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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
----------------
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-27972
TREGA BIOSCIENCES, INC.
(Exact Name of Registrant as Specified in its Charter)
--------------------------
DELAWARE 51-0336233
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3550 GENERAL ATOMICS COURT 92121
San Diego, California (Zip Code)
(Address of principal executive offices)
(Registrant's telephone number, including area code): (619) 455-3814
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK $.001 PAR VALUE
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulations S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on March
20, 1998 as reported on the Nasdaq National Market, was approximately
$39,856,000. Shares of Common Stock beneficially held by each officer and
director of the Registrant and by each person who beneficially owns 10% or more
of the Registrant's outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
As of March 20, 1998, there were 13,927,098 shares of the Registrant's
Common Stock outstanding.
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TREGA BIOSCIENCES, INC.
FORM 10-K
INDEX
PAGE
PART I
Item 1. Business.............................................. 3
Item 2. Properties............................................ 15
Item 3. Legal Proceedings..................................... 15
Item 4. Submission of Matters to a Vote of Security Holders... 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................... 17
Item 6. Selected Financial Data............................... 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 18
Item 8. Financial Statements and Supplementary Data........... 22
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure................... 22
PART III
Item 10. Directors and Executive Officers of the Registrant.... 22
Item 11. Executive Compensation................................ 25
Item 12. Security Ownership of Certain Beneficial Owners and
Management............................................ 30
Item 13. Certain Relationships and Related Transactions........ 32
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K. 33
SIGNATURES............................................................ 36
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PART I
ITEM 1. BUSINESS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS
DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K ARE FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. FOR A DISCUSSION OF CERTAIN FACTORS WHICH MAY
AFFECT THE OUTCOMES PROJECTED IN SUCH STATEMENTS, SEE "RISK FACTORS" ON PAGES 9
TO 15 OF THIS ANNUAL REPORT ON FORM 10-K. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE PROJECTED. THESE FORWARD-LOOKING STATEMENTS REPRESENT THE COMPANY'S
JUDGMENT AS OF THE DATE OF THE FILING OF THIS ANNUAL REPORT ON FORM 10-K. THE
COMPANY DISCLAIMS, HOWEVER, ANY INTENT OR OBLIGATION TO UPDATE THESE
FORWARD-LOOKING STATEMENTS.
OVERVIEW
Trega Biosciences, Inc. (the "Company" or "Trega") is a drug discovery
company pursuing the identification and early-stage development of novel,
small-molecule drug therapies through combinatorial chemistry and other drug
discovery technologies. The synthetic chemistry technologies used by Trega in
its combinatorial chemistry program enable the Company to provide a wide range
of small-molecule libraries constructed in single-based compound arrays -- a
format that permits the rapid identification of active compounds after testing
in a biological assay. Trega believes its technologies position the Company to
become a leading developer and resource of drug discovery technologies and a
leading provider of novel chemical drug leads to the pharmaceutical industry.
Trega is engaged in drug discovery alliances as well as internal discovery
programs. The Company's alliances include agreements with Ono Pharmaceuticals
Co., Ltd., Warner-Lambert Company, Novo Nordisk A/S and Chugai
Biopharmaceuticals, Inc. Currently, Trega's internal drug discovery program is
focused on investigating the biological role of melanocortin receptors, which
have been identified as playing a role in the body's inflammatory processes and
in metabolic diseases. The Company is currently screening its small-molecule
combinatorial chemistry libraries against these receptors to discover potential
drug leads.
In 1993, the Company used its combinatorial chemistry technologies to
discover a family of proprietary compounds that appear to influence the
production and activity of anti-inflammatory and pro-inflammatory cytokines
through interaction with the melanocortin receptors. The most clinically
advanced of these compounds, HP 228, is in a Phase II study evaluating the
compound's effectiveness in relieving post-surgical pain -- an inflammatory
condition -- in patients undergoing elective hip or knee replacement surgery. If
the results of the study support further development efforts, Trega's objective
is to engage a pharmaceutical partner to undertake such development and possible
commercialization of HP 228.
Trega's strategy to leverage its technology platform consists of the
following components:
- - Provide combinatorial chemistry libraries to pharmaceutical companies to
support their drug discovery efforts and to provide the Company with
near-term revenues for reinvestment in strengthening and broadening the
technologies it offers to the pharmaceutical industry;
- - Discover and develop selected compounds through early-stage clinical trials
in an effort to demonstrate their potential value, and attempt to develop
and commercialize those compounds through partnering arrangements with
pharmaceutical companies; and
- - Access the increasing number of unique biological targets by selectively
entering into joint discovery collaborations with companies possessing these
targets.
Consistent with the Company's focus on drug discovery and early-stage
development, in February 1997, the Company sold Multiple Peptide Systems, Inc.
("MPS"), which had been engaged in manufacturing and marketing certain peptides
and other compounds to government entities, universities, research institutions
and private companies. MPS was sold to RAH Acquisition Corp., an entity formed
by Richard A. Houghten, Ph.D. (the founder and a former Director and Officer of
the Company).
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TREGA'S DRUG DISCOVERY TECHNOLOGIES
Combinatorial Chemistry
Discovering drugs involves screening chemical compounds against biological
assays to identify those compounds that trigger a desired activity in the body.
An effective drug discovery program requires access to a large collection of
compounds that can be rapidly tested for activity in assays representing novel
biologic intervention points. Combinatorial chemistry -- a technique for
simultaneously creating thousands of chemical compounds -- directly addresses
the demand for large collections of compounds. Combinatorial chemistry involves
rapidly and systematically assembling a variety of molecular entities, or
building blocks, in many different combinations to create tens of thousands of
diverse compounds that can be tested in drug discovery screening assays to
identify potential lead compounds.
Trega believes that its combinatorial chemistry technologies facilitate the
rapid identification of lead compounds for its pharmaceutical partners and for
its internal discovery programs by creating compounds that offer the following
important characteristics:
- - Pharmaceutically relevant compounds. Trega believes that its libraries are
designed to result in the creation of significant numbers of potentially
pharmaceutically relevant compounds. The Company's combinatorial chemistry
libraries are carefully created to meet the design, diversity, quality and
purity criteria established by the pharmaceutical industry.
- - Template novelty. Trega believes that the distinctive core structures, or
templates, around which the Company's small-molecule libraries are built
possess the physico-chemical weight and structure characteristic of
pharmaceutical compounds, yet have not been thoroughly explored as potential
drugs. The Company has applied for patents on nearly all of these libraries.
- - Easy-to-screen formats. The Company's libraries are formatted in
single-based compound arrays and consist of compounds free in solution,
without interfering solid support, such as beads, pins, chips or tags.
Trega's current libraries do not require the deconvolution strategies
employed to identify active compounds in mixture-based libraries -- the
library format previously employed by the Company.
- - Validation. Multiple leads and highly active compounds have been identified
and/or optimized utilizing Trega's technologies, both by Trega and in
several of the Company's external collaborations.
Trega creates both early identification screening libraries and lead
optimization libraries for both external collaborators and to support its
internal discovery programs.
Design of Combinatorial Chemistry Screening Libraries
The Company's screening libraries are carefully designed and constructed by
chemists to meet the stringent purity, molecular weight and quantity
requirements set forth by the pharmaceutical industry. Trega's combinatorial
chemistry approach to the design and synthesis of novel, diverse chemical
libraries involves the integration of medicinal chemistry, computational design,
solid-phase chemical synthesis, the Tea-Bag method of simultaneous parallel
synthesis and automated library synthesis.
Trega focuses its combinatorial library synthesis program on creating
diverse, lower molecular weight compounds, especially heterocyclic structures,
for its collaborators and its scientists for use in internal discovery programs.
Heterocycles, as a class of compounds, are considered desirable pharmaceutical
candidates because they are more likely to be orally available, are generally
less expensive to manufacture, and typically have a longer duration of action
than other compound classes such as peptides and proteins. Compounds of low
molecular weight, especially heterocycles, represent the majority of drugs
currently in use.
Extending the range of the Company's libraries involves developing novel
templates and, subsequently, libraries based on those templates. These new
libraries likely will add to the structural diversity of the Company's existing
libraries. Such an increase in diversity enhances the utility of the Company's
libraries because it increases the likelihood that screening the libraries
against a particular biological target will result in identification of a
compound with activity against that target.
Trega has recently undertaken a major shift in its combinatorial chemistry
techniques by providing its libraries only in single-based compound arrays,
rather than the mixture-based formats it had previously employed. A mixture is a
pool of tens to hundreds of distinct compounds that are created and tested
together rather than as individual compounds. Formatting libraries as mixtures
was an effective
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way of addressing the relatively slow screening systems used in the 1980s and
early 1990s. As the speed of biological screening throughput has increased
within the past several years to address the number of compounds produced
through combinatorial chemistry, the Company believes that mixture-based
techniques are no longer necessary. As a result, the Company ceased the
development of its mixture-based combinatorial libraries in 1997 and began
preparing its libraries exclusively in single-based compound arrays. Compounds
formatted as single-based compound arrays are created and screened as individual
compounds to facilitate the rapid identification of active compounds.
Due to this shift in the development of its libraries, as well as the
substantial increase in the number of chemists employed in Trega's internal
chemistry program, the Company recently notified the Torrey Pines Institute for
Molecular Studies ("TPIMS") that it would not be extending the research and
licensing agreement with TPIMS. (See "Certain License and Other Technology
Arrangements -- Torrey Pines Institute for Molecular Studies".)
Design of Optimization Libraries
Once a lead compound is identified from a Trega screening library, the
Company's virtual library -- a computational representation of all the possible
compounds that can be created around a template -- is searched to uncover a set
of closely related compounds that can be synthesized in highly purified form and
screened to identify the most active chemical structure.
Combinatorial Biology
Trega is conducting an early-stage combinatorial biology program through its
wholly owned subsidiary, ChromaXome Corporation ("ChromaXome"). In combinatorial
biology, genetic material from a naturally occurring microorganism is
molecularly manipulated, cloned and transferred into a suitable production host
microorganism. The recombinant production host efficiently manufactures
metabolites, or compounds, from the introduced "donor" genetic sequences.
Through this process, scientists can create libraries of potentially new
compounds which can then be screened for biological activity. In 1997,
ChromaXome successfully completed a proof-of-principle collaboration with
Bristol-Myers Squibb Pharmaceutical Research Institute to test the utility of
ChromaXome's technology. ChromaXome's objective is to assist pharmaceutical
companies in their natural products drug discovery programs.
TREGA'S DRUG DISCOVERY PROGRAMS -- MELANOCORTIN BIOLOGY
Trega's internal drug discovery programs are currently focused on the
identification of small-molecule compounds active against a series of five known
melanocortin receptors (MC-1 through MC-5) that have been shown to play a role
in inflammatory processes and metabolic diseases. Active compounds that interact
with these receptors may be useful in potentially treating inflammatory
conditions, such as pain, asthma and arthritis, or metabolic conditions, such as
diabetes and obesity.
In 1993, the Company used its early combinatorial chemistry technologies to
discover a family of proprietary peptide compounds that appear to influence the
production and activity of anti-inflammatory and pro-inflammatory cytokines --
hormone-like proteins that act as messengers between cells -- through
interaction with the melanocortin receptors. HP 228, the first compound
identified in this series, is currently the subject of a Phase II trial to
evaluate its effectiveness in treating acute, post-surgical pain -- an
inflammatory condition -- in patients undergoing elective hip or knee
replacement surgery. If the results of the study warrant further development,
the Company anticipates that it will engage a pharmaceutical partner to
undertake such development and possible commercialization.
The Company has conducted preliminary dose tolerance studies of HP 228 in
obese, type II diabetics and patients experiencing chemotherapeutic-induced
toxicities with no significant safety concerns resulting. However, in mid-1997,
Trega discontinued studying HP 228 for these chronic conditions and discontinued
the pre-clinical evaluation of HP 466, another compound in the peptide series,
for treating rheumatoid arthritis, asthma and acute bronchitis. The compounds'
injectable formats, as well as the Company's decision to focus on the potential
discovery of orally available, small-molecule melanocortin agonists active
against the melanocortin receptors, led to the Company's decision to discontinue
the evaluations.
Trega's internal discovery strategy is to collaborate with pharmaceutical
partners to identify small-molecule compounds active against the melanocortin
receptors by screening the Company's small-molecule combinatorial chemistry
libraries. In 1997, the Company entered into an alliance with Ono
Pharmaceuticals Co., Ltd. to identify small-molecule agonists of MC-1 to treat
inflammatory conditions. (See "Trega's External Collaborations -- Ono
Pharmaceuticals Co., Ltd." below.) One of the Company's objectives is to enter
into a collaboration with a major pharmaceutical company to identify orally
active, small-molecule agonists of MC-4 to treat metabolic conditions. The
Company anticipates that it will selectively add additional biological targets
to its internal drug discovery program to continue the development of its
integrated discovery program.
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TREGA'S BUSINESS STRATEGY
The Company's objective is to be a leading developer and resource of drug
discovery technologies and early-stage clinical development candidates that are
active against biological targets of importance to major pharmaceutical and
biotechnology companies. In 1997, the Company invested significantly in two
areas: 1) the development of combinatorial chemistry libraries formatted in
single-based compound arrays; and 2) screening of the Company's combinatorial
chemistry libraries against a series of melanocortin receptors.
The Company's commercial approach continues to focus on the development and
implementation of a sustainable business strategy principally through a mix of
corporate collaborations and focused internal discovery programs. The Company
intends to manage a portfolio of discovery and development programs that balance
funded discovery collaborations involving large pharmaceutical companies with
potentially higher-return discovery and development projects conducted
internally and in collaborations with biotechnology companies. To implement its
strategy, the Company continues to:
- - Provide combinatorial chemistry libraries to pharmaceutical companies to
support their drug discovery efforts and to provide the Company with
near-term revenues for reinvestment in strengthening and broadening the
technologies it offers to the pharmaceutical industry. In existing funded
discovery collaborations with pharmaceutical companies, the Company is paid
for access to its libraries and individually synthesized compounds.
Collaborations of this type typically have included potential milestone
payments and royalties from any resulting products that are developed and
commercialized. The Company anticipates that collaborations commencing in
the future may include relatively larger library access fees and fewer
potential milestone payments and royalties, if any.
- - Internally discover and develop selected compounds through early-stage
clinical trials in an effort to demonstrate their potential value. The
Company is pursuing the discovery and development of small-molecule
compounds that are active against melanocortin receptors. In 1997, the
Company initiated a Phase II study of its most advanced drug candidate, HP
228, for the treatment of acute, post-surgical pain for patients undergoing
elective hip or knee replacement surgery. In addition, the Company intends
to selectively develop, to early-stage clinical development, a limited
number of future discoveries from internal efforts or screening alliances
with biotechnology companies.
- - Develop and commercialize products derived from internal and external
discovery efforts through partnering arrangements with pharmaceutical
companies. With respect to compounds to which it has commercialization
rights, the Company intends to partner such compounds with major
pharmaceutical companies (prior to the initiation of Phase II clinical
trials when possible) in order to mitigate the costs associated with
development and commercialization, and to gain access to development and
marketing expertise.
- - Access unique biological targets by selectively entering into joint
discovery collaborations with companies possessing these targets. Through
these types of relationships, the Company obtains access to a range of
molecular targets and assays without having to make a major investment in
biotechnology infrastructure. In a typical relationship, the Company
provides access to its combinatorial libraries, the collaborator screens the
libraries through its assays, and the Company and its partner jointly own
lead compounds discovered, if any.
TREGA'S EXTERNAL COLLABORATIONS
In certain collaborations, the Company is paid for access to its
combinatorial chemistry libraries either on an as-provided basis or through an
up-front payment against which library or individual compound fees are
subsequently credited. Collaborations of this type may involve the Company's
receipt of milestone payments and royalties from resulting products which are
developed and commercialized, if any, and may also involve an equity investment
in the Company. The Company has current collaborations with Ono Pharmaceuticals
Co., Ltd. ("Ono"), Warner-Lambert Company ("Warner-Lambert"), Novo Nordisk A/S
("Novo Nordisk"), Chugai Biopharmaceuticals, Inc. ("Chugai"), The Procter and
Gamble Company ("P&G") and a major ophthalmic company. Trega's relationships
with P&G and the major ophthalmic company will expire in early 1999 and 1998,
respectively, and the Company anticipates that these agreements may not be
renewed due to shifts in research objectives between the companies. The
Company's previous collaboration with Osiris Therapeutics, Inc. expired in 1997.
- - Ono. In June 1997, the Company entered into a Research and Development
Agreement with Ono whereby the Company is screening its combinatorial
chemistry libraries and certain of Ono's chemical compounds against a
melanocortin-1 receptor screen to identify potential small-molecule agonists
of the receptor to treat inflammatory conditions. The Company received an
upfront
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license fee and an additional payment for work to be done during the first
12 months under the agreement. Subject to Ono's right of early termination,
the Company will receive $2,000,000 in July 1998 for further research during
an additional 12-month period. The Company will also receive milestone and
royalty payments on products it discovers which are subsequently developed
and marketed by Ono, if any. Rights to commercialize products resulting from
the arrangement, if any, will belong to Ono in China, Japan, South Korea and
Taiwan and to Ono and the Company in Europe, with the Company holding such
rights with respect to North America and the rest of the world.
- - Warner-Lambert. In May 1997, the Company entered into a collaboration with
Warner-Lambert regarding the identification of lead compounds in an area of
interest to Warner-Lambert. This collaboration involved utilizing Trega's
combinatorial chemistry libraries and Warner-Lambert's biological assays and
screening technology. In February 1998, the Company met a milestone in this
collaboration, triggering a requirement for a $1,500,000 investment by
Warner-Lambert in the Company's common stock (at fair market value). The
timing of this investment may be determined by Trega prior to February 11,
2000.
- - Novo Nordisk. This collaboration commenced in February 1996 and has focused
on the application of the Company's combinatorial chemistry technology to
selected therapeutic targets of interest to Novo Nordisk. Novo Nordisk has
rights to access the Company's technology on a non-exclusive basis. The
screening period under this agreement expires in mid-1998.
- - Chugai. The collaboration with Chugai, a subsidiary of Chugai Pharmaceutical
Co., Ltd., was initiated in January 1997. Trega provides Chugai with
combinatorial libraries which Chugai screens against a range of targets.
Compounds identified with activity in bone, cardiovascular and infectious
diseases as well as hematological growth factors and oncology may be
developed by Chugai, and Chugai would pay milestone payments and royalties
on compounds, if any, discovered from the Company's libraries and
subsequently developed and marketed by Chugai (for which Chugai would have
worldwide rights). Chugai and the Company will jointly own any compounds
with identified activity in Chugai's inflammation screens. In addition, the
Company may develop any compounds discovered in selected Chugai screens
targeted at obesity and central nervous system diseases, with a royalty
obligation payable to Chugai for any compounds that are commercialized.
Under other agreements, the Company selectively enters into joint discovery
alliances with companies that have access to novel biological targets to jointly
develop lead compounds, potentially for outlicense to pharmaceutical companies
for later-stage development. In these relationships, the Company provides access
to its combinatorial chemistry libraries to a collaborator in exchange for joint
ownership of any resulting discoveries. These discovery alliances, if
successful, will provide the Company with a source of potential products based
on its collaborators' innovative biologic approaches to disease therapies. This
approach allows the Company to avoid the initial capital-intensive
infrastructure investment required for basic biological research. The Company's
current such collaborations are with Chiroscience Group, plc. ("Chiroscience"),
RiboGene, Inc. ("RiboGene") and Cadus Pharmaceutical Corporation ("Cadus").
- - Chiroscience. This collaboration, which commenced in May 1997, entails the
Company's development of combinatorial libraries targeted at inhibiting cell
adhesion molecules involved in a variety of diseases such as inflammation
and cancer. Trega and Chiroscience would have joint ownership of any lead
compounds discovered through the collaboration.
- - RiboGene. This collaboration commenced in April 1995 to screen the Company's
libraries in a range of RiboGene assays. The Company and RiboGene would have
joint ownership of any lead compounds discovered through the collaboration.
- - Cadus. This collaboration commenced in January 1995 with acute inflammation
as the initial therapeutic target. The Company and Cadus would have joint
ownership of any lead compounds discovered through the collaboration.
Under the above agreements, joint ownership indicates that a lead compound
is owned equally by the Company and its collaborator. Equal ownership is
maintained to the extent that the Company and its collaborator contribute
equally to development costs of the compound. However, if one company continues
in the development and the other does not, the company pursing development
typically will own a greater portion of the compound being pursued.
CERTAIN LICENSE AND OTHER TECHNOLOGY ARRANGEMENTS
TPIMS
Pursuant to a Restated and Third Amended Research and Option Agreement with
TPIMS (the "TPIMS Agreement"), the Company historically has relied upon TPIMS, a
not-for-profit biomedical research institute founded by the founder of the
Company (Dr. Richard Houghten) for certain basic research and laboratory
facilities and scientific personnel necessary for the
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Company to conduct a significant portion of its combinatorial chemistry
business. As a result of (i) the Company's development of internal resources and
personnel to support the conduct of its combinatorial chemistry business and
(ii) the Company's adoption of techniques for the creation of combinatorial
libraries in single-based arrays, which techniques are not within the special
interest of TPIMS in creating mixture-based libraries, the Company is no longer
dependent upon TPIMS for those facilities and services previously provided.
