XENOMETRIX INC \DE\, 10KSB, 1999-10-04

XENOMETRIX INC \DE\
10KSB, 1999-10-04
LABORATORY ANALYTICAL INSTRUMENTS

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Securities and Exchange Commission

Washington DC 20549

Form 10-KSB

Annual Report under Section 13 of the
Securities Exchange Act of 1934

For the Year Ended June 30, 1999 Commission File No. 1-14004

Xenometrix, Inc.

2425 North 55th Street
Boulder, Colorado 80301-5700

Incorporated in Delaware IRS ID # 04-3166089

Telephone: (303) 447-1773

Securities registered under Section 12(g) of the Act:
Common Stock; $0.001 par value
Warrants to purchase Common Stock

Xenometrix, Inc. (Xenometrix or the Company) has filed all reports under Section
13 of the Securities Exchange Act of 1934 during the preceding 12 months, and
has been subject to such filing requirements for the past 90 days.

Disclosure of delinquent filers pursuant to Item 405 of Regulation S-B will be
contained in the definitive proxy statement incorporated by reference in Part
III of this Form 10-KSB.

Xenometrix' revenue for the year ended June 30, 1999 was $3,137,000.

The aggregate market value of Xenometrix' voting stock held as of September 28,
1999 by nonaffiliates was $760,793.

2,950,247 shares of Common Stock were outstanding on September 28, 1999.

Transitional small business disclosure format. Yes____ No X

Incorporated by reference in Part III of this Report is the information
contained in the Xenometrix Proxy Statement for the annual meeting of
stockholders, which will be filed with the Securities and Exchange Commission
within 120 days after June 30, 1999.

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Part I

Item 1. Business

Except for the historical information contained herein, this Report contains
forward-looking statements that involve risks and uncertainties. Xenometrix'
actual results could differ materially from those discussed herein. Factors that
could cause or contribute to such differences include, but are not limited to,
those discussed in "Business," "Risk Factors," and "Management's Discussion and
Analysis of Financial Condition and Result of Operations" in this Report and the
documents incorporated herein by reference. For definitions of certain terms
used in this Report, see "Glossary".

General

Xenometrix, Inc. (the "Company" or "Xenometrix") is a biotechnology company
with a proprietary gene profiling system that characterizes a cell's response
upon exposure to compounds and other agents by the pattern of gene expression in
the cell. The Company develops, manufactures and sells assays that measure the
genetic response of human and bacterial cells to various compounds, along with
proprietary software for reporting and analyzing the test results. In addition,
Xenometrix offers a contract laboratory service that tests and evaluates
compounds for clients.

The Company continues to focus its efforts on licensing of its intellectual
property and exploring strategic alliances. In November 1997, the Company was
granted a European patent claiming methods and kits for generating gene profiles
resulting from exposure of eukaryotic cells, (including human, animal and yeast
cells) to compounds. In September 1998, the Company was issued a patent covering
similar subject matter in the U.S. In January 1998, the Company was granted a
European patent claiming methods and kits for generating gene profiles resulting
from the exposure of prokaryotic cells to compounds. Xenometrix shares ownership
of certain patents with Harvard University, and has an exclusive worldwide
license to Harvard's ownership interests in portion of the intellectual
property. The Company is in disagreement with Harvard on a section of the
Company's license agreement from Harvard and filed a Demand for Arbitration with
American Arbitration Association. However, arbitration proceedings were
suspended by mutual agreement between the Company and Harvard University in
favor of negotiating the differences directly. In addition to the gene profiling
patents, Xenometrix has an exclusive worldwide license to the bacterial strains
used in the family of Ames II* Assays from the University of California,
Berkeley and an exclusive license for yeast strains used in Yeast DEL. The U.S.
patent for the Ames II bacterial strains was issued October 1997 and its
European equivalent was issued July 1998 to the University of California,
Berkeley. The Company's President and Chief Scientific Officer is an inventor on
this patent estate.

In order to conserve resources, the Company restructured its operations in
February 1999, and reduced its staff to four full time employees. As of
September 28, 1999 the Company has three full time employees and five
independent consultants, some of who were Xenometrix employees, that contribute
to the operations on a fee for service basis. Of these, three are engaged in
scientific and technical activities, and the remainder in business development,
licensing, finance and general administration.

At September 28, 1999, the Company had cash of approximately $90,000. The
Company estimates that this cash together with projected collections on
licensing revenues and accounts receivable from customers will be sufficient to
meet its operating needs through to the end of 1999. In order to fund its
operations, the Company has borrowed $1,500,000 from June 1997 to January 1998
under a short-term bridge financing line of credit. The Company has repaid the
Notes in full and the Note holders no longer secure its assets.

The first of the Company's two current core technologies, the Gene Profile
Assays, represents a low-cost method for identifying the specific molecular
mechanisms underlying the cellular response to exposure to a particular compound
or test article. The Company's second core technology, the Genotoxicity Assays,
assesses the carcinogenic potential of a compound by measuring damage to DNA.
Together, these two assay systems provide information about what is occurring at
the molecular level when living cells are in the presence of a foreign
substance, including, but not limited to, activation of receptors and signaling

- ----------

* Xenometrix(TM), Gene Profile Assay(TM), Ames II(TM), and Yeast Del(TM) are
trademarks of Xenometrix, Inc.

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pathways, changes in cell metabolism, damage to cellular components, cell death,
tumorigenesis, teratogenesis, irritation and other reactions. Xenometrix has
developed a proprietary software system for reporting and analyzing the results
of its assays. This software has been evaluated to assure compliance with "Year
2000" issues.

The Company has developed a small Bioinformatics database consisting of the
gene response profiles of approved pharmaceutical products and other classes of
compounds that are well known to many industries. The Company believes that a
larger, expanded Bioinformatics database would enhance the utility of all of its
existing products, and might provide an additional revenue source. Proprietary
software developed by Xenometrix as well as the search engines used in the
database have been evaluated to assure compliance with "Year 2000" issues.

Numerous public sources estimate that approximately $19 billion is spent
annually on all phases of pharmaceutical research and development, with over $9
billion being spent on drug discovery and pre-clinical development efforts.
Xenometrix believes that its products and services can add value to drug
discovery and pre-clinical research efforts by providing important efficacy and
safety data with regard to a compound's potential therapeutic effects and
toxicity in a unique and cost effective manner. The Company believes that its
technology can add value to the chemical industry in ways similar to those
described for the pharmaceutical industry.

Markets and Industry Background

The Company began operations in 1992 to serve the toxicology and drug
safety markets with a line of assays designed to analyze the genetic response of
cells when exposed to various compounds. While Xenometrix continues to provide
products and services to the toxicology market, the Company believes that much
larger and nearer-term opportunities lie in using its proprietary technology to
assist pharmaceutical and chemical companies to select and optimize their
products earlier in their development.

The Drug Discovery Process. The discovery and development of drugs has
traditionally been a lengthy, expensive, inefficient and often unsuccessful
process, typically taking 10 to 15 years from the inception of a research
program until the market introduction of a drug. Costs are estimated to be
approximately $350 million to $500 million for development from concept through
FDA marketing clearance, with only a small fraction of those compounds that
enter pre-clinical testing actually receiving FDA marketing approval.

Of the estimated $19 billion that will be spent on pharmaceutical research
and development annually, approximately half of this amount will fund drug
discovery and pre-clinical development efforts. Lower profit margins, shorter
product lives, the proliferation of generic drugs, managed care and cost
containment initiatives, together with scientific and technological advances,
have created powerful incentives for drug developers to discover drugs more
quickly and cost effectively. Xenometrix believes that its products, services
and intellectual property can add value to drug discovery and pre-clinical
research efforts by providing important efficacy and safety data with regard to
a chemical compound's potential therapeutic effects and toxicity in a unique and
cost effective manner.

Drug discovery involves three key elements: (i) the target, such as a gene,
enzyme, receptor or other protein, which is associated with a disease and on
which the drug will act, (ii) potential drug compounds, and (iii) the assays or
tests used to screen compounds to determine their effect upon the target. Drug
discovery methods generally involve the synthesis and testing of large numbers
of compounds in assays that contain targets designed to mimic aspects of a
disease process. Assays are used to identify those chemicals that physically
interact with the target, which are referred to as "hits." Hits are subjected to
additional rounds of screening for specificity, potency and other desirable
characteristics to identify lead compounds. Typically, lead compounds become the
basis for additional synthesis programs creating hundreds or thousands of
analogs that are then further screened. This process is typically referred to as
"lead optimization." The lead optimization process generates drug development
candidates that will be moved into FDA-mandated pre-clinical safety testing.
Drug development candidates are lead compounds that in laboratory studies have
demonstrated the most promising combination of desirable characteristics such as
pharmacological activity, potency, selectivity, minimal side effects and
economic feasibility.

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The following diagram illustrates the steps in the drug discovery process.
The Company believes that its assays may be used throughout the lead
optimization and safety screening portions of the process, assisting drug
developers to both develop "hits" into lead compounds and optimize lead
compounds into drug development candidates.

DRUG DISCOVERY PROCESS

[GRAPHIC OMITTED]

Targets. Targets are specific biological molecules, such as genes,
receptors or other proteins, which are believed to play a role in the onset or
progression of a disease or medical condition. Most drugs work by binding to a
target and affecting the target's biological function or activity. Thus, most
drugs are discovered by identifying compounds that affect an established
target's biological function. Recent developments in molecular biology and
genomics have led to a dramatic increase in the number of potential therapeutic
targets available for drug discovery

Potential Drug Compounds. Traditionally, chemists synthesized new compounds
one at a time or isolated them from natural sources. Over the years, chemists in
pharmaceutical firms built up collections of hundreds or thousands of compounds,
or "libraries". In recent years, however, combinatorial chemistry techniques
have been developed which have greatly increased the number and diversity of
potential drug compounds. Some firms have used these techniques to quickly
create chemical libraries of hundreds of thousands of molecules which are
available to be tested against both established and novel targets in order to
determine which compounds may become lead compounds or drug development
candidates

Screening. After a target has been selected by a researcher, the next step
in traditional drug discovery is to identify one or more chemical compounds that
have an effect on the target. These compounds are typically identified by the
sequential synthesis and testing of large numbers of compounds against the
target through the use of screens, such as a receptor-binding assay. If high
throughput screening, such as the use of a receptor-binding assay, indicates
that a compound binds with the target, the compound is then considered a hit.
While receptor-binding assay screens will indicate whether a particular compound
has physically interacted with the target, such assays provide no additional
information about the biological impact that the binding event had on the
target. After re-testing confirms initial hits, secondary screening identifies
which hits have the properties of a lead compound meriting further development
efforts. Secondary screening evaluates numerous characteristics, including
efficacy (the degree to which a compound produces the desired therapeutic
effect), potency (the amount of the compound required to exert its effect) and
specificity (the degree to which the compound does not affect unintended
targets).

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Historically, screening was a manual process in which it was generally
possible to test only limited numbers of compounds per day. Even though numerous
distinct chemical structures exist, it has not been unusual for traditional
screening to be terminated after several years with no lead compounds identified
after examining only a small portion of available compounds. Today,
pharmaceutical and biotechnology companies with advanced drug discovery programs
use semi-automated or robotic high throughput screening systems that can process
thousands of compounds per day, resulting in a greater number of hits.

Lead Optimization. After initial and secondary screening of hits has
identified a lead compound, drug researchers will next "optimize" the lead
compound by the sequential synthesis and testing of variations, or analogs, of a
lead compound to identify promising drug development candidates. After the
numerous chemical analogs of a lead compound have been synthesized, scientists
then rely upon various types of laboratory tests, including additional
receptor-binding assays, cell based assays and in vivo testing, to determine
whether a lead compound exhibits the characteristics of a drug development
candidate.

The Growing Drug Development Backlog. Drug discovery researchers have
recently begun to apply a number of modern technologies to the early stages of
the drug discovery and development process. Genomics has led to the
identification of additional targets. Automated high throughput screening has
allowed scientists to test significantly higher numbers of chemical compounds
and to generate numerous hits. Combinatorial chemistry has allowed scientists to
develop more compounds for initial screening as well as to synthesize the large
number of chemical analogs used for lead optimization in a shorter period of
time.

The methods used for secondary screening of hits and optimization of lead
compounds have not kept pace with the new technologies being employed in other
stages of the drug discovery process. Traditional methods, such as in vivo
testing, have historically been too slow and expensive to be incorporated into
higher volume development methods. As a result, there is a growing backlog of
hits and lead compounds awaiting further evaluation. The Company believes that
drug and chemical manufacturers are looking for alternatives to traditional
testing techniques in order to more quickly and cost effectively evaluate which
compounds should be advanced further through the drug development process.

Receptor-binding assays consist of a target, which is isolated from its
natural cellular environment. If enough of the target can be isolated, such
assays can be relatively simple to develop and perform. The artificial
environment of such assays, however, has limited their usefulness in furthering
the development process after initial hits have been identified. For example, in
a cellular environment a receptor may be woven throughout the external surface
of a cell while in a receptor-binding assay the receptor is completely removed
from the cell. This differentiation can mean that a compound that has one effect
in a receptor-binding assay can result in a significantly different interaction
with the target in its natural cellular environment. Also, many receptors and
cellular compounds cannot be isolated for use in receptor-binding assays.

Cellular assays bridge the gap between receptor-binding assays and
traditional in vivo, animal, pre-clinical methods of testing because they employ
whole cells in an attempt to more closely mirror the environment within which a
chemical compound must interact. These cellular assays allow scientists to
determine whether a particular compound binds with the receptor in the cell. By
more closely replicating the physiological environment and the complex
interactions that take place within a cell, such cell-based assays provide a
number of advantages, including in many cases greater predictive value of
therapeutic effect and potential toxicity.

Currently, simple cell-based assays are subject to a number of limitations
that prevent them from solving the development backlog of drug discovery
companies. Cell based assays have typically been difficult and time consuming to
develop and perform due to the challenge of detecting the function of a target
in a cell. The complexity of cellular assays has prevented their adaptation to
high throughput screening applications, which would be necessary for them to be
used to test the thousands of compounds being generated by new drug discovery
techniques. Some cell-based assays use cells, which are less complex than human
cells in an attempt to create a more usable assay. However, these simple cell
based assays are limited because they fail to mirror the complexity of a human
cellular environment.

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Xenometrix's Role in Drug Discovery and Lead Optimization. Xenometrix's
assays and technology platform permit the measurement of the activity of
batteries of genes, or targets, in both human and bacterial cells in an
environment which more closely approximates the physiology of a living organism.
The Company believes that the use of multiple genes in an assay covering a broad
range of cellular responses provides information that is more useful than the
information relating to a single cellular response yielded by simple cell-based
assay. This information can be used as a cost-effective means of prioritizing
which of the positive hits from initial screening has the highest probability of
subsequent success, based on their safety and efficacy profiles. In addition,
the Company believes that its assays can be readily modified to facilitate
automated high throughput screening. The genes monitored in the Company's
current product line include both safety and efficacy markers.

Xenometrix has been involved in the characterization, licensing and
commercialization of genes and gene constructs in cells for over six years. The
study of gene expression as an indicator of cellular response to a compound is
relatively new and the Company believes that it has significant know-how
relative to other companies entering this emerging area. Individual testing of
compounds and the analysis of the gene expression they cause in a cellular
environment is difficult because it involves purchases from multiple suppliers,
integration of varying assay designs into a single system and complex quality
control issues. The Company believes its technology platform significantly
reduces these problems.

Technology, Products and Services

One of the Company's cell based assay systems, Gene Profile Assays,
represents a cost-effective method of identifying the specific molecular
mechanisms underlying the cellular response to exposure to a particular
compound. The Company's other cell based assay system, Genotoxicity Assays,
assesses the carcinogenic potential of a chemical entity by measuring damage to
DNA.

Gene Profile Assays. The Company's Gene Profile Assays measure the
activation of various bacterial and mammalian genes in response to exposure of a
test compound. The genes monitored respond to compounds and test articles, with
potential results indicating, among other things, information about the
metabolic pathway of the biological response within a cell, whether the compound
is an agonist or an antagonist, the potential toxicity of the compound, and the
potential for the liver to metabolize the drug before it reaches its therapeutic
target. Gene Profile Assay kits are shipped to customer locations in the United
States and overseas, as well as being offered through the Client Research
Laboratory for in-house testing at Xenometrix.

The Company's Gene Profile Assays are not yet adapted for automated high
throughput screening. As part of the Company's collaborative agreement with OSI
Pharmaceuticals, Inc. ("OSIP"), the Company has access to certain technology and
know-how that will assist efforts to automate its Gene Profile Assays.

