTION 3.3 NO VIOLATION OF LAW OR AGREEMENTS. The execution and delivery of the Loan Documents and the performance by it of its obligations thereunder, will not violate any provision of law and will not conflict with or result in a breach of any order, writ, injunction, ordinance, resolution, decree, or other similar document or instrument of any court or governmental authority, bureau or agency, domestic or foreign, its charter or bylaws or create (with or without the giving of notice or lapse of time, or both) a default under or breach of any agreement, bond, note or indenture to which it is a party, or by which it is bound or any of its properties or assets is affected, or result in the imposition of any Lien of any nature whatsoever upon any of the properties or assets owned by or used in connection with its business. SECTION 3.4 DUE EXECUTION, VALIDITY, ENFORCEABILITY. This Agreement and each of the other Loan Documents has been, or upon the execution and delivery thereof, will be, duly executed and delivered by it, and each constitutes, or, upon the execution and delivery thereof, will constitute, its valid and legally binding obligation enforceable in accordance with its terms, except to the extent that the enforcement thereof may be limited by applicable bankruptcy, moratorium, insolvency, reorganization, or other similar laws or equitable principles relating to the enforcement of creditors' rights generally. SECTION 3.5 JUDGMENTS, ACTIONS, PROCEEDINGS. Except as set forth in Schedule 3.5, there are no outstanding judgments, actions (including, without limitation, derivative actions), suits or proceedings pending before any court or governmental authority, bureau or agency, having a claim or amount in controversy that exceeds $100,000 in any one instance or $500,000 in the aggregate at any one time with respect to or, to the best of its knowledge, threatened against or affecting either of the Borrowers. SECTION 3.6 NO DEFAULTS, COMPLIANCE WITH LAWS. It is not in material default under any agreement, ordinance, resolution, decree, bond, note, indenture, order or judgment to which it is a 13 party or by which it is bound (including, without limitation, any collaborative agreements), or its charter documents or bylaws, or any other agreement or other instrument by which any of the properties or assets owned by it or used in the conduct of its business is affected or evidencing, guaranteeing or relating to any outstanding indebtedness, liability or obligation for borrowed money or lease obligations, which default could have a material adverse effect on its business, operations, financial condition or properties, or on its ability to perform its obligations under the Loan Documents. It has complied and is in compliance in all material respects with all applicable federal, state, local and other laws, ordinances and regulations, including, without limitation, the statutes, rules and regulations of the Food and Drug Administration and the Nuclear Regulatory Commission, the non-compliance with which could have a material adverse effect on its business, operations, financial condition or properties, or on its ability of to perform its obligations under the Loan Documents, and it has not received notice and has no knowledge of any violations or alleged violations by either of the Borrowers of any of the foregoing. SECTION 3.7 NO MATERIALLY ADVERSE CONTRACTS, ETC. It is not subject to any charter, corporate or other legal restriction, or any judgment, decree, order, rule or regulation that has, or is expected in the judgment of its officers to have a materially adverse effect on its business, assets or financial condition. It is understood that the preceding sentence shall not apply to government rules and regulations which affect the Borrowers in the same general manner as they do other companies similar to Borrowers such as general tax laws and rules regulating the sale of pharmaceuticals in countries throughout the world. It is not a party to any contract or agreement that has or is expected, in the judgment of its officers, to have any materially adverse effect on its business. SECTION 3.8 FINANCIAL STATEMENTS. (a) It has furnished to the Bank its most recent audited Financial Statements and all subsequent unaudited Financial Statements which are available to the public. Each of the Financial Statements is correct and complete in all material respects and presents fairly its financial condition, at its date or for the respective period, and has been prepared in accordance with generally accepted accounting principles. (a) It has no material obligation, liability or commitment, direct or contingent, which is not reflected in the Financial Statements or in any notes thereto in accordance with generally accepted accounting principles. (a) There has been no material adverse change in its financial position or operations since the date of the Financial Statement for the fiscal quarter ending March 1, 1997. (a) Its fiscal year is the twelve (12) month period ending on August 31 in each year. SECTION 3.9 TITLE TO PROPERTIES; LEASES. Except as disclosed in the footnotes to the Financial Statements or on Schedule 3.9, it owns all of the assets reflected in the most recent balance sheet or acquired since that date (except property and assets leased, sold or otherwise disposed of in the ordinary course of business since that date), subject to no rights of others, including any mortgages, ordinary or capital leases, conditional sales agreements, title retention agreements, liens or other encumbrances. SECTION 3.10 PRIORITY OF LIENS. The Liens which have been or will be created and granted by the Loan Documents upon the execution and delivery thereof constitute, or will constitute upon such execution and delivery, valid first priority Liens on the properties and assets covered by the Loan Documents, subject to no other liens. SECTION 3.11 PATENTS, COPYRIGHTS, LICENSES, ETC. It owns or has a valid right to use all patents, copyrights, trademarks, trade names, licenses, franchises, and rights in respect of the foregoing ("Intellectual Property Rights"), adequate for the conduct of its business substantially as now conducted without conflict with any rights of others, and there are no suits or claims for infringement with respect to the Intellectual Property Rights except as set forth in Schedule 3.11. Schedule 3.11 lists all pending suits or claims for infringement with respect to Intellectual Property Rights. SECTION 3.12 TAX RETURNS. (a) It has filed all federal and state income tax returns and all other tax returns, reports, and declarations required to be filed by it and has not failed to pay any taxes, or interest and penalties relating thereto, on or before the due dates thereof except for returns, taxes, interest or penalties with respect to which it has duly filed extensions or is contesting the validity thereof by appropriate legal proceedings diligently conducted in good faith. No audits of its federal income tax returns are pending. (a) Except to the extent that reserves therefor are reflected in the Financial Statements, (i) it has no material federal, state or local tax liabilities due or to become due for any tax year ended on or prior to the date of the most recent balance sheet included in the Financial Statements, whether incurred in respect of or measured by the income of such entity, which are not properly reflected in such balance sheet, and (ii) it has no material claims pending or, to its knowledge proposed or threatened against it for past federal, state or local taxes. SECTION 3.13 REGULATION U; MARGIN STOCK. No part of the proceeds from the Loan will be used directly or indirectly for the purpose of purchasing or carrying, or for payment in full or in part of indebtedness which was incurred for the purposes of purchasing or carrying, any margin stock as such term is defined in Regulation U of the Board of Governors of the Federal Reserve System, 12 C.F.R., Chapter II, Part 221. It does not own margin stock. SECTION 3.14 FULL DISCLOSURE. Neither the Financial Statements nor any certificate, opinion, or any other statement made or furnished in writing to Bank by or on behalf of the Borrower in connection with this Agreement or the transactions contemplated herein, contains any untrue statement of a material fact, or omits to state a material fact necessary to make the statements contained therein or herein, in light of the circumstances under which they were made, not misleading. SECTION 3.15 ERISA. (a) With the exceptions of its 401(K) plans, certain other employee benefit plans, all as set forth in Schedule 3.15, none of its or any of its Affiliates has pension or other employee benefit plans which are subject to the provisions of Title IV of ERISA (any such plans which have been or may hereafter be adopted or assumed by it are hereinafter referred to individually as a "Plan" and, collectively, as the "Plans"). In connection with the Plans, it does not have, or know of any likely event which will give rise to, any direct or contingent material liabilities of it to the Pension Benefit Guaranty Corporation ("PBGC"), the Department of Labor or the Internal Revenue Service ("IRS"). (a) Neither it nor any of its Affiliates is a participating employer in any Plan under which more than one employer makes contributions as described in Sections 4063 and 4064 of ERISA. (a) Neither it nor any of its Affiliates is a participating employer in a multiemployer plan as defined in Section 4001(a) of ERISA, which participation could give rise to material withdrawal liability on the part of the Borrower, as the case may be under Subtitle E of Title IV of ERISA. For purposes of this Agreement, all references to "ERISA" shall be deemed to refer to the Employee Retirement Income Security 14 Act of 1974 (including any sections of the Code) as heretofore amended and as it may hereafter be amended or modified, and all regulations promulgated thereunder, and all references to the Borrower in this Section 3.15, or in any other Section of this Agreement relating to ERISA, shall be deemed to refer to the Borrower and all other entities which are part of a Controlled Group with respect to the Borrower. SECTION 3.16 ENVIRONMENTAL COMPLIANCE. Except as set forth in Schedule 3.16, it has taken all necessary steps to comply with Environmental Laws (as hereinafter defined) and has determined that: (a) It is not in violation, or alleged violation, of any judgment, decree, order, law, license, rule or regulation pertaining to environmental matters, including without limitation, those arising under the Resource Conservation and Recovery Act ("RCRA"), the Comprehensive Environmental Response, Compensation and Liability Act of 1980 as amended ("CERCLA"), the Superfund Amendments and Reauthorization Act of 1986 ("SARA"), the Federal Clean Water Act, the Federal Clean Air Act, the Toxic Substances Control Act, each as amended as of the date hereof, or any other federal, state or local statute, regulation, ordinance, order or decree relating to health, safety or the environment (hereinafter "Environmental Laws"), which violation would have a material adverse effect on its