-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NRSn/OFLCflMwv1a28sOXcxeoe/XSjlS115rkGKQYBKGoq352FtZldIQq4e+iSIR QAW5fSCbk4E4hXutFCPJzQ== 0000950135-98-001617.txt : 19980318 0000950135-98-001617.hdr.sgml : 19980318 ACCESSION NUMBER: 0000950135-98-001617 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980317 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ARQULE INC CENTRAL INDEX KEY: 0001019695 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 043221586 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21429 FILM NUMBER: 98567733 BUSINESS ADDRESS: STREET 1: 200 BOSTON AVE CITY: MEDFORD STATE: MA ZIP: 02155 BUSINESS PHONE: 6173954100 MAIL ADDRESS: STREET 1: 200 BOSTON AVE CITY: MEDFORD STATE: MA ZIP: 02155 10-K 1 ARQULE, INC. 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER: 000-21429 ARQULE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 04-3221586 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
200 BOSTON AVENUE, MEDFORD, MASSACHUSETTS 02155 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 395-4100 Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE (TITLE OF EACH CLASS) ON WHICH REGISTERED --------------------- --------------------- None None
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the registrant as of March 5, 1998 was: $218,276,085. There were 11,938,236 shares of the registrant's Common Stock outstanding as of March 5, 1998. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement of the Registrant's 1998 Annual Meeting of Shareholders to be held on May 14, 1998, which definitive proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the registrant's fiscal year of December 31, 1997, are incorporated by reference into Part III of this Form 10-K. ================================================================================ 2 PART I ITEM 1. BUSINESS OVERVIEW ArQule has created a new technology platform for the discovery and production of novel chemical compounds with commercial potential. The Company has developed proprietary technologies for the identification and optimization of drug development candidates and agrochemicals. Using combinatorial chemistry, a modular building block approach to the development of compounds, structure-guided compound design, high speed parallel chemical synthesis and information technology, the Company rapidly develops large, diverse collections of compounds that have the potential to be biologically active. To date, the Company has entered into collaborative arrangements with Abbott Laboratories, Monsanto Company, Amersham Pharmacia Biotech AB, Roche Bioscience, Solvay Duphar B.V., American Homes Products Corporation, Inc. and Sankyo Company, Ltd. and has formed joint discovery programs with many biotechnology companies. The Company's goal is to penetrate the product development pipelines of major pharmaceutical, biotechnology and agrochemical companies and to maximize the likelihood that active compounds are discovered and successfully developed. In order to achieve this goal, the Company pursues a strategy designed to maximize the number of biological targets against which its compounds are screened. ArQule believes that its technologies will allow its collaborative partners in the pharmaceutical, biotechnology and agrochemical industries to accelerate the product development process by several years, permitting them to realize significant cost reductions and the earlier recovery of research and development expenditures for successful drugs and agrochemicals. In addition, the Company believes its technologies will allow researchers to seek solutions to product development challenges previously deemed too costly or otherwise impractical because of the inherent limitations of traditional medicinal chemistry. The potential market for ArQule's proprietary modular building block technology is comprised of all consumers of novel chemical compounds, including developers of drugs, separations media, agrochemical products, industrial catalysts, specialty materials and other industrial products. The Company's initial business focus has been on the pharmaceutical, biotechnology and agrochemical industries. APPLICATION OF THE COMPANY'S TECHNOLOGIES IN THE DRUG DISCOVERY INDUSTRY Industry Background Traditional Drug Discovery and Its Limitations. Drugs are chemical compounds that modulate the activity of biological targets associated with particular disease states to achieve a desired therapeutic effect. The discovery and development of drugs has traditionally been a lengthy, expensive and often unsuccessful process. Typically, it takes 12 to 15 years from the original concept of modulating the activity of a particular biological target to the market introduction of a drug that performs such a function. The average cost of bringing a new drug to market has been estimated to be in excess of $300 million. The first major step in the drug discovery process is the identification of one or more compounds that interact with a biological target, such as an enzyme, receptor or other protein, that is associated with a disease state. To identify such a compound, collections of compounds are tested or screened for activity with respect to the biological target. A compound that interacts with a target is referred to as a hit, and a hit with characteristics making it suitable as a potential drug is referred to as a lead compound. Historically, drug developers have obtained collections of chemical compounds for screening from natural product sources and by synthesis. These collections are often neither sufficiently diverse to be likely to result in a hit nor preselected to include compounds with promising structures or desirable drug characteristics. This random screening approach has yielded a relatively small percentage of hits and only a relatively small portion of those hits have resulted in lead compounds. The second major step in the drug discovery process is the optimization of a lead compound by the sequential synthesis and testing of variations, or analogs, of a lead compound to identify promising drug development candidates. A drug development candidate is a lead compound that in preclinical studies 1 3 demonstrates pharmacological efficacy, lack of toxicity, potency, selectivity and other desirable characteristics such as oral availability, cell penetration and stability. Using traditional medicinal chemistry, lead optimization has required an average of two years of synthesizing hundreds of analogs of a lead compound and has been the most expensive and time consuming part of the drug development process prior to clinical testing. The synthesis of a single compound analog takes approximately 7 to 10 days and costs approximately $7,500. As a result, a chemist is usually able to synthesize only 100 to 200 analogs per year. On average, as many as 6,000 chemical compounds may be synthesized per successful drug at a cost of approximately $45 million in chemistry costs. Drug Development in Transition. Lower profit margins, shorter product lives, the proliferation of generic drugs, managed care and cost containment initiatives, combined with scientific and technological advances, have created powerful incentives for drug developers to explore new technologies to discover novel drugs more quickly and cost effectively. The growing biotechnology and gene discovery (genomics) industries are rapidly identifying numerous new biological targets and developing highly sensitive assays incorporating these targets. Advances in robotics have led to automated high throughput screening systems, allowing biologists to assay large numbers of chemical compounds against novel targets. These developments have resulted in increased demand for large and diverse collections of novel compounds. In addition, in recent years, structure-guided and rational drug design approaches have allowed scientists, using structure-activity relationship ("SAR") data about biological targets, to design compounds that are likely to show activity with respect to a biological target. These developments, together with the developments referred to in the preceding paragraph, have resulted in a proliferation of hits, generating demand for tools to rapidly create analogs of hits and optimize lead compounds. Current Combinatorial Chemistry Technology and Its Limitations. Combinatorial chemistry is the rapid creation of hundreds of thousands of chemical compounds, most of which do not exist in nature, for the purpose of rapidly identifying hits through random screening. Current combinatorial chemistry has been successful in producing large numbers of compounds and correspondingly large numbers of hits. However, current combinatorial chemistry techniques have been less successful in generating lead compounds and, ultimately, drug development candidates for some or all of the following reasons: - Time-Consuming Isolation of Hits. In certain combinatorial chemistry applications, large numbers of chemical compounds are synthesized and screened in mixtures. Hits must therefore be isolated from the mixtures, which is a costly, slow, labor-intensive process. - Lack of Structural and SAR Information. Once a hit is isolated, many current combinatorial techniques fail to facilitate the identification of the structure of the hit or to provide SAR data to guide the lead optimization process. - Incompatibility with Drug Developers' Screening Protocols. Many combinatorial compounds are produced in a format that is incompatible with standard screening protocols of drug developers. In addition, once a hit is found and the compound is isolated, significant additional work must often be performed by the combinatorial chemistry company to determine the structure of the compound. Drug developers relying on this format may therefore be required to transfer hits to the combinatorial chemistry company. - Limitations of Solid Phase Chemistry. Several combinatorial chemistry techniques involve the production of compounds using solid phase chemistry in which compounds are attached to small beads. Because many compounds with desirable chemistries cannot be synthesized using solid phase chemistry, collections of compounds based exclusively on solid phase chemistry may have limited diversity. - Limited Compound Quantities. Certain current combinatorial chemistry techniques produce very small quantities of each compound, which limits further testing once a lead compound is found and precludes archiving of compounds for future testing against additional targets. 2 4 - Scale-Up Limitations. Many current combinatorial chemistry techniques involve laboratory methods that cannot be easily translated into large scale manufacturing processes. This creates the possibility that active compounds will be identified that are difficult or impractical to produce in quantities necessary for clinical trials or commercial production. - Unproductive Screening. Because certain combinatorial chemistry techniques involve the screening of random compounds without preselection for desirable drug characteristics, suitable lead compounds often can be identified only after many unproductive screenings. In addition, testing of mixtures frequently produces equivocal or false positive screening results because the observed activity with a biological target is caused by several compounds within the mixture rather than the interaction of an individual compound with a target, leading to further unproductive screening. Although recent developments in combinatorial chemistry have shortened the time between identifying a biological target and obtaining a hit in the target assay, the proliferation of hits has not led to a commensurate increase in lead compounds. In addition, current combinatorial chemistry techniques have not significantly improved the lead optimization process and, therefore, have not significantly shortened the time it takes to produce a drug development candidate from a lead compound. The ArQule Revolution ArQule believes its modular building block technology overcomes many of the limitations of current combinatorial chemistry approaches by achieving Targeted Discovery(TM) to accelerate the identification and optimization of lead compounds. Targeted Discovery is the design of diverse compound arrays that are biased toward specific biological targets by selecting molecules from a variety of chemical classes and constructing compound arrays in a manner believed to increase the probability of discovering one or more active compounds for those biological targets. Many organic molecules, including amino acids, peptides, nucleosides, carbohydrates, steroids and alkaloids, may be viewed as comprised of structural components, consisting of a scaffold, or core structure, around which a set of substituent groups and connectors (bonds) is varied. ArQule's scientists have developed proprietary methods for selecting and combining molecular components, or building blocks, to produce arrays of compounds that possess properties they believe will exhibit activity in biological systems. Using SAR data regarding biologically active compounds and modular molecular components, ArQule's synthetic and computational chemists work together to rapidly design compound arrays that include all combinations of a set of selected building blocks around a common core structure or theme. ArQule's arrays are created by using structure-guided and rational drug design tools to systematically select and assemble molecular building blocks with properties the Company's scientists believe are likely to exhibit biological activity. Each compound in the array is different from the adjacent compound as a result of a single structural modification. Each ArQule array omits compounds that are closely analogous to other compounds in the array, using representative diversity to create a logical representation of a virtual library of hundreds of times as many compounds as are in the array. Drug developers are able to realize significant savings by screening the thousands of compounds in each ArQule array rather than the millions of compounds they represent. In addition, the SAR data of compounds within the array provides a navigational tool for lead optimization by indicating the most promising investigational direction for analoging. In order to enhance the effectiveness of this modular building block technology, ArQule integrates the following tools: - structure-guided design; - a proprietary "automated molecular assembly plant" (AMAP(TM)) system for high speed parallel synthesis, purification and structural verification of chemical compounds; and - proprietary computer applications that facilitate the integration of all of the Company's proprietary technologies. 3 5 Structure-Guided Design. ArQule's scientists believe that the likelihood of generating a drug development candidate can be substantially increased if the collection of compounds used for screening is created using three-dimensional structural and SAR data. The Company designs its arrays based on chemical structures that are believed to be biologically active and also on SAR data regarding a particular target and a particular lead compound. Using this data, as well as knowledge of the chemical reactions that are feasible using high speed parallel synthesis, ArQule's scientists design logically arranged arrays of diverse compounds that can easily be synthesized. The Company believes that this approach will accelerate the lead discovery and optimization process by increasing the probability of identifying a lead compound that will result in a drug development candidate. The AMAP High Speed Parallel Synthesis System. Using its AMAP system, ArQule synthesizes, purifies and verifies structural information for individual compounds through automated high speed parallel synthesis. The AMAP system is capable of synthesizing thousands of compounds per day, each in milligram quantities adequate for multiple screens, analyzing such compounds for structural integrity and purity, registering the structural data in a relational database, and delivering the compounds in a 96-well microtiter plate format for high throughput screening. Integrated Proprietary Computer Applications ("Informatics"). ArQule has developed a proprietary information system which incorporates (i) databases of the molecular structures of building blocks and the compounds in its arrays, (ii) multi-dimensional matrix geometry which provides guidance for the creation of the Company's spatially addressable arrays of compounds containing systematic variations of modular building blocks, (iii) instructions for the robotics involved in the AMAP parallel synthesis production process, (iv) resulting databases of structural information regarding the compounds produced in any particular array which can be supplied in a format compatible with customers' own data registration systems and (v) databases of SAR data regarding particular compounds and their molecular components contained in an array generated when these compounds are screened against biological targets. This integrated information system enables ArQule to gather and apply data on an ongoing basis to enhance the efficiency of the production process and to design compounds based on a growing knowledge of the structure and activity of its molecular components. Advantages of ArQule's Combinatorial Drug Discovery and Development Platform The Company believes the integration of its technological capabilities offers a unique combinatorial drug discovery and development platform. This platform offers the following significant advantages over current combinatorial chemistry approaches: - Elimination of Isolation Issues. Unlike combinatorial chemistry processes involving the production of synthesized compounds in mixtures, ArQule's AMAP system produces one compound per well, with each well containing a known compound with a high level of purity. - Enhanced Structural and SAR Data. ArQule produces arrays using preselected modular building blocks that its scientists believe are likely to produce lead compounds with desirable characteristics, and, in the case of Directed Array sets, based upon the SAR data of the target and/or lead compound. As a result, the Company believes the success rate for drugs developed using its arrays will be improved and the risk of downstream clinical failure will be reduced. The wealth of SAR data available with respect to compounds in its arrays will also facilitate the development of analogs for the further optimization of active compounds. - Compatibility with Drug Developers' Screening Protocols. ArQule's compounds are delivered to its collaborators in 96-well microtiter plates containing one known compound per well. This delivery format is compatible with most existing screening protocols and permits the owner of the assay to screen compounds in its own laboratories, thereby having complete control over the screening process. - Solution and Solid Phase Chemistry. ArQule's compounds may be produced using either solution or solid phase chemistry, permitting the creation of a broad range of novel chemical compounds. - Significant Compound Quantities. ArQule's compounds are delivered to its collaborators in milligram quantities, permitting the collaborator to engage in extensive testing of a lead compound or to screen 4 6 compounds against multiple biological targets without having to obtain additional samples from the Company. - Ease of Scale-Up. ArQule's compounds are produced using fully reproducible and scalable manufacturing processes. - Reduction in Unproductive Screening. By creating logical arrays of compounds based on known structural and SAR data and eliminating compounds that are closely analogous to others in the array, ArQule believes that fewer compounds will need to be screened prior to identifying compounds with activity. In addition, because ArQule delivers single compounds for screening, such compounds do not generate the false positives and false negatives associated with screening mixtures of compounds. ArQule believes these significant advantages will allow its collaborative partners to accelerate the drug discovery process by several years by shortening the time required to identify a lead compound and to optimize that compound into a drug development candidate. This acceleration should permit drug developers to realize significant cost reductions and the earlier recovery of research and development expenditures for successful drugs. APPLICATION OF THE COMPANY'S TECHNOLOGIES IN THE AGROCHEMICAL INDUSTRY Industry Background. Agrochemicals are chemical products used in the agricultural industry. Examples of agrochemicals are herbicides, pesticides, fungicides, bactericides and soil treatment agents. Historically, agrochemical developers have obtained chemical compounds for screening from natural product sources and by traditional medicinal synthesis, and then screened those compounds against whole organisms rather than specific molecular targets. Lead compounds have traditionally been optimized using medicinal chemistry techniques similar to those used in the drug industry. Agrochemicals are also expensive and time-consuming to develop. As an example, the American Crop Protection Association estimates that development, testing, and regulatory approval of a pesticide product typically requires eight to ten years and may cost up to $50 million. As in the case of the pharmaceutical industry, the agrochemical industry is under pressure to identify lead compounds for the development of new products. As patents expire on existing products and generic equivalents become available, developers must introduce improved products to stay competitive and maintain profit margins. To gain market acceptance of a new product at a premium price, the product must provide some advantage to the customer as compared with existing products, such as an improvement in environmental profile, user health and safety, consumer health and safety, user convenience, or effectiveness at lower concentrations. Alternatively, a producer can maintain profit margins on a product sold without a premium if that product can be manufactured at a lower cost. Therefore, products in the agrochemical industry have historically been subject to a cost-benefit analysis that only recently has affected the pharmaceutical industry with the advent of managed care. Combinatorial Chemistry in the Agrochemical Industry. The agrochemical industry is now adopting new technologies including high throughput screening and combinatorial chemistry for many of the same reasons as the pharmaceutical industry. The limitations of certain combinatorial chemistry techniques, as described in the context of the pharmaceutical industry, are also applicable to the agrochemical industry. Indeed, compound quantities and scale-up issues are perhaps more important to the agrochemical industry than the pharmaceutical industry. - Compound Quantities. The agrochemical industry has historically used whole-organism screening methods and has not completed the transition to screening for specific molecular targets. These whole-organism assays consume quantities of test compounds in excess of the quantities produced using certain current combinatorial chemistry techniques. - Scale-Up. As compared with the pharmaceutical industry, the agrochemical industry manufactures and sells larger quantities of product at a lower margin. In addition, these products will not succeed in the marketplace unless they offer a clear advantage over existing products, with cost-effectiveness as a 5 7 major factor. Because of these constraints, the ease and cost of manufacture for a product is a more important consideration in the agrochemical industry than in the pharmaceutical industry. - The ArQule Advantage. The advantages of the ArQule approach to combinatorial chemistry, as described in the context of the pharmaceutical industry, are also advantages for the agrochemical industry. Indeed, the ArQule combinatorial compound discovery and development platform satisfies the important considerations of adequate compound quantities for initial screening and ease of scale-up for manufacturing. ArQule's compounds are delivered to its collaborators in milligram quantities sufficient for whole-organism screening methods, which are traditionally used in agrochemical development. In addition, ArQule's compounds are produced using fully reproducible and scalable manufacturing processes. ARQULE'S PRODUCTS ArQule's integrated technologies result in the production of significant quantities of pure small molecule compounds contained in a logically structured spatially-addressable array. ArQule provides its collaborative partners with two types of arrays of synthesized compounds: (i) Mapping Array compound sets, which are arrays of novel, diverse, small molecule compounds used for screening against biological targets and (ii) Directed Array compound sets, which are arrays of analogs of a particular lead compound synthesized for the purpose of optimizing that lead compound. Mapping Array(TM) Program. ArQule's Mapping Array Program is a multi-year subscription to annual Mapping Array compound sets which are designed around certain core structures or themes selected by ArQule. Through this program, the Company provides 15 to 20 Mapping Array compound sets, on an annual basis, each containing between 3,000 and 10,000 individual compounds for a minimum aggregate of 100,000 compounds. The Mapping Array Program is provided to subscribers without limitation as to the targets against which the compounds may be screened. ArQule believes this approach will maximize the number of targets against which its Mapping Array sets are tested, thereby maximizing the potential for identifying activity for each compound in the array. Initially, the Company provides its Mapping Array sets on a non-exclusive, subscription fee basis for screening purposes only. If a compound shows activity in a subscriber's assay, the subscriber may license that compound from the Company for development purposes on an exclusive basis, unless such compound has already been licensed to another collaborative partner. The Company does not provide any structural information regarding the compounds in the Mapping Array sets until a particular compound is licensed. Directed Array(TM) Programs. Under its Directed Array Programs, the Company provides Directed Array sets in order to optimize lead compounds. In a Directed Array set, the Company uses its modular building block technology to create analogs of a lead compound identified by the collaborator, either independently or as a result of screening a Mapping Array set. Successive Directed Array sets are generated in order to identify the analog or analogs having the greatest biological activity and most desirable development characteristics. When delivering each Directed Array set, the Company provides the collaborator with structural information for each compound in the array, and each compound is owned by the collaborator either individually or jointly with ArQule, subject to the payment of fixed fees, milestones and royalties to the Company. Under a typical Directed Array Program, ArQule provides three to seven Directed Array sets, each averaging about 1,000 analogs of a particular lead compound chosen by a collaborator in consultation with ArQule. BUSINESS STRATEGY ArQule's goal is to become the leading drug and chemical product discovery company by using its high throughput molecular technologies to design, synthesize and test high performance molecules for health care and specialty chemical applications. The Company seeks to penetrate the product development pipelines of pharmaceutical, agrochemical and biotechnology companies and to maximize the likelihood of the discovery 6 8 of activity and successful development of commercial compounds. Key elements of the Company's strategy include: - Collaborations with Pharmaceutical and Agrochemical Companies. The Company seeks collaborations with those companies that have established manufacturing, marketing and sales resources and a strong commitment to the development of pharmaceutical or agrochemical products. ArQule offers to each of its collaborative partners access to its Mapping Array Program for an annual subscription fee and provides, if requested, customized Directed Array Programs for a fixed fee. In addition, the Company is entitled to payments upon the achievement of certain milestones and royalties upon the commercialization of products developed by the collaborator from ArQule compounds. The Company plans to pursue additional collaborations aggressively to gain access to additional targets and development expertise and to generate additional revenue. - Joint Discovery Programs with Biotechnology Companies. Biotechnology companies have identified numerous proprietary biological targets and assays and therefore represent important potential collaborators for joint discovery and development efforts using ArQule's Mapping Array and Directed Array sets. ArQule provides Mapping Array and Directed Array sets to biotechnology companies in exchange for joint ownership of any lead compounds that exhibit activity in the proprietary assays developed by the biotechnology company collaborators. ArQule seeks collaborators with promising drug development programs in a broad range of therapeutic areas. - Expansion of Proprietary Drug Discovery Capabilities. The Company intends to expand its proprietary drug discovery capabilities by developing or acquiring, either independently or in partnership with others, proprietary biological targets, proprietary assays and the capability to screen its compounds against such assays. The Company will also consider investing in the lead optimization and initial preclinical and clinical development efforts for selected lead compounds in order to realize a greater portion of the value created by its technologies. - Extension of Chemistry Tools to Other Areas. The Company intends to extend its integrated technologies outside the fields of pharmaceuticals, agrochemicals and bioseparations to a variety of other applications, including industrial catalysts and polymeric structures for non-biological applications. - Continued Investment in Proprietary Chemistry Technology. ArQule intends to continue its aggressive investment in proprietary chemistry technologies through internal development and licensing of third party technologies. ArQule will also continue to invest in improving the cost-effectiveness of its products through automation and information technologies. ARQULE'S PRODUCT DISCOVERY PROGRAMS Pharmaceutical and Agrochemical Company Collaborations To date, the Company has entered into the following major collaborations with pharmaceutical and agrochemical companies: Amersham Pharmacia Biotech AB. In March 1995, the Company entered into a collaborative agreement with Amersham Pharmacia Biotech AB ("Amersham"), to allow Amersham to evaluate the utility of the Company's technology for the development of products in the fields of bioseparations, synthesis of biomolecules and cell culture (the "Amersham Agreement"). On the same date, the Company and Amersham also signed an agreement under which Amersham has an option to acquire an exclusive, worldwide license to develop and commercialize specified compounds generated by the Company in additional fields covered under the Amersham Agreement, subject to the payment by Amersham of additional fees and the negotiation and execution by the parties of a license agreement containing commercially reasonable terms (the "Option Agreement"). In accordance with its terms, the Amersham Agreement expired on December 31,1997. The parties are actively engaged in negotiations to extend and expand the contract. 