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 . . ._ _ . ._ ,..~. , . . " . . . P:. .r~~ a • > .. . ,. . . . . ....w. ,..... ~...~ .w.... ~+`. The fiscal year just ended has been one of new directions for Cetus. Some -;'fundamental decisions have been made, and will continue to be made during the ~1977-78 fiscal year, all intended to hasten and_ensure the fulfillment of our potential and our promise. . .. . ~ . . ~ . . - ~.a:.. ' :Comparing this year's results with those of the previous year, it is seen'that a- revenues were up slightly, and expenditures were up substantially.— ` This increased spending,"representing a concerted investment in the future of Cetus, "='reflected in significant strengthening of our staff and facilities, resulted ='•in a loss for the year, compared to last year's small profit. Last year we reported that we had demonstrated the ability to live within our means. At the same time we stated that having done so, we would not hesitate to undertake significant commitments to ensure that we would be in a position to exploit the exciting and unique opportunities available to us, and for which we had successfully positioned ourselves. Our "very comfortable liquid- ity" at that time was a "nest egg" of some $3,000,000. We reported that "we intend to undertake longer term projects outside the drug industry and, if appropriate, without client support. Most important, Cetus is determined to become a leading force in the exciting field of genetic engineering ...•and this could have negative impact on profitability." We also stated that "we are actively exploring alternative means of funding such programs, which could involve spending from $10,000,000 to $20,000,000 over the next five to ten - years." : : _. ,..:. . a..• i In this connection we are pleased to announce the signing of a definitive•.: agreement with Standard Oil Company (Indiana) which will result in significant funding for Cetus. In addition, Standard intends in the near future to make a tender offer for a portion of the shares issued in our earlier financings. Details of this offer will be contained in Standard's letter to Cetus share- holders. The company views this new involvement with much pleasure and urges shareholders to view it in that light. Whether or not any individual share- holder decides to tender shares is, of course, a matter of personal judgment. As indicated in interim reports we have made bold moves in several areas, and we will report here on each of them in turn. C The result of our various decisions has been to strengthen the company's stra- tegic position considerably, while, within the one fiscal year just completed, spending about one third of our "nest egg" to do so. This reflects our own confidence in the new directions we've taken, as well as a reasonable expecta- tion that financing plans in the works will assure that our nest egg will require no further depletion. Even if those financing plans failed to materi- alize, our current budgets and plans call for our cash balance on January 1, 1978, to be essentially unchanged from that shown in the enclosed financial statements for June 30, 1977, thus preserving our ability to look to other sources of new funds. ' Cetus Corporation, 600 Bancroft Way, Berkeley, California 94710 Phone: (415) 549 3300 • . . . ... , ~

Letter to the Shareholders July 29, 1977 Page 2 . .. . J % ~'~. Now to discuss each of our activities/in turn. ~ Antibiotics -~ . . As previously reported, our contracts for productivity improvements for`Yclients a. :,look for real rewards when royalties are received--from the actual use of Cetus .'microorganisms in production. There are two such candidates presently being : tested by clients. One involves a well-established antibiotic where Cetus •.strains have demonstrated improvements in lab (and pilot plant) scale, which if . translated successfully by our client to production scale, would result in imme- `diate royalties in excess of •$1,000,000 yearly. We wait and hope to report ;success. -The other project involves a relatively new antibiotic family where the client is now using a Cetus microorganism, but where the real pay-off will come when the client's hopes are realized and the antibiotic family achieves' major market penetration in the 1980's. Great impact on Cetus profitability in ' this case will be slower in coming, but very significant if and when it does."~ti w . _ _ . .;_ .,.,. ; ~ . . . . . ~. _ _ _ We continue to explore possibilities for new antibiotic relationships with several other drug companies. .s,. Other Pharmaceuticals We are pleased to announce the commencement of a new program to improve the productivity of a non-antibiotic drug for a major company. Revenues for the --work should be $1,000,000 and there are significant additional rewards for success. Regretfully, our contractual obligation to secrecy precludes any further disclosure. We are in late stages of negotiating an agreement with Again significant rewards are long term; the immediate our diversification out of the drug industry. .. ... : .. :. ,. . , .. . ~ Chemicals r t, • . . .•~,'. • . .. ,- _ . We are in active negotiation with several chemical companies excited about the potential for biological alternatives to long established chemical processes. We are happy to announce the recent signing of an agreement to study the feasi- bility of utilizing a biological process with major energy as well as chemical ramifications funded by a company well-poised to exploit our expertise if the results of the feasibility study should warrant a full-scale program. Y Cetus Proprietary Processes One of our early imperatives has been to confine our activities to working for clients. The corollary has been that their needs, priorities, and judgment frequently dictate our behavior. We have repeatedly expressed the wish to use