Given the above-described divergence in directions and the Company's
development of internal resources, the Company recently notified TPIMS that it
would not extend the TPIMS Agreement beyond the contract year expiring April 14,
1998. As a consequence, the Company is obligated to continue to fund TPIMS
through July 14, 1998.
Pursuant to the TPIMS Agreement, the Company has purchased TPIMS' entire
right, title, and interest in and to certain technology identified in the TPIMS
Agreement, subject to the continuing rights of the United States government, if
any, and of TPIMS to use the technology for academic purposes. This purchase
eliminates the obligation of the Company to make milestone payments and to pay
royalties in respect of products based upon this technology. The purchase price
is $1,300,000, which amount is required to be put into escrow by the Company on
April 14, 1998, and to be disbursed to TPIMS on July 14, 1998.
Dura Pharmaceuticals, Inc.
In February 1996, the Company entered into a research and development
agreement with Dura Pharmaceuticals, Inc. ("Dura"). Dura markets pharmaceuticals
for the treatment of respiratory diseases and is developing a dry powder
inhalation system for pulmonary delivery of respiratory drugs and other
pharmaceuticals. In this collaboration, the Company is committed to provide
funding totaling $6,000,000 over four years to seek to apply Dura's proprietary
drug delivery technology to Company compounds. Concurrent with the execution of
this contract, Dura purchased shares of the Company's Preferred Stock,
which was converted to the Company's Common Stock upon closing of the Company's
initial public offering, for $5,000,000.
The Company and Dura have agreed to negotiate certain manufacturing and
licensing agreements for any Company compounds successfully developed using
Dura's technologies. Separately, Dura will have the option to participate in
funding the development of, and to receive a commensurate share of the
commercial benefits from, respiratory compounds discovered and owned by the
Company in the course of its drug discovery efforts.
The Scripps Research Institute ("Scripps")
The Company is the assignee of a license to the method patent covering the
Tea Bag simultaneous parallel solid-phase synthesis technology from Scripps.
This license was acquired from the technology's inventor, Dr. Richard Houghten.
The Company, under certain circumstances, may be required to pay royalties to
Scripps for use of the Tea Bag technology.
Chiron Corporation
Pursuant to agreements with Chiron Corporation ("Chiron"), in January 1994,
the Company and Chiron cross-licensed certain patent rights held by each company
related to the synthesis and screening of peptide libraries. The combined
cross-licensed portfolios of patent rights provide substantial research
platforms and methodologies for developing and screening peptide libraries. The
rights granted by the Company to Chiron include rights to utilize the Tea Bag
method of synthesis (including synthesis of non-peptide libraries). The Company
is required to pay royalties to Chiron on products generated using Chiron's
technology.
Northwest Neurologic, Inc.
As of May 30, 1997, the Company entered into a Research & License Agreement
with Northwest Neurologic, Inc. ("NNL"), which was subsequently amended (the
"License Agreement"). Under the License Agreement, the Company acquired a
nonexclusive license to certain technology related to the melanocortin receptors
for use in a defined field. In exchange, the Company agreed to pay cash to NNL
and to provide NNL with the use of up to 10 combinatorial libraries and certain
other services to be provided by the Company. Each party will owe milestone
payments and royalties to the other based upon the development and
commercialization of products employing the technology received under the
License Agreement. In March 1998, NNL announced that it had entered into an
agreement to be acquired by Neurocrine Biosciences, Inc.
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RESEARCH AND DEVELOPMENT EXPENSES
The Company incurred research and development expenses totaling
approximately $14,819,000, $11,781,000 and $7,289,000 in 1997, 1996 and 1995,
respectively. (See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" below.)
EMPLOYEES
As of March 20, 1998, the Company had 87 full-time employees, including 73
in research and development. Of the Company's total employees, approximately 41
hold advanced degrees. The Company places an emphasis on obtaining the highest
available quality of staff. The Company has selected and assembled a group of
experienced scientists and managers with skills in a wide variety of
disciplines, including chemistry, biology and pharmaceutical development. None
of the Company's employees are covered by collective bargaining arrangements and
management considers relationships with its employees to be good.
RISK FACTORS
THE COMPANY WISHES TO CAUTION READERS THAT THE FOLLOWING IMPORTANT FACTORS,
AMONG OTHERS (INCLUDING THOSE NOTED ELSEWHERE IN THIS ANNUAL REPORT ON FORM
10-K), IN SOME CASES HAVE AFFECTED, AND IN THE FUTURE COULD AFFECT, THE
COMPANY'S ACTUAL RESULTS AND COULD CAUSE THE COMPANY'S ACTUAL CONSOLIDATED
RESULTS FOR FUTURE PERIODS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY
FORWARD-LOOKING STATEMENTS MADE BY, OR ON BEHALF OF, THE COMPANY.
NEW AND UNCERTAIN TECHNOLOGIES AND BUSINESS
Drug discovery methods based upon combinatorial chemistry technology are
relatively new compared to traditional methods of drug discovery and there can
be no assurance that these methods will lead to the discovery or development of
commercial pharmaceutical products or that the Company will be able to employ
these or other methods of drug discovery successfully. The Company's technology
development programs (including the Company's combinatorial biology technology
program (conducted through its subsidiary, ChromaXome) and the Company's efforts
to synthesize compounds through automation) are at early stages of development,
and there can be no assurance that such technology programs will be developed or
employed successfully, work efficiently or otherwise enhance the Company's
ability to engage effectively in drug discovery. The types of combinatorial
libraries the Company is capable of offering and the nature of the compounds the
Company is able to synthesize will, in large part, determine the demand for the
Company's drug discovery capabilities. An inability to offer competitive
libraries or an inability to synthesize compounds that have actual or potential
utility would have a material adverse effect on the Company. Failures in the
field of drug discovery, including combinatorial chemistry, could have a
material adverse effect on the Company.
DEPENDENCE ON COLLABORATORS
The Company's strategy for the utilization of its drug discovery
technologies and for the development, clinical testing, manufacturing and
commercialization of any compounds depends upon the formation of collaborations
and arrangements with corporate collaborators, licensors, licensees and others.
There may only be a limited number of pharmaceutical and biotechnology companies
that would potentially collaborate with the Company. Historically,
pharmaceutical and biotechnology companies have conducted lead compound
identification and optimization within their own research departments, due to
the highly proprietary nature of the activities being conducted, the central
importance of these activities to their drug discovery and development efforts
and the desire to obtain maximum patent and other proprietary protection on the
results of their internal programs. Pharmaceutical and biotechnology companies
must be convinced that the Company's drug discovery technologies and expertise
justify outsourcing these programs to the Company. The amount and timing of
resources that current and future collaborators, if any, devote to
collaborations with the Company are not within the control of the Company. There
can be no assurance that such collaborators will perform their obligations as
expected or that the Company will derive any additional revenue from such
arrangements. Because the Company's arrangements with its collaborators may
entail the provision of identical or similar libraries or compounds to multiple
parties, there can be no assurance that conflicts will not arise between
collaborators as to proprietary rights to particular libraries or as to
particular compounds in the Company's libraries. Moreover, the Company's
collaborations may be terminated under certain circumstances by its
collaborators, which terminations could result in the Company relinquishing
rights to products developed jointly with its collaborators. Any such conflicts
or terminations could have a material and adverse effect on the Company.
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<PAGE> 10
There can be no assurance that (i) the Company's present or any future
collaborators will not pursue their existing or alternative technologies in
preference to those of the Company, (ii) any product will be developed and
marketed as a result of such collaborations or (iii) the Company will be able to
negotiate additional collaborative arrangements in the future on acceptable
terms, if at all, or that such current or future collaborative arrangements will
be successful. To the extent that the Company chooses not to or is unable to
establish such arrangements, it will require substantially greater capital to
undertake the research, development and marketing of products at its own
expense. In addition, the Company may encounter significant delays in developing
compounds or find that the development, manufacture or sale of its proposed
products is materially and adversely affected by the absence of such
collaborative agreements.
EARLY STAGE OF PRODUCT DEVELOPMENT
The Company's research and product development programs (including the
Company's program with respect to potential drug candidates for the treatment of
diseases mediated by the melanocortin receptor pathway) are at early stages. Any
compounds resulting from the Company's research and development programs are not
expected to be commercially available for a number of years, if ever, even if
any such compounds are successfully developed and proven to be safe and
effective. There can be no assurances that any of the Company's product
development efforts will be successfully completed, that development
arrangements with pharmaceutical partners will be established on acceptable
terms, if at all, that regulatory approvals will be obtained or will be as broad
as sought, that any candidate products will be capable of being produced in
commercial quantities at reasonable cost, or that any products, if introduced,
will achieve market acceptance or profitability.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING
The continued development of the Company's technologies and compounds will
require the commitment of substantial additional funds to continue to maintain
the competitiveness of its drug discovery technologies and to conduct the costly
and time consuming research and preclinical and clinical testing necessary to
bring products to market. The Company's future capital requirements will depend
on many factors, including, among others, (i) continued scientific progress in
its research and development programs, (ii) the ability of the Company to
establish and maintain collaborative arrangements with respect to the Company's
drug discovery technologies and the clinical testing of candidate products,
(iii) progress with preclinical and clinical trials, (iv) the costs involved in
further developing and sustaining internal combinatorial chemistry capabilities,
(v) the costs involved in developing additional drug discovery technologies,
including combinatorial biology and the synthesis of compounds through
automation, (vi) the costs involved in preparing, filing, prosecuting,
maintaining and enforcing patent claims, (vii) competing technological and
market developments and (viii) changes in the Company's existing research
relationships. Although the Company estimates that its existing capital
resources will be sufficient to fund its current and planned operations for the
next 12 months, there can be no assurance that changes will not occur that would
consume available capital resources before such time.
The Company anticipates that it will be required to raise additional capital
over a period of several years in order to conduct its operations. Such capital
may be raised through additional public or private financings, as well as
collaborative arrangements, borrowings and other available sources. There can be
no assurance that additional financing will be available on acceptable terms, if
at all. If adequate funds are not available, the Company may be required to
delay, reduce the scope of or eliminate one or more of its research or
development programs, which could have a material adverse effect on the Company.
COMPETITION
The Company is engaged in a highly competitive and rapidly changing
industry. The Company competes not only with other combinatorial chemistry
companies, but also with companies utilizing other technologies (such as
combinatorial biology) for the same objectives. Competition from fully
integrated pharmaceutical companies and biotechnology companies and other drug
discovery companies is intense and is expected to increase. Many pharmaceutical
and biotechnology companies, which represent the largest potential market for
the Company's combinatorial chemistry and other drug discovery technologies,
have developed or are developing internal combinatorial chemistry and other drug
discovery technology programs or have entered into collaborations with companies
conducting such programs. Many of these pharmaceutical companies, as compared
with the Company, have significantly greater financial resources and expertise
in research and development, manufacturing, preclinical and clinical testing,
obtaining regulatory approvals and marketing. Smaller companies may also prove
to be significant competitors, particularly through collaborative arrangements
with large pharmaceutical and established biotechnology companies. Academic
institutions, governmental agencies and other public and private research
organizations also conduct research, seek patent protection and establish
collaborative arrangements for products and clinical development and marketing
which may be competitive with the Company's efforts. These companies and
institutions compete with the Company in recruiting and retaining highly
qualified scientific and management personnel. There is also
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competition for access to novel pharmacophores and desirable assays to use for
screening of libraries, and any inability of the Company to develop novel
pharmacophores or maintain access to a sufficiently broad range of assays for
screening potential drugs would have a material adverse effect on the Company.
There can be no assurance that the Company's competitors will not develop more
effective or more affordable technology or products, or achieve earlier product
development and commercialization than the Company, thus rendering the Company's
technologies and/or products obsolete, uncompetitive or uneconomical. In
combinatorial chemistry and other drug discovery technologies, the Company faces
competition based on a number of factors, including size and diversity of
libraries, ease of use of libraries, speed and costs of identifying and
optimizing potential lead compounds, access to novel pharmacophores and
desirable assays, and patent position.
In addition, products and therapies that will compete directly with any
compounds that the Company seeks to develop (such as HP 228), or that the
Company's collaborative partners may seek to develop, currently exist or are
being developed. In product development and marketing, the Company, and its
collaborative partners will face competition based on product efficacy and
safety, the timing and scope of regulatory approvals, availability of supply,
marketing and sales capability, reimbursement coverage, price and patent
position.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company's success will depend in large part on its ability to obtain
patents for its methodologies and the compounds and other products, if any,
resulting from the application of such methodologies, defend patents once
obtained, maintain trade secrets and operate without infringing upon the
proprietary rights of others, both in the U.S. and in foreign countries. The
patent positions of pharmaceutical and biotechnology companies, and companies
utilizing drug discovery technologies such as combinatorial chemistry and
combinatorial biology, including the Company, are uncertain and involve complex
legal and factual questions for which important legal principles are largely
unresolved. There can be no assurance that the Company will develop or obtain
the rights to products or processes that are patentable, that patents will issue
from any of the pending applications or that claims allowed will be sufficient
to protect the Company's technologies or products. Pending patent applications
for which rights are uncertain include applications being prosecuted by the
Company with respect to the Company's combinatorial chemistry libraries and
certain uses for HP 228, as well as patent applications filed by the Company
(through ChromaXome) with respect to certain aspects of the combinatorial
biology technologies being developed by the Company (through ChromaXome). There
can be no assurance that the patents of, or with respect to which rights have
been licensed to, the Company will not be challenged, invalidated or
circumvented, or that the rights granted or licensed to the Company will provide
proprietary protection or competitive advantages to the Company. Such patents
include a U.S. patent for the Tea Bag technology, which is licensed to the
Company and the Company's U.S. patent for the composition of matter of HP 228
and certain uses of HP 228. The U.S. patent on the Tea Bag technology, that the
Company believes is important to the Company's business, expires in 2003.
Competitors (some of which have, or are affiliated with companies having,
substantially greater resources than the Company) may have filed applications,
may have been issued patents or may obtain additional patents and proprietary
rights to or the use of certain methodologies relating to products or processes
competitive with those of the Company or which could block the Company's efforts
to obtain patents or conduct its business.
A number of pharmaceutical companies, biotechnology companies, universities
and research institutions have filed patent applications or received patents in
the fields of combinatorial chemistry, combinatorial biology and other drug
discovery technologies and with respect to products and therapies that may have
potential uses which are similar to the Company's current research and
development areas. The commercial success of the Company will depend in part on
the Company's not infringing patents and not breaching the patent and know-how
licenses upon which any of the Company's technologies or compounds are based or
having such licenses breached or terminated by others. Certain patent
applications or patents may conflict with the Company's patent applications and
patents either by claiming the same methods or compounds or by claiming methods
or compounds which would dominate those of the Company. A U.S. patent
application is maintained under conditions of confidentiality while the
application is pending in the U.S. Patent and Trademark Office ("PTO") so that
the Company cannot determine the inventions being claimed in pending patent
applications filed by its competitors in the PTO. Any such conflicts could
result in a significant reduction of the coverage of the Company's issued or
licensed patents and its ability to obtain issuance of significant patent
protection from its applications. In addition, if patents are issued to other
companies which contain competitive or conflicting claims, the Company may be
required to obtain licenses to these patents or to develop or obtain alternative
technology. If any license is required, there can be no assurance that the
Company will be able to obtain any such license on commercially favorable terms,
if at all. If such licenses are not obtained, the Company could be prevented
from pursuing the development or commercialization of its technologies or
potential products. The Company's breach of an existing license or failure to
obtain a license to any technology that it may require to commercialize its
technologies or its potential products may have a material adverse impact on the
Company.
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Litigation, which could result in substantial costs to the Company, may also
be necessary to enforce any patents issued or licensed to the Company or to
determine the scope and validity of third party proprietary rights. There can be
no assurance that the Company's issued or licensed patents would be held valid
by a court of competent jurisdiction or that an alleged infringer would be found
to be infringing. Further, with respect to certain technology in-licensed by the
Company, the Company does not have the right to control any litigation with
respect to such technology. An adverse outcome could subject the Company to
significant liabilities to third parties, require disputed rights to be licensed
from third parties or require the Company to cease using such technology, any of
which could have a material adverse effect on the Company. Moreover, merely the
uncertainties resulting from institution and continuation of any
technology-related litigation could have a material adverse effect on the
Company's ability to compete in the marketplace pending resolution of the
disputed matters. If competitors of the Company prepare and file patent
applications in the U.S. that claim technology also claimed by the Company, the
Company may have to participate in interference proceedings declared by the PTO
to determine the priority of the invention, which could result in substantial
cost to the Company, even if the outcome is favorable to the Company. An adverse
outcome could subject the Company to significant liabilities to third parties
and require the Company to license disputed rights from third parties or
discontinue using the technology.
The Company also relies on trade secrets to protect technology, especially
where patent protection is not believed to be appropriate or obtainable. The
Company attempts to protect its proprietary technology and processes in part
through confidentiality agreements with its employees, consultants and certain
contractors. There can be no assurance, however, that these agreements will not
be breached or terminated, that the Company would have adequate remedies for any
breach, or that the Company's trade secrets will not otherwise become known or
be independently discovered by competitors. The Company, as well as its
consultants and research collaborators in their work for the Company, use
intellectual property owned by others. Disputes may arise as to the rights in
technology resulting from collaborations and in the related know-how and
inventions. The Company relies on certain technologies to which it does not have
exclusive rights or which may not be patentable or proprietary and thus may be
available to competitors.
HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY
The Company has experienced significant operating losses since inception.
For the years ended December 31, 1997, 1996 and 1995, the Company had net losses
of approximately $9,372,000, $11,688,000 and $9,490,000, respectively. As of
December 31, 1997, the Company had an accumulated deficit of approximately
$55,629,000. The Company expects that its ability to achieve profitability will
be dependent upon the ability of the Company to enter into and achieve success
under additional collaborative arrangements or to expand and achieve success
under existing relationships. There can be no assurance that the Company will be
successful in entering into additional collaboration arrangements that will
result in revenues or that the Company will receive additional revenues under
existing collaboration arrangements. If the Company is unable to receive
additional revenues under collaboration arrangements, the Company expects to
incur additional operating losses in the future and expects cumulative losses to
increase as the Company's research and development efforts and preclinical and
clinical testing are expanded. Any revenues from the achievement of milestones,
royalties or license fees from the discovery, development or sale of a
commercial drug by a collaborator are not expected to be material to the
Company's financial position for several years, if at all. The Company is unable
to predict when, if ever, it will become profitable.
CLINICAL DEVELOPMENT OF HP 228
To date, the Company has itself developed one drug candidate (HP 228) that
has entered the early stages of human clinical testing. Even though HP 228 has
demonstrated indications of efficacy in preclinical models and the results of
certain Phase I and II studies have shown no significant safety concerns, there
can be no assurance that HP 228 will be demonstrated to be effective in treating
human diseases or safe in further trials. Lack of progress, adverse results or
discontinuation of the HP 228 clinical programs could have a material adverse
effect on the Company. HP 228 is not expected to be commercially available for a
number of years, if ever, even if it is successfully developed and proven to be
safe and effective.
GOVERNMENT REGULATION
The manufacturing and marketing of any products developed by the Company or
its collaborators will be subject to regulation for safety and efficacy by
governmental authorities in the U.S. and other countries. In the U.S.,
pharmaceuticals are subject to rigorous regulation by the Food and Drug
Administration ("FDA"). The Federal Food, Drug and Cosmetic Act and the Public
Health Service Act govern the testing, manufacture, safety, efficacy, labeling,
storage, record keeping, approval, advertising and promotion of pharmaceutical
products. Product development and approval within this regulatory framework
takes a number of years and involves the expenditure of substantial resources.
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The steps required before a pharmaceutical agent may be marketed in the U.S.
include (i) preclinical laboratory and animal tests, (ii) submission to the FDA
of an Investigational New Drug application ("IND"), which must be deemed
acceptable before human clinical trials may commence, (iii) adequate and
well-controlled human clinical trials to establish the safety and efficacy of
the drug, (iv) submission of a New Drug Application ("NDA") or Product License
Application ("PLA") to the FDA and (v) FDA approval of the NDA or PLA prior to
any commercial sale or shipment of the drug. In addition to obtaining FDA
approval for each product, each domestic drug manufacturing facility is subject
to inspections every two years by the FDA and must comply with current Good
Laboratory Practices and Good Manufacturing Practices ("GMP"). To supply
products for use in the U.S., foreign manufacturing facilities also must comply
with GMP and are subject to periodic inspection by the FDA or by regulatory
authorities in such countries under reciprocal agreements with the FDA.
Preclinical tests include laboratory evaluation of product chemistry and
animal studies to assess the safety and efficacy of the product and its
formulation. The results of the preclinical tests are submitted to the FDA as
part of an IND and, unless the FDA objects, the Company submitting the IND may
start clinical studies 30 days following its submission to the FDA.
Clinical trials involve the administration of the pharmaceutical product to
volunteers or to patients identified as having the condition for which the
pharmaceutical is being tested. The pharmaceutical is administered under the
supervision of a qualified principal investigator. Clinical trials are conducted
in accordance with protocols previously submitted to the FDA as part of the IND
which detail the objectives of the study, the parameters used to monitor safety
and the efficacy criteria evaluated. Each clinical study is conducted under the
auspices of an independent Institutional Review Board ("IRB") at the institution
at which the study is conducted. The IRB considers, among other things, ethical
factors, the safety of the human subjects and the possible liability risk for
the institution.