Genotoxicity Assays. The Company's Genotoxicity Assays, consist of the Ames
II family of assays, which assess the mutagenic and carcinogenic potential of a
compound by measuring specific types of damage to DNA. These assays are largely
used in safety assessment, and are offered by Xenometrix for shipment to
customers as well as through the Client Research Laboratory. Xenometrix is the
only company offering the Ames II family of assays. The Company believes the
Ames II assay offers both scientific and commercial advantages over the widely
accepted original Ames assay. These advantages include automation that allows
significantly more compounds to be tested, and new bacterial strains that
provide more specific information about the mutations created by the compound.

Software. Xenometrix has developed proprietary software to facilitate
performing its assays and analyzing and interpreting the results. The software
used with gene profile assays records the results for a compound by reporting
data regarding the compound's gene response induction profile from each assay
and presents a graphical illustration producing a unique fingerprint of each
compound's molecular response in the assays. The gene profile for a given assay
can then be compared to profiles of well known compounds (derived from in vitro
and in vivo test data) to assess a compound's relative activity and its impact
on gene activity. The software used with the Ames II assays provides a
statistical analysis of the test results. Xenometrix software has been evaluated
to assure compliance with "Year 2000" issues.

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Client Research Laboratory. The Company has established a fully equipped
laboratory at its Boulder, Colorado facility, to serve the needs of clients
wishing to obtain assay data without investing in training or capital equipment.
Xenometrix's scientists receive compounds, perform requested assays in the
required time periods, and deliver the test results in the form of a detailed
report to the client. This service introduces the Company's assay systems to new
customers, helping them to understand and adopt the technology.

Bioinformatics Database. The Company has developed a small relational
database consisting of the gene response profiles and mutational spectra of
approved pharmaceutical products and other classes of compounds. Comparing the
gene profile of a new compound being tested to those in the database may
facilitate improved evaluation and decision-making for pharmaceutical products
in the development stage. Resource constraints have prohibited the Company from
performing the work necessary to expand the size of the Bioinformatics database.
The Company believes that a larger, expanded Bioinformatics database would
enhance the utility of all of its existing products, and might provide an
additional revenue source.

Potential Expansion of Current Products and Services. In order to expand
its product offering and increase the usefulness of the Company's current
products to drug discovery and development customers, Xenometrix believes that
automation and the addition of gene endpoints and cell lines are desirable. The
Company believes that an strategic alliance with chip technology would be
synergistic, however, due to severe resource limitations, the Company has been
unable to invest the funds necessary to expand its product line. The Company
explores actively strategic alliances with potential partners.

Business Development & Licensing

Xenometrix's business development strategy has been and continues to focus
on licensing of the Company's intellectual property. In November 1997, the
Company was granted a European patent claiming methods and kits for generating
gene profiles resulting from exposure of eukaryotic cells, (including human,
animal and yeast cells) to compounds. In September 1998, the Company was issued
a U.S. patent covering similar subject matter. In January 1998, the Company was
granted a European patent claiming methods and kits for generating gene profiles
resulting from the exposure of prokaryotic cells (including bacterial cells) to
compounds. Xenometrix shares ownership of the patents with Harvard University,
and has an exclusive worldwide license to Harvard's ownership interests of the
intellectual property. The Company is currently renegotiating in good faith a
section of its license agreement with Harvard.

In addition to the gene profiling patents, Xenometrix has an exclusive
license to the bacterial strains used in the family of Ames II Assays from the
University of California, Berkeley and an exclusive license for yeast strains
used in Yeast DEL. The U.S. patent for the bacterial strains was issued October
1997 and its European equivalents was issued July 1998 to the University of
California, Berkeley. The Company's President and Chief Scientific Officer is an
inventor on this patent estate.

In addition to the licensing of its patents, Xenometrix is seeking to use
its intellectual property to facilitate entry into broad strategic relationships
with pharmaceutical and biotechnology companies. The Company believes that these
relationships may allow the Company to gain access to additional technologies
that would enhance the Company's assays to better serve the drug development
market, or may enable the Company to enter into collaborative arrangements with
other companies to screen large numbers of compounds using the Company's assays.
The Company believes that by developing strategic relationships it will be able
to more quickly broaden its current line of products and services and more
effectively penetrate the drug discovery and development market.

In June 1997, the Company entered into an agreement with OSIP, a leading
high throughput screening and drug discovery company with development programs
targeting major human diseases independently and in co-ventures with major
pharmaceutical companies. The agreement includes the cross licensing of certain
intellectual property rights. Pursuant to the agreement, the Company granted
OSIP a worldwide, non-exclusive license to use the Company's Gene Profile
technology in conjunction with cell-based reporter-promoter constructs. In

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return, OSIP granted the Company a worldwide, non-exclusive license to OSIP's
proprietary technology for measuring gene activation using reporter constructs
and access to technology used in high throughput screening applications.

Sales and Marketing

The Company's primary target market for the sale of its products and
services consists of large international research-based pharmaceutical companies
as well as smaller biopharmaceutical and biotechnology companies. The Company's
business development department is primarily responsible for maintaining and
expanding business opportunities with existing customers and for developing
collaborative relationships with new customers. The Company sells its products
directly to pharmaceutical, chemical and biotechnology customers in the United
States. International distribution in Switzerland, France, Germany, Belgium, and
Japan is handled by distributors in Europe and Japan. The Company's technical
staff supports the distributors with training and consultation at the Boulder
facility as well as at the facility of clients when a client decides to bring
the assays in-house.

Manufacturing

Xenometrix manufactures and assembles its products at its facilities in
Boulder, Colorado. The assays consist of the Company's proprietary components
and components purchased from outside vendors. The Company's assays contain the
components required to perform a specific test in a reproducible and uniform
manner. Specific components typically include genetically engineered human or
bacterial cells, proprietary software, specially formulated chemical reagents,
reference manuals, other supplies and appropriate packaging. Xenometrix
manufactures assays in a production process that is subject to quality control
procedures.

The Xenometrix manufacturing process involves growing cells in controlled
environmental incubators, maintaining the cells under appropriate conditions and
preparing the cells for shipment in 96-well plates. Bacterial assays include
freeze-dried cells or frozen cells and are shipped so that they may be grown at
the customers' facility to perform the assays. Mammalian cell-based assays
include live human cells immersed in a growth medium ready to be used with only
a media change and equilibration with an appropriate environmental incubator.
Gene Profile Assay kits contain both human and bacterial cells, while the
Company's genotoxicity assay kits, contain only bacterial cells. Kits are
offered for shipment to customer locations in the United States and overseas, as
well as being offered through the Client Research Laboratory where the test is
performed at Xenometrix.

Apart from the genetically engineered cells and organisms developed and
manufactured by Xenometrix and the Company's proprietary software, all of the
components of the Company's assays are available from outside manufacturers.
Certain of these components are currently provided to Xenometrix from a single
source.

Xenometrix maintains inventories of certain components and raw materials at
what it believes to be prudent levels. Xenometrix believes that, if necessary,
it would be able to obtain alternative sources of supply of these components.
Any supply interruption, however, in a sole-sourced component or raw material
could have a material adverse effect on the Company's business when inventory is
depleted and until a new source of supply is qualified. See "Management's
Discussion and Analysis--Risk Factors- Manufacturing; Dependence on Outside
Suppliers."

Research and Development

R&D scientists provide support to the manufacturing, quality control and
client research laboratory functions. Additional R&D efforts were focused on
collaborations with clients by assisting them to validate Xenometrix's
technology, and resolve technical issues. The Company collaborates with OSIP in
developing new cell lines utilizing luciferase reporter constructs that are more
amenable to automated high throughput screening systems. The Company's
researchers have performed preliminary feasibility studies on methods and
procedures to expose cells to large numbers of compounds, and for the subsequent
isolation of high quality mRNA in large volumes and continues to explore
strategic alliances to continue this work.

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Competition

Competition in the drug discovery and development sector of the
biotechnology industry is intense. The Company believes that its assays may be
used throughout the secondary screening and lead optimization portions of the
drug discovery process. The Company, therefore, faces competition from firms
which are pursuing the same or similar technologies as those which constitute
the Company's technology platform, as well as from all other technologies or
processes that are or can be used by drug developers to develop "hits" into lead
compounds or to optimize lead compounds into drug development candidates. The
Company faces competition both from other firms which, like Xenometrix, are
developing drug discovery tools and services and from drug researchers using
their own proprietary drug discovery methods in house. As a result, the Company
faces competition from large pharmaceutical companies, biotechnology companies,
academic and research institutions and government agencies.

The Company's technology platform principally consists of using genetically
engineered cell based assays to measure gene activation. The Company also is
working to develop high throughput screening capabilities for its assays. A
number of pharmaceutical and biotechnology companies are active in the areas of
gene expression assays and high throughput screening. Such competitors include
Aurora Biosciences Corporation, Digital Gene Technology, Inc., Gene Logic, Inc.,
Cerep, S.A., Perkin-Elmer Corporation, Phase-1 Molecular Toxicology, Inc. and
OSI Pharmaceuticals. There may also be several private companies that are
pursuing drug discovery using gene transcription methods, which could be
considered competitors of the Company. In addition, the Company faces
competition from traditional methods used by drug researchers to identify and
optimize lead compounds, such as receptor-binding assays, other in vitro assays
and animal testing.

There can be no assurance that pharmaceutical and biotechnology companies
which compete with the Company in specific areas will not merge or enter into
joint ventures or other alliances with one or more other such companies and
become more substantial competitors offering a broader platform of drug
discovery products and services. In addition, genomics, combinatorial chemistry
and primary screening firms, recognizing the growing bottleneck of compounds
awaiting evaluation and optimization, may also expand their businesses to
include secondary screening, optimization and assay development, either alone or
pursuant to alliances with others.

It is very common in the drug discovery industry for biotechnology firms to
have one or more significant corporate partners or collaborative arrangements.
An important part of the Company's strategy is to enter into such arrangements
with major contract research organization and/or drug discovery firms with
complementary technologies. The Company, therefore, competes for opportunities
to enter into promising collaborative arrangements with other biotechnology
firms and also competes for the limited funds which major pharmaceutical firms
can commit to out-sourced lead identification and optimization activities.

The Company also competes with firms developing new or alternative methods
of drug discovery, such as rational drug design and DNA probe technology, which
may eliminate or significantly alter the market for identifying and optimizing
lead drug compounds. The Company's technological approaches may be rendered
obsolete or uneconomical by advances in existing technological approaches or the
development of different approaches by one or more of the Company's current or
future competitors.

Historically, pharmaceutical, chemical and biotechnology companies have
maintained close control over their research activities, including the
synthesis, screening and optimization of chemical compounds. Many of these
companies, which represent the greatest potential market for the Company's
products and services, have developed or are developing, at substantial cost,
internal programs and methodologies to approach drug discovery efforts. The
Company competes with the processes internally developed by pharmaceutical and
biotechnology companies, who must be convinced that Xenometrix's drug discovery
products and services justify outsourcing a portion of these activities to the
Company or complete a license agreement to practice the Company's technology.

Because of the nature of the drug discovery industry, many companies that
could be customers or collaborators of Xenometrix may also be actual or
potential competitors, either alone or in combination with other firms. Many of
Xenometrix's actual or potential competitors have been addressing the drug
discovery market for a longer period of time than the Company, have already
established corporate partnering relationships and have significantly greater
financial and other resources than those available to the Company. There can be
no assurance that the Company will be able to develop products that are
competitive with those offered by existing or future competitors. See
"Management's Discussion and Analysis--Risk Factors--Competition".

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Patents and Proprietary Rights

The Company believes that patents and other proprietary rights are
important to the development of its business. During the past year, the
Company's efforts to license its intellectual property have generated the
majority of the Company's revenues. The Company also relies upon trade secrets,
know-how, continuing technological innovations and licensing opportunities to
develop and maintain its competitive position.

The Company's core technology relates to eukaryotic and bacterial gene
profiling assays and genotoxicity assays. This technology is comprised of
multiple patents and patent applications, some of which are owned directly by
Xenometrix and others exclusively licensed from Harvard University, the
University of California at Berkeley and other entities. The exclusive license
agreements cover five U.S. and five foreign patent equivalents that have been
issued and certain additional patent applications. In general, these license
agreements (i) provide for the payment of royalties on net sales of products
covered by the licensed technology, (ii) provide for the payment of royalties on
sublicense revenues received by Xenometrix (iii) provide for certain minimum
royalties, and (iv) terminate upon the expiration of the last to expire patent
included in the license. If the Company fails to meet its obligations under any
such agreement, including payment of royalties or minimum royalties, such
agreements may be terminated by the licensors. The Company is in disagreement
with Harvard on a section of the Company's license agreement from Harvard and
filed a Demand for Arbitration with American Arbitration Association. However,
arbitration proceedings were suspended by mutual agreement between the Company
and Harvard University in favor of negotiating the differences directly.

The Company has obtained an exclusive worldwide license to one issued U.S.
patent, its foreign equivalents and several patent applications that relate to
kits and other means of generating gene profiles by exposing eukaryotic cells
(including human, animal and yeast cells) to compounds.

The Company has obtained an exclusive worldwide license to two issued U.S.
patents, the foreign equivalents and several patent applications that relate to
methods and kits for generating gene profiles using bacterial promoters fused to
reporter genes.

The Company has also obtained a worldwide exclusive license to one issued
U.S. patent, its foreign equivalents and several patent applications for a
microbiological system for the detection and identification of mutagens. This
technology is a modification and improvement over the widely accepted Ames
assay.

In addition, the Company has an exclusive worldwide license under one
issued patent and an additional patent application covering a process for
detecting potential carcinogens by monitoring deletions in the yeast genome.

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<PAGE>

Company's or its licensor's patents is opposed, there is no assurance that the
Company will be successful in defending against such opposition. The Company's
European eukaryotic gene profiling patent is currently under opposition in the
European Patent Office. Resolution of the opposition may not be reached for one
to two years. In any event, such opposition could result in substantial cost to
the Company, whether or not the result of such proceedings was favorable to the
Company. There can be no assurance that any of the Company's issued or licensed
patents would ultimately be held valid or that any efforts to defend any of its
patents, trade secrets, know-how or other intellectual property rights would be
successful.

The drug discovery industry, including screening technology companies, has
become intensely competitive. This industry has a history of patent litigation
and will likely continue to have patent litigation concerning drug discovery
technologies. A number of pharmaceutical and biotechnology companies, research
and academic institutions have developed technologies, filed patent applications
or received patents on various technologies that may be related to the Company's
technology. Some of the technologies, applications or patents of these entities
may conflict with the Company's technologies, the patents and patent
applications licensed by the Company, or the Company's patent applications.
Moreover, because patent applications in the United States are maintained in
secrecy until patents issue, because patent applications in certain other
countries generally are not published until more than eighteen months after they
are filed and because publication of discoveries in scientific or patent
literature often lag behind the date of actual discoveries, the Company cannot
be certain that it or any of its licensors was the first creator of inventions
covered by pending patent applications or that it or any such licensor was the
first to file patent applications for such inventions. If an issue regarding
priority of inventions were to arise with respect to any of the patents or
patent applications of the Company or its licensors, the Company might have to
participate in one or more interference proceedings declared by the U.S. Patent
and Trademark Office or similar agencies in other countries to determine
priority of invention, which could result in substantial cost to the Company,
whether or not the result of such proceedings was favorable to the Company.

In some cases, litigation or other proceedings may be necessary to defend
against or assert claims of infringement, to enforce patents issued to the
Company or its licensors, to protect trade secrets, know-how or other
intellectual property rights owned by the Company, or to determine the scope and
validity of the proprietary rights of third parties. Such litigation could
result in substantial costs to and diversion of resources by the Company. An
adverse outcome in any such litigation or proceeding could subject the Company
to significant liabilities, require the Company to obtain alternative
non-infringing technology, require the Company to cease using the subject
technology or require the Company to license the subject technology from the
third party, all of which could have a material adverse effect upon the
Company's business, financial condition and results of operations. If any
licenses are required, there can be no assurance that the Company will be able
to obtain any such license on commercially reasonable terms, if at all, and if
these licenses are not obtained, the Company might be prevented from using
certain of its technologies. To the extent consistent with its business
objectives, the Company intends to resolve any such conflicts that develop
through negotiation or by entering into licensing arrangements regarding the
disputed technology. The Company's failure to obtain a license to any technology
that it may require to continue its efforts to develop drug discovery products
and services may have a material adverse effect on the Company's business,
financial condition and results of operations.

The Company is aware that patents have issued or may issue on certain
targets and gene endpoints and related technology or their use in screening
assays that could prevent the Company and its collaborators from developing
screening assays using such targets or endpoints, or relate to certain other
aspects of technology utilized or expected to be utilized by the Company.

