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.~:f~~~. .. _ ...i. ....,.. _~ Letter to the Shareholders ._~..F.'i.... t...j-.~''1X.} ORIGINAL BUSINESS . • . . _ ._., .,., . _ _ i C ;;Cetud has just completed its fourth full year of operations, and we are enrlot;ing the audited financial statements for the fiscal year ending June 30, 1976 certain IIoard of Directors resolutions which require shareholder approval.-w+ holders, to be held on Thursday, September 2, 1976, and'proxy forms concerning Please also note the enclosed notice of the Anri'ual Meeting of Cetus Share- > We would like to take this opportunity to comment upon the present status ~ ~';iJl ,+f~~ on the frontiers of molecular biology, we are about to initiate programs We have furthermore demonstrated the ability to do this while living within our means, and having done so, we are now undertaking to expand into new applications for Cetus technology. And, in keeping with our commitmel,t to exhibit leadership in the industrial application of the latest d'evelopments improved'upon them,.enlisted clients in the'pharmaceutical industry for , work in strain improvement, and has supplied to clients new microorganisms expected to provide higher yields of antibiotics in their production facilities. During the past few years Cetus has developed large scale screening systems, ,f of the company and'.the plans and hopes of management concerning the future. in genotic engineering. I will comment on each of these points in turn. As you know, Cetus was founded to bring sophistication to certain aspects of industrial microbiology. There were many possible applications of our capa-:; bility. We chose to focus first on improving, for drug companies, the yields FOR ,; of antibiotics produced in their fermentation plants. We felt that as a new " ^ .. this criterion. We have a number of projects in this area and are currently N, discussing several others. It is our original business, we expect it to (O provide a substantial stream of royalties in coming years, and we continue tc~ .41 exploit opportunities in this field of antibiotic strain improvement while at ~ the same time moving into new areas. In last year's report we stated that significant rewards could well begin this year based primarily on our expecta- tions for a particular project. Although royalites were received, these rewards start-up company, Cetus should tirst address projects in whicn revenue coutu vo generated quickly, and urgent drug company antibiotic yield problems best mot were not as large as anticipated'due to factors other than those reflecting Cetus' contribution. When we forward an improved strain to a client we are hopeful that its full scale utilization by that client wi1L provide the expected x Cctus Corporation, 600 Bancroft Way, Berkrley, California 9471 U Phone: (415)549•33U0

l.otteY to tii,: Sliirr-lic>lt3'ers Au(jue;t 21, 1976 !>a; je 2 Y :, . . .. .. .< . ., - .. ~ , • . . . . . . . . ~ ~ .. . ~ . ~ i. yk. ; ruyulty yield; however, the client is not contractually obligated to fully strt'.4im. utilize that strain and external factors can significantly alter the royalty Anuthor component of our past history concerns cash flow. Although we look to rewards from success ("royalties") for our real profitability and growth, massive screening, that we can operate in a break-even mode and accomplish our of tiie danger that small companies face when overent}1usiasm can lead to over- extension. We:irow have confidence, less than three years after actually beginning wlien it was unclear when additional investment funds would ever be available) sui,porting."' We were especially mindful (particularly'during the recent recession ``- to exercise prudence to determine whether, in facif; we were really "self- :;rz:,-, ~, we f`lt it necessary, as an unproven company in aheretofore non-existent field, of about $175,000y these figures reflect tax-loss carry-forwards and interest. Note that, while for two years in a row our income statement has shown a "profit" result in a substantial stream of additional rewards some time in the future.` tecnnicat Objectives. Ot course, the work done to date is still expected to At the same time, I want to point out, as was done in last year's report, :This tends to exaggerate our expenses and understate t.he value of our assets. "~ expensing everything we can, including research and development expenditures. that our financial statements reflect conservative accounting principles, ..;.. It is now appropriate to take advantage of opportunities in exci.ting,new areas. . ~i~. NRW IITRA'rTTl)Nq Thus, wt, believe that we _have "got our feet wet" in a business which wil l be highly profitable and we have demonstrated financial stabiLit.y in doing so. products. If we are successful and if the clients adopt Cetus processes, there Kl~ ~ cesses, for products presently made chemically, or in some cases, totally n.•w industries. These companies are interested in developiny entirely now pro- The mass screening,capability around which Cetus was founded has many lucra- tive applications unrelated to our present activity. We have been exploring some of these for over a year, and we can now report high levels of interest looking toward contract relationships with companies in the chemical and food the ultimate rewards offsets their less immediate realization. N rewards might be more than five years away. We feel however that the scupe of have waited until now to push hard on such projects - implementation and Cetus .~ :I would then have to follow major capital.commitments and perhaps marketiny ufforts r~l ~ by these clients to exploit our mutual developments. It should be cl, ear why we Proprietary Cetus Products funded by Cetus, whereby the resulting processes and products would be'proprir_t3ry tliatL it is in the best interest of the company to carefully select projects, no client support at all, either front-end or in yuarantecd royalties. We believe Another strategy under active consideration is the undoi-taking of projects with