Clinical trials are typically conducted in three sequential phases that may
overlap. Phase I consists of the initial introduction of the pharmaceutical into
human volunteers, and the emphasis is on testing for safety (adverse effects),
dosage tolerance, absorption, metabolism, distribution, excretion and clinical
pharmacology. Phase II involves studies in a limited patient population to
determine the efficacy of the pharmaceutical for specific targeted indications,
to determine dosage tolerance, optimal dosage and dosing frequency, and to
identify possible adverse side effects and safety risks. Once a compound is
found to be effective and to have an acceptable safety profile in Phase II
evaluations, Phase III trials are undertaken to further evaluate both clinical
efficacy and safety within an expanded patient population at multiple clinical
study sites. The FDA reviews both the clinical plans and results of the trials
and may order suspension of the trials at any time if there are significant
safety issues.
Results of the preclinical and clinical trials are submitted to the FDA in
the form of an NDA or PLA for marketing approval. The testing and approval
process is likely to require substantial time and effort, and there can be no
assurance that any approval will be granted on a timely basis, if at all. The
approval process is affected by a number of factors, including severity of the
disease, availability of alternative treatments, and risks and benefits
demonstrated in clinical trials. Additional animal studies or clinical trials
may be requested during the FDA review process and may delay marketing approval.
After FDA approval for the initial indications, further clinical trials are
necessary to gain approval for use of the product for any additional
indications. The FDA may also require post-marketing testing to monitor for
adverse effects, which can involve significant expense. Failure to comply with
applicable regulatory requirements after obtaining regulatory approval can,
among other things, result in the suspension of regulatory approval, as well as
possible civil and criminal sanctions. In addition, changes in regulations could
have a material adverse effect on this industry.
For marketing outside the U.S., the Company's collaborators and the Company
will also be subject to foreign regulatory requirements governing human clinical
trials and marketing approval for pharmaceutical products. The requirements
governing the conduct of clinical trials, product licensing, pricing and
reimbursement vary widely from country to country.
With respect to any potential products that enter clinical trials (such as
the Company's HP 228), there can be no assurance that the Company or its
collaborators will be permitted to continue or undertake new human clinical
testing of such potential products, or, if permitted, that such potential
products will be demonstrated to be safe and efficacious. The lead compounds of
the Company or its collaborators may prove to have undesirable and unintended
side effects or other characteristics that may prevent or limit their commercial
use. In addition, there can be no assurance that any of the potential products
of the Company or its collaborators will ultimately obtain FDA or foreign
marketing approval for any indication, that an approved compound will be capable
of being produced in commercial quantities at reasonable cost or that any such
compound will be successfully marketed. Furthermore, even if approval is
ultimately obtained, delays in the approval process could have a material
adverse effect on the Company.
In addition to regulations enforced by the FDA, the Company is also subject
to other regulation, including regulation under the Occupational Safety and
Health Act, the Environmental Protection Act, the Toxic Substances Control Act,
the Resource Conservation
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and Recovery Act, regulations promulgated by the United States Department of
Agriculture, and other federal, state and local laws and regulations.
MANAGEMENT
The Company has multiple collaborative arrangements, and the Company desires
to enter into additional collaborative relationships. The Company's success will
depend upon the effective management of these current and prospective
collaborative relationships, including maintaining confidentiality of the
research being provided for each of these collaborators, as well as the
maintenance and further development of the Company's technologies and progress
in the Company's research and development programs. To further develop its
technologies (including combinatorial chemistry, combinatorial biology and
automated compound synthesis), and to pursue its product development plans, the
Company will be required to hire additional qualified scientific personnel to
perform research and development, as well as personnel with expertise in
clinical testing and government regulation. These requirements, as well as the
management of current and prospective collaborative arrangements, are expected
to demand the addition of management personnel and the development of additional
expertise by existing management personnel. The Company faces intense
competition for qualified individuals from numerous pharmaceutical and
biotechnology companies, universities and other research institutions.
MANUFACTURING
The Company has no manufacturing facilities and will need to rely on
contract manufacturers to produce its compounds for clinical trials and
commercialization. The proposed pharmaceutical products under development by the
Company have never been manufactured on a commercial scale and there can be no
assurance that such products can be manufactured at a cost or in quantities
necessary to make them commercially viable. If the Company were unable to
produce internally or to contract for a sufficient supply of its compounds on
acceptable terms, or if it should encounter delays or difficulties in its
relationships with manufacturers, the Company's human clinical testing schedule
would be delayed, resulting in delay in the submission of products for
regulatory approval and the market introduction and subsequent sales of such
products, which could have a material adverse effect on the Company. Moreover,
contract manufacturers that the Company may use must adhere to GMP regulations
enforced by the FDA through its facilities inspection program. If these
facilities cannot pass a pre-approval plant inspection, the FDA pre-market
approval of the products will not be granted.
RISK OF PRODUCT LIABILITY; POTENTIAL UNAVAILABILITY OF INSURANCE
The Company's business will expose it to potential product liability risks
that are inherent in the testing, manufacturing and marketing of human
therapeutic products. The Company does not currently have product liability
insurance, and there can be no assurance that the Company will be able to obtain
or maintain such insurance on acceptable terms or that insurance will provide
adequate coverage against potential liabilities. The Company does have clinical
trial liability insurance, but there can be no assurance that the Company will
be able to maintain such insurance for any of its clinical trials or that such
insurance will provide adequate coverage against potential liabilities.
POTENTIAL LIABILITY REGARDING HAZARDOUS MATERIALS
The Company's research and development activities involve the controlled use
of hazardous materials, chemicals and various radioactive compounds. The Company
is subject to federal, state and local laws and regulations governing the use,
manufacture, storage, handling and disposal of such materials and certain waste
products. The risk of accidental contamination or injury from these materials
cannot be completely eliminated. In the event of such an accident, the Company
could be held liable for any damages that result and any such liability could
exceed the resources of the Company. In addition, there can be no assurance that
the Company will not be required to incur significant costs to comply with
environmental laws and regulations in the future.
POSSIBLE VOLATILITY OF STOCK PRICE
The market prices for securities of life sciences companies have been highly
volatile and the market has experienced significant price and volume
fluctuations, some of which are unrelated to the operating performance of
particular companies. Announcements of technological innovations or new
commercial products or failures of potential products by the Company, its
collaborators or its competitors, developments in the Company's relationships
with current or future collaborative partners, developments concerning
proprietary rights, including patents and litigation matters, publicity
regarding actual or potential results with respect to compounds under
development by the Company or its collaborators, regulatory developments in both
the U.S. and foreign countries, public
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concern as to the efficacy of combinatorial chemistry or other new drug
discovery technologies, changes in reimbursement policies, general market
conditions, as well as quarterly fluctuations in the Company's revenues and
financial results and other factors, may have a significant impact on the market
price of the Company's Common Stock. In particular, the realization of any of
the risks described in these "Risk Factors" may have a material adverse impact
on such market price.
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER AND BY-LAW PROVISIONS AND DELAWARE LAW
The Company's Amended and Restated Certificate of Incorporation (the
"Certificate of Incorporation") authorizes the Board of Directors to issue,
without stockholder approval, 5,000,000 shares of preferred stock with voting,
conversion and other rights and preferences that could adversely affect the
voting power and other rights of the holders of the Company's Common Stock.
Although the Company has no current plans to issue any shares of preferred
stock, the issuance of preferred stock or of rights to purchase preferred stock
could be used to discourage an unsolicited acquisition proposal. In addition,
the possible issuance of preferred stock could discourage a proxy contest, make
more difficult the acquisition of a substantial block of the Company's Common
Stock or limit the price that investors might be willing to pay in the future
for shares of the Company's Common Stock. The Company's Certificate of
Incorporation provides for staggered terms for the members of the Board of
Directors. A staggered Board of Directors and certain provisions of the
Company's by-laws and Certificate of Incorporation and of Delaware law
applicable to the Company could delay or make more difficult a merger, tender
offer or proxy contest involving the Company. In addition, the Company is
subject to Section 203 of the General Corporate Law of Delaware which, subject
to certain exceptions, restricts certain transactions and business combinations
between a corporation and a stockholder owning 15% or more of the corporation's
outstanding voting stock (an "interested stockholder") for a period of three
years from the date the stockholder becomes an interested stockholder. These
provisions, and certain other provisions of the Certificate of Incorporation and
the Company's by-laws, may have the effect of delaying or preventing a change of
control of the Company without action by the stockholders and, therefore, could
adversely affect the price of the Company's Common Stock.
UNCERTAINTY OF PHARMACEUTICAL PRICING AND HEALTH CARE REFORM
The Company expects that significantly all of its revenues in the
foreseeable future will be derived from services and compounds provided to the
pharmaceutical and biotechnology industries. Accordingly, the Company's success
in the foreseeable future is directly dependent upon the success of the
companies within those industries and their continued demand for the Company's
services and compounds. The levels of revenues and profitability of
pharmaceutical companies may be affected by the continuing efforts of
governmental and third party payors to contain or reduce the costs of health
care through various means and the initiatives of third party payors with
respect to the availability of reimbursement. For example, in certain foreign
markets, pricing or profitability of prescription pharmaceuticals is subject to
governmental control. In the U.S., there have been, and the Company expects that
there will continue to be, a number of federal and state proposals to implement
similar governmental control. It is uncertain what legislative proposals may be
adopted or what actions federal, state or private payors for health care goods
and services may take in response to any health care reform proposals or
legislation. To the extent that such proposals or reforms have a material
adverse effect on the business, financial condition and profitability of
pharmaceutical or biotechnology companies that are actual or prospective
collaborators for the Company's services or potential products, the Company's
market value, access to financing, business, financial condition and results of
operations could be materially and adversely affected.
ITEM 2. PROPERTIES
The Company currently leases approximately 28,000 square feet of laboratory
and office space at 3550 General Atomics Court, San Diego, California. In
September 1997, the Company entered into a lease for a 71,625 square foot
facility (approximately 55,000 square feet of laboratory and office space)
located at 9880 Campus Point Drive, San Diego, California. The lease term
extends for ten years from a defined possession and commencement date.
Management expects that the entire Company will be relocated to the newly-leased
facility by the end of the second quarter of 1998. Management expects that the
Company will experience minimal down time during the relocation process;
however, there can be no assurance that the processes of certifying the new
facility, decertifying the existing facility and moving large customized pieces
of equipment will not result in unanticipated costs and delays.
ITEM 3. LEGAL PROCEEDINGS
On October 7, 1996, a complaint was filed in San Diego Superior Court naming
the Company, ChromaXome, and the officers and directors of the Company as
defendants. The complaint, filed by Michael Dickman and Katie Thompson, the
founders of ChromaXome, alleged various contract and tort claims against the
defendants, including that the defendants acted wrongfully in
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connection with the Company's acquisition of ChromaXome to deny Mr. Dickman and
Ms. Thompson access to and employment with ChromaXome and to prevent them from
obtaining certain consideration in connection with the ChromaXome acquisition.
On August 21, 1997, the Company announced the settlement and dismissal of the
action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during the
fourth quarter of 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the over-the-counter market (the
Nasdaq National Market) under the symbol "TRGA". The following table sets forth
the high and low sale prices for the Company's Common Stock as reported on the
Nasdaq National Market for the periods indicated. These prices reflect
interdealer prices, without retail mark-up, mark-down or commission, and may not
necessarily represent actual transactions.
1996 High Low
- ---- ------- ---------
Second Quarter (trading commenced April 1) $12 1/4 $ 8
Third Quarter......................... 8 1/2 4 3/4
Fourth Quarter........................ 7 1/2 3 3/4
1997 High Low
- ---- ------- ---------
First Quarter......................... $ 8 1/4 $ 5
Second Quarter........................ 6 3/4 3 3/8
Third Quarter......................... 6 1/4 3 1/2
Fourth Quarter........................ 5 1/2 2 5/8
1998 High Low
- ---- ------- ---------
First Quarter (through March 20)...... $ 4 2/3 $ 2 13/16
There were approximately 185 holders of record of the Company's Common Stock
as of February 28, 1998. The Company has not paid any cash dividends to date on
its Common Stock and does not anticipate any being paid in the foreseeable
future.
ITEM 6. SELECTED FINANCIAL DATA
The data presented below should be read in conjunction with "Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements of the Company (and the
notes thereto) contained elsewhere herein.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------
1997 (1) 1996 1995 (1) 1994 (1) 1993
-------- -------- -------- -------- --------
CONSOLIDATED STATEMENTS OF OPERATIONS DATA: (in thousands, except net loss per share)
<S> <C> <C> <C> <C> <C>
Revenues:
Contract research and license fees ......... $ 7,334 $ 5,750 $ 293 $ 315 $ --
Net sales .................................. 430 2,507 1,077 315 4,468
-------- -------- -------- -------- --------
Total revenues ..................... 7,764 8,257 1,370 630 4,468
Costs and expenses:
Cost of sales .............................. 341 2,025 1,313 249 2,742
Research and development ................... 14,819 11,781 7,289 6,524 5,759
Acquired in-process research and development -- 2,585 -- -- --
Selling, general and administrative ........ 4,346 4,191 2,722 2,319 3,728
-------- -------- -------- -------- --------
Total costs and expenses ........... 19,506 20,582 11,324 9,092 12,229
-------- -------- -------- -------- --------
Loss from operations ......................... (11,742) (12,325) (9,954) (8,462) (7,761)
Other income (expense):
Loss on investment ......................... (88) (534) -- -- --
Interest income ............................ 1,405 1,274 136 77 41
Interest expense ........................... (202) (103) (86) (110) (245)
Gain on sale of MPS ........................ 1,255 -- -- -- --
Corporate joint venture ..................... -- -- 414 (557) --
-------- -------- -------- -------- --------
Net loss ..................................... $ (9,372) $(11,688) $ (9,490) $ (9,052) $ (7,965)
======== ======== ======== ======== ========
Basic and diluted net loss per share(2) ...... $ (.69) $ (.97) $ (1.32) $ (1.57) $ (2.02)
======== ======== ======== ======== ========
Shares used in computing basic and diluted
net loss per share(2) ...................... 13,603 12,071 7,215 5,751 3,934
======== ======== ======== ======== ========
</TABLE>
17
<PAGE> 18
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996 1995 1994 1993
--------- --------- ---------- ---------- --------
CONSOLIDATED BALANCE SHEETS DATA: (in thousands)
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and short-term investments...... $ 19,427 $ 27,443 $ 1,161 $ 516 $ 366
Working capital........................................ 12,791 22,482 (2,345) (721) (546)
Total assets........................................... 25,119 30,513 2,746 1,882 3,045
Notes payable, obligations under capital
leases, less current portion......................... 1,589 633 470 647 1,037
Series One Redeemable Preferred Stock.................. -- -- 2,772 2,604 2,436
Accumulated deficit.................................... (55,629) (46,257) (34,522) (24,865) (15,645)
Total stockholders' equity (deficit)................... 16,218 24,156 (4,375) (2,799) (2,139)
</TABLE>
- ----------
(1) The 1994 and a portion of the 1995 results do not include revenues from the
Company's former subsidiary, MPS, as substantially all of MPS's assets were
transferred to a separate entity, Chiron Mimotopes Peptide Systems, LLC, as
of January 1, 1994; however, the separate entity was dissolved and certain
assets were transferred to MPS beginning April 1, 1995. The 1997 results
reflect MPS operations through February 1997 after which time MPS was sold.
See "Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations" below.
(2) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of basic and diluted net loss per share.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS
DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K ARE FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES (SUCH FORWARD-LOOKING STATEMENTS INCLUDE,
WITHOUT LIMITATION, STATEMENTS USING WORDS SUCH AS "MAY," "POTENTIAL,"
"EXPECTS," "BELIEVES," "ESTIMATES," "PLANS," "INTENDS," "ANTICIPATES" AND
SIMILAR EXPRESSIONS). THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND
UNCERTAINTIES, INCLUDING THOSE SET FORTH BELOW AND IN ITEM 1 OF THIS ANNUAL
REPORT ON FORM 10-K UNDER THE CAPTION "RISK FACTORS," THAT COULD CAUSE ACTUAL
RESULTS TO VARY MATERIALLY FROM THOSE PROJECTED. THESE FORWARD-LOOKING
STATEMENTS SPEAK ONLY AS OF THE DATE HEREOF. THE COMPANY EXPRESSLY DISCLAIMS ANY
OBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANY
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO REFLECT ANY CHANGE IN THE
COMPANY'S EXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN EVENTS, CONDITIONS
OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.
THE FOLLOWING DISCUSSION AND ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION
AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH "ITEM 6 - SELECTED
FINANCIAL DATA" AND THE CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY (AND
NOTES THERETO) CONTAINED ELSEWHERE HEREIN.
OVERVIEW
Trega Biosciences, Inc. (the "Company" or "Trega") is a drug discovery
company pursuing the identification and early-stage development of novel,
small-molecule drug therapies through combinatorial chemistry and other drug
discovery technologies. The Company has devoted substantially all of its
resources since its founding to developing methods to synthesize and screen
large libraries of chemicals for new drug discovery and optimization, to
developing a select number of chemical compounds as potential pharmaceutical
products, and to acquiring or developing technologies with the potential to
expand the methods available to generate drug candidates.
The Company leverages its technology platform by entering into
pharmaceutical alliances, providing partners access to the Company's
technologies in exchange for licensing fees and potential milestone payments and
royalties, or by establishing joint-discovery alliances with biotechnology
companies. The timing and amounts of revenues from such alliances, if any, are
subject to significant fluctuations and therefore the Company's results of
operations for any period may not be comparable to the results of operations for
any other period and may not be indicative of future operating results. The
Company will be required to conduct significant research, development and
production activities during the next several years to fulfill its obligations
to corporate partners
18
<PAGE> 19
and for the development of its own compounds. The Company has been unprofitable
since its inception and the Company is unable to predict when, if ever, it will
become profitable. As of December 31, 1997, the Company's accumulated deficit
was approximately $55,629,000.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The Company recorded revenues of approximately $7,764,000, $8,257,000 and
$1,370,000 in 1997, 1996 and 1995, respectively. Revenues for 1997 include
$7,246,000 derived from shipments of combinatorial libraries or individual
compounds along with research conducted under collaborative research agreements.
An additional $88,000 in contract research revenues reported in 1997 were
derived from grant revenues. Revenues from collaborative research agreements
account for approximately $2,381,000 in 1996 and $293,000 in 1995. Increases
over the three years are primarily attributable to increased activity through
research collaborations and the recognition of a $2,000,000 up-front license fee
in 1997. The Company believes that maintenance of, or growth from, its level of
revenues in 1997 will require the Company to enter into additional collaborative
research agreements or to expand existing agreements. Contract research revenues
for 1996 also include $3,369,000 resulting from the receipt, by the Company's
former subsidiary, Multiple Peptide Systems, Inc. ("MPS"), of 275,000 shares of
Magainin Pharmaceuticals, Inc. ("Magainin") common stock in exchange for a
royalty interest in Magainin's lead compound, MSI-78. Net sales in 1997 of
$430,000 were derived from the sale of custom peptides and combinatorial peptide
libraries by MPS and are confined to the first two months of the year, after
which time MPS was sold. MPS sales for 1996 and 1995 were approximately
$2,507,000 and $1,077,000, respectively (reflecting an entire year for 1996 and
only nine months in 1995, beginning April 1, 1995, when Chiron Mimotopes Peptide
Systems, LLC ("CMPS"), a limited liability company formed by the Company and
Chiron Corporation in 1994 was dissolved and certain assets were transferred to
MPS.) (See Note 8 of Notes to the Company's Consolidated Financial Statements
included elsewhere herein.)
As of December 31, 1997, the Company's financial statements reflect a
liability for deferred revenue in the amount of approximately $3,002,000. This
represents the excess of payments received from research collaborators over the
revenue from libraries shipped or work performed. (See Note 6 of Notes to the
Company's Consolidated Financial Statements included elsewhere herein.)
Cost of sales were approximately $341,000, $2,025,000 and $1,313,000 in
1997, 1996 and 1995, respectively, and relate primarily to sales made by MPS.
The decrease in cost of sales from 1996 to 1997 is a result of the sale of MPS
on February 28, 1997. The sale of MPS also resulted in accounts receivable
decreasing from approximately $481,000 in 1996 to $2,000 in 1997, as reflected
in accounts receivable and other current assets on the Company's Consolidated
Balance Sheets. The increase in cost of sales in 1996 compared to 1995 is
attributable to an overall increase in sales volume along with a full year of
operations for MPS in 1996 (accounting for costs of approximately $1,917,000),
whereas operations for 1995 (accounting for costs of approximately $1,150,000)
commenced in April.
The Company incurred research and development expenses totaling
approximately $14,819,000, $11,781,000 and $7,289,000 in 1997, 1996 and 1995,
respectively. Increased spending in research and development in 1997, compared
to 1996 and 1995, resulted primarily from increased funding for (i) the
Company's combinatorial chemistry program, largely reflecting a shift in the
Company's combinatorial chemistry from mixture-based libraries to libraries
formatted in single-based compound arrays, (ii) the Company's automation and
robotics synthesis program, (iii) the Company's melanocortin program, and (iv)
the Company's combinatorial biology technology program (conducted through its
subsidiary, ChromaXome Corporation ("ChromaXome"), acquired in August 1996). The
increased spending for the combinatorial chemistry program was partially offset
by reduced spending under arrangements with Torrey Pines Institute for Molecular
Studies ("TPIMS"). Funding to TPIMS was $1,751,000, $2,522,000 and $2,434,000 in
1997, 1996 and 1995, respectively. Research and development expenses for 1997
and 1996 include $1,439,000 and $1,785,000, respectively, for the Company's
collaboration with Dura Pharmaceuticals, Inc. ("Dura") to evaluate delivery of
the Company's lead compound, HP 228, in Dura's dry powder inhalation system.