In addition to patent protection, Xenometrix also relies upon copyright,
trademark and trade secret protection for its confidential and proprietary
information. In an effort to maintain the confidentiality and ownership of trade
secrets and proprietary information, the Company requires employees and
consultants to execute confidentiality and invention assignment agreements upon
commencement of a relationship with the Company. There can be no assurance,
however, that these agreements will provide meaningful protection for the
Company's trade secrets or other confidential information or that adequate
remedies would exist in the event of such unauthorized use or disclosure. The
loss or exposure of trade secrets possessed by the Company could adversely
affect its business. Like many high technology companies, Xenometrix may from
time to time hire scientific personnel formerly employed by other companies
involved in one or more areas similar to the activities conducted by the
Company. Although the Company requires its employees to maintain the
confidentiality of all confidential information of previous employers, there can
be no assurance that the Company or these individuals will not be subjected to
allegations of trade secret misappropriation or other similar claims as a result
of their prior affiliations.

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Government Regulation

The Company's products and services have applications in the
pharmaceutical, biotechnology, chemical, cosmetic and environmental industries.
Those industries are subject to regulation pursuant to federal, state, local and
foreign legislation, including the Food, Drug and Cosmetic Act; the
Environmental Protection Act; the Occupational Safety and Health Act; and state,
local and foreign counterparts to such acts. Certain of these regulations
require the use of testing procedures in federally mandated trial studies to
evaluate the efficacy and safety of products. The Company's products are
currently used to supplement established protocols for safety and efficacy
testing in the pharmaceutical, chemical, cosmetic and environmental industries.

The Company's products and services do not require FDA, EPA or other
regulatory approval before they can be used by Xenometrix customers. However,
Xenometrix is, or may become subject to, various other federal, state and local
laws, regulations and recommendations relating to safe working conditions, good
laboratory and manufacturing practices and the disposal of hazardous or
potentially hazardous substances.

Employees

As of September 28, 1999, the Company had three full time employees, all in
the United States. Of these, three are engaged in client research, scientific
and technical activities, and the remainder are engaged in business development,
licensing, finance and general administration. The Company's success depends, in
large part, upon the continued services of its key scientific, technical and
senior management staff, and its continuing ability to attract and retain highly
qualified technical and managerial personnel. None of the Company's employees is
represented by a labor union and Xenometrix has not experienced any work
stoppages. Xenometrix considers its relations with its employees to be good.

Glossary of Terms

Agonist - A chemical which interacts with a receptor and initiates a
cellular reaction.

Analog - A structural derivative of a parent compound which often varies
from it by a single element.

Antagonist - A chemical that negates the effect of an agonist.

Assay - An analysis of (or analytical process designed to examine) the
composition, characteristics or strengths of a substance.

Bioinformatics - The science of storing, managing and analyzing
biologically related data with the aim of understanding causes of disease, the
mechanisms of action of chemical entities, and the development of therapeutic
drugs, or pharmacologically active substances.

Carcinogenic - Capable of causing or contributing to the incidence of
cancerous tumors (in humans or test organisms).

Cell Line - A population of animal cells derived from a single precursor,
having the characteristic of continuous growth under appropriate conditions.
Such lines are often called "immortal" because of this continuous growth
capacity, and may be infected with a virus, or contain foreign genes which
confer this capacity.

Cellular - Pertaining to the cell, the plant or animal structure containing
genetic material. The cell is basic unit of all organisms.

Client Research Laboratory - Xenometrix's service laboratory, which
performs assays and contract research for the Company's clients.

Combinatorial Chemistry - Typically, the application of robotics and
systematic changes in chemical structures to produce quickly and inexpensively
large numbers, often tens of thousands, of distinct compounds that can be tested
for biological activity.

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DNA - Deoxyribonucleic acid; the chemical building block of genes and
chromosomes; a double helix sequence of nucleotide base pairs which encode
genetic information.

Endpoint - A specific measurement determined to reflect a quantitative or
qualitative change. Examples of endpoints in pharmacology include degree of
tumor growth suppression, degree of inflammation, and level of gene expression.

Eukaryotic - Cells in which DNA is organized into chromosomes contained
within a distinct cellular compartment, and in which division occurs through
replication and distribution of these chromosomes. Such cells include human,
mammalian, animal, plant and yeast cells.

Gene - The fundamental physical unit of heredity. A linear series of
deoxyribonucleotides encoding a specific protein, protein part, or function.
Chromosomes are made up of genes.

Genome - The complete set of chromosomes and extra-chromosomal DNA coding
for cellular proteins which is contained within every cell of a given species.

Genomics - Science pertaining to the genome.

Genotoxicity Assays - Assay systems designed to detect and quantify damage
caused to the genetic material (DNA) of a test organism.

Gene Profile Assays - Assay systems developed by Xenometrix to assess the
effects of compounds on cells by measuring the activity (induction or
suppression) of specific genes in these cells, by the compounds or test agents.

High Throughput Screening - A process whereby large numbers of unique
chemical entities are assessed for biological activity in a short period of
time. Activity screens include, but are not limited to, specific receptor
binding and enzyme activity. Chemicals of interest are commonly available in
only very small quantities, and may exist as part of a library arising from
combinatorial chemistry methodology.

Hit - The term applied to a compound that has shown biological activity
when tested against a specific screening endpoint (commonly receptor binding).

In vitro - Outside of the living body, in an artificial environment,
literally, "in glass."

In vivo - In the living body of a plant or animal.

Induction - A measurable increase in the activity of a specific gene in
response to a change in the cellular environment or exposure to a compound or
other test agent.

Lead Compound - A specific chemical entity which has demonstrated a desired
biological activity in a drug development program.

Lead Optimization - The process of qualifying and modifying a lead compound
or "hit" as a viable drug candidate to be further developed.

Molecular - Pertaining to molecules. In this context it pertains to events
which occur at the level of biochemical reactions affecting microscopic and
submicroscopic processes.

mRNA - Messenger ribonucleic acid; a complimentary strand of RNA,
transcribed from a DNA template, which is ultimately translated into a protein
by the cell.

Mutagenicity - The degree to which an agent is capable of causing a genetic
mutation, which is a change in the linear sequence of the nucleotide bases
constituting DNA.

Prokaryotic - Unicellular organisms which do not contain distinct cellular
compartments. These cells contain DNA which is usually organized onto a single
circular chromosome. Cell division is usually by fission or budding. Such cells
include bacteria and blue-green algae.

Protein - Molecules composed of amino acids, responsible (as enzymes) for
many of the cell's biological reactions, and signaling events.

Receptor - A molecule on or within a cell membrane to which a substance,
such as an agonist or ligand binds.

RNA - Ribonucleic acid. Contains information required for protein
synthesis, and is chemically related to DNA.

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Toxicity - Disturbances in the biochemical or biophysical homeostasis of a
cell, which may have long-term or short-term harmful effects.

Toxicology - The study of toxic substances, their structures and
properties, and their effects on the various biochemical and genetic processes
in living plants and organisms.

Transcription - The synthesis of mRNA from a DNA template.

Item 2. Property

The Company's executive offices, research laboratories, manufacturing
operations and ancillary operations are located in Boulder, Colorado in a 22,700
square foot facility. The facility is leased is for a six-year period ending
July 31, 2002, with two optional renewal periods of three years each. A
substantial portion of the Company's facility was subleased to another
biotechnology company in November 1998 to reduce overhead while still allowing
for the full production and shipment of its line of Gene Profiling and
Genotoxicity Assays and to provide the services of its Client Research
Laboratory.

Part II

Item 5. Market for Common Stock

Xenometrix's Common Stock was traded on NASDAQ SmallCap Market under the
symbol XENO and on the Boston Stock Exchange under the symbol XEN until January
1998 when it was delisted from both markets for failure to meet the respective
financial requirements for continued listing. The Common Stock currently trades
on the OTC Bulletin Board under the symbol XENO.OB.

Reported bid prices for the Common Stock on the NASDAQ SmallCap Market
prior to the delisting and prices of actual trades on the OTC Bulletin Board
subsequent to the delisting are summarized below. The NASDAQ and OTC bid prices
reflect interdealer quotations, without retail markup, markdown or commission,
and do not necessarily represent actual transactions.

Quarter Ended: High Low
-------------- ---- ---
September 30, 1997 3.75 2.50
December 31, 1997 2.88 1.00
March 31, 1998 1.81 0.16
June 30, 1998 1.02 0.25
September 30, 1998 0.47 0.13
December 31, 1998 0.38 0.03
March 31, 1999 0.34 0.06
June 30, 1999 0.45 0.20

As of September 28, 1999 there were 104 holders of record of Common Stock.

Xenometrix expects that it will retain any available earnings generated by
its operations for the payment of debt obligations and the development and
growth of its business and does not anticipate paying any cash dividends on its
Common Stock in the foreseeable future. Any future determination as to dividend
policy will be made at the discretion of the Board of Directors of Xenometrix
and will depend on a number of factors, including the future earnings, capital
requirements, financial condition and business prospects of Xenometrix and other
factors.

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Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations

The following discussion of the results of operations and financial
condition should be read in conjunction with the Company's audited Financial
Statements and Notes thereto appearing elsewhere in this Report. Except for the
historical information contained herein, this Report contains forward-looking
statements that involve risks and uncertainties. Xenometrix' actual results
could differ materially from those discussed in this Report. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed in "Business" and "Risk Factors" in this Report and the documents
incorporated herein by reference.

Overview

The Company's customers include companies in the chemical, pharmaceutical,
biotechnology, consumer products, environmental industries and governmental
agencies that have a need to test and assess the potential safety of chemical
compounds used in their products. The Company's proprietary gene profiles may
provide valuable information that can be used in assessing relative risk. In the
pharmaceutical industry, the Company believes its technology can help companies
evaluate and optimize the growing number of drug leads emerging from genetic
sequencing, combinatorial chemistry and high throughput screening. The Company
believes that its technology can aid the chemical industry in a similar fashion.
The Company believes that its focus on these markets will enable it to expand
its business through collaborative arrangements with potential customers and
strategic alliances with business partners.

The Company focussed a significant portion of its previous effort and
resources developing and marketing its intellectual property and its products
and services to companies for testing, evaluation and optimization of their lead
compounds. The timing and amount of revenues from sales of products and services
to the drug discovery and development and chemical markets cannot be predicted
with certainty. Similarly, the Company's ability to enter into license
agreements and meaningful collaborative arrangements with customers or other
potential collaborators and licensees cannot be predicted with a high degree of
accuracy. Accordingly, results of operations for any period may be unrelated to
results of operations for any other period and are likely to fluctuate sharply.
In addition, historical results should not be viewed as indicative of future
operating results.

While the Company is in discussions with potential licensing partners, the
Company continues to pursue broad business collaborations with parties whose
current or future business activities may be complementary to those of the
Company. During the fiscal year ended June 30, 1999, Xenometrix recognized
$2,730,000 of revenue from option and license agreements related to the
Company's intellectual property, representing approximately a 114% increase in
licensing revenue from $1,275,000 in 1998.

In order to conserve resources, the Company restructured its operations in
February 1999, to four full time employees. As of September 28, 1999 the
Company's has three full time employees and five independent consultants, some
of who were Xenometrix employees, that contribute to the operations on a fee for
service basis. Of these, three are engaged in client research, scientific and
technical activities, and the remainder in business development, licensing,
finance and general administration.

At June 30, 1999, Xenometrix had an accumulated deficit of $16,149,000 that
is approximately $549,000 less than $16,698,000 at June 30, 1998. The Company
has significant future cash expenditure requirements related to the accumulated
accounts payable and to the further development and maintenance of its
intellectual property, research, product development and manufacturing
operations.

In order to fund its operations, the Company has borrowed $1,500,000 from
June 1997 to January 1998 under a short-term bridge financing line of credit.
The Company repaid the Notes in September 1999 and the Note holders no longer
secure its assets.

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Results of Operations

Comparison of the Fiscal Years Ended June 30, 1999 and June 30, 1998
--------------------------------------------------------------------

Revenue. For the fiscal year ended June 30, 1999, revenue increased 66% to
$3,137,000 from $1,886,000 reported in the prior year. Approximately 87% of the
revenue for fiscal year 1999 was attributed to revenue from up-front licensing
fees and option payments relating to the Company's recently issued patents in
the United States and Europe. Sales of products and services from the Company's
Client Research Laboratory declined 33% to $407,000 from $611,000 reported in
the prior year, primarily due to a decline in the demand for kits and laboratory
service work. This decline in gross sales of kits and services is due to the
Company's focus on its licensing strategy and a decrease in the pricing of kits
and services as a strategy to increase the volume of sales.

Gross Profit. For the fiscal year ended June 30, 1999, gross profit
increased to $2,128,000 from $1,259,000 reported in the prior year. The 69%
increase in gross profit was due to the large portion of total revenue from
licensing fees and option payments. The cost of licensing revenue was $449,000
representing mostly royalties paid to ownership interests in the Company's
intellectual property under existing exclusive license agreements. Gross profit
margins on revenue from sales of products and services were approximately -38%
in the current fiscal year, compared to approximately 14% from the prior year,
primarily due to declining kit sales and laboratory service work while fixed
costs in manufacturing and service work remained approximately the same. The 38%
decline in kits sales was due partly to a decision in 1998 to stop shipping the
Company's mammalian Gene Profiling Assays. The cost of services increased 19%
over the prior year in spite of a decline of 28% in revenue generated from
service work, while the costs of kits decreased only 7% when the revenue
declined by 38%. The increase in the total costs of products and services of 7%
from the prior year was due to a higher cost of personnel in the allocation of a
proportion of the costs of highly specialized Research and Development personnel
to manufacturing and quality control.

Research and Development Expenses (R&D). R&D expenses for the fiscal year
ended June 30, 1999 decreased 76% to $276,000 from $1,150,000 reported in the
prior year. This decrease was primarily attributable to the restructuring of the
Company that resulted in downsizing R&D operations and a portion of R&D
personnel efforts were moved to manufacturing and quality control
responsibilities.

Selling, General and Administrative Expenses (SG&A). For the fiscal year
ended June 30, 1999, SG&A expenses were $1,061,000, down 42% from $1,833,000 in
the prior year. This decrease was attributable primarily to the loss of four out
of five officers of the Company, including the resignation of the Chief
Executive Officer, and the elimination of the Vice President of Business
Development in the restructuring of February 1999, the resignation of Chief
Financial Officer in the third quarter of the this fiscal year and the
resignation of the Vice President of Legal Affairs in the fourth quarter of the
prior fiscal year. Other reductions resulted from a re-negotiation of some
general and administrative contracts in the third and fourth quarter of this
fiscal year.

Interest Income (Expense), Net. During the fiscal year ended June 30, 1999,
the Company incurred net interest expense of $242,000 compared to $641,000 down
62% from the prior fiscal year. The net interest expense incurred in the current
fiscal year was due primarily to interest accrued on the $1,500,000 Notes at the
stated interest rate. In the prior fiscal year, the Company's net interest
expense accrued was greater because the principal amount was higher. The
amortization of the values attributable to the initial issuance and subsequent
repricing of the Warrants issued in conjunction with the Notes and the
amortization of deferred financing costs associated with bridge financing line
of credit was attributed the higher interest expense in the prior year.

Net Income. For the fiscal year ended June 30, 1999, the net income was
$549,000 or $0.17 per share fully diluted compared to a net loss of $2,365,000
or $0.80 per share, reported for prior year.

Comparison of the Fiscal Years Ended June 30, 1998 and June 30, 1997
--------------------------------------------------------------------

Revenue. For the fiscal year ended June 30, 1998, revenue increased 147% to
$1,886,000 from $764,000 reported in the prior year. The increase was
attributable to revenue from up-front licensing fees and option payments
relating to Company's gene expression profiling patents issued in 1998 in the
United States and in Europe. Sales of products and service revenue from the

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<PAGE>

Company's client research laboratory declined 20% to $611,000 in the fiscal
year, 1998 from $764,000 reported in the 1997 fiscal year, primarily due to a
decline in the demand for laboratory service work.

Gross Profit. For the fiscal year ended June 30, 1998, gross profit
increased to $1,259,000 from $79,000 reported in the 1997 fiscal year. The
increase in gross profit was due to the large portion of total revenue from
licensing fees and option payments. The cost of licensing revenue was $104,000,
representing royalties due to Harvard University under the Company's existing
licensing agreement. Gross profit margins on revenue from sales of products and
services were up approximately 1% in the 1998 fiscal year, primarily due to the
reductions in manufacturing personnel and other cost reduction initiatives
implemented during the year.

Research and Development Expenses (R&D). R&D expenses for the fiscal year
ended June 30, 1998 increased 8% to $1,150,000 from $1,067,000 reported in the
prior year. This increase was primarily attributable to higher personnel costs
in the R&D department, as well as increased research and product development
work performed by personnel in other departments. In the 1997 fiscal year, R&D
personnel performed contract research work for a customer on a fee for service
basis, and the costs associated with this work were allocated to cost of sales.