business, assets or financial condition; (a) It has not received notice from any third party including, without limitation, any federal, state or local governmental authority, (i) that it has been identified by the United States Environmental Protection Agency ("EPA") as a potentially responsible party under CERCLA with respect to a site listed on the National Priorities List, 40 C.F.R. Part 300 Appendix B (1986); (ii) that any hazardous waste, as defined by 42 U.S.C. ss. 9601(5), any hazardous substances as defined by 42 U.S.C. ss. 9601(14), any pollutant or contaminant as defined by 42 U.S.C. ss.9601(33) and any toxic substances, oil or hazardous materials or other chemicals or substances regulated by any Environmental Laws ("Hazardous Substances") which it has generated, transported or disposed of has been found at any site at which a federal, state or local agency or other third party has conducted or has ordered that it conduct a remedial investigation, removal or other response action pursuant to any Environmental Law; or (iii) that it is or shall be a named party to any claim, action, cause of action, complaint, or legal or administrative proceeding (in each case, contingent or otherwise) arising out of any third party's incurrence of costs, expenses, losses or damages of any kind whatsoever in connection with the release of Hazardous Substances; (a) (i) the properties on which it conducts its business have not been used for the handling, processing, storage or Disposal of Hazardous Substances except in accordance with applicable Environmental Laws; (ii) in the course of any activities conducted by it, no Hazardous Substances have been generated or are being used on property leased by it on which it conducts its business except in accordance with applicable Environmental Laws; (iii) there has been no Release or threatened Release of Hazardous Substances by it on, upon, into or from the properties on which it operates its business, which Release would have a material adverse effect on its business; (iv) to the best of its knowledge, there have been no Releases on, upon, from or into any real property in the vicinity of any of the properties on which either of Genome or Collaborative conducts its business, through soil or groundwater contamination, which may have come to be located on, and which would have a material adverse effect on its business; and (v) in addition, any Hazardous Substances that have been generated by it on the properties on which it conducts its business have been transported off-site only by carriers having an identification number issued by the EPA, treated or Disposed of only by treatment or disposal facilities maintaining valid permits as required under applicable Environmental Laws, which transporters and facilities have been and are, to the best of its knowledge, operating in compliance with such permits and applicable Environmental Laws; and (a) none of the properties on which it conducts its business is or is expected to be in violation of any applicable environmental clean-up responsibility law or regulation or environmental restrictive transfer law or regulation, in regard to which failure to comply would have a material adverse effect on its business, assets or financial condition. SECTION 3.17 OTHER REGULATIONS. It is not subject to regulation under the Investment Company Act of 1940, the Public Utility Holding Company Act of 1935, the Federal Power Act, the Interstate Commerce Act, any state public utilities code or any federal or state statute or regulations limiting its ability to incur Indebtedness. SECTION 3.18 COMPLIANCE WITH SECURITIES LAWS. All offers and sales of its securities have been made in material compliance with all applicable federal and state securities laws, including without limitation the Securities Act of 1933 and the Securities Exchange Act of 1934, both as amended. SECTION 3.19 SOLVENCY. It is solvent and is not the subject of a bankruptcy or insolvency proceeding. SECTION 3.20 SUBSIDIARIES OR AFFILIATES. Except for Collaborative being a wholly-owned subsidiary of Genome and as otherwise set forth on Schedule 3.20, it does not have any Subsidiary or Affiliate. SECTION 3.21 PENDING LITIGATION. Except as set forth in Schedule 3.21, there are no lawsuits or claims pending against it which could have a material adverse affect on its financial condition or the financial condition of the Borrowers taken as a whole. SECTION 3.22 COMPLIANCE WITH INVESTMENT POLICY. It is in compliance with its "Investment Policy" for investment of Cash and Cash Equivalents (as mandated and adopted by Genome's and Collaborative's Board of Directors). True and correct copies of such Investment Policy is attached as Schedule 8.1(j). SECTION 3.23 NUCLEAR REGULATORY COMPLIANCE. It is in compliance with all rules, regulations, orders, decrees, findings or other determinations pertaining to matters regulated, reviewed or overseen by the Nuclear Regulatory Commission. Upon request by the Bank, it shall furnish reasonable evidence of such compliance. ARTICLE IV CONDITIONS PRECEDENT SECTION 4.1 CONDITIONS PRECEDENT TO THE EFFECTIVENESS OF THIS AGREEMENT. The effectiveness of this Agreement and the obligations of the Bank hereunder shall be subject to the following conditions precedent: (a) Each of the Borrowers will have executed and delivered to the Bank the Note, the Collateral Bailment Agreement, the Restricted Account and Security Agreement, the Irrevocable Instructions and Power of Attorney, the Custodian Agreement, the Financing Statement and an original counterpart of this Agreement. (a) The Bailee will have executed and delivered the Collateral Bailment Agreement, the Custodian Agreement and the Restricted Account and Security Agreement; (a) The initial Custodian will have executed and delivered its consent to the Irrevocable Instructions and Power of Attorney to the Bank; (a) The Borrowers shall have deposited, in the aggregate, One Thousand Dollars ($1,000) into the Custodian Account; (a) Each of the Borrowers will have otherwise fully complied with all of the terms and conditions of the Loan Documents; 15 (a) Each of the Borrowers will have delivered to the Bank the following, in form and substance acceptable to the Bank: (i) a copy of its Articles of Organization certified by the Secretary of the Commonwealth of the Commonwealth of Massachusetts; (i) a copy of its by-laws certified by its Clerk; (i) a copy of resolutions of its Board of Directors authorizing its execution, delivery and performance of this Agreement, the Note, the Loan Documents and all instruments and documents provided for herein or therein, certified by its Clerk; (i) a good standing certificate for each of the Borrowers, dated as of a date not more than ten (10) days prior to the Closing Date from the Secretary of the Commonwealth of the Commonwealth of Massachusetts; and (i) an incumbency certificate with respect to its officers, certified by its Clerk. (a) Counsel of each of the Borrowers will have delivered to the Bank its favorable legal opinion as to the due organization, existence, qualification to do business, and good standing of each of Genome and Collaborative, the due authorization, execution and enforceability of this Agreement and the other Loan Documents, the absence of pending and threatened litigation, the non-contravention of other documents, instruments, laws, and regulations, and such other matters as the Bank may require, in form and substance reasonably satisfactory to the Bank; (a) The Bank shall have received the Loan Fee with respect to the initial Disbursement and all other fees and expenses (including, without limitation, Bank's legal fees and expenses incurred in the negotiation and preparation of the Loan Documents and any other fees and expenses of the Bank for UCC searches or filing fees) required to be paid to Bank on or before the Closing Date; (a) All representations and warranties of the Borrowers contained herein are true and correct as of the Closing Date and each of Genome and Collaborative will have executed and delivered to Bank such certificates with respect thereto as Bank may require; (a) There shall have occurred no materially adverse change in the financial condition, business or prospects of either Genome or 16 Collaborative between the date of the most recent Financial Statements of them provided to the Bank and the Closing Date; (a) Each of Genome and Collaborative shall have provided the Bank or has caused to be provided to the Bank by the Custodian a current list of investments held in the Custodian Account and which is in form satisfactory to the Bank. ARTICLE V AFFIRMATIVE COVENANTS So long as the Borrowers are indebted to the Bank hereunder, and until payment in full of the Note and full and complete performance of all of its other obligations arising hereunder (except for the Borrowers' obligations under Section 5.7 or Section 9.1 to indemnify the Bank under certain circumstances following the payment of the Note), each of the Borrowers shall in all material respects: SECTION 5.1 BOOKS AND RECORDS. Keep proper books of record and account in a manner reasonably satisfactory to the Bank in which full true and correct entries shall be made of all dealings or transactions in relation to its business and activities. SECTION 5.2 INSPECTIONS AND AUDITS. Permit the Bank to make or cause to be made reasonable inspections and audits of any of its books, records and papers and to make extracts therefrom and copies thereof at all such reasonable times and as often as the Bank may reasonably require, provided, however, that certain areas of the Borrowers' facilities may be restricted for reasons of health and safety and the Bank will not be permitted access to such restricted areas. SECTION 5.3 PERFORM OBLIGATIONS. Pay and discharge all of its obligations and liabilities including, without limitation, all taxes, assessments and governmental charges upon its income and properties, when due, unless and to the extent only that such obligations, liabilities, taxes, assessments and governmental charges are contested in good faith and by appropriate proceedings and that, to the extent required by generally accepted accounting principles then in effect, proper and adequate book reserves relating thereto are established by the Borrowers, and provided that the Bank is reasonably satisfied that the Accounts are not in danger of being the subject of a Lien (except to the extent permitted by Section 7.1) or sold, forfeited or lost as a result thereof and the Borrowers have provided such security or other assurances as Bank reasonably requests. 