7 9 Abbott Laboratories. In June 1995, the Company entered into a collaborative agreement with Abbott Laboratories ("Abbott") pursuant to which Abbott subscribed to the Company's Mapping Array Program and has the right to request customized Directed Array sets (the "Abbott Agreement"). To date, the Company has provided Abbott with many Mapping Array and Directed Array sets. In August 1996, the Abbott Agreement was amended to provide for the Company to supply Abbott with additional Mapping Array sets and to eliminate restrictions on the period during which Abbott may screen the Mapping Array sets. In December 1996, the Abbott Agreement was further amended to extend the term of the Abbott Agreement until March 1999, to provide for the Company to supply Abbott with additional Mapping Array sets during such extended period and additional Directed Array sets during part of such extended period, and to provide for the payment by Abbott of additional research and development funding during such extended period. In December 1997, the Abbott Agreement was further amended to provide for the Company to supply Abbott with additional Mapping Array sets through March 1999 and with additional Directed Array sets through December 1999. Abbott may not terminate the Abbott Agreement prior to March 1999 without cause. Absent early termination, Abbott has agreed to pay the Company $7.4 million through March 1999. Abbott is also obligated under the Abbott Agreement to make additional payments upon the achievement of certain milestones and to pay royalties on the sale of drugs that may result from the relationship. Solvay Duphar B.V. In November 1995, the Company entered into a collaborative agreement with Solvay Duphar B.V. ("Solvay") pursuant to which Solvay has subscribed to the Company's Mapping Array Program and has the right to request customized Directed Array sets (the "Solvay Agreement"). To date, the Company has provided Solvay with several Mapping Array and Directed Array sets. Absent early termination, Solvay agreed to pay the Company a minimum of $17.5 million over five years. Solvay is also obligated to make additional payments upon the achievement of certain milestones and to pay royalties on sales of drugs that may result from the relationship. The Solvay Agreement expires in November 2000. Solvay has the right to terminate the Mapping Array Program on twelve months' written notice at any time subject to its payment of a termination fee of approximately $1.0 million. Solvay may also terminate the delivery of Directed Array sets on six months' written notice at any time subject to its payment of a termination fee equal to a certain percentage of the aggregate research payments made by Solvay in the year in which notice is given. To date, Solvay has paid the Company an aggregate of $4.3 million under the Solvay Agreement. In connection with this collaboration, an affiliate of Solvay, Physica B.V., made a $7.0 million equity investment in the Company. Under the Solvay Agreement, Solvay has the right to license, on an exclusive basis, lead compounds identified from a Mapping Array set that are active against specified biological targets and that have not previously been committed to another of ArQule's collaborative partners or to an internal program of the Company. Solvay also has the right to use certain of ArQule's technologies internally. Roche Bioscience. In September 1996, the Company entered into a collaborative agreement with Roche Bioscience ("Roche Bioscience"), a division of Syntex (U.S.A.) Inc. and indirect subsidiary of Roche Holding Ltd., pursuant to which the Company will synthesize Directed Array sets from compounds provided to the Company by Roche Bioscience, developed by the Company internally and/or developed by the Company as a part of the collaboration (the "Roche Bioscience Agreement"). Absent early termination, Roche Bioscience will pay the Company approximately $12.1 million over three years. The parties may jointly agree to increase the number of Directed Array sets to be provided by the Company under the Roche Bioscience Agreement, which may result in increased payments to the Company. Roche Bioscience is also obligated to make additional payments upon the achievement of certain milestones and to pay royalties on sales of drugs that may result from the relationship. The Roche Bioscience Agreement expires in September 1999 and is terminable by Roche Bioscience on or after September 1998 on six months' advance notice. If such termination occurs on September 30, 1998, the Company will have received payments of approximately $8.4 million from Roche Bioscience through that date and no further payments, other than milestone payments and royalties, will be due to the Company. Monsanto Company. In December 1996, the Company entered into a collaborative agreement with Monsanto Company ("Monsanto"), pursuant to which Monsanto subscribed to the Company's 8 10 Mapping Array Program and the Company agreed to synthesize Directed Array sets from compounds provided to the Company by Monsanto and/or developed by the Company under the Mapping Array Program (the "Monsanto Agreement"). Assuming Monsanto requests the synthesis of at least one Directed Array per year over the term of the Monsanto Agreement, the Company will receive a minimum of $12.0 million over five years. Monsanto is also obligated to make additional payments upon the achievement of certain milestones and to pay royalties on sales of products that may result from the relationship. The Monsanto Agreement expires in December 2001, subject to Monsanto's right to extend the term of the Monsanto Agreement for two additional one-year periods. Monsanto has the right to terminate the Mapping Array Program and/or the Directed Array Program on six months' written notice at any time subject to its payment of a termination fee equal to the aggregate minimum amount that would have been paid to the Company by Monsanto under the program to be terminated over the entire five-year term. American Home Products. In July 1997, the Company entered into a collaborative agreement with Wyeth-Ayerst Pharmaceuticals, a division of American Home Products Corporation ("Wyeth-Ayerst"), pursuant to which Wyeth-Ayerst subscribed to the Company's Mapping Array Program and has committed to a minimum number of Directed Array Programs. Wyeth-Ayerst will pay ArQule approximately $28 million, which includes a $2 million equity investment in ArQule to be paid in 1998. Wyeth-Ayerst will make further payments to ArQule throughout the five year collaboration as development milestones are reached. In addition, ArQule will be entitled to royalties from sales of any products emanating from this collaboration. Sankyo Company, Ltd. In November 1997, the Company entered into a collaborative agreement with Sankyo Company, Ltd. ("Sankyo") to discover and optimize drug candidates. The agreement calls for use of ArQule's Mapping Array and Directed Array Programs in identifying and optimizing lead compounds for a number of therapeutic areas. Under terms of the agreement, Sankyo will receive a three year subscription to ArQule's Mapping Array Program to discover new lead compounds. Sankyo is also committed to a minimum number of Direct Array Programs during the term of the agreement. Absent early termination, the Company will receive a minimum of $9.0 million over this three year period. Payments will be made to ArQule for delivery of the Mapping Array and Directed Array Programs and for achieved milestones. In addition, ArQule will be entitled to royalties from sales of any products emanating from this collaboration. 9 11 Joint Discovery Programs with Biotechnology Companies ArQule has initiated joint programs for lead generation and optimization with a number of biotechnology companies. Some of ArQule's biotechnology collaborators and their areas of focus are listed below:
COMPANY AREA OF FOCUS ------- ------------- Acacia Biosciences Biosynthesis and metabolism Aurora Biosciences, Inc. Mammalian Cell-Based Assays Cubist Pharmaceuticals, Inc. Infectious Diseases CuraGen Genomics FibroGen Fibrotic Disorders GenQuest Cancer Genzyme Corp. Cancer ICAgen, Inc. Ion Channel Receptors Ontogeny Developmental Biology Targets Ribogene Pathogen specific translation Scriptgen Pharmaceuticals, Inc. RNA/Protein Interaction Sepracor, Inc. Resistant HIV and Hepatitis B Signal Pharmaceuticals, Inc. Gene Transcription/Transcription Factors SUGEN, Inc. Signal Transduction/Kinases T Cell Sciences, Inc. T Cell Activation/Inhibition ViroPharma, Inc. RNA viruses
In the United States, small biotechnology companies have been highly successful in the discovery of biological targets associated with disease states. Many of these companies, however, lack both (i) large libraries of chemical compounds to screen against identified targets and (ii) the sophisticated chemistry expertise required to optimize compounds once a lead compound has been identified. Under the Company's typical arrangement with a biotechnology company, ArQule provides Mapping Array sets for screening without collecting upfront fees, and the biotechnology company executes a preliminary material transfer agreement. If the collaborator detects an active compound within a Mapping Array set, and that compound has not been previously committed to a third party or to an internal ArQule program, the Company and the collaborator establish a joint discovery program and execute a more focused research collaboration agreement. If the parties are unable to negotiate the scope of a joint discovery program within a certain period, ArQule has the right to license such compound to any third party. Although ArQule's formal research collaboration agreement varies from transaction to transaction, it typically establishes a joint drug development program for the lead compound and a particular target, and gives ArQule shared control over the program. MARKETING AND SALES The Company markets its products directly to customers through participation in trade conferences and seminars and publications in scientific and trade journals. To date, the Company has sold its products to its collaborative partners primarily through the efforts of its senior management. The Company's senior management has limited experience in marketing products similar to those of the Company. In order to achieve significant long-term growth in revenues and its overall strategic goals, the Company intends to hire several dedicated sales and marketing personnel. There can be no assurance that the Company will be able to achieve anticipated expansion of its business, attract a significant number of new collaborative partners as customers or build an efficient and effective sales and marketing organization. In the event the Company is unable to achieve any one or more of the foregoing goals, the Company's business, financial condition and results of operations could be materially adversely affected. In addition to the risks inherent in the Company's efforts to market its own products, the Company's revenues 10 12 from royalties and milestone payments from its collaborative partners are substantially dependent upon the marketing efforts of such collaborative partners. RESEARCH AND DEVELOPMENT ArQule intends to continue its aggressive investment in its proprietary technologies through internal development and licensing of third party technologies in order to increase the diversity and improve other characteristics of the compounds offered. The Company will also continue to invest in improving the cost-effectiveness of its products and capabilities through automation and information technologies. The Company is actively pursuing research projects aimed at identifying and developing new chemistries to improve and expand on its Mapping Array and Directed Array Programs. The Company is also undertaking collaborations with other researchers in order to pursue the possible acquisition of chemistries and other technologies developed by academic institutions and other third parties. PATENTS AND PROPRIETARY RIGHTS ArQule has three issued U.S. utility patents, one issued U.S. design patent, one issued Australian patent, and over 70 patent applications in the U.S. and other countries. There can be no assurance that patent applications filed by ArQule will result in patents being issued, that the claims of such patents will offer significant protection of the Company's technology, or that any patents issued to or licensed by ArQule will not be challenged, narrowed, invalidated or circumvented. The Company may also be subject to proceedings that result in the revocation of patent rights previously owned by or licensed to ArQule, as a result of which the Company may be required to obtain licenses from others to continue to develop, test or commercialize its products. There can be no assurance that ArQule will be able to obtain such licenses on acceptable terms, if at all. In addition, there may be pending or issued patents held by parties not affiliated with ArQule that relate to the technology utilized by ArQule. As a result, ArQule may need to acquire licenses, to assert infringement, or contest the validity, of such patents or other similar patents which may be issued. ArQule could incur substantial costs in defending itself against patent infringement claims, interference proceedings, opposition proceedings or other challenges to its patent rights made by third parties, or in bringing such proceedings or enforcing any patent rights of its own. The Company also relies upon trade secrets, know-how and continuing technological advances to develop and maintain its competitive position. In an effort to maintain the confidentiality and ownership of trade secrets and proprietary information, the Company requires employees, consultants and certain collaborators to execute confidentiality and invention assignment agreements upon commencement of a relationship with the Company. These agreements are intended to enable the Company to protect its proprietary information by controlling the disclosure and use of technology to which it has rights and provide for ownership by the Company of proprietary technology developed at the Company or with the Company's resources. There can be no assurance, however, that these agreements will provide meaningful protection for the Company's trade secrets or other confidential information in the event of unauthorized use or disclosure of such information or that adequate remedies would exist in the event of such unauthorized use or disclosure. The loss or exposure of trade secrets possessed by ArQule could have a material adverse effect on its business. COMPETITION Many organizations are actively attempting to identify and optimize compounds for potential pharmaceutical or agrochemical development. The Company's services and products face competition based on a number of factors, including size, diversity and ease of use of libraries of compounds, speed and costs of identifying and optimizing potential lead compounds and patent position. ArQule competes with the research departments of pharmaceutical companies, biotechnology companies, agrochemical companies, combinatorial chemistry companies and research and academic institutions. Many of these competitors have greater financial and human resources and more experience in research and development than the Company. Smaller companies may also prove to be significant competitors, particularly through arrangements with large corporate collaborators. In addition to competition for customers, these companies and institutions also compete with the Company in recruiting and retaining highly qualified scientific and management personnel. 11 13 Historically, pharmaceutical and agrochemical companies have maintained close control over their research activities, including the synthesis, screening and optimization of chemical compounds. Many of these companies, which represent a significant potential market for ArQule's products and services, are developing in-house combinatorial chemistry and other methodologies to improve productivity, including major investments in robotics technology to permit the automated parallel synthesis of compounds. In addition, these companies may already have large collections of compounds previously synthesized or ordered from chemical supply catalogs or other sources against which they may screen new targets. Other sources of compounds include extracts from natural products such as plants and microorganisms and compounds created using rational design. Academic institutions, governmental agencies and other research organizations are also conducting research in areas in which the Company is working either on their own or through collaborative efforts. The Company anticipates that it will face increased competition in the future as new companies enter the market and advanced technologies become available. The Company's processes may be rendered obsolete or uneconomical by technological advances or entirely different approaches developed by one or more of the Company's competitors. The existing approaches of the Company's competitors or new approaches or technology developed by the Company's competitors may be more effective than those developed by the Company. There can be no assurance that the Company's competitors will not develop more effective or more affordable technology or products, or achieve earlier product development and commercialization than the Company, thus rendering the Company's technologies and/or products obsolete, uncompetitive or uneconomical. GOVERNMENT REGULATION Although the manufacture, transportation and storage of the Company's products are subject to certain laws and regulations discussed in the last paragraph of this section, the licensing of the Company's products is not subject to significant government regulations. However, the Company's future profitability is dependent on the sales of pharmaceuticals and other products developed from the Company's compounds by its customers and collaborators. Regulation by governmental entities in the United States and other countries will be a significant factor in the production and marketing of any pharmaceutical products that may be developed by a customer of the Company, or in the event the Company decides to develop a drug beyond the preclinical phase. The nature and the extent to which such regulation may apply to the Company's customers will vary depending on the nature of any such pharmaceutical products. Virtually all pharmaceutical products developed by the Company's customers will require regulatory approval by governmental agencies prior to commercialization. In particular, human pharmaceutical products are subject to rigorous preclinical and clinical testing and other approval procedures by the FDA and by foreign regulatory authorities. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of such pharmaceutical products. The process of obtaining these approvals and the subsequent compliance with appropriate federal and foreign statutes and regulations are time consuming and require the expenditure of substantial resources. Generally, in order to gain FDA approval, a company first must conduct preclinical studies in the laboratory and in animal models to gain preliminary information on a compound's efficacy and to identify any safety problems. The results of these studies are submitted as a part of an IND that the FDA must review before human clinical trials of an investigational drug can start. In order to commercialize any products, the Company or its customer will be required to sponsor and file an IND and will be responsible for initiating and overseeing the clinical studies to demonstrate the safety and efficacy that are necessary to obtain FDA approval of any such products. Clinical trials are normally done in three phases and generally take two to five years, but may take longer, to complete. After completion of clinical trials of a new product, FDA and foreign regulatory authority marketing approval must be obtained. If the product is classified as a new drug, the Company or its customer will be required to file an NDA and receive approval before commercial marketing of the drug. The testing and approval processes require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis, if at all. NDAs submitted to the FDA can take 12 14 several years to obtain approval. Even if FDA regulatory clearances are obtained, a marketed product is subject to continual review, and later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions. For marketing outside the United States, the Company will also be subject to foreign regulatory requirements governing human clinical trials and marketing approval for pharmaceutical products. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country. Fertilizers, pesticides and other agrochemicals are heavily regulated in the United States. The EPA regulates such products under the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA"). Agrochemicals are also regulated by various state agencies. Some states, such as California, have their own extensive registration requirements. To develop and commercialize a pesticide product, detailed and complex procedures must be followed and Federal approvals obtained under FIFRA. Small scale field testing usually can be conducted prior to product registration to evaluate product efficacy. To conduct large scale tests, a company must obtain an Experimental Use Permit which generally requires satisfactory completion of certain toxicology and environmental studies. Synthetic chemical pesticides require extensive toxicology and environmental testing to substantiate product safety prior to obtaining a product registration. Commercial sale of agrochemicals requires a product registration for each pest and crop for which the product is used. The research and development processes of the Company involve the controlled use of hazardous materials. The Company is subject to federal state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and certain waste products. Although the Company believes that its activities currently comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, the Company could be held liable for any damages that result and any liability could exceed the resources of the Company. In addition, there can be no assurance that the Company will not be required to incur significant costs to comply with environmental laws and regulations in the future. EMPLOYEES As of March 5, 1998, ArQule employed 159 people of whom 51 have Ph.D. degrees. Of these, 90 were engaged in operations, 52 were engaged in research and development and 17 were engaged in marketing and general administration. None of ArQule's employees are covered by collective bargaining agreements. ArQule believes its employee relations are good. EXECUTIVE OFFICERS OF THE REGISTRANT The current executive officers of the Company are as follows:
NAME AGE POSITION ---- --- -------- Eric B. Gordon........................ 50 President, Chief Executive Officer and Director Joseph C. Hogan, Jr., Ph.D............ 56 Chairman of the Board, Senior Vice President of Research and Development, Chief Scientific Officer, and Director James R. Fitzgerald, Jr............... 53 Vice President, Chief Financial Officer and Treasurer
Eric B. Gordon has been the President and Chief Executive Officer of the Company since January 1996. From 1987 until he joined the Company, Mr. Gordon served in various capacities in the United States and Europe with Pasteur Merieux Connaught -- U.S., a pharmaceutical company, most recently as Vice President and Chief Financial Officer. In addition, since 1993 he held the additional position of Chief Executive Officer of Virogenetics Corporation, a partially owned joint venture company and since 1994 Vice President and Treasurer of Pasteur Merieux. Mr. Gordon received his A.M.P. from the Wharton School of Business of the University of Pennsylvania and his B.S. in Accounting and Finance from Syracuse University. 13 15 Joseph C. Hogan, Jr., Ph.D. is a founder of the Company and has served as the Chief Scientific Officer and Senior Vice President of Research and Development since its inception. Dr. Hogan has served as the Chairman of the Board since January 1996. From 1990 until he founded the Company, Dr. Hogan was the founder and president of Applied Modular Chemistries, Inc., a chemistry company. Dr. Hogan received his M.S. and B.S. in Chemistry from Boston College and his Ph.D. from Boston College and the Max Planck Institut fuer Kohlenforschung, Muelheim/Ruhr, Germany. James R. Fitzgerald, Jr. joined the Company in July 1996 as the Vice President, Chief Financial Officer and Treasurer. From 1988 until he joined the Company, Mr. Fitzgerald was the Chief Financial Officer of Hoyts Cinemas Corporation, an owner and operator of cinemas. Mr. Fitzgerald received his M.B.A. and his B.A. in Economics from Northeastern University. ITEM 2. PROPERTIES ArQule's research facilities include approximately 63,000 square feet of laboratory and office space in Medford, Massachusetts pursuant to three lease agreements. These leases extend through July 30, 2001, at which time the Company has an option to renew the leases for an additional five year period. The company has obtained 12,000 square feet of additional laboratory space in Waltham, Massachusetts pursuant to a sublease agreement. This lease extends through November 30, 2000, at which time the Company has an option to extend for one year. ArQule believes its facilities are adequate for its current operations. The Company believes that suitable additional space will be available to it, when needed, on commercially reasonable terms. ITEM 3. LEGAL PROCEEDINGS On July 21, 1997, a complaint was filed in the United States District Court of Connecticut (Case No. 397CV01449) against the Company and two of the Company's stockholders by two individuals alleging that they were entitled to compensation from the Company and these two stockholders equal to approximately five percent of the equity interest in the Company for services in connection with the initial financing of ArQule Partners, L.P. in 1993. In addition, one of the plaintiffs is alleging that he was denied the opportunity to make a five percent investment in the Company at the time of its incorporation. Prior to the Company's initial public offering of its Common Stock, ArQule Partners, L.P. was a major stockholder of the Company. An answer was filed on September 15, 1997 denying the material allegations in the complaint and Phase I of the discovery process has been completed. Although the parties to this lawsuit have had mediation proceedings, the Company intends to continue to contest this lawsuit vigorously. No assurance can be given regarding the outcome of this lawsuit. Except as stated above, ArQule is not a party to any other legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 14 16 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Common Stock began trading on The Nasdaq Stock MarketSM on October 16, 1996 under the symbol "ARQL". Prior to October 16, 1996, there was no public market for the Common Stock or any other securities of the Company. The following table sets forth, for the periods indicated, the range of the high and low closing sale prices for the Company's Common Stock:
HIGH LOW ------ ------ 1996 Fourth Quarter (from October 16, 1996).................... $15.75 $ 9.00 1997 First Quarter............................................. 24.25 14.25 Second Quarter............................................ 19.50 12.00 Third Quarter............................................. 22.75 14.75 Fourth Quarter............................................ 29.25 17.75 1998 First Quarter (through March 5, 1998)..................... 25.50 15.00
As of March 5, 1998, there were approximately 89 holders of record and approximately 2,546 beneficial shareholders of the Company's Common Stock. During the first quarter of the Company's fiscal year ended December 31, 1997 and prior to the Company filing a registration statement on Form S-8 for option exercises under its Amended and Restated 1994 Equity Incentive Plan (the "Plan"), options to purchase 34,375 shares of Common Stock were exercised at $0.20 per share pursuant to Rule 701 of the Securities Act of 1933, as amended. The Company has never paid cash dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to fund the development of its business. Use of Proceeds from Registered Securities A Registration Statement on Form S-1 (File No. 333-11105) registering 2,875,000 shares of the Company's Common Stock, filed in connection with the Company's IPO was declared effective by the Securities and Exchange Commission on October 16, 1996. Exercise of the over-allotment option was initiated on November 13, 1996 and was closed on November 18, 1996. The Company and its selling shareholders sold, in aggregate, all 2,875,000 shares registered in the IPO, with an aggregate offering price to the public of $34,500,000. The managing underwriters of the IPO were Hambrecht & Quist LLC, Oppenheimer & Co., Inc. and Vector Securities International Inc. In connection with the IPO, the Company incurred total expenses of $2,979,000, including underwriting discounts and commissions of $2,415,000 and other expenses of $564,000. After such expenses, the Company's net proceeds from the IPO were $31,521,000. The amount of net offering proceeds used by the Company as of December 31, 1997 was as follows: approximately $9,500,000 for fixed asset additions and approximately $1,500,000 for capital lease obligations. 15 17 ITEM 6. SELECTED FINANCIAL DATA The following data, insofar as it relates to the period from inception (May 6, 1993) through December 31, 1993 and for the years 1994, 1995, 1996 and 1997, have been derived from the Company's audited financial statements, including the balance sheet as of December 31, 1996 and 1997 and the related statements of operations and of cash flows for the three years ended December 31, 1997 and notes thereto appearing elsewhere herein. The data should be read in conjunction with the Financial Statements and the Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Form 10-K. The historical results are not necessarily indicative of the results of operations to be expected in the future (in thousands, except per share data).
