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PROSPECTUS
5,000,000 SHARES
[LOGO]
COMMON STOCK
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This is our initial public offering of shares of common stock. We are offering
5,000,000 shares. No public market currently exists for our common stock.
Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "KOSN."
INVESTING IN THE SHARES INVOLVES RISKS. "RISK FACTORS" BEGIN ON PAGE 7.
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<CAPTION>
Per Share Total
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<S> <C> <C>
Public offering price....................................... $14.00 $70,000,000
Underwriting discounts and commissions...................... $ 0.98 $ 4,900,000
Proceeds, before expenses, to Kosan......................... $13.02 $65,100,000
</TABLE>
We have granted the underwriters a 30-day option to purchase up to 750,000
shares of common stock to cover any over-allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
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LEHMAN BROTHERS
CIBC WORLD MARKETS
SG COWEN
FIDELITY CAPITAL MARKETS
a division of National Financial Services LLC
October 5, 2000
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ARTWORK
[DESCRIPTION OF ARTWORK]
[Front cover
"KOSAN TECHNOLOGY PLATFORM" The art shows 4 cells (arranged diagonally), each
containing a polyketide gene with modules of different color; an arrow leads
from one cell to the next indicating a conversion, and each cell has an arrow to
a polyketide structure, indicating the production of that polyketide. Each
conversion has an explanatory caption by its side. The conversions indicated by
color and size changes are over-production, gene manipulation and
chemobiosynthesis.
Following are captions that will be presented with the artwork:
OVER-PRODUCTION. Genes transferred to better hosts.
GENE MANIPULATION. Altered genes yield new compounds.
CHEMOBIOSYNTHESIS. Synthetic starting materials yield new compounds.]
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary...................... 3
Risk Factors............................ 7
Forward-Looking Statements.............. 14
Use of Proceeds......................... 15
Dividend Policy......................... 15
Dilution................................ 16
Capitalization.......................... 17
Selected Financial Data................. 18
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................ 20
Business................................ 25
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<TABLE>
Management and Directors................ 38
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Related Party Transactions.............. 50
Principal Stockholders.................. 53
Description of Capital Stock............ 56
Shares Eligible for Future Sale......... 58
Underwriting............................ 60
Legal Matters........................... 63
Change in Independent Auditors.......... 63
Experts................................. 63
Where You Can Find More Information..... 63
Index to Financial Statements........... F-1
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PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS
THAT WE BELIEVE MOST IMPORTANT ABOUT THIS OFFERING AND OUR BUSINESS. YOU SHOULD
READ THE ENTIRE PROSPECTUS CAREFULLY FOR A COMPLETE UNDERSTANDING OF THIS
OFFERING AND OUR BUSINESS.
OUR BUSINESS
We are a biotechnology company using our proprietary technologies to develop
drug candidates from an important class of natural product compounds known as
polyketides. Polyketides are naturally made in very small amounts in
microorganisms and are structurally complex and difficult to make or modify by
chemical means. We have developed technologies to manipulate the natural process
by which polyketides are made. These technologies give us the ability to create
novel polyketides thereby providing a pipeline of potential drug candidates.
Polyketides have been a source of many different pharmaceuticals including
antibiotics, anticancer drugs, cholesterol-lowering drugs, immunosuppressants,
and other therapeutics, as well as animal health and agricultural products.
Natural or semi-synthetic polyketide pharmaceuticals represent over
20 products, with sales of approximately $10 billion per year.
Using our technologies, we are able to modify and produce polyketides in
ways chemists cannot. Our approach mimics, accelerates and expands the
evolutionary process that gave rise to this important class of molecules. We use
our technologies to:
- create improved versions of currently marketed pharmaceuticals that
address large markets;
- modify an existing polyketide used in one therapeutic area to create a new
polyketide to be used in another;
- transfer the ability to make a polyketide from one organism to another to
enable large-scale production; and
- generate large numbers of new polyketides to provide a source of new drug
candidates.
OUR TECHNOLOGIES
Our technology platform has five components which allow us to modify, create
and produce new polyketides:
- polyketide gene alteration--the creation of new polyketides using our
technology to manipulate the genetic instructions by which polyketides are
made;
- chemobiosynthesis--the creation of new polyketides by incorporating
synthetic starting materials into the biological processes by which
polyketides are made;
- heterologous over-expression--the over-production of polyketides by
transferring the genes to better hosts;
- combinatorial biosynthesis--the rapid and efficient production of many
different polyketides with related structures; and
- screening libraries--large collections of many different polyketides that
can be readily tested for biological activities of interest.
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OUR STRATEGY
Our strategy is to apply our technologies to create new polyketides for
development as pharmaceutical products and to advance these drug candidates into
clinical trials. We aim to:
- maximize the value and minimize the risk associated with new drug
development by focusing on new compounds with structures related to
existing polyketides that have known utility, safety and significant
market potential;
- establish collaborative relationships with large pharmaceutical companies
to advance our most complex programs through clinical trials and into the
market, as well as to prepare and test our screening libraries;
- expand and enhance our technologies and increase our capabilities for
making new and useful polyketides; and
- acquire or license complementary technologies or drug candidates from
third parties.
OUR PRODUCT DEVELOPMENT OPPORTUNITIES
We have six primary programs for the discovery and development of new
polyketides that are directed at infectious disease, gastrointestinal motility
disorders, mucus hypersecretion, cancer, immunosuppression and nerve
regeneration. These programs were selected because they represent opportunities
where our technologies could improve existing products or fill unmet needs, and
address large markets. Since September 1998, we have identified several
polyketide antibiotic drug candidates that kill organisms that are resistant to
existing products. We have developed these drug candidates in collaboration with
The R.W. Johnson Pharmaceutical Research Institute, a Johnson & Johnson company.
In August 2000, we signed a collaboration and license agreement with the
Sloan-Kettering Institute for Cancer Research relating to potential anti-cancer
compounds known as epothilones.
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THE OFFERING
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Common stock offered by us................ 5,000,000 shares
Common stock to be outstanding after this
offering................................ 23,844,539 shares(1)
Nasdaq National Market symbol............. KOSN
Use of proceeds........................... We intend to use the net proceeds from this offering for
advancing our drug candidates through preclinical and
later-stage development, discovering or acquiring new
drug candidates, expanding our technology platform,
capital expenditures, working capital, general corporate
purposes and possible future acquisitions. See "Use of
Proceeds."
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Unless otherwise indicated, information in this prospectus assumes:
- the automatic conversion of all outstanding shares of our convertible
preferred stock into 12,220,719 shares of common stock upon the closing of
this offering;
- no exercise of the underwriters' over-allotment option to purchase up to
750,000 shares; and
- an increase in the authorized shares of our common stock and preferred
stock to 200,000,000 shares and 10,000,000 shares, respectively, at the
closing of this offering.
------------------------
(1) The number of shares of common stock to be outstanding after this offering
excludes:
- 2,902,107 shares of common stock reserved for issuance under our 1996
stock option plan, of which 1,141,800 shares are subject to outstanding
options at June 30, 2000 with a weighted average exercise price of $1.35
per share;
- 300,000 shares of common stock reserved for issuance under our 2000
employee stock purchase plan approved by our board of directors in March
2000; and
- 300,000 shares of common stock reserved for issuance under our 2000
non-employee director stock option plan approved by our board of directors
in March 2000.
Our principal executive offices are located at 3832 Bay Center Place,
Hayward, California, 94545. Our phone number is (510) 732-8400. Our website is
http://www.kosan.com. We do not intend for the information found on our website
to be incorporated into or be a part of this prospectus.
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SUMMARY FINANCIAL DATA
The following tables summarize our financial data, and should be read
together with our financial statements and the related notes, the "Selected
Financial Data" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this prospectus. The pro forma
information contained in the statement of operations data gives effect to the
automatic conversion of all convertible preferred stock upon the completion of
this offering. The pro forma balance sheet data reflects the automatic
conversion of our preferred stock into common stock on a three-for-one basis and
the sale of 5,000,000 shares of our common stock at an initial public offering
price of $14.00 per share, after deducting the underwriting discounts,
commissions and estimated offering expenses payable by us.
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<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------ ----------------------------
1997 1998 1999 1999 2000
STATEMENT OF OPERATIONS DATA: ---------- ---------- ---------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Total revenue......................... $ 287 $ 1,236 $ 5,346 $ 3,107 $ 2,224
Total operating expenses.............. 2,379 5,021 10,400 4,650 9,414
Loss from operations.................. (2,092) (3,785) (5,054) (1,543) (7,190)
Net loss.............................. $(1,994) $(3,267) $(4,401) $(1,280) $ (6,679)
Deemed dividend upon issuance of
Series C convertible preferred
stock............................... -- -- -- -- (11,267)
------- ------- ------- ------- --------
Net loss attributable to common
stockholders........................ $(1,994) $(3,267) $(4,401) $(1,280) $(17,946)
Basic and diluted net loss per
share............................... $ (0.49) $ (0.77) $ (0.98) $ (0.29) $ (3.57)
Shares used in computing basic and
diluted net loss per share.......... 4,094 4,270 4,509 4,430 5,029
Pro forma basic and diluted net loss
per share (unaudited)............... $ (0.31) $ (1.12)
Shares used in computing pro forma
basic and diluted net loss per share
(unaudited)......................... 14,318 16,056
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<CAPTION>
AS OF JUNE 30, 2000
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ACTUAL PRO FORMA
BALANCE SHEET DATA: -------- ---------
(IN THOUSANDS)
<S> <C> <C>
Cash, cash equivalents and short-term investments........... $ 25,027 $ 88,877
Working capital............................................. 22,370 86,220
Long-term investments....................................... 7,235 7,235
Total assets................................................ 36,898 100,748
Capital lease and debt obligations, less current portion.... 2,099 2,099
Accumulated deficit......................................... (18,272) (18,272)
Stockholders' equity........................................ 31,777 95,627
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RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW TOGETHER WITH ALL OF
THE OTHER INFORMATION INCLUDED IN THIS PROSPECTUS BEFORE MAKING AN INVESTMENT
DECISION.
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF NET LOSSES AND MAY NEVER BECOME PROFITABLE.
We commenced operations in 1996 and are still in an early stage of
development. We have not commercialized any products and we have incurred
significant losses to date. As of June 30, 2000, we had an accumulated deficit
of approximately $18.3 million. To date, our revenues have been solely from
collaborations and government grants. Our expenses have consisted principally of
costs incurred in research and development and from general and administrative
costs associated with our operations. We have incurred net losses since our
inception, including a net loss of approximately $6.7 million for the six months
ended June 30, 2000. We expect our expenses to increase and to continue to incur
operating losses for at least the next several years as we continue our research
and development efforts for our drug candidates. The amount of time necessary to
successfully commercialize any of our drug candidates is long and uncertain and
successful commercialization may not occur at all. As a result, we may never
become profitable.
IF WE ARE UNABLE TO OBTAIN ADDITIONAL FUNDS, WE MAY NOT BE ABLE TO SUPPORT OUR
OPERATIONS.
Based on our current plans, we believe our cash, cash equivalents and
investments, together with the net proceeds of this offering, will be sufficient
to fund our operating expenses and capital requirements through at least the
next 24 months. However, the actual amount of funds that we will need during or
after the next 24 months will be determined by many factors, including those
discussed in this section. If additional funds are required and we are unable to
obtain them on terms favorable to us, we may be required to delay, scale back or
eliminate some or all of our research and development programs or to license
third parties to develop or market products or technologies that we would
otherwise seek to develop or market ourselves. If we raise additional funds by
selling additional shares of our capital stock, the ownership interest of our
stockholders will be diluted.
IF WE DON'T ESTABLISH AND MAINTAIN COLLABORATIONS WITH OTHER PARTIES, THE
DEVELOPMENT OF OUR PRODUCTS MAY BE DELAYED OR STOPPED.
Because we do not currently possess the financial and other resources
necessary to develop potential products that may result from our technologies,
or the financial and other resources to complete any approval processes which
may be required for these products, we must enter into collaborative
arrangements to develop many of our drug candidates. If we do not maintain or
further extend our current collaboration with The R.W. Johnson Pharmaceutical
Research Institute and Ortho-McNeil Pharmaceutical, Inc., both Johnson & Johnson
companies, which expires on December 28, 2001, or if we do not enter into new
collaborative agreements, then our revenues will be reduced, and our drug
candidates may not be developed, manufactured or marketed.
OUR POTENTIAL PRODUCTS ARE IN AN EARLY STAGE OF DEVELOPMENT AND SUBSTANTIAL
ADDITIONAL EFFORT WILL BE NECESSARY FOR DEVELOPMENT.
Our technologies are new and our drug candidates are in the early stage of
development. We may not develop products that prove to be safe and effective,
meet applicable regulatory standards, are capable of being manufactured at
reasonable costs, or can be marketed successfully. All of the potential
proprietary products that we are currently developing will require significant
development and investment, including extensive preclinical and clinical testing
before we can submit any application for regulatory approval. Before obtaining
regulatory approvals for the commercial sale of any of our
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products, we must demonstrate through preclinical testing and clinical trials
that our drug candidates are safe and effective in humans. We have not commenced
clinical testing of any of our potential products, nor have we submitted any
application to test any potential products in humans. Conducting clinical trials
is a lengthy, expensive and uncertain process. Completion of clinical trials may
take several years or more. The length of time generally varies substantially
according to the type, complexity, novelty and intended use of the drug
candidate. Our clinical trials, when commenced, may be suspended at any time if
we or the U.S. Food and Drug Administration, or the FDA, believe the patients
participating in our studies are exposed to unacceptable health risks. We may
encounter problems in our studies which will cause us or the FDA to delay or
suspend the studies. Our commencement and rate of completion of clinical trials
may be delayed by many factors, including:
- ineffectiveness of the study compound, or perceptions by physicians that
the compound is not effective for a particular indication;
- inability to manufacture sufficient quantities of compounds for use in
clinical trials;
- failure of the FDA to approve our clinical trial protocols;
- slower than expected rate of patient recruitment;
- unforeseen safety issues; or
- government or regulatory delays.
If any future clinical trials are not successful, our business, financial
condition and results of operations will be harmed.
ANY INABILITY TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGIES COULD HARM OUR
COMPETITIVE POSITION.
Our success will depend in part on our ability to obtain patents and
maintain adequate protection of other intellectual property for our technologies
and products in the United States and other countries. If we do not adequately
protect our intellectual property, competitors may be able to use our
technologies and erode or negate our competitive advantage. The laws of some
foreign countries do not protect our proprietary rights to the same extent as
the laws of the United States, and we may encounter significant problems in
protecting our proprietary rights in these foreign countries.
The patent positions of biotechnology companies, including our patent
position, involve complex legal and factual questions and, therefore, validity
and enforceability cannot be predicted with certainty. Patents may be
challenged, deemed unenforceable, invalidated or circumvented. We will be able
to protect our proprietary rights from unauthorized use by third parties only to
the extent that our proprietary technologies are covered by valid and
enforceable patents or are effectively maintained as trade secrets. We will
apply for patents covering both our technologies and drug candidates as we deem
appropriate. However, we may fail to apply for patents on important technologies
or products in a timely fashion or at all, and in any event, the applications we
do file may be challenged and may not result in issued patents. Our existing
patents and any future patents we obtain may not be sufficiently broad to
prevent others from practicing our technologies or from developing competing
products. Furthermore, others may independently develop similar or alternative
technologies or design around our patented technologies. In addition, others may
challenge or invalidate our patents, or our patents may fail to provide us with
any competitive advantages. If the use or validity of any of our patents is ever
challenged, resulting in litigation or administrative proceedings, we would
incur substantial costs and the diversion of management in defending the patent.
In addition, we generally do not control the patent prosecution of technology
that we license from others. Accordingly, we are unable to exercise the same
degree of control over this intellectual property as we would over technology we
own.
We rely upon trade secret protection for our confidential and proprietary
information. We have taken measures to protect our proprietary information.
These measures may not provide adequate protection for our trade secrets or
other proprietary information. We seek to protect our proprietary
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information by entering into confidentiality agreements with employees,
collaborators, and consultants. Nevertheless, employees, collaborators, or
consultants may still disclose our proprietary information, and we may not be
able to meaningfully protect our trade secrets. In addition, others may
independently develop substantially equivalent proprietary information or
techniques or otherwise gain access to our trade secrets.
LITIGATION OR OTHER PROCEEDINGS OR THIRD-PARTY CLAIMS OF INTELLECTUAL PROPERTY
INFRINGEMENT WOULD REQUIRE US TO SPEND TIME AND MONEY AND COULD PREVENT US FROM
DEVELOPING OR COMMERCIALIZING PRODUCTS.
Our commercial success depends in part on not infringing the patents and
proprietary rights of third parties and not breaching any licenses that we have
entered into with regard to our technologies and products. The biotechnology
industry is characterized by extensive litigation regarding patents and other
intellectual property rights. Other parties may have been issued relevant
patents or may have filed relevant patent applications that could affect our
ability to obtain patents or to operate as we would like to in our research,
development, and commercialization efforts. If we wish to use technologies
claimed by third parties in issued and unexpired patents, then we may need to
obtain license(s) from the owner(s) of such patent(s), enter into litigation, or
incur the risk of litigation. Litigation or failure to obtain necessary licenses
may impede our ability to obtain collaborations or to develop our products and
could prevent us or our collaborators from developing or commercializing our
products.
Other biotechnology and pharmaceutical companies have filed patent
applications and obtained patents, and in the future will likely continue to
file patent applications and obtain patents, claiming polyketide synthase genes,
gene fragments, and methods for modifying such genes or gene fragments. If these
patents are valid or if these applications issue into valid patents, we will
have to either circumvent the claims in these patents, or obtain licenses to use
the patented technology in order to use these genes or technologies in the
research, development and commercialization of our products and technologies. If
we are unsuccessful in circumventing or acquiring licenses to these patents, our
ability to research, develop or commercialize products may be blocked.
Third parties may sue us in the future to challenge our patent rights or
claim infringement of their patents. An adverse determination in litigation to
which we may become a party could subject us to significant liabilities to third
parties, require us to license disputed rights from third parties or require us
to cease using the disputed technology.
We are aware of a significant number of patents and patent applications
relating to aspects of our technologies and families of compounds filed by, and
issued to, third parties. If any of our competitors have filed patent
applications or have been granted patents claiming inventions also claimed by
us, we may have to participate in an interference proceeding declared by the
relevant patent regulatory agency to determine priority of invention and, thus,
the right to a patent for these inventions in the United States. Such a
proceeding could result in substantial cost to us even if the outcome is
favorable. For example, a number of companies have cloned polyketide synthase
genes and described in patents or publications technology to modify those genes
or express them in heterologous hosts using recombinant DNA technology. Such
companies include, for example, Abbott Laboratories (erythromycin, niddamycin);
Dow Agrosciences (spinosyn); Eli Lilly and Company (tylosin, spiramycin),
Novartis (soraphen, epothilone); and Merck (avermectin, lovastatin). Even if
successful on priority grounds, an interference may result in loss of claims
based on patentability grounds raised in the interference. Although patent and
intellectual property disputes in the biotechnology area are often settled
through licensing or similar arrangements, costs associated with these
arrangements may be substantial and could include ongoing royalties.
Furthermore, we cannot be certain that the necessary licenses would be available
to us on satisfactory terms, if at all.
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Third parties may obtain patents in the future and then claim that the use
of our technologies infringes these patents or that we are employing their
proprietary technology without authorization. This is because patent
applications in the United States are secret until issued into corresponding
patents and the applications can be pending for several years after filing. We
could incur substantial costs and diversion of management and technical
personnel in defending ourselves against any of these claims or enforcing our
patents against others. Furthermore, parties making claims against us may be
able to obtain injunctive or other equitable relief which could effectively
block our ability to further develop, commercialize, and sell products, and
could result in the award of substantial damages against us. In the event of a
successful claim of infringement against us, we may be required to:
- pay damages;
- stop using our products or methods;
- develop non-infringing products or methods; and
- obtain one or more licenses from third parties.
We may not be able to obtain these licenses at a reasonable cost, if at all.
In that event, we could encounter substantial delays in product introductions
while we attempt to develop alternative methods or products, which we may not be
able to accomplish.
IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH THROUGH RECRUITING AND
RETAINING SKILLED EMPLOYEES AND EXPAND OUR MANAGEMENT AND IMPROVE OUR CONTROLS
AND SYSTEMS, WE MAY NOT BE ABLE TO MANAGE OUR DAY-TO-DAY OPERATIONS.
We have experienced a period of rapid and substantial growth that has
placed, and if this growth continues will further place, a strain on our human
and capital resources. If we are unable to manage this growth effectively, then
our losses could increase. The number of our employees increased from 21 on
December 31, 1997 to 62 on June 30, 2000. Retaining our current employees and
recruiting qualified scientific personnel to perform future research and
development work will be critical to our success. Competition is intense for
experienced scientists, and we may not be able to retain or recruit sufficient
skilled personnel to allow us to pursue collaborations and develop our products
and core technologies to the extent otherwise possible. Additionally, we are
highly dependent on the principal members of our management and scientific
staff, such as our two co-founders, the loss of whose services would adversely
impact the achievement of our objectives. Although we maintain and are the
beneficiary of $1.0 million key-man life insurance policies for the lives of
each of our two co-founders, Dr. Daniel Santi, our chief executive officer, and
Dr. Chaitan Khosla, a director and consultant, we do not believe the proceeds
would be adequate to compensate us for their loss.
Our ability to manage our operations and growth effectively requires us to
continue to expend funds to expand our management and improve our controls and
systems. If we are unable to successfully implement these expansions and
improvements, then we may not be able to effectively manage our day-to-day
operations.
WE FACE INTENSE COMPETITION FROM LARGE PHARMACEUTICAL COMPANIES, BIOTECHNOLOGY
COMPANIES AND ACADEMIC GROUPS.
We face, and will continue to face, intense competition from organizations
such as large biotechnology and pharmaceutical companies, as well as academic
and research institutions and government agencies, that are pursuing competing
technologies for modifying DNA. These organizations may develop technologies
that are superior alternatives to our technologies. Further, our competitors in
the polyketide gene engineering field may be more effective at implementing
their technologies to develop commercial products. Some of these competitors
have entered into collaborations with leading companies within our target
markets to produce polyketides for commercial purposes.
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Any products that we develop through our technologies will compete in
multiple, highly competitive markets. Development of pharmaceutical products
requires significant investment and resources. Many of the organizations
competing with us in the markets for such products have greater capital
resources, research and development and marketing staffs, facilities and
capabilities, and greater experience in modifying DNA, obtaining regulatory
approvals, and product manufacturing and marketing. Accordingly, our competitors
may be able to develop technologies and products more easily, which would render
our technologies and products and those of our collaborators obsolete and
noncompetitive.
IF WE FACE CLAIMS IN CLINICAL TRIALS OF A DRUG CANDIDATE, THESE CLAIMS WILL
DIVERT OUR MANAGEMENT'S TIME AND WE WILL INCUR LITIGATION COSTS.
We face an inherent business risk of clinical trial liability claims in the
event that the use or misuse of our potential products results in personal
injury or death. We may experience clinical trial liability claims if our drug
candidates are misused or cause harm before regulatory authorities approve them
for marketing. We currently do not maintain clinical trial liability insurance
coverage. Even if we do obtain an insurance policy, it may not be sufficient to
cover claims that may be made against us. Clinical trial liability insurance is
expensive, difficult to obtain and may not be available in the future on
acceptable terms, if at all. Any claims against us, regardless of their merit,
could materially and adversely affect our financial condition, because
litigation related to these claims would strain our financial resources in
addition to consuming the time and attention of our management. If we are sued
for any injuries caused by our products, our liability could exceed our total
assets.
WE USE HAZARDOUS CHEMICALS AND RADIOACTIVE AND BIOLOGICAL MATERIALS IN OUR
BUSINESS. ANY CLAIMS RELATING TO IMPROPER HANDLING, STORAGE, OR DISPOSAL OF
THESE MATERIALS COULD BE TIME CONSUMING AND COSTLY.
Our research and development processes involve the controlled use of
hazardous materials, including hazardous chemicals and radioactive and
biological materials. Some of these materials may be novel, including bacteria
with novel properties and bacteria that produce biologically active compounds.
Our operations also produce hazardous waste products. We cannot eliminate the
risk of accidental contamination or discharge and any resultant injury from
these materials. Federal, state, and local laws and regulations govern the use,
manufacture, storage, handling, and disposal of these materials. We believe that
our current operations comply in all material respects with these laws and
regulations. We could be subject to civil damages in the event of an improper or
unauthorized release of, or exposure of individuals to, hazardous materials. In
addition, we could be sued for injury or contamination that results from our use
or the use by third parties or our collaborators of these materials, and our
liability may exceed our total assets. Compliance with environmental laws and
regulations may be expensive, and current or future environmental regulations
may impair our research, development, or commercialization efforts.
WE HAVE ANTI-TAKEOVER PROVISIONS IN OUR CORPORATE CHARTER DOCUMENTS THAT MAY
RESULT IN OUTCOMES WITH WHICH YOU DO NOT AGREE.
Our board of directors will have the authority to issue up to 10,000,000
shares of undesignated preferred stock and to determine the rights, preferences,
privileges and restrictions of those shares without further vote or action by
our stockholders. The rights of the holders of any preferred stock that may be
issued in the future may adversely affect the rights of the holders of common
stock. The issuance of preferred stock could make it more difficult for third
parties to acquire a majority of our outstanding voting stock.
Our certificate of incorporation will provide for staggered terms for the
members of the board of directors and prevent our stockholders from acting by
written consent. These provisions and other provisions of our bylaws and of
Delaware law applicable to us could delay or make more difficult a merger,
tender offer or proxy contest involving us. This could reduce the price that
investors might be willing to pay for shares of our common stock and result in
the market price being lower than it would be without these provisions.
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SOME OF OUR EXISTING STOCKHOLDERS CAN EXERT CONTROL OVER US, AND MAY NOT MAKE
DECISIONS THAT ARE IN THE BEST INTERESTS OF ALL STOCKHOLDERS.
After this offering, our officers, directors and principal stockholders
(greater than 5% stockholders) will together control approximately 47.0% of our
outstanding common stock. As a result, these stockholders, if they act together,
will be able to exert a significant degree of influence over our management and
affairs and over matters requiring stockholder approval, including the election
of directors and approval of significant corporate transactions. In addition,
this concentration of ownership may delay or prevent a change in control of us
and might affect the market price of our common stock, even when a change may be
in the best interests of all stockholders. In addition, the interests of this
concentration of ownership may not always coincide with our interests or the
interests of other stockholders and accordingly, they could cause us to enter
into transactions or agreements which we would not otherwise consider.
RISKS RELATED TO THE OFFERING
OUR STOCK PRICE COULD BE VOLATILE AND YOUR INVESTMENT COULD SUFFER A DECLINE IN
VALUE.
