-----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, RzZ269teMipI7gw4ruG7P1QJa+zsp6xZFU2uDS5XBd1DG4L/reIaFRxFcLd5hOFA dyeDh7/lqsZEyvO9ZmQGZg== 0000899243-97-000556.txt : 19970401 0000899243-97-000556.hdr.sgml : 19970401 ACCESSION NUMBER: 0000899243-97-000556 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENERGY BIOSYSTEMS CORP CENTRAL INDEX KEY: 0000895677 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 043078857 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-21130 FILM NUMBER: 97570587 BUSINESS ADDRESS: STREET 1: 4200 RESEARACH FOREST DR CITY: THE WOODLANDS STATE: TX ZIP: 77381 BUSINESS PHONE: 7133646100 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NO. 0-21130 ------------------------- ENERGY BIOSYSTEMS CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 04-3078857 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) ENERGY BIOSYSTEMS CORPORATION 77381 4200 RESEARCH FOREST DRIVE (ZIP CODE) THE WOODLANDS, TEXAS (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (281) 364-6100 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) ---------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Title of Class Common Stock, par value $.01 per share Preferred Stock Purchase Rights 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 Regulations 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 was approximately $75,573,256 as of March 14, 1997, based on the closing sales price of the registrant's common stock on the Nasdaq National Market on such date of $6.75 per share and assuming full conversion of the registrant's Series A and Series B Convertible Preferred Stock. For purposes of the preceding sentence only, all directors, executive officers and beneficial owners of ten percent or more of the common stock are assumed to be affiliates. As of March 14, 1997, 11,605,377 shares of common stock were outstanding, 2,000 shares of Series A Convertible Preferred Stock were outstanding and 702,100 shares of Series B Convertible Preferred Stock were outstanding. Certain sections of the registrant's definitive proxy statement relating to the registrant's 1997 annual meeting of stockholders, which proxy statement will be filed under the Securities Exchange Act of 1934 within 120 days of the end of the registrant's fiscal year ended December 31, 1996, are incorporated by reference into Part III of this Form 10-K. When used in this document, the words "anticipate," "believe," "expect," "estimate," "project" and similar expressions are intended to identify forward- looking statements. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, expected, estimated or projected. For additional discussion of such risks, uncertainties and assumptions, see "Item 1. Business--Risk Factors" included elsewhere in this report. PART I. ITEM 1. BUSINESS OVERVIEW Energy BioSystems Corporation ("EBC" or the "Company") is developing and commercializing innovative biotechnology-based processes for the petroleum refining and production industries. The Company's focus to date has been on developing biocatalytic desulfurization ("BDS"), a proprietary process involving the use of enzymes to remove sulfur from petroleum. EBC believes that BDS can be used as a substitute for, or in conjunction with, existing desulfurization technology and expects BDS to be significantly less expensive than conventional desulfurization methods. The Company's BDS pilot plant, which is a fully integrated desulfurization unit capable of processing up to five barrels of diesel fuel per day, was completed in late 1994 and began processing diesel feedstock in March 1995. The pilot plant is intended to provide the basis for the design of a commercial-scale BDS unit. Removal of sulfur is one of the most costly issues facing the petroleum industry and is a growing problem worldwide. Sulfur removal is desirable to the refining industry because of (i) environmental regulations mandating decreased sulfur in refined products, (ii) an increasing level of sulfur in crude oil processed by refiners and (iii) high operating and maintenance costs associated with the existence of sulfur in petroleum. Desulfurization is also attractive to the crude oil production market, where low-sulfur crude oil commands a premium price over high-sulfur crude oil. The Company has entered into a number of strategic alliances with recognized industry leaders in support of the Company's BDS development and commercialization activities, providing an opportunity for the Company to build on established expertise and resources in critical areas. The Company has an agreement with The M.W. Kellogg Company ("M.W. Kellogg") for the basic engineering services necessary for BDS implementation at customer sites, and an agreement with Petrolite Corporation ("Petrolite") relating to the development of the Company's BDS technology and the construction and operation of the Company's pilot plant. The Company also has entered into collaborations focusing on the application of the BDS technology as follows: an alliance with Total Raffinage Distribution, S.A. ("Total") to develop a BDS process for diesel fuel streams; an alliance with Koch Refining Company ("Koch") to develop a BDS process for certain gasoline streams; an alliance with the Exploration and Production Technology Division of Texaco Inc. ("Texaco") to develop a BDS process for crude oil; and an alliance with The Carbide/Graphite Group, Inc. ("Carbide/Graphite") to develop a BDS process for decant oil. The Company is pursuing additional alliances with potential customers, particularly in the Middle East and Asia, two markets which are expected to make significant investments in desulfurization technology over the next decade. The Company is also pursuing agreements with leading worldwide biocatalyst manufacturers to ensure a continuous supply of biocatalyst for the Company's BDS process. See "- - -Alliances." To date, the Company has engaged primarily in research and development related to its BDS process. The Company's BDS process will require substantial additional research, development and testing in order to determine its commercial viability. See "--Risk Factors--Technological Uncertainty; Risks Associated with Commercialization of BDS Technology." The Company was incorporated in Delaware on December 20, 1989. The Company's executive offices are located at 4200 Research Forest Drive, The Woodlands, Texas 77381 and its telephone number is (281) 364-6100. -1- THE COMPANY'S TECHNOLOGY Background of BDS The first patents covering the use of bacteria to reduce the sulfur content of petroleum were issued in the United States in 1948. However, early attempts to utilize bacteria and enzymes to selectively remove sulfur from hydrocarbons failed, primarily because of an inability to control the action of the bacteria, which resulted in significant degradation of the fuel value of the hydrocarbon. In 1988, researchers at the Institute of Gas Technology ("IGT") achieved a breakthrough in microbial desulfurization when they isolated two unique strains of bacteria. These strains have the ability to desulfurize coal and selectively remove sulfur from dibenzothiophene, the industry-recognized model for heterocyclic sulfur molecules found in coal and petroleum. U.S. patents were issued on these two bacterial strains in 1992. In 1991, the Company obtained exclusive, worldwide, royalty-free rights to IGT's desulfurization technology. A critical milestone was achieved in 1992 when the relevant genes from the patented bacteria were cloned and sequenced. These genes have now been characterized extensively. The cloned genes are now being manipulated and transferred to alternative microbial hosts and modified to increase the expression of the desired properties. The Company has been issued a fundamental patent on these genes, plus numerous other patents on the BDS process by the U.S. and foreign patent offices. With bacteria strain isolation and molecular cloning of the genes achieved, further development of BDS technology involves primarily a new combination of established biotechnology and chemical engineering processes. In late 1992, the Company initiated operations of a continuous bench-scale unit capable of desulfurizing up to one-half of a barrel of crude oil per day. A fully integrated BDS pilot plant capable of processing up to five barrels of diesel fuel per day was constructed in late 1994 and began processing diesel feedstock for desulfurization in March 1995. The pilot plant was designed with the instrumentation and scale necessary to provide the operating data needed for commercial scale-up. The pilot plant is utilizing diesel fuel from the Company's strategic ally, Total, as feedstock, and is undergoing a variety of experiments that will allow the Company's team of scientists and engineers to evaluate the performance of the biocatalyst, the reactor and the separations systems for a wide range of operating conditions. The information generated from the pilot plant will also be used to guide further development of the Company's other BDS applications for crude oil and other petroleum products. Overview of the Company's BDS Technology BDS is a proprietary process based on naturally occurring bacteria that can remove organically bound sulfur from petroleum without degrading the fuel value of the hydrocarbon. Enzymes in the bacteria selectively cleave carbon-sulfur bonds in the presence of oxygen to yield an oxygenated hydrocarbon product and a sulfate by-product. Because the chemical reaction is catalyzed by enzymes associated with the bacteria, the bacteria do not have to grow in order to desulfurize fossil fuels. Operating at ambient temperatures and atmospheric pressure, BDS is expected to be significantly lower in cost than conventional hydrodesulfurization ("HDS") technology and flexible enough to desulfurize a wide range of petroleum streams including crude oil. Since the process is oxidative, the addition of hydrogen is not required, thus avoiding a significant element of conventional desulfurization operating costs. The basic steps of the BDS process are: The biocatalyst is combined with water and transferred to the bioreactor. The biocatalyst slurry and high-sulfur petroleum stream are mixed in the continuous stirred-tank bioreactor and air is sparged in as a source of oxygen. The desulfurized oil is separated from the oil/aqueous/biocatalyst output stream. The aqueous phase is further treated to separate out the biocatalyst and water. -2- The sulfur byproduct is captured from the aqueous phase as a sulfate salt or other water-soluble sulfur compound and removed from the process. The biocatalyst and water are recycled to the bioreactor and spent biocatalyst is drawn off. Conventional Desulfurization Technologies Hydrotreating is the conventional technology for the removal of sulfur, nitrogen and other impurities from oil. When this process is used primarily for the removal of sulfur, it is called hydrodesulfurization ("HDS"). In this process, petroleum fractions are subjected to high temperatures and pressure in the presence of an inorganic catalyst and hydrogen. As a result, organic sulfur molecules are converted to hydrogen sulfide, which is further processed to yield elemental sulfur. HDS is relatively ineffective against more complex sulfur molecules found in diesel and heavier fractions. HDS is a costly process for refiners. A typical HDS unit costs between $30 million and $80 million to construct, depending on the product stream to be treated, the level of desulfurization required and the unit size. The high pressure and temperature required for HDS translate directly into high capital and maintenance costs because these units require high-pressure vessels and exotic metals which are expensive to manufacture and maintain. Although some refinery units produce hydrogen, the large amount of hydrogen required for HDS may require refiners to build new hydrogen production capacity at an additional significant capital expense. Benefits of BDS The Company believes that its BDS technology will offer the refining industry an effective alternative to HDS and will in many cases complement existing technology. The Company believes that BDS may provide refiners with the following principal benefits: Cost Effectiveness. BDS is designed to operate at ambient temperatures and pressures, in contrast to HDS, which requires thick-walled reactors and other equipment designed to tolerate high temperatures and pressures. As a result, the Company expects that its BDS units will be significantly less expensive to build than HDS units. The Company expects that the capital costs of a BDS unit will be approximately 50 percent less than a comparable HDS unit. In addition, the BDS process will not require hydrogen, which is an expensive component of HDS. Ease of Integration. The Company believes the BDS process can be integrated into refinery operations without significant difficulty. Most of the components of the BDS units are expected to be readily available equipment. The biocatalyst will be produced off-site and delivered to the refinery, as is now the case with inorganic catalysts used in conventional refinery processes. The BDS process is not expected to generate any unusual byproducts, and byproduct disposition is expected to be accomplished with existing processes familiar to most refiners. The mild operating conditions of BDS are also expected to contribute to improved operating safety over HDS in many applications. Effectiveness Against Complex Sulfur Molecules. The Company believes that BDS will be effective in removing complex sulfur molecules that are resistant to conventional desulfurization technologies. Diesel fractions, for example, contain more complex sulfur molecules against which HDS is relatively ineffective. As a result, HDS becomes increasingly more costly and less effective in desulfurizing diesel fuel as the lighter-sulfur compounds are removed and the remaining complex molecules constitute an increasing proportion of the remaining sulfur. Accordingly, the Company expects that any reduction in the level of sulfur permitted under applicable regulations will make BDS increasingly cost-effective as compared to HDS. While the Company believes its BDS process will be economically attractive to petroleum refiners and to crude oil producers, the BDS process will require significant capital expenditures by refiners and producers. The refining and oil production industries historically have been reluctant to accept new technologies. There is a risk, therefore, that the Company will have difficulty in obtaining the refining and oil production industries' acceptance of the BDS process. -3- Also, the rate of purchase of the Company's BDS process may be affected by economic conditions in the refining and oil production industries. The refining and oil production industries have been subject to periods of depressed profitability and are substantially affected by fluctuations in the price of crude oil and finished products. Oil production and drilling activity are also largely dependent on the level and volatility of oil prices. MARKET OVERVIEW Refining Industry One of the principal markets for the Company's BDS technology is the worldwide refining industry, which processes more than 60 million barrels of crude oil per day or approximately 22 billion barrels per year. A significant portion of worldwide refining capacity is concentrated among a small number of large corporations and nationalized oil companies. In the United States, the top 10 companies process approximately 60 percent of the refined petroleum products, and in Western Europe and Asia, the 10 largest refining companies process more than half of the refined petroleum products. Refineries purchase crude oil and process it into three principal products: (i) middle distillates (including diesel fuel), (ii) gasoline and (iii) residual fuel oil (used primarily by electric utilities and ships). In the refining process, crude oil is subjected to distillation, resulting in the separation or fractionation of the hydrocarbons into several intermediate products. These intermediate products are subjected to additional processing steps before formulation into finished products. These additional processing steps include the removal of impurities (such as sulfur, metals and nitrogen), the "cracking" of large hydrocarbon molecules and the upgrading of lower-quality intermediate products. Refinery Desulfurization The refining industry is expected to spend more than $35 billion in capital and up to $10 billion annually in operating expenditures for sulfur removal through the next decade, assuming the use of conventional technologies. Asia accounts for approximately 40 percent of this total expenditure with Western Europe and the United States accounting for approximately 30 percent each. Pollution regulations have increasingly targeted sulfur in fossil fuels due to its harmful effects on the environment. The combustion of sulfur results in the emission of sulfur oxides ("SOx"), which are believed to be a cause of "acid rain" and smog. Regulations issued under the 1990 amendments to the U.S. federal Clean Air Act (the "Amendments") required a reduction in the sulfur content of all on-highway diesel fuels to 500 ppm on October 1, 1993, from a prior national average of over 2,000 ppm. Similar regulations worldwide will significantly reduce the level of sulfur allowed in certain petroleum products, including diesel fuel. In Western Europe, diesel fuel was required to meet the 500 ppm specification by October 1996. In Asia, many countries have adopted or plan to adopt similar sulfur regulations on diesel fuel which will be implemented in various stages over the next decade. The European Union has announced its intention to implement regulations requiring the further reduction in the sulfur content of diesel fuel, with the expectation that the diesel sulfur specification will be reduced to 350 ppm by the year 2000 and to 100 ppm by the year 2005. In the past, environmental standards in the larger economies around the world have tended to follow each other. Therefore, it is possible that another series of diesel sulfur regulations, similar to those now anticipated in Europe, will be forthcoming in the U.S. and in Asian countries. Sulfur also inactivates catalysts contained in automobile catalytic converters over time, resulting in a significant increase in the emission of unburned hydrocarbons and nitrogen oxides ("NOx") from automobile tailpipes, which in turn contribute to smog. The Amendments required a targeted reduction in U.S. gasoline emissions of 15 percent by the year 1995 and call for a targeted reduction of 25 percent by the year 2000. The Environmental Protection Agency (the "EPA") established a detailed model (the "Complex Model") for determining the emissions of various gasoline formulations to be sold in most large cities that have not attained certain prescribed levels of improvement in air quality ("Nonattainment Areas"). Use of the Complex Model becomes mandatory starting in 1998 for certifying gasoline sold in Nonattainment Areas, which currently represents approximately 25 percent of all gasoline produced in the U.S. The Complex Model explicitly recognizes the detrimental impact of sulfur on gasoline tailpipe pollution, giving refiners -4- incentive to decrease the level of sulfur in gasoline they produce. Regulations in Europe further limiting sulfur levels permitted in gasoline are anticipated for the year 2000 and similar regulations may be adopted in Asia. Industry sources believe that sulfur will play a key role in refiners' plans to reduce gasoline emissions in the latter part of this decade. The Amendments, as well as various state and local regulations, generally limit the atmospheric emission of SOx by stationary sources, such as refineries and utilities. For example, permit regulations limit allowable SOx emissions from fluid catalytic cracking units ("FCCUs") (the refinery processing unit for upgrading heavier oil molecules to gasoline), which may cause refiners to constrain the output of a unit that is critical to refining profitability. New or modified FCCUs are also subject to SOx emissions limitations. The Amendments and state and local regulations also limit the amount of high-sulfur fuel that electric utilities may burn, restricting one of the refining industry's largest end markets for residual fuels. Consequently, the value of residual fuel is significantly affected by its sulfur content. The increasing average level of sulfur in crude oils is also expected to stimulate demand for new desulfurization technologies. Low-sulfur crude oils have traditionally been in greater demand and commanded a price premium over higher-sulfur crude oils. Over the last decade, the average sulfur content of crude oil processed by U.S. refiners increased by more than 20 percent. In the future, refiners worldwide are expected to process increased volumes of high- sulfur crude oil, raising the demand for additional desulfurization capacity. Sulfur in crude oil increases refiners' operating costs because of sulfur's detrimental effect on refinery equipment and catalytic processes. Many sulfur compounds are corrosive, and the processing of high-sulfur crude oil necessitates more frequent maintenance of refinery processing units. The presence of sulfur in the feedstock for FCCUs decreases the effectiveness of the inorganic catalyst used to crack the fuel, increasing the operating cost of the FCCU and decreasing product yield. Sulfur has a similar degrading effect on most catalytic processes in the refinery, increasing operating costs on a variety of key processing units. Crude Oil Desulfurization The price of crude oil is affected by its sulfur content. The difference in price between low-sulfur and high-sulfur crude oils is affected by increasingly stringent regulation of sulfur content in finished products. Lower-sulfur crude oils have typically commanded a $1 to $3 per barrel premium in the market compared to higher-sulfur crude. Over 50 percent of the crude oil produced worldwide is considered high in sulfur (greater than one percent). The Company believes the price difference between low-sulfur crude oil and high-sulfur crude oil will create an incentive for oil producers to reduce the sulfur levels in their product, resulting in demand for crude oil desulfurization technologies. Accordingly, the Company believes that by reducing the sulfur content of crude oil at the production stage, BDS has the potential to greatly improve the marketability and value of higher-sulfur oil reserves and improve producers' access to pipelines that limit the sulfur content of crude oil. To date, conventional desulfurization technologies have not proven economically viable for the desulfurization of crude oil. Large reserves of high-sulfur crude oil exist in Venezuela, Canada, the United States, Mexico, the former Soviet Union and the Middle East. Venezuela has proven reserves in excess of one trillion barrels of crude oil with a sulfur content greater than two percent. Canada has in excess of 50 billion barrels of proven reserves of crude oil with a two percent or greater sulfur content, and the United States has approximately 125 billion barrels of proven reserves of crude oil with a two percent or greater sulfur content. Cost-effective desulfurization technology will play a key role in making many of these high- sulfur crude oil reserves more economically exploitable. Other Potential Applications of Biorefining The Company believes there are numerous other applications for its biorefining technology. These potential applications include the following: -5- Nitrogen Removal. Nitrogen compounds in petroleum present refiners with many of the same problems associated with sulfur. Refiners currently remove nitrogen using a hydrotreating process. The Company believes that a system similar to the BDS system can be developed to remove nitrogen. Metals Removal. Heavy metals in petroleum damage refinery catalysts and reduce the value of refined petroleum products. In addition, heavy metals limit the efficiency of conventional desulfurization technologies. Bioreactor systems have been developed for the extraction of metals from wastewater. The Company believes that similar systems can be developed for the biocatalytic removal of metals from crude oil and residual oil. Viscosity Reduction and Cracking. Bioprocessing technologies have been used for many years to depolymerize very viscous solutions of corn starch to produce high fructose corn syrup. A similar chemical process in refineries is called cracking, which refers to the thermal degradation of complex hydrocarbon molecules into simpler, higher-value products. The Company believes that a biocatalytic liquefaction system could be applied to molecules in some highly viscous crude oils which currently have little commercial value. The Company believes that this process could produce crude oil with significantly reduced viscosity, a higher proportion of molecules in the gasoline and diesel fuel boiling range, and increased commercial value. Coal Desulfurization. Conventional desulfurization technologies cannot economically remove organic sulfur from coal. Therefore, high-sulfur coal represents a potential future market for the Company's desulfurization technology. The Company believes that the BDS technology it develops for liquid fossil fuels may eventually have application in the desulfurization of coal and, in particular, coal slurries. BUSINESS STRATEGY The Company's goal is to become the leading provider of biorefining solutions for the petroleum industry. The Company's strategy is to concentrate its internal resources on the research, development and marketing of the Company's BDS technology while entering into strategic alliances to assist in the engineering and construction of BDS units and in the manufacturing of the biocatalyst employed in the BDS process. To commercialize BDS, the Company must develop the BDS process to a competitive commercial level, establish the infrastructure required to deliver, supply and service the BDS units, and sell the BDS units to refiners and oil producers. The Company believes it has chosen the most rapid commercialization strategy by working on these efforts in parallel and leveraging internal resources with strategic alliances. The Company believes that its technology has broad potential application in the processing of petroleum products. Although the Company's technology will first be directed at biocatalytic desulfurization, the Company's long-term plan is to expand the capabilities of its technology to address the removal of other petroleum impurities (e.g., nitrogen and metals), to address other refining processes (e.g., viscosity reduction and cracking) and to remove sulfur from coal. RESEARCH AND DEVELOPMENT To commercialize BDS, the Company must improve the productivity of the biocatalyst to a competitive economic level while developing an engineered bioreactor system that allows the control of several variables to induce optimal biocatalytic desulfurization. To accomplish these goals, the Company has conducted extensive research, development and testing of the biocatalyst and bioreactor and has assembled a team of scientists and engineers with extensive experience in microbial physiology, molecular biology, biochemistry, fermentation, process development and scale-up, biochemical engineering, separations technology, and refinery process engineering and operations. The focus of the Company's research and development efforts has been to develop the BDS process for use in treating diesel fuel, gasoline and crude oil. The Company also has efforts underway to develop the BDS process for use in treating decant oil under its collaboration with Carbide/Graphite. The Company expects the desulfurization of diesel fuel, where its development efforts are the most advanced, to be the first commercial application of its BDS technology. As a result of the specificity of the biocatalyst for each product application, the Company expects that further development will be required to commercialize its BDS technology for use in treating gasoline and crude oil. -6- In late 1992, the Company initiated operations of a continuous bench-scale unit capable of desulfurizing up to one-half of a barrel of crude oil per day. A fully integrated BDS pilot plant capable of processing up to five barrels of diesel fuel per day was constructed in late 1994 and began processing diesel feedstock for desulfurization in March 1995. The pilot plant was designed with the instrumentation and scale necessary to provide the operating data needed for commercial scale-up. The pilot plant is utilizing diesel fuel from Total as feedstock, and is undergoing a variety of experiments that will allow the Company's team of scientists and engineers to evaluate the performance of the biocatalyst, the reactor and the separations systems for a wide range of operating conditions. The information derived from operating the pilot plant will provide the design basis for the first commercial units and will be used to guide further development of the Company's other BDS applications for crude oil and other petroleum products. In 1994, the Company was awarded a $2 million federal grant under the Advanced Technology Program ("ATP") administered by the National Institute of Standards and Technology. The grant is dedicated to the development of a biotechnology- based method of removing sulfur from crude oil. The three-year program funded with this award is intended to accelerate the pace of development in crude oil desulfurization, moving the BDS technology in this area from the research level toward the pilot plant phase. The Company had research and development expenses for the years ended December 31, 1994, 1995 and 1996 of $5,723,131, $7,338,319 and $9,210,227, respectively. The Company expects its research and development expenditures to decrease in 1997, as a result of a nonrecurring $1,000,000 payment to Petrolite in 1996 offset in part by additional scientific and technical personnel and a recently completed 4,500 square-foot expansion of the Company's laboratory facilities. The Company's research and development expenses will increase substantially, however, if the Company makes the $9,000,000 payment to exercise the Petrolite option in 1997, the entire amount of which will be recorded as a research and development expense. The Company does not presently intend to exercise the Petrolite option until it has raised additional funds or received additional capital. Biocatalyst Productivity The Company is focusing on maximizing the biocatalyst's productivity to minimize the quantity of catalyst and the time needed to complete the reaction. This biocatalyst strain improvement is being pursued through both conventional and genetic engineering programs. The conventional programs rely on mutagenesis to produce variants of the original bacteria that desulfurize more efficiently. The molecular biology program has identified the genetic elements responsible for desulfurization, and is pursuing direct improvements in their operation, primarily through recombinant DNA techniques patented by the Company. Additionally, fermentation development is being used to identify growth media which optimize the production of the biocatalyst. Development of BDS entails research and development in the areas of molecular biology, biochemistry, fermentation and longevity of the biocatalyst. Set forth below is a description of the Company's research in these areas. Increasing the Specific Activity of the Biocatalyst. The understanding and manipulation of the molecular biology involved in the BDS process is vital for the successful commercialization of the BDS technology. The Company has cloned, sequenced and characterized genes responsible for the desulfurization activity. The genes are now being manipulated, transferred to alternative microbial hosts and modified to increase the expression of the desired properties. Over the past three years, the Company isolated, purified and characterized three key enzymes used in the BDS process. Additionally, in 1995 the Company identified, isolated, characterized and cloned the gene responsible for the expression of a previously unrecognized fourth enzyme that increases the rate of the BDS process. By manipulating the genes responsible for desulfurization activity to increase the expression of the fourth enzyme and by transferring the desulfurization genes to alternative microbial hosts, the Company increased the productivity of the biocatalyst by a factor of ten in 1996. The Company's ability to make the BDS technology commercially viable will depend in large part on its success in manipulating these genes to increase the expression of the desulfurization trait. Production of the Biocatalyst. Large-scale growth and production, or fermentation, of biocatalysts is essential to the commercialization of the BDS technology. The Company's efforts in developing alternative microbial hosts have been intended to select hosts that can be produced more rapidly and at lower cost. The Company believes that this -7- fermentation will not be substantially different from the many antibiotic and enzyme fermentations routinely commercialized by other biotechnology companies. The Company currently conducts small- and intermediate-scale (300 liter) fermentations at its laboratory facilities. These facilities are sufficient to supply laboratory and preliminary pilot plant needs for the biocatalyst. The Company is pursuing agreements with leading worldwide biocatalyst manufacturers to ensure a continuous supply of biocatalyst for the Company's BDS process. Longevity of Biocatalysts. All catalysts become inactive after prolonged exposure to hydrocarbons. Catalyst replacement is a significant factor in the cost of BDS. By extending the longevity of the biocatalyst, this component of the operating cost of BDS can be minimized. The Company is developing resistant strains of bacteria to serve as hosts, or "platforms," for the desulfurization enzymes in order to maximize the longevity of the biocatalyst in diesel fuel. Process Engineering In addition to efforts in biocatalyst development, the Company has allocated considerable resources to the development of the process engineering for the first BDS units. The Company believes that scale-up of its BDS process can be accomplished with conventional process engineering technology. The Company and Petrolite jointly operate the BDS pilot plant, which is a fully integrated desulfurization unit capable of processing up to five barrels of diesel fuel per day. The pilot plant was completed in late 1994 and began processing diesel feedstock in March 1995. The pilot plant is intended to provide the basis for the design of a commercial-scale BDS unit. Although many aspects of the bioreactor are standard, the specific configuration of the bioreactor to be used at each site will be customized based on, among other things, the specific petroleum fraction to be desulfurized and the configuration of the refinery. Bioreactor Technology. The Company has designed and constructed the pilot plant to develop the catalytic process with hydrocarbon molecules in the presence of air, water and various process chemicals. Variables such as temperature, agitation rate and pH (acidity or alkalinity) can be controlled, and measured amounts of oxygen and process chemicals can be added to the mixture of biocatalyst and petroleum, optimizing the desulfurization environment. The Company, however, has not yet developed a bioreactor capable of operating at commercial levels of throughput and desulfurization, and there can be no assurance that the Company can develop a commercial-scale bioreactor that will desulfurize petroleum on a commercial basis. Separations Issues. The completion of the BDS process results in a mixture of water, desulfurized hydrocarbons, biocatalyst and sulfur byproduct. The Company has developed proprietary technology for the efficient separation of these components. The Company's improved separations system has been demonstrated in the laboratory and was successfully implemented at the Company's pilot plant in 1996. The separation process uses a unique combination of conventional technologies which the Company believes can be scaled up to commercial levels without substantial difficulty. Byproduct Disposition. The principal by-product of the BDS process is a water-soluble, inorganic sulfur compound which has been removed from the target hydrocarbons. The Company has evaluated alternatives for the disposition of the sulfur and believes that the best alternative for most refineries will be conversion of the sulfur byproduct either to ammonium sulfate, which can be used as a fertilizer, or to sodium sulfate. A secondary byproduct will be the spent biocatalyst stream, which is expected to be disposed of at an off-site commercial disposal facility as either a solid or other refinery waste. Mass Transfer Issues The Company's recent success in improving the productivity of the biocatalyst has increased the intrinsic reaction rate of the biocatalyst to the point that it exceeds the rate at which sulfur molecules transfer from the petroleum to the surface of the biocatalyst. Limitations in the speed of a catalytic reaction as a result of the rate at which a substrate transfers to a catalyst (known as "mass transfer limitations") are commonly encountered in both biological and chemical catalysis and can frequently be overcome through one or more commonly used biological and chemical engineering solutions. The Company is modifying both the biocatalyst and the reactor design in an effort to overcome the mass transfer limitation that currently affects the rate of the BDS reaction. -8- Scientific Advisory Board The Company has retained a group of distinguished research scientists and engineers to provide advice on matters relating to its research, development and business activities. The Scientific Advisory Board, composed of six members, meets with the Company's scientists and management and is regularly available for consultation. Scientific advisors are compensated for expenses and certain advisors have been granted options to acquire Common Stock. The members of the Scientific Advisory Board are as follows: Charles L. Cooney, Ph.D., Professor of Chemical and Biochemical Engineering, Massachusetts Institute of Technology. Dr. Cooney is widely recognized as an expert in the field of bioreactor design and engineering. Dr. Cooney is the author or co-author of more than 200 scientific publications and patents and has received many academic awards and honors, including being named Founding Fellow, American Institute for Medical and Biological Engineering, in 1992. Dr. Cooney received his B.S. in Chemical Engineering from the University of Pennsylvania and his M.S. and Ph.D. in Biochemical Engineering from Massachusetts Institute of Technology. Norman Hackerman, Ph.D., President Emeritus and Distinguished Professor Emeritus of Chemistry, Rice University, and Former President and Professor Emeritus of Chemistry, The University of Texas at Austin. Dr. Hackerman is a member of the National Academy of Sciences and of the American Philosophical Society, a Fellow of the American Academy of Arts and Sciences, and Chairman of the Scientific Board of the Robert A. Welch Foundation. Dr. Hackerman has been the recipient of many awards, including the American Institute of Chemists Gold Medal and the Mirabeau B. Lamar Award of the Association of Texas Colleges and Universities. He received his A.B. and Ph.D. from Johns Hopkins University. Herbert L. Heyneker, Ph.D., Visiting Scholar, Standford University School of Medicine, Department of Genetics. Dr. Heyneker is an authority in microbial expression of human proteins, including insulin, growth hormone and tPA; protein engineering; and expression systems for industrial microorganisms. Dr. Heyneker serves as a director of Genpharm International, Inc., and Genomysx Corporation. He also serves as a scientific advisor for Institutional Venture Partners and as a member of the scientific advisory board for Cytel Corporation. He earned his Ph.D. from the University of Leiden, The Netherlands and completed his post- doctoral fellowship at the University of California-San Francisco Medical School. Charles F. Kulpa, Jr., Ph.D., Professor of Microbiology, University of Notre Dame. Dr. Kulpa is regarded as an expert in the fields of microbiology, bioremediation and biochemistry. His laboratory research work is concentrated in the areas of environmental and applied microbiology. Dr. Kulpa has authored or co-authored numerous papers detailing his research in microbiological and biochemistry processes. Active in many scientific organizations, Dr. Kulpa has served as President of the Indiana Branch of the American Society for Microbiology. He received his B.S., M.S. and Ph.D. in Microbiology from the University of Michigan. W. Arthur Porter, Ph.D., President and Chief Executive Officer of the Houston Advanced Research Center. The Houston Advanced Research Center ("HARC") is a non-profit research consortium with major research interests in materials science, lasers, high energy physics, supercomputing, geotechnology, space and policy studies located in The Woodlands, Texas. Dr. Porter is also adjunct professor of electrical and computer engineering at Rice University in Houston. Dr. Porter serves on the boards of Stewart Information Services Corporation; Electro Scientific Industries; HARC; and the American Productivity and Quality Center. He also serves as a Governor-appointed member of the Texas Partnership for Economic Development Board and is a past member of the U.S. Department of Commerce Semiconductor Technical Advisory Committee. He received his B.S. and M.S. degrees in Physics from the University of North Texas and his Ph.D. in Interdisciplinary Engineering from Texas A&M University. -9- Derek Redmore, Ph.D., Vice President, Technology Department, Petrolite. Dr. Redmore has served at the managerial level within Petrolite since he joined the company as a Senior Research Chemist in 1965. During his career, he has received 108 patent awards and was named Missouri Inventor of the Year in 1981. He received his B.Sc. and Ph.D. in Chemistry from Nottingham University in England and completed his post-doctoral work at Washington University in St. Louis. ALLIANCES The Company has entered into alliances with potential customers and suppliers in support of its BDS development and commercialization activities. These alliances give the Company an opportunity to build on established expertise and resources in areas critical to its success. In the case of alliances with potential customers, the Company believes that these relationships may enhance its ability to sell BDS units. Entering into alliances with recognized industry suppliers is expected to facilitate commercialization of the BDS technology. However, there can be no assurance that the Company will be successful in maintaining its existing collaborative relationships or in establishing new relationships. Alliances with Potential Customers Total Raffinage Distribution S.A. In July 1994, the Company entered into an agreement with Total Raffinage Distribution S.A. ("Total") to collaborate on the application of the Company's BDS process to diesel and other middle distillate fuel streams. The Company and Total will each bear their own costs and expenses incurred under the collaboration. In addition, as part of its obligations under the agreement, Total has provided the Company with the use of analytical equipment valued at approximately $200,000. The agreement with Total provides that upon commercialization, the site licenses will be waived on Total's first commercial BDS unit. In addition, Total will be entitled to receive a 10 percent discount on future site license and service fees until it has recovered two and one-half times its research costs and expenses for BDS projects under the agreement. The Company expects that its alliance with Total will facilitate commercialization of the BDS technology for diesel fuel and the Company's entrance into the European market. The Company's alliance agreement with Total contemplates an evaluation of pilot plant operations, commencing after the Company's completion of the development of a prototype biocatalyst. The Company completed the development of a prototype biocatalyst in late 1996 and expects to complete the evaluation by mid-1997. The prototype biocatalyst is intended to possess characteristics sufficiently similar to the commercial biocatalyst to permit the design of a commercial-scale BDS unit although it is not expected or intended to possess sufficient specific activity or other characteristics necessary to be commercially viable. If the results from the pilot plant are satisfactory, it is expected that Total will build and operate at Total's expense a pilot BDS unit at Total's European Center for Research and Technology and simultaneously will build a commercial BDS unit at one of its refineries. The Company intends to continue the development of the biocatalyst to improve its specific activity and other characteristics necessary for commercial viability during the period in which Total is building these BDS units. Total has indicated that it intends to employ its initial BDS units for the "ultra deep" (below 500 ppm) desulfurization of diesel, a range of desulfurization below current regulatory standards in which BDS is expected to possess greater cost advantages as compared to HDS. The Company is also continuing to develop its BDS technology for the desulfurization of diesel fuel in ranges above 500 ppm. Total is a wholly owned subsidiary of Total S.A., a leading international oil and gas company based in France. Total S.A. participates in every phase of the oil and gas industry with operations in more than 80 countries worldwide and revenues of over $25 billion. Koch Refining Company. In December 1993, the Company entered into an alliance with Koch Refining Company ("Koch") for the development of a biotechnology-based desulfurization system for refinery oil streams. The alliance is expected to accelerate the development of BDS for certain gasoline streams and customize that development for Koch's applications. Under the terms of the alliance, the Company is primarily responsible for improving the performance of the biocatalyst used in the BDS process and developing a commercial BDS system. Koch is primarily -10- responsible for selecting and providing the target gasoline stream as well as testing desulfurized product quality. Koch will also provide engineering support as needed in the development of a BDS unit for Koch's operations. Until commercialization, the Company and Koch will each bear their own costs and expenses incurred in connection with the collaboration. Upon commercialization, Koch will be repaid for direct costs and expenses incurred in assisting BDS development. Repayment will be in the form of a 10 percent rebate on desulfurization processing fees charged to Koch until Koch has been repaid its share of BDS development costs. The Company expects that the development alliance with Koch will facilitate commercialization of the Company's BDS technology for target gasoline streams. Koch is a part of Koch Industries, one of the largest privately held companies in the United States. Koch Industries, with annual revenues in excess of $20 billion, is involved in virtually all phases of the oil and gas industry, as well as chemicals, chemical technology products, agriculture, hard minerals, real estate, and financial investments. Texaco Exploration and Production Technology Division. In July 1993, the Company signed an agreement with the Exploration and Production Technology Division of Texaco Inc. ("Texaco") for the development of a BDS process for crude oil. Under the terms of the alliance, the Company is primarily responsible for improving the performance of the biocatalyst used in the BDS process. Texaco is primarily responsible for field operations, analytical chemistry work, and selecting and providing the target crude oil stream as well as testing desulfurized product quality. Process engineering is conducted jointly by the parties. The Company and Texaco each bear their own costs and expenses incurred in connection with the collaboration. In the event the Company sub-licenses Texaco's intellectual property and proprietary information, licensed by Texaco to the Company, the Company has agreed to pay Texaco an amount equal to 10 percent of the desulfurization processing fee charged to Texaco until such time as the Company has paid Texaco an aggregate amount equal to two and one-half times the aggregate amount of Texaco's direct costs and expenses incurred in connection with the collaboration. The Company expects that the development alliance with Texaco will facilitate commercialization of the Company's BDS technology for crude oil applications. Texaco Inc. is one of the largest oil companies in the world with operations in crude oil production, refining and marketing. Texaco Inc. has annual revenues in excess of $36 billion. The Carbide/Graphite Group, Inc. In December, 1995, the Company entered into an agreement with The Carbide/Graphite Group, Inc. ("Carbide/Graphite") to collaborate on the development of the Company's BDS technology for the removal of sulfur from decant oil. Decant oil is a heavy, highly viscous refined petroleum product which is used primarily to make needle coke. Needle coke is the principal raw material used in the manufacture of graphite electrodes. Under the terms of the alliance, the Company will be primarily responsible for customizing and commercializing a biocatalyst and desulfurization system specifically for decant oil. Carbide/Graphite primarily will be responsible for providing the development and commercialization funding for this particular BDS process. The Company expects that the development alliance with Carbide/Graphite will facilitate commercialization of the Company's BDS technology for decant oil. Carbide/Graphite, which has annual revenues in excess of $259 million, is a major U.S. manufacturer of graphite electrode and calcium carbide products. Graphite electrodes are used as conductors of electricity, and are consumed in the electric arc furnace steelmaking process common to all mini-mill steel producers. Carbide/Graphite is the only manufacturer of graphite electrodes that produces its own requirements of needle coke. Carbide/Graphite also sells needle coke to other manufacturers of graphite products. Prospective Additional Customer Alliances. The Company is pursuing additional alliances with potential customers, particularly in the Middle East and Asia, two markets which are expected to make significant investments in desulfurization technology over the next decade. Alliances with Suppliers The M.W. Kellogg Company. In August 1994, the Company signed an agreement with The M.W. Kellogg Company ("M.W. Kellogg") to collaborate on the development and commercialization of BDS technology. Under the terms of the collaboration, M.W. Kellogg will serve as an engineering consultant to the Company during completion -11- of the BDS development process and will be the exclusive provider of the basic engineering design services required for commercial BDS units. In return for these services, M.W. Kellogg will receive a portion of the site license fee generated by the sale of BDS units. The collaboration has a minimum term of at least five years or the completion of 20 BDS units, whichever is longer, and applies to all biorefining technologies the Company develops. During the first phase of the collaboration, M.W. Kellogg provided 500 engineering work hours of service at no cost to the Company. M.W. Kellogg also agreed to provide an additional 1,500 work hours of service at M.W. Kellogg offices at reduced rates, of which 500 had been utilized by the Company at December 31, 1996. The Company expects that the development alliance with M.W. Kellogg will substantially enhance its refinery engineering capabilities and market access. M.W. Kellogg is an ISO 9001-certified, international technology-based engineering and construction contractor, serving primarily the hydrocarbon, chemical and energy related industries. M.W. Kellogg is a wholly owned subsidiary of Dresser Industries, Inc., a major supplier of highly engineered products and services primarily used in hydrocarbon and energy-related activities throughout the world. Dresser Industries, Inc. has annual revenues in excess of $6 billion. Petrolite Corporation. In March 1992, the Company entered into a collaboration agreement with Petrolite Corporation ("Petrolite"). The Company and Petrolite agreed to jointly develop the Company's BDS process and utilize emulsification and separations technologies and process chemicals developed by Petrolite, if needed. In connection with this collaboration, Petrolite agreed to provide the emulsification and separations equipment necessary for the storage, mixing, injection and delivery of biocatalysts and process chemicals used in the BDS process and to pay the Company $5.4 million during the first two years of the agreement for research and development. Petrolite also agreed to design and finance construction of the pilot plant and to provide service personnel to operate and service the BDS units on site at customer locations. The Company agreed to market the BDS process and the Company's biocatalyst, and to fund, during the third through fifth years of the agreement, research and development related to BDS at an annual rate of not less than four percent of the Company's net revenues from BDS projects or $2.5 million, whichever is greater. Under the collaboration agreement, the Company is obligated to pay Petrolite 22 percent of all site license fees received by the Company from BDS customers and 22 percent of adjusted gross profit (as defined in the agreement) realized from operation of the BDS units. The Company expects that the development alliance with Petrolite will facilitate commercialization of the Company's BDS technology through the development and testing of the pilot plant. In October 1996, the Company entered into an agreement with Petrolite providing the Company with the option to amend the terms of its strategic alliance with Petrolite. Under the agreement, the Company made an initial payment of $1 million to Petrolite in December 1996 in exchange for the option and the extension of Petrolite's obligations to provide operational and technical support for the pilot plant from September 1, 1996 through December 31, 1998. If the Company exercises its option, the percentage of site license fees and adjusted gross profit payable to Petrolite will be reduced to 9.5% from 22%, in exchange for which the Company will (i) assume responsibility for servicing the BDS units on site at customer locations (ii) pay Petrolite an additional $9 million in cash and (iii) issue to Petrolite a warrant entitling Petrolite to purchase 138,889 shares of Common Stock at an exercise price of $7.20 per share. The Company may exercise the Petrolite option at any time on or before the earlier to occur of (i) ten business days following the closing of any equity financing by the Company in which the gross cash proceeds raised in such financing (together with the gross cash proceeds raised by the Company in any other equity financing after the date of the option agreement, if applicable) equal or exceed $25 million and (ii) December 30, 1998. Petrolite is a refinery services company with over $360 million in annual revenues. Petrolite's research and development capabilities include process engineering, emulsification and separations chemistry and analytical chemistry. Prospective Additional Supplier Alliances. The Company is pursuing agreements with leading worldwide biocatalyst manufacturers to ensure a continuous supply of biocatalyst for the Company's BDS process. COMPETITION The primary competition for BDS technology is expected to come from licensors of HDS technology and the manufacturers of catalysts used in those units. In most initial diesel fuel applications, BDS will be sold as a -12- complementary process where expanded capacity is desired or a greater degree of desulfurization becomes necessary in connection with an existing HDS unit. Subsequently, BDS will be developed as a stand-alone diesel fuel desulfurization process, competing directly with HDS. In the case of gasoline, where HDS units are not typically used, the Company expects BDS to operate as a stand-alone desulfurization system. The Company intends to compete on the basis of cost effectiveness, ease of integration, effectiveness in removing complex sulfur molecules that are resistant to conventional desulfurization technologies, and the ability to process petroleum streams that are difficult for HDS to process. HDS process technologies and catalysts are supplied by a small number of companies that maintain their market positions through a combination of recognized expertise, intellectual property rights and established relationships with refiners. Increasing environmental regulation has caused these catalyst suppliers to make significant investments in research and development during the past several years to develop more efficient HDS technologies. The Company believes that these efforts have been directed at refinement of the conventional HDS technology rather than development of entirely new processes. Many of these companies supplying HDS technology have substantially greater financial, technical and human resources than the Company. BDS may face competition from other biotechnology processes, although the Company believes it is the leading developer of biorefining in the world. The most significant competitive effort of which the Company is aware is based in Japan at the Petroleum Energy Center ("PEC"), a consortium of Japanese petroleum companies conducting research funded by the Japanese Ministry of International Trade and Industry. The Company believes, based upon meetings with PEC personnel and third-party sources, that it has a substantial lead in developing BDS technology and that its patents provide it with a substantial competitive advantage over the PEC effort. The Company is also aware that one or more major oil companies have from time to time attempted to develop microbial or biocatalytic desulfurization technologies, although the Company believes that none of these companies has successfully developed any of these technologies to date. Based upon information available to the Company, the Company believes that these efforts do not currently present significant competition for its BDS technology in its primary markets. PATENTS AND PROPRIETARY TECHNOLOGY The Company's ability to compete will depend in part on maintaining the proprietary nature of its technology. The Company has established an active program for the protection of its intellectual property. This program includes, among other things: procedures, notebooks and forms for documenting, evidencing and disclosing all Company inventions to management; a Patent Review Committee which meets regularly to discuss all intellectual property issues; a system for continuously monitoring patents issued to, and patent applications filed by, relevant third parties; a program of seminars for employees on intellectual property topics; a recognized intellectual property law firm on retainer; a patent administrator and other personnel dedicated to assisting in the preparation and prosecution of the Company's patents; personnel policies and agreements requiring disclosure by employees of all inventions and protection of confidential information; and agreements with all technical and scientific employees providing for the assignment of inventions made by such employees to the Company. The Company has an active program in place to maintain and build its intellectual property position. Seven U.S. patents on BDS technology have been issued to The Institute of Gas Technology ("IGT") and licensed exclusively to the Company, subject to the U.S. government's rights to certain of such patents. Additionally, one U.S. patent has been issued to the Korean Institute of Science & Technology and licensed on a nonexclusive basis to the Company. A U.S. patent claiming the use of BDS in combination with HDS for BDS technology was issued to the Company in 1993. The two-stage process for deep desulfurization covered by this patent involves the use of BDS in conjunction with conventional HDS technology, taking advantage of the significant synergies between the two technologies. The Company was issued three patents during the year ended December 31, 1994 and three patents during the year ended December 31, 1995. The most significant of the three patents issued in 1994 is the "Recombinant DNA Encoding a Desulfurization Biocatalyst" patent, which is a fundamental recombinant DNA patent on the genetic sequences for enzymes that desulfurize petroleum. This patent is an important milestone in the development of the Company's worldwide competitive position and establishes its technical leadership in biodesulfurization. The remaining two patents issued in 1994 include "A Process for the Desulfurization and the Desalting of Fossil Fuels" and "Microemulsion -13- Process for Direct Biocatalytic Desulfurization of Organosulfur Molecules." The patents issued in 1995 include "Multistage Process for Deep Desulfurization of Fossil Fuels," "Method for Separating a Sulfur Compound from Carbonaceous Materials" and "Continuous Process for Biocatalytic Desulfurization of Sulfur- Bearing Heterocyclic Molecules." In 1996, an additional five U.S. patents were issued to the Company, including continuations in part on the HDS/BDS patent first issued in 1993 and the desalting patent first issued in 1994 as well as two entirely new patents related to oil/water separations technology and a novel process for the reduction of oil viscosity. These patents are expected to yield long-term improvement in the economics of biodesulfurization for the Company. Patents issued to or licensed by the Company begin to expire in the year 2010. The Company has filed patent applications in the U.S. and worldwide under the Patent Cooperation Treaty as well as in targeted countries not involved in the treaty such as Venezuela. In total, the Company has rights to 20 U.S. patents (including cell recombinant DNA and fundamental process patents) and 32 foreign patents. In addition, the Company has 12 applications pending in the U.S. patent office, and more than 60 foreign patent applications pending to cover BDS process technology and the molecular cloning of the biocatalyst gene. See "-- Risk Factors--Patents and Proprietary Technologies." EMPLOYEES AND CONSULTANTS The Company believes that its success will be based, among other things, on achieving and retaining scientific and technological superiority and on identifying and retaining capable management in order to conduct a fully integrated program of biorefining technology development. The Company has assembled a highly qualified team of scientists as well as executives with extensive experience in the petroleum industry. The Company's product development program combines basic scientific disciplines, such as molecular biology, microbial genetics, biochemistry and biochemical engineering, with applied disciplines such as fermentation, process development, petroleum product separations and recovery, and byproduct disposition expertise. As of December 31, 1996, the Company employed 83 people, 26 of whom hold Ph.D. degrees and 13 of whom hold other advanced degrees. The Company's employees with doctoral degrees represent collective expertise in molecular biology, microbiology, biochemistry, chemistry and chemical and process engineering. The Company believes that its relationship with its employees is good. GOVERNMENT REGULATION Certain of the Company's current and planned operations are, or may be, subject to regulation under various federal and state laws pertaining to protection of the environment and employee health and safety. In the course of its current research and development activities, the Company generates small quantities of solid and hazardous wastes that are subject to regulation under the Resource Conservation and Recovery Act ("RCRA") and various other federal and state regulations. The research and development activities of the Company are also subject to the Occupational Safety and Health Act ("OSHA") and similar state laws and regulations. Upon commercialization of the Company's technology, the Company's operations will be subject to the full scope of environmental and employee health and safety regulations including not only RCRA and OSHA, but also the Clean Air Act, the Federal Water Pollution Control Act, the Toxic Substances Control Act ("TSCA") and other applicable state and federal environmental laws and regulations. Although current information is not definitive enough to accurately predict compliance requirements with such laws and regulations, the Company believes that compliance will not materially affect its operations. Under TSCA, the EPA regulates the use of chemicals for commercial purposes, and the EPA has asserted that it has jurisdiction under TSCA to regulate genetically engineered microorganisms ("GEMs"). Prior to commercialization of the Company's biocatalyst product, the Company will most likely be subject to the Premanufacture Notice Requirements under TSCA in marketing its BDS technology. Under the Premanufacture Notice Requirements, if the EPA finds that the Company's biocatalyst product poses an unreasonable risk to the environment, it may establish controls on its manufacture, distribution or disposal. Based on written communication with the EPA, the Company does not believe that compliance with TSCA will delay the commercialization of the BDS process. -14- Commercialization of the Company's technology outside the U.S. will require compliance with the regulations of foreign countries. In anticipation of early commercialization in Europe, the Company has begun efforts to prepare for compliance with European Union regulations for genetically modified organisms ("GMOs"). Directive 90/219 of the European Commission provides a framework for contained use of GMOs. Each of the member countries has enacted specific regulations consistent with this directive. Based upon discussions with authorities in France, Belgium and the United Kingdom regarding their regulations under Directive 90/219, the Company does not believe that compliance with such regulations will delay commercialization of the BDS process in Europe. RISK FACTORS Technological Uncertainty; Risks Associated with Commercialization of BDS Technology Since its inception, the Company has engaged primarily in research and development related to its BDS process. The Company's BDS process will require substantial additional research, development and testing in order to determine its commercial viability. The Company has not proven its BDS technology other than to a limited extent in laboratory, bench-scale and pilot plant trials. The Company's ability to make its BDS technology commercially viable will depend in large part on its success in (i) achieving improvement of its biocatalyst, including the manipulation of the genes responsible for desulfurization activity to increase the expression and longevity of the desulfurization trait, (ii) improving the rate at which sulfur molecules transfer from petroleum to the biocatalyst, (iii) developing the fermentation process, (iv) contracting for the manufacture of, or manufacturing, sufficient biocatalyst for use in commercial BDS units, (v) developing a bioreactor for use with the BDS process capable of operating at commercial levels of throughput and desulfurization, (vi) identifying economically viable processes for commercial-scale, sulfur byproduct disposition and (vii) marketing its BDS systems effectively. The accomplishment of some or all of these objectives may take longer than anticipated or may never occur. If the accomplishment of any of these objectives takes longer than anticipated, the Company may require additional capital to continue the development and commercialization of its BDS technology, and there can be no assurance that such capital will be available or that the Company will be able to successfully commercialize the BDS technology. History of Operating Losses and Uncertainty of Future Profitability The Company has incurred net losses since its inception and expects its losses to increase in the foreseeable future as it increases its expenditures for the continued development and commercialization of its biorefining technology. The Company has not derived any revenues to date from the use or sale of its biorefining technology and had an accumulated deficit of $42,713,302 at December 31, 1996. The time required for the Company to become profitable is uncertain, and there can be no assurance that the Company will achieve profitability on a sustained basis, if at all. Manufacture of Biocatalyst The Company currently intends to manufacture, at its own facility, only a quantity of biocatalyst sufficient for its in-house research and pilot plant needs. The Company expects that the biocatalyst to be employed in the commercial BDS process initially will be manufactured by a third party. The Company has had discussions regarding non-exclusive biocatalyst supply arrangements with several parties that it believes are capable of satisfying the Company's supply requirements. If the Company is unable to enter into agreements for the supply of commercial quantities of biocatalyst, the Company may be forced to establish its own fermentation facilities. This alternative could delay the commercialization of the BDS process and would require significant capital expenditures. Market Acceptance The BDS process will require significant capital expenditures by refiners and producers. The refining and oil production industries historically have been reluctant to accept new technologies. There is a risk, therefore, that the Company will have difficulty in obtaining the refining and oil production industries' acceptance of the BDS process. Also, the rate of purchase of the Company's BDS process may be affected by economic conditions in the refining and oil production industries. The refining and oil production industries have been subject to periods of depressed -15- profitability and are substantially affected by fluctuations in the price of crude oil and finished products. Oil production and drilling activity are also largely dependent on the level and volatility of oil prices. Reliance on Environmental Regulation Demand for the BDS units and services being developed by the Company is based, in large part, on legislation and regulations in the United States, Europe and Asia that specify stringent environmental quality standards and that impose penalties for noncompliance. The amendments to the federal Clean Air Act required the EPA to develop maximum sulfur content standards for highway diesel fuel and new standards for gasoline content. In response, EPA promulgated regulations regarding the maximum sulfur content of highway diesel fuel in 1990 and regulations for a reformulated gasoline program in 1994. Similar regulations regarding the maximum sulfur content of diesel fuel have been adopted in Western Europe and certain Asian countries. The Company also expects that European and Asian countries will adopt and enforce additional standards requiring a reduction in the sulfur content of petroleum products. Any reduction of severity in current regulations, lax enforcement of current regulations, delay in implementation and enforcement of planned regulations, or reduction of severity in planned or anticipated regulations worldwide may delay or decrease the worldwide demand for the Company's BDS process. Patents and Proprietary Technologies The Company's success is heavily dependent upon its proprietary BDS and other technologies. In total, the Company has rights to 20 U.S. and 32 foreign patents. In addition, the Company has 12 patent applications pending in the U.S. patent office and more than 60 foreign patent applications pending to cover BDS process technology and the molecular cloning of the biocatalyst genes. There can be no assurance concerning the scope, validity or value of such patents, patent applications or related intellectual property rights. Furthermore, there can be no assurance that the steps taken by the Company to protect its proprietary technologies will be adequate to prevent misappropriation of these technologies by third parties, particularly where third parties may independently develop similar technologies, duplicate any of the Company's technologies or design around any proprietary technologies owned by the Company. Any such misappropriation could have a material adverse effect on the Company. Although the Company does not believe any of its proprietary technologies infringe the patent or other proprietary rights of third parties, there can be no assurance that infringement claims will not be asserted against the Company in the future or that any such claims will not require the Company to enter into license arrangements or result in litigation. In the event that the Company may be required to obtain licenses to patents or other proprietary rights of third parties, there can be no assurance that any required licenses would be made available to the Company on terms acceptable to the Company, or at all. If the Company does not obtain such licenses, it could encounter delays in commercializing its BDS technology while it attempts to design around such patents or could find that the commercialization of its BDS technology could be foreclosed. In addition, to the extent that the Company seeks to protect its proprietary technologies overseas, there can be no assurance that steps taken by the Company to protect its proprietary technologies will be adequate under the laws of certain foreign countries, which may not protect the Company's proprietary rights to the same extent as do the laws of the United States. The Company relies on secrecy to protect its proprietary technologies in addition to patent protection, especially where patent protection is not believed to be appropriate or obtainable. The Company has entered into confidentiality agreements with its employees, licensors and certain of its collaborators and consultants. There can be no assurance that such obligations of confidentiality will be honored, that other parties will not otherwise gain access to the Company's trade secrets or that the Company can effectively protect its rights to its unpatented trade secrets. See " -- Patents and Proprietary Technology." -16- Dependence on Collaborators The Company has been dependent on collaborative relationships for development of certain key components of the BDS process, and the Company's commercialization strategy contemplates continued dependence on collaborative relationships. The Company has signed an agreement with M. W. Kellogg to provide the basic engineering designs necessary for BDS implementation at customer sites and an agreement with Petrolite relating to the development of the Company's BDS technology and the construction and operation of the Company's pilot plant. Each alliance partner is currently providing technical assistance during the development of the BDS process. The Company also has entered into an alliance with Total relating to the application of the BDS process to diesel fuel, an alliance with Koch to develop the BDS process for certain gasoline products, an alliance with Texaco to develop a process for desulfurizing high- sulfur crude oil, and an alliance with Carbide/Graphite relating to the development of the BDS process for the desulfurization of decant oil. Collaborative arrangements involve risks that the participating partners may disagree on business decisions and strategies, which may result in delays, additional costs or litigation. The inability of the Company to successfully maintain existing collaborative relationships or enter into new collaborative relationships could have a material adverse effect on the Company. See "-- Alliances." Need for Additional Funds EBC's operations to date have consumed substantial amounts of cash. The negative cash flow from operations is expected to continue over the foreseeable future. The Company believes that its existing capital resources will be sufficient to fund its operations through year-end 1998. Thereafter, the Company may need to raise additional funds to continue development and commercialization of its biorefining technology. The Company may seek additional funding through public or private financings, including equity financings, and through collaborative arrangements. Adequate funds for these purposes, whether obtained through financial markets or collaborative or other arrangements with corporate partners or from other resources, may not be available when needed or on terms acceptable to the Company. The Company's inability to raise funds when needed may require the Company to delay, scale back or eliminate some or all of its research and product development programs. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Limited Marketing Experience The Company has only limited experience marketing its BDS technology, and has assembled only a small sales and marketing staff. There can be no assurance that the Company will be able to successfully implement its sales and marketing plan. Dependence on Key Personnel The Company is dependent on the efforts of its executive officers, scientists and other key employees, the loss of any one of whom could have a materially adverse effect on the Company's business. Shortages of qualified scientists within certain disciplines may occur and competition for the services of qualified scientists may intensify. The Company may not be successful in recruiting or retaining such personnel in the future. Government Regulation Certain of the Company's current and planned operations are, or may be, subject to regulation under various federal and state laws pertaining to protection of the environment and employee health and safety. In the course of its current research and development activities, the Company generates small quantities of solid and hazardous wastes that are subject to regulation under the Resource Conservation and Recovery Act ("RCRA") and various other federal and state regulations. The research and development activities of the Company are also subject to the Occupational Safety and Health Act ("OSHA") and similar state laws and regulations. Upon commercialization of the Company's technology, the Company's operations will be subject to the full scope of environmental and employee health and safety regulations including not only RCRA and OSHA, but also the Clean Air Act, the Federal Water Pollution Control Act, the Toxic Substances Control Act ("TSCA") and other applicable state and federal environmental laws and regulations. In -17- addition, commercialization of the BDS technology outside the United States will require compliance with the regulations of foreign countries. Failure to comply with applicable regulations could have an adverse effect on the Company. See "-- Government Regulation." Competition The Company expects to encounter competition from suppliers of existing desulfurization technology in the marketing of the Company's BDS units. These companies have well-established relationships in the refining industry and have substantially greater financial, technical and human resources than the Company. In addition, new desulfurization technologies could be developed that are competitive with or superior to the Company's BDS technology. See "-- Competition." ITEM 2. PROPERTIES FACILITIES The Company's corporate offices and laboratories are situated in a 28,500 square-foot leased building located at 4200 Research Forest Drive in The Woodlands, Texas, a suburb of Houston, Texas. Pursuant to the lease, monthly payments of $30,440 are required for base rent. The lease for this facility expires in 1998 and the Company has a renewal option extending the lease to 2003. Approximately 20,500 square feet of this space is devoted to research and development. The facility includes two laboratories designed for molecular biology/microbiology/microbial physiology, a process engineering laboratory, a biochemistry laboratory, a media preparation laboratory, and an analytical laboratory which provides all the routine sulfur and hydrocarbon analyses for the operation. In March 1995 the Company completed construction of a fermentation laboratory, microbiology laboratory and accelerated development program laboratories. See "Item 1. Business - Patents and Proprietary Technology" for a description of the Company's patents. ITEM 3. LEGAL PROCEEDINGS. There are no material pending legal proceedings required to be reported in response to this item. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Company's security holders during the last quarter of the fiscal year ended December 31, 1996. -18- PART II. ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's common stock (symbol: ENBC) is traded on the Nasdaq National Market. The following table sets forth the range of high and low sales prices for each calendar quarterly period in the two years ended December 31, 1996 as reported on the Nasdaq National Market: YEAR ENDED DECEMBER 31, 1996 High Low - ---------------------------- ------ ----- First Quarter.............................. $ 8.75 $5.25 Second Quarter............................. 9.50 5.50 Third Quarter.............................. 8.63 4.38 Fourth Quarter............................. 7.50 4.88 YEAR ENDED DECEMBER 31, 1995 High Low - ---------------------------- ------ ----- First Quarter.............................. $ 6.25 $4.75 Second Quarter............................. 8.00 3.75 Third Quarter.............................. 10.00 4.00 Fourth Quarter............................. 9.75 7.00 As of March 14, 1997, 11,605,377 shares of common stock were outstanding and the Company had approximately 105 shareholders of record. DIVIDENDS The Company has never paid cash dividends on its common stock. The Company currently intends to retain any earnings to finance the growth and development of its business and does not anticipate paying cash dividends in the foreseeable future. -19- ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below with respect to the Company's statements of operations for each of the five years in the period ended December 31, 1996 and with respect to the Company's balance sheets as of December 31, 1992, 1993, 1994, 1995 and 1996 are derived from the Financial Statements of the Company that have been audited by Arthur Andersen LLP, independent public accountants. The financial data should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Financial Statements and Notes thereto included elsewhere in this report.
