MICROCIDE PHARMACEUTICALS INC, 424B4, 1996-05-16

MICROCIDE PHARMACEUTICALS INC
424B4, 1996-05-16
PHARMACEUTICAL PREPARATIONS

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<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration Statement No. 333-02400

PROSPECTUS

2,500,000 SHARES

LOGO

MICROCIDE PHARMACEUTICALS, INC.
COMMON STOCK
------------------------

All of the 2,500,000 shares of Common Stock offered hereby are being issued
and sold by Microcide Pharmaceuticals, Inc. ("Microcide" or the "Company").
Prior to this offering (the "Offering"), there has been no public market for the
Common Stock. See "Underwriting" for information relating to the factors
considered in determining the initial public offering price. The Common Stock
has been approved for listing on the Nasdaq National Market under the symbol
"MCDE."

SEE "RISK FACTORS" (BEGINNING ON PAGE 5) FOR A DISCUSSION OF CERTAIN
MATERIAL RISK FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE
COMMON STOCK OFFERED HEREBY.
------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------

<TABLE>
<S> <C> <C> <C>
- --------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- -------------------------------------------------------------------------------------------------
Per Share......................... $14.00 $.98 $13.02
- -------------------------------------------------------------------------------------------------
Total(3).......................... $35,000,000 $2,450,000 $32,550,000
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
</TABLE>

(1) The Company has agreed to indemnify the several Underwriters against, and to
provide contribution with respect to, certain liabilities, including certain
liabilities under the Securities Act of 1933, as amended. See
"Underwriting."

(2) Before deducting estimated expenses of $800,000 payable by the Company.

(3) The Company has granted to the Underwriters an option, exercisable within 30
days after the date hereof, to purchase up to 375,000 additional shares of
Common Stock, solely to cover over-allotments, if any. If such option is
exercised in full, the total Price to Public, Underwriting Discount and
Proceeds to Company will be $40,250,000, $2,817,500 and $37,432,500,
respectively. See "Underwriting."
------------------------

The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if issued to and accepted by them, subject to
approval of certain legal matters by counsel for the Underwriters and certain
other conditions. The Underwriters reserve the right to withdraw, cancel or
modify such offer and to reject orders in whole or in part. It is expected that
delivery of the shares of Common Stock will be made in New York, New York, on or
about May 20, 1996.
------------------------

MERRILL LYNCH & CO.
ALEX. BROWN & SONS
INCORPORATED
COWEN & COMPANY
------------------------

The date of this Prospectus is May 14, 1996.
<PAGE> 2

[GRAPHIC APPEARS HERE]

[Narrative description: Graphic description of the stages
of the Company's research programs]

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET, OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.

Microcide(TM), Microcide Pharmaceuticals(TM) and the Microcide logo are
claimed as trademarks of the Company. This Prospectus also includes names and
marks of companies other than the Company.
<PAGE> 3

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by reference to the more
detailed information and financial statements appearing elsewhere in this
Prospectus. Investors should carefully consider the information set forth under
the heading "Risk Factors."

THE COMPANY

Microcide is a biopharmaceutical company founded to discover, develop and
commercialize novel antibiotics for the treatment of serious bacterial
infections. The Company's discovery and development programs address the growing
problem of bacterial drug resistance through two principal themes: (i) Targeted
Antibiotics, which focuses on developing novel antibiotics and antibiotic
potentiators, and (ii) Targeted Genomics, which utilizes bacterial genetics to
discover new classes of antibiotics and other novel treatments for bacterial
disease.

The Company believes that the antibiotics market provides an attractive
opportunity for its research and development activities because (i) it is the
third largest pharmaceutical market, totaling $22.9 billion in worldwide sales,
including $6.3 billion in the United States, for the twelve months ended
September 1995; (ii) there are significant unmet clinical needs, caused by
growing bacterial resistance problems, that require new antibacterial therapies;
and (iii) the preclinical and clinical development process for antibiotics
generally follows an efficient and well-defined path to the market.

Microcide's Targeted Antibiotics programs seek to rapidly develop
clinically useful antibiotics tailored to treat specific bacterial infections,
as well as antibiotic potentiators, which will overcome resistance pathways and
restore usefulness to existing antibiotics that have been rendered ineffective.
The specific problematic bacteria being addressed by the Company (staphylococci,
enterococci, Pseudomonas aeruginosa and Streptococcus pneumoniae) are
responsible for 44% of the approximately two million hospital-acquired
infections occurring annually in the United States. These infections are
estimated to result in approximately eight million days of extended hospital
stay and account for more than $4.0 billion in additional health care costs each
year.

Microcide's Targeted Genomics programs seek to identify the
pharmaceutically relevant portion of bacterial genomes that are essential to
bacterial viability in vitro (the Essential Genes Program) or to bacterial
growth and virulence in vivo (the Pathogenesis Program). In the Essential Genes
Program, Microcide has identified approximately 80 essential gene targets which
are being incorporated into the Company's high-throughput, multi-channel
screening system to discover new classes of antibiotics. In the Pathogenesis
Program, Microcide is developing and utilizing new molecular genetics
technologies to identify pathogenesis genes in order to discover and develop
novel therapeutic agents.

The Company has entered into collaborative agreements with three major
pharmaceutical companies to enhance certain of its discovery and development
programs. As of March 31, 1996, the Company's collaborative partners have
provided the Company with $9.6 million of license fees and research support
payments and $10.0 million in equity investments. Assuming each of the
collaborative agreements continues until its scheduled expiration, the Company
will be entitled to receive an additional $35.9 million of research support
payments. The Company has retained rights to products which may result from its
internal programs.

Ortho/J&J. Microcide is collaborating with Ortho Pharmaceutical
Corporation, a Johnson & Johnson company ("Ortho/J&J"), to discover and develop
novel beta-lactam antibiotics, antibiotic potentiators and inhibitors of
bacterial signal transduction targeted at problematic Gram-positive bacteria,
including staphylococci and enterococci. The Company expects to select with
Ortho/J&J its initial product candidate, a Gram-positive beta-lactam, in 1996
and to enter into clinical trials during 1997. If specified research and
development milestones are achieved, the Company will be entitled to receive up
to $16.5 million for the initial product and up to $15.5 million for each
subsequent product developed within the collaboration.

Daiichi. Microcide is collaborating with Daiichi Pharmaceutical Co., Ltd.
("Daiichi") to discover and develop bacterial efflux pump inhibitors to be used
in combination with Daiichi's quinolone antibiotics to target Gram-negative
bacteria, including pseudomonas. The Company expects to select with Daiichi its
first quinolone potentiation candidate by mid-1997 for clinical development. If
specified research and development milestones are achieved, Microcide will be
entitled to receive up to $13.0 million for each product developed within the
collaboration.

Pfizer. Microcide is collaborating with Pfizer Inc ("Pfizer") to implement
its essential gene and multi-channel screening system to discover novel classes
of antibiotics. If specified research and development milestones are achieved,
Microcide will be entitled to receive milestone payments of up to $32.5 million
for each product developed within the collaboration.

3
<PAGE> 4

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered............................. 2,500,000 shares
Common Stock to be outstanding after the
Offering....................................... 10,256,981 shares(1)
Use of proceeds.................................. To fund certain of the Company's
research and development activities and
for general corporate purposes. See "Use
of Proceeds."
Proposed Nasdaq National Market symbol........... MCDE
</TABLE>

- ---------------
(1) Based upon shares of Common Stock outstanding as of March 31, 1996, on a
fully converted basis. Excludes 160,187 shares of Common Stock issuable upon
exercise of warrants and 690,600 shares of Common Stock issuable upon
exercise of options outstanding as of March 31, 1996. See
"Business -- Collaborative Agreements," "Management -- Employee Benefit
Plans," "Description of Capital Stock," and Note 8 of Notes to Financial
Statements.

SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION THREE MONTHS
(DECEMBER 11, YEAR ENDED ENDED
1992) DECEMBER 31, MARCH 31,
TO DECEMBER 31, ----------------- -----------------
1993 1994 1995 1995 1996
------------------ ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
License fees.............................. $ -- $ -- $ 3,000 $ -- $ 1,000
Research revenue.......................... -- -- 1,985 -- 1,625
------- ------- ------- ------- -------
Total revenues......................... -- -- 4,985 -- 2,625
Operating expenses:
Research and development.................. 1,685 5,180 6,400 1,324 1,780
General and administrative................ 1,251 1,823 2,080 479 526
------- ------- ------- ------- -------
Total operating expenses............... 2,936 7,003 8,480 1,803 2,306
------- ------- ------- ------- -------
Income (loss) from operations............... (2,936) (7,003) (3,495) (1,803) 319
Interest income............................. 32 218 257 85 137
Interest expense............................ (13) (249) (278) (70) (73)
------- ------- ------- ------- -------
Net income (loss)...................... $ (2,917) $(7,034) $(3,516) $(1,788) $ 383
======= ======= ======= ======= =======
Pro forma net income (loss) per share(1).... $ (0.44) $ (0.22) $ 0.04
======= ======= =======
Shares used in computing pro forma net loss
per share(1).............................. 8,052 8,039 8,563
</TABLE>

<TABLE>
<CAPTION>
MARCH 31, 1996
--------------------------
ACTUAL AS ADJUSTED(2)
------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................................... $15,093 $ 46,843
Working capital..................................................... 11,020 42,770
Total assets........................................................ 20,691 52,441
Long-term obligations............................................... 1,810 1,810
Deficit accumulated during development stage........................ (13,084) (13,084)
Total stockholders' equity.......................................... 14,596 46,346
</TABLE>

- ---------------
(1) See Note 1 of Notes to Financial Statements for information concerning the
calculation of pro forma net loss per share.

(2) As adjusted to reflect the sale of 2,500,000 shares of Common Stock offered
by the Company hereby at the initial public offering price of $14 per share
and the receipt of the estimated net proceeds therefrom. See "Use of
Proceeds."

------------------------

Unless otherwise indicated, all information in this Prospectus (i) assumes
the Underwriters' over-allotment option is not exercised, (ii) reflects the
Company's reincorporation in the State of Delaware, (iii) reflects a 1-for-5
reverse stock split effective April 5, 1996, and (iv) assumes the issuance of
6,880,791 shares of Common Stock upon the conversion of outstanding shares of
Convertible Preferred Stock, which will occur in accordance with the terms
thereof upon completion of the Offering. See "Capitalization," "Description of
Capital Stock" and "Underwriting."

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<PAGE> 5

RISK FACTORS

This Prospectus contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities and Exchange Act of 1934
(the "Exchange Act"). Actual results and the timing of certain events could
differ materially from those projected in the forward-looking statements as a
result of the risk factors set forth below and other factors discussed elsewhere
in this Prospectus. An investment in the shares of Common Stock being offered
hereby involves a high degree of risk. Accordingly, prospective investors should
consider carefully the following risk factors, as well as all other information
contained in this Prospectus, before purchasing the shares of Common Stock
offered hereby.

ABSENCE OF DEVELOPED PRODUCTS; EARLY STAGE OF PRODUCT DEVELOPMENT. The
Company was founded in December 1992, has not commenced clinical development of
any drugs and does not expect that any drugs resulting from its and its
collaborative partners' research and development efforts will be commercially
available for a significant number of years, if at all. Since inception, the
Company has focused its activities on the development of a gene function-based
technology platform and other proprietary information to identify and
commercialize novel antibiotics for the treatment of serious bacterial
infections. It is difficult to predict when, if ever, the Company will be able
to successfully discover novel lead compounds for potential development as
product candidates. All compounds discovered by the Company will require
extensive preclinical and clinical testing prior to submission of any regulatory
application for commercial use. Extensive preclinical and clinical testing
required to establish safety and efficacy will take a number of years, and the
time required to commercialize new drugs cannot be predicted with accuracy.
There can be no assurance that the Company's approach to drug discovery, or the
efforts of any collaborative partner of the Company, will result in the
development of any drugs, or that any drugs, if successfully developed, will be
proven to be safe and effective in clinical trials, meet applicable regulatory
standards, be capable of being manufactured in commercial quantities at
reasonable costs or be successfully commercialized. Product development of new
pharmaceuticals is highly uncertain, and unanticipated developments, clinical or
regulatory delays, unexpected adverse effects or inadequate therapeutic efficacy
would slow or prevent product development efforts of the Company or its
collaborative partners and have a material adverse effect on the Company's
operations. See "Business."

DEPENDENCE ON COLLABORATIVE PARTNERS AND OTHERS. Part of the Company's
business strategy is to enhance its research and development capabilities, and
to fund in part its capital requirements by entering into collaborative and
licensing arrangements with major pharmaceutical companies. The Company has
entered into two Research and License Agreements, dated as of October 24, 1995,
with Ortho/J&J and the R.W. Johnson Pharmaceutical Research Institute (the
"Ortho/J&J Agreements"), a Joint Research Agreement, dated as of November 6,
1995, with Daiichi (the "Daiichi Agreement"), and a Collaborative Research
Agreement and License and Royalty Agreement, dated as of March 1, 1996, with
Pfizer (the "Pfizer Agreements" and, together with the Ortho/J&J Agreements and
the Daiichi Agreement, the "Collaborative Agreements"). Under the Collaborative
Agreements, which cover three of the Company's programs, each of Ortho/J&J,
Daiichi and Pfizer is responsible for (i) selecting compounds discovered in its
collaboration with the Company for subsequent development, (ii) conducting
preclinical testing, clinical trials and obtaining required regulatory approvals
of such drug candidates, and (iii) manufacturing and commercializing resulting
drugs. As a result, the Company's receipt of revenues (whether in the form of
continued research funding, product development milestones or royalties on
sales) under the Collaborative Agreements is dependent upon the decisions made
and activities undertaken by its collaborative partners and upon the
development, manufacturing and marketing resources of its collaborative
partners. The amount and timing of resources dedicated by the Company's
collaborative partners to their respective collaborations with the Company is
not within the Company's control. Moreover, certain compounds discovered by the
Company may be viewed by the Company's collaborative partners as competitive
with such partners' products or potential products. Accordingly, there can be no
assurance that the Company's collaborators will elect to proceed with the
development of compounds which the Company believes to be promising, or that
they will not pursue their existing or alternative technologies in preference to
such compounds. There can be no assurance that the interests of the Company will
continue to coincide with those of its collaborative partners, that some of the

5
<PAGE> 6

Company's collaborative partners will not develop independently or with third
parties drugs that could compete with drugs of the types covered by the
collaborations, or that disagreements over rights or technology or other
proprietary interests will not occur.

The Company is dependent on its collaborative partners to fund a
substantial portion of its activities over the next several years. However,
Ortho/J&J can terminate its collaboration with the Company at any time upon six
months' prior written notice, Daiichi can terminate its collaboration with the
Company at any time after July 1, 1997 upon six months' prior written notice,
and Pfizer can terminate its collaboration with the Company at any time after
February 1999 upon six months' prior written notice. If any of the Company's
collaborative partners terminates or breaches its Collaborative Agreement with
the Company, or fails to devote adequate resources to or to conduct in a timely
manner its collaborative activities, the research program under the applicable
Collaborative Agreement or the development and commercialization of drug
candidates subject to such collaboration would be materially adversely affected.
Further, there can be no assurance that the Company's collaborations with
Ortho/J&J, Daiichi and Pfizer will be successful. Nor can there be any assurance
that the Company will be able to enter into acceptable collaborative or
licensing arrangements with other pharmaceutical companies in the future, or
that, if negotiated, such arrangements would be successful. See
"Business -- Collaborative Agreements."

The Company intends to rely on its collaborative partners for the
manufacturing and marketing of any products which result from such
collaborations. In addition, as part of its business strategy, the Company plans
to retain rights to certain research programs not currently covered by the
Collaborative Agreements for internal product development and subsequent
commercialization by the Company in North America. Outside North America, the
Company anticipates entering into collaborations with third parties for
distribution and commercialization of any products developed internally by the
Company. See "Business -- Microcide's Research Programs." There can be no
assurance that the Company will be able either to successfully commercialize any
internally developed products in North America itself or to enter into any such
collaborations for distribution and commercialization of such products outside
North America on acceptable terms, if at all.

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The operation of
the Company's business will require substantial capital resources. The Company
believes that the anticipated net proceeds from this Offering, together with its
existing capital resources, interest income and future payments due under the
Collaborative Agreements, will be sufficient to enable it to satisfy its current
funding requirements through 1998. However, there is no assurance that such
funds will be sufficient to meet the capital needs of the Company during such
period. Moreover, a significant amount of the future payments due under the
Collaborative Agreements is contingent upon achieving various milestones, and
there can be no assurance that the Company will receive the expected level of
payments under the Collaborative Agreements. In the event that the Company
requires additional funding, the Company will seek to raise such additional
funding from other sources, including other collaborative partners and
licensees, and through public or private financings, including sales of equity
or debt securities. Any such collaborative or licensing arrangement could result
in limitations on the Company's ability to control the research and development
of potential drugs and the commercialization of resulting drugs, if any, and
could limit profits, if any, therefrom. Any such equity financing could result
in dilution to the Company's then-existing stockholders. There can be no
assurance that additional funds will be available on favorable terms or at all,
or that such funds, if raised, would be sufficient to permit the Company to
continue to conduct its operations. If adequate funds are not available, the
Company may be required to curtail significantly or eliminate one or more of its
research programs. See "Use of Proceeds," "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources" and "Business -- Collaborative Agreements."

HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT; NO PRODUCT
REVENUE. The Company has incurred net losses every year since its inception in
December 1992. At March 31, 1996, the Company's accumulated deficit was
approximately $13.1 million. Losses have resulted principally from costs
incurred in connection with the Company's research and development activities
and from general and administrative costs associated with the Company's
operations. The Company expects to continue to incur operating losses. The only
revenues generated by the Company to date have resulted from license fees and
research support payments under the Collaborative Agreements. Microcide's right
to receive research support payments under

6
<PAGE> 7

the Ortho/J&J Agreements, the Daiichi Agreement and the Pfizer Agreements are
scheduled to expire in October 1998, March 1998 and February 2001, respectively,
unless the research programs under such agreements are extended or earlier
terminated. Research support payments under each of the Collaborative Agreements
will terminate if Ortho/J&J, Daiichi or Pfizer terminates its research program
with the Company earlier than the scheduled expiration date of such research
program. See "Business -- Collaborative Agreements." The Company will not
receive revenues or royalties from drug sales unless it or one of its
collaborative partners successfully completes clinical trials with respect to a
drug candidate, obtains regulatory approvals for that drug candidate and
commercializes the resulting drug. The Company will not receive revenues or
royalties from sales of drugs for a significant number of years, if at all.
Failure to receive significant revenue or achieve profitable operations could
impair the Company's ability to sustain operations, and there can be no
assurance that the Company will ever receive significant revenues or achieve
profitable operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

DEPENDENCE ON PROPRIETARY TECHNOLOGY AND UNPREDICTABILITY OF PATENT
PROTECTION. The Company's success depends, in part, on its ability to
establish, protect and enforce its proprietary rights relating to its lead
compounds, gene discoveries, screening technology and certain other proprietary
technology. The Company has filed approximately 30 patent applications in the
United States, in addition to applications filed in other countries, in order to
protect lead compounds, gene discoveries and screening technology, but no United
States or foreign patent has been issued to the Company to date. The patent
position of biotechnology and pharmaceutical companies is highly uncertain and
involves many complex legal and technical issues. There can be no assurance that
patents will be granted with respect to any of the Company's patent applications
currently pending in the United States or in other countries, or with respect to
applications filed by the Company in the future. The failure by the Company to
obtain patents pursuant to the applications referred to herein and any future
applications could have a material adverse effect on the Company. Furthermore,
no assurance can be given that any patents which may be issued to the Company
will not be infringed, challenged, invalidated or circumvented by others, or
that the rights granted thereunder will provide competitive advantages to the
Company. In particular, it is difficult to enforce patents covering methods of
use of screening and other similar technologies. Litigation to establish the
validity of patents, to defend against patent infringement claims and to assert
infringement claims against others can be expensive and time-consuming, even if
the outcome is favorable to the Company. If the outcome of patent prosecution or
litigation is not favorable to the Company, the Company could be materially
adversely affected.

The commercial success of the Company also depends on the Company's ability
to operate without infringing patents and proprietary rights of third parties.
There can be no assurance that the Company's products will not infringe on the
patents or proprietary rights of others. The Company may be required to obtain
licenses to patents or other proprietary rights of others. No assurance can be
given that any such licenses would be made available on terms acceptable to the
Company, if at all. The failure to obtain such licenses could result in delays
in the Company's or its collaborative partners' activities, including the
development, manufacture or sale of drugs requiring such licenses, or preclude
such development, manufacture or sale. See "Business -- Collaborative
Agreements" and "Business -- Patents, Proprietary Technology and Trade Secrets."

In addition to patent protection, the Company relies on trade secrets,
proprietary know-how and technological advances which it seeks to protect, in
part, by confidentiality agreements with its collaborative partners, employees
and consultants. There can be no assurance that these agreements will not be
breached, that the Company would have adequate remedies for any such breach, or
that the Company's trade secrets, proprietary know-how and technological
advances will not otherwise become known or be independently discovered by
others.

RISK OF TECHNOLOGICAL OBSOLESCENCE; HIGHLY COMPETITIVE INDUSTRY. The
Company operates in a field in which new developments are occurring at an
increasing pace. Competition from biotechnology and pharmaceutical companies,
joint ventures, academic and other research institutions and others is intense
and is expected to increase. Many of the Company's competitors have
substantially greater financial, technical and personnel resources than the
Company. Although the Company believes that it has identified new and distinct
approaches to drug discovery, there are other companies with drug discovery
programs, at least some of the

7
<PAGE> 8

objectives of which are the same as or similar to those of the Company.
Competing technologies may be developed which would render the Company's
technologies obsolete or non-competitive. The Company is aware of many
pharmaceutical and biotechnology companies that are engaged in efforts to treat
each of the infectious diseases for which the Company is seeking to develop
therapeutic products. There can be no assurance that competitors of the Company
will not develop competing drugs that are more effective than those developed by
the Company and its collaborative partners or obtain regulatory approvals of
their drugs more rapidly than the Company and its collaborative partners,
thereby rendering the Company's and its collaborative partners' drugs obsolete
or noncompetitive. Moreover, there can be no assurance that the Company's
competitors will not obtain patent protection or other intellectual property
rights that would limit the Company's or its collaborative partners' ability to
use the Company's technology or commercialize its or their drugs. See
"Business -- Competition."

NO ASSURANCE OF MARKET ACCEPTANCE OR THIRD PARTY REIMBURSEMENT. There can
be no assurance that any products successfully developed by the Company or its
collaborative partners, if approved for marketing, will achieve market
acceptance. The antibiotic products which the Company is attempting to develop
will compete with a number of well-established traditional antibiotic drugs
manufactured and marketed by major pharmaceutical companies. The degree of
market acceptance of any products developed by the Company will depend on a
number of factors, including the establishment and demonstration in the medical
community of the clinical efficacy and safety of the Company's product
candidates, their potential advantage over existing treatment methods, and
reimbursement policies of government and third-party payors. There is no
assurance that physicians, patients or the medical community in general will
accept and utilize any products that may be developed by the Company or its
collaborative partners.

The ability of the Company and its collaborative partners to receive
revenues and income with respect to drugs, if any, developed through the use of
the Company's technology will depend, in part, upon the extent to which
reimbursement for the cost of such drugs will be available from third-party
payors, such as government health administration authorities, private health
care insurers, health maintenance organizations, pharmacy benefits management
companies and other organizations. Third-party payors are increasingly
challenging the prices charged for pharmaceutical products. There can be no
assurance that third-party reimbursement will be available or sufficient to
allow profitable price levels to be maintained for drugs developed by the
Company or its collaborative partners. The inability to maintain profitable
price levels for such drugs could adversely affect the Company's business.

LACK OF MANUFACTURING, MARKETING OR SALES CAPABILITIES. The Company does
not have any experience in the manufacture of commercial quantities of drugs,
and its current facilities and staff are inadequate for the commercial
production or distribution of drugs. The Company intends to rely on its
collaborative partners for the manufacturing, marketing and sales of any
products which result from such collaborations. The Company will be required to
contract with third parties for the manufacture of other products or to acquire
or build production facilities before it can manufacture any such products
itself. There can be no assurance that the Company will be able to enter into
such contractual manufacturing arrangements with third parties on acceptable
terms, if at all, or acquire or build such production facilities itself. To date
the Company has no experience with sales, marketing or distribution.
Consequently, in order to market any of its products, the Company will be
required to develop marketing and sales capabilities, either on its own or in
conjunction with others. There can be no assurance that the Company will be able
to develop any of these capabilities.

STRINGENT GOVERNMENT REGULATION AND NEED FOR PRODUCT APPROVALS. The
preclinical testing and clinical trials of any compounds developed by the
Company or its collaborative partners and the manufacturing and marketing of any
drugs resulting therefrom are subject to regulation by numerous federal, state
and local governmental authorities in the United States, the principal one of
which is the United States Food and Drug Administration (the "FDA"), and by
similar agencies in other countries in which drugs developed by the Company or
its collaborative partners may be tested and marketed (each of such federal,
state, local and other authorities and agencies, a "Regulatory Agency"). Any
compound developed by the Company or its collaborative partners must receive
Regulatory Agency approval before it may be marketed as a drug in a particular
country. The regulatory process, which includes preclinical testing and clinical
trials of each

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<PAGE> 9

compound in order to establish its safety and efficacy, can take many years and
requires the expenditure of substantial resources. Data obtained from
preclinical and clinical activities are susceptible to varying interpretations
which could delay, limit or prevent Regulatory Agency approval. In addition,
delays or rejections may be encountered based upon changes in Regulatory Agency
policy during the period of drug development and/or the period of review of any
application for Regulatory Agency approval for a compound. Delays in obtaining
Regulatory Agency approvals could adversely affect the marketing of any drugs
developed by the Company or its collaborative partners, impose costly procedures
upon the Company's and its collaborative partners' activities, diminish any
competitive advantages that the Company or its collaborative partners may attain
and adversely affect the Company's ability to receive royalties. There can be no
assurance that, even after such time and expenditures, Regulatory Agency
approvals will be obtained for any compounds developed by or in collaboration
with the Company. Moreover, if Regulatory Agency approval for a drug is granted,
such approval may entail limitations on the indicated uses for which it may be
marketed that could limit the potential market for any such drug. Furthermore,
approved drugs and their manufacturers are subject to continual review, and
discovery of previously unknown problems with a drug or its manufacturer may
result in restrictions on such drug or manufacturer, including withdrawal of the
drug from the market. In addition, Regulatory Agency approval of prices is
required in many countries and may be required for the marketing of any drug
developed by the Company or its collaborative partners in such countries. See
"Business -- Government Regulation."

