-----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, VYcdQSsWRiab2kMTShdEzy3G7M1kqgBUHt2gBrq54NZLq9xA3sYvlDhY/+t9AP7r l1j7UMqlWhihiguzkRGbwQ== 0000950168-00-000699.txt : 20000327 0000950168-00-000699.hdr.sgml : 20000327 ACCESSION NUMBER: 0000950168-00-000699 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMBREX INC/NC CENTRAL INDEX KEY: 0000878725 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 561469825 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-19495 FILM NUMBER: 578184 BUSINESS ADDRESS: STREET 1: 1035 SWABIA COURT CITY: DURHAM STATE: NC ZIP: 27703 BUSINESS PHONE: 9199415185 MAIL ADDRESS: STREET 1: PO BOX 13989 CITY: RESEARCH TRIANGLE PK STATE: NC ZIP: 27709 10-K 1 FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 Commission file number 000-19495 Embrex, Inc. (Exact name of registrant as specified in its charter) North Carolina 56-1469825 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 1035 Swabia Court, Durham, North Carolina 27703 (Address of principal executive offices) (Zip Code) (919) 941-5185 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.01 Par Value Per Share (and Rights Attached Thereto) (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of February 25, 2000, the aggregate market value of the voting stock held by non-affiliates was $114.3 million, based on a price per common share of $15.625 at the close of business on that date. As of February 25, 2000, there were 8,006,361 shares of the registrant's common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Document Where Incorporated Proxy Statement with respect to the Annual Part III Meeting of Shareholders to be held on May 18, 2000, to be filed with the Securities and Exchange Commission INDEX PAGE PART I ITEM 1. BUSINESS.....................................................1 ITEM 2. PROPERTIES...................................................7 ITEM 3. LEGAL PROCEEDINGS............................................7 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..........9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........................................9 ITEM 6. SELECTED FINANCIAL DATA......................................9 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........................10 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...13 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................13 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..........................29 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...........29 ITEM 11. EXECUTIVE COMPENSATION.......................................29 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...................................................29 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...............29 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K..................................................30 SIGNATURES....................................................................37 PART I ITEM 1. BUSINESS GENERAL Embrex, Inc. ("Embrex" or the "Company") develops and markets biological delivery technology and biological products to increase the productivity and profitability of the global poultry industry. The Company was incorporated in 1985 in North Carolina. Embrex has developed and commercialized the Inovoject(R) system, a proprietary, automated in-the-egg injection system which can inoculate 20,000 to 50,000 eggs per hour and eliminates the need for manual, post-hatch injection of certain vaccines. The Inovoject(R) system is designed to inject vaccines and other compounds in precisely calibrated volumes into targeted compartments within the egg. Embrex markets the Inovoject(R) system to commercial poultry producers, charging a fee for each egg injected. In addition to the Inovoject(R) system, Embrex has developed and is marketing its Viral Neutralizing Factor ("VNF(R)") technology, useful in the development of certain avian vaccines. The Company also has developed and is marketing Bursaplex(R), a VNF(R)-based vaccine for protection against avian infectious bursal disease ("IBD"). Embrex also is developing various other proprietary pharmaceutical and biological products to improve bird health, reduce bird production costs and provide other economic benefits to the poultry industry. These products are in various stages of development, and some are being developed in collaboration with major drug companies, the United States Department of Agriculture (the "USDA"), and several leading universities in the field of avian science. These products are being designed to be delivered through the Inovoject(R) system, and some may also be administered after hatching. EXISTING PRODUCTS Inovoject(R) Patented Egg Injection System Embrex has developed and commercialized a proprietary, automated in-the-egg injection system which can inoculate 20,000 to 50,000 eggs per hour and eliminates the need for manual, post-hatch injection of certain vaccines. This proprietary system, called Inovoject(R), is designed to inject vaccines and other compounds in precisely calibrated volumes into targeted compartments within the egg. Embrex markets the Inovoject(R) system to commercial poultry producers, charging a fee for each egg injected. In 1999, the Company converted a number of hatcheries to the Inovoject(R) system and continued operating Inovoject(R) systems in hatcheries converted prior to 1999. The Company estimates that its Inovoject(R) system inoculates in excess of 80% of all eggs produced for the North American broiler poultry market and, therefore, expects diminished growth in the number of system installations and only modest Inovoject(R) system revenue growth in this market. Therefore, the Company must expand its Inovoject(R) system installations and product sales in markets outside North America in order to realize significant overall revenue growth. The Company estimates that approximately 69% of the world broiler production occurs outside the United States and Canada. Accordingly, the Company is continuing to implement a strategy of marketing its Inovoject(R) system outside North America. During 1999, the Company placed a number of Inovoject(R) systems for trial and on contract at locations outside the United States and Canada. The Company's expansion outside the United States and Canada was focused initially on Europe, the Middle East, and Africa. In the second half of 1997, the Company began expansion efforts in Asia and, in 1998, in Latin America. At year end 1999, the Company had Inovoject(R) systems either installed or on trial in 29 countries. Overall, the placement of Inovoject(R) systems outside the United States and Canada is dependent on market acceptance of various in ovo ("in the egg") vaccines and obtaining regulatory approval of these vaccines in numerous countries. Certain poultry diseases are more prevalent in some geographic regions than in others. For example, Marek's disease, for which the Inovoject(R) system primarily is used in the United States, is not as widespread in Europe as in North America. IBD (also known as Gumboro disease) is prevalent both in Northern Europe and Asia and, to a lesser extent, in the United States. The Company expects that the primary usage of its Inovoject(R) systems will vary 1 by geographic region according to the prevailing diseases as well as regulatory approval and market acceptance of vaccines for in ovo delivery. VNF(R) (Viral Neutralizing Factor) Embrex has developed, patented and commercialized a Viral Neutralizing Factor technology which permits single-dose immunization of the avian embryo effective for the life of the bird. By using the VNF(R) technology to form an antibody-vaccine virus complex, immunization is provided in a single step, reducing or eliminating many of the multiple vaccinations carried out in the industry. VNF(R) can temporarily neutralize a virulent vaccine virus without impairing the virus' ability to stimulate an immune response. By using VNF(R) in this manner, the virulent vaccine virus can be made into a safe and effective vaccine which can be used in ovo or after hatching. The VNF(R) technology is the subject of two issued U.S. patents, a pending U.S. patent application, and several foreign patents and foreign patent applications. The U.S. patents are owned by the University of Arkansas and exclusively licensed to Embrex on a royalty basis for the life of the patents. Embrex also is researching application of VNF(R) technology for other avian disease vaccines, including Newcastle disease and infectious bronchitis, although there is no assurance such research will result in product opportunities. To date, the Company's research efforts with its VNF(R) technology have been focused primarily on avian uses. Based on initial experimental data, the Company now believes that the potential exists for VNF(R) to be used in several non-primate species. A U.S. patent claiming the use of VNF(R) viral vaccines in all non-primate animals was allowed in 1997 and issued in February 1999. The Company is in the early stages of exploring collaborative relationships with other companies for the development and licensing of VNF(R) for non-primate uses. In August 1999, Embrex entered into a renewable research collaboration with Boehringer Ingelheim Vetmedica, Inc., part of the Boehringer Ingelheim worldwide group of companies, North Carolina State University, and The William R. Kenan Institute for Engineering Technology and Science, with the objective of developing VNF(R)-based vaccines for animal species other than poultry. Embrex has not initiated any regulatory approval processes with respect to non-primate uses of VNF(R) technology, nor is there any assurance that its efforts in this area will result in products or other collaborative agreements. Infectious Bursal Disease (IBD) Vaccines VNF(R) technology is especially useful in vaccines against avian IBD, which weakens a bird's immune system. Birds infected by IBD typically exhibit poor growth or can succumb to other diseases because of a compromised immune system. This disease is currently widespread in Northern Europe, Asia and, to a lesser extent, in the United States To date, IBD has been treated post-hatch via manually delivered vaccines or in drinking water. Existing vaccines are associated with certain limitations, and some vaccines cannot be used safely or effectively in ovo. The Company estimates the worldwide market for IBD vaccines is approximately $60 million annually. In August 1995, the Company entered into an agreement with Cyanamid Websters ("Websters"), a unit of Fort Dodge Animal Health ("Ft. Dodge"), a division of American Home Products Corp., for the joint development of another IBD vaccine containing VNF(R), which is being marketed by Ft. Dodge in certain European countries and, upon receipt of appropriate regulatory approvals, will be marketed by Ft. Dodge throughout the rest of Europe, the Middle East, and Africa, under Ft. Dodge's trade name "Bursamune(R)". To date, Bursamune(R) has received regulatory approval in South Africa and Spain and, in October 1999, has received temporary authorization from French regulatory authorities for the utilization of Bursamune(R) for in ovo administration. In June 1997, Ft. Dodge indicated that its U.K. application for in ovo regulatory approval of Bursamune(R)had been provisionally refused. Ft. Dodge also indicated that the U.K. regulatory authority requested that further data be supplied. The Company has worked with Ft. Dodge, which is responsible for obtaining the necessary approvals for Bursamune(R)in both the U.K. and other European Community markets, to respond to the U.K. regulatory authority requests for data with respect to Bursamune(R). The Company anticipates that the regulatory review process will be completed during the first half of 2000. Embrex currently is seeking regulatory approval in selected Latin American and Asian markets for in ovo and post-hatch use of Bursaplex(R). Although Embrex has received regulatory approval in some of these markets, there is no assurance that the remaining approvals will be obtained. The placement of Inovoject(R) systems outside the United 2 States and Canada depends, in part, on market acceptance of various in ovo vaccines as well as regulatory approval. To date, regulatory approval for Bursaplex(R) has been received in nine countries besides the United States, and regulatory approval is temporary or pending in thirteen countries. PRODUCTS UNDER DEVELOPMENT Embrex is developing individually and in collaboration with others additional products which address poultry health and performance needs when administered in ovo and, in some cases, after hatching. These additional products are in various stages of development. There can be no assurance that Embrex will successfully develop or market any of these products. Marketing products developed jointly with others may require royalty or other payments by Embrex to its co-developers. Embrex has not initiated the regulatory approval process for any of these potential products, and there is no assurance regulatory approval will be obtained. In Ovo Products For Control Of Coccidiosis In 1995, the Company began an initiative aimed at developing a novel in ovo biological control method for coccidiosis. Coccidiosis is caused by a protozoan parasite which attacks the gut of the chicken, causing significant problems with the intake and digestion of feed and, therefore, the physical and economic performance of the bird. Currently, virtually all broiler chickens, and most poultry in general, receive anti-coccidiosis compounds called coccidiostats incorporated into poultry feed. Over the years, coccidia have developed levels of resistance to these coccidiostats and thus effectiveness has been somewhat reduced. A limited number of live vaccines have also been developed and are administered orally soon after hatch. However, due to difficulties in providing a precise oral dose to each bird, growth depression can occur in broiler flocks. Therefore, such live vaccines are used primarily in parent stock. Using its Inovoject(R) system technology and its knowledge of avian embryology, the Company has begun this initiative to develop a novel, efficacious and cost-effective means of preventing coccidiosis in broiler chickens. This program is aimed at overcoming many of the problems associated with current practices. In 1997, the Company established the feasibility of an in ovo biological control method for coccidiosis. During 1998, this project met the required internal milestones regarding results and timeliness. In 1999, Embrex entered into a collaborative research and development agreement with Pfizer Inc. to research and develop a live coccidiosis vaccine for in ovo delivery to poultry. Further development of this project will involve extensive clinical and field trials. There can be no assurances that any of these development efforts will be successful. Embrex has not initiated the regulatory approval process with respect to these development efforts, and does not expect any coccidiosis product developed by the Company to reach the market in the near future. OTHER PRODUCTS UNDER DEVELOPMENT During 1999, Embrex continued to evaluate technologies which, when coupled with Embrex's proprietary in ovo enabling delivery know-how, might have the potential to yield improvements in the areas of feed conversion, muscle mass and leanness within broiler chickens. These technologies typically need to be applied in the first several days of embryonic development in order to have the desired effect. While the Company plans to continue its research efforts in these areas in 2000, there is no assurance that these efforts will yield product opportunities. Embrex is also evaluating technologies and developing capabilities for characterizing and sorting eggs before or after injection by the Inovoject(R) system. One of these evaluation programs has resulted in the development and introduction of the Vaccine Saver(TM) option for the Inovoject(R) system. The Vaccine Saver(TM) option was introduced in Europe in the fourth quarter of 1999. The capabilities being developed by Embrex include automated gender sorting. Early gender sorting improves processing plant efficiencies by enabling gender-specific feed rations, therefore improving feed conversion. In 1999, Embrex received a small business research grant to support the development of an automated device to sort poultry eggs by gender. There is no assurance, however, that such research will result in product opportunities. The Company has also researched the feasibility of developing a treatment for avian leukosis disease, a viral infection that can result in production losses for poultry producers. Based upon its findings, the Company does not intend to continue research on this program for the foreseeable future. Embrex routinely enters into collaborative agreements with various animal health companies, pharmaceutical companies and research and academic institutions to evaluate the utility of certain of their compounds or devices 3 when delivered or applied in ovo. Depending upon the outcome of these evaluations, Embrex may or may not proceed with these collaborations for further development. There is no assurance that these efforts will yield products or further collaborations. In March 1998, Embrex entered into a marketing agreement with UniSoma, Inc., the U.S. subsidiary of UniSoma Matematica para Productividade, S.A. ("UniSoma"). The marketing agreement granted Embrex the exclusive North American marketing rights for 5 years for the poultry management decision support system developed by UniSoma. This decision support system is designed to assist producers in optimizing decisions in production, scheduling, processing and marketing to maximize profitability. In 1999, the Company determined that there was insufficient demand for this system and terminated the marketing agreement with Unisoma, Inc. PATENTS AND PROPRIETARY RIGHTS Embrex controls (either through direct ownership or exclusive license) 23 issued U.S. patents, 13 pending U.S. patent applications, and more than 60 issued foreign patents and more than 50 pending foreign patent applications. In addition, Embrex has executed confidentiality agreements with its collaborators, subcontractors, employees and directors. The Inovoject(R) system utilizes a process of injecting viral, bacterial or fungal vaccines into avian eggs that was patented in the United States by the USDA in 1984. Embrex holds the exclusive license to this patent through its expiration in 2002. Embrex has supplemented the USDA patent with seven additional issued U.S. patents (and multiple foreign patents and patent applications) covering specific design features of the Inovoject(R) system. See Item 3, "Legal Proceedings", below. Embrex also owns or licenses method-of-use patents for the in ovo administration of VNF(R) vaccines and other compounds to elicit various beneficial responses in poultry. Two U.S. patents for methods of treating IBD virus infections using VNF(R) vaccines, including in ovo administration, were issued to Embrex in March 1995. A U.S. patent claiming the use of VNF(R) viral vaccines in all non-primate animals was allowed in 1997 and issued in February 1999. These patents and additional patent applications encompass the use of VNF(R) vaccine compounds regardless of the source of the VNF(R). These VNF(R) patents additionally include composition-of-matter claims to VNF(R) vaccines against IBD virus disease and composition-of-matter claims to VNF(R) vaccines for combating viral diseases in non-primate animals. These patent claims cover the vaccine preparation, regardless of the manner in which the preparation is used. The Company filed three new U.S. patent applications in 1998 and 10 new U.S. patent applications in 1999. During 1999, Embrex filed 42 new patent applications in the United States and other countries. Each application covered various aspects of in ovo technology. Also, in April 1999, a U.S. patent was issued covering the methods and apparatus for "candling" poultry eggs, or examining the viability of eggs by holding the egg between the eye and light to determine suitability for injection. Embrex continues its efforts to patent methods of delivering compounds in ovo, including early intervention methods and devices. In 1998, five U.S. patents with claims to methods of, or devices for, delivering compounds to avian embryos in ovo were allowed or issued. In 1999, one U.S. patent was allowed covering a pump used for the precise metering of small quantities of fluid used in in ovo administration and another U.S. patent was allowed for selectively injecting poultry eggs. Additionally, Embrex has federally registered the trademarks Embrex(R), Inovoject(R), VNF(R), and Bursaplex(R) in the United States, and has applied for federal registration of Vaccine Saver(TM) and other various trademarks. COMPETITION The primary competition for the Inovoject(R) system is the manual, post-hatch administration of biological products. Since most of Embrex's products and potential products are being designed to be administered through the Inovoject(R) system, the Inovoject(R) system must continue to be accepted within the poultry industry and operated as intended under long-term commercial conditions for these potential products to be marketed successfully. The Company holds the exclusive license to the U.S. patent for injecting vaccines into an avian embryo. Embrex has supplemented this patent with seven additional U.S. patents covering specific design features of the Inovoject(R) 4 system. In addition, Embrex relies on numerous foreign patents to protect its intellectual properties and to afford a competitive advantage. See "Patents and Proprietary Rights," above. There can be no assurance, however, that a competitive delivery method, either within or outside the United States, will not be developed and gain commercial acceptance. Embrex continues to monitor for the presence of any competitive in ovo administration systems worldwide. See Item 3, "Legal Proceedings," below. Competitive success for Embrex will be based primarily on commercial acceptance of its in ovo products, achieving and retaining scientific expertise and technological superiority, identifying and pursuing scientifically feasible and commercially viable opportunities, obtaining proprietary protection for its research achievements, obtaining adequate funding and timely regulatory approvals, and attracting corporate sponsors or partners in developing, testing, producing, and marketing products, none of which can be assured. In addition, a primary competitive factor affecting Embrex is its ability to conduct research and development. Embrex's ability to successfully compete also is dependent on its ability to attract and retain key personnel. Maintaining financial and human resources, therefore, are important factors for success. PRODUCTION, MARKETING AND DISTRIBUTION Production Embrex currently subcontracts the production of substantially all of its mechanical and biological products and expects to continue to do so for the foreseeable future. The Company believes that alternative sources of manufacture and supply generally exist. Inovoject(R) System Embrex's in-house engineering staff designs the Inovoject(R) system, which incorporates proprietary mechanical, pneumatic and electronic sub-systems and concepts. The Company uses one contract manufacturer to fabricate its Inovoject(R) systems. While other machine fabricators exist and have constructed limited numbers of Inovoject(R) systems, a change in fabricators could cause a delay in manufacturing and a possible delay in the timing of future Inovoject(R) system installations and revenues from those installations. VNF(R) (Viral Neutralizing Factor) In 1993, Embrex signed multi-year agreements with SPAFAS, Inc. ("SPAFAS"), a subsidiary of Charles River Laboratories, Inc., under which SPAFAS will supply the active ingredient in VNF(R). In connection with this agreement, Embrex maintains appropriate inventory levels and places orders with SPAFAS to allow Embrex to satisfy anticipated customer demand for VNF(R). The regulatory approval granted by the USDA for Bursaplex(R) in January 1997 specifically covers the vaccine produced with SPAFAS-manufactured VNF(R). The Company has granted Merial Select, Inc. ("Select") (a Merck Rhone-Poulenc company) exclusive rights to manufacture IBD vaccines containing Embrex's VNF(R) product, known as Bursaplex(R), for Embrex to market in North America, Latin America and Asia. Embrex has also granted Ft. Dodge (a unit of American Home Products Corp.) rights to manufacture IBD vaccines containing the Company's VNF(R) product, known as Bursamune(R), to be marketed in Europe, the Middle East and Africa. Abic Ltd. has been granted similar rights to manufacture and market an IBD vaccine, known as GuMBryo(TM), in Israel. The manufacture of the IBD vaccines being produced by Select and Ft. Dodge, and the Company's VNF(R) product, generally must be performed in licensed facilities or under approved regulatory methods. Although there are other manufacturers who are capable of manufacturing IBD products and producing products such as VNF(R), a change of supplier for the Company could adversely affect Embrex's future operating results due to the time it would take a new supplier to obtain regulatory approval of its production process or manufacturing facilities. MARKETING AND DISTRIBUTION Because of the geographical and industrial concentration of the poultry industry in the United States, Embrex markets its products and provides ongoing service directly to the industry. Embrex's marketing is focused principally on the broiler chicken segment of the poultry industry, but the Company also has adapted its products for use by, 5 and initiated trials and entered into commercial contracts with broiler breeder companies, a layer company and a limited number of turkey producers. In order to encourage proper use of the Inovoject(R) system technology within an appropriate production environment, Embrex leases and licenses Inovoject(R) systems to hatcheries. The agreements cover the use of the mechanical equipment and ongoing field service, maintenance and technical support provided by Embrex. The agreements also include a license with royalty fees for use of Embrex's proprietary injection process. Products which are delivered in ovo are sold separately and generate some royalty revenue for the Company. The Company also is initiating arrangements for international distribution of Bursaplex(R), subject in each case to the availability of required regulatory approvals. The Company has agreements with other parties to distribute Bursaplex(R) in Chile, Ecuador, Peru and Pakistan. Of these countries, regulatory approval has been granted in Ecuador, Peru and Pakistan. An agreement for Israel also entitles a distributor, Abic Ltd., to manufacture a VNF(R)-based IBD vaccine mentioned above. Subject to these agreements, the Company also will conduct international marketing directly. Other significant poultry markets exist in Asia and Latin America. Embrex has held a number of discussions regarding marketing and distribution in each of these markets. In 1997 and 1998, the Company entered into agreements with other parties to distribute Bursaplex(R) in Venezuela, Colombia, South Korea, Malaysia, Taiwan, Japan and Vietnam, subject to regulatory approvals. To date, regulatory approval for Bursaplex(R) has been granted in nine countries besides the United States, and regulatory approval is temporary or pending in thirteen countries. Embrex also hired management for selected Asian and Latin American markets and installed Inovoject(R) systems on a commercial or trial basis in certain Asian markets. In 1998, Embrex established Embrex BioTech Trade (Shanghai) Co., Ltd. in China, which will focus on marketing and distribution of Embrex products in China. Also in 1998, Embrex established Embrex Inc. Sucursal Argentina, a branch office in Argentina, responsible for commercial development and customer service and support. Initially, this office will serve only Argentina, but may extend to other regional markets such as Chile, Paraguay or Uruguay. In 1999, Embrex established a subsidiary in Brazil, Inovoject(R) do Brasil Ltda. Also, in April 1999, Bangkok Livestock Processing Company, Ltd. began administering Bursaplex(R) using Embrex's Inovoject(R) system in Thailand. Embrex has initiated activities necessary for the commercialization of its technology in Japan. In 1992, Embrex entered into a distribution agreement with Ishii Company, Ltd. ("Ishii"), a leading chick producer and the dominant supplier of hatchery equipment in Japan. Veterinary medical device regulatory approval was granted by the Japanese Ministry of Agriculture, Fisheries and Forestry in 1999. Ishii intends to distribute the Inovoject(R) egg injection system to poultry producers throughout Japan. The Company's revenues attributable to international operations in 1999, 1998 and 1997 were 23%, 20% and 15% of the Company's consolidated revenues, respectively. The Company's identifiable assets attributable to international operations in 1999, 1998 and 1997 were 16%, 26% and 24% of the Company's consolidated assets, respectively. The Company's gross profit attributable to international operations in 1999, 1998 and 1997 were 19%, 14% and 7% of the Company's consolidated gross margin, respectively. See "Notes to Consolidated Financial Statements." RESEARCH AND DEVELOPMENT In 1998, Embrex opened a 12,800 square-foot research facility near the Company's headquarters. This new facility has increased the Company's clinical trial capabilities. Research and development expense was $4.2 million in 1997, $5.0 million in 1998 and $5.9 million in 1999. The increase in research and development expense from 1997 to 1999 largely reflects increases in outside contract research, supplies consumption, operating activities at the new research facility, and Inovoject(R) design and development and global technical support activity. Research and development is principally Company sponsored and funded primarily from internal sources. GOVERNMENTAL REGULATION Regulation by governmental authorities in the United States and other countries is a significant factor in the production and marketing of Embrex's products and in its on-going research and development activities. Although the use of the Inovoject(R) system is not subject to regulatory approval in the United States, animal health products 6 being developed by Embrex and other companies must receive approval for marketing from either the USDA or the Food and Drug Administration (the "FDA") and from similar agencies in foreign countries where the Company has begun or contemplates doing business. These countries may also require approval of the Inovoject(R) system. Regulatory agencies require that products be tested and demonstrate appropriate levels of safety and efficacy. Generally, with respect to animal health products, the USDA has regulatory authority over products which are biological in origin or which stimulate or affect an animal's immune system, and the FDA has authority over all other products. The time and cost of USDA approvals are generally less than those for FDA approvals. FDA approval generally requires more extensive animal and toxicology testing than USDA approvals and may take five or more years to obtain, whereas USDA approvals generally take one to three years to obtain. The Company's products also are subject to regulatory approval in other countries. Management believes that compliance with environmental regulations currently has no material adverse effect on the Company's capital expenditures, earnings or competitive position. EMPLOYEES At December 31, 1999, Embrex employed 171 persons, 169 of whom were full-time employees, an increase of 44 persons from the 125 full-time employees at December 31, 1998. SIGNIFICANT CUSTOMERS Tyson Foods, Inc.("Tyson") accounted for approximately 24% of Embrex's consolidated 1999 revenues. Based on millions of pounds of ready-to-cook poultry meat produced in 1999, Tyson accounted for approximately 24% of the broilers grown in the United States. During 1997, Tyson extended its contract with Embrex through 2004. There are no customers besides Tyson that represent 10% or greater of total revenues. However, Embrex's three largest customers, including Tyson, accounted for approximately 38% of consolidated 1999 revenues, down from 42% in 1998. The decrease in 1999 is partly the result of the expansion of the Company's customer base. See "Risk Factors" filed as Exhibit 99 to this report. ITEM 2. PROPERTIES Embrex leases its corporate headquarters and research and development facilities, which occupy approximately 23,000 square feet and are located adjacent to Research Triangle Park, North Carolina. Two-thirds of the space is devoted to research and development. The lease is a fifteen-year term expiring March 31, 2002. Embrex paid an annual rent of approximately $208,000 during 1999. Annual rent increases thereafter amount to approximately 3%. In addition to research and development activities conducted at its corporate headquarters, Embrex opened a new 12,800 square-foot research facility near its headquarters in 1998. The lease is a ten-year term expiring November 14, 2007, with a five-year renewal option. The annual rent paid in 1999 was approximately $139,000, with annual increases of approximately 3% through the first ten years and approximately 4% during the five-year renewal term. During the fourth quarter 1999, Embrex entered into a six-year lease for a larger corporate headquarters and research and development facility near its present facilities. This building has been leased in two phases. The first phase encompasses approximately 20,000 square feet. The second phase encompasses another 24,000 square feet. The annual rent is approximately $400,000, with annual increases of approximately 3% through the initial six-year term and approximately 4% during an additional six-year renewal term. The Company intends to vacate its present corporate headquarters once the second phase is ready for occupancy during the second quarter of 2001. Embrex leases approximately 3,000 square feet of warehouse space in Springdale, Arkansas, on a year-to-year basis, which is used to support the Embrex customer service function in the region. The Company also leases offices of 1,250 square feet and warehouse space of 2,500 square feet in Great Dunmow, Essex, England. Embrex also has access to facilities at certain universities. The use of these facilities is important to Embrex's ongoing research and development efforts. Embrex also has access to facilities used for incubating eggs and growing live birds and for research and testing purposes at North Carolina State University. ITEM 3. LEGAL PROCEEDINGS In September 1996, Embrex filed a patent infringement suit in the U.S. District Court for the Eastern District of North 7 Carolina against Service Engineering Corporation, a Maryland corporation, and Edward G. Bounds, Jr., a Maryland resident and officer of Service Engineering Corporation. The suit alleged that each of the defendants' development of an in ovo injection device, designed to compete with Embrex's patented Inovoject(R) injection method, infringes at least one claim of U.S. Patent No. 4,458,630 exclusively licensed to Embrex for the in ovo injection of vaccines into an avian embryo (the "Sharma Patent"). Further, Embrex claimed that the defendants had violated the terms of a Consent Judgment and Settlement Agreement entered into with Embrex in November 1995 in which prior litigation was concluded with Service Engineering Corporation and Edward G. Bounds, Jr. agreeing not to engage in future activities violating the Sharma Patent. Embrex sought injunctive relief to prevent infringement of the Sharma Patent as well as monetary damages. In November 1996, Service Engineering Corporation and Edward G. Bounds, Jr., responded to Embrex's patent infringement suit by asserting various affirmative defenses and denying the substantive allegations in Embrex's complaint. This suit concluded on July 30, 1998 with a jury verdict in favor of Embrex. The verdict fully upheld the validity of all claims of the Sharma Patent, finding that the defendants had willingly infringed all asserted claims of the patent. The jury also found that Service Engineering Corporation and Edward G. Bounds, Jr., had breached the 1995 Consent Judgment and Settlement Agreement and that such breach was not in good faith. The jury awarded Embrex damages of $500,000 plus litigation expenses and court costs. The U.S. District Court for the Eastern District of North Carolina entered a Judgment in favor of Embrex on September 28, 1998, which included a monetary award of $2,612,885 and an injunction prohibiting Service Engineering Corporation and Edward G. Bounds, Jr., from practicing methods claimed in, or otherwise infringing, the Sharma Patent. On October 28, 1998, Service Engineering Corporation and Edward G. Bounds, Jr. filed a notice of appeal in the U.S. Court of Appeals for the Federal Circuit seeking a reversal of the Judgment. The Company has opposed the appeal. In November 1996, Embrex filed a patent infringement suit in the U.S. District Court for the Eastern District of North Carolina against IGI, Inc., a Delaware corporation. The suit alleged that IGI, Inc., through its activities with Service Engineering Corporation and Edward G. Bounds, Jr. was engaging in activities that constituted infringement of the Sharma Patent. Embrex sought injunctive relief to prevent infringement of the Sharma Patent as well as monetary damages. In January 1997, IGI, Inc. responded to Embrex's patent infringement suit by asserting various affirmative defenses and denying the substantive allegations in Embrex's complaint. This suit was concluded by agreement between Embrex and IGI, Inc. in January 1998, pursuant to which Embrex and IGI have agreed to dismiss all pending claims against each other, and IGI has agreed to abide by the terms of a royalty-bearing sublicense to the Sharma Patent for avian vaccination. In March 1997, Service Engineering Corporation and Edward G. Bounds, Jr. filed suit against the U.S. Department of Agriculture in the U.S. District Court for the District of Maryland with respect to its grant to Embrex of an exclusive license for the Sharma Patent. The complaint alleged that the USDA did not adequately comply with statutory and regulatory requirements in making the grant to Embrex of an exclusive license to the Sharma Patent, the revision of the exclusive license in 1991 and the revision of the exclusive license in 1994, which extended the period of exclusivity, originally set to terminate on December 31, 1996, through the patent expiration date. Plaintiffs alleged that in December 1996 (after Embrex had instituted the above referenced action for patent infringement and breach of contract), the Plaintiffs requested the USDA to grant them a license of the Sharma Patent. The Plaintiffs alleged that the USDA refused to do so because the USDA said that the license was not available and that the Plaintiffs had no basis for relief. Plaintiffs also alleged that the USDA wrongfully consented to Embrex's bringing suit against the Plaintiffs. Plaintiffs sought to have the court set aside the extension of the exclusive license, the USDA's grant of permission for Embrex to sue Service Engineering Corporation, Edwards G. Bounds, Jr. and IGI, Inc. for patent infringement, the USDA's refusal to grant to Service Engineering Corporation a non-exclusive license to the Sharma Patent and the USDA's refusal to act favorably upon Service Engineering Corporation's appeal from the refusal to grant it a non-exclusive license. In addition, Plaintiffs sought to have the court issue an order requiring the USDA, prior to granting any exclusive license under the Sharma Patent, including by extending the term of a pre-existing exclusive license, to observe the procedures set forth under laws and regulations governing the grant of licenses to patents owned by the USDA, and to remand the matter to the USDA to take action in accordance with the order. Plaintiffs also sought attorneys' fees and costs from the USDA. The USDA filed a motion for summary judgment. In March 1999, the U.S. District Court for the District of Maryland granted the USDA's motion for summary judgment, agreeing that "the plaintiff lacked standing to challenge the USDA's actions in this matter and that the [USDA's] motion for summary judgment will be granted." On April 15, 1999, Machining Technologies, Inc. of Hebron, Maryland served on Embrex a Complaint for Declaratory Judgment against Embrex in the U.S. District Court for the District of Maryland. Machining 8 Technologies, Inc. seeks a declaration that the Sharma Patent is not infringed, invalid and/or not enforceable. Machining Technologies, Inc. was a manufacturer of egg injection machine parts to Edward G. Bounds, Jr. and Service Engineering Corporation. Embrex believed the action was without legal basis and, on June 4, 1999, filed a motion to dismiss the action. On March 7, 2000, the U.S. District Court for the District of Maryland granted Embrex's motion to dismiss this action and ordered this case closed. See "Risk Factors" filed as Exhibit 99 to this report. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock trades on the Nasdaq National Market System under the symbol EMBX. The quarterly trading ranges of the Company's Common Stock for the last two fiscal years were as shown in the table below: Common Stock Price Per Share --------------- Quarter Ended High Low ------------- ---- --- 1998 ---- March 31, 1998 6 3/8 5 June 30, 1998 6 7/8 5 3/8 September 30, 1998 6 3/16 4 5/16 December 31, 1998 6 3 5/8 1999 ---- March 31, 1999 5 1/2 4 1/8 June 30, 1999 8 1/2 4 3/16 September 30, 1999 10 7 15/16 December 31, 1999 12 5/8 7 At February 25, 2000 (the most recent practicable date), there were 427 holders of record of the Common Stock. The Company has paid no dividends on any stock since inception and has no plans to pay dividends on its Common Stock in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA SUMMARY OF OPERATIONS BY QUARTERS (UNAUDITED) (Dollars In Thousands, Except Per Share Amounts)
