10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 1999

OR

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

For the transition period from ________to _________

Commission file number 0-22570

Lynx Therapeutics, Inc.
(Exact name of Registrant as specified in its charter)

 

Delaware	94-3161073
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

25861 Industrial Blvd.
Hayward, CA 94545
(Address of principal executive offices, including zip code)

(510) 670-9300
(Registrant's telephone number, including area code)

    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 reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [  ]

The number of shares of Common Stock outstanding as of November 1, 1999, was 11,200,769. The aggregate market value of the Common Stock of the Registrant held by non-affiliates as of November 1, 1999, was $102,898,521.

Lynx Therapeutics, Inc.
FORM 10-Q
INDEX

PART I FINANCIAL INFORMATION (unaudited)

Item 1. Financial Statements

        Condensed Consolidated Balance Sheets - September 30, 1999 and December 31, 1998

        Condensed Consolidated Statements of Operations - three and nine months ended September 30, 1999 and 1998

        Condensed Consolidated Statements of Cash Flows - six months ended September 30, 1999 and 1998

        Notes to Condensed Consolidated Financial Statements

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

        Introduction

        Results of Operations

        Liquidity and Capital Resources

Item 3. Quantitative and Qualitative Disclosures about Market Risk

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities

Item 3. Defaults Upon Senior Securities

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

Item 5. Other Information

Item 6. Exhibits and Reports on Form 8-K

Signatures

PART I -- FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

Lynx Therapeutics, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

                                                     September 30, December 31,
                                                          1999        1998*
                                                     ------------  -----------
                                                     (Unaudited)
Assets
Current assets:
   Cash and cash equivalents........................      $9,086      $16,170
   Short-term investments...........................      12,128        7,692
   Accounts receivable..............................      10,000        5,316
   Other current assets.............................         521          678
                                                     ------------  -----------
Total current assets................................      31,735       29,856
                                                     ------------  -----------
Property and equipment:
   Leasehold improvements...........................      11,067        9,510
   Laboratory and other equipment...................       5,416        3,657
                                                     ------------  -----------
                                                          16,483       13,167
   Less accumulated depreciation and amortization...      (4,838)      (3,530)
                                                     ------------  -----------
Net property and equipment..........................      11,645        9,637

Long-term receivable................................       4,000          --
Other non-current assets............................       1,007          841
                                                     ------------  -----------
                                                         $48,387      $40,334
                                                     ============  ===========
Liabilities and stockholders' equity
Current liabilities:
   Accounts payable.................................        $734       $5,102
   Accrued compensation.............................         257          295
   Accrued professional fees........................          86          136
   Deferred revenue - current portion...............      16,179        3,000
   Equipment loan - current portion.................         493          --
   Other accrued liabilities........................         480          489
                                                     ------------  -----------
Total current liabilities...........................      18,229        9,022

Deferred revenue....................................      14,250        7,667
Equipment loan......................................       2,633          --
Other noncurrent liabilities........................         385          188

Stockholders' equity:
   Common stock.....................................      74,460       74,329
   Notes receivable from stockholders...............        (436)        (436)
   Deferred compensation............................      (2,701)      (3,742)
   Accumulated comprehensive income (loss)..........         (39)          (7)
   Accumulated deficit..............................     (58,394)     (46,687)
                                                     ------------  -----------
Total stockholders' equity..........................      12,890       23,457
                                                     ------------  -----------
                                                         $48,387      $40,334
                                                     ============  ===========

* The Balance Sheet amounts at December 31, 1998, have been derived from audited financial statements at that date but do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

Lynx Therapeutics, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

                                          Three Months Ended   Nine Months Ended
                                              September 30,       September 30,
                                         ------------------- -------------------
                                            1999      1998      1999      1998
                                         --------- --------- --------- ---------
Technology access revenue..............    $1,122      $691    $2,737    $2,196


Operating  expenses:
   Research and development............     4,261     3,004    12,427     9,917
   General and administrative..........     1,057       347     2,778     1,348
                                         --------- --------- --------- ---------
Total operating expenses...............     5,318     3,351    15,205    11,265
                                         --------- --------- --------- ---------
Loss from operations...................    (4,196)   (2,660)  (12,468)   (9,069)

Interest income........................       237       276       881       936
Other income/(expense).................        59      (280)       86     2,896
                                         --------- --------- --------- ---------
Loss before provision for income taxes.    (3,900)   (2,664)  (11,501)   (5,237)

Provision for income taxes.............       (50)      --       (206)      --
                                         --------- --------- --------- ---------
Net loss...............................   ($3,950)  ($2,664) ($11,707)  ($5,237)
                                         ========= ========= ========= =========

Basic and diluted net loss per share...    ($0.36)   ($0.24)   ($1.06)   ($0.57)
                                         ========= ========= ========= =========

Shares used in per share computation...    11,108    10,959    11,086     9,190
                                         ========= ========= ========= =========

See accompanying notes.