17 SECTION 5.4 FEES AND EXPENSES. Pay upon written request by Bank: (i) up to $15,000 towards the costs and expenses (including, without limitation, legal fees, filing fees and UCC search fees, but excluding any Commitment Fee, Loan Fee or other fee payable to the Bank for this Loan) of the Bank in connection with the preparation, execution and delivery of this Agreement and the other Loan Documents; (ii) all costs and expenses of the Bank in enforcing the Borrowers' (or either of them) performance of and compliance with all agreements and conditions contained in the Loan Documents on its part to be performed or complied with or in connection with the negotiation, preparation and execution and delivery of any amendment, modification or supplement of or to, or any consent or waiver under, any such document (or any such instrument which is proposed but not executed and delivered) or relating to any claim or action threatened, made or brought against the Bank arising out of or relating to any extent to the Loan Documents, or the transactions contemplated hereby or thereby; (iii) all costs and expenses (including, without limitation, reasonable fees and disbursements of counsel) suffered or incurred by the Bank in connection with the enforcement or the payment of the Note or any other sum due to it under any of the other Loan Documents or any of its other rights hereunder or thereunder; and (iv) any and all costs and expenses (which, prior to the occurrence of an Event of Default, shall not exceed $1,500 per calendar year) incurred by Bank in conducting lien searches, UCC searches or other due diligence investigations which the Bank determines are necessary to monitor the Borrowers' performance hereunder and which are incurred after the Closing Date. SECTION 5.5 MAINTENANCE OF EXISTENCE; CONDUCT OF BUSINESS. Preserve and maintain its corporate existence and all of its rights, privileges and franchises necessary or desirable in the normal conduct of its business except for transfers (including, without limitation, transfers in the form of paid-up licenses) for reasonably equivalent value in the normal course of its business. The Borrowers shall comply in all material respects with all applicable laws, rules, regulations, orders, writs, decrees and judgments and its charter and bylaws, and with the material terms of all mortgages, indentures, leases, contracts and other agreements and instruments binding upon them. The Borrowers will continue to engage in business of the same general type as now conducted by them. SECTION 5.6 INSURANCE. Maintain with financially sound and reputable insurers insurance with respect to its properties and business against such liabilities, casualties and contingencies and of such types and in such amounts as shall be customary for businesses engaged in similar activities in similar geographic areas. Without limiting the foregoing, the Borrowers will (i) keep 18 all of its physical property insured against fire and extended coverage risks in amounts and with deductibles equal to those generally maintained by businesses engaged in similar activities in similar geographic areas, (ii) maintain all such workers' compensation or similar insurance as may be required by law, and (iii) maintain, in amounts and with deductibles equal to those generally maintained by businesses engaged in similar activities in similar geographic areas, general public liability insurance against claims for bodily injury, death or property damage occurring on, in or about the Borrowers' properties, and business interruption insurance. SCHEDULE 5.6 lists insurance of each of Genome and Collaborative currently in effect. The Borrowers shall furnish to the Bank, from time to time upon the Bank's request, certificates or other evidence satisfactory to the Bank of compliance with the foregoing. At such time as it would be customary for a business engaged in similar activities as Genome or Collaborative to obtain product liability or other insurance not currently maintained by Genome or Collaborative or specified herein, Genome and/or Collaborative, as the case may be, shall obtain and maintain such insurance in accordance with the provisions of this Section. SECTION 5.7 CERTAIN TAXES. (a) If, under any law in effect on the date hereof, or under any law subsequently enacted, it is determined that any U.S. federal, state or local tax is payable in respect of the issuance of the Note, or in connection with the filing or recording of any assignments, mortgages, financing statements, or other documents (whether measured by the amount of indebtedness secured or otherwise) as contemplated by this Agreement, then the Borrowers shall pay any such tax and all interest and penalties thereon, if any, and shall indemnify the Bank against and save it harmless from any loss or damage resulting from or arising out of the nonpayment or delay in payment of any such tax. (a) If any such tax or taxes shall be assessed or levied against the Bank or any other holder of the Note, the Bank, or such other holder, as the case may be, may notify the Borrowers and make immediate payment thereof, together with interest or penalties in connection therewith, and will thereupon be entitled to and shall receive immediate reimbursement therefor from the Borrowers. (a) Notwithstanding any other provision contained in this Agreement, the covenants and agreements of the Borrowers in this Section 5.7 will survive for four years following the payment of the Note and the termination of this Agreement. SECTION 5.8 USE OF PROCEEDS. Use the proceeds of all Disbursements made by the Bank hereunder only for the purpose 19 specified in Section 2.2 -- "Use of Proceeds." Neither Genome nor Collaborative will use any of the proceeds of such Loans, directly or indirectly, for the purpose of purchasing or carrying any margin stock or for the purpose of purchasing or carrying or trading in any securities under such circumstances as to involve Genome, Collaborative or the Bank in a violation of Regulation G, T, U or X issued by the Federal Reserve Board. SECTION 5.9 FURTHER ASSURANCES WITH RESPECT TO ACCOUNTS. Promptly supply the Bank with such information concerning the Investment Account as the Bank may reasonably request from time to time hereafter, including, without limitation, Account statements which shall be delivered not less frequently than quarterly (or more frequently if required pursuant to Section 6.4), which Account statements will summarize the value of deposits and investments in the Accounts. SECTION 5.10 FINANCIAL COVENANTS. The Borrowers on a consolidated basis shall at all times maintain: (i) A maximum ratio of Total Debt to Net Worth, as calculated on a quarterly basis, of 0.50:1; (i) A minimum Current Ratio, as calculated on a quarterly basis, of 1.50:1; (i) A minimum Adjusted Net Cash Level equal to the then outstanding principal balance due under the Note plus Twenty Million Dollars ($20,000,000); (i) A minimum Net Cash Level equal to the then outstanding principal balance due under the Note plus three (3) months interest thereon at the applicable rate provided for herein; (i) A minimum Net Worth of Twenty Million Dollars ($20,000,000); and (i) Cash and Cash Equivalents, which are not subject to any Lien or claim of any Person other than the Bank, on hand in the Investment Account equal to at least the sum of the then outstanding principal balance of the Loan plus three (3) months interest thereon at the then applicable rate provided for herein. The failure of the Borrowers to maintain any of the covenants set forth in this Section 5.10(i)-(v) and/or the occurrence of an Event of Default under Section 8.1 of this Agreement shall be a "Trigger Event." 20 SECTION 5.11 DEPOSITS INTO CUSTODIAN ACCOUNT. Upon the occurrence of a Trigger Event, the Borrowers will make, or, through the Custodian pursuant to the Irrevocable Instructions and Power of Attorney cause to be made, payments or deposits to the Custodian Account such that after giving effect to such payments or deposits the Restricted Account Balance equals or exceeds the Required Restricted Account Balance. At the time of each such payment, the Borrowers will submit to the Bank a statement setting forth the market values of marketable securities and the Restricted Account Balance as of the date of deposit (after giving effect to any deposits made on or before such day). ARTICLE VI DELIVERY OF FINANCIAL REPORTS, DOCUMENTS AND OTHER INFORMATION So long as the Borrowers are indebted to the Bank hereunder and until payment in full of the Note and full and complete performance of all of their other obligations arising hereunder, the Borrowers shall deliver to the Bank: SECTION 6.1 ANNUAL FINANCIAL STATEMENTS. Annually, as soon as available, but in any event within ninety (90) days after the last day of the fiscal year, (i) the balance sheet of the Borrowers as of such last day of the fiscal year and statements of operations, stockholders' equity and cash flows, for such fiscal year, on a consolidated basis, prepared in accordance with generally accepted accounting principles consistently applied, in reasonable detail, audited and opined on by Arthur Anderson LLP or by another firm of independent public accountants reasonably satisfactory to the Bank (which audit opinion shall contain no qualification unsatisfactory to the Bank), to present fairly the financial position and the results of operations of the Borrowers as of the end of such fiscal year and to have been prepared in accordance with generally accepted accounting principles and (ii) calculations, certified by the chief financial officer of each of the Borrowers, demonstrating compliance with the financial covenants set forth in Section 5.10. SECTION 6.2 QUARTERLY FINANCIAL STATEMENTS. As soon as available, but in any event within forty-five (45) days after the end of each fiscal quarter ended on the last day of each November, February and May, (i) balance sheets for the Borrowers as of the last day of each such quarter and statements of operations, and cash flows, for such quarter, all in reasonable detail and on a consolidated basis and (ii) calculations demonstrating compliance with the financial covenants set forth in Section 5.10. Each such statement shall be certified on behalf of the Borrowers by each of 21 the Borrowers' controller or chief financial officer as fairly presenting the financial position and the results of operations of the Borrowers as of the end of such fiscal quarter and as having been prepared in accordance with generally accepted accounting principles consistently applied (subject to normal adjustments). SECTION 6.3 10Q AND 10K FILINGS. At the time its Form 10-Q is released to the public (which in all events shall be within forty-five (45) days after the end of the fiscal quarters ended November, February and May or, if later, the date of the filing of the Form 10-Q with the Securities and Exchange Commission), a copy of each Form 10-Q; and, each year at the time its Form 10K is released to the public (which in all events shall be within one hundred twenty (120) days after the end of the Borrowers' fiscal year), a copy of its Annual Report to Stockholders along with its Form 10K. SECTION 6.4 CASH AND COVENANT REPORTS. The following reports, statements or certificates: (i) at the same time as it delivers the Financial Statements required under the provisions of Sections 6.1 -- "Annual Financial Statements" and 6.2 -- "Quarterly Financial Statements", a report as to the calculations with respect to, and compliance with, the financial covenants set forth in Section 5.10(i) through 5.10(iv); (ii) within twenty (20) days of the end of each calendar quarter, a compliance statement, certified by the Chief Financial Officer of the Borrowers, listing (A) the Borrowers' Adjusted Net Cash Level at the end of such calendar quarter and the domicile of such cash and investments and of the Committed R&D Funds for the next 24 months and (B) the cash balances and Cash Equivalent Balances of the Investment Account as of the end of such calendar quarter, provided that during any period when the Borrower's Adjusted Net Cash Level is less than an amount equal to Twenty-Five Million Dollars ($25,000,000) minus the difference between Six Million Dollars ($6,000,000) and the then outstanding principal balance due under the Loan (i.e. the amount of principal repayment made under the Loan), the Borrowers shall submit to the Bank, (i) within twenty (20) days of the end of each calendar month, a compliance statement indicating the Borrower's actual Adjusted Net Cash Level and the amount of Committed R&D Funds for the next 24 months and (ii) within ten (10) days of the end of each calendar month, a cash summary listing all of the Borrower's cash balances and Cash Equivalent Balances as of month end wherever domiciled, accompanied by confirming statements of the custodians of such cash balances and Cash Equivalent Balances; and (iii) within sixty (60) days after the end of any fiscal year of Borrowers, an annual operating budget for the next twelve months, shown on at least a quarterly basis and projecting the Adjusted Net Cash Level for such period in form consistent with the calculation described in Section 5.10(iii). 