This collaboration was initiated in February 1996 and is a related party
transaction. The Company expects to incur continued and substantial increases in
research and development expenses relating to combinatorial chemistry,
melanocortin biology, product development and clinical trials, as well as for
the development of combinatorial biology technologies (through ChromaXome) and
the development of other drug discovery technologies.
In connection with the acquisition of ChromaXome, in August 1996 the Company
recorded an expense of $2,585,000 related to acquired in-process research and
development, including $1,281,000 relating to the achievement of certain
milestones by the business of ChromaXome. (See Note 3 of Notes to the Company's
Consolidated Financial Statements included elsewhere herein.)
19
<PAGE> 20
The Company's selling, general and administrative expenses total
approximately $4,346,000, $4,191,000 and $2,722,000 for the years ended December
31, 1997, 1996 and 1995, respectively. These expenses include administrative
salaries and legal, finance, investor relations and corporate development
activities. Increases in selling, general and administrative expenses are
primarily attributable to higher legal costs incurred for corporate development
activities and litigation, amortization of deferred compensation and costs
associated with being a public company. Selling, general and administrative
expenses are expected to increase as the Company's research activities increase.
In 1996, the Company recognized a loss on investment of $534,000 related to
the sale of 225,000 shares of Magainin common stock. In 1997, the Company
recognized a loss on investment of $88,000 related to the sale of the remainder
of shares of Magainin common stock it was holding. (See Note 7 of Notes to the
Company's Consolidated Financial Statements included elsewhere herein.)
The Company's interest income increased to approximately $1,405,000 for the
year ended December 31, 1997 compared to $1,274,000 and $136,000 for 1996 and
1995, respectively. The increases in 1997 and 1996 over 1995 result from higher
cash balances generated by revenues received from collaboration arrangements
(particularly in 1997) and by the sale of the Company's securities (including
the Company's initial public offering in March 1996).
The Company incurred interest expense totaling approximately $202,000,
$103,000 and $86,000 in the years ending December 31, 1997, 1996 and 1995,
respectively. Interest expense has increased as the Company utilized capital
lease and equipment notes payable in order to fund the acquisition of certain
capital assets, primarily laboratory equipment.
In 1997, the Company recorded a gain of $1,255,000 in connection with the
sale of MPS on February 28, 1997. (See Note 2 of Notes to the Company's
Consolidated Financial Statements.)
In 1995, the Company recorded other income of $414,000 from the return of
certain assets in connection with the dissolution of CMPS. (See Note 8 of Notes
to the Company's Consolidated Financial Statements.)
As of December 31, 1997, the Company had federal and California income tax
net operating loss carryforwards of approximately $45,091,000 and $9,460,000,
which will begin to expire in 2007 and 1998, respectively, unless previously
utilized. The Company also has federal and California research and development
tax credit carryforwards of $2,168,000 and $1,040,000, respectively, which will
begin to expire in 2007 unless previously utilized. Pursuant to Internal Revenue
Code Sections 382 and 383, use of the Company's net operating loss and tax
credit carryforwards may be limited due to a cumulative change in ownership of
more than 50% within a three-year period, which occurred in April 1996. However,
the Company's management does not anticipate that such limitation would
materially affect the Company's ability to utilize the net operating loss and
tax credit carryforwards. (See Note 11 of Notes to the Company's Consolidated
Financial Statements included elsewhere herein.)
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company had cash, cash equivalents and
short-term investments totaling approximately $19,427,000 compared with
$27,443,000 at December 31, 1996 and $1,161,000 at December 31, 1995.
In September 1997, the Company entered into a 10-year lease covering a
facility located in San Diego, California, not far from its existing
headquarters. Management expects to relocate its entire headquarters and all
operations in the second quarter of 1998. This building, constructed in 1980, is
71,625 square feet (including approximately 55,000 square feet of laboratory and
office space as compared to approximately 28,000 square feet at the Company's
existing headquarters). The annual rent is $1,685,000 and is subject to a 3.5%
annual escalation clause. The landlord has agreed to fund up to a specified
amount of tenant improvements for construction, project management, space
planning, architect and engineering fees and other related costs on behalf of
the Company. The Company believes that the amount of tenant improvements
absorbed by the landlord is adequate to complete necessary modifications to the
building. However, the Company expects to incur approximately $700,000 to
furnish and equip the new facility. (See Note 4 of Notes to the Company's
Consolidated Financial Statements.)
In July 1997, the Company was notified of approval for a $3,000,000
equipment financing line for the financing of the majority of its equipment
needs. The Company intends to use this financing source through mid-1998. The
Company has granted all rights, title and security interest in the equipment
acquired through this financing source, as set forth on periodic equipment
schedules, to the secured party. The terms of the Company's loan agreement,
which became effective in September 1997, call for amounts drawn down under the
loan to be repaid monthly over a four-year term. As of December 31, 1997, the
Company had drawn down approximately $1,582,000 against this equipment financing
line. (See Note 4 of Notes to the Company's Consolidated Financial Statements.)
20
<PAGE> 21
In June 1997, the Company entered into a Research and Development Agreement
with Ono Pharmaceutical Co., Ltd. ("Ono") whereby the Company received
$2,000,000 as a license fee in connection with the screening by the Company of
certain of its combinatorial libraries against certain of its biological
screens. The Company also received $2,000,000 in July 1997 for work to be done
during the first 12 months under the agreement and, subject to Ono's right of
early termination, will receive an additional $2,000,000 in July 1998 for
further research during an additional 12-month period. The research related
payments are treated as deferred revenue and recognized as revenues as related
work is performed under the contract. The non-refundable license fee was
recognized as revenue in 1997. (See Note 6 of Notes to the Company's
Consolidated Financial Statements.)
In June 1997, the Company entered into an arrangement with Northwest
Neurologic, Inc. ("NNL") whereby the Company received a non-exclusive license to
patents covering certain melanocortin receptors. In return, NNL received
non-exclusive access to a limited number of the Company's combinatorial
libraries and a $300,000 license fee, of which $175,000 was paid in June 1997
with the remaining $125,000 due to NNL in May 1998.
Pursuant to the Restated and Third Amended Research and Option Agreement
entered into with TPIMS on April 15, 1997, the Company is committed to spend
$1,631,000, due in quarterly installments, for the twelve-month period
commencing April 15, 1997, of which $1,245,000 has been paid through December
31, 1997. The Company is obligated to fund research through July 14, 1998 (at a
cost of approximately $463,000 for the period from April 15, 1998 to July 14,
1998) and has agreed to pay TPIMS the amount of $1,300,000 plus applicable
interest (10% per annum) under the terms of the Restated Agreement, in
connection with the acquisition of certain technology and the elimination of
related royalties. This payment becomes due April 14, 1998. (See Note 5 of Notes
to the Company's Consolidated Financial Statements.)
In connection with the Company's research agreement with Dura, the Company
is committed to fund $6,000,000 over four years in a drug discovery and
development collaboration using Dura's proprietary drug delivery technology and
Company compounds(such as HP 228). As of December 31, 1997, $3,154,000 had been
funded under the Dura agreement.
Pursuant to a drug discovery collaboration with Novo Nordisk A/S, the
Company received $2,000,000 in February 1996 as an advance payment of library
access fees and received an additional $2,000,000 in February 1997. Payments
have been treated as deferred revenue and are recognized as revenue as libraries
are shipped.
Effective December 31, 1996, the Company entered into a drug discovery
collaboration and license agreement with Chugai Biopharmaceuticals, Inc.
("Chugai"). Under the terms of the agreement, the Company received, as an
advance towards future library access charges, up-front payments in January and
December 1997 of $1,250,000 and $1,000,000, respectively.
During 1997, the Company used approximately $9,072,000 of cash to fund
operations. The Company's future cash requirements will depend on many factors,
including continued scientific progress in its research and development
programs, the acquisition or initiation of new research and development
programs, the costs involved in filing, prosecuting and enforcing patents,
competing technological and market developments, and the scope and results of
clinical trials. It is probable, however, that for the foreseeable future, the
Company's cash requirements will exceed its revenues. The Company expects that
its primary potential revenue source for the foreseeable future will be
additional collaborative agreements. The Company intends to seek additional
funding through additional research and development agreements with suitable
corporate collaborators, extensions of existing corporate collaborations, and
through public or private financings if available and consistent with the
Company's business objectives. There can be no assurances, however, that such
collaboration arrangements, or any public or private financings, will be
available on acceptable terms, if at all. If funds are raised through equity
arrangements, further dilution to stockholders may result. If adequate funds are
not available, the Company may be required to delay, reduce the scope of, or
eliminate one or more of its research or development programs or take other
measures to cut costs, which could have a material adverse effect on the
Company.
The Company estimates that its existing capital resources, together with
facility and equipment financing, will be sufficient to fund its current and
planned operations for at least the next 12 months. There can be no assurance,
however, that changes in the Company's research and development plans or other
changes affecting the Company's operating expenses will not result in the
expenditure of such resources before such time. In any event, the Company will
need to raise substantial additional capital to fund its operations in future
periods.
21
<PAGE> 22
OTHER MATTERS
Impact of Year 2000
The Year 2000 will impact computer programs written using two digits rather
than four to define the applicable year. Any programs with time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operation (including a temporary inability to process
transactions, send invoices or engage in other ordinary activities). This
problem largely affects software programs written years ago, before the issue
came to prominence.
The Company is presently reviewing all of its software for exposure to the
Year 2000 issue, including network and workstation software, and does not
believe that it has significant associated risk. The Company primarily uses
third-party software programs written and updated by outside firms. Currently a
plan is being put into place to request certification from each company that its
software is Year 2000 compliant. To assure that all software programs can
successfully work in conjunction with each other after 1999, the Company plans
to test all of its software during 1998 using a combination of past and future
dates. Although no problems are expected to result from these tests, the Company
expects that any problems would be corrected before the end of 1998. The cost of
modifying or replacing software to bring the Company into compliance, if
necessary, is not expected to be material.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Company's Consolidated Financial Statements (and
notes thereto) and supplementary data required by this item and set forth at the
pages indicated in Item 14(a) of this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors.
The Company has three classes of Directors (designated Class I, Class II
and Class III) serving staggered three-year terms. Class I, II and III Directors
have terms expiring at the time of the Annual Meetings of Stockholders to be
held in 1998, 1999 and 2000, respectively, or until each such Director's
successor shall have been elected and qualified.
Set forth below is information regarding the Directors as to their
principal occupations at present and for the past five years, certain
directorships held by each and their ages as of March 1, 1998.
<TABLE>
<CAPTION>
Name Age
- ---- ---
CLASS I
<S> <C>
Cam L. Garner......................................................................................... 49
Mr. Garner has served as a Director of the Company since May 1995. Since
1990, he has been President and Chief Executive Officer and a Director
of Dura, a pharmaceutical marketing company and developer of pulmonary
drug delivery technology, and in January 1996 he was elected Chairman of
the Board of Dura. Prior to joining Dura, Mr. Garner served as President
of Syntro Corp. Earlier positions included serving as Senior Vice
President of Sales and Marketing for Hybritech, Inc., a division of Eli
Lilly & Co., and acting in several management positions at Corning Glass
Works and its subsidiary, Gilford, Inc. Mr. Garner is on the Board of
Directors of Cardio Dynamics International, Nanogen, Inc., Safeskin
Corporation, and Spiros Development Corporation II, Inc. ("Spiros
Corp."). Mr. Garner earned an M.B.A. from Baldwin-Wallace College and a
B.A. in Biology from Virginia Wesleyan College.
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C>
Harvey S. Sadow, Ph.D....................................................................... 75
Dr. Sadow has served as a Director of the Company since October 1992.
From January 1988 through December 1990, Dr. Sadow served as Chairman of
the Board of Boehringer Ingelheim Corporation and Boehringer Ingelheim
Pharmaceuticals, Inc. Dr. Sadow served as the President and Chief
Executive Officer of Boehringer Ingelheim Corporation until his
retirement in January 1988. Dr. Sadow serves as the Chairman of the
Board of Cortex Pharmaceuticals, Inc. and Cholestech Corp., and is a
Director of Anika Therapeutics, Inc. and Penederm Corporation. Dr. Sadow
received a B.S. from the Virginia Military Institute, an M.S. from the
University of Kansas and a Ph.D. from the University of Connecticut.
Robert S. Whitehead......................................................................... 47
Mr. Whitehead has served as President and Chief Executive Officer of the
Company and as a Director of the Company since August 1993. Mr.
Whitehead was also appointed the Company's acting Chief Financial
Officer and Chairman of the Board of Directors in February 1998. Prior
to joining the Company, Mr. Whitehead was Senior Vice President,
Commercial Operations, Solvay Pharmaceuticals ("Solvay") from February
1992 to April 1993. Before joining Solvay, Mr. Whitehead worked at
Searle Pharmaceuticals where, over 13 years, he held such positions as
President and General Manager, Searle Canada, from March 1989 to
February 1992; Vice President, International Marketing Operations,
Director of Marketing, Europe; and Vice President, Sales and Marketing,
Searle de Mexico. Mr. Whitehead is on the Board of Directors of Spiros
Corp. Mr. Whitehead graduated from Temple University with a degree in
pre-medicine.
CLASS II
Jeremy M. Levin, Ph.D....................................................................... 44
Dr. Levin was the Chief Executive Officer, President and Chairman of the
Board of Directors of Cadus Pharmaceutical Corporation ("Cadus") from
December 1992 until January 1998. Dr. Levin joined Cadus in December
1992 as its Chief Executive Officer and became a Director in January
1993. In May 1995, Dr. Levin became a Co-Chairman of the Board of
Directors and in May 1996, Dr. Levin became the Chairman of the Board of
Directors of Cadus. From December 1990 to December 1992, Dr. Levin was
Vice President of Corporate Development for Genzyme Corporation's
majority-owned subsidiary, IG Laboratories, Inc., a public laboratory
testing company. Prior to that time, Dr. Levin served in a number of
positions at biotechnology companies and at major teaching hospitals in
Europe. Dr. Levin is a member of the Board of Directors of Physiome
Sciences, Inc., a private biotechnology company, and Cadus, a member of
the Board and Executive Committee of the New York Biotechnology
Association and a member of the Emerging Companies Section of the
Biotechnology Industry Organization. Dr. Levin received a D.Phil. in
Molecular Biology from the University of Oxford and an MB.BCHIR from the
University of Cambridge.
Lawrence D. Muschek, Ph.D................................................................... 54
Dr. Muschek has served as President, Research and Development of the
Company and as a Director of the Company since October 1997. Prior to
joining the Company, Dr. Muschek worked for Solvay as Senior Vice
President, Research and Development worldwide from April 1994 to
September 1997 and Senior Vice President, Research & Development, United
States from March 1990 to April 1994. Before joining Solvay, Dr. Muschek
worked as the Vice President, Research for Ayerst Laboratories Research,
Inc. and spent 18 years at McNeil Pharmaceuticals, Inc., a Johnson &
Johnson affiliate company, where he held positions of increasing
responsibility in pharmaceutical research and development. Dr. Muschek
received a B.S. in Chemistry from the Philadelphia College of Pharmacy
and Science and a Ph.D. in Biochemistry from Michigan State University.
Anders Wiklund.............................................................................. 57
Mr. Wiklund has been an advisor to the biotechnology and pharmaceutical
industries since January of 1997 when he formed Wiklund International
Inc. In 1997, Mr. Wiklund was appointed Senior Vice President of Biacore
Holding, Inc., a supplier of analytical instruments to the life sciences
industry. Between 1993 and 1996, Mr. Wiklund served as President of
Pharmacia Development Corporation, as Executive Vice President of
</TABLE>
23
<PAGE> 24
<TABLE>
<S> <C>
Pharmacia U.S. Inc. and as Vice President, Pharmacia & Upjohn. Prior to
1993, Mr. Wiklund held a series of executive management positions within
the Pharmacia group, including President and CEO of Kabi Vitrum Inc. and
Kabi Pharmacia Inc. Mr. Wiklund is on the Board of Directors of InSite
Vision, Inc., Ribozyme Pharmaceuticals, Inc., Medivir AB and Vascular
Therapeutics, Inc., a private biotechnology company. Mr. Wiklund
graduated from the Pharmaceutical Institute in Stockholm where he
received a Master of Pharmacy degree.
CLASS III
James C. Blair, Ph.D........................................................................ 58
Dr. Blair has served as Chairman of the Board of Directors of the
Company from September 1992 through January 1998, and as a Director
since May 1992. Dr. Blair has been a general partner of Domain
Associates, a venture capital management company, since 1985. Domain
Associates manages Domain Partners, L.P., Domain Partners II, L.P.,
Domain Partners III, L.P. and DP III Associates, L.P., and is the
venture capital advisor to Biotechnology Investments Limited. Dr. Blair
is on the Boards of Directors of Amylin Pharmaceuticals, Inc., Aurora
Biosciences, Inc., CoCensys, Inc., Dura, Gensia Sicor, Inc. ("Gensia"),
and Vista Medical Technologies, Inc. Dr. Blair received a B.S.E. from
Princeton University and an M.S.E. and Ph.D. from the University of
Pennsylvania, all in electronic engineering.
Harry D. Lambert............................................................................ 58
Mr. Lambert has served as a Director of the Company since April 1994. He
has been a partner of InnoCal Associates, L.P., a venture capital
company, since June 1993. Prior to joining InnoCal, Mr. Lambert was a
partner of the Edison Venture Fund from January 1991 to June 1993. He is
a former Group Vice President of Phelps Dodge International Company. Mr.
Lambert is on the Boards of Directors of several private companies. Mr.
Lambert received his B.S. from the U.S. Military Academy at West Point,
and is a graduate of the Columbia University Graduate School of Business
Administration Executive Program and the Harvard Graduate School of
Business Administration Advanced Management Program.
Ronald R. Tuttle, Ph.D...................................................................... 61
Dr. Tuttle has served as a Director of the Company since May 1992. He
served as the Company's Executive Vice President, Research and
Development, from January 1992 to January 1996 and as Chief Scientific
Officer from January 1996 to December 1996. Dr. Tuttle was Vice
President, New Drug Discovery at Gensia from 1987 to 1992 and is the
inventor of the pharmacological cardiac stress testing system marketed
by that company. Prior to joining Gensia, Dr. Tuttle served as the Vice
President, New Drug Development at Key Pharmaceuticals, Inc. Dr. Tuttle
spent 13 years at Eli Lilly & Co., where he invented and led the
development of dobutamine (Dobutrex(E)). Dr. Tuttle received his Ph.D.
in Pharmacology from the University of Manitoba, Canada.
</TABLE>
(b) Identification of Executive Officers.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company as of March 20, 1998 are as follows:
ROBERT S. WHITEHEAD, Chairman of the Board, Chief Executive Officer,
President and Acting Chief Financial Officer (see information above in Item 10
(a)).
LAWRENCE D. MUSCHEK, Ph.D., President, Research and Development, and
Director (see information above in Item 10 (a)).
MICHAEL J. GREEN, PH.D., age 55, has served as Vice President, Chemistry
since February 1996. He is responsible for all Company activities in
combinatorial and medicinal chemistry programs. Before joining the Company, Dr.
Green held positions with Schering-Plough Research Institute, culminating with
his position as a director of chemistry (first in the anti-allergy and
anti-inflammatory, and then in the cardiovascular and central nervous system
therapy areas). During his 24 years at Schering-Plough, Dr. Green discovered the
topical anti-inflammatory corticosteroid, alclometasone dipropionate
(Legerderm(R) and Aclovate(R)) and was
24
<PAGE> 25
part of the team that discovered the non-sedating antihistamine, loratadine
(Claritin(R)), and also led the discovery efforts of several compounds that were
tested clinically in asthma and psoriasis. Dr. Green received his Ph.D. in
Organic Chemistry from The University of Sheffield, United Kingdom.
SUSAN M. HANAN, age 51, was appointed Vice President of Organizational and
Strategic Development in February 1998, a role she managed since joining the
Company in 1997. Prior to joining the Company in 1997, Ms. Hanan was an
independent consultant with ChangeNet - The Business Transformation Group, from
1994 to 1997, and Megaworx, from 1984 to 1997, where she consulted in the areas
of business management and operations. Ms. Hanan spent twelve years at Loyola
Marymount University as Dean of Student Affairs from 1973 to 1982 and as
Academic Dean of Marymount College from 1970 to 1973. Ms. Hanan received an MS
in Higher Education from California State University, Long Beach and a BA in
Psychology from Mount Saint Mary's College, Los Angeles.
(c) Section 16(a) Beneficial Ownership Reporting Compliance.
