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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, 1997 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:
(781) 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 5, 1998 was: $218,276,085.
There were 11,938,236 shares of the registrant's Common Stock outstanding
as of March 5, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement of the Registrant's 1998 Annual
Meeting of Shareholders to be held on May 14, 1998, 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, 1997, 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 agrochemicals. 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, Amersham Pharmacia Biotech AB, Roche Bioscience, Solvay Duphar
B.V., American Homes Products Corporation, Inc. and Sankyo Company, Ltd. and has
formed joint discovery programs with many biotechnology companies.
The Company's goal is to penetrate the product development pipelines of
major pharmaceutical, biotechnology and agrochemical 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 agrochemical 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 agrochemicals. 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, agrochemical products, industrial
catalysts, specialty materials and other industrial products. The Company's
initial business focus has been on the pharmaceutical, biotechnology and
agrochemical 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.
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- 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 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
Discovery(TM) to accelerate the identification and optimization of lead
compounds. Targeted Discovery 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(TM)) 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.
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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
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 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
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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.
- 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 AGROCHEMICAL INDUSTRY
Industry Background. Agrochemicals are chemical products used in the
agricultural industry. Examples of agrochemicals are herbicides, pesticides,
fungicides, bactericides and soil treatment agents. Historically, agrochemical
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. Agrochemicals 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 agrochemical 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 agrochemical 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 Agrochemical Industry. The agrochemical
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 agrochemical industry. Indeed, compound quantities and scale-up issues are
perhaps more important to the agrochemical industry than the pharmaceutical
industry.
- Compound Quantities. The agrochemical 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 agrochemical
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
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major factor. Because of these constraints, the ease and cost of manufacture for
a product is a more important consideration in the agrochemical 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 agrochemical
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. ArQule's compounds are delivered to its collaborators in
milligram quantities sufficient for whole-organism screening methods,
which are traditionally used in agrochemical 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(TM) 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(TM) 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, agrochemical and biotechnology companies and to
maximize the likelihood of the discovery
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of activity and successful development of commercial compounds. Key elements of
the Company's strategy include:
- Collaborations with Pharmaceutical and Agrochemical 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 agrochemical 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.
- 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,
agrochemicals 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
to continue 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 Agrochemical Company Collaborations
To date, the Company has entered into the following major collaborations
with pharmaceutical and agrochemical companies:
Amersham Pharmacia Biotech AB. In March 1995, the Company entered
into a collaborative agreement with Amersham Pharmacia Biotech AB
("Amersham"), to allow Amersham 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 "Amersham Agreement"). On
the same date, the Company and Amersham also signed an agreement under
which Amersham 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 Amersham Agreement, subject to the
payment by Amersham of additional fees and the negotiation and execution by
the parties of a license agreement containing commercially reasonable terms
(the "Option Agreement"). In accordance with its terms, the Amersham
Agreement expired on December 31,1997. The parties are actively engaged in
negotiations to extend and expand the contract.
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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 many 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 additional Directed Array sets during part
of such extended period, and to provide for the payment by Abbott of
additional research and development funding during such extended period. In
December 1997, the Abbott Agreement was further amended to provide for the
Company to supply Abbott with additional Mapping Array sets through March
1999 and with additional Directed Array sets through December 1999. Abbott
may not terminate the Abbott Agreement prior to March 1999 without cause.
Absent early termination, Abbott has agreed to pay the Company $7.4 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.
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. 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. 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.
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.
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
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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 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.
American Home Products. In July 1997, the Company entered into a
collaborative agreement with Wyeth-Ayerst Pharmaceuticals, a division of
American Home Products Corporation ("Wyeth-Ayerst"), pursuant to which
Wyeth-Ayerst subscribed to the Company's Mapping Array Program and has
committed to a minimum number of Directed Array Programs. Wyeth-Ayerst will
pay ArQule approximately $28 million, which includes a $2 million equity
investment in ArQule to be paid in 1998. Wyeth-Ayerst will make further
payments to ArQule throughout the five year collaboration as development
milestones are reached. In addition, ArQule will be entitled to royalties
from sales of any products emanating from this collaboration.
Sankyo Company, Ltd. In November 1997, the Company entered into a
collaborative agreement with Sankyo Company, Ltd. ("Sankyo") to discover
and optimize drug candidates. The agreement calls for use of ArQule's
Mapping Array and Directed Array Programs in identifying and optimizing
lead compounds for a number of therapeutic areas. Under terms of the
agreement, Sankyo will receive a three year subscription to ArQule's
Mapping Array Program to discover new lead compounds. Sankyo is also
committed to a minimum number of Direct Array Programs during the term of
the agreement. Absent early termination, the Company will receive a minimum
of $9.0 million over this three year period. Payments will be made to
ArQule for delivery of the Mapping Array and Directed Array Programs and
for achieved milestones. In addition, ArQule will be entitled to royalties
from sales of any products emanating from this collaboration.
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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
------- -------------
Acacia Biosciences Biosynthesis and metabolism
Aurora Biosciences, Inc. Mammalian Cell-Based Assays
Cubist Pharmaceuticals, Inc. Infectious Diseases
CuraGen Genomics
FibroGen Fibrotic Disorders
GenQuest Cancer
Genzyme Corp. Cancer
ICAgen, Inc. Ion Channel Receptors
Ontogeny Developmental Biology Targets
Ribogene Pathogen specific translation
Scriptgen Pharmaceuticals, Inc. RNA/Protein Interaction
Sepracor, Inc. Resistant HIV and Hepatitis B
Signal Pharmaceuticals, Inc. Gene Transcription/Transcription Factors
SUGEN, Inc. Signal Transduction/Kinases
T Cell Sciences, Inc. T Cell Activation/Inhibition
ViroPharma, Inc. RNA viruses
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 a more focused
research collaboration 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
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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 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 three issued U.S. utility patents, one issued U.S. design
patent, one issued Australian patent, and over 70 patent applications in the
U.S. and other countries. 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 agrochemical 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, agrochemical 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.
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Historically, pharmaceutical and agrochemical 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.