1999 1998 ---- ---- 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr ------- ------- ------- ------- ------- ------- ------- ------- Revenues $8,016 $8,411 $8,249 $9,074 $6,857 $6,961 $7,404 $7,393 Operating Expenses 3,314 3,551 3,250 3,923 2,857 2,618 3,179 3,178 Net income 1,137 1,330 1,552 1,725 527 605 753 976
9
1999 1998 ---- ---- 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr ------- ------- ------- ------- ------- ------- ------- ------- Net income (per share of Common Stock) Basic $0.14 $0.16 $0.19 $0.22 $0.06 $0.07 $0.09 $0.12 Diluted $0.14 $0.16 $0.18 $0.20 $0.06 $0.07 $0.09 $0.12 Number of Shares Used in Per Share Calculation (thousands) Basic 8,293 8,250 8,135 7,927 8,243 8,249 8,262 8,264 Diluted 8,368 8,456 8,683 8,443 8,334 8,340 8,339 8,341 5-YEAR SUMMARY OF SELECTED FINANCIAL DATA (Dollars In Thousands, Except Per 1999 1998 1997 1996 1995 Share Amounts) ---- ---- ---- ---- ---- (Restated) STATEMENTS OF OPERATIONS DATA Revenues ............................ $ 33,750 $ 28,615 $ 24,789 $ 20,632 $ 13,719 Research and development expenses ... 5,857 4,995 4,188 4,036 3,416 Other operating expenses ............ 8,181 6,837 5,607 3,775 3,836 Net income (loss) ................... 5,744 2,861 1,760 341 (4,512) Net income (loss) per share of Common Stock Basic ........................ $ 0.70 $ 0.35 $ 0.21 $ 0.05 ($ 0.73) Diluted ...................... $ 0.68 $ 0.34 $ 0.21 $ 0.06 ($ 0.73) Number of Shares Used in Per Share Calculation (thousands) Basic ......................... 8,151 8,255 8,184 7,218 6,187 Diluted ....................... 8,488 8,339 8,339 7,520 6,187 BALANCE SHEET DATA Working capital ..................... $ 7,858 $ 8,299 $ 7,585 $ 7,552 $ 5,934 Total assets ........................ 26,233 24,990 25,161 25,554 21,789 Long-term liabilities ............... 20 644 3,278 5,814 10,966 Accumulated deficit ................. (30,328) (36,072) (38,933) (40,693) (41,034) Shareholders' equity ................ 21,035 18,805 15,741 13,309 5,909
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Company's financial statements and related notes appearing elsewhere in this report. Consolidated net income for 1999 was $5.7 million compared to $2.9 million in 1998 and $1.8 million in 1997. Diluted earnings per share increased from $0.21 in 1997 and $0.34 in 1998 to $0.68 in 1999. For the year ended 1999, shares outstanding on a diluted basis were 8.5 million, up from 8.3 million for the years ended 1998 and 1997. The change in diluted average shares outstanding from 1998 to 1999 is attributable to the increase in the number of in-the-money stock options included in the diluted average shares outstanding calculation following an appreciation in the price of the Company's Common Stock during the second half of 1999 as well as Common Stock repurchases. REVENUES Consolidated revenues in 1999 totaled $33.8 million, representing an increase of 18% over 1998 revenues of $28.6 million, which were 15% over 1997 revenues of $24.8 million. Inovoject(R) revenues totaled $32.3 million in 1999 compared to $27.4 million in 1998 and $23.6 million in 1997, representing increases of 18% from 1998 to 1999, and 16% from 1997 to 1998, with the 1999 increase coming principally from increased placement and throughput of Inovoject(R) systems in North America and Europe. The 1999 revenues include Inovoject(R) lease fees derived from multi-year contracts and paid trials in the United States and foreign countries, and the sale of Inovoject(R) systems to distributors. Embrex estimates that as of December 31, 1999, it was vaccinating in excess of 80% of the estimated 8.0 billion broiler birds grown in the 10 United States in 1999, 1998 and 1997. Given its market penetration, the Company expects only moderate Inovoject(R) systems revenue growth in this market. Management anticipates moderate revenue and earnings growth in 2000 from existing Inovoject(R) operations in the United States and Canada, new Inovoject(R) system leases in other countries, and sales of Bursaplex(R) product to poultry producers worldwide. However, the rate at which the marketplace will accept the Inovoject(R) technology outside the United States and Canada, the timing of regulatory approvals of third-party vaccines for in ovo use outside the United States and Canada, start-up costs in new markets, possible variability in United States hatchery bird production as a result of grain price fluctuations, and variability in the demand for, and pricing of, U.S. poultry and poultry products outside the United States, will impact the pace of revenue growth, if any, and the sustaining of profitability from the installation and operational throughputs of Inovoject(R) systems. Sales of Bursaplex(R), the Company's proprietary vaccine for the treatment of avian infectious bursal disease, was the principal source of $1.3 million of product revenues in 1999 and $931,000 of product revenues in 1998. The Company's ability to generate revenue from product sales has been constrained by the previously announced delay associated with Ft. Dodge's obtaining British regulatory approval for the sale of Bursamune(R) in the United Kingdom, lower levels of breeder and broiler flock vaccination rates, and fewer reported incidences of bursal disease in the United States. Product sales increased 34% during 1999 from the $931,000 recorded for the same period in 1998. Sales of VNF(R) for inclusion in IBD vaccines were the principal source of previous years' product revenues, which generated $1.1 million and $1.2 million in 1997 and 1996, respectively. COST OF PRODUCT SALES AND INOVOJECT(R) REVENUES Cost of revenues as a percentage of revenues decreased from 47% and 49% of total revenues in 1998 and 1997, respectively, to 39% of total revenues in 1999. The improvement in 1999 is primarily attributable to Inovoject(R) system-related cost reductions and some price increases in selected markets. OPERATING EXPENSES Operating expenses totaled $14.0 million in 1999 compared to $11.8 million in 1998, and $9.8 million in 1997. General and administrative ("G&A") expenses were $7.4 million in 1999, up 19% from $6.2 million in 1998, and up 48% from $5.0 million in 1997. The 1999 and 1998 G&A increases over 1997 were primarily attributable to development costs in Asia and Latin America as well as legal expenses incurred in connection with various patent infringement lawsuits filed by the Company. Sales and marketing expenses totaled $795,000 in 1999 compared to $633,000 in 1998 and $587,000 in 1997. Fluctuations during these periods resulted from various levels of activity in the Company's sales and customer service functions to support market expansion and field support of Inovoject(R) systems, as well as stepped-up international activity, principally in Europe. Certain 1997 operating expenses were reclassified to cost of revenues to conform to the 1998 presentation. These reclassifications had no effect on previously reported net income or shareholders' equity. Research and development ("R&D") expenses were $5.9 million in 1999 compared to $5.0 million in 1998 and $4.2 million in 1997. The increase in R&D expense from 1997 to 1999 largely reflects an increase in outside contract research, supplies consumption, operating expenses for the new research facility and Inovoject(R) design and development and global technical support activity. The Company continues to manage its research and development effort to leverage its know-how, patent position, market presence and expenditures. OTHER INCOME AND EXPENSE Interest income totaled $315,000, $402,000 and $488,000 in years 1999, 1998 and 1997, respectively. The 1999 decrease relative to 1998 resulted principally from lower cash balances and the 1998 decrease relative to 1997 resulted principally from lower cash balances and lower interest rates. Interest expense totaled $311,000 in 1999 compared to $645,000 in 1998 and $1.1 million in 1997. In 1999, the 11 decrease in interest expense reflected the repayment of approximately $2.7 million of external financing, primarily in the form of equipment leases. In 1998, the decrease in interest expense reflected the repayment of approximately $2.8 million of external financing, primarily in the form of equipment leases. In 1997, the amount of interest expense was principally attributable to the Company's funding of its growing installed base of Inovoject(R) systems with the use of capital lease financing. Management expects to continue to rely on the use of internally generated funds to finance the cost of additional Inovoject(R) systems in 2000, as was the case in 1999. EFFECT OF INFLATION Management expects cost of product sales and Inovoject(R) systems revenues, operating expenses and capital equipment costs to change in line with periodic inflationary changes in price levels. While management generally believes that the Company will be able to offset the effect of price level changes by adjusting selling/lease prices and effecting operating efficiencies, any material unfavorable changes in price levels could have a material adverse affect on its results of operations. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1999, the Company's cash and short-term investment balances totaled $4.8 million compared to $7.2 million and $8.6 million at December 31, 1998 and 1997, respectively. The decrease reflected the ability of the Company to fund capital expenditures with internal cash instead of equipment lease financing. Working capital decreased to $7.9 million in 1999 from $8.3 million in 1998, as a decrease in cash was offset by a reduction in the short-term portions of capital lease obligations. During 1999, operating activities generated $9.6 million in cash, primarily due to non-cash depreciation and net income. Within investing activities, Inovoject(R) systems, the Company's new research facility, and equipment purchases required $5.9 million. Financing activities used $5.8 million, of which $2.7 million was used to repay long-term debt and capital lease obligations and $3.8 million was used to repurchase the Company's Common Stock (see below). In October 1998, the Company announced that the Board of Directors authorized a share repurchase program to purchase up to 10% of outstanding shares of Common Stock, or up to approximately 830,000 shares over 18 months, in open market or privately negotiated transactions. As of December 31, 1999, the Company had purchased 499,600 shares for $4.0 million at an average price of $7.9844. See "Notes to Consolidated Financial Statements." As of December 31, 1999, the Company had outstanding purchase commitments of approximately $3.4 million related to the production of the Company's Bursaplex(R) product, VNF(R) for the manufacture of Bursaplex(R) and Bursamune(R), and materials and supplies for construction and maintenance of Inovoject(R) egg injection systems. The Company maintained during 1998 a $2.0 million secured line of credit with a bank in the United Kingdom, which could be used to finance the construction of additional Inovoject(R) systems for Europe, the Middle East and Africa. The Company utilized $0.4 million of this line during 1998. This line of credit was repaid and terminated by year-end 1998. In April 1999, the Company obtained a $6.0 million secured revolving line of credit from its bank, Branch Banking and Trust Company. This line of credit may be used for working capital purposes and has a term of 18 months. Based on its current operations, management believes that the Company's available cash and short-term investments, together with cash flow from operations, will be sufficient to meet its foreseeable cash requirements. YEAR 2000 ISSUE The Company established a team to address the Year 2000 issue in June 1998. The team conducted an inventory and assessment of the Company's computer hardware and software systems, as well as embedded systems in its Inovoject(R) systems, manufacturing and laboratory equipment and office facilities. The team developed remediation, testing, and implementation plans for imbedded systems, including the Inovoject(R) system, which remediation, testing, and implementation was completed in October 1999. The Company also engaged an outside 12 consulting firm to conduct an independent verification and validation of the controls and software that operate the Inovoject(R) system, which determined that the Inovoject(R) system was not affected by Year 2000 considerations. The Company incurred approximately $200,000 in 1999 addressing Year 2000 issues. To date, the Company is not aware of any immediate, adverse impact resulting from Year 2000 issues, either on the Company's ability to operate and manage the Inovoject(R) system at its customers' hatcheries or its ability to manage its business and to communicate with its customers and suppliers. However, the Company cannot provide any assurance that its systems and business relationships have not been impacted in a manner that is not yet apparent. The Company will continue to monitor its systems in order to promptly remediate any adversely impacted systems. FORWARD-LOOKING STATEMENTS Information set forth in this Annual Report on Form 10-K contains various "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which statements represent the Company's judgment concerning the future and are subject to risks and uncertainties that could cause the Company's actual operating results and financial position to differ materially. Such forward looking statements can be identified by the use of forward looking terminology such as "may," "will," "expect," "anticipate," "estimate," "believe," or "continue," or the negative thereof or other variations thereof or comparable terminology. The Company cautions that any such forward looking statements include statements with respect to future products, services, markets and financial results. These statements involve risks and uncertainties that could cause actual results to differ materially, including without limitation the ability of the Company to penetrate new markets, place Inovoject(R) systems worldwide, establish a degree of market acceptance for new products such as but not limited to Bursaplex(R) and Bursamune(R), prevail in the outcome of its patent litigation appeal, the number of eggs set by poultry producers, complete commercial development of potential future products or obtain regulatory approval of its products, which approval is dependent upon a number of factors, such as results of trials, the discretion of regulatory officials, and potential changes in regulations, and the Company's dependence on certain customers. These statements are also contingent upon continued growth and production levels of the global poultry industry and the economic viability of certain markets. Additional information on these risks and other factors which could affect the Company's financial results are included in the Risk Factors described in Exhibit 99 to this report and in the Company's other filings with the SEC, including the Company's Forms 10-Q, 10-K and 8-K. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK A portion of the Company's operations are in jurisdictions outside North America. The Company leases Inovoject(R) systems and sells products in Europe, Asia, and Latin America. As a result, the Company's financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. At December 31, 1999, the Company's operations outside North America were not material to the Company's consolidated results as a whole, and a significant change in currency exchange rates or economic conditions in the jurisdictions outside North America in which the Company operates would not have a material effect on the Company's consolidated financial results. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Embrex Inc. We have audited the accompanying consolidated balance sheets of Embrex, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. 13 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Embrex, Inc. and subsidiaries at December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Raleigh, North Carolina February 15, 2000 14 CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) December 31, ------------ ASSETS 1999 1998 ---- ---- Current Assets Cash and cash equivalents................................. $4,799 $7,167 Restricted cash (Note 2).................................. 275 275 Inventories: Materials and supplies............................. 1,562 925 Product............................................ 827 1,281 Accounts receivable - trade............................... 4,751 3,454 Other current assets............................................ 822 738 -------- -------- Total Current Assets...................... 13,036 13,840 Inovoject(R)Systems under construction.......................... 978 568 Inovoject(R)Systems............................................. 27,386 24,161 Less accumulated depreciation............................. (19,804) (16,297) -------- -------- 7,582 7,864 Equipment, furniture and fixtures............................... 7,195 5,060 Less accumulated depreciation............................. (2,906) (2,468) -------- -------- 4,289 2,592 OTHER ASSETS: Patents and exclusive licenses of patentable technology (net of accumulated amortization of $108 in 1999 and $196 in 1998). 348 126 TOTAL ASSETS.................................................... $26,233 $24,990 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable.......................................... $538 $393 Accrued expenses.......................................... 2,738 2,033 Deferred revenue.......................................... 584 175 Product warranty accrual.................................. 394 322 Current portion of capital lease obligations.............. 568 2,618 Line of credit (Note 4)................................... 356 -0- -------- -------- Total Current Liabilities ............... 5,178 5,541 Capital lease obligations, less current portion (Note 3)....... 20 634 Long-term debt, less current portion (Note 4)................... 0 10
15
Shareholders' Equity (Notes 5, 6, 7 and 8) Common Stock, $.01 par value per share Authorized - 30,000,000 shares Issued and outstanding - 7,922,627 net of 499,600 treasury shares and 8,264,490 net of 40,800 treasury shares at December 31, 1999 and 1998, respectively 84 83 Additional paid-in capital................................ 55,231 54,894 Accumulated other comprehensive income.................... 37 113 Accumulated deficit....................................... (30,328) (36,072) Treasury stock............................................ (3,989) (213) -------- -------- Total Shareholders' Equity................ 21,035 18,805 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY...................... 26,233 $24,990 ======== ========
See accompanying notes. 16 CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts) Year ended December 31, ----------------------- 1999 1998 1997 -------- -------- -------- REVENUES Inovoject(R)revenue ............................... $ 32,314 $ 27,426 $ 23,614 Product revenue ................................... 1,252 931 1,062 Other revenue ..................................... 184 258 113 -------- -------- -------- Total Revenues .............................. 33,750 28,615 24,789 Cost of Product Sales and Inovoject(R)Revenues ......... 13,119 13,341 12,244 -------- -------- -------- 20,631 15,274 12,545 OPERATING EXPENSES General and administrative ........................ 7,386 6,204 5,020 Sales and marketing ............................... 795 633 587 Research and development .......................... 5,857 4,995 4,188 -------- -------- -------- Total Operating Expenses .................... 14,038 11,832 9,795 -------- -------- -------- Operating Income ....................................... 6,593 3,442 2,750 Other Income (Expense) Interest income ................................... 315 402 488 Interest expense .................................. (311) (645) (1,070) Other ............................................. (12) 38 14 -------- -------- -------- Total Other Expense ........................ (8) (205) (568) -------- -------- -------- Income Before Taxes ........................ 6,585 3,237 2,182 Income Taxes (Note 9) .................................. 841 376 422 -------- -------- -------- Net Income ............................................. $ 5,744 $ 2,861 $ 1,760 ======== ======== ======== Net Income per share of Common Stock (Note 11) Basic ............................................. $ 0.70 $ 0.35 $ 0.21 Diluted ........................................... $ 0.68 $ 0.34 $ 0.21 Number of Shares Used in Per Share Calculation (Note 11) Basic ............................................. 8,151 8,255 8,184 Diluted ........................................... 8,488 8,339 8,339
See accompanying notes. 17 CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) Year ended December 31, ----------------------- 1999 1998 1997 ---- ---- ---- Operating Activities Net income................................................... $5,744 $2,861 $1,760 Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization.......................... 4,096 4,884 4,043 Changes in operating assets and liabilities: Accounts receivable, inventories and other current assets................................. (1,564) (1,526) (797) Accounts payable, accrued expenses and other current liabilities.................. 1,331 (537) 1,083 ------- ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES 9,607 5,682 6,089 Investing Activities Sales of short-term investments -0- -0- 876 Collateralization of Lease (Note 2) -0- -0- (275) Purchases of Inovoject(R)systems, equipment, furniture and fixtures (5,903) (4,850) (3,962) (Additions)/reductions to patents and other noncurrent assets (240) 248 280 ------- ------- ------- NET CASH USED IN INVESTING ACTIVITIES (6,143) (4,602) (3,081) Financing Activities Issuance of Common Stock 338 107 257 Net proceeds from line of credit 356 -0- -0- Repayment of long-term debt (10) (286) (119) Proceeds from capital lease obligations -0- 101 102 Payments on capital lease obligations (2,664) (2,511) (3,328) Repurchase of Common Stock (3,776) (213) -0- ------- ------- ------- NET CASH USED IN FINANCING ACTIVITIES (5,756) (2,802) (3,088) ------- ------- ------- DECREASE IN CASH AND CASH EQUIVALENTS (2,292) (1,722) (80) CURRENCY TRANSLATION ADJUSTMENTS (76) 309 (376) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 7,167 8,580 9,036 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $4,799 $7,167 $8,580 ======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Total interest paid was $311,000, $645,000 and $1,070,000 for the years ended December 31, 1999, 1998 and 1997 respectively. Total income taxes paid were $618,000, $277,000 and $70,000 for the years ended December 31, 1999, 1998 and 1997, respectively. SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITY: During 1997, $425,000 of outstanding debentures along with $139,000 of accrued interest were converted into 98,267 shares of Common Stock net of unamortized debt issuance costs totaling $1,000. In addition, 419 shares of Embrex Common Stock were issued pursuant to the non-cash exercise of warrants related to the initial sale of the debentures in May 1995. As of December 1, 1997, all debentures had been converted into Common Stock. On May 27, 1997, 34,320 shares of Common Stock were issued in exchange for substantially all of the assets of Agrimatic Corporation. See accompanying notes. 18 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in thousands)
Accumulated Additional Other Common Paid-in Comprehensive Accumulated Treasury Stock Capital Income Deficit Stock Total ----- ------- ------ ------- ----- ----- BALANCE AT DECEMBER 31, 1996 ................ $ 80 $ 53,742 $ 180 $(40,693) $ 0 $ 13,309 Stock issued: Upon exercise of options ............ 1 201 202 Under employee stock purchase plan .. 55 55 Upon conversion of long-term debt (net of issuance cost of $111) .. 1 563 564 Upon issuance of shares for Agrimatic acquisition ............ 227 227 Other Comprehensive Income, Net of Tax (Note 1) Currency translation adjustments . (376) (376) Net income ....................... 1,760 1,760 ----- ------- ------ ------- ----- ----- Comprehensive income ............. 1,384 -------- BALANCE AT DECEMBER 31, 1997 ................ 82 54,788 (196) (38,933) 0 15,741 Stock Repurchased ....................... (213) (213) Stock issued: Upon exercise of options ............ 1 1 Under employee stock purchase plan .. 1 105 106 Other Comprehensive Income, Net of Tax (Note 1) Currency translation adjustments . 309 309 Net income ....................... 2,861 2,861 ----- ------- ------ ------- ----- ----- Comprehensive income ............. 3,170 ----- BALANCE AT DECEMBER 31, 1998 ................ 83 54,894 113 (36,072) (213) 18,805 Stock Repurchased ....................... (3,776) (3,776) Stock issued: Upon exercise of options and issuance of bonus stock ...................... 1 401 402 Under employee stock purchase plan .. 87 87 Upon exercise of warrants ........... (151) (151) Other Comprehensive Income, Net of Tax (Note 1) Currency translation adjustments . (76) (76) Net income ....................... 5,744 5,744 ----- ------- ------ ------- ----- ----- Comprehensive income ............. 5,668 ----- BALANCE AT DECEMBER 31, 1999 ................ $ 84 $ 55,231 $ 37 $(30,328) $ (3,989) $ 21,035 ======== ======== ======== ======== ======== ========
See accompanying notes. 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS Embrex, Inc. has developed and commercialized the Inovoject(R) system, a proprietary, automated, in-the-egg injection system which eliminates the need for manual, post-hatch injection of certain vaccines for newly hatched broiler chicks. Embrex also develops and markets proprietary pharmaceutical and biological products to improve bird health, reduce bird production costs and provide other economic benefits to the poultry industry. ACQUISITION On May 27, 1997, the Company issued 34,320 shares of Common Stock in exchange for substantially all of the assets of Agrimatic Corporation. In 1998, the book value of the assets acquired in this acquisition was written off. This transaction and subsequent write-off had an immaterial effect on the operations of Embrex. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Embrex, Inc. and its wholly owned subsidiaries, Embrex Europe Limited and Embrex Sales, Inc. (the "Company"). All significant intercompany transactions and accounts have been eliminated. Currently, non-U.S. operations account for approximately 23% of the Company's revenues. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. INVENTORIES Items recorded as inventory are generally purchased from others and recorded at the lower of cost or market using the average cost method. Materials and supplies inventories include spare parts for the Inovoject(R) systems as well as laboratory and general supplies. Product inventories are comprised of biological compounds, principally the Company's Viral Neutralizing Factor product (VNF(R)). INOVOJECT(R) SYSTEMS Inovoject(R) systems are comprised of egg injection and related equipment available for lease to customers. The equipment is recorded at the lower of cost or estimated net realizable value. Depreciation is computed principally by using accelerated and straight-line methods over the estimated useful life of the equipment and commences after construction is complete and the equipment is placed in service. EQUIPMENT, FURNITURE AND FIXTURES Equipment, furniture and fixtures are recorded at cost. Depreciation is computed principally by using accelerated and straight-line methods over the estimated three-to-five years useful lives of the assets placed in service. PATENTS AND EXCLUSIVE LICENSES OF PATENTABLE TECHNOLOGY Costs incurred to acquire exclusive licenses of U.S. patentable technology and to apply for and obtain U.S. patents on internally developed technology are capitalized and amortized using the straight-line method. Exclusive license agreements are amortized over the period of the license. Patents are amortized over the shorter of the useful or legal life of the patent. 20 FOREIGN CURRENCY TRANSLATION All assets and liabilities in the balance sheets of the Company's foreign subsidiary, Embrex Europe Limited, and its Asian operations, are translated at year-end exchange rates except shareholders' equity which is translated at historical rates. Revenues, costs and expenses are recorded at average rates of exchange during the year. Translation gains and losses are accumulated as a component of shareholders' equity. Foreign currency transaction gains and losses are included in determining net income. REVENUE RECOGNITION Inovoject(R) system fees are recognized based on eggs processed during the period. Product sales are recognized when the products are shipped. Contract research revenue is recognized as services are performed over the term of the contract. Revenue received, but not yet earned, is classified as deferred revenue. RESEARCH AND DEVELOPMENT COSTS Research and development costs, including costs incurred to complete contract research, are charged to operations when incurred and are included in operating expenses. INCOME TAXES The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary basis differences that have arisen between financial statement and income tax reporting. NET INCOME PER SHARE Basic net income per share was determined by dividing net income available for common shareholders by the weighted average number of common shares outstanding during each year. Diluted net income per share reflects the potential dilution that could occur assuming conversion or exercise of all convertible securities and issued and unexercised stock options. A reconciliation of the net income available for common shareholders and number of shares used in computing basic and diluted net income per share is in Note 11. USE OF ESTIMATES The presentation of 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 these estimates. PRINCIPAL CUSTOMERS Tyson Foods, Inc. ("Tyson") accounted for approximately 24%, 27% and 28% of consolidated 1999, 1998 and 1997 revenues, respectively. Based on the millions of pounds of ready-to-eat poultry meat produced in 1999, Tyson accounted for approximately 24% of the broilers grown in the United States. In 1999, Tyson was the only customer that represented greater than 10% of total revenues. CONCENTRATION OF CREDIT RISK The Company's principal financial instrument, subject to potential concentration of credit risk, is accounts receivable which are unsecured. As of December 31, 1999, Tyson Foods, Inc. accounted for approximately 13% of consolidated accounts receivable, and substantially all of the Company's accounts receivable are due from companies in the poultry industry. SOURCES OF SUPPLY The Company has developed a strategic relationship with one contract manufacturer to fabricate its Inovoject(R) 21 systems. While other machine fabricators exist and have constructed limited numbers of Inovoject(R) systems, a change in fabricators could cause a delay in manufacturing and a possible delay in the timing of future Inovoject(R) installations and revenues from those installations. The Company has granted Merial Select, Inc. ("Select") (a Merck Rhone-Poulenc company) exclusive rights to manufacture IBD vaccines containing Embrex's proprietary VNF(R) product for Embrex to market in North America, Latin America and Asia under the trade name Bursaplex(R). In 1995, Embrex granted Cyanamid Websters ("Websters"), a unit of Ft. Dodge Animal Health, which is a division of American Home Products Corp. ("Ft. Dodge"), rights to manufacture and market bursal disease vaccines containing the Company's VNF(R) product to be marketed in Europe, the Middle East and Africa under the trade name Bursamune(R). Additionally, the Company has one contract supplier of its VNF(R) product. The manufacture of the bursal disease vaccines being produced by Select and Ft. Dodge and the Company's VNF(R) product generally must be performed in licensed facilities and/or under methods approved by regulatory agencies. Although there are other manufacturers who are capable of manufacturing bursal disease products and producing products such as VNF(R), a change of suppliers could adversely effect the Company's future operating results due to the time it would take a new supplier to obtain regulatory approval of its production process and/or manufacturing facilities. The Company seeks to minimize this exposure through multi-year supply agreements and the maintenance of adequate inventories. COMPREHENSIVE INCOME In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income (SFAS 130). This Statement establishes standards for reporting and display of comprehensive income and its components in the financial statements. In accordance with SFAS 130, the Company has determined total comprehensive income, net of tax, to be $5.7 million, $3.2 million and $1.4 million for the years ended December 31, 1999, 1998 and 1997, respectively. Embrex's total comprehensive income represents net income plus the after-tax effect of foreign currency translation adjustments for the years presented. SEGMENTS Effective January 1, 1998, the Company adopted SFAS 131, "Disclosures about Segments of an Enterprise and Related Information". This pronouncement superseded SFAS 14, "Financial Reporting for Segments of a Business Enterprise". SFAS 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The adoption of SFAS 131 did not affect results of operations or financial position. The Company is considered to have only one operating segment based on SFAS 131. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and for Hedging Activities". This pronouncement was originally effective for annual periods beginning after June 15, 1999. The FASB amended SFAS 133 to defer the effective date of adoption until all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", was issued in June 1999. SFAS 133 requires all derivatives to be recorded on the balance sheet and establishes accounting rules for hedging activities. The effect of the hedge accounting rules is to offset changes in value or cash flows of both the hedge and hedged item in earnings in the same period. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported in earnings in the period of the change. Based on the fact that the Company does not currently use derivatives, adoption of this pronouncement is not expected to have a material impact on the Company's financial position or results of operations. During 1998, the Company adopted SOP 98-1, "Accounting for the Costs of Computer Software Developed or 22 Obtained for Internal Use", which requires capitalization of certain costs incurred in connection with developing or obtaining internal use software. The impact of adoption was not material. 2. RESTRICTED CASH On October 13, 1997, the Company executed a ten-year collateralized lease relative to the facilities housing the Company's new research facility. Such collateral exists in the form of a certificate of deposit, which is required to be maintained at least through the end of the seventh year of the lease. 3. LEASES At December 31, 1999 and 1998, the Company had assets totaling $944,000 and $3.3 million, respectively, financed by capital lease agreements which expire through December 2001. Accumulated depreciation and amortization includes $784,000 and $2.3 million of amortization related to these assets at December 31, 1999 and 1998, respectively. Amortization of assets financed by capital leases is included with depreciation expense. The Company leases its facilities under a number of operating leases extending through November 2007. The Company has the option to cancel one of its operating lease agreements with the payment of a $180,000 penalty. Total rent expense was $483,000, $456,000 and $312,000 for the years ended December 31, 1999, 1998 and 1997, respectively. At December 31, 1999, the Company's minimum future commitments under capital and operating leases were as follows: Operating Capital Leases Leases ------ ------ 2000................................... $765,000 $616,000 2001................................... 834,000 11,000 2002................................... 682,000 11,000 2003................................... 628,000 0 2004................................... 648,000 0 Beyond................................. 896,000 0 ------- - Total.................................. $4,453,000 $638,000 ========== ======== Less amounts representing interest..... (50,000) -------- Present value of future minimum lease payments $588,000 ======== 4. DEBT During 1997, $425,000 of outstanding debentures along with $66,000 of accrued interest were converted into 98,267 shares of Common Stock net of unamortized debt issuance costs totaling $1,000. In addition, 419 shares of Embrex Common Stock were issued pursuant to the non-cash exercise of warrants related to the initial sale of such debentures. In April 1999, the Company obtained a $6.0 million secured revolving line of credit facility from its bank, Branch Banking and Trust Company. This facility may be used for working capital purposes, has a term of 18 months and matures on October 2, 2000. The entire unpaid balance of the line of credit then-outstanding plus accrued interest is due in full at maturity. Borrowings drawn down under this facility bear interest at a rate over LIBOR and are collateralized by a security interest in the Company's inventory and accounts receivable. At December 31, 1999, the unused amount of this line of credit facility amounted to $5.6 million. A $10,000 note from the State of North Carolina with an interest rate of 8.75% was repaid along with accrued interest in 1999. 23 5. SHAREHOLDERS' EQUITY On May 16, 1996, the Company's shareholders approved an increase in the number of authorized shares of Common Stock from 15,000,000 to 30,000,000 shares and an increase in the amount of authorized Preferred Stock from 20,000 to 15,000,000 shares. In addition, the Company changed the par value of the Common Stock and Series A Participating Preferred Stock from no par value to par value stock, with a par value of $.01 per share. At December 31, 1999, the Company had reserved a total of 2,048,114 shares of its Common Stock for future issuance as follows: For exercise of warrants to purchase Common Stock................... 122,000 For exercise of Common Stock options and Bonus Stock................ 1,914,475 For possible future issuance to employees and others under employee stock purchase plans................................. 11,639 --------- Total reserved...................................................... 2,048,114 ========= At December 31, 1999, the Company had issued and outstanding warrants to purchase Common Stock as follows:
Date through Which Exercise Price Shares Reserved for Warrants are Per Share Exercise of Warrants Exercisable --------- -------------------- ----------- $9.50................................................. 30,000 12/31/00 $9.50................................................. 15,000 6/9/01 $6.00................................................. 47,000 4/30/00 $7.28................................................. 30,000 10/30/01 ------ 122,000 =======
In October 1998, the Company announced that the Board of Directors authorized a share repurchase program to purchase up to 10% of outstanding shares of Common Stock, or up to approximately 830,000 shares over 18 months, in open market or privately negotiated transactions. As of December 31, 1999, the Company had purchased 499,600 shares for $4.0 million at an average price of $7.9844. 6. STOCK OPTION PLANS The Company has elected to follow Accounting Principles Board Option No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company's stock option plans provide for option grants designated as either non-qualified or incentive stock options. The options generally vest over a four-year period and expire ten years from the date of grant. In general, the exercise price of stock options is the closing price of the Company's Common Stock on the date of grant. Most U.S. employees and certain employees outside the United States are eligible to receive a grant of stock options periodically with the number of shares generally determined by the employee's salary grade and performance level. In addition, certain management and professional level employees may receive a stock option grant upon hire. Non-employee directors of the Company receive annual grants of stock options in amounts specified in the applicable plan. 24 Stock option information with respect to all of the Company's stock option plans follows:
Number Option Price Expiration of Shares Range per Share Date --------- --------------- ---- Balance at December 31, 1996, outstanding options................................................... 866,414 $2.00 to $8.375 1998-2006 Granted............................................. 279,525 $6.063 to $7.125 2007 Exercised........................................... (53,773) $2.00 to $7.00 Canceled............................................ (53,468) $6.125 to $7.00 -------- Balance at December 31, 1997, outstanding options................................................... 1,038,698 $2.00 to $8.75 1998-2007 Granted............................................. 307,495 $5.00 to $6.375 Exercised........................................... (3,900) $2.00 Canceled............................................ (47,754) $5.375 to $7.00 -------- Balance at December 31, 1998, outstanding options................................................... 1,294,539 $2.00 to $8.75 1999-2008 Granted............................................. 340,416 $4.625 to $6.125 Exercised........................................... (159,513) $2.00 to $7.00 Canceled............................................ (75,412) $5.125 to $7.125 Balance at December 31, 1999, outstanding options................................................... 1,400,030 $2.00 to $8.75 1998-2008