PERIOD FROM INCEPTION (MAY 6, 1993) THROUGH YEAR ENDED DECEMBER 31, DECEMBER 31, ---------------------------------------- 1993 1994 1995 1996 1997 --------------------- ------- ------- ------- ------- Statement of Operations Data: Revenue......................... $ -- $ 85 $ 3,330 $ 7,255 $17,420 ------- ------- ------- ------- ------- Cost and expenses: Cost of revenue............... -- -- 1,644 4,739 10,218 Research and development...... 769 2,806 2,095 3,076 4,704 Marketing, general and administrative............. 687 1,346 1,557 2,850 4,670 ------- ------- ------- ------- ------- Total costs and expenses... 1,456 4,152 5,296 10,665 19,592 ------- ------- ------- ------- ------- Loss from operations............ (1,456) (4,067) (1,966) (3,410) (2,172) Interest income (expense), net........................... (9) (139) (286) 417 2,463 ------- ------- ------- ------- ------- Net income (loss)............... $(1,465) $(4,206) $(2,252) $(2,993) $ 291 ======= ======= ======= ======= ======= Basic net income (loss) per share(1)...................... $ (3.76) $ (1.23) $ .03 ======= ======= ======= Weighted average common shares outstanding -- basic(1)....... 599 2,430 11,337 ======= ======= ======= Diluted net income (loss) per share(1)...................... $ (3.76) $ (1.23) $ .02 ======= ======= ======= Weighted average common shares and equivalents outstanding -- diluted(1).................... 599 2,430 12,394 ======= ======= =======
DECEMBER 31, -------------------------------------------------- 1993 1994 1995 1996 1997 ------ ------- ------- ------- ------- Balance Sheet Data: Cash, cash equivalents and marketable securities........................... $ 595 $ 425 $ 7,791 $37,086 $49,282 Working capital (deficit)............... 275 (2,108) 5,074 31,440 46,023 Total assets............................ 1,538 2,321 10,190 43,509 66,925 Capital lease obligations, less current portion.............................. 376 962 911 1,728 1,213 Series B mandatorily redeemable convertible preferred stock.......... -- -- 6,888 -- -- Total stockholders' equity (deficit).... 771 (1,203) (1,000) 34,621 57,340
- --------------- (1) The Company adopted Statement of Financial Accounting Standards No. 128 -- "Earnings Per Share" ("SFAS 128") in the fourth quarter of 1997. SFAS 128 requires retroactive restatement of previously reported income (loss) per share calculations. As a result of adopting SFAS 128, certain anti-dilutive pro-forma share amounts included in the computation of the loss per share in 1995 and 1996 are no 16 18 longer included in the weighted average common shares and equivalents outstanding. Prior to the restatement required by SFAS 128, pro forma net loss per share for the year ended December 31, 1995 was ($0.33), based upon weighted average common shares outstanding of 6,853 and for the year ended December 31, 1996 was ($0.39), based upon weighted average common shares outstanding of 7,705. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW ArQule is engaged in the discovery and development of novel chemical compounds with commercial potential in the pharmaceutical, biotechnology and agrochemical industries. ArQule manufactures and delivers two types of arrays of synthesized compounds to its pharmaceutical, biotechnology and agrochemical partners: (i) Mapping Array compound sets, which are arrays of novel, diverse small molecule compounds used in screening for lead generation and (ii) Directed Array compound sets, which are arrays of analogs of a particular lead compound (identified from a Mapping Array set or otherwise), synthesized for the purpose of optimizing such lead compounds. The Company currently generates revenue primarily through compound development from collaborative agreements, which provide for the development and delivery of Mapping Array and Directed Array sets. The Company's revenue to date is primarily attributable to seven major corporate collaborations: Amersham Pharmacia Biotech AB, entered into in March 1995; Abbott Laboratories, entered into in June 1995; Solvay Duphar B.V., entered into in November 1995; Roche Bioscience, entered into in September 1996; Monsanto Company, entered into in December 1996; American Home Products, entered into July 1997; and Sankyo Ltd, entered into November 1997. Under these collaborations, the Company has received payments of $29.1 million through December 31, 1997 and has recognized $28.1 million as revenue. The Company recognizes revenue under its corporate collaborations as related work is performed and arrays are delivered. Payments received from corporate partners prior to the completion of the related work are recorded as deferred revenue. License option fees are recognized as the options are granted because such fees are nonrefundable and the Company has no further obligations to fulfill. Technology access fees are recognized over the length of the research and development agreement. The Company is also entitled to receive milestone and royalty payments if products generated under the collaborations are developed. The Company has not received any milestone or royalty payments to date. The Company has additionally entered into joint discovery agreements with a number of biotechnology companies to which it has provided Mapping Array and Directed Array sets in exchange for joint ownership interests of resulting drug candidates. These agreements have not yet yielded any significant revenue for the Company. The Company experienced its first year of profitability in 1997, reflecting the increase in revenues resulting from ArQule's growing collaborator base and an increase in interest income. Quarterly variations in future financial performance may be expected as increases in revenue are dependent on expanding existing collaborations, additional corporate collaborations, and future milestone payments, which may be inconsistent and difficult to anticipate. In addition, the Company will continue to aggressively invest in new technologies to expand its drug discovery capabilities. The Company also expects that strategic opportunities will arise to broaden the Company's participation in drug discovery and to extend the Company's proprietary technology platform to industry segments beyond pharmaceutical and agrochemical product discovery. Strategic investments of this nature have the potential for enhancing longer term equity value but may result in near term earnings fluctuations or impact profitability. RESULTS OF OPERATIONS Years Ended December 31, 1997 and 1996 Revenue. The Company's revenue for the year ended December 31, 1997 increased $10.1 million to $17.4 million from $7.3 million for the same period in 1996. This increase was primarily due to increased compound development revenue from work performed on and the delivery of Mapping Array and Directed Array sets under the Company's collaborative agreements. The Company began recognizing revenue from Roche BioScience, Monsanto Company, American Home Products and Sankyo collaborations in October 1996, December 1996, July 1997, and November 1997, respectively. 17 19 Cost of revenue. The Company's cost of revenue for the year ended December 31, 1997 increased $5.5 million to $10.2 million from $4.7 million for the same period in 1996. These increases are primarily attributable to the costs of additional facilities and scientific personnel and the necessary supplies and overhead expenses related to the performance of the work and the delivery of the Mapping Array and Directed Array sets pursuant to the Company's collaborative agreements. The Company anticipates that the aggregate cost of revenue will increase over the next several years as its business expands. Research and development expenses. The Company's research and development expenses for the year ended December 31, 1997 increased $1.6 million to $4.7 million from $3.1 million for the same period in 1996. These increases are the result of the Company's expansion of its chemical libraries and related proprietary technologies. The Company expects research and development spending to increase over the next several years as the Company further expands its chemistry discovery and development programs. Marketing, general and administrative expenses. The Company's marketing, general and administrative expenses for the year ended December 31, 1997 increased $1.8 million to $4.7 million from $2.9 million for the same period in 1996. These increases are primarily associated with increased marketing and business development activities, expenses of being a public company for a full year, and higher levels of administrative support in concert with the Company's growth during 1997. These expenses will likely increase in the aggregate in future periods to support the projected growth of the Company. Net interest income (expense). The Company's net interest income for the year ended December 31, 1997 was $2.5 million, compared to $0.4 million for the same period in 1996. Higher interest income in 1997 resulted primarily from the Company holding higher cash and marketable securities balances following its initial and follow-on offerings of common stock in October 1996 and April 1997, respectively. Net income (loss). The Company's net income for the year ended December 31, 1997 was $0.3 million as compared to a net loss of $3.0 million for the same period in 1996. The net income for 1997 is primarily attributable to increase in revenues from the Company's growing collaborator base and higher net interest income recognized during 1997. Quarterly variations in future financial performance may be expected as increases in revenue are dependent on expanding existing collaborations, additional corporate collaborations, and future milestone payments, which may be inconsistent and difficult to anticipate. Years Ended December 31, 1996 and 1995 Revenue. The Company's revenue for the year ended December 31, 1996 increased $4.0 million to $7.3 million from $3.3 million for the same period in 1995. This was attributable to a $5.0 million increase in compound development revenue related to the performance of work and the delivery of Mapping Array and Directed Array sets under the Company's collaborative agreements, offset by a $1.0 million decrease in license option fees during the same period. The Company began recognizing revenue from the Amersham Pharmacia Biotech AB, Abbott Laboratories and Solvay Duphar B.V. collaborations in March, June and November 1995, respectively and for Roche Bioscience and Monsanto Company in October and December of 1996, respectively. Cost of revenue. The Company's cost of revenue for the year ended December 31, 1997 increased $3.1 million to $4.7 million from $1.6 million for the same period in 1995. This increase was primarily attributable to the costs of additional scientific personnel and the necessary supplies and overhead expenses related to the performance of the work and the delivery of the Mapping Array and Directed Array sets pursuant to its collaborative agreements. Research and development expenses. The Company's research and development expenses for the year ended December 31, 1997 increased $1.0 million to $3.1 million from $2.1 million from the same period in 1995. This increase was the result of the Company's expansion of its chemical libraries and related proprietary technologies. Marketing, general and administrative expenses. The Company's marketing, general and administrative expenses for the year ended December 31, 1996 increased $1.3 million to $2.9 million from $1.6 million for the same period in 1995. The increase was primarily associated with increased business development activities, 18 20 expenses of being a public company, and higher levels of administrative support for the Company's growth during 1996. Net interest income (expense). The Company's net interest income for the year ended December 31, 1996 was $0.4 million, which compared to a net interest expense of $0.3 million for the same period in 1995. Higher interest income in 1996 resulted primarily from the Company holding higher cash balances following its initial public offering of common stock in October 1996. Net loss. The Company's net loss for the year ended December 31, 1996 increased $0.7 million to $3.0 million from $2.3 million for 1995. The increase was primarily attributable to operating and development expenses exceeding the increase in revenue generated from corporate collaborations during 1996. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1997, the Company held cash and cash equivalents and marketable securities with a value of $49.3 million. The Company's working capital at December 31, 1997 was $46.0 million. The Company has funded operations through December 31, 1997 with sales of common stock, payments from corporate collaborators and the utilization of capital equipment lease financing. The Company has maintained a master lease agreement since February 1994. Under the terms of this agreement, the Company has funded certain capital expenditures through leases with terms of 42 months in duration. As of December 31, 1997, the Company had utilized $4.5 million of the available $8.5 million financing facility. Net cash provided by operating activities was $0.6, $0.8 million and $0.7 million for each of the years ended December 31, 1997, 1996 and 1995, respectively. The positive cash flow from operating activities primarily reflects payments received from the seven corporate collaborators. Net cash used by investing activities during the year ended December 31, 1997 was $42.7 million, resulting primarily from the proceeds of the purchase of marketable securities and from the proceeds of the initial and secondary public offerings. Net cash provided by investing activities during the year ended December 31, 1996 was $2.0 million, resulting primarily from the sale of marketable securities offset by the purchases of property and equipment. Net cash used in investing activities for the year ended December 31, 1995 was $5.3 million. This increase primarily reflects purchases of marketable securities. Net cash provided by financing activities for the year ended December 31, 1997 and 1996 was $20.7 and $30.8 million, respectively, primarily reflecting proceeds from the Company's April 1997 secondary public offering and October 1996 initial public offering. Net cash provided by financing activities for the year ended December 31, 1995 was $7.2 million, largely due to a $7.0 million equity investment by Solvay Duphar B.V. The Company expects that its available cash and marketable securities, together with operating revenues, investment income and lease financing arrangements, will be sufficient to finance its working capital and capital requirements for the foreseeable future. The Company's cash requirements may vary materially from those now planned depending upon the results of its drug discovery and development strategies, the ability of the Company to enter into any corporate collaborations in the future and the terms of such collaborations, the results of research and development, the need for currently unanticipated capital expenditures, competitive and technological advances, acquisitions, and other factors. There can be no assurance that the Company will be able to obtain additional customers for the Company's products and services, or that such products and services will produce revenues adequate to fund the Company's operating expenses. If the Company experiences increased losses, the Company may have to seek additional financing from the public or private sale of its securities, including equity securities. There can be no assurance that additional funding will be available when needed or on acceptable terms. The Company has evaluated its computer software and database software to identify modifications, if any, that may be required to address year 2000 compliance. Management does not expect the financial impact of any required modifications to have a material impact on its results of operations of financial position. 19 21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Independent Accountants.......................................... 21 Balance Sheet at December 31, 1996 and 1997................................ 22 Statement of Operations for the three years ended December 31, 1997........ 23 Statement of Redeemable Preferred Stock and Stockholders' Equity (Deficit) for the three years ended December 31, 1997............. 24 Statement of Cash Flows for the three years ended December 31, 1997........ 25 Notes to Financial Statements.............................................. 27 Financial Statement Schedules: Schedules are not included because they are not applicable or the information is included in the Notes to Financial Statements.
20 22 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of ArQule, Inc. In our opinion, the accompanying balance sheet and the related statements of operations, of redeemable preferred stock and stockholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of ArQule, Inc. at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Boston, Massachusetts February 9, 1998 21 23 ARQULE, INC. BALANCE SHEET
DECEMBER 31, ---------------------------- 1996 1997 ------------ ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 36,586,000 $ 15,137,000 Marketable securities..................................... 500,000 34,145,000 Accounts receivable....................................... 250,000 3,133,000 Inventory................................................. -- 953,000 Prepaid expenses and other current assets................. 338,000 520,000 Notes receivable from related parties..................... 176,000 30,000 ------------ ------------ Total current assets.............................. 37,850,000 53,918,000 Property and equipment, net................................. 5,293,000 12,654,000 Other assets................................................ 139,000 156,000 Notes receivable from related parties....................... 227,000 197,000 ------------ ------------ $ 43,509,000 $ 66,925,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of capital lease obligations.............. $ 1,138,000 $ 1,174,000 Accounts payable and accrued expenses..................... 1,109,000 2,804,000 Deferred revenue.......................................... 4,163,000 3,917,000 ------------ ------------ Total current liabilities......................... 6,410,000 7,895,000 ------------ ------------ Capital lease obligations................................... 1,728,000 1,213,000 ------------ ------------ Deferred revenue............................................ 750,000 477,000 ------------ ------------ Stockholders' equity Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding at December 31, 1996 and 1997...................................... -- -- Common stock, $0.01 par value; 30,000,000 shares authorized; 9,851,487 and 11,877,315 shares issued and outstanding at December 31, 1996 and 1997, respectively........................................... 99,000 119,000 Additional paid-in capital................................ 46,102,000 68,418,000 Accumulated deficit....................................... (10,934,000) (10,643,000) ------------ ------------ 35,267,000 57,894,000 Deferred compensation..................................... (646,000) (554,000) ------------ ------------ Total stockholders' equity............................. 34,621,000 57,340,000 ------------ ------------ Commitments and contingency (Note 13)....................... -- -- ------------ ------------ $ 43,509,000 $ 66,925,000 ============ ============
The accompanying notes are an integral part of these financial statements. 22 24 ARQULE, INC. STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, ----------------------------------------- 1995 1996 1997 ----------- ----------- ----------- Revenue Compound development revenue...................... $ 1,830,000 $ 4,255,000 $13,840,000 Compound development revenue -- related party..... 500,000 3,000,000 3,580,000 License option fees............................... 1,000,000 -- -- ----------- ----------- ----------- 3,330,000 7,255,000 17,420,000 ----------- ----------- ----------- Costs and expenses: Cost of revenue................................... 1,367,000 2,683,000 8,039,000 Cost of revenue -- related party.................. 277,000 2,056,000 2,179,000 Research and development.......................... 2,095,000 3,076,000 4,704,000 Marketing, general and administrative............. 1,557,000 2,850,000 4,670,000 ----------- ----------- ----------- 5,296,000 10,665,000 19,592,000 ----------- ----------- ----------- Loss from operations........................... (1,966,000) (3,410,000) (2,172,000) Interest income..................................... 133,000 607,000 2,686,000 Interest expense.................................... (419,000) (190,000) (223,000) ----------- ----------- ----------- Net (loss) income.............................. $(2,252,000) $(2,993,000) $ 291,000 =========== =========== =========== Basic net income (loss) per share................... $ (3.76) $ (1.23) $ .03 =========== =========== =========== Weighted average common shares outstanding -- basic.............................. 599,000 2,430,000 11,337,000 =========== =========== =========== Diluted net income (loss) per share................. $ (3.76) $ (1.23) $ .02 =========== =========== =========== Weighted average common shares and equivalents outstanding -- diluted............................ 599,000 2,430,000 12,394,000 =========== =========== ===========
The accompanying notes are an integral part of these financial statements. 23 25 ARQULE, INC. STATEMENT OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
STOCKHOLDERS' EQUITY (DEFICIT) SERIES B MANDATORILY ---------------------------------------------------------------- REDEEMABLE CONVERTIBLE SERIES A CONVERTIBLE PREFERRED STOCK PREFERRED STOCK COMMON STOCK ADDITIONAL ------------------------ ------------------------- ---------------------- PAID-IN SHARES AMOUNT SHARES AMOUNT SHARES PAR VALUE CAPITAL ---------- ----------- ----------- ----------- ---------- --------- ----------- BALANCE AT DECEMBER 31, 1994....... 8,591,000 $ 86,000 554,597 $ 6,000 $4,376,000 Employee restricted stock purchases......................... 68,200 -- 1,000 Issuance of common stock purchase warrants under bridge financing... 57,000 Cancellation of unvested portion on restricted stock upon employee termination....................... (100,000) (1,000) 1,000 Conversion of bridge notes into Series A convertible preferred stock............................. 1,920,000 2,400,000 Issuance of Series B mandatorily redeemable convertible preferred stock, net of issuance costs of $115,000.......................... 1,800,000 $ 6,885,000 Accretion of Series B mandatorily redeemable preferred stock to redemption value.................. 3,000 Net loss........................... ---------- ----------- ----------- ----------- ---------- -------- ----------- BALANCE AT DECEMBER 31, 1995....... 1,800,000 6,888,000 10,511,000 2,486,000 522,797 5,000 4,435,000 Conversion of interest on bridge notes to Series A convertible preferred stock................... 113,429 142,000 Issuance of Series B mandatorily redeemable convertible preferred stock to maintain ownership percentage (Note 9)............... 15,468 Cancellation of unvested portion of restricted stock upon employee termination....................... (1,875) -- Employee option exercise........... 625 -- Accretion of Series B mandatorily redeemable preferred stock to redemption value.................. 15,000 Conversion of Series B mandatorily redeemable preferred stock to common stock...................... (1,815,468) (6,903,000) 907,734 9,000 6,894,000 Conversion of Series A convertible preferred stock to common stock... (10,624,429) (2,628,000) 5,312,214 54,000 2,574,000 Exercise of warrants pursuant to a cashless exercise provision....... 234,992 2,000 (2,000) Issuance of common stock in connection with initial public offering, net of issuance costs of $2,979,000........................ 2,875,000 29,000 31,492,000 Compensation related to the grant of common stock options........... 709,000 Amortization of deferred compensation...................... Net loss........................... ---------- ----------- ----------- ----------- ---------- -------- ----------- BALANCE AT DECEMBER 31, 1996....... -- -- -- -- 9,851,487 99,000 46,102,000 Cancellation of unvested portion of restricted stock upon employee termination.............. (49,219) -- Employee stock option exercises.... 133,374 1,000 352,000 Employee stock purchase plan....... 9,173 -- 110,000 Issuance of common stock in connection with secondary public offering, net of issuance costs of $1,645,000........................ 1,932,500 19,000 21,526,000 Compensation related to the grant of common stock options........... 328,000 Amortization of deferred compensation...................... Net income......................... ---------- ----------- ----------- ----------- ---------- -------- ----------- BALANCE AT DECEMBER 31, 1997....... -- $ -- -- $ -- 11,877,315 $119,000 $68,418,000 ========== =========== =========== =========== ========== ======== =========== STOCKHOLDERS' EQUITY (DEFICIT) ---------------------------------------------- TOTAL ACCUMULATED DEFERRED STOCKHOLDERS' DEFICIT COMPENSATION EQUITY (DEFICIT) ------------ ------------ ---------------- BALANCE AT DECEMBER 31, 1994....... $(5,671,000) $(1,203,000) Employee restricted stock purchases......................... 1,000 Issuance of common stock purchase warrants under bridge financing... 57,000 Cancellation of unvested portion on restricted stock upon employee termination....................... -- Conversion of bridge notes into Series A convertible preferred stock............................. 2,400,000 Issuance of Series B mandatorily redeemable convertible preferred stock, net of issuance costs of $115,000.......................... Accretion of Series B mandatorily redeemable preferred stock to redemption value.................. (3,000) (3,000) Net loss........................... (2,252,000) (2,252,000) ------------ --------- ----------- BALANCE AT DECEMBER 31, 1995....... (7,926,000) -- (1,000,000) Conversion of interest on bridge notes to Series A convertible preferred stock................... 142,000 Issuance of Series B mandatorily redeemable convertible preferred stock to maintain ownership percentage (Note 9)............... Cancellation of unvested portion of restricted stock upon employee termination....................... -- Employee option exercise........... -- Accretion of Series B mandatorily redeemable preferred stock to redemption value.................. (15,000) (15,000) Conversion of Series B mandatorily redeemable preferred stock to common stock...................... 6,903,000 Conversion of Series A convertible preferred stock to common stock... -- Exercise of warrants pursuant to a cashless exercise provision....... -- Issuance of common stock in connection with initial public offering, net of issuance costs of $2,979,000........................ 31,521,000 Compensation related to the grant of common stock options........... $(709,000) -- Amortization of deferred compensation...................... 63,000 63,000 Net loss........................... (2,993,000) (2,993,000) ------------ --------- ----------- BALANCE AT DECEMBER 31, 1996....... (10,934,000) (646,000) 34,621,000 Cancellation of unvested portion of restricted stock upon employee termination.............. -- Employee stock option exercises.... 353,000 Employee stock purchase plan....... 110,000 Issuance of common stock in connection with secondary public offering, net of issuance costs of $1,645,000........................ 21,545,000 Compensation related to the grant of common stock options........... (328,000) -- Amortization of deferred compensation...................... 420,000 420,000 Net income......................... 291,000 291,000 ------------ --------- ----------- BALANCE AT DECEMBER 31, 1997....... $(10,643,000) $(554,000) $57,340,000 ============ ========= ===========
The accompanying notes are an integral part of these financial statements. 24 26 ARQULE, INC. STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------ 1995 1996 1997 ----------- ----------- ------------ Increase (Decrease) in Cash and Cash Equivalents Cash flows from operating activities: Net (loss) income................................ $(2,252,000) $(2,993,000) $ 291,000 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation and amortization................. 506,000 1,171,000 2,580,000 Amortization of debt discount................. 164,000 -- -- Amortization of deferred compensation......... -- 63,000 420,000 Increase in accounts receivable............... -- (250,000) (2,883,000) Increase in inventory......................... -- -- (953,000) Increase in prepaid expenses and other current assets...................................... (94,000) (215,000) (182,000) (Increase) decrease in other assets........... 203,000 (40,000) (17,000) (Increase) decrease in notes receivable from related parties............................. (120,000) (220,000) 176,000 Increase in accounts payable and accrued expenses.................................... 141,000 482,000 1,695,000 Increase (decrease) in deferred revenue....... 2,108,000 2,805,000 (519,000) ----------- ----------- ------------ Net cash provided by operating activities............................. 656,000 803,000 608,000 ----------- ----------- ------------ Cash flows from investing activities: Purchases of marketable securities............... (9,052,000) -- (61,447,000) Proceeds from sale or maturity of marketable securities.................................... 4,250,000 4,302,000 27,802,000 Additions to property and equipment.............. (495,000) (2,292,000) (9,085,000) ----------- ----------- ------------ Net cash (used in) provided by investing activities............................. (5,297,000) 2,010,000 (42,730,000) ----------- ----------- ------------ Cash flows from financing activities: Proceeds from bridge financing -- related party......................................... 700,000 -- -- Principal payments of capital lease obligations................................... (381,000) (737,000) (1,335,000) Proceeds from issuance of mandatorily redeemable convertible preferred stock, net.............. 6,885,000 -- -- Proceeds from issuance of common stock, net...... 1,000 31,521,000 22,008,000 ----------- ----------- ------------ Net cash provided by financing activities............................. 7,205,000 30,784,000 20,673,000 ----------- ----------- ------------ Net (decrease) increase in cash and cash equivalents...................................... 2,564,000 33,597,000 (21,449,000) Cash and cash equivalents, beginning of period..... 425,000 2,989,000 36,586,000 ----------- ----------- ------------ Cash and cash equivalents, end of period........... $ 2,989,000 $36,586,000 $ 15,137,000 =========== =========== ============
