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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 COMMISSION FILE NUMBER: 000-21429
ARQULE, INC.
(exact name of registrant as specified in its charter)
DELAWARE 04-3221586
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
200 BOSTON AVENUE, MEDFORD, MASSACHUSETTS 02155
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code:
(617) 395-4100
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
(Title of each Class) on which registered
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None None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 3, 1997 was: $76,261,110.
There were 9,857,737 shares of the registrant's Common Stock outstanding as of
March 3, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement of the Registrant's 1997 Annual
Meeting of Shareholders to be held on May 14, 1997 which definitive proxy
statement will be filed with the Securities and Exchange Commission not later
than 120 days after the registrant's fiscal year of December 31, 1996, are
incorporated by reference into Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
OVERVIEW
ArQule has created a new technology platform for the discovery and
production of novel chemical compounds with commercial potential. The Company
has developed proprietary technologies for the identification and optimization
of drug development candidates and agrichemicals. Using combinatorial chemistry,
a modular building block approach to the development of compounds,
structure-guided compound design, high speed parallel chemical synthesis and
information technology, the Company rapidly develops large, diverse collections
of compounds that have the potential to be biologically active. To date, the
Company has entered into collaborative arrangements with Abbott Laboratories,
Monsanto Company, Pharmacia Biotech AB, Roche Bioscience and Solvay Duphar B.V.,
and has formed joint discovery programs with several biotechnology companies.
The Company's goal is to penetrate the product development pipelines of
major pharmaceutical, biotechnology and agrichemical companies and to maximize
the likelihood that active compounds are discovered and successfully developed.
In order to achieve this goal, the Company pursues a strategy designed to
maximize the number of biological targets against which its compounds are
screened. ArQule believes that its technologies will allow its collaborative
partners in the pharmaceutical, biotechnology and agrichemical industries to
accelerate the product development process by several years, permitting them to
realize significant cost reductions and the earlier recovery of research and
development expenditures for successful drugs and agrichemicals. In addition,
the Company believes its technologies will allow researchers to seek solutions
to product development challenges previously deemed too costly or otherwise
impractical because of the inherent limitations of traditional medicinal
chemistry.
The potential market for ArQule's proprietary modular building block
technology is comprised of all consumers of novel chemical compounds, including
developers of drugs, separations media, agrichemical products, industrial
catalysts, specialty materials and other industrial products. The Company's
initial business focus has been on the pharmaceutical, biotechnology and
agrichemical industries.
APPLICATION OF THE COMPANY'S TECHNOLOGIES IN THE DRUG DISCOVERY INDUSTRY
INDUSTRY BACKGROUND
Traditional Drug Discovery and Its Limitations. Drugs are chemical
compounds that modulate the activity of biological targets associated with
particular disease states to achieve a desired therapeutic effect. The discovery
and development of drugs has traditionally been a lengthy, expensive and often
unsuccessful process. Typically, it takes 12 to 15 years from the original
concept of modulating the activity of a particular biological target to the
market introduction of a drug that performs such a function. The average cost of
bringing a new drug to market has been estimated to be in excess of $300
million.
The first major step in the drug discovery process is the identification of
one or more compounds that interact with a biological target, such as an enzyme,
receptor or other protein, that is associated with a disease state. To identify
such a compound, collections of compounds are tested or screened for activity
with respect to the biological target. A compound that interacts with a target
is referred to as a hit, and a hit with characteristics making it suitable as a
potential drug is referred to as a lead compound.
Historically, drug developers have obtained collections of chemical
compounds for screening from natural product sources and by synthesis. These
collections are often neither sufficiently diverse to be likely to result in a
hit nor preselected to include compounds with promising structures or desirable
drug characteristics. This random screening approach has yielded a relatively
small percentage of hits and only a relatively small portion of those hits have
resulted in lead compounds.
The second major step in the drug discovery process is the optimization of
a lead compound by the sequential synthesis and testing of variations, or
analogs, of a lead compound to identify promising drug development candidates. A
drug development candidate is a lead compound that in preclinical studies
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demonstrates pharmacological efficacy, lack of toxicity, potency, selectivity
and other desirable characteristics such as oral availability, cell penetration
and stability. Using traditional medicinal chemistry, lead optimization has
required an average of two years of synthesizing hundreds of analogs of a lead
compound and has been the most expensive and time consuming part of the drug
development process prior to clinical testing. The synthesis of a single
compound analog takes approximately 7 to 10 days and costs approximately $7,500.
As a result, a chemist is usually able to synthesize only 100 to 200 analogs per
year. On average, as many as 6,000 chemical compounds may be synthesized per
successful drug at a cost of approximately $45 million in chemistry costs.
Drug Development in Transition. Lower profit margins, shorter product
lives, the proliferation of generic drugs, managed care and cost containment
initiatives, combined with scientific and technological advances, have created
powerful incentives for drug developers to explore new technologies to discover
novel drugs more quickly and cost effectively. The growing biotechnology and
gene discovery (genomics) industries are rapidly identifying numerous new
biological targets and developing highly sensitive assays incorporating these
targets. Advances in robotics have led to automated high throughput screening
systems, allowing biologists to assay large numbers of chemical compounds
against novel targets. These developments have resulted in increased demand for
large and diverse collections of novel compounds.
In addition, in recent years, structure-guided and rational drug design
approaches have allowed scientists, using structure-activity relationship
("SAR") data about biological targets, to design compounds that are likely to
show activity with respect to a biological target. These developments, together
with the developments referred to in the preceding paragraph, have resulted in a
proliferation of hits, generating demand for tools to rapidly create analogs of
hits and optimize lead compounds.
Current Combinatorial Chemistry Technology and Its
Limitations. Combinatorial chemistry is the rapid creation of hundreds of
thousands of chemical compounds, most of which do not exist in nature, for the
purpose of rapidly identifying hits through random screening. Current
combinatorial chemistry has been successful in producing large numbers of
compounds and correspondingly large numbers of hits. However, current
combinatorial chemistry techniques have been less successful in generating lead
compounds and, ultimately, drug development candidates for some or all of the
following reasons:
- Time-Consuming Isolation of Hits. In certain combinatorial chemistry
applications, large numbers of chemical compounds are synthesized and screened
in mixtures. Hits must therefore be isolated from the mixtures, which is a
costly, slow, labor-intensive process.
- Lack of Structural and SAR Information. Once a hit is isolated, many
current combinatorial techniques fail to facilitate the identification of the
structure of the hit or to provide SAR data to guide the lead optimization
process.
- Incompatibility with Drug Developers' Screening Protocols. Many
combinatorial compounds are produced in a format that is incompatible with
standard screening protocols of drug developers. In addition, once a hit is
found and the compound is isolated, significant additional work must often be
performed by the combinatorial chemistry company to determine the structure of
the compound. Drug developers relying on this format may therefore be required
to transfer hits to the combinatorial chemistry company.
- Limitations of Solid Phase Chemistry. Several combinatorial chemistry
techniques involve the production of compounds using solid phase chemistry in
which compounds are attached to small beads. Because many compounds with
desirable chemistries cannot be synthesized using solid phase chemistry,
collections of compounds based exclusively on solid phase chemistry may have
limited diversity.
- Limited Compound Quantities. Certain current combinatorial chemistry
techniques produce very small quantities of each compound, which limits further
testing once a lead compound is found and precludes archiving of compounds for
future testing against additional targets.
- Scale-Up Limitations. Many current combinatorial chemistry techniques
involve laboratory methods that cannot be easily translated into large scale
manufacturing processes. This creates the possibility that
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active compounds will be identified that are difficult or impractical to produce
in quantities necessary for clinical trials or commercial production.
- Unproductive Screening. Because certain combinatorial chemistry
techniques involve the screening of random compounds without preselection for
desirable drug characteristics, suitable lead compounds often can be identified
only after many unproductive screenings. In addition, testing of mixtures
frequently produces equivocal or false positive screening results because the
observed activity with a biological target is caused by several compounds within
the mixture rather than the interaction of an individual compound with a target,
leading to further unproductive screening.
Although recent developments in combinatorial chemistry have shortened the
time between identifying a biological target and obtaining a hit in the target
assay, the proliferation of hits has not led to a commensurate increase in lead
compounds. In addition, current combinatorial chemistry techniques have not
significantly improved the lead optimization process and, therefore, have not
significantly shortened the time it takes to produce a drug development
candidate from a lead compound.
THE ARQULE REVOLUTION
ArQule believes its modular building block technology overcomes many of the
limitations of current combinatorial chemistry approaches by achieving targeted
diversity to accelerate the identification and optimization of lead compounds.
Targeted diversity is the design of diverse compound arrays that are biased
toward specific biological targets by selecting molecules from a variety of
chemical classes and constructing compound arrays in a manner believed to
increase the probability of discovering one or more active compounds for those
biological targets.
Many organic molecules, including amino acids, peptides, nucleosides,
carbohydrates, steroids and alkaloids, may be viewed as comprised of structural
components, consisting of a scaffold, or core structure, around which a set of
substituent groups and connectors (bonds) is varied. ArQule's scientists have
developed proprietary methods for selecting and combining molecular components,
or building blocks, to produce arrays of compounds that possess properties they
believe will exhibit activity in biological systems.
Using SAR data regarding biologically active compounds and modular
molecular components, ArQule's synthetic and computational chemists work
together to rapidly design compound arrays that include all combinations of a
set of selected building blocks around a common core structure or theme.
ArQule's arrays are created by using structure-guided and rational drug design
tools to systematically select and assemble molecular building blocks with
properties the Company's scientists believe are likely to exhibit biological
activity. Each compound in the array is different from the adjacent compound as
a result of a single structural modification. Each ArQule array omits compounds
that are closely analogous to other compounds in the array, using representative
diversity to create a logical representation of a virtual library of hundreds of
times as many compounds as are in the array. Drug developers are able to realize
significant savings by screening the thousands of compounds in each ArQule array
rather than the millions of compounds they represent. In addition, the SAR data
of compounds within the array provides a navigational tool for lead optimization
by indicating the most promising investigational direction for analoging.
In order to enhance the effectiveness of this modular building block
technology, ArQule integrates the following tools:
- structure-guided design;
- a proprietary "automated molecular assembly plant" (AMAP) system for high
speed parallel synthesis, purification and structural verification of
chemical compounds; and
- proprietary computer applications that facilitate the integration of all
of the Company's proprietary technologies.
Structure-Guided Design. ArQule's scientists believe that the likelihood
of generating a drug development candidate can be substantially increased if the
collection of compounds used for screening is created using three-dimensional
structural and SAR data. The Company designs its arrays based on chemical
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structures that are believed to be biologically active and also on SAR data
regarding a particular target and a particular lead compound. Using this data,
as well as knowledge of the chemical reactions that are feasible using high
speed parallel synthesis, ArQule's scientists design logically arranged arrays
of diverse compounds that can easily be synthesized. The Company believes that
this approach will accelerate the lead discovery and optimization process by
increasing the probability of identifying a lead compound that will result in a
drug development candidate.
The AMAP High Speed Parallel Synthesis System. Using its "automated
molecular assembly plant" (AMAP) system, ArQule synthesizes, purifies and
verifies structural information for individual compounds through automated high
speed parallel synthesis. The AMAP system is capable of synthesizing thousands
of compounds per day, each in milligram quantities adequate for multiple
screens, analyzing such compounds for structural integrity and purity,
registering the structural data in a relational database, and delivering the
compounds in a 96-well microtiter plate format for high throughput screening.
Integrated Proprietary Computer Applications ("Informatics"). ArQule has
developed a proprietary information system which incorporates (i) databases of
the molecular structures of building blocks and the compounds in its arrays,
(ii) multi-dimensional matrix geometry which provides guidance for the creation
of the Company's spatially addressable arrays of compounds containing systematic
variations of modular building blocks, (iii) instructions for the robotics
involved in the AMAP parallel synthesis production process, (iv) resulting
databases of structural information regarding the compounds produced in any
particular array which can be supplied in a format compatible with customers'
own data registration systems and (v) databases of SAR data regarding particular
compounds and their molecular components contained in an array generated when
these compounds are screened against biological targets. This integrated
information system enables ArQule to gather and apply data on an ongoing basis
to enhance the efficiency of the production process and to design compounds
based on a growing knowledge of the structure and activity of its molecular
components.
ADVANTAGES OF ARQULE'S COMBINATORIAL DRUG DISCOVERY AND DEVELOPMENT PLATFORM
The Company believes the integration of its technological capabilities
offers a unique combinatorial drug discovery and development platform. This
platform offers the following significant advantages over current combinatorial
chemistry approaches:
- Elimination of Isolation Issues. Unlike combinatorial chemistry
processes involving the production of synthesized compounds in mixtures,
ArQule's AMAP system produces one compound per well, with each well containing a
known compound with a high level of purity.
- Enhanced Structural and SAR Data. ArQule produces arrays using
preselected modular building blocks that its scientists believe are likely to
produce lead compounds with desirable characteristics, and, in the case of
Directed Array sets, based upon the SAR data of the target and/or lead compound.
As a result, the Company believes the success rate for drugs developed using its
arrays will be improved and the risk of downstream clinical failure will be
reduced. The wealth of SAR data available with respect to compounds in its
arrays will also facilitate the development of analogs for the further
optimization of active compounds.
- Compatibility with Drug Developers' Screening Protocols. ArQule's
compounds are delivered to its collaborators in 96-well microtiter plates
containing one known compound per well. This delivery format is compatible with
most existing screening protocols and permits the owner of the assay to screen
compounds in its own laboratories, thereby having complete control over the
screening process.
- Solution and Solid Phase Chemistry. ArQule's compounds may be produced
using either solution or solid phase chemistry, permitting the creation of a
broad range of novel chemical compounds.