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 licensing 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
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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 agrochemicals are heavily regulated in
the United States. The EPA regulates such products under the Federal
Insecticide, Fungicide and Rodenticide Act ("FIFRA"). Agrochemicals 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 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 agrochemicals 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 March 5, 1998, ArQule employed 159 people of whom 51 have Ph.D.
degrees. Of these, 90 were engaged in operations, 52 were engaged in research
and development and 17 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.
EXECUTIVE OFFICERS OF THE REGISTRANT
The current executive officers of the Company are as follows:
NAME AGE POSITION
---- --- --------
Eric B. Gordon........................ 50 President, Chief Executive Officer and
Director
Joseph C. Hogan, Jr., Ph.D............ 56 Chairman of the Board, Senior Vice
President of Research and
Development, Chief Scientific
Officer, and Director
James R. Fitzgerald, Jr............... 53 Vice President, Chief Financial
Officer and Treasurer
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.
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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.
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.
ITEM 2. PROPERTIES
ArQule's research facilities include approximately 63,000 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. The
company has obtained 12,000 square feet of additional laboratory space in
Waltham, Massachusetts pursuant to a sublease agreement. This lease extends
through November 30, 2000, at which time the Company has an option to extend for
one year. ArQule believes its 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
On July 21, 1997, a complaint was filed in the United States District Court
of Connecticut (Case No. 397CV01449) against the Company and two of the
Company's stockholders by two individuals alleging that they were entitled to
compensation from the Company and these two stockholders equal to approximately
five percent of the equity interest in the Company for services in connection
with the initial financing of ArQule Partners, L.P. in 1993. In addition, one of
the plaintiffs is alleging that he was denied the opportunity to make a five
percent investment in the Company at the time of its incorporation. Prior to the
Company's initial public offering of its Common Stock, ArQule Partners, L.P. was
a major stockholder of the Company. An answer was filed on September 15, 1997
denying the material allegations in the complaint and Phase I of the discovery
process has been completed. Although the parties to this lawsuit have had
mediation proceedings, the Company intends to continue to contest this lawsuit
vigorously. No assurance can be given regarding the outcome of this lawsuit.
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
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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 Stock MarketSM 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............................................. 24.25 14.25
Second Quarter............................................ 19.50 12.00
Third Quarter............................................. 22.75 14.75
Fourth Quarter............................................ 29.25 17.75
1998
First Quarter (through March 5, 1998)..................... 25.50 15.00
As of March 5, 1998, there were approximately 89 holders of record and
approximately 2,546 beneficial shareholders of the Company's Common Stock.
During the first quarter of the Company's fiscal year ended December 31,
1997 and prior to the Company filing a registration statement on Form S-8 for
option exercises under its Amended and Restated 1994 Equity Incentive Plan (the
"Plan"), options to purchase 34,375 shares of Common Stock were exercised at
$0.20 per share pursuant to Rule 701 of the Securities Act of 1933, as amended.
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.
Use of Proceeds from Registered Securities
A Registration Statement on Form S-1 (File No. 333-11105) registering
2,875,000 shares of the Company's Common Stock, filed in connection with the
Company's IPO was declared effective by the Securities and Exchange Commission
on October 16, 1996. Exercise of the over-allotment option was initiated on
November 13, 1996 and was closed on November 18, 1996.
The Company and its selling shareholders sold, in aggregate, all 2,875,000
shares registered in the IPO, with an aggregate offering price to the public of
$34,500,000. The managing underwriters of the IPO were Hambrecht & Quist LLC,
Oppenheimer & Co., Inc. and Vector Securities International Inc.
In connection with the IPO, the Company incurred total expenses of
$2,979,000, including underwriting discounts and commissions of $2,415,000 and
other expenses of $564,000. After such expenses, the Company's net proceeds from
the IPO were $31,521,000. The amount of net offering proceeds used by the
Company as of December 31, 1997 was as follows: approximately $9,500,000 for
fixed asset additions and approximately $1,500,000 for capital lease
obligations.
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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, 1996 and 1997,
have been derived from the Company's audited financial statements, including the
balance sheet as of December 31, 1996 and 1997 and the related statements of
operations and of cash flows for the three years ended December 31, 1997 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 (in
thousands, except per share data).
PERIOD FROM INCEPTION
(MAY 6, 1993) THROUGH YEAR ENDED DECEMBER 31,
DECEMBER 31, ----------------------------------------
1993 1994 1995 1996 1997
--------------------- ------- ------- ------- -------
Statement of Operations Data:
Revenue......................... $ -- $ 85 $ 3,330 $ 7,255 $17,420
------- ------- ------- ------- -------
Cost and expenses:
Cost of revenue............... -- -- 1,644 4,739 10,218
Research and development...... 769 2,806 2,095 3,076 4,704
Marketing, general and
administrative............. 687 1,346 1,557 2,850 4,670
------- ------- ------- ------- -------
Total costs and expenses... 1,456 4,152 5,296 10,665 19,592
------- ------- ------- ------- -------
Loss from operations............ (1,456) (4,067) (1,966) (3,410) (2,172)
Interest income (expense),
net........................... (9) (139) (286) 417 2,463
------- ------- ------- ------- -------
Net income (loss)............... $(1,465) $(4,206) $(2,252) $(2,993) $ 291
======= ======= ======= ======= =======
Basic net income (loss) per
share(1)...................... $ (3.76) $ (1.23) $ .03
======= ======= =======
Weighted average common shares
outstanding -- basic(1)....... 599 2,430 11,337
======= ======= =======
Diluted net income (loss) per
share(1)...................... $ (3.76) $ (1.23) $ .02
======= ======= =======
Weighted average common shares
and equivalents outstanding --
diluted(1).................... 599 2,430 12,394
======= ======= =======
DECEMBER 31,
--------------------------------------------------
1993 1994 1995 1996 1997
------ ------- ------- ------- -------
Balance Sheet Data:
Cash, cash equivalents and marketable
securities........................... $ 595 $ 425 $ 7,791 $37,086 $49,282
Working capital (deficit)............... 275 (2,108) 5,074 31,440 46,023
Total assets............................ 1,538 2,321 10,190 43,509 66,925
Capital lease obligations, less current
portion.............................. 376 962 911 1,728 1,213
Series B mandatorily redeemable
convertible preferred stock.......... -- -- 6,888 -- --
Total stockholders' equity (deficit).... 771 (1,203) (1,000) 34,621 57,340
- ---------------
(1) The Company adopted Statement of Financial Accounting Standards No.