The trading price of our common stock is likely to be highly volatile and
could be subject to wide fluctuations in price in response to various factors,
many of which are beyond our control, including:
- announcements of technological developments in research by us or our
competitors;
- delay or failure in initiating, conducting, completing or analyzing
clinical trials or unsatisfactory design or results of these trials;
- achievement of regulatory approvals;
- new products or services introduced or announced by us or our competitors;
- changes in financial estimates by securities analysts;
- announcements of departures or departures of key personnel; and
- sales of our common stock.
In addition, the stock market in general, and the Nasdaq National Market and
the market for biotechnology companies in particular, has experienced extreme
price and volume fluctuations that have often been unrelated or disproportionate
to the operating performance of those companies. These broad market and industry
factors may seriously harm the market price of our common stock, regardless of
our operating performance. In the past, following periods of volatility in the
market price of a company's securities, securities class-action litigation has
often been instituted against that company. If this type of litigation were
instituted against us, we would be faced with substantial costs and management's
attention and resources would be diverted, which could in turn seriously harm
our business, financial condition and results of operations.
WE EXPECT THAT OUR QUARTERLY RESULTS OF OPERATIONS WILL FLUCTUATE, AND THIS
FLUCTUATION COULD CAUSE OUR STOCK PRICE TO DECLINE, CREATING INVESTOR LOSSES.
Our quarterly operating results have fluctuated in the past and are likely
to do so in the future. These fluctuations could cause our stock price to
fluctuate significantly or decline. Some of the factors which could cause our
operating results to fluctuate include:
- expiration of research contracts with collaborators or government research
grants, which may not be renewed or replaced;
- the success rate of our discovery efforts leading to milestones and
royalties;
12
<PAGE>
- the timing and willingness of collaborators to commercialize our products;
and
- general and industry specific economic conditions, which may affect our
collaborators' research and development expenditures.
A large portion of our expenses are relatively fixed, including expenses for
facilities, equipment, and personnel. Accordingly, if revenues decline or do not
grow due to expiration of research contracts or government research grants,
failure to obtain new contracts or other factors, we may not be able to
correspondingly reduce our operating expenses. In addition, we expect operating
expenses to continue to increase. Failure to achieve anticipated levels of
revenues could therefore significantly harm our operating results for a
particular fiscal period.
Due to the possibility of fluctuations in our revenues and expenses, we
believe that quarter-to-quarter comparisons of our operating results are not a
good indication of our future performance. Our operating results in some
quarters may not meet the expectations of stock market analysts and investors.
In that case, our stock price would probably decline.
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE.
The market price of our common stock could decline as a result of sales of
substantial amounts of our common stock in the public market after the closing
of this offering or the perception that these sales could occur. In addition,
these factors could make it more difficult for us to raise funds through future
offerings of common stock. There will be 23,844,539 shares of common stock
outstanding immediately after this offering, or 24,594,539 shares if the
representatives of the underwriters exercise their over-allotment option in
full. The shares sold in this offering will be freely transferable without
restriction or further registration under the Securities Act of 1933, except for
any shares purchased by our affiliates, as defined in Rule 144 of the Securities
Act. 18,844,539 shares of common stock outstanding will be restricted securities
as defined in Rule 144. Of these shares, 16,449,285 shares will be subject to a
lock-up agreement providing that the stockholder will not offer, sell, or
otherwise dispose of any of the shares of common stock owned by them for a
period of 180 days after the date of this prospectus. These shares may be sold
on the 181st day after the date of this prospectus without registration under
the Securities Act to the extent permitted by Rule 144 or other exemptions under
the Securities Act. Lehman Brothers Inc. may, in its sole discretion, at any
time without notice, release all or any portion of the shares subject to the
lock-up agreements, which would result in more shares being available for sale
in the public market at an earlier date. In addition, as soon as practicable
after the date of this prospectus, we intend to file a registration statement on
Form S-8 with the Commission covering 3,502,107 shares of common stock reserved
for issuance under our 1996 stock option plan, our 2000 employee stock purchase
plan and our 2000 non-employee director stock option plan. Sales of common stock
by existing stockholders in the public market, or the availability of such
shares for sale, could materially and adversely affect the market price of our
common stock. See "Shares Eligible for Future Sale."
AS A NEW INVESTOR, YOU WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION.
If you purchase shares of our common stock in this offering, you will incur
immediate and substantial dilution of $9.99 per share in pro forma net tangible
book value. If the holders of outstanding options exercise those options, you
will incur further dilution. To the extent we raise additional capital by
issuing equity securities, our stockholders may experience additional
substantial dilution. See "Dilution."
13
<PAGE>
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that relate to future
events or our future financial performance. You can identify forward-looking
statements by terminology such as "may," "will," "should," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "intend," "potential," or
"continue" and variations of these words or other comparable words. Examples of
these forward-looking statements include, but are not limited to, statements
regarding the following:
- our technologies and programs,
- our ability to realize commercially valuable discoveries in our programs,
- our intellectual property portfolio,
- our business strategies and plans, and
- our ability to develop products suitable for commercialization.
Although we believe that the predictions and expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance, or achievements. The safe harbor for
forward-looking statements contained in the Securities Litigation Reform Act of
1995 protects companies from liability for their forward-looking statements if
they comply with the requirements of the Act. The Act does not provide the
protection for initial public offerings and is not available for our
forward-looking statements in this prospectus.
ABOUT THIS PROSPECTUS
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of time of delivery of this prospectus
or of any sale of our common stock.
14
<PAGE>
USE OF PROCEEDS
We estimate that the net proceeds from the sale of the 5,000,000 shares of
common stock that we are offering at an initial public offering price of $14.00
per share will be $63.9 million after deducting underwriters' discounts and
commissions and estimated offering expenses. If the underwriters' over-allotment
option is exercised in full, we estimate that the net proceeds will be
$73.6 million.
We anticipate using the net proceeds from this offering for advancing our
drug candidates through preclinical and later stage development, discovering or
acquiring new drug candidates, expanding our technology platform, capital
expenditures, working capital, general corporate purposes and possible future
acquisitions. The amounts and timing of our actual expenditures will depend upon
numerous factors, including the status of our product development and
commercialization efforts, technological advances, the amount of proceeds
actually raised in this offering and the amount of cash generated by our
operations. We may use a portion of the proceeds for the acquisition of, or
investment in, companies, technologies or assets that complement our business,
although we are not currently planning any acquisitions, and no portion of the
net proceeds has been allocated to any particular acquisition. We have not
determined the amounts we plan to spend on any of the areas listed above or the
timing of these expenditures. As a result, our management will have broad
discretion to allocate the net proceeds from this offering.
We believe that the net proceeds of this offering, existing cash, cash
equivalents and investments, will be sufficient to meet our operating expenses
and capital requirements for at least the next 24 months. Pending the use of the
net proceeds, we intend to invest the net proceeds in interest-bearing
investment grade and U.S. government securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain earnings, if any, for use in the expansion and
operation of our business and do not anticipate paying cash dividends for the
foreseeable future.
15
<PAGE>
DILUTION
Our pro forma net tangible book value, as of June 30, 2000, was
$31.8 million, or $1.69 per share of common stock after giving effect to the
automatic conversion of all outstanding shares of preferred stock into an
aggregate of 12,220,719 shares of common stock. Pro forma net tangible book
value represents the amount of total tangible assets less total liabilities,
divided by the number of shares of common stock outstanding. After giving effect
to our sale of common stock offered hereby at an initial public offering price
of $14.00 per share, and our receipt of the estimated net proceeds from the
offering of $63.9 million, our pro forma net tangible book value as of June 30,
2000 would have been approximately $95.7 million, or $4.01 per share. This
represents an immediate increase in net tangible book value of $2.32 per share
to existing stockholders and an immediate dilution of $9.99 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 before the
offering................................................ $ 1.69
Increase per share attributable to new investors.......... 2.32
Pro forma net tangible book value per share after this
offering.................................................. 4.01
------
Dilution per share to new investors......................... $ 9.99
======
</TABLE>
If the underwriters' over-allotment option were exercised in full, the pro
forma net tangible book value per share after this offering would be $4.29 per
share, the increase in net tangible book value per share to existing
stockholders would be $2.60 per share and the dilution in net tangible book
value to new investors would be $9.71 per share.
The following table summarizes, on a pro forma basis as of June 30, 2000,
the differences between existing stockholders and the new investors with respect
to the number of shares of common stock purchased from us, the total
consideration paid and the average price per share paid before deducting the
underwriting discounts and commissions and our estimated offering expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------- ----------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- -------- ------------ -------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders.................. 18,844,539 79% $ 46,744,000 40% $ 2.48
New investors.......................... 5,000,000 21 70,000,000 60 14.00
---------- ----- ------------ -----
Total................................ 23,844,539 100.0% $116,744,000 100.0%
========== ===== ============ =====
</TABLE>
The discussion and tables above assume no exercise of stock options
outstanding. At June 30, 2000, there were options outstanding to purchase a
total of 1,141,800 shares of common stock, with a weighted average exercise
price of $1.35 per share. To the extent that any of these options are exercised,
there will be further dilution to new investors.
16
<PAGE>
CAPITALIZATION
The following table shows our capitalization as of June 30, 2000:
- on an actual basis;
- on a pro forma basis to reflect the automatic conversion of all
outstanding shares of preferred stock into common stock and an increase in
the authorized shares of common stock and preferred stock to 200,000,000
shares and 10,000,000 shares, respectively, upon the closing of this
offering; and
- on a pro forma as adjusted basis to give effect to the sale of 5,000,000
shares of common stock by us in this offering at an initial public
offering price of $14.00 per share less the underwriters' discounts and
commissions and our estimated offering expenses.
<TABLE>
<CAPTION>
AS OF JUNE 30, 2000
----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Capital lease and debt obligations, less current portion.... $ 2,099 $ 2,099 $ 2,099
-------- -------- --------
Stockholders' equity:
Convertible preferred stock, par value $0.001; 4,348,182
shares authorized (actual); 10,000,000 shares authorized
(pro forma and pro forma as adjusted), 4,073,573 shares
issued and outstanding (actual); no shares issued and
outstanding (pro forma and pro forma as adjusted)....... 4 -- --
Common stock, par value $0.001; 36,000,000 shares
authorized (actual); 200,000,000 shares authorized (pro
forma and pro forma as adjusted), 6,623,820 shares
issued and outstanding, actual; 18,844,539 shares issued
and outstanding, pro forma; 23,844,539 shares issued and
outstanding, pro forma as adjusted...................... 7 19 24
Additional paid-in capital.................................. 61,651 61,643 125,488
Notes receivable from stockholders.......................... (647) (647) (647)
Deferred stock compensation................................. (10,906) (10,906) (10,906)
Accumulated other comprehensive loss........................ (60) (60) (60)
Accumulated deficit......................................... (18,272) (18,272) (18,272)
-------- -------- --------
Total stockholders' equity............................ 31,777 31,777 95,627
-------- -------- --------
Total capitalization.................................. $ 33,876 $ 33,876 $ 97,726
======== ======== ========
</TABLE>
This table excludes:
- 2,902,107 shares of our common stock reserved for issuance under our 1996
stock option plan, of which 1,141,800 shares are subject to outstanding
options with a weighted average exercise price of $1.35 per share;
- 300,000 shares available for issuance under our 2000 employee stock
purchase plan approved by our board of directors in March 2000; and
- 300,000 shares available for issuance under our 2000 non-employee director
stock option plan approved by our board of directors in March 2000.
17
<PAGE>
SELECTED FINANCIAL DATA
You should read the following selected historical financial data in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and related notes
appearing elsewhere in this prospectus. We have derived the selected financial
data set forth below with respect to our statements of operations for the years
ended December 31, 1997, 1998 and 1999 and with respect to our balance sheets at
December 31, 1998 and 1999 from our financial statements that Ernst & Young LLP
audited. The audited financial statements qualify the disclosure in this
selected financial data. You can review the audited financial statements
elsewhere in this prospectus. We have derived the statement of operations data
for the period from inception (January 5, 1995) to December 31, 1995 and for the
year ended December 31, 1996 and the balance sheet data as of December 31, 1996
and 1997 from our audited financial statements that we do not include in this
prospectus. We have derived the selected financial data set forth below with
respect to our statements of operations for the six months ended June 30, 1999
and 2000 and the balance sheet data at June 30, 2000 from our unaudited
financial statements included elsewhere in this prospectus. The unaudited
financial statements include, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, which we consider necessary for
a fair presentation of our financial position and results of operations for
these periods. We do not intend for the selected data in this section to replace
our financial statements. Historical results are not necessarily indicative of
the results that you might expect in the future.
<TABLE>
<CAPTION>
FROM INCEPTION
(JANUARY 5, SIX MONTHS ENDED
1995) TO YEAR ENDED DECEMBER 31, JUNE 30,
DECEMBER 31, ----------------------------------------- -------------------
STATEMENT OF OPERATIONS DATA: 1995 1996 1997 1998 1999 1999 2000
----------------------------- -------------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Contract revenue........................... $ -- $ -- $ 10 $ 974 $ 5,206 $ 3,027 $ 2,084
Grant revenue.............................. -- 200 277 262 140 80 140
------ ------- ------- ------- ------- ------- --------
Total revenues........................... -- 200 287 1,236 5,346 3,107 2,224
Operating expenses:
Research and development (1)............. 197 1,286 1,922 4,030 8,587 3,838 7,621
General and administrative (1)........... 281 402 457 991 1,813 812 1,793
------ ------- ------- ------- ------- ------- --------
Total operating expenses................. 478 1,688 2,379 5,021 10,400 4,650 9,414
------ ------- ------- ------- ------- ------- --------
Loss from operations....................... (478) (1,488) (2,092) (3,785) (5,054) (1,543) (7,190)
Other income, net.......................... -- 35 98 518 653 263 511
------ ------- ------- ------- ------- ------- --------
Net loss................................... (478) (1,453) (1,994) (3,267) (4,401) (1,280) (6,679)
Deemed dividend upon issuance of Series C
convertible preferred stock.............. -- -- -- -- -- -- (11,267)
------ ------- ------- ------- ------- ------- --------
Net loss attributable to common
stockholders............................. $ (478) $(1,453) $(1,994) $(3,267) $(4,401) $(1,280) $(17,946)
====== ======= ======= ======= ======= ======= ========
Basic and diluted net loss per share....... $(0.16) $ (0.47) $ (0.49) $ (0.77) $ (0.98) $ (0.29) $ (3.57)
====== ======= ======= ======= ======= ======= ========
Shares used in computing basic and diluted
net loss per share....................... 2,934 3,081 4,094 4,270 4,509 4,430 5,029
Pro forma basic and diluted net loss per
share (unaudited)........................ $ (0.31) $ (1.12)
======= ========
Shares used in computing pro forma basic
and diluted net loss per share
(unaudited).............................. 14,318 16,056
======= ========
</TABLE>
------------------------
(1) Includes non-cash charges for stock-based compensation as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
------------------------------ -------------------
1997 1998 1999 1999 2000
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Research and development............................... $ -- $ -- $ 964 $403 $2,597
General and administrative............................. -- -- 181 -- 708
------ ------ ------ ---- ------
$ -- $ -- $1,145 $403 $3,305
====== ====== ====== ==== ======
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------------------- AS OF
BALANCE SHEET DATA: 1995 1996 1997 1998 1999 JUNE 30, 2000
------------------- -------- -------- -------- -------- -------- --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Cash, cash equivalents and short-term
investments................................. $ 31 $ 1,465 $ 2,019 $ 6,328 $ 2,022 $ 25,027
Working capital............................... (257) 1,369 1,976 4,267 750 22,370
Long-term investments......................... -- -- -- 9,073 8,442 7,235
Total assets.................................. 62 1,965 2,757 17,201 14,157 36,898
Capital lease and debt obligations,
less current portion........................ -- -- 385 1,004 1,591 2,099
Accumulated deficit........................... (478) (1,930) (3,924) (7,192) (11,593) (18,272)
Stockholders' equity.......................... (226) 1,721 2,111 13,759 10,471 31,777
</TABLE>
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH
OUR "SELECTED FINANCIAL DATA," OUR FINANCIAL STATEMENTS AND THE RELATED NOTES
INCLUDED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
We are a biotechnology company that has proprietary technologies to develop
potential pharmaceutical products that will address large markets. We use our
technologies to make new drug candidates derived from an important class of
natural product compounds known as polyketides. Our product opportunities
currently target the areas of infectious disease, gastrointestinal motility,
mucus hypersecretion, cancer, immunology and nerve regeneration. In infectious
disease, we have a collaboration with The R.W. Johnson Pharmaceutical Research
Institute, a Johnson & Johnson company, focusing on the development of a next
generation antibiotic. In cancer, we have a collaboration with the
Sloan-Kettering Institute for Cancer Research focusing on the development of
potential anti-cancer compounds known as epothilones.
We have incurred significant losses since our inception. As of June 30,
2000, our accumulated deficit was $18.3 million. We expect to incur additional
operating losses over the next several years as we continue to develop our
technologies and fund internal product research and development.
STOCK-BASED COMPENSATION
Stock-based compensation expense for the year ended December 31, 1999 and
for the six months ended June 30, 2000 represents the difference between the
exercise price of an option and the deemed fair value of our common stock on the
date of the grant calculated in accordance with Accounting Principles Board
Opinion No. 25 and its related interpretations. We recorded total deferred
stock-based compensation of $11.1 million in the six months ended June 30, 2000
and $2.9 million in 1999. Subsequent to June 30, 2000 we recorded deferred
stock-based compensation of $1.4 million for stock options granted from July 1,
2000 through August 31, 2000. Such amounts are included as a reduction of
stockholders' equity and are being amortized to expense using the graded vesting
method over the vesting periods of the underlying options, which are generally
four years. Stock-based compensation has been allocated to research and
development expense and general and administrative expense, as appropriate.
Based on deferred stock-based compensation recorded as of August 31, 2000, we
expect to record amortization for deferred stock-based compensation
approximately as follows: $3.8 million for the remaining six months in 2000,
$4.7 million in 2001, $2.6 million in 2002, $1.1 million in 2003 and $106,000 in
2004.
In connection with the grants of stock options and restricted stock to
non-employees, we recognize compensation on a ratable basis over the related
service period. We recognized other stock-based compensation for non-employees
of $752,000 for the six months ended June 30, 2000 and $610,000 in 1999. In
addition, we expect to recognize other stock-based compensation in connection
with stock options and restricted stock granted to non-employees of $662,000 for
the remaining six months in 2000, $1.3 million in 2001, $979,000 in 2002,
$318,000 in 2003 and $58,000 in 2004. The measurement of stock-based
compensation to our non-employees is subject to periodic adjustment as our stock
price changes and as the underlying securities vest. As such, changes to these
measurements could be substantial should we experience significant changes in
our stock price. See Notes 1 and 9 of our financial statements.
20
<PAGE>
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2000 AND 1999
REVENUE. Our revenues decreased to $2.2 million for the six months ended
June 30, 2000 from $3.1 million for the six months ended June 30, 1999. This
decrease was due to a $1.0 million non-recurring milestone payment recognized in
1999 under our collaboration with The R.W. Johnson Pharmaceutical Research
Institute. Total contract revenues under this collaboration were $2.1 million
for the six months ended June 30, 2000 and $2.9 million for the six months ended
June 30, 1999, inclusive of the $1.0 million non-recurring milestone payment.
The initial term of our collaboration with The R.W. Johnson Pharmaceutical
Research Institute has been extended to December 28, 2001. If we do not maintain
or further extend this agreement, our revenues will significantly decrease
thereafter, unless we enter into additional collaborations.
RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
consist primarily of stock-based compensation, salaries and other
personnel-related expenses, facility related expenses, lab consumables and
depreciation of facilities and equipment. Research and development expenses
increased to $7.6 million for the six months ended June 30, 2000 from
$3.8 million for the six months ended June 30, 1999. This increase was due in
large part to an increase in the stock-based compensation to $2.6 million for
the six months ended June 30, 2000 from $403,000 for the six months ended
June 30, 1999. The remainder of the increase was primarily due to increased
payroll and personnel related expenses, including recruiting and relocation
expenses. We expect our research and development expenses will increase
substantially to fund the expansion of our technology platform, support our
collaborative research programs and advance our in-house research programs into
later stages of development.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $1.8 million for the six months ended June 30, 2000 from $812,000
for the six months ended June 30, 1999. This increase was primarily due to
amortization of deferred stock-based compensation of $708,000 for the six months
ended June 30, 2000. No such expenses were recognized during the same period in
1999. We expect our general and administrative expenses will increase in the
future to support the continued growth of our research and development efforts
and to fulfill our obligations associated with being a publicly held company.
INTEREST INCOME. Interest income increased to $678,000 for the six months
ended June 30, 2000 from $334,000 for the six months ended June 30, 1999. This
increase was due to higher average investment balances due to the $24.6 million
in net proceeds received in connection with the issuance of Series C convertible
preferred stock in March 2000 combined with higher yields earned on investment
balances.
INTEREST EXPENSE. Interest expense increased to $167,000 for the six months
ended June 30, 2000 from $71,000 for the six months ended June 30, 1999. The
increase resulted from additional debt financing associated with our capital
purchases along with a higher cost of capital due to rising interest rates
during the first half of 2000.
BENEFICIAL CONVERSION FEATURE. In March 2000, we sold 804,196 shares of
Series C convertible preferred stock (convertible into 2,412,588 shares of
common stock at the closing of this offering) for net proceeds of approximately
$24.6 million. After evaluating the fair value of our common stock in
contemplation of this offering, we determined that the issuance of the Series C
convertible preferred stock resulted in a beneficial conversion feature
calculated in accordance with Emerging Issues Task Force Consensus No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features." The
beneficial conversion feature was reflected as a deemed dividend of
$11.3 million in our financial statements for the six months ended June 30,
2000.
21
<PAGE>
YEARS ENDED DECEMBER 31, 1999 AND 1998
REVENUE. Our revenues increased to $5.3 million in 1999 from $1.2 million
in 1998. This increase primarily reflected the full year of funding under our
corporate collaboration with The R.W. Johnson Pharmaceutical Research Institute
which was established in September 1998. Total contract revenues earned under
this collaboration were $5.0 million in 1999 and $969,000 in 1998. Also included
in 1999 contract revenue was $1.2 million of non-recurring milestone payments
earned under this agreement. The initial term of our collaboration with The R.W.
Johnson Pharmaceutical Research Institute has been extended to December 28,
2001. If we do not maintain or further extend this agreement, our revenues will
significantly decrease thereafter, unless we enter into additional
collaborations.
RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
increased to $8.6 million in 1999 from $4.0 million in 1998. The increase was
primarily due to increases in employee costs as our scientific headcount
increased to 43 individuals in December 1999 from 17 in January 1998 and higher
occupancy expenses associated with our move to a larger facility in March 1999.
In addition, we recorded $964,000 in stock-based compensation in 1999. No such
expense was recorded in 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $1.8 million in 1999 from $991,000 in 1998. This increase was
primarily due to additional staffing as our administrative headcount increased
to 10 in December 1999 from 6 in January 1998. In addition, we recorded $181,000
in stock-based compensation in 1999. No such expense was recorded in 1998.
INTEREST INCOME. Interest income increased to $679,000 in 1999 from
$598,000 in 1998. This increase resulted from higher average investment balances
due to contract revenue received under our collaboration with The R.W. Johnson
Pharmaceutical Research Institute.
INTEREST EXPENSE. Interest expense increased to $196,000 in 1999 from
$80,000 in 1998. This increase resulted from additional debt financing
associated with our fixed asset purchases.
OTHER INCOME. For the year ended December 31, 1999, other income included a
$170,000 termination fee received from the landlord of our previously occupied
facility for the buy-out of the rights to our sublease agreement.
YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUE. Our revenue increased to $1.2 million in 1998 from $287,000 in
1997. This increase was attributable to the initiation of our corporate
collaboration with The R.W. Johnson Pharmaceutical Research Institute in
September 1998.
RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
increased to $4.0 million in 1998 from $1.9 million in 1997. The increase was
primarily due to increases in employee related costs as our scientific headcount
increased to 37 at December 1998 from 12 in January 1997.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $991,000 in 1998 from $457,000 in 1997. This increase was primarily
due to higher employee and consulting costs to support our expanding research
and development activities.
INTEREST INCOME. Interest income increased to $598,000 in 1998 from
$154,000 in 1997. This increase resulted from higher investment balances arising
from our April 1998 private placement of Series B convertible preferred stock
and contract revenue received under our collaboration with The R.W. Johnson
Pharmaceutical Research Institute.
INTEREST EXPENSE. Interest expense increased to $80,000 in 1998 from
$56,000 in 1997. This increase resulted from additional debt financing
associated with our fixed asset purchases.
22
<PAGE>
PROVISION FOR INCOME TAXES
We incurred net operating losses in the years ended December 31, 1999 and
1998, and consequently did not pay federal, state or foreign income taxes. As of
December 31, 1999, we had federal and state net operating loss carryforwards of
approximately $9.6 million and $4.1 million, respectively. We also had federal
research and development tax credit carryforwards of approximately $300,000. If
not utilized, the net operating losses and credit carryforwards will expire at
various dates beginning in 2002 through 2019. Use of the net operating losses
and credits may be subject to a substantial annual limitation due to the change
in the ownership provisions of the Internal Revenue Code of 1986, as amended,
and similar state provisions. The annual limitation may result in the expiration
of net operating losses and credits before utilization. See Note 10 of our
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations from inception primarily through sales of
convertible preferred stock, totaling $45.6 million in net proceeds, contract
payments under our collaboration agreement, equipment financing arrangements and
government grants. As of June 30, 2000, we had $32.3 million in cash and
investments compared to $10.5 million as of December 31, 1999. Our funds are
currently invested in U.S. Treasury and government agency obligations,
investment-grade asset-backed securities and corporate obligations.
Our operating activities used cash of $2.9 million for the six months ended
June 30, 2000 compared to $1.1 million for the six months ended June 30, 1999.
Our net loss of $6.7 million for the six months ended June 30, 2000 was
partially offset by non-cash expenses of $3.8 million related to stock-based
compensation and depreciation expense. Cash used in operating activities was
$3.9 million in the year ended December 31, 1999 compared to $1.2 million in the
year ended December 31, 1998. Cash used in 1999 operating activities were
primarily to fund our net operating losses. Non-cash charges of $1.8 million
related to stock-based compensation and depreciation expenses were nearly offset
by working capital changes of $1.3 million. The $1.2 million used for 1998
operations consisted of our $3.3 million net loss for the period, partially
offset by depreciation and working capital changes of $2.1 million.
Our investing activities, excluding changes in our investments, for the six
months ended June 30, 2000 used cash of $808,000 compared to $1.1 million for
the six months ended June 30, 1999 reflecting facility improvements and capital
expenditures as we continue to enhance our laboratory capabilities. Investing
activities in 1999, excluding changes in our investments, used cash of
$1.8 million compared to $1.2 million in 1998 as a result of capital purchases
and leasehold improvements.
