<PAGE>
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934 (Amendment No. )
Filed by the Registrant /X/
Filed by a Party other than the Registrant / /
Check the appropriate box:
/ / Preliminary Proxy Statement
/ / Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
/X/ Definitive Proxy Statement
/ / Definitive Additional Materials
/ / Soliciting Material Pursuant to Section 240.14a-11(c) or Section
240.14a-12
ARRIS PHARMACEUTICAL CORPORATION
- - --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- - --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement if other than the Registrant)
Payment of Filing Fee (Check the appropriate box)
/ / $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1), or 14a-6(j)(2) or
Item 22(a)(2) of Schedule 14A.
/ / $500 per each party to the controversy pursuant to Exchange Act Rule
14a-6(i)(3).
/ / Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
1. Title of each class of securities to which transaction applies:
------------------------------------------------------------------------
2. Aggregate number of securities to which transaction applies:
------------------------------------------------------------------------
3. Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
------------------------------------------------------------------------
4. Proposed maximum aggregate value of transaction:
------------------------------------------------------------------------
5. Total fee paid:
------------------------------------------------------------------------
/X/ Fee paid previously with preliminary materials.
/ / Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
1. Amount Previously Paid:
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2. Form, Schedule or Registration Statement No.:
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3. Filing Party:
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4. Date Filed:
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ARRIS PHARMACEUTICAL CORPORATION
385 OYSTER POINT BOULEVARD, SUITE 3
SOUTH SAN FRANCISCO, CALIFORNIA 94080
------------------------
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD ON JUNE 5, 1996
---------------------
TO THE STOCKHOLDERS OF ARRIS PHARMACEUTICAL CORPORATION:
NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders of ARRIS
PHARMACEUTICAL CORPORATION, a Delaware corporation (the "Company"), will be held
on Wednesday, June 5, 1996 at 8:00 a.m. local time at 385 Oyster Point
Boulevard, Suite 3, South San Francisco, California for the following purposes:
1. To elect directors to serve for the ensuing year and until their
successors are elected.
2. To approve the issuance of a sufficient number of shares to satisfy the
payment of the Second Stock Payment, pursuant to the Company's recent
acquisition of Khepri Pharmaceuticals, Inc. ("Khepri").
3. To approve the issuance of a sufficient number of shares to satisfy the
exercise of certain exchange rights of the Class B Shareholders of Khepri
Pharmaceuticals Canada, Inc.
4. To approve the Company's 1989 Stock Plan, as amended, to increase the
aggregate number of shares of Common Stock authorized for issuance under
such plan by 550,000 shares, to 2,667,500 shares.
5. To approve the Company's Employee Stock Purchase Plan, as amended, to
increase the number of shares of Common Stock authorized for issuance
under such plan by 100,000 shares, to 250,000 shares.
6. To ratify the selection of Ernst & Young LLP as independent auditors of
the Company for its fiscal year ending December 31, 1996.
7. To transact such other business as may properly come before the meeting
or any adjournment or postponement thereof.
The foregoing items of business are more fully described in the Proxy
Statement accompanying this Notice.
The Board of Directors has fixed the close of business on April 15, 1996, as
the record date for the determination of stockholders entitled to notice of and
to vote at this Annual Meeting and at any adjournment or postponement thereof.
By Order of the Board of Directors
Daniel H. Petree
ASSISTANT SECRETARY
South San Francisco, California
May 8, 1996
ALL STOCKHOLDERS ARE CORDIALLY INVITED TO ATTEND THE MEETING IN PERSON.
WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE COMPLETE, DATE, SIGN
AND RETURN THE ENCLOSED PROXY AS PROMPTLY AS POSSIBLE IN ORDER TO ENSURE YOUR
REPRESENTATION AT THE MEETING. A RETURN ENVELOPE (WHICH IS POSTAGE PREPAID IF
MAILED IN THE UNITED STATES) IS ENCLOSED FOR THAT PURPOSE. EVEN IF YOU HAVE
GIVEN YOUR PROXY, YOU MAY STILL VOTE IN PERSON IF YOU ATTEND THE MEETING.
PLEASE NOTE, HOWEVER, THAT IF YOUR SHARES ARE HELD OF RECORD BY A BROKER, BANK
OR OTHER NOMINEE AND YOU WISH TO VOTE AT THE MEETING, YOU MUST OBTAIN FROM THE
RECORD HOLDER A PROXY ISSUED IN YOUR NAME.
<PAGE>
ARRIS PHARMACEUTICAL CORPORATION
385 OYSTER POINT BOULEVARD, SUITE 3
SOUTH SAN FRANCISCO, CALIFORNIA 94080
------------------------
PROXY STATEMENT
FOR ANNUAL MEETING OF STOCKHOLDERS
JUNE 5, 1996
---------------------
INFORMATION CONCERNING SOLICITATION AND VOTING
GENERAL
The enclosed proxy is solicited on behalf of the Board of Directors of Arris
Pharmaceutical Corporation, a Delaware corporation (the "Company"), for use at
the Annual Meeting of Stockholders to be held on June 5, 1996, at 8:00 a.m.
local time (the "Annual Meeting"), or at any adjournment or postponement
thereof, for the purposes set forth herein and in the accompanying Notice of
Annual Meeting. The Annual Meeting will be held at 385 Oyster Point Boulevard,
Suite 3, South San Francisco, California. The Company intends to mail this proxy
statement and accompanying proxy card on or about May 8, 1996, to all
stockholders entitled to vote at the Annual Meeting.
SOLICITATION
The Company will bear the entire cost of solicitation of proxies, including
preparation, assembly, printing and mailing of this proxy statement, the proxy
and any additional information furnished to stockholders. Copies of solicitation
materials will be furnished to banks, brokerage houses, fiduciaries and
custodians holding in their names shares of Common Stock beneficially owned by
others to forward to such beneficial owners. The Company may reimburse persons
representing beneficial owners of Common Stock for their costs of forwarding
solicitation materials to such beneficial owners. Original solicitation of
proxies by mail may be supplemented by telephone, telegram or personal
solicitation by directors, officers or other regular employees of the Company
or, at the Company's request, First Interstate Bank, N.A. No additional
compensation will be paid to directors, officers or other regular employees for
such services, but First Interstate Bank, N.A. will be paid its customary fee,
estimated to be approximately $1,000, if it renders solicitation services.
VOTING RIGHTS AND OUTSTANDING SHARES
Only holders of record of Common Stock at the close of business on April 15,
1996 will be entitled to notice of and to vote at the Annual Meeting. At the
close of business on April 15, 1996 the Company had outstanding and entitled to
vote 13,532,059 shares of Common Stock.
Each holder of record of Common Stock on such date will be entitled to one
vote for each share held on all matters to be voted upon at the Annual Meeting.
All votes will be tabulated by the inspector of election appointed for the
meeting, who will separately tabulate affirmative and negative votes,
abstentions and broker non-votes. Abstentions will be counted towards the
tabulation of votes cast on proposals presented to the stockholders and will
have the same effect as negative votes. Broker non-votes are counted towards a
quorum, but are not counted for any purpose in determining whether a matter has
been approved.
REVOCABILITY OF PROXIES
Any person giving a proxy pursuant to this solicitation has the power to
revoke it at any time before it is voted. It may be revoked by filing with the
Secretary of the Company at the Company's principal executive office, 385 Oyster
Point Boulevard, Suite 3, South San Francisco, California 94080, a written
notice of revocation or a duly executed proxy bearing a later date, or it may be
revoked by attending the meeting and voting in person. Attendance at the meeting
will not, by itself, revoke a proxy.
<PAGE>
STOCKHOLDER PROPOSALS
Proposals of stockholders that are intended to be presented at the Company's
1997 Annual Meeting of Stockholders must be received by the Company not later
than January 8, 1997 in order to be included in the proxy statement and proxy
relating to that Annual Meeting.
PROPOSAL 1
ELECTION OF DIRECTORS
The Board of Directors is currently comprised of six members. Each of the
nominees is currently a director of the Company and five were previously elected
by the stockholders at the 1995 Annual Meeting. One director, Vaughn M. Kailian,
was elected by the Board of Directors on December 14, 1995, effective December
22, 1995. The Board at the same time increased the number of authorized
directors to six. If elected, each of the nominees would hold office until the
next annual meeting of stockholders and until his successor is elected and has
qualified, or until such director's earlier death, resignation or removal.
Shares represented by executed proxies will be voted, if authority to do so
is not withheld, for the election of the six nominees named below. In the event
that any nominee should be unavailable for election as a result of an unexpected
occurrence, such shares will be voted for the election of such substitute
nominee as management may propose. Each person nominated for election has agreed
to serve if elected and management has no reason to believe that any nominee
will be unable to serve.
Directors are elected by a plurality of the votes present in person or
represented by proxy and entitled to vote at the meeting.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF EACH NAMED
NOMINEE.
NOMINEES
The names of the nominees, their ages as of January 31, 1996, and certain
information about them are set forth below:
<TABLE>
<CAPTION>
NAME AGE PRINCIPAL OCCUPATION/POSITION HELD WITH THE COMPANY
- - -------------------------------- --- --------------------------------------------------------------------------
<S> <C> <C>
John P. Walker 47 President, Chief Executive Officer and Director
Michael J. Ross, Ph.D. 46 Executive Vice President, Chief Technical Officer and Director
Brook H. Byers 50 Director
Anthony B. Evnin, Ph.D. 55 Director
Vaughn M. Kailian 51 Director
Hans U. Sievertsson, Ph.D. 55 Director
</TABLE>
JOHN P. WALKER has been President, Chief Executive officer and a Director of
the Company since February 1993. From 1991 to 1993, he was a venture capitalist
at Alpha Venture Partners. Prior to that time, he was Chairman, President and
Chief Executive Officer of Vitaphore Corporation, a company which was acquired
in April 1990 by Union Carbide Chemicals and Plastics Company, Inc. Following
that acquisition, Mr. Walker served as the latter company's Vice President,
Biomaterials Systems. From 1971 to 1985, Mr. Walker was employed by American
Hospital Supply Corporation in variety of general management, sales and
marketing positions, most recently serving as President of the American Hospital
Company. He received his B.A. degree from the State University of New York at
Buffalo and conducted graduate business studies at Northwestern University
Institute for Management. Mr. Walker serves as director of several private
companies.
MICHAEL J. ROSS, PH.D., has been Executive Vice President and Chief
Technical Officer of the Company since February 1993 and a Director since he
joined the Company in September 1990 as President and Chief Executive Officer.
From 1978 to 1990, he was employed by Genentech, Inc., a
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<PAGE>
biopharmaceutical company, where he most recently was Vice President, Medicinal
and Biomolecular Chemistry and was responsible for building that company's small
molecule discovery effort. Dr. Ross received a Ph.D. in chemistry from the
California Institute of Technology and held a postdoctoral fellowship in
molecular biology at Harvard University.
BROOK H. BYERS, through Kleiner Perkins Caufield & Byers, was an original
investor in the Company and has served as a member of the Board of Directors
since October 1990. Mr. Byers is a general partner of Kleiner Perkins Caufield &
Byers, a private venture capital firm which he joined in 1977. He has been the
founding president and chairman of four life sciences companies: Hybritech
Incorporated, IDEC Pharmaceuticals Corporation, InSite Vision Inc. and Ligand
Pharmaceuticals Incorporated. Mr. Byers currently serves as a director of IDEC
Pharmaceuticals Corporation, InSite Vision, Inc., Ligand Pharmaceuticals
Incorporated, Athena Neurosciences, Inc. and Pharmacopeia. He also serves as a
director of a number of privately-held technology companies. Mr. Byers sits on
the University of California, San Francisco Foundation Board of Directors.
ANTHONY B. EVNIN, PH.D., through Venrock Associates, was an original
investor in the Company and has served as a member of the Board of Directors
since April 1989. He is a general partner of Venrock Associates, a venture
capital firm that he joined in 1974. Dr. Evnin is a Director of Centocor, Inc.,
Genetics Institute, Inc., IDEXX Laboratories, Inc., Athena Neurosciences, Inc.,
Escalon Medical Corp., Kopin Corporation, Opta Food Ingredients, Inc., and
Sugen, Inc. He also serves as a director of several private companies.
VAUGHN M. KAILIAN has been a director of the Company since December 1995.
Mr. Kailian is also President, Chief Executive Officer and a director of COR
Therapeutics and has served in such capacities since March 1990. From 1967 to
1990 Mr. Kailian was employed by Marion Merrell Dow Inc., a pharmaceutical
company, and its predecessor companies in various general management, marketing
and sales positions. Most recently, Mr. Kailian served as Corporate Vice
President of Global Commercial Development, Marion Merrell Dow, Inc. Prior to
that, Mr. Kailian served as: President and General Manager, Merrell Dow USA;
Vice President, Marketing and Sales, Merrell Dow USA; and Vice President,
Marketing and Sales of Merrell Dow, Europe, Africa and the Middle East. Mr.
Kailian also serves as a director of Amylin Pharmaceuticals, Inc.
HANS U. SIEVERTSSON, PROFESSOR, PH.D., has been a Director of the Company
since June 1993. Dr. Sievertsson is Executive Vice President at Pharmacia AB
(publ), a pharmaceutical company and an investor in Arris. He is also a Board
member of the Karolinska Institute and a Board Member of the Swedish Medical
Research Council. Dr. Sievertsson's extensive management and scientific
expertise includes former positions as Senior Vice President of Research,
Development and Environment, Nobel Industries Sweden AB and as President of
Nobel Kemi AB, parent company of the explosive and chemical business area of
Nobel Industries Sweden AB. Dr. Sievertsson is also Professor of Organic
Medicinal Chemistry at the University of Uppsala, Sweden.
BOARD COMMITTEES AND MEETINGS
During the fiscal year ended December 31, 1995 the Board of Directors held
five meetings. The Board has an Audit Committee, a Compensation Committee and an
Option Committee.
The Audit Committee meets with the Company's independent auditors at least
annually to: review the results of the annual audit and discuss the financial
statements; recommend to the Board the independent auditors to be retained; and
receive and consider the accountants' comments as to internal controls, adequacy
of staff and management performance and procedures in connection with audit and
financial controls. The Audit Committee is composed of two non-employee
directors: Hans U. Sievertsson, Ph.D. and Anthony B. Evnin, Ph.D. It met twice
during the year ended December 31, 1995.
The Compensation Committee makes recommendations concerning salaries and
incentive compensation, awards stock options to employees and consultants under
the Company's stock option plans and otherwise determines compensation levels
and performs such other functions regarding
3
<PAGE>
compensation as the Board may delegate. The Compensation Committee is composed
of two non-employee directors: Brook H. Byers and Anthony B. Evnin. It met twice
during the year ended December 31, 1995.
The Option Committee administers the Company's 1989 Plan for grants to
non-executive officer employees. The Option Committee has the authority to
approve the price and terms of such options, within the limits set by the Board.
In 1995, the Option Committee was composed of John P. Walker.
During the year ended December 31, 1995, all directors attended at least 75%
of the aggregate of the meetings of the Board and of the committees on which
they served, held during the period for which they were a director or committee
member, respectively.
PROPOSAL 2
APPROVAL OF THE ISSUANCE OF ARRIS COMMON STOCK
TO FORMER KHEPRI SHAREHOLDERS
IN CONNECTION WITH ARRIS' ACQUISITION OF
KHEPRI PHARMACEUTICALS, INC.
BACKGROUND
In December 1995, Arris acquired Khepri Pharmaceuticals, Inc., a Delaware
corporation located in South San Francisco, California ("Khepri") in a
stock-for-stock merger (the "Merger"). In connection with this acquisition, the
Company issued 1,414,759 shares of its Common Stock to former shareholders of
Khepri (the "Initial Stock Payment"). The acquisition agreement also provided
that on December 30, 1996, at the election of the Company, the Company must make
either (i) an additional issuance of shares to certain former shareholders of
Khepri, subject to the approval of the Arris stockholders (the "Second Stock
Payment"), or (ii) a cash payment (the "Cash Payment"), each as described below.