128 -- "Earnings Per Share" ("SFAS 128") in the fourth quarter of 1997. SFAS
128 requires retroactive restatement of previously reported income (loss)
per share calculations. As a result of adopting SFAS 128, certain
anti-dilutive pro-forma share amounts included in the computation of the
loss per share in 1995 and 1996 are no
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longer included in the weighted average common shares and equivalents
outstanding. Prior to the restatement required by SFAS 128, pro forma net
loss per share for the year ended December 31, 1995 was ($0.33), based upon
weighted average common shares outstanding of 6,853 and for the year ended
December 31, 1996 was ($0.39), based upon weighted average common shares
outstanding of 7,705.
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
agrochemical industries. ArQule manufactures and delivers two types of arrays of
synthesized compounds to its pharmaceutical, biotechnology and agrochemical
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 seven major corporate collaborations: Amersham
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; Monsanto Company, entered into in
December 1996; American Home Products, entered into July 1997; and Sankyo Ltd,
entered into November 1997. Under these collaborations, the Company has received
payments of $29.1 million through December 31, 1997 and has recognized $28.1
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. Technology access fees are recognized over the length of
the research and development agreement. 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 interests of resulting drug
candidates. These agreements have not yet yielded any significant revenue for
the Company.
The Company experienced its first year of profitability in 1997, reflecting
the increase in revenues resulting from ArQule's growing collaborator base and
an increase in interest income. Quarterly variations in future financial
performance may be expected as increases in revenue are dependent on expanding
existing collaborations, additional corporate collaborations, and future
milestone payments, which may be inconsistent and difficult to anticipate. In
addition, the Company will continue to aggressively invest in new technologies
to expand its drug discovery capabilities. The Company also expects that
strategic opportunities will arise to broaden the Company's participation in
drug discovery and to extend the Company's proprietary technology platform to
industry segments beyond pharmaceutical and agrochemical product discovery.
Strategic investments of this nature have the potential for enhancing longer
term equity value but may result in near term earnings fluctuations or impact
profitability.
RESULTS OF OPERATIONS
Years Ended December 31, 1997 and 1996
Revenue. The Company's revenue for the year ended December 31, 1997
increased $10.1 million to $17.4 million from $7.3 million for the same period
in 1996. This increase was primarily due to increased compound development
revenue from work performed on and the delivery of Mapping Array and Directed
Array sets under the Company's collaborative agreements. The Company began
recognizing revenue from Roche BioScience, Monsanto Company, American Home
Products and Sankyo collaborations in October 1996, December 1996, July 1997,
and November 1997, respectively.
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Cost of revenue. The Company's cost of revenue for the year ended December
31, 1997 increased $5.5 million to $10.2 million from $4.7 million for the same
period in 1996. These increases are primarily attributable to the costs of
additional facilities and 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 the Company's collaborative
agreements. The Company anticipates that the aggregate cost of revenue will
increase over the next several years as its business expands.
Research and development expenses. The Company's research and development
expenses for the year ended December 31, 1997 increased $1.6 million to $4.7
million from $3.1 million for the same period in 1996. These increases are 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, 1997
increased $1.8 million to $4.7 million from $2.9 million for the same period in
1996. These increases are primarily associated with increased marketing and
business development activities, expenses of being a public company for a full
year, and higher levels of administrative support in concert with the Company's
growth during 1997. 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, 1997 was $2.5 million, compared to $0.4 million for the
same period in 1996. Higher interest income in 1997 resulted primarily from the
Company holding higher cash and marketable securities balances following its
initial and follow-on offerings of common stock in October 1996 and April 1997,
respectively.
Net income (loss). The Company's net income for the year ended December
31, 1997 was $0.3 million as compared to a net loss of $3.0 million for the same
period in 1996. The net income for 1997 is primarily attributable to increase in
revenues from the Company's growing collaborator base and higher net interest
income recognized during 1997. Quarterly variations in future financial
performance may be expected as increases in revenue are dependent on expanding
existing collaborations, additional corporate collaborations, and future
milestone payments, which may be inconsistent and difficult to anticipate.
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 Amersham 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, 1997 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.
Research and development expenses. The Company's research and development
expenses for the year ended December 31, 1997 increased $1.0 million to $3.1
million from $2.1 million from the same period in 1995. This increase was the
result of the Company's expansion of its chemical libraries and related
proprietary technologies.
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,
18
20
expenses of being a public company, and higher levels of administrative support
for the Company's growth during 1996.
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.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company held cash and cash equivalents and
marketable securities with a value of $49.3 million. The Company's working
capital at December 31, 1997 was $46.0 million. The Company has funded
operations through December 31, 1997 with sales of common stock, payments from
corporate collaborators and the utilization of capital equipment lease
financing. 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, 1997, the Company had utilized $4.5 million of the available $8.5 million
financing facility.
Net cash provided by operating activities was $0.6, $0.8 million and $0.7
million for each of the years ended December 31, 1997, 1996 and 1995,
respectively. The positive cash flow from operating activities primarily
reflects payments received from the seven corporate collaborators.
Net cash used by investing activities during the year ended December 31,
1997 was $42.7 million, resulting primarily from the proceeds of the purchase of
marketable securities and from the proceeds of the initial and secondary public
offerings.
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. This
increase primarily reflects purchases of marketable securities.
Net cash provided by financing activities for the year ended December 31,
1997 and 1996 was $20.7 and $30.8 million, respectively, primarily reflecting
proceeds from the Company's April 1997 secondary public offering and 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.
The Company expects that its available cash and marketable securities,
together with operating revenues, investment income and lease financing
arrangements, will be sufficient to finance its working capital and capital
requirements for the foreseeable future. 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 the 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.
The Company has evaluated its computer software and database software to
identify modifications, if any, that may be required to address year 2000
compliance. Management does not expect the financial impact of any required
modifications to have a material impact on its results of operations of
financial position.
