-----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, M5+GkmIAYk/NxfZqPltntFK9iL1dAY2j1Z8J9A+HE57Bo+SlaB2Ev5/k1PjpGm94 I4yPpQ84bgLGkXeLLlGqSQ== 0000950135-99-001595.txt : 19990330 0000950135-99-001595.hdr.sgml : 19990330 ACCESSION NUMBER: 0000950135-99-001595 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 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-K405 SEC ACT: SEC FILE NUMBER: 000-21429 FILM NUMBER: 99576245 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-K405 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, 1998 COMMISSION FILE NUMBER: 000-21429 ARQULE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 04-3221586 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER 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. [X] The aggregate market value of voting stock held by non-affiliates of the registrant as of March 8, 1999 was: $53,649,327. There were 12,505,052 shares of the registrant's Common Stock outstanding as of March 8, 1999. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement of the Registrant's 1999 Annual Meeting of Shareholders to be held on May 27, 1999, 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, 1998, 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 eight companies in the pharmaceutical, agrochemical, and bioseparations industries, 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, bioseparations 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 demonstrates pharmacological efficacy, lack of toxicity, potency, selectivity and other desirable characteristics 1 3 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. - 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 2 4 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. 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 3 5 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 compounds against multiple biological targets without having to obtain additional samples from the Company. 4 6 - 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 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. 5 7 - 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 40 to 50 Mapping Array compound sets, on an annual basis, each containing between 2,000 and 10,000 individual compounds for a minimum aggregate of 200,000 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. Typically, 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 life sciences, 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 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 6 8 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. In August, 1998, the Company expanded its collaboration agreement with Amersham. Under the expanded collaboration, the parties will jointly develop and commercialize bioseparations products for industrial, life science and research applications. 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 7 9 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 1998. Abbott has paid 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"). The Roche Bioscience Agreement was amended in September 1998 and will continue through March 1999. Under the revised collaboration, ArQule will provide Roche Bioscience with proprietary screening libraries while continuing lead optimization on a number of Roche compounds. 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. 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 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 8 10 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 paid in June 1998. Wyeth-Ayerst will make further payments to ArQule 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 Sets and for achieved milestones. In addition, ArQule will be entitled to royalties from sales of any products emanating from this collaboration. Johnson and Johnson. In December, 1998, the Company entered into a collaborative agreement with R.W. Johnson Pharmaceutical Research Institute, a division of Johnson & Johnson, Inc. ("R.W. Johnson"), pursuant to which R.W. Johnson subscribed to the Company's Mapping Array Program. Absent early termination, the Company will receive a minimum of $8.1 million over this four year period. Payments will be made to ArQule for delivery of the Mapping Array Program and for achieved milestones. In addition, ArQule will be entitled to royalties from sales of any products emanating from this collaboration. 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 - ------- ------------- ACADIA Pharmaceuticals........................ Cell-Based Assays for reception Aurora Biosciences, Inc. ..................... Mammalian Cell-Based Assays Cubist Pharmaceuticals, Inc. ................. Infectious Diseases DGI Biotechnologies........................... Chemokine/cytokine receptors FibroGen...................................... Fibrotic Disorders Genome Therapeutics........................... Antimicrobials GenQuest...................................... Cancer Genzyme Corp. ................................ Cancer ICAgen, Inc. ................................. Ion Channel Receptors Immunex Corp. ................................ Inflammatory Disorders 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 ViroPharma, Inc. ............................. RNA viruses
9 11 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 licensed 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 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 seven issued U.S. utility patents, one issued U.S. design patent, four issued Australian patents, and 59 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 10 12 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. 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. 11 13 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 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 12 14 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 8, 1999, ArQule employed 190 people of whom 71 have Ph.D. degrees. Of these, 95 were engaged in operations, 78 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......................... 51 President, Chief Executive Officer and Director* Dr. Stephen A. Hill.................... 40 President, Chief Executive Officer and Director* Joseph C. Hogan, Jr., Ph.D. ........... 57 Chairman of the Board, Senior Vice President of Research and Development, Chief Scientific Officer, and Director James R. Fitzgerald, Jr................ 54 Vice President, Chief Financial Officer and Treasurer Michael D. Rivard...................... 33 Vice President, General Counsel and Assistant Secretary John M. Sorvillo, Ph.D. ............... 44 Vice President, Business Development Robert F. Tilton, Ph.D. ............... 42 Vice President, Information, Design and Discovery
- --------------- * Mr. Gordon has resigned as President and Chief Executive Officer, effective March 31, 1999. Dr. Hill has been appointed President and Chief Executive Officer, effective April 1, 1999. 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. Dr. Stephen A. Hill, B.M. B.Ch. M.A., F.R.C.S., has been appointed President and Chief Executive Officer and elected as director of ArQule effective April 1, 1999. From September 1989 to March 1999, Dr. Hill served in various capacities in the United Kingdom and Switzerland for Roche Ltd., most recently as the Head of Global Drug Development at F. Hoffmann -- La Roche, Ltd. Dr. Hill graduated from Oxford University. 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. 13 15 Michael D. Rivard joined the Company in February 1997 as Vice President, Legal, General Counsel and Assistant Secretary. Prior to his position at the Company, Mr. Rivard was Associate Counsel at the University of Massachusetts. Mr. Rivard received his B.A. in Biochemistry from Bowdoin College and his J.D. from the UCLA School of Law. John M. Sorvillo, Ph.D., joined the Company in December 1995 as Vice President of Business Development. Prior to joining the Company, Dr. Sorvillo was Vice President and General Manager at Oncogene Science, Inc. Dr. Sorvillo received his B.A. in Biology from the City University of New York, Hunter College and his Ph.D. in Immunology from the New York University Medical Center. Robert F. Tilton, Ph.D., joined the Company in August 1997 as Vice President of Informatics, Design and Discovery. Prior to joining the Company, Dr. Tilton was responsible for Structural Biology, Computational Design, and Analytical Chemistry for the Pharmaceutical Division of Bayer Corp. -- the United States branch of Bayer AG. Dr. Tilton received his B.A. in Biophysics from UC Berkeley and his Ph.D. in Pharmaceutical Chemistry from UC San Francisco. ITEM 2. PROPERTIES ArQule's research facilities include approximately 68,000 square feet of laboratory and office space in Medford, Massachusetts pursuant to three lease agreements, two of which expire on July 30, 2000 and one of which expires on July 30, 2001, at which time the Company has an option to renew each of the leases for an additional five year period. The Company also occupies approximately 12,000 square feet of additional laboratory space in Waltham, Massachusetts pursuant to a sublease agreement. This lease expires on November 30, 2000, at which time the Company has an option to extend for one additional year. ArQule believes its facilities are adequate for its current operations. On May 29, 1998, the Company reached agreement with Metro North Corporate Center LLC to lease approximately 130,000 square feet of laboratory and office space currently under construction in Woburn, Massachusetts pursuant to a fifteen-year lease agreement, under which the Company has the option to extend the original lease term by two additional five-year periods, the option to expand its operations into approximately 130,000 square feet of additional laboratory and office space to be constructed on a lot adjacent to the lot housing the aforementioned facility, the option to purchase the entire project, the right of first opportunity to purchase the entire project and the right of first refusal with regard to purchase of the entire project. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on The Nasdaq Stock Market(R) under the symbol "ARQL". 14 16 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 ----- ----- 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............................................... 24.75 16.38 Second Quarter.............................................. 20.63 10.81 Third Quarter............................................... 13.25 4.22 Fourth Quarter.............................................. 7.38 4.50 1999 First Quarter (through March 8, 1999)....................... 7.50 5.13
As of March 8, 1999, there were approximately 97 holders of record and approximately 2,936 beneficial shareholders of the Company's Common Stock. 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 initial public offering (the "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 $34.5 million. 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 $3.0 million, including underwriting discounts and commissions of $2.4 million and other expenses of $0.6 million. After such expenses, the Company's net proceeds from the IPO were $31.5 million. The amount of net offering proceeds used by the Company as of December 31, 1998 was as follows: approximately $19.3 million for fixed asset additions and approximately $2.7 million for capital lease obligations. ITEM 6. SELECTED FINANCIAL DATA The following data, insofar as it relates to the years 1994, 1995, 1996, 1997 and 1998, have been derived from the Company's audited financial statements, including the balance sheet as of December 31, 1997 and 1998 and the related statements of operations and of cash flows for the three years ended December 31, 1998 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 Annual Report on Form 10-K. The historical results are 15 17 not necessarily indicative of the results of operations to be expected in the future (in thousands, except per share data).
YEAR ENDED DECEMBER 31, --------------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- ------- ------- STATEMENT OF OPERATIONS DATA: Revenue.................................. $ 85 $ 3,330 $ 7,255 $17,420 $22,193 Cost and expenses: Cost of revenue........................ -- 1,644 4,739 10,218 14,036 Research and development............... 2,806 2,095 3,076 4,704 10,427 Marketing, general and administrative...................... 1,346 1,557 2,850 4,670 6,387 ------- ------- ------- ------- ------- Total costs and expenses....... 4,152 5,296 10,665 19,592 30,850 ------- ------- ------- ------- ------- Loss from operations................... (4,067) (1,966) (3,410) (2,172) (8,657) Interest income (expense), net......... (139) (286) 417 2,463 2,195 ------- ------- ------- ------- ------- Net income (loss)...................... $(4,206) $(2,252) $(2,993) $ 291 $(6,462) ======= ======= ======= ======= ======= Basic net income (loss) per share(1)... $ (7.93) $ (1.32) $ .03 $ (0.54) ======= ======= ======= ======= Weighted average common shares outstanding -- basic(1)............. 284 2,272 11,282 12,031 ======= ======= ======= ======= Diluted net income (loss) per share(1)............................ $ (7.93) $ (1.32) $ .02 $ (0.54) ======= ======= ======= ======= Weighted average common shares outstanding -- diluted(1), (2)...... 284 2,272 12,394 12,031 ======= ======= ======= =======
DECEMBER 31, ---------------------------------------------------- 1994 1995 1996 1997 1998 ------- ------- ------- ------- ------- BALANCE SHEET DATA: Cash, cash equivalents and marketable... securities.............................. $ 425 $ 7,791 $37,086 $49,282 $33,870 Working capital (deficit)............... (2,108) 5,074 31,440 46,023 35,546 Total assets............................ 2,321 10,190 43,509 66,925 60,480 Capital lease obligations, less current portion....................... 962 911 1,728 1,213 306 Series B mandatorily redeemable convertible preferred stock........... -- 6,888 -- -- -- Total stockholders' equity (deficit).... (1,203) (1,000) 34,621 57,340 54,267
- --------------- (1) The Company adopted Statement of Financial Accounting Standards No. 128 -- "Earnings Per Share" ("SFAS 128") in the fourth quarter of 1997. SFAS 128 required retroactive restatement of previously reported income (loss) per share calculations. As a result of adopting SFAS 128, certain anti-dilutive pro-forma share amounts and unvested shares of common stock subject to restriction agreements previously included in the computation of the loss per share in 1995 and 1996 are no 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. (2) 1997 includes common shares and common share equivalents. 16 18 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 for generating leads 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 revenues to date are primarily attributable to eight major corporate collaborations. Under these collaborations, the Company has received payments of $47.4 million through December 31, 1998 and has recognized $50.3 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 received one milestone and no 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 and screening services in exchange for joint ownership interests of resulting drug candidates. These agreements have not yet yielded any significant revenue for the Company. Quarterly variations in financial performance may be expected as levels of revenue are dependent on expanding or continuing existing collaborations, additional corporate collaborations, and future milestone payments, which are 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, 1998 and 1997 Revenue. The Company's revenue for the year ended December 31, 1998 increased $4.8 million to $22.2 million from $17.4 million for the same period in 1997. 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. Cost of revenue. The Company's cost of revenue for the year ended December 31, 1998 increased $3.8 million to $14.0 million from $10.2 million for the same period in 1997. 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, 1998 increased $5.7 million to $10.4 million from $4.7 million for the same period in 1997. These increases are the result of the Company's expansion of its chemistry capabilities and related proprietary technologies. The Company expects research and development spending to increase over the next 17 19 several years as the Company further expands its chemistry related technologies, drug discovery and development programs. Marketing, general and administrative expenses. The Company's marketing, general and administrative expenses for the year ended December 31, 1998 increased $1.7 million to $6.4 million from $4.7 million for the same period in 1997. These increases are primarily associated with increased marketing and business development activities, and higher levels of administrative support in concert with the Company's growth during 1998. These expenses will likely increase in the aggregate in future periods to support the projected growth of the Company. Net interest income. The Company's net interest income for the year ended December 31, 1998 was $2.2 million, compared to $2.5 million for the same period in 1997. Lower interest income in 1998 resulted primarily from the Company utilizing cash and marketable securities balances to finance operations and capital additions. Net income (loss). The Company's net loss for the year ended December 31, 1998 was $6.5 million as compared to net income of $0.3 million for the same period in 1997. The net loss for 1998 is primarily attributable to increased expenditures as the Company invested in new technologies to expand its drug discovery capabilities. 