22 SECTION 6.5 OTHER INFORMATION. Promptly after a written request therefor, such other financial data or information evidencing compliance with the requirements of this Agreement and the other Loan Documents as the Bank may reasonably request from time to time. SECTION 6.6 NO DEFAULT CERTIFICATE. At the same time as it delivers the Financial Statements required under the provisions of Sections 6.1 -- "Annual Financial Statements" and 6.2 -- "Quarterly Financial Statements," a certificate of each of the Borrowers signed on their behalf by an Authorized Signatory or their controller, to the effect that, to the best of their knowledge, no Trigger Event hereunder has occurred and is continuing or, if such cannot be so certified, specifying in reasonable detail the exceptions, if any, to such statement. SECTION 6.7 NOTICES. (a) DEFAULTS. As soon as possible and in any event within seven (7) days after either of the Borrowers has knowledge of the occurrence or existence of a Trigger Event or any event which with the giving of notice or passage of time or both, would constitute either an Event of Default or Trigger Event, the statement of the Borrowers setting forth details of such Trigger Event or event and the action which the Borrowers propose to take with respect thereto. (a) LITIGATION AND JUDGMENTS. Promptly after obtaining knowledge thereof, written notification of any litigation or legal proceedings instituted against either of the Borrowers, regardless of the subject matter thereof, having claims or amounts in controversy of more than $1,000,000 in any one instance or $2,000,000 in the aggregate at any one time. (a) ENVIRONMENTAL EVENTS. Promptly after obtaining knowledge or receipt thereof, written notice of any of the following which has the potential to materially adversely affect the assets, liabilities, financial condition or operations of either of the Borrowers: (i) any violation of any Environmental Laws regarding the Borrowers' operations; (ii) any potential or known Release, or threat of Release, of any Hazardous Substances at, from or into the Borrowers' place of business which the Borrowers report in writing or is reportable in writing (or for which any written report supplemental to any oral report is made) to any federal, state, or local environmental agency; (iii) any notice of violation of any Environmental Laws or of any release or threatened release of Hazardous Substances, including a notice or claim of liability or potential responsibility from any third party (including without limitation any federal, state or local governmental officials) and including notice of any formal inquiry, proceeding, demand, 23 investigation or other action with regard to the Borrowers' business operation; or (iv) any expense or loss that has been identified by such governmental authority in connection with the assessment, containment, removal or remediation of any Hazardous Substances with respect to which the Borrowers may be liable. ARTICLE VII NEGATIVE COVENANTS So long as the Borrowers are indebted to the Bank hereunder, and until payment in full of the Note and full and complete performance of all of their other obligations arising hereunder (except for the Borrowers' obligations under Sections 5.7 or Section 9.1 to indemnify the Bank under certain circumstances following the payment of the Note), neither of the Borrowers shall do, or permit to be done, any of the following: SECTION 7.1 LIENS. Without the Bank's consent, create or assume or permit to exist, any Lien upon or with respect to any of its assets, or assign or otherwise convey any right to receive income except: (a) Liens in favor of the Bank; (a) Liens for taxes, assessments or governmental charges or levies on the Borrowers' property 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 the enforcement thereof and as to which adequate reserves have been made; (a) Liens imposed by law, such as carrier's, warehousemen's and mechanic's 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 have been made; (a) Liens arising out of pledgor deposits under workers' compensation laws, unemployment insurance, social security, retirement benefits or similar legislation; (a) Permitted Purchase Money Liens (including, without limitation, Liens arising in connection with equipment leases); (a) Rights of other parties under technology licenses from the Borrowers granted in connection with the development, 24 manufacture or marketing of pharmaceutical or other products, or otherwise in the ordinary course of business; (a) Rights of the United States government in certain technology, the development of which is or was funded in whole or in part by the United States government; and (a) Security deposits under the Borrowers' leased premises. SECTION 7.2 CHANGES IN BUSINESS; MERGER OR CONSOLIDATION; DISPOSITION OF ASSETS. Without the Bank's consent: (a) Consolidate with, merge into or convey or transfer its properties substantially as an entirety to, any Person, except that the Borrowers may participate in any merger in which either of the Borrowers is the surviving entity so long as after giving effect to such merger the Borrowers remain in compliance with all covenants and conditions of this Agreement. (a) Make any material change in the nature of its business, or in the nature of its operations, or liquidate or dissolve itself (or suffer any liquidation or dissolution). (a) Effect any disposition of all or any material portion of its assets (whether in one or more transactions) except that (i) the Borrowers may dispose of obsolete or worn out equipment, (ii) the Borrowers may replace equipment with upgraded equipment and may thereafter dispose of the equipment so upgraded and replaced, (iii) the Borrowers may engage in research and development transactions (each, an "R&D Transaction") involving the licensing of their rights in certain technology to other persons and the licensing back of such rights to them, provided that after giving effect to each such R&D Transaction, the Borrowers remain in compliance with all covenants and conditions of this Agreement; and (iv) dispose of other assets in the ordinary course of their business provided that they receive equivalent value on such disposition of assets. SECTION 7.3 CHANGE OF OFFICE ADDRESS. Except upon five (5) days' prior written notice to the Bank, change the address of their principal office or place of business or the place where they maintain their records with respect to the Accounts. SECTION 7.4 VIOLATION OF AGREEMENT. Take any action the effect of which would constitute a breach or violation of any provision of this Agreement. ARTICLE VIII EVENTS OF DEFAULT 25 SECTION 8.1 EVENTS OF DEFAULT. If any one or more of the following events ("Event of Default") shall occur and be continuing, the entire unpaid balance of the principal of and interest on the Note and all other obligations and Indebtedness of the Borrowers to the Bank arising hereunder and under the other Loan Documents will, in the case of any Event of Default of the types referred to in subparagraph (e) hereinbelow, immediately become due and payable without notice and in the case of any other Event of Default, will immediately become due and payable upon written notice to that effect given to the Borrowers by the Bank, without presentment or demand for payment, notice of non-payment, protest or further notice or demand of any kind, all of which are expressly waived by the Borrowers. Upon an Event of Default, the Bank shall have the rights and remedies provided for herein and in the other Loan Documents and under applicable law and in equity, and the rights and remedies provided for herein shall be cumulative and in addition to the rights and remedies provided for therein. Each of the following shall constitute an Event of Default: (a) Failure by the Borrowers to make any payment when due of any amount payable under the Loan Documents, which failure is not cured within five (5) days of the occurrence thereof. (a) Failure by the Borrowers to make any mandatory payments under any borrowing agreement (other than the Loan Documents) to which either is a party within any applicable grace period provided in such agreement or any other default by either of the Borrowers under any such borrowing agreement and the failure of them to cure such default within any applicable grace period, but in any event not later than thirty (30) days after such default, provided that no Event of Default will be deemed to have occurred under this paragraph (b) with respect to any indebtedness under any borrowing agreement if payment of such indebtedness, after notice thereof having been given to the Bank, is being contested by the Borrowers in good faith and by appropriate proceedings and such contest operates to prevent the other party to such agreement from exercising its remedies against the Borrowers or any of their properties and the amount in dispute is in the aggregate less than $100,000. (a) Failure by the Borrowers to perform or observe any material term, condition or covenant of this Agreement or of any of the Loan Documents (other than the financial covenants set forth in Section 5.10 which shall constitute a Trigger Event instead) which failure (other than a failure which by its nature is not capable of cure and other than a failure to perform or observe any term, condition or covenant referred to or set forth in Subparagraphs 26 (a), (b) and (c) hereinabove) is not cured within thirty (30) days of the occurrence thereof. (a) Any representation or warranty made in writing to the Bank in any of the Loan Documents or in connection with the making of the Loan or a certificate, statement or report made or