19
21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Accountants.......................................... 21
Balance Sheet at December 31, 1996 and 1997................................ 22
Statement of Operations for the three years ended December 31, 1997........ 23
Statement of Redeemable Preferred Stock and Stockholders'
Equity (Deficit) for the three years ended December 31, 1997............. 24
Statement of Cash Flows for the three years ended December 31, 1997........ 25
Notes to Financial Statements.............................................. 27
Financial Statement Schedules:
Schedules are not included because they are not applicable
or the information is included in the Notes to Financial Statements.
20
22
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of ArQule, Inc.
In our opinion, the accompanying balance sheet and the related statements
of operations, of redeemable preferred stock and stockholders' equity (deficit)
and of cash flows present fairly, in all material respects, the financial
position of ArQule, Inc. at December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, 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 reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 9, 1998
21
23
ARQULE, INC.
BALANCE SHEET
DECEMBER 31,
----------------------------
1996 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 36,586,000 $ 15,137,000
Marketable securities..................................... 500,000 34,145,000
Accounts receivable....................................... 250,000 3,133,000
Inventory................................................. -- 953,000
Prepaid expenses and other current assets................. 338,000 520,000
Notes receivable from related parties..................... 176,000 30,000
------------ ------------
Total current assets.............................. 37,850,000 53,918,000
Property and equipment, net................................. 5,293,000 12,654,000
Other assets................................................ 139,000 156,000
Notes receivable from related parties....................... 227,000 197,000
------------ ------------
$ 43,509,000 $ 66,925,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations.............. $ 1,138,000 $ 1,174,000
Accounts payable and accrued expenses..................... 1,109,000 2,804,000
Deferred revenue.......................................... 4,163,000 3,917,000
------------ ------------
Total current liabilities......................... 6,410,000 7,895,000
------------ ------------
Capital lease obligations................................... 1,728,000 1,213,000
------------ ------------
Deferred revenue............................................ 750,000 477,000
------------ ------------
Stockholders' equity
Preferred stock, $0.01 par value; 1,000,000 shares
authorized; no shares issued or outstanding at December
31, 1996 and 1997...................................... -- --
Common stock, $0.01 par value; 30,000,000 shares
authorized; 9,851,487 and 11,877,315 shares issued and
outstanding at December 31, 1996 and 1997,
respectively........................................... 99,000 119,000
Additional paid-in capital................................ 46,102,000 68,418,000
Accumulated deficit....................................... (10,934,000) (10,643,000)
------------ ------------
35,267,000 57,894,000
Deferred compensation..................................... (646,000) (554,000)
------------ ------------
Total stockholders' equity............................. 34,621,000 57,340,000
------------ ------------
Commitments and contingency (Note 13)....................... -- --
------------ ------------
$ 43,509,000 $ 66,925,000
============ ============
The accompanying notes are an integral part of these financial statements.
22
24
ARQULE, INC.
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31,
-----------------------------------------
1995 1996 1997
----------- ----------- -----------
Revenue
Compound development revenue...................... $ 1,830,000 $ 4,255,000 $13,840,000
Compound development revenue -- related party..... 500,000 3,000,000 3,580,000
License option fees............................... 1,000,000 -- --
----------- ----------- -----------
3,330,000 7,255,000 17,420,000
----------- ----------- -----------
Costs and expenses:
Cost of revenue................................... 1,367,000 2,683,000 8,039,000
Cost of revenue -- related party.................. 277,000 2,056,000 2,179,000
Research and development.......................... 2,095,000 3,076,000 4,704,000
Marketing, general and administrative............. 1,557,000 2,850,000 4,670,000
----------- ----------- -----------
5,296,000 10,665,000 19,592,000
----------- ----------- -----------
Loss from operations........................... (1,966,000) (3,410,000) (2,172,000)
Interest income..................................... 133,000 607,000 2,686,000
Interest expense.................................... (419,000) (190,000) (223,000)
----------- ----------- -----------
Net (loss) income.............................. $(2,252,000) $(2,993,000) $ 291,000
=========== =========== ===========
Basic net income (loss) per share................... $ (3.76) $ (1.23) $ .03
=========== =========== ===========
Weighted average common shares
outstanding -- basic.............................. 599,000 2,430,000 11,337,000
=========== =========== ===========
Diluted net income (loss) per share................. $ (3.76) $ (1.23) $ .02
=========== =========== ===========
Weighted average common shares and equivalents
outstanding -- diluted............................ 599,000 2,430,000 12,394,000
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
23
25
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 ADDITIONAL
------------------------ ------------------------- ---------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT SHARES PAR VALUE CAPITAL
---------- ----------- ----------- ----------- ---------- --------- -----------
BALANCE AT DECEMBER 31, 1994....... 8,591,000 $ 86,000 554,597 $ 6,000 $4,376,000
Employee restricted stock
purchases......................... 68,200 -- 1,000
Issuance of common stock purchase
warrants under bridge financing... 57,000
Cancellation of unvested portion on
restricted stock upon employee
termination....................... (100,000) (1,000) 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 4,435,000
Conversion of interest on bridge
notes to Series A convertible
preferred stock................... 113,429 142,000
Issuance of Series B mandatorily
redeemable convertible 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 6,894,000
Conversion of Series A convertible
preferred stock to common stock... (10,624,429) (2,628,000) 5,312,214 54,000 2,574,000
Exercise of warrants pursuant to a
cashless exercise provision....... 234,992 2,000 (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 31,492,000
Compensation related to the grant
of common stock options........... 709,000
Amortization of deferred
compensation......................
Net loss...........................
---------- ----------- ----------- ----------- ---------- -------- -----------
BALANCE AT DECEMBER 31, 1996....... -- -- -- -- 9,851,487 99,000 46,102,000
Cancellation of unvested portion of
restricted stock upon
employee termination.............. (49,219) --
Employee stock option exercises.... 133,374 1,000 352,000
Employee stock purchase plan....... 9,173 -- 110,000
Issuance of common stock in
connection with secondary public
offering, net of issuance costs of
$1,645,000........................ 1,932,500 19,000 21,526,000
Compensation related to the grant
of common stock options........... 328,000
Amortization of deferred
compensation......................