- Significant Compound Quantities. ArQule's compounds are delivered to its
collaborators in milligram quantities, permitting the collaborator to engage in
extensive testing of a lead compound or to screen compounds against multiple
biological targets without having to obtain additional samples from the Company.
- Ease of Scale-Up. ArQule's compounds are produced using fully
reproducible and scalable manufacturing processes.
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- Reduction in Unproductive Screening. By creating logical arrays of
compounds based on known structural and SAR data and eliminating compounds that
are closely analogous to others in the array, ArQule believes that fewer
compounds will need to be screened prior to identifying compounds with activity.
In addition, because ArQule delivers single compounds for screening, such
compounds do not generate the false positives and false negatives associated
with screening mixtures of compounds.
ArQule believes these significant advantages will allow its collaborative
partners to accelerate the drug discovery process by several years by shortening
the time required to identify a lead compound and to optimize that compound into
a drug development candidate. This acceleration should permit drug developers to
realize significant cost reductions and the earlier recovery of research and
development expenditures for successful drugs.
APPLICATION OF THE COMPANY'S TECHNOLOGIES IN THE AGRICHEMICAL INDUSTRY
Industry Background. Agrichemicals are chemical products used in the
agricultural industry. Examples of agrichemicals are herbicides, pesticides,
fungicides, bactericides and soil treatment agents. Historically, agrichemical
developers have obtained chemical compounds for screening from natural product
sources and by traditional medicinal synthesis, and then screened those
compounds against whole organisms rather than specific molecular targets. Lead
compounds have traditionally been optimized using medicinal chemistry techniques
similar to those used in the drug industry. Agrichemicals are also expensive and
time-consuming to develop. As an example, the American Crop Protection
Association estimates that development, testing, and regulatory approval of a
pesticide product typically requires eight to ten years and may cost up to $50
million.
As in the case of the pharmaceutical industry, the agrichemical industry is
under pressure to identify lead compounds for the development of new products.
As patents expire on existing products and generic equivalents become available,
developers must introduce improved products to stay competitive and maintain
profit margins. To gain market acceptance of a new product at a premium price,
the product must provide some advantage to the customer as compared with
existing products, such as an improvement in environmental profile, user health
and safety, consumer health and safety, user convenience, or effectiveness at
lower concentrations. Alternatively, a producer can maintain profit margins on a
product sold without a premium if that product can be manufactured at a lower
cost. Therefore, products in the agrichemical industry have historically been
subject to a cost-benefit analysis that only recently has affected the
pharmaceutical industry with the advent of managed care.
Combinatorial Chemistry in the Agrichemical Industry. The agrichemical
industry is now adopting new technologies including high throughput screening
and combinatorial chemistry for many of the same reasons as the pharmaceutical
industry. The limitations of certain combinatorial chemistry techniques, as
described in the context of the pharmaceutical industry, are also applicable to
the agrichemical industry. Indeed, compound quantities and scale-up issues are
perhaps more important to the agrichemical industry than the pharmaceutical
industry.
- Compound Quantities. The agrichemical industry has historically used
whole-organism screening methods and has not completed the transition to
screening for specific molecular targets. These whole-organism assays consume
quantities of test compounds in excess of the quantities produced using certain
current combinatorial chemistry techniques.
- Scale-Up. As compared with the pharmaceutical industry, the agrichemical
industry manufactures and sells larger quantities of product at a lower margin.
In addition, these products will not succeed in the marketplace unless they
offer a clear advantage over existing products, with cost-effectiveness as a
major factor. Because of these constraints, the ease and cost of manufacture for
a product is a more important consideration in the agrichemical industry than in
the pharmaceutical industry.
The ArQule Advantage. The advantages of the ArQule approach to
combinatorial chemistry, as described in the context of the pharmaceutical
industry, are also advantages for the agrichemical industry. Indeed, the ArQule
combinatorial compound discovery and development platform satisfies the
important considerations of adequate compound quantities for initial screening
and ease of scale-up for manufacturing.
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ArQule's compounds are delivered to its collaborators in milligram quantities
sufficient for whole-organism screening methods, which are traditionally used in
agrichemical development. In addition, ArQule's compounds are produced using
fully reproducible and scalable manufacturing processes.
ARQULE'S PRODUCTS
ArQule's integrated technologies result in the production of significant
quantities of pure small molecule compounds contained in a logically structured
spatially-addressable array. ArQule provides its collaborative partners with two
types of arrays of synthesized compounds: (i) Mapping Array compound sets, which
are arrays of novel, diverse, small molecule compounds used for screening
against biological targets and (ii) Directed Array compound sets, which are
arrays of analogs of a particular lead compound synthesized for the purpose of
optimizing that lead compound.
Mapping Array Program. ArQule's Mapping Array Program is a multi-year
subscription to annual Mapping Array compound sets which are designed around
certain core structures or themes selected by ArQule. Through this program, the
Company provides 15 to 20 Mapping Array compound sets, on an annual basis, each
containing between 3,000 and 10,000 individual compounds for a minimum aggregate
of 100,000 compounds. The Mapping Array Program is provided to subscribers
without limitation as to the targets against which the compounds may be
screened. ArQule believes this approach will maximize the number of targets
against which its Mapping Array sets are tested, thereby maximizing the
potential for identifying activity for each compound in the array. Initially,
the Company provides its Mapping Array sets on a non-exclusive, subscription fee
basis for screening purposes only. If a compound shows activity in a
subscriber's assay, the subscriber may license that compound from the Company
for development purposes on an exclusive basis, unless such compound has already
been licensed to another collaborative partner. The Company does not provide any
structural information regarding the compounds in the Mapping Array sets until a
particular compound is licensed.
Directed Array Programs. Under its Directed Array Programs, the Company
provides Directed Array sets in order to optimize lead compounds. In a Directed
Array set, the Company uses its modular building block technology to create
analogs of a lead compound identified by the collaborator, either independently
or as a result of screening a Mapping Array set. Successive Directed Array sets
are generated in order to identify the analog or analogs having the greatest
biological activity and most desirable development characteristics. When
delivering each Directed Array set, the Company provides the collaborator with
structural information for each compound in the array, and each compound is
owned by the collaborator either individually or jointly with ArQule, subject to
the payment of fixed fees, milestones and royalties to the Company. Under a
typical Directed Array Program, ArQule provides three to seven Directed Array
sets, each averaging about 1,000 analogs of a particular lead compound chosen by
a collaborator in consultation with ArQule.
BUSINESS STRATEGY
ArQule's goal is to become the leading drug and chemical product discovery
company by using its high throughput molecular technologies to design,
synthesize and test high performance molecules for health care and specialty
chemical applications. The Company seeks to penetrate the product development
pipelines of pharmaceutical, agrichemical and biotechnology companies and to
maximize the likelihood of the discovery of activity and successful development
of commercial compounds. Key elements of the Company's strategy include:
- Collaborations with Pharmaceutical and Agrichemical Companies. The
Company seeks collaborations with those companies that have established
manufacturing, marketing and sales resources and a strong commitment to the
development of pharmaceutical or agrichemical products. ArQule offers to each of
its collaborative partners access to its Mapping Array Program for an annual
subscription fee and provides, if requested, customized Directed Array Programs
for a fixed fee. In addition, the Company is entitled to payments upon the
achievement of certain milestones and royalties upon the commercialization of
products developed by the collaborator from ArQule compounds. The Company plans
to pursue additional collaborations aggressively to gain access to additional
targets and development expertise, and to generate additional revenue.
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- Joint Discovery Programs with Biotechnology Companies. Biotechnology
companies have identified numerous proprietary biological targets and assays and
therefore represent important potential collaborators for joint discovery and
development efforts using ArQule's Mapping Array and Directed Array sets. ArQule
provides Mapping Array and Directed Array sets to biotechnology companies in
exchange for joint ownership of any lead compounds that exhibit activity in the
proprietary assays developed by the biotechnology company collaborators. ArQule
seeks collaborators with promising drug development programs in a broad range of
therapeutic areas.
- Expansion of Proprietary Drug Discovery Capabilities. The Company
intends to expand its proprietary drug discovery capabilities by developing or
acquiring, either independently or in partnership with others, proprietary
biological targets, proprietary assays and the capability to screen its
compounds against such assays. The Company will also consider investing in the
lead optimization and initial preclinical and clinical development efforts for
selected lead compounds in order to realize a greater portion of the value
created by its technologies.
- Extension of Chemistry Tools to Other Areas. The Company intends to
extend its integrated technologies outside the fields of pharmaceuticals,
agrichemicals and bioseparations to a variety of other applications, including
industrial catalysts and polymeric structures for non-biological applications.
- Continued Investment in Proprietary Chemistry Technology. ArQule intends
tocontinue its aggressive investment in proprietary chemistry technologies
through internal development and licensing of third party technologies. ArQule
will also continue to invest in improving the cost-effectiveness of its products
through automation and information technologies.
ARQULE'S PRODUCT DISCOVERY PROGRAMS
Pharmaceutical and Agrichemical Company Collaborations
To date, the Company has entered into the following major collaborations
with pharmaceutical and agrichemical companies:
Abbott Laboratories. In June 1995, the Company entered into a
collaborative agreement with Abbott Laboratories ("Abbott") pursuant to which
Abbott subscribed to the Company's Mapping Array Program and has the right to
request customized Directed Array sets (the "Abbott Agreement"). To date, the
Company has provided Abbott with several Mapping Array and Directed Array sets.
In August 1996, the Abbott Agreement was amended to provide for the Company to
supply Abbott with additional Mapping Array sets and to eliminate restrictions
on the period during which Abbott may screen the Mapping Array sets. In December
1996, the Abbott Agreement was further amended to extend the term of the Abbott
Agreement until March 1999, to provide for the Company to supply Abbott with
additional Mapping Array sets during such extended period and to provide for the
payment by Abbott of additional research and development funding during such
extended period. Abbott may not terminate the Abbott Agreement prior to March
1999 without cause. Absent early termination, Abbott has agreed to pay the
Company $6.8 million through March 1999. Abbott is also obligated under the
Abbott Agreement to make additional payments upon the achievement of certain
milestones and to pay royalties on the sale of drugs that may result from the
relationship. To date, Abbott has paid the Company an aggregate of $5.0 million
under the Abbott Agreement.
Monsanto Company. In December 1996, the Company entered into a
collaborative agreement with Monsanto Company ("Monsanto"), pursuant to which
Monsanto subscribed to the Company's Mapping Array Program and the Company
agreed to synthesize Directed Array sets from compounds provided to the Company
by Monsanto and/or developed by the Company under the Mapping Array Program (the
"Monsanto Agreement"). Assuming Monsanto requests the synthesis of at least one
Directed Array per year over the term of the Monsanto Agreement, the Company
will receive a minimum of $12.0 million over five years. Monsanto is also
obligated to make additional payments upon the achievement of certain milestones
and to pay royalties on sales of products that may result from the relationship.
The Monsanto Agreement expires in December 2001, subject to Monsanto's right to
extend the term of the Monsanto Agreement for two
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additional one-year periods. Monsanto has the right to terminate the Mapping
Array Program and/or the Directed Array Program on six months' written notice at
any time subject to its payment of a termination fee equal to the aggregate
minimum amount that would have been paid to the Company by Monsanto under the
program to be terminated over the entire five-year term. To date, Monsanto has
paid the Company an aggregate of $0.8 million under the Monsanto Agreement.
Pharmacia Biotech AB. In March 1995, the Company entered into a
collaborative agreement with Pharmacia Biotech AB ("Pharmacia"), a wholly-owned
subsidiary of Pharmacia & Upjohn, Inc., to allow Pharmacia to evaluate the
utility of the Company's technology for the development of products in the
fields of bioseparations, synthesis of biomolecules and cell culture (the
"Pharmacia Agreement"). On the same date, the Company and Pharmacia also signed
an agreement under which Pharmacia has an option to acquire an exclusive,
worldwide license to develop and commercialize specified compounds generated by
the Company in additional fields covered under the Pharmacia Agreement, subject
to the payment by Pharmacia of additional fees and the negotiation and execution
by the parties of a license agreement containing commercially reasonable terms
(the "Option Agreement"). To date, Pharmacia has paid the Company an aggregate
of $2.5 million under the Pharmacia Agreement and the Option Agreement.
Roche Bioscience. In September 1996, the Company entered into a
collaborative agreement with Roche Bioscience ("Roche Bioscience"), a division
of Syntex (U.S.A.) Inc. and indirect subsidiary of Roche Holding Ltd., pursuant
to which the Company will synthesize Directed Array sets from compounds provided
to the Company by Roche Bioscience, developed by the Company internally and/or
developed by the Company as a part of the collaboration (the "Roche Bioscience
Agreement"). Absent early termination, Roche Bioscience will pay the Company
approximately $12.1 million over three years. The parties may jointly agree to
increase the number of Directed Array sets to be provided by the Company under
the Roche Bioscience Agreement, which may result in increased payments to the
Company. Roche Bioscience is also obligated to make additional payments upon the
achievement of certain milestones and to pay royalties on sales of drugs that
may result from the relationship. The Roche Bioscience Agreement expires in
September 1999 and is terminable by Roche Bioscience on or after September 1998
on six months' advance notice. If such termination occurs on September 30, 1998,
the Company will have received payments of approximately $8.4 million from Roche
Bioscience through that date and no further payments, other than milestone
payments and royalties, will be due to the Company. To date, Roche Bioscience
has paid the Company an aggregate of $3.6 million under the Roche Bioscience
Agreement.
