-----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, Ks9PAwoR016gP2nIUEc/hpohedB44Z3tmhq+LcgCkO6/s4YUS3mkgI1HTih8k0BX klIL0RmpSFmNcWKidoa/zA== 0001095811-01-002059.txt : 20010409 0001095811-01-002059.hdr.sgml : 20010409 ACCESSION NUMBER: 0001095811-01-002059 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HYSEQ INC CENTRAL INDEX KEY: 0000907654 STANDARD INDUSTRIAL CLASSIFICATION: IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES [2835] IRS NUMBER: 363855489 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22873 FILM NUMBER: 1591398 BUSINESS ADDRESS: STREET 1: 670 ALMANOR AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 BUSINESS PHONE: 4085248100 MAIL ADDRESS: STREET 1: 670 ALMANOR AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 10-K 1 f69819e10-k.txt FORM 10-K FISCAL YEAR ENDED DECEMBER 31, 2000 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 0-22873 ------------------------ HYSEQ, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEVADA 36-3855489 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 670 ALMANOR AVENUE, SUNNYVALE, CA 94085 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 408-524-8100 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: COMMON STOCK, $.001 ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Common Stock held by non-affiliates of the Registrant on March 1, 2001 was $142,940,000, based on the last sale price of the Common Stock as reported by the Nasdaq Stock Market. As of March 1, 2001, the Registrant had 13,757,882 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement, which will be filed with the Commission pursuant to Section 14A in connection with the 2001 meeting of stockholders, are incorporated by reference into Part III of this Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS This Annual Report on Form 10-K contains historical information as well as forward-looking statements that involve risks and uncertainty. Our actual results could differ significantly from discussions and forward-looking statements in this document. Factors that could cause or contribute to such differences include but are not limited to those discussed in this section under the caption "Risk Factors," as well as those under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and those discussed elsewhere in this Annual Report on Form 10-K. COMPANY OVERVIEW We are engaged in research and development of novel biopharmaceutical products from our collection of proprietary genes discovered using our high-throughput screening-by-hybridization platform . We believe our screening-by-hybridization platform, which is related to our proprietary sequencing-by-hybridization (SBH) technology, gives us a significant advantage in discovering novel, rarely-expressed genes. We believe we possess one of the most important proprietary databases of full-length human gene sequences. To date, our activities have focused primarily on full-length gene sequencing, patenting, bioinformatics and early stage research activities to prioritize our therapeutic protein candidates. As of March 1, 2001, we had filed patent applications on more than 5,600 full-length gene sequences. We are currently advancing two molecules, IL-1Hy1 with potential applications for inflammatory diseases and CD39L4 with potential applications for heart disease, into development in order to generate data required to file an Investigational New Drug (IND) application with the Food and Drug Administration (FDA). Meanwhile, we are expanding and accelerating our research activities to elucidate the role of other novel genes in our proprietary database. Our database includes genes which encode chemokines, growth factors, stem cell factors, interferons, integrins, hormones, receptors and other potential protein therapeutics or drug targets. SCIENTIFIC AND INDUSTRY BACKGROUND Genes are the hereditary units that control the structure, health and function of all organisms. The study of genes and their functions has led to the development of products and services for diverse markets, ranging from health care to agriculture. Genomics, the study of all genetic information of organisms, is a growing field that is expected to lead to the development of additional gene-based therapeutics. The large market potential for the gene-based products has led to a worldwide effort to discover and sequence the human genome in searching for new drugs and treatments for unmet medical needs. The entire genetic content of each organism, known as its genome, is encoded in deoxyribonucleic acid (DNA). DNA, which is found in cells, is a molecule comprising two single strands entwined in the form of a double helix. Various combinations of four chemical building blocks or "bases" of DNA, adenine (A), thymine (T), cytosine (C) and guanine (G), are linked together in series to form each DNA strand. The bases of one DNA strand bind to the bases of the other strand in a specific fashion to form base pairs: A pairs with T and G pairs with C. In humans, there are approximately six billion base pairs organized into 23 pairs of DNA structures called chromosomes. Scientists believe that each gene has at least two basic regions, a structural region and a regulatory region. The structural region of a gene encodes the specific protein. The process by which the structural region of a gene directs the production of a protein is known as gene expression. In that process, the sequence of bases in a gene is copied into a related molecule called messenger ribonucleic acid (mRNA). The mRNA instructs the cell to combine amino acids together in a particular order to form a protein. The regulatory region of a gene is responsible for determining when, and how much of a resultant protein is produced in specific cells of the body. Because genes encode proteins, which govern functions of the human body, the sequences of genes and their levels of expression determine when, where and how well essential functions are performed. The addition, deletion or substitution of one or more bases in a gene, known as a mutation, can alter the resultant protein's 1 3 structure and/or level of expression and result in a disease. Most diseases are believed to be polygenic, meaning that multiple genes interact to cause the disease. In developing a drug for a polygenic disease, the most effective target may be best selected when all genes which interact to cause or affect the disease are known. STRATEGY Our goal is to build a fully-integrated biopharmaceutical company. Our execution strategy will involve a combination of carefully-staged internal infrastructure growth, strategic relationships to share research and development efforts and marketing opportunities with other biotechnology and pharmaceutical companies, and outsourcing, on a fee-for-service basis, to accelerate and expand our drug discovery and development efforts. The first part of our strategy involves internal infrastructure growth to expand our staff and bring additional expertise into the company. Our early efforts have been focused on gene discovery, which requires a research staff of molecular biologists and bioinformatics personnel. As we begin to characterize the genes in our database, we are expanding our research and development staff to include additional expertise in basic biology, physiology, cell biology and protein sciences. Further progress into development will require additional expertise in project management and product development including pharmacology, toxicology, assay development, formulation and process development, medical and regulatory affairs, quality control and quality assurance and an expanded capability in facilities and engineering. Expertise in these areas will be required to ensure that we meet FDA and foreign regulatory requirements for conducting clinical trials. Internal infrastructure growth will also involve building out additional research and development space. We have leased an additional 59,000 square feet of space in Sunnyvale, California. Our plan is to build out approximately 34,000 square feet of this space in the initial phase of our planned facilities expansion to support new research and development laboratories and offices. This laboratory space is expected to bolster our preclinical development capabilities, including preliminary preclinical safety and efficacy studies in rodents, functional cell biology assays, cell based functional screening efforts, protein production (in multiple systems), protein characterization and analytical assay development. This additional lab space, and related staffing, is expected to expand our ability to identify, clone and express, purify and characterize our preclinical candidates. To complete the initial phase of our build out as currently planned, we intend to seek necessary additional financing before the end of 2001. The remaining approximately 25,000 square feet of space, located in an adjacent building, may be used for further expansion of preclinical efforts or to build a pilot manufacturing plant capable of producing protein therapeutics according to current good manufacturing practices (cGMP) for testing in Phase I and Phase II clinical trials. Planning for the second phase of the build out is underway and will be dictated by our needs over the next year. The second part of our strategy involves strategic relationships to share research and development efforts and marketing opportunities with other biotechnology and pharmaceutical companies. We believe this approach will greatly enhance our chances to move a number of drug candidates into clinical trials over the next several years. As we have shifted our business focus from gene discovery to research and development of biopharmaceutical candidates, we did not enter into any additional gene discovery collaborations during 2000. We are now focusing instead on new corporate relationships with other biotechnology and pharmaceutical companies to share costs and expertise of identifying and developing product candidates. This focus also includes plans to collaborate with strategic partners with expertise to develop antibodies and small molecules from our proprietary targets. The third part of our strategy involves outsourcing, on a fee-for-service basis, to accelerate and expand our drug discovery and development efforts. Initially, we intend to use outsourcing while we expand our in-house capabilities, although we expect to continue to use outsourcing when there are opportunities to accelerate and expand our drug discovery and development efforts. We currently use contract research organizations and university collaborators to supplement our ability to conduct in vitro and in vivo testing of our therapeutic protein candidates. We also intend to use contract research organizations to conduct good 2 4 laboratory practices (GLP) toxicology and other studies required for filing an IND, for the production of any cGMP drug and for conducting clinical trials on our lead therapeutic protein candidates. RESEARCH AND DEVELOPMENT We have discovered a large collection of novel genes with our screening-by-hybridization platform. See "-- SBH Technology and Applications." Since 1997 we have used our screening-by-hybridization platform to discover genes expressed in a large number of tissue-specific complementary DNA (cDNA) libraries. Our bioinformatics group conducts high-throughput analysis using sequence analysis and protein structure modeling techniques to identify candidate genes for biological screening. In general, candidates are grouped into the broad categories of potential protein therapeutics and small molecule or antibody targets. We believe genes with sequence characteristics and motifs similar to those found in known secreted proteins are more likely to be useful as protein therapeutics and those with characteristics of membrane or intracellular proteins are more likely to serve as targets for antibodies and small molecules. Our focus has been on development of molecules that we believe will result in protein therapeutics. We plan to pursue targets for antibodies and small molecules through strategic relationships. The process of selecting and evaluating drug candidates involves a broad range of skills and a highly-trained scientific staff. Following initial candidate identification by our bioinformatics group, full-length genes are obtained, expressed, and screened for biological activity by our cloning and cell screening groups. Molecules showing biological activity, and molecules with sequence or structural homology to known proteins, are further evaluated by our functional genomics group. Our protein production and purification group is responsible for providing larger quantities of selected proteins for further in vitro and in vivo testing. These tests are conducted by our functional genomics group, working in conjunction with contract research organizations and university collaborators. Throughout this process, information is provided to our legal group to pursue patent protection for our candidates. To expand these efforts, we have leased additional space and planned the initial phase of building out additional laboratory space, including the establishment of our own animal facility, and staffing for a preclinical safety and efficacy group. To complete the initial phase of our build out as currently planned, we intend to seek additional financing before the end of 2001. Following initial safety and pharmacokinetic analysis, the preclinical safety and efficacy group will be responsible for working with contract research organizations to conduct GLP toxicology and other studies required for filing an IND. Until adequate staff and facilities are established in-house, we plan to use contract organizations for the production of cGMP drug and for conducting clinical trials on our lead therapeutic protein candidates. The chart below indicates the stage of development for product candidates in our discovery pipeline as of December 31, 2000, which have been publicly discussed.
CANDIDATE POTENTIAL APPLICATIONS DEVELOPMENT STAGE - --------- ---------------------- ----------------- IL-1Hy1 Inflammatory Diseases Preclinical CD39L4 Heart Disease Preclinical IL-1Hy2 Inflammatory Diseases Research CD39L2 Heart Disease Research BPIL-196 Infectious Diseases Research BPIL-232 Infectious Diseases Research BPIL-325 Infectious Diseases Research EGFL-6 Oncology Research
IL-1Hy1: Product Candidate for Treating Inflammatory Disease The IL-1Hy1 protein may have therapeutic applications in the treatment of inflammatory disease. Our scientists have published results for IL-1Hy1 in Biochemical & Biophysical Research Communications. IL-1Hy1 was found to be expressed in the skin, spleen and other tissues consistent with its potential role as a mediator of inflammatory processes. In addition, our research demonstrated that IL-1Hy1 can be activated by 3 5 signals that induce inflammation and immune responses. We are currently focusing research on the protein's ability to disrupt the process of inflammation in allergic diseases. CD39L4: Product Candidate for Preventing Blood Clotting We believe that our CD39L4 anti-clotting product candidate may help prevent or treat blood vessel blockage that can cause heart attacks and strokes. Our scientists have published results for CD39L4 in The Journal of Biological Chemistry. When blood vessels are damaged, a substance called adenosine diphosphate (ADP) is released at the site of injury to initiate blood clotting for repair. In cardiovascular disease, blood clotting can be excessive and result in blockage of blood flow. By decreasing the levels of ADP, abnormal clotting and blockage of blood flow may be reduced or prevented. CD39L4 breaks down ADP, as well as other nucleotide diphosphates, but does not significantly affect a related substance, adenosine triphosphate (ATP) that regulates other physiological processes. We believe this specificity, and the protein's solubility, makes CD39L4 a promising therapeutic candidate. None of our therapeutic protein product candidates has progressed beyond preclinical testing. Accordingly, the results of testing to date may not be indicative of results that will be obtained in further preclinical studies or in clinical trials. Human clinical results could be different from our expectations following our preclinical studies. Consequently, there is no assurance that the results in our preclinical testing are predictive of the results that we will see in our clinical trials with humans. As further results of tests are received, we may abandon or reduce our efforts regarding particular projects. Additionally, there can be no assurance that clinical trials as to any particular product candidate, if commenced, will be successful, that the proposed disease indication will prove true, or that any product can be successfully commercialized. See "Risk Factors -- Development of Our Products Will Take Years; Our Products Will Require Approval Before They Can Be Sold" and "Risk Factors -- The Success of Our Potential Products in Preclinical Studies Does Not Guarantee that these Results Will Be Replicated in Humans." INTELLECTUAL PROPERTY We seek patent protection on isolated partial and full-length gene sequences, as well as their resultant proteins. As of March 1, 2001, we had filed patent applications on more than 5,600 full-length gene sequences and their corresponding proteins. We have also filed patent applications on more than 830,000 partial gene sequences. See "-- Patents and Trade Secrets" and "Risk Factors -- Dependence upon Proprietary Rights; Risks of Infringement." We hold ten United States patents with claims covering the methods, compositions, apparatus and applications relating to SBH technology. We have filed several additional patent applications covering improvements to and new applications of the SBH technology. We are currently in litigation with Affymetrix alleging infringement by Affymetrix of five of our SBH technology patents. Affymetrix has alleged infringement by us of three of their patents. See "Item 3. Legal Proceedings." RESEARCH AND DEVELOPMENT COLLABORATIONS As we have shifted our business focus from gene discovery to research and development of biopharmaceutical candidates, we did not enter into any additional gene discovery collaborations during 2000. We are now focusing instead on strategic relationships to share research and development efforts and marketing opportunities with other biotechnology and pharmaceutical companies. Our current collaborations include gene discovery collaborations with BASF Plant Sciences GmbH (BASF), Chiron Corporation (Chiron) and Kirin Brewery Co, Ltd. of Japan (Kirin), and a collaboration with the University of California, San Francisco (UCSF) to conduct research on genes that may have important roles in the development of cardiovascular and related diseases. We also have a collaboration with the Applied Biosystems Group of Applera Corporation (Applied Biosystems) to commercialize one application of our SBH technology. 4 6 Chiron In May 1997, we entered into a collaboration with Chiron in which we used our screening-by-hybridization platform to target solid tumor cancer therapeutics, diagnostic molecules and vaccines. The collaboration had an initial term of three years ending in May 2000, and has been extended by Chiron for an additional two-year period ending in May 2002. At its option, Chiron may extend the collaboration for one more two-year period before the current extension ends in May 2002. Our gene sequencing obligations under the original term of the agreement are substantially completed. Chiron has the exclusive right to commercialize any solid tumor products resulting from the collaboration. We will receive royalties on any such products. In addition to research funding payments, in 1997 Chiron made an equity investment in us of $7.5 million in conjunction with the collaboration. Applied Biosystems In May 1997, we entered into an agreement with Applied Biosystems to commercialize HyChip products. Pursuant to this agreement, we were required to commit $5.0 million to further development of the chip component of the HyChip system, which we satisfied in 1998. Applied Biosystems must also commit certain funds for development of the overall system. The collaboration has an initial term of five years and will be extended automatically thereafter unless the parties mutually agree to termination. The agreement required us to design, develop and manufacture the HyChip chip component, while Applied Biosystems is responsible for the design, development and manufacture of the system that processes and analyzes data from the HyChip chip, as well as marketing and customer support. We are highly dependent upon the performance of Applied Biosystems for commercialization of HyChip products. We do not directly control the amount or timing of resources devoted by Applied Biosystems to development of the overall HyChip system. The development of the HyChip system is, therefore, not entirely in our control. In 1997, Applera Corporation made an equity investment in us of $10.0 million in conjunction with the collaboration. University of California, San Francisco In February 1998, we entered into an agreement with UCSF to conduct research on genes that may have important roles in the development of cardiovascular and related diseases. Under the agreement, researchers at UCSF are collecting DNA samples from up to 20,000 genetically diverse individuals. We can use these DNA samples to identify genetic traits related to heart disease and hypertension. Kirin In October 1998, we entered into a collaboration with Kirin in which we use our screening-by-hybridization platform to target potential pharmaceutical candidates involved in cell growth regulation from specific cell lines provided by Kirin. During the fourth quarter of 2000, we extended the term of our collaboration with Kirin through March 2001 in order to complete additional research. We retain rights in North America to develop pharmaceutical products resulting from the collaboration, subject to milestone and royalty payments to Kirin. Kirin has equivalent rights in Asia and Oceania, and we share rights equally in Europe and in the rest of the world. Our gene sequencing obligations under the original term of the agreement are substantially complete. BASF In December 1999, we entered into a collaboration with American Cyanamid Company in which we use our screening-by-hybridization platform to target potential agricultural products. During 2000, BASF Aktiengesellschaft acquired the crop protection business of American Cyanamid Company and subsequently assigned our collaboration with American Cyanamid to BASF Plant Sciences GmbH. The collaboration provides for funding of $60 million over its initial term of three and one half years. The collaboration can be extended by mutual agreement, for up to four additional one-year terms. BASF has the exclusive right to commercialize any agricultural products resulting from the collaboration. We will receive royalties on any 5 7 such products. The agreement requires us to generate data at a specified level per year which, if not met, could result in our breach of the agreement. SBH TECHNOLOGY AND APPLICATIONS Our proprietary SBH technology generally involves using DNA probes of known sequence that are hybridized with DNA samples. Different probe sets can be used for different applications. We use a complete set of probes of a given length, or a subset of probes that are selected based on statistical properties, to assemble an unknown sequence of a DNA sample. DNA analysis applications using complete sets or subsets of probes include de novo sequencing, resequencing, genotyping, mutation discovery and polymorphism detection. In addition, we have a proprietary screening-by-hybridization technology in which we use a small set of probes to screen for and discover genes in a large number of DNA samples. Gene Discovery using High-Throughput Screening Using our high-throughput screening-by-hybridization platform, we have screened large numbers of DNA samples for our internal gene discovery and in our gene discovery collaborations. Our screening-by-hybridization platform is related to our SBH technology but uses a small set of probes to group or cluster DNA samples derived from either DNA or cDNA libraries. As this small set of probes is applied to large numbers of DNA samples, certain probes in the small set hybridize to the DNA samples and generate a pattern (called a "signature"). We use these signatures to identify genes, and to group or cluster DNA samples with similar signatures. DNA Analysis Applications using SBH While our screening-by-hybridization platform uses a small set of probes, in DNA analysis applications of our SBH technology we use a complete set of probes of a given length, or a subset of probes that are selected based on statistical properties. The complete set or subset of probes of known sequences is combined with a DNA sample for hybridization. Following the hybridization process, the sequences of hybridized probes can be used to assemble or determine the sequence of the DNA sample. DNA analysis applications of our SBH technology using complete sets or subsets of probes include de novo sequencing, resequencing, genotyping, mutation discovery and polymorphism detection. Our HyChip system is an example of a DNA analysis application of our SBH technology. Licensed Technology In 1994, we acquired an exclusive license from Arch Development Corporation, a not-for-profit corporation affiliated with the University of Chicago that manages The Argonne National Laboratories (Argonne), to further develop and use certain SBH improvements developed by one of our chief scientists while he was at Argonne. In July 1997, we began paying minimum royalties as required under the exclusive license. PATENTS AND TRADE SECRETS The U.S. Patent and Trademark Office (USPTO) and patent authorities outside the United States issue patents for inventions based on genes that have been isolated from their natural state (through a purifying step that separates the gene from other molecules naturally associated with it), but only if the invention meets all the criteria for a patent. Each country has its own standards for granting a patent. In the United States, to be eligible for patent protection, an invention must at least be novel and useful and the patent application must contain sufficient detail to allow one skilled in the art or technology to reproduce the invention. We apply for patent applications on both partial and full-length gene sequences. As of March 1, 2001, we had filed patent applications on more than 5,600 full-length gene sequences and their corresponding proteins. Fewer than 5,000 applications are pending because some of our patent applications include many gene sequences in one application. These applications may or may not result in the issuance of patents. In January 2001, the USPTO issued final revised guidelines on the standard of utility required for inventions, including gene-based 6 8 inventions. The revised guidelines state that a patent application for an invention must disclose a well-established utility or a specific, substantial and credible utility for the isolated and purified gene. There can be no assurance that our disclosures in these applications are sufficient to meet the statutory requirements for patentability in all cases. We cannot assure you that any of our currently pending or future applications will issue as patents, or that any patent issued to us will not be challenged, invalidated, circumvented or held unenforceable by way of an interference proceeding or litigation. We have also filed United States patent applications on more than 830,000 partial human gene sequences. There can be no assurance that the disclosures in these applications are sufficient to meet the statutory requirements for patentability. Where only a partial sequence is disclosed, the USPTO may issue patents of a very limited scope that will not cover a full-length gene sequence that includes the partial sequence. Therefore, there is a significant risk that the USPTO will not issue patents based on patent disclosures limited to partial gene sequences or will issue patents of a very limited scope. The commercial protection provided by any patents issued on the basis of partial gene sequences is uncertain. Other companies or institutions may have filed patent applications, or may file patent applications in the future, which attempt to patent genes similar to or the same as those covered in our patent applications, including applications based on our potential products. The USPTO would decide the priority of competing patent claims in an interference proceeding. Any patent application filed by a third party may have priority over a patent application we filed, in which event such third party may require us to stop pursuing a potential product, or negotiate a royalty arrangement to pursue and commercialize the potential product. Issued patents may not provide freedom to operate with respect to our potential products because certain uses of our potential products may give rise to claims that such uses infringe the patents of others. This risk will increase as the biotechnology industry expands and as other companies obtain more patents and attempt to discover the utility and function of all known genes. Other persons could bring legal actions against us to claim damages or to stop our manufacturing and marketing of the affected products. If any of these actions are successful, in addition to any potential liability for past damages, these persons may require us to obtain a license in order to continue to manufacture or market the affected products. We believe that there will continue to be significant litigation in our industry regarding patent and other intellectual property rights. We are currently involved in patent litigation with Affymetrix. See "Item 3. Legal Proceedings." If we become involved in additional patent litigation related to our technology or potential products, it could consume a substantial portion of our resources. We pursue patent protection for products and processes where appropriate and we also rely on trade secrets, know-how and continuing technological advancement to develop and maintain our competitive position. Our policy is to have each employee enter into an agreement that contains provisions prohibiting the disclosure of confidential information to anyone outside the company. Research and development contracts and relationships between us and our scientific consultants provide access to aspects of our know-how that is protected generally under confidentiality agreements with the parties involved. There can be no assurance, however, that these confidentiality agreements will be honored or that we can effectively protect our rights to our unpatented trade secrets. Moreover, there can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. COMPETITION Our strategy as a biopharmaceutical company is to define and patent human genes that are most likely to be involved in a disease condition and to focus on identifying product candidates from the proteins produced by these genes. There are a finite number of genes in the human genome, virtually all of which will soon be identified. Other active companies include major pharmaceutical and biotechnology firms, not-for-profit entities and United States and foreign government-financed programs, many of which have substantially greater research and product development capabilities and financial, scientific, marketing and human resources than we do. As a result, they may succeed in identifying genes and determining their functions or developing products earlier than we or our current or future collaboration partners do. They also may obtain patents and regulatory approvals for such products more rapidly than we or our current or future collaboration 7 9 partners, or develop products that are more effective than those proposed to be developed by us or our collaboration partners. Further, any potential products based on genes we identify ultimately will face competition from other companies developing gene-based products as well as from companies developing other forms of treatment for diseases which may be caused by, or related to, the genes we identify. There can be no assurance that research and development by others will not render the products which we may develop obsolete or uneconomical or result in treatments, cures or diagnostics superior to any therapy or diagnostic developed by us or that any therapy we develop will be preferred to any existing or newly developed technologies. Certain of our collaboration partners may now be, or could become, competitors. Competition in the area of DNA analysis tools is intense and expected to increase. Technologies in this area are new and rapidly evolving. Applications of our SBH technology compete primarily with Affymetrix and Applied Biosystems. See "Item 3. Legal Proceedings," regarding our litigation with Affymetrix. Although we are collaborating with Applied Biosystems to develop an application of our SBH technology, Applied Biosystems presently markets gel sequencers, a well-established sequencing technology, which compete with applications of our SBH technology. Other companies also are developing or have developed DNA analysis tools that may compete with applications of our SBH technology, including Aclara Biosciences, Inc., Agilent Technologies, Inc., Corning, Inc., CuraGen, Inc., IBM, Illumina, Inc., Molecular Dynamics, Motorola Inc., Nanogen, Inc., Sequenome, Inc. and Synteni (Incyte). Many of these companies have significantly greater research and development, marketing and financial resources than we do, and therefore represent significant competition. GOVERNMENT REGULATION Regulation by governmental authorities in the United States and most foreign countries will be a significant factor in manufacturing and marketing our potential products and in our ongoing research and product development activities. Virtually all of our products and those of our partners, such as Chiron and Kirin, will require regulatory approval by governmental agencies prior to commercialization. In particular, human therapeutic products are subject to rigorous preclinical and clinical testing and other approval requirements by the FDA and comparable agencies in foreign countries. The time required for completing such testing and obtaining such approvals is uncertain. Unexpected biological activities, some of which may result in safety issues, may arise during preclinical evaluation. Such observations could delay or alter the course of a development program or ultimately result in the termination of a program. Any delay in clinical testing may also delay product development. In addition, delays or rejections may be encountered based on changes in FDA or foreign regulatory policy during the period of product development and testing. Various federal statutes and regulations also regulate the manufacturing, safety, labeling, storage, record-keeping and marketing of such products. The lengthy process of obtaining regulatory approvals and ensuring compliance with appropriate federal statutes and regulations requires the expenditure of substantial resources. Any delay or failure by us or by our collaboration partners to obtain regulatory approval could adversely affect the commercialization of products we or they are developing, our ability to achieve product collaboration milestones or receive royalty revenue and thus negatively impact our liquidity and capital resources. Preclinical studies are generally conducted in the laboratory to evaluate the potential efficacy and safety of a therapeutic product. The results of these studies are submitted to the FDA as part of an IND, which must be reviewed by FDA personnel before clinical testing can begin. Typically, clinical evaluation involves three sequential phases, which may overlap. During Phase I, clinical trials are conducted with a relatively small number of subjects to determine the early safety profile of a drug, as well as the pattern of drug distribution and drug metabolism. In Phase II, trials are conducted with groups of patients afflicted by a specific target disease to determine preliminary efficacy, optimal dosages, and dosage tolerance and to gather additional safety data. In Phase III, larger-scale, multi-center comparative trials are conducted with patients afflicted with a specific target disease to provide data for the statistical proof of efficacy and safety as required by the FDA and foreign regulatory agencies. The FDA, the clinical trial sponsor or the investigator may suspend clinical trials at any time if they believe that clinical subjects are being exposed to an unacceptable health risk. The results of preclinical and clinical testing are submitted to the FDA in the form of a New Drug Application (NDA) for small molecule products or a Biologic License Application (BLA) for biological 8 10 products. In responding to an NDA or BLA, it may grant marketing approval, request additional information, or deny the application if the FDA determines that the application does not satisfy its regulatory approval criteria. There can be no assurance that approvals will be granted on a timely basis, if at all. The failure to obtain timely permission for clinical testing or timely approval for product marketing would have a material negative effect on us. Product approvals may subsequently be withdrawn if compliance with regulatory standards is not maintained or if problems are identified after the product reaches the market. The FDA may require testing and surveillance programs to monitor the effect of a new product and may prevent or limit future marketing of the product based on the results of these post-marketing programs. Our policy is to conduct research activities in compliance with the National Institute of Health Guidelines for Research Involving Recombinant DNA Molecules. We also are subject to various federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, used in connection with our work. The extent and character of governmental regulation that might result from future legislation or administrative action and its effect on us cannot be accurately predicted. Even if regulatory approval for a product is obtained, the product and the facilities manufacturing the product are subject to continued review and periodic inspection. Each drug and device manufacturing establishment in the United States must be registered with the FDA. Domestic manufacturing establishments are subject to biannual inspections by the FDA and must comply with the FDA's cGMP regulations, as well as regulatory agencies in other countries if products are sold outside the United States. If we manufacture for sale to third parties diagnostic product applications of our SBH technology, we will need to comply with cGMP regulations pertaining to devices. We will need to spend funds, time and effort to ensure full technical compliance with these regulations. The FDA stringently applies regulatory standards for manufacturing drugs, biologics, and medical devices. The FDA's cGMP regulations require that drugs and medical devices be manufactured and records be maintained in a prescribed manner with respect to manufacturing, testing and control activities. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of hazardous materials, including 33P, a low energy radioactive isotope used in labeling some of our probes and subsequently present in certain waste products. Although we believe that our safety procedures for such materials comply with the standards prescribed by local, state, and federal laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, we could be held liable for any damages that result and any liability could exceed our resources. HUMAN RESOURCES At December 31, 2000, we had 257 full-time equivalent employees, including approximately 220 scientists. Fifty-nine of our employees hold doctorate degrees. No employees are represented by unions. We believe that relations with our employees are good. RISK FACTORS We Must Be Able to Continue to Secure Additional Financing Our business does not currently generate the cash needed to finance our operations. We will require substantial additional financial resources to conduct the time-consuming and costly research, preclinical development, clinical trials and regulatory approval and marketing activities necessary to commercialize our potential products. Also, in pursuing our goal of building a fully-integrated biopharmaceutical company, we intend to expand our facilities and hire and train significant numbers of employees to staff these facilities, which will require substantial additional funds. We will need to secure additional financing within the next fiscal year in order to conduct our research and expand our facilities as we have planned. Unanticipated expenses, or unanticipated opportunities that require financial commitments, could give rise to requirements for additional financing sooner than we expect. However, financing may be unavailable when we need it or 9 11 may not be available on acceptable terms. If we are unable to raise additional funds when we need them, we may be required to delay, scale back or eliminate expenditures for some of our development programs or our facilities expansion plans, or grant rights to third parties to develop and market product candidates that we would prefer to develop and market ourselves. If we are required to grant such rights, the ultimate value of these product candidates to us would be reduced. We intend to seek additional funding through collaborations and public or private equity or debt financings. We have financed our operations since inception primarily through sale of equity securities and revenue from corporate collaborations. We have not generated royalty revenues from product sales, and do not expect to receive significant revenues from royalties in the foreseeable future, if ever. To execute our current operating plan, we will need to secure additional financing by at least the fourth quarter of 2001, however, we plan to seek additional funding prior to that time. Additional financing, however, may not be available on acceptable terms, if at all. For approximately the past six months, the capital markets have been volatile and uncertain. Given the current state of the markets for public and private offerings of securities, we may have difficulty raising the amount of funds, on reasonable terms, necessary to finance our current operating plan. If we cannot raise the financing that our current operating plan requires, we may have to scale back some of our operations, including our planned facilities expansion, which may have a negative effect on our business. In addition, the perception in the capital markets that we may not be able to raise the amount of financing we desire, or on terms favorable to us, may have a negative effect on the trading price of our stock. Additional equity financings could result in significant dilution of stockholders' equity interests. If sufficient capital is not available, we may be required to delay, reduce the scope of, eliminate or divest one or more of our discovery, research or development programs or our planned facilities expansion. Any such action could significantly harm our business, financial condition and results of operations. Our future capital requirements and the adequacy of our currently available funds will depend on many factors, including, among others, the following: - continued scientific progress in our research and development programs, including progress in our research and preclinical studies on our therapeutic protein candidates; - the cost involved in our facilities expansion to support research and development of our therapeutic protein candidates; - our ability to attract additional financing on favorable terms; - the magnitude and scope of our research and development programs, including development of therapeutic protein candidates and SBH technology and applications; - our ability to maintain, and the financial commitments involved in, our existing collaborative and licensing arrangements; - our ability to establish new corporate relationships with other biotechnology and pharmaceutical companies to share costs and expertise of identifying and developing product candidates; - the cost of prosecuting and enforcing our intellectual property rights, including our patent litigation with Affymetrix; - the cost of manufacturing material for preclinical, clinical and commercial purposes; - the time and cost involved in obtaining regulatory approvals; - our need to develop, acquire or license new technologies or products; - competing technological and market developments; and - other factors not within our control. 10 12 Development of Our Products Will Take Years; Our Products Will Require Approval Before They Can Be Sold Because substantially all of our potential products currently are in research or preclinical development, revenues from sales of any products will not occur for at least the next several years, if at all. We cannot be certain that any of our products will be safe and effective or that we will obtain regulatory approvals. In addition, any products that we develop may not be economical to manufacture on a commercial scale. Even if we develop a product that becomes available for commercial sale, we cannot be certain that consumers will accept the product. We cannot predict whether we will be able to successfully develop and commercialize any of our protein candidates. If we are unable to do so, our business, results of operations and financial condition will be materially adversely affected. We do not yet have products in the commercial markets. All of our potential products are in research or preclinical development. We cannot apply for regulatory approval of our potential products until we have performed additional research and development and testing. We cannot be certain that we, or our strategic partners, will be permitted to undertake clinical testing of our potential products and, if we are successful in initiating clinical trials, we may experience delays in conducting them. Our clinical trials may not demonstrate the safety and efficacy of our potential products, and we may encounter unacceptable side effects or other problems in the clinical trials. Should this occur, we may have to delay or discontinue development of the potential product that causes the problem. After a successful clinical trial, we cannot market products in the United States until we receive regulatory approval. Even if we are able to gain regulatory approval of our products after successful clinical trials and then commercialize and sell those products, we may be unable to manufacture enough product to maintain our business which could have a negative impact on our financial condition. The Success of Our Potential Products in Preclinical Studies Does Not Guarantee that these Results Will Be Replicated in Humans Even though some of our therapeutic protein candidates have shown results in preclinical studies, these results may not be replicated in our clinical trials with humans. Human clinical results could be different from our expectations following our preclinical studies. Consequently, there is no assurance that the results in our preclinical studies are predictive of the results that we will see in our clinical trials with humans. Also, while we have demonstrated some evidence that our therapeutic protein candidates have utility in preclinical studies, these results do not mean that the resulting products will be safe and effective in humans. Our therapeutic protein candidates may have undesirable and unintended side effects or other characteristics that may prevent or limit their use. Our Ability To Commercialize Gene-Based Products is Unproven We have not developed any therapeutic or diagnostic products using proteins produced by the genes we have discovered. Before we make any products available to the public, we or our collaboration partners will need to conduct further research and development and complete laboratory testing and animal and human studies. Moreover, with respect to biopharmaceutical products, we or our collaboration partners will need to obtain regulatory approval before releasing any such products. With respect to agricultural products, our collaboration partner may need to obtain regulatory approval before releasing any such products. We have spent, and expect to continue to spend, significant amounts of time and money in determining the function of genes and the proteins they produce. Such determination process constitutes the first step in developing commercial products. We also have spent and expect to continue to spend significant amounts of time and money in developing our most advanced product candidates, IL-1Hy1 and CD39L4. However, a commercially viable product may never be developed from our gene discoveries, either by us alone or with our collaboration partners. 