UNCERTAINTY OF PHARMACEUTICAL PRICING; IMPACT OF HEALTH CARE REFORM
MEASURES. The levels of revenue and profitability of pharmaceutical companies
may be affected by continuing governmental efforts to contain or reduce the
costs of health care through various means. For example, in certain foreign
markets pricing or profitability of prescription pharmaceuticals is already
subject to governmental control. In the United States, there have been, and the
Company expects that there will continue to be, a number of federal and state
proposals to implement similar governmental control. Cost control initiatives
could decrease the price that the Company or its collaborative partners receive
for any products which it or they may develop in the future and have a material
adverse effect on the Company's business, financial condition and results of
operations. Further, to the extent that such proposals or initiatives have a
material adverse effect on the Company's collaborative partners or potential
collaborative partners, the Company's ability to commercialize its potential
products may be materially adversely affected.

POTENTIAL PRODUCT LIABILITY CLAIMS; ABSENCE OF INSURANCE. The Company
faces an inherent business risk of exposure to potential product liability
claims in the event that drugs, if any, developed through the use of its
technology are alleged to have caused adverse effects on patients. Such risk
exists for products being tested in human clinical trials, as well as products
that receive regulatory approval for commercial sale. The Company does not carry
product liability insurance. The Company will, if appropriate, seek to obtain
product liability insurance with respect to drugs developed by it and by its
collaborative partners. However, there can be no assurance that the Company will
be able to obtain such insurance. Even if such insurance is obtainable, there
can be no assurance that it can be acquired at a reasonable cost or in a
sufficient amount to protect the Company against liability that could have an
adverse effect on the Company.

DEPENDENCE ON KEY PERSONNEL. The Company is highly dependent on its
management and scientific staff, including James E. Rurka, its President and
Chief Executive Officer, and Keith A. Bostian, Ph.D., its Chief Operating
Officer, as well as members of its scientific advisory board. Loss of the
services of any key individual could have an adverse effect on the Company. The
Company does not carry key-man life insurance on any of its executives. The
Company believes that its future success will depend, in part, on its ability to
attract and retain highly talented managerial and scientific personnel and
consultants. The Company faces intense competition for such personnel from,
among others, biotechnology and pharmaceutical companies, as well as academic
and other research institutions. There can be no assurance that the Company will
be able to attract and retain the personnel it requires on acceptable terms. See
"Management -- Executive Officers, Directors and Key Employees,"
"Business -- Scientific Consultants" and "Certain Transactions."

STRINGENT REGULATIONS RELATING TO HAZARDOUS MATERIALS. As with many
biotechnology and pharmaceutical companies, the Company's activities involve the
use of radioactive compounds and hazardous materials. As a consequence, the
Company is subject to numerous environmental and safety laws and regulations.
Any

9
<PAGE> 10

violation of, and the cost of compliance with, these regulations could
materially adversely affect the Company's operations. The Company is subject to
periodic inspections, and has not received notice of any material violations of
any environmental or safety law or regulation. See "Business -- Government
Regulation."

CONTROL BY MANAGEMENT AND CURRENT STOCKHOLDERS. Upon completion of the
Offering, management of the Company, including executive officers and key
employees, will own or control approximately 4% of the outstanding shares of
Common Stock, and the existing stockholders of the Company will own or control
approximately 76% of the outstanding shares of Common Stock (approximately 73%
if the Underwriters' over-allotment option is exercised in full) and will be
able to continue to elect the Company's Board of Directors and take other
corporate actions requiring stockholder approval, as well as dictate the
direction and policies of the Company. See "Principal Stockholders" and
"Underwriting."

EFFECT OF CERTAIN CHARTER AND BYLAWS PROVISIONS; CERTAIN ANTI-TAKEOVER
PROVISIONS. Certain provisions of the Restated Certificate of Incorporation and
Bylaws to be adopted by the Company in connection with its reincorporation in
Delaware (the "Restated Certificate" and "Bylaws", respectively) may have the
effect of making it more difficult for a third party to acquire, or discouraging
a third party from attempting to acquire, control of the Company. Such
provisions could limit the price that certain investors might be willing to pay
in the future for shares of the Common Stock. Certain of these provisions allow
the Company to issue Preferred Stock without any vote or further action by the
stockholders, provide for staggered elections of the Company's Board of
Directors and specify procedures for director nominations by stockholders and
submission of other proposals for consideration at stockholder meetings. None of
these provisions provide for cumulative voting in the election of directors.
Certain provisions of Delaware law applicable to the Company could also delay or
make more difficult a merger, tender offer or proxy contest involving the
Company, including Section 203 of the Delaware General Corporation Law, which
prohibits a Delaware corporation from engaging in any business combination with
any stockholder owning fifteen percent or more of Company's outstanding voting
stock ("interested stockholder") for a period of three years from the date a
stockholder becomes an interested stockholder unless certain conditions are met.
The possible issuance of Preferred Stock, the procedures required for director
nominations and stockholder proposals and Delaware law could have the effect of
delaying, deferring or preventing a change in control of the Company, including
without limitation, discouraging a proxy contest or making more difficult the
acquisition of a substantial block of Common Stock. These provisions could also
limit the price that investors might be willing to pay in the future for shares
of Common Stock. See "Description of Capital Stock."

POTENTIAL ADVERSE MARKET IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE. Sales
of substantial amounts of the Common Stock in the public market after the
Offering could adversely affect the market price of the Common Stock. Upon
completion of the Offering, the Company will have outstanding 10,256,981 shares
of Common Stock (including shares to be issued upon conversion of the
Convertible Preferred Stock upon completion of the Offering). All of the
2,500,000 shares sold in the Offering will be freely transferable as of the date
of this Prospectus by persons other than "affiliates" of the Company without
restriction or further registration under the Securities Act. The remaining
7,756,981 shares of Common Stock that will be outstanding upon completion of the
Offering (the "Restricted Shares") will be held by officers, directors,
employees, consultants and other stockholders of the Company. The Restricted
Shares were sold by the Company in reliance on exemptions from the registration
requirements of the Securities Act and are "restricted securities" under the
Securities Act. The officers, directors, employees and certain stockholders of
the Company, who together hold the Restricted Shares, have agreed not to sell
their shares without the consent of Merrill Lynch, Pierce, Fenner & Smith
Incorporated for a period of 180 days from the date of this Prospectus. Certain
holders of shares of Common Stock and securities convertible into or exercisable
for shares of Common Stock have certain registration rights under a registration
rights agreement among such holders and the Company. The shares of Common Stock
covered by these registration rights include: the 6,880,791 shares of Common
Stock which will be issued upon conversion of the Convertible Preferred Stock
upon completion of the Offering; and the 160,187 shares of Common Stock issuable
upon conversion of the Convertible Preferred Stock for which warrants are
exercisable. These registration rights have been waived in connection with the
Offering but will, subject to the agreements not to sell referred to above,
continue to apply

10
<PAGE> 11

to the aforementioned shares of Common Stock upon completion of the Offering. In
addition, the Company intends to register approximately 1,380,000 shares of
Common Stock subject to outstanding stock options or reserved for issuance under
the Company's stock option plans and employee stock purchase plan following
completion of the Offering. See "Management -- Employee Benefit Plans" and
"Shares Eligible for Future Sale."

ABSENCE OF PRIOR TRADING MARKET; DETERMINATION OF PUBLIC OFFERING PRICE;
POSSIBLE VOLATILITY OF STOCK PRICE. Prior to the Offering, there has been no
public market for the Common Stock, and there can be no assurance that an active
trading market will develop or be sustained or that shares of Common Stock can
be resold at or above the initial public offering price after the Offering. The
initial public offering price of the Common Stock has been established by
negotiation between the Company and the Representatives of the Underwriters.
Such price should not, however, be considered indicative of the actual value of
the Common Stock. See "Underwriting." There has been a history of significant
volatility in the market prices for shares of biotechnology companies, and it is
likely that the market price of the Common Stock will be similarly volatile.
Prices for the Common Stock following the Offering may be influenced by many
factors, including the depth of the market for the Common Stock, investor
perception of the Company, fluctuations in the Company's operating results and
market conditions relating to the biotechnology and pharmaceutical industries.
In addition, the market price of the Common Stock may be influenced by
announcements of technological innovations, new commercial drugs or clinical
progress or the lack thereof by the Company, its collaborative partners or its
competitors. In addition, announcements concerning regulatory developments,
developments with respect to proprietary rights and the Company's collaborations
may also affect the market price of the Common Stock. Period-to-period
fluctuations in financial results and general market conditions could also have
a significant impact on the Company's business and on the market price of the
Common Stock. Finally, future sales of substantial amounts of Common Stock by
existing stockholders could also adversely affect the prevailing price of the
Common Stock. See "Description of Capital Stock," "Shares Eligible for Future
Sale" and "Underwriting."

DILUTION. The initial public offering price is substantially higher than
the net tangible book value per share of Common Stock. Investors purchasing
shares of Common Stock in the Offering will, therefore, incur immediate and
substantial dilution. At the initial public offering price of $14 per share, the
immediate dilution to purchasers of shares of Common Stock in the Offering is
$9.48 per share of Common Stock, or 68%. Additional dilution is likely to occur
upon the exercise of options and warrants granted by the Company. See
"Dilution."

ABSENCE OF CASH DIVIDENDS. The Company has never paid any cash dividends
and does not anticipate paying cash dividends in the foreseeable future. See
"Dividend Policy."

11
<PAGE> 12

THE COMPANY

The Company originally was incorporated in California in December 1992 and
was reincorporated in Delaware in May 1996. The Company's offices are located at
850 Maude Avenue, Mountain View, California 94043, and its telephone number is
(415) 428-1550.

USE OF PROCEEDS

The net proceeds to be received by the Company from the sale of Common
Stock offered hereby, after deducting estimated offering expenses payable by the
Company, are estimated to be approximately
$31.8 million ($36.6 million if the Underwriters exercise their over-allotment
option in full).

The Company expects to use approximately $18 million of the net proceeds of
the Offering to fund its research and development activities, including the
Company's Targeted Genomics programs and Cell Wall Program; approximately $6
million of the net proceeds of the Offering for leasehold improvements to the
Company's facilities, the purchase of additional laboratory equipment and other
capital expenditures; and the balance of the net proceeds of the Offering for
working capital and general corporate purposes. The amount and timing of these
expenditures will depend on numerous factors, including the progress of the
Company's research and development programs. Pending application of the net
proceeds of the Offering as described above, the Company intends to invest such
proceeds in United States government securities and investment grade,
interest-bearing instruments.

The Company believes that its existing capital resources, together with the
net proceeds from the Offering, interest income and future payments due under
the Collaborative Agreements, will be sufficient to satisfy its current and
projected funding requirements at least through 1998. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

DIVIDEND POLICY

The Company has never paid cash dividends on its capital stock and does not
anticipate paying any cash dividends in the foreseeable future. The Company
currently expects to retain future earnings to fund the growth and development
of its operations.

12
<PAGE> 13

CAPITALIZATION

The following table sets forth the capitalization of the Company (i) as of
March 31, 1996, after giving effect to the 1-for-5 reverse stock split of the
Common Stock and the Convertible Preferred Stock, (ii) on a pro forma basis
after giving effect to the automatic conversion of all outstanding Convertible
Preferred Stock into Common Stock and the authorization of 5,000,000 shares of
undesignated Preferred Stock upon the closing of the Offering, and (iii) as
adjusted to give effect to the receipt of the estimated net proceeds from the
sale of 2,500,000 shares of Common Stock offered hereby at the initial public
offering price of $14 per share:

<TABLE>
<CAPTION>
MARCH 31, 1996
-------------------------------------------
ACTUAL PRO FORMA AS ADJUSTED
----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term obligations.................................... $ 1,810 $ 1,810 $ 1,810
Stockholders' equity:
Preferred Stock, no par value, 7,810,000 shares
authorized, 6,880,791 shares issued and outstanding,
actual, 5,000,000 shares authorized, $0.001 par
value, no shares issued and outstanding, pro forma
and as adjusted..................................... 27,425 -- --
Common Stock, no par value, 10,000,000 shares
authorized,
876,190 shares issued and outstanding, actual,
50,000,000 shares authorized, $0.001 par value,
7,756,981 shares issued and outstanding pro forma,
and 10,256,981 shares issued and outstanding as
adjusted(1)......................................... 2,266 29,691 61,441
Stockholder note receivable............................ (35) (35) (35)
Deferred compensation.................................. (1,974) (1,974) (1,974)
Net unrealized loss on securities available-for-sale... (2) (2) (2)
Deficit accumulated during development stage........... (13,084) (13,084) (13,084)
-------- -------- --------
Total stockholders' equity.......................... 14,596 14,596 46,346
-------- -------- --------
Total capitalization.............................. $ 16,406 $ 16,406 $ 48,156
======== ======== ========
</TABLE>

- ---------------

(1) Excludes as of March 31, 1996, 690,600 shares of Common Stock issuable upon
exercise of stock options outstanding as of March 31, 1996 with a weighted
average exercise price of $0.97 per share, of which options to purchase
236,696 shares of Common Stock are exercisable. Also excludes warrants to
purchase 160,187 shares of various series of Convertible Preferred Stock at
an average exercise price of $2.85 per share. See "Management -- Employee
Benefit Plans."

13
<PAGE> 14

DILUTION

The pro forma net tangible book value of the Company's Common Stock as of
March 31, 1996, was approximately $14.6 million, or $1.88 per share. "Pro forma
net tangible book value" represents the amount of the Company's total tangible
assets reduced by the amount of its total liabilities and divided by the pro
forma total number of shares of Common Stock outstanding (reflecting the
conversion of all outstanding Preferred Stock into shares of Common Stock upon
the closing of the Offering). Without taking into account any changes in such
pro forma net tangible book value after March 31, 1996, other than to give
effect to the receipt by the Company of the net proceeds from the sale of the
2,500,000 shares of Common Stock offered hereby at the initial public offering
price of $14 per share, the adjusted pro forma net tangible book value of the
Company as of March 31, 1996 would have been $46.3 million, or $4.52 per share.
This represents an immediate increase in pro forma net tangible book value of
$2.64 per share to existing stockholders and an immediate dilution of $9.48 per
share to new investors. The following table illustrates this per share dilution:

<TABLE>
<S> <C> <C>
Initial public offering price per share......................... $14.00
Pro forma net tangible book value per share at March 31, 1996... $1.88
Increase per share attributable to new investors................ 2.64
-----
Pro forma net tangible book value per share after the 4.52
Offering...................................................... ------
Dilution per share to new investors............................. $ 9.48
======
</TABLE>

The following table summarizes on a pro forma basis, as of March 31, 1996,
the differences between existing stockholders and new investors (at the initial
public offering price of $14 per share and before deducting underwriting
discounts and commissions and estimated offering expenses payable by the
Company) with respect to the number of shares of Common Stock purchased from the
Company, the total consideration paid and the average price per share paid:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
---------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 7,756,981 75.6% $27,579,000 44.1% $ 3.56
New investors............. 2,500,000 24.4 35,000,000 55.9 14.00
---------- ----- ----------- ----- -------
Total..................... 10,256,981 100.0% $62,579,000 100.0%
========== ===== =========== =====
</TABLE>

The foregoing computations assume no exercise of stock options or warrants
after March 31, 1996. As of March 31, 1996, there were outstanding options to
purchase 690,600 shares of Common Stock, with a weighted average exercise price
of $0.97 per share and warrants to purchase 160,187 shares of various series of
Convertible Preferred Stock at an average price of $2.85 per share. In addition,
as of March 31, 1996, 485,450 shares of Common Stock were reserved for future
issuance under the Company's stock plans. If all options and warrants
outstanding at March 31, 1996 were exercised for cash, the pro forma net
tangible book value per share immediately after completion of the Offering would
be $4.27 per share. See "Management -- Employee Benefit Plans" and "Description
of Capital Stock."

14
<PAGE> 15

SELECTED FINANCIAL DATA

The selected financial data set forth below as of December 31, 1994 and
1995, for the period from inception (December 11, 1992) to December 31, 1993,
and for the years ended December 31, 1994 and 1995 have been derived from the
Company's financial statements, which have been audited by Ernst & Young LLP,
independent auditors, and are included elsewhere herein. The selected financial
data set forth below as of March 31, 1996, for the three month periods ended
March 31, 1995 and 1996 and for the period from inception (December 11, 1992) to
March 31, 1996 have been derived from unaudited financial statements included
elsewhere herein and include, in the opinion of the Company, all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the Company's financial position at that date and results of
operations for those periods. The results for the three months ended March 31,
1996 are not necessarily indicative of the results for any future period. The
selected financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Financial Statements of the Company and related notes thereto
and other financial information included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
INCEPTION INCEPTION
(DECEMBER 11, YEAR ENDED THREE MONTHS ENDED (DECEMBER 11,
1992) TO DECEMBER 31, MARCH 31, 1992) TO
DECEMBER 31, ------------------------------- ------------------- MARCH 31,
1993 1994 1995 1995 1996 1996
------------- ------------- ------------- ------- ------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
License fees..................... $ -- $ -- $ 3,000 $ -- $ 1,000 $ 4,000
Research revenue................. -- -- 1,985 -- 1,625 3,610
------- ------- ------- -------- ------- ---------
Total revenues................. -- -- 4,985 -- 2,625 7,610
Operating expenses:
Research and development......... 1,685 5,180 6,400 1,324 1,780 15,045
General and administrative....... 1,251 1,823 2,080 479 526 5,680
------- ------- ------- -------- ------- ---------
Total operating expenses....... 2,936 7,003 8,480 1,803 2,306 20,725
------- ------- ------- -------- ------- ---------
Income (loss) from operations...... (2,936) (7,003) (3,495) (1,803) 319 (13,115)
Interest income.................... 32 218 257 85 137 644
Interest expense................... (13) (249) (278) (70) (73) (613)
------- ------- ------- -------- ------- ---------
Net income (loss).............. $(2,917) $ (7,034) $ (3,516) $(1,788) $ 383 $ (13,084)
======= ======= ======= ======== ======= =========
Pro forma net income (loss) per
share(1)......................... $ (0.44) $ (0.22) $ 0.04
======= ======== =======
Shares used in computing pro forma
net income (loss) per share(1)... 8,052 8,039 8,563
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, MARCH
------------------- 31,
1994 1995 1996
------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................................. $ 5,810 $ 8,517 $ 15,093
Working capital........................................................ 4,845 6,388 11,020
Total assets........................................................... 11,340 13,493 20,691
Long-term obligations.................................................. 2,530 2,075 1,810
Deficit accumulated during development stage........................... (9,951) (13,467) (13,084)
Total stockholders' equity............................................. 7,506 9,151 14,596
</TABLE>

- ---------------

(1) See Note 1 of Notes to Financial Statements for information concerning the
calculation of pro forma net loss per share.

15
<PAGE> 16

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW

Microcide is a biopharmaceutical company founded to discover, develop and
commercialize novel antibiotics for the treatment of serious bacterial
infections. The Company's discovery and development programs address the growing
problem of bacterial drug resistance through two principal themes: (i) Targeted
Antibiotics, which focus on developing novel antibiotics and antibiotic
potentiators, and (ii) Targeted Genomics, which utilize bacterial genetics to
discover new classes of antibiotics and other novel treatments for bacterial
disease.

As part of the Company's strategy to enhance its research and development
capabilities and to fund, in part, its capital requirements, Microcide has
entered into collaborative agreements with three major pharmaceutical companies.
See "Business -- Strategy" and "Business -- Collaborative Agreements." Pursuant
to the Collaborative Agreements, the Company has received license fees and
research support payments, and can potentially receive additional research
support payments, milestone payments and royalty payments. License payments are
typically nonrefundable up-front payments for licenses to develop, manufacture
and market products, if any, that are developed as a result of the
collaboration. Research support payments are typically contractually obligated
payments to fund research and development over the term of the collaboration.
Milestone payments are payments contingent upon the achievement of specified
milestones, such as selection of candidates for drug development, the
commencement of clinical trials or receipt of regulatory approvals. If drugs are
successfully developed and commercialized as a result of the Collaborative
Agreements, the Company will receive royalty payments based upon the net sales
of such drugs.

Through March 31, 1996, the Company had received in the aggregate $4.0
million in license fees and $5.6 million in research support payments under the
Collaborative Agreements. Assuming none of the Collaborative Agreements is
terminated prior to its scheduled expiration, the Company will be entitled to
receive an additional $35.9 million of research support payments in the
aggregate from Ortho, Daiichi and Pfizer. In addition, in the event that any of
the Collaborative Agreements are extended beyond their current terms, the
Company will be entitled to receive additional research support payments. See
"Risk Factors -- Dependence on Collaborative Partners and Others" and
"Business -- Collaborative Agreements."

No milestone or royalty payments have yet been received. In the event that
the Company achieves the specified research and product development milestones,
the Company will be entitled to receive milestone payments as follows: up to
$16.5 million for the first product, and up to $15.5 million for each additional
product developed pursuant to the Ortho/J&J Agreements, up to $13.0 million for
each product developed pursuant to the Daiichi Agreement and up to $32.5 million
for each product developed pursuant to the Pfizer Agreements. Receipt of these
milestone payments is contingent upon achieving specified research and product
development milestones, a number of which may not be achieved for several years,
if ever. The Company does not expect to receive royalties based upon net sales
of drugs for a significant number of years, if at all. See "Risk
Factors -- Absence of Developed Products; Early Stage of Product Development."

Quarterly results of operations are subject to significant fluctuations
based on the timing and amount of certain revenues earned under the
Collaborative Agreements. The Company expects to continue to incur operating
losses in the future.

In addition to the revenues received under the Collaborative Agreements,
the Company received $5.0 million from the sale of equity to an affiliate of
Ortho/J&J in October 1995 in conjunction with the execution of the Ortho/J&J
Agreements, and an additional $5.0 million from the sale of equity to Pfizer in
March 1996 in conjunction with the execution of the Pfizer Agreements.

This Prospectus contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed in "Risk
Factors."

16
<PAGE> 17

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 1995 AND 1996

Revenues. Total revenues for the first quarter of 1996 were $2.6 million,
consisting of $1.0 million in license fees received from Pfizer and $1.6 million
in revenues earned for research performed under the Collaborative Agreements.
Although the Company received $3.1 million in research support payments in the
first quarter of 1996, only $1.6 million was recognized as revenue in that
quarter, with the balance to be recognized as related research services are
performed under the Daiichi Agreement and the Pfizer Agreements. No revenues
were recognized for the first quarter of 1995. The Company expects revenues to
increase in the future due to scheduled research support payments from the
Collaborative Agreements.

Research and Development Expenses. Research and development expenses for
the first quarter increased approximately 34% from $1.3 million in 1995 to $1.8
million in 1996, primarily due to increased compensation and supplies expenses
resulting from a 35% increase in the number of research personnel. The Company
expects research and development expenses to increase in the future due to the
hiring of additional research personnel to support its internal and
collaborative research programs, further expenditures for research materials,
additional utilization of outside research services and amortization of deferred
compensation.

General and Administrative Expenses. General and administrative expenses
for the first quarter increased 10% from $479,000 in 1995 to $526,000 in 1996,
primarily due to increased compensation expenses resulting from the amortization
of deferred compensation. The Company expects general and administrative
expenses to increase in the future due to the hiring of additional
administrative personnel to support the expansion of its research activities and
amortization of deferred compensation.

Interest Income and Expense. Interest income for the first quarter
increased from $85,000 in 1995 to $137,000 in 1996, primarily due to an increase
in average cash balances in 1996 related to proceeds received from the sale of
equity and cash received under the Collaborative Agreements. The Company expects
interest income to increase in the future due to an increase in average cash
balances related to net proceeds received from the Offering. Interest expense
for the first quarter increased 4% from $70,000 in 1995 to $73,000 in 1996 due
to an increase in capital lease balances outstanding. The Company expects
interest expense to remain constant for 1996.

Net Income (Loss). Net income for the first quarter increased $2.2 million
from a loss of $1.8 million in 1995 to a profit of $383,000 in 1996 primarily as
a result of the items discussed above.

FISCAL YEARS ENDED DECEMBER 31, 1994 AND 1995

Revenues. The Company began receiving revenues upon the signing of the
Ortho/J&J Agreements in October 1995 and the Daiichi Agreement in November 1995.
Revenues recognized for research performed during 1995 totaled $5.0 million,
consisting of $3.0 million in license fees and $2.0 million in research revenue.
Although the Company received $2.4 million in research support payments in 1995,
only $2.0 million was recognized as revenue in that year, with the balance to be
recognized as revenue over the life of the Daiichi Agreement.

Research and Development Expenses. The Company's research and development
expenses increased approximately 24% from $5.2 million for 1994 to $6.4 million
for 1995. This increase was largely due to higher compensation expenses,
purchases of research materials and outside research service payments.

General and Administrative Expenses. General and administrative expenses
increased approximately 14% from $1.8 million for 1994 to $2.1 million for 1995.
This increase was primarily due to increased compensation expense and legal,
travel and other expenses related to business development activities in 1995, in
particular the negotiation of the Collaborative Agreements. See
"Business -- Collaborative Agreements."

Interest Income and Expense. Interest income increased 18% from $218,000
for 1994 to $257,000 for 1995. This increase was due to an increase in average
cash balances in 1995 related to proceeds received from the sale of equity and
cash received from the Collaborative Agreements. Interest expense increased 12%
from

17
<PAGE> 18

$249,000 for 1994 to $278,000 for 1995. This increase was due to an increase in
capital lease balances outstanding in 1995.

Net Loss. Net loss decreased by 50% from $7.0 million for 1994 to $3.5
million for 1995, primarily from the receipt of license fees and research
revenues used to support existing research programs.

PERIOD FROM INCEPTION (DECEMBER 11, 1992) TO DECEMBER 31, 1993 AND
FISCAL YEAR ENDED DECEMBER 31, 1994

Revenues. No revenues were received during this period.

Research and Development Expenses. The Company's research and development
expenses increased 207% from $1.7 million in the period from inception to
December 31, 1993 to $5.2 million for 1994. This increase was primarily due to
additional personnel hired to support the Company's increased research efforts.
Depreciation related to increased capital equipment purchases increased by
$850,000, supply costs increased by $405,000, and other costs also increased as
a result of these increased research activities.

General and Administrative Expenses. The Company's general and
administrative expenses increased 46% from $1.3 million in the period from
inception to December 31, 1993 to $1.8 million for 1994. This increase was
primarily due to additional personnel which increased compensation expense,
benefit costs, relocation and recruiting expenses.

Interest Income and Expense. Interest income increased from $32,000 in the
period from inception to December 31, 1993 to $218,000 in 1994. This increase
was due to an increase in average cash balances in 1994 related to proceeds
received from the sale of equity. Interest expense increased from $13,000 in the
period to December 31, 1993 to $249,000 in 1994. This increase was due to an
increase in capital lease balances outstanding.