Solvay Duphar B.V. In November 1995, the Company entered into a
collaborative agreement with Solvay Duphar B.V. ("Solvay") pursuant to which
Solvay has subscribed to the Company's Mapping Array Program and has the right
to request customized Directed Array sets (the "Solvay Agreement"). To date, the
Company has provided Solvay with several Mapping Array and Directed Array sets.
Absent early termination, Solvay agreed to pay the Company a minimum of $17.5
million over five years. Solvay is also obligated to make additional payments
upon the achievement of certain milestones and to pay royalties on sales of
drugs that may result from the relationship. The Solvay Agreement expires in
November 2000. Solvay has the right to terminate the Mapping Array Program on
twelve months' written notice at any time subject to its payment of a
termination fee of approximately $1.0 million. Solvay may also terminate the
delivery of Directed Array sets on six months' written notice at any time
subject to its payment of a termination fee equal to a certain percentage of the
aggregate research payments made by Solvay in the year in which notice is given.
If Solvay gave notice to terminate both programs on March 7, 1997, as of the
effective termination dates, Solvay would have paid the Company $4.3 million,
not including the termination fees. No further payments would be due from Solvay
other than milestone or royalty payments. To date, Solvay has paid the Company
an aggregate of $4.3 million under the Solvay Agreement. In connection with this
collaboration, an affiliate of Solvay, Physica B.V., made a $7.0 million equity
investment in the Company. See "Certain Transactions." Under the Solvay
Agreement, Solvay has the right to license, on an exclusive basis, lead
compounds identified from a Mapping Array set that are active against specified
biological targets and that have not previously been committed to another of
ArQule's collaborative partners or to an internal program of the Company. Solvay
also has the right to use certain of ArQule's technologies internally.
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Joint Discovery Programs with Biotechnology Companies
ArQule has initiated joint programs for lead generation and optimization
with a number of biotechnology companies. Some of ArQule's biotechnology
collaborators and their areas of focus are listed below:
COMPANY AREA OF FOCUS
- --------------------------------- -------------------------------------
Aurora Biosciences, Inc. Mammalian Cell-Based Assays
Cadus Pharmaceuticals Corporation Signal Transduction
Cubist Pharmaceuticals, Inc. Infectious Diseases
ICAgen, Inc. Ion Channel Receptors
Scriptgen Pharmaceuticals, Inc. RNA/Protein Interaction
Gene Transcription/Transcription
Signal Pharmaceuticals, Inc. Factors
SUGEN, Inc. Signal Transduction
T Cell Sciences, Inc. T Cell Activation/Inhibition
In the United States, small biotechnology companies have been highly
successful in the discovery of biological targets associated with disease
states. Many of these companies, however, lack both (i) large libraries of
chemical compounds to screen against identified targets and (ii) the
sophisticated chemistry expertise required to optimize compounds once a lead
compound has been identified. Under the Company's typical arrangement with a
biotechnology company, ArQule provides Mapping Array sets for screening without
collecting upfront fees, and the biotechnology company executes a preliminary
material transfer agreement. If the collaborator detects an active compound
within a Mapping Array set, and that compound has not been previously committed
to a third party or to an internal ArQule program, the Company and the
collaborator establish a joint discovery program and execute the research
collaboration agreement that is attached to the material transfer agreement. If
the parties are unable to negotiate the scope of a joint discovery program
within a certain period, ArQule has the right to license such compound to any
third party.
Although ArQule's formal research collaboration agreement varies from
transaction to transaction, it typically establishes a joint drug development
program for the lead compound and a particular target, and gives ArQule shared
control over the program.
MARKETING AND SALES
The Company markets its products directly to customers through
participation in trade conferences and seminars and publications in scientific
and trade journals.
To date, the Company has sold its products to its collaborative partners
primarily through the efforts of its senior management. The Company's senior
management has limited experience in marketing products similar to those of the
Company. In order to achieve significant long-term growth in revenues and its
overall strategic goals, the Company intends to hire several dedicated sales and
marketing personnel. There can be no assurance that the Company will be able to
achieve anticipated expansion of its business, attract a significant number of
new collaborative partners as customers or build an efficient and effective
sales and marketing organization. In the event the Company is unable to achieve
any one or more of the foregoing goals, the Company's business, financial
condition and results of operations could be materially adversely affected. In
addition to the risks inherent in the Company's efforts to market its own
products, the Company's revenues from royalties and milestone payments from its
collaborative partners are substantially dependent upon the marketing efforts of
such collaborative partners.
RESEARCH AND DEVELOPMENT
ArQule intends to continue its aggressive investment in its proprietary
technologies through internal development and licensing of third party
technologies in order to increase the diversity and improve other
characteristics of the compounds offered. The Company will also continue to
invest in improving the cost-effectiveness of its products and capabilities
through automation and information technologies. The Company is actively
pursuing research projects aimed at identifying and developing new chemistries
to improve and expand on its Mapping Array and Directed Array Programs. The
Company is also undertaking collaborations
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with other researchers in order to pursue the possible acquisition of
chemistries and other technologies developed by academic institutions and other
third parties.
PATENTS AND PROPRIETARY RIGHTS
ArQule has one issued patent and has filed a number of patent applications.
There can be no assurance that patent applications filed by ArQule will result
in patents being issued, that the claims of such patents will offer significant
protection of the Company's technology, or that any patents issued to or
licensed by ArQule will not be challenged, narrowed, invalidated or
circumvented. The Company may also be subject to proceedings that result in the
revocation of patent rights previously owned by or licensed to ArQule, as a
result of which the Company may be required to obtain licenses from others to
continue to develop, test or commercialize its products. There can be no
assurance that ArQule will be able to obtain such licenses on acceptable terms,
if at all. In addition, there may be pending or issued patents held by parties
not affiliated with ArQule that relate to the technology utilized by ArQule. As
a result, ArQule may need to acquire licenses, to assert infringement, or
contest the validity, of such patents or other similar patents which may be
issued. ArQule could incur substantial costs in defending itself against patent
infringement claims, interference proceedings, opposition proceedings or other
challenges to its patent rights made by third parties, or in bringing such
proceedings or enforcing any patent rights of its own.
The Company also relies upon trade secrets, know-how and continuing
technological advances to develop and maintain its competitive position. In an
effort to maintain the confidentiality and ownership of trade secrets and
proprietary information, the Company requires employees, consultants and certain
collaborators to execute confidentiality and invention assignment agreements
upon commencement of a relationship with the Company. These agreements are
intended to enable the Company to protect its proprietary information by
controlling the disclosure and use of technology to which it has rights and
provide for ownership by the Company of proprietary technology developed at the
Company or with the Company's resources. There can be no assurance, however,
that these agreements will provide meaningful protection for the Company's trade
secrets or other confidential information in the event of unauthorized use or
disclosure of such 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 ArQule could have a material adverse effect on its
business.
COMPETITION
Many organizations are actively attempting to identify and optimize
compounds for potential pharmaceutical or agrichemical development. The
Company's services and products face competition based on a number of factors,
including size, diversity and ease of use of libraries of compounds, speed and
costs of identifying and optimizing potential lead compounds and patent
position. ArQule competes with the research departments of pharmaceutical
companies, biotechnology companies, agrichemical companies, combinatorial
chemistry companies and research and academic institutions. Many of these
competitors have greater financial and human resources and more experience in
research and development than the Company. Smaller companies may also prove to
be significant competitors, particularly through arrangements with large
corporate collaborators. In addition to competition for customers, these
companies and institutions also compete with the Company in recruiting and
retaining highly qualified scientific and management personnel.
Historically, pharmaceutical and agrichemical companies have maintained
close control over their research activities, including the synthesis, screening
and optimization of chemical compounds. Many of these companies, which represent
a significant potential market for ArQule's products and services, are
developing in-house combinatorial chemistry and other methodologies to improve
productivity, including major investments in robotics technology to permit the
automated parallel synthesis of compounds. In addition, these companies may
already have large collections of compounds previously synthesized or ordered
from chemical supply catalogs or other sources against which they may screen new
targets. Other sources of compounds include extracts from natural products such
as plants and microorganisms and compounds created using rational design.
Academic institutions, governmental agencies and other research organizations
are also conducting research in areas in which the Company is working either on
their own or through collaborative efforts.
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The Company anticipates that it will face increased competition in the
future as new companies enter the market and advanced technologies become
available. The Company's processes may be rendered obsolete or uneconomical by
technological advances or entirely different approaches developed by one or more
of the Company's competitors. The existing approaches of the Company's
competitors or new approaches or technology developed by the Company's
competitors may be more effective than those developed by the Company.
There can be no assurance that the Company's competitors will not develop
more effective or more affordable technology or products, or achieve earlier
product development and commercialization than the Company, thus rendering the
Company's technologies and/or products obsolete, uncompetitive or uneconomical.
GOVERNMENT REGULATION
Although the manufacture, transportation and storage of the Company's
products are subject to certain laws and regulations discussed in the last
paragraph of this section, the sale of the Company's products is not subject to
significant government regulations. However, the Company's future profitability
is dependent on the sales of pharmaceuticals and other products developed from
the Company's compounds by its customers and collaborators. Regulation by
governmental entities in the United States and other countries will be a
significant factor in the production and marketing of any pharmaceutical
products that may be developed by a customer of the Company, or in the event the
Company decides to develop a drug beyond the preclinical phase. The nature and
the extent to which such regulation may apply to the Company's customers will
vary depending on the nature of any such pharmaceutical products. Virtually all
pharmaceutical products developed by the Company's customers will require
regulatory approval by governmental agencies prior to commercialization. In
particular, human pharmaceutical products are subject to rigorous preclinical
and clinical testing and other approval procedures by the FDA and by foreign
regulatory authorities. Various federal and, in some cases, state statutes and
regulations also govern or influence the manufacturing, safety, labeling,
storage, record keeping and marketing of such pharmaceutical products. The
process of obtaining these approvals and the subsequent compliance with
appropriate federal and foreign statutes and regulations are time consuming and
require the expenditure of substantial resources.
Generally, in order to gain FDA approval, a company first must conduct
preclinical studies in the laboratory and in animal models to gain preliminary
information on a compound's efficacy and to identify any safety problems. The
results of these studies are submitted as a part of an IND that the FDA must
review before human clinical trials of an investigational drug can start. In
order to commercialize any products, the Company or its customer will be
required to sponsor and file an IND and will be responsible for initiating and
overseeing the clinical studies to demonstrate the safety and efficacy that are
necessary to obtain FDA approval of any such products. Clinical trials are
normally done in three phases and generally take two to five years, but may take
longer, to complete. After completion of clinical trials of a new product, FDA
and foreign regulatory authority marketing approval must be obtained. If the
product is classified as a new drug, the Company or its customer will be
required to file an NDA and receive approval before commercial marketing of the
drug. The testing and approval processes require substantial time and effort and
there can be no assurance that any approval will be granted on a timely basis,
if at all. NDAs submitted to the FDA can take several years to obtain approval.
Even if FDA regulatory clearances are obtained, a marketed product is subject to
continual review, and later discovery of previously unknown problems or failure
to comply with the applicable regulatory requirements may result in restrictions
on the marketing of a product or withdrawal of the product from the market as
well as possible civil or criminal sanctions. For marketing outside the United
States, the Company will also be subject to foreign regulatory requirements
governing human clinical trials and marketing approval for pharmaceutical
products. The requirements governing the conduct of clinical trials, product
licensing, pricing and reimbursement vary widely from country to country.
Fertilizers, pesticides and other agrichemicals are heavily regulated in
the United States. The EPA regulates such products under the Federal
Insecticide, Fungicide and Rodenticide Act ("FIFRA"). Agrichemicals are also
regulated by various state agencies. Some states, such as California, have their
own extensive registration requirements. To develop and commercialize a
pesticide product, detailed and complex
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procedures must be followed and Federal approvals obtained under FIFRA. Small
scale field testing usually can be conducted prior to product registration to
evaluate product efficacy. To conduct large scale tests, a company must obtain
an Experimental Use Permit which generally requires satisfactory completion of
certain toxicology and environmental studies. Synthetic chemical pesticides
require extensive toxicology and environmental testing to substantiate product
safety prior to obtaining a product registration. Commercial sale of
agrichemicals requires a product registration for each pest and crop for which
the product is used.
The research and development processes of the Company involve the
controlled use of hazardous materials. The Company is subject to federal state
and local laws and regulations governing the use, manufacture, storage, handling
and disposal of such materials and certain waste products. Although the Company
believes that its activities currently comply with the standards prescribed by
such laws and regulations, the risk of accidental contamination or injury from
these materials cannot be eliminated. In the event of such an accident, the
Company could be held liable for any damages that result and any liability could
exceed the resources of the Company. In addition, there can be no assurance that
the Company will not be required to incur significant costs to comply with
environmental laws and regulations in the future.
EMPLOYEES
As of February 28, 1997, ArQule employed 66 people of whom 29 have Ph.D.
degrees. Of these, 45 were engaged in operations, 12 were engaged in research
and development and 9 were engaged in marketing and general administration. None
of ArQule's employees are covered by collective bargaining agreements. ArQule
believes its employee relations are good.
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT
The current executive officers of the Company are as follows:
NAME AGE POSITION
- ------------------------------ ---- -------------------------------------------------------
Eric B. Gordon................ 49 President, Chief Executive Officer and Director
Joseph C. Hogan, Jr., Ph.D.... 55 Chairman of the Board, Senior Vice President of
Research and Development, Chief Scientific Officer
David L. Coffen, Ph.D......... 58 Vice President of Chemistry
James R. Fitzgerald, Jr....... 52 Vice President, Chief Financial Officer and Treasurer
John M. Sorvillo, Ph.D........ 42 Vice President of Business Development
Eric B. Gordon has been the President and Chief Executive Officer of the
Company since January 1996. From 1987 until he joined the Company, Mr. Gordon
served in various capacities in the United States and Europe with Pasteur
Merieux Connaught -- U.S., a pharmaceutical company, most recently as Vice
President and Chief Financial Officer. In addition, since 1993 he held the
additional position of Chief Executive Officer of Virogenetics Corporation, a
partially owned joint venture company and since 1994 Vice President and
Treasurer of Pasteur Merieux. Mr. Gordon received his A.M.P. from the Wharton
School of Business of the University of Pennsylvania and his B.S. in Accounting
and Finance from Syracuse University.