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------- 1992 1993 1994 1995 1996 --------- ---------- ---------- ----------- ----------- STATEMENTS OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA) ----------------------------------------------------------------------- Revenues: Sponsored research revenues...................... $ 867 $ 1,134 $ 1,148 $ 1,567 $ 1,778 Interest and investment income................... 329 510 573 1,401 807 ---------- ---------- ---------- ----------- ----------- Total revenues........................... 1,196 1,644 1,721 2,968 2,585 Costs and Expenses: Research and development......................... 4,839 (1) 4,894 5,723 7,338 9,210 General and administrative....................... 3,162 (2) 2,037 2,978 2,877 2,608 ---------- ---------- ---------- ----------- ----------- Total costs and expenses................. $ 8,001 $ 6,931 $ 8,701 $ 10,215 $ 11,818 ---------- ---------- ---------- ----------- ----------- Net loss........................................... $ (6,805) $ (5,287) $ (6,980) $ (7,247) $ (9,233) ========== ========== ========== =========== =========== Net loss per common share.......................... $ (0.96) $ (0.57) $ (0.75)(3) $ (0.95)(3) $ (1.04)(3) ========== ========== ========== =========== =========== Shares used in computing net loss.................. 7,058,547 9,195,517 9,967,645 10,227,595 11,248,029 per common share................................. ========== ========== ========== =========== ===========
- ---------------- (1) Includes a non-cash charge of $432,655 for compensation expense related to executive stock options issued prior to the Company's initial public offering. (2) Includes a non-cash charge of $2,250,135 for compensation expense related to executive stock options issued prior to the Company's initial public offering. (3) Net loss per common share has been computed by dividing the net loss, which has been increased for periodic accretion and dividends on the preferred stock issued in October 1994, by the weighted average number of shares of common stock outstanding during the period.
DECEMBER 31, -------------------------------------------------------------- 1992 1993 1994 1995 1996 ------------- --------- -------------- --------- --------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents................................. $ 3,496 $ 6,135 $ 28,284 $ 6,172 $ 3,106 Working capital........................................... 1,817 11,650 26,269 15,084 8,770 Total assets.............................................. 4,962 16,055 32,175 23,809 13,711 Long-term capital lease obligations....................... 44 32 21 11 -- Accumulated deficit....................................... (9,148) (14,501) (21,907) (31,321) (42,713) Total stockholders' equity................................ 106 12,891 28,444 21,577 12,715
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Since its inception in December 1989, the Company has devoted substantially all of its resources to research and development. To date, all of the Company's revenues have resulted from interest and investment income and sponsored research payments from collaborative agreements. The Company has incurred cumulative losses since inception and expects to incur substantial losses for at least the next several years, due primarily to the increase in its research and development activities and acceleration of the development of its biocatalyst, fermentation and bioreactor programs. -20- The Company expects that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. As of December 31, 1996, the Company's accumulated deficit was $42,713,302. Results of Operations The Company had total revenues for the years ended December 31, 1994, 1995 and 1996 of $1,721,309, $2,967,954 and $2,585,419, respectively. Sponsored research revenues increased by $14,000, $419,329 and $211,354 in 1994, 1995 and 1996, respectively, primarily as a result of the Company's grant from the National Institute of Standards and Technology in 1995 and 1996 and the Carbide/Graphite agreement in 1996. Payments under the Petrolite agreement were initiated on April 1, 1992 and totaled $5,400,000 through March 1994. Payments received from Petrolite were $675,000 in 1994; no payments were received from Petrolite in 1995 or 1996. In each of the years ended December 31, 1994, 1995 and 1996, $1,134,000 was recognized as revenue under the Petrolite agreement; as of December 31, 1994, 1995 and 1996, the Company had balances of $2,461,500, $1,147,500 and $13,500 respectively, of deferred revenues under the Petrolite agreement. The amount recognized is based on the total payments received in relation to the total research and development costs to be incurred under the terms of the agreement. Interest and investment income increased by $63,231 and $827,316 in 1994 and 1995, respectively, as a result of the increase in cash and cash equivalents and related investments in marketable securities. In 1996, interest and investment income decreased by $593,889 as a result of the decrease in cash and cash equivalents and related investments in marketable securities. The Company had research and development expenses for the years ended December 31, 1994, 1995 and 1996 of $5,723,131, $7,338,319 and $9,210,227, respectively. The $1,615,188 increase from 1994 to 1995 resulted from the addition of 16 personnel in the research and development department and the completion of 4,500 square feet of additional laboratory space at the end of the first quarter of 1995. The increase of $1,871,908 from 1995 to 1996 resulted from the addition of nine personnel in the research and development department, additional office space acquired during the first quarter of 1996 for research personnel and a $1,000,000 option payment to Petrolite. The Company expects its research and development expenses to decrease during 1997, reflecting the nonrecurring payment to Petrolite in 1996 of $1,000,000, offset in part by a slight increase in expenditures related to hiring additional personnel. The Company's research and development expenses will increase substantially, however, if the Company makes the $9,000,000 payment to exercise the Petrolite option in 1997, the entire amount of which will be recorded as a research and development expense. The Company does not presently intend to exercise the Petrolite option until it has raised additional funds or received additional capital. The Company had general and administrative expenses for the years ended December 31, 1994, 1995 and 1996 of $2,977,679, $2,877,351 and $2,607,972, respectively. The $100,328 decrease from 1994 to 1995 resulted primarily from the reassignment of a vice president to responsibilities within the research and development department offset in part by increased expenditures for consulting related to the stock rights plan instituted in 1995. The $269,379 decrease from 1995 to 1996 resulted primarily from decreased consulting fees, legal fees and insurance. The Company expects its general and administrative expenses to increase slightly in 1997 in support of its research facilities and personnel, and corporate development activities. Liquidity and Capital Resources In February 1997, the Company completed a convertible preferred stock offering resulting in net cash proceeds of approximately $10.2 million in exchange for the sale of 224,100 shares of Series B Convertible Preferred Stock. In October 1994, the Company completed a convertible preferred stock offering resulting in net cash proceeds of approximately $22.2 million in exchange for the sale of 480,000 shares of Series A Convertible Preferred Stock. The Company completed its initial public offering in the first quarter of 1993, resulting in net cash proceeds of approximately $14.9 million. For the year ended December 31, 1996, the Company used $4,787,699 of funds in operating activities, and incurred $936,877 of capital expenditures. At December 31, 1996, the Company had cash, cash equivalents, and short term investments totaling $8,997,588 and working capital of $8,770,324. -21- The Company expects to incur substantial additional research and development expenses, including expenses associated with biocatalyst, fermentation and bioreactor development. The Company has commitments through 1997 requiring the Company to spend approximately $95,000 under research and development agreements. In addition, the Company is subject to cost sharing arrangements under various collaborative agreements, as discussed below. The Company also expects its general and administrative expenses to increase as it adds marketing, sales and other personnel and prepares for the commercialization of the Company's proprietary BDS technology. To supplement its research and development budgets, the Company intends to seek additional collaborative research and development agreements with corporate partners. In this regard, the Company entered into an agreement with Carbide/Graphite in December 1995 to collaborate on the development of the Company's BDS technology for the removal of sulfur from decant oil. Under the terms of the agreement, the Company will be primarily responsible for customizing and commercializing a biocatalyst and desulfurization system specifically for decant oil. Carbide/Graphite will be primarily responsible for providing the development and commercialization funding for this particular BDS process. The Company signed an agreement with M.W. Kellogg in August 1994, to collaborate on the development and commercialization of the Company's proprietary biocatalytic desulfurization technology for reducing sulfur levels in petroleum streams. Under the terms of the collaboration, M.W. Kellogg will serve as an engineering partner to the Company during completion of the BDS development process and will be the exclusive provider of the basic engineering design services required for the commercial BDS units. In return for these services, M.W. Kellogg will receive a portion of the site license fee generated by the sale of BDS units. The collaboration has a minimum term of at least five years or the completion of 20 BDS units, whichever is longer, and has applications to all biorefining technologies the Company develops. During the first phase of the collaboration, M.W. Kellogg provided 500 engineering work hours of service at no cost to the Company. M.W. Kellogg has agreed to provide an additional 1,500 work hours of service at M.W. Kellogg offices at reduced rates, of which 500 had been utilized by the Company at December 31, 1996. In July 1994, the Company entered into an Agreement with Total to collaborate on the application of the Company's biodesulfurization process to diesel fuel streams. Following the evaluation of results from Energy BioSystems' domestic pilot operation, it is anticipated that Total will build and operate at Total's expense a pilot BDS unit at Total's European Centre for Research and Technology. Upon successful economic trials of the pilot unit, Total plans to build the first commercial BDS unit at one of its refineries. In December 1993, the Company entered into a research collaboration agreement with Koch, to facilitate the development of BDS technology in refinery petroleum streams. Under the terms of the alliance, the Company will be primarily responsible for improving the performance of the biocatalyst used in the desulfurization process. Koch will be primarily responsible for selecting and improving the target refinery stream as well as testing desulfurized product quality. Koch will also provide engineering support as needed in the development of a BDS unit for Koch's operation. The Company and Koch will each bear their own costs and expenses incurred in connection with the collaboration. The Company expects that the development alliance with Koch will facilitate commercialization of the Company's BDS technology. In October 1993, the Company amended its existing Collaboration Agreement with Petrolite. The Collaboration Agreement, as amended (the "Agreement"), provides for an expanded territory covered by the Agreement and permits the use of third party engineering and construction companies to assist with certain matters. The Agreement expands the territory of Petrolite's participation from North America, Venezuela and Mexico to the entire world. In return for the expansion of the territory covered by the Agreement, the Company's primary participation rate was increased from 70% of gross profits from biodesulfurization unit sales and fees to 78% of worldwide gross profits from such sales and fees. Additionally, the Agreement allows the Company, after obtaining the advice and input of Petrolite, to enter into an alliance with one or more world-class third party engineering and construction firms to provide certain equipment and services in connection with the design and construction of biodesulfurization units. -22- In October 1996, the Company entered into an agreement with Petrolite providing the Company with the option to amend the terms of its strategic alliance with Petrolite. Under the agreement, the Company made an initial payment of $1 million to Petrolite in December 1996 in exchange for the option and the extension of Petrolite's obligations to provide operational and technical support for the pilot plant from September 1, 1996 through December 31, 1998. If the Company exercises its option, the percentage of site license fees and adjusted gross profit payable to Petrolite will be reduced to 9.5% from 22%, in exchange for which the Company will (i) assume responsibility for servicing the BDS units on site at customer locations, (ii) pay Petrolite an additional $9 million in cash and (iii) issue to Petrolite a warrant entitling Petrolite to purchase 138,889 shares of Common Stock at an exercise price of $7.20 per share. The Company may exercise the Petrolite option at any time on or before the earlier to occur of (i) ten business days following the close of any equity financing by the Company in which the gross cash proceeds raised in such financing (together with cash proceeds raised by the Company in any other equity financing after the date of the option agreement, if applicable) equal or exceed $25 million and (ii) December 30, 1998. In July 1993, the Company entered into a research collaboration agreement with Texaco to facilitate the development of the Company's BDS technology in crude oil. Under the terms of the alliance, the Company will be primarily responsible for improving the performance of the biocatalyst used in the desulfurization process. Texaco will be primarily responsible for field operations and analytical chemistry work with respect to the application of the Company's BDS technology to crude oil. The Company and Texaco will each bear their own costs and expenses incurred in connection with the collaboration. The Company expects that the development alliance with Texaco will facilitate commercialization of the Company's BDS technology. The Company entered into a license agreement with Stanford University in November 1993 for the use of its patented recombinant DNA technology which may be employed in the development of the Company's biocatalytic desulfurization process. The license requires a minimum annual advance on earned royalties of $10,000. The Company believes that its available cash, investments and interest income will be adequate to satisfy its funding needs through year-end 1998. The Company's future funding requirements will depend on many factors, including the progress of the Company's research and development, timing of environmental regulations, the rate of technological advances, determinations as to the commercial potential of the Company's technology under development, the status of competitive technology, the establishment of biocatalyst manufacturing capacity or third-party manufacturing arrangements and the establishment of other collaborative relationships. The Company may seek additional funding through public or private financings, including equity financings, and through collaborative arrangements. ITEM 8. FINANCIAL STATEMENTS. The financial statements required by this Item are incorporated under Item 14 in Part IV of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. -23- PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this Item as to the directors and executive officers of the Company is hereby incorporated by reference from the information appearing under the captions "Election of Directors" and "Executive Officers" in the Company's definitive proxy statement which involves the election of directors and is to be filed with the Securities and Exchange Commission ("Commission") pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 1996. ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item as to the management of the Company is hereby incorporated by reference from the information appearing under the captions "Executive Compensation" and "Election of Directors - Director Compensation" in the Company's definitive proxy statement which involves the election of directors and is to be filed with the Commission pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 1996. Notwithstanding the foregoing, in accordance with the instructions to Item 402 of Regulation S-K, the information contained in the Company's proxy statement under the sub-heading "Report of the Compensation Committee of the Board of Directors" and "Performance Graph" shall not be deemed to be filed as part of or incorporated by reference into this Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item as to the ownership by management and others of securities of the Company is hereby incorporated by reference from the information appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" to the Company's definitive proxy statement which involves the election of directors and is to be filed with the Commission pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 1996. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item as to certain business relationships and transactions with management and other related parties of the company is hereby incorporated by reference to such information appearing under the captions "Certain Transactions" and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive proxy statement which involves the election of directors and is to be filed with the Commission pursuant to the Securities Exchange Act of 1934 within 120 days of the end of the Company's fiscal year on December 31, 1996. -24- PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents Filed as a Part of this Report 1. FINANCIAL STATEMENTS: PAGE ---- Report of Independent Public Accountants...................... F-1 Balance Sheets as of December 31, 1995 and 1996............... F-2 Statements of Operations for the Years Ended December 31, 1994, 1995 and 1996............................. F-3 Statements of Stockholders' Equity for the Period from December 31, 1993 to December 31, 1996.................. F-4 Statements of Cash Flows for the Years Ended December 31, 1994, 1995 and 1996............................. F-5 Notes to Financial Statements................................. F-6 All other schedules are omitted because they are not applicable, not required, or because the required information is included in the financial statements or notes thereto. 2. EXHIBITS: Exhibits to the Form 10-K have been included only with the copies of the Form 10-K filed with the Commission and the Nasdaq Stock Market. Upon request to the Company and payment of a reasonable fee, copies of the individual exhibits will be furnished. EXHIBIT NO. DESCRIPTION - ----------- ----------- 3.1(a) Amended and Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 2 filed with Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form 8-A as filed with the Commission on March 15, 1993). 3.1(b) Certificate of the Powers, Designations, Preferences and Rights of the Series A Convertible Preferred Stock (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994). 3.1(c) Certificate of Designation of Series One Junior Participating Preferred Stock of the Company (incorporated by reference to Exhibit 3.1(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). *3.1(d) Certificate of the Powers, Designation, Preferences and Rights of the Series B Convertible Preferred Stock. 3.2 Bylaws of Registrant (incorporated by reference to Exhibit 3 filed with Post-Effective Amendment No. 1 to the Registrant's Registration Statement on Form 8-A as filed with the Commission on March 15, 1993). 4.1 Form of Stock Purchase Agreement, dated as of October 27, 1994, by and between the Company and the Purchasers of the Series A Convertible Preferred Stock (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994). -25- EXHIBIT NO. DESCRIPTION - ----------- ----------- *4.2 Form of Stock Purchase Agreement, dated as of February 21, 1997, by and between the Company and the Purchasers of the Series B Convertible Preferred Stock. *4.3 Form of Stock Exchange Agreement, dated as of February 21, 1997, by and between the Company and the Exchanging Holders of Series A Convertible Preferred Stock. 4.4 Stockholder Rights Agreement, dated as of March 8, 1995, between the Company and Society National Bank (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated March 8, 1995). 10.1 License and Technology Assistance Agreement, dated January 15, 1991, between the Company and Institute of Gas Technology ("IGT") (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.2 First Amendment to License and Technology Assistance Agreement, dated June 25, 1992, between the Company and IGT (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.3 Agreement, dated August 27, 1992, among the Company, IGT, the University of North Dakota ("UND") and Dr. Kevin Young (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.4 Agreement, dated September 30, 1992, among the Company, UND and Dr. Kevin Young (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.5 Collaboration Agreement, dated March 5, 1992, between the Company and Petrolite Corporation (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.6 Lease Agreement, dated January 24, 1994, between The Woodlands Corporation and the Company (incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.7 Registration Agreement, dated January 30, 1992, among the Company, The Travelers Indemnity Company and Gryphon Ventures II, Limited Partnership (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.8 Registration Agreement, dated April 29, 1991, between the Company and Gryphon Ventures II, Limited Partnership (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.9** Energy BioSystems Corporation 1992 Stock Compensation Plan (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (No. 33-56718)). *10.10** Employment Agreement, dated January 31, 1996, between the Company and Daniel J. Monticello. 10.11** Consultant Agreement between the Company and John T. Preston (incorporated by reference to Exhibit 10.12 to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.12** Employment Agreement, dated August 21, 1991, between the Company and John H. Webb (incorporated by reference to Exhibit 10.13 to the Company's Registration Statement on Form S-1 (No. 33-56718)). -26- EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.13** Amendment No. 1 to Employment Agreement, dated as of January 15, 1996, between the Company and John H. Webb (incorporated by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995). 10.14** Employment Agreement, dated July 18, 1995, between the Company and Paul G. Brown, III (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-96096)). 10.15** Employment Agreement, dated July 18, 1995, between the Company and Mark W. John (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-96096)). 10.16** Employment Agreement, dated July 18, 1995, between the Company and Robert E. Levy (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-96096)). 10.17** Amended and Restated Consultant Agreement between the Company and William M. Haney, III (incorporated by reference to the Exhibit 10.14 to the Company's Registration Statement on Form S-1 (No. 33- 56718)). 10.18** Simplified Employee Pension Plan Retirement Plan Adoption Agreement (incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.19** Energy BioSystems Corporation Non-Employee Director Option Plan (incorporated by reference to the similarly numbered exhibit to the Company's Registration Statement on Form S-1 (No. 33-96096)). 10.20 First Amendment to Collaboration Agreement, dated July 1, 1992, between the Company and Petrolite Corporation (incorporated by reference to the Exhibit 10.16 to the Company's Registration Statement on Form S-1 (No. 33-56718)). 10.21 Research Agreement, dated November 8, 1993, between the Company and The University of Notre Dame (incorporated by reference to Exhibit 10.19 to the Company's Registration Statement on Form S-1 (No. 33- 56718)). 10.22 Research Collaboration Agreement, dated July 8, 1993, between the Company and Texaco, Inc. (incorporated by reference to Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993). 10.23 Extension and Assignment of Research Collaboration Agreement, dated June 23, 1995, between the Company and Texaco Inc. (incorporated by reference to the similarly numbered exhibits to the Company's Registration Statement on Form S-1 (No. 3-96096)). 10.24 Second Amendment to Collaboration Agreement, dated October 18, 1993, between the Company and Petrolite Corporation (incorporated by reference to Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993). 10.25 Lease Agreement, dated May 24, 1993, between the Company and The Woodlands Corporation (incorporated by reference to Exhibit 99.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993). 10.26 Second Amendment to License and Technology Assistance Agreement, dated September 23, 1993, between the Company and IGT (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). -27- EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.27 Letter Agreement dated February 10, 1994, between The M. W. Kellogg Company and the Company (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.28 Letter Agreement for Accelerated Development Program dated December 8, 1993, between the Company and Koch Refining Company (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.29 License Agreement dated November 1, 1993, between the Company and Stanford University (incorporated by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993). 10.30 Collaboration Agreement dated July 7, 1994, between the Company and Total Raffinage Distribution S.A. (incorporated by reference to Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q for the second quarter ended June 30, 1994). 10.31 Research Agreement, dated July 1, 1994, between the Company and Massachusetts Institute of Technology (incorporated by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.32 Research Agreement, dated November 8, 1994, between the Company and The University of Notre Dame (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.33 Research, Option and License Agreement, dated December 15, 1994, between the Company and the University of Houston (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.34 Cooperative Agreement between the Company and the National Institute of Standards and Technology (incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.35 Extension and Assignment of Research Collaboration Agreement, dated July 3, 1996, between the Company and Texaco Group, Inc. (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996). *10.36 Third Amendment and Addendum to Collaboration Agreement, dated August 24, 1995, between the Company and Petrolite Corporation. *10.37 Fourth Amendment and Addendum to Collaboration Agreement, dated October 25, 1996, between the Company and Petrolite Corporation, as modified by Letter Agreement dated December 30, 1996. *11.1 Computation of earnings per share. *23.1 Consent of Arthur Andersen LLP. - ---------------- * Filed herewith ** Management contract or compensatory plan. (b) Reports on Form 8-K The Company filed one report on Form 8-K during the last quarter of the year ended December 31, 1996. Such report on Form 10-K, dated November 20, 1996, enclosed a copy of a press release announcing the commencement of -28- a private offering of Series B Convertible Preferred Stock, and was filed pursuant to Rule 135c under the Securities Act of 1933, as amended. -29- SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. Energy BioSystems Corporation By: /s/ John H. Webb --------------------------------------- John H. Webb Chairman of the Board, President and Chief Executive Officer DATED the 20th day of March, 1997. 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 COMPANY AND IN THE CAPACITIES AND ON THE DATES INDICATED:
NAME TITLE DATE ---- ----- ---- /s/ JOHN H. WEBB Chairman of the Board, President March 20, 1997 - ----------------------------- and Chief Executive Officer John H. Webb (Principal executive officer) /s/ PAUL G. BROWN, III Vice President--Finance and March 20, 1997 - ----------------------------- Administration (Principal Paul G. Brown, III financial and accounting officer) /s/ DANIEL J. MONTICELLO, PH.D. Vice President--Science and March 20, 1997 - ------------------------------ Technology, and Director Daniel J. Monticello, Ph.D. /s/ BERNARD LEE, PH.D. Director March 20, 1997 - ----------------------------- Bernard Lee, Ph.D. /s/ RAMON LOPEZ Director March 20, 1997 - ----------------------------- Ramon Lopez /s/ EDWARD B. LURIER Director March 20, 1997 - ----------------------------- Edward B. Lurier /s/ THOMAS E. MESSMORE Director March 20, 1997 - ----------------------------- Thomas E. Messmore /s/ WILLIAM E. NASSER Director March 20, 1997 - ----------------------------- William E. Nasser /s/ JOHN S. PATTON Director March 20, 1997 - ----------------------------- John S. Patton /s/ JOHN T. PRESTON Director March 20, 1997 - ----------------------------- John T. Preston /s/ WILLIAM D. YOUNG Director March 20, 1997 - ----------------------------- William D. Young
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Energy BioSystems Corporation: We have audited the accompanying balance sheets of Energy BioSystems Corporation (a Delaware corporation) as of December 31, 1995 and 1996, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 Energy BioSystems Corporation as of December 31, 1995 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP The Woodlands, Texas March 7, 1997 F-1 ENERGY BIOSYSTEMS CORPORATION BALANCE SHEETS December 31, ---------------------------- 1995 1996 ------------- ------------- ASSETS Current assets: Cash and cash equivalents............. $ 6,172,400 $ 3,106,004 Short term investments................ 10,431,444 5,891,584 Prepaid expenses and other current.... 687,530 767,893 assets............................... ------------ ------------ Total current assets.......... $ 17,291,374 $ 9,765,481 ------------ ------------ Long term investments................... 2,492,874 -- Note receivable......................... 45,633 6,683 Furniture, equipment and leasehold improvements, net...................... 3,322,609 3,136,635 Intangible and other assets, net........ 656,961 801,832 ------------ ------------ Total assets.................. $ 23,809,451 $ 13,710,631 ============ ============ LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities.......................... $ 591,534 $ 537,583 Current portion of deferred revenue... 1,314,000 193,500 Current portion of obligations under capital lease........................ 7,256 11,632 Note payable.......................... 294,713 252,443 ------------ ------------ Total current liabilities..... $ 2,207,503 $ 995,158 ------------ ------------ Long term liabilities: Capital lease obligations............. 11,632 -- Deferred revenue...................... 13,500 -- ------------ ------------ Total long term liabilities... $ 25,132 -- ------------ ------------ Stockholders' equity: Series A convertible preferred stock.... 22,968,152 23,295,585 $0.01 par value (liquidation value $24,000,000, 508,800 shares authorized, 480,000 shares issued and outstanding) Common stock, $0.01 par value (30,000,000 shares authorized, 10,584,269 and 11,497,135 shares issued and outstanding, respectively)......................... 105,843 114,972 Additional paid-in capital.............. 29,823,343 32,018,218 Accumulated deficit..................... (31,320,522) (42,713,302) ------------ ------------ Total stockholders' equity.... $ 21,576,816 $ 12,715,473 ------------ ------------ Total liabilities and......... $ 23,809,451 $ 13,710,631 stockholders' equity......... ============ ============ The accompanying notes are an integral part of these financial statements. F-2 ENERGY BIOSYSTEMS CORPORATION STATEMENTS OF OPERATIONS
Year Ended December 31, --------------------------------------------- 1994 1995 1996 --------------- ------------- ------------- REVENUES: Sponsored research revenues................. $ 1,148,000 $ 1,567,329 $ 1,778,683 Interest and investment income.............. 573,309 1,400,625 806,736 ----------- ----------- ----------- Total revenues...................... 1,721,309 2,967,954 2,585,419 ----------- ----------- ----------- COSTS AND EXPENSES: Research and development.................... 5,723,131 7,338,319 9,210,227 General and administrative.................. 2,977,679 2,877,351 2,607,972 ----------- ----------- ----------- Total costs and expenses............ 8,700,810 10,215,670 11,818,199 ----------- ----------- ----------- NET LOSS...................................... $(6,979,501) $(7,247,716) $(9,232,780) =========== =========== =========== NET LOSS PER COMMON SHARE..................... $(0.75) $(0.95) $(1.04) =========== =========== =========== SHARES USED IN COMPUTING NET LOSS PER COMMON SHARE........................... 9,967,645 10,227,595 11,248,029 =========== =========== ===========
The accompanying notes are an integral part of these financial statements. F-3 ENERGY BIOSYSTEMS CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE PERIOD FROM DECEMBER 31, 1993 TO DECEMBER 31, 1996
Preferred Stock Common Stock Additional --------------- ------------ Paid-in Accumulated Shares Amount Shares Amount Capital Deficit Total -------- -------- --------- -------- ----------- ------------ ------- BALANCE AT DECEMBER 31, 1993 -- $ -- 9,864,629 $ 98,646 $27,293,378 $(14,501,305) $12,890,719 Exercise of stock options in 1994 ($0.3036 to $4.80 per share)................... -- -- 123,780 1,238 310,177 -- 311,415 Issuance of Series A Convertible Preferred Stock for cash at October 27, 1994 ($50.00 per share), net of $1,778,403 offering costs.... 480,000 22,221,597 -- -- -- -- 22,221,597 Accretion and dividends on Series A Preferred Stock..... -- 473,334 -- -- (47,334) (426,000) -- Net loss...................... (6,979,501) (6,979,501) -------- ----------- ---------- -------- ----------- ------------ ----------- BALANCE AT DECEMBER 31, 1994 480,000 22,694,931 9,988,409 99,884 27,556,221 (21,906,806) 28,444,230 Exercise of stock options in 1995 ($0.3036 to $7.25 per share)....................... -- -- 261,949 2,620 329,392 -- 332,012 Issuance of stock for services ($6.25 per share)............ -- -- 10,000 100 62,400 -- 62,500 Additional offering costs for Series A Preferred Stock..... -- (14,132) -- -- -- -- (14,132) Dividends on Series A Preferred Stock paid in Common Stock................. -- (2,178,000) 323,910 3,239 2,174,683 -- (78) Accretion and dividends on Series A Preferred Stock..... 2,465,353 -- -- (299,353) (2,166,000) -- Net loss...................... -- -- -- -- -- (7,247,716) (7,247,716) -------- ----------- ---------- -------- ----------- ------------ ----------- BALANCE AT DECEMBER 31, 1995 480,000 22,968,152 10,584,268 105,843 29,823,343 (31,320,522) 21,576,816 Exercise of stock options in 1996 ($0.3036 to $5.50 per share)................... -- -- 589,200 5,892 365,620 -- 371,512 Dividends on Series A Preferred Stock paid in Common Stock................. -- (2,160,000) 323,667 3,237 2,156,688 -- (75) Accretion and dividends on Series A Preferred Stock..... -- 2,487,433 -- -- (327,433) (2,160,000) -- Net loss...................... -- -- -- -- -- (9,232,780) (9,232,780) -------- ----------- ---------- -------- ----------- ------------ ----------- BALANCE AT DECEMBER 31, 1996 480,000 $23,295,585 11,497,135 $114,972 $32,018,218 $(42,713,302) $12,715,473 ======== =========== ========== ======== =========== ============ ===========
The accompanying notes are an integral part of these financial statements. F-4 ENERGY BIOSYSTEMS CORPORATION STATEMENTS OF CASH FLOWS
Year Ended December 31, --------------------------------------------------------------- 1994 1995 1996 ---------------------- ------------------- ------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(6,979,501) $ (7,247,716) $(9,232,780) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization............ 676,873 998,384 1,160,179 Compensation expense related to stock options and stock issued for services rendered............................... 48,000 62,500 -- Loss on sale of leasehold improvements... -- -- -- Changes in assets and liabilities: Decrease (increase) in trading securities............................. 6,754,863 (4,419,020) 4,444,020 Decrease in prepaid expenses and other current assets................... 301,153 143,061 172,079 Decrease in notes receivable............. 32,896 37,054 38,950 Increase in intangible and other assets.. (148,690) (211,804) (182,196) Decrease in accounts payable and accrued liabilities.................... 295,127 (377,958) (53,951) Decrease in deferred revenue............. (279,000) (1,134,000) (1,134,000) ----------- ------------ ----------- Net cash (used in) provided by operating activities................................ 701,721 (12,149,499) (4,787,699) ----------- ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures........................ (1,025,980) (1,505,045) (936,877) Net purchase of investments held to maturity.................................. -- (8,480,298) 2,588,713 ----------- ------------ ----------- Net cash (used in) investing activities (1,025,980) (9,985,343) 1,651,836 ----------- ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments on notes payable................... -- (281,374) (294,713) Payments on capital lease obligations....... (12,007) (12,995) (7,256) Proceeds from Series A Preferred Stock, net. 22,221,597 (14,132) -- Proceeds from Common Stock, net............. 263,415 331,934 371,436 ----------- ------------ ----------- Net cash provided by financing activities............................... 22,473,005 23,433 69,467 ----------- ------------ ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................ 22,148,746 (22,111,409) (3,066,396) ----------- ------------ ----------- CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR..................................... 6,135,063 28,283,809 6,172,400 ----------- ------------ ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR..... $28,283,809 $ 6,172,400 $ 3,106,004 =========== ============ =========== SUPPLEMENTAL INFORMATION OF CASH FLOWS: Cash paid for interest....................... $ 4,078 $ 4,010 $ 2,046 =========== ============ =========== SUPPLEMENTAL INFORMATION OF NONCASH FINANCING ACTIVITIES: The Company had an outstanding note payable of $281,374, $294,713 and $252,442 for prepaid insurance for the years ended December 31, 1994, 1995 and 1996, respectively.
The accompanying notes are an integral part of these financial statements. F-5 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996 1. DESCRIPTION OF THE COMPANY Energy BioSystems Corporation (the "Company"), formerly Environmental BioScience Corporation, was incorporated in the State of Delaware on December 20, 1989, and commenced operations in January 1990. The Company was formed to develop and commercialize innovative biotechnology-based processes for the refining of fossil fuels. The Company's focus to date has been on developing biocatalytic desulfurization ("BDS"), a proprietary process involving the use of enzymes to remove sulfur from petroleum. The Company's BDS process will require substantial additional research, development and testing in order to determine its commercial viability. The Company has not proven its BDS technology other than to a limited extent in laboratory, bench-scale and pilot plant trials. If the Company successfully field tests its BDS technology, the commercialization of the Company's BDS technology will require significant additional time and expenditures. The commercialization of the technology will depend on the Company's success in achieving improvement of its biocatalyst and success in developing fermentation processes, as well as the Company's ability to manufacture or contract for the manufacture of sufficient biocatalyst for use in commercial BDS units; to apply process engineering to design bioreactor systems capable of accomplishing the BDS process on a commercial scale; and to market its BDS systems effectively. The accomplishment of some or all of these objectives may be delayed or may never occur. The Company may require additional capital to continue the development and commercialization of its BDS technology, and there can be no assurance that such capital will be available or that the Company will be able to successfully commercialize BDS technology. The Company believes that its available cash and cash equivalents, investments and interest income will be adequate to satisfy its funding needs through year-end 1998. See "Liquidity and Capital Resources" and "Risk Factors" included elsewhere herein. The Company has devoted substantially all of its efforts to research and development. There have been no revenues from operations other than sponsored research revenues (see Note 7) and there is no assurance of future revenues. Prior to the receipt of the sponsored research revenues, the Company was in the development stage. 2. ACCOUNTING POLICIES Cash, Cash Equivalents and Short Term Investments Debt and equity securities that the Company has the intent and ability to hold to maturity are classified as "held to maturity" and reported at amortized cost. Debt and equity securities that are held for current resale are classified as "trading securities" and reported at fair value with unrealized gains and losses included in earnings. Debt and equity securities not classified as either "held to maturity" or "trading securities" are classified as "securities available for sale" and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Cash and cash equivalents include corporate debt securities with an original maturity less than 90 days and are classified as held to maturity. These securities have an amortized cost and fair market value of $245,000. Included in short-term investments are U.S. government obligations and discount commercial paper of $5,891,584 that are classified as held to maturity and reported at amortized cost at December 31, 1996. At December 31, 1995 and 1996, the Company had cash and cash equivalents of approximately $257,284 and $49,684, respectively, in excess of the federally insured amounts. F-6 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) Furniture, Equipment and Leasehold Improvements Furniture and equipment consists of office furniture and equipment, computers and laboratory equipment and is carried at cost. Depreciation is calculated on the straight-line method using a five-year estimated useful life. Leasehold improvements are amortized on the straight-line method over the term of the lease or the useful life of the assets, whichever is shorter. Maintenance and repairs that do not improve or extend the life of assets and expenditures for research and development equipment for which there is no future alternative use are expressed as incurred. Expenditures which improve or extend the life of assets are capitalized. Intangible and Other Assets Intangible and other assets mainly consist of patent costs, which are primarily legal fees. These costs are being amortized over 17 years. Accumulated amortization at December 31, 1995 and 1996 amounted to $198,553 and $235,878, respectively. Research and Development Sponsored research revenue is recognized based on the percentage of total research payments to be received in relation to the total research and development costs to be incurred under the specific research agreements. All research and development costs, both generated internally and from research and development contracts, are expensed as incurred. The Company allocates certain indirect costs to research and development expenses which consist primarily of overhead related to the administration of research and development activities. Net Loss Per Common Share Net loss per common share has been computed by dividing the net loss, which has been increased for periodic accretion and accrued dividends on the Series A Convertible Preferred Stock issued in October 1994, by the weighted average number of shares of Common Stock outstanding during the periods. In all applicable years, all Common Stock equivalents were antidilutive and, accordingly, were not included in the computation. Pending Accounting Change In March 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting No. 128, "Earnings Per Share." Statement 128 simplifies the standards for computing earnings per share previously found in APB Opinion No. 15, Earnings per Share, and makes them comparable to international earnings per share standards. The Statement also retroactively revises the presentation of earnings per share in the financial statements. The Company will adopt this Standard for the year ended December 31, 1997 and has not currently quantified the effect of applying the new standard. Use of Estimates 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 at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. F-7 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) Presentation Certain reclassifications have been made to prior year balances to conform to current year presentation. 3. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS A summary of furniture, equipment and leasehold improvements is as follows: December 31, --------------------------- 1995 1996 ------------- ------------ Office furniture and equipment $ 330,312 $ 395,332 Laboratory equipment 2,454,320 3,176,179 Computer equipment 683,218 805,850 Leasehold improvements 1,667,120 1,694,489 Equipment under capital lease 55,203 55,203 Automobiles 23,670 23,670 ----------- ----------- $ 5,213,843 $ 6,150,723 Less--Accumulated depreciation (1,891,234) (3,014,088) ----------- ----------- Furniture, equipment and leasehold improvements, net $ 3,322,609 $ 3,136,635 =========== =========== 4. STOCKHOLDERS' EQUITY Series A Convertible Preferred Stock On March 19, 1993, the Company filed an Amended and Restated Certificate of Incorporation pursuant to which, among other things, the authorized shares of Preferred Stock were increased from 2,400,000 to 5,000,000. In October 1994, the Company offered and sold 480,000 shares of Series A Convertible Preferred Stock at $50.00 per share. The net proceeds from the offering were approximately $22.2 million. The placement agents for the Series A Convertible Preferred Stock received warrants to purchase an aggregate of 28,800 shares of Series A Convertible Preferred Stock at an exercise price of $50.00 per share of Series A Convertible Preferred Stock, in addition to customary commissions. Dividends on the Series A Convertible Preferred Stock are cumulative and payable semi-annually from October 27, 1994, at an annual rate equal to $4.00 per share if paid in cash and $4.50 per share if paid in Common Stock. The shares of Series A Convertible Preferred Stock are convertible into Common Stock at the option of the holder at a conversion price equal to $8.25 per share subject to adjustment in certain circumstances. The Series A Convertible Preferred Stock, if not earlier redeemed, must be redeemed on November 7, 1999 at the redemption price. The redemption price, which is equal to $50.00 per share plus accrued and unpaid dividends, may be paid in shares of Common Stock or cash or in a combination of Common Stock and cash, at the Company's option. It is the Company's intent, however, to redeem the Series A Convertible Preferred Stock for Common Stock. Accordingly, the Series A Convertible Preferred Stock is included in stockholders' equity. The carrying amount of the Preferred Stock is increased for accrued and unpaid dividends plus periodic accretion, using the effective interest method, such that the carrying amount will equal the redemption amount on November 7, 1999. F-8 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) Common Stock On March 19, 1993, the Company filed an Amended and Restated Certificate of Incorporation pursuant to which, among other things, the authorized shares of Common Stock were increased from 20,000,000 to 30,000,000. In March 1995, the Company adopted a Stockholder Rights Plan (the "Rights Plan") in which Preferred Stock Purchase Rights (the "Rights") were distributed for each share of Common Stock held as of the close of business on March 27, 1995 and are distributed to each share of Common Stock issued thereafter until the earlier of (i) the Distribution Date (as defined in the Rights Plan), (ii) the date Rights are redeemed or (iii) March 8, 2005. The Rights Plan is designed to deter coercive takeover tactics and to prevent an acquirer from gaining control of the Company without offering a fair price to all of the Company's stockholders. The Rights will expire on March 8, 2005. Each Right entitles stockholders to buy one-hundredth of a share of a new series of Junior Preferred Stock of the Company at an exercise price of $50.00 per one-hundredth of a share. The Rights are exercisable only if a person acquires beneficial ownership of 20% or more of the Company's outstanding Common Stock. The Rights Plan grandfathers certain stockholders who beneficially owned more than 20% of the outstanding shares of the Company's Common Stock on the effective date of the Rights Plan from triggering the exercisability of the Rights. 5. STOCK OPTIONS The 1992 Stock Compensation Plan (the "1992 Plan") is composed of non- qualified stock options, incentive stock options, year-end stock bonuses and restricted and non-restricted stock grants. Under the 1992 Plan, 2,031,030 shares of Common Stock are reserved for issuance upon the exercise of stock options. Under a 1994 Non-Employee Director Option Plan, composed of non- qualified stock options, 175,000 shares of Common Stock are reserved for issuance upon the exercise of stock options. At December 31, 1996, employees had been granted options to purchase 1,637,638 shares of Common Stock pursuant to the 1992 Plan. Additionally, as of December 31, 1996 consultants and directors had been granted options to purchase 386,155 shares of Common Stock that were not issued under the 1992 Plan. Options generally vest over a three-year period and upon the earlier of the completion of the specified performance milestones or nine years and ten months from the date of grant. The options expire ten years from the date of grant. At December 31, 1996, 1,113,184 shares of Common Stock were exercisable at per share exercise prices ranging from $.296 to $13.00. The Company accounts for its stock options under APB Opinion No. 25 under which no compensation cost has been recognized. The Company records deferred compensation for the difference between the exercise price and the fair market value on the measurement date. During 1994, 1995 and 1996, the Company issued all options at fair market value. Had compensation cost for these options been determined consistent with FASB Statement No. 123, the Company's net loss and loss per share would have been increased to the following pro forma amounts: 1995 1996 ---- ---- Net Loss: As Reported $(7,247,716) $(9,232,780) ----------- ----------- Pro Forma $(7,439,375) $(9,627,267) ----------- ----------- Net Loss Per Share: As Reported $ (0.95) $ (1.04) ----------- ----------- Pro Forma $ (0.97) $ (1.08) ----------- ----------- Because the Statement 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that expected in future years. A summary of F-9 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) the status of the Company's stock options at December 31, 1994, 1995 and 1996 and changes during the years then ended is presented in the table and narrative below:
1992 Plan Options not issued under Plan --------------------------- --------------------------------------------- Number Weighted Avg. Number Weighted Avg. of Options Exercise Price of Options Exercise Price ----------- -------------- ------------------------------ -------------- December 31, 1993 1,194,963 $ 3.28 994,920 $ 0.83 Granted 210,840 8.34 60,000 10.00 Exercised (94,580) 2.67 (29,200) 1.56 Forfeited (42,159) 4.93 -- -- --------- ------ --------- Balance at December 31, 1994 1,269,064 4.04 1,025,720 1.34 Granted 270,880 5.03 -- -- Exercised (126,949) 1.86 (145,000) 0.64 Forfeited (19,550) 10.08 -- -- --------- ------ --------- ------ Balance at December 31, 1995 1,393,445 4.35 880,720 1.46 Granted 286,170 6.46 -- -- Exercised (26,645) 1.83 (562,565) 0.57 Forfeited (15,332) 8.49 -- -- --------- ------ Balance at December 31, 1996 1,637,638 $ 4.74 318,155 $ 3.02 ========= ====== ========= ====== Exercisable at December 31, 1994 685,056 $ 2.55 959,020 $ 0.86 Exercisable at December 31, 1995 652,466 $ 3.21 838,220 $ 1.08 Exercisable at December 31, 1996 727,029 $ 3.77 318,155 $ 3.02
The weighted average fair value of the options issued under the 1992 Plan for the years ended December 31, 1995 and 1996 was $3.98 and $4.92, respectively. During the years ended December 31, 1994, 1995 and 1996, the Company granted 20,000, 24,000 and 24,000 options, respectively, under the Non-Employee Director Option Plan. These options are fully vested upon issuance. The weighted average exercise price per share on these grants was $8.00, $4.00 and $7.88, respectively. As of December 31, 1994, 1995 and 1996, the Company had 20,000, 44,000 and 68,000 options exercisable, respectively, under this plan with weighted average exercise price of $8.00, $5.82 and $6.54 respectively. The weighted average fair market value of the options issued under this plan during the years ended December 31, 1995 and 1996 was $3.04 and $5.31, respectively. The fair market value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1995 and 1996, respectively: risk-free interest rates of 6.6 and 6.5 percent for the 1992 Plan options and 6.6 and 6.9 percent for the Non-Employee Director Plan options; expected dividend yields of zero for both the 1992 Plan and the Non-Employee Director Plan; expected lives of nine years and ten months for all options; and expected volatility of 60.5 and 65.4 percent for the 1992 Plan and 58.3 and 65.1 percent for the Non-Employee Director Plan. 6. FEDERAL INCOME TAXES The Company has had losses since inception and, therefore, has not been subject to federal income taxes. As of December 31, 1996, the Company had accumulated net operating loss ("NOL") and research and development tax credit carryforwards for income tax purposes of approximately $34,750,000 and $980,000, respectively. These carryforwards begin to expire in 2005. The Tax Reform Act of 1986 provided for an annual limitation on the use of NOL and tax credit carryforwards following certain ownership changes that limit the Company's ability to utilize these carryforwards. In April 1991 and October 1994, the Company underwent a "more than 50 percent change in ownership" as defined by Internal Revenue Code Section 382. Additionally, because U.S. tax laws limit the time during which NOL and tax credit F-10 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) carryforwards may be applied against future taxable income and tax liabilities, the Company may not be able to take full advantage of its NOL and tax credits for federal income tax purposes. Significant components of the Company's net deferred tax asset at December 31, 1995 and 1996 are as follows: 1995 1996 ------------- ------------- Deferred tax assets relating to: - -------------------------------- Federal net operating loss carryforwards......................... $ 8,475,689 $ 11,814,351 Research and development credit carryovers............................ 923,338 989,171 Capital and Texas business loss carryforwards......................... 301,346 357,846 Book/tax differences on depreciable, amortizable and other assets and accrued liabilities................... 73,081 263,347 Deferred revenue and unrealized gains 451,350 65,790 ------------ ------------ Deferred tax valuation reserve......... (10,224,804) (13,490,505) Net deferred tax asset................. $ -- $ -- ============ ============ Beginning January 1, 1993, the Company adopted SFAS 109 which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. Since the Company has had a net operating loss carry forward since inception and there is no assurance of future taxable income, a valuation allowance has been established to fully offset the deferred tax assets. 7. LICENSE AND RESEARCH AGREEMENTS To supplement its research and development budgets, the Company intends to seek additional collaborative research and development agreements with corporate partners. In this regard, the Company entered into an agreement with The Carbide/Graphite Group, Inc. ("Carbide/Graphite") in December 1995 to collaborate on the development of the Company's BDS technology for the removal of sulfur from decant oil. Under the terms of the agreement, the Company will be primarily responsible for customizing and commercializing a biocatalyst and desulfurization system specifically for decant oil. Carbide/Graphite will be primarily responsible for providing the development and commercialization funding for this particular BDS process. The Company recognized $150,000 in sponsored research revenue as of December 31, 1996. The Company signed an agreement with The M.W. Kellogg Company ("M.W. Kellogg") in August 1994, to collaborate on the development and commercialization of the Company's biocatalytic desulfurization ("BDS") technology. Under the collaboration, M.W. Kellogg will serve as an engineering partner to the Company during completion of the BDS development process and will be the exclusive provider of the basic engineering design services required for the commercial units. In return for these services, M.W. Kellogg will receive a portion of the site license fee generated by the sale of BDS units. The collaboration has a minimum term of at least five years or the completion of 20 BDS units, whichever is longer, and has applications to all biorefining technologies the Company develops. During the first phase of the collaboration, M.W. Kellogg provided up to 500 engineering work hours of service at no cost to the Company. M.W. Kellogg has also agreed to provide an additional 1,500 work hours per year of service at M.W. Kellogg offices at reduced rates, of which 500 had been utilized by the Company at December 31, 1996. In July 1994, the Company entered into an agreement with Total Raffinage Distribution S.A. ("Total") to collaborate on the application of the Company's biodesulfurization process to diesel fuel streams. Following the evaluation of results from the Company's domestic pilot operation, it is anticipated that Total will build and operate at Total's expense a pilot BDS unit at Total's European Centre for Research and Technology. Upon successful economic trials of the pilot unit, Total plans to build the first commercial BDS unit at one of its refineries. The Company and Total F-11 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) will each bear their own costs and expenses incurred under the collaboration. In addition, as part of its obligations under the agreement, Total will provide the Company with the use of analytical equipment valued at approximately $200,000. The Total agreement provides that upon commercialization, the site licenses will be waived on Total's first commercial BDS unit. In addition, Total will be entitled to receive a ten percent (10%) discount on future site licenses and service fees until it has recovered two and one-half times its research cost and expenses for BDS projects under the agreement. The Company expects that the development alliance with Total will facilitate commercialization of the BDS technology for middle distillates and facilitate the Company's entrance into the European market. In December 1993, the Company entered into an alliance with Koch Refining Company ("Koch") to facilitate the development of BDS technology in crude oil. Under the terms of the alliance, the Company will be primarily responsible for improving the performance of the biocatalyst used in the desulfurization process. Koch will be primarily responsible for selecting and improving the target oil stream as well as testing desulfurized product quality. Koch will also provide engineering support as needed in the development of a BDS unit for Koch's operation. The Company and Koch will each bear their own costs and expenses incurred in connection with the collaboration. Repayment will be in the form of a ten percent (10%) rebate on desulfurization processing fees charged to Koch until Koch has been repaid their contribution of BDS development costs. The Company expects that the development alliance with Koch will facilitate commercialization of the Company's BDS technology. The Company entered into a license agreement with Stanford University in November 1993 for the use of their patented recombinant DNA technology, which may be employed in the development of the Company's BDS process. The license requires a minimum annual advance on earned royalties of $10,000. In July 1993, the Company entered into an agreement with the Exploration and Development Division of Texaco, Inc. ("Texaco") to facilitate the development of the Company's BDS technology in crude oil. Under the terms of the alliance, the Company will be primarily responsible for improving the performance of the biocatalyst used in the desulfurization process. Texaco will be primarily responsible for field operations and analytical chemistry work with respect to the application of the Company's BDS technology to crude oil. The Company and Texaco will each bear their own costs and expenses incurred in connection with the collaboration. In the event the Company sub-licenses Texaco's intellectual and proprietary information, licensed by agreement to the Company by Texaco, the Company shall pay Texaco an amount equal to ten percent (10%) of the desulfurization processing fee charged to Texaco until such time as the Company has paid Texaco an aggregate amount equal to two and one-half times the aggregate amount of Texaco's direct costs and expenses incurred in connection with the collaboration. The Company expects that the development alliance with Texaco will facilitate commercialization of the Company's BDS technology. In January 1991, the Company paid $25,000 and issued 730,800 shares of its Common Stock to the Institute of Gas Technology ("IGT") for the license to IGT's technology for desulfurizing petroleum which expires at the later of 20 years or when all patents related to the technology expire. As consideration for future royalties, the Company agreed to pay IGT $400,000, of which $200,000 was paid and charged to expense as of December 31, 1992 and the remaining $200,000 was paid and charged to expense as of December 31, 1993. These payments eliminate the royalty to be paid upon future revenues. Payments to IGT were approximately none, $150,000 and none in 1994, 1995 and 1996, respectively, for research performed under the terms of the research agreements. As part of the total payments made to IGT in 1993, the Company had paid $150,000 under the amended agreement which provided an additional $300,000 financing for research. The remaining payment of $150,000 was made in June 1995. The Company has also entered into other contracts with various institutions for research and development. The amounts paid under these agreements totaled $237,956, $211,500 and $114,900 for the years ended December 31, 1994, 1995 and 1996, respectively. The Company is also committed to pay these institutions approximately $95,000 through December 1997 under various agreements. F-12 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) In March 1992, the Company entered into a collaborative agreement with Petrolite Corporation ("Petrolite") to commercialize the Company's BDS technology. Under the terms of the agreement, both parties are to perform research and development. Petrolite is to perform research and development in its own laboratory at its own cost and is to fund research, as agreed under the terms of the agreement, at the Company beginning April 1, 1992, at a rate of $225,000 per month for the first two years of the agreement for a total of $5,400,000. Additionally, Petrolite, under the terms of the agreement, constructed a pilot plant at its own expense, not to exceed $1,500,000, to begin testing the effectiveness of the BDS technology. The Company is committed to fund research and development at its own expense in the third through fifth years of the agreement at an annual rate equal to the greater of $2,500,000 per year or 4% of the Company's net revenues, as defined in the agreement. As of December 31, 1996, the Company has received $5,400,000 in research payments of which $1,134,000 has been recognized as revenue in each of the three years ended December 31, 1994, 1995 and 1996. The revenue recognized is based on the percentage of total research payments to be received from Petrolite in relation to the total research and development costs to be incurred under the terms of the agreement. The remaining $13,500 has been recorded as deferred revenue. The amended collaborative agreement dated October 18, 1993, provides for an expanded territory covered by the agreement from North America, Venezuela and Mexico to the entire world and permits the use of third party engineering and construction companies to assist with certain matters. In return, the Company's obligation to pay Petrolite decreased from 30% to 22% of all site licenses fees and adjusted gross profit from the operation of the desulfurization units. In the event the collaboration is terminated, the percentage of site license fees and adjusted gross profit paid to Petrolite will be adjusted as outlined under the terms of the agreement. In October 1996, the Company entered into an agreement with Petrolite providing the Company with the option to amend the terms of its strategic alliance with Petrolite. Under the agreement, the Company made an initial payment of $1 million to Petrolite in December 1996, which was expensed by the Company when made, in exchange for the option and the extension of Petrolite's obligations to provide operational and technical support for the pilot plant from September 1, 1996 through December 31, 1998. If the Company exercises its option, the percentage of site license fees and adjusted gross profit payable to Petrolite will be reduced to 9.5% from 22%, in exchange for which the Company will (i) assume responsibility for servicing the BDS units on site at customer locations, (ii) pay Petrolite an additional $9 million in cash and (iii) issue to Petrolite a warrant entitling Petrolite to purchase 138,889 shares of Common Stock at an exercise price of $7.20 per share. The Company may exercise the Petrolite option at any time on or before the earlier to occur of (i) ten business days following the close of any equity financing by the Company in which the gross cash proceeds raised in such financing (together with cash proceeds raised by the Company in any other equity financing after the date of the option agreement, if applicable) equal or exceed $25 million and (ii) December 30, 1998. In December 1994, the Company was awarded a $2 million federal grant under the Advanced Technology Programs administered by the National Institute of Standards and Technology ("NIST"). The three-year program funded by this grant is dedicated to the development of a biotechnology-based method of removing sulfur from crude oil. As of December 31, 1996, the Company has recognized $928,012 in sponsored research revenue relating to this grant. Included in this revenue amount is $176,403 of grant receivable from NIST. The approved budget for 1997 commits NIST to sponsor research of approximately $1,072,000. 8. COMMITMENTS The Company maintains a Simplified Employee Pension Plan (the "Plan") for all employees. Under the terms of the Plan, employees are eligible to participate after completion of six months of service. The Company contributes an amount equal to 8% of the employees' annual compensation to the Plan. Employees are vested immediately and there is at present no employee contribution. Total expenses under the Plan were approximately $206,000, $246,000 and $302,000 for the years ended December 31, 1994, 1995 and 1996, respectively. F-13 ENERGY BIOSYSTEMS CORPORATION NOTES TO FINANCIAL STATEMENTS-(CONTINUED) The Company maintains two capital leases for computer and laboratory equipment. In addition, the Company entered into an operating lease agreement in May 1993 for its premises. In January 1994, the Company amended its lease agreement to include additional space. The agreement expires in 1998. Future minimum payments under the non-cancelable operating lease and capital leases consist of the following at December 31, 1996: Fiscal Year Operating Capital - ----------- --------- --------- 1997 .................................. $378,228 $11,631 1998 .................................. 303,959 -- 1999 .................................. 1,158 -- -------- ------- Total minimum lease payments ..... $683,345 11,631 ======== Less interest ......................... (731) ------- Present value of future minimum lease payments ............................. $10,900 ======= The Company incurred rent expense of $278,824, $320,456 and $391,788 during 1994, 1995 and 1996, respectively. 9. RELATED-PARTY TRANSACTIONS The Company paid consulting fees to certain stockholders and directors totaling $44,100, $60,021 and $12,155 during the years ended December 31, 1994, 1995 and 1996, respectively. The former Chairman of the Board and Chief Executive Officer of Petrolite serves as a director for the Company. 10. SUBSEQUENT EVENTS In January 1997, the Company's Board of Directors adopted the 1996 Stock Option Plan (the "1996 Plan"). Under the 1996 Plan, the Company may issue options for and sell up to 100,000 shares of Common Stock to employees and consultants of the Company. The options granted under this plan may not have an exercise price per share less than the fair market value on the date of grant and are limited to a term not to exceed ten years. In February and March 1997, the Company completed a convertible preferred stock offering resulting in net cash proceeds of approximately $10.2 million in exchange for the sale of 224,100 shares of Series B Convertible Preferred Stock. Dividends on the Series B Convertible Preferred Stock will be cumulative from the date of the initial closing and will be payable semi-annually commencing May 1, 1997, at an annual rate equal to (i) $4.00 per share of Series B Convertible Preferred Stock to the extent the dividend is paid in cash and (ii) $4.50 per share of Preferred Stock to the extent the dividend is paid in Common Stock. Dividends on shares of Series B Convertible Preferred Stock are payable in cash or Common Stock or a combination thereof, at the Company's option. In connection with the offering, the Company also completed an exchange offering in which it exchanged 478,000 shares of Series A Convertible Preferred Stock for an equal number of shares of its Series B Convertible Preferred Stock. F-14 EX-3.1(D) 2 CERTIFICATE OF POWERS Exhibit 3.1(d) CERTIFICATE OF THE POWERS, DESIGNATIONS, PREFERENCES AND RIGHTS OF THE SERIES B CONVERTIBLE PREFERRED STOCK ($.01 Par Value) (Liquidation Preference $50.00 per Share) OF ENERGY BIOSYSTEMS CORPORATION ______________________ Pursuant to Section 151(g) of the General Corporation Law of the State of Delaware ______________________ THE UNDERSIGNED, being the President and Chief Executive Officer of Energy BioSystems Corporation, a Delaware corporation (the "Company"), DOES HEREBY CERTIFY that, pursuant to the provisions of Section 151(g) of the General Corporation Law of the State of Delaware and pursuant to authority conferred upon the Board of Directors by the provisions of the Amended and Restated Certificate of Incorporation of the Company (the "Certificate of Incorporation), the Board of Directors of the Company has duly adopted resolutions providing for the issuance of a series of its preferred stock and fixing the relative powers, designations, preferences and rights of such stock and the qualifications, limitations and restrictions thereof. These resolutions are as follows: RESOLVED, that pursuant to authority expressly granted to and vested in the Board of Directors of the Company by the provisions of the Certificate of Incorporation, the issuance of a series of preferred stock, par value $.01 per share, which shall consist of 785,350 of the 5,000,000 shares of preferred stock which the Company now has authority to issue, be, and the same hereby is, authorized, and the Board of Directors hereby fixes the powers, designations, preferences and relative, participating, optional and other special rights, and the qualifications, limitations and restrictions thereof, of the shares of such series (in addition to the powers, designations, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, set forth in the Certificate of Incorporation which may be applicable to the preferred stock of this series) as follows: 1. Number of Shares and Designation. 785,350 shares of the preferred stock, $.01 par value per share, of the Company are hereby constituted as a series of the preferred stock designated as Series B Convertible Preferred Stock, par value $.01 per share (the "Series B Preferred Stock"). 2. Definitions. For purposes of the Series B Preferred Stock, in addition to those terms otherwise defined herein, the following terms shall have the meanings indicated: (a) "Board of Directors" shall mean the board of directors of the Company or any committee authorized by such Board of Directors to perform any of its responsibilities with respect to the Series B Preferred Stock. (b) "Business Day" shall mean any day other than a Saturday, Sunday or a day on which state or federally chartered banking institutions in the State of New York or the State of Texas are authorized or obligated by law or executive order to close. (c) "Closing Price" of a security with respect to any day shall mean the average of the daily closing prices for the ten (10) consecutive Trading Dates commencing twelve (12) Trading Dates before such day. The closing price for each Trading Date shall be the reported last sales price, regular way, for the security or, in case no sale takes place on such day, the average of the reported closing bid and asked prices, regular way, for the security in either case as reported on the New York Stock Exchange or the principal national securities exchange on which the security is listed or admitted to trading, or, if not listed or admitted to trading on any national securities exchange, on The Nasdaq Stock Market, Inc. ("Nasdaq") National Market, or if such security is not quoted on such The Nasdaq National Market, the average of the closing bid and asked prices on such day in the over-the-counter market as reported by Nasdaq. If the Closing Price cannot be so determined, then the Closing Price shall be determined: -2- (i) by the written agreement of the Company and the holders of shares of Series B Preferred Stock representing a majority of the Common Shares then obtainable from the conversion of outstanding shares of Series B Preferred Stock, or (ii) in the event that no such agreement is reached within twenty (20) days after the event giving rise to the need to determine the Closing Price, by the agreement of two arbitrators, one of whom shall be selected by the Company and the other of whom shall be selected by such majority holders or (iii) if the two arbitrators so selected fail to agree within twenty (20) days, by a third arbitrator selected by the mutual agreement of the other two (with all costs and expenses of any arbitrators to be paid by the Company). The Company shall cooperate to permit any determination under the preceding clauses (i), (ii) or (iii). (d) "Common Stock" shall mean the Common Stock of the Company, par value $.01 per share. (e) "Common Shares" shall have the meaning set forth in Section 7 hereof. (f) "Company Notice" shall have the meaning set forth in paragraph (d) of Section 5. (g) "Conversion Price" shall mean the Conversion Price per Common Share into which the Series B Preferred Stock is convertible, as such Conversion Price may be adjusted pursuant to Section 7 hereof. The initial Conversion Price shall be $7.25. (h) "Dividend Payment Date" shall have the meaning set forth in paragraph (a) of Section 3 hereof. (i) "Dividend Payment Record Date" shall have the meaning set forth in paragraph (a) of Section 3 hereof. (j) "Dividend Periods" shall mean the interval beginning on the most recent Dividend Payment Date and ending on and including the day immediately preceding the next succeeding Dividend Payment Date. (k) "Fundamental Change" shall have the meaning set forth in paragraph (c) of Section 8 hereof. -3- (l) "Initial Dividend Period" shall mean the interval beginning on the Issue Date to and including May 1, 1997. (m) "Issue Date" shall mean the first date on which shares of the Series B Preferred Stock are issued. (n) "Person" shall mean any individual, association, partnership, corporation, a government or a political subdivision thereof, a governmental agency or other entity, and shall include any agency successor (by merger or otherwise) of such entity. (o) "Series A Preferred Stock" shall mean the Company's Series A Preferred Stock, as designated by the Certificate of the Powers, Designations, Preferences and Rights filed with the Secretary of State of the State of Delaware on October 25, 1994. (p) "Trading Date" with respect to Common Shares means (i) if the Common Shares are listed or admitted for trading on the New York Stock Exchange or another national securities exchange, a day on which the New York Stock Exchange or such other national securities exchange is open for business, or (ii) if the Common Shares are quoted on The Nasdaq National Market, a day on which trades may be made on The Nasdaq National Market, or (iii) otherwise, any Business Day. (q) "Transfer Agent" means KeyCorp Shareholder Services, Inc. or such other agent or agents of the Company as may be designated by the Board of Directors of the Company as the transfer agent for the Series B Preferred Stock. 