Cash provided by financing activities was $25.5 million for the six months
ended June 30, 2000 compared to $1.2 million for the six months ended June 30,
1999. Financing activities included $24.6 million in net proceeds from the
issuance of our Series C convertible preferred stock in March 2000. Cash
provided by financing activities was $898,000 in 1999 compared to $15.7 million
in 1998. 1998 financing activities included $14.9 million in net proceeds from
the issuance of our Series B convertible preferred stock in April 1998.
In January 2000, we secured a $2.0 million line of credit for facility
improvements and equipment purchases. As of June 30, 2000 we had drawn down
$1.3 million and had $700,000 remaining available under this credit facility.
For periods subsequent to June 30, 2000, we have estimated our
non-cancelable commitments under our collaboration with Sloan-Kettering to be
approximately $700,000 in addition to our internal development efforts under
this agreement. We have no material non-cancelable commitments under the
Stanford and Harvard collaborations.
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<PAGE>
We believe our existing cash and investments, together with the proceeds of
this offering, will be sufficient to meet our anticipated cash requirements for
at least 24 months. Our future capital uses and requirements depend on numerous
forward-looking factors. These factors include, but are not limited to the
following:
- Our ability to establish and the scope of any new collaborations;
- The progress and number of research programs carried out by us;
- The progress and success of preclinical and clinical trials of our drug
candidates;
- Our ability to maintain our existing collaboration with The R.W. Johnson
Pharmaceutical Research Institute;
- The costs and timing of obtaining, enforcing and defending our patent and
intellectual rights;
- The costs and timing of regulatory approvals; and
- Expenses associated with unforeseen litigation.
For the next several years, we do not expect our operations to generate the
amounts of cash required for our future cash needs. In order to fulfill our cash
requirements, we expect to finance future cash needs through the sale of equity
securities, strategic collaborations and debt financing. We cannot assure you
that additional financing or collaboration and licensing arrangements will be
available when needed or that, if available, will be on terms favorable to us or
our stockholders. Insufficient funds may require us to delay, scale back or
eliminate some or all of our research or development programs, to lose rights
under existing licenses or to relinquish greater or all rights to product
candidates at an earlier stage of development or on less favorable terms than we
would otherwise choose or may adversely affect our ability to operate as a going
concern. If additional funds are obtained by issuing equity securities,
substantial dilution to existing stockholders may result.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximize the income we receive from our investments
without significantly increasing risk. Some of the securities that we invest in
may have market risk. This means that a change in prevailing interest rates may
cause the principal amount of the investment to fluctuate. To minimize this risk
in the future, we intend to maintain our portfolio of cash equivalents and
investments in a variety of securities, including commercial paper, money market
funds, government and non-government debt securities and corporate obligations.
The table below presents the principal amounts of our investments and
equipment loans by expected maturity and related weighted average interest rates
at December 31, 1999:
<TABLE>
<CAPTION>
2000 2001 2002 2003 TOTAL FAIR VALUE
-------- -------- -------- -------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Debt securities:
U.S. treasury.................... $ -- $1,300 $ -- $ -- $1,300 $1,290
Corporate bond................... 1,000 -- -- -- 1,000 990
Average interest rate.............. 5.6% 5.6% -- -- 5.6%
Asset-backed securities............ -- -- -- -- 7,198 7,152
Average interest rate.............. -- -- -- -- 5.9%
Equipment financing................ 447 497 616 311 1,871 1,871
Average interest rate.............. 10.8% 10.8% 10.8% 11.0% 10.8%
</TABLE>
24
<PAGE>
BUSINESS
OVERVIEW
We are a biotechnology company using our proprietary technologies to develop
drug candidates from an important class of natural product compounds known as
polyketides. Polyketides are naturally made in very small amounts in
microorganisms and are difficult to make or modify chemically. Using our
proprietary technologies we are able to create, modify and produce polyketides
in ways that chemists cannot. Creating novel polyketides should provide us with
a pipeline of potential drug candidates that address large markets.
We can make improved versions of a known polyketide pharmaceutical product
and are able to change a polyketide used in one therapeutic area to create a new
polyketide used for another. We can take the genetic instructions for making a
polyketide out of one microorganism and put them into another microorganism
which provides a more favorable environment to grow and produce more of the
polyketides.
Our strategy is to use our technologies to create new polyketides for
development as pharmaceutical products. We plan to produce those polyketides at
the levels required to support clinical development and commercialization.
We have programs to exploit all aspects of our technology. Our programs in
the areas of infectious disease and immunosuppression are directed to the
development of improved versions of existing products. Our programs in the areas
of gastrointestinal motility, mucus hypersecretion, and nerve regeneration are
directed to the development of new drugs derived from drugs developed for other
indications. Our program in the area of cancer is directed to the large scale
production and development of a polyketide that is produced in very low amounts
naturally. All of our programs address large markets.
OVERVIEW OF POLYKETIDES
Polyketides are complex natural products that are produced by
microorganisms. There are about 7,000 known polyketides, from which numerous
pharmaceutical products in many therapeutic areas have been derived. The
following table illustrates the many different uses for polyketides.
SELECTED POLYKETIDE PRODUCTS AND THEIR USES
<TABLE>
<CAPTION>
PRODUCT (TRADE NAME) USE
-------------------- --------------------
<S> <C>
Azithromycin (Zithromax)................................. Antibacterial
Clarithromycin (Biaxin).................................. Antibacterial
Erythromycin............................................. Antibacterial
Rifamycin (Rifampin)..................................... Antibacterial
Tetracyclines............................................ Antibacterial
Doxorubicin (Adriamycin)................................. Anticancer
Amphotericin B........................................... Antifungal
Lovastatin (Mevacor)..................................... Cholesterol-lowering
Pravastatin (Pravacol)................................... Cholesterol-lowering
Simvastatin (Zocor)...................................... Cholesterol-lowering
Tacrolimus (FK506, Prograf).............................. Immunosuppressant
Sirolimus (Rapamycin).................................... Immunosuppressant
Spinosad................................................. Insecticide
Avermectin............................................... Veterinary Product
</TABLE>
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We focus on polyketides because of their demonstrated ability to treat many
different disease conditions. To understand what we do and why we believe our
company can develop valuable, new polyketide pharmaceutical products, one needs
to understand how polyketides are made.
Unlike most classes of compounds, different polyketides often have unrelated
structures. The common features that link the polyketides as a class are the
sequence of reactions by which they are formed, and the intermediate compounds
made in these reactions. Each polyketide is produced by a unique polyketide
synthase, or PKS, which is a large enzyme composed of many component enzymes.
There are two types of PKSs, modular and iterative. Modular PKSs contain many
enzymes, each of which is used only once during polyketide production, while
iterative PKSs may use some enzymes several times. Erythromycin is an example of
a polyketide made by a modular PKS. Erythromycin is not only a valuable
antibiotic product but is also used in the production of the antibiotics
azithromycin and clarithromycin.
A modular PKS is composed of multiple proteins. The instructions for making
these proteins is contained in the DNA, or genome, of the microorganism that
produces the modular PKS. Each protein has its own set of instructions, which is
called the gene for the protein. The complete set of genes for a modular PKS
that produces a polyketide is called a gene cluster. When any gene of a
polyketide gene cluster is identified, the entire cluster can be easily
obtained. We accomplish this by using recombinant DNA technology, which is a set
of techniques that enable scientists to combine or alter DNA from different
organisms.
[GRAPH]
[DESCRIPTION OF POLYKETIDE SYNTHESIS]
[THE ARTWORK IS A DEPICTION OF A POLYKETIDE (PKS) GENE CLUSTER, WITH 4 MODULES
INDICATED; UNDERNEATH EACH MODULE IS THE 2-CARBON UNIT BUILDING BLOCK OF
POLYKETIDES IT SPECIFIES. UNDERNEATH THE 4 BUILDING BLOCKS (IN A ROW) IS THE
CORRESPONDING PKS, SHOWING THE COMPONENT ENZYMES OF EACH OF THE 4 MODULES AND
THE INTERMEDIATE POLYKETIDE CHAINS FORMED AT EACH MODULE. FINALLY, AT THE BOTTOM
LEFT THERE IS A DEPICTION OF THE BUILDING BLOCKS USED BY THE PKS WITH AN ARROW
LEADING FROM THE BUILDING BLOCKS TO THE PKS; AT THE RIGHT THERE IS A DOWNWARD
ARROW LEADING FROM THE PKS TO THE POLYKETIDE SHOWN IN THE RIGHT, LOWER CORNER.]
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To understand how we modify the gene cluster for a modular PKS to create new
polyketides, an understanding of how a modular PKS actually makes or synthesizes
a polyketide is necessary. The synthesis of a polyketide essentially involves
the linking of a number of small building block compounds to form the larger
polyketide. A modular PKS can be functionally subdivided into units called
modules, each of which is responsible for a single building block used in the
synthesis. Synthesis begins at the first module, called the loading module,
located at one end of the PKS, and continues to the end through multiple
extender modules, each of which adds and modifies another building block. This
process creates a chain of building blocks that forms the polyketide; in many
instances the chain is linked to itself to form a ring. Because each module
codes for one building block, the number of modules in a PKS codes for the size
of the polyketide. Each module contains three essential enzyme activities
responsible for connecting the polyketide building blocks. One of these
activities selects which building block (there are at least 4 different building
blocks) is used, and the other two are involved in linking the building block to
the growing chain and passing the chain to the next module. A module may also
have 1, 2, or 3 additional enzymes that modify the building blocks once they are
incorporated into the chain.
The structure of a polyketide can therefore be viewed as being determined by
the types, order and number of modules in a modular PKS. The types of modules
dictate which building blocks are used, the order of the modules dictates the
sequence of building blocks, and the number of modules dictates the number of
building blocks in, or size of, the polyketide. Modifying, adding or deleting
the modules results in specific and predictable changes to the structure of the
polyketide.
OUR STRATEGY
Our goal is to use our technologies to create a pipeline of drug candidates
that can be developed into pharmaceuticals and advanced into clinical trials.
Our focus is on drug candidates that address large markets. Our strategy
includes the following components:
MAXIMIZE VALUE, MINIMIZE RISK. We apply our technologies to generate a
pipeline of drug candidates that improve existing pharmaceutical products. By
improving the properties of currently marketed pharmaceuticals, we believe we
can create novel products that take advantage of the known utility, safety,
development path and market for existing drugs to reduce the risk and time
required for development.
ESTABLISH COLLABORATIVE RELATIONSHIPS. We have entered into a collaboration
with The R.W. Johnson Pharmaceutical Research Institute, a Johnson & Johnson
company, in the area of infectious disease. We plan to establish additional
collaborative relationships with large pharmaceutical companies to move our drug
candidates into and through clinical trials and to the market, prepare and
screen our polyketide libraries, apply our technologies to create new
polyketides and develop large-scale production systems.
ENHANCE LEADERSHIP POSITION OF OUR TECHNOLOGY PLATFORM. We will expand and
enhance our technologies by increasing in-house research activities. We will
continue to extend the reach of our technologies through strategic alliances or
acquisitions. We plan to broaden and protect our intellectual property portfolio
and in-license patents that complement our core technologies.
ACQUIRE COMPLEMENTARY TECHNOLOGIES AND PRODUCTS. We have a collaboration
and license agreement with Sloan-Kettering in the area of cancer therapeutics.
We may acquire or license additional complementary technologies or product
candidates from other third parties.
OUR TECHNOLOGY PLATFORM
Our technology platform has five components: polyketide gene alteration,
chemo-biosynthesis, heterologous over-expression, combinatorial biosynthesis,
and screening libraries. Together, our
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<PAGE>
technologies enable us to modify, create and produce proprietary polyketides
with potential for development as valuable pharmaceutical products.
POLYKETIDE GENE ALTERATION
The structure of a polyketide is primarily determined by variation in the
number, order and type of modules in the PKS. Our technologies enable us to make
these alterations in a specific, directed manner, and thus we can control the
polyketide structure.
Polyketides are structurally complex compounds that are difficult to make or
modify chemically. Because each building block of a polyketide is selected by a
specific module of the PKS, we use our technologies to make precise structural
changes by altering the module that specifies the targeted building block. We
use our technologies to improve properties of known biologically active
molecules. This can be done by using our technology to change a portion of the
polyketide that cannot be chemically modified to one that can, allowing us to
make subsequent chemical modifications not otherwise feasible. We can also make
changes in the structure of existing proprietary polyketide products to create a
new polyketide proprietary to us. In addition, by changing the order, type and
number of modules, we can create entirely new libraries of polyketides as
sources of new compounds both for screening for new activities and for improving
a lead compound.
CHEMO-BIOSYNTHESIS
We incorporate chemically synthesized fragments into complicated polyketide
structures, permitting changes in their structures and properties in ways that
have not been achieved by any other process. This has enabled us to produce
novel polyketides used in the production of the drug candidates in our
collaboration with The R.W. Johnson Pharmaceutical Research Institute.
First, we disable the loading and first extender modules in a PKS by
altering the gene that contains the instructions for these modules. This
prevents formation of the two-building-block intermediate that feeds the second
extender module, but leaves the remainder of the PKS fully functional. Then,
microorganisms containing this modified PKS are fed our chemically synthesized
fragments that substitute for the natural building-block intermediate.
HETEROLOGOUS OVER-EXPRESSION
We can isolate a polyketide gene cluster from one organism and transfer it
to another. This is important because many polyketides are produced by
microorganisms that are difficult or slow to grow, or in which recombinant DNA
methods have not been developed. In addition, polyketides are often produced in
small amounts in organisms that naturally produce them, which can limit their
commercial development. We have created microorganisms for efficient polyketide
manipulation and production. Our proprietary technologies allow us to transfer
polyketide genes to these microorganisms to enable easier manipulation and
increased production of polyketides necessary for commercialization.
COMBINATORIAL BIOSYNTHESIS
We have developed a technology to produce large collections, called
libraries, of polyketides rapidly and efficiently. Because the approximately
7,000 naturally occurring polyketides have yielded many pharmaceutical products,
we believe that libraries of new polyketides may do likewise. To create these
libraries we separate the large polyketide gene cluster into several fragments.
Each of these fragments is then genetically manipulated to produce numerous
variations. We then reassemble the gene cluster with all possible combinations
of the altered fragments to create large polyketide libraries. Because many
different combinations of the altered fragments can be assembled simultaneously,
our combinatorial biosynthesis technology is used to produce large polyketide
libraries. For example, we
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<PAGE>
believe our scientists have created the largest number of erythromycin analogs
produced by genetic engineering.
[GRAPH]
[DESCRIPTION OF ARTWORK]
[The artwork is a depiction of the process of combinatorial biosynthesis.
1) The first drawing depicts a PKS gene cluster, and underneath it are
individual modules obtained from other PKS gene clusters. 2) The second drawing
shows the incorporation of new individual modules into the gene cluster to make
hybrid gene clusters. 3) The third drawing shows a number of cells containing
individual (colored) hybrid genes. 4) The fourth drawing shows cell colonies,
each producing a different polyketide (color-coded)] 5) The fifth drawing shows
test tubes containing individual polyketides (color-coded)].
SCREENING LIBRARIES
In addition to our polyketide libraries made by combinatorial biosynthesis,
we have acquired a collection of over 10,000 soil microorganisms. The collection
is unusual because it has been pre-selected for bioactivities from a larger
group of over 100,000 microorganisms. Our collection shows antibiotic,
antiviral, and pesticidal activities, as well as activity specific to one or
more of about 20 enzyme targets. We believe that the lead compounds from this
library, together with our technologies, will provide new drug candidates for
our product pipeline.
OUR PRODUCT DEVELOPMENT OPPORTUNITIES
Our primary programs are currently directed at discovery and development of
polyketides for infectious disease, gastrointestinal motility disorders, mucus
hypersecretion, cancer, immunosuppression and nerve regeneration. These programs
were selected because they represent opportunities where our technologies could
improve upon existing products or fill unmet needs, and because each addresses
large markets. We are able to maintain a diverse portfolio of drug candidates
because the fundamental aspects of our technology generally apply to all modular
PKS gene clusters.
INFECTIOUS DISEASE
Clarithromycin, marketed as Biaxin, and azithromycin, marketed as Zithromax,
are polyketide-derived antibiotics that show high potency, a broad spectrum of
activity and few side effects. These products had revenues in 1999 of
approximately $2.3 billion. However, organisms are emerging that are resistant
to these two drugs. Ketolides, analogs of the polyketide erythromycin, possess
the potency and spectrum of activity shown by clarithromycin and azithromycin,
but are effective against these resistant
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<PAGE>
organisms. Aventis Pharmaceuticals has recently filed a New Drug Application
with the FDA for a ketolide and Abbott Laboratories also has a ketolide in
clinical trials.
We have a collaborative research agreement with The R.W. Johnson
Pharmaceutical Research Institute, a Johnson & Johnson company, to discover and
develop a next-generation ketolide. Our collaboration was established in
September 1998, and has already resulted in several proprietary ketolides that
we believe have activities competitive with other ketolides. One of these
compounds is currently undergoing preclinical evaluation.
GASTROINTESTINAL MOTILITY
One of the actions of erythromycin is stimulation of gastrointestinal
movement, or GI motility. Therefore, erythromycin-derived compounds called
motilides may be useful to treat diseases such as gastroparesis and
gastroesophageal reflux disease, also known as GERD or heartburn, that are
unresponsive to antacids. The leading product currently used for stimulation of
GI motility is cisapride, marketed as Propulsid, which had sales of
approximately $1 billion in 1999. Cisapride has been reported to have side
effects, including arrhythmias and various drug interactions. Cisapride's
manufacturer has announced that Cisapride will no longer be marketed in the
United States and several other countries. Motilides have an entirely different
mechanism of action and should not have the same side effects. Chugai
Pharmaceuticals has a motilide candidate in clinical trials.
Many compounds in our erythromycin library can readily be converted into
motilides. We have prepared several proprietary motilides with IN VITRO activity
comparable to the motilide in clinical trials. In addition, our technologies
enable the preparation of numerous new motilides that could not easily be made
chemically. We expect to have drug candidates to advance into preclinical
testing within a year.
MUCUS HYPERSECRETION
Mucus hypersecretion, or excessive production of mucus, is a major,
problematic symptom of asthma, chronic obstructive pulmonary disease, or COPD,
cystic fibrosis and allergic rhinitis, including hay fever. Mucus hypersecretion
in these diseases results from the release of mucus from abnormally high numbers
of large mucus-secreting cells called goblet cells. There is no effective
treatment for this type of mucus hypersecretion from which to determine market
potential, but we believe, based on disease prevalence, that the market
potential is large.
Our scientists, in collaboration with scientists at the University of
California, San Francisco, have discovered a potential target for inhibiting
mucus hypersecretion. We have prepared a non-antibiotic analog of erythromycin
that inhibits this target, and are using our technologies to optimize its
activity. Although this is an early-stage project, we believe we will have drug
candidates to advance into preclinical testing within a year.
CANCER
Many cancers are treated by paclitaxel, marketed as Taxol, which had
revenues in 1999 of approximately $1.5 billion. However, some tumors are
resistant to Taxol. Epothilone, a polyketide with an identical mechanism of
action and similar potency to Taxol, is active against Taxol-resistant tumors. A
major problem with the further development of epothilone is that its sole
natural source produces small amounts. Moreover, one of the most effective forms
of epothilone, epothilone D, represents only about 10% of the total epothilones
produced.
Although epothilone has been chemically synthesized, the synthesis is not
readily amenable to large-scale production. Our technology allows polyketide
genes to be moved from the natural producer organism to another to produce
greater quantities of the polyketide. Our scientists have cloned and expressed
the epothilone gene cluster in two different organisms and demonstrated
production of all
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important forms of epothilone, including epothilone D. We believe we can
increase current yields of the important types of epothilone using our
technologies. We also expect to produce proprietary analogs of epothilone.
In August 2000, we entered into a collaboration and license agreement with
Sloan-Kettering to discover and develop epothilone compounds, including an
epothilone compound that is in preclinical development by Sloan-Kettering. We
expect to initiate clinical trials of this compound in 2001.
IMMUNOSUPPRESSION
Prograf, also known as FK506, is one of the most widely used
immunosuppressants for organ transplantation, with 1999 worldwide revenues of
approximately $259 million. Additionally, FK506 has been approved in Japan to
treat atopic dermatitis and approval for this indication is pending in the
United States. It is also in clinical trials to treat psoriasis and rheumatoid
arthritis. The enzyme P450-3A metabolizes FK506 at a single site to destroy over
90% of the drug. A major problem is that P450-3A levels are variable among
individuals and fluctuate in the presence of other drugs. As a result, FK506
metabolism is variable in different people and its dosage must be carefully
individualized and monitored to avoid under- or over-dosing.
If the sites at which FK506 is metabolized by P450-3A could be blocked
without affecting biological activity, the variable metabolism of the drug might
be avoided. The primary sites of metabolism of FK506 are different from those
required for activity, so we do not expect their modification to prevent
metabolism to be detrimental. These sites of metabolism cannot be protected by
chemical modification, but can be protected using our technology. We are
modifying these sites in an FK506 analog, FK520, to make proprietary,
metabolically stable analogs. We expect to have drug candidates to advance into
preclinical testing within a year.
NERVE REGENERATION
The immunosuppressive effect of FK506 is generated by concurrent binding to
two proteins, FKBP and calcineurin. However, analogs of FK506 that bind to FKBP
but not calcineurin stimulate nerve regeneration without immunosuppression. Such
compounds could be used to treat peripheral and spinal cord injury, Parkinson's
disease, and other diseases involving nerve degeneration.
We are converting our metabolically stable FK520 analogs to compounds that
can be used for nerve regeneration without immunosuppression. This conversion
involves a chemical modification that prevents the compounds from binding to a
protein, calcineurin, involved in immunosuppression. Our analogs may have
advantages because we expect them to be orally available, have
well-characterized pharmacokinetic properties, and penetrate the blood brain
barrier. We expect to have drug candidates to advance into preclinical testing
within a year.
INTELLECTUAL PROPERTY
Our intellectual property consists of patents, copyrights, trade secrets and
know-how. Our ability to compete effectively depends in large part on our
ability to obtain patents for our technologies and products, maintain trade
secrets and operate without infringing the rights of others and to prevent
others from infringing on our proprietary rights. We will be able to protect our
technologies from unauthorized use by third parties only to the extent that they
are covered by valid and enforceable patents, or are effectively maintained as
trade secrets. Accordingly, patents or other proprietary rights are an essential
element of our business. As of August 31, 2000, we owned four U.S. patents and
one foreign patent (which expire beginning in 2013) and had exclusive license
rights to nine U.S. patents and five foreign patents (which expire beginning in
2013) owned by Stanford University and two foreign patents (which expire
beginning in 2014) owned by the Sloan-Kettering Institute for Cancer Research.
On that date, we also had 43 U.S. patent applications and 31 foreign patent
applications, as well as the exclusive rights to 21 U.S. patent applications and
45 foreign patent applications.
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<PAGE>
We have exclusive rights to technologies developed by Dr. Chaitan Khosla and
claimed in a series of issued and pending patents filed by Stanford University
beginning in 1993. These patents include claims to recombinant expression of
polyketide synthase enzymes and production of polyketides using recombinantly
expressed enzymes, as well as useful hosts, vectors and methods of library
production. To date, nine of these patents have issued by the U.S. Patent
Office. We have also entered into an agreement with Stanford University that
grants us an exclusive option to license certain new technologies involving
polyketides and their production developed by Dr. Khosla.
We have exclusive rights to technology developed by Dr. S. Danishefsky
claimed in a series of issued and pending patents filed by Sloan-Kettering.
These patents include claims to epothilone compounds and methods of making and
using epothilones.
We have an issued U.S. patent claiming the production of polyketide
libraries using our proprietary multi-vector technology and the production of
polyketides in E. COLI and yeast. We have applied for patents claiming the
production of polyketides in plant cells, polyketide gene clusters cloned and
expressed in heterologous hosts, and novel polyketide compounds generated in our
drug discovery and development programs.
Our policy is to file patent applications to protect technology, compounds
and improvements commercially important to our business. We also rely on trade
secrets to protect our technology, especially where patent protection is deemed
inappropriate or unobtainable. We protect our proprietary technology and
processes, in part, by confidentiality agreements with our employees,
consultants, collaborators and certain contractors. There can be no assurance
that proprietary information will not be disclosed, that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets or that we can
meaningfully protect our trade secrets.
COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS
JOHNSON & JOHNSON
Effective September 28, 1998, we signed a two-year collaborative agreement
with The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil
Pharmaceutical, Inc., both Johnson & Johnson companies, which has been extended
through December 2001. Under the terms of the agreement, we use our technologies
to produce specific novel antibiotics on a best efforts basis. The agreement
provides for payments to us, including for research and development, and for
reaching certain milestones. In addition to creating a three-year collaborative
research term, the agreement grants several licenses that include:
- a research license, whereby we and The R.W. Johnson Pharmaceutical
Research Institute grant each other a non-exclusive license, with no
sublicense rights, to make and use methods and material covered under the
parties' respective patents to carry out research during the term of the
agreement;
- a screening license, whereby we grant to The R.W. Johnson Pharmaceutical
Research Institute a non-transferable exclusive license, with the right to
grant sublicenses, to conduct screening for antibiotic activity; and
- a development and commercialization license, whereby we grant to The R.W.
Johnson Pharmaceutical Research Institute and Ortho-McNeil
Pharmaceutical, Inc. exclusive worldwide rights to make, use, develop and
sell the licensed products as defined in the agreement.
The development, marketing, and sale of drugs resulting from this collaboration
will be undertaken by The R.W. Johnson Pharmaceutical Research Institute and
Ortho-McNeil Pharmaceutical, Inc. Should the development efforts result in a
marketable product, we will receive royalty payments based on
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<PAGE>
product sales as well as payments based on reaching research and development
milestones. We recognized $2.1 million of contract revenue for the six months
ended June 30, 2000, $5.0 million for the year ended December 31, 1999 and
$969,000 for the same period in 1998, pursuant to this agreement. Such amounts,
excluding initial and milestone payments, approximated research and development
expenses under this collaboration. Included in such amounts is the ratable
portion of a $1 million up-front fee received upon signing the agreement, which
is being recognized over the initial two-year term of the agreement. Included in
1999 contract revenue were $1.2 million of non-recurring milestone payments
earned under this agreement. The R.W. Johnson Pharmaceutical Research Institute
and Ortho-McNeil Pharmaceutical, Inc. can, until January 28, 2001, reduce
research funding for the third year of the research term, and after
December 28, 2000, can terminate the agreement as a whole upon payment of a
termination fee. After the research term under this agreement ends, The R.W.
Johnson Pharmaceutical Research Institute and Ortho-McNeil Pharmaceutical, Inc.
can terminate the agreement as a whole or with respect to any pharmaceutical
product upon three months' written notice and they or we may terminate the
agreement upon 90 days' written notice upon a material breach of the agreement.