Joseph C. Hogan, Jr., Ph.D. is a founder of the Company and has served as
the Chief Scientific Officer and Senior Vice President of Research and
Development since its inception. Dr. Hogan has served as the Chairman of the
Board since January 1996. From 1990 until he founded the Company, Dr. Hogan was
the founder and president of Applied Modular Chemistries, Inc., a chemistry
company. Dr. Hogan received his M.S. and B.S. in Chemistry from Boston College
and his Ph.D. from Boston College and the Max Planck Institut fuer
Kohlenforschung, Muelheim/Ruhr, Germany.
David L. Coffen, Ph.D. has been the Vice President of Chemistry since July
1995. From 1971 until he joined the Company, Dr. Coffen was employed by
Hoffman-LaRoche Inc., a pharmaceutical company, in a variety of positions, most
recently as Vice President of Molecular Sciences. Dr. Coffen received his Ph.D.
in Synthetic Organic Chemistry from the Massachusetts Institute of Technology
and his B.S. in Chemistry from the University of Toronto.
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James R. Fitzgerald, Jr. joined the Company in July 1996 as the Vice
President, Chief Financial Officer and Treasurer. From 1988 until he joined the
Company, Mr. Fitzgerald was the Chief Financial Officer of Hoyts Cinemas
Corporation, an owner and operator of cinemas. Mr. Fitzgerald received his
M.B.A. and his B.A. in Economics from Northeastern University.
John M. Sorvillo, Ph.D. joined the Company in December 1995 as Vice
President of Business Development. Prior to joining the Company, Dr. Sorvillo
had provided consulting services to the Company since August 1995. From 1985
until he joined the Company, Dr. Sorvillo was employed by Oncogene Science,
Inc., a biotechnology company, in a variety of positions, most recently as Vice
President and General Manager. Dr. Sorvillo attended the Massachusetts Institute
of Technology Program for Senior Executives. He received his Ph.D. in Immunology
from the New York University Medical Center and his B.A. in Biology from the
City University of New York, Hunter College.
ITEM 2. PROPERTIES
ArQule's research facilities include approximately 51,389 square feet of
laboratory and office space in Medford, Massachusetts pursuant to three lease
agreements. These leases extend through July 30, 2001, at which time the Company
has an option to renew the leases for an additional five year period.
ArQule believes its current facilities are adequate for its current
operations. The Company believes that suitable additional space will be
available to it, when needed, on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
In October 1996, two individuals asserted that they are entitled to
compensation from certain of the Company's stockholders and/or the Company equal
to approximately five percent of the equity interests in the Company for
services in connection with the initial financing of the Partnership in 1993. No
litigation has been commenced and settlement discussions are in progress.
However, no assurance can be given that such individuals will not commence
litigation relating to such claims. The Company intends to vigorously defend any
claim brought by such individuals and believes that it has meritorious defenses
to such claims. No assurances can be given regarding the outcome of any such
litigation.
Except as stated above, ArQule is not a party to any other legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock began trading on the Nasdaq National Market on
October 16, 1996 under the symbol "ARQL". Prior to October 16, 1996, there was
no public market for the Common Stock or any other securities of the Company.
The following table sets forth, for the periods indicated, the range of the
high and low closing sale prices for the Company's Common Stock:
HIGH LOW
------ ------
1996
Fourth Quarter (from October 16, 1996)............................. $15.75 $ 9.00
1997
First Quarter (through March 4, 1997).............................. 24.25 14.75
As of March 4, 1997, there were approximately 58 holders of record of the
Company's Common Stock.
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Under its Amended and Restated 1994 Equity Incentive Plan and pursuant to
Rule 701 of the Securities Act of 1933, as amended (the "Securities Act"), the
Company has granted options for 1,372,420 shares of the Company's Common Stock
as of December 31, 1996. As of such date, an option for 625 shares of Common
Stock had been exercised at $0.02 per share.
In April 1996, all accrued interest outstanding through November 1995 on a
series of bridge loans to the Company from certain stockholders in the aggregate
amount of $2,400,000 (the "Bridge Loans") was converted into shares of Series A
Convertible Preferred Stock, $0.01 par value (the "Series A Preferred Stock"),
which were converted into 56,714 shares of Common Stock in October 1996. The
stockholders of the Company made Bridge Loans to the Company in exchange for
promissory notes and warrants to purchase an aggregate of 240,000 shares of
Common Stock exercisable at $0.25 per share until the earlier of the effective
date of an initial public offering or various dates through December 31, 1999
(the "Bridge Warrants"). In October 1996, the Bridge Warrants were exercised on
a cashless basis for 234,992 shares of Common Stock. The Company privately
placed these shares relying on Section 4(2) of the Securities Act as its
exemption from registration under Section 5 of the Securities Act.
In April 1996, the Company also issued shares of Series B Convertible
Preferred Stock, $0.01 par value, to Physica B.V., which were converted into
7,734 shares of Common Stock in October 1996, in consideration of Physica B.V.'s
waiver of its anti-dilution rights to acquire shares of Series A Preferred
Stock. The Company privately placed these shares relying on Section 4(2) of the
Securities Act as its exemption from registration under Section 5 of the
Securities Act.
The Company has never paid cash dividends on its Common Stock and does not
anticipate paying any cash dividends in the foreseeable future. The Company
currently intends to retain future earnings, if any, to fund the development of
its business.
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ITEM 6. SELECTED FINANCIAL DATA
The following data, insofar as it relates to the period from inception (May
6, 1993) through December 31, 1993 and for the years 1994, 1995 and 1996, have
been derived from the Company's audited financial statements, including the
balance sheet as of December 31, 1995 and 1996 and the related statements of
operations and of cash flows for the three years ended December 31, 1996 and
notes thereto appearing elsewhere herein. The data should be read in conjunction
with the Financial Statements and the Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" appearing
elsewhere in this Form 10-K. The historical results are not necessarily
indicative of the results of operations to be expected in the future.
PERIOD FROM INCEPTION YEAR ENDED DECEMBER 31,
(MAY 6, 1993) THROUGH -----------------------------
DECEMBER 31, 1993 1994 1995 1996
--------------------- ------- ------- -------
Statement of Operations Data:
Revenue...................................... $ -- $ 85 $ 3,330 $ 7,255
------- ------- ------- -------
Cost and expenses:
Cost of revenue............................ -- -- 1,644 4,739
Research and development................... 769 2,806 2,095 3,076
Marketing, general and administrative...... 687 1,346 1,557 2,850
------- ------- ------- -------
Total costs and expenses................ 1,456 4,152 5,296 10,665
------- ------- ------- -------
Loss from operations......................... (1,456) (4,067) (1,966) (3,410)
Interest income (expense), net............... (9) (139) (286) 417
------- ------- ------- -------
Net loss..................................... $(1,465) $(4,206) $(2,252) $(2,993)
======= ======= ======= =======
Unaudited pro forma net loss per shares(1)... $ (0.33) $ (0.39)
======= =======
Shares used in computing unaudited pro forma
net loss per share(1)...................... 6,853 7,705
======= =======
DECEMBER 31,
------------------------------------
1993 1994 1995 1996
------ ------- ------- -------
Balance Sheet Data:
Cash, cash equivalents and marketable securities......... $ 595 $ 425 $ 7,791 $37,086
Working capital (deficit)................................ 275 (2,108) 5,074 31,440
Total assets............................................. 1,538 2,321 10,190 43,509
Capital lease obligations, less current portion.......... 376 962 911 1,728
Series B mandatorily redeemable convertible preferred
stock................................................. -- -- 6,888 --
Total stockholders' equity (deficit)..................... 771 (1,203) (1,000) 34,621
- ---------------
(1) Unaudited pro forma net loss per share is determined by dividing the Net
loss by Shares used in computing unaudited pro forma net loss per share. For
information regarding Shares used in computing unaudited pro forma net loss
per share, see Note 2 of Notes to Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
ArQule is engaged in the discovery and development of novel chemical
compounds with commercial potential in the pharmaceutical, biotechnology and
agrichemical industries. ArQule manufactures and delivers two types of arrays of
synthesized compounds to its pharmaceutical, biotechnology and agrichemical
partners: (i) Mapping Array compound sets, which are arrays of novel, diverse
small molecule compounds used in screening for lead generation and (ii) Directed
Array compound sets, which are arrays of analogs of a particular lead compound
(identified from a Mapping Array set or otherwise), synthesized for the purpose
of optimizing such lead compounds.
The Company currently generates revenue primarily through compound
development from collaborative agreements, which provide for the development and
delivery of Mapping Array and Directed Array sets. The Company's revenue to date
is primarily attributable to five major corporate collaborations: Pharmacia
Biotech AB, entered into in March 1995; Abbott Laboratories, entered into in
June 1995; Solvay Duphar B.V., entered into in November 1995; Roche Bioscience,
entered into in September 1996; and Monsanto Company, entered into in December
1996. Under these collaborations, the Company has received payments of $15.1
million through December 31, 1996 and has recognized $10.4 million as revenue.
The Company recognizes revenue under its corporate collaborations as related
work is performed and arrays are delivered. Payments received from corporate
partners prior to the completion of the related work are recorded as deferred
revenue. License option fees are recognized as the options are granted because
such fees are nonrefundable and the Company has no further obligations to
fulfill. The Company is also entitled to receive milestone and royalty payments
if products generated under the collaborations are developed. The Company has
not received any milestone or royalty payments to date. The Company has
additionally entered into joint discovery agreements with a number of
biotechnology companies to which it has provided Mapping Array and Directed
Array sets in exchange for joint ownership of resulting drug candidates. These
agreements have not yet yielded any significant revenue for the Company.
The Company has not been profitable since inception and has incurred a
cumulative net loss of $10.9 million through December 31, 1996. Losses have
resulted principally from costs incurred in research and development activities
related to the Company's efforts to develop its technologies and from the
associated administrative costs required to support these efforts. The Company's
ability to achieve profitability is dependent on its ability to market its
Mapping Array and Directed Array Programs to pharmaceutical, biotechnology and
agrichemical companies and the joint development and commercialization of
products in which it has an economic interest.
RESULTS OF OPERATIONS
Years Ended December 31, 1996 and 1995
Revenue. The Company's revenue for the year ended December 31, 1996
increased $4.0 million to $7.3 million from $3.3 million for the same period in
1995. This was attributable to a $5.0 million increase in compound development
revenue related to the performance of work and the delivery of Mapping Array and
Directed Array sets under the Company's collaborative agreements, offset by a
$1.0 million decrease in license option fees during the same period. The Company
began recognizing revenue from the Pharmacia Biotech AB, Abbott Laboratories and
Solvay Duphar B.V. collaborations in March, June and November 1995, respectively
and for Roche Bioscience and Monsanto Company in October and December of 1996,
respectively.
Cost of revenue. The Company's cost of revenue for the year ended December
31, 1996 increased $3.1 million to $4.7 million from $1.6 million for the same
period in 1995. This increase was primarily attributable to the costs of
additional scientific personnel and the necessary supplies and overhead expenses
related to the performance of the work and the delivery of the Mapping Array and
Directed Array sets pursuant to its collaborative agreements. The Company
anticipates that the aggregate cost of revenue will increase over the next
several years as its business expands.
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Research and development expenses. The Company's research and development
expenses for the year ended December 31, 1996 increased $1.0 million to $3.1
million from $2.1 million for the same period in 1995. This increase was the
result of the Company's expansion of its chemical libraries and related
proprietary technologies. The Company expects research and development spending
to increase over the next several years as the Company further expands its
chemistry discovery and development programs.
Marketing, general and administrative expenses. The Company's marketing,
general and administrative expenses for the year ended December 31, 1996
increased $1.3 million to $2.9 million from $1.6 million for the same period in
1995. The increase was primarily associated with increased business development
activities, expenses of being a public company, and higher levels of
administrative support for the Company's growth during 1996. These expenses will
likely increase in the aggregate in future periods to support the projected
growth of the Company.
Net interest income (expense). The Company's net interest income for the
year ended December 31, 1996 was $0.4 million, which compared to a net interest
expense of $0.3 million for the same period in 1995. Higher interest income in
1996 resulted primarily from the Company holding higher cash balances following
its initial public offering of Common Stock in October 1996.
Net loss. The Company's net loss for the year ended December 31, 1996
increased $0.7 million to $3.0 million from $2.3 million for 1995. The increase
was primarily attributable to operating and development expenses exceeding the
increase in revenue generated from corporate collaborations during 1996.
Years Ended December 31, 1995 and 1994
Revenue. The Company's revenue for the year ended December 31, 1995
increased to $3.3 million from $0.1 million for the same period in 1994. This
increase was attributable to compound development revenue related to the
performance of work and the delivery of Mapping Array and Directed Array sets
under the Company's collaborative agreements which were entered into during
1995. The Company also recognized a $1.0 million license option fee related to
the Pharmacia Biotech AB collaborative agreement entered into in 1995.
Cost of revenue. The Company's cost of revenue for the year ended December
31, 1995 was $1.6 million, reflecting costs associated with the development,
production and delivery of compounds pursuant to the corporate collaborations
entered into in 1995. There was no cost of revenue in 1994 as there were no
collaborative agreements during this year and as the Company's efforts were
directed toward the research and development of its technology.