11 13 Our development of gene-based products is subject to several risks, including but not limited to: - the possibility that a product is toxic, ineffective or unreliable; - failure to obtain regulatory approval for the product; - the product may be hard to manufacture on a large scale or may not be economically feasible to market; - competitors may develop a superior product; or - other persons' or companies' patents may preclude our marketing of a product. Our biopharmaceutical development programs are currently in the research stage or in preclinical development. None of our therapeutic protein candidates have advanced to Phase I clinical trials. Our programs may not move beyond their current stages of development. Even if our research does advance, we will need to engage in certain additional preclinical development efforts to determine whether a product is sufficiently safe and efficacious to enter clinical trials. We have little experience with these activities and may not be successful in developing or commercializing products. Under our collaboration arrangement with Chiron in the solid tumor cancer field, Chiron maintains responsibility for the development of a product. Under our collaboration arrangement with Kirin, Kirin has primary responsibility for clinical development in its territory and we have primary responsibility in our territory. With respect to these arrangements, we run the risk that Chiron or Kirin may not pursue clinical development in a timely or effective manner, if at all. If a product receives approval from the FDA to enter clinical trials, Phase III of those trials include multi-phase, multi-center clinical studies to determine the product's safety and efficacy prior to marketing. We cannot predict the number or extent of clinical trials that will be required or the length of the period of mandatory patient follow-up that will be imposed. Assuming clinical trials of any product are successful and other data appear satisfactory to us, we or our applicable collaboration partner will submit an application to the FDA and appropriate regulatory bodies in other countries to seek permission to market the product. Typically, the review process at the FDA is not predictable and can take up to several years. Upon completion of such review, the FDA may not approve our or our collaboration partner's application or may require us to conduct additional clinical trials or provide other data prior to approval. Furthermore, even if our products or our collaboration partner's products receive regulatory approval, delays in the approval process could significantly harm our business, financial condition and results of operations. In addition, we may not be able to produce any products in commercial quantities at a reasonable cost or may not be able to successfully market such products. If we do not develop a commercially viable product, then we would suffer significant harm to our business, financial condition and operating results. The Success of Our Business Depends on Patents and Other Proprietary Information We currently have patents that cover some of our technological discoveries and patent applications that we expect to cover our gene, protein and technological discoveries. We will continue to apply for patents for our discoveries. We cannot assure you that any of our currently pending or future applications will issue as patents, or that any patent issued to us will not be challenged, invalidated, circumvented or held unenforceable by way of an interference proceeding or litigation. The patent positions of biotechnology companies involve complex legal and factual questions. Even though we own patents, we cannot be certain that: - our patents will not be challenged; - protection against competitors will be provided by such patents; or - competitors will not independently develop similar products or design around our patents. 12 14 We seek patents on: - full-length gene sequences; - partially-sequenced gene sequences; - proteins produced by those genes; and - processes, devices and other technology that enhance our ability to develop and/or manufacture gene-based products. To obtain a patent, we must identify a utility for the gene or the protein we seek to patent. Identifying a utility may require significant research and development with respect to which we may incur a substantial expense and invest a significant amount of time. Patent applications we may apply for with respect to human therapeutics could require us to generate data which may involve substantial costs. Finally, we cannot predict the timing of the grant of a patent. We also rely on trade secret protection for our confidential and proprietary information. Although our policy is to enforce security measures to protect our assets, trade secrets are difficult to protect. We require all employees to enter into confidentiality agreements with us. However: - competitors may independently develop substantially equivalent proprietary information and techniques; - competitors may otherwise gain access to our trade secrets; - persons with whom we have confidentiality agreements may disclose our trade secrets; or - we may be unable to protect our trade secrets meaningfully. Certain of our patents protecting our SBH technology are filed only in the United States. Therefore, we currently are not able to prevent others from practicing SBH technology outside of the United States. Furthermore, although we intend to defend our patents, we may not prevail in a court case against others who use our SBH technology. We currently have two suits against, and are defending a countersuit and suit against us by, our competitor Affymetrix. We have claimed that Affymetrix has infringed our SBH patents and Affymetrix claims that our patents are invalid. If we lose our exclusive rights to SBH technology because of the litigation, then competitors could be free to design products that incorporate or use such technology. We have and will continue to incur substantial costs and expend substantial personnel time in defending our patents rights in court. See "Item 3. Legal Proceedings," for additional information. We may be required to obtain licenses to patents or other proprietary rights of others. These required licenses may not, however, be made available on terms acceptable to us, or at all. If we do not obtain these licenses, we may not be able to develop, manufacture or sell products, or encounter delays in product market introductions, or incur substantial costs while we attempt to design around existing patents. Any of these obstacles could significantly harm our business, financial condition and operating results. Certain Litigation We have filed suit against Affymetrix alleging infringement of five of our patents related to our SBH technology. Affymetrix has filed a countersuit and a suit of its own alleging that our patents are invalid and that we infringe certain of Affymetrix' patents. We have incurred, and will continue to incur, substantial costs and personnel time in asserting our patent rights against Affymetrix, and in our defense in the suit brought by Affymetrix. We may not be successful in asserting our patent rights or in our defense against Affymetrix. We cannot assure you that any of our patents will not be challenged, invalidated, circumvented or held unenforceable by way of an interference proceeding or litigation. Failure to enforce our patent rights successfully, or the loss of these patent rights covering our proprietary technologies, also could remove a legal obstacle to competitors in designing platforms with similar competitive advantages, which could significantly harm our business, financial condition and operating results. See "Item 3. Legal Proceedings," for additional information. 13 15 Our Business is Difficult to Evaluate Because We Have Been Focused on Our Current Business Strategy for Only Approximately Three Years. Our company commenced operations in the fourth quarter of 1994. Our initial business focused on gene discovery using our screening-by-hybridization platform, and applications of our SBH technology including the HyChip system, although our vision has been to become a biopharmaceutical company. Not only is our operating history relatively short, but we began to transition our business strategy from gene discovery to research and development of potential biopharmaceutical candidates in 1998. Accordingly, we have a limited operating history from which you can evaluate our present business and future prospects. As a relatively new entrant to the business of biopharmaceutical research and development, we face risks and uncertainties relating to our ability to implement our business plan successfully. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early state of development, particularly companies in new and rapidly evolving markets such as research and development of gene-based products. If we are unsuccessful in addressing these risks and uncertainties, our business, results of operations, financial condition and prospects will be materially adversely affected. We Lack Manufacturing Experience and We Intend to Rely Initially on Contract Manufacturers We do not currently have significant manufacturing facilities. We are dependent on contract research and manufacturing organizations, and will be subject to the risk of finalizing contractual arrangements, transferring technology and maintaining relationships with such organizations in order to file an IND with the FDA and proceed with clinical trials for any of our therapeutic protein candidates. We are dependent on third-party contract research organizations to conduct certain research, including GLP toxicology studies in order to gather the data necessary to file an IND with the FDA for any of our therapeutic protein candidates. Our therapeutic protein candidates have never been manufactured on a commercial scale. Third-party manufacturers may not be able to manufacture such proteins at a cost or in quantities necessary to make them commercially viable. In addition, if any of our therapeutic protein candidates enter the clinical trial phase, initially we will be dependent on third-party contract manufacturers to produce the volume of cGMP materials needed to complete such trials. We expect to enter into relationships with third-party contract research organizations that are capable of conducting such research and third-party contract manufacturers that are capable of producing such volume of material. We will need to enter into contractual relationships with these or other organizations in order to (i) complete the GLP toxicology and other studies necessary to file an IND with the FDA, and (ii) produce a sufficient volume of cGMP material in order to conduct clinical trials of our therapeutic protein candidates. We cannot assure you that we will be able to do so on a timely basis or that we will be able to obtain sufficient quantities of material on commercially reasonable terms. In addition, the failure of any of these relationships with third-party contract organizations may result in a delay of our filing for an IND, or our progress through the clinical trial phase. Any significant delay or interruption would have a material adverse effect on our ability to file an IND with the FDA and/or proceed with the clinical trial phase for any of our therapeutic protein candidates. Moreover, contract manufacturers that we may use must continually adhere to current cGMP regulations enforced by the FDA through a facilities inspection program. If the facilities of such manufacturers cannot pass a pre-approval plant inspection, the FDA premarket approval of our products will not be granted. We Are Dependent Upon Collaborative Arrangements As we have transitioned our business from gene discovery to research and development of biopharmaceutical candidates, we have shifted our focus for new collaborative arrangements. We are now focusing on new collaborative arrangements where we would share costs of identifying, developing and marketing product candidates. There can be no assurance that we will be able to negotiate new collaboration arrangements of this type on acceptable terms, or at all. 14 16 The success of our business is dependent, in significant part, upon our ability to enter into multiple collaboration arrangements and to effectively manage the numerous issues that arise from such collaborations. Management of our relationships with our collaboration partners will require: - our management team to devote a significant amount of time and effort to the management of these relationships; - effective allocation of our resources to multiple projects; and - an ability to obtain and retain management, scientific and other personnel. Our need to manage simultaneously a number of collaboration arrangements may not be successful, and the failure to effectively manage such collaborations would significantly harm our business, financial condition and results of operations. The research we perform in our gene discovery collaborative arrangements is at an early stage of product development. The successful development of products under these collaborations is highly dependent on the performance of our collaboration partners. Under our gene discovery collaborative arrangements, our collaboration partners are generally required to (i) undertake and fund certain research and development activities with us, (ii) make payments to us upon achievement of certain scientific milestones and (iii) pay royalties to us when and if they commercially market a product developed from the collaborative arrangement. We do not directly control the amount or timing of resources devoted to development activities by our collaboration partners. We, therefore, face a risk that our collaboration partners may not commit sufficient resources to our research and development programs or the commercialization of our products or may not perform their obligations as expected. If any collaboration partner fails to conduct its activities to be performed under our collaboration arrangement in a timely manner, or at all, our expectations of royalties and milestone payments related to such collaboration arrangement could be delayed or eliminated. Also, our current or future collaboration partners, if any, may independently pursue existing or other development-stage products or alternative technologies in preference to those they are developing in collaboration with us. Further, disputes may arise with respect to ownership of products developed under any such collaboration arrangement. Finally, any of our current collaboration arrangements may be terminated or not renewed by our collaboration partners, and we may not be able to negotiate additional collaboration arrangements in the future on acceptable terms, or at all. We Are Dependent on Key Personnel The success of our business is highly dependent on the principal members of our scientific and management staff. The loss of the services of such individuals might significantly delay or prevent us from achieving our scientific or business objectives. Competition among biotechnology and biopharmaceutical companies for qualified employees is intense. The ability to retain and attract qualified individuals is critical to our success. We may not be able to attract and retain qualified employees currently or in the future on acceptable terms, or at all. The failure to do so would significantly harm our business, financial condition and results of operations. Management of Growth We expect to significantly increase the number of our employees and the scope of our operations. Such growth may place a significant strain on our management and operations. In order to execute our strategy to build a fully-integrated biopharmaceutical company, develop therapeutic or diagnostic products, and obtain regulatory approvals, we will need to: - attract and train skilled employees; - attract and retain employees with expertise to ensure that we meet FDA and foreign regulatory requirements for conducting clinical trials; - expand our facilities for additional research and development laboratories and offices and acquire additional equipment and supplies; 15 17 - expand our protein production capacity; and - enter into and manage contractual relationships with contract research and manufacturing organizations. Our ability to manage such growth effectively will depend upon our ability to broaden our management team and to attract, hire and retain skilled employees. Our success also will depend on the ability of our officers and key employees to continue to implement and improve our operational, management information and financial control systems and to expand, train and manage our employee base. Inability to manage growth effectively could significantly harm our business, financial condition and operating results. We Must Attract and Retain Qualified Employees and Consultants Our success will depend on our ability to retain our key executive officers and scientific staff to develop our potential products and formulate our research and development strategy. We have programs in place to retain personnel, including programs to create a positive work environment and competitive compensation packages. Because competition for employees in our field is intense, however, we may be unable to retain our existing personnel or attract additional qualified employees. Our success also depends on the continued availability of outside scientific collaborators to perform research and develop processes to advance and augment our internal research efforts. Competition for collaborators is intense. If we do not attract and retain qualified personnel and scientific collaborators, and if we experience significant turnover or difficulties recruiting new employees, our research and development programs could be delayed and we could experience difficulties in generating sufficient revenue to maintain our business. Future Sales of Our Common Stock May Depress Our Stock Price Sales in the public market of substantial amounts of our common stock could depress prevailing market prices of our common stock. As of March 1, 2001, we had 13,757,882 shares of our common stock outstanding. All of these shares are freely transferable without restriction or further registration under the Securities Act of 1933, as amended (Securities Act), except for shares held by our affiliates. Our affiliates hold 2,207,141 shares of our common stock which are transferable pursuant to Rule 144 as promulgated under the Securities Act, subject to the volume limitations of Rule 144. Although we do not believe that our affiliates have any present intentions to dispose of any shares of common stock owned by them, there can be no assurance that such intentions will not change in the future. An additional 708,480 shares owned by a Yugoslav entity have been held in a blocked account pursuant to restrictions imposed by the U.S. Department of Treasury arising from the political situation in former Yugoslavia and therefore have not been able to be voted or transferred. We believe that some of these restrictions may have recently been removed and the remaining restrictions may be removed in the future. There can be no assurance as to how long any such restrictions will remain in effect. As of March 1, 2001, warrants to purchase 312,881 shares of our common stock were outstanding. In addition, under registration statements on Form S-8 under the Securities Act, we have registered approximately 2,592,974 shares of our common stock for sale upon the exercise of outstanding options under our 1995 Stock Option Plan, Non-Employee Director Stock Option Plan, Scientific Advisory Board/Consultants Stock Option Plan, and stock option agreements entered into outside of any of our stock option plans. Shares of our common stock acquired pursuant to these plans and agreements are available for sale in the open market. In addition, we have reserved approximately 468,160 shares of our common stock for issuance upon the exercise of outstanding options under a stock option agreement entered into outside of any of our stock option plans. As of March 1, 2001, 150,000 of these 468,160 shares of this option were exercisable. Although these shares have not been registered under the Securities Act, and therefore are restricted securities within the meaning of Rule 144 under the Securities Act, we intend to register these shares on a registration statement on Form S-8 under the Securities Act. Certain options or warrants may have exercise prices that are substantially below the prevailing market price of our common stock. The exercise of those options or warrants, and the prompt resale of shares of our common stock received, may result in downward pressure on the price of our common stock. 16 18 The existence of the currently outstanding warrants and options to purchase our common stock may negatively affect our ability to complete future equity financings at acceptable prices and on acceptable terms. We Have a History of Operating Losses and May Never Be Profitable For the years ended December 31, 2000, 1999 and 1998, we had net losses of $22.3 million, $18.5 million and $16.4 million, respectively. As of December 31, 2000, we had an accumulated deficit of $71.9 million. The process of developing our therapeutic protein candidates will require significant additional research and development, preclinical testing, clinical trials and regulatory approvals. These activities, together with general administrative expenses, are expected to result in operating losses for the foreseeable future. We may never generate profits, and if we do become profitable, we may be unable to sustain or increase profitability on a quarterly or annual basis. As a result, the trading price of our stock could decline. We May Face Fluctuations in Operating Results Our operating results may rise or fall significantly as a result of many factors, including: - the amount of research and development we engage in; - the progress we make with research and preclinical studies on our therapeutic protein candidates, and the number of candidates in research and preclinical studies; - our ability to expand our facilities to support our operations; - the ability to enter into new strategic relationships; - the nature, effectiveness, size, timing or termination of our collaborative arrangements; - the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; - the possibility that others may have or obtain patent rights that are superior to ours; - changes in government regulation; and - competitors' release of successful products into the market. Because substantially all of our potential products currently are in research or preclinical development, revenues from sales of any products will not occur for at least the next several years, if at all. We also have a high percentage of fixed costs such as lease obligations. As a result, we may experience fluctuations in our operating results from quarter to quarter and continue to generate losses. Quarterly comparisons of our financial results may not necessarily be meaningful and investors should not rely upon such results as an indication of our future performance. We Face Potential Volatility of Our Stock Price Our common stock has been traded on the Nasdaq National Market only since August 1997. The market price of our common stock may fluctuate substantially because of a variety of factors, including: - volatility and uncertain in the capital markets in general; - quarterly fluctuations in our results of operations; - adverse circumstances affecting the introduction or market acceptance of new products we offer; - announcements by competitors; - developments in our litigation proceedings; - changes in our earnings estimates; - changes in accounting principles; - sales of our common stock by existing holders; 17 19 - loss of key personnel; and - economic and other external factors. In addition, the stock market in general, and the market for biotechnology and other life science stocks in particular, has historically been subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. In the past, following periods of volatility in the market price of a company's securities, class action securities litigation has often been instituted against such a company. Any such litigation instigated against us could result in substantial costs and a diversion of management's attention and resources, which could significantly harm our business, financial condition and operating results. FDA Regulatory Approval of Our Products is Uncertain; We Face Heavy Government Regulation Products such as those proposed to be developed by us, alone, or in conjunction with our collaboration partners, typically will be subject to an extensive regulatory process by federal, state and local governmental authorities, including the FDA, and comparable agencies in other countries before we may market and sell such products. In order to obtain regulatory approval of a drug product, we, alone, or in conjunction with our collaboration partners, must demonstrate to the satisfaction of the applicable regulatory agency, among other things, that such product is safe and effective for its intended uses. In addition, we must show that the manufacturing facilities used to produce the products are in compliance with cGMP requirements. In the event we, alone, or in conjunction with our collaboration partners, develop products classified as drugs, we and our collaboration partners will be required to obtain appropriate approvals as well. If we sell applications of our SBH technology for clinical diagnostics, we will need to comply with appropriate cGMP regulations pertaining to devices. The new Quality System Regulation imposes design controls and makes other significant changes in the requirements applicable to manufacturers. We must also demonstrate that a BLA or NDA for any biological products would be approved by the applicable government agency. In addition, if we market applications of our SBH technology as diagnostic products, they may be considered to be medical devices and we or our collaboration partners will be required to show that the diagnostic product is substantially equivalent to a legally marketed product not requiring FDA approval. In addition, we must demonstrate that we are capable of manufacturing the product in accordance with the relevant standards. To obtain FDA approval for such products, we must submit extensive data to the FDA, including pre-clinical and clinical trial data to prove the safety and efficacy of the device. Clinical trials are normally conducted over a two- to five-year period, but may take longer to complete as a result of many factors, including: - slower than anticipated patient enrollment; - difficulty in finding a sufficient number of patients fitting the appropriate inclusion criteria; - difficulty in acquiring a sufficient supply of clinical trial materials; or - adverse events occurring during the trials. Furthermore, data obtained from preclinical and clinical activities are susceptible to varying interpretations which could delay, limit or prevent regulatory approval or clearance for a product. The process of obtaining FDA and other required regulatory approvals and clearances is lengthy and will require us to expend substantial capital and resources. We may not ultimately be able to obtain the necessary approvals and clearances. Moreover, if and when our products do obtain such approval or clearances, the marketing, distribution and manufacture of such products would remain subject to extensive ongoing regulatory requirements. Failure to comply with applicable regulatory requirements can result in: - warning letters; - fines; - injunctions; 18 20 - civil penalties; - recall or seizure of products; - total or partial suspension of production; - refusal of the government to grant approvals, premarket clearance or premarket approval; or - withdrawal of approvals and criminal prosecution. We also are subject to numerous federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, the environment and the use and disposal of hazardous substances used in connection with our discovery, research and development work, including radioactive compounds and infectious disease agents. In addition, we cannot predict the extent of government regulations or the impact of new governmental regulations which might significantly harm the discovery, development, production and marketing of our products. We may be required to incur significant costs to comply with current or future laws or regulations and we may be adversely affected by the cost of such compliance. If we market therapeutic and diagnostic products outside the United States, such products will be subject to foreign regulatory requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement. Such requirements vary from country to country and are becoming more restrictive throughout the European Community. The process of obtaining foreign regulatory approvals can be lengthy and require the expenditure of substantial capital and resources. We or our collaboration partners may not be successful in obtaining the necessary approvals. Any delay or failure by us or our collaboration partners to obtain regulatory approvals for our products: - would adversely affect our ability to generate product and royalty revenues; - could impose significant additional costs on us or our collaboration partners; - could diminish competitive advantages that we may attain; and - would adversely affect the marketing of our products. We Lack Marketing Experience for Biopharmaceuticals We currently have no sales, marketing or distribution capability. For the foreseeable future, we intend to rely primarily on our current and future collaboration partners or licensors, if any, to market our products. Such collaboration partners, however, may not have effective sales forces and distribution systems. If we are unable to maintain or establish such relationships and are required to market any of our products directly, we will have to develop our own marketing and sales force with the appropriate technical expertise and with supporting distribution capabilities. We may not be able to maintain or establish such relationships with third parties or develop in-house sales and distribution capabilities. To the extent that we depend on our collaboration partners or third parties for marketing and distribution, any revenues we receive will depend upon the efforts of such collaboration partners or third parties. Such efforts may not be successful. Our Products May Not Be Accepted in the Marketplace Even if they are approved for marketing, products we develop may never achieve market acceptance. Our products, if successfully developed, will compete with a number of traditional drugs and therapies manufactured and marketed by major pharmaceutical and other biotechnology companies. Our products will also compete with new products currently under development by such companies and others. The degree of market acceptance of any products developed by us, alone, or in conjunction with our collaboration partners, will depend on a number of factors, including: - the establishment and demonstration of the clinical efficacy and safety of the products; - our products' potential advantage over alternative treatment methods; and 19 21 - reimbursement policies of government and third-party payors. Physicians, patients or the medical community in general may not accept and utilize any of the products that we alone, or in conjunction with our collaboration partners, develop. The lack of such market acceptance would significantly harm our business, financial condition and results of operations. We may develop diagnostic testing products in the future. Our success in diagnostics will depend in large part upon our ability to obtain customers and upon the ability of these customers to properly market genetic tests performed with our technology. Genetic tests, including any performed using applications of our SBH technology, may be difficult to interpret and may lead to misinformation or misdiagnosis. Even when a genetic test identifies the existence of a mutation in a person, the test cannot determine with absolute certainty whether the tested individual will develop the disease or condition for which the test is performed. The prospect of broadly available genetic predisposition testing has raised societal and governmental concerns regarding the appropriate use and the confidentiality of information provided by such testing. Government authorities could limit the use of genetic testing or prohibit testing for genetic predisposition to certain conditions. Ethical concerns about genetic testing may adversely effect market acceptance of our technology for diagnostic applications. Impaired market acceptance of our technology could significantly harm our business, financial condition and operating results. We Face Uncertainties Related to SBH Technology Applications We have developed applications of our SBH technology, including the chip component to be used with the HyChip system. As we continue development of SBH technology applications, we may discover problems in the functioning of these applications, including the HyChip system. We may be unable to improve applications of our SBH technology enough to be able to market them successfully. Further, SBH technology applications compete against other DNA analysis tools and well-established technologies. We cannot predict the outcome of these uncertainties. We Face Intense Competition The genomics and biopharmaceutical industries are intensely competitive. Our strategy as a biopharmaceutical company is to find the genes of the human genome that are most likely to be involved in a disease condition and to focus on identifying product candidates from the proteins produced by genes. There are a finite number of genes in the human genome, virtually all of which will soon be identified. Our competitors include major pharmaceutical and biotechnology firms, not-for-profit entities and United States and foreign government-financed programs, many of which have substantially greater research and product development capabilities and financial, scientific, marketing and human resources than we do. As a result, they may succeed in identifying genes and determining their functions or developing products earlier than we or our current or future collaboration partners do. They also may obtain patents and regulatory approvals for such products more rapidly than we or our current or future collaboration partners, or develop products that are more effective than those proposed to be developed by us or our collaboration partners. Further, any potential products based on genes we identify ultimately will face competition from other companies developing gene-based products as well as from companies developing other forms of treatment for diseases which may be caused by, or related to, the genes we identify. Many of the companies developing competing products have significantly greater financial resources than we have. Many such companies also have greater expertise than we or our collaboration partners have in discovery, research and development, manufacturing, preclinical and clinical testing, obtaining regulatory approvals and marketing. Other smaller companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. Academic institutions, government agencies and other public and private research organizations may also conduct research, seek patent protection and establish collaborative arrangements for discovery, research, clinical development and marketing of products similar to our products. These companies and institutions compete with us in recruiting and retaining 20 22 qualified scientific and management personnel as well as in acquiring technologies complementary to our programs. We will face competition with respect to: - product efficacy and safety; - the timing and scope of regulatory approvals; - availability of resources; - reimbursement coverage; and - price and patent position, including potentially dominant patent positions of others. There can be no assurance that research and development by others will not render the products which we may develop obsolete or uneconomical or result in treatments, cures or diagnostics superior to any therapy or diagnostic developed by us or that any therapy we develop will be preferred to any existing or newly developed technologies. While we believe that our technology provides a significant competitive advantage, any one of our competitors may discover and establish a patent position in one or more genes which we designate as a product candidate before we do. Competition in this field is expected to intensify. Certain of our collaboration partners may now be, or could become, competitors. Competition in the area of DNA analysis tools is intense and expected to increase. Technologies in this area are new and rapidly evolving. Applications of our SBH technology compete primarily with Affymetrix and Applied Biosystems. See "Item 3. Legal Proceedings," regarding our litigation with Affymetrix. Although we are collaborating with Applied Biosystems to develop an application of our SBH technology, Applied Biosystems presently markets gel sequencers, a well-established sequencing technology, which compete with applications of our SBH technology. Other companies also are developing or have developed DNA analysis tools that may compete with applications of our SBH technology. Many of these companies have significantly greater research and development, marketing and financial resources than we do, and therefore represent significant competition. We Face Uncertainty With Respect to Pricing, Third-Party Reimbursement and Health Care Reform Our ability to collect significant royalties from our products may depend on our ability, and the ability of our collaboration partners or customers, to obtain adequate levels of reimbursement from third-party payors such as: - government health administration authorities; - private health insurers; - health maintenance organizations; - pharmacy benefit management companies; and - other health care related organizations. Currently, third-party payors are increasingly challenging the prices charged for medical products and services, and the overall availability of third-party reimbursement is limited and uncertain for genetic predisposition tests. Third-party payors may deny their insured reimbursement if they determine that a prescribed device or diagnostic test (i) has not received appropriate clearances from the FDA or other government regulators, (ii) is not used in accordance with cost-effective treatment methods as determined by the third-party payor, or (iii) is experimental, unnecessary or inappropriate. If third-party payors routinely deny reimbursement, we may not be able to market our products effectively. We also face the risk that we will have to offer our diagnostic products at low prices as a result of the current trend in the United States towards managed health care through health maintenance organizations. Prices could be driven down by health maintenance organizations which control or significantly influence purchases of health care services and products. Legislative proposals to reform health care or reduce government insurance programs could also adversely affect prices of our products. The cost containment measures that health care providers are instituting and the results of potential health care reforms may prevent us from maintaining prices for our 21 23 products that are sufficient for us to realize profits and may otherwise significantly harm our business, financial condition and operating results. We Face Product Liability Exposure and Potential Unavailability of Insurance We risk financial exposure to product liability claims in the event that the use of products developed by us, alone or in conjunction with our collaboration partners, if any, result in personal injury. We may experience losses due to product liability claims in the future. We have obtained limited product liability insurance coverage. Such coverage, however, may not be adequate or may not continue to be available to us in sufficient amounts or at an acceptable cost, or at all. We may not be able to obtain commercially reasonable product liability insurance for any product approved for marketing. A product liability claim or other claim, product recalls, as well as any claims for uninsured liabilities or in excess of insured liabilities, may significantly harm our business, financial condition and results of operations. We Use Hazardous Materials Our research and development activities involve the controlled use of hazardous materials. Although we believe that our safety procedures for handling and disposing of these materials comply with applicable laws and regulations, we cannot eliminate the risk of accidental contamination or injury from hazardous materials. If a hazardous material accident occurred, we would be liable for any resulting damages. This liability could exceed our financial resources. Additionally, hazardous materials are subject to regulatory oversight. If our access to hazardous materials necessary for our operations is limited by federal, state or local regulatory agencies, we could experience delays in our research and development programs. Paying damages or experiencing delays caused by restricted access to necessary materials could reduce our ability to generate revenues and make it more difficult to fund our operations. We Have Implemented Anti-Takeover Provisions that May Reduce the Market Price of Our Common Stock Our Amended and Restated By-Laws provide that members of our board of directors serve staggered three-year terms. Our Amended and Restated Articles of Incorporation provide that all stockholder action must be effected at a duly called meeting and not by a consent in writing. The Amended and Restated By-Laws provide, however, that our stockholders may call a special meeting of stockholders only upon a request of stockholders owning at least 50% of our capital stock. These provisions of our Amended and Restated Articles of Incorporation and our Amended and Restated By-Laws could discourage potential acquisition proposals and could delay or prevent a change in control. These provisions are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies formulated by our board of directors. We also intended these provisions to discourage certain types of transactions that may involve an actual or threatened change of control. We designed these provisions to reduce our vulnerability to unsolicited acquisition proposals and to discourage certain tactics that may be used in proxy fights. These provisions, however, could also have the effect of discouraging others from making tender offers for our shares. As a consequence, they also may inhibit fluctuations in the market price of our shares that could result from actual or rumored takeover attempts. Such provisions also may have the effect of preventing changes in our management. We are permitted to issue shares of our preferred stock without stockholder approval upon such terms as our board of directors determines. Therefore, the rights of the holders of our common stock are subject to, and may be adversely affected by, the rights of the holders of our preferred stock that may be issued in the future. In addition, the issuance of preferred stock could have a dilutive effect on the holdings of our current stockholders. On June 5, 1998, our board of directors adopted a rights plan and declared a dividend with respect to each share of our common stock then outstanding. This dividend took the form of a right which entitles the holders to purchase one-one thousandth of a share of our Series B Junior Participating Preferred Stock at a purchase price of $175, subject to adjustment from time to time. These rights have also been issued in connection with each share of our common stock issued after June 5, 1998. The rights are exercisable only if a person or entity 22 24 or affiliated group of persons or entities acquires, or has announced its intention to acquire, 15% (27.5% in the case of certain approved stockholders) or more of our outstanding common stock. The adoption of the rights plan makes it more difficult for a third party to acquire control of us without the approval of our board of directors. Nevada Revised Statutes Sections 78.411 through 78.444 prohibit an "interested stockholder," under certain circumstances, from entering into specified combination transactions with a Nevada corporation, unless certain conditions are met. Under the statute, an "interested stockholder" is a person who, together with affiliates and associates, beneficially owns (or within the prior three years, did beneficially own) 10% or more of a corporation's voting stock. According to the statute, we may not engage in a combination within three years after an interested stockholder acquires our shares, unless (i) our board of directors approves the combination prior to the interested stockholder becoming an interested stockholder or (ii) holders of a majority of voting power not beneficially owned by the interested stockholder approve the combination at a meeting called no earlier than three years after the date the interested stockholder became an interested stockholder. Nevada Revised Statutes Sections 78.378 through 78.3793 further prohibit an acquirer, under certain circumstances, from voting shares of a target corporation's stock after crossing certain threshold ownership percentages, unless the acquirer obtains the approval of the target corporation's stockholders. This statute only applies to Nevada corporations that do business directly or indirectly in Nevada. We do not intend to do business in Nevada within the meaning of the statute. Therefore, it is unlikely that the statute will apply to us. The provisions of our governing documents, our existing agreements and current Nevada law may, collectively: - lengthen the time required for a person or entity to acquire control of us through a proxy contest for the election of a majority of our board of directors; - discourage bids for our common stock at a premium over market price; and - generally deter efforts to obtain control of us. Risk of Natural Disasters and Power Blackouts Our facilities are located in Sunnyvale, California. In the event that a fire or other natural disaster (such as an earthquake) prevents us from operating our production line, our business, financial condition and operating results would be materially, adversely affected. Some of our landlords maintain earthquake coverage for our facilities. Although we maintain personal property and business interruption, we do not maintain earthquake coverage for personal property or resulting business interruption. In addition, the State of California has experienced natural gas and electricity problems which have resulted in rolling power blackouts. Power blackouts have disrupted our business, and may continue to disrupt our business until these problems are resolved. In addition, we, like others, have experienced large increases in our natural gas rates and may experience steep increases in our electric rates. Although we have an auxiliary generator, it is intended for emergency backup in the event of a power outage and is not capable of powering our entire operations. Continued power blackouts and/or large increases in our utility costs could harm our business, financial condition and results of operations. ITEM 2. PROPERTIES We lease a 12,000 square foot facility at 670 Almanor Avenue, Sunnyvale, California. The lease on this facility expires June 30, 2005, and requires base payments on average of approximately $25,000 per month. We also lease approximately 59,000 square feet of space at 675 Almanor Avenue, Sunnyvale, California, which is across the street from 670 Almanor. This lease expires on June 30, 2005, and has a five-year renewal option which, if exercised, would extend the lease to June 30, 2010. It requires base payments on average of approximately $95,000 per month. In June 2000 we leased an additional approximately 59,000 square feet of space at 225, 249 and 257 Humbolt Court in Sunnyvale, California, approximately one mile from our current 23 25 operating facilities. The lease on this new space requires base lease payments on average of approximately $317,000 per month and extends through July 2011. In the initial phase of our facilities expansion, we plan to build out approximately 34,000 square feet of this space to accommodate new research and development offices and laboratories to support preclinical development activities, including preliminary preclinical safety and efficacy studies in rodents, functional cell biology assays, cell based functional screening efforts, protein production, protein characterization and analytical assay development. To complete this build out as planned, we will need to secure additional financing before the end of the 2001 fiscal year. In the next phase of build out, we expect to expand our in-house capabilities for the production and purification of proteins, although this may not provide us with manufacturing facilities capable of supplying materials suitable for clinical trials or for commercial sale. We expect to rely on a third party for the production of proteins for use in our early clinical work. ITEM 3. LEGAL PROCEEDINGS On March 3, 1997, we sued Affymetrix, Inc. in the U.S. District Court for the Northern District of California, San Jose Division, alleging infringement by Affymetrix of our U.S. Patent Nos. 5,202,231 and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C 97-20188 RMW (PVT)) (Hyseq I). On May 5, 1997, we filed an Amended Complaint. On December 9, 1997, we filed a second lawsuit against Affymetrix alleging infringement by Affymetrix of our U.S. Patent No. 5,695,940 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C-97 4469 THE) (Hyseq II). On April 22, 1998 the two cases were consolidated before Judge Ronald M. Whyte. The consolidated suits allege that Affymetrix willfully infringed, and continues to infringe, our patents covering SBH technology. Through the lawsuit, we seek both to enjoin Affymetrix from infringing our patents covering SBH technology and an award of monetary damages for Affymetrix' past infringement. On May 19, 1997, Affymetrix filed an Answer and Affirmative Defenses to the First Amended Complaint in Hyseq I and also filed a counterclaim against us. The counterclaim seeks a declaratory judgment of invalidity and non-infringement with respect to the two patents asserted in Hyseq I. On September 9, 1997, we filed a reply to the counterclaim in which we denied the allegations of invalidity and non-infringement. A similar answer and counterclaim was filed by Affymetrix in Hyseq II on December 28, 1997, and a similar reply to the counterclaim was filed by us on January 29, 1998. On August 1, 1997 (Hyseq I), and on March 28, 1998 (Hyseq II), initial case management conferences were held in each case in which the Court entered a pre-trial schedule. The Court held a claims construction hearing on November 17 and 18, 1998 in Hyseq I and II. On July 12, 1999, Affymetrix filed an amended answer and counterclaim alleging the additional defense that the patents were obtained through inequitable conduct. On October 27, 1999, the Court issued a Claims Construction Order construing terms in the claims of the patents-in-suit and inviting the parties to submit briefs setting forth any perceived errors or inconsistencies in the Order. Affymetrix and we submitted our briefs on December 17 and 27, 1999, respectively. On January 7, 2000, the Court held a further Case Management Conference. On February 22, 2000, the Court received oral argument from the parties regarding the claims construction Order. On July 27, 2000, the Court issued a modified claims construction Order. Affymetrix and we are currently engaged in pretrial discovery during which documents and other written discovery are being exchanged and depositions are being taken. While we believe we have asserted valid claims and have meritorious defenses to the counterclaims, this litigation is at an early stage and there can be no assurance that we will prevail in these actions. On August 18, 1998, Affymetrix filed suit against us in the U.S. District Court for the Northern District of California, San Francisco Division, alleging that we infringed two of Affymetrix' U.S. Patents Nos. 5,795,716 and 5,744,305 (Affymetrix, Inc. v. Hyseq, Inc., Case No. C 98-13192). Affymetrix filed an amended complaint on September 1, 1998 alleging infringement of its U.S. Patent No. 5,800,992. The case was reassigned to Judge Jeremy Fogel in the San Jose Division. At the time of the assignment to Judge Fogel, the case was also renumbered as Case No. C 99-21163 JF (MEJ). A Case Management Conference before Judge Fogel was held on July 10, 2000. A claims construction hearing was held November 29-30, 2000 with respect to U.S. Patents Nos. 5,445,934, 5,744,305, 5,800,992 and 5,795,716. The Court issued an Order on January 22, 2001 construing certain claim terms and requesting additional briefing regarding U.S. Patent No. 5,800,992. We believe that Affymetrix' allegations are without merit and we intend to vigorously defend 24 26 the action. However, the litigation is at a very early stage and it is impossible to predict the ultimate outcome of this matter. On October 26, 1999, we filed a third lawsuit against Affymetrix in the U.S. District Court for the Northern District of California, San Francisco Division (Hyseq, Inc. v. Affymetrix, Inc., Case No. C-99 4735 MJJ) (Hyseq III), alleging infringement by Affymetrix of our U.S. Patent No. 5,972,619 ('619 Patent). We also allege that Affymetrix' U.S. Patent No. 5,795,716 is invalid because the subject matter was first invented by our scientists and is claimed and covered by our '619 Patent. Affymetrix filed an answer and counterclaim on November 15, 1999. The counterclaim seeks a declaratory judgment of invalidity, unenforceability and non-infringement with respect to our '619 Patent. On December 9, 1999, we filed a reply to the counterclaim in which we denied the allegations of invalidity, unenforceability, and non-infringement. Subsequently, Hyseq III was reassigned to Judge Fogel and was given Case No. C-00-20050 JF/PVT. A Case Management Conference was held on July 10, 2000 along with Affymetrix, Inc. v. Hyseq, Inc. On September 6, 2000, we filed a motion seeking the Court's permission to supplement our complaint in Hyseq III to add a claim for infringement by Affymetrix of our U.S. Patent No. 6,018,041 ('041 patent), which was issued to us on January 25, 2000. On November 2, 2000, Judge Fogel granted our motion. On October 12, 2000, Affymetrix filed an Ex Parte application before Judges Fogel and Whyte requesting reassignment of our infringement claims under the '619 patent from Judge Fogel to Judge Whyte. On November 2, 2000, Judges Fogel and Whyte reassigned our infringement claims against Affymetrix under the '619 patent (as well as our infringement claims against Affymetrix under the '041 patent) to Judge Whyte, and ordered that the claim construction of the '619 patent claims would proceed before Judge Whyte. On March 20, 2001, the Court issued a tentative Claims Construction Order construing terms in the '619 patent. In the Order, Judge Whyte indicated that the tentative order will be adopted as the Claims Construction Order unless one of the parties files a written request for a hearing within 15 days. On January 20, 2001, the USPTO Board of Patent Appeals and Interferences declared an interference between one of our pending patent applications covering subject matter related to SBH technology and Affymetrix' issued patent no. 5,795,716 (Chee and Lipshutz v. Drmanac and Crkvenjakov). We are the senior party to the interference. We have incurred substantial costs and expended substantial personnel time in asserting our patent rights and defending our technology against Affymetrix and may continue to incur such costs in asserting our patent rights and defending our technology against Affymetrix or others. There can be no assurance that we will be successful in these efforts. Failure to successfully enforce our patent rights or the loss of these patent rights covering SBH technology could remove a legal obstacle to competitors in designing platforms with similar competitive advantages. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to the vote of stockholders through the solicitation of proxies or otherwise during the fourth quarter of the year ended December 31, 2000. 25 27 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock began trading on the Nasdaq Stock Market on August 8, 1997 under the symbol "HYSQ." Prior to that date, there was no established trading market for the common stock. The following table sets forth, for the periods indicated, the high and low bid information for the common stock, as reported by the Nasdaq Stock Market:
HIGH LOW ------- ------ FISCAL 1999: First Quarter............................................. $ 5.19 $ 2.50 Second Quarter............................................ $ 3.56 $ 2.56 Third Quarter............................................. $ 8.38 $ 2.75 Fourth Quarter............................................ $ 20.00 $ 4.00 FISCAL 2000: First Quarter............................................. $139.50 $12.44 Second Quarter............................................ $ 46.88 $17.00 Third Quarter............................................. $ 53.25 $30.25 Fourth Quarter............................................ $ 37.00 $11.25
As of March 1, 2001, there were approximately 182 stockholders of record of our common stock. We have not paid dividends to our stockholders since our inception and we do not plan to pay cash dividends in the foreseeable future. We currently intend to retain earnings, if any, to finance our growth. 26 28 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 1997 1996 -------- -------- -------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENTS OF OPERATIONS DATA: Contract revenues..................... $ 15,604 $ 6,397 $ 9,590 $ 6,199 $ 426 Net loss.............................. $(22,253) $(18,547) $(16,369) $(6,537) $(4,839) Basic and diluted net loss per share............................... $ (1.65) $ (1.43) $ (1.27) $ (0.86) $ (0.91) Shares used in computing basic and diluted net loss per share.......... 13,449 13,004 12,839 7,589 5,344
DECEMBER 31, -------------------------------------------------- 2000 1999 1998 1997 1996 ------- ------- ------- ------- ------ (IN THOUSANDS) BALANCE SHEET DATA: Working capital........................... $(2,577) $22,077 $42,345 $56,824 $5,955 Total assets.................... $21,288 $45,364 $57,914 $66,950 $9,366 Noncurrent portion of capital lease and loan obligations........................ $ 4,722 $ 5,221 $ 4,479 $ 613 $ 791
A factor that affected the comparability of information between 1996 and 1997 was the Company's initial public offering completed in the third quarter of 1997 and private placements in May and August of 1997 in which an aggregate of 4,798,794 shares of common stock were sold for net proceeds of $61.4 million. 27 29 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words including "anticipate," "believe," "intends," "estimates," "expect," "should," "may," "potential" and similar expressions. Such statements are based on our management's current expectations and involve risks and uncertainties. Actual results and performance could differ materially from those projected in the forward-looking statements as a result of many factors discussed herein. Actual results and performance could also differ materially from time to time from those projected in our filings with the Securities and Exchange Commission as a result of certain factors, including those set forth in this section as well as under "Item 1. Business," including "Risk Factors." RESULTS OF OPERATIONS Contract Revenues Comparison of Years Ended December 31, 2000 and 1999. Our contract revenues were $15.6 million for 2000 compared to $6.4 million for 1999. The increase was primarily due to higher revenues earned from our collaboration with BASF as a result of our initiating gene screening services to target potential agricultural products, and completion of the related data center. Processing was at full contractual capacity of approximately 1.0 million clones per month in the second half of 2000. Our collaboration with Chiron was extended for an additional two-year period in May 2000 and requires Chiron to pay a minimum annual research funding payment of $1.0 million, which is being recognized on a straight-line basis over the extension term. Chiron has the right to extend the agreement for one additional two-year period. Our contract revenues earned during 2000 included $11.7 million under our agreement with BASF, $3.3 million under our agreement with Chiron, $0.3 million under our agreement with Kirin and $0.3 million under an agreement that expanded our relationship with Applied Biosystems. Revenues recognized under our agreement with Chiron include a portion of the $1.0 million minimum annual research funding payment received for the first year of the two-year extension. Revenues recognized under our agreement with Kirin represented the completion of the initial phase of the collaboration. Our revenues typically vary from quarter to quarter and may result in significant fluctuations in our operating results from year to year. In the future, we may not be able to maintain existing collaborations, obtain additional collaboration partners or obtain revenue from other sources. The failure to maintain existing collaborations, the inability to enter into additional collaborative arrangements or obtain revenue from other sources could have a material adverse effect on our revenues and operating results. Comparison of Years Ended December 31, 1999 and 1998. Our contract revenues decreased by $3.2 million to $6.4 million in 1999 compared to $9.6 million for 1998. Contract revenues recognized in 1999 included $4.9 million from Chiron and $1.2 million from Kirin. The decrease of $3.2 million was due primarily to a decrease in revenues earned from our collaboration with Chiron during 1999 due to minimum production requirements being higher under the Chiron agreement in 1998, and additionally some of the scheduled requirements for the first half of 1999, and therefore our recognition of that revenue, were accelerated into 1998. Operating Expenses Comparison of Years Ended December 31, 2000 and 1999. Our total operating expenses, consisting of research and development expenses and general and administrative expenses, increased by $12.0 million to $38.3 million for 2000 compared to $26.3 million for 1999. For 2000, our research and development expenses increased by $10.8 million to $29.0 million compared to $18.2 million for 1999. This increase in our research and development expenses was primarily attributable to $5.1 million increase in costs associated with the addition of scientific and bioinformatic personnel, $1.9 million increase in outside contract services, $2.5 million increase in supplies purchases related to our 28 30 collaborations, a $0.6 million write-off of certain capitalized software development costs and an increase in production throughput in our gene discovery and complete gene sequencing programs. Our general and administrative expenses increased $1.2 million to $9.3 million in 2000 compared to $8.1 million in 1999. The increase in general and administrative expenses during 2000 included $0.8 million increase in rent expenses associated with the new leased facilities for laboratory and office expansion which is expected to be occupied during 2001, $0.5 million increase in recruiting and salary expenses, plus increases in legal expenses related to our patent litigation with Affymetrix, and other outside services. We expect operating expenses to increase during 2001 as we plan to continue research and development of our therapeutic protein candidates, expansion of our facilities to support our research and development efforts, further development of SBH technology applications, and efforts related to prosecuting and enforcing our intellectual property rights, including expenses related to our patent litigation with Affymetrix. The magnitude of the increases in our operating expenses will be significantly affected by our ability to secure adequate sources of external financing or additional sources of revenue. If we do not obtain adequate financing or revenue in a timely manner, this could significantly harm our business, financial condition and results of operations, and may require us to delay or eliminate one or more of our research or development programs and/or delay the build out and occupation of our new leased facilities. See "-- Liquidity and Capital Resources." Comparison of Years Ended December 31, 1999 and 1998. Our total operating expenses, consisting of research and development expenses and general and administrative expenses, decreased by $2.4 million to $26.3 million for 1999 compared to $28.7 million for 1998. For 1999, our research and development expenses decreased by $1.0 million to $18.2 million compared to $19.2 million for 1998. Our lower 1999 research and development expenses primarily reflect lower material consumption costs resulting from decreased gene screening activities during our facilities expansion in 1999, partially offset by higher salary expenses, increased depreciation and rental expenses associated with the expansion of our facilities, and increased expenditures related to prosecuting and enforcing our intellectual property rights. For 1999, our general and administrative expenses decreased by $1.4 million to $8.1 million compared to $9.5 million in 1998. The decrease in general and administrative expenses during 1999 resulted primarily from lower legal expenses during this period. Legal expenses decreased, in part, due to delayed activity in our litigation with Affymetrix while awaiting the results of the November 1998 claims construction hearing that the Court released in October 1999. The decrease in legal expenses was partially offset by increased staffing costs and higher costs associated with business development. Interest Income and Expense, Net Comparison of Years Ended December 31, 2000 and 1999. Our interest income and expense, net decreased by $0.8 million to $0.5 million for 2000 compared to $1.3 million for 1999. This decrease in 2000 resulted from lower cash and investment balances held by us and higher interest expense from our increased financing activities. Comparison of Years Ended December 31, 1999 and 1998. Our interest income and expense, net decreased by $1.4 million to $1.3 million for 1999 compared to $2.7 million for 1998. This decrease in 1999 resulted from lower cash and investment balances held by us and higher interest expense from our increased financing activities. Net Loss Since our inception, we have incurred net losses, and as of December 31, 2000, we had an accumulated deficit of $71.9 million. During 2000, we incurred a net loss of $22.3 million as compared to an $18.5 million net loss in 1999 and a net loss of $16.4 million in 1998. We expect to continue to incur significant net losses, 29 31 which may increase substantially as we pursue research and development of our therapeutic protein candidates and other operations, and prosecute and enforce our intellectual property rights. LIQUIDITY AND CAPITAL RESOURCES Cash and Cash Equivalents and Short-Term Investments Comparison of Years Ended December 31, 2000 and 1999. As of December 31, 2000, we had $2.7 million in cash and cash equivalents. These amounts reflect a net decrease of $27.9 million from the $30.6 million in cash, cash equivalents and short-term investments we had as of December 31, 1999. This decrease resulted primarily from $21.0 million of net cash used in operating activities plus $8.3 million investments in equipment and capitalized software. In 2000, we entered into a new facilities lease to accommodate a planned expansion of our biopharmaceutical development efforts. We are currently building this space out to meet our specifications. In order to continue with and complete this build out, we will need to secure additional financing before the end of the 2001 fiscal year. In connection with the execution of this lease, we paid $2.0 million in advance rent and a security deposit of $0.4 million. The advance rent and security deposit are accounted for as a prepaid asset and as other assets, respectively. Lease payments over the eleven-year term of the lease total approximately $42.0 million. In November 2000, we received a commitment from our Chairman to provide a line of credit of up to $20.0 million in aggregate principal amount, secured by a promissory note and available for draw down through November 29, 2002. Amounts outstanding under the line of credit bear interest at prime plus 1% and are payable in 48 equal monthly installments beginning upon the expiration date of November 30, 2002. The promissory note issued pursuant to such line of credit may be converted at our option into shares of our common stock at fair market value on the day we elect such conversion. On March 20, 2001, our Board of Directors decided to complete the draw down of the balance of the $20.0 million available under the line of credit and pay off the outstanding principal balance in shares of our common stock, as provided in the agreement. As a consequence, we issued 2,237,637 shares of common stock to our Chairman in satisfaction of $20.0 million of outstanding principal under the line of credit. See Note 10 of Notes to Consolidated Financial Statements. All of our investments in marketable securities have had maturities of less than one year, have been considered available-for-sale and as such have been classified as short-term investments. We have held our cash equivalents and investments in investment-grade commercial paper, bank certificates of deposit and other interest-bearing securities. We make our investments in accordance with our investment policy. The primary objectives of our investment policy are liquidity, safety of principal and diversity of investments. At December 31, 2000, we did not hold any marketable securities. In addition, we have $2.1 million in restricted cash on deposit as security for a $2.0 million letter of credit in conjunction with a facility lease. Provided that no event of default under the lease occurs, the letter of credit and the cash collateralizing it will be reduced by $0.5 million per year commencing in July 2001. The cash on deposit at any time in conjunction with this letter of credit is restricted and cannot be withdrawn. We control the investment of the cash and receive the interest earned thereon. Cash Used in Operating Activities Comparison of Years Ended December 31, 2000 and 1999. The amount of net cash used by operating activities increased by $8.0 million to $21.0 million in 2000 from $13.0 million in 1999. This increase in cash used for operations in 2000 compared to 1999 was due primarily to increased research and development expenses related to our collaborations, our product candidates and our complete gene sequencing programs, increased scientific personnel headcount and addition of new leased facilities for laboratory and office expansion and payment of advanced rent on our new lease facilities, partially offset by a decrease in accounts receivable and increased amounts received from collaborative partners. 30 32 Comparison of Years Ended December 31, 1999 and 1998. The amount of net cash used in operating activities increased by $1.3 million to $13.0 million during 1999 from $11.7 million in 1998. The increase in cash used for operations for 1999 compared to 1998 was due primarily to a significant increase in our accounts receivables balance, increased expenses related to our complete gene sequencing programs, expansion of our functional genomics and protein purification efforts to support research and development of our therapeutic protein candidates, and efforts related to prosecuting our intellectual property rights. This increase in cash used in operations for 1999 was partially offset by lower spending related to enforcing our intellectual property rights. Cash Provided by Investing Activities Our investing activities, other than purchases and sales of short-term investments, have consisted primarily of capital expenditures. Comparison of Years Ended December 31, 2000 and 1999. Net cash provided by investing activities increased by $5.2 million to $8.7 million in 2000 compared to $3.5 million in 1999. The increase was primarily due to higher net redemptions of short-term investments which were higher in 2000 than 1999, partially offset by higher purchases of equipment used to support our expanding research and development activities and investment in capitalized software. In 2000, all of our short-term investments were reinvested upon maturity into commercial paper with maturities of less than 90 days. Comparison of Years Ended December 31, 1999 and 1998. Net cash provided by investing activities decreased by $1.0 million to $3.5 million for 1999 compared to $4.5 million for 1998. Our capital expenditures slightly decreased in 1999 primarily due to lower expenditures related to the facilities expansion compared to 1998. Offsetting this, our net redemptions of short-term investments were lower in 1999 than in 1998. Cash Provided by Financing Activities Comparison of Years Ended December 31, 2000 and 1999. Net cash provided by financing activities decreased slightly to $1.3 million in 2000 compared to $1.6 million in 1999. The decrease was primarily due to lower proceeds from financing arrangements, partially offset by higher proceeds from employee stock option exercises and higher payments on loan obligations. In 2000, we borrowed the remaining $2.0 million of a $5.0 million asset-backed financing commitment obtained in 1999. Comparison of Years Ended December 31, 1999 and 1998. Net cash provided by financing activities decreased by $4.0 million to $1.6 million for 1999 compared to $5.6 million for 1998. The net cash provided in 1999 was primarily derived from $3.0 million of proceeds we received from asset-backed financing. The financing was partially offset by higher payments on loan obligations. In 1998, the net cash provided by financing activities resulted primarily from our $5.0 million asset-backed financing and higher proceeds from employee stock option exercises. We anticipate that existing capital resources, anticipated cash from existing collaborative partners and commitments will be sufficient to support our current biopharmaceutical research and development and other operations through 2001. However, we plan to seek additional funding prior to that time in order to finance the expansion of our biopharmaceutical research and the build out of our new leased facilities to support such research. If we do not obtain adequate financing or revenue in a timely manner, this could significantly harm our business, financial condition and results of operations, and may require us to delay, scale back or eliminate one or more of our research or development programs, discontinue the build out of our new leased facilities, or relinquish greater or all rights to products at an earlier stage of development or on less favorable terms than we would otherwise seek to obtain, which could materially adversely affect our business, financial condition and operating results. Our future capital requirements and the adequacy of our available funds will depend on many factors, including, but not limited to: - continued scientific progress in our research and development programs, including progress in our research and preclinical studies on our therapeutic protein candidates; 31 33 - the cost involved in our facilities expansion to support research and development of our therapeutic protein candidates; - our ability to attract additional financing on favorable terms; - the magnitude and scope of our research and development programs, including development of therapeutic protein candidates and SBH technology and applications; - our ability to maintain, and the financial commitments involved in, our existing collaborative and licensing arrangements; - our ability to establish new corporate relationships with other biotechnology and pharmaceutical companies to share costs and expertise of identifying and developing product candidates; - the cost of prosecuting and enforcing our intellectual property rights, including our patent litigation with Affymetrix; - the cost of manufacturing material for preclinical, clinical and commercial purposes; - the time and cost involved in obtaining regulatory approvals; - our need to develop, acquire or license new technologies or products; - competing technological and market developments; and - other factors not within our control. We may not be able to secure additional financing to meet our funding requirements on acceptable terms, if at all. If we raise additional funds by issuing equity securities, substantial dilution to our existing stockholders may result. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133), which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In accordance with SFAS 133, an entity is required to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement and requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting. SFAS 133, as amended by SFAS 137 and 138, shall be effective for the Company January 1, 2001. Implementation of SFAS 133, as amended, will not have a material effect on the Company's results of operations or financial position as the Company holds no derivative instruments. ITEM 7A.QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Market Rate Risk We have exposure to changes in interest rates in our short term investments, which are held primarily in money market accounts which earn interest at variable rates. We do not use derivative financial instruments in our investment portfolio. We place our investments with high quality issuers and, by policy, limit the amount of credit exposure to any one issuee. We are averse to principal loss and ensure the safety and preservation of our invested funds by limiting default, market and reinvestment risk. We also have exposure to changes in interest rates in our line of credit with our Chairman, which bears interest at the prime rate plus one percentage point. See Note 10 of Notes to Consolidated Financial Statements. 32 34 Changes in interest rates do not affect interest income on our restricted cash as it is maintained in commercial paper with fixed rates and maturities of less than 90 days. Changes in interest rates do not affect interest expense on our lease obligations as they bear fixed rates of interest. The table below presents the amounts and related interest rates of our short-term investments, restricted cash, lease obligations and line of credit at December 31, 2000:
AVERAGE CARRYING RATE AMOUNT ------- -------------- (IN THOUSANDS) Short-term investments................................ 5.50% $2,699 Restricted cash....................................... 6.42% $2,106 Lease obligation...................................... 11.90% $7,100 Line of credit........................................ N/A% $ --
33 35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Hyseq, Inc.'s financial statements and notes thereto appear on pages 35 to 54 of this Annual Report on Form 10-K.
PAGE NO. ---- Report of KPMG LLP, Independent Auditors.................... 35 Report of Ernst & Young LLP, Independent Auditors........... 36 Consolidated Balance Sheets as of December 31, 2000 and 1999...................................................... 37 Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998.......................... 38 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998.............. 39 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998.......................... 40 Notes to Consolidated Financial Statements.................. 41
34 36 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders of Hyseq, Inc. We have audited the accompanying consolidated balance sheet of Hyseq, Inc. as of December 31, 2000, and the related consolidated statement of operations, stockholders' equity and cash flows for the year then ended. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hyseq, Inc. at December 31, 2000, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP San Francisco, California February 2, 2001 35 37 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders Hyseq, Inc. We have audited the accompanying consolidated balance sheet of Hyseq, Inc. as of December 31, 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1999. 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 auditing standards generally accepted in the United States. 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 consolidated financial position of Hyseq, Inc. at December 31, 1999, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP Palo Alto, California February 2, 2000 36 38 HYSEQ, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION) ASSETS
AT DECEMBER 31, -------------------- 2000 1999 -------- -------- Cash and cash equivalents................................... $ 2,699 $ 13,675 Short-term investments...................................... -- 16,962 Accounts receivable......................................... 22 1,250 Prepaid rent................................................ 2,224 117 Other current assets........................................ 682 994 -------- -------- Total current assets.............................. 5,627 32,998 Cash on deposit............................................. 2,106 2,106 Equipment, leasehold improvements and capitalized software, net....................................................... 12,465 8,427 Patents, licenses and other assets, net..................... 1,090 1,833 -------- -------- Total assets...................................... $ 21,288 $ 45,364 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable............................................ $ 1,979 $ 1,473 Accrued professional fees, related parties.................. -- 119 Accrued professional fees, other............................ 833 1,659 Accrued vacation............................................ 556 237 Other current liabilities................................... 659 343 Deferred revenue............................................ 1,798 5,000 Current portion of capital lease and loan obligations....... 2,379 2,090 -------- -------- Total current liabilities......................... 8,204 10,921 Noncurrent portion of capital lease and loan obligations.... 4,722 5,221 -------- -------- Total liabilities................................. 12,926 16,142 -------- -------- Commitments and contingencies Stockholders' equity: Preferred stock, par value $0.001; 8,000,000 shares authorized; none issued and outstanding as of December 31, 2000 and 1999............................................. -- -- Common stock, par value $0.001; 50,000,000 shares authorized; 13,722,388 and 13,083,242 issued and outstanding as of December 31, 2000 and 1999, respectively.............................................. 14 13 Additional paid-in capital.................................. 80,278 82,450 Notes receivable from stockholders.......................... -- (3,503) Deferred stock compensation................................. (8) (37) Accumulated other comprehensive loss........................ -- (32) Accumulated deficit......................................... (71,922) (49,669) -------- -------- Total stockholders' equity........................ 8,362 29,222 -------- -------- Total liabilities and stockholders' equity........ $ 21,288 $ 45,364 ======== ========
See accompanying Notes to Consolidated Financial Statements. 37 39 HYSEQ, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 -------- -------- -------- Contract revenues.......................................... $ 15,604 $ 6,397 $ 9,590 -------- -------- -------- Operating expenses: Research and development................................. 29,018 18,157 19,207 General and administrative............................... 9,315 8,101 9,495 -------- -------- -------- Total operating expenses......................... 38,333 26,258 28,702 -------- -------- -------- Loss from operations....................................... (22,729) (19,861) (19,112) Interest income............................................ 1,347 2,004 2,919 Interest expense........................................... (871) (690) (176) -------- -------- -------- Net loss................................................... $(22,253) $(18,547) $(16,369) ======== ======== ======== Basic and diluted net loss per share....................... $ (1.65) $ (1.43) $ (1.27) ======== ======== ======== Weighted average shares used in computing basic and diluted net loss per share....................................... 13,449 13,004 12,839 ======== ======== ========
See accompanying Notes to Consolidated Financial Statements. 38 40 HYSEQ, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS)
NOTES ACCUMULATED COMMON STOCK ADDITIONAL RECEIVABLE OTHER --------------- PAID-IN FROM DEFERRED COMPREHENSIVE ACCUMULATED SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION LOSS DEFICIT ------ ------ ---------- ------------ ------------ ------------- ----------- BALANCE AT DECEMBER 31, 1997............ 12,734 $13 $81,782 $(3,658) $(445) $ (6) $(14,749) Cash payments of note receivable from stockholders.......................... -- -- -- 155 -- -- -- Issuance of common stock upon exercise of stock option grants................ 24 -- 46 -- -- -- -- Issuance of common stock upon cashless exercise of warrants.................. 173 -- 500 -- -- -- -- Amortization of deferred compensation... -- -- -- -- 319 -- -- Cost to repurchase stock for ESPP....... -- -- -- -- -- -- (4) Comprehensive loss: Net loss.............................. -- -- -- -- -- -- (16,369) Other comprehensive income (loss)..... -- -- -- -- -- (8) -- Comprehensive loss...................... ------ --- ------- ------- ----- ---- -------- BALANCE AT DECEMBER 31, 1998............ 12,931 $13 $82,328 $(3,503) $(126) $(14) $(31,122) ====== === ======= ======= ===== ==== ======== Issuance of common stock upon exercise of stock options and under ESPP....... 152 -- 122 -- -- -- -- Amortization of deferred compensation... -- -- -- -- 89 -- -- Comprehensive loss: Net loss.............................. -- -- -- -- -- -- (18,547) Other comprehensive income (loss)..... -- -- -- -- -- (18) -- Comprehensive loss...................... ------ --- ------- ------- ----- ---- -------- BALANCE AT DECEMBER 31, 1999............ 13,083 $13 $82,450 $(3,503) $ (37) $(32) $(49,669) ====== === ======= ======= ===== ==== ======== Issuance of common stock upon exercise of stock options and under ESPP....... 560 1 1,481 -- -- -- -- Issuance of common stock upon cash exercise of warrants.................. 1 -- 6 -- -- -- -- Issuance of common stock upon cashless exercise of warrants.................. 149 -- -- -- -- -- -- Compensation expense related to SAB option grants......................... -- -- 157 -- -- -- -- Notes receivable from stockholders repaid by surrendering shares of stock................................. (71) -- (3,816) 3,503 -- -- -- Amortization of deferred compensation... -- -- -- -- 29 -- -- Comprehensive loss: Net loss.............................. -- -- -- -- -- -- (22,253) Other comprehensive income (loss)..... -- -- -- -- -- 32 -- Comprehensive loss...................... ------ --- ------- ------- ----- ---- -------- BALANCE AT DECEMBER 31, 2000............ 13,722 $14 $80,278 $ -- $ (8) $ -- $(71,922) ====== === ======= ======= ===== ==== ======== TOTAL STOCKHOLDERS' EQUITY ------------- BALANCE AT DECEMBER 31, 1997............ $ 62,937 Cash payments of note receivable from stockholders.......................... 155 Issuance of common stock upon exercise of stock option grants................ 46 Issuance of common stock upon cashless exercise of warrants.................. 500 Amortization of deferred compensation... 319 Cost to repurchase stock for ESPP....... (4) Comprehensive loss: Net loss.............................. (16,369) Other comprehensive income (loss)..... (8) -------- Comprehensive loss...................... (16,377) -------- BALANCE AT DECEMBER 31, 1998............ $ 47,576 ======== Issuance of common stock upon exercise of stock options and under ESPP....... 122 Amortization of deferred compensation... 89 Comprehensive loss: Net loss.............................. (18,547) Other comprehensive income (loss)..... (18) -------- Comprehensive loss...................... (18,565) -------- BALANCE AT DECEMBER 31, 1999............ $ 29,222 ======== Issuance of common stock upon exercise of stock options and under ESPP....... 1,482 Issuance of common stock upon cash exercise of warrants.................. 6 Issuance of common stock upon cashless exercise of warrants.................. -- Compensation expense related to SAB option grants......................... 157 Notes receivable from stockholders repaid by surrendering shares of stock................................. (313) Amortization of deferred compensation... 29 Comprehensive loss: Net loss.............................. (22,253) Other comprehensive income (loss)..... 32 -------- Comprehensive loss...................... (22,221) -------- BALANCE AT DECEMBER 31, 2000............ $ 8,362 ========
See accompanying Notes to Consolidated Financial Statements. 39 41 HYSEQ, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss................................................. $(22,253) $(18,547) $(16,369) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of patents and licenses............................................ 3,095 2,876 1,691 Stock compensation expense............................ 157 -- -- Amortization of deferred stock compensation........... 29 89 319 Non-cash change in deferred revenue................... (11,954) -- -- Loss on disposal of assets............................ 578 -- -- Realized gain (loss) on short-term investments........ -- (18) (8) Changes in operating assets and liabilities: Accounts receivable................................... 1,228 (599) 1,535 Prepaid rent.......................................... (2,107) (11) (27) Other current assets.................................. 17 18 (187) Intangible and other assets........................... (639) (1,158) (94) Deferred revenue...................................... 10,666 5,000 -- Accounts payable...................................... 506 (432) 334 Accrued professional fees............................. (945) 203 991 Accrued vacation...................................... 319 (39) (109) Other current liabilities............................. 316 (406) 227 -------- -------- -------- Net cash used in operating activities............ (20,987) (13,024) (11,697) -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment...................... (8,269) (4,374) (4,581) Purchases of short-term investments...................... (57,101) (16,382) (44,511) Maturities of short-term investments..................... 74,095 24,300 53,561 Proceeds from sale of fixed assets....................... 9 -- -- -------- -------- -------- Net cash provided by investing activities........ 8,734 3,544 4,469 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from financing arrangements..................... 2,073 3,001 5,324 Payment on capital lease and loan obligations............ (2,283) (1,523) (442) Repurchases of common stock.............................. -- (115) (4) Payment of stockholder notes receivable.................. -- -- 155 Proceeds from issuance of common stock, net of issuance costs................................................. 1,487 237 546 -------- -------- -------- Net cash provided by financing activities........ 1,277 1,600 5,579 -------- -------- -------- Net decrease in cash....................................... (10,976) (7,880) (1,649) Cash and cash equivalents at beginning of year............. 13,675 21,555 23,204 -------- -------- -------- Cash and cash equivalents at end of year................... $ 2,699 $ 13,675 $ 21,555 ======== ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid............................................ $ 868 $ 690 $ 176 ======== ======== ======== Noncash investing and financing activities: Cashless exercise of stock options.................... $ 687 $ -- $ 74 -------- -------- -------- Cashless exercise of warrants......................... $ 745 $ 206 $ -- -------- -------- --------
See accompanying Notes to Consolidated Financial Statements. 40 42 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization Hyseq, Inc. (the Company or Hyseq) was established in August 1992 as an Illinois corporation and subsequently reincorporated as a Nevada corporation on November 12, 1993. The Company's wholly-owned subsidiary, Hyseq Diagnostics, Inc., was formed as a Nevada corporation on July 18, 1995. The Company's other wholly-owned subsidiary, GeneSolutions Inc., was formed as a Nevada corporation on July 23, 1999. Hyseq researches and develops biopharmaceutical products from its collection of novel genes discovered using its high-throughput screening platform, related to its proprietary sequencing-by-hybridization (SBH) technology. Hyseq has collaborations for discovering gene-based products and for commercializing SBH technology applications. Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of the Company's wholly-owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash, Cash Equivalents and Short-Term Investments The Company considers all highly liquid investments with original maturities of up to 90 days to be cash equivalents. Investments with maturities of less than one year from the balance sheet date and with original maturities greater than 90 days are considered short-term investments. Investments consist primarily of money market accounts, commercial paper, certificates of deposit and other short-term instruments. This is consistent with the Company's policy to maintain high liquidity and ensure safety of principal. The Company's short-term investments are classified as available-for-sale. Available-for-sale securities are carried at fair value based on quoted market prices, with the unrealized gains and losses, net of tax, included in accumulated other comprehensive loss in stockholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income and expense. Interest and dividends on securities classified as available-for-sale are included in interest income. The cost of securities sold is based on the specific identification method. At December 31, 2000, the Company did not hold any short-term investments. Equipment, Leasehold Improvements and Capitalized Software Equipment, leasehold improvements and capitalized software are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives ranging from three to five years, except that leasehold improvements are amortized over the shorter of the remaining life of the lease or the life of the improvement. 41 43 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Revenue Recognition Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. Revenues related to collaborative research agreements and government grants are generally recognized over the related funding periods for each contract as the services are performed. Nonrefundable up-front payments received in connection with collaborative research agreements where the Company has no continuing performance obligation are recognized when receivable. When a continuing performance obligation exists, these revenues are deferred and recognized over the relevant periods of service, generally the research term. Revenues from collaborative agreements representing 10% or more of total revenue are as follows:
YEAR ENDED DECEMBER 31, ------------------------- 2000 1999 1998 ----- ----- ----- Source: BASF Plant Sciences GmbH.................................. 75% * * Chiron Corporation........................................ 21% 76% 84% Kirin Brewery Co. Ltd..................................... * 19% 16%
- --------------- * less than 10% In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." This statement gives specific guidance and clarification on the conditions that must be met before an entity may recognize revenue. The implementation of SAB 101 should be accounted for as a cumulative effect of a change in accounting principle pursuant to APB 20. In March 2000, the SEC issued SAB 101A to defer the effective date of implementation of SAB 101. In June 2000, the SEC issued SAB 101B to defer further the effective date of implementation of SAB 101 with earlier application encouraged. The Company adopted SAB 101 as of December 31, 1999. The implementation of SAB 101 did not have a material effect on the Company's results of operations and financial position. Revenues by Geographic Area Revenues by geographic area are based on customers' country of domicile rather than customer's shipping locations:
YEAR ENDED DECEMBER 31, --------------------------- 2000 1999 1998 ------- ------ ------ (IN THOUSANDS) Revenues: Domestic.............................................. $ 3,639 $5,178 $8,090 Germany............................................... 11,665 19 -- Japan................................................. 300 1,200 1,500 ------- ------ ------ Total revenues................................ $15,604 $6,397 $9,590 ======= ====== ======
Stock-Based Compensation In accordance with the provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation" the Company has elected to account for stock-based compensation to employees under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and its related interpretations, and to adopt the "disclosure only" 42 44 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) alternative described in SFAS No. 123. Stock options granted to non-employees are accounted for in accordance with SFAS No. 123. Research and Development Research and development costs are expensed to operations as incurred and include costs related to the Company's collaborations. Collaboration related costs of approximately $10.4 million, $7.0 million and $10.7 million were recorded in 2000, 1999 and 1998, respectively. Net Loss per Share Basic and diluted net loss per share are presented in conformity with the Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share" for all periods presented. In accordance with SFAS No. 128, basic and diluted net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period. In 2000, 1999 and 1998, outstanding options and warrants of 1,513,000, 369,000 and 728,000 shares, respectively, (as determined using the treasury stock method) were not included as they were antidilutive. Segment Reporting To date, the Company has viewed its operations as principally one segment. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker in making decisions how to allocate resources and assess performance. The Company's chief operating decision maker is the Chief Executive Officer. As a result, the financial information disclosed herein materially represents all of the financial information related to the Company's principal operating segment. Reclassification Certain prior year amounts have been reclassified to conform to current year presentation. 2. EQUIPMENT, LEASEHOLD IMPROVEMENTS AND CAPITALIZED SOFTWARE Equipment, leasehold improvements and capitalized software, net consist of the following (in thousands):