Lynx Therapeutics, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

                                                             Nine Months Ended
                                                                September 30,
                                                          ----------------------
                                                              1999        1998
                                                          ----------  ----------
Cash flows from operating activities:
Net loss...............................................    ($11,707)    ($5,237)
Adjustments to reconcile net loss to net cash
 provided by operating activities:
     Depreciation and amortization.....................       1,308         831
     Amortization of deferred compensation.............       1,041       1,337
     Non-cash consideration received and costs
       incurred on the sale of the
       antisense business, net.........................         --         (138)
     Changes in operating assets and liabilities:
         Accounts receivable...........................      (8,684)        109
         Other current assets..........................         157        (122)
         Accounts payable..............................      (4,368)        379
         Accrued liabilities...........................         (97)       (293)
         Deferred revenue..............................      19,762      (2,063)
         Other non-current liabilities.................         197          14
                                                          ----------  ----------
Net cash provided by operating activities..............      (2,391)     (5,183)
                                                          ----------  ----------
Cash flows from investing activities:
Purchases of short-term investments....................     (16,467)    (21,357)
Maturities of short-term investments...................      11,999      29,528
Leasehold improvements and equipment products..........      (3,316)     (1,883)
Other assets...........................................        (166)       (188)
                                                          ----------  ----------
Net cash provided by (used in) investing activities....      (7,950)      6,100
                                                          ----------  ----------
Cash flows from financing activities:
Proceeds from equipment loan                                  3,243           0
Repayments of equipment loans                                  (117)          0
Issuance of common stock...............................         131         239
                                                          ----------  ----------
Net cash provided by financing activities..............       3,257         239
                                                          ----------  ----------
Net increase (decrease) in cash and cash equivalents...      (7,084)      1,156
Cash and cash equivalents at beginning of period.......      16,170       8,798
                                                          ----------  ----------
Cash and cash equivalents at end of period.............      $9,086      $9,954
                                                          ==========  ==========

Supplemental schedule of non-cash investing activities:
  Effects of non-cash transactions relating to the
    sale of the Antisense Business.....................       $ --         $813
                                                          ==========  ==========

Supplemental disclosure of cash flow information:
  Cash paid during the periiod for income taxes.........       $303       $ --
                                                          ==========  ==========

See accompanying notes.

Lynx Therapeutics, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)

1. Nature of Business

Formed in 1992, Lynx Therapeutics, Inc. ("Lynx" or the "Company") has developed, and continues to develop, unique, proprietary processes aimed at handling and analyzing, simultaneously, very large numbers of DNA molecules or fragments in complex biological samples. At the core of these processes is Lynx's MegacloneTM technology. This is a micro-bead technology that allows both the simultaneous collection of millions of clones on as many micro-beads, and subsequent simultaneous manipulation or analyses of these clones. Applications include the physical extraction of genes (whether known or unknown) that are differentially expressed between samples (MegasortT technology), the characterization of gene expression within a sample by Massively Parallel Signature Sequencing (MPSSr technology), and a novel, highly efficient means for genotyping large numbers of genetic markers or single nucleotide polymorphisms ("SNPs"), simultaneously, against very large populations of genomes (MegatypeT technology).

2. Basis of Presentation

The accompanying condensed consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations promulgated by the Securities and Exchange Commission (the "SEC"). Certain prior year amounts have been reclassified to conform to current year presentation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to SEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, the financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. The results of operations for the three and nine months ended September 30, 1999, are not necessarily indicative of the results for the full year.

The unaudited condensed consolidated financial statements include all accounts of the Company and its wholly owned subsidiary, Lynx Therapeutics GmbH, formed under the laws of the Federal Republic of Germany. All significant intercompany balances have been eliminated.

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the Company's year ended December 31, 1998, included in its annual report on Form 10-K filed with the SEC.

3. Summary of Significant Accounting Policies

Revenue Recognition

Technology access fees or contract initiation fees are deferred and recognized as revenue on a straight-line basis over the noncancelable term of the agreement, exclusive of any possible future extension to, or renewals of, the contract term by the other party. Payments for services and/or materials to be provided by Lynx will be recognized as revenue when earned over the contract period in which the services are performed and/or materials are delivered by Lynx, provided no other obligations, refunds, or credits to be applied to future work exist. Milestone payments are recognized as revenue upon the achievement of the related milestone and the satisfaction of any related obligations. Revenues from the sales of products are recognized upon shipment or initiation of delivery to the customer.