The Company's 1998 Amendment to its 1993 Incentive Stock Option Plan increased the authorized grant of options to company personnel from 1.2 million shares of common stock up to 1.9 million shares. All options granted have ten year terms and a four-year vesting schedule. Pro forma information regarding net income and income per share is required by SFAS 123, and has been determined as if the Company accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: 1999 1998 1997 ---- ---- ---- Risk free interest rate......... 4.76% 4.92% 6.13% Dividends....................... -- -- -- Volatility factor............... 0.500 0.305 0.358 The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. 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. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows: For the year ended December 31 1999 1998 1997 ---- ---- ---- Pro forma net income (in thousands).......... $5,017 $2,212 $1,272 Pro forma basic income per share............. $0.62 $0.27 $0.16 At December 31, 1999, 1998 and 1997, exercisable options for 857,962, 791,468 and 612,628 shares, respectively were outstanding. 25 The weighted average remaining contractual life of those options is 6.65 years. The weighted average exercisable price of outstanding options at December 31, 1999 is $5.89. 7. EMPLOYEE STOCK PURCHASE PLAN The Company has an Employee Stock Purchase Plan (the "Purchase Plan") to provide its employees with an additional opportunity to share in the ownership of the Company. Under terms of the Purchase Plan, all regular full-time employees of the Company may make voluntary payroll contributions thereby enabling them to purchase Common Stock. Contributions are limited to 20% of an employee's compensation. Up to 100,000 shares of Common Stock may be issued under the Purchase Plan. The purchase price of the stock is the lesser of 85% of the Fair Market Value on the first business day of the Purchase Period or 85% of the Fair Market Value on the date of exercise which can be at any time during the Plan year. Under the Purchase Plan, during 1999, 1998 and 1997, 21,074, 20,594 and 9,764 shares of Common Stock, respectively, were purchased. To date, 88,361 shares of Common Stock have been purchased. 8. 401(K) RETIREMENT SAVINGS PLAN The Company has a 401(k) plan which is available to all employees upon employment who are at least 18 years of age. Employer contributions are voluntary at the discretion of the Company. Company contributions amounted to $74,542, $62,988 and $44,080 for the years ended December 31, 1999, 1998 and 1997, respectively. 9. INCOME TAXES The components of income tax expense for the year ended December 31 are as follows: 1999 1998 1997 ---- ---- ---- Current: Federal.......................... $348,000 $197,000 $ 59,000 State............................ 169,000 34,000 84,000 Foreign.......................... 324,000 145,000 279,000 ------- ------- ------- $841,000 $376,000 $422,000 ======== ======== ======== The Company's consolidated effective tax rate differed from the statutory rate as set forth below for the year ended December 31:
1999 1998 1997 ---- ---- ---- Federal taxes at statutory rate ............ $ 2,178,000 $ 1,101,000 $ 742,000 State and local income taxes, net of Federal benefit .................................. 321,000 162,000 84,000 Non-deductible expenses .................... 488,000 75,000 24,000 Foreign losses for which no benefit has been recognized ............................... (67,000) 230,000 346,000 Change in valuation allowance .............. (2,403,000) (1,337,000) (1,112,000) Alternative minimum and foreign withholding taxes .................................... 324,000 145,000 338,000 ----------- ----------- ----------- $ 841,000 $ 376,000 $ 422,000 =========== =========== ===========
26 Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has no deferred tax liabilities. Significant components of the Company's deferred tax assets are as follows:
At December 31, --------------- 1999 1998 ---- ---- Deferred tax assets: Book over tax depreciation and amortization ...... $ 88,000 $ 278,000 Net operating loss carryforwards ................. 7,450,000 9,710,000 Research and experimental tax credit carryforwards 2,487,000 2,228,000 Charitable contributions carryforward ............ 27,000 22,000 Accrued liabilities and reserves ................. 245,000 457,000 Alternative Minimum Tax credit carryforward ...... 200,000 205,000 ------------ ------------ Total deferred tax assets .................. $ 10,497,000 $ 12,900,000 Valuation allowance for deferred tax assets ............ ($10,497,000) ($12,900,000) ------------ ------------ Net deferred tax assets ....................... $ 0 $ 0 ============ ============
During 1999 and 1998, the valuation allowance decreased by ($2,403,000) and ($1,337,000), respectively. At December 31, 1999, the Company had net operating loss carryforwards for federal income tax purposes of approximately $19.6 million which are available to offset future taxable income. These net operating loss carryforwards expire during the years 2000 through 2006. Any loss carryforward amounts exceeding the limitation can be carried forward to future years within the carryforward period. In addition, the Company has Research and Experimental Tax Credit carryforwards totaling approximately $2.5 million which are available to offset future federal income taxes. These credits expire during the years 2000 through 2014. 10. COMMITMENTS AND CONTINGENCIES As of December 31, 1999, the Company had outstanding purchase commitments of approximately $3.4 million related to the production of the Company's Bursaplex(R) product, VNF(R) for the manufacture of Bursaplex(R) and Bursamune(R), and materials and supplies for the construction and maintenance of Inovoject(R) egg injection systems. The Company is engaged in certain legal and administrative proceedings incidental to its normal business activities. While it is not possible to determine the ultimate outcome of those actions, in the opinion of management after discussion with legal counsel, it is unlikely that the outcome of such litigation and other proceedings will have a material adverse effect on the results of the Company's operations or its financial position. 11. NET INCOME PER SHARE The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
1999 1998 1997 ------ ------ ------ Numerator: Net Income Available To Common Stockholders ................ $5,744 $2,861 $1,760 Effect of dilutive securities: Regulation S Debentures .......................... 0 0 9 ------ ------ ------ Numerator for diluted earnings per share-income available to common stockholders after assumed 27 conversions ................................... $5,744 $2,861 $1,769 ====== ====== ====== Denominator: Denominator for basic net income per share--weighted-average shares ..................................................... 8,151 8,255 8,184 Effect of Dilutive Securities: Employee Stock Options ........................... 336 84 143 Warrants ......................................... 1 0 8 Convertible Debentures ........................... 0 0 4 Dilutive Potential Shares ..................... 337 84 155 Denominator for diluted net income per share--adjusted weighted-average shares and assumed conversions ........................... 8,488 8,339 8,339 ====== ====== ====== Basic net income per share ................................. $ 0.70 $ 0.35 $0.21 ====== ====== ====== Diluted net income per share ............................... $ 0.68 $ 0.34 $0.21 ====== ====== ======
28 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information on the executive officers and directors is incorporated by reference from the Company's Proxy Statement (under the headings "Management" and "Proposal 1: Election of Directors," respectively), with respect to the Annual Meeting of Shareholders to be held on May 18, 2000, to be filed with the Securities and Exchange Commission. ITEM 11. EXECUTIVE COMPENSATION This information is incorporated by reference from the Company's Proxy Statement (under the heading "Executive Compensation"), with respect to the Annual Meeting of Shareholders to be held on May 18, 2000, to be filed with the Securities and Exchange Commission. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information is incorporated by reference from the Company's Proxy Statement (under the heading "Share Ownership of Management and Certain Beneficial Owners"), with respect to the Annual Meeting of Shareholders to be held on May 18, 2000, to be filed with the Securities and Exchange Commission. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. 29 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1). The financial statements listed below are included in Item 8 of this report. Report of Independent Auditors Financial Statements Consolidated Balance Sheets at December 31, 1999 and 1998 Consolidated Statements of Operations for each of the three years ended December 31, 1999, 1998 and 1997 Consolidated Statements of Cash Flows for each of the three years ended December 31, 1999, 1998 and 1997 Consolidated Statements of Shareholders' Equity for each of the three years ended December 31, 1999, 1998 and 1997 Notes to Consolidated Financial Statements The financial statements of the Company's Employee Stock Purchase Plan listed below are filed herewith, pursuant to Form 10-K, General Instruction F. Report of Independent Auditors Financial Statements Statements of Net Assets Available for Plan Benefits at December 31, 1999 and 1998 Statements of Changes in Net Assets Available for Plan Benefits for the three years ended December 31, 1999, 1998 and 1997 Notes to Financial Statements (a)(2) Financial Statement Schedule Schedule II - Valuation and Qualifying Accounts 30 (a)(3). The exhibits listed below are filed as part of this report. Executive compensation plans and arrangements are listed in Exhibits 10.15 through 10.43. Exhibits Description 3.1(1) Restated Articles of Incorporation 3.2(2) Articles of Amendment to Restated Articles of Incorporation, effective March 21, 1996 3.3(3) Articles of Amendment to Restated Articles of Incorporation, effective May 28, 1996 3.4 Amended and Restated Bylaws, effective April 16, 1999 4.1 Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4 4.2(4) Specimen of Common Stock Certificate 4.3(5) Warrant to Purchase Common Stock of Embrex issued to Schwartz Investments, Inc. 4.4(6) Rights Agreement dated as of March 21, 1996 between Embrex and Branch Banking and Trust Company, as Rights Agent 10.1(7) Exchange Agreement dated May 28, 1991, between Embrex and American Cyanamid Company, Advent First Limited Partnership A, Biotechnology Venture Fund S.A., Biotechnology Investments Limited, Domain Partners, L.P., Elf Technologies, Inc., Prince Venture Partners III, L.P., 3I Securities Corporation, and Charles E. Austin 10.2(7) License Agreement dated December 11, 1991, between Embrex and the National Technical Information Service, a primary operating unit of the United States Department of Commerce 10.3(7) Collaborative Research Agreement dated January 17, 1989 between Embrex and the University of Arkansas 10.4(7) License Agreement dated October 1, 1998 between Embrex and the National Technical Information Service, a primary operating unit of the United States Department of Commerce 10.5(7) Lease Agreement dated December 9, 1986 between Embrex, as tenant, and Imperial Center Partnership and Petula Associates, Ltd., as landlord, as amended by First Amendment dated June 11, 1987, Second Amendment dated December 1, 1988, and Third Amendment dated May 2, 1989 10.6(4) Fourth Amendment of Lease dated October 1, 1994 between the Company and Glaxo Inc. (as successor in interest to Imperial Center Partnership and Petula Associates, Ltd.) 10.7(4) Fifth Amendment of Lease dated December 13, 1996 between the Company and Glaxo Wellcome Inc. (as successor in interest to Glaxo Inc.) 10.8(8) Lease for Royal Center II dated October 13, 1997 between the Company and Petula Associates, Ltd. 10.9 Sublease Agreement dated October 1, 1999, between Embrex, as subtenant, and Wandel & Goltermann Technologies, Inc., as sublandlord 10.10 First Amendment to Sublease Agreement dated February 29, 2000, among Wandel & Goltermann Technologies, Inc., Embrex and W & G Associates 10.11(7) Facility Agreement dated March 1, 1991, between Embrex and Mississippi Agriculture and 31 Forestry Experiment Station, Mississippi State University 10.12(7) Unrestricted Grant Agreement dated April 1, 1988, between Embrex and North Carolina State University, as amended by Amendment dated September 15, 1989 and Amendment dated April 22, 1991 10.13(7) Unrestricted Grant Agreement dated November 1, 1986, between Embrex and North Carolina State University, as amended by Amendment dated May 3, 1989, Amendment dated September 15, 1989, and Amendment dated April 22, 1991 10.14(7) Basic Research Agreement dated October 24, 1989, between Embrex and University of Arkansas, as amended on October 23, 1990, February 1, 1991 and July 22, 1991 10.15(7) 1988 Incentive Stock Option Plan and form of Incentive Stock Option Agreement 10.16(7) 1989 Nonstatutory Stock Option Plan and form of Nonstatutory Stock Option Agreement 10.17(7) 1991 Nonstatutory Stock Option Plan and form of Nonstatutory Stock Option Agreement 10.18(9) Incentive Stock Option and Nonstatutory Stock Option Plan and forms of Stock Option Agreements - June 1993 10.19(3) Amendment dated May 16, 1996 to Incentive Stock Option and Nonstatutory Stock Option Plan - June 1993 10.20(10) Amended and Restated Incentive Stock Option and Nonstatutory Stock Option Plan - May 1998 10.21(14) Amended and Restated Incentive Stock Option and Nonstatutory Stock Option Plan - January 1999 and form of Stock Option Agreement 10.22(4) Amended and Restated Employee Stock Purchase Plan 10.23(7) Employment Agreement dated November 15, 1989, between Embrex and Randall L. Marcuson 10.24(4) Amendment to Employment Agreement dated May 21, 1996 between Embrex and Randall L. Marcuson 10.25(4) Change In Control Severance Agreement dated May 21, 1996 between Embrex and Randall L. Marcuson 10.26(13) Amendment to Change in Control Severance Agreement dated October 1, 1998 between Embrex and Randall L. Marcuson 10.27(7) Employment Agreement dated October 16, 1989, between Embrex and Catherine A. Ricks 10.28(4) Change In Control Severance Agreement dated May 21, 1996 between Embrex and Catherine A. Ricks 10.29(13) Amendment to Change in Control Severance Agreement dated October 1, 1998 between Embrex and Catherine A. Ricks 10.30(2) General Provisions to Employment Agreement between Embrex and Brian V. Cosgriff dated August 18, 1995 10.31(4) Change In Control Severance Agreement dated May 21, 1996 between Embrex and Brian V. Cosgriff 32 10.32(13) Amendment to Change in Control Severance Agreement dated October 1, 1998 between Embrex and Brian V. Cosgriff 10.33(2) Terms and Conditions of Employment between Embrex Europe Limited and David M. Baines dated May 12, 1994 10.34(4) Change In Control Severance Agreement dated June 9, 1996 between Embrex and David M. Baines 10.35(13) Amendment to Change in Control Severance Agreement dated October 1, 1998 between Embrex and David M. Baines 10.36(4) Letter Agreement and General Provisions to Employment Agreement dated August 20, 1996 between Embrex and Don T. Seaquist and Amendment to Employment Agreement dated September 9, 1996 between Embrex and Don T. Seaquist 10.37(4) Change In Control Severance Agreement dated September 9, 1996 between Embrex and Don T. Seaquist 10.38(13) Amendment to Change in Control Severance Agreement dated October 1, 1998 between Embrex and Don T. Seaquist 10.39(13) Letter Agreement and General Provisions to Employment Agreement dated May 31, 1991 between Embrex and V. Hayes Fenstermacher and Amendment to Employment Agreement dated July 18, 1996 between Embrex and V. Hayes Fenstermacher 10.40(13) Change In Control Severance Agreement dated October 16, 1996 between Embrex and V. Hayes Fenstermacher 10.41(13) Amendment to Change in Control Severance Agreement dated October 1, 1998 between Embrex and V. Hayes Fenstermacher 10.42(13) Letter Agreement and General Provisions to Employment Agreement dated February 3, 1999 between Embrex and Brian C. Hrudka 10.43(13) Change In Control Severance Agreement dated March 24, 1999 between Embrex and Brian C. Hrudka 10.44(7) Shareholders' Agreement dated August 14, 1991 by and among Embrex, Advent Euroventures Limited Partnership, and Plant Resource Venture Fund II Limited Partnership 10.45(14) Agreement among Embrex, Micro Cap Partners, L.P., Palo Alto Investors, Inc., Walter Smiley and William L. Edwards dated as of April 18, 1999 10.46(14) Indemnification Agreement among Embrex, Randall L. Marcuson, Charles E. Austin, C. Daniel Blackshear, Lester M. Crawford, Peter J. Holzer, Kenneth N. May, and Arthur M. Pappas dated as of April 1, 1999 10.47(16) Letter Agreement among Embrex, Micro Cap Partners, L.P., Palo Alto Investors, Inc., and William L. Edwards dated as of February 11, 2000 10.48(8) Inovoject(R) Egg Injection System Lease, Limited License, Supply and Service Agreement dated September 1, 1994 between Embrex and Tyson Foods, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) 33 10.49(8) Amendment dated March 26, 1997 to the Inovoject(R) Egg Injection System Lease, Limited License, Supply and Service Agreement dated September 1, 1994 between Embrex and Tyson Foods, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) 10.50(11) Master Lease Agreement dated December 3, 1993 between Embrex and Capital Associates International, Inc. with a form of equipment schedule and collateral assignment of lease attached 10.51(11) Master Lease Agreement dated January 28, 1994 between Embrex and Aberlyn Capital Management Limited Partnership with a form of lease schedule and collateral assignment of lease attached 10.52(11) Agreement to Issue Warrant dated January 28, 1994 between Embrex and Aberlyn Capital Management Limited Partnership 10.53(11) Common Stock Purchase Warrant issued to Aberlyn Capital Management Limited Partnership 10.54(11) Agreement to Issue Warrant dated January 28, 1994 between Embrex and Aberlyn Holding Company, Inc. 10.55(11) Common Stock Purchase Warrant issued to Aberlyn Holding Company, Inc. 10.56(12) Master Equipment Lease Agreement dated as of December 7, 1994between Financing for Science International, Inc. and Embrex with a Consent to Assignment of Equipment Lease Agreement, Security Agreement and Rental Schedule attached 10.57(12) License Agreement dated as of December 7, 1994 between Financing for Science International, Inc. and Embrex with Sublicense Agreement attached 10.58(12) Common Stock Purchase Warrant dated January 17, 1995 issued to Financing for Science International, Inc. 10.59(12) Agreement for Sale of Equipment and Rights Under User Agreement dated as of December 7, 1994 between Financing for Science International, Inc. and Embrex 10.60(2) Limited License and Supply Agreement dated as of July 20, 1995 between Embrex and Webster 10.61(4) Amendments dated August 1, 1996 and November 11, 1996 to Limited License and Supply Agreement dated as of July 20, 1995 between Embrex and Webster 10.62(2) Agreement dated as of January 22, 1996 between Embrex and Select 10.63(2) Letter Agreement dated as of January 22, 1996 between Select and Embrex 10.64(2) License dated as of January 22, 1996 granted by Select to Embrex 10.65(2) Commitment letter accepted June 14, 1995 between Embrex and Financing for Science International, Inc. for $2.0 million capital lease financing facility 10.66(2) Stock Purchase Warrant dated June 9, 1995 issued to Financing for Science International, Inc. 34 10.67(2) Financing Agreement (Number 10783) dated as of October 30, 1995 between Lease Management Services, Inc. and Embrex, and Addendum thereto dated October 30, 1995 attached 10.68(2) License Agreement dated October 30, 1995 between Embrex and Lease Management Services, Inc. 10.69(2) Sublicense Agreement dated as of October 30, 1995 between Embrex and Lease Management Services, Inc. 10.70(2) Movable Hypothec on Equipment and Contracts dated as of October 30, 1995 between Embrex and Lease Management Services, Inc. 10.71(2) Warrant to Purchase 30,000 Shares of Common Stock dated October 30, 1995 issued to Lease Management Services, Inc. 10.72(2) Intercreditor Agreement dated as of October 31, 1995 among Financing for Science International, Inc., Lease Management Services, Inc., and Embrex 10.73(15) Loan Agreement between Embrex and Branch Banking and Trust Company dated as of April 7, 1999 21 Subsidiaries 23 Consent of Ernst & Young LLP to the inclusion of their report dated February 15, 2000 with respect to the consolidated financial statements and schedule of the Company in this Form 10-K and the incorporation by reference of such report into the Registration Statements on Form S-3 (Registration Nos. 333-18231 and 333-31811), as filed with the Securities and Exchange Commission on December 19, 1996 and July 22, 1997, respectively, and into the Registration Statements under the Securities Act of 1933 on Form S-8 (Registration Nos. 33-51582, 33-63318, 333-04109, and 333-56279), as filed with the Securities and Exchange Commission on September 1, 1992, May 25, 1993, May 20, 1996, and June 8, 1998, respectively, and to the incorporation by reference in the Registration Statement on Form S-8 (Registration No. 33-63318) pertaining to the Employee Stock Purchase Plan of their report dated March 20, 2000 with respect to the financial statements of the Embrex, Inc. Employee Stock Purchase Plan included in this Form 10-K 24 Powers of Attorney (included in the signature page for this report) 27 Financial Data Schedule to the Company's Form 10-K for the year ended December 31, 1999 99 Risk Factors relating to the Company (1) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for fiscal year ending December 31, 1991 and incorporated herein by reference (2) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for the fiscal year ending December 31, 1995 and incorporated herein by reference (3) Exhibit to the Company's Form 10-Q as filed with the Securities and Exchange Commission for the three months ended June 30, 1996 and incorporated herein by reference (4) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for fiscal year ending December 31, 1996 and incorporated herein by reference (5) Exhibit to the Company's Form 10-Q as filed with the Securities and Exchange Commission for the three 35 months ended June 30, 1995 and incorporated herein by reference (6) Exhibit to the Company's Registration Statement on Form 8-A as filed with the Securities and Exchange Commission on March 22, 1996 and incorporated herein by reference (7) Exhibit to the Company's Registration Statement on Form S-1 as filed with the Securities and Exchange Commission (Registration No. 33-42482) effective November 7, 1991 and incorporated herein by reference (8) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for the fiscal year ending December 31, 1997 and incorporated herein by reference. (9) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for the fiscal year ending December 31, 1992 and incorporated herein by reference (10) Exhibit to the Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission (Registration No. 333-56279) effective June 8, 1998 and incorporated herein by reference (11) Exhibit to the Company's Form 10-KSB, as amended, as filed with the Securities and Exchange Commission for the fiscal year ending December 31, 1993 and incorporated herein by reference (12) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for the fiscal year ending December 31, 1994 and incorporated herein by reference (13) Exhibit to the Company's Form 10-K as filed with the Securities and Exchange Commission for the fiscal year ending December 31, 1998 and incorporated herein by reference (14) Exhibit to the Company's Form 10-Q as filed with the Securities and Exchange Commission for the three months ended March 31, 1999 and incorporated herein by reference (15) Exhibit to the Company's Form 10-Q as filed with the Securities and Exchange Commission for the three months ended June 30, 1999 and incorporated herein by reference (16) Exhibit to the Company's Form 8-K as filed with the Securities and Exchange Commission on February 22, 2000. (b). No reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 1999. The Company filed a report of Form 8-K on February 22, 2000. 36 SIGNATURES AND POWER OF ATTORNEY Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. EMBREX, INC. /s/ Randall L. Marcuson By:________________________ Date : March 24, 2000 Randall L. Marcuson President and Chief Executive Officer We, the undersigned directors and officers of Embrex, Inc. (the "Company"), do hereby constitute and appoint Randall L. Marcuson and Don T. Seaquist or either of them, our true and lawful attorneys-in-fact and agents, with full power of substitution, to execute and deliver an Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the "Act"), with respect to the year ended December 31, 1999, to be filed with the Securities and Exchange Commission, and to do any and all acts and things and to execute any and all instruments for us and in our names in the capacities indicated below, which said attorneys-in-fact and agents, or either of them, may deem necessary or advisable to enable the Company to comply with the Act and any rules, regulations, and requirements of the Securities and Exchange Commission in connection with such Report, including without limitation the power and authority to execute and deliver for us or any of us in our names and in the capacities indicated below any and all amendments to such Report; and we do hereby ratify and confirm all that the said attorneys-in-fact and agents, or either of them, shall do or cause to be done by virtue of this power of attorney. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Randall L. Marcuson President, Chief Executive Officer March 24, 2000 - -------------------------------- and Director Randall L. Marcuson /s/ Don T. Seaquist Vice President, Finance and March 24, 2000 - --------------------- Administration (Principal Financial Don T. Seaquist and Accounting Officer) /s/ Charles E. Austin Director March 24, 2000 - -------------------------------- Charles E. Austin /s/ C. Daniel Blackshear Director March 24, 2000 - -------------------------------- C. Daniel Blackshear /s/ Lester M. Crawford Director March 24, 2000 - -------------------------------- Lester M. Crawford, D.V.M. Ph.D. /s/ Peter J. Holzer Director March 24, 2000 - -------------------------------- Peter J. Holzer /s/ Kenneth N. May Director March 24, 2000 - -------------------------------- Kenneth N. May, Ph.D. /s/ Arthur M. Pappas Director March 24, 2000 - -------------------------------- Arthur M. Pappas /s/ Walter V. Smiley Director March 24, 2000 - -------------------------------- Walter V. Smiley
37 Report of Independent Auditors The Board of Directors Embrex, Inc. We have audited the accompanying statements of net assets available for plan benefits of Embrex, Inc. Employee Stock Purchase Plan as of December 31, 1999 and 1998, and the related statements of changes in net assets available for plan benefits for each of the three 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 net assets available for plan benefits of Embrex, Inc. Employee Stock Purchase Plan at December 31, 1999 and 1998, and the changes in net assets available for plan benefits for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Raleigh, North Carolina March 20, 2000 38 STATEMENTS OF NET ASSETS AVAILABLE FOR PLAN BENEFITS EMBREX, INC. EMPLOYEE STOCK PURCHASE PLAN At December 31, 1999 1998 ---- ---- Receivable from Company............................. $74,719 $46,243 ------- ------- Net assets available for Plan benefits.............. $74,719 $46,243 ======= ======= See accompanying notes. STATEMENTS OF CHANGES IN NET ASSETS AVAILABLE FOR PLAN BENEFITS EMBREX, INC. EMPLOYEE STOCK PURCHASE PLAN Years Ended December 31, 1999 1998 1997 Employee contributions ...................... $136,073 $137,454 $87,189 Deductions: Purchases of Common Stock 95,535 99,354 46,355 Withdrawals ............. 12,062 30,523 28,245 -------- -------- ------- 107,597 129,877 74,600 -------- -------- ------- Net (decrease) increase ..................... 28,476 7,577 12,589 Net assets available for Plan benefits at beginning of period ..... 46,243 38,666 26,077 -------- -------- ------- Net assets available for Plan benefits at end of period ........... $ 74,719 $ 46,243 $ 38,666 ======== ======== ======= Shares of Common Stock purchased during year ...................... $ 21,074 20,594 8,209 ======== ======== ======= 39 EMBREX, INC. EMPLOYEE STOCK PURCHASE PLAN NOTES TO FINANCIAL STATEMENTS December 31, 1999 NOTE 1 - BASIS OF PRESENTATION The accompanying financial statements of the Embrex, Inc. Employee Stock Purchase Plan ("the Plan") have been prepared on the accrual basis. NOTE 2 - PLAN DESCRIPTION AND SUMMARY OF SIGNIFICANT PLAN PROVISIONS The Board of Directors of Embrex, Inc. ("the Company") adopted the Plan on January 28, 1993, and the Plan was approved by shareholders of the Company at the Annual Meeting of Shareholders on May 20, 1993. The Plan became effective as of June 1, 1993. The purpose of this Plan is to provide the Company's employees with an additional opportunity to share in the ownership of the Company. Under terms of the Plan, all regular full-time employees of the Company may make voluntary payroll contributions thereby enabling them to purchase Common Stock at a price to be determined by the Compensation Committee of the Board, but not less than 85% of the lower of the fair market values as of the first business day of the twelve-month offering period or the date of exercise which can be at any time during the offering period. Contributions are limited to 20% of an employee's compensation, and the aggregate number of shares of Common Stock which may be purchased in total by all Plan participants may not exceed 100,000 shares. Contributions to the Plan are maintained in a non-interest bearing account until such time as the participant exercises the option to purchase shares of Common Stock from his or her available contributions, or withdraws from the account. All amounts representing net Plan assets are considered general assets of the Company and may be subject to the claims of creditors. In addition to contributions, plan activity consists of voluntary purchases of shares of Common Stock and withdrawals from participation in the Plan. Participants may purchase whole shares of Common Stock during a Purchase Period (generally a twelve-month period ending each June 30th). A participant may withdraw from the Plan and cease making contributions at any time. The Plan is not subject to the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA") and is not qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended which relates to qualification of certain pension, profit-sharing and stock bonus plans. All costs to administer the Plan are paid by the Company. 40 FINANCIAL STATEMENT SCHEDULE SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS EMBREX, INC. AND CONSOLIDATED SUBSIDIARIES
ADDITIONS (1) (2) CHARGED TO CHARGED TO BALANCE AT COSTS AND OTHER BALANCE AT BEGINNING OF EXPENSES ACCOUNTS-- DEDUCTIONS-- END OF PERIOD -------- DESCRIBE DESCRIBE PERIOD ------ -------- -------- ------ DESCRIPTION YEAR ENDED DECEMBER 31, 1999 Allowance for doubtful accounts $ 133,521 $ 66,231(a) $ (28,446)(a) $ 171,306 Inventory valuation allowance 585,049 110,000(a) (247,061)(a) 447,988 Amortization of intangible assets 74,364 9,543(a) 0 83,907 YEAR ENDED DECEMBER 31, 1998 Allowance for doubtful accounts $ 48,665 $ 94,227(a) $ (9,371)(a) $ 133,521 Inventory valuation allowance 333,416 313,942(a) (62,309)(a) 585,049 Amortization of intangible assets 79,952 55,143(a) (60,731)(f) 74,364 YEAR ENDED DECEMBER 31, 1997 Allowance for doubtful accounts $ 6,590 $ 42,075(a) $ 0 $ 48,665 Inventory valuation allowance 272,385 173,500(a) (112,469)(a) 333,416 Amortization of intangible assets 57,673 22,279(a) 0 79,952
(a) To adjust allowance for change in estimates. (b) Fully-amortized intangible assets written off. (c) Purchase accounting adjustments. (d) Sales of assets (e) Revaluation adjustments. (f) Not fully amortized - intangible asset write off 41 EX-3.4 2 AMENDED AND RESTATED BYLAWS EXHIBIT 3.4 RESTATED EFFECTIVE MAY 21, 1998 AMENDED EFFECTIVE APRIL 16, 1999 AMENDED AND RESTATED BYLAWS OF EMBREX, INC. ARTICLE I DEFINITIONS In these bylaws, unless otherwise provided, the following terms shall have the following meanings: (1) "Act" shall mean the North Carolina Business Corporation Act as codified in Chapter 55 of the North Carolina General Statutes effective July 1, 1990, and as amended from time to time; (2) "Articles of Incorporation" shall mean the Corporation's articles of incorporation, including amended and restated articles of incorporation and articles of merger; (3) "Corporation" shall mean Embrex, Inc.; (4) "Distribution" shall mean a direct or indirect transfer of money or other property (except the Corporation's own shares) or incurrence of indebtedness by the Corporation to or for the benefit of its shareholders in respect of any of its shares. A distribution may be in the form of a declaration or payment of a dividend, a purchase, redemption, or other acquisition of shares, a distribution of indebtedness, or otherwise; (5) "Emergency" shall mean a catastrophic event which prevents a quorum of the board of directors from being readily assembled; (6) "Shares" shall mean the units into which the proprietary interests in the Corporation are divided; and (7) "Voting group" shall mean all shares of one or more classes or series that under the articles of incorporation or the Act are entitled to vote and be counted together collectively on a matter at a meeting of shareholders. All shares entitled by the articles of incorporation or the Act to vote generally on a matter are for that purpose a single voting group. ARTICLE II OFFICES SECTION 1. PRINCIPAL OFFICE: The principal office of the Corporation shall be located at 1035 Swabia Court, Durham, Durham County, North Carolina 27703, or at such other place as may be determined from time to time by the directors. SECTION 2. REGISTERED OFFICE: The registered office of the Corporation shall be located at 1035 Swabia Court, Durham, Durham County, North Carolina 27703. SECTION 3. OTHER OFFICES: The Corporation may have offices at such other places, either within or without the State of North Carolina, as the board of directors may from time to time determine, or as the affairs of the Corporation may require. ARTICLE III MEETINGS OF SHAREHOLDERS SECTION 1. PLACE OF MEETINGS: All meetings of shareholders shall be held at the principal office of the Corporation, or at such other place, either within or without the State of North Carolina, as shall be designated in the notice of the meeting or as may be agreed upon by a majority of the shareholders entitled to vote at the meeting. SECTION 2. ANNUAL MEETING: The annual meeting of shareholders for the election of directors and the transaction of other business shall be held annually in any month on any day (except Saturday, Sunday or a legal holiday) as fixed by the board of directors. SECTION 3. SUBSTITUTE ANNUAL MEETING: If the annual meeting shall not be held on the day designated by these bylaws, a substitute annual meeting may be called by the board of directors, the chairman of the board, the chief executive officer or the president. A meeting so called shall be designated and treated for all purposes as the annual meeting. SECTION 4. SPECIAL MEETINGS: Special meetings of the shareholders may be called at any time by any two directors. Only business within the purpose or purposes described in the meeting notice specified in Section 6 of this Article may be conducted at a special meeting of shareholders. SECTION 5. CONDUCT OF BUSINESS: The chairman of the meeting of shareholders shall determine the order of business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussion as seem to him in order. SECTION 6. NOTICE OF MEETING: Written or printed notice stating the time and place of the meeting shall be delivered not less than ten (10) nor more than sixty (60) days before the date of any shareholders' meeting, either personally, by mail, by telegraph, by teletype, or by facsimile transmission, by or at the direction of the chairman of the board, the chief executive officer, the president, the secretary, or other person calling the meeting to each shareholder of record entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail, addressed to the shareholder at his address as it appears on the record of the shareholders of the Corporation, with postage thereon prepaid. In the case of a special meeting, the notice of meeting shall specifically state the purpose or purposes for which the meeting is called. In the case of an annual or substitute annual meeting, the notice of meeting need not specifically state the business to be transacted unless such a statement is required by the Act. When an annual or special meeting is adjourned to a different date, time, and place, it is not necessary to give any notice of the adjourned meeting other than by announcement at the meeting at which the adjournment is taken; provided, however, that if a new record date for the adjourned meeting is or must be set, notice of the adjourned meeting must be given to persons who are shareholders as of the new record date. 2 The record date for determining the shareholders entitled to notice of and to vote at an annual or special meeting shall be fixed as provided in Section 3 of Article VIII. SECTION 7. WAIVER OF NOTICE: A shareholder may waive notice of any meeting either before or after such meeting. Such waiver shall be in writing, signed by the shareholder, and filed with the minutes or corporate records. A shareholder's attendance at a meeting: (i) waives objection to lack of notice or defective notice of the meeting, unless the shareholder at the beginning of the meeting objects to holding the meeting or transacting business at the meeting; and (ii) waives objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless the shareholder objects to considering the matter before it is voted upon. SECTION 8. SHAREHOLDER LIST: Commencing two (2) business days after notice of a meeting of shareholders is given and continuing through such meeting, the secretary of the Corporation shall maintain at the principal office of the Corporation an alphabetical list of the shareholders entitled to vote at such meeting, arranged by voting group, with the address of and number of shares held by each. This list shall be subject to inspection by any shareholder or his agent or attorney at any time during usual business hours and may be copied at the shareholder's expense. SECTION 9. QUORUM: A majority of the votes entitled to be cast on a matter by any voting group, represented in person or by proxy, shall constitute a quorum of that voting group for action on that matter. The shareholders present at a duly organized meeting may continue to transact business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum. In the absence of a quorum at the opening of any meeting of shareholders, such meeting may be adjourned from time to time by a majority of the votes voting on the motion to adjourn; and at any adjourned meeting at which a quorum is present, any business may be transacted which might have been transacted at the original meeting. SECTION 10. PROXIES: Shares may be voted either in person or by one or more agents authorized by a written proxy executed by the shareholder or by his duly authorized attorney in fact. A proxy may take the form of a telegram, telex, facsimile or other form of wire or wireless communication which appears to have been transmitted by a shareholder. A proxy is effective when received by the secretary or other officer or agent authorized to tabulate votes. A proxy is not valid after the expiration of eleven (11) months from the date of its execution, unless the person executing it specifies therein the length of time for which it is to continue in force or limits its use to a particular meeting. SECTION 11. VOTING OF SHARES: Unless otherwise provided in these bylaws, the articles of incorporation, or the Act, each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of shareholders. Except for the election of directors, which is governed by the provisions of Section 4 of Article IV, if a quorum is present, action on a matter by a voting group is approved if the votes cast within the voting group favoring the action exceed the votes cast against the action, unless the vote of a greater number is required by the Act, the articles of incorporation, or these bylaws. Shares of the Corporation are not entitled to vote if: (i) they are owned, directly or indirectly, by the Corporation, unless they are held by it in a fiduciary capacity; (ii) they are owned, directly or indirectly, by a second corporation in which the Corporation owns a majority of the shares entitled to vote for directors of the second corporation; or (iii) they are redeemable shares and (x) notice of redemption has been given and (y) a sum sufficient to redeem the shares has been deposited with a bank, trust company, or other financial institution under an irrevocable obligation to pay the holders the redemption price upon surrender of the shares. 