DECEMBER 31, ------------------ 2000 1999 ------- ------- Machinery, equipment and furniture....................... $ 8,535 $ 6,336 Computers and capitalized software....................... 7,633 4,991 Leasehold improvements................................... 5,191 2,901 ------- ------- 21,359 14,228 Less: accumulated depreciation........................... (8,894) (5,801) ------- ------- Equipment, leasehold improvements and capitalized software, net.......................................... $12,465 $ 8,427 ======= =======
Depreciation expense totaled $3.1 million, $2.8 million and $1.6 million for the years ended December 31, 2000, 1999 and 1998, respectively. Equipment and leasehold improvements at December 31, 2000 and 1999 include items under capitalized leases in the amount of $0.7 million and $0.6 million, respectively, and related accumulated depreciation of $0.5 million and $0.4 million at December 31, 2000 and 1999, respectively. These leases are secured by the equipment leased thereunder. During 2000, there were write-offs 43 45 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) of certain capitalized software totaling $0.6 million. These write-offs are included in research and development expenses in the accompanying Statement of Operations. 3. ACCUMULATED OTHER COMPREHENSIVE LOSSES Accumulated other comprehensive income or loss consists entirely of unrealized gains and losses on securities. The change in accumulated other comprehensive income (loss) was $32,000, ($18,000) and ($8,000) in 2000, 1999 and 1998, respectively. This change consisted entirely of unrealized gains (losses) on securities. 4. PATENTS, LICENSES AND OTHER ASSETS Patents and Licenses Patent costs are incurred in connection with obtaining certain patents and filing of related patent applications. Patent and license amortization expense was $27,633, $27,633 and $65,133 for the years ended December 31, 2000, 1999 and 1998, respectively. Patent amortization expense is recorded on a straight-line basis over the patent's estimated useful life which approximates 17 years. Patent License Agreement In 1994, the Company entered into a patent license agreement with an affiliate of the University of Chicago for an exclusive license to use certain proprietary technology developed by the Company's Chief Scientific Officer and to develop, use, and sell licensed products or processes. The Company issued 15,244 shares of Series A preferred stock (which converted to common stock in connection with the Company's initial public offering in 1997). The Company began paying minimum royalties of $25,000 per annum beginning in 1997 and increasing to $100,000 per annum in 1999, and will continue to pay minimum royalties at the rate of $100,000 per annum over the term of the agreement, which terminates upon the later to occur of (a) fifteen years after the date of the agreement or (b) the expiration of the last-to-expire patents of the licensed patent rights. 5. CAPITAL LEASE AND LOAN OBLIGATIONS The Company has financed equipment purchases through capital lease and loan agreements. The capital lease and loan obligations are to be repaid over terms of 48 to 60 months at interest rates ranging from 8.10% to 14.98% and are secured by the related equipment. Future minimum payments under the capital lease and loan agreements are as follows (in thousands): YEARS ENDING DECEMBER 31: 2001..................................................... $ 3,105 2002..................................................... 2,938 2003..................................................... 1,432 2004..................................................... 871 2005..................................................... 198 ------- Total loan payments.............................. 8,544 Less: Amount representing interest....................... (1,443) ------- Present value of future loan payments...................... 7,101 Less: Current portion.................................... (2,379) ------- Noncurrent portion......................................... $ 4,722 =======
44 46 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. COMMITMENTS AND CONTINGENCIES Operating Leases The Company leases two facilities under operating lease agreements that expire in June 2005. One of the leases has a five-year renewal option, which if exercised, would extend the lease to 2010. In June 2000 the Company leased an additional approximately 59,000 square feet of space at 225, 249 and 257 Humbolt Court in Sunnyvale, California, approximately one mile from our current operating facilities. The lease on this new space requires base lease payments on average of approximately $317,000 per month and extends through July 2011. Rental expense was approximately $2.1 million in 2000, $1.4 million in 1999, $1.1 million in 1998. The leases provide for scheduled rent increases annually over the terms of the leases. The rent is being recognized as expense on a straight-line basis. Minimum future rental commitments under non-cancelable operating leases at December 31, 2000 are as follows (in thousands):
MINIMUM RENTAL COMMITMENTS -------------- YEAR ENDED DECEMBER 31, 2001................................................ $ 4,674 2002................................................ 4,885 2003................................................ 5,103 2004................................................ 5,328 2005................................................ 4,717 2006 and thereafter................................. 20,971 ------- $45,678 =======
Letter of Credit In accordance with the terms of a facility lease agreement signed in the fourth quarter of 1997, the Company was required to obtain an irrevocable standby letter of credit in the amount of $2.0 million as partial security for the Company's lease obligations. In connection with obtaining the letter of credit, the Company was required to place $2.1 million restricted cash on deposit with the Company's primary bank as security for the letter of credit. Provided that no event of default under the lease has occurred, the letter of credit and the cash collateralizing it will be reduced by $0.5 million commencing in July 2001 and will be further reduced by $0.5 million each year thereafter. The cash on deposit at any time in conjunction with this letter of credit is restricted and cannot be withdrawn. The Company controls the investment of the cash and receives interest earned thereon. Contingencies On March 3, 1997, the Company sued Affymetrix, Inc. in the U.S. District Court for the Northern District of California, San Jose Division, alleging infringement by Affymetrix of its U.S. Patent Nos. 5,202,231 and 5,525,464 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C 97-20188 RMW (PVT)) (Hyseq I). On May 5, 1997, the Company filed an Amended Complaint. On December 9, 1997, the Company filed a second lawsuit against Affymetrix alleging infringement by Affymetrix of its U.S. Patent No. 5,695,940 (Hyseq, Inc. v. Affymetrix, Inc., Case No. C-97 4469 THE) (Hyseq II). On April 22, 1998 the two cases were consolidated before Judge Ronald M. Whyte. The consolidated suits allege that Affymetrix willfully infringed, and continues to infringe, the Company's patents covering SBH technology. Through the lawsuit, the Company seeks both to enjoin Affymetrix from infringing its patents covering SBH technology and an award of monetary damages for Affymetrix' past 45 47 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) infringement. On May 19, 1997, Affymetrix filed an Answer and Affirmative Defenses to the First Amended Complaint in Hyseq I and also filed a counterclaim against the Company. The counterclaim seeks a declaratory judgment of invalidity and non-infringement with respect to the two patents asserted in Hyseq I. On September 9, 1997, the Company filed a reply to the counterclaim in which it denied the allegations of invalidity and non-infringement. A similar answer and counterclaim was filed by Affymetrix in Hyseq II on December 28, 1997, and a similar reply to the counterclaim was filed by the Company on January 29, 1998. On August 1, 1997 (Hyseq I), and on March 28, 1998 (Hyseq II), initial case management conferences were held in each case in which the Court entered a pre-trial schedule. The Court held a claims construction hearing on November 17 and 18, 1998 in Hyseq I and II. On July 12, 1999, Affymetrix filed an amended answer and counterclaim alleging the additional defense that the patents were obtained through inequitable conduct. On October 27, 1999, the Court issued a claims construction Order construing terms in the claims of the patents-in-suit and inviting the parties to submit briefs setting forth any perceived errors or inconsistencies in the Order. Affymetrix and the Company submitted briefs on December 17 and 27, 1999, respectively. On January 7, 2000, the Court held a further Case Management Conference. On February 22, 2000, the Court received oral argument from the parties regarding the claims construction Order. On July 27, 2000, the Court issued a modified claims construction Order. Affymetrix and the Company are currently engaged in pretrial discovery during which documents and other written discovery are being exchanged and depositions are being taken. While the Company believes it has asserted valid claims and has meritorious defenses to the counterclaims, this litigation is at an early stage and there can be no assurance that the Company will prevail in these actions. On August 18, 1998, Affymetrix filed suit against the Company in the U.S. District Court for the Northern District of California, San Francisco Division, alleging that the Company infringed two of Affymetrix' U.S. Patents Nos. 5,795,716 and 5,744,305 (Affymetrix, Inc. v. Hyseq, Inc., Case No. C 98-13192). Affymetrix filed an amended complaint on September 1, 1998 alleging infringement of its U.S. Patent No. 5,800,992. The case was reassigned to Judge Jeremy Fogel in the San Jose Division. At the time of the assignment to Judge Fogel, the case was also renumbered as Case No. C 99-21163 JF (MEJ). A Case Management Conference before Judge Fogel was held on July 10, 2000. A claims construction hearing was held November 29 - 30, 2000 with respect to U.S. Patents Nos. 5,445,934, 5,744,305, 5,800,992 and 5,795,716. The Court issued an Order on January 22, 2001 construing certain claim terms and requesting additional briefing regarding U.S. Patent No. 5,800,992. The Company believes that Affymetrix' allegations are without merit and intends to vigorously defend the action. However, the litigation is at a very early stage and it is impossible to predict the ultimate outcome of this matter. On October 26, 1999, the Company filed a third lawsuit against Affymetrix in the U.S. District Court for the Northern District of California, San Francisco Division (Hyseq, Inc. v. Affymetrix, Inc., Case No. C-99 4735 MJJ) (Hyseq III), alleging infringement by Affymetrix of its U.S. Patent No. 5,972,619 ('619 Patent). The Company also alleges that Affymetrix' U.S. Patent No. 5,795,716 is invalid because the subject matter was first invented by the Company's scientists and is claimed and covered by its '619 Patent. Affymetrix filed an answer and counterclaim on November 15, 1999. The counterclaim seeks a declaratory judgment of invalidity, unenforceability and non-infringement with respect to the Company's '619 Patent. On December 9, 1999, the Company filed a reply to the counterclaim in which it denied the allegations of invalidity, unenforceability, and non-infringement. Subsequently, Hyseq III was reassigned to Judge Fogel and was given Case No. C-00-20050 JF/PVT. A Case Management Conference was held on July 10, 2000 along with Affymetrix, Inc. v. Hyseq, Inc. On September 6, 2000, the Company filed a motion seeking the Court's permission to supplement its complaint in Hyseq III to add a claim for infringement by Affymetrix of its U.S. Patent No. 6,018,041 ('041 patent), which was issued on January 25, 2000. On November 2, 2000, Judge Fogel granted the motion. On October 12, 2000, Affymetrix filed an Ex Parte application before Judges Fogel and Whyte requesting reassignment of the Company's infringement claims under the '619 patent from Judge Fogel to Judge Whyte. On November 2, 2000, Judges Fogel and Whyte reassigned the Company's 46 48 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) infringement claims against Affymetrix under the '619 patent (as well as its infringement claims against Affymetrix under the '041 patent) to Judge Whyte, and ordered that the claim construction of the '619 patent claims would proceed before Judge Whyte. On March 20, 2001, the Court issued a tentative Claims Construction Order construing terms in the '619 patent. In the Order, Judge Whyte indicated that the tentative order will be adopted as the Claims Construction Order unless one of the parties files a written request for a hearing within 15 days. On January 20, 2001, the USPTO Board of Patent Appeals and Interferences declared an interference between one of the Company's pending patent applications covering subject matter related to SBH technology and Affymetrix' issued patent no. 5,795,716 (Chee and Lipshutz v. Drmanac and Crkvenjakov). The Company is the senior party to the interference. The Company has incurred substantial costs and expended substantial personnel time in asserting its patent rights and defending its technology against Affymetrix and may continue to incur such costs in asserting its patent rights and defending its technology against Affymetrix or others. There can be no assurance that the Company will be successful in these efforts. Failure to successfully enforce the Company's patent rights or the loss of these patent rights covering SBH technology could remove a legal obstacle to competitors in designing platforms with similar competitive advantages. 7. COLLABORATIVE AGREEMENTS In December 1999, the Company entered into a collaboration with American Cyanamid Company in which the Company uses its screening-by-hybridization technology to target agricultural products. During 2000, BASF Aktiengesellschaft acquired the crop protection business of American Cyanamid Company and subsequently assigned our collaboration with American Cyanamid to BASF Plant Sciences GmbH (BASF). The collaboration provides for funding of $60 million over its initial term of three and one half years. The collaboration can be extended by mutual agreement for up to four additional one-year terms. Subject to compliance with the terms of the contract, the Company expects to recognize revenue from this collaboration over the term of the agreement as services are performed. Total revenue recognized in 2000 under the agreement was $11.7 million. BASF has the exclusive right to commercialize any agricultural products resulting from the collaboration. The Company will receive royalties on any such products. The agreement requires the Company to generate data at a specified level per year that, if not met, could result in its breach of the agreement. In October 1998, the Company entered into a collaboration with Kirin Brewery Co. Ltd. (Kirin), in which the Company used its proprietary gene discovery technologies to target novel genes relating to a specific growth factor activity from certain cell lines provided by Kirin. The Company retains exclusive rights to develop and market pharmaceutical products resulting from the collaboration in North America, subject to milestone and royalty payments to Kirin. Kirin retains equivalent rights and obligations in Asia and Oceania. The Company and Kirin share such rights equally in Europe and the rest of the world. Under the terms of the agreement, Kirin paid the Company $3.0 million for the initial phase of the collaboration. Total revenue recognized in 2000, 1999 and 1998 under the agreement was $0.3 million, $1.2 million and $1.5 million, respectively. The agreement has been extended through March 2001. In May 1997, the Company entered into an exclusive collaboration with Chiron Corporation (Chiron). Pursuant to the terms of the collaboration agreement, the Company and Chiron are collaborating to develop solid tumor therapeutics, diagnostic molecules and vaccines. The collaboration had an initial term of three years and has been extended by Chiron for an additional two-year period. Chiron may extend the collaboration for one more two-year period. Chiron has the exclusive right to commercialize solid tumor therapeutics, diagnostic molecules and vaccines resulting from the collaboration. The Company will receive royalties on any such products. Concurrently with execution of the collaboration agreement in 1997, Chiron made an equity investment of $5.0 million in return for shares of the Company's preferred stock, which subsequently 47 49 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) converted into common stock upon the Company's initial public offering in 1997. Chiron also purchased shares of common stock directly from the Company in a private placement concurrent with the Company's initial public offering in 1997 for an aggregate purchase price of $2.5 million. Total revenue recognized in 2000, 1999, and 1998 under the agreement with Chiron was $3.3 million, $4.9 million, and $8.1 million, respectively, which the Company received as research funding payments and recognized as revenue as earned. The Company has no future performance obligations related to the revenue recognized in 2000, 1999 and 1998 and no portions of such revenues are refundable. In May 1997, the Company entered into an agreement with the Applied Biosystems Group of Applera Corporation (Applied Biosystems) to combine certain of the Company's chip technology and Applied Biosystems' life science system capabilities to commercialize the HyChip system. Pursuant to the terms of the agreement, the Company committed $5.0 million to further development of the Company's "chip" component of the HyChip system. The Company spent approximately $2.0 million for the development of the chip component of the HyChip system from June 1997 through December 1997. Of this amount, $0.5 million was reimbursed to the Company under its NIST grant. As of December 31, 1998, the Company had satisfied the $5.0 million obligation under its agreement with Applied Biosystems. The collaboration has an initial term of five years and will be extended automatically thereafter unless the parties mutually agree to terminate the collaboration. Pursuant to the agreement, the design, development and manufacture of the HyChip "chip" is under the direction of the Company, while design, development, manufacture and marketing of the system is under the direction of Applied Biosystems. The HyChip system will be distributed through Applied Biosystems. In June 1997 Applied Biosystems made an equity investment of $5.0 million in return for shares of the Company's preferred stock, which subsequently converted into common stock upon the Company's initial public offering in 1997. Applied Biosystems also purchased shares of common stock directly from the Company in a private placement concurrent with the initial public offering in 1997 for an aggregate purchase price of $5.0 million. The Company recognized approximately $0.3 million in revenue in each of 2000 and 1999 from Applied Biosystems from research funding reimbursement under the collaboration and from an expansion of the existing relationship as services were performed. In February 1998, the Company entered into a collaborative agreement with the University of California San Francisco (UCSF) to conduct research on genes that may have important roles in the development of cardiovascular and related diseases. Under the terms of the five-year agreement, the Company makes quarterly payments of approximately $0.1 million to UCSF in connection with the agreement to reimburse UCSF for direct and indirect expenses incurred in clinical sample collection and for research conducted. 8. STOCKHOLDERS' EQUITY Preferred Stock The Company is authorized to issue 8,000,000 shares of preferred stock. The Company's Board of Directors may set the rights and privileges of any preferred stock issued. As of December 31, 2000 and 1999, there were no issued and outstanding shares of preferred stock. On June 5, 1998, Hyseq's Board of Directors adopted a rights plan and declared a dividend with respect to each share of common stock then outstanding. This dividend took the form of a right that entitles the holders to purchase one one-thousandth of a share of our Series B Junior Participating Preferred Stock at a purchase price of $175, subject to adjustment from time to time. These rights have also been issued in connection with each share of common stock issued after June 5, 1998. The rights are exercisable only if a person or entity or affiliated group of persons or entities acquires, or has announced its intention to acquire, 15% (27.5% in the case of certain approved stockholders) or more of the Company's outstanding common stock. The adoption of the rights plan makes it more difficult for a third party to acquire control of the Company without the approval of the Board of Directors. 48 50 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Common Stock In January 2000, a former officer of the Company repaid two promissory notes, which were recorded as a reduction to stockholders' equity, plus accrued interest totaling $2,003,624. The notes were repaid by surrendering to the Company approximately 56,000 shares of common stock that were cancelled. In February 2000, a former officer and director of the Company repaid two promissory notes, which were recorded as a reduction to stockholders' equity, plus accrued interest totaling $1,811,208. The notes were repaid by surrendering to the Company approximately 15,000 shares of common stock that were cancelled. Deferred Compensation The Company recorded deferred compensation of $695,000 in 1997 representing the difference between the issuance and exercise prices related to stock awards and options and the fair value for financial reporting purposes of the Company's common stock. The deferred compensation is being amortized to expense over the vesting period of the options and over the two-year repurchase period for the stock awards. The deferred compensation expense was $29,000, $89,000, and $319,000 in 2000, 1999, and 1998, respectively. At December 31, 2000, the deferred compensation balance was approximately $8,000. Warrants As of December 31, 2000, warrants to purchase 312,881 shares of common stock were outstanding at exercise prices ranging from $3.42 to $5.21 ($3.79 weighted average exercise price) per share. These warrants are held by certain investors and executive officers and expire at various times between November 2001 and July 2002. Stock Option Plans In 1995, the Company's stockholders adopted the 1995 Employee Stock Option Plan (1995 Plan). The Company initially reserved a total of 1,152,000 common shares for issuance under the 1995 Plan. At the 1998 annual meeting, the Company's stockholders approved a proposal to increase the number of shares authorized for issuance under the Plan to 2,152,000. Options granted under the 1995 Plan may be either incentive stock options or nonstatutory stock options. Incentive stock options may be granted to employees with exercise prices of not less than fair value and nonstatutory options may be granted to employees at exercise prices of not less than par value of the common stock on the date of grant as determined by the board of directors. Options vest as determined by the board of directors (generally in four equal annual installments commencing one year after the date of grant), and expire 10 years from the date of grant. At December 31, 2000, 1,181,518 options were outstanding under the 1995 Plan. The Company granted options to purchase common stock to several key employees, directors, scientific advisory board members and scientists prior to adoption of the 1995 Plan. Each option gives the holder the right to purchase common stock at prices between $0.78 and $1.82 per share. In 1998, the Company granted options outside of any of the Company's stock option plans to purchase a total of 9,500 shares of common stock to three non-employee directors and a scientific advisory board member at prices between $4.75 and $10.06 per share. The options vest over periods up to four years. In February 2000, an officer and director of the Company was granted an option to purchase 1,000,000 shares of common stock at $31.69 per share, the closing price on the day prior to the grant, as an inducement to become an employee of the Company. This option becomes exercisable one-third upon the date of grant, one-third on the one-year anniversary and one third on the two-year anniversary of the date of grant. As of December 31, 2000, 1,276,946 options issued outside of any of the Company's stock option plans were outstanding. In 1997, the Company's stockholders adopted the Non-Employee Director Stock Option Plan (Directors Plan) providing for periodic stock option grants to non-employee directors of the Company. Under the 49 51 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Directors Plan, each new, non-employee director receives a one-time grant of options to purchase 23,040 shares of common stock, of which options to purchase 11,520 shares vest immediately, with the balance vesting in two equal allotments on the first and second anniversaries of joining the Board. All non-employee directors automatically receive options to purchase up to 5,760 shares each year (such that the amount received under the Directors Plan when added to all prior options granted to a director which vest in that year total 5,760) on the date of the annual meeting of the stockholders commencing in 1997. Options under the Directors Plan are granted at the fair market value of the Company's common stock on the date of the grant. In 2000, the Company's stockholders approved an amendment to the Directors Plan that changed the method for determining the number of shares granted under the Plan, and lengthened the vesting date for the new director's initial and first annual grants of options. Under the amendment, the number of shares that are granted will be equal to the lesser of the number determined by dividing $200,000 by the fair market value of our common stock on the date of grant, or 10,000 shares. The amendment also revised the vesting date for initial options that are granted when a new director joins our Board such that 50% of a new director's option will vest one year after the grant date and the other 50% will vest two years after the grant date. A total of 138,240 shares of common stock have been reserved for issuance under the Directors Plan, of which options to purchase 102,915 shares were outstanding at December 31, 2000. In 1999, the Company adopted a Scientific Advisory Board/Consultants Stock Option Plan (SAB Plan), which provides for periodic grants of non-qualified stock options to members of the Company's scientific advisory board and allows the Board of Directors to approve grants of stock options to consultants. A total of 30,000 shares of common stock have been reserved for issuance under the SAB Plan, of which options to purchase 5,000 shares were outstanding at December 31, 2000. The Company recorded compensation expense of $157,000 in accordance with SFAS 123 for stock options issued to non-employees during 2000, all of which became exercisable on the date of grant. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: 10 years for the expected life of the option, 6.2% risk-free interest rate, and 1.11 volatility rate. The Directors Plan, the 1995 Plan, and the options granted to an officer and director to purchase 1,000,000 shares (as described above) provide for the acceleration of vesting of options upon certain specified events. The Company values employee stock options using the intrinsic method of APB 25, rather than the fair value method of SFAS 123. Nevertheless, the Company is required for purposes of comparison to present net loss and loss per share on a pro forma basis as if the fair value method had been used. The fair value for employee stock options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
YEAR ENDED DECEMBER 31, ------------------------------------- 2000 1999 1998 --------- --------- --------- Volatility....................................... 1.38 1.64 .77 Risk-free interest rate.......................... 6.14% 6.25% 4.8% Dividend yield................................... -- -- -- Expected life of option.......................... 2.6 years 2.5 years 2.3 years
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 50 52 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Because SFAS 123 is applicable only to options granted subsequent to December 15, 1994, the pro forma adjustment to net income was not fully reflected until fiscal year 1999. The Company's pro forma information follows (in thousands, except for per share information):
YEAR ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 -------- -------- -------- Net loss as reported............................... $(22,253) $(18,547) $(16,369) Pro forma net loss................................. (42,717) (19,484) (16,896) Basic and diluted net loss per share as reported... (1.65) (1.43) (1.27) Pro forma basic and diluted net loss per share..... (3.18) (1.50) (1.31)
A summary of the Company's stock option activity, and related information follows:
YEAR ENDED DECEMBER 31, -------------------------------------------------------------------------- 2000 1999 1998 ---------------------- ---------------------- ---------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE --------- --------- --------- --------- --------- --------- Options outstanding at beginning of period... 1,779,324 $ 3.80 1,583,558 $4.03 1,356,941 $3.88 Options granted....... 1,500,275 $31.80 776,720 $3.77 424,780 $5.87 Options exercised..... (562,722) $ 3.29 (144,466) $1.96 (39,138) $3.17 Options canceled...... (150,498) $ 7.19 (436,488) $5.18 (159,025) $7.91 --------- ------ --------- ----- --------- ----- Options outstanding at end of period......... 2,566,379 $20.10 1,779,324 $3.80 1,583,558 $4.03 ========= ====== ========= ===== ========= =====
The following table summarizes information about stock options outstanding and exercisable at December 31, 2000:
OPTIONS OUTSTANDING --------------------------------------------- OPTIONS EXERCISABLE WEIGHTED- -------------------------- AVERAGE WEIGHTED- WEIGHTED- RANGE OF NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE EXERCISE PRICE SHARES CONTRACTUAL LIFE EXERCISE PRICE SHARES EXERCISE PRICE - ---------------- --------- ---------------- -------------- --------- -------------- $ 0.78 - $ 3.30 558,382 6.77 $ 2.67 268,840 $ 2.00 $ 4.17 - $ 8.33 516,736 7.11 $ 5.43 296,607 $ 5.38 $10.06 - $ 31.00 385,861 9.70 $28.22 61,530 $24.23 $31.69 - $ 31.69 1,000,000 9.08 $31.69 333,333 $31.69 $31.88 - $101.44 105,400 9.49 $44.67 18,000 $48.47 --------- ------- 2,566,379 8.29 $20.10 978,310 $15.39 ========= =======
The weighted-average grant-date fair value of options granted during the years ended December 31, 2000, 1999 and 1998 was $22.90, $3.52 and $3.71, respectively. Employee Stock Purchase Plan In 1998, the Company's stockholders approved an Employee Stock Purchase Plan (ESPP), covering an aggregate of 50,000 shares of the Company's common stock. Each quarter, an eligible employee may elect to purchase shares of the Company's stock through payroll deductions at a price equal to the lower of 85% of the fair value of the stock as of the first business day of the quarter or the last business day. In 1999, the Company's stockholders approved an amendment to the Company's ESPP that increased the maximum 51 53 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) number of shares of common stock available for purchase under the Plan from 50,000 to 250,000. In the year ended December 31, 2000, 21,973 shares of the Company's stock were sold under the ESPP at a weighted-average price of $14.14 per share. In 1999, the Company adopted a Non-Qualified Stock Purchase Plan covering an aggregate of 50,000 shares of the Company's common stock, of which no shares were sold as of December 31, 2000. 9. INCOME TAXES A summary of the components of income tax expense as of December 31, 2000 follows (in thousands):
CURRENT DEFERRED TOTAL ------- -------- ----- Federal.................................................. -- -- -- State.................................................... -- -- -- -- -- -- Total.......................................... -- -- -- == == ==
The reconciliation between the amount computed by applying the U.S. federal statutory tax rate of 34% to income taxes and the actual provision for income taxes as of December 31, 2000 follows (in thousands): Income tax at statutory rate (34%).......................... (7,566) Net losses and temporary differences for which no current benefit is recognized..................................... 11,322 Permanent differences....................................... (3,756) ------ Income tax expense reported................................. -- ======
As of December 31, 2000, the Company had federal and state net operating loss carryforwards of approximately $81.3 million and $22.2 million, respectively. The Company also had federal and California research and development tax credit carryforwards of approximately $3.8 million and $3.7 million, respectively. The federal net operating loss and credit carryforwards will expire at various dates beginning in the year 2008 through 2020, if not utilized. The State of California net operating losses will expire at various dates beginning in 2001 through 2010, if not utilized. Utilization of the Company's net operating loss carryforwards and credits may be subject to an annual limitation due to the "change in ownership" provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets for financial reporting and the amount used for income tax purposes. Significant components of the Company's deferred tax assets for federal and state income taxes are as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------ 2000 1999 ---------- ---------- Deferred Tax Assets: Net operating loss carryforwards..................... $ 28,971 $ 16,400 Research and other credits........................... 6,564 3,100 Capitalized research expenses........................ 856 1,300 Other -- net......................................... 1,362 1,300 -------- -------- Total deferred tax assets.................... 37,753 22,100 Valuation allowance.................................. (37,753) (22,100) -------- -------- Net deferred tax assets.............................. $ -- $ -- ======== ========
52 54 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Deferred tax assets are reduced by a valuation allowance as management believes that it is more likely than not that the deferred tax assets will not be realized. The net valuation allowance increased by $15.7 million, $8.3 million and $8.5 million for the fiscal years ended December 31, 2000, 1999 and 1998, respectively. Approximately $11.9 million of the federal net operating losses and $6.4 million of the state net operating losses relate to deductions from stock based compensation. No income statement benefit will result from the realization of these losses. 10. TRANSACTIONS WITH RELATED PARTIES As of December 31, 2000, 1999 and 1998, the Company had outstanding accounts payable balances of $44,882, $86,180 and $100,237, respectively, for professional services rendered by a law firm of which the spouse of the Company's then President and Chief Executive Officer was a member during these periods. The Company incurred legal fees and costs to this law firm of approximately $400,000, $441,000 and $979,000 for the years ended December 31, 2000, 1999 and 1998, respectively. In November 2000, the Company received a commitment from its Chairman to provide a line of credit of up to $20.0 million in aggregate principal amount, secured by a promissory note and available for draw down through November 29, 2002. Amounts outstanding under the line of credit bear interest at prime plus 1% and are payable in 48 equal monthly installments beginning upon the expiration date of November 30, 2002. The promissory note issued pursuant to such line of credit may be converted at the Company's option into shares of its common stock at fair market value on the day the Company elects such conversion. No amounts were drawn on this line of credit at December 31, 2000. In March 2001, the Company completed the draw down of the balance of the $20.0 million available under the line of credit and paid off the outstanding principal balance in shares of the Company's common stock as provided in the agreement. As a consequence, the Company issued 2,237,637 shares of common stock to its Chairman in satisfaction of $20.0 million of outstanding principal under the line of credit. In February 2000, the Company granted an option to its Chairman to purchase 1,000,000 shares as an incentive to join the Company as an employee. The Chairman receives no cash compensation as an employee and instead receives options to purchase 3,000 shares per month. However, to date, at the request of the Chairman, the Company has not granted the Chairman any equity incentives appropriate for an active Chairman of the Board, or in recognition of the line of credit that the Chairman made available to the Company. While the Board has taken no formal action to date, the Company believes that the Board is likely to take action in the future to provide appropriate incentives to the Chairman in order to ensure his continued active involvement in the Company. 11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized selected quarterly financial data is as follows (in thousands):
QUARTER ENDED ------------------------------------------------------ DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, 2000 2000 2000 2000 ------------ ------------- -------- --------- Contract revenues............................ $ 4,289 $ 5,936 $ 3,574 $ 1,805 ------- ------- ------- ------- Loss from operations....................... $(6,627) $(4,199) $(5,331) $(6,572) ======= ======= ======= ======= Net loss................................ $(6,695) $(4,116) $(5,112) $(6,330) ======= ======= ======= ======= Basic and diluted net loss per share......... $ (0.49) $ (0.30) $ (0.38) $ (0.48) ======= ======= ======= =======
53 55 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
QUARTER ENDED ------------------------------------------------------ DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, 1999 1999 1999 1999 ------------ ------------- -------- --------- Contract revenues............................ $ 1,112 $ 1,490 $ 1,043 $ 2,752 ------- ------- ------- ------- Loss from operations....................... $(5,284) $(4,656) $(4,882) $(5,039) ======= ======= ======= ======= Net loss................................ $(5,078) $(4,332) $(4,534) $(4,603) ======= ======= ======= ======= Basic and diluted net loss per share......... $ (0.39) $ (0.33) $ (0.35) $ (0.36) ======= ======= ======= =======
Historically, the Company's revenues have varied considerably from period to period due to the nature of the Company's collaborative arrangements. As a consequence, the Company's results in any one quarter are not necessarily indicative of results to be expected for a full year. The fourth quarter of 2000 included (i) an adjustment to reduce contract revenues of approximately $402,000 and (ii) the write-off of certain capitalized software costs of approximately $562,000. 12. SUBSEQUENT EVENTS In January 2001, the Company entered into an employment agreement with an officer and director of the Company. Pursuant to the employment agreement, the officer will receive a severance package upon termination of his employment under certain conditions. In addition, the employment agreement provided that the officer would receive a payment of $4.0 million, less an offset measured by appreciation of certain vested options, if the officer were not promoted to the position of chief executive officer by July 1, 2002, or, if earlier, upon a change of control of the Company under certain circumstances. The officer was promoted to Chief Executive Officer in March 2001. Also pursuant to the employment agreement, the officer was granted an option to purchase 500,000 shares of common stock as an inducement to become an employee of the Company. Of the 500,000 shares, this officer was granted (i) an option under the Company's 1995 Employee Stock Option Plan to purchase 31,840 shares at an exercise price of $12.56 per share, the fair market value on the date of grant as determined under the 1995 Plan, which shares become exercisable in four equal annual installments commencing one year after the date of grant, and (ii) an option to purchase 468,160 shares at an exercise price of $12.50 per share, the closing price on the date of grant, of which 150,000 shares became exercisable immediately and the remainder become exercisable in four equal annual installments commencing one year after the date of grant. These option agreements provide for the acceleration of vesting of options upon certain specified events. Also pursuant to the employment agreement, the Company entered into a loan agreement with this officer. Under the terms of the loan agreement, the officer may borrow up to $2.0 million from the Company. The interest rate on the loan is the lowest applicable federal interest rate or such other higher rate of interest, if required, to constitute a market rate of interest as contemplated by the Rules and Regulations of the Financial Accounting Standards Board and the U.S. Securities and Exchange Commission. Interest accrues but is deferred and all interest and principal is due in January 2006. The employment agreement provides that, at any time following his first year of employment but before the third anniversary of beginning his employment, this officer may forfeit the option to purchase 150,000 of the 500,000 shares of the option granted to him in exchange for $2.0 million plus the accrued interest under the loan agreement and the loan then becomes immediately due and payable. The guaranteed value of the 150,000 options at $2.0 million will be recognized ratably as compensation expense over the service period of one year. In November 2000, the Company received a commitment from its Chairman to provide a line of credit of up to $20.0 million in aggregate principal amount secured by a promissory note. The promissory note issued pursuant to such line of credit may be converted at the Company's option into shares of its common stock at 54 56 HYSEQ, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) fair market value on the day the Company elects such conversion. No amounts were drawn on this line of credit at December 31, 2000. On March 20, 2001, the Company's Board of Directors decided to complete the draw down of the balance of the $20.0 million available under the line of credit and pay off the outstanding principal balance in shares of the Company's common stock, as provided in the agreement. As a consequence, the Company issued 2,237,637 shares of common stock to its Chairman in satisfaction of $20.0 million of outstanding principal under the line of credit. See Note 10 of Notes to Consolidated Financial Statements. 55 57 ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 21, 2000, the Company engaged the accounting firm of KPMG LLP (KPMG) as its independent auditors to audit the Company's financial statements for its fiscal year ending December 31, 2000. The engagement of new independent auditors was approved by the Audit Committee and Board of Directors of the Company. The Company dismissed its former independent auditors, Ernst & Young (E&Y) effective as of April 7, 2000. During the fiscal years ended December 31, 1999 and 1998, there were no disagreements with E&Y on any matter of accounting principles or practices, financial statement disclosures, or auditing scope or procedure which would have caused E&Y to make reference in their report to such disagreements if not resolved to their satisfaction. E&Y's reports on the financial statements for the years ended December 31, 1999 and 1998, contained no adverse opinion or disclaimer of opinion and were not modified as to uncertainty, audit scope or accounting principles. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The response to this item is incorporated by reference from the discussion responsive thereto under the captions "Management" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Company's Proxy Statement for its 2001 Annual Meeting of Stockholders. ITEM 11. EXECUTIVE COMPENSATION The response to this item is incorporated by reference to the Company's Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (Exchange Act), in connection with the Company's annual meeting of stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this item is incorporated by reference to the Company's Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act, in connection with the Company's annual meeting of stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The response to this item is incorporated by reference to the Company's Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act, in connection with the Company's annual meeting of stockholders. 56 58 PART IV ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) The Financial Statements and report of independent auditors required by this Item are submitted in a separate section, beginning on page 35 of this Report.
PAGE NO. ---- Report of KPMG LLP, Independent Auditors.................... 35 Report of Ernst & Young LLP, Independent Auditors........... 36 Consolidated Balance Sheets................................. 37 Consolidated Statements of Operations....................... 38 Consolidated Statements of Stockholders' Equity............. 39 Consolidated Statements of Cash Flows....................... 40 Notes to Consolidated Financial Statements.................. 41
(a)(2) The schedules have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Financial Statements or notes thereto. (a)(3) Exhibits The following documents are filed as part of this annual report on Form 10-K. The Company will furnish a copy of any exhibit listed to requesting stockholders upon payment of the Company's reasonable expenses in furnishing those materials.
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 Amended and Restated Articles of Incorporation of the Company, as amended* 3.2(c) Amended and Restated By-Laws of the Company 4.1 Specimen Common Stock certificate* 4.2 Form of Registration Rights Agreement* 4.3 Form of Warrant Agreement* 4.4 Rights Agreement between Hyseq, Inc. and U.S. Stock Transfer dated June 5, 1998** 10.1 Form of Indemnification Agreement between the Company and each of its directors and officers* 10.2 Stock Option Plan, as amended+*** 10.4 Non-Employee Director Stock Option Plan, as amended+**** 10.5 Patent License Agreement between Arch Development Corporation and Hyseq, Inc. dated June 7, 1994* 10.6 Stock Purchase Agreement for Series B Convertible Preferred Stock dated May 28, 1997* 10.7 Collaboration Agreement between Hyseq Inc. and Chiron Corporation dated May 28, 1997* 10.9 Collaboration Agreement between Hyseq Inc. and The Perkin-Elmer Corporation dated May 28, 1997* 10.11 Employee Stock Purchase Plan+***** 10.12 Non-Qualified Employee Stock Purchase Plan******** 10.13 Scientific Advisory Board/Consultants Stock Option Plan******** 10.14 Collaboration Agreement between Hyseq, Inc. and American Cyanamid Company dated December 10, 1999****** 10.15 Line of Credit Agreement between Hyseq, Inc. and Dr. George B. Rathmann dated November 10, 2000******* 10.16 Employment Agreement between Hyseq, Inc. and Ted W. Love dated January 11, 2001
57 59
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.17 Lease by and between AMB Property, L.P. and Hyseq, Inc. dated June 23, 2000 21.1 Subsidiaries of Hyseq, Inc. as of December 31, 2000: GeneSolutions Inc., a Nevada corporation Hyseq Diagnostics, Inc., a Nevada corporation 23.1 Consent of KPMG LLP, Independent Auditors 23.2 Consent of Ernst & Young LLP, Independent Auditors
- --------------- * Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement filed on Form S-1, File No. 333-29091. ** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Form 8-K, filed on July 31, 1998, File No. 00-22873. *** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement on Form S-8, File No. 333-41663. **** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement on Form S-8, File No. 333-53089. ***** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement on Form S-8, File No. 333-53087. ****** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's report on Form 8-K/A, filed on March 17, 2000, File No. 00-22873. ******* Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's report on Form 8-K, filed on December 14, 2000, File No. 000-22873. ******** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 000-22873. + Denotes compensation plan in which an executive officer or director participates. (b) Reports on Form 8-K. One report on Form 8-K was filed on behalf of the Company during the last quarter of the year ended December 31, 2000 (Form 8-K filed on December 14, 2000, which included as an exhibit the Line of Credit Agreement between Hyseq, Inc. and Dr. George B. Rathmann dated November 10, 2000). 58 60 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale, State of California, on March 30, 2001. HYSEQ, INC. By: /s/ TED W. LOVE ------------------------------------ Ted W. Love President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on March 30, 2001.