Net Loss Per Share

Basic net loss per share is computed by dividing loss applicable to common stockholders by the weighted average number of common shares outstanding for the period, net of certain common shares outstanding which are subject to continued vesting and the Company's right of repurchase. Diluted loss per share reflects the potential dilution of securities that could share in the earnings of the Company, to the extent such securities are dilutive. Basic and diluted loss per share amounts are equivalent for all periods presented herein due to the Company's net losses for such periods. The following have been excluded from the calculation of loss per share because the effect of inclusion would be antidilutive: approximately 75,000 common shares which are outstanding but are subject to the Company's right of repurchase which expires ratably over 5 years, and options to purchase approximately 1,778,000 shares of common stock at a weighted average price of $6.79 per share. The repurchasable shares and options will be included in the calculation at such time as the effect is no longer antidilutive, as calculated using the treasury stock method.

Comprehensive Income

As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards, No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes new rules for the reporting and presentation of comprehensive income and its components; however, the adoption of SFAS 130 had an immaterial impact on the Company's net loss and shareholders' equity. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities to be included in other comprehensive loss.

Total comprehensive loss during the quarters ended September 30, 1999 and 1998 was $3.9 million and $2.7 million, respectively. For the nine months ended September 30, 1999 and 1998, total comprehensive loss amounted to $11.7 million and $5.2 million, respectively.

4. Corporate Collaborations

In September 1999, Lynx signed a research collaboration agreement with Hoechst Schering AgrEvo GmbH ("AgrEvo"). AgrEvo will receive access to Lynx's DNA analysis technologies for the study of certain plants. Under the terms of the agreement AgrEvo paid Lynx an access fee upon execution of the agreement. Additional fees can be earned by Lynx for the performance of various DNA analyses, the delivery of genomic maps of certain plants, and milestone payments and licensing fees related to the discovery of trait-associated single nucleotide polymorphisms for the subject plants.

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

This discussion and analysis should be read in conjunction with the Company's financial statements and accompanying notes included in this report and the Company's 1998 audited financial statements and notes thereto included in its 1998 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 1999 are not necessarily indicative of results that may occur in future periods.

Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. When used herein, the words "believe," "anticipate," "expect," "estimate" and similar expressions are intended to identify such forward-looking statements. There can be no assurance that these statements will prove to be correct. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, as well as in the Company's 1998 Annual Report on Form 10-K as filed with the SEC. Lynx undertakes no obligation to update any of the forward-looking statements contained herein to reflect any future events or developments.

Results of Operations

Revenue

Revenues for the third quarter and nine-month period ended September 30, 1999 were $1.1 million and $2.7 million, respectively, earned primarily from technology access fees paid to Lynx under certain of its agreements. For the corresponding third quarter and nine-month period of 1998, revenues were $0.7 and $2.2 million respectively, including $0.7 million and $2.1 million of technology access fees, respectively.

Operating Expenses

Research and development expenses increased by 43% to $4.3 million for the quarter ended September 30, 1999, compared to $3.0 million in the corresponding period in the previous year. For the nine-month period ended September 30, 1999, research and development expenses increased by 25% to $12.4 million, compared to $9.9 million in the corresponding period in 1998. The change was primarily due to increased expenditures for scientific materials and supplies, increased compensation expense resulting from higher headcount and increased expenses related to the Company's facilities expansion as the Company builds capacity for the anticipated commercial application of its technologies. Lynx expects to continue to incur substantial research and development expenses.

General and administrative expenses increased to $1.1 million for the quarter ended September 30, 1999, compared to $0.3 million in the corresponding period in the previous year. For the nine-month period ended September 30, 1999, general and administrative expenses increased to $2.8 million, compared to $1.3 million in the same period in 1998. Contributing factors include increased compensation expense due to additional headcount, higher outside professional services expense associated primarily with business development activities, and expenses related to the Company's facilities expansion. Lynx expects to continue to incur substantial administrative expenses in support of its research and development, business development, and commercialization efforts.

Interest Income

Net interest income was $0.2 million and $0.9 million for the third quarter and nine-month period ended September 30, 1999, respectively, compared to $0.3 and $0.9 million for the same respective periods in 1998.

Other Income and Expense

Other income was $0.1 million in the quarter ended September 30, 1999, compared to other expense of $0.3 million in the quarter ended September 30, 1998. The 1999 income relates primarily to sublease rental income on property previously occupied by Lynx. The 1998 expense reflects an adjustment in the carrying value of Inex Pharmaceuticals Corporation common stock. For the nine-month period ended September 30, 1999, other income was $0.1 million compared to $2.9 million in the same period in 1998. The 1999 income was attributable to a gain on the sale of certain fixed assets no longer used in Lynx's operations and sublease rental income, offset by compensation-related payments associated with the sale of Lynx's former antisense therapeutics business. The 1998 income was comprised primarily of the gain from the March 1998 sale of Lynx's former antisense therapeutics business.

Liquidity and Capital Resources

Net cash provided by operating activities of $2.4 million for the nine-month period ended September 30, 1999 differed from the net loss primarily due to an increase in deferred revenue from amounts received under agreements, partially offset by an increase in accounts receivable and a decrease in current liabilities. Net cash used in investing activities related primarily to purchases of short-term investments and capital expenditures. Net cash provided by financing activities related primarily to borrowings under an equipment loan arrangement. Cash, cash equivalents and short-term investments were $21.2 million at September 30, 1999.