delivered in compliance with this Agreement, will have been false or misleading in any material respect when made or delivered. (a) Either of the Borrowers makes an assignment for the benefit of creditors, files a petition for bankruptcy, petitions or applies to any tribunal for the appointment of a receiver, custodian, or any trustee for it or a substantial part of its assets, or commences any proceeding under any bankruptcy, reorganization, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, whether now or hereafter in effect; or there will have been filed any such petition or application, or any such proceeding has been commenced against it, which remains undismissed for a period of sixty (60) days or more; or any order for relief is entered in any such proceeding; or either of the Borrowers by any act or omission indicates its consent to, approval of or acquiescence in any such petition, application or proceeding or the appointment of a custodian, receiver or any trustee for it or any substantial part of any of its properties; or either of Genome or Collaborative suffers any custodianship, receivership or trusteeship to continue undischarged for a period of sixty (60) days or more. (a) Any single judgment of $1,000,000 or more or a combination of unsecured judgments aggregating $2,000,000 or more against Genome and/or Collaborative remains unpaid, unstayed on appeal, undischarged, unbonded or undismissed for a period of thirty (30) days or more. (a) Any Loan Document ceases to be in full force and effect in all material respects for any reason (other than due to the payment in full of all amounts secured or evidenced thereby or due to discharge in writing by the Bank). (a) After the occurrence of a Trigger Event under Section 5.10, the failure of the Borrowers and/or the Custodian to make the requisite transfer to the Custodian Account as provided in Section 5.11 such that, not later than 5:00 P.M. in New York, New York on the first Business Day following the occurrence of the Trigger Event, the Restricted Account Balance equals or exceeds the Required Restricted Account Balance. (a) After the occurrence of a Trigger Event under Section 5.10, the failure of either of the Borrowers to execute and deliver, or cause to be executed and delivered, any additional 27 documents requested by the Bank in connection with the transfer by the Borrowers and/or Custodian to the Custodian Account as provided in Section 5.11 (including without limitation any additional documents requested by the Bank in order to further implement or perfect the pledge of assets held in the Custodian Account and any additional opinion of the Borrowers' counsel on such matters the Bank may require, in a form and substance satisfactory to Bank). (a) Failure by either of the Borrowers to comply with or make a material change to its "Investment Policy" described in Section 3.22 hereof without the Bank's prior written approval, which approval shall not be unreasonably withheld. A copy of each Borrowers' Investment Policy is attached hereto as SCHEDULE 8.1.(J). (a) After the occurrence of a Trigger Event and the initial transfer to the Custodian Account as provided in Section 5.11, the failure of the Borrowers and/or the Custodian to make, within one Business Day following the request of the Bank, such additional transfers to the Custodian Account as may be necessary, from time to time, to increase the Restricted Account Balance so that it equals the Required Restricted Account Balance. (a) The failure by the Borrowers, at any time, to maintain a Adjusted Net Cash Level equal to an amount equal to the sum of: (i) Fifteen Million Dollars ($15,000,000) plus (ii) the then outstanding principal balance due under the Note. (a) The failure by the Borrowers, at any time, to maintain a Net Cash Level equal to an amount equal to the outstanding principal balance due under the Note plus three (3) months interest thereon at the then applicable rate provided for herein. ARTICLE IX MISCELLANEOUS PROVISIONS SECTION 9.1 INDEMNITY; ADDITIONAL FEES. The Borrowers shall indemnify Bank against, and hold it harmless from, any loss, liabilities, damages, claims, and reasonable costs and expenses (including attorneys' fees and disbursements) suffered or incurred by the Bank arising out of, resulting from or in any manner connected with, the Loan Documents, or any transaction related hereto or thereto, except any such loss arising solely from the Bank's own gross negligence or willful misconduct. The provisions of this Section 9.1 will survive for a period of three (3) years following the repayment of the Note and the termination of this Agreement. 28 SECTION 9.2 SURVIVAL OF AGREEMENTS AND REPRESENTATIONS. All agreements, representations and warranties made herein will survive the delivery of the Loan Documents and shall be in full force and effect during the term of this Agreement. SECTION 9.3 MODIFICATIONS, CONSENTS AND WAIVERS. No modification, amendment or waiver of or with respect to any provision of the Loan Documents, nor consent to any departure by a party from any of the terms or conditions thereof shall in any event be effective unless it is in writing and signed by the party against whom such modification, amendment, waiver or consent is sought to be enforced. Any such waiver or consent will be effective only in the specific instance and for the purpose for which given. No consent to or demand on the Borrowers in any case will, of itself, entitle it to any other or further notice or demand in similar or other circumstances. SECTION 9.4 ENTIRE AGREEMENT. This Agreement and the other Loan Documents embody the entire agreement and understanding between the Bank and the Borrowers and supersede all prior agreements and understandings relating to the subject matter hereof. SECTION 9.5 REMEDIES CUMULATIVE. Each and every right granted to the Bank hereunder or under any other document delivered hereunder or in connection herewith, or allowed it by law or equity, is cumulative and may be exercised from time to time. No failure on the part of the Bank or the holder of the Note to exercise, and no delay in exercising, any right shall operate as a waiver thereof, nor will any single or partial exercise of any right preclude any other or future exercise thereof or the exercise of any other right. SECTION 9.6 FURTHER ASSURANCES. At any time and from time to time, upon the request of the Bank, the Borrowers shall execute, deliver and acknowledge or cause to be executed, delivered and acknowledged such further documents and instruments and do such other acts and things as the Bank may reasonably request to fully effect the purposes of the Loan Documents and any other agreements, instruments and documents delivered pursuant hereto or in connection with the Loan. SECTION 9.7 NOTICES. All notices, requests, reports and other communications pursuant to this Agreement must be in writing, either by letter (delivered by hand or commercial delivery service or sent by certified mail, return receipt requested, except for routine reports which may be by ordinary first class mail) or facsimile or telecopier, addressed as follows: 29 If to Genome or Collaborative: Genome Therapeutics Corp. or Collaborative Securities Corp. 100 Beaver Street Waltham, MA 02154 Attn: Mr. Fenel M. Eloi, Treasurer and CFO Telephone: (617) Facsimile: (617) If to Borrower's counsel: Ropes & Gray One International Place Boston, MA 02110 Attn: David A. McKay, Esq. Telephone: (617) 951-7000 Facsimile: (617) 951-7050 If to Bank: The Sumitomo Bank, Limited One Post Office Square, Suite 3820 Boston, MA 02109 Attn: Daniel G. Eastman, Vice President Telephone: (617) 451-3200 Facsimile: (617) 423-4884 and The Sumitomo Bank, Limited 233 S. Wacker Drive, Suite 5400 Chicago, IL 60606 Attn: Stan Marciniak, Vice President Telephone: (312) 993-6210 Facsimile: (312) 876-1993 If to Bank's Counsel: Hale and Dorr LLP 60 State Street Boston, MA 02109 Attn: Paul P. Daley, Esq. Telephone: (617) 526-6000 Facsimile: (617) 526-5000 Any notice, request or communication hereunder will be deemed to have been given (i) on the day on which it is delivered by hand to such party at its address specified above, (ii) if sent by mail, on the third (3rd) Business Day following the day it was deposited in the mail, postage prepaid, or (iii) if sent by telecopy, when 30 transmitted addressed as aforesaid on a Business Day during normal business hours and receipt is confirmed, on such Business Day. Any party may change the person or address to whom or which notices are to be given hereunder, by notice duly given hereunder, provided, however, that any such notice will be deemed to have been given hereunder only when actually received by the party to which it is addressed. SECTION 9.8 CONSTRUCTION; GOVERNING LAW. (a) The headings used in this Agreement and the table of contents are for convenience only and will not be deemed to constitute a part hereof. All uses herein of the masculine gender or of singular or plural terms will be deemed to include uses of the feminine or neuter gender or plural or singular terms, as the context may require. All references herein (including the definitions set out in APPENDIX A hereto) to any agreements shall be to such agreement as amended or modified to the date of reference. All references to a particular entity shall include a reference to such entity's successors and permitted assigns. The words "herein," "hereof" and "hereunder" refer to this Agreement as a whole and not to any particular section or subsection of this Agreement. "Including" means "including, without limitation". (a) THIS AGREEMENT WILL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS WITHOUT REFERENCE TO ITS CONFLICT OF LAWS RULES. SECTION 9.9 WAIVER OF JURY TRIAL. EACH OF THE BORROWERS AND THE BANK HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES ANY AND ALL RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED ON, OR ARISING OUT OF, UNDER, OR IN CONNECTION WITH, THIS AGREEMENT, ANY LOAN DOCUMENT OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER ORAL OR WRITTEN), OR ACTIONS OF THE BORROWERS OR THE BANK. THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE BANK PROVIDING THE LOAN DESCRIBED HEREIN. SECTION 9.10 JURISDICTION. (a) Each of the Borrowers and the Bank hereby irrevocably and unconditionally submits, for itself and its property, to service of process (directly or on an agent) in Massachusetts to the nonexclusive jurisdiction of any Massachusetts state court or Federal court of the United States of America in each case sitting in Boston, and any appellate court handling an appeal from any thereof, in any action or proceeding arising out of or relating to this Agreement or any other Loan Agreement, or for recognition or enforcement of any judgment, and each of the Borrowers and the Bank hereby irrevocably and unconditionally agree that all claims in respect of any such action or proceeding may be heard and determined in such Massachusetts state or, to the extent permitted 31 by law, in such Federal court. Each of the Borrowers and the Bank agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that a party may otherwise have to bring any