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 and royalty payments, which may be inconsistent and difficult to anticipate. 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. 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 chemistry capabilities 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. 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 an increase in revenues from the Company's growing collaborator base and higher net interest 18 20 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 and royalty payments, which may be inconsistent and difficult to anticipate. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, the Company held cash and cash equivalents and marketable securities with a value of $33.9 million. The Company's working capital at December 31, 1998 was $35.5 million. The Company has funded operations through December 31, 1998 with sales of common stock, revenues 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, 1998, the Company had utilized $4.5 million of the available $8.5 million financing facility. Subsequent to year end the Company consummated a term loan facility under which up to $15.0 million will be available to support capital expenditures. Net cash used by operating activities was $7.6 million in 1998. Net cash provided by operating activities was $0.6 million and $0.8 million for the years ended December 31, 1997 and 1996, respectively. The negative cash flow from operating activities primarily reflects the net operating loss in 1998. The positive cash flow from operating activities in 1997 and 1996 primarily reflects payments received from corporate collaborators. Net cash used by investing activities during the year ended December 31, 1998 was $3.7 million, resulting primarily from fixed asset additions. Net cash used by investing activities during the year ended December 31, 1997 was $42.7 million, resulting primarily from the purchase of marketable securities from the proceeds of the initial and secondary public offerings. Net cash provided by investing activities for the year ended December 31, 1996 was $2.0 million. This increase primarily reflects the sale of marketable securities offset by the purchases of property and equipment. Net cash provided by financing activities for the year ended December 31, 1998 and 1997 was $2.0 million and $20.7 million, respectively, primarily reflecting the equity investment of $2.0 million by Wyeth-Ayerst, Inc., in June 1998 and proceeds from the Company's April 1997 secondary public offering. Net cash provided by financing activities for the year ended December 31, 1996 was $30.8 million, largely due to the Company's October 1996 initial public offering. The Company expects that its available cash and marketable securities, together with operating revenues, investment income and 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. YEAR 2000 COMPLIANCE Many currently installed systems are not capable of distinguishing 21st century dates from 20th century dates. As a result, in less than one year, computer systems and/or software used by many companies in a very wide variety of applications may experience operating difficulties unless they are modified or upgraded to adequately process information involving, related to or dependent upon the century change. Significant uncertainty exists concerning the scope and magnitude of problems associated with the century change. The Company has established a project team to address Year 2000 risks. The Company has also initiated various Information Technology enhancement projects intended to improve the access and dissemination of scientific and business information throughout the enterprise to enhance development and operational 19 21 efficiencies. The Company expects to be in full Y2K compliance with its internal financial systems by the second quarter of 1999. As the costs associated with these initiatives are part of the Company's continuing improvement process they have been recognized as incurred. The Company is in the data gathering phase with regard to non-financial software and imbedded chip technology and is currently gathering data to assess the impact of the Year 2000 on its non-financial systems such as automated production equipment, security equipment, etc. In addition to data gathered to date by the project team, the Company has acquired compliance certificates and commitments from IT vendors that Y2K upgrades will be available with Year 2000 compliance scheduled for the second quarter of 1999. The Company does not, at this time, have any indications that the cost of achieving Year 2000 compliance for its non-financial systems will be material. If the Company is unable to achieve Year 2000 compliance for its major non-financial system, the Year 2000 could have a material impact on the operations of the Company. Since the Company is in the information-gathering phase, the Company does not currently have a contingency plan in place for its internal non-financial software and imbedded chip technology. The Company is in the process of contacting its critical suppliers, service providers and contractors to determine the extent to which the Company's interface systems are vulnerable to those third parties' failure to remedy their own Year 2000 issues. To the extent that responses to Year 2000 readiness are unsatisfactory, the Company intends to change suppliers, service providers or contractors to those who have demonstrated Year 2000 readiness but the Company cannot be assured that it will be successful in finding such alternative suppliers, service providers and contractors. The Company does not currently have any formal information concerning the year 2000 compliance status of its customers but has received indications that most of its customers are working on Year 2000 compliance. In the event that any of the Company's significant customers and suppliers do not successfully and timely achieve Year 2000 compliance, and the Company is unable to replace them with new customers or alternate suppliers, the Company's business or operations could be adversely affected. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In January 1997, the Securities and Exchange Commission issued Financial Reporting Release No. 48, which expands the disclosure requirements for certain derivatives and other financial instruments. The Company does not utilize derivative financial instruments. See Notes 1 and 2 to the Consolidated Financial Statements for a description of the Company's use of other financial instruments. The carrying amounts reflected in the consolidated balance sheet of cash and cash equivalents, trade receivables, and trade payables approximates fair value at December 31, 1998 due to the short maturities of these instruments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Independent Accountants........................... 21 Balance Sheet at December 31, 1997 and 1998................. 22 Statement of Operations for the three years ended December 31, 1998.................................................. 23 Statement of Redeemable Preferred Stock and Stockholders' Equity (Deficit) for the three years ended December 31, 1998...................................................... 24 Statement of Cash Flows for the three years ended December 31, 1998.................................................. 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 consolidated balance sheet and the related consolidated 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. and its subsidiary at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, 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 a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP Boston, Massachusetts January 28, 1999 21 23 ARQULE, INC. CONSOLIDATED BALANCE SHEET
DECEMBER 31, -------------------- 1997 1998 -------- -------- (IN THOUSANDS) ASSETS Current assets: Cash and cash equivalents................................. $ 15,137 $ 5,780 Marketable securities..................................... 34,145 28,090 Accounts receivable....................................... 3,133 5,708 Inventory................................................. 953 526 Prepaid expenses and other current assets................. 520 869 Notes receivable from related parties..................... 30 30 -------- -------- Total current assets.............................. 53,918 41,003 Property and equipment, net................................. 12,654 17,821 Other assets................................................ 156 1,656 Notes receivable from related parties....................... 197 -- -------- -------- $ 66,925 $ 60,480 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of capital lease obligations.............. $ 1,174 $ 907 Accounts payable and accrued expenses..................... 2,804 2,094 Deferred revenue.......................................... 3,917 2,456 -------- -------- Total current liabilities......................... 7,895 5,457 -------- -------- Capital lease obligations................................... 1,213 306 -------- -------- Deferred revenue............................................ 477 450 -------- -------- Stockholders' equity Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding............ -- -- Common stock, $0.01 par value; 30,000,000 shares authorized; 11,878,090 and 12,171,335 shares issued and outstanding at December 31, 1997 and 1998, respectively........................................... 119 122 Additional paid-in capital................................ 68,418 71,432 Accumulated deficit....................................... (10,643) (17,105) -------- -------- 57,894 54,449 Deferred compensation..................................... (554) (182) -------- -------- Total stockholders' equity........................ 57,340 54,267 -------- -------- Commitments (Note 12)....................................... -- -- -------- -------- $ 66,925 $ 60,480 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 22 24 ARQULE, INC. CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, ----------------------------- 1996 1997 1998 ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenue Compound development revenue.............................. $ 4,255 $13,840 $11,868 Compound development revenue -- related party............. 3,000 3,580 10,325 ------- ------- ------- 7,255 17,420 22,193 ------- ------- ------- Costs and expenses: Cost of revenue........................................... 2,683 8,039 7,506 Cost of revenue -- related party.......................... 2,056 2,179 6,530 Research and development.................................. 3,076 4,704 10,427 Marketing, general and administrative..................... 2,850 4,670 6,387 ------- ------- ------- 10,665 19,592 30,850 ------- ------- ------- Loss from operations................................... (3,410) (2,172) (8,657) Interest income............................................. 607 2,686 2,364 Interest expense............................................ (190) (223) (169) ------- ------- ------- Net (loss) income...................................... $(2,993) $ 291 $(6,462) ======= ======= ======= Basic net income (loss) per share........................... $ (1.32) $ .03 $ (0.54) ======= ======= ======= Weighted average common shares outstanding -- basic......... 2,272 11,282 12,031 ======= ======= ======= Diluted net income (loss) per share......................... $ (1.32) $ .02 $ (0.54) ======= ======= ======= Weighted average common shares outstanding -- diluted(1).... 2,272 12,394 12,031 ======= ======= =======
- --------------- (1) 1997 includes common shares and common share equivalents The accompanying notes are an integral part of these consolidated financial statements. 23 25 ARQULE, INC. CONSOLIDATED 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 ----------- -------- ----------- ------- ------------ --------- ---------- (DOLLARS IN THOUSANDS) Balance at December 31, 1995...... 1,800,000 $ 6,888 10,511,000 $ 2,486 522,797 $ 5 $ 4,435 Conversion of interest on bridge notes to Series A convertible preferred stock................. 113,429 142 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 Conversion of Series B mandatorily redeemable preferred stock to common stock.................... (1,815,468) (6,903) 907,734 9 6,894 Conversion of Series A convertible preferred stock to common stock........................... (10,624,429) (2,628) 5,312,214 54 2,574 Exercise of warrants pursuant to a cashless exercise provision..... 234,992 2 (2) Issuance of common stock in connection with initial public offering, net of issuance costs of $2,979....................... 2,875,000 29 31,492 Compensation related to the grant of common stock options......... 709 Amortization of deferred compensation.................... Net loss.......................... ---------- ------- ----------- ------- ---------- ---- ------- Balance at December 31, 1996...... -- -- -- -- 9,851,487 99 46,102 Cancellation of unvested portion of restricted stock stock upon employee termination............ (48,444) -- Employee stock option exercises... 133,374 1 352 Employee stock purchase plan...... 9,173 -- 110 Issuance of common stock in connection with secondary public offering, net of issuance costs of $1,645....................... 1,932,500 19 21,526 Compensation related to the grant of common stock options......... 328 Amortization of deferred compensation.................... Net income........................ ---------- ------- ----------- ------- ---------- ---- ------- Balance at December 31, 1997...... -- -- -- -- 11,878,090 119 68,418 Employee stock option exercises... 134,639 1 793 Employee stock purchase plan...... 53,619 1 381 Issuance of common stock in connection with American Home Products investment in ArQule, Inc............................. 104,987 1 1,999 Compensation related to the grant of common stock options......... (159) Amortization of deferred compensation.................... Net loss.......................... ---------- ------- ----------- ------- ---------- ---- ------- Balance at December 31, 1998...... -- $ -- -- $ -- 12,171,335 $122 $71,432 ========== ======= =========== ======= ========== ==== ======= STOCKHOLDERS' EQUITY (DEFICIT) --------------------------------------------- TOTAL ACCUMULATED DEFERRED STOCKHOLDERS' DEFICIT COMPENSATION EQUITY (DEFICIT) ----------- ------------ ---------------- (DOLLARS IN THOUSANDS) Balance at December 31, 1995...... $ (7,926) -- $(1,000) Conversion of interest on bridge notes to Series A convertible preferred stock................. 142 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) (15) Conversion of Series B mandatorily redeemable preferred stock to common stock.................... 6,903 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....................... 31,521 Compensation related to the grant of common stock options......... (709) -- Amortization of deferred compensation.................... 63 63 Net loss.......................... (2,993) (2,993) -------- ----- ------- Balance at December 31, 1996...... (10,934) (646) 34,621 Cancellation of unvested portion of restricted stock stock upon employee termination............ -- Employee stock option exercises... 353 Employee stock purchase plan...... 110 Issuance of common stock in connection with secondary public offering, net of issuance costs of $1,645....................... 21,545 Compensation related to the grant of common stock options......... (328) -- Amortization of deferred compensation.................... 420 420 Net income........................ 291 291 -------- ----- ------- Balance at December 31, 1997...... (10,643) (554) 57,340 Employee stock option exercises... 794 Employee stock purchase plan...... 382 Issuance of common stock in connection with American Home Products investment in ArQule, Inc............................. 2,000 Compensation related to the grant of common stock options......... 159 -- Amortization of deferred compensation.................... 213 213 Net loss.......................... (6,462) (6,462) -------- ----- ------- Balance at December 31, 1998...... $(17,105) $(182) $54,267 ======== ===== =======