In late 1998, the Company entered into an agreement with a financial institution ("Lender") whereby the Company could borrow up to $5.0 million through September 30, 1999, for the purchase of equipment and certain other capital expenditures. The Lender has obtained a security interest in all items financed by it under this agreement. Each loan has a term of forty-eight months from the date of the draw down. As of September 30, 1999, the Company had equipment loans outstanding of approximately $3.1 million under this agreement.

Lynx plans to use available funds for the continuing development of, and the expansion of applications for, its technologies. Pending such uses as described above, Lynx intends to invest its excess cash in short- term, investment grade, interest-bearing securities or certificates of deposit.

Lynx has obtained funding for its operations through sales of preferred and common stock to venture capital investors, institutional investors and contract partners, and revenue from contractual arrangements, interest income, product sales and government grants. The cost, timing and amount of funds required for specific uses by Lynx cannot be precisely determined at this time and will be based upon Lynx's efforts in its research and development, legal and administrative costs, the establishment of corporate collaborations and other arrangements, additional facilities capacity needs and the availability of alternate methods of financing.

Lynx expects to incur substantial and increasing research and development expenses and intends to seek additional financing, as needed, through contractual arrangements with corporate partners and others, and equity or debt offerings. There can be no assurance that any additional financing required by Lynx will be available or, if available, will be on terms favorable to Lynx. The Company believes that, at current spending levels, its existing capital resources, and interest income thereon, will enable it to maintain its current and planned operations through the end of the year 2000.

Impact of Year 2000

The Year 2000 ("Y2K") issue is the result of computer programs using two rather than four digits to define the year. A company's hardware or computer programs that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations.

Lynx has established a team comprised of financial, information technology ("IT") and scientific personnel to address the potential exposure related to the impact of Y2K issues on its IT and non-IT systems. Lynx's approach to the Y2K issue involves the following four phases: assessment, remediation, testing and implementation including development of a contingency plan. As of October 1999, the Company had completed assessment, remediation, testing and implementation of all of its facilities, IT equipment and systems, non-IT equipment and systems, third-party services and vendors. Facilities

In January 1999, the Company moved to a newly built facility with building systems that are Y2K compliant. IT Equipment and Systems

Lynx's network, computers and computer software are now either Y2K compliant or have been made compliant with patches available from the vendors at minimal cost, and the Company continues to be alert for updates as necessary. During the second quarter of 1999, the Company installed new Y2K compliant software for accounting, purchasing and human resources applications. The decision to implement the new administrative software was made as a result of overall Company need, irrespective of Y2K issues. Non-IT Equipment and Systems

Lynx's non-IT equipment consists primarily of laboratory equipment. Based on its identification and assessment efforts, the Company has determined that most of the equipment it currently uses has no date function and will not be affected by Y2K. Those systems that are not compliant are not in use and will be replaced in the normal course of business, as necessary. Overall, the Company found the level of non- compliant equipment was minimal. Third Party Services and Vendors

Lynx has surveyed its primary suppliers, banks, investment managers/brokers and other third party service providers to determine whether they are Y2K compliant. The Company has determined that certain of the third parties use systems that are not Y2K compliant, but all of the third parties surveyed have programs in place to address these Y2K issues. The Company cannot guarantee that all of the third parties will achieve Y2K compliance in a timely manner. The failure of third parties to successfully address the Y2K issue could have a material adverse effect on the Company's business, financial condition and results of operations.

Due to the relatively low level of Y2K non-compliance of Lynx's facilities, equipment and systems, the assessment, remediation and testing proces was limited. The Company to date has spent an insignificant amount of funds addressing the Y2K issue; the total costs associated with addressing the Y2K issue and attaining compliance was immaterial.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The primary objective of the Company's investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, the Company invests in highly liquid and high quality debt securities. The Company's investments in debt securities are subject to interest rate risk. To minimize the exposure due to adverse shifts in interest rates, the Company invests in short-term securities and maintains an average maturity of less than one year.

PART II OTHER INFORMATION

Item 1: Legal Proceedings

       None

Item 2: Changes in Securities

       None

Item 3: Defaults Upon Senior Securities

       None

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

       None

Item 5: Other Information

       None

Item 6: Exhibits and Reports on Form 8-K

        (a)     Exhibits

Exhibit 10.13 - Employment Agreement dated as of October 19, 199, between the Company and Norman John Wilkie Russell

Exhibit 27.1 - Financial Data Schedule

        (b)     Reports on Form 8-K

                 No reports on Form 8-K were filed during the three-month period ended September 30, 1999.

LYNX THERAPEUTICS, INC.

SIGNATURES

Pursuant to the requirement of the Security Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned thereunto duly authorized.