Net Loss. Net loss increased 141% from $2.9 million for the period from
inception to December 31, 1993 to $7.0 million for 1994, primarily as a result
of the items discussed above.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations since inception primarily through
the sale of equity, through funds provided under the Collaborative Agreements
and through equipment financing. As of March 31, 1996, the Company had received
approximately $27.4 million in net proceeds from the sale of equity and
approximately $9.6 million in cash for license fees and research support
payments under the Collaborative Agreements.

Cash and cash equivalents at March 31, 1996 were $15.1 million compared to
$8.5 million at December 31, 1995. The increase during the first quarter of 1996
was due primarily to the proceeds received from the sale of equity and payments
received under the Collaborative Agreements.

Net cash used in the Company's operations was $2.7 million, $6.2 million
and $1.2 million for the period from inception to December 31, 1993 and for 1994
and 1995, respectively. The cash used in operations was primarily used to fund
research and development expenses and for general and administrative expenses to
support the Company's activities. Net cash provided by the Company's operations
was $2.8 million for the first quarter of 1996. The cash provided by operations
was primarily due to prepayments of research support payments due under the
Collaborative Agreements which are included in deferred revenue.

Through March 31, 1996, the Company had invested approximately $7.7 million
in property and equipment, including $4.6 million in equipment and leasehold
improvements under capital leases. The present value of obligations under
capital leases at March 31, 1996 was $2.8 million. Minimum annual principal
payments due under capital leases total $1.1 million in 1996 and decline each
year thereafter until expiration in the year 2000. The Company made principal
payments under capital lease obligations in the period from inception to
December 31, 1993, and in 1994 and 1995 of $29,000, $569,000 and $927,000,
respectively. The Company expects its capital expenditures in 1996 to be $3.3
million, consisting of $1.2 million of leasehold improvements and $2.1 million
of laboratory and other equipment purchases.

18
<PAGE> 19

Of the $3.3 million in expected capital equipment expenditures in 1996,
approximately $120,000 is expected to be spent on environmental control
equipment required by federal, state and local health statutes and regulations.
Ongoing environmental control expenses, which include hazardous material
removal, are expected to total approximately $50,000 in 1996 and approximately
$60,000 in each of 1997 and 1998.

The Company believes that the anticipated net proceeds from the Offering,
together with its existing capital resources, interest income and future
revenues due under the Collaborative Agreements, will be sufficient to satisfy
its funding requirements at least through 1998. These funding requirements
include continued expenditures for research and development activities, as well
as expenditures related to leasehold improvements and the purchase of additional
laboratory and other equipment. The Company has not entered into any formal
commitments to use the proceeds from the Offering for increased personnel,
capital expenditures or any other purpose. See "Use of Proceeds."

The Company has not generated significant taxable income to date. At
December 31, 1995, the net operating losses available to offset future taxable
income for federal income tax purposes were approximately $13.0 million. Because
the Company has experienced ownership changes, future utilization of the
carryforwards may be limited in any one fiscal year pursuant to Internal Revenue
Code regulations. The carryforwards expire at various dates beginning in 2008
through 2010 if not utilized. As a result of the annual limitation, a portion of
these carryforwards may expire before becoming available to reduce the Company's
federal income tax liabilities.

19
<PAGE> 20

BUSINESS
INTRODUCTION

Microcide's Targeted Genomics programs seek to identify the
pharmaceutically relevant portion of bacterial genomes that are essential to
bacterial viability in vitro (the Essential Genes Program) or to bacterial
growth and virulence in vivo (the Pathogenesis Program). In the Essential Genes
Program, Microcide has identified approximately 80 essential gene targets, which
are being incorporated into the Company's high-throughput, multi-channel
screening system to discover new classes of antibiotics. In the Pathogenesis
Program, Microcide is developing and utilizing new molecular genetics
technologies to identify pathogenesis genes in order to discover and develop
novel therapeutic agents.

Ortho/J&J. Microcide is collaborating with Ortho/J&J to discover and
develop novel beta-lactam antibiotics, antibiotic potentiators and inhibitors of
bacterial signal transduction targeted at problematic Gram-positive bacteria,
including staphylococci and enterococci. The Company expects to select with
Ortho/J&J its initial product candidate, a Gram-positive beta-lactam, in 1996
and to enter into clinical trials during 1997. If specified research and
development milestones are achieved, the Company will be entitled to receive up
to $16.5 million for the initial product and up to $15.5 million for each
subsequent product developed within the collaboration.

Daiichi. Microcide is collaborating with Daiichi to discover and develop
bacterial efflux pump inhibitors to be used in combination with Daiichi's
quinolone antibiotics to target Gram-negative bacteria, including pseudomonas.
The Company expects to select with Daiichi its first quinolone potentiation
candidate by mid-1997 for clinical development. If specified research and
development milestones are achieved, Microcide will be entitled to receive up to
$13.0 million for each product developed within the collaboration.

Pfizer. Microcide is collaborating with Pfizer to implement its essential
gene and multi-channel screening system to discover novel classes of
antibiotics. If specified research and development milestones are achieved,
Microcide will be entitled to receive milestone payments of up to $32.5 million
for each product developed within the collaboration.

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<PAGE> 21

INFECTIOUS DISEASE ENVIRONMENT

BACTERIAL INFECTIONS AND ANTIBIOTICS OVERVIEW

Bacterial infections are a significant and growing medical problem. They
occur when the body's immune system cannot prevent the invasion and colonization
of the body by disease-causing bacteria. These infections may either be confined
to a single organ or tissue, or disseminated throughout the body by blood stream
infections, and can cause many serious diseases, including pneumonias,
endocarditis, osteomyelitis, meningitis, deep-seated soft tissue infections,
bacteremia and complicated urinary tract infections.

According to estimates from the United States Centers for Disease Control
and Prevention (the "CDC") for the period 1980 to 1992, approximately two
million hospital-acquired infections occur annually in the United States,
accounting for more than eight million days of extended hospital stay and
causing more than $4.0 billion in additional health care costs each year. While
overall per capita mortality rates declined in the United States from 1980 to
1992, the per capita mortality rate due to infectious diseases increased 58%
over this period, making infectious diseases the third leading cause of death in
the United States. The Company believes that bacterial infections, especially
infections caused by difficult-to-treat, antibiotic-resistant bacteria, cause or
contribute to a substantial majority of these deaths.

Antibiotics are administered both to prevent bacterial infections and to
treat established bacterial disease. When administered to prevent an infection,
antibiotics are given prophylactically, before any clinical signs or symptoms of
an infection are present. When administered to treat an established infection,
antibiotics are often chosen and administered empirically, before diagnostic
testing has established the causative bacterium and its susceptibility to
specific antibiotics.

Antibiotics work by interfering with a vital bacterial cell function at a
specific cellular target, either killing the bacteria or arresting their
multiplication, thereby allowing the patient's immune system to clear the
bacteria from the body. Currently available antibiotics work on relatively few
targets, through mechanisms such as inhibiting protein or cell wall synthesis.
These targets tend to be present in all bacteria and are highly similar in
structure and function, such that certain antibiotics kill or inhibit growth of
a broad range of bacterial species (i.e., broad-spectrum antibiotics).

Major structural classes of antibiotics include beta-lactams,
fluoro-quinolones, macrolides, tetracyclines, aminoglycosides, glycopeptides and
trimethoprim combinations. Penicillin, a member of the beta-lactam class (which
also includes extended-spectrum penicillins, cephalosporins and carbapenems),
was first developed in the 1940s. Nalidixic acid, the earliest member of the
quinolone class, was discovered in the 1960s. The creation of broad-spectrum
antibiotics began in the 1970s and 1980s, with major advances seen in the 1970s
with the development of newer beta-lactams, and in the 1980s with the
development of fluoro-quinolones. These antibiotics are still being used
extensively. No major new class of antibiotics has been discovered and
commercialized in the last 20 years.

ANTIBIOTICS MARKET

According to sales data compiled by IMS International, an independent
pharmaceutical industry research firm, the market for systemic (orally or
parenterally administered) antibiotics constitutes the third largest worldwide
pharmaceutical market, generating $22.9 billion in worldwide sales for the 12
months ended September 1995, including $6.3 billion in the United States. The
in-hospital antibiotic market, where bacterial resistance poses the most serious
threat, totaled $7.7 billion worldwide during this period, including $2.2
billion in the United States. Worldwide systemic antibiotic sales, aggregated by
major antibiotic class, are shown below, along with a listing of the top 20
systemic antibiotic products, shown in rank order of sales within each class.

21
<PAGE> 22

WORLDWIDE SALES OF SYSTEMIC ANTIBIOTICS

<TABLE>
<CAPTION>
WORLDWIDE TOP 20
SALES(1) ANTIBIOTICS
DRUG CLASS ($ MILLIONS) (WITHIN CLASS)
<S> <C> <C>
- --------------------------------------------------------------------------------------------------
Beta-lactams--Cephalosporins..................... $ 8,446 Cefaclor
Cefuroxime/axetil
Ceftriaxone
Ceftazidime
Cephalexin
Cefixime
Cefazolin
Beta-lactams--Broad-spectrum Penicillins......... 3,804 Amoxicillin/clavulanate
Amoxicillin
Ampicillin/sulbactam
Fluoro-quinolones................................ 3,309 Ciprofloxacin
Ofloxacin
Levofloxacin
Macrolides....................................... 2,927 Clarithromycin
Erythromycin
Azithromycin
Tetracyclines.................................... 744 Minocycline
Aminoglycosides.................................. 729 (2)
Beta-lactams--Medium/Narrow-spectrum
Penicillins................................... 609 (2)
Glycopeptides.................................... 462(3) Vancomycin
Beta-lactams--Carbapenems........................ 443 Imipenem
Trimethoprim Combinations........................ 381 TMP/SMX
All Other Systemic Antibiotics................... 1,049 (2)
- --------------------------------------------------------------------------------------------------
TOTAL....................................... $ 22,903
- --------------------------------------------------------------------------------------------------
</TABLE>

(1) For the 12-month period ended September 1995.
(2) No single antibiotic in this class ranks among the top 20 antibiotics.
(3) Includes Vancomycin only.

ANTIBIOTIC RESISTANCE PROBLEMS

One of the key contributors to the increase in mortality and morbidity due
to bacterial infections is the increasing prevalence of drug-resistant bacteria.
Evidence of bacterial resistance to penicillin was first seen in the 1940s
shortly after its introduction. Methicillin and subsequent second-generation
penicillins were developed to overcome these penicillin-resistant organisms, but
resistance to methicillin in turn began to occur in the 1970s shortly after its
release, and has continued to increase. Similar resistance problems are now seen
with a number of clinically important bacteria targeted by the Company's initial
products, including staphylococci, enterococci, pseudomonas and pneumococci.
Strains of these bacteria have become resistant to all but a few antibiotics.
According to estimates based on CDC data, these four bacteria are responsible
for 44% of all hospital-acquired infections and for 63% of hospital-acquired
blood stream infections in the United States.

A number of factors are believed to contribute to the increased rate of
bacterial drug resistance: (i) physician reliance on broad-spectrum antibiotics
for empiric treatment of an infection before it is definitively diagnosed; (ii)
repeated exposure of bacteria to long-term antibiotic therapy, providing a
competitive advantage to bacteria harboring drug resistance; (iii) the
increasing number of immunosup-

22
<PAGE> 23

pressed patients (from cancer chemotherapy, AIDS and organ transplants); (iv)
the growing number of institutionalized, often elderly, patients receiving
multiple courses of antibiotics; (v) the increased frequency of invasive medical
procedures; and (vi) societal and technological changes, including air travel,
that accelerate the spread of drug-resistant bacteria.

One example of the seriousness of antibiotic resistance is
methicillin-resistant staphylococci ("MRS"), which have become resistant to
virtually all currently used antibiotics, except vancomycin. The heavy use of
vancomycin to treat MRS infections has in turn contributed to the emergence of
new strains of enterococci, the third most prevalent cause of bacterial
infection in hospitals in the United States, which are resistant to vancomycin.
Infections caused by these vancomycin-resistant enterococci ("VRE") frequently
do not respond to any current therapies, and in many cases prove fatal. The
transfer of vancomycin resistance from enterococci to staphylococci has been
demonstrated experimentally. If vancomycin resistance is transferred in the
clinical setting by VRE to staphylococci, the leading cause of hospital-acquired
bacterial infections, no effective antibiotic therapy will remain to treat MRS
infections.

As a result of increasing bacterial resistance to existing antibiotics,
numerous clinical infections occur that resist first-line therapy. When bacteria
develop resistance to established first-line antibiotics, it is often necessary
to use a combination of two drugs, or multiple antibiotic therapy of three or
more drugs, to treat these resistant infections. Such combination or multiple
antibiotic therapy is generally more costly, potentially less effective, and
more toxic to the patient due to additive and sometimes synergistic side
effects. The table below outlines some of the major problematic drug-resistant
bacteria, the classes of antibiotics to which they already show clinically
significant levels of resistance, and the remaining recommended treatments:

PROBLEMATIC DRUG-RESISTANT BACTERIA

<TABLE>
<S> <C> <C>
- ---------------------------------------------------------------------------------------------
BACTERIA CLINICALLY REMAINING
SIGNIFICANT RECOMMENDED TREATMENT
RESISTANCE PROBLEMS
- ---------------------------------------------------------------------------------------------
Staphylococci Beta-lactams Vancomycin
(Staphylococcus aureus) Fluoro-quinolones Combination Therapy
(coagulase-negative Aminoglycosides
staphylococci)
Macrolides
- ---------------------------------------------------------------------------------------------
Enterococci Beta-lactams Multiple Antibiotic Therapy
Aminoglycosides
Glycopeptides
- ---------------------------------------------------------------------------------------------
Pseudomonas aeruginosa Beta-lactams Combination Therapy
Fluoro-quinolones
Aminoglycosides
- ---------------------------------------------------------------------------------------------
Streptococcus pneumoniae Beta-lactams Cephalosporin or Carbapenem
Macrolides Vancomycin
Tetracyclines
- ---------------------------------------------------------------------------------------------
</TABLE>

STRATEGY

The Company believes that the antibiotics market provides an attractive
opportunity for its research and development activities because (i) there are
significant unmet clinical needs, caused by growing bacterial resistance
problems, that require new antibacterial therapies and (ii) the preclinical and
clinical development process for antibiotics typically follows an efficient and
well-defined path to the market, and early testing is generally predictive of
later stage results. The Company believes these factors will lead to shorter
overall development timelines and higher approval rates for its products.
Microcide's strategy is to focus near-term preclinical research activities on
drug resistance pathways and to conduct longer-term drug discovery using

23
<PAGE> 24

novel antibacterial targets identified through its Targeted Genomics programs.
This strategy is comprised of the following five key elements:

Develop Novel Antibiotics by Targeting Drug Resistance
Pathways. Microcide's near-term research programs focus on rapidly identifying
and optimizing proprietary compounds that are effective against problematic
antibiotic-resistant bacteria, notably MRS, VRE, penicillin-resistant
pneumococci and quinolone-resistant pseudomonas. Since antibiotic resistance
problems are often due to a single defined pathway, the Company believes that
targeting those pathways will enable it to rapidly develop novel antibiotics
tailored to specific resistant bacteria, as well as to develop antibiotic
potentiators that overcome resistance pathways and restore the usefulness of
established antibiotics that have been rendered ineffective. The Company's
Gram-Positive, Efflux Pump and Cell Wall Programs are focused in this area.

Accelerate the Discovery of New Antibiotic Classes through Targeted
Genomics. Microcide has developed a technology platform which utilizes
bacterial genetics to discover the genes which are essential for a bacterium's
in vitro survival or in vivo pathogenecity. Microcide is utilizing essential
bacterial genes discovered in its Essential Genes Program as the basis for
identifying and characterizing novel antibiotic targets. The Company has
developed an innovative methodology for parallel high- throughput screening of
these targets to identify a large number of lead compounds. The Company believes
that this genetics technology platform will enable it to rapidly identify drug
candidates within new classes of antibiotics.

Extend Targeted Genomics to Pathogenesis Genes, Creating Novel Therapeutic
Approaches. Microcide has extended its molecular genetics technologies in
targeted genomics to identify and characterize genes that are critical to
bacterial growth or virulence in vivo. The Company believes that inhibitors of
such targets have not been previously sought in antibiotic discovery programs,
and that its Pathogenesis Program utilizes novel methods to discover inhibitors
of pathogenesis genes for development as new treatment approaches for bacterial
disease.

Enhance Research and Development and Reduce Capital Requirements
through Collaborative Agreements. The Company has entered into collaborations
with three major pharmaceutical companies to develop its initial products. Such
collaborations are expected to provide Microcide with funding, discovery
technologies, research staffing, access to molecular diversity, and development
and commercialization capabilities. By utilizing the resources of its
collaborators, Microcide expects to lower its capital requirements and reduce
the time needed to commercialize its products worldwide.

Retain the Ability to Independently Develop and Market Certain
Products. Microcide's long-term development strategy is to continue to utilize
strategic collaborations selectively to complement internal efforts. Microcide
plans to retain rights to market products resulting from specific programs,
including the Company's Pathogenesis and Cell Wall Programs, and to enter into
collaborative relationships where appropriate for distribution and
commercialization.

MICROCIDE'S RESEARCH PROGRAMS

Microcide's research programs employ an interdisciplinary approach that
incorporates several drug discovery and research technologies, including
targeted genomics, high-throughput and multi-channel screening, combinatorial
and medicinal chemistry, computer-assisted drug design and bioinformatics. The
Company believes that its interdisciplinary approach more effectively utilizes a
broader range of novel bacterial targets for new compound discovery than
traditional biochemical approaches. Microcide believes that drug resistance
genes, essential genes and pathogenesis genes can be developed into screens for
selective inhibitors and widely employed in the lead discovery process.

Access to molecular diversity libraries for screening against targets is
critical to drug discovery. In some instances, the Company's collaborative
partners are providing molecular diversity libraries to support the screening
process. However, the Company is committed to establishing a stand-alone
molecular diversity capability for its programs, and is actively building
strategically defined libraries of synthetic compounds and natural product
extracts for this purpose. The Company's natural products program provides
access to broad-based molecular diversity not possible in synthetic compound
libraries alone. The Company believes that both its libraries contain
significant structural diversity. These libraries currently provide more than
50,000 samples

24
<PAGE> 25

for high-throughput screening. The Company is in the process of expanding its
libraries to more than 100,000 samples by the end of 1996.

The Company's discovery and preclinical research activities center on two
themes: Targeted Antibiotics and Targeted Genomics. The Company's Targeted
Antibiotics programs focus on overcoming bacterial drug resistance, either by
interfering with resistance pathways to potentiate existing antibiotics, or by
developing novel lead compounds which avoid such resistance pathways. The
Company's Targeted Genomics programs utilize bacterial genetics and genomics
approaches to discover inhibitors of novel drug targets for further development
as effective antibiotics.

MICROCIDE'S RESEARCH PROGRAMS

<TABLE>
<S> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------
CURRENT
PROGRAM PROGRAM GOAL STAGE(1) PARTNER
- --------------------------------------------------------------------------------------------------------
TARGETED ANTIBIOTICS
- --------------------------------------------------------------------------------------------------------
Gram-Positive Program
Novel Beta-lactams Novel antibiotics for treatment of Gram- Candidate Ortho/J&J
positive bacteria, including resistant Selection
strains (MRS, VRE and penicillin-resistant
Streptococcus pneumoniae)
- --------------------------------------------------------------------------------------------------------
Antibiotic Potentiators which restore efficacy to Drug Ortho/J&J
Potentiators existing classes of antibiotics through Design
inhibition of resistance mechanisms
- --------------------------------------------------------------------------------------------------------
Signal Transduction Anti-virulence adjunct to existing Leads Ortho/J&J
antibiotics for treatment of resistant and Identified
susceptible staphylococci
- --------------------------------------------------------------------------------------------------------
Efflux Pump Program Potentiators for use with existing Drug Daiichi
quinolones against resistant Gram-negative Design
bacteria, including Pseudomonas aeruginosa
- --------------------------------------------------------------------------------------------------------
Cell Wall Program
First Generation Narrow-spectrum antibiotics Drug Internal
Design
Second Generation Broad-spectrum antibiotics Drug Internal
Design
- --------------------------------------------------------------------------------------------------------
TARGETED GENOMICS
- --------------------------------------------------------------------------------------------------------
Essential Genes Program Novel classes of broad- and narrow-spectrum Screening Pfizer
antibiotics
- --------------------------------------------------------------------------------------------------------
Pathogenesis Program Novel anti-virulence or anti-pathogenesis Gene Internal
bacterial therapeutics Identification
- --------------------------------------------------------------------------------------------------------
</TABLE>

- ---------------
(1) The Company's preclinical research programs generally consist of the
following stages, listed chronologically:

"Gene Identification" -- development and implementation of methods to
identify appropriate gene targets to be used in screening.

"Screening" -- development and implementation of assay technologies to
identify selective target inhibitors ("leads").

"Leads Identified" -- lead compounds have been identified whose in vitro and
in vivo characteristics are being evaluated in biochemical, microbiological,
pharmacological and toxicological tests for entry into drug design programs.

"Drug Design" -- structure-activity relationships of selected compounds are
being defined and such compounds optimized through medicinal chemistry
efforts.

"Candidate Selection" -- optimized leads are being scaled-up and evaluated
in key efficacy, toxicological and pharmacological tests in the final stage
of preclinical research for selection as clinical development candidates.

25
<PAGE> 26

TARGETED ANTIBIOTICS

Microcide's Targeted Antibiotics programs involve two approaches: (i) the
development of novel antibiotics which overcome bacterial resistance by
interfering with resistance pathways to potentiate existing antibiotics, and
(ii) the development of novel lead compounds which avoid such resistance
pathways. The Company's Targeted Antibiotics programs include the Gram-Positive,
Efflux Pump and Cell Wall programs.

GRAM-POSITIVE PROGRAM

Microcide's Gram-Positive Program is focused on discovering and developing
novel antibiotics and antibiotic potentiators for the treatment of infections
caused by drug-resistant Gram-positive bacteria, including MRS, VRE and
pneumococci. Gram-positive and Gram-negative bacteria have fundamentally
different surface characteristics. These surface properties greatly affect the
ability of an antibiotic to penetrate the bacterium and reach its target site.
As a result, antibiotics that are effective against Gram-positive bacteria are
often less effective against Gram-negative bacteria, and vice versa. The
problematic Gram-positive bacteria targeted by this program cause serious
infections, including endocarditis, osteomyelitis, meningitis, deep-seated soft
tissue infections, bacteremia, complicated urinary tract infections and
pneumonias.

The Gram-Positive Program is being conducted in collaboration with
Ortho/J&J and consists of the following major areas: (i) discovery of
beta-lactam antibiotics with specific efficacy against resistant Gram-positive
bacteria; (ii) discovery of novel antibiotic potentiators of existing
beta-lactams or vancomycin for use against MRS and VRE, respectively; and (iii)
discovery of inhibitors of signal transduction in bacteria.

Novel Beta-lactams

Traditional beta-lactam antibiotics work by inhibiting enzymes
(penicillin-binding proteins, or PBPs) that carry out crucial steps in the
synthesis of the bacterial cell wall. Resistance to beta-lactam antibiotics in
MRS is primarily caused by bacterial production of PBP2a, an enzyme capable of
conducting cell-wall synthesis in the presence of such antibiotics, as well as
by the production of beta-lactamases, which render beta-lactams ineffective.

Microcide's beta-lactam program seeks initially to develop a novel
beta-lactam antibiotic which is beta-lactamase-stable and inhibits PBPs,
including PBP2a, thereby gaining efficacy against MRS. Compounds emerging from
the Company's beta-lactam program are expected to be active against
staphylococci, including MRS, enterococci, including VRE, and possibly other
Gram-positive bacteria. The Company has prepared over 400 new synthetic analogs
and has made advances in drug design, resulting in several leads with desirable
in vitro potency, in vivo efficacy, favorable pharmacokinetics and solubility,
and low toxicity.

Antibiotics developed within this program are expected to be parenterally
administered in the institutional setting to prevent or treat infections caused
by Gram-positive bacteria, including those resistant to other antibiotics. Such
newly developed antibiotics could potentially be clinically adopted for the
following uses: as a single agent following treatment failure in patients with a
documented drug-resistant infection, or empirically as a single agent or in
combination with a broad-spectrum antibiotic to extend coverage to resistant
bacterial strains. The Company believes that the clinical adoption of such
antibiotics could be similar to that of vancomycin as a single agent, or
ceftazidime or an aminoglycoside in combination use for empiric therapy.

The Company, in collaboration with Ortho/J&J, expects to select its first
beta-lactam drug candidate for clinical development in 1996 and enter into
clinical trials during 1997. There can be no assurance that such selection will
occur, or that the Company will begin clinical trials, by such dates, or ever.
The Company has filed patent applications on ten series of lead structures
discovered in this program in the United States and elsewhere. See "Risk
Factors -- Dependence on Collaborative Partners and Others" and "Risk Factors --
Dependence on Proprietary Technology and Unpredictability of Patent Protection."

Antibiotic Potentiation

The loss of utility of an antibiotic class in the treatment of bacteria is
often due to a single, defined resistance pathway, as is the case in MRS and
VRE. The goal of the Company's antibiotic potentiation program is to discover
compounds that directly interfere with methicillin or vancomycin resistance
pathways in these organisms, in order to restore the effectiveness of
beta-lactams or glycopeptides in the treatment of

26
<PAGE> 27

MRS or VRE infections. Microcide has developed novel screening technologies to
discover inhibitors of these pathways, and has discovered leads from these
screens which show desirable characteristics in vitro and in vivo. Several of
the methicillin potentiator leads, tested in combination with a number of
currently marketed beta-lactams, demonstrate control of MRS infection in animal
models at doses where the beta-lactams alone are ineffective.

Potentiators resulting from this program may be developed for use with oral
or parenteral antibiotics, with the goal of creating a combination product which
either targets a specific resistance problem (for example, in combination with
an anti-staphylococcal penicillin) or alternatively provides broad-spectrum
empiric coverage (such as in combination with imipenem). The Company believes
that the clinical adoption of such potential products could be similar to that
of vancomycin as a targeted narrow-spectrum potentiator, or
amoxicillin/clavulanate or imipenem as a broad-spectrum potentiator.

The Company, in collaboration with Ortho/J&J, is designing compounds based
on methicillin potentiation leads, and expects to select its first candidate
from this program in 1997 for clinical development. There can be no assurance
that such selection will occur in 1997 or ever. The Company has filed patent
applications covering two series of lead structures originating from this
program in the United States. See "Risk Factors -- Dependence on Collaborative
Partners and Others" and "Risk Factors -- Dependence on Proprietary Technology
and Unpredictability of Patent Protection."