3. Dividends. (a) Holders of the Series B Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors, out of the funds of the Company legally available therefor, a semi-annual dividend payable in Common Stock or cash or a combination of Common Stock and cash, at the Board of Directors' option (except that if in the preceding 6 months the Company has paid cash dividends on any preferred stock other than the Preferred Stock with respect to which the Company had the option to pay dividends in Common Stock, such semi- annual dividend on the Preferred Stock shall be paid in cash), from the Issue Date for the Initial Dividend Period and for each Dividend Period thereafter, at an annual rate equal to (i) $4.00 per share of Series B Preferred Stock to the extent the dividend is paid in cash and (ii) $4.50 per share of Series B Preferred Stock to the extent the dividend is paid in Common Stock (and, in the case of any accrued but unpaid dividends, upon liquidation as provided under Section 4 hereof, upon redemption as provided under Section 5 hereof and upon conversion as provided under Section 7 hereof). Notwithstanding the above, the Company will not declare and cause to be paid dividends on the Series B Preferred Stock in shares of Common Stock until a registration statement covering the resale of such shares of Common Stock has been filed with the Securities and Exchange Commission and has been declared -4- effective thereby. If May 1 and November 1 of each year (each a "Dividend Payment Date") or any other Dividend Payment Date shall be on a day other than a Business Day, then the Dividend Payment Date shall be on the next succeeding Business Day. Dividends on the Series B Preferred Stock will be cumulative from the Issue Date, whether or not in any Dividend Period or Periods there shall be funds of the Company legally available for the payment of such dividends, whether or not such dividends are declared, and whether or not there are other legal or contractual restrictions on the declaration or payment of such dividends. Dividends will be payable to holders of record as they appear on the stock books of the Company on the Dividend Payment Record Date (the "Dividend Payment Record Date"), which shall be not more than 60 days nor less than 10 days preceding the Dividend Payment Dates thereof, as shall be fixed by the Board of Directors. The amount of dividends payable per share of Series B Preferred Stock for each full semi-annual Dividend Period shall be computed by dividing the annual dividend rate by two. Dividends on the Series B Preferred Stock shall accrue (whether or not declared) on a daily basis from the Issue Date in the amounts described above. Accrued dividends for each Dividend Period shall accumulate to the extent not paid on the Dividend Payment Date first following the Dividend Period for which they accrue. As used herein, the term "accrued" with respect to dividends includes both accrued and accumulated dividends. (b) If, and to the extent, the Board of Directors elects to pay dividends on the Series B Preferred Stock in Common Stock, the number of shares of Common Stock which shall be issued in payment of such dividend shall be equal to the amount of such dividend specified in (a) of this Section 3 for dividends payable in Common Stock divided by the Closing Price as of the relevant Dividend Payment Date. No fractional shares of Common Stock shall be issued in connection with such a dividend, but, in lieu of any fraction of a share of Common Stock which would otherwise be issuable in respect of the aggregate number of shares of Series B Preferred Stock held by the holder thereof, the holder shall have the right to receive an amount in cash equal to the same fraction of the Closing Price as of the Dividend Payment Date for such dividend. (c) Holders of shares of Series B Preferred Stock called for redemption on a redemption date falling between the close of business on a Dividend Payment Record Date and the opening of business on the corresponding Dividend Payment Date shall, in lieu of receiving such dividend payment on the Dividend Payment Date fixed therefor, receive an amount equal to such dividend payment (consisting of all accumulated and unpaid dividends through and including the redemption date) on the date fixed for redemption (unless such holder converts such shares of Series B Preferred Stock in accordance with Section 7 hereof). If a conversion of shares of Series B Preferred Stock occurs between a Dividend Payment Record Date and the corresponding Dividend Payment Date, the dividends payable on the conversion date under Section 7 hereof shall be calculated through and including such conversion date. If, for whatever reason (i) any share of Series B Preferred Stock has not been converted pursuant to Section 7 hereof on a conversion date, or (ii) all payments have not been made with respect to any share of Series B Preferred Stock as required by Section 5 on a redemption date or all payments have not been made with respect to any share of Series B Preferred -5- Stock as required by Section 8 on a repurchase date (other than because of a failure by the holder thereof to tender such shares for payment on such date) then, notwithstanding any other provision hereof, dividends shall continue to accrue on such outstanding shares until paid. (d) If the Company shall, after the Issue Date, fix a record date for the making of a Distribution on Common Stock to holders of its Common Stock (other than any distribution referred to in Section 7(d) hereof and cash dividends paid out of retained earnings of the Company determined under generally accepted accounting principles consistently applied), the Company shall set aside in an escrow reasonably acceptable to the holders of a majority of the Series B Preferred Stock, the Distribution on Common Stock to which they would have been entitled if they had converted all of the Series B Preferred Stock held by them for the Company's Common Stock immediately prior to the record date for the purpose of determining stockholders entitled to receive such Distribution on Common Stock and any such Distribution on Common Stock shall thereafter be distributed from time to time out of such escrow to persons converting the Series B Preferred Stock (immediately upon conversion) to the extent such Distribution on Common Stock relates to the shares of Series B Preferred Stock then being converted. As used herein, the term "Distribution on Common Stock" means a distribution to holders of the Common Stock (including any such distribution made in connection with a consolidation or merger in which the Company is the continuing corporation) of (i) assets (including any cash dividends or distributions), (ii) evidences of indebtedness or other securities of the Company or of any entity other than the Company or (iii) subscription rights (including, without limitation, rights issued pursuant to a rights plan as authorized by Article Fifth of the Company's Amended and Restated Certificate of Incorporation), options or warrants to purchase any of the foregoing assets or securities, whether or not such rights, options or warrants are immediately exerciseable. (e) The amount of dividends payable on the Series B Preferred Stock for the Initial Dividend Period and any other Dividend Period shorter or longer than a full Dividend Period shall be computed on the basis of a 360-day year consisting of twelve 30-day months. Holders of shares of Series B Preferred Stock shall not be entitled to any dividends, whether payable in cash, property or stock, in excess of the cumulative and other dividends herein provided. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments on the Series B Preferred Stock which may be in arrears. (f) So long as any shares of the Series B Preferred Stock are outstanding, no dividends, except as described in the next succeeding sentence, shall be declared or paid or set apart for payment on any class or series of stock of the Company ranking, as to dividends, on a parity with the Series B Preferred Stock, for any period unless full cumulative dividends have been or contemporaneously are declared and paid, or declared and an amount sufficient for the payment thereof set apart for such payment, on the Series B Preferred Stock for all Dividend Periods terminating on or prior to the date of payment, or setting apart for payment, of such dividends on such parity stock. When dividends are not paid in full or a sum sufficient for such payment is not -6- set apart, as aforesaid, upon the shares of the Series B Preferred Stock and any other class or series of stock ranking on a parity as to dividends with the Series B Preferred Stock, all dividends declared upon shares of the Series B Preferred Stock and all dividends declared upon such other stock shall be declared pro rata so that the amounts of dividends per share declared on the Series B Preferred Stock and such other stock shall in all cases bear to each other the same ratio that accrued dividends per share on the shares of the Series B Preferred Stock and on such other stock bear to each other. (g) So long as any shares of the Series B Preferred Stock are outstanding, no other stock of the Company ranking on a parity with the Series B Preferred Stock as to dividends or upon liquidation, dissolution or winding up shall be redeemed, purchased or otherwise acquired for any consideration (or any moneys be paid to or made available for a sinking fund or otherwise for the purchase or redemption of any shares of any such stock) by the Company unless the full cumulative dividends, if any, accrued on all outstanding shares of the Series B Preferred Stock shall have been paid or set apart for payment for all past Dividend Periods. (h) So long as any shares of the Series B Preferred Stock are outstanding, no dividends (other than dividends or distributions paid in shares of, or options, warrants or rights to subscribe for or purchase shares of, Common Stock or other stock ranking junior to the Series B Preferred Stock, as to dividends and upon liquidation, dissolution or winding up) shall be declared or paid or set apart for payment and no other distribution shall be declared or made or set apart for payment, in each case upon the Common Stock or any other stock of the Company ranking junior to the Series B Preferred Stock as to dividends or upon liquidation, dissolution or winding up, nor shall any Common Stock nor any other such stock of the Company ranking junior to the Series B Preferred Stock as to dividends or upon liquidation, dissolution or winding up be redeemed, purchased or otherwise acquired for any consideration (or any moneys be paid to or made available for a sinking fund or otherwise for the purchase or redemption of any shares of any such stock) by the Company except by conversion into or exchange for stock of the Company ranking junior to the Series B Preferred Stock as to dividends and upon liquidation, dissolution or winding up unless, in each case the full cumulative dividends, if any, accrued on all outstanding shares of the Series B Preferred Stock and any other stock of the Company ranking on a parity with the Series B Preferred Stock as to dividends shall have been paid or set apart for payment for all past Dividend Periods and all past dividend periods with respect to such other stock. 4. Liquidation Preference. (a) In the event of any liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, before any payment or distribution of the assets of the Company (whether capital or surplus) shall be made to or set apart for the holders of Common Stock or any other series or class or classes of stock of the Company ranking junior to the Series B Preferred Stock upon liquidation, dissolution or winding up, the holders of the shares of Series B Preferred Stock shall be entitled to receive from the assets of the Company, whether represented by capital, surplus, reserves or earnings, payment in cash or other assets, if the holders of a majority of the shares of Series B Preferred Stock have agreed to accept the distribution -7- hereunder in assets of the Company, in an amount (the "Preferred Liquidation Value") equal to the greater of (i) $50.00 per share, or (ii) the amount per share of Series B Preferred Stock that would have been payable had each such share been converted to Common Shares immediately prior to such event of liquidation, dissolution or winding-up pursuant to Section 7 hereof, plus, in either case, an amount per share equal to all dividends (whether or not earned or declared) accrued and unpaid thereon to the date of final distribution to such holders; but such holders shall not be entitled to any further payment. No payment on account of any liquidation, dissolution or winding up of the Company shall be made to the holders of any class or series of stock ranking on a parity with the Series B Preferred Stock in respect of the distribution of assets upon dissolution, liquidation or winding up unless there shall likewise be paid at the same time to the holders of the Series B Preferred Stock like proportionate amounts determined ratably in proportion to the full amounts to which the holders of all outstanding shares of Series B Preferred Stock and the holders of all outstanding shares of such parity stock are respectively entitled with respect to such distribution. If, upon any liquidation, dissolution or winding up of the Company, the assets of the Company, or proceeds thereof, distributable among the holders of the shares of Series B Preferred Stock shall be insufficient to pay in full the preferential amount aforesaid and liquidating payments on any other shares of stock ranking, as to liquidation, dissolution or winding up, on a parity with the Series B Preferred Stock, then such assets, or the proceeds thereof, shall be distributed among the holders of shares of Series B Preferred Stock and any such other stock ratably in accordance with the respective amounts which would be payable on such shares of Series B Preferred Stock and any such other stock if all amounts payable thereon were paid in full. For the purposes of this Section 4, (i) a consolidation or merger of the Company with one or more corporations or other entities, (ii) a sale, lease, exchange or transfer of all or any part of the Company's assets or (iii) a statutory share exchange shall not be deemed to be a liquidation, dissolution or winding up, voluntary or involuntary. (b) Subject to the rights of the holders of shares of any series or class or classes of stock ranking on a parity with or prior to the Series B Preferred Stock upon liquidation, dissolution or winding up, upon any liquidation, dissolution or winding up of the Company, after payment shall have been made in full to the holders of Series B Preferred Stock, as provided in this Section 4, any other series or class or classes of stock ranking junior to the Series B Preferred Stock upon liquidation, dissolution or winding up shall, subject to the respective terms and provisions (if any) applying thereto, be entitled to receive any and all assets remaining to be paid or distributed, and the holders of Series B Preferred Stock shall not be entitled to share therein. (c) Written notice of any liquidation, dissolution or winding up of the Company, stating the payment date or dates when and the place or places where the amounts distributable in such circumstances shall be payable, shall be given by first class mail, postage prepaid, not less than thirty (30) days prior to any payment date stated therein, to the holders of record of the Series B Preferred Stock at their respective addresses as the same shall appear on the books of the Transfer Agent. -8- 5. Redemption. (a) Any redemption of Series B Preferred Stock pursuant to this Section 5 shall be at a price equal to $50.00 per share of Series B Preferred Stock, plus in each case an amount equal to accrued and unpaid dividends, if any, to (and including) the redemption date, whether or not earned or declared (the "Redemption Price"). The Redemption Price may be paid in cash or, at the Company's option, subject to the provisions of this Section 5, in Common Shares or in a combination of Common Shares and cash. If, and to the extent, the Company elects to pay the Redemption Price for the Series B Preferred Stock in Common Shares, then such number of Common Shares payable to a holder of Series B Preferred Stock shall be equal to the greater of (i) the number of Common Shares into which the shares of Series B Preferred Stock held by the holder of such Series B Preferred Stock could be converted as of the date on which notice of such redemption is given by the Company or (ii) the number of Common Shares determined by dividing the Redemption Price payable to such holder of Series B Preferred Stock by the Closing Price as of the date on which notice of such redemption is given by the Company. (b) At any time on or after February 26, 1999 (and not before) and prior to February 26, 2002, if the daily closing price (as referred to in the second sentence of the definition of "Closing Price" in Section 2) of the Common Shares has been $10.875 (a 50% premium to the Conversion Price) or higher for the 30 consecutive Trading Dates commencing 32 Trading Dates before the date of the notice of redemption under Section 5(d), the Company may at its option (subject to the other provisions of this Section 5) redeem all or a portion of the outstanding Series B Preferred Stock pursuant to this Section 5(b). (c) On February 26, 2002 (or, if such date is not a Business Day, the next succeeding Business Day), the Company shall (subject to the other provisions of this Section 5) redeem all the outstanding Series B Preferred Stock pursuant to this Section 5(c); provided, that if the Company intends to elect in accordance with this Section 5 to pay the Redemption Price in Common Shares and, having used its reasonable best efforts to do so, has not been able to arrange for the firm commitment underwriting referred to in Section 5(d)(xi) below prior to such date, the Company shall not be required to redeem the Series B Preferred Stock for cash on such date but shall be required to (i) redeem for the Redemption Price payable in Common Shares all Series B Preferred Stock held by holders which waive the firm commitment underwriting requirements herein, and (ii) if any Series B Preferred Stock is not so redeemed, to continue to use its reasonable best efforts to arrange for such firm commitment underwriting as promptly as practicable thereafter and shall effect the redemption of all outstanding shares of Series B Preferred Stock upon arranging for such firm commitment underwriting. (d) In the event the Company shall elect to redeem shares of Series B Preferred Stock pursuant to Section 5(b) or shall be required to redeem shares of Series B Preferred Stock pursuant to Section 5(c), a notice of such redemption shall be given by the Company (a "Company Notice") -9- by first class mail, postage prepaid, mailed not less than 30 nor more than 90 days prior to the redemption date, to each holder of record of the shares to be redeemed, at such holder's address as the same appears on the stock records of the Company. Each such notice shall state: (i) the redemption date; (ii) the number of shares of Series B Preferred Stock to be redeemed and, if less than all the shares held by such holder are to be redeemed, the number of such shares to be redeemed from such holder; (iii) the Redemption Price; (iv) whether the Redemption Price will be paid in Common Shares or cash, or in a combination of Common Shares and cash; (v) the place or places where certificates for such shares of Series B Preferred Stock are to be surrendered for payment of the Redemption Price; (vi) that payment will be made upon presentation and surrender of such Series B Preferred Stock; (vii) the then current Conversion Price and the date on which the right to convert such shares of Series B Preferred Stock will expire; (viii) that dividends on the shares to be redeemed shall cease to accrue following such redemption date; (ix) whether such redemption is at the option of the Company; (x) that dividends accrued to and including the date fixed for redemption will be paid as specified in said notice on the shares to be redeemed; and (xi) if the Redemption Price will be paid in Common Shares, that an investment banking firm mutually acceptable to the Company and the holders of a majority of the shares of Series B Preferred Stock has agreed to proceed with a firm commitment underwriting (l) for holders of Series B Preferred Stock to be redeemed under this Section 5 by such notice, (m) with respect to the Common Shares obtainable by such holders upon redemption of the Series B Preferred Stock and (n) which will yield net proceeds (after deducting underwriting commissions and fees and other expenses of the offering) (which net proceeds may be supplemented by the Company, at its option, to meet the following threshold amounts) (a) in the case of a redemption under section 5(b), for such holders for such Common Shares equal to at least $10.875 (a 50% premium to the Conversion Price) -10- for each Common Share sold and (b) in the case of a redemption under Section 5(c), for such holders of such redeemed Series B Preferred Stock equal to the Redemption Price for each redeemed share of Series B Preferred Stock. Notice having been mailed as aforesaid, from and after the redemption date, unless the Company shall be in default in providing money or Common Shares for the payment of the Redemption Price (including any accrued and unpaid dividends to (and including) the date fixed for redemption), (1) dividends on the shares of the Series B Preferred Stock so called for redemption shall cease to accrue, (2) said shares shall be deemed no longer outstanding, and (3) all rights of the holders thereof as stockholders of the Company (except the right to receive from the Company any moneys or Common Shares payable upon redemption without interest thereon) shall cease except for the rights applicable to any Common Shares paid pursuant to the redemption. Neither the failure to mail a Company Notice required by this paragraph (d) nor any defect in the mailing thereof to a particular holder, shall affect the sufficiency of the notice or the validity of the proceedings for redemption with respect to any other holder. If the Company chooses to redeem the Series B Preferred Stock for cash, its obligation to provide moneys in accordance with this paragraph shall be deemed fulfilled if, on or before the redemption date, the Company shall deposit with a bank or trust company having an office or agency in the Borough of Manhattan, City of New York, and having a capital and surplus of at least $50,000,000, the principal amount of funds necessary for such redemption, in trust for the account of the holders of the shares to be redeemed (and so as to be and continue to be available therefor), with irrevocable instructions and authority to such bank or trust company that such funds be applied to the redemption of the shares of Series B Preferred Stock so called for redemption. Any interest accrued on such funds shall be paid to the Company from time to time. Any funds so deposited and unclaimed at the end of two years from such redemption date shall be released or repaid to the Company, after which, subject to any applicable laws relating to escheat or unclaimed property, the holder or holders of such shares of Series B Preferred Stock so called for redemption shall look only to the general funds of the Company for payment of the Redemption Price. Upon surrender in accordance with said notice of the certificates for any such shares so redeemed (properly endorsed or assigned for transfer, if the Board of Directors shall so require and the notice shall so state), such shares shall be redeemed by the Company at the applicable Redemption Price aforesaid. If fewer than all the outstanding shares of Series B Preferred Stock are to be redeemed, shares to be redeemed shall be selected by the Company from outstanding shares of Series B Preferred Stock not previously called for redemption by lot or pro rata (as near as may be) or by any other equitable method determined by the Company in its sole discretion. If fewer than all the shares represented by any certificate are redeemed, a new certificate shall be issued representing the unredeemed shares without cost to the holder thereof. Notwithstanding the foregoing, if the Company Notice of redemption has been given pursuant to this Section 5 and any holder of shares of Series B Preferred Stock shall, prior to the -11- close of business on the third Business Day preceding the redemption date, give written notice to the Company pursuant to Section 7(b) hereof of the conversion of any or all of the shares to be redeemed held by such holder (accompanied by a certificate or certificates for such shares, duly endorsed or assigned to the Company), then the conversion of such shares to be redeemed shall become effective as provided in Section 7. (e) In the case of a redemption under Section 5(b) or Section 5(c) hereof, if the Redemption Price will be paid, in whole or in part, in Common Shares, within 20 days after the receipt of the Company Notice described in Section 5(d) hereof, each holder of Series B Preferred Stock shall notify the Company whether or not it elects to participate in such underwritten offering (the failure to timely provide the required notice being deemed an election not to participate in such underwritten offering for purposes of this Section 5). As soon as practicable thereafter, the Company and the holders wishing to participate in such underwritten offering will, using such investment banking firm, proceed with a registration, qualification and offering of the Common Shares obtainable upon conversion of the Series B Preferred Stock held by such holders wishing to participate and subject to required redemption by the Company under the notice given under Section 5(d) hereof. It shall be a condition to the obligation of selling holders to close under such firm commitment underwriting that such underwriting shall net to the holders wishing to participate in such underwritten offering an amount (after deducting underwriting commissions and fees and other expenses of the underwriting) at least equal to the amounts stated in Section 5(d)(xi)(n)(a) or (b), as the case may be. (f) An election by any holders under the first sentence of Section 5(e) hereof to participate in an underwritten public offering shall suspend any redemption under this Section 5 with respect to Series B Preferred Stock held by such holders. If such holders who notified the Company that they wished to participate in the public offering refuse to close under the underwriting agreement despite the satisfaction of all conditions therein to their obligation to close thereunder, then the Company shall redeem the Series B Preferred Stock held by such holders scheduled for redemption in accordance with the notice given under Section 5(d) hereof; any such required redemption shall be made no later than the date (which shall be a Business Day) to be specified (not more than 20 days or less than 5 days after such failure to close) to such holders by the Company. If any underwriting under Section 5(e) does not close due to one or more of the conditions to the sellers' obligations to close under the underwriting agreement not being satisfied, then the notice of the Company requiring redemption of the Series B Preferred Stock described in Section 5(d) hereof shall be rescinded with respect to the shares held by the holders electing to participate in such offering, subject, in the case of a redemption pursuant to Section 5(c) hereof, to an obligation of the Company to use its reasonable best efforts to arrange as promptly as practicable thereafter for another firm commitment underwriting for the Common Shares issuable in connection with such redemption and to effect the redemption of all outstanding shares of Series B Preferred Stock upon arranging for such firm commitment underwriting. -12- (g) Neither the Company nor any of its subsidiaries shall repurchase any outstanding shares of Series B Preferred Stock unless the Company on the same terms either (i) offers to purchase all of the then outstanding shares of Series B Preferred Stock or (ii) offers to purchase shares of Series B Preferred Stock from the holders thereof in proportion to the respective number of shares of Series B Preferred Stock held by each holder. In any such repurchase by the Company, if all shares of Series B Preferred Stock are not being repurchased, then the number of shares of Series B Preferred Stock to be repurchased shall be allocated among all shares of Series B Preferred Stock held by holders which accept the Company's repurchase offer so that the shares of Series B Preferred Stock are repurchased from such holders in proportion to the respective number of shares of Series B Preferred Stock held by each such holder which accepts the Company's offer (or in such other proportion as agreed by all such holders who accept the Company's offer). Nothing in this Section 5(g) shall (i) obligate a holder of shares of Series B Preferred Stock to accept the Company's repurchase offer or (ii) prevent the Company from redeeming shares of Series B Preferred Stock in accordance with the terms of Sections 5(a) through (f) hereof. 6. Shares To Be Retired. Any share of Series B Preferred Stock converted, redeemed or otherwise acquired by the Company shall be retired and canceled and shall upon cancellation be restored to the status of authorized but unissued shares of preferred stock, subject to reissuance by the Board of Directors as shares of preferred stock of one or more other series but not as shares of Series B Preferred Stock. 7. Conversion. Holders of shares of Series B Preferred Stock shall have the right to convert all or a portion of such shares (including fractions of such shares) into fully paid and non-assessable shares of Common Stock or any capital stock or other securities into which such Common Stock shall have been changed or any capital stock or other securities resulting from a reclassification thereof (such shares, the "Common Shares"), as follows: (a) Subject to and upon compliance with the provisions of this Section 7, a holder of shares of Series B Preferred Stock shall have the right, at the option of such holder, at any time after the expiration of 60 days following the last date of original issuance of the Series B Preferred Stock (excluding the Series B Preferred Stock issued pursuant to the exercise of certain warrants referred to in Section 7(d)(vi)(E)), to convert any of such shares (or fractions thereof) into the number of fully paid and non-assessable shares of Common Stock (calculated as to each conversion to the nearest 1/100th of a share) obtained by dividing (x) the product of (i) the number of shares to be converted and (ii) $50.00 per share by (y) the Conversion Price, and by surrender of such shares, such surrender to be made in the manner provided in paragraph (b) of this Section 7; provided, however, that the right to convert shares called for redemption pursuant to Section 5 shall terminate at the close of business on the third Business Day preceding the date fixed for such redemption, unless the Company shall default in making payment of the amount payable upon such redemption. Subject to the following provisions of this Section 7(a), any share of Series B Preferred Stock may be converted, at the option of its holder, in part into Common Shares under the procedures set forth -13- above. If a part of a share of Series B Preferred Stock is converted, then the Company will convert such share into the appropriate number of Common Shares (subject to paragraph (c) of this Section 7) and issue a fractional share of Series B Preferred Stock evidencing the remaining interest of such holder. The Common Shares issuable upon conversion of the shares of Series B Preferred Stock, when such Common Shares shall be issued in accordance with the terms hereof, are hereby declared to be and shall be duly authorized, validly issued, fully paid and non-assessable Common Shares held by the holders thereof. (b) In order to exercise the conversion right, the holder of each share of Series B Preferred Stock (or fraction thereof) to be converted shall surrender the certificate representing such share, duly endorsed or assigned to the Company or in blank, at the office or agency of the Transfer Agent in the Borough of Manhattan, City of New York or Houston, Texas, accompanied by written notice to the Company that the holder thereof elects to convert the holder's Series B Preferred Stock or a specified portion thereof. Unless the shares issuable on conversion are to be issued in the same name as the name in which such share of Series B Preferred Stock is registered, each share surrendered for conversion shall be accompanied by instruments of transfer, in form satisfactory to the Company, duly executed by the holder or such holder's duly authorized attorney and an amount sufficient to pay any required transfer or similar tax (or evidence reasonably satisfactory to the Company demonstrating that such taxes have been paid). Within five (5) Business Days after receipt of any share of Series B Preferred Stock and an election to convert all or a portion of such share of Series B Preferred Stock under this Section 7, the Company will pay, out of funds legally available therefor, to the holder of such share of Series B Preferred Stock full cumulative dividends, if any, accrued to the effective date of conversion of such share of Series B Preferred Stock and relating to the portion of such share to be converted; provided, however, that if a share of Series B Preferred Stock is surrendered for conversion between a Dividend Payment Record Date and a Dividend Payment Date, the Company shall only be obligated to pay such full cumulative dividends to the record holder of such share of Series B Preferred Stock on the Dividend Payment Record Date. As promptly as practicable after the surrender of certificates for shares of Series B Preferred Stock as aforesaid and in any event within five (5) Business Days thereafter (unless such conversion is in connection with an underwritten public offering of Common Shares as specified in a written notice provided to the Company, in which event concurrently with such conversion) the Company shall issue and shall deliver at such office to such holder, or on his or her written order, a certificate or certificates for the number of Common Shares issuable upon the conversion of such shares in accordance with the provisions of this Section 7, and any fractional interest in respect of a Common Share arising upon such conversion shall be settled as provided in paragraph (c) of this Section 7. Each conversion shall be deemed to have been effected immediately prior to the close of business on the date on which the certificate or certificates for shares of Series B Preferred Stock -14- shall have been surrendered and such notice received by the Company as aforesaid (except that if such conversion is in connection with an underwritten public offering of Common Shares, then such conversion shall be deemed to have been effected upon such surrender), and the person or persons in whose name or names any certificate or certificates for Common Shares shall be issuable upon such conversion shall be deemed to have become the holder or holders of record of the shares represented thereby at such time on such date, and such conversion shall be at the Conversion Price in effect at such time on such date, unless the stock transfer books of the Company shall be closed on that date, in which event such person or persons shall be deemed to have become such holder or holders of record at the close of business on the next succeeding day on which such stock transfer books are open, but such conversion shall be at the Conversion Price in effect on the date and at the time referred to above. All Common Shares delivered upon conversion of the Series B Preferred Stock will, upon delivery, be duly authorized, validly issued and fully paid and non-assessable. (c) In connection with the conversion of any shares of Series B Preferred Stock, fractions of such shares may be converted; however, no fractional shares or securities representing fractions of Common Shares shall be issued upon conversion of the Series B Preferred Stock. Instead of any fractional interest in a Common Share which would otherwise be deliverable upon the conversion of a share of Series B Preferred Stock (or fraction thereof), the Company shall pay to the holder of such share an amount in cash (computed to the nearest cent) equal to the daily closing price (as referred to in the second sentence of the definition of "Closing Price'') of a Common Share on the Trading Date immediately preceding the date of conversion multiplied by the fraction of a share of Common Stock represented by such fractional interest. If more than one share (or fraction thereof) of Series B Preferred Stock shall be surrendered for conversion at one time by the same holder, the number of full shares of Common Stock issuable upon conversion thereof shall be computed on the basis of the aggregate number of shares of Series B Preferred Stock (or fractions thereof) so surrendered. (d) The Conversion Price shall be adjusted from time to time as follows: (i) Stock Dividends and Stock Splits. If at any time after the Issue Date, (i) the Company shall fix a record date for the issuance of any dividend payable in Common Shares or (ii) the number of Common Shares shall be increased by a subdivision or split-up of Common Shares, then, on the record date fixed for the determination of holders of Common Shares entitled to receive such dividend or immediately after the effective date of such subdivision or split-up, as the case may be, the number of shares to be delivered upon surrender of any share of Series B Preferred Stock for conversion will be appropriately increased so that each holder of Series B Preferred Stock thereafter will be entitled to receive the number of Common Shares that such holder would have owned immediately following such action had such share of Series B Preferred Stock been surrendered for conversion immediately prior thereto, and the Conversion Price will be appropriately adjusted. The time of occurrence of an event giving rise to an adjustment made pursuant to this paragraph d(i) -15- shall, in the case of a subdivision or split-up, be the effective date thereof and shall, in the case of a stock dividend, be the record date thereof. (ii) Combination of Stock. If the number of Common Shares outstanding at any time after the Issue Date shall have been decreased by a combination of the outstanding Common Shares, then, immediately after the effective date of such combination, the number of shares to be delivered upon surrender of any share of Series B Preferred Stock for conversion will be appropriately decreased so that each holder of Series B Preferred Stock thereafter will be entitled to receive the number of Common Shares that such holder would have owned immediately following such action had such share of Series B Preferred Stock been surrendered for conversion immediately prior thereto, and the Conversion Price will be appropriately adjusted. (iii) Reorganization. If any capital reorganization of the Company, or any reclassification of the Common Stock, or any consolidation of the Company with or merger of the Company with or into any other corporation or any sale, lease or other transfer of all or substantially all of the assets of the Company to any other person (including any individual, partnership, joint venture, corporation, trust or group thereof) shall be effected in such a way that the Common Shares shall be converted into the right to receive stock, securities or other property (including cash or any combination thereof), then, upon surrender of the Series B Preferred Stock for conversion in accordance with the terms of this Section 7, each holder shall have the right to receive the kind and amount of stock and other securities and property receivable (including cash or any combination thereof) upon such reorganization, reclassification, consolidation, merger or sale, lease or other transfer by a holder of the number of Common Shares that such holder of the Series B Preferred Stock would have been entitled to receive upon surrender of the Series B Preferred Stock for conversion pursuant to this Section 7 had the Series B Preferred Stock been surrendered for conversion immediately prior to such reorganization, reclassification, consolidation, merger or sale, lease or other transfer. As a condition to any such transaction, the Company shall require such person to confirm in writing the rights of the holders of Series B Preferred Stock pursuant to this paragraph d(iii). (iv) Rights Offering. If the Company at any time after the Issue Date shall issue or sell or fix a record date for the issuance of rights, options or warrants to all holders of Common Shares entitling the holders thereof to subscribe for or purchase or otherwise acquire Common Shares (or securities convertible into or exchangeable for Common Shares), in any such case, at a price per share (or having a conversion price or exchange value per share) that, together with the value (if for consideration other than cash, as determined in good faith by the Board of Directors) of any consideration paid for any such rights, options or warrants is less than the Closing Price of the Common Shares as of the date of such issuance or sale or as of such record date, then, immediately after such record date, -16- the number of shares to be delivered upon surrender of the Series B Preferred Stock for conversion shall be appropriately increased so that each holder thereafter will be entitled to receive the number of Common Shares determined by multiplying the number of Common Shares such holder would have been entitled to receive immediately before the date of such issuance or sale on such record date by a fraction, the numerator of which will be the number of Common Shares outstanding on such date plus the number of additional Common Shares offered for subscription or purchase (or into which the convertible securities so offered are initially convertible) and the denominator of which will be the number of Common Shares outstanding on such date plus the number of Common Shares that the aggregate offering price of the total number of shares so offered for subscription or purchase would purchase at such Closing Price, and the Conversion Price shall be appropriately adjusted. Notwithstanding the foregoing, rights issued by the Company to all holders of its Common Shares entitling the holders thereof to subscribe for or purchase securities of the Company, which rights (i) are deemed to be transferred with such Common Shares, (ii) are not immediately exerciseable, and (iii) are also issued in respect of future issuances of Common Shares pursuant to a stockholder rights plan or similar plan of the Company, in each case in clauses (i) through (iii) until the occurrence of a specified event or events, shall for purposes of this paragraph (d) of this Section 7 not be deemed issued until the occurrence of the earliest such specified event. (v) Certain Issuances. If the Company shall sell or issue any Additional Stock (as defined below), the Conversion Price in effect immediately prior to each such sale or issuance shall forthwith (except as otherwise provided in this clause (v)) be adjusted to a price determined by multiplying such Conversion Price by a fraction: (x) the numerator of which shall be (1) the aggregate number of outstanding Common Shares immediately prior to such sale (assuming conversion of all outstanding shares of Series B Preferred Stock into Common Shares); plus (2) the number of Common Shares which the aggregate consideration received by the Company for the shares of Additional Stock would purchase at the current Conversion Price immediately prior to this adjustment ; and (y) the denominator of which shall be (1) the aggregate number of outstanding Common Shares immediately prior to such sale (assuming conversion of all outstanding shares of Series B Preferred Stock into Common Shares) ; plus -17- (2) the number of such shares of Additional Stock so issued or sold by the Company. The consideration for the issuance of Common Shares shall be deemed to be the amount of cash paid therefor before deducting any reasonable discounts, commissions or other expenses allowed, paid or incurred by the Company for any underwriting or otherwise in connection with the issuance and sale thereof or the value of other consideration received therefor as determined in good faith by the Board of Directors. In the case of the issuance of Additional Stock consisting of Common Shares issuable under options to purchase or rights to subscribe for Common Shares, securities by their terms convertible into or exchangeable for Common Shares or options to purchase or rights to subscribe for such convertible or exchangeable securities, the following provisions shall apply: (A) The aggregate maximum number of Common Shares deliverable upon exercise of such options to purchase or rights to subscribe for Common Shares shall be deemed to have been issued as Additional Stock at the time such options or rights were issued and for a consideration equal to the cash consideration, if any, received by the Company upon the issuance of such options or rights plus the minimum purchase or exercise price provided in such options or rights for the Common Shares covered thereby. (B) The aggregate maximum number of Common Shares deliverable upon conversion of or in exchange for any such convertible or exchangeable securities or upon the exercise of options to purchase or rights to subscribe for such convertible or exchangeable securities and subsequent conversion or exchange thereof shall be deemed to have been issued as Additional Stock at the time such securities were issued or such options or rights were issued and for a consideration equal to the consideration, if any, received by the Company for any such securities and related options or rights (excluding any cash received on account of accrued interest or accrued dividends), plus the additional consideration, if any, to be received by the Company upon the conversion or exchange of such securities or the exercise of any related options or rights. (C) In the event of any change in the number of Common Shares deliverable or any change in the consideration payable to the Company upon exercise of such options or rights or upon conversion of or in exchange for such convertible or exchangeable securities, including, but not limited to, a change resulting from the antidilution provisions thereof, the Conversion Price obtained with respect to the adjustment which was made upon the issuance of such options, rights or securities, and any subsequent adjustments based thereon, shall be recomputed to reflect such change, but in no case shall a further adjustment be made for the actual issuance of Common Shares or any payment of such consideration upon the exercise of any such options or rights or the conversion or exchange of such securities; provided, however, that this section shall not have any effect on any conversion of the Series B Preferred Stock prior to such change; provided, further, that -18- if such adjustment would result in an increase in the Conversion Price then in effect, such adjustment shall not be effective until 30 days after written notice thereof has been given by the Company to all holders of the Series B Preferred Stock; and provided further that the Conversion Price shall in no event be increased to an amount greater than that which would have been effective without regard to the original issuance. (D) Upon the expiration of any such options or rights, the termination of any such rights to convert or exchange or the expiration of any options or rights related to such convertible or exchangeable securities, the Conversion Price obtained with respect to the adjustment which was made upon the issuance of such options, rights or securities or options or rights related to such securities, and any subsequent adjustments based thereon, shall be recomputed to reflect the issuance of only the number of Common Shares actually issued upon the exercise of such options or rights, upon the conversion or exchange of such securities or upon the exercise of the options or rights related to such securities; provided, however, that this section shall not have any effect on any conversion of Series B Preferred Stock prior to such expiration or termination; and provided further that the Conversion Price shall in no event be increased to an amount greater than that which would have been effective without regard to the original issuance. (vi) Additional Stock. "Additional Stock" shall mean any Common Shares issued by the Company after the Issue Date for a consideration per share of $6.50 or less, as adjusted for stock splits, dividends and combinations, (or Common Shares issuable pursuant to options or rights or convertible or exchangeable securities as referred to in paragraph (v) above if the consideration therefor as provided in clause (A) therein is $6.50 or less, as adjusted as aforesaid) other than (A) Common Shares issued pursuant to any transaction described in Sections 3(e) or 7(d)(i)-(iv) hereof, (B) Common Shares issued or issuable to employees, directors, consultants or advisors of the Company directly or pursuant to a stock plan or stock purchase plan or agreement, which have been issued as of the date hereof or are issuable pursuant to agreements entered into on or prior to the date hereof. Any further Common Shares issued or issuable to employees, directors, consultants or advisors of the Company other than those referenced in the preceding sentence that in the aggregate do not exceed 5% of the outstanding Common Shares at such Common Shares' date of issuance or deemed date of issuance, (C) Common Shares issued upon conversion or redemption of the Series A Preferred Stock (provided, in the case of the redemption of the Series A Preferred Stock, that Common Shares issued upon redemption of the Series A Preferred Stock shall be deemed to be Additional Stock to the extent that the number of Common Shares so issued exceeds the number of Common Shares issuable immediately prior to such redemption upon conversion of the redeemed shares of Series A Preferred Stock), -19- (D) Common Shares issued in payment of dividends or upon conversion or redemption of the Series B Preferred Stock, (E) Securities issued or issuable for consideration other than solely cash in connection with any license, collaborative, corporate partnership, co- marketing or co-promotion, research and development or similar arrangement; and (F) Common Shares issuable to a certain party retained as exclusive agent of the Company in connection with the offer and sale by the Company of the shares of Series B Preferred Stock pursuant to the exercise of warrants to purchase shares of Series B Preferred Stock and the subsequent conversion of such shares of Series B Preferred Stock. (vii) No Adjustments to Exercise Price. No adjustment in the number of Common Shares issuable upon conversion and consequently the Conversion Price in accordance with the provisions of Sections 7(d)(i)-(v) above need be made if such adjustment would amount to a change in such Conversion Price of less than $.10; provided, however, that the amount by which any adjustment is not made by reason of the provisions of this section shall be carried forward and taken into account at the time of any subsequent adjustment in the Conversion Price; and provided further, that adjustment shall be required and made in accordance with the provisions of this Section 7 not later than such time as may be required in order to preserve the tax free nature of a distribution to the holder of any Common Share. Anything in this Section 7 to the contrary notwithstanding, the Company shall be entitled to the extent permitted by law to make such reductions in the Conversion Price, in addition to those required by this Section 7, as it in its sole discretion shall determine to be advisable in order to avoid or diminish any income tax to any holder of Common Share resulting from any dividend or distribution of capital stock or rights or warrants to purchase capital stock or from any event treated as such for income tax purposes or for any other reasons. (viii) Readjustments, Etc. If an adjustment is made under Sections 7(d)(i)-(v) above, and the event to which the adjustment relates does not occur, then any adjustments in the Conversion Price or Common Shares to be delivered upon surrender of the Series B Preferred Stock for conversion that were made in accordance with such paragraphs shall be adjusted back to the Conversion Price and the number of Common Shares to be delivered upon surrender of the Series B Preferred Stock for conversion that were in effect immediately prior to the record date for such event (subject to the effect of any subsequent intervening adjustments). (e) Whenever the Conversion Price is adjusted as herein provided, the Company shall promptly file in the custody of its Secretary or an Assistant Secretary at its principal office and with the Transfer Agent an officers' certificate setting forth the adjusted number of Common Shares to be delivered upon surrender of the Series B Preferred Stock for conversion and the Conversion Price after such adjustment, the method of calculation thereof and a brief statement of the facts requiring such adjustment and upon which such adjustment is based. Promptly after each such adjustment, the -20- Company shall cause a copy of such certificate to be mailed to the holder of each share of Series B Preferred Stock at his or her last address as shown on the stock books of the Company. Each such officers' certificate shall be made available at all reasonable times for inspection by each holder of Series B Preferred Stock. (f) In any case in which paragraph (d) of this Section 7 provides that an adjustment shall become effective immediately after a record date for an event and the date fixed for conversion pursuant to Section 7 occurs after such record date but before the occurrence of such event, the Company may defer until the actual occurrence of such event (A) issuing to the holder of any share of Series B Preferred Stock surrendered for conversion the additional Common Shares issuable upon such conversion by reason of the adjustment required by such event over and above the Common Shares issuable upon such conversion before giving effect to such adjustment and (B) paying to such holder any amount in cash in lieu of any fraction pursuant to paragraph (c) of this Section 7. (g) The Company covenants that it will at all times reserve and keep available, free from preemptive rights, out of the aggregate of its authorized but unissued Common Shares the maximum number of Common Shares into which all shares of the Series B Preferred Stock from time to time may be converted, but Common Shares held in the treasury of the Company may, in its discretion, be delivered upon any conversion of shares of Series B Preferred Stock. Before taking any action which would cause an adjustment reducing the Conversion Price below the then par value, if any, of the Common Shares issuable upon conversion of the Series B Preferred Stock, the Company will take any corporate action which may in the opinion of its counsel, be necessary in order that the Company may validly and legally issue Common Shares at such adjusted Conversion Price, which shares shall be fully-paid and nonassessable and free from all taxes, liens and charges with respect to the issue thereof. Prior to the delivery of any securities which the Company shall be obligated to deliver upon conversion of the Series B Preferred Stock, the Company will endeavor in good faith and as expeditiously as possible to comply with all federal and state laws and regulations thereunder requiring the registration of such securities with, or any approval of or consent to the delivery thereof by, any governmental authority. (h) The Company will pay any and all documentary stamp or similar issue or transfer taxes payable in respect of the issue or delivery of the shares of Series B Preferred Stock (or any other securities issued on account of the Series B Preferred Stock pursuant hereto) or Common Shares on conversion of the Series B Preferred Stock pursuant hereto; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the issue or delivery of shares of Series B Preferred Stock (or any other securities issued on account of the Series B Preferred Stock pursuant hereto) or Common Shares in a name other than the name in which the shares of Series B Preferred Stock with respect to which such Common Shares -21- are issued were registered, and the Company shall not be required to make any issue or delivery unless and until the person requesting such issue or delivery has paid to the Company the amount of any such tax. If: (i) the Company shall authorize the issuance to all holders of Common Shares of rights or warrants to subscribe for or purchase Common Shares or any other subscription rights or warrants; or (ii) the Company shall authorize the distribution to all holders of Common Shares of evidences of its indebtedness or assets (other than cash dividends payable out of retained earnings, distributions excluded from the operation of subparagraph (d)(iv) of this Section 7, stock dividends or securities issued pursuant to any stockholder rights plan or any similar plan of the Company); or (iii) there shall be any capital reorganization or reclassification of the Common Shares (other than a subdivision, split-up or combination of the outstanding Common Shares, an increase in the authorized capital stock of the Company not involving the issuance of any shares thereof, or a change in par value of the Common Shares), or any other consolidation or merger to which the Company is a party (other than a consolidation or merger with a subsidiary in which the Company is the continuing entity and that does not result in any reclassification or change in the Common Shares outstanding) or a sale, lease or transfer of all or substantially all of the assets of the Company; or (iv) there shall be a voluntary or involuntary dissolution, liquidation or winding-up of the Company; or (v) there shall be any other event that would result in an adjustment pursuant to paragraph (d) of this Section 7 of the Conversion Price or the number of Common Shares that may be issuable upon the conversion of the Series B Preferred Stock; then the Company will cause to be filed with the Transfer Agent and to be mailed to each holder of Series B Preferred Stock by first class mail addressed to such holder at the address appearing in the stock records of the Company, at least twenty (20) days (or ten (10) days in any case specified in clauses (i) or (ii) above) before the applicable record or effective date hereinafter specified, a notice stating (A) the date as of which the holders of Common Shares of record entitled to receive any such rights, warrants or distributions are to be determined or (B) the date on which any such consolidation, merger, sale, lease, transfer, dissolution, liquidation or winding-up is expected to become effective, and the date as of which it is expected that holders of Common Shares of record will be entitled to exchange their Common Shares for securities or other property, if any, deliverable upon such reorganization, reclassification, consolidation, merger, sale, lease, transfer, dissolution, liquidation or winding-up. Such notice shall also state whether such transaction will result in any -22- adjustment in the Conversion Price and, if so, shall state what the adjusted Conversion Price will be and when it will become effective. The failure to give such notice or any defect therein shall not affect the legality or validity of any distribution, right, warrant, consolidation, merger, sale, lease, transfer, dissolution, liquidation or winding-up or the vote upon any such action. 8. Redemption at Option of Holder Upon a Fundamental Change. (a) If a Fundamental Change (as defined in paragraph (c) of this Section 8) occurs, each holder of Series B Preferred Stock shall have the right, at the holder's option, to require the Company to redeem all of such holder's Series B Preferred Stock, or any portion thereof that has an aggregate liquidation value that is a multiple of $50.00, on the date (the "Repurchase Date") selected by the Company that is not less than 10 nor more than 20 days after the Final Surrender Date (as defined in paragraph (b) of this Section 8), at a price per share equal to the Redemption Price. The Company may, at its option, pay all or any portion of such Redemption Price upon a Fundamental Change in Common Shares, provided that if the Company elects to pay all or any portion of the repurchase price in Common Shares, the holders of Series B Preferred Stock electing to sell their shares of Series B Preferred Stock to the Company pursuant to this Section 8 must be given the opportunity to sell the Common Shares received from the Company pursuant to this Section 8 in a firm commitment underwriting by an investment banking firm mutually acceptable to the Company and the holders of a majority of such shares. For purposes of calculating the number of Common Shares issuable upon such redemption, the value of any such Common Shares will be equal to the Closing Price of such Common Shares as of the Repurchase Date. Payment may not be made in Common Shares unless (i) the issuance or resale of such shares has been, or will be registered on or prior to the Final Surrender Date (as defined in paragraph (b) of this Section 8) under the Securities Act of 1933, as amended, or such shares are freely tradable pursuant to an exemption thereunder and (ii) such shares are listed on a United States national securities exchange or quoted on the National Market of NASDAQ at (or immediately after) the time of payment. (b) Within 30 days after the occurrence of a Fundamental Change, the Company must mail to all holders of record of the Series B Preferred Stock a Company Notice containing the information set out in paragraph (d) of Section 5, except that, for purposes of this Section 8 only, instead of stating that a redemption is occurring at the option of the Company, the Company Notice shall describe the occurrence of such Fundamental Change and of the redemption right arising as a result thereof. The Company must cause a copy of such notice to be published in a newspaper of general circulation in the Borough of Manhattan, the City of New York. At least two Business Days prior to the Repurchase Date, the Company must publish a similar notice stating whether and to what extent the Redemption Price will be paid in cash or Common Shares. To exercise the redemption right, a holder of Series B Preferred Stock must surrender, on or before the date which is, subject to any contrary requirements of applicable law, 60 days after the date of mailing of the Company Notice (the "Final Surrender Date"), the certificate or certificates representing the Series B Preferred Stock with respect to which the right is being exercised, duly endorsed for transfer to the Company, together with a written notice of election. -23- (c) The term "Fundamental Change" shall mean any of the following: (i) a "person" or "group" (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), together with any affiliates thereof, becoming the "beneficial owners" as defined in Rule 13d-3 under the Exchange Act) of Voting Shares (as defined in this Section 8) of the Company entitled to exercise more than 60% of the total voting power of all outstanding Voting Shares of the Company (including any Voting Shares that are not then outstanding of which such person or group is deemed the beneficial owner); (ii) any consolidation of the Company with, or merger of the Company into, any other person, any merger of another person (other than a wholly- owned subsidiary of the Company) into the Company, or any sale, lease or transfer of all or substantially all of the assets of the Company to another person (other than a merger (a) which results in the holders of Common Stock of the Company immediately prior to giving effect to such transaction owning shares of capital stock of the surviving corporation in such transaction representing in excess of 40% of the total voting power of all shares of capital stock of such surviving corporation entitled to vote generally in the election of directors and (b) in which the shares of the surviving corporation held by such holders are, or immediately upon issuance will be, listed on a national securities exchange or quoted on the National Market of NASDAQ, are not subject to any right of repurchase by the issuer thereof or any third party and are not otherwise subject to any encumbrance as a result of such transaction, provided, that the surviving corporation amends its charter or certificate of incorporation to include the rights of the Series B Preferred Stock and its terms as set forth herein); or (iii) the substantial reduction or elimination of a public market for the Common Shares as the result of repurchases, delisting or deregistration of the Common Shares or a corporate reorganization or recapitalization undertaken by the Company; provided, however, that a Fundamental Change shall not occur under clause (i) or (ii) above if, (x) as of the fifteenth (15th) Trading Date after the public announcement by the Company of such transaction and, if later, three days prior to the consummation of such transaction, the Closing Price is at least equal to 110% of the Conversion Price then in effect on such dates and (y) in the case of clause (ii) above, at least 90% of the consideration (excluding cash payments for fractional shares) in such transaction or transactions to the holders of Common Shares consists of shares of common stock that are, or immediately upon issuance will be, listed on a national securities exchange or quoted on the National Market of NASDAQ, and as a result of such transaction or transactions, the Series B Preferred Stock becomes convertible into such common stock. -24- (d) An election by a holder of Series B Preferred Stock to have the Company redeem shares of Series B Preferred Stock pursuant to subsection 8(a) shall become irrevocable at the close of business on the relevant Repurchase Date. (e) The Company agrees that it will not complete any Fundamental Change described in subsection 8(c) unless proper provision has been made to satisfy its obligations under this Section 8. For purposes of this Section 8, "Voting Shares" is defined to mean all outstanding shares of any class or classes (however designated) of capital stock entitled to vote generally in the election of members of the Board of Directors. 9. Ranking. Any class or classes of stock of the Company shall be deemed to rank: (i) prior to the Series B Preferred Stock, as to dividends or as to distribution of assets upon liquidation, dissolution or winding up, if the holders of such class shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up, as the case may be, in preference or priority to the holders of Series B Preferred Stock. (ii) on a parity with the Series B Preferred Stock, as to dividends or as to distribution of assets upon liquidation, dissolution or winding up, whether or not the dividend rates, dividend payment dates or redemption or liquidation prices per share thereof be different from those of the Series B Preferred Stock, if the holders of such class of stock and the Series B Preferred Stock shall be entitled to the receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up, as the case may be, in proportion to their respective amounts of accrued and unpaid dividends per share or liquidation prices, without preference or priority of one over the other; and (iii) junior to the Series B Preferred Stock, as to dividends or as to the distribution of assets upon liquidation, dissolution or winding up, if such stock shall be Common Stock or if the holder of Series B Preferred Stock shall be entitled to receipt of dividends or of amounts distributable upon liquidation, dissolution or winding up, as the case may be, in preference or priority to the holders of shares of such stock. Without limiting the foregoing, the Series A Preferred Stock shall be deemed to rank on a parity with the Series B Preferred Stock as to dividends and as to distributions of assets upon liquidation, dissolution or winding up. 10. Voting and Special Rights. (a) In addition to the voting rights provided below, the holders of Series B Preferred Stock will have voting rights on all matters subject to a vote of holders of Common Stock as if such shares of Series B Preferred Stock were converted into the applicable number of Common Shares consistent with Section 7 hereof; provided, however, that -25- notwithstanding the foregoing provisions of this Section 10(a), any holder of Series B Preferred Stock that would be required to make a filing under the Hart- Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") in connection with the acquisition of Series B Preferred Stock shall not be entitled, pursuant to the provisions of this Section 10(a), to vote in the election of directors of the Company until (i) such holder has notified the Company in writing of its election to exercise its right to vote in the election of directors of the Company pursuant to the provisions of this Section 10(a), (ii) the required filings under the HSR Act have been made and (iii) the waiting period under the HSR Act applicable to the election by such holder described in (i) of this Section 10(a) has expired or been terminated. (b) Notwithstanding (a) above of this Section 10, so long as any shares of the Series B Preferred Stock remain outstanding, the consent of the holders of at least two-thirds (2/3) of the shares of Series B Preferred Stock outstanding at the time, voting separately as a class, given in person or by proxy either in writing (as permitted by law and the Certificate of Incorporation and By-laws of the Company) or at any special or annual meeting, shall be necessary to permit, effect or validate any one or more of the following: (i) the authorization, creation or issuance, or any increase in the authorized or issued amount, of any class or series of stock ranking prior to the Series B Preferred Stock as to dividends or the distribution of assets upon liquidation, dissolution or winding up; (ii) the creation, authorization or issuance of any class or series of common stock other than the class of Common Stock presently authorized for issuance under the Certificate of Incorporation as in effect on January 1, 1997, subject to changes to the terms thereof hereafter made to the Certificate of Incorporation; provided that (A) there shall be no more than one class (and there shall be no separate series) of Common Stock and (B) the Company will not permit the par value or the determined or stated value of any shares of the Common Stock receivable upon the conversion of the shares of Series B Preferred Stock to exceed the amount payable therefor upon such conversion and (C) the Company will not take any action which results in any adjustment of the current Conversion Price under this Certificate if the total number of shares of Common Stock then available for issuance upon conversion of all shares of Series B Preferred Stock (and upon conversion of all other then outstanding shares of the Company's capital stock convertible into Common Stock) would be insufficient to satisfy all such conversion rights; (iii) the amendment, alteration or repeal, whether by merger, consolidation or otherwise, of any of the provisions of the Certificate of Incorporation of the Company which would adversely affect any right, preference, privilege or voting power of the Series B Preferred Stock or of the holders thereof; provided, however, that any increase in the amount of authorized preferred stock or the creation and issuance of other series of preferred stock, or any increase in the amount of authorized shares of such series or of any other series of preferred stock, in each case ranking on a parity with or junior to the Series B Preferred Stock with respect to the payment of dividends and -26- the distribution of assets upon liquidation, dissolution or winding up, shall not be deemed to adversely affect such rights, preferences or voting powers; (iv) the authorization of any reclassification of the Series B Preferred Stock; (v) any increase in the number of shares of Series B Preferred Stock authorized for issuance; (vi) the creation, authorization or issuance of any series or class of stock or any other obligation or security convertible into any capital stock which capital stock is prohibited under clauses (i) or (ii) above; (vii) the amendment of this Certificate of Designations; or (viii) at any time after March 31, 1997, the issuance of any shares of Series B Preferred Stock (excluding the issuance of share certificates upon transfers or exchanges of shares by holders (other than the Company) or upon replacement of lost, stolen, damaged or mutilated share certificates and excluding the shares of Series B Preferred Stock to be issued upon the exercise of the warrants issued to the exclusive agent for the Company in connection with the issuance and sale of the shares of the Series B Preferred Stock). (c) Additional Voting Rights. (i) If on the sixth anniversary of the Issue Date any shares of the Series B Preferred Stock are outstanding, the size of the Board of Directors of the Company shall be increased by such number representing not less than 20% (rounded to the nearest whole number) of the total number of directors after giving effect to the increase in the size of the Board of Directors contemplated by this paragraph and during the period (hereinafter in this Section 10 called the "Class Voting Period") commencing upon such date and ending on the date on which no shares of Series B Preferred Stock remain outstanding, the holders of at least two-thirds (2/3) of the then outstanding shares of Series B Preferred Stock, by the affirmative vote in person or by proxy at a special meeting of holders of Series B Preferred Stock called for such purpose (or at any adjournment thereof) by holders of at least 25% of the then outstanding shares of Series B Preferred Stock or at any annual meeting of stockholders, or by written consent delivered to the Secretary of the Company, with the holders of the Series B Preferred Stock voting as a separate class and with each share of Series B Preferred Stock having one vote, shall be entitled, as a class, to the exclusion of the holders of all other classes or series of capital stock of the Company, to elect such additional number of directors of the Company. (ii) At any time when such voting right under this Section l0(c) shall have vested in the holders of shares of Series B Preferred Stock entitled to vote thereon, and if such right shall not -27- already have been initially exercised, an officer of the Company shall, upon the written request of at least 25% of the holders of record of shares of the Series B Preferred Stock then outstanding, addressed to the Secretary of the Corporation, call a special meeting of holders of shares of the Series B Preferred Stock. Such meeting shall be held at the earliest practicable date upon the notice required for special meetings of stockholders at the place for holding annual meetings of stockholders of the Company or, if none, at a place designated by the Secretary of the Company. If such meeting shall not be called by the proper officers of the Company within 30 days after the personal service of such written request upon the Secretary of the Company, or within 30 days after mailing the same within the United States, by registered mail, addressed to the Secretary of the Company at its principal office (such mailing to be evidenced by the registry receipt issued by the political authorities), then the holders of record of at least 25% of the shares of Series B Preferred Stock then outstanding may designate in writing any person to call such meeting at the expense of the Company, and such meeting may be called by such person so designated upon the notice required for special meetings of stockholders and shall be held at the same place as is elsewhere provided in this paragraph or, if none, at a place designated by the person selected to call the meeting. Any holder of shares of Series B Preferred Stock then outstanding that would be entitled to vote at such meeting shall have access to the stock books of the Company for the purpose of causing a meeting of stockholders to be called pursuant to the provisions of this paragraph. (iii) Any director who shall have been elected by the holders of Series B Preferred Stock pursuant to this Section l0(c) may be removed at any time during the Class Voting Period, by the vote of the holders of at least two-thirds (2/3) of all of the then outstanding shares of Series B Preferred Stock, voting as a separate class in person or by proxy at a special meeting of holders of shares of Series B Preferred Stock called for such purpose by the holders of at least 25% of the then outstanding shares of Series B Preferred Stock. Any director who shall have been elected by the holders of Series B Preferred Stock may not be removed at any time during the Class Voting Period without the consent of the holders of at least two-thirds (2/3) of all of the then outstanding shares of Series B Preferred Stock. Any vacancy created by the removal, death or resignation of a director elected by the holders of Series B Preferred Stock may be filled during the Class Voting Period by the holders of at least two-thirds (2/3) of all of the then outstanding shares of Series B Preferred Stock by vote in person or by proxy at a special meeting of holders of shares of Series B Preferred Stock of the Company called for such purpose by holders of at least 25% of the then outstanding shares of Series B Preferred Stock. (iv) The term of any director elected pursuant to the provisions of this Section l0(c) shall in all events expire at the end of the Class Voting Period and the size of the Board of Directors shall be reduced accordingly. (d) Special Rights. Each holder of 100,000 shares or more of Series B Preferred Stock or such number of Common Shares issued upon conversion of at least 100,000 or more shares of the Series B Preferred Stock (such number being subject to adjustment in a manner consistent -28- with the provisions of Section 7 hereof) (each such person, an "Eligible Holder") shall have the right, during the period such Person holds the number of shares of Series B Preferred Stock or Common Shares specified above, and (if requested by the Company) subject to execution by such Eligible Holder of a reasonable confidentiality agreement, to send one (1) representative to meetings of the Company's and each subsidiary's, if any, Board of Directors (and the executive committee if the executive committee has more than five members) of such Board of Directors, such representatives to act as observers without a vote or other rights as a director (except the right to receive sufficient notice to enable such attendance and the right to receive all other communications, information and materials furnished, from time to time, to directors of the Company and each subsidiary). (e) To alter or amend the voting or special rights of the holders of Series B Preferred Stock or any Eligible Holder as provided in this Section 10 requires the consent of the holders of a majority of the Common Shares issuable upon conversion of the then outstanding Series B Preferred Stock; provided that the holders of a majority of the Common Shares issuable upon conversion of the then outstanding Series B Preferred Stock held by the Eligible Holders also consent to such alteration or amendment. 11. Record Holders. The Company and the Transfer Agent may deem and treat the record holder of any shares of Series B Preferred Stock as the true and lawful owner thereof for all purposes, and neither the Company nor the Transfer Agent shall be affected by any notice to the contrary. 12. Notices. Except as may otherwise be provided for herein, all notices referred to herein shall be in writing, and all notices hereunder shall be deemed to have been given upon receipt, in the case of a notice of conversion given to the Company as contemplated in Section 7(b) hereof, or, in all other cases, upon the earlier of receipt of such notice or three Business Days after the mailing of such notice if sent by registered mail (unless first-class mail shall be specifically permitted for such notice under the terms of this Certificate of Designations) with postage prepaid, addressed: if to the Company, to its offices at 4200 Research Forest Drive, The Woodlands, Texas 77381 (Attention: Investor Relations Department) or to an agent of the Company designated as permitted by this Certificate of Designations, or, if to any holder of the Series B Preferred Stock, to such holder at the address of such holder of the Series B Preferred Stock as listed in the stock record books of the Company (which may include the records of any transfer agent for the Series B Preferred Stock); or to such other address as the Company or holder, as the case may be, shall have designated by notice similarly given. 