LYNX THERAPEUTICS, INC.

(Registrant)

Date: November 12, 1999

By:  /s/ Norman J.W. Russell

Norman J.W. Russell, Ph.D.

President and Chief Executive Officer

(Chief Executive Officer)

Date: November 12, 1999

By:  /s/ Edward C. Albini

Edward C. Albini

Chief Financial Officer

(Principal Financial and Accounting Officer)

LYNX THERAPEUTICS, INC.

EXHIBIT INDEX

 

Exhibit Number	Description
10.13	Employment agreement, dated as of October 18, 1999, between the Company and Norman John Wilkie Russell.
27.1	Financial Data Schedule

EX-10.13

Exhibit 10.13

Employment Agreement

LYNX THERAPEUTICS, INC.
EMPLOYEE AGREEMENT
for
NORMAN JOHN WILKIE RUSSELL, Ph.D.

This Employment Agreement ("Agreement") by and between Norman John Wilkie Russell, Ph.D. ("Executive") and LYNX THERAPEUTICS, INC., a Delaware corporation (the "Company"), is entered into and is effective as of the last date upon which either party executes this Agreement.

WHEREAS, the Company desires to employ Executive to provide personal services to the Company, and wishes to provide Executive with certain compensation and benefits in return for his services; and

WHEREAS, Executive wishes to be employed by the Company and provide personal services to the Company in return for certain compensation and benefits;

NOW, THEREFORE, in consideration of the mutual promises and covenants contained herein, it is hereby agreed by and between the parties hereto as follows:

1. EMPLOYMENT BY THE COMPANY.

1.1 Subject to terms set forth herein, the Company agrees to employ Executive in the position of President and Chief Executive Officer ("CEO") and Executive hereby accepts such employment effective as of October 18, 1999. The Company shall use its best efforts to elect Executive to the Company's Board of Directors (the "Board") for so long as Executive holds the position of President and CEO. During the term of his employment with the Company, Executive will devote his best efforts and substantially all of his business time and attention (except for vacation periods permitted by the Company's general employment policies, reasonable periods of illness or other incapacities permitted by the Company's general employment policies, and as otherwise provided herein) to the business of the Company.

1.2 Executive shall serve in an executive capacity and shall perform such duties as are customarily associated with his then current title, consistent with the Bylaws of the Company and as required by the Company's Board.

1.3 The employment relationship between the parties shall also be governed by the general employment policies and practices of the Company, including those relating to protection of confidential information and assignment of inventions, except that when the terms of this Agreement differ from or are in conflict with the Company's general employment policies or practices, this Agreement shall control. COMPENSATION.

1.4 Salary. Executive shall receive for services to be rendered hereunder an annualized base salary of Two Hundred Fifty-five Thousand U.S. Dollars ($255,000), payable on the Company's normal payroll schedule, and subject to standard payroll deductions and withholdings.

1.5 Bonuses. The Board may provide Executive with bonuses, within its sole discretion. Additionally, the Board may determine, within its sole discretion, milestones or other criteria upon which bonus payments to Executive may be conditioned.

1.6 Stock Option. Subject to approval by the Board, the Company will grant Executive a nonstatutory stock option (the "Option") in the amount of Two Hundred Thousand (200,000) shares of the common stock of the Company (the "Common Stock") pursuant to the Company's 1992 Stock Option Plan (the "Plan"). The exercise price per share of the Option will be the fair market value per share of the Common Stock on the date of grant. Except as otherwise provided herein, the Option will vest and become exercisable over five (5) years, with Twenty Percent (20%) of the shares covered by the Option vesting and becoming exercisable on the first year anniversary of the date of grant and the remaining Eighty Percent (80%) of the shares covered by the Option vesting and becoming exercisable in Forty-Eight (48) equal monthly installments thereafter, in accordance with the Company's standard vesting and exercisability policy, as long as the Executive remains in service with the Company. The Option will be subject to the terms of the Plan and Executive's corresponding Stock Option Grant Notice and Stock Option Agreement.

1.7 Relocation Assistance.

(a) Housing Purchase Assistance. The Company shall provide a loan to Executive in the principal amount of Two Hundred Fifty Thousand U.S. Dollars ($250,000) for the sole purpose of the purchase by Executive of residential housing, which loan shall be secured by the residential housing purchased by Executive. Interest paid on the principal sum of the loan to Executive shall be simple interest accrued from the date of the loan. The principal amount and all interest shall be forgiven by the Company during Executive's continued employment by the Company on the following schedule: (a) Fifty Percent (50%) shall be forgiven after Executive has been employed for two full years; (b) an additional Twenty-Five Percent (25%) shall be forgiven after Executive has been employed for a full three years; and (c) the remaining Twenty-five Percent (25%) shall be forgiven after Executive has been employed for a full four years. In the event Executive resigns his employment with the Company for any reason or Executive's employment with the Company is terminated for any reason, including without limitation, termination with or without cause, or termination due to disability or death, prior to the Company's full forgiveness of the loan, the loan shall be accelerated and all remaining unforgiven principal and interest shall become due and payable thirty (30) days after such resignation or termination. The Company shall provide Executive with the necessary documents to execute the loan.