Inhibitors of Bacterial Signal Transduction

Signal transduction is a mechanism by which a cell senses and responds to
changes in its external environment and which occurs when a sensor protein,
usually at the cell surface, receives and transmits a signal that results in the
expression of a specific set of genes. A wide range of bacteria use signal
transduction systems to regulate a variety of cellular functions. For example,
it is generally believed that disease-causing bacteria are able to use such
mechanisms to establish infections in different sites of the body. Signal
transduction systems are also utilized by staphylococci and enterococci to
express methicillin and vancomycin resistance. Elements of these regulatory
systems are conserved within bacteria and across bacterial species, but are
dissimilar to signal transduction mechanisms found in mammalian cells. For that
reason, the Company believes that bacterial-specific signal transduction
inhibitors can be developed into effective therapeutic agents.

Microcide is initially focused on a specific signal-transduction system in
staphylococci, which controls the expression of a large number of bacterial
toxins and surface proteins produced during infection. The Company has developed
screening and lead evaluation technologies and has identified compounds which
block signal transduction control in staphylococci. These compounds are
currently undergoing biochemical, microbiological and pharmacological testing in
vitro and in vivo.

Any products resulting from the bacterial signal transduction program will
represent a new therapeutic approach, in that they will be anti-pathogenesis or
anti-virulence agents. Potential initial products will be targeted at
Gram-positive bacteria, and are expected to be used independently or in
combination to enhance the potency of existing antibiotics in particularly
difficult-to-treat clinical situations, such as deep-seated soft tissue
infections, endocarditis, osteomyelitis and meningitis.

The Company, in collaboration with Ortho/J&J, is in the process of
selecting lead compounds for drug design efforts. The Company has filed a patent
application covering the screening technology and is preparing to file a patent
application in the United States covering four series of lead structures
discovered to date in this program. See "Risk Factors -- Dependence on
Collaborative Partners and Others" and "Risk Factors -- Dependence on
Proprietary Technology and Unpredictability of Patent Protection."

EFFLUX PUMP PROGRAM

The high intrinsic resistance of Pseudomonas aeruginosa to many
antibiotics, including quinolones, has generally been attributed to the
impermeable outer membrane of this Gram-negative bacterium. Recent information,
however, indicates that this intrinsic resistance is due to the combined effects
of low membrane permeability and the production of membrane proteins (efflux
pumps) which bind to antibiotics of many different types as they enter the
bacterial cell and eject (efflux) them from the bacterium.

27
<PAGE> 28

The Company believes that the combination of bacterial efflux pump
inhibitors with existing antibiotics could increase the susceptibility of
Gram-negative bacteria like pseudomonas to such antibiotics and could increase
the activity of such antibiotics in bacteria expressing efflux pump-mediated
drug resistance ("MDR"). The Company has established a genetics and molecular
biology program which focuses on bacterial efflux systems, and has developed
novel screening and lead evaluation technologies which have resulted in the
discovery of lead compounds with the desired potency, specificity for bacterial
efflux pumps, and low toxicity in mammalian cells. Drug design efforts are being
pursued to identify metabolically stable and pharmacologically suitable efflux
pump inhibitors for selection as clinical development candidates. The Company
expects that any products resulting from this effort will be combined with
Daiichi's oral and parenteral quinolone antibiotics to increase their
effectiveness against Gram-negative bacteria and to overcome efflux
pump-mediated MDR in pseudomonas and other bacteria. The Company believes that
the clinical adoption of such antibiotic/inhibitor combinations could be similar
to that of Daiichi's levofloxacin and other quinolones.

The Company, in collaboration with Daiichi, is designing compounds based on
efflux pump inhibitor leads and expects by mid-1997 to select its first
candidate from this program for clinical development. There can be no assurance
that such selection will occur by such date, or ever. The Company has filed
patent applications related to the initial series of lead structures originating
from this program in the United States and is preparing patent applications
relating to four other series of lead structures. See "Risk Factors --
Dependence on Collaborative Partners and Others" and "Risk Factors -- Dependence
on Proprietary Technology and Unpredictability of Patent Protection."

CELL WALL PROGRAM

Enzymes involved in bacterial cell wall biosynthesis represent attractive
and proven targets for antibiotic development. Many inhibitors of this process,
which is essential and unique to bacteria, have been identified. However,
relatively few of these inhibitors have been developed into commercially usable
antibiotic classes. Microcide's Cell Wall Program is based on unexploited
structural classes of known inhibitors which fall outside existing cell wall
drug classes, and for that reason are not expected to be subject to existing
resistance mechanisms.

One class of inhibitors currently under research at Microcide shows potent
activity against Pseudomonas aeruginosa and certain other bacteria, and is well
tolerated and non-toxic in animal studies. The Company is working toward the
design of a first-generation drug candidate, to be administered orally or
parenterally, and to be targeted against specific, difficult-to-treat
infections. The Company believes that the clinical adoption of the Company's
potential first-generation product from this program could be similar to that of
existing narrow-spectrum antibiotics such as aztreonam, a Gram-negative
beta-lactam. The Company is also pursuing a second-generation antibiotic with an
expanded spectrum of activity which could include Gram-negative and possibly
Gram-positive bacteria.

The Company has retained all commercial rights relating to this program and
expects to fund it internally. The Company expects to select in the second half
of 1997 the initial first-generation candidate for clinical development. There
can be no assurance that such selection will occur by such date, or ever. The
Company is preparing patent applications in the United States related to two
series of lead structures originating from this program. See "Risk
Factors -- Dependence on Collaborative Partners and Others" and "Risk
Factors -- Dependence on Proprietary Technology and Unpredictability of Patent
Protection."

TARGETED GENOMICS

Microcide believes that it has developed a unique approach to antibiotic
research using bacterial genetics as a foundation for drug discovery. The
Company believes that this approach will yield a large number of relevant novel
drug targets that in turn are expected to lead to the development of new classes
of antibiotics. The Company's strategy is to target its gene discovery efforts
to the pharmaceutically relevant portion of bacterial genomes, by identifying
genes that are essential to bacterial viability in vitro (the Essential Genes
Program) or to bacterial pathogenicity in vivo (the Pathogenesis Program). These
target genes, once identified, are incorporated into the Company's
high-throughput screening systems to identify compounds for further development.
The Company believes that its targeted genomics approach may also be applied to
other cellular systems, such as other microbial pathogens or mammalian cells.
The Company believes that this

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approach offers significant advantages over traditional pharmaceutical company
approaches, as well as the more recent bacterial genomic sequencing approaches.

Traditional approaches to antibiotic drug discovery have centered on
biochemically defined targets. In such approaches, screening assays are
developed based on selectively chosen enzyme or receptor targets. Appropriately
designed assays can be highly effective but have several significant drawbacks.
First, such an approach is limited in its application since it requires
pre-existing data with respect to the function or mechanism of an identified
target, and only identifies inhibitors of that specific target. Since many
targets lack such information, the range of targets that can be employed to find
inhibitors is limited. Second, target-specific assays have relatively high
set-up times and costs. Third, these techniques often employ an extracellular
biochemical approach which may identify compounds that are excellent inhibitors
of essential biochemical enzymes, but subsequently prove not to be good
antibiotic candidates because sufficient concentrations within the bacterium are
not achieved at the target site, or for other reasons.

Drug discovery efforts have recently employed whole-genome sequencing
approaches to antibiotic target identification. Although such approaches reveal
all of the genetic information in a bacterium, the Company believes that only an
estimated 5% - 10% of the total bacterial genetic material encodes proteins that
are pharmaceutically relevant as drug targets. Genome sequencing approaches can
only address gene function through sequence analysis and comparison, and do not
adequately address the issue of the relevance of a particular gene as a drug
target. Thus, while two complete bacterial genomes were sequenced and publicized
in the summer of 1995, considerable research will be necessary to identify the
pharmaceutically relevant target genes from this information, and to develop
screens for potential inhibitors. Such screens will then face many of the same
limitations as traditional screening approaches.

ESSENTIAL GENES PROGRAM

In contrast, Microcide's Essential Genes Program utilizes a targeted
genomic approach to discover the pharmaceutically relevant genes present in
bacterial genomes, and focuses on several important and diverse pathogenic
bacteria. The Company has created unique molecular tools and approaches in
bacterial molecular genetics, which allow it to create and use gene mutants to
quickly and directly clone essential bacterial genes. These same mutants are
then used to characterize and prioritize drug targets. This targeted genomics
approach accelerates the entire discovery process by focusing on the relevant
portions of the genome and bypassing the task of sequencing and characterizing
irrelevant portions of the genome.

To date, Microcide has identified approximately 80 of the estimated
150 - 200 essential genes in its bacterial genomic systems. Because essential
genes are generally common among different bacteria, the Company believes that a
number of the drug targets identified to date could lead to the discovery of new
classes of broad-spectrum antibiotics. The Company has filed patent applications
covering approximately 55 essential genes and related screening methods in the
United States.

The Company has also created a multi-channel screening process that it
believes will accelerate antibiotic discovery in several important ways.
Foremost is the ability to move directly and rapidly from gene identification to
drug screen using gene mutants. Using genetic rather than biochemical assays,
many targets can be utilized simultaneously to evaluate compounds, as opposed to
the traditional screening approach which utilizes few targets in single assay
format. This multi-channel process creates a multi-dimensional profile or
"phenoprint" of each compound tested. Both multiple targets and multiple
biological properties of compounds can thus be simultaneously evaluated during
primary screening. Using defined testing algorithms and statistical analyses of
resulting data, many compounds are tested in high-throughput mode. Collectively,
the resulting compound phenoprints, along with other data on the properties of
the genes and the compounds, form a database of information correlating
biological effects of compounds and their structures to the various targets
early in the development process. This facilitates and enhances the selection of
optimal hits and most promising leads prior to commitment to drug design
efforts.

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[GRAPHIC APPEARS HERE]

[Narrative description: Graphic showing the Company's targeted genomic
approach and multi-channel screening process.]

The Company's multi-channel screening method has the following benefits:
(i) it is broadly applicable to all of the pharmaceutically relevant essential
genes identified; (ii) it identifies compounds that can enter cells and effect
inhibitory action, given its whole-cell based nature; (iii) it utilizes more
sensitive assays than traditional whole-cell screens, allowing for the
identification of a broader range of potential drug candidates; and (iv) it can
be applied even before the novel genes or biochemical targets are fully
characterized. The database created by the Company's Essential Genes Program is
expected to grow in information content and ability to discriminate among
compounds as each new gene or compound is evaluated and added to the database.
The Company believes this database represents a significant competitive
advantage in antibiotic development.

The Company, in collaboration with Pfizer, is implementing its essential
gene and multi-channel screening systems to discover and develop multiple new
antibiotic drug classes. In addition, Microcide and Pfizer will select between
four and six essential gene targets of high interest for biochemical screening.
The molecular diversity libraries of the Company and Pfizer will be selectively
applied to these screening efforts. Potential products resulting from the drug
design efforts of this program are expected to constitute new classes of
broad-spectrum antibiotics. The Company believes that the clinical adoption of
such compounds could be similar to that of clarithromycin, ciprofloxacin or
imipenem. In addition to patent applications covering essential genes, the
Company has filed patent applications covering its multi-channel screening
technology in the United States and elsewhere. See "Risk Factors -- Dependence
on Proprietary Technology and Unpredictability of Patent Protection."

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PATHOGENESIS PROGRAM

Bacterial pathogenesis is a complex process by which bacteria enter the
host, locate and establish an appropriate growth niche, evade host defenses,
circumvent host clearing mechanisms, and amplify at the site of infection.
Specialized bacterial genes are required for survival in the host that are not
required for growth in the laboratory environment. Damage to the host arises
from bacterial products produced during growth, and from the bacterium's ability
to modify and destroy host tissue. The bacterial gene products causing this
damage contribute to bacterial virulence. The Company believes that cellular
functions underlying these processes of pathogenicity and virulence are
conserved among many disease-causing bacteria, and inhibitors of these cellular
functions may be broadly acting and detrimental to the bacterium and its
disease-causing ability.

Microcide's Pathogenesis Program is targeted to the genetic determinants
underlying bacterial pathogenicity and virulence. The genetic basis of bacterial
pathogenicity is largely unknown and unexplored for drug targeting. The Company
has developed novel molecular and genetic methods to identify pathogenesis gene
targets in vitro and in animal models, and to genetically assess the effect of
target inhibition in vivo. These methods are being employed to create a library
of such genes for drug discovery research. To date, the Company has identified
37 pathogenesis gene mutants, and cloned and sequenced at least eight potential
pathogenesis gene targets, which are being examined in vitro and in animal
systems. Specific screens will be devised and implemented to identify inhibitors
of the most attractive pathogenesis gene targets, in which inhibition of the
target function will prevent the bacterium's proliferation or virulence in vivo.
Inhibition of genetic processes underlying pathogenesis is expected to
constitute a novel approach to the prevention and treatment of bacterial
disease, and potentially offer therapeutic advantages over traditional
antibiotic therapy.

The Company has retained all commercial rights to this program and intends
to fund this program internally. The Company has filed patent applications in
the United States covering methods for discovery and characterization of
pathogenesis genes.

COLLABORATIVE AGREEMENTS

The Company's strategy is to enter into collaborations with major
pharmaceutical companies to develop its initial products. Such collaborations
are expected to provide the Company with funding, discovery technologies,
research staffing, access to molecular diversity, and development and
commercialization capabilities. To date the Company has entered into
Collaborative Agreements with three major pharmaceutical companies: Ortho/J&J
with regard to the Gram-Positive Program; Daiichi with regard to the Efflux Pump
Program; and Pfizer with regard to the Essential Genes Program. The Company has
certain rights to co-promote in North America products developed pursuant to
these collaborations.

ORTHO/J&J -- GRAM-POSITIVE PROGRAM

In October 1995, Microcide and Ortho/J&J entered into the Ortho/J&J
Agreements pursuant to which they agreed to collaborate to discover and develop
certain antibiotics and antibiotic potentiators targeted at Gram-positive
bacteria. The term of the Ortho/J&J Agreements is three years, subject to
Ortho/J&J's right to earlier terminate the Ortho/J&J Agreements on six months
prior written notice, and with Ortho/J&J having an option to extend the term for
an additional one-year period. Ortho/J&J has made a $3.0 million up-front
license payment to the Company and an affiliate of Ortho/J&J has made a $5.0
million equity investment in the Company. Ortho/J&J is obligated to provide the
Company with $3.5 million per year in research support payments throughout the
term of the Ortho/J&J Agreements. Microcide may also receive from Ortho/J&J
milestone payments of up to $16.5 million for the first product and $15.5
million for each subsequent product upon the achievement of product development
milestones and, in addition, royalties on the worldwide sale of drugs resulting
from the collaboration. The Ortho/J&J Agreements provide Ortho/J&J with
exclusive worldwide rights to products developed during the collaboration. The
development, manufacture and sale of drugs resulting from the collaboration will
be conducted by Ortho/J&J, provided that Microcide has the right to undertake
certain co-promotion activity in North America subject to Ortho/J&J's approval.
There can be no assurance that any potential products will be discovered during
the collaboration or that, if discovered, Ortho/J&J will elect to proceed with
the development of such potential products. As a result,

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there can be no assurance that any of the milestone or royalty payments
contemplated by the Ortho/J&J Agreements will be made. See "Targeted
Antibiotics -- Gram-Positive Program."

DAIICHI -- EFFLUX PUMP PROGRAM

In November 1995, Microcide and Daiichi entered into the Daiichi Agreement
pursuant to which they agreed to collaborate to discover and develop antibiotics
and antibiotic potentiators, acting through inhibition of the efflux pump
mechanism, primarily targeted at pseudomonas. The term of the research program
under the Daiichi Agreement is two years and nine months commencing as of July
1, 1995 subject to Daiichi's right to earlier terminate the research program
under the Daiichi Agreement after July 1, 1997 upon six months prior notice, and
with Daiichi having an option to extend the term of the research program under
the Daiichi Agreement for an additional six months or one year. Daiichi is
obligated to provide research support funding to Microcide of $3.0 million for
the first nine months and $3.5 million for each subsequent year during the term
of the research program. Daiichi has the right to enter into a license agreement
(the "Daiichi License Agreement") for exclusive worldwide rights to products
developed during the collaboration. Pursuant to the Daiichi License Agreement,
Microcide is entitled to receive from Daiichi milestone payments of up to $13.0
million for each product developed during the collaboration upon the achievement
of certain drug development milestones and, in addition, royalties on the
worldwide sale of drugs resulting from the collaboration. The development,
manufacture and sale of drugs resulting from the collaboration will be conducted
by Daiichi subject to Microcide's right to co-promote such drugs in North
America, for which Microcide shall receive reasonable compensation. There can be
no assurance that any potential products will be discovered during the
collaboration or that, if discovered, Daiichi will elect to proceed with the
development of such potential products. As a result, there can be no assurance
that any of the milestone or royalty payments contemplated by the Daiichi
License Agreement will be made. See "Targeted Antibiotics -- Efflux Pump
Program."

PFIZER -- ESSENTIAL GENES PROGRAM

In March 1996, Microcide and Pfizer entered into the Pfizer Agreements
pursuant to which they agreed to collaborate to implement genetics-based
screening technology to identify and subsequently develop antibacterial
products. The term of the Pfizer Agreements is five years, subject to Pfizer's
right to earlier terminate after February 1999 with six months prior written
notice. Pfizer has made a $1.0 million up-front license payment to the Company
and a $5.0 million equity investment in the Company. Pfizer is obligated to
provide Microcide with $4.2 million per year in research support payments during
the term of the Pfizer Agreements. Microcide may also receive from Pfizer
milestone payments of up to $32.5 million for each product developed during the
collaboration upon the achievement of product development milestones and, in
addition, royalties on the worldwide sale of drugs resulting from the
collaboration. The Pfizer Agreements provide Pfizer with exclusive worldwide
rights to products developed during the collaboration. The development,
manufacture and sale of drugs resulting from the collaboration will be conducted
by Pfizer, subject to Microcide's right to co-promote such products in North
America. There can be no assurance that any potential products will be
discovered during the collaboration or that if discovered, Pfizer will elect to
proceed with the development of such potential product. As a result, there can
be no assurance that any of the milestone or royalty payments contemplated by
the Pfizer Agreements will be made. See "Targeted Genomics -- Essential Genes
Program."

The Company is dependent on its collaborative partners for drug
development, obtaining regulatory approvals, funding and other resources for
products emerging from these collaborations. See "Risk Factors -- Dependence on
Collaborative Partners and Others" and "Risk Factors -- Future Capital Needs;
Uncertainty of Additional Funding."

PATENTS, PROPRIETARY TECHNOLOGY AND TRADE SECRETS

Protection of the Company's proprietary compounds and technology is
essential to the Company's business. The Company's policy is to seek, when
appropriate, protection for its lead compounds, gene discoveries, screening
technologies and certain other proprietary technology by filing patent
applications in the

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United States and other countries. The Company has filed approximately 30 patent
applications in the United States, in addition to applications filed in other
countries, covering its inventions. To date, the Company has not been issued any
United States or foreign patents. See "Risk Factors -- Dependence on Proprietary
Technology and Unpredictability of Patent Protection."

Patent law as it relates to inventions in the biotechnology field is still
evolving, and involves complex legal and factual questions for which legal
principles are not firmly established. Accordingly, there can be no assurance
that patents will be granted with respect to any of the Company's pending patent
applications or with respect to any patent applications filed by the Company in
the future. Moreover, because patent applications in the United States are
maintained in secrecy until patents issue, because patent applications in
certain other countries generally are not published until more than eighteen
months after they are filed, because publication of technological developments
in the scientific or patent literature often lags behind the date of such
developments, and because searches of prior art may not reveal all relevant
prior inventions, the Company cannot be certain that it was the first to invent
the subject matter covered by its patent applications or that it was the first
to file patent applications for such inventions.

The commercial success of the Company will depend in part on not infringing
patents or proprietary rights of others. There can be no assurance that the
Company will be able to obtain a license to any third-party technology it may
require to conduct its business or that if obtainable, such technology can be
licensed at reasonable cost. Failure by the Company to obtain a license to
technology that it may require to utilize its technologies or commercialize its
products may have a material adverse effect on the Company. In some cases,
litigation or other proceedings may be necessary to defend against or assert
claims of infringement, to enforce patents issued to the Company, to protect
trade secrets, know-how or other intellectual property rights owned by the
Company, or to determine the scope and validity of the proprietary rights of
third parties. Any potential litigation could result in substantial costs to and
diversion of resources by the Company and could have a material adverse impact
on the Company. There can be no assurance that any of the Company's issued or
licensed patents would ultimately be held valid or that efforts to defend any of
its patents, trade secrets, know-how or other intellectual property rights would
be successful. An adverse outcome in any such litigation or proceeding could
subject the Company to significant liabilities, require the Company to cease
using the subject technology or require the Company to license the subject
technology from the third party, all of which could have a material adverse
effect on the Company's business.

In addition to patent protection, the Company relies upon trade secrets,
proprietary know-how and continuing technological advances to develop and
maintain its competitive position. To maintain the confidentiality of its trade
secrets and proprietary information, the Company requires its employees,
consultants and collaborative partners to execute confidentiality agreements
upon the commencement of their relationships with the Company. In the case of
employees, the agreements also provide that all inventions resulting from work
performed by them while in the employ of the Company will be the exclusive
property of the Company. There can be no assurance, however, that these
agreements will not be breached, that the Company would have adequate remedies
in the event of any such breach or that the Company's trade secrets or
proprietary information will not otherwise become known or developed
independently by others. See "Risk Factors -- Dependence on Proprietary
Technology and Unpredictability of Patent Protection."

COMPETITION

The biotechnology and pharmaceutical industries are intensely competitive.
Many companies, including large, multinational pharmaceutical and biotechnology
companies, are actively engaged in activities similar to those of the Company.
Many of these companies may employ in such activities greater financial and
other resources, including larger research and development staffs and more
extensive marketing and manufacturing organizations, than the Company or its
collaborative partners. There are also academic institutions, governmental
agencies and other research organizations that are conducting research in areas
in which the Company is working. See "Risk Factors -- Highly Competitive
Industry."

The Company also expects to encounter significant competition with respect
to the drugs that it and its collaborative partners plan to develop. Companies
that complete clinical trials, obtain required Regulatory Agency approvals and
commence commercial sale of their drugs before their competitors may achieve a
significant competitive advantage. In order to compete successfully, the
Company's goal is to obtain patent

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protection for its potential products and to make those available selectively to
pharmaceutical companies through collaborative and licensing arrangements. There
can be no assurance, however, that the Company will obtain patents covering its
potential products that protect them against competitors. Moreover, there can be
no assurance that the Company's competitors will not succeed in developing
technologies and drugs that are more effective than those developed by the
Company and its collaborative partners or that would render technology or drugs
of the Company and its collaborators less competitive or obsolete. See
"-- Patents, Proprietary Technology and Trade Secrets."

GOVERNMENT REGULATION

The development, manufacture and marketing of drugs developed by the
Company or its collaborative partners are subject to regulation by numerous
governmental agencies in the United States and in other countries. The FDA and
comparable Regulatory Agencies in other countries impose mandatory procedures
and standards for the conduct of certain preclinical testing and clinical trials
and the production and marketing of drugs for human therapeutic use. Product
development and approval of a new drug are likely to take a number of years and
involve the expenditure of substantial resources. See "Risk Factors -- Stringent
Government Regulation and Need For Product Approvals."

The steps required by the FDA before new drugs may be marketed in the
United States include: (i) preclinical studies; (ii) the submission to the FDA
of a request for authorization to conduct clinical trials on an investigational
new drug (an "IND"); (iii) adequate and well-controlled clinical trials to
establish the safety and efficacy of the drug for its intended use; (iv)
submission to the FDA of a new drug application (an "NDA"); and (v) review and
approval of the NDA by the FDA before the drug may be shipped or sold
commercially.

In the United States, preclinical testing includes both in vitro and in
vivo laboratory evaluation and characterization of the safety and efficacy of a
drug and its formulation. Laboratories involved in preclinical testing must
comply with FDA regulations regarding Good Laboratory Practices. Preclinical
testing results are submitted to the FDA as part of the IND and are reviewed by
the FDA prior to the commencement of human clinical trials. Unless the FDA
objects to an IND, the IND becomes effective 30 days following its receipt by
the FDA. There can be no assurance that submission of an IND will result in the
commencement of human clinical trials.

Clinical trials, which involve the administration of the investigational
drug to healthy volunteers or to patients under the supervision of a qualified
principal investigator, are typically conducted in three sequential phases,
although the phases may overlap with one another. Clinical trials must be
conducted in accordance with the FDA's Good Clinical Practices under protocols
that detail the objectives of the study, the parameters to be used to monitor
safety and the efficacy criteria to be evaluated. Each protocol must be
submitted to the FDA as part of the IND. Further, each clinical study must be
conducted under the auspices of an independent Institutional Review Board (the
"IRB") at the institution where the study will be conducted. The IRB will
consider, among other things, ethical factors, the safety of human subjects and
the possible liability of the institution. Compounds must be formulated
according to the FDA's Good Manufacturing Practices ("GMP").

Phase I clinical trials represent the initial administration of the
investigational drug to a small group of healthy human subjects or, more rarely,
to a group of selected patients with the targeted disease or disorder. The goal
of Phase I clinical trials is typically to test for safety (adverse effects),
dose tolerance, absorption, biodistribution, metabolism, excretion and clinical
pharmacology and, if possible, to gain early evidence regarding efficacy.

Phase II clinical trials involve a small sample of the actual intended
patient population and seek to assess the efficacy of the drug for specific
targeted indications, to determine dose tolerance and the optimal dose range and
to gather additional information relating to safety and potential adverse
effects.

Once an investigational drug is found to have some efficacy and an
acceptable safety profile in the targeted patient population, Phase III clinical
trials are initiated to establish further clinical safety and efficacy of the
investigational drug in a broader sample of the general patient population at
geographically dispersed study sites in order to determine the overall
risk-benefit ratio of the drug and to provide an adequate basis for

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all physician labeling. The results of the research and product development,
manufacturing, preclinical testing, clinical trials and related information are
submitted to the FDA in the form of an NDA for approval of the marketing and
shipment of the drug.

Timetables for the various phases of clinical trials and NDA approval
cannot be predicted with any certainty. The Company, its collaborative partners
or the FDA may suspend clinical trials at any time if it is believed that
individuals participating in such trials are being exposed to unacceptable
health risks. Even assuming that clinical trials are completed and that an NDA
is submitted to the FDA, there can be no assurance that the NDA will be reviewed
by the FDA in a timely manner or that once reviewed, the NDA will be approved.
The approval process is affected by a number of factors, including the severity
of the targeted indications, the availability of alternative treatments and the
risks and benefits demonstrated in clinical trials. The FDA may deny an NDA if
applicable regulatory criteria are not satisfied, or may require additional
testing or information with respect to the investigational drug. Even if initial
FDA approval is obtained, further studies, including post-market studies, may be
required in order to provide additional data on safety and will be required in
order to gain approval for the use of a product as a treatment for clinical
indications other than those for which the product was initially tested. The FDA
will also require post-market reporting and may require surveillance programs to
monitor the side effects of the drug. Results of post-marketing programs may
limit or expand the further marketing of the drug. Further, if there are any
modifications to the drug, including changes in indication, manufacturing
process or labeling, an NDA supplement may be required to be submitted to the
FDA.