SIGNATURE TITLE --------- ----- /s/ TED W. LOVE President and Chief Executive - ----------------------------------------------------- Officer (Principal Executive Officer), Ted W. Love Director /s/ MARK E. GITTER Chief Financial Officer - ----------------------------------------------------- (Principal Financial and Accounting Officer) Mark E. Gitter /s/ GEORGE B. RATHMANN Chairman of the Board - ----------------------------------------------------- George B. Rathmann /s/ RADOJE T. DRMANAC Director - ----------------------------------------------------- Radoje T. Drmanac /s/ RAYMOND F. BADDOUR Director - ----------------------------------------------------- Raymond F. Baddour /s/ GRETA E. MARSHALL Director - ----------------------------------------------------- Greta E. Marshall /s/ THOMAS N. MCCARTER III Director - ----------------------------------------------------- Thomas N. McCarter III /s/ ERNST SCHWEIZER Director - ----------------------------------------------------- Ernst Schweizer /s/ ROBERT D. WEIST Director - ----------------------------------------------------- Robert D. Weist
59 61 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 Amended and Restated Articles of Incorporation of the Company, as amended* 3.2(c) Amended and Restated By-Laws of the Company 4.1 Specimen Common Stock certificate* 4.2 Form of Registration Rights Agreement* 4.3 Form of Warrant Agreement* 4.4 Rights Agreement between Hyseq, Inc. and U.S. Stock Transfer dated June 5, 1998** 10.1 Form of Indemnification Agreement between the Company and each of its directors and officers* 10.2 Stock Option Plan, as amended+*** 10.4 Non-Employee Director Stock Option Plan, as amended+**** 10.5 Patent License Agreement between Arch Development Corporation and Hyseq, Inc. dated June 7, 1994* 10.6 Stock Purchase Agreement for Series B Convertible Preferred Stock dated May 28, 1997* 10.7 Collaboration Agreement between Hyseq Inc. and Chiron Corporation dated May 28, 1997* 10.9 Collaboration Agreement between Hyseq Inc. and The Perkin-Elmer Corporation dated May 28, 1997* 10.11 Employee Stock Purchase Plan+***** 10.12 Non-Qualified Employee Stock Purchase Plan******** 10.13 Scientific Advisory Board/Consultants Stock Option Plan******** 10.14 Collaboration Agreement between Hyseq, Inc. and American Cyanamid Company dated December 10, 1999****** 10.15 Line of Credit Agreement between Hyseq, Inc. and Dr. George B. Rathmann dated November 10, 2000******* 10.16 Employment Agreement between Hyseq, Inc. and Ted W. Love dated January 11, 2001 10.17 Lease by and between AMB Property, L.P. and Hyseq, Inc. dated June 23, 2000 21.1 Subsidiaries of Hyseq, Inc. as of December 31, 2000: GeneSolutions Inc., a Nevada corporation Hyseq Diagnostics, Inc., a Nevada corporation 23.1 Consent of KPMG LLP, Independent Auditors 23.2 Consent of Ernst & Young LLP, Independent Auditors
- --------------- * Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement filed on Form S-1, File No. 333-29091. ** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Form 8-K, filed on July 31, 1998, File No. 00-22873. *** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement on Form S-8, File No. 333-41663. **** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement on Form S-8, File No. 333-53089. ***** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Registration Statement on Form S-8, File No. 333-53087. ****** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's report on Form 8-K/A, filed on March 17, 2000, File No. 00-22873. ******* Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's report on Form 8-K, filed on December 14, 2000, File No. 000-22873. 62 ******** Previously filed with the Commission as an Exhibit to and incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 000-22873. + Denotes compensation plan in which an executive officer or director participates. EX-3.2(C) 2 f69819ex3-2c.txt EXHIBIT 3.2(C) 1 Exhibit 3.2(c) AMENDED AND RESTATED BY-LAWS OF HYSEQ, INC. ARTICLE I OFFICES The corporation shall continuously maintain in the State of Nevada, a registered office and a resident agent whose office is identical with such registered office and may have other offices within or without the state. The address of the corporation's registered office in the State of Nevada is Laughlin Associates, Inc., 2533 North Carson Street, Carson City, Nevada 89706. The name of the corporation's resident agent at such address is the Laughlin Associates, Inc. The corporation reserves the power to change its resident agent and registered office at any time. ARTICLE II STOCKHOLDERS SECTION 1. ANNUAL MEETING. An annual meeting of the stockholders entitled, under the Articles of Incorporation, to vote on matters properly to be considered at an annual meeting shall be held not less than thirty (30) days after delivery of the annual report, but within six (6) months after the end of each fiscal year, for the purpose of electing directors and for the transaction of such other business, as may come before the meeting. SECTION 2. SPECIAL MEETINGS. Special meetings of the stockholders may be called by the chief executive officer, president, the board of directors, or by holders of Common Stock who hold, in the aggregate, not less than fifty percent (50%) of the outstanding shares of Common Stock for the purpose or purposes stated in the call of the meeting. SECTION 3. PLACE OF MEETINGS. Each meeting of the stockholders for the election of directors shall be held at the offices of the corporation in Carson City, Nevada, unless the board of directors shall by resolution, designate any other place of such meeting. Meetings of stockholders for any other purpose may be held at such place, within or without the State of Nevada, and at such time as shall be determined pursuant to Section 2 of this Article II, and stated in the notice of the meeting or in a duly executed waiver of notice thereof. SECTION 4. NOTICE OF MEETINGS. A written notice of each meeting of stockholders, stating the place, date and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given to each stockholder entitled to vote at the meeting. Unless otherwise provided by the Laws of the State of Nevada ("Nevada Law"), the notice shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting, and, if mailed, shall be deposited in the United States mail, postage prepaid, both directed to the stockholder at his address as it appears on the records of the 2 corporation. No notice need be given to any person with whom communication is unlawful, nor shall there be any duty to apply for any permit or license to give notice to any such person. SECTION 5. NOMINATIONS AND STOCKHOLDER BUSINESS. (a) Annual Meeting of Stockholders. (i) Nominations of persons for election to the board of directors and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (A) pursuant to the corporation's notice of meeting, (B) by or at the direction of the board of directors, or (C) by any stockholder of the corporation who was a stockholder of record at the time of giving notice provided for in Section 5(a)(ii), who is entitled to vote at the meeting and who complied with the notice procedures set forth in Section 5(a)(ii). (ii) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to Section 5(a)(i)(C), the stockholder must have given timely notice thereof in writing to the secretary of the corporation. To be timely, a stockholder's notice shall be delivered to the secretary at the principal executive offices of the corporation not less than 60 days nor more than 90 days prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is advanced by more than 30 days or delayed by more than 60 days from such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than the 90th day prior to such annual meeting and not later than the close of business on the later of the 60th day prior to such annual meeting or the 10th day following the day on which public announcement of the date of such meeting is first made. Such stockholder's notice shall set forth (A) as to each person whom the stockholder proposes to nominate for election or reelection as a director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as amended (the "Exchange Act") (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected), (B) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and of the beneficial owner, if any, on whose behalf the proposal is made, and (C) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made, (i) the name and address of such stockholder, as they appear on the corporation's books, and of such beneficial owner and (ii) the class and number of shares of the corporation which are owned beneficially and of record by such stockholders and such beneficial owner. (iii) Notwithstanding anything in the second sentence of Section 5(a)(ii) to the contrary, in the event that the number of directors to be elected to the board of directors is increased and there is no public announcement naming all of the nominees for director or specifying the size of the increased board of directors made by the corporation at least 70 days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice 2 3 required by this Section 5(a) shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the secretary at the principal executive offices of the corporation not later than the close of business on the 10th day following the day on which such public announcement is first made by the corporation. (b) Special Meeting of Stockholders. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the corporation's notice of meeting. Nominations of persons for election to the board of directors may be made at a special meeting of stockholders at which directors are to be elected (i) pursuant to the corporation's notice of meeting, (ii) by or at the direction of the board of directors, or (iii) provided, that the board of directors has determined that directors shall be elected at such special meeting, by any stockholder of the corporation who is a stockholder of record at the time of giving of notice provided for in this Section 5(b), who is entitled to vote at the meeting and who complied with the notice procedures set forth in this Section 5(b). In the event the corporation calls a special meeting of stockholders for the purpose of electing one or more persons (as the case may be) for election to such position as specified in the corporation's notice of meeting, if the stockholder's notice required by Section 5(a)(i) 5 shall be delivered to the secretary at the principal executive offices of the corporation not earlier than the 90th day prior to such special meeting and not later than the close of business on the later of the 60th day prior to such special meeting or the 10th day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the board of directors to be elected at such meeting. (c) General. (i) Except as set forth in Section 9 of Article III, only such persons who are nominated in accordance with the procedures set forth in this Section 5 shall be eligible to serve as directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Section 5. The presiding officer of the meeting shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made in accordance with the procedures set forth in this Section 5 and, if any proposed nomination or business is not in compliance with this Section 5, to declare that such defective nomination or proposal be disregarded. (ii) For purposes of this Section 5, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. (iii) Notwithstanding the foregoing provisions of this Section 5, a stockholder shall also comply with all applicable requirements of state law and of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 5. Nothing in this Section 5 shall be deemed to affect any rights of stockholders to request inclusion of proposals in the corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act. 3 4 SECTION 6. WAIVER OF NOTICE. Anything herein to the contrary notwithstanding, with respect to any stockholder meeting, any stockholder who in person or by proxy shall have waived in writing notice of the meeting, either before or after such meeting, or who shall attend the meeting in person or by proxy, shall be deemed to have waived notice of such meeting unless he attends for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. SECTION 7. QUORUM; MANNER OF ACTING AND ORDER OF BUSINESS. (a) Subject to the provisions of these by-laws, the Articles of Incorporation and Nevada Law as to the vote that is required for a specified action, the presence in person or by proxy of the holders of a majority of the outstanding shares of the corporation entitled to vote at any meeting of stockholders shall constitute a quorum for the transaction of business. The vote of the holders of a majority of the shares of the corporation's stock entitled to vote, present in person or represented by proxy, shall be binding on all stockholders of the corporation, unless the vote of a greater number or voting by classes is required by law or the Articles of Incorporation or these by-laws. The stockholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum. (b) In the absence of a quorum, stockholders holding a majority of the shares present in person or by proxy and entitled to vote, regardless of whether or not they constitute a quorum, or if no stockholders are present, any officer entitled to preside at or act as secretary of the meeting, may adjourn the meeting to another time and place. Any business which might have been transacted at the original meeting may be transacted at any adjourned meeting at which a quorum is present. No notice of an adjourned meeting need be given if the time and place are announced at the meeting at which the adjournment is taken except that, if adjournment is for more than thirty (30) days or if, after the adjournment, a new record date is fixed for the meeting, notice of the adjourned meeting shall be given pursuant to Section 4 of this Article II. (c) Meetings of the stockholders shall be presided over by the chairman of the board, or in his absence by the chief executive officer, or in his absence by the president, or in his absence by a vice president, or in the absence of the foregoing persons by a chairman designated by the board of directors, or in the absence of such designation by a chairman chosen at the meeting. The secretary shall act as secretary of the meeting, but in his absence the chairman of the meeting may appoint any person to act as secretary of the meeting. The order of business at all meetings of the stockholders shall be determined by the chairman. The order of business so determined, however, may be changed by vote of the holders of a majority of the shares present at the meeting in person or represented by proxy. SECTION 8. VOTING; PROXIES. Each stockholder of record on the record date, as determined pursuant to Section 6 of Article VI, shall be entitled to one vote for every share registered in his name. However, all elections of directors shall be by written ballot. Each stockholder entitled to vote at any meeting of stockholders or to express consent to or dissent 4 5 from corporate action in writing without a meeting may authorize another person to act for him by proxy. No proxy shall be valid after three years from its date of execution, unless the proxy provides for a longer period. SECTION 9. INSPECTORS OF ELECTION. (a) In advance of any meeting of stockholders, the board of directors may appoint inspectors of election to act at each meeting of stockholders and any adjournment thereof. If inspectors of election are not so appointed, the chairman of the meeting may, and upon the request of any stockholder or his proxy shall, appoint inspectors of election at the meeting. The number of inspectors shall be either one or three. If appointed at the meeting upon the request of one or more stockholders or proxies, the vote of the holders of a majority of shares present shall determine whether one or three inspectors are appointed. In any case any person appointed as an inspector fails to appear or fails or refuses to act, the vacancy may be filled by appointment made by the directors in advance of the convening of the meeting or at the meeting by the person acting as chairman. (b) The inspectors of election shall determine the outstanding stock of the corporation, the stock represented at the meeting and the existence of a quorum, shall receive votes, ballots, or consents, shall count and tabulate all votes and shall determine the result; and in connection therewith, the inspector shall determine the authority, validity and effect of proxies, hear and determine all challenges and questions, and do such other ministerial acts as may be proper to conduct the election or vote with fairness to all stockholders. If there are three inspectors of election, the decision, act or certificate of a majority is effective in all respects as the decision, act or certificate of all. If no inspectors of election are appointed, the secretary shall pass upon all questions and shall have all other duties specified in this Section 9. (c) Upon request of the chairman of the meeting or any stockholder or his proxy, the inspector(s) of election shall make a report in writing of any challenge or question or other matter determined by him and shall execute a certificate of any fact found in connection therewith. Any such report or certificate shall be filed with the record of the meeting. SECTION 10. NO ACTION WITHOUT A MEETING. No action of the stockholders may be taken by written consent. SECTION 11. REVOCATION OF CONSENT. Any stockholder giving a written consent, or the stockholder's proxyholders, or a transferee of the shares or a personal representative of the stockholder or its respective proxyholder, may revoke the consent by a writing received by the corporation prior to the time that written consents of the number of shares required to authorize the proposed action have been filed with the secretary of the corporation, but may not do so thereafter. Such revocation is effective upon its receipt by the secretary of the corporation. 5 6 ARTICLE III DIRECTORS SECTION 1. NUMBER, TENURE AND QUALIFICATIONS. (a) The number of directors of the corporation shall consist of not less than two (2) nor more than nine (9) directors, the exact number of directors to be determined from time to time by resolution adopted by the affirmative vote of a majority of the directors. A director shall hold office until the later of (i) the next annual meeting of the stockholders of the corporation immediately following, or (ii) coinciding with the expiration of his term or until his successor shall be elected and shall qualify, subject, however, to prior death, resignation, retirement, disqualification or removal from office. Directors need not be residents of the State of Nevada or stockholders of the corporation. (b) Each director shall serve a term of one, two or three years as is designated at the time of his election provided that no less than one-fourth (1/4) of the directors serving in any year shall be subject to annual reelection. (c) Any director or the entire board of directors may be removed, with cause, by the holders of 66-2/3% of the voting rights of the shares then entitled to vote at an election of directors, unless otherwise provided under Nevada Law or the Articles of Incorporation. SECTION 2. RESIGNATIONS. Any director may resign at any time by giving written notice to the chairman of the board or to the chief executive officer or to the president. SECTION 3. MEETINGS. Meetings of the board of directors may be called by or at the request of the chairman of the board, the chief executive officer, the president or a majority of the directors. The person or persons authorized to call meetings of the board of directors may fix any place as the place for holding any meeting of the board of directors called by them. Meetings of the board of directors may be held within or outside the State of Nevada. SECTION 4. BUSINESS OF MEETINGS. Except as otherwise expressly provided in these by-laws, any and all business may be transacted at any meeting of the board of directors. SECTION 5. NOTICE OF MEETINGS. Notice of any meeting shall be given at least one (1) day previous thereto by prior written notice to each director at his principal place of business. SECTION 6. ATTENDANCE BY TELEPHONE. Directors may participate in meetings of the board of directors by means of conference telephone or similar communications equipment by means of which all directors participating in the meeting can hear one another, and such participation shall constitute presence in person at the meeting. SECTION 7. QUORUM AND MANNER OF ACTING; ADJOURNMENT. A majority of the directors shall constitute a quorum for the transaction of business at any meeting 6 7 of the board of directors and the act of a majority of the directors present at any meeting at which a quorum is present shall be the act of the board. SECTION 8. ACTION WITHOUT A MEETING. Any action which could be taken at a meeting of the board of directors may be taken without a meeting if all of the directors consent to the action in writing and the writing or writings are filed with the minutes of proceedings of the board. SECTION 9. FILLING OF VACANCIES. (a) A vacancy or vacancies in the board of directors shall exist when any previously authorized position of director is not then filled by a duly elected director, whether caused by death, resignation or removal. Vacancies caused by reason of death, resignation or removal shall be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director. (b) Vacancies and newly created directorships resulting from an increase in the authorized number of directors elected by all the stockholders having the right to vote as a single class may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director. (c) If at any time, by reason of death or resignation or other cause, the corporation should have no directors in office, then any officer or any stockholder or an executor, administrator, trustee or guardian of a stockholder, or other fiduciary entrusted with like responsibility for the person or estate of a stockholder, may call a special meeting of stockholders in accordance with the Articles of Incorporation or the by-laws, or may apply to a court of appropriate jurisdiction for a decree summarily ordering an election. SECTION 10. COMPENSATION OF DIRECTORS. The board of directors shall have the authority to fix the compensation of directors, unless otherwise provided in the Articles of Incorporation. SECTION 11. PRESIDING OFFICER. The presiding officer at any meeting of the board of directors shall be the chairman of the board, or in his absence, any other director elected chairman by vote of a majority of the directors present at the meeting. SECTION 12. COMMITTEE. The board of directors, by resolution adopted by a majority of the number of directors fixed by the by-laws or otherwise, may designate one (1) or more committees, each committee to consist of one (1) or more directors of the corporation, which committees, to the extent provided in such resolution, shall have and exercise all of the authority of the board of directors in the management of the corporation, except as otherwise required by law. The board of directors may designate one (1) or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. 7 8 SECTION 13. WAIVER OF NOTICE. Anything herein to the contrary notwithstanding, with respect to any meeting of the board of directors, any director who in person shall have waived in writing notice of the meeting, either before or after such meeting, or who shall attend the meeting in person, shall be deemed to have waived notice of such meeting unless he attends for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. ARTICLE IV OFFICERS SECTION 1. NUMBER. The officers of the corporation may consist of the chairman of the board, the chief executive officer, the president, one or more vice presidents (the number thereof to be determined by the board of directors), the secretary, the treasurer, the registered agent, and such assistant secretaries and assistant treasurers or any other officers thereunto authorized or elected by the board of directors. Any two or more offices may be held by the same person. SECTION 2. ELECTION AND TERM OF OFFICE. The officers of the corporation shall be elected by the board of directors at their first meeting and thereafter at any subsequent meeting and shall hold their offices for such term as determined by the board of directors. Each officer shall hold office until his successor is duly elected and qualified, or until his death or disability, or until he resigns or is removed from his duties in the manner hereinafter provided. SECTION 3. REMOVAL AND RESIGNATION. Any officer may be removed, either with or without cause, by a majority of the directors, then in office, at any meeting of the board of directors. Any officer may resign at any time by giving written notice to the corporation. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein. SECTION 4. VACANCIES. A vacancy in any office because of death, resignation or removal or any other cause may be filled for the unexpired portion of the term by the board of directors. SECTION 5. CHAIRMAN OF THE BOARD. The chairman of the board of the corporation shall preside at all meetings of the board of directors, and at all stockholders' meetings, whether annual or special, at which he is present and shall exercise such other powers and perform such other duties as the board of directors may from time to time assign to him or as may be prescribed by these by-laws. In the event that the chairman of the board is not present at a directors' meeting the chief executive officer, or in his absence the president of the corporation, shall serve in his place and stead. Except in those instances in which the authority to execute is expressly delegated to another officer or agent of the corporation, or a different mode of execution is expressly prescribed by the board of directors or these by-laws, he may execute for the corporation, certificates for its shares, and any contracts, deeds, mortgages, bonds or other instruments which the board of directors have authorized to be executed, and he may accomplish such execution either under or without the seal of the corporation, or either individually with the 8 9 secretary, any assistant secretary or any other officer thereunto authorized by the board of directors, according to the requirements of the form of the instrument. SECTION 6. CHIEF EXECUTIVE OFFICER. Subject to the direction and control of the board of directors, the chief executive officer shall be in charge of the general management and supervision over the property, affairs and business of the corporation. Except in those instances in which the authority to execute is expressly delegated to another officer or agent of the corporation, or a different mode of execution is expressly prescribed by the board of directors or these by-laws, he may execute for the corporation, certificates for its shares, and any contracts, deeds, mortgages, bonds or other instruments which the board of directors have authorized to be executed, and he may accomplish such execution either under or without the seal of the corporation, or either individually or with the secretary, any assistant secretary or any other officer thereunto authorized by the board of directors, according to the requirements of the form of the instrument. He may vote all securities which the corporation is entitled to vote, except as and to the extent such authority shall be vested in a different officer or agent of the corporation by the board of directors. SECTION 7. PRESIDENT. Subject to the direction and control of the board of directors and the chief executive officer, the president shall be in charge of the general management and supervision over the operating functions of the corporation; he shall see that the resolutions and directions of the board of directors are carried into effect, except in those instances in which that responsibility is specifically assigned to some other person by the board of directors; and in general, he shall discharge all duties incident to the office of president and such other duties as may be prescribed by the board of directors from time to time. Except in those instances in which the authority to execute is expressly delegated to another officer or agent of the corporation, or a different mode of execution is expressly prescribed by the board of directors or these by-laws, he may execute for the corporation, certificates for its shares, and any contracts, deeds, mortgages, bonds or other instruments which the board of directors have authorized to be executed, and he may accomplish such execution either under or without the seal of the corporation, or either individually or with the secretary, any assistant secretary or any other officer thereunto authorized by the board of directors, according to the requirements of the form of the instrument. SECTION 8. VICE PRESIDENT. The vice president (or in the event there be more than one vice president, each of the vice presidents), if one shall he elected, shall assist the president in the discharge of his duties, as the president may direct and shall perform such other duties as from time to time may be assigned to him by the president or by the board of directors. In the absence of the president or in the event of his inability or refusal to act, the vice president (or in the event there be more than one vice president, the vice presidents in the order designated by the board of directors, or by the president if the board of directors have not made such a designation, or in the absence of any designation, then in the order of seniority of tenure as vice president) shall perform the duties of the president, and when so acting, shall have the powers of and be subject to all the restrictions upon the president. Except in those instances in which the authority to execute is expressly delegated to another officer or agent of the corporation, or a different mode of execution is expressly prescribed by the board of directors or these by-laws, the 9 10 vice president (or each of them if there are more than one) may execute for the corporation, certificates for its shares and any contracts, deeds, mortgages, bonds or other instruments which the board of directors have authorized to be executed, and he may accomplish such execution either under or without the seal of the corporation, and either individually or with the secretary, any assistant secretary or any other officer thereunto authorized by the board of directors, according to the requirements of the form of the instrument. SECTION 9. TREASURER. The treasurer, if any, shall be the principal accounting and financial officer of the corporation. The treasurer shall: (i) have charge of and be responsible for the maintenance of the adequate books and records for the corporation; (ii) have charge and custody of all funds and securities of the corporation, and be responsible therefor and for the receipt and disbursement thereof; and (iii) perform all the duties incident to the office of treasurer and such other duties as from time to time may be assigned to him by the president or by the board of directors. If required by the board of directors, the treasurer shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the board of directors may determine. SECTION 10. SECRETARY. The secretary shall: (i) record the minutes of the stockholders and of the board of directors' meetings in one or more books provided for that purpose; (ii) see that all notices are duly given in accordance with the provisions of these by-laws or as required by law; (iii) be custodian of the corporate books and records and of the seal of the corporation; (iv) keep a register of the post-office address of each stockholder which shall be furnished to the secretary by such stockholder; (v) sign with the chairman of the board or the chief executive officer or the president or a vice president or any other officer thereunto authorized by the board of directors, certificates for the shares of the corporation, the issue of which shall have been authorized by the board of directors, and any contracts, deeds, mortgages, bonds or other instruments which the board of directors have authorized to be executed, according to the requirements of the form of the instrument, except when a different mode of execution is expressly prescribed by the board of directors or these by-laws; (vi) have general charge of the stock transfer books of the corporation; (vii) perform all duties incident to the office of secretary and such other duties as from time to time may be assigned to him by the president or by the board of directors. Consistently with the foregoing, the secretary shall be responsible for the corporation's compliance with Section 78.105 of the Nevada Laws and shall supply to the registered agent, any and all amendments to the corporation's Articles of Incorporation and any and all amendments or changes to its by-laws. In compliance with said Section 78.105, the secretary will also supply to the registered agent, and maintain, a current statement setting out the name of the custodian of the stock ledger or duplicate stock ledger, and the present and complete post office address, including street and number, if any, where such stock ledger or duplicate stock ledger specified in the section is kept. SECTION 11. REGISTERED AGENT. The registered agent shall be in charge of the corporation's registered office in the State of Nevada, upon whom process against the corporation may be served and shall perform all duties required by statute. 10 11 SECTION 12. ASSISTANT TREASURERS AND ASSISTANT SECRETARIES. The assistant treasurers and assistant secretaries shall perform such duties as shall be assigned to them by the board of directors. When the secretary is unavailable, any assistant secretary may sign with the chief executive officer, the president, or a vice president, or any other officer thereunto authorized by the board of directors, any contracts, deeds, mortgages, bonds or other instruments according to the requirements of the form of the instrument, except when a different mode of execution is expressly prescribed by the board of directors or these by-laws. The assistant treasurers shall, respectively, if required by the board of directors, give bonds for the faithful discharge of their duties in such sums and with such sureties as the board of directors shall determine. SECTION 13. SALARIES. The salaries of the officers shall be fixed from time to time by the board of directors and no officer shall be prevented from receiving such salary by reason of the fact that he is also a director of the corporation. ARTICLE V CONTRACTS, LOANS, CHECKS AND DEPOSITS SECTION l. CONTRACTS. The board of directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the corporation and such authority may be general or confined to specific instances. SECTION 2. LOANS. No loans shall be contracted on behalf of the corporation and no evidences of indebtedness shall be issued in its name, unless authorized by a resolution of the board of directors. Such authority may be general or confined to specific instances. SECTION 3. CHECKS, DRAFTS, ETC. All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued by the name of the corporation, shall be signed by such officer or officers, agent or agents of the corporation and in such manner as shall from time to time be determined by resolution of the board of directors. SECTION 4. DEPOSITS. All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies or other depositaries as the board of directors may select. ARTICLE VI CERTIFICATES OF STOCK AND THEIR TRANSFER SECTION 1. STOCK RECORD AND CERTIFICATES. Records shall be kept by or on behalf of the corporation, which shall contain the names and addresses of stockholders, the number of shares held by them respectively, and the number of certificates, if any, representing the shares, and in which there shall be recorded all transfers of shares. Every stockholder shall be entitled to a certificate signed by the chairman of the board of directors, or the chief executive officer or the president or a vice president, and by the treasurer or an assistant treasurer, or the 11 12 secretary or an assistant secretary of the corporation, certifying the class and number of shares owned by him in the corporation, provided that any and all signatures on a certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he or it were such officer, transfer agent or registrar at the date of issue. SECTION 2. TRANSFER AGENTS AND REGISTRARS. The board of directors may, in its discretion, appoint one or more responsible banks or trust companies as the board may deem advisable, from time to time, to act as transfer agents and registrars of shares of the corporation; and, when such appointments shall have been made, no certificate for shares of the corporation shall be valid until countersigned by one of such transfer agents and registered by one of such registrars. SECTION 3. STOCKHOLDERS' ADDRESSES. Every stockholder or transferee shall furnish the secretary or a transfer agent with the address to which notice of meetings and all other notices may be served upon or mailed to such stockholder or transferee, and in default thereof, such stockholder or transferee shall not be entitled to service or mailing of any such notice. SECTION 4. LOST CERTIFICATES. In case any certificate for shares of the corporation is lost, stolen or destroyed, the board of directors, in its discretion, or any transfer agent duly authorized by the board, may authorize the issue of a substitute certificate in place of the certificate so lost, stolen or destroyed. The corporation may require the owner of the lost, stolen or destroyed certificate or his legal representative to give the corporation a bond sufficient to indemnify the corporation against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate or uncertified shares. SECTION 5. DISTRIBUTIONS TO STOCKHOLDERS. To the extent permitted by Nevada Law and subject to any restrictions contained in the Articles of Incorporation, the directors may declare and pay dividends upon the shares of its capital stock in the manner and upon the terms and conditions provided by Nevada Law and the Articles of Incorporation. SECTION 6. RECORD DATES. In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders, or any adjournment thereof, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of shares or for the purpose of any other lawful action, the board of directors may fix, in advance, a record date which shall be not more than sixty (60) nor less than ten (10) days before the date of any meeting of stockholders, and not more than sixty (60) days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting. 12 13 In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which date shall not be more than ten (l0) days after the date upon which the resolution fixing the record date is adopted by the board of directors. In such case, those stockholders, and only those stockholders, who are stockholders of record on the date fixed by the board of directors shall, notwithstanding any subsequent transfer of shares on the books of the corporation, be entitled to notice of and to vote at such meeting of stockholders, or any adjournment thereof, or to express consent to such corporate action in writing without a meeting, or entitled to receive payment of such dividend or other distribution or allotment of rights, or entitled to exercise rights in respect of any such change, conversion or exchange of shares or to participate in any such other lawful action. SECTION 7. TRANSFERS OF SHARES. Shares of the corporation may be transferred by delivery of the certificates therefor, accompanied either by an assignment in writing on the back of the certificates, or by written power of attorney to sell, assign and transfer the same, signed by the record holder thereof; but no transfer shall affect the right of the corporation to pay any distribution upon the shares to the holder of record thereof, or to treat the holder of record as the holder in fact thereof for all purposes, and no transfer shall be valid, except between the parties thereto, until such transfer shall have been made upon the books of the corporation. SECTION 8. REPURCHASE OF SHARES ON OPEN MARKET. The corporation may purchase its shares on the open market and invest its assets in its own shares, provided that in each case the consent of the board of directors shall have been obtained. ARTICLE VII INDEMNIFICATION AND INSURANCE SECTION 1. DEFINITIONS. For the purposes of this Article VII the following definitions shall apply: "Agent" means any person who: (i) is or was a director, officer, employee, or other agent of this corporation; or (ii) is or was serving at the request of this corporation as a director, officer, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise ("enterprise"). "Proceeding" means any threatened, pending or completed action suit or proceeding, whether civil, criminal, administrative, or investigative and whether internal or external to the corporation. "Expenses" includes, without limitation, attorneys' fees and any expenses of establishing a right to indemnification under this Article VII. 13 14 "Losses" mean the total amount which the agent becomes legally obligated to pay in connection with any proceeding, including judgments, fines, amounts paid in settlement and Expenses. SECTION 2. THIRD PARTY ACTIONS. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to, or otherwise becomes involved in, any Proceeding (other than an action by or in the right of the corporation) by reason of the fact that he is or was an Agent of the corporation against Losses actually and reasonably incurred by him in connection with such Proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal Proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any Proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in such a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal Proceeding, had reasonable cause to believe that his conduct was unlawful. SECTION 3. ACTIONS BY OR IN THE RIGHT OF THE CORPORATION. The corporation shall indemnify any person who was or is a party or is threatened to be made a party to, or otherwise becomes involved in, any Proceeding by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was an Agent of the corporation against Expenses, including amounts paid in settlement, actually and reasonably incurred by him in connection with the defense or settlement of such Proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged by a court of competent jurisdiction after exhaustion of all appeals to be liable to the corporation or for amounts paid in settlement to the corporation unless and only to the extent that the court in which such Proceeding was brought shall determine upon application that, in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such Expenses as the court shall deem proper. SECTION 4. SUCCESSFUL DEFENSE. To the extent that an Agent of the corporation has been successful on the merits or otherwise in defense of any Proceeding referred to in Sections 2 and 3 of this Article VII, or in defense of any claim, issue or matter therein, he must be indemnified against Expenses actually and reasonably incurred by him in connection therewith. SECTION 5. DETERMINATION OF CONDUCT. Any indemnification under Sections 2 and 3 of this Article VII, (unless ordered by a court or advanced pursuant to Section 6 of this Article VII) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of the Agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 2 and 3 of this Article VII. Such determination shall be made (a) by the board of directors by a majority vote of a quorum consisting of directors who were not parties to such Proceeding, or (b) if such a quorum is not obtainable or, even if obtainable, a quorum of disinterested directors so directs, by independent 14 15 legal counsel in a written opinion, or (c) if a majority vote of a quorum consisting of directors who were not parties to the Proceeding so orders, by independent legal counsel in a written opinion, or (d) by the stockholders. SECTION 6. PAYMENT OF EXPENSES IN ADVANCE. Expenses incurred by an Agent in connection with a Proceeding shall be paid by the corporation as they are incurred and in advance of the final disposition of such Proceeding upon receipt of an undertaking by or on behalf of such Agent to repay such amount if it shall ultimately be determined by a court of competent jurisdiction that he is not entitled to be indemnified by the corporation as authorized in this Article VII. SECTION 7. INDEMNITY NOT EXCLUSIVE. The indemnification and advancement of Expenses provided by, or granted pursuant to, the other provisions of this Article VII shall not be deemed exclusive of any other rights to which a person seeking indemnification or advancement of Expenses may be entitled under any by-law, agreement, vote of stockholders or disinterested directors, or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office. SECTION 8. INSURANCE INDEMNIFICATION. The corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was an Agent of the corporation against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this Article VII. SECTION 9. HEIRS, EXECUTORS AND ADMINISTRATORS. The indemnification and advancement of Expenses provided by, or granted pursuant to, this Article VII shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be an Agent and shall inure to the benefit of the heirs, executors and administrators of such a person. SECTION 10. FURTHER AMENDMENT. Notwithstanding any provision in this Article VII to the contrary, in the event the Nevada Law is either amended to provide, or interpreted by judicial or other binding legal decision to provide, broader indemnification rights than those contained herein, such broader indemnification rights shall be provided to any and all persons entitled to be indemnified pursuant to the Nevada Law the intent of this provision being to permit the corporation to indemnify, to the full extent permitted by Nevada Law, persons whom it may indemnify thereunder. ARTICLE VIII AMENDMENTS The by-laws may be amended by a majority vote of the directors or by an affirmative vote by the holders of 66-2/3% of the voting rights of all classes of stock entitled to vote. The by-laws may contain any provisions for the regulation and management of the affairs of the corporation not inconsistent with Nevada Law or the Articles of Incorporation. 15 EX-10.16 3 f69819ex10-16.txt EXHIBIT 10.16 1 Exhibit 10.16 - -------------------------------------------------------------------------------- EMPLOYMENT AND CONFIDENTIAL INFORMATION AGREEMENT - -------------------------------------------------------------------------------- AGREEMENT made and entered into this 11th day of January 2001, by and between Hyseq, Inc. of 670 Almanor Avenue, Sunnyvale, California 94085 (the "COMPANY") and Ted W. Love ("EMPLOYEE"). 1. The Company hereby employs Employee in such capacity or capacities as set forth in the attached Addendum ("ADDENDUM"), beginning as soon as possible, and continuing until terminated by Employee or by the Company, as provided in the Addendum which provides for at-will employment, subject in all cases to the terms and conditions of the Addendum. 2. The term "CLIENT" in all paragraphs of this Agreement shall mean any person, firm, entity, company, partnership, or corporation with whom the Company has contracted, negotiated, or otherwise dealt or has attempted to contract, negotiate, or otherwise deal. 3. For all of the services rendered by Employee, the Company shall pay to Employee as compensation, the initial sum of $485,000.00 per year, payable semi-monthly, so long as Employee continues to render services to the Company, or such other sum in the manner and the amount as may be determined from time to time by the Company. Employee shall also participate in Company's management bonus pool, with bonus payments to be determined and paid in accordance with the terms of such plan. Employee shall also participate in employee benefit plans maintained by the Company and in other benefits provided to senior executives, including retirement and 401(k) plans, deferred compensation, medical and dental, annual vacation, paid holidays, sick leave, and similar benefits, which are subject to change from time-to-time at the reasonable discretion of the Company. 4. Employee shall not during the period of employment engage in any other business or sideline that interferes with Employee's ability to work for the Company, constitutes a conflict of interest, involves a disclosure of Company Confidential Information, except as may be required by the Employee's duties. In compliance with California Labor Code section 2863 and other applicable law, Employee will give preference to the Company's business over business transacted on his own account. During the period of employment, Employee shall perform all of the duties assigned in a manner satisfactory to the Company shall comply with Company's directions, shall use all skills possessed, shall use care and diligence in performing duties, and shall adhere to the policies, practices and operating guidelines as from time to time may be established by the Company. 5. Confidential Information of the Company (a) Employee shall use during his or her employment and at any time thereafter his or her best efforts and exercise utmost diligence to protect and guard Confidential Information (as hereinafter defined). Except as specifically required in the performance of Employee's services for the Company, Employee will not directly or indirectly use, permit others to use, disseminate, or disclose any Confidential Information. (b) Employee may lecture upon, disseminate, and publish under Employee's own name scientific papers arising from the work done in the course of performance of services for the Company as reasonably determined by Employee. (c) All rights, title and interest in all documents, records, notebooks, correspondence, trademarks, servicemarks, copyrights, deposits of microorganisms, cells or parts thereof, cell lines, parts and progeny thereof, and all products made thereby that directly or indirectly relate to and arise out of Employee's work under this Agreement shall belong to the Company, and upon expiration or termination of this Agreement, Employee shall turn over to the Company all such documents and material, including copies thereof, then in Employee's possession or subject to his or her control, whether prepared by him/her or others. (d) For the purposes of this Agreement, "CONFIDENTIAL INFORMATION" shall mean information disclosed to Employee or known to Employee as a consequence of or through performance of services for the Company, whether or not related to his or her duties at the Company, and includes trade secrets or any other like information of value relating to the business and/or field of interest of the Company, - -------------------------------------------------------------------------------- 2 including, but not limited to, information relating to products, inventions, disclosures, processes, systems, methods, formulas, patents, patent applications, machinery, materials, research activities and plans, cost of production, contract forms, prices, volume of sales, promotional methods, lists of names or classes of customers, customer contacts and buyer lists. Information shall be considered, for purposes of this Agreement, to be confidential if not known by the trade generally, even though such information has been disclosed to one or more third parties pursuant to distribution agreements, joint research agreements, or other agreements entered into by the Company or any of its affiliates. For purposes of this Agreement, information shall not be considered confidential to the extent that such information is or becomes, through no fault of Employee, part of the public domain, such information is independently known to Employee, or such information is lawfully furnished to Employee by a third party without restriction on disclosure. (e) In addition to the foregoing, the Company shall also have such rights as are provided by common law or any other applicable law for the protection of confidential information. (f) Employee recognizes that a client of the Company may have specific requirements for the protection of information and agrees to execute such documents as may be required by the client, if in the exercise of reasonable discretion, he believes the documents should be executed. (g) Employee understands and acknowledges that, in connection with employment by the Company, Employee shall be expected to participate in programs of training or skill development, which may be formal, informal, and/or on the job, including those involving the Company's methodology and "business processes"; and Employee further acknowledges and agrees that all records, files, documents, or other materials concerning in any manner the Company, its methods of operation, its clients, or any other facet of the business of the Company or its clients, disclosed to Employee in the course of said programs or in the course of employment, shall be deemed to be Confidential Information within the meaning of this Agreement and shall not, during the period of employment or at any time thereafter, be disclosed to others or used for Employee's own benefit, except to the extent necessary in the ordinary course of completing said program or in performing other duties assigned to Employee as an employee of the Company. 