Letter to the Shareholders July 29, 1977 Page 3 part of our resources to fund Cetus-owned projects, and have been doing so for suing the patent and marketing consequences. several months. We have already achieved some technical success, and are pur- comb' a t DNA i..:~, L {..~k~s° ~i. yri R lead article in the current issue of Scientific American. ° copy of a recent cover story in Time magazine,'in case you missed it, and the regarding Cetus' position, my testimony before a Congressional Subcommittee, a and government to this particular activity. -We are enclosing, as background have proceeded prudently, mindful of the sensitivity of the public, the press, nor will we lose sight of the fundamentally commercial objectives of Cetus. We potential processes. We will definitely not put all our eggs in one basket, and will shortly begin programs designed to be applicable to a whole series of ' As discussed repeatedly in these reports, we continue to build our capability, . . . . . ~ , . ' ... ~ ...... . . . . . .. - .. _. . , . {~i . •r?y Facilities '~ . . . - . .. . . ;.,y~..~ A considerable effort now completed has been directed during the past year o upgra ing some o our scie n c ac es - tifi f t d' iliti ~1 f Our own enaineers have desianed and installed special custom environmental .. . .. '+!' ...,. ,. .,..... . ... . . . .. .. . .. . - . . . . .. .. . chambers, and this should greatly enhance our effectiveness as we grow. ?'r y . .x., - -01 will not only enhance our capability to small-scale fermenters This facilit -recognized the need for an in-house small-scaLe pilot plant capability. Toward ; that end we have this year installed, staffed and utilized highly instrumented -As our activities have spread beyond the pharmaceutical industry we have ;,,;work with "new industries" but will also provide a pilot piant interrace witn -.our pharmaceutical clients. Personnel appointments. Cetus has grown to a company with about 120 employees, in six buildings, cover- ing over 60,000 sq. ft. To accomplish this has required flexible, imaginative people, and we are especially grateful to three members of the management team who participated in this growth almost from the beginning. In recognition of their contributions, the Board of Directors recently approved the following Goulden, Ph.D., is now Vice President, Biological Development. Terry Mahuron, M.B.A., M.S., is now Vice President, Administration and Controller. Douglas R. Miller, M.B.A., is now Vice President and General Manager. Stephen A. There have been several other significant additions to the Cetus team during the past year. William F. Amon, Jr., is Director of New Business Development. Mr Amon has an extensive background in new product development in the.

ahemicals industrv. His former nositions include Vice President for New Business Ventures of the Borden Chemical Company and Executive;:4-..~?:~": ;,Assistant to the President of CPC International. As we broaden our.,%',Zs, outlook beyond the drug industry, Mr. Amon's experience in the . chemical and food industries is invaluable. He joins Cetus after brilliant accomplishments at the University of -- . David Gelfand is our Director of Recombinant Molecular Research. the expression of foreign DNA sequences. He has also been the first - leagues constructed the first plasmid DNA cloning vehicle permitting California at San Diego and at San Francisco, where he and his col- ,.to amplify (2500$:) by mutation the number of plasmid DNA molecules - in a cell and their products, a crucial element in plans to develop 'Sg DNA technology. Dr. Gelfand is establishing a highly trained and 'high yielding industrial fermentation processes utilizing recombinant 7t- motivated group to carry out Cetus work in this area. design and configuration, are being applied to our developing capa- Dr. Khosrovi's experience in continuous fermentation, and reactor University of Manchester, and Shell Research Limited, in England. Dr. Behzad Khosrovi comes to Cetus from Cambridge University, the .bility at the process level, as discussed above. Financial our cash balance at that time. We anticipated that we might embark on programs ,; break-even operations of a year ago, and a "stand pat" policy with respect to ; while highlighting the principal reasons why we showed a loss of about $700,000 and a reduction of over $1,000,000 in cash. This, in contrast to essentially .In analyzing the performance of the company over the past year, it is worth- a o o s u ,~,,. o wo t t with t ese ramifi cations, u t on y wi e onvic ion c ' th t t d 1d h b 1 h th strengthen, rather than weaken the company. Two factors convinced us that it was wise and safe to do so. Eli Lilly and Imperial Chemical Industries. We were, however, sensi- tive that we lacked the capital to pay the club's membership dues over an extended period of time. And, at first, we were hesitanft to embark upon a venture where it wasn't clear where the resources would come from to see it through. On the other hand, it was clear that the opportunity to remain among the world leaders would pass us by if we didn't exhibit the courage of our convictions and commit some of our own resources to making a beginning. charter membership in an exclusive club together with the likes of 1. It was clear that we were uniquely poised to act regarding recom- binant DNA. Cetus was widely recognized as possessing, as it were, We have indeed put our best foot forward. During the last half of the just completed fiscal year, we have spent over $75,000 in expenses and