The Company's Common Stock trades on the Nasdaq National Market. The
National Association of Securities Dealers ("NASD") rules applicable to Arris
provide that Arris' stockholders must approve the issuance of Arris Common Stock
issued in connection with the transaction to the extent the number of shares of
Arris Common Stock to be issued exceeds 20% of the number of shares of Arris
Common Stock outstanding prior to the Merger.
Proposal 2 seeks the approval, to the extent required by the NASD rule
described above, for the issuance of shares of Arris Common Stock to the former
shareholders of Khepri sufficient to make the Second Stock Payment as described
below. It does not seek approval of the Merger itself, which has already been
completed. The Second Stock Payment would consist of the issuance of
approximately 518,700 shares of Arris Common Stock, assuming no collar
adjustment (as described below). The Cash Payment would consist of a payment by
Arris to former shareholders of Khepri of approximately $6,185,000. If the Arris
stockholders do not approve Proposal 2, the Company must make the Cash Payment.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF PROPOSAL 2.
DESCRIPTION OF KHEPRI
Khepri was incorporated in Delaware in August 1992 as a privately held
corporation. Khepri was a development stage corporation focused on accelerating
the discovery and development of cysteine protease-based therapeutics. Khepri
had three product development programs: a protease for asthma and chronic
obstructive pulmonary disease, and small molecule protease inhibitors for
arthritis and for osteoporosis. For more information on the business of Khepri,
see "Khepri -- Business" herein.
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<PAGE>
MATERIAL FEATURES OF THE MERGER
CONVERSION OF KHEPRI CAPITAL STOCK; ASSUMPTION OF KHEPRI OPTIONS.
Pursuant to the Agreement and Plan of Reorganization and Merger, dated as of
November 7, 1995, by and among Arris, Khepri, and a wholly-owned subsidiary of
Arris (the "Merger Agreement"), each share of capital stock of Khepri issued and
outstanding on December 22, 1995 was converted into a portion of a share of
Common Stock of Arris on the basis of exchange ratios described below. In
addition, the former holders of Khepri preferred stock will receive the Second
Stock Payment or the Cash Payment, as described below.
The Initial Stock Payment was issued pursuant to an exemption under Section
3(a)(10) of the Securities Act of 1933, as amended. A permit for the offer and
sale of such securities was issued by the California Department of Corporations
in December 1995, following a fairness hearing. The Second Stock Payment, if
effected, will be made pursuant to the same exemption.
The Merger was effected as a forward triangular merger. The Company created
a wholly-owned subsidiary, Chapel Acquisition Corp., a Delaware corporation,
solely for the purpose of effecting the Merger. Upon completion of the Merger,
Khepri ceased to exist and the newly created subsidiary survived as the
successor to all the assets and liabilities of Khepri. Subsequent to the closing
of the Merger, the subsidiary was renamed Arris Protease, Inc.
COMMON STOCK; OPTIONS TO PURCHASE COMMON STOCK. Each share of Khepri Common
Stock was exchanged for 0.081484 of a share of Arris Common Stock (the "Common
Exchange Ratio") on December 22, 1995. In addition, all unexpired and
unexercised options to purchase Khepri Common Stock outstanding under Khepri's
1993 Stock Option Plan were assumed by Arris, and became exercisable for Arris
Common Stock, with the number of shares and exercise price adjusted by the
Common Exchange Ratio.
PREFERRED STOCK
SERIES A PREFERRED STOCK. Each share of Khepri Series A Preferred Stock
received (1) 0.053434 of a share of Arris Common Stock (the "Series A Preferred
Exchange Ratio") on December 22, 1995 plus (2) the right to receive on December
30, 1996, at Arris' option, either (x) .022259 of a share of Arris Common Stock
(the "Second Series A Stock Consideration"), adjusted as described below, or (y)
cash in an amount equal to $0.265438 (the "Series A Cash Consideration").
SERIES B PREFERRED STOCK. Each share of Khepri Series B Preferred Stock
received (1) 0.106872 of a share of Arris Common Stock (the "Series B Preferred
Exchange Ratio") on December 22, 1995 plus (2) the right to receive on December
30, 1996, at Arris' option, either (x) .044519 of a share of Arris Common Stock
(the "Second Series B Stock Consideration"), adjusted as described below, or (y)
cash in an amount equal to $0.530889 (the "Series B Cash Consideration").
SERIES C PREFERRED STOCK. Each share of Khepri Series C Preferred Stock
received (1) .080169 of a share of Arris Common Stock (the "Series C Preferred
Exchange Ratio") on December 22, 1995 plus (2) the right to receive on December
30, 1996, at Arris' option, either (x) .033395 of a share of Arris Common Stock
(the "Second Series C Stock Consideration"), adjusted as described below, or (y)
cash in an amount equal to $0.39824 (the "Series C Cash Consideration").
The Second Series A Stock Consideration, the Second Series B Stock
Consideration and the Second Series C Stock Consideration constitute the "Second
Stock Payment." The Series A Cash Consideration, the Series B Cash Consideration
and the Series C Cash Consideration constitute the "Cash Payment." The Second
Stock Payment and Cash Payment are sometimes collectively referred to as the
"Second Payment." If the Stockholders do not approve the Second Stock Payment,
the Company must make the Cash Payment. If the Stockholders do approve the
Second Stock Payment, Arris will make a determination in December 1996 as to
which payment method to elect.
5
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The aggregate number of shares of Arris Common Stock issuable to the holders
of Khepri Preferred Stock in the Second Stock Payment are subject to a "collar"
adjustment as follows: (1) in the event that the average closing price of Arris
Common Stock on the Nasdaq National Market (the "Average Closing Price") during
the ninety (90) trading days ending on December 27, 1996 (the "Arris Second
Payment Date Stock Price") is less than $10.13625 (which number is equal to
eighty-five percent (85%) of the Average Closing Price for the thirty (30)
trading days ending on November 6, 1995, or $11.925), the percentage of a share
of Arris Common Stock to be received in exchange for each share of Khepri
Preferred Stock will be increased by multiplying it by a fraction, the numerator
of which is $10.13625, and the denominator of which is the Arris Second Payment
Date Stock Price, or (2) in the event that the Arris Second Payment Date Stock
Price is greater than $13.71375 (which number is equal to one hundred fifteen
percent (115%) of the Average Closing Price during the thirty (30) trading days
ending on November 6, 1995, or $11.925), the percentage of a share of Arris
Common Stock to be received in exchange for each share of Khepri Preferred Stock
will be decreased by multiplying it by a fraction, the numerator of which is
$13.71375, and the denominator of which is the Arris Second Payment Date Stock
Price.
The purchase price of the Company's Common Stock that will be issued to
former stockholders of Khepri is set forth in the Merger Agreement. The purchase
price was determined at the time of execution of the Merger Agreement, subject
to the collar adjustment described below, by arm's-length negotiations by the
Board of Directors of the Company following negotiations with Khepri and its
stockholders, with the advice of management and the Company's advisors.
The following table shows the approximate number of shares of Arris Common
Stock that will be issued to the former holders of Khepri Preferred Stock at a
range of possible Arris Common Stock prices during the 90 trading days ending
December 27, 1996.
<TABLE>
<CAPTION>
APPROXIMATE NUMBER OF SHARES
ISSUABLE TO FORMER HOLDERS
ARRIS SECOND PAYMENT OF
DATE STOCK PRICE KHEPRI PREFERRED STOCK
- - -------------------- ----------------------------
<S> <C>
$10.00 525,800
$12.00 518,700
$14.00 508,100
$16.00 444,600
</TABLE>
RESTRICTIONS ON TRANSFERABILITY FOR KHEPRI STOCKHOLDERS. All shares of
Arris Common Stock issued in the Merger on December 22, 1995 to the holders of
Khepri Preferred Stock and three executive officers of Khepri (the "Designated
Stockholders") are subject to certain restrictions as set forth in the Merger
Agreement. The Designated Stockholders have each executed and delivered to Arris
a Stockholder Agreement, which includes an agreement by such Designated
Stockholders to abide by the transfer restrictions contained in the Merger
Agreement. Pursuant to such restrictions, which were negotiated in part to
provide assurance that the Merger would be treated as a tax-free reorganization,
Designated Stockholders who held Khepri Preferred Stock have agreed not to sell
or transfer an aggregate of 1,000,000 of the shares of Arris Common Stock they
received at closing of the Merger (except for permitted pro rata distributions
by partnerships) until after January 1, 1997. Designated Stockholders who held
Khepri Common Stock have similarly agreed not to sell or transfer an aggregate
of approximately 41,000 of the shares of Arris Common Stock they received at the
closing of the Merger. The Designated Stockholders have further agreed not to
sell or transfer the remainder of the shares they received at the closing of the
Merger prior to June 20, 1996, as required in connection with the Company's
March 1996 public offering.
TAX AND ACCOUNTING TREATMENT. The exchange of Khepri capital stock for
Arris Common Stock in the Merger is intended to be a tax-free reorganization
within the meaning of Section 368(a) of the Code and accounted for as a
"purchase" for accounting purposes.
6
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DISSENTERS' RIGHTS. Shareholders of Khepri were entitled to certain
dissenters' rights under applicable state law. No shareholder chose to perfect
such rights at the time the Merger was consummated.
GENERAL EFFECT UPON THE RIGHTS OF EXISTING STOCKHOLDERS
The Merger did not change the rights of the existing stockholders of Arris;
however, the Merger did dilute Arris stockholders' equity interest in Arris
because of the increase in the number of shares of Common Stock of Arris
outstanding and subject to options. As of April 15, 1996, 13,532,059 shares of
Common Stock were issued and outstanding, no shares of Preferred Stock were
issued and outstanding, 1,598,191 shares of Common Stock were subject to
issuance upon the exercise of outstanding vested and unvested options, 275,214
shares of Common Stock were issuable upon the exercise of outstanding warrants
and 161,418 shares of Common Stock were issuable upon outstanding exchange
rights (see Proposal 3). The Second Stock Payment would consist of the issuance
of approximately 518,700 shares of Arris Common Stock, assuming no collar
adjustment. The Cash Payment would consist of a payment by Arris to the former
shareholders of Khepri of approximately $6,185,000. Pursuant to Section
6(i)(1)(c)(ii) of Part III of Schedule D to the NASD By-Laws, the stockholders
of Arris are required, by vote of a majority of the shares represented by proxy
or in person at the Annual Meeting, to approve any issuance of stock which
constituted an amount equal to more than twenty percent (20%) of the outstanding
capital stock of Arris at the time of the Merger. Arris may not make the Second
Stock Payment to the holders of Khepri Preferred Stock without the prior
authorization of the stockholders of Arris. At Arris' election, or if the Second
Stock Payment is not authorized by Arris' stockholders, Arris will make the Cash
Payment.
REASON FOR THE RECOMMENDATION OF THE BOARD OF DIRECTORS
The Board of Directors recommends a vote in favor of Proposal 2 in order to
give the Company the flexibility to make the Second Payment in the manner which
is in the best interests of the Company. Historically, the share prices of
biotechnology companies have been extremely volatile. Development of commercial
products, even with collaborative agreements in place, requires significant cash
resources. The Board of Directors therefore currently intends to make the Second
Stock Payment, if the stockholders approve this Proposal 2, but the Board will
retain the right to make the Cash Payment should the Board decide that this is
in the best interests of the stockholders.
ADVANTAGES AND DISADVANTAGES OF PROPOSAL 2
The principal advantage of Proposal 2 to the Arris stockholders is that
approval would provide the Board of Directors with the ability to make the
Second Payment in either cash or Common Stock. In approving the proposal, the
stockholders will provide the Board with the flexibility to determine which form
of payment would be in the best interests of the Company and its stockholders
when payment becomes due. As noted above, the Company expects the development of
its proposed products and programs to require significant additional cash
resources. Therefore, providing the Board with the flexibility to effect the
Second Payment in stock rather than cash may be of significant value to the
stockholders by allowing the Company to retain its cash resources for other
uses, if appropriate. A further advantage relates to timing considerations. By
approving Proposal 2, the Arris stockholders will allow the Board to make its
determination at the time the Second Payment is due rather than months in
advance of the due date. The collar adjustment, if any, cannot now be determined
because it will be based on the price of the Common Stock during the 90 trading
days ending on December 27, 1996. The Board will therefore have more information
available at the time payment is due and will be able to incorporate such
information in its determination.
If Proposal 2 is not approved by the stockholders, the Company would be
required to effect the Second Payment with cash. Therefore, stockholders would
not be subject to additional dilution as a result of the stock issuance.
However, payment in cash may not be in the best interests of the Company and its
stockholders at the time payment is due. Accordingly, the Company believes that
approval of Proposal 2, which leaves this decision to the Board of Directors
based upon facts as they come to exist in December, is in the best interests of
the Company and its stockholders.
7
<PAGE>
OTHER MATERIAL TERMS OF MERGER AGREEMENT
REPRESENTATIONS AND WARRANTIES. The Merger Agreement contains certain
representations and warranties made by Arris and Khepri as of the date of the
Merger Agreement. Each party's representations and warranties are primarily
concerned with various aspects of such party's business, including its corporate
powers, assets, liabilities, intellectual and other properties, recent
operations, and financial condition. All representations and warranties made by
Khepri will terminate on March 31, 1997. All representations and warranties made
by Arris terminated as of December 22, 1995, except for certain representations
and warranties with respect to the corporate organization and capitalization of
Arris, the authority and legal ability of Arris to enter into the Merger
Agreement and consummate the Merger, the issuance of Arris Common Stock pursuant
to the merger and Arris' lack of any obligation to pay finders' or similar fees
except to a certain financial advisor, which representations and warranties will
terminate on March 31, 1997.
INDEMNIFICATION. Under the terms of the Merger Agreement, Arris will be
indemnified for any costs, losses, liabilities, damages, lawsuits, deficiencies,
claims and expenses incurred in connection with, arising out of, resulting from
or relating to (i) any inaccuracy in or breach of any representation or
warranty, or (ii) any breach of any covenant or obligation of Khepri in any
material respect, or (iii) any failure by Khepri to pay any tax required to have
been paid on or prior to the closing of the Merger, or (iv) any legal proceeding
relating to (i)-(iii) above. Claims with respect to such indemnification must be
made by the indemnified parties prior to March 31, 1997, although payment or
other resolution of claims made within such period may take longer. The
indemnification is payable by the holders of Khepri Preferred Stock entitled to
receive the Second Payment on a pro-rata basis (the "Indemnifying
Stockholders"). Under the terms of the Merger Agreement, the maximum liability
of each Indemnifying Stockholder is equal to the following percentage of the
total consideration payable to such Indemnifying Stockholder pursuant to the
Merger: (i) twenty percent (20%) up to and including June 22, 1996; (ii) fifteen
percent (15%) from June 23, 1996 until December 31, 1996, together with any
claims made during the period specified in (i) above (subject to the maximum
specified in (i)); (iii) seven and one-half percent (7.5%) from and after
January 1, 1997 up to and including March 31, 1997, plus any claims previously
made (subject to the maximums set forth in (i) and (ii) above); and (iv) zero
percent (0%) after March 31, 1997, plus any claims previously made (subject to
the maximums set forth in (i), (ii) and (iii) above). Subject to certain
procedures set forth in the Merger Agreement, Arris first must satisfy any
liability of the Indemnifying Stockholders for indemnification by offsetting
such liability against the amounts payable to the Indemnifying Stockholders in
the Second Payment. The Indemnifying Stockholders will not be required to make
any indemnification payment until the total amount of damages for which
indemnification is applicable exceeds $100,000 in the aggregate, and then are
only required to pay for the portion of such damages which exceeds $100,000.
Certain provisions have been made for purposes of resolving disputed claims and
the like. By approving the terms of the Merger, Khepri's stockholders appointed
A. Grant Heidrich as Stockholders' Representative with authority and power to
act on behalf of the stockholders with respect to indemnification issues and in
certain other matters in connection with the Merger Agreement.