action or proceeding relating to this Agreement or any other Loan Agreement against any other party or its respective properties in the court of any jurisdiction. (a) Each of the Borrowers and the Bank hereby irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection which it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Agreement in any such Massachusetts state or Federal court. Each of the Borrowers and the Bank hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. SECTION 9.11 RELATIONSHIP OF THE BORROWERS AND THE BANK. The Borrowers and the Bank agree that nothing contained in this Agreement or any other document executed in connection with the Loan is intended or shall be construed to establish the Borrowers and the Bank as joint venturers or partners; and the Borrowers hereby indemnify and agree to hold the Bank, its officers, directors, agents and employees harmless from any and all damages resulting from such a construction of the relationship of the parties hereto, except any such damage arising solely from the Bank's own gross negligence or willful misconduct. SECTION 9.12 SEVERABILITY. The provisions of this Agreement are severable, and if any clause or provision hereof shall be held invalid or unenforceable in whole or in part in any jurisdiction, then such invalidity or unenforceability will affect only such clause or provision, or part thereof, in such jurisdiction and will not in any manner affect such clause or provision in any other jurisdiction, or any other clause or provision in this Agreement in any jurisdiction. Each of the covenants, agreements and conditions contained in this Agreement is independent and compliance by the Borrowers with any of them will not excuse noncompliance by the Borrowers with any other. SECTION 9.13 BINDING EFFECT; ASSIGNMENT. (a) This Agreement will be binding upon and inure to the benefit of the Borrowers and their successors and assigns as permitted herein and to the benefit of Bank and its successors and assigns. 32 (a) The rights and obligations of the Borrowers under this Agreement may not be assigned or delegated without the prior written consent of the Bank, and any purported assignment or delegation without such consent shall be void. (a) Bank, without the consent of the Borrowers, may at any time assign or grant participations to any other Person in all or part of its rights and obligations under the Loan Documents; PROVIDED, HOWEVER, that no such assignment or participation may be made or shall be effective unless the Bank shall have delivered prior notice thereof to the Borrowers of the proposed effective date and amount of such assignment or participation and the identity of the proposed assignee or participant. The Bank shall be the agent of all such assignees and participants for the purpose of the receipt and delivery of funds and notices under the Loan Documents unless the Borrowers otherwise consent (which consent will not unreasonably be withheld). SECTION 9.14 COUNTERPARTS. This Agreement may be executed in counterparts, each of which will be deemed an original, but all of which will constitute one and the same document. SECTION 9.15 JOINT AND SEVERAL OBLIGATIONS. The obligations of the Borrowers hereunder shall be joint and several. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. COLLABORATIVE SECURITIES CORP. GENOME THERAPEUTICS CORP. By: ____________________________ By: ____________________________ Title: _________________________ Title: _________________________ THE SUMITOMO BANK, LIMITED By: ____________________________ Title: _________________________ By: ____________________________ Title: _________________________ 33 APPENDIX A TO LOAN AGREEMENT -- DEFINITIONS The following words shall have the meanings specified below in the Section of the Agreement referred to below. "ACCOUNTS" -- the Investment Account and the Custodian Account. "ACTUAL CASH BURN" -- the amount of the actual reduction in the Borrowers' Cash and Cash Equivalents (including short-term and long-term investments) as calculated as of the last day of each calendar quarter for the period commencing with the first day of such quarter and ending on the last day of such calendar quarter and as determined by the Bank, in its sole discretion, based upon the financial reports delivered to Bank by Borrowers pursuant to Article VI (including without limitation the reports provided pursuant to Section 6.4). "ADJUSTED NET CASH LEVEL" -- the aggregate amount of the market value of Cash and Cash Equivalents plus, to the extent not otherwise included, the aggregate amount of Committed R&D Funds, less otherwise restricted cash and amounts which may be restricted in the future pursuant to existing or future agreements between the Borrowers (or either of them) and third parties. "ADVANCE TERMINATION DATE" -- June 30, 1998. "AFFILIATE" -- as to any Person, any other Person which directly or indirectly controls, or is under common control with, or is controlled by, such Person. As used in this definition, "control" (including, with its correlative meanings, "controlled by" and "under common control with") shall mean possession directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of securities or partnership or other ownership interests, by contract or otherwise). The term "Affiliate" shall not include any Person who controls another Person solely by virtue of such Person's position as a corporate officer or director of such other Person. "AGREEMENT" -- is defined in the Preamble. "APPLICABLE MARGIN" -- for any Eurodollar Rate Loan portion shall be one and one-half percent (1.5%). "AUTHORIZED SIGNATORY" -- with respect to a corporation, any officer of such corporation. "BAILEE" -- is defined in Subsection 2.6(b). 34 "BANK" -- is defined in the Preamble. "BORROWER" -- is either Genome or Collaborative. "BORROWERS" -- is defined in the Preamble. "BUSINESS DAY" -- a day when commercial banks in both Boston, Massachusetts and Chicago, Illinois and, in the case of setting the Reserve Adjusted Eurodollar Rate, London, England, are open for business with respect to transactions of the kind contemplated in this Agreement. "CERCLA" -- is defined in Subsection 3.16(a). "CASH AND CASH EQUIVALENTS" -- liquid investments, consisting of cash and cash equivalents and other investments in investment grade securities, that are classified on the Borrower's consolidated balance sheet as current, noncurrent, long-term or restricted. "CASH EQUIVALENT BALANCES" -- the aggregate amount of the lower of cost or market value of Cash Equivalents, as reported in the Financial Statements. "CLOSING DATE" -- July __, 1997. "CODE" -- the Internal Revenue Code of 1986, as amended. "COLLABORATIVE" -- Collaborative Securities Corp., a Massachusetts corporation. "COLLATERAL BAILMENT AGREEMENT" -- the Collateral Bailment Agreement of even date herewith by and between the Bank and Sumitomo Bank of New York Trust Company. "COMMITTED R&D FUNDS" -- the aggregate amount of funds due to or receivable by the Borrowers from a Person pursuant to a collaboration or similar agreement with respect to research and development in the biotechnology field, provided (i) such funds are due and payable pursuant to a written agreement, a copy of which has been provided the Bank, within the twenty-four (24) months following the date of determination, (ii) no amounts due to the Borrowers under such agreement have remained unpaid for more than 45 days beyond their due date, (iii) such Person has annual sales of at least $500,000,000 and a net worth of at least $50,000,000 and is not the subject of any proceeding of the type described in Section 8.1(e) hereof (with such Person being substituted for the Borrowers), and (iv) the payment of such funds are not subject to any contingency, such as the attainment of any milestones, other than solely the passage of time. 35 "CONTROLLED GROUP" -- all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower, are treated as a single employer under Section 414(b), 414(c) or 414(m) of the Code and Section 4001(a)(2) of ERISA. "CURRENT RATIO" -- the ratio of total current assets to total current liabilities. "CUSTODIAN ACCOUNT" -- is defined in Subsection 2.6(b). "CUSTODIAN" -- is defined in Subsection 2.6(a). "CUSTODIAN AGREEMENT" -- Custodian Agreement of even date herewith by and between the Borrower and Sumitomo Bank of New York Trust Company. "DEFAULT RATE" -- is defined in Subsection 2.3(c). "DISBURSEMENT" -- a disbursement of available proceeds of the Loan. "DISPOSAL," "DISPOSE(d)" -- as specified in RCRA and in the regulations promulgated thereunder. "ELECTION NOTICE" -- is defined in Subsection 2.1(c). "EPA" -- is defined in Subsection 3.16(b). "ENVIRONMENTAL LAWS" -- is defined in Subsection 3.16(b). "ERISA" -- is defined in Section 3.15. "EUROCURRENCY RESERVE PERCENTAGE" -- with respect to each Interest Period, a percentage (expressed as a decimal) equal to the percentage (if any) in effect two Business Days prior to the first day of such Interest Period, as prescribed by the F.R.S. Board, for determining reserve requirements applicable to "Eurocurrency liabilities" pursuant to Regulation D or any other then applicable regulation of the F.R.S. Board which prescribes reserve requirements applicable to "Eurocurrency liabilities," as presently defined in said Regulation D. For purposes of this definition, Eurodollar Rate Loan Portions hereunder shall be deemed to be "Eurocurrency liabilities" as defined in said Regulation D. "EURODOLLAR RATE LOAN PORTION -- any portion of the Loan, which the Borrowers have notified the Bank (in accordance with the provisions of Section 2.1) is to bear interest at the Reserve 36 Adjusted Eurodollar Rate plus the Applicable Margin for the applicable Interest Period. "EURODOLLAR RATE" -- for any Eurodollar Rate Loan Portion, with respect to the applicable Interest Period relating to such Eurodollar Rate Loan Portion, the rate per annum (rounded up to the next whole multiple of 1/16 of 1%) equal to the rate at which United States dollar deposits are offered to the Bank in the London interbank Eurodollar market as of approximately 11:00 a.m., London, England time, on the second Business Day prior to the first day of such Interest Period for delivery in immediately available funds on the first day of such Interest Period for the number of days in such Interest Period and in an amount equal to the amount of the Eurodollar Rate Loan Portion. "EVENT OF DEFAULT" -- is defined in Section 8.1. "FINANCIAL STATEMENTS" (a) the audited consolidated balance sheet and consolidated statements of operations, shareholders' equity and cash flows of Borrowers for the fiscal year then ended, together with the unqualified opinion of the independent public accountants preparing such statements; and (b) the quarterly unaudited consolidated balance sheet and unaudited consolidated statements of operations, and cash flows for Borrowers for the fiscal quarters ended November, February and May, certified as to accuracy by the Chief Financial Officer or controller of each Borrower, provided, however, that such quarterly unaudited financial statements may not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. "FINANCING