Selling, General and Administrative Expenses (SG&A). For the fiscal year
ended June 30, 1998, SG&A expenses were $1,833,000, down 40% from $3,058,000 in
the prior year. This decrease was primarily attributable to the elimination of
the field sales and marketing functions in the fourth quarter of the 1997 fiscal
year, lower finance, accounting and administrative costs resulting from
personnel reductions in the 1998 fiscal year and lower Board of Directors costs
associated with reducing the size of the Board and replacing cash compensation
to Board members with increased stock option grants.

Interest Income (Expense), Net. During the fiscal year ended June 30, 1998,
the Company incurred net interest expense of $641,000 compared to net interest
income of $112,000 in the 1997 fiscal year. The net interest expense incurred in
the current fiscal year includes interest accrued on the $1,500,000 Notes at the
stated interest rate, the amortization of the values attributable to the initial
issuance and subsequent repricing of the warrants issued in conjunction with the
Notes and the amortization of deferred financing costs associated with bridge
financing line of credit. In the 1997 fiscal year, the Company's net interest
income resulted primarily from the investment of excess cash balances, partially
offset by interest expense incurred on the first borrowings under the bridge
financing line of credit.

Net Loss. For the fiscal year ended June 30, 1998, the net loss decreased
to $2,365,000 or $0.80 per share from the net loss of $2,842,000 or $0.97 per
share, reported for the 1997 fiscal year. During the 1997 fiscal year, the
Company recognized a one-time gain of $1,028,000 from the early termination of
an operating lease.

Liquidity and Capital Resources

At June 30, 1999 the Company's cash and cash equivalents were $137,000
compared to $341,000 at June 30, 1998. During the current year $1,244,000 was
provided by the Company's operations, and $190,000 was invested in patents. The
cost of the Company's operations was provided for by revenues generated by its
licensing activities.

At June 30, 1999, Xenometrix had an accumulated deficit of $16,149,000 that
is approximately $549,000 less than the $16,698,000 at June 30, 1998. The
Company has significant future cash expenditure requirements related to the
accumulated accounts payable and to the further development of its research,
product development and maintenance of its manufacturing operations and
intellectual property. The Company's future capital requirements may be
substantial and will depend on many factors. These may include the pace of
growth, if any, in sales and services, progress of Xenometrix's research and
development programs, the cost of obtaining access to new technology, the cost
involved in filing, prosecuting and enforcing patent claims, payments received
under prospective collaborative agreements, agreements for and changes in
collaborative research relationships, the cost associated with commercialization
of its products, the cost and availability of third party financing for capital
expenditures, and legal and administrative expense.

16
<PAGE>

Between June 20, 1997 and January 12, 1998, Xenometrix issued Notes in the
total amount of $1,500,000 to serve as bridge financing and were collateralized
by a security interest in all of the assets of the Company. The Company has
repaid the Notes in full and the Note holders no longer secure its assets. In
connection with the issuance of these Notes, Xenometrix issued warrants to
purchase 499,995 shares of common stock. The Note holders agreed that in the
event that the Company is acquired by a third party at a price per share that is
greater than the exercise price of the Warrants ($0.125), to exercise their
Warrants at the closing of such acquisition to purchase for shares in exchange
for either cash or freely tradable common stock of the acquiring company in an
aggregate amount equal to the difference between the acquisition price per share
and the exercise price per share of the warrants, multiplied by the total number
of Warrants held by the Note holders. The outcome of this matter cannot be
predicted at this time.

Impact of Year 2000 Issues

The Year 2000 issue is related to computer software utilizing two digits
rather than four to define the appropriate year. As a result, any of the
Company's computer programs or any of the Company's suppliers or vendors that
have date sensitive software may incur system failures or generate incorrect
data if "00" is recognized as 1900 rather than 2000.

The Company has evaluated the proprietary software used to facilitate
performing, analyzing and interpreting the results of its assays, and the
proprietary software used in conjunction with its Bioinformatics database, and
found them to appropriately address the date issues associated with the year
2000. The Company believes that all dates in its proprietary software are stored
with either a minimum of four digits for the year or as a text string, thereby
preventing inappropriate sequencing of date sensitive information. While the
Company believes that its proprietary software will not produce any material
problems, erroneous calculations or degradation of performance as a result of
Year 2000 issues, users are advised that the Company's software must be run on
Year 2000 compliant platforms.

The Company has verified that most of its major suppliers, service
providers and financial institutions are year 2000 compliant, however there can
be no assurance that the systems and networks of its key suppliers and customers
will not be affected by Year 2000 issues, which could have an adverse effect on
the Company's business, operating results and financial condition. The Company
believes, based upon the evaluations performed upon its proprietary software and
the claims of Year 2000 compliance made by the providers of non-proprietary
software used by the Company, that the impact of Year 2000 will not be material.
However, to the extent the Company or third parties upon which it relies do not
timely achieve Year 2000 readiness, the Company's results of operations may be
adversely affected.

Risk Factors

The following risk factors should be read in conjunction with information
appearing elsewhere in this Report.

Limited Operating History; History of Operating Losses; Uncertainty of
Future Profitability; Going Concern Qualification. The Company has a limited
operating history and is in the early stage of commercializing its products. As
of June 30, 1999, Xenometrix had incurred cumulative net losses of approximately
$16,149,000. Losses to date have resulted principally from research, product and
intellectual property development, and administrative and selling expense. The
Company's ability to achieve and maintain profitability depends in part on its
ability to license its intellectual property and to market, sell and support its
products and services successfully. There can be no assurance that the Company's
licensing efforts will continue to generate revenue for the Company. There can
also be no assurance when, or if, any of the Company's current or future
products will be commercially successful or that the Company will continue to
operate profitably in the future.

Future Capital Needs; Inability to Access Capital Markets; Delisting of the
Company's Securities. The Company estimates that its cash resources at September
28, 1999 will be sufficient to fund anticipated operating expenses and working
capital requirements though December 31, 1999. The Company is evaluating its
strategic alternatives and has indicated a willingness to entertain offers for
the purchase of the Company. There can be no assurance that a sale of the
business or other strategic transaction that would raise additional capital for
the Company will be consummated. The Company's future capital requirements will
depend on many factors, including its ability to generate revenues through the

17
<PAGE>

licensing of its intellectual property, its ability to market its products
successfully, the cost of manufacturing activities, the size of its research and
development programs, the length of time required to collect accounts
receivable, competing technological and market developments, costs associated
with and the timing relating to the implementation of the Company's business
strategy. Changes in the Company's business or business plan could affect the
Company's capital requirements. The Company's ability to satisfy future capital
needs will depend on conditions in the securities markets generally and in the
market for the securities of small capitalization biotechnology companies in
particular. The Company's securities were delisted from the NASDAQ SmallCap
Market in January 1998, and the Company's securities now trade on the NASDAQ OTC
Bulletin Board. When the delisting occurred, the average daily trading volume in
the Company's common stock and warrants declined sharply, resulting in a lack of
liquidity in the market for the Company's securities. There can be no assurance
that the Company will be able to qualify in the future to have its shares
relisted on the NASDAQ SmallCap Market, or any other recognized exchange. There
can also be no assurance that the Company will be able to raise any additional
funds required to conduct its operations, that any such funds will be available
on terms acceptable to the Company or that existing stockholders will not suffer
substantial dilution as a result of subsequent financings.

Uncertainties Regarding Patents and Proprietary Rights. The Company
believes that patents and other proprietary rights are important to the
development of its business. During the past year, the Company's efforts to
license its intellectual property have generated the majority of the Company's
revenues. The Company also relies upon trade secrets, know-how, continuing
technological innovations and licensing opportunities to develop and maintain
its competitive position.

The Company's core technology relates to eukaryotic and bacterial gene
profiling assays and genotoxicity assays. This technology is comprised of
multiple patents and patent applications, some of which are owned directly by
Xenometrix and others exclusively licensed from Harvard University, the
University of California at Berkeley and other entities. The exclusive license
agreements cover five U.S. and foreign equivalents that have been issued and
certain additional patent applications. In general, these license agreements (i)
provide for the payment of royalties on net sales of products covered by the
licensed technology, (ii) provide for the payment of royalties on sublicense
revenues received by Xenometrix (iii) provide for certain minimum royalties, and
(iv) terminate upon the expiration of the last to expire patent included in the
license. If the Company fails to meet its obligations under any such agreement,
including payment of royalties or minimum royalties, such agreements may be
terminated by the licensors.

The Company is in disagreement with Harvard on a section of the Company's
license agreement from Harvard and filed a Demand for Arbitration with American
Arbitration Association in December 1998. Arbitration proceedings were suspended
in April 1999 by mutual agreement between the Company and Harvard University in
favor of negotiating the differences directly. The parties are negotiating in
good faith and expect to settle any differences although either party has the
right to resume binding arbitration at any time. The nature and the date of the
settlement is unpredictable at this time.

The Company has obtained an exclusive worldwide license to one issued U.S.
patent, several issued foreign equivalents and several patent applications that
relate to methods and kits for generating gene profiles by exposing eukaryotic
cells (including human, animal and yeast cells) to compounds and then
determining levels of expression of multiple genes in the cells.

The Company has obtained an exclusive worldwide license to two issued U.S.
patents, several issued foreign equivalents and several patent applications that
relate to methods and kits for generating gene profiles using bacterial
promoters fused to reporter genes.

The Company has also obtained a worldwide exclusive license to one issued
U.S. patent, several issued foreign equivalents and several patent applications
for a microbiological system for the detection and identification of mutagens.
This technology is a modification and improvement over the widely accepted Ames
assay.

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<PAGE>

The Company's success will depend in part upon its ability to obtain patent
protection for its products, services and technologies, to continue to license
such intellectual property to others, and to operate without infringing the
proprietary rights of third parties. Patent law as it relates to inventions in
the biotechnology field is still evolving, and involves complex legal and
factual questions for which important legal principles are largely unresolved.
Accordingly, no predictions can be made regarding the breadth or enforceability
of claims issued or allowed in the patents that have been issued to the Company
or its licensors or in patents that may be issued to the Company or its
licensors in the future. Accordingly, no assurance can be given that the claims
in such patents, either as initially allowed by the U.S. Patent and Trademark
Office or any of its foreign counterparts or as may be subsequently interpreted
by courts inside or outside the United States, will be sufficiently broad to
protect the Company's proprietary rights, will be commercially valuable, will
provide competitive advantages to the Company and its present or future
collaborative partners or licensees, or will not be challenged, narrowed,
invalidated or circumvented. Further, there can be no assurance that patents
will be granted with respect to any of the Company's or licensor's pending
patent applications or with respect to any patent applications filed by the
Company in the future. Moreover, upon allowance, patents in certain countries
are published for opposition before final grant. If the grant of any of the
Company's or its licensor's patents is opposed, there is no assurance that the
Company will be successful in defending against such opposition. The Company's
European eukaryotic gene profiling patent is currently under opposition in the
European Patent Office. Resolution of the opposition may not be reached for one
to three years. In any event, such opposition could result in substantial cost
to the Company, whether or not the result of such proceedings was favorable to
the Company. There can be no assurance that any of the Company's issued or
licensed patents would ultimately be held valid or that any efforts to defend
any of its patents, trade secrets, know-how or other intellectual property
rights would be successful.

The drug discovery industry, including screening technology companies, has
become intensely competitive. This industry has a history of patent litigation
and will likely continue to have patent litigation concerning drug discovery
technologies. A number of pharmaceutical and biotechnology companies and
research and academic institutions have developed technologies, filed patent
applications or received patents on various technologies that may be related to
the Company's technology. Some of the technologies, applications or patents of
these entities may conflict with the Company's technologies, the patents and
patent applications licensed by the Company, or the Company's patent
applications. Moreover, because patent applications in the United States are
maintained in secrecy until patents issue, because patent applications in
certain other countries generally are not published until more than eighteen
months after they are filed and because publication of discoveries in scientific
or patent literature often lag behind the date of actual discoveries, the
Company cannot be certain that it or any of its licensors was the first creator
of inventions covered by pending patent applications or that it or any such
licensor was the first to file patent applications for such inventions. If an
issue regarding priority of inventions were to arise with respect to any of the
patents or patent applications of the Company or its licensors, the Company
might have to participate in one or more interference proceedings declared by
the U.S. Patent and Trademark Office or similar agencies in other countries to
determine priority of invention, which could result in substantial cost to the
Company, whether or not the result of such proceedings was favorable to the
Company.

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<PAGE>

The Company is aware that patents may have issued or may issue on certain
targets and gene endpoints and related technology or their use in screening
assays that could prevent the Company and its collaborators from developing
screening assays using such targets or endpoints, or relate to certain other
aspects of technology utilized or expected to be utilized by the Company.

Dependence upon Emerging Market; No Assurance of Market Acceptance. The
Company believes that it is likely that any significant increases in sales of
products and services in future periods will be derived from sales to the drug
discovery and development market. The market for identifying and optimizing lead
drug compounds is new and evolving and there are many uncertainties associated
with the Company's entry into this new market, including lack of industry
acceptance, increasing competition, advances in technology and changes in laws,
regulations and industry practices. The backlog of compounds awaiting secondary
screening and optimization is a relatively recent phenomenon, resulting from the
use by drug researchers of new technologies (such as gene sequencing,
combinatorial chemistry and high throughput screening) to create large numbers
of potential lead drug compounds. The Company's future financial performance,
therefore, will be highly dependent upon the development and growth of this
market and the methods that drug researchers adopt or develop to identify and
optimize lead compounds

In order for Xenometrix to achieve broad market acceptance of its products
in drug lead identification and optimization applications, the Company must
demonstrate to drug researchers that its assays are useful and cost-effective
supplements to existing drug discovery and development technology and
techniques. There can be no assurance that the Company's existing or future
products will be accepted commercially by drug researchers. The Company's
targeted customer base may not change its current testing methods, may choose to
adopt methods marketed by competitors of the Company or may refuse to make the
investment necessary to purchase the Company's products. If market acceptance of
the Company's products does not develop, the Company's prospects and its results
of operations may be materially adversely affected. There can be no assurance
that the Company's products and services can be successfully adapted to meet the
needs of this new market, that these products and services will be received
positively by clients in this new market segment or that the Company will be
able to generate sufficient revenue from sales in this new market segment to
maintain profitability.

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<PAGE>

Dependence upon Collaborative Arrangement. One of the Company's strategies
to penetrate the chemical and drug discovery and development market is to enter
into various collaborative and licensing arrangements with chemical,
pharmaceutical, drug discovery and biotechnology companies. The Company recently
reorganized its marketing department in order to focus on identifying and
cultivating corporate partnering relationships. These arrangements may be
necessary in order to obtain additional gene lines or gain access to additional
technologies so that the Company's products and services can be adapted to the
needs of the chemical and drug discovery and development market; to establish
joint marketing relationships with other firms whose technology can be used in
chemical manufacturing or drug discovery and development; to obtain access to
additional lead compounds so that the Company's Bioinformatics database can be
built and expanded, or to establish the utility of the Company's technology in
the drug discovery and development process.

It is common for biotechnology companies to have one or more significant
corporate partners or collaborative relationships. The Company has very limited
experience with respect to such relationships. There can be no assurance that
the Company will be successful in entering into meaningful arrangements on terms
acceptable to Xenometrix, that any collaborative partner will perform its
responsibilities under any such arrangement or that any or all of the
contemplated benefits from such collaborative arrangements will be realized. The
failure of the Company to successfully develop such relationships would have a
material adverse effect on the Company's business and results of operations.

Uncertainties Regarding Product Development and Technological Change Rapid
technological developments are expected to continue in the fields of drug
development and discovery, molecular response assessment and toxicology testing.
The Company believes that its future success will depend upon its ability to
develop, manufacture and market products and services that meet changing or
emerging customer needs and to anticipate successfully or respond to
technological changes on a cost effective and timely basis. Although the Company
is considering new products for commercial development, such development depends
upon the Company's ability to obtain adequate funding, make satisfactory
technical progress and validate the commercial potential of such products. There
can be no assurance that any of the Company's products that are currently in the
research and development stage will be successfully developed, that
technological changes will not render the Company's products obsolete, that the
Company's existing products and services can be successfully adapted to serve
the needs of the drug discovery and development market or that the Company will
be able to keep pace with technological developments.

Competition. Competition in the drug discovery and development sector of
the biotechnology industry is intense. The Company believes that its assays may
be used throughout the secondary screening and lead optimization portions of the
drug discovery process. The Company, therefore, faces competition from firms
which are pursuing the same or similar technologies as those which constitute
the Company's technology platform, as well as from all other technologies or
processes that are or can be used by drug developers to develop "hits" into lead
compounds or to optimize lead compounds into drug development candidates. The
Company faces competition both from other firms which, like Xenometrix, are
developing drug discovery tools and services and from drug researchers using
their own proprietary drug discovery methods in house. As a result, the Company
faces competition from large pharmaceutical companies, biotechnology companies,
academic and research institutions and government agencies.