Letter to the Shareholders July 29, 1977 Page 5 .. . ~ . ..~° ° \K~.. /..:: .~ . . ~ . .- ... .._~ :`.~ t..~ about $2ooyoov for equipment ana racilities to carry out this dramatic work. The Board of Directors had authorized that no more than S500.000 in total be spent in this area until it was more clear where additional financing would come from, 7 .In that connection, during the past year, we were approached by 4,. ,"`Standard Oil Company (Indiana), whose represeritatives perceived our =dreams, our dilemmas and our future in terms very similar to our own. With reasonable expectation that discussions with Standard would result in a substantial input of new funds for Cetias we have ersisted in , p _ seeing our commitments through to completion . , . , . , .-. ~ . . . . - .. . .1~ .. . . ~ ' ~ ...,1. .~~~z~.JWY++. C Thus, the first category of major additional spending of the past year has -been for recombinant DNA. ; -, __._.. :, The second major expenditure was described above - it involved about $340,000 sion as well as to do a better job on our ongoing projects. ''"to postpone the completion of these improvements - now essentially finished. „ We are now, as a result, much better equipped to handle our anticipated expan- , sions anticipating that major new funding was to be available, and not wishing - spent in major improvements to our physical plant. Again, we made these deci- it, and have put it to good use with new conference and computer facilities. opportunity to take the space, and spent about $35,000 improving and furnishing due to the departure of a previous tenant. We did not wish to forego the During the year additional space became available at our head office location During the past fiscal year, there was not a substantial change in the total revenues received compared to the previous year. However, we had anticipated initiation of two new client-financed projects, with revenue from them total- ling $800,000. As reported in the December 13 letter to shareholders, one of reasons as already cited we decided to stick with these ambitious commitments, negotiations and budgeting. By way of contrast, an agreement not expected at that time was signed during the year, and the new resources are applicable to this new project.) However, in-expectation of these contracts we embarked on some major expansion programs, including the instrumented fermenters and the staffing of them. When the contracts didn't materialize, for much the same final agreement than we had anticipated. (This is a constant problem in our these failed to materialize. The other has taken longer to negotiate to a and are very pleased that we did, as they have already proved quite productive in other work. Capital expenditures for biology equipment last year exceeded $100000. Finally, due to increased selling and public relations efforts, especially in connection with our visible recombinant DNA involvement, and in marketing to new industries, our general and administrative expenses, including travel, increased. There were no salary changes in top management or at the vice- presidential level. ~. N N ~.

Letter to the Shareholders July 29, 1977 Page 6 In sumanary, our costs for the 1976-77 fiscal year were about as we planned, with increases as explained above, and with some expected revenues unrealized ~ ~ (partly postponed) , We are very optimistic about the future, based on'success in existing projects, expected new contracts, expected new funding,,Arid initial success in our first self-funded work. We consider our financial position to be strong and that it will become stronger shortly. We are equally confident of our ability to con- ;., Lfigure the company to match any change in external circumstances, to be sure ~ that we remain in a position to perform according to our commitments, and _ _ deliver on our promises. r:. ,o .., .. :. . . s., _ ~t vt.~,a, }w ,..~. . ... . . ....... . ..... . . . . Capital Structure The exchange offer of Series B for Series A preferred shares, made at the end of December, 1976, was successfully completed. In this connection, we should like to confirm that, in the opinion of our counsel, such exchange did not, Y result in taxable income to the exchanging stockholders. " " +,~ S~ 1.:~'. ~i.. «L~ .:./' .... . .. .. . .. .. .. ... .. . t ..Y .~~'. . . ~./1 _ As part of the transaction with Standard Oil Company, it will be necessary to increase the authorized common shares of the company. Proxy material for this purpose is enclosed, and the immediate return of the written consent form is requested. `~__.'The regular annual meeting of shareholders of Cetus Corporation will be held on Tuesday, September 27, at 1:30 PM. Further details and proxy forms will be mailed early in September. ' n REC/asg Enclosures