The accompanying notes are an integral part of these consolidated financial statements. 24 26 ARQULE, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1997 1998 -------- --------- --------- (IN THOUSANDS, EXCEPT SHARE DATA) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS Cash flows from operating activities: Net (loss) income......................................... $(2,993) $ 291 $ (6,462) Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Depreciation and amortization.......................... 1,171 2,580 4,620 Amortization of deferred compensation.................. 63 420 213 Increase in accounts receivable........................ (250) (2,883) (2,575) (Increase) decrease in inventory....................... -- (953) 427 Increase in prepaid expenses and other current assets............................................... (215) (182) (349) Increase in other assets............................... (40) (17) (1,500) (Increase) decrease in notes receivable from related parties.............................................. (220) 176 197 Increase (decrease) in accounts payable and accrued expenses............................................. 482 1,695 (710) Increase (decrease) in deferred revenue................ 2,805 (519) (1,488) ------- -------- -------- Net cash provided by (used in) operating activities........................................ 803 608 (7,627) ------- -------- -------- Cash flows from investing activities: Purchases of marketable securities........................ -- (61,447) (44,109) Proceeds from sale or maturity of marketable securities... 4,302 27,802 50,164 Additions to property and equipment....................... (2,292) (9,085) (9,787) ------- -------- -------- Net cash provided by (used in) investing activities........................................ 2,010 (42,730) (3,732) ------- -------- -------- Cash flows from financing activities: Principal payments of capital lease obligations........... (737) (1,335) (1,174) Proceeds from issuance of common stock, net............... 31,521 22,008 3,176 ------- -------- -------- Net cash provided by financing activities............ 30,784 20,673 2,002 ------- -------- -------- Net increase (decrease) in cash and cash equivalents........ 33,597 (21,449) (9,357) Cash and cash equivalents, beginning of period.............. 2,989 36,586 15,137 ------- -------- -------- Cash and cash equivalents, end of period.................... $36,586 $ 15,137 $ 5,780 ======= ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 25 27 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Capital lease obligations of $2,178 and $856 were incurred in 1996 and 1997, respectively, when the Company entered into leases for various machinery and equipment, furniture and fixtures, and leasehold improvements. 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 1996, 1997 and 1998, the Company paid approximately $190, $223 and $169, respectively, for interest expense. 26 28 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 1. ORGANIZATION AND NATURE OF OPERATIONS ArQule, Inc. 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 and product development candidates. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies followed in the preparation of these financial statements are as follows: Basis of Consolidation The consolidated financial statements include the accounts of ArQule, Inc. and its majority-owned subsidiary ArQule Catalytics, Inc., which was incorporated in February 1998 (collectively, the "Company"). All intercompany transactions and balances have been eliminated. 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, 1997 and 1998, the Company has classified its investments as available-for-sale. Fair Value of Financial Instruments At December 31, 1997 and 1998, 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 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 27 29 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 develop and produce compound arrays. These costs consist primarily of payroll and payroll-related costs, chemicals, supplies and overhead expenses. Stock Compensation Options granted to employees 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. Segment Data The Company is engaged principally in one industry segment. The Company also operates principally in one geographic location. See Note 3 with respect to significant customers. 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 1996 and 1997 financial statements to conform to the 1998 presentation. These reclassifications had no effect on the net loss for 1996 or net income for 1997. 3. SIGNIFICANT AGREEMENTS The Company has entered into a number of license, research and development agreements (the "Agreements") with eight corporate collaborators who accounted for substantially all of the Company's 1998 revenue. Two Agreements were entered into with Solvay Duphar B.V. ("Solvay") and Wyeth-Ayerst Pharmaceuticals, a division of American Home Products Corporation ("Wyeth-Ayerst"). Revenue related to the Solvay Agreement is included in compound development revenue -- related party from 1996 through 1998. In 1998, Wyeth-Ayerst became a 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 28 30 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. 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 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 be allotted between the parties in accordance with the individual agreements, after, in some instances, the reimbursement of direct research costs incurred by the respective 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, 1997 and 1998:
DECEMBER 31, ------------------ MATURITY 1997 1998 ------------- ------- ------- U.S. Government obligations.............. Within 1 year $ 2,200 $ 2,002 Corporate bonds.......................... Within 1 year 31,945 26,088 ------- ------- $34,145 $28,090 ======= =======
At December 31, 1997 and 1998, 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, 1997 and 1998 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, 1997 and 1998 were not significant. 5. INVENTORY Inventories at December 31, 1997 and 1998 consists of the following:
1997 1998 ---- ---- Raw materials............................................... $361 $526 Finished goods.............................................. 592 0 ---- ---- $953 $526 ==== ====
29 31 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
USEFUL LIFE DECEMBER 31, ESTIMATED ------------------ (YEARS) 1997 1998 ----------- ------- ------- Machinery and equipment.................... 5 $ 5,936 $ 9,083 Leasehold improvements..................... 3-7 6,125 9,548 Furniture and fixtures..................... 7 451 606 Computer equipment......................... 3 3,372 4,527 Construction-in-progress................... -- 1,218 3,125 ------- ------- 17,102 26,889 Less -- accumulated depreciation and amortization............................. 4,448 9,068 ------- ------- $12,654 $17,821 ======= =======
Assets held under capital leases at December 31, 1997 and 1998 consisted of $1,900 of machinery and equipment, $1,785 of leasehold improvements, $703 in computer equipment and $107 of furniture and fixtures. Accumulated amortization of these assets totaled $2,207 and $3,290 at December 31, 1997 and 1998, respectively. For the years ended December 31, 1996, 1997 and 1998, amortization expense related to assets held under capital lease obligations was $751, $1,198 and $1,083, respectively. 7. NOTES RECEIVABLE FROM RELATED PARTIES Notes receivable from related parties consist of the following:
DECEMBER 31, ------------- 1997 1998 ----- ---- Note receivable due from the an 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............................................... 60 30 Note receivable due from another officer of the Company, payable in three equal annual installments commencing on February 16, 1998, secured by shares of common stock of the Company issuable to the officer upon the exercise of options................................................... 167 -- ---- --- 227 30 Less current portion........................................ 30 30 ---- --- $197 $-- ==== ===
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, 1997 and 1998, $13 and $16, respectively, was included in prepaid expenses and other current assets. 30 32 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses include the following:
DECEMBER 31, ---------------- 1997 1998 ------ ------ Accounts payable........................................... $2,161 $ 818 Accrued professional fees.................................. 379 360 Other accrued expenses..................................... 264 916 ------ ------ $2,804 $2,094 ====== ======
9. 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. 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. 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 two to four year periods. At December 31, 1997 and 1998, the approximate number of unvested common shares is 9,800 and 0, respectively. Each stock restriction agreement may be terminated at the election of the Company. Collaborator Investment. On June 4, 1998, American Home Products invested $2.0 million in the Company in accordance with the Common Stock Purchase Agreement and the Research and License Agreement, both dated July 3, 1997. 10. EQUITY INCENTIVE AND STOCK PURCHASE PLANS During 1998, 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 4,700,000. All shares are awarded at the discretion of a Committee 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 31 33 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) not less than the exercise price of the related option. As of December 31, 1998, 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, 1998, options to purchase 65,500 shares of common stock have been granted under this plan of which 48,000 shares are currently exercisable. 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 59,500 shares are available for future grant. The Company applies APB No. 25 and related interpretations in accounting for employee grants under the Equity Incentive Plan (the "Plan"). No compensation expense has been recognized under the Plan 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, ------------------------------ 1996 1997 1998 ------- ------- -------- Pro forma net loss........................... $(3,186) $(2,583) $(13,217) Pro forma basic and diluted net loss per share...................................... $ (1.40) $ (0.23) $ (1.10)
During 1997 and 1998, the Company issued 69,000 and 45,500 options to certain members of its Scientific Advisory Board (SAB) under the Equity Incentive Plan. In April 1997, 11,000 shares were cancelled. A total of $554 and $183 at December 31, 1997 and 1998, respectively, was recorded as deferred compensation and is being amortized as compensation expense over the vesting period of the options. Compensation expense in 1997 and 1998 was $420 and $213, 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. 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, 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. The model was calculated using the following assumptions: no dividend yield for both years; 45% volatility for 1996, 50% volatility for 1997, and 75% volatility for 1998 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 and 1998; expected lives of 3 to 6 years in 1996 and 4 years in 1997 and 1998 for options granted. 32 34 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Option activity under the Plans for the three years ended December 31, 1998 was as follows:
WEIGHTED AVERAGE NUMBER EXERCISE STOCK OPTIONS OF SHARES PRICE - ------------- ---------- -------- Outstanding at December 31, 1995...................... 298,500 $ .22 Granted............................................... 1,073,920 4.39 Exercised............................................. 0 .00 Cancelled............................................. (99,750) .50 ---------- Outstanding at December 31, 1996...................... 1,272,670 3.71 Granted............................................... 1,016,412 16.62 Exercised............................................. (133,374) 2.64 Cancelled............................................. (44,456) 9.57 ---------- Outstanding at December 31, 1997...................... 2,111,252 9.88 ---------- Granted............................................... 1,606,265 9.06 Exercised............................................. (134,639) 5.90 Cancelled............................................. (1,244,292) 15.25 ---------- Outstanding as of December 31, 1998................... 2,338,586 $ 6.68 ========== Exercisable at December 31, 1998...................... 736,337 7.13 ========== Weighted average estimated value of options granted during the year ended December 31, 1998............. $ 5.58 ======
The following table summarizes information about options outstanding at December 31, 1998:
OPTIONS OUTSTANDING ---------------------------------------- OPTIONS 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 1998 LIFE PRICE 1998 PRICE - ------------------------ --------------- ----------- -------- ------------ -------- $ 0.0000 - 2.4000............... 486,508 7.0 $ 0.83 297,058 $ 0.81 4.8001 - 7.2000............... 1,331,611 9.0 5.19 158,737 5.86 9.6001 - 12.0000............... 125,334 7.8 10.90 81,189 10.90 12.0001 - 14.4000............... 112,929 5.2 14.13 88,375 14.13 14.4001 - 16.8000............... 46,000 8.6 16.04 41,000 16.11 16.8001 - 19.2000............... 133,204 8.3 17.70 54,978 17.64 19.2001 - 21.6000............... 57,500 8.7 21.00 15,000 21.00 21.6001 - 24.0000............... 45,500 9.0 22.94 -- -- --------- ------- 2,338,586 8.3 $ 6.68 736,337 $ 7.13 ========= === ====== ======= ======
At December 31, 1998, there were 1,685,480 shares available for future grant under the Equity Incentive Plan. On September 8, 1998 the Company determined that certain stock options issued to employees of the Company had an exercise price significantly higher than the fair market value of the Company's common stock. In light of the Company's conclusions that such options were not providing the desired incentive, the Company provided employees with the opportunity to exchange options previously granted to them under the Plan on or after June 25, 1996 for new options ("the Replacement Options") to purchase the same number of 33 35 ARQULE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) shares of common stock at an exercise price of $4.875 per share, the then fair market value of the Company's common stock. A total of 985,059 options were exchanged. Employees (other than those individuals designated as "officers" by the Company, including those officers subject to Section 16 of the Securities Exchange Act of 1934) were given the choice of retaining their existing options, with the original vesting schedule, or accepting the Replacement Options, with a vesting schedule extended by one year. 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 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, 1998, 62,792 shares have been purchased pursuant to the Purchase Plan. 11. INCOME TAXES There is no current or deferred tax expense for the years ended December 31, 1996, 1997 and 1998. 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 1998 ------- ------- -------- Deferred tax assets: Preoperating costs capitalized for tax purposes................................ $ 370 $ 288 $ 210 Net operating loss carryforwards........... 3,906 4,506 7,068 Tax credit carryforwards................... 311 811 2,324 Non-employee equity based compensation..... -- 173 286 Book depreciation in excess of tax......... -- -- 411 Other...................................... 30 40 39 ------- ------- -------- $ 4,617 $ 5,818 $ 10,338 Deferred tax liabilities: Tax depreciation in excess of book......... -- (135) -- Valuation allowance.......................... (4,617) (5,683) (10,338) ------- ------- -------- 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 $10.3 million valuation allowances at December 31, 1998, $1.0 million 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 CONSOLIDATED 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, 1998 follows:
YEAR ENDED DECEMBER 31, --------------------------- 1996 1997 1998 ------- ----- ------- Income tax benefit (expense) at statutory rate.......................................... $ 1,048 $(102) $ 2,262 State tax benefit (expense), net................ 180 (18) 399 Losses and credits without current tax benefit....................................... (1,180) -- (2,650) Utilization of net operating loss carryforwards................................. -- 133 -- Other........................................... (48) (13) (11) ------- ----- ------- Tax Provision.............................. $ -- $ -- $ -- ======= ===== =======
The Company has available net operating loss carryforwards of approximately $17.3 million for tax purposes to offset future taxable income. The net operating loss carryforwards expire principally in 2009 to 2018. Federal and state tax credit carryforwards of approximately $2.3 million expire principally in 2009 to 2018. 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. 12. COMMITMENTS 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 - ------------ --------- ------- 1999..................................................... $ 871 $ 907 2000..................................................... 738 305 2001..................................................... 322 1 ------ ------ 1,213 Interest due on capital leases........................... 81 ------ ------ Total minimum lease payments............................. $1,931 $1,294 ====== ======
The Company has a lease line agreement with a financial institution (the "Lessor") for $8,500 of which approximately $4,000 was available for future leases at December 31, 1998. 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 $283, $582 and $1,105 for the years ended December 31, 1996, 1997, and 1998, respectively. 35 37 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 27, 1999 (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 1998. 36 38 (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 ended through April 8, 1998. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter amended June 30, 1998 (File No. 000-21429) 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 as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 filed with the Commission on March 17, 1998 (File No. 000-21429) and incorporated herein by reference. 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.