3 Either the board of directors or the chairman of the meeting may appoint one or more voting inspectors, each of whom shall take an oath to execute his duties impartially and to the best of his ability. The voting inspector may be an officer, employee or agent of the Corporation. The voting inspectors shall, by majority vote, resolve all questions regarding voting of shares, including the number of shares outstanding, the voting power of each, the shares represented at the meeting, the qualification of voters, the validity of proxies, the existence of a quorum as to any voting group, and the acceptance, rejection and tabulation of votes. SECTION 12. INFORMAL ACTION BY SHAREHOLDERS: Any action which may be taken at a meeting of the shareholders may be taken without a meeting if a consent in writing, setting forth the action so taken, is signed by all of the persons who would be entitled to vote upon such action at a meeting and is delivered to the Corporation to be included in the minutes or to be kept as part of the corporate records. SECTION 13. SHAREHOLDER PROPOSALS: Any shareholder wishing to bring any business before a meeting of shareholders must provide notice to the Corporation not more than ninety (90) and not less than fifty (50) days before the meeting in writing by registered mail, return receipt requested, of the business to be presented by such shareholder at the meeting. Any such notice shall set forth the following as to each matter the shareholder proposes to bring before the meeting: (i) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting and, if such business includes a proposal to amend the bylaws of the Corporation, the language of the proposed amendment; (ii) the name and address, as they appear on the Corporation's books, of the shareholder proposing such business; (iii) the class and number of shares of the Corporation which are beneficially owned by such shareholder; (iv) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business; and (v) any material interest of the shareholder in such business. Notwithstanding the foregoing provisions of this Section, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this Section. In the absence of such notice to the Corporation meeting the above requirements, a shareholder shall not be entitled to present any business at any meeting of the shareholders. SECTION 14. CORPORATION'S ACCEPTANCE OF VOTES: If the name signed on a vote, consent, waiver, or proxy appointment corresponds to the name of a shareholder, the Corporation is entitled to accept the vote, consent, waiver, or proxy appointment and to give it effect as the act of the shareholder. If the name signed on a vote, consent, waiver, or proxy appointment does not correspond to the name of its shareholder, the Corporation is nevertheless entitled to accept the vote, consent, waiver, or proxy appointment and to give it effect as the act of the shareholder if: (i) the shareholder is an entity and the name signed purports to be that of an officer or agent of the entity; (ii) the name signed purports to be that of an administrator, executor, guardian, or conservator representing the shareholder and, if the Corporation requests, evidence of fiduciary status acceptable to the Corporation has been presented with respect to the vote, consent, waiver, or proxy appointment; (iii) the name signed purports to be that of a receiver or trustee in bankruptcy of the shareholder and, if the Corporation requests, evidence of its status acceptable to the Corporation has been presented with respect to the vote, consent, waiver, or proxy appointment; (iv) the name signed purports to be that of a beneficial owner or attorney-in-fact of the shareholder and, if the Corporation requests, evidence acceptable to the Corporation of the signatory's authority to sign for the shareholder has been presented with respect to the vote, consent, waiver, or proxy appointment; or (v) two or more persons 4 are the shareholder as co-tenants or fiduciaries and the name signed purports to be the name of at least one of the co-owners and the person signing appears to be acting on behalf of all the co-owners. The Corporation is entitled to reject a vote, consent, waiver, or proxy appointment if the secretary or other officer or agent authorized to tabulate votes has a reasonable basis for doubt about the validity of the signature on it or about the signatory's authority to sign for the shareholder. SECTION 15. NUMBER OF SHAREHOLDERS: The following persons or entities identified as a shareholder in the Corporation's current record of shareholders constitute one shareholder for purposes of these bylaws: (i) all co-owners of the same shares; (ii) a corporation, partnership, trust, estate, or other entity; (iii) the trustees, guardians, custodians, or other fiduciaries of a single trust, estate, or account. Shareholdings registered in substantially similar names constitute one shareholder if it is reasonable to believe that the names represent the same person. ARTICLE IV BOARD OF DIRECTORS SECTION 1. GENERAL POWERS: All corporate powers shall be exercised by or under the authority of, and the business and affairs of the Corporation shall be managed under the direction of, its board of directors. SECTION 2. NUMBER, TERM AND QUALIFICATIONS: The number constituting the board of directors shall be not less than one (1) nor more than twelve (12). The number of directors within this variable range may be fixed or changed from time to time by the shareholders or the board of directors. Each director shall hold office until his death, resignation, retirement, removal, disqualification, or until his successor is elected and qualified. Directors need not be residents of the State of North Carolina or shareholders of the Corporation. SECTION 3. NOMINATION OF DIRECTORS: Nominations for the election of directors may only be made by the board of directors, by the nominating committee of the board of directors (or, if none, any other committee serving a similar function) or by any shareholder entitled to vote generally in elections of directors where the shareholder complies with the requirements of this Section. The Chief Executive Officer of the Corporation shall be a nominee for election to the board of directors. Any shareholder of record entitled to vote generally in elections of directors may nominate one or more persons for election as directors at a meeting of shareholders only if written notice of such shareholder's intent to make such nomination or nominations has been given, either by personal delivery or by registered mail, return receipt requested, to the Secretary of the Corporation (i) with respect to an election to be held at an annual meeting of shareholders, not more than ninety (90) days nor less than fifty (50) days in advance of such meeting; and (ii) with respect to an election to be held at a special meeting of shareholders called for the purpose of the election of directors, not later than the close of business on the tenth business day following the date on which notice of such meeting is first given to shareholders. Each such notice of a shareholder's intent to nominate a director or directors at an annual or special meeting shall set forth the following: (A) the name and address, as they appear on the Corporation's books, of the shareholder who intends to make the nomination and the name and residence address of the person or persons to be nominated; (B) the class and number of shares of the Corporation which are beneficially owned by the shareholder; (C) a representation that the shareholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (D) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the 5 nomination or nominations are to be made by the shareholders; (E) such other information regarding each nominee proposed by such shareholder as would be required to be disclosed in solicitations of proxies for election of directors, or as would otherwise be required, in each case pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as amended, including any information that would be required to be included in a proxy statement filed pursuant to Regulation 14A had the nominee been nominated by the board of directors; and (F) the written consent of each nominee to be named in a proxy statement and to serve as director of the Corporation if so elected. No person nominated by a shareholder shall be eligible to serve as a director of the Corporation unless nominated in accordance with the procedures set forth in this Section. If the chairman of the shareholders meeting shall determine that a nomination was not made in accordance with the procedures described by the bylaws of the Corporation, he shall so declare to the meeting, and the defective nomination shall be disregarded. Notwithstanding the foregoing provisions of this Section, a shareholder shall also comply with all applicable requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder with respect to the matters set forth in this Section. SECTION 4. ELECTION OF DIRECTORS: Except as provided in Section 6 of this Article, the directors shall be elected at the annual meeting of shareholders by plurality vote; and accordingly those persons who receive the highest number of votes shall be deemed to have been elected. If any shareholder so demands, the election of directors shall be by ballot. SECTION 5. REMOVAL: Any director, or the entire board of directors, may be removed from office at any time, with or without cause, but only if the number of votes cast to remove him exceeds the number of votes cast not to remove him. If a director is elected by a voting group of shareholders, only members of that voting group may participate in the vote to remove him. A director may not be removed by the shareholders at a meeting unless the notice of the meeting specifies such removal as one of its purposes. If any directors are removed, new directors may be elected at the same meeting. SECTION 6. VACANCIES: Any vacancy occurring in the board of directors, including, without limitation, a vacancy resulting from an increase in the number of directors or from the failure by the shareholders to elect the full authorized number of directors, shall be filled by the shareholders or the board of directors. If such vacancy is to be filled by the board of directors, and if the directors remaining in office constitute fewer than a quorum of the board, such vacancy may be filled by the affirmative vote of a majority of the remaining directors or by the sole remaining director. If the vacant office was held by a director elected by a voting group of shareholders, only the remaining director or directors elected by that voting group or the holders of shares of that voting group are entitled to fill the vacancy. The term of a director elected to fill a vacancy shall expire at the next shareholders' meeting at which directors are elected. SECTION 7. CHAIRMAN OF THE BOARD: The board of directors from time to time may appoint from their number a chairman of the board. The chairman of the board, if one is appointed, shall preside at all meetings of the board of directors and the shareholders and shall perform such other duties as may be prescribed from time to time by the board of directors. SECTION 8. COMPENSATION: The board of directors may compensate directors for their services as such and may provide for the payment of all expenses incurred by directors in attending regular and special meetings of the board. SECTION 9. COMMITTEES: The board of directors may create one or more committees of the board, each of which shall have at least two (2) members, all of whom shall be directors. The creation of a committee and the appointment of members to it must be approved by a majority of all the directors in office when the action is taken. Each committee may, as specified by the board of 6 directors, exercise some or all of the authority of the board except that a committee may not: (i) authorize distributions; (ii) approve or propose to shareholders action that the Act requires be approved by shareholders; (iii) fill vacancies on the board of directors or on any of its committees; (iv) amend the articles of incorporation pursuant to N.C. Gen. Stat. Section 55-10-02 or its successor; (v) adopt, amend, or repeal bylaws; (vi) approve a plan of merger not requiring shareholder approval; (vii) authorize or approve a reacquisition of shares, except according to a formula or method prescribed by the board of directors; or (viii) authorize or approve the issuance or sale or contract for sale of shares, or determine the designation and relative rights, preferences, and limitations of a class or series of shares, except that the board of directors may authorize a committee to do so within limits specifically prescribed by the board of directors to the full extent permitted by applicable law. The provisions of Article V, which govern meetings of the board of directors, shall likewise apply to meetings of any committee of the board. SECTION 10. EXECUTIVE COMMITTEE: In accordance with Section 9 of this Article, the board of directors may designate an executive committee. Subject to the provisions of Section 9 of this Article, any executive committee so designated may exercise all of the power of the board of directors during intervals between meetings thereof, including but not limited to the power to authorize the execution of contracts, deeds, leases, and other agreements respecting real or personal property. The board of directors shall approve, disapprove, or modify action taken by any such executive committee and shall record such action in the minutes of the board meeting. ARTICLE V MEETINGS OF DIRECTORS SECTION 1. REGULAR MEETINGS: Regular meetings of the board of directors shall be held at such place or places, on such date or dates, and at such time or times as shall have been established by the board of directors and publicized among all directors. SECTION 2. SPECIAL MEETINGS: Special meetings of the board of directors may be called by one-third of the directors then in office or by the chief executive officer and shall be held at such place, either within or without the State of North Carolina, on such date, and at such time as they or he shall fix. SECTION 3. NOTICE OF MEETINGS: Regular meetings of the board of directors may be held without notice. The person or persons calling a special meeting of the board of directors shall, at least three (3) days before the meeting, give notice of the meeting by any usual means of communication, including by telephone, telegraph, teletype, mail, private carrier, facsimile transmission, or other form of wire or wireless communication. Such notice may be oral and need not specify the purpose for which the meeting is called. SECTION 4. WAIVER OF NOTICE: Any director may waive notice of any meeting either before or after such meeting. Such waiver shall be in writing, signed by the director, and filed with the minutes or corporate records; provided, however, that a director's attendance at or participation in a meeting waives any required notice to him unless the director at the beginning of the meeting (or promptly upon his arrival) objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting. SECTION 5. QUORUM: A majority of the directors fixed by or pursuant to these bylaws shall constitute a quorum for the transaction of business at any meeting of the board of directors. 7 SECTION 6. MANNER OF ACTING: The act of a majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors, unless a greater number is required by the articles of incorporation or these bylaws. SECTION 7. PRESUMPTION OF ASSENT: A director of the Corporation who is present at a meeting of the board of directors or a committee of the board of directors when corporate action is taken is deemed to have assented to the action taken unless: (i) he objects at the beginning of the meeting (or promptly upon his arrival) to holding it or transacting business at the meeting; (ii) his dissent or abstention from the action taken is entered in the minutes of the meeting; or (iii) he files written notice of his dissent or abstention with the presiding officer of the meeting before its adjournment or with the Corporation immediately after adjournment of the meeting. This right of dissent or abstention is not available to a director who votes in favor of the action taken. SECTION 8. PARTICIPATION IN MEETINGS: Any or all of the directors may participate in a regular or special meeting by, or conduct the meeting through the use of, any means of communication by which all directors participating may simultaneously hear each other during the meeting. SECTION 9. ACTION WITHOUT MEETING: Action which may be taken at a board of directors meeting may be taken without a meeting if the action is taken by all members of the board and is evidenced by one or more written consents signed by each director before or after such action, which describes the action taken and is included in the minutes or filed with the corporate records. Such action is effective when the last director signs the consent, unless the consent specifies a different effective date. ARTICLE VI OFFICERS SECTION 1. OFFICERS OF THE CORPORATION: The officers of the Corporation shall consist of a chief executive officer, president, secretary, treasurer, and such vice presidents, assistant secretaries, assistant treasurers, and other officers as the board of directors may from time to time appoint. Any two or more offices may be held by the same person, but no officer may act in more than one capacity where action of two or more officers is required. SECTION 2. APPOINTMENT AND TERM: The officers of the Corporation shall be appointed by the board of directors. A duly appointed officer may appoint one or more officers or assistant officers if authorized by the board of directors. Each officer shall hold office until his death, resignation, retirement, removal, disqualification or until his successor is appointed and qualifies. The appointment of an officer does not itself create contract rights for either the officer or the Corporation. SECTION 3. COMPENSATION OF OFFICERS: The compensation of officers of the Corporation shall be fixed by the board of directors. No officer shall receive compensation for serving the Corporation in any other capacity unless such additional compensation be authorized by the board of directors. SECTION 4. RESIGNATION AND REMOVAL: An officer may resign at any time by communicating his resignation to the Corporation. A resignation is effective when it is communicated unless it specifies in writing a later date. If a resignation is made effective as of a later date and the Corporation accepts the future effective date, the board of directors may fill the pending vacancy before the effective date if the board provides that the successor does not take office until the effective date. An officer's resignation does not affect the Corporation's contract rights, if any, with the officer. 8 Any officer or agent appointed by the board of directors may be removed by the board at any time, with or without cause, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. SECTION 5. BONDS: The board of directors may by resolution require any officer, agent, or employee of the Corporation to give bond to the Corporation, with sufficient sureties, conditioned on the faithful performance of the duties of his respective office or position, and to comply with such other conditions as may from time to time be required by the board of directors. SECTION 6. CHIEF EXECUTIVE OFFICER: The chief executive officer shall have general authority and supervision over the officers and employees of the Corporation, and shall perform such other duties as may be prescribed from time to time by the board of directors. All officers shall report to him except to the extent specifically required by the board of directors. He shall consult with the president as to matters within the scope of the authority of the president. He shall have the authority to sign certificates for shares, as well as any deeds, mortgages, contracts, or other instruments which the board of directors has authorized to be executed, except in cases where the signing and execution of such contracts or instruments shall be expressly delegated by the board of directors or by these bylaws to some other officer or agent of the Corporation, or shall be required by the Act to be otherwise signed or executed. SECTION 7. PRESIDENT: The president shall be the chief operating officer of the Corporation and shall have general charge of the operation of the business of the Corporation. The president shall perform such duties and have such powers as the board of directors from time to time may assign. He shall have the authority to sign certificates for shares, as well as any deeds, mortgages, contracts, or other instruments which the board of directors has authorized to be executed, except in cases where the signing and execution of such contracts or instruments shall be expressly delegated by the board of directors or by these bylaws to some other officer or agent of the Corporation, or shall be required by the Act to be otherwise signed or executed. SECTION 8. VICE PRESIDENTS: In the absence of the president, the vice presidents in the order of their length of service as vice presidents, unless otherwise determined by the board of directors, shall perform the duties of the president, and when so acting shall have all the powers of and be subject to all the restrictions upon that office. Any vice president may sign certificates for shares, as well as any deeds, mortgages, contracts, or other instruments which the board of directors has authorized to be executed, except in cases where the signing and execution of such documents or instruments shall be expressly delegated by the board of directors or these bylaws to some other officer or agent of the Corporation or shall be required by the Act to be otherwise signed or executed. A vice president shall perform such other duties as from time to time may be assigned to him by the chief executive officer, the president, or the board of directors. SECTION 9. SECRETARY: The secretary shall: (i) keep the minutes of the meetings of shareholders, of the board of directors, and of all committees of the board in one or more books provided for that purpose; (ii) see that all notices are duly given in accordance with the provisions of these bylaws or as required by law; (iii) be custodian of the seal of the Corporation and see that the seal of the Corporation is affixed to all documents the execution of which on behalf of the Corporation under its seal is duly authorized; (iv) keep a register of the mailing address of each shareholder which shall be furnished to the secretary by such shareholder; (v) sign, with the chief executive officer, the president, or a vice president, certificates for shares, the issuance of which shall have been authorized by resolution of the board of directors; (vi) have general charge of the stock transfer books of the Corporation; (vii) keep or cause to be kept in the State of North Carolina at the Corporation's principal office a record of the Corporation's shareholders, giving the names and addresses of all shareholders and the number and class of shares held by each, and prepare or cause to be prepared a shareholder 9 list prior to each meeting of shareholders as required by the Act; (viii) maintain and authenticate the books and records of the Corporation; (ix) with the assistance of the treasurer and other officers, prepare and deliver to the Corporation's shareholders such financial statements, notices, and reports as may be required by N.C. Gen. Stat. Sections 55-16-20 and 55-16-21 (or their successors); (x) prepare and file with the North Carolina Secretary of Revenue the annual report required by N.C. Gen. Stat. Section 55-16-22 (or its successor); and (xi) in general 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 chief executive officer, the president or the board of directors. SECTION 10. ASSISTANT SECRETARIES: In the absence of the secretary, the assistant secretaries in the order of their length of service as assistant secretary, unless otherwise determined by the board of directors, shall perform the duties of the secretary, and when so acting shall have all the powers of and be subject to all the restrictions upon the secretary. They shall perform such other duties as may be assigned to them by the secretary, the chief executive officer, the president, or the board of directors. Any assistant secretary may sign, with the chief executive officer, the president or a vice president, certificates for shares. SECTION 11. TREASURER: The treasurer shall be the chief financial officer of the Corporation and shall: (i) have charge and custody of and be responsible for all funds and securities of the Corporation; (ii) receive and give receipts for monies due and payable to the Corporation from any source whatsoever, and deposit all such monies in accordance with the provisions of Section 4 of Article VII; (iii) prepare, or cause to be prepared, an annual financial statement in accordance with Section 3 of Article IX; and (iv) in general, perform all of the duties incident to the office of treasurer and such other duties as from time to time may be assigned to him by the chief executive officer, the president or the board of directors. The treasurer may sign, with the chief executive officer, the president or a vice president, certificates for shares. SECTION 12. ASSISTANT TREASURERS: In the absence of the treasurer, the assistant treasurers, in the order of their length of service as assistant treasurer, unless otherwise determined by the board of directors, shall perform the duties of the treasurer, and when so acting shall have all the powers of and be subject to all the restrictions upon the treasurer. They shall perform such other duties as may be assigned to them by the treasurer, the chief executive officer, the president, or the board of directors. Any assistant treasurer may sign, with the chief executive officer, the president or a vice president, certificates for shares. SECTION 13. ACTION RE: SECURITIES OF OTHER CORPORATIONS: Unless otherwise directed by the board of directors, the President shall have power to vote and otherwise act on behalf of the Corporation, in person or by proxy, at any meeting of shareholders of or with respect to any action of shareholders of any other corporation in which this Corporation may hold securities and otherwise to exercise any and all rights and powers which this Corporation may possess by reason of its ownership of securities in such other corporation. ARTICLE VII CONTRACTS, LOANS, CHECKS AND DEPOSITS SECTION 1. CONTRACTS: The board of directors may authorize any officer or agent to enter into any contract or to execute and deliver any instrument on behalf of the Corporation, and such authority may be general or confined to specific instances. 10 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 AND DRAFTS: All checks, drafts or other orders for payment of money issued in the name of the Corporation shall be signed by such officers 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 depositories as the board of directors shall direct. ARTICLE VIII CERTIFICATES FOR SHARES AND THEIR TRANSFER SECTION 1. CERTIFICATES FOR SHARES: Shares may, but need not, be represented by certificates. If certificates are issued, they shall be in such form as the board of directors shall determine; provided that, at a minimum, each certificate shall state on its face: (i) the name of the Corporation and that it is organized under the laws of North Carolina; (ii) the name of the person to whom issued; and (iii) the number and class of shares and the designation of the series, if any, the certificate represents. If the Corporation issues certificates for shares of preferred stock, the designations, relative rights, preferences, and limitations applicable to that class, and the variations in rights, preferences, and limitations for each series within that class (and the authority of the board of directors to determine variations for future series) must be summarized on the front or back of each certificate; alternatively, each certificate may state conspicuously on its front or back that the Corporation will furnish the shareholder this information in writing and without charge. These certificates shall be signed, either manually or in facsimile, by the chief executive officer, the president, or any vice president, and the secretary or any assistant secretary, the treasurer or any assistant treasurer. They shall be consecutively numbered or otherwise identified and the name and address of the persons to whom they are issued, with the number of shares and date of issue, shall be entered on the stock transfer books of the Corporation. SECTION 2. TRANSFER OF SHARES: Transfer of shares of the Corporation shall be made only on the stock transfer books of the Corporation by the holder of record, by his legal representative (who shall furnish proper evidence of authority to transfer) or by his attorney (whose authority shall be evidenced by a power of attorney duly executed and filed with the secretary), and only upon surrender for cancellation of the certificates for such shares. SECTION 3. FIXING RECORD DATE: For the purpose of determining shareholders entitled to receive notice of a meeting of shareholders, to demand a special meeting, to vote, to take any other action, or to receive payment, or for any other purpose, the board of directors may fix in advance a date as the record date for any such determination of shareholders, such record date in any case to be not more than seventy (70) days, and, in case of a meeting of shareholders, not less than ten (10) days, before the date on which the particular action requiring such determination of shareholders is to be taken. If no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or of shareholders entitled to receive a distribution, the day before the first notice of the meeting is mailed or the day on which the board of directors authorize the distribution, as the case may be, shall be the record date for such determination of shareholders. 11 When a determination of shareholders entitled to notice of or to vote at any meeting of shareholders has been made as provided in this Section, such determination shall apply to any adjournment of such meeting unless the board of directors fixes a new record date, which it must do if the meeting is adjourned to a date more than 120 days after the date fixed for the original meeting. SECTION 4. LOST CERTIFICATES: The board of directors may authorize the issuance of a new share certificate in place of a certificate claimed to have been lost or destroyed, upon receipt of an affidavit of such fact from the person claiming the loss or destruction. When authorizing the issuance of a new certificate, the board of directors may require the claimant to give the Corporation a bond in such sum as it may direct to indemnify the Corporation against loss from any claim with respect to the certificate claimed to have been lost or destroyed; or the board of directors may, by resolution reciting that the circumstances justify such action, authorize the issuance of the new certificate without requiring such a bond. SECTION 5. REACQUIRED SHARES: The Corporation may acquire its own shares and shares so acquired constitute authorized but unissued shares. ARTICLE IX GENERAL PROVISIONS SECTION 1. DISTRIBUTIONS: The board of directors may from time to time declare, and the Corporation may make, distributions on its outstanding shares in the manner and subject to the terms and conditions provided by the Act and by the articles of incorporation. SECTION 2. SEAL: The corporate seal of the Corporation shall consist of two concentric circles between which is the name of the Corporation and in the center of which is inscribed "CORPORATE SEAL" or "SEAL," and which shall have such other characteristics as the board of directors may determine. SECTION 3. RECORDS AND REPORTS: All of the Corporation's records shall be maintained in written form or in another form capable of conversion into written form within a reasonable time. The Corporation shall keep as permanent records minutes of all meetings of its incorporators, shareholders, and board of directors, a record of all actions taken by the shareholders or board of directors without a meeting, and a record of all actions taken by a committee of the board of directors in place of the board of directors. The Corporation shall keep a copy of the following records at its principal office: (i) the articles of incorporation and all amendments to them currently in effect; (ii) these bylaws and all amendments to them currently in effect; (iii) resolutions adopted by its board of directors creating one or more classes or series of shares and fixing their relative rights, preferences, and limitations (if shares issued pursuant to those resolutions are outstanding); (iv) the minutes of all meetings of shareholders and records of all actions taken by shareholders without a meeting during the past three years; (v) all written communications to shareholders generally within the past three years; (vi) the annual financial statements described below, prepared during the past three years; (vii) a list of the names and business addresses of its current directors and officers; and (viii) its most recent annual report delivered to the North Carolina Secretary of Revenue (or Secretary of State, if applicable). 12 The Corporation shall prepare and make available to its shareholders annual financial statements for the Corporation and its subsidiaries that: (i) include a balance sheet as of the end of the fiscal year, an income statement for that year, and a statement of cash flows for the year; and (ii) are accompanied by either (x) a report of a public accountant on the annual financial statements, or (y) a statement by the treasurer stating his reasonable belief whether the annual financial statements were prepared on the basis of generally accepted accounting principles (and, if not, describing the basis of preparation) and describing any respects in which the statements were not prepared on a basis of accounting consistent with the statements prepared for the preceding year. These annual financial statements, or a written notice of their availability, shall be mailed to each shareholder within 120 days after the close of each fiscal year of the Corporation. On written request from a shareholder who was not mailed the annual financial statements, the Corporation shall mail to him the latest such statements. The Corporation shall also prepare and file with the North Carolina Secretary of Revenue an annual report in such form as required by N.C. Gen. Stat. Section 55-16-22, or its successor. SECTION 4. INDEMNIFICATION: Any person who at any time serves or has served as a director or officer of the Corporation, or at the request of the Corporation is or was serving as an officer, director, agent, partner, trustee, administrator, or employee for any other foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, shall be indemnified by the Corporation to the fullest extent from time to time permitted by law in the event he is made, or is threatened to be made, a party to any threatened, pending or completed civil, criminal, administrative, investigative or arbitrative action, suit or proceeding and any appeal therein (and any inquiry or investigation that could lead to such action, suit or proceeding), whether or not brought by or on behalf of the Corporation, seeking to hold him liable by reason of the fact that he is or was acting in such capacity. In addition, the board may provide such indemnification for the employees and agents of the Corporation as it deems appropriate. The rights of those receiving indemnification hereunder shall, to the fullest extent from time to time permitted by law, cover (i) reasonable expenses, including without limitation all attorneys' fees actually and necessarily incurred by him in connection with any such action, suit or proceeding, (ii) all reasonable payments made by him in satisfaction of any judgment, money decree, fine (including an excise tax assessed with respect to an employee benefit plan), penalty, or settlement for which he may have become liable in such action, suit or proceeding; and (iii) all reasonable expenses incurred in enforcing the indemnification rights provided herein. Expenses incurred by anyone entitled to receive indemnification under this Section in defending a proceeding may be paid by the Corporation in advance of the final disposition of such proceeding as authorized by the board of directors in the specific case or as authorized or required under any provisions in the bylaws or by any applicable resolution or contract upon receipt of an undertaking by or on behalf of the director to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation against such expenses. The board of directors of the Corporation shall take all such action as may be necessary and appropriate to authorize the Corporation to pay the indemnification required by this bylaw, including without limitation, to the extent needed, making a good faith evaluation of the manner in which the claimant for indemnity acted and of the reasonable amount of indemnity due him. Any person who at any time serves or has served in any of the aforesaid capacities for or on behalf of the Corporation shall be deemed to be doing or to have done so in reliance upon, and as consideration for, the right of indemnification provided herein. Any repeal or modification of these 13 indemnification provisions shall not affect any rights or obligations existing at the time of such repeal or modification. The rights provided for herein shall inure to the benefit of the legal representatives of any such person and shall not be exclusive of any other rights to which such person may be entitled apart from the provisions of this bylaw. The rights granted herein shall not be limited by the provisions contained in N.C. Gen. Stat. Section 55-8-51 (or its successor), provided, however, that the Corporation shall not indemnify or agree to indemnify a potential indemnitee against liability or expenses he may incur on account of his activities which were at the time taken known or believed by the potential indemnitee to be clearly in conflict with the best interests of the Corporation. The Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent for any other foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, 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 the Act or these bylaws. SECTION 5. FISCAL YEAR: The fiscal year of the Corporation shall be fixed by the board of directors. SECTION 6. AMENDMENTS: (a) The board of directors may amend or repeal these bylaws, except to the extent otherwise provided in the articles of incorporation, a bylaw adopted by the shareholders, or the Act, and except that a bylaw adopted, amended or repealed by the shareholders may not be readopted, amended or repealed by the board of directors if neither of the articles of incorporation nor a bylaw adopted by the shareholders authorizes the board of directors to adopt, amend, or repeal that particular bylaw or the bylaws generally. (b) The Corporation's shareholders may adopt, amend, alter, change, or repeal any of these bylaws consistent with the provisions of Section 11 of Article III. (c) A bylaw that fixes a greater quorum or voting requirement for the board of directors may be amended or repealed: (i) if originally adopted by the shareholders, only by the shareholders, unless the bylaw permits amendment or repeal by the board of directors; or (ii) if originally adopted by the board of directors, either by the shareholders or by the board of directors. (d) A bylaw referred to in Subsection (c) above: (i) may not be adopted by the board of directors by a vote of less than a majority of the directors then in office; and (ii) may not itself be amended by a quorum or vote of the directors less than the quorum or vote therein prescribed or prescribed by a bylaw adopted or amended by the shareholders. (e) A bylaw adopted or amended by the shareholders that fixes a greater voting or quorum requirement for the board of directors may provide that it may be amended or repealed only by a specified vote of either the shareholders or the board of directors. SECTION 7. TIME PERIODS: In applying any provision of these bylaws which requires an act to be done or not done a specified number of days prior to an event or that an act be done during a period of a specified number of days prior to an event, calendar days shall be used, the day of the doing of the act shall be excluded and the day of the event shall be included. 14 SECTION 8. OPT-OUT OF NORTH CAROLINA SHAREHOLDER PROTECTION ACT: The provisions of the North Carolina Shareholder Protection Act, N.C. Gen. Stat.ss.ss.55-9-01 - 05, as presently enacted or hereafter amended, shall not be applicable to the Corporation. SECTION 9. OPT-OUT OF NORTH CAROLINA CONTROL SHARE ACQUISITION ACT: The provisions of the North Carolina Control Share Acquisition Act, N.C. Gen. Stat.ss.ss.55-9A-01 - 09, as presently enacted or hereafter amended, shall not be applicable to the Corporation. SECTION 10. EMERGENCIES: In anticipation of or during an emergency, the board of directors may: (i) modify lines of succession to accommodate the incapacity of any director, officer, employee, or agent; and (ii) relocate the principal office or designate alternative principal or regional offices, or authorize the officers to do so. During an emergency: (i) notice of a meeting of the board of directors need be given only to those directors whom it is practicable to reach and may be given in any practicable manner, including by publication and radio; and (ii) one or more officers present at a meeting of the board of directors may be deemed to be directors for the meeting, in order of rank and within the same rank in order of seniority, as necessary to achieve a quorum. SECTION 11. SEVERABILITY: Should any provision of these bylaws become ineffective or be declared to be invalid for any reason, such provision shall be severable from the remainder of these bylaws and all other provisions of these bylaws shall continue to be in full force and effect. THESE RESTATED BYLAWS CONSIST OF THE AMENDED AND RESTATED BYLAWS ADOPTED AT A MEETING OF THE BOARD OF DIRECTORS OF THE CORPORATION ON MARCH 27, 1998 WITH THE ADDITION OF THE AMENDMENT IN ITS ENTIRETY OF SECTION 2 OF ARTICLE IV ADOPTED AT A MEETING OF THE SHAREHOLDERS ON MAY 21, 1998 AND THE AMENDMENT IN ITS ENTIRETY OF SECTION 4 OF ARTICLE III ADOPTED AT A MEETING OF THE BOARD OF DIRECTORS ON APRIL 16, 1999. ATTESTED: /s/ Don T. Seaquist - ----------------------------- Dated: February 28, 2000 Don T. Seaquist Secretary 15 EX-10.9 3 SUBLEASE AGREEMENT EXHIBIT 10.9 SUBLEASE AGREEMENT THIS SUBLEASE (the "Sublease") dated for reference purposes October 1, 1999, is entered into by and between Wandel & Goltermann Technologies, Inc., a North Carolina corporation, hereinafter referred to as "Sublandlord", and Embrex, Inc., a North Carolina corporation, hereinafter referred to as "Subtenant". WHEREAS, W&G Instruments, Incorporated, a predecessor in interest of Sublandlord, as Tenant, and W&G Associates, a North Carolina Limited Partnership, as Landlord, hereinafter referred to as "Prime Landlord", entered into that certain Lease Agreement dated October 1, 1984, which Lease has been amended by instruments dated January 31, 1986, October 1, 1989, January 24, 1994, February 23, 1999, and October 1, 1999 (said Lease as amended being referred to herein as the "Prime Lease") pertaining to the rental of certain premises on Swabia Court, Durham, NC, more particularly described as Lot S-5B, containing 10 acres as shown on plat of survey recorded in Plat Book 131, Page 87, Durham County Registry (the "Premises"); WHEREAS, Sublandlord desires to sublet a portion of the Premises to Subtenant (defined herein as the "Sublease Premises"), subject to the written consent of the Prime Landlord, and Subtenant desires to sublet the Sublease Premises from Sublandlord, all on the terms and conditions set forth in this Sublease; NOW, THEREFORE, in consideration of the mutual covenants contained herein, the Sublandlord and Subtenant agree as follows: 1. Unless otherwise defined in this Sublease, all capitalized terms used herein that are defined in the Prime Lease shall have the meaning ascribed to such terms in the Prime Lease. 