The accompanying notes are an integral part of these financial statements. 25 27 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Capital lease obligations of $503,000, $2,178,000 and $856,000 were incurred in 1995, 1996 and 1997, respectively, when the Company entered into leases for various machinery and equipment, furniture and fixtures, and leasehold improvements. During 1995, the Company converted $2,400,000 of bridge loans into 1,920,000 shares of Series A convertible preferred stock (Note 8). In addition, during 1996, the Company converted $142,000 of interest relating to the bridge loans into 113,429 shares of Series A convertible preferred stock. During 1996, 12,439,897 shares of Series A and Series B preferred stock were converted into 6,219,948 shares of common stock, in connection with the Company's initial public offering of common stock (Note 9). In addition, 234,992 shares of common stock were issued in connection with the cashless exercise of outstanding warrants. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: During 1995, 1996 and 1997, the Company paid approximately $254,000, $190,000 and $223,000 respectively, for interest. 26 28 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND NATURE OF OPERATIONS ArQule, Inc. (the "Company") is engaged in the discovery, development and production of novel chemical compounds primarily for the pharmaceutical, biotechnology and agrochemical industries. Its operations are focused on the integration of combinatorial chemistry, structure-guided rational drug design and other proprietary technologies which automate the process of chemical synthesis to produce arrays of novel small organic chemical compounds used to generate and optimize drug development candidates. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies followed in the preparation of these financial statements are as follows: Cash Equivalents and Marketable Securities The Company considers all highly liquid investments purchased within three months of maturity date to be cash equivalents. The Company invests its available cash primarily in money market mutual funds and U.S. government and other investment grade debt securities which have strong credit ratings. These investments are subject to minimal credit and market risks. At December 31, 1996 and 1997, the Company has classified its investments as available-for-sale. Fair Value of Financial Instruments At December 31, 1996 and 1997, the Company's financial instruments consist of cash, cash equivalents, marketable securities, accounts receivable, notes receivable from related party, accounts payable and accrued expenses. The carrying amount of these instruments approximate their fair values. Property and Equipment Property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Assets under capital leases and leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the respective leases by use of the straight-line method. Maintenance and repair costs are expensed as incurred. Revenue Recognition Compound development revenue relates to revenue from significant collaborative agreements (Note 3) and from licensing of compound arrays. Revenue from collaborative agreements relates to the delivery of compounds and to compound development work and is recognized using the percentage of completion method. The application of this revenue recognition method is dependent on the contractual arrangement of either compound delivery or development. Accordingly, revenue is recognized on the proportional achievement of deliveries against a compound delivery schedule or as development labor is expended against a total research and development labor plan. Payments received under these arrangements prior to the completion of the related work are recorded as deferred revenue. Revenue from licensing of compound arrays with no additional obligations is recognized upon delivery of the compound array. License option fees represent payments made to the Company for a right to evaluate and negotiate the terms of potential licensing arrangements and are recognized as revenue as the options are granted, as the Company has no further obligations and as payments are nonrefundable. Cost of Revenue Cost of revenue represents the actual costs incurred in connection with performance pursuant to collaborative agreements and the costs incurred to produce compound arrays. These costs consist primarily of payroll and payroll-related costs, chemicals, supplies and overhead expenses. 27 29 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Net Income (Loss) per Share During the fourth quarter of 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS No. 128 replaces primary and fully diluted earnings per share with basic and diluted earnings per share. The adoption of this standard resulted in the Company's retroactive restatement of previously reported loss per share calculations reflecting the removal of certain anti-dilutive pro forma share amounts. For the year ended December 31, 1997, the dilutive effect of 1,057,000 weighted average common stock option equivalents were added to the basic weighted average shares outstanding to arrive at diluted weighted average shares outstanding. Stock Compensation Options granted to employees and directors are accounted for in accordance with Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). Under APB No. 25, no compensation expense is recognized for options granted at fair market value. The Company has adopted the disclosure requirements of SFAS No. 123, "Accounting for Stock Based Compensation" ("SFAS No. 123"). Options granted to nonemployees are accounted for using the fair value method and are recognized as compensation expense over their respective service periods. Inventories Inventory consists of costs associated with the Company's Mapping Array libraries and is stated at the lower of cost, on a first-in, first-out basis, or market. Such costs are capitalized after achieving technological feasibility. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Reclassifications Certain reclassifications have been made to the 1995 and 1996 financial statements to conform to the 1997 presentation. These reclassifications had no effect on the net loss for 1995 and 1996. 3. SIGNIFICANT AGREEMENTS The Company has entered into a number of license, research and development agreements (the "Agreements") with seven corporate collaborators who accounted for substantially all of the Company's 1997 revenue. One Agreement was entered into with Solvay Duphar B.V. ("Solvay"), a related party (Note 9). Revenue related to the Solvay Agreement is included in compound development revenue -- related party. Under the terms of these Agreements, the Company will provide a certain number of compounds per year and has granted the right to screen these compounds against targets to identify biological activity (an "Active Compound") and will provide research and development services. The collaborators have the right to enter into an exclusive, worldwide license (the "License") for any Active Compound identified. The initial terms of these Agreements generally range from two to five years during which period the collaborators make payments to the Company for technology access, delivery of compounds and for its research and development services. In exchange for a License, the Company will receive milestone payments during product development and royalty payments based on the sales of the product. Solvay exercised its right to license certain of the Company's technologies on a non-exclusive basis in December 1997. 28 30 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Additionally, the Company has entered into a number of agreements with biotechnology companies (the "biotech collaborators"). Under the terms of material transfer agreements with biotech collaborators, the Company has granted the biotech collaborator the nonexclusive, royalty-free license to test certain compound arrays supplied by the Company. Upon identification of an active compound, the Company will negotiate a joint drug development program with the biotech collaborator to develop the compound, provided the Company has not previously licensed the compound. Under the collaboration agreements with these joint drug development programs, the Company and the biotech collaborator will each bear the costs and expenses of their respective activities. Proceeds received on sales or a third party license of the jointly developed compound will first reimburse development costs incurred by each party on a pro rata basis. After all such reimbursements have been made, the remaining proceeds will be split evenly between the parties. 4. CASH EQUIVALENTS AND MARKETABLE SECURITIES The following is a summary of the fair market value of available-for-sale marketable securities held by the Company at December 31, 1996 and 1997:
DECEMBER 31, ----------------------- MATURITY 1996 1997 ------------- -------- ----------- U.S. Government obligations................. Within 1 year $500,000 $ 2,200,000 Corporate bonds............................. Within 1 year -- 31,945,000 -------- ----------- $500,000 $34,145,000 ======== ===========
At December 31, 1996 and 1997, marketable securities are carried at amortized cost, which approximates fair market value. All of the Company's marketable securities are classified as current at December 31, 1996 and 1997 as funds are highly liquid and are available to meet working capital needs and to fund current operations. Gross unrealized gains and losses on sales of securities for the years ended December 31, 1996 and 1997 were not significant. 5. INVENTORY Inventories at December 31, 1997 consists of the following:
1997 -------- Raw Materials............................................... $361,000 Finished Goods.............................................. 592,000 -------- $953,000 ========
29 31 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 6. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
ESTIMATED DECEMBER 31, USEFUL LIFE ------------------------- (YEARS) 1996 1997 ----------- ---------- ----------- Machinery and equipment........................ 3-7 $3,053,000 $ 5,997,000 Leasehold improvements......................... 5 2,728,000 4,183,000 Furniture and fixtures......................... 7 178,000 178,000 Computer equipment............................. 3 1,197,000 3,253,000 Construction-in-progress....................... -- 5,000 3,491,000 ---------- ----------- 7,161,000 17,102,000 Less -- accumulated depreciation and amortization................................. 1,868,000 4,448,000 ---------- ----------- $5,293,000 $12,654,000 ========== ===========
Assets held under capital leases at December 31, 1997 and 1996 consisted of $2,416,000 in 1996 and $3,272,000 in 1997 of machinery and equipment, $832,000 of leasehold improvements, $746,000 in computer equipment and $107,000 of furniture and fixtures. Accumulated amortization of these assets totaled $1,305,000 and $2,503,000 at December 31, 1996 and 1997, respectively. For the years ended December 31, 1995, 1996 and 1997, amortization expense related to assets held under capital lease obligations was $300,000, $751,000 and $1,198,000, respectively. 7. NOTES RECEIVABLE FROM RELATED PARTIES Notes receivable from related parties consist of the following:
DECEMBER 31, -------------------- 1996 1997 -------- -------- Note receivable due from an officer of the Company, due in full on November 3, 1997.................................. $ 63,000 $ -- Note receivable due from the same officer of the Company, payable in four equal annual installments commencing on November 2, 1996, principal due on each installment date will be forgiven so long as the officer is employed by the Company on the installment date, secured by the officer's beneficial interest in 48,000 shares of common stock of the Company............................................... 90,000 60,000 Note receivable due from another officer of the Company, payable in three equal annual installments commencing on October 16, 1997, secured by shares of common stock of the Company issuable to the officer upon the exercise of options................................................... 250,000 167,000 -------- -------- 403,000 227,000 Less current portion........................................ 176,000 30,000 -------- -------- $227,000 $197,000 ======== ========
Interest on the notes receivable from related parties accrues on the unpaid principal and interest at 5.9%. Interest due on the notes at December 31, 1996 and 1997, $6,000 and $13,248, respectively, was included in prepaid expenses and other current assets. 30 32 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses include the following:
DECEMBER 31, ------------------------ 1996 1997 ---------- ---------- Accounts payable............................................ $ 485,000 $2,161,000 Accrued professional fees................................... 469,000 379,000 Other accrued expenses...................................... 155,000 264,000 ---------- ---------- $1,109,000 $2,804,000 ========== ==========
9. CONVERTIBLE PREFERRED STOCK On November 5, 1995, as part of a collaborative agreement (Note 3), the Company sold to Solvay Duphar B.V. ("Solvay") 1,800,000 shares of Series B preferred stock which resulted in net proceeds to the Company of $6,885,000. In April 1996, the Company issued to Solvay an additional 15,468 shares of Series B preferred stock in connection with the conversion of the bridge financing interest into Series A preferred stock to maintain the original, agreed-upon ownership percentage. At December 31, 1995, the Company had 15,000,000 shares of convertible preferred stock authorized. Upon the closing of the Company's initial public offering on October 16, 1996 (Note 10), all outstanding shares of Series A and Series B preferred stock automatically converted into 6,219,948 shares of common stock, and the number of authorized shares of preferred stock was reduced to 1,000,000 shares. 10. COMMON STOCK On October 4, 1996, the Company effected a 1-for-2 reverse stock split on the common stock of the Company. Accordingly, all common share and per share data have been restated to give retroactive effect to the stock split for all periods presented. In October and November 1996, the Company completed its initial public offering of 2,875,000 shares of common stock. Proceeds to the Company, net of issuance costs, amounted to $31,521,000. In connection with its initial public offering, the stockholders approved an amendment to the Company's Certificate of Incorporation to increase the number of authorized common shares to 30,000,000. On April 4, 1997, the Company completed a follow-on offering of 1,932,500 shares of Common Stock, which included the underwriters' exercise of their over-allotment of 300,000 shares of Common Stock on April 14, 1997. Proceeds to the Company, net of issuance costs, amounted to $21,545,000. Stock Restriction Agreements The Company has common stock issued pursuant to the Equity Incentive Plan which is subject to stock restriction agreements whereby the stockholder automatically forfeits to the Company the unvested portion of shares of common stock in the event of termination of their employment with the Company. All such forfeited shares shall immediately be retired by the Company. Shares subject to this agreement vest over a four year period. At December 31, 1996 and 1997, the approximate number of unvested common shares is 96,500 and 13,500, respectively. Each stock restriction agreement may be terminated at the election of the Company. 11. EQUITY INCENTIVE AND STOCK PURCHASE PLANS During 1996, the stockholders approved an amendment to the 1994 Amended and Restated Equity Incentive Plan (the "Equity Incentive Plan") increasing the number of shares of common stock available for awards under the Equity Incentive Plan to 2,600,000. All shares are awarded at the discretion of a Committee 31 33 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) of the Board of Directors (the "Committee") in a variety of stock-based forms including stock options and restricted stock. Pursuant to the Equity Incentive Plan, incentive stock options may not be granted at less than the fair market value of the Company's common stock at the date of the grant, and the option term may not exceed ten years. For holders of 10% or more of the Company's voting stock, options may not be granted at less than 110% of the fair market value of the common stock at the date of the grant, and the option term may not exceed five years. Stock appreciation rights granted in tandem with an option shall have an exercise price not less than the exercise price of the related option. As of December 31, 1997, no stock appreciation rights have been issued. Subject to the restrictions above, the Committee is authorized to designate the options, awards, and purchases under the Equity Incentive Plan, the number of shares covered by each option, award and purchase, and the related terms, exercise dates, prices and methods of payment. In 1996, the stockholders approved the 1996 Director Stock Option Plan (the "1996 Director Plan") for nonemployee directors. Under this plan, eligible directors are automatically granted once a year, at the annual meeting of stockholders of the Company, options to purchase 3,500 shares of common stock which are exercisable on the date of grant. Upon initial election of an eligible director, options to purchase 7,500 shares of common stock will be granted which will become exercisable in three equal annual installments commencing on the date of the Company's next annual stockholders' meeting held after the date of grant. All options granted pursuant to the 1996 Director Plan have a term of ten years with exercise prices equal to fair market value on the date of grant. Through December 31, 1997, options to purchase 33,000 shares of common stock have been granted under this plan. A maximum of 125,000 shares of common stock of the Company is reserved for issuance in accordance with the terms of this plan, of which 92,000 are available for future grant. The Company applies APB No. 25 and related interpretations in accounting for employee grants under the Equity Incentive Plan and the 1996 Director Plan (collectively the "Plans"). No compensation expense has been recognized under the Plans for employee grants. Had compensation cost been determined based on the estimated value of options at the grant date consistent with the provisions of SFAS No. 123, the Company's pro forma net loss, pro forma basic net loss per share and diluted net loss per share would have been as follows:
DECEMBER 31, ----------------------------------------- 1995 1996 1997 ----------- ----------- ----------- Pro Forma net loss.......................... $(2,254,000) $(3,186,000) $(2,583,000) Pro Forma basic and diluted net loss per share..................................... (3.76) (1.31) (0.23)
During 1996 and 1997, the Company issued 117,500 and 69,000 options to certain consultants and members of its Scientific Advisory Board (SAB) under the Equity Incentive Plan. In April 1997, 11,000 shares were cancelled. The estimated value of these options totaled $709,000 and $328,000 in 1996 and 1997, respectively, was recorded as deferred compensation and is being amortized as compensation expense over the vesting period of the options. Compensation expense in 1996 and 1997 was $63,000 and $420,000, respectively. For the purposes of pro forma disclosure, the estimated value of each employee and nonemployee option grant was calculated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield for both years; 45% volatility for 1996 and 50% volatility for 1997 for nonemployee grants and employee grants subsequent to the initial filing of the Registration Statement in connection with the Company's initial public offering; no volatility for employee grants prior to the initial public offering; risk-free interest rates of 5.2% to 7.1% in 1996 and 6.0% in 1997; expected lives of 3 to 6 years in 1996 and 4 years in 1997 for options granted. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the use of highly subjective assumptions, including the expected stock price volatility. Because the corporation's employee stock options have characteristics significantly different from those of traded options, 32 34 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) and because changes in the subjective assumptions can materially affect the fair value estimates, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock-based compensation. Option activity under the Plans for the three years ended December 31, 1997 was as follows:
WEIGHTED AVERAGE NUMBER EXERCISE STOCK OPTIONS OF SHARES PRICE - ------------- --------- -------- Outstanding at December 31, 1994............................ 2,500 $ .02 Granted..................................................... 298,500 .22 --------- Outstanding at December 31, 1995............................ 301,000 .22 Granted..................................................... 1,073,920 4.39 Exercised................................................... (625) .02 Cancelled................................................... (101,625) .49 --------- Outstanding at December 31, 1996............................ 1,272,670 3.72 Granted..................................................... 1,016,912 16.63 Exercised................................................... (133,374) 2.64 Cancelled................................................... (44,456) 9.57 --------- Outstanding at December 31, 1997............................ 2,111,752 $ 9.88 ========= Exercisable at December 31, 1997............................ 373,025 ========= Weighted average estimated value of options granted during the year ended December 31, 1997.......................... $ 4.17 ======
The following table summarizes information about options outstanding at December 31, 1997:
OPTIONS OPTIONS OUTSTANDING EXERCISABLE --------------------------------------- ----------------------- WEIGHTED NUMBER AVERAGE WEIGHTED EXERCISABLE WEIGHTED OUTSTANDING AT REMAINING AVERAGE AS OF AVERAGE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE RANGE OF EXERCISE PRICES 1997 LIFE PRICE 1997 PRICE - ------------------------ -------------- ----------- -------- ------------ -------- $ 0.0000 - 2.4000........................ 602,820 7.9 $ 0.74 203,617 $ 0.68 4.8001 - 7.2000........................ 359,875 8.5 6.00 71,125 6.00 9.6001 - 12.0000........................ 157,250 8.8 10.86 44,216 10.95 12.0001 - 14.4000........................ 490,807 9.3 14.13 43,567 14.13 14.4001 - 16.8000........................ 35,500 9.1 15.70 -- -- 16.8001 - 19.2000........................ 276,000 9.3 17.84 10,500 17.63 19.2001 - 21.6000........................ 133,000 9.7 20.88 -- -- 21.6001 - 24.0000........................ 56,500 9.9 24.00 -- -- --------- ------- 2,111,752 8.8 $ 9.88 373,025 $ 4.96 ========= === ====== ======= ======
At December 31, 1997, there were 515,546 shares available for future grant under the Equity Incentive Plan. Stock Purchase Plan In 1996, the stockholders adopted the 1996 Employee Stock Purchase Plan (the "Purchase Plan"). This plan enables eligible employees to exercise rights to purchase the Company's common stock at 85% of the fair 33 35 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) market value of the stock on the date the right was granted or the date the right is exercised, whichever is lower. Rights to purchase shares under the Purchase Plan are granted by the Board of Directors. The rights are exercisable during a period determined by the Board of Directors; however, in no event will the period be longer than twenty-seven months. The Purchase Plan is available to substantially all employees, subject to certain limitations. The Company has reserved 120,000 shares of common stock for purchases under the Purchase Plan. At December 31, 1997, 9,173 shares have been purchased pursuant to the Purchase Plan. 12. INCOME TAXES There is no current or deferred tax expense for the years ended December 31, 1995, 1996 and 1997. The deferred tax consequences of temporary differences in reporting items for financial statement and income tax purposes are recognized, if appropriate. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including the company's ability to generate taxable income within the net operating loss carryforward period. Management has considered these factors in reaching its conclusion as to the valuation allowance for financial reporting purposes. The income tax effect of temporary differences comprising the deferred tax assets and deferred tax liabilities on the accompanying balance sheets is a result of the following:
DECEMBER 31, -------------------------- 1996 1997 ----------- ----------- Deferred tax assets: Preoperating costs capitalized for tax purposes......... $ 370,000 $ 288,000 Net operating loss carryforwards........................ 3,906,000 4,506,000 Tax credit carryforwards................................ 311,000 811,000 Non-employee equity based compensation.................. -- 173,000 Other................................................... 30,000 40,000 ----------- ----------- $ 4,617,000 $ 5,818,000 Deferred tax liabilities: Tax depreciation in excess of book...................... -- (135,000) Valuation allowance....................................... (4,617,000) (5,683,000) ----------- ----------- Net deferred tax assets................................. $ -- $ -- =========== ===========
The Company has provided a full valuation allowance for the deferred tax assets as the realization of these future benefits is not sufficiently assured as of the end of each related year. If the Company achieves profitability, the deferred tax assets will be available to offset future income tax liabilities and expense. Of the $5.7 million valuation allowances at December 31, 1997, $615,000 relates to deductions for disqualifying dispositions and non qualified stock options which will be credited to paid in capital, if realized. 34 36 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation between the statutory federal income tax rate (35%) and the effective rate of income tax expense for each of the three years during the period ended December 31, 1997 follows:
YEAR ENDED DECEMBER 31, ------------------------------------- 1995 1996 1997 --------- ----------- --------- Income tax benefit (expense) at statutory rate......................................... $ 788,000 $ 1,048,000 $(102,000) State tax benefit (expense), net............... 135,000 180,000 (18,000) Losses without current tax benefit............. (907,000) (1,180,000) -- Utilization of net operating loss carryforwards................................ -- -- 133,000 Other.......................................... (16,000) (48,000) (13,000) --------- ----------- --------- Tax Provision............................. $ -- $ -- $ -- ========= =========== =========
The Company has available net operating loss carryforwards of approximately $11,000,000 for tax purposes to offset future taxable income. The net operating loss carryforwards expire principally in 2009 to 2012. General tax credit carryforwards of approximately $811,000 expire principally in 2009 to 2012. Under the Internal Revenue Code, certain substantial changes in the Company's ownership could result in an annual limitation on the amount of net operating loss and tax credit carryforwards which can be utilized in future years. 13. COMMITMENTS AND CONTINGENCY Leases The Company leases facilities and equipment under noncancelable operating and capital leases. The future minimum lease commitments under these leases are as follows:
YEAR ENDING OPERATING CAPITAL DECEMBER 31, LEASES LEASES ------------ ---------- ---------- 1998........................................................ $ 838,000 $1,174,000 1999........................................................ 780,000 907,000 2000........................................................ 721,000 305,000 2001........................................................ 315,000 1,000 ---------- ---------- 2,387,000 Interest due on capital leases.............................. 243,000 ---------- ---------- Total minimum lease payments................................ $2,654,000 $2,630,000 ========== ==========
The Company has a lease line agreement with a financial institution (the "Lessor") for $8,500,000 of which approximately $4,000,000 was available for future leases at December 31, 1997. The term for each lease under the agreement is forty-two months, commencing on the purchase date of the asset, and the lease bears interest at a rate determined by the Lessor at the transaction date. Rent expense under noncancelable operating leases was approximately $163,000, $283,000 and $582,000 for the years ended December 31, 1995, 1996, and 1997, respectively. Employment Agreements The Company has employment agreements with an officer who is also a member of the board of directors. The agreement provides that if employment is terminated without cause, the officer is entitled to receive up to six months' salary. 35 37 ARQULE, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Contingency On July 21, 1997, a complaint was filed in the United States District Court of Connecticut against the Company and two of the Company's stockholders by two individuals alleging that they were entitled to compensation from the Company and these two stockholders equal to approximately five percent of the equity interests in the Company for services in connection with the initial financing of ArQule Partners, L.P. in 1993. In addition, one of the plaintiffs is alleging that he was denied the opportunity to make a five percent investment in the Company at the time of its incorporation. Prior to the Company's initial public offering of its Common Stock, ArQule Partners, L.P. was a major stockholder of the Company. An answer was filed on September 15, 1997 denying the material allegations in the complaint and Phase I of the discovery process has been completed. Although the parties to this lawsuit have had mediation proceedings, the Company intends to continue to contest this lawsuit vigorously. No assurance can be given regarding the outcome of this lawsuit. The Company is currently unable to estimate the range of potential loss, if any, that might result as a consequence of this action. 36 38 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not Applicable PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The response to this item is contained in part under the caption "Executive Officers of the Registrant" in Part I, Item 1 hereof and the remainder is incorporated herein by reference from the discussion responsive thereto under the caption "Election of Directors" in the Company's Proxy Statement relating to its Annual Meeting of Stockholders scheduled for May 14, 1998 (the "Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION The response to this item is incorporated herein by reference from the discussion responsive thereto under the caption "Executive Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this item is incorporated herein by reference from the discussion responsive thereto under the caption "Share Ownership" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The response to this item is incorporated herein by reference from the discussion responsive thereto under the caption, "Compensation Committee Interlocks and Insider Participation" in the Proxy Statement and from Notes 7 and 9 to the Financial Statements included herein. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K (A) 1. FINANCIAL STATEMENTS The financial statements are listed under Item 8 of this report. 2. FINANCIAL STATEMENT SCHEDULES The financial statement schedules listed under Item 8 of this report are omitted because they are not applicable or required information and are shown in the financial statements of the footnotes thereto. (B) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the fourth quarter of 1997. 37 39 (C) EXHIBITS
EXHIBIT NO. DESCRIPTION - ----------- ----------- 3.1 Amended and Restated Certificate of Incorporation of the Company. Filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.5 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 4.1 Specimen Common Stock Certificate. Filed as Exhibit 4.1 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.1* Amended and Restated 1994 Equity Incentive Plan, as amended through October 17, 1994. Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.2* 1996 Employee Stock Purchase Plan. Filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.3* Amended and Restated 1996 Director Stock Option Plan. Filed herewith. 10.4 Form of Indemnification Agreement between the Company and its directors. Such agreements are materially different only as to the signing directors and the dates of execution. Filed as Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.5 Investors' Rights Agreement among the Company and certain stockholders of the Company dated November 2, 1995. Filed as Exhibit 10.5 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.6 Lease Agreement dated September 29, 1993 between the Company and Beautyrest Property, Inc. and WRB, Inc. Filed as Exhibit 10.6 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.7 Lease Agreement, dated July 27, 1995, between the Company and Cummings Properties Management, Inc. as amended. Filed as Exhibit 10.7 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.8* Employment Agreement effective as of January 2, 1996, between the Company and Eric B. Gordon. Filed as Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.9* Employment Agreement effective as of July 9, 1996, between the Company and James R. Fitzgerald, Jr. Filed as Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.10* Promissory Note dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the Company. Filed as Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.11* Pledge Agreement dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the Company. Filed as Exhibit 10.11 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.12* Promissory Note and Pledge Agreement dated July 9, 1996 between Eric B. Gordon and the Company. Filed as Exhibit 10.12 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.13* Promissory Note dated November 4, 1993 between Dr. Joseph C. Hogan, Jr. and the Company. Filed as Exhibit 10.13 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.14+ Research, Development and License Agreement between the Company and Solvay Duphar B.V. dated November 2, 1995. Filed as Exhibit 10.14 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.
38 40
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.15+ Research & Development and License Agreement between the Company and Abbott Laboratories dated June 15, 1995, as amended. Filed as Exhibit 10.15 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.16+ Research & Development Agreement between the Company and Amersham Pharmacia Biotech AB dated March 10, 1995, as amended. Filed as Exhibit 10.16 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.17+ Option Agreement between the Company and Amersham Pharmacia Biotech AB dated March 10, 1995, as amended. Filed as Exhibit 10.17 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.18* Adoption Agreement for Fidelity Management and Research Company (the Company's 401(k) plan). Filed as Exhibit 10.18 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.19 Research and License Agreement between the Company and Roche Bioscience dated September 13, 1996. Filed as Exhibit 10.19 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.20+ Array Delivery and Testing Agreement between the Company and Monsanto Company dated as of December 23, 1996. Filed as Exhibit 10.20 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 10.21+ Amendment No. 2 to Research & Development License Agreement between the Company and Abbott Laboratories dated as of December 24, 1996. Filed as Exhibit 10.21 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 10.22 Lease Agreement, dated December 20, 1996 between the Company and Cummings Property Management, Inc. Filed as Exhibit 10.22 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 10.23+ Research and License Agreement between the Company and American Home Products Corporation acting through its Wyeth-Ayerst Research Division dated July 3, 1997. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 000-21249) and incorporated herein by reference. 10.24 Common Stock Purchase Agreement between the Company and American Home Products Corporation Dated July 3, 1997. Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.25+ Second Amendment to Option Agreement and Research and Development Agreement between the Company and Amersham Pharmacia Biotech AB dated September 23, 1996. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.26+ Third Amendment to Option Agreement and Research and Development Agreement between the Company and Amersham Pharmacia Biotech AB dated June 24, 1997. Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.27* First Allonge to Promissory Note between the Company and Eric B. Gordon dated July 16, 1997. Filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.28 Intentionally omitted. 10.29+ Research and Development Agreement between the Company and Sankyo Co., Ltd. dated November 1, 1997. Filed herewith.
39 41
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.30+ Amendment No. 3 to Research & Development and License Agreement between the Company and Abbott Laboratories dated December 23, 1997. Filed herewith. 11.1 Statement re computation of unaudited pro forma net loss per share. Filed herewith. 23.1 Consent of Price Waterhouse LLP. Filed herewith. 99.1 Important Factors Regarding Forward-Looking Statements. Filed herewith.