37 39
EXHIBIT NO. DESCRIPTION - ------- ----------- 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. 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.
38 40
EXHIBIT NO. DESCRIPTION - ------- ----------- 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 as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, filed with the Commission on March 17, 1998 (File No. 000-21429) and incorporated herein by reference. 10.30+ Amendment No. 3 to Research & Development and License Agreement between the Company and Abbott Laboratories dated December 23, 1997. Filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 filed with the Commission on March 17, 1997 (File No. 000-21249) and incorporated herein by reference. 10.31+ Research Collaboration and License Agreement between the Company and Amersham Pharmacia Biotech AB dated August 13, 1998. Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-3 (File No. 333-62203) and incorporated herein by reference. 10.32+ Commercialization Agreement between the Company and Amersham Pharmacia Biotech AB dated August 13, 1998. Filed as Exhibit 10.2 to the Company's Registration Statement on Form S-3 (File No. 333-62203) and incorporated herein by reference. 10.33+ Amendment No. 1 to Research and License Agreement between the Company and Roche Bioscience, a division of Syntex, Inc., dated as of September 30, 1998. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 000-21429) and incorporated herein by reference. 10.34* Resignation Agreement between Eric Gordon and the Company dated as of September 11, 1998. Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 000-21429) and incorporated herein by reference. 10.35 Lease by and between MetroNorth Corporate Center LLC and the Company dated as of May 29, 1998. Filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 000-21429) and incorporated herein by reference. 10.36+ Compound Supply and License Agreement between the Company and R.W. Johnson Pharmaceutical Research Institute, a division of Ortho-McNeil Pharmaceutical, Inc., dated as of December 15, 1998. Filed herewith. 11.1 Statement re computation of per share net income (loss). Filed herewith. 21.1 Subsidiaries of the Company. Filed herewith. 23.1 Consent of PricewaterhouseCoopers LLP. Filed herewith. 27.1 Financial Data Schedule. 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 24b-2 of the Securities and Exchange Act of 1934, as amended. 39 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant 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 29, 1999. 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 March 29, 1999 - --------------------------------------------------- and Director (Principal Executive Eric B. Gordon Officer) /s/ JAMES R. FITZGERALD, JR. Vice President, Chief Financial March 29, 1999 - --------------------------------------------------- Officer and Treasurer (Principal James R. Fitzgerald, Jr. Financial Officer and Principal Accounting Officer) /s/ JOSEPH C. HOGAN, JR. Chairman of the Board, Senior Vice March 29, 1999 - --------------------------------------------------- President of Research and Joseph C. Hogan, Jr. Development, Chief Scientific Officer and Director /s/ ADRIAN DE JONGE Director March 29, 1999 - --------------------------------------------------- Adrian De Jonge /s/ ALLAN R. FERGUSON Director March 29, 1999 - --------------------------------------------------- Allan R. Ferguson /s/ STEPHEN M. DOW Director March 29, 1999 - --------------------------------------------------- Stephen M. Dow /s/ L. PATRICK GAGE Director March 29, 1999 - --------------------------------------------------- L. Patrick Gage /s/ MICHAEL ROSENBLATT Director March 29, 1999 - --------------------------------------------------- Michael Rosenblatt
40 42 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 April 8, 1998. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for this quarter amended June 30, 1998 (File No. 000-21429) and incorporated herein by refernce. 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 as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 filed with the Commission on March 17, 1998 (File No. 000-21429) and incorporated herein by reference. 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.
41 43
EXHIBIT NO. DESCRIPTION - ------- ----------- 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. 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.
42 44
EXHIBIT NO. DESCRIPTION - ------- ----------- 10.29+ Research and Development Agreement between the Company and Sankyo Co., Ltd. dated November 1, 1997. Filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, filed with the Commission on March 17, 1998 (File No. 000-21429) and incorporated herein by reference. 10.30+ Amendment No. 3 to Research & Development and License Agreement between the Company and Abbott Laboratories dated December 23, 1997. Filed as Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 filed with the Commission on March 17, 1998 (File No. 000-21249) and incorporated herein by reference. 10.31+ Research Collaboration and License Agreement between the Company and Amersham Pharmacia Biotech AB dated August 13, 1998. Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-3 (File No. 333-62203) and incorporated herein by reference. 10.32+ Commercialization Agreement between the Company and Amersham Pharmacia Biotech AB dated August 13, 1998. Filed as Exhibit 10.2 to the Company's Registration Statement on Form S-3 (File No. 333-62203) and incorporated herein by reference. 10.33+ Amendment No. 1 to Research and License Agreement between the Company and Roche Bioscience, a division of Syntex, Inc., dated as of September 30, 1998. Filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 000-21429) and incorporated herein by reference. 10.34* Resignation Agreement between Eric Gordon and the Company dated as of September 11, 1998. Filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 000-21429) and incorporated herein by reference. 10.35 Lease by and between MetroNorth Corporate Center LLC and the Company dated as of May 29, 1998. Filed as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 000-21429) and incorporated herein by reference. 10.36+ Compound Supply and License Agreement between the Company and R.W. Johnson Pharmaceutical Research Institute, a division of Ortho-McNeil Pharmaceutical, Inc., dated as of December 15, 1998. Filed herewith. 11.1 Statement re computation of per share net income (loss). Filed herewith. 21.1 Subsidiaries of the Company. Filed herewith. 23.1 Consent of PricewaterhouseCoopers LLP. Filed herewith. 27.1 Financial Data Schedule. 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 24b-2 of the Securities and Exchange Act of 1934, as amended. 43 EX-10.36 2 COMPOUND SUPPLY AND LICENSE AGREEMENT 1 COMPOUND SUPPLY AND LICENSE AGREEMENT This Compound Supply and License Agreement dated as of December 15, 1998 (the "Effective Date") is between the R.W. Johnson Pharmaceutical Research Institute ("PRI"), a division of Ortho-McNeil Pharmaceutical, Inc, a Delaware corporation, having a business address of U.S.Route 202, Raritan, NJ 08869, and ArQule, Inc. ("ArQule"), a Delaware corporation, having a business address of 200 Boston Avenue, Medford, MA 02155. R E C I T A L S --------------- WHEREAS, ArQule has expertise relating to the design and synthesis of libraries of chemical compounds in Mapping Array Sets using rapid parallel synthesis methods, including its AMAP(TM) chemical synthesis system; WHEREAS, PRI desires to access compound libraries produced by ArQule to identify lead molecules by subscribing to the ArQule Mapping Array Program pursuant to which ArQule will synthesize and deliver to PRI at least * small organic molecules each year in a collection of Mapping Array Sets representing at least * Chemical Themes; and WHEREAS, ArQule is willing to provide its compound libraries comprising ArQule Compounds in Mapping Array Sets delivered as individual compounds in a spatially addressable array format in a microtiter plate wherein the ArQule Compounds within each Mapping Array Set are, on average, at least * pure; and WHEREAS, ArQule and PRI desire that the implementation of the Mapping Array Program be managed by a joint Research Committee; and WHEREAS, PRI desires to screen the ArQule Compounds against biological targets in the Screening Field in order that PRI may obtain an exclusive license to Available Compounds in the Development Field whereby PRI will pay ArQule success fees and royalties on Royalty-Bearing Products; and WHEREAS, PRI also desires to receive a non-exclusive license to practice certain ArQule Patent Rights outside of the Mapping Array Program. NOW, THEREFORE, in consideration of the mutual covenants set forth in this Agreement, PRI and ArQule hereby agree as follows: 2 1. DEFINITIONS. 1.1. "ACTIVE COMPOUND" means an ArQule Compound that exhibits activity against a Target, as determined by PRI according to a predetermined threshold set by PRI for each Target consistent with the manner it treats other compounds resulting from its drug discovery program. 1.2. "AFFILIATE" means any legal entity (such as a corporation, partnership, or limited liability company) that is controlled by, controls or is under common control with a party. For the purposes of this definition, the term "control" means (i) beneficial ownership of at least fifty percent (50%) of the voting securities of a corporation or other business organization with voting securities or (ii) a fifty percent (50%) or greater interest in the net assets or profits of a partnership or other business organization without voting securities. 1.3. "ANALOG" means a chemical compound (i) that exhibits significant structural similarity to an ArQule Compound, (ii) was discovered or developed using information obtained by screening ArQule Compounds, or (iii) was structurally derived in one or more steps from a parent ArQule Compound 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. 1.4. "ARQULE COMPOUND" means a chemical compound provided by ArQule to PRI pursuant to this Agreement, and specifically includes all compounds in the Mapping Array Sets provided to PRI under the Mapping Array Program. 1.5. "AVAILABLE COMPOUND" means an Active Compound that, as of the date PRI reports activity to ArQule, (i) ArQule has the right to grant to PRI the licenses set forth under Section 4.1. and (ii) is not committed to an internal ArQule program, as evidenced by written or electronic records, in the Development Field. 1.6. "CHEMICAL THEME" means the chemical or structural characteristics that define the compounds in a Mapping Array Set. 1.7. "CONFIDENTIAL INFORMATION" means any technical or business information furnished by one party (the "Disclosing Party") to the other party (the "Receiving Party") in connection with this Agreement or generated pursuant to this Agreement as more fully defined in Article 9. Such Confidential Information may include, without limitation, the identity or use of a chemical compound, the identity or use of a biological target, trade secrets, know-how, inventions, technical data or specifications, testing methods, business or financial information, research and development activities, Research Committee reports, royalty reports, product and marketing plans, clinical development plans, and customer and supplier information. 1.8. "DEVELOPMENT FIELD" means applications in * . 1.9. "EMEA" means the European Medicine Evaluation Agency. - ------------ *Confidential treatment has been requested for the marked portion. 2 3 1.10. "FDA" means the United States Food and Drug Administration or any successor agency. 1.11. "IND" means an investigational new drug application filed with the FDA prior to beginning clinical trials in humans as more fully defined in 21 C.F.R. 312.3 or any comparable application filed with the regulatory authorities of a country other than the United States, prior to beginning clinical trials in humans in that country. 1.12. "LICENSED COMPOUND" means an Available Compound for which PRI has elected to obtain an exclusive license, as further described in Section 3.3. below. 1.13. "LICENSED COMPOUND GROUP" means a group of from two to four Licensed Compound Sets that contain Licensed Compounds and Analogs which exhibit activity for the same Target, as further described in Section 7.2. 1.14. "LICENSED COMPOUND SET" means a set of Licensed Compounds that are from the same Mapping Array Set and which are Active Compounds with respect to the same Target, as well as Analogs of those Licensed Compounds that demonstrate biological activity with respect to the same Target, as further described in Section 7.1. 1.15. "MAJOR MARKET COUNTRY" means any of the United States, United Kingdom, France, Germany, Italy, or Japan. 1.16. "MAPPING ARRAY(TM) PROGram" means an annual program under which ArQule provides its collaborators with a certain number of ArQule Compounds organized in Mapping Array Sets and grants its collaborators a non-exclusive right to screen the ArQule Compounds against any Target in the Screening Field, as further described in Article 3 below. 1.17. "MAPPING ARRAY(TM) Set" means a set of ArQule Compounds consisting of diverse, structurally related small organic chemical compounds arranged in a spatially addressable format such as a microtiter screening plate and having the same Chemical Theme, which are provided to PRI under the Mapping Array Program. 1.18. "NDA" means a New Drug Application and all supplements thereto filed with the FDA, including all documents, data, and other information concerning a Royalty-Bearing Product, which are necessary for, or included in, FDA approval to market such Royalty-Bearing Product, as more fully defined in 21 C.F.R. 314.5 et seq. 1.19. "NET SALES" means * . 1.20. "PATENT RIGHTS" means any United States and foreign patent application and any divisional, continuation, or continuation-in-part of such patent application (to the extent the - ------------ *Confidential treatment has been requested for the marked portion. 3 4 claims are directed to subject matter specifically described therein), as well as any patent issued thereon and any reissue or reexamination of such patent, and any foreign counterparts to such patents and patent applications, including those arising out of this Agreement. "ARQULE PATENT RIGHTS" means Patent Rights that are either (i) invented solely by ArQule employees or assigned solely to ArQule, (ii) invented jointly by ArQule employees and employees of a party other than PRI or assigned jointly to ArQule and a party other than PRI, or (iii) licensed to or otherwise controlled by ArQule, in each case to the extent that ArQule has the ability to license or sublicense the rights required under this Agreement. "PRI PATENT RIGHTS" means Patent Rights developed or discovered solely in connection with this Agreement that are either (i) invented solely by employees of PRI or assigned solely to PRI, (ii) invented jointly by PRI employees and employees of a party other than ArQule or assigned jointly to PRI and a party other than ArQule, or (iii) licensed to or otherwise controlled by PRI, in each case to the extent that PRI has the ability to license or sublicense the rights required under this Agreement. "JOINT PATENT RIGHTS" means Patent Rights developed or discovered solely in connection with this Agreement assigned to both ArQule and PRI as joint owners. 