13. Rights Plan. The Company's ability to adopt a rights plan as authorized by Article Fifth of the Company's Amended and Restated Certificate of Incorporation shall not be limited or restricted in any respect by the provisions of this Certificate, except as provided in Sections 3(e) and 7(d)(iv) herein. -29- IN WITNESS WHEREOF, this Certificate has been signed by John H. Webb, and attested to by Paul G. Brown, III, of the Company, all as of the 20th day of February, l997. ENERGY BIOSYSTEMS CORPORATION By: /s/ John H. Webb --------------------------------------- John H. Webb President and Chief Executive Officer Attest: By: /s/ Paul G. Brown, III ---------------------------------- Paul G. Brown, III Secretary -30- EX-4.2 3 FORM OF STOCK PURCHASE AGREEMENT Exhibit 4.2 SERIES B CONVERTIBLE PREFERRED STOCK PURCHASE AGREEMENT BETWEEN ENERGY BIOSYSTEMS CORPORATION AND THE PURCHASER LISTED ON SCHEDULE I DATED AS OF FEBRUARY 21, 1997 STOCK PURCHASE AGREEMENT STOCK PURCHASE AGREEMENT dated as of February 21, 1997 by and between Energy BioSystems Corporation, a Delaware corporation (the "Company"), and the Purchaser listed on Schedule I of this Agreement (the "Purchaser"). W I T N E S S E T H : - - - - - - - - - - WHEREAS, the Company desires to sell to the Purchaser and the Purchaser desires to purchase from the Company shares of the authorized but unissued Series B Convertible Preferred Stock, par value $0.01 per share, of the Company (the "Series B Preferred Stock"), upon the terms and provisions hereinafter set forth. WHEREAS, concurrently with this offering, the Company has made an exchange offer whereby holders of Series A Preferred Stock will exchange shares of Series A Preferred Stock for shares of the authorized but unissued Series B Preferred Stock, par value $0.01 per share, of the Company (the "Exchange Offer") to exchanging parties who will be executing Stock Exchange Agreements substantially similar to this Agreement, containing similar representations and warranties by the Company, covenants of the Company, registration rights, conditions and other terms. NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: SECTION 1. SALE AND PURCHASE OF THE PREFERRED SHARES (a) The Company agrees to sell to the Purchaser and, subject to the terms and conditions hereof and in reliance upon the representations and warranties of the Company contained herein or made pursuant hereto, the Purchaser agrees to purchase from the Company on the Closing Date specified in Section 2 hereof, the number of shares of Series B Preferred Stock set forth opposite the Purchaser's name on Schedule I hereto. The shares of Series B Preferred Stock being acquired under this Agreement and by the other Purchasers under the other Stock Purchase Agreements (as hereinafter defined) are collectively herein referred to as the "Shares", containing rights and privileges as more fully set forth in the Certificate of Designations for the Series B Preferred Stock of the Board of Directors of the Company which shall be substantially in the form attached hereto as Exhibit A (the "Series B Certificate of Designations"). (b) The aggregate purchase price to be paid to the Company by the Purchaser for the Shares to be purchased by the Purchaser pursuant to this Agreement shall be the amount set forth opposite the Purchaser's name on Schedule I hereto. No further payment shall be required from the Purchaser for the Shares. (c) The Shares are being sold to the Purchaser listed on Schedule I hereto and to other Purchasers under substantially identical agreements (collectively, the "Purchasers") pursuant to this Agreement and other substantially identical agreements dated as of the date hereof (all such agreements collectively, as from time to time assigned, supplemented or amended or as the terms thereof may be waived, the "Stock Purchase Agreements"). All Stock Purchase Agreements shall be dated the date hereof and shall be identical except as to the identities of the respective Purchasers. The sale of Shares to each Purchaser under each Stock Purchase Agreement is to be a separate sale, and no Purchaser shall have any liability under any Stock Purchase Agreement other than the Stock Purchase Agreement to which it is a party. (d) The Company will use the proceeds from the sale of the Shares as described in the section of the Memorandum entitled "Use of Proceeds." (e) If an aggregate of fewer than 280,000 Shares are sold at the Closing under the Stock Purchase Agreements, the Company shall have the right, from time to time thereafter, but not later than March 31, 1997, to sell additional Shares up to an overall aggregate of 400,000 Shares pursuant to Stock Purchase Agreements substantially identical to this Stock Purchase Agreement. Upon completion of any such sale, such additional Shares shall be "Shares" hereunder, the purchasers of such additional Shares shall be "Purchasers" hereunder and such additional Stock Purchase Agreements shall be "Stock Purchase Agreements" hereunder. SECTION 2. THE CLOSING (a) Subject to the terms and conditions hereof, the closing of the purchase and sale of the Shares to be purchased by the Purchaser (the "Closing") will take place at the offices of Andrews & Kurth L.L.P., 4200 Texas Commerce Tower, Houston, Texas at 10:00 A.M., Houston, Texas time, on February 26, 1997, or such other location, time and date as shall be determined by the Company and the Agent. Such time and date are herein referred to as the "Closing Date." (b) Subject to the terms and conditions hereof, on the Closing Date (i) the Company will deliver to the Purchaser a certificate registered in the Purchaser's name (or the name of its nominee, if any, as specified on Schedule I hereto) evidencing the number of Shares equal to that number of Shares set forth opposite the Purchaser's name on Schedule I, and (ii) upon the Purchaser's receipt thereof, the escrow agent (the "Escrow Agent") for the Purchaser's funds -2- previously deposited in an escrow account will release from such escrow account and deliver to the Company a certified or official bank check (or wire transfer) in an amount equal to the purchase price (as specified in Section l(b) hereof) for the Shares to be purchased by the Purchaser payable to the order of the Company in next day funds. SECTION 3. DEFINITIONS (a) For purposes of this Agreement, the following definitions shall apply (such definitions to be equally applicable to both the singular and plural forms of the terms defined): "Affiliate", when used with respect to any Person, means (i) if such Person is a corporation, any executive officer or director thereof (other than a director nominated pursuant to the Series B Certificate of Designations) and any Person which is, directly or indirectly, the beneficial owner (by itself or as part of any group) of more than five percent (5%) of any class of any equity security (within the meaning of the Securities Exchange Act) thereof, and, if such beneficial owner is a partnership, any general partner thereof, or if such beneficial owner is a corporation, any Person controlling, controlled by or under common control with such beneficial owner, or any executive officer or director of such beneficial owner or of any corporation occupying any such control relationship, (ii) if such Person is a partnership, any general partner thereof, and (iii) any other Person which, directly or indirectly, controls or is controlled by or is under common control with such Person. For purposes of this definition, "control" (including the correlative terms "controlling", "controlled by" and "under common control with"), with respect to any Person, shall mean possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise. Except as provided above, the holding of Shares (or Conversion Shares obtained upon conversion of Shares), and the rights under any Stock Purchase Agreement or under the Series B Certificate of Designations (or the exercise of any such rights, including, without limitation, nominating a director to the Board of the Company or sending an observer to Board meetings of the Company or any of the Subsidiaries), shall not, by themselves, cause a Purchaser to be deemed to be an "Affiliate" of the Company or of any Subsidiary. "Agreement" means this Stock Purchase Agreement (together with exhibits and schedules) as from time to time assigned, supplemented or amended or as the terms hereof may be waived. "Board" or "Board of Directors" means with respect to any Person which is a corporation, a business trust or other entity, the board of directors or other group, however -3- designated, which is charged with legal responsibility for the management of such Person, or any committee of such board of directors or group, however designated, which is authorized to exercise the power of such board or group in respect of the matter in question. "Business Day" means any day other than a Saturday, Sunday or a day on which banking institutions in the State of New York or the State of Texas are authorized or obligated by law or executive order to close. "Capitalized Leases" means any lease to which the Company or a Subsidiary is a party as lessee, or by which it is bound, under which it leases any property (real, personal or mixed) from any lessor other than the Company or a Subsidiary, and which is required to be capitalized in accordance with generally accepted accounting principles consistently applied. "Closing" has the meaning set forth in Section 2(a) hereof. "Closing Date" has the meaning set forth in Section 2(a) hereof. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and the regulations and interpretations thereunder. "Commission" means the Securities and Exchange Commission and any other similar or successor agency of the federal government administering the Securities Act or the Securities Exchange Act. "Common Stock" of the Company or of a Subsidiary (as the case may be) shall mean the Company's or a Subsidiary's (as the case may be) present authorized common stock and any stock into which such Common Stock may hereafter be changed or for which such Common Stock may be exchanged after giving effect to the terms of such change or exchange (by way of reorganization, recapitalization, merger, consolidation or otherwise) and shall also include any common stock of the Company or of a Subsidiary (as the case may be) hereafter authorized and any capital stock of the Company or of a Subsidiary (as the case may be) of any other class hereafter authorized which is not preferred as to dividends or assets over any other class of capital stock of the Company or of a Subsidiary (as the case may be) or which has ordinary voting power for the election of directors of the Company or of a Subsidiary (as the case may be); provided that preferred stock of the Company or a Subsidiary with the right to vote together with the common stock of such entity on various matters shall not be treated as "Common Stock" hereunder. -4- "Company" means Energy BioSystems Corporation, a Delaware corporation, its successors and assigns. "Consent and Exchange Agreement" is the agreement by which holders of Series A Preferred Stock elect to exchange shares of Series A Preferred Stock for shares of Series B Preferred Stock on a one-for-one basis. "Conversion Price" has the meaning specified in Section 2 of the Series B Certificate of Designations. "Conversion Share" or "Conversion Shares" means the shares of the Company's Common Stock, par value $0.01 per share, obtained or obtainable upon conversion of the Shares and shall also include any capital stock or other securities into which Conversion Shares are changed and any capital stock or other securities resulting from or comprising a reclassification, combination or subdivision of, or a stock dividend on, any Conversion Shares. In the event that any Conversion Shares are sold either in a public offering pursuant to a registration statement under Section 6 of the Securities Act or pursuant to a Rule 144 Transaction, then the transferees of such Conversion Shares shall not be entitled to any benefits under this Agreement with respect to such Conversion Shares and such Conversion Shares shall no longer be considered to be "Conversion Shares" for purposes of Section 8 hereof, for purposes of the definition of Majority Shareholders or for purposes of any consent or waiver provision or any other provision of this Agreement. "Eligible Holder" means any holder (or group of affiliated holders) which is a Purchaser (or transferee of a Purchaser approved by the Company, such approval not to be unreasonably withheld) or a purchaser of Series A Preferred Stock that has elected to exchange its shares of Series A Preferred Stock for Shares (or a transferee of such exchanging party approved by the Company, such approval not to be unreasonably withheld) and which holds 100,000 or more Shares, or Conversion Shares issued on conversion of 100,000 or more Shares, or an equivalent combination of the foregoing. "Environmental Lien" has the meaning set forth in Section 7.7 hereof. "ERISA" means, collectively, the Employee Retirement Income Security Act of 1974, as amended, and the regulations and interpretations thereunder. "Exchange Agreement" means the Series B Convertible Preferred Stock Exchange Agreement, dated the date hereof, by which holders of Series A Preferred Stock agree to exchange shares of Series A Preferred Stock for shares of Series B Preferred Stock on a one- -5- for-one basis consistent with their election reflected in the Consent and Exchange Agreement. The Exchange Agreement is substantially similar to this Agreement, containing similar representations and warranties by the Company, covenants of the Company, registration rights, conditions and other terms. "Guaranty" means (i) any guaranty or endorsement of the payment or performance of, or any contingent obligation in respect of, any indebtedness or other obligation of any other Person, (ii) any other arrangement whereby credit is extended to one obligor (directly or indirectly) on the basis of any promise or undertaking of another Person (a) to pay the indebtedness of such obligor, (b) to purchase an obligation owed by such obligor, (c) to purchase or lease assets (or to provide funds, goods or services) under circumstances that would enable such obligor to discharge one or more of its obligations or (d) to maintain the capital, working capital, solvency or general financial condition of such obligor, in each case whether or not such arrangement is disclosed in the balance sheet of such other Person or is referred to in a footnote thereto and (iii) any liability as a general partner of a partnership in respect of indebtedness or other obligations of such partnership; provided, however, that the term "Guaranty" shall not include (1) endorsements for collection or deposit in the ordinary course of business or (2) obligations of the Company or its Subsidiaries which would constitute Guaranties solely by virtue of the continuing liability of a Person which has sold assets subject to liabilities for the liabilities which were assumed by the Person acquiring the assets, unless such liability is required to be carried on the consolidated balance sheet of the Company. The amount of any Guaranty and the amount of indebtedness resulting from such Guaranty shall be the maximum amount of the guarantor's potential obligation in respect of such Guaranty. "Hazardous Materials" means any pollutant, toxic substance, petroleum or petroleum by-products, hazardous waste, or any material, compound, element or chemical identified as a pollutant, toxic substance or hazardous waste or determined to be hazardous or toxic by a governmental agency under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA), 42 U.S.C. 9601 et seq., the Resource Conservation and Recovery Act (RCRA), 42 U.S.C. 6901 et seq., the Toxic Substances Control Act (TSCA), 15 U.S.C. 2601 et seq., the Water Pollution Control Act (CWA), 33 U.S.C. 1251 et seq., the Clean Air Act (CAA), 42 U.S.C. 7501 et seq., the Occupational Safety and Health Act (OSHA), 29 U.S.C. 655 and any other federal, state, local or municipal laws, statutes, ordinances, codes, rules or regulations imposing liability or establishing standards of conduct for environmental protection. The term "Hazardous Materials" shall also include: raw materials used or stored by the Company that contain Hazardous Materials; building components (including but not limited to asbestos- containing materials) that contain Hazardous Materials and manufactured products containing Hazardous Materials. -6- "Indebtedness" of any Person means, without duplication, as of any date as of which the amount thereof is to be determined, (i) all obligations of such Person to repay money borrowed (including, without limitation, all notes payable and drafts accepted representing extensions of credit, all obligations under letters of credit, all obligations evidenced by bonds, debentures, notes or other similar instruments and all obligations upon which interest charges are customarily paid), (ii) all Capitalized Leases in respect of which such Person is liable as lessee or as the guarantor of the lessee, (iii) all monetary obligations which are secured by any Lien existing on property owned by such Person whether or not the obligations secured thereby have been incurred or assumed by such Person, (iv) all conditional sales contracts and similar title retention debt instruments under which such Person is obligated to make payments, (v) all Guaranties by such Person and (vi) all contractual obligations (whether absolute or contingent) of such Person to repurchase goods sold or distributed. "Indebtedness" shall not include, however, Indebtedness of the Company to any of its wholly-owned Subsidiaries or Indebtedness of any wholly-owned Subsidiary to the Company or to another wholly-owned Subsidiary. "Lien" means any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), or preference, priority or other security interest of any kind or nature whatsoever (including, without limitation, any conditional sale or other title retention agreement, any financing lease having substantially the same effect as any of the foregoing, any assignment or other conveyance of any right to receive income and any assignment of receivables with recourse against the assignor), any filing of a financing statement as debtor under the Uniform Commercial Code or any similar statute and any agreement to give or make any of the foregoing. "Majority Shareholders" means the holder or holders, at the time, of at least a majority of the Conversion Shares, including the Conversion Shares then outstanding and the Conversion Shares then obtainable under outstanding Shares; provided that such majority must in any event include each Eligible Holder. "Material Adverse Effect" means any material and adverse effect on the assets, properties, liabilities, business affairs, results of operations, condition (financial or otherwise) or prospects of the Company. "Memorandum" means that certain Confidential Offering Memorandum dated February 14, 1997 relating to the Shares. "Outstanding" or "outstanding" means (a) when used with reference to the Shares or the Conversion Shares as of a particular time, all Shares or Conversion Shares theretofore -7- duly issued except (i) Shares and Conversion Shares theretofore reported as lost, stolen, mutilated or destroyed or surrendered for transfer, exchange or replacement, in respect of which new or replacement Shares or Conversion Shares have been issued by the Company, (ii) Shares and Conversion Shares theretofore canceled by the Company and (iii) Shares and Conversion Shares registered in the name of, as well as Shares and Conversion Shares owned beneficially by, the Company, any Subsidiary or any of their Affiliates and (b) when used with reference to the number of shares of Common Stock of the Company as of a particular time, the then issued and outstanding shares of Common Stock of the Company (not including treasury shares or any other shares registered in the name of the Company, any Subsidiary or any of their Affiliates), together with shares of Common Stock of the Company issuable pursuant to any then outstanding warrants, options, convertible securities or other rights to acquire shares of Common Stock of the Company. For purposes of the preceding sentence, in no event shall "Affiliates" include (x) the persons which are identified as "Purchasers" on Schedule I hereto or (y) any Affiliates of any such persons, except if such persons would otherwise fall within the definition of "Affiliate" described above. "Person" or "person" means an individual, corporation, partnership, firm, association, joint venture, trust, unincorporated organization, government, governmental body, agency, political subdivision or other entity. "Preferred Stock" means any class of the capital stock of a corporation (whether or not convertible into any other class of such capital stock) which has any right, whether absolute or contingent, to receive dividends or other distributions of the assets of such corporation (including, without limitation, amounts payable in the event of the voluntary or involuntary liquidation, dissolution or winding-up of such corporation), which right is superior to the rights of another class of the capital stock of such corporation. "Preferred Stock" includes without limitation the Series B Preferred Stock. "Purchaser" means the person who accepts and agrees to the terms hereof as indicated by such person's signature (as "the undersigned Purchaser") on the execution page of this Agreement, together with such person's successors and assigns. "Purchasers" has the meaning set forth in Section l(c) hereof, together with their respective successors and assigns. "Registered Securities" means the Conversion Shares, any Common Stock issued in payment of dividends on, or in connection with the redemption or repurchase of, the Shares and any Shares included herein pursuant to Section 8.1(g) hereof. -8- "Restricted Payment" means (i) every dividend or other distribution paid, made or declared by the Company or any Subsidiary on or in respect of any class of its capital stock (as defined below), and (ii) every payment in connection with the redemption, purchase, retirement or other acquisition by or on behalf of the Company or any Subsidiary of any shares of the Company's or a Subsidiary's capital stock (as defined below), whether or not owned by the Company or any Subsidiary; provided, however, that the restrictions of the foregoing clauses (i) and (ii) shall not apply to (a) any dividend, distribution or other payment on or in respect of capital stock of the Company to the extent payable in shares of Common Stock of the Company, (b) any payments from the Company to a wholly-owned Subsidiary, from a Subsidiary to the Company or from a Subsidiary to a wholly-owned Subsidiary, (c) any repurchase of Common Stock under stock purchase or option agreements from employees, advisors, consultants or directors of the Company or otherwise upon termination of such relationship with the Company (provided, that the aggregate amount paid pursuant to such repurchases after the Closing Date shall not exceed $300,000 without the consent of the Majority Shareholders), (d) any payments, dividends, distributions or other transfers or actions (I) on or with respect to the Company's Series A Preferred Stock or the shares of Common Stock issuable upon conversion thereof pursuant to the terms of the Stock Purchase Agreements or the Certificate of Designations relating to the Series A Preferred Stock or (II) on or with respect to the Shares or the Conversion Shares pursuant to terms of the Stock Purchase Agreements, Stock Exchange Agreements or the Series B Certificate of Designations and (e) any payments or distributions in respect of the liquidation and dissolution, or winding up of the business and affairs, of the Company. For purposes of this definition, "capital stock" shall also include warrants and other rights and options to acquire shares of capital stock (whether upon exercise, conversion, exchange or otherwise). "Rights Expiration Date" means, with respect to any Eligible Holder, the earlier of (a) the date on which such Eligible Holder owns neither (i) 100,000 or more Shares nor (ii) Conversion Shares issued on conversion of a number of Shares at least equal to 100,000 less the number of any Shares remaining owned by such Eligible Holder, and (b) the third anniversary of the Closing Date, unless such Eligible Holder then owns 100,000 or more Shares. "Rule 144" means (i) Rule 144 under the Securities Act as such Rule is in effect from time to time and (ii) any successor rule, regulation or law, as in effect from time to time. "Rule 144A" means (i) Rule 144A under the Securities Act as such Rule is in effect from time to time and (ii) any successor rule, regulation or law, as in effect from time to time. -9- "Rule 144 Transaction" means a transfer of Shares or Conversion Shares (A) complying with Rule 144 as such Rule is in effect on the date of such transfer (but not including a sale other than pursuant to (i) "brokers' transactions" as defined in clauses (1) and (2) of paragraph (g) or (ii) paragraph (k) of such Rule as in effect on the date hereof) and (B) occurring at a time when Shares (in the case of a transfer of Shares) or Conversion Shares (in the case of a transfer of Conversion Shares) are registered pursuant to Section 12 of the Securities Exchange Act. "Securities Act" means the Securities Act of 1933, as amended, and the rules, regulations and interpretations thereunder. "Securities Exchange Act" means the Securities Exchange Act of 1934, as amended, and the rules, regulations and interpretations thereunder. "Series A Certificate of Designations" has the meaning set forth in Section 4.2(d) hereof. "Series A Preferred Stock" has the meaning set forth in Section 4.2(a) hereof. "Series B Certificate of Designations" has the meaning set forth in Section l(a) hereof. "Series B Preferred Stock" means the Company's Series B Convertible Preferred Stock, par value $0.01 per share, which will be duly authorized on the Closing Date and which will have the rights, powers and privileges on the Closing Date as more fully set forth in the Series B Certificate of Designations. "Shares" has the meaning set forth in Section l(a) hereof, except that for purposes of Section 7 and Section 8 hereof and the definition of "Conversion Shares," the term "Shares" shall include the shares of Series B Preferred Stock issued upon the exercise of the warrant, dated the date hereof, granting Alex. Brown & Sons Incorporated (the "Agent") the right to purchase a specified number of shares of Series B Preferred Stock and the shares of Series B Preferred Stock issued upon the exchange of the Series A Preferred Stock pursuant to the Exchange Agreement. In the event that any Shares are sold either in a public offering pursuant to a registration statement under Section 6 of the Securities Act or pursuant to a Rule 144 Transaction, then the transferees of such Shares shall not be entitled to any benefits under this Agreement with respect to such Shares and such Shares shall no longer be considered to be ''Shares" for purposes of Section 8 hereof or any consent or waiver provision or any other provision of this Agreement. -10- "Stock Purchase Agreements" has the meaning set forth in Section l(c) hereof. "Subsidiary", with respect to any Person, means any corporation, association or other entity of which more than 50% of the total voting power of shares of stock or other equity interests (without regard to the occurrence of any contingency) entitled to vote in the election of directors, managers or trustees thereof is, at the time as of which any determination is being made, owned or controlled, directly or indirectly, by such Person or one or more of its Subsidiaries, or both. The term "Subsidiary" or "Subsidiaries" when used herein without reference to any particular Person, means a Subsidiary or Subsidiaries of the Company. (b) For all purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires: (i) the words "herein", "hereof" and "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular Section or other subdivision; (ii) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles consistently applied (except as otherwise provided herein); (iii) all computations provided for herein, if any, shall be made in accordance with generally accepted accounting principles consistently applied (except as otherwise expressly provided herein); (iv) any uses of the masculine, feminine or neuter gender shall also be deemed to include any other gender, as appropriate; (v) all references herein to actions by the Company or any Subsidiary, such as "create", "sell", "transfer", "dispose of", etc., mean such action whether voluntary or involuntary, by operation of law or otherwise; (vi) the exhibits and schedules to this Agreement shall be deemed a part of this Agreement; (vii) each of the representations of the Company contained in Section 4 hereof is separate and is not limited, qualified or modified by the existence, wording or satisfaction of any other representation of the Company in Section 4 or otherwise; -11- (viii) each of the covenants of the Company contained in Section 7 hereof or otherwise contained in any Stock Purchase Agreement or the Series B Certificate of Designations is separate and is not limited or satisfied by the existence, wording or satisfaction of any other covenant of the Company in Section 7 or otherwise; and (ix) all references herein (in covenants or otherwise) to any action(s) which are to be taken (or which are prohibited from being taken) by any Person, the Company or any Subsidiary shall apply to such Person, the Company or such Subsidiary, as the case may be, whether such action is taken directly or indirectly. SECTION 4. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to the Purchaser as follows as of the date hereof and as of the Closing Date: 4.1. Corporate Existence, Power and Authority. (a) The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company is duly qualified, licensed and authorized to do business and is in good standing in each jurisdiction in which it owns or leases any material property or in which the conduct of its business requires it to so qualify or be so licensed. (b) The Company has no Subsidiaries, and does not control, directly or indirectly, any other entity and does not own of record or beneficially, directly or indirectly, (i) any shares of capital stock or securities convertible into capital stock of any other corporation (except for short-term investments of the Company's cash reserves and publicly-traded mutual funds) or (ii) any participating interest in any partnership, joint venture or other non- corporate business enterprise, except for the strategic alliances described in the Memorandum. (c) No proceeding has been commenced looking toward the dissolution or merger of the Company or the amendment of its certificate of incorporation (other than the Series B Certificate of Designations). The Company is not in violation in any respect of its certificate of incorporation or bylaws. (d) The Company has all requisite power, authority (corporate and other) and legal right to own or to hold under lease and to operate the properties it owns or holds and to conduct -12- its business as now being conducted and as proposed to be conducted, except where the failure to have such requisite power, authority and legal right would not result in a Material Adverse Effect. (e) The Company has all requisite power, authority (corporate and other) and legal right to execute, deliver, enter into, consummate and perform the Stock Purchase Agreements, including, without limitation, the issuance, sale and delivery by the Company of the Shares and to issue and deliver the Conversion Shares issuable upon conversion of the Shares as contemplated herein and therein and in the Series B Certificate of Designations. The execution, delivery and performance of the Stock Purchase Agreements by the Company (including, without limitation, the issuance, sale and delivery by the Company of the Shares and the issuance and delivery of the Conversion Shares upon conversion of the Shares as contemplated herein and therein and in the Series B Certificate of Designations) have been duly authorized by all required corporate and other actions. As described in the Memorandum, the Company may not have the ability to pay dividends on the Shares under certain circumstances. The Company has duly executed and delivered the Stock Purchase Agreements. The Stock Purchase Agreements constitute the legal, valid and binding obligations of the Company enforceable in accordance with their respective terms, subject to bankruptcy, insolvency, reorganization, moratorium and other similar laws relating to the rights of creditors generally and except that the enforceability of the indemnification provisions contained in the Stock Purchase Agreements may be subject to considerations of public policy. 4.2. Stock. (a) The authorized capital stock of the Company consists of (i) 30,000,000 shares of Common Stock, par value $0.01 per share, and (ii) 5,000,000 shares of Preferred Stock, par value $0.01 per share, issuable in one or more series, of which, after giving effect to the Series B Certificate of Designations, (w) 508,800 shares have been designated as Series A Convertible Preferred Stock ("Series A Preferred Stock"), (x) 904,000 shares have been designated as Series B Preferred Stock, (y) 300,000 shares have been designated as Series One Junior Participating Preferred Stock and (z) 3,287,200 shares are Undesignated Preferred Stock. On the Closing Date and before giving effect to the exchange of any shares of Series A Preferred Stock into shares of Series B Preferred Stock: (A) 11,505,395 shares of the Company's Common Stock, par value $0.01 per share, will be issued and outstanding (plus any shares of Common Stock issued after February 13, 1997 pursuant to stock options in effect on such date), (B) 480,000 shares of Series A Preferred Stock will be issued and outstanding and (C) up to 280,000 Shares of the Series B Preferred Stock will be outstanding. The number of shares of Series A Preferred Stock will be reduced and the number of shares of Series B Preferred Stock will be increased on a one- for-one basis to the extent that shares of Series A Preferred Stock are exchanged for shares of Series B Preferred Stock in the Exchange Offer. All of such outstanding shares will be duly authorized, validly issued and outstanding, fully paid and non-assessable with no personal liability attaching to the ownership -13- thereof. The Shares issued and delivered pursuant to this Stock Purchase Agreement will be free and clear of all liens, charges, restrictions, claims and encumbrances imposed by or through the Company. The Conversion Shares have been reserved for issuance upon conversion of the Shares and, when issued in accordance with the terms of the Shares, will be duly authorized, validly issued, fully paid and non-assessable. None of the shares of the Company's capital stock outstanding at Closing (including, without limitation, the Shares issued under the Stock Purchase Agreements) (i) are subject to preemptive rights or (ii) provide the holders thereof with any preemptive rights with respect to any issuances of capital stock. Neither the issuance, sale or delivery of the Shares nor the issuance or delivery of the Conversion Shares is subject to any preemptive right of stockholders of the Company or to any right of first refusal or other right in favor of any person. (b) The only shares of the Company's Common Stock reserved for issuance by the Company are as follows (before giving effect to the exchange of any shares of Series A Preferred Stock into shares of Series B Preferred Stock): (i) 3,083,636 shares issuable upon conversion of the Series A Preferred Stock (including the Series A Preferred Stock issuable upon the exercise of warrants issued to the placement agents in connection with the offering of the Series A Preferred Stock), (ii) 2,105,862 shares issuable upon conversion of the Series B Preferred Stock (including the Series B Preferred Stock issuable upon the exercise of warrants issued to the Agent in connection with the offering of the Series B Preferred Stock), (iii) 2,030,964 shares issuable upon exercise of currently outstanding stock options pursuant to the Company's 1992 Stock Compensation Plan, its Non-Employee Director Stock Option Plan and director and consultant stock option agreements and (iv) 263,020 shares reserved for issuance pursuant to the 1992 Stock Compensation Plan, the Non-Employee Director Stock Option Plan and the Company's 1997 Stock Option Plan with respect to which no options are presently outstanding. (c) Except as referred to in Section 4.2(b) or in the Company's Amended and Restated Certificate of Incorporation, there are no outstanding options, warrants, subscriptions, rights, convertible securities or other agreements or plans under which the Company may become obligated to issue, sell or transfer shares of its capital stock or other securities. (d) The designations, powers, preferences, rights, qualifications, limitations and restrictions in respect of each class and series of authorized capital stock of the Company are as set forth in the Amended and Restated Certificate of Incorporation of the Company and the Certificate of Designations with respect to the Series A Preferred Stock (the "Series A Certificate of Designations"), a copy of each of which is attached hereto as Exhibit B and Exhibit C, respectively, and the Series B Certificate of Designations. -14- (e) Except as contemplated by Section 8 hereof or as summarized on Schedule II hereto, there are no outstanding registration rights with respect to any capital stock of the Company. (f) Except as provided in the Series A Certificate of Designations and the Series B Certificate of Designations, the Company has no obligation (contingent or other) to purchase, redeem or otherwise acquire any of its capital stock or any interest therein or to pay any dividend or make any other distribution in respect thereof. (g) The Company has no knowledge of any voting agreements, voting trusts, stockholders' agreements, proxies or other agreements or understandings that are currently in effect or that are currently contemplated with respect to the voting of any capital stock of the Company. (h) There are no anti-dilution protections or other adjustment provisions in existence with respect to any capital stock of the Company or any capital stock referred to in Section 4.2(b) or 4.2(c) above, except with respect to the Shares and except as provided in the Amended and Restated Certificate of Incorporation of the Company, the Series A Certificate of Designations and for standard provisions in option agreements under the Company's plans for employees, directors, consultants and advisors and in the warrants and warrant agreements issued by the Company and described in (b) above. (i) All of the outstanding securities of the Company were issued in compliance with all applicable federal and state securities laws. (j) The Series B Certificate of Designations has been duly adopted by the Company and is fully effective. The Series B Certificate of Designations accurately describes all of the rights, priorities and terms of the Shares. 4.3. Business. The Company is engaged in the business of developing and commercializing innovative biotechnology-based processes for the petroleum refining and production industries. The Company does not currently engage in, or have any intention of engaging in, any other business other than that which is described in the Memorandum. 4.4. No Defaults or Conflicts. (a) The Company is not in violation or default in any material respect under any indenture, agreement or instrument to which it is a party or by which it or its properties may be -15- bound. The Company is not in violation of or default in any material respect under any law, rule, regulation, order, writ, injunction, judgment, decree, award or other action of any court or governmental authority or arbitrator(s). The Company is not in violation of its certificate of incorporation or bylaws. (b) The execution, delivery and performance by the Company of the Stock Purchase Agreements and any of the transactions contemplated hereby or thereby (including, without limitation, the issuance of the Shares and the Conversion Shares as contemplated herein and therein and in the Series B Certificate of Designations and the adoption of the Series B Certificate of Designations) does not and will not (i) violate or conflict with, with or without the giving of notice or the passage of time or both, any provision of (A) the certificate of incorporation or bylaws of the Company or (B) any law, rule, regulation or order of any federal, state, county, municipal or other governmental authority, or any judgment, writ, injunction, decree, award or other action of any court or governmental authority or arbitrator(s), or any agreement, indenture or other instrument applicable to the Company or any of its properties, except in the case of this clause (B) for such violations or conflicts that will not individually or in the aggregate have a Material Adverse Effect, (ii) result in the creation of any Lien upon any of the Company's properties, assets or revenues, (iii) require the consent, waiver, approval, order or authorization of, or declaration, registration, qualification or filing with, any Person (whether or not a governmental authority and including, without limitation, any shareholder approval) except for required securities law filings and board of director approvals, certain approvals of the holders of Series A Preferred Stock and certain registration rights modifications, which board of director and Series A Preferred Stockholder approvals and registration rights modifications have been obtained or (iv) cause anti-dilution clauses of any outstanding securities to become operative except with respect to the Series A Preferred Stock pursuant to the Series A Certificate of Designations or give rise to any preemptive rights. No provision referred to in the preceding clause (i) materially adversely affects or reasonably may be expected to materially adversely affect the continued conduct of the Company's business as described in the Memorandum or the ability of the Company to perform its obligations under the Stock Purchase Agreements, the Series B Certificate of Designations or any of the transactions contemplated hereby or thereby. 4.5. Disclosure Materials: Other Information. (a) The Company has previously furnished to the Purchaser the Confidential Offering Memorandum dated October 21, 1996 of the Company (Alex. Brown & Sons Incorporated as exclusive agent), as updated by the Confidential Offering Memorandum dated January 10, 1997, the Memorandum and the documents incorporated therein (the "Disclosure Material"). The audited and unaudited financial statements referred to or contained in the Disclosure Material fairly present the financial condition of the Company as of the respective dates thereof and the results of the operations of the Company for such periods and have been prepared in accordance with generally -16- accepted accounting principles consistently applied, except that any such unaudited statements may omit notes and may be subject to normal year-end adjustments. (b) Since December 31, 1995, (i) the business of the Company has been conducted in the ordinary course and (ii) there has been no material adverse change in the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company that has not been described in the Disclosure Material. As of the Closing Date and as of the date hereof, there are no material liabilities of the Company which would be required to be provided for in a balance sheet of the Company as of either such date prepared in accordance with generally accepted accounting principles consistently applied, other than liabilities provided for in the financial statements referred to in Section 4.5(a) above. Since December 31, 1995, no amount or property has directly or indirectly been declared, ordered, paid, made or set aside for any Restricted Payment nor has any such action been agreed to. (c) The Company is not aware of any material liabilities, contingent or otherwise, of the Company that have not been disclosed in the financial statements (including the notes thereto) referred to in Section 4.5(a) above or otherwise disclosed in the Disclosure Material. (d) Nothing has come to the attention of the Company that would cause it to believe that any of the Disclosure Material contained or contains a false or misleading statement of a material fact or omits to state any material fact necessary in order to make the statements made in such material, in light of the circumstances under which they were made, not misleading. (e) There is no fact known to the Company which is not in the Disclosure Material and which materially and adversely affects, or would reasonably be expected to materially and adversely affect, the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. 4.6. Litigation. There is no action, suit, proceeding, investigation or claim pending against the Company or, to the knowledge of the Company, threatened against the Company in law, equity or otherwise before any federal, state, municipal or local court, administrative agency, commission, board, bureau, instrumentality or arbitrator which either (i) questions the validity of the Stock Purchase Agreements, the Series B Certificate of Designations, the Shares or the Conversion Shares or any action taken or to be taken pursuant hereto or thereto, or (ii) might adversely affect the right, title or interest of any Purchaser to the Shares or the Conversion Shares or (iii) might result in a material adverse change in the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. The Company has not received any -17- opinion or memorandum or legal advice from legal counsel to the effect that it is exposed, from a legal standpoint, to any liability or disadvantage which may be material to its assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects. There is no action or suit by the Company pending or threatened against others. 4.7. Taxes. The Company has filed all federal, state, local and other tax returns and reports (except for foreign returns and reports the failure to file which will not result in any material liability to the Company), and any other material returns and reports with any governmental authorities (federal, state or local), required to be filed by it. The Company has paid or caused to be paid all taxes (including interest and penalties) that are due and payable, except those which are being contested by it in good faith by appropriate proceedings and in respect of which adequate reserves are being maintained on its books in accordance with generally accepted accounting principles consistently applied. The Company does not have any material liabilities for taxes other than those incurred in the ordinary course of business and in respect of which adequate reserves are being maintained by it in accordance with generally accepted accounting principles consistently applied. Federal and state income tax returns for the Company have not been audited by the Internal Revenue Service or state authorities. No deficiency assessment with respect to or proposed adjustment of the Company's federal, state, local or other tax returns is pending or, to the best of the Company's knowledge, threatened. There is no tax lien, whether imposed by any federal, state, local or other tax authority outstanding against the assets, properties or business of the Company. There are no applicable taxes, fees or other governmental charges payable by the Company in connection with the execution and delivery of the Stock Purchase Agreements or the issuance by the Company of the Shares or the Conversion Shares, except for governmental fees paid in connection with securities law filings. 4.8. Employees; ERISA. The Company has good relationships with its employees and has not had and does not expect to have any substantial labor problems. The Company does not have any knowledge as to any intentions of any key employee or any group of employees to leave the employ of the Company. Each of the officers of the Company, each key employee and each other employee now employed by the Company who has access to proprietary business information of the Company has executed a confidentiality and non-disclosure agreement and such agreements are in full force and effect. Other than the Company's Simplified Employee Pension Plan adopted in April 1992, the Company has not established, sponsored, maintained, made any contributions to or been obligated by law to establish, maintain, sponsor or make any contributions to any "employee pension benefit plan" or "employee welfare benefit plan" (as such terms are defined in ERISA), including, without -18- limitation, any "multi-employer plan". The Company has complied in all material respects with all applicable laws relating to the employment of labor, including provisions relating to wages, hours, equal opportunity, collective bargaining and the payment of Social Security and other taxes, and with ERISA. 4.9. Legal Compliance. (a) The Company has complied with all applicable laws, rules, regulations, orders, licenses, judgments, writs, injunctions, decrees or demands, except to the extent that failure to comply would not materially adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. The Company has all necessary permits, licenses and other authorizations required to conduct its business as currently conducted, and as proposed to be conducted, in all material respects. (b) There are no adverse orders, judgments, writs, injunctions, decrees or demands of any court or administrative body, domestic or foreign, or of any other governmental agency or instrumentality, domestic or foreign, outstanding against the Company. (c) There is no existing law, rule, regulation or order, and the Company is not aware of any proposed law, rule, regulation or order, which would prohibit or materially restrict the Company from, or otherwise materially adversely affect the Company in, conducting its business as now being conducted and as proposed to be conducted. 4.10. Permits, Licenses and Approvals. The Company owns or possesses and holds free from restrictions or conflicts with the rights of others all franchises, licenses, permits, consents, approvals and other authority (governmental or otherwise), and all rights and privileges with respect to the foregoing, as are necessary for the conduct of its business as now being conducted, and as proposed to be conducted, except where the failure to own or possess and hold such franchises, licenses, permits, consents, approvals and other authority (governmental or otherwise) would not have a Material Adverse Effect, and none is in default in any material respects under any of such franchises, licenses, permits, consents, approvals or other authority. 4.11. Patents, Trademarks and Other Rights. The Company has sufficient trademarks, trade names, service marks, patent rights, copyrights, manufacturing processes, formulae, applications, trade secrets, know how, licenses, approvals and governmental authorizations (or rights thereto) (collectively, the "Intellectual -19- Property") to conduct its business as now conducted and the Company believes that it will be able to obtain such Intellectual Property as will be necessary to conduct its business as proposed to be conducted except in either case where the absence of such Intellectual Property would not have a Material Adverse Effect. No claim is pending or, to the Company's knowledge, threatened to the effect that any such Intellectual Property owned or licensed by the Company, or which the Company otherwise has the right to use, is invalid or unenforceable by the Company, and, to the best of the Company's knowledge, there is no basis for any such claim (whether or not pending or threatened). To the best of the Company's knowledge, all proprietary technology developed by or belonging to the Company and material to its business which has not been patented has been kept confidential by the Company, its employees and agents. The Company has no knowledge of any infringement by it of any Intellectual Property or other similar rights of others, and there is no claim being made or, to the Company's knowledge, threatened against the Company regarding infringement by the Company on such Intellectual Property of others which could reasonably be expected to have a Material Adverse Effect and, to the Company's knowledge, there is no basis for any such claim (whether or not pending or threatened). 4.12. Status Under Certain Statutes. The Company is not: (i) a "public utility company" or a "holding company", or an "affiliate" or a "subsidiary company" of a "holding company", or an "affiliate" of such a "subsidiary company", as such terms are defined in the Public Utility Holding Company Act of 1935, as amended, (ii) a "public utility" as defined in the Federal Power Act, as amended, or (iii) an "investment company" or an "affiliated person" thereof or an "affiliated person" of any such "affiliated person", as such terms are defined in the Investment Company Act of 1940, as amended . 4.13. Title to Properties; Leasehold Interests. The Company has good and marketable title to each of the properties and assets owned by it. The Company does not own any real property. Certain real property used by the Company in the conduct of its business is held under lease, and the Company is not aware of any pending or threatened claim or action by any lessor of any such property to terminate any such lease. None of the properties owned or leased by the Company is subject to any Liens which could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. Each lease or agreement to which the Company is a party under which it is the lessee of any property, real or personal, is a valid and subsisting agreement without any material default of the Company thereunder and, to the best of the Company's knowledge, without any material default thereunder of any other party thereto. No event has occurred and is continuing which, with due notice or lapse of time or both, would constitute a default or event of default by the Company under any such lease or -20- agreement or, to the best of the Company's knowledge, by any party thereto, except for such defaults that would not individually or in the aggregate have a Material Adverse Effect. The Company's possession of such property has not been disturbed and, to the best of the Company's knowledge, no claim has been asserted against it adverse to its rights in such leasehold interests. 4.14. Environmental Compliance. (a) There is no Hazardous Material about or in, any property, real or personal, in which the Company has any interest, in violation of law in a manner which could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. (b) There is no (and has not been any) off-site disposal or on-site disposal at any locations currently or formerly owned or occupied by the Company as a result of which disposal there would exist a reasonably foreseeable risk that the Company would incur a material liability or obligation under federal, state or local environmental or other laws, regulations or ordinances. (c) Neither the Company nor, to the best of the knowledge of the Company, any prior or present owner, operator, tenant, subtenant or invitee of any of the real property (including improvements) currently or formerly owned or occupied by the Company has (i) used, installed, stored, spilled, released, transported, disposed of or discharged any Hazardous Material upon, into, beneath, from or affecting such real property (including improvements) in violation of law in a manner which could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company, or (ii) received any verbal or written notice, citation, subpoena, summons, complaint or other correspondence or communication from any Person (not previously satisfactorily resolved) with respect to the presence of Hazardous Material upon, into, beneath, or emanating from or affecting any of the real property (including improvements) currently or formerly owned or occupied by the Company which could materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. (d) There has been no intentional or unintentional, gradual or sudden, release, disposal or discharge upon, into or beneath the real property (including improvements) currently or formerly owned or occupied by the Company by the Company or, to the best of the knowledge of the Company, by any prior owner, operator, tenant, subtenant or invitee with respect thereto, that has caused or is causing soil or ground water contamination which under applicable environmental laws, regulations or ordinances could require investigation or remediation or could otherwise create a material liability or obligation on the part of the Company. -21- 4.15. Disaster. Neither the business nor the properties of the Company is currently affected (or has been affected at any time since December 31, 1995) by any fire, explosion, accident, strike, lockout or other dispute, drought, storm, hail, earthquake, embargo, act of God or of the public enemy or other casualty (whether or not covered by insurance), of a kind which (individually or in the aggregate) has materially adversely affected, or could reasonably be expected to materially adversely affect, the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. 4.16. No Burdensome Agreements; Transactions with Affiliates. Except as disclosed in the Disclosure Material, the Company is not a party to, or bound by (nor is any of its properties affected by), any commitment, contract or agreement, any term of which materially adversely affects, or which the Company expects in the future to materially adversely affect, the assets, properties, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. Except as disclosed in the Disclosure Material, the Company is not a party to any contract or agreement with any Affiliate of the Company. The terms of any contracts or agreements between the Company and any of its Affiliates are no less favorable to the Company than those which might have been obtained, at the time such contract or agreement was entered into, from a person who was not such an Affiliate. 4.17. Other Names. The business previously or presently conducted by the Company has not been conducted under any corporate, trade or fictitious name other than "Energy BioSystems Corporation" and "Environmental BioScience Corporation", which was the name of the Company until it was so changed in March 1992. 4.18. Offering of the Shares. Neither the Company nor, to the knowledge of the Company, any person authorized or employed by the Company as agent, broker, dealer or otherwise acting on its behalf, directly or indirectly, (i) offered any of the Shares or any similar security of the Company (A) by any form of general solicitation or general advertising (within the meaning of Regulation D under the Securities Act) or (B) for sale to or solicited offers to buy any thereof from, or otherwise approached or negotiated with respect thereto with, any person which the Company did not reasonably believe was an "accredited investor" within the meaning of Regulation D under the Securities Act or (ii) has done or caused to be done (or has omitted to do or to cause to be done) any act, which act (or which -22- omission) would result in bringing the issuance or sale of the Shares within the provisions of Section 5 of the Securities Act or the filing, notification or reporting provisions of any state securities laws, except for filings, notices or reports pursuant to state securities laws which have already been made or which are contemplated in connection with the offering and sale of the Shares. 4.19. No Foreign Assets Control Regulation Violation. The transactions contemplated by this Agreement will not result in a violation of any of the foreign assets control regulations of the United States Treasury Department, 31 C.F.R., Subtitle B, Chapter V, as amended (including, without limitation, the Foreign Assets Control Regulations, the Transaction Control Regulations, the Cuban Assets Control Regulations, the Foreign Funds Control Regulations, the Iranian Assets Control Regulations, the Nicaraguan Trade Control Regulations, the South African Transactions Regulations, the Libyan Sanctions Regulations, the Soviet Gold Coin Regulations, the Panamanian Transactions Regulations, the Kuwaiti Assets Control Regulations and the Iraqi Sanctions Regulations contained in said Chapter V), or any ruling issued thereunder or any enabling legislation or other Presidential Executive Order granting authority therefor, and the proceeds of the sale of the Shares will not be used by the Company in a manner which would violate any such regulations. 4.20. Indebtedness. Schedule II hereto sets forth (i) the amount of all Indebtedness of the Company outstanding on the Closing Date (excluding Indebtedness in individual amounts of less than $35,000, but not exceeding an aggregate excluded amount of $75,000), (ii) any Lien with respect to such Indebtedness and (iii) a brief description of each instrument or agreement governing such Indebtedness. The Company has made available to the Purchaser a complete and correct copy of each such instrument or agreement (including all amendments, supplements or modifications thereto). No default exists with respect to or under any such Indebtedness or any instrument or agreement relating thereto. 4.21. Proprietary Information of Third Parties. No third party has claimed or, to the best of the Company's knowledge, has reason to claim that any person now or previously employed or engaged as a consultant by the Company has (a) violated or, to the Company's knowledge, may be violating any of the terms or conditions of his employment, non-competition or non-disclosure agreement with such third party, (b) disclosed or, to the best of the Company's knowledge, may be disclosing or utilized or, to the best of the Company's knowledge, may be utilizing any trade secret or proprietary information of documentation of such third party or violated any confidential relationship which such person may -23- have had with such third party in connection with the business of the Company or (c) interfered or may be interfering in the employment relationship between such third party and any of its present or former employees. No third party has requested information from the Company which reasonably suggests that such a claim might be contemplated. To the best of the Company's knowledge, none of the execution or delivery of the Stock Purchase Agreements, or the carrying on the business of the Company as officers, employees or agents by any officer, director or key employee of the Company, or the conduct or proposed conduct of the business of the Company, will conflict with or result in a breach of the terms, conditions or provisions of or constitute a default under any contract, covenant or instrument under which any such individual is obligated. 4.22 Insurance. The Company holds valid policies covering insurance in the amounts and type that the Company reasonably believes is appropriate and customary for companies in the same or similar businesses to that of the Company or otherwise required to be maintained by it. 4.23 Material Contracts and Agreements. With respect to all material contracts, agreements, indentures or instruments not otherwise specifically referred to herein, the Company and, to the best of the Company's knowledge, each other party thereto have in all material respects performed all the obligations required to be performed by them to date, have received no notice of default and are not in default, in any material respect, (with due notice or lapse of time or both) under any material contract, agreement, indenture or other instrument now in effect to which the Company is a party or by which it or its property may be bound. The Company has no present expectation or intention of not fully performing all its obligations under each such material contract, agreement, indenture or other instrument and the Company has no knowledge of any breach and has received no written notice of any anticipated breach by the other party to any material contract or commitment which the Company is a party. 4.24. Governmental Approvals. Subject to the accuracy of the representations and warranties of the Purchaser set forth in Section 5 hereof, no registration or filing with, or consent or approval of or other action by, any federal, state or other governmental agency or instrumentality is or will be necessary for the valid execution, delivery and performance by the Company of this Stock Purchase Agreement, the issuance, sale and delivery of the Shares to the Purchaser or, upon conversion thereof, the issuance and delivery of the Conversion Shares, other than filings pursuant to federal and state securities laws (all of which filings have been or, with respect to those filings which may be duly made after the Closing will be, made by or on behalf of the Company) in connection with the sale of the Shares. -24- 4.25. Brokers. Except with respect to Alex. Brown & Sons Incorporated, which acted as the exclusive agent on behalf of the Company, the Company has no contract, arrangement or understanding with any broker, finder or similar agent with respect to the transactions contemplated by this Agreement. 4.26. Disclosure. The Disclosure Material, as of its date, does not contain an untrue statement of a material fact or omit a material fact necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. All of the statements contained in this Stock Purchase Agreement, including any Schedule or Exhibit hereto, and contained in any document, certificate or other items prepared or supplied by the Company directly to the Purchaser with respect to the transactions contemplated hereby are accurate in all material respects. There is no fact which the Company has not disclosed to the Purchaser in writing and of which the Company is aware which materially and adversely affects or could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. SECTION 5. REPRESENTATIONS OF THE PURCHASER The Purchaser hereby makes the representations and warranties to the Company contained in this Section 5. (a) The Purchaser has all requisite power, authority and legal right to execute, deliver, enter into, consummate and perform this Agreement. The execution, delivery and performance of this Agreement by the Purchaser have been duly authorized by all required corporate, partnership or other actions on the part of the Purchaser. The Purchaser has duly executed and delivered this Agreement, and this Agreement constitutes the legal, valid and binding obligation of the Purchaser enforceable against the Purchaser in accordance with its terms, subject to bankruptcy, insolvency, reorganization, moratorium and other similar laws relating to the rights of creditors generally. (b) The Purchaser hereby represents to the Company that it has substantial knowledge, skill and experience in making investment decisions of this type, it is capable of evaluating the risk of its investment in the Shares being purchased by it and is able to bear the economic risk of such investment, including the risk of losing the entire investment, that (except as the Purchaser has otherwise advised the Company and the Purchaser's counsel in writing) it is -25- purchasing the Shares to be purchased by it for its own account, and that the Shares are being purchased by it for investment and not with a present view to any distribution thereof in violation of applicable securities laws. It is understood that the disposition of the Purchaser's property shall at all times be within the Purchaser's control. If the Purchaser should in the future decide to dispose of any of its Shares, it is understood that it may do so only in compliance with the Securities Act, applicable state securities laws and this Agreement. The Purchaser represents that it is an "accredited investor" as defined in Rule 501(a) under the Securities Act. (c) The Purchaser has received and reviewed the Disclosure Material and it has had an opportunity to fully discuss the Company's business, management and financial affairs with the Company's management. (d) The Purchaser understands that (i) the Shares and the Conversion Shares have not been registered under the Securities Act by reason of their issuance in a transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) or Section 3(b) thereof or Rule 506 promulgated under the Securities Act, (ii) the Shares and, upon conversion thereof, the Conversion Shares must be held indefinitely unless a subsequent disposition thereof is registered under the Securities Act or is exempt from such registration and (iii) the Shares and the Conversion Shares will bear a legend to such effect. (e) The Purchaser represents that at no time was the Purchaser presented with or solicited by or through any leaflet (other than the Memorandum), public promotional meeting, advertisement or any other form of general or public advertising or solicitation. In addition, the Purchaser acknowledges that there has never been any representation, guaranty or warranty made by the Company or any agent or representative of the Company as to the amount of or type of consideration or profit, if any, to be realized as a result of any investment by the Purchaser in the Preferred Stock. (f) If the Purchaser is a resident of the State of Florida, he understands that he has the privilege of voiding the purchase within three (3) days after the first tender of consideration is made by such Purchaser to the Company or an agent of the Company. (g) If the Purchaser is a resident of the Commonwealth of Pennsylvania, he will not sell his Shares within 12 months from the date of purchase unless the Shares are registered under the Pennsylvania Securities Act of 1972 or the Securities Act. SECTION 6. RESTRICTIONS ON TRANSFER -26- (a) The Purchaser agrees that it will not sell or otherwise dispose of any Shares or Conversion Shares unless (i) such Shares or Conversion Shares have been registered under the Securities Act and, to the extent required, under any applicable state securities laws, or (ii) such Shares or Conversion Shares are sold in accordance with the applicable requirements and limitations of Rule 144 or Rule 144A, or (iii) the Company has been furnished with an opinion or opinions from counsel to the Purchaser (which counsel and which opinion(s) shall be reasonably satisfactory to the Company and which counsel may be inside counsel to the Purchaser) to the effect that registration under the Securities Act is not required for the transfer as proposed (which opinion may be conditioned upon the transferee assuming the obligations of a holder of Shares or Conversion Shares under this Section) or (iv) the Company has been furnished with a letter from the Division of Corporate Finance of the Commission to the effect that such Division would not recommend any action to the Commission if such proposed transfer were effected without a registration statement effective under the Securities Act. The Company agrees that within five (5) Business Days after receipt of any opinion referred to in (iii) above, it will notify the holder supplying such opinion whether such opinion is satisfactory to the Company. (b) The Company may endorse on all certificates evidencing Shares or Conversion Shares a legend stating or referring to the transfer restrictions contained in paragraph (a) above; provided, that no such legend shall be endorsed on any certificates which, when issued, are no longer subject to the restrictions of this Section 6; provided, further, that if a transfer is made pursuant to clause (i), (ii) (other than pursuant to Rule 144A) or (iv) of paragraph (a) of this Section 6, or if an opinion of counsel provided pursuant to clause (iii) of paragraph (a) concludes that the legend is no longer necessary, the Company will deliver upon transfer, certificates without such legends. SECTION 7. COVENANTS OF THE COMPANY The Company covenants and agrees, so long as (i) any Shares are outstanding or (ii) there are any Eligible Holders, whichever is longer (unless such other period is expressly provided in any subsections of this Section 7, in which case such specific period will govern) as follows: 7.1. Use of Proceeds. The Company will use the proceeds from the sale of the Shares for purposes described in the section of the Memorandum entitled "Use of Proceeds." No portion of such proceeds will be used for the purpose, whether immediate, incidental or ultimate, of purchasing or carrying, within the meaning of Regulation U of the Board of Governors of the Federal Reserve System, as amended from time to time, any "margin stock" as defined in said Regulation U, or any "margin stock" as defined in Regulation G of the Board of Governors of the Federal Reserve System, as amended from -27- time to time, or for the purpose of purchasing, carrying or trading in securities within the meaning of Regulation T of the Board of Governors of the Federal Reserve System, as amended from time to time, or for the purpose of reducing or retiring any indebtedness which both (i) was originally incurred to purchase any such margin stock or other securities and (ii) was directly or indirectly secured by such margin stock or other securities. None of the assets of the Company or any Subsidiary includes any such "margin stock", and neither the Company nor any Subsidiary has any present intention of acquiring any such "margin stock." 7.2. Financial Information. (a) The Company will maintain a system of accounting established and administered in accordance with sound business practices to permit preparation of financial statements in accordance with generally accepted accounting principles consistently applied. The Company will deliver the following to each Eligible Holder during the period through the Rights Expiration Date for such Eligible Holder (and, in the case of paragraph (v) below, each other holder of Shares and/or Conversion Shares): (i) as soon as practicable but not later than ten (10) Business Days after their issuance, and in any event within ninety (90) days after the close of each fiscal year of the Company, (A) a consolidated balance sheet of the Company and its Subsidiaries as of the end of such fiscal year and (B) consolidated statements of operations, stockholders' equity and cash flows of the Company and its Subsidiaries for such fiscal year, in each case setting forth in comparative form the corresponding figures for the preceding fiscal year, all such balance sheets and statements to be in reasonable detail and certified by an independent public accounting firm of recognized national standing selected by the Company, and such statements shall be accompanied by management analyses of any material differences between the results for such fiscal year and the corresponding figures for the preceding fiscal year and between the budgeted figures (as supplied pursuant to paragraph (ii) below) and the results for such year and a narrative discussion of the Company's liquidity and capital resources as of the end of such year materially conforming to the disclosure requirements contained in Item 303 of Regulation S-K under the Securities Act. The Company's Annual Report on Form 10-K filed, or to be filed, with the Commission will satisfy the requirements of this paragraph, except for the requirement of the management analyses regarding the comparison of the Company's results for such fiscal year to the budgeted figures (as supplied pursuant to paragraph (ii) below); (ii) as soon as reasonably practicable, and in any event within thirty (30) days after the close of the preceding fiscal year of the Company, a budget for the current fiscal year (or the upcoming fiscal year, as the case may be) prepared on a quarterly basis regarding the Company's operations and capital expenditures on a consolidated basis, together with an analysis -28- of such budget prepared in reasonable detail by the Vice President of Finance or the President of the Company; and (A) any operating budget of the Company otherwise prepared and submitted to the Board and (B) any revisions or amendments made by the Company (and submitted to its Board) to any budget delivered under this paragraph (ii); (iii) as soon as reasonably practicable, and in any event within forty-five (45) days after the close of each of the first three (3) fiscal quarters of the Company, (A) a consolidated balance sheet of the Company and its Subsidiaries as of the end of such fiscal quarter and (B) consolidated statements of operations and cash flows of the Company and its Subsidiaries for the quarter just ended and for the portion of the fiscal year ended with the end of such quarter, in each case in reasonable detail, certified by the Vice President of Finance or the President of the Company and setting forth in comparative form the corresponding figures for the comparable period one year prior thereto (subject to normal year-end adjustments) and the comparable figures included in the budget for such quarter (as delivered or modified pursuant to paragraph (ii) above), together with management analyses of any material differences between such results and the corresponding figures for such prior period and between such results for such quarter and such budgeted figures. The Company's Quarterly Report on Form 10-Q filed, or to be filed, with the Commission will satisfy the requirements of this paragraph, except for the requirement of the management analyses regarding the comparison of the Company's results for such quarter to the budgeted figures; (iv) as soon as reasonably practicable, copies of summary financial information prepared on a quarterly basis regarding the Company on a consolidated basis as presented to the Board and any other summary financial information otherwise prepared and provided to the Board; (v) as soon as reasonably practicable, copies of (A) all financial statements, proxy material or reports sent by the Company to the Company's or any Subsidiary's stockholders, (B) any public announcements or press releases issued by the Company and (C) all reports or registration statements (excluding registration statements on Form S-8) filed by the Company with the Commission pursuant to the Securities Act or the Securities Exchange Act; (vi) as soon as reasonably practicable and without duplication of any of the above items, all materials furnished, from time to time, to the Board of Directors of the Company (including without limitation all communications and information furnished to the Board of Directors), and copies of minutes of meetings of the Boards of Directors of the Company; (vii) as soon as reasonably practicable and without duplication of any of the above items, any other materials furnished to holders of the Company's capital stock or any -29- material information furnished to holders of the Company's indebtedness, including without limitation any compliance certificates furnished in respect of such indebtedness; and (viii) as soon as reasonably practicable, such other material information as may reasonably be requested by a holder of Shares (unless reasonably objected to by the Company), regarding the assets, properties, liabilities, business, affairs, results of operations, conditions (financial or otherwise) or prospects of the Company or any Subsidiary. All such financial statements shall be prepared in accordance with generally accepted accounting principles consistently applied (except for any change in accounting principles specified in the accompanying certificate and except that any interim financial statements may omit notes and may be subject to normal year-end adjustments). (b) Without limiting the foregoing provisions of this Section 7.2, the Company agrees that, if requested in writing by any Eligible Holder, it will not deliver to such Eligible Holder (until otherwise instructed by such Eligible Holder) (x) any non-public information or non-public materials regarding the Company or any Subsidiary (whether described in this Section 7.2 or otherwise) and (y) any information (whether or not included in clause (x)) which such holder specifies that it does not want to receive. The Company shall comply with any such request with respect to each such Eligible Holder and any subsequent holders of Shares or Conversion Shares acquired directly or indirectly (through one or more transfers) from such Eligible Holder, until instructed otherwise in writing by the then holder of such Shares or Conversion Shares. 