Each manufacturing establishment for new drugs is also required to receive
some form of approval by the FDA. Among the conditions for such approval is the
requirement that the prospective manufacturer's quality control and
manufacturing procedures conform to GMP, which must be followed at all times. In
complying with standards set forth in these regulations, manufacturers must
continue to expend time, monies and effort in the area of production and quality
control to ensure full technical compliance. Manufacturing establishments, both
foreign and domestic, are also subject to inspections by or under the authority
of the FDA and may be subject to inspections by foreign and other federal, state
or local agencies.

There can be no assurance that the regulatory framework described above
will not change or that additional regulations will not arise that may affect
approval of or delay an IND or an NDA. Moreover, because the Company's present
collaborative partners are, and it is expected that the Company's future
collaborative partners may be, primarily responsible for preclinical testing,
clinical trials, regulatory approvals, manufacturing and commercialization of
drugs, the ability to obtain and the timing of regulatory approvals are not
within the control of the Company.

Prior to the commencement of marketing a product in other countries,
approval by the Regulatory Agencies in such countries is required, whether or
not FDA approval has been obtained for such product. The requirements governing
the conduct of clinical trials and product approvals vary widely from country to
country, and the time required for approval may be longer or shorter than the
time required for FDA approval. Although there are some procedures for unified
filings for certain European countries, in general, each country has its own
procedures and requirements.

The Company is also subject to regulation under other federal laws and
regulation under state and local laws, including laws relating to occupational
safety, laboratory practices, the use, handling and disposition of radioactive
materials, environmental protection and hazardous substance control. Although
the Company believes that its safety procedures for handling and disposing of
radioactive compounds and other hazardous materials used in its research and
development activities comply with the standards prescribed by federal, state
and local regulations, the risk of accidental contamination or injury from these
materials cannot be completely eliminated. In the event of any such accident,
the Company could be held liable for any damages that result and any such
liability could exceed the resources of the Company.

SCIENTIFIC CONSULTANTS

The Company has consulting arrangements with a number of leading academic
scientists and clinicians who serve as members of its scientific advisory board
("SAB") or as consultants to the SAB and management. Many of these individuals
are experts in the fields of bacterial pathogenesis, cellular biochemis-

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try, bacterial genetics and genomics, medicinal chemistry, host-pathogen
signaling and clinical infectious disease. The consultants bring unique insight
into product selection, access to leading academic research in molecular biology
and microbial pathogenesis, and significant experience in clinical trial design
and patient care.

Scientific advisory board members attend periodic SAB meetings as well as
certain project meetings on an ad hoc basis and are frequently contacted by the
Company's scientific staff and management for advice. Members of the SAB
generally provide approximately 10 days of consulting services per year. Members
of the SAB are paid fixed fees on a quarterly basis and per diem fees and travel
expenses for their attendance at SAB meetings. Other scientific consultants are
paid fixed fees for their services on a monthly or quarterly basis.

Many of the Company's consultants, including several of those identified
below, have purchased shares of Common Stock and have written contracts with the
Company pursuant to which they are required to provide to the Company a minimum
number of days per year of consulting services, typically 8 - 10 days. In 1995,
the Company paid its consultants approximately $300,000 in the aggregate. In
1994, such payments aggregated approximately $260,000.

None of the consultants is an employee of the Company. Most of the
consultants have other commitments to, or consulting or advisory contracts with,
their employers and other institutions.

The Company's consultants include the following individuals:

Sydney Brenner, Ph.D., is Honorary Professor of Genetic Medicine in the
Department of Medicine at the University of Cambridge Clinical School. He is
known for his research in molecular genetics and particularly for his work on
the genetic code and on the transfer of information from DNA to proteins. In the
1960's, he was one of the pioneers in the area of the molecular biology of
multicellular organisms, establishing the nematode worm, Caenorhabditis elegans,
as a model for the genetic and cellular basis of development and behavior. Dr.
Brenner was formerly Director of the Laboratory of Molecular Biology in
Cambridge, and a member of the Scripps Research Institute in La Jolla,
California.

Henry Chambers, M.D., is Chief of the Division of Infectious Disease and
Director of the Microbial Pathogenesis Unit at University of California, San
Francisco Hospital and San Francisco General Hospital. He is also an Associate
Professor of Medicine at University of California, San Francisco. Dr. Chambers
is an expert in clinical infectious diseases, serving as Co-Chairman of San
Francisco General Hospital's Infection Control Committee and Chairman of the
Antibiotic Advisory Committee of Pharmacy and Therapeutics. Dr. Chambers has
published widely, and is a member of the editorial board of Antimicrobial Agents
and Chemotherapy.

Burton G. Christensen, Ph.D., was formerly Senior Vice President,
Chemistry, of the Merck Research Laboratories. Dr. Christensen holds over 180
issued United States patents. Dr. Christensen received the Thomas Alva Edison
Patent Award for his discovery of cefoxitin (Mefoxin), and was an inventor of
imipenem (Primaxin). He is a recipient of the Chemical Pioneer Award by the
American Institute of Chemistry for his development of novel synthetic
methodology in beta-lactam chemistry, and led programs at Merck responsible for
the discovery of ivermectin (Ivomec), an animal health product, PedVaxHIB, a
conjugate vaccine for the prevention of H. influenza, and finasteride (Proscar),
for the treatment of benign prostatic hypertrophy.

Patrice Courvalin, M.D., is a Professor at the Pasteur Institute, where he
directs the French National Reference Center for Antibiotics and is the head of
the Antibacterial Agents Unit. He is an internationally recognized expert in the
genetics and biochemistry of antibiotic resistance. His work has defined the
molecular mechanisms of the evolution, dissemination and function of antibiotic
resistance genes, which has led to a revision of the dogma on natural
dissemination of antibiotic resistance. Dr. Courvalin has received numerous
awards and honors including the Jacques Monod Award of the Foundation de France,
the Louis Garrod award of the British Society for Antimicrobial Chemotherapy and
the Hamao Umezawa award of the International Society for Chemotherapy for his
work on antibiotic resistance.

Julian Davies, Ph.D., F.R.S., is Professor and the Head of the Department
of Microbiology and Immunology and Director of the West-East Center at the
University of British Columbia. He has been actively engaged in studies of
antibiotic mode-of-action and resistance mechanisms for more than 25 years. He
received the Hoechst-Roussel Prize for studies of antimicrobial agents and
numerous other awards for his

36
<PAGE> 37

work in this field. He was the first to identify the mechanism-of-action and
resistance of the aminoglycosides. Dr. Davies was formerly Head of the Microbial
Engineering Unit at the Pasteur Institute in Paris, and President and Research
Director of Biogen.

Stanley Falkow, Ph.D., is Professor of Microbiology and Immunology and
Medicine at Stanford University School of Medicine. Dr. Falkow is recognized
internationally for his research related to the molecular mechanisms of
bacterial pathogenesis. Dr. Falkow has been elected to the National Academy of
Sciences and to the American Academy of Arts and Sciences. He is a recipient of
the Squibb Award (Infectious Diseases Society of America), the Becton Dickinson
Award (American Society for Microbiology), and the Paul Ehrlich-Ludwig
Darmstaedter Prize. He has served on the editorial boards of Infection and
Immunology, Molecular Microbiology, the Journal of Infectious Diseases and the
Journal of Bacteriology. Dr. Falkow formerly held faculty appointments at
University of Washington, Georgetown University and Walter Reed Army Institute
of Research.

Robert Moellering, Jr., M.D., is the Shields Warren-Mallinckrodt Professor
of Medical Research at Harvard University Medical School and Physician-in-Chief
at the New England Deaconess Hospital, where he serves as Chairman of the
Department of Medicine. Dr. Moellering is an internationally recognized expert
in clinical infectious diseases and in research on the mechanism of action and
resistance to antimicrobial agents. Dr. Moellering is the recipient of the
Garrod Medal from the British Society for Antimicrobial Chemotherapy, the
Hoechst-Roussel Award from the American Academy of Microbiology and the Feldman
Award from the Infectious Diseases Society of America for which he is a past
President. He is Editor-in-Chief Emeritus of Antimicrobial Agents and
Chemotherapy, Editor of Infectious Disease Clinics of North America and Editor
of the European Journal of Clinical Microbiology and Infectious Diseases.

Hiroshi Nikaido, M.D., Ph.D., is Professor of Biochemistry and Molecular
Biology at University of California, Berkeley. Dr. Nikaido is internationally
recognized for his pioneering work on the structure, function and biosynthesis
of macromolecules that comprise the surface of the bacterial cell. His studies
have dealt mainly with the outer membrane of Gram-negative bacteria; studies of
channel-forming proteins ("porins"); studies of numerous specific transport
channels; and the unusual barrier properties of the lipid bilayer in the
membrane conferred by the presence of lipopolysaccharides. Dr. Nikaido was
awarded the Paul Ehrlich Prize of West Germany for his work on the biosynthesis
of lipopolysaccharides and the Hoechst-Roussel Award of the American Society for
Microbiology for his work on the role of the outer membrane in antibiotic
resistance.

Staffan Normark, M.D., Ph.D., is Professor of Bacteriology at Karolinska
Institute and Head of the Bacteriology Unit at the Swedish Institute for
Infectious Disease Control. Dr. Normark is internationally known for his work on
the molecular mechanisms of microbial attachment to host cells and antibiotic
resistance. He is a member of the Swedish Royal Academy of Sciences, the Nobel
Assembly and the Nobel Committee for Medicine or Physiology. Dr. Normark has
received the Femstrom's Award to Young Scientists (for studies on gene
amplification), the Svedberg's Award in Biochemistry (for studies on bacterial
adhesions), the Axel Hirsch's Award in Bacteriology and the Domagk Award (for
studies on beta-lactams and beta-lactamases), the Goran Gustavsson Award in
Medicine and Jean-Pierre Lecoqc Award in Molecular Medicine. He is a member of
the editorial boards of Molecular Microbiology and Science.

David Relman, M.D., is Assistant Professor of Medicine (Infectious Diseases
and Geographic Medicine) and of Microbiology and Immunology at Stanford
University School of Medicine, and is a staff physician at the Palo Alto
Department of Veterans Affairs Medical Center. Dr. Relman's expertise is in the
molecular mechanisms of bacterial pathogenesis. He discovered two previously
uncharacterized, uncultivated bacterial pathogens, agents of bacillary
angiomatosis and Whipple's disease. Dr. Relman is a recipient of a Biomedical
Scholar Award from the Lucille P. Markey Charitable Trust and the Baxter
Diagnostics MicroScan Young Investigator Award from the American Society for
Microbiology.

Merle Sande, M.D., is Chief of Medical Services at San Francisco General
Hospital, and Professor and Vice Chairman of Medicine at University of
California, San Francisco. Dr. Sande is recognized internationally as a clinical
infectious disease expert, is actively involved in the medical community and has
served on a variety of AIDS and infectious disease advisory boards at the state
and national level. He serves on several editorial boards including AIDS,
Antimicrobial Agents and Chemotherapy, Infectious Diseases in Clinical

37
<PAGE> 38

Practice, Journal of Acquired Immune Deficiency Syndromes and Journal of
Infectious Diseases. He is editor of the premier AIDS textbook and co-editor of
the Sanford Guide to Antimicrobial Therapy. He holds numerous professional
society memberships and honors including the American Association for the
Advancement of Science.

Robert M. Williams, Ph.D., is Professor of Chemistry at Colorado State
University. Dr. Williams is an expert in organic and biological chemistry. He
developed a general method for synthesis of non-proteinogenic amino acids widely
used by industry. He has designed and synthesized numerous antibiotics and
anti-tumor agents, and has advanced synthetic chemistry to probe and discover
molecular mechanisms of small molecule drug interactions with biomacromolecular
targets. Dr. Williams serves on the Editorial Advisory Board of Chemistry and
Biology and is Editor-in-Chief of Amino Acids. His honors and awards include an
Eli Lilly Young Investigator award, a Merck Academic Development Award and an
NIH Research Career Development Award.

EMPLOYEES

As of March 31, 1996, the Company had 68 full-time employees, 27 of whom
hold Ph.D. degrees. Of the Company's full-time employees, approximately 57 are
engaged directly in scientific research and 11 are engaged in general and
administrative functions. The Company believes that its future success will
depend, in part, on its continuing ability to attract, retain and motivate
qualified scientific, technical and managerial personnel. The Company faces
intense competition in this regard from other companies, research and academic
institutions, government entities and other organizations. None of the Company's
employees is represented by a collective bargaining agreement, nor has the
Company experienced work stoppages. The Company considers its relations with
employees to be good.

FACILITIES

The Company's principal facility consists of approximately 35,500 square
feet of leased laboratory and office space in Mountain View, California under a
lease agreement with an initial term expiring on September 30, 2000. The Company
intends to exercise its option to extend the term of this lease for five
additional years. From the Company's inception through March 31, 1996, the
Company has made capital expenditures aggregating approximately $3.7 million in
constructing and equipping its Mountain View facility. The Company believes that
its facilities are sufficient to accommodate the anticipated research and
administrative needs of the Company through the end of 1996. Thereafter, the
Company believes that it will be able to secure adequate additional facilities
for its continued operations.

LEGAL PROCEEDINGS

The Company is not a party to any legal proceedings.

38
<PAGE> 39

MANAGEMENT

EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES

The executive officers, directors and key employees of the Company are as
follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- ----------------------------------------------
<S> <C> <C>
James E. Rurka..................... 50 President, Chief Executive Officer and
Director
Keith A. Bostian, Ph.D. ........... 44 Chief Operating Officer and Director
Joseph S. Lacob(1)................. 40 Chairman of the Board of Directors
Hugh Y. Rienhoff, Jr., M.D.(1)..... 44 Director
Jon S. Saxe(1)..................... 59 Director
David Schnell, M.D.(2)............. 35 Director
L. James Strand, M.D.(2)........... 54 Director
John P. Walker(2).................. 47 Director
Matthew J. Hogan................... 36 Chief Financial Officer
Ving J. Lee, Ph.D. ................ 45 Vice President, Medicinal Chemistry and
Preclinical Evaluation
James G. Christenson, Ph.D. ....... 53 Executive Director, Project Management
Molly B. Schmid, Ph.D. ............ 42 Director, Discovery Biology
Scott J. Hecker, Ph.D. ............ 37 Associate Director, Chemistry
May D. Lee, Ph.D. ................. 46 Associate Director, Molecular Diversity
Suzanne Chamberland, Ph.D. ........ 35 Assistant Director, In Vitro Pharmacology
</TABLE>

- ---------------
(1) Member of Audit Committee.

(2) Member of Compensation Committee.

James E. Rurka, President, Chief Executive Officer and a Director, joined
the Company in February 1994. From August 1983 to December 1993 he was with
Cetus Corporation and Chiron Corporation where he was most recently President of
the Cetus Oncology Division. Prior to joining Cetus Corporation, Mr. Rurka
held several group marketing and product management positions at Bristol
Laboratories and Schering Laboratories. Mr. Rurka holds a B.A. in English with a
minor in Business from Seton Hall University, and he attended Seton Hall
University Graduate School of Business.

Keith A. Bostian, Ph.D., Chief Operating Officer and a Director, is a
Founder of the Company. Dr. Bostian joined the Company in December 1992. From
June 1987 through December 1992 he was employed at Merck Research Laboratories,
where he was Executive Director of Microbiology and Molecular Genetics. Dr.
Bostian was an Assistant and Adjunct Associate Professor of Biology in the
Division of Biology at Brown University from 1982 to 1990 and was elected to the
American Academy of Microbiology in 1993. Dr. Bostian received a B.A. in Biology
and Chemistry from Augustana College and a Ph.D. in Biochemistry from Queen Mary
College, University of London.

Joseph S. Lacob, Chairman of the Board, has served as a Director of the
Company since December 1992. Mr. Lacob, a Partner with Kleiner Perkins Caufield
& Byers since May 1987, has participated in investments of 33 new life science
companies. He is Chairman of the Board of CellPro, Inc. and he is a Director of
Pharmacyclics, Inc., Heartport and Axion, Inc. and several other life science
companies. Mr. Lacob has served as General Manager for FHP International, a
management consultant with Booz, Allen & Hamilton and a Marketing Manager at
Cetus Corporation. Mr. Lacob received a B.S. in Biochemistry from University of
California, Irvine, an M.P.H. from University of California, Los Angeles and an
M.B.A. from Stanford University Graduate School of Business.

Hugh Y. Rienhoff, Jr., M.D., became a Director of the Company in July 1994.
Dr. Rienhoff is a Partner at New Enterprise Associates, where his focus is on
biopharmaceuticals and health information technology. Prior to joining New
Enterprise Associates in July 1992, Dr. Rienhoff was a member of the faculty in
the Department of Molecular Biology and Genetics at The Johns Hopkins University
School of Medicine from

39
<PAGE> 40

July 1989 through June 1992. Dr. Rienhoff trained in internal medicine and human
genetics at The Johns Hopkins Hospital, and received a B.A. in English and
Biology at Williams College and an M.D. from The Johns Hopkins University.

Jon S. Saxe became a Director of the Company in October 1993. Mr. Saxe
performed consulting services for the Company from August 1993 to July 1995. Mr.
Saxe serves as a Director on several corporate boards, including Protein Design
Labs, Inc., Insite Vision, Inc., ID Biomedical Inc. and InCyte Pharmaceuticals,
Inc. Mr. Saxe has served as President of Protein Design Labs, Inc. since January
1995. He was President of Saxe Associates in Boulder, Colorado from April 1993
to January 1995, and was President of Synergen, Inc. from October 1989 to April
1993. He has over 25 years of experience with Hoffmann-LaRoche Inc. primarily in
the areas of patent law, licensing and corporate development. Mr. Saxe received
a B.S. in Chemical Engineering from Carnegie-Mellon University, a J.D. from
George Washington University School of Law and an LL.M. from New York University
School of Law.

David Schnell, M.D., has served as a Director of the Company since December
1992 and is a Founder of the Company. He has been a partner at Kleiner Perkins
Caufield & Byers since January 1994 where he leads the firm's investments in
health care services and information systems. From August 1987 to December 1993,
he was a marketing and business development executive at Sandoz Pharmaceuticals
Corporation. From January 1992 to December 1993, he managed Sandoz' venture
capital activities and with Avalon Medical Partners founded the Company. Dr.
Schnell is the founding President of HealthScape and serves on the Board of
Directors of Neurocrine Biosciences and several other privately-held companies.
Dr. Schnell received a B.S. in Biological Sciences and an A.M. in Health
Services Research from Stanford University and an M.D. from Harvard University.

L. James Strand, M.D., became a Director of the Company in January 1993.
Dr. Strand joined Institutional Venture Partners as a Consultant in 1987, was
named a Venture Partner of Institutional Venture Partners in 1993 and a General
Partner of Institutional Venture Management VI in 1994. Prior to joining IVP
full time, Dr. Strand was President of Advanced Marketing Decisions, a
biomedical marketing and product development consulting company. Previously, he
was Vice President of Medical Affairs and Director of Marketing Planning at
Syntex Laboratories, Medical Director and Chairman of the Product Assessment
Committee at Alza and CEO and Director of both DDI Pharmaceuticals and
Laserscope. He is currently a Director of Accordant Health Services, Aviron and
Prograft. He was Assistant Professor of Medicine at University of Texas
Southwestern Medical School in Dallas. Dr. Strand holds a B.S., M.A. and M.D.
from University of California, San Francisco and an M.B.A. from Santa Clara
University.

John P. Walker became a Director of the Company in December 1995. He has
been President, Chief Executive Officer and a Director of Arris Pharmaceutical
Corporation since February 1993. From September 1991 to January 1993 he was a
General Partner of Alpha Venture Partners. From June 1986 to January 1991, Mr.
Walker was Chairman, President and Chief Executive Officer of Vitaphore
Corporation, a company which was acquired in April 1990 by Union Carbide
Chemicals and Plastics Company Inc. Following that acquisition, Mr. Walker
served as the latter company's Vice President, BioMaterials Systems from January
1991 to September 1991. From 1971 to 1985, Mr. Walker was employed by American
Hospital Supply Corporation in a variety of general management, sales, and
marketing positions, most recently serving as President of the American Hospital
Company. Mr. Walker received a B.A. from State University of New York at Buffalo
and conducted graduate business studies at Northwestern University Institute for
Management. He serves as a director of several private companies.

Matthew J. Hogan, Chief Financial Officer, joined the Company in May 1996.
Prior to joining the Company, he held various positions since 1986 in the
investment banking group at Merrill Lynch & Co., most recently as a Director
focusing on the biotechnology and pharmaceutical sectors. Mr. Hogan holds a B.A.
in Economics from Dartmouth College and an M.B.A. from the Amos Tuck School of
Business Administration.

Ving J. Lee, Ph.D., Vice President, Medicinal Chemistry and Preclinical
Evaluation, joined the Company in December 1993. He held various positions at
Lederle Laboratories, Division of American Cyanamid, from September 1977 to
December 1993, most recently Head of the Department of Chemistry for Infectious
Diseases and Molecular Biology Research. He was a recipient of the Cyanamid
Scientific Achievement

40
<PAGE> 41

Award in 1981 for research in Natural Products. Dr. Lee received a B.A. in
Chemistry from Ohio State University, Columbus, and an M.S. in Organic Chemistry
and a Ph.D. in Organic Chemistry from University of Illinois, Champaign-Urbana.

James G. Christenson, Ph.D., Executive Director, Project Management, joined
the Company in August 1995. Prior to joining the Company, Dr. Christenson was an
independent consultant from November 1994 to August 1995. Dr. Christenson held a
series of research positions at Hoffmann-LaRoche from June 1968 to November
1994, most recently as International Project Director. He was instrumental in
the discovery and development of Rocephin(R) (ceftriaxone). Dr. Christenson
received a B.S. in Chemistry from Stanford University, an S.M. in Biology from
Massachusetts Institute of Technology and a Ph.D. in Biochemistry from City
University of New York for research at the Roche Institute of Molecular Biology.

Molly B. Schmid, Ph.D., Director, Discovery Biology, joined the Company in
June 1994. Dr. Schmid served as a consultant to the Company from December 1993
to May 1994 prior to joining the Company. She was an Associate Professor of
Biology at University of Houston from January 1994 to August 1995, where she was
on leave from May 1994 to August 1995. Dr. Schmid was Assistant Professor of
Molecular Biology at Princeton University from April 1986 to January 1994. She
is a recipient of the Searles Scholar's Award from The Chicago Community Trust.
Dr. Schmid earned a B.S. in Biology from State University of New York, Albany
and a Ph.D. in Biology from University of Utah.

Scott J. Hecker, Ph.D., Associate Director, Chemistry, joined the Company
in December 1993. From November 1985 to December 1993 he was employed at Pfizer
Inc. Dr. Hecker received a B.A. in Chemistry from Wesleyan University and a
Ph.D. in Chemistry from University of California, Berkeley.

May D. Lee, Ph.D., Associate Director, Molecular Diversity, joined the
Company in May 1994. Prior to joining the Company, Dr. Lee was with American
Cyanamid Co., Medical Research Division, from September 1977 to March 1994. She
was a recipient of the Cyanamid Scientific Achievement Award in 1986. Dr. Lee
received a B.Sc. in Honors Chemistry from University of British Columbia and an
M.S. and a Ph.D. in Organic Chemistry from University of Illinois,
Champaign-Urbana.

Suzanne Chamberland, Ph.D., Assistant Director, In Vitro Pharmacology,
joined the Company in March 1994. From July 1991 to March 1994, Dr. Chamberland
was Assistant Professor at Universite Laval and a Scholar of the Health Research
Foundation of the Pharmaceutical Manufacturer Association of Canada and the
Medical Research Council of Canada. Dr. Chamberland received a B.S. in
Microbiology at Universite de Sherbrooke (Canada), an M.S. in Microbiology and
Immunology at Universite de Montreal (Canada) and a Ph.D. in Medical Science
(Medical Microbiology) from University of Calgary (Canada).

The Restated Certificate provides for a Board of Directors that is divided
into three classes. The directors in Class I hold office until the first annual
meeting of stockholders following this Offering, the directors in Class II hold
office until the second annual meeting of stockholders following this Offering,
and the directors in Class III hold office until the third annual meeting of
stockholders following this Offering (or, in each case, until their successors
are duly elected and qualified or their earlier resignation, removal from office
or death), and, after each such election, the directors in each such case will
then serve in succeeding terms of three years and until their successors are
duly elected and qualified. Officers of the Company serve at the discretion of
the Board of Directors. There are no family relationships among the Company's
directors and executive officers. However, Ving J. Lee, Ph.D. and May D. Lee,
Ph.D., key employees of the Company, are husband and wife.

The Board of Directors currently has an Audit Committee and a Compensation
Committee. The Audit Committee oversees the actions taken by the Company's
independent auditors and reviews the Company's internal financial and accounting
controls and policies. The Compensation Committee is responsible for determining
salaries, incentives and other forms of compensation for officers and other
employees of the Company and administers various incentive compensation and
benefit plans.

DIRECTOR COMPENSATION

Except as described below, members of the Company's Board of Directors do
not receive compensation for their services as directors.

41
<PAGE> 42

Non-employee directors are entitled to participate in the 1996 Director
Option Plan (the "Director Plan"). The Director Plan was adopted by the Board of
Directors in March 1996, and will be submitted to the shareholders for approval
at the Company's 1996 annual stockholders meeting. The Director Plan has a term
of ten years, unless terminated sooner by the Board of Directors. A total of
80,000 shares of Common Stock have been reserved for issuance under the Director
Plan.

The Director Plan provides for the automatic grant of an option (the "First
Option") to purchase 12,000 shares of Common Stock to each non-employee director
who first becomes a non-employee director after the effective date of the
Director Plan, provided that such director was not an employee director of the
Company immediately prior to becoming a non-employee director. Each non-employee
director, whether or not eligible to receive a First Option, shall automatically
be granted an option to purchase 4,000 shares of Common Stock (a "Subsequent
Option") each year on the date of the Company's annual stockholders meeting, if
on such date he or she has served on the Board for at least six months. First
Options and Subsequent Options have terms of ten years. First Options vest and
become exercisable as to 1/6th of the shares subject to the option six months
after the date of grant, and as to 1/36th of the shares each month thereafter.
Subsequent Options vest as to 1/12th of the shares subject to the option each
month after the date of grant. The exercise prices of First Options and
Subsequent Options are 100% of the fair market value per share of the Common
Stock, generally determined with reference to the closing price of the Common
Stock as reported on the Nasdaq National Market on the date of grant.