1.21. "PHASE I CLINICAL TRIAL" shall mean that portion of the FDA submission and approval process which provides for the first introduction into humans of a product with the purpose of determining human toxicity, metabolism, absorption, elimination and other pharmacological action as more fully defined in 21 C.F.R. ss. 312.21(a). 1.22. "PHASE II CLINICAL TRIAL" shall mean that portion of the FDA submission and approval process which provides for the initial trials of product on a limited number of patients for the purposes of determining dose and evaluating safety and efficacy in the proposed therapeutic indication as more fully defined in 21 C.F.R. ss. 312.21(b). 1.23. "PHASE III CLINICAL TRIAL" shall mean that portion of the clinical development program which provides for continued trials of a product on sufficient numbers of patients to establish the safety and efficacy of a product and generate, if required, pharmacoeconomics data to support regulatory approval in the proposed therapeutic indication as more fully defined in 21 C.F.R. ss. 312.2(c). 1.24. "PROPRIETARY MATERIALS" means any tangible research materials, whether biological, chemical, physical, or otherwise, that one party (the "Provider") furnishes to the other party (the "Recipient") under this Agreement and designates as proprietary or confidential, including without limitation all ArQule Compounds. 1.25. "POP" means the internal PRI proof of principal program in which a clinical candidate is selected, produced in quantity under GMP conditions, pre-clinical toxicology studies are performed, and first administration to human subjects is performed. PRI formally selects a compound as a clinical candidate for POP according to its internal procedures. * . 1.26. "RESEARCH COMMITTEE" means the joint Research Committee described in - ------------ *Confidential treatment has been requested for the marked portion. 4 5 Section 2.1. 1.27. "ROYALTY PERIOD" means the partial calendar quarter commencing on the date on which the first Royalty-Bearing Product is sold and every complete or partial calendar quarter thereafter during which PRI has the obligation to pay a royalty pursuant to Section 5.3.1. 1.28. "ROYALTY-BEARING PRODUCT" means* . 1.29. "SCREENING FIELD" means *. 1.30. "TARGET" means any biological target in the Screening Field that PRI selects for screening against ArQule Compounds. 1.31. "TECHNOLOGY" means any proprietary development, idea, design, concept, technique, process, invention, compound, discovery, or improvement, whether or not patentable or copyrightable, including those arising out of this Agreement. "ARQULE TECHNOLOGY" means Technology that is either (i) assigned solely to ArQule, (ii) assigned jointly to ArQule and a party other than PRI, or (iii) licensed to or otherwise controlled by ArQule, in each case to the extent that ArQule has the ability to license or sublicense the rights required under this Agreement. "PRI TECHNOLOGY" means Technology developed or discovered solely in connection with this Agreement that is either (i) assigned solely to PRI, (ii) assigned jointly to PRI and a party other than ArQule, or (iii) licensed to or otherwise controlled by PRI, in each case to the extent that PRI has the ability to license or sublicense the rights required under this Agreement. "JOINT TECHNOLOGY" means Technology that is developed or discovered jointly by one or more employees or consultants of PRI and one or more employees or consultants of ArQule solely in connection with this Agreement. 1.32. "UNBLINDED ARQULE COMPOUND" means (i) an Available Compound for which PRI has received the structure under Subsection 3.3.1, (ii) all ArQule Compounds within a Mapping Array Set containing a Licensed Compound for which PRI has received structures under Subsection 3.3.3, or (iii) any other ArQule Compounds for which PRI has received structures from ArQule under this Agreement. 1.33 "VALID CLAIM" means either (i) 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 (ii) a claim of patent application that has been pending for less than five (5) years from the earliest filing date of a non-provisional application and that has not been abandoned or finally rejected without the possibility of appeal or refiling. 2. MANAGEMENT OF MAPPING ARRAY PROGRAM. - -------------------------------------- 2.1. ESTABLISHMENT OF RESEARCH COMMITTEE. The parties hereby establish a Research Committee comprised of four (4) members or such other number as the parties may agree, with - ------------ *Confidential treatment has been requested for the marked portion. 5 6 an equal number of representatives appointed by each party. The parties shall designate the initial members of the Research Committee within thirty (30) days after the Effective Date. A party may change any of its representatives to the Research Committee at any time upon written notice to the other party. 2.2. DUTIES OF RESEARCH COMMITTEE. The Research Committee shall monitor, manage, and administer the Mapping Array Program under this Agreement. In general, the Research Committee will have responsibility for all issues of a scientific or technical nature (e.g., scheduling, quality, and delivery formats). Specifically, the Research Committee will discuss which Chemical Themes to include in the Mapping Array Program for each calendar year, verify that Active Compounds exhibit the required activity against a specific Target, and resolve all matters involving scientific questions. The Research Committee may have other responsibilities as expressly set forth in this Agreement. 2.3. MEETINGS OF RESEARCH COMMITTEE. Unless otherwise determined by the Research Committee, the Research Committee shall meet at least once each calendar quarter alternately at the location of each party, or at other times, locations, or manner (e.g., telephone conferences) determined by the Research Committee. A representative of the Research Committee jointly appointed by its members shall provide each member with five (5) business days notice of the time and location of each quarterly meeting, unless such notice is waived by all members. If a designated representative of a party cannot attend a meeting of the Research Committee, such party may designate a different representative for that meeting without notice to the other party, and the substitute member will have all the powers of the permanent member. Except as otherwise provided in this Agreement, all actions and decisions of the Research Committee will require the unanimous consent of all of its members. If the Research Committee fails to reach agreement upon any matter, the dispute will be resolved in accordance with the procedures set forth in Article 12 below. Within ten (10) business days following each quarterly meeting of the Research Committee, a representative of the Research Committee jointly appointed by its members shall prepare and deliver, to both parties, a written report describing the program status and the issues, decisions, conclusions, and other actions taken by the Research Committee. 2.4. COOPERATION. Each party agrees to provide the Research Committee with information and documentation as reasonably required for the Research 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 Research Committee. The parties anticipate and intend that members of the Research Committee will communicate informally with each other and with employees and consultants of the parties on matters relating to the Mapping Array Program. 3. CONDUCT OF MAPPING ARRAY PROGRAM. - ----------------------------------- 3.1. DELIVERY OF MAPPING ARRAY SETS. During calendar year 1998, ArQule will supply PRI with approximately * ArQule Compounds, representing at least * Chemical Themes, produced in its 1996, 1997, and 1998 Mapping Array Programs. ArQule shall deliver a duplicate of these Mapping Array Sets on a date requested by PRI between * . Thereafter, in each calendar year during the term of this Agreement, ArQule - ---------- *Confidential treatment has been requested for the marked portion. 6 7 will supply PRI with at * different Mapping Array Sets (in duplicate) containing in the aggregate approximately * ArQule Compounds produced in the Mapping Array Program for that calendar year. In general, each Mapping Array Set will contain a minimum of * and a maximum of * ArQule Compounds. In this regard, beginning in 1999, ArQule shall deliver the ArQule Compounds to PRI spread out throughout the calendar year, it being the intention of the parties that ArQule will deliver approximately * ArQule Compounds in duplicate per quarter. The ArQule Compounds within each Mapping Array Set delivered under the 1998 Mapping Array Program and thereafter shall have an average purity level of at least * as measured by standard analytical chemistry methods used at ArQule. Unless otherwise determined by the Research Committee, ArQule shall deliver * solution of each ArQule Compound in duplicate in DMSO solution in 96 well microtiter plates (representing approximately * of each ArQule Compound per well). The ArQule Compounds are organized and shipped in Mapping Array Sets. ArQule will identify the Chemical Theme for each Mapping Array Set upon shipment. Except as provided in Section 3.3 below, ArQule shall have no obligation to identify the individual ArQule Compounds in the Mapping Array Sets and PRI shall have no obligation to identify its Targets. During the planning process to select Chemical Themes for each annual Mapping Array Program, PRI shall have an opportunity to suggest Chemical Themes which ArQule will consider for inclusion in the Mapping Array Program, and PRI shall have the opportunity to comment on Chemical Themes proposed by ArQule for inclusion in the Mapping Array Program. 3.2. SCREENING OF MAPPING ARRAY SETS. Subject to the terms and conditions of this Agreement, ArQule hereby grants PRI and its Affiliates a nonexclusive, worldwide license (without the right to sublicense) under the ArQule Patent Rights and other rights in ArQule Technology to screen the ArQule Compounds in the Mapping Array Sets against any Targets within the Screening Field. PRI agrees to use efforts consistent with its normal scientific practices to screen the ArQule Compounds in the Mapping Array Sets against its Targets in the Screening Field. 3.3. DESIGNATION OF LICENSED COMPOUNDS. -------------------------------------- 3.3.1. DETERMINATION OF AVAILABILITY. PRI shall disclose to ArQule the array plate number and well number of any Active Compounds by facsimile transmission followed by a confirmatory letter. ArQule will promptly determine whether the Active Compounds are Available Compounds and notify PRI of such determination within ten (10) business days. ArQule will also inform PRI if an Available Compound is licensed outside the Development Field or is a reverted Licensed Compound under any other agreement with another ArQule collaborator. If an Active Compound is not an Available Compound, PRI shall have no rights with respect to that Active Compound. If an Active Compound is an Available Compound, ArQule shall disclose to PRI the chemical composition and theoretical structure of the Active Compound within * . At the request of PRI, ArQule shall (i) internally designate that Active Compound as a Licensed Compound (subject to the annual maintenance fee in accordance with Section 5.5) and (ii) no longer identify that Active Compound as an Available Compound in the - ------------ *Confidential treatment has been requested for the marked portion. 7 8 Development Field to any other third party or ArQule collaborator. The Research Committee may verify that ArQule Compounds meet the criteria of Active Compounds. 3.3.2. CONFIRMATION SAMPLES AND RESYNTHESIZED COMPOUNDS. If PRI requests confirmation samples of a Licensed Compound, ArQule shall resupply PRI with * of the Licensed Compound for confirmation of activity within * from the date requested, subject to a maximum of * confirmation requests per month and a maximum number of * per ArQule Compound during the term of this Agreement. Within * after receiving the resupplied Licensed Compound from ArQule, subject to extension by the Research Committee, PRI shall notify ArQule whether the activity is confirmed. If PRI confirms activity, then PRI shall disclose to ArQule the Target and the level of activity. If PRI requests resynthesized samples of a Licensed Compound, ArQule will supply PRI with a sufficient quantity (determined by the Research Committee) of the resynthesized Licensed Compound to confirm activity and perform secondary assays within * from the date requested, unless synthesis starting materials are unavailable for such resynthesized Active Compound, subject to a maximum of * such resynthesis requests per quarter (i.e., *) and no more than * such requests in any one month. Within * after receiving the resynthesized Active Compound from ArQule to confirm activity, subject to extension by the Research Committee, PRI shall notify ArQule whether activity is confirmed. If PRI confirms activity and has not previously confirmed activity with a confirmation sample, then PRI shall disclose to ArQule the Target and level of activity. In the event that PRI (i) requests resupply of more than * per month, (ii) exceeds the * total resupply quantity, or (iii) requests resynthesis of more than * in a given calendar quarter, ArQule shall have no obligation to supply the excess compounds unless PRI and ArQule establish a mutually acceptable fee for such excess services. 3.3.3. ACTIVATION OF DEVELOPMENT LICENSES. If PRI does not confirm activity within the applicable confirmation period for a resupplied or resynthesized Licensed Compound, or if PRI has no further interest in that Licensed Compound for any other reason, the Licensed Compound shall revert to ArQule as provided in Section 7.5. If PRI confirms activity of a resynthesized Licensed Compound within the applicable confirmation period and desires to retain that Licensed Compound, then (i) ArQule shall remove the Licensed Compound from future shipments of its Mapping Array Set in the Development Field, (ii) ArQule shall provide to PRI the chemical composition and theoretical structures (but not the locations) for all of the ArQule Compounds within the Mapping Array Set containing the Licensed Compound, and (iii) subject to disclosure to ArQule by PRI of the Target and level of activity, the licenses set forth in Section 4.1. shall immediately become effective with respect to that Licensed Compound. The Research Committee shall verify that ArQule Compounds have been confirmed by PRI as Active Compounds under Subsection 3.3.2. Any disagreements regarding whether ArQule Compounds are Active Compounds or confirmed Active Compounds shall be submitted to the scientific dispute resolution procedures set forth in Article 12. All information disclosed by ArQule and PRI under this Section shall be deemed Confidential Information and, as such, is subject to the restrictions set forth in Article 9. 4. LICENSE GRANT. - ---------------- - ------------ *Confidential treatment has been requested for the marked portion. 