- --------------- * Indicates a management contract or compensatory plan. + Certain confidential material contained in the document has been omitted and filed separately, with the Securities and Exchange Commission pursuant to Rule 406 of the Securities Act of 1933, as amended or Rule 246-2 of the Securities and Exchange Act of 1934, as amended. 40 42 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registration has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Medford, Commonwealth of Massachusetts, on March 13, 1998. ARQULE, INC. By: /s/ ERIC B. GORDON ------------------------------------ Eric B. Gordon President and Chief Executive Officer
SIGNATURE TITLE DATE --------- ----- ---- /s/ ERIC B. GORDON President, Chief Executive Officer and March 13, 1998 - ------------------------------------------ Director (Principal Executive Officer) Eric B. Gordon /s/ JAMES R. FITZGERALD, JR. Vice President, Chief Financial Officer March 13, 1998 - ------------------------------------------ and Treasurer (Principal Financial Officer James R. Fitzgerald, Jr. and Principal Accounting Officer) /s/ JOSEPH C. HOGAN, JR. Chairman of the Board, Senior Vice March 13, 1998 - ------------------------------------------ President of Research and Development, Joseph C. Hogan, Jr. Chief Scientific Officer and Director /s/ ADRIAN DE JONGE Director March 13, 1998 - ------------------------------------------ Adrian de Jonge /s/ ALLAN R. FERGUSON Director March 13, 1998 - ------------------------------------------ Allan R. Ferguson /s/ STEPHEN M. DOW Director March 13, 1998 - ------------------------------------------ Stephen M. Dow /s/ L. PATRICK GAGE Director March 13, 1998 - ------------------------------------------ L. Patrick Gage
41 43 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION ----------- ----------- 3.1 Amended and Restated Certificate of Incorporation of the Company. Filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.5 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 4.1 Specimen Common Stock Certificate. Filed as Exhibit 4.1 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.1* Amended and Restated 1994 Equity Incentive Plan, as amended through October 17, 1994. Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.2* 1996 Employee Stock Purchase Plan. Filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.3* Amended and Restated 1996 Director Stock Option Plan. Filed herewith. 10.4 Form of Indemnification Agreement between the Company and its directors. Such agreements are materially different only as to the signing directors and the dates of execution. Filed as Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.5 Investors' Rights Agreement among the Company and certain stockholders of the Company dated November 2, 1995. Filed as Exhibit 10.5 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.6 Lease Agreement dated September 29, 1993 between the Company and Beautyrest Property, Inc. and WRB, Inc. Filed as Exhibit 10.6 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.7 Lease Agreement, dated July 27, 1995, between the Company and Cummings Properties Management, Inc. as amended. Filed as Exhibit 10.7 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.8* Employment Agreement effective as of January 2, 1996, between the Company and Eric B. Gordon. Filed as Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.9* Employment Agreement effective as of July 9, 1996, between the Company and James R. Fitzgerald, Jr. Filed as Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.10* Promissory Note dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the Company. Filed as Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.11* Pledge Agreement dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the Company. Filed as Exhibit 10.11 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.12* Promissory Note and Pledge Agreement dated July 9, 1996 between Eric B. Gordon and the Company. Filed as Exhibit 10.12 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.13* Promissory Note dated November 4, 1993 between Dr. Joseph C. Hogan, Jr. and the Company. Filed as Exhibit 10.13 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.14+ Research, Development and License Agreement between the Company and Solvay Duphar B.V. dated November 2, 1995. Filed as Exhibit 10.14 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.15+ Research & Development and License Agreement between the Company and Abbott Laboratories dated June 15, 1995, as amended. Filed as Exhibit 10.15 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.
42 44
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.16+ Research & Development Agreement between the Company and Amersham Pharmacia Biotech AB dated March 10, 1995, as amended. Filed as Exhibit 10.16 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.17+ Option Agreement between the Company and Amersham Pharmacia Biotech AB dated March 10, 1995, as amended. Filed as Exhibit 10.17 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.18* Adoption Agreement for Fidelity Management and Research Company (the Company's 401(k) plan). Filed as Exhibit 10.18 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.19 Research and License Agreement between the Company and Roche Bioscience dated September 13, 1996. Filed as Exhibit 10.19 to the Company's Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference. 10.20+ Array Delivery and Testing Agreement between the Company and Monsanto Company dated as of December 23, 1996. Filed as Exhibit 10.20 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 10.21+ Amendment No. 2 to Research & Development License Agreement between the Company and Abbott Laboratories dated as of December 24, 1996. Filed as Exhibit 10.21 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 10.22 Lease Agreement, dated December 20, 1996 between the Company and Cummings Property Management, Inc. Filed as Exhibit 10.22 to the Company's Registration Statement on Form S-1 (File No. 333-22945) and incorporated herein by reference. 10.23+ Research and License Agreement between the Company and American Home Products Corporation acting through its Wyeth-Ayerst Research Division dated July 3, 1997. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 000-21249) and incorporated herein by reference. 10.24 Common Stock Purchase Agreement between the Company and American Home Products Corporation Dated July 3, 1997. Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.25+ Second Amendment to Option Agreement and Research and Development Agreement between the Company and Amersham Pharmacia Biotech AB dated September 23, 1996. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.26+ Third Amendment to Option Agreement and Research and Development Agreement between the Company and Amersham Pharmacia Biotech AB dated June 24, 1997. Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.27* First Allonge to Promissory Note between the Company and Eric B. Gordon dated July 16, 1997. Filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (File No. 000-21429) and incorporated herein by reference. 10.28 Intentionally omitted. 10.29+ Research and Development Agreement between the Company and Sankyo Co., Ltd. dated November 1, 1997. Filed herewith. 10.30+ Amendment No. 3 to Research & Development and License Agreement between the Company and Abbott Laboratories dated December 23, 1997. Filed herewith. 11.1 Statement re computation of unaudited pro forma net loss per share. Filed herewith. 23.1 Consent of Price Waterhouse LLP. Filed herewith. 99.1 Important Factors Regarding Forward-Looking Statements. Filed herewith.
- --------------- * Indicates a management contract or compensatory plan. + Certain confidential material contained in the document has been omitted and filed separately, with the Securities and Exchange Commission pursuant to Rule 406 of the Securities Act of 1933, as amended or Rule 246-2 of the Securities and Exchange Act of 1934, as amended. 43
EX-10.3 2 AMENDED AND RESTATED 1996 DIRECTOR STOCK PLAN 1 EXHIBIT 10.3 ARQULE, INC. AMENDED AND RESTATED 1996 DIRECTOR STOCK OPTION PLAN Effective as of May 14, 1997 The purpose of this Amended and Restated 1996 Director Stock Option Plan (the "Plan") of ArQule, Inc. (the "Company") is to attract and retain highly qualified non-employee directors of the Company and to encourage ownership of stock of the Company by such directors so as to provide additional incentives to promote the success of the Company. 1. ADMINISTRATION OF THE PLAN. Grants of stock options under the Plan shall be automatic as provided in Section 6. However, all questions of interpretation with respect to the Plan and options granted under it shall be determined by the Board of Directors of the Company (the "Board") or by a committee consisting of one or more directors appointed by the Board and such determination shall be final and binding upon all persons having an interest in the Plan. 2. PERSONS ELIGIBLE TO PARTICIPATE IN THE PLAN. Each director of the Company who is not an employee of the Company or of any subsidiary of the Company shall be eligible to participate in the Plan unless such director irrevocably elects not to participate. 3. SHARES SUBJECT TO THE PLAN. (a) The aggregate number of shares of the Company's Common Stock which may be optioned under this Plan is 125,000 shares. Shares issued under the Plan may consist in whole or in part of authorized but unissued shares or treasury shares. (b) In the event of a stock dividend, split-up, combination or reclassification of shares, recapitalization or other similar capital change relating to the Company's Common Stock, the maximum aggregate number and kind of shares or securities of the Company as to which options may be granted under this Plan and as to which options then outstanding shall be exercisable, and the option price of such options shall be appropriately adjusted so that the proportionate number of shares or other securities as to which options may be granted and the proportionate interest of holders of outstanding options shall be maintained as before the occurrence of such event. (c) In the event of a consolidation or merger of the Company with another corporation where the Company's stockholders do not own a majority in interest of the surviving or resulting corporation, or the sale or exchange of all or substantially all of the 2 assets of the Company, or a reorganization or liquidation of the Company, any deferred exercise period shall be automatically accelerated and each holder of an outstanding option shall be entitled to receive upon exercise and payment in accordance with the terms of the option the same shares, securities or property as he would have been entitled to receive upon the occurrence of such event if he had been, immediately prior to such event, the holder of the number of shares of Common Stock purchasable under his or her option; provided, however, that in lieu of the foregoing the Board may upon written notice to each holder of an outstanding option or right under the Plan, provide that such option or right shall terminate on a date not less than 20 days after the date of such notice unless theretofore exercised. (d) Whenever options under this Plan lapse or terminate or otherwise become unexercisable the shares of Common Stock which were subject to such options may again be subjected to options under this Plan. The Company shall at all times while this Plan is in force reserve such number of shares of Common Stock as will be sufficient to satisfy the requirements of this Plan. 4. NON-STATUTORY STOCK OPTIONS. All options granted under this Plan shall be non-statutory options not entitled to special tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). 5. FORM OF OPTIONS. Options granted hereunder shall be in substantially the form of the attached EXHIBIT A or in such other form as the Board or any committee appointed pursuant to Section 1 above may from time to time determine. 6. GRANT OF OPTIONS AND OPTION TERMS. (a) AUTOMATIC GRANT OF OPTIONS. Upon the initial election of any person as a member of the Board who is an eligible director (whether or not such election is at an annual meeting of stockholders or otherwise), such person shall automatically be granted (i) an option to purchase 7,500 shares of Common Stock (an "Initial Option"). In addition, at each annual meeting of stockholders, each eligible director serving as a member of the Board prior to and immediately after such annual meeting (whether or not such director was reelected at such meeting) shall automatically be granted an Annual Option to purchase 3,500 shares of Common Stock ("Annual Option"; the Annual Option together with the Initial Option are sometimes collectively referred to as "Options"). No Options shall be granted hereunder after ten years from the date on which this Plan was initially approved and adopted by the Board. - 2 - 3 (b) DATE OF GRANT. The "Date of Grant" for Options granted under this Plan shall be the date of initial election as a director or the date of the annual stockholder meeting at which such Option was granted, as the case may be in accordance with Section 6(a). (c) OPTION PRICE. The option price for each Option granted under this Plan shall be the closing price for the Company's Common Stock as reported by the National Association of Securities Dealers Automated Quotations ("Nasdaq") National Market on the last trading day prior to Date of Grant. (d) TERM OF OPTION. The term of each Option granted under this Plan shall be ten years from the Date of Grant. (e) EXERCISABILITY OF OPTIONS. (1) The Initial Options granted under this Plan shall become exercisable with respect to 2,500 shares on the date of the Company's next annual meeting of stockholders from the Date of Grant and each of the next two annual meetings of stockholders following such annual meeting of stockholders, but in all cases if and only if the Option holder is a member of the Board at the opening of business on that date. (2) The Annual Options granted under this Plan shall become exercisable with respect to all 3,500 shares on the Date of Grant. (f) GENERAL EXERCISE TERMS. Directors holding exercisable Options under this Plan who cease to serve as members of the Board may, during their lifetime, exercise the rights they had under such Options at the time they ceased being a director for the full unexpired term of such Option. Any rights that have not yet become exercisable shall terminate upon cessation of membership on the Board. Upon the death of a director, those entitled to do so shall have the right, at any time within twelve months after the date of death, to exercise in whole or in part any rights which were available to the director at the time of his or her death. The rights of the Option holder may be exercised by the holder's guardian or legal representative in the case of disability and by the beneficiary designated by the holder in writing delivered to the Company or, if none has been designated, by the holder's estate or his or her transferee on death in accordance with this Plan, in the case of death. Options granted under the Plan shall terminate, and no rights thereunder may be exercised, after the expiration of the applicable exercise period. Notwithstanding the foregoing provisions of this section, no rights under any Options may be exercised after the expiration of ten years from their Date of Grant. (g) METHOD OF EXERCISE AND PAYMENT. Options may be exercised only by written notice to the Company at its head office accompanied by payment of the full Option price for the shares of Common Stock as to which they are exercised. The Option price shall be paid in cash or by check or in shares of Common Stock of the Company, or in any combination thereof. Shares of Common Stock surrendered in payment of the Option price shall have been held by the person exercising the Option for at least six months, unless otherwise permitted by the Board. The value of shares delivered in payment of the Option price shall be their fair market value, as determined in accordance with Section 6(c) above, as of the date of exercise. Upon receipt of such notice and payment, the Company shall promptly issue and deliver to the optionee (or other person entitled to exercise the Option) a certificate or certificates for the number of shares as to which the exercise is made. - 3 - 4 (h) NON-TRANSFERABILITY. Options granted under this Plan shall not be transferable by the holder thereof otherwise than by will or the laws of descent and distribution or as permitted by Rule 16b-3 (or any successor provision) under the Securities Exchange Act of 1934, as amended ("Rule 16b-3"). 7. LIMITATION OF RIGHTS. (a) NO RIGHT TO CONTINUE AS A DIRECTOR. Neither the Plan, nor the granting of an Option or any other action taken pursuant to the Plan, shall constitute an agreement or understanding, express or implied, that the Company will retain an Option holder as a director for any period of time or at any particular rate of compensation. (b) NO STOCKHOLDERS' RIGHTS FOR OPTIONS. A director shall have no rights as a stockholder with respect to the shares covered by Options until the date the director exercises such Options and pays the Option price to the Company, and no adjustment will be made for dividends or other rights for which the record date is prior to the date such Option is exercised and paid for. 8. AMENDMENT OR TERMINATION. The Board may amend or terminate this Plan at any time, provided that, to the extent necessary or desirable to comply with Rule 16b-3, this Plan shall not be amended more than once every six months, other than to comport with changes in the Code, ERISA or the rules thereunder. 9. STOCKHOLDER APPROVAL. The 1996 Director Stock Option Plan was approved by the stockholders of the Company by an affirmative vote of the holders of a majority of the shares of Common Stock present, or represented and entitled to vote, at the Company's 1997 annual meeting of stockholders and any further amendments hereto shall be subject to stockholder approval to the extent (i) required by law, (ii) required by Nasdaq or stock exchange listing requirements, as determined by the Board of Directors, or (iii) as desirable, as determined by the Board of Directors, to comply with Rule 16b-3. In the event any approval is not obtained, all Options granted under this Plan after such further amendment shall be void and without effect. 10. GOVERNING LAW. This Plan shall be governed by and interpreted in accordance with the laws of the State of Delaware. - 4 - EX-10.29 3 R & D AGREEMENT BETWEEN SANKYO & ARQULE 1 EXHIBIT 10.29 RESEARCH AND DEVELOPMENT AGREEMENT between SANKYO CO., LTD and ARQULE, INC. 2 TABLE OF CONTENTS
Page ---- 1. DEFINITIONS........................................................... (1) 1.1. "ACTIVE HOMOLOG"............................................... (1) 1.2. "ACTIVE ARQULE COMPOUND"....................................... (1) 1.3. "ACTIVE COMPOUND".............................................. (1) 1.4. "ACTIVE SANKYO COMPOUND"....................................... (1) 1.5. "AFFILIATE".................................................... (1) 1.6. "AGREEMENT".................................................... (2) 1.7. "ARQULE COMPOUND".............................................. (2) 1.8. "ARQULE DERIVATIVE COMPOUND"................................... (2) 1.9. "ARQULE PATENT RIGHTS"......................................... (2) 1.10. "ARQULE TECHNOLOGY"............................................ (2) 1.11. "ARRAY"........................................................ (2) 1.12. "BASE RATE OF INTEREST"........................................ (2) 1.13. "CHEMICAL THEME"............................................... (2) 1.14. "CONFIDENTIAL INFORMATION"..................................... (2) 1.15. "CONTRACT YEAR"................................................ (2) 1.16. "DERIVATIVE COMPOUND".......................................... (2) 1.17. "DIRECTED ARRAY(TM)"........................................... (3) 1.18. "DIRECTED ARRAY(TM)PROGRAM".................................... (3) 1.19. "DISCLOSING PARTY"............................................. (3) 1.20. "EFFECTIVE DATE"............................................... (3) 1.21. "EXTRAORDINARY EXPENSES"....................................... (3) 1.22. "FDA".......................................................... (3) 1.23. "JOINT PATENT RIGHTS".......................................... (3) 1.24. "LICENSED COMPOUND"............................................ (3) 1.25. "LICENSED COMPOUND SET"........................................ (3) 1.26. "MAPPING ARRAY(TM)"............................................ (3) 1.27. "MAPPING ARRAY(TM)PROGRAM"..................................... (3) 1.28. "NET SALES".................................................... (3) 1.29. "NET SALES PRICE".............................................. (4) 1.30. "PARTY"........................................................ (4) 1.31. "PATENT RIGHTS"................................................ (4) 1.32. "PHASE I CLINICAL TRIALS"...................................... (4) 1.33. "PHASE II CLINICAL TRIALS"..................................... (4) 1.34. "PHASE III CLINICAL TRIALS".................................... (4) 1.35. "PRECLINICAL COMPOUND"......................................... (5) 1.36. "PRECLINICAL DEVELOPMENT"...................................... (5) 1.37. "RECEIVING PARTY".............................................. (5) 1.38. "RESEARCH PERIOD".............................................. (5) 1.39. "RESEARCH PROGRAM"............................................. (5) 1.40. "RESEARCH PLAN"................................................ (5) 1.41. "ROYALTY-BEARING PRODUCT"...................................... (5)
(i) 3 1.42. "ROYALTY PERIOD"............................................... (5) 1.43. "SANKYO COMPOUND".............................................. (5) 1.44. "SANKYO DERIVATIVE COMPOUND"................................... (5) 1.45. "SANKYO PATENT RIGHTS"......................................... (6) 1.46. "STEERING COMMITTEE"........................................... (6) 1.47. "SUBLICENSEE".................................................. (6) 1.48. "TARGET"....................................................... (6) 1.49. "U.S. TERRITORY"............................................... (6) 1.50. "VALID CLAIM".................................................. (6) 1.51. "WORLDWIDE TERRITORY".......................................... (6) 2. MANAGEMENT OF RESEARCH PROGRAM........................................ (6) 2.1. COMPOSITION OF STEERING COMMITTEE.............................. (6) 2.2. DUTIES OF THE STEERING COMMITTEE............................... (6) 2.3. COMPOUNDS EXCLUDED FROM THE DIRECTED ARRAY(TM)PROGRAM.......... (7) 2.4. MEETINGS OF THE STEERING COMMITTEE............................. (7) 2.5. COOPERATION.................................................... (8) 2.6. VISITS TO FACILITIES........................................... (8) 3. MAPPING ARRAY(TM)PROGRAM.............................................. (8) 3.1. CONDUCT OF MAPPING ARRAY(TM)PROGRAM............................ (8) 3.2. MUTUAL DISCLOSURE.............................................. (9) 3.3. RESERVATION OF ACTIVE ARQULE COMPOUNDS......................... (9) 3.4. MAPPING ARRAY(TM)PROGRAM PAYMENTS.............................. (9) 3.5. TERM OF MAPPING ARRAY(TM)PROGRAM............................... (10) 3.6. PERFORMANCE OF MAPPING ARRAY(TM)PROGRAM........................ (10) 4. DIRECTED ARRAY(TM)PROGRAM............................................. (10) 4.1. DESCRIPTION OF DIRECTED ARRAY(TM)PROGRAM....................... (10) 4.2. CONDUCT OF DIRECTED ARRAY(TM)PROGRAM........................... (10) 4.3. DIRECTED ARRAY(TM)PROGRAM PAYMENTS............................. (11) 4.3.1. DELIVERY FEE........................................... (11) 4.3.2. EXPENSES............................................... (11) 4.4. TERM OF DIRECTED ARRAY(TM) PROGRAM............................. (11) 5. LICENSE GRANTS; REVERSION OF RIGHTS................................... (11) 5.1. SCREENING LICENSES............................................. (11) 5.2. PRECLINICAL AND CLINICAL LICENSES.............................. (11) 5.3. COMMERCIALIZATION LICENSE...................................... (12) 5.4. REVERSION OF RIGHTS; RETURN OF MATERIALS....................... (12) 6. OWNERSHIP OF COMPOUNDS................................................ (12) 6.1. SANKYO COMPOUNDS; SANKYO DERIVATIVE COMPOUNDS.................. (12) 6.2. ARQULE COMPOUNDS; ARQULE DERIVATIVE COMPOUNDS.................. (12) 7. INTELLECTUAL PROPERTY RIGHTS.......................................... (12)
(ii) 4 7.1. OWNERSHIP OF PATENT RIGHTS..................................... (12) 7.2. MANAGEMENT OF JOINT PATENT RIGHTS.............................. (13) 7.3. COOPERATION OF THE PARTIES..................................... (13) 7.4. INFRINGEMENT BY THIRD PARTIES.................................. (13) 8. PAYMENTS, REPORTS, AND RECORDS........................................ (14) 8.1. MILESTONE PAYMENTS............................................. (14) 8.2. ALTERNATIVE TO MILESTONE PAYMENTS.............................. (14) 8.3. ROYALTIES...................................................... (14) 8.4. REPORTS AND PAYMENTS........................................... (15) 8.5. INVOICES; PAYMENTS IN U.S. DOLLARS............................. (15) 8.6. PAYMENTS IN OTHER CURRENCIES................................... (15) 8.7. RECORDS........................................................ (15) 8.8. LATE PAYMENTS.................................................. (16) 8.9. WITHHOLDING TAX PAYMENTS....................................... (16) 8.9.1. PAYMENTS............................................... (16) 8.9.2. ROYALTY PAYMENTS....................................... (16) 9. CONFIDENTIAL INFORMATION.............................................. (16) 9.1. DEFINITION OF CONFIDENTIAL INFORMATION......................... (16) 9.2. DESIGNATION OF CONFIDENTIAL INFORMATION........................ (17) 9.3. OBLIGATIONS.................................................... (17) 9.4. EXCEPTIONS..................................................... (17) 9.5. RETURN OF CONFIDENTIAL INFORMATION............................. (18) 9.6. SURVIVAL OF OBLIGATIONS........................................ (18) 10. REPRESENTATIONS AND WARRANTIES........................................ (18) 10.1. AUTHORIZATION.................................................. (18) 11. INDEMNIFICATION AND INSURANCE......................................... (18) 11.1. SANKYO INDEMNITY OBLIGATIONS................................... (18) 11.2. PROCEDURE...................................................... (19) 11.3. INSURANCE...................................................... (19) 12. TERM AND TERMINATION.................................................. (19) 12.1. TERM........................................................... (19) 12.2. BREACH OF PAYMENT OBLIGATIONS.................................. (19) 12.3. MATERIAL BREACH................................................ (20) 12.4. EFFECT OF TERMINATION.......................................... (20) 13. MISCELLANEOUS......................................................... (20) 13.1. RELATIONSHIP OF PARTIES........................................ (20) 13.2. PUBLICITY...................................................... (20) 13.3. NON-SOLICITATION............................................... (20) 13.4. GOVERNING LAW.................................................. (20) 13.5. DISPUTE RESOLUTION PROCEDURES.................................. (20) 13.6. COUNTERPARTS................................................... (22)
(iii) 5 13.7. HEADINGS....................................................... (22) 13.8. BINDING EFFECT................................................. (22) 13.9. ASSIGNMENT..................................................... (22) 13.10. NOTICES........................................................ (22) 13.11. AMENDMENT AND WAIVER........................................... (23) 13.12. SEVERABILITY................................................... (23) 13.13. ENTIRE AGREEMENT............................................... (23) 13.14. FORCE MAJEURE.................................................. (23) EXHIBIT A.................................................................. (25)