6. Confidential Information of Others (a) If Employee learned about confidential or proprietary information which belongs to a former employer, Employee has not brought and will not bring to the Company or make use of any such confidential and proprietary information, trade secrets, materials, documents or ideas during employment by the Company unless such information or ideas (i) become publicly available for reasons other that actions by Employee, (ii) are independently developed by others at or on behalf of the Company who do not receive access to such information from Employee, or (iii) are received by the Company from a third party who had possession of such information or ideas. (b) Employee represents that Employee's performance of (i) all the terms of this Agreement and (ii) all duties as an Employee of the Company, does not and will not breach any agreement to keep in confidence confidential or proprietary information acquired by Employee in confidence or in trust prior to employment by the Company. Employee has not entered into, and Employee agrees that Employee will not enter into, any agreement, either written or oral, in conflict with the provisions of this Section 6. (c) Employee will not bring on to the premises of the Company any unpublished document or any property belonging to his or her former or concurrent employers or companies, if any, unless consented to in writing by such former or concurrent employers or companies. (d) Employee recognizes that the Company has received and in the future will receive from third parties their confidential or proprietary information subject to a duty on the Company's part to maintain the confidentially of such information and to use it only for certain limited purposes. Employee agrees that Employee owes the Company and such third parties, during the term of employment and thereafter, a duty to hold all such confidential or proprietary information in the strictest confidence and not to disclose it to any person, firm, or corporation (except as necessary in carrying out his or her work for the Company consistent with the Company's agreement with such third party) or to use it for the benefit of anyone other than for the Company or such third party. - -------------------------------------------------------------------------------- 2 3 7. Inventions and Other Intellectual Property (a) Employee agrees that all Inventions and Other Intellectual Property (as hereinafter defined) made, developed, conceived, or completed by Employee, individually or in conjunction with others during the term of this Agreement (or, which having possibly been conceived prior hereto, may be developed or completed during the term of this Agreement or thereafter ) shall be the sole and exclusive property of the Company; provided such Inventions and Other Intellectual Property: (i) are made, conceived, or completed with the equipment, supplies, facilities or Confidential Information of the Company, its subsidiaries, or affiliates, or (ii) are made, conceived, or completed by Employee during the term of his or her employment with the Company unless Employee develops the invention entirely on Employee's own time without using the Company's equipment, supplies, facilities or Confidential Information, or (iii) result from any work performed by Employee for the Company; provided, however, that this Agreement does not apply to any Inventions and Other Intellectual Property that qualify fully under Section 2870 of the California Labor Code, a copy of which is attached as Exhibit B hereto. (b) For the purposes of this Agreement, "INVENTIONS AND OTHER INTELLECTUAL PROPERTY" shall mean any and all inventions, discoveries, concepts, trademarks, servicemarks, copyrights and ideas, whether patentable or not, including, but not limited to, processes, methods, formulas, compositions, techniques, articles, and machines, as well as improvements thereof or know-how related thereto, relating to the business and/or field of interest, including, actual or anticipated research and development, of the Company. (c) Employee shall, without royalty or any further consideration to Employee therefor, but at the expense of the Company: (i) Keep and maintain adequate and current written records of all inventions and original works of authorship made by Employee (solely or jointly with others) during the term of employment with the Company. The records will be in the form of notes, sketches, drawings, and any other format that may be specified by the Company. The records will be available and remain the sole property of the Company at all times. (ii) As promptly as known or possessed by Employee, disclose to the Company all information with respect to any Inventions and Other Intellectual Property made solely or jointly with others during the term of employment. (iii) Whenever so requested to do by the Company, promptly execute and assign any and all applications, assignments, and other instruments that the Company shall deem necessary to apply for and obtain letters patent of the United States and of foreign countries for said Inventions and Other Intellectual Property, and to assign and convey to the Company or to the Company's nominee the sole and exclusive right, title, and interest in and to the Inventions and Other Intellectual Property or any applications or patents thereon. (iv) Whenever so requested to do by the Company, deliver to the Company any Company-owned information in his/her possession for interference purposes or other legal proceedings and testify in any interference or other legal proceedings. (v) Do such other acts as may be necessary in the opinion of the Company to obtain and maintain United States and foreign letters patent for the Inventions and Other Intellectual Property. (d) Employee represents that (i) he/she is not obligated under any consulting, employment or other agreement which would affect the Company's rights or his/her duties under this Agreement, (ii) there is no action, investigation, or proceeding pending or threatened, or any basis therefor known to him/her involving his/her prior employment or any consultancy or the use of any information or techniques alleged to be proprietary to any former employer, and (c) the performance of his/her duties as an employee of the Company will not breach, or constitute a default under any agreement to which he/she is bound, including, without limitation, any agreement limiting the use or disclosure of proprietary information acquired in confidence prior to engagement by the Company. Employee agrees that he/she will not, in connection with his/her employment by the Company, use or disclose to the Company any confidential, trade secret or other proprietary information of any previous employer or other person to which he/she is not lawfully entitled. Attached as Exhibit C of this Agreement is a brief description of all Inventions made or conceived by Employee prior to his/her employment with the Company which Employee desires to be excluded from this Agreement. - -------------------------------------------------------------------------------- 3 4 (e) Employee further agrees that the obligations and undertakings stated in this Paragraph 7 shall continue beyond the termination of Employee's employment with the Company, at the Company's expense. 8. Employee acknowledges that Employee has been informed of the current policies, practices, and operating guidelines of the Company and agrees to comply with all such policies, practices, and such other policies, practices and operating guidelines as from time to time may be adopted by the Company and disclosed to him/her or of which Employee is otherwise aware. 9. Non-Competition (a) During the term of Employee's employment with the Company, Employee will not: (i) own or have any interest, directly or indirectly, in, or act as an officer, director, agent, employee, or consultant of, or assist in any way or in any capacity, any person, firm, association, partnership, corporation, or other entity which is in competition with the Company, (ii) divert or attempt to divert any business or client from the Company, or (iii) directly or indirectly entice, induce or in any manner influence any person who is, or shall be, in the service of the Company to leave such services for the purpose of engaging in a business, or being employed by or associated with any person, firm, association, partnership, corporation or other entity, which is in competition with the Company to the extent applicable law authorizes such provisions. The language of this Agreement is intended to comply with California Business and Professions Code ss. 16600 and other laws allowing fair competition and is intended only to prevent unfair or unlawful competition or other conduct or practices that the Company can lawfully restrict. (b) Employee agrees that Employee will not at any time during or after his or her employment with the Company reveal, divulge or make known to any person, firm, corporation or other entity any knowledge or information or any facts concerning any suppliers, customers, methods, processes, developments, schedules, lists or plans of or relating to the business of the Company, except as reasonably necessary, in Employee's judgment, to carry out Employee's duties and/or responsibilities, and will retain all knowledge and information which Employee has acquired or which Employee will acquire during his or her employment therewith relating to such supplier, customers, methods, processes, developments, schedules, lists and plans and the business of the Company for the sole benefit of the Company, its successors or assigns, except as reasonably necessary, in Employee's judgment, to carry out Employee's duties and/or responsibilities. (c) In the event any court shall finally hold that any provision of this Paragraph 9 constitutes an unreasonable restriction against Employee, Employee agrees that the provision hereof shall not be rendered void but shall apply as to such extent as such court may judicially determine or indicate constitutes a reasonable restriction under the circumstances involved. (d) The provisions for this Paragraph 9 shall survive the termination of the terms of this Agreement and shall run to and inure to the benefit of the Company, its successors and assigns. 10. Non-Solicitation (a) Employee further covenants and agrees that Employee shall not, during the period of his or her employment, be employed by or provide services to any present or former client of the Company with whom Employee has dealt or attempted to deal in the capacity of business development, analyst, consultant, or in any other capacity, except as reasonably necessary, in Employee's judgment, to carry out Employee's duties and/or responsibilities. (b) Employee shall make available to the Company any and all information of which Employee has gained knowledge during the course of his or her employment with respect to any client with which Employee has had contact. (c) Upon termination of Employee's employment with the Company, regardless of whether Employee or the Company initiates the termination of employment, Employee shall promptly surrender to the Company all property provided him/her by the Company for use in relation to his or her employment, and, in addition, Employee shall surrender to the Company any and all sales materials, lists of clients, customers and prospective customers, price lists, files, patent applications, records, models, or other materials and information of or pertaining to the Company or its clients, customers or prospective customers or the products, business, and operations of the Company. 11. It is mutually agreed between the parties that the breach of Section 5(a) of this Agreement by Employee - -------------------------------------------------------------------------------- 4 5 will cause irreparable injury to the Company, not fully compensable by damages in an action at law, and the rights and remedies of the Company hereunder may therefore be enforced both at law and in equity, by injunction or otherwise; and the rights and remedies of the Company hereunder shall be cumulative and not alternative. 12. It is mutually understood and agreed that all agreements and covenants contained herein are severable and that, in the event any of them shall be held to be invalid or unenforceable to any extent or in any application by any court, then the remainder of this Agreement and such agreement or covenant except to such extent or in such application, shall not be affected hereby, and each and every agreement and covenant of this Agreement and Addendum shall be valid and enforced to the fullest extent and in the broadest application permitted by law. 13. This Agreement and the Addendum shall be governed, interpreted and enforceable pursuant to the laws of the State of California. The Company and Employee agree that either the United States District Court for the Northern District of California (Ninth Circuit) or the Superior Court of the State of California in and for the County of Santa Clara shall be the exclusive forum for the resolution of any controversies or disputes hereunder. 14. Employee represents and agrees that Employee has had the opportunity to discuss all aspects of this Agreement with his or her advisors, including an attorney, if any, and that Employee has carefully read and fully understood all of the provisions herein. Employee has had an opportunity to ask questions and suggest alternative language. Employee agrees that the presumptions against the drafter of a document shall not apply to any dispute regarding interpretation of this Agreement. Employee acknowledges that, in executing this Agreement, except as set forth in this Agreement and/or the Addendum, Employee does not rely and has not relied on any representations or statements made by the Company or by any of the Company's agents or representatives with regard to the subject matter, basis or effect of this Agreement or otherwise. This Agreement and the Addendum hereto incorporates the entire understanding between Employee and the Company, recites the sole considerations for the promises exchanged, and fully supersedes any and all prior agreements or understandings (written, oral, or implied) between Employee and the Company pertaining to the subject matter of this Agreement. In reaching this Agreement, Employee has not relied on any statement or representation except those expressly stated in this Agreement or the attached Addendum. 15. If any term or any condition in this Agreement in any way, whether directly or indirectly, whether superficially or substantively, conflicts with any term or condition contained in the attached Addendum, the term(s) and/or condition(s) of the Addendum shall control in their entirety, and the conflicting term(s) and/or condition(s) of this Agreement shall be completely null and void, and of no further effect. 16. This Agreement shall become binding upon Employee immediately upon his or her signing. This Agreement shall become binding on the Company when signed by a person authorized by the Board of Directors of the Company. 17. No termination or amendment of this Agreement or the attached Addendum or any provision hereof or thereof, or waiver of any right or remedy herein or therein provided, shall be effective for any purpose unless specifically set forth in writing, that is signed by the party or parties to be bound thereby and that expressly states that it is modifying this "Employment and Confidential Information Agreement" or the attached "Addendum." The waiver of any right or remedy in respect of any occurrence or event on one occasion shall not be deemed a waiver of such right or remedy in respect of the same or any similar occurrence or event on any other occasion. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first set forth above. HYSEQ, INC. By: /s/ GEORGE B. RATHMANN -------------------------------------------- Name: George B. Rathmann Title: President and Chief Executive Officer EMPLOYEE /s/ TED W. LOVE -------------------------------------------- Name: Ted W. Love - -------------------------------------------------------------------------------- 5 6 ADDENDUM TO EMPLOYMENT AGREEMENT This Addendum ("Addendum") to the Employment Agreement ("Agreement") between Hyseq, Inc., a Nevada corporation ("Company" or "Hyseq"), with its principal place of business at 670 Almanor Avenue, Sunnyvale, California, 94085, and Dr. Ted W. Love ("Executive") is effective as of the date of the Agreement ("Effective Date"). EMPLOYMENT 1.1 Position and Duties: The Company employs Executive and Executive accepts employment according to the terms and conditions set forth in the Agreement and this Addendum. (a) Executive shall serve as President and Chief Operating Officer ("COO") of Hyseq from the Effective Date until the date Hyseq promotes Executive to Chief Executive Officer ("CEO") and President of the Company. Executive shall have all the rights, responsibilities, authority, and titles commensurate with the position of President and COO. As long as Executive serves as President and COO, Executive shall report only to the CEO, Dr. George B. Rathmann, and the Company's Board of Directors ("Board"). (b) In his position as President and COO, Executive shall be responsible for all aspects of the Company's operations and all functional areas of the Company. (c) Hyseq shall (x) promote Executive to President and CEO of the Company on or before July 1, 2002 (the "Promotion Date"), or (y) pay Executive four million dollars ($4,000,000), less the Stock Appreciation (as defined below), in one lump sum, on the Promotion Date or on any other applicable date as set forth in Section 3.2(b) or the date on which Executive's employment terminates before the Promotion Date other than for Cause (as defined below) or Good Reason (as defined below) exists (the applicable payment date is referred to in this Addendum as the "NonPromotion Date"); providing that if Company had Cause (as defined below) not to promote Executive to CEO, then Company shall not pay Executive the payment called for in this Section. (d) Hyseq understands and acknowledges that Company's representation that it will pay Executive four million dollars, less the Stock Appreciation, if Company chooses not to promote Executive (unless Cause exists not to promote Executive) is a material representation inducing Executive to enter into the Page 1 of 10 Hyseq, Inc. - Ted Love Employment Agreement 7 Agreement and this Addendum, and that Executive will not accept employment with the Company without this representation. Executive represents that, in reliance on the Company's representation, he has given up multiple opportunities to become Chief Executive Officer of other biotechnology companies. (e) In addition, if the Company is required to pay Executive $4 million less the Stock Appreciation pursuant to Sections 1.1(c) or 3.2(b), then during the period of time beginning on the NonPromotion Date and ending sixty (60) days after the NonPromotion Date, Executive, at his sole discretion, may sell all or any portion of his vested Option Shares (whether exercised or unexercised) ("Forced Sale Shares") to Hyseq and Hyseq shall be immediately required to purchase all Forced Sale Shares at the fair market value as of date Executive elects such sale (but in the case of vested but unexercised Shares, the fair market value less the exercise price). (f) The Executive shall be appointed to the vacancy currently existing on the Company's Board of Directors ("Board") and thereafter, at all times while Executive is employed by the Company, the Company shall nominate to the Board and recommend to the shareholders that the shareholders elect Executive to the Company's Board. (g) For purposes of this Addendum, "Stock Appreciation" means an amount equal to (x) the number of Executive's vested option Shares in excess of 150,000 Shares (regardless of whether such Shares have been exercised or forfeited) on the NonPromotion Date multiplied by (y) the amount resulting from taking (i) the closing price of Hyseq's common stock on the NASDAQ Stock Market on the NonPromotion Date and subtracting (ii) the exercise price of the vested option Shares. 1.2 Best Efforts. Executive agrees to devote his full time and attention to the Company, to use his best efforts to advance the business and welfare of the Company, to render his services under the Agreement and this Addendum fully, faithfully, diligently, competently and to the best of his ability. Notwithstanding any other term in the Agreement and this Addendum, the Executive may undertake any of the following activities, provided that such activities do not materially interfere with the proper performance of his duties and responsibilities under the Agreement and this Addendum: (a) Executive may engage in charitable activities and community affairs. (b) Executive may manage his personal investments and affairs. Page 2 of 10 Hyseq, Inc. - Ted Love Employment Agreement 8 (c) Executive may invest in, or own up to 5% of a publicly held company engaged in the same or similar business as the Company. (d) Executive may serve as a director of, or advisor to any corporation which does not compete in any material way with the Company's business. (e) Executive may participate in conferences, prepare or publish papers or books or teach; and, (f) Executive may take on other positions of responsibility, with the approval of the Board, which approval shall not be unreasonably withheld. 1.3 Location of Employment. Executive's principal place of employment shall be at a location that is within thirty (30) miles of the Company's current headquarters, unless the relocation of Executive's principal place of employment by more than thirty (30) miles results in moving Executive's principal place of employment closer to the Executive's current residence in Hillsborough, California. 1.4 Authorization to Work in the United States. The Immigration Reform and Control Act of 1986 requires that Executive provide verification of identity and legal right to work in the United States. Consequently, within three days of beginning his employment with the Company, Executive must provide the Company with proper documentation as required by the Employment Eligibility Verification Form I-9. COMPENSATION AND BENEFITS 2.1 Base Salary. For services rendered by Executive under the Agreement and this Addendum, the Company shall pay Executive a base salary of $485,000 per year, less deductions required by law, payable in equal bi-monthly installments. The Board shall review annually Executive's compensation, and the Board shall adjust Executive's base salary if the performance of the Company or the services of the Executive reasonably merit an adjustment; provided, however, that at all times Executive's base salary shall be no lower than the highest base salary paid by the Company to any other Company employee. 2.2 Bonus Plan. The Executive shall participate in Company's management bonus pool, with bonus payments to be determined and paid based upon written performance objectives to be determined by the Compensation Committee of the Company's Board. 2.3 Stock Option. As a material inducement to Executive to enter into the Agreement and this Addendum and as part of Executive's compensation, the Company Page 3 of 10 Hyseq, Inc. - Ted Love Employment Agreement 9 shall grant Executive a stock option ("Option") to purchase 500,000 shares ("Shares") of Hyseq's common stock at a per share exercise price equal to the closing price of the Company's common stock on the NASDAQ Stock Market on the date of grant. The Company represents that it will use every effort to make the date of grant the Effective Date, or the next business day after the Effective Date. The Option shall be an incentive stock option to the fullest extent permitted by law and the Company's Stock Option Plan. The vesting commencement date for the Option shall be the Effective Date. 150,000 Shares shall vest on the date of grant. 87,500 Shares shall vest on each one (1) year anniversary of the Effective Date thereafter, until all Shares are fully vested or Executive's employment terminates, whichever occurs first, subject in all cases to the acceleration and other provisions set forth in this Addendum. The Option shall terminate on the ten (10) year anniversary of the Effective Date and shall be governed by an option agreement. The Executive shall receive the benefit, with respect to all options issued to him now or in the future, of any changes in the Company's stock option vesting schedule. All of Executive's options shall be amended to provide for prorata monthly vesting after the first anniversary date of the option in the event any optionee under any Company stock option plan receives monthly vesting at any time. 2.4 Put. Provided that Executive has not previously exercised the 150,000 Shares which immediately vest under the Option, at any time after Executive has been a Company employee for 12 months, but before the third anniversary of Executive's first day of employment (regardless of whether Executive is employed by the Company), Executive shall have the right, but not the obligation, to forfeit the option to purchase 150,000 Shares (and the post termination exercise period for the 150,000 Shares shall be extended to the third anniversary date of Executive's employment unless extended for a longer period by Section 3.2(a)(iii)). Immediately on receiving notice that Executive has forfeited his option to purchase 150,000 Shares, the Company shall pay Executive the sum of (x) two million dollars ($2,000,000), plus (y) the aggregate amount of all interest accrued on the Loan (described in Section 2.5 below) up to the date Company makes the payment required by this paragraph, and on the date the Company makes the payment required under this Section 2.4 the Loan shall become immediately due and payable in full. For purposes of this paragraph only, if Executive's employment terminates before the one year anniversary of the first date of his employment and the termination is other than for Cause (as defined below) or Good Reason (as defined below) exists, then Executive will be deemed to be a Company employee for 12 months, and shall have the right to forfeit the 150,000 Shares until the third anniversary of the first day of his employment (and the post termination exercise period for the 150,000 Shares shall be extended to the third anniversary date of Executive's employment). 2.5 Promissory Note. (a) The Company shall, at Executive's sole discretion, loan Executive two million dollars ($2,000,000) (the "Loan"), in increments, and at times, chosen by Executive. The interest rate on the Loan shall be the lowest applicable federal interest rate (or such other higher Page 4 of 10 Hyseq, Inc. - Ted Love Employment Agreement 10 rate of interest, if required, to constitute a market rate of interest as contemplated by the Rules and Regulations of the Financial Accounting Standards Board and the U.S. Securities and Exchange Commission) on the day the Loan (or Loan increments) is issued. The Loan shall be due and payable five (5) years from the Effective Date (the "Loan Due Date"). Interest shall accrue, but shall be deferred and all interest and principal shall be due on the Loan Due Date. It is the intent of the parties that interest accruing and deferred under the Loan not be reportable as taxable income to Executive in a year or years prior to the interest payment being due pursuant to the Loan. (b) In the event any state or federal taxing agency determines that interest is reportable as taxable income to Executive in a year or years prior to the Loan Due Date, then Company agrees to extend Executive one or more promissory note(s) at the interest rate described in 2.5(a) in order to cover the tax, and other amount, if any, paid by Executive on this additional taxable income. 2.6 Contingencies. In the event that any statute or regulation or any contract between Executive and/or Company and any Company underwriter, prevents Executive and Company from consummating any of the securities transactions described in Sections 1.1 or 2.4 or 3.2 of this Agreement, then (x) the transaction shall not take place on the original transaction date, (y) the transaction shall take place at the first date when legally and contractually permissible, and (z) Company shall pay Executive the sum that Executive would have received on the original transaction date (i.e., either the NonPromotion Date pursuant to Sections 1.1(c) and 1.1(e) or the date of the Put pursuant to Section 2.4, or the applicable date pursuant to Section 3.2(b)); provided that in the case of a sale pursuant to Section 2.4 above, (i) Company shall also pay the aggregate amount of all interest accrued on the Loan between the original transaction date and the date the transaction takes place pursuant to this Section 2.6 and (ii) if applicable, the term of the Loan shall be extended until the first date when the transaction is legally and contractually permissible. 2.7 Reimbursement of Expenses. The Company shall reimburse Executive for actual and reasonable business expenses in accordance with Company policy. The Company shall also reimburse Executive for all reasonable legal and accounting expenses and all professional membership dues and continuing professional education in accordance with Company policy. In addition, Company shall reimburse Executive for all reasonable financial counseling and legal expenses incurred in connection with the negotiation of the Agreement and this Addendum. 2.8 Indemnification Agreement. The Company and Executive shall enter into an indemnification agreement in the form of agreement attached as Exhibit A. Page 5 of 10 Hyseq, Inc. - Ted Love Employment Agreement 11 TERMINATION AND SEPARATION PACKAGE 3.1 At Will Employment. Executive and the Company agree that Executive's employment with the Company is "at-will." This means that either party may terminate Executive's employment, with or without cause. However, any termination of Executive's employment shall be subject to the terms and conditions of the Agreement and this Addendum, including without limitation, the Company's obligation to pay and/or provide the Separation Package as set forth in Section 3.2(a) and, if applicable, the additional payments referred to in Section 3.2(b) of this Addendum. 3.2 Involuntary Termination, Good Reason to Resign, and Change of Control. (a) Separation Package in the Event of Termination Without Cause and/or Good Reason to Resign Exists. In the event that Executive's employment terminates (x) other than for Cause (defined below) if terminated by the Company, and/or (y) Good Reason (defined below) exists for Executive to terminate, then the Company shall (i) immediately accelerate the vesting of 100% of Executive's then unvested Option Shares so that Executive's vested Option Shares and 100% of all unvested Option Shares are fully vested and immediately exercisable, (ii) immediately accelerate the vesting of 100% of all unvested shares of all options issued to and/or granted to Executive in the first four (4) years of Executive's employment ("New Option Shares") so that Executive's vested New Option Shares and 100% of all unvested New Option Shares are fully vested and immediately exercisable, (iii) extend by eighteen (18) months the time period Executive has to exercise any vested Option Shares and/or New Options Shares, (iv) immediately pay Executive, in one lump sum, a sum equal to twelve (12) months of Executive's then current base salary, and (v) continue the health, disability, and life insurance benefits for Executive (including his family) for the twelve (12) months following the termination date or Good Reason Termination Date at the same level of benefits as existed immediately before the termination date or Good Reason Termination Date. The benefits set forth in this Section 3.2(a) are referred to as the "Separation Package". (b) In addition, in the event (x) Executive has not been Hyseq's Chief Executive Officer for at least six (6) months before the termination of his employment other than for Cause (defined below) and/or Good Reason (defined below) exists, or (y) Executive has been promoted to Chief Executive Officer and President in anticipation of a Change of Control and is not employed as the surviving Page 6 of 10 Hyseq, Inc. - Ted Love Employment Agreement 12 entity's Chief Executive Officer and President for at least the one (1) year period beginning with the effective date of the Change of Control and ending on the one year anniversary of the effective date of the Change of Control (unless Executive is terminated for Cause), then (i) the Company shall immediately pay Executive four million dollars ($4,000,000), less the Stock Appreciation (but using the applicable event date instead of the NonPromotion Date for purposes of making the calculation) and (ii) Executive shall have the right to sell any or all of his vested Option Shares to Hyseq pursuant to Section 1.1(e) above (but using the applicable event date instead of the NonPromotion Date for purposes of determining the beginning of the 60 day period). (c) Benefits. Following termination, Executive shall cease to be a Company employee and shall not be entitled to any benefits other than the Separation Package as set forth in Section 3.2(a) and, if applicable, the additional payments referred to in Section 3.2(b). (d) Termination For Cause and/or Resignation Without Good Reason. In the event the Company terminates Executive for "Cause" as "Cause" is defined below, and/or Executive terminates without "Good Reason" as "Good Reason" is defined below, Executive shall not receive the Separation Package. For purposes of the Agreement and this Addendum, a resignation tendered by Executive pursuant to a direct request of the Board where no Cause exists shall be deemed an involuntary termination without Cause, and Executive shall be entitled to the Separation Package. 3.3 Cause. "Cause" shall mean (1) Executive's willful refusal or willful failure to comply with a lawful instruction of the Board, or (2) Executive's conviction of any felony involving an act of moral turpitude. The Company may not terminate Executive for Cause under subsection (1) above unless the Company gives Executive written notice of its intent to terminate Executive for Cause with an explicit written explanation for all reasons for the for Cause termination, and the Company, in good faith, permits Executive thirty (30) days to cure the alleged wrongs. If the Executive cures the alleged wrongs, within thirty (30) days of such notice, he cannot be terminated for Cause. 3.4 Good Reason. "Good Reason" shall mean (1) the material reduction or material modification of Executive's authority, duties, title or responsibilities without his prior written consent, provided that a change in the number of persons reporting to the Executive shall not, by itself, constitute Good Reason, or (2) the material reduction or material modification of Executive's base salary, Executive's stock option rights as set forth in this Agreement or employee benefits without his prior written consent; or (3) any requirement that Executive move his principal place of employment more than thirty (30) miles from the Company's current headquarters, unless the relocation of Executive's Page 7 of 10 Hyseq, Inc. - Ted Love Employment Agreement 13 principal place of employment by more than thirty (30) miles results in moving his principal place of employment closer to the Executive's current residence in Hillsborough, California; or (4) Hyseq's failure to promote Executive to Chief Executive Officer and President on or before the Promotion Date (unless the Company had Cause not to promote Executive to CEO); or (5) in the event of a Change of Control, if Executive is not employed as the surviving entity's Chief Executive Officer and President for at least the one (1) year period beginning with the effective date of the Change of Control and ending on the one year anniversary of the effective date of the Change of Control (unless Executive is terminated for Cause). Executive shall give the Company written notice of his intent to resign for Good Reason ("Notice of Good Reason") thirty (30) days before the date he will terminate his employment ("Good Reason Termination Date"). In the event the Company disputes that Executive has Good Reason, the Company shall inform Executive in writing before the Good Reason Termination Date of every reason that the Company disputes Executive's Good Reason claim. In the event that the Company disputes the existence of Good Reason, Executive, at his sole discretion, shall have the right to withdraw his notice of intent to resign for Good Reason and to continue his employment under the same terms and conditions as if no Notice of Good Reason had been given. 3.5 Change of Control. "Change of Control" shall mean (1) any event in which the Company sells, transfers, or disposes of by other means all or substantially all of the Company's assets (or consummation of any transaction having similar effect), or (2) the dissolution or liquidation of the Company, or (3) any merger, consolidation or transfer of securities of the Company with, to or into another corporation, entity or person, other than a merger, consolidation or transfer of securities in which the holders of more than 50% of the shares of capital stock of the Company outstanding immediately prior to such transaction continue to hold (either by the voting securities remaining outstanding or by their being converted into voting securities of the surviving entity) more than 50% of the total voting power represented by the voting securities of the Company, or such surviving entity, outstanding immediately after such transaction. 3.6 Death. In the event of Executive's death while Executive is an employee of the Company, the Company shall pay the Separation Package set forth in Sections 3.2(a)(i), (ii), (iii), (iv) and (v) of this Addendum to Executive's heirs. 3.7 Disability. In the event of Executive's Disability for any period of at least six consecutive months while Executive is an employee of the Company, the Company shall have the right, which may be exercised in its sole discretion, to terminate Executive. In the event the Company elects to terminate Executive, the Company shall pay Executive the Separation Package set forth in Sections 3.2(a)(i), (ii), (iii), (iv) and (v) of this Addendum. For purposes of this Addendum, "Disability" shall mean the inability of Executive to perform the employment services called for in this Agreement by reason of physical or mental illness or incapacity as determined by a physician chosen by Executive and reasonably satisfactory to Company or its legal representative. Page 8 of 10 Hyseq, Inc. - Ted Love Employment Agreement 14 ADDITIONAL PROVISIONS 4.1 Successors, Binding Agreement. The Agreement and this Addendum shall not automatically be terminated by the voluntary or involuntary dissolution of the Company or by any merger or consolidation, whether or not the Company is the surviving or resulting corporation, or upon any transfer of all or substantially all of the assets of the Company. In the event of any such merger, consolidation or transfer of assets, the provisions of the Agreement and this Addendum shall bind and inure to the benefit of the surviving or resulting corporation, or the corporation to which such assets shall have been transferred, as the case may be; provided, however, that the Company will require any successor to all or substantially all of the business and/or assets of the Company, by agreement in form and substance satisfactory to Executive, to expressly assume and agree to perform the Agreement and the Addendum in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. 4.2 No Mitigation. Executive shall have no duty to mitigate any breach of the Agreement and/or this Addendum. 4.3 Headings. Section headings in the Agreement and this Addendum are for convenience only and shall be given no effect in the construction or interpretation of the Agreement and this Addendum. 4.4 Notice. All notices made pursuant to the Agreement and this Addendum, shall be given in writing, delivered by a generally recognized overnight express delivery service, and shall be made to the Company's principal place of business, attention Legal Department, and to the Executive's residence. 4.5 Facsimile Signatures. This Addendum may be entered into by facsimile signatures, and in counterparts, all of which taken together shall constitute one original Agreement. Page 9 of 10 Hyseq, Inc. - Ted Love Employment Agreement 15 IN WITNESS WHEREOF, the parties execute and deliver this Agreement as of the day and year first above written. HYSEQ, INC. Date: January 8, 2001 By: /s/ GEORGE B. RATHMANN ------------------------------------- George B. Rathmann ------------------------------------- Print Name President and Chief Executive Officer ------------------------------------- Print Title TED W. LOVE Date: January 11, 2001 By: /s/ TED W. LOVE ------------------------------------- Page 10 of 10 Hyseq, Inc. - Ted Love Employment Agreement EX-10.17 4 f69819ex10-17.txt EXHIBIT 10.17 1 Exhibit 10.17 FIRST AMENDMENT TO LEASE AGREEMENT This First Amendment to Lease Agreement (the "Amendment") is made and entered into to be effective as of December 14, 2000, by and between AMB PROPERTY, L.P., a Delaware limited partnership ("Landlord"), and HYSEQ, INC., a Nevada corporation ("Tenant"), with reference to the following facts: RECITALS A. Landlord and Tenant have entered into that certain Lease Agreement dated June 23, 2000 (the "Lease"), for the leasing of certain premises containing approximately 59,300 rentable square feet of space located at 225, 249 and 257 Humboldt Court, Sunnyvale, California (the "Premises") as such Premises are more fully described in the Lease. B. Landlord and Tenant wish to amend certain provisions of the Lease associated with a Change in the Commencement Date. NOW, THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Landlord and Tenant hereby agree as follows: 1. RECITALS: Landlord and Tenant agree that the above recitals are true and correct. 2. PREMISES: Tenant's occupancy of the Expansion Premises 1 shall be modified to March 1, 2001 3. TERM: The Expansion Premises 1 Commencement Date of the Lease shall be March 1, 2001 (the "EP 1 Commencement Date"). 4. BASE RENT: The dates on which the Base Rent will be adjusted are: August 1, 2000 through and including February 28, 2001 = $ 98,175.00 March 1, 2001 through and including July 31, 2001 = $252,025.00 August 1, 2001 through and including July 31, 2002 = $264,626.00 August 1, 2002 through and including July 31, 2003 = $277,858.00 August 1, 2003 through and including July 31, 2004 = $291,750.00 August 1, 2004 through and including July 31, 2005 = $306,338.00 August 1, 2005 through and including July 31, 2006 = $321,655.00 August 1, 2006 through and including July 31, 2007 = $337,738.00 August 1, 2007 through and including July 31, 2008 = $354,625.00 August 1, 2008 through and including July 31, 2009 = $372,356.00 August 1, 2009 through and including July 31, 2010 = $390,974.00 August 1, 2010 through and including July 31, 2011 = $410,522.00
5. TENANT'S SHARE OF OPERATING EXPENSES: As of the EP 1 Commencement Date, the Lease shall be modified to provide that Tenant's Share of Operating Expenses (as defined in the Basic Provisions and Section 4.2 of the Lease) shall be increased to 83.05%. 6. EFFECT OF AMENDMENT: Except as modified herein, the terms and conditions of the Lease shall remain unmodified and continue in full force and effect. In the event of any conflict between the terms and conditions of the Lease and this Amendment, the terms and conditions of this Amendment shall prevail. 7. DEFINITIONS: Unless otherwise defined in this Amendment, all terms not defined in this Amendment shall have the meaning set forth in the Lease. 8. AUTHORITY: Subject to the provisions of the Lease, this Amendment shall be binding upon and inure to the benefit of the parties hereto, their respective heirs, legal representatives, successors and assigns. Each party hereto and the persons signing below warrant that the person signing below on such party's behalf is authorized to do so and to bind such party to the terms of this Amendment. 9. The terms and provisions of the Lease are hereby incorporated in this Amendment. IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. Landlord: Tenant: AMB PROPERTY, L.P., HYSEQ, INC., a Delaware limited partnership a Nevada corporation By: AMB PROPERTY CORPORATION, a Maryland corporation, its general partner By: /s/ JOHN L. ROSSI By: /s/ GEORGE B. RATHMANN ----------------------- --------------------------- John L. Rossi George B. Rathmann Its: Vice President Its: Chief Executive Officer ----------------------- -------------------------- Executed at: San Francisco, CA Executed at: Sunnyvale, CA ------------------------- ------------------ on: March 16, 2001 on: February 28, 2001 ---------------------------------- --------------------------- Landlord's Address: Tenant's Address: Pier 1, Bay 1 670 Almanor Ave. San Francisco, CA 94111 Sunnyvale, CA 94085 1 2 With a copy to: Tenant's Address: Legacy Partners Commercial, Inc. __________________________________ 101 Lincoln Center Drive/4th Floor __________________________________ Foster City, California 94404 Attention: Humboldt Business Center Phone: (650) 571-2200 FAX: (650) 571-2211 2 3 INDUSTRIAL MULTI-TENANT LEASE HUMBOLDT BUSINESS CENTER SUNNYVALE, CALIFORNIA DATED JUNE 23, 2000 AMB PROPERTY, L.P., A DELAWARE LIMITED PARTNERSHIP AS LANDLORD, AND HYSEQ, INC., A NEVADA CORPORATION AS TENANT AFFECTING PREMISES COMMONLY KNOWN AS 225, 249 & 257 HUMBOLDT CT. SUNNYVALE, CALIFORNIA 4 TABLE OF CONTENTS 1. BASIC PROVISIONS ("BASIC PROVISIONS")....................................................2 1.1 PARTIES..............................................................................2 1.2 PREMISES.............................................................................2 1.3 TERM.................................................................................2 1.4 BASE RENT............................................................................2 1.5 TENANT'S SHARE OF OPERATING EXPENSES ("TENANT'S SHARE"):.............................3 1.6 TENANT'S ESTIMATED MONTHLY RENT PAYMENT..............................................3 1.7 SECURITY DEPOSIT.....................................................................3 1.8 PERMITTED USE ("PERMITTED USE")......................................................3 1.9 GUARANTOR............................................................................3 1.10 ADDENDUM...........................................................................3 1.11 EXHIBITS...........................................................................3 1.12 ADDRESS FOR RENT PAYMENTS..........................................................3 2. PREMISES, PARKING AND COMMON AREAS.......................................................3 2.1 LETTING..............................................................................3 2.2 COMMON AREAS - DEFINITION............................................................4 2.3 COMMON AREAS - TENANT'S RIGHTS.......................................................4 2.4 COMMON AREAS - RULES AND REGULATIONS.................................................4 2.5 COMMON AREA CHANGES..................................................................4 2.6 PARKING..............................................................................4 3. TERM.....................................................................................4 3.1 TERM.................................................................................4 3.2 DELAY IN POSSESSION..................................................................4 3.3 COMMENCEMENT DATE CERTIFICATE........................................................5 4. RENT.....................................................................................5 4.1 OPERATING EXPENSES...................................................................5 5. SECURITY DEPOSIT.........................................................................6 6. USE......................................................................................6 6.1 PERMITTED USE........................................................................6 6.2 HAZARDOUS SUBSTANCES.................................................................6 6.3 TENANT'S COMPLIANCE WITH REQUIREMENTS................................................7 6.4 INSPECTION; COMPLIANCE WITH LAW......................................................8 6.5 HAZARDOUS MATERIALS DISCLOSURE CERTIFICATE...........................................8 7. MAINTENANCE, REPAIRS, TRADE FIXTURES AND ALTERATIONS.....................................8 7.1 TENANT'S OBLIGATIONS.................................................................8 7.2 LANDLORD'S OBLIGATIONS...............................................................8 7.3 ALTERATIONS..........................................................................8 7.4 SURRENDER/RESTORATION................................................................8 8. INSURANCE; INDEMNITY.....................................................................9 8.1 PAYMENT OF PREMIUMS..................................................................9 8.2 TENANT'S INSURANCE...................................................................9 8.3 LANDLORD'S INSURANCE.................................................................9 8.4 WAIVER OF SUBROGATION...............................................................10 8.5 INDEMNITY...........................................................................10 8.6 EXEMPTION OF LANDLORD FROM LIABILITY................................................10 9. DAMAGE OR DESTRUCTION...................................................................10 9.1 TERMINATION RIGHT...................................................................10 9.2 DAMAGE CAUSED BY TENANT.............................................................11 10. REAL PROPERTY TAXES.....................................................................11 10.1 PAYMENT OF REAL PROPERTY TAXES....................................................11 10.2 REAL PROPERTY TAX DEFINITION......................................................11 10.3 JOINT ASSESSMENT..................................................................11
i 5 10.4 TENANT'S PROPERTY TAXES...........................................................11 11. UTILITIES...............................................................................11 12. ASSIGNMENT AND SUBLETTING...............................................................11 12.1 LANDLORD'S CONSENT REQUIRED.......................................................11 12.2 RENT ADJUSTMENT...................................................................12 12.3 EXCESS CONSIDERATION..............................................................12 12.4 AFFILIATED........................................................................12 13. DEFAULT; REMEDIES.......................................................................13 13.1 DEFAULT...........................................................................13 13.2 REMEDIES..........................................................................14 13.3 LATE CHARGES......................................................................14 14. CONDEMNATION............................................................................14 15. ESTOPPEL CERTIFICATE AND FINANCIAL STATEMENTS...........................................14 15.1 ESTOPPEL CERTIFICATE..............................................................14 15.2 FINANCIAL STATEMENT...............................................................14 16. ADDITIONAL COVENANTS AND PROVISIONS.....................................................14 16.1 SEVERABILITY......................................................................14 16.2 INTEREST ON PAST-DUE OBLIGATIONS..................................................14 16.3 TIME OF ESSENCE...................................................................15 16.4 LANDLORD LIABILITY................................................................15 16.5 NO PRIOR OR OTHER AGREEMENTS......................................................15 16.6 NOTICE REQUIREMENTS...............................................................15 16.7 DATE OF NOTICE....................................................................15 16.8 WAIVERS...........................................................................15 16.9 HOLDOVER..........................................................................15 16.10 CUMULATIVE REMEDIES...............................................................15 16.11 BINDING EFFECT: CHOICE OF LAW.....................................................16 16.12 LANDLORD..........................................................................16 16.13 ATTORNEYS' FEES AND OTHER COSTS...................................................16 16.14 LANDLORD'S ACCESS; SHOWING PREMISES; REPAIRS......................................16 16.15 SIGNS.............................................................................16 16.16 TERMINATION: MERGER...............................................................16 16.17 QUIET POSSESSION..................................................................16 16.18 SUBORDINATION; ATTORNMENT; NON-DISTURBANCE........................................16 16.19 RULES AND REGULATIONS.............................................................17 16.20 SECURITY MEASURES.................................................................17 16.21 RESERVATIONS......................................................................17 16.22 CONFLICT..........................................................................17 16.23 OFFER.............................................................................17 16.24 AMENDMENTS........................................................................17 16.25 MULTIPLE PARTIES..................................................................18 16.26 AUTHORITY.........................................................................18 17. LETTER OF CREDIT........................................................................18