8 9 4.1. DEVELOPMENT AND COMMERCIALIZATION LICENSE. Subject to disclosure to ArQule by PRI of the Target and the level of activity of a Licensed Compound and confirmation of activity in accordance with Subsection 3.3.2. above, and subject to the other terms and conditions of this Agreement, ArQule hereby grants to PRI and its Affiliates the following licenses: (i) an exclusive, worldwide license (with the right to sublicense) under the ArQule Patent Rights, Joint Patent Rights, and other rights in ArQule Technology and Joint Technology to conduct development of Licensed Compounds in the Development Field, including the right to make and have made Analogs of Licensed Compounds; (ii) an exclusive, worldwide license (with the right to sublicense) under the ArQule Patent Rights, Joint Patent Rights, and other rights in ArQule Technology and Joint Technology to make, have made, use, sell, have sold, and import Licensed Compounds in the Development Field; and (iii) a non-exclusive, worldwide license (with the right to sublicense) under the ArQule Patent Rights and other rights in ArQule Technology to use chemical synthesis methods within the ArQule Patent Rights and ArQule Technology to make Royalty-Bearing Products. ArQule shall not grant to any third party any rights under Joint Patent Rights to make, have made, use, sell, have sold, or import Analogs. The parties understand and agree that this limitation applies only to the Joint Patent Rights; accordingly, ArQule has no obligation to grant to PRI any other legal rights that ArQule may obtain in Analogs, and ArQule may license such other legal rights to any third party. PRI and ArQule acknowledge that the exclusive license granted under this Section prohibits ArQule from granting any third party any right or license to use Licensed Compounds to develop Analogs in the Development Field. Since PRI has a non-exclusive screening license under Section 3.2. and since ArQule has granted other such non-exclusive licenses, it is possible that other ArQule partners may make analogs of their licensed compounds which overlap in scope with Analogs made by PRI. Accordingly, ArQule makes no representation that PRI will have the exclusive right to Analogs of Licensed Compounds. PRI acknowledges and agrees that the license grant in clause (iii) above is subject to the terms, conditions, and limitations of any agreement under which ArQule has acquired rights in a chemical synthesis method from a third party and, in such event, PRI may need to enter into a separate license agreement with the third party or sublicensee agreement with ArQule before such license grant shall take effect. As of the Effective Date, ArQule has entered into such third-party agreements with * . After the licenses set forth above take effect for a Licensed Compound, and at the written request of PRI, ArQule will notify PRI if any such third-party agreements apply to the synthesis of that Licensed Compound as a Royalty-Bearing Product. In the event that PRI decides to sublicense its rights - ------------ *Confidential treatment has been requested for the marked portion. 9 10 under this Section to a third party, PRI shall furnish ArQule with written notice of the sublicense grant and shall ensure that all sublicense agreements conform to this Agreement. 4.2. RIGHTS OUTSIDE THE DEVELOPMENT FIELD. PRI acknowledges that its rights in Licensed Compounds under this Agreement are limited to the Development Field. PRI further acknowledges that, as a direct result of its rights to screen ArQule Compounds and develop Licensed Compounds pursuant to this Article 4, PRI may obtain PRI Patent Rights, Joint Patent Rights, or other rights in PRI Technology and Joint Technology that may have effect outside the Development Field and thereby limit the rights of ArQule collaborators who may have exclusive rights to develop and commercialize ArQule Compounds outside the Development Field. PRI hereby grants to ArQule and its Affiliates an exclusive, worldwide, royalty-free license (with the right to sublicense) under the PRI Patent Rights, Joint Patent Rights, and other rights in PRI Technology and Joint Technology to develop, manufacture, use, sell, and import Licensed Compounds outside of the Development Field. 4.3. NON-EXCLUSIVE PATENT LICENSE. In connection with this Agreement, ArQule has granted to PRI a non-exclusive license to practice certain of its United States patents. The terms and conditions of this patent license are set forth on EXHIBIT A. 5. PAYMENTS. - ----------- 5.1. TECHNOLOGY ACCESS FEE. In consideration of the licenses granted PRI as set forth on EXHIBIT A and in partial consideration of PRI obtaining access to the Mapping Array Program as set forth in this Agreement, PRI shall pay to ArQule a technology access fee in the amount of * , payable within thirty (30) days of the Effective Date, but not later than December 31, 1998. 5.2. DELIVERY FEES. In partial consideration of the delivery by ArQule of the duplicate Mapping Array Sets under the Mapping Array Program and certain compound resupply and resynthesis services as set forth in Section 3.3. of this Agreement, PRI shall pay to ArQule (i) an initial delivery fee in the amount of *, payable within thirty (30) days of the Effective Date, but no later than December 31, 1998, for the first copy of Mapping Array Sets containing 300,000 ArQule Compounds from the 1996, 1997, and 1998 Mapping Array Programs, (ii) a delivery fee in the amount of *, payable not later than March 31, 1999, for the second copy of the ArQule Compounds delivered in 1998, and (iii) the annual delivery fee set forth below during each subsequent calendar year in which this Agreement remains in effect, payable in four equal quarterly installments which shall be invoiced by ArQule on or about January 1, April 1, July 1, and October 1 of each such calendar year and payable by PRI thirty (30) days thereafter. The annual delivery fee payable to ArQule in 1999 shall be * and the annual delivery fee payable in each year after calendar year 1999 shall be determined as follows: Annual Delivery Fee = * x (1 + CPI) - ------------ *Confidential treatment has been requested for the marked portion. 10 11 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 calendar 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. The parties acknowledge that the base annual delivery fee of * represents an aggregate of three component payments: *. It is the intention of the parties that ArQule will deliver to PRI approximately * ArQule Compounds per quarter. *. 5.3. PRODUCT ROYALTIES. ----------------- 5.3.1. EARNED ROYALTIES; ROYALTY TERM. In partial consideration of the performance by ArQule of the Mapping Array Program, PRI shall pay to ArQule the following royalties on Net Sales of Royalty-Bearing Products in accordance with the procedures set forth in Article 6. * * This royalty obligation shall commence with the first commercial sale of a Royalty-Bearing Product in any country and shall continue on a country-by-country basis for a period of * after the first commercial sale of the Royalty-Bearing Product in such country. Upon expiration of the * royalty payment obligations in a country, PRI shall thereafter have, in perpetuity, a fully paid up license under Section 4.1. of this Agreement. 5.3.2. THIRD PARTY ROYALTIES. PRI shall be responsible for procuring such licenses as it deems, in its sole discretion, appropriate for the manufacture, use, marketing, sale or distribution of Royalty-Bearing Products by PRI and its Affiliates and sublicensees, and for the payment of any amounts due third parties under such licenses; *. 5.4. MILESTONE PAYMENTS. In partial consideration of the performance by ArQule of the Mapping Array Program, PRI shall pay ArQule the following milestone payments within thirty (30) days after each occurrence of each event for each Royalty-Bearing Product: * * 5.5. ANNUAL MAINTENANCE FEE. PRI shall pay ArQule an annual license maintenance fee in the amount of * for each Licensed Compound Set on each anniversary of the first date upon which ArQule provided PRI with the structure of a Licensed Compound within that Licensed - ------------ *Confidential treatment has been requested for the marked portion. 11 12 Compound Set, as described in Section 3.3. For the convenience of the parties, PRI may pay this fee for all affected Licensed Compound Sets on the last day of the calendar quarter in which said anniversary occurs. *. 5.6. PAYMENT FOR USE OF SYNTHETIC METHODS. Under Section 4.1 of this Agreement, ArQule granted to PRI a non-exclusive, worldwide license under the ArQule Patent Rights and ArQule Technology to use chemical synthesis methods within the ArQule Patent Rights and ArQule Technology to make Royalty-Bearing Products. PRI acknowledges that ArQule may have acquired or may, in the future, acquire such methods from a third party and that, in such event, PRI may need to execute a separate license agreement with the third party or sublicense agreement with ArQule before the license grant may take effect. ArQule has notified PRI of all such third-party agreements as of the Effective Date. After the licenses set forth in Section 4.1. above take effect for a Licensed Compound, and at the written request of PRI, ArQule will notify PRI if any such third-party agreements apply to the synthesis of that Licensed Compound as a Royalty-Bearing Product. To the extent that use of a chemical synthesis method requires payment to a third party, PRI agrees to make such payments under the terms of the separate license or sublicense agreement. ArQule represents that there are no such agreements which, under the terms of this Agreement, would require payment to a third party as of the Effective Date hereof. 5.7. * . 6. REPORTS, RECORDS, AND PAYMENT PROCEDURES. ---------------------------------------- 6.1. ROYALTY REPORTS AND PAYMENTS. Within sixty (60) days after the conclusion of each Royalty Period, PRI shall deliver to ArQule a written report setting forth the Net Sales of Royalty Bearing Products sold and the royalty due and payable on a product-by-product and country-by-country basis (including all deductions taken from the gross sales price in determining Net Sales). If no payment is due to the other party for any reporting period, the report shall so state. All such reports shall be considered Confidential Information under this Agreement. Concurrent with this report, PRI shall remit to ArQule any payment due for the applicable Royalty Period. 6.2. METHOD AND CURRENCY OF PAYMENT. The remittance of royalties payable on Net Sales will be payable in U.S. dollars to ArQule at a bank and to an account designated by ArQule using a rate of exchange of the currency of the country from which the royalties are payable in accordance with the rate of exchange published in THE WALL STREET JOURNAL as of the last business day of the month immediately preceding the month during which payment of such royalties is required to be made to ArQule hereunder. All references to dollars hereunder are references to U.S. dollars. 6.3. BLOCKED CURRENCY. Where royalties are due for Net Sales in a country where by reason of currency regulations of any kind or taxes of any kind it is impossible to make royalty - ------------ *Confidential treatment has been requested for the marked portion. 12 13 payments for that country's Net Sales in accordance with Section 5.3., said royalties shall be deposited in whatever currency is allowable for the benefit or credit of ArQule in any accredited bank in that country as shall be acceptable to ArQule. Moreover, in order to facilitate payments from countries other than the United States, when requested by PRI, ArQule shall enter into direct license agreements with PRI Affiliates or sublicensees designated by PRI, whereby such Affiliate or sublicensee will be obligated to remit royalty payments due for Net Sales in such country directly to ArQule. If such Affiliate or sublicensee fails to deposit or remit royalty payments as provided herein, PRI will make such deposits or remittances. Each such license agreement shall recite specifically the applicable terms of this Agreement insofar as such terms are lawful under applicable laws and regulations of the particular country. 6.4. LATE PAYMENTS. Any payments by PRI 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 two percentage points above the Prime Rate of interest as reported in the WALL STREET JOURNAL on the date payment is due, with interest calculated based on the number of days that payment is delinquent. 6.5. TAXES. Any tax required to be withheld by PRI or any Affiliate or sublicensee under the laws of any foreign country for the account of ArQule under this Article 6 shall be promptly paid by PRI or said Affiliate or sublicensee for and on behalf of ArQule to the appropriate governmental authority, and PRI or the Affiliate or sublicensee shall furnish ArQule with proof of payment of such tax together with official or other appropriate evidence issued by the appropriate governmental authority sufficient to enable ArQule to support a claim for income tax credit in respect of any sum so withheld. 6.6. RECORDS. PRI shall maintain, and shall require its Affiliates and other authorized sellers of Royalty-Bearing Products to maintain, complete and accurate records of the sales of Royalty-Bearing Products with respect to which a royalty is payable according to this Agreement. PRI shall retain such records relating to a given Royalty Period for at least * after the conclusion of that Royalty Period (and access to such records shall not be denied thereafter, if such records are reasonably available). ArQule shall have the right, at its own expense, to cause an independent certified public accountant reasonably acceptable to PRI to inspect such records during normal business hours for the sole purpose of verifying any reports and payments delivered under this Agreement. The accountant shall conduct the audit at a date and time reasonably acceptable to PRI but not later than fifteen (15) business days after ArQule notifies PRI of the audit. Such accountant shall not disclose to ArQule any information other than information relating to accuracy of reports and payments delivered under this Agreement and shall provide PRI with a copy of any report given to ArQule. The parties shall reconcile any underpayment or overpayment within sixty (60) 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 five percent (5%) in any Royalty Period, PRI shall bear the full cost of such audit. - ------------ *Confidential treatment has been requested for the marked portion. 13 14 7. DILIGENCE AND REVERSION. ----------------------- 7.1. ESTABLISHMENT OF LICENSED COMPOUND SET. Licensed Compound Sets shall be established automatically to include (i) each Licensed Compound and (ii) all Analogs of the Licensed Compound that are synthesized by PRI and exhibit biological activity for the same Target. In the event that two or more Licensed Compounds from the same Mapping Array Set exhibit activity for the same Target, the Research Committee will establish one Licensed Compound Set for those related Licensed Compounds and all Analogs of the Licensed Compounds that are synthesized by PRI and exhibit biological activity for the same Target. 