2. The Prime Lease is attached hereto and by reference made a part hereof as Exhibit C. Except as otherwise expressly provided herein, this Sublease is subject to and made upon all the terms, covenants and conditions of the Prime Lease, with the same force and effect as if fully set forth therein. It is the intention of the parties hereto that, except as otherwise expressly provided in this Sublease, and except as inapplicable hereto or inconsistent herewith, the relationship between Sublandlord and Subtenant with respect to the Sublease Premises shall be governed by the provisions of the Prime Lease as if they have been set forth in full in this Sublease with the term "Sublandlord" replacing the term "Landlord" and the term "Subtenant " replacing the term "Tenant". 3. All of the non-monetary obligations contained in the Prime Lease conferred and imposed upon Sublandlord (as Tenant therein) with respect to the Sublease Premises, except as modified and amended by this Sublease, and all rights and privileges conferred upon Sublandlord (as Tenant therein) with respect to the Sublease Premises, are hereby conferred and imposed upon Subtenant. Except as expressly modified and amended by this Sublease or inconsistent herewith, Subtenant covenants and agrees fully and faithfully to perform the non-monetary obligations and conditions of the Prime Lease with respect to the Sublease Premises on Sublandlord's part to be performed. Subtenant further agrees, as an express inducement for Sublandlord executing this Sublease, that, with respect to the Sublease Premises, if there is any conflict between the provisions of this Sublease and the provisions of the Prime Lease which would permit Subtenant to do or cause to be done or suffer or permit any act or thing to be done which is prohibited by the Prime Lease, then, except to the extent expressly agreed by Prime Landlord in consenting to this Sublease, the provisions of the Prime Lease shall prevail with respect to the Sublease Premises. Except as expressly provided to the contrary in this Sublease, the remedies of the parties, as Subtenant and Sublandlord hereunder, shall be the same as the respective remedies of the "Landlord" and "Tenant" under the Prime Lease. Subtenant shall pay to Sublandlord, within five (5) days after demand therefor by Sublandlord, any and all sums (except rent under the Prime Lease) due pursuant to the Prime Lease with respect to the Sublease Premises; provided, however (and as an express departure from the terms of the Prime Lease), except as set forth in or determined by Section 6 of this Sublease, through and including December 31, 2000, Subtenant shall have no liability for Sublandlord's obligations under Section 3.2 of the Prime Lease and through and including December 31, 2000, Subtenant shall have no liability under Section 5.1 of the Prime Lease. Notwithstanding the foregoing but subject to any agreement of Sublandlord and Subtenant pursuant to Section 6 hereof with respect to an allocation of responsibility between them with respect to certain conditions of the Sublease Premises, Tenant shall comply with all laws, ordinances, and regulations of any lawful authority with respect to Subtenant's particular use and occupancy of the Sublease Premises provided that such compliance does not require any repairs, reconstruction, or improvements that are not expressly the result of Subtenant's particular use and occupancy of the Sublease Premises. Notwithstanding anything to the contrary herein, Sublandlord shall have no duty itself to perform any obligations of Prime Landlord, including, without limitation, constructing any improvements to the Sublease Premises, nor shall such default of Prime Landlord affect this Sublease or waive or defer the performance of any of Subtenant's obligations hereunder. Notwithstanding anything to the contrary herein, Sublandlord expressly agrees that through and including December 31, 2000, Subtenant, except as set forth in or determined by Section 6, shall have no obligation or liabilities with respect to the roof, foundation, load-bearing walls, fire and safety systems, and parking lot except to the extent directly attributable to the intentional acts or negligence of Subtenant, its employees, agents, representatives, invitees, and contractors. The foregoing is an allocation of responsibility of certain obligations with respect to the Sublease Premises between Sublandlord and Subtenant and shall not affect the obligations owed by Sublandlord to Prime Landlord under the Prime Lease. 4. Subject to the terms of the second and third paragraphs of Section 5 of this Sublease, Sublandlord hereby subleases to Subtenant and Subtenant hereby subleases from Sublandlord the Sublease Premises for a term of approximately seventy-two (72) months (the "Initial Sublease Term") commencing on October 1, 1999 (the "Commencement Date") and expiring on September 30, 2005 (the "Expiration Date"). Notwithstanding the occurrence of the Commencement Date on October 1, 1999, Subtenant's only monetary obligation under this Sublease until its actual occupancy of the Sublease Premises shall be to pay rent as set forth in Section 6. 2 5. Subject to a Right of First Refusal for additional space as set forth in Section 7 hereof, the Sublease Premises shall be approximately 44,725 rentable square feet defined for purposes hereof as the combination of the "Initial Sublease Premises" and the "Expansion Sublease Premises" as defined below and as more particularly shown in the attached Exhibit B. Effective from the Commencement Date until September 30, 2000, Subtenant shall sublease from Sublandlord and Sublandlord shall sublease to Subtenant an area of approximately 20,837 rentable square feet as shown on Exhibit B (the "Initial Sublease Premises"). Effective October 1, 2000 and continuing through the remainder of the Initial Sublease Term or any extension thereof, Subtenant shall sublease from Sublandlord and Sublandlord shall sublease to Subtenant an additional area totaling approximately 23,888 rentable square feet as shown on Exhibit B (the "Expansion Sublease Premises"). Rent for the Expansion Sublease Premises is incorporated into the Rent Schedule below. 6. Subtenant shall pay Sublandlord monthly rent throughout the Initial Sublease Term or any extension thereof, in advance on the first day of each and every month of the Initial Sublease Term or any extension thereof in the amounts set forth in the Rent Schedule below. All rent and any other sums due to Sublandlord shall be paid to Sublandlord at 1030 Swabia Court, P.O. Box 13585, Research Triangle Park, NC 27709-3585, or at such other address directed by Sublandlord to Subtenant in writing. The first monthly installment of rent, Twenty-Two Thousand Five Hundred Seventy-Three Dollars and Forty-Two Cents ($22,573.42), shall be paid and delivered to Sublandlord at execution of this Sublease by Subtenant, provided, however, that if the Commencement Date occurs on a day other than the first day of the month, rent for the first month of the Initial Sublease Term shall be pro-rated based on the number of days remaining in the first month of the Initial Sublease Term. Notwithstanding the foregoing, Subtenant shall not be obligated to pay rent to Sublandlord until Sublandlord and Subtenant have agreed upon the repairs, replacements, or improvements required to be made to the Sublease Premises or Building (as hereinafter defined) as hereinafter set forth in this Section 6. If neither Sublandlord nor Subtenant has terminated this Sublease pursuant to the terms of this Section 6, Subtenant shall pay to Sublandlord rent from the Commencement Date to the date of delivery to Subtenant of an amendment to this Sublease acceptable to Sublandlord and Subtenant setting forth the repairs, replacements, or improvements the parties have agreed each shall make to the Sublease Premises. If this Sublease is terminated pursuant to the terms of this Section 6, Subtenant shall pay to Sublandlord with its notice of termination or promptly after receipt from Sublandlord of its notice of termination, as its total obligation to pay rent under this Sublease, two and one-half (2 1/2) months' installments of rent in the amount of Fifty-Six Thousand Four Hundred Thirty-Three Dollars and Fifty-Five Cents ($56,433.55). 3 RENT SCHEDULE: ------------- RENT PERIOD $/RSF/YR. MONTHLY RENT STRUCTURE ------------------------------------------------- -------------------- 10/01/99 - 09/30/00 $13.00 $22,573.42 Full-Service 10/01/00 - 12/31/00 $13.39 $49,905.65 Full-Service 01/01/01 - 09/30/01 $ 9.14 $34,065.54 Triple-Net 10/01/01 - 09/30/02 $ 9.41 $35,087.51 Triple-Net 10/01/02 - 09/30/03 $ 9.70 $36,140.13 Triple-Net 10/01/03 - 09/30/04 $ 9.99 $37,233.56 Triple-Net 10/01/04 - 09/30/05 $10.29 $38,351.69 Triple-Net. As per the Rent Schedule above, the rent during the Initial Sublease Term shall adjust on January 1, 2001 from "Full-Service" to "Triple-Net". For purposes of this Sublease, "Full-Service" shall be deemed to include the following expenses and services to be provided at Sublandlord's sole cost and expense: o JANITORIAL - regular trash removal, maintenance, dusting, vacuuming and cleaning of lavatories but in no event at a lesser frequency than that provided for Sublandlord's own facilities. o EXTERIOR MAINTENANCE - pertains to landscaping, parking lots, sidewalks, and windows. o STRUCTURAL/INTERIOR MAINTENANCE - pertains to the building's structure including foundation, walls, roof, floor, light fixtures and bulbs, and all mechanical systems (including HVAC) and plumbing. o PROPORTIONATE SHARE OF REAL ESTATE TAXES o PROPORTIONATE SHARE OF REAL PROPERTY INSURANCE UNDER PRIME LEASE o ALL UTILITIES - water for lavatory and drinking purposes, gas, sewer and electricity. In regards to electric service, said service shall be provided specifically to power Subtenant's lights, plugs and HVAC, at the same level at which said services are available to Sublandlord. Until that time that the rental structure becomes "triple-net" and Subtenant's utilities are separately metered, Subtenant shall utilize only normal, non-heat generating office equipment such as personal computers, copiers, fax machines, printers, refrigerators, vending machines and coffee makers. o HVAC - heating and cooling for the Sublease Premises so as to maintain an average temperature of 72 degrees Fahrenheit, plus or minus 2 degrees. 4 o CARD READER SYSTEM - During the period in which the Rent is "Full-Service", Sublandlord shall provide Subtenant with Card Reader Access services, at the same level at which said services are available to Sublandlord. Upon the Rent becoming "Triple-Net", to the extent that Sublandlord continues to operate and share use of its Card Reader Access System, Sublandlord agrees to continue to provide, at its expense, Card Reader services to Subtenant. Notwithstanding the foregoing, if Sublandlord notifies Subtenant that Sublandlord will not make some or all of the repairs or replacements indicated in the inspection report described in the third following paragraph, "Triple-Net" shall not include such repairs or replacements. "Proportionate Share" shall mean 41.08% (20,837 RSF/ 50,725 RSF) for the period when Subtenant subleases the Initial Sublease Premises, 88.17% (44,725 RSF / 50,725 RSF) when Subtenant subleases the Initial Subleases Premises and the Expanded Sublease Premises, and 100% should Subtenant sublease the entire Premises. Before Subtenant is permitted to occupy the Sublease Premises, the Sublease Premises shall be inspected by a building inspector reasonably acceptable to Sublandlord and Subtenant, whose report (the "Report") shall be delivered to Sublandlord and Subtenant by January 20, 2000. The scope of the inspection, for purposes of this Sublease, shall be limited to determining whether the structure of the Sublease Premises and its HVAC, plumbing, mechanical, electrical and fire protection systems are in good condition and working order and whether the Sublease Premises currently comply with all applicable local, state, and federal laws and regulations related to occupancy of the Sublease Premises by Subtenant for its intended uses, it being understood that except as Sublandlord may otherwise agree after its review of the Report, Subtenant is otherwise leasing the Sublease Premises "as is." All costs and expenses incurred in connection with this inspection shall be the sole responsibility of Subtenant. Sublandlord shall deliver to Subtenant within ten (10) days after receipt of a copy of the Report a statement indicating which, if any of the defects or non-complying conditions noted in the Report, Sublandlord is willing to repair or replace at its expense; provided, however, Sublandlord at its sole cost and expense shall bear the cost of making the existing bathroom facilities serving the Sublease Premises comply with the requirements of The Americans With Disabilities Act ("ADA") to the same extent that would be required if Sublandlord were to continue its prior use of the Building. Subtenant shall then have ten (10) days after receipt of Sublandlord's statement to accept Sublandlord's proposal with respect to the repairs and replacements recommended in the Report, to reject Sublandlord's statement in its entirety, or to propose an alternative description of the repairs and replacements for which Sublandlord and Subtenant would be responsible; provided, however, Subtenant shall be responsible at its cost and expense for additions or improvements to the existing bathroom facilities to accommodate its use beyond that for which Sublandlord is responsible under the preceding sentence. If Sublandlord and Subtenant agree as to the repairs and replacements for which each is responsible, Sublandlord and Subtenant shall enter into the appropriate amendment to this Sublease to reflect the allocation of their respective responsibilities for repairs or replacements to the Sublease Premises. If, after good faith efforts to negotiate their differences, Sublandlord and Subtenant have not agreed on such an allocation of responsibility by March 1, 5 2000, each shall have the right to terminate this Sublease upon written notice to the other in which event neither party shall have any other or further obligations to the other under this Sublease, except for any obligations which accrued before the date of such termination and further except that Subtenant shall pay to Sublandlord two and one-half (2 1/2) months' rent referenced in the first paragraph of this Section 6 in consideration of Sublandlord keeping the Premises off the market during the negotiation of this Sublease and the security deposit shall be returned to Subtenant. For purposes hereof, unless stated elsewhere herein to the contrary, "Triple-Net" shall be defined as that rent structure and treatment of all those expenses and services, including but not limited to, those services and associated expenses outlined under the definition of "Full-Service" above, which are required to occupy and conduct business in the Sublease Premises and as set forth in the Prime Lease (but with respect to only the Sublease Premises or Subtenant's Proportionate Share of the Building or the Premises), including, but not limited to, the parking lot, walkways, exterior lighting, landscaping, and all HVAC, mechanical, roof and structural maintenance and repair. Therefore, at the effective date on which the rent adjusts from Full-Service to Triple-Net (i.e., on January 1, 2001), in addition to the monthly rent stated in the Rent Schedule above, Subtenant shall contract directly with service providers for its utilities and other services used in the Sublease Premises, including, but not limited to, janitorial services and trash removal services, and shall pay all charges for said utilities and services directly to the relevant service provider. Notwithstanding the foregoing, to the extent services with respect to the parking lot, walkways, exterior lighting, and landscaping are currently contracted by Sublandlord, Subtenant may meet its obligations under this paragraph by paying to Sublandlord promptly after receipt of an invoice and supporting documentation Subtenant's Proportionate Share of such expenses. To the extent that the elements or components of the Building for which Subtenant is responsible under this paragraph service space other than the Sublease Premises, Subtenant shall only pay its Proportionate Share of such expenses. In the event Subtenant assumes responsibility for any of the foregoing services currently contracted by Sublandlord, Sublandlord shall pay to Subtenant promptly after receipt of an invoice and supporting documentation Sublandlord's proportionate share of such expenses, which proportionate share shall be 11.83% unless Subtenant occupies the entire Building, in which event Sublandlord's proportionate share shall be 0. In addition, Subtenant shall reimburse Sublandlord Subtenant's Proportionate Share of taxes and insurance expenses and any increase therein with respect to the Premises required to be paid by Sublandlord under the Prime Lease, which amounts shall be paid to Sublandlord along with Subtenant's monthly rent. The first monthly reimbursement of said expenses shall be paid and delivered to Sublandlord, together with the then escalated monthly rent under this Sublease, in advance of the first day of the first month in which the rent becomes Triple-Net, as per the Rent Schedule above. Sublandlord shall provide Subtenant with a statement detailing such expenses no fewer than thirty (30) days before the date when the Triple-Net rent becomes effective and at least thirty (30) days before any escalation of such expenses. After this Sublease converts to a "Triple-Net" lease on January 1, 2001, Subtenant shall cause the exterior of the Sublease Premises to be maintained in a manner consistent with the maintenance of the exterior of Sublandlord's leased property on Swabia Court known as Lot S-5A containing 6 five (5) acres as shown on plat of survey recorded in Plat Book 131, Page 87, Durham County Registry (the "W&G Building"). Sublandlord shall provide to Subtenant a schedule of exterior maintenance such as parking lot restriping, parking lot sweeping, exterior painting, and window washing currently in place (meaning as of the date Subtenant occupies the Sublease Premises) with respect to the W&G Building. Subtenant shall not be obligated under this paragraph to any level of service or maintenance with respect to the exterior of the Sublease Premises greater than that in place for the W&G Building when Subtenant occupies the Sublease Premises. Throughout the Initial Sublease Term and any extension thereof, Sublandlord shall notify Subtenant within thirty (30) days of any increase or decrease in any reimbursable expenses once Sublandlord has received such information from Prime Landlord. Sublandlord shall deliver to Subtenant such information supporting or substantiating such expenses under the Prime Lease as Subtenant may reasonably request. Notwithstanding anything contained herein to the contrary, if, due to the gross negligence or intentional misconduct of Prime Landlord or Sublandlord or their respective employees, agents, representatives, or contractors, any of the foregoing services is not continuously provided to Subtenant and such failure to provide continues for ten (10) business days, rent shall abate until such service is restored, Sublandlord agreeing to exercise best efforts to restore such service. In no event, however, shall Prime Landlord or Sublandlord be liable to Subtenant for consequential damages as a result of any failure to provide such services or as a result of the interruption in such services. The foregoing shall not affect in any way the obligations of Sublandlord to pay rent to Prime Landlord under the Prime Lease, which does not allow abatement of rent. 7. Sublandlord intends to continue to occupy after the Commencement Date a portion of the Premises comprising the cafeteria, kitchen, and adjacent lab area, totaling approximately 6,000 rentable square feet, and as is more particularly shown in the attached Exhibit B (the "Retained Space"). During the Initial Sublease Term or any extension thereof, Subtenant shall have a continuous, exclusive Right of First Refusal on that portion of the Retained Space which Sublandlord may make available for sublet. Space subleased by Subtenant by Right of First Refusal shall be sublet on the same terms and conditions of the Sublease. All space subleased under the Right of First Refusal shall be delivered in "as-is" condition with Sublandlord's personal property first removed, space broom-cleaned, and all mechanical systems in good working order with all regularly scheduled maintenance first completed. Subtenant shall have fifteen (15) days after receipt by Subtenant of written notice to refuse that portion of the Retained Space being made available for sublease. Notwithstanding the foregoing, if Sublandlord opts to cease operations of its cafeteria and has no plans to reutilize that portion of the Retained Space for other purposes of its own, Subtenant, together with its Right of First Refusal for the space, shall have a right to operate its own cafeteria facility. In conjunction therewith, Subtenant shall have a Right of First Offer on the tables, chairs, and all kitchen equipment owned by Sublandlord, said offer to be made within 15 days of receiving notice as to its availability. 7 8. Sublandlord grants Subtenant an option to extend the Initial Sublease Term for three (3) renewal periods of two (2) years each (individually or collectively, the "Extended Sublease Term") commencing upon the expiration of the Initial Sublease Term on the same terms and conditions as contained in this Sublease except rent. This option shall be exercised only by delivery of written notice to Sublandlord no later than two hundred ten days (210) before the Expiration Date or the expiration of any Extended Sublease Term. Rent for the first year of the first Extended Sublease Term shall be the escalated "Triple-Net" rental payable in the last year of the Initial Sublease Term increased by four percent (4%) and increased each year thereafter by four percent (4%). If Sublandlord receives at least two hundred ten (210) days advance written notice of Subtenant's exercise of its options to extend the Initial Sublease Term, Sublandlord shall timely exercise its renewal terms under the Prime Lease as necessary to provide Subtenant the renewal term or terms provided in this Section 8. 9. The Right of First Refusal belonging to Sublandlord per Section 7 of the Third Amendment to Lease of the Prime Lease regarding the purchase of the property on which the Sublease Premises is located shall not transfer under this Sublease to Subtenant. Said First Right of Refusal shall remain valid, in force, and available to Sublandlord. 10. Subtenant acknowledges that this Sublease shall not be effective unless and until Prime Landlord's written consent is given. 11. Upon receiving any written notice, statement or other written communication from Prime Landlord which pertains to the Premises or Sublease Premises, the party receiving such notice shall promptly forward a copy of such notice to the other. 12. It is understood and agreed by all parties hereto that neither the sublease of the Sublease Premises nor anything contained in this Sublease shall release Sublandlord from its duty and obligation to perform and be bound by all the covenants, terms, and conditions contained in the Prime Lease with Prime Landlord; provided, however, that Subtenant, except as expressly provided herein to the contrary, shall perform all such duties and obligations and be bound by such covenants, terms, and conditions in the first instance but only with respect to the Sublease Premises. 13. Sublandlord agrees that if Subtenant pays all rents and other sums due hereunder and performs all of the terms and conditions of this Sublease and of the Prime Lease required hereunder, Subtenant's quiet enjoyment of the Sublease Premises for the term of this Sublease shall not be disturbed or interfered with by Sublandlord. Provided Subtenant pays all rents and other sums due hereunder and performs all of the terms and conditions of this Sublease and of the Prime Lease required hereunder, Sublandlord shall defend, indemnify, and hold harmless Subtenant from all costs, expenses, liabilities, damages, actions, and proceeding caused by Sublandlord's failure to pay the rent and other sums due under the Prime Lease and to perform any obligations under the Prime Lease that are the obligation of Sublandlord to perform. 14. Subtenant agrees that it will not assign this Sublease or sublet the Sublease Premises without the prior written approval of Prime Landlord and Sublandlord, which approval 8 by Sublandlord will not be unreasonably withheld, conditioned, or delayed. Acquisition of all or substantially all of the stock or assets of Subtenant by an unrelated third party shall not be deemed an assignment or sublease or other transfer of Subtenant's interest in this Sublease or the Sublease Premises provided the following conditions are satisfied: (a) Subtenant shall give Sublandlord written notice of such acquisition at least sixty (60) days before the anticipated effective date of such acquisition (the "Effective Acquisition Date"); (b) the acquirer of the stock or assets of Subtenant (the "Acquirer") shall not be a competitor of Sublandlord or Prime Landlord in the reasonable judgment of Sublandlord and Prime Landlord; (c) the Acquirer shall have a creditworthiness equal to or greater than that of Subtenant as of the date hereof in the reasonable judgment of Sublandlord and Prime Landlord; (d) Subtenant shall not be in default hereunder as of the Effective Acquisition Date; (e) the Acquirer shall execute and deliver to Sublandlord and Prime Landlord a written acknowledgment of assumption of Subtenant's obligations under this Sublease in form and substance acceptable to Sublandlord and Prime Landlord; and (f) Subtenant shall not be released from its obligations hereunder but shall continue to be liable for all obligations of Subtenant under this Sublease. Subtenant shall provide to Sublandlord and Prime Landlord such documents and information as may be reasonably requested in order to determine whether the conditions in this Section 14 have been satisfied. 15. During the term of this Sublease, Subtenant, at its sole cost and expense and for the mutual benefit of the Sublandlord, Prime Landlord and Subtenant, shall carry and maintain casualty insurance for the full replacement cost of the Sublease Premises and comprehensive public liability insurance, including property damage, insuring Sublandlord, Prime Landlord, and Subtenant against liability for injury to persons or property occurring in or about the Sublease Premises arising out of the ownership, maintenance, use, or occupancy thereof, and Subtenant shall name Sublandlord and Prime Landlord as additional insureds hereunder. Said liability insurance shall be in amounts as called for in the Prime Lease. On or before the Commencement Date, Subtenant shall deliver to Sublandlord a copy of a Certificate of Insurance evidencing that such insurance has been purchased and is in effect. Any insurance which Subtenant is required to maintain under this Sublease shall include a provision which requires the insurance carrier to give Prime Landlord and Sublandlord not fewer than thirty (30) days' written notice before any cancellation or modification of such coverage. Further, if Subtenant fails to maintain said liability insurance, this act shall be a material breach of this Sublease, and Sublandlord may elect any of its remedies under this Sublease, and, in addition, Sublandlord may obtain such insurance on behalf of Subtenant, in which case Subtenant shall reimburse Sublandlord for the costs thereof within fifteen (15) days after receipt of a statement indicating the cost of such insurance. If Subtenant cannot obtain casualty insurance for only the portion of the Premises containing the Sublease Premises, Subtenant shall carry and maintain casualty insurance for all of the Premises and Sublandlord, within fifteen (15) days after receipt of a statement indicating Sublandlord's proportionate share of such premium, shall reimburse Subtenant for the cost thereof. Sublandlord's proportionate share shall be fifty-eight and ninety-two one hundredths percent (58.92%) when Subtenant is leasing only the Initial Sublease Premises and eleven and eighty- three one hundredths percent (11.83%) when Subtenant is leasing the Sublease Premises. The casualty insurance to be maintained with respect to the Sublease Premises (or with respect to the 9 Premises if applicable) shall be payable to Sublandlord, and if such proceeds shall be paid to Subtenant, Subtenant agrees to hold such proceeds in trust for Sublandlord. 16. Subtenant shall not do or permit to be done or omit or permit to be omitted any act or thing that will constitute or cause a breach or violation of any of the terms, covenants, or conditions of the Prime Lease (to the extent applicable to the Sublease Premises) or this Sublease. In addition, Subtenant is expressly prohibited from using the Sublease Premises in a manner, or storing materials therein, which would constitute an environmental violation under any of the applicable laws, rules, or regulations. Each party will defend, indemnify, and hold harmless the other from and against all losses, costs, damages, expenses, liability, actions, orders, and proceedings, including reasonable attorneys' fees actually incurred at standard hourly rates, which such party may incur or pay out by reason of injuries to person or property occurring in, on, or about the Sublease Premises, occasioned by the other party's use, occupancy, negligence, or intentional acts or by reason of any breach or default of this Sublease. Sublandlord hereby represents that to the best of its knowledge ("Knowledge" is defined for the purposes hereof as the actual knowledge of the officers of Sublandlord who are directly engaged in the management of the sublease transaction contemplated herein), Sublandlord knows of no facts or circumstances related to environmental matters concerning the Sublease Premises that could lead to any future environmental claims, liabilities, or responsibilities against Subtenant. Sublandlord shall defend, indemnify, and hold Subtenant harmless from all costs, expenses, losses, damages, liabilities, claims, actions, orders, or proceedings (including attorney's fees) arising out of the operations or activities or presence of Sublandlord on the Sublease Premises relating to environmental matters. 17. Sublandlord makes no representation with respect to this transaction or the Sublease Premises, except as specifically set forth herein, and Subtenant expressly acknowledges that no such representations have been made. Except as otherwise expressly provided in Exhibit A attached to and made a part hereof and except as may be provided in any amendment to this Sublease , Subtenant takes possession of the Sublease Premises in their "as is" condition. 18. Any alterations, additions, or improvements made by Subtenant in the Initial Sublease Premises or Expansion Sublease Premises, including those contemplated to be made as set forth in Exhibit D attached hereto, shall be made in compliance with the Prime Lease, performed in a good and workmanlike manner by a bonded (if deemed necessary by Sublandlord and Prime Landlord in their reasonable discretion, taking into account the cost and scope of the proposed alterations, additions, or improvements), insured and reputable contractor, any and all such work being subject to approval by Sublandlord and Prime Landlord, which approval by Sublandlord and Prime Landlord shall not to be unreasonably withheld, conditioned, or delayed in each case, and compliant with all relevant building and fire codes. Subtenant shall permit no mechanic's liens to be placed against the Sublease Premises or any portion thereof for services performed or materials supplied at the request of or for the benefit of Subtenant; provided, however, Subtenant shall have the right to contest the correctness or validity of any such lien if, immediately upon demand by Sublandlord, Subtenant procures and records a lien release bond in 10 form and substance sufficient under the General Statutes of North Carolina to release the Sublease Premises from such lien. Notwithstanding anything contained herein to the contrary, except as expressly contemplated by this Sublease with the consent of Prime Landlord and Sublandlord, Subtenant shall not make any changes or take any actions which would adversely affect the structural integrity of the Building, including foundation, roof, and load-bearing walls, or the mechanical systems serving the Building. Notwithstanding anything contained herein to the contrary, the listing in Exhibit D of certain work that Subtenant may desire to undertake does not constitute Prime Landlord's or Sublandlord's approval of any of such items. No alterations, additions, or improvements may be made without the prior approval of Sublandlord and Prime Landlord, which approval shall not be unreasonably withheld. Sublandlord and Prime Landlord reserve the right to approve or not approve any work (subject to the foregoing reasonableness standard), including the items hereinabove listed, after submission by Subtenant in good faith of detailed plans and specifications which reasonably describe the scope and extent of the proposed work, but Sublandlord and Prime Landlord shall have the burden of showing beyond a commercially reasonable doubt that the improvements shown on the submitted plans and specifications are not improvements contemplated by this Sublease or are otherwise not in conformance with the Prime Lease or this Sublease. Subtenant shall use reasonable efforts to deliver to Sublandlord and Prime Landlord by July 1, 2000 the plans and specifications for the improvements contemplated by Exhibit D. 19. Subtenant agrees at its expense to keep and maintain the Sublease Premises in good repair and in a good, sanitary, and safe condition. If so required by Prime Landlord or Sublandlord, and to the extent either Subtenant's trade fixtures and equipment or the improvements, alterations, or additions performed by Subtenant cannot be utilized in whole or in part by the next tenant of the Sublease Premises, as determined by Sublandlord and Prime Landlord in their reasonable discretion, upon expiration or sooner termination of the Initial Sublease Term or any extension thereof, Subtenant shall remove its trade fixtures and equipment and such alterations, improvements, or additions made by Subtenant as required by Sublandlord and shall restore the Initial Sublease Premises and Expansion Sublease Premises to the same condition and repair as delivered to it at commencement, reasonable wear and tear and loss by insured casualty excepted; provided that underground, under-floor, or behind-wall elements or pipes or wiring are not required to be removed, Subtenant agreeing that drains or other openings or apertures will be capped or filled as required by Sublandlord or Prime Landlord. 20. In addition to funding and performing the Improvements outlined in attached Exhibit A, upon (a) full-execution of this Sublease and receipt of Consent of Prime Landlord to Sublease attached and (b) receipt of the Security Deposit set forth in Section 25 hereof, Sublandlord shall pay Subtenant Thirty Thousand Dollars ($30,000) (the "Cash Inducement"). The Cash Inducement may be used by Subtenant for whatever purposes it pleases (e.g. telecommunication expenses, signage, furniture, rent, other, etc.) 11 21. Subtenant shall, at its sole cost and expense, provide all of its own telecommunication and networking needs, including installation of systems and wiring in the Initial Sublease Premises and Expansion Sublease Premises. Subtenant's telecommunications and networking equipment shall be installed in a mutually acceptable location not to be within Sublandlord's existing telecommunications closet. Expressly notwithstanding anything contained herein or in the Prime Lease to the contrary, Subtenant shall not be required to remove that portion of its telecommunications and networking equipment located underground, behind walls, or under floors upon vacating the Sublease Premises other than at its own discretion. Sublandlord intends to continue to locate and operate its telecommunications equipment in the existing telecommunications closet located within the Initial Sublease Premises. From time to time and with reasonable advance notice, Sublandlord reserves the right to access this telecommunications closet for means of service and installations during Subtenant's business hours. Subtenant, at its expense, shall have the right to run fiber optic cable from its premises at 1035 Swabia Court to the Sublease Premises. Said right shall be subject to the approval of Prime Landlord and all other relevant parties requiring prior approval or permits. Subtenant shall promptly submit to Sublandlord and Prime Landlord plans/schematics of said fiber optic installations. If so required by Prime Landlord or Sublandlord, upon expiration or sooner termination of the Initial Sublease Term or any extension thereof, Subtenant shall remove the entire length of fiber optic cable which may or may not include that portion of cable running within the Sublease Premises. Upon said removal, Subtenant shall reasonably repair and restore the ground and any part of the structure impacted by said cable installation and removal. 22. Subtenant shall have the non-exclusive right to a maximum of one hundred ten (110) parking spaces during the Initial Sublease Term and any extension thereof, free of charge, which spaces shall be made available to Subtenant on a non-exclusive basis in the area shown on Exhibit E attached hereto. 23. Subtenant, at its sole cost and expense, may install signage on the facade of the building on the Premises (the "Building") and at all monument and directional sign locations which currently read or recently read "ATE". Before the Commencement Date, Sublandlord, at its sole cost and expense, shall remove the "WG" sign on the facade of the Sublease Premises. Said signage shall be subject to the approval of Prime Landlord and Sublandlord, which approval by Sublandlord shall not be unreasonably withheld, conditioned, or delayed, and same shall be subject to all governmental permits and regulations as well as the covenants of Imperial Center, the master-planned development in which the Sublease Premises is located. 24. Subtenant shall have access to Sublandlord's on-site cafeteria. Subtenant shall pay non-subsidized prices for all goods purchased and shall comply with the rules, regulations, 12 and hours of operation (6AM to 3PM) currently in place. Subtenant may not access the cafeteria during planned corporate events of Sublandlord, which Sublandlord shall make Subtenant aware of with reasonable advance written notice. Access shall be limited only to those employees of Subtenant who are officed within the Initial Sublease Premises or Expansion Sublease Premises, and their guests. Subtenant shall require all of its employees and guests to comply with the applicable rules and regulations of the cafeteria, with non-compliance triggering Sublandlord's right to prohibit the violating individual or individuals from further use of the cafeteria. In good faith, Sublandlord is providing Subtenant with access to its cafeteria as an amenity. However, Sublandlord shall have the right at any time during the Initial Sublease Term or any extension thereof to cease operating a cafeteria within the Building. 25. As security for Subtenant's obligations under this Sublease, Subtenant shall deposit with Sublandlord, first, together with the payment made at Sublease execution of the first monthly installment of rent, and if applicable expenses and/or other personal property of Sublandlord purchased by Subtenant, the sum of Forty-Five Thousand One Hundred Forty-Six Dollars and Eighty-Four Cents ($45,146.84) AND second, together with the first payment of monthly rent to be paid following the delivery of the Expansion Sublease Premises, the sum of Forty-Nine Thousand Nine Hundred Five Dollars and Sixty-Five Cents ($49,905.65). Sublandlord shall keep the security deposit separate from its general funds and deposited in an interest-bearing account. Subtenant shall be entitled to interest earned on the security deposit annually or as accrued at the expiration of the Term or extension thereof. The security deposit will not be a limitation on Sublandlord's damages or other rights under this Sublease, or an advance on the payment of any amounts due from Subtenant under this Sublease. If Subtenant pays all such due amounts and performs all of its obligations under this Sublease, Sublandlord will return the unused portion of the security deposit to Subtenant within thirty (30) days after the end of the Initial Sublease Term or any extension thereof. 