If The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil
Pharmaceutical, Inc. terminate the agreement or reduce the research funding for
the third year of the research term, rights to compounds developed under the
agreement revert to us except for rights to compounds being commercialized by
The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil
Pharmaceutical, Inc. So long as The R.W. Johnson Pharmaceutical Research
Institute and Ortho-McNeil Pharmaceutical, Inc. are actively developing or
commercializing a product under the agreement, the agreement does not terminate
until the last patent claiming the product or its manufacture or use expires or,
in the absence of any such patent, until ten years after the first commercial
sale of the product.
SLOAN-KETTERING INSTITUTE FOR CANCER RESEARCH
Effective August 26, 2000, we signed a collaboration and license agreement
with the Sloan-Kettering Institute for Cancer Research relating to epothilones.
Under the agreement, we will use our technologies to produce a specific
epothilone compound to be tested in clinical trials and work collaboratively
with Sloan-Kettering to develop new compounds and production methods and to
conduct clinical trials. Under the agreement, we are required to pay to
Sloan-Kettering an initial license fee and annual maintenance fees as well as
payments for research and development costs, including the costs of clinical
trials, and, should the development efforts result in a marketable product,
royalty payments based on product sales as well as payments for reaching
clinical development milestones. Based on preclinical work done by
Sloan-Kettering, the agreement contemplates the initiation of Phase I clinical
trials during 2001.
In addition to creating a collaborative research program with at least a two
year term, the agreement grants licenses that include:
- A research license, whereby we and Sloan-Kettering grant each other a
license to make and use methods and material covered under each of our
patents to carry out research during the term of the agreement; and
- A development and commercialization license, with the right to sublicense,
whereby Sloan-Kettering grants us exclusive worldwide rights, with the
conditional right to sublicense, to make, use, develop and sell the
licensed products.
At any time prior to the initiation of the Phase II clinical trials
contemplated by the agreement, if we and Sloan-Kettering jointly determine that
the objectives of the collaboration cannot be met, then the agreement
terminates. Also, if we are unable to produce or otherwise provide the materials
required for Phase II clinical trials within specified time periods in advance
of the conclusion of the Phase I clinical trials, Sloan-Kettering has the right
to terminate the agreement. Upon termination, all
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rights granted by one party to the other revert to the granting party.
Otherwise, so long as we are actively developing or commercializing a product
under the agreement, the agreement does not terminate until the last patent
claiming the product or its manufacture or use expires or, in the absence of any
such patents, until ten years after the first commercial sale of the product.
STANFORD UNIVERSITY
Effective March 11, 1996, we entered into an exclusive license agreement
with the Board of Trustees of the Leland Stanford Junior University, or Stanford
University, for certain technology and related patent rights now contained in
nine issued U.S. patents and five foreign patents, as well as 45 U.S. and
foreign patent applications, and materials for the recombinant production of
novel polyketides. Under the terms of the agreement, we pay annual license fees
to Stanford University, make milestone payments and pay royalties on net sales
resulting from successful products originating from the licensed technology. In
March 2000, an amendment to the agreement was signed that provides us an
exclusive option to acquire an exclusive license to future patents or patent
applications as determined by Stanford which are related to certain technology
developed by Dr. Khosla related to polyketides and their production.
We may terminate this agreement with respect to any country or patent or in
its entirety on 60 days' advance notice. Stanford University may terminate this
agreement if we are in default for failure to make royalty payments or required
reports or for making materially incorrect reports or for a material breach of
the agreement and do not cure the breach within 60 days after being notified of
the breach by Stanford University. Otherwise, the agreement does not terminate
until the last patent claiming a product licensed under the agreement or its
manufacture or use expires or, in the absence of such patents, until ten years
after the first commercial sale of the product.
HARVARD COLLEGE
Effective December 2, 1998, we entered into an exclusive license agreement
with the President and Fellows of Harvard College for certain technology and
related patent rights for the production of polyketides. In connection with the
license agreement, which gives us the exclusive license rights to the technology
in five patent applications, we paid a non-refundable license fee and will pay
annual maintenance fees, milestones and royalties on net sales of products
originating from the licensed technology.
We may terminate this agreement in its entirety on 90 days' advance notice
and payment of a nominal termination fee. Harvard College may terminate this
agreement if we are in default for failure to make royalty or other payments and
do not make such payments within 45 days of receiving notice from Harvard
College or if we are in default for failure to make required reports or for
making materially incorrect reports or for a material breach of the agreement
and do not cure the breach, if a period for cure is allowed, within 90 days or
less after being notified of the breach by Harvard College. Otherwise, the
agreement does not terminate until the last patent claiming a product licensed
under the agreement or its manufacture or use expires.
We made total payments under the Stanford University and Harvard College
collaborations for the years ended December 31, 1997, 1998 and 1999, and the six
months ended June 30, 2000 of $25,000, $32,500, $42,500, and $42,500,
respectively. For periods subsequent to June 30, 2000, we have estimated our
non-cancelable commitments under the Sloan-Kettering collaboration to be
approximately $700,000 in addition to internal development efforts under this
agreement. We have no material non-cancelable commitments under the Stanford and
Harvard collaborations.
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COMPETITION
The pharmaceutical and biotechnology industries are intensely competitive.
Many companies, including biotechnology, chemical and pharmaceutical companies,
are actively engaged in research and development of drugs for the treatment of
the same diseases and conditions as our potential product candidates. Many of
these companies have substantially greater financial and other resources, larger
research and development staffs, and more extensive marketing and manufacturing
organizations than we do. In addition, some of them have considerable experience
in preclinical testing, clinical trials and other regulatory approval
procedures. There are also academic institutions, governmental agencies and
other research organizations that are conducting research in areas in which we
are working. They may also market commercial products, either on their own or
through collaborative efforts.
We face significant competition from large pharmaceutical companies that are
pursuing the same or similar technologies, including polyketide manipulation, as
the technologies used by us in our drug discovery efforts. For example, a number
of companies have cloned polyketide synthase genes and described in patents or
publications technology to modify those genes or express them in heterologous
hosts using recombinant DNA technology. Such companies include, for example,
Abbott Laboratories (erythromycin, niddamycin); Dow Agrosciences (spinosyn); Eli
Lilly and Company (tylosin, spiramycin), Novartis (soraphen, epothilone); and
Merck (avermectin, lovastatin). We also face competition from biotechnology
companies that engage in research similar to our own. For example,
Biotica Ltd., is a biotechnology company that has published patent applications
and entered into collaborations with pharmaceutical companies relating to
efforts to modify polyketide synthase genes using recombinant DNA technology.
We expect to encounter significant competition for any of the pharmaceutical
products we plan to develop. Companies that complete clinical trials, obtain
required regulatory approvals and commence commercial sales of their products
before their competitors may achieve a significant competitive advantage. We are
aware that many other companies or institutions are pursuing development of
drugs and technologies directly targeted at applications for which we are
developing our drug compounds. Aventis Pharmaceuticals has filed a new drug
application for a ketolide compound, and Abbott Laboratories has a ketolide
compound in clinical trials. Chugai Pharmaceuticals has a motilide compound in
clinical trials. We believe that two other large pharmaceutical companies have
epothilone compounds in clinical trials. Because we have not yet initiated
clinical trials for our own ketolide, motilide and epothilone compounds, it is
likely that, even if we are successful in developing a product, one or more of
these compounds of our competitors will be approved and marketed as products
before our own. This could place us and our collaborators at a significant
disadvantage, especially in the event our compounds do not have superior
properties or cost advantages, and prevent us from realizing significant
commercial benefit from such products.
Developments by others may render our drug candidates or technologies
obsolete or noncompetitive. We face and will continue to face intense
competition from other companies for collaborative arrangements with
pharmaceutical and biotechnology companies, for establishing relationships with
academic and research institutions and for licenses to additional technologies.
These competitors, either alone or with their collaborative partners, may
succeed in developing technologies or products that are more effective than
ours.
To compete successfully, we must develop proprietary positions and patented
drugs for therapeutic markets that have not been satisfactorily addressed by
conventional research strategies and, in the process, expand our technical
expertise. Our potential products, even if successfully tested and developed,
may not be adopted by physicians over other products and may not offer
economically feasible alternatives to other therapies.
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GOVERNMENT REGULATION
The FDA and comparable regulatory agencies in state and local jurisdictions
and in foreign countries impose substantial requirements upon the clinical
development, manufacture and marketing of pharmaceutical products. These
agencies and other federal, state and local entities regulate research and
development activities and the testing, manufacture, quality control, safety,
effectiveness, labeling, storage, record keeping, approval, advertising and
promotion of our potential products.
The process required by the FDA before our products may be marketed in the
United States generally involves the following:
- preclinical laboratory and animal tests;
- submission of an investigational new drug, or IND, application, which must
become effective before clinical trials may begin;
- adequate and well-controlled human clinical trials to establish the safety
and efficacy of the proposed drug for its intended use; and
- FDA approval of a new drug application, or NDA, or biologics license
application, or BLA.
The testing and approval process requires substantial time, effort, and
financial resources, and we cannot be certain that any approvals for any of our
potential products will be granted on a timely basis, if at all.
Prior to commencing clinical trials, which are typically conducted in three
sequential phases, we must submit an IND application to the FDA. The IND
automatically becomes effective 30 days after receipt by the FDA, unless the
FDA, within the 30-day time period, raises concerns or questions about the
conduct of the trial. In such a case, the IND sponsor and the FDA must resolve
any outstanding concerns before the clinical trial can begin. Our submission of
an IND may not result in FDA authorization to commence a clinical trial.
Further, an independent institutional review board at the medical center
proposing to conduct the clinical trial must review and approve the plan for any
clinical trial before it commences.
We may not successfully complete any of the three phases of testing of any
of our potential products within any specific time period, if at all.
Furthermore, the FDA or an institutional review board or the sponsor may suspend
a clinical trial at any time on various grounds, including a finding that the
subjects or patients are being exposed to an unacceptable health risk.
The results of product development, preclinical studies and clinical studies
are submitted to the FDA as part of a NDA or BLA. The FDA may deny a NDA or BLA
if the applicable regulatory criteria are not satisfied or may require
additional clinical data. Even if such data is submitted, the FDA may ultimately
decide that the NDA or BLA does not satisfy the criteria for approval. Once
issued, the FDA may withdraw product approval if compliance with regulatory
standards is not maintained or if problems occur after the product reaches the
market. In addition, the FDA may require testing and surveillance programs to
monitor the effect of approved products which have been commercialized, and the
FDA has the power to prevent or limit further marketing of a product based on
the results of these post-marketing programs.
Satisfaction of FDA requirements or similar requirements of state, local and
foreign regulatory agencies typically takes several years and the actual time
required may vary substantially, based upon the type, complexity and novelty of
the product or indication. Government regulation may delay or prevent marketing
of potential products or new indications for a considerable period of time and
impose costly procedures upon our activities. Success in early stage clinical
trials does not assure success in later stage clinical trials. Data obtained
from clinical activities is not always conclusive and may be susceptible to
varying interpretations which could delay, limit or prevent regulatory approval.
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Even if a product receives regulatory approval, the approval may be
significantly limited to specific indications and dosages. Further, even after
regulatory approval is obtained, later discovery of previously unknown problems
with a product may result in restrictions on the product or even complete
withdrawal of the product from the market. Delays in obtaining, or failures to
obtain additional regulatory approvals for any of our products would have a
material adverse effect on our business.
Any products manufactured or distributed by us pursuant to FDA approvals are
subject to continuing regulation by the FDA, including record-keeping
requirements and reporting of adverse experiences with the drug. Drug
manufacturers and their subcontractors are required to register their
establishments with the FDA and certain state agencies, and are subject to
periodic unannounced inspections by the FDA and certain state agencies for
compliance with good manufacturing practices, which impose certain procedural
and documentation requirements upon us and our third party manufacturers. We
cannot be certain that we or our suppliers will be able to comply with the good
manufacturing practices regulations and other FDA regulatory requirements.
Outside the United States, our ability to market a product is contingent
upon receiving a marketing authorization from the appropriate regulatory
authorities. The requirements governing the conduct of clinical trials,
marketing authorization, pricing and reimbursement vary widely from country to
country. At present, foreign marketing authorizations are applied for at a
national level, although within the European Community, or EC, registration
procedures are available to companies wishing to market a product in more than
one EC member state. If the regulatory authority is satisfied that adequate
evidence of safety, quality and efficacy has been presented, a marketing
authorization will be granted. This foreign regulatory approval process involves
all of the risks associated with FDA clearance.
LITIGATION
We are not currently involved in any litigation.
EMPLOYEES
As of June 30, 2000 we had 62 full-time employees, 32 of whom hold Ph.D.
degrees and 51 of whom were engaged in research and development activities. We
believe that our relations with our employees are good.
FACILITIES
Our facilities consist of approximately 44,000 square feet of research and
office space located in Hayward, California that is leased to us until 2003. We
believe that our facility will meet our space requirements for research and
development and administration functions into the year 2002, and beyond that
time, that suitable additional space will be available on commercially
reasonable terms.
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MANAGEMENT AND DIRECTORS
The following table provides information regarding our directors, executive
officers and key employees:
<TABLE>
<CAPTION>
NAME AGE TITLE
---- --- -----
<S> <C> <C>
Daniel V. Santi, M.D., Ph.D............... 58 Chief Executive Officer and Chairman of
the Board of Directors
Michael S. Ostrach........................ 48 Chief Operating Officer
Brian Metcalf, Ph.D....................... 54 Senior Vice President, Chief Scientific
Officer
Robert G. Johnson, Jr., M.D., Ph.D........ 48 Vice President, Medical Affairs and
Corporate Development
Susan M. Kanaya........................... 37 Vice President, Finance and Chief
Financial Officer
Kevin Kaster.............................. 40 Vice President, Intellectual Property
Susan B. Dillon, Ph.D..................... 47 Vice President, Pharmacological Sciences
C. Richard Hutchinson, Ph.D............... 56 Vice President, New Technologies
Chaitan Khosla, Ph.D...................... 35 Director
Jean Deleage, Ph.D........................ 60 Director
Raymond Whitaker, Ph.D.................... 52 Director
Peter Davis, Ph.D......................... 56 Director
Christopher Walsh, Ph.D................... 56 Director
</TABLE>
------------------------
DANIEL V. SANTI, M.D., PH.D., is one of our co-founders, and has served as
Chairman of the Board of Directors since our inception. In November 1998,
Dr. Santi was appointed as our Chief Executive Officer. He is on leave of
absence from his position as Professor of Biochemistry and Biophysics, and of
Pharmaceutical Chemistry at University of California, San Francisco. Dr. Santi
was one of the original members of the Scientific Advisory Boards of Chiron
Corporation and Mitotix, Inc., and has served as a consultant to several large
pharmaceutical companies. In 1988, Dr. Santi founded and served as Chairman of
the Board of Directors of the biotechnology firm Protos, a subsidiary of Chiron
Corporation, which was merged with Chiron in 1992. Dr. Santi was also founder
and Chairman of Parnassus Pharmaceuticals. Dr. Santi has published over 275
scientific papers and is inventor on many patents in combinatorial chemistry and
other areas. Dr. Santi received a Ph.D. in medicinal chemistry from the State
University of New York, his M.D. from the University of California, San
Francisco, and his B.S. in pharmacy from the State University of New York.
MICHAEL S. OSTRACH has served as our Chief Operating Officer since
October 1998. Prior to joining Kosan as Vice President, Corporate Development in
October 1997, Mr. Ostrach worked as an independent consultant for biotechnology
companies from October 1996 to October 1997. Mr. Ostrach was Executive Vice
President and Chief Operating Officer of Neurobiological Technologies, Inc., a
publicly-held biotechnology company from 1994 to 1996. From 1981 to 1991, he was
a Senior Vice President at Cetus Corporation. In 1991, Cetus Corporation merged
into Chiron Corporation and during 1992 Mr. Ostrach was a Vice President of
Chiron Corporation and a founder and the President of Chiron Technologies, a
Chiron business unit. Mr. Ostrach received his B.A. from Brown University and
his J.D. from Stanford Law School.
BRIAN W. METCALF, PH.D. has served as our Senior Vice President and Chief
Scientific Officer since March 2000. From 1983 to 2000, Dr. Metcalf held a
number of executive management positions with SmithKline Beecham, most recently
as Senior Vice President, Discovery Chemistry & Platform Technologies worldwide.
Prior to joining SmithKline Beecham, Dr. Metcalf held positions with Merrell
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Research Center from 1973-1983. Dr. Metcalf is a director of Argonaut
Technologies, Inc. Dr. Metcalf received his B.S. and Ph.D. in organic chemistry
from the University of Western Australia.
ROBERT G. JOHNSON, JR., M.D., PH.D. has served as our Vice President,
Medical Affairs and Corporate Development since September 2000. From 1998 to
September 2000, Dr. Johnson was employed by Chiron Corporation, a biotechnology
company, serving as Vice President, Pharmacology and Preclinical Affairs through
1999 and most recently as Vice President, Corporate Development. From 1991 to
1998, Dr. Johnson was Director of Pharmacology at Merck & Co., Inc., a
pharmaceutical company. In addition, Dr. Johnson was a member of the faculty at
the University of Pennsylvania from 1987 to 1991 and at Harvard Medical School
from 1985 to 1987. Dr. Johnson received his B.A. and Ph.D in biophysics and his
M.D. from the University of Pennsylvania.
SUSAN M. KANAYA has served as our Vice President, Finance and Chief
Financial Officer since November 1999. Prior to joining Kosan, Ms. Kanaya was
most recently Vice President, Finance and Treasurer at SUGEN, Inc., a
publicly-held biotechnology company that was recently acquired by Pharmacia &
Upjohn, Inc. Since joining SUGEN in 1994, Ms. Kanaya held various positions in
finance. Before joining SUGEN, Ms. Kanaya was the Controller at 50/50 Micro
Electronics, Inc. and at Power Up Software Corporation. Ms. Kanaya received her
B.S. in business administration from the University of California, Berkeley.
KEVIN KASTER has served as our Vice President, Intellectual Property since
August 1998. Prior to joining Kosan, he was Vice President, Intellectual
Property at Geron Corporation. Prior to joining Geron in 1994, Mr. Kaster
managed the patent group at Affymax N.V. between 1991 and 1994. Between 1988 and
1991, he was a Patent Attorney at Cetus Corporation. After receiving a B.S.,
magna cum laude, in chemistry and molecular biology from Vanderbilt University,
Mr. Kaster joined Eli Lilly and Co. as an Associate Biologist, later becoming a
patent technician. Mr. Kaster received his J.D. from Indiana University,
Indianapolis.
SUSAN B. DILLON, PH.D., has served as our Vice President, Pharmacological
Sciences since May 2000. From 1988 to 2000, Dr. Dillon held a number of
management positions with SmithKline Beecham, most recently as Director,
Molecular Virology and Host Defense. Dr. Dillon received her B.S. in Medical
Technology from State University of New York at Buffalo, her M.S. in Medical
Technology from Temple University School of Medicine and her Ph.D. in
Microbiology and Immunology from Thomas Jefferson University.
C. RICHARD HUTCHINSON, PH.D. has served as our Vice President, New
Technologies since March 2000. From 1971 to 2000, Dr. Hutchinson served on the
faculty of the University of Wisconsin-Madison, most recently as Professor of
Medicinal Chemistry, School of Pharmacy and Professor of Bacteriology.
Dr. Hutchinson received his B.S. in pharmacy from Ohio State University and his
Ph.D. in organic chemistry from the University of Minnesota.
CHAITAN KHOSLA, PH.D., is one of our co-founders and has served as our
director since our inception. Dr. Khosla has been Associate Professor of
chemical engineering, chemistry and biochemistry at Stanford University since
1997, and has been a faculty member since 1992. Dr. Khosla is co-chairman of our
Scientific Advisory Board. Dr. Khosla is the inventor of the combinatorial
biosynthesis technology that we licensed from Stanford University. He is the
recipient of several awards, including the 1999 Alan T. Waterman award by the
National Science Foundation, the 1999 Eli Lilly Award in biological chemistry,
and the 2000 ACS Award in pure science. Dr. Khosla is the author of over 90
publications and is an inventor on numerous patents. Dr. Khosla received his B.
Tech. from the Indian Institute of Technology, Bombay, India and his Ph.D. from
the California Institute of Technology.
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JEAN DELEAGE, PH.D., has served as our director since April 1996. He is a
founder and managing general partner of Alta Partners, a venture capital
partnership investing in information technologies and life science companies.
From 1979 to 1996, Dr. Deleage was a managing partner of Burr, Egan, Deleage &
Co., a venture capital firm. Dr. Deleage was the founder of Sofinnova, a venture
capital firm in France, and Sofinnova, Inc., the U.S. subsidiary of Sofinnova.
Dr. Deleage is a director of Flamel Technologies, S.A., Aclara
BioSciences, Inc. and several privately held companies. Dr. Deleage received a
Baccalaureate in France, a Masters Degree in electrical engineering from the
Ecole Superieure d'Electricite, and a Ph.D. in economics from the Sorbonne.
RAYMOND WHITAKER, MBA, PH.D., has served as our director since April 1998.
Dr. Whitaker has been Vice President of S.R. One, Ltd., the venture investment
affiliate of SmithKline Beecham, since 1997. From 1992 to 1996, he was Director,
Worldwide Business Development, SmithKline Beecham Pharmaceuticals. He has over
twenty-five years of international business development experience. His previous
appointments include Director, Corporate Development at Recordati SpA, Milan,
Italy, and Director, Business Development with Laboratories Delagrange--SESIF in
Paris, France. He is a member of the Board of Directors of CPBD, Inc.,
Electrosols Limited, OnyVax Limited and Xenogen Corporation. Dr. Whitaker
received his Ph.D. in biochemistry, his M.B.A. and his B.S. in biochemistry and
mathematics from the National University of Ireland, University College Dublin.
PETER DAVIS, PH.D., has served as our director since April 1998. Dr. Davis
has been a member of the Executive Committee of Pulsar International, S.A., an
affiliate of A.G. Biotech Capital since 1993. Dr. Davis was a faculty member at
the Wharton School of the University of Pennsylvania, where he was Director of
the Applied Research Center and Director of Executive Education. He is a Board
member of several Pulsar companies including Bionova Holdings Inc. and
Seminis, Inc. He is also a Board member of Lutron Electronics, Inc.,
Instromedix, Inc., C.H. Werfen and Celsa S.A. Dr. Davis received his B.A. in
physics from Cambridge University, his Masters Degree in operations research
from the London School of Economics and his Ph.D. in operations research from
the Wharton School.
CHRISTOPHER WALSH, PH.D., has served as our director since April 1996.
Dr. Walsh has been the Hamilton Kuhn Professor of biological chemistry and
molecular pharmacology at Harvard Medical School since 1991 and formerly was
President of the Dana-Farber Cancer Institute and Chairman of the Department of
Biological Chemistry and Molecular Pharmacology at Harvard Medical School. He
has performed extensive research in enzyme stereochemistry, reaction mechanisms
and the mechanisms of action of anti-infective and immunosuppressive agents. He
is co-chairman of the Kosan Scientific Advisory Board. Dr. Walsh is also a
member of the board of directors of Diacrin, Inc. and Versicor Inc. Dr. Walsh
received his A.B. in biology from Harvard University and Ph.D. in life sciences
from The Rockefeller University, New York.
In April 1998, Mr. Ostrach consented, without admitting or denying the
Securities and Exchange Commission's allegations and conclusions, to the entry
of a Commission administrative order requiring future compliance with Rule 102
of the Commission's Regulation M, a regulation which prohibits participants in a
public stock offering from purchasing securities for their own account until the
public distribution is complete. The administrative order resulted from
Mr. Ostrach's purchase of 600 shares of Neurobiological Technologies, Inc., or
NTI, common stock during a restricted period preceding a 1996 stock offering by
NTI.
SCIENTIFIC ADVISORY BOARD
The following individuals are members of our Scientific Advisory Board, or
SAB:
CHAITAN KHOSLA, PH.D., is co-chairman of our SAB and a member of our board
of directors.
CHRISTOPHER WALSH, PH.D., is co-chairman of our SAB and a member of our
board of directors.
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HOMER A. BOUSHEY, M.D., is a Professor of Medicine at the University of
California, San Francisco. Dr. Boushey is an expert in clinical research on the
causes and treatment of asthma and serves as Principal Investigator for UCSF's
Asthma Clinical Research Center.
DAVID CANE, PH.D., is Professor of Chemistry at Brown University. Dr. Cane
is an expert in the biosynthesis of natural products, with particular emphasis
on macrolide polyketides and terpenes.
SAMUEL DANISHEFSKY, PH.D., is Professor of Chemistry at Columbia University.
Dr. Danishefsky is an expert in synthetic organic chemistry.
SIR DAVID A. HOPWOOD, PH.D., is Professor and Head of the Genetics Dept. at
John Innes Institute, Norwich, U.K. Dr. Hopwood is an expert in Streptomyces
genetics, molecular biology and the genetic manipulation of polyketide genes.
IVAN KOMPIS, PH.D., has an extensive background in natural products
chemistry, in particular antibacterial agents. Dr. Kompis recently retired from
Hoffmann-La Roche, where he held the position of Deputy Director of the
Department of Infectious Diseases since 1987.
MOHAMMED A. MARAHIEL, PH.D., is Professor of Biochemistry at Philipps
University, Marburg, Germany. Dr. Marahiel is an expert in the field of
non-ribosomal peptide biosynthesis.
HARUO SETO, PH.D., is Professor of the Institute of Molecular and Cellular
Biosciences, University of Tokyo, Japan. Dr. Seto has an extensive background in
the structure, biosynthesis and screening of antibiotics.
CHI-HUEY WONG, PH.D. is the Ernest W. Hahn Professor of Chemistry at the
Scripps Research Institute, La Jolla, California. Dr. Wong's areas of expertise
include chemical-enzymatic organic synthesis, mechanism-based inhibition of
carbohydrate-mediated biological recognitions, enzyme inhibition and organic and
bioorganic reaction mechanisms.
BOARD COMPOSITION
Dr. Santi is currently the chairman of the board of directors. Immediately
following the sale of securities under this registration statement, our board of
directors will consist of six directors divided into three classes with each
class serving for a term of three years.
- Drs. Khosla and Whitaker will be the Class A directors whose terms expire
at the annual meeting of stockholders to be held in 2001;
- Drs. Walsh and Davis will be the Class B directors whose terms will expire
at the annual meeting of stockholders to be held in 2002; and
- Drs. Deleage and Santi will be the Class C directors whose terms will
expire at the annual meeting of stockholders to be held in 2003.
At each annual meeting of stockholders after the initial classification, the
successors to directors whose terms will then expire will be elected to serve
from the time of election and qualification until the third annual meeting
following the election. Any additional directorships resulting from an increase
in the number of directors will be distributed among the three classes so that,
as nearly as possible, each class will consist of one-third of the directors.
This classification of our board of directors may have the effect of delaying or
preventing change in our control or management.