In the event of a merger of the Company or the sale of substantially all of
the assets of the Company, each option granted under the Director Plan may be
assumed or an equivalent option substituted by the successor corporation. If an
option is assumed or substituted, it will continue to vest as provided in the
Director Plan. However, if a non-employee director's status as a director of the
Company or the successor corporation, as applicable, is terminated other than
upon a voluntary resignation by the non-employee director, each option granted
to such non-employee director will become fully vested and exercisable. If the
successor corporation does not agree to assume or substitute the option, each
option will also become fully vested and exercisable for a period of 30 days
from the date the Board of Directors notifies the optionee of the option's full
exercisability, after which period the option will terminate. Options granted
under the Director Plan must be exercised within three months of the end of the
optionee's tenure as a director of the Company, or within twelve months after
such director's termination by death or disability, but in no event later than
the expiration of the option's ten-year term. No option granted under the
Director Plan is transferable by the optionee other than by will or the laws of
descent and distribution, and each option is exercisable, during the lifetime of
the optionee, only by such optionee.

The administration and other terms of the Director Plan have been
structured so that options granted to any non-employee directors who administer
the Company's stock plans will qualify as transactions exempt from Section 16(b)
of the Exchange Act, pursuant to Rule 16b-3 promulgated thereunder.

Pursuant to a letter agreement dated August 2, 1993, as revised and
superseded by letter agreements dated August 30, 1993 and September 20, 1993,
Director Jon S. Saxe has received options to purchase 20,000 shares of Common
Stock at an exercise price of $0.25 per share which vest over a four-year period
at a rate of 1/48th of the total number of shares subject to the option for each
month Mr. Saxe serves as a Director of the Company.

Pursuant to a stock purchase agreement dated January 29, 1996, Director
John Walker purchased 20,000 shares of Common Stock at a price of $0.375 per
share, subject to a repurchase option by the Company with 1/48th of the total
number of shares being released from the Company's repurchase option for each
month Mr. Walker serves as a Director of the Company.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Compensation Committee of the Board of Directors is responsible for
determining salaries, incentives and other forms of compensation for officers
and other employees of the Company and administers various incentive
compensation and benefit plans. The Compensation Committee consists of Directors
Schnell, Strand and Walker. Mr. Rurka, President and Chief Executive Officer of
the Company, participates in all discussions and decisions regarding salaries
and incentive compensation for all employees and

42
<PAGE> 43

consultants of the Company, except that Mr. Rurka is excluded from discussions
regarding his own salary and incentive compensation.

EXECUTIVE COMPENSATION

The following table sets forth total compensation for the year ended
December 31, 1995 for the Chief Executive Officer and each of the other
executive officers of the Company whose total salary and bonus for such fiscal
year exceeded $100,000 (the "Named Executive Officers"):

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
1995 COMPENSATION ------------
-------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($) OPTIONS(#) COMPENSATION($)
- ---------------------------------- --------- -------- --------------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
James E. Rurka.................... $ 254,166 $50,000 $35,721(1) 60,000(2) --
President and Chief
Executive Officer
Keith A. Bostian, Ph.D. .......... 244,391 50,000 70,433(3) -- --
Chief Operating Officer
</TABLE>

- ---------------
(1) Represents the portion of a forgivable loan for moving, housing and other
expenses incurred by Mr. Rurka in connection with relocating to the
Company's geographic region attributed to 1995 compensation.

(2) Pursuant to the Company's 1993 Amended Incentive Stock Plan, an option to
purchase 60,000 shares of Common Stock at a price of $0.375 per share was
granted to Mr. Rurka in December 1995. At December 31, 1995, such option was
vested with respect to 27,500 shares of Common Stock. Such option vested at
the rate of 1/4th of the shares on the first anniversary of Mr. Rurka's date
of hire and vests at the rate of an additional 1/48th of the shares each
month thereafter. As of December 31, 1995, Mr. Rurka held 75,833 shares of
Common Stock which were subject to repurchase rights by the Company having a
value of $1,061,662 based upon the initial public offering price of $14 per
share.

(3) Represents reimbursement for taxes incurred by Dr. Bostian as a result of
the payment by the Company in 1994 of $100,908 of moving, housing and other
expenses incurred by Dr. Bostian in connection with relocating to the
Company's geographic region.

OPTION GRANTS IN LAST FISCAL YEAR

The following table provides information concerning each grant of options
to purchase Common Stock made during the year ended December 31, 1995 to the
Named Executive Officers:

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE MINUS
INDIVIDUAL GRANTS EXERCISE PRICE AT
------------------------------------------------- ASSUMED ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK PRICE
SECURITIES OPTIONS EXERCISE APPRECIATION
UNDERLYING GRANTED TO PRICE FOR OPTION TERM(1)
OPTIONS EMPLOYEES IN PER SHARE EXPIRATION -----------------------
NAME GRANTED FISCAL YEAR (2)(3) DATE 5%($) 10%($)
- ---------------------------- --------- ------------ --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
James E. Rurka.............. 60,000 41% $ 0.375 12/07/2005 $1,345,771 $2,156,244
</TABLE>

- ---------------
(1) Potential realizable value is based on the assumption that the Common Stock
appreciates at the annual rate shown (compounded annually) from the date of
grant until the expiration of the ten-year option term and the initial
public offering price of $14 per share. These numbers are calculated based
on the requirements promulgated by the Securities and Exchange Commission
and do not reflect the Company's estimate of future stock price growth.

(2) The option granted to Mr. Rurka in 1995 became exercisable as to 1/4th on
the first anniversary of Mr. Rurka's date of hire and becomes exercisable as
to an additional 1/48th each month thereafter with full vesting occurring on
the fourth anniversary of the date of hire. Under the 1993 Amended Incentive
Stock Plan, the Board of Directors retains the discretion to reduce the
exercise price of outstanding options in certain limited circumstances.

(3) Options were granted at an exercise price equal to the fair market value of
the Common Stock, as determined by the Board of Directors on the date of
grant.

43
<PAGE> 44

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES

The following table sets forth certain information regarding stock options
held as of December 31, 1995 by the Named Executive Officers. No options were
exercised by such individuals in 1995.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 1995 (#) DECEMBER 31, 1995 ($)(1)
----------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
James E. Rurka............................. 27,500 32,500 $ 374,688 $ 442,813
Keith A. Bostian, Ph.D..................... 4,375 5,625 59,609 76,641
</TABLE>

- ---------------
(1) Based upon the initial public offering price of $14 per share minus the
exercise price.

EMPLOYEE BENEFIT PLANS

1993 AMENDED INCENTIVE STOCK PLAN

The Company's 1993 Amended Incentive Stock Plan (the "Option Plan") was
adopted by the Board of Directors in April 1993 and approved by the shareholders
in April 1994. A total of 1,380,000 shares of Common Stock has been reserved for
issuance under the Option Plan. The Option Plan provides for grants of incentive
stock options within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended (the "Code") to employees (including officers and employee
directors), and nonstatutory stock options and stock purchase rights ("SPRs") to
employees (including officers and employee directors) and consultants.
Non-employee directors are not eligible to participate in the Option Plan. The
Option Plan may be administered by the Board of Directors or by a committee of
the Board (the "Committee"), which Committee must be constituted to comply with
Rule 16b-3 under the Exchange Act, and applicable laws. The Board of Directors
or the Committee (the "Administrator") determines the grantees and the terms of
options and SPRs to be granted, including the exercise price, number of shares
subject to the option or SPR, and the exercisability thereof.

The terms of options granted under the Option Plan generally may not exceed
10 years. The exercise price of such options granted is determined by the
Administrator, but, in the case of incentive stock options, cannot be less than
100% of the fair market value of the Common Stock on the date of grant. Options
granted under the Option Plan to new employees and consultants generally have
not been immediately exercisable but have vested at the rate of 25% of the
shares subject to option on the first anniversary of the date of hire and 1/48th
of such shares at the end of each calendar month thereafter. Subsequent grants
generally vest as to 1/48th of the option shares at the end of each month after
the date of grant. Shares that may be purchased upon exercise of SPRs generally
vests according to similar schedules. No option or SPR may be transferred by the
grantee other than by will or the laws of descent or distribution. An optionee
whose relationship with the Company or any related corporation ceases for any
reason (other than by death or permanent and total disability) may exercise
options in the 30-day period following such cessation (unless such options
terminate or expire sooner by their terms) or in such longer period determined
by the Administrator. Unvested shares purchased upon exercise of an SPR by a
purchaser whose relationship with the Company ceases generally must be resold to
the Company at the original purchase price.

Shares subject to options and SPRs granted under the Option Plan which have
lapsed or terminated may again be subject to options and SPRs granted under the
Option Plan. Furthermore, the Board of Directors may offer to exchange new
options for existing options, with the shares subject to the existing options
again becoming available for grant under the Option Plan. Upon any merger or
consolidation in which the Company is not the surviving corporation, or upon a
sale of substantially all of the Company's assets, all outstanding options and
SPRs may either be assumed or substituted for by the surviving entity.

As of March 31, 1996, 203,950 shares of Common Stock had been issued upon
the exercise of options or SPRs granted under the Option Plan, options to
purchase 690,600 shares of Common Stock at a weighted

44
<PAGE> 45

average exercise price of $0.965 per share were outstanding and 485,450 shares
remained available for future grants of options and SPRs. The Option Plan
terminates in April 2003, unless terminated sooner by the Board of Directors.

1996 EMPLOYEE STOCK PURCHASE PLAN

The Company's 1996 Employee Stock Purchase Plan (the "1996 Purchase Plan")
was adopted by the Board of Directors in March 1996 and will be submitted to the
shareholders for approval at the Company's 1996 annual shareholders meeting. A
total of 120,000 shares of Common Stock has been reserved for issuance under the
1996 Purchase Plan. The 1996 Purchase Plan, which is intended to qualify under
Section 423 of the Internal Revenue Code, has two six-month offering periods
each year beginning on the first trading day on or after May 1 and November 1,
except for the first offering period, which begins on the effective date of the
Company's initial public offering and ends on the last trading day on or before
October 31, 1996. The 1996 Purchase Plan is administered by the Board of
Directors or by a committee appointed by the Board. Employees are eligible to
participate if they are customarily employed by the Company or any participating
subsidiary for at least 20 hours per week and more than five months in any
calendar year. The 1996 Purchase Plan permits eligible employees to purchase
Common Stock through payroll deductions of up to 10% of an employee's
"compensation," which includes base earnings and commissions but excludes
overtime and other bonuses and incentive compensation, up to a maximum of
$21,250 for all offering periods ending within the same calendar year. The price
of stock purchased under the 1996 Purchase Plan will be 85% of the lower of the
fair market value of the Common Stock at the beginning and at the end of each
offering period. Employees may end their participation in the offering at any
time during an offering period, and upon withdrawal are paid their payroll
deductions to date not yet used to purchase Common Stock. Participation ends
automatically on termination of employment with the Company.

Rights granted under the 1996 Purchase Plan are not transferable by a
participant other than by will, the laws of descent and distribution, or as
otherwise provided under the 1996 Purchase Plan. The 1996 Purchase Plan provides
that, in the event of a merger of the Company with or into another corporation
or a sale of substantially all of the Company's assets, the offering period then
underway is shortened (so that employees' rights to purchase stock under the
1996 Purchase Plan are exercised prior to the merger or sale of assets. The 1996
Purchase Plan terminates in March 2006. The Board of Directors has the authority
to amend or terminate the 1996 Purchase Plan, except that no such action may
adversely affect any outstanding rights to purchase stock under the 1996
Purchase Plan.

401(K) PLAN

The Company adopted a 401(k) savings plan (the "401(k) Plan") effective in
June 1994. Eligible employees who have attained age 18 may participate in the
401(k) Plan. Participants in the 401(k) Plan may defer compensation in an amount
not in excess of 15% of the employee's total annual compensation from the
Company, up to the annual statutory limit ($9,500 in 1996). The Company may make
matching contributions in an amount determined annually by the Board of
Directors. All contributions are credited to separate accounts maintained in
trust for each participant and are invested, at the participant's direction, in
one or more of the investment funds made available under the 401(k) Plan.
Matching contributions are subject to 25% annual vesting over a four-year
period. The 401(k) Plan is intended to qualify under Sections 401 and 501 of the
Internal Revenue Code so that contributions to the 401(k) Plan, and income
earned on plan contributions, are not taxable to employees until withdrawn, and
so that the contributions will be deductible by the Company when made.

EMPLOYMENT AGREEMENTS

In February 1994, the Company entered into an employment agreement with
James E. Rurka, President and Chief Executive Officer of the Company, for a
three-year term. Pursuant to such agreement, Mr. Rurka receives an annual base
salary of $260,000. Also pursuant to such agreement, Mr. Rurka received the
right to purchase 140,000 shares of Common Stock at $0.25 per share, on which
shares the Company has a right of repurchase which lapses over a four-year
period subject to Mr. Rurka's continued employment with the

45
<PAGE> 46

Company, and an option to purchase an additional 60,000 shares of Common Stock
based on Mr. Rurka's having met certain bonus objectives. In addition, the
Company provided Mr. Rurka, pursuant to the agreement, a forgivable loan to
cover certain relocation expenses. See "Certain Transactions -- Transactions
with Directors and Executive Officers."

In December 1992, the Company entered into an employment agreement with
Keith A. Bostian, Ph.D., Chief Operating Officer and a Director, for a
three-year term which provides for a minimum annual salary of $150,000 subject
to annual review and increase by mutual agreement, in addition to a guaranteed
annual bonus of $79,000, and the right to purchase 256,000 shares of Common
Stock at a purchase price of $0.005 per share subject to vesting over a
four-year period at the rate of 1/48th of such shares each month based upon
continued employment. The Company subsequently agreed with Dr. Bostian to modify
his compensation to an annual salary of $250,000, with no guaranteed bonus. The
Company's employment agreement with Dr. Bostian was automatically renewed for an
additional term of one year on January 11, 1996 and provides for further
automatic renewal for successive terms of one year each unless either party
gives notice of cancellation 90 days prior to such renewal.

The Company currently has no other compensatory plan or arrangement with
any of the Named Executive Officers where the amounts to be paid exceed $100,000
and which are activated upon resignation, termination or retirement of any such
executive officer upon a change in control of the Company.

LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION

The Restated Certificate limits the liability of directors to the maximum
extent permitted by Delaware law. Delaware law provides that directors of a
corporation will not be personally liable for monetary damages for breach of
their fiduciary duties as directors, except liability for (i) any breach of
their duty of loyalty to the corporation or its stockholders, (ii) acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) unlawful payments of dividends or unlawful stock
repurchases or redemptions, or (iv) any transaction from which the director
derived an improper personal benefit. Such limitation of liability does not
apply to liabilities arising under the federal securities laws and does not
affect the availability of equitable remedies such as injunctive relief or
rescission.

The Bylaws provide that the Company will indemnify its directors and
executive officers and may indemnify its other officers and employees and other
agents to the fullest extent permitted by law. The Company believes that
indemnification under its Bylaws covers at least negligence and gross negligence
on the part of indemnified parties. The Company's Bylaws also permit it to
secure insurance on behalf of any officer, director, employee or other agent for
any liability arising out of his or her actions in such capacity, regardless of
whether the Bylaws permit such indemnification.

The Company has entered into indemnification agreements with its officers
and directors containing provisions which may require the Company, among other
things, to indemnify the officers and directors against certain liabilities that
may arise by reason of their status or service as directors or officers (other
than liabilities arising from willful misconduct of a culpable nature), and to
advance their expenses incurred as a result of any proceeding against them as to
which they could be indemnified. The Company believes that these provisions and
agreements are necessary to attract and retain qualified persons as directors
and executive officers.

At the present time, there is no pending litigation or proceeding involving
a director, officer, employee or other agent of the Company in which
indemnification would be required or permitted. The Company is not aware of any
threatened litigation or proceeding which may result in a claim for such
indemnification.

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<PAGE> 47

CERTAIN TRANSACTIONS

PRIVATE PLACEMENT OF SECURITIES

The price per share and number of shares presented herein give effect to
the 1-for-5 reverse stock split effective April 5, 1996 and assume conversion of
all outstanding Convertible Preferred Stock of the Company into Common Stock,
which will occur automatically upon the completion of the Offering.

In connection with the incorporation of the Company in December 1992,
240,000 shares of Common Stock were sold to Avalon Medical Partners, L.P. for an
aggregate price of $1,200 and 256,000 shares of Common Stock were sold to Keith
A. Bostian, Ph.D. for an aggregate price of $1,280.

Since the Company's inception in December 1992, the Company issued, in
private placement transactions (collectively, the "Private Placement
Transactions"), the following shares of Common Stock and Convertible Preferred
Stock: 496,000 shares of Common Stock at a price of $0.005 per share; 170,200
shares of Common Stock at a price of $0.025 per share; 17,771 shares of Common
Stock at $0.20 per share; 164,470 shares of Common Stock at a price of $0.25 per
share; 27,748 shares of Common Stock at a price of $.375 per share; 1,078,267
shares of Series A Preferred Stock at a price of $1.875 per share; 1,591,000
shares of Series B Preferred Stock at a price of $2.50 per share; 3,066,666
shares of Series C Preferred Stock at a price of $3.75 per share; 573,429 shares
of Series D Preferred Stock at a price of $8.75 per share, and 571,429 shares of
Series E Preferred Stock at a purchase price of $8.75 per share. In connection
with certain equipment leasing agreements, the Company issued warrants to
purchase the following shares of Preferred Stock: 19,467 shares of Series A
Preferred Stock at an exercise price of $1.875 per share; 86,320 shares of
Series B Preferred Stock at an exercise price of $2.50 per share; and 54,400
shares of Series C Preferred Stock at an exercise price of $3.75 per share. See
"Description of Capital Stock -- Warrants."

All of the Convertible Preferred Stock issued in the Private Placement
Transactions will convert into Common Stock on a 1-for-1 basis upon the closing
of the sale of the shares of the Common Stock offered hereby. All of the
outstanding warrants terminate, if not previously exercised, three years after
this offering. The Company can, under certain conditions, cause all of the
outstanding warrants issued to Dominion Ventures to be exercised in connection
with the Offering.

The purchasers of the Convertible Preferred Stock and Common Stock
described above included, among others, the following officers and directors and
holders of more than five percent of the Company's voting securities:

<TABLE>
<CAPTION>
SHARES OF COMMON STOCK ISSUABLE UPON
CONVERSION OF CONVERTIBLE PREFERRED STOCK(1)(2)
-----------------------------------------------
COMMON SERIES SERIES SERIES SERIES SERIES
PURCHASER STOCK A B C D E
- ----------------------------------------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Kleiner Perkins Caufield & Byers
Entities(3)............................ -- 506,667 760,000 533,334 -- --
Institutional Venture
Partners/Institutional Venture
Management Entities(4)................. -- 374,400 561,200 533,334 -- --
Avalon Entities.......................... 240,000 177,600 266,800 -- -- --
Johnson & Johnson Development
Corporation............................ -- -- -- -- 571,429 --
Pfizer Inc .............................. -- -- -- -- -- 571,429
Atlas Venture Europe Fund Entities....... -- -- -- 533,334 -- --
New Enterprise Associates VI(5).......... -- -- -- 533,333 -- --
Abingworth Bioventures................... -- -- -- 400,000 -- --
Keith A. Bostian, Ph.D................... 256,000 8,000 -- -- -- --
James E. Rurka........................... 140,000 -- -- -- -- --
David Schnell, M.D....................... 20,000 3,600
John P. Walker........................... 20,000 -- -- -- -- --
L. James Strand, M.D..................... 8,000
Jon S. Saxe.............................. 6,040 -- -- -- -- --
</TABLE>

47
<PAGE> 48

- ---------------
(1) The purchasers of these securities are entitled to registration rights. See
"Description of Capital Stock -- Registration Rights."

(2) Except as otherwise indicated, shares held by affiliated persons and
entities have been aggregated. See "Principal Stockholders."

(3) Does not include 20,000 shares of Common Stock and 3,600 shares of Series A
Preferred Stock held by David Schnell, M.D., a Director of the Company. Dr.
Schnell is a Venture Limited Partner of Kleiner Perkins Caufield & Byers VI
Associates, which is the General Partner of Kleiner Perkins Caufield & Byers
VI and Kleiner Perkins Caufield & Byers VI Founders Fund. Joseph A. Lacob,
the Chairman of the Board of Directors of the Company, is a General Partner
of Kleiner Perkins Caufield & Byers.

(4) Does not include 8,000 shares of Series A Preferred Stock held by L. James
Strand, M.D., a Director of the Company. Does not include 12,000 shares of
Common Stock issuable upon exercise of stock options held by Dr. Strand. Dr.
Strand is a General Partner of Institutional Venture Management VI.

(5) Hugh Y. Rienhoff, Jr., M.D., a Director of the Company, is a Partner of New
Enterprise Associates.

TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS

In February 1994, under the terms of his acceptance of employment with the
Company and in order to defray the costs of relocating to the Company's
geographic area, James E. Rurka, President, Chief Executive Officer and Director
of the Company, borrowed $53,861 from the Company pursuant to an Employment
Agreement between the Company and Mr. Rurka dated effective February 1994. The
loan to Mr. Rurka did not bear interest, and was forgiven over a two-year period
at the rate of one-quarter of the loan amount for each six-month period of his
employment with the Company. See "Management -- Employment Agreements."

In 1993, under the terms of his acceptance of employment with the Company
and in order to defray the costs of relocating to the Company's geographic area,
the Company reimbursed Keith A. Bostian, Ph.D. $100,908 for expenses incurred by
Dr. Bostian with respect to his relocation. In 1995, pursuant to the terms of
his employment agreement, Dr. Bostian received $70,433 to cover the income tax
impact of the reimbursement by the Company of his moving expenses.

In January 1993 Institutional Venture Partners transferred to L. James
Strand, M.D., a Director of the Company, and a General Partner of Institutional
Venture Partners, 8,000 shares of Series A Preferred Stock of the Company in
consideration of Dr. Strand's assistance on behalf of the Company.

Prior to his appointment as a Director of the Company, pursuant to a letter
agreement dated August 2, 1993, as revised and superseded by letter agreements
dated August 30, 1993 and September 20, 1993, which terminated in July 1995, Jon
S. Saxe agreed to provide consulting services to the Company on business
development issues in exchange for $1,333 per consulting day in cash and 267
shares of Common Stock of the Company per consulting day. Mr. Saxe received
$3,048 and 1,000 shares of Common Stock in 1993, $12,609 in 1994 and $15,422 and
5,040 shares of Common Stock in 1995 for consulting services rendered to the
Company.

The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties. All future transactions, including loans, between
the Company and its officers, directors, principal stockholders and their
affiliates will be approved by a majority of the Board of Directors, including a
majority of the independent and disinterested outside directors and will
continue to be on terms no less favorable to the Company than could be obtained
from unaffiliated third parties.

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<PAGE> 49

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of March 31, 1996, assuming
conversion of all shares of the Company's outstanding Preferred Stock into
shares of the Company's Common Stock, and as adjusted to reflect the sale by the
Company of the shares offered hereby, (i) by each person (or group of affiliated
persons) who is known by the Company to own beneficially more than 5% of the
outstanding shares of Common Stock, (ii) by each of the Company's directors,
(iii) by the Named Executive Officers, and (iv) by all directors and executive
officers as a group.

<TABLE>
<CAPTION>
PERCENTAGE
BENEFICIALLY OWNED(1)
SHARES ---------------------
BENEFICIALLY BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL HOLDER OWNED(1) OFFERING OFFERING
- ------------------------------------------------------------------------- ------------ -------- --------
<S> <C> <C> <C>
Entities Affiliated with Kleiner Perkins Caufield & Byers (2)(3)......... 1,823,600 23.5 17.8
2750 Sand Hill Road
Menlo Park, CA 94025
Entities Affiliated with Institutional Venture Partners(4)............... 1,488,934 19.2 14.5
3000 Sand Hill Road, Bldg. 2, Ste. 290
Menlo Park, CA 94025
Entities Affiliated with Avalon Ventures(5).............................. 684,400 8.8 6.7
1020 Prospect Street, #405
La Jolla, CA 92037
Johnson & Johnson Development Corporation................................ 571,429 7.4 5.6
1 Johnson & Johnson Plaza
New Brunswick, NJ 08933
Pfizer Inc............................................................... 571,429 7.4 5.6
Eastern Point Road
Groton, CT 06340
Entities Affiliated with Atlas Venture(6)................................ 533,333 6.9 5.2
222 Berkeley Street
Boston, MA 02116
New Enterprise Associates VI (7)......................................... 533,333 6.9 5.2
1119 St. Paul Street
Baltimore, MD 21202
Abingworth Bioventures................................................... 400,000 5.2 3.9
231 Valdes Bon Malades
Kirchberg 2121
Luxembourg
David Schnell, M.D. (2).................................................. 1,823,600 23.5 17.8
Kleiner Perkins Caufield & Byers
2750 Sand Hill Road
Menlo Park, CA 94025
Joseph S. Lacob (3)...................................................... 1,800,000 23.2 17.5
Kleiner Perkins Caufield & Byers
2750 Sand Hill Road
Menlo Park, CA 94025
L. James Strand, M.D. (4)................................................ 1,488,934 19.2 14.5
Institutional Venture Partners
3000 Sand Hill Road, Bldg. 2, Ste. 290
Menlo Park, CA 94025
Hugh Y. Rienhoff, Jr., M.D. (7).......................................... 533,333 6.9 5.2
New Enterprise Associates
1119 St. Paul Street
Baltimore, MD 21202
Keith A. Bostian, Ph.D. (8).............................................. 271,084 3.5 2.6
James E. Rurka (9)....................................................... 176,875 2.3 1.6
John P. Walker........................................................... 20,000 * *
Jon S. Saxe(10).......................................................... 19,374 * *
Matthew J. Hogan (11).................................................... 0 * *
All directors and executive officers as a group (9 persons)(12).......... 4,333,200 55.4 42.0
</TABLE>

- ---------------
* Less than 1% of the outstanding shares of Common Stock.

49
<PAGE> 50

(1) Applicable percentage ownership is based on 7,756,981 shares of Common
Stock outstanding as of March 31, 1996, together with applicable options
for such stockholder. Beneficial ownership is determined in accordance with
the rules of the Securities and Exchange Commission and generally includes
voting or investment power with respect to securities, subject to the
community property laws, where applicable. Shares of Common Stock subject
to options that are currently exercisable or exercisable within 60 days of
March 31, 1996 are deemed to be beneficially owned by the person holding
such options for the purpose of computing the percentage of ownership of
such person but are not treated as outstanding for the purpose of computing
the purchase of any other person.

(2) David Schnell, M.D., a Director of the Company, is a Venture Limited
Partner of Kleiner Perkins Caufield & Byers VI Associates, which is the
General Partner of Kleiner Perkins Caufield & Byers VI and Kleiner Perkins
Caufield & Byers VI Founders Fund. Includes 1,560,600 shares held by
Kleiner Perkins Caufield & Byers VI, L.P., 239,400 shares held by Kleiner
Perkins Caufield & Byers Founders Fund VI, L.P., and 23,600 shares held by
Dr. Schnell.