26. Subtenant shall not do or permit to be done or permit to be omitted any act or thing in or with respect to the Sublease Premises which will constitute or cause a breach or violation of any of the terms, covenants, or conditions of the Prime Lease; provided, however, the foregoing shall not apply to the obligation of Sublandlord to pay rent and other sums due under the Prime Lease so long as Subtenant has fulfilled its obligations to Sublandlord hereunder with respect to payment of rent and other sums reserved in this Sublease. 27. The parties also agree that: (a) Subtenant shall use and occupy the Sublease Premises for general office, manufacturing, research, and laboratory purposes associated with the conduct of Subtenant's business, as is permitted under the covenants of Imperial Center and all applicable zoning and other governmental regulations; (b) Sublandlord's refusal to consent to or to approve any matter or thing, whenever Sublandlord's consent or approval is required under this Sublease or under the Prime Lease, shall be deemed reasonable if Prime Landlord has refused to give such consent or approval, Sublandlord agreeing to use reasonable efforts and 13 good faith to assist Subtenant in obtaining Prime Landlord's consent; (c) if for any reason the term of the Prime Lease shall be terminated prior to the Expiration Date (Sublandlord, and Prime Landlord by its consent hereto, agreeing that the Prime Lease may not be terminated for any reason other than a default by Sublandlord or Prime Landlord or other event (such as condemnation or casualty) which allows either party to terminate pursuant to the terms of the Prime Lease without Subtenant's prior written consent), this Sublease shall thereupon be automatically terminated, and Sublandlord shall not be liable to Subtenant by reason thereof, unless such termination shall have been affected because of the breach or default by Sublandlord under the Prime Lease not occasioned by any breach or default by Subtenant, but Subtenant shall be entitled to whatever rights and remedies against the Prime Landlord that may be available to Sublandlord in connection with such termination, provided, however, that Subtenant shall receive from Sublandlord prompt notice of any default under the Prime Lease by Sublandlord and Subtenant shall have the right to cure such default; and (d) Subtenant acknowledges and agrees that in the event Subtenant fails to vacate the Sublease Premises when required hereunder, Sublandlord may incur damages under the terms of the Prime Lease. In such event, Subtenant agrees to indemnify and hold harmless Sublandlord from and against any and all costs, expenses and liabilities (including reasonable attorneys' fees actually incurred at standard hourly rates) incurred by Sublandlord arising out of such failure. 28. Subtenant shall have no right or interest in, and shall make no claim with respect to, any condemnation proceeds or other compensation awarded upon a total or partial taking of the Sublease Premises. 29. Sublandlord shall have no obligation or liability to Subtenant in the event that Prime Landlord fails to perform any of its obligations under the Prime Lease, unless such failure arose as a result of Sublandlord's defaulting in the performance of any of Sublandlord's obligations under the Prime Lease beyond any applicable cure periods contained therein. If the Sublease Premises shall be destroyed or if so much of the Sublease Premises shall be damaged that Subtenant cannot conduct its business therein, and if in the reasonable opinion of a contractor or architect mutually satisfactory to Sublandlord and Subtenant the Sublease Premises cannot be repaired or reconstructed within 150 days after the occurrence of the casualty, Sublandlord and Subtenant, upon written notice to the other, shall each have the right to terminate this Sublease within ten (10) business days after receipt of the written opinion of the approved contractor or architect. Upon such termination, rent and additional rent due under this Sublease shall be prorated to the date of the occurrence of the casualty and any sums paid by Subtenant with respect to a period beyond the date of the casualty shall be reimbursed to Subtenant by Sublandlord. In the event the damage or destruction can be repaired or reconstructed in fewer than 150 days after the occurrence of the casualty, this Sublease shall continue in force and effect and Sublandlord shall proceed with restoration of the Sublease Premises (excluding Subtenant's furniture, furnishings, fixtures, and equipment). For the period of reconstruction or restoration, rent shall abate as of the date of the casualty, unless Subtenant is able to continue its occupancy of the Sublease Premises for the normal conduct of its business during restoration in which event rent shall be adjusted and prorated in the proportion that the area of usable space bears to the area of the Initial Sublease Premises or the Sublease Premises, as the case may be. Except for Sublandlord's gross negligence or willful misconduct, 14 Sublandlord shall not be liable for any inconvenience or annoyance to Subtenant, injury to the business of Subtenant, loss of use of any part of the Sublease Premises by Subtenant, or loss of Subtenant's personal property resulting in any way from such damage or the repair thereof. Sublandlord and Subtenant agree to cooperate in good faith in connection with any reconstruction or repair in order efficiently to schedule repair or restoration of the Sublease Premises and the installation of Subtenant's furniture, furnishings, fixtures or equipment. Notwithstanding the foregoing, however, if the Prime Lease is terminated as a result of any such damage or destruction, then Sublandlord shall have no obligations hereunder to repair or reconstruct. Further, in no such event shall Sublandlord be required to undertake such reconstruction or repair unless the insurance proceeds received for such purpose are sufficient to cover the entire cost thereof or, if insufficient, unless Subtenant or Prime Landlord has agreed to pay the difference between the cost of reconstruction or repair and insurance proceeds received. The provisions of this paragraph shall expressly control over any provision of the Prime Lease that would otherwise be the obligation of Subtenant pursuant to the terms of this Sublease. 30. Default and Remedies: If Subtenant (a) fails to pay within five (5) days of when due any rent or any other sum of money which Subtenant is obligated to pay as provided in this Sublease; or (b) defaults in observing, performing, or keeping any other term, provision, agreement, covenant, or obligation herein set forth and such default shall continue and not be remedied within ten (10) business days after written notice from Sublandlord specifying the default, or if such default cannot be cured completely within the 10-business day period, if Subtenant does not promptly commence within such period and thereafter proceed and continue with due diligence to cure the same within thirty (30) days after receipt of said written notice from Sublandlord; or (c) files (or has filed against it and not stayed or vacated within ninety (90) days after filing) any petition or action for relief under creditors' law (including bankruptcy, reorganization, or similar action), either in state or Federal court; or (d) makes any transfer in fraud of creditors as defined in Section 548 of the United States Bankruptcy Code, has a receiver appointed for its assets (and such appointment shall not have been stayed or vacated within 30 days), or makes an assignment for the benefit of creditors; then Subtenant shall be in default hereunder, and, Sublandlord, in addition to any other lawful right or remedy which it may have, may do any one or more of the following: (i) declare the rent for the balance of the term immediately due and payable, and collect the same less all sums received from any re-letting of the Sublease Premises by distress or otherwise, or in the event the Sublease Premises is not re-let, the difference, if any, between the rent reserved hereunder for the remainder of the Initial Sublease Term or any exercised Extended Sublease Term reduced to present value at a 15 discount rate of eight percent (8%) per annum; provided, however, after payment by Subtenant to Sublandlord of such sum, Sublandlord shall remit to Subtenant any rent received from the re-letting of the Sublease Premises with respect to the term of this Sublease for which Subtenant paid Sublandlord accelerated rent, less any costs incurred by Sublandlord in re-letting the Sublease Premises, including, but not limited to, brokers' commissions and costs of readying the premises for the third party's occupancy, the intent of the parties being that Sublandlord shall not have a double recovery with respect to accelerated rent paid by Subtenant. Sublandlord's obligation in the preceding sentence shall survive termination of this Sublease; (ii) with or without terminating this Sublease, immediately or at any time thereafter, enter upon the Sublease Premises, take possession thereof, and re-let the Sublease Premises or any part thereof for such time or times and at such rental or rentals and upon such other terms and conditions as Sublandlord, in Sublandlord's sole discretion, may deem advisable, and Sublandlord may make alterations or repairs to the Sublease Premises which Sublandlord may deem necessary or proper to facilitate such re-letting; and Subtenant shall pay all reasonable costs of such re-letting, including the cost of any such reasonable repairs to the Sublease Premises, together with all reasonable leasing commissions and other reasonable expenses in seeking and obtaining a new tenant; and if this Sublease shall not have terminated, Subtenant will continue to pay all rent due under this Sublease up to and including the date of the beginning of the payment of rent by any subsequent tenant of the Sublease Premises and thereafter Subtenant shall pay monthly during the remainder of the term of this Sublease the difference, if any, between the rent collected from such subsequent subtenant or subtenants and the rent reserved in this Sublease, but Subtenant shall not be entitled to receive any excess of such rents collected over the rents reserved therein; (iii) immediately or at any time thereafter terminate this Sublease (without demand to vacate the Sublease Premises) and this Sublease shall be deemed to have been terminated upon the receipt by Subtenant of such written notice of such termination and upon such termination, Subtenant shall immediately vacate the Sublease Premises and Sublandlord shall have and recover from Subtenant all damages Sublandlord may suffer by reason of such termination, including, without limitation, the inability of Sublandlord to re-let the Sublease Premises, and the cost of any repairs to the Sublease Premises which are necessary or proper to prepare the same for re-letting; and (iv) re-enter the Sublease Premises, without notice, either by summary proceedings or by any suitable action or proceeding at law, and may have, hold, and enjoy the Sublease Premises, together with all appurtenances thereto. Sublandlord's reasonable attorneys' fees actually incurred at standard hourly rates in pursuing any of the foregoing remedies or in collecting any rents due by Subtenant hereunder shall be paid by Subtenant within five (5) days of demand therefor. 31. Any notice, demand, request, direction, or other communication required to be given by either party to the other shall be in writing and shall be (a) delivered personally, and the 16 giving of such notice shall be complete on the date of delivery; (b) sent by reputable overnight delivery service, and the giving of such notice shall be complete on the immediately succeeding business day after such notice is deposited with such delivery service for pick up on the business day of deposit; or (c) sent by United States registered or certified mail, postage prepaid, return receipt requested, and the giving of such notice shall be complete on the day received or on the day acceptance of delivery is first refused; at the following addresses: IF TO SUBLANDLORD: Wandel & Goltermann Technologies, Inc. 1030 Swabia Court P.O. Box 13585 Research Triangle Park, NC 27709-3585 ATTN: Chief Financial Officer WITH COPY TO: Moore & Van Allen, PLLC 220 West Main Street Suite 800 Durham, NC 27705 ATTN: Reich L. Welborn IF TO SUBTENANT: Embrex, Inc. 1035 Swabia Court P.O. Box 13989 Research Triangle Park, NC 27709-3989 ATTN: Vice President, Finance and Administration WITH A COPY TO: Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, L.L.P 2500 First Union Capitol Center, NC 27601 P.O. Box 2611 Raleigh, NC 27602-2611 ATTN: Francis C. Bagbey WITH A COPY TO PRIME LANDLORD: W & G Associates, a North Carolina limited partnership c/o Wavetech Wandel & Goltermann, Inc. Muhleweg-5 D-72800 ENINGEN U.A. Germany ATTN: Frank Goltermann 17 WITH COPY TO: Maupin, Taylor & Ellis, P.A. Highwoods Tower One Suite 500 3200 Beechleaf Court Raleigh, North Carolina 27604-1064 ATTN: Tony Tingen Either party may change its address by written notice to the other. 32. Sublandlord and Subtenant each represent and warrant to the other that it had no dealings with any broker or agent in connection with this Sublease except for Vector Properties, LLC. Sublandlord shall be responsible for payment of any and all fees payable to Vector Properties, LLC as a result of this Sublease. 33. This Sublease and the exhibits incorporated herein by reference set forth all of the agreements, covenants, representations and warranties of Sublandlord and Subtenant. No modification or amendment of this Sublease shall be binding or effective unless in writing signed by Sublandlord and Subtenant. 34. This Sublease shall be governed by the laws of the State of North Carolina. 35. Time is of the essence hereof. 18 IN WITNESS WHEREOF, the parties hereto have executed this Sublease the day and year first written above. SUBLANDLORD: WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation By: /s/ Bert Kuthe --------------------------------- Its: Vice President -------------------------------- SUBTENANT: EMBREX, INC. By: /s/ Randall L. Marcuson --------------------------------- Its: President & CEO -------------------------------- (REMAINDER OF PAGE INTENTIONALLY LEFT BLANK) 19 EXHIBIT A IMPROVEMENTS AND WORK Sublandlord shall, at its sole cost and expense, on or before the Commencement Date of this Sublease perform the following improvements and work to the Initial Sublease Premises: o FURNITURE - Sublandlord shall provide for use by Subtenant, free of charge, any office and systems furniture ("Furniture") currently located within the Initial Sublease Premises and which Sublandlord does not intend to remove for its own purposes. Subtenant may offer to purchase said Furniture at any time prior to or during the Initial Sublease Term. o CEILING TILES - Replace any stained or broken ceiling tiles. Replace additional tiles displaced or impacted by the installation of the fire-rated Demising Wall. o LIGHT FIXTURES - Replace any burned-out bulbs and repair any malfunctioning ballasts. o DEMISING WALLS - Install fire-rated demising walls between the Initial Sublease Premises and the Expansion Sublease Premises (the width of the building) and as necessary to construct a corridor from the Initial Sublease Premises to the cafeteria. o ALL SYSTEMS - Sublandlord shall deliver all systems, including Card Reader System, in good working order, with all regularly scheduled maintenance first completed. Prior to delivery of the Expansion Sublease Premises, Sublandlord shall remove all of its personal property, unless agreed to otherwise, shall broom clean the Expansion Sublease Premises, and shall deliver all relevant HVAC systems in good working order, with regularly scheduled maintenance first completed. When the rent structure is adjusted from "Full-Service" to "Triple-Net", should the Sublease Premises not be separately metered for all relevant utilities, Sublandlord and Subtenant agree to work in good faith to install the appropriate meters and to split the cost of said installations on a 50%/50% basis. (REMAINDER OF PAGE LEFT INTENTIONALLY BLANK) 20 EXHIBIT B SUBLEASE PREMISES 21 EXHIBIT C (PRIME LEASE AND AMENDMENTS) NORTH CAROLINA LEASE DURHAM COUNTY LEASE This LEASE AGREEMENT made and entered into as of the 1st day of October 1984, by and between W & G ASSOCIATES, a North Carolina general partnership with its principal office in Durham County, North Carolina, hereinafter referred to as "Landlord", and W & G INSTRUMENTS, INCORPORATED, a New Jersey corporation with its principal office in Durham County, North Carolina, hereinafter referred to as "Tenant." WITNESSETH: WHEREAS Landlord is the owner of a certain tract or parcel of land in Durham County, North Carolina, commonly known as 1 Swabia Court, Durham, North Carolina, and being more particularly described in Exhibit A attached hereto and being hereinafter referred to as the "Premises"; and WHEREAS, Landlord has financed the construction of the improvements on the Premises (together with the cost of the land) through borrowing from The Durham County Industrial Facilities and Pollution Control Financing Authority (the "Authority"), said loan funds to be raised by the Authority issuing and selling its industrial revenue bond in the principal amount of $2,600,000 (the "Bond") pursuant to a Bond Purchase Agreement with Wachovia Bank & Trust Company, N.A. ("Wachovia"); and WHEREAS, the said funds borrowed or to be borrowed by the Landlord from the Authority is pursuant to a Loan Agreement dated as of October 1, 1984, between the Authority and the Landlord (the "Loan Agreement") and is or shall be represented by )Landlord's promissory note given to the Authority (the "Note"); and WHEREAS Landlord desires to lease to Tenant and Tenant desires to lease and hire from Landlord the Premises together with all improvements thereon, and subject to all of the terms and conditions hereinafter set out; NOW, THEREFORE, for and in consideration of the mutual covenants set out herein and other good and valuable consideration, the parties covenant and agree as follows: 1. DEMISE. Landlord hereby demises and leases to Tenant and Tenant hereby takes and hires from Landlord the Premises, for the term and subject to all the conditions hereof. 2. TERM. 2.1. Base Term. This lease shall commence on the date this lease is executed and continue for fifteen (15) years thereafter. 2.2. Renewal Terms. Upon written notice given to Landlord by Tenant at least ninety (90) days prior to the expiration of the term hereof or any renewal term, Tenant may extend this Lease for five (5) additional successive terms of two (2) years each; provided however, any such extended term shall be subject to such terms and conditions, including, without limitation, rents, as Landlord and Tenant may then mutually agree upon prior to expiration of the original term or any renewal term. Any such extended term shall be subject to all the terms and conditions hereof. 3. RENT. 3.1. Base Rent. During the initial term hereof Tenant shall pay to Landlord an annual base rent of Three hundred and ninety thousand ($390,000.00) Dollars, payable in monthly installments of Thirty-two thousand five hundred ($32,500.00) Dollars on or before the first (1st) day of each month, in advance, without notice or demand therefor, throughout the term of this Lease; provided, however, that if the aggregate of the monthly installments paid by the -2- Tenant for the three months immediately prior to the due date for each quarterly payment by Landlord under the Note, as described on page 1 hereof, is insufficient to cover such quarterly payment, then Tenant shall pay as additional rent such excess amount as is required to equal such quarterly payment. Notwithstanding anything contained herein, the Landlord shall have the right to increase the annual base rent at any time during the term hereof in order that the annual base rent to be paid hereunder shall be in an amount at least equal to the debt service under Landlord's Note given to the Authority, as described on page 1 hereof. If the Lease shall commence on any day other than the first day of a month, the rent shall be prorated for that partial month and paid on or before the commencement date. 3.2. Net, Net, Net Lease. It is mutually agreed and understood that this lease is one which is known in commercial practices as a net, net, net lease, and all payments due hereunder to Landlord are net payments to be made without deduction for whatever cause. 4. PRO RATA RENT. If the Premises are occupied by Tenant for any fraction of a month, Tenant shall pay to Landlord base rent for such fraction of a month on a pro rata basis for each day of occupancy, based on the monthly base rental herein reserved. If Tenant's occupancy of the Premises ends, for any reason provided for in this agreement, before the end of a month, Tenant shall pay to Landlord for those days of occupancy up to and including Tenant's final day of occupancy minus an amount equaling the total base rental paid by Tenant to Landlord for that part of the month in which Tenant occupied the Premises. 5. USE OF PREMISES. The Premises shall be used by Tenant only to conduct Tenant's business activities. Any other business to be operated on the Premises shall be done only after prior written approval is granted by Landlord. Tenant shall operate the Premises in such a manner that the same will be a "project" within the meaning of Chapter 800 of the 1975 -3- Session Laws of North Carolina, as amended, which as codified appears as Chapter 159C of the General Statutes of North Carolina. 5.1. Compliance with Laws. In occupying the Premises, Tenant shall comply with all laws, ordinances, orders and regulations of any lawful authority and shall keep the Premises in a neat and clean condition. Any failure by Tenant to comply with the above mentioned requirements shall give Landlord the option to terminate this lease by written notice to Tenant, without prejudice to any other remedies Landlord may have for such breach. 5.2. Compliance with Bond Documents. Notwithstanding anything contained herein, in the event that any of the terms or provisions of this Lease conflict with any of the terms or provisions of the Bond Documents, as defined in the Loan Agreement, then the latter shall control and Landlord and Tenant shall comply with the applicable terms and provisions thereof. 5.3. Trade Fixtures. Tenant shall have the right to deliver to and install in the Premises any equipment, trade fixtures, stock or other material to be used by it in the operation of its business, and such delivery and placing of trade fixtures, equipment or stock or other material in said Premises shall constitute acceptance of the Premises by Tenant. All furnishings and equipment used in the improvements and on the Premises and supplied and installed at the sole cost and expense of Tenant at all times shall be the sole property of Tenant. 5.4. Alterations. Tenant may, only with Landlord's written consent, make improvements or alterations and additions to existing improvements upon the Premises. Tenant shall have a continuing right, without Landlord's consent, to erect, install, maintain. and operate on the Premises such equipment, fixtures and signs as Tenant may deem advisable. It is mutually agreed that with respect to the usual trade fixtures and equipment, including without limitation, refrigerating equipment and interior signs which may be installed in the Premises by Tenant prior -4- to or during the term hereof, such trade fixtures shall not be deemed to become part of the Premises but shall remain chattels and the sole and exclusive property of Tenant. 5.5 Removal of Tenant's Property. Tenant shall have the right at any time during the term, and for a period of thirty (30) days after the termination of this lease, to enter upon and remove from the Premises any of the Tenant's equipment or trade fixtures. All damage caused to the Premises by such removal shall be repaired by Tenant within ten (10) days after removal; provided, however, that no such property shall be removed if such removal would cause permanent injury to the building structure. 6. LANDLORD'S RIGHT TO ENTER. Landlord may, at all reasonable times, enter the Premises to inspect, repair, alter or add to the same; exhibit the same to prospective tenants, purchasers or other persons; and, in the event Tenant has vacated the Premises, to repair the same for re-occupancy by another tenant. Such entry by Landlord shall not constitute an eviction of Tenant, or a deprivation of any right of Tenant and shall not alter the obligations of Tenant hereunder nor create any right in Tenant adverse to Landlord. 7. MAINTENANCE. Tenant, at its sole cost and expense, shall maintain and keep in good repair the foundation, roof, exterior walls and the paved parking lot. All maintenance, including, but not limited to, the interior of the building, exterior doors, signs, windows, electrical, plumbing, heating and air conditioning systems, etc., shall be the responsibility of the Tenant and shall be done at Tenant's sole cost and expense. Upon the termination of this lease Tenant shall surrender the Premises to Landlord in as good a condition as existed at the time of its initial occupancy, ordinary wear and tear after diligent maintenance and damage or destruction by fire or other casualty excepted. If Tenant defaults in keeping or performing its obligations hereunder, Landlord, shall have the right, after fifteen (15) days notice (except no -5- notice need to be sent in cases of emergency) to keep or perform Tenant's obligation in its behalf and the cost of same shall be additional rent and shall be added to the next rent payment as the same becomes due. 8. UTILITIES. Tenant shall pay for all sewer, water, gas, electric, telephone and other utilities used or consumed in or at the Premises. 9. TAXES. Tenant shall promptly pay as and when the same become due and payable, all taxes and special assessments upon the Premises and all personal property located thereon by the Tenant, except franchise, income, estate and inheritance or other similar taxes which may be levied or assessed against the Premises. If Tenant defaults in keeping or performing its obligations hereunder, Landlord shall have the right after fifteen (15) days written notice to Tenant to perform the same in Tenant's behalf and the cost of same shall be additional rent and shall be added to the next rental installment as it becomes due. 10. TENANT'S RIGHT TO CONTEST. Tenant, at its option, shall have the right, at its own cost and expense and for its sole benefit, to initiate and prosecute any proceedings permitted by law for the purpose of obtaining an abatement of or otherwise contesting the validity or amount of taxes or special assessments assessed to or levied upon the demised Premises and required to be paid by the Tenant hereunder and to defend any claims for liens that maybe asserted against Landlord's estate; and, if required by law, the Tenant may take such action in the name of the Landlord, who shall cooperate with Tenant to such extent as the Tenant may reasonably require, to the end that such proceedings may be brought to a successful conclusion; provided, however, that the Tenant shall fully indemnify and save the Landlord harmless from all loss, cost, damage and expense incurred by or to be incurred or suffered by the Landlord. -6- 11. INSURANCE. Tenant, at its sole cost and expense, shall keep the Premises and the buildings and improvements thereon insured to the extent of the full replacement value thereof against loss or damage by fire or other casualty, with extended coverage. Tenant shall provide to Landlord evidence of such insurance and, additionally, such policies shall name Landlord as an additional insured thereunder and shall be non-cancellable absent thirty (30) days' prior written notice to Landlord. 12. DAMAGE OR DESTRUCTION OF PREMISES. If the building on the Premises shall be damaged by fire or other casualty, Tenant will, within ninety (90) days from the date of said damage or destruction, repair, restore or replace said building so that the same will thereafter be in as good a condition as existed immediately prior to such fire or other casualty. It is further agreed that if said building cannot be replaced, restored or repaired in ninety (90) days due to the inability of Tenant to obtain materials and labor needed therefor because of strikes, acts of God, or governmental restrictions that would prohibit, limit or delay said construction, then the time for completion of such repair or replacement shall be extended accordingly; provided, however, that in any event, if the repair, restoration or replacement of the building has not been completed within a period of six months from the date of said damage or destruction Landlord or Tenant may, at its option, terminate this lease. Provided, further, however, that if this lease is terminated under the provisions of this paragraph, all insurance proceeds otherwise payable to Tenant for repair of said damage or destruction shall be paid by Tenant to Landlord, except to the extent that said insurance proceeds are for damage to Tenant's equipment and fixtures on the Premises. 13. EMINENT DOMAIN. In the event the Premises are made subject to a proceeding by which the right of eminent domain is exercised, or any like proceedings, Landlord and Tenant shall join and cooperate in resisting such proceeding if such resistance is feasible and desirable, -7- and if it is not, shall join and cooperate in prosecuting their respective claims for damages incurred from the successful exercise of such right or proceeding. Tenant reserves unto itself all damages awarded which are based upon its leasehold interest and ownership of trade fixtures, signs and equipment or interruption of business. If the whole of the demised Premises shall be taken or condemned by any competent authority for any public use or purpose during the term of this lease, all obligations of Tenant shall cease upon the date Tenant vacates the Premises or upon the date of such taking, whichever is later, and any unearned rent paid by Tenant shall be refunded. In the event that a part of the demised Premises shall be taken or condemned, and: (a) The part so taken includes the building on the demised Premises or any part thereof; or (b) Such partial taking shall result in cutting off access from the demised Premises to any adjacent public street or highway; or (c) Such partial taking in any other way reduces or damages the Premises to an extent that the same may not be effectively used for the purposes hereof; then, and in any such event, the Tenant may at any time, either prior to or within a period of sixty (60) days after the date when possession of the Premises shall be required by the condemning authority, elect to terminate this lease. In the event that Tenant shall fail to exercise any such option to terminate this lease, or in the event that a part of the demised Premises shall be taken or condemned under circumstances under which the Tenant will have no such option, then in either such event this lease shall continue in effect with respect to the portion of the demised Premises not so taken, and Landlord will, with all due diligence and at its own cost and expense, repair and -8- restore the demised Premises or what may remain thereof to as near their former condition as is practicable, in which event all proceeds shall belong to the Landlord. Until the completion of such work, the obligation of the Tenant to pay rent shall abate and, upon completion, the monthly rent due Landlord under this lease shall be equitably adjusted to compensate Tenant for any loss sustained in area and usability. If Tenant terminates this lease under the provision of paragraph 13, then Landlord shall be entitled to all proceeds of the condemnation award, subject to the provisions of paragraph 5.2 hereof. 14. INDEMNIFICATION OF LANDLORD. Tenant shall indemnify and save Landlord harmless from all liability, expenses, claims, causes of action, actions and judgment for personal injury, loss of life or property damage suffered in, upon and about the Premises and Tenant shall provide to Landlord, at Tenant's expense, a defense to such claims, except such as may be result of the negligence of Landlord. In addition to, and not in lieu of the foregoing indemnification, Tenant shall provide and keep in force during the term of this lease and any extension of said term for the benefit of Landlord, a comprehensive general public liability insurance policy insuring Landlord against loss resulting from any of the foregoing; said policy to provide minimum coverage in the amount of $1,000,000 per occurrence with respect to bodily injury to any one or more persons and $500,000 per occurrence with respect to property damage. Such insurance may be carried under a blanket policy covering the Premises and other locations of Tenant, but such policy shall bear an endorsement making it non-cancellable absent ten (10) days prior written notice to Landlord. Tenant shall also provide and keep in force during the term of this Lease and any extensions of said term, workers compensation insurance as required by applicable law. -9- 15. DEFAULT OF TENANT. If Tenant shall fail to pay any installments of rent when due after ten (10) days written notice of such default, or if Tenant shall fail to keep and perform any other covenant of this lease and shall continue in default for a period of thirty (30) days after Landlord has given Tenant written notice of such default and demand of performance, or if any court or tribunal shall commence any proceedings, whether voluntary or involuntary to declare Tenant insolvent or unable to pay its debts; or if there is a filing by or on behalf of or against Tenant of any petition or pleading to declare Tenant a bankrupt under any bankruptcy law or act; or if there is an appointment by any court under any law of a receiver, custodian or trustee of the business or assets of Tenant; or the assignment by Tenant of all or any part of its property or assets for the benefit of creditors, then Landlord may declare the term ended and enter upon the Premises and expel Tenant therefrom without prejudice to other remedies of Landlord. No such entry by Landlord shall bar Landlord from the recovery of damages for the breach of any covenant hereof by Tenant. Provided, however, if any default shall occur (other than in the payment of rent) which cannot with due diligence be cured within a period of thirty (30) days from and after the giving of notice as aforesaid, and Tenant commences to eliminate such default and proceeds diligently to take steps to cure the same, Landlord shall not have the right to declare the term ended by reason thereof. Except for non-payment of rent, no liens upon the trade fixtures, equipment or signs erected or placed on the Premises by Tenant shall arise or be erected in Landlord's favor by virtue of any default by Tenant hereunder. 16. COVENANT OF QUIET ENJOYMENT. Landlord covenants and warrants that Landlord alone has full right and authority to enter into this lease for the full term hereof; and that at all times when Tenant is not in default hereunder in its covenants and during the term of -10- this lease, Tenant's quiet and peaceful enjoyment of the Premises shall not be disturbed or interfered with by anyone. 17. HOLDING OVER. In the event Tenant remains in possession of the Premises after the expiration of the initial term hereof or any extension Tenant shall occupy the Premises as a tenant from month to month, subject to all the conditions of this lease insofar as consistent with such a tenancy. 18. SUBORDINATION. This Lease Agreement is specifically and in all respects subordinate to any and all deeds of trust encumbering the demised Premises whether now existing or hereafter arising, and Tenant agrees from time to time, upon demand, to execute any and all instruments as may be required to evidence such subordination. Landlord agrees to utilize its best efforts to obtain at Tenant's request a non-disturbance agreement executed by any mortgagees on deeds of trust covering the Premises providing that so long as the Tenant is not in default in the performance of its obligations hereunder that such mortgagees will not interfere with the leasehold interest of Tenant. 19. MONETARY CURE. Any default by the Tenant hereunder which is susceptible to monetary cure by Landlord may be so cured and the cost thereof shall be additional rent due and payable with the next due monthly installment of base rent. 20. PROHIBITION AGAINST ASSIGNMENT. Tenant may not, without the written consent of Landlord, sublet, assign, or encumber this lease to any person, natural or corporate, whomsoever. In the event of such written consent by Landlord, Tenant shall remain primarily liable for the keeping and performance of all its covenants hereunder, including but not limited to, the prompt and due payment of rent. -11- 21. BINDING EFFECT; CONSTRUCTION. Each and every provision of this lease shall bind and inure to the benefit of the parties hereto, their legal representatives, heirs, successors and assigns. Feminine or neuter pronouns shall be substituted for those of the masculine form and the plural for the singular number in any place or places herein in which the context may require the same. This agreement is made in the State of North Carolina and is to be construed in accordance with and take effect under the laws of the State of North Carolina. The captions and headings throughout this lease are inserted for the convenience and reference of the parties only and in no way shall they be held or deemed to limit, define, modify, amplify or add to the interpretation, construction or meaning of any provision of or intent of this lease, nor in any other way affect this lease. 22. NOTICE. Any notice necessary to be given hereunder for whatever reason shall be deemed duly given if delivered personally, on the date of delivery, or by certified mail, postage prepaid, return receipt requested, upon the date of mailing, to the Landlord: W & G Associates c/o W. Travis Porter P. O. Box 3843 Durham, North Carolina 27702 to the Tenant: W & G Instruments, Incorporated Attn:. Hans Marosfalvy, Executive Vice President 1 Swabia Court Durham, North Carolina 27709 23. ENTIRE AGREEMENT. This lease contains all of the agreements and conditions made between the parties and no statement, promises or inducements made by any party hereof, or agent or employee of either party hereto, which is not contained in this written contract, shall be valid or binding; and this lease may only be modified or amended by an agreement in writing -12- signed by all parties hereto or their respective successors in interest and appended hereto, and, so long as the Note shall remain outstanding, agreed to by Wachovia as the Holder of the Bond, and the Authority. 