Research and development expenses. The Company's research and development
expenses for the year ended December 31, 1995 decreased $0.7 million to $2.1
million from $2.8 million for the same period in 1994. This decrease was the
result of the Company focusing, in 1995, on producing compounds delivered
pursuant to its collaborative agreements.
Marketing, general and administrative expenses. The Company's marketing,
general and administrative expenses for the year ended December 31, 1995
increased $0.3 million to $1.6 million from $1.3 million for the same period in
1994. This increase was primarily due to costs associated with increased
business development activities and administrative support, which accompanied
the Company's expansion during 1995.
Net interest expense. The Company's net interest expense for the year
ended December 31, 1995 was $0.3 million, which compared to $0.1 million for the
same period in 1994. This increase was primarily attributable to increased use
of capital equipment lease financing.
Net loss. The Company's net loss for the year ended December 31, 1995
decreased $1.9 million to $2.3 million from $4.2 million for the same period in
1994. The decrease was primarily attributable to the increase in revenue
generated from corporate collaborations.
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LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company held cash and cash equivalents and
marketable securities with a value of $37.1 million. The Company's working
capital at December 31, 1996 was $31.4 million. The Company has funded
operations through December 31, 1996 with sales of preferred stock and common
stock totaling $45.3 million, payments from corporate collaborators totaling
$15.1 million, and the utilization of capital equipment lease financing totaling
$4.1 million. The Company has maintained a master lease agreement since February
1994. Under the terms of this agreement, the Company has funded certain capital
expenditures through leases with terms of 42 months in duration. As of December
31, 1996, the Company had utilized $3.6 million of the available $8.5 million
financing facility.
Net cash provided by financing activities for the year ended December 31,
1996 was $30.8 million, primarily reflecting proceeds from the Company's October
1996 initial public offering. Net cash provided by financing activities for the
year ended December 31, 1995 was $7.2 million, largely due to a $7.0 million
equity investment by Solvay Duphar B.V. Net cash provided by financing
activities for the year ended December 31, 1994 was $3.8 million, resulting
mainly from capital contributions and proceeds from bridge financings.
Net cash provided by operating activities was $0.8 million and $0.7 million
for each of the years ended December 31, 1996 and December 31, 1995,
respectively. The positive cash flow from operating activities primarily
reflects additional payments received from the five corporate collaborators. Net
cash used in operating activities for the year ended December 31, 1994 was $3.8
million, largely due to the Company's scale-up of research and development
activities prior to generating significant revenue.
Net cash provided by investing activities during the year ended December
31, 1996 was $2.0 million, resulting primarily from the sale of marketable
securities offset by the purchases of property and equipment. Net cash used in
investing activities for the year ended December 31, 1995 was $5.3 million as
compared to $0.2 million for the year ended December 31, 1994. This increase
primarily reflects purchases of marketable securities.
Management estimates that the Company's existing cash equivalents,
short-term investments, cash generated from operations and research funding from
corporate collaborators, will enable the Company to maintain its current and
planned operations at least through March 1999. The Company's cash requirements
may vary materially from those now planned depending upon the results of its
drug discovery and development strategies, the ability of the Company to enter
into any corporate collaborations in the future and the terms of such
collaborations, the results of research and development, the need for currently
unanticipated capital expenditures, competitive and technological advances,
acquisitions, and other factors. There can be no assurance that the Company will
be able to obtain additional customers for the Company's products and services,
or that such products and services will produce revenues adequate to fund the
Company's operating expenses. If the Company experiences increased losses, the
Company may have to seek additional financing from public or private sale of its
securities, including equity securities. There can be no assurance that
additional funding will be available when needed or on acceptable terms.
19
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
PAGE
-----
Report of Independent Accountants..................................................... 21
Balance Sheet at December 31, 1995 and 1996........................................... 22
Statement of Operations for the three years ended December 31, 1996................... 23
Statement of Redeemable Preferred Stock and Stockholders' Equity (Deficit) for the
three years ended December 31, 1996................................................. 24
Statement of Cash Flows for the three years ended December 31, 1996................... 25
Notes to Financial Statements......................................................... 26
Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts and Reserves for the three years
ended December 31, 1996.......................................................... 37
20
21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of ArQule, Inc.
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of ArQule, Inc.
at December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996, 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 audits. We conducted our audits 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 audits provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 25, 1997
21
22
ARQULE, INC.
BALANCE SHEET
DECEMBER 31,
----------------------------
1995 1996
----------- ------------
ASSETS
Current assets:
Cash and cash equivalents...................................... $ 2,989,000 $ 36,586,000
Marketable securities.......................................... 4,802,000 500,000
Accounts receivable............................................ -- 250,000
Prepaid expenses and other current assets...................... 123,000 338,000
Notes receivable from related parties.......................... 93,000 176,000
----------- ------------
Total current assets................................... 8,007,000 37,850,000
Property and equipment, net...................................... 1,994,000 5,293,000
Other assets..................................................... 99,000 139,000
Notes receivable from related parties............................ 90,000 227,000
----------- ------------
$10,190,000 $ 43,509,000
=========== ============
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of capital lease obligations................... $ 514,000 $ 1,138,000
Accounts payable and accrued expenses.......................... 769,000 1,109,000
Deferred revenue............................................... 1,650,000 4,163,000
----------- ------------
Total current liabilities.............................. 2,933,000 6,410,000
----------- ------------
Capital lease obligations........................................ 911,000 1,728,000
----------- ------------
Deferred revenue................................................. 458,000 750,000
----------- ------------
Series B mandatorily redeemable convertible preferred stock...... 6,888,000 --
----------- ------------
Stockholders' equity (deficit):
Preferred stock, $0.01 par value; 1,000,000 shares authorized;
no shares issued or outstanding at December 31, 1996 -- --
Series A convertible preferred stock; 10,511,000 shares issued
and outstanding at December 31, 1995........................ 2,486,000 --
Common stock, $0.01 par value; 30,000,000 shares authorized;
522,797 and 9,851,487 shares issued and outstanding at
December 31, 1995 and 1996, respectively.................... 5,000 99,000
Additional paid-in capital..................................... 4,435,000 46,102,000
Accumulated deficit............................................ (7,926,000) (10,934,000)
----------- ------------
(1,000,000) 35,267,000
Deferred compensation.......................................... -- (646,000)
----------- ------------
Total stockholders' equity (deficit)................... (1,000,000) 34,621,000
----------- ------------
Commitments and contingency (Note 13)............................ -- --
----------- ------------
$10,190,000 $ 43,509,000
=========== ============
The accompanying notes are an integral part of these financial statements.
22
23
ARQULE, INC.
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
Revenue:
Compound development revenue...................... $ 85,000 $ 1,830,000 $ 4,255,000
Compound development revenue--related party....... -- 500,000 3,000,000
License option fees............................... -- 1,000,000 --
----------- ----------- -----------
85,000 3,330,000 7,255,000
----------- ----------- -----------
Costs and expenses:
Cost of revenue................................... -- 1,367,000 2,683,000
Cost of revenue--related party.................... -- 277,000 2,056,000
Research and development.......................... 2,806,000 2,095,000 3,076,000
Marketing, general and administrative............. 1,346,000 1,557,000 2,850,000
----------- ----------- -----------
4,152,000 5,296,000 10,665,000
----------- ----------- -----------
Loss from operations........................... (4,067,000) (1,966,000) (3,410,000)
Interest income..................................... -- 133,000 607,000
Interest expense.................................... (139,000) (419,000) (190,000)
----------- ----------- -----------
Net loss....................................... $(4,206,000) $(2,252,000) $(2,993,000)
=========== =========== ===========
Unaudited proforma net loss per share assuming
conversion of convertible preferred stock (Note
9):
Net loss per share............................. $ (0.33) $ (0.39)
=========== ===========
Shares used in computing net loss per share.... 6,853,000 7,705,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
23
24
ARQULE, INC.
STATEMENT OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
STOCKHOLDERS' EQUITY (DEFICIT)
--------------------------------------------------
SERIES B MANDATORILY
REDEEMABLE CONVERTIBLE SERIES A CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
------------------------ ------------------------- ----------------------
SHARES AMOUNT SHARES AMOUNT SHARES PAR VALUE
---------- ----------- ----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1993................. 1,500 $ --
Capital contribution from ArQule Partners,
L.P. (Note 1)..............................
3,333.33 for 1 stock split effected in the
form of a stock dividend................... 4,998,500 50,000
Cancellation of common stock................. (140,528) (1,000)
Issuance of Series A convertible preferred
stock in exchange for common stock......... 8,591,000 $ 86,000 (4,295,500) (43,000)
Cancellation of unvested portion of
restricted stock upon employee
termination................................ (9,375) --
Issuance of common stock purchase warrants
under bridge financing.....................
Net loss.....................................
----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1994................. 8,591,000 86,000 554,597 6,000
Employee restricted stock purchases.......... 68,200 --
Issuance of common stock purchase warrants
under bridge financing.....................
Cancellation of unvested portion of
restricted stock upon employee
termination................................ (100,000) (1,000)
Conversion of bridge notes into Series A
convertible preferred stock................ 1,920,000 2,400,000
Issuance of Series B mandatorily redeemable
convertible preferred stock, net of
issuance costs of $115,000................. 1,800,000 $ 6,885,000
Accretion of Series B mandatorily redeemable
preferred stock to redemption value........ 3,000
Net loss.....................................
---------- ----------- ----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1995................. 1,800,000 6,888,000 10,511,000 2,486,000 522,797 5,000
Conversion of interest on bridge notes to
Series A convertible preferred stock....... 113,429 142,000
Issuance of Series B mandatorily redeemable
preferred stock to maintain ownership
percentage (Note 9)........................ 15,468
Cancellation of unvested portion of
restricted stock upon employee
termination................................ (1,875) --
Employee option exercise..................... 625 --
Accretion of Series B mandatorily redeemable
preferred stock to redemption value........ 15,000
Conversion of Series B mandatorily redeemable
preferred stock to common stock............ (1,815,468) (6,903,000) 907,734 9,000
Conversion of Series A convertible preferred
stock to common stock...................... (10,624,429) (2,628,000) 5,312,214 54,000
Exercise of warrants pursuant to a cashless
exercise provision......................... 234,992 2,000
Issuance of common stock in connection with
initial public offering, net of issuance
costs of $2,979,000........................ 2,875,000 29,000
Compensation related to the grant of common
stock options..............................
Amortization of deferred compensation........
Net loss.....................................
---------- ----------- ----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1996................. -- $ -- -- $ -- 9,851,487 $ 99,000
========== =========== =========== =========== ========== =========
ADDITIONAL TOTAL
PAID-IN ACCUMULATED DEFERRED STOCKHOLDERS'
CAPITAL DEFICIT COMPENSATION EQUITY (DEFICIT)
----------- ------------ ------------ ----------------
<
BALANCE AT DECEMBER 31, 1993................. $ 2,236,000 $ (1,465,000) $ 771,000
Capital contribution from ArQule Partners,
L.P. (Note 1).............................. 2,100,000 2,100,000
3,333.33 for 1 stock split effected in the
form of a stock dividend................... (50,000) --
Cancellation of common stock................. 1,000 --
Issuance of Series A convertible preferred
stock in exchange for common stock......... (43,000) --
Cancellation of unvested portion of
restricted stock upon employee
termination................................ --
Issuance of common stock purchase warrants
under bridge financing..................... 132,000 132,000
Net loss..................................... (4,206,000) (4,206,000)
----------- ------------ ------------
BALANCE AT DECEMBER 31, 1994................. 4,376,000 (5,671,000) (1,203,000)
Employee restricted stock purchases.......... 1,000 1,000
Issuance of common stock purchase warrants
under bridge financing..................... 57,000 57,000
Cancellation of unvested portion of
restricted stock upon employee
termination................................ 1,000 --
Conversion of bridge notes into Series A
convertible preferred stock................ 2,400,000
Issuance of Series B mandatorily redeemable
convertible preferred stock, net of
issuance costs of $115,000.................
Accretion of Series B mandatorily redeemable
preferred stock to redemption value........ (3,000) (3,000)
Net loss..................................... (2,252,000) (2,252,000)
----------- ------------ ------------
BALANCE AT DECEMBER 31, 1995................. 4,435,000 (7,926,000) (1,000,000)
Conversion of interest on bridge notes to
Series A convertible preferred stock....... 142,000
Issuance of Series B mandatorily redeemable
preferred stock to maintain ownership
percentage (Note 9)........................
Cancellation of unvested portion of
restricted stock upon employee
termination................................ --
Employee option exercise..................... --
Accretion of Series B mandatorily redeemable
preferred stock to redemption value........ (15,000) (15,000)
Conversion of Series B mandatorily redeemable
preferred stock to common stock............ 6,894,000 6,903,000
Conversion of Series A convertible preferred
stock to common stock...................... 2,574,000 --
Exercise of warrants pursuant to a cashless
exercise provision......................... (2,000) --
Issuance of common stock in connection with
initial public offering, net of issuance
costs of $2,979,000........................ 31,492,000 31,521,000
Compensation related to the grant of common
stock options.............................. 709,000 $ (709,000) --
Amortization of deferred compensation........ 63,000 63,000
Net loss..................................... (2,993,000) (2,993,000)
----------- ------------ ---------- ------------
BALANCE AT DECEMBER 31, 1996................. $46,102,000 $(10,934,000) $ (646,000) $ 34,621,000
=========== ============ ========== ============
The accompanying notes are an integral part of these financial statements.
24
25
ARQULE, INC.