COMMITTEES OF THE BOARD
COMPENSATION COMMITTEE. The compensation committee, which is composed of
Drs. Davis, Deleage and Walsh, reviews and recommends to our board of directors
the compensation and benefits
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of all our officers and establishes and reviews general policies relating to
compensation and benefits to our employees.
AUDIT COMMITTEE. The audit committee, which is comprised of Drs. Whitaker,
Davis and Deleage, reviews our internal accounting procedures and the services
provided by our independent auditors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the compensation committee is currently, or has ever
been at any time since our formation, one of our officers or employees, nor has
served as a member of the board of directors or compensation committee of any
entity that has one or more officers serving as a member of our board of
directors or compensation committee.
COMPENSATION OF DIRECTORS
We reimburse our non-employee directors for expenses incurred in connection
with attending board and committee meetings but do not compensate them for their
services as board or committee members. We have in the past granted non-employee
directors options to purchase our common stock pursuant to the terms of our
stock option plans, and our board continues to have the discretion to grant
options to new non-employee directors. On March 14, 2000, we granted an option
to purchase 15,000 shares of common stock to director Dr. Christopher Walsh. See
"Management--Stock Plans--2000 Non-Employee Director Stock Option Plan" and
"Related Party Transactions."
EMPLOYMENT AGREEMENTS
We require each of our employees to enter into confidentiality agreements
prohibiting the employee from disclosing any of our confidential or proprietary
information. At the time of commencement of employment, our employees also
generally sign offer letters specifying basic terms and conditions of
employment.
In September 2000, we entered into an agreement with Robert G. Johnson, Jr.,
M.D., Ph.D. in connection with his appointment as Vice President, Medical
Affairs and Corporate Development. Under the agreement, Dr. Johnson is entitled
to receive an annual salary of $230,000, a $50,000 sign-on bonus and an option
to purchase 192,000 shares of our common stock at fair value. In addition,
Dr. Johnson is entitled to a housing loan of $150,000 which will be secured by a
deed of trust on Dr. Johnson's residence, 50% of which will be forgiven on the
third anniversary date of his employment and the remainder of which will be
forgiven on the fourth anniversary date. Dr. Johnson is also entitled to monthly
mortgage assistance of $1,000 during the first three years of employment. Either
we or Dr. Johnson may terminate his employment at any time for any reason. If we
terminate Dr. Johnson without cause, he will receive six months of salary
continuation and six additional months of vesting of his stock options will be
accelerated.
In March 2000, we entered into an agreement with Brian Metcalf, Ph.D. in
connection with his appointment as Senior Vice President and Chief Scientific
Officer. Under the agreement, Dr. Metcalf is entitled to receive an annual
salary of $280,000, a $100,000 sign-on bonus and an option to purchase 300,000
shares of our common stock at fair value. The option was subsequently granted
with an exercise price of $1.00 per share. In addition, Dr. Metcalf is entitled
to a housing loan up to $400,000, which will be secured by a deed of trust on
Dr. Metcalf's principal residence, and five years of monthly mortgage assistance
to support up to a $400,000 mortgage. Either we or Dr. Metcalf may terminate his
employment at any time for any reason. If we terminate Dr. Metcalf without cause
during his first three years of employment, he will receive twelve months of
salary continuation. Further, if such termination occurred after one year from
his date of hire, six additional months of vesting of his stock options will be
accelerated.
42
<PAGE>
In October 1999, we entered into an agreement with Susan M. Kanaya in
connection with her appointment as Vice President, Finance and Chief Financial
Officer. Under the agreement, Ms. Kanaya is entitled to receive an annual salary
of $172,500, a $20,000 sign-on bonus and an option to purchase 150,000 shares of
our common stock at fair value. The option was subsequently granted with an
exercise price of $0.33 per share. In addition, Ms. Kanaya is entitled to a
$50,000 loan to replace an existing loan arrangement with her former employer,
which is forgiven on the third anniversary date of her employment with us.
Either we or Ms. Kanaya may terminate her employment at any time for any reason.
If we terminate Ms. Kanaya's employment without cause during the first two years
of employment, she will receive six months of salary continuation and an
additional six months of vesting on her stock options. If such termination
occurs following a change in control, the period of salary continuation will be
twelve months.
In November 1998, we entered into an agreement with Daniel V. Santi, M.D.,
Ph.D. in connection with his appointment as our Chief Executive Officer. Under
the agreement, Dr. Santi is entitled to receive an annual base salary of
$250,000, adjusted annually by a minimum of a percentage change equal to the
annual percentage change in the Consumer Price Index, and an option to purchase
750,000 shares of our common stock at $0.33 per share. The option was
subsequently granted with an exercise price of $0.37 per share, 110% of fair
value, because of a provision in our 1996 stock option plan. Either we or
Dr. Santi may terminate his employment at any time for any reason. If we
terminate Dr. Santi without cause, he will receive a lump sum severance payment
in the amount equal to eighteen months of his then current base salary, and
eighteen months accelerated vesting of the shares subject to the stock option.
In July 1998, we entered into an agreement with Kevin Kaster in connection
with his appointment as Vice President, Intellectual Property. Under the
agreement, Mr. Kaster is entitled to receive an annual base salary of $180,000
and an option to purchase 180,000 shares of our common stock at fair value. The
option was subsequently granted with an exercise price of $0.33 per share.
Either we or Mr. Kaster may terminate his employment at any time for any reason.
If we terminate Mr. Kaster without cause during the first three and one-half
years of employment, he will receive an amount equal to six months of his then
current base salary and will accelerate the vesting of the lesser of (a) six
months of his original stock option grant and (b) the remainder of his original
stock option grant.
Drs. Santi, Khosla, Metcalf and Johnson, Messrs. Ostrach and Kaster and
Ms. Kanaya each have stock option or stock purchase agreements which contain
acceleration clauses providing for 100% vesting of the unvested shares in the
event of a change in control.
EXECUTIVE COMPENSATION
The following table sets forth information concerning compensation that we
paid during 1999 to our Chief Executive Officer and to our four other most
highly compensated executive officers who received salary and bonus compensation
of more than $100,000 during 1999 on an annualized basis. All option grants were
made under our 1996 stock option plan.
43
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
------------
NUMBER OF
ANNUAL COMPENSATION SECURITIES
------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY BONUS OTHER OPTIONS
--------------------------- -------- -------- -------- ------------
<S> <C> <C> <C> <C>
Daniel V. Santi .................................... $250,812 -- -- --
Chairman and Chief Executive Officer
Michael S. Ostrach ................................. 191,667 -- -- --
Chief Operating Officer
Susan M. Kanaya(1) ................................. 26,870 $20,000 -- 150,000
Vice President, Finance and Chief Financial
Officer
Kevin Kaster ....................................... 190,559 -- -- 37,500
Vice President, Intellectual Property
Daniel Chu(2) ...................................... 172,560 -- $46,800 --
Former Vice President, Research
</TABLE>
------------------------
(1) Ms. Kanaya joined Kosan in November 1999. Her annual salary is $190,000.
(2) Dr. Chu resigned as Vice President, Research, effective November 30, 1999.
His other compensation represents a separation payment.
OPTION GRANTS
The following table sets forth summary information regarding the option
grants made to our Chief Executive Officer and four of our other executive
officers whose salary and bonus was in excess of $100,000 on an annualized basis
during 1999. Options granted to purchase shares of our common stock under our
1996 stock option plan are generally immediately exercisable by the optionee but
are subject to a right of repurchase pursuant to the vesting schedule of each
specific grant. In the event that a purchaser ceases to provide service to us,
we have the right to repurchase any of that person's unvested shares of common
stock at the original option exercise price. The purchase price per share is
equal to the deemed fair value of our common stock on the date of grant as
determined by our board of directors. The percentage of total options was
calculated based on options to purchase an aggregate of 464,100 shares of common
stock granted under our 1996 stock option plan in 1999. The potential realizable
value was calculated based on the ten-year term of the options and assumed rates
of stock appreciation of 5% and 10%, compounded annually from the date the
options were granted to their expiration date based on the fair value of the
common stock on the date of grant. These assumed rates of appreciation comply
with the rules of the Securities and Exchange Commission and do not represent
our estimate of our future stock price. For our employees and officers, 25% of
the option grant generally vests on the one-year anniversary of employment, and
the remainder vest in a series of equal monthly installments beginning on the
one-year anniversary of employment and continuing over the next three years of
service. See "Management--Stock Plans" for a description of the material terms
of these options.
44
<PAGE>
OPTION GRANTS IN 1999
<TABLE>
<CAPTION>
PERCENTAGE OF POTENTIAL REALIZABLE
NUMBER OF TOTAL VALUE AT ASSUMED ANNUAL
SECURITIES OPTIONS RATES OF STOCK APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION ----------------------------
NAME GRANTED FISCAL YEAR (PER SHARE) DATE 5% 10%
---- ---------- ------------- ----------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Daniel V. Santi................. -- -- -- -- $ -- $ --
Michael S. Ostrach(1)........... -- -- -- -- -- --
Susan M. Kanaya(2).............. 150,000 32% $0.33 11/04/09 81,363 129,557
Kevin Kaster(3)................. 37,500 8% 0.33 08/06/09 19,372 32,389
Daniel Chu...................... -- -- -- -- -- --
</TABLE>
------------------------
(1) In February 2000, we granted Mr. Ostrach an option to purchase 75,000 shares
of common stock at an exercise price of $0.42 per share, which was equal to
the fair value of the common stock on the date of grant as determined by the
board of directors. These options vest over a four-year period from the date
of grant.
(2) In March 2000, we granted Ms. Kanaya an option to purchase 15,000 shares of
common stock at an exercise price of $1.00 per share, which was equal to the
fair value of the common stock on the date of grant. These options vest over
a four-year period from the date of grant.
(3) In February 2000, we granted Mr. Kaster an option to purchase 37,500 shares
of common stock at an exercise price of $0.42 per share, which was equal to
the fair value of the common stock on the date of grant as determined by the
board of directors. These options vest over a four-year period from the date
of grant.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table provides summary information concerning the shares of
common stock represented by outstanding stock options held by our Chief
Executive Officer and four of our other most highly compensated executive
officers with annualized base salaries in excess of $100,000 as of December 31,
1999. Options granted to purchase shares of our common stock under our 1996
stock option plan are generally immediately exercisable by optionees but are
subject to a right of repurchase pursuant to the vesting schedule of each
specific grant. The repurchase option generally lapses over a four-year period
with 25% lapsing after the first year and the remainder in equal monthly
installments thereafter over a three-year period. In the event that a purchaser
ceases to provide service to us, we have the right to repurchase any of that
person's unvested shares of common stock at the original option exercise price.
Amounts shown in the value realized column were calculated based on the
difference between the option exercise price and the fair value of the common
stock on the date of exercise, without taking into account any taxes that may be
payable in connection with the transaction, multiplied by the number of shares
of common stock underlying the option.
45
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1999 DECEMBER 31, 1999(1)
ACQUIRED VALUE --------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- --------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Daniel V. Santi................... -- -- -- -- -- --
Michael S. Ostrach................ -- -- 330,000 -- $4,545,750 --
Susan M. Kanaya................... -- -- 150,000 -- 2,050,000 --
Kevin Kaster...................... -- -- 217,500 -- 2,972,500 --
Daniel Chu........................ -- -- -- -- -- --
</TABLE>
(1) The value of unexercised in-the-money options is calculated based on the
difference between an initial public offering price of $14.00 per share and
the exercise price for these shares, multiplied by the number of shares
underlying the option.
STOCK PLANS
1996 STOCK OPTION PLAN
Our 1996 stock option plan was adopted by our board of directors in
June 1996 and approved by the stockholders in June 1996. This plan provides for
the grant of incentive stock options to our employees and nonstatutory stock
options to our employees, directors and consultants. The board of directors
approved amendments to the stock option plan to increase the number of shares
reserved under the stock option plan in October 1998, October 1999 and
March 2000. The stockholders approved these amendments in October, 1998,
November, 1999 and March 2000, respectively. As of June 30, 2000, 5,100,000
shares of common stock were reserved for issuance under this plan. Of these
shares, 2,197,893 shares were issued upon exercise of stock options, 1,141,800
shares were subject to outstanding options and 1,760,307 shares were available
for future grant.
Our board of directors or a committee appointed by the board administers the
stock option plan and determines the terms of options granted, including the
exercise price, the number of shares subject to individual option awards and the
vesting of the options. The exercise price of nonstatutory options must
generally be at least 85% of the fair market value of the common stock on the
date of grant. The exercise price of incentive stock options cannot be lower
than 100% of the fair market value of the common stock on the date of the grant
and, in the case of incentive stock options granted to holders of more than 10%
of our voting power, not less than 110% of the fair market value. The term of an
incentive stock option cannot exceed ten years, and the term of an incentive
stock option granted to a holder of more than 10% of our voting power cannot
exceed five years.
A participant may not transfer rights granted under our stock option plan
other than by will, the laws of descent and distribution or as otherwise
provided under the stock option plan.
Options granted under our stock option plan are immediately exercisable.
Unvested shares are subject to our right of repurchase in the event the
employee, director or consultant ceases his or her employment with us. Our board
of directors may not, without the adversely affected optionee's prior written
consent, amend, modify or terminate the stock option plan if the amendment,
modification or termination would impair the rights of optionees. Our stock
option plan will terminate in 2006 unless terminated earlier by the board of
directors.
2000 EMPLOYEE STOCK PURCHASE PLAN
Our 2000 employee stock purchase plan was adopted by our board of directors
in March 2000, and approved by our stockholders in August 2000, but will not
become effective until the closing of this offering. A total of 300,000 shares
of our common stock has been reserved for issuance under the 2000 employee stock
purchase plan.
46
<PAGE>
The 2000 employee stock purchase plan, which is intended to qualify under
Section 423 of the Internal Revenue Code, contains a 6 month offering period.
The offering period generally starts on the first trading day on or after
October 1 and April 1 of each year, except for the first such offering period
which commences on the first trading day on or after the effective date of this
offering and ends on the last trading day on or before March 31.
Employees are eligible to participate if they are employed by us for at
least 20 hours per week and more than five months in any calendar year. However,
employees may not be granted an option to purchase stock under the 2000 employee
stock purchase plan if they either:
- immediately after grant, own stock possessing 5% or more of the total
combined voting power or value of all classes of our capital stock; or
- hold rights to purchase stock under our employee stock purchase plans
which accrue at a rate which exceeds $25,000 worth of stock for each
calendar year.
The 2000 employee stock purchase plan permits participants to purchase our
common stock through payroll deductions of up to 15% of the participant's
compensation. Compensation is defined as the participant's base gross earnings
but exclusive of incentive compensation and bonuses. The maximum number of
shares a participant may purchase during a single purchase period is 15,000
shares.
Amounts deducted and accumulated by the participant are used to purchase
shares of common stock at the end of each purchase period. The price of stock
purchased under the 2000 employee stock purchase plan is generally 85% of the
lower of the fair market value of the common stock either:
- at the beginning of the offering period; or
- at the end of the purchase period.
In the event the fair market value at the end of a purchase period is less
than the fair market value at the beginning of the offering period, the
participants will be withdrawn from the current offering period following
exercise and automatically re-enrolled in a new offering period. The new
offering period will use the lower fair market value as of the first date of the
new offering period to determine the purchase price for future purchase periods.
Participants may end their participation at any time during an offering period,
and they will be paid their payroll deductions to date. Participation ends
automatically upon termination of employment with us.
Rights granted under the 2000 employee stock purchase plan are not
transferable by a participant other than by will, the laws of descent and
distribution, or as otherwise provided under the 2000 employee stock purchase
plan. The 2000 employee stock purchase plan provides that, in the event we merge
with or into another corporation or there is a sale of substantially all of our
assets, each outstanding option may be assumed or substituted for by the
successor corporation. If the successor corporation refuses to assume or
substitute for the outstanding options, the offering period then in progress
will be shortened and a new exercise date will be set.
The 2000 employee stock purchase plan will terminate in 2010. Our board of
directors has the authority to amend or terminate the 2000 employee stock
purchase plan, except that no such action may adversely affect any outstanding
rights to purchase stock under the 2000 employee stock purchase plan.
47
<PAGE>
2000 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
Non-employee directors are entitled to participate in our 2000 non-employee
director stock option plan, or the director option plan. The director option
plan was adopted by our board of directors in March 2000 and approved by our
stockholders in August 2000, but will not become effective until the closing of
this offering. The director option plan has a term of ten years, unless
terminated sooner by our board of directors. A total of 300,000 shares of our
common stock have been reserved for issuance under the director option plan.
The director option plan generally provides for an automatic initial grant
of an option to purchase 7,500 shares of our common stock to each non-employee
director on the date which the later of the following events occur:
- the effective date of the director option plan; or
- the date when a person first becomes a non-employee director.
After the initial grant, a non-employee director will automatically be
granted subsequent options to purchase 3,750 shares of our common stock each
year on the date of our annual stockholder's meeting, if on such date he or she
has served on our board of directors for at least six months. Each initial
option grant and each subsequent option grant shall have a term of 10 years.
Each initial option grant will vest as to 25% of the shares subject to the
option on each anniversary of its date of grant and each subsequent option grant
will vest as to 100% of the shares subject to the option on each anniversary of
its date of grant. The exercise price of all options will be 100% of the fair
market value per share of our common stock on the date of grant.
The director option plan provides that in the event of our merger with or
into another corporation, or a sale of substantially all of our assets, each
option will become fully vested and exercisable for a period of thirty days from
the date our board of directors notifies the optionee of the option's full
exercisability, after which period the option shall terminate. Options granted
under the director option plan must be exercised within three months of the end
of the optionee's tenure as a director of the Company, or within 12 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 option 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 the optionee.
LIMITATION OF LIABILITY OF DIRECTORS AND INDEMNIFICATION MATTERS
Our certificate of incorporation and bylaws limit the liability of our
directors, officers, employees, and other agents to the fullest extent permitted
by Delaware law. However, we will indemnify a person in connection with a
proceeding initiated by such person only if such proceeding was authorized by
our board. 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 for liability for
- breach of their duty of loyalty to the corporation or its stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
- any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal or state securities laws and does not affect the availability of
equitable remedies such as injunctive relief or rescission.
48
<PAGE>
We believe that indemnification under our bylaws and certificate of
incorporation covers at least negligence and gross negligence on the part of
indemnified parties. Our bylaws also permit us to secure insurance on behalf of
any officer, director, employee, or other agent for any liability arising out of
his or her actions in this capacity, regardless of whether the bylaws permit
indemnification.
We have entered and intend to continue to enter into agreements to indemnify
our directors, in addition to the indemnification provided for in our bylaws.
These agreements, among other things, indemnify our directors and officers for
certain expenses (including attorneys' fees), judgments, fines, and settlement
amounts incurred by any such person in any action or proceeding, including any
action by or in our right arising out of such person's services as one of our
directors or such person's services to any of our subsidiaries or any other
company or enterprise to which the person provides services at our request. We
believe that these provisions and agreements are necessary to attract and retain
qualified persons as directors and officers. See "Related Party Transactions."
There is no pending litigation or proceeding involving any of our directors
or officers in which indemnification is required or permitted, and we are not
aware of any threatened litigation or proceeding that may result in a claim for
indemnification.
49
<PAGE>
RELATED PARTY TRANSACTIONS
SALES OF SECURITIES
From January 1997 through March 2000, we issued the following securities in
private placement transactions:
- 571,429 shares of our Series A convertible preferred stock in January 1997
at a per share purchase price of $4.20 for aggregate proceeds of
approximately $2.4 million, convertible into 1,714,287 shares of common
stock upon the closing of this offering.
- 1,818,182 shares of our Series B convertible preferred stock in
April 1998 at a per share purchase price of $8.25 for aggregate proceeds
of approximately $15.0 million, convertible into 5,454,546 shares of
common stock upon the closing of this offering.
- 804,196 shares of our Series C convertible preferred stock in March 2000
at a per share purchase price of $31.00 for aggregate proceeds of
approximately $24.9 million, convertible into 2,412,588 shares of common
stock upon the closing of this offering.
Our certificate of incorporation provides that our Series A and B
convertible preferred stock will automatically convert into common stock in the
event this offering results in proceeds to us of at least $15.0 million and the
offering price per share is at least $7.00. Our Series C convertible preferred
stock will automatically convert into common stock in the event this offering
results in proceeds to us of at least $25.0 million and the offering price per
share is at least $11.00.
The following executive officers, directors and holders of more than five
percent of our voting securities purchased securities in the amounts as of the
dates shown below.
<TABLE>
<CAPTION>
SHARES OF CONVERTIBLE PREFERRED STOCK
COMMON ---------------------------------------
STOCK SERIES A SERIES B SERIES C
----------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
DIRECTORS AND EXECUTIVE
OFFICERS
Daniel V. Santi, M.D.,
Ph.D.(1)............. 2,899,494 229,761 24,244 --
Chaitan Khosla,
Ph.D.(2)............. 1,763,571 7,143 -- --
Michael S. Ostrach..... 330,000 -- -- --
Susan Kanaya........... 165,000 -- -- --
Kevin Kaster........... 217,500 -- -- --
5% STOCKHOLDERS
AG Biotech Capital
LLC(3)............... -- -- 484,848 16,129
Alta California
Partners, L.P.(4).... 156,789 462,968 237,009 23,654
Alta Embarcadero
Partners, LLC(4)..... 4,656 13,224 5,415 540
Franklin Biotechnology
Discovery Fund(5).... -- -- -- 387,097
Lombard Odier &
Cie(6)............... -- -- 363,636 58,065
S.R. One, Limited(7)... -- -- 303,030 16,129
Price per share........ $0.0003 to $1.00 $ 4.20 $ 8.25 $ 31.00
Date(s) of Issuance.... Jan 1995 - Apr 00 Jan 97 Apr 98 Mar 00
</TABLE>
------------------------
(1) Dr. Santi received 229,761 shares of Series A convertible preferred stock in
exchange for the surrender of certain shares previously held by him. See
note 9 of our financial statements. All
50
<PAGE>
shares of convertible preferred stock owned by Dr. Santi will convert into
762,015 shares of common stock upon the closing of this offering.
(2) Dr. Khosla received 7,143 shares of Series A convertible preferred stock in
exchange for his surrender of certain shares previously held by him. See
Note 9 of our financial statements. All shares of convertible preferred
stock owned by Dr. Khosla will convert into 21,429 shares of common stock
upon the closing of this offering.
(3) Peter Davis, one of our directors, is a member of the Executive Committee of
Pulsar International, S.A., an affiliate of AG Biotech Capital LLC. All
shares of convertible preferred stock owned by AG Biotech Capital LLC will
convert into 1,502,931 shares of common stock upon the closing of this
offering.
(4) Jean Deleage, one of our directors, is a general partner of Alta Partners,
an affiliate of Alta California Partners and Alta Embarcadero Partners. All
shares of convertible preferred stock owned by Alta California Partners,
L.P. and Alta Embarcadero Partners, LLC will convert into 2,228,430 shares
of common stock upon the closing of this offering.
(5) All shares of convertible preferred stock owned by Franklin Biotechnology
Discovery Fund will convert into 1,161,291 shares of common stock upon the
closing of this offering.
(6) All shares of convertible preferred stock owned by Lombard Odier & Cie will
convert into 1,265,103 shares of common stock upon the closing of this
offering.
(7) Raymond Whitaker, one of our directors, is Vice President of S.R. One,
Limited, the venture investment affiliate of SmithKline Beecham. All shares
of convertible preferred stock owned by S.R. One, Limited will convert into
957,477 shares of common stock upon the closing of this offering.
OTHER TRANSACTIONS
PROMISSORY NOTES. Stock options granted under our 1996 Stock Option Plan
are immediately exercisable as to both vested and unvested shares, with unvested
shares being subject to a right of repurchase in our favor in the event of
termination of employment or consultancy prior to vesting of all shares. These
individuals pay the exercise price for their outstanding options pursuant to
full recourse promissory notes secured in part by the common stock underlying
the options. The notes bear interest at the Applicable Mid Term Federal Rate at
the time of exercise. Principal and interest is due on the earlier of the
employee's or consultant's termination date or three years after the date of the
promissory note. As of June 30, 2000, the original and outstanding principal
amounts of each promissory note by a director or executive officer are set forth
below.
<TABLE>
<CAPTION>
ORIGINAL AND
OUTSTANDING INTEREST ACCRUED
DIRECTOR OR EXECUTIVE OFFICER ISSUANCE DATE NOTE AMOUNT RATE INTEREST
----------------------------- -------------- ------------ -------- --------
<S> <C> <C> <C> <C>
Daniel V. Santi................ December 1998 $275,000 4.47% $18,854
Michael S. Ostrach............. February 2000 74,250 6.46% 1,719
Susan M. Kanaya................ February 2000 50,000 6.46% 1,157
Susan M. Kanaya................ April 2000 15,000 6.60% 179
Kevin Kaster................... February 2000 72,500 6.46% 1,678
Chaitan Khosla................. September 1999 71,500 5.89% 3,252
</TABLE>
EXECUTIVE OFFICER LOANS. In connection with Dr. Brian Metcalf's relocation
to California, we loaned Dr. Metcalf $400,000 in May 2000 and received a full
recourse promissory note, which bears interest at 6.3% per year, and is secured
by a deed of trust on Dr. Metcalf's principal residence. Principal and
51
<PAGE>
accrued interest is payable in full on the earlier of May 30, 2005 or the date
on which Dr. Metcalf voluntarily terminates his employment with us.
In accordance with the terms of our employment agreement with Susan M.
Kanaya, we loaned Ms. Kanaya $52,900 in March 2000 and received a full recourse
promissory note, which bears interest at 6.35% per year, and is secured by a
deed of trust on Ms. Kanaya's principal residence. Such loan and accrued
interest is forgivable on November 4, 2002. In the event Ms. Kanaya voluntarily
terminates her employment with us prior to November 4, 2002, principal and
accrued interest is payable in full.
CONSULTING AGREEMENTS. In December 1998, we entered into an amended and
restated consulting agreement with our co-founder and director, Dr. Chaitan
Khosla. Under the terms of this agreement, Dr. Khosla is entitled to receive
consulting fees of not less than $100,000 per year and was granted an option to
purchase 195,000 shares of our common stock at an exercise price of $0.37 per
share which vest over a four year period. Total consulting fees paid to
Dr. Khosla totaled $104,279 in 1999, $126,171 in 1998 and $61,846 in 1997.
Either Kosan or Dr. Khosla may terminate his consultancy at any time for any
reason. If we terminate Dr. Khosla without cause or as a result of a change in
control, he will receive the greater of (i) any compensation payable during the
extended term of his consulting agreement or (ii) an amount equal to two times
his then-current annual compensation. Further, all of Dr. Khosla's stock options
and other similar equity rights will immediately vest in full.