7.3. Tax Matters. Unless otherwise required by the Code or applicable state or local law, the Company agrees that it will not report the accrual of a dividend under Section 305 of the Code with respect to any redemption premium with which the Series B Preferred Stock may have been issued, whether on Form 1099 or any other form, to the Internal Revenue Service or any state or local taxing authority. 7.4. Inspection. At the request of an Eligible Holder, and without out of pocket expenses to the Company, the Company will permit such Eligible Holder and any authorized representative of such holder, subject to (if requested by the Company) execution by such Eligible Holder of a reasonable confidentiality agreement, to visit and inspect any of the properties of the Company and its Subsidiaries, and to discuss with their officers the business, results of operations, condition (financial or otherwise) or prospects of the Company or any Subsidiary, at mutually acceptable times. -30- 7.5. Maintenance of Existence; Properties and Franchises; Compliance with Law; Taxes; Insurance. The Company will, and will cause each Subsidiary to: (a) maintain their respective corporate existences, rights and other franchises in full force and effect, except as may be affected by a transaction permitted by Section 7.11; provided, that the Company may terminate the corporate existence of any Subsidiary, or permit the termination or abandonment of rights or other franchises, if in the opinion of the Company it is no longer in the Company's best interests to maintain such existence, rights or other franchises and such termination or abandonment will not be prejudicial in any material respect to the holders of the Shares; (b) maintain their respective tangible assets in good repair, working order and condition so far as necessary or advantageous to the proper carrying on of their respective businesses; (c) comply with all applicable laws and with all applicable orders, rules, rulings, certificates, licenses, regulations, demands, judgments, writs, injunctions and decrees, provided, that such compliance shall not be necessary so long as (i) the applicability or validity of any such law, order, rule, ruling, certificate, license, regulation, demand, judgment, writ, injunction or decree shall be contested in good faith by appropriate proceedings and (ii) failure to comply will not have a Material Adverse Effect on a consolidated basis; (d) pay promptly when due all taxes, fees, assessments and other government charges imposed upon their respective properties, assets or income and all claims or indebtedness (including, without limitation, materialmen's, vendor's, workmen's and like claims) which might become a lien upon such properties or assets; provided, that payment of any such tax, fee, assessment, charge, claim or indebtedness shall not be necessary so long as (i) the applicability or validity thereof shall be contested in good faith by appropriate proceedings and a reserve, if appropriate, shall have been established with respect thereto and (ii) failure to make such payment will not have a Material Adverse Effect on a consolidated basis; and (e) keep adequately insured, by financially sound and reputable insurers of nationally recognized stature, all their respective properties of a character customarily insured by entities similarly situated, against loss or damage of the kinds and in amounts customarily insured against by such entities and with such deductibles or co-insurance as is customary. 7.6. Office for Payment, Exchange and Registration; Location of Office; Notice of Change of Name or Office. -31- (a) So long as any of the Shares is outstanding, the Company will maintain an office or agency where Shares may be presented for payment, exchange, conversion or registration of transfer as provided in this Agreement. Such office or agency initially shall be the office of the Company's transfer agent and shall be the following: KeyCorp Shareholder Services, Inc., 700 Louisiana, Suite 2620, Houston, Texas 77002. (b) The Company shall give each holder of Shares at least twenty (20) days' prior written notice of any change in (i) the name of the Company as then in effect or (ii) the location of the office of the Company required to be maintained under this Section 7.6. 7.7. Environmental Matters. (a) The Company and each Subsidiary shall keep any property either owned or occupied by the Company or any Subsidiary free and clear of any material Liens imposed for failure to comply with any environmental laws, regulations or ordinances (each, an "Environmental Lien"), and the Company and each Subsidiary, as the case may be, shall keep all such property in material compliance with all environmental laws, regulations and ordinances; provided, however, that the Company or any Subsidiary shall have the right at its cost and expense, and acting in good faith, to contest, object or appeal by appropriate legal proceeding the validity of any Environmental Lien. The contest, objection or appeal with respect to the validity of an Environmental Lien shall suspend the Company's obligation to eliminate such Environmental Lien under this paragraph pending a final determination by appropriate administrative or judicial authority of the legality, enforceability or status of such Environmental Lien, provided that the following conditions are satisfied: (i) contemporaneously with the commencement of such proceedings, the Company shall give written notice thereof to each holder of Shares or Conversion Shares; and (ii) if under applicable law any real property or improvements thereon are subject to sale or forfeiture for failure to satisfy the Environmental Lien prior to a final determination of the legal proceedings, the Company or such Subsidiary must successfully move to stay such sale, forfeiture or foreclosure pending final determination of the Company's (or Subsidiary's) action; and (iii) the Company or such Subsidiary must, if requested, furnish to the holders of Shares or Conversion Shares a good and sufficient bond, surety, letter of credit or other security satisfactory to such holders equal to the amount (including any interest and penalty) secured by the Environmental Lien. (b) The Company will defend, indemnify and hold harmless each current, former and future holder of Shares or Conversion Shares, its employees, officers, directors, stockholders, partners, agents, representatives and assigns, from and against any liabilities, obligations, losses, damages, penalties, actions, judgments, suits and claims, joint or several, and any costs, disbursements and expenses (including attorneys' fees and expenses and costs of investigation) of whatever kind or nature, known or unknown, contingent or otherwise, arising out of or in any way -32- related to (i) the presence, disposal, release, removal, discharge, storage or transportation of any Hazardous Material upon, into, from or affecting any real property (including improvements) owned or occupied (or formerly owned or occupied) by the Company or any Subsidiary; and (ii) any judicial or administrative action, suit or proceeding, actual or threatened, relating to Hazardous Material upon, in, from or affecting any real property (including improvements) owned or occupied (or formerly owned or occupied) by the Company or any Subsidiary; and (iii) any violation of any environmental law, regulation or ordinance by the Company or any Subsidiary or any of their agents, tenants, subtenants or invitees; and (iv) the imposition of any Environmental Lien for the recovery of costs expended in the investigation, study or remediation of any environmental liability of (or asserted against) the Company or any Subsidiary, provided, however, that in no case shall such persons be entitled to indemnification under this Section 7.7(b) for a decrease in the value of the Shares or the Conversion Shares resulting from or in any way related to items (i) though (iv) herein, but that the preceding clause shall in no way limit any indemnification that a Purchaser may otherwise be entitled to under any other provisions of this Stock Purchase Agreement. This Section 7.7(b) shall survive any payment, conversion or transfer of Shares and any termination of this Agreement. 7.8. No Change in Business. Neither the Company nor any of its Subsidiaries will engage in any business other than business of the general nature described in the Memorandum. 7.9. Restrictive Agreements Prohibited. Neither the Company nor any of its Subsidiaries shall become a party to any agreement which by its terms restricts the Company's performance of this Agreement. 7.10. Restricted Payments. Neither the Company nor any Subsidiary will declare or make or permit to be declared or made any Restricted Payment. 7.11. Consolidation, Merger and Sale. Without the consent of the Majority Shareholders, neither the Company nor any Subsidiary will do any of the following (or agree to do any of the following) pursuant to a transaction approved by the Board of Directors of the Company: (a) wind up, liquidate or dissolve its affairs; (b) sell, lease, transfer or otherwise dispose of all or substantially all of its assets to any other Person; (c) consolidate with, merge into or enter into a share exchange with any other Person; -33- or (d) permit any other Person (other than a wholly-owned Subsidiary on the date hereof) to merge into or sell, lease or transfer all or substantially all of its property, assets or capital stock to the Company or any Subsidiary, unless: (i) in the case of actions under clause (a) or (b) above, a wholly- owned Subsidiary is wound-up, dissolved and liquidated into another wholly-owned Subsidiary or into the Company or a wholly-owned Subsidiary sells, leases, transfers or otherwise disposes of all or substantially all of its assets to another wholly-owned Subsidiary or to the Company; or (ii) in the case of actions under clause (c) or (d) above, each of the following conditions is satisfied: (A) if such action involves the Company and if such surviving Person is a corporation other than the Company, all liabilities and obligations of the Company under the Stock Purchase Agreements shall remain in effect and shall have been expressly assumed by such surviving Person (pursuant to a document in form and substance reasonably satisfactory to the Majority Shareholders and their counsel) as if such surviving Person were the "Company" hereunder and thereunder; and (B) either (x) the Common Stock of such transferee Person into which the Series B Preferred Stock will thereafter be convertible (or American Depositary Receipts with respect thereto) is listed on a national securities exchange in the United States or traded on The Nasdaq Stock Market, or (y) all of the Series B Preferred Stock is concurrently redeemed for cash in accordance with Section 5 of the Series B Certificate of Designations. 7.12. Transactions with Affiliates. The Company will not, and will not permit any Subsidiary to, directly or indirectly, enter into any transaction or agreement (including, without limitation, the purchase, sale, distribution, lease or exchange of any property or the rendering of any service) with any Affiliate of the Company or of any Subsidiary, other than a wholly-owned Subsidiary of the Company, unless such transaction or agreement (a) is approved by disinterested members of the Board of Directors of the Company, and (b) is on terms that are no less favorable to the Company or such Subsidiary, as the case may be, than those which might be obtained at the time of such transaction from a Person who is not such an Affiliate; provided, however, that this Section 7.12 shall not limit, or be applicable to, (i) employment arrangements with any individual who is an employee of the Company or any Subsidiary if such arrangements are approved by the Board; and (ii) the payment of reasonable and customary regular fees to directors who are not employees of the Company. -34- 7.13. Observer Rights. Each of the Eligible Holders shall have the right, during the period through the Rights Expiration Date for such Eligible Holder, and (if requested by the Company) subject to execution by such observer of a reasonable confidentiality agreement, to send one (1) representative to meetings of the Company's and each Subsidiary's Board of Directors (and the executive committee if the executive committee has more than five members) of such Boards, such representatives to act as observers without a vote or other rights as a director (except the right to receive sufficient notice to enable such attendance and the right to receive all other communications, information and materials furnished, from time to time, to directors of the Company and each Subsidiary). Any representative acting under this Section 7.13 shall be chosen from the list of Persons provided to the Company concurrently with execution of this Agreement (or another individual selected by such holders and reasonably acceptable to the Company). 7.14. No Dilution or Impairment; No Changes in Capital Stock. The Company will not, by amendment of its certificate of incorporation or through any consolidation, merger, reorganization, transfer of assets, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of the Stock Purchase Agreements or the Series B Certificate of Designations. The Company will at all times in good faith assist in the carrying out of all such terms, and in the taking of all such action, as may be necessary or appropriate in order to protect the rights of the holders of Shares (as such rights are set forth in the Stock Purchase Agreements and the Series B Certificate of Designations) against impairment. Without limiting the generality of the foregoing, the Company (a) will not permit the par value or the determined or stated value of any shares of the Company's Common Stock receivable upon the conversion of the Shares to exceed the amount payable therefor upon such conversion, (b) will take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and non- assessable shares of the Company's Common Stock free from all taxes, Liens and charges with respect to the issue thereof, upon the conversion of the Shares from time to time outstanding, (c) will not take any action which results in any adjustment of the Conversion Price under the Series B Certificate of Designations if the total number of shares of the Company's Common Stock (or other securities) issuable after the action upon the conversion of all of the then outstanding Shares would exceed the total number of shares of the Company's Common Stock (or other securities) then authorized by the Company's certificate of incorporation and available for the purpose of issuance upon such conversion, (d) will not have any authorized Common Stock other than its existing authorized Common Stock, (e) will not amend its certificate of incorporation to change any terms of its Common Stock, (f) will not amend its certificate of incorporation in any manner to alter or change the powers, privileges or preferences of the holders of the Series B Preferred Stock (including without limitation changing the Series B -35- Certificate of Designations after any Shares have been called for redemption), (g) will not create or authorize the creation of any additional class or series of shares of capital stock unless the same ranks junior to the Series B Preferred Stock as to the payment of dividends or the distribution of assets on the liquidation, dissolution or winding up of the Company, or increase the authorized amount of the Series B Preferred Stock, or increase the authorized amount of any additional class or series of shares of stock unless the same ranks junior to the Series B Preferred Stock as to the payment of dividends or the distribution of assets on the liquidation, dissolution or winding up of the Company, or create or authorize any obligation or security convertible into shares of Series B Preferred Stock or into shares of any other class or series of stock unless the same ranks junior to the Series B Preferred Stock as to the payment of dividends or the distribution of assets on the liquidation, dissolution or winding up of the Company, whether any such creation, authorization or increase shall be by means of amendment to the certificate of incorporation or by merger, consolidation or otherwise and (h) after the date hereof, will not create or establish (or make any grants or awards under) any phantom stock, stock appreciation rights or other equity equivalent plan for employees, officers, directors, agents or consultants of the Company (unless such plans in the aggregate relate to the equivalent of less than 5% of the Common Stock of the Company) whereby the Company or any Subsidiary agrees to pay any Person a percentage of, or an amount otherwise determined by reference to, the earnings of the Company or any Subsidiary, the value of their stock or the proceeds from a sale of their stock or upon their liquidation. 7.15. Reservation of Shares. There have been reserved, and the Company shall at all times keep reserved, free from preemptive rights, out of its authorized Common Stock, a number of shares of Common Stock sufficient to provide for the exercise of the conversion rights of the Shares provided in the Series B Certificate of Designations. If at any time the number of authorized but unissued shares of Common Stock of the Company shall not be sufficient to effect the conversion of the Shares or otherwise to comply with the terms of this Agreement, the Company will forthwith take such corporate action as may be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purpose. The Company will obtain any authorization, consent, approval or other action by or make any filing with any court or administrative body that may be required under applicable state securities laws in connection with the issuance of the Common Stock upon conversion of the Shares. 7.16. Listing of Shares. If any shares of the Company's Common Stock or Series B Preferred Stock are listed on any national securities exchange (or on The Nasdaq Stock Market or comparable system), then the Company will take such action as may be necessary, from time to time, to list the Conversion -36- Shares or the Shares, as the case may be, on such exchange (or system as the case may be). The Company shall have no obligation to list the Shares if the Series B Preferred Stock is not so listed. 7.17. Securities Exchange Act Registration. (a) The Company will maintain effective a registration statement (containing such information and documents as the Commission shall specify and otherwise complying with the Securities Exchange Act) under Section 12(b) or Section 12(g), whichever is applicable, of the Securities Exchange Act, with respect to the Company's Common Stock, and will file on time such information, documents and reports as the Commission may require or prescribe for companies whose stock has been registered pursuant to such Section 12(b) or Section 12(g), whichever is applicable. (b) The Company will, upon the request of any holder of Shares or Conversion Shares, make whatever other filings with the Commission, or otherwise make generally available to the public such financial and other information, as any such holder may deem reasonably necessary or desirable in order to enable such holder to be permitted (i) to sell Conversion Shares pursuant to the provisions of Rule 144 and (ii) after the Company has filed a registration statement with respect to Series B Preferred Stock under Section 6 of the Securities Act or Section 12(b) or 12(g) of the Securities Exchange Act, to sell Shares pursuant to the provisions of Rule 144. 7.18. Maintenance of Public Market. Except as contemplated by Section 7.11, the Company will not (i) proceed with a program of acquisition of its own Common Stock or of Series B Preferred Stock (other than by redemption in accordance with the Series B Certificate of Designations), (ii) initiate a corporate reorganization or recapitalization or undertake a consolidation or merger or (iii) authorize, consent to or take any action without the consent of the Eligible Holders, which would have the effect of: (a) removing the Company from registration with the Commission under the Securities Exchange Act with respect to the Company's Common Stock, (b) requiring the Company to make a filing under Section 13(e) of the Securities Exchange Act, (c) reducing substantially or eliminating the public market for shares of Common Stock of the Company, -37- (d) if any shares of the Company's Common Stock or Series B Preferred Stock are at any time listed on The Nasdaq Stock Market, causing a delisting of the Company's Common Stock or Series B Preferred Stock, as the case may be, from such systems (unless such stock is delisted as a result of being listed on a national securities exchange), or (e) if any shares of the Company's Common Stock or Series B Preferred Stock are at any time listed on a national securities exchange, causing a delisting of such stock from such exchange. 7.19. Private Placement Status. Neither the Company nor any agent nor other Person acting on the Company's behalf will do or cause to be done (or will omit to do or to cause to be done) any act which act (or which omission) would result in bringing the issuance or sale of the Shares or the Conversion Shares within the provisions of Section 5 of the Securities Act or the filing, notification or reporting requirements of any state securities law (other than in accordance with a registration and qualification of Conversion Shares pursuant to Section 7.17 hereof), except for filings, notices or reports pursuant to state securities laws which have already been made or which are contemplated in connection with the offering and sale of the Shares. 7.20. Delivery of Information. If a holder of Shares or Conversion Shares proposes to transfer any such Shares or Conversion Shares pursuant to Rule 144A, the Company agrees to provide (upon the request of such holder or the prospective transferee) to such holder and (if requested) to the prospective transferee any information concerning the Company and its Subsidiaries which is required to be delivered to any transferee of such Shares or Conversion Shares pursuant to such Rule 144A. 7.21. Notices. The Company will give to all holders of Shares or Conversion Shares copies of all notices given by the Company to holders of its Common Stock concurrently with the giving of such notices to such holders of Common Stock. 7.22 No Dividends in Common Stock Unless Registered. The Company will not declare and cause to be paid dividends on the Shares in shares of Common Stock until a registration statement covering the resale of such Common Stock has been filed with the Commission and has been declared effective thereby. -38- SECTION 8. REGISTRATION RIGHTS 8.1. Registration of the Shares. (a) The holders of at least an aggregate of 100,000 Shares may request the Company to register under the Securities Act the resale of all or any portion of such Shares, but in no event less than 60,000 Shares, held by such requesting holder or holders for sale in the manner specified in such notice. (b) Following receipt of any notice under this Section 8.1, the Company shall immediately notify all holders of the Shares from whom notice has not been received and shall commit to register under the Securities Act, for public sale in accordance with the method of disposition specified in such notice from requesting holders, the number of Shares specified in such notice (and in all notices received by the Company from other holders within 30 days after the giving of such notice by the Company). All such holders who submit requests to the Company pursuant to this Section 8.1 shall be referred to individually as a "Requesting Holder" and collectively as "Requesting Holders." If the Requesting Holders may elect to have the Shares sold to one or more persons participating as underwriters ("Underwriters") for an offering of Shares to the public (an offering of any shares of capital stock of the Company by means of Underwriters to the public shall be referred to as an "Underwritten Offering"), the holders of a majority of the Shares to be sold in such offering may designate the managing Underwriter of such offering, subject to approval of the Company, which approval will not be unreasonably withheld or delayed. The Company shall be obligated to register the Shares pursuant to this Section 8.1 on two occasions only, provided, however, that such obligation shall be deemed satisfied only when a registration statement covering at least 60% of the total Shares specified in notices received as aforesaid, for sale in accordance with the method of disposition specified by the Requesting Holders, shall have become effective and, if such method of disposition is an Underwritten Offering, all such shares shall have been sold pursuant thereto. (c) Except for registration statements on Form S-4, S-8 or any successor thereto and except as required under the registration rights agreements referred to in Schedule II hereto, the Company will not file with the Commission without the approval of the Requesting Holders any other new registration statements with respect to its capital stock, whether for its own account or that of other stockholders, from the date of receipt of a notice from Requesting Holders pursuant to this Section 8.1 until the earlier of (i) six (6) months from the date of receipt of such notice and (ii) the completion of the period of distribution of the registration contemplated thereby. The registration statement, together with all amendments and supplements, including post-effective amendments, in each case including the prospectus contained therein (including the preliminary prospectus and all amendments and supplements to the prospectus, including post-effective amendments) (collectively, -39- the "Prospectus"), all exhibits thereto or to the Prospectus and all material incorporated by reference therein or to the Prospectus, is referred to as the "Registration Statement". (d) If and whenever the Company is required by the provisions of this Section 8.1 to effect the registration of any Shares under the Securities Act, the Company will, as expeditiously as possible: (i) prepare and file with the Commission, no later than 60 days after the receipt of the first notice from the Requesting Holders, a Registration Statement on Form S-2 (or other appropriate form) with respect to such securities and use its reasonable best efforts to cause such Registration Statement to become and remain effective for the period of distribution contemplated thereby (determined as hereinafter provided); (ii) prepare and file with the Commission such amendments and supplements to such Registration Statement and the Prospectus used in connection therewith as may be necessary to keep such Registration Statement effective for the period contemplated in (i) above and comply with the provisions of the Securities Act with respect to the disposition of all Shares covered by such Registration Statement in accordance with the sellers' intended method of disposition set forth in such Registration Statement for such period; (iii) register or qualify the Shares, by the time the Registration Statement is declared effective by the Commission, under all applicable state securities or "Blue Sky" laws of such jurisdictions as each Underwriter, if any, or the Requesting Holders shall request in writing, provided that the Company shall not be obligated to qualify as a foreign corporation or as a dealer in securities in any jurisdiction in which it is not so qualified or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject; (iv) keep each such registration or qualification effective during the period the Registration Statement is required to be kept effective; -40- (v) upon request by the Requesting Holders, do any and all other acts and things which may be reasonably necessary to enable such Underwriter, if any, and the Requesting Holders to consummate the disposition of the Shares in each such jurisdiction; (vi) notify the Requesting Holders when the Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective; (vii) in connection with an Underwritten Offering, if any, notify the Requesting Holders if, between the effective date of the Registration Statement and the closing of any sale of Shares, the representations and warranties of the Company contained in the underwriting agreement relating to any Underwritten Offering cease to be true and correct in all material respects or if the Company receives any notification with respect to the suspension of the qualification of the Shares for sale in any jurisdiction or the initiation of any proceeding for such purpose; (viii) furnish or cause to be furnished forthwith to the Requesting Holders, a "cold comfort" letter of the Company's independent accountants, as of the effective date of the Registration Statement, as to such matters as customarily are covered in accountant's letters delivered to underwriters in underwritten public offerings of securities; (ix) furnish or cause to be furnished forthwith to the Requesting Holders, an opinion of counsel to the Company, as of the effective date of the Registration Statement, in the form customarily provided by issuer's counsel in underwritten public offerings of securities; (x) furnish such number of Prospectuses and other documents incident thereto, including any amendment of or supplement to the Prospectus as the Requesting Holders from time to time may reasonably request during the period of distribution of the Shares; (xi) provide a transfer agent and registrar for all of the Shares; and (xii) otherwise use its reasonable best efforts to comply with all applicable rules and regulations of the Commission with respect to the disposition of the Shares covered by such Registration Statement, and make available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of at least twelve months, but not more than eighteen months, beginning with the first month after the effective date of the Registration Statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act. (e) For purposes of this Section 8.1, the period of distribution of the Shares in an Underwritten Offering shall be deemed to extend until each Underwriter has completed the distribution of all securities purchased by it (but no later than 180 days), and the period of distribution of the Shares in any other registration shall be deemed to extend until the earlier of the sale of all Shares covered thereby and 180 days after the effective date thereof. (f) In connection with each registration under this Section 8.1, and as a condition to the inclusion of their shares therein, the Requesting Holders will furnish to the Company in writing such information with respect to themselves and the proposed distribution by them as -41- reasonably shall be necessary in order to assure compliance with federal and applicable state securities laws. (g) As soon as the Company is eligible to register the Shares on Form S-3 (or any successor form thereto under the Securities Act), the Company will, as expeditiously as possible but in any event no later than 60 days after the Company is eligible to register the Shares on Form S-3, undertake to amend the "shelf" Registration Statement on Form S-3 referred to in Section 8.2 to include any Shares outstanding or to file and to use its reasonable best efforts to have declared effective a separate registration statement registering the resale of the Shares. Any Shares so registered pursuant to the Company's "shelf" Registration Statement on Form S-3 or such other registration statement shall be thereinafter included within the definition of "Registered Securities". (h) Subject to Section 8.3 below, the Company agrees to supplement or amend the Registration Statement, if required by the Securities Act. 8.2 Shelf Registration of the Registered Securities. The Company agrees to use its reasonable best efforts to file with the Commission a "shelf" Registration Statement on Form S-3 (or other appropriate form under the Securities Act), providing for the resale of all of the Registered Securities, within sixty (60) days after the Closing Date. The Company will use its reasonable best efforts to have the Registration Statement declared effective by the Commission as soon as practicable after the filing thereof. Subject to Section 8.3 hereof, the Company will use its reasonable best efforts to keep the Registration Statement continuously effective until the earlier of: (A) the date upon which all of the outstanding Registered Securities have been sold pursuant to the Registration Statement or are no longer outstanding, or (B) such date as the Company and each of the Eligible Holders shall be satisfied that Rule 144(k) of the regulations under the Securities Act is available for the resale of the Registered Securities held by them, or, in the case of Eligible Holders for whom Rule 144(k) is unavailable, such Eligible Holders have consented in writing to permit the Company to discontinue the effectiveness of the Registration Statement. Subject to Section 8.3 below, the Company agrees to supplement or amend the Registration Statement, if required by the Securities Act. 8.3. Interference with Registration. -42- (a) For purposes of this Section 8.3, any Registration Statement pursuant to either Section 8.1 or 8.2 hereof shall collectively be referred to as the "Registration Statements." If, after the Registration Statements have been declared effective, a stop order, injunction or other order or requirement of the Commission or any other governmental agency or court is issued which suspends the effectiveness of a Registration Statement, (i) upon receipt of notice from the Company, the Requesting Holders or Purchaser (as applicable) will discontinue any disposition of Shares or Registered Securities, respectively, pursuant to that Registration Statement until receipt of notice from the Company that the suspension of the effectiveness of the Registration Statement has been withdrawn and (ii) the Company will use its reasonable best efforts to obtain the withdrawal of such order or to meet such requirement at the earliest possible time. (b) If, after the Registration Statements have become effective, an event occurs as a result of which the Company determines that a Registration Statement or the related Prospectus contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, the Company will notify the Requesting Holders and any Purchaser (as applicable) thereof and, if applicable, use its reasonable best efforts to prepare and promptly file a post-effective amendment or a supplement to the Registration Statement or the related Prospectus or promptly file any other required document so that, as thereafter delivered to purchasers of the Shares or Registered Securities, such Prospectus will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (c) Without limiting Section 8.3(a) and 8.3(b) hereof, if any Requesting Holder or Purchaser (as applicable) shall propose to sell any Shares or Registered Securities, respectively, pursuant to the Registration Statements, it shall notify the Company of its intent to do so at least three (3) full Business Days prior to such sale. At any time within such three (3) Business Day period, the Company may refuse to permit the Requesting Holder or Purchaser (as applicable) to resell any Shares or Registered Securities, respectively, pursuant to the Registration Statements; except that the Company may exercise this right only once in any one hundred eighty (180) day period, unless the matter giving rise to the exercise by the Company of this right is beyond the Company's control; and provided, further, that in order to exercise this right, the Company must deliver a certificate in writing to the Requesting Holder or Purchaser (as applicable) to the effect that a delay in such sale is necessary because a sale pursuant to such Registration Statement in its then-current form would reasonably be expected to constitute a violation of the federal securities laws. Without limiting Section 8.3(b) hereof, in no event shall such delay exceed ten (10) Business Days; provided, however, that if, prior to the expiration of such ten (10) Business Day period, the Company delivers a certificate in writing to the Requesting Holder or Purchaser (as applicable) to the effect that a further delay in such sale beyond such ten (10) Business Day trading period is necessary -43- because a sale pursuant to the Registration Statement in its then-current form would reasonably be expected to constitute a violation of the federal securities laws, the Company may refuse to permit such Requesting Holder or Purchaser (as applicable) to resell any Shares or Registered Securities, respectively, pursuant to the Registration Statement for an additional period not to exceed five (5) Business Days, but in no event shall any such delay exceed in the aggregate fifteen (15) Business Days, unless the matter giving rise to the exercise of such right is beyond the Company's control. 8.4. Selection of Underwriters for Registered Securities. With respect to the registration of Registered Securities pursuant to Section 8.2 hereof, at any time or from time to time after the Closing, the Purchaser may elect to have the Registered Securities sold to one or more persons participating as Underwriters for an Underwritten Offering. In such event, the Company shall engage (a) Alex. Brown & Sons Incorporated or (b) another nationally recognized independent investment banking firm reasonably acceptable to the holders of a majority of the Registered Securities, as Underwriters; provided, however, that the Company shall not be required to engage any Underwriter if such engagement would require the consent or approval of any governmental authority (including the necessity of obtaining an exemptive order under the Investment Company Act of 1940, as amended); provided, further, that after three years after the Closing Date such Underwriters shall be selected by mutual agreement of the Company and the holders of a majority of the Registered Securities, each acting reasonably. In such event, the Company and each such Purchaser will cooperate with the Underwriter or the managing Underwriter and take all customary and reasonable actions to facilitate the disposition of Registered Securities in an Underwritten Offering. 8.5. Other Obligations of the Company with respect to the Registered Securities. After the Closing, the Company will: (a) use its reasonable best efforts (i) to register or qualify the Registered Securities, by the time the Registration Statement is declared effective by the Commission, under all applicable state securities or "Blue Sky" laws of such jurisdictions as each Underwriter, if any, or the Purchaser shall request in writing, provided that the Company shall not be obligated to qualify as a foreign corporation or as a dealer in securities in any jurisdiction in which it is not so qualified or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject; (ii) to keep each such registration or qualification effective during the period the Registration Statement is required to be kept effective; and -44- (iii) upon request by the Purchaser, to do any and all other acts and things which may be reasonably necessary to enable such Underwriter, if any, and the Purchaser to consummate the disposition of the Registered Securities in each such jurisdiction; (b) notify the Purchaser (i) when the Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective and (ii) in connection with an Underwritten Offering, if any, if, between the effective date of the Registration Statement and the closing of any sale of Registered Securities, the representations and warranties of the Company contained in the underwriting agreement relating to any Underwritten Offering cease to be true and correct in all material respects or if the Company receives any notification with respect to the suspension of the qualification of the Registered Securities for sale in any jurisdiction or the initiation of any proceeding for such purpose; (c) Furnish or cause to be furnished forthwith to the Purchaser, (i) a "cold comfort" letter of the Company's independent accountants, as of the effective date of the Registration Statement, as to such matters as customarily are covered in accountant's letters delivered to underwriters in underwritten public offerings of securities and (ii) an opinion of counsel to the Company, as of the effective date of the Registration Statement, in the form customarily provided by issuer's counsel in underwritten public offerings of securities; (d) furnish such number of Prospectuses and other documents incident thereto, including any amendment of or supplement to the Prospectus as a Purchaser from time to time may reasonably request; (e) cause all such Registered Securities registered as described herein to be listed on each securities exchange and quoted on each quotation service on which securities of the same class and series issued by the Company are then listed or quoted; (f) provide a transfer agent and registrar for all Registered Securities; (g) otherwise use its reasonable best efforts to comply with all applicable rules and regulations of the Commission with respect to the disposition of the Registered Securities, and make available to its security holders, as soon as reasonably practicable, an earnings statements -45- covering the period of at least twelve months, but not more than eighteen months, beginning with the first month after the effective date of the Registration Statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act. 8.6. Registration Expenses. The Company agrees to pay all Registration Expenses in connection with the registrations pursuant to this Section 8. "Registration Expenses" means any and all expenses incident to performance of or compliance with the provisions of this Section 8 by the Company, including without limitation: (i) all Commission and National Association of Securities Dealers, Inc. ("NASD") registration and filing fees, (ii) all fees and expenses incurred in connection with compliance with state securities or "Blue Sky" laws and compliance with the rules of the NASD, (iii) all expenses in preparing, printing and distributing the Registration Statements and other documents relating to the performance of and compliance with this Agreement by the Company, (iv) the reasonable fees and disbursements of counsel for the Company and of one counsel selected by the Eligible Holders and reasonably acceptable to the Company and of the independent public accountants of the Company, (v) any fees and disbursements of Underwriters, dealers and agents, if any, customarily paid by issuers of securities under similar circumstances relating to compliance with applicable state securities or "Blue Sky" laws and the fees and expenses of any special experts retained by the Company in connection with the Registration Statements; but excluding (x) underwriting discounts and commissions and (other than as provided in clause (v) of this paragraph) fees and disbursements of Underwriters, dealers and agents in connection with an Underwritten Offering of Shares or Registered Securities, if any, and (y) transfer taxes, if any, relating to the sale and disposition of Shares or Registered Securities. 8.7. Short Sales. No Purchaser shall engage in any short-sales of the Company's Common Stock prior to the effectiveness of the Registration Statement, except to the extent that any such shortsale is fully covered by freely tradable shares of Common Stock of the Company. 8.8. Representations of the Company. The Company represents and warrants to, and agrees with, the Purchaser that: (a) The Registration Statements and the Prospectuses contained therein, when they become effective or are filed with the Commission, as the case may be, and, in the case of an Underwritten Offering, at the time of the closing under the underwriting agreement relating thereto, will conform in all material respects to the requirements of the Securities Act and will not contain -46- an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and at all times subsequent to the effective date of such Registration Statements when a Prospectus would be required to be delivered under the Securities Act, except for the periods provided under Section 8.3 hereof, such Registration Statements and Prospectuses will conform in all material respects to the requirements of the Securities Act and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by the Purchaser or any Underwriter expressly for use therein. (b) Any documents incorporated by reference in the Prospectuses, when they become or became effective or are or were filed with the Commission, as the case may be, will conform or conformed in all material respects to the requirements of the Securities Act or the Exchange Act, as applicable, and none of such documents will contain or contained, as of their respective dates, an untrue statement of a material fact or will omit or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading at the time they become or became effective or are or were filed with the Commission, as the case may be; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and conformity with information furnished in writing to the Company by the Purchaser or any Underwriter expressly for use therein. 8.9. Indemnification. (a) The Company will indemnify and hold harmless each holder of Shares and Registered Securities and any underwriter (as defined in the Securities Act) for such holder and each person, if any, who controls the holder or underwriter within the meaning of the Securities Act against any losses, claims, damages or liabilities, joint or several, and expenses (including reasonable attorneys' fees and expenses and reasonable costs of investigation) to which the holder or underwriter or such controlling person may be subject, under the Securities Act or otherwise, insofar as any thereof arise out of or are based upon (x) any untrue statement or alleged untrue statement of a material fact contained in a Registration Statement, a Prospectus or any amendment or supplement thereto, or (y) the omission or alleged omission to state in any item referred to in the preceding clause a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such losses, claims, damages, liabilities or expenses arise out of or are based upon any untrue statement or alleged untrue statement or omission or alleged omission based upon information furnished to the Company in writing by such holder or by any underwriter for such holder expressly for use therein (with respect to which information such holder or underwriter shall so indemnify and hold harmless the Company, any underwriter for the Company and each person, -47- if any, who controls the Company or such underwriter within the meaning of the Securities Act). The foregoing is subject to the condition that, insofar as the foregoing indemnities relate to any untrue statement, alleged untrue statement, omission or alleged omission made in any prospectus which is eliminated or remedied in any amendment, supplement or final prospectus, the above indemnity obligations of the Company shall not inure to the benefit of any indemnified person (or to the benefit of any person who controls such indemnified person within the meaning of the Securities Act) if a copy of such amendment, supplement or final prospectus was not sent or given by such indemnified person at or prior to the time such action is required of such indemnified person by the Securities Act and if delivery of such amendment, supplement or final prospectus would have eliminated (or been a sufficient defense to) any liability of such indemnified person with respect to such statement or omission. (b) The Purchaser will indemnify and hold harmless the Company, any other Purchasers, any underwriter (as defined in the Securities Act) and each person, if any, who controls the Company, such other Purchasers or any underwriter within the meaning of the Securities Act, against any losses, claims, damages or liabilities, joint and several, and expenses (including reasonable attorneys' fees and expenses and reasonable costs of investigation) to which the Company, such other Purchaser, underwriter or such controlling person may be subject, under the Securities Act or otherwise, insofar as any thereof arise out of or are based upon (x) any untrue statement or alleged untrue statement of a material fact contained in a Registration Statement, a Prospectus or any amendment or supplement thereto, (y) the omission or alleged omission to state in any item referred to in the preceding clause a material fact required to be stated therein or necessary to make the statements therein not misleading or (z) any failure of the Purchaser to perform its obligations hereunder or under law; provided, however, that the Purchaser will be liable hereunder in any such case if and only to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in strict conformity with information pertaining to the Purchaser, as such, furnished in writing to the Company by the Purchaser stated to be specifically for use in such Registration Statement and Prospectus; provided, further, however, that the liability of the Purchaser hereunder shall be limited to the proportion of any such loss, claim, damage, liability or expense which is equal to the proportion that the public offering price of the Shares or Registered Securities sold by the Purchaser under such Registration Statement bears to the total public offering price of all securities sold thereunder, but not in any event to exceed the proceeds received by the Purchaser from the sale of the Shares or Registered Securities covered by such Registration Statement. The foregoing is subject to the condition that, insofar as the foregoing indemnities relate to any untrue statement, alleged untrue statement, omission or alleged omission made in any prospectus which is eliminated or remedied in any amendment, supplement or final prospectus, the above indemnity obligations of the Purchaser shall not inure to the benefit of any indemnified person (or to the benefit of any person who controls such indemnified person within the -48- meaning of the Securities Act) if a copy of such amendment, supplement or final prospectus was not sent or given by such indemnified person at or prior to the time such action is required of such indemnified person by the Securities Act and if delivery of such amendment, supplement or final prospectus would have eliminated (or been a sufficient defense to) any liability of such indemnified person with respect to such statement or omission. (c) Promptly after receipt by an indemnified party under Section 8.9(a) or (b) hereof of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against an indemnifying party under such subsection, notify the indemnifying party in writing of the commencement thereof; but the failure to so notify an indemnifying party shall not relieve the indemnifying party of its obligations under this Section 8.9 unless such failure to notify materially prejudices the indemnifying party's defense. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party, and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party under this subsection for any legal expenses of other counsel or any other expenses, in each case subsequently incurred by such indemnified party, in connection with the defense thereof other than reasonable costs of investigation. Notwithstanding the foregoing, the indemnifying party shall pay as incurred the fees and expenses of separate counsel retained by the indemnified party in the event (i) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel or (ii) the named parties to any such proceeding (including any impleaded parties) include both the indemnifying party and the indemnified party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them. It is understood that the indemnifying party shall not, in connection with any proceeding or related proceedings in the same jurisdiction, be liable for the reasonable fees and expenses of more than one separate firm for all such indemnified parties. In addition, an indemnifying party shall not be required to indemnify, reimburse, or otherwise make any contribution to the amount paid or payable by the indemnified party for any losses, claims, damages, expenses or liabilities incurred by the indemnified party in settlement of any actions, proceedings or investigations otherwise covered hereunder, unless such settlement has been previously approved by the indemnifying party, which approval shall not be unreasonably withheld. (d) If the indemnification provided for in this Section 8.9 is unavailable to or insufficient to hold harmless an indemnified party under Section 8.9(a) or (b) hereof in respect of any losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such -49- indemnified party as a result of such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) in such proportion as is appropriate to reflect not only (i) the relative benefits received by the Purchaser on the one hand and the underwriter on the other from the offering of the Shares or the Registered Securities but also (ii) the relative fault of the Company, the Purchaser and the underwriter in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions or proceedings in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Purchaser on the one hand and the underwriter on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Purchaser bear to the total underwriting discounts and commissions received by the underwriter, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact related to information supplied by the Company, the Purchaser or the underwriter and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. (e) The Company and the Purchaser agree that it would not be just and equitable if contributions pursuant to this Section 8.9 were determined by pro rata allocation (even if several underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 8.9. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to above in this Section 8.9 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 8.9, no underwriter, if any, will be required to contribute any amount in excess of the amount agreed to between the Company and the underwriter at the time of such offering. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Any underwriters' obligations to contribute will be several in proportion to their respective underwriting obligations and not joint. (f) In any proceeding relating to a Registration Statement, a Prospectus or any supplement or amendment thereto, each party against whom contribution may be sought under this Section 8.9 hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon him or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join him or it as an additional defendant in any such proceeding in which such other contributing party is a party. -50- 8.10. Transferees. The right to sell Shares and Registered Securities pursuant to a Registration Statement described herein will automatically be assigned to each transferee of Shares or Registered Securities, other than any purchaser of Shares or Registered Securities sold under a Registration Statement. In the event that it is necessary, in order to permit a Purchaser to sell Shares or Registered Securities pursuant to a Registration Statement, to amend or supplement the Registration Statement to name such transferee, such transferee shall, upon written notice to the Company, be entitled to have the Company make such amendment or supplement as soon as reasonably practicable. SECTION 9. CONDITIONS TO PURCHASER'S OBLIGATIONS The Purchaser's obligation to purchase Shares hereunder is subject to satisfaction of the following conditions at the Closing (any of which may be waived by the Purchaser) 9.1. Series B Certificate of Designations. The Series B Certificate of Designations shall have been filed with the Delaware Secretary of State in substantially the form attached hereto as Exhibit A. 9.2. Certificates for Shares. The Purchaser shall concurrently receive the certificates for Shares contemplated by Section 2(b) hereof. 9.3. Accuracy of Representations and Warranties. The representations and warranties of the Company in the Stock Purchase Agreements or in any certificate or document delivered pursuant hereto or thereto shall be correct and complete on and as of the Closing Date with the same effect as though made on and as of the Closing Date (after giving effect to transactions contemplated by this Agreement). 9.4. Compliance with Agreements. The Company shall have performed and complied with all agreements, covenants and conditions contained in the Stock Purchase Agreements and any other document contemplated hereby or thereby which are required to be performed or complied with by the Company on or before the Closing Date. -51- 9.5. Officers' Certificates. The Purchaser shall have received a certificate dated the Closing Date and signed by the President and by the Secretary of the Company, to the effect that the conditions of this Section 9 have been satisfied. 9.6. Proceedings. All corporate and other proceedings in connection with the transactions contemplated by the Stock Purchase Agreements, and all documents incident thereto, shall be in form and substance satisfactory to the Purchaser and its counsel, and the Purchaser shall have received all such originals or certified or other copies of such documents as the Purchaser or its counsel may reasonably request. 9.7. Legality; Governmental and Other Authorization. The purchase of and payment for the Shares shall not be prohibited by any law or governmental order, rule, ruling, regulation, release, interpretation or opinion applicable to the Purchaser and shall not subject the Purchaser to any penalty, tax, liability or other onerous condition. Any necessary consents, approvals, licenses, permits, orders and authorizations of, and any filings, registrations or qualifications with, any governmental or administrative agency or other person with respect to the transactions contemplated by the Stock Purchase Agreements shall have been obtained or made and shall be in full force and effect. The Company shall have delivered to the Purchaser upon its reasonable request factual certificates or other evidence, in form and substance satisfactory to the Purchaser and its counsel, setting forth what is required to enable the Purchaser to establish compliance with this condition. 9.8. Time of Purchase. The Closing shall not be later than 5:00 P.M., New York City time, on March 31, 1997. 9.9. No Change in Law, etc. No legislation, order, rule, ruling or regulation shall have been proposed, enacted or made by or on behalf of any governmental body, department or agency, and no legislation shall have been introduced in either House of Congress, and no investigation by any governmental authority shall have been commenced or threatened, and no action, suit or proceeding shall have been commenced before, and no decision shall have been rendered by, any court, other governmental -52- body or arbitrator, which, in any such case, in the Purchaser's reasonable judgment could adversely affect, restrain, prevent or change the transactions contemplated by the Stock Purchase Agreements (including without limitation the issuance of the Shares hereunder and thereunder and the issuance of the Conversion Shares under the Series B Certificate of Designations) or materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. 9.10. Opinions of Counsel. The Purchaser shall have received an opinion dated the Closing Date and addressed to the Purchaser of Andrews & Kurth L.L.P., counsel for the Company, which opinion shall be in form and substance reasonably satisfactory to the Purchaser. 9.11. Other Documents and Opinions. The Purchaser shall have received such other documents and opinions, in form and substance satisfactory to the Purchaser and its counsel, relating to matters incident to the transactions contemplated hereby as the Purchaser may reasonably request. 9.12 Receipt of Consent and Exchange Agreements. The Company shall have received a sufficient number of Consent and Exchange Agreements executed by the holders of Series A Preferred Stock in order to have the necessary authorization for the parity treatment of the Series B Preferred Stock and the modification to the registration rights as contemplated therein. SECTION 10. CONDITIONS TO COMPANY'S OBLIGATIONS The Company's obligation to sell and issue the Shares at the Closing is, at the option of the Company, subject to the fulfillment or waiver of the following conditions: 10.1. Representations and Warranties Correct. The representations and warranties made by the Purchaser in Section 5 hereof shall be true and correct in all material respects when made, and shall be true and correct in all material respects on the Closing Date with the same force and effect as if they had been made on and as of said date. 10.2. Covenants. -53- All covenants, agreements and conditions contained in this Agreement to be performed by the Purchaser on or prior to the Closing Date shall have been performed or complied with in all material respects. 10.3. Blue Sky. The Company shall have obtained all necessary blue sky law permits and qualifications, or secured exemptions therefrom, required by any state for the offer and sale of the Shares. No stop order or other order enjoining the sale of the Shares shall have been issued and no proceedings for such purpose shall be pending or, to the knowledge of the Company, threatened. SECTION 11. BROKERS Except for certain fees payable to the Agent (all of which fees will be paid by the Company), the Company represents and warrants to the Purchaser that there is no liability for (and the Company will pay and indemnify the Purchaser against) any fees or expenses (or claims therefor) of any investment banker, finder or broker retained by the Company or its Affiliates (or that claims it was retained by the Company or its Affiliates) in connection with any Stock Purchase Agreement or any of the transactions contemplated hereby or thereby. The Company will indemnify the Purchaser against all such fees or expenses payable to the enumerated persons in the preceding sentence and against any other such fees, expenses or claims of any person, unless such person was engaged by the Purchaser in connection with this Agreement or any of the transactions contemplated hereby. SECTION 12. BREACH OF REPRESENTATIONS, WARRANTIES AND COVENANTS (a) The representations and warranties (as of the date hereof and as of the Closing Date), covenants and agreements of the Company and the Purchaser contained in this Agreement or in any document or certificate delivered pursuant hereto or in connection herewith shall survive, and shall continue in effect following, the execution and delivery of the Stock Purchase Agreements, the closings hereunder and thereunder, any investigation at any time made by the Purchaser or on its behalf or by any other Person, the issuance, sale and delivery of the Shares, any disposition thereof and any payment, conversion or cancellation of the Shares provided, that Section 7 (other than Sections 7.1, 7.2, 7.4, 7.5, 7.7, 7.8, 7.9, 7.12, 7.13, 7.16, 7.17, 7.18, 7.20 and 7.21) shall terminate when no Shares are outstanding. All statements contained in any certificate delivered to the Purchaser by or on behalf of the Company pursuant hereto shall constitute representations and warranties by the Company hereunder. (b) The Company agrees to indemnify and hold the Purchaser harmless from and against and will pay to the Purchaser the full amount of any loss, damage, liability or expense -54- (including amounts paid in settlement and attorneys' fees and expenses) to the Purchaser resulting either directly or indirectly from any breach of the representations, warranties, covenants or agreements of the Company contained in any Stock Purchase Agreement, or in any certificate delivered to the Purchaser pursuant hereto or in connection herewith. SECTION 13. SPECIFIC PERFORMANCE The parties agree that irreparable damage will result in the event that this Agreement is not specifically enforced, and the parties agree that any damages available at law for a breach of this Agreement would not be an adequate remedy. Therefore, the provisions hereof and the obligations of the parties hereunder shall be enforceable in a court of equity, or other tribunal with jurisdiction, by a decree of specific performance, and appropriate injunctive relief may be applied for and granted in connection therewith. Such remedies and all other remedies provided for in this Agreement shall, however, be cumulative and not exclusive and shall be in addition to any other remedies which a party may have under this Agreement or otherwise. SECTION 14. EXPENSES (a) Whether or not the transactions herein contemplated are consummated, the Company will pay (i) the costs and expenses of the preparation and production of the Stock Purchase Agreements and the Series B Certificate of Designations and the issuance of the Shares and the Conversion Shares and the furnishing of all opinions by counsel for the Company, (ii) the fees and expenses of Piper & Marbury L.L.P. in connection with the Stock Purchase Agreements and the Series B Certificate of Designations and the transactions contemplated hereby and thereby (whether or not a closing occurs hereunder and if a closing occurs the Company will make such payment on the Closing Date), (iii) the reasonable fees and expenses of counsel to the Eligible Holders in connection with any amendments to or modifications or waivers of any provisions of the Stock Purchase Agreements or the Series B Certificate of Designations or in connection with any other agreements between the Purchasers and the Company after the date hereof, any of which are requested by the Company, (iv) the fees and expenses of any investment banker, broker or finder retained by the Company or its Affiliates (or that claims it was retained by the Company or its Affiliates) and involved with the Stock Purchase Agreements or the Series B Certificate of Designations or any of the transactions contemplated hereby or thereby, and (v) the fees and expenses (including reasonable attorneys' fees and expenses) of any holder of Shares or Conversion Shares in enforcing its rights against the Company if the Company materially defaults in its obligations hereunder or under the Series B Certificate of Designations. The obligations of the Company under this Section 14 shall survive the Closing hereunder and any termination of the Stock Purchase Agreements. -55- (b) In addition to all other sums due hereunder or provided for in this Agreement, the Company shall pay to the Purchaser or its agents, respectively, an amount sufficient to indemnify such persons (net of any taxes on any indemnity payments) against all reasonable costs and expenses (including reasonable attorneys' fees and expenses and reasonable costs of investigation) and damages and liabilities incurred by the Purchaser or its agents pursuant to any investigation or proceeding against any or all of the Company, the Purchasers, or their agents, arising out of or in connection with the Stock Purchase Agreements, the Shares or the Conversion Shares (or any transaction contemplated hereby or thereby or any other document or instrument executed herewith or therewith or pursuant hereto or thereto), whether or not the transactions contemplated by this Agreement are consummated, which investigation or proceeding requires the participation of the Purchaser or its agents or is commenced or filed against the Purchaser or its agents because of the Stock Purchase Agreements, the Shares or the Conversion Shares or any of the transactions contemplated hereby or thereby (or any other document or instrument executed herewith or therewith or pursuant hereto or thereto), other than any investigation or proceeding in which it is finally determined that there was gross negligence or willful misconduct on the part of the Purchaser or its agents which was not taken by them in reliance upon any of the Company's representations, warranties, covenants or agreements in the Stock Purchase Agreements or in any other documents or instruments contemplated hereby or thereby or executed herewith or therewith or pursuant hereto or thereto, except to the extent that any costs, expenses, damages or liabilities incurred by the Purchaser is the direct result of its breach of any of its representations, warranties, covenants or agreements in this Stock Purchase Agreement or in any other documents or instruments contemplated hereby or thereby or executed in connection herewith or therewith or pursuant hereto or thereto. The Company shall assume the defense, and shall have its counsel represent the Purchaser and such agents, in connection with investigating, defending or preparing to defend any such action, suit, claim or proceeding (including any inquiry or investigation); provided, however, that the Purchaser, or any such agent, shall have the right (without releasing the Company from any of its obligations hereunder) to employ its own counsel and either to direct its own defense or to participate in the Company's defense, but the fees and expenses of such counsel shall be at the expense of such person unless (i) the employment of such counsel shall have been authorized in writing by the Company in connection with such defense or (ii) the Company shall not have provided its counsel to take charge of such defense or (iii) the Purchaser, or such agent of the Purchaser, shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to those available to the Company, then in any of such events referred to in clauses (i), (ii) or (iii) such reasonable counsel fees and expenses (but only for one counsel for the Purchasers and their agents) shall be borne by the Company. Any settlement of any such action, suit, claim or proceeding shall require the consent of both the Company and such indemnified person (neither of which shall unreasonably withhold its consent). -56- (c) The Company agrees to pay, or to cause to be paid, all documentary, stamp and other similar taxes levied under the laws of the United States of America or any state or local taxing authority thereof or therein in connection with the issuance and sale of the Shares and the execution and delivery of the Stock Purchase Agreements and any other documents or instruments contemplated hereby or thereby and any modification of the Series B Certificate of Designations or the Stock Purchase Agreements or any such other documents or instruments and will hold the Purchaser harmless without limitation as to time against any and all liabilities with respect to all such taxes. (d) The obligations of the Company under this Section 14 shall survive the Closing hereunder and any termination of the Stock Purchase Agreements. SECTION 15. HOME OFFICE PAYMENTS As long as the Purchaser or any institutional holder which is a direct or indirect transferee (as a result of one or more transfers) from the Purchaser shall be the holder of record of any Shares, the Company will make all dividends, redemption payments, repurchase payments, liquidation payments and other distributions by wire transfer to the Purchaser's or such other holder's (or its nominee's) account at any bank or trust company in the United States of America, notwithstanding any contrary provision herein or in the Company's certificate of incorporation with respect to the place of payment. The Purchaser has provided an address on Schedule I hereto for payments by wire transfer, and such address may be changed for the Purchaser or any subsequent holder by notice to the Company. All such payments shall be made in U.S. dollars and in federal or other immediately available funds. SECTION 16. AMENDMENTS AND WAIVERS (a) The terms and provisions of this Agreement may be amended, waived, modified or terminated only with the written consent of the Majority Shareholders; provided, however, that no such amendment, waiver, modification or termination shall (i) change the provisions of Section 8 hereof in any material respect, without the consent of the holders of all Shares or Conversion Shares affected thereby or (ii) change the definition of Majority Shareholders or this Section 16(a) without the written consent of the holders of all the Shares and Conversion Shares then outstanding; and provided further that no such amendment, waiver, modification or termination shall be effective with respect to a term or provision of this Agreement unless it is also effective with respect to the corresponding term or provision, if any, of each other Stock Purchase Agreement and each Stock Exchange Agreement. The Purchaser acknowledges that by operation hereof, the Majority Shareholders (which may not include the Purchaser) will have the right and power to diminish or eliminate certain rights of the Purchaser under this Agreement. -57- (b) The Company agrees that all holders of Shares and Conversion Shares shall be notified by the Company in advance of any proposed amendment, waiver, modification or termination, but failure to give such notice shall not in any way affect the validity of any such amendment, waiver, modification or termination. In addition, promptly after obtaining the written consent of the holders as herein provided, the Company shall transmit a copy of any amendment, waiver, modification or termination which has been adopted to all holders of Shares and Conversion Shares then outstanding, but failure to transmit copies shall not in any way affect the validity of any such amendment, waiver, modification or termination. SECTION 17. EXCHANGE OF SHARES; CANCELLATION OF SURRENDERED SHARES; REPLACEMENT (a) Subject to Section 6 hereof, at any time at the request of any holder of Shares to the Company at its address provided under Section 18 hereof, the Company at its expense (except for any transfer tax arising out of the exchange) will issue and deliver to or upon the order of the holder in exchange therefor a new certificate or certificates therefor in such amount or amounts as such holder may request in the aggregate representing the number of Shares represented by such surrendered certificates, and registered in the name of such holder or otherwise as such holder may direct. (b) Any Share certificate which is converted into Conversion Shares in whole or in part shall be canceled by the Company, and no new Share certificates shall be issued in lieu of any Shares which have been converted into Conversion Shares. The Company shall issue a new certificate with respect to any Shares which were not converted into Conversion Shares and were represented by a certificate which was converted in part. (c) Upon receipt of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of any Share certificate and, in the case of any such loss, theft or destruction, upon delivery of an indemnity agreement reasonably satisfactory to the Company (unsecured in the case of an institutional holder), or in the case of any such mutilation, upon surrender of such Share certificate (which surrendered Share certificate shall be canceled by the Company), the Company will issue a new Share certificate, of like tenor in lieu of such lost, stolen, destroyed or mutilated Share certificate as if the lost, stolen, destroyed or mutilated Share certificate were then surrendered for exchange. SECTION 18. NOTICES -58- All notices, requests, demands, consents and other communications hereunder shall be in writing and shall be delivered by hand or shall be sent by telex or telecopy (confirmed by registered, certified or overnight mail or courier, postage and delivery charges prepaid), if to the Company at the address indicated below, or if to the Purchaser at the address indicated on Schedule I hereto, or at such other address as a party may from time to time designate as its address in writing to the other party to this Agreement. Whenever any notice is required to be given hereunder, such notice shall be deemed given and such requirement satisfied only when such notice is delivered or, if sent by telex or telecopier, when received. (a) If to the Company: Energy BioSystems Corporation 4200 Research Forest Drive The Woodlands, Texas 77381 Attn: Vice President of Finance With a copy to: Andrews & Kurth L.L.P. 4200 Texas Commerce Tower Houston, Texas 77002 Attn: William N. Finnegan, IV (b) If to the Purchaser, at the address of the Purchaser set forth on Schedule I. SECTION 19. MISCELLANEOUS (a) The Stock Purchase Agreements (including all schedules and exhibits thereto) and, upon the closing hereunder, the Series B Certificate of Designations, together with any further agreements entered into by the Purchaser and the Company at the closing hereunder, contain the entire agreement between the Purchaser and the Company, and supersede any prior oral or written agreements, commitments, terms or understandings regarding the subject matter hereof. (b) Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, the parties hereby waive any provision of law which may render any provision hereof prohibited or unenforceable in any respect. -59- (c) If the Company fails to pay any amount required to be paid to a holder of Shares or Conversion Shares or to a party under this Agreement (not including dividends not declared by the Board of Directors), within thirty (30) days after notice from such holder or such party demanding such payment (together with reasonably detailed supporting information), then the Company agrees to pay such holder or such party interest on any such overdue amount at a rate of 10% per annum from the date of such notice from such holder or such party until such overdue amount is paid in full. (d) Unless otherwise expressly provided herein, any provision of this Agreement relating to the consent, determination, decision or waiver of a holder or holders of Shares or Conversion Shares means such holder's consent, determination, decision or waiver in such holder's sole discretion. (e) This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, whether so expressed or not; provided, that the Company may not assign any of its rights, duties or obligations under this Agreement, except in connection with a transaction permitted by Section 7.11 or with the Purchaser's written consent. (f) In addition to any assignment by operation of law, the Purchaser may assign, in whole or in part, any or all of its rights (and/or obligations) under this Agreement to any permitted transferee of any or all of its Shares or Conversion Shares, except as provided in Section 8.10, and (unless such assignment expressly provides otherwise) any such assignment shall not diminish the rights the Purchaser would otherwise have under this Agreement or with respect to any remaining Shares or Conversion Shares held by the Purchaser. (g) No course of dealing and no delay on the part of any party hereto in exercising any right, power, or remedy conferred by this Agreement shall operate as a waiver thereof or otherwise prejudice such party's rights, powers and remedies. No single or partial exercise of any rights, powers or remedies conferred by this Agreement shall preclude any other or further exercise thereof or the exercise of any other right, power or remedy. (h) The headings and captions in this Agreement are for convenience of reference only and shall not define, limit or otherwise affect any of the terms or provisions hereof. (i) This Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware (other than any conflict of laws rule which might result in the application of the laws of any other jurisdiction). -60- (j) This Agreement may be executed by the parties hereto in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute one and the same instrument, and all signatures need not appear on any one counterpart. (k) WAIVER OF JURY TRIAL. THE COMPANY AND THE PURCHASER HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT, THE SERIES B CERTIFICATE OF DESIGNATIONS, THE SHARES OR THE CONVERSION SHARES, OR ANY DEALINGS BETWEEN THEM RELATING TO THE SUBJECT MATTER OF THIS TRANSACTION. THE SCOPE OF THIS WAIVER IS INTENDED TO BE ALL-ENCOMPASSING OF ANY AND ALL DISPUTES THAT MAY BE FILED IN ANY COURT AND THAT RELATE TO THE SUBJECT MATTER OF THIS TRANSACTION, INCLUDING WITHOUT LIMITATION, CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW AND STATUTORY CLAIMS. THE COMPANY AND THE PURCHASER FURTHER WARRANT AND REPRESENT THAT EACH HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL, AND THAT EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. THIS WAIVER IS IRREVOCABLE, MEANING THAT IT MAY NOT BE MODIFIED EITHER ORALLY OR IN WRITING, AND THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO (OR ASSIGNMENTS OF) THIS AGREEMENT, THE CERTIFICATE OF DESIGNATIONS, THE SHARES OR THE CONVERSION SHARES. IN THE EVENT OF LITIGATION, THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL (WITHOUT A JURY) BY THE COURT. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written. ENERGY BIOSYSTEMS CORPORATION By /s/ John H. Webb ---------------- Name: John H. Webb Title: President Accepted and Agreed to as of the date first above written by -61- the undersigned Purchaser: (See Omnibus Signature Page) By ____________________________ Name: Title: -62- SCHEDULE I TO THE STOCK PURCHASE AGREEMENT Purchase Name of Purchaser Number of Shares Price ----------------- ---------------- ----- (a) address for communications: Attn: (b) address for payments by wire transfer: Attn: (providing sufficient information with such wire transfer to identify the source and application of such funds) -63- SCHEDULE II TO THE STOCK PURCHASE AGREEMENT Summary of Registration Rights 1. Piggyback registration rights granted by the Company pursuant to that certain First Amendment to License and Technology Assistance Agreement, dated June 25, 1992, between the Company and Institute of Gas Technology. 2. Demand and piggyback registration rights granted by the Company pursuant to that certain Registration Agreement, dated January 30, 1992, by and among the Company, The Travelers Indemnity Company, The Travelers Indemnity Company of Rhode Island, The Phoenix Insurance Company and Gryphon Ventures II, Limited Partnership. 3. Demand and piggyback registration rights granted by the Company pursuant to that certain Registration Agreement, dated April 29, 1991, by and between the Company and Gryphon Ventures II, Limited Partnership. 4. Registration rights granted by the Company to the holders of the Series A Preferred Stock pursuant to those certain Stock Purchase Agreements dated October 27, 1994. 5. Registration rights granted by the Company to the parties exchanging shares of Series A Preferred Stock for shares of Series B Preferred Stock pursuant to those certain Stock Exchange Agreements dated February 21, 1997. Indebtedness ------------ NONE. -64- EX-4.3 4 FORM OF STOCK EXCHANGE AGREEMENT Exhibit 4.3 SERIES B CONVERTIBLE PREFERRED STOCK EXCHANGE AGREEMENT between ENERGY BIOSYSTEMS CORPORATION and THE EXCHANGING PARTY LISTED ON SCHEDULE I Dated as of February 21, 1997 STOCK EXCHANGE AGREEMENT STOCK EXCHANGE AGREEMENT dated as of February 21, 1997 by and between Energy BioSystems Corporation, a Delaware corporation (the "Company"), and the Exchanging Party listed on Schedule I of this Agreement (the "Exchanging Party"). W I T N E S S E T H : WHEREAS, the Company has offered to the holders of shares of Series A Preferred Stock to exchange (the "Exchange Offer") their shares of Series A Preferred Stock for shares of the authorized but unissued Series B Convertible Preferred Stock, par value $0.01 per share, of the Company (the "Series B Preferred Stock"), and the Exchanging Party desires to exchange its shares of Series A Preferred Stock for shares of Series B Preferred Stock upon the terms and provisions hereinafter set forth. WHEREAS, concurrently with this Exchange Offer, the Company will be selling up to 280,000 shares of the Company's authorized but unissued Series B Preferred Stock to purchasers who will be executing Stock Purchase Agreements substantially similar to this Agreement, containing similar representations and warranties by the Company, covenants of the Company, registration rights, conditions and other terms. NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: SECTION 1. EXCHANGE OF THE PREFERRED SHARES (a) The Company agrees to issue to the Exchanging Party and, subject to the terms and conditions hereof and in reliance upon the representations and warranties of the Company contained herein or made pursuant hereto, the Exchanging Party agrees to exchange all of its shares of Series A Preferred Stock which are set forth opposite the Exchanging Party's name on Schedule I hereto (the "Exchanged Shares") for the same number of shares of the Company's Series B Preferred Stock on the Closing Date specified in Section 2 hereof. The exchange of Exchanged Shares for Shares shall be on a one-for-one basis. The shares of Series B Preferred Stock being acquired under this Agreement and by the other Exchanging Parties under the other Stock Exchange Agreements (as hereinafter defined) are collectively herein referred to as the "Shares", containing rights and privileges as more fully set forth in the Certificate of Designations for the Series B Preferred Stock of the Board of Directors of the Company which shall be substantially in the form attached hereto as Exhibit A (the "Series B Certificate of Designations"). (b) The Shares are being issued to the Exchanging Party listed on Schedule I hereto and to other Exchanging Parties under substantially identical agreements (collectively, the "Exchanging Parties") pursuant to this Agreement and other substantially identical agreements dated as of the date hereof (all such agreements collectively, as from time to time assigned, supplemented or amended or as the terms thereof may be waived, the "Stock Exchange Agreements"). All Stock Exchange Agreements shall be dated the date hereof and shall be identical except as to the identities of the respective Exchanging Parties. The exchange of Exchanged Shares for Shares by each Exchanging Party under each Stock Exchange Agreement is to be a separate exchange, and no Exchanging Party shall have any liability under any Stock Exchange Agreement other than the Stock Exchange Agreement to which it is a party. (c) The Company will not be receiving any proceeds from the exchange of the Exchanged Shares for the Shares. SECTION 2. THE CLOSING (a) Subject to the terms and conditions hereof, the closing of the exchange of the Exchanged Shares for Shares by the Exchanging Party (the "Closing") will take place at the offices of Andrews & Kurth L.L.P., 4200 Texas Commerce Tower, Houston, Texas at 10:00 A.M., Houston, Texas time, on February 26, 1997, or such other location, time and date as shall be determined by the Company and the Agent. The Exchanging Party acknowledges that the Company will conduct an initial closing of the Exchange Offer (the "Initial Closing") concurrently with a closing of the sale of shares of Series B Preferred Stock under one or more Stock Purchase Agreements, and may subsequently conduct an additional closing or closings (a "Subsequent Closing") of the Exchange Offer from time to time thereafter. The Closing shall occur on the date of the Initial closing if the conditions to the Closing have been satisfied on or before the Business Day preceding the Initial Closing and on the date of the Subsequent Closing that follows the satisfaction of such conditions if the Closing does not occur on the date of the Initial Closing. The Subsequent Closing shall take place no later than March 10, 1997 unless such date is extended by the Company in its sole discretion, to a date no later than March 31, 1997. The time and date of the Closing are herein referred to as the "Closing Date." (b) Subject to the terms and conditions hereof, on the Closing Date (i) the Exchanging Party will deliver to the Company the certificate or certificates representing the Exchanged Shares, duly endorsed for transfer to the Company and (ii) the Company will deliver to the Exchanging Party a certificate registered in the Exchanging Party's name (or the name of its nominee, if any, as specified on Schedule I hereto) evidencing the same number of Shares. -2- SECTION 3. DEFINITIONS (a) For purposes of this Agreement, the following definitions shall apply (such definitions to be equally applicable to both the singular and plural forms of the terms defined): "Affiliate", when used with respect to any Person, means (i) if such Person is a corporation, any executive officer or director thereof (other than a director nominated pursuant to the Series B Certificate of Designations) and any Person which is, directly or indirectly, the beneficial owner (by itself or as part of any group) of more than five percent (5%) of any class of any equity security (within the meaning of the Securities Exchange Act) thereof, and, if such beneficial owner is a partnership, any general partner thereof, or if such beneficial owner is a corporation, any Person controlling, controlled by or under common control with such beneficial owner, or any executive officer or director of such beneficial owner or of any corporation occupying any such control relationship, (ii) if such Person is a partnership, any general partner thereof, and (iii) any other Person which, directly or indirectly, controls or is controlled by or is under common control with such Person. For purposes of this definition, "control" (including the correlative terms "controlling", "controlled by" and "under common control with"), with respect to any Person, shall mean possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise. Except as provided above, the holding of Shares (or Conversion Shares obtained upon conversion of Shares), and the rights under any Stock Exchange Agreement or under the Series B Certificate of Designations (or the exercise of any such rights, including, without limitation, nominating a director to the Board of the Company or sending an observer to Board meetings of the Company or any of the Subsidiaries), shall not, by themselves, cause an Exchanging Party to be deemed to be an "Affiliate" of the Company or of any Subsidiary. "Agreement" means this Stock Exchange Agreement (together with exhibits and schedules) as from time to time assigned, supplemented or amended or as the terms hereof may be waived. "Board" or "Board of Directors" means with respect to any Person which is a corporation, a business trust or other entity, the board of directors or other group, however designated, which is charged with legal responsibility for the management of such Person, or any committee of such board of directors or group, however designated, which is authorized to exercise the power of such board or group in respect of the matter in question. "Business Day" means any day other than a Saturday, Sunday or a day on which banking institutions in the State of New York or the State of Texas are authorized or obligated by law or executive order to close. "Capitalized Leases" means any lease to which the Company or a Subsidiary is a party as lessee, or by which it is bound, under which it leases any property (real, personal or mixed) from any lessor other than the Company or a Subsidiary, and which is required to be capitalized in accordance with generally accepted accounting principles consistently applied. -3- "Closing" has the meaning set forth in Section 2(a) hereof. "Closing Date" has the meaning set forth in Section 2(a) hereof. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and the regulations and interpretations thereunder. "Commission" means the Securities and Exchange Commission and any other similar or successor agency of the federal government administering the Securities Act or the Securities Exchange Act. "Common Stock" of the Company or of a Subsidiary (as the case may be) shall mean the Company's or a Subsidiary's (as the case may be) present authorized common stock and any stock into which such Common Stock may hereafter be changed or for which such Common Stock may be exchanged after giving effect to the terms of such change or exchange (by way of reorganization, recapitalization, merger, consolidation or otherwise) and shall also include any common stock of the Company or of a Subsidiary (as the case may be) hereafter authorized and any capital stock of the Company or of a Subsidiary (as the case may be) of any other class hereafter authorized which is not preferred as to dividends or assets over any other class of capital stock of the Company or of a Subsidiary (as the case may be) or which has ordinary voting power for the election of directors of the Company or of a Subsidiary (as the case may be); provided that preferred stock of the Company or a Subsidiary with the right to vote together with the common stock of such entity on various matters shall not be treated as "Common Stock" hereunder. "Company" means Energy BioSystems Corporation, a Delaware corporation, its successors and assigns. "Consent and Exchange Agreement" is the agreement by which holders of Series A Preferred Stock elect to exchange shares of Series A Preferred Stock for shares of Series B Preferred Stock on a one-for-one basis. "Conversion Price" has the meaning specified in Section 2 of the Series B Certificate of Designations. "Conversion Share" or "Conversion Shares" means the shares of the Company's Common Stock, par value $0.01 per share, obtained or obtainable upon conversion of the Shares and shall also include any capital stock or other securities into which Conversion Shares are changed and any capital stock or other securities resulting from or comprising a reclassification, combination or subdivision of, or a stock dividend on, any Conversion Shares. In the event that any Conversion Shares are sold either in a public offering pursuant to a registration statement under Section 6 of the Securities Act or pursuant to a Rule 144 Transaction, then the transferees of such Conversion Shares shall not be entitled to any benefits under this Agreement with respect to such Conversion Shares and such Conversion Shares shall no longer be considered to be "Conversion Shares" for purposes -4- of Section 8 hereof, for purposes of the definition of Majority Shareholders or for purposes of any consent or waiver provision or any other provision of this Agreement. "Eligible Holder" means any holder (or group of affiliated holders) which is an Exchanging Party (or transferee of an Exchanging Party approved by the Company, such approval not to be unreasonably withheld) or a purchaser of Series B Preferred Stock (or transferee of such purchaser approved by the Company, such approval not to be unreasonably withheld) and which holds 100,000 or more Shares, or Conversion Shares issued on conversion of 100,000 or more Shares, or an equivalent combination of the foregoing. "Environmental Lien" has the meaning set forth in Section 7.7 hereof. "ERISA" means, collectively, the Employee Retirement Income Security Act of 1974, as amended, and the regulations and interpretations thereunder. "Exchanged Shares" has the meaning set forth in Section 1(a) hereof. "Exchanging Party" means the person who accepts and agrees to the terms hereof as indicated by such person's signature (as "the undersigned Exchanging Party") on the execution page of this Agreement, together with such person's successors and assigns. "Exchanging Parties" has the meaning set forth in Section l(b) hereof, together with their respective successors and assigns. "Guaranty" means (i) any guaranty or endorsement of the payment or performance of, or any contingent obligation in respect of, any indebtedness or other obligation of any other Person, (ii) any other arrangement whereby credit is extended to one obligor (directly or indirectly) on the basis of any promise or undertaking of another Person (a) to pay the indebtedness of such obligor, (b) to purchase an obligation owed by such obligor, (c) to purchase or lease assets (or to provide funds, goods or services) under circumstances that would enable such obligor to discharge one or more of its obligations or (d) to maintain the capital, working capital, solvency or general financial condition of such obligor, in each case whether or not such arrangement is disclosed in the balance sheet of such other Person or is referred to in a footnote thereto and (iii) any liability as a general partner of a partnership in respect of indebtedness or other obligations of such partnership; provided, however, that the term "Guaranty" shall not include (1) endorsements for collection or deposit in the ordinary course of business or (2) obligations of the Company or its Subsidiaries which would constitute Guaranties solely by virtue of the continuing liability of a Person which has sold assets subject to liabilities for the liabilities which were assumed by the Person acquiring the assets, unless such liability is required to be carried on the consolidated balance sheet of the Company. The amount of any Guaranty and the amount of indebtedness resulting from such Guaranty shall be the maximum amount of the guarantor's potential obligation in respect of such Guaranty. "Hazardous Materials" means any pollutant, toxic substance, petroleum or petroleum by-products, hazardous waste, or any material, compound, element or chemical identified as a pollutant, -5- toxic substance or hazardous waste or determined to be hazardous or toxic by a governmental agency under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA), 42 U.S.C. 9601 et seq., the Resource Conservation and Recovery Act (RCRA), 42 U.S.C. 6901 et seq., the Toxic Substances Control Act (TSCA), 15 U.S.C. 2601 et seq., the Water Pollution Control Act (CWA), 33 U.S.C. 1251 et seq., the Clean Air Act (CAA), 42 U.S.C. 7501 et seq., the Occupational Safety and Health Act (OSHA), 29 U.S.C. 655 and any other federal, state, local or municipal laws, statutes, ordinances, codes, rules or regulations imposing liability or establishing standards of conduct for environmental protection. The term "Hazardous Materials" shall also include: raw materials used or stored by the Company that contain Hazardous Materials; building components (including but not limited to asbestos-containing materials) that contain Hazardous Materials and manufactured products containing Hazardous Materials. "Indebtedness" of any Person means, without duplication, as of any date as of which the amount thereof is to be determined, (i) all obligations of such Person to repay money borrowed (including, without limitation, all notes payable and drafts accepted representing extensions of credit, all obligations under letters of credit, all obligations evidenced by bonds, debentures, notes or other similar instruments and all obligations upon which interest charges are customarily paid), (ii) all Capitalized Leases in respect of which such Person is liable as lessee or as the guarantor of the lessee, (iii) all monetary obligations which are secured by any Lien existing on property owned by such Person whether or not the obligations secured thereby have been incurred or assumed by such Person, (iv) all conditional sales contracts and similar title retention debt instruments under which such Person is obligated to make payments, (v) all Guaranties by such Person and (vi) all contractual obligations (whether absolute or contingent) of such Person to repurchase goods sold or distributed. "Indebtedness" shall not include, however, Indebtedness of the Company to any of its wholly-owned Subsidiaries or Indebtedness of any wholly- owned Subsidiary to the Company or to another wholly-owned Subsidiary. "Lien" means any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), or preference, priority or other security interest of any kind or nature whatsoever (including, without limitation, any conditional sale or other title retention agreement, any financing lease having substantially the same effect as any of the foregoing, any assignment or other conveyance of any right to receive income and any assignment of receivables with recourse against the assignor), any filing of a financing statement as debtor under the Uniform Commercial Code or any similar statute and any agreement to give or make any of the foregoing. "Majority Shareholders" means the holder or holders, at the time, of at least a majority of the Conversion Shares, including the Conversion Shares then outstanding and the Conversion Shares then obtainable under outstanding Shares; provided that such majority must in any event include each Eligible Holder. "Material Adverse Effect" means any material and adverse effect on the assets, properties, liabilities, business affairs, results of operations, condition (financial or otherwise) or prospects of the Company. -6- "Memorandum" means that certain Confidential Offering Memorandum dated February 14, 1997 relating to the Shares. "Outstanding" or "outstanding" means (a) when used with reference to the Shares or the Conversion Shares as of a particular time, all Shares or Conversion Shares theretofore duly issued except (i) Shares and Conversion Shares theretofore reported as lost, stolen, mutilated or destroyed or surrendered for transfer, exchange or replacement, in respect of which new or replacement Shares or Conversion Shares have been issued by the Company, (ii) Shares and Conversion Shares theretofore canceled by the Company and (iii) Shares and Conversion Shares registered in the name of, as well as Shares and Conversion Shares owned beneficially by, the Company, any Subsidiary or any of their Affiliates and (b) when used with reference to the number of shares of Common Stock of the Company as of a particular time, the then issued and outstanding shares of Common Stock of the Company (not including treasury shares or any other shares registered in the name of the Company, any Subsidiary or any of their Affiliates), together with shares of Common Stock of the Company issuable pursuant to any then outstanding warrants, options, convertible securities or other rights to acquire shares of Common Stock of the Company. For purposes of the preceding sentence, in no event shall "Affiliates" include (x) the persons which are identified as "Exchanging Parties" on Schedule I hereto or (y) any Affiliates of any such persons, except if such persons would otherwise fall within the definition of "Affiliate" described above. "Person" or "person" means an individual, corporation, partnership, firm, association, joint venture, trust, unincorporated organization, government, governmental body, agency, political subdivision or other entity. "Preferred Stock" means any class of the capital stock of a corporation (whether or not convertible into any other class of such capital stock) which has any right, whether absolute or contingent, to receive dividends or other distributions of the assets of such corporation (including, without limitation, amounts payable in the event of the voluntary or involuntary liquidation, dissolution or winding-up of such corporation), which right is superior to the rights of another class of the capital stock of such corporation. "Preferred Stock" includes without limitation the Series B Preferred Stock. "Registered Securities" means the Conversion Shares, any Common Stock issued in payment of dividends on, or in connection with the redemption or repurchase of, the Shares and any Shares included herein pursuant to Section 8.1(g) hereof. "Restricted Payment" means (i) every dividend or other distribution paid, made or declared by the Company or any Subsidiary on or in respect of any class of its capital stock (as defined below), and (ii) every payment in connection with the redemption, purchase, retirement or other acquisition by or on behalf of the Company or any Subsidiary of any shares of the Company's or a Subsidiary's capital stock (as defined below), whether or not owned by the Company or any Subsidiary; provided, however, that the restrictions of the foregoing clauses (i) and (ii) shall not apply to (a) any dividend, distribution or other payment on or in respect of capital stock of the -7- Company to the extent payable in shares of Common Stock of the Company, (b) any payments from the Company to a wholly-owned Subsidiary, from a Subsidiary to the Company or from a Subsidiary to a wholly-owned Subsidiary, (c) any repurchase of Common Stock under stock purchase or option agreements from employees, advisors, consultants or directors of the Company or otherwise upon termination of such relationship with the Company (provided, that the aggregate amount paid pursuant to such repurchases after the Closing Date shall not exceed $300,000 without the consent of the Majority Shareholders), (d) any payments, dividends, distributions or other transfers or actions (I) on or with respect to the Company's Series A Preferred Stock or the shares of Common Stock issuable upon conversion thereof pursuant to the terms of the Stock Purchase Agreements or the Certificate of Designations relating to the Series A Preferred Stock should any such shares of Series A Preferred Stock be remaining after the exchange contemplated by this Agreement or (II) on or with respect to the Shares or the Conversion Shares pursuant to terms of the Stock Exchange Agreements, Stock Purchase Agreements or the Series B Certificate of Designations and (e) any payments or distributions in respect of the liquidation and dissolution, or winding up of the business and affairs, of the Company. For purposes of this definition, "capital stock" shall also include warrants and other rights and options to acquire shares of capital stock (whether upon exercise, conversion, exchange or otherwise). "Rights Expiration Date" means, with respect to any Eligible Holder, the earlier of (a) the date on which such Eligible Holder owns neither (i) 100,000 or more Shares nor (ii) Conversion Shares issued on conversion of a number of Shares at least equal to 100,000 less the number of any Shares remaining owned by such Eligible Holder, and (b) the third anniversary of the Closing Date, unless such Eligible Holder then owns 100,000 or more Shares. "Rule 144" means (i) Rule 144 under the Securities Act as such Rule is in effect from time to time and (ii) any successor rule, regulation or law, as in effect from time to time. "Rule 144A" means (i) Rule 144A under the Securities Act as such Rule is in effect from time to time and (ii) any successor rule, regulation or law, as in effect from time to time. "Rule 144 Transaction" means a transfer of Shares or Conversion Shares (A) complying with Rule 144 as such Rule is in effect on the date of such transfer (but not including a sale other than pursuant to (i) "brokers' transactions" as defined in clauses (1) and (2) of paragraph (g) or (ii) paragraph (k) of such Rule as in effect on the date hereof) and (B) occurring at a time when Shares (in the case of a transfer of Shares) or Conversion Shares (in the case of a transfer of Conversion Shares) are registered pursuant to Section 12 of the Securities Exchange Act. "Securities Act" means the Securities Act of 1933, as amended, and the rules, regulations and interpretations thereunder. "Securities Exchange Act" means the Securities Exchange Act of 1934, as amended, and the rules, regulations and interpretations thereunder. "Series A Certificate of Designations" has the meaning set forth in Section 4.2(d) hereof. -8- "Series A Preferred Stock" has the meaning set forth in Section 4.2(a) hereof. "Series B Certificate of Designations" has the meaning set forth in Section l(a) hereof. "Series B Preferred Stock" means the Company's Series B Convertible Preferred Stock, par value $0.01 per share, which will be duly authorized on the Closing Date and which will have the rights, powers and privileges on the Closing Date as more fully set forth in the Series B Certificate of Designations. "Shares" has the meaning set forth in Section l(a) hereof, except that for purposes of Section 7 and Section 8 hereof and the definition of "Conversion Shares," the term "Shares" shall include the shares of Series B Preferred Stock issued upon the exercise of the warrant, dated the date hereof, granting Alex. Brown & Sons Incorporated (the "Agent") the right to purchase a specified number of shares of Series B Preferred Stock and the shares of Series B Preferred Stock issued upon the sale of shares of Series B Preferred Stock to purchasers pursuant to the Stock Purchase Agreements. In the event that any Shares are sold either in a public offering pursuant to a registration statement under Section 6 of the Securities Act or pursuant to a Rule 144 Transaction, then the transferees of such Shares shall not be entitled to any benefits under this Agreement with respect to such Shares and such Shares shall no longer be considered to be "Shares" for purposes of Section 8 hereof or any consent or waiver provision or any other provision of this Agreement. "Stock Exchange Agreements" has the meaning set forth in Section 1(b) hereof. "Stock Purchase Agreements" means the Series B Convertible Stock Purchase Agreements, dated the date hereof, by which purchasers agree to purchase and the Company agrees to sell shares of its authorized but unissued shares of Series B Preferred Stock, par value $.01 per share. The Stock Purchase Agreement is substantially similar to this Agreement, containing similar representations and warranties by the Company, covenants of the Company, registration rights, conditions and other terms. "Subsidiary", with respect to any Person, means any corporation, association or other entity of which more than 50% of the total voting power of shares of stock or other equity interests (without regard to the occurrence of any contingency) entitled to vote in the election of directors, managers or trustees thereof is, at the time as of which any determination is being made, owned or controlled, directly or indirectly, by such Person or one or more of its Subsidiaries, or both. The term "Subsidiary" or "Subsidiaries" when used herein without reference to any particular Person, means a Subsidiary or Subsidiaries of the Company. (b) For all purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires: (i) the words "herein", "hereof" and "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular Section or other subdivision; -9- (ii) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles consistently applied (except as otherwise provided herein); (iii) all computations provided for herein, if any, shall be made in accordance with generally accepted accounting principles consistently applied (except as otherwise expressly provided herein); (iv) any uses of the masculine, feminine or neuter gender shall also be deemed to include any other gender, as appropriate; (v) all references herein to actions by the Company or any Subsidiary, such as "create", "sell", "transfer", "dispose of", etc., mean such action whether voluntary or involuntary, by operation of law or otherwise; (vi) the exhibits and schedules to this Agreement shall be deemed a part of this Agreement; (vii) each of the representations of the Company contained in Section 4 hereof is separate and is not limited, qualified or modified by the existence, wording or satisfaction of any other representation of the Company in Section 4 or otherwise; (viii) each of the covenants of the Company contained in Section 7 hereof or otherwise contained in any Stock Exchange Agreement or the Series B Certificate of Designations is separate and is not limited or satisfied by the existence, wording or satisfaction of any other covenant of the Company in Section 7 or otherwise; and (ix) all references herein (in covenants or otherwise) to any action(s) which are to be taken (or which are prohibited from being taken) by any Person, the Company or any Subsidiary shall apply to such Person, the Company or such Subsidiary, as the case may be, whether such action is taken directly or indirectly. SECTION 4. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to the Exchanging Party as follows as of the date hereof and as of the Closing Date: 4.1 Corporate Existence, Power and Authority. (a) The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company is duly qualified, licensed and authorized to -10- do business and is in good standing in each jurisdiction in which it owns or leases any material property or in which the conduct of its business requires it to so qualify or be so licensed. (b) The Company has no Subsidiaries, and does not control, directly or indirectly, any other entity and does not own of record or beneficially, directly or indirectly, (i) any shares of capital stock or securities convertible into capital stock of any other corporation (except for short-term investments of the Company's cash reserves and publicly-traded mutual funds) or (ii) any participating interest in any partnership, joint venture or other non- corporate business enterprise, except for the strategic alliances described in the Memorandum. (c) No proceeding has been commenced looking toward the dissolution or merger of the Company or the amendment of its certificate of incorporation (other than the Series B Certificate of Designations). The Company is not in violation in any respect of its certificate of incorporation or bylaws. (d) The Company has all requisite power, authority (corporate and other) and legal right to own or to hold under lease and to operate the properties it owns or holds and to conduct its business as now being conducted and as proposed to be conducted, except where the failure to have such requisite power, authority and legal right would not result in a Material Adverse Effect. (e) The Company has all requisite power, authority (corporate and other) and legal right to execute, deliver, enter into, consummate and perform the Stock Exchange Agreements, including, without limitation, the issuance, exchange and delivery by the Company of the Shares and to issue and deliver the Conversion Shares issuable upon conversion of the Shares as contemplated herein and therein and in the Series B Certificate of Designations. The execution, delivery and performance of the Stock Exchange Agreements by the Company (including, without limitation, the issuance, exchange and delivery by the Company of the Shares and the issuance and delivery of the Conversion Shares upon conversion of the Shares as contemplated herein and therein and in the Series B Certificate of Designations) have been duly authorized by all required corporate and other actions. As described in the Memorandum, the Company may not have the ability to pay dividends on the Shares under certain circumstances. The Company has duly executed and delivered the Stock Exchange Agreements. The Stock Exchange Agreements constitute the legal, valid and binding obligations of the Company enforceable in accordance with their respective terms, subject to bankruptcy, insolvency, reorganization, moratorium and other similar laws relating to the rights of creditors generally and except that the enforceability of the indemnification provisions contained in the Stock Exchange Agreements may be subject to considerations of public policy. 4.2 Stock. (a) The authorized capital stock of the Company consists of (i) 30,000,000 shares of Common Stock, par value $0.01 per share, and (ii) 5,000,000 shares of Preferred Stock, par value $0.01 per share, issuable in one or more series, of which, after giving effect to the Series B Certificate of Designations, (w) 508,800 shares have been designated as Series A Convertible Preferred Stock ("Series A Preferred Stock"), (x) 904,000 shares have been designated as Series B -11- Preferred Stock, (y) 300,000 shares have been designated as Series One Junior Participating Preferred Stock and (z) 3,287,200 shares are Undesignated Preferred Stock. On the Closing Date and before giving effect to the exchange of any shares of Series A Preferred Stock into shares of Series B Preferred Stock: (A) 11,505,395 shares of the Company's Common Stock, par value $0.01 per share, will be issued and outstanding (plus any shares of Common Stock issued after February 13, 1997 pursuant to stock options in effect on such date), (B) 480,000 shares of Series A Preferred Stock will be issued and outstanding and (C) up to 280,000 Shares of the Series B Preferred Stock will be outstanding. The number of shares of Series A Preferred Stock will be reduced and the number of shares of Series B Preferred Stock will be increased on a one-for-one basis to the extent that shares of Series A Preferred Stock are exchanged for shares of Series B Preferred Stock in the Exchange Offer. All of such outstanding shares will be duly authorized, validly issued and outstanding, fully paid and non-assessable with no personal liability attaching to the ownership thereof. The Shares issued and delivered pursuant to this Stock Exchange Agreement will be free and clear of all liens, charges, restrictions, claims and encumbrances imposed by or through the Company. The Conversion Shares have been reserved for issuance upon conversion of the Shares and, when issued in accordance with the terms of the Shares, will be duly authorized, validly issued, fully paid and non-assessable. None of the shares of the Company's capital stock outstanding at Closing (including, without limitation, the Shares issued under the Stock Exchange Agreements) (i) are subject to preemptive rights or (ii) provide the holders thereof with any preemptive rights with respect to any issuances of capital stock. Neither the issuance, exchange or delivery of the Shares nor the issuance or delivery of the Conversion Shares is subject to any preemptive right of stockholders of the Company or to any right of first refusal or other right in favor of any person. (b) The only shares of the Company's Common Stock reserved for issuance by the Company are as follows (before giving effect to the exchange of any shares of Series A Preferred Stock into shares of Series B Preferred Stock): (i) 3,083,636 shares issuable upon conversion of the Series A Preferred Stock (including the Series A Preferred Stock issuable upon the exercise of warrants issued to the placement agents in connection with the offering of the Series A Preferred Stock), (ii) 2,105,862 shares issuable upon conversion of the Series B Preferred Stock (including the Series B Preferred Stock issuable upon the exercise of warrants issued to the Agent in connection with the offering of the Series B Preferred Stock), (iii) 2,030,964 shares issuable upon exercise of currently outstanding stock options pursuant to the Company's 1992 Stock Compensation Plan, its Non-Employee Director Stock Option Plan and director and consultant stock option agreements and (iv) 263,020 shares reserved for issuance pursuant to the 1992 Stock Compensation Plan, the Non-Employee Director Stock Option Plan and the Company's 1997 Stock Option Plan with respect to which no options are presently outstanding. (c) Except as referred to in Section 4.2(b) or in the Company's Amended and Restated Certificate of Incorporation, there are no outstanding options, warrants, subscriptions, rights, convertible securities or other agreements or plans under which the Company may become obligated to issue, sell, exchange or transfer shares of its capital stock or other securities. -12- (d) The designations, powers, preferences, rights, qualifications, limitations and restrictions in respect of each class and series of authorized capital stock of the Company are as set forth in the Amended and Restated Certificate of Incorporation of the Company and the Certificate of Designations with respect to the Series A Preferred Stock (the "Series A Certificate of Designations"), a copy of each of which is attached hereto as Exhibit B and Exhibit C, respectively, and the Series B Certificate of Designations. (e) Except as contemplated by Section 8 hereof or as summarized on Schedule II hereto, there are no outstanding registration rights with respect to any capital stock of the Company. (f) Except as provided in the Series A Certificate of Designations and the Series B Certificate of Designations, the Company has no obligation (contingent or other) to purchase, redeem or otherwise acquire any of its capital stock or any interest therein or to pay any dividend or make any other distribution in respect thereof. (g) The Company has no knowledge of any voting agreements, voting trusts, stockholders' agreements, proxies or other agreements or understandings that are currently in effect or that are currently contemplated with respect to the voting of any capital stock of the Company. (h) There are no anti-dilution protections or other adjustment provisions in existence with respect to any capital stock of the Company or any capital stock referred to in Section 4.2(b) or 4.2(c) above, except with respect to the Shares and except as provided in the Amended and Restated Certificate of Incorporation of the Company, the Series A Certificate of Designations and for standard provisions in option agreements under the Company's plans for employees, directors, consultants and advisors and in the warrants and warrant agreements issued by the Company and described in (b) above. (i) All of the outstanding securities of the Company were issued in compliance with all applicable federal and state securities laws. (j) The Series B Certificate of Designations has been duly adopted by the Company and is fully effective. The Series B Certificate of Designations accurately describes all of the rights, priorities and terms of the Shares. 4.3 Business. The Company is engaged in the business of developing and commercializing innovative biotechnology-based processes for the petroleum refining and production industries. The Company -13- does not currently engage in, or have any intention of engaging in, any other business other than that which is described in the Memorandum. 4.4 No Defaults or Conflicts. (a) The Company is not in violation or default in any material respect under any indenture, agreement or instrument to which it is a party or by which it or its properties may be bound. The Company is not in violation of or default in any material respect under any law, rule, regulation, order, writ, injunction, judgment, decree, award or other action of any court or governmental authority or arbitrator(s). The Company is not in violation of its certificate of incorporation or bylaws. (b) The execution, delivery and performance by the Company of the Stock Exchange Agreements and any of the transactions contemplated hereby or thereby (including, without limitation, the issuance of the Shares and the Conversion Shares as contemplated herein and therein and in the Series B Certificate of Designations and the adoption of the Series B Certificate of Designations) does not and will not (i) violate or conflict with, with or without the giving of notice or the passage of time or both, any provision of (A) the certificate of incorporation or bylaws of the Company or (B) any law, rule, regulation or order of any federal, state, county, municipal or other governmental authority, or any judgment, writ, injunction, decree, award or other action of any court or governmental authority or arbitrator(s), or any agreement, indenture or other instrument applicable to the Company or any of its properties, except in the case of this clause (B) for such violations or conflicts that will not individually or in the aggregate have a Material Adverse Effect, (ii) result in the creation of any Lien upon any of the Company's properties, assets or revenues, (iii) require the consent, waiver, approval, order or authorization of, or declaration, registration, qualification or filing with, any Person (whether or not a governmental authority and including, without limitation, any shareholder approval) except for required securities law filings and board of director approvals, certain approvals of the holders of Series A Preferred Stock and certain registration rights modifications, which board of director and Series A Preferred Stockholder approvals and registration rights modifications have been obtained or (iv) cause anti-dilution clauses of any outstanding securities to become operative except with respect to the Series A Preferred Stock pursuant to the Series A Certificate of Designations or give rise to any preemptive rights. No provision referred to in the preceding clause (i) materially adversely affects or reasonably may be expected to materially adversely affect the continued conduct of the Company's business as described in the Memorandum or the ability of the Company to perform its obligations under the Stock Exchange Agreements, the Series B Certificate of Designations or any of the transactions contemplated hereby or thereby. 4.5 Disclosure Materials: Other Information. (a) The Company has furnished to the Exchanging Party the Memorandum and the documents incorporated therein (the "Disclosure Material"). The audited and unaudited financial statements referred to or contained in the Disclosure Material fairly present the financial condition of the Company as of the respective dates thereof and the results of the operations of the Company -14- for such periods and have been prepared in accordance with generally accepted accounting principles consistently applied, except that any such unaudited statements may omit notes and may be subject to normal year-end adjustments. (b) Since December 31, 1995, (i) the business of the Company has been conducted in the ordinary course and (ii) there has been no material adverse change in the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company that has not been described in the Disclosure Material. As of the Closing Date and as of the date hereof, there are no material liabilities of the Company which would be required to be provided for in a balance sheet of the Company as of either such date prepared in accordance with generally accepted accounting principles consistently applied, other than liabilities provided for in the financial statements referred to in Section 4.5(a) above. Since December 31, 1995, no amount or property has directly or indirectly been declared, ordered, paid, made or set aside for any Restricted Payment nor has any such action been agreed to. (c) The Company is not aware of any material liabilities, contingent or otherwise, of the Company that have not been disclosed in the financial statements (including the notes thereto) referred to in Section 4.5(a) above or otherwise disclosed in the Disclosure Material. (d) Nothing has come to the attention of the Company that would cause it to believe that any of the Disclosure Material contained or contains a false or misleading statement of a material fact or omits to state any material fact necessary in order to make the statements made in such material, in light of the circumstances under which they were made, not misleading. (e) There is no fact known to the Company which is not in the Disclosure Material and which materially and adversely affects, or would reasonably be expected to materially and adversely affect, the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. 4.6 Litigation. There is no action, suit, proceeding, investigation or claim pending against the Company or, to the knowledge of the Company, threatened against the Company in law, equity or otherwise before any federal, state, municipal or local court, administrative agency, commission, board, bureau, instrumentality or arbitrator which either (i) questions the validity of the Stock Exchange Agreements, the Series B Certificate of Designations, the Shares or the Conversion Shares or any action taken or to be taken pursuant hereto or thereto, or (ii) might adversely affect the right, title or interest of any Exchanging Party to the Shares or the Conversion Shares or (iii) might result in a material adverse change in the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. The Company has not received any opinion or memorandum or legal advice from legal counsel to the effect that it is exposed, from a legal standpoint, to any liability or disadvantage which may be material to its assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects. There is no action or suit by the Company pending or threatened against others. -15- 4.7 Taxes. The Company has filed all federal, state, local and other tax returns and reports (except for foreign returns and reports the failure to file which will not result in any material liability to the Company), and any other material returns and reports with any governmental authorities (federal, state or local), required to be filed by it. The Company has paid or caused to be paid all taxes (including interest and penalties) that are due and payable, except those which are being contested by it in good faith by appropriate proceedings and in respect of which adequate reserves are being maintained on its books in accordance with generally accepted accounting principles consistently applied. The Company does not have any material liabilities for taxes other than those incurred in the ordinary course of business and in respect of which adequate reserves are being maintained by it in accordance with generally accepted accounting principles consistently applied. Federal and state income tax returns for the Company have not been audited by the Internal Revenue Service or state authorities. No deficiency assessment with respect to or proposed adjustment of the Company's federal, state, local or other tax returns is pending or, to the best of the Company's knowledge, threatened. There is no tax lien, whether imposed by any federal, state, local or other tax authority outstanding against the assets, properties or business of the Company. There are no applicable taxes, fees or other governmental charges payable by the Company in connection with the execution and delivery of the Stock Exchange Agreements or the issuance by the Company of the Shares or the Conversion Shares, except for governmental fees paid in connection with securities law filings. 4.8 Employees; ERISA. The Company has good relationships with its employees and has not had and does not expect to have any substantial labor problems. The Company does not have any knowledge as to any intentions of any key employee or any group of employees to leave the employ of the Company. Each of the officers of the Company, each key employee and each other employee now employed by the Company who has access to proprietary business information of the Company has executed a confidentiality and non-disclosure agreement and such agreements are in full force and effect. Other than the Company's Simplified Employee Pension Plan adopted in April 1992, the Company has not established, sponsored, maintained, made any contributions to or been obligated by law to establish, maintain, sponsor or make any contributions to any "employee pension benefit plan" or "employee welfare benefit plan" (as such terms are defined in ERISA), including, without limitation, any "multi-employer plan". The Company has complied in all material respects with all applicable laws relating to the employment of labor, including provisions relating to wages, hours, equal opportunity, collective bargaining and the payment of Social Security and other taxes, and with ERISA. 4.9 Legal Compliance. (a) The Company has complied with all applicable laws, rules, regulations, orders, licenses, judgments, writs, injunctions, decrees or demands, except to the extent that failure to -16- comply would not materially adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. The Company has all necessary permits, licenses and other authorizations required to conduct its business as currently conducted, and as proposed to be conducted, in all material respects. (b) There are no adverse orders, judgments, writs, injunctions, decrees or demands of any court or administrative body, domestic or foreign, or of any other governmental agency or instrumentality, domestic or foreign, outstanding against the Company. (c) There is no existing law, rule, regulation or order, and the Company is not aware of any proposed law, rule, regulation or order, which would prohibit or materially restrict the Company from, or otherwise materially adversely affect the Company in, conducting its business as now being conducted and as proposed to be conducted. 4.10 Permits, Licenses and Approvals. The Company owns or possesses and holds free from restrictions or conflicts with the rights of others all franchises, licenses, permits, consents, approvals and other authority (governmental or otherwise), and all rights and privileges with respect to the foregoing, as are necessary for the conduct of its business as now being conducted, and as proposed to be conducted, except where the failure to own or possess and hold such franchises, licenses, permits, consents, approvals and other authority (governmental or otherwise) would not have a Material Adverse Effect, and none is in default in any material respects under any of such franchises, licenses, permits, consents, approvals or other authority. 4.11 Patents, Trademarks and Other Rights. The Company has sufficient trademarks, trade names, service marks, patent rights, copyrights, manufacturing processes, formulae, applications, trade secrets, know how, licenses, approvals and governmental authorizations (or rights thereto)(collectively, the "Intellectual Property") to conduct its business as now conducted and the Company believes that it will be able to obtain such Intellectual Property as will be necessary to conduct its business as proposed to be conducted except in either case where the absence of such Intellectual Property would not have a Material Adverse Effect. No claim is pending or, to the Company's knowledge, threatened to the effect that any such Intellectual Property owned or licensed by the Company, or which the Company otherwise has the right to use, is invalid or unenforceable by the Company, and, to the best of the Company's knowledge, there is no basis for any such claim (whether or not pending or threatened). To the best of the Company's knowledge, all proprietary technology developed by or belonging to the Company and material to its business which has not been patented has been kept confidential by the Company, its employees and agents. The Company has no knowledge of any infringement by it of any Intellectual Property or other similar rights of others, and there is no claim being made or, to the Company's knowledge, threatened against the Company regarding infringement by the Company on such Intellectual Property of others which could reasonably be expected to have a -17- Material Adverse Effect and, to the Company's knowledge, there is no basis for any such claim (whether or not pending or threatened). 4.12 Status Under Certain Statutes. The Company is not: (i) a "public utility company" or a "holding company", or an "affiliate" or a "subsidiary company" of a "holding company", or an "affiliate" of such a "subsidiary company", as such terms are defined in the Public Utility Holding Company Act of 1935, as amended, (ii) a "public utility" as defined in the Federal Power Act, as amended, or (iii) an "investment company" or an "affiliated person" thereof or an "affiliated person" of any such "affiliated person", as such terms are defined in the Investment Company Act of 1940, as amended. 4.13 Title to Properties; Leasehold Interests. The Company has good and marketable title to each of the properties and assets owned by it. The Company does not own any real property. Certain real property used by the Company in the conduct of its business is held under lease, and the Company is not aware of any pending or threatened claim or action by any lessor of any such property to terminate any such lease. None of the properties owned or leased by the Company is subject to any Liens which could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. Each lease or agreement to which the Company is a party under which it is the lessee of any property, real or personal, is a valid and subsisting agreement without any material default of the Company thereunder and, to the best of the Company's knowledge, without any material default thereunder of any other party thereto. No event has occurred and is continuing which, with due notice or lapse of time or both, would constitute a default or event of default by the Company under any such lease or agreement or, to the best of the Company's knowledge, by any party thereto, except for such defaults that would not individually or in the aggregate have a Material Adverse Effect. The Company's possession of such property has not been disturbed and, to the best of the Company's knowledge, no claim has been asserted against it adverse to its rights in such leasehold interests. 4.14 Environmental Compliance. (a) There is no Hazardous Material about or in, any property, real or personal, in which the Company has any interest, in violation of law in a manner which could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. (b) There is no (and has not been any) off-site disposal or on-site disposal at any locations currently or formerly owned or occupied by the Company as a result of which disposal there would exist a reasonably foreseeable risk that the Company would incur a material liability or obligation under federal, state or local environmental or other laws, regulations or ordinances. -18- (c) Neither the Company nor, to the best of the knowledge of the Company, any prior or present owner, operator, tenant, subtenant or invitee of any of the real property (including improvements) currently or formerly owned or occupied by the Company has (i) used, installed, stored, spilled, released, transported, disposed of or discharged any Hazardous Material upon, into, beneath, from or affecting such real property (including improvements) in violation of law in a manner which could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company, or (ii) received any verbal or written notice, citation, subpoena, summons, complaint or other correspondence or communication from any Person (not previously satisfactorily resolved) with respect to the presence of Hazardous Material upon, into, beneath, or emanating from or affecting any of the real property (including improvements) currently or formerly owned or occupied by the Company which could materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. (d) There has been no intentional or unintentional, gradual or sudden, release, disposal or discharge upon, into or beneath the real property (including improvements) currently or formerly owned or occupied by the Company by the Company or, to the best of the knowledge of the Company, by any prior owner, operator, tenant, subtenant or invitee with respect thereto, that has caused or is causing soil or ground water contamination which under applicable environmental laws, regulations or ordinances could require investigation or remediation or could otherwise create a material liability or obligation on the part of the Company. 4.15 Disaster. Neither the business nor the properties of the Company is currently affected (or has been affected at any time since December 31, 1995) by any fire, explosion, accident, strike, lockout or other dispute, drought, storm, hail, earthquake, embargo, act of God or of the public enemy or other casualty (whether or not covered by insurance), of a kind which (individually or in the aggregate) has materially adversely affected, or could reasonably be expected to materially adversely affect, the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. 4.16 No Burdensome Agreements; Transactions with Affiliates. Except as disclosed in the Disclosure Material, the Company is not a party to, or bound by (nor is any of its properties affected by), any commitment, contract or agreement, any term of which materially adversely affects, or which the Company expects in the future to materially adversely affect, the assets, properties, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. Except as disclosed in the Disclosure Material, the Company is not a party to any contract or agreement with any Affiliate of the Company. The terms of any contracts or agreements between the Company and any of its Affiliates are no less favorable to the Company -19- than those which might have been obtained, at the time such contract or agreement was entered into, from a person who was not such an Affiliate. 4.17 Other Names. The business previously or presently conducted by the Company has not been conducted under any corporate, trade or fictitious name other than "Energy BioSystems Corporation" and "Environmental BioScience Corporation", which was the name of the Company until it was so changed in March 1992. 4.18 Offering of the Shares. Neither the Company nor, to the knowledge of the Company, any person authorized or employed by the Company as agent, broker, dealer or otherwise acting on its behalf, directly or indirectly, (i) offered any of the Shares or any similar security of the Company (A) by any form of general solicitation or general advertising (within the meaning of Regulation D under the Securities Act) or (B) for sale to or solicited offers to buy any thereof from, or otherwise approached or negotiated with respect thereto with, any person which the Company did not reasonably believe was an "accredited investor" within the meaning of Regulation D under the Securities Act or (ii) has done or caused to be done (or has omitted to do or to cause to be done) any act, which act (or which omission) would result in bringing the issuance or sale of the Shares within the provisions of Section 5 of the Securities Act or the filing, notification or reporting provisions of any state securities laws, except for filings, notices or reports pursuant to state securities laws which have already been made or which are contemplated in connection with the offering and exchange of the Shares. 4.19 No Foreign Assets Control Regulation Violation. The transactions contemplated by this Agreement will not result in a violation of any of the foreign assets control regulations of the United States Treasury Department, 31 C.F.R., Subtitle B, Chapter V, as amended (including, without limitation, the Foreign Assets Control Regulations, the Transaction Control Regulations, the Cuban Assets Control Regulations, the Foreign Funds Control Regulations, the Iranian Assets Control Regulations, the Nicaraguan Trade Control Regulations, the South African Transactions Regulations, the Libyan Sanctions Regulations, the Soviet Gold Coin Regulations, the Panamanian Transactions Regulations, the Kuwaiti Assets Control Regulations and the Iraqi Sanctions Regulations contained in said Chapter V), or any ruling issued thereunder or any enabling legislation or other Presidential Executive Order granting authority therefor, and the proceeds of the sale of the Shares will not be used by the Company in a manner which would violate any such regulations. 4.20 Indebtedness. Schedule II hereto sets forth (i) the amount of all Indebtedness of the Company outstanding on the Closing Date (excluding Indebtedness in individual amounts of less than $35,000, but not exceeding an aggregate excluded amount of $75,000), (ii) any Lien with respect to such Indebtedness -20- and (iii) a brief description of each instrument or agreement governing such Indebtedness. The Company has made available to the Exchanging Party a complete and correct copy of each such instrument or agreement (including all amendments, supplements or modifications thereto). No default exists with respect to or under any such Indebtedness or any instrument or agreement relating thereto. 4.21 Proprietary Information of Third Parties. No third party has claimed or, to the best of the Company's knowledge, has reason to claim that any person now or previously employed or engaged as a consultant by the Company has (a) violated or, to the Company's knowledge, may be violating any of the terms or conditions of his employment, non-competition or non-disclosure agreement with such third party, (b) disclosed or, to the best of the Company's knowledge, may be disclosing or utilized or, to the best of the Company's knowledge, may be utilizing any trade secret or proprietary information of documentation of such third party or violated any confidential relationship which such person may have had with such third party in connection with the business of the Company or (c) interfered or may be interfering in the employment relationship between such third party and any of its present or former employees. No third party has requested information from the Company which reasonably suggests that such a claim might be contemplated. To the best of the Company's knowledge, none of the execution or delivery of the Stock Exchange Agreements, or the carrying on the business of the Company as officers, employees or agents by any officer, director or key employee of the Company, or the conduct or proposed conduct of the business of the Company, will conflict with or result in a breach of the terms, conditions or provisions of or constitute a default under any contract, covenant or instrument under which any such individual is obligated. 4.22 Insurance. The Company holds valid policies covering insurance in the amounts and type that the Company reasonably believes is appropriate and customary for companies in the same or similar businesses to that of the Company or otherwise required to be maintained by it. 4.23 Material Contracts and Agreements. With respect to all material contracts, agreements, indentures or instruments not otherwise specifically referred to herein, the Company and, to the best of the Company's knowledge, each other party thereto have in all material respects performed all the obligations required to be performed by them to date, have received no notice of default and are not in default, in any material respect, (with due notice or lapse of time or both) under any material contract, agreement, indenture or other instrument now in effect to which the Company is a party or by which it or its property may be bound. The Company has no present expectation or intention of not fully performing all its obligations under each such material contract, agreement, indenture or other instrument and the Company has no knowledge of any breach and has received no written notice of any anticipated breach by the other party to any material contract or commitment which the Company is a party. -21- 4.24 Governmental Approvals. Subject to the accuracy of the representations and warranties of the Exchanging Party set forth in Section 5 hereof, no registration or filing with, or consent or approval of or other action by, any federal, state or other governmental agency or instrumentality is or will be necessary for the valid execution, delivery and performance by the Company of this Stock Exchange Agreement, the issuance, exchange and delivery of the Shares to the Exchanging Party or, upon conversion thereof, the issuance and delivery of the Conversion Shares, other than filings pursuant to federal and state securities laws (all of which filings have been or, with respect to those filings which may be duly made after the Closing will be, made by or on behalf of the Company) in connection with the exchange of the Shares. 4.25 Brokers. The Company has no contract, arrangement or understanding with any broker, finder or similar agent with respect to the transactions contemplated by this Agreement. 4.26 Disclosure. The Disclosure Material, as of its date, does not contain an untrue statement of a material fact or omit a material fact necessary to make the statements contained therein, in light of the circumstances under which they were made, not misleading. All of the statements contained in this Stock Exchange Agreement, including any Schedule or Exhibit hereto, and contained in any document, certificate or other items prepared or supplied by the Company directly to the Exchanging Party with respect to the transactions contemplated hereby are accurate in all material respects. There is no fact which the Company has not disclosed to the Exchanging Party in writing and of which the Company is aware which materially and adversely affects or could reasonably be expected to materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. SECTION 5. REPRESENTATIONS OF THE EXCHANGING PARTY The Exchanging Party hereby makes the representations and warranties to the Company contained in this Section 5. (a) The Exchanging Party has all requisite power, authority and legal right to execute, deliver, enter into, consummate and perform this Agreement. The execution, delivery and performance of this Agreement by the Exchanging Party have been duly authorized by all required corporate, partnership or other actions on the part of the Exchanging Party. The Exchanging Party has duly executed and delivered this Agreement, and this Agreement constitutes the legal, valid and binding obligation of the Exchanging Party enforceable against the Exchanging Party in accordance with its terms, subject to bankruptcy, insolvency, reorganization, moratorium and other similar laws relating to the rights of creditors generally. -22- (b) The Exchanging Party hereby represents to the Company that it has substantial knowledge, skill and experience in making investment decisions of this type, it is capable of evaluating the risk of its investment in the Shares being received by it pursuant to the exchange and is able to bear the economic risk of such investment, including the risk of losing the entire investment, that (except as the Exchanging Party has otherwise advised the Company and the Exchanging Party's counsel in writing) it is taking the Shares to be received by it upon the exchange for its own account, and that the Shares are being exchanged by it for investment and not with a present view to any distribution thereof in violation of applicable securities laws. It is understood that the disposition of the Exchanging Party's property shall at all times be within the Exchanging Party's control. If the Exchanging Party should in the future decide to dispose of any of its Shares, it is understood that it may do so only in compliance with the Securities Act, applicable state securities laws and this Agreement. The Exchanging Party represents that it is an "accredited investor" as defined in Rule 501(a) under the Securities Act. (c) The Exchanging Party has received and reviewed the Memorandum and it has had an opportunity to fully discuss the Company's business, management and financial affairs with the Company's management. (d) The Exchanging Party understands that (i) the Shares and the Conversion Shares have not been registered under the Securities Act by reason of their issuance in a transaction exempt from the registration requirements of the Securities Act pursuant to Section 4(2) or Section 3(b) thereof or Rule 506 promulgated under the Securities Act, (ii) the Shares and, upon conversion thereof, the Conversion Shares must be held indefinitely unless a subsequent disposition thereof is registered under the Securities Act or is exempt from such registration and (iii) the Shares and the Conversion Shares will bear a legend to such effect. (e) The Exchanging Party represents that at no time was the Exchanging Party presented with or solicited by or through any leaflet (other than the Memorandum), public promotional meeting, advertisement or any other form of general or public advertising or solicitation. In addition, the Exchanging Party acknowledges that there has never been any representation, guaranty or warranty made by the Company or any agent or representative of the Company as to the amount of or type of consideration or profit, if any, to be realized as a result of any investment by the Exchanging Party in the Preferred Stock. (f) If the Exchanging Party is a resident of the State of Florida, he understands that he has the privilege of voiding the exchange within three (3) days after the first tender of consideration is made by such Exchanging Party to the Company or an agent of the Company. (g) If the Exchanging Party is a resident of the Commonwealth of Pennsylvania, he will not sell his Shares within 12 months from the date of receipt upon exchange unless the Shares are registered under the Pennsylvania Securities Act of 1972 or the Securities Act. -23- SECTION 6. RESTRICTIONS ON TRANSFER (a) The Exchanging Party agrees that it will not sell or otherwise dispose of any Shares or Conversion Shares unless (i) such Shares or Conversion Shares have been registered under the Securities Act and, to the extent required, under any applicable state securities laws, or (ii) such Shares or Conversion Shares are sold in accordance with the applicable requirements and limitations of Rule 144 or Rule 144A, or (iii) the Company has been furnished with an opinion or opinions from counsel to the Exchanging Party (which counsel and which opinion(s) shall be reasonably satisfactory to the Company and which counsel may be inside counsel to the Exchanging Party) to the effect that registration under the Securities Act is not required for the transfer as proposed (which opinion may be conditioned upon the transferee assuming the obligations of a holder of Shares or Conversion Shares under this Section) or (iv) the Company has been furnished with a letter from the Division of Corporate Finance of the Commission to the effect that such Division would not recommend any action to the Commission if such proposed transfer were effected without a registration statement effective under the Securities Act. The Company agrees that within five (5) Business Days after receipt of any opinion referred to in (iii) above, it will notify the holder supplying such opinion whether such opinion is satisfactory to the Company. (b) The Company may endorse on all certificates evidencing Shares or Conversion Shares a legend stating or referring to the transfer restrictions contained in paragraph (a) above; provided, that no such legend shall be endorsed on any certificates which, when issued, are no longer subject to the restrictions of this Section 6; provided, further, that if a transfer is made pursuant to clause (i), (ii) (other than pursuant to Rule 144A) or (iv) of paragraph (a) of this Section 6, or if an opinion of counsel provided pursuant to clause (iii) of paragraph (a) concludes that the legend is no longer necessary, the Company will deliver upon transfer, certificates without such legends. SECTION 7. COVENANTS OF THE COMPANY The Company covenants and agrees, so long as (i) any Shares are outstanding or (ii) there are any Eligible Holders, whichever is longer (unless such other period is expressly provided in any subsections of this Section 7, in which case such specific period will govern) as follows: 7.1 Use of Proceeds. The Company will use the proceeds from the sale of the Shares pursuant to the Stock Purchase Agreements for purposes described in the section of the Memorandum entitled "Use of Proceeds." No portion of such proceeds will be used for the purpose, whether immediate, incidental or ultimate, of purchasing or carrying, within the meaning of Regulation U of the Board of Governors of the Federal Reserve System, as amended from time to time, any "margin stock" as defined in said Regulation U, or any "margin stock" as defined in Regulation G of the Board of Governors of the Federal Reserve System, as amended from time to time, or for the purpose of purchasing, carrying or trading in securities within the meaning of Regulation T of the Board of Governors of the Federal Reserve System, as amended from time to time, or for the purpose of reducing or retiring any indebtedness which both (i) was originally incurred to purchase any such -24- margin stock or other securities and (ii) was directly or indirectly secured by such margin stock or other securities. None of the assets of the Company or any Subsidiary includes any such "margin stock", and neither the Company nor any Subsidiary has any present intention of acquiring any such "margin stock." 7.2 Financial Information. (a) The Company will maintain a system of accounting established and administered in accordance with sound business practices to permit preparation of financial statements in accordance with generally accepted accounting principles consistently applied. The Company will deliver the following to each Eligible Holder during the period through the Rights Expiration Date for such Eligible Holder (and, in the case of paragraph (v) below, each other holder of Shares and/or Conversion Shares): (i) as soon as practicable but not later than ten (10) Business Days after their issuance, and in any event within ninety (90) days after the close of each fiscal year of the Company, (A) a consolidated balance sheet of the Company and its Subsidiaries as of the end of such fiscal year and (B) consolidated statements of operations, stockholders' equity and cash flows of the Company and its Subsidiaries for such fiscal year, in each case setting forth in comparative form the corresponding figures for the preceding fiscal year, all such balance sheets and statements to be in reasonable detail and certified by an independent public accounting firm of recognized national standing selected by the Company, and such statements shall be accompanied by management analyses of any material differences between the results for such fiscal year and the corresponding figures for the preceding fiscal year and between the budgeted figures (as supplied pursuant to paragraph (ii) below) and the results for such year and a narrative discussion of the Company's liquidity and capital resources as of the end of such year materially conforming to the disclosure requirements contained in Item 303 of Regulation S-K under the Securities Act. The Company's Annual Report on Form 10-K filed, or to be filed, with the Commission will satisfy the requirements of this paragraph, except for the requirement of the management analyses regarding the comparison of the Company's results for such fiscal year to the budgeted figures (as supplied pursuant to paragraph (ii) below); (ii) as soon as reasonably practicable, and in any event within thirty (30) days after the close of the preceding fiscal year of the Company, a budget for the current fiscal year (or the upcoming fiscal year, as the case may be) prepared on a quarterly basis regarding the Company's operations and capital expenditures on a consolidated basis, together with an analysis of such budget prepared in reasonable detail by the Vice President of Finance or the President of the Company; and (A) any operating budget of the Company otherwise prepared and submitted to the Board and (B) any revisions or amendments made by the Company (and submitted to its Board) to any budget delivered under this paragraph (ii); -25- (iii) as soon as reasonably practicable, and in any event within forty- five (45) days after the close of each of the first three (3) fiscal quarters of the Company, (A) a consolidated balance sheet of the Company and its Subsidiaries as of the end of such fiscal quarter and (B) consolidated statements of operations and cash flows of the Company and its Subsidiaries for the quarter just ended and for the portion of the fiscal year ended with the end of such quarter, in each case in reasonable detail, certified by the Vice President of Finance or the President of the Company and setting forth in comparative form the corresponding figures for the comparable period one year prior thereto (subject to normal year-end adjustments) and the comparable figures included in the budget for such quarter (as delivered or modified pursuant to paragraph (ii) above), together with management analyses of any material differences between such results and the corresponding figures for such prior period and between such results for such quarter and such budgeted figures. The Company's Quarterly Report on Form 10-Q filed, or to be filed, with the Commission will satisfy the requirements of this paragraph, except for the requirement of the management analyses regarding the comparison of the Company's results for such quarter to the budgeted figures; (iv) as soon as reasonably practicable, copies of summary financial information prepared on a quarterly basis regarding the Company on a consolidated basis as presented to the Board and any other summary financial information otherwise prepared and provided to the Board; (v) as soon as reasonably practicable, copies of (A) all financial statements, proxy material or reports sent by the Company to the Company's or any Subsidiary's stockholders, (B) any public announcements or press releases issued by the Company and (C) all reports or registration statements (excluding registration statements on Form S-8) filed by the Company with the Commission pursuant to the Securities Act or the Securities Exchange Act; (vi) as soon as reasonably practicable and without duplication of any of the above items, all materials furnished, from time to time, to the Board of Directors of the Company (including without limitation all communications and information furnished to the Board of Directors), and copies of minutes of meetings of the Boards of Directors of the Company; (vii) as soon as reasonably practicable and without duplication of any of the above items, any other materials furnished to holders of the Company's capital stock or any material information furnished to holders of the Company's indebtedness, including without limitation any compliance certificates furnished in respect of such indebtedness; and (viii) as soon as reasonably practicable, such other material information as may reasonably be requested by a holder of Shares (unless reasonably objected to by the Company), regarding the assets, properties, liabilities, business, affairs, results of operations, conditions (financial or otherwise) or prospects of the Company or any Subsidiary. -26- All such financial statements shall be prepared in accordance with generally accepted accounting principles consistently applied (except for any change in accounting principles specified in the accompanying certificate and except that any interim financial statements may omit notes and may be subject to normal year-end adjustments). (b) Without limiting the foregoing provisions of this Section 7.2, the Company agrees that, if requested in writing by any Eligible Holder, it will not deliver to such Eligible Holder (until otherwise instructed by such Eligible Holder) (x) any non-public information or non-public materials regarding the Company or any Subsidiary (whether described in this Section 7.2 or otherwise) and (y) any information (whether or not included in clause (x)) which such holder specifies that it does not want to receive. The Company shall comply with any such request with respect to each such Eligible Holder and any subsequent holders of Shares or Conversion Shares acquired directly or indirectly (through one or more transfers) from such Eligible Holder, until instructed otherwise in writing by the then holder of such Shares or Conversion Shares. 