STATEMENT" -- a financing statement or statements on form UCC-1, signed by the Borrowers and describing the property in which the Bank has a security interest under the Restricted Account and Security Agreement, all in form and substance suitable for filing as a financing statement under Article 9 of the Uniform Commercial Code as enacted in Massachusetts and/or New York. "GENOME" -- Genome Therapeutics Corp., a Massachusetts corporation. "HAZARDOUS SUBSTANCES" -- is defined in Subsection 3.16(b). "INDEBTEDNESS" -- with respect to any Person, all: 37 (a) all indebtedness, liabilities or other obligations of such Person for borrowed money or for the deferred purchase price of property or services (excluding trade accounts payable and accrued obligations incurred in the ordinary course of business) and any other liabilities, which in accordance with generally accepted accounting principles would be included in determining total liabilities as shown on the liability side of a balance sheet of such Person at the date as of which such Indebtedness is to be determined, excluding all operating lease obligations, as determined in accordance with generally accepted accounting principles consistently applied and any other contingent liabilities of such Person; (b) all indebtedness, liabilities or obligations evidenced by notes, bonds, debentures or similar instruments, including obligations so evidenced incurred in connection with the acquisition of property, assets or businesses; (c) all reimbursement and other obligations of such Person in respect of letters of credit and bankers acceptance and all net obligations in respect of interest rate swaps, caps, floors and collars, currency swaps, and other similar financial products; (d) all indebtedness created or arising under any conditional sale or other title retention agreement with respect to property acquired by such Person; (e) all obligations under leases which shall have been or should be, in accordance with GAAP, recorded as capital leases; and (f) all indebtedness of another Person of the types referred to in clauses (a) through (e) guaranteed directly or indirectly in any manner by the Person for whom Indebtedness is being determined, or in effect guaranteed directly or indirectly by such Person through an agreement to purchase or acquire such indebtedness, to advance or supply funds for the payment or purchase of such indebtedness or otherwise assure a creditor against loss, or secured by any Lien upon or in property owned by the Person for whom Indebtedness is being determined, whether or not such Person has assumed or become liable for the payment of such indebtedness of such other Person. "INTELLECTUAL PROPERTY RIGHTS" -- is defined in Section 3.11. "INTEREST DIFFERENTIAL" -- with respect to any prepayment of a Eurodollar Rate Loan Portion on a day other than an Interest Payment Date falling at the end of the applicable Interest Period, 38 the sum of: (a) the per annum interest rate payable with respect to such Eurodollar Rate Loan Portion as of the date of the prepayment MINUS (b) what the Reserve Adjusted Eurodollar Rate plus the Applicable Margin would have been on, or as near as practicable to, the date of the prepayment for a Eurodollar Rate Loan Portion for a period commencing on such date and ending on the last day of the applicable Interest Period. The determination of the Interest Differential by the Bank shall be conclusive in the absence of manifest error. "INTEREST PAYMENT DATE" -- with respect to any Loan Portion, the earlier to occur of (a) the last Business Day of each calendar month occurring within an Interest Period; or (b) the last day of each applicable Interest Period; or (c) the date that the Loan Portion is due by either the occurrence of Maturity Date or an Event of Default having occurred and the maturity of the Loan having been accelerated pursuant to the terms of the Loan Documents. "INTEREST PERIOD" -- as to any Eurodollar Rate Loan Portion, the period commencing on the date of the initial funding of such Eurodollar Rate Loan Portion or the last day of the immediately preceding Interest Period for any Eurodollar Rate Loan Portion that is to be continued as a Eurodollar Rate Loan Portion and ending, with respect to such Eurodollar Rate Loan Portion, on the numerically corresponding day (or if there is no numerically corresponding day, on the last day), in the calendar month that is one, two, three, six or, if available, twelve months thereafter, in each case as the Borrower may elect in the Election Notice; provided however, that (a) no Interest Period with respect to any Eurodollar Rate Loan Portion shall end later than the Maturity Date, (b) if an Interest Period would end on a day that it is not a Business Day, such Interest Period shall be extended to the next succeeding Business Day unless such next succeeding day would fall in the next calendar month, in which case, such Interest Period shall end on the immediately preceding Business Day, and (c) interest shall accrue from and including the first day of an Interest Period to but excluding the last Business Day of such Interest Period. "INTEREST RESERVE" -- on any date of determination means an amount equal to the interest that would accrue in three months on an amount equal to the principal balance of the Loan outstanding on such date of determination. "INVESTMENT ACCOUNT" -- is defined in Subsection 2.6(a). "IRREVOCABLE INSTRUCTIONS AND POWER OF ATTORNEY" -- is defined in Subsection 2.6(b). 39 "IRS" -- is defined in Subsection 3.15(a). "LIEN" -- any mortgage, deed of trust, pledge, security interest, encumbrance, lien or charge of any kind (including any agreement to give any of the foregoing, any conditional sale or other title retention agreement and any lease in the nature of a security interest or lien). "LOAN" -- is defined in Section 2.1. "LOAN DOCUMENTS" -- this Agreement, the Note, the Restricted Account and Security Agreement, the Collateral Bailment Agreement, the Irrevocable Instructions and Power of Attorney, the Custodian Agreement, and all other documents executed and delivered in connection herewith or therewith, including all amendments, modifications and supplements of or all such documents. "LOAN FEE" -- is defined in Subsection 2.3(d). "LOAN PORTION" -- as the circumstances or context warrants, the portion of the Loan which is a Eurodollar Rate Loan Portion, or Prime Rate Loan Portion. "MATURITY DATE" -- May 31, 2002. "NET CASH LEVEL" -- the aggregate amount of the market value of Cash and Cash Equivalents, less otherwise restricted cash and amounts which may be restricted in the future pursuant to existing or future agreements between the Borrowers (or either of them) and third parties. "NET WORTH" -- an amount equal to the Total Assets minus Total Debt. "NOTE" -- is defined in Section 2.1. "PBGC" -- is defined in Subsection 3.15(a). "PERMITTED PURCHASE MONEY LIENS" -- purchase money security interests in personal property acquired after the date hereof to secure purchase money Indebtedness, to the extent that the amount of money borrowed does not exceed the value of the personal property purchased, and the security interest granted does not extend beyond the personal property purchased. "PERSON" -- an individual, a corporation, a partnership, a joint venture, a trust or unincorporated organization, a joint stock company or other similar organization, a government or any political subdivision thereof, a court, or any other legal entity, whether acting in an individual, fiduciary or other capacity. 40 "PLAN(S)" -- is defined in Subsection 3.15(a) hereof. "PRIME RATE" -- the higher of (i) the interest rate which the Bank announces from time to time as its floating prime rate in the United States and (ii) the federal funds rate announced from time to time plus one-half percent (0.5%). "PRIME RATE LOAN PORTION" -- any portion of the Loan which bears interest at the Prime Rate as provided in Section 2.1 or 2.7. "RCRA" -- is defined in Subsection 3.16(a). "R&D TRANSACTION" -- is defined in Subsection 7.2(c). "REGULATORY CHANGE" -- any change after the date of this Agreement in United States federal, state or local laws or regulations or the adoption or making after such date of any interpretations, directives or requests applying to a class of banks including the Bank of or under any United States federal, state, or local laws or regulations (whether or not having the force of law) by any court or governmental or monetary authority charged with the interpretation or administration thereof. "RELEASE" -- as specified in CERCLA. "REPORTING PERIOD" -- a fiscal quarter of the Borrowers. "REQUIRED RESTRICTED ACCOUNT BALANCE" -- on and after a Trigger Event has occurred, the sum of the Borrower's then outstanding principal balance of the Loan PLUS the Interest Reserve. "RESERVE ADJUSTED EURODOLLAR RATE" -- with respect to any Eurodollar Rate Loan Portion for any Interest Period, a rate per annum (rounded upwards, if necessary, to the nearest 1/100 of 1%) determined pursuant to the following formula: Reserve Adjusted = EURODOLLAR RATE ---------------- ------------------------------------- Eurodollar Rate 1 - Eurocurrency Reserve Percentage "RESTRICTED ACCOUNT AND SECURITY AGREEMENT" -- the Restricted Account and Security Agreement of even date herewith by and between the Bank and the Borrowers. "RESTRICTED ACCOUNT BALANCE" -- the sum of all Cash and Cash Equivalents and any other investments on deposit in the Custodian Account, the amount of such Cash Equivalents or investments to be calculated at the lower of cost or market value. 41 "SARA" -- is defined in Subsection 3.16(a). "SUBSIDIARY" -- any person of which a Borrower owns directly or indirectly: (i) sufficient capital stock to enable it to elect at least a majority of the board of directors or similar managing body of such person, or (ii) capital stock with rights under the charter documents of such Person to elect a director or similar managing official with the power to veto material business decisions and organizational changes. "TAXES" -- is defined in Subsection 2.5(a). "TOTAL ASSETS" -- total assets as determined in accordance with generally accepted accounting principles, consistently applied; provided, however, that Total Assets shall be reduced by the amount (if any) of intangible assets (other than intangible assets consisting of patent and trademark costs as shown on the Company's Financial Statements and determined in accordance with, and consistent with, both generally accepted accounting principals consistently applied and the Company's accounting practices prior to the date hereof. "TOTAL DEBT" -- the aggregate amount of the Borrowers' Indebtedness. "TRIGGER EVENT" -- is defined in Section 5.10. "UCC" -- the Uniform Commercial Code in effect from time to time in the relevant jurisdiction. 