(iv) 6 RESEARCH AND DEVELOPMENT AGREEMENT This Agreement, dated as of November 1, 1997, is between Sankyo Co., LTD ("Sankyo"), a Japanese corporation, having a business address at 5-1, Nihonbashi Honcho 3-chome, Chuo-ku Tokyo 103, Japan, and ArQule, Inc. ("ArQule"), a Delaware corporation, having a business address at 200 Boston Avenue, Medford, Massachusetts, U.S.A.. R E C I T A L S WHEREAS, ArQule has developed certain technology that has applications in the discovery and development of pharmaceutical compounds; WHEREAS, Sankyo desires that ArQule apply its technologies to the research and development of pharmaceutical compounds for Sankyo; and WHEREAS, in exchange for payment by Sankyo of research funds, milestone payments and royalties, ArQule is willing to perform certain research and development activities for Sankyo, subject to the terms and conditions of this Agreement; NOW, THEREFORE, in consideration of the mutual covenants set forth in this Agreement, the Parties hereby agree as follows: 1. DEFINITIONS. 1.1. "ACTIVE HOMOLOG" shall mean any ArQule Derivative Compound or Sankyo Derivative Compound that exhibits substantial homology with an Active Compound as determined by the Steering Committee. 1.2. "ACTIVE ARQULE COMPOUND" shall mean any ArQule Compound or ArQule Derivative Compound which exhibits confirmed significant functional activity against a Target. The Steering Committee shall establish the criteria for "significant functional activity" at the time of selection of each Target. 1.3. "ACTIVE COMPOUND" shall mean any Active ArQule Compound or Active Sankyo Compound. 1.4. "ACTIVE SANKYO COMPOUND" shall mean any Sankyo Compound or Sankyo Derivative Compound which exhibits confirmed significant functional activity against a Target. The Steering Committee shall establish the criteria for "significant functional activity" at the time of selection of each Target. 1.5. "AFFILIATE" shall mean a corporation or other legal entity that controls, is controlled by, or is under common control with such Party. For purposes of this definition, "control" means the ownership, directly or indirectly, of fifty percent (50%) or more of the 7 outstanding equity securities of a corporation which are entitled to vote in the election of directors or a fifty percent (50%) or greater interest in the net assets or profits of an entity which is not a corporation. 1.6. "AGREEMENT" shall mean this Research and Development Agreement, together with EXHIBIT A hereto. 1.7. "ARQULE COMPOUND" shall mean any organic chemical molecule that is synthesized by ArQule using its proprietary technology and provided by ArQule to Sankyo under the Mapping Array(TM) Program. 1.8. "ARQULE DERIVATIVE COMPOUND" shall mean a Derivative Compound synthesized by ArQule from an ArQule Compound under the Directed Array(TM) Program described in Section 4. 1.9. "ARQULE PATENT RIGHTS" shall mean Patent Rights controlled or owned by ArQule as of the Effective Date or during the Research Period; all to the extent and only to the extent that ArQule now has or hereafter will have the right to grant licenses, immunities or other rights thereunder. 1.10. "ARQULE TECHNOLOGY" shall mean all information and data which is owned by ArQule or licensed by third parties to ArQule prior to or during the Research Program and is necessary or useful to conduct the screening to discover Active ArQule Compounds and Active Homologs thereto or to develop, make, use, sell or seek regulatory approval in any country to market a product containing a Licensed Compound; all to the extent and only to the extent that ArQule now has or hereafter will have the right to grant licenses, immunities or other rights thereunder. 1.11. "ARRAY" shall mean a set of samples of structurally related chemical compounds arranged in a format such as a microtiter screening plate. 1.12. "BASE RATE OF INTEREST" shall mean the base rate of interest declared from time to time by the Bank of Boston. 1.13. "CHEMICAL THEME" shall mean the chemical or structural characteristics shared by a group of compounds as determined by the Steering Committee pursuant to Section 2.2. 1.14. "CONFIDENTIAL INFORMATION" shall have the meaning set forth in Section 9.1. 1.15. "CONTRACT YEAR" shall mean each twelve (12) month period of the Research Period, commencing on the Effective Date. 1.16. "DERIVATIVE COMPOUND" shall mean a chemical compound structurally derived in one or more steps from another by a process of modification or partial substitution of at least one component wherein at least one structural feature is retained at each process step. The number of intermediate steps or compounds is not relevant to the classification of a (2) 8 compound as a Derivative Compound. A compound need not have structural similarity to another compound in order to be classified as a Derivative Compound. 1.17. "DIRECTED ARRAY(TM)" shall mean an Array comprised of ArQule Derivative Compounds synthesized by ArQule under the Directed Array(TM) Program described in Section 4. 1.18. "DIRECTED ARRAY(TM) PROGRAM" shall mean a Directed Array(TM) Program conducted by ArQule as set forth in Section 4, with each Directed Array(TM) Program consisting of multiple Arrays derived from one (1) Sankyo Compound or one (1) Active ArQule Compound. 1.19. "DISCLOSING PARTY" shall mean that Party disclosing Confidential Information to the other Party under Section 9. 1.20. "EFFECTIVE DATE" shall mean the first business day of the month immediately following the date of execution of this Agreement by the Parties hereto. 1.21. "EXTRAORDINARY EXPENSES" shall mean those expenses incurred from time to time by ArQule in connection with the Directed Array(TM) Program which are not (a) direct, out-of-pocket costs provided for in the Research Plan which are directly attributable to the Directed Array(TM) Program or (b) fixed overhead costs provided for in the Research Plan which are allocable to the Directed Array(TM) Program. 1.22. "FDA" shall mean the United States Food and Drug Administration (or its foreign equivalent in Japan or Europe). 1.23. "JOINT PATENT RIGHTS" shall mean any Patent Rights that are jointly owned by the Parties, as set forth in Section 7.1(b). 1.24. "LICENSED COMPOUND" shall mean any Active Compound or Active Homolog thereto with respect to which the Steering Committee has designated in accordance with Sections 2.2 and 3.2. 1.25. "LICENSED COMPOUND SET" shall mean, with respect to a Licensed Compound, such Licensed Compound and any Active Homolog thereto. 1.26. "MAPPING ARRAY(TM)" shall mean an Array of ArQule Compounds synthesized by ArQule under the Mapping Array(TM) Program set forth in Section 3. 1.27. "MAPPING ARRAY(TM) PROGRAM" shall mean the Mapping Array(TM) component of the Research Program as set forth in Section 3. 1.28. "NET SALES" shall mean the aggregate Net Sales Price of Royalty-Bearing Products in any Royalty Period. (3) 9 1.29. "NET SALES PRICE" shall mean the * received on sales by Sankyo, its Affiliates and Sublicensees of Royalty-Bearing Products, less the following: *. In any transfers of Royalty-Bearing Products between Sankyo and an Affiliate, the Net Sales Price shall be calculated based on the * of the Royalty-Bearing Product to an independent third party. In the event that Sankyo receives non-monetary consideration for any Royalty-Bearing Products, the Net Sales Price shall be calculated based on the * by Sankyo for such Royalty-Bearing Products during the * Royalty Period. 1.30. "PARTY" means ArQule or Sankyo or their respective Affiliates; "PARTIES" means ArQule and Sankyo and their respective Affiliates. 1.31. "PATENT RIGHTS" shall mean all rights arising under issued patents and reissues, reexaminations, extensions and supplementary protection certificates thereof and all patent applications and any divisions, continuations, or continuations-in-part thereof or patents issuing thereon. 1.32. "PHASE I CLINICAL TRIALS" shall mean clinical trials in healthy adults and/or in a small number of patients commencing upon the filing of a trial protocol with the appropriate regulatory body and designed to determine the metabolism and pharmacologic actions of a product in humans, the side effects associated with increasing doses and to gather evidence on effectiveness and meeting the requirements established by the FDA or by the equivalent Japanese agency for Phase I clinical trials. The completion of the Phase I Clinical Trials will be deemed to have occurred upon the first formal internal issuance of trial results as measured by trial objectives, or in any event no later than the commencement of the Phase II Clinical Trials. 1.33. "PHASE II CLINICAL TRIALS" shall mean clinical trials in a small sample of the intended patient population commencing upon the filing of a trial protocol with the appropriate regulatory body and designed to assess the efficacy for a specific indication of a compound proposed to be used as a therapeutic or diagnostic pharmaceutical product, to determine dose tolerance and the optimal dose range as well as to gather additional information relating to safety and potential adverse effects, and meeting the requirements established by the FDA or the equivalent Japanese agency for Phase II clinical trials. The completion of the Phase II Clinical Trials will be deemed to have occurred upon the first formal internal issuance of trial results as measured by trial objectives, or in any event no later than the commencement of the Phase III Clinical Trials. 1.34. "PHASE III CLINICAL TRIALS" shall mean clinical trials commencing upon the filing of a trial protocol with the appropriate regulatory body and designed to demonstrate safety and efficacy of a compound proposed to be used as a prophylactic, therapeutic or diagnostic pharmaceutical product in an expanded patient population at geographically dispersed study sites, meeting the requirements established by the FDA or the equivalent Japanese agency for Phase III clinical trials. The completion of the Phase III Clinical Trials - ------------- *Confidential Treatment has been requested for the marked portion. (4) 10 will be deemed to have occurred upon the first formal internal issuance of trial results as measured by trial objectives, or in any event no later than the filing of an NDA. 1.35. "PRECLINICAL COMPOUND" shall mean any Licensed Compound selected by Sankyo or an Affiliate of Sankyo to enter into Preclinical Development. 1.36. "PRECLINICAL DEVELOPMENT" shall mean, with respect to any Preclinical Compound, the commencement of potency and efficacy testing in animal models. 1.37. "RECEIVING PARTY" shall mean that Party receiving Confidential Information under Section 9.1. 1.38. "RESEARCH PERIOD" shall mean the period during which the Research Program remains in effect. The duration of the Research Period shall be a *, unless extended by the mutual agreement of the Parties. 1.39. "RESEARCH PROGRAM" shall mean, collectively, each of the Directed Array(TM) Programs and the Mapping Array(TM) Program. 1.40. "RESEARCH PLAN" shall mean a plan of research for the Directed Array(TM) Program covering a minimum of a * period, which shall be updated quarterly pursuant to Section 2.2 to reflect developments during the previous three (3) months and extended for the subsequent three (3) months. The parties will begin development of the initial Research Plan by *. The parties will complete the Research Plan for the first Directed Array Program by * and will complete the Research Plan for the second Directed Array Program by *. The completed Research Plan will be attached to this Agreement as EXHIBIT A. 1.41. "ROYALTY-BEARING PRODUCT" shall mean a product containing *. 1.42. "ROYALTY PERIOD" shall mean, with respect to each Royalty-Bearing Product, every calendar quarter, or partial calendar quarter, commencing with the first commercial sale of such Royalty-Bearing Product in any country and ending on the later to occur of (i) the end of the quarter during which all Valid Claims of all Patent Rights covering such Royalty-Bearing Product expire in the applicable country, or * years after such first commercial sale in the applicable country. 1.43. "SANKYO COMPOUND" shall mean any chemical compound provided by Sankyo or its Affiliates to ArQule under the Directed Array(TM) Program described in Section 4. 1.44. "SANKYO DERIVATIVE COMPOUND" shall mean a Derivative Compound synthesized by ArQule from a Sankyo Compound under the Directed Array(TM) Program described in Section 4. - -------------- *Confidential Treatment has been requested for the marked portion. (5) 11 1.45. "SANKYO PATENT RIGHTS" shall mean Patent Rights controlled or owned by Sankyo as of the Effective Date or during the Research Period; all to the extent and only to the extent that Sankyo now has or hereafter will have the right to grant licenses, immunities or other rights thereunder. 1.46. "STEERING COMMITTEE" shall have the meaning set forth in Section 2.1. 1.47. "SUBLICENSEE" shall mean any non-Affiliate third party licensed by Sankyo to make, use (except where the right to use accompanies the sale of any Royalty-Bearing Product by Sankyo or its Affiliates or Sublicensees) or sell any Royalty-Bearing Product. 1.48. "TARGET" shall mean any biological target selected by Sankyo for which Sankyo has certain proprietary technology and/or expertise. 1.49. "U.S. TERRITORY" shall mean the fifty states comprising the United States of America and all American possessions. 1.50. "VALID CLAIM" shall mean either (a) a claim of an issued patent that has not been held unenforceable or invalid by an agency or a court of competent jurisdiction in any unappealable or unappealed decision or (b) a claim of a pending patent application that has not been abandoned or finally rejected without the possibility of appeal or refiling. 1.51. "WORLDWIDE TERRITORY" shall mean the world excluding the U.S. Territory. 1.52. The above definitions are intended to encompass the defined terms in both the singular and plural tenses. 2. MANAGEMENT OF RESEARCH PROGRAM. 2.1. COMPOSITION OF STEERING COMMITTEE. The Parties hereby establish a Steering Committee comprised of six (6) members, with three (3) representatives appointed by each Party. The initial members of the Steering Committee shall be as follows: ARQULE REPRESENTATIVES SANKYO REPRESENTATIVES * A Party may change one or more of its representatives to the Steering Committee at any time upon notice to the other Party. Each Party will designate one of its representatives as its team leader. 2.2. DUTIES OF THE STEERING COMMITTEE. The Steering Committee shall direct and administer the Research Program. With respect to each Directed Array(TM) Program, the - ----------------- *Confidential Treatment has been requested for the marked portion. (6) 12 Steering Committee shall specifically determine the following: (i) the appropriate objectives of each Chemical Theme and/or Active Compound to be submitted to the Directed Array(TM) Program; (ii) the appropriate number and type of Chemical Themes to be submitted to the Directed Array(TM) Program, subject to ArQule's right to exclude certain compounds as set forth in Section 2.3 below; (iii) the appropriate number of compounds that ArQule should generate in a Directed Array(TM) for a particular Chemical Theme; and (iv) the appropriate amount of each compound in a Directed Array(TM) that ArQule should deliver to Sankyo for further research and development. The scope of each Chemical Theme will be determined on the basis of the following criteria: (i) the specific reaction or reaction sequence used to combine members of two or more discrete chemical units in which each chemical unit bears the functional group(s) required for the specific reaction(s) that result in the combination of the chemical units; and (ii) the extent to which a class of compounds is related by a recurring structural motif associated with a particular biological activity. In addition, the Steering Committee shall (i) determine whether any Active Compound should be designated as a Licensed Compound; (ii) determine and update the list of Licensed Compounds; (iii) determine the allocation of the funding and personnel resources to be contributed by ArQule under this Agreement; (iv) revise and extend the Research Plan each calendar quarter for the subsequent six (6) months based on prior developments; and (v) resolve matters involving scientific questions. 2.3. COMPOUNDS EXCLUDED FROM THE DIRECTED ARRAY(TM) PROGRAM. ArQule shall have the right, at the time Sankyo seeks to include any Active ArQule Compound or Active Homolog thereto in any Directed Array(TM) Program, to exclude from such Directed Array(TM) Program any Active ArQule Compound or Active Homolog thereto that is at that time either (i) included within a Directed Array(TM) Program for a third party, (ii) being optimized by a third party from a Mapping Array(TM) Program, (iii) previously licensed or reserved by a third party, or (iv) is included within an existing ArQule internal development program. 2.4. MEETINGS OF THE STEERING COMMITTEE. The Steering Committee shall communicate regularly, but in no event less than monthly, via written project status reports through written communications means, including, without limitation, electronic mail. A member of the committee from each Party will promptly respond to such communications where appropriate within * of its receipt by such member. In the event that questions or issues arise from such written communications that cannot be, or are not being effectively addressed by such written communications, or upon request by any member of the Steering Committee, the Steering Committee shall promptly conduct one or more telephone conferences to address such questions or issues and shall prepare and deliver to each Party a brief written report describing the significant issues and discussions that take place during such telephone conference(s). A representative of the Steering Committee jointly appointed by its members shall provide each member with * notice of the time of any such telephone conferences and the proposed agenda with respect thereto, unless waived by all members. The Steering Committee shall meet at least once each quarter at the facilities of ArQule, or at such other times and locations as the Steering Committee determines. A representative of the Steering Committee jointly appointed by its members shall provide each member with* - ------------------- *Confidential Treatment has been requested for the marked portion. (7) 13 notice of the time and location of meetings, unless such notice is waived by all members. If a designated representative of a Party cannot attend any meeting of the Steering Committee, such Party may designate a different representative for that meeting without notice to the other Party, and the substitute member will have full power to vote on behalf of the permanent member. Except as otherwise provided in this Section 2, all actions and decisions of the Steering Committee will require the unanimous consent of all of its members. If the Steering Committee fails to reach agreement upon any matter, the dispute will be resolved in accordance with the procedures set forth in Section 13.5 below. Within * following each quarterly meeting of the Steering Committee, the Steering Committee shall prepare and deliver, to both Parties, a written report describing the decisions made, conclusions and actions agreed upon. 2.5. COOPERATION. Each Party agrees to provide the Steering Committee with information and documentation as reasonably required for the Steering Committee to fulfill its duties under this Agreement. In addition, each Party agrees to make available its employees and consultants as reasonably requested by the Steering Committee. The Parties anticipate that members of the Steering Committee will communicate informally with each other and with employees and consultants of the Parties on matters relating to the Directed Array(TM) Program. 2.6. VISITS TO FACILITIES. Members of the Steering Committee shall have reasonable access to the facilities of each Party where activities under this Agreement are in progress, but only during normal business hours and with reasonable prior notice. Each Party shall bear its own expenses in connection with such site visits. 3. MAPPING ARRAY(TM) PROGRAM. 3.1. CONDUCT OF MAPPING ARRAY(TM) PROGRAM. ArQule will supply Sankyo with Mapping Arrays(TM) containing approximately * each of approximately * different ArQule Compounds during the first Contract Year selected by ArQule from the * based on no more than * Chemical Themes selected by Sankyo and approved by the Steering Committee. Subject to Section 3.6, ArQule will supply Sankyo with Mapping Arrays(TM) containing approximately * each of approximately * different ArQule Compounds during each subsequent Contract Year of the term of the Mapping Array(TM) Program provided for in Section 3.5, selected at the start of such subsequent Contract Year from the then available Mapping Array(TM) compounds based on no more than * Chemical Themes selected by Sankyo and approved by the Steering Committee. ArQule agrees to ship such * Mapping Array(TM) compounds (i) for the first Contract Year by * (ii) for the second Contract Year on or after the earlier to occur of (a) * after Sankyo completes initial screening, as determined by the Steering Committee, of the Mapping Array(TM) compounds shipped to Sankyo during the first Contract Year, or (ii) *, or earlier when available if so requested by Sankyo in writing, and (iii) for the third Contract Year *. Sankyo agrees to accept each such shipment of Mapping Array(TM) compounds *. Promptly upon its receipt of any such Mapping Arrays(TM), Sankyo shall commence testing of such Mapping Arrays(TM) for activity against Targets. Upon the - ------------------- *Confidential Treatment has been requested for the marked portion. (8) 14 completion by Sankyo of its testing of any such Mapping Arrays(TM), Sankyo shall promptly provide each member of the Steering Committee with notice by telefax communication detailing the discovery of Active Compounds, together with relevant information concerning the functional activity identified, which telefax shall be followed by a confirmatory letter. 3.2. MUTUAL DISCLOSURE. Initially, ArQule will identify the Chemical Themes of each Mapping Array(TM) but not the structures of the individual ArQule Compounds in the Mapping Arrays(TM). Sankyo may screen the Mapping Arrays(TM) against any Targets during the term of this Agreement and thereafter. Initially, Sankyo will not disclose the Targets screened. If Sankyo detects any Active ArQule Compound in a Mapping Array(TM), ArQule will disclose (a) the structure of each Active ArQule Compound and (b) the structures, but not the locations in the Mapping Array(TM), of all other ArQule Compounds in the Mapping Array(TM) and Sankyo will disclose (a) the identity of the Target and (b) the level of activity. All such disclosed information shall be treated as Confidential Information by both Parties. Sankyo shall submit each such Active ArQule Compound to the Directed Array(TM) Program pursuant to Section 4. Sankyo, at its discretion, may request that the Steering Committee designate any such Active ArQule Compound and Active Homologs thereto as Licensed Compounds comprising a Licensed Compound Set if such Active ArQule Compound and Active Homologs are still available as Licensed Compounds. * Subject to the foregoing, (a) ArQule shall notify the Steering Committee that such Active ArQule Compound and Active Homologs thereto are properly designated as Licensed Compounds, and (b) provide Sankyo with the confirmed chemical composition, structure, purity information and location of all Active ArQule Compounds and Active Homologs thereto so designated as Licensed Compounds belonging to such Licensed Compound Set. 3.3. RESERVATION OF ACTIVE ARQULE COMPOUNDS. Prior to designating any Active ArQule Compounds and Active Homologs thereto as Licensed Compounds pursuant to Section 3.2 hereof, Sankyo, at its discretion, may notify ArQule of its intent to license such Active ArQule Compounds and Active Homologs, and request a reservation of such Active ArQule Compounds and Active Homologs thereto (collectively the "Reserved Compounds"). Upon ArQule receiving from Sankyo (i) a written request to reserve such Reserved Compounds, and (ii) disclosure of the Target and activity information pursuant to Section 3.2 hereof, ArQule shall reserve such Reserved Compounds for subsequent designation by Sankyo as Licensed Compounds for a period ending upon the earlier to occur of (i) * or (ii) * days. 3.4. MAPPING ARRAY(TM) PROGRAM PAYMENTS. In consideration of the performance by ArQule of the Mapping Array(TM) Program, during each Contract Year, Sankyo shall pay ArQule a delivery fee equal to * in the initial Contract Year, payable *. Thereafter, Sankyo shall make the following annual payment to ArQule during each Contract Year, in the second Contract Year payable * and in the third Contract Year payable *: Annual Payment = * - ---------------- *Confidential Treatment has been requested for the marked portion. (9) 15 Where CPI is a fraction, the numerator of which is the difference between the Consumer Price Index (CPI-U; U.S. City Average for all items; 1982-84 = 100) as of the last month of the immediately preceding Contract Year and the Consumer Price Index as of the month immediately preceding the Effective Date and the denominator of which is the Consumer Price Index as of the month immediately preceding the Effective Date. 3.5. TERM OF MAPPING ARRAY(TM) PROGRAM. The Mapping Array(TM) Program shall commence on the Effective Date, continue for a period of * Contract Years, unless earlier terminated as provided in Section 3.6 or Article 12 below. Termination of the Mapping Array(TM) Program shall have no effect on the continuation of any Directed Array(TM) Program. 3.6. PERFORMANCE OF MAPPING ARRAY(TM) PROGRAM. Sankyo shall have the * the Mapping Array(TM) Program on or before the earlier to occur of (i) * as determined by the Steering Committee, of the Mapping Array(TM) compounds shipped to Sankyo during the first Contract Year, or (ii) *, upon written notice to ArQule, in the event that *. ArQule shall be under the obligation to deliver Mapping Arrays(TM) for the successive Contract Years *. 4. DIRECTED ARRAY(TM) PROGRAM. 4.1. DESCRIPTION OF DIRECTED ARRAY(TM) PROGRAM. Under the direction of the Steering Committee and in accordance with the Research Plan, ArQule will synthesize multiple Directed Arrays(TM) of compounds derived from (i) each Sankyo Compound provided to ArQule by Sankyo and/or (ii) each Active ArQule Compound provided by ArQule to Sankyo under the Mapping Array(TM) Program, subject to Section 2.3 above. The Parties intend that, during the Research Period, ArQule will produce such Directed Arrays(TM) in * Directed Array(TM) Programs, each based on a different Chemical Theme and intended to produce approximately *, per Contract Year for a minimum of * Contract Years beginning on the Effective Date. However, the number of closely related Chemical Themes actually submitted to each Directed Array(TM) Program for the same Target pursuant to a given Research Plan and the number of ArQule Derivative Compounds and/or Sankyo Derivative Compounds actually produced per Chemical Theme will be determined by the Steering Committee. The Parties also intend that ArQule will produce approximately * of each ArQule Derivative Compound and/or Sankyo Derivative Compound in the Directed Arrays(TM), subject to the availability of the original Sankyo Compounds and/or the ArQule Compounds; PROVIDED, HOWEVER, that the amount of each ArQule Derivative Compound and/or Sankyo Derivative Compound that ArQule actually produces will ultimately be determined by the Steering Committee. 4.2. CONDUCT OF DIRECTED ARRAY(TM) PROGRAM. The Directed Array(TM) Program shall be conducted in a good scientific manner and in compliance with all applicable legal requirements. The conduct of the Directed Array(TM) Program shall be the primary responsibility of ArQule with participation by Sankyo. Sankyo shall propose Chemical Themes to the Steering Committee for inclusion in the Directed Array(TM) Program. If the Steering Committee approves the inclusion of the proposed Chemical Theme, Sankyo shall - --------------- *Confidential Treatment has been requested for the marked portion. (10) 16 provide ArQule with the requisite amount and purity of Sankyo Compounds for that Chemical Theme, as directed by the Steering Committee. ArQule shall thereupon diligently synthesize Directed Arrays(TM) of ArQule Derivative Compounds and/or Sankyo Derivative Compounds, as the case may be, in accordance with the Research Plan. Sankyo shall, in its discretion, test all compounds in the Directed Arrays(TM). The Parties shall continue the procedure described in this Section 4.2 for each Active Compound until the earliest to occur of (i) the determination by the Steering Committee, in accordance with Section 2.2, to designate any such Active Compound and any Active Homolog thereto as a Licensed Compound Set, (ii) the determination by the Steering Committee to cease further testing of such Active Compound, or (iii) the termination of this Agreement in accordance with Section 12. 4.3. DIRECTED ARRAY(TM) PROGRAM PAYMENTS. 4.3.1. DELIVERY FEE. In consideration of the performance by ArQule of the Directed Array(TM) Program, Sankyo shall pay ArQule a delivery fee equal to * per Directed Array(TM) Program during the first Contract Year, payable *. Thereafter, Sankyo shall make the following annual payment to ArQule during each Contract Year, payable *: Annual Payment = * Notwithstanding the foregoing, if the number of Active Compounds submitted to all Directed Array(TM) Programs exceeds * for the first * Contract Years, the Parties *. 4.3.2. EXPENSES. In addition to the amounts payable pursuant to Section 4.3.1 above, Sankyo shall pay any and all Extraordinary Expenses of ArQule, as required and approved by the Steering Committee. 4.4. TERM OF DIRECTED ARRAY(TM) PROGRAM. The term of each Directed Array(TM) Program shall begin upon the commencement of the Research Plan and terminate no later than the first anniversary of such commencement date unless extended by the Steering Committee because of extraordinary circumstances. The period for initiating and completing all Directed Array(TM) Programs commenced pursuant to Section 4.1 hereof shall terminate at the end of the * Contract Year, PROVIDED, HOWEVER, that upon * months prior written notice by Sankyo, such period may be extended for * period at * on terms and conditions to be mutually agreed upon by the Parties. 5. LICENSE GRANTS; REVERSION OF RIGHTS. 5.1. SCREENING LICENSES. ArQule hereby grants to Sankyo, under ArQule Patent Rights and ArQule Technology *. 5.2. PRECLINICAL AND CLINICAL LICENSES. Upon the identification by Sankyo of any Active Compound and the determination by the Steering Committee that such Active - ----------------- *Confidential Treatment has been requested for the marked portion. (11) 17 Compound and any Active Homolog thereto should properly be designated as a Licensed Compound Set, ArQule shall grant to Sankyo, under any intellectual property rights covering the composition, manufacture or use of such Licensed Compound Set, *. 5.3. COMMERCIALIZATION LICENSE. ArQule hereby grants to Sankyo *. 5.4. REVERSION OF RIGHTS; RETURN OF MATERIALS. In the event that *. In such event, ArQule shall thereafter be free to grant licenses covering such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds to third parties. Upon termination of such license by ArQule, Sankyo shall (i) grant to ArQule an exclusive, royalty-free license, with the right to grant sublicenses, to manufacture, use or sell such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds under any patent rights of Sankyo covering the composition or use of such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds and (ii) return to ArQule all Proprietary Materials and Confidential Information supplied by ArQule which relate to such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds. Notwithstanding the foregoing, the provisions of this Section 5.4 shall not apply to Sankyo Compounds or Sankyo Derivative Compounds. 6. OWNERSHIP OF COMPOUNDS. 6.1. SANKYO COMPOUNDS; SANKYO DERIVATIVE COMPOUNDS. All Sankyo Compounds and Sankyo Derivative Compounds shall be owned by Sankyo or its Affiliates, except, and only to the extent that, with respect to the Directed Array(TM) Program, ArQule can show that any such compound *. 6.2. ARQULE COMPOUNDS; ARQULE DERIVATIVE COMPOUNDS. All ArQule Compounds and ArQule Derivative Compounds shall be owned by ArQule except, and only to the extent that, Sankyo can show that any such compound was in the possession of Sankyo before it was provided by ArQule to Sankyo or its Affiliates. 7. INTELLECTUAL PROPERTY RIGHTS. 7.1. OWNERSHIP OF PATENT RIGHTS. (a) ARQULE PATENT RIGHTS. Any Patent Rights filed by either Party covering Active ArQule Compounds only will be owned solely by ArQule except as provided in Section 7.1(b). (b) JOINT PATENT RIGHTS. Any Patent Rights (i) filed by either Party covering both Active ArQule Compounds and Active Sankyo Compounds, (ii) claiming an Active ArQule Compound and uses thereof discovered by Sankyo; and/or - --------------- *Confidential Treatment has been requested for the marked portion. (12) 18 (iii) claiming an Active Sankyo Compound and uses thereof discovered by ArQule, shall be owned jointly by ArQule and Sankyo. (c) SANKYO PATENT RIGHTS. Any Patent Rights filed by either Party covering solely Active Sankyo Compounds will be owned solely by Sankyo. (d) PATENT RIGHTS GENERALLY. Any Patent Rights arising out of or related to this Agreement, the ownership of which cannot be determined from Subsections (a), (b) or (c) of this Section 7.1, will be owned by the Party(ies) having inventorship under the patent laws of the United States. 7.2. MANAGEMENT OF JOINT PATENT RIGHTS. In the case of Joint Patent Rights, the Parties shall agree on the allocation of responsibility for, and the expense of, the preparation, filing, prosecution, and maintenance of any Joint Patent Rights claiming such inventions. In the event of any disagreement concerning any Joint Patent Rights, the matter shall be resolved by the Steering Committee or, in the absence thereof, by the President of ArQule and the Director of the Patent Department of Sankyo. The Party controlling a Joint Patent Right shall consult with the other Party as to the preparation, filing, prosecution, and maintenance of such Joint Patent Right reasonably prior to any deadline or action with the U.S. Patent & Trademark Office or its foreign equivalent in Japan or Europe, and shall furnish to the other Party copies of all relevant documents reasonably in advance of such consultation. In the event that the Party controlling a Joint Patent Right desires to abandon such Joint Patent Right, or if the Party assuming control of a Joint Patent Right later declines responsibility for such Joint Patent Right, the controlling Party shall provide reasonable prior written notice to the other Party of such intention to abandon or decline responsibility, and such other Party shall have the right, at its expense, to prepare, file, prosecute, and maintain such Joint Patent Rights. 7.3. COOPERATION OF THE PARTIES. Each Party agrees to cooperate fully in the preparation, filing, and prosecution of any Patent Rights under this Agreement. Such cooperation includes, but is not limited to: (a) executing all papers and instruments, or requiring its employees or agents, to execute such papers and instruments, so as to effectuate the ownership of Patent Rights set forth in Section 7.1 above and to enable the other Party to apply for and to prosecute patent applications in any country; (b) promptly informing the other Party of any matters coming to such Party's attention that may affect the preparation, filing, or prosecution of any such patent applications; and (c) undertaking no actions that are potentially deleterious to the preparation, filing, or prosecution of such patent applications. 7.4. INFRINGEMENT BY THIRD PARTIES. ArQule and Sankyo shall each promptly notify the other in writing of any alleged or threatened infringement by a third party of any ArQule (13) 19 Patent Right, Sankyo Patent Right or Joint Patent Right of which they become aware. The parties shall consult concerning the action(s) to be taken. 8. PAYMENTS, REPORTS, AND RECORDS. 8.1. MILESTONE PAYMENTS. In partial consideration of the rights granted Sankyo under this Agreement, Sankyo shall pay ArQule the following amounts within * days after each occurrence of the following milestones: Payment for Royalty- Bearing Products Milestone - -------------------- --------- * * Such milestone payments shall be non-refundable and shall not be credited against royalties payable to ArQule under this Agreement, PROVIDED, HOWEVER, that * of any such milestone payments made with respect to any Royalty-Bearing Product consisting of an ArQule Compound provided to Sankyo pursuant to the Mapping Array(TM) Program, and not submitted to a Directed Array(TM) Program, shall be creditable up to * per year against royalties due ArQule for such Royalty-Bearing Product pursuant to Section 8.3. Sankyo shall promptly notify ArQule of each occurrence of any of the foregoing milestones. 8.2. ALTERNATIVE TO MILESTONE PAYMENTS. If any time on or before * days prior to the * with respect to any Royalty-Bearing Product, Sankyo elects, *, it shall so notify ArQule in writing. Promptly upon its receipt of such written notice, ArQule shall enter into good faith negotiations with Sankyo for an appropriate amendment to this Agreement under which either *. If the Parties are unable to reach agreement with respect to the foregoing by the expiration of * days from the commencement of such negotiations, Sankyo shall remain obligated to pay the full amount of milestone payments set forth in Section 8.1 above for such Royalty-Bearing Product. 8.3. ROYALTIES. In consideration of the licenses granted to Sankyo hereunder, for each Royalty Period, Sankyo shall pay to ArQule a royalty for each Royalty-Bearing Product as follows:
Source of Royalty-bearing Product Royalty Rate (Percentage of Net Sales) --------------------------------- -------------------------------------- Worldwide Territory U.s. Territory ------------------- -------------- Sankyo Derivative Compound * * ArQule Compound or ArQule * * Derivative Compound
- ------------- *Confidential Treatment has been requested for the marked portion. (14) 20 8.4. REPORTS AND PAYMENTS. Within * days after the conclusion of each Royalty Period, Sankyo shall deliver to ArQule a report containing the following information: * All such reports shall be maintained in confidence by ArQule. If no royalties are due to ArQule for any reporting period, the report shall so state. Concurrent with this report, Sankyo shall remit to ArQule any payment due for the applicable Royalty Period. The method of payment shall be mutually agreed to. All amounts payable to ArQule under this Section will first be calculated in the currency of sale and then converted into U.S. dollars in accordance with Section 8.6, and such amounts shall be paid without deduction of any withholding taxes, value-added taxes, or other charges applicable to such payments, except as provided for in Section 8.9. 8.5. INVOICES; PAYMENTS IN U.S. DOLLARS. With the exception of royalty payments due under Section 8.3, ArQule shall submit invoices to Sankyo for each payment due ArQule hereunder (including without limitation all payments due pursuant to Section 3.3), and Sankyo shall pay such invoices within * days of receipt thereof. All payments due under this Agreement shall, except as provided in Section 8.6 below, be payable in United States dollars. Conversion of foreign currency to U.S. dollars shall be made at the conversion rate existing in the United States (as reported in the WALL STREET JOURNAL) on the last working day of the calendar quarter preceding the applicable calendar quarter. Such payments shall be without deduction of exchange, collection, or other charges, except as provided for in Section 8.9. 8.6. PAYMENTS IN OTHER CURRENCIES. If by law, regulation, or fiscal policy of a particular country, conversion into United States dollars or transfer of funds of a convertible currency to the United States is restricted or forbidden, Sankyo shall give ArQule prompt written notice of such restriction, which notice shall satisfy the *day payment deadline described in Section 8.4. Sankyo shall pay any amounts due ArQule through whatever lawful methods ArQule reasonably designates; provided, however, that if ArQule fails to designate such payment method within * days after ArQule is notified of the restriction, then Sankyo may deposit such payment in local currency to the credit of ArQule in a recognized banking institution selected by Sankyo and identified by written notice to ArQule, and such deposit shall fulfill all obligations of Sankyo to ArQule with respect to such payment. 8.7. RECORDS. Sankyo and its Affiliates shall maintain complete and accurate records of Royalty-Bearing Products made, used or sold by them or their Sublicensees under this Agreement, and any amounts payable to ArQule in relation to such Royalty-Bearing Products, which records shall contain sufficient information to permit ArQule to confirm the accuracy of any reports delivered to ArQule in accordance with Section 8.4. The relevant Party shall retain such records relating to a given Royalty Period for at least * years after the conclusion of that Royalty Period. Each Party (acting as the "Auditing Party") shall have the right, at its own expense, to cause an independent certified public accountant to inspect such records of the other Party (the "Audited Party") during normal business hours for the - ---------------- *Confidential Treatment has been requested for the marked portion. (15) 21 sole purpose of verifying any reports and payments delivered under this Agreement. Such accountant shall not disclose to the Auditing Party any information other than information relating to accuracy of reports and payments delivered under this Agreement and shall provide the Audited Party with a copy of any report given to the Auditing Party. The Parties shall reconcile any underpayment or overpayment within * days after the accountant delivers the results of the audit. In the event that any audit performed under this Section reveals an underpayment in excess of * in any Royalty Period, the Audited Party shall bear the full cost of such audit. Each party may exercise its rights under this Section only once every year and only with reasonable prior notice to the other Party. 8.8. LATE PAYMENTS. Any payments by Sankyo that are not paid on or before the date such payments are due under this Agreement shall bear interest, to the extent permitted by law, at * calculated based on the number of days that payment is delinquent. 8.9. WITHHOLDING TAX PAYMENTS. 8.9.1. PAYMENTS. All amounts payable under Section 3.4, 4.3 and 8.1 shall represent the actual proceeds to be received by ArQule after any applicable deductions have been made, including without limitation any withholding taxes. ArQule agrees to reasonably cooperate with Sankyo in obtaining a refund of any withholding taxes paid by Sankyo with respect to any payments to ArQule hereunder. In the event that ArQule is successful in obtaining any refund of tax withholding amounts paid by Sankyo under Sections 3.4, 4.3 and 8.1 of this Agreement, ArQule agrees to promptly remit such refund amount received by ArQule to Sankyo. 8.9.2. ROYALTY PAYMENTS. Sankyo may only withhold from royalties due to ArQule under Section 8.3 amounts for payment of Japanese withholding tax that is required by law to be paid to the Japanese taxing authority with respect to such royalty amounts due to ArQule; PROVIDED, HOWEVER, that such amount withheld shall not exceed the lesser of * and FURTHER PROVIDED, HOWEVER, that in regard to any such tax withholding Sankyo shall give ArQule such documents, and provide any other cooperation or assistance on a reasonable basis, as may be necessary to enable ArQule to claim exemption therefrom, to receive a full allowance of such withholding tax or claim a foreign tax credit, and Sankyo shall upon ArQule's request give proper evidence as to the payment of such tax. In the event that Sankyo is successful in obtaining any refund of tax withholding amounts paid by Sankyo under Sections 8.3 of this Agreement, Sankyo agrees to promptly remit such refund amount received by Sankyo to ArQule. 9. CONFIDENTIAL INFORMATION. 9.1. DEFINITION OF CONFIDENTIAL INFORMATION. Confidential Information shall mean any technical or business information furnished by the Disclosing Party to the Receiving Party in connection with this Agreement and specifically designated as confidential. Such - --------------- *Confidential Treatment has been requested for the marked portion. (16) 22 Confidential Information may include, without limitation, the identity of a chemical compound, the use of a chemical compound, trade secrets, know-how, inventions, technical data or specifications, testing methods, business or financial information, research and development activities, product and marketing plans, and customer and supplier information. 9.2. DESIGNATION OF CONFIDENTIAL INFORMATION. Confidential Information that is disclosed in writing shall be marked with a legend indicating its confidential status. Confidential Information that is disclosed orally or visually shall be documented in a written notice prepared by the Disclosing Party and delivered to the Receiving Party within thirty (30) days of the date of disclosure; such notice shall summarize the Confidential Information disclosed to the Receiving Party and reference the time and place of disclosure. 9.3. OBLIGATIONS. The Receiving Party agrees that it shall: (a) maintain all Confidential Information in strict confidence, except that the Receiving Party may disclose or permit the disclosure of any Confidential Information to its, and its Affiliates, directors, officers, employees, consultants, and advisors who are obligated to maintain the confidential nature of such Confidential Information and who need to know such Confidential Information for the purposes set forth in this Agreement; (b) use all Confidential Information solely for the purposes set forth in, or as permitted by, this Agreement; and (c) allow its directors, officers, employees, consultants, and advisors to reproduce the Confidential Information only to the extent necessary to effect the purposes set forth in this Agreement, with all such reproductions being considered Confidential Information. 9.4. EXCEPTIONS. The obligations of the Receiving Party under Section 9.3 above shall not apply to the extent that the Receiving Party can demonstrate that certain Confidential Information: (a) was in the public domain prior to the time of its disclosure under this Agreement; (b) entered the public domain after the time of its disclosure under this Agreement through means other than an unauthorized disclosure resulting from an act or omission by the Receiving Party; (c) was independently developed or discovered by the Receiving Party without use of the Confidential Information; (d) is or was disclosed to the Receiving Party at any time, whether prior to or after the time of its disclosure under this Agreement, by a third party having no fiduciary relationship with the Disclosing Party and having no obligation of (17) 23 confidentiality to the Disclosing Party with respect to such Confidential Information; or (e) is required to be disclosed to comply with applicable laws or regulations (such as disclosure to the FDA or the United States Patent and Trademark Office or to their foreign equivalents), or to comply with a court or administrative order, provided that the Disclosing Party receives prior written notice of such disclosure and that the Receiving Party takes all reasonable and lawful actions to obtain confidential treatment for such disclosure and, if possible, to minimize the extent of such disclosure. 9.5. RETURN OF CONFIDENTIAL INFORMATION. Upon the termination of this Agreement, at the request of the Disclosing Party, the Receiving Party shall destroy or return to the Disclosing Party all originals, copies, and summaries of documents, materials, and other tangible manifestations of Confidential Information in the possession or control of the Receiving Party, except that the Receiving Party may retain one copy of the Confidential Information in the possession of its legal counsel (for ArQule) and its Legal Department (for Sankyo) solely for the purpose of monitoring its obligations under this Agreement. 9.6. SURVIVAL OF OBLIGATIONS. The obligations set forth in this Article shall remain in effect for a period of * years after termination of this Agreement, except that the obligations of the Receiving Party to destroy or return Confidential Information to the Disclosing Party shall survive until fulfilled. 10. REPRESENTATIONS AND WARRANTIES. 10.1. AUTHORIZATION. Each Party represents and warrants to the other that it has the legal right and power to enter into this Agreement, to extend the rights and licenses granted to the other in this Agreement, and to fully perform its obligations hereunder, and that the performance of such obligations will not conflict with its charter documents or any agreements, contracts, or other arrangements to which it is a Party. 11. INDEMNIFICATION AND INSURANCE. 11.1. SANKYO INDEMNITY OBLIGATIONS. Sankyo agrees to defend, indemnify and hold ArQule, its Affiliates and their respective directors, officers, employees and agents harmless from all costs, judgments, liabilities and damages assessed by a court of competent jurisdiction arising from claims asserted by a third party against ArQule, its Affiliates or their respective directors, employees or agents as a result of: (a) actual or asserted violations of any applicable law or regulation by Sankyo, its Affiliates, sublicensees or third party manufacturers by virtue of which the Royalty-Bearing Products manufactured, distributed or sold shall be alleged or determined to be adulterated, misbranded, mislabeled or otherwise - --------------- *Confidential Treatment has been requested for the marked portion. (18) 24 not in compliance with such applicable law or regulation; (b) claims for bodily injury, death or property damage attributable to the manufacture, distribution, sale or use of the Royalty-Bearing Products by Sankyo, its Affiliates, sublicensees or third party manufacturers; or (c) a recall ordered by a governmental agency, or required by a confirmed failure, of Royalty-Bearing Products manufactured, distributed, or sold by Sankyo, its Affiliates, sublicensees or third party manufacturers as reasonably determined by the Parties hereto. 11.2. PROCEDURE. In the event that ArQule or any of its Affiliates or their respective employees or agents (the "Indemnitee") intends to claim indemnification under this Article 11, such Party shall promptly notify Sankyo of any loss, claim, damage, liability or action in respect of which the Indemnitee intends to claim such indemnification, and Sankyo shall assume the defense thereof with counsel mutually satisfactory to the Parties; provided, however, that an Indemnitee shall have the right to retain its own counsel, with the fees and expenses to be paid by Sankyo, if representation of such Indemnitee by the counsel retained by Sankyo would be inappropriate due to actual or potential differing interests between such Indemnitee and any other Party represented by such counsel in such proceedings. The indemnity agreement in this Article 11 shall not apply to amounts paid in settlement of any loss, claim, damage, liability or action if such settlement is effected without the consent of Sankyo, which consent shall not be withheld unreasonably. The failure to deliver notice to Sankyo within a reasonable time after the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve Sankyo of any liability to the Indemnitee under this Article 11, but the omission so to deliver notice to Sankyo will not relieve it of any liability that it may have to any Indemnitee otherwise than under this Article 11. The Indemnitee under this Article 11, its employees and agents, shall cooperate fully with Sankyo and its legal representatives in the investigation of any action, claim or liability covered by this indemnification. 11.3. INSURANCE. Sankyo shall maintain appropriate product liability insurance with respect to development, manufacture and sales of the Royalty-Bearing Products by Sankyo in such amount as Sankyo customarily maintains with respect to sales of its other products. Sankyo shall each maintain such insurance for so long as it continues to manufacture or sell the Royalty-Bearing Products, and thereafter for so long as Sankyo maintains insurance for itself covering such manufacture or sales. 12. TERM AND TERMINATION. 12.1. TERM. This Agreement shall commence on the Effective Date and shall remain in effect until the expiration of the last Royalty Period covering any Royalty-Bearing Product, unless earlier terminated as provided in this Article 12. 12.2. BREACH OF PAYMENT OBLIGATIONS. In the event that Sankyo fails to make timely payment of any amounts due to ArQule under this Agreement, ArQule may terminate this (19) 25 Agreement upon * days written notice to Sankyo, unless Sankyo pays all past-due amounts within such *day notice period. 12.3. MATERIAL BREACH. In the event that either Party commits a material breach of any of its obligations under this Agreement (other than as provided in Section 12.2) and such Party fails (i) to remedy that breach within * days after receiving written notice thereof from the other Party or (ii) to commence dispute resolution pursuant to Section 13.5, within * days after receiving written notice of that breach from the other Party, the other Party may immediately terminate this Agreement upon written notice to the breaching Party. 12.4. EFFECT OF TERMINATION. Termination of this Agreement shall not relieve the Parties of any obligation accruing prior to such termination. The provisions of Article 5, Article 6, Article 7 and Article 8 (with respect only to milestone payments and royalties accrued at the time of termination but not yet paid), Article 9, Article 11 and Article 13 shall survive the expiration or termination of this Agreement. 13. MISCELLANEOUS. 13.1. RELATIONSHIP OF PARTIES. Nothing in this Agreement is intended or shall be deemed to constitute a partnership, agency, employer-employee or joint venture relationship between the Parties. No Party shall incur any debts or make any commitments for the other, except to the extent, if at all, specifically provided therein. 13.2. PUBLICITY. Neither Party shall use the name of the other Party or reveal the terms of this Agreement in any publicity or advertising without the prior written approval of the other Party, except that (i) either Party may use the text of a written statement approved in advance by both Parties without further approval, (ii) either Party shall have the right to identify the other Party and to disclose the terms of this Agreement as required by applicable securities laws or other applicable law or regulation, and (iii) either Party may use the name of the other Party and reveal the existence of this Agreement. 13.3. NON-SOLICITATION. During the term of this Agreement and thereafter for a period of * years, each Party agrees not to seek to persuade or induce any employee of the other Party to discontinue his or her employment with that Party in order to become employed by or associated with any business, enterprise, or effort that is associated with its own business. 13.4. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts. 13.5. DISPUTE RESOLUTION PROCEDURES. (a) The Parties hereby agree that they will attempt in good faith to resolve any controversy, claim or dispute ("Dispute") arising out of or relating to this - ------------ *Confidential Treatment has been requested for the marked portion. (20) 26 Agreement promptly by negotiations. Any such Dispute which is not settled by the Parties within fifteen (15) days after notice of such Dispute is given by one Party to the other in writing shall be referred to a senior executive of ArQule and the Director of the Research Institute of Sankyo who are authorized to settle such Disputes on behalf of their respective companies ("Senior Executives"). The Senior Executives will meet for negotiations within fifteen (15) days of the end of the 15 day negotiation period referred to above, at a time and place mutually acceptable to both Senior Executives. If the Dispute has not been resolved within thirty (30) days after the end of the 15 day negotiation period referred to above (which period may be extended by mutual agreement), subject to any rights to injunctive relief and unless otherwise specifically provided for herein, any Dispute will be settled first by non-binding mediation and thereafter by arbitration as described in subsections (b) and (c) below. (b) Any Dispute which is not resolved by the Parties within the time period described in subsection (a) shall be submitted to an alternative dispute resolution process ("ADR"). Within five (5) business days after the expiration of the thirty (30) day period set forth in subsection (a), each Party shall select for itself a representative with the authority to bind such Party and shall notify the other Party in writing of the name and title of such representative. Within ten (10) business days after the date of delivery of such notice, the representatives shall schedule a date for engaging in non-binding ADR with a neutral mediator or dispute resolution firm mutually acceptable to both representatives. Any such mediation shall be held in Boston, Massachusetts. Thereafter, the representatives of the Parties shall engage in good faith in an ADR process under the auspices of such individual or firm. If the representatives of the Parties have not been able to resolve the Dispute within thirty (30) business days after the conclusion of the ADR process, or if the representatives of the Parties fail to schedule a date for engaging in non-binding ADR within the ten (10) day period set forth above, the Dispute shall be settled by binding arbitration as set forth in subsection (c) below. If the representatives of the Parties resolve the dispute within the thirty (30) day period set forth above, then such resolution shall be binding upon the Parties. If either Party fails to abide by such resolution, the other Party can immediately refer the matter to arbitration under Section 13.5(c). (c) If the Parties have not been able to resolve the Dispute as provided in subsections (a) and (b) above, the Dispute shall be finally settled by binding arbitration. Any arbitration hereunder shall be conducted under rules of the American Arbitration Association. The arbitration shall be conducted before three arbitrators chosen according to the following procedure: each of the Parties shall appoint one arbitrator and the two so nominated shall choose the third. If the arbitrators chosen by the Parties cannot agree on the choice of the third arbitrator within a period of thirty (30) days after their appointment, then the third arbitrator shall be appointed by the Court of Arbitration of the American Arbitration Association. Any such arbitration shall be held in Boston, Massachusetts. The arbitrators shall have the authority to grant specific performance, and to allocate between the Parties the costs of arbitration in such equitable manner as they determine. The arbitral award (i) shall be final and binding upon the Parties; and (ii) may be entered in any court of competent jurisdiction. (21) 27 (d) Nothing contained in this Section or any other provisions of this Agreement shall be construed to limit or preclude a Party from bringing any action in any court of competent jurisdiction for injunctive or other provisional relief to compel the other Party to comply with its obligations hereunder before or during the pendency of mediation or arbitration proceedings. The Parties hereby irrevocably consent to submit to the jurisdiction of the courts of the Commonwealth of Massachusetts and/or any other court having jurisdiction for this purpose. 13.6. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, and all of which together shall be deemed to be one and the same instrument. 13.7. HEADINGS. All headings in this Agreement are for convenience only and shall not affect the meaning of any provision hereof. 13.8. BINDING EFFECT. This Agreement shall inure to the benefit of and be binding upon the Parties, their Affiliates, and their respective lawful successors and assigns. 13.9. ASSIGNMENT. This Agreement may not be assigned by either Party without the prior written consent of the other Party, except that either Party may assign this Agreement to a successor in connection with the merger, consolidation, or sale of all or substantially all of its assets or that portion of its business pertaining to the subject matter of this Agreement. 13.10. NOTICES. All notices, requests, demands and other communications required or permitted to be given pursuant to this Agreement shall be in writing and shall be deemed to have been duly given upon the date of receipt if delivered by hand, recognized international overnight courier, confirmed facsimile transmission, or registered or certified mail, return receipt requested, postage prepaid to the following addresses or facsimile numbers: If to Sankyo: If to ArQule: Sankyo Co., LTD ArQule, Inc. 2-58, Hiromachi 1-Chome 200 Boston Avenue, Suite 3600 Shinagawa-ku Medford, MA 02155 Tokyo 140 Japan Attention: Eric B. Gordon Attention: Hiroshi Fukumi Tel: 03 3492 3131 Tel: (617) 395-4100 Fax: 03 5436 8561 Fax: (617) 395-1225 with a copy to: Palmer & Dodge One Beacon Street Boston, MA 02108 Attention: Michael Lytton, Esquire Tel: (617) 573-0327 Fax: (617) 227-4420 (22) 28 Either Party may change its designated address and facsimile number by notice to the other Party in the manner provided in this Section. 13.11. AMENDMENT AND WAIVER. This Agreement may be amended, supplemented, or otherwise modified only by means of a written instrument signed by both Parties. Any waiver of any rights or failure to act in a specific instance shall relate only to such instance and shall not be construed as an agreement to waive any rights or fail to act in any other instance, whether or not similar. 13.12. SEVERABILITY. In the event that any provision of this Agreement shall, for any reason, be held to be invalid or unenforceable in any respect, such invalidity or unenforceability shall not affect any other provision hereof, and the Parties shall negotiate in good faith to modify the Agreement to preserve (to the extent possible) their original intent. 13.13. ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the Parties with respect to the subject matter hereof and supersedes all prior agreements or understandings between the Parties relating to the subject matter hereof. 13.14. FORCE MAJEURE. Neither Party shall be held liable or responsible to the other Party, nor be deemed to be in breach of this Agreement, for failure or delay in fulfilling or performing any provisions of this Agreement when such failure or delay is caused by or results from any cause whatsoever outside the reasonable control of the Party concerned including, but not limited to, fire, explosion, breakdown of plant, strike, lock-out, labor disputes, casualty or accident, lack or failure of transportation facilities, flood, lack or failure of sources of supply or of labor, raw materials or energy, civil commotion, embargo, any law, regulation, decision, demand or requirement of any national or local government or authority. The Party claiming relief shall, without delay, notify the other Party by registered airmail or by telefax of the interruption and cessation thereof and shall use its best efforts to remedy the effects of such hindrance with all reasonable dispatch. The onus of proving that any such Force Majeure event exists shall rest upon the Party so asserting. During the period that one Party is prevented from performing its obligations under this Agreement due to a Force Majeure event, the other Party may, in its sole discretion, suspend any obligations that relate thereto. Upon cessation of such Force Majeure event the Parties hereto shall use their best efforts to make up for any suspended obligations. If such Force Majeure event is anticipated to continue, or has existed for nine (9) consecutive months or more, this Agreement may be forthwith terminated by either Party by registered airmail or by telefax. In case of such termination the terminating Party will not be required to pay to the other Party any indemnity whatsoever. [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] (23) 29 IN WITNESS WHEREOF, the undersigned have duly executed and delivered this Agreement as a sealed instrument effective as of the date first above written. SANKYO CO., LTD ARQULE, INC. By: /s/ Tetsuo Hiraoka By: /s/ Eric B. Gordon -------------------------- -------------------------------- Name: Tetsuo Hiraoka, Ph.D. Name: Eric B. Gordon Title: Member of the Board and Title: President and Chief Executive Director of Research (24) 30 EXHIBIT A RESEARCH PLAN [THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK]