7.2. DILIGENCE. PRI shall use efforts consistent with its normal business practices to develop, manufacture, market, and sell a Royalty-Bearing Product based on at least one Licensed Compound or Analog within a Licensed Compound Group, the Licensed Compound Sets of which are selected by PRI and reported to the Research Committee. PRI shall satisfy its diligence obligations under this Article 7 so long as one Licensed Compound or Analog within a Licensed Compound Group is being developed as a Royalty-Bearing Product. At any time, PRI may add a Licensed Compound Set to a Licensed Compound Group or substitute a new Licensed Compound Set for a Licensed Compound Set within a Licensed Compound Group, effective immediately upon notice to the Research Committee. In the event of a substitution, the Licensed Compounds in the replaced Licensed Compound Set shall revert to ArQule as set forth in Section 7.5. below. 7.3. STATUS REPORTS. PRI will furnish ArQule with a brief semi-annual statement, within sixty (60) days after the conclusion of each calendar six (6) month period, that describes the status of each Licensed Compound or Analog which remains under development by PRI as a Royalty-Bearing Product. A status report will meet the requirements of this Section 7.3. if it states the development phase of the Licensed Compound or Analog and outlines the future development plans for the upcoming six (6) months. After PRI completes development of a Royalty-Bearing Product, PRI will promptly notify ArQule of the first commercial sale of that Royalty-Bearing Product in each country. 7.4. REVERSION. In certain limited circumstances, as described in Sections 7.5 and 7.6, Licensed Compound(s) may revert to ArQule, whereupon (i) PRI shall exclusively license to ArQule, without payment, any PRI Patent Rights, Joint Patent Rights, and other rights to PRI Technology and Joint Technology that claim the composition or use of the Licensed Compound(s) but only insofar as said PRI Patent Rights, Joint Patent Rights, and other rights in PRI Technology and Joint Technology claim the Licensed Compound(s) (i.e., PRI does not grant ArQule a license with respect to Analogs), and (ii) PRI shall return to ArQule all ArQule Confidential Information and ArQule Proprietary Materials relating to the Licensed Compound(s). Thereafter, PRI shall have no further right or interest in the reverted Licensed Compound(s) under Section 4.1. of this Agreement, but shall retain rights to screen such ArQule Compounds pursuant to Section 3.2. PRI Technology and Joint Technology licensed to ArQule hereunder shall not include any PRI data or NDAs or foreign equivalents relating to such reverted Licensed Compound(s). Under no circumstances will PRI be required to grant to 14 15 ArQule any rights to the composition or use of Analogs of Licensed Compound(s). PRI shall retain the right, with regard to any Analogs of reverted Licensed Compounds, to screen, develop, and commercialize such Analogs for activity against Targets; however, PRI may screen but shall not develop or commercialize such Analogs for activity against the Target for which the reverted Licensed Compound exhibited activity without the consent of ArQule, which consent shall not be unreasonably withheld. 7.5. VOLUNTARY REVERSION. PRI agrees that Licensed Compounds will revert to ArQule in accordance with Section 7.4. in the event that (i) PRI does not confirm the biological activity of a Licensed Compound within the * confirmation period(s), as may be extended by the Research Committee, or if PRI has no further interest in that Licensed Compound for any other reason, as described in Section 3.3. above, (ii) PRI substitutes a Licensed Compound Set in accordance with Section 7.2. or if PRI notifies the Research Committee that PRI has no further interest in a Licensed Compound Set for any reason, or (iii) PRI notifies the Research Committee that PRI will cease the development of all Licensed Compounds and Analogs within an individual Licensed Compound Set or, if applicable, within all Licensed Compound Sets of a Licensed Compound Group. 7.6. INVOLUNTARY REVERSION. In the event that ArQule reasonably believes that PRI has not met its diligence obligations under Section 7.2. or reporting obligations under Section 7.3 with regard to an individual Licensed Compound Set or the Licensed Compound Sets within a Licensed Compound Group, ArQule shall furnish PRI with written notice to that effect and PRI shall have a period of ninety (90) days to furnish ArQule with a written response. ArQule may exercise this right only once in each calendar year for all such affected Licensed Compound Sets. If PRI fails to answer within the ninety-day response period, ArQule may institute the dispute resolution procedure according to Article 12. If PRI furnishes ArQule with an answer within the ninety-day response period, but ArQule reasonably determines that PRI has not met its obligations under Section 7.2 or 7.3, ArQule shall furnish PRI with a written request to meet, whereupon the parties shall meet to discuss the matter and shall establish measurable diligence objectives that are reasonably acceptable to both parties. If PRI does not meet with ArQule within sixty (60) days after PRI receives the meeting request, or if the parties fail to establish diligence objectives within six (6) months after PRI receives the meeting request, then ArQule may institute the dispute resolution procedure under Article 12. If the dispute resolution procedure under Article 12 finds that PRI did not meet its diligence or reporting obligations under Sections 7.2 or 7.3, respectively, then such Licensed Compound(s) shall revert to ArQule in accordance with Section 7.4. 7.7. NON-REVERSION. In the event that ArQule is entitled to reversion of Licensed Compound(s) under Section 7.4 either by Voluntary Reversion under Section 7.5 or Involuntary Reversion under Section 7.6, PRI shall, at its sole discretion, be entitled to cease development of such Licensed Compound(s) but maintain all rights under Section 4.1. to all such Licensed Compound(s) within a Licensed Compound Set by payment of a license fee in the following amounts: - ------------ *Confidential treatment has been requested for the marked portion. 15 16 * PRI may cease payment of this annual license fee with respect to a given Licensed Compound Set at any time by effecting a voluntary reversion of the Licensed Compounds in that Licensed Compound Set as set forth in Section 7.5. above. Upon expiration of the * license fee payment obligations for a Licensed Compound Set hereunder, PRI shall thereafter have, in perpetuity, a fully paid up license to the applicable Licensed Compounds under Section 4.1. of this Agreement. If PRI desires to resume development of the applicable Licensed Compounds at any time, the payment provisions of Article 5 shall resume. 8. INTELLECTUAL PROPERTY. --------------------- 8.1. OWNERSHIP OF INTELLECTUAL PROPERTY. Other than as specifically provided for herein, neither party shall have any rights in Patent Rights and Technology that is invented, developed or discovered by the other party prior to the Effective Date or outside the research performed under this Agreement. Ownership of Patent Rights and Technology arising from the research performed under this Agreement shall be allocated in the following manner: (i) ArQule shall have sole ownership of all right, title, and interest in ArQule Patent Rights and ArQule Technology; (ii) PRI shall have sole ownership of all right, title, and interest in PRI Patent Rights and PRI Technology; and (iii) ArQule and PRI shall have joint ownership of all right, title, and interest in Joint Patent Rights and Joint Technology. 8.2. MANAGEMENT OF PATENT RIGHTS. --------------------------- 8.2.1. PATENT RIGHTS IN LICENSED COMPOUNDS. PRI shall have the primary right and responsibility, at its own expense, for the preparation, filing, prosecution, and maintenance of Patent Rights claiming the composition or use of a Licensed Compound. PRI shall use outside patent counsel reasonably acceptable to ArQule. The outside counsel will keep both parties informed of all actions in the course of its work and provide adequate opportunity for both parties to comment on any decisions or actions undertaken. The parties will cooperate reasonably in filing and prosecuting Patent Rights claiming the composition or use of a Licensed Compound with such outside counsel and with each other and will share all material information relating thereto promptly after receipt. In the event the parties, working with the outside counsel, are unable to agree as to any action or decision in regard to the preparation, filing, prosecution, or maintenance of any such United States Patent Rights, then ArQule will have final say on the matter with the basis for such decision being effective and broad coverage of discoveries and inventions. PRI shall have the final say with respect to the preparation, filing, - ------------ *Confidential treatment has been requested for the marked portion. 16 17 prosecution, and maintenance of such Patent Rights outside the United States. In the event that PRI screens Analogs in the PRI compound collection but not the Unblinded ArQule Compounds, and PRI prepares a patent application claiming such Analogs, PRI shall not exclude the Unblinded ArQule Compounds from such Patent Rights in order to circumvent the provisions of this Section 8.2.1. or to circumvent the payment provisions under Sections 5.3. and 5.4. by eliminating a compound or product from the definition of Royalty-Bearing Product. 8.2.2. OTHER PATENT RIGHTS. Except as otherwise provided in Subsection 8.2.1., PRI shall have sole responsibility for and control over the management of PRI Patent Rights, and ArQule shall have sole responsibility for and control over the management of ArQule Patent Rights. Each party will bear its own expenses in connection with such Patent Rights. In the case of Joint Technology not subject to Subsection 8.2.1., the Research Committee will decide whether to seek Joint Patent Rights claiming that Technology. If the Research Committee decides to seek any Joint Patent Rights under this Subsection, the parties shall jointly prepare, file, prosecute, and maintain such Patent Rights, and all related expenses shall be borne equally by the parties. If the Research Committee decides not to seek such Joint Patent Rights and has not decided to maintain the relevant Joint Technology as a trade secret, and if one of the parties desires to seek such Joint Patent Rights, then that party may prepare, file, prosecute, and maintain such Joint Patent Rights, and all related expenses shall be borne by such party. In the event that a party declines to pay or desires to cease further payment of patent-related expenses for such a Joint Patent Right in any country and the other party desires to maintain the Joint Patent Right, the withdrawing party may assign or exclusively license to the continuing party all rights in that Joint Patent Right in such country and thereafter have no further obligation to pay such expenses. 8.3. COOPERATION. Each party agrees to cooperate fully in the preparation, filing, and prosecution of any Joint Patent Rights and other Patent Rights claiming the composition or use of a Licensed Compound. Such cooperation includes, but is not limited to: (i) 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 as established under this Agreement and to enable the other party to apply for and to prosecute patent applications in any country; (ii) 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 (iii) undertaking no actions that are potentially deleterious to the preparation, filing, or prosecution of such patent applications. 8.4. INFRINGEMENT 8.4.l. OFFENSIVE ACTIONS. With respect to infringement of any Patent Right claiming the composition or use of a Licensed Compound, Analog, or Royalty-Bearing Product, 17 18 PRI shall have the primary right, but not the obligation, to enforce such Patent Right under its sole control and at its sole expense. In such event, PRI shall be exclusively entitled to all proceeds or recoveries resulting therefrom, but from such proceeds or recoveries PRI shall pay ArQule a royalty in accordance with Subsection 5.3.1. on sales lost to the infringer. In the event that PRI declines to enforce such Patent Right with respect to a Royalty-Bearing Product where the sales of the alleged infringer are at least twenty percent (20%) of the market for said product, then ArQule shall have the secondary right to enforce such Patent Right under its sole control and at its sole expense. In such event, ArQule shall be exclusively entitled to all proceeds or recoveries resulting therefrom. 8.4.2. DEFENSIVE ACTIONS. PRI will indemnify, defend, and hold harmless ArQule, its Affiliates, and their respective officers, directors, employees, and agents from any and all loss, damage, cost, and expense (including reasonable attorneys fees) and amounts paid in settlement arising from any actual or alleged infringement claim brought by a third party, in law or in equity, based on activities undertaken pursuant to this Agreement (except for claims based solely on the practice of an ArQule Patent Right or the use of an ArQule Technology) or based on the manufacture or sale of a Royalty-Bearing Product. In the event that ArQule intends to claim indemnification under this Subsection, ArQule shall promptly notify PRI of the infringement action and PRI shall assume the defense of the action under its sole control, including the right to effect a settlement. A failure to deliver notice to PRI within a reasonable time shall relieve PRI of its indemnity obligation under this Subsection to the extent such failure prejudices the ability of PRI to defend such action. ArQule shall cooperate fully with PRI and its legal representatives in the investigation and defense of the action. In the event of a settlement, PRI shall obtain the prior consent of ArQule before agreeing to any settlement that imposes restrictions which are inconsistent with the rights and obligations of the parties under this Agreement. 9. CONFIDENTIAL INFORMATION. ------------------------ 9.1. 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. 9.2. OBLIGATIONS. The Receiving Party agrees that it shall: ----------- (i) 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; ArQule will not allow any directors who are employees of pharmaceutical companies to have access to Confidential Information of PRI except for Confidential Information they reasonably need to 18 19 perform their function as directors (e.g., general status of collaboration but not specific targets, compounds, or disease indications); (ii) use all Confidential Information solely for the purposes set forth in, or as permitted by, this Agreement; and (iii) 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. 9.3. EXCEPTIONS. The obligations of the Receiving Party under Section 9.2. above shall not apply to the extent that the Receiving Party can demonstrate that certain Confidential Information: (i) was in the public domain prior to the time of its disclosure under this Agreement; (ii) 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; (iii) was independently developed or discovered by the Receiving Party without use of the Confidential Information as evidenced by written records of the Receiving Party; (iv) 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 confidentiality to the Disclosing Party with respect to such Confidential Information; or (v) 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 in order that the Disclosing Party shall have an opportunity to intervene to limit or prevent such disclosure; in any event, Receiving Party shall disclose only the minimum Confidential Information required to be disclosed in order to comply with its disclosure obligations. 