(b) Moving Expenses. The Company shall reimburse Executive for his reasonable and necessary moving costs incurred in connection with his relocation from the United Kingdom to the United States in order to commence employment with the Company ("Moving Costs"), of approximately Forty Thousand Dollars ($40,000). Executive must provide appropriate documentation of each Moving Cost to the Company, including all receipts. In the event that Executive voluntarily terminates his employment with the Company within one year of his hire date, Executive shall repay to the Company the unforgiven portion of the Moving Costs, calculated as specified herein, including tax assistance payments or other amounts paid to the federal or state agencies as withholding or other credit against taxes. The amount of the Moving Costs forgiven by the Company shall be calculated as follows: for each full month of Executive's full-time employment, the Company will forgive one- twelfth (1/12th) of the Moving Costs.

(c) Temporary Housing Assistance. The Company will reimburse Executive for the actual cost of rental housing paid by Executive. The Company's obligation to provide rental reimbursement to Executive shall immediately cease upon the earliest of: (a) the Executive's purchase of residential housing; (b) the termination of Executive's employment for any reason and at the request of either party; or (c) six months after Executive's hire date.

(d) Automobile Assistance. In the event that Executive is unable to purchase or lease at least two automobiles in California due to his relocation from the United Kingdom to the United States, the Company shall assist Executive in obtaining the use of at least two automobiles. The Company retains the sole discretion to determine the manner and means by which it provides this assistance. The Company's obligation to provide this automobile assistance to Executive shall immediately cease upon the earliest of: (a) the Executive's purchase or lease of the same number of automobiles; (b) the termination of Executive's employment for any reason and at the request of either party; or (c) six months after Executive's hire date.

(e) Assistance In Obtaining a Visa. The Company will reimburse Executive for the actual and necessary costs incurred by Executive in applying for a Visa. The Company also will pay any fees required for obtaining a Visa so that Executive may be employed by the Company in the United States.

(f) Tax Treatment of Relocation Assistance. All reimbursements or payments made to Executive or on his behalf by the Company pursuant to this Agreement may be included as Executive's gross income and therefore may be subject to tax. Executive understands that his ability to deduct any portion of these reimbursements or payments is subject to specific limits and other Internal Revenue Service ("IRS") requirements, including the requirement that he must be able to substantiate these expenses by retaining copies of receipts. Executive understands that if he is audited by the IRS or any state tax agency, Executive alone will be liable for any taxes, interest or penalties due if any claimed deductions are denied for any reason, including but not limited to due to his failure to retain copies of receipts. Executive further understands that he is responsible for obtaining independent advice from his own personal tax advisor and that the Company cannot provide such advice to him.

1.8 Standard Company Benefits. Executive shall be entitled to all rights and benefits for which he is eligible under the terms and conditions of the standard Company benefits and compensation practices which may be in effect from time to time and provided by the Company to its employees generally, including but not limited to medical, dental and vision benefit plans and life insurance. Executive also shall be eligible to participate in the Company's 401(k) Plan, including eligibility for a monthly matching contribution by the Company on Executive's behalf, in an amount equal to that contributed by Executive up to a maximum annual matching contribution of Seven Hundred Fifty Dollars ($750). Executive shall be provided specific information concerning these Company benefits upon commencement of his employment.

2. CHANGE IN CONTROL.

2.1 Definitions.

(a) Change in Control. For the purposes of this Agreement, a "Change in Control" shall mean: (1) a sale of substantially all of the assets of the Company; (2) a merger or consolidation in which the Company is not the surviving corporation; or (3) a reverse merger in which the Company is the surviving corporation but the shares of Common Stock outstanding immediately preceding the merger are converted by virtue of the merger into other property whether in the form of securities, cash or otherwise.

(b) Cause. For the purposes of this Agreement, "Cause" shall have the

meaning specified in Section 6.2(b) of this Agreement.

(c) Good Reason. For the purposes of this Agreement, "Good Reason"

means: (i) a material breach by the Company of its obligations under this Agreement and the failure of the Company to remedy such breach within a reasonable period of time following receipt of written notice from Executive; (ii) a material reduction to Executive's duties and responsibilities, in the aggregate; (iii) a reduction of Executive's "base compensation" unless such reduction in "base compensation" is implemented for the majority of the Company's officers ("base compensation" for this purpose being all gross earnings of Executive that would be required to be reflected on Form W-2 by the Company, exclusive of bonus, income recognized by virtue of the exercise or disposition of Company stock options or by the sale of stock acquired pursuant to the Company's employee stock purchase plan, plus amounts that are deferred into the Company's 401(k) Plan and cafeteria plans); or (iv) without Executive's express written consent, the Company requires Executive to change the location of his job or office more than fifty (50) miles from the location of his prior job or office, except in connection with a relocation to the Company's headquarters.