STATEMENT OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
YEAR ENDED DECEMBER 31,
-----------------------------------------
1994 1995 1996
----------- ----------- -----------
Cash flows from operating activities:
Net loss..................................................... $(4,206,000) $(2,252,000) $(2,993,000)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization........................... 189,000 506,000 1,171,000
Amortization of debt discount........................... 25,000 164,000 --
Amortization of deferred compensation................... -- -- 63,000
Increase in accounts receivable......................... -- -- (250,000)
(Increase) decrease in prepaid expenses and other
current assets....................................... 41,000 (94,000) (215,000)
(Increase) decrease in other assets..................... (188,000) 203,000 (40,000)
Increase in notes receivable from related parties....... -- (120,000) (220,000)
Increase in accounts payable and accrued expenses....... 340,000 141,000 482,000
Increase in deferred revenue............................ -- 2,108,000 2,805,000
----------- ----------- -----------
Net cash (used in) provided by operating
activities......................................... (3,799,000) 656,000 803,000
----------- ----------- -----------
Cash flows from investing activities:
Purchases of marketable securities........................... -- (9,052,000) --
Proceeds from sale or maturity of marketable securities...... -- 4,250,000 4,302,000
Additions to property and equipment.......................... (168,000) (495,000) (2,292,000)
----------- ----------- -----------
Net cash (used in) provided by investing
activities......................................... (168,000) (5,297,000) 2,010,000
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from bridge financing--related party................ 1,700,000 700,000 --
Principal payments of capital lease obligations.............. (110,000) (381,000) (737,000)
Proceeds from issuance of mandatorily redeemable convertible
preferred stock, net...................................... -- 6,885,000 --
Proceeds from issuance of common stock....................... -- 1,000 31,521,000
Capital contribution from ArQule Partners, L.P. ............. 2,100,000 -- --
Proceeds from sale-leaseback transactions.................... 107,000 -- --
----------- ----------- -----------
Net cash provided by financing activities............ 3,797,000 7,205,000 30,784,000
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents........... (170,000) 2,564,000 33,597,000
Cash and cash equivalents, beginning of period................. 595,000 425,000 2,989,000
----------- ----------- -----------
Cash and cash equivalents, end of period....................... $ 425,000 $ 2,989,000 $36,586,000
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations of $935,000, $503,000 and $2,178,000, were
incurred in 1994, 1995 and 1996, respectively, when the Company entered into
leases for various machinery and equipment, furniture and fixtures, and
leasehold improvements.
During 1995, the Company converted $2,400,000 of bridge loans into
1,920,000 shares of Series A convertible preferred stock (Note 8). In addition,
during 1996, the Company converted $142,000 of interest relating to the bridge
loans into 113,429 shares of Series A convertible preferred stock.
During 1996, 12,439,897 shares of Series A and Series B preferred stock
were converted into 6,219,948 shares of common stock, in connection with the
Company's initial public offering of common stock (Note 9). In addition, 234,992
shares of common stock were issued in connection with the cashless exercise of
outstanding warrants.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
During 1994, 1995 and 1996, the Company paid approximately $98,000,
$254,000 and $190,000, respectively, for interest.
The accompanying notes are an integral part of these financial statements.
25
26
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS
ArQule, Inc. (the "Company") is engaged in the discovery, development and
production of novel chemical compounds for the pharmaceutical, biotechnology and
agrichemical industries. Its operations are focused on the integration of
combinatorial chemistry, structure-guided rational drug design and other
proprietary technologies which automate the process of chemical synthesis to
produce arrays of small organic chemical compounds used to generate and optimize
drug development candidates.
In May 1993 and in connection with the formation of ArQule Partners L.P.
("the Partnership"), Legomer Technologies, Inc. ("LTI"), formerly Molecular
Recognition Technologies, Inc., a company owned by the two founding limited
partners in the Partnership, contributed to the Partnership all rights and
interests in certain LTI patented technology (the "Technology") in exchange for
a 0.5% general partner ownership position. The Company was legally incorporated
on December 30, 1993 to carry on the operations of the Partnership. Immediately
following the incorporation of the Company, the Partnership transferred
substantially all of its assets, liabilities and patented technology (the
"Operating Assets"), having an aggregate net book value of $771,000, to the
Company in exchange for 1,500 shares of the Company's $0.01 par value common
stock, representing all of the Company's then outstanding common stock. Because
of the related party nature of these transactions, the Operating Assets and
Technology transfers have been accounted for as transfers of assets between
entities under common control. Accordingly, the accompanying financial
statements include the assets, liabilities and results of operations of the
Company at historical amounts as if the transfers occurred at the inception of
the Partnership.
Amounts which reflect the funding of the Partnership's operations prior to
the conversion of certain shares of the Company's common stock into Series A
preferred stock (Note 9) are reflected as paid-in capital in the accompanying
balance sheet and as capital contributed by ArQule Partners L.P. in the
statements of changes in redeemable preferred stock and stockholders' equity
(deficit) and of cash flows. Such funding totaled $2,100,000 of cash for the
year ended December 31, 1994, and was comprised of aggregate investments in
general partnership interests of $20,000 and limited partnership interests of
$2,080,000.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies followed in the preparation of these
financial statements are as follows:
Cash Equivalents and Marketable Securities
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The Company
invests its available cash primarily in money market mutual funds and U.S.
government and other investment grade debt securities which have strong credit
ratings. These investments are subject to minimal credit and market risks. The
Company specifically identifies securities for purposes of determining gains and
losses on the sale of cash equivalents and short-term investments. At December
31, 1996 and 1995, the Company has classified its investments as
available-for-sale as defined in Statement of Financial Accounting Standards
("SFAS") No. 115.
Fair Value of Financial Instruments
At December 31, 1995 and 1996, the Company's financial instruments consist
of cash, cash equivalents, marketable securities, accounts receivable, notes
receivable from related party, accounts payable and accrued expenses and
mandatorily redeemable convertible preferred stock. The carrying amount of these
instruments approximate their fair values.
26
27
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives. Assets under capital
leases and leasehold improvements are amortized over the shorter of their
estimated useful lives or the term of the respective leases by use of the
straight-line method. Maintenance and repair costs are expensed as incurred.
Revenue Recognition
Compound development revenue relates to revenue from significant
collaborative agreements (Note 3) and from licensing of compound arrays. Revenue
from collaborative agreements relates to the delivery of compounds and to
compound development work and is recognized using the percentage of completion
method. The application of this revenue recognition method is dependent on the
contractual arrangement of either compound delivery or development. Accordingly,
revenue is recognized on the proportional achievement of deliveries against a
compound delivery schedule or as development labor is expended against a total
research and development labor plan. Payments received under these arrangements
prior to the completion of the related work are recorded as deferred revenue.
Revenue from licensing of compound arrays with no additional obligations is
recognized upon delivery of the compound array. License option fees represent
payments made to the Company for a right to evaluate and negotiate the terms of
potential licensing arrangements and are recognized as revenue as the options
are granted, as the Company has no further obligations and as payments are
nonrefundable.
Cost of Revenue
Cost of revenue represents the actual costs incurred in connection with
performance pursuant to collaborative agreements and the costs incurred to
produce compound arrays. These costs consist primarily of payroll and
payroll-related costs, supplies and overhead expenses.
Stock Compensation
Options granted to employees and directors are accounted for in accordance
with Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to
Employees". The Company has adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock Based Compensation." Options granted to nonemployees are
accounted for using the fair value method and are recognized as compensation
expense over their respective vesting periods.
Unaudited Pro Forma Net Loss Per Share
Pro forma net loss per share is determined by dividing the net loss by the
weighted average number of common stock and common stock equivalents outstanding
during the period, assuming the conversion of all convertible preferred stock
which occurred upon the closing of the Company's initial public offering as
described in Note 9.
Common stock equivalents, although anti-dilutive, issued at prices below
the offering price per share during the twelve month period preceding the
initial filing of the Registration Statement have been included in the
calculation of unaudited pro forma net loss per share using the treasury stock
method and the initial public offering price of $12.00 per share as if
outstanding for all periods presented through June 30, 1996.
Historical net loss per share has not been presented as the Series A
convertible preferred stock would have been omitted from the weighted average
shares outstanding as it is anti-dilutive and was issued more than twelve months
prior to the initial public offering.
27
28
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Use of 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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Reclassifications
Certain reclassifications have been made to the 1994 and 1995 financial
statements to conform to the 1996 presentation. These reclassifications had no
effect on the net loss for 1994 and 1995.
3. SIGNIFICANT AGREEMENTS
The Company has entered into a number of license, research and development
agreements (the "Agreements") with certain corporate collaborators. One
Agreement was entered into with Solvay Duphar B.V. ("Solvay"), a related party
(Note 9). Revenue related to the Solvay Agreement is included in compound
development revenue--related party. Under the terms of these Agreements, the
Company will provide a certain number of compounds per year and has granted the
right to screen these compounds against targets to identify biological activity
(an "Active Compound") and will provide research and development services. The
collaborators have the right to enter into an exclusive, worldwide license (the
"License") for any Active Compound identified. The initial terms of these
Agreements generally range from two to five years during which period the
collaborators make payments to the Company for technology access, delivery of
compounds and for its research and development services. In exchange for a
License, the Company will receive milestone payments during product development
and royalty payments based on the sales of the product. Solvay also has a right
which expires on December 31, 1997 to license certain of the Company's
technologies on a nonexclusive basis for internal use only. Deferred revenue
represents payments made to the Company in advance for technology access,
delivery of compounds and research and development pursuant to these Agreements.
At December 31, 1995, $100,000 of the deferred revenue amount is from a related
party.
Under the terms of material transfer agreements with biotechnology
companies (the "biotech collaborators"), the Company has granted the biotech
collaborator the nonexclusive, royalty-free license to test certain compound
arrays supplied by the Company. Upon identification of an active compound, the
Company will negotiate a joint drug development program with the biotech
collaborator to develop the compound, provided the Company has not previously
licensed the compound. Under the collaboration agreements with these joint drug
development programs, the Company and the biotech collaborator will each bear
the costs and expenses of their respective activities. Proceeds received on
sales or a third party license of the jointly developed compound will first
reimburse development costs incurred by each party on a pro rata basis. After
all such reimbursements have been made, the remaining proceeds will be split
evenly between the parties.
4. CASH EQUIVALENTS AND MARKETABLE SECURITIES
The fair market value of cash equivalents was $2,688,000 and $36,126,000 at
December 31, 1995 and 1996, respectively. At December 31, 1995 and 1996, all of
the Company's cash equivalents were held in money market funds.
28
29
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the fair market value of available-for-sale
marketable securities held by the Company at December 31, 1995 and 1996:
DECEMBER 31,
-----------------------
MATURITY 1995 1996
----------- ---------- --------
U.S. Government obligations..................... 1-5 years $3,786,000 $500,000
U.S. Government obligations..................... 5-10 years 1,016,000 --
---------- --------
$4,802,000 $500,000
========== ========
At December 31, 1995 and 1996, marketable securities are carried at fair
market value, which approximates amortized cost. All of the Company's marketable
securities are classified as current at December 31, 1996 as these funds are
highly liquid and are available to meet working capital needs and to fund
current operations. Gross unrealized gains and losses at December 31, 1995 and
1996 and realized gains and losses on sales of securities for the years ended
December 31, 1995 and 1996 were not significant.
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
ESTIMATED
USEFUL DECEMBER 31,
LIFE -------------------------
(YEARS) 1995 1996
---------- ---------- ----------
Machinery and equipment.......................... 3-7 $1,839,000 $4,350,000
Leasehold improvements........................... 5 656,000 2,628,000
Furniture and fixtures........................... 7 72,000 178,000
Construction-in-progress......................... -- 124,000 5,000
---------- ----------
2,691,000 7,161,000
Less--Accumulated depreciation and amortization.............. 697,000 1,868,000
---------- ----------
$1,994,000 $5,293,000
========== ==========
Assets held under capital leases at December 31, 1995 consisted of
$1,438,000 of machinery and equipment and $485,000 of leasehold improvements. At
December 31, 1996, assets held under capital leases consisted of $3,162,000 of
machinery and equipment, $832,000 of leasehold improvements and $107,000 of
furniture and fixtures. Accumulated amortization of these assets totaled
$554,000 and $1,305,000 at December 31, 1995 and 1996, respectively. For the
years ended December 31, 1994, 1995 and 1996, amortization expense related to
assets held under capital lease obligations was $163,000, $300,000 and $751,000,
respectively.
29
30
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. NOTES RECEIVABLE FROM RELATED PARTIES
Notes receivable from related parties consist of the following:
DECEMBER 31,
---------------------
1995 1996
-------- --------
Note receivable due from an officer of the Company, due in full
on November 3, 1997.......................................... $ 63,000 $ 63,000
Note receivable due from the same officer of the Company,
payable in four equal annual installments commencing on
November 2, 1996, principal due on each installment date will
be forgiven so long as the officer is employed by the Company
on the installment date, secured by the officer's beneficial
interest in 48,000 shares of common stock of the Company..... 120,000 90,000
Note receivable due from another officer of the Company,
payable in three equal annual installments commencing on
October 16, 1997, secured by shares of common stock of the
Company issuable to the officer upon the exercise of
options...................................................... -- 250,000
-------- --------
183,000 403,000
Less--Current portion.......................................... 93,000 176,000
-------- --------
$ 90,000 $227,000
======== ========
Interest on the notes receivable from related parties accrues on the unpaid
principal and interest at the lowest applicable federal rate of interest as
published by the Internal Revenue Service (6.3% at December 31, 1996). Interest
due on the notes at December 31, 1995 and 1996 totaling $15,000 and $6,000,
respectively, is included in prepaid expenses and other current assets.