(3) Joseph S. Lacob, Chairman of the Board of the Company, is a General Partner
of Kleiner Perkins Caufield & Byers. Includes 1,560,600 shares held by
Kleiner Perkins Caufield & Byers VI, L.P. and 239,400 shares held by
Kleiner Perkins Caufield & Byers Founders Fund VI, L.P.

(4) L. James Strand, M.D., a Director of the Company, is a General Partner of
Institutional Venture Management VI. Includes 1,444,233 shares held by
Institutional Venture Partners V, L.P., 24,701 shares held by Institutional
Venture Management V, L.P. 8,000 shares held by Dr. Strand, and 12,000
shares issuable to Dr. Strand pursuant to options exercisable within 60
days of March 31, 1996.

(5) Includes 222,200 shares held by Avalon BioVentures II, L.P. and 462,200
shares held by Avalon Medical Partners, L.P.

(6) Includes 200,000 shares held by Atlas Venture Europe Fund BV and 333,333
shares held by Atlas Venture Fund II.

(7) Hugh Y. Rienhoff, Jr., M.D., a Director of the Company, is a Partner of New
Enterprise Associates.

(8) Includes 240,000 shares held by Dr. Bostian, 16,000 shares held by Arthur
Weil as trustee for Dr. Bostian's children with respect to which Dr.
Bostian disclaims beneficial ownership, and 7,084 shares issuable pursuant
to options exercisable within 60 days of March 31, 1996.

(9) Includes 140,000 shares held by Mr. Rurka and 36,875 shares issuable
pursuant to options exercisable within 60 days of March 31, 1996.

(10) Includes 6,040 shares held by Mr. Saxe and 13,334 shares issuable pursuant
to options exercisable within 60 days of March 31, 1996.

(11) Mr. Hogan joined the Company in May 1996 as Chief Financial Officer and
will receive options to purchase 50,000 shares of Common Stock, none of
which were exercisable as of March 31, 1996.

(12) Includes 69,293 shares issuable pursuant to options exercisable within 60
days of March 31, 1996.

50
<PAGE> 51

DESCRIPTION OF CAPITAL STOCK

GENERAL

Upon completion of the Offering, the Company will be authorized to issue
50,000,000 shares of Common Stock, $.001 par value per share, and 5,000,000
shares of undesignated Preferred Stock, $.001 par value per share. The price and
per share information presented herein give effect to the 1-for-5 reverse stock
split effective April 5, 1996 and the assumed conversion of all outstanding
Convertible Preferred Stock of the Company into Common Stock, which will occur
automatically upon the completion of the Offering.

COMMON STOCK

As of March 31, 1996, there were 7,756,981 shares of Common Stock
outstanding held of record by approximately 40 stockholders, assuming no
exercise after March 31, 1996 of outstanding options to purchase Common Stock,
and after giving effect to the conversion of the Convertible Preferred Stock
into Common Stock at a 1-to-1 ratio and assuming no exercise of outstanding
warrants to purchase 160,187 shares of Common Stock (or securities convertible
into Common Stock). There will be 10,256,981 shares of Common Stock outstanding
(assuming no exercise of the Underwriters' over-allotment option) after giving
effect to the sale of the shares of Common Stock offered hereby. See
"Management -- Employee Benefit Plans."

The holders of Common Stock are entitled to one vote per share on all
matters to be voted on by stockholders. Subject to the prior rights of holders
of Preferred Stock, if any, the holders of Common Stock are entitled to receive
such dividends, if any, as may be declared from time to time by the Board of
Directors in its discretion from funds legally available therefore. Upon
liquidation or dissolution of the Company, after payment of liabilities and the
liquidation preferences of any outstanding shares of Preferred Stock, the
remainder of the assets of the Company will be distributed ratably among the
holders of Common Stock. The Common Stock has no preemptive or other
subscription rights and there are no conversion rights or redemption rights or
sinking fund provisions with respect to such shares. All of the outstanding
shares of Common Stock are, and the shares to be sold in the Offering will be,
fully paid and nonassessable.

WARRANTS

As of March 31, 1996, there were outstanding warrants to purchase 19,467
shares of Series A Preferred Stock at an exercise price of $1.875 per share,
warrants to purchase an aggregate of 86,320 shares of Series B Preferred Stock
at an exercise price of $2.50 per share, and warrants to purchase an aggregate
of 54,400 shares of Series C Preferred Stock at an exercise price of $3.75 per
share. The warrants were issued in May 1993 and June 1994 in connection with
lease financing arrangements between the Company and Dominion Ventures, and in
September 1993 in connection with a lease financing arrangement between the
Company and Comdisco, Inc. All of the outstanding warrants terminate, if not
previously exercised, three years after the Offering. The Company can, under
certain conditions, cause all of the outstanding warrants issued to Dominion
Ventures to be exercised in connection with the Offering.

PREFERRED STOCK

Effective upon the closing of the Offering, the Company will be authorized
to issue 5,000,000 shares of undesignated Preferred Stock. The Board of
Directors has the authority to issue the Preferred Stock in one or more series
and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, redemption rights, redemption prices, liquidation
preferences and the number of shares constituting a Series or the designation of
such Series, without further vote or action by the stockholders. The issuance of
Preferred Stock may have the effect of delaying, deferring or preventing a
change in control in the Company without further action by the stockholders and
may adversely affect the market price of, and the voting and other rights of,
the holders of Common Stock. Upon the closing of the Offering, the Company will
have no shares of Preferred Stock outstanding. At present, the Company has no
plans to issue any of the Preferred Stock.

REGISTRATION RIGHTS

The holders of approximately 6,880,791 shares of Common Stock and their
permitted transferees (the "Holders") are entitled to certain rights with
respect to the registration of such shares under the Securities

51
<PAGE> 52

Act. Under the terms of the Information and Registration Rights Agreement dated
June 29, 1994, as amended to date, among the Company and certain holders of its
securities, if the Company proposes to register any of its securities under the
Securities Act, either for its own account or the account of other security
holders holding registration rights, the Holders are entitled to notice of such
registration and are entitled to include their registrable securities therein;
provided, among other conditions, that the underwriters have the right to limit
the number of such shares included in any such registration. The Holders also
have the right, beginning six months after the date of the Offering, to request
on two occasions that the Company file a registration statement under the
Securities Act at the Company's expense with respect to their shares of Common
Stock, and the Company, subject to certain limitations, is required to use its
best efforts to effect such registration. In addition, the Holders may require
the Company to register, at the expense of the Company, all or a portion of
their Registrable Securities on Form S-3 when such form becomes available to the
Company. All of the foregoing registration rights are subject to certain
conditions and limitations, including the right of the underwriters of an
offering to limit the number of shares to be included in such registration. In
addition, the Company need not effect a requested registration on a form other
than Form S-3 within three months of the effective date of any Company-initiated
registration. All of the foregoing registration rights terminate on the date
eight years after the closing of the Offering. See "Risk Factors -- Potential
Adverse Market Impact of Shares Eligible for Future Sale."

CERTAIN CHANGE OF CONTROL PROVISIONS

The Company is subject to Section 203 of the Delaware General Corporation
Law, an anti-takeover law. In general, Section 203 prohibits a publicly held
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years following the date the
person became an interested stockholder, unless (with certain exceptions) the
"business combination" or the transaction in which the person became an
interested stockholder is approved in a prescribed manner. Generally, a
"business combination" includes a merger, asset or stock sale, or other
transaction resulting in a financial benefit to the interested stockholder.
Generally, an "interested stockholder" is a person who, together with affiliates
and associates, owns (or within three years prior to the determination of
interested stockholder status, did own) 15% or more of a corporation's voting
stock. The existence of this provision would be expected to have an
anti-takeover effect with respect to transactions not approved in advance by the
Board of Directors, including discouraging attempts that might result in a
premium over the market price for the shares of Common Stock held by
stockholders.

The Restated Certificate provides for a Board of Directors that is divided
into three classes. The directors in Class I hold office until the first annual
meeting of stockholders following the Offering, the directors in Class II hold
office until the second annual meeting of stockholders following the Offering,
and the directors in Class III hold office until the third annual meeting of
stockholders following the Offering, (or, in each case, until their successors
are duly elected and qualified or until their earlier resignation, removal from
office or death), and, after each such election, the directors in each such
class will then serve in succeeding terms of three years and until their
successors are duly elected and qualified. The classification system of electing
directors may tend to discourage a third party from making a tender offer or
otherwise attempting to obtain control of the Company and may maintain the
incumbency of the Board of Directors, as the classification of the Board of
Directors generally increases the difficulty of replacing a majority of the
directors.

The Restated Certificate and Bylaws do not provide for cumulative voting in
the election of directors. The authorization of undesignated Preferred Stock
makes it possible for the Board of Directors to issue Preferred Stock with
voting or other rights or preferences that could impede the success of any
attempt to change control of the Company. These and other provisions may have
the effect of delaying or preventing hostile takeovers or delaying changes in
control or management of the Company. The amendment of any of these provisions
would require approval by holders of at least 66-2/3rd% of the outstanding
Common Stock. See "Risk Factors -- Effect of Certain Charter and Bylaw
Provisions; Certain Anti-Takeover Provisions."

TRANSFER AGENT

The transfer agent for the Common Stock is Chemical Mellon Shareholder
Services L.L.C.

52
<PAGE> 53

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of the Offering, the Company will have 10,256,981 shares of
Common Stock outstanding, assuming no exercise of the Underwriters'
over-allotment option and no exercise of outstanding options and warrants. Of
these shares, the 2,500,000 shares of Common Stock sold in this offering will be
freely transferable without restriction under the Securities Act unless they are
held by "affiliates" of the Company as that term is used under the Securities
Act and the regulations promulgated thereunder. The remaining approximately
7,756,981 shares of Common Stock (the "Restricted Shares") held by officers,
directors, employees, consultants and other stockholders of the Company were
sold by the Company in reliance on exemptions from the registration requirements
of the Securities Act and are "restricted" securities within the meaning of Rule
144 under the Securities Act and may not be sold publicly unless they are
registered under the Securities Act or are sold pursuant to Rule 144 or another
exemption from registration.

Beginning 180 days after commencement of the Offering, approximately
6,612,373 Restricted Shares that are subject to lock-up agreements (as described
below under "Underwriting") will become eligible for sale upon expiration of
such agreements, subject to compliance with Rule 144. The remaining
approximately 1,144,858 Restricted Shares, which are also subject to such
lock-up agreements, will have been held for less than two years upon the
expiration of such lock-up agreements and will become eligible for sale under
Rule 144 at various dates thereafter as the holding period provisions of Rule
144 are satisfied. In addition, 160,187 shares of Common Stock issuable upon
conversion of the Convertible Preferred Stock for which warrants are currently
outstanding will be subject to 180-day lock-up agreements and the two-year
holding period of Rule 144.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an affiliate, who has beneficially owned
shares for at least two years is entitled to sell, within any three-month period
commencing 90 days after the Offering, a number of shares that does not exceed
the greater of (i) 1% of the then outstanding Common Stock (approximately
102,570 shares immediately after the Offering) or (ii) the average weekly
trading volume in the Common Stock during the four calendar weeks preceding such
sale, subject to the filing of a Form 144 with respect to such sale and certain
other limitations and restrictions. In addition, a person who is not deemed to
have been an affiliate of the Company at any time during the three months
preceding a sale, and who has beneficially owned the shares proposed to be sold
for at least three years, would be entitled to sell such shares under Rule
144(k) without regard to the volume limitations described above or certain other
restrictions of Rule 144.

Under Rule 701 under the Securities Act, any employee, officer or director
of or consultant to the Company, who is not an affiliate of the Company, and who
purchased shares pursuant to a written compensatory plan or contract, including
the Option Plan, is entitled to sell such shares without having to comply with
the public information, holding period, volume limitation or notice provisions
of Rule 144, and affiliates of the Company are permitted to sell such shares
without having to comply with the Rule 144 holding period restrictions, in each
case commencing 90 days after the Offering.

The Company presently intends to file a registration statement under the
Securities Act to register Common Stock to be issued pursuant to the exercise of
options, including options granted or to be granted under the Option Plan and
the Director Plan, as well as Common Stock reserved for issuance under the 1996
Purchase Plan. Taking into account the effect of the lock-up agreements with the
holders of options, 325,002 shares issuable upon exercise of vested options will
be eligible for sale in the public market beginning 180 days after commencement
of this offering, subject, in the case of sales by affiliates, to the volume,
manner of sale, notice and public information requirements of Rule 144. See
"Management -- Employee Benefit Plans."

The holders of approximately 6,880,791 shares of Common Stock and their
permitted transferees are entitled to certain rights with respect to the
registration of such shares under the Securities Act. See "Description of
Capital Stock -- Registration Rights."

Prior to the Offering, there has been no public market for the securities
of the Company. No predictions can be made of the effect, if any, that the sale
or availability for sale of shares of additional Common Stock will have on the
market price of the Common Stock. Nevertheless, sales of a substantial amount of
such shares by existing stockholders or by stockholders purchasing in the
Offering could have a negative impact on the market price of the Common Stock.

53
<PAGE> 54

UNDERWRITING

Subject to the terms and conditions set forth in a purchase agreement (the
"Purchase Agreement") between the Company and each of the underwriters named
below (the "Underwriters"), the Company has agreed to sell to each of the
Underwriters, and each of the Underwriters, for whom Merrill Lynch, Pierce,
Fenner & Smith Incorporated, Alex. Brown & Sons Incorporated and Cowen & Company
are acting as the representatives (the "Representatives"), has severally agreed
to purchase from the Company, the number of shares of Common Stock set forth
opposite its name below. In the Purchase Agreement, the several Underwriters
have agreed, subject to the terms and conditions set forth therein, to purchase
all of the shares of Common Stock offered hereby, if any are purchased. In the
event of default by an Underwriter, the Purchase Agreement provides that, in
certain circumstances, purchase commitments of the non-defaulting Underwriters
may be increased or the Purchase Agreement may be terminated.

<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
------------------------------------------------------------- ----------------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.................................... 720,000
Alex. Brown & Sons Incorporated.............................. 720,000
Cowen & Company.............................................. 720,000
Hambrecht & Quist LLC........................................ 55,000
Lehman Brothers Inc. ........................................ 55,000
Oppenheimer & Co., Inc. ..................................... 55,000
Smith Barney Inc. ........................................... 55,000
Kaufman Bros., L.P. ......................................... 30,000
Van Kasper & Company......................................... 30,000
Vector Securities International, Inc. ....................... 30,000
Wedbush Morgan Securities.................................... 30,000
---------
Total........................................... 2,500,000
=========
</TABLE>

The Representatives have advised the Company that the Underwriters propose
initially to offer the shares of Common Stock to the public at the initial
public offering price set forth on the cover page of this Prospectus, and to
certain dealers at such price less a concession not in excess of $.58 per share
of Common Stock. The Underwriters may allow, and such dealers may reallow, a
discount not in excess of $.10 per share of Common Stock on sales to certain
other dealers. After the initial public offering, the public offering price,
concession and discount may be changed.

At the request of the Company, the Underwriters have reserved up to 150,000
shares of Common Stock for sale at the initial public offering price to
directors, officers, employees, business associates and related persons of the
Company. The number of shares of Common Stock available for sale to the general
public will be reduced to the extent such persons purchase such reserved shares.
Any reserved shares which are not so purchased will be offered by the
Underwriters to the general public on the same basis as the other shares offered
hereby.

The Company has granted to the Underwriters an option exercisable for 30
days after the date of this Prospectus, to purchase up to an additional 375,000
shares of Common Stock to cover over-allotments, if any, at the initial public
offering price set forth on the cover page hereof, less the underwriting
discount. If the Underwriters exercise this option, each Underwriter will have a
firm commitment, subject to certain conditions, to purchase approximately the
same percentage thereof that the number of shares of Common Stock to be
purchased by it shown in the foregoing table is of the 2,500,000 shares of
Common Stock initially offered hereby.

54
<PAGE> 55

The Company, its officers, directors and certain stockholders of the
Company have agreed, subject to certain exceptions, not to, directly or
indirectly, (i) sell, grant any option to purchase or otherwise transfer or
dispose of any shares of Common Stock or securities convertible into or
exchangeable or exercisable for Common Stock or file a registration statement
under the Securities Act with respect to the foregoing or (ii) enter into any
swap or other agreement or transaction that transfers, in whole or in part, the
economic consequence of ownership of the Common Stock, without the prior written
consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated, for a period of
180 days after the date of this Prospectus. The foregoing does not prohibit the
Company's issuing shares pursuant to the exercise of the Underwriters'
overallotment option or under the Option Plan, the Director Plan or the 1996
Purchase Plan.

The Company has agreed to indemnify the Underwriters and others against
certain liabilities, including certain liabilities under the Securities Act and
other applicable securities laws, or to contribute to payments the Underwriters
may be required to make in respect thereof.

The Representatives have advised the Company that the Underwriters do not
intend to confirm sales of the Common Stock offered hereby to any accounts over
which they exercise discretionary authority.

Prior to the Offering, there has been no market for the Common Stock. The
initial public offering price was determined through negotiations between the
Company and the Representatives. Among the factors considered in determining the
initial public offering price, in addition to prevailing market conditions, were
certain financial information of the Company, estimates of the business
potential and earnings prospects of the Company, an assessment of the Company's
management, the present state of the Company's development and operations, and
the above factors in relation to market values and various valuation measures of
other companies engaged in activities similar to the Company. The initial public
offering price set forth on the cover page of this Prospectus should not,
however, be considered an indication of the actual value of the Common Stock.
Such price is subject to change as a result of market conditions and other
factors. There can be no assurance that an active trading market will develop
for the Common Stock or that the Common Stock will trade in the public market
subsequent to the Offering at or above the initial public offering price.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto, California.
Certain legal matters in connection with the Offering will be passed upon for
the Underwriters by Skadden, Arps, Slate, Meagher & Flom, Los Angeles,
California. As of the date of this Prospectus, Michael J. O'Donnell, Secretary
of the Company and a member of Wilson Sonsini Goodrich & Rosati, P.C.,
beneficially owns 3,000 shares of Common Stock.

EXPERTS

The financial statements of Microcide Pharmaceuticals, Inc. at December 31,
1994 and 1995, and for the period from inception (December 11, 1992) to December
31, 1993, the years ended December 31, 1994 and 1995 and for the period from
inception to December 31, 1995, appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their report thereon appearing elsewhere herein and in the Registration
Statement, and are included in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.

The statements in this Prospectus under the captions "Risk
Factors -- Dependence on Proprietary Technology and Unpredictability of Patent
Protection" and "Business -- Patents, Proprietary Technology and Trade Secrets"
with respect to the intellectual property of the Company have been reviewed by
Lyon & Lyon, patent counsel for the Company.

55
<PAGE> 56

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 under the Securities Act,
with respect to the Common Stock offered hereby. This Prospectus does not
contain all of the information set forth in the Registration Statement and the
exhibits and schedules thereto. For further information with respect to the
Company and the Common Stock, reference is made to the Registration Statement
and the exhibits and schedules filed as a part thereof. Statements contained in
this Prospectus as to the contents of any contract or any other document
referred to are not necessarily complete. In each instance, reference is made to
the copy of such contract or document filed as an exhibit to the Registration
Statement, and each such statement is qualified in all respects by such
reference. Copies of the Registration Statement, including exhibits and
schedules thereto, may be inspected without charge at the Commission's principal
office in Washington, D.C., or obtained at prescribed rates from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549. The Company intends to distribute to its stockholders annual reports
containing audited financial statements and will make available copies of
quarterly reports for the first three quarters of each fiscal year containing
unaudited interim financial information.

56
<PAGE> 57

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors...................................... F-2
Financial Statements:
Balance Sheets....................................................................... F-3
Statements of Operations............................................................. F-4
Statement of Stockholders' Equity.................................................... F-5
Statements of Cash Flows............................................................. F-6
Notes to Financial Statements........................................................ F-7
</TABLE>

F-1
<PAGE> 58

REPORT OF ERNST & YOUNG, LLP, INDEPENDENT AUDITORS

The Board of Directors
Microcide Pharmaceuticals, Inc.

We have audited the accompanying balance sheets of Microcide
Pharmaceuticals, Inc. (a development stage company) as of December 31, 1994 and
1995, and the related statements of operations, stockholders' equity, and cash
flows for the period from inception (December 11, 1992) to December 31, 1993,
for each of the two years in the period ended December 31, 1995 and for the
period from inception (December 11, 1992) to December 31, 1995 (not separately
presented herein). 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Microcide Pharmaceuticals,
Inc. at December 31, 1994 and 1995 and the results of its operations and its
cash flows for the period from inception (December 11, 1992) to December 31,
1993, for each of the two years in the period ended December 31, 1995 and for
the period from inception (December 11, 1992) to December 31, 1995 (not
separately presented herein), in conformity with generally accepted accounting
principles.

ERNST & YOUNG LLP

Palo Alto, California
February 13, 1996, except for
the third paragraph of Note 8,
as to which the date is April 5, 1996

F-2
<PAGE> 59

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

BALANCE SHEETS
(In thousands, except share amounts)

<TABLE>
<CAPTION>
UNAUDITED
DECEMBER 31, MARCH PRO FORMA
------------------ 31, STOCKHOLDERS'
1994 1995 1996 EQUITY AT
------- -------- -------- MARCH 31,
1996
(UNAUDITED) ------------
(Note 8)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 5,810 $ 8,517 $ 15,093
Prepaid expenses and other current assets.......... 339 138 212
------- -------- --------
Total current assets................................. 6,149 8,655 15,305
Property and equipment, net.......................... 4,959 4,606 5,177
Other assets......................................... 232 232 209
------- -------- --------
$11,340 $ 13,493 $ 20,691
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 266 $ 463 $ 823
Accrued compensation and other accrued
liabilities..................................... 232 273 309
Current portion of capital lease obligations....... 806 1,118 1,116
Deferred revenue................................... -- 413 2,037
------- -------- --------
Total current liabilities............................ 1,304 2,267 4,285
Long-term portion of capital lease obligations....... 2,413 1,920 1,657
Accrued rent......................................... 117 155 153
Commitments
Stockholders' equity:
Preferred stock, no par value; 7,810,000 shares
authorized, issuable in series; 5,735,933
shares, 6,309,362 and 6,880,791 shares issued
and outstanding as of December 31, 1994 and 1995
and March 31, 1996, respectively -- aggregate
liquidation value of $27,517 at March 31, 1996;
pro forma -- no shares.......................... 17,443 22,435 27,425 $ --
Common stock, no par value; 10,000,000 shares
authorized, 836,533 shares, 855,440 and 876,190
shares issued and outstanding at December 31,
1994 and 1995 and March 31, 1996, respectively;
pro forma 7,756,981 shares...................... 49 632 2,266 29,691
Stockholder note receivable........................ (35) (35) (35) (35)
Deferred compensation.............................. -- (412) (1,974) (1,974)
Net unrealized loss on securities
available-for-sale.............................. -- (2) (2) (2)
Deficit accumulated during the development stage... (9,951) (13,467) (13,084) (13,084)
------- -------- -------- --------
Total stockholders' equity........................... 7,506 9,151 14,596 $ 14,596
------- -------- ======== ========
$11,340 $ 13,493 $ 20,691
======= ======== ========
</TABLE>

See accompanying notes.

F-3
<PAGE> 60

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
INCEPTION INCEPTION
(DECEMBER 11, YEARS ENDED THREE MONTHS ENDED (DECEMBER 11,
1992) TO DECEMBER 31, MARCH 31, 1996 1992) TO
DECEMBER 31, ------------------- ------------------- MARCH 31,
1993 1994 1995 1995 1996 1996
------------- ------- ------- ------- ------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
License fees................ $ -- $ -- $ 3,000 $ -- $ 1,000 $ 4,000
Research revenue............ -- -- 1,985 -- 1,625 3,610
------- -------- ------- ------- ------- ---------
Total revenues................ -- -- 4,985 -- 2,625 7,610
Operating expenses:
Research and development.... 1,685 5,180 6,400 1,324 1,780 15,045
General and
administrative............ 1,251 1,823 2,080 479 526 5,680
------- -------- ------- ------- ------- ---------
Total operating expenses...... 2,936 7,003 8,480 1,803 2,306 20,725
------- -------- ------- ------- ------- ---------
Income (loss) from
operations.................. (2,936) (7,003) (3,495) (1,803) 319 (13,115)
Interest income............... 32 218 257 85 137 644
Interest expense.............. (13) (249) (278) (70) (73) (613)
------- -------- ------- ------- ------- ---------
Net income (loss)............. $(2,917) $(7,034) $(3,516) $(1,788) $ 383 $ (13,084)
======== ======== ======== ========= ======= =========
Pro forma net income (loss)
per share................... $ (0.44) $ (0.22) $ 0.04
======== ========= =======
Shares used in computing pro
forma net income (loss) per
share....................... 8,052 8,039 8,563
</TABLE>

See accompanying notes.