The Company's technology platform principally consists of using genetically
engineered cell based assays to measure gene activity. The Company also is
working to develop high throughput screening capabilities for its assays. A
number of pharmaceutical and biotechnology companies are active in the areas of
gene expression assays and high throughput screening. Such competitors include
Aurora Biosciences Corporation, Digital Gene Technology, Inc., Gene Logic, Inc.,
Cerep, S.A., Perkin-Elmer Corporation, Phase-1 Molecular Toxicology, Inc. and
OSIP. There may also be several private companies, which are pursuing drug
discovery using gene transcription methods, which could be considered
competitors of the Company. In addition, the Company faces competition from
traditional methods used by drug researchers to identify and optimize lead
compounds, such as receptor binding assays, other in vitro assays and animal
testing.

21
<PAGE>

It is very common in the drug discovery industry for biotechnology firms to
have one or more significant corporate partners or collaborative arrangements.
An important part of the Company's strategy is to enter into such arrangements
with major pharmaceutical companies and other drug discovery firms. The Company,
therefore, competes for opportunities to enter into promising collaborative
arrangements with other biotechnology firms and also competes for the limited
funds which major pharmaceutical firms can commit to outsourced lead
identification and optimization activities.

Historically, pharmaceutical and biotechnology companies have maintained
close control over their research activities, including the synthesis, screening
and optimization of chemical compounds. Many of these companies, which represent
the greatest potential market for the Company's products and services, have
developed or are developing, at substantial cost, internal programs and
methodologies to approach drug discovery efforts. The Company competes with the
processes internally developed by pharmaceutical and biotechnology companies,
who must be convinced that Xenometrix's drug discovery products and services
justify outsourcing a portion of these activities to the Company.

As a result of drug discovery industry characteristics, many companies that
could be customers or collaborators of Xenometrix may also be actual or
potential competitors, either alone or in combination with other firms. Many of
Xenometrix's actual or potential competitors have been addressing the drug
discovery market for a longer period of time than the Company, have already
established corporate partnering relationships and have significantly greater
financial and other resources than those available to the Company. There can be
no assurance that the Company will be able to develop products, which are
competitive with those offered by existing or future competitors.

Fluctuations in Operating Results The Company's operating results may vary
significantly from quarter to quarter or year to year, depending on factors such
as the timing of license agreements, timing of product development and
commercialization programs of the Company's customers, the timing and terms of
collaborative or corporate partner agreements entered into by Xenometrix, the
timing of increased research and development and sales and marketing expenses,
the timing and size of orders and the introduction of new products by the
Company and by competitors. The Company's current and planned expense levels are
based in part on its expectations as to future revenue. Consequently, revenue
and operating results may vary significantly from quarter to quarter or year to
year and revenue and operating results in any period will not necessarily be
predictive of results in subsequent periods.

Manufacturing; Dependence on Outside Suppliers. Although Xenometrix has
produced quantities of certain of its products for limited sales, it has no
experience in manufacturing its products in large commercial quantities, and
there can be no assurance that it will be able to make a successful transition,
if necessary, to large-scale commercial production or to manufacture its
products at a commercially viable cost.

Certain key components and raw materials used in the manufacturing of the
Company's products are currently provided by single source vendors. Although the
Company believes that alternative sources for such components and raw materials
are available, an interruption in the supply of a sole-sourced raw material
would have a material adverse effect on the Company's ability to manufacture
products until a new source of supply was qualified and, as a result, might have
a material adverse effect on the Company's business. In addition, an uncorrected
impurity or supplier's variation in a raw material, either unknown to the
Company or incompatible with the Company's manufacturing process, could have a
material adverse effect on the Company's ability to manufacture products and/or
the performance of the product. Also, because the Company is a small customer of
many of its suppliers, there can be no assurance that suppliers will devote
adequate resources to supplying the Company's needs.

22
<PAGE>

Dependence upon Key Personnel. The Company depends on the services of
certain key personnel, particularly those of Dr. Pauline Gee, its President and
Chief Scientific Officer, B. John Schneider, Director of Client Research and
Operations, and Jill Yates, Office Manager. The Company does not maintain key
man insurance policies on the lives of its executives. Currently, the Company
has an employment agreement with Dr. Gee that expires on December 17, 1999.
Xenometrix believes that the loss of the services of any of these key employees
could have a material adverse effect on the Company.

Competition among pharmaceutical and biotechnology companies for qualified
employees is intense, and the loss of any such qualified employees, or an
inability to attract, retain and motivate any additional highly skilled
employees necessary for the maintenance and expansion of the Company's
activities, could have a material adverse effect on the Company. There can be no
assurance that the Company will be able to retain its existing personnel or to
attract additional qualified employees.

Risk of Contamination The Company relies heavily on the maintenance and
distribution of mammalian, bacterial and yeast cells for the manufacturing of
its various products. Although rare, contamination of cell culture, particularly
mammalian culture, by the introduction of agents such as molds, fungi,
mycoplasma or bacteria, is a risk associated with these processes. It is
possible for assays to perform aberrantly as a consequence of undetected
contamination. If such contamination were to be detected, the Company might be
required to halt production of particular assay(s) in order to establish the
cause and eliminate such contamination. The Company has established quality
control standards for minimizing the potential for contamination, and for
effectively eliminating contamination after it is detected, but cannot guarantee
that such contamination will not occur.

Hazardous Materials The Company's research and development involves the
controlled use of hazardous materials, chemicals and various radioactive
compounds. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state
and federal regulations, the risk of accidental contamination or injury from
these materials cannot be completely eliminated. Although the Company maintains
workers' compensation and liability insurance, there can be no assurance that,
in the event of such an accident, the Company would not be held liable for any
damages that result, that the Company's insurance coverage would be adequate to
cover such liabilities or that any such excess liability would not exceed the
resources of the Company. The Company may incur substantial costs of compliance
with environmental regulations if the Company expands its manufacturing
capacity.

Product Liability; Availability of Insurance Although the Company has
obtained product liability insurance, there can be no assurance that it will be
able to maintain such insurance on acceptable terms or that insurance will
provide adequate coverage against potential liabilities.

Anti-Takeover Effects of Certain Provisions of Certificate of Incorporation
and By-laws The Company's Certificate of Incorporation authorizes the Board of
Directors to issue up to 5,000,000 shares of Preferred Stock, par value $.001
per share. The Preferred Stock may be issued in one or more series, the terms of
which may be determined at the time of issuance by the Board of Directors,
without further action by the stockholders, and may include voting rights
(including the right to vote as a class or series on particular matters),
preferences as to dividends and liquidation, conversion and redemption rights,
and sinking fund provisions. The issuance of any Preferred Stock could
materially adversely affect the rights of holders of Common Stock and,
therefore, could reduce the value of the Common Stock. In addition, specific
rights granted to future holders of Preferred Stock could be used to restrict
the Company's ability to merge with, or sell its assets to, a third party, and
thereby preserving control of the Company by present stockholders. The issuance
of Preferred Stock may, in some circumstances, deter or discourage takeover
attempts and other changes in control of the Company, including takeovers and
changes in control which some holders of the Common Stock may deem to be in
their best interests and in the best interests of the Company, by making it more
difficult for a person who has gained a substantial equity interest in the
Company to obtain voting control or to exercise control, thereby effectively
preserving control of the Company for the current controlling stockholders.

The Company's Certificate of Incorporation and By-laws (the "Charter
Documents") provide that (i) the Company's Board of Directors may fix the number
of Directors, (ii) the Company's Board of Directors may fill any vacancies of
the Board of Directors, (iii) stockholders may not act by written consent and
(iv) any stockholder proposals or director nominations be submitted to the

23
<PAGE>

Company well in advance of the mailing of the Company's proxy statement. These
provisions in certain circumstances could discourage a future attempt to acquire
control of the Company, make it more difficult for stockholders to change the
composition of the Company's Board of Directors or management team and make a
proxy contest a less effective means of removing or replacing existing directors
or effecting a change in control of the Company which is opposed by the Board of
Directors.

Item 7. Financial Statements

The financial statements begin on page F1.

Item 8. Change in Certifying Accountant

In June 1999, the Company filed a Form 8-K report to the Securities and
Exchange Commission to change its independent accountants.
PricewaterhouseCoopers, LLP ("PWC") reported on the Company's financial
statements in the past two fiscal years and contained no adverse opinion or
disclaimer of opinion. There were no disagreements with PWC on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure. The Company's Audit Committee approved the decision to
change from PWC to Gordon, Hughes and Banks, LLP as its new independent
accountants.

Part III

Items 9 through 12

The information contained in the Xenometrix Proxy Statement for the annual
meeting of stockholders, under the headings, "Election of Directors", "Executive
Officers", "Executive Compensation", "Security Ownership of Certain Beneficial
Owners and Management", "Certain Relationships and Related Transactions" and
"Principal Stockholders" is incorporated herein by reference. The Proxy
Statement will be filed with the Securities and Exchange Commission within 120
days after June 30, 1999.

24
<PAGE>

Part IV

Item 13. Exhibits and Reports of Form 8-K

(a) Exhibits

Exhibit
Number Description of Document
------ -----------------------

3.1+ Certificate of Incorporation of the Registrant, filed with
the Secretary of State of Delaware on June 15, 1992.
3.2+ Certificate of Merger of the Registrant filed with the
Secretary of State of Delaware on July 29, 1992.
3.3+ Certificate of Amendment of Certificate of Designation of
the 5% Cumulative Convertible Series A Preferred Stock of
the Registrant.
3.4+ Certificate of Amendment of Certificate of Designation of
the 5% Cumulative Convertible Series B Preferred Stock of
the Registrant.
3.5+ Certificate of Amendment of Certificate of Incorporation of
the Registrant with regard to the reverse stock split.
3.6+ Amended and Restated By-Laws of the Registrant.
3.7+ Certificate of Amendment of Certificate of Incorporation of
the Registrant with regard to the addition of Article XII.
3.8+ Certificate of Elimination of the 5% Cumulative Convertible
Series A Preferred Stock of the Registrant.
3.9+ Certificate of Elimination of the 5% Cumulative Convertible
Series B Preferred Stock of the Registrant.
3.10+ Certificate of Amendment of Certificate of Incorporation of
the Registrant with regard to the reduction of the number
of the Registrant's authorized shares.
3.11+ Amendment to the Amended and Restated By-laws of the
Registrant as Approved by the Registrant's Board of
Directors on September 12th, 1995 and September 27th, 1995.
4.1+ Certificate representing shares of Common Stock.
4.2+ Warrant.
4.3+ Warrant Agreement.
10.1+ Form of Indemnity Agreement between the Registrant and its
directors and Executive officers.
10.5+ Employment Agreement, dated as of October 5, 1995, between
the Registrant and Pauline Gee.
10.7+ Amended and Restated Stock Option Plan of the Registrant.
10.8+ 1993 Non-Employee Directors Stock Option Plan of the
Registrant.
10.9+ Form of Proprietary Information and Inventions Agreement
between the Registrant and each of its employees.
10.10+ Voting Agreement, dated as of December 2, 1994, among the
Registrant and certain of its stockholders.
10.11+ Registration Rights Agreement, dated as of December 31,
1991, between the Registrant and certain of its
stockholders.
10.12+ Form of Subscription and Preferred Stock Purchase Agreement
between the Registrant and each purchaser of shares of its
5% Cumulative Convertible Series A Preferred Stock.
10.13+ Form of Warrant for the Purchase of shares of 5% Cumulative
Convertible Series A Preferred Stock of the Registrant.
10.14+ Form of Preferred Stock Purchase Agreement among the
Registrant and the Purchasers of shares of its 5%
Cumulative Convertible Series B Preferred Stock.
10.15+ Form of Amendment No. 2 to Subscription and Preferred Stock
Purchase Agreement among the Registrant and the purchasers
of shares of its 5% Cumulative Convertible Series A
Preferred Stock.
10.16+** Exclusive License Agreement, effective October 1, 1994,
between the Regents of the University of California and the
Registrant.

25
<PAGE>

Exhibit
Number Description of Document
------ -----------------------

10.17+** License Agreement, effective January 18, 1992, between the
President and Fellows of Harvard College and the
Registrant.
10.18+** License Agreement, dated May 27, 1992, among GeneBioMed,
Inc., Robert Schiestl and Venmark Ltd.
10.19+ Lease Agreement, dated January 8, 1993, between Wilderness
Place, Ltd. and the Registrant.
10.20+ Exchange Agreement, dated as of January 31, 1993, between
D.H. Blair Holdings, Inc. and the Registrant.
10.21+ Amendment to Preferred Stock Purchase Agreement, dated as of
May 6, 1994, among the Registrant and the purchasers of
Shares of its 5% Cumulative Convertible Series B Preferred
Stock.
10.22* License Agreement dated January 1, 1996 between Stanford
University and the Registrant.
10.23** License Agreement dated June 4, 1996 between The Wistar
Institute and the Registrant.
10.24*** Lease dated July 1, 1996 between Flatirons Cottonwood, Inc.
and the Registrant.
10.25*** Lease Termination Agreement effective July 1996 between
Wilderness Place, Ltd. and the Registrant.
10.26*** Lease Takeover Agreement effective July 1996 between NexStar
Pharmaceuticals, Inc. and the Registrant.
10.33++ Amendment dated January 16, 1998 to the Employment Agreement
dated October 5, 1995, between the Company and Pauline Gee
10.39** License Agreement dated April 17, 1998 between Aurora
Biosciences Corporation and the Registrant.
10.41** License Agreement dated June 5, 1998 between Cerep S.A. and
the Registrant.
10.43** License Agreement dated July 27, 1998 between Phase-1
Molecular Toxicology, Inc. and the Registrant.
10.44 Employment Agreement, dated as of December 17, 1998, between
the Registrant and Pauline Gee.
23.1 Consent of PricewaterhouseCoopers LLP.
27.1 Summary Financial Information Schedule.

- ----------

+ Incorporated herein by reference from Xenometrix's Form SB-2 Registration
Statement, Registration No. 33-96636-D, dated October 17, 1995.

** Xenometrix has been granted or is applying for confidential treatment with
respect to portions of these exhibits.

*** Incorporated herein by reference from Xenometrix's Form 10-KSB for the
fiscal year ended June 30, 1996.

(b) Reports on Form 8-K

On February 10, 1999, Registrant filed a Form 8-K reporting the Company's
execution of eight license agreements, a corporate restructuring to four
employees and changes in the Company's management and Board of Directors.
Mr. Stephen J. Sullivan resigned as President and CEO and was elected
non-executive Chairman of the Board, and Dr. Pauline Gee was appointed
President and Chief Scientific Officer, the sole officer of the Company.

On June 30, 1998, Registrant filed a Form 8-K reporting that it had changed
independent accountants, from PricewaterhouseCoopers, LLP to Gordon, Hughes
and Banks, LLP.

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<PAGE>

Signatures

Pursuant to Section 13 of the Securities Exchange Act of 1934, the Registrant
has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized on the 30th day of September, 1999.

XENOMETRIX, INC.

By: /s/ Pauline Gee
-------------------
September 30, 1999 Pauline Gee
President, Chief Scientific Officer

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Dr. Pauline Gee, his or her attorney-in-fact, each with
the power of substitution, for him or her in any and all capacities, to sign any
amendments to this Report, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact, or his
or her substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the Exchange Act, this Report has been signed on behalf of
Xenometrix and in the capacities indicated.

Signature Title Date
- --------- ----- ----

/s/ Stephen J. Sullivan Chairman, Corporate September 30, 1999
- ----------------------- Secretary, Director
Stephen J. Sullivan

/s/ Walter M. Lovenberg Director September 30, 1999
- -----------------------
Walter M. Lovenberg, Ph.D.

/s/ John K. A. Prendergast Director September 30, 1999
- --------------------------
John K. A. Prendergast, Ph.D.

/s/ Randal P. Schumacher Director September 30, 1999
- ------------------------
Randal P. Schumacher

27
<PAGE>

Xenometrix, Inc.

Index To Financial Statements

Report of Independent Accountants for Year Ended June 30, 1998.............. F-1

Report of Independent Accountants for Year Ended June 30, 1999.............. F-2

Balance Sheet as of June 30, 1999 and 1998.................................. F-3

Statement of Operations for the Years Ended June 30, 1999 and 1998.......... F-4

Statement of Changes in Stockholders' Equity for the Years Ended
June 30, 1999 and 1998..................................................... F-5

Statement of Cash Flows for the Years Ended June 30, 1999 and 1998.......... F-6

Notes to Financial Statements............................................... F-7

<PAGE>

Report of Independent Accountants

To the Board of Directors and
Stockholders of Xenometrix, Inc.