Let ter Lo the Shareholders August 21, 1976 Page 3 to Cetus. It is our judgment that doing so will enhance the level of rewards we can expect after success. Remember that Cetus, in negotiating with potential 0 i't clients, has always insisted on "a piece of the action" - participation in th e • benerits or the success of our work ("rewards" or "royalties"). Working for must adhere to clients' internally dictated priorities. ."He who pays the piper ourselves instead of for clients will also permit us more latitude of project selection. In the present mode we are offered the.most dilfficult projects and " . .. .. ;l ,.- ca s t e tune: A go-it-alone approach will also permit us to formally publicize our work and our successes. We are presently precluded from doing so because our clients characteristically insist that we not even identify them by name. n'lfj ( . Since the founding of Cetus, a new revolution has-taken place in biology. - •_.. .- . .. , until now, created thz mutations with our eyes closed. " . . _ .. ! , ~,. Cetus' activity up to now. Although we screen~with our eyes open, we have random, and only rarely industrially "improved." Screening for those rare - mutations in new, innovative ways, in large numbers, has been the essence of began, these"changes have occurred as random mutations, and the selection by nature of those most fit to survive and reproduce is the mechanism responsible for evolution. As you know, mutations can also be induced in the laboratory, much more frequently than in nature. But evemin those cases, the mutations are This means changing the genetic message in the'DNA of the organism. Since life .. . .. - .. ; ~ The most exciting new activity upon which we are about to embark is genetic engineering, and'it requires some careful discussion. As we have described~in earlier reports, our work involves the genetic improvement of microorganisms. they develop. this new technology. We will keep you advised of specific plans and'programs as hope that you will find Dr. Cohen's Scientific American article, also enclosed, to be interesting reading. As stated in Business Week, Cetus, committed to . eminence in molecular biology, will take a leading role in the application of area and'estabiishes Cetus as a major force in thiis exciting new technology. We for this latest biological breakthrough. His involvement together with Drs. Leder- berg and'Hopwood provides Cetus with an exceptionally strong capability in this create genetically new microorganisms withiour eyes open. Rather than bl'indly mutating old "bugs," we can literally "stitch" into appropriate organisms the specific genes (pieces of DNA) already known to do a particular job. We are particularly pleased that our Board of Scientific Advisors has been joined by Dr. Stanley Cohen, of Stanford Med'icaL School, who has been, largely.respcnsible from Business Week to bring you up-to-date. In short, it is now possible to Yr? Perhaps you have read'about it in the press. " We are ericlosing a recent article ~ There.are many possible, some incredible, projects which must be considered. w V Some relate to concepts so new that their impact cannot be evaluated. The e:,q Business Week article and Dr. CoheWs paper refer to some of these. It should ~ be clear that the pay-off for these is manyyears away: For a small company <

LutL L:r to t[io Shareholdor5 AuqusL 21, 1976 Paya: 1 ~ like Cttus, it is important to select projects which, if long-term, are ade- `~ ~ "d ' qudtelyfunded to be seen through to successful scientific conclusion ar, ultimate economic return. For this reason we are actively exploring alterna=' tive means of funding'suctr programs which could involve spending'from $10000000 ,,, to $2U,000,000 over the next five to ten years. ' ~ . ._ - J . . : ~,. : . ;;. ~ ~-• ~ . . . . .. ~ -.. , . . , ~ . . . . r ~ ~ -Y, f • . .. . . At the same'timz, there are some'projects with shorter pay-outs,"cind I alluded ~t sme'f thm'i tlk t the Ai Chicl Sit in Aril of this ' oooen aaomercanemaoceyp year. A copy of that speech is also enclosed. .:s,.., , . - ;. . . . ' - , . SUMMARY :...... A n This, then, is the status of CetusCorPoration. We have come through aur A•~,t;~ initial phase, characterized by successful massive screening to improve anti,7-, ~ biotic production processes foT drug companies. We have demonstrated ability. to live within our means, and disinclination to make impulsive moves for which , we were not ready, notwithstanding our very comfortable liquidity. ~ .. . .. . ..._ ..._.. . .. . _ . , . ., . _ .- . . ~ •--_ a ~ ~ - . ~ . ~ . . . .... ~. . - . .. -~ F . ~~ . . '_ - ., f e_ Now-winttnd 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. `J !. :~ ~. . . -. .. . . . , .. .. . .,.... _ . ,,. ". .,_. . . . . ._ . ... . . , . . . ... . . ., .. ~ . We cannot yet forecast what the budgetary implications of these decisions -'may be. We would like, if possible, to remain "in'the black," and perhaps even show some real increase in net profit for the coming year. However, if the new ventures for which we feel we are now ready requi~re it, we are now prepared, as we have previously not been,"to use our "nest egg" - the :' ' funds raised in our second financing, and, until now, carefully husbanded. This could have negative impact on profitability, in the short run. We will advise the shareholders when and if any such decisions are made. i htl ~" Some shareholders have, uite r q g y, urged us to report more fully and _ more frequently, and we undertake to do so quarterly, from now on. We have enjoyed arid appreciated your trust, and we look forward to seeing as ' many of you as possible at the shareholders' meeting on September 2.