24. MEMORANDUM OF LEASE. The parties hereto agree to execute a Memorandum of Lease suitable for recording upon the request of either party. IN WITNESS WHEREOF, Landlord and Tenant have executed or caused this lease to be executed in their behalf in the manner prescribed by law on the day and year first above written. LANDLORD: W & G ASSOCIATES By: -------------------------------- Managing Partner WITNESS: - ---------------------------- TENANT: W & G INSTRUMENTS, INCORPORATED By: -------------------------------- President ATTEST: - ---------------------------- Secretary [Corporate Seal] -13- NORTH CAROLINA DURHAM COUNTY I, ______________________, a Notary Public of said state and county certify that _____________ personally appeared before me this day and acknowledged that he is Managing Partner of W & G Associates, a North Carolina general partnership, and that he signed the foregoing Lease. Witness my hand and notarial seal this the ___ day of ________________, 1984. --------------------------- Notary Public My Commission Expires: - -------------------------- NORTH CAROLINA DURHAM COUNTY I, ______________________, a Notary Public of said state and county certify that _____________ personally appeared before me this day and acknowledged that he is Secretary of W & G Instruments, Incorporated and that by authority duly given and as the act of the corporation, the foregoing Lease was signed in its name by its _____ President, sealed with its corporate seal, and attested by himself as its Secretary. Witness my hand and notarial seal this the ___ day of ________________, 1984. --------------------------- Notary Public My Commission Expires: - --------------------------- -14- EXHIBIT A BEGINNING at an iron pipe set located in the right-of-way line of a cul-de-sac at the northern end of Swabia Court, said point having North Carolina Grid Coordinates X=2,045,606.25 and Y=773,399.78; running thence North 01(degree) 33' 22" East 706.93 feet to a new iron pipe, said iron pipe being located South 88(degree) 26' 38" East 1,534.22 feet from an existing iron pipe in the eastern right-of-way line of North Carolina Highway 54; thence South 88(degree) 26' 38" East 749.96 feet to a Black Gum Tree, said tree being further identified with a P. K. nail set in its tree trunk on the south side; thence South 01(degree) 33' 13" West 881.45 feet to a new iron pipe; thence North 88(degree) 26' 38" West 700.99 feet to a new iron pipe located in the eastern right-of-way line of Swabia Court; thence North 09(degree) 34' 52" West 64.28 feet to a point; thence along a curve to the right in a northeasterly direction having a radius of 25 feet an arc distance of 22.39 feet to a point; thence along a curve to the left in a northwesterly direction having a radius of 55 feet an arc distance of 124.96 feet to an iron pipe, the point and place of BEGINNING, containing 15.00 acres, all according to that survey entitled W & G Associates dated October 5, 1984 and prepared by Kenneth Close, Inc., Registered Land Surveyor. NORTH CAROLINA DURHAM COUNTY AMENDMENT TO LEASE AGREEMENT This Amendment to Lease Agreement made and entered into as of the 31st day of January, 1986, by and between W & G Associates, a North Carolina general partnership with its principal office in Durham County, North Carolina, hereinafter referred to as "Landlord" and Wandel & Goltermann, Inc. (formerly W & G Instruments, Inc.), a New Jersey corporation with its principal office in Durham County, North Carolina, hereinafter referred to as "Tenant". WITNESSETH: WHEREAS, Landlord and Tenant previously entered into a Lease Agreement dated the 1st day of October, 1984, with respect to a certain tract or parcel of land in Durham County, North Carolina, commonly known as One Swabia Court, Durham, North Carolina, and being more particularly described in the exhibit attached to said Lease Agreement; and WHEREAS, Landlord has financed the cost of the leased premises through borrowing from the Durham County Industrial Facilities and Pollution Control Financing Authority, said loan represented by bonds issued by the authority and purchased by Wachovia Bank & Trust Company, N.A.; and WHEREAS, Wachovia Bank & Trust Company, N.A. as purchaser and holder of the bonds has consented to the amendment as provided herein; and WHEREAS, Landlord and Tenant mutually desire to amend the Lease Agreement as provided herein; -1- NOW, THEREFORE, for and in consideration the mutual promises set out herein and other good and valuable consideration, the parties covenant and agree as follows: 1. The Lease Agreement previously entered into by and between Landlord and Tenant and dated October 1, 1984 is amended by the deletion of Paragraph 2 thereof and the insertion of the following in lieu thereof: "2. TERM. The term of this lease shall extend to and including the 90th day from and after the mailing of notice (registered mail, return receipt requested) of termination of the lease by the Landlord or the Tenant." In all other respects, the Lease Agreement between the Landlord and Tenant dated October 1, 1984 is hereby ratified and confirmed. This the day and year first above written. LANDLORD W & G ASSOCIATES By: ------------------------------ Managing Partner TENANT WANDEL & GOLTERMANN, INC. (formerly W & G Instruments, Inc.) By: ------------------------------ Executive Vice President ATTEST: - ------------------------------ Secretary (Corporate Seal) -2- NORTH CAROLINA DURHAM COUNTY I, LYNN F. PORTER , a Notary Public of said County and State do hereby certify that FRANK GOLTERMANN BY W. TRAVIS PORTER, ATTY. IN FACT Managing Partner of W & G Associates, personally appeared before me this day and acknowledged the due execution of the foregoing instrument. Witness my hand and notarial seal, this the 29th day of JANUARY , 1986. ------------------------------ Notary Public My Commission Expires: March 1, 1989 - ------------------------------ NORTH CAROLINA DURHAM COUNTY I, _______________________, a Notary Public of said state and county certify that ____________________________________, Secretary, of Wandel & Goltermann, Inc. (formerly W & G Instruments, Inc.), personally appeared before me this day and acknowledged that he is Secretary of such corporation and that by authority duly given and as the act of the corporation, the foregoing document was signed in its name by its Executive Vice President, sealed with its corporate seal, and attested by himself as its Secretary. Witness my hand and notarial seal this the ___ day of ___________________, 1986. ------------------------------ Notary Public My Commission Expires: - ------------------------------ NORTH CAROLINA DURHAM COUNTY AMENDMENT TO LEASE THIS AMENDMENT TO LEASE (the "Amendment") effective as of the 1st day of October, 1989, by and between Frank Goltermann, hereinafter referred to as "Landlord" and Wandel & Goltermann Technologies, Inc., a New Jersey corporation with its principal office in Durham, North Carolina, hereinafter referred to as "Tenant". WITNESSETH: WHEREAS, W & G Associates, a North Carolina general partnership, and W & G Instruments, Incorporated, a New Jersey corporation, entered into that certain lease agreement (hereinafter the "Lease Agreement") as of the 1st day of October, 1984 for a tract of land commonly known as 1 Swabia Court, Durham, North Carolina (the "Premises"); and WHEREAS, Frank Goltermann has succeeded to all of the interests of W & G Associates and is now the sole owner of the Premises which is the subject of the Lease Agreement; and WHEREAS, W & G Instruments, Incorporated has changed its name to Wandel & Goltermann Technologies, Inc.; and WHEREAS, the parties desire to amend the Lease Agreement as hereinafter set out, effective October 1, 1989; NOW, THEREFORE, for and in consideration of the mutual agreements set forth herein and other good and valuable consideration, the parties covenant and agree as follows: 1. Rent. The annual base rent for the remainder of the Base Term (as set forth in the Lease Agreement) shall be $8.00 per square foot, payable in equal monthly installments as set forth in the Lease Agreement. The parties agree and acknowledge that the Premises contains -1- 50,725 square feet. The base rent shall be adjusted annually on each October 1st, beginning October 1, 1990 for any increase in the Consumer Price Index for Urban Consumers, U.S. City Average - All Items, published by the Bureau of Labor Statistics of the United States Department of Labor (the "CPI Index"). The Base CPI Index shall be the Index for the month of September, 1989, and the corresponding Index number for the month of September of each subsequent year shall be the then "Current Index Number" as applicable. Prior to each October 1, the Current Index Number shall be divided by the Base Index Number. From the quotient thereof, there shall be subtracted the integer one (1), and any resulting positive number shall be deemed to be the percentage of increase in the cost of living. The percentage of increase multiplied by $8.00 per square foot, the original annual rental rate, shall be the increase in rent required to be determined by this Amendment. The increase so determined shall be added to the Base Rent of $8.00 per square foot and Tenant agrees to pay the larger rent amount beginning on October 1st of each year during the term of the Lease Agreement. The Landlord shall, within a reasonable time after obtaining the appropriate data necessary for computing such increase, give the Tenant notice of any increase so determined, and the Landlord's computation shall be conclusive and binding upon the Tenant. This provision shall not preclude any adjustment which may be required in the event of a published amendment of the Index figures upon which the computation was based. 2. Amendment. The parties agree to record this Amendment or a memorandum thereof in the Durham County Register of Deeds upon the request of either party. Except as set forth in this Amendment, the terms and conditions of the Lease Agreement shall remain in full force and effect. Capitalized terms not defined in this Amendment shall have the meaning set forth in the Lease Agreement. -2- IN WITNESS WHEREOF, Landlord and Tenant have executed this Amendment in their behalf in the manner prescribed by law effective on the day and year first above written. LANDLORD: (SEAL) ---------------------------- Frank Goltermann TENANT: WANDEL & GOLTERMANN TECHNOLOGIES, INC. By: ------------------------------ Attest: President - ------------------------------ Secretary [Corporate Seal] -3- NORTH CAROLINA _________ COUNTY I, , a Notary Public of said County and State do hereby certify that Frank Goltermann personally appeared before me this day and acknowledged the due execution of the foregoing instrument. Witness my hand and notarial seal, this the ___ day of _______________, 1991. ------------------------------ Notary Public My Commission Expires: - ------------------------------ NORTH CAROLINA _________ COUNTY I, _______________________________, a Notary Public of said state and county certify that ________________________________ personally appeared before me this day and acknowledged that he is_________________ Secretary of Wandel & Goltermann Technologies, Inc. and that by authority duly given and as the act of the corporation, the foregoing instrument was signed in its name by its _________ President, sealed with its corporate seal, and attested by himself as its ____________ Secretary. Witness my hand and notarial seal, this the ___ day of _______________, 1991. ------------------------------ Notary Public My Commission Expires: - ------------------------------ Kreisstadt Reutlingen Land Baden-Wurttemberg I, Wolfgang Wenz, a Notary Public of said County do hereby certify that Frank Goltermann personally appeared before me this day and acknowledged the due execution of the foregoing instrument. Witness my hand and notarial seal, this the 19 day of August, 1991. Notariat Reutlingen My Commission Expires: unlimited (Wenz) Notar NORTH CAROLINA DURHAM COUNTY THIRD AMENDMENT TO LEASE AGREEMENT This Third Amendment to Lease Agreement (the "Third Amendment") made and entered into as of the 24 day of January, 1994, by and between WANDEL & GOLTERMANN ASSOCIATES, a North Carolina general partnership with its principal office in Durham County, North Carolina ("Landlord") and WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation with its principal office in Durham County, North Carolina ("Tenant"). WITNESSETH: WHEREAS, W & G Associates, a North Carolina general partnership, and W & G Instruments, Incorporated, a New Jersey corporation, previously entered into that certain Lease Agreement dated October 1, 1984 and amended January 1, 1986 and October 1, 1989 (collectively the "Lease Agreement") with respect to a certain tract or parcel of land containing ten (10) acres in Durham County, North Carolina, commonly known as One Swabia Court, Durham, North Carolina, and more particularly described in Exhibit A, Book 1932, Page 293 of the Durham county Registry, attached hereto (the "Premises"); WHEREAS, Wandel & Goltermann, Inc., a New Jersey corporation, fully succeeded to all of the interests of W & G Instruments, Incorporated as the tenant in said Lease Agreement; WHEREAS, W & G Associates and Wandel & Goltermann, Inc., amended the Lease Agreement on January 31, 1986; WHEREAS, Frank Goltermann fully succeeded to all of the interests of W & G Associates as the landlord in the Lease Agreement and became the sole owner of the Premises which is the subject of the Lease Agreement; WHEREAS, Wandel & Goltermann, Inc. changed its name to Wandel & Goltermann Technologies, Inc.; WHEREAS, Frank Goltermann and Wandel & Goltermann Technologies, Inc. amended the Lease Agreement on October 1, 1989; WHEREAS, Landlord has fully succeeded to all of the interests of Frank Goltermann as the landlord in the Lease Agreement and is now the sole owner of Premises which is the subject of the Lease Agreement; WHEREAS, Landlord and Tenant mutually desire to amend the Lease Agreement as provided herein, effective October 1, 1993. -1- NOW, THEREFORE, for and in consideration of the mutual agreements as set forth herein and other good and valuable consideration, the parties covenant and agree as follows: 1. The Lease Agreement is amended by the deletion of paragraph 2 thereof and the insertion of the following in lieu thereof: 2. TERM. The term of this Lease Agreement shall extend to and including September 30, 2005. Upon written notice (certified or registered mail, return receipt requested) at least six (6) months prior to the expiration of the term hereof or any renewal term, Tenant may extend the Lease Agreement for three (3) successive renewal terms of two (2) years each. 2. The Lease Agreement is amended by the deletion of the first sentence of Paragraph 1 of the Amendment To Lease dated October 1, 1989 and the insertion of the following in lieu thereof: The annual base rent for the year beginning October 1, 1989 shall be $8.00 per square foot, payable in equal monthly installments as set forth in the Lease Agreement. The parties agree and acknowledge that the Premises contains 50,725 square feet. 3. The Lease Agreement is amended by the addition of the following to Paragraph I of the Amendment To Lease dated October 1, 1989: If the Lease Agreement is renewed by Tenant, Tenant's rent to Landlord shall be adjusted annually on each October 1st, to an amount equal to the higher of: (a) the base rent of $8.00 plus additional rent adjustments reflecting the increase in the Base CPI Index from September, 1989 as provided herein or (b) the fair market rental value as determined by an appraisal conducted by a mutually acceptable realtor or appraiser. The appraisal to determine the fair market rental value shall be at the Landlord's expense. 4. The Lease Agreement is amended by the deletion of the first sentence of Paragraph 5.4 and the insertion of the following in lieu thereof: Tenant acknowledges that all upfit work on the Premises has been completed and accepts the Premises "as is." Tenant may make alterations and additions to the existing improvements on the Premises; provided, however, that all additional tenant alterations and additions will be performed by Tenant at Tenant's cost and that, prior to conducting any alterations or additions, Tenant shall obtain Landlord's written consent to such alterations or additions, which consent shall not be unreasonably withheld. At the expiration of the lease term, if so requested by Landlord, Tenant shall restore at its own cost the Premises to the condition and repair as at the commencement of the lease term, natural wear and tear excepted. -2- 5. The Lease Agreement is amended by the addition of the following to Paragraph 5.4 Landlord may construct buildings or make other structural improvements upon the Premises; provided, however, that all Landlord construction or structural improvements will be performed by the Landlord at Landlord's cost and that, prior to conducting any construction or structural improvement, Landlord shall notify Tenant of such construction or improvement activities. Landlord shall not unreasonably burden Tenant's use of the Premises and, at no time, shall the sidewalks, office entrances, parking or public areas be unreasonably blocked or interfered with as a result of such construction activities. 6. The Lease Agreement is amended by the deletion of Paragraph 20 thereof and the insertion of the following in lieu thereof: 20. SUBLEASE AND ASSIGNMENT. Tenant may sublet all or portions of the Premises for the remainder of the term or any renewal term, as the case may be, with Landlord's approval, which shall not be unreasonably withheld. No subletting by Tenant shall affect its obligations to perform all of its covenants under this Lease Agreement. Landlord and Tenant each may assign or transfer its respective right, title, and interest in and to this Lease Agreement to an affiliate without the other party's consent. No such assignment or transfer shall release the assigning party of any obligation or liability hereunder unless the other party specifically agrees in writing to such release. 7. The Lease Agreement is amended by the addition of the following as Paragraph 25: 25. RIGHT OF FIRST REFUSAL. It is agreed that if Landlord, at any time during the term of this Lease Agreement or any renewal term hereof, receives any bona fide offer from a third party to purchase the Premises, and any such offer is acceptable to Landlord, Landlord agrees to notify Tenant in writing, giving name and address of the offeror and the price, terms and conditions of such offer, and Tenant shall have twenty (20) business days from and after the receipt of such notice from Landlord in which to elect to purchase the Premises on the terms and conditions contained in said bona fide offer. If Tenant does not elect to purchase, and Landlord sells the Premises to the third party making such offer, then the purchaser shall take the Premises subject to and burdened with all the terms, provisions, and conditions of this Lease, and the rights of Tenant under this Lease as against the new owner shall not be lessened or diminished by reason of the change of ownership. If Tenant purchases the Premises, then contemporaneously with the conveyance of the property to Tenant, this Lease Agreement shall become null and void, without further notice and Tenant shall thereupon be released and discharged from all further rentals and other obligations on the part of Tenant to be paid, kept and performed. -3- 8. The parties agree to record this Third Amendment To Lease Agreement or a memorandum thereof in the Durham County Register of Deeds upon the request of either party. Except as set forth in this Amendment, the terms and conditions of this Lease Agreement shall remain in full force and effect. Capitalized terms not defined in this Amendment shall have the meaning set forth in the Lease Agreement. [SIGNATURES CONTAINED ON NEXT PAGE] -4- IN WITNESS WHEREOF, Landlord and Tenant have executed this Amendment in their behalf under seal and in the manner prescribed by law. LANDLORD: WANDEL & GOLTERMANN ASSOCIATES By: ---------------------------------- Frank Goltermann, Managing Partner NORTH CAROLINA DURHAM COUNTY I, _________________________________, a Notary Public of the aforesaid County and State, do hereby certify that Frank Goltermann personally appeared before me this day and acknowledged that he is the Managing Partner of Wandel & Goltermann Associates, a North Carolina general partnership, and acknowledged the execution of the foregoing instrument. Witness my hand and notarial seal this ___ day of ____________________, 1994. ------------------------------ Notary Public My Commission Expires: - ------------------------------ -5- TENANT: WANDEL & GOLTERMANN TECHNOLOGIES, INC. By: -------------------------------- Adelbert Kuthe Vice-President Attest: - -------------------------------- Adelbert Kuthe, Secretary [CORPORATE SEAL] NORTH CAROLINA MECKLENBURG COUNTY I, ____________________________, a Notary Public of the aforesaid County and State, do hereby certify that Adelbert Kuthe personally appeared before me this day and acknowledged that he is the Secretary of Wandel & Goltermann Technologies, Inc., a North Carolina corporation, and that by authority duly given and as an act of the corporation, the foregoing instrument was signed in its name by its President, and attested by himself as Secretary, and sealed with its common corporate seal. Witness my hand and notarial seal this ___ day of ____________________, 1994. -------------------------------- Notary Public My Commission Expires: - -------------------------------- -6- EXHIBIT A Beginning at an iron pipe found located in the northern boundary of the right-of-way of Swabia Court, said iron pipe also being located in the eastern line of property now or formerly belonging to Glaxo Inc. as described in Deed Book 1664, Page 298, and shown on plat recorded in Plat Book 125, Page 110, Durham County Registry; running thence along and with the eastern line of said Glaxo Inc. North 01(degree) 34' 57" East 706.93 feet to an iron pipe found; running thence along and with the southern line of property now or formerly belonging to Imperial Center Partnership and Petula Associates, Ltd., as described in Book 1660, Page 458, Durham County Registry, South 88(degree) 25' 03" East 749.96 feet to an iron pipe found; running thence along and with the western line of property now or formerly belonging to Imperial Center Partnership and Petula Associates, Ltd. as described in Book 1690, Page 537, Durham County Registry, South 01(degree) 34' 48" West 265.00 feet to an iron pipe found; running thence along and with the western line of property now or formerly belonging to Imperial Center Partnership and Petula Associates, Ltd. as described in Book 1660, Page 458, Durham County Registry, South 01(degree) 34' 48" West 291.55 feet to an iron pipe set; running hence along and with the northern line of Lot S-5A as shown on the plat hereinafter referred to, North 88(degree) 25' 03" West 567.39 feet to an iron pipe set, and South 41(degree) 54' 51" West 220.10 feet to an iron pipe set in the boundary of the right-of-way of Swabia Court; running thence along and with said right-of-way along and with a curve in a counterclockwise direction, said curve having a Radius of 55.00 feet, an arc distance of 33.00 feet, and a chord bearing and distance of North 58(degree) 43' 40" West 32.51 feet to an iron pipe set; thence continuing along said right-of-way along and with a curve in a counterclockwise direction, said curve having a radius of 55.00 feet, an arc distance of 12.00 feet, and a chord bearing and distance of North 82(degree) 10' 01" West 11.98 feet to an iron pipe found, the point and. place of Beginning, and being Lot S-5B, containing 10.00 acres, more or loss, as shown on plat and survey thereof entitled "Subdivision Map For Lot S-5A and Lot S-5B, Imperial Center", prepared by Kenneth Close, Inc., dated 07-30-93, and recorded in Plat Book ___, Page ___, Durham County Registry, to which plat reference is hereby made for a more particular description of same. Prepared by and mail after recording to: Porter & Steel, PLLC; P.O. Box 13646, Research Triangle Park, North Carolina 27709, Attn: Gerald A. Tingen NORTH CAROLINA DURHAM COUNTY FOURTH AMENDMENT TO LEASE AGREEMENT THIS FOURTH AMENDMENT TO LEASE AGREEMENT (the "Fourth Amendment") made and entered into as of the 23rd day of February 1999 by and between W & G ASSOCIATES, A NORTH CAROLINA LIMITED PARTNERSHIP with its principal office in Durham, North Carolina ("Landlord") and WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation with its principal office in Durham, North Carolina ("Tenant"); WHEREAS, W & G Associates, a North Carolina general partnership, and W & G Instruments, Incorporated, a New Jersey Corporation previously entered into that certain Lease Agreement dated October 1, 1984 and amended January 1, 1986, October 1, 1989 and January 24, 1994 as ratified July 5, 1994 (collectively the "Lease Agreement") with respect to a certain parcel of land more commonly known as One Swabia Court, Durham, North Carolina; and WHEREAS, Wandel & Goltermann, Inc., a New Jersey corporation, fully succeeded to all of the interests of W & G Instruments, Incorporated as the tenant in said Lease Agreement; and WHEREAS, W & G Associates, a North Carolina general partnership, and Wandel & Goltermann, Inc., amended the Lease Agreement on January 31, 1986; and WHEREAS, Frank Goltermann fully succeeded to all of the interests of W & G Associates as the landlord in the Lease Agreement and became the sole owner of the Premises which is the subject of the Lease Agreement; and WHEREAS, Wandel & Goltermann, Inc. changed its name to Wandel & Goltermann Technologies, Inc.; and WHEREAS, Frank Goltermann and Wandel & Goltermann Technologies, Inc. amended the Lease Agreement on October 1, 1989; and WHEREAS, Wandel & Goltermann Technologies, Inc., a New Jersey corporation, merged into W & G Sub, Inc., a North Carolina corporation, with the surviving corporation being Wandel & Goltermann Technologies, Inc., a North Carolina corporation; and WHEREAS, the real property subject to the Lease was conveyed from Frank Goltermann and wife, Dorothea Goltermann to W & G Associates, a North Carolina limited partnership by deed recorded in Book 1886, Page 784, Durham County Registry, and Landlord has fully -1- succeeded to all of the interests of Frank Goltermann as the landlord in the Lease Agreement and is now the sole owner of Premises which is the subject of the Lease Agreement; and WHEREAS, a Third Amendment to Lease was made and entered into as of the 24th day of January, 1994 by Wandel and Goltermann Technologies, Inc. a North Carolina corporation as Tenant and Wandel & Goltermann Associates, a North Carolina general partnership as Landlord covering certain Premises located on Lot S-5B as shown on Plat Book 131, Page 87, Durham County Registry; and WHEREAS, a Memorandum of Lease referencing the Third Amendment to Lease was recorded in Book 1972, Pages 855 through 860, Durham County Registry was executed in the name of Wandel and Goltermann Associates, a North Carolina general partnership as Landlord; and WHEREAS, although the Third Amendment to Lease and the Memorandum of Lease referencing the Third Amendment to Lease incorrectly named the Landlord as "Wandel & Goltermann Associates, a North Carolina general partnership", both documents have been ratified by W & G Associates, a North Carolina limited partnership by Ratification recorded in Book 1999, Page 773, Durham County Registry; and WHEREAS, Landlord and Tenant mutually desire to amend the Lease Agreement as provided herein; NOW THEREFORE, for and in consideration of the mutual agreements as set forth herein and for other good and valuable consideration exchanged between the parties hereto, the receipt and sufficiency of which is hereby acknowledged, the parties covenant and agree as follows: 1. The Lease Agreement is amended by the deletion of Exhibit A thereof and the insertion of EXHIBIT A attached hereto in lieu thereof. 2. Subpart (a) of Paragraph 3 of the Third Amendment to Lease Agreement which reads, "...(a) the base rent of $8.00 plus additional rent adjustments reflecting the increase in the Base CPI Index from September, 1989 as provided herein, or..." is deleted and replaced with, "...(a) the base rent of $8.00 per square foot plus additional rent adjustments reflecting the increase in the Base CPI Index from September, 1989 as provided herein, or..." 3. The parties hereto agree to record a this Fourth Amendment or a memorandum of the Lease as amended hereby in the Durham County Register of Deeds upon the request of either party. Except as set forth in this Fourth Amendment, the terms and conditions of the Lease Agreement shall remain in full force and effect. Capitalized terms not defined in this Fourth Amendment shall have the meaning set forth in the Lease Agreement. -2- IN WITNESS WHEREOF, Landlord and Tenant have executed this Fourth Amendment under seat in the manner prescribed by law. W & G ASSOCIATES, A NORTH CAROLINA LIMITED PARTNERSHIP (SEAL) By: (SEAL) -------------------------- Frank Goltermann, General Partner, by Bert Kuthe, attorney-in-fact under power of attorney recorded in Book 1999, Page 771, Durham County Registry. WANDEL & GOLTERMANN TECHNOLOGIES, INC. a North Carolina corporation ------------------------------------ President ATTEST: - ------------------------------------ Secretary (Corporate Seal) -3- STATE OF NORTH CAROLINA COUNTY OF DURHAM I, ______________________, do hereby certify that Bert Kuthe, attorney-in-fact for Frank Goltermann, General Partner of W & G Associates, a North Carolina Limited Partnership, personally appeared before me this day, and being by me duly sworn, says that he executed the foregoing and annexed instrument for and in behalf of Frank Goltermann, as General Partner and as an act and deed of the Partnership and that his authority to execute and acknowledge said instrument is contained in an instrument duly executed, acknowledged and recorded on the 5th day of July, 1994 in Book 1999, Page 771, Durham County Registry, and that this instrument was executed under and by virtue of the authority given by said instrument granting him power of attorney; that the said Bert Kuthe acknowledged the due execution of the foregoing and annexed instrument for the purposed therein expressed for and in behalf of the said Frank Goltermann as General Partner and as an act and deed of the Partnership. Witness my hand and official seat, this 23 day of February, 1999. ------------------------------------ Notary Public (Notary Seal) My commission expires: CAROL F. JOHNSON ---------------- STATE OF NORTH CAROLINA COUNTY OF DURHAM I, a Notary Public of the County and state aforesaid, certify that _______________________, personally appeared before me this day and acknowledged that (s)he is _____________ Secretary of WANDEL & GOLTERMANN TECHNOLOGIES, INC. a North Carolina corporation, and that by authority duly given and as an act of the corporation, the foregoing instrument was signed its name by its _______ President, sealed with its corporate seal and attested by him/herself as its _________________ Secretary. Witness my hand and official seal, this ____ day of __________________, 199_. ------------------------------------ Notary Public (Notary Seal) My commission expires: CAROL F. JOHNSON ---------------- EXHIBIT A Being all of Lot S-5B, containing 10.00 acres, more or less, as shown on plat and survey thereof entitled, "Subdivision Map for Lot S-5A and Lot S-5B, Imperial Center", prepared by Kenneth Close, Inc., dated 07-30-93, and recorded in Plat Book 131, Page 87, Durham County Registry, to which plat reference is hereby made for a more particular description thereof TOGETHER WITH and SUBJECT TO all easements and rights appurtenant as set forth in those certain Declaration of Covenants Containing Easements recorded in Book 1963, Page 190, Durham County Registry. Prepared by and mail after recording to: Maupin, Taylor & Ellis, P.O. Drawer 19764, Raleigh, North Carolina 27619-9764 Attn. Gerald A. Tingen NORTH CAROLINA DURHAM COUNTY FIFTH AMENDMENT TO LEASE AGREEMENT THIS FIFTH AMENDMENT TO LEASE AGREEMENT (the "Fifth Amendment") dated for reference purposes October 1, 1999, by and between W & G ASSOCIATES, A NORTH CAROLINA LIMITED PARTNERSHIP ("Landlord") and WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation ("Tenant") WHEREAS, W & G Associates, a North Carolina general partnership, and W & G Instruments, Incorporated, a New Jersey Corporation previously entered into that certain Lease Agreement dated October 1, 1984 and amended January 31, 1986, October 1, 1989 and January 24, 1994 as ratified July 5, 1994 and amended as of February 23, 1999 (collectively the "Lease Agreement") with respect to a certain parcel of land more commonly known as Lot 5-5B, containing 10.00 acres, more or less as shown on plat and survey thereof entitled "Subdivision Map for Lot S-5-A and Lot S-5B, Imperial Center", prepared by Kenneth Close, Inc. dated July 30, 1993, and recorded in Plat Book 131, Page 87, Durham County Registry, TOGETHER with certain easements set out in Book 1963, Page 190, Durham County Registry. WHEREAS, Wandel & Goltermann, Inc., a New Jersey corporation, fully succeeded to all of the interests of W & G Instruments, Incorporated as the tenant in said Lease Agreement; and WHEREAS, W & G Associates, a North Carolina general partnership, and Wandel & Goltermann, Inc. amended the Lease Agreement on January 31, 1986; and WHEREAS, Frank Goltermann fully succeeded to all of the interests of W & G Associates as the landlord in the Lease Agreement and became the sole owner of the Premises which is the subject of the Lease Agreement; and WHEREAS, Wandel & Goltermann, Inc. changed its name to Wandel & Goltermann Technologies, Inc.; and WHEREAS, Frank Goltermann and Wandel & Goltermann Technologies, Inc. amended the Lease Agreement on October 1, 1989; and WHEREAS, Wandel & Goltermann Technologies, Inc., a New Jersey corporation, merged into W & G Sub, Inc., a North Carolina corporation, with the surviving corporation being Wandel & Goltermann Technologies, Inc., a North Carolina corporation; and WHEREAS, the real property subject to the Lease was conveyed from Frank Goltermann and wife, Dorothea Goltermann to W & G Associates, a North Carolina limited partnership by -1- deed recorded in Book 1886, Page 784, Durham County Registry, and Landlord has fully succeeded to all of the interests of Frank Goltermann as the landlord in the Lease Agreement and is now the sole owner of Premises which is the subject of the Lease Agreement; and WHEREAS, a Third Amendment to Lease was made and entered into as of the 24th day of January, 1994 by Wandel and Goltermann Technologies, Inc. a North Carolina corporation as Tenant and Wandel & Goltermann Associates, a North Carolina general partnership as Landlord covering certain Premises located on Lot S-5B as shown on Plat Book 131, Page 87, Durham County Registry; and WHEREAS, a Memorandum of Lease referencing the Third Amendment to Lease was recorded in Book 1972, Page 855 through 860, Durham County Registry was executed in the name of Wandel and Goltermann Associates, a North Carolina general partnership as Landlord; and WHEREAS, although the Third Amendment to Lease and the Memorandum of Lease referencing the Third Amendment to Lease incorrectly name the Landlord as "Wandel & Goltermann Associates, a North Carolina general partnership", both documents have been ratified by W & G Associates, a North Carolina limited partnership by Ratification recorded in Book 1999, Page 773, Durham County Registry; and WHEREAS, Landlord and Tenant entered into a Fourth Amendment to Lease Agreement dated as of February 23, 1999; and WHEREAS, Landlord and Tenant have agreed to amend the Lease Agreement as more fully set out herein; NOW THEREFORE, for and in consideration of the promises set out herein, and for other good and valuable consideration exchanged between the parties hereto, the receipt and sufficiency of which is hereby acknowledged, Landlord and Tenant agree as follows: 1. Paragraph 12 of the Lease Agreement, "Damage or Destruction of Premises" is hereby deleted and the following substituted in lieu thereof: 12. DAMAGE OR DESTRUCTION OF PREMISES. If the building or the Premises shall be damaged or destroyed by fire or other casualty, Tenant will, within one hundred fifty (150) days from the date of said damage or destruction, repair, restore or replace said building or Premises so that the same will thereafter be in as good a condition as existed immediately prior to such fire or other casualty. If in the reasonable opinion of a contractor or architect mutually agreeable to Landlord and Tenant the building cannot be replaced, restored and repaired within 150 days from the date of the casualty or damage, Landlord or, so long as Tenant's unreasonable delay is not a factor in such contractor's or architect's opinion that the Premises cannot be replaced, restored and repaired within 150 days, Tenant, upon written notice to the other, shall have the right to terminate this Lease within fifteen (15) business days after receipt of the written opinion of the approved contractor or architect. Provided, however, that if this Lease is terminated -2- pursuant to the provisions of this Paragraph, all insurance proceeds otherwise payable to Tenant for repair, replacement or restoration of said damage or destruction shall be paid to Landlord, except to the extent that said insurance proceeds are for damage to Tenant's equipment or fixtures on the Premises that are to remain the property of Tenant. 2. Pursuant to Paragraph 2, TERM of the Lease Agreement, Tenant has the option to extend the term of the Lease Agreement for three (3) successive renewal terms of two (2) years each upon written notice to Landlord at least six (6) months prior to the expiration of the then current term. It is agreed between the parties that (i) once a renewal term is exercised it ceases to exist and may not be exercised in a subsequent renewal term and (ii) subject to the requirement to notify Landlord at least six (6) months prior to the expiration of the then current term, Tenant may notify Landlord of the exercise of one or more of the renewal terms at any one time. Notwithstanding the foregoing, upon termination or earlier expiration of the term of the Lease Agreement, all renewal terms and any unexercised right to renew shall be terminated. 3. The loan financing the construction of the improvements on the Premises (together with the cost of the land) through borrowing from The Durham County Industrial Facilities and Pollution Control Financing Authority (the "Authority"), such loan funds having been raised by the Authority issuing and selling its industrial revenue bonds in the principal amount of $2,600,000.00 and made pursuant to a Loan Agreement dated as of October 1, 1984, between the Authority and Landlord, has been paid in full and cancelled of record. Accordingly, Paragraph 5 of the Lease Agreement, USE, is hereby amended to delete the requirements that Tenant operate the Premises in such a manner that the same will be a "project" within the meaning of Chapter 800 of the 1975 Session Laws of North Carolina, as amended, which as codified appears as Chapter 159C of the General Statutes of North Carolina, and that Landlord and Tenant comply with the applicable terms and provisions of the Bond Documents. 4. As modified by this Fifth Amendment, the Lease Agreement is ratified, confirmed and continues in full force and effect. Capitalized terms not defined herein shall have the meaning set forth in the Lease Agreement. 5. This Amendment is subject to the consent of First Union National Bank, Landlord's lender whose consent has been granted in writing, a copy of which consent is attached hereto. [SIGNATURE PAGE ATTACHED] -3- IN WITNESS WHEREOF, Landlord and Tenant have executed this Fifth Amendment under seal in the manner prescribed by law. W & G ASSOCIATES, A NORTH CAROLINA LIMITED PARTNERSHIP (SEAL) By: (Seal) --------------------------------- WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation By: --------------------------------- President ATTEST: By: --------------------------------- Secretary (Corporate Seal) -4- IN WITNESS WHEREOF, Landlord and Tenant have executed this Fifth Amendment under seal in the manner prescribed by law. W & G ASSOCIATES, A NORTH CAROLINA LIMITED PARTNERSHIP (SEAL) By: (Seal) --------------------------------- WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation By: --------------------------------- President ATTEST: By: --------------------------------- Secretary (Corporate Seal) -5- CONSENT OF LENDER First Union National Bank executes this Fifth Amendment for the sole purpose of evidencing its consent to the terms of such Fifth Amendment. FIRST UNION NATIONAL BANK (formerly, First Union National Bank of North Carolina) By: --------------------------------- President ATTEST: By: --------------------------------- Secretary (corporate seal) -6- EXHIBIT D DESCRIPTION OF POSSIBLE SUBTENANT ALTERATIONS OR ADDITIONS TO SUBLEASE PREMISES Subtenant intends to make certain alterations or additions to the Sublease Premises during the Initial Sublease Term and possibly the Extended Sublease Term, which alterations or additions are contemplated to allow a continuation of substantially the same uses and purposes of the improvements and equipment in Subtenant's premises at 1035 Swabia Court, Durham, North Carolina. Such alterations or additions may include, but are not limited to, the following: o Fiber optic cable that will be laid underground from Prime Landlord's property line with Glaxo Wellcome, Inc. up to and into the Sublease Premises and into Subtenant's computer and telecommunications equipment room. o Possible removal from the Sublease Premises of existing coaxial cable and various related attachments and installation of CAT-5 or equivalent wiring and related attachments for connecting and operating Subtenant's computer network. o Telecommunications wiring, equipment, and related attachments to the extent required in the event that Sublandlord's existing telecommunication wiring, equipment, and related attachments cannot be utilized by Subtenant for establishing both internal and external voice and data communications within the Sublease Premises and with external third parties. o The possible installation of non-load-bearing walls as may be required to reconfigure the Sublease Premises to meet the requirements of Subtenant's use. o The construction of laboratory facilities typical of that used by industrial researchers for biological research purposes equipped with standard laboratory equipment, including: laboratory benches with hot and cold running water, natural gas outlets and sinks with drains leading to plumbing that will have been installed in the Sublease Premises and connected to the Sublease Premises sewer system; additional lighting fixtures, ventilation hoods with external venting and other such equipment that is typical in a laboratory facility. o The following specialized facilities will be required: a tissue culture room(s) and associated ventilation and fume hoods; a pilot manufacturing laboratory and clean room space, a Bio-level Safety 2 (BL-2) licensed laboratory for use with poultry specific pathogens, a licensed radioactive use and associated storage area, an area(s) designated for work with poultry embryos, a laboratory designed for use with various poultry microbiological samples from the field, a dark room, a storage room for supplies, dedicated space(s) with egg delivery equipment and associated devices for use in testing biological materials and for process 23 optimization studies, bio-hazard waste storage facility, laundry, autoclaves and dishwashing room. o Specialized laboratory equipment includes -70oC freezers, walk-in freezers for the storage of freeze-dried vaccines, high speed centrifuges and specialized equipment for purification of biological materials and production of recombinant materials by fermentation and autoclaves. o The ventilation and fume hoods will require anywhere from between six and ten individual ventilation ducts that will penetrate the roof to the outside of the Sublease Premises. Subtenant's R&D personnel and outside consulting engineers have advised Subtenant that these hoods must be vented vertically and not horizontally through the wall of the Sublease Premises in order to ensure that the vented exhaust clears the Sublease Premises "envelope" and is not drawn back into the building through the HVAC units on the roof. The two autoclaves will also require external venting, and the HVAC units for the walk in freezers will most likely be mounted on the roof, also necessitating penetration of the roof. Subtenant agrees that any penetrations of the roof will only be performed by Sublandlord's contractor and only if Sublandlord's contractor will affirm the continuing warranty given with respect to the roof after installation of the roof penetrations to accommodate Subtenant's vents. o The construction of manufacturing facilities, including: steel-framed mezzanine storage areas, compressed air and related compressed air outlets connected to an external compressor, 220-volt electrical power outlets, additional lighting fixtures, power lift assists on the loading docks and plumbing outlets similar to those installed in the laboratory facilities. o The requirements for specialized facilities will require a number of individual rooms, possibly needing individual air handling and temperature controls for controlling the atmosphere, the quality of air, and the air pressure variance with respect to the rest of the Sublease Premises. The air would in all probability be HEPA filtered, both coming in and being exhausted, and may require individual HVAC equipment to be positioned on top of the rooms or on the roof of the Sublease Premises. The walls for these rooms will in all probability be self-contained and may be prefabricated, similar to clean rooms used to manufacture silicon wafers for the semiconductor industry. o The manufacturing area will perform the following activities: o Receive Subtenant's INOVOJECT(R) vaccination system from its outsourced manufacturer approximately 85% complete. 