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following:
DECEMBER 31,
-----------------------
1995 1996
-------- ----------
Accounts payable............................................. $369,000 $ 485,000
Accrued professional fees.................................... 176,000 469,000
Other accrued expenses....................................... 224,000 155,000
-------- ----------
$769,000 $1,109,000
======== ==========
8. BRIDGE FINANCING--RELATED PARTY
During 1994 and 1995, the Company received $1,700,000 and $700,000,
respectively under bridge financing arrangements with certain stockholders. In
connection with this financing, the Company issued unsecured promissory notes
and on November 2, 1995, the Company and the stockholders agreed to convert the
principal of these notes into 1,960,000 shares of Series A convertible preferred
stock. At December 31, 1995, interest payable relating to these bridge
financings was $142,000. In April 1996, the Company and the stockholders
converted the interest payable into an additional 113,429 shares of Series A
convertible preferred stock. In 1996, all outstanding shares of Series A
convertible preferred stock were converted into shares of common stock upon the
closing of the Company's initial public offering (Note 9).
As partial consideration for the promissory notes, the Company issued
warrants to purchase 240,000 shares of the Company's common stock. In connection
with the Company's initial public offering, the Company issued 234,992 shares of
common stock upon the cashless exercise of these warrants.
30
31
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The proceeds from the bridge financings were allocated to the notes and to
the warrants based on management's estimate of their relative fair values and of
the then-current market interest rate of 12%. This resulted in $132,000 and
$57,000 being ascribed to the warrants in 1994 and 1995, respectively, which was
recorded as additional paid-in-capital and as a discount to the face value of
the notes. The discount was amortized over the period from issuance to
conversion into Series A convertible preferred stock. The amortization of debt
discount totaled $25,000 and $164,000 for the years ended December 31, 1994 and
1995, respectively, and is included in interest expense.
9. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND CONVERTIBLE PREFERRED
STOCK
On November 18, 1994, the Partnership (the sole stockholder of the Company
as of that date) exchanged 563,972 shares of common stock of the Company for
Partnership interests held by certain employees and consultants. The Partnership
also contributed 140,528 shares of common stock to the Company for future
issuance pursuant to the Equity Incentive Plan (Note 11). The Company
immediately retired these contributed shares and reserved 140,528 shares of
common stock for issuance pursuant to the Equity Incentive Plan. The
stockholders of the Company approved the issuance of 8,591,000 shares of Series
A convertible preferred stock to the Partnership in exchange for the remaining
4,295,500 shares of common stock held by the Partnership. Upon the exchange of
preferred stock, the Company retired the related shares of common stock.
On November 5, 1995, as part of a collaborative agreement (Note 3), the
Company sold to Solvay Duphar B.V. ("Solvay") 1,800,000 shares of Series B
preferred stock which resulted in net proceeds to the Company of $6,885,000. In
April 1996, the Company issued to Solvay an additional 15,468 shares of Series B
preferred stock in connection with the conversion of the bridge financing
interest into Series A preferred stock (Note 8) to maintain the original,
agreed-upon ownership percentage.
At December 31, 1995, the Company had 15,000,000 shares of convertible
preferred stock authorized. Upon the closing of the Company's initial public
offering on October 16, 1996 (Note 10), all outstanding shares of Series A and
Series B preferred stock automatically converted into 6,219,948 shares of common
stock, and the number of authorized shares of preferred stock was reduced to
1,000,000 shares.
10. COMMON STOCK
On October 4, 1996, the Company effected a 1-for-2 reverse stock split on
the common stock of the Company. Accordingly, all common share and per share
data have been restated to give retroactive effect to the stock split for all
periods presented.
In October and November 1996, the Company completed its initial public
offering of 2,875,000 shares of common stock. Proceeds to the Company, net of
issuance costs, amounted to $31,521,000. In connection with its initial public
offering, the stockholders approved an amendment to the Company's Certificate of
Incorporation to increase the number of authorized common shares to 30,000,000.
At December 31, 1996, the Company has 2,203,453 shares of its common stock
reserved for issuance upon the exercise of options.
Stock Restriction Agreements
At December 31, 1996, the Company had outstanding 520,922 shares of common
stock issued pursuant to the Equity Incentive Plan (Note 11) which are subject
to stock restriction agreements whereby the stockholder automatically forfeits
to the Company the unvested portion of shares of common stock in the event of
termination of their employment with the Company. All such forfeited shares
shall immediately be retired by the Company. Shares subject to this agreement
vest over a four year period, either monthly or
31
32
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
annually. At December 31, 1996, the aggregate number of unvested common shares
is 277,903. Each stock restriction agreement may be terminated at the election
of the Company.
11. EQUITY INCENTIVE AND STOCK PURCHASE PLANS
During 1994, the stockholders approved the 1994 Amended and Restated Equity
Incentive Plan (the "Equity Incentive Plan"). During 1996, the stockholders
approved an amendment to increase the number of shares of common stock available
for awards under the Equity Incentive Plan to 2,600,000. All shares will be
awarded at the discretion of a Committee of the Board of Directors (the
"Committee") in a variety of stock-based forms including stock options and
restricted stock. Pursuant to the Equity Incentive Plan, incentive stock options
may not be granted at less than the fair market value of the Company's common
stock at the date of the grant, and the option term may not exceed ten years.
For holders of 10% or more of the Company's voting stock, options may not be
granted at less than 110% of the fair market value of the common stock at the
date of the grant, and the option term may not exceed five years. Stock
appreciation rights granted in tandem with an option shall have an exercise
price not less than the exercise price of the related option.
Subject to the restrictions above, the Committee is authorized to designate
the options, awards, and purchases under the Equity Incentive Plan, the number
of shares covered by each option, award and purchase, and the related terms,
exercise dates, prices and methods of payment.
In 1996, the stockholders approved, the 1996 Director Stock Option Plan
(the "1996 Director Plan") for nonemployee directors. Under this plan, eligible
directors are automatically granted once a year, at the annual meeting of
stockholders of the Company, options to purchase 3,500 shares of common stock
which are exercisable on the date of grant. Upon initial election of an eligible
director, options to purchase 7,500 shares of common stock will be granted which
will become exercisable in three equal annual installments commencing on the
date of the Company's next annual stockholders' meeting held after the date of
grant. All options granted pursuant to the 1996 Director Plan have a term of ten
years with exercise prices equal to fair market value on the date of grant.
Through December 31, 1996, options to purchase 22,500 shares of common stock
have been granted under this plan. A maximum of 125,000 shares of common stock
of the Company is reserved for issuance in accordance with the terms of this
plan, of which 102,500 are available for future grant.
The Company applies APB No. 25 and related interpretations in accounting
for employee grants under the Equity Incentive Plan and the 1996 Director Plan
(collectively the "Plans"). For the three years ended December 31, 1996, no
compensation expense has been recognized under the Plans for employee grants.
Had compensation cost been determined based on the estimated value of options at
the grant date consistent with the provisions of SFAS No. 123, the Company's pro
forma net loss and pro forma net loss per share would have been as follows:
YEAR ENDED
DECEMBER 31,
-------------------------
1995 1996
----------- -----------
Pro forma net loss......................................... $(2,254,000) $(3,186,000)
Pro forma net loss per share............................... (0.33) (0.41)
During 1996, the Company issued 140,000 options to certain consultants and
members of its scientific advisory board under the Equity Incentive Plan. The
estimated value of these options totaled $709,000, was recorded as deferred
compensation and is being amortized as compensation expense over the vesting
period of the options.
For the purposes of pro forma disclosure, the estimated value of each
employee and nonemployee option grant was calculated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions: no
dividend yield for both years; 45% volatility for nonemployee grants in both
years and employee grants subsequent to the initial filing of the Registration
Statement in connection with the
32
33
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company's initial public offering; no volatility for employee grants prior to
the initial public offering; risk-free interest rates ranging from 5.20% to
7.10% and expected lives ranging from 3 to 6 years for options granted during
both years.
Option activity under the Plans for the three years ended December 31, 1996
was as follows:
WEIGHTED
AVERAGE
NUMBER EXERCISE
STOCK OPTIONS OF SHARES PRICE
--------------------------------------------------------------- --------- --------
Granted........................................................ 2,500 $ 0.02
---------
Outstanding at December 31, 1994............................... 2,500 $ 0.02
Granted........................................................ 298,500 $ 0.17
---------
Outstanding at December 31, 1995............................... 301,000 $ 0.17
Granted........................................................ 1,096,420 $ 4.55
Exercised...................................................... (625) $ 0.02
Cancelled...................................................... (1,875) $ 0.02
---------
Outstanding at December 31, 1996............................... 1,394,920 $ 3.62
=========
Exercisable at December 31, 1996............................... 149,611 $ 0.50
=========
Weighted average estimated value of options granted during the
year ended December 31, 1996................................. $ 1.49
=========
The following table summarizes information about options outstanding at
December 31, 1996:
OPTIONS OUTSTANDING
-------------------------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED
OUTSTANDING AT REMAINING AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES 1996 LIFE PRICE
-------------------------------------------------- -------------- ----------- --------
$0.02....................................... 50,000 8.3 years.. $ 0.02
0.20....................................... 248,500 8.6 years.. 0.20
0.80 - 1.20...................................... 477,420 9.1 years.. 0.81
2.40....................................... 27,500 9.4 years.. 2.40
6.00....................................... 395,000 9.5 years.. 6.00
10.25 - 12.00..................................... 196,500 9.8 years.. 11.04
---------
1,394,920
=========
OPTIONS EXERCISABLE
-------------------------
NUMBER
EXERCISABLE WEIGHTED
AT AVERAGE
DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1996 PRICE
-------------------------------------------------------------- ------------ --------
$0.02.................................................... 12,500 $ 0.02
0.20.................................................... 59,625 0.20
0.80.................................................... 77,486 0.80
-------
149,611
=======
At December 31, 1996, restricted common stock purchased pursuant to the
Equity Incentive Plan totaled 520,922 shares (Note 10), and there were 706,033
shares available for future grant under the Equity Incentive Plan.
33
34
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Stock Purchase Plan
In 1996, the stockholders adopted the 1996 Employee Stock Purchase Plan
(the "Purchase Plan"). This plan enables eligible employees to exercise rights
to purchase the Company's common stock at 85% of the fair market value of the
stock on the date the right was granted or the date the right is exercised,
whichever is lower. Rights to purchase shares under the Purchase Plan are
granted by the Board of Directors. The rights are exercisable during a period
determined by the Board of Directors; however, in no event will the period be
longer than twenty-seven months. The Purchase Plan is available to substantially
all employees, subject to certain limitations. The Company has reserved 120,000
shares of common stock for purchases under the Purchase Plan. At December 31,
1996, no shares have been purchased pursuant to the Purchase Plan.
12. INCOME TAXES
The benefit (provision) for income taxes was as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
Deferred tax benefit:
Federal................................... $ 1,420,000 $ 794,000 $ 886,000
State..................................... 338,000 246,000 347,000
----------- ----------- -----------
1,758,000 1,040,000 1,233,000
Deferred tax asset valuation allowance...... (1,758,000) (1,040,000) (1,233,000)
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
The Company's deferred tax assets consist of the following:
DECEMBER 31,
---------------------------
1995 1996
----------- -----------
Preoperating costs capitalized for tax purposes........... $ 416,000 $ 370,000
Net operating loss carryforwards.......................... 2,590,000 3,906,000
Tax credit carryforwards.................................. 272,000 311,000
Book depreciation in excess of tax........................ 106,000 30,000
----------- -----------
Gross deferred tax assets................................. 3,384,000 4,617,000
Deferred tax asset valuation allowance.................... (3,384,000) (4,617,000)
----------- -----------
$ -- $ --
=========== ===========
The Company has provided a full valuation allowance for the deferred tax
assets as the realization of these future benefits is not sufficiently assured
as of the end of each related year. If the Company achieves profitability, the
deferred tax assets will be available to offset future income tax liabilities
and expense.
34
35
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1996, the Company has federal net operating loss
carryforwards and tax credit carryforwards available to reduce future taxable
income and tax liabilities, respectively, which expire as follows:
NET RESEARCH AND
OPERATING DEVELOPMENT
YEAR OF LOSS TAX CREDIT
EXPIRATION CARRYFORWARDS CARRYFORWARDS
----------------------------------------------------------- ------------- -------------
2009..................................................... $ 4,320,000 $ 84,000
2010..................................................... 2,181,000 52,000
2011..................................................... 3,319,000 16,000
----------- ---------
$ 9,820,000 $ 152,000
=========== =========
Under the Internal Revenue Code, certain substantial changes in the
Company's ownership could result in an annual limitation on the amount of net
operating loss and tax credit carryforwards which can be utilized in future
years.
A reconciliation between the amounts of reported income tax benefit and the
amount determined by applying the U.S. federal statutory rate of 35% for 1994,
1995 and 1996 to pre-tax loss is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
Income tax benefit at statutory rate........ $ 1,472,000 $ 788,000 $ 1,048,000
State tax benefit, net of federal benefit... 252,000 135,000 180,000
Research and investment tax credits......... 139,000 133,000 53,000
Other....................................... (105,000) (16,000) (48,000)
----------- ----------- -----------
1,758,000 1,040,000 1,233,000
Increase in valuation allowance............. (1,758,000) (1,040,000) (1,233,000)
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
13. COMMITMENTS AND CONTINGENCY
Leases
The Company leases facilities and equipment under noncancelable operating
and capital leases. The future minimum lease commitments under these leases are
as follows:
YEAR ENDING OPERATING CAPITAL
DECEMBER 31, LEASES LEASES
------------------------------------------------------------ ---------- ----------
1997..................................................... $ 541,000 $1,343,000
1998..................................................... 520,000 1,058,000
1999..................................................... 458,000 697,000
2000..................................................... 373,000 102,000
2001..................................................... 148,000 --
------- ----------
Total minimum lease payments................................ $2,040,000 3,200,000
=======
Less--Amount representing interest.......................... 334,000
----------
Present value of minimum lease payments..................... $2,866,000
==========
The Company has a lease line agreement with a financial institution (the
"Lessor") for $8,500,000 of which approximately $4,884,000 was available for
future leases at December 31, 1996. The term for each lease
35
36
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
under the agreement is forty-two months, commencing on the purchase date of the
asset, and the lease bears interest at a rate determined by the Lessor at the
transaction date. During 1994, the Company sold and leased back approximately
$107,000 in machinery and equipment, furniture and fixtures and office equipment
from the Lessor.