In December 1995, we entered into a consulting agreement with our director,
Dr. Christopher Walsh. Under the terms of this agreement, Dr. Walsh is entitled
to receive $1,000 per day for consultations and entered into a restricted stock
purchase agreement which provided for the purchase of 60,000 shares of common
stock at a purchase price of $0.0007 per share, which vest over five years. In
March 2000, we granted Dr. Walsh an additional option to purchase 15,000 shares
of common stock at a purchase price of $1.00 per share, which vest over a
four-year period. Total consulting fees paid to Dr. Walsh totaled $4,000 in
1999, $2,000 in 1998 and $4,000 in 1997.
INDEMNIFICATION AGREEMENTS. We have entered into indemnification agreements
with Drs. Davis, Deleage, Khosla, Santi, Walsh and Whitaker, Mr. Ostrach,
Ms. Kanaya and Mr. Kaster. We intend to enter into indemnification agreements
with all of our directors and officers for the indemnification of those persons
to the full extent permitted by law. We also intend to execute these agreements
with our future directors and officers.
STOCK OPTIONS. Stock option grants to our executive officers and directors
are described in this prospectus under the captions "Management--Compensation of
Directors," "--Executive Compensation" and "--Option Grants."
EVALUATION AGREEMENT. Effective in March 1998, we entered into a 14-month
evaluation agreement with Savia Corporation and DNA Plant Technologies. The
evaluation program was for the development of intellectual property and
technology for use in the field of production of polyketides in plants. We
received revenue of approximately $90,000 upon signing the agreement for work
performed to that date. The agreement was terminated effective December 31,
1999. Under the terms of the termination agreement we received approximately
$160,000 for development services performed through December 31, 1999.
Dr. Davis, one of our board members, is also a board member of the company that
controls DNA Plant Technologies.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to beneficial
ownership of our common stock as of August 31, 2000, as adjusted to reflect the
sale of common stock in this offering. Information is given for:
- each stockholder who is known by us to beneficially own more than five
percent of our common stock;
- each of our directors and executive officers; and
- all of our directors and officers as a group.
Percentage of ownership in the following table is calculated based on
19,006,026 shares of our common stock and convertible preferred stock on an
as-converted basis outstanding as of August 31, 2000 and 24,006,026 shares of
common stock outstanding after completion of this offering.
Beneficiary ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of common stock subject to options held by that person are deemed
outstanding. Those shares, however, are not deemed outstanding for the purposes
of computing the percentage ownership of any other person. Except as indicated
in the footnotes to the table, the persons named in the table have sole voting
and investment power with respect to all shares of common stock shown as
beneficially owned by them, subject to community property laws, where
applicable.
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<PAGE>
<TABLE>
<CAPTION>
AMOUNT OF SHARES BENEFICIALLY OWNED
AS OF AUGUST 31, 2000
-----------------------------------------
PERCENTAGE OF TOTAL
OUTSTANDING SHARES
BENEFICIALLY OWNED
-------------------
NUMBER OF SHARES BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING OFFERING
------------------------------------ ------------------- -------- --------
<S> <C> <C> <C>
Daniel V. Santi, M.D., Ph.D.(1)......................... 3,645,009 19.2% 15.2%
Jean Deleage, Ph.D. (2)................................. 2,389,875 12.6% 10.0%
Alta Partners
One Embarcadero Center, Suite 4050
San Francisco, CA 94111
Peter Davis, Ph.D. (3).................................. 1,502,931 7.9% 6.3%
AG Biotech Capital, LLC
c/o Viridian Management, LLC
686 N. DuPont Boulevard #220
Milford, DE 19963
Lombard Odier & Cie (4)................................. 1,265,103 6.7% 5.3%
Sihlstrasse 20
8021 Zurich, Switzerland
Kurt von Emster (5)..................................... 1,161,291 6.1% 4.8%
Franklin Biotechnology Discovery Fund
777 Mariners Island Boulevard
San Mateo, CA 94404
Raymond Whitaker, Ph.D. (6)............................. 957,477 5.0% 4.0%
S.R. One, Limited
Four Tower Bridge
West Conshohoken, PA 19428
Chaitan Khosla, Ph.D. (7)............................... 1,785,000 9.4% 7.4%
Christopher Walsh, Ph.D. (8)............................ 79,500 * *
Michael S. Ostrach (9).................................. 405,000 2.1% 1.7%
Brian W. Metcalf, Ph.D. (10)............................ 300,000 1.6% 1.2%
Susan M. Kanaya (11).................................... 165,000 * *
Kevin Kaster (12)....................................... 255,000 1.3% 1.1%
Daniel Chu (13)......................................... 67,500 * *
All current directors and executive officers as a group
(10 persons)(14)...................................... 11,484,793 59.1% 47.0%
</TABLE>
------------------------
* Less than one percent (1%)
(1) Includes 390,624 shares that are subject to our right of repurchase as of
August 31, 2000 if Dr. Santi is no longer an employee, director or
consultant with us. Dr. Santi is located at 3832 Bay Center Place, Hayward,
CA 94545.
(2) Consists of 2,389,875 shares beneficially owned by Alta Partners including
2,327,682 shares held directly by Alta California Partners, L.P. and 62,193
shares held directly by Alta Embarcadero Partners, LLC. Dr. Deleage, one of
our directors, is the managing general partner of Alta Partners and
disclaims beneficial ownership of such shares except to the extent of his
proportionate pecuniary interest therein.
(3) Consists of 1,502,931 shares held directly by AG Biotech Capital LLC.
Dr. Davis, one of our directors, is a member of the Executive Committee of
Pulsar International, S.A., an affiliate of
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<PAGE>
AG Biotech Capital. Dr. Davis disclaims beneficial ownership of the shares
held by AG Biotech Capital except to the extent of his proportionate
pecuniary interest therein.
(4) Lombard Odier & Cie is a private Swiss banking institution. The shares
consist of shares held by Lombard Odier for the benefit of certain Swiss
publicly traded mutual funds and private and institutional clients over
which Lombard Odier has sole voting and dispositive power through its asset
managers. No single person exercises voting and dispositive control over
the shares held by Lombard Odier.
(5) Kurt von Emster is Vice President, Franklin Advisors and Portfolio
Manager/Analyst for Franklin Templeton Group and is deemed to share
investment power with respect to the 1,161,291 shares held directly by
Franklin Biotechnology Discovery Fund. Mr. von Emster disclaims beneficial
ownership of such shares.
(6) Consists of 957,477 shares held directly by S.R. One, Limited.
Dr. Whitaker, one of our directors, is Vice President of S.R. One, Limited,
the venture investment affiliate of SmithKline Beecham. Dr. Whitaker
disclaims beneficial ownership of the shares held by S.R. One, Limited
except to the extent of his proportionate pecuniary interest therein.
(7) Includes 113,748 shares that are subject to our right of repurchase as of
August 31, 2000 if Dr. Khosla is no longer an employee, director or
consultant with us. Dr. Khosla is located at 3832 Bay Center Place,
Hayward, CA 94545.
(8) Includes the following:
(i) 3,999 shares that are subject to our right of repurchase as of
August 31, 2000; and
(ii) 19,500 shares that are subject to option as of August 31, 2000, of
which 13,437 would be subject to our right of repurchase in the
event of exercise if Dr. Walsh is no longer an employee, director
or consultant with us.
(9) Includes the following.
(i) 124,374 shares that are subject to our right of repurchase as of
August 31, 2000; and
(ii) 75,000 shares that are subject to option as of August 31, 2000, of
which 65,625 would be subject to our right of repurchase in the
event of exercise if Mr. Ostrach is no longer an employee, director
or consultant with us.
(10) Consists of 300,000 shares that are subject to option as of August 31,
2000, all of which would be subject to our right of repurchase in the
event of exercise if Dr. Metcalf is no longer an employee, director or
consultant with us.
(11) Consists of 165,000 shares that are subject to our right of repurchase as
of August 31, 2000.
(12) Includes the following:
(i) 118,125 shares that are subject to our right of repurchase as of
August 31, 2000; and
(ii) 37,500 shares that are subject to option as of August 31, 2000, of
which 32,811 would be subject to our right of repurchase in the
event of exercise if Mr. Kaster is no longer an employee, director
or consultant with us.
(13) Dr. Chu resigned as Vice President, Research, effective November 30, 1999.
(14) Includes shares included pursuant to notes (1) through (3) and (6) through
(12) above.
55
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Our certificate of incorporation, the filing of which will occur at the
closing of this offering, authorizes the issuance of up to 200,000,000 shares of
common stock, par value $0.001 per share, and 10,000,000 shares of preferred
stock, par value $0.001 per share, the rights and preferences of which may be
established from time to time by our board of directors. As of June 30, 2000,
after giving effect to the conversion of all of our preferred stock into common
stock, 18,844,539 shares of common stock were outstanding. As of June 30, 2000,
we had 100 stockholders.
COMMON STOCK
Each holder of common stock is entitled to one vote for each share on all
matters to be voted upon by the stockholders and there are no cumulative voting
rights. Subject to preferences to which holders of convertible preferred stock
issued after the sale of the common stock offered hereby may be entitled,
holders of common stock are entitled to receive ratably such dividends, if any,
as may be declared from time to time by the board of directors out of funds
legally available therefor. In the event of our liquidation, dissolution or
winding up, holders of common stock will be entitled to share in our assets
remaining after the payment of liabilities and the satisfaction of any
liquidation preference granted to the holders of any outstanding shares of
convertible preferred stock. Holders of common stock have no preemptive or
conversion rights or other subscription rights, and there are no redemption or
sinking fund provisions applicable to the common stock. All outstanding shares
of common stock are, and the shares of common stock offered by us in this
offering, when issued and paid for, will be, fully paid and nonassessable. The
rights, preferences and privileges of the holders of common stock are subject
to, and may be adversely affected by, the rights of the holders of shares of any
series of preferred stock, which we may designate in the future.
PREFERRED STOCK
Upon the closing of this offering, the board of directors will be
authorized, subject to any limitations prescribed by law, without stockholder
approval, from time to time to issue up to an aggregate of 10,000,000 shares of
convertible preferred stock, $0.001 par value per share, in one or more series,
each of such series to have such rights and preferences, including voting
rights, dividend rights, conversion rights, redemption privileges and
liquidation preferences, as shall be determined by the board of directors. The
rights of the holders of common stock will be subject to, and may be adversely
affected by, the rights of holders of any convertible preferred stock that may
be issued in the future. Issuance of preferred stock, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to acquire, a majority
of our outstanding voting stock. We have no present plans to issue any shares of
preferred stock.
REGISTRATION RIGHTS
Pursuant to the Third Amended and Restated Registration Rights Agreement
entered into between us and holders of 13,226,481 shares of common stock and
holders of shares of common stock issuable upon conversion of our Series A,
Series B and Series C convertible preferred stock, we are obligated, under
limited circumstances and subject to specified conditions and limitations, to
use our reasonable best efforts to register the registrable shares.
We must use our reasonable best efforts to register shares subject to such
registration rights if we:
- receive written notice from holders of 50% or more of the registrable
shares requesting that we effect a registration with respect to at least
20% of the registrable shares then held by the holders requesting
registration;
- decide to register our own securities; or
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<PAGE>
- both receive written notice from any holder or holders of the registrable
shares requesting that we effect a registration on Form S-3 (a shortened
form of registration statement) with respect to the registrable shares,
and are then eligible to use Form S-3 (which at the earliest could occur
12 calendar months after the closing of this offering).
However, in addition to certain other conditions and limitations, if we are
proposing to issue registered shares and the underwriters request to decrease
the number of shares registered, we can limit the number of registrable shares
included in the registration statement. The underwriters have requested that no
registrable shares be registered in this offering. In addition, the holders of
these registration rights have entered into lockup agreements and waived their
registration rights until 180 days following the completion of this offering.
DELAWARE ANTI-TAKEOVER LAW AND CHARTER PROVISIONS
Certain provisions of our certificate of incorporation and bylaws may have
the effect of making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire, control of us. Such
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock. Certain of these provisions will
create a classified board of directors, will allow us to issue preferred stock
without any vote or further action by the stockholders, require advance
notification of stockholder proposals and nominations of candidates for election
as directors, eliminate cumulative voting in the election of directors and
eliminate shareholder action by written consent. In addition, our bylaws will
provide that special meetings of the stockholders may be called only by the
Chairman of the Board, the President, or board of directors and that the
authorized number of directors may be changed only by resolution of the board of
directors. These provisions may make it more difficult for stockholders to take
certain corporate actions and could have the effect of delaying or preventing a
change in our control.
In addition, we will be subject to Section 203 of the Delaware General
Corporation Law. This law prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder, unless any of the
following conditions are met. First, this law does not apply if prior to the
date of the transaction, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder. Second, the law does not apply
if upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at least
85% of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned by persons who are directors and also
officers and by employee stock plans in which employee participants do not have
the right to determine confidentially whether shares held subject to the plan
will be tendered in a tender or exchange offer. Third, the law does not apply if
at or after the date of the transaction, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at least
66 2/3% of the outstanding voting stock which is not owned by the interested
stockholder.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for our common stock is ChaseMellon
Shareholder Services, L.L.C.
57
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. Future sales of substantial amounts of our common stock in the public
market could reduce prevailing market prices. Furthermore, since certain shares
will not be available for sale shortly after this offering because of
contractual and legal restrictions on resale as described below, sales of
substantial amounts of our common stock in the public market after any
restrictions on sale lapse could adversely affect the prevailing market price of
the common stock and impair our ability to raise equity capital in the future.
Upon completion of the offering, we will have 23,844,539 outstanding shares
of common stock, assuming no exercise of the over-allotment option and no
exercises of outstanding options after June 30, 2000. Of these shares, all of
the shares sold in the public offering will be freely tradable without
restriction or further registration under the Securities Act, unless these
shares are purchased by affiliates. The remaining 18,844,539 shares of common
stock held by existing stockholders are restricted securities. Restricted
securities may be sold in the public market only if registered or if they
qualify for an exemption from registration described below under Rules 144,
144(k) or 701 promulgated under the Securities Act.
As a result of contractual restrictions described below and the provisions
of Rules 144, 144(k) and 701, the restricted shares will be available for sale
in the public market as follows:
- unless held by affiliates, the 5,000,000 shares sold in the public
offering will be freely tradable upon completion of the offering;
- 16,449,285 shares will be eligible for sale upon the expiration of the
lock-up agreements, described below, beginning 180 days after the date of
this prospectus; and
- 213,403 shares will be eligible for sale upon the exercise of vested
options 180 days after the date of this prospectus.
LOCK-UP AGREEMENTS
We, our directors, officers, employees and other stockholders, who together
hold 98.8 percent of our securities, have entered into lock-up agreements in
connection with this offering. These lock-up agreements generally provide that
these holders will not offer, sell, contract to sell, grant any option to
purchase or otherwise dispose of our common stock or any securities exercisable
for or convertible into our common stock owned by them for a period of 180 days
after the date of this prospectus without the prior written consent of Lehman
Brothers Inc. Notwithstanding possible earlier eligibility for sale under the
provisions of Rules 144, 144(k) and 701, shares subject to lock-up agreements
may not be sold until these agreements expire or are waived by Lehman Brothers
Inc.
RULE 144
In general, under Rule 144 as currently in effect, after the expiration of
the lock-up agreements, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- one percent of the number of shares of common stock then outstanding,
which will equal approximately 238,445 shares immediately after this
offering; and
- the average weekly trading volume of our common stock during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to requirements with respect to manner
of sale, notice and the availability of current public information about us.
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RULE 144(K)
Under Rule 144(k), a person who is not deemed to have been our affiliate at
any time during the three months preceding a sale, and who has beneficially
owned the shares proposed to be sold for at least two years, may sell these
shares without complying with the manner of sale, public information, volume
limitation or notice requirements of Rule 144.
RULE 701
Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares pursuant to a written compensatory plan or
contract to resell such shares in reliance upon Rule 144, but without compliance
with certain restrictions. Rule 701 provides that affiliates may sell their
Rule 701 shares under Rule 144 90 days after effectiveness without complying
with the holding period requirement and that non-affiliates may sell such shares
in reliance on Rule 144 90 days after effectiveness without complying with the
holding period, public information, volume limitation or notice requirements of
Rule 144.
REGISTRATION RIGHTS
Upon completion of this offering, the holders of 13,226,481 shares of our
common stock, or their transferees, will be entitled to rights with respect to
the registration of their shares under the Securities Act. Registration of their
shares under the Securities Act would result in these shares becoming freely
tradeable without restriction under the Securities Act, except for shares
purchased by affiliates, immediately upon the effectiveness of such
registration.
STOCK OPTIONS
Ninety days after the date of this prospectus, shares issued upon exercise
of options that we granted prior to the date of this offering will also be
available for sale in the public market pursuant to Rule 701 under the
Securities Act of 1933, subject to the expiration of lock-up agreements. As of
June 30, 2000, options to purchase a total of 1,141,800 shares of our common
stock were outstanding, 106,950 of which were vested.
Upon the closing of this offering, we intend to file a registration
statement to register for resale the 3,502,107 shares of common stock reserved
for issuance under our 1996 stock option plan, our 2000 employee stock purchase
plan and our 2000 non-employee director stock option plan. We expect the
registration statement to become effective immediately upon filing. Shares
issued upon the exercise of stock options granted under these plans will be
eligible for sale in the public market from time to time, subject to vesting
provisions, Rule 144 volume limitations applicable to our affiliates and, in the
case of some options, the expiration of lock-up agreements.
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<PAGE>
UNDERWRITING
Under the terms of an underwriting agreement, which is filed as an exhibit
to the registration statement relating to this prospectus, each of the
underwriters named below, for whom Lehman Brothers Inc., CIBC World Markets
Corp., SG Cowen Securities Corporation and Fidelity Capital Markets, a division
of National Financial Services LLC, are acting as representatives, have
severally agreed to purchase from us the respective number of shares of common
stock opposite their names below:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
----------- ----------------
<S> <C>
Lehman Brothers Inc. ....................................... 2,118,500
CIBC World Markets Corp. ................................... 1,059,250
SG Cowen Securities Corporation............................. 1,059,250
Fidelity Capital Markets, a division of National Financial
Services LLC.............................................. 60,000
Chase Securities Inc. ...................................... 60,000
A.G. Edwards & Sons, Inc. .................................. 60,000
ING Barings LLC............................................. 60,000
Lazard Freres & Co. LLC..................................... 60,000
J.P. Morgan Securities Inc.................................. 60,000
Prudential Securities Incorporated.......................... 60,000
Fahnestock & Co. Inc. ...................................... 49,000
Edwards D. Jones & Co., L.P. ............................... 49,000
Raymond James & Associates, Inc............................. 49,000
Ragen Mackenzie Incorporated................................ 49,000
Wm. Smith Securities, Incorporated.......................... 49,000
UBS Warburg LLC............................................. 49,000
Wachovia Securities, Inc. .................................. 49,000
---------
Total..................................................... 5,000,000
=========
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all of the shares of common stock in the offering if any are purchased,
other than those covered by the over-the-allotment option described below.
Lehman Brothers Inc., on behalf of the underwriters, expects to deliver the
shares on or about October 10, 2000.
We have granted the underwriters a 30 day option after the date of the
underwriting agreement to purchase, from time to time, in whole or in part, up
to 750,000 shares at the public offering price less underwriting discounts and
commissions. The option may be exercised to cover over-allotments, if any, made
in connection with the offering. To the extent that this option is exercised,
each underwriter will be obligated, subject to certain conditions, to purchase
its pro rata portion of these additional shares based on the underwriter's
percentage underwriting commitment in the offering as indicated in the preceding
table.
The representatives of the underwriters have advised us that the
underwriters propose to offer shares of common stock directly to the public at
the public offering price on the cover of this prospectus and to selected
dealers, who may include the underwriters, at this public offering price less a
selling concession not in excess of $0.56 per share. The underwriters may allow,
and the selected dealers may re-allow, a discount from the concession not in
excess of $0.10 per share to other dealers. After the completion of the
offering, the representatives may change the public offering price and other
selling terms.
The following table summarizes the underwriting discounts and commissions we
will pay to the underwriters. These amounts are shown assuming both no exercise
and full exercise of the
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underwriters' overallotment option to purchase 750,000 additional shares. The
underwriting fee is the difference between the initial price to the public and
the amount the underwriters pay to the Company for the shares.
<TABLE>
<CAPTION>
PAID BY US
---------------------------------------------
NO EXERCISE OF FULL EXERCISE OF
OVER-ALLOTMENT OPTION OVER-ALLOTMENT OPTION
--------------------- ---------------------
<S> <C> <C>
Per Share.............................. $ 0.98 $ 0.98
Total.................................. $4,900,000 $5,635,000
</TABLE>
We estimate that the total expense of this offering, excluding the
underwriting discounts and commissions, will be approximately $1,250,000.
Our common stock has been approved for quotation on the NASDAQ National
Market under the symbol "KOSN."
We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act, and liabilities incurred in
connection with the directed share program referred to below, and to contribute
to payments that the underwriters may be required to make for these liabilities.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price was determined by negotiation between
us and the underwriters. The factors that the representatives considered in
determining the public offering price include:
- the history and prospects for the industry in which we compete;
- the ability of our management and our business potential and earning
prospects;
- the prevailing securities markets at the time of this offering; and
- the recent market prices of, and the demand for, publicly traded shares of
generally comparable companies.
The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions, and penalty bids or purchases for the purpose
of pegging, fixing or maintaining the price of the common stock, in accordance
with Regulation M under the Securities Exchange Act.
- Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.
- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specific maximum.
- Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed.
- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a syndicate covering transaction to cover
syndicate short positions.
The underwriters may purchase and sell shares of common stock in the open
market. These transactions may include short sales, stabilizing transactions and
purchases to cover positions created by short sales. Short sales involve the
sale by the underwriters of a greater number of shares than they are required to
purchase in the offering. Covered short sales are sales made in an amount not
greater than the underwriters' option to purchase additional shares from the
issuer in the offering. The underwriters may close out any covered short
position by either exercising their option to purchase additional shares or
purchasing shares in the open market. In determining the source of shares to
close out the covered short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the
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<PAGE>
over-allotment option. Naked short sales are any sales in excess of such option.
The underwriters must close out any naked short position by purchasing shares in
the open market. A naked short position is more likely to be created if the
underwriters are concerned that there may be downward pressure on the price of
the common stock in the open market after pricing that could adversely affect
investors who purchase in the offering. Stabilizing transactions consist of
various bids for or purchases of common stock made by the underwriters in the
open market prior to the completion of the offering.
Similar to other purchase transactions, the underwriters' purchases to cover
the syndicate short sales may have the effect of raising or maintaining the
market price of the common stock or preventing or retarding a decline in the
market price of the common stock. As a result, the price of the common stock may
be higher than the price that might otherwise exist in the open market.
Neither we nor any of the underwriters make any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the common stock. In addition, neither we nor any
of the underwriters make any representation that the representatives will engage
in these stabilizing transactions or that any transaction, once commenced, will
not be discontinued without notice.
The underwriters have informed us that they do not intend to confirm sales
to discretionary accounts that exceed 5% of the total number of shares offered
by them.
We, our directors, officers, employees and other stockholders holding 98.8
percent of our securities have agreed not to offer to sell, sell or otherwise
dispose of, directly or indirectly, any shares of capital stock or any
securities that may be converted into or exchanged for any shares of capital
stock for a period of 180 days from the date of the prospectus without the prior
written consent of Lehman Brothers Inc., except that we may issue and grant
options to purchase shares of common stock under our option plans and pursuant
to collaborative relationships that we establish or acquisitions of assets,
products or technologies from others. See "Shares Eligible for Future Sale."
At our request, Lehman Brothers Inc. has reserved up to 250,000 shares of
the common stock offered by this prospectus for sale pursuant to a directed
share program to our employees, directors and friends at the initial public
offering price on the cover page of this prospectus. These persons must commit
to purchase no later than the close of business on the day following the date of
this prospectus. The number of shares available for sale to the general public
will be reduced to the extent these persons purchase the reserved shares.
Lehman Brothers Inc., CIBC World Markets Corp. and SG Cowen Securities
Corporation intend to distribute and deliver this prospectus only by hand or
mail and intend to use only printed prospectuses. Fidelity Capital Markets, a
division of National Financial Services LLC, is acting as an underwriter of this
offering and will be facilitating electronic distribution through the Internet.
Purchasers of the shares of common stock offered in this prospectus may be
required to pay stamp taxes and other charges under the laws and practices of
the county of purchase, in addition to the offering price listed on the cover of
this prospectus.
62
<PAGE>
LEGAL MATTERS
Wilson Sonsini Goodrich & Rosati, Professional Corporation, will pass upon
the validity of the issuance of the shares of common stock offered by this
prospectus. The underwriters have been represented by Brobeck, Phleger &
Harrison LLP. An investment partnership composed of current and former members
of and persons associated with Wilson Sonsini Goodrich & Rosati, Professional
Corporation, beneficially owns 16,437 shares of our common stock.
CHANGE IN INDEPENDENT AUDITORS
Effective May 28, 1998, Ernst & Young LLP was engaged as our independent
auditors and replaced Coopers & Lybrand L.L.P. (now, PricewaterhouseCoopers
LLP), who were dismissed as our independent auditors in May 1998. The decision
to change auditors was approved by our Board of Directors. The audit reports of
PricewaterhouseCoopers LLP for the years ended December 31, 1997 and 1996
contained no adverse opinion or disclaimer of opinion and were not qualified or
modified as to uncertainty, audit scope or accounting principle. In connection
with its audits through December 31, 1997 and through May 1998, there were no
disagreements with PricewaterhouseCoopers LLP on any matter of accounting
principles or practices, financial statements disclosure or auditing scope or
procedures, which disagreements, if not resolved to their satisfaction would
have caused them to make reference in connection with their opinion to the
subject matter of the disagreement. PricewaterhouseCoopers LLP has not audited
or reported on any of the financial statements or information included in this
prospectus. For purposes of this filing, the financial statements at December
31, 1997, 1996 and 1995 as well as the financial statements for the years ended
December 31, 1997 and 1996 and the period from inception (January 5, 1995) to
December 31, 1995 have been audited by Ernst & Young LLP. Prior to May 28, 1998,
we had not consulted with Ernst & Young LLP on items that involved our
accounting principles or the form of audit opinion to be issued on our financial
statements.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our financial
statements at December 31, 1998 and 1999 and for each of the three years in the
period ended December 31, 1999, as set forth in their report. We have included
our financial statements in the prospectus and elsewhere in the registration
statement in reliance on Ernst & Young LLP's report, given on their authority as
experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission, Washington, D.C.,
a registration statement on Form S-1 under the Securities Act, with respect to
the common stock offered by this prospectus. This prospectus does not contain
all of the information set forth in the registration statement and the exhibits
and schedules to the registration statement. For further information with
respect to us and our common stock, reference is made to the registration
statement and the exhibits and schedules filed as part of the registration
statement. Statements contained in this prospectus as to the contents of any
contract or document filed as an exhibit to the registration statement are
qualified by reference to the applicable exhibit as filed.