2.2 Accelerated Vesting. In the event of a Change in Control, then the

vesting and exercisability of the shares covered by the Option (or by any option substituted for the Option) shall accelerate so that Fifty Percent (50%) of the then unvested shares covered by the Option shall immediately vest and become exercisable upon the effective date of the Change in Control. In the event that Executive remains in service with the Company after the Change in Control, the remaining unvested shares shall continue to vest on a monthly basis in equal installments over the balance of the 5 year vesting period in accordance with the Company's standard vesting policy. However, if within twelve (12) months after a Change in Control, Executive's employment with the Company is involuntarily terminated without Cause or Executive voluntarily terminates his employment with the Company with Good Reason, then all remaining unvested shares covered by the Option shall vest and become exercisable as of the date of such termination.

Pooling. Notwithstanding the immediately preceding Section, in the event that the potential acceleration of vesting and exercisability of the shares covered by the Option would cause a contemplated Change in Control transaction that would otherwise be accounted for as a "pooling-of-interests" transaction to become ineligible for such accounting treatment under generally accepted accounting principles as determined by the Company's independent public accountants (the "Accountants") prior to the Change in Control, such acceleration shall not occur.

Handling of Golden Parachute Payments. In the event that it shall be determined that any payments or distributions by the Company, or the grant of any benefit by the Company, to Executive or for Executive's benefit (whether paid or payable, distributed or distributable or granted or to be granted pursuant to the terms of this Agreement or otherwise) would both (i) constitute "parachute payments" within the meaning of Section 280G (as it may be amended or replaced) of the Internal Revenue Code of 1986, as amended (the "Code") and (ii) but for this Section of this Agreement, would be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then Executive's benefits hereunder shall be either:

5. delivered in full, or

6. delivered as to such lesser extent which would result in no portion of such benefits being subject to the Excise Tax,

whichever of the foregoing amounts, taking into account the applicable federal, state and local income taxes and the Excise Tax, results in the receipt by Executive on an after-tax basis, of the greatest amount of benefits, notwithstanding that all or some portion of such benefits may be taxable under the Excise Tax. Unless the Company and Executive otherwise agree in writing, all determinations required hereunder shall be made in writing in good faith by the Accountants. In the event of a reduction in benefits hereunder, Executive shall be given the choice of which benefits to reduce. For purposes of making the calculations required hereunder, the Accountants may make reasonable assumptions and approximations concerning applicable taxes and may rely on reasonable, good faith interpretations concerning the application of the Code. The Company and Executive shall furnish to the Accountants such information and documents as the Accountants may reasonably request in order to make a determination hereunder. The Company shall bear all costs the Accountants may reasonably incur in connection with any calculations contemplated hereunder.

PROPRIETARY INFORMATION OBLIGATIONS.

2.3 Agreement. Executive agrees to execute and abide by the Employee Invention Agreement attached hereto as Exhibit A.

2.4 Remedies. Executive's duties under the Employee Invention Agreement shall survive termination of his employment with the Company. Executive acknowledges that a remedy at law for any breach or threatened breach by him of the provisions of the Employee Invention Agreement would be inadequate, and he therefore agrees that the Company shall be entitled to injunctive relief in case of any such breach or threatened breach.

OUTSIDE ACTIVITIES.

2.5 Except with the prior written consent of the Company's Board, Executive will not during the term of this Agreement undertake or engage in any other employment, occupation or business enterprise, other than ones in which Executive is a passive investor. Executive may engage in civic and not-for-profit activities so long as such activities do not materially interfere with the performance of his duties hereunder.

2.6 Except as permitted by Section 5.3, Executive agrees not to acquire, assume or participate in, directly or indirectly, any position, investment or interest known by him to be adverse or antagonistic to the Company, its business or prospects, financial or otherwise.

2.7 During the term of his employment by the Company, except on behalf of the Company, Executive will not directly or indirectly, whether as an officer, director, stockholder, partner, proprietor, associate, representative, consultant, or in any capacity whatsoever engage in, become financially interested in, be employed by or have any business connection with any other person, corporation, firm, partnership or other entity whatsoever which were known by him to compete directly with the Company, throughout the world, in any line of business engaged in (or planned to be engaged in) by the Company; provided, however, that anything above to the contrary notwithstanding, he may own, as a passive investor, securities of any competitor corporation, so long as his direct holdings in any one such corporation shall not in the aggregate constitute more than One Percent (1%) of the voting stock of such corporation.

TERMINATION OF EMPLOYMENT.

2.8 Termination Without Cause.

(a) The Company shall have the right to terminate Executive's employment with the Company at any time without cause or advance notice.