Under the securities laws of the United States, the Company's Directors,
executive officers and any persons holding more than 10% of the issued and
outstanding Common Stock are required to report their initial ownership of
Common Stock, any subsequent changes in that ownership and, in certain
instances, an annual statement of changes in ownership to the Securities and
Exchange Commission. Specific due dates for these reports have been established
and the Company is required to identify in this Annual Report on Form 10-K those
persons who failed to file these reports in a timely manner. In making this
disclosure the Company has relied solely upon the written representations of its
Directors and executive officers and copies of the reports that have been filed
with the SEC. Based upon the Company's review of such representations and
reports, the Company believes that all such reports were filed on a timely basis
for the year ended December 31, 1997.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF DIRECTORS
Directors who are employees of the Company do not receive any fees for
service on the Board of Directors. The Company's non-employee Directors receive
an initial grant of a non-qualified option to purchase 10,000 shares of Common
Stock (an "Initial Option") and a yearly grant (following each Annual Meeting of
Stockholders) of a non-qualified option to purchase 3,500 shares of Common Stock
(an "Annual Option"). The exercise price for each Initial Option and Annual
Option is equal to the fair market value of Common Stock on the date of grant.
Initial Options become exercisable in 12 equal installments at three-month
intervals over the 36-month period commencing on the date of grant. Annual
Options vest in full on the earlier of the first anniversary of the date of
grant or the date of the next Annual Meeting of Stockholders. Directors may also
be reimbursed for certain expenses in connection with attendance at meetings of
the Company's Board of Directors and its committees.
25
<PAGE> 26
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table summarizes all compensation paid in the fiscal years
ended December 31, 1997, 1996 and 1995 to (i) the Company's Chief Executive
Officer and (ii) certain of the Company's other most highly compensated
executive officers during 1997.
<TABLE>
<CAPTION>
LongTerm
Compensation
Awards
Annual Compensation Number of
------------------------------------------ Securities
Other Annual Underlying All Other
Name and Principal Position Year Salary (1) Bonus Compensation Options(#) (2) Compensation (3)
- --------------------------- --------- -------------- ----------- -------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Robert S. Whitehead 1997 $ 290,625 $62,550 $ 31,250 (4) - 2,000
President and Chief Executive Officer 1996 254,167 24,300 25,000 (4) 151,627 1,333
1995 225,000 - 25,000 (4) - 2,000
Lawrence D. Muschek (5) 1997 52,083 - - 200,000 20,841
President, Research and Development 1996 - - - - -
1995 - - - - -
Michael J. Green 1997 175,000 96,837 - 25,000 13,820
Vice President, Chemistry 1996 141,288 - - 30,232 38,080
1995 - - - - -
Bernard D. King (6) 1997 164,180 39,750 - - 10,395
Executive Vice President, Biological 1996 195,000 - - 62,557 2,000
Sciences and Development 1995 179,500 - - 58,139 2,000
Terence E. McMorrow (7) 1997 83,542 36,750 - - 107,140
Vice President, Finance and 1996 145,000 27,000 - 33,069 31,640
Corporate Development, and Secretary 1995 145,000 - - - 2,000
</TABLE>
- ----------------
(1) Includes amounts deferred pursuant to the Company's 401(k) Plan.
(2) In January 1996, the unvested portions of certain options granted under the
Company's Amended and Restated 1992 Stock Plan for certain Company executive
officers were canceled and options exercisable for share amounts equivalent
to such canceled portions were granted under the Company's 1995 Stock Plan
to such executives (the "Regranted Options"). Although the exercise price of
the Regranted Options ($2.15 per share of Common Stock) represented an
increase over the exercise prices of the canceled options (ranging from
$.7525 to $1.075 per share of Common Stock), the Company agreed to
distribute to each executive, at the time of any exercise of a Regranted
Option, an amount equal to the increase in exercise price incurred. The
Regranted Options retain the vesting schedule of the canceled options. The
Regranted Options include options to acquire 45,348 shares, 26,093 shares
and 58,604 shares for Dr. King, Mr. McMorrow and Mr. Whitehead,
respectively.
(3) Includes reimbursement for relocation expenses paid to Dr. Muschek ($20,841
in 1997), Dr. Green ($11,820 in 1997 and $36,080 in 1996) and Mr. McMorrow
($12,453 in 1997 and $29,640 in 1996); compensation to Mr. McMorrow ($28,049
in 1997) for the exercise of Regranted Options; compensation to Mr. McMorrow
($44,923 in 1997) pursuant to a consulting arrangement implemented following
his resignation from the Company on June 30, 1997; as well as amount paid in
1997 to Dr. King and Mr. McMorrow for earned vacation in connection with
their resignations from the Company on October 24, 1997 and June 30, 1997
($8,395 for Dr. King and $20,631 for Mr. McMorrow). The balance of these
amounts reflects the Company's matching contributions pursuant to the
Company's 401(k) plan.
(4) In 1994, the Company loaned Mr. Whitehead $100,000, which is evidenced by a
promissory note. The loan bears simple interest at prime rate plus 1% per
annum, with interest payable quarterly. The original principal amount of the
loan is forgiven at a rate of 25% per year on the anniversary date of the
note. In 1997, the Company loaned Mr. Whitehead an additional $100,000 which
is evidenced by a promissory note having the same terms as the first loan.
Amounts reflected represent the recognition of compensation for the
forgiveness of principal on the loans.
(5) Dr. Muschek joined the Company on October 6, 1997. In 1997, the Company
loaned Dr. Muschek $75,000, which was evidenced by a promissory note. The
loan was repaid in full, in the third quarter 1997, with interest at the
prime rate plus 1% per annum.
(6) Dr. King resigned from his position with the Company on October 24, 1997.
26
<PAGE> 27
(7) Mr. McMorrow resigned from his position with the Company on June 30, 1997.
Stock Options
The following tables set forth certain information as of December 31, 1997
and for the fiscal year then ended with respect to options to acquire Common
Stock granted to and exercised by the individuals named in the Summary
Compensation Table above. No stock appreciation rights have been granted to
date.
<TABLE>
<CAPTION>
Individual Grants
-------------------------------------------------------------------
Potential Realizable
Value at Assumed
Number of Percentage of Annual Rates of Stock
Securities Total Options Price Appreciation
Underlying Granted to Exercise for Option Term (5)
Options Employees in Price Expiration -----------------------------
Name Granted (#) Fiscal Year ($/Sh) (3) Date (4) 5% ($) 10% ($)
---- --------------- ------------------ ------------ ----------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Lawrence D. Muschek 200,000 (1) 32.5% $ 4.63 10/6/07 $ 302,089 $ 1,506,634
Michael J. Green 25,000 (2) 4.1 4.38 4/25/07 68,785 174,316
</TABLE>
- ---------------
(1) The options granted to Dr. Muschek are subject to the following vesting
schedule: (i) 10% of the shares subject to the option vest three months
following the date of grant; and (ii) 6% of the shares subject to the option
vest at the end of each successive three-month period following the vesting
of the initial 10% (thus permitting 100% vesting over the course of 48
months); provided that these options, subject to certain conditions,
immediately vest upon a merger, reorganization or other change in control of
the Company.
(2) The options granted to Dr. Green are subject to the following vesting
schedule: (i) 4% of the shares subject to the option immediately vest upon
grant; and (ii) 6% of the shares subject to the option vest at the end of
each successive three-month period following the date of the grant (thus
permitting 100% vesting over the course of 48 months); provided that these
immediately vest upon a merger, reorganization or other change in control of
the Company.
(3) The exercise price on the date of grant was equal to 100% of the per share
fair market value of Common Stock on the date of grant.
(4) The options have a term of 10 years, subject to earlier termination in
certain events related to termination of employment.
(5) The 5% and 10% assumed annual rates of compounded stock price appreciation
are suggested by rules of the Securities and Exchange Commission and do not
represent Company estimates or projections regarding the future price of
Common Stock. There can be no assurance provided to any executive officer or
any other holder of the Company's securities that actual stock price
movement over the 10-year option term will be at the assumed 5% and 10%
levels of appreciation, or any other defined level.
27
<PAGE> 28
Aggregate Option Exercises in 1997
and 1997 Year-End Option Values
<TABLE>
<CAPTION>
Number of Value of
Securities Underlying Unexercised
Shares Unexercised Options in-the-Money Options
Acquired at December 31, 1997(#) at December 31, 1997(1)
on Value ------------------------------------ ------------------------------------
Name Exercise(#) Realized Exercisable Unexercisable Exercisable Unexercisable
- ---- --------------- ---------------- ------------- ----------------- ------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Robert S. Whitehead - $ - 182,325 50,232 $ 347,843 $ 64,674
Lawrence D. Muschek - - - 200,000 - -
Michael J. Green - - 17,907 37,325 17,905 21,018
Bernard D. King - - 44,092 - 70,519 -
Terence E. McMorrow 46,510 94,379 (2) - - - -
</TABLE>
- ------------
(1) Calculated on the basis of (i) the fair market value of Common Stock at
December 31, 1997 ($3.4375 per share) minus (ii) the exercise price.
(2) Calculated on the basis of (i) the fair market value of Common Stock at
September 25, 1997 ($3.875 per share) minus (ii) the exercise price
Executive Employment Agreement and Termination of Employment and Change in
Control Arrangements
Pursuant to the terms of an Executive Employment Agreement dated August 16,
1993 between the Company and Robert S. Whitehead, the Company agreed to retain
Mr. Whitehead as President and Chief Executive Officer of the Company at an
annual salary of $225,000. In May 1997, this amount was increased to $300,000
per year. The Agreement also provides that Mr. Whitehead is entitled to a
continuation of 75% of his base salary for up to 180 days if he is terminated
without cause. In connection with the Agreement, Mr. Whitehead was granted
options to acquire 139,534 shares of Common Stock at $0.75 per share (vesting
over four years). Of this amount, options to acquire 58,604 shares were canceled
under the original grant and regranted in January 1996, but with an exercise
price of $2.15 per share (although arrangements have been made by the Company to
distribute to Mr. Whitehead an amount equal to the difference in exercise prices
upon any exercise - see "Certain Transactions" below). In March 1994, the
Company also made a loan in the principal amount of $100,000 to Mr. Whitehead.
The principal amount of the loan is being forgiven on a quarterly basis over a
four-year term, which commenced in June 1994. In July 1997, the Company made an
additional loan to Mr. Whitehead in the principal amount of $100,000 with the
same terms as the first loan.
Pursuant to the terms of an Executive Employment Agreement dated October 6,
1997 between the Company and Lawrence D. Muschek, the Company agreed to retain
Dr. Muschek as President, Research & Development of the Company at an annual
salary of $250,000. The Agreement also provides that if Dr. Muschek is
terminated without cause, he is entitled to the balance of his base salary
during the period from the date of termination through October 6, 1999, the end
of the term of the Agreement. In connection with the Agreement, Dr. Muschek was
granted options to acquire 200,000 shares of Common Stock at $4.625 per share
(vesting over four years).
Options granted to officers and Directors of the Company vest fully in the
event the Company is subject to a change in control (as defined in the
respective stock option plans under which such options are granted).
28
<PAGE> 29
Compensation Committee Interlocks and Insider Participation
During 1997, the Compensation Committee consisted of Dr. Blair, Mr. Lambert,
and Mr. Wiklund, each of whom is an outside Director of the Company. None of the
members of the Compensation Committee had any "interlock" relationship to report
during the Company's fiscal year ended December 31, 1997.
29
<PAGE> 30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of March 1, 1998 as to
shares of Common Stock beneficially owned by: (i) each person who is known by
the Company to own beneficially more than 5% of the issued and outstanding
Common Stock; (ii) each of the Company's Directors; (iii) each of the
individuals named in the Summary Compensation Table above; and (iv) all
Directors and executive officers of the Company as a group. Ownership
information is based upon information furnished by the respective individuals or
entities, as the case may be.
<TABLE>
<CAPTION>
Directors, Nominees, Named Executive Percent
Officers, 5% Stockholders, and Directors Shares Beneficially Beneficially
and Executive Officers as a Group Owned (1)(2) Owned (1)(2)
- ------------------------------------------------ ---------------------- -------------------------
<S> <C> <C>
Amerindo Investment Advisors 855,000 6.1%
399 Park Avenue, 18th Floor
New York, New York 10022
Biotechnology Investments Limited 1,386,832 10.0
Post Office Box 58
St. Julian's Court
St. Peter Port
Guernsey, Channel Islands
Domain Partners II, L.P. 1,444,084 10.4
One Palmer Square
Princeton, New Jersey 08542
Domain Partners III, L.P. 1,086,633 7.8
One Palmer Square
Princeton, New Jersey 08542
DP III Associates, L.P. 37,793 *
One Palmer Square
Princeton, New Jersey 08542
Domain Associates 6,966 *
One Palmer Square
Princeton, New Jersey 08542
Dura Pharmaceuticals 775,193 5.6
7474 Lusk Boulevard
San Diego, California 92121
InnoCal, L.P. (3) 654,643 4.7
600 Anton Boulevard
Costa Mesa, California 92626
James C. Blair (4) 3,387,741 24.3
Cam L. Garner (5) 786,924 5.7
Harry D. Lambert (6) 654,643 4.7
Jeremy M. Levin (7) 3,124 *
Lawrence D. Muschek (8) 33,000 *
Harvey S. Sadow (9) 21,015 *
Ronald R. Tuttle (10) 244,938 1.8
Anders Wiklund (11) 3,124 *
Robert S. Whitehead (12) 199,446 1.4
Michael J. Green (13) 24,878 *
Bernard D. King 44,605 *
Terence E. McMorrow 47,672 *
All directors and executive officers as a group (13 persons)(14) 4,679,657 33.9
</TABLE>
------------
* Less than 1%.
(1) Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, the persons named in the table have
sole voting and investment power with respect to all shares of Common
Stock.
30
<PAGE> 31
(2) The number of shares of Common Stock beneficially owned includes the shares
issuable pursuant to stock options that may be exercised within 60 days
after March 1, 1998. Shares issuable pursuant to such options are deemed
outstanding for purposes of computing the percentage of the person holding
such options but are not deemed outstanding for purposes of computing the
percentage of any other person.
(3) Includes 12,642 shares issuable upon exercise of options held by InnoCal,
L.P. that are exercisable within the 60-day period following March 1, 1998.
(4) Includes 7,072 shares issuable upon exercise of options held by Dr. Blair
that are exercisable within the 60-day period following March 1, 1998. Also
includes 1,444,084 shares beneficially owned by Domain Partners II, L.P.,
1,086,633 shares beneficially owned by Domain Partners III, L.P., 37,793
shares beneficially owned by DP III Associates, L.P. and 6,966 shares
beneficially owned by Domain Associates. Dr. Blair is a general partner of
One Palmer Square Associates, II, L.P., which is the general partner of
Domain Partners II, L.P., and he is also a general partner of One Palmer
Square Associates, III, L.P., the general partner of Domain Partners III,
L.P. and DP III Associates, L.P. Dr. Blair has indirect beneficial ownership
of these shares. Dr. Blair is a general partner of Domain Associates. Dr.
Blair disclaims beneficial ownership of shares held by One Palmer Square
Associates, II, L.P. and One Palmer Square Associates, III, L.P. which are
not actually distributed to him. Also includes 775,193 shares beneficially
owned by Dura Pharmaceuticals, Inc. ("Dura"). Dr. Blair is a director of
Dura. Dr. Blair disclaims beneficial ownership of shares held by Dura.
(5) Includes 775,193 shares beneficially owned by Dura. Mr. Garner is President,
Chief Executive Officer and Chairman of the Board of Dura. Mr. Garner
disclaims beneficial ownership of shares held by Dura. Includes 11,173
shares issuable upon exercise of options held by Mr. Garner that are
exercisable within the 60-day period following March 1, 1998.
(6) Includes 642,001 shares beneficially owned by InnoCal, L.P. Mr. Lambert is a
general partner of InnoCal Associates, L.P., the general partner of InnoCal,
L.P. Also includes 12,642 shares issuable upon exercise of options held by
InnoCal, L.P. that are exercisable within the 60-day period following March
1, 1998. Mr. Lambert disclaims beneficial ownership of the shares issued or
issuable to InnoCal, L.P. except to the extent of his pecuniary interest
therein.
(7) Includes 3,124 shares issuable upon exercise of options held by Dr. Levin
that are exercisable within the 60-day period following March 1, 1998.
(8) Includes 32,000 shares issuable upon exercise of options held by Dr. Muschek
that are exercisable within the 60-day period following March 1, 1998.
(9) Includes 9,555 shares issuable upon exercise of options held by Dr. Sadow
that are exercisable within the 60-day period following March 1, 1998.
(10) Includes 31,859 shares issuable upon exercise of options held by Dr. Tuttle
that are exercisable within the 60-day period following March 1, 1998.
(11) Includes 3,124 shares issuable upon exercise of options held by Mr. Wiklund
that are exercisable within the 60-day period following March 1, 1998.
(12) Includes 193,487 shares issuable upon exercise of options held by Mr.
Whitehead that are exercisable within the 60-day period following March 1,
1998.
(13) Includes 22,721 shares issuable upon exercise of options held by Dr. Green
that are exercisable within the 60-day period following March 1, 1998.
(14) Includes 330,497 shares issuable upon exercise of options that are
exercisable within the 60-day period following March 1, 1998. Includes
1,444,084 shares held by Domain Partners II, L.P., 1,086,633 shares held by
Domain Partners III, L.P., 37,793 shares held by DP III Associates, L.P.,
and 6,966 shares held by Domain Associates. See footnote (4). Includes
775,193 shares held by Dura and 654,643 shares held by InnoCal, L.P. See
footnotes (3), (4) and (5).
31
<PAGE> 32
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Jeremy M. Levin, a current member of the Company's Board of Directors,
served as the Chief Executive Officer, President and Chairman of the Board of
Directors of Cadus Pharmaceutical Corporation ("Cadus") from December 1992
through January 1998. The Company and Cadus are parties to a joint discovery
alliance which commenced in January 1995. Pursuant to this arrangement, the
Company is providing Cadus with access to the Company's combinatorial libraries
at no charge in exchange for joint ownership of any resulting discoveries.
During 1997, no amounts were paid either to Cadus from the Company or from Cadus
to the Company pursuant to this or any other relationship between the parties.
The Company's scientific founder and a former member of the Company's Board
of Directors, Richard A. Houghten, is a founder, Director and President of the
Torrey Pines Institute for Molecular Studies ("TPIMS"). Pursuant to a Restated
and Third Amended Research and Option Agreement (the "TPIMS Agreement"), the
Company relied upon TPIMS during 1997, as an independent contractor, for basic
research and laboratory facilities and scientific personnel necessary for the
Company to conduct a portion of its combinatorial chemistry program and
syntheses of iterations and individual compounds. Pursuant to the TPIMS
Agreement, the Company has provided TPIMS with funding totaling approximately
$1,867,066, $2,522,000, $2,434,000, $1,797,000, $1,855,000 and $1,351,000 for
the years ending December 31, 1997, 1996, 1995, 1994, 1993 and 1992,
respectively. However, on January 26, 1998, the Company announced that effective
July 14, 1998, it would discontinue the research and licensing arrangement under
the TPIMS Agreement.
On September 19, 1997, the Company advanced to its President, Research &
Development, Lawrence D. Muschek, Ph.D., a loan in the amount of $75,000.
Interest accumulated on the outstanding principal balance at the rate of 9.5%
per annum from the date of the note until paid in full. The note was due and
payable on November 19, 1997. However, the principal balance of the loan, plus
applicable interest, was paid to the Company in full on November 7, 1997.
On July 3, 1997, the Company advanced to its Chief Executive Officer, Robert
S. Whitehead, a forgivable loan in the amount of $100,000 due on or before June
11, 2001. Interest on the loan, calculated at prime plus 1% in effect from time
to time, is payable quarterly, with the principal balance to be forgiven in
equal quarterly installments of $6,250 until either the loan is forgiven in full
or the total amount of the forgiveness and principal paid in lawful money equals
the original principal amount of the note. The note, to the extent unpaid or
unforgiven, becomes due and payable upon the termination of Mr. Whitehead's
employment. In March 1994, the Company made a similar loan to Mr. Whitehead in
the initial amount of $100,000 with the same terms as the July 1997 note.
On February 28, 1997, the Company sold all of the issued and outstanding
shares (the "Shares") of the capital stock of Multiple Peptide Systems, Inc.
("MPS") to a company ("Newco") owned by Richard A. Houghten. In exchange for the
Shares, the Company received $1,500,000 during 1997. In addition, on each of
February 28, 2000, 2001 and 2002, Newco will be required to make payments to the
Company of at least $250,000 (the "Future Payments"). The obligations of Newco
with respect to Future Payments are secured by a pledge of shares of Common
Stock held by a revocable trust formed by Dr. Houghten and his wife. The
consideration for the Shares was determined by negotiation between Dr. Houghten
and the Company. As part of the arrangements made in connection with the sale of
the Shares, the Company has agreed, for a period of seven years, not to (i)
engage in certain activities which would be competitive with the business of MPS
or (ii) license certain technologies (which are presently licensed from the
Company to MPS) to entities which are engaged primarily in a business similar to
the business of MPS. In addition to being a founder and a former member of the
Company's Board of Directors, prior to the sale of the Shares Dr. Houghten was
also the Chief Technical Officer of the Company. In connection with the sale,
however, Dr. Houghten resigned as an officer of the Company. Upon such
resignation (effective February 28, 1997), previously unvested options held by
Dr. Houghten to acquire 28,605 shares of Common Stock (with an exercise price of
$2.15 per share) became fully vested.
In February 1996, the Company entered into an agreement with Dura which
requires, among other things, the Company to pay Dura $6,000,000 over four years
for product development (the "Dura Agreement"). As of December 31, 1997,
$3,154,000 had been funded under the Dura Agreement. Cam L. Garner, a member of
the Company's Board of Directors, is the President, Chief Executive Officer and
Chairman of the Board of Directors of Dura. James C. Blair, a member of the
Board of Directors of Dura, is a member of the Company's Board of Directors. Mr.