Net income.........................
---------- ----------- ----------- ----------- ---------- -------- -----------
BALANCE AT DECEMBER 31, 1997....... -- $ -- -- $ -- 11,877,315 $119,000 $68,418,000
========== =========== =========== =========== ========== ======== ===========
STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------
TOTAL
ACCUMULATED DEFERRED STOCKHOLDERS'
DEFICIT COMPENSATION EQUITY (DEFICIT)
------------ ------------ ----------------
BALANCE AT DECEMBER 31, 1994....... $(5,671,000) $(1,203,000)
Employee restricted stock
purchases......................... 1,000
Issuance of common stock purchase
warrants under bridge financing... 57,000
Cancellation of unvested portion on
restricted stock upon employee
termination....................... --
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....... (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 convertible 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...................... 6,903,000
Conversion of Series A convertible
preferred stock to common stock... --
Exercise of warrants pursuant to a
cashless exercise provision....... --
Issuance of common stock in
connection with initial public
offering, net of issuance costs of
$2,979,000........................ 31,521,000
Compensation related to the grant
of common stock options........... $(709,000) --
Amortization of deferred
compensation...................... 63,000 63,000
Net loss........................... (2,993,000) (2,993,000)
------------ --------- -----------
BALANCE AT DECEMBER 31, 1996....... (10,934,000) (646,000) 34,621,000
Cancellation of unvested portion of
restricted stock upon
employee termination.............. --
Employee stock option exercises.... 353,000
Employee stock purchase plan....... 110,000
Issuance of common stock in
connection with secondary public
offering, net of issuance costs of
$1,645,000........................ 21,545,000
Compensation related to the grant
of common stock options........... (328,000) --
Amortization of deferred
compensation...................... 420,000 420,000
Net income......................... 291,000 291,000
------------ --------- -----------
BALANCE AT DECEMBER 31, 1997....... $(10,643,000) $(554,000) $57,340,000
============ ========= ===========
The accompanying notes are an integral part of these financial statements.
24
26
ARQULE, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
----------- ----------- ------------
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities:
Net (loss) income................................ $(2,252,000) $(2,993,000) $ 291,000
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Depreciation and amortization................. 506,000 1,171,000 2,580,000
Amortization of debt discount................. 164,000 -- --
Amortization of deferred compensation......... -- 63,000 420,000
Increase in accounts receivable............... -- (250,000) (2,883,000)
Increase in inventory......................... -- -- (953,000)
Increase in prepaid expenses and other current
assets...................................... (94,000) (215,000) (182,000)
(Increase) decrease in other assets........... 203,000 (40,000) (17,000)
(Increase) decrease in notes receivable from
related parties............................. (120,000) (220,000) 176,000
Increase in accounts payable and accrued
expenses.................................... 141,000 482,000 1,695,000
Increase (decrease) in deferred revenue....... 2,108,000 2,805,000 (519,000)
----------- ----------- ------------
Net cash provided by operating
activities............................. 656,000 803,000 608,000
----------- ----------- ------------
Cash flows from investing activities:
Purchases of marketable securities............... (9,052,000) -- (61,447,000)
Proceeds from sale or maturity of marketable
securities.................................... 4,250,000 4,302,000 27,802,000
Additions to property and equipment.............. (495,000) (2,292,000) (9,085,000)
----------- ----------- ------------
Net cash (used in) provided by investing
activities............................. (5,297,000) 2,010,000 (42,730,000)
----------- ----------- ------------
Cash flows from financing activities:
Proceeds from bridge financing -- related
party......................................... 700,000 -- --
Principal payments of capital lease
obligations................................... (381,000) (737,000) (1,335,000)
Proceeds from issuance of mandatorily redeemable
convertible preferred stock, net.............. 6,885,000 -- --
Proceeds from issuance of common stock, net...... 1,000 31,521,000 22,008,000
----------- ----------- ------------
Net cash provided by financing
activities............................. 7,205,000 30,784,000 20,673,000
----------- ----------- ------------
Net (decrease) increase in cash and cash
equivalents...................................... 2,564,000 33,597,000 (21,449,000)
Cash and cash equivalents, beginning of period..... 425,000 2,989,000 36,586,000
----------- ----------- ------------
Cash and cash equivalents, end of period........... $ 2,989,000 $36,586,000 $ 15,137,000
=========== =========== ============
The accompanying notes are an integral part of these financial statements.
25
27
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations of $503,000, $2,178,000 and $856,000 were
incurred in 1995, 1996 and 1997, 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 1995, 1996 and 1997, the Company paid approximately $254,000,
$190,000 and $223,000 respectively, for interest.
26
28
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 primarily for the pharmaceutical,
biotechnology and agrochemical 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 novel small organic chemical compounds used to
generate and optimize drug development candidates.
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 within three
months of maturity date 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. At December 31, 1996
and 1997, the Company has classified its investments as available-for-sale.
Fair Value of Financial Instruments
At December 31, 1996 and 1997, the Company's financial instruments consist
of cash, cash equivalents, marketable securities, accounts receivable, notes
receivable from related party, accounts payable and accrued expenses. The
carrying amount of these instruments approximate their fair values.
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, chemicals, supplies and overhead expenses.
27
29
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Net Income (Loss) per Share
During the fourth quarter of 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS
No. 128 replaces primary and fully diluted earnings per share with basic and
diluted earnings per share. The adoption of this standard resulted in the
Company's retroactive restatement of previously reported loss per share
calculations reflecting the removal of certain anti-dilutive pro forma share
amounts. For the year ended December 31, 1997, the dilutive effect of 1,057,000
weighted average common stock option equivalents were added to the basic
weighted average shares outstanding to arrive at diluted weighted average shares
outstanding.
Stock Compensation
Options granted to employees and directors are accounted for in accordance
with Accounting Principles Board No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"). Under APB No. 25, no compensation expense is
recognized for options granted at fair market value. The Company has adopted the
disclosure requirements of SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS No. 123"). Options granted to nonemployees are accounted
for using the fair value method and are recognized as compensation expense over
their respective service periods.