(b) In the event Executive's employment is terminated by the Company without cause which is not the result of a Change in Control as defined in Section 3.1, Executive shall be eligible to receive severance compensation, calculated as specified herein, as his only severance compensation and benefit, provided that, Executive executes a general release of any and all claims he may have against the Company, which general release shall be in a form acceptable to the Company. The amount of severance compensation that Executive shall receive shall be calculated pursuant to the following schedule: (a) if the termination occurs on or prior to the second year anniversary of Executive's hire date, he shall receive an amount equal to twelve (12) months of his base salary, subject to standard payroll deductions and withholdings, and paid in a lump sum; (b) if the termination occurs between the second and third year anniversary of Executive's hire date, he shall receive an amount equal to twelve (12) months of his base salary minus one month of salary for every two months of his employment during his third year of employment, subject to standard payroll deductions and withholdings, and paid in a lump sum; or (c) if the termination occurs after the third year anniversary of Executive's hire date, he shall receive an amount equal to six (6) months of his base salary, subject to standard payroll deductions and withholdings, and paid in a lump sum.

2.9 Termination for Cause.

(a) The Company shall have the right to terminate Executive's employment with the Company at any time for Cause.

(b) "Cause" for termination shall mean: (a) indictment or conviction of any felony or of any crime involving dishonesty; (b) participation in any fraud against the Company; (c) Executive's persistent failure to perform his duties to the Company in a satisfactory manner, after written notice is provided to the Executive by the Board, which notice includes the steps to be taken by the Executive to remedy his failure to perform his duties; (d) intentional damage to any property of the Company; or (e) conduct by Executive which in the good faith and reasonable determination of the Board demonstrates gross unfitness to serve.

(c) In the event Executive's employment is terminated at any time for Cause, Executive will not be entitled to severance pay or any other such compensation or benefit.

2.10 Voluntary or Mutual Termination.

(a) Executive may voluntarily terminate his employment with the Company at any time, after which no further compensation will be paid to Executive.

(b) In the event Executive voluntarily terminates his employment, he will not be entitled to severance pay or any other such compensation or benefit.

NONINTERFERENCE.

While employed by the Company, and for two (2) years immediately following the Termination Date, Executive agrees not to interfere with the business of the Company by soliciting, attempting to solicit, inducing, or otherwise causing any employee of the Company to terminate his or her employment in order to become an employee, consultant or independent contractor to or for any competitor of the Company.

GENERAL PROVISIONS.

2.11 Notices. Any notices provided hereunder must be in writing and shall be deemed effective upon the earlier of personal delivery (including personal delivery by facsimile) or the third day after mailing by first class mail, to the Company at its primary office location and to Executive at his address as listed on the Company payroll.

2.12 Severability. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability will not affect any other provision or any other jurisdiction, but this Agreement will be reformed, construed and enforced in such jurisdiction in order to most closely effectuate the parties' intentions.

2.13 Waiver. If either party should waive any breach of any provisions of this Agreement, he or it shall not thereby be deemed to have waived any preceding or succeeding breach of the same or any other provision of this Agreement.

2.14 Complete Agreement. This Agreement and its Exhibit constitute the entire agreement between Executive and the Company and it is the complete, final, and exclusive embodiment of their agreement with regard to this subject matter. It is entered into without reliance on any promise or representation other than those expressly contained herein, and it cannot be modified or amended except in writing signed by a member of the Company's Board.

2.15 Counterparts. This Agreement may be executed in separate counterparts, any one of which need not contain signatures of more than one party, but all of which taken together will constitute one and the same Agreement.

2.16 Headings. The headings of the sections hereof are inserted for convenience only and shall not be deemed to constitute a part hereof nor to affect the meaning thereof.

2.17 Successors and Assigns. This Agreement is intended to bind and inure to the benefit of and be enforceable by Executive and the Company, and their respective successors, assigns, heirs, executors and administrators, except that Executive may not assign any of his duties hereunder and he may not assign any of his rights hereunder without the written consent of the Company, which shall not be withheld unreasonably.

2.18 Attorney Fees. If either party hereto brings any action to enforce his or its rights hereunder, the prevailing party in any such action shall be entitled to recover his or its reasonable attorneys' fees and costs incurred in connection with such action.

2.19 Governing Law. All questions concerning the construction, validity and interpretation of this Agreement will be governed by the law of the State of California. Executive hereby expressly consents to the personal jurisdiction of the state and federal courts located in Alameda County, California for any lawsuit filed there against Executive by the Company arising from or related to this Agreement.

IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year written below.

LYNX THERAPEUTICS, INC.

By:  /s/ Craig C. Taylor

Craig C. Taylor

Director

Date:  June 16, 1999

Accepted and agreed this
18th day of June, 1999.

/s/ Norman John Wilkie Russell, Ph.D.
Norman John Wilkie Russell, Ph.D.

June 18, 1999
Date

EX-27.1

 

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