7.3 Tax Matters. Unless otherwise required by the Code or applicable state or local law, the Company agrees that it will not report the accrual of a dividend under Section 305 of the Code with respect to any redemption premium with which the Series B Preferred Stock may have been issued, whether on Form 1099 or any other form, to the Internal Revenue Service or any state or local taxing authority. 7.4 Inspection. At the request of an Eligible Holder, and without out of pocket expenses to the Company, the Company will permit such Eligible Holder and any authorized representative of such holder, subject to (if requested by the Company) execution by such Eligible Holder of a reasonable confidentiality agreement, to visit and inspect any of the properties of the Company and its Subsidiaries, and to discuss with their officers the business, results of operations, condition (financial or otherwise) or prospects of the Company or any Subsidiary, at mutually acceptable times. 7.5 Maintenance of Existence; Properties and Franchises; Compliance with Law; Taxes; Insurance. The Company will, and will cause each Subsidiary to: (a) maintain their respective corporate existences, rights and other franchises in full force and effect, except as may be affected by a transaction permitted by Section 7.11; provided, that the Company may terminate the corporate existence of any Subsidiary, or permit the termination or abandonment of rights or other franchises, if in the opinion of the Company it is no longer in the Company's best interests to maintain such existence, rights or other franchises and such termination or abandonment will not be prejudicial in any material respect to the holders of the Shares; -27- (b) maintain their respective tangible assets in good repair, working order and condition so far as necessary or advantageous to the proper carrying on of their respective businesses; (c) comply with all applicable laws and with all applicable orders, rules, rulings, certificates, licenses, regulations, demands, judgments, writs, injunctions and decrees, provided, that such compliance shall not be necessary so long as (i) the applicability or validity of any such law, order, rule, ruling, certificate, license, regulation, demand, judgment, writ, injunction or decree shall be contested in good faith by appropriate proceedings and (ii) failure to comply will not have a Material Adverse Effect on a consolidated basis; (d) pay promptly when due all taxes, fees, assessments and other government charges imposed upon their respective properties, assets or income and all claims or indebtedness (including, without limitation, materialmen's, vendor's, workmen's and like claims) which might become a lien upon such properties or assets; provided, that payment of any such tax, fee, assessment, charge, claim or indebtedness shall not be necessary so long as (i) the applicability or validity thereof shall be contested in good faith by appropriate proceedings and a reserve, if appropriate, shall have been established with respect thereto and (ii) failure to make such payment will not have a Material Adverse Effect on a consolidated basis; and (e) keep adequately insured, by financially sound and reputable insurers of nationally recognized stature, all their respective properties of a character customarily insured by entities similarly situated, against loss or damage of the kinds and in amounts customarily insured against by such entities and with such deductibles or co-insurance as is customary. 7.6 Office for Payment, Exchange and Registration; Location of Office; Notice of Change of Name or Office. (a) So long as any of the Shares is outstanding, the Company will maintain an office or agency where Shares may be presented for payment, exchange, conversion or registration of transfer as provided in this Agreement. Such office or agency initially shall be the office of the Company's transfer agent and shall be the following: KeyCorp Shareholder Services, Inc., 700 Louisiana, Suite 2620, Houston, Texas 77002. (b) The Company shall give each holder of Shares at least twenty (20) days' prior written notice of any change in (i) the name of the Company as then in effect or (ii) the location of the office of the Company required to be maintained under this Section 7.6. 7.7 Environmental Matters. (a) The Company and each Subsidiary shall keep any property either owned or occupied by the Company or any Subsidiary free and clear of any material Liens imposed for failure to comply with any environmental laws, regulations or ordinances (each, an "Environmental Lien"), and the Company and each Subsidiary, as the case may be, shall keep all such property in material compliance with all environmental laws, regulations and ordinances; provided, however, that the -28- Company or any Subsidiary shall have the right at its cost and expense, and acting in good faith, to contest, object or appeal by appropriate legal proceeding the validity of any Environmental Lien. The contest, objection or appeal with respect to the validity of an Environmental Lien shall suspend the Company's obligation to eliminate such Environmental Lien under this paragraph pending a final determination by appropriate administrative or judicial authority of the legality, enforceability or status of such Environmental Lien, provided that the following conditions are satisfied: (i) contemporaneously with the commencement of such proceedings, the Company shall give written notice thereof to each holder of Shares or Conversion Shares; and (ii) if under applicable law any real property or improvements thereon are subject to sale or forfeiture for failure to satisfy the Environmental Lien prior to a final determination of the legal proceedings, the Company or such Subsidiary must successfully move to stay such sale, forfeiture or foreclosure pending final determination of the Company's (or Subsidiary's) action; and (iii) the Company or such Subsidiary must, if requested, furnish to the holders of Shares or Conversion Shares a good and sufficient bond, surety, letter of credit or other security satisfactory to such holders equal to the amount (including any interest and penalty) secured by the Environmental Lien. (b) The Company will defend, indemnify and hold harmless each current, former and future holder of Shares or Conversion Shares, its employees, officers, directors, stockholders, partners, agents, representatives and assigns, from and against any liabilities, obligations, losses, damages, penalties, actions, judgments, suits and claims, joint or several, and any costs, disbursements and expenses (including attorneys' fees and expenses and costs of investigation) of whatever kind or nature, known or unknown, contingent or otherwise, arising out of or in any way related to (i) the presence, disposal, release, removal, discharge, storage or transportation of any Hazardous Material upon, into, from or affecting any real property (including improvements) owned or occupied (or formerly owned or occupied) by the Company or any Subsidiary; and (ii) any judicial or administrative action, suit or proceeding, actual or threatened, relating to Hazardous Material upon, in, from or affecting any real property (including improvements) owned or occupied (or formerly owned or occupied) by the Company or any Subsidiary; and (iii) any violation of any environmental law, regulation or ordinance by the Company or any Subsidiary or any of their agents, tenants, subtenants or invitees; and (iv) the imposition of any Environmental Lien for the recovery of costs expended in the investigation, study or remediation of any environmental liability of (or asserted against) the Company or any Subsidiary, provided, however, that in no case shall such persons be entitled to indemnification under this Section 7.7(b) for a decrease in the value of the Shares or the Conversion Shares resulting from or in any way related to items (i) though (iv) herein, but that the preceding clause shall in no way limit any indemnification that an Exchanging Party may otherwise be entitled to under any other provisions of this Stock Exchange Agreement. This Section 7.7(b) shall survive any payment, conversion or transfer of Shares and any termination of this Agreement. 7.8 No Change in Business. Neither the Company nor any of its Subsidiaries will engage in any business other than business of the general nature described in the Memorandum. -29- 7.9 Restrictive Agreements Prohibited. Neither the Company nor any of its Subsidiaries shall become a party to any agreement which by its terms restricts the Company's performance of this Agreement. 7.10 Restricted Payments. Neither the Company nor any Subsidiary will declare or make or permit to be declared or made any Restricted Payment. 7.11 Consolidation, Merger and Sale. Without the consent of the Majority Shareholders, neither the Company nor any Subsidiary will do any of the following (or agree to do any of the following) pursuant to a transaction approved by the Board of Directors of the Company: (a) wind up, liquidate or dissolve its affairs; (b) sell, lease, transfer or otherwise dispose of all or substantially all of its assets to any other Person; (c) consolidate with, merge into or enter into a share exchange with any other Person; or (d) permit any other Person (other than a wholly-owned Subsidiary on the date hereof) to merge into or sell, lease or transfer all or substantially all of its property, assets or capital stock to the Company or any Subsidiary, unless: (i) in the case of actions under clause (a) or (b) above, a wholly- owned Subsidiary is wound-up, dissolved and liquidated into another wholly- owned Subsidiary or into the Company or a wholly-owned Subsidiary sells, leases, transfers or otherwise disposes of all or substantially all of its assets to another wholly-owned Subsidiary or to the Company; or (ii) in the case of actions under clause (c) or (d) above, each of the following conditions is satisfied: (A) if such action involves the Company and if such surviving Person is a corporation other than the Company, all liabilities and obligations of the Company under the Stock Exchange Agreements shall remain in effect and shall have been expressly assumed by such surviving Person (pursuant to a document in form and substance reasonably satisfactory to the Majority Shareholders and their counsel) as if such surviving Person were the "Company" hereunder and thereunder; and (B) either (x) the Common Stock of such transferee Person into which the Series B Preferred Stock will thereafter be convertible (or American Depositary Receipts with respect thereto) is listed on a national securities exchange in the United States or traded on The Nasdaq Stock Market, or (y) all of the Series B Preferred Stock is concurrently redeemed for cash in accordance with Section 5 of the Series B Certificate of Designations. -30- 7.12 Transactions with Affiliates. The Company will not, and will not permit any Subsidiary to, directly or indirectly, enter into any transaction or agreement (including, without limitation, the purchase, sale, distribution, lease or exchange of any property or the rendering of any service) with any Affiliate of the Company or of any Subsidiary, other than a wholly-owned Subsidiary of the Company, unless such transaction or agreement (a) is approved by disinterested members of the Board of Directors of the Company, and (b) is on terms that are no less favorable to the Company or such Subsidiary, as the case may be, than those which might be obtained at the time of such transaction from a Person who is not such an Affiliate; provided, however, that this Section 7.12 shall not limit, or be applicable to, (i) employment arrangements with any individual who is an employee of the Company or any Subsidiary if such arrangements are approved by the Board; and (ii) the payment of reasonable and customary regular fees to directors who are not employees of the Company. 7.13 Observer Rights. Each of the Eligible Holders shall have the right, during the period through the Rights Expiration Date for such Eligible Holder, and (if requested by the Company) subject to execution by such observer of a reasonable confidentiality agreement, to send one (1) representative to meetings of the Company's and each Subsidiary's Board of Directors (and the executive committee if the executive committee has more than five members) of such Boards, such representatives to act as observers without a vote or other rights as a director (except the right to receive sufficient notice to enable such attendance and the right to receive all other communications, information and materials furnished, from time to time, to directors of the Company and each Subsidiary). Any representative acting under this Section 7.13 shall be chosen from the list of Persons provided to the Company concurrently with execution of this Agreement (or another individual selected by such holders and reasonably acceptable to the Company) 7.14 No Dilution or Impairment; No Changes in Capital Stock. The Company will not, by amendment of its certificate of incorporation or through any consolidation, merger, reorganization, transfer of assets, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of the Stock Exchange Agreements or the Series B Certificate of Designations. The Company will at all times in good faith assist in the carrying out of all such terms, and in the taking of all such action, as may be necessary or appropriate in order to protect the rights of the holders of Shares (as such rights are set forth in the Stock Exchange Agreements and the Series B Certificate of Designations) against impairment. Without limiting the generality of the foregoing, the Company (a) will not permit the par value or the determined or stated value of any shares of the Company's Common Stock receivable upon the conversion of the Shares to exceed the amount payable therefor upon such conversion, (b) will take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and non- assessable shares of the Company's Common Stock free from all taxes, Liens and charges with respect to the issue thereof, upon the -31- conversion of the Shares from time to time outstanding, (c) will not take any action which results in any adjustment of the Conversion Price under the Series B Certificate of Designations if the total number of shares of the Company's Common Stock (or other securities) issuable after the action upon the conversion of all of the then outstanding Shares would exceed the total number of shares of the Company's Common Stock (or other securities) then authorized by the Company's certificate of incorporation and available for the purpose of issuance upon such conversion, (d) will not have any authorized Common Stock other than its existing authorized Common Stock, (e) will not amend its certificate of incorporation to change any terms of its Common Stock, (f) will not amend its certificate of incorporation in any manner to alter or change the powers, privileges or preferences of the holders of the Series B Preferred Stock (including without limitation changing the Series B Certificate of Designations after any Shares have been called for redemption), (g) will not create or authorize the creation of any additional class or series of shares of capital stock unless the same ranks junior to the Series B Preferred Stock as to the payment of dividends or the distribution of assets on the liquidation, dissolution or winding up of the Company, or increase the authorized amount of the Series B Preferred Stock, or increase the authorized amount of any additional class or series of shares of stock unless the same ranks junior to the Series B Preferred Stock as to the payment of dividends or the distribution of assets on the liquidation, dissolution or winding up of the Company, or create or authorize any obligation or security convertible into shares of Series B Preferred Stock or into shares of any other class or series of stock unless the same ranks junior to the Series B Preferred Stock as to the payment of dividends or the distribution of assets on the liquidation, dissolution or winding up of the Company, whether any such creation, authorization or increase shall be by means of amendment to the certificate of incorporation or by merger, consolidation or otherwise and (h) after the date hereof, will not create or establish (or make any grants or awards under) any phantom stock, stock appreciation rights or other equity equivalent plan for employees, officers, directors, agents or consultants of the Company (unless such plans in the aggregate relate to the equivalent of less than 5% of the Common Stock of the Company) whereby the Company or any Subsidiary agrees to pay any Person a percentage of, or an amount otherwise determined by reference to, the earnings of the Company or any Subsidiary, the value of their stock or the proceeds from a sale of their stock or upon their liquidation. 7.15 Reservation of Shares. There have been reserved, and the Company shall at all times keep reserved, free from preemptive rights, out of its authorized Common Stock, a number of shares of Common Stock sufficient to provide for the exercise of the conversion rights of the Shares provided in the Series B Certificate of Designations. If at any time the number of authorized but unissued shares of Common Stock of the Company shall not be sufficient to effect the conversion of the Shares or otherwise to comply with the terms of this Agreement, the Company will forthwith take such corporate action as may be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purpose. The Company will obtain any authorization, consent, approval or other action by or make any filing with any court or administrative body that may be required under applicable state securities laws in connection with the issuance of the Common Stock upon conversion of the Shares. -32- 7.16 Listing of Shares. If any shares of the Company's Common Stock or Series B Preferred Stock are listed on any national securities exchange (or on The Nasdaq Stock Market or comparable system), then the Company will take such action as may be necessary, from time to time, to list the Conversion Shares or the Shares, as the case may be, on such exchange (or system as the case may be). The Company shall have no obligation to list the Shares if the Series B Preferred Stock is not so listed. 7.17 Securities Exchange Act Registration. (a) The Company will maintain effective a registration statement (containing such information and documents as the Commission shall specify and otherwise complying with the Securities Exchange Act) under Section 12(b) or Section 12(g), whichever is applicable, of the Securities Exchange Act, with respect to the Company's Common Stock, and will file on time such information, documents and reports as the Commission may require or prescribe for companies whose stock has been registered pursuant to such Section 12(b) or Section 12(g), whichever is applicable. (b) The Company will, upon the request of any holder of Shares or Conversion Shares, make whatever other filings with the Commission, or otherwise make generally available to the public such financial and other information, as any such holder may deem reasonably necessary or desirable in order to enable such holder to be permitted (i) to sell Conversion Shares pursuant to the provisions of Rule 144 and (ii) after the Company has filed a registration statement with respect to Series B Preferred Stock under Section 6 of the Securities Act or Section 12(b) or 12(g) of the Securities Exchange Act, to sell Shares pursuant to the provisions of Rule 144. 7.18 Maintenance of Public Market. Except as contemplated by Section 7.11, the Company will not (i) proceed with a program of acquisition of its own Common Stock or of Series B Preferred Stock (other than by redemption in accordance with the Series B Certificate of Designations), (ii) initiate a corporate reorganization or recapitalization or undertake a consolidation or merger or (iii) authorize, consent to or take any action without the consent of the Eligible Holders, which would have the effect of: (a) removing the Company from registration with the Commission under the Securities Exchange Act with respect to the Company's Common Stock, (b) requiring the Company to make a filing under Section 13(e) of the Securities Exchange Act, (c) reducing substantially or eliminating the public market for shares of Common Stock of the Company -33- (d) if any shares of the Company's Common Stock or Series B Preferred Stock are at any time listed on The Nasdaq Stock Market, causing a delisting of the Company's Common Stock or Series B Preferred Stock, as the case may be, from such systems (unless such stock is delisted as a result of being listed on a national securities exchange), or (e) if any shares of the Company's Common Stock or Series B Preferred Stock are at any time listed on a national securities exchange, causing a delisting of such stock from such exchange. 7.19 Private Placement Status. Neither the Company nor any agent nor other Person acting on the Company's behalf will do or cause to be done (or will omit to do or to cause to be done) any act which act (or which omission) would result in bringing the issuance or exchange of the Shares or the Conversion Shares within the provisions of Section 5 of the Securities Act or the filing, notification or reporting requirements of any state securities law (other than in accordance with a registration and qualification of Conversion Shares pursuant to Section 7.17 hereof), except for filings, notices or reports pursuant to state securities laws which have already been made or which are contemplated in connection with the offering and exchange of the Shares. 7.20 Delivery of Information. If a holder of Shares or Conversion Shares proposes to transfer any such Shares or Conversion Shares pursuant to Rule 144A, the Company agrees to provide (upon the request of such holder or the prospective transferee) to such holder and (if requested) to the prospective transferee any information concerning the Company and its Subsidiaries which is required to be delivered to any transferee of such Shares or Conversion Shares pursuant to such Rule 144A. 7.21 Notices. The Company will give to all holders of Shares or Conversion Shares copies of all notices given by the Company to holders of its Common Stock concurrently with the giving of such notices to such holders of Common Stock. 7.22 No Dividends in Common Stock Unless Registered. The Company will not declare and cause to be paid dividends on the Shares in shares of Common Stock until a registration statement covering the resale of such Common Stock has been filed with the Commission and has been declared effective thereby. -34- SECTION 8. REGISTRATION RIGHTS 8.1 Registration of the Shares. (a) The holders of at least an aggregate of 100,000 Shares may request the Company to register under the Securities Act the resale of all or any portion of such Shares, but in no event less than 60,000 Shares, held by such requesting holder or holders for sale in the manner specified in such notice. (b) Following receipt of any notice under this Section 8.1, the Company shall immediately notify all holders of the Shares from whom notice has not been received and shall commit to register under the Securities Act, for public sale in accordance with the method of disposition specified in such notice from requesting holders, the number of Shares specified in such notice (and in all notices received by the Company from other holders within 30 days after the giving of such notice by the Company). All such holders who submit requests to the Company pursuant to this Section 8.1 shall be referred to individually as a "Requesting Holder" and collectively as "Requesting Holders." If the Requesting Holders may elect to have the Shares sold to one or more persons participating as underwriters ("Underwriters") for an offering of Shares to the public (an offering of any shares of capital stock of the Company by means of Underwriters to the public shall be referred to as an "Underwritten Offering"), the holders of a majority of the Shares to be sold in such offering may designate the managing Underwriter of such offering, subject to approval of the Company, which approval will not be unreasonably withheld or delayed. The Company shall be obligated to register the Shares pursuant to this Section 8.1 on two occasions only, provided, however, that such obligation shall be deemed satisfied only when a registration statement covering at least 60% of the total Shares specified in notices received as aforesaid, for sale in accordance with the method of disposition specified by the Requesting Holders, shall have become effective and, if such method of disposition is an Underwritten Offering, all such shares shall have been sold pursuant thereto. (c) Except for registration statements on Form S-4, S-8 or any successor thereto and except as required under the registration rights agreements referred to in Schedule II hereto, the Company will not file with the Commission without the approval of the Requesting Holders any other new registration statements with respect to its capital stock, whether for its own account or that of other stockholders, from the date of receipt of a notice from Requesting Holders pursuant to this Section 8.1 until the earlier of (i) six (6) months from the date of receipt of such notice and (ii) the completion of the period of distribution of the registration contemplated thereby. The registration statement, together with all amendments and supplements, including post- effective amendments, in each case including the prospectus contained therein (including the preliminary prospectus and all amendments and supplements to the prospectus, including post-effective amendments) (collectively, the "Prospectus"), all exhibits thereto or to the Prospectus and all material incorporated by reference therein or to the Prospectus, is referred to as the "Registration Statement". -35- (d) If and whenever the Company is required by the provisions of this Section 8.1 to effect the registration of any Shares under the Securities Act, the Company will, as expeditiously as possible: (i) prepare and file with the Commission, no later than 60 days after the receipt of the first notice from the Requesting Holders, a Registration Statement on Form S-2 (or other appropriate form) with respect to such securities and use its reasonable best efforts to cause such Registration Statement to become and remain effective for the period of distribution contemplated thereby (determined as hereinafter provided); (ii) prepare and file with the Commission such amendments and supplements to such Registration Statement and the Prospectus used in connection therewith as may be necessary to keep such Registration Statement effective for the period contemplated in (i) above and comply with the provisions of the Securities Act with respect to the disposition of all Shares covered by such Registration Statement in accordance with the sellers' intended method of disposition set forth in such Registration Statement for such period; (iii) register or qualify the Shares, by the time the Registration Statement is declared effective by the Commission, under all applicable state securities or "Blue Sky" laws of such jurisdictions as each Underwriter, if any, or the Requesting Holders shall request in writing, provided that the Company shall not be obligated to qualify as a foreign corporation or as a dealer in securities in any jurisdiction in which it is not so qualified or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject; (iv) keep each such registration or qualification effective during the period the Registration Statement is required to be kept effective; (v) upon request by the Requesting Holders, do any and all other acts and things which may be reasonably necessary to enable such Underwriter, if any, and the Requesting Holders to consummate the disposition of the Shares in each such jurisdiction; (vi) notify the Requesting Holders when the Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective; (vii) in connection with an Underwritten Offering, if any, notify the Requesting Holders if, between the effective date of the Registration Statement and the closing of any sale of Shares, the representations and warranties of the Company contained in the underwriting agreement relating to any Underwritten Offering cease to be true and correct in all material respects or if the Company receives any notification with respect to the suspension of the qualification of the Shares for sale in any jurisdiction or the initiation of any proceeding for such purpose; -36- (viii) furnish or cause to be furnished forthwith to the Requesting Holders, a "cold comfort" letter of the Company's independent accountants, as of the effective date of the Registration Statement, as to such matters as customarily are covered in accountant's letters delivered to underwriters in underwritten public offerings of securities; (ix) furnish or cause to be furnished forthwith to the Requesting Holders, an opinion of counsel to the Company, as of the effective date of the Registration Statement, in the form customarily provided by issuer's counsel in underwritten public offerings of securities; (x) furnish such number of Prospectuses and other documents incident thereto, including any amendment of or supplement to the Prospectus as the Requesting Holders from time to time may reasonably request during the period of distribution of the Shares; (xi) provide a transfer agent and registrar for all of the Shares; and (xii) otherwise use its reasonable best efforts to comply with all applicable rules and regulations of the Commission with respect to the disposition of the Shares covered by such Registration Statement, and make available to its security holders, as soon as reasonably practicable, an earnings statement covering the period of at least twelve months, but not more than eighteen months, beginning with the first month after the effective date of the Registration Statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act. (e) For purposes of this Section 8.1, the period of distribution of the Shares in an Underwritten Offering shall be deemed to extend until each Underwriter has completed the distribution of all securities purchased by it (but no later than 180 days), and the period of distribution of the Shares in any other registration shall be deemed to extend until the earlier of the sale of all Shares covered thereby and 180 days after the effective date thereof. (f) In connection with each registration under this Section 8.1, and as a condition to the inclusion of their shares therein, the Requesting Holders will furnish to the Company in writing such information with respect to themselves and the proposed distribution by them as reasonably shall be necessary in order to assure compliance with federal and applicable state securities laws. (g) As soon as the Company is eligible to register the Shares on Form S-3 (or any successor form thereto under the Securities Act), the Company will, as expeditiously as possible but in any event no later than 60 days after the Company is eligible to register the Shares on Form S-3, undertake to amend the "shelf" Registration Statement on Form S-3 referred to in Section 8.2 to include any Shares outstanding or to file and to use its reasonable best efforts to have declared effective a separate registration statement registering the resale of the Shares. Any Shares so registered pursuant to the Company's "shelf" Registration Statement on Form S-3 or such other registration statement shall be thereinafter included within the definition of "Registered Securities". -37- (h) Subject to Section 8.3 below, the Company agrees to supplement or amend the Registration Statement, if required by the Securities Act. 8.2 Shelf Registration of the Registered Securities. The Company agrees to use its reasonable best efforts to file with the Commission a "shelf" Registration Statement on Form S-3 (or other appropriate form under the Securities Act), providing for the resale of all of the Registered Securities, within sixty (60) days after the Closing Date. The Company will use its reasonable best efforts to have the Registration Statement declared effective by the Commission as soon as practicable after the filing thereof. Subject to Section 8.3 hereof, the Company will use its reasonable best efforts to keep the Registration Statement continuously effective until the earlier of: (A) the date upon which all of the outstanding Registered Securities have been sold pursuant to the Registration Statement or are no longer outstanding, or (B) such date as the Company and each of the Eligible Holders shall be satisfied that Rule 144(k) of the regulations under the Securities Act is available for the resale of the Registered Securities held by them, or, in the case of Eligible Holders for whom Rule 144(k) is unavailable, such Eligible Holders have consented in writing to permit the Company to discontinue the effectiveness of the Registration Statement. Subject to Section 8.3 below, the Company agrees to supplement or amend the Registration Statement, if required by the Securities Act. 8.3 Interference with Registration. (a) For purposes of this Section 8.3, any Registration Statement pursuant to either Section 8.1 or 8.2 hereof shall collectively be referred to as the "Registration Statements." If, after the Registration Statements have been declared effective, a stop order, injunction or other order or requirement of the Commission or any other governmental agency or court is issued which suspends the effectiveness of a Registration Statement, (i) upon receipt of notice from the Company, the Requesting Holders or Exchanging Party (as applicable) will discontinue any disposition of Shares or Registered Securities, respectively, pursuant to that Registration Statement until receipt of notice from the Company that the suspension of the effectiveness of the Registration Statement has been withdrawn and (ii) the Company will use its reasonable best efforts to obtain the withdrawal of such order or to meet such requirement at the earliest possible time. (b) If, after the Registration Statements have become effective, an event occurs as a result of which the Company determines that a Registration Statement or the related Prospectus contains any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were -38- made, not misleading, the Company will notify the Requesting Holders and any Exchanging Party (as applicable) thereof and, if applicable, use its reasonable best efforts to prepare and promptly file a post-effective amendment or a supplement to the Registration Statement or the related Prospectus or promptly file any other required document so that, as thereafter delivered to purchasers of the Shares or Registered Securities, such Prospectus will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (c) Without limiting Section 8.3(a) and 8.3(b) hereof, if any Requesting Holder or Exchanging Party (as applicable) shall propose to sell any Shares or Registered Securities, respectively, pursuant to the Registration Statements, it shall notify the Company of its intent to do so at least three (3) full Business Days prior to such sale. At any time within such three (3) Business Day period, the Company may refuse to permit the Requesting Holder or Exchanging Party (as applicable) to resell any Shares or Registered Securities, respectively, pursuant to the Registration Statements; except that the Company may exercise this right only once in any one hundred eighty (180) day period, unless the matter giving rise to the exercise by the Company of this right is beyond the Company's control; and provided, further, that in order to exercise this right, the Company must deliver a certificate in writing to the Requesting Holder or Exchanging Party (as applicable) to the effect that a delay in such sale is necessary because a sale pursuant to such Registration Statement in its then- current form would reasonably be expected to constitute a violation of the federal securities laws. Without limiting Section 8.3(b) hereof, in no event shall such delay exceed ten (10) Business Days; provided, however, that if, prior to the expiration of such ten (10) Business Day period, the Company delivers a certificate in writing to the Requesting Holder or Exchanging Party (as applicable) to the effect that a further delay in such sale beyond such ten (10) Business Day trading period is necessary because a sale pursuant to the Registration Statement in its then-current form would reasonably be expected to constitute a violation of the federal securities laws, the Company may refuse to permit such Requesting Holder or Exchanging Party (as applicable) to resell any Shares or Registered Securities, respectively, pursuant to the Registration Statement for an additional period not to exceed five (5) Business Days, but in no event shall any such delay exceed in the aggregate fifteen (15) Business Days, unless the matter giving rise to the exercise of such right is beyond the Company's control. 8.4 Selection of Underwriters for Registered Securities. With respect to the registration of Registered Securities pursuant to Section 8.2 hereof, at any time or from time to time after the Closing, the Exchanging Party may elect to have the Registered Securities sold to one or more persons participating as Underwriters for an Underwritten Offering. In such event, the Company shall engage (a) Alex. Brown & Sons Incorporated or (b) another nationally recognized independent investment banking firm reasonably acceptable to the holders of a majority of the Registered Securities, as Underwriters; provided, however, that the Company shall not be required to engage any Underwriter if such engagement would require the consent or approval of any governmental authority (including the necessity of obtaining an exemptive order under the Investment Company Act of 1940, as amended); provided, further, that after three years after the -39- Closing Date such Underwriters shall be selected by mutual agreement of the Company and the holders of a majority of the Registered Securities, each acting reasonably. In such event, the Company and each such Exchanging Party will cooperate with the Underwriter or the managing Underwriter and take all customary and reasonable actions to facilitate the disposition of Registered Securities in an Underwritten Offering. 8.5 Other Obligations of the Company with respect to the Registered Securities. After the Closing, the Company will: (a) use its reasonable best efforts (i) to register or qualify the Registered Securities, by the time the Registration Statement is declared effective by the Commission, under all applicable state securities or "Blue Sky" laws of such jurisdictions as each Underwriter, if any, or the Exchanging Party shall request in writing, provided that the Company shall not be obligated to qualify as a foreign corporation or as a dealer in securities in any jurisdiction in which it is not so qualified or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject; (ii) to keep each such registration or qualification effective during the period the Registration Statement is required to be kept effective; and (iii) upon request by the Exchanging Party, to do any and all other acts and things which may be reasonably necessary to enable such Underwriter, if any, and the Exchanging Party to consummate the disposition of the Registered Securities in each such jurisdiction; (b) notify the Exchanging Party (i) when the Registration Statement has become effective and when any post-effective amendments and supplements thereto become effective and (ii) in connection with an Underwritten Offering, if any, if, between the effective date of the Registration Statement and the closing of any sale of Registered Securities, the representations and warranties of the Company contained in the underwriting agreement relating to any Underwritten Offering cease to be true and correct in all material respects or if the Company receives any notification with respect to the suspension of the qualification of the Registered Securities for sale in any jurisdiction or the initiation of any proceeding for such purpose; (c) Furnish or cause to be furnished forthwith to the Exchanging Party, (i) a "cold comfort" letter of the Company's independent accountants, as of the effective date of the Registration Statement, as to such matters as customarily are covered -40- in accountant's letters delivered to underwriters in underwritten public offerings of securities and (ii) an opinion of counsel to the Company, as of the effective date of the Registration Statement, in the form customarily provided by issuer's counsel in underwritten public offerings of securities; (d) furnish such number of Prospectuses and other documents incident thereto, including any amendment of or supplement to the Prospectus as an Exchanging Party from time to time may reasonably request; (e) cause all such Registered Securities registered as described herein to be listed on each securities exchange and quoted on each quotation service on which securities of the same class and series issued by the Company are then listed or quoted; (f) provide a transfer agent and registrar for all Registered Securities; (g) otherwise use its reasonable best efforts to comply with all applicable rules and regulations of the Commission with respect to the disposition of the Registered Securities, and make available to its security holders, as soon as reasonably practicable, an earnings statements covering the period of at least twelve months, but not more than eighteen months, beginning with the first month after the effective date of the Registration Statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act. 8.6 Registration Expenses. The Company agrees to pay all Registration Expenses in connection with the registrations pursuant to this Section 8. "Registration Expenses" means any and all expenses incident to performance of or compliance with the provisions of this Section 8 by the Company, including without limitation: (i) all Commission and National Association of Securities Dealers, Inc. ("NASD") registration and filing fees, (ii) all fees and expenses incurred in connection with compliance with state securities or "Blue Sky" laws and compliance with the rules of the NASD, (iii) all expenses in preparing, printing and distributing the Registration Statements and other documents relating to the performance of and compliance with this Agreement by the Company, (iv) the reasonable fees and disbursements of counsel for the Company and of one counsel selected by the Eligible Holders and reasonably acceptable to the Company and of the independent public accountants of the Company, (v) any fees and disbursements of Underwriters, dealers and agents, if any, customarily paid by issuers of securities under similar circumstances relating to compliance with applicable state securities or "Blue Sky" laws and the fees and expenses of any special experts retained by the Company in connection with the Registration Statements; but excluding (x) underwriting discounts and commissions and (other than as provided in clause (v) of this paragraph) fees and disbursements of Underwriters, dealers and agents in connection with an Underwritten Offering of Shares or Registered Securities, if any, and (y) transfer taxes, if any, relating to the sale and disposition of Shares or Registered Securities. -41- 8.7 Short Sales. No Exchanging Party shall engage in any short-sales of the Company's Common Stock prior to the effectiveness of the Registration Statement, except to the extent that any such shortsale is fully covered by freely tradable shares of Common Stock of the Company. 8.8 Representations of the Company. The Company represents and warrants to, and agrees with, the Exchanging Party that: (a) The Registration Statements and the Prospectuses contained therein, when they become effective or are filed with the Commission, as the case may be, and, in the case of an Underwritten Offering, at the time of the closing under the underwriting agreement relating thereto, will conform in all material respects to the requirements of the Securities Act and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and at all times subsequent to the effective date of such Registration Statements when a Prospectus would be required to be delivered under the Securities Act, except for the periods provided under Section 8.3 hereof, such Registration Statements and Prospectuses will conform in all material respects to the requirements of the Securities Act and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by the Exchanging Party or any Underwriter expressly for use therein. (b) Any documents incorporated by reference in the Prospectuses, when they become or became effective or are or were filed with the Commission, as the case may be, will conform or conformed in all material respects to the requirements of the Securities Act or the Exchange Act, as applicable, and none of such documents will contain or contained, as of their respective dates, an untrue statement of a material fact or will omit or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading at the time they become or became effective or are or were filed with the Commission, as the case may be; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and conformity with information furnished in writing to the Company by the Exchanging Party or any Underwriter expressly for use therein. 8.9 Indemnification. (a) The Company will indemnify and hold harmless each holder of Shares and Registered Securities and any underwriter (as defined in the Securities Act) for such holder and each person, if any, who controls the holder or underwriter within the meaning of the Securities Act against any losses, claims, damages or liabilities, joint or several, and expenses (including reasonable attorneys' fees and expenses and reasonable costs of investigation) to which the holder or underwriter or such -42- controlling person may be subject, under the Securities Act or otherwise, insofar as any thereof arise out of or are based upon (x) any untrue statement or alleged untrue statement of a material fact contained in a Registration Statement, a Prospectus or any amendment or supplement thereto, or (y) the omission or alleged omission to state in any item referred to in the preceding clause a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such losses, claims, damages, liabilities or expenses arise out of or are based upon any untrue statement or alleged untrue statement or omission or alleged omission based upon information furnished to the Company in writing by such holder or by any underwriter for such holder expressly for use therein (with respect to which information such holder or underwriter shall so indemnify and hold harmless the Company, any underwriter for the Company and each person, if any, who controls the Company or such underwriter within the meaning of the Securities Act). The foregoing is subject to the condition that, insofar as the foregoing indemnities relate to any untrue statement, alleged untrue statement, omission or alleged omission made in any prospectus which is eliminated or remedied in any amendment, supplement or final prospectus, the above indemnity obligations of the Company shall not inure to the benefit of any indemnified person (or to the benefit of any person who controls such indemnified person within the meaning of the Securities Act) if a copy of such amendment, supplement or final prospectus was not sent or given by such indemnified person at or prior to the time such action is required of such indemnified person by the Securities Act and if delivery of such amendment, supplement or final prospectus would have eliminated (or been a sufficient defense to) any liability of such indemnified person with respect to such statement or omission. (b) The Exchanging Party will indemnify and hold harmless the Company, any other Exchanging Parties, any underwriter (as defined in the Securities Act) and each person, if any, who controls the Company, such other Exchanging Parties or any underwriter within the meaning of the Securities Act, against any losses, claims, damages or liabilities, joint and several, and expenses (including reasonable attorneys' fees and expenses and reasonable costs of investigation) to which the Company, such other Exchanging Party, underwriter or such controlling person may be subject, under the Securities Act or otherwise, insofar as any thereof arise out of or are based upon (x) any untrue statement or alleged untrue statement of a material fact contained in a Registration Statement, a Prospectus or any amendment or supplement thereto, (y) the omission or alleged omission to state in any item referred to in the preceding clause a material fact required to be stated therein or necessary to make the statements therein not misleading or (z) any failure of the Exchanging Party to perform its obligations hereunder or under law; provided, however, that the Exchanging Party will be liable hereunder in any such case if and only to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in strict conformity with information pertaining to the Exchanging Party, as such, furnished in writing to the Company by the Exchanging Party stated to be specifically for use in such Registration Statement and Prospectus; provided, further, however, that the liability of the Exchanging Party hereunder shall be limited to the proportion of any such loss, claim, damage, liability or expense which is equal to the proportion that the public offering price of the Shares or Registered Securities sold by the Exchanging Party under such Registration Statement bears to the total public offering price of all securities sold thereunder, -43- but not in any event to exceed the proceeds received by the Exchanging Party from the sale of the Shares or Registered Securities covered by such Registration Statement. The foregoing is subject to the condition that, insofar as the foregoing indemnities relate to any untrue statement, alleged untrue statement, omission or alleged omission made in any prospectus which is eliminated or remedied in any amendment, supplement or final prospectus, the above indemnity obligations of the Exchanging Party shall not inure to the benefit of any indemnified person (or to the benefit of any person who controls such indemnified person within the meaning of the Securities Act) if a copy of such amendment, supplement or final prospectus was not sent or given by such indemnified person at or prior to the time such action is required of such indemnified person by the Securities Act and if delivery of such amendment, supplement or final prospectus would have eliminated (or been a sufficient defense to) any liability of such indemnified person with respect to such statement or omission. (c) Promptly after receipt by an indemnified party under Section 8.9(a) or (b) hereof of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against an indemnifying party under such subsection, notify the indemnifying party in writing of the commencement thereof; but the failure to so notify an indemnifying party shall not relieve the indemnifying party of its obligations under this Section 8.9 unless such failure to notify materially prejudices the indemnifying party's defense. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party, and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party under this subsection for any legal expenses of other counsel or any other expenses, in each case subsequently incurred by such indemnified party, in connection with the defense thereof other than reasonable costs of investigation. Notwithstanding the foregoing, the indemnifying party shall pay as incurred the fees and expenses of separate counsel retained by the indemnified party in the event (i) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel or (ii) the named parties to any such proceeding (including any impleaded parties) include both the indemnifying party and the indemnified party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them. It is understood that the indemnifying party shall not, in connection with any proceeding or related proceedings in the same jurisdiction, be liable for the reasonable fees and expenses of more than one separate firm for all such indemnified parties. In addition, an indemnifying party shall not be required to indemnify, reimburse, or otherwise make any contribution to the amount paid or payable by the indemnified party for any losses, claims, damages, expenses or liabilities incurred by the indemnified party in settlement of any actions, proceedings or investigations otherwise covered hereunder, unless such settlement has been previously approved by the indemnifying party, which approval shall not be unreasonably withheld. -44- (d) If the indemnification provided for in this Section 8.9 is unavailable to or insufficient to hold harmless an indemnified party under Section 8.9(a) or (b) hereof in respect of any losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) in such proportion as is appropriate to reflect not only (i) the relative benefits received by the Exchanging Party on the one hand and the underwriter on the other from the offering of the Shares or the Registered Securities but also (ii) the relative fault of the Company, the Exchanging Party and the underwriter in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions or proceedings in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Exchanging Party on the one hand and the underwriter on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Exchanging Party bear to the total underwriting discounts and commissions received by the underwriter, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact related to information supplied by the Company, the Exchanging Party or the underwriter and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. (e) The Company and the Exchanging Party agree that it would not be just and equitable if contributions pursuant to this Section 8.9 were determined by pro rata allocation (even if several underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 8.9. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to above in this Section 8.9 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 8.9, no underwriter, if any, will be required to contribute any amount in excess of the amount agreed to between the Company and the underwriter at the time of such offering. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Any underwriters' obligations to contribute will be several in proportion to their respective underwriting obligations and not joint. (f) In any proceeding relating to a Registration Statement, a Prospectus or any supplement or amendment thereto, each party against whom contribution may be sought under this Section 8.9 hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon him or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join him or it as an additional defendant in any such proceeding in which such other contributing party is a party. -45- 8.10 Transferees. The right to sell Shares and Registered Securities pursuant to a Registration Statement described herein will automatically be assigned to each transferee of Shares or Registered Securities, other than any purchaser of Shares or Registered Securities sold under a Registration Statement. In the event that it is necessary, in order to permit an Exchanging Party to sell Shares or Registered Securities pursuant to a Registration Statement, to amend or supplement the Registration Statement to name such transferee, such transferee shall, upon written notice to the Company, be entitled to have the Company make such amendment or supplement as soon as reasonably practicable. SECTION 9. CONDITIONS TO EXCHANGING PARTY'S OBLIGATIONS The Exchanging Party's obligation to exchange Shares hereunder is subject to satisfaction of the following conditions at the Closing (any of which may be waived by the Exchanging Party): 9.1 Series B Certificate of Designations. The Series B Certificate of Designations shall have been filed with the Delaware Secretary of State in substantially the form attached hereto as Exhibit A. 9.2 Certificates for Shares. The Exchanging Party shall concurrently receive the certificates for Shares contemplated by Section 2(b) hereof. 9.3 Accuracy of Representations and Warranties. The representations and warranties of the Company in the Stock Exchange Agreements or in any certificate or document delivered pursuant hereto or thereto shall be correct and complete on and as of the Closing Date with the same effect as though made on and as of the Closing Date (after giving effect to transactions contemplated by this Agreement). 9.4 Compliance with Agreements. The Company shall have performed and complied with all agreements, covenants and conditions contained in the Stock Exchange Agreements and any other document contemplated hereby or thereby which are required to be performed or complied with by the Company on or before the Closing Date. 9.5 Officers' Certificates. The Exchanging Party shall have received a certificate dated the Closing Date and signed by the President and by the Secretary of the Company, to the effect that the conditions of this Section 9 have been satisfied. -46- 9.6 Proceedings. All corporate and other proceedings in connection with the transactions contemplated by the Stock Exchange Agreements, and all documents incident thereto, shall be in form and substance satisfactory to the Exchanging Party and its counsel, and the Exchanging Party shall have received all such originals or certified or other copies of such documents as the Exchanging Party or its counsel may reasonably request. 9.7 Legality; Governmental and Other Authorization. The purchase of and payment for the Shares shall not be prohibited by any law or governmental order, rule, ruling, regulation, release, interpretation or opinion applicable to the Exchanging Party and shall not subject the Exchanging Party to any penalty, tax, liability or other onerous condition. Any necessary consents, approvals, licenses, permits, orders and authorizations of, and any filings, registrations or qualifications with, any governmental or administrative agency or other person with respect to the transactions contemplated by the Stock Exchange Agreements shall have been obtained or made and shall be in full force and effect. The Company shall have delivered to the Exchanging Party upon its reasonable request factual certificates or other evidence, in form and substance satisfactory to the Exchanging Party and its counsel, setting forth what is required to enable the Exchanging Party to establish compliance with this condition. 9.8 Time of Exchange. The Closing shall not be later than 5:00 P.M., New York City time, on March 10, 1997 unless such date is extended by the Company, in its sole discretion, to a date no later than March 31, 1997. 9.9 No Change in Law, etc. No legislation, order, rule, ruling or regulation shall have been proposed, enacted or made by or on behalf of any governmental body, department or agency, and no legislation shall have been introduced in either House of Congress, and no investigation by any governmental authority shall have been commenced or threatened, and no action, suit or proceeding shall have been commenced before, and no decision shall have been rendered by, any court, other governmental body or arbitrator, which, in any such case, in the Exchanging Party's reasonable judgment could adversely affect, restrain, prevent or change the transactions contemplated by the Stock Exchange Agreements (including without limitation the issuance of the Shares hereunder and thereunder and the issuance of the Conversion Shares under the Series B Certificate of Designations) or materially and adversely affect the assets, properties, liabilities, business, affairs, results of operations, condition (financial or otherwise) or prospects of the Company. -47- 9.10 Opinions of Counsel. The Exchanging Party shall have received an opinion dated the Closing Date and addressed to the Exchanging Party of Andrews & Kurth L.L.P., counsel for the Company, which opinion shall be in form and substance reasonably satisfactory to the Exchanging Party. 9.11 Other Documents and Opinions. The Exchanging Party shall have received such other documents and opinions, in form and substance satisfactory to the Exchanging Party and its counsel, relating to matters incident to the transactions contemplated hereby as the Exchanging Party may reasonably request. 9.12 Receipt of Consent and Exchange Agreements. The Company shall have received a sufficient number of Consent and Exchange Agreements executed by the holders of Series A Preferred Stock in order to have the necessary authorization for the parity treatment of the Series B Preferred Stock and the modification to the registration rights as contemplated therein. 9.13 Special Dividend. The Company shall have declared a dividend on the Series A Preferred Stock to the holders of record of shares of Series A Preferred Stock immediately preceding the Initial Closing Date. Such dividend shall be paid promptly following the Initial Closing and shall constitute the amount of all accrued but unpaid dividends on the Series A Preferred Stock through the date of the Initial Closing. SECTION 10. CONDITIONS TO COMPANY'S OBLIGATIONS The Company's obligation to exchange and issue the Shares at the Closing is, at the option of the Company, subject to the fulfillment or waiver of the following conditions: 10.1 Representations and Warranties Correct. The representations and warranties made by the Exchanging Party in Section 5 hereof shall be true and correct in all material respects when made, and shall be true and correct in all material respects on the Closing Date with the same force and effect as if they had been made on and as of said date. 10.2 Covenants. All covenants, agreements and conditions contained in this Agreement to be performed by the Exchanging Party on or prior to the Closing Date shall have been performed or complied with in all material respects. -48- 10.3 Blue Sky. The Company shall have obtained all necessary blue sky law permits and qualifications, or secured exemptions therefrom, required by any state for the offer and sale of the Shares. No stop order or other order enjoining the sale of the Shares shall have been issued and no proceedings for such purpose shall be pending or, to the knowledge of the Company, threatened. 10.4 Surrender of Certificates. The Exchanging Party shall have delivered to the Company, on or prior to the Closing Date, the certificate or certificates representing the Exchanged Shares, duly endorsed for transfer to the Company. 10.5 Closing of Private Placement. The Company shall have completed a closing of the sale of shares of Series B Preferred Stock under one or more Stock Purchase Agreements. SECTION 11. BROKERS Except for certain fees payable to the Agent (all of which fees will be paid by the Company), the Company represents and warrants to the Exchanging Party that there is no liability for (and the Company will pay and indemnify the Exchanging Party against) any fees or expenses (or claims therefor) of any investment banker, finder or broker retained by the Company or its Affiliates (or that claims it was retained by the Company or its Affiliates) in connection with any Stock Exchange Agreement or any of the transactions contemplated hereby or thereby. The Company will indemnify the Exchanging Party against all such fees or expenses payable to the enumerated persons in the preceding sentence and against any other such fees, expenses or claims of any person, unless such person was engaged by the Exchanging Party in connection with this Agreement or any of the transactions contemplated hereby. SECTION 12. BREACH OF REPRESENTATIONS, WARRANTIES AND COVENANTS (a) The representations and warranties (as of the date hereof and as of the Closing Date), covenants and agreements of the Company and the Exchanging Party contained in this Agreement or in any document or certificate delivered pursuant hereto or in connection herewith shall survive, and shall continue in effect following, the execution and delivery of the Stock Exchange Agreements, the closings hereunder and thereunder, any investigation at any time made by the Exchanging Party or on its behalf or by any other Person, the issuance, exchange and delivery of the Shares, any disposition thereof and any payment, conversion or cancellation of the Shares provided, that Section 7 (other than Sections 7.1, 7.2, 7.4, 7.5, 7.7, 7.8, 7.9, 7.12, 7.13, 7.16, 7.17, 7.18, 7.20 and 7.21) shall terminate when no Shares are outstanding. All statements contained in any certificate delivered to the Exchanging Party by or on behalf of the Company pursuant hereto shall constitute representations and warranties by the Company hereunder. -49- (b) The Company agrees to indemnify and hold the Exchanging Party harmless from and against and will pay to the Exchanging Party the full amount of any loss, damage, liability or expense (including amounts paid in settlement and attorneys' fees and expenses) to the Exchanging Party resulting either directly or indirectly from any breach of the representations, warranties, covenants or agreements of the Company contained in any Stock Exchange Agreement, or in any certificate delivered to the Exchanging Party pursuant hereto or in connection herewith. SECTION 13. SPECIFIC PERFORMANCE The parties agree that irreparable damage will result in the event that this Agreement is not specifically enforced, and the parties agree that any damages available at law for a breach of this Agreement would not be an adequate remedy. Therefore, the provisions hereof and the obligations of the parties hereunder shall be enforceable in a court of equity, or other tribunal with jurisdiction, by a decree of specific performance, and appropriate injunctive relief may be applied for and granted in connection therewith. Such remedies and all other remedies provided for in this Agreement shall, however, be cumulative and not exclusive and shall be in addition to any other remedies which a party may have under this Agreement or otherwise. SECTION 14. EXPENSES (a) Whether or not the transactions herein contemplated are consummated, the Company will pay (i) the costs and expenses of the preparation and production of the Stock Exchange Agreements and the Series B Certificate of Designations and the issuance of the Shares and the Conversion Shares and the furnishing of all opinions by counsel for the Company, (ii) the fees and expenses of Piper & Marbury L.L.P. in connection with the Stock Exchange Agreements and the Series B Certificate of Designations and the transactions contemplated hereby and thereby (whether or not a closing occurs hereunder and if a closing occurs the Company will make such payment on the Closing Date), (iii) the reasonable fees and expenses of counsel to the Eligible Holders in connection with any amendments to or modifications or waivers of any provisions of the Stock Exchange Agreements or the Series B Certificate of Designations or in connection with any other agreements between the Exchanging Parties and the Company after the date hereof, any of which are requested by the Company, (iv) the fees and expenses of any investment banker, broker or finder retained by the Company or its Affiliates (or that claims it was retained by the Company or its Affiliates) and involved with the Stock Exchange Agreements or the Series B Certificate of Designations or any of the transactions contemplated hereby or thereby, and (v) the fees and expenses (including reasonable attorneys' fees and expenses) of any holder of Shares or Conversion Shares in enforcing its rights against the Company if the Company materially defaults in its obligations hereunder or under the Series B Certificate of Designations. The obligations of the Company under this Section 14 shall survive the Closing hereunder and any termination of the Stock Exchange Agreements. (b) In addition to all other sums due hereunder or provided for in this Agreement, the Company shall pay to the Exchanging Party or its agents, respectively, an amount sufficient to -50- indemnify such persons (net of any taxes on any indemnity payments) against all reasonable costs and expenses (including reasonable attorneys' fees and expenses and reasonable costs of investigation) and damages and liabilities incurred by the Exchanging Party or its agents pursuant to any investigation or proceeding against any or all of the Company, the Exchanging Parties, or their agents, arising out of or in connection with the Stock Exchange Agreements, the Shares or the Conversion Shares (or any transaction contemplated hereby or thereby or any other document or instrument executed herewith or therewith or pursuant hereto or thereto), whether or not the transactions contemplated by this Agreement are consummated, which investigation or proceeding requires the participation of the Exchanging Party or its agents or is commenced or filed against the Exchanging Party or its agents because of the Stock Exchange Agreements, the Shares or the Conversion Shares or any of the transactions contemplated hereby or thereby (or any other document or instrument executed herewith or therewith or pursuant hereto or thereto), other than any investigation or proceeding in which it is finally determined that there was gross negligence or willful misconduct on the part of the Exchanging Party or its agents which was not taken by them in reliance upon any of the Company's representations, warranties, covenants or agreements in the Stock Exchange Agreements or in any other documents or instruments contemplated hereby or thereby or executed herewith or therewith or pursuant hereto or thereto, except to the extent that any costs, expenses, damages or liabilities incurred by the Exchanging Party is the direct result of its breach of any of its representations, warranties, covenants or agreements in this Stock Exchange Agreement or in any other documents or instruments contemplated hereby or thereby or executed in connection herewith or therewith or pursuant hereto or thereto. The Company shall assume the defense, and shall have its counsel represent the Exchanging Party and such agents, in connection with investigating, defending or preparing to defend any such action, suit, claim or proceeding (including any inquiry or investigation); provided, however, that the Exchanging Party, or any such agent, shall have the right (without releasing the Company from any of its obligations hereunder) to employ its own counsel and either to direct its own defense or to participate in the Company's defense, but the fees and expenses of such counsel shall be at the expense of such person unless (i) the employment of such counsel shall have been authorized in writing by the Company in connection with such defense or (ii) the Company shall not have provided its counsel to take charge of such defense or (iii) the Exchanging Party, or such agent of the Exchanging Party, shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to those available to the Company, then in any of such events referred to in clauses (i), (ii) or (iii) such reasonable counsel fees and expenses (but only for one counsel for the Exchanging Parties and their agents) shall be borne by the Company. Any settlement of any such action, suit, claim or proceeding shall require the consent of both the Company and such indemnified person (neither of which shall unreasonably withhold its consent). (c) The Company agrees to pay, or to cause to be paid, all documentary, stamp and other similar taxes levied under the laws of the United States of America or any state or local taxing authority thereof or therein in connection with the issuance and exchange of the Shares and the execution and delivery of the Stock Exchange Agreements and any other documents or instruments contemplated hereby or thereby and any modification of the Series B Certificate of Designations or the Stock Exchange Agreements or any such other documents or instruments and will hold the -51- Exchanging Party harmless without limitation as to time against any and all liabilities with respect to all such taxes. (d) The obligations of the Company under this Section 14 shall survive the Closing hereunder and any termination of the Stock Exchange Agreements. SECTION 15. HOME OFFICE PAYMENTS As long as the Exchanging Party or any institutional holder which is a direct or indirect transferee (as a result of one or more transfers) from the Exchanging Party shall be the holder of record of any Shares, the Company will make all dividends, redemption payments, repurchase payments, liquidation payments and other distributions by wire transfer to the Exchanging Party's or such other holder's (or its nominee's) account at any bank or trust company in the United States of America, notwithstanding any contrary provision herein or in the Company's certificate of incorporation with respect to the place of payment. The Exchanging Party has provided an address on Schedule I hereto for payments by wire transfer, and such address may be changed for the Exchanging Party or any subsequent holder by notice to the Company. All such payments shall be made in U.S. dollars and in federal or other immediately available funds. SECTION 16. AMENDMENTS AND WAIVERS (a) The terms and provisions of this Agreement may be amended, waived, modified or terminated only with the written consent of the Majority Shareholders; provided, however, that no such amendment, waiver, modification or termination shall (i) change the provisions of Section 8 hereof in any material respect, without the consent of the holders of all Shares or Conversion Shares affected thereby or (ii) change the definition of Majority Shareholders or this Section 16(a) without the written consent of the holders of all the Shares and Conversion Shares then outstanding; and provided further that no such amendment, waiver, modification or termination shall be effective with respect to a term or provision of this Agreement unless it is also effective with respect to the corresponding term or provision, if any, of each other Stock Exchange Agreement and each Stock Purchase Agreement. The Exchanging Party acknowledges that by operation hereof, the Majority Shareholders (which may not include the Exchanging Party) will have the right and power to diminish or eliminate certain rights of the Exchanging Party under this Agreement. (b) The Company agrees that all holders of Shares and Conversion Shares shall be notified by the Company in advance of any proposed amendment, waiver, modification or termination, but failure to give such notice shall not in any way affect the validity of any such amendment, waiver, modification or termination. In addition, promptly after obtaining the written consent of the holders as herein provided, the Company shall transmit a copy of any amendment, waiver, modification or termination which has been adopted to all holders of Shares and Conversion Shares then outstanding, but failure to transmit copies shall not in any way affect the validity of any such amendment, waiver, modification or termination. -52- SECTION 17. EXCHANGE OF SHARES; CANCELLATION OF SURRENDERED SHARES; REPLACEMENT (a) Subject to Section 6 hereof, at any time at the request of any holder of Shares to the Company at its address provided under Section 18 hereof, the Company at its expense (except for any transfer tax arising out of the exchange) will issue and deliver to or upon the order of the holder in exchange therefor a new certificate or certificates therefor in such amount or amounts as such holder may request in the aggregate representing the number of Shares represented by such surrendered certificates, and registered in the name of such holder or otherwise as such holder may direct. (b) Any Share certificate which is converted into Conversion Shares in whole or in part shall be canceled by the Company, and no new Share certificates shall be issued in lieu of any Shares which have been converted into Conversion Shares. The Company shall issue a new certificate with respect to any Shares which were not converted into Conversion Shares and were represented by a certificate which was converted in part. (c) Upon receipt of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of any Share certificate and, in the case of any such loss, theft or destruction, upon delivery of an indemnity agreement reasonably satisfactory to the Company (unsecured in the case of an institutional holder), or in the case of any such mutilation, upon surrender of such Share certificate (which surrendered Share certificate shall be canceled by the Company), the Company will issue a new Share certificate, of like tenor in lieu of such lost, stolen, destroyed or mutilated Share certificate as if the lost, stolen, destroyed or mutilated Share certificate were then surrendered for exchange. SECTION 18. NOTICES All notices, requests, demands, consents and other communications hereunder shall be in writing and shall be delivered by hand or shall be sent by telex or telecopy (confirmed by registered, certified or overnight mail or courier, postage and delivery charges prepaid), if to the Company at the address indicated below, or if to the Exchanging Party at the address indicated on Schedule I hereto, or at such other address as a party may from time to time designate as its address in writing to the other party to this Agreement. Whenever any notice is required to be given hereunder, such notice shall be deemed given and such requirement satisfied only when such notice is delivered or, if sent by telex or telecopier, when received. a. If to the Company: Energy BioSystems Corporation 4200 Research Forest Drive The Woodlands, Texas 77381 -53- Attn: Vice President of Finance With a copy to: Andrews & Kurth L.L.P. 4200 Texas Commerce Tower Houston, Texas 77002 Attn: William N. Finnegan, IV (b) If to the Exchanging Party, at the address of the Exchanging Party set forth on Schedule I. SECTION 19. MISCELLANEOUS (a) The Stock Exchange Agreements (including all schedules and exhibits thereto) and, upon the closing hereunder, the Series B Certificate of Designations, together with any further agreements entered into by the Exchanging Party and the Company at the closing hereunder, contain the entire agreement between the Exchanging Party and the Company, and supersede any prior oral or written agreements, commitments, terms or understandings regarding the subject matter hereof. (b) Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, the parties hereby waive any provision of law which may render any provision hereof prohibited or unenforceable in any respect. (c) If the Company fails to pay any amount required to be paid to a holder of Shares or Conversion Shares or to a party under this Agreement (not including dividends not declared by the Board of Directors), within thirty (30) days after notice from such holder or such party demanding such payment (together with reasonably detailed supporting information), then the Company agrees to pay such holder or such party interest on any such overdue amount at a rate of 10% per annum from the date of such notice from such holder or such party until such overdue amount is paid in full. (d) Unless otherwise expressly provided herein, any provision of this Agreement relating to the consent, determination, decision or waiver of a holder or holders of Shares or Conversion -54- Shares means such holder's consent, determination, decision or waiver in such holder's sole discretion. (e) This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, whether so expressed or not; provided, that the Company may not assign any of its rights, duties or obligations under this Agreement, except in connection with a transaction permitted by Section 7.11 or with the Exchanging Party's written consent. (f) In addition to any assignment by operation of law, the Exchanging Party may assign, in whole or in part, any or all of its rights (and/or obligations) under this Agreement to any permitted transferee of any or all of its Shares or Conversion Shares, except as provided in Section 8.10, and (unless such assignment expressly provides otherwise) any such assignment shall not diminish the rights the Exchanging Party would otherwise have under this Agreement or with respect to any remaining Shares or Conversion Shares held by the Exchanging Party. (g) No course of dealing and no delay on the part of any party hereto in exercising any right, power, or remedy conferred by this Agreement shall operate as a waiver thereof or otherwise prejudice such party's rights, powers and remedies. No single or partial exercise of any rights, powers or remedies conferred by this Agreement shall preclude any other or further exercise thereof or the exercise of any other right, power or remedy. (h) The headings and captions in this Agreement are for convenience of reference only and shall not define, limit or otherwise affect any of the terms or provisions hereof. (i) This Agreement shall be governed by, and construed in accordance with, the laws of the State of Delaware (other than any conflict of laws rule which might result in the application of the laws of any other jurisdiction). (j) This Agreement may be executed by the parties hereto in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute one and the same instrument, and all signatures need not appear on any one counterpart. (k) WAIVER OF JURY TRIAL. THE COMPANY AND THE EXCHANGING PARTY HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT, THE SERIES B CERTIFICATE OF DESIGNATIONS, THE SHARES OR THE CONVERSION SHARES, OR ANY DEALINGS BETWEEN THEM RELATING TO THE SUBJECT MATTER OF THIS TRANSACTION. THE SCOPE OF THIS WAIVER IS INTENDED TO BE ALL-ENCOMPASSING OF ANY AND ALL DISPUTES THAT MAY BE FILED IN ANY COURT AND THAT RELATE TO THE SUBJECT MATTER OF THIS TRANSACTION, INCLUDING WITHOUT LIMITATION, CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW AND STATUTORY CLAIMS. THE COMPANY AND THE EXCHANGING PARTY FURTHER WARRANT AND REPRESENT THAT EACH HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL, AND THAT EACH -55- KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. THIS WAIVER IS IRREVOCABLE, MEANING THAT IT MAY NOT BE MODIFIED EITHER ORALLY OR IN WRITING, AND THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO (OR ASSIGNMENTS OF) THIS AGREEMENT, THE CERTIFICATE OF DESIGNATIONS, THE SHARES OR THE CONVERSION SHARES. IN THE EVENT OF LITIGATION, THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL (WITHOUT A JURY) BY THE COURT. -56- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written. ENERGY BIOSYSTEMS CORPORATION By /s/ John H. Webb ------------------------- Name: John H. Webb Title: President Accepted and Agreed to as of the date first above written by the undersigned Exchanging Party: (See Omnibus Signature Page) By _____________________________ Name: Title: -57- SCHEDULE I TO THE STOCK EXCHANGE AGREEMENT Number of Shares of Series A Preferred Name of Exchanging Party Number of Shares Received Stock Exchanged - ------------------------ ------------------------- --------------- (a) address for communications: Attn: (b) address for payments by wire transfer: -58- Attn: (providing sufficient information with such wire transfer to identify the source and application of such funds) -59- SCHEDULE II TO THE STOCK EXCHANGE AGREEMENT Summary of Registration Rights 1. Piggyback registration rights granted by the Company pursuant to that certain First Amendment to License and Technology Assistance Agreement, dated June 25, 1992, between the Company and Institute of Gas Technology. 