Rent expense under noncancelable operating leases was approximately
$91,000, $163,000 and $283,000 for the years ended December 31, 1994, 1995 and
1996, respectively.
Employment Agreements
The Company entered into an employment agreement with an officer who is
also a member of the board of directors. This agreement provides that if his
employment is terminated without cause, the officer is entitled to receive up to
six months' salary. The Company also entered into an employment agreement with
another officer. This agreement provides that if his employment is terminated
without cause during the first year of the agreement, the officer is entitled to
receive up to six months' salary.
Contingency
In October 1996, the Company received a letter from two individuals who
have asserted that they are entitled to compensation from certain of the
Company's stockholders and/or the Company equal to approximately five percent of
the equity interest in the Company. The Company believes that there are
meritorious defenses against such claims and intends to contest them vigorously;
however, they are currently unable to estimate the outcome of this matter,
including the range of potential loss, if any.
36
37
SCHEDULE II
ARQULE, INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
BALANCE AT CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING OF COSTS AND CHARGED TO AND END OF
DESCRIPTION PERIOD EXPENSES OTHER ACCOUNTS WRITE-OFFS PERIOD
- ------------------------------------ ------------ ---------- -------------- ----------- ----------
Deferred tax asset valuation
allowance.........................
Year ended Dec. 31, 1994.......... $ 586,000 1,758,000 -- -- $2,344,000
Year ended Dec. 31, 1995.......... 2,344,000 1,040,000 -- -- 3,384,000
Year ended Dec. 31, 1996.......... 3,384,000 1,233,000 -- -- 4,617,000
37
38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not Applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is contained in part under the caption "Executive
Officers of the Registrant" in Part I, Item 1A hereof and the remainder is
incorporated herein by reference from the discussion responsive thereto under
the caption "Election of Directors" in the Company's Proxy Statement relating to
its Annual Meeting of Stockholders scheduled for May 14, 1997 (the "Proxy
Statement").
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated herein by reference from the
discussion responsive thereto under the caption "Executive Compensation" in the
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND MANAGEMENT
The response to this item is incorporated herein by reference from the
discussion responsive thereto under the caption "Share Ownership" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated herein by reference from the
discussion responsive thereto under the caption, "Compensation Committee
Interlocks and Insider Participation" in the Proxy Statement and from Notes 6
and 8 to the Financial Statements included herein.
38
39
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(A) 1. FINANCIAL STATEMENTS
The financial statements are listed under Item 8 of this report.
2. FINANCIAL STATEMENT SCHEDULES
The financial statement schedules are listed under Item 8 of this report.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of 1996.
(C) EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- ------------------------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation of the Company. Filed as
Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No.
333-22945) and incorporated herein by reference.
3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.5 to the
Company's Registration Statement on Form S-1 (File No. 333-11105) and
incorporated herein by reference.
4.1 Specimen Common Stock Certificate. Filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333- 11105) and incorporated
herein by reference.
10.1* Amended and Restated 1994 Equity Incentive Plan, as amended through October
17, 1994. Filed as Exhibit 10.1 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.2* 1996 Employee Stock Purchase Plan. Filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (File No. 333- 11105) and incorporated
herein by reference.
10.3* 1996 Director Stock Option Plan. Filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (File No. 333- 11105) and incorporated
herein by reference.
10.4 Form of Indemnification Agreement between the Company and its directors. Such
agreements are materially different only as to the signing directors and the
dates of execution. Filed as Exhibit 10.4 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by
reference.
10.5 Investors' Rights Agreement among the Company and certain stockholders of the
Company dated November 2, 1995. Filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.6 Lease Agreement dated September 29, 1993 between the Company and Beautyrest
Property, Inc. and WRB, Inc. Filed as Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.7 Lease Agreement, dated July 27, 1995, between the Company and Cummings
Properties Management, Inc. as amended. Filed as Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.8* Employment Agreement effective as of January 2, 1996, between the Company and
Eric B. Gordon. Filed as Exhibit 10.8 to the Company's Registration Statement
on Form S-1 (File No. 333- 11105) and incorporated herein by reference.
10.9* Employment Agreement effective as of July 9, 1996, between the Company and
James R. Fitzgerald, Jr. Filed as Exhibit 10.9 to the Company's Registration
Statement on Form S-1 (File No. 333- 11105) and incorporated herein by
reference.
10.10* Promissory Note dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and
the Company. Filed as Exhibit 10.10 to the Company's Registration Statement on
Form S-1 (File No. 333- 11105) and incorporated herein by reference.
10.11* Pledge Agreement dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and
the Company. Filed as Exhibit 10.11 to the Company's Registration Statement on
Form S-1 (File No. 333- 11105) and incorporated herein by reference.
39
40
EXHIBIT NO. DESCRIPTION
----------- ------------------------------------------------------------------------------
10.12* Promissory Note and Pledge Agreement dated July 9, 1996 between Eric B. Gordon
and the Company. Filed as Exhibit 10.12 to the Company's Registration
Statement on Form S-1 (File No. 333- 11105) and incorporated herein by
reference.
10.13* Promissory Note dated November 4, 1993 between Dr. Joseph C. Hogan, Jr. and
the Company. Filed as Exhibit 10.13 to the Company's Registration Statement on
Form S-1 (File No. 333- 11105) and incorporated herein by reference.
10.14+ Research, Development and License Agreement between the Company and Solvay
Duphar B.V. dated November 2, 1995. Filed as Exhibit 10.14 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.15+ Research & Development and License Agreement between the Company and Abbott
Laboratories dated June 15, 1995, as amended. Filed as Exhibit 10.15 to the
Company's Registration Statement on Form S-1 (file No. 333-11105) and
incorporated herein by reference.
10.16+ Research & Development Agreement between the Company and Pharmacia Biotech AB
dated March 10, 1995, as amended. Filed as Exhibit 10.16 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.17+ Option Agreement between the Company and Pharmacia Biotech AB dated March 10,
1995, as amended. Filed as Exhibit 10.17 to the Company's Registration
Statement on Form S-1 (File No. 333- 11105) and incorporated herein by
reference.
10.18* Adoption Agreement for Fidelity Management and Research Company (the Company's
401(k) plan). Filed as Exhibit 10.18 to the Company's Registration Statement
on Form S-1 (File No. 333- 11105) and incorporated herein by reference.
10.19 Research and License Agreement between the Company and Roche Bioscience dated
September 13, 1996. Filed as Exhibit 10.19 to the Company's Registration
Statement on Form S-1 (File No. 333- 11105) and incorporated herein by
reference.
10.20+ Array Delivery and Testing Agreement between the Company and Monsanto Company
dated as of December 23, 1996. Filed as Exhibit 10.20 to the Company's
Registration Statement on Form S-1 (File No. 333-22945) and incorporated
herein by reference.
10.21+ Amendment No. 2 to Research & Development License Agreement between the
Company and Abbot Laboratories dated as of December 24, 1996. Filed as Exhibit
10.21 to the Company's Registration Statement on Form S-1 (File No.
333-22949).
10.22 Lease Agreement, dated December 20, 1996 between the Company and Cummings
Property Management, Inc. Filed as Exhibit 10.22 to the Company's Registration
Statement on Form S-1 (File No. 333-22949).
11.1 Statement re computation of unaudited pro forma net loss per share. Filed
herewith.
23.1 Consent of Price Waterhouse LLP. Filed herewith.
99.1 Important Factors Regarding Forward-Looking Statements. Filed herewith.
- ---------------
* Indicates a management contract or compensatory plan.
+ Certain confidential material contained in the document has been omitted and
filed separately, with the Securities and Exchange Commission pursuant to Rule
406 of the Securities Act of 1933, as amended.
40
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registration has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the Town of
Medford, Commonwealth of Massachusetts, on March 31, 1997.
ARQULE, INC.
By: /s/ ERIC B. GORDON
----------------------------------
ERIC B. GORDON
President and Chief Executive
Officer
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------- ---------------
/s/ ERIC B. GORDON President, Chief Executive March 31, 1997
- ------------------------------------------ Officer and Director (Principal
ERIC B. GORDON Executive Officer)
/s/ JAMES R. FITZGERALD, JR. Vice President, Chief Financial March 31, 1997
- ------------------------------------------ Officer and Treasurer
JAMES R. FITZGERALD, JR. (Principal Financial Officer
and Principal Accounting
Officer)
/s/ STEPHEN M. DOW Director March 31, 1997
- ------------------------------------------
STEPHEN M. DOW
/s/ JOSEPH C. HOGAN, JR. Chairman of the Board, Senior March 31, 1997
- ------------------------------------------ Vice President of Research and
JOSEPH C. HOGAN, JR. Development, Chief Scientific
Officer and Director
/s/ ADRIAN DE JONGE Director March 31, 1997
- ------------------------------------------
ADRIAN DE JONGE
/s/ ALLAN R. FERGUSON Director March 31, 1997
- ------------------------------------------
ALLAN R. FERGUSON
41
42
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- ------------------------------------------------------------------------------
3.1 Amended and Restated Certificate of Incorporation of the Company. Filed as
Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No.
333-22945) and incorporated herein by reference.
3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.5 to the
Company's Registration Statement on Form S-1 (File No. 333-11105) and
incorporated herein by reference.
4.1 Specimen Common Stock Certificate. Filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.1* Amended and Restated 1994 Equity Incentive Plan, as amended through October
17, 1994. Filed as Exhibit 10.1 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.2* 1996 Employee Stock Purchase Plan. Filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.3* 1996 Director Stock Option Plan. Filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.4 Form of Indemnification Agreement between the Company and its directors. Such
agreements are materially different only as to the signing directors and the
dates of execution. Filed as Exhibit 10.4 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by
reference.
10.5 Investors' Rights Agreement among the Company and certain stockholders of the
Company dated November 2, 1995. Filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.6 Lease Agreement dated September 29, 1993 between the Company and Beautyrest
Property, Inc. and WRB, Inc. Filed as Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.7 Lease Agreement, dated July 27, 1995, between the Company and Cummings
Properties Management, Inc. as amended. Filed as Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (File No.333-11105) and incorporated herein
by reference.
10.8* Employment Agreement effective as of January 2, 1996, between the Company and
Eric B. Gordon. Filed as Exhibit 10.8 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.9* Employment Agreement effective as of July 9, 1996, between the Company and
James R. Fitzgerald, Jr. Filed as Exhibit 10.9 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by
reference.
10.10* Promissory Note dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and
the Company. Filed as Exhibit 10.10 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.11* Pledge Agreement dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and
the Company. Filed as Exhibit 10.11 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.12* Promissory Note and Pledge Agreement dated July 9, 1996 between Eric B. Gordon
and the Company. Filed as Exhibit 10.12 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by
reference.
10.13* Promissory Note dated November 4, 1993 between Dr. Joseph C. Hogan, Jr. and
the Company. Filed as Exhibit 10.13 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.
42
43
EXHIBIT NO. DESCRIPTION
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10.14+ Research, Development and License Agreement between the Company and Solvay
Duphar B.V. dated November 2, 1995. Filed as Exhibit 10.14 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.15+ Research & Development and License Agreement between the Company and Abbott
Laboratories dated June 15, 1995, as amended. Filed as Exhibit 10.15 to the
Company's Registration Statement on Form S-1 (file No. 333-11105) and
incorporated herein by reference.
10.16+ Research & Development Agreement between the Company and Pharmacia Biotech AB
dated March 10, 1995, as amended. Filed as Exhibit 10.16 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated
herein by reference.
10.17+ Option Agreement between the Company and Pharmacia Biotech AB dated March 10,
1995, as amended. Filed as Exhibit 10.17 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by
reference.
10.18* Adoption Agreement for Fidelity Management and Research Company (the Company's
401(k) plan). Filed as Exhibit 10.18 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.19 Research and License Agreement between the Company and Roche Bioscience dated
September 13, 1996. Filed as Exhibit 10.19 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by
reference.
10.20+ Array Delivery and Testing Agreement between the Company and Monsanto Company
dated as of December 23, 1996. Filed as Exhibit 10.20 to the Company's
Registration Statement on Form S-1 (File No. 333-22945) and incorporated
herein by reference.
10.21+ Amendment No. 2 to Research & Development License Agreement between the
Company and Abbot Laboratories dated as of December 24, 1996. Filed as Exhibit
10.21 to the Company's Registration Statement on Form S-1 (File No.
333-22949).
10.22 Lease Agreement, dated December 20, 1996 between the Company and Cummings
Property Management, Inc. Filed as Exhibit 10.22 to the Company's Registration
Statement on Form S-1 (File No. 333-22949).
11.1 Statement re computation of unaudited pro forma net loss per share. Filed
herewith.
23.1 Consent of Price Waterhouse LLP. Filed herewith.
99.1 Important Factors Regarding Forward-Looking Statements. Filed herewith.
- ---------------
* Indicates a management contract or compensatory plan.
+ Certain confidential material contained in the document has been omitted and
filed separately, with the Securities and Exchange Commission pursuant to Rule
406 of the Securities Act of 1933, as amended.
43