Inventories
Inventory consists of costs associated with the Company's Mapping Array
libraries and is stated at the lower of cost, on a first-in, first-out basis, or
market. Such costs are capitalized after achieving technological feasibility.
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 1995 and 1996 financial
statements to conform to the 1997 presentation. These reclassifications had no
effect on the net loss for 1995 and 1996.
3. SIGNIFICANT AGREEMENTS
The Company has entered into a number of license, research and development
agreements (the "Agreements") with seven corporate collaborators who accounted
for substantially all of the Company's 1997 revenue. 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 exercised its
right to license certain of the Company's technologies on a non-exclusive basis
in December 1997.
28
30
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Additionally, the Company has entered into a number of agreements with
biotechnology companies (the "biotech collaborators"). Under the terms of
material transfer agreements with 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 following is a summary of the fair market value of available-for-sale
marketable securities held by the Company at December 31, 1996 and 1997:
DECEMBER 31,
-----------------------
MATURITY 1996 1997
------------- -------- -----------
U.S. Government obligations................. Within 1 year $500,000 $ 2,200,000
Corporate bonds............................. Within 1 year -- 31,945,000
-------- -----------
$500,000 $34,145,000
======== ===========
At December 31, 1996 and 1997, marketable securities are carried at
amortized cost, which approximates fair market value. All of the Company's
marketable securities are classified as current at December 31, 1996 and 1997 as
funds are highly liquid and are available to meet working capital needs and to
fund current operations. Gross unrealized gains and losses on sales of
securities for the years ended December 31, 1996 and 1997 were not significant.
5. INVENTORY
Inventories at December 31, 1997 consists of the following:
1997
--------
Raw Materials............................................... $361,000
Finished Goods.............................................. 592,000
--------
$953,000
========
29
31
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
ESTIMATED DECEMBER 31,
USEFUL LIFE -------------------------
(YEARS) 1996 1997
----------- ---------- -----------
Machinery and equipment........................ 3-7 $3,053,000 $ 5,997,000
Leasehold improvements......................... 5 2,728,000 4,183,000
Furniture and fixtures......................... 7 178,000 178,000
Computer equipment............................. 3 1,197,000 3,253,000
Construction-in-progress....................... -- 5,000 3,491,000
---------- -----------
7,161,000 17,102,000
Less -- accumulated depreciation and
amortization................................. 1,868,000 4,448,000
---------- -----------
$5,293,000 $12,654,000
========== ===========
Assets held under capital leases at December 31, 1997 and 1996 consisted of
$2,416,000 in 1996 and $3,272,000 in 1997 of machinery and equipment, $832,000
of leasehold improvements, $746,000 in computer equipment and $107,000 of
furniture and fixtures. Accumulated amortization of these assets totaled
$1,305,000 and $2,503,000 at December 31, 1996 and 1997, respectively. For the
years ended December 31, 1995, 1996 and 1997, amortization expense related to
assets held under capital lease obligations was $300,000, $751,000 and
$1,198,000, respectively.
7. NOTES RECEIVABLE FROM RELATED PARTIES
Notes receivable from related parties consist of the following:
DECEMBER 31,
--------------------
1996 1997
-------- --------
Note receivable due from an officer of the Company, due in
full on November 3, 1997.................................. $ 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............................................... 90,000 60,000
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................................................... 250,000 167,000
-------- --------
403,000 227,000
Less current portion........................................ 176,000 30,000
-------- --------
$227,000 $197,000
======== ========
Interest on the notes receivable from related parties accrues on the unpaid
principal and interest at 5.9%. Interest due on the notes at December 31, 1996
and 1997, $6,000 and $13,248, respectively, was included in prepaid expenses and
other current assets.
30
32
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses include the following:
DECEMBER 31,
------------------------
1996 1997
---------- ----------
Accounts payable............................................ $ 485,000 $2,161,000
Accrued professional fees................................... 469,000 379,000
Other accrued expenses...................................... 155,000 264,000
---------- ----------
$1,109,000 $2,804,000
========== ==========
9. CONVERTIBLE PREFERRED 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 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.
On April 4, 1997, the Company completed a follow-on offering of 1,932,500
shares of Common Stock, which included the underwriters' exercise of their
over-allotment of 300,000 shares of Common Stock on April 14, 1997. Proceeds to
the Company, net of issuance costs, amounted to $21,545,000.
Stock Restriction Agreements
The Company has common stock issued pursuant to the Equity Incentive Plan
which is 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. At December 31, 1996 and 1997, the
approximate number of unvested common shares is 96,500 and 13,500, respectively.
Each stock restriction agreement may be terminated at the election of the
Company.
11. EQUITY INCENTIVE AND STOCK PURCHASE PLANS
During 1996, the stockholders approved an amendment to the 1994 Amended and
Restated Equity Incentive Plan (the "Equity Incentive Plan") increasing the
number of shares of common stock available for awards under the Equity Incentive
Plan to 2,600,000. All shares are awarded at the discretion of a Committee
31
33
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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. As of December 31, 1997, no stock appreciation rights have been issued.
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, 1997, options to purchase 33,000 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 92,000 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"). 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, pro forma basic net loss per
share and diluted net loss per share would have been as follows:
DECEMBER 31,
-----------------------------------------
1995 1996 1997
----------- ----------- -----------
Pro Forma net loss.......................... $(2,254,000) $(3,186,000) $(2,583,000)
Pro Forma basic and diluted net loss per
share..................................... (3.76) (1.31) (0.23)
During 1996 and 1997, the Company issued 117,500 and 69,000 options to
certain consultants and members of its Scientific Advisory Board (SAB) under the
Equity Incentive Plan. In April 1997, 11,000 shares were cancelled. The
estimated value of these options totaled $709,000 and $328,000 in 1996 and 1997,
respectively, was recorded as deferred compensation and is being amortized as
compensation expense over the vesting period of the options. Compensation
expense in 1996 and 1997 was $63,000 and $420,000, respectively.
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 1996 and 50% volatility for
1997 for nonemployee grants and employee grants subsequent to the initial filing
of the Registration Statement in connection with the Company's initial public
offering; no volatility for employee grants prior to the initial public
offering; risk-free interest rates of 5.2% to 7.1% in 1996 and 6.0% in 1997;
expected lives of 3 to 6 years in 1996 and 4 years in 1997 for options granted.