Garner and Robert S. Whitehead, the Company's President, Chief Executive
Officer, Chairman of the Board and acting Chief Financial Officer, are members
of the Board of Directors of Spiros Development Corporation II, Inc., a research
and development company for which Dura performs certain work concerning
applications of Dura's drug delivery technology. In connection with the Dura
Agreement, Dura invested $5,000,000 in the Company's stock.
32
<PAGE> 33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THIS REPORT:
(1) Financial Statements
The financial statements required by this item are submitted in a separate
section beginning on Page F-1 of this Annual Report on Form 10-K:
Report of Ernst & Young LLP,
Independent Auditors....................... F-2
Consolidated Balance Sheets at December
31, 1997 and 1996.......................... F-3
Consolidated Statements of Operations for
each of the three years in the period
ended December 31, 1997.................... F-4
Consolidated Statements of Stockholders'
Equity (Deficit) for each of the
three years in the period ended
December 31, 1997.......................... F-5
Consolidated Statements of Cash Flows
for each of the three years in the
period ended December 31, 1997............. F-6
Notes to Consolidated Financial
Statements................................. F-7
(2) Financial Statement Schedules
Financial statement schedules have been omitted since they are either not
required or not applicable, or the information is otherwise included.
(3) Each management contract or compensatory plan or arrangement required
to be filed as an exhibit to this Form 10-K has been identified with an
asterisk ("*") in the table of exhibits set forth below at item 14(c).
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1997.
(C) EXHIBITS
The exhibits listed below are required by Item 601 of Regulation S-K.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
2.1+(1) Stock Purchase Agreement dated as of February 28, 1997 among the
Registrant, Multiple Peptide Systems, Inc., RAH Acquisition Corp. and
Richard A. Houghten, Ph.D.
3.3(2) Restated Certificate of Incorporation of the Registrant.
3.4(3) Certificate of Ownership and Merger (amending Section 1 of the
Restated Certificate of Incorporation)
3.5(4) Amended and Restated Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.3, 3.4 and 3.5.
10.1(2) Form of Indemnification Agreement entered into between the Registrant
and its directors and officers.
33
<PAGE> 34
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
*10.2(2) Amended and Restated 1992 Stock Plan of the Registrant (the "1992
Plan").
*10.3(2) Forms of agreements under the 1992 Plan.
*10.4(2) 1995 Stock Plan of the Registrant (the "1995 Plan").
*10.5(2) Forms of agreements under the 1995 Plan.
*10.6(5) 1996 Incentive Stock Plan of the Registrant, as amended (the "1996
Plan").
*10.7(2) 1996 Employee Stock Purchase Plan.
10.8(2) Form of Agreement Regarding Confidentiality and Non-Competition.
*10.9(2) The 401(k) Plan of the Registrant, as amended.
*10.11(2) Executive Employment Agreement between Robert S. Whitehead and the
Registrant dated August 16, 1993.
*10.12(2) Promissory Note in the initial principal amount of $100,000 dated
March 11, 1994 made by Robert S. Whitehead in favor of the
Registrant.
10.26(2) Standard Industrial Lease between General Atomics and the Registrant
dated February 9, 1996.
10.28(2) Master Equipment Lease Agreement No. 8020 between Dominion Ventures,
Inc. and the Registrant dated October 7, 1992, with amendments.
10.29+(2) April 11, 1985 License Agreement between The Scripps Clinic and
Research Foundation and Richard Houghten (re: "Means for Sequential
Solid Phase Organic Syntheses and Methods Using the Same; Patent
Disclosure #85-35)-- the "Tea Bag" License Agreement, including
assignments to the Registrant.
10.30+(2) Research and Option Agreement dated as of July 1, 1992, between
Torrey Pines Institute for Molecular Studies and the Registrant.
10.31+(2) April 30, 1995 Amendment to Research and Option Agreement between
Torrey Pines Institute for Molecular Studies and the Registrant.
10.32+(2) December 30, 1995 Second Amendment to Research and Option Agreement
between Torrey Pines Institute for Molecular Studies and the
Registrant.
10.33+(2) January 1, 1994 License and Option to License Agreement between
Chiron Corporation, Chiron Mimotopes Pty Ltd. and the Registrant.
10.34+(2) January 1, 1994 Sub-License Agreement between Chiron Corporation and
the Registrant
10.35+(2) Letter of Understanding Concerning Licensing Agreements from the
Registrant to Chiron Corporation and Chiron Mimotopes U.S. dated
December 15, 1994.
10.36+(2) March 31, 1995 Heads of Agreement Contract between Chiron
Corporation, the Registrant, Multiple Peptide Systems, Chiron
Mimotopes U.S. and Chiron Mimotopes Peptide Systems L.L.C.
10.46+(2) Research and Development Agreement dated February 7, 1996 between
Dura Pharmaceuticals, Inc. and the Registrant.
10.47++ Officers & Associates Bonus Plan (1997 - June 1998)
10.48+(6) Restated and Third Amended Research and Option Agreement entered into
as of April 15, 1997 between Torrey Pines Institute for Molecular
Studies and the Company
34
<PAGE> 35
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
10.49+(6) Research and Development Agreement dated as of June 18, 1997 between
Ono Pharmaceutical Co., Ltd. and the Company.
10.50(7) Lease between the Company and Aid Associations for Lutherans, dated
September 24, 1997, for premises at 9880 Campus Point Drive.
10.51(7) Equipment Financing Line between the Company and Lease Management
Services, Inc. dated September 19, 1997.
10.52(7) Note for $100,000 from Robert S. Whitehead dated June 12, 1997.
*10.53 Executive Employment Agreement between Lawrence D. Muschek and the
Registrant dated October 6, 1997.
10.54(7) Note for $75,000 from Lawrence D. Muschek dated September 18, 1997.
10.55 Reference is made to Exhibits 2.1 and 2.2.
11.1 Schedule computing net loss per share.
21.1(4) Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (included in Signature section of this Report).
27.1 Financial Data Schedule.
- ----------
(1) Incorporated by reference from the Registrant's Current Report on Form 8-K
dated February 28, 1997 (Exhibit 1).
(2) Incorporated by reference from the Company's Registration Statement on Form
S-1 (File No. 333-1376) which was declared effective on March 29, 1996 (to
the Exhibits of the same numbers in such Registration Statement).
(3) Incorporated by reference from the Registrant's Current Report on Form 8-K
dated May 1, 1997 (Exhibit 1).
(4) Incorporated by reference from the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997 (Exhibit 3.4).
(5) Incorporated by reference from Appendix A of the Registrant's Proxy
Statement for the 1997 Annual Meeting of Stockholders.
(6) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the Quarter Ended June 30, 1998.
(7) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the Quarter Ended September 30, 1998.
+ The Registrant has been granted confidential treatment of certain portions
of these agreements or arrangements.
++ The Registrant has requested confidential treatment of certain portions of
these agreements or arrangements.
(D) FINANCIAL STATEMENT SCHEDULES.
Not applicable.
35
<PAGE> 36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.
TREGA BIOSCIENCES, INC.
Date: March 31, 1998 /s/ Robert S. Whitehead
--------------------
Robert S. Whitehead
President, Chief Executive Officer,
Chairman of the Board of
Directors and Acting Chief Financial Officer
(Principal Executive, Financial and
Accounting Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Robert S. Whitehead and Lawrence D. Muschek,
Ph.D., and each one of them, his true and lawful attorney-in-fact, each with
full power of substitution, in any and all capacities to sign any amendments to
this Annual Report on Form 10-K and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that said attorneys-in-fact or
their substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
<S> <C> <C>
/s/ Robert S. Whitehead President, Chief Executive March 31, 1998
- -------------------------- Officer,
Robert S. Whitehead Chairman of the Board of
Directors and Acting Chief
Financial Officer (Principal
Executive, Financial and
Accounting Officer)
/s/ James C. Blair Director March 31, 1998
- ---------------------------
James C. Blair
/s/ Cam L. Garner Director March 31, 1998
- ---------------------------
Cam L. Garner
/s/ Harry D. Lambert Director March 31, 1998
- ---------------------------
Harry D. Lambert
/s/ Jeremy M. Levin Director March 31, 1998
- ---------------------------
Jeremy M. Levin
/s/ Lawrence D. Muschek Director March 31, 1998
- ---------------------------
Lawrence D. Muschek
/s/ Harvey S. Sadow Director March 31, 1998
- ---------------------------
Harvey S. Sadow
/s/ Ronald R. Tuttle Director March 31, 1998
- ---------------------------
Ronald R. Tuttle
/s/ Anders P. Wiklund Director March 31, 1998
- ---------------------------
Anders P. Wiklund
</TABLE>
36
<PAGE> 37
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
TREGA BIOSCIENCES, INC.
Report of Ernst & Young LLP, Independent Auditors F-2
Consolidated Balance Sheets at December 31, 1997 and 1996 F-3
Consolidated Statements of Operations for each of the
three years in the period ended December 31, 1997 F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for each of the three years in the period ended
December 31, 1997 F-5
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 1997 F-6
Notes to Consolidated Financial Statements F-7
F-1
<PAGE> 38
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Trega Biosciences, Inc.
We have audited the accompanying consolidated balance sheets of Trega
Biosciences, Inc. as of December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Trega Biosciences,
Inc. at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
San Diego, California
February 28, 1998
F-2
<PAGE> 39
Trega Biosciences, Inc.
Consolidated Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
---- ----
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 5,457 $ 13,615
Short-term investments 13,970 13,828
Accounts receivable and other current assets 676 763
-------- --------
Total current assets 20,103 28,206
Property and equipment, at cost:
Machinery and equipment 4,531 2,757
Leasehold improvements 422 426
Furniture and fixtures 241 229
-------- --------
5,194 3,412
Less accumulated depreciation and amortization (2,453) (1,667)
-------- --------
2,741 1,745
Other assets 2,275 562
-------- --------
$ 25,119 $ 30,513
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 211 $ 810
Accrued compensation 497 769
Other accrued liabilities 1,479 1,951
Current portion of obligations under capital leases 271 433
Current portion of equipment notes payable 346 -
Current portion of notes payable 1,506 -
Deferred revenue 3,002 1,761
-------- --------
Total current liabilities 7,312 5,724
Obligations under capital leases 298 633
Long-term equipment notes payable 1,159 -
Long-term notes payable 132 -
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value:
Authorized shares - 40,000,000 at December 31, 1997
Issued and outstanding shares - 13,863,562 and
13,368,772 at December 31, 1997 and 1996,
respectively 14 13
Additional paid-in capital 73,087 71,050
Common stock issuable 16 1,281
Deferred compensation (1,270) (1,931)
Accumulated deficit (55,629) (46,257)
-------- --------
Total stockholders' equity 16,218 24,156
-------- --------
$ 25,119 $ 30,513
======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE> 40
Trega Biosciences, Inc.
Consolidated Statements of Operations
(in thousands, except net loss per share)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
Revenues:
<S> <C> <C> <C>
Contract research and license fees $ 7,334 $ 5,750 $ 293
Net sales 430 2,507 1,077
------------ ---------- ----------
7,764 8,257 1,370
Costs and expenses:
Cost of sales 341 2,025 1,313
Research and development 14,819 11,781 7,289
Acquired in-process research and
development - 2,585 -
Selling, general and administrative 4,346 4,191 2,722
------------ ---------- ----------
19,506 20,582 11,324
------------ ---------- ----------
Loss from operations (11,742) (12,325) (9,954)
Other income (expense):
Loss on investment (88) (534) -
Interest income 1,405 1,274 136
Interest expense (202) (103) (86)
Gain on sale of MPS 1,255 - -
Corporate joint venture - - 414
------------ ---------- ----------
Net loss $ (9,372) $ (11,688) $ (9,490)
============ ========== ==========
Basic and diluted net loss per share $ (.69) $ (.97) $ (1.32)
============ =========== ===========
Shares used in computing basic and
diluted net loss per share 13,603 12,071 7,215
============ ======== =======
</TABLE>
See accompanying notes.
F-4
<PAGE> 41
Trega Biosciences, Inc.
Consolidated Statements of Stockholders' Equity (Deficit)
(in thousands, except share data)
<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED STOCK COMMON STOCK PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 13,086,040 $ 13 266,651 $ -- $ 22,053
Issuance of preferred stock 2,845,453 3 -- -- 7,997
Exercise of stock options -- -- 43,723 -- 29
Deferred compensation for
issuance of stock options -- -- -- -- 288
Amortization of deferred
compensation -- -- -- -- --
Dividends on Series One
preferred stock at $.08 per
share -- -- -- -- --
Net loss -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance at December 31, 1995 15,931,493 16 310,374 -- 30,367
Issuance of preferred stock 3,366,670 3 -- -- 10,054
Exercise of stock options -- -- 94,383 -- 100
Deferred compensation for
issuance of stock options -- -- -- -- 2,218
Amortization of deferred
compensation -- -- -- -- --
Dividends on Series One
preferred stock at $.08 per
share -- -- -- -- --
Initial public offering of
common stock -- -- 3,795,000 4 27,339
Conversion of preferred stock to
common stock (19,298,163) (19) 8,975,845 9 10
Issuance of common stock for
business acquisition of
ChromaXome Corp. -- -- 193,170 -- 1,093
Recognition of ChromaXome Corp.
milestones -- -- -- -- --
Unrealized loss on short-term
investments -- -- -- -- (131)
Net loss -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance at December 31, 1996 -- -- 13,368,772 13 71,050
----------- ----------- ----------- ----------- -----------
Exercise of stock options and other -- -- 211,284 -- 473
Issuance of common stock under
employee stock purchase plan -- -- 30,581 -- 119
Amortization of deferred
compensation -- -- -- -- --
Reverse unrealized loss on
short-term investments -- -- -- -- 131
Issuance of common stock
related to previous recognition
of ChromaXome Corp. milestones -- -- 240,804 1 1,264
Issuance of common stock for services -- -- 12,121 -- 50
Net loss -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance at December 31, 1997 -- -- 13,863,562 $ 14 $ 73,087
----------- ----------- ----------- ----------- -----------
=========== =========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
COMMON
STOCK DEFERRED ACCUMULATED
ISSUABLE COMPENSATION DEFICIT TOTAL
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 $ -- $ -- $ (24,864) $ (2,798)
Issuance of preferred stock -- -- -- 8,000
Exercise of stock options -- -- -- 29
Deferred compensation for
issuance of stock options -- (288) -- --
Amortization of deferred
compensation -- 52 -- 52
Dividends on Series One
preferred stock at $.08 per
share -- -- (168) (168)
Net loss -- -- (9,490) (9,490)
----------- ----------- ----------- -----------
Balance at December 31, 1995 -- (236) (34,522) (4,375)
Issuance of preferred stock -- -- -- 10,057
Exercise of stock options -- -- -- 100
Deferred compensation for
issuance of stock options -- (2,218) -- --
Amortization of deferred
compensation -- 523 -- 523
Dividends on Series One
preferred stock at $.08 per
share -- -- (47) (47)
Initial public offering of
common stock -- -- -- 27,343
Conversion of preferred stock to
common stock -- -- -- --
Issuance of common stock for
business acquisition of
ChromaXome Corp. -- -- -- 1,093
Recognition of ChromaXome Corp.
milestones 1,281 -- -- 1,281
Unrealized loss on short-term
investments -- -- -- (131)
Net loss -- -- (11,688) (11,688)
----------- ----------- ----------- -----------
Balance at December 31, 1996 1,281 (1,931) (46,257) 24,156
----------- ----------- ----------- -----------
Exercise of stock options and other -- -- -- 473
Issuance of common stock under
employee stock purchase plan -- -- -- 119
Amortization of deferred
compensation -- 661 -- 661
Reverse unrealized loss on
short-term investments -- -- -- 131
Issuance of common stock
related to previous recognition
of ChromaXome Corp. milestones (1,265) -- -- --
Issuance of common stock for services -- -- -- 50
Net loss -- -- (9,372) (9,372)
----------- ----------- ----------- -----------
Balance at December 31, 1997 $ 16 $ (1,270) $ (55,629) $ 16,218
----------- ----------- ----------- -----------
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
F-5
<PAGE> 42
Trega Biosciences, Inc.
Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
-------- -------- --------
OPERATING ACTIVITIES
<S> <C> <C> <C>
Net loss $ (9,372) $(11,688) $ (9,490)
Adjustments to reconcile net loss to net cash flows
used in operating activities:
Depreciation and amortization 1,033 790 434
Amortization of note receivable discount (37) -- --
Amortization of deferred compensation 661 523 52
Realized loss on sale of investment 88 534 --
Corporate joint venture -- -- (414)
License fee income -- (3,369) --
Common stock issued for services 50 -- --
Gain on sale of MPS (1,255) -- --
Acquired in-process research and development -- 2,374 --
Changes in operating assets and liabilities, net of
effects from the transfer of assets from
sale of MPS in 1997 and corporate joint venture in
1995:
Accounts receivable (61) (220) 250
Other current assets (422) (150) 116
Accounts payable (479) 481 (32)
Other accrued liabilities (522) 1,361 221
Deferred revenue 1,244 (243) 1,932
-------- -------- --------
Net cash used in operating activities (9,072) (9,607) (6,931)
INVESTING ACTIVITIES
Purchase of short-term investments (21,540) (26,574) --
Maturities of short-term investments 21,441 15,450 --
Additions to property and equipment, net (2,045) (798) (134)
Proceeds from sale of MPS, net 1,149 -- --
Cash acquired from corporate joint venture -- -- 130
Purchase of ChromaXome Corp., net of cash acquired -- 6 --
Other assets (39) (288) (205)
-------- -------- --------
Net cash used in investing activities (1,034) (12,204) (209)
FINANCING ACTIVITIES
Principal payments under debt obligations (569) (416) (244)
Proceeds from equipment notes and notes payable 1,925 -- --
Redemption of preferred stock -- (2,819) --
Issuance of common and preferred stock 592 37,500 8,029
-------- -------- --------
Net cash provided by financing activities 1,948 34,265 7,785
-------- -------- --------
Net (decrease) increase in cash and cash equivalents (8,158) 12,454 645
Cash and cash equivalents at beginning of year 13,615 1,161 516
-------- -------- --------
Cash and cash equivalents at end of year $ 5,457 $ 13,615 $ 1,161
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 117 $ 87 $ 86
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Property and equipment acquired under capital lease
obligations $ -- $ 450 $ 185
======== ======== ========
Receipt of Magainin common stock in exchange for
license agreement $ -- $ 3,369 $ --
======== ======== ========
Common stock issued and common stock issuable in
connection with the purchase of ChromaXome Corp. $ -- $ 2,374 $ --
======== ======== ========
Dividends on Series One preferred stock at $.08 per
share $ -- $ 47 $ 168
======== ======== ========
Notes received in connection with the sale
of MPS, net of discount of $213,000 $ 537 $ -- $ --
======== ======== ========
Note payable issued in exchange for TPIMS patent and
purchased technology $ 1,300 $ -- $ --
======== ======== ========
</TABLE>
See accompanying notes.
F-6
<PAGE> 43
Trega Biosciences, Inc.
Notes to Consolidated Financial Statements
December 31, 1997
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Trega Biosciences, Inc. (the "Company" or "Trega") is a drug discovery
company pursuing the identification and early-stage development of novel,
small-molecule drug therapies through combinatorial chemistry and other drug
discovery technologies. The synthetic chemistry technologies used by Trega in
its combinatorial chemistry program enable the Company to provide a wide range
of small-molecule libraries constructed in single-based compound arrays -- a
format that permits the rapid identification of active compounds after testing
in a biological assay. The Company has devoted substantially all of its
resources since its founding to developing methods to synthesize and screen
large libraries of chemicals for new drug discovery and optimization, to
developing a select number of chemical compounds as potential pharmaceutical
products, and to acquiring or developing technologies with the potential to
expand the methods available to generate drug candidates. The Company also
conducts an internal drug discovery program currently focused on investigating
the biological role of melanocortin receptors. The most clinically advanced
compound, HP 228, is being evaluated in a Phase II study in patients undergoing
elective hip or knee replacement surgery. The Company's subsidiary, ChromaXome
Corporation ("ChromaXome"), was acquired in August 1996 (See Note 3) and is
developing a range of technologies to facilitate the discovery of drug leads
from natural sources. The Company's former subsidiary, Multiple Peptide Systems,
Inc. ("MPS"), was sold in February 1997 and was engaged in the manufacture and
sale of peptides and other compounds (See Note 2). Significant intercompany
accounts and transactions have been eliminated in consolidation.
The Company's success is largely dependent on its ability to enter into
collaborations for drug discovery, which utilize the Company's combinatorial
chemistry, melanocortin biology and other drug discovery technologies, and for
drug development based on drug candidates discovered in internal research
programs or through alliances with biotechnology or pharmaceutical companies.
The Company faces risks associated with companies whose products are in
development. These risks include, among others, the Company's need for
additional financing to maintain the competitiveness of its combinatorial
chemistry and other drug discovery technologies and to conduct research and
development and clinical testing. There is no assurance such financing will be
available to the Company when required or that such financing would be available
under favorable terms.
The Company believes that patents and other proprietary rights are important
to its business. The Company's policy is to file patent applications to protect
technology, inventions and improvements that are considered important to the
development of its business. The patent positions of pharmaceutical and
biotechnology firms, including the Company, are uncertain and involve complex
legal and factual questions for which important legal principles are largely
unresolved.