EX-10.30 4 AMENDMENT NO.3 TO R & D AND LICENSE AGREEMENT 1 EXHIBIT 10.30 AMENDMENT NO. 3 TO RESEARCH & DEVELOPMENT AND LICENSE AGREEMENT This Amendment No. 3 to Research & Development and License Agreement, dated as of December 23, 1997, is between Abbott Laboratories, an Illinois corporation having a principal place of business at 100 Abbott Park Road, Abbott Park, Illinois ("Abbott") and ArQule, Inc., a Delaware corporation having a principal place of business at 200 Boston Avenue, Suite 1000, Medford, Massachusetts ("ArQule"). RECITALS WHEREAS, Abbot and ArQule have entered into that certain Research & Development and License Agreement, dated as of June 16, 1995, as amended by Amendment No. 1 dated August 13, 1996 and Amendment No. 2 dated December 24, 1996 (as so amended, the "License Agreement"), pursuant to which ArQule agreed, among other things, to perform certain contract research activities and to provide Abbott with certain ArQule Core Compounds and Abbott Derivative Compounds (these and other capitalized terms used herein without definition shall have the respective meanings provided in the License Agreement) for screening in consideration of the payment by Abbott to ArQule of certain technology access fees, license fees, milestone and royalty payments, and research funding payments on the terms and subject to the conditions set forth in the License Agreement; and WHEREAS, ArQule and Abbott desire to further amend the License Agreement to amend the Research Term thereof and to provide for additional financial terms in connection therewith, and to further provide for delivery of additional ArQule Core Compounds to Abbott. NOW, THEREFORE, in consideration of the premises and mutual covenants and conditions contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. R & D PROGRAM. Abbott has previously extended the R & D Program set forth in Article 2 beyond the initial Research Term, which ended June 15, 1997. The parties hereby agree to amend the R & D Program, with certain modifications, as follows: (i) The research and development services provided by ArQule to Abbott pursuant to Section 2.1 of the License Agreement shall continue until *, unless extended pursuant to paragraph (iii) below. (ii) Abbott shall by December 31, 1997 pay ArQule additional research and development funding of *, which funding will support the research and development services provided by ArQule to Abbott pursuant to Section 2.1 of the License Agreement through *. *Confidential Treatment has been requested for the marked portion. 2 (iii) Abbott may, at its option, extend the R & D Program for the * period commencing on * and concluding on *, upon written notice to ArQule which is received by ArQule not later than *. The research and development funding for such * period shall be *, payable in two equal installments of * with the first installment due on or before * and the second installment due on or before *. (iv) The parties acknowledge and agreement that the research and development funding set forth in this Article is calculated based on a rate of * per ArQule FTE per calendar year (the "FTE Rate"). ArQule shall have no obligation to perform services in the R & D Program without payment by Abbott at the FTE Rate. (v) This Article shall supersede Sections 2.3, 2.4(c), and 2.4(d) of the License Agreement. 2. INCREASE IN DELIVERY OF ARQULE ARRAYS. ArQule hereby agrees to increase the number of ArQule Core Compounds that ArQule will deliver to Abbott during the Initial Contract Extension Period (through March 16, 1999) by * ArQule Core Compounds, without additional charge, such that Abbott will receive a total of * ArQule Core Compounds within ArQule Arrays having not less than * different Chemical Themes (with a minimum of * ArQule Core Compounds and a maximum of * ArQule Core Compounds for each Chemical Theme). 3. PAYMENT OF TECHNOLOGY ACCESS FEE. Abbott agrees to pay ArQule the amount of * on or before December 31, 1997, which amount represents the * installment of the technology access fee for the Initial Contract Extension Period which is payable under Section 2.4(b) of the License Agreement. This Article shall supersede Section 2.4(b) of the License Agreement. 4. MISCELLANEOUS. 4.1 GOVERNING LAW. This Amendment shall be governed in all respects by the laws of the State of Illinois without giving effect to principles of conflicts of law thereunder. 4.2 SUCCESSORS AND ASSIGNS. Except as otherwise expressly provided herein, the provisions hereof shall inure to the benefit of, and be binding upon, the successors, permitted assigns, heirs, executors, and administrators of the parties hereto. 4.3 LICENSE AGREEMENT. Except as specifically provided herein, the License Agreement as previously executed and amended by Amendments No. 1 and 2 shall remain in full force and effect. *Confidential Treatment has been requested for the marked portion. 3 4.4 COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which shall be an original, but all of which together shall constitute one in the same instrument. IN WITNESS WHEREOF, the parties have duly executed this Amendment No. 3 as of the date first written above. ABBOTT LABORATORIES ARQULE, INC. By: /s/ Andre G. Pernet By: /s/ Eric B. Gordon ----------------------------------- ------------------------- Name: Andre G. Pernet, Ph.D. Eric B. Gordon Title: Vice President, President and Chief Executive Pharmaceutical Research and Development Officer EX-11.1 5 COMPUTATION OF PER SHARE NET INCOME(LOSS) 1 EXHIBIT 11.1 ARQULE, INC. STATEMENT RE COMPUTATION OF PER SHARE NET INCOME (LOSS) PER SHARE Basic Net Income (Loss) Per Share
YEAR ENDED DECEMBER 31, ----------------------- 1995 1996 1997 ------------ ------------- ----------- Net income (loss) $(2,252,000) $(2,993,000) $ 291,000 ----------- ----------- ----------- Weighted average shares outstanding: Common Stock 599,000 2,430,000 11,337,000 Weighted average common shares outstanding 599,000 2,430,000 11,337,000 ----------- ----------- ----------- Basic net income (loss) per share $ (3.76) $ (1.23) $ 0.03 ----------- ----------- -----------
Diluted Net Income (Loss) Per Share
YEAR ENDED DECEMBER 31, ----------------------- 1995 1996 1997 ------------- ------------- ------------- Net income (loss) $(2,252,000) $(2,993,000) $ 291,000 Weighted average shares outstanding: Common Stock 599,000 2,430,000 11,337,000 Stock option common stock equivalents -- -- 1,057,000 ----------- ----------- ----------- Weighted average common shares and equivalents outstanding 599,000 2,430,000 12,394,000 ----------- ----------- ----------- Diluted net income (loss) per share $ (3.76) $ (1.23) $ 0.02 ----------- ----------- -----------
39
EX-23.1 6 CONSENT OF PRICE WATERHOUSE LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (File No. 333-19469) pertaining to the 1996 Employee Stock Purchase Plan, the Registration Statement on Form S-8 (File No. 333-25369) pertaining to the 1996 Director Stock Option Plan and the Registration Statement on Form S-8 (File No. 333-25371) pertaining to the Amended and Restated 1994 Equity Incentive Plan of ArQule, Inc., of our report dated February 9, 1998, appearing on page 21 on this Form 10-K. PRICE WATERHOUSE LLP Boston, Massachusetts March 13, 1998 40 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 1 15,137 34,145 3,133 0 953 53,918 17,102 4,448 66,925 7,895 0 0 0 119 57,221 66,925 17,420 17,420 10,218 19,592 0 0 223 291 0 291 0 0 0 291 .03 .02
EX-99.1 8 FACTORS REGARDING FORWARD-LOOKING STATEMENTS 1 EXHIBIT 99.1 ARQULE, INC. IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS MARCH 1998 From time to time, ArQule through its management may make forward-looking public statements, such as statements concerning then expected future revenues or earnings or concerning anticipated collaborative agreements, projected plans, performance, product development and commercialization as well as other estimates relating to future operations. Forward-looking statements may be in reports filed under the Securities Exchange Act of 1934, as amended, in press releases or in oral statements made with the approval of an authorized executive officer. The words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," or similar expressions are intended to identify "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933, as enacted by the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on these forward-looking statements which speak only as of the date on which they are made. In addition, the Company wishes to advise readers that the factors listed below, as well as other factors not currently identified by management, could affect the Company's financial or other performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods or events in any current statement. The Company will not undertake and specifically declines any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events which may cause management to re-evaluate such forward-looking statements. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company is hereby filing cautionary statements identifying important factors that could cause the Company's actual results to differ materially from those projected in forward-looking statements of the Company made by or on behalf of the Company. Limited Operating History; History of Operating Losses; Uncertainty of Future Profitability. The Company has had a limited operating history. For the years ended December 31, 1995 and 1996, the Company had net losses of approximately $2.3 million and $3.0 million, respectively. As of December 31, 1997, the Company had net income of approximately $291,000. The Company's expansion of its operations and enhancements to its technology will result in significant expenses over the next several years that may not be offset by significant revenues. The Company expects that revenue for the foreseeable future and the Company's ability to achieve profitability will be dependent upon the ability of the Company to enter into additional collaborative arrangements with customers. To date, all revenue received by the Company has been derived from up-front fees, payments for compound deliveries, and research and development funding paid pursuant to collaborative agreements with the Company's collaborative partners. The Company has not realized any revenue from the achievement of milestones or royalties from the discovery, development or sale of a commercial product by one of the Company's collaborative partners, and there can be no assurance that any such revenue will be realized. The Company is unable to determine whether, and for how long, it will continue to be profitable. Unproven Business Strategy. The Company's modular building block approach to chemistry has not yet resulted in the commercialization of a product. The Company uses chemical building blocks for the purpose of rapidly identifying, optimizing and obtaining proprietary rights to as many compounds with commercial potential as possible. The pricing and nature of the Company's programs are such that there may only be a limited number of companies that are potential customers for such programs. The Company's ability to succeed is dependent upon the acceptance by potential customers of the Company's approach to chemistry and compound analysis as an effective tool in the discovery and development of compounds with commercial potential. Due to the highly proprietary nature of the activities being conducted, the central importance of these activities to their product discovery and development efforts, and the desire to obtain maximum patent and other proprietary protection on the results of their internal programs, pharmaceutical, biotechnology and agrochemical companies have historically conducted lead compound identification and optimization within their own research departments. There can be no assurance that the Company's present or future collaborators will not pursue existing or alternative technology, either independently or in collaboration with others, in preference to that of the 42 2 Company or that the Company will be able to attract future collaborators on acceptable terms or develop a sustainable, profitable business. Competition and the Risk of Obsolescence of Technology. Competition among the many organizations actively attempting to identify and optimize compounds for development in the pharmaceutical industry and in other areas is intense. ArQule competes with the research departments of pharmaceutical companies, biotechnology companies, agrochemical companies, combinatorial chemistry companies and research and academic institutions. Many of these competitors have greater financial and human resources, and more experience in research and development, than the Company. Historically, pharmaceutical and agrochemical companies have maintained close control over their research activities, including the synthesis, screening and optimization of chemical compounds. Many of these companies, which represent the greatest potential market for ArQule's products and services, have developed or are developing internal combinatorial chemistry and other methodologies to improve productivity, including major investments in robotics technology to permit the automated parallel synthesis of compounds. In addition, ArQule competes with biotechnology and combinatorial chemistry companies that offer a range of products and services. Academic institutions, governmental agencies and other research organizations are also conducting research in areas in which the Company is working, either on their own or in collaboration with others. The Company anticipates that it will face increased competition in the future as new companies enter the market and advanced technologies, including more sophisticated information technologies, become available. The Company's technological approaches may be rendered obsolete or uneconomical by advances in existing technological approaches or the development of different approaches by one or more of the Company's competitors. Limited Sales and Marketing Experience; Expansion of Sales Activities. To date, the Company has sold its products to its collaborative partners primarily through the efforts of its senior management. The Company's senior management has limited experience in marketing products similar to those of the Company. In order to achieve significant long-term growth in revenue and its overall strategic goals, the Company intends to hire several dedicated sales and marketing personnel. There can be no assurance that the Company will be able to achieve anticipated expansion of its business, attract a significant number of new collaborative partners as customers or build an efficient and effective sales and marketing organization. In the event the Company is unable to achieve any one or more of the foregoing goals, the Company's business, financial condition and results of operations could be materially adversely affected. In addition to the risks inherent in the Company's efforts to market its own products, the Company's revenue from royalties and milestone payments from its collaborative partners is substantially dependent upon the marketing efforts of such collaborative partners as discussed below under "Dependence on Third Parties." Dependence on Third Parties. The Company's strategy for the development and commercialization of its products and services involves the formation of collaborative arrangements with third parties, initially pharmaceutical, biotechnology and agrochemical companies. To date, the Company has entered into numerous such arrangements. There can be no assurance that the Company's existing collaborations will not be terminated under certain circumstances by its collaborators and any such terminations could have a material adverse effect on the Company. There can be no assurance that the Company will be able to establish additional collaborative arrangements, that any such arrangements will be on terms favorable to the Company, or that current or future collaborative arrangements will ultimately be successful. Further, ArQule's receipt of revenue from collaborative arrangements is affected by the timing of efforts expended by third parties. The Company's products and services will result in commercialized pharmaceutical and agrochemical products generating milestone payments and royalties only after significant preclinical and clinical development efforts or the completion of preliminary field trials, the receipt of the requisite regulatory approvals, and the integration of manufacturing capabilities and successful marketing efforts. With the exception of certain aspects of preclinical drug development, the Company does not currently intend to perform any of these activities. Therefore, the Company will be dependent upon the expertise of, and dedication of sufficient resources by, third parties to develop and commercialize products. Should a collaborative partner fail to develop or commercialize a compound or product to which it has obtained rights from the Company, the Company may not receive any future milestone payments or royalties associated with such compound or product. Furthermore, there can be no assurance that any such development or commercialization would be successful or that disputes will not arise over the application of payment provisions to such products. There can be no assurance that current or future collaborative partners will not pursue alternative technologies or develop alternative products, either on their own or in collaboration with others, including the Company's competitors, as a means for developing alternative solutions in the areas targeted by collaborative arrangements with the Company. Dependence on Key Employees. The Company is highly dependent on the principal members of its scientific and management staff, in particular, Dr. Joseph C. Hogan, Jr. and Dr. David L. Coffen. The loss of one or more members of its staff could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not maintain key person life insurance on the life of any employee. The Company's future success will also depend, in part, on its ability to identify, hire and retain additional qualified personnel, including individuals with doctorates in basic sciences. There is intense competition for such personnel in the areas of the Company's activities, and there can be no assurance that the Company will be able to continue to 43 3 attract and retain personnel with the advanced technical qualifications necessary for the development of the Company's business. Failure to attract and retain key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Future Capital Needs; Uncertainty of Additional Funding. The Company may be required to raise additional capital over a period of several years in order to conduct its operations. Such capital may be raised through additional public or private equity financings, as well as collaborative arrangements, borrowings and other available sources. The Company's capital requirements depend on numerous factors, including entering into additional collaborative arrangements, competing technological and market developments, changes in the Company's existing collaborative relationships, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, the purchase of additional capital equipment, the progress of the Company's drug discovery programs and the progress of the Company's collaborators' milestone and royalty-producing activities. The Company does not currently plan to independently develop, manufacture or market any products it discovers. Should the Company choose to develop any such products, however, the Company will require substantial funds to conduct research and development, preclinical studies, clinical trials and field trials and to market any products that may be developed. There can be no assurance that additional funding, if necessary, will be available on favorable terms, if at all. If adequate funds are not available, the Company may be required to curtail operations significantly or to obtain funds by entering into arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates, products or potential markets. To the extent that additional capital is raised through the sale of equity or securities convertible into equity, the issuance of such securities could result in dilution to the Company's existing stockholders. Dependence on Scale Up and Management of Growth. The Company's success will depend on the expansion of its operations and the management of these expanded operations. To be cost-effective in its delivery of services and products, the Company must enhance productivity through further automation of its processes and improvements to its technology. The Company also must successfully structure and manage multiple additional collaborative relationships. There can be no assurance that the Company will be successful in its engineering efforts to further automate its processes or that the Company will be successful in managing and meeting the staffing requirements of additional collaborative relationships. Failure to achieve any of these goals could have a material adverse effect on the Company's business, financial condition or results of operations. Dependence on Patents and Proprietary Rights. ArQule has three issued utility patents, one issued design patent in the United States and has filed a number of patent applications. There can be no assurance that patent applications filed by ArQule will result in patents being issued, that the claims of such patents will offer significant protection of the Company's technology, or that any patents issued to or licensed by ArQule will not be challenged, narrowed, invalidated or circumvented. The Company believes its success will depend in large part on its ability, and the ability of its licensees and its licensors, to obtain patents for its technologies and the compounds and other products, if any, resulting from the application of such technologies, to defend such patents once obtained and to maintain trade secrets, both in the United States and in foreign countries. In the absence of such patents, the Company may be unable to prevent others from utilizing the Company's technology and may need to rely upon expertise developed during pre-commercial implementation of the technology, which may not provide the same level of competitive advantages. The commercial success of the Company will also depend upon avoiding the infringement of patents issued to others and maintaining the technology licenses upon which certain of the Company's current products are, or any future products under development might be, based. Some of the Company's competitors have, or are affiliated with companies having, substantially greater resources than the Company, and such competitors may be able to sustain the costs of complex patent litigation to a greater degree and for longer periods of time than the Company. Uncertainties resulting from the initiation and continuation of any patent or related litigation could have a material adverse effect on the Company's ability to compete in the marketplace pending resolution of the disputed matters. To date, three utility patents and one design patent have been issued to the Company. There can be no assurance that other patents will issue to the Company or its licensors as a result of their pending applications or that, if issued, such patents will contain claims sufficiently broad to afford protection against competitors with similar technology. Moreover, there can be no assurance that the Company or its customers will be able to obtain significant patent protection for compounds or products based upon the Company's technology. There can be no assurance that any patents issued to the Company or its collaborative partners, or for which the Company has license rights, will not be challenged, narrowed, invalidated or circumvented, or that the rights granted thereunder will provide competitive advantages to the Company. Litigation, which could result in substantial cost to the Company, may be necessary to enforce the Company's patent and license rights, to enforce or defend an infringement claim, or to determine the scope and validity of others' proprietary rights. If competitors of the Company prepare and file patent applications in the United States or abroad that claim technology also claimed by the Company, the Company may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of invention, or opposition proceedings in a foreign patent office, both of which could result in substantial cost to the Company, even if the outcome is favorable. An adverse outcome could subject the Company to 44 4 significant liabilities to third parties, and require the Company to cease using the technology or to license disputed rights from third parties, which licenses may not be available at reasonable cost. A number of pharmaceutical, biotechnology and agrochemical companies, as well as research and academic institutions, have developed technologies, filed patent applications or received patents on various technologies that may be related to the Company's business. Some of these technologies, applications or patents may conflict with the Company's technologies or patent applications. Such conflicts could also limit the scope of the claim of any patents that the Company may be able to obtain, or result in the rejection of the Company's patent applications. The Company currently has certain licenses to patents and patent applications from third parties, and in the future may require additional licenses from other parties. There can be no assurance that: (i) such licenses will be obtainable on commercially reasonable terms, if at all; (ii) the patents underlying such licenses will be valid and enforceable; (iii) patents having commercially valuable claims will issue from any licensed patent applications; or (iv) the proprietary nature of any other technology underlying such licenses will remain proprietary. The Company relies substantially on certain technologies that are not patentable or proprietary and are therefore available to the Company's competitors. The Company also relies on certain proprietary trade secrets and know-how that are not patentable. Although the Company has taken steps to protect its unpatented trade secrets and know-how, in part through the use of confidentiality agreements with its employees, consultants and certain of its collaborators, there can be no assurance that (i) the agreements will not be breached; (ii) the Company would have adequate remedies for any breach; or (iii) the Company's trade secrets will not otherwise become known or be independently developed or discovered by competitors. Potential Liability Regarding Hazardous Materials. The research and development processes of the Company involve the controlled use of hazardous materials. The Company is subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and certain waste products. The risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result and any such liability could exceed the resources of the Company. In addition, there can be no assurance that the Company will not be required to incur significant costs to comply with environmental laws and regulations in the future. Government Regulation. Although the manufacture, transportation and storage of the Company's products are subject to the laws and regulations regarding hazardous materials discussed in the preceding risk factor, the sale of the Company's products is not subject to significant government regulations. However, the Company's future profitability is dependent on the sales of pharmaceuticals and other products developed from the Company's compounds by its customers and collaborators. Regulation by governmental entities in the United States and other countries may be a significant factor in the production and marketing of products that may be developed by a customer or collaborative partner of the Company. The nature and the extent to which such regulation may apply to the Company's customers or its collaborative partners will vary depending on the nature of any such products. Virtually all pharmaceutical products developed by the Company's customers or its collaborative partner will require regulatory approval by governmental agencies prior to commercialization. In particular, human pharmaceutical products are subject to rigorous preclinical and clinical testing and other approval procedures by the U.S. Food and Drug Administration (the "FDA") and by foreign regulatory authorities. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of such pharmaceutical products. The process of obtaining these approvals and the subsequent compliance with appropriate federal and foreign statutes and regulations are time consuming and require the expenditure of substantial resources. Generally, in order to gain FDA approval, a company first must conduct preclinical studies in the laboratory and in animal models to gain preliminary information on a compound's efficacy and to identify any safety problems. The results of these studies are submitted as a part of an Investigational New Drug application ("IND") that the FDA must review before human clinical trials of an investigational drug can start. In order to commercialize any products, the Company or its customers or its collaborative partners will be required to sponsor and file an IND and will be responsible for initiating and overseeing the clinical studies to demonstrate the safety and efficacy that are necessary to obtain FDA approval of any such products. Clinical trials are normally done in three phases and generally take two to five years, but may take longer, to complete. After completion of clinical trials of a new product, FDA and foreign regulatory authority marketing approval must be obtained. If the product is classified as a new drug, a New Drug Application ("NDA") must be filed and approved before commercial marketing of the drug. The testing and approval processes require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis, if at all. NDAs submitted to the FDA can take several years to obtain approval. Even if FDA regulatory clearances are obtained, a marketed product is subject to continual review, and later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions. For marketing outside the United States, the Company will also be subject to foreign regulatory requirements governing human clinical trials and marketing approval for pharmaceutical products. The 45 5 requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country. Fertilizers, pesticides and other agrochemical products sold by the Company's collaborators will be subject to rigorous testing and approval processes by the U.S. Environmental Protection Agency and similar regulatory authorities in certain states and in other countries. The process of obtaining these approvals can be time consuming and costly. There can be no assurance that such approvals will be granted on a timely basis. During the first quarter of the Company's fiscal year ended December 31, 1997 and prior to the Company filing a registration statement on Form S-8 for option exercises under its Amended and Restated 1994 Equity Incentive Plan (the "Plan"), options to purchase 34,375 shares of Common Stock were exercised at $0.20 per share pursuant to Rule 701 of the Securities Act of 1933, as amended. The Company has never paid cash dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings, if any, to fund the development of the business. 46
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