INTEREST OF CERTAIN PARTIES
Brook Byers, a member of the Board of Directors of Arris, is a general
partner of Kleiner Perkins Caufield & Byers, which, together with its
affiliates, owned approximately 17.2% of the outstanding capital stock of Khepri
prior to the Merger. Kleiner Perkins Caufield & Byers and its affiliates would
receive 92,662 shares of Arris Common Stock in the Second Stock Payment,
assuming no collar adjustment, or $1,154,740 if the Company makes the Cash
Payment. Mr. Byers did not participate in the negotiation of the Merger or the
Arris Board of Directors' consideration or approval of the Merger. No other
officer, director or principal stockholder of Arris had any material interest in
the Merger, other than an interest arising solely from ownership of securities
of Arris.
Arris has entered into transition service agreements with each of Donald G.
Payan, M.D., David A. Estell, Ph.D, and N. Jean Warner, M.D., each a former
executive officer of Khepri, pursuant to which
8
<PAGE>
such persons became Vice Presidents of Arris upon consummation of the Merger.
Such transition services agreements provide that such persons (i) continued to
receive their then-current salaries, subject to a percentage increase which
occurred on January 1, 1996 determined by the Arris compensation committee to be
awarded to employees rated as outstanding on such date, (ii) were granted a
signing bonus in the amount of $10,000 in the cases of Drs. Payan and Estell,
and an option to purchase 10,000 shares of Arris Common Stock in accordance with
Arris' company policies in the case of Drs. Warner and Estell, (iii) receive a
one-time lump sum bonus of fifty percent (50%) of their respective base salaries
on December 22, 1996 if still employed by Arris on such date, and (iv) shall
receive as severance if terminated by Arris without cause prior to December 22,
1996, twelve months salary and continued vesting of their stock options for two
years.
Pursuant to the Merger Agreement, each of Arris and Khepri adopted a
severance plan which provides for severance payments to be paid to their
employees if such employees are terminated in connection with the Merger on or
before June 22, 1996. Such severance arrangement consists of a cash payment of
either three, six or twelve months base salary, depending upon the nature of
such employee's position with Arris or Khepri, as the case may be (together with
payment of such employee's medical coverage during such period), and
acceleration of vesting of such employee's stock options for the period of such
employee's severance period plus one year.
9
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
ARRIS PHARMACEUTICAL CORPORATION
The selected consolidated financial data set forth below with respect to the
statements of operations for each of the three years in the period ended
December 31, 1995 and balance sheets at December 31, 1994 and 1995, are derived
from financial statements of Arris that have been audited by Ernst & Young LLP,
independent auditors. These financial statements are not included in this Proxy
Statement but are incorporated by reference from the audited financial
statements in Arris' Annual Report on Form 10-K for the year ended December 31,
1995, which financial statements are included in the Annual Report to
Stockholders being mailed to stockholders together with this Proxy Statement.
The statement of operations data for the years ended December 31, 1991 and 1992
and the balance sheet data as of December 31, 1992 and 1993 are also derived
from financial statements audited by Ernst & Young LLP but not included in this
Proxy Statement. The data should be read in conjunction with the financial
statements and related notes incorporated by reference and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" which
is also included in the Annual Report to Stockholders.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1991 1992 1993 1994 1995 (1)
--------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS:
Contract revenues................................... $ 25 $ -- $ 2,542 $ 8,304 $ 16,727
Operating expenses
Research and development.......................... 4,833 6,994 8,910 13,155 14,689
General and administrative........................ 869 1,531 2,283 4,010 4,247
Acquired in-process research and development...... -- -- -- -- 22,514
--------- ---------- ---------- ---------- ----------
Total operating expenses........................ 5,702 8,525 11,193 17,165 41,450
--------- ---------- ---------- ---------- ----------
Operating loss...................................... (5,677) (8,525) (8,651) (8,861) (24,723)
Interest income (expense), net...................... 49 (68) 172 522 990
--------- ---------- ---------- ---------- ----------
Net loss............................................ $ (5,628) $ (8,593) $ (8,479) $ (8,339) $ (23,733)
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
Net loss per share.................................. $ (1.44) $ (2.15) $ (2.10) $ (0.97) $ (2.71)
Weighted average number of shares outstanding....... 3,904 4,006 4,031 8,570 8,745
<CAPTION>
DECEMBER 31,
---------------------------------------------------------
1991 1992 1993 1994 1995 (2)
--------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable investments... $ 2,518 $ 8,422 $ 25,610 $ 30,070 $ 31,105
Total assets........................................ 4,949 11,934 31,063 34,786 40,293
Long-term obligations............................... 11,860 26,429 3,352 7,645 16,490
Accumulated deficit................................. (7,732) (16,325) (24,804) (33,298) (56,876)
Total stockholders' equity.......................... (7,698) (16,288) 21,654 13,425 7,278
</TABLE>
- - ------------------------
(1) Includes the results of operations of Khepri from December 22, 1995 through
December 31, 1995, including a one-time charge for acquired in-process
research and development. Excluding such one time charge, net loss and net
loss per share would have been $1,219,000 and $0.14 per share, respectively.
With the acquisition of Khepri, the Company expects net loss from continuing
operations to increase significantly.
(2) Includes the acquisition of Khepri as of December 22, 1995.
10
<PAGE>
SELECTED FINANCIAL DATA
KHEPRI PHARMACEUTICALS, INC.
The selected financial data set forth below with respect to the statements
of operations for the period from inception (April 24, 1992) to December 31,
1992 and the years ended December 31, 1993 and 1994, are derived from financial
statements of Khepri that have been audited by Ernst & Young LLP. These
financial statements are not included in this Proxy Statement but are
incorporated by reference from the Current Report on Form 8-K filed by Arris on
January 5, 1996, as amended on February 5, 1996 and the selected financial data
set forth below with respect to Khepri is qualified in its entirety by reference
to such financial statements and notes thereto. The statement of operations data
for the period ending December 22, 1995 is derived from unaudited financial
statements not included in this Proxy Statement. The unaudited financial
statements include all adjustments, consisting only of normal recurring
adjustments and accruals that Arris and Khepri consider necessary for a fair
presentation of the financial positions and results of operations for these
periods.
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED DECEMBER PERIOD FROM
INCEPTION (APRIL 31, JANUARY 1 TO
24, 1992) TO -------------------- DECEMBER 22, 1995
DECEMBER 31, 1992 1993 1994 (UNAUDITED)
------------------- --------- --------- -----------------
<S> <C> <C> <C> <C>
Revenues............................................. $ -- $ -- $ -- $ 727
Operating expenses:
Research and development........................... 544 3,596 6,991 6,600
General and administrative......................... 137 1,030 1,497 1,983
------ --------- --------- -------
Loss from operations................................. (681) (4,626) (8,488) (7,856)
Interest income (net)................................ 5 113 8 166
Loss from subsidiary................................. -- -- -- (322)
------ --------- --------- -------
Net loss............................................. $ (676) $ (4,513) $ (8,480) $ 8,012
------ --------- --------- -------
------ --------- --------- -------
Net loss per share................................... $ (.45)
Weighted average number of shares outstanding (1).... 17,609
</TABLE>
- - ------------------------
(1) Weighted average number of shares outstanding includes Common Stock and
Preferred Stock, on an as-if-converted basis.
11
<PAGE>
PRO FORMA COMBINED
The following table sets forth the unaudited combined pro forma statement of
operations for the year ended December 31, 1995 as if the operations of Arris
and Khepri had been combined as of January 1, 1995. The pro forma combined
statement of operations includes the consolidated financial results of Arris for
the twelve months ended December 31, 1995 (which consolidates the results of the
acquired operation for the nine-day period from date of acquisition, December
22, 1995, to December 31, 1995) and Khepri for the period from January 1, 1995
through the date of the Merger. All operations of Khepri were closed for the
nine-day period from the acquisition date to December 31, 1995. The combined
results are not necessarily indicative of the actual results that would have
occurred had the acquisition been consummated January 1, 1995, or of the future
operations of the combined entities.
<TABLE>
<CAPTION>
KHEPRI
PERIOD FROM
JANUARY 1, PRO FORMA
ARRIS 1995 THROUGH COMBINED
YEAR ENDED ACQUISITION YEAR ENDED
DECEMBER 31, DECEMBER 22, PRO FORMA DECEMBER 31,
1995 1995 ADJUSTMENTS 1995
------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Contract revenues....................... $ 16,727 $ 727 $ -- $ 17,454
Operating expenses:
Research and development.............. 14,689 6,600 645(1) 22,079
145(2)
General and administrative............ 4,247 1,983 30(2) 6,260
Acquired in-process research and
development.......................... 22,514 -- (22,514)(3) --
------------ ------------ ------------ ------------
Total operating expenses............ 41,450 8,583 (21,694) 28,339
------------ ------------ ------------ ------------
Operating loss.......................... (24,723) (7,856) 21,694 (10,885)
Interest income, net.................... 990 166 -- 1,156
Loss from subsidiary.................... -- (322) 322(1) --
------------ ------------ ------------ ------------
Net loss................................ $(23,733) $ (8,593) $ 22,016 $ (9,729)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net loss per share...................... $ (0.96)(4)
Weighted average number of shares
outstanding............................ 10,124
</TABLE>
- - ------------------------
(1) Adjustment to consolidate Khepri Canada operations into Arris operations and
reverse Khepri's recognition of Khepri Canada expense recorded under the
equity method of accounting.
(2) Adjustment reflects one year of amortization of acquired work force in
place, with a total fair value of $525,000, which is being amortized over a
three year life.
(3) Adjustment to reverse write-off of acquired research and development. This
amount is reflected as an expense in Arris' Consolidated Statement of
Operations for the year ended December 31, 1995 and in the Arris'
Consolidated Balance Sheet at December 31, 1995. It is eliminated from the
pro forma statements of operations since it is a nonrecurring charge
directly attributable to the acquisition.
(4) The pro forma combined net loss per share and shares used in computing
amounts for the year ended December 31, 1995 have been calculated assuming
that the acquisition occurred on January 1, 1995. Accordingly, the 1,415,000
shares issued on December 22, 1995 in the acquisition have been treated as
outstanding since January 1, 1995.
12
<PAGE>
INFORMATION WITH RESPECT TO ARRIS
Arris Annual Report on Form 10-K for the year ended December 31, 1995 as
filed with the Securities and Exchange Commission on March 14, 1996, is
incorporated by reference herein. Certain Sections of the Form 10-K are included
in the 1995 Annual Report to Stockholders which is being mailed to stockholders
concurrently with this Proxy Statement.
DESCRIPTION OF ARRIS CAPITAL STOCK
The description of Arris capital stock is incorporated by reference from the
Company's Registration Statement on Form 8-A (File No. 0-22788), as filed with
the Securities and Exchange Commission on November 4, 1993.
KHEPRI -- BUSINESS
Khepri was incorporated in the State of Delaware in August 1992, and was a
privately held corporation at the time of the Merger. Khepri was a development
stage corporation focused on accelerating the discovery and development of the
next-generation of protease-based therapeutics. Khepri's technology was directed
exclusively on those regulatory proteases and their inhibitors that provide
potential therapeutic utility. Khepri's goal was to develop novel therapeutics
that intervene at key control points in disease processes with an approach that
combines biology and chemistry to create new tools for rapid lead compound
development. At the time of the Merger, Khepri had three product development
programs: a protease (aerosolized rNEP) for asthma and chronic obstructive
pulmonary disease, and small molecule protease inhibitors for arthritis and for
osteoporosis.
Khepri built a technology platform with emphasis on protease genomics, gene
expression, chemistry, biology and drug design. These capabilities led to the
identification of proteases that may be important disease targets. Khepri's
protease technology provides new opportunities in the discovery of
protease-based therapeutics for various diseases, including infectious diseases,
organ transplant rejection, cancer and tissue ischemia.
In the field of regulatory proteases and their inhibitors, Khepri's
strategic focus was based on the following capabilities and tools:
- PROTEASE GENOMICS: The ability to rapidly identify and analyze new genes,
their associated proteins, and to determine their pharmaceutical relevance
is a critical step in drug discovery. Using a variety of techniques,
Khepri had, within the last year, isolated and characterized nine full
length protease genes. Khepri believed that its capabilities in protease
expression, inhibitor design and protease biology would facilitate the
accelerated determination of the biological and medical importance and
potential therapeutic utility of these and other novel genes.
- PROTEASE EXPRESSION: Khepri researchers have developed multiple expression
systems that can be used to express large amounts of human proteases. This
capability accelerates target characterization and inhibitor design.
- PROTEASE INHIBITOR DESIGN: Khepri's proprietary chemistries and experience
relevant to structure/function relationships in proteases may permit
inhibitor design for specific target proteases. Khepri scientists have
designed inhibitors which are orally bioavailable, chemically stable and
are unreactive in the absence of specific targeted proteases. In addition
to this drug design approach, Khepri has augmented its discovery
capabilities by implementing a "targeted" combinatorial chemistry
approach. Khepri believed that these tools reduce the time required to
produce a new lead compound.
- PROTEASE BIOLOGY: Khepri has developed proprietary IN VIVO and IN VITRO
techniques for determining the therapeutic utility of proteases and
specific inhibitors against novel targets. In addition, Khepri has
technology to identify the biological substrate(s) for a specific
protease. Khepri scientists also have developed techniques for labeling
the particular protease involved in a given biological process. This
technology allows Khepri to identify regulatory proteases and inhibitors
that are involved in disease processes.
13
<PAGE>
In March 1995, Khepri formed Khepri Pharmaceuticals Canada, Inc. ("Khepri
Canada"), a subsidiary incorporated under the laws of Quebec, Canada and located
in Montreal. Fifty percent (50%) of the outstanding capital stock of Khepri
Canada is owned by Khepri, and the remaining fifty percent (50%) is held in
equal amounts by two Canadian investors.
At the time of the Merger, Khepri had 44 employees, 36 of whom were directly
involved in research and development. Khepri's principal executive offices were
located at 260 Littlefield Avenue, South San Francisco, California, 94080, and
its telephone number was (415) 794-3500.
PROPERTIES
At the time of the Merger, Khepri occupied approximately 32,000 square feet
of office and laboratory space in South San Francisco, California. Arris is now
occupying this space as an expansion of its corporate facilities.
LEGAL PROCEEDINGS
At the time of the Merger, Khepri was not a party to any material legal
proceedings.
FINANCIAL INFORMATION
Prior to the Merger, the Common Stock of Khepri was not publicly traded.
Khepri did not, from its inception until December 22, 1995, declare or pay any
dividends on its Common Stock.
Financial statements of Khepri for the years ended December 31, 1994 and
December 31, 1993, which were audited by Ernst & Young LLP, and the unaudited
pro forma combined financial statements, which include the financial operations
of Khepri for the period from January 1 to December 22, 1995, are incorporated
by reference from the Current Report on Form 8-K filed by Arris on January 5,
1996, as amended on February 5, 1996.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FROM JANUARY 1,
1995
TO THE DATE OF
ACQUISITION YEAR ENDED YEAR ENDED
(DECEMBER 22, 1995) DECEMBER 31, 1994 DECEMBER 31, 1993
------------------- ----------------- -----------------
($000'S)
<S> <C> <C> <C>
Revenues.............................................. $ 727 $ -- $ --
Operating expenses:
Research and development............................ 6,600 6,991 3,596
General and administrative.......................... 1,983 1,497 1,030
------- ------- -------
Total operating expenses.......................... 8,583 8,488 4,626
------- ------- -------
Operating loss........................................ (7,856) (8,488) (4,626)
Interest income, net.................................. 166 8 113
Loss from subsidiary.................................. (322) -- --
------- ------- -------
Net Loss.............................................. $ (8,012) $ (8,480) $ (4,513)
------- ------- -------
------- ------- -------
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
In December 1995, Arris acquired Khepri in a stock-for-stock merger. The
following discussion relates to the historical operations of Khepri prior to the
completion of the Merger. As a result of the Merger, the operations of Khepri
have been substantially restructured. Therefore, the information set forth below
may not be indicative of future operating results of Khepri or Khepri and Arris
combined. See the information appearing under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations" which
is included in the Annual Report to Stockholders being mailed to stockholders
concurrently with this Proxy Statement and is incorporated by reference herein.