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 consolidated financial
statements and disclosures made in the accompanying notes to the consolidated
financial statements. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with maturities, when
purchased, of three months or less to be cash equivalents. The Company invests
in short-term debt securities with original maturities in excess of 90 days,
which are presented as short-term investments in the accompanying consolidated
balance sheets. At December 31, 1997, the cost of cash equivalents and
short-term investments approximated the market value. Accordingly, there were no
unrealized gains or losses. The Company evaluates the financial strength of
institutions at which significant investments are made and believes the related
credit risk is limited to an acceptable level.
F-7
<PAGE> 44
The following is a summary of available-for-sale securities (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
---- ----
<S> <C> <C>
U.S. corporate debt securities $15,571 $20,999
U.S. corporate equity securities -- 481
Other 412 356
------- -------
$15,983 $21,836
======= =======
</TABLE>
All available-for-sale securities by contractual maturities are due in one
year or less. Included in cash and cash equivalents at December 31, 1997 and
1996 were $2,013 and $8,008, respectively, of securities classified as
available-for-sale.
REVENUE RECOGNITION
Contract research is recorded as earned, generally ratably, as research and
development activities are performed under the terms of the contract. Payments
received in excess of amounts earned are deferred. Revenue from product sales
and library access fees are recognized upon shipment. Non-refundable license
fees and milestone payments are recognized when received as the Company has no
other performance obligations.
DEPRECIATION AND AMORTIZATION
Depreciation of property and equipment is provided using the straight-line
method over the estimated useful lives of three to five years or the lease term.
Amortization of leasehold improvements is provided using the straight-line
method over the lesser of the remaining lease term or the life of the asset.
PATENTS
Patents and purchased technology are stated at cost and are included in
other assets in the accompanying consolidated balance sheets. The patents and
purchased technology are being amortized using the straight-line method over a
useful life of ten years. Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount. The Company periodically monitors the
patents and purchased technology for indications of impairment of value. At
December 31, 1997, management believes that no impairment has occurred.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs are expensed as incurred.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the
current years' presentation.
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation," which is effective for the year ending December 31,
1996. SFAS No. 123 allows companies to either account for stock-based
compensation under the new provisions of SFAS No. 123 or under the provisions of
Accounting Principles Opinion No. 25 ("APB No. 25"), "Accounting for Stock
Issued to Employees," but requires pro forma disclosure in the footnotes to the
financial statements as if the measurement provisions of SFAS No. 123 had been
adopted. The Company has continued accounting for its stock-based compensation
in accordance with the provisions of APB No. 25.
F-8
<PAGE> 45
NET LOSS PER SHARE
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per Share," which
replaced the calculation of primary and fully diluted income (loss) per share
with basic and diluted income (loss) per share. Unlike primary income (loss) per
share, basic income (loss) per share excludes any dilutive effects of stock
options, warrants and convertible securities. Diluted income (loss) per share is
very similar to the previously reported primary income (loss) per share. All
loss per share amounts for all periods presented, where appropriate, have been
restated to conform to the SFAS No. 128 requirements, the recently effective
Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 98
("SAB 98") and certain rules of the SEC for shares of convertible preferred
stock that converted into common stock in conjunction with the Company's initial
public offering as if these shares were converted into common stock as of the
date of issuance.
Net loss per share information as presented on the statements of operations
has been presented because historical net loss per share is not indicative of
the Company's capital structure following its March 1996 initial public
offering. Historical net loss per share, without an adjustment for convertible
preferred stock, would have been ($.69) in 1997, ($1.17) in 1996 and ($33.49) in
1995.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130 ("SFAS No. 130"), "Reporting and
Comprehensive Income" and Statement of Financial Accounting Standard No. 131
("SFAS No. 131"), "Segment Information." Both of these standards are effective
for fiscal years beginning after December 15, 1997. SFAS No. 130 requires that
all components of comprehensive income, including net income, be reported in the
financial statements in the period in which they are recognized. Comprehensive
income is defined as the change in equity during a period from transactions and
other events and circumstances from non-owner sources. Net income and other
comprehensive income, including foreign currency translation adjustments, and
unrealized gains and losses on investments, shall be reported, net of their
related tax effect, to arrive at comprehensive income. The Company believes that
comprehensive income or loss will not be materially different than net income or
loss. SFAS No. 131 amends the requirements for public enterprises to report
financial and descriptive information about its reportable operating segments.
Operating segments, as defined in SFAS No. 131, are components of an enterprise
for which separate financial information is available and is evaluated regularly
by the Company in deciding how to allocate resources and in assessing
performance. The financial information is required to be reported on the basis
that is used internally for evaluating the segment performance. The Company
believes it operates in one business and operating segment and that the adoption
of these standards will not have a material impact on the Company's financial
statements.
2. SALE OF MULTIPLE PEPTIDE SYSTEMS, INC.
In February 1997, the Company sold its wholly-owned subsidiary, Multiple
Peptide Systems, Inc. ("MPS"), to an entity owned by Richard A. Houghten, Ph.D.
("Dr. Houghten"). Dr. Houghten is a founder of the Company and prior to the sale
of MPS was the Chief Technical Officer and a Director of the Company. In
connection with the sale, Dr. Houghten resigned as an officer of the Company.
Dr. Houghten did not stand for re-election at the Annual Stockholder's Meeting
held on June 11, 1997. Dr. Houghten also is the founder, an executive officer
and a Director of Torrey Pines Institute for Molecular Studies ("TPIMS"), a
not-for-profit biomedical research institution which performs contract research
services for the Company. Prior to the Company's sale of MPS, the business of
MPS was comprised of manufacturing and marketing certain peptides and other
compounds to government entities, universities, research institutions and
private companies.
As consideration for the sale of MPS, the Company received consideration of
$1,500,000 (net $1,250,000 cash) and a $750,000 non-interest bearing note due on
the third, fourth, and fifth anniversaries of the sale. The $750,000 was
discounted by $213,000 to a present value of $537,000, using an imputed rate of
interest of 9%. The Company recorded a gain on the sale of MPS of $1,255,000. In
connection with the sale, the Company has agreed, for a period of seven years,
not to (i) engage in certain activities which would be competitive with the
business of MPS or (ii) license certain technologies (which are presently
licensed from the Company to MPS) to entities which are engaged primarily in a
business similar to the business of MPS.
3. CHROMAXOME ACQUISITION
Effective August 1, 1996, the Company acquired all the outstanding shares of
ChromaXome in exchange for 193,170 shares of the Company's common stock and
options to acquire 27,660 shares of the Company's common stock. The Company
accounted for the acquisition of ChromaXome using the purchase method of
accounting. The purchase price of $1,321,000 consisted of the following: (i)
$1,093,000 related to market value of shares and options issued in connection
with the transaction, (ii) $100,000 of cash advances to
F-9
<PAGE> 46
ChromaXome and (iii) transaction costs of approximately $128,000. The purchase
price has been allocated to the fair market value of the tangible and intangible
assets acquired and liabilities assumed. Substantially all of the purchase price
was allocated to acquired in-process research and development which resulted in
a charge to operations of $1,304,000 when the transaction was consummated.
In connection with the ChromaXome acquisition, the Company also committed to
issue or distribute up to an additional 412,600 shares of the Company's common
stock, including up to approximately 26,260 shares issuable upon the exercise of
options, upon the achievement of certain scientific milestones by the business
of ChromaXome. At December 31, 1996, the Company deemed that certain milestones
were achieved and the Company issued 240,804 shares of its common stock in
August and November 1997. An additional amount of 659 shares, currently
reflected as common stock issuable, is expected to be issued in 1998. The fair
value of these shares and options resulted in an additional charge of $1,281,000
for acquired in-process research and development in the statement of operations
for the year ended December 31, 1996.
In October 1996, a complaint was filed against the Company, ChromaXome, and
the officers and directors of the Company. The complaint alleged various
contract and tort claims against the defendants by former owners of ChromaXome.
In August 1997, the Company settled the lawsuit. The Company agreed to pay
$250,000 cash in connection with the settlement, which may be offset partially
by insurance reimbursement. Up to 137,500 shares of the Company's common stock
remained issuable at December 31, 1997 upon the achievement of certain business
milestones (although an amount of up to 68,750 of these shares is subject to (i)
adjustment upward or downward, if and when issued, to achieve a value of $4.00
per share or (ii) replacement, if earned and at the Company's election, with
$4.00 in cash per share).
4. COMMITMENTS AND LONG-TERM DEBT
LEASES
In September 1997, the Company entered into a 10-year lease for its new
headquarters that it anticipates occupying in the second quarter of 1998. Annual
rent is $1,685,000 and is subject to annual increases of 3.5%. The Company has
the option to extend the lease for an additional term of 5 years subject to
terms and conditions specified in the lease.
The Company's current facility is leased through April 1998. Rent expense
for the years ending December 31, 1997, 1996 and 1995 was $777,000, $ 791,000
and $431,000 (net of sublease rental income of $0, $24,000 and $67,000 for 1997,
1996 and 1995), respectively.
The Company leases certain equipment under a capital lease obligation.
Equipment acquired under capital leases totaled $0 and $1,008,000 (net of
accumulated amortization of $0 and $1,062,000) at December 31, 1997 and 1996,
respectively. The Company also leases certain equipment under operating leases.
Annual future minimum payments under capital and operating leases at
December 31 are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
YEARS ENDED DECEMBER 31 LEASES LEASES
- ----------------------- ------------- ---------
<S> <C> <C>
1998 $1,685,000 $ 316,000
1999 1,985,000 199,000
2000 2,054,000 104,000
2001 2,126,000 9,000
2002 2,200,000 -
---------- -----------
$10,050,000 628,000
=========== ===========
Less amounts representing interest (59,000)
-----------
Present value of remaining minimum payments 569,000
Less current portion of obligations (271,000)
-----------
Long-term obligations $ 298,000
===========
</TABLE>
F-10
<PAGE> 47
LONG-TERM DEBT
The Company obtained a $3,000,000 equipment financing line in 1997, of which
approximately $1,582,000 had been utilized at December 31, 1997. The Company
intends to use this financing source through mid-1998 to fund the majority of
its equipment needs. The loan is secured by the equipment. The terms of the
Company's loan agreement call for amounts drawn down under the loan to be repaid
monthly over a four-year term, including interest payments based on the average
of the Federal Reserve 3- and 5-year treasuries.
Principal payments due on long-term debt at December 31 are as follows:
<TABLE>
<CAPTION>
LONG-TERM
YEARS ENDED DECEMBER 31 DEBT
- ----------------------- -----------
<S> <C>
1998 $ 346,000
1999 379,000
2000 417,000
2001 363,000
2002 -
-----------
1,505,000
Less current portion of obligations (346,000)
-----------
Long-term obligations $ 1,159,000
===========
</TABLE>
5. TPIMS AGREEMENT
Since 1992, the Company has been party to a Research and Option Agreement,
as amended, with TPIMS. A primary purpose of the Company's relationship with
TPIMS has been to give the Company access to support services provided by TPIMS
scientific personnel and to provide a source of combinatorial libraries and
other discoveries. As of April 15, 1997, the Company entered into a Restated and
Third Amended Research and Option Agreement with TPIMS (the "TPIMS Agreement").
In connection with the Restated Agreement, the Company acquired certain patents
and purchased technology, previously invented by TPIMS, in exchange for
$1,300,000. In addition, the agreement eliminated potential related royalties on
the technology. The agreement also extended, through July 14, 1998, the existing
funded research relationship between the parties, with a further extension
through April 14, 2000, upon agreement on a work plan. Included in other assets
on the Company's consolidated balance sheets is $1,300,000 representing the
acquisition of the patents and purchased technology. In January 1998, the
Company announced that the TPIMS Agreement would be terminated. The Company is
obligated to fund research through July 14, 1998, and will be required to pay
$1,300,000, plus applicable interest (10% per annum), to TPIMS on April 14,
1998. The $1,300,000, along with approximately $82,000 of accrued interest, is
reflected in current notes payable in the accompanying consolidated balance
sheets.
6. COLLABORATIVE ARRANGEMENTS
In February 1998, the Company signed a non-binding letter of intent with Ono
Pharmaceutical Co., Ltd. ("Ono") whereby the Company received an upfront payment
of $500,000. Immediately upon signing the letter of intent, the Company began
optimizing lead compounds discovered by Ono and undertaking screening of those
compounds in a new target of interest to Ono.
In May 1997, the Company entered into a collaboration with Warner-Lambert
regarding the identification of lead compounds in an area of interest to
Warner-Lambert. This collaboration involved utilizing Trega's combinatorial
chemistry libraries and Warner-Lambert's biological assays and screening
technology. In February 1998, the Company met a milestone in this collaboration
triggering a requirement for a $1,500,000 investment by Warner-Lambert in the
Company's common stock (at fair market value). The timing of this investment may
be determined by Trega prior to February 11, 2000.
In June 1997, the Company entered into a Research and Development Agreement
with Ono Pharmaceutical Co., Ltd. ("Ono") whereby the Company received
$2,000,000 as a license fee in connection with the screening by the Company of
certain of its combinatorial libraries against certain of its biological
screens. The Company also received $2,000,000 in July 1997 for work to be done
during the first 12 months under the agreement and, subject to Ono's right of
early termination, will receive an additional $2,000,000 in July 1998 for
further research during an additional 12-month period. The non-refundable
license fee was recognized as revenue in 1997. The research related payments are
treated as deferred revenue and recognized as revenue as related work is
performed under the contract. The Company will also receive milestone and
royalty payments on products it discovers which are subsequently developed and
marketed by Ono, if any.
F-11
<PAGE> 48
In December 1996, the Company entered into a drug discovery collaboration
with Chugai Biopharmaceuticals, Inc. ("Chugai"), a subsidiary of Chugai
Pharmaceuticals Co., Ltd. Under the terms of the agreement, the Company provides
Chugai with combinatorial libraries, which Chugai will screen against a range of
targets. The Company received, as advances against future library shipments,
$1,250,000 in January 1997 and an additional payment of $1,000,000 in December
1997. The advanced payments are treated as deferred revenue and recognized as
revenues as materials are shipped. This arrangement includes both collaborative
and independent research and development activities by the parties utilizing
therapeutic targets provided by Chugai and small-molecule combinatorial
libraries provided by the Company.
In February 1996, the Company entered into a collaborative arrangement with
Novo Nordisk A/S whereby the Company received $2,000,000 for library access
charges and received an additional $2,000,000 in February 1997. Payments have
been treated as deferred revenue and are recognized as revenue as libraries are
shipped. The Company will also receive milestone and royalty payments on any
products discovered and subsequently developed and marketed by Novo Nordisk A/S,
if any.
In February 1996, the Company entered into an agreement with Dura
Pharmaceuticals, Inc. ("Dura"). A member of Company's Board of Directors is a
member of the Board of Directors of Dura and Dura's Chairman and Chief Executive
Officer is a member of the Company's Board of Directors. Under the contract,
Dura will perform research to apply Dura's drug delivery technology to compounds
developed by the Company. The Company is required to make minimum contract
payments of $6,000,000 over four years. Payments are due quarterly and must
aggregate $2,000,000 in each of the first two years of the contract and
$1,000,000 in each of the last two years of the contract. Concurrent with the
execution of this contract, Dura purchased shares of the Company's Series G
Preferred Stock, which converted to the Company's Common Stock upon closing of
the Company's initial public offering, for $5,000,000. As of December 31, 1997,
the Company has funded $3,154,000 under this agreement.
7. LICENSE FEE
In September 1996, the Company received, through MPS, 275,000 shares of
common stock of Magainin Pharmaceuticals Inc. ("Magainin"), with a then current
market value of $3,369,000, in exchange for a royalty interest in Magainin's
lead compound MSI-78. The Company subsequently sold 225,000 shares of the common
stock and recognized a loss of approximately $534,000. All remaining shares of
Magainin stock were sold in January 1997. In connection with the sale in
January, the Company recognized a loss on the sale of the investment of
approximately $88,000.
8. CORPORATE JOINT VENTURE
In January 1994, the Company transferred substantially all tangible assets
and certain liabilities having a net carrying value of $497,000 from its
wholly-owned subsidiary, MPS, to a newly formed entity, Chiron Mimotopes Peptide
Systems, L.L.C. ("CMPS"). Chiron Corporation ("Chiron") also transferred certain
tangible assets of its peptide product line to CMPS. As of January 1, 1994, CMPS
was 25% owned by MPS and 75% owned by Chiron. CMPS engaged in the manufacture
and sale of peptides and peptide libraries to the research community.
The Company recorded its investment in the stock of CMPS at the carrying
value of the net assets transferred to CMPS and during 1994 advanced $60,000 to
CMPS. No gain or loss was recognized on the transfer of net assets. The Company
accounted for its investment in CMPS under the equity method and, as a result of
operating losses at CMPS, the Company reduced the carrying value of its
investment in CMPS to zero.
In March 1995, Chiron and the Company determined to cease the operations of
CMPS and return the previously contributed technology and certain assets back to
the members of CMPS. In connection with the dissolution, the Company agreed to
provide Chiron certain products at no cost and Chiron provided the Company with
a $145,000 note payable which was subsequently repaid.
The effect of the transaction on the Company was as follows:
<TABLE>
Assets received:
<S> <C>
Cash $ 130,000
Accounts receivable, net 449,000
Other, net 71,000
Cost of products to be provided (236,000)
----------
Gain on dissolution $ 414,000
==========
</TABLE>
F-12
<PAGE> 49
The Company also received property and equipment for which no value has been
assigned. The net monetary assets received over the cost to provide product to
Chiron of approximately $414,000 is reported as other income from corporate
joint venture.
9. STOCKHOLDERS' EQUITY
In April 1996, the Company completed its initial public offering of
3,795,000 shares of common stock at $8.00 per share for net cash proceeds of
$27,343,000. Upon closing of the initial public offering, shares of the
Company's preferred stock automatically converted into 8,975,845 shares of
common stock and the Company redeemed 2,100,000 shares of the Company's Series
One Preferred Stock for $2,819,000 (including cumulative dividends of $719,000)
in cash.
COMMON STOCK WARRANTS
At December 31, 1997, the Company had outstanding warrants to purchase
35,437 shares of its common stock at $4.52 per share and 8,118 shares of common
stock at $5.91 per share, expiring on October 7, 2002 and June 21, 2005,
respectively. An aggregate 43,555 shares of common stock have been reserved for
issuance upon conversion of common stock purchased upon exercise of the
warrants.
STOCK INCENTIVE PLANS
The Company is authorized to issue 2,960,465 shares of common stock to
eligible employees, officers, directors and consultants. Of the authorized
shares, 1,038,153 options were granted under the 1992 Stock Option Plan and 1995
Stock Plan (the "Predecessor Plans"). In February 1996, the Board of Directors
approved the 1996 Stock Plan (the "1996 Plan") under which an additional 822,312
shares of common stock were reserved for issuance. In the second quarter of
1997, the Company's Board of Directors and stockholders approved an additional
1,100,000 shares of common stock for issuance under the 1996 Plan.
The 1996 Plan provides for awards in the form of restricted shares, stock
units, options or stock appreciation rights. The 1996 Plan replaces the
Predecessor Plans whereby shares available and options outstanding under the
Predecessor Plans were transferred to the 1996 Plan. All outstanding options
under the Predecessor Plans will remain exercisable in accordance with their
original terms, which are substantially the same terms and conditions specified
for option grants under the 1996 Plan. Options under the 1996 Plan provide for
the grant of incentive and nonstatutory stock options. Terms of the stock option
agreements, including vesting requirements, are determined by the Board of
Directors. The exercise price of incentive stock options must equal at least the
fair market value on the date of grant and the maximum term of options granted
is ten years.
In February 1998, the Company's Board of Directors approved an exchange
program for certain stock options under the 1996 Plan. Options having a price
greater than the closing price of the Company's stock, as reported by the Nasdaq
National Market, on the date of approval were eligible to participate; however,
options granted to executive officers, directors, consultants, and advisors of
the Company were excluded from exchange. There are 360,174 options eligible for
participation, which will result in an effective repricing to an exercise price
of $3.375 (as well as the modification of certain terms). Eligible employees who
elect to participate are subject to a 12 month "no-vest" clause. Following the
12 month period, the vesting schedules revert to their original vesting
schedules prior to participation in the exchange program.
F-13
<PAGE> 50
A summary of the Company's stock option activity, including those issued
outside of the plans, and related information for the years ended December 31
follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------- -------------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 1,111,027 $ 1.99 614,847 $ 0.86 477,680 $ 0.73
Granted 653,019 4.43 795,856 2.51 194,872 1.13
Exercised (212,084) 1.76 (93,583) 1.07 (43,723) 0.67
Forfeited (141,990) 3.74 (206,093) 1.02 (13,982) 0.87
----------- ------------ ------------
Outstanding at end of year 1,409,972 $ 3.10 1,111,027 $ 1.99 614,847 $ 0.86
============ ====== ============ ====== ============ ======
Exercisable at end of year 643,965 493,394 302,867
============ ============ ============
Weighted average fair value of
options granted during the
year $ 4.45 $ 3.97 $ 2.29
====== ====== ======
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
Outstanding Exercisable
----------------------------------------- ---------------------------------------------------
Weighted
Remaining Weighted Average
Number Contractual Average Number Exercise
Range of Exercise Prices Outstanding Life Exercise Price Exercisable Price
- ------------------------------------- ---------------------- ------------------ ------------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
$0.1932 - $1.8300 309,214 6.35 $0.85 270,666 $0.83
$2.1500 - $2.1500 359,455 7.66 2.15 218,941 2.15
$3.1880 - $4.3750 429,625 9.31 4.19 123,112 4.15
$4.6250 - $8.5000 311,678 9.05 4.94 31,246 5.64
---------------------- ---------------
1,409,972 8.18 $3.10 643,965 $2.15
========= ==== ===== ======= =====
</TABLE>
The Company recorded $2,218,000 of deferred compensation for options granted
during the year ended December 31, 1996, representing the difference between the
option exercise price and the deemed fair market value for financial statement
presentation purposes. The Company is amortizing the deferred compensation
ratably over the vesting period of the options.