42 NOTE $6,000,000.00 Boston, Massachusetts July 31, 1997 FOR VALUE RECEIVED, GENOME THERAPEUTICS CORP., a Massachusetts corporation and its wholly owned subsidiary, Collaborative Securities Corp., a Massachusetts corporation (together "Borrower"), hereby jointly and severally promise to pay to the order of The Sumitomo Bank, Limited, a Japanese banking corporation ("Bank"), without counterclaim, offset or deduction, the principal sum of SIX MILLION DOLLARS ($6,000,000) or, if less, the aggregate unpaid principal amount of all Disbursements (as defined in the Loan Agreement), in accordance with the terms of the Loan Agreement (referred to below) and to pay interest on the outstanding principal balance at the interest rates and at such times as provided in the Loan Agreement and elected by Borrower and calculated in accordance with the terms of Loan Agreement. This Note is the Note referred to in the Loan Agreement, of even date herewith, between Borrower and Bank, and is subject to all of the terms and conditions of the Loan Agreement (which are incorporated herein by reference), including the rights of prepayment and the rights of acceleration of maturity. Terms used herein have the meanings assigned to those terms in the Loan Agreement, unless otherwise defined herein. Interest on the unpaid principal balance hereunder shall be paid commencing on the Closing Date and shall be paid monthly in arrears on the first Business Day of each full calendar month hereafter until the Maturity Date (defined below) at which time all unpaid interest shall be due and payable. The unpaid principal balance hereunder shall be paid in forty-eight (48) equal consecutive monthly installments of principal (each installment being in an amount sufficient to amortize the outstanding principal balance of the Loan over a period of forty-eight (48) months), payable on the first Business Day of each calendar month commencing with the first payment due on July 1, 1998 and continuing until May 31, 2002 (the "Maturity Date"), on which date Borrower shall make a final payment in an amount equal to all of the then unpaid principal of the Loan and all unpaid interest thereon, provided, however, that repayment of any or all of the outstanding principal balance hereunder and all accrued and unpaid interest thereon may be accelerated by Bank as hereinafter provided upon the occurrence of any failure to make any payment required under this Note and/or any Event of Default under the Loan Agreement. Any installment of interest only or of 43 principal and interest paid more than five (5) days late or any other amount payable hereunder which is not paid when due will bear (and Borrower shall pay) interest (to the extent permitted by law) from such due date until such unpaid amount has been paid in full (whether before or after judgment) at a rate per annum equal to the Default Rate. Borrower hereby authorizes Bank to record on schedule(s) annexed to this Note (a) the date and amount of each portion of the Loan which constitutes a Eurodollar Rate Loan Portion or Prime Rate Loan Portion; (b) the term of the Interest Period for the Eurodollar Rate Loan Portion; (c) the interest rate or rates for each Eurodollar Rate Loan Portion or Prime Rate Loan Portion and the effective date(s) of all changes in such rates; (d) the date and amount of each interest only payment on each Eurodollar Rate Loan Portion or Prime Rate Loan Portion; and (e) the date and amount of each principal and interest payment on each Eurodollar Rate Loan Portion or Prime Rate Loan Portion and of each prepayment of principal made by Borrower, and Borrower agrees that all such notations shall constitute PRIMA FACIE evidence of the matters noted. Bank's failure to record such information shall not reduce or affect the obligations of Borrower hereunder or under the Loan Agreement. Upon the occurrence of any failure to make a payment required under this Note and/or any Event of Default under the Loan Agreement, Bank, at its option and without further notice, demand, or presentment for payment to Borrower, may declare immediately due and payable the unpaid principal balance and interest accrued thereon together with all other sums owed by Borrower under this Note and the Loan Documents (including, but not limited to attorneys' fees as provided below), anything in this Note and the Loan Documents to the contrary notwithstanding. Notwithstanding the foregoing, under certain circumstances as provided in the Loan Agreement or under applicable law, the unpaid principal balance and interest accrued thereon together with all other sums owed by Borrower under this Note and the Loan Documents (including, but not limited to, attorneys fees as provided below) shall automatically become due and payable. Payment of such sums may be enforced and recovered in whole or in part at any time by one or more of the remedies provided to Bank in this Note or the Loan Documents. All amounts so accelerated under this Note or the Loan Documents, or all such amounts that become due and payable on the Maturity Date but remain unpaid, shall in each case (without need for further notice) bear interest from the date of such acceleration or the Maturity Date, as applicable, until the date such amounts are paid in full at a rate per annum equal to the Default Rate. 44 Borrower shall make all payments hereunder in lawful money of the United States and in immediately available funds to Bank's account by means of a wire transfer addressed as follows: The Sumitomo Bank, Limited, Chicago Bank, ABA 071001850, through the Federal Reserve Bank of Chicago, Reference: Genome Therapeutics Corp. The computation of interest hereunder shall be on the basis of a 360 day year, for actual days elapsed. All agreements between Borrower and Bank, whether now existing or hereafter arising, are hereby limited so that in no event shall the interest charged hereunder or under the Loan Agreement or any other charges hereunder or under the Loan Agreement which may at any time be deemed to be interest or agreed to be paid to Bank exceed the maximum amount permissible under applicable law. Bank shall be entitled to amortize, prorate and spread throughout the full term of this Note all interest paid or payable so that the interest paid does not exceed the maximum amount permitted by law. In the event that the total liability for payments of interest and payments in the nature of interest, including without limitation, all charges, fees or other sums which may at any time be deemed to be interest, shall for any reason whatsoever, result in an effective rate of interest that for any interest payment period exceeds the amount which Bank may lawfully collect, then the interest rate shall automatically be reduced to the maximum rate permitted by law and all sums in excess of those lawfully collectible as interest for the period in question shall, without further notice to any party hereto, be applied as a premium-free reduction of the principal balance, provided, however, that Bank may, at any time, and from time to time, elect, by notice in writing to Borrower, to waive, reduce or limit the collection of any sums (or refund to Borrower any sums collected) in excess of those lawfully collectible as interest rather than accept such sums as prepayment of the principal balance. Borrower shall pay all reasonable fees, costs and expenses, including reasonable attorneys' fees, incurred by Bank in the preparation and negotiation of this Note and the Loan Documents and in the enforcement or attempt to enforce any of Borrower's obligations hereunder not performed when due, whether or not any legal action is actually filed, litigated or prosecuted to judgment of award. This Note shall be governed by, construed and interpreted in accordance with the laws of the Commonwealth of Massachusetts. Time is of the essence in the performance of the obligations evidenced by this Note. In the event that Borrower defaults under this Note, or an Event of Default occurs under the Loan Agreement, Bank shall have all of the rights and remedies provided for in any of the Loan Documents or at law or in equity. 45 The remedies of Bank shall be cumulative and may be exercised from time to time. No failure on the part of Bank or the holder of the Note to exercise, and no delay in exercising, any right shall operate as a waiver thereof, nor will any single or partial exercise of any right preclude any other or future exercise thereof or the exercise of any other right. Borrower hereby waives diligence, presentment for payment, demand, notice of demand, notice of non-payment or dishonor, protest and notice of protest of this Note, and all other notices in connection with the delivery, acceptance, performance, default or enforcement of the payment of this Note, except such notices as are required under the terms of any of the Loan Documents. If this Note is destroyed, lost or stolen, Borrower shall deliver a new note to Bank on the same terms and conditions as this Note, with all appropriate schedules annexed thereto, in substitution of the prior Note. Bank shall furnish to Borrower reasonable evidence that the Note was destroyed, lost or stolen, and any security or indemnity that may be reasonably required by Borrower in connection with the replacement of the Note. 46 Executed as an instrument under seal as of the day and date referred to above. GENOME THERAPEUTICS CORP. _____________________________ By: ____________________________ Attest Name: __________________________ Title:__________________________ COLLABORATIVE SECURITIES CORP. _____________________________ By: ____________________________ Attest Name: __________________________ Title:__________________________ EX-11.1 3 CALCULATION OF SHARES 1 EXHIBIT 11.1 GENOME THERAPEUTICS CORP. AND SUBSIDIARIES CALCULATION OF SHARES USED IN DETERMINING PRIMARY NET INCOME (LOSS) PER SHARE
YEAR ENDED AUGUST 31, ---------------------------------------- 1995 1996 1997 ---------- ---------- ---------- Weighted average common stock outstanding during the year.................................................... 12,287,918 15,530,639 17,617,614 Weighted average common stock equivalents outstanding during the year......................................... 673,816 2,599,155 -- ---------- ---------- ---------- 12,961,734 18,129,794 17,617,614 ========== ========== ==========
CALCULATION OF SHARES USED IN DETERMINING FULLY DILUTED NET INCOME (LOSS) PER SHARE
YEAR ENDED AUGUST 31, ---------------------------------------- 1995 1996 1997 ---------- ---------- ---------- Weighted average common stock outstanding during the year.................................................... 12,287,918 15,530,639 17,617,614 Weighted average common stock equivalents outstanding during the year......................................... 748,823 2,599,155 -- ---------- ---------- ---------- 13,036,741 18,129,794 17,617,614 ========== ========== ==========
EX-23 4 CONSENT OF ARTHUR ANDERSON LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statements No. 2-77846, No. 2-81123, No. 2-95446, No. 33-12633, No. 33-27885, No. 33-45432, No. 0-10824, No. 03-361191, No. 333-30617 and No. 333-15935. ARTHUR ANDERSEN LLP Boston, Massachusetts October 10, 1997 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 U.S.DOLLARS YEAR AUG-31-1997 SEP-01-1996 AUG-31-1997 1 8,603 38,939 55 0 0 45,462 15,724 5,353 60,688 9,593 0 0 0 1,778 42,168 60,688 0 19,619 0 30,211 79 0 631 0 0 0 0 0 0 (11,302) (.64) 0
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