9.4. 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 19 20 possession of its Legal Department solely for the purpose of monitoring its obligations under this Agreement. 9.5. SURVIVAL OF OBLIGATIONS. The obligations set forth in this Article shall remain in effect for a period of five (5) 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. PROPRIETARY MATERIALS. --------------------- 10.1. OWNERSHIP. PRI acknowledges and agrees that the ArQule Compounds and any other ArQule Proprietary Materials provided to PRI and its Affiliates under this Agreement are and shall remain the property of ArQule. ArQule acknowledges and agrees that any PRI Analogs of an ArQule Compound that are synthesized by PRI and its Affiliates and any other Proprietary Materials provided to ArQule under this Agreement are and shall remain the property of PRI. The foregoing notwithstanding, the parties agree that ownership of any intellectual property rights in ArQule Compounds, and Analogs of ArQule Compounds, and other Proprietary Materials shall be determined in accordance with Article 8. 10.2. RESTRICTIONS ON USE AND TRANSFER. PRI shall use the ArQule Compounds only for the purposes contemplated by this Agreement, and shall not transfer the ArQule Compounds to any third party other than PRI Affiliates without the prior written consent of ArQule. PRI may, however, transfer Licensed Compounds to third parties for any purpose and may transfer Active Compounds to third parties for the purpose of conducting research on behalf of PRI. PRI shall not attempt to identify the chemical structure of the ArQule Compounds in the Mapping Array Sets. In the case of Proprietary Materials other than ArQule Compounds, each Recipient agrees to use such Proprietary Materials only for the purposes indicated by the Provider, and shall not transfer the Proprietary Materials to any third party without the prior written consent of the Provider. Each Recipient further agrees to inform its employees and consultants about the proprietary nature of the Proprietary Materials and to take reasonable precautions, at least as stringent as those observed by Recipient to protect its own Proprietary Materials, to ensure that such employees and consultants observe the obligations of Recipient under this Section. 10.3. DISPOSITION OF UNUSED MATERIALS. At the request of Provider, Recipient will return or destroy any unused Proprietary Materials furnished by Provider other than ArQule Compounds. 10.4. DISPOSITION OF ARQULE COMPOUNDS. Except in the case of a material breach of this Agreement by PRI, PRI shall be entitled to retain and continue to screen all ArQule Compounds in PRI's possession. 10.6. COMPLIANCE WITH LAW. Recipient agrees to comply with all federal, state, and local laws and regulations applicable to the use, storage, disposal, and transfer of Proprietary Materials furnished by Provider, including without limitation the Toxic Substances Control Act (15 USC 2601 ET SEQ.) and implementing regulations (in particular, 40 CFR 720.36 [Research and 20 21 Development Exemption]), the Food, Drug, and Cosmetic Act (21 USC 301 ET SEQ.) and implementing regulations, and all Export Administration Regulations of the Department of Commerce. Recipient assumes sole responsibility for any violation of such laws or regulations by Recipient or any of its Affiliates. 10.7. LIMITATION OF LIABILITY. Any Proprietary Materials delivered pursuant to this Agreement are understood to be experimental in nature and may have hazardous properties. Recipient should assume that the materials are dangerous and should use appropriate precautions. PROVIDER MAKES NO REPRESENTATIONS, AND EXTENDS NO WARRANTIES OF ANY KIND, EITHER EXPRESS OR IMPLIED, WITH RESPECT TO THE PROPRIETARY MATERIALS FURNISHED TO RECIPIENT. THERE ARE NO EXPRESS OR IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. PROVIDER DISCLAIMS ANY WARRANTY, EXPRESS OR IMPLIED, THAT THE USE OF ANY PROPRIETARY MATERIALS WILL NOT INFRINGE ANY PATENT OR OTHER INTELLECTUAL PROPERTY RIGHTS OF A THIRD PARTY, AND PROVIDER SHALL HAVE NO LIABILITY RELATING THERETO. 11. TERM AND TERMINATION. -------------------- 11.1. TERM. This Agreement shall commence on the Effective Date and shall remain in effect until the expiration of PRI's obligation to pay royalties for all Royalty-Bearing Products, unless earlier terminated as provided in this Article 11. 11.2. TERM OF ARQULE COMPOUND SUPPLY. ArQule's obligation to supply ArQule Compounds to PRI pursuant to this Agreement shall commence on the Effective Date and shall remain in effect until December 31, 2001, unless earlier terminated as provided in this Article 11; provided, however, that if ArQule continues to offer the Mapping Array Program during the year 2002, PRI may extend on the same terms the supply of ArQule Compounds through December 31, 2002 upon written notice to ArQule which is received by ArQule not later than July 1, 2001. Upon expiration of the term of the ArQule Compound supply, PRI shall be entitled to retain and continue to screen all ArQule Compounds in PRI's possession (except as otherwise provided in Section 11.5.). 11.3. MATERIAL BREACH. In the event that either party commits a material breach of any of its obligations under this Agreement and such breaching party fails (i) to remedy that breach within sixty (60) days after receiving written notice thereof from the non-breaching party or (ii) to commence dispute resolution pursuant to Article 12, within sixty (60) days after receiving written notice of that breach from the non-breaching party, the non-breaching party may immediately terminate this Agreement upon written notice to the breaching party. 11.4. FORCE MAJEURE. Neither party will be responsible for delays resulting from acts beyond the control of such party, provided that the nonperforming party uses commercially reasonable efforts to avoid or remove such causes of nonperformance and continues performance hereunder with reasonable dispatch whenever such causes are removed. 21 22 11.5. EFFECT OF TERMINATION. Termination of this Agreement shall not relieve the parties of any obligation accruing prior to such termination. The following provisions shall survive the expiration or termination of this Agreement: Articles 6, 7, 8, 9, 10, 12 and 13; Sections 3.2., 3.3., 4.1., 4.2., 5.3., 5.4., 5.5., 5.6., 11.5., 14.8., 14.10., and 14.13. * . 12. DISPUTE RESOLUTION. ------------------ 12.1. PROCEDURES MANDATORY. The parties agree that any dispute arising out of or relating to this Agreement shall be resolved solely by means of the procedures set forth in this Article, and that such procedures constitute legally binding obligations that are an essential provision of this Agreement; provided, however, that all procedures and deadlines specified in this Article may be modified by written agreement of the parties. If either party fails to observe the procedures of this Article, as modified by their written agreement, the other party may bring an action for specific performance in any court of competent jurisdiction. 12.2. DISPUTE RESOLUTION PROCEDURES. ----------------------------- 12.2.1. NEGOTIATION. In the event of any dispute arising out of or relating to this Agreement, the affected party shall notify the other party, and the Research Committee shall attempt to resolve the matter, subject to the approval of the senior management of both parties, within ten (10) days after the date such notice is received by the other party (the "Notice Date"). Any disputes not resolved by discussions by the Research Committee shall be referred to the Chief Executive Officer of ArQule and the President of PRI (collectively, the "Senior Executives"), who shall meet at a mutually acceptable time and location within thirty (30) days after the Notice Date and attempt to negotiate a settlement. If the Senior Executives fail to meet within the thirty-day period, or if the matter remains unresolved for a period of sixty (60) days after the Notice Date, then either party may submit the dispute to arbitration as provided in this Section 12.2. 12.2.2. ARBITRATION. Any dispute, controversy, or claim arising out of or relating to this Agreement or the breach, termination, or invalidity thereof, shall be finally settled by binding arbitration in New York, New York in accordance with the then-existing rules (the "Rules") of the American Arbitration Association ("AAA"), except as otherwise provided in this Subsection. Any award or decision by the arbitrators shall be final and binding upon the parties, and judgment thereon may be entered in any court having jurisdiction thereof. All disputes involving issues of a scientific or technical nature, such as whether an ArQule Compound is an Active Compound or confirmed Active Compound or whether the Mapping Array Sets have the requisite average purity levels, and disputes involving intellectual property issues, such as the legitimate scope of a claim in a Patent Right, shall be decided by a sole arbitrator who is an experienced medicinal chemist (in the case of scientific or technical issues) or an experienced patent attorney with reasonable expertise in the technological subject matter at issue (in the case of intellectual property issues). The arbitrator shall be appointed by the parties. If the parties fail to agree on an arbitrator within thirty (30) days after the date upon which a party first demanded - ------------ *Confidential treatment has been requested for the marked portion. 22 23 arbitration, then each party shall designate a neutral representative who together shall appoint an arbitrator within thirty (30) days, failing which the arbitrator shall be appointed by the AAA in accordance with the Rules. All other disputes shall be decided by a majority of the members of the Board of Arbitration consisting of three (3) members, one (1) of whom shall be appointed by each party and the third of whom shall be the chairman of the panel and be appointed by mutual agreement of the two (2) party appointed arbitrators. In the event of failure of the two (2) arbitrators to agree within sixty (60) days after the commencement of the arbitration proceeding upon the appointment of the third arbitrator, the third arbitrator shall be appointed by the AAA in accordance with the Rules. An arbitration proceeding under this Section shall be deemed to commence upon request or demand for arbitration filed with the AAA. The arbitrator(s) shall apply the law as set forth in Section 14.10. below. The arbitrator(s) shall provide for discovery by the parties not to exceed six (6) months from the filing date of the arbitration demand. The arbitrator(s) shall be required to render a brief written decision, which shall set forth the rationale underlying the decision, within thirty (30) days after the hearings are completed. The arbitrator(s) may award the prevailing party its costs and reasonable attorneys fees, in addition to any other award granted to such party. 12.3. PRESERVATION OF RIGHTS PENDING RESOLUTION. ----------------------------------------- 12.3.1. PERFORMANCE TO CONTINUE. Each party shall continue to perform its obligations under this Agreement pending final resolution of any dispute arising out or relating to this Agreement; provided, however, that a party may suspend performance of its obligations during any period in which the other party fails or refuses to perform its obligations. 12.3.2. PROVISIONAL REMEDIES. Although the procedures specified in this Article are the sole and exclusive procedures for the resolution of disputes arising out of relating to this Agreement, either party may seek a preliminary injunction or other provisional equitable relief if, in its reasonable judgment, such action is necessary to avoid irreparable harm to itself or to preserve its rights under this Agreement. 12.3.3. STATUTE OF LIMITATIONS. The parties agree that all applicable statutes of limitation and time-based defenses (such as estoppel and laches) shall be tolled while the procedures set forth in Subsections 12.2.1. and 12.2.2. are pending. The parties shall take any actions necessary to effectuate this result. 13. INDEMNIFICATION AND INSURANCE. ----------------------------- 13.1. INDEMNIFICATION. PRI agrees to defend, indemnify and hold ArQule, its Affiliates and their respective directors, officers, employees, and agents (the "Indemnitees") 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, officers, employees, or agents as a result of: (i) actual or asserted violations by PRI or its Affiliates, sublicensees, or third party manufacturers of any applicable law or regulation that relates to the manufacture, distribution, or sale of any product containing an ArQule Compound, Analog, or Royalty-Bearing Product, including without any alleged or actual claim that such 23 24 product was adulterated, misbranded, or mislabeled; (ii) claims for bodily injury, death, or property damage attributable to the manufacture, distribution, sale, or use by PRI or its Affiliates, sublicensees, or third party manufacturers of any product containing an ArQule Compound, Analog, or Royalty-Bearing Product; or (iii) a recall ordered by a governmental agency, or required by a confirmed failure, of any product containing an ArQule Compound, Analog, or Royalty-Bearing Product that is manufactured, distributed, or sold by PRI, its Affiliates, sublicensees, or third party manufacturers; provided, however, that such indemnification shall not apply to any liability, damage, loss or expense to the extent directly attributable to (i) the negligent activities or intentional misconduct of the Indemnitees or (ii) the settlement of a claim, suit, action, or demand by the Indemnitees without the prior written approval of PRI. 13.2. PROCEDURE. The Indemnitees agree to provide PRI with prompt written notice of any claim, suit, action, demand, or judgment for which indemnification is sought under this Agreement. PRI agrees, at its own expense, to provide attorneys reasonably acceptable to ArQule to defend against any such claim. The Indemnitees shall cooperate fully with PRI in such defense and will permit PRI to conduct and control such defense and the disposition of such claim, suit, or action (including all decisions relative to litigation, appeal, and settlement); provided, however, that any Indemnitee shall have the right to retain its own counsel, at the expense of PRI, if representation of such Indemnitee by the counsel retained by PRI would be inappropriate because of actual or potential differences in the interests of such Indemnitee and any other party represented by such counsel. PRI agrees to keep ArQule informed of the progress in the defense and disposition of such claim and to consult with ArQule with regard to any proposed settlement. 13.3. INSURANCE. During any period in which PRI makes any ArQule Compound, Analog, or Royalty-