2. Demand and piggyback registration rights granted by the Company pursuant to that certain Registration Agreement, dated January 30, 1992, by and among the Company, The Travelers Indemnity Company, The Travelers Indemnity Company of Rhode Island, The Phoenix Insurance Company and Gryphon Ventures II, Limited Partnership. 3. Demand and piggyback registration rights granted by the Company pursuant to that certain Registration Agreement, dated April 29, 1991, by and between the Company and Gryphon Ventures II, Limited Partnership. 4. Registration rights granted by the Company to the holders of the Series A Preferred Stock pursuant to those certain Stock Purchase Agreements dated October 27, 1994. 5. Registration rights granted by the Company to the purchasers of Series B Preferred Stock pursuant to those certain Stock Purchase Agreements dated February 21, 1997. Indebtedness NONE. -60- EX-10.10 5 EMPLOYMENT AGREEMENT EXHIBIT 10.10 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT is made as of the 31st day of January, 1996 by and between Energy BioSystems Corporation, a Delaware corporation (the "Company"), and Daniel J. Monticello ("Employee"). W I T N E S S E T H : WHEREAS, the Company wishes to employ Employee and Employee wishes to be employed by the Company on the terms and subject to the conditions set forth below; NOW, THEREFORE, in consideration of the foregoing recital and of the mutual covenants herein set forth, the Company and Employee hereby agree as follows: 1. Employment. Effective as of January 15, 1996 (the "Effective Date"), the Company hereby employs Employee and Employee accepts such employment, effective as of the Effective Date, for the compensation and on the terms and subject to the conditions herein set forth. 2. Compensation. The Company shall pay Employee an initial monthly salary equivalent to Employee's current monthly salary payable in accordance with the Company's normal pay practices, which shall be reviewed no less than annually and from time to time changed (but not to be decreased to an amount below the initial monthly salary) at the discretion of the Board of Directors of the Company. Employee shall also be entitled to all rights and benefits for which he shall be eligible under group insurance and other fringe benefits which may be in force from time to time (including any profit-sharing, option or other incentive compensation plan either Company-wide or specific to the Employee) and provided to the Company's employees generally. 3. Duties. Prior to the termination hereof, Employee agrees to devote his full time and attention to the service of the Company and, in furtherance thereof, to use his best efforts and to perform such duties as may be assigned to him from time to time by or under authority of the Board of Directors of the Company. Employee agrees that he will not undertake any other employment, consulting services or business venture during the period of his employment hereunder, unless the Company, by action of the Board, shall consent thereto in writing. The foregoing shall not be construed as preventing Employee from engaging in such personal and business investment activities as are essentially passive in nature and do not conflict with or adversely affect in any material respect the performance or discharge of Employee's duties and responsibilities hereunder. 4. Term and Termination. 4.1 The term of this Agreement shall commence on the Effective Date and shall continue until April 1, 1999 unless earlier terminated as hereinafter provided. 4.2 This Agreement shall terminate automatically on the death of Employee. 4.3 The Company shall have the right to terminate Employee's employment for cause by giving notice in writing to Employee. As used herein, the term "cause" shall mean (i) dishonesty; (ii) conviction of any crime other than misdemeanors or minor traffic violations; (iii) material breach of any provision of this Agreement; (iv) commission of any action or omission to take any action in bad faith and to the detriment of the Company; (v) willful refusal or failure of Employee to obey the lawful directions of the Board of Directors of the Company; or (vi) failure to adequately perform the duties and responsibilities assigned to Employee pursuant to this Agreement, which failure shall continue for a period of thirty (30) days after receipt of written notice from the Board of Directors indicating with specificity the acts or omissions upon which the Board intends to terminate his employment. 4.4 The Company shall have the right to terminate Employee's employment in the event of complete disability by giving notice in writing to Employee. As used herein, the term "complete disability" shall mean the inability of Employee, due to illness or injury, to perform his duties hereunder for a period of 180 consecutive days. 4.5 The foregoing notwithstanding, the Company may terminate Employee's employment for whatever reason it deems appropriate by one month's prior notice in writing. 4.6 Employee shall have the right to terminate Employee's employment at any time following the occurrence of a Change in Control, as defined below, if Employee's duties or responsibilities are materially reduced in connection with or following the Change in Control from those in effect immediately prior to the Change in Control, except in connection with the termination of Employee's employment pursuant to Sections 4.2, 4.3, 4.4, 4.5 or 4.7. For purposes of this Agreement, a "Change in Control" shall be deemed to have occurred if: (i) any individual, entity or group (within the meaning of Section 13(d) or 14(d)(2) of the Securities and Exchange Act of 1934) shall become (directly or indirectly) the "beneficial owner" (within the meaning of Rule 13d-3 promulgated under such Act) of more than 50% of the combined voting power of the then outstanding securities of the Company entitled to vote generally in the election of directors ("Voting Power"); or -2- (ii) the Company's stockholders shall approve a merger or consolidation, sale or disposition of all or substantially all of the Company's assets or a plan of liquidation or dissolution of the Company, other than (A) a merger or consolidation in which the voting securities of the Company outstanding immediately prior thereto will become (by operation of law), or are to be converted into, voting securities of the surviving corporation or its parent corporation that, immediately after such merger or consolidation, (x) are owned by the same person or entity or persons or entities that owned the voting securities of the Company immediately prior thereto and (y) possess at least 75% of the Voting Power held by the voting securities of the surviving corporation or its parent corporation, or (B) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no person acquires more than 50% of the Voting Power. 4.7 The foregoing notwithstanding, Employee shall have the right to terminate Employee's employment for whatever reason Employee deems appropriate by one month's prior notice in writing. 4.8 In the event of termination of Employee's employment pursuant to Sections 4.2, 4.3, 4.4 or 4.7 hereof, the Company shall pay Employee his salary at the then current rate up to the date of such termination, and Employee shall be entitled to no further compensation hereunder. 4.9 In the event of termination of Employee's employment pursuant to Sections 4.5 or 4.6 hereof, the Company shall pay Employee severance compensation for the lesser of a period of (i) six (6) months from the date of such termination, (ii) the remaining term of this Agreement, or (iii) a period ending on the date on which Employee becomes employed by another entity, payable as and when Employee would otherwise be paid his salary under Section 2 hereof. 5. Nondisclosure; Inventions; Non-Competition. 5.1 For the purposes of this Agreement the terms set forth below shall have the following meanings: 5.1.1 Confidential Information. That secret proprietary information of the Company of whatever kind or nature disclosed to Employee or known by Employee (whether or not invented, discovered or developed by Employee). Such proprietary information shall include information relating to the design, manufacture and application of the Company's products, know-how and research and development relating to the Company's products, sources of supply and material, operating and other cost data, lists of present, past or prospective customers, customer proposals, and price lists and -3- data relating to pricing of the Company's products or services, any of which information is not generally known in the industry, and shall specifically include, without limitation, all information contained in manuals, memoranda, formulae, plans, drawings and designs, specifications, supply sources, and records of the Company. 5.1.2 Concepts and Ideas. Those concepts and ideas known to Employee relating to the Company's activities and products. 5.1.3 Inventions. Those discoveries and developments, whether or not patentable, relating to the Company's activities and products (whether made by Employee acting alone or in conjunction with others) made (i) prior to July 23, 1990 related to microbial desulfurization of fossil fuels or (ii) on or after July 23, 1990 and prior to three years after the termination of Employee's employment with the Company. The term "Invention" shall also include any other discovery or development made by Employee on or after July 23, 1990 and prior to the termination of this Agreement, except for any invention or discovery for which no equipment, supplies, facility, or trade secret information of the Company was used and which was developed entirely on the Employee's own time and (i) which does not relate (a) to the business of the Company, or (b) to the Company's actual or demonstrably anticipated research or development, or (ii) which does not result from any work performed by the Employee for the Company. Such term shall not be limited to the meaning of "invention" under the United States patent laws. Listed below by descriptive title for purposes of identification are all inventions made by Employee prior to the date on which Employee was first employed by the Company in any capacity which he considers to be his property and which are hereby excluded from this Agreement: NONE 5.2 All Inventions and all Concepts and Ideas shall be the property of and are hereby assigned to the Company free of any reserved or other rights of any kind on the part of Employee in respect thereof. 5.3 Employee will promptly make full disclosure of any such Inventions and Concepts and Ideas to the Company. Further, Employee will, at the Company's cost and expense, promptly execute formal applications for patents and also do all other acts and things (including, among others, the execution and delivery of instruments of further assurance or confirmation) deemed by the Company to be necessary or desirable at any time or times in order to effect the full assignment to the Company of Employee's right and title to such Inventions and Concepts and Ideas, without, during the term of this Agreement, further compensation beyond Employee's agreed salary. Employee further understands that the absence of a request by the Company for information, or for the making of an oath, or for the execution of any document, -4- shall in no way be construed to constitute a waiver of the Company's rights under this Agreement. 5.4 Except as required by Employee's duties hereunder, Employee will not, directly or indirectly, use, publish, disseminate or otherwise disclose any Confidential Information, Concepts and Ideas or Inventions relating to the past, present or planned business of the Company without the prior written consent of the Company, unless any such items are, prior to such disclosure, part of the written public knowledge or become part of the written public knowledge through no fault of Employee or are disclosed to Employee by a third party having the right to do so. 5.5 All documents, procedural manuals, guides, specifications, plans, drawings, designs and similar materials, lists of present, past or prospective customers, customer proposals, invitations to submit proposals, price lists and data relating to pricing of the Company's products and services, records, notebooks and similar repositories of or containing Confidential Information and Inventions, including all copies thereof, that are or come into Employee's possession or control by reason of Employee's employment, whether prepared by Employee or others, are the property of the Company, will not be used by Employee in any way adverse to the Company, will not be removed from the Company's premises except as Employee's normal duties require and, at the termination of Employee's employment with the Company, will be left with or forthwith returned by Employee to the Company. 5.6 During the term of Employee's employment with the Company and for a period of five (5) years thereafter, Employee shall not, individually or on behalf of or in conjunction with any other person or entity, directly or indirectly, own, manage, operate, control or be employed by, solicit the Company's past, present or prospective employees or customers on behalf of, or, otherwise participate in any manner in any corporation, partnership, proprietorship or other business entity which is engaged in the development or sale of technology for the microbial desulfurization of hydrocarbons or in any activity or development of any product directly competitive with any of the activities engaged in or products developed by the Company at the time of Employee's termination; provided, however, that Employee may own not more than 1% of the outstanding capital stock of a company in a competitive business whose stock is publicly traded. 6. Expenses. Employee shall be entitled to reimbursement for reasonable expenses incurred in the performance of services hereunder, provided that the same are accounted for in accordance with the Company's general requirements. 7. Survival; Remedies. Employee's duties under sections 5.2, 5.3, 5.4, 5.5, and 5.6 of this Agreement shall survive termination of this Agreement and Employee's employment with the Company. Employee acknowledges that a remedy at law for -5- any breach or threatened breach by Employee of the provisions of this Agreement may be inadequate and Employee therefore agrees that the Company shall be entitled to injunctive relief in case of any such breach or threatened breach. 8. Assignment. This Agreement and the rights and obligations of the parties hereto shall bind and inure to the benefit of each of the parties hereto and shall also bind and inure to the benefit of any successor or successors of the Company by reorganization, merger or consolidation and any assignee of all or substantially all of its business and properties, but, except as to any such successor or assignee of the Company, neither this Agreement nor any rights or benefits hereunder may be assigned by the Company or by Employee. 9. Governing Law. This Agreement shall be construed in accordance with and governed for all purposes by the laws and public policy of the State of Texas applicable to contracts executed and wholly performed within such state. 10. Separability. In case any one or more of the provisions contained in this Agreement shall, for any reason, be held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provisions of this Agreement, but this Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been contained herein. If, moreover, any one or more of the provisions contained in this Agreement shall for any reason be held to be excessively broad as to duration, geographical scope, activity or subject, it shall be construed by limiting and reducing it, so as to be enforceable to the extent compatible with the applicable law as it shall then appear. 11. Waiver. If either party should waive any breach of any provision of this Agreement, he or it shall not thereby be deemed to have waived any preceding or succeeding breach of the same or any other provision of this Agreement. No party shall be deemed to waive any rights hereunder unless such waiver be in writing and signed by such party. 12. Entire Agreement. The foregoing is the entire Agreement of the parties with respect to the subject matter hereof and may not be amended, supplemented, cancelled or discharged except by written instrument executed by both parties hereto. This Agreement supersedes and replaces in all respects the employment agreement dated April 5, 1991 between the Company and Employee. -6- IN WITNESS WHEREOF, the parties have executed this Agreement as of the day, month and year first above stated. /s/ Daniel J. Monticello -------------------------------- Daniel J. Monticello ENERGY BIOSYSTEMS CORPORATION By:/s/ John H. Webb ----------------------------- -7- EX-10.36 6 THIRD AMENDMENT TO COLLABORATION EXHIBIT 10.36 THIRD AMENDMENT AND ADDENDUM TO COLLABORATION AGREEMENT This Third Amendment and Addendum (the "Third Amendment") is made and entered into as of the 24th day of August, 1995, by and between Energy BioSystems Corporation, a Delaware corporation, ("EBC"), and Petrolite Corporation, a Delaware corporation, ("PLIT"). WITNESSETH: WHEREAS, EBC and PLIT are parties to that certain Collaboration Agreement dated March 5, 1992 (the "Collaboration Agreement"); WHEREAS, the Collaboration Agreement was amended by the parties on July 1, 1992 (the "First Amendment") and again on October 18, 1993 (the "second Amendment"); WHEREAS, PLIT has fully paid all of the amounts due under Section 2.5 of the Collaboration Agreement; WHEREAS, Article II of the Collaboration Agreement provides that PLIT shall use its best efforts at its sole expense to develop and deliver to EBC a Working Pilot Plant, as defined therein, as promptly as possible; WHEREAS, EBC has requested PLIT to develop and deliver to EBC a Working Pilot Plant even though the process provided by EBC has not been the subject of ten (10) bench scale test trials as contemplated in paragraph 1.74 of the Collaboration Agreement, and even though EBC contemplates that additional modifications to the process as currently developed by EBC may be necessary; WHEREAS, PLIT is willing to begin work on a Working Pilot Plant as request by EBC only pursuant to the terms of this Third Amendment to the Collaboration Agreement: NOW, THEREFORE, in consideration of the mutual covenants and promises contained herein and other good and valuable consideration, the receipt and sufficiency of which hereby are acknowledged, the parties hereby agree to the following: 1. The "Process" contemplated by Sections 1.57 and 1.74 of the Collaboration Agreement shall, for purposes of PLIT's obligation to deliver a Working Pilot Plant pursuant to Section 2.1 of Article II of the Collaboration Agreement, be the process described on Exhibit A, which is attached hereto and incorporated herein by this reference. 2. Section 1.74 of the Collaboration Agreement, as amended, hereby is deleted in its entirety, and the following new Section 1.74 is substituted therefor; "Working Pilot Plant - shall mean a pilot plant constructed in accordance with the design specifications contained on Exhibit B attached hereto and incorporated herein by reference; provided, however, that in no event shall PLIT be required to expend more than $1.5 million towards the design, procurement, fabrication and construction of the Working Pilot Plant." 3. PLIT shall be deemed to have fulfilled its obligations under Article II, Section 2.1(1) of the Collaboration Agreement, as amended, and shall be deemed to have delivered a Working Pilot Plant for all purposes under the Collaboration Agreement, upon PLIT's design, procurement, fabrication and construction of the Working Pilot Plant as defined in this Third Amendment as promptly as possible, or upon PLIT's expenditure of $1.5 million towards the design, procurement, fabrication and construction of the Working Pilot Plant, as defined in this Third Amendment, as promptly as possible, whichever first occurs, regardless of whether the process shown on Exhibit A is the Process developed and commercialized pursuant to the collaboration Agreement, regardless of whether the Working Pilot Plant is capable of reducing the sulfur content of any hydrocarbon stream, and regardless of whether additional changes or modifications to the process shown on Exhibit A or the design specifications shown on Exhibit B are made after the date of the Third Amendment. In addition, in the event PLIT has expended $1.5 million towards the design, procurement, fabrication and construction of the Working Pilot Plant but the working Pilot Plant has not been completed, PLIT agrees that (a) EBC shall have the right to complete the design, procurement, fabrication, construction and installation of the Working Pilot Plant at EBC's own expense, and (b) PLIT shall cooperate with EBC in EBC's efforts to complete the design, procurement, fabrication, construction and installation of the Working Pilot Plant in order to permit start-up of the Working Pilot Plant. 4. The parties intend that the Working Pilot Plant will be used as a research tool only at such times as may be reasonably required by EBC pursuant to the Collaboration, but in no event will the Working Pilot Plant be operated more than five (5) consecutive days, twenty-four (24) hours per day. Until September 1, 1996, or some other date as to which the parties agree in writing, PLIT will assign not less than three (3) employees full-time to provide operational and engineering staff support for the Working Pilot Plant. The costs of these employees, and the reasonable costs of maintaining the Working Pilot Plant and providing analytical lab support for the Working Pilot Plant, will be the sole responsibility of PLIT until September 1, 1996, unless the parties agree in writing to some other date. EBC will be solely responsible for all other costs of the Working Pilot Plant including, but not limited to: (a) having an appropriate individual on-site to direct and supervise the experimental program and operating parameters to be followed at the Working Pilot Plant and to provide such other staff support as necessary for operation of the Working Pilot Plant, (b) paying the costs of such individual and such other staff support as is necessary to guide the experimental program to be conducted at the Working Pilot Plant, (c) supplying all Catalyst and feedstock -2- for the Working Pilot Plant, and (d) paying the costs of disposing of all wastes and by-products from the Working Pilot Plant. IN WITNESS WHEREOF, the parties have caused this Third Amendment to be executed by their duly authorized representatives as of the date set forth above. ENERGY BIOSYSTEMS CORPORATION PETROLITE CORPORATION By: /s/ John H. Webb By: /s/ J. S. Titone ______________________________ _________________________________ Title: Chief Executive Officer Title: Vice President ___________________________ _____________________________ Date: September 5, 1995 Date: October 12, 1995 ___________________________ ______________________________ -3- EX-10.37 7 FOURTH AMENDMENT TO COLLABORATION AGREEMENT EXHIBIT 10.37 FOURTH AMENDMENT AND ADDENDUM TO COLLABORATION AGREEMENT THIS FOURTH AMENDMENT AND ADDENDUM TO COLLABORATION AGREEMENT (the "Fourth Amendment") is made and entered into as of the 25th day of October, 1996 (the "Effective Date"), by and between Energy BioSystems Corporation, a Delaware corporation ("EBC"), and Petrolite Corporation, a Delaware corporation ("PLIT"). WITNESSETH WHEREAS, EBC and PLIT are parties to that certain Collaboration Agreement dated March 5, 1992, as amended July 1, 1992 (the "First Amendment"), October 18, 1993 (the "Second Amendment") and August 24, 1995 (the "Third Amendment") (collectively, the "Collaboration Agreement"); WHEREAS, EBC is engaged in discussions with an investment banking firm regarding a possible equity financing scheduled to be completed in 1996 (the "Financing") and in connection therewith has agreed with PLIT to amend and grant to EBC the right to amend the Collaboration Agreement pursuant to the terms of this Fourth Amendment to the Collaboration Agreement; NOW, THEREFORE, in consideration of the mutual covenants and promises contained herein, One Dollar ($1.00) and other good and valuable consideration, the receipt and sufficiency of which hereby are acknowledged, the parties hereby agree to the following: 1. (a) If the Financing is completed during 1996, EBC shall pay to PLIT One Million Dollars ($1,000,000) (the "First Cash Payment") by corporate check or wire transfer within ten business days of the closing of the Financing and the Collaboration Agreement shall be amended as provided in Section 1(b) hereof. (b) Upon delivery of the First Cash Payment, without any further action by the parties: (i) Until the first to occur of the Election Date and the Expiration Date, as hereinafter defined, except as provided in this Section 1(b) PLIT shall be under no obligation to provide any research and development, technical support or consulting services pursuant to the Collaboration Agreement including, but not limited to, any obligations contained in Section 2.4 of the Collaboration Agreement. (ii) The Collaboration Agreement shall be automatically amended by deleting the second and third sentence of Section 4 of the Third Amendment and substituting in place thereof the following sentences: "Until December 31, 1998, or some other date as to which the parties agree in writing, PLIT will assign not less than three (3) employees full-time to provide operational and engineering staff support for the Working Pilot Plant. The costs of these employees and the reasonable costs of maintaining the Working Pilot Plant and providing analytical lab support for the Working Pilot Plant, will be the sole responsibility of PLIT until December 31, 1998, unless the parties agree in writing to some other date; provided that during the period commencing January 1, 1997 and ending on the date of the Second Cash Payment (as defined in the Fourth Amendment and Addendum to Collaboration Agreement dated October 25, 1996), EBC will reimburse PLIT quarterly for the direct out-of-pocket cash costs and expenses incurred by PLIT relating to these employees, maintaining the Working Pilot Plant and providing analytical lab support for the Working Pilot Plant (the "Reimbursable Expenses")." 2. (a) EBC may, at any time during the period commencing with the payment of the First Cash Payment and ending at 5:00 p.m. (Central time) on the "Expiration Date," as hereinafter defined, elect to amend the Collaboration Agreement as provided in Section 2(b) hereof. If EBC shall elect to amend the Collaboration Agreement as provided in Section 2(b) hereof, on the date of such election (the "Election Date") EBC shall deliver to PLIT: (i) written notice (the "Notice") of the exercise of its right to amend the Collaboration Agreement as provided in Section 2(b) hereof; (ii) Nine Million Dollars ($9,000,000) less the amount of Reimbursable Expenses previously paid by EBC to PLIT (the "Second Cash Payment") by corporate check or wire transfer; and (iii) a warrant (the "Warrant"), in the form attached hereto as Exhibit A, granting PLIT the right to purchase upon the terms and subject to the conditions set forth in the Warrant at an aggregate exercise price of One Million Dollars ($1,000,000) that number of shares of EBC common stock, par value $0.01 per share, (the "Common Stock"), equal to One Million dollars ($1,000,000) divided by the "Conversion Price,") as hereinafter defined. The "Expiration date" shall mean (x) if the Financing raises at least Twenty-Five Million Dollars ($25,000,000) in gross cash proceeds, December 31, 1996 or (y) if the Financing raises less than Twenty-Five Million Dollars ($25,000,000) in gross cash proceeds, the earlier to occur of (i) ten business days following the closing of any subsequent equity financing by EBC in which the gross cash proceeds raised in such equity financing together with the gross cash proceeds raised in the Financing equal or exceed Twenty-Five Million Dollars ($25,000,000) and (ii) the date that is 24 months following the payment of the First Cash Payment. The "Conversion Price" shall mean the initial per share price at which the EBC securities issued in the Financing may be converted into one share of Common Stock. (b) Upon delivery of the Notice, the Second Cash Payment and the Warrant, the Collaboration Agreement shall be automatically amended, without any further action by the parties, as follows: -2- (i) Section 1.24 of the Collaboration Agreement, as amended by the Second Amendment, is hereby deleted in its entirety, and the following new Section 1.24 is substituted therefor: "1.24 EBC Ninety and One-Half Percent Royalty - shall be equal to ninety and one-half percent (90.5%) of the Throughput Base for PLIT for each barrel of liquid hydrocarbons throughput by Site Licensees of PLIT during a calendar month plus ninety and one-half percent (90.5%) of the site Fee base for PLIT for such calendar month." (ii) Section 5.1 of the Collaboration Agreement, as amended by the Second Amendment, is hereby deleted in its entirety, and the following new Section 5.1 is substituted therefor: "5.1 Site License Fees. During the Collaboration Period, EBC shall be entitled to retain ninety and one-half percent (90.5%) of all Site License Fees and shall pay the remaining nine and one-half percent (9.5%) of such Site License Fees to PLIT." (iii) Section 5.2 of the Collaboration Agreement, as amended by the Second Amendment, is hereby deleted in its entirety, and the following new Section 5.2 is substituted therefor: "5.2 Site Throughput Fees. During the Collaboration Period, EBC shall be entitled to keep ninety and one-half percent (90.5%) of the Adjusted Gross Profit of EBC and EBC shall pay nine and one-half percent (9.5%) of the Adjusted Gross Profit of EBC to PLIT. The Catalyst Charge shall be paid by the Site Licensor to the Third Party Catalyst Supplier unless the Site Licensee has purchased the Catalyst directly from the Third Party Catalyst Supplier. EBC shall not collect any Equipment Amortization Charge from the Site Licensee if the Site Licensee purchases the Equipment itself." (iv) Section 6.2 of the Collaboration Agreement is hereby deleted in its entirety, and the following new Section 6.2 is substituted therefor: "6.2 Termination. Either party may terminate the Collaboration for Cause, effective on one hundred twenty (120) days' notice, unless the party in breach makes all payments under or cures the breach within said one hundred twenty (120) days. PLIT may terminate the Collaboration without Cause upon one (1) year's notice. If not earlier terminated, the Collaboration shall terminate on March 5, 2016." (v) Subsections 7.1(2)(e) and 7.1(3)(e) of the Collaboration Agreement, as amended by the Second Amendment, are hereby deleted in their entirety and the following new Subsections 7.1(2)(e) and 7.1(3)(e) are substituted therefor: -3- "7.1(2)(e) If the termination is with Cause, PLIT shall pay EBC the EBC Fifty Percent Royalty and the Five Percent Customer Products Royalty. If the termination is without Cause, PLIT shall pay EBC the EBC Ninety and One-Half Percent Royalty and the Five Percent Customer Products Royalty." "7.1(3)(e) PLIT shall pay EBC the EBC Ninety and One-Half Percent Royalty and the Five Percent Customer Products Royalty." (vi) Section 7.2(1) of the Collaboration Agreement is hereby deleted in its entirety. (vii) Section 7.2(2) of the Collaboration Agreement is hereby deleted in its entirety. (viii) Section 7.2(4) of the Collaboration Agreement is hereby deleted in its entirety. (ix) The percentage "22%," "18%," "11%," and "3%" in subsections i), ii), iii) and iv) of the Section a) of Schedule A of the Collaboration Agreement, as amended by the Second Amendment, are hereby deleted and "9.5%," "7.8%," "4.7%" and "1.3%" are hereby substituted, respectively, therefor. (x) The percentages "18%," "15%," "11%" and "3%" in subsections i), ii), iii) and iv) of Section b) of Schedule A of the Collaboration Agreement, as amended by the Second Amendment, are hereby deleted and "7.8%," "6.5%," "4.7%" and "1.3%" are hereby substituted, respectively, therefor. (xi) The percentages "15%," "11%," "7%" and "3%" in subsections i), ii), iii) and iv) of Section c) of Schedule A of the Collaboration Agreement, as amended by the Second Amendment, are hereby deleted and "6.5%," "4.7%," "3.0%" and "1.3%" are hereby substituted, respectively, therefor. (xii) The percentages "11%," "7%," "3%" and "3%" in subsections i), ii), iii) and iv) of Section d) of Schedule A of the Collaboration Agreement, as amended by the Second Amendment, are hereby deleted and "4.7%," "3.0%," "1.3%" and "1.3%" are hereby substituted respectively, therefor. (xiii) All of PLIT's obligations to provide research and development, technical support or consulting services in the Collaboration Agreement including, but not limited to, those set out in Section 2.4 of the Collaboration Agreement, are hereby deleted and the following shall remain the sole obligation of PLIT to provide research and development, technical support or consulting services pursuant to the Collaboration Agreement: -4- "Until December 31, 1998, or some other date as to which the parties agree in writing, PLIT will assign not less than three (3) employees full-time to provide operational and engineering staff support for the Working Pilot Plant. The costs of these employees and the reasonable costs of maintaining the Working Pilot Plant and providing analytical lab support for the Working Pilot Plant, will be the sole responsibility of PLIT until December 31, 1998, unless the parties agree in writing to some other date. In addition to the foregoing support, during the Collaboration Period PLIT shall make the appropriate employees available upon reasonable request, to consult with EBC employees or consultants regarding the operation of the Working Pilot Plant and the commercialization of MDS." 3. Except as expressly amended herein, the Collaboration Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the parties have caused this Fourth Amendment to be executed by their duly authorized representatives as of the Effective Date. ENERGY BIOSYSTEMS CORPORATION PETROLITE CORPORATION By: /s/ John H. Webb By: /s/ David Winslette ---------------- ------------------------------ Title: President and Chief Executive Officer Title: Vice President, Technology ------------------------------------- --------------------------- -5- EXHIBIT A NEITHER THIS WARRANT NOR THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR THE SECURITIES LAWS OF ANY STATE. SUCH SECURITIES MAY NOT BE SOLD OR OTHERWISE DISPOSED OF UNLESS PURSUANT TO A REGISTERED OFFERING OR BY TRANSFER EXEMPT FROM REGISTRATION OR UNLESS SOLD PURSUANT TO RULE 144 UNDER THE SECURITIES ACT. THIS WARRANT SHALL BE VOID AFTER 5:00 P.M., CENTRAL TIME, ON ____________ /(1)/, 2001 OR, IF SUCH DAY IS NOT A BUSINESS DAY, AT 5:00 P.M., CENTRAL TIME, ON THE NEXT FOLLOWING BUSINESS DAY. THE TRANSFER OF THIS WARRANT IS RESTRICTED. SEE SECTION 6.02 - "RESTRICTIONS ON TRANSFER." THE COMPANY HAS THE RIGHT TO ACCELERATE THE EXPIRATION DATE OF THIS WARRANT UNDER CERTAIN CIRCUMSTANCES. SEE SECTION 4.04 - "COMPANY'S RIGHT TO ACCELERATE EXPIRATION DATE." COMMON STOCK PURCHASE WARRANT OF ENERGY BIOSYSTEMS CORPORATION NO. ___ ____________, 1996 This certifies that Petrolite Corporation, a Delaware corporation, any successor in interest thereto, or any assignee or transferee thereof in whose name this Warrant is registered upon the books to be maintained by the Company for that purpose (the "Warrantholder"), is entitled to purchase from Energy BioSystems Corporation, a Delaware corporation (the "Company"), at any time on or prior to 5:00 p.m., Central time, on the Expiration Date (as hereinafter defined) and subject to the terms and conditions hereof _________/2/, fully paid and nonassessable shares of the Company's Common Stock at a price per share equal to the Exercise Price. The Exercise Price and the number of shares which may be purchased pursuant to this Warrant are subject to adjustment under certain conditions as provided in Article III hereof. - --------------- /1/ Five years after EBC issues this Warrant. /2/ A number of shares equal to One Million Dollars ($1,000,000) divided by the Conversion Price (as such term is defined in the Fourth Amendment and Addendum to Collaboration Agreement). -1- Stock at a price per share equal to the Exercise Price. The Exercise Price and the number of shares which may be purchased pursuant to this Warrant are subject to adjustment under certain conditions as provided in Article III hereof. ARTICLE I DEFINITIONS As used in this Warrant, the following capitalized terms shall have the following respective meanings: (a) Business Day: A day other than a Saturday, Sunday or other day on which banks in the States of New York or Texas are authorized by law to remain closed. (b) Common Stock: Common Stock, par value $0.01 per share, of the Company. (c) Exercise Price: The per share price for which the Warrantholder may purchase shares of Common Stock pursuant to this Warrant. The initial Exercise Price is $____/3/. The Exercise Price may be adjusted from time to time pursuant to Article III hereof. (d) Expiration Date: _____________/4/, 2001 or, if such day is not a Business Day, on the next following Business Day. (e) Net Consideration Per Share: The Total Consideration attributable to purchase rights, options or warrants exercisable for Common Stock, divided by the aggregate number of shares of Common Stock that would be issued if all such purchase rights, options or warrants were exercised. (f) Person: An individual, partnership, joint venture, corporation, trust, unincorporated organization or government or any department or agency thereof. (g) Registrable Securities: (i) The Warrant Shares, and (ii) any Common Stock issued as a dividend or other distribution with respect to or in exchange for or in replacement of such Warrant Shares, provided, however, that Registrable Securities shall not include any shares of Common Stock which have previously been registered under the Securities Act or which may be sold pursuant to Rule 144 (or any successor to such Rule). - ------------------- /3/ A number equal to $1,000,000 divided by the number of shares calculated pursuant to footnote (2). /4/ Five years after EBC issues this Warrant. -2- (h) Securities Act: The Securities Act of 1933, as amended. (i) Total Consideration: The amount equal to the total amount of consideration received by the Company for the issuance of purchase rights, options or warrants exercisable for Common Stock, plus the minimum amount of consideration, if any, payable to the Company upon exercise thereof. (j) Warrant: This Warrant and all other warrants that may be issued in its place. (k) Warrant Shares: Shares of Common Stock purchasable upon exercise of the Warrant. ARTICLE II DURATION AND EXERCISE OF WARRANT Section 2.01 Duration of Warrant. Subject to the terms contained herein, this Warrant may be exercised at any time on or after the date of issuance of this Warrant and before 5:00 p.m., Central time, on the Expiration Date. If this Warrant is not exercised at or before 5:00 p.m., Central time, on the Expiration Date, it shall become void and all rights hereunder shall thereupon cease. Section 2.02 Exercise of Warrant. (a) The Warrantholder may exercise this Warrant, in whole or in part, upon surrender of this Warrant with the Subscription Form attached hereto duly executed, to the Company at its corporate office, together with payment in full of the Exercise Price for the Warrant Shares to be purchased in lawful money of the United States or by certified check or bank draft payable in currency of the United States to the order of the Company. (b) Upon receipt of this Warrant with the Subscription Form duly executed and accompanied by payment of the Exercise Price for the Warrant Shares for which this Warrant is then being exercised, the Company will cause to be issued certificates for the total number of whole shares of Common Stock for which this Warrant is being exercised in such denominations as are required for delivery to the Warrantholder and the Company shall thereupon deliver such certificates to the Warrantholder. (c) In case the Warrantholder shall exercise this Warrant with respect to less than all of the Warrant Shares that may then be purchased under this Warrant, the Company will execute a new warrant in the form of this Warrant for the balance of such Warrant Shares and deliver such new warrant to the Warrantholder. (d) The Company covenants and agrees that (i) it will pay, when due and payable, any and all stock transfer and similar taxes that may be payable in respect of the issuance of this Warrant or of -3- any Warrant Shares; and (ii) the Warrant Shares shall be deemed to be issued to the Warrantholder as the record owner of such Warrant Shares as of the close of business on the date on which this Warrant shall have been surrendered and payment has been tendered for the purchase of such Warrant Shares. ARTICLE III ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE The Exercise Price and the number and type of Warrant Shares shall be subject to adjustment from time to time upon the occurrence of certain events as provided in this Article III. Section 3.01 Mechanical Adjustments. (a) If at any time prior to the full exercise of this Warrant, the Company shall: (i) pay a dividend or make a distribution on its shares of Common Stock in shares of Common Stock; (ii) subdivide, reclassify or recapitalize its outstanding shares of Common Stock into a greater number of shares; or (iii) combine, reclassify or recapitalize its outstanding shares of Common Stock into a smaller number of shares, the number of Warrant Shares in effect at the time of the record date of such dividend, subdivision, combination, reclassification or recapitalization shall be proportionately adjusted so that the Warrantholder shall be entitled to receive the aggregate number and type of shares that, if this Warrant had been exercised in full immediately prior to such time, it would have owned upon such exercise and been entitled to receive upon such dividend, distribution, subdivision, combination, reclassification or recapitalization. Such adjustment shall be made successively whenever any event listed in this Section 3.01 (a) shall occur. (b) In case the Company shall issue after the date hereof purchase rights, options or warrants exercisable for Common Stock to Persons other than employees, directors, consultants or advisors of the Company entitling the holders thereof to subscribe for or purchase shares of Common Stock at a Net Consideration Per Share which is less than the Exercise Price at the time of such issuance, the Exercise Price shall be adjusted so that the same shall equal the price determined by multiplying the Exercise Price in effect immediately prior thereto by a fraction, of which the numerator shall be the number of shares of Common Stock outstanding on the date of such issuance, plus the number of additional shares of Common Stock which the Total Consideration could purchase at the Exercise Price, and of which the denominator shall be the number of shares of Common Stock outstanding on such record date plus the number of shares of Common Stock issuable upon the exercise of such purchase rights, options or warrants. Such adjustment shall be made whenever such purchase rights, options or warrants are issued and shall become effective immediately (or if a record date has been established by the Company for the determination of stockholders entitled to receive such purchase rights, options or warrants, shall become effective retroactively immediately after the record date for the determination of stockholders entitled to receive such purchase rights, options or warrants). In -4- the event the Company shall subsequently cancel or terminate any of such purchase rights, options or warrants, or any of such purchase rights, options or warrants shall expire unexercised, the Exercise Price shall be readjusted to be the same as if the Company had not issued such purchase rights, options or warrants so cancelled, terminated or expired. (c) Whenever the number of Warrant Shares issuable upon exercise of this Warrant is adjusted pursuant to Section 3.01(a), the Exercise Price payable for such Warrant Shares shall simultaneously be adjusted by multiplying the number of Warrant Shares initially issuable upon exercise of each Warrant by the Exercise Price in effect on the date thereof and dividing the product so obtained by the number of Warrant Shares, as adjusted. (d) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least five cents ($.05) in such price; provided, however, that any adjustments which by reason of this Section 3.01(d) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 3.01 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. (e) In the event that at any time, as a result of any adjustment made pursuant to this Section 3.01(a), the Warrantholder thereafter shall become entitled to receive any securities of the Company other than shares of Common Stock, thereafter the number of such other securities so receivable upon exercise of any warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in this Section 3.01. Section 3.02 No Adjustment for Cash Dividends. No adjustment in respect of any cash dividends shall be made during the term of this Warrant or upon the exercise of this Warrant. Section 3.03 Adjustment for Merger, Consolidation, etc. In case of any consolidation of the Company with or merger of the Company into another corporation or any sale or other disposition to another corporation of all or substantially all the property of the Company, the corporation resulting from such consolidation or surviving such merger or to which such sale or transfer shall be made, as the case may be, shall make suitable provision and shall assume the obligations of the Company hereunder (by written instrument executed and mailed to the Warrantholder) pursuant to which, upon exercise of this Warrant, at any time during the duration of this Warrant after such consolidation, merger, sale or other disposition the Warrantholder shall be entitled to receive the stock or other securities or property that the Warrantholder would have been entitled to receive upon consummation if the Warrantholder had executed this Warrant immediately prior thereto, all subject to further adjustment as provided in this Article III. Section 3.04 Notice of Adjustment. Whenever the number of Warrant Shares or the Exercise Price is adjusted as herein provided, the Company shall prepare and deliver to the Warrantholder a certificate signed by its President, or any Vice President, Treasurer or Secretary, setting forth the adjusted number of shares purchasable upon the exercise of this Warrant and the Exercise Price of -5- such shares after such adjustment, setting forth a brief statement of the facts requiring such adjustment and setting forth the computation by which such adjustment was made. Section 3.05 Form of Warrant After Adjustments. The form of this Warrant need not be changed because of any adjustments in the Exercise Price or the number or kind of the Warrant Shares, and Warrants theretofore and thereafter issued may continue to express the same price and number and kind of shares as are stated in this Warrant as initially issued. Section 3.06 Action by the Company. The Company will not, by amendment of its certificate of incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of the Warrant but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Warrantholder against dilution or other impairment; provided, that the provisions of this Section 3.06 shall not preclude the Company from taking any action that the Company determines is in the best interests of the Company and its stockholders, independent of its effect on the Warrant and the Warrantholder. ARTICLE IV OTHER PROVISIONS RELATING TO RIGHTS OF WARRANTHOLDER Section 4.01 Lost, Stolen, Mutilated or Destroyed Warrants. If this Warrant is lost, stolen, mutilated or destroyed, the Company shall, on such reasonable terms as it may in its discretion impose (which shall, in the case of a mutilated Warrant, include the surrender thereof), issue a new Warrant of like denomination and tenor as, and in substitution for, this Warrant. Section 4.02 Reservation of Shares. The Company covenants and agrees that at all times it shall reserve and keep available for the exercise of this Warrant such number of authorized shares of Common Stock as are sufficient to permit the exercise in full of this Warrant, and that it will take such action as may be required from time to time to assure that the par value per share of the Warrant Shares is at all times equal to or less than the per share Exercise Price. Section 4.03 No Fractional Shares. Anything contained herein to the contrary notwithstanding, the Company shall not be required to issue any fraction of a share in connection with the exercise of this Warrant, and in any case where the Warrantholder would, except for the provisions of this Section 4.03, be entitled under the terms of this Warrant to receive a fraction of a share upon the exercise of this Warrant, the Company shall, upon the exercise of this Warrant and receipt of the Exercise Price, issue the larger number of whole shares purchasable upon exercise of this Warrant. -6- Section 4.04 Company's Right to Accelerate Expiration Date. If at any time after _________/5/, 1998, the Common Stock trades at a price per share that is greater than two times the Exercise Price for a period of 20 trading days, the Company shall thereafter have the right, exercisable at any time in its sole discretion, to accelerate the Expiration Date of this Warrant by providing written notice of such acceleration to Warrantholder. The Warrantholder shall have the right to exercise this Warrant, in whole or in part, at any time during the period of 60 days after the date such notice is given. The Company's provision of written notice of acceleration hereunder shall have the effect of causing the last day of such 60 day period to be the Expiration Date of this Warrant for all purposes thereof. Section 4.05 Notice of Record Date. In case of: (a) any setting of a record date by the Company for the purpose of determining the holders of any class of securities who are entitled to receive any dividend or other distribution, or any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, that, in any such case, will result in an adjustment in the number of Warrant Shares or the Exercise Price pursuant to Article III, or (b) any capital reorganization of the Company, any reclassification or recapitalization of the Common Stock of the Company or any transfer of all or substantially all the assets of the Company to or consolidation or merger of the Company with or into any other person, or (c) any voluntary or involuntary dissolution, liquidation or winding up of the Company, or (d) any proposed issue or grant by the Company of any purchase right, option or warrant to subscribe for, purchase or otherwise acquire any shares of Common Stock that will result in an adjustment to the Exercise Price pursuant to Article III, then and in each such event the Company will mail or cause to be mailed to the Warrantholder a notice specifying (i) the date on which any such record is to be taken for the purpose of such dividend, distribution or right, and stating the amount and character of such dividend, distribution or right, (ii) the date on which any such reorganization, reclassification, recapitalization, transfer, consolidation, merger, dissolution, liquidation or winding up is to take place, and the time, if any is to be fixed, as of which the holders of record of Common Stock shall be entitled to exchange their shares of Common Stock for securities or other property deliverable on such reorganization, reclassification, recapitalization, transfer, consolidation, merger, dissolution, liquidation or winding up, and (iii) the amount and character of any purchase rights, options or warrants with respect to Common Stock that will result in an adjustment to the Exercise Price pursuant to Article III, proposed to be issued or granted, the date of such proposed issue or grant and the persons or class of persons to whom such proposed issue or grant is to be offered or made. Such notice shall be - -------------- /5/ Two years after EBC issues this Warrant. -7- mailed at least 30 days prior to the date specified in such notice on which any such action is to be taken. Section 4.06 Incidental Registration Rights (a) Notice of Registration. If the Company shall determine to register any of its Common Stock either for its own account or the account of a stockholder, other than a registration relating solely to employee benefit plans, a registration on Form S-4 or S-8 or any successor or similar forms, or a registration on any registration form that does not permit secondary sales, the Company will: (i) promptly give to Petrolite Corporation ("Petrolite") written notice thereof; and (ii) use reasonable efforts to include in such registration (and any related qualification under blue sky laws or other compliance), except as set forth in Sections 4.06(b) and (c), and in any underwriting involved therein, all the Registrable Securities specified in a written request or requests, made by Petrolite within 20 days after the written notice from the Company described in clause (i) above is given. Such written request may specify all or a part of Petrolite's Registrable Securities. (b) Right to Terminate Registration. The Company shall have the right to terminate or withdraw any registration prior to the effectiveness of such registration whether or not Petrolite has elected to include Registrable Securities in such registration. (c) Underwriting. (i) If the registration of which the Company gives notice is for a registered public offering involving an underwriting, the Company shall so advise Petrolite as a part of the written notice given pursuant to subsection Section 4.06(a). In such event, the right of Petrolite to registration pursuant to this Section 4.06 shall be conditioned upon Petrolite's participation in such underwriting and the inclusion of Petrolite's Registrable Securities in the underwriting to the extent provided herein. Petrolite (together with the Company and such other stockholders of the Company exercising registration rights with respect to such registration) shall enter into an underwriting agreement in customary form with the representative of the underwriter or underwriters selected by the Company or the stockholders initiating such registration, as the case may be. (ii) Notwithstanding any other provision of this Section 4.06, if the representative of the underwriters advises the Company in writing that marketing factors require a limitation on the number of shares to be underwritten, the representative may (subject to the limitations set forth below) exclude all Registrable Securities from, or limit the number of Registrable Securities to be included in, the registration and underwriting. The Company shall so advise all holders of securities requesting registration, and the amount of securities that are entitled to be included in the registration and underwriting shall be allocated as follows: (a) first, to the Company up to the full number of securities proposed to be sold for its own account) (b) second, to the stockholders on behalf of whom registration may have been initially requested -8- up to the full number of securities proposed to be sold for the account of such stockholders, and (c) third, to Petrolite and other stockholders entitled to participate in the registration, drawn from them pro rata based on the number of securities each has requested to be included in such registration. If Petrolite does not agree to the terms of any such underwriting, Petrolite shall be excluded therefrom by written notice from the Company or the underwriter. Any Registrable Securities or other securities excluded or withdrawn from such underwriting shall be withdrawn from such registration. (d) Delay of Registration. Petrolite shall not have any right to take any action to restrain, enjoin, or otherwise delay any registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Section 4.06. (e) Termination of Registration Rights. The right of Petrolite to request registration or inclusion in any registration pursuant to this Section 4.06 shall terminate on the earlier of (i) the second anniversary of the earlier of (A) the Expiration Date and (B) the date on which the Warrant has been exercised in full and (ii) such date as all shares of Registrable Securities held or entitled to be held upon conversion by such Holder may immediately be sold under Rule 144 (or any successor to such Rule). (f) Number of Incidental Registrations. Petrolite may exercise its right to incidental registration under this Section 4.06 two times; provided, however, that if Petrolite has exercised its incidental registration rights during the term of this Agreement but was prevented from registering all Registrable Securities due to Section 4.06(c)(ii), Petrolite may exercise its right to incidental registration one additional time for each such occurrence. ARTICLE V TREATMENT OF WARRANTHOLDER Prior to due presentment for registration of transfer of this Warrant, the Company may deem and treat the Warrantholder as the absolute owner of this Warrant (notwithstanding any notation of ownership or other writing hereon) for the purpose of any exercise hereof and for all other purposes and the Company shall not be affected by any notice to the contrary. This Warrant does not entitle the Warrantholder to any rights of a stockholder of the Company. -9- ARTICLE VI SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS Section 6.01 Split-Up, Combination, Exchange and Transfer of Warrants. Subject to and limited by the provisions of Section 6.02 hereof, this Warrant may be split up, combined or exchanged for another Warrant or Warrants containing the same terms and entitling the Warrantholder to purchase a like aggregate number of Warrant Shares. If the Warrantholder desires to split up, combine or exchange this Warrant, it shall make such request in writing delivered to the Company and shall surrender to the Company this Warrant and any other Warrants to be so split up, combined or exchanged. Upon any such surrender for a split- up, combination or exchange, the Company shall execute and deliver to the Person entitled thereto a Warrant or Warrants, as the case may be, as so requested. The Company shall not be required to effect any split-up, combination or exchange which will result in the issuance of a Warrant entitling the Warrantholder to purchase upon exercise a fraction of a share of Common Stock or a fractional Warrant. The Company may require such Warrantholder to pay a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any split-up, combination or exchange of Warrants. Section 6.02 Restrictions on Transfer. (a) This Warrant and the Warrant Shares shall be restricted from sale, transfer, assignment, exercise or hypothecation, except in compliance with the Securities Act and the provisions of this Section 6.02. (b) The Company may require the Person to whom the Warrantholder or holder of such Warrant Shares proposes to transfer such Warrant or Warrant Shares to make such investment intent representations, and may place such legends on certificates representing this Warrant or the Warrant Shares, as may reasonably be required in the opinion of counsel to the Company to permit the Warrant or Warrant Shares, as the case may be, to be transferred without registration under the Securities Act. ARTICLE VII REPRESENTATIONS AND WARRANTIES Section 7.01 Representations and Warranties of the Company. The Company represents and warrants to and agrees with the Warrantholder that: (a) The Company has all requisite power and authority, corporate or otherwise, and has taken all necessary action, to execute, deliver and perform its obligations under this Warrant. This Warrant has been duly and validly authorized, executed and delivered by the Company and constitutes a valid and binding agreement of the Company enforceable against the -10- Company in accordance with its terms. No authorization, approval, consent, order, license, franchise, certificate or permit of or from any Person or regulatory authority is required to be obtained by the Company in connection with the execution, delivery or performance of this Warrant. (b) None of the execution, delivery or performance of the Company's obligations under this Warrant will conflict with, or result in a breach of any of the terms or provisions of, or constitute a default under or violate any term of (i) the certificate of incorporation, as amended, or the by- laws of the Company; (ii) any indenture, mortgage, joint venture agreement, lease, sublease, sales agreement or other agreement or instrument to which the Company is a party or by which it or any of its properties is bound; or (iii) any law, rule, regulation, judgment, order or decree of any government, governmental or regulatory body or court, foreign or domestic, having jurisdiction over the Company or any of its properties or assets. (c) The Warrant Shares have been duly reserved for issuance upon exercise of this Warrant and, when issued upon such exercise in accordance with the terms of this Warrant, will be duly and validly issued, fully paid and nonassessable, and the issuance of the Warrant Shares is not subject to any preemptive or similar rights granted by the Company, any other Person or any statute. Section 7.02 Representations and Warranties of the Warrantholder. The Warrantholder represents and warrants to the Company that it is acquiring this Warrant for its own account, for investment purposes and not with a view to, or for resale in connection with, any distribution or public offering thereof. The Warrantholder understands that this Warrant has not been registered under the Securities Act or any applicable state securities laws; that it was issued in reliance upon an exemption therefrom; that it may not be transferred unless registered under the Securities Act and such state securities laws or pursuant to an exemption therefrom; and that it will bear a restrictive legend to such effect. ARTICLE VIII MISCELLANEOUS Section 8.01 Expenses of Transfer. The Company will from time to time promptly pay all taxes and charges that may be imposed upon the Company with respect to the issuance or delivery of Warrant Shares upon the exercise of this Warrant by the Warrantholder. Section 8.02 Successors and Assigns. All the covenants and provisions of this Warrant shall bind and inure to the benefit of successors and assigns of the Company and the Warrantholder; provided that the rights granted to Petrolite pursuant to Section 4.06 are personal to Petrolite and may not be assigned by Petrolite to any other Person. -11- Section 8.03 No Inconsistent Agreements. The Company will not on or after the date of this Warrant enter into any agreement with respect to its capital stock which is inconsistent with the rights granted to the Warrantholder in this Warrant or otherwise conflicts with the provisions hereof. Section 8.04 Governing Law. THIS WARRANT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF DELAWARE, EXCEPT FOR THE CONFLICTS OF LAWS PRINCIPLES THEREOF. Section 8.05 Severability. In the event that any one or more of the provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provisions in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. Section 8.06 Integration/Entire Agreement. This Warrant is intended by the parties as a final expression of their agreement and intended to be a complete and exclusive statement of the agreement and understanding of the parties hereto with respect to the subject matter contained herein. This Warrant supersedes all prior agreements and understandings between the parties with respect to such subject matter. Section 8.07 Attorney's Fees. In any action or proceeding brought to enforce any provisions of this Warrant, or where any provisions hereof or thereof is validly asserted as a defense, the successful party shall be entitled to recover attorneys' fees and disbursements in addition to its costs and expenses and any other available remedy. Section 8.08 Notices. Notice or demand pursuant to this Warrant to be given or made by the Warrantholder to or on the Company shall be sufficiently given or made if sent by first class mail, postage prepaid, addressed (until another address is designated in writing by the Company) as follows: Energy BioSystems Corporation 4200 Research Forest Drive The Woodlands, Texas 77381 Attention: President Any notice or demand authorized by this Warrant to be given or made by the Company to or on the Warrantholder shall be sufficiently given or made if sent by first class mail, postage prepaid, to the Warrantholder at its last known address as it shall appear on the books of the Company. Section 8.09 Headings. The article and section headings in this Warrant are for convenience only and are not part of this Warrant and shall not affect the interpretation thereof. IN WITNESS WHEREOF, this Warrant has been duly executed by the Company as of the ____ day of __________, 1996. -12- ENERGY BIOSYSTEMS CORPORATION By: -------------------------- John H. Webb President and Chief Executive Officer -13- ASSIGNMENT (TO BE EXECUTED ONLY UPON ASSIGNMENT OF WARRANT) For value received, _________________________ hereby sells, assigns and transfers unto _________________________ the within Warrant, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint _________________________ attorney, to transfer said Warrant on the books of the within-named Company with respect to the number of Warrant Shares set forth below, with full power of substitution in the premises: NAME(S) OF ASSIGNEE(S) ADDRESS NO. OF WARRANTS - -------------------------------------------------------------------------------- If said number of Warrant Shares shall not be all the Warrant Shares represented by the Warrant, a new Warrant is to be issued in the name of said undersigned for the balance remaining of the Warrant Shares represented by said Warrant. Signature: __________________________________ Note: The above signature should correspond exactly with the name on the first page of said Warrant. Dated:____________ -14- SUBSCRIPTION FORM (TO BE EXECUTED UPON EXERCISE OF WARRANT) Energy BioSystems Corporation: The undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant for, and to purchase thereunder, _______ shares of Common Stock, as provided for therein, and tenders herewith payment of the purchase price in full in the form of cash or a certified or official bank check in the amount of $__________________. Please issue a certificate or certificates for such shares of Common Stock in the name of: Name:_______________________ Address: Social Security Number: (Please Print) If said number of shares shall not be all the shares purchasable under the within Warrant, a new Warrant is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder. Signature:__________________ NOTE: The above signature should correspond exactly with the name on the first page of said Warrant or with the name of the assignee appearing in the assignment form above. Dated: _________________ -15- [LOGO OF ENERGY BIOSYSTEMS APPEARS HERE] PAUL G. BROWN, III Vice President, Finance December 27, 1996 Mr. Charles Miller Petrolite Corporation 369 Marshall Ave St. Louis, MO 63119 Dear Mr. Miller: At this time it appears that the Financing referred to in the Fourth Amendment and Addendum to Collaboration Agreement (the "Fourth Amendment") between Energy Biosystems Corporation and Petrolite Corporation will close sometime early in 1997. We would like, however, to proceed with the payment of the First Cash Payment under the Fourth Amendment of One Million Dollars ($1,000,000). By acceptance of the First Cash Payment of One Million Dollars ($1,000,000) you also agree that the definitions of Expiration Date and Conversion Price as set forth in the Fourth Amendment shall be amended and restated in their entirety as set forth on Exhibit A hereto. If you are in agreement with the foregoing, please execute a copy of this letter in the space provided below. Upon receipt of a copy of this letter signed by Petrolite Corporation we will wire transfer to your account the First Cash Payment of One Million Dollars ($1,000,000). Sincerely, ENERGY BIOSYSTEMS CORPORATION By: /s/ PAUL G. BROWN III --------------------------- Name: Paul G. Brown ------------------------- Title: Vice President Finance ------------------------ Agreed to this 30th day of December, 1996: PETROLITE CORPORATION By: /s/ DAVID WINSLETT ------------------------- Name: David Winslett ----------------------- Title: Vice President ---------------------- ENERGY BIOSYSTEMS CORPORATION 4200 Research Forest Drive, The Woodlands, Texas 77381 TEL 281.364.6100 FAX 281.364.6110 EXHIBIT A The "Expiration Date" shall mean the earlier to occur of (x) ten business days following the closing of any equity financing by EBC after the date hereof in which the gross cash proceeds raised in such equity financing together with the gross cash proceeds raised in any other equity financings by EBC after the date hereof equal or exceed Twenty-Five Million Dollars ($25,000,000) and (y) the date that is 24 months following the payment of the First Cash Payment. The "Conversion Price" shall mean (x) if the Financing is completed by January 31, 1997, and the securities issued in the Financing are convertible into shares of Common Stock, the initial conversion price per share of Common Stock at which the EBC securities issued in the Financing may be converted into Common Stock or (y) if the Financing is not completed by January 31, 1997, or if the securities issued in the Financing are not convertible into shares of Common Stock, 120% of the closing sale price of the shares of EBC Common Stock as reported on the Nasdaq Stock Market on the date of the First Cash Payment. EX-11.1 8 COMPUTATION OF EARNINGS EXHIBIT 11.1 ENERGY BIOSYSTEMS CORPORATION COMPUTATION OF EARNINGS PER SHARE FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1994 Weighted Average Shares Outstanding: # Days Total Shares Outstanding 9,864,629 x 3 = 29,593,887 9,872,629 x 1 = 9,872,629 9,874,629 x 1 = 9,874,629 9,875,629 x 1 = 9,875,629 9,880,629 x 4 = 39,522,516 9,881,629 x 1 = 9,881,629 9,882,629 x 22 = 217,417,838 9,892,949 x 4 = 39,571,796 9,901,209 x 3 = 29,703,627 9,909,609 x 15 = 148,644,135 9,917,609 x 4 = 39,670,436 9,969,809 x 3 = 29,909,427 9,970,609 x 21 = 209,382,789 9,975,609 x 73 = 728,219,457 9,979,609 x 36 = 359,265,924 9,980,409 x 20 = 199,608,180 9,983,809 x 11 = 109,821,899 9,988,409 x 142 = 1,418,354,078 --- ------------- 365 3,638,190,505 Weighted Avg. Shares: 3,638,190,505 / 365 = 9,967,645 ========= FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1994 Loss Per Share: Net Loss plus dividend accrual plus accretion of offering costs $(7,452,835) = $($0.75) --------------------------- ---------- ======= Weighted Avg. Shares 9,967,645 ENERGY BIOSYSTEMS CORPORATION COMPUTATION OF EARNINGS PER SHARE FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1995 Weighted Average Shares Outstanding: # Days Total Shares Outstanding 9,988,409 x 28 = 19,976,81 9,998,409 x 28 = 279,955,452 9,999,404 x 4 = 39,997,616 10,000,604 x 4 = 40,002,416 10,040,604 x 16 = 160,649,664 10,041,604 x 1 = 10,041,604 10,046,604 x 62 = 622,889,448 10,228,645 x 21 = 214,801,545 10,233,645 x 89 = 910,794,405 10,235,645 x 2 = 20,471,290 10,237,645 x 7 = 71,663,515 10,242,640 x 18 = 184,367,520 10,249,640 x 13 = 133,245,320 10,258,241 x 7 = 71,807,687 10,270,241 x 1 = 10,270,241 10,293,241 x 4 = 41,172,964 10,368,241 x 3 = 31,104,723 10,370,749 x 23 = 238,527,227 10,512,618 x 1 = 10,512,618 10,513,388 x 6 = 63,080,328 10,514,288 x 1 = 10,514,288 10,514,788 x 2 = 21,029,576 10,516,788 x 2 = 21,033,576 10,524,188 x 30 = 315,725,640 10,524,268 x 18 = 189,436,824 --- -------------- 365 3,733,072,305 Weighted Avg. Shares: 3,733,072,305 / 365 = 10,227,595 ========== FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1995 Loss Per Share: Net Loss plus dividend accrual plus accretion of offering costs $(9,713,069) = $(0.95) --------------------------- ----------- ====== Weighted Avg. Shares 10,227,595 ENERGY BIOSYSTEMS CORPORATION COMPUTATION OF EARNINGS PER SHARE FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1996 Weighted Average Shares Outstanding: Total Shares # Days Outstanding 10,584,268 x 23 = 243,438,164 11,107,568 x 14 = 155,505,952 11,139,268 x 27 = 300,760,236 11,140,768 x 8 = 89,126,144 11,142,868 x 55 = 612,857,740 11,301,975 x 28 = 316,455,300 11,302,025 x 16 = 180,832,400 11,303,525 x 7 = 79,124,675 11,309,355 x 1 = 11,309,295 11,309,355 x 5 = 56,546,775 11,310,855 x 7 = 79,175,985 11,311,955 x 5 = 56,559,775 11,316,955 x 4 = 45,267,820 11,318,210 x 28 = 316,909,880 11,320,010 x 4 = 45,280,040 11,320,210 x 23 = 260,364,830 11,325,210 x 41 = 464,333,610 11,326,210 x 9 = 101,935,890 11,490,770 x 52 = 597,520,040 11,497,135 x 9 = 103,474,215 --- ------------- 366 4,116,778,766 Weighted Avg. Shares: 4,116,778,766 / 366 = 11,248,029 ========== FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1996 Loss Per Share: Net Loss plus dividend accrual plus accretion of offering costs $(11,720,213) = $(1.04) --------------------------- ------------ ====== Weighted Avg. Shares 11,248,029 EX-23.1 9 CONSENT OF ARTHUR ANDERSEN Exhibit 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTS As independent public accountants, we hereby consent to the incorporation of our reports incorporated by reference in this Form 10-K, into the Company's previously filed Registration Statement on Form S-8 dated September 9, 1993 and September 13, 1993, and Form S-3 dated February 13, 1995. ARTHUR ANDERSEN LLP The Woodlands, Texas March 26, 1997 EX-27 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 3,106,004 5,891,584 197,264 0 14,252 9,765,481 6,150,723 3,014,088 13,710,631 995,158 0 0 23,295,585 114,972 32,018,218 13,710,631 0 2,585,419 0 0 11,818,199 0 0 (9,232,780) 0 0 0 0 0 (9,232,780) (1.04) 0
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