A copy of the registration statement, and the exhibits and schedules to the
registration statement, as well as reports and other information filed by us
with the SEC may be inspected without charge at the public reference facilities
maintained by the SEC in Room 1025, 450 Fifth Street, N.W., Washington, D.C.
20549, and at the SEC's regional offices located at the Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven
World Trade Center, 13th Floor, New York, New York 10048, and copies of all of
any part of the registration statement may be
63
<PAGE>
obtained from those offices upon the payment of the fees prescribed by the SEC.
You can obtain information about the operation of the public reference
facilities by calling the SEC at 1-800-SEC-0330. In addition, registration
statements and other filings we make with the SEC through its electronic data
gathering, analysis and retrieval, or EDGAR, system, including our registration
statement, are publicly available through the Internet. The SEC maintains a web
site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the SEC. The
SEC's web site is http://www.sec.gov.
As a result of this offering, we will become subject to the information and
reporting requirements of the Exchange Act and, in accordance with the Exchange
Act, will file periodic reports, proxy statements and other information with the
SEC.
64
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... F-2
Balance Sheets as of December 31, 1998 and 1999............. F-3
Statements of Operations for the years ended December 31,
1997, 1998 and 1999....................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1998 and 1999.......................... F-5
Statements of Cash Flows for the years ended December 31,
1997, 1998 and 1999....................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Kosan Biosciences Incorporated
We have audited the accompanying balance sheets of Kosan Biosciences
Incorporated as of December 31, 1998 and 1999, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. 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 Kosan Biosciences
Incorporated at December 31, 1998 and 1999, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States.
/s/ ERNST & YOUNG LLP
Palo Alto, California
March 10, 2000, except for
the first paragraph of Note 9,
as to which the date is September 28, 2000.
F-2
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY AT
------------------- JUNE 30, JUNE 30,
1998 1999 2000 2000
-------- -------- ----------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,049 $ 1,032 $ 19,015
Short-term investments.................................... 3,279 990 6,012
Other receivables......................................... 168 498 112
Prepaid expenses and other current assets................. 209 325 253
------- -------- --------
Total current assets........................................ 6,705 2,845 25,392
Property and equipment, net................................. 1,407 2,587 2,974
Long-term investments....................................... 9,073 8,442 7,235
Notes receivable from related party......................... 12 87 711
Other assets................................................ 4 196 586
------- -------- --------
Total assets................................................ $17,201 $ 14,157 $ 36,898
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 333 $ 486 $ 750
Accrued liabilities....................................... 98 626 1,209
Deferred revenue.......................................... 1,719 409 125
Current portion of capital lease obligation............... 118 127 174
Current portion of equipment loan......................... 170 447 764
------- -------- --------
Total current liabilities................................... 2,438 2,095 3,022
Equipment loan, less current portion........................ 700 1,424 2,046
Capital lease obligation, less current portion.............. 304 167 53
Stockholders' equity:
Convertible preferred stock, $0.001 par value; 4,348,182
shares authorized, 3,269,377 3,269,377 and 4,073,573
shares issued and outstanding at December 31, 1998 and
1999 and June 30, 2000, respectively (none pro forma)
(aggregate liquidation preference of $21,095 and $46,025
at December 31, 1999 and June 30, 2000,
respectively)........................................... 3 3 4 $ --
Common stock, $0.001 par value, 36,000,000 shares
authorized, 5,187,951, 5,480,544 and 6,623,820 shares
issued and outstanding at December 31, 1998 and 1999 and
June 30, 2000, respectively, (18,844,539 shares issued
and outstanding pro forma).............................. 5 5 7 19
Additional paid-in capital................................ 21,227 24,848 61,651 61,643
Notes receivable from stockholders........................ (275) (349) (647) (647)
Deferred stock-based compensation......................... -- (2,377) (10,906) (10,906)
Accumulated other comprehensive income (loss)............. (9) (66) (60) (60)
Accumulated deficit....................................... (7,192) (11,593) (18,272) (18,272)
------- -------- -------- --------
Total stockholders' equity.................................. 13,759 10,471 31,777 $ 31,777
------- -------- -------- ========
Total liabilities and stockholders' equity.................. $17,201 $ 14,157 $ 36,898
======= ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER SIX MONTHS ENDED JUNE 30,
------------------------------ ---------------------------
1997 1998 1999 1999 2000
-------- -------- -------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Contract revenue........................ $ 10 $ 974 $ 5,206 $ 3,027 $ 2,084
Grant revenue........................... 277 262 140 80 140
------- ------- ------- ------- --------
Total revenues............................ 287 1,236 5,346 3,107 2,224
Operating expenses:
Research and development (Including
charges for stock-based compensation
of $0, $0, $964, $403 and $2,597,
respectively)......................... 1,922 4,030 8,587 3,838 7,621
General and administrative (Including
charges for stock-based compensation
of $0, $0, $181, $0 and $708,
respectively)......................... 457 991 1,813 812 1,793
------- ------- ------- ------- --------
Total operating expenses.................. 2,379 5,021 10,400 4,650 9,414
------- ------- ------- ------- --------
Loss from operations...................... (2,092) (3,785) (5,054) (1,543) (7,190)
Interest income........................... 154 598 679 334 678
Interest expense.......................... (56) (80) (196) (71) (167)
Other income.............................. -- -- 170 -- --
------- ------- ------- ------- --------
Net loss.................................. (1,994) (3,267) (4,401) (1,280) (6,679)
Deemed dividend upon issuance of Series C
convertible preferred stock............... -- -- -- -- (11,267)
------- ------- ------- ------- --------
Net loss attributable to common
stockholders.............................. $(1,994) $(3,267) $(4,401) $(1,280) $(17,946)
======= ======= ======= ======= ========
Basic and diluted net loss per share........ $ (0.49) $ (0.77) $ (0.98) $ (0.29) $ (3.57)
======= ======= ======= ======= ========
Shares used in computing basic and diluted
net loss per share........................ 4,094 4,270 4,509 4,430 5,029
Pro forma basic and diluted net loss per
share (unaudited)......................... $ (0.31) $ (1.12)
======= ========
Shares used in computing pro forma basic and
diluted net loss per share (unaudited).... 14,318 16,056
</TABLE>
See accompanying notes.
F-4
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE NOTES
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE DEFERRED
---------------------- ------------------------- PAID-IN FROM STOCK-BASED
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION
--------- ---------- ------------ ---------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1996...... 1,215,988 $ 2 3,468,285 $ 3 $ 3,647 $ -- $ --
Conversion of Series A convertible
preferred stock to common
stock............................ (213,722) (1) 641,166 1 -- -- --
Conversion of Series B convertible
preferred stock to Series A
convertible preferred stock and
common stock..................... (122,500) -- 367,500 -- -- -- --
Issuance of Series A convertible
preferred stock, net of issuance
costs of $15..................... 571,429 -- -- -- 2,384 -- --
Repurchase of common stock......... -- -- (20,400) -- -- -- --
Net loss........................... -- -- -- -- -- -- --
--------- ---------- --------- ---------- ------- ----- --------
BALANCES AT DECEMBER 31, 1997...... 1,451,195 1 4,456,551 4 6,031 -- --
Issuance of common stock upon
exercise of options.............. -- -- 12,024 -- 1 -- --
Issuance of common stock upon
exercise of options in exchange
for promissory note.............. -- -- 750,000 1 274 (275) --
Issuance of Series B convertible
preferred stock, net of issuance
costs of $77..................... 1,818,182 2 -- -- 14,921 -- --
Repurchase of common stock......... -- -- (30,624) -- -- -- --
Comprehensive income (loss):
Net loss......................... -- -- -- -- -- -- --
Unrealized loss on
available-for-sale
securities..................... -- -- -- -- -- -- --
Comprehensive loss................. -- -- -- -- -- -- --
--------- ---------- --------- ---------- ------- ----- --------
BALANCES AT DECEMBER 31, 1998...... 3,269,377 3 5,187,951 5 21,227 (275) --
Issuance of common stock upon
exercise of options.............. -- -- 80,718 -- 25 -- --
Issuance of common stock upon
exercise of options in exchange
for promissory note.............. -- -- 211,875 -- 74 (74) --
Deferred stock compensation........ -- -- -- -- 2,912 -- (2,912)
Amortization of deferred stock
compensation..................... -- -- -- -- -- -- 535
Revaluation of stock options issued
to non-employees................. -- -- -- -- 610 -- --
Comprehensive income (loss):
Net loss......................... -- -- -- -- -- -- --
Unrealized loss on
available-for-sale
securities..................... -- -- -- -- -- -- --
Comprehensive loss................. -- -- -- -- -- -- --
--------- ---------- --------- ---------- ------- ----- --------
BALANCES AT DECEMBER 31, 1999...... 3,269,377 3 5,480,544 5 24,848 (349) (2,377)
Issuance of common stock upon
exercise of options
(unaudited)...................... -- -- 146,274 1 43 -- --
Issuance of common stock upon
exercise of options in exchange
for promissory note
(unaudited)...................... -- -- 997,002 1 297 (298) --
Issuance of Series C convertible
preferred stock, net of issuance
costs of $300 (unaudited)........ 804,196 1 -- -- 24,629 -- --
Beneficial conversion feature
associated with the issuance of
Series C convertible preferred
stock (unaudited)................ -- -- -- -- 11,267 -- --
Deemed dividend to preferred
stockholders (unaudited)......... -- -- -- -- (11,267) -- --
Deferred stock-based compensation
(unaudited)...................... -- -- -- -- 11,082 -- (11,082)
Amortization of deferred
stock-based compensation
(unaudited)...................... -- -- -- -- -- -- 2,553
Other stock-based compensation
(unaudited)...................... -- -- -- -- 752 -- --
Comprehensive income (loss):
Net loss (unaudited)............. -- -- -- -- -- -- --
Unrealized gain on
available-for-sale securities
(unaudited).................... -- -- -- -- -- -- --
Comprehensive loss (unaudited)..... -- -- -- -- -- -- --
--------- ---------- --------- ---------- ------- ----- --------
BALANCE AT JUNE 30, 2000
(UNAUDITED)...................... 4,073,573 $ 4 6,623,820 $ 7 $61,651 $(647) $(10,906)
========= ========== ========= ========== ======= ===== ========
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
INCOME (LOSS) DEFICIT EQUITY
-------------- ------------ -------------
<S> <C> <C> <C>
BALANCES AT DECEMBER 31, 1996...... $ -- $ (1,931) $ 1,721
Conversion of Series A convertible
preferred stock to common
stock............................ -- -- --
Conversion of Series B convertible
preferred stock to Series A
convertible preferred stock and
common stock..................... -- -- --
Issuance of Series A convertible
preferred stock, net of issuance
costs of $15..................... -- -- 2,384
Repurchase of common stock......... -- -- --
Net loss........................... -- (1,994) (1,994)
---- -------- -------
BALANCES AT DECEMBER 31, 1997...... -- (3,925) 2,111
Issuance of common stock upon
exercise of options.............. -- -- 1
Issuance of common stock upon
exercise of options in exchange
for promissory note.............. -- -- --
Issuance of Series B convertible
preferred stock, net of issuance
costs of $77..................... -- -- 14,923
Repurchase of common stock......... -- -- --
Comprehensive income (loss):
Net loss......................... -- (3,267) (3,267)
Unrealized loss on
available-for-sale
securities..................... (9) -- (9)
-------
Comprehensive loss................. -- -- (3,276)
---- -------- -------
BALANCES AT DECEMBER 31, 1998...... (9) (7,192) 13,759
Issuance of common stock upon
exercise of options.............. -- -- 25
Issuance of common stock upon
exercise of options in exchange
for promissory note.............. -- -- --
Deferred stock compensation........ -- -- --
Amortization of deferred stock
compensation..................... -- -- 535
Revaluation of stock options issued
to non-employees................. -- -- 610
Comprehensive income (loss):
Net loss......................... -- (4,401) (4,401)
Unrealized loss on
available-for-sale
securities..................... (57) -- (57)
-------
Comprehensive loss................. -- -- (4,458)
---- -------- -------
BALANCES AT DECEMBER 31, 1999...... (66) (11,593) 10,471
Issuance of common stock upon
exercise of options
(unaudited)...................... -- -- 44
Issuance of common stock upon
exercise of options in exchange
for promissory note
(unaudited)...................... -- -- --
Issuance of Series C convertible
preferred stock, net of issuance
costs of $300 (unaudited)........ -- -- 24,630
Beneficial conversion feature
associated with the issuance of
Series C convertible preferred
stock (unaudited)................ -- -- 11,267
Deemed dividend to preferred
stockholders (unaudited)......... -- -- (11,267)
Deferred stock-based compensation
(unaudited)...................... -- -- --
Amortization of deferred
stock-based compensation
(unaudited)...................... -- -- 2,553
Other stock-based compensation
(unaudited)...................... -- -- 752
Comprehensive income (loss):
Net loss (unaudited)............. -- (6,679) (6,679)
Unrealized gain on
available-for-sale securities
(unaudited).................... 6 -- 6
-------
Comprehensive loss (unaudited)..... -- -- (6,673)
---- -------- -------
BALANCE AT JUNE 30, 2000
(UNAUDITED)...................... $(60) $(18,272) $31,777
==== ======== =======
</TABLE>
See accompanying notes.
F-5
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------ ---------------------
1997 1998 1999 1999 2000
-------- -------- -------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................... $(1,994) $(3,267) $(4,401) $(1,280) $(6,679)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................... 122 246 654 270 484
Amortization of stock-based compensation........ -- -- 535 98 2,553
Other stock-based compensation.................. -- -- 610 304 752
Issuance of convertible preferred stock for
license fees.................................. -- -- -- -- 30
Loss on sale of investments..................... -- -- 41 -- --
Loss on disposal of property and equipment...... -- -- 10 -- --
Changes in assets and liabilities:
Other receivables............................. (136) (8) (330) (76) 386
Prepaid expenses and other current assets..... (42) (156) (116) (162) 72
Other assets and notes receivable from related
parties..................................... 8 28 (267) (215) (1,014)
Accounts payable.............................. 8 282 153 (74) 264
Accrued liabilities........................... 46 (17) 528 327 583
Deferred revenue.............................. (8) 1,719 (1,310) (250) (284)
------- ------- ------- -------- --------
Net cash used in operating activities....... (1,996) (1,173) (3,893) (1,058) (2,853)
------- ------- ------- -------- --------
INVESTING ACTIVITIES
Acquisition of property and equipment............. (111) (1,173) (1,828) (1,071) (808)
Proceeds from sale of property and equipment...... 324 -- 2 -- --
Purchase of investments........................... (1,914) (21,419) (11,929) (6,030) (4,591)
Proceeds from maturity of investments............. -- 10,972 14,733 7,522 719
------- ------- ------- -------- --------
Net cash provided by (used in) investing
activities................................ (1,701) (11,620) 978 421 (4,680)
------- ------- ------- -------- --------
FINANCING ACTIVITIES
Proceeds from issuance of common stock............ -- 1 25 -- 44
Proceeds from issuance of convertible preferred
stock, net of issuance costs.................... 2,385 14,923 -- -- 24,600
Proceeds from equipment loans..................... -- 870 1,336 1,336 1,308
Principal payments under capital lease
obligations..................................... (48) (34) (128) (57) (67)
Principal payments under equipment loans.......... -- (23) (335) (108) (369)
------- ------- ------- -------- --------
Net cash provided by financing activities... 2,337 15,737 898 1,171 25,516
------- ------- ------- -------- --------
Net decrease in cash and cash equivalents........... (1,360) 2,944 (2,017) 534 17,983
Cash and cash equivalents at beginning of period.... 1,465 105 3,049 3,049 1,032
------- ------- ------- -------- --------
Cash and cash equivalents at end of period.......... $105 $3,049 $1,032 $3,583 $19,015
======= ======= ======= ======== ========
SUPPLEMENTAL DISCLOSURES
Interest expense paid in cash....................... $56 $80 $196 $43 $161
======= ======= ======= ======== ========
NON-CASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock under note receivable...... $-- $275 $74 $-- $298
Fixed assets acquired under capital lease........... 403 35 -- -- --
Deferred stock-based compensation................... -- -- 2,912 541 11,082
</TABLE>
See accompanying notes.
F-6
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OVERVIEW
Kosan Biosciences Incorporated (the "Company") was incorporated under the
laws of the state of California on January 6, 1995. In July 2000, the Company
was reincorporated under the laws of the state of Delaware. The Company was
considered to be in the development stage through December 31, 1998. The Company
uses its technology to develop drug candidates from a class of natural product
compounds known as polyketides by manipulating the natural process by which they
are made. The Company's product opportunities currently target the areas of
infectious disease, gastrointestinal motility disorders, mucus hypersecretion,
cancer, immunosuppression and nerve regeneration.
The Company has funded its operations primarily through sales of convertible
preferred stock, contract payments under our collaboration agreement, equipment
financing arrangements and government grants. Prior to achieving profitable
operations, the Company intends to fund operations through the additional sale
of equity securities, strategic collaborations and debt financing.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
INTERIM FINANCIAL INFORMATION
The financial information at June 30, 2000 and for the six months ended
June 30, 1999 and 2000 is unaudited but, in the opinion of management, has been
prepared on the same basis as the annual financial statements and includes all
adjustments (consisting only of normal recurring adjustments) that the Company
considers necessary for a fair presentation of the financial position at such
date and the operating results and cash flows for such periods. Results for the
six months ended June 30, 2000 are not necessarily indicative of the results to
be expected for any subsequent period.
INITIAL PUBLIC OFFERING
In March, 2000, the Board of Directors authorized management of the Company
to file a registration statement with the Securities and Exchange Commission to
sell shares of its common stock to the public. If the initial public offering is
completed under the terms presently anticipated, all of the convertible
preferred stock outstanding will automatically convert into 12,220,719 shares of
common stock. Unaudited pro forma stockholders' equity, as adjusted for the
assumed conversion of the preferred stock, is set forth on the balance sheet.
UNAUDITED PRO FORMA INFORMATION
The unaudited pro forma stockholders' equity at June 30, 2000 has been
adjusted for the assumed conversion of all outstanding shares of convertible
preferred stock upon the completion of the Company's initial public offering.
F-7
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
limits its concentration of risk by diversifying its investments among a variety
of issuers.
The Company classifies all investment securities as available-for-sale in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" ("SFAS 115").
Available-for-sale investments are recorded at fair value determined based on
quoted market prices, with unrealized gains and losses excluded from earnings
and reported in other comprehensive income. Purchase premiums and discounts are
recognized in interest income using the interest method over the terms of the
securities. Declines in the fair value of available-for-sale securities below
their cost that are deemed to be other than temporary are reflected in earnings
as realized losses. Gains and losses on the sale of securities are recorded on
the trade date and are determined using the specific identification method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of three to five years. Leasehold
improvements are amortized over the shorter of their estimated useful lives or
the lease term.
REVENUE RECOGNITION
The Company recognizes license and other upfront fees on a ratable basis
over the term on the respective agreement. Milestone payments are recognized
upon successful completion of a performance milestone event. Contract revenues
related to collaborative research and development agreements and government
grants are recognized on a ratable basis as services are performed. Any amounts
received in advance of performance are recorded as deferred revenue.
RESEARCH AND DEVELOPMENT
Research and development expenses consist of costs incurred for
Company-sponsored and collaborative research and development activities. These
costs consist of direct and indirect internal costs related to specific projects
as well as fees paid to other entities which conduct certain research activities
on behalf of the Company. Research and development expenses under the government
grants and collaborative agreements approximated the revenue recognized, less
milestone payments received under such arrangements for the years ended
December 31, 1998 and 1999 and for the six months ended June 30, 1999 and 2000.
NET LOSS PER SHARE
Basic and diluted net loss per common share are presented in conformity with
the Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("SFAS 128"), for all periods presented. Following the guidance given by the
Securities and Exchange Commission Staff Accounting Bulletin No. 98, common
stock and convertible preferred stock that has been issued or granted for
nominal
F-8
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
consideration prior to the anticipated effective date of the initial public
offering must be included in the calculation of the basic and diluted net loss
per common share as if these shares had been outstanding for all periods
presented. To date, the Company has not issued or granted shares for nominal
consideration.
In accordance with SFAS 128, basic and diluted net loss per share has been
computed using the weighted-average number of shares of common stock outstanding
during the period, less shares subject to repurchase. Diluted net loss is not
presented separately as the Company is in a net loss position. Pro forma basic
and diluted net loss per common share, as presented in the statement of
operations, has been computed for the year ended December 31, 1999 and for the
six months ended June 30, 2000 as described above, and also gives effect to the
conversion of the convertible preferred stock which will automatically convert
to common stock immediately prior to the completion of the Company's initial
public offering (using the if-converted method) from the original date of
issuance.
The following table presents the calculation of basic, diluted and pro forma
basic and diluted net loss per share (in thousands, except per share data):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------ ---------------------
1997 1998 1999 1999 2000
-------- -------- -------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net loss attributable to common
stockholders.............................. $(1,994) $(3,267) $(4,401) $(1,280) $(17,946)
======= ======= ======= ======= ========
Weighted-average shares of common stock
outstanding............................... 4,373 4,453 5,273 5,188 6,248
Less: weighted-average shares subject to
repurchase................................ (279) (183) (764) (758) (1,219)
------- ------- ------- ------- --------
Weighted-average shares used in computing
basic
and diluted net loss per share............ 4,094 4,270 4,509 4,430 5,029
======= ======= ======= ======= ========
Basic and diluted net loss per share........ $ (0.49) $ (0.77) $ (0.98) $ (0.29) $ (3.57)
======= ======= ======= ======= ========
Pro forma:
Shares used above........................... 4,509 5,029
Pro forma adjustment to reflect weighted
effect of assumed conversion of
convertible preferred stock (unaudited)... 9,809 11,027
------- --------
Shares used in computing pro forma basic
and diluted net loss per share
(unaudited)............................... 14,318 16,056
======= ========
Pro forma basic and diluted net loss per
share (unaudited)......................... $ (0.31) $ (1.12)
======= ========
</TABLE>
The Company has excluded all convertible preferred stock, outstanding stock
options and shares subject to repurchase from the calculation of diluted net
loss per common share because all such securities are antidilutive for all
applicable periods presented. The total number of shares excluded from the
calculations of diluted net loss per share, prior to application of the treasury
stock method for
F-9
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
options was 104,400, 1,414,800 and 1,367,700 for the years ended December 31,
1997, 1998 and 1999, respectively and 1,560,000 and 1,141,800 for the six months
ended June 30, 1999 and 2000, respectively. Such securities, had they been
dilutive, would have been included in the computations of diluted net loss per
share. See Note 9 for further information on these securities.
STOCK-BASED COMPENSATION
The Company accounts for common stock options granted to employees using the
intrinsic value method and, thus, recognizes no compensation expense for options
granted with exercise prices equal to or greater than the deemed fair value of
the Company's common stock on the date of the grant.
Stock compensation expense for options granted to non-employees has been
determined in accordance with Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and EITF 96-18
as the fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured. The measurement of
stock-based compensation to non-employees is subject to periodic adjustment as
the underlying securities vest.
COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), at December 31, 1998. Under
SFAS 130, the Company is required to display comprehensive income and its
components as part of the Company's full set of financial statements.
Comprehensive income is comprised of net income and other comprehensive income.
Other comprehensive income includes certain changes in equity of the Company
that are excluded from net income. Specifically, SFAS 130 requires unrealized
holding gains and losses on the Company's available-for-sale securities, which
were reported separately in shareholders' equity, to be included in accumulated
other comprehensive income.
INCOME TAXES
Since inception, the Company has recognized income taxes under the liability
method. Deferred income taxes are recognized for differences between the
financial statement and tax basis of assets and liabilities at enacted statutory
tax rates in effect for years in which the differences are expected to reverse.
The effect on deferred taxes of a change in tax rates is recognized in income in
the period that includes the enactment date. In addition, valuation allowances
are established when necessary to reduce deferred tax assets to the amounts
expected to be realized.
SEGMENT REPORTING
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 131 established standards for the way companies
report information about operating segments in annual financial statements. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company did not have any separately
reportable business segments as of December 31, 1999.
F-10
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
DERIVATIVE INSTRUMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivatives Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 requires the Company to recognize
all derivatives on the balance sheet at fair value. Derivatives that are not
hedges must be adjusted to fair value through net income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of the
derivative are either offset against the change in fair value of asset,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. SFAS 133
is effective for years beginning after June 15, 2000. The Company does not
currently hold any derivatives and does not expect this pronouncement to
materially impact the results of its operations.
REVENUE RECOGNITION
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 summarizes certain areas of the Staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. The Company believes that its current revenue recognition principles
comply with SAB 101.
SOFTWARE COSTS
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 requires the capitalization of certain
costs incurred in connection with developing or obtaining internal use software.
The Company has no capitalized software at December 31, 1999, therefore, the
adoption of this statement did not have a significant impact on the Company's
results of operations or financial condition.
2. COLLABORATIVE RESEARCH AND DEVELOPMENT AND LICENSE AGREEMENTS
THE R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE
In September 1998, the Company signed a collaborative agreement with The
R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil
Pharmaceutical, Inc., both Johnson & Johnson companies. Under the terms of the
agreement, the Company will use its technologies to produce novel macrolide
antibiotics on a "best efforts" basis. The agreement provides for the Company to
receive certain payments, including payments for research and development costs
for at least two years, and receive payments for reaching certain research and
development milestones. The collaborative partner received exclusive worldwide
rights to the products developed in the field of use as defined in the
agreement. The development, marketing, and sale of drugs resulting from the
collaboration will be undertaken by the partner and should the development
efforts result in a marketable product, the Company will receive royalty
payments based on product sales. Upon the execution of the collaborative
agreement the Company received an initial up-front fee of $1.0 million which was
deferred and will be recognized on a ratable basis over the term of the
agreement. For the years ended December 31, 1998
F-11
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
2. COLLABORATIVE RESEARCH AND DEVELOPMENT AND LICENSE AGREEMENTS (CONTINUED)
and 1999 and the six months ended June 30, 1999 and 2000, the Company recognized
$969,000, $5.0 million, $2.9 million and $2.1 million, respectively, of contract
revenues pursuant to this agreement which represents 99%, 96%, 96% and 100% of
the contract revenues for fiscal year 1998 and 1999 and the six months ended
June 30, 1999 and 2000, respectively. Included in the six months ended June 30,
1999 and the year ended December 31, 1999 was $1.0 million and $1.2 million,
respectively, of milestones earned under this agreement.
LICENSE AGREEMENTS
The Company entered into exclusive license agreements with The Board of
Trustees of The Leland Stanford Junior University and with the President and
Fellows of Harvard College in March 1996 and December 1998, respectively. These
licenses provide the Company with certain technology and related patent rights
and materials for the production of polyketides. Under the terms of the
agreements, the Company pays annual license or maintenance fees and will pay
milestones and royalties on net sales of products originating from the licensed
technology.