ii 6 AMB PROPERTY CORPORATION INDUSTRIAL MULTI-TENANT LEASE 1. BASIC PROVISIONS ("BASIC PROVISIONS"). 1.1 PARTIES: This Lease ("Lease") dated June 23, 2000, is made by and between AMB PROPERTY, L.P., a Delaware limited partnership, ("Landlord") and HYSEQ, INC., a Nevada corporation, ("Tenant") (collectively the "Parties," or individually a "Party"). 1.2 PREMISES: Commencing August 1, 2000, a portion of the buildings ("Building" or "Buildings") consisting of 23,100 square feet of leasable area located at 257 Humboldt Court ("Initial Premises") increasing on November 1, 2000 by 25,200 square feet, of the Building located at 225 Humboldt Court ("Expansion Premises 1"), increasing on March 1, 2001 by 11,000 square feet, of the Building located at 249 Humboldt Court ("Expansion Premises 2") to an aggregate of 59,300 square feet, located at 225, 249 & 257 Humboldt Court, in the City of Sunnyvale, State of California collectively & hereinafter referred to as ("Premises"), as outlined on Exhibit A attached hereto. The Buildings are located in the business center commonly known as Humboldt Business Center (the "Business Center"). Tenant shall have non-exclusive rights to the Common Areas (as defined in Paragraph 2.3 below), but shall not have any rights to the roof, exterior walls or utility raceways of the Building or to any other buildings in the Business Center. The Premises, the Building, the Common Areas, the land upon which they are located and all other buildings and improvements thereon are herein collectively referred to as the "Business Center." Tenant acknowledges that the Initial Premises, Expansion Premises 1 and Expansion Premises 2 are presently occupied by tenants (the "Existing Tenants"). In the event the Existing Tenants do not vacate the Initial Premises, Expansion Premises 1 or Expansion Premises 2 by the Commencement Dates, Section 3.2 of this Lease shall apply. In the event any of the Commencement Dates are delayed, the parties agree to enter into an amendment to this Lease setting forth the new Commencement Dates and the modified Base Rent schedule. 1.3 TERM: The term for the Initial Premises shall be Eleven (11) years; the term for the Expansion Premises 1 shall be Ten (10) years and Nine (9) months and the term for the Expansion Premises 2 shall be Ten (10) years and Five (5) months (collectively the "Term"), commencing on August 1, 2000 for the Initial Premises, November 1, 2000 for the Expansion Premises 1 and March 1, 2001 for the Expansion Premises 2, (collectively hereinafter referred to as the "Commencement Dates") and ending July 31, 2011 ("Expiration Date"). The Lease shall commence on the Commencement Dates without regard to completion of Tenant Improvements. 1.4 BASE RENT: Initially $98,175.00 per month ("Base Rent"). Tenant shall pay advance Base Rent to Landlord in the amount of $2,000,000.00, which amount shall be payable on execution of this Lease and shall be for the period of August 1, 2000 through a portion of June, 2001. The initial monthly Base Rent shall increase according to the following schedule: > August 1, 2000 through and including October 31, 2000 = $ 98,175.00 November 1, 2000 through and including February 28, 2001 = $205,275.00 March 1, 2001 through and including July 31, 2001 = $252,025.00 August 1, 2001 through and including July 31, 2002 = $264,626.00 August 1, 2002 through and including July 31, 2003 = $277,858.00 August 1, 2003 through and including July 31, 2004 = $291,750.00 August 1, 2004 through and including July 31, 2005 = $306,338.00 August 1, 2005 through and including July 31, 2006 = $321,655.00 August 1, 2006 through and including July 31, 2007 = $337,738.00 August 1, 2007 through and including July 31, 2008 = $354,625.00 August 1, 2008 through and including July 31, 2009 = $372,356.00 August 1, 2009 through and including July 31, 2010 = $390,974.00 August 1, 2010 through and including July 31, 2011 = $410,522.00
Tenant shall pay to Landlord Base Rent eleven months in advance on the first day of each month commencing August 1, 2000. For example, (1) the Base Rent due on August 1, 2000, shall be the Base Rent due for June 1, 2001, which amount will be the balance of the amount due for this month, which amount shall be $123,725.00 (of the full monthly amount of $252,025.00); and (2) the Base Rent due on September 1, 2000, shall be the Base Rent due for July 1, 2001, which 2 7 amount shall be $252,025.00. At such time as Tenant has paid all of the Base Rent for the entire Term, Tenant shall no longer be required to pay Base Rent to Landlord. 1.5 TENANT'S SHARE OF OPERATING EXPENSES ("TENANT'S SHARE"): (a) Business Center 32.35% initially, increasing to 67.65% commencing on November 1, 2000, increasing to 83.05% commencing March 1, 2001. (b) Building N/A 1.6 TENANT'S ESTIMATED MONTHLY RENT PAYMENT: Following is the estimated monthly Rent payment to Landlord pursuant to the provisions of this Lease. This estimate is made at the inception of the Lease and is subject to adjustment pursuant to the provisions of this Lease: (a) Base Rent (Paragraph 4.1) $98,175.00 (b) Estimated Operating Expenses (Paragraph 4.2) $ 3,407.00 (c) Estimated Landlord Insurance (Paragraph 8.3) $ 135.00 (d) Estimated Real Property Taxes (Paragraph 10) $ 2,903.00 ESTIMATED MONTHLY PAYMENT $104,620.00
1.7 SECURITY DEPOSIT: $410,522.00 ("Security Deposit"). 1.8 PERMITTED USE ("PERMITTED USE"): General office, storage, administration, labs and animal facility and assembly, but only to the extent permitted by the City of Sunnyvale and any and all agencies having jurisdiction 1.9 GUARANTOR: George Rathmann. 1.10 ADDENDUM: Attached hereto is the following Addendum which constitutes a part of this Lease: Addendum 1: Landlord's Remedies Addendum in Event of Tenant Default 1.11 EXHIBITS: Attached hereto are the following Exhibits, all of which constitute a part of this Lease: Exhibit A: Diagram of Premises Exhibit B: Commencement Date Certificate Exhibit C: Rules and Regulations Exhibit D: Hazardous Materials Disclosure Certificate Exhibit E: Tenant Improvements (Intentionally omitted) 1.12 ADDRESS FOR RENT PAYMENTS: All amounts payable by Tenant to Landlord shall until further notice from Landlord be paid to AMB Property, L.P. at the following address: c/o Legacy Partners Commercial, Inc. P.O. Box 840437 Dallas, TX 75284-0437 2. PREMISES, PARKING AND COMMON AREAS. 2.1 LETTING. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the Premises upon all of the terms, covenants and conditions set forth in this Lease. Any statement of square footage set forth in this Lease or that may have been used in calculating Base Rent and/or Operating Expenses is an approximation which Landlord and Tenant agree is reasonable and the Base Rent and Tenant's Share based thereon is not subject to revision whether or not the actual square footage is more or less. Tenant accepts the Premises in its present condition, state of repair and operating order and in its present "As-Is" condition. 3 8 2.2 COMMON AREAS - DEFINITION. "Common Areas" are all areas and facilities outside the Premises and within the exterior boundary line of the Business Center and interior utility raceways within the Premises that are provided and designated by the Landlord from time to time for the general non-exclusive use of Landlord, Tenant and other tenants of the Business Center and their respective employees, suppliers, shippers, tenants, contractors and invitees. 2.3 COMMON AREAS - TENANT'S RIGHTS. Landlord hereby grants to Tenant, for the benefit of Tenant and its employees, suppliers, shippers, contractors, customers and invitees, during the term of this Lease, the non-exclusive right to use, in common with others entitled to such use, the Common Areas as they exist from time to time, subject to any rights, powers, and privileges reserved by Landlord under the terms hereof or under the terms of any rules and regulations or covenants, conditions and restrictions governing the use of the Business Center. 2.4 COMMON AREAS - RULES AND REGULATIONS. Landlord shall have the exclusive control and management of the Common Areas and shall have the right, from time to time, to establish, modify, amend and enforce reasonable Rules and Regulations with respect thereto in accordance with Paragraph 16.19. 2.5 COMMON AREA CHANGES. Landlord shall have the right, in Landlord's sole discretion, from time to time: (a) To make changes to the Common Areas, including, without limitation, changes in the locations, size, shape and number of driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic, landscaped areas, walkways and utility raceways; (b) To close temporarily any of the Common Areas for maintenance purposes so long as reasonable access to the Premises remains available; (c) To designate other land outside the boundaries of the Business Center to be a part of the Common Areas; (d) To add additional buildings and improvements to the Common Areas; (e) To use the Common Areas while engaged in making additional improvements, repairs or alterations to the Business Center, or any portion thereof; and To do and perform such other acts and make such other changes in, to or with respect to the Common Areas and Business Center as Landlord may, in the exercise of sound business judgment, deem to be appropriate. 2.6 PARKING. Tenant may use a proportionate share of undesignated vehicle parking spaces, unreserved and unassigned, on those portions of the Common Areas designated by Landlord for such parking. Tenant shall not use more parking spaces than such number. Such parking spaces shall be used only for parking by vehicles no larger than full sized passenger automobiles or pick-up trucks. Tenant shall not permit or allow any vehicles that belong to or are controlled by Tenant or Tenant's employees, suppliers, shippers, customers or invitees to be loaded, unloaded or parked in areas other than those designated by Landlord for such activities. If Tenant permits or allows any of the prohibited activities described herein, then Landlord shall have the right, without notice, in addition to such other rights and remedies that it may have, to remove or tow away the vehicle involved and charge the cost to Tenant, which cost shall be immediately payable as additional rent upon demand by Landlord. 3. TERM. 3.1 TERM. The Commencement Date, Expiration Date and Term of this Lease are as specified in Paragraph 1.3. 3.2 DELAY IN POSSESSION. If for any reason Landlord cannot deliver possession of the Premises to Tenant by the Commencement Date, Landlord shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease or the obligations of Tenant hereunder. In such case, Tenant shall not, except as otherwise provided herein, be obligated to pay Rent or perform any other obligation of Tenant under the terms of this Lease until Landlord delivers possession of the Premises to Tenant. The term of the Lease shall commence on the 4 9 earlier of (i) the date Tenant takes possession of the Premises to Tenant or (ii) 10 days following notice to Tenant that Landlord is prepared to tender possession of the Premises to Tenant. If possession of the Premises is not delivered to Tenant within 180 days after the Commencement Date and such delay is not due to Tenant's acts, failure to act or omissions Tenant may by notice in writing to Landlord within 10 days after the end of said 180 day period cancel this Lease and the parties shall be discharged from all obligations hereunder. If such written notice of Tenant is not received by Landlord within said 10 day period, Tenant's right to cancel this Lease shall terminate. 3.3 COMMENCEMENT DATE CERTIFICATE. At the request of Landlord, Tenant shall execute and deliver to Landlord a completed certificate ("Commencement Date Certificate") in the form attached hereto as Exhibit B. 4. RENT. 4.1 Base Rent. Tenant shall pay to Landlord Base Rent and other monetary obligations of Tenant to Landlord under the terms of this Lease (such other monetary obligations are herein referred to as "Additional Rent") in lawful money of the United States, without offset or deduction, in advance on or before the first day of each month as set forth in Section 1.4. Base Rent and Additional Rent for any period during the term hereof which is for less than one full month shall be prorated based upon the actual number of days of the month involved. Payment of Base Rent and Additional Rent shall be made to Landlord at its address stated herein or to such other persons or at such other addresses as Landlord may from time to time designate in writing to Tenant. Base Rent and Additional Rent are collectively referred to as "Rent". All monetary obligations of Tenant to Landlord under the terms of this Lease are deemed to be rent. 4.2 OPERATING EXPENSES. Tenant shall pay to Landlord on the first day of each month during the term hereof, in addition to the Base Rent, Tenant's Share of all Operating Expenses in accordance with the following provisions: (a) "Operating Expenses" are all costs incurred by Landlord relating to the ownership and operation of the Business Center, Building and Premises including, but not limited to, the following: (i) the operation, repair, maintenance and replacement in neat, clean, good order and condition of the Common Areas, including parking areas, loading and unloading areas, trash areas, roadways, sidewalks, walkways, parkways, driveways, landscaped areas, striping, bumpers, irrigation systems, drainage systems, lighting facilities, fences and gates, exterior signs and tenant directories. (ii) Water, gas, electricity, telephone and other utilities servicing the Common Areas. (iii) Trash disposal, janitorial services, snow removal and the property management fee. (iv) Reserves set aside for maintenance, repair and replacement of the Common Areas and Building. (v) Real Property Taxes. (vi) Premiums for the insurance policies maintained by Landlord under Paragraph 8 hereof. (vii) Environmental monitoring and insurance programs. (viii) Monthly amortization of capital improvements to the Common Areas and the Building. The monthly amortization of any given capital improvement shall be the sum of the (i) quotient obtained by dividing the cost of the capital improvement by Landlord's estimate of the number of months of useful life of such improvement plus (ii) an amount equal to the cost of the capital improvement times 1/12 of the lesser of 12% or the maximum annual interest rate permitted by law. 5 10 (ix) Maintenance of the Building including, but not limited to, painting, caulking and repair and replacement of Building components, including, but not limited to, roof, elevators and fire detection and sprinkler systems. (x) If Tenant fails to maintain the Premises, any expense incurred by Landlord for such maintenance. (b) Tenant's Share of Operating Expenses that are not specifically attributed to the Premises or Building ("Common Area Operating Expenses") shall be that percentage shown in Paragraph 1.5(a). Landlord in its sole discretion shall determine which Operating Expenses are Common Area Operating Expenses or expenses to be entirely borne by Tenant. (c) The inclusion of the improvements, facilities and services set forth in Subparagraph 4.2(a) shall not be deemed to impose any obligation upon Landlord to either have said improvements or facilities or to provide those services. (d) Tenant shall pay monthly in advance on the same day as the Base Rent is due Tenant's Share of estimated Operating Expenses in the amount set forth in Paragraph 1.6. Landlord shall deliver to Tenant within 90 days after the expiration of each calendar year a reasonably detailed statement showing Tenant's Share of the actual Operating Expenses incurred during the preceding year. If Tenant's estimated payments under this Paragraph 4(d) during the preceding year exceed Tenant's Share as indicated on said statement, Tenant shall be credited the amount of such overpayment against Tenant's Share of Operating Expenses next becoming due. If Tenant's estimated payments under this Paragraph 4.2(d) during said preceding year were less than Tenant's Share as indicated on said statement, Tenant shall pay to Landlord the amount of the deficiency within 10 days after delivery by Landlord to tenant of said statement. At any time Landlord may adjust the amount of the estimated Tenant's Share of Operating Expenses and HVAC maintenance costs to reflect Landlord's estimate of such expenses for the year. 5. SECURITY DEPOSIT. Tenant shall deposit with Landlord upon Tenant's execution hereof the Security Deposit set forth in Paragraph 1.7 as security for Tenant's faithful performance of Tenants obligations under this Lease. If Tenant fails to pay Base Rent or Additional Rent or otherwise defaults under this Lease (as defined in Paragraph 13.1), Landlord may use the Security Deposit for the payment of any amount due Landlord or to reimburse or compensate Landlord for any liability, cost, expense, loss or damage (including attorney's fees) which Landlord may suffer or incur by reason thereof. Tenant shall on demand pay Landlord the amount so used or applied so as to restore the Security Deposit to the amount set forth in Paragraph 1.7. Landlord shall not be required to keep all or any part of the Security Deposit separate from its general accounts. Landlord shall, at the expiration or earlier termination of the term hereof and after Tenant has vacated the Premises, return to Tenant that portion of the Security Deposit not used or applied by Landlord. No part of the Security Deposit shall be considered to be held in trust, to bear interest, or to be prepayment for any monies to be paid by Tenant under this Lease. 6. USE. 6.1 PERMITTED USE. Tenant shall use and occupy the Premises only for the Permitted Use set forth in Paragraph 1.8. Tenant shall not commit any nuisance, permit the emission of any objectionable noise or odor, suffer any waste, make any use of the Premises which is contrary to any law or ordinance or which will invalidate or increase the premiums for any of Landlord's insurance. Tenant shall not service, maintain or repair vehicles on the Premises, Building or Common Areas. Tenant shall not store foods, pallets, drums or any other materials outside the Premises, except in designated areas. 6.2 HAZARDOUS SUBSTANCES. (a) Reportable Uses Require Consent. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, chemical, material or waste whose presence, nature, quantity and/or intensity of existence, use, manufacture, disposal, 6 11 transportation, spill, release or effect, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment, or the Premises; (ii) regulated or monitored by any governmental authority; or (iii) a basis for potential liability of Landlord to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substance shall include, but not be limited to, hydrocarbons, petroleum, gasoline, crude oil or any products or by-products thereof. Tenant shall not engage in any activity in or about the Premises which constitutes a Reportable Use (as hereinafter defined) of Hazardous Substances without the express prior written consent of Landlord and compliance in a timely manner (at Tenant's sole cost and expense) with all Applicable Requirements (as defined in Paragraph 6.3). "Reportable Use" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and (iii) the presence in, on or about the Premises of a Hazardous Substance with respect to which any Applicable Requirements require that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Tenant may, without Landlord's prior consent, but upon notice to Landlord and in compliance with all Applicable Requirements, use any ordinary and customary materials reasonably required to be used by Tenant in the normal course of the Permitted Use, so long as such use is not a Reportable Use and does not expose the Premises, or neighboring properties to any meaningful risk of contamination or damage or expose Landlord to any liability therefor. In addition, Landlord may (but without any obligation to do so) condition its consent to any Reportable Use of any Hazardous Substance by Tenant upon Tenant's giving Landlord such additional assurances as Landlord, in its reasonable discretion, deems necessary to protect itself, the public, the Premises and the environment against damage, contamination or injury and/or liability therefor, including but not limited to the installation (and, at Landlord's option, removal on or before Lease expiration or earlier termination) of reasonably necessary protective modifications to the Premises (such as concrete encasements) and/or the deposit of an additional Security Deposit. (b) Duty to Inform Landlord. If Tenant knows, or has reasonable cause to believe, that a Hazardous Substance is located in, under or about the Premises or the Building, Tenant shall immediately give Landlord written notice thereof, together with a copy of any statement, report, notice, registration, application, permit, business plan, license, claim, action, or proceeding given to, or received from, any governmental authority or private party concerning the presence, spill, release, discharge of, or exposure to, such Hazardous Substance. Tenant shall not cause or permit any Hazardous Substance to be spilled or released in, on, under or about the Premises (including, without limitation, through the plumbing or sanitary sewer system). (c) Indemnification. Tenant shall indemnify, protect, defend and hold Landlord, Landlord's affiliates, Lenders, and the officers, directors, shareholders, partners, employees, managers, independent contractors, attorneys and agents of the foregoing ("Landlord Entities") and the Premises, harmless from and against any and all damages, liabilities, judgments, costs, claims, liens, expenses, penalties, loss of permits and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Tenant or by any of Tenant's employees, agents, contractors or invitees. Tenant's obligations under this Paragraph 6.2(c) shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Tenant, and the cost of investigation (including consultants' and attorneys' fees and testing), removal, remediation, restoration and/or abatement thereof, or of any contamination therein involved. Tenant's obligations under this Paragraph 6.2(c) shall survive the expiration or earlier termination of this Lease. 6.3 TENANT'S COMPLIANCE WITH REQUIREMENTS. Tenant shall, at Tenant's sole cost and expense, fully, diligently and in a timely manner, comply with all "Applicable Requirements," which term is used in this Lease to mean all laws, rules, regulations, ordinances, directives, covenants, easements and restrictions of record, permits, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Landlord's engineers and/or consultants, relating in any manner to the Premises (including but not limited to matters pertaining to (i) industrial hygiene, (ii) environmental conditions on, in, under or about the Premises, including soil and groundwater conditions, and (iii) the use, generation, manufacture, production, installation, maintenance, removal, transportation, storage, spill or release of any Hazardous Substance), now in effect or which may hereafter come into effect. 7 12 Tenant shall, within 5 days after receipt of Landlord's written request, provide Landlord with copies of all documents and information evidencing Tenant's compliance with any Applicable Requirements and shall immediately upon receipt, notify Landlord in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving failure by Tenant or the Premises to comply with any Applicable Requirements. 6.4 INSPECTION; COMPLIANCE WITH LAW. In addition to Landlord's environmental monitoring and insurance program, the cost of which is included in Operating Expenses, Landlord and the holders of any mortgages, deeds of trust or ground leases on the Premises ("Lenders") shall have the right to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Tenant with this Lease and all Applicable Requirements. Landlord shall be entitled to employ experts and/or consultants in connection therewith to advise Landlord with respect to Tenant's installation, operation, use, monitoring, maintenance, or removal of any Hazardous Substance on or from the Premises. The cost and expenses of any such inspections shall be paid by the party requesting same unless a violation of Applicable Requirements exists or is imminent or the inspection is requested or ordered by a governmental authority. In such case, Tenant shall upon request reimburse Landlord or Landlord's Lender, as the case may be, for the costs and expenses of such inspections. 6.5 HAZARDOUS MATERIALS DISCLOSURE CERTIFICATE. Prior to executing this Lease, Tenant has completed, executed and delivered to Landlord the Hazardous Material Disclosure Certificate (the "Hazardous Material Disclosure Certificate"), a copy of which is attached hereto as Exhibit D and incorporated herein by this reference. Tenant covenants, represents and warrants to Landlord that the information on the Hazardous Material Disclosure Certificate is true and correct and accurately describes the use(s) of Hazardous Substances, which will be made and/or used on the Premises by Tenant. 7. MAINTENANCE, REPAIRS, TRADE FIXTURES AND ALTERATIONS. 7.1 TENANT'S OBLIGATIONS. Subject to the provisions of Paragraph 7.2 (Landlord's Obligations), Paragraph 9 (Damage or Destruction) and Paragraph 14 (Condemnation), Tenant shall, at Tenant's sole cost and expense and at all times, keep the Premises and every part thereof in good order, condition and repair (whether or not such portion of the Premises requiring repair, or the means of repairing the same, are reasonable or readily accessible to Tenant and whether or not the need for such repairs occurs as a result of Tenant's use, any prior use, the elements or the age of such portion of the Premises) including, without limiting the generality of the foregoing, all equipment or facilities specifically serving the Premises, such as plumbing, heating, air conditioning, ventilating, electrical, lighting facilities, boilers, fired or unfired pressure vessels, fire hose connectors if within the Premises, fixtures, interior walls, interior surfaces of exterior walls, ceilings, floors, windows, doors, plate glass, skylights and dock doors related equipment (including but not limited to dock levelers, bumpers, lights and adjacent dock wells), but excluding any items which are the responsibility of Landlord pursuant to Paragraph 7.2 below. Tenant's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair. 7.2 LANDLORD'S OBLIGATIONS. Subject to the provisions of Paragraph 6 (Use), Paragraph 7.1 (Tenant's Obligations), Paragraph 9 (Damage or Destruction) and Paragraph 14 (Condemnation), Landlord at its expense and not subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the foundations and exterior walls of the Building and utility systems outside the Building. Landlord, subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the air conditioning systems servicing the Premises, Building roof and Common Areas. 7.3 ALTERATIONS. Tenant shall not make nor cause to be made any alterations, installations in, on, under or about the Premises without Landlord's prior written consent which consent shall not be unreasonably withheld or delayed. 7.4 SURRENDER/RESTORATION. Upon the termination of this Lease, Tenant shall surrender the Premises by the end of the last day of the Lease term or any earlier termination date, clean and free of debris and in good operating order, condition and state of repair ordinary wear and tear excepted. Without limiting the generality of the above, Tenant shall remove all 8 13 personal property, trade fixtures, unless Landlord requests, in writing, that Tenant not remove some or all of such fixtures (other than trade fixtures), additions or improvements installed by, or on behalf of Tenant or situated in or about the Premises and floor bolts, patch all floors and cause all lights to be in good operating condition. By the date which is sixty (60) days prior to such termination of this Lease, Landlord shall notify Tenant in writing of those fixtures (other than trade fixtures), alterations, additions and other improvements which Landlord shall require Tenant not to remove from the Premises. Tenant shall repair any damage caused by the installation or removal of such signs, trade fixtures, furniture, furnishings, fixtures, additions and improvements which are to be removed from the Premises by Tenant hereunder. If Landlord fails to so notify Tenant at least sixty (60) days prior to such termination of this Lease, then Tenant shall remove all tenant signage, alterations, furniture, furnishings, trade fixtures, additions and other improvements (other than the Tenant Improvements) installed in or about the Premises by, or on behalf of Tenant. Tenant shall ensure that the removal of such items and the repair of the Premises will be completed prior to such termination of this Lease. 8. INSURANCE; INDEMNITY. 8.1 PAYMENT OF PREMIUMS. The cost of the premiums for the insurance policies maintained by Landlord under this Paragraph 8 shall be a Common Area Operating Expense pursuant to Paragraph 4.2 hereof. Premiums for policy periods commencing prior to, or extending beyond, the term of this Lease shall be prorated to coincide with the corresponding Commencement Date of Expiration Date. 8.2 TENANT'S INSURANCE. (i) At its sole cost and expense, Tenant shall maintain in full force and effect during the Term of the lease the following insurance coverages insuring against claims which may arise from or in connection with the Tenant's operation and use of the leased premises. (a) Commercial General Liability with minimum limits of $1,000,000 per occurrence; $3,000,000 general aggregate for bodily injury, personal injury and property damage. If required by Landlord, liquor liability coverage will be included. (b) Workers' Compensation insurance with statutory limits and Employers Liability with a $1,000,000 per accident limit for bodily injury or disease. (c) Automobile Liability covering all owned, non-owned and hired vehicles with a $1,000,000 per accident limit for bodily injury and property damage. (d) Property insurance against all risks of loss to any tenant improvements or betterments and business personal property on a full replacement cost basis with no coinsurance penalty provision; and Business Interruption Insurance with a limit of liability representing loss of at least approximately six months of income. (ii) Tenant shall deliver to AMB or Landlord's property management company certificates of all insurance reflecting evidence of required coverages prior to initial occupancy; and annually thereafter. (iii) If, in the opinion of Landlord's insurance advisor, the amount of scope of such coverage is deemed inadequate at any time during the Term, Tenant shall increase such coverage to such reasonable amounts or scope as Landlord's advisor deems adequate. (iv) All insurance required under Paragraph 8.2 (i) shall be primary and non-contributory (ii) shall provide for severability of interests, (iii) shall be issued by insurers, licensed to do business in the state in which the Premises are located and which are rated A:VII or better by Best's Key Rating Guide, (iv) shall be endorsed to include Landlord and such other persons or entities as Landlord may from time to time designate, as additional insureds (Commercial General Liability only), and (v) shall be endorsed to provide at least 30-days prior notification of cancellation or material change in coverage to said additional insureds. 8.3 LANDLORD'S INSURANCE. Landlord may, but shall not be obligated to, maintain all risk, including earthquake and flood, insurance covering the buildings within the Business Center, Commercial General Liability and such other insurance in such amounts and covering such other liability or hazards as deemed appropriate by Landlord. The amount and scope of 9 14 coverage of Landlord's insurance shall be determined by Landlord as reasonable and customary from time to time in its sole discretion and shall be subject to such deductible amounts as Landlord may elect. Landlord shall have the right to reduce or terminate any insurance or coverage. Premiums for any such insurance shall be a Common Area Operating Expense. 8.4 WAIVER OF SUBROGATION. To the extent permitted by law and without affecting the coverage provided by insurance required to be maintained hereunder, Landlord and Tenant each waive any right to recover against the other on account of any and all claims Landlord or Tenant may have against the other with respect to property insurance actually carried, or required to be carried hereunder, to the extent of the proceeds realized from such insurance coverage. 8.5 INDEMNITY. Tenant shall protect, indemnify and hold the Landlord Entities harmless from and against any and all loss, claims, liability or costs (including court costs and attorney's fees) incurred by reason of: (i) any damage to any property (including but not limited to property of any Landlord Entity) or death or injury to any person occurring in or about the Premises, the Building or the Business Center to the extent that such injury or damage shall be caused by or arise from any actual or alleged act, neglect, fault or omission by or of Tenant, its agents, servants, employees, invitees, or visitors; (ii) the conduct or management of any work or anything whatsoever done by the Tenant on or about the Premises or from transactions of the Tenant concerning the Premises; (iii) Tenant's failure to comply with any and all governmental laws, ordinances and regulations applicable to the condition or use of the Premises or its occupancy; or (iv) any breach or default of the part of Tenant in the performance of any covenant or agreement on the part of the Tenant to be performed pursuant to this Lease. The provisions of this Paragraph 8.5 shall survive the termination of this Lease with respect to any claims or liability accruing prior to such termination. 8.6 EXEMPTION OF LANDLORD FROM LIABILITY. Except to the extent caused by the gross negligence or willful misconduct of Landlord, Landlord Entities shall not be liable for and Tenant waives any claims against Landlord Entities for injury or damage to the person or the property of Tenant, Tenant's employees, contractors, invitees, customers or any other person in or about the Premises, Building or Business Center from any cause whatsoever, including, but not limited to, damage or injury which is caused by or results from (i) fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures or (ii) from the condition of the Premises, other portions of the Building or Business Center. Landlord shall not be liable for any damages arising from any act or neglect of any other tenant of Landlord nor from the failure by Landlord to enforce the provisions of any other lease in the Business Center. Notwithstanding Landlord's negligence or breach of this Lease, Landlord shall under no circumstances be liable for injury to Tenant's business, for any loss of income or profit therefrom or any indirect, consequential or punitive damages. 9. DAMAGE OR DESTRUCTION. 9.1 TERMINATION RIGHT. Tenant shall give Landlord immediate written notice of any damage to the Premises. Subject to the provisions of Paragraph 9.2, if the Premises or the Building shall be damaged to such an extent that there is substantial interference for a period exceeding 120 consecutive days with the conduct by Tenant of its business at the Premises, Tenant, at any time prior to commencement of repair of the Premises and following 10 days written notice to Landlord, may terminate this Lease effective 30 days after delivery of such notice to Landlord. Such termination shall not excuse the performance by Tenant of those covenants, which under the terms hereof survive termination. Rent shall be abated in proportion to the degree of interference during the period that there is such substantial interference with the conduct of Tenant's business at the Premises. Abatement of rent and Tenant's right of termination pursuant to this provision shall be Tenant's sole remedy for failure of Landlord to keep in good order, condition and repair the foundations and exterior walls of the Building, Building roof, utility systems outside the Building, the Common Areas and HVAC. 10 15 9.2 DAMAGE CAUSED BY TENANT. Tenant's termination rights under Paragraph 9.1 shall not apply if the damage to the Premises or Building is the result of any act or omission of Tenant or of any of Tenant's agents, employees, customers, invitees or contractors ("Tenant Acts"). Any damage resulting from a Tenant Act shall be promptly repaired by Tenant. Landlord at its option may at Tenant's expense repair any damage caused by Tenant Acts. Tenant shall continue to pay all rent and other sums due hereunder and shall be liable to Landlord for all damages that Landlord may sustain resulting from a Tenant Act. 10. REAL PROPERTY TAXES. 10.1 PAYMENT OF REAL PROPERTY TAXES. Landlord shall pay the Real Property Taxes due and payable during the term of this Lease and, except as otherwise provided in Paragraph 10.3, any such amounts shall be included in the calculation of Operating Expenses in accordance with the provisions of Paragraph 4.2. 10.2 REAL PROPERTY TAX DEFINITION. As used herein, the term "Real Property Taxes" is any form of tax or assessment, general, special, ordinary or extraordinary, imposed or levied upon (a) the Business Center, (b) any interest of Landlord in the Business Center, (c) Landlord's right to rent or other income from the Business Center, and/or (d) Landlord's business of leasing the Premises. Real Property Taxes include (i) any license fee, commercial rental tax, excise tax, improvement bond or bonds, levy or tax; (ii) any tax or charge which replaces or is in addition to any of such above-described "Real Property Taxes" and (iii) any fees, expenses or costs (including attorney's fees, expert fees and the like) incurred by Landlord in protesting or contesting any assessments levied or any tax rate. The term "Real Property Taxes" shall also include any increase resulting from a change in the ownership of the Business Center or Building, or the improvements thereon, the execution of this Lease or any modification, amendment or transfer thereof. Real Property Taxes for tax years commencing prior to, or extending beyond, the term of this Lease shall be prorated to coincide with the corresponding Commencement Date of Expiration Date. Real Estate Taxes shall specifically exclude any Federal and State income taxes. 10.3 JOINT ASSESSMENT. If the Building is not separately assessed, Real Property Taxes allocated to the Building shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed. 10.4 TENANT'S PROPERTY TAXES. Tenant shall pay prior to delinquency all taxes assessed against and levied upon Tenant's improvements, fixtures, furnishings, equipment and all personal property of Tenant contained in the Premises or stored within the Business Center. 11. UTILITIES. Tenant shall pay directly for all utilities and services supplied to the Premises, including but not limited to electricity, telephone, security, gas and cleaning of the Premises, together with any taxes thereon. 12. ASSIGNMENT AND SUBLETTING. 12.1 LANDLORD'S CONSENT REQUIRED. (a) Except as expressly set forth herein with respect to an Affiliated company (as hereinafter defined), Tenant shall not assign, transfer, mortgage or otherwise transfer or encumber (collectively, "assign") or sublet all or any part of Tenant's interest in this Lease or in the Premises without Landlord's prior written consent which consent shall not be unreasonably withheld. Relevant criteria in determining reasonability of consent include, but are not limited to, credit history of a proposed assignee or sublessee, references from prior landlords, any change or intensification of use of the Premises or the Common Areas and any limitations imposed by the Internal Revenue Code and the Regulations promulgated thereunder relating to Real Estate Investment Trusts. Assignment or sublet shall not release Tenant from its obligations hereunder. Tenant shall not (i) sublet or assign or enter into other arrangements such that the amounts to be paid by the sublessee or assignee thereunder would be based, in whole or in part, on the income or profits derived by the business activities of the sublessee or assignee; (ii) sublet the Premises or assign this Lease to any person in which Landlord owns an interest, directly or indirectly (by applying constructive ownership rules set forth in Section 856(d)(5) of the Internal Revenue Code (the "Code"); or (iii) sublet the Premises or assign this Lease in any other manner which could cause any portion of the amounts received by Landlord pursuant to this Lease or any sublease to fail to qualify as "rents from real property" within the meaning of 11 16 Section 856(d) of the Code, or which could cause any other income received by Landlord to fail to qualify as income described in Section 856(c)(2) of the Code. The requirements of this Section 12.1 shall apply to any further subleasing by any subtenant. (b) A change in the control of Tenant shall constitute an assignment requiring Landlord's consent. The transfer, on a cumulative basis, of 40% or more of the voting or management control of Tenant shall constitute a change in control for this purpose. 12.2 RENT ADJUSTMENT. As of the effective date of any permitted assignment or subletting, Landlord may, as a condition to its consent: (i) require that the amount and adjustment schedule of the rent payable on the portion of the Premises under this Lease subject to the sublease or assignment be adjusted to what is then the market value and/or adjustment schedule for property similar to the Premises as then constituted, as determined by Landlord (or, in the event of a sublease, the portion of the Premises subject to such sublease (and for the term of such sublease)); or (ii) terminate the Lease as of the date of assignment or subletting subject to the performance by Tenant of those covenants which under the terms hereof survive termination if (i) the permitted assignment or subletting by itself or taken together with then existing or pending assignment or subleases covers or totals, as the case may be, more than forty three percent (43%) of the rentable square feet of the Premises, or (ii) if for a term which by itself or taken together with the then existing or pending assignment or subleases is greater than fifty percent (50%) of the period then remaining in the term of this Lease as of the time of the effective date then Landlord shall have the right, to be exercised by giving written notice to tenant to recapture the proposed subleased or assigned space. 12.3 EXCESS CONSIDERATION. In the event of any assignment or sublease, Landlord shall receive as additional rent hereunder fifty percent (50%) of Tenant's "Excess Consideration" derived from such assignment or sublease. If Tenant shall elect to assign or sublet, Tenant shall use reasonable and good faith efforts to secure consideration from any such assignee or subtenant which would be generally equivalent to then-current market rent, but in no event shall Tenant's monetary obligations to Landlord, as set forth in this Lease, be reduced. In the event of a sublease, "Excess Consideration" shall mean all rent, additional rent or other consideration actually received by Tenant from such subtenant and/or actually paid by such subtenant on behalf of Tenant in connection with the subletting in excess of the rent, additional rent and other sums payable by Tenant under this Lease during the term of the sublease on a per square foot basis if less than all of the Premises is subleased, less marketing costs, attorneys' fees and brokerage commissions, if any, reasonably incurred by Tenant to procure the sublease, and the cost of any alterations made by Tenant specifically for the benefit of such subtenant. In the event of an assignment, "Excess Consideration" shall mean key money, bonus money or other consideration paid by the assignee to Tenant in connection with such assignment, and any payment in excess of fair market value for services rendered by Tenant to assignee or for assets, fixtures, inventory, equipment, or furniture transferred by Tenant to assignee in connection with such assignment, less marketing costs, attorneys' fees and brokerage commissions, if any, reasonably incurred by Tenant to procure the assignment, and the cost of any alterations made by Tenant specifically for the benefit of such assignee. If part of the Excess Consideration shall be payable by the assignee or subtenant other than in case, then Landlord's share of such non-cash consideration shall be in such form as is reasonably satisfactory to Landlord. 12.4 AFFILIATED. Companies/Restructuring of Business Organization . The assignment or subletting by Tenant of all or any portion of this Lease or the Premises to (i) a parent or subsidiary of Tenant, or (ii) any person or entity which controls, is controlled by or under the common control with Tenant, or (iii) any entity which purchases all or substantially all of the assets of Tenant, or (iv) any entity into which Tenant is merged or consolidated (all such persons or entities described in clauses (i), (ii), (iii) and (iv) being sometimes herein referred to as "Affiliate") shall not be deemed a sublet or assign under Section 12 (hence, the aforesaid events shall not be subject to obtaining Landlord's prior consent; Landlord shall not have any right to receive any Excess Consideration in connection therewith; and Landlord shall not have the termination rights described in Section 12.2 above), provided in all instances that: 12.4.1 any such Affiliate was not formed as a subterfuge to avoid the obligations of this Section 12; 12.4.2 Tenant give Landlord prior notice of any such assignment or sublease to an Affiliate; 12.4.3 the successor of Tenant has as of the effective date of any such assignment or sublease a tangible net worth and net assets, in the aggregate, computed in accordance with generally accepted accounting principles (but excluding goodwill as an asset), which is sufficient to meet the obligations of Tenant under this Lease, as reasonably determined by Landlord; 12 17 12.4.4 any such assignment or sublease shall be subject to all of the terms and provisions of this Lease, and such assignee or sublessee (i.e. any such Affiliate), other than in the case of an Affiliate resulting from a merger or consolidation as described in Section 12.4(iv) above, shall assume, in a written document reasonably satisfactory to Landlord and delivered to Landlord upon or prior to the effective date of such assignment or sublease, all the obligations of Tenant under this Lease; and 12.4.5 Tenant and any guarantor shall remain fully liable for all obligations to be performed by Tenant under this Lease, except in the case of an Affiliate resulting from the acquisition of all or substantially all of the assets of Tenant described in Section 12.4(iii) or from a merger or consolidation as described in Section 12.4(iv) above. For purposes hereof, if Tenant is a publicly held corporation, the public offering or trading of stock shall not be deemed an assignment or transfer within the meaning of this paragraph. If Tenant is a business entity, direct or indirect transfer of fifty percent (50%) or more of the ownership interest of the entity (whether in a single transaction or in the aggregate through more than one transaction) to any party other than an Affiliate in accordance with the provisions of Section 12.4 hereof shall be deemed an assignment or sublease to a non-affiliated company and shall be subject to all the provisions set forth in Sections 12.1, 12.2, & 12.3. 13. DEFAULT; REMEDIES. 13.1 DEFAULT. The occurrence of any one of the following events shall constitute an event of default on the part of Tenant ("Default"): (a) The abandonment of the Premises by Tenant; (b) Failure to pay any installment of Base Rent, Additional Rent or any other monies due and payable hereunder, said failure continuing for a period of 5 days after delivery of written notice from Landlord that said payment is due. Tenant agrees that such written notice shall serve as the statutorily required notice under the law; (c) A general assignment by Tenant or any guarantor for the benefit of creditors; (d) The filing of a voluntary petition in bankruptcy by Tenant or any guarantor, the filing of a voluntary petition for an arrangement, the filing of a petition, voluntary or involuntary, for reorganization, or the filing of an involuntary petition by Tenant's creditors or guarantors; (e) Receivership, attachment, of other judicial seizure of the Premises or all or substantially all of Tenant's assets on the Premises; (f) Failure of Tenant to maintain insurance as required by Paragraph 8.2; (g) Any breach by Tenant of its covenants under Paragraph 6.2; (h) Failure in the performance of any of Tenant's covenants, agreements or obligations hereunder (except those failures specified as events of Default in other Paragraphs of this Paragraph 13.1 which shall be governed by such other Paragraphs), which failure continues for 10 days after written notice thereof from Landlord to Tenant provided that, if Tenant has exercised reasonable diligence to cure such failure and such failure cannot be cured within such 10 day period despite reasonable diligence, Tenant shall not be in default under this subparagraph unless Tenant fails thereafter diligently and continuously to prosecute the cure to completion; (i) Any transfer of a substantial portion of the assets of Tenant, or any incurrence of a material obligation by Tenant, unless such transfer or obligation is undertaken or incurred in the ordinary course of Tenants business or in good faith for equivalent consideration, or with Landlord's consent; and (j) The default of any guarantors of Tenant's obligations hereunder under any guaranty of this Lease, or the attempted repudiation or revocation of any such guaranty. 13 18 13.2 REMEDIES. In the event of any Default by Tenant, Landlord shall have the remedies set forth in the Addendum attached hereto entitled "Landlord's Remedies in Event of Tenant Default". 13.3 LATE CHARGES. Tenant hereby acknowledges that late payment by Tenant to Landlord of rent and other sums due hereunder will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges. Accordingly, if any installment of rent or other sum due from Tenant shall not be received by Landlord or Landlord's designee within 5 days after such amount shall be due, then, without any requirement for notice to Tenant, Tenant shall pay to Landlord a late charge equal to 5% of such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of late payment by Tenant. Acceptance of such late charge by Landlord shall in no event constitute a waiver of Tenant's Default with respect to such overdue amount, nor prevent Landlord from exercising any of the other rights and remedies granted hereunder. 14. CONDEMNATION. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of exercise of said power (all of which are herein called "condemnation"), this Lease shall terminate as to the part so taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than 10% of the floor area of the Premises, or more than 25% of the portion of the Common Areas designated for Tenant's parking, is taken by condemnation, Tenant may, at Tenant's option, to be exercised in writing within 10 days after Landlord shall have given Tenant written notice of such taking (or in the absence of such notice, within 10 days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Tenant does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in the same proportion as the rentable floor area of the Premises taken bears to the total rentable floor area of the Premises. No reduction of Base Rent shall occur if the condemnation does not apply to any portion of the Premises. Any award for the taking of all or any part of the Premises under the power of eminent domain or any payment made under threat of the exercise of such power shall be the property of Landlord, provided, however, that Tenant shall be entitled to any compensation, separately awarded to Tenant for Tenant's relocation expenses and/or loss of Tenants trade fixtures. In the event that this Lease is not terminated by reason of such condemnation, Landlord shall to the extent of its net severance damages in the condemnation matter, repair any damage to the Premises caused by such condemnation authority. Tenant shall be responsible for the payment of any amount in excess of such net severance damages required to complete such repair. 15. ESTOPPEL CERTIFICATE AND FINANCIAL STATEMENTS. 