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option pricing models require the use of highly
subjective assumptions, including the expected stock price volatility. Because
the corporation's employee stock options have characteristics significantly
different from those of traded options,
32
34
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
and because changes in the subjective assumptions can materially affect the fair
value estimates, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock-based
compensation.
Option activity under the Plans for the three years ended December 31, 1997
was as follows:
WEIGHTED
AVERAGE
NUMBER EXERCISE
STOCK OPTIONS OF SHARES PRICE
- ------------- --------- --------
Outstanding at December 31, 1994............................ 2,500 $ .02
Granted..................................................... 298,500 .22
---------
Outstanding at December 31, 1995............................ 301,000 .22
Granted..................................................... 1,073,920 4.39
Exercised................................................... (625) .02
Cancelled................................................... (101,625) .49
---------
Outstanding at December 31, 1996............................ 1,272,670 3.72
Granted..................................................... 1,016,912 16.63
Exercised................................................... (133,374) 2.64
Cancelled................................................... (44,456) 9.57
---------
Outstanding at December 31, 1997............................ 2,111,752 $ 9.88
=========
Exercisable at December 31, 1997............................ 373,025
=========
Weighted average estimated value of options granted during
the year ended December 31, 1997.......................... $ 4.17
======
The following table summarizes information about options outstanding at
December 31, 1997:
OPTIONS
OPTIONS OUTSTANDING EXERCISABLE
--------------------------------------- -----------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED EXERCISABLE WEIGHTED
OUTSTANDING AT REMAINING AVERAGE AS OF AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1997 LIFE PRICE 1997 PRICE
- ------------------------ -------------- ----------- -------- ------------ --------
$ 0.0000 - 2.4000........................ 602,820 7.9 $ 0.74 203,617 $ 0.68
4.8001 - 7.2000........................ 359,875 8.5 6.00 71,125 6.00
9.6001 - 12.0000........................ 157,250 8.8 10.86 44,216 10.95
12.0001 - 14.4000........................ 490,807 9.3 14.13 43,567 14.13
14.4001 - 16.8000........................ 35,500 9.1 15.70 -- --
16.8001 - 19.2000........................ 276,000 9.3 17.84 10,500 17.63
19.2001 - 21.6000........................ 133,000 9.7 20.88 -- --
21.6001 - 24.0000........................ 56,500 9.9 24.00 -- --
--------- -------
2,111,752 8.8 $ 9.88 373,025 $ 4.96
========= === ====== ======= ======
At December 31, 1997, there were 515,546 shares available for future grant
under the Equity Incentive Plan.
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
33
35
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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, 1997, 9,173 shares have been purchased pursuant to the Purchase
Plan.
12. INCOME TAXES
There is no current or deferred tax expense for the years ended December
31, 1995, 1996 and 1997.
The deferred tax consequences of temporary differences in reporting items
for financial statement and income tax purposes are recognized, if appropriate.
Realization of the future tax benefits related to the deferred tax assets is
dependent on many factors, including the company's ability to generate taxable
income within the net operating loss carryforward period. Management has
considered these factors in reaching its conclusion as to the valuation
allowance for financial reporting purposes. The income tax effect of temporary
differences comprising the deferred tax assets and deferred tax liabilities on
the accompanying balance sheets is a result of the following:
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
Deferred tax assets:
Preoperating costs capitalized for tax purposes......... $ 370,000 $ 288,000
Net operating loss carryforwards........................ 3,906,000 4,506,000
Tax credit carryforwards................................ 311,000 811,000
Non-employee equity based compensation.................. -- 173,000
Other................................................... 30,000 40,000
----------- -----------
$ 4,617,000 $ 5,818,000
Deferred tax liabilities:
Tax depreciation in excess of book...................... -- (135,000)
Valuation allowance....................................... (4,617,000) (5,683,000)
----------- -----------
Net deferred tax assets................................. $ -- $ --
=========== ===========
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. Of the $5.7 million valuation allowances at December 31, 1997,
$615,000 relates to deductions for disqualifying dispositions and non qualified
stock options which will be credited to paid in capital, if realized.
34
36
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation between the statutory federal income tax rate (35%) and
the effective rate of income tax expense for each of the three years during the
period ended December 31, 1997 follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
--------- ----------- ---------
Income tax benefit (expense) at statutory
rate......................................... $ 788,000 $ 1,048,000 $(102,000)
State tax benefit (expense), net............... 135,000 180,000 (18,000)
Losses without current tax benefit............. (907,000) (1,180,000) --
Utilization of net operating loss
carryforwards................................ -- -- 133,000
Other.......................................... (16,000) (48,000) (13,000)
--------- ----------- ---------
Tax Provision............................. $ -- $ -- $ --
========= =========== =========
The Company has available net operating loss carryforwards of approximately
$11,000,000 for tax purposes to offset future taxable income. The net operating
loss carryforwards expire principally in 2009 to 2012. General tax credit
carryforwards of approximately $811,000 expire principally in 2009 to 2012.
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.
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
------------ ---------- ----------
1998........................................................ $ 838,000 $1,174,000
1999........................................................ 780,000 907,000
2000........................................................ 721,000 305,000
2001........................................................ 315,000 1,000
---------- ----------
2,387,000
Interest due on capital leases.............................. 243,000
---------- ----------
Total minimum lease payments................................ $2,654,000 $2,630,000
========== ==========
The Company has a lease line agreement with a financial institution (the
"Lessor") for $8,500,000 of which approximately $4,000,000 was available for
future leases at December 31, 1997. The term for each lease 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.
Rent expense under noncancelable operating leases was approximately
$163,000, $283,000 and $582,000 for the years ended December 31, 1995, 1996, and
1997, respectively.
Employment Agreements
The Company has employment agreements with an officer who is also a member
of the board of directors. The agreement provides that if employment is
terminated without cause, the officer is entitled to receive up to six months'
salary.