3. INVESTMENTS
The amortized cost and fair value of securities, with gross unrealized gains
and losses, were as follows (in thousands):
<TABLE>
<CAPTION>
1998 1999
------------------------------------------------ ------------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ---------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Debt securities:
US treasury.......... $ 2,967 $ 2 $ -- $ 2,969 $1,300 $ -- $(10) $1,290
US agency notes...... 3,298 -- (8) 3,290 -- -- -- --
Corporate bonds...... 1,000 1 -- 1,001 1,000 -- (10) 990
Asset-backed
securities........... 5,096 -- (4) 5,092 7,198 1 (47) 7,152
------- ---- ---- ------- ------ ---- ---- ------
$12,361 $ 3 $(12) $12,352 $9,498 $ 1 $(67) $9,432
======= ==== ==== ======= ====== ==== ==== ======
</TABLE>
The fair value of available-for-sale debt securities by contractual maturity
at December 31, 1999 were as follows:
<TABLE>
<S> <C>
Within 1 year............................................... $ 990
Greater than 1 year less than 5 years....................... 1,290
Mortgage-backed securities.................................. 7,152
------
$9,432
======
</TABLE>
F-12
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- JUNE 30,
1998 1999 2000
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Computer equipment and software.................. $ 249 $ 362 $ 403
Office furniture................................. 138 165 191
Lab equipment.................................... 1,400 2,228 2,920
Leasehold improvements........................... 42 825 874
------ ------ -------
1,829 3,580 4,388
Less accumulated depreciation and amortization... (422) (993) (1,414)
------ ------ -------
$1,407 $2,587 $ 2,974
====== ====== =======
</TABLE>
Depreciation expense was $246,000 and $636,000 for the years ended
December 31, 1998 and 1999, respectively and $262,000 and $421,000 for the six
months ended June 30, 1999 and 2000, respectively. Property and equipment
financed under capital leases amounted to $562,000 at December 31, 1998 and 1999
and June 30, 2000. Accumulated amortization related to this property and
equipment amounted to $264,000, $378,000 and $490,000 at December 31, 1998 and
1999 and June 30, 2000, respectively.
5. CAPITAL LEASES AND EQUIPMENT FINANCING
The Company leases certain equipment and facility improvements under
noncancelable capital leases and debt obligations. As of December 31, 1999,
future minimum lease and loan payments under these obligations are as follows
(in thousands):
<TABLE>
<CAPTION>
CAPITAL LEASES EQUIPMENT LOANS
-------------- ---------------
<S> <C> <C>
Year ended December 31,.........................
2000.......................................... $ 162 $ 627
2001.......................................... 168 627
2002.......................................... 9 688
2003.......................................... -- 324
----- ------
Total minimum lease payments.................... 339 2,266
Less amount representing interest............... (45) (395)
----- ------
Present value of net minimum lease payments..... 294 1,871
Less current portion............................ (127) (447)
----- ------
Long-term portion............................... $ 167 $1,424
===== ======
</TABLE>
In 1997, the Company entered into a capital lease line agreement for up to
$1.0 million in aggregate borrowings. Financing under this lease line was
available through June 1998, at which time approximately $569,000 had been
utilized and $431,000 was allowed to expire. In August 1998, the Company entered
into a $2.2 million equipment loan agreement which was fully utilized by
June 1999.
The terms of the lease and loan obligations are for four years. The
equipment loans have a balloon payment at the end of the term. The interest
rates of each of the leases and loans are fixed at
F-13
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
5. CAPITAL LEASES AND EQUIPMENT FINANCING (CONTINUED)
the time of the draw down, with the interest rates range from 10.55% to 10.96%.
Obligations under the leases and loans are secured by the assets financed under
the leases.
In January 2000, the Company secured a $2.0 million line of credit which is
available for draw down through December 2000. Each note will have a term of
43 months and have a balloon payment at the end of the term. The Company
borrowed on this line of credit to fund equipment purchases totaling $823,000
and $485,000 in January 2000 and May 2000, respectively.
6. FACILITY LEASES
In March 1999, the Company moved its facilities from Burlingame, California
to Hayward, California. The Company leases its new facility under a
noncancelable operating lease with no renewal options, which commenced in
February 1999 and expires in 2003. Minimum annual rental commitments under the
operating lease at December 31, 1999 are as follows (in thousands):
<TABLE>
<S> <C>
Year ended December 31,
2000...................................................... $1,081
2001...................................................... 1,118
2002...................................................... 1,144
2003...................................................... 682
------
Total minimum payments...................................... $4,025
======
</TABLE>
In September 1999, the Company terminated its Burlingame facility lease
agreement and at the same time, the rights to the Company's sublease agreement
under this facility lease was bought out by the former landlord. In connection
with this buy-out, the Company received a $170,000 termination fee which was
recorded as other income.
Rent expense for operating leases was approximately $181,000, $204,000,
$1.2 million, $577,000 and $686,000 for the years ended December 31, 1997, 1998
and 1999 and the six months ended June 30, 1999 and 2000, respectively. The
sublease income was approximately $100,000, $14,000, $159,000, $97,000 and $0
for the years ended December 31, 1997, 1998 and 1999 and the six months ended
June 30, 1999 and 2000, respectively.
7. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- JUNE 30,
1998 1999 2000
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Facilities related.................................. $ -- $280 $ 430
Compensation........................................ 37 163 409
Professional fees................................... 40 120 87
Other............................................... 21 63 283
---- ---- ------
$ 98 $626 $1,209
==== ==== ======
</TABLE>
F-14
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
8. RELATED PARTY TRANSACTIONS
In December 1998 and September 1999, the Company issued promissory notes to
an officer and to a director totaling $346,500 for the exercise of certain stock
options. These notes bear interest of 4.47% and 5.89% per annum, compounded
semiannually, and the principal and accrued interest is repayable three years
from the date of issuance. During the first six months of 2000, the Company
received additional promissory notes from three officers and various employees
totaling $298,000 for the exercise of stock options for 997,002 shares of common
stock. These notes bear interest between 6.46% and 6.60% with terms of 3 years.
These are full recourse notes secured in part by a pledge of the Company's
common stock owned.
The Company issued full recourse loans to certain employees, of which
$12,000 and $87,000 were outstanding at December 31, 1998 and 1999,
respectively. These loans bear interest at rates ranging from 4.47% to 5.43%
with terms ranging from 4 to 5 years. The loans were issued for the purchase of
the employees' residence, are secured by deeds of trust and are classified on
the balance sheet as other assets. During the first six months of 2000, the
Company issued additional full recourse loans to two employees and two officers
totaling $190,000 and $453,000, respectively. These notes bear interest between
6.30% and 6.62% with terms ranging from 3 to 5 years. The loans are secured by
deeds of trust and are classified on the balance sheet as other assets. One of
the notes to an officer totaling $53,000 will be forgiven upon the third
anniversary date of the officer's employment.
The Company entered into a 14-month evaluation agreement with Savia
Corporation and DNA Plant Technologies ("DNAP") effective March 1, 1998. The
evaluation program was for the development of intellectual property and
technology for use in the field. The Company received revenue of approximately
$90,000 upon signing the agreement for work performed to that date. This
agreement was subsequently terminated effective December 31, 1999. Under the
terms of the termination agreement the Company will receive approximately
$160,000 for development services performed through December 31, 1999, which is
included in revenue and other receivables in 1999. A board member of the company
which controls DNAP is also a board member of the Company.
9. STOCKHOLDERS' EQUITY
STOCK SPLIT
In September 2000, the Company split its common stock 3-for-1 and increased
the authorized shares of common stock to 36,000,000 shares. All common stock and
options to purchase common stock and per share amounts in the accompanying
financial statements have been adjusted retroactively to reflect the stock
split. The conversion ratios of the respective series of convertible preferred
stock were automatically adjusted to reflect the stock split.
During January 1997, the Company converted each existing share of "Original"
Series A convertible preferred stock into 2.28570 shares of common stock and
0.23810 shares of Series A convertible preferred stock. Each existing share of
"original" Series B convertible preferred stock was converted into 0.39285
shares of common stock and 0.86905 shares of Series A convertible preferred
F-15
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
stock. Outstanding shares of the Company's preferred stock were converted to
Series A convertible preferred stock and common stock as follows:
<TABLE>
<CAPTION>
SHARES OF
CONVERTIBLE
SHARES SERIES A SHARES OF
OUTSTANDING SERIES A PREFERRED COMMON STOCK COMMON STOCK
BEFORE CONVERSION STOCK AFTER CONVERSION AFTER
SERIES CONVERSION RATE CONVERSION RATE CONVERSION
------ ----------- ---------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
"Original" A...................... 280,512 0.23810 66,790 2.28570 641,166
"Original" B...................... 935,476 0.86905 812,976 0.39285 367,500
</TABLE>
Convertible preferred stock outstanding was as follows (in thousands, except
share data):
<TABLE>
<CAPTION>
DECEMBER 31, 1999 JUNE 30, 2000
-------------------------------------------- --------------------------------------------
SHARES SHARES
SHARES ISSUED AND REDEMPTION/ SHARES ISSUED AND REDEMPTION/
DESIGNATED OUTSTANDING LIQUIDATION VALUE DESIGNATED OUTSTANDING LIQUIDATION VALUE
---------- ----------- ----------------- ---------- ----------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Convertible preferred
stock:
Series A................ 1,480,000 1,451,195 $ 6,095 1,480,000 1,451,195 $ 6,095
Series B................ 1,818,182 1,818,182 15,000 1,818,182 1,818,182 15,000
Series C................ -- -- -- 1,050,000 804,196 24,930
--------- --------- ------- --------- --------- -------
Total................. 3,298,182 3,269,377 $21,095 4,348,182 4,073,573 $46,025
========= ========= ======= ========= ========= =======
</TABLE>
Upon the closing of an initial public offering, each of the outstanding
4,073,573 shares of convertible preferred stock will be automatically converted
into three shares of common stock.
SERIES A CONVERTIBLE PREFERRED STOCK
On January 31, 1997, the Company completed a private placement for the sale
of 571,429 shares of Series A convertible preferred stock resulting in gross
proceeds of $2.4 million. The Series A convertible preferred stock is
convertible at any time after the issuance date, at the option of the holder,
into a number of shares of common stock equal to the stated value divided by the
conversion price. Additionally, the Series A convertible preferred stock shall
be automatically converted into common stock upon the closing of an initial
public offering where the gross proceeds are at least $15.0 million and the
offering price is not less than $7.00 per share. The conversion price of $1.40
will be adjusted for any stock split or combination, consolidation, stock
dividend, and recapitalization. The Series A convertible preferred stockholders
are entitled to vote together with Series B convertible preferred stockholders,
Series C convertible preferred stockholders and common stockholders as a single
class on all matters, except as otherwise required by law. The number of votes
to which each Series A convertible preferred stockholder will be entitled will
equal the maximum number of shares of common stock into which each preferred
stock will be converted. In the event of liquidation, dissolution or winding up
of the Company, funds available for distribution to stockholders shall be paid
to the holders of Series A convertible preferred stock in an amount per share
equal to $4.20 (adjusted for any stock dividend, split or combination,
recapitalization, consolidation with respect to such shares) prior to any
distribution to holders of common stock. If there are inadequate funds available
to provide a full payment of the liquidation preference amount to the Series A,
B and C convertible preferred
F-16
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
stockholders, then the assets available for distribution shall first be paid to
the Series C convertible preferred stockholders. Noncumulative annual dividends
of $0.25 per share (as adjusted for any stock dividend, combination, or split
with respect to these shares), payable quarterly, will be paid if and when
declared by the board of directors.
SERIES B CONVERTIBLE PREFERRED STOCK
On April 3, 1998, the Company completed a private placement for the sale of
1,818,182 shares of Series B convertible preferred stock resulting in gross
proceeds of $15.0 million. The Series B convertible preferred stock is
convertible into a number of shares of common stock equal to the stated value
divided by the conversion price. Additionally, the Series B convertible
preferred stock shall be automatically converted into common stock upon the
closing of an initial public offering where the gross proceeds are at least
$15.0 million and the offering price is not less than $7.00 per share. The
conversion price of $2.75 will be adjusted for any stock split or combination,
consolidation, stock dividend, and recapitalization. The Series B convertible
preferred stockholders are entitled to vote together with the Series A and
Series C convertible preferred stockholders and common stockholders as a single
class on all matters, except as otherwise required by law. The number of votes
to which each Series B convertible preferred stockholder will be entitled will
equal the maximum number of shares of common stock into which each preferred
stock is convertible. In the event of a liquidation, the holders of Series B
convertible preferred stock shall be paid an amount per share equal to $8.25
(adjusted for any stock split or combination, consolidation, stock dividend, and
recapitalization respect to such shares) prior to any distribution to holders of
common stock. If there are inadequate funds available to provide a full payment
of the liquidation preference amount to the Series A, B and C preferred
stockholders, then the assets available for distribution shall first be paid to
the Series C convertible preferred stockholders. Noncumulative annual dividends
of $0.49 per share (as adjusted for any stock dividend, combination, or split
with respect to these shares), payable quarterly, will be paid if and when
declared by the board of directors.
SERIES C CONVERTIBLE PREFERRED STOCK
On March 30, 2000, the Company completed a private placement for the sale of
804,196 shares of Series C convertible preferred stock resulting in gross
proceeds of $24.9 million. The issuance of the Series C convertible preferred
stock resulted in a beneficial conversion feature in accordance with Emerging
Issues Task Force Consensus No. 98-5, "Accounting for Convertible Securities
with Beneficial Conversion Features." The beneficial conversion feature was
reflected as a deemed dividend in the Statement of Operations of $11.3 million
for the six months ended June 30, 2000.
The Series C convertible preferred stock is convertible at any time after
the issuance date, at the option of the holder, into a number of shares of
common stock equal to the stated value divided by the conversion price.
Additionally, the Series C convertible preferred stock shall be automatically
converted into common stock upon the closing of an initial public offering where
the gross proceeds are at least $25.0 million and the offering price is not less
than $11.00 per share. The conversion price of $10.33 will be adjusted for any
stock split or combination, consolidation, stock dividend, and recapitalization.
The Series C convertible preferred stockholders are entitled to vote together
with Series A and B convertible preferred stockholders and common stockholders
as a single class on all matters, except as otherwise required by law. The
number of votes to which each Series C convertible preferred
F-17
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
stockholder will be entitled will equal the maximum number of shares of common
stock into which each preferred stock will be converted. In the event of
liquidation, dissolution or winding up of the Company, funds available for
distribution to stockholders shall be paid to the holders of Series C
convertible preferred stock in an amount per share equal to $31.00 (adjusted for
any stock dividends, split or combination, recapitalization, consolidation with
respect to such shares) prior to any distribution to holders of Series A and
Series B convertible preferred stock and common stock. If there are inadequate
funds available to provide a full payment of the liquidation preference amount
to the Series A, B and C convertible preferred stockholders, then the assets
available for distribution shall first be paid to the Series C convertible
preferred stockholders. Noncumulative annual dividends of $1.86 per share (as
adjusted for any stock dividend, combination, or split with respect to these
shares), payable quarterly, will be paid if and when declared by the board of
directors.
COMMON STOCK
Under the terms of the 1996 Stock Option Plan (the "1996 Plan"), options are
exercisable when granted and such shares are subject to repurchase upon
termination of employment or consulting agreement. Repurchase rights lapse over
the vesting periods which are generally four years. Should the employment of the
holders of common stock subject to repurchase terminate prior to full vesting of
the outstanding shares, the Company may repurchase all unvested shares at a
price per share equal to the original exercise price. At December 31, 1999,
742,659 shares were subject to such repurchase terms.
1996 STOCK OPTION PLAN
In 1996, the board of directors adopted the 1996 Plan that provides for the
granting of incentive stock options and nonstatutory stock options to employees,
officers, directors and consultants of the Company. Incentive stock options may
be granted with exercise prices not less than fair value, and nonstatutory stock
options may be granted with an exercise price not less than 85% of the fair
value of the common stock on the date of grant. The fair value is determined by
the board of directors. Stock options granted to a stockholder owning more than
10% of voting stock of the Company may be granted with an exercise price of not
less than 110% of the fair value of the common stock on the date of grant.
Options expire no later than ten years from the date of the grant. The number of
shares, terms, and exercise period are determined by the board of directors.
Options generally vest at 25% per year over a four-year period.
2000 EMPLOYEE STOCK PURCHASE PLAN
In March 2000, subject to stockholder approval, the Company adopted its 2000
Employee Stock Purchase Plan (the "Purchase Plan"). A total of 300,000 shares of
the Company's common stock have been reserved for issuance under the Purchase
Plan. In addition, the Purchase Plan provides for annual increases in the number
of shares available for issuance under the Purchase Plan on each anniversary
date of the effective date of the offering. The number of shares reserved
automatically is equal to the lesser of 150,000 shares, 0.75% of the outstanding
shares on the date of the annual increase or such amount as may be determined by
the board. The Purchase plan permits eligible employees to purchase common stock
at a discount through payroll deductions during defined offering periods. The
price at which the stock is purchased is equal to the lower of 85% of the fair
market value of the common
F-18
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
stock on the first day of the offering or 85% of the fair market value of the
Company's common stock on the purchase date. The initial offering period will
commence on the effective date of the offering.
2000 NON-EMPLOYEE DIRECTORS PLAN
In March 2000, subject to stockholder approval, the Company adopted the 2000
Non-Employee Directors' Stock Option Plan (the "Directors' Plan") and reserved
300,000 shares of common stock for issuance thereunder. Each non-employee
director who becomes a director of the Company will be automatically granted a
non-statutory stock option to purchase 7,500 shares of common stock on the date
on which such person first becomes a director and will vest over four years.
Beginning with the 2001 Annual Stockholders Meeting and each year thereafter,
each non-employee director will automatically be granted a non-statutory option
to purchase 3,750 shares of common stock which will vest in one year from the
date of grant. The exercise price of options under the Directors' Plan will be
equal to the fair market value of the common stock on the date of grant. The
maximum term of the options granted under the Directors' Plan is ten years. The
Directors' Plan will terminate in March 2010, unless terminated in accordance
with the provisions of the Directors' Plan.
F-19
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of stock option activity is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------------------------
WEIGHTED
SHARES AVAILABLE NUMBER OF EXERCISE AGGREGATE AVERAGE
FOR GRANT SHARES PRICE PRICE EXERCISE PRICE
---------------- ---------- ------------ ---------- --------------
<S> <C> <C> <C> <C> <C>
Reserved at inception......... 750,000 -- -- $ -- $ --
Granted..................... (198,000) 198,000 $0.08 16,500 $0.08
---------- ---------- ----------
Balances at December 31,
1996........................ 552,000 198,000 16,500 $0.08
Granted..................... (86,400) 86,400 $0.08-$0.15 11,960 $0.14
Canceled.................... 180,000 (180,000) $0.08 (15,000) $0.08
---------- ---------- ----------
Balances at December 31,
1997........................ 645,600 104,400 13,460 $0.13
Additional reserved......... 1,770,000 -- -- -- --
Granted..................... (2,085,000) 2,085,000 $0.15-$0.37 671,775 $0.32
Canceled.................... 12,576 (12,576) $0.08-$0.33 (1,978) $0.16
Exercised................... -- (762,024) $0.08-$0.37 (276,262) $0.36
---------- ---------- ----------
Balances at December 31,
1998........................ 343,176 1,414,800 406,995 $0.29
Additional reserved......... 180,000 -- -- -- --
Granted..................... (464,100) 464,100 $0.33 154,700 $0.33
Canceled.................... 218,607 (218,607) $0.15-$0.33 (66,023) $0.30
Exercised................... -- (292,593) $0.08-$0.37 (99,127) $0.34
---------- ---------- ----------
Balances at December 31,
1999........................ 277,683 1,367,700 396,545 $0.29
Additional reserved
(unaudited)............... 2,400,000 -- -- -- --
Granted (unaudited)......... (953,700) 953,700 $0.42-$4.00 1,501,775 $1.57
Canceled (unaudited)........ 36,324 (36,324) $0.15-$2.00 (14,812) $0.41
Exercised (unaudited)....... -- (1,143,276) $0.15-$1.00 (342,008) $0.30
---------- ---------- ----------
Balances at June 30, 2000
(unaudited)................. 1,760,307 1,141,800 $1,541,500 $1.35
========== ========== ==========
</TABLE>
Options vested at December 31, 1998 and 1999 and June 30, 2000 were 119,034,
392,163 and 106,950, respectively.
F-20
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
The options outstanding and currently exercisable by exercise price at
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
-------------------------------------------------
NUMBER OPTIONS VESTED
OUTSTANDING WEIGHTED-AVERAGE ---------------------------------
WEIGHTED-AVERAGE AND REMAINING NUMBER OF WEIGHTED-AVERAGE
EXERCISE PRICE EXERCISABLE CONTRACTUAL LIFE OPTIONS VESTED EXERCISE PRICE
---------------- ----------- ---------------- -------------- ----------------
(IN YEARS)
<S> <C> <C> <C> <C>
$0.08 15,000 7.02 10,938 $0.08
$0.15 303,300 7.97 163,995 $0.15
$0.33 1,049,400 9.05 217,230 $0.33
--------- -------
1,367,700 8.79 392,163 $0.25
========= =======
</TABLE>
STOCK-BASED COMPENSATION
The Company has elected to follow the provision of APB Opinion No. 25 and
related interpretations in the accounting for the stock-based awards because, as
discussed below, the alternative fair value accounting provided for under
FAS 123 requires use of option valuation models that were not developed for use
in valuing employee stock-based awards. During the year ended December 31, 1999,
in connection with the grant of stock options to employees, the Company recorded
deferred stock-based compensation totaling $2.9 million, representing the
difference between the deemed fair market value of the common stock on the date
such options were granted and the applicable exercise prices. Such amount is
included as a reduction of stockholders' equity and is being amortized using the
graded vesting method over the vesting period of the individual options, which
is generally four years. The Company recognized amortization of deferred
stock-based compensation of $535,000 for the year ended December 31, 1999 and
$2.6 million for the six months ended June 30, 2000.
As of June 30, 2000, the Company has issued non-employee stock options
totaling 423,750 shares with exercise prices ranging from $0.15 to $2.00 and
terms of 2 to 5 years. Additionally, the Company had issued 210,000 shares of
restricted stock to non-employees at a price of $0.001 per share. The restricted
shares vest over 5 years. The Company records compensation related to the grants
of stock options and restricted stock to non-employees in accordance with SFAS
123 and EITF 96-18 using the Black-Scholes Model with the following assumptions:
risk-free interest rate of 5%; volatility of 70%, expected lives of 2 to 3
years; and a dividend yield of zero. The Company recognized other stock-based
compensation for grants to non-employees of $610,000 and $752,000 for the year
ended December 31, 1999 and the six months ended June 30, 2000. The measurement
of stock-based compensation to non-employees is subject to periodic adjustment
as the underlying awards vest.
Pro forma net loss and net loss per share information is required by
SFAS 123 which also requires that the information be determined as if the
Company had accounted for its employee stock options granted since inception
under the fair value method of that statement. The fair value of these options
was estimated at the date of grant using a minimum value option pricing model
with the following assumptions: risk-free interest rate of 5.0%; a
weighted-average expected life of the option of four years from the grant date
for grants under the 1996 Plan; and a dividend yield of zero.
F-21
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
9. STOCKHOLDERS' EQUITY (CONTINUED)
The Company's pro forma information follows (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Net loss:
As reported..................................... $(1,994) $(3,267) $(4,401)
Pro forma....................................... (1,994) (3,454) (4,772)
Basic and diluted net loss per share:
As reported..................................... $ (0.49) $ (0.77) $ (0.98)
Pro forma....................................... (0.49) (0.81) (1.06)
</TABLE>
10. INCOME TAXES
As of December 31, 1999, the Company had federal and state net operating
loss carryforwards of approximately $9.6 million and $4.1 million, respectively.
The Company also had federal and California research and development tax credit
carryforwards of approximately $300,000 and $200,000. The federal and state net
operating loss and credit carryforwards will expire at various dates beginning
in the year 2002 through 2019, if not utilized.
Utilization of the federal and state net operating loss and credit
carryforwards may be subject to a substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986. The
annual limitation may result in the expiration of net operating losses and
credits before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets for financial reporting and the amount
used for income tax purposes. Significant components of the Company's deferred
tax assets for federal and state income taxes as of December 31, are as follows
(in thousands):
<TABLE>
<CAPTION>
1998 1999
-------- --------
<S> <C> <C>
Deferred tax assets
Net operating loss carryforwards........................ $ 2,100 $ 3,500
Research and development credits........................ 300 500
Capitalized research and development expenses........... 200 300
------- -------
Total deferred tax assets................................. 2,600 4,300
Valuation allowance....................................... (2,600) (4,300)
------- -------
Net deferred taxes........................................ $ -- $ --
======= =======
</TABLE>
Due to the Company's lack of earnings history, the net deferred tax assets
have been fully offset by a valuation allowance. The valuation allowance
increased by $900,000 and $1.7 million during the years ended December 31, 1998
and 1999, respectively.
F-22
<PAGE>
KOSAN BIOSCIENCES INCORPORATED
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000 IS UNAUDITED)
11. SUBSEQUENT EVENTS (UNAUDITED)
SLOAN-KETTERING INSTITUTE FOR CANCER RESEARCH
In August 2000, the Company signed a collaboration and license agreement
with the Sloan-Kettering Institute for Cancer Research relating to epothilones.
Under the agreement, the Company will use its technologies to produce a specific
epothilone compound to be tested in clinical trials and work collaboratively
with Sloan-Kettering to develop new compounds and production methods and to
conduct clinical trials. Additionally, the Company is required to pay to
Sloan-Kettering an initial license fee and annual maintenance fees as well as
payments for research and development costs, including costs of clinical trials,
over a term of at least 24 months. If development efforts result in a marketable
product, the Company will make royalty payments based on product sales as well
as payments for reaching clinical development milestones. Estimated
non-cancelable commitments under this agreement are approximately $700,000 in
addition to internal development efforts under this agreement.
EXTENSION OF COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENT
In August 2000, the Company amended its collaborative Research and
Development Agreement with the R.W. Johnson Pharmaceutical Research Institute
and Ortho-McNeil Pharmaceutical, Inc., both Johnson & Johnson Companies. Under
the terms of the agreement, subject to termination provisions, the research
program and funding have been extended until at least December 28, 2001.
F-23
<PAGE>
[GRAPHIC -- BACKGROUND MAP]
5,000,000 SHARES
[LOGO]
COMMON STOCK
--------------
PROSPECTUS
OCTOBER 5, 2000
---------------------
LEHMAN BROTHERS
CIBC WORLD MARKETS
SG COWEN
FIDELITY CAPITAL MARKETS
a division of National Financial Services LLC
Until October 30, 2000 (25 days after commencement of the offering), all
dealers that buy, sell or trade our common stock, whether or not participating
in this offering, may be required to deliver a prospectus. This requirement is
in addition to the dealers' obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