15.1 ESTOPPEL CERTIFICATE. Each party (herein referred to as "Responding Party") shall within 10 days after written notice from the other Party (the "Requesting Party") execute, acknowledge and deliver to the Requesting Party, to the extent it can truthfully do so, an estoppel certificate in the form attached hereto, plus such additional information, confirmation a/or statements as be reasonably requested by the Requesting Party. 15.2 FINANCIAL STATEMENT. If Landlord desires to finance, refinance, or sell the Building, Business Center or any part thereof, Tenant and all Guarantors shall deliver to any potential lender or purchaser designated by Landlord such financial statements of Tenant and such Guarantors as may be reasonably required by such lender or purchaser, including but not limited to Tenant's financial statements for the past 3 years. All such financial statements shall be received by Landlord and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. 16. ADDITIONAL COVENANTS AND PROVISIONS. 16.1 SEVERABILITY. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall not affect the validity of any other provision hereof. 16.2 INTEREST ON PAST-DUE OBLIGATIONS. Any monetary payment due Landlord hereunder not received by Landlord within 10 days following the date on which it was due shall 14 19 bear interest from the date due at 12% per annum, but not exceeding the maximum rate allowed by law in addition to the late charge provided for in Paragraph 13.3. 16.3 TIME OF ESSENCE. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 16.4 LANDLORD LIABILITY. Tenant, its successors and assigns, shall not assert nor seek to enforce any claim for breach of this Lease against any of Landlord's assets other than Landlord's interest in the Business Center. Tenant agrees to look solely to such interest for the satisfaction of any liability or claim against Landlord under this Lease. In no event whatsoever shall Landlord (which term shall include, without limitation, any general or limited partner, trustees, beneficiaries, officers, directors, or stockholders of Landlord) ever be personally liable for any such liability. 16.5 NO PRIOR OR OTHER AGREEMENTS. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and supersedes all oral, written prior or contemporaneous agreements or understandings. 16.6 NOTICE REQUIREMENTS. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by messenger or courier service) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission during normal business hours, and shall be deemed sufficiently given if served in a manner specified in the Paragraph 16.6. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notice purposes. Either Party may by written notice to the other specify a different address for notice purposes, except that upon Tenant's taking possessing of the Premises, the Premises shall constitute Tenant's address for the purpose of mailing or delivering notices to Tenant. A copy of all notices required or permitted to be given to Landlord hereunder shall be concurrently transmitted to such party or parties at such addresses as Landlord may from time to time hereafter designate by written notice to Tenant. 16.7 DATE OF NOTICE. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail, the notice shall be deemed given 48 hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantees next day delivery shall be deemed given 24 hours after delivery of the same to the United States Postal Service or courier. If any notice is transmitted by facsimile transmission or similar means, the same shall be deemed served or delivered upon telephone or facsimile confirmation of receipt of the transmission thereof, provided a copy is also delivered via hand or overnight delivery or certified mail. If notice is received on a Saturday or a Sunday or a legal holiday, it shall be deemed received on the next business day. 16.8 WAIVERS. No waiver by Landlord of a Default by Tenant shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default by Tenant of the same or any other term, covenant or condition hereof. 16.9 HOLDOVER. Tenant has no right to retain possession of the Premises or any part thereof beyond the expiration or earlier termination of this Lease. If Tenant holds over with the consent of Landlord: (i) the Base Rent payable shall be increased to 175% of the Base Rent applicable during the month immediately preceding such expiration or earlier termination; (ii) Tenant's right to possession shall terminate on 30 days notice from Landlord and (iii) all other terms and conditions of this Lease shall continue to apply. Nothing contained herein shall be construed as a consent by Landlord to any holding over by Tenant. Tenant shall indemnify, defend and hold Landlord harmless from and against any and all claims, demands, actions, losses, damages, obligations, costs and expenses, including, without limitation, attorneys' fees incurred or suffered by Landlord by reason of Tenant's failure to surrender the Premises on the expiration or earlier termination of this Lease in accordance with the provisions of this Lease. 16.10 CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies in law or in equity. 15 20 16.11 BINDING EFFECT: CHOICE OF LAW. This Lease shall be binding upon the Parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 16.12 LANDLORD. The covenants and obligations contained in this Lease on the part of Landlord are binding on Landlord, its successors and assigns, only during and in respect of their respective period of ownership of such interest in the Business Center. In the event of any transfer or transfers of such title to the Business Center, Landlord (and in case of any subsequent transfers or conveyances, the then grantor) shall be concurrently freed and relieved from and after the date of such transfer or conveyance, without any further instrument or agreement, of all liability with respect to the performance of any covenants or obligations on the part of Landlord contained in this Lease thereafter to be performed. 16.13 ATTORNEYS' FEES AND OTHER COSTS. If any Party brings an action or proceeding to enforce the terms hereof or declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding shall be entitled to reasonable attorneys' fees. The term "Prevailing Party" shall include, without limitation, a Party who substantially obtains or defeats the relief sought. Landlord shall be entitled to attorneys' fees, costs and expenses incurred in preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting breach. Tenant shall reimburse Landlord on demand for all reasonable legal, engineering and other professional services expenses incurred by Landlord in connection with all requests by Tenant for consent or approval hereunder. 16.14 LANDLORD'S ACCESS; SHOWING PREMISES; REPAIRS. Landlord and Landlord's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times upon reasonable notice for the purpose of showing the same to prospective purchasers, lenders, or tenants, and making such alterations, repairs, improvements or additions to the Premises or to the Building, as Landlord may reasonably deem necessary. Landlord may at any time place on or about the Premises or Building any ordinary "For Sale" signs and Landlord may at any time during the last 180 days of the term hereof place on or about the Premises any ordinary "For Lease" signs. All such activities of Landlord shall be without abatement of rent or liability to Tenant. 16.15 SIGNS. Tenant shall not place any signs at or upon the exterior of the Premises or the Building, except that Tenant may, with Landlord's prior written consent, install (but not on the roof) such signs as are reasonably required to advertise Tenant's own business so long as such signs are in a location designated by Landlord and comply with sign ordinances and the signage criteria established for the Business Center by Landlord. 16.16 TERMINATION: MERGER. Unless specifically stated otherwise in writing by Landlord, the voluntary or other surrender of this Lease by Tenant, the mutual termination or cancellation hereof, or a termination hereof by Landlord for Default by Tenant, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, Landlord shall, in the event of any such surrender, termination or cancellation, have the option to continue any one or all of any existing subtenancies. Landlord's failure within 10 days following any such event to make a written election to the contrary by written notice to the holder of any such lesser interest, shall constitute Landlord's election to have such event constitute the termination of such interest. 16.17 QUIET POSSESSION. Upon payment by Tenant of the Base Rent and Additional Rent for the Premises and the performance of all of the covenants, conditions and provisions on Tenant's part to be observed and performed under this Lease, Tenant shall have quiet possession of the Premises for the entire term hereof subject to all of the provisions of this Lease. 16.18 SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. (a) Subordination. This Lease shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or mortgage (collectively, "Mortgage") now or hereafter placed by Landlord upon the real property of which the Premises are a part, to any and all advances made on the security thereof and to all renewals, modifications, consolidations, replacements and extensions thereof. Tenant agrees that any person holding any 16 21 Mortgage shall have no duty, liability or obligation to perform any of the obligations of Landlord under this Lease. In the event of Landlord's default with respect to any such obligation, Tenant will give any Lender, whose name and address have previously in writing been furnished Tenant, notice of a default by Landlord. Tenant may not exercise any remedies for default by Landlord unless and until Landlord and the Lender shall have received written notice of such default and a reasonable time (not less than 90 days) shall thereafter have elapsed without the default having been cured. If any Lender shall elect to have this Lease superior to the lien of its Mortgage and shall give written notice thereof to Tenant, this Lease shall be deemed prior to such Mortgage. The provisions of a Mortgage relating to the disposition of condemnation and insurance proceeds shall prevail over any contrary provisions contained in this Lease. (b) Attornment. Subject to the non-disturbance provisions of subparagraph C of this Paragraph 16.18, Tenant agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Mortgage. In the event of such foreclosure, such new owner shall not: (i) be liable for any act or omission of any prior landlord or with respect to events occurring prior to acquisition of ownership, (ii) be subject to any offsets or defenses which Tenant might have against any prior Landlord, or (iii) be liable for security deposits or be bound by prepayment of more than one month's rent. (c) Non-Disturbance. With respect to Mortgage entered into by Landlord after the execution of this Lease, Tenant's subordination of this Lease shall be subject to receiving assurance (a "non-disturbance agreement") from the Mortgage holder that Tenant's possession and this Lease will not be disturbed so long as Tenant is not in default and attorns to the record owner of the Premises. (d) Self-Executing. The agreements contained in this Paragraph 16.18 shall be effective without the execution of any further documents; provided, however, that upon written request from Landlord or a Lender in connection with a sale, financing or refinancing of Premises, Tenant and Landlord shall execute such further writings as may be reasonably required to separately document any such subordination or non-subordination, attornment and/or non-disturbance agreement as is provided for herein. Landlord is hereby irrevocably vested with full power to subordinate this Lease to a Mortgage. 16.19 RULES AND REGULATIONS. Tenant agrees that it will abide by, and to cause its employees, suppliers, shippers, customers, tenants, contractors and invitees to abode by all the rules and regulations attached hereto as Exhibit C ("Rules and Regulations") which Landlord may change from time to time for the management, safety, care, and cleanliness of the Common Areas, the parking and unloading of vehicles and the preservation of good order, as well as for the convenience of other occupants or tenants of the Building and the Business Center and their invitees. Landlord shall not be responsible to Tenant for the non-compliance with said Rules and Regulations by other tenants of the Business Center. 16.20 SECURITY MEASURES. Tenant acknowledges that the rental payable to Landlord hereunder does not include the cost of guard service or other security measures. Landlord has no obligations to provide same. Tenant assumes all responsibility for the protection of the Premises, Tenant, its agents and invitees and their property from the acts of third parties. 16.21 RESERVATIONS. Landlord reserves the right to grant such easements that Landlord deems necessary and to cause the recordation of parcel maps, so long as such easements and maps do not reasonably interfere with the use of the Premises by Tenant. Tenant agrees to sign any documents reasonable requested by Landlord to effectuate any such easements or maps. 16.22 CONFLICT. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 16.23 OFFER. Preparation of this Lease by either Landlord or Tenant or Landlord's agent or Tenant's agent and submission of same to Tenant or Landlord shall not be deemed an offer to lease. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 16.24 AMENDMENTS. This Lease may be modified only in writing, signed by the parties in interest at the time of the modification. 17 22 16.25 MULTIPLE PARTIES. Except as otherwise expressly provided herein, if more than one person or entity is named herein as Tenant, the obligations of such persons shall be the joint and several responsibility of all persons or entities named herein as such Tenant. 16.26 AUTHORITY. Each person signing on behalf of Landlord or Tenant warrants and represents that she or is authorized to execute and deliver this Lease and to make it a binding obligation of Landlord or Tenant. 17. LETTER OF CREDIT. By no later than August 1, 2001, in accordance with the provisions of Sections 1.4 and 4.1 above, Tenant shall deliver to Landlord, as collateral for the full and faithful performance by Tenant of all of its obligations under this Lease and for all losses and damages Landlord may suffer as a result of any default by Tenant under this Lease, an irrevocable and unconditional negotiable letter of credit, in the form and containing the terms required herein, payable in the City of Foster City, California (or in addition you may state "payable in the County of San Mateo") running in favor of Landlord issued by a solvent nationally recognized bank with a long term rating of BBB or higher, under the supervision of the Superintendent of Banks of the State of California, or a National Banking Association, in the amount of Two Million and 00/100 Dollars ($2,000,000.00) (the "Two Million Dollar Letter of Credit"). By no later than August 1, 2002, Tenant shall increase the Two Million Dollar Letter of Credit by One Million Dollars ($1,000,000.00) (the "Three Million Dollar Letter of Credit"). By no later than August 1, 2003, Tenant shall increase the Three Million Dollar Letter of Credit by One Million Dollars ($1,000,000.00) (the "Four Million Dollar Letter of Credit"). On August 1, 2007, provided Tenant has not been in default of any term of this Lease (following notice and an opportunity to cure as set forth in this Lease), Landlord will agree to allow Tenant to reduce the Four Million Dollar Letter of Credit by Two Million Dollars ($2,000,000.00). Subject to the foregoing, the Letters of Credit referenced above (hereinafter referred to as the "Letter of Credit") shall be (a) at sight and irrevocable and unconditional, (b) maintained in effect, whether through replacement, renewal or extension, for the entire Lease Term (the "Letter of Credit Expiration Date") and Tenant shall deliver a new Letter of Credit or certificate of renewal or extension to Landlord at least thirty (30) days prior to the expiration of the Letter of Credit, without any action whatsoever on the part of Landlord, (c) subject to the Uniform Customs and Practices for Documentary Credits (1993-Rev) International Chamber of Commerce Publication #500, (d) acceptable to Landlord in its sole discretion, and (e) fully assignable by Landlord and permit partial draws. In addition to the foregoing, the form and terms of the Letter of Credit (and the bank issuing the same) shall be acceptable to Landlord, in Landlord's sole discretion, and shall provide, among other things, in effect that: (1) Landlord, or its then managing agent, shall have the right to draw down an amount up to the face amount of the Letter of Credit upon the presentation to the issuing bank of Landlord's (or Landlord's then managing agent's) statement that such amount is due to Landlord under the terms and conditions of this Lease, it being understood that if Landlord or its managing agent be a limited liability company, corporation, partnership or other entity, then such statement shall be signed by a managing member (if a limited liability company) an officer (if a corporation), a general partner (if a partnership), or any authorized party (if another entity); (2) the Letter of Credit will be honored by the issuing bank without inquiry as to the accuracy thereof and regardless of whether the Tenant disputes the content of such statement; and (3) in the event of a transfer of Landlord's interest in the Building, Landlord shall transfer the Letter of Credit, in whole or in part (or cause a substitute letter of credit to be delivered, as applicable), to the transferee and thereupon the Landlord shall, without any further agreement between the parties, be released by Tenant from all liability therefor, and it is agreed that the provisions hereof shall apply to every transfer or assignment of the whole or any portion of said Letter of Credit to a new Landlord. Tenant hereby acknowledges and agrees that Landlord is entering into this Lease in material reliance upon the ability of Landlord to draw upon the Letter of Credit upon the occurrence of any default on the part of Tenant hereunder which continues beyond any applicable notice and cure periods. Tenant further acknowledges and agrees that if Landlord cannot draw upon the Letter of Credit within the times and in the manner as anticipated by Landlord herein, Landlord shall suffer irreparable damage, harm and injury. From time to time during the Term of this Lease it is anticipated by the parties that the Letter of Credit will need to be amended, modified and, possibly reissued. Landlord and Tenant hereby covenant and agree to cooperate with one another to promptly effectuate any such amendments, modifications and new issuances, including without limitation, executing and submitting to the Issuer any and all documents or instruments as may be reasonably required to effectuate same. Each and every time during the Term of this Lease there is a change in the identity or address of the parties, including without limitation, any change in the identity of 18 23 Landlord due to the sale, transfer or other conveyance by Landlord of its rights and interests in, to and under this Lease to any other party, person or entity, the Letter of Credit shall immediately be amended or reissued to reflect such changes and the parties hereby agree to execute and submit to the Issuer such further applications, documents and instruments as may be necessary to effectuate same. It is the intention of the parties that each and every successor and assign of both Landlord and Tenant be bound by and subject to the terms and provisions of this Section 17. Landlord may, at any time and without notice to Tenant and without first obtaining Tenant's consent thereto, assign all or any portion of its interest in and to the Letter of Credit to another party, person or entity, regardless of whether or not such assignment is separate from or as a part of the assignment by Landlord of its rights and interests in and to this Lease. If, as a result of any such application of all or any part of the Letter of Credit, the amount of the Letter of Credit shall be less than the face amount of the Letter of Credit (the "Face Amount") then required of Tenant pursuant to the foregoing, Tenant shall within five (5) days thereafter provide Landlord with additional letter(s) of credit in an amount equal to the deficiency (or a replacement letter of credit in the Face Amount and each such additional (or replacement) letter of credit shall comply with all of the provisions of this Section 17, and if Tenant fails to do so, notwithstanding anything to the contrary contained in Section 13 hereof, the same shall constitute an incurable default by Tenant. Tenant further covenants and warrants that it will neither assign nor encumber the Letter of Credit or any part thereof and that neither Landlord nor its successors or assigns will be bound by any such assignment, encumbrance, attempted assignment or attempted encumbrance. Without limiting the generality of the foregoing, if the Letter of Credit expires earlier than the Letter of Credit Expiration Date, Landlord will accept a renewal thereof or substitute letter of credit (such renewal or substitute letter of credit to be in effect not later than thirty (30) days prior to the expiration thereof), which shall be irrevocable and automatically renewable as above provided through the Letter of Credit Expiration Date upon the same terms as the expiring letter of credit or such other terms as may be acceptable to Landlord in its sole discretion. However, if the Letter of Credit is not timely renewed or a substitute letter of credit is not timely received, or if Tenant fails to maintain the Letter of Credit in the amount and terms set forth in this Section 17, Landlord shall have the right to present such Letter of Credit to the bank in accordance with the terms of this Section 17, and the entire sum evidenced thereby shall be paid to and held by Landlord as collateral for performance of all of Tenant's obligations under this Lease and for all losses and damages Landlord may suffer as a result of any default by Tenant under this Lease. If there shall occur a default under this Lease as set forth in Section 13 of this Lease, Landlord may, but without obligation to do so, draw upon the Letter of Credit, in part or in whole, to cure any default of Tenant and/or to compensate Landlord for any and all damages of any kind or nature sustained or which may be sustained by Landlord resulting from Tenant's default. Tenant agrees not to interfere in any way with payment to Landlord of the proceeds of the Letter of Credit, either prior to or following a "draw" by Landlord of any portion of the Letter of Credit, regardless of whether any dispute exists between Tenant and Landlord as to Landlord's right to draw from the Letter of Credit. No condition or term of this Lease shall be deemed to render the Letter of Credit conditional to justify the issuer of the Letter of Credit in failing to honor a drawing upon such Letter of Credit in a timely manner. Landlord and Tenant acknowledge and agree that in no event or circumstance shall the Letter of Credit or any renewal thereof or substitute therefor be (i) deemed to be or treated as a "security deposit" within the meaning of California Civil Code Section 1950.7 (as supplemented, amended, replaced and substituted from time to time), (ii) subject to the terms of such Section 1950.7 (as supplemented, amended, replaced and substituted from time to time), or (iii) intended to serve as a "security deposit" within the meaning of such Section 1950.7 (as supplemented, amended, replaced and substituted from time to time). The parties hereto recite that with respect to the Letter of Credit, (x) the Letter of Credit is not intended to serve as a security deposit and such Section 1950.7 (as supplemented, amended, replaced and substituted from time to time), and any and all other laws, rules and regulations applicable to security deposits in the commercial context ("Security Deposit Laws") shall have no applicability or relevancy to the Letter of Credit and (y) Tenant waives any and all rights, duties and obligations it may now or, in the future, will have relating to or arising from the Security Deposit Laws. The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures. Landlord: Tenant: 19 24 AMB PROPERTY, L.P., HYSEQ, INC., a Delaware limited partnership a Nevada corporation By: AMB PROPERTY CORPORATION, a Maryland corporation, its general partner By: /s/ JOHN L. ROSSI By: /s/ MARK GILTER -------------------------------- ---------------------------- John L. Rossi Mark Gilter Its: Vice President Its: Chief Financial Officer --------------------------- Executed at: San Francisco, CA Executed at: Sunnyvale, CA ------------------------------- ------------------- on: July 17, 2000 on: July 7, 2000 ---------------------------------------- ---------------------------- Landlord's Address: Tenant's Address: 505 Montgomery Street, 5th Floor San Francisco, CA 94111 With a copy to: Tenant's Address: Legacy Partners Commercial, Inc. 675 Almanor 101 Lincoln Center Drive/4th Floor ------------------------------- Foster City, California 94404 Sunnyvale, CA 94085 Attention: Humboldt Business Center ------------------------------- Phone: (650) 571-2200 FAX: (650) 571-2211 20 25 EXHIBIT A DIAGRAM OF PREMISES 26 EXHIBIT B COMMENCEMENT DATE CERTIFICATE LANDLORD: AMB PROPERTY, L.P. TENANT: ------------------------------------------------ LEASE DATE: ------------------------------------------------ PREMISES: ------------------------------------------------ ------------------------------------------------ Tenant hereby accepts the Premises as being in the condition required under the Lease. The Commencement Date of the Lease is _______________________, ____. The Expiration Date of the Lease is _______________________, ____. Landlord: Tenant: AMB PROPERTY, L.P., __________________________________ a Delaware limited partnership __________________________________ By: AMB PROPERTY CORPORATION, a Maryland corporation, its general partner By:_________________________ By: ______________________________ John L. Rossi ______________________________ Its: Vice President Its: Vice President Executed at:________________________ Executed at:______________________ on:_________________________________ on:_______________________________ B-1 27 EXHIBIT C RULES & REGULATIONS 1. No advertisement, picture or sign of any sort shall be displayed on or outside the Premises or the Building without the prior written consent of Landlord. Landlord shall have the right to remove any such unapproved item without notice and at Tenant's expense. 2. Tenant shall not regularly park motor vehicles in designated parking areas after the conclusion of normal daily business activity. 3. Tenant shall not use any method of heating or air conditioning other than that supplied by Landlord without the prior written consent of Landlord, which shall not be unreasonably withheld. 4. All window coverings installed by Tenant and visible from the outside of the Building require the prior written approval of Landlord. 5. Tenant shall not use, keep or permit to be used or kept any foul or noxious gas or substance or any flammable or combustible materials on or around the Premises, the Building or the Business Center, except as expressly permitted by Tenant's Hazardous Materials Plan and disclosed in accordance with Exhibit D - Hazardous Materials Disclosure Certificate. 6. Tenant shall not alter any lock or install any new locks or bolts on any door at the Premises without the prior consent of Landlord. 7. Tenant agrees not to make any duplicate keys without the prior consent of Landlord. 8. Tenant shall park motor vehicles in those general parking areas as designated by Landlord except for loading and unloading. During those periods of loading and unloading, Tenant shall not unreasonably interfere with traffic flow within the Business Center and loading and unloading areas of other tenants. 9. Tenant shall not disturb, solicit or canvas any occupant of the Building or Business Center and shall cooperate to prevent same. 10. No person shall go on the roof without Landlord's permission. 11. Business machines and mechanical equipment belonging to Tenant which cause noise or vibration that may be transmitted to the structure of the Building, to such a degree as to be objectionable to Landlord or other Tenants, shall be placed and maintained by Tenant, at Tenant's expense, on vibration eliminators or other devices sufficient to eliminate noise or vibration. 12. All goods, including material used to store goods, delivered to the Premises of Tenant shall be immediately moved into the Premises and shall not be left in parking or receiving areas overnight. 13. Tractor trailers, which must be unhooked or parked with dolly wheels beyond the concrete loading areas must use steel plates or wood blocks under the dolly wheels to prevent damage to the asphalt paving surfaces. No parking or storing of such trailers will be permitted in the auto parking areas of the Business Center or on streets adjacent thereto. 14. Forklifts which operate on asphalt paving areas shall not have solid rubber tires and shall only use tires that do not damage the asphalt. 15. Tenant is responsible for the storage and removal of all trash and refuse. All such trash and refuse shall be contained in suitable receptacles stored behind screened enclosures at locations approved by Landlord. 16. Tenant shall not store or permit the storage or placement of goods, or merchandise or pallets or equipment of any sort outside of the Premises nor in or around the Building, the Business Center or any of the Common Areas of the foregoing. No displays or sales of merchandise shall be allowed in the parking lots or other Common Areas. C-1 28 17. Tenant shall not permit any motor vehicles to be washed on any portion of the Premises or in the Common Areas of the Business Center, nor shall Tenant permit mechanical work or maintenance of motor vehicles to be performed on any portion of the premises or in the Common Areas of the Business Center. C-2 29 EXHIBIT D HAZARDOUS MATERIALS DISCLOSURE CERTIFICATE Your cooperation in this matter is appreciated. Initially, the information provided by you in this Hazardous Materials Disclosure Certificate is necessary for the Landlord (identified below) to evaluate and finalize a lease agreement with you as Tenant. After a lease agreement is signed by you and the Landlord (the "Lease Agreement"), on an annual basis in accordance with the provisions of Section 6.5 of the signed Lease Agreement, you are to provide an update to the information initially provided by you in this certificate. The information contained in the initial Hazardous Materials Disclosure Certificate and each annual certificate provided by you thereafter will be maintained in confidentiality by Landlord subject to release and disclosure as required by (i) any lenders and owners and their respective environmental consultants, (ii) any prospective purchaser(s) of all or any portion of the property on which the Premises are located, (iii) Landlord to defend itself or its lenders, partners or representatives against any claim or demand, and (iv) any laws, rules, regulations, orders, decrees, or ordinances, including, without limitation, court orders or subpoenas. Any and all capitalized terms used herein, which are not otherwise defined herein, shall have the same meaning ascribed to such term in the signed Lease Agreement. Any questions regarding this certificate should be directed to, and when completed, the certificate should be delivered to: Landlord: AMB Property, L.P., a Delaware limited partnership c/o Legacy Partners Commercial, Inc. 101 Lincoln Centre Drive, Fourth Floor Foster City, California 94404 Attn:_____________________________ Phone: (650) 571-2200 Name of (Prospective) Tenant:__________________________________________________ Mailing Address:_______________________________________________________________ _______________________________________________________________________________ Contact Person, Title and Telephone Number(s):_________________________________ Contact Person for Hazardous Waste Materials Management and Manifests and Telephone Number(s): _______________________________________________________________________________ _______________________________________________________________________________ Address of (Prospective) Premises:_____________________________________________ Length of (Prospective) Initial Term:__________________________________________ _______________________________________________________________________________ 1. GENERAL INFORMATION: Describe the initial proposed operations to take place in, on, or about the Premises, including, without limitation, principal products processed, manufactured or assembled services and activities to be provided or otherwise conducted. Existing Tenants should describe any proposed changes to on-going operations. _______________________________________________________________________________ _______________________________________________________________________________ 2. USE, STORAGE AND DISPOSAL OF HAZARDOUS MATERIALS 2.1 Will any Hazardous Materials be used, generated, stored or disposed of in, on or about the Premises? Existing Tenants should describe any Hazardous Materials which continue to be used, generated, stored or disposed of in, on or about the Premises. Wastes Yes [ ] No [ ] D-1 30 Chemical Products Yes [ ] No [ ] Other Yes [ ] No [ ] If Yes is marked, please explain:______________________________________ _______________________________________________________________________________ _______________________________________________________________________________ 2.2 If Yes is marked in Section 2.1, attach a list of any Hazardous Materials to be used, generated, stored or disposed of in, on or about the Premises, including the applicable hazard class and an estimate of the quantities of such Hazardous Materials at any given time; estimated annual throughput; the proposed location(s) and method of storage (excluding nominal amounts of ordinary household cleaners and janitorial supplies which are not regulated by any Environmental Laws); and the proposed location(s) and method of disposal for each Hazardous Material, including, the estimated frequency, and the proposed contractors or subcontractors. Existing Tenants should attach a list setting forth the information requested above and such list should include actual data from on-going operations and the identification of any variations in such information from the prior year's certificate. 3. STORAGE TANKS AND SUMPS 3.1 Is any above or below ground storage of gasoline, diesel, petroleum, or other Hazardous Materials in tanks or sumps proposed in, on or about the Premises? Existing Tenants should describe any such actual or proposed activities. Yes [ ] No [ ] If yes, please explain:________________________________________________ _______________________________________________________________________________ _______________________________________________________________________________ 4. WASTE MANAGEMENT 4.1 Has your company been issued an EPA Hazardous Waste Generator I.D. Number? Existing Tenants should describe any additional identification numbers issued since the previous certificate. Yes [ ] No [ ] 4.2 Has your company filed a biennial or quarterly reports as a hazardous waste generator? Existing Tenants should describe any new reports filed. Yes [ ] No [ ] If yes, attach a copy of the most recent report filed. 5. WASTEWATER TREATMENT AND DISCHARGE 5.1 Will your company discharge wastewater or other wastes to: ______ storm drain? ______ sewer? ______ surface water? ______ no wastewater or other wastes discharged. Existing Tenants should indicate any actual discharges. If so, describe the nature of any proposed or actual discharge(s). _______________________________________________________________________________ _______________________________________________________________________________ 5.2 Will any such wastewater or waste be treated before discharge? Yes [ ] No [ ] If yes, describe the type of treatment proposed to be conducted. Existing Tenants should describe the actual treatment conducted. _______________________________________________________________________________ D-2 31 _______________________________________________________________________________ 6. AIR DISCHARGES 6.1 Do you plan for any air filtration systems or stacks to be used in your company's operations in, on or about the Premises that will discharge into the air; and will such air emissions be monitored? Existing Tenants should indicate whether or not there are any such air filtration systems or stacks in use in, on or about the Premises which discharge into the air and whether such air emissions are being monitored. Yes [ ] No [ ] If yes, please describe:_______________________________________________ _______________________________________________________________________________ _______________________________________________________________________________ 6.2 Do you propose to operate any of the following types of equipment, or any other equipment requiring an air emissions permit? Existing Tenants should specify any such equipment being operated in, on or about the Premises. _______ Spray booth(s) ______ Incinerator(s) _______ Dip tank(s) ______ Other (Please describe) _______ Drying oven(s) ______ No Equipment Requiring Air Permits If yes, please describe:_______________________________________________ _______________________________________________________________________________ _______________________________________________________________________________ 7. HAZARDOUS MATERIALS DISCLOSURES 7.1 Has your company prepared or will it be required to prepare a Hazardous Materials management plan ("Management Plan") pursuant to Fire Department or other governmental or regulatory agencies' requirements? Existing Tenants should indicate whether or not a Management Plan is required and has been prepared. Yes [ ] No [ ] If yes, attach a copy of the Management Plan. Existing Tenants should attach a copy of any required updates to the Management Plan. 7.2 Are any of the Hazardous Materials, and in particular chemicals, proposed to be used in your operations in, on or about the Premises regulated under Proposition 65? Existing Tenants should indicate whether or not there are any new Hazardous Materials being so used which are regulated under Proposition 65. Yes [ ] No [ ] If yes, please describe:_______________________________________________ _______________________________________________________________________________ _______________________________________________________________________________ 8. Enforcement Actions and Complaints 8.1 With respect to Hazardous Materials or Environmental Laws, has your company ever been subject to any agency enforcement actions, administrative orders, or consent decrees or has your company received requests for information, notice or demand letters, or any other inquiries regarding its operations? Existing Tenants should indicate whether D-3 32 or not any such actions, orders or decrees have been, or are in the process of being, undertaken or if any such requests have been received. Yes [ ] No [ ] If yes, describe the actions, orders or decrees and any continuing compliance obligations imposed as a result of these actions, orders or decrees and also describe any requests, notices or demands, and attach a copy of all such documents. Existing Tenants should describe and attach a copy of any new actions, orders, decrees, requests, notices or demands not already delivered to Landlord pursuant to the provisions of Section 6.2, 6.3, 6.4 and 6.5 of the signed Lease Agreement. _______________________________________________________________________________ _______________________________________________________________________________ 8.2 Have there ever been, or are there now pending, any lawsuits against your company regarding any environmental or health and safety concerns? Yes [ ] No [ ] If yes, describe any such lawsuits and attach copies of the complaint(s), cross-complaint(s), pleadings and all other documents related thereto as requested by Landlord. Existing Tenants should describe and attach a copy of any new complaint(s), cross-complaint(s), pleadings and other related documents not already delivered to Landlord pursuant to the provisions of Section 6.2, 6.3, 6.4 and 6.5 of the signed Lease Agreement. _______________________________________________________________________________ _______________________________________________________________________________ 8.3 Have there been any problems or complaints from adjacent Tenants, owners or other neighbors at your company's current facility with regard to environmental or health and safety concerns? Existing Tenants should indicate whether or not there have been any such problems or complaints from adjacent Tenants, owners or other neighbors at, about or near the Premises. Yes [ ] No [ ] If yes, please describe. Existing Tenants should describe any such problems or complaints not already disclosed to Landlord under the provisions of the signed Lease Agreement. _______________________________________________________________________________ _______________________________________________________________________________ 9. PERMITS AND LICENSES 9.1 Attach copies of all Hazardous Materials permits and licenses including a Transporter Permit number issued to your company with respect to its proposed operations in, on or about the Premises, including, without limitation, any wastewater discharge permits, air emissions permits, and use permits or approvals. Existing Tenants should attach copies of any new permits and licenses as well as any renewals of permits or licenses previously issued. The undersigned hereby acknowledges and agrees that (A) this Hazardous Materials Disclosure Certificate is being delivered in connection with, and as required by, Landlord in connection with the evaluation and finalization of a Lease Agreement and will be attached thereto as an exhibit; (B) that this Hazardous Materials Disclosure Certificate is being delivered in accordance with, and as required by, the provisions of Section 6.5 of the Lease Agreement; and (C) that Tenant shall have and retain full and complete responsibility and liability with respect to any of the Hazardous Materials disclosed in the HazMat Certificate notwithstanding Landlord's/Tenant's receipt and/or approval of such certificate. Tenant further agrees that none of the following described acts or events shall be construed or otherwise interpreted as either (a) excusing, diminishing or otherwise limiting Tenant from the requirement to fully and faithfully perform its D-4 33 obligations under the Lease with respect to Hazardous Materials, including, without limitation, Tenant's indemnification of the Indemnitees and compliance with all Environmental Laws, or (b) imposing upon Landlord, directly or indirectly, any duty or liability with respect to any such Hazardous Materials, including, without limitation, any duty on Landlord to investigate or otherwise verify the accuracy of the representations and statements made therein or to ensure that Tenant is in compliance with all Environmental Laws; (i) the delivery of such certificate to Landlord and/or Landlord's acceptance of such certificate, (ii) Landlord's review and approval of such certificate, (iii) Landlord's failure to obtain such certificate from Tenant at any time, or (iv) Landlord's actual or constructive knowledge of the types and quantities of Hazardous Materials being used, stored, generated, disposed of or transported on or about the Premises by Tenant or Tenant's Representatives. Notwithstanding the foregoing or anything to the contrary contained herein, the undersigned acknowledges and agrees that Landlord and its partners, lenders and representatives may, and will, rely upon the statements, representations, warranties, and certifications made herein and the truthfulness thereof in entering into the Lease Agreement and the continuance thereof throughout the term, and any renewals thereof, of the Lease Agreement. I (print name)_______________, acting with full authority to bind the (proposed) Tenant and on behalf of the (proposed) Tenant, certify, represent and warrant that the information contained in this certificate is true and correct. (PROSPECTIVE) TENANT: By:________________________________ Title:_____________________________ Date:______________________________ D-5 34 EXHIBIT E TENANT IMPROVEMENTS [INTENTIONALLY OMITTED] E-1 35 ADDENDUM 1 LANDLORD'S REMEDIES ADDENDUM IN EVENT OF TENANT DEFAULT (STATE OF CALIFORNIA) (a) TERMINATION. In the event of any Default by Tenant, then in addition to any other remedies available to Landlord at law or in equity and under this Lease, Landlord shall have the immediate option to terminate this Lease and all rights of Tenant hereunder by giving written notice of such intention to terminate. In the event that Landlord shall elect to so terminate this Lease then Landlord may recover from Tenant: (1) the worth at the time of award of any unpaid Rent and any other sums due and payable which have been earned at the time of such termination; plus (2) the worth at the time of award of the amount by which the unpaid Rent and any other sums due and payable which would have been earned after termination until the time of award exceeds the amount of such rental loss Tenant proves could have been reasonably avoided; plus (3) the worth at the time of award of the amount by which the unpaid Rent and any other sums due and payable for the balance of the term of this Lease after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; plus (4) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course would be likely to result therefrom, including, without limitation, any costs or expenses incurred by Landlord (i) in retaking possession of the Premises; (ii) in maintaining, repairing, preserving, restoring, replacing, cleaning, altering or rehabilitating the Premises or any portion thereof, including such acts for reletting to a new tenant or tenant's; (iii) for leasing commissions; or (iv) for any other costs necessary or appropriate to relet the Premises; plus (5) such reasonable attorneys' fees incurred by Landlord as a result of a Default, and costs in the event suit is filed by Landlord to enforce such remedy; and plus (6) at Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable law. As used in subparagraphs (1) and (2) above, the "worth at the time of award" is computed by allowing interest at an annual rate equal to twelve percent (12%) per annum or the maximum rate permitted by law, whichever is less. As used in subparagraph (3) above, the "worth at the time of award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award, plus one percent (1%). Tenant waives redemption or relief from forfeiture under California Code of Civil Procedure Sections 1174 and 1179, or under any other present or future law, in the event Tenant is evicted or Landlord takes possession of the Premises by reason of any Default of Tenant hereunder. (b) CONTINUATION OF LEASE. In the event of any Default by Tenant, then in addition to any other remedies available to Landlord at law or in equity and under this Lease, Landlord shall have the remedy described in California Civil Code Section 1951.4 (Landlord may continue this Lease in effect after Tenant's Default and abandonment and recover Rent as it becomes due, provided tenant has the right to sublet or assign, subject only to reasonable limitations). (c) RE-ENTRY. In the event of any Default by Tenant, Landlord shall also have the right, with or without terminating this Lease, in compliance with applicable law, to re-enter the Premises and remove all persons and property from the Premises; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of Tenant. E-2 36 (d) RELETTING. In the event of the abandonment of the Premises by Tenant or in the event that Landlord shall elect to re-enter or shall take possession of the Premises pursuant to legal proceeding or pursuant to any notice provided by law, then if Landlord does not elect to terminate this Lease as provided in Paragraph a, Landlord may from time to time, without terminating this Lease, relet the Premises or any part thereof for such term or terms and at such rental or rentals and upon such other terms and conditions as Landlord in its sole discretion may deem advisable with the right to make alterations and repairs to the Premises. In the event that Landlord shall elect to so relet, then rentals received by Landlord from such reletting shall be applied in the following order: (1) to reasonable attorneys' fees incurred by Landlord as a result of a Default and costs in the event suit is filed by Landlord to enforce such remedies; (2) to the payment of any indebtedness other than Rent due hereunder from Tenant to Landlord; (3) to the payment of any costs of such reletting; (4) to the payment of the costs of any alterations and repairs to the Premises; (5) to the payment of Rent due and unpaid hereunder; and (6) the residue, if any, shall be held by Landlord and applied in payment of future Rent and other sums payable by Tenant hereunder as the same may become due and payable hereunder. Should that portion of such rentals received from such reletting during any month, which is applied to the payment of Rent hereunder, be less than the Rent payable during the month by Tenant hereunder, then Tenant shall pay such deficiency to Landlord. Such deficiency shall be calculated and paid monthly. Tenant shall also pay to Landlord, as soon as ascertained, any costs and expenses incurred by Landlord in such reletting or in making such alterations and repairs not covered by the rentals received from such reletting. (e) TERMINATION. No re-entry or taking of possession of the Premises by LANDLORD pursuant to this Addendum shall be construed as an election to terminate this Lease unless a written notice of such intention is given to Tenant or unless the termination thereof is decreed by a court of competent jurisdiction. Notwithstanding any reletting without termination by Landlord because of any Default by Tenant, Landlord may at any time after such reletting elect to terminate this Lease for any such Default. (f) CUMULATIVE REMEDIES. The remedies herein provided are not exclusive and Landlord shall have any and all other remedies provided herein or by law or in equity. (g) NO SURRENDER. No act or conduct of Landlord, whether consisting of the acceptance of the keys to the Premises, or otherwise, shall be deemed to be or constitute an acceptance of the surrender of the Premises by Tenant prior to the expiration of the Term, and such acceptance by Landlord of surrender by Tenant shall only flow from and must be evidenced by a written acknowledgment of acceptance of surrender signed by Landlord. The surrender of this Lease by Tenant, voluntarily or otherwise, shall not work a merger unless Landlord elects in writing that such merger take place, but shall operate as an assignment to Landlord of any and all existing subleases, or Landlord may, at its option, elect in writing to treat such surrender as a merger terminating Tenant's estate under this Lease, and thereupon Landlord may terminate any or all such subleases by notifying the sublessee of its election so to do within five (5) days after such surrender. (h) NOTICE PROVISIONS. Tenant agrees that any notice given by Landlord pursuant to Paragraph 13.1 of the Lease shall satisfy the requirements for notice under California Code of Civil Procedure Section 1161, and Landlord shall not be required to give any additional notice in order to be entitled to commence an unlawful detainer proceeding. TENANT INITIALS LANDLORD INITIALS _______________________________ ___________________________________ E-3 EX-23.1 5 f69819ex23-1.txt EXHIBIT 23.1 1 EXHIBIT 23.1 KPMG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the registration statements (Nos. 333-41663, 333-08978, 333-53087, 333-39194, 333-53089, 333,91471, and 333-96313) on forms S-8 of Hyseq, Inc. of our report dated February 2, 2001, relating to the consolidated balance sheet of Hyseq, Inc. and subsidiaries as of December 31, 2000, and the related consolidated statement of operations, stockholders' equity and cash flows for the year then ended, which appears in the December 31, 2000, annual report on Form 10-K of Hyseq, Inc. /s/ KPMG LLP Palo Alto, California March 30, 2001 EX-23.2 6 f69819ex23-2.txt EXHIBIT 23.2 1 EXHIBIT 23.2 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Forms S-8 Nos. 333-41663, 333-08978, 333-53089, 333-53087, 333-91471, 333-96313 and 333-39194) pertaining to the Hyseq, Inc. 1995 Stock Option Plan, the Hyseq, Inc. Non-Employee Director Stock Option Plan and Stock Option Agreements, the Hyseq Inc. Employee Stock Purchase Plan, the Hyseq, Inc. Non-Qualified Employee Stock Purchase Plan, the Hyseq, Inc. Scientific Advisory Board / Consultants Stock Option Plan and Miscellaneous Option Agreements, and the Hyseq, Inc. Employee Stock Purchase Plan, As Amended of our report dated February 2, 2000, with respect to the consolidated financial statements of Hyseq, Inc. included in its Annual Report (Form 10-K) for the year ended December 31, 2000. /s/ ERNST & YOUNG LLP Palo Alto, California March 28, 2001 -----END PRIVACY-ENHANCED MESSAGE-----