14
<PAGE>
RESULTS OF OPERATIONS
PERIOD FROM JANUARY 1 TO DECEMBER 22, 1995 AND YEAR ENDED DECEMBER 31, 1994
Khepri reported revenues of $727,000 in 1995 from evaluation studies by
potential collaboration partners, federal research grants, and the sale of
scientific compounds to its Canadian subsidiary. Khepri had no revenues in 1993
and 1994.
Research and development costs decreased to $6,600,000 in 1995 from
$6,991,000 in 1994 due to a reduction in the use of outside services, scientific
and general supplies, and travel.
General and administrative costs increased to $1,983,000 in 1995 from
$1,497,000 in 1994 mainly due to an increase in professional and banking fees
related to the acquisition of Khepri by Arris and additional personnel expenses,
due to the addition of a chief financial officer.
Net interest income increased to $166,000 in 1995 from $8,000 in 1994 mainly
due to higher interest income as a result of high average cash and cash
equivalent balances in 1995 from the closing of approximately $11 million of
equity financing in November 1994. Interest expense in 1995 was approximately
equal to interest expense in 1994.
Khepri recorded a loss of $322,000 under the equity method of accounting,
representing its share in the operating results of its 50% owned Canadian
subsidiary, formed in March 1995.
YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993
Research and development costs increased to $6,991,000 in 1994 from
$3,596,000 in 1993 due to expansion of Khepri's scientific programs and the
expenses of such programs, the most significant including increased personnel
and related expenses, scientific and general supply expenditures and outside
services.
General and administrative costs increased to $1,497,000 in 1994 from
$1,030,000 in 1993 mainly due to an increase in personnel, including the
addition of a chief executive officer, and increased consulting, facilities and
depreciation expenses.
Net interest income decreased to $8,000 in 1994 from $113,000 in 1993 mainly
due to lower interest income as a result of lower average cash balances in 1994
and higher interest expense in 1994 due to higher average borrowings in 1994.
LIQUIDITY AND CAPITAL RESOURCES
At the time of the Merger, Khepri had $3,697,000 of cash and cash
equivalents, including $1,947,000 which was held by the Canadian subsidiary.
Khepri also had approximately $500,000 of credit availability under a lease line
facility.
COMPARATIVE PER SHARE DATA
The following table sets forth certain per share data of Arris and Khepri
and combined per share data on an unaudited pro forma basis after giving effect
to the Merger described herein. The table assumes that all the outstanding
shares of Khepri will be acquired through the issuance of 1,933,460 shares of
Arris common stock (effectively a .1097 exchange ratio) in the Merger. This data
should be read in conjunction with the unaudited pro forma condensed financial
statements and the separate historical financial statements of Arris and Khepri
and notes thereto incorporated by reference in this Proxy Statement. The pro
forma combined financial data and supplemental pro forma combined
15
<PAGE>
financial data are not necessarily indicative of the operating results that
would have been achieved had the Merger been consummated as of the beginning of
the year nor is such data necessarily indicative of future financial condition
or results of operations.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31, 1995
-----------------
<S> <C>
Arris:
Loss per share............................................................................... $ (2.71)
Book value per share (1)..................................................................... $ .72
Khepri:
Loss per share (2)........................................................................... $ (.45)
Book value per share (3)..................................................................... $ .08
Pro Forma combined Loss Per Share:
Per Arris share (4).......................................................................... $ (.96)
Equivalent per Khepri share (5).............................................................. $ (.11)
Pro forma combined book value per share (4):
Per Arris share.............................................................................. $ .72
Equivalent per Khepri share (5).............................................................. $ .08
</TABLE>
- - ------------------------
(1) The historical book value per share is computed by dividing stockholders'
equity by the number of shares of Common Stock outstanding at the end of the
year.
(2) Weighted average shares outstanding includes common stock and preferred
stock, included on an as-if-converted basis.
(3) The historical book value per share of Khepri is computed by dividing
stockholders' equity immediately preceding the acquisition (as of December
22, 1995) by the aggregate number of shares of Khepri's Common and Preferred
Stock outstanding at December 22, 1995.
(4) The write-off of acquired in-process research and development has been
eliminated from the pro forma combined loss per share since it is a
non-recurring charge directly attributable to the Merger. It has been
included in the pro forma combined book value per share, as the charge had
been accrued as of December 31, 1995.
(5) Calculated by multiplying the Arris proforma combined per share amounts by
the exchange ratio of .1097.
PRO FORMA FINANCIAL INFORMATION
Unaudited pro forma financial statements for the combined operations of
Arris and Khepri for the year ended December 31, 1995, are incorporated by
reference from the Current Report on Form 8-K filed by Arris on January 5, 1996,
as amended on February 5, 1996.
OTHER INFORMATION
A public fairness hearing was held at the offices of the California
Department of Corporations, Sacramento, California, on December 14, 1995, in
connection with the Merger, pursuant to Section 3(a)(10) of the Securities Act
of 1933, as amended.
The high and low sale prices per share of the Company's Common Stock on the
Nasdaq National Market on November 7, 1995, the trading day prior to the date
the transaction was announced, were $10.75 and $9.50, respectively.
Representatives of Ernst & Young LLP, the Company's independent auditors are
expected to be present at the Annual Meeting, will have the opportunity to make
a statement if they desire to do so, and are expected to be available to respond
to stockholder questions.
16
<PAGE>
PROPOSAL 3
APPROVAL OF THE ISSUANCE OF ARRIS COMMON STOCK
TO SHAREHOLDERS OF KHEPRI CANADA
IN CONNECTION WITH ARRIS' ACQUISITION OF
KHEPRI PHARMACEUTICALS, INC.
BACKGROUND
In December 1995, Arris acquired Khepri in a transaction more fully
described in Proposal 2. As part of the Merger, Arris assumed certain rights and
obligations under existing agreements between Khepri, Khepri Pharmaceuticals
Canada, Inc. (a 50% owned subsidiary of Khepri referred to herein as "Khepri
Canada") and two Canadian investors (the "Class B Shareholders"), and entered
into amendments to two of such agreements. Under the terms of such amended
agreements, Arris and the Class B Shareholders will make additional investments
in Khepri Canada in exchange for additional shares of Khepri Canada stock (Class
B Shares in the case of the Class B Shareholders), provided neither Arris nor
such Class B Shareholders terminate the obligations to make such additional
investments prior to July 1, 1996. Class B Shares issued pursuant to such
additional investments will be exchangeable for shares of Arris Common Stock on
or after March 24, 1998, as more fully described below.
The Company's Common Stock trades on the Nasdaq National Market. The NASD
rules applicable to Arris provide that Arris' stockholders must approve the
issuance of Arris Common Stock issued in connection with the Merger to the
extent the number of shares of Arris Common Stock to be issued exceeds 20% of
the number of shares of Arris Common Stock outstanding prior to the Merger.
Proposal 3 seeks the approval, to the extent required by the NASD rule
described above, for the issuance of shares of Arris Common Stock to the Class B
Shareholders of Khepri Canada sufficient to meet the exchange right of the Class
B Shareholders with respect to Class B Shares they acquire on or after July 1,
1996, as more fully described below.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF PROPOSAL 3.
DESCRIPTION OF TRANSACTION
Khepri Canada was formed in March 1995 as a subsidiary of Khepri,
incorporated under the laws of Quebec, Canada and located in Montreal. Fifty
percent (50%) of the outstanding capital stock of Khepri Canada are Class A
Shares and are owned by Arris, and the remaining fifty percent (50%) are Class B
Shares and are held in equal amounts by the Class B Shareholders. The Class A
Shares and Class B Shares have equal voting rights.
On March 24, 1995, Khepri entered into a Subscription Agreement and a Stock
Exchange Agreement with Khepri Canada and the Class B Shareholders pursuant to
which Khepri and the Class B Shareholders were obligated to make certain equity
investments in Khepri at specified times (the "Khepri Canada Agreements"). Under
the terms of the Khepri Canada Agreements, Class B Shares would have been
convertible into shares of Khepri Class D Preferred Stock. The Khepri Canada
Agreements were amended in connection with the Merger.
The Khepri Canada Agreements, as amended, provide for additional investments
(the "Additional Investments") in Khepri Canada as follows: on each of July 1,
1996, and March 24, 1997, Arris will invest CDN $666,667 in Khepri Canada and
each of the two Class B Shareholders will invest CDN $1,333,333 in Khepri
Canada. In exchange for the Additional Investments, on each such investment
date: (i) Arris will receive that number of Class A Shares equal to CDN $666,667
divided by the then current CDN dollar equivalent of U.S. $0.45 (if on the July
1, 1996 investment date) or U.S. $0.54 (if on the March 24, 1997 investment
date); and (ii) the two Class B Shareholders will each receive that number of
Class B Shares equal to CDN $1,333,333 divided by the then current CDN
equivalent of U.S. $1.80 (if on the July 1, 1996 investment date) or U.S. $2.16
(if on the March 24, 1997 investment date).
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The Khepri Canada Agreements, as amended, give each of Arris and the Class B
Shareholders the right to terminate, prior to July 1, 1996, the obligations to
make the Additional Investments. If such obligations are so terminated, the
Class B Shareholders would have the right to exchange their currently held Class
B Shares for shares of Arris Common Stock at an exchange rate of 0.12766 shares
of Arris Common Stock per Class B Share (the "Exchange Ratio"), resulting in an
aggregate of 161,418 shares of Arris Common Stock. If the obligations to make
the Additional Investments are not terminated, the Class B Shareholders will
have the right, on or after March 24, 1998, to exchange their Class B Shares
then held for shares of Arris Common Stock at the Exchange Ratio. The effective
price per share of Arris Common Stock that will be paid by the Class B
Shareholders if the Khepri Canada Agreements are not terminated is $14.10 for
the July 1, 1996 investment and $16.92 for the March 24, 1997 investment. The
exact number of such shares of Arris Common Stock is not presently determinable
as it is dependent upon the currency exchange rate for Canadian funds at the
time of the Additional Investments.
Upon the exchange of Class B Shares for Arris Common Stock, whether or not
the obligation to make the Additional Investments is terminated, the Class B
Shareholders will be entitled to certain registration rights with respect to
shares of Arris Common Stock received in the exchange.
Pursuant to Section 6(i)(1)(c)(ii) of Part III of Schedule D to the NASD
By-Laws, the stockholders of Arris are required, by majority vote, to approve
any issuance of stock in connection with the Merger which constitutes an amount
equal to more than twenty percent (20%) of the outstanding capital stock prior
to the Merger. As a result, Arris may not issue Arris Common Stock to the Class
B Shareholders in exchange for Class B Shares acquired in connection with the
Additional Investments unless this Proposal 3 is approved by the Arris
stockholders. If Proposal 3 is not approved, Arris will exercise its right to
terminate the Khepri Canada Agreements.
The Board of Directors is recommending a vote in favor of this Proposal 3 in
order to give the Company the flexibility to continue the Khepri Canada
Agreements. Such agreements not only provide additional funding to Arris on
potentially attractive terms but also permit the Company to receive certain
Canadian and Province of Quebec benefits associated with research and
development conducted by Canadian private companies in Canada and the Province
of Quebec. Even if the stockholders of Arris approve this Proposal 3, the Board
of Directors will retain the right (through June 30, 1996) to terminate the
Khepri Canada Agreements if it subsequently determines that such termination is
in the best interests of the Company.
PROPOSAL 4
APPROVAL OF THE 1989 STOCK PLAN, AS AMENDED
In May 1989, the Board of Directors adopted the Company's 1989 Stock Plan
(the "1989 Plan"). As a result of a series of amendments, at February 29, 1996
there were 2,117,500 shares of the Company's Common Stock authorized for
issuance under the 1989 Plan.
At February 29, 1996, options (net of canceled, repurchased or expired
options) covering an aggregate of 2,107,273 shares of the Company's Common Stock
had been granted under the 1989 Plan and 10,227 shares (plus any shares that
might in the future be returned to the reserve as a result of cancellations or
expiration of options) remained available for future grants under the 1989 Plan.
In December and February 1996, options covering an additional 190,000 shares
were granted subject to stockholder approval of the amendment to the 1989 Plan,
pursuant to this Proposal 4. See "Option Grants Subject to Stockholder
Approval." During the last fiscal year, under the 1989 Plan, the Company granted
to the officers named in the Summary Compensation Table the options described in
the Option Grants Table and granted to all employees as a group (excluding
executive officers) options to purchase 368,925 shares at exercise prices of
$6.19 to $13.08 per share. No options have been granted under the 1989 Plan to
any of the current directors who are not officers of the Company.
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<PAGE>
In February 1996, the Board approved an amendment to the 1989 Plan, subject
to stockholder approval, to increase the number of shares authorized for
issuance under the 1989 Plan by 550,000 shares, to a total of 2,667,500 shares.
The Board adopted this amendment to ensure that the Company can continue to
grant options under the 1989 Plan to employees at levels determined appropriate
by the Board and the Compensation Committee.
Stockholders are requested in this Proposal 4 to approve the 1989 Plan, as
amended. If the stockholders fail to approve this Proposal 4, options approved
by the Board covering 190,000 shares could not be exercised under the 1989 Plan.
The affirmative vote of the holders of a majority of the shares present in
person or represented by proxy and entitled to vote at the meeting will be
required to approve the 1989 Plan, as amended. Abstentions will be counted
toward the tabulation of votes cast on proposals presented to the stockholders
and will have the same effect as negative votes. Broker non-votes are counted
towards a quorum, but are not counted for any purpose in determining whether
this matter has been approved.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF PROPOSAL 4.
THE 1989 STOCK PLAN
The essential features of the 1989 Plan are outlined below.
GENERAL
The 1989 Plan was adopted by the Board of Directors in May 1989 and amended
in November 1990, March 1992, April 1993, April 1994 and February 1995, and
approved by the stockholders from time to time thereafter. The 1989 Plan
provides for the grant of both incentive and nonstatutory stock options as well
as restricted stock purchase rights. Incentive stock options granted under the
1989 Plan are intended to qualify as "incentive stock options" within the
meaning of Section 422 of the Internal Revenue Code of 1989, as amended (the
"Code"). Nonstatutory stock options granted under the 1989 Plan are intended not
to qualify as incentive stock options under the Code. See "Federal Income Tax
Information" for a discussion of the tax treatment of the various awards
provided under the 1989 Plan.
PURPOSE
The purpose of the 1989 Plan is to attract and retain qualified personnel,
to provide additional incentives to employees, officers and consultants of the
Company and to promote the success of the Company's business. Pursuant to the
1989 Plan, the Company may grant or issue incentive stock options to employees
and officers and nonstatutory stock options or stock purchase rights to
consultants, employees and officers. Directors who are not salaried employees of
or consultants to the Company are not eligible to participate in the 1989 Plan.
All the Company's approximately 127 employees presently are eligible to
participate in the 1989 Plan.
ADMINISTRATION
The 1989 Plan is administered by the Board of Directors of the Company. The
Board has the power to construe and interpret the 1989 Plan and, subject to the
provisions of the 1989 Plan, to determine the persons to whom and the dates on
which awards will be granted, the number of shares to be subject to each award,
the time or times during the term of each award within which all or a portion of
such award may be exercised, the exercise price, the type of consideration and
other terms of the award. The Board of Directors is authorized to delegate
administration of the 1989 Plan to a committee and has delegated such authority
to the Compensation Committee and, for grants to employees other than executive
officers, the Option Committee. As used herein with respect to the 1989 Plan,
the "Board" refers to the Compensation Committee and the Option Committee as
well as to the Board of Directors itself.
The Company currently limits the directors who may serve as members of the
Compensation Committee to those who are "outside directors." This limitation
excludes from the Compensation
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Committee (i) current employees of the Company, (ii) former employees of the
Company receiving compensation for past services (other than benefits under a
tax-qualified retirement plan), (iii) current and former officers of the
Company, (iv) directors currently receiving direct or indirect compensation from
the Company in any capacity (other than as a director), unless any such person
is otherwise considered an "outside director" under applicable federal guidance.
ELIGIBILITY
No stock option may be granted under the 1989 Plan to any person who, at the
time of the grant, owns (or is deemed to own) stock possessing more than 10% of
the total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at least 110% of the fair market value of
the stock subject to the option on the date of grant, and the term of the option
does not exceed five years from the date of grant. For incentive stock options,
the aggregate fair market value, determined at the time of grant, of the shares
of Common Stock with respect to which such options are exercisable for the first
time by an optionee during any calendar year (under all such plans of the
Company and its affiliates) may not exceed $100,000.