F-4
<PAGE> 61

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except share and per share amounts)

PERIOD FROM INCEPTION (DECEMBER 11, 1992) TO MARCH 31, 1996

<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED
PREFERRED STOCK COMMON STOCK STOCKHOLDER NET UNREALIZED DURING THE TOTAL
------------------- --------------- NOTE DEFERRED LOSS ON DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT RECEIVABLE COMPENSATION SECURITIES STAGE EQUITY
--------- ------- ------- ------ ----------- ------------ -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of
common stock at
$0.005 per
share to
founders for
cash and
services in
December
1992........... -- $ -- 496,000 $ 2 $ -- $ -- $ -- $ -- $ 2
Issuance of
Series A
convertible
preferred stock
to investors at
$1.875 per
share for cash
in December
1992........... 62,160 117 -- -- -- -- -- -- 117
Issuance of
Series A
convertible
preferred stock
to investors at
$1.875 per
share for cash
in January
1993, less
issuance costs
of $18......... 1,016,107 1,887 -- -- -- -- -- -- 1,887
Issuance of
Series B
convertible
preferred stock
to investors at
$2.50 per share
for cash in
September and
December 1993,
less issuance
costs of $6.... 1,454,600 3,630 -- -- -- -- -- -- 3,630
Issuance of
common stock at
$0.025 to $0.25
share to
employees and
consultants for
cash in
January,
October and
December
1993........... -- -- 191,200 10 -- -- -- -- 10
Net loss......... -- -- -- -- -- -- (2,917) (2,917)
--------- ------- ------- ------ ----------- ------------ --- ----------- -------------
Balances at
December 31,
1993............. 2,532,867 5,634 687,200 12 -- -- -- (2,917) 2,729
Issuance of
Series B
convertible
preferred stock
to investors at
$2.50 per share
for cash in
January 1994... 136,400 341 -- -- -- -- -- -- 341
Issuance of
Series C
convertible
preferred stock
to investors at
$3.75 per share
for cash and
conversion of
subordinated
debt in July
1994, less
issuance costs
of $32......... 3,066,666 11,468 -- -- -- -- -- -- 11,468
Exercise of
common stock
options by
employees at
$0.20 and $0.25
per share for
cash and note
receivable in
March, July,
September and
October 1994... -- -- 149,333 37 (35) -- -- -- 2
Net loss......... -- -- -- -- -- -- -- (7,034) (7,034)
--------- ------- ------- ------ ----------- ------------ --- ----------- -------------
Balances at
December 31,
1994............. 5,735,933 17,443 836,533 49 (35) -- -- (9,951) 7,506
Issuance of
Series D
convertible
preferred stock
to investors at
$8.75 per share
for cash in
October and
November 1995,
less issuance
costs of $26... 573,429 4,992 -- -- -- -- -- -- 4,992
Exercise of
common stock
options by
employees and
issuance of
common stock
for services at
$0.25 to $0.38
per share for
cash in April,
May and July
1995........... -- -- 18,907 5 -- -- -- -- 5
Net unrealized
loss on
securities
available-for-
sale........... -- -- -- -- -- -- (2) -- (2)
Deferred
compensation... -- -- -- 578 -- (578) -- -- --
Amortization of
deferred
compensation... -- -- -- -- -- 166 -- -- 166
Net loss......... -- -- -- -- -- -- -- (3,516) (3,516)
--------- ------- ------- ------ ----------- ------------ --- ----------- -------------
Balances at
December 31,
1995............. 6,309,362 22,435 855,440 632 (35) (412) (2) (13,467) 9,151
Issuance of
Series E
convertible
preferred stock
to investors at
$8.75 per share
for cash in
March 1996,
less issuance
costs of $10
(unaudited).... 571,429 4,990 -- -- -- -- -- -- 4,990
Exercise of
common stock
options by
employees and
issuance of
common stock
for services at
$0.25 to $0.375
per share for
cash in January
(unaudited).... -- 20,750 8 -- -- -- -- 8
Deferred
compensation
(unaudited).... -- -- -- 1,626 (1,626) -- -- --
Amortization of
deferred
compensation
(unaudited).... -- -- -- -- -- 64 -- -- 64
Net income
(unaudited).... -- -- -- -- -- -- -- 383 383
--------- ------- ------- ------ ----------- ------------ --- ----------- -------------
Balances at March
31, 1996
(unaudited)...... 6,880,791 $27,425 876,190 $2,266 $ (35) $ (1,974) $ (2) $ (13,084) $14,596
======== ======= ======= ====== ========= =========== ============ ========== ==========
</TABLE>

See accompanying notes.

F-5
<PAGE> 62

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF CASH FLOWS
(In thousands)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
INCEPTION THREE MONTHS ENDED INCEPTION
(DECEMBER 11, YEARS ENDED (DECEMBER 11,
1992) TO DECEMBER 31, MARCH 31, 1992) TO
DECEMBER 31, ------------------- ------------------- MARCH 31,
1993 1994 1995 1995 1996 1996
-------------- ------- ------- ------- ------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES
Net income (loss)............................. $ (2,917) $(7,034) $(3,516) $(1,787) $ 383 $(13,084)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization............... 63 859 1,247 297 351 2,520
Amortization of deferred compensation....... -- -- 166 -- 64 230
Accrued rent................................ 54 63 38 4 (2) 153
Net unrealized loss on securities........... -- -- (2) -- -- (2)
Changes in assets and liabilities:
Prepaid expenses and other current
assets.................................. (137) (202) 201 210 (74) (212)
Other assets.............................. (209) (23) -- (79) 23 (209)
Accounts payable.......................... 229 37 197 (106) 360 823
Accrued compensation and other accrued
liabilities............................. 181 51 41 37 36 309
Deferred revenue.......................... -- -- 413 -- 1,624 2,037
------- ------- ------- -------- ------- --------
Net cash provided by (used in) operating
activities.................................. (2,736) (6,249) (1,215) (1,424) 2,765 (7,435)
------- ------- ------- -------- ------- --------
CASH FLOWS USED IN INVESTING ACTIVITIES
Capital expenditures.......................... (1,372) (692) (148) -- (922) (3,134)
------- ------- ------- -------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of convertible
promissory notes............................ -- 2,000 -- -- -- 2,000
Principal payments on capital lease
obligations................................. (29) (569) (927) (177) (265) (1,790)
Proceeds from issuances of common stock....... 12 2 5 -- 8 27
Net proceeds from issuance of convertible
preferred stock............................. 5,634 9,809 4,992 -- 4,990 25,425
------- ------- ------- -------- ------- --------
Net cash provided by financing activities..... 5,617 11,242 4,070 (177) 4,733 25,662
------- ------- ------- -------- ------- --------
Net increase in cash and cash equivalents..... 1,509 4,301 2,707 (1,601) 6,576 15,093
Cash and cash equivalents at beginning of
period...................................... -- 1,509 5,810 5,810 8,517 --
------- ------- ------- -------- ------- --------
Cash and cash equivalents at end of period.... $ 1,509 $ 5,810 $ 8,517 $ 4,209 $15,093 $ 15,093
======= ======= ======= ======== ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid................................. $ 12 $ 246 $ 274 $ 73 $ 70 $ 602
======= ======= ======= ======== ======= ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Equipment purchased under capital leases...... $ 1,817 $ 2,000 $ 746 $ -- $ -- $ 4,563
======= ======= ======= ======== ======= ========
Stockholder note receivable................... $ -- $ 35 $ -- $ -- $ -- $ 35
======= ======= ======= ======== ======= ========
Conversion of convertible promissory notes to
convertible preferred stock................. $ -- $ 2,000 $ -- $ -- $ -- $ 2,000
======= ======= ======= ======== ======= ========
</TABLE>

See accompanying notes.

F-6
<PAGE> 63

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

Microcide Pharmaceuticals, Inc. (the "Company") is a biopharmaceutical
company founded to discover, develop and commercialize novel antibiotics for the
treatment of serious bacterial infections. The Company's discovery and
development programs address the growing problem of antibiotic resistance in
certain bacteria through two principal themes: (i) Targeted Antibiotics, which
focuses on developing novel antibiotics and antibiotic potentiators, and (ii)
Targeted Genomics, which utilizes bacterial genetics to discover new classes of
antibiotics and other novel treatments for bacterial disease. The Company's
results of operations for the period from inception (December 11, 1992) to
December 31, 1992 were immaterial.

The Company's activities to date have consisted principally of raising
capital, arranging for facilities, acquiring equipment and intellectual
property, recruiting managerial and technical personnel and conducting research
and development. Accordingly, the Company is classified as a development stage
enterprise at December 31, 1995.

Use of Estimates

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Interim Financial Information

The financial information at March 31, 1996 and for the three month periods
ended March 31, 1995 and 1996 is unaudited but includes all adjustments
(consisting only of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the financial position at such date and the
operating results and cash flows for those periods. Results for the March 31,
1996 period are not necessarily indicative of the results for the entire year.

Stock-Based Compensation

In accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees," the Company records and amortizes over the related vesting periods
deferred compensation representing the difference between the price per share of
stock issued or the exercise price of stock options granted and the deemed fair
value (for accounting purposes) of the Company's common stock at the time of
issuance or grant.

Revenue Recognition

Revenues related to research contracts are recognized ratably over the
related funding periods for each contract. The Company is required to perform
research activities as specified in each respective agreement on a best efforts
basis and the Company is reimbursed based on the costs associated with the
number of full time equivalent employees working on each specific contract,
which is generally on a ratable basis over the term of the agreement. Deferred
revenue may result when the Company does not incur the required level of effort
during a specific period in comparison to funds received under the respective
contracts. Revenues related to license agreements with noncancelable,
nonrefundable terms and no significant future obligations are recognized upon
execution of the agreements. Milestone payments will be recognized pursuant to
collaborative agreements upon the achievement of specified milestones, such as
selection of candidates for drug

F-7
<PAGE> 64

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

development, the commencement of clinical trials or receipt of regulatory
approvals. For collaborative arrangements which include both revenue received on
a cost reimbursement basis and funds received associated with the purchase of
the Company's equity, the Company accounts for the equity component based on the
estimated fair value of the Company's securities issued at the date that the
terms of the respective agreements were agreed upon.

Net Income (Loss) Per Share

Except as noted below, historical net income (loss) per share is computed
using the weighted average number of common shares outstanding. Common
equivalent shares from stock options and warrants are excluded from the
computation if their effect is antidilutive, except that, pursuant to the
Securities and Exchange Commission ("SEC") Staff Accounting Bulletins, common
and common equivalent shares (stock options and preferred stock) issued during
the 12 month period prior to the initial filing of the proposed public offering
at prices below the assumed public offering price have been included in the
calculation as if they were outstanding for all periods presented (using the
treasury stock method for stock options).

Historical net income (loss) per share information is as follows:

<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION THREE MONTHS
(DECEMBER 11, YEAR ENDED ENDED
1992) TO DECEMBER 31, MARCH 31,
DECEMBER 31, ----------------- -----------------
1993 1994 1995 1995 1996
------------- ------ ------ ------ ------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Net income (loss) per share....... $ (1.37) $(3.11) $(1.52) $(0.78) $ 0.14
====== ====== ====== ====== ======
Shares used in computing net
income (loss) per share........ 2,126 2,263 2,316 2,303 2,827
</TABLE>

Pro forma net income (loss) per share has been computed as described above
and also gives effect, pursuant to SEC staff policy, to common equivalent shares
from convertible preferred shares issued more than 12 months from the initial
filing of the proposed initial public offering that will be automatically
converted upon completion of the offering.

Cash, Cash Equivalents and Investments

The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. The Company
maintains deposits with financial institutions in the United States and invests
its excess cash in commercial paper which bears minimal risk.

In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("Statement 115"). The Company adopted the
provisions of Statement 115 as of January 1, 1994, the cumulative effect of
which was immaterial.

Management determines the appropriate classification of debt securities in
accordance with Statement 115 at the time of purchase and reevaluates such
designation as of each balance sheet date. At December 31, 1994, 1995 and March
31, 1996, all debt securities are designated as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses reported in stockholders' equity. The amortized cost of debt
securities in this category is adjusted for amortization of

F-8
<PAGE> 65

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Realized gains and losses and declines in value judged to be
other-than-temporary for available-for-sale securities are included in interest
income. The cost of securities sold is based on the specific identification
method. Interest and dividends on securities classified as available-for-sale
are included in interest income.

Property and Equipment

Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over the estimated useful lives of the assets, which
are five to seven years. Equipment under capital lease and leasehold
improvements are amortized using the straight-line method over the estimated
useful lives of the assets or the term of the lease, whichever is shorter.

2. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1994 1995 1996
------ ------- ---------
(In thousands)
<S> <C> <C> <C>
Laboratory and office equipment........................ $3,137 $ 3,949 $ 4,015
Leasehold improvements................................. 2,744 2,826 3,682
------ ------- -------
5,881 6,775 7,697
Less accumulated depreciation and amortization......... (922) (2,169) (2,520)
------ ------- -------
Property and equipment, net............................ $4,959 $ 4,606 $ 5,177
====== ======= =======
</TABLE>

Properties leased under capital leases are included above with a cost of
approximately $3,817,000 and $4,559,000 at December 31, 1994 and 1995,
respectively, with accumulated amortization of approximately $682,000 and
$1,589,000 at December 31, 1994 and 1995, respectively.

3. INVESTMENTS

The following is a summary of available-for-sale securities (estimated fair
value) as of:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------- MARCH 31,
1994 1995 1996
------ ------ ---------
(In thousands)
<S> <C> <C> <C>
Cash equivalents:
Money market funds.................................... $ 290 $1,039 $ 7,181
Commercial paper...................................... 5,520 7,478 7,912
------ ------ -------
$5,810 $8,517 $15,093
====== ====== =======
</TABLE>

F-9
<PAGE> 66

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

4. LEASES

The Company is making payments under capital lease lines of credit with
leasing companies which financed certain equipment purchases.

The Company also leases its office and research facilities under operating
leases. Future minimum lease payments under all noncancelable leases are as
follows:

<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
(In thousands)
<S> <C> <C>
Year ended December 31,
1996.......................................................... $ 1,360 $ 386
1997.......................................................... 1,247 393
1998.......................................................... 764 412
1999.......................................................... 197 418
2000.......................................................... -- 329
------- ------
Total minimum payment required.................................. 3,568 $ 1,938
======
Less amount representing interest............................... (530)
-------
Present value of future lease payments.......................... 3,038
Less current portion............................................ (1,118)
-------
$ 1,920
=======
</TABLE>

Rent expense for operating leases was approximately $161,000 for the period
from inception (December 11, 1992) to December 31, 1993, $377,000 in 1994 and
1995, $94,000 for the three months ended March 31, 1996 and $1,009,000 for the
period from inception (December 11, 1992) to March 31, 1996.

The Company has a commitment with a general contractor to install leasehold
improvements and certain equipment at a total cost of $1,217,000, subject to
modifications which may be requested by the Company. At March 31, 1996 the
Company estimates that its remaining obligation is approximately $350,000.

5. STOCKHOLDERS' EQUITY

Stock Purchase Agreements

Through December 31, 1995, the Company has issued 422,600 shares of its
common stock to officers, employees and consultants subject to stock purchase
agreements that allow the Company to repurchase, at the original issuance price,
unvested shares upon termination of employment. Under the agreements, shares
purchased vest at a rate of 25% at the end of the first year with the remaining
balance vesting in equal amounts monthly over the next three years. As of
December 31, 1995, 93,988 shares were subject to this repurchase provision (at
the original purchase prices ranging from $0.005 to $0.375 per share).

Preferred Stock

All series of preferred stock are convertible at the stockholders' option
at any time into common stock at a conversion rate of one share of common stock
for each share of preferred stock, subject to adjustment for antidilution.
Conversion is automatic upon the closing of an underwritten public offering with
aggregate offering proceeds exceeding $10,500,000 and an offering price of at
least $10.00 (adjusted for any

F-10
<PAGE> 67

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

recapitalizations) per share or written election of holders of record more than
2/3 of the outstanding shares. The Company has reserved 6,469,549 shares of
common stock to be issued to stockholders upon conversion of the outstanding
preferred stock and exercise of warrants.

Holders of Series A, B, C, D and E convertible preferred stock are entitled
to noncumulative dividends of $0.15, $0.20, $0.30, $0.875 and $0.875 per share,
respectively, if and when declared by the board of directors. These dividends
are to be paid in advance of any distributions to common stockholders. No
dividends have been declared through March 31, 1996.

In the event of a liquidation or winding up of the Company, holders of
Series A, B, C, D and E convertible preferred stock shall have a liquidation
preference of $1.875, $2.50, $3.75, $8.75 and $8.75 per share, respectively,
together with any declared but unpaid dividends, over holders of common shares.

Preferred stockholders are entitled to the number of votes they would have
upon conversion of their preferred shares into common stock.

The authorized and outstanding Series A, B, C, D and E shares of
convertible preferred stock were as follows at March 31, 1996:

<TABLE>
<CAPTION>
AGGREGATE
LIQUIDATION
SHARES ISSUANCE VALUE
AUTHORIZED ISSUED AND PRICE PER --------------
DESIGNATION (ALL CONVERTIBLE) SHARES OUTSTANDING SHARE
----------------------------------- ---------- ----------- --------- (In thousands)
<S> <C> <C> <C> <C>
Series A........................... 1,100,000 1,078,267 $ 1.875 $ 2,022
Series B........................... 1,700,000 1,591,000 $ 2.50 3,977
Series C........................... 3,210,000 3,066,666 $ 3.75 11,500
Series D........................... 1,200,000 573,429 $ 8.75 5,018
Series E........................... 600,000 571,429 $ 8.75 5,000
---------- ---------- -------
7,810,000 6,880,791 $ 27,517
========== ========== =======
</TABLE>

Warrants

In connection with various capital lease arrangements, the Company issued
warrants to purchase 19,467 shares of Series A preferred stock at $1.875 per
share, 86,320 shares of Series B preferred stock at $2.50 per share and 54,400
shares of Series C preferred stock at $3.75 per share. As of December 31, 1995,
no warrants had been exercised. The warrants expire the earlier of seven years
after their issuance or three years after an underwritten initial public
offering.

1993 Stock Plan

During 1993, the board of directors adopted the 1993 Stock Plan (the
"Plan"). The Company has reserved a total of 880,000 common shares for issuance
under the Plan.

Under the Plan, options and stock purchase rights may be granted by the
board of directors to employees and consultants. Options granted may be either
incentive stock options or nonstatutory stock options. Incentive stock options
may be granted to employees with exercise prices of no less than the fair value
and nonstatutory options may be granted to employees or consultants at exercise
prices of no less than 85% of the fair value of the common stock on the grant
date as determined by the board of directors. Options vest as determined by the
board of directors, generally at the rate of 25% at the end of the first year
with the

F-11
<PAGE> 68

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

remaining balance vesting ratably over the next three years. Common stock issued
pursuant to exercise of stock purchase rights are subject to repurchase by the
Company upon termination of employment. The Company's repurchase right generally
lapses over four years.

Activity under the Plan is as follows:

<TABLE>
<CAPTION>
SHARES OPTIONS OUTSTANDING
AVAILABLE -------------------------
FOR GRANT NUMBER OF PRICE PER
OF OPTIONS SHARES SHARE
---------- --------- -----------
<S> <C> <C> <C>
Shares reserved.......................................... 680,000 -- --
Options granted........................................ (188,200) 188,200 $0.20-$0.25
Options exercised...................................... -- (20,000) $ 0.25
-------- -------- -----------
Balance at December 31, 1993............................. 491,800 168,200 $0.20-$0.25
Additional shares reserved............................. 200,000 -- --
Options granted........................................ (402,700) 402,700 $0.25-$0.38
Options exercised...................................... -- (149,333) $0.20-$0.25
Options canceled....................................... 37,167 (37,167) $0.20-$0.25
-------- -------- -----------
Balance at December 31, 1994............................. 326,267 384,400 $0.20-$0.38
Options granted........................................ (144,800) 144,800 $ 0.38
Options exercised...................................... -- (13,867) $0.25-$0.38
Options canceled....................................... 18,833 (18,833) $0.20-$0.38
-------- -------- -----------
Balance at December 31, 1995............................. 200,300 496,500 $0.20-$0.38
Additional shares reserved............................. 500,000 -- --
Options granted........................................ (215,600) 215,600 $0.38-$2.50
Options exercised...................................... (20,750) $0.25-$0.38
Options canceled....................................... 750 (750) $ 0.25
-------- -------- -----------
Balance at March 31, 1996................................ 485,450 690,600 $0.20-$2.50
======== ======== ===========
</TABLE>

As of March 31, 1996 and December 31, 1995, options to purchase 236,696 and
212,967 shares of common stock, respectively, were exercisable under the Plan.
Through March 31, 1996, 180,000 shares of common stock have been issued pursuant
to stock purchase rights granted under the Plan, of which 80,625 shares were
subject to the Company's repurchase right at original purchase prices, ranging
from $0.25 to $0.38 per share (69,375 shares subject to repurchase at March 31,
1996).

At December 31, 1995, the Company has recorded deferred compensation of
$578,000 representing the difference between the exercise price and the deemed
fair value for financial reporting purposes of the Company's common stock
ranging from $1.25 to $6.25 per share for 144,500 shares subject to common stock
options and stock purchase rights granted. The deferred stock compensation is
amortized to expense over the period during which the options become
exercisable, generally four years. During the first quarter of 1996 options to
purchase a total of 215,600 shares were granted at a weighted average exercise
price of $2.44 per share, and for which deemed fair values of $9.25 to $10.00
per share were recorded, resulting in additional deferred compensation of
$1,626,000.

F-12
<PAGE> 69

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

6. COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS

Ortho Pharmaceutical Corporation

In October 1995, the Company entered into a research and development
agreement with Ortho Pharmaceutical Corporation ("Ortho"), a Johnson & Johnson
company, to discover and develop novel beta-lactam antibiotics, antibiotic
potentiators and inhibitors of bacterial signal transduction targeted at
problematic Gram-positive bacteria, including staphylococci and enterococci. The
agreement provides for certain revenue payments, including payments for research
and development costs for three years and for reaching certain research and
development goals. Ortho received exclusive worldwide rights to products
developed during the collaboration in the field of use as defined in the
agreement. The development, manufacturing, marketing and sales of drugs
resulting from the collaboration will be conducted by Ortho, provided that the
Company has the right to undertake certain co-promotion activities in North
America, subject to Ortho's approval. Should the development efforts result in a
marketable product, the Company will receive royalty payments based on Ortho's
sales. In connection with the agreement, Ortho made a nonrefundable $3,000,000
up-front license payment to the Company, and an affiliate of Ortho made an
equity investment of $5,000,000 in return for 571,429 shares of Series D
preferred stock (see Note 5). Total revenue recognized under the agreement for
the year ended December 31, 1995 and the three months ended March 31, 1996 was
$3,647,000 and $875,000, respectively.

Daiichi Pharmaceuticals Co. Ltd.

In November 1995, the Company entered into a research and development
agreement with Daiichi Pharmaceuticals Co. Ltd. ("Daiichi") to discover and
develop bacterial efflux pump inhibitors to be used in combination with
Daiichi's quinolone antibiotics to target Gram-negative bacteria, including
pseudomonas. The agreement provides for certain revenue payments, including
payments for research and development costs for three years commencing March 31,
1995 and for reaching certain research and development goals. Daiichi has the
right to enter into a license agreement for exclusive worldwide rights to
products developed during the collaboration in the field of use as defined in
the agreement. The development, manufacturing and sale of drugs resulting from
the collaboration will be conducted by Daiichi, subject to the Company's right
to co-promote such drugs in North America. Should the development efforts result
in a marketable product, the Company will receive royalty payments based on
Daiichi's sales. Total research revenue recognized under the agreement for the
year ended December 31, 1995 and the three months ended March 31, 1996 was
$1,338,000 and $652,000, respectively.

Pfizer Inc

In February 1996, the Company entered into a research and development
agreement with Pfizer Inc ("Pfizer") to implement its essential gene and
multi-channel screening system to discover novel classes of antibiotics. The
agreement provides for certain revenue payments, including payments for research
and development costs for five years and for reaching certain research and
development goals. Pfizer received exclusive worldwide rights to products
developed during the collaboration. The development, manufacturing, and sale of
drugs resulting from the collaboration will be conducted by Pfizer, subject to
the Company's right to co-promote such products in North America. Should the
development efforts result in a marketable product, the Company will receive
royalty payments based on Pfizer's sales. In connection with the agreement,
Pfizer made a $1,000,000 up-front license payment and a $5,000,000 equity
investment in return for 571,429 shares of Series E preferred stock. Revenue
recognized under the agreement for the three months ended March 31, 1996 was
$1,098,000.

Costs related to research revenues under the above agreements for the year
ended December 31, 1995 and the three months ended March 31, 1996 approximated
the related revenue recognized.

F-13
<PAGE> 70

MICROCIDE PHARMACEUTICALS, INC.
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(INFORMATION FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

7. INCOME TAXES

As of December 31, 1995, the Company had federal and state net operating
loss carryforwards of approximately $13,000,000 and $4,000,000, respectively.
The Company also had federal research and development tax credit carryforwards
of approximately $300,000. The federal net operating loss and credit
carryforwards will expire at various dates beginning in 2008 through 2010, if
not utilized. The state net operating loss carryforward will expire at various
dates beginning in 1998 through 2000, if not utilized.

Utilization of the net operating losses and credits may be subject to an
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
------- -------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............................... $ 3,400 $ 4,700
Research credit carryforwards.................................. 300 500
Other.......................................................... 300 400
------- -------
Total deferred tax assets........................................ 4,000 5,600
Valuation allowance.............................................. (4,000) (5,600)
------- -------
Net deferred tax assets.......................................... $ -- $ --
======= =======
</TABLE>

The valuation allowance increased by $1,600,000 during the year ended
December 31, 1995 ($2,900,000 in 1994).

8. SUBSEQUENT EVENTS

On February 23, 1996, the Board of Directors authorized the filing of a
registration statement with the Securities and Exchange Commission permitting
the Company to sell shares of its common stock to the public. If the offering is
consummated under terms presently anticipated, all of the currently outstanding
preferred stock will automatically convert to 6,880,791 shares of common stock.
Unaudited pro forma stockholders' equity as adjusted for the matters described
above is set forth in the accompanying balance sheet.

On February 23, 1996, the Board of Directors, subject to stockholder
approval, (1) authorized the reincorporation of the Company in the State of
Delaware, and (2) approved a one-for-five reverse stock split of its common
stock and preferred stock through an amendment to the Articles of Incorporation.
All share and per share amounts in the accompanying financial statements have
been retroactively adjusted to reflect the reverse stock split. The Board has
also approved an amendment to the Articles of Incorporation to change the number
of authorized shares of common stock to 50,000,000 shares and preferred stock to
5,000,000 shares upon the closing of the offering, both of which will have a par
value of $0.001 per share. On March 7, 1996, the Board approved the adoption of
the 1996 Employee Stock Purchase Plan and the 1996 Directors' Stock Option Plan,
which authorizes the issuance of 120,000 and 80,000 shares, respectively, under
the plans. The Board also approved an amendment to the Company's 1993 stock
option plan to increase the number of common shares authorized for issuance by
500,000 shares for a total of 1,380,000 common shares reserved for issuance
under the plan. In April 1996, the above actions were approved by the
stockholders.

On April 5, 1996 the Company effected the one-for-five reverse stock split
described in the previous paragraph.

F-14
<PAGE> 71

[GRAPHIC APPEARS HERE]

[Narrative Description: Graphic depiction of the molecular
aspects of bacteria and antibiotic action.]
<PAGE> 72

- ------------------------------------------------------
- ------------------------------------------------------

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO
WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO
ANY PERSON IN ANY JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 5
The Company........................... 12
Use of Proceeds....................... 12
Dividend Policy....................... 12
Capitalization........................ 13
Dilution.............................. 14
Selected Financial Data............... 15
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 16
Business.............................. 20
Management............................ 39
Certain Transactions.................. 47
Principal Stockholders................ 49
Description of Capital Stock.......... 51
Shares Eligible for Future Sale....... 53
Underwriting.......................... 54
Legal Matters......................... 55
Experts............................... 55
Additional Information................ 56
Index to Financial Statements......... F-1
</TABLE>

------------------------

UNTIL JUNE 8, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

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2,500,000 SHARES

LOGO

MICROCIDE PHARMACEUTICALS, INC.

COMMON STOCK
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PROSPECTUS
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MERRILL LYNCH & CO.

ALEX. BROWN & SONS
INCORPORATED

COWEN & COMPANY
MAY 14, 1996
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