24 o Complete the other 15% of the INOVOJECT(R)system's construction, including the programming, installation and testing of electro-mechanical controls, and the attachment of vaccination tubing, injection head tooling and sterilization system. o Test the INOVOJECT(R) system. This requires either a 110-volt or a 220-volt power source and compressed air supply of approximately 100 pounds per square inch. Subtenant has a compressor located outside its present facility which it would relocate outside of the Sublease Premises if unable to use Sublandlord's compressed air supply. o Rebuild and refurbish used INOVOJECT(R)systems and components. This will require disassembly, some cleaning with a portable steam generator outside and beyond the loading dock area, and reassembly with new or rebuilt components such as pumps, vacuum motors and air and electrically actuated controls. Very little if any cleaning solvents are used (possibly some de-greasing agents) and the sterilization fluid used during test cycles and system cleaning prior to shipment of the INOVOJECT(R)system to the customer consists of a tap water and a household bleach or isopropyl alcohol mixture which, as a non-hazardous substance, is collected and discharged into a sink or other plumbed drain outlet. Any recyclable materials would be deposited in specially designated containers outside the Sublease Premises for removal by a third party waste hauler as is currently done at Embrex's present facility. o Shipping and Receiving activities are predominantly the dispatching (usually by Federal Express) of spare parts to INOVOJECT(R) system customers or Subtenant's field service technicians. Prior to the commencement of any alterations or additions, Subtenant will make a videotaped record of that part of the Sublease Premises to which Subtenant intends to make such alterations or additions and review said tape with Sublandlord. The parties shall then agree in good faith to resolve any differences of opinion with respect to the condition of the Sublease Premises. Subtenant will make a copy of the videotaped record for Sublandord. The purpose of the videotaped record is to facilitate Subtenant's compliance with its obligations to restore the Initial Sublease Premises and Expansion Sublease Premises in accordance with Section 19 of the Sublease. (REMAINDER OF PAGE LEFT INTENTIONALLY BLANK) 25 CONSENT OF PRIME LANDLORD TO SUBLEASE (REMAINDER OF PAGE LEFT INTENTIONALLY BLANK) 26 EX-10.10 4 FIRST AMENDMENT TO SUBLEASE EXHIBIT 10.10 FIRST AMENDMENT TO SUBLEASE THE FIRST AMENDMENT TO SUBLEASE (the "First Amendment") made and entered into as of the 29th day of February, 2000, by and among WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation, hereinafter referred to as "Sublandlord", EMBREX, INC., a North Carolina corporation, hereinafter referred to as "Subtenant", and W & G ASSOCIATES, a North Carolina partnership, hereinafter referred to as "Prime Landlord." WHEREAS, Sublandlord and Subtenant are parties to that certain Sublease Agreement dated as of October 1, 1999 (said Sublease being referred to herein as the "Sublease"), pertaining to the rental of certain premises on Swabia Court, Durham, North Carolina, as more particularly described in the Sublease (the "Sublease Premises"); and WHEREAS, pursuant to Section 6 of the Sublease, the Sublease Premises have been inspected by O'Neal, Inc., whose report has been delivered to Sublandlord and Subtenant (the "Inspection Report"), the purposes of said inspection being to determine whether the structure of the Sublease Premises and its HVAC, plumbing, mechanical, electrical and fire protection systems are in good condition and working order and whether the Sublease Premises currently comply with all applicable local, state and federal laws and regulations related to the occupancy of the Sublease Premises by Subtenant for its intended uses; and WHEREAS, pursuant to Section 6 of the Sublease, based upon the Inspection Report, Sublandlord and Subtenant desire to agree as to the repairs and replacements for which each is responsible, and to enter into this First Amendment to reflect the allocation of their respective responsibilities for repairs or replacements to the Sublease Premises. NOW, THEREFORE, in consideration of the mutual covenants contained herein, the Sublandlord and Subtenant agree as follows: 1. Unless otherwise defined herein, all capitalized terms used herein that are defined in the Sublease shall have the meaning ascribed to such terms in the Sublease. 2. A copy of the Inspection Report is attached hereto and by reference made a part hereof as EXHIBIT A. 3. Notwithstanding anything contained in the Sublease to the contrary, Sublandlord agrees to be responsible for the following repairs and/or replacements: (a) HVAC: (i) For the period beginning January 1, 2001 and ending December 31, 2002, Sublandlord and Subtenant shall share the cost of any necessary maintenance, repairs and replacements to any of the existing rooftop HVAC units, with Sublandlord agreeing to reimburse Subtenant for one-third (1/3) of any such costs, and Subtenant being responsible for the remaining two-thirds (2/3); subject, however, to a maximum aggregate reimbursement from Sublandlord to Subtenant of $70,000. (ii) In addition to the foregoing, Sublandlord agrees to repair and place in good working order the economizer cycles on two of the packaged rooftop units which are in need of repair, as described on page 7 of 8 of the Inspection Report, said repair and placement to be done promptly after the execution of this First Amendment. (iii) Sublandlord shall install smoke detectors in the ducts of the HVAC units, as described on page 8 of 8 of the Inspection Report, said installation to be done promptly after the execution of this First Amendment. (b) Parking Lot: The parties agree that the parking lot shall be resealed and restriped as soon as practicable, weather permitting, with Sublandlord being responsible for the cost of resealing the lot and Subtenant being responsible for the cost of restriping the parking spaces, including restriping as necessary to establish the appropriate number of handicapped parking spaces, as required by applicable laws and regulations. (c) Miscellaneous Items: Sublandlord assumes responsibility for the following items to be done promptly at its expense after the execution of this First Amendment, except as otherwise provided in (vii) below: (i) The installation of railings on both sides of the main door landing in the truck dock area, as described on page 3 of 8 of the Inspection Report. (ii) Repair of the drain discharging water and oil at the compressor room, as described on page 3 of 8 of the Inspection Report. (iii) Repair of the damage caused by the several leaks observed along the far/west wall of the Sublease Premises, which work will include resealing of the windows along said wall, replacement of damaged ceiling tiles, and appropriate repainting of the wall. (iv) On page 5 of 8 of the Inspection Report, under Building Code Issues, the Report addresses the fire separation wall and the door located therein. Sublandlord shall install 45-minute rated doors in said fire separation wall. (v) With respect to the observation of a potential natural gas leak, as described on page 6 of 8 of the Inspection Report, Sublandlord shall be responsible for the identification and correction of this problem. (vi) Sublandlord shall cause a guard to be placed upon the air compressor in the mechanical room, as described in page 7 of 8 of the Inspection Report. -2- (vii) The current bathroom facilities in the Sublease Premises are identified as rooms numbered 127, 128, 155 and 156 in the report prepared for Sublandlord by Dabney Gomes, AIA, dated 13 February 2000, a copy of which is attached hereto and by reference made a part hereof as Exhibit B. It has been determined that, due to the amount otherwise being expended to improve the parking areas and the amount to be expended to revise and renovate the bathrooms numbered 127 and 128, the applicable laws, ordinances and regulations do not require Sublandlord to revise or expand the bathrooms numbered 155 and 156. Sublandlord shall revise and expand bathrooms numbered 127 and 128 as described in Exhibit B, or at Subtenant's option, allow Subtenant to undertake such work at a later date. If Subtenant elects to defer having said bathroom renovations performed by Sublandlord and Subtenant thereafter undertakes, at its expense, to have the bathrooms within the Sublease Premises renovated in a manner in full compliance with the applicable laws, ordinances and regulations, then Sublandlord shall contribute to Subtenant's cost for such work, subject to a maximum contribution of $23,451 from Sublandlord. 4. Except for the responsibilities assumed by Sublandlord as hereinabove described, and except as otherwise expressly provided in the Sublease, Sublandlord shall have no other responsibilities with respect to matters described in the Inspection Report. The allocation to Sublandlord of responsibility for the matters hereinabove described and the execution of this First Amendment extinguishes Subtenant's right to terminate the Sublease pursuant to Section 6 thereof. 5. The amendments described in this First Amendment supersede any provisions in the Sublease which are inconsistent with said amendments. As hereby modified and amended, all of the terms and provisions of the Sublease shall remain in full force and effect. All references in the Sublease shall include the original Sublease and this First Amendment. 6. Prime Landlord consents to this First Amendment as requested, it being understood that Prime Landlord is not a party to the Sublease and is executing this First Amendment for the sole purpose of acknowledging its consent thereto, to the extent that Prime Landlord's consent is required pursuant to the Prime Lease. 7. This First Amendment may be executed in two or more counterparts, all of which taken together shall constitute one original instrument. -3- IN WITNESS WHEREOF, the parties hereto have executed this First Amendment the day and year first above written. SUBLANDLORD: WANDEL & GOLTERMANN TECHNOLOGIES, INC., a North Carolina corporation By /s/ Bert Kuthe --------------------------------- Title: Vice President -------------------------- SUBTENANT: EMBREX, INC., a North Carolina corporation By /s/ Randall L. Marcuson --------------------------------- Title: President & CEO -------------------------- PRIME LANDLORD: W & G ASSOCIATES, a North Carolina partnership By /s/ Frank Goltermann (SEAL) ---------------------------------- Frank Goltermann, General Partner -4- EX-21 5 SUBSIDIARIES EMBREX, INC. SUBSIDIARIES Name Jurisdiction of Incorporation - ---- ----------------------------- Embrex Europe Limited United Kingdom Embrex Sales, Inc. North Carolina Embrex BioTech Trade (Shanghai) Co., Ltd. People's Republic of China Inovoject(R) do Brasil Ltda. Brazil EX-23 6 CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the inclusion in the Annual Report (Form 10-K) of Embrex, Inc. of our report dated February 15, 2000 with respect to the consolidated financial statements and schedule of Embrex, Inc. and subsidiaries and of our report dated March 20, 2000 with respect to the financial statements of Embrex, Inc. Employee Stock Purchase Plan. We also consent to the incorporation by reference in the Registration Statements on Form S-3 (Nos. 333-18231 and 333-31811) and the Registration Statements on Form S-8 (Nos. 33-51582, 33-63318, 333-04109, and 333-56279) of our report dated February 15, 2000 with respect to the consolidated financial statements and schedule of Embrex, Inc. and subsidiaries included in the Annual Report (Form 10-K) for the year ended December 31, 1999. We also consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-63318) of our report dated March 20, 2000 with respect to the financial statements of Embrex, Inc. Employee Stock Purchase Plan included in the Annual Report (Form 10-K) for the year ended December 31, 1999. /s/ Ernst & Young LLP --------------------- Raleigh, North Carolina March 22, 2000 EX-27 7 FDS
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 5,074 0 4,751 0 2,389 822 35,907 (22,710) 26,233 5,178 0 0 0 84 20,951 26,233 33,750 33,750 (13,119) (13,119) (14,038) 0 (311) 6,585 841 5,744 0 0 0 5,744 0.70 0.68
EX-99 8 RISK FACTORS EXHIBIT 99 RISK FACTORS IN ADDITION TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS REPORT, YOU SHOULD CONSIDER THE FOLLOWING FACTORS CAREFULLY IN EVALUATING US AND OUR BUSINESS BEFORE MAKING AN INVESTMENT DECISION. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US, THAT WE CURRENTLY DEEM IMMATERIAL OR THAT ARE SIMILAR TO THOSE FACED BY OTHER COMPANIES IN OUR INDUSTRY OR BUSINESS IN GENERAL, SUCH AS COMPETITIVE CONDITIONS, MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. IF ANY OF THE FOLLOWING RISKS OCCUR, OUR BUSINESS, FINANCIAL CONDITION, OR RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. IN THAT EVENT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, IN WHICH CASE THE VALUE OF YOUR INVESTMENT MAY DECLINE AS WELL. YOU SHOULD ALSO REFER TO "FORWARD-LOOKING STATEMENTS" IN THIS REPORT AND OUR OTHER REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. OUR FUTURE GROWTH DEPENDS ON EXPANSION OF INTERNATIONAL REVENUES We estimate that our Inovoject(R) system inoculates more than 80% of all eggs produced for the North American broiler poultry market. Given this market penetration, we expect diminished growth in the number of system installations and only modest system revenue growth in this market. For this reason, we must expand our Inovoject(R) system installations and product sales in markets outside the United States and Canada in order to realize significant overall revenue growth. In 1999, sales outside of the United States accounted for 23% of our consolidated revenues, up from 20% in 1998 and 15% in 1997. Lack of market acceptance of our Inovoject(R) system and in ovo ("in the egg") products in these markets would adversely affect our revenue growth. Revenue growth outside the United States and Canada depends on a number of factors, including the following: o gaining market acceptance of the Inovoject(R) system and in ovo administration of biological products in markets outside the United States and Canada to treat prevailing poultry diseases in those markets; o obtaining regulatory approval of the Inovoject(R)system and products in those markets and the timing of such approval; and o the extent of start-up costs required to enter new markets. International sales are also subject to a variety of risks, including risks arising from the following: o currency fluctuations, trading restrictions, tariffs, trade barriers and taxes; and o economic and political conditions beyond our control, including country-specific conditions. OUR FUTURE GROWTH ALSO DEPENDS ON THE DEVELOPMENT AND MARKET ACCEPTANCE OF NEW PRODUCTS In addition to international expansion, we need to develop and market new products in order to continue to generate increased revenues and growth of our business. We currently are developing, both independently and in collaboration with others, various products which address poultry health and performance needs. Some of these products are being designed to be delivered in ovo through the Inovoject(R) system, and some may also be administered via injection after hatching. These products are in various stages of development. There is no guarantee that any new products will be successfully developed and marketed. In addition, we have not initiated the regulatory approval process for any of these potential products, and we cannot assure you that regulatory approval will be obtained. Our inability to develop new products or any delay in our development of them may adversely affect our revenue growth. Because of a number of factors, a new product may not reach the market without lengthy delays, if at all. Some of the factors which may affect our development and marketing of new products include the following: o our research and evaluations of compounds and new technologies may not yield product opportunities; o potential products may involve extensive clinical trials and the results of such trials are uncertain; o potential products may require collaborative partners and we may be unable to identify partners or enter into arrangements on terms acceptable to us; o regulatory approval of these products may not be obtained or may be obtained only with lengthy delays; and o marketing products developed jointly with other parties may require royalty payments or other payments by us to our co-developers, which may adversely affect our profitability. We have developed and commercialized a technology using our proprietary viral neutralizing factor ("VNF(R)") which permits a single-dose immunization of an egg embryo effective for the life of the bird. Our Bursaplex(R) product uses this technology. The United States Department of Agriculture ("USDA") has approved the Bursaplex(R) vaccine for in ovo and post-hatch use. Regulatory approval for Bursaplex(R) has also been granted in nine countries besides the United States and regulatory approval is temporary or pending in thirteen countries. However, Bursaplex(R) has only recently been sold in commercial quantities, and there is no assurance that the product will continue to be sold in commercial quantities even if it is shown to be effective. ECONOMIC FACTORS AFFECTING OUR CUSTOMERS MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS Our revenues come from purchases by the poultry producing industry. If there is a general economic decline in that industry, our operations and financial condition could be materially and adversely affected. Also, domestic and global economic factors beyond our control may adversely impact our customers and, as a result, our revenues and earnings. Examples of these factors include the following: o fluctuations in the price of poultry feed; o export demand for U.S. poultry products; and o the extent to which our cost of products and operating expenses increase faster than contractual price adjustments with our customers. For example, if rising poultry feed prices increase the production costs of commercial poultry producers, these producers may reduce production. This decreased production could adversely impact our revenues, since a principal component of our revenues is fees charged to customers for the number of eggs injected by the Inovoject(R) system. THE LOSS OF KEY CUSTOMERS COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS Historically, a significant portion of our revenues has come from a relatively small number of customers. Tyson Foods, Inc. ("Tyson") accounted for approximately 24% of our consolidated 1999 revenues. Our top three customers, including Tyson, accounted for approximately 38% of our consolidated 1999 revenues, which is down from 42% in 1998. We expect a similar level of customer concentration to continue in future years. The poultry market is highly concentrated, with the largest poultry producers dominating the market. For example, in 1999, Tyson supplied approximately 24% of all broilers grown in the United States. 2 The concentration of our revenues with these large customers makes us particularly dependent on factors affecting those customers. If we lose a large customer and fail to add new customers to replace lost revenues, our operating results will be materially and adversely affected. Also, if these customers reduce the number of eggs they produce at hatcheries, we will receive lower Inovoject(R) system revenues since our fees our based on the number of eggs injected. IF WE LOSE THE PROTECTION OF OUR PATENTS AND PROPRIETARY RIGHTS, OUR FINANCIAL RESULTS COULD SUFFER Some of our products and processes used to produce our products involve proprietary rights, including patents. Some of the technologies employed in these processes are owned by us, and some are owned by others and licensed to us. The Inovoject(R) system utilizes a process that was patented by the USDA. We hold an exclusive license to this primary patent which expires in 2002. We have supplemented the USDA patent with additional U.S. and foreign patents covering specific design features of the Inovoject(R) system. We believe that patent protection of materials or processes we develop and any products that may result from the research and development efforts of us and our licensors are important to the possible commercialization of our products. The loss of the protection of these patents and proprietary rights could adversely affect our business and our competitive position in the market. The patent position of companies such as ours generally is highly uncertain and involves complex legal and factual questions. Some of the reasons for this uncertainty include the following: o To date no consistent regulatory policy has emerged regarding the breadth of claims allowed in biotechnology patents. So, there can be no assurance that patent applications relating to our products or technology will result in patents being issued or that, if issued, the patents will afford protection against competitors with similar technology; o Some patent licenses held by us may be terminated upon the occurrence of specified events or become non-exclusive after a specified period; o Companies that obtain patents claiming products or processes that are necessary for or useful to the development of our products could bring legal actions against us claiming infringement, though we currently are not the subject of any patent infringement claim; o We may not have the financial resources necessary to enforce any patent rights we may hold; o We may be required to obtain licenses from others to develop, manufacture or market our products. We may not be able to obtain these licenses on commercially reasonable terms, and the patents underlying the licenses may not be valid and enforceable; and o We rely upon unpatented, proprietary technology, which we may not be able to protect fully if others independently develop substantially equivalent proprietary information or techniques, properly gain access to our proprietary technology, or disclose this technology to others. We attempt to protect our proprietary materials and processes by relying on trade secret laws and non-disclosure and confidentiality agreements with our employees and other persons with access to our proprietary materials or processes or who have licensing or research arrangements with us. We plan to continue to use these protections in the future. Despite these protections, others may independently develop or obtain access to these materials or processes that may adversely affect our competitive position. 3 We have been involved in the patent litigation summarized below: Embrex v. Service Engineering Corporation and Edward G. Bounds, Jr. In September 1996, we filed a patent infringement suit against Service Engineering Corporation and Edward G. Bounds, Jr. in the U.S. District Court for the Eastern District of North Carolina. We made the following claims against the defendants: o Their development of an in ovo injection device, designed to compete with our patented Inovoject(R)injection method, infringes at least one claim of the U.S. Patent No. 4,458,630 exclusively licensed to us for the in ovo injection of vaccines into an avian embryo (the "Sharma Patent"); and o They violated the terms of a Consent Judgment and Settlement Agreement entered into with us in November 1995 in which prior litigation was concluded with Service Engineering Corporation and Edward G. Bounds, Jr. agreeing not to engage in future activities violating the Sharma Patent. o We sought injunctive relief to prevent infringement of the Sharma Patent as well as monetary damages. In November 1996, Service Engineering Corporation and Edward G. Bounds, Jr. responded to our suit by asserting various affirmative defenses and denying the substantive claims in our complaint. This suit concluded on July 30, 1998 with a jury verdict in favor of us, which verdict: o fully upheld the validity of all claims of the Sharma Patent, finding that the defendants had willingly infringed all asserted claims of the patent; o found that the defendants had breached the 1995 Consent Judgment and Settlement Agreement and that the breach was not in good faith; and o awarded us damages of $500,000 plus litigation expenses and court costs. The Court entered a Judgment in favor of us on September 28, 1998, which included a monetary award of $2,612,885 and an injunction prohibiting the defendants from practicing methods claimed in, or otherwise infringing, the Sharma Patent. On October 28, 1998, Service Engineering Corporation and Edward G. Bounds, Jr. filed a notice of appeal in the U.S. Court of Appeals for the Federal Circuit seeking a reversal of the Judgment. We have opposed the appeal, but there is no assurance that we will collect any or all of the monetary award. Embrex v. IGI, Inc. In November 1996, we filed a patent infringement suit against IGI, Inc. in the U.S. District Court for the Eastern District of North Carolina, where we: o Alleged that IGI, Inc., through its activities with Service Engineering Corporation and Edward G. Bounds, Jr., was engaging in activities that constituted infringement of the Sharma Patent; and o Sought injunctive relief to prevent infringement of the Sharma Patent and sought monetary damages. In January 1997, IGI, Inc. responded to our patent infringement suit by asserting various affirmative defenses and denying the substantive allegations in our complaint. This suit concluded in January 1998 by agreement between us and IGI, Inc. Pursuant to this agreement, we and IGI, Inc. dismissed all pending 4 claims against each other, and IGI, Inc. agreed to abide by the terms of a royalty-bearing sublicense to the Sharma Patent for avian vaccination. Service Engineering Corporation and Edward G. Bounds, Jr. v. United States Department of Agriculture In March 1997, Service Engineering Corporation and Edward G. Bounds, Jr. filed suit against the U.S. Department of Agriculture in the U.S. District Court for the District of Maryland with respect to its grant to us of an exclusive license for the Sharma Patent. The complaint made the following claims: o The USDA did not adequately comply with statutory and regulatory requirements in making the grant to us of an exclusive license to the Sharma Patent, the revision of the exclusive license in 1991 and again in 1994, which extended the period of exclusivity, originally set to terminate on December 31, 1996, through the patent expiration date; o The USDA wrongly refused to grant Plaintiffs a license of the Sharma Patent. The Plaintiffs claim this refusal occurred in December 1996 (after we filed the suit described above), and that the USDA refused to do so because the USDA said that the license was not available and that the Plaintiffs had no basis for relief; and o The USDA wrongfully consented to our bringing suit against the Plaintiffs. Plaintiffs asked the Court for the following relief: o To set aside the extension of the exclusive license, the USDA's grant of permission for us to sue Service Engineering Corporation, Edward G. Bounds, Jr. and IGI, Inc. for patent infringement, the USDA's refusal to grant to Service Engineering Corporation a non-exclusive license to the Sharma Patent and the USDA's refusal to act favorably upon Service Engineering Corporation's appeal from the refusal to grant it a non-exclusive license; o To issue an order requiring the USDA, prior to granting any exclusive license under the Sharma Patent, including by extending the term of a pre-existing exclusive license, to observe the procedures set forth under laws and regulations governing the grant of licenses to patents owned by the USDA, and to remand the matter to the USDA to take action in accordance with the order; and o To recover attorneys' fees and costs from the USDA. The USDA filed a motion for summary judgment. In March 1999, the U.S. District Court for the District of Maryland granted the USDA's motion for summary judgment, agreeing that "the plaintiff lacked standing to challenge the USDA's actions in this matter and that the [USDA's] motion for summary judgment will be granted." Machining Technologies, Inc. v. Embrex On April 15, 1999, Machining Technologies, Inc. of Hebron, Maryland served on us a Complaint for Declaratory Judgment against us in the U.S. District Court for the District of Maryland. Machining Technologies, Inc. seeks a declaration that the Sharma Patent is not infringed, invalid and/or not enforceable. Machining Technologies, Inc. was a manufacturer of egg injection machine parts to Edward G. Bounds, Jr. and Service Engineering Corporation. We believed that this action was without legal basis. On June 4, 1999, we filed a motion to dismiss this action. On March 7, 2000, the U.S. District Court for the District of Maryland granted our motion to dismiss this action and ordered this case closed. 5 THE LOSS OF KEY COLLABORATORS, SUPPLIERS AND OTHER KEY PARTIES COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS We currently conduct our operations with various third-party collaborators, licensors or licensees. We plan to continue developing these relationships and believe our present and future collaborators, licensors and licensees will perform their obligations under their agreements with us, based on an economic motivation to succeed. However, financial or other difficulties facing these parties may affect the amount and timing of funds and other resources devoted by the parties under these agreements. Thus, there is no assurance that we will generate any revenues from these agreements. We currently do not have large scale facilities for the production of our Inovoject(R) system and biological products and do not plan to develop these facilities in the foreseeable future. Therefore, we will rely principally upon relationships with contract manufacturers. There can be no assurance that we can maintain manufacture and supply agreements on terms and at costs acceptable to us. We have various relationships with manufacturers and suppliers, including those described below. The loss of any of these relationships could adversely affect our operating results, as described below: Inovoject(R) System o A manufacturer of Inovoject(R) systems, which is the sole contract manufacturer of Inovoject(R) systems, with which we have a relationship. While other machine fabricators exist and have constructed limited numbers of Inovoject(R) systems, a change in manufacturers could cause a delay in manufacturing and a possible delay in the timing of future Inovoject(R) installations and revenues from those installations. VNF(R)Product -- Bursaplex(R) o Merial Select, Inc., which has exclusive rights to manufacture infectious bursal disease vaccines containing our proprietary VNF(R)product marketed by us in North America, Latin America and Asia under the trade name Bursaplex(R); and o SPAFAS, Inc., the sole contract supplier of our VNF(R)product, which is the only supplier that was included in the USDA's approval for in ovo use of Bursaplex(R). Infectious bursal disease vaccines, including the Bursaplex(R) product and the Bursamune(R) product described below, and our VNF(R) product generally must be manufactured in licensed facilities or under approved regulatory methods. Although we believe that other manufacturers are capable of manufacturing infectious bursal disease vaccines and producing products such as VNF(R), a change of suppliers could adversely affect our future operating results due to the time it would take a new supplier to obtain regulatory approval of our production process and/or manufacturing facilities. VNF(R)Product -- Bursamune(R) o Fort Dodge Animal Health ("Ft. Dodge"), a division of American Home Products Corp., has rights to manufacture and market infectious bursal disease vaccines containing our VNF(R)product to be marketed in Europe, the Middle East and Africa under the trade name Bursamune(R). To date, Bursamune(R) has received regulatory approval in South Africa and Spain and, in October 1999, received temporary authorization from French regulatory authorities for in ovo administration of Bursamune(R). In June 1997, Ft. Dodge announced that our application for U.K. in ovo regulatory approval of Bursamune(R) had been provisionally refused, and that the U.K. regulatory authority requested that further data be supplied. We have worked with Ft. Dodge, 6 which is responsible for obtaining the necessary approvals for Bursamune(R) in both the U.K. and other European Community markets, to respond to the U.K. regulatory authority request for data with respect to Bursamune(R). While we anticipate that the regulatory review process will be completed during the first half of 2000, there can be no assurances that this review will occur by this time. WE MAY NEED ADDITIONAL FINANCING AND, IF THE FINANCING IS UNAVAILABLE, OUR OPERATING RESULTS COULD SUFFER From our inception in May 1985 through December 31, 1999, we had cumulative operating losses (accumulated deficit) of $30.3 million. Until the first quarter of 1996, we had incurred operating losses since our inception. Although we have been profitable since 1996, we cannot assure you that we will continue to operate profitably. Our ability to generate revenues sufficient to meet our cash requirements for operations depends upon several factors, including the following: o continued market acceptance of the Inovoject(R)system; o our leasing of Inovoject(R)systems on lease terms acceptable to us; and o the successful development and commercialization of additional products by us and other suppliers of in ovo products that will be delivered through the Inovoject(R) system. The extent of our future revenues derived from Inovoject(R) system fees is subject to many variables, including the following: o whether additional lease agreements for Inovoject(R)systems are reached with customers; o the timing of any lease agreements; o whether existing or new installation schedules are met; o the extent to which customers use the Inovoject(R)system; and o the market acceptance and regulatory approval of in ovo products. Although we anticipate that our existing funds, as well as revenues from operations, will sustain our existing operations for the foreseeable future, there are no assurances that these funds will be sufficient. If additional funds become necessary to sustain existing operations or anticipated growth, we will need to seek additional financing. There can be no assurance that any financing will be obtainable or that, if available, the financing will be on terms favorable or acceptable to us. GOVERNMENT REGULATION AND THE NEED FOR REGULATORY APPROVAL MAY ADVERSELY AFFECT OUR BUSINESS Regulatory approval required in various areas of our business may adversely affect our operations. While the use of the Inovoject(R) system is not subject to regulatory approval in the United States, it may require regulatory approval by foreign agencies. Also, research and development activities and the investigation, manufacture and sale of poultry health and performance enhancement products are subject to regulatory approval in the United States by either the USDA or the United States Food & Drug Administration ("FDA") and state agencies, as well as by foreign agencies. Obtaining regulatory approval is a lengthy and costly process. Approval by the USDA generally takes 1 to 3 years, while approval by the FDA generally takes 5 or more years. Various problems may arise during the regulatory approval process and may have an adverse impact on our operations. Delays in obtaining 7 approval may adversely affect the marketing of, and the ability to receive revenues and royalties from, products developed by us. There is no assurance that any future products developed by us will receive regulatory approval without lengthy delays, if at all. Pursuant to some of our licensing or joint development agreements, the licensees or joint developers bear the costs associated with the regulatory approval process for some products. We plan to continue to enter into these types of agreements in the future. If we cannot generate sufficient funds from operations or enter into licensing or joint development agreements to develop products, we may not have the financial resources to complete the regulatory approval process with respect to all or any of the products currently under development. Products developed by us may not be marketed commercially in any jurisdiction in which required approvals have not been obtained. Other regulations apply or may apply to research and manufacturing activities, including federal, state and local laws, regulations and recommendations relating to the following: o safe working conditions; o laboratory and manufacturing practices; and o use and disposal of hazardous substances used in conjunction with research activities. It is difficult to predict the extent to which these or other government regulations may adversely impact the production and marketing of our products. OUR INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS We must continue to attract and retain experienced and highly educated scientific and management personnel and advisors to be able to develop marketable products and maintain a competitive research and technological position. Competition for qualified employees among biotechnology companies is intense, and the loss of key scientific or management personnel would adversely affect us. There can be no assurance that we will be able to continue to attract and retain qualified staff. Our inability to recruit and retain key personnel could have an adverse affect on our business, results of operations or financial condition. We have obtained insurance in the amount of $1,000,000 on the life of Randall L. Marcuson, our President and Chief Executive Officer, of which we are the sole beneficiary. IF WE CANNOT CONTINUE TO PROVIDE TIMELY SUPPORT AND MAINTENANCE TO OUR CUSTOMERS, OUR BUSINESS MAY SUFFER We are required to supply, support, and maintain large numbers of Inovoject(R) systems at our customers' hatcheries on a timely basis at a reasonable cost to us. There can be no assurance that we will be able to continue to provide these services on a cost-effective basis. If we are unable to do so, our customers may reduce their use of our products, which could adversely affect operating results. WE FACE RISKS OF RAPIDLY CHANGING TECHNOLOGY AND COMPETITION We are involved in areas of technology which are subject to rapid and significant technological change. Competitors include independent companies that specialize in biotechnology as well as major chemical and pharmaceutical companies, universities, and public and private research organizations. Many of our competitors are well established and have substantially greater marketing, financial, technological and other resources than us. A competitive delivery method, either within or outside the United States, may be developed and gain commercial acceptance. Also, competitors may succeed in developing technologies and products that are more effective than any which have been or are being developed by us or which would render our technology and products obsolete or non-competitive. 8 THE ISSUANCE OF PREFERRED STOCK AND OUR SHAREHOLDER RIGHTS PLAN MAY DISCOURAGE A TAKEOVER The Board of Directors has the authority to issue up to 15,000,000 shares of Preferred Stock in one or more series and to determine the designations, preferences and relative rights and qualifications, limitations or restrictions of the shares constituting any series of Preferred Stock, without any further vote or action by the shareholders. The issuance of Preferred Stock by the Board of Directors could affect the rights of the holders of Common Stock. For example, an issuance could result in a class of securities outstanding that would have preferences with respect to voting rights and dividends and in liquidation over the Common Stock, and could (upon conversion or otherwise) enjoy all of the rights applicable to Common Stock. The authority of the Board of Directors to issue Preferred Stock potentially could be used to discourage attempts by others to obtain control of us through merger, tender offer, proxy contest or otherwise by making these attempts more difficult to achieve or more costly. The Board of Directors may issue the Preferred Stock without shareholder approval and with voting and conversion rights which could adversely affect the voting power of the holders of Common Stock. No agreements or understandings currently exist for the issuance of Preferred Stock, and the Board of Directors has no present intention to issue any Preferred Stock. We adopted a shareholder rights plan which could have the effect of discouraging a takeover of us. The rights plan, if triggered, would make it more difficult to acquire us by, among other things, allowing existing shareholders to acquire additional shares at a substantial discount, thus substantially inhibiting an acquiror's ability to obtain control of us. 9 -----END PRIVACY-ENHANCED MESSAGE-----