Under the 1989 Plan, no individual may be granted options covering more than
300,000 shares of Common Stock in any calendar year. The principal purpose for
such a per-employee limitation is to comply with IRS regulations that permit
certain performance-based compensation, including compensation attributable to
stock options that meet specified criteria, to be exempt from the $1,000,000
limitation under Section 162(m) of the Code on the amount that may be deducted
by publicly held corporations for compensation paid to certain employees. See
"Federal Income Tax Information." To date, the Company has not granted to any
employee in any calendar year options to purchase a number of shares equal to or
greater than the limitation and does not currently have any intention of
granting such number of options to any employee. There can be no assurance,
however, that the Board will not determine in some future circumstances that it
would be in the best interests of the Company and its stockholders to grant
options to purchase such number of shares to a single employee during a calendar
year.
STOCK SUBJECT TO THE 1989 PLAN
If options granted under the 1989 Plan expire or otherwise terminate without
being exercised, the Common Stock not purchased pursuant to such options again
becomes available for issuance under the 1989 Plan.
The permissible terms of options and restricted stock purchase rights under
the 1989 Plan are
described below. Individual option grants and restricted stock purchase rights
may be more restrictive as to any or all of the permissible terms described
below.
TERMS OF OPTIONS
EXERCISE PRICE; PAYMENT. The exercise price of incentive stock options
under the 1989 Plan may not be less than the fair market value of the Common
Stock subject to the option on the date of the option grant, and in some cases
(see "Eligibility" above), may not be less than 110% of such fair market value.
The exercise price of nonstatutory options under the 1989 Plan may not be less
than 85% of the fair market value of the Common Stock subject to the option on
the date of the option grant, and also in some cases may not be less than 110%
of such fair market value (see "Eligibility" above). If options are granted with
exercise prices below market value, however, deductions for compensation
attributable to the exercise of such options could be limited by Section 162(m)
of the Code. See "Federal Income Tax Information." In its discretion, the Board
may later reduce the exercise price of any option to the then current fair
market value of the Common Stock. Deductions for compensation attributable to
the exercise of such options could also be limited by Section 162(m) of the
Code. At May 2, 1996, the closing price of the Company's Common Stock as
reported on the Nasdaq National Market was $14.875 per share.
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<PAGE>
The exercise price of options granted under the 1989 Plan must be paid
either: (a) in cash at the time the option is exercised; or (b) at the
discretion of the Board, (i) by delivery of other Common Stock of the Company
(ii) pursuant to a deferred payment arrangement or (iii) in any other form of
legal consideration acceptable to the Board.
OPTION EXERCISE. Options granted under the 1989 Plan may become exercisable
in cumulative increments ("vest") as determined by the Board. Shares covered by
currently outstanding options under the 1989 Plan typically vest at the rate of
12.5% of the shares subject to the option at the end of the first six months and
1/48th of the shares subject to the option each month for 42 months thereafter.
Shares covered by options granted in the future under the 1989 Plan may be
subject to different vesting terms. The Board has the power to accelerate the
time during which an option may be exercised. To the extent provided by the
terms of an option, an optionee may satisfy any federal, state or local tax
withholding obligation relating to the exercise of such option by a cash payment
upon exercise, by authorizing the Company to withhold a portion of the stock
otherwise issuable to the optionee, by delivering already owned stock of the
Company or by a combination of these means.
TERM. The maximum term of options under the 1989 Plan is 10 years, except
that in certain cases (see "Eligibility") the maximum term is five years.
Options under the 1989 Plan terminate ninety days after termination of the
optionee's employment or relationship as a consultant of the Company or any
subsidiary of the Company, unless (a) such termination is due to such person's
permanent and total disability (as defined in the Code), in which case the
option may, but need not, provide that it may be exercised at any time within
twelve months of such termination; (b) the optionee dies while employed by or
serving as a consultant of the Company or any affiliate of the Company, or
within 90 days after termination of such relationship, in which case the option
may, but need not, provide that it may be exercised (to the extent the option
was exercisable at the time of the optionee's death) within twelve months of the
optionee's death by the person or persons to whom the rights to such option pass
by will or by the laws of descent and distribution; or (c) the option by its
terms specifically provides otherwise. Individual options by their terms may
provide for exercise within a longer period of time following termination of
employment or the consulting relationship. The option term may also be extended
in the event that exercise of the option within these periods is prohibited for
specified reasons.
TERMS OF RESTRICTED STOCK PURCHASE RIGHTS
PURCHASE PRICE; TERM. The purchase price under each stock purchase
agreement may not be less than 50% of the fair market value of the Common Stock
subject to the restricted stock purchase right on the date such right is
granted. The term of such restricted stock purchase right may not exceed 30 days
or such longer time as may be determined by the Board.
REPURCHASE. Shares of the Common Stock sold under the 1989 Plan may, but
need not, be subject to a repurchase option in favor of the Company in
accordance with a vesting schedule determined by the Board. In the event a
purchaser ceases to be an employee of or consultant to the Company or an
affiliate of the Company, the Company may repurchase any or all of the shares of
the Common Stock held by that purchaser that have not vested as of the date of
termination at the original price paid by the purchaser and the repurchase price
may be paid by cancellation of an indebtedness of the purchaser to the Company.
ADJUSTMENT PROVISIONS
If there is any change in the stock subject to the 1989 Plan or subject to
any option granted under the 1989 Plan (through merger, consolidation,
reorganization, recapitalization, stock dividend, dividend in property other
than cash, stock split, liquidating dividend, combination of shares, exchange of
shares, change in corporate structure or otherwise), the 1989 Plan and options
outstanding thereunder will be appropriately adjusted as to the class and the
maximum number of shares subject to such plan, the maximum number of shares
which may be granted to an employee during a calendar year, and the class,
number of shares and price per share of stock subject to such outstanding
options.
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<PAGE>
EFFECT OF CERTAIN CORPORATE EVENTS
The 1989 Plan provides that, in the event of a merger of the Company, such
options shall be assumed or equivalent options substituted by each successor
corporation or a parent or subsidiary of such successor corporation.
DURATION, AMENDMENT AND TERMINATION
The Board may suspend or terminate the 1989 Plan without stockholder
approval at any time. Unless sooner terminated, the 1989 Plan will terminate in
May 1999.
The Board may also amend the 1989 Plan at any time or from time to time.
However, no amendment will be effective unless approved by the stockholders of
the Company within twelve months before or after its adoption by the Board if
the amendment would: (a) modify the requirements as to eligibility for
participation (to the extent such modification requires stockholder approval in
order for the Plan to satisfy Section 422 of the Code, if applicable, or Rule
16b-3 ("Rule 16b-3") of the Securities Exchange Act of 1934, as amended (the
"Exchange Act")); (b) increase the number of shares reserved for issuance upon
exercise of options; or (c) change any other provision of the Plan in any other
way if such modification requires stockholder approval in order to comply with
Rule 16b-3 or satisfy the requirements of Section 422 of the Code. The Board may
submit any other amendment to the 1989 Plan for stockholder approval, including,
but not limited to, amendments intended to satisfy the requirements of Section
162(m) of the Code regarding the exclusion of performance-based compensation
from the limitation on the deductibility of compensation paid to certain
employees.
RESTRICTIONS ON TRANSFER
Under the 1989 Plan, an option may not be transferred by the optionee
otherwise than by will or by the laws of descent and distribution and during the
lifetime of the optionee, may be exercised only by the optionee.
FEDERAL INCOME TAX INFORMATION
INCENTIVE STOCK OPTIONS. Incentive stock options under the 1989 Plan are
intended to be eligible for the favorable federal income tax treatment accorded
"incentive stock options" under the Code.
There generally are no federal income tax consequences to the optionee or
the Company by reason of the grant or exercise of an incentive stock option.
However, the exercise of an incentive stock option may result in the imposition
of or an increase in liability of the optionee for alternative minimum tax
liability.
If an optionee holds stock acquired through exercise of an incentive stock
option for at least two years from the date on which the option is granted and
at least one year from the date on which the shares are transferred to the
optionee upon exercise of the option, any gain or loss on a disposition of such
stock will be a long-term capital gain or loss. Generally, if the optionee
disposes of the stock before the expiration of either of these holding periods
(a "disqualifying disposition"), at the time of disposition, the optionee will
recognize taxable ordinary income equal to the lesser of (i) the excess of the
stock's fair market value on the date of exercise over the exercise price, or
(ii) the optionee's actual gain, if any, on the purchase and sale. The
optionee's additional gain, or any loss, upon the disqualifying disposition will
be a capital gain or loss, which will be long-term or short-term depending on
whether the stock was held for more than one year. Long-term capital gains
currently are generally subject to lower tax rates than ordinary income. The
maximum capital gains rate for federal income tax purposes is currently 28%
while the maximum ordinary income rate is effectively 39.6% at the present time.
Slightly different rules may apply to optionees who acquire stock subject to
certain repurchase options or who are subject to Section 16(b) of the Exchange
Act.
To the extent the optionee recognizes ordinary income by reason of a
disqualifying disposition, the Company will generally be entitled (subject to
the requirement of reasonableness, the provisions of Section 162(m) of the Code
and the satisfaction of a tax reporting obligation) to a corresponding business
expense deduction in the tax year in which the disqualifying disposition occurs.
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NONSTATUTORY STOCK OPTIONS. Nonstatutory stock options granted under the
1989 Plan generally have the following federal income tax consequences:
There are no tax consequences to the optionee or the Company by reason of
the grant of a nonstatutory stock option. Upon exercise of a nonstatutory stock
option, the optionee normally will recognize taxable ordinary income equal to
the excess of the stock's fair market value on the date of exercise over the
option exercise price. Generally, with respect to employees, the Company is
required to withhold from regular wages or supplemental wage payments an amount
based on the ordinary income recognized. Subject to the requirement of
reasonableness, the provisions of Section 162(m) of the Code and the
satisfaction of a tax reporting obligation, the Company will generally be
entitled to a business expense deduction equal to the taxable ordinary income
realized by the optionee. Upon disposition of the stock, the optionee will
recognize a capital gain or loss equal to the difference between the selling
price and the sum of the amount paid for such stock plus any amount recognized
as ordinary income upon exercise of the option. Such gain or loss will be long
or short-term depending on whether the stock was held for more than one year.
Slightly different rules may apply to optionees who acquire stock subject to
certain repurchase options or who are subject to Section 16(b) of the Exchange
Act.
RESTRICTED STOCK. Restricted stock granted under the 1989 Plan generally
has the following federal income tax consequences:
Upon acquisition of stock under a restricted stock award, the recipient
normally will recognize taxable ordinary income equal to the excess of the
stock's fair market value over the purchase price, if any. However, to the
extent the stock is subject to certain types of vesting restrictions, the
taxable event will be delayed until the vesting restrictions lapse unless the
recipient elects to be taxed on receipt of the stock. Generally, with respect to
employees, the Company is required to withhold from regular wages or
supplemental wage payments an amount based on the ordinary income recognized.
Subject to the requirement of reasonableness, the provisions of Section 162(m)
of the Code and the satisfaction of a tax reporting obligation, the Company will
generally be entitled to a business expense deduction equal to the taxable
ordinary income realized by the recipient. Upon disposition of the stock, the
recipient will recognize a capital gain or loss equal to the difference between
the selling price and the sum of the amount paid for such stock, if any, plus
any amount recognized as ordinary income upon acquisition (or vesting) of the
stock. Such gain or loss will be long or short-term depending on whether the
stock was held for more than one year from the date ordinary income is measured.
Slightly different rules may apply to persons who acquire stock subject to
forfeiture under Section 16(b) of the Exchange Act.
POTENTIAL LIMITATION ON COMPANY DEDUCTIONS. As part of the Omnibus Budget
Reconciliation Act of 1993, the U.S. Congress amended the Code to add Section
162(m), which denies a deduction to any publicly held corporation for
compensation paid to certain employees in a taxable year to the extent that
compensation exceeds $1,000,000 for a covered employee. It is possible that
compensation attributable to awards under the 1989 Plan, when combined with all
other types of compensation received by a covered employee from the Company, may
cause this limitation to be exceeded in any particular year.
Certain kinds of compensation, including qualified "performance-based
compensation," are disregarded for purposes of the deduction limitation. In
accordance with Treasury regulations issued under Section 162(m) of the Code,
compensation attributable to stock options will qualify as performance-based
compensation, provided that: (i) the stock award plan contains a per-employee
limitation on the number of shares for which stock options may be granted during
a specified period; (ii) the per-employee limitation is approved by the
shareholders; (iii) the award is granted by a compensation committee comprised
solely of "outside directors"; and (iv) the exercise price of the award is no
less than the fair market value of the stock on the date of grant. Restricted
stock qualifies as performance-based compensation under these proposed Treasury
regulations only if: (i) the award is granted by a compensation committee
comprised solely of "outside directors"; (ii) the award is
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<PAGE>
granted (or exercisable) only upon the achievement of an objective performance
goal established in writing by the compensation committee while the outcome is
substantially uncertain; (iii) the compensation committee certifies in writing
prior to the granting (or exercisability) of the award that the performance goal
has been satisfied; and (iv) prior to the granting (or exercisability) of the
award, shareholders have approved the material terms of the award (including the
class of employees eligible for such award, the business criteria on which the
performance goal is based, and the maximum amount (or formula used to calculate
the amount) payable upon attainment of the performance goal).
OPTION GRANTS SUBJECT TO STOCKHOLDER APPROVAL
The following table presents certain information with respect to options
granted under the 1989 Plan, subject to approval of the amendment of the 1989
Plan by the stockholders, to (i) each of the executive officers, (ii) the
executive officers as a group, and (iii) all non-executive officer employees as
a group. Non-employee directors are not eligible for options grants under the
1989 Plan.
NEW PLAN BENEFITS
<TABLE>
<CAPTION>
NUMBER OF SHARES
SUBJECT TO
NAME AND POSITION DOLLAR VALUE (1) OPTIONS GRANTED
- - ------------------------------------------------------------------------------ ----------------- -----------------
<S> <C> <C>
John P. Walker N/A 40,000
President and Chief Executive Officer
Michael J. Ross, Ph.D. N/A 20,000
Executive Vice President and Chief Technical Officer
Heinz W. Gschwend, Ph.D. N/A 20,000
Vice President, Research and Development, Inflammation
Daniel H. Petree N/A 20,000
Vice President, Corporate Development and Chief Financial Officer
All Executive Officers as a Group N/A 100,000
All Non-Executive Officer Employees as a Group N/A 90,000
</TABLE>
- - ------------------------
(1) All shares were granted at the fair market value of Arris Common Stock at
the date of grant, and will have a determinable dollar value only if the
fair market value of the Common Stock on the date of exercise is greater
than the fair market value on the date of grant. For an example of potential
realizable option values, see the table "Option Grants in Fiscal Year 1995"
under the heading "Executive Compensation."
PROPOSAL 5
APPROVAL OF EMPLOYEE STOCK PURCHASE PLAN, AS AMENDED
In October 1993, the Board of Directors adopted and the stockholders
subsequently approved, the Employee Stock Purchase Plan (the "Purchase Plan")
authorizing the issuance of 150,000 shares of the Company's Common Stock. At
February 29, 1996, an aggregate of 104,412 shares had been issued under the
Purchase Plan and only 45,488 shares remained for the grant of future rights
under the Plan. In February 1996, the Board of Directors of the Company adopted
an amendment to the Purchase Plan to increase the number of shares authorized
for issuance under the Purchase Plan by 100,000 shares to a total of 250,000
shares. This amendment is intended to afford the Company greater flexibility in
providing employees with stock incentives and to ensure that the Company can
continue to provide such incentives at levels determined appropriate by the
Board. During the last fiscal year, shares were purchased in the amounts and at
the weighted average prices per share under the Purchase Plan as follows: 47,045
shares at a weighted average price of $4.97 per share, all current executive
officers as a group 13,230 shares ($4.89), and all employees (excluding
executive officers) as a group 33,815 shares ($5.00).