In our opinion, the balance sheet and the related statements of operations, of
cash flows and of changes in stockholders' equity as of and for the year ended
June 30, 1998, present fairly, in all material respects, the financial position,
results of operations and cash flows of Xenometrix, Inc. (the "Company") as of
and for the year ended June 30, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above. We have not audited the
financial statements of Xenometrix, Inc. for any period subsequent to June 30,
1998.

The financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 1 to the financial statements,
the Company has suffered recurring losses from operations and has an accumulated
deficit of $16,698,000 at June 30, 1998 that raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.

/s/ PricewaterhouseCoopers LLP
- ------------------------------
PricewaterhouseCoopers LLP

Broomfield, Colorado
September 1, 1998

F-1

<PAGE>

Report of Independent Certified Public Accountants

Board of Directors and Stockholders
Xenometrix, Inc.
Boulder, Colorado

We have audited the accompanying balance sheet of Xenometrix, Inc. as of June
30, 1999 and the related statements of operations, stockholders' and cash flows
for the year then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Xenometrix, Inc. as of June 30,
1999 and the results of operations and cash flows for the year then ended, in
conformity with generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered losses in prior years from
operations, has material liabilities and has an accumulated deficit of
$16,149,000, all of which raise substantial doubt about its ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note 1. The financial statements do not include any adjustments
that might result from the outcome of this uncertainty.

/s/ Gordon, Hughes & Banks, LLP
- ------------------------------
Gordon, Hughes & Banks, LLP

August 31, 1999
Englewood, Colorado

F-2

Xenometrix, Inc.
Balance Sheet

Assets

June 30,
----------------------------
1999 1998
---- ----
<S> <C> <C>
Cash and cash equivalents $ 137,000 $ 341,000
Accounts receivable, net of allowance for doubtful accounts
of $5,000 and $10,000 in 1999 and 1998, respectively 80,000 115,000
Inventory, net 46,000 55,000
Prepaid insurance 83,000 181,000
Other current assets 50,000 52,000
------------ ------------

Total current assets 396,000 744,000
Property and equipment, net 453,000 654,000
Patents, net of accumulated amortization of $584,000 and
$427,000 in 1999 and 1998, respectively 373,000 340,000
------------ ------------
$ 1,222,000 $ 1,738,000
============ ============

Liabilities and Stockholders' Equity (Deficit)

Accounts payable $ 361,000 $ 356,000
Accrued salaries and wages 143,000 163,000
Other accrued liabilities 529,000 426,000
Senior promissory notes, net of discount of $105,000
in 1998 242,000 1,395,000
------------ ------------
Total current liabilities 1,275,000 2,340,000
------------ ------------

Commitments and contingencies (Note 4)

Stockholders' Equity (Deficit):
Preferred stock -- $0.001 par value; 5,000,000 shares
authorized, no shares issued and outstanding
at June 30, 1999 and 1998 -- --
Common stock -- $0.001 par value; 20,000,000 shares
authorized, 2,950,000 and 2,948,000 shares issued and
outstanding at June 30, 1999 and 1998, respectively 3,000 3,000
Additional paid-in capital 16,093,000 16,093,000
Accumulated deficit (16,149,000) (16,698,000)
------------ ------------
Total stockholders' equity (deficit) (53,000) (602,000)
------------ ------------
$ 1,222,000 $ 1,738,000
============ ============

The accompanying notes are an integral part of these financial statements.

F-3
</TABLE>
<PAGE>

Xenometrix, Inc.
Statement of Operations

Year Ended June 30,
--------------------------
1999 1998
---- ----

Revenue:
Products and services $ 407,000 $ 611,000
Licensing revenue 2,730,000 1,275,000
----------- -----------
Total revenue 3,137,000 1,886,000
Cost of revenue:
Cost of products and services 560,000 523,000
Cost of licensing revenue 449,000 104,000
----------- -----------
Total cost of revenue 1,009,000 627,000
----------- -----------
Gross profit 2,128,000 1,259,000
----------- -----------
Research and development 276,000 1,150,000
Selling, general and administrative 1,061,000 1,833,000
----------- -----------
Total operating expense 1,337,000 2,983,000
----------- -----------
Operating income (loss) 791,000 (1,724,000)

Interest income (expense), net (242,000) (641,000)
----------- -----------

Net income (loss) $ 549,000 $(2,365,000)
=========== ===========

Income (loss) per common share - basic $ 0.19 $ (0.80)
=========== ===========

Income (loss) per common share - diluted $ 0.17 $ (0.80)
=========== ===========

Weighted average shares outstanding - basic 2,948,000 2,948,000
=========== ===========

Weighted average shares outstanding - diluted 3,158,000 2,948,000
=========== ===========

The accompanying notes are an integral part of these financial statements.

F-4
<PAGE>
<TABLE>
<CAPTION>

Xenometrix, Inc.
Statement of Changes in Stockholders' Equity (Deficit)

Convertible Additonal
Common Stock Preferred Stock Paid in Accumulated
Shares Amount Shares Amount Capital Deficit Total
------ ------ ------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1997 2,945,000 $ 3,000 -- $ -- $ 15,795,000 $(14,333,000) $ 1,465,000

Stock options exercised 3,000 1,000 1,000
Value allocated to warrants issued
with senior promissory notes 187,000 187,000
Revaluation of warrants upon change
in exercise price 110,000 110,000
Net loss (2,365,000) (2,365,000)
------------ ---------- ------ ------- ------------ ------------ ------------
Balance at June 30, 1998 2,948,000 3,000 -- -- 16,093,000 (16,698,000) (602,000)

Stock options exercised 2,000 --
Net income 549,000 549,000
------------ ---------- ------ ------- ------------ ------------ ------------
Balance at June 30, 1999 2,950,000 $ 3,000 -- $ -- $ 16,093,000 $(16,149,000) $ (53,000)
============ ========== ====== ======= ============ ============ ============

The accompanying notes are an integral part of these financial statements.

F-5
</TABLE>
<PAGE>
<TABLE>
<CAPTION>

Xenometrix, Inc.
Statement of Cash Flows

Year Ended June 30,
--------------------------
1999 1998
---- ----
Cash flows from operating activities:
<S> <C> <C>
Net income (loss) $ 549,000 $(2,365,000)

Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities:
Depreciation and amortization 358,000 349,000
Amortization of note discount 105,000 417,000
Provision for inventory obsolesence -- 5,000
Provision for doubtful accounts (5,000) (25,000)
Net book value of retired assets -- 1,000
Changes in assets and liabilities:
Accounts receivable 40,000 133,000
Receivable from termination of operating lease -- 115,000
Inventory 9,000 41,000
Prepaid insurance 98,000 (65,000)
Other current assets 1,000 43,000
Accounts payable and accrued liabilities 89,000 234,000
----------- -----------
Net cash provided (used) by operating activities 1,244,000 (1,117,000)
----------- -----------

Cash flows from investing activities:
Capital expenditures -- (17,000)
Patent acquisition cost (190,000) (129,000)
----------- -----------
Net cash used in investing activities (190,000) (146,000)
----------- -----------

Cash flows from financing activities:
Net proceeds from senior promissory notes (1,258,000) 1,000,000
Net proceeds from issuance of common stock -- 1,000
----------- -----------
Net cash used (provided) by financing activities (1,258,000) 1,001,000
----------- -----------

Net change in cash (204,000) (262,000)
Cash and cash equivalents at beginning of year 341,000 603,000
----------- -----------
Cash and cash equivalents at end of year $ 137,000 $ 341,000
=========== ===========

Supplemental disclosure of cash flow information:
Interest paid $ 291,000 $ 76,000
=========== ===========

The accompanying notes are an integral part of these financial statements.

F-6
</TABLE>
<PAGE>

XENOMETRIX, INC.

NOTES TO FINANCIAL STATEMENTS

1. Organization and Summary of Significant Accounting Policies

Xenometrix, Inc. ("Xenometrix" or the "Company"), a Delaware corporation,
is a biotechnology company with proprietary technology designed to characterize
the cells' response to pharmaceutical compounds and other chemicals. The
Company's gene response profiling systems improve the effectiveness of drug
discovery and development for the pharmaceutical industry and the manufacture of
chemicals used in the production of many commodities. Xenometrix genetically
engineers living cells with gene promoters that enable researchers to quantify
the level of gene expression when the cells are exposed to chemicals and other
agents like ultraviolet light. This proprietary platform technology can be used
by chemical, pharmaceutical, and biotechnology companies to optimize their
products. Xenometrix offers this technology in the form of molecular information
assays that are used by customers in their facilities. The Company's Client
Research Laboratory provides a testing and evaluation service to clients who do
not wish to perform the evaluation of their compounds in their own facilities.
The Company offers reasonable worldwide non-exclusive licenses to companies that
engage in gene expression profiling of chemicals. Xenometrix was incorporated on
July 24, 1991.

Financial Condition

The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplates continuation of the
Company as a going concern. At June 30, 1999, Xenometrix had an accumulated
deficit of $16,149,000, which is approximately $549,000 less than the
$16,698,000 deficit at June 30, 1998. Subsequent to June 30, 1999, the Company
has repaid the Senior Promissory Notes (the "Notes"), as described more fully in
Note 4. At June 30, 1999, the Company had cash equivalents of $137,000. The
Company has significant future cash expenditure requirements related to the
accumulated accounts payable. Management believes that the cash equivalents on
hand and the cash to be provided from accounts receivable and licensing
agreements will be sufficient to meet those requirements through December 1999.
The Company's future capital requirements will depend on many factors, including
the pace of growth, if any, in sales and services, progress of Xenometrix's
research and development programs, the cost of obtaining access to new
technology, the cost involved in filing, prosecuting and enforcing patent
claims, payments received under prospective collaborative agreements, agreements
for and changes in collaborative research relationships, the cost associated
with commercialization of its products, the cost and availability of third party
financing for capital expenditures, and legal and administrative expense. While
Management believes that actions presently taken to revise the Company's
operating and financial requirements might provide the opportunity for the
Company to continue as a going concern, the Company continues to explore
strategic alternatives and opportunities to continue to develop its competitive
position in pharmacogenomics.

Revenue Recognition

Revenue from product sales is recognized upon shipment. Revenue from
contract laboratory services and product development is recognized as such
services are performed and a study report is shipped. Revenue from the up-front
payments due to the Company under patent licensing agreements is recognized upon
receipt of monies at the execution of agreements, provided the Company has no
future obligation with respect to such payments and provided the arrangements
contain no provisions which would permit offsetting those payments against
future royalties or other sums due to the Company.

Financial Instruments and Concentration of Credit Risk

Credit risk represents the accounting loss that would be recognized if
counterparties to financial instruments failed to perform as contracted.
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash, receivables, prepaid expenses and
deposits. The Company maintains its cash at a high quality financial
institution. Receivables are from customers and partners in the pharmaceutical
industry and have historically demonstrated payment is less than 90 days.
Prepaid expenses relate to insurance policies, all of which are in force, and
deposits are associated with office and laboratory space and equipment leases
currently in use. The carrying amounts of the Company's financial instruments,
including cash, accounts receivable, accounts payable, and accrued liabilities
approximate their fair values.

F-7
<PAGE>

Xenometrix sells its products and services primarily to companies in the
pharmaceutical, biotechnology, chemical, and consumer products industries as
well as to governmental agencies, which means receivables are concentrated in
these sectors. The market for the products and services sold by Xenometrix is to
a limited number of customers. During the year ended June 30, 1999, one customer
accounted for 56% of total product and services which is 11% of total revenue.
Export sales accounted for 68% of total sales, with 56% in Switzerland, 8% in
Belgium and the remaining 3% in several other European and Asian countries. In
the year ended June 30,1998, one customer accounted for 19% of total sales.
Export sales accounted for 34% of total sales, with 19% in Switzerland, 6% in
Belgium and the remaining 9% from several European and Asian countries.

Concentration of Materials Supply

Certain essential components and raw materials used in the manufacturing of
Xenometrix's products are currently provided by single source vendors. Although
Xenometrix believes that alternative sources for such components and raw
materials are available, an interruption in the supply of sole-sourced materials
could have a material adverse effect on Xenometrix's ability to manufacture
products until a new source of supply is found and, as a result, could have a
material adverse effect on the Company's business.

Licensing Revenue

During the years ended June 30, 1999 and 1998, the Company entered into
several nonexclusive license agreements and option agreements relating to the
licensing and the sub-licensing of the Company's patents, licensed patents, and
intellectual property. In accordance with the terms of the non-exclusive license
agreements, the Company recognized up-front payments received as licensing
revenue during the years ended June 30, 1999 and 1998.

Research and Development Cost

Research and development costs are expensed as incurred.

Net Income (Loss) Per Common Share

Net income (loss) per common share is computed using the Financial
Accounting Standards Board's Statement of Financial Accounting Standards (SFAS)
No. 128, "Earnings Per Share" (EPS). SFAS No. 128 establishes standards for
computing and presenting EPS and supercedes all prior EPS guidance found in APB
Opinion 15.

Basic income per common share is computed by dividing the net income by the
weighted-average number of common shares outstanding during the period.

Diluted income per share is computed using the treasury stock method, based
upon the weighted-average number of common shares, dilutive common stock
equivalent shares and the assumed conversion of any dilutive convertible
securities outstanding during the period. Because the inclusion of these common
stock equivalents and convertible securities would be anti-dilutive for the
fiscal year ended June 30, 1998, they are excluded from the Company's
calculation of diluted loss per share for that fiscal year.

Stock Options and Warrants

The Company continues to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the amount an employee (directors are treated as
employees) must pay to acquire the stock. Statement of Financial Accounting
Standards ("SFAS") No. 123, " Accounting for Stock-Based Compensation,"
established accounting and disclosure requirements using a fair value based
method for stock based employee (and director) compensation plans. The Company
has elected to remain on its current method of accounting as described above,
and has adopted the disclosure requirements for SFAS No. 123. Changes in any
terms of warrants issued to other than employees and directors are treated as a
replacement of the old warrants with new warrants. In accordance with SFAS 123,
the Company records the increment in value of the new warrants over the old
warrants as additional expense using the fair value based method calculation.

F-8
<PAGE>

Statement of Cash Flows

Xenometrix considers all highly liquid investments, purchased with a
maturity of three months or less, to be cash equivalents.

Inventory

Inventory is stated at the lower of cost or market and is computed using
the first-in, first-out method. Inventory is comprised of raw materials of
$37,000 and work in process of $13,000 at June 30, 1999 and raw materials of
$111,000 at June 30, 1998. The Company recorded reserves for inventory
obsolescence of $4,000 at June 30, 1999 and $56,000 at June 30, 1998.

Depreciation and Amortization

Depreciation and amortization is computed using the straight-line method
over the estimated useful lives of the respective assets, which ranges from
three to seven years. Leasehold improvements are amortized over the shorter of
the estimated asset life or the term of the lease. Maintenance and repairs are
expensed as incurred.

Patent Cost

The cost of obtaining patents on the Company's technology is capitalized as
incurred. Amortization of that cost is computed using the straight-line method
over the estimated useful lives of five years.

Reclassifications

Certain 1998 amounts have been reclassified to conform with the 1999
presentation.

Significant Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities as of the date of the financial
statements, and the reported amounts of revenue and expenses during the periods.
Significant estimates have been made by management in several areas including
the realizability of the Company's deferred tax assets (see Note 7). Actual
results could differ materially from these estimates making it reasonably
possible that a change in these estimates could occur in the near term.

Income Taxes

The Company uses the asset and liability method of accounting for income
taxes. Under the asset and liability method, deferred income tax assets and
liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. This method also
requires the recognition of future benefits such as net operating loss
carryforwards, to the extent that realization of such benefits are more likely
than not. Valuation allowances are provided against assets that are not likely
to be realized. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in the tax rate is recognized in
income in the period that the includes the enactment date.

Recently Issued Accounting Standards

In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130, which is effective for
all fiscal years beginning after December 15, 1997, establishes standards for
reporting and displaying comprehensive income and its components with the same
prominence as other financial statement items. All prior periods must be
restated to conform with the provisions of SFAS No. 130. The Company adopted
SFAS No. 130 during the quarter ended September 30, 1998, with no material
impact on the Company's reported financial statements.

F-9
<PAGE>

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131, which is effective for
fiscal years beginning after December 15, 1997, establishes new disclosure
requirements for operating segments, including products, services, geographic
areas, and major customers. The Company adopted SFAS No. 131 for the 1999 fiscal
year, but does not expect the new accounting standard to have a material effect
on the Company's reported financial results. The Company previously reported two
revenue segments, products and service income and licensing revenues in 1998 and
1999.

Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pension and other Post Retirement Benefits" (SFAS No. 132) is
effective for financial statements with fiscal years beginning after December
31, 1997. Earlier application is permitted. The new standard revise employers'
disclosures about pension and other post retirement benefit plans but does not
change the measurement or recognition of those plans. SFAS No. 132 standardizes
the disclosure requirements for pensions and other post retirement benefits to
the extent practicable, requires additional information on the changes in the
benefit obligations and fair values of the plan assets that will facilitate
financial analysis, and eliminates certain disclosures previously required when
no longer useful. The Company adopted SFAS No. 132 in fiscal year 1999, with no
material impact on its financial statements.

In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes standards for recognizing all derivative
instruments including those for hedging Activities as either assets or
liabilities in the statement of financial position and measuring those
instruments at fair value. In June 1999, the FASB issued SFAS No. 137 which
delayed the effective date of FASB No. 133. SFAS NO. 137 is effective for fiscal
years beginning after June 15, 2000. The Company will adopt SFAS No. 133 in the
fiscal year 2000 and believes that there will be no impact on its financial
statements.

2. Property and Equipment

Property and equipment is stated at cost and is comprised of the following:

June 30
--------------------------
1999 1998
---- ----

Laboratory equipment ............................. $ 388,000 $ 420,000
Leasehold improvements ........................... 501,000 501,000
Computer equipment and software .................. 158,000 204,000
Office equipment and furniture ................... 208,000 209,000
----------- -----------
1,255,000 1,334,000
Less accumulated depreciation and amortization ... (802,000) (680,000)
----------- -----------
$ 453,000 $ 654,000
=========== ===========

Depreciation expense for the years ended June 30, 1999 and 1998 was
approximately $201,000 and $223,000, respectively.

F-10
<PAGE>

3. Commitments and Contingencies

Leasing Arrangements

Xenometrix leases certain of its equipment and its facilities under
non-cancelable operating leases. Future minimum lease payments under such leases
at June 30, 1999 are as follows:

Year Ending June 30,
2000.................................................. $ 352,000
2001.................................................. 343,000
2002.................................................. 318,000
2003.................................................. 26,000
Thereafter................................................... --
----------
$1,039,000
==========

Gross rent expense for the years ended June 30, 1999 and 1998 was approximately
$344,000 and $313,000, respectively. Gross rent expense for the year ended June
30, 1999 has been reduced by payments of approximately $139,000 made to
Xenometrix under a sublease agreement with another biotechnology company.

Royalty Agreements

During the years ended June 30, 1999 and June 30, 1998, Xenometrix expensed
total royalties of $505,000 and $174,000 respectively. Xenometrix is obligated
to pay royalties on sales of testing kits or services and on sub-licensing
revenues pursuant to various technology licenses. These royalties are paid to
universities, not-for-profit research institutes and companies that have
royalty-sharing agreements with Xenometrix. Both current and former officers of
the Company have royalty-sharing agreements with these universities.

4. Senior Promissory Notes

Between June 20, 1997 and January 12, 1998, Xenometrix issued Notes in the
total amount of $1,500,000 to serve as bridge financing and were collateralized
by a security interest in all of the assets of the Company. In connection with
the issuance of these Notes, the Xenometrix issued warrants to purchase 499,995
shares of common stock. The Notes were originally due March 25, 1998, but were
extended until June 25, 1998, at an interest rate of 18% and was again extended
at the original interest rate of 12% until October 25, 1998. In consideration
for the extension of the Notes to June 25, 1998, the exercise price of the
warrants was reduced to $0.37 per share and the Company agreed to pay 38.5% of
all gross licensing revenues received during the extension to the Note holders,
as payment against the accrued interest and principal due on the Notes. On
October 25, 1998, the exercise price of the warrants was reduced further to
$0.125 per share in conjunction with an extension to February 25, 1999. The
interest rate on the Notes remained at 12% and the Company agreed to continue
paying 38.5% of licensing revenues. In addition to paying 38.5% of licensing
revenues, the Company paid $700,000 on March 15, 1999 towards the principal and
accrued interest on the Notes for an extension of the maturity date to June 15,
1999 without any further change to the number or the exercise price per share of
the Warrants. An extension to September 15, 1999 from June 15, 1999 was granted
upon payment of $50,000 on June 15, 1999 and $50,000 on July 15, 1999. Payment
of 38.5% of all gross licensing revenues, the exercise price and number of the
Warrants remained unchanged from the previous extension.

In accordance with SFAS 123, the Company has recorded the increment in
value of the warrants resulting from the reduction in the exercise price as a
discount from debt principal. As of June 30, 1999, all note discount has been
amortized. Amortization of expense of note discounts of $105,000 and $417,000
have been recognized for the years ended June 30, 1999 and 1998, respectively.

F-11
<PAGE>

5. Stock Options and Warrants

Stock Options

Xenometrix has two stock option plans; an Employee Stock Option Plan
("Employee Plan") and a Non-Employee Directors Stock Option Plan ("Director
Plan"). In November 1997, the shareholders authorized increases in the number of
stock options that may be granted under the Employee Plan and the Director Plan
to 960,000 and 350,000 shares, respectively, of common stock. The stock options
are generally granted at an exercise price not less than the fair market value
of the common stock on the date of grant as determined by the Board of
Directors. Options granted generally vest over thirty-six months and expire ten
years after the date of grant.

On June 25, 1998, the Board of Directors authorized the cancellation of all
stock options with an exercise price in excess of the then current fair market
value of the common stock in consideration for the issuance of new stock options
exercisable for seventy-five percent of the number of cancelled options, at an
exercise price equal to the current fair market value of the common stock. All
other terms and conditions of the cancelled options were to apply to the
replacement options issued under this plan. Under the Employee Plan, 780,956
options with a weighted average exercise price of $4.08 were forfeited and
585,717 new options with a weighted average exercise price of $0.38 were
granted. Under the Director Plan, 80,000 options with a weighted average
exercise price of $5.26 were forfeited and 60,000 new options with a weighted
average exercise price of $0.38 were granted.

On April 26, 1999, the Board of Directors authorized the cancellation of
55,000 options from Stephen J. Sullivan's total stock option grants. The Board
authorized that Mr. Sullivan's remaining options would continue to vest from the
period when Mr. Sullivan was an employee of Xenometrix through to the time when
he is no longer Chairman of the Board.

Stock option transactions are summarized below:

Employee Plan Director Plan
---------------------- --------------------
Weighted Weighted
Average Average
Exercise Exercise
Price Price
of Shares Of Shares
Shares Under Plan Shares Under Plan
------ ---------- ------ ----------

Outstanding at June 30, 1997 ..... 269,816 6.57 114,545 5.10
Granted .......................... 1,304,255 1.66 60,000 0.38
Exercised ........................ (3,182) 0.22 -- --
Forfeited ........................ (954,242) 3.90 (114,545) 5.10
---------- ------- ------- --------
Outstanding at June 30, 1998 ..... 616,647 $ 0.35 60,000 $ 0.38
========== ======= ======= ========
Granted .......................... 95,163 0.21 70,000 0.20
Exercised ........................ (2,112) 0.16 -- --
Forfeited ........................ (343,239) 0.34 (25,000) 0.30
---------- ------- ------- --------
Outstanding at June 30, 1999 ..... 366,459 $ 0.33 105,000 $ 0.28
========== ======= ======= ========

Available for issue, June 30, 1999 568,813 234,500
========== =======

F-12
<PAGE>

The following table summarizes information concerning outstanding and
exercisable options as of June 30, 1999:

Outstanding Options Exercisable
---------------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Life Exercise Number Exercise
Price Outstanding In Years Price Exercisable Price
----- ----------- -------- ----- ----------- -----
Employee Plan:
- --------------
$ 0.16 23,982 8.66 $ 0.16 7,994 $ 0.16
0.19 17,663 9.06 0.19 -- 0.19
0.22 58,500 9.82 0.22 -- 0.22
0.25 5,000 9.87 0.25 -- 0.25
0.38 261,314 7.90 0.38 142,089 0.38
------- ---- ------ ------- ------
366,459 8.34 $ 0.33 150,083 $ 0.36
======= ==== ====== ======= ======

Director Plan:
- --------------
$ 0.19 30,000 9.06 $ 0.19 -- $ 0.19
0.22 30,000 9.82 0.22 -- 0.22
0.38 45,000 6.98 0.38 41,250 0.38
------- ---- ------ ------ ------
105,000 8.39 $ 0.28 41,250 $ 0.38
======= ==== ====== ====== ======

The Company applies the intrinsic value method set forth in APB No. 25 in
accounting for its stock-based compensation plans. Net loss and net loss per
share as reported and as calculated pursuant to SFAS No. 123 to reflect the fair
value method of accounting for stock-based compensation plans (SFAS 123) were as
follows:

Year Ended
---------------------------------
June 30, 1999 June 30, 1998
------------- -------------
Net Income (Loss): As Reported $ 549,000 $(2,365,000)
SFAS 123 $ 519,000 $(2,846,000)

Basic Income(Loss)Per As Reported $0.19 $(0.80)
Share: SFAS 123 $0.18 $(0.97)

The weighted average fair values of options is estimated at $0.18 per
option granted during the year ended June 30, 1999 and $.94 per option granted
during the year ended June 30, 1998, using the Black-Scholes option pricing
model with the following weighted average assumptions: dividend yield of 0%,
volatility of 201% and 110%, risk-free interest rate of 5.38% and 5.7%, and an
expected life of 2 years, for the years ended June 30, 1999 and 1998,
respectively. Compensation cost for the options granted is computed reflecting
the actual forfeitures of options within the respective years.

In addition to the above options, options to purchase 110,000 units
(consisting of one common share of stock and a warrant to purchase an additional
share for $7.0875) at a price of $11.14 per unit are outstanding at June 30,
1999. These options were granted in October 1995 in connection with the
Company's initial public offering (the "IPO"), as part of the underwriter's
compensation. These options expire in October 2000.

F-13
<PAGE>

Stock Warrants

In August, 1995, Xenometrix issued warrants to purchase up to 18,182 shares
of common stock at a price of $8.40 per share to affiliates of a former director
and stockholder as consideration for the cancellation of a private placement
agreement. These warrants expire in August 2000.

Xenometrix issued warrants in connection with the 10% Senior Secured
Promissory Notes issued to serve as bridge financing prior to the Company's IPO
in October 1995. The warrants are exercisable until October 2000 for the
purchase of 200,000 shares of Xenometrix common stock at a price of $4.05 per
share. Holders of these warrants are entitled to "demand" and "piggyback"
registration rights with respect to the common stock issuable upon the exercise
of these warrants.

In connection with its IPO, Xenometrix issued 1,235,900 warrants to
purchase newly issued common stock at a price of $7.0875 per share, until
October 17, 2000. For these warrants to be exercisable, Xenometrix must maintain
a current registration statement with the Securities and Exchange Commission and
qualification with or approval from various state securities agencies. The
warrants are callable by Xenometrix after the public price of a share of
Xenometrix common stock is $13.50 or higher for 20 consecutive trading days.

In conjunction with the Notes issued in June 1997 through January 1998 (see
Note 5), Xenometrix issued warrants to purchase 499,995 shares of common stock.
In consideration for the October 25, 1998 to February 25, 1999 extension of the
due date on the Notes, the exercise price of the warrants was reduced to $0.125
per share. The warrants are exercisable during the ten year period ending on
September 24, 2007. Holders of these warrants are entitled to "demand" and
"piggy-back" registration rights with respect to the common shares issuable upon
exercise of these warrants. The amount expensed with regard to the revised
warrant exercise price was deemed not to be of material significance.

7. Income Taxes

At June 30, 1999, Xenometrix had net operating loss carryforwards for
federal income tax purposes of approximately $14,832,000. Annual utilization of
the loss carryforwards is subject to significant limitations due to historical
changes in Xenometrix's ownership. Future changes in ownership could further
reduce the annual availability of these benefits. If unused, the carryforwards
will expire beginning in 2007.

The tax effects of significant items comprising the Company's deferred
taxes are as follows:

June 30
-----------------------------
1999 1998
---- ----
Deferred tax assets
Net operating loss carryforwards ......... $ 5,784,000 $ 6,236,000
Patent and start-up cost ................. 157,000 118,000
Depreciation and amortization ............ 154,000 110,000
Other temporary differences, net ......... 82,000 109,000
----------- -----------
6,177,000 6,573,000

Valuation allowance ...................... (6,177,000) (6,573,000)
----------- -----------
Net deferred tax assets .................... $ 0 $ 0
=========== ===========

Deferred tax assets have been reduced to zero by a valuation allowance based on
current evidence which indicates that it is currently not considered likely that
these benefits will be realized. The valuation allowance decreased by $396,000
during the year ended June 30, 1999, primarily due to utilization of
approximately $825,000 of loss carryforwards partially offset by additional
losses for which no tax benefit was recorded.

F-14
<PAGE>

A reconciliation of differences between the statutory U.S. federal income
tax rate and the Company's effective tax rate follows:

1999 1998
---- ----

U.S. statutory rate 35.0% 35.0%
State taxes 4.0 4.0
Loss carryforwards (39.0) --
Valuation allowance -- (39.0)
---- ----
Effective tax rate 0.0% 0.0%
==== ====

8. Related Party Transactions

Xenometrix has had agreements with two former members and one current
member of its Board of Directors, under which they provide certain scientific,
managerial and financial consulting services to Xenometrix. During the years
ended June 30, 1999 and 1998, Xenometrix paid $3,500 and $43,000 for those
services, respectively. In December 1996, the Company entered into a consulting
agreement with Summercloud Bay, Inc., an entity controlled by Dr. John
Prendergast, one of Company's directors. The Company entered into a consulting
agreement with Stephen J. Sullivan, when he resigned as President and Chief
Executive Officer, and became non-executive Chairman of the Board of the
Directors. Both of these agreements have been terminated.

The Chairman of the investment groups holding Xenometrix's Notes is a
former member of the Board of Directors for Xenometrix.

9. Subsequent Events

Xenometrix shares ownership of these patents with Harvard University
("Harvard"), and has an exclusive worldwide license (the "Agreement") to
Harvard's portion of the intellectual property. The Company is in disagreement
with Harvard on a section of the Company's license agreement from Harvard and
filed a Demand for Arbitration with American Arbitration Association in December
1998. Arbitration proceedings were suspended in April 1999 by mutual agreement
between the Company and Harvard University in favor of negotiating the
differences directly. The parties are negotiating in good faith and expect to
settle any differences although either party has the right to resume binding
arbitration at any time. The nature and the date of the settlement are
unpredictable at this time.

Between June 20, 1997 and January 12, 1998, Xenometrix issued Notes in the
total amount of $1,500,000 to serve as bridge financing. The Notes were
collateralized by a security interest in all of the assets of the Company. The
Notes were originally due March 25, 1998. The maturity date on the Notes has
been extended at several month intervals until this last time to September 15,
1999. In September 1999, the Company repaid in full Notes which are no longer
collateralized by a security interest in all of the assets of the Company. In
connection with the issuance of these Notes, the Xenometrix issued warrants to
purchase 499,995 shares of common stock. The Note holders agreed that in the
event that the Company is acquired by a third party at a price per share that is
greater than the exercise price of the Warrants ($0.125), to surrender the
Warrants at the closing of such acquisition in exchange for either cash or
freely tradable common stock of the acquiring company in an aggregate amount
equal to the difference between the acquisition price per share and the exercise
price per share of the warrants, multiplied by the total number of Warrants held
by the Note holders.

F-15

Exhibit 10.44

EMPLOYMENT AGREEMENT

EMPLOYMENT AGREEMENT, dated as of December 17, 1998, by and between XENOMETRIX,
INC. a Delaware corporation (the "Corporation"), and PAULINE GEE (the
"Employee").