Adjusted pro forma information regarding net income is required by SFAS 123,
and has been determined as if the Company had accounted for its employee stock
options under the fair value method of that Statement. The fair value of these
options was estimated at the date of grant using the "Black-Scholes" method for
option pricing with the following weighted-average assumptions: risk-free
interest rate of 5.71%; dividend yield of 0%; volatility of .9168; and a
weighted-average expected life of the option of 1 year to 6 years.
For purposes of adjusted pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting periods. The
Company's adjusted pro forma information is as follows (in thousands, except for
per share information):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997 1996
---- ----
<S> <C> <C>
Adjusted pro forma net loss $ (10,380) $ (12,321)
========= =========
Adjusted pro forma basic and diluted net loss per share $ (.76) $ (1.00)
========= =========
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN
In February 1996, the Board of Directors approved the Employee Stock
Purchase Plan (the "Purchase Plan") under which 100,000 shares of common stock
are reserved for sale to eligible employees. On January 1 or July 1, employees
may enroll in the Purchase Plan and purchase stock over a six-month
participation period valued at up to but not exceeding 10% of each employee's
earnings.
F-14
<PAGE> 51
The stock purchase price shall be the lesser of 85% of the fair market value
of the stock on the last day before the participation period commences or 85% of
the fair market value on the last day of the participation period.
10. 401(K) PLAN
The Company has a 401(k) defined contribution savings and retirement plan
(the "Plan"). The Plan is for the benefit of all qualifying employees and
permits employee voluntary contributions up to 15% of base salary (as defined)
and elective Company matching contributions. Company contributions to the Plan
totaled $80,000, $66,000 and $56,000 for the years ended December 31, 1997, 1996
and 1995, respectively.
11. INCOME TAXES
As of December 31, 1997, the Company had federal and California income tax
net operating loss carryforwards of approximately $45,091,000 and $9,460,000
respectively. The difference between the federal and California tax loss
carryforwards is primarily attributable to the capitalization of research and
development expenses for California income tax purposes and the 50% limitation
on California loss carryforwards. The federal and California tax loss
carryforwards will begin to expire in 2007 and 1998, respectively, unless
previously utilized. The Company also has federal and California research and
development tax credit carryforwards of $2,168,000 and $1,040,000, respectively,
which will begin to expire in 2007 unless previously utilized. Pursuant to
Internal Revenue Code Section 382 and 383, use of the Company's net operating
loss and tax credit carryforwards may be limited due to a cumulative change in
ownership of more than 50% within a three-year period, which occurred in April
1996. However, the Company's management does not anticipate that such limitation
would materially affect the Company's ability to utilize the net operating loss
and tax credit carryforwards.
Significant components of the Company's deferred tax assets are shown below.
A valuation allowance of $22,705,000 has been recognized to offset the deferred
tax assets, as realization of such assets is uncertain.
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
---- ----
Deferred tax assets:
<S> <C> <C>
Net operating loss carryforwards $ 16,350,000 $ 13,358,000
Research and development credits 2,844,000 1,926,000
Capitalized research and 1,429,000 1,383,000
development
Deferred revenue 1,231,000 -
Other, net 851,000 664,000
------------ ------------
Total deferred tax assets 22,705,000 17,331,000
Valuation allowance for deferred tax
assets (22,705,000) (17,331,000)
------------ ------------
Net deferred tax assets $ - $ -
============ ============
</TABLE>
F-15
<PAGE> 1
EXHIBIT 10.47
[*] = CONFIDENTIAL TREATMENT REQUESTED
M E M O R A N D U M STRICTLY CONFIDENTIAL
TO: Trega Compensation Committee
FROM: Bob Whitehead
DATE: September 5, 1997
RE: Executive Bonus Program
The following is the proposed Trega bonus program for the balance of 1997
through June, 1998 for your review and approval.
- The plan will cover corporate managers (my direct reports) and as last
year will include a provision to reward department managers (their
direct reports)1 for significant contribution toward organizational
goals and objectives.
- Total bonus compensation will be rewarded for [_________*___________]
and [__________*____________], for [__________*__________] and in
selected cases, for [__________*__________].
- Maximum payout differs on a percentage of salary basis per executive
and is proposed as follows:
<TABLE>
<CAPTION>
Key Executive Incumbent Percentage of Bonus On:
------------- --------- -----------------------
<S> <C> <C> <C> <C> <C>
[*]2 [*] [*] [*]3
Chief Executive Officer R. Whitehead [*] [*] [*] [*] *
President, R&D L. Muschek [*] [*] [*] [*] *
VP, Business Development Open [*] [*] [*] [*] *
VP, Finance & CFO Open [*] [*] [*] [*] *
VP, Chemistry M. Green [*] [*] [*] [*] *
Director, Corp. Communications N. Wheeler [*] [*] [*] [*] *
Director, Employee Development S. Hanan [*] [*] [*] [*] *
</TABLE>
- -------------------
1 [__________*__________]
2 [__________*__________]
3 [__________*__________]
<PAGE> 2
[*] = CONFIDENTIAL TREATMENT REQUESTED
- Bonuses will be a mix of cash plus potential conversion of cash
payouts in stock/options at the discretion of the Compensation
Committee and valued using Black Shoals methodology.
- Based upon your approval of the general concepts, specific bonusable
criteria sheets will be developed in concert with each executive and
submitted to the Compensation Committee for information and
commentary.
I look forward to your comments and suggestions.
-2-
<PAGE> 1
EXHIBIT 10.53
TREGA BIOSCIENCES, INC.
EXEMPT EMPLOYEE LETTER AGREEMENT
Lawrence D. Muschek, PhD
Muthesiusweg 47
D-30559 Hannover
GERMANY
Dear Larry:
This letter sets forth the basic terms and conditions of your
employment with Trega Biosciences, Inc. ("Trega") effective October 6, 1997
("Effective Date"). By signing this letter, you will be agreeing to these terms.
It is important that you understand clearly both what your benefits are and what
is expected of you by Trega.
1. Salary. You will be paid an annual base salary of $250,000 ("Base
Salary"), less regular payroll deductions, (payable as $10,416.67 semi-monthly),
which compensates you for all hours worked. Generally, your salary will be
reviewed annually but Trega reserves the right to change your compensation from
time to time on reasonable notice.
2. Term of Employment. Trega agrees to employ you for a period of two
(2) years (the "Term of Employment") commencing on the effective date of this
agreement unless terminated sooner as provided in paragraph 14 below.
3. Eligibility for Bonus. You will be eligible for a bonus compensation
award of up to sixty percent (60%) of your annual Base Salary contingent upon
the Board of Directors' assessment of your annual performance, achievement of
business development objectives, achievement of pre-agreed targets in stock
price performance and other factors that are jointly determined. These bonus
criteria are set forth in greater detail in Attachment A. To be eligible for a
bonus you must perform at a level acceptable to the Board of Directors and be on
the Trega payroll when the bonus is paid. No pro-rata payment will be made if
you are not employed by Trega when the bonus is paid.
4. Incentive Stock Options. You will be eligible to receive 86,486
Incentive Stock Options. The options will be issued pursuant and subject to the
Trega 1996 Stock Incentive Plan ("Plan") a copy of which is attached here to as
Attachment B. The above-referenced shares shall vest according to the Plan, and
shall become fully vested in the event of a "Change in Control" as defined in
the Plan. You will also be eligible to receive 113,514 shares nonqualifying
stock options. You may be eligible for additional stock option grants at the
discretion of the Board of Directors and its Compensation Committee.
-1-
<PAGE> 2
5. Duties. Your job title will be President of Research and
Development. Your duties generally will include responsibility for all
activities relating to combinatorial chemistry, combinatorial biology,
biological screening and pre-clinical and clinical development. You will work
closely with the Board of Directors, the management team and the Scientific
Advisory Board in the development and implementation of the strategic and
technical planning necessary to enhance the company's valuation and global
recognition. You will also play a major role in all corporate collaborations,
negotiations and future financings. You may be assigned other duties as needed
and your duties may change from time to time on reasonable notice, based on the
needs of Trega and your skills, as determined by Trega.
As an exempt employee, you are required to exercise your specialized
expertise, independent judgment and discretion to provide high-quality services.
You are required to follow office policies and procedures adopted from time to
time by Trega and to take such general direction as you may be given from time
to time by your superiors. Trega reserves the right to change these policies and
procedures at any time. (Also see Adjustments and Changes in Employment Status).
You are required to devote your full energies, efforts and abilities to your
employment, unless Trega expressly agrees otherwise.
6. Competitive Activity. You shall not during the Term of Employment
period directly or indirectly own, manage, operate, control or participate in
the ownership, management, operation or control of, or be connected as an
officer, employee, partner, director, or otherwise with, or have any financial
interest in or aid or assist anyone else in the conduct of a "Competitive
Operation" which is in competition with any aspect of the business conducted by
Trega (or any of the Company's affiliates) at any time during the two (2) year
period immediately preceding the date on which you propose to own, participate
in, or be connected with, or have any financial interest in or aid or assist
anyone else in the conduct of, such Competitive Operation in any area in which
such business is or was then being conducted by Trega (or any of the Trega's
affiliates); provided, however, that ownership of not more than one percent (1%)
of the equity securities of any publicly held Competitive Operation shall not
constitute a violation hereof.
7. Adjustments and Changes in Employment Status. You understand that
the Company reserves the right to make personnel decisions regarding your
employment, including but not limited to decisions regarding any promotion,
salary adjustment, transfer or disciplinary action, up to and including
termination (in accordance with paragraph 14 below), consistent with the needs
of the business.
8. Hours of Work. As an exempt employee, you are expected to work the
number of hours required to get the job done. However, you are generally
expected to be present during normal working hours of Trega. Normal working
hours will be established by Trega and may be changed as needed to meet the
needs of the business.
9. Proprietary Information Agreement. You will be required to sign and
abide by the terms of the enclosed proprietary information agreement, which is
incorporated into this agreement by reference as Attachment C.
-2-
<PAGE> 3
10. Immigration Documentation. Please be advised that your employment
is contingent on your ability to prove your identity and authorization to work
in the U.S. for Trega. You must comply with the Immigration and Naturalization
Service's employment verification requirements.
11. Representation and Warranty of Employee. You represent and warrant
to Trega that the performance of your duties will not violate any agreements
with or trade secrets of any other person or entity.
12. Employee Benefits. You will be eligible for three weeks paid
vacation each calendar year. Vacation will accrue on a pro-rata basis
semi-monthly. You will receive an additional vacation day for each year of
service subject to Trega's vacation policy. You will also be paid for sick leave
and holidays also subject to Trega's policies. You will be provided with health
insurance benefits and dental insurance benefits, as provided in our benefit
plans. You will be eligible to participate in Trega's 401(k) retirement savings
plan and Trega's flexible spending account. These benefits may change from time
to time. You will be covered by workers' compensation insurance and State
Disability Insurance, as required by state law.
13. Additional Benefits. You will be provided with the following
additional benefits: You will be reimbursed for reasonable relocation expenses
for (i) the move of your household goods from Atlanta, Georgia and Fort Walton
Beach, Florida to San Diego; (ii) a pre-move house hunting trip; (iii) temporary
living quarters and temporary transportation for up to thirty (30) days; and
(iv) specific costs relating to the sale and purchase of your primary residence
as pre-approved by Trega. Any payments made to you or third parties on your
behalf for relocation, other than the moving of household goods and travel, is
required to be included in your gross earnings for the year. Trega agrees to pay
you a cash bonus "grossed up" to compensate you for the taxes you will be
required to pay on this additional income. Trega will also reimburse you for
accounting fees for expatriot status for two years. Trega will further reimburse
you for a lease payoff for your residence in Germany if it is not re-leased
after reasonable efforts.
14. Termination and Severance Benefits. Trega and you each retain the
right to terminate this Agreement, with or without cause, upon thirty (30) days
prior written notice to the other. In the event of termination without "cause"
(as hereinafter defined), you shall be entitled to the balance of your salary
during the period from the date of termination through the end of the Term of
Employment (the "Severance Pay"). The Severance Pay will be paid in equal
semi-monthly installments. In the event of termination of this Agreement for
"cause," you shall not be entitled to Severance Pay or any other benefits.
"Cause," for purposes of this agreement shall mean (i) conviction of a criminal
offense; (ii) failure to substantially perform duties hereunder other than
because of physical or mental illness resulting in disability; or (iii) acts of
moral turpitude or other conduct which is injurious to the reputation of Trega
or you.
15. Dispute Resolution Procedure. The parties agree that any dispute
arising out of or related to the employment relationship between them, including
the termination of that relationship and any allegations of unfair or
discriminatory treatment arising under state or federal law or otherwise, shall
be resolved by final and binding arbitration, except where the law
-3-
<PAGE> 4
specifically forbids the use of arbitration as a final and binding remedy.
(a) The party claiming to be aggrieved shall furnish to the other party
a written statement of the grievance identifying any witnesses or documents that
support the grievance and the relief requested or proposed.
(b) If the other party does not agree to furnish the relief requested
or proposed, or otherwise does not satisfy the demand of the party claiming to
be aggrieved, the parties shall submit the dispute to nonbinding mediation
before a mediator to be jointly selected by the parties. Trega will pay the cost
of the mediation.
(c) If the mediation does not produce a resolution of the dispute, the
parties agree that the dispute shall be resolved by final and binding
arbitration. The parties shall attempt to agree to the identity of an
arbitrator, and, if they are unable to do so, they will obtain a list of
arbitrators from the Federal Mediation and Conciliation Service and select an
arbitrator by striking names from that list.
The arbitrator shall have the authority to determine whether the
conduct complained of in paragraph (a) of this section violates the rights of
the complaining party and, if so, to grant any relief authorized by law;
provided, however, the parties agree, that for violations of the employee's
trade secret obligations, Trega retains the right to seek preliminary injunctive
relief in court in order to preserve the status quo or prevent irreparable
injury before the matter can be heard in arbitration. The arbitrator shall not
have the authority to modify, change or refuse to enforce the terms of any
employment agreement between the parties. In addition, the arbitrator shall not
have the authority to require Trega to change any lawful policy or benefit plan.
The hearing shall be transcribed. Trega shall bear the costs of the
arbitration if the employee prevails. If Trega prevails, the employee will pay
half the cost of the arbitration or $500, whichever is less. Each party shall
be responsible for paying its own attorneys fees.
(d) Arbitration shall be the exclusive final remedy for any dispute
between the parties, and the parties agree that no dispute shall be submitted to
arbitration where the party claiming to be aggrieved has not complied with the
preliminary steps provided for in paragraphs (a) and (b) above.
(e) Trega reserves the right to modify, change or cancel this provision
upon 30 days written notice. However, such cancellation shall not affect matters
which have already been submitted to arbitration.
16. Integrated Agreement. Please note that this Agreement supersedes
any prior agreements, representations or promises of any kind, whether written,
oral, express or implied between the parties hereto with respect to the subject
matters herein. It constitutes the full, complete and exclusive agreement
between you and Trega with respect to the subject matters herein. This agreement
cannot be changed unless in writing, signed by you and Robert S. Whitehead or
the then current Chief Executive Officer.
-4-
<PAGE> 5
17. Severability. If any term of this Agreement is held to be invalid,
void or unenforceable, the remainder of this Agreement shall remain in full
force and effect and shall in no way be affected; and, the parties shall use
their best efforts to find an alternative way to achieve the same result.
We look forward to your joining our organization. In order to confirm
your agreement with and acceptance of these terms, please sign one copy of this
letter and return it to me. The other copy is for your records. If there is any
matter in this letter which you wish to discuss further, please do not hesitate
to speak to me.
Very truly yours,
Trega Biosciences, Inc.
By: /s/ Robert S. Whitehead
-----------------------------
Title: President and Chief Executive Officer
................................................................................
I agree to the terms of employment set forth in this Agreement.
/s/ Lawrence D. Muschek 11/26/97
----------------------------- -----------------------
Employee Date
-5-
<PAGE> 1
EXHIBIT 11.1
STATEMENT OF COMPUTATION OF EARNINGS PER SHARE
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net loss $ (9,372) $(11,688) $ (9,490)
======== ======== ========
Weighted average common shares outstanding
13,603 9,956 283
Effect of assumed conversion of preferred
shares -- 2,115 6,932
-------- -------- --------
Adjusted Shares outstanding - Basic and
Diluted 13,603 12,071 7,215
======== ======== ========
Basic and Diluted Net loss per share $ (0.69) $ (.97) $ (1.32)
======== ======== ========
</TABLE>
<PAGE> 1
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in (i) the Registration Statement
(Form S-8 No. 333-17235) pertaining to the 1992 Stock Incentive Plan; (ii) the
Registration Statement (Form S-8 No. 333-17273) pertaining to the 1995 Stock
Incentive Plan; (iii) the Registration Statements (Form S-8 No. 333-2910 and
Form S-8 No. 333-40903) pertaining to the 1996 Stock Incentive Plan; and (iv)
the Registration Statement (Form S-8 No. 333-2908) pertaining to the Employee
Stock Purchase Plan of Trega Biosciences, Inc. of our report dated February 28,
1998 with respect to the consolidated financial statements of Trega Biosciences,
Inc. included in this Annual Report (Form 10-K) for the year ended December 31,
1997.
/s/ ERNST & YOUNG LLP
San Diego, California
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEET AT DECEMBER 31, 1997 AND CONSOLIDATED STATEMENT OF OPERATIONS FOR
THE YEAR ENDED DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 5,457
<SECURITIES> 13,970
<RECEIVABLES> 676
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 20,103
<PP&E> 5,194
<DEPRECIATION> 2,453
<TOTAL-ASSETS> 25,119
<CURRENT-LIABILITIES> 7,312
<BONDS> 0
0
0
<COMMON> 14
<OTHER-SE> 16,204
<TOTAL-LIABILITY-AND-EQUITY> 25,119
<SALES> 430
<TOTAL-REVENUES> 7,764
<CGS> 341
<TOTAL-COSTS> 341
<OTHER-EXPENSES> 19,165
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 202
<INCOME-PRETAX> (9,372)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,372)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,372)
<EPS-PRIMARY> (0.69)
<EPS-DILUTED> (0.69)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<RESTATED>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996
<PERIOD-END> MAR-31-1996 JUN-30-1996
<CASH> 10,218,152 6,617,456
<SECURITIES> 0 25,539,606
<RECEIVABLES> 310,633 419,225
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 34,467,671 32,971,324
<PP&E> 861,816 836,875
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 36,467,671 32,971,324
<CURRENT-LIABILITIES> 5,467,991 5,535,897
<BONDS> 0 0
2,814,000 0
19,298 0
<COMMON> 351 13,145
<OTHER-SE> 66,096,919 28,382,332
<TOTAL-LIABILITY-AND-EQUITY> 36,392,085 34,246,961
<SALES> 1,565,052 2,455,481
<TOTAL-REVENUES> 1,565,052 2,455,481
<CGS> 466,851 949,403
<TOTAL-COSTS> 3,428,113 949,403
<OTHER-EXPENSES> 0 6,830,685
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 26,036 43,509
<INCOME-PRETAX> (1,810,581) (4,858,320)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (1,810,581) (4,858,320)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,810,581) (4,858,320)
<EPS-PRIMARY> (0.21)<F1> (0.37)<F1>
<EPS-DILUTED> (0.21) (0.37)
<FN>
<F1>For Purposes of This Exhibit, Primary means Basic.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEETS AT DECEMBER 31, 1995 AND MARCH 31, 1996 AND CONSOLIDATED
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31 1995 AND 1996, AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<RESTATED>
<MULTIPLIER> 1,000
<PERIOD-TYPE> 9-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996
<PERIOD-END> SEP-30-1996 DEC-31-1996
<CASH> 9,841 13,615
<SECURITIES> 21,600 13,828
<RECEIVABLES> 383 481
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 669 28,206
<PP&E> 1,424 1,745
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 34,563 30,513
<CURRENT-LIABILITIES> 5,535 5,724
<BONDS> 0 0
0 0
0 0
<COMMON> 13 13
<OTHER-SE> 28,430 24,143
<TOTAL-LIABILITY-AND-EQUITY> 34,563 30,513
<SALES> 3,655 4,888
<TOTAL-REVENUES> 7,024 8,257
<CGS> 1,429 2,025
<TOTAL-COSTS> 1,429 2,025
<OTHER-EXPENSES> 12,367 19,091
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 69 103
<INCOME-PRETAX> (5,924) (11,688)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (5,924) (11,688)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (5,924) (11,688)
<EPS-PRIMARY> (0.45)<F1> (0.97)<F1>
<EPS-DILUTED> (0.45) (0.97)
<FN>
<F1>For Purposes of This Exhibit, Primary means Basic.
</FN>
</TABLE>