35
37
ARQULE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Contingency
On July 21, 1997, a complaint was filed in the United States District Court
of Connecticut against the Company and two of the Company's stockholders by two
individuals alleging that they were entitled to compensation from the Company
and these two stockholders equal to approximately five percent of the equity
interests in the Company for services in connection with the initial financing
of ArQule Partners, L.P. in 1993. In addition, one of the plaintiffs is alleging
that he was denied the opportunity to make a five percent investment in the
Company at the time of its incorporation. Prior to the Company's initial public
offering of its Common Stock, ArQule Partners, L.P. was a major stockholder of
the Company. An answer was filed on September 15, 1997 denying the material
allegations in the complaint and Phase I of the discovery process has been
completed. Although the parties to this lawsuit have had mediation proceedings,
the Company intends to continue to contest this lawsuit vigorously. No assurance
can be given regarding the outcome of this lawsuit. The Company is currently
unable to estimate the range of potential loss, if any, that might result as a
consequence of this action.
36
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 1 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, 1998 (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 BENEFICIAL 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 7
and 9 to the Financial Statements included herein.
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 listed under Item 8 of this report are
omitted because they are not applicable or required information and are shown in
the financial statements of the footnotes thereto.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
37
39
(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* Amended and Restated 1996 Director Stock Option Plan. Filed
herewith.
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.
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.
38
40
EXHIBIT NO. DESCRIPTION
- ----------- -----------
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
Amersham 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 Amersham 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 Abbott Laboratories dated as of
December 24, 1996. Filed as Exhibit 10.21 to the Company's
Registration Statement on Form S-1 (File No. 333-22945) and
incorporated herein by reference.
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. 333-22945) and incorporated herein by reference.
10.23+ Research and License Agreement between the Company and
American Home Products Corporation acting through its
Wyeth-Ayerst Research Division dated July 3, 1997. Filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997 (File No. 000-21249) and
incorporated herein by reference.
10.24 Common Stock Purchase Agreement between the Company and
American Home Products Corporation Dated July 3, 1997. Filed
as Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997 (File No.
000-21429) and incorporated herein by reference.
10.25+ Second Amendment to Option Agreement and Research and
Development Agreement between the Company and Amersham
Pharmacia Biotech AB dated September 23, 1996. Filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997 (File No.
000-21429) and incorporated herein by reference.
10.26+ Third Amendment to Option Agreement and Research and
Development Agreement between the Company and Amersham
Pharmacia Biotech AB dated June 24, 1997. Filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997 (File No. 000-21429) and
incorporated herein by reference.
10.27* First Allonge to Promissory Note between the Company and
Eric B. Gordon dated July 16, 1997. Filed as Exhibit 10.3 to
the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997 (File No. 000-21429) and
incorporated herein by reference.
10.28 Intentionally omitted.
10.29+ Research and Development Agreement between the Company and
Sankyo Co., Ltd. dated November 1, 1997. Filed herewith.
39
41
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.30+ Amendment No. 3 to Research & Development and License
Agreement between the Company and Abbott Laboratories dated
December 23, 1997. Filed herewith.
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 or Rule 246-2 of the Securities
and Exchange Act of 1934, as amended.
40
42
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 City of
Medford, Commonwealth of Massachusetts, on March 13, 1998.
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 Officer and March 13, 1998
- ------------------------------------------ Director (Principal Executive Officer)
Eric B. Gordon
/s/ JAMES R. FITZGERALD, JR. Vice President, Chief Financial Officer March 13, 1998
- ------------------------------------------ and Treasurer (Principal Financial Officer
James R. Fitzgerald, Jr. and Principal Accounting Officer)
/s/ JOSEPH C. HOGAN, JR. Chairman of the Board, Senior Vice March 13, 1998
- ------------------------------------------ President of Research and Development,
Joseph C. Hogan, Jr. Chief Scientific Officer and Director
/s/ ADRIAN DE JONGE Director March 13, 1998
- ------------------------------------------
Adrian de Jonge
/s/ ALLAN R. FERGUSON Director March 13, 1998
- ------------------------------------------
Allan R. Ferguson
/s/ STEPHEN M. DOW Director March 13, 1998
- ------------------------------------------
Stephen M. Dow
/s/ L. PATRICK GAGE Director March 13, 1998
- ------------------------------------------
L. Patrick Gage
41
43
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* Amended and Restated 1996 Director Stock Option Plan. Filed
herewith.
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.
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.
42
44
EXHIBIT NO. DESCRIPTION
----------- -----------
10.16+ Research & Development Agreement between the Company and
Amersham 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 Amersham 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 Abbott Laboratories dated as of
December 24, 1996. Filed as Exhibit 10.21 to the Company's
Registration Statement on Form S-1 (File No. 333-22945) and
incorporated herein by reference.
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. 333-22945) and incorporated herein by reference.
10.23+ Research and License Agreement between the Company and
American Home Products Corporation acting through its
Wyeth-Ayerst Research Division dated July 3, 1997. Filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997 (File No. 000-21249) and
incorporated herein by reference.
10.24 Common Stock Purchase Agreement between the Company and
American Home Products Corporation Dated July 3, 1997. Filed
as Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997 (File No.
000-21429) and incorporated herein by reference.
10.25+ Second Amendment to Option Agreement and Research and
Development Agreement between the Company and Amersham
Pharmacia Biotech AB dated September 23, 1996. Filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997 (File No.
000-21429) and incorporated herein by reference.
10.26+ Third Amendment to Option Agreement and Research and
Development Agreement between the Company and Amersham
Pharmacia Biotech AB dated June 24, 1997. Filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997 (File No. 000-21429) and
incorporated herein by reference.
10.27* First Allonge to Promissory Note between the Company and
Eric B. Gordon dated July 16, 1997. Filed as Exhibit 10.3 to
the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997 (File No. 000-21429) and
incorporated herein by reference.
10.28 Intentionally omitted.
10.29+ Research and Development Agreement between the Company and
Sankyo Co., Ltd. dated November 1, 1997. Filed herewith.
10.30+ Amendment No. 3 to Research & Development and License
Agreement between the Company and Abbott Laboratories dated
December 23, 1997. Filed herewith.
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 or Rule 246-2 of the Securities
and Exchange Act of 1934, as amended.
43