WITNESSETH:

WHEREAS, the Corporation desires to employ the Employee and the Employee desires
to be employed by the Corporation as its Vice President of Research and
Development, all pursuant to the terms and conditions hereinafter set forth; and

WHEREAS, the Employee recognizes that the Corporation is at this point in its
development dependent upon his capabilities, that its products during its first
years of operation may be few in number and limited in scope, and that the
imposition of the restriction set forth below upon the Employee and other key
employees and advisors may be essential to the success of the Corporation and
the livelihood of the Employee's associates in the Corporation;

NOW, THEREFORE, in consideration of the foregoing and the mutual promises and
covenants herein contained, it is agreed as follows:

1. EMPLOYMENT; DUTIES.

a) The Corporation engages and employs the Employee, and the Employee
hereby accepts engagement and employment, as the Vice President of
Research and Development. During the Employment Period (as hereinafter
defined), the Employee shall have responsibility for legal affairs of
the Corporation and performing such other services and duties,
consistent with the office of Vice President of Research and
Development, as he may from time to time be reasonable requested to
perform by the President and/or Board of Directors of the Corporation
(the "Board"). In performing his duties hereunder, the Employee shall
report directly to the President of the Corporation. If requested by
the Corporation and duly elected or appointed, the Employee will also
serve as a director of the Corporation without additional
compensation.

b) The Employee shall be located within a reasonable distance from
Boulder, Colorado so as to be able to perform his duties hereunder
from the Corporation's executive offices which will be located in
Boulder, Colorado; provided, however, that the Employee acknowledges
and agrees that the performance by the Employee of this duties
hereunder may require significant domestic and international travel by
the Employee.

c) During the Employment Period, the Employee shall devote his full time
and best efforts to the business and affairs of the Corporation.
Notwithstanding the foregoing, the Employee shall be permitted to
serve on the board of directors of commercial and charitable
organization and to make investments which are not related to the
business and affairs of the Corporation for which he may receive
compensation, so long as such activities or investments do not
interfere with the performance of the Employee's duties and
obligations hereunder. Employee and the Board of Directors will
periodically review such outside commitments to insure that such
commitments do not interfere with the Employee's duties with the
Company.

2. TERM.

The term of employment under this Agreement shall be for a period commencing on
December 17, 1998 and continuing through December 17, 1999. The term of
employment referred to in this Section 2, together with any extensions thereof
shall be referred to herein collectively as the "Employment Period".

3. COMPENSATION AND BENEFITS.

As compensation for the performance of his duties on behalf of the Corporation,
the Employee shall be compensated as follows:

<PAGE>

a) During the period under this Agreement commencing on December 17, 1998
and ending on December 17, 1999, the Corporation shall pay or cause to
be paid to the Employee a base salary at an annual rate of $106,000,
payable in substantially equal installments in accordance with the
Corporation's usual practice. The Employee's annual salary for any
subsequent periods contemplated hereunder, shall be reviewed by the
Board of Directors not less often than annually and the Board of
Directors shall grant increases thereof based on the performance of
the Corporation and the Employee's relative contribution to that
performance. The annual base salary payable in any year pursuant to
this Agreement is hereinafter known as the "Annual Salary." Any
increase in Annual Salary or other compensation shall in no way limit
or reduce any other obligation of the Corporation hereunder. The
Corporation shall withhold all applicable federal, state and local
taxes, social security and workers' compensation contributions and
such other amounts as may be required by law or agreed upon by the
parties with respect to the compensation payable to the Employee
pursuant to this Section 3(a).

b) In addition to an Annual Salary, for the fiscal year ending June 30,
1999, the Employee shall be entitled to receive as incentive
compensation a cash bonus pursuant to a bonus plan, the terms and
payment of which shall be mutually agreed upon by the Board of
Directors and the Employee (the "Bonus Plan").

c) The corporation shall reimburse the Employee for all reasonable
expenses incurred by the Employee in furtherance of the business and
affairs of the Corporation, including reasonable travel and
entertainment, against receipt by the Corporation of appropriate
vouchers or other proof of the Employee's expenditures and otherwise
in accordance with such policies and procedures as may from to time be
adopted by the Company.

d) The Employee shall be entitled to the number of paid vacation days in
each calendar year determined by the Corporation from time to time for
its officers, but not less than two weeks in any calendar year. The
Employee shall also be entitled to all paid holidays given to the
Corporation's officers.

e) The Corporation shall make available to the Employee and his
dependents such retirement, life insurance, health insurance and
disability benefits as the Corporation makes available to its other
officers.

4. NON-COMPETITION.

a) The Employee understands and recognizes that his services to the
Corporation are special and unique and agrees that, during the term of
this Agreement and for a period of two (2) years from the date of
termination of his employment hereunder, he shall not in any manner,
directly or indirectly, on behalf of himself or any person, firm,
partnership, joint venture, corporation or other business entity (a
"Person"), enter into or engage in any business competitive with the
Corporation's business, proposed business or research activities,
either as an individual for his own account, or as a partner, joint
venture, executive, agent, consultant, sales or marketing person,
officer, director of shareholder (other than passive investment of not
more than five percent (5%) of the outstanding shares of, or any other
equity interest in, any company or entity listed or traded on a
national securities exchange or an interest in a partnership for which
the Employee does not exercise control over investment decisions of
such partnership) of a Person operating or selling or intending to
operate or sell in the areas of business and within the product
markets listed in Schedule 1 attached hereto, within the geographic
area of the Corporation's business. Schedule I hereto shall be amended
from time to time upon agreement by the parties hereto to take into
account additional areas of business and product markets in which the
Corporation may become engaged.

b) During the term of this Agreement and for two (2) years thereafter,
the Employee shall not, directly or indirectly, without the prior
written consent of the corporation interfere with the business of the
Company by soliciting, attempting to solicit, inducing, or otherwise
causing any employee of the Company to terminate his or her employment
in order to become an employee, consultant or independent contractor
to or for any competitor of the Company.

c) In the event that the Employee breaches any provisions of this Section
4 or there is a threatened breach, then, in addition to any other
rights which the Corporation may have, the Corporation shall be
entitled, without the posting of a bond or other security, to
injunctive relief to enforce the restrictions contained herein. In the
event that an actual proceeding is brought in equity to enforce the
provisions of this Section 4, the Employee shall not urge as a defense
that there is an adequate remedy at law nor shall the Corporation be
prevented from seeking any other remedies which may be available.

<PAGE>

5. TERMINATION.

a) Death Or Retirement. The Employee's employment hereunder shall
terminate upon his death or retirement.

b) Disability. If, as a result of the Employee's incapacity due to
physical or mental illness ("Disability"), the Employee shall have
been absent from his duties hereunder for ninety (90) consecutive
business days, and within thirty (30) days after written Notice of
Termination (as hereinafter defined) is given shall not have returned
to the performance of his duties hereunder on a full-time basis, the
Corporation may terminate the Employee's employment hereunder.

c) Cause. The Corporation may terminate the Employee's employment
hereunder for "Cause". For purposes of this Agreement, "Cause" shall
mean (i) the willful engaging by the Employee in gross misconduct
materially injurious to the Corporation, (ii) the willful and material
violation by the Employee of the provisions of Section 4 hereof or of
the Proprietary Agreement, or (iii) the willful and material violation
by the Employee of any provision of this Agreement, other than Section
4 hereof or of the Proprietary Agreement, which is not cured by the
Employee within fifteen (15) days after written notice thereof from
the Corporation. For purposes of this paragraph, no act, or failure to
act, on the Employee's part shall be considered "willful" unless done,
or omitted to be done, by him not in good faith and without reasonable
belief that his action or omission was in the best interest of the
corporation. Notwithstanding the foregoing, the Employee shall not be
deemed to have been terminated for Cause unless and until there shall
have been delivered to the Employee a copy of a resolution, duly
adopted by the Board of Directors at a meeting of the Board of
Directors called and held (after five (5) days notice to the Employee
of such meeting and an opportunity for him, together with his counsel,
to be heard before the Board of Director at such meeting) for the
purposes of finding that in the good faith opinion of the Board of
Directors, the Employee was guilty of conduct set forth above in
clauses (i), (ii) or (iii) of this Section 5(c).

d) Change Of Duties. Any assignment to the Employee of duties which are
inconsistent with the Employee's status as a Vice President of
Research and Development or are a substantial reduction in the nature
or the status of the Employee's responsibilities may be treated by him
as a termination pursuant to Section 5(f) hereof.

e) Sale Of Assets. In the event of the sale of all or substantially all
of the Corporation, or a sale of all or substantially all of the
assets of the Corporation, the Employee may treat his employment as
having been terminated pursuant to Section 5(f) herein.

f) Other Termination By The Corporation. Notwithstanding the foregoing
provisions, the Corporation may terminate the Employee's employment
hereunder at any time, subject to the provisions of Section 6(d)
hereof.

g) Voluntary Termination By The Employee. Notwithstanding the foregoing
provisions, the Employee may terminate his employment hereunder at any
time upon three month's written notice to the Corporation, subject to
the provisions of Section 6(c) hereof.

h) Notice Of Termination. Any termination by the Corporation pursuant to
paragraphs (b), (c), or (d) above or by the Employee pursuant to
paragraph (e) above shall be communicated by a written Notice of
Termination. For purposes of this Agreement, a "Notice of Termination"
shall mean a notice which shall indicate the specific termination
provisions in this Agreement relied upon and shall set forth in
reasonable detail the facts and circumstances claimed to provide a
basis for termination of the Employee's employment under the provision
so indicated.

i) Date Of Termination. "Date of Termination" shall mean (i) if the
Employee's employment is terminated as a result of the Employee's
incapacity due to physical or mental illness, thirty (30) days after
Notice of Termination is duly given (provided that the Employee shall
not have returned to the performance of his duties on a full-time
basis during such thirty (30) day period), (ii) the date of the
Employee's death or retirement, or (iii) if the Employee terminates
his employment or his employment is terminated for any other reason,
the date on which a Notice of Termination is duly given.

<PAGE>

6. COMPENSATION UPON TERMINATION OR DURING DISABILITY.

a) If the Employee's employment shall be terminated due to death, the
Employee's estate or other legal representative shall be entitled to
receive any accrued but unpaid Annual Salary installments and any
accrued reimbursable expenses (to the extent provided in Section 3(c)
hereof). In addition, the Employee's estate shall be entitled to
receive a payment for (i) any accrued but unused vacation days and
(ii) a pro rata portion of any cash bonus due pursuant to Section 3(b)
hereof. In the event of Employee's death, rights and benefits of the
Employee under employee benefit and fringe benefit plans and programs
of the Corporation will be determined in accordance with the terms and
provision so such plans and programs.

b) During any period that the Employee fails to perform his duties
hereunder due to Disability, the Employee shall continue to receive
his full Annual Salary until the Employee's employment is terminated
pursuant to Section 5(b) hereof. After termination due to Disability,
the Employee shall be paid disability benefits in accordance with any
long term disability plan of the Corporation then in effect. In the
event of the Employee's disability as determined above, rights and
benefits of the Employee under employee benefit and fringe benefit
plans and programs of the corporation will be determined in accordance
with the terms and provisions of such plans and programs.

c) If the Employee's employment shall be terminated for Cause or if the
Employee shall terminate his employment pursuant to Section 5(g)
hereof, the Corporation shall pay the Employee any accrued but unpaid
Annual Salary installments and any accrued reimbursable expenses (to
the extent provided in Section 3(c) hereof) only through the Date of
Termination and the Corporation shall have no further obligations to
the Employee under this Agreement. Any rights and benefits the
Employee may have under employee benefit and fringe benefit plans and
programs of the corporation will be determined in accordance with the
terms of such plans and programs.

d) If the Employee's employment shall be terminated by the Corporation
pursuant to Section 5(d), (e) or (f) hereof then the corporation shall
continue to pay the Employee his regular salary through the date which
is six (6) months after the Date of Termination; provided, however,
that the Corporation's obligation to pay such salary shall terminate
at such time as the Employee commences any alternative full-time
employment. Notwithstanding the foregoing, the Corporation will only
be obligated to reimburse the Employee for reimbursable expenses ( to
the extent provided in Section (c) hereof) accrued through the Date of
Termination. The Employee shall also be entitled to receive a payment
for (i) any accrued but unused vacation days and (ii) a pro rata
portion of any cash bonus due pursuant to Section 3(b) hereof. If the
Employee's employment shall be terminated by the Corporation pursuant
to Section 5(d), (e) or (f) hereof, and if the Employee shall be
ineligible to participate in any of the Corporation's fringe benefit
plans or arrangements as a result of his ceasing to be an employee of
the Corporation, then the Corporation shall arrange to provide the
Employee with substantially equivalent benefits as if he remained
employed by the Corporation until the earlier of (i) six (6) months or
(ii) the end of the term of employment referred to in Section 2 hereof
at no additional expense to the Employee.

e) If the Employee's employment is terminated due to retirement, the
Employee shall be entitled to receive accrued but unpaid Annual Salary
installments and any accrued reimbursable expenses (to the extent
provided in Section 3(c) hereof).

7. NOTICES.

Any notice or other communication under this Agreement shall be in writing
and shall be deemed to have been given: (a) when delivered personally
against receipt therefore; (b) one day after being sent by Federal Express
or similar overnight delivery; or (c) three days after being mailed
registered or certified mail, postage prepaid, return receipt requested, to
the Employee at such address as the Employee shall provide to the
Corporation or to the Corporation at the following address:

Xenometrix, Inc.
2425 N. 55th Street
Boulder, Co 80301
Attn: Chief Executive Officer

or to such other address or person as either party may have furnished to
the other in writing in accordance herewith.

<PAGE>

8. RENEWAL OF AGREEMENT.

Upon expiration of the term of this Agreement, this Agreement may be
renewed for additional one (1) year periods by the mutual written agreement
of the parties hereto.

9. SEVERABILITY OF PROVISIONS.

If any provision of this Agreement shall be declared by a court of
competent jurisdiction to be invalid, illegal or incapable of being
enforced in whole or in part, such provision shall be interpreted so as to
remain enforceable to the maximum extent permissible consistent with
applicable law and the remaining conditions and provisions or portions
thereof shall nevertheless remain in full force and effect and enforceable
to the extent they are valid, legal and enforceable, and no provision shall
be deemed dependent upon any other covenant or provision unless so
expressed herein.

10. ENTIRE AGREEMENT; MODIFICATION.

This Agreement contains the entire agreement of the parties relating to the
subject matter hereof, and the parties hereto have made no agreements,
representations or warranties relating to the subject matter of this
Agreement which are not set forth herein. No modification of this Agreement
shall be valid unless made in writing and signed by the parties hereto.
This Agreement supersedes any previous terms of employment between the
Corporation and Employee and any previous employment contractual terms are
terminated as of the date hereof.

11. BINDING EFFECT.

The rights, benefits, duties and obligations under this Agreement shall
inure to, and be binding upon , the Corporation, its successors and
assigns, and upon the Employee and his legal representatives. This
Agreement constitutes a personal service agreement, and the performance of
the Employee's obligations hereunder may not be transferred or assigned by
the Employee.

12. NON-WAIVER.

The failure of either party to insist upon the strict performance of any of
the terms, conditions and provisions of this Agreement shall not be
construed as a waiver or relinquishment of future compliance therewith, and
said terms, conditions and provisions shall remain in full force and
effect. No waiver of any term or condition of this Agreement on the part of
either party shall be effective for any purpose whatsoever unless such
waiver is in writing and signed by such party.

13. GOVERNING LAW.

This Agreement shall be governed by, and construed and interpreted in
accordance with, the laws of the State of Colorado without regard to
principles of conflict of laws.

14. HEADINGS.

The headings of paragraphs are inserted for convenience and shall not
affect any interpretation of this Agreement.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the
day and year first above written.

Xenometrix, Inc.

By: /s/ Stephen J. Sullivan
---------------------------
Stephen J. Sullivan
Its: CEO and President

PAULINE GEE

/s/ Pauline Gee
---------------
Pauline Gee

<PAGE>

SCHEDULE I

Development, manufacture or sale of gene activity profiling assays, products or
systems, and in vitro and in vivo toxicity, mutagenicity or carcinogenicity
assays, products or systems marketed to the pharmaceutical, biotechnology,
chemical, consumer products and/or environmental companies that test new
chemical entities or test for environmental contaminants.

Exhibit 23.1

A. Consent of Independent Accountants

We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-42381) of Xenometrix, Inc. of our report dated
September 1, 1998 relating to the financial statements as of and for the year
ended June 30, 1998, which appears on page F-1 of this Annual Report on Form
10-KSB.

/s/ PricewaterhouseCoopers LLP
- ------------------------------
PricewaterhouseCoopers LLP

Broomfield, Colorado
September 30, 1999

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1999 AND THE CONSOLIDATED STATEMENT OF
OPERATIONS FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-1-1998
<PERIOD-END> JUN-30-1999
<CASH> 137
<SECURITIES> 0
<RECEIVABLES> 85
<ALLOWANCES> 5
<INVENTORY> 46
<CURRENT-ASSETS> 396
<PP&E> 1,255
<DEPRECIATION> 802
<TOTAL-ASSETS> 1,222
<CURRENT-LIABILITIES> 1,275
<BONDS> 0
0
0
<COMMON> 3
<OTHER-SE> (56)
<TOTAL-LIABILITY-AND-EQUITY> 1,222
<SALES> 407
<TOTAL-REVENUES> 3,137
<CGS> 560
<TOTAL-COSTS> 1,009
<OTHER-EXPENSES> 1,337
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 242
<INCOME-PRETAX> 549
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 549
<EPS-BASIC> 0.19
<EPS-DILUTED> 0.17

</TABLE>