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<PAGE>
Stockholders are requested in this Proposal 5 to approve the Purchase Plan,
as amended. The affirmative vote of the holders of a majority of the shares
present in person or represented by proxy and entitled to vote at the meeting
will be required to approve the Purchase Plan, as amended. Abstentions will be
counted toward the tabulation of votes cast on proposals presented to the
stockholders and will have the same effect as negative votes. Broker non-votes
are counted towards a quorum, but are not counted for any purpose in determining
whether this matter has been approved.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF PROPOSAL 5.
EMPLOYEE STOCK PURCHASE PLAN
The essential features of the Purchase Plan, as amended, are outlined below.
PURPOSE
The purpose of the Purchase Plan is to provide a means by which employees of
the Company (and any parent or subsidiary of the Company designated by the Board
of Directors to participate in the Purchase Plan) may be given an opportunity to
purchase Common Stock of the Company through payroll deductions, to assist the
Company in retaining the services of its employees, to secure and retain the
services of new employees, and to provide incentives for such persons to exert
maximum efforts for the success of the Company. All of the Company's
approximately 127 employees are eligible to participate in the Purchase Plan.
The rights to purchase Common Stock granted under the Purchase Plan are
intended to qualify as options issued under an "employee stock purchase plan" as
that term is defined in Section 423(b) of the Code.
ADMINISTRATION
The Purchase Plan is administered by the Board of Directors, which has the
final power to construe and interpret the Purchase Plan and the rights granted
under it. The Board has the power, subject to the provisions of the Purchase
Plan, to determine when and how rights to purchase Common Stock of the Company
will be granted, the provisions of each offering of such rights (which need not
be identical), and whether any parent or subsidiary of the Company shall be
eligible to participate in such plan. The Board of Directors is authorized to
delegate administration of the Purchase Plan to a committee and has delegated
such authority to the Compensation Committee. As used herein with respect to the
Purchase Plan, the "Board" refers to the Compensation Committee as well as the
Board itself.
OFFERINGS
Under the Purchase Plan, the Board from time to time may institute an
offering consisting of rights granted to all eligible employees to purchase
Common Stock periodically while such offering is in effect. Each such offering
may have a duration of no more than twenty-seven months. The Board determines
the duration of each offering and establishes one or more purchase dates during
the offering on which shares will be purchased by participating employees. Under
the terms of the offerings approved by the Board to date, each offering lasts
for two years, except that if, on a purchase date during an offering, the price
of the Company's Common Stock on such purchase date is lower than it was at the
start of the offering, then that offering automatically terminates and a new
offering begins on the following day. Currently, the Board has established
purchase dates to occur every six months, on each July 31, and January 31.
ELIGIBILITY
Generally, under the terms of the Purchase Plan, any employee who is
customarily employed at least 20 hours per week and five months per calendar
year by the Company (or by any parent or subsidiary of the Company designated
from time to time by the Board) on the first day of the offering period is
eligible to participate in that offering, provided that such employee has been
employed continuously for such period (which may not exceed two years) as the
Board may establish as a service
25
<PAGE>
requirement for participation. In addition, the Board may provide for the
commencement of participation at specified dates during an offering by employees
who first meet the eligibility requirements after the first day of the offering.
Currently, a continuous period of employment of three months is required for
otherwise eligible employees to participate in the Purchase Plan.
Notwithstanding the foregoing, no employee is eligible for the grant of any
rights under the Purchase Plan if, immediately after such grant, the employee
would own, directly or indirectly, stock possessing 5% or more of the total
combined voting power or value of all classes of stock of the Company or of any
parent or subsidiary of the Company (including any stock which such employee may
purchase under all outstanding rights and options). Also, under the Purchase
Plan no employee may be granted rights that would permit the purchase of more
than $25,000 worth of Common Stock (determined by using the fair market value of
the shares at the time such rights are granted) under all employee stock
purchase plans of the Company for each calendar year in which such rights are
outstanding. Under current and prior offerings, the Board has limited the amount
of Common Stock that any participant could purchase to 5,000 shares per
offering. Effective with the next offering under the Purchase Plan, which is
scheduled to begin on August 1, 1996, a participant may purchase on each
purchase date during an offering no more than the number of shares of Common
Stock determined by dividing $12,500 by the fair market value of the Common
Stock on the first day of the offering.
PARTICIPATION IN THE PLAN
Eligible employees become participants in the Purchase Plan by delivering to
the Company, prior to the date selected by the Board, an agreement authorizing
payroll deductions from such employees' total compensation during the offering.
The Purchase Plan permits payroll deductions of up to 15%, but under the
offerings made to date the Board has limited payroll deductions to no more than
10% of an employee's total compensation.
PURCHASE PRICE
The purchase price per share at which Common Stock is sold in an offering
under the Purchase Plan is the lower of (a) 85% of the fair market value of a
share of Common Stock on the date of commencement of the offering, or (b) 85% of
the fair market value of a share of Common Stock on the applicable purchase date
for the purchase of such Common Stock.
ACCUMULATION OF PURCHASE PRICE; PAYROLL DEDUCTIONS
The purchase price of the Common Stock is accumulated by payroll deductions
over the period of the offering. Payroll deductions of a participant begin on
the date specified in the offering and may be increased or reduced on the date
or dates specified in the offering. All payroll deductions made for a
participant are credited to the participant's account under the Purchase Plan
and are deposited with the general funds of the Company. A participant may not
make any additional payments into such account unless permitted under the terms
of an offering.
PURCHASE OF STOCK
By executing an agreement to participate in an offering under the Purchase
Plan, the employee becomes entitled to purchase shares under such offering. In
connection with offerings made under the Purchase Plan, the Board specifies a
maximum number of shares any participant may be granted the right to purchase
and the maximum aggregate number of shares which may be purchased pursuant to
such offering by all participants. Under the Purchase Plan, if the aggregate
number of shares to be purchased upon exercise of rights granted in the offering
would exceed the maximum aggregate number, the Board would make a pro rata
allocation of shares available in a uniform and equitable manner. Unless the
participant's participation is discontinued, the right to purchase shares is
exercised automatically on each purchase date at the applicable price. See
"Withdrawal" below.
26
<PAGE>
WITHDRAWAL
A participant may withdraw from a given offering by terminating payroll
deductions for such offering and delivering to the Company a notice of
withdrawal from the offering. Such withdrawal must be elected by the time set
forth in the applicable offering.
Upon any withdrawal from an offering by the participant, the Company will
distribute to the participant, without interest, the accumulated payroll
deductions in the participant's account under the Purchase Plan, less any
accumulated deductions previously applied to the purchase of stock on the
participant's behalf during such offering period, and such participant's
interest in the offering will be automatically terminated. The employee is not
entitled to again participate in such offering. An employee's withdrawal from an
offering will not have any effect upon such employee's eligibility to
participate in subsequent offerings under the Purchase Plan.
TERMINATION OF EMPLOYMENT
Rights granted pursuant to any offering under the Purchase Plan terminate
immediately upon cessation of a participant's employment for any reason, and the
Company will distribute to such participant, without interest, all of the
accumulated payroll deductions from the participant's account under the Purchase
Plan.
RESTRICTIONS ON TRANSFER
Rights granted under the Purchase Plan are not transferable and may be
exercised only by the person to whom such rights are granted.
DURATION, AMENDMENT AND TERMINATION
The Board may suspend or terminate the Purchase Plan at any time. Unless
terminated earlier, such plan will terminate on December 31, 2002.
The Board may amend the Purchase Plan at any time. To be effective any
amendment of the Purchase Plan must be approved by the stockholders within 12
months of its adoption by the Board if the amendment would (a) increase the
number of shares of Common Stock reserved for issuance under the Purchase Plan,
(b) modify the requirements relating to eligibility for participation in the
Purchase Plan, or (c) modify any other provision of the Purchase Plan in a
manner that would materially increase the benefits accruing to participants
under the Purchase Plan, if such approval is required in order to comply with
the requirements of Rule 16b-3 under the Exchange Act or Section 423 of the
Code.
Rights granted before amendment or termination of the Purchase Plan will not
be altered or impaired by any amendment or termination of such plan without the
consent of the employee to whom such rights were granted.
EFFECT OF CERTAIN CORPORATE EVENTS
In the event of a dissolution, liquidation or specified type of merger of
the Company, then, as determined by the Board in its sole discretion, the
surviving corporation either will assume the rights under the Purchase Plan or
substitute similar rights, or the purchase date under any ongoing offering will
be accelerated such that the outstanding rights may be exercised immediately
prior to any such event.
STOCK SUBJECT TO PURCHASE PLAN
If rights granted under the Purchase Plan expire, lapse or otherwise
terminate without being exercised, the Common Stock not purchased under such
rights again becomes available for issuance under such plan.
FEDERAL INCOME TAX INFORMATION
Rights granted under the Purchase Plan are intended to qualify for favorable
federal income tax treatment associated with rights granted under an employee
stock purchase plan which qualifies under provisions of Section 423 of the Code.
27
<PAGE>
A participant will be taxed on amounts withheld for the purchase of shares
as if such amounts were actually received. Other than this, no income will be
taxable to a participant until disposition of the shares acquired, and the
method of taxation will depend upon the holding period of the purchased shares.
If the stock is disposed of at least two years after the beginning of the
offering period and at least one year after the stock is transferred to the
participant, then the lesser of (a) the excess of the fair market value of the
stock at the time of such disposition over the purchase price or (b) the excess
of the fair market value of the stock as of the beginning of the offering period
over the exercise price (which for this purpose is deemed to be 85% of the fair
market value of the stock as of the beginning of the offering period) will be
treated as ordinary income. Any further gain or any loss will be taxed as a
long-term capital gain or loss. Capital gains currently are generally subject to
lower tax rates than ordinary income. The maximum capital gains rate for federal
income tax purposes is 28% while the maximum ordinary rate is effectively 39.6%
at the present time.
If the stock is sold or disposed of before the expiration of either of the
holding periods described above, then the excess of the fair market value of the
stock on the purchase date over the purchase price will be treated as ordinary
income at the time of such disposition, and the Company may, in the future, be
required to withhold income taxes relating to such ordinary income from other
payments made to the participant. The balance of any gain will be treated as
capital gain. Even if the stock is later disposed of for less than its fair
market value on the purchase date, the same amount of ordinary income is
attributed to the participant, and a capital loss is recognized equal to the
difference between the sales price and the fair market value of the stock on
such purchase date. Any capital gain or loss will be long or short-term
depending on whether the stock has been held for more than one year.
There are no federal income tax consequences to the Company by reason of the
grant or exercise of rights under the Purchase Plan. The Company is entitled to
a deduction to the extent amounts are taxed as ordinary income to a participant
(subject to the requirement of reasonableness, the provisions of Section 162(m)
of the Code and the satisfaction of a tax reporting obligation).
PROPOSAL 6
RATIFICATION OF SELECTION OF INDEPENDENT AUDITORS
The Board of Directors has selected Ernst & Young LLP as the Company's
independent auditors for the fiscal year ending December 31, 1996 and has
further directed that management submit the selection of independent auditors
for ratification by the stockholders at the Annual Meeting. Ernst & Young LLP
has audited the Company's financial statements since the Company's inception.
Representatives of Ernst & Young LLP are expected to be present at the Annual
Meeting, will have an opportunity to make a statement if they so desire and will
be available to respond to appropriate questions.
Stockholder ratification of the selection of Ernst & Young LLP as the
Company's independent auditors is not required by the Company's By-laws or
otherwise. However, the Board is submitting the selection of Ernst & Young LLP
to the stockholders for ratification as a matter of good corporate practice. If
the stockholders fail to ratify the selection, the Audit Committee and the Board
will reconsider whether or not to retain that firm. Even if the selection is
ratified, the Audit Committee and the Board in their discretion may direct the
appointment of different independent auditors at any time during the year if
they determine that such a change would be in the best interests of the Company
and its stockholders.
The affirmative vote of the holders of a majority of the shares present in
person or represented by proxy and entitled to and voting at the Annual Meeting
will be required to ratify the selection of Ernst & Young LLP.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE IN FAVOR OF PROPOSAL 6.
28
<PAGE>
SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the ownership
of the Company's Common Stock as of February 29, 1996 by: (i) each director and
each of the four executive officers; (ii) all executive officers and directors
as a group; and (iii) those stockholders known by the Company to be beneficial
owners of more than five percent of the Company's Common Stock.
The information as to each person has been furnished by such persons, and
each person has sole voting power and sole investment power with respect to all
shares beneficially owned by such persons except as otherwise indicated and
subject to community property laws where applicable. Except as set forth below,
the address of each named individual is the address of the Company as set forth
herein.
<TABLE>
<CAPTION>
NUMBER OF
BENEFICIAL
OWNERSHIP PERCENT OF
BENEFICIAL OWNER SHARES TOTAL
- - ----------------------------------------------------------------------------------------- ----------- -------------
<S> <C> <C>
FMR Corp. (2)
82 Devonshire Street
Boston, MA 02109....................................................................... 827,900 8.0
Pharmacia AB (3)
Hans U. Sievertsson
Frusadaviks Alle 15
S-171 97 Stockholm, Sweden............................................................. 738,570 7.2
State Street Research & Management Company (4)
One Financial Center, 30th Floor
Boston, MA 02111....................................................................... 640,100 6.2
John P. Walker (5)....................................................................... 256,784 2.4
Michael J. Ross (6)...................................................................... 208,789 2.0
Heinz W. Gschwend (7).................................................................... 81,305 *
Daniel H. Petree (8)..................................................................... 48,160 *
Brook H. Byers (9)....................................................................... 234,594 2.3
Anthony B. Evnin (10).................................................................... 24,762 *
Vaughn M. Kailian (11)................................................................... 4,092 *
All Directors and Executive Officers as a Group
(8 Persons)(12)........................................................................ 1,597,056 14.9
</TABLE>
- - ------------------------
* Less than 1 percent.
(1) Percentage of beneficial ownership is based on 10,305,939 shares of Common
Stock outstanding as of February 29, 1996.
(2) Based upon a Schedule 13G filed by FMR Corp. reporting such beneficial
ownership as of December 31, 1995. Includes 773,500 shares of Common Stock
beneficially owned by Fidelity Management & Research Company ("Fidelity"),
a wholly-owned subsidiary of FMR Corp. and an investment advisor to various
investment companies. Of such 773,500 shares, 523,500 shares were held by
Fidelity Select Biotechnology Portfolio and the remainder were held by
other funds. Edward C. Johnson 3d of FMR Corp., through its control of
Fidelity, and the funds each has sole power to dispose of the 773,500
shares. Fidelity votes such shares under written guidelines established at
the direction of the funds' boards of trustees. Also includes 54,400 shares
of Common Stock beneficially owned by Fidelity Management Trust Company
("FMTC"), a wholly-owned subsidiary of FMR Corp. and a bank, which serves
as investment manager of certain institutional accounts. Edward C. Johnson
3d and FMR Corp., through their control of
29
<PAGE>
FMTC, have sole voting and dispositive power over such 54,400 shares. Mr.
Johnson is the chairman of, and Ms. Abigail P. Johnson is a director of,
FMR Corp. and, consequently, each may be deemed to beneficially own all
827,900 shares of Common Stock. In addition, members of the Edward C.
Johnson 3d family and trusts for their benefit may be deemed to be a
controlling group with respect to FMR Corp. and therefore may be deemed to
beneficially own all 827,900 shares of Common Stock.
(3) Includes 67,142 shares issuable upon exercise of warrants exercisable
within 60 days of February 29, 1996. Hans U. Sievertsson, a Director of the
Company, is Vice President at Pharmacia AB. Dr. Sievertsson disclaims
beneficial ownership of all shares held by Pharmacia AB.
(4) State Street Research & Management Company, an investment advisor ("State
Street") has sole voting power with respect to 624,500 of such shares and
sole investment power with respect to all such shares. State Street is a
wholly-owned subsidiary of Metropolitan Life Insurance Company, which also
may be deemed to beneficially own such shares. State Street disclaims
beneficial ownership of all such shares.
(5) Includes 216,815 shares issuable upon exercise of options and exercisable
within 60 days of February 29, 1996. Also includes an aggregate of 8,574
shares beneficially owned by Mr. Walker's wife as trustee of educational
trusts for his children.
(6) Includes 8,795 shares issuable upon exercise of options and exercisable
within 60 days of February 29, 1996. Also includes 45,000 shares
beneficially owned by the Ross Family Trust, of which Mr. Ross is a
co-trustee.
(7) Includes 73,974 shares issuable upon exercise of options and exercisable
within 60 days of February 29, 1996.
(8) Includes 47,188 shares issuable upon exercise of options exercisable within
60 days of February 29, 1996.
(9) Consists of 203,545 shares held by Kleiner Perkins Caufield & Byers VI,
19,317 shares held by KPCB Founders Fund I, L.P., and 9,597 shares held by
KPCB VI Founders Fund, L.P. Also includes 758 shares issuable upon exercise
of a warrant exercisable within 60 days of February 29, 1996. Mr. Byers is
a general partner of each such partnership. Mr. Byers disclaims beneficial
ownership of the shares held by each such partnership except to the extent
of his pro rata interest therein.
(10) Includes 57 shares beneficially owned collectively by Venrock Associates
and Venrock Associates II, L.P., of which Mr. Evnin is a general partner.
(11) Consists of 4,092 shares issuable upon exercise of options exercisable
within 60 days of February 29, 1996.
(12) Includes an aggregate of 418,764 shares issuable upon exercise of warrants
and options exercisable within 60 days of February 29, 1996. See footnotes
3, 5, 6, 7, 8, 9 and 11.
30
<PAGE>
EXECUTIVE OFFICERS AND KEY EMPLOYEES
Set forth below is information regarding executive officers and key
employees of the Company as of March 21, 1996.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- - ------------------------------- --- ---------------------------------------------------------------------------
<S> <C> <C>
John P. Walker 47 President, Chief Executive Officer and Director
Michael J. Ross, Ph.D. 46 Executive Vice President, Chief Technical Officer and Director
Heinz W. Gschwend, Ph.D. 59 Vice President, Research and Development
Daniel H. Petree 40 Vice President, Corporate Development and Chief Financial Officer
Michael C. Venuti, Ph.D. 42 Vice President, Research Technology
Natalie J. Warner, M.D. 47 Vice President, Medical Affairs
Alan C. Mendelson 47 Secretary
</TABLE>
- - ------------------------
John P. Walker has been President, Chief Executive Officer and a Director of
the Company since February 1993. From 1991 to 1993, he was a venture capitalist
at Alpha Venture Partners. Prior to that time, he was Chairman, President and
Chief Executive Officer of Vitaphore Corporation, a company which was acquired
in April 1990 by Union Carbide Chemicals and Plastics Company, Inc. Following
that acquisition, Mr. Walker served as the latter company's Vice President,
Biomaterials Systems. From 1971 to 1985, Mr. Walker was employed by American
Hospital Supply Corporation in a variety of general management, sales and
marketing positions, most recently serving as President of the American Hospital
Company. He received his B.A. degree from the State University of New York at
Buffalo and conducted graduate business studies at Northwestern University
Institute for Management. Mr. Walker serves as a director of several private
companies.
Michael J. Ross, Ph.D. has been Executive Vice President and Chief Technical
Officer of the Company since February 1993 and a Director since he joined the
Company in September 1990 as President and Chief Executive Officer. From 1978 to
1990, he was employed by Genentech, Inc., a biopharmaceutical company, where he
most recently was Vice President, Medicinal and Biomolecular Chemistry and was
responsible for building that company's small molecule discovery effort. Dr.
Ross received a Ph.D. in chemistry from the California Institute of Technology
and held a postdoctoral fellowship in molecular biology at Harvard University.
Heinz W. Gschwend, Ph.D. has been Vice President of Chemistry of the Company
since January 1992 and was named Vice President, Research and Development in
September 1993. Prior to that time, he was Head of the Central Research
Laboratories of Ciba-Geigy Ltd., a multinational chemical and pharmaceutical
company, in Basel, Switzerland. An employee of Ciba-Geigy Corporation (U.S.)
since 1967, Dr. Gschwend has also held the senior management positions of Vice
President, Drug Discovery and Vice President, Cardiovascular/ Atherosclerosis
Research (U.S.). Dr. Gschwend received his Ph.D. from the Swiss Federal
Institute of Technology (ETH) and conducted postdoctoral studies at that
institution and at Harvard University.
Daniel H. Petree has been Vice President of Corporate Development and Chief
Financial Officer of the Company since August 1993. From 1992 to 1993, he was
Vice President, Business Development of TSI Corporation, a biotechnology service
company. Prior to that time, he was with Montgomery Securities, an investment
banking firm, from 1987 to 1992, ultimately serving as Vice President, Health
Care Group in Montgomery's corporate finance division. From 1983 to 1987, Mr.
Petree was a corporate attorney in the offices of Heller, Ehrman, White &
McAuliffe. Mr. Petree received his J.D. degree from the University of Michigan
Law School and holds a B.A. degree from Stanford University.
Michael C. Venuti, Ph.D., has been Vice President, Research Technology since
November 1994. Prior to that he was at Parnassus Pharmaceuticals, a start-up
biotechnology company where he was Vice President, Chief Scientific Officer and
a founder. From 1988 to 1993, Dr. Venuti was at
31
<PAGE>
Genentech, where he was Director of Bioorganic Chemistry, a program that he
helped establish. Previously, he was with Syntex Corporation, a pharmaceutical
company, as a section head at the Institute of Bioorganic Chemistry. Dr. Venuti
received his A.B. in chemistry from Dartmouth College in 1975, his Ph.D. in
organic chemistry in 1979 from the Massachusetts Institute of Technology and was
a postdoctoral fellow at the Syntex Institute of Organic Chemistry.
Natalie Jean Warner, M.D., joined Arris in December 1995 as Vice President
of Medical Affairs directly from Khepri, where she was Vice President of Medical
Affairs and Drug Development. Prior to Khepri, Dr. Warner worked at Syntex
Corporation (1988-1993), where she held a number of positions, most recently
Vice President, Worldwide Safety Surveillance and Reporting. She has 11 years
experience in clinical research and regulatory affairs at Khepri, Syntex and
Merck, Sharp and Dohme (1984-1988) and has worked on a number of successful NDAs
and worldwide marketing applications. She completed her fellowship and residency
at Columbia University. She holds an M.D. from Cornell Medical College and a
B.A. from Swathmore College.
Alan C. Mendelson has served as Secretary of the Company from July 1993 to
present, with the exception of several months in 1994. He has been a partner of
Cooley Godward Castro Huddleson & Tatum, a private law firm and counsel to the
Company, since 1980 and served as the managing partner of its Palo Alto office
from May 1990 through March 1995. Mr. Mendelson also served as Secretary and
Acting General Counsel of Amgen, a biopharmaceutical company, from April 1990 to
March 1991 and has served as Acting General Counsel of Cadence Design Systems,
Inc., an electronic design automation software company, since November 1995. Mr.
Mendelson is currently a director of Acuson Corporation, CoCensys, Inc., Elexsys
International, Inc. and Isis Pharmaceuticals, Inc. Mr. Mendelson received a J.D.
from Harvard University in 1973.
COMPLIANCE WITH THE REPORTING REQUIREMENTS OF SECTION 16(A)
Section 16(a) of the Securities Exchange Act of 1934 (the "1934 Act")
requires the Company's directors and executive officers, and persons who own
more than ten percent of a registered class of the Company's equity securities,
to file with the SEC initial reports of ownership and reports of changes in
ownership of Common Stock and other equity securities of the Company. Officers,
directors and greater than ten percent stockholders are required by SEC
regulation to furnish the Company with copies of all Section 16(a) forms they
file.
To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, during the fiscal year ended December 31, 1995, all
Section 16(a) filing requirements applicable to its officers, directors and
greater than ten percent beneficial owners were complied with.
EXECUTIVE COMPENSATION
COMPENSATION OF DIRECTORS
The Company's directors do not currently receive any cash compensation for
service of the Board or any committee thereof, but directors may be reimbursed
for certain expenses incurred in connection with attendance at Board and
Committee Meetings.
Each non-employee director of the Company also receives stock option grants
under the 1994 Non-Employee Directors' Stock Option Plan (the "Directors'
Plan"). Only non-employee directors of the Company or an affiliate of such
directors (as defined in the Code) are eligible to receive options under the
Directors' Plan. Options granted under the Directors' Plan are intended by the
Company not to qualify as incentive stock options under the Code.
Option grants under the Directors' Plan are non-discretionary. Pursuant to
the terms of the Directors' Plan, each person elected for the first time to be a
non-employee director of the Company will automatically be granted an option to
purchase 15,000 shares of Common Stock upon the date of his or her initial
election as a non-employee director by the Board or the Stockholders of the
Company. On the date of the Annual Meeting of Stockholders of each year
beginning in 1995, each member of the
32
<PAGE>
Company's Board of Directors who is not an employee of the Company (or an
affiliate of such director where specified by the non-employee director), and
has served as a non-employee director for at least three months, is
automatically granted under the Directors' Plan, without further action by the
Company, the Board of Directors or the stockholders of the Company, an option to
purchase 2,500 shares of Common Stock of the Company. No other options may be
granted at any time under the Directors' Plan. The exercise price of options
granted under the Directors' Plan is 100% of the fair market value of the Common
Stock subject to the option on the date of the option grant. Options granted
under the Directors' Plan may not be exercised until the date upon which such
optionee, or the affiliate of such optionee, as the case may be, has provided
one year of continuous service as a non-employee director following the date of
grant of such option, whereupon such option shall become exercisable as to 25%
of the option shares and 25% of the option shares shall become exercisable each
year thereafter in accordance with it terms. The term of options granted under
the Directors' Plan is ten years. In the event of a merger of the Company with
or into another corporation or a consolidation, acquisition of assets or other
change-in-control transaction involving the Company, the vesting of each option
will accelerate and the option will terminate if not exercised prior to such
event.
During the last fiscal year, the Company granted options covering 2,500
shares to each non-employee Director of the Company, at an exercise price per
share of $8.06, which was the fair market value of the stock as of June 7, 1995,
the date of grant. In addition, during the last fiscal year the Company granted
options covering 15,000 shares to one non-employee Director of the Company upon
his election as a Director, at an exercise price of $10.15, which was the fair
market value of the stock as of December 22, 1995, the date of grant. Arris also
assumed options that had been granted to Mr. Kailian by Khepri in April 1995,
which effective December 22, 1995, were converted to options to purchase 4,092
shares of Arris Common Stock at an exercise price of $2.45 per share. As of
February 29, 1996, no options had been exercised under the Directors' Plan.
COMPENSATION OF EXECUTIVE OFFICERS
The following table shows for the fiscal years ended December 31, 1995, 1994
and 1993, compensation awarded or paid to, or earned by, the Company's Chief
Executive Officer and its other executive officers at December 31, 1995 (the
"Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
AWARDS
ANNUAL COMPENSATION ----------------------------
----------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
SALARY BONUS COMPENSATION OPTIONS/ COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) SARS (#) ($)(1)
- - ---------------------------------------- --------- --------- --------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C>
1995 265,000 75,000 -- 100,000 696
John P. Walker ......................... 1994 245,000 62,475 -- -- 667
President and Chief Executive Officer 1993 206,250 56,000 -- 260,714 638
Michael J. Ross, Ph.D. ................. 1995 208,400 31,385 -- 45,000 696
Executive Vice President and Chief 1994 193,000 31,210 -- -- 696
Technical Officer (2)(3) 1993 173,750 34,200 -- 28,571 5,265
Heinz W. Gschwend, Ph.D ................ 1995 191,200 29,254 -- 45,000 1,800
Vice President, Research and 1994 177,000 30,090 -- 15,000 1,725
Development, Inflammation 1993 165,000 31,350 -- 14,285 810
Daniel H. Petree ....................... 1995 156,500 26,622 12,903(4) 45,000 391
Vice President, Corporate Development 1994 145,000 24,650 17,727(4) 15,000 264
and Chief Financial Officer 1993 58,518 13,500 29,523(4) 50,000 110
</TABLE>
- - ------------------------
(1) Consists of life insurance premiums paid.
33
<PAGE>
(2) Prior to 1993, Dr. Ross was President, Chief Executive Officer and Chief
Financial Officer of the Company. He became Executive Vice President and
Chief Technical Officer in February 1993.
(3) Dr. Ross was granted the right to purchase 125,713 shares of Common Stock
prior to 1993, which shares were purchased at the market value on the date
of purchase. The shares purchased vest over a four-year period. As of
December 31, 1995, the aggregate value of these restricted shares would be
$1,697,126 based on the fair market value of $13.50 per share at such date.
(4) Consists of payments to Mr. Petree in connection with his relocation to
California.
STOCK OPTION GRANTS AND EXERCISES
The Company grants options to its executive officers under its 1989 Plan. As
of February 29, 1996, options to purchase a total of 2,297,273 shares had been
granted under the 1989 Plan, and no shares remained available for grant
thereunder. Certain additional information concerning options granted to the
Named Executive Officers since January 1, 1996 are set forth above in the "New
Plan Benefits" table. See Proposal 4.
The following tables show for the year ended December 31, 1995, certain
information regarding options granted to, exercised by and held at year end by
the Named Executive Officers:
OPTION GRANTS IN FISCAL YEAR 1995
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
-------------------------------- ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK PRICE
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM (3)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION --------------------
NAME GRANTED (#)(1) FISCAL YEAR (2) ($/SH) DATE 5% ($) 10% ($)
- - --------------------------------- -------------- ----------------- ------------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
John P. Walker................... 50,000 8.1 6.20 01/12/05 194,957 494,060
50,000 8.1 8.06 06/06/05 253,445 642,278
Michael J. Ross, Ph.D............ 25,000 4.1 6.90 03/27/05 108,484 274,921
20,000 3.2 8.06 06/06/05 101,377 256,911
Heinz W. Gschwend, Ph.D.......... 25,000 4.1 6.90 03/27/05 108,484 274,921
20,000 3.2 8.06 06/06/05 101,377 256,911
Daniel H. Petree................. 25,000 4.1 6.90 03/22/05 108,484 274,921
20,000 3.2 8.06 06/06/05 101,377 256,911
</TABLE>
- - ------------------------
(1) Options granted in January and March 1995 become exercisable with respect to
1/8 of the number of underlying shares on the 6-month anniversary of the
grant and at a rate of 1/48 of such options per month thereafter. Options
granted in June 1995 become exercisable on June 7, 2005 if the optionee is
continuously employed through such date; provided, however, that all or a
portion of these options may become exercisable no sooner than June 7, 1998
upon the price of the Company's Common Stock attaining certain levels and
the Company meeting performance goals determined by the Board of Directors,
provided that the optionee continues to remain employed through such date.
(2) Based on options to purchase 617,175 shares granted in 1995.
(3) The potential realizable value is based on the term of the option at its
time of grant (10 years). It is calculated by assuming that the stock price
on the date of grant appreciates at the indicated annual rate, compounded
annually for the entire term of the option and that the option is exercised
and sold on the last day of its term for the appreciated stock price.
34
<PAGE>
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1995
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FY-END (#) AT FY-END ($)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE (#) REALIZED UNEXERCISABLE UNEXERCISABLE (1)
- - --------------------------------------- ------------------- ----------- ------------------- ------------------------
<S> <C> <C> <C> <C>
John P. Walker......................... -- -- 190,922/169,792 2,278,658/1,506,482
Michael J. Ross, Ph.D.................. -- -- 23,736/49,835 264,088/359,421
Heinz W. Gschwend, Ph.D................ -- -- 67,574/56,711 821,317/396,731
Daniel H. Petree....................... -- -- 38,855/71,145 380,328/540,372
</TABLE>
- - ------------------------
(1) Based on the fair market value of the Common Stock as of December 31, 1995
($13.50), minus the exercise price, multiplied by the number of shares
underlying the option.
EMPLOYMENT AGREEMENT
In August 1990, the Company entered into an employment agreement with Dr.
Michael J. Ross, which provides for the employment of Dr. Ross as an executive
officer of the Company. The agreement provides that if Dr. Ross is terminated
other than for cause, he is entitled to monthly installments of $10,000 for each
of the first three months following termination or until he is reemployed,
whichever occurs first. The agreement further provides that the Board of
Directors will either vote or recommend to the stockholders of the Company, that
Dr. Ross be nominated for election as a director of the Company during his term
of employment. The agreement is terminable at will upon delivery of written
notice.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
From January 1 through June 7, 1995, the Company's Compensation Committee
was composed of Brook H. Byers and James M. Garvey. From June 7, 1995 through
the close of the fiscal year, the Compensation Committee was composed of Brook
H. Byers and Anthony B. Evnin. None of Messrs. Byers, Garvey or Evnin is or has
been an officer or employee of the Company.
35
<PAGE>
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
ON EXECUTIVE COMPENSATION (1)
GENERAL
From January 1 to June 7, 1995, the Compensation Committee was comprised of
Brook H. Byers and James M. Garvey. In June 1995, Mr. Garvey was replaced on the
Compensation Committee by Anthony B. Evnin.
COMPENSATION PHILOSOPHY
The primary goal of the Company is to align compensation with the Company's
business objectives and performance. The Company's aim is to attract, retain and
reward executive officers and other employees who contribute to the long-term
success of the Company and to motivate those individuals to enhance long-term
stockholder value. To establish this relationship between executive compensation
and the creation of stockholder value, the Board of Directors has adopted a
total compensation package comprised of base salary, bonus and stock option and
stock grant awards. Key elements of this compensation package are:
- The Company pays salaries at least competitive with those of leading
biotechnology and pharmaceutical companies with which the Company competes
for talent.
- The Company maintains incentive opportunities designed to motivate and
reward achievement of specific Company and individual goals. The
availability of these incentives is designed to bring the total
compensation for key employees to competitive levels within the industry.
- The Company provides significant equity-based incentives for executives
and other key employees to ensure that individuals are motivated over the
long term to respond to the Company's business challenges and
opportunities as owners and not just as employees.
SALARY
The salary compensation for all employees, including executive officers, is
based upon a matrix that plots the base compensation of an employee against the
compensation of employees in similar positions in other biotechnology and
pharmaceutical companies, in accordance with a published survey of the employee
compensation of such companies. Base salaries are targeted at the upper quartile
for comparable positions in the other companies in the matrix. Salary
adjustments for 1995 were based on each individual's performance ranking. In
establishing base salaries for the executive officers, the Board carefully
reviewed the progress made in the programs headed by each officer and the
dependence of the Company on these officers for the scientific and business
development of their respective programs. The Board also considered salary
information of other biotechnology and pharmaceutical corporations.
ANNUAL INCENTIVE COMPENSATION
A portion of the cash compensation paid to the Company's executive officers,
including the Chief Executive Officer, is in the form of discretionary bonus
payments that are paid on an annual basis, as part of the Company's Incentive
Bonus Plan. Bonus payments are expressly linked to the attainment of goals
established for each executive officer, as well as overall corporate goals, and
are limited by the target bonus pool established for each officer which is a
percentage of the officer's base salary. General corporate goals in 1995
included the establishment of collaborative partnering arrangements in key areas
of research, the continuation of clinical development of the Company's
compounds, research milestones in each of the Company's discovery programs, and
strengthening of the Company's balance sheet.
- - ------------------------
(1) The material in this report is not "soliciting material," is not deemed
filed with the SEC and is not to be incorporated by reference in any filing
of the Company under the Securities Act of 1933 as amended (the "Securities
Act") or the Exchange Act.
36
<PAGE>
In awarding discretionary bonuses to the officers, the Board of Directors
believed that both corporate and individual goals for the year were
substantially attained. Accordingly, the officers, including the Chief Executive
Officer, were awarded substantially all of their individual bonus potential.
LONG-TERM INCENTIVES
The Company's primary long-term incentive program presently consists of the
1989 Plan and the Purchase Plan. The 1989 Plan utilizes vesting periods
(generally four years) to encourage key employees to continue in the employ of
the Company. Through option grants, executives receive significant equity
incentives to build long-term stockholder value. The exercise price of options
granted under the 1989 Plan generally is 100% of the fair market value of the
underlying stock on the date of grant. Employees receive value from these grants
only if the Company's Common Stock appreciates in the long term.
The Company established the Purchase Plan both to encourage employees to
continue in the employ of the Company and to motivate employees through an
ownership interest in the Company. Under the Purchase Plan, employees, including
officers, may have up to 10% of their earnings withheld for purchases of Common
Stock on certain dates specified by the Board. The price of Common Stock
purchased will be equal to 85% of the lower of the fair market value of the
Common Stock on the date of commencement of participation in each 24-month
offering period or on each specified purchase date.
In June 1995, the Board of Directors granted stock options to four of the
continuing executive officers. The grant of the options was based on the prior
performance of each executive officer and the need to retain these officers in
light of the increasing demands placed upon them as a result of the Company's
growth. In this regard, the Board was mindful of, among other things, the
success of these officers, which was evidenced by the completion of the
Company's collaboration agreements with Pharmacia AB, which the Company entered
into in August 1995, and the acquisition of Khepri Pharmaceuticals, Inc. in
December 1995. In reaching its decisions, the Board relied on its experience,
information gained in the hiring process, and the value of the executive
officer's previously issued stock options.
COMPANY PERFORMANCE AND CHIEF EXECUTIVE OFFICER COMPENSATION
The Chief Executive Officer joined the Company in February 1993. His initial
salary, potential bonus and stock option grants were determined on the basis of
negotiations between the Board of Directors and the Chief Executive Officer with
due regard to his experience, competitive salary information and market
conditions at the time. Mr. Walker's 1995 salary was set by the Compensation
Committee. As with the other executive officers, the amount of Mr. Walker's
total compensation was based on the Company's 1995 accomplishments and the Chief
Executive Officer's significant contribution thereto, including, among other
things, performance to plan, the completion of the collaboration agreement with
Pharmacia AB in August 1995 and the acquisition of Khepri Pharmaceuticals, Inc.
in December 1995.
CERTAIN TAX CONSIDERATIONS
Section 162(m) of the Internal Revenue Code (the "Code") limits the Company
to a deduction for federal income tax purposes of not more than $1 million of
compensation paid to certain executive officers in a taxable year. Compensation
above $1 million may be deducted if it is "performance-based compensation"
within the meaning of the Code.
37
<PAGE>
The Compensation Committee has determined that stock options granted under
the 1989 Plan with an exercise price at least equal to the fair market value of
the Company's common stock on the date of grant should be treated as
"performance-based compensation." To achieve this result, in 1995 the
stockholders approved a per-employee, per-year limitation on the size of stock
option grants.
From the members of the Compensation Committee of Arris Pharmaceutical
Corporation:
Brook H. Byers
Anthony B. Evnin, Ph.D.
PERFORMANCE MEASUREMENT COMPARISON (1)
The following chart shows the value of an investment of $100 in cash of (i)
the Company's Common Stock, (ii) the Nasdaq Stock Market -- US Index and (iii)
the AMEX Biotechnology Index. All values assume reinvestment of the full amount
of all dividends*:
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
ARRIS PHARMACEUTICAL NASDAQ STOCK MARKET - US AMEX BIOTECHNOLOGY
<S> <C> <C> <C>
Nov93 100.00 100.00 100.00
Dec93 90.74 99.72 91.76
Dec94 96.30 97.48 65.03
Dec95 200.00 137.85 106.02
</TABLE>
* $100 invested on November 19, 1993 in Common Stock of Arris (the date of the
Company's initial public offering) or on October 31, 1993 in the indices,
including reinvestment of dividends. Fiscal year ending December 31.
- - ------------------------
(1) This Section is not "soliciting material," is not deemed filed with the SEC
and is not to be incorporated by reference in any filing of the Company
under the Securities Act or the Exchange Act.
38
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In August 1995, the Company entered into a research and development
agreement with Pharmacia & Upjohn, a 5% stockholder of the Company, focused on
the development of inhibitors of Thrombin, Factor Xa and Factor VIIa using the
Company's technology, for the treatment of blood clotting disorders. In March
1996 the Company entered into an additional research and development agreement
with Pharmacia & Upjohn, pursuant to which the Company will share with Pharmacia
& Upjohn certain of its compound libraries and technologies for synthesis and
screening in exchange for license fees and milestone payments. During 1995, the
Company received an aggregate of $9,574,000 from Pharmacia & Upjohn relating to
commitment fees and research funding and support under new and existing
collaborative agreements with the Company. The Company paid Pharmacia & Upjohn
approximately $389,000 for routine purchases of materials and supplies. Hans U.
Sievertsson, a director of the Company, is Vice President of Pharmacia AB, a
unit of Pharmacia & Upjohn.
In December 1995, the Company acquired Khepri Pharmaceuticals, Inc.
("Khepri") in a stock-for-stock merger (the "Merger"). Brook Byers, a member of
the Board of Directors of Arris, is a general partner of Kleiner Perkins
Caufield & Byers, which, together with its affiliates, owned approximately 17.2%
of the outstanding capital stock of Khepri prior to the Merger. Mr. Byers did
not participate in the negotiation of the Merger or the Arris Board of
Directors' consideration or approval of the Merger. See Proposal 2 -- "Interest
of Certain Parties".
In March 1993, the Company loaned $200,000 to John P. Walker, the Company's
President and Chief Executive Officer, to purchase 31,475 shares of Series D
Preferred Stock. The loan is full-recourse and secured by the shares, bears
interest at the rate of 7% per annum and is due in February 1999. As of February
29, 1996, principal and interest in an aggregate amount of $240,000 was
outstanding on the loan. Since January 1, 1995, the largest aggregate amount
outstanding on the loan was $240,000. The Company believes that the foregoing
transaction was in its best interests.
The Company has entered into an employment agreement with one of its
officers. See "Executive Compensation."
The Company's Bylaws provide that the Company will indemnify its directors
and executive officers and may identify its other officers, employees and other
agents to the fullest extent permitted by Delaware law. The Company is also
empowered under its Bylaws to enter into indemnification contracts with its
directors and officers and to purchase insurance on behalf of and person it is
required or permitted to indemnify. Pursuant to this provision, the Company has
entered into indemnity agreements with each of its directors and officers.
39
<PAGE>
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
Financial statements for Khepri for the years ended December 31, 1994 and
1993, and for the period from inception (April 24, 1992) through December 31,
1992, together with the report of Ernst & Young LLP, Khepri's independent
auditors, are incorporated by reference from the Company's Current Report on
Form 8-K (File No. 0-22788), dated December 22, 1995, filed January 5, 1996, and
amended February 5, 1996.
Unaudited pro forma financial statements for the combined operations of
Arris and Khepri for the year ended December 31, 1995, are incorporated by
reference from the Company's Current Report on Form 8-K (File No. 0-22788), as
amended, dated December 22, 1995, filed January 5, 1996, and amended February 5,
1996.
Arris' Annual Report on Form 10-K for the year ended December 31, 1995 (File
No. 0-22788), filed March 14, 1996, is incorporated by reference herein. Certain
financial information from the Form 10-K and management's discussion and
analysis of this information is included in the Annual Report to Stockholders
being mailed concurrently with this Proxy Statement.
Arris' Registration Statement on Form 8-A (File No. 0-22788), as filed with
the Securities and Exchange Commission on November 4, 1993, is incorporated by
reference herein.
All documents filed by the Company pursuant to sections 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934, as amended, after the mailing date
of this proxy statement and prior to June 5, 1996, the date of the Annual
Meeting, shall be deemed to be incorporated by reference herein and to be a part
hereof from the date of filing of such documents. Any statement contained in
this proxy statement or in a document incorporated or deemed to be incorporated
by reference herein shall be deemed to be modified or superseded for purposes of
this Proxy Statement to the extent that a statement contained herein or in any
subsequently-filed document which also is or is deemed to be incorporated by
reference herein modifies or superseded such statement. Any such statement so
modified or superseded shall not be deemed, as modified or superseded, to
constitute a part of this Proxy Statement.
OTHER MATTERS
The Board of Directors knows of no other matters that will be presented for
consideration at the Annual Meeting. If any other matters are properly brought
before the meeting, it is the intention of the persons named in the accompanying
proxy to vote on such matters in accordance with their best judgment.
By Order of the Board of Directors
Daniel H. Petree
ASSISTANT SECRETARY
May 8, 1996
40
<PAGE>
- - -------------------------------------------------------------------------------
ARRIS PHARMACEUTICAL CORPORATION
PROXY SOLICITED BY BOARD OF DIRECTORS
FOR THE ANNUAL MEETING JUNE 5, 1996
John P. Walker and Daniel H. Petree, or either of them, each with power of
substitution, hereby are authorized to represent and vote as designated on the
reverse side the shares of the undersigned at the Annual Meeting of Stockholders
of Arris Pharmaceutical Corporation to be held Wednesday, June 5, 1996, at
8:00 a.m. local time, at the Company's offices located at 385 Oyster Point
Boulevard, Suite 3, South San Francisco, California, or at any adjournment of
the Annual Meeting.
Shares represented by this proxy will be voted as directed by the
stockholder. If no such directions are indicated, the proxies will have
authority to vote FOR the Election of Directors and FOR Proposals 2 through 6.
- - -------------------------------------------------------------------------------
* FOLD AND DETACH HERE *
<PAGE>
- - -------------------------------------------------------------------------------
PLEASE MARK, DATE, SIGN AND RETURN.
Please mark
your votes as /X/
indicated in
this example
FOR all WITHHOLD AUTHORITY
nominees to vote for all nominees
listed below. listed below.
1. Election of / / / /
Directors
Authority to vote for any nominee may be withheld by lining through such
nominee's name below.
John P. Walker, Michael J. Ross, Ph.D., Brook H. Byers, Anthony B. Evnin, Ph.D.,
Vaughn M. Kailian, Hans U. Sievertsson, Ph.D.
FOR AGAINST ABSTAIN
2. To approve the issuance of a sufficient / / / / / /
number of shares to satisfy the payment
of the Second Stock Payment, pursuant to
the Company's recent acquisition of Khepri
Pharmaceuticals, Inc. ("Khepri").
3. To approve the issuance of a sufficient / / / / / /
number of shares to satisfy the exercise
of certain exchange rights of the Class B
Shareholders of Khepri Pharmaceuticals
Canada, Inc.
4. To approve the Company's 1989 Stock Plan, / / / / / /
as amended, to increase the aggregate
number of shares of Common Stock authorized
for issuance under such plan by 550,000
shares, to 2,667,500 shares.
5. To approve the Company's Employee Stock / / / / / /
Purchase Plan, as amended, to increase the
number of shares of Common Stock authorized
for issuance under such plan by 100,000
shares, to 250,000 shares.
6. To ratify the selection of Ernst & Young / / / / / /
LLP as independent auditors of the Company
for its fiscal year ending December 31,
1996.
7. To transact such other business as may / / / / / /
properly come before the meeting or any
adjournment or postponement thereof.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE ELECTION OF DIRECTORS AND
FOR PROPOSALS 2 THROUGH 6.
SIGNATURE(s) DATED ,1996
-------------------------------- --------------
PLEASE SIGN EXACTLY AS YOUR NAME APPEARS ON THIS PROXY. IF SIGNING FOR ESTATES,
TRUSTS OR CORPORATIONS, TITLE OR CAPACITY SHOULD BE STATED. IF SHARES ARE HELD
JOINTLY, EACH HOLDER SHOULD BE STATED. IF SHARES ARE HELD JOINTLY, EACH HOLDER
SHOULD SIGN.
- - -------------------------------------------------------------------------------
* FOLD AND DETACH HERE *
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Proxy Statement of Arris
Pharmaceutical Corporation of our reports dated April 8, 1994 and March 31,
1995, with respect to the financial statements of Khepri Pharmaceuticals,
Inc. included in the Arris' Current Report on Form 8-K filed January 5, 1996,
as amended by Amendment No. 1 on Form 8-K/A dated February 2, 1996, filed with
the Securities and Exchange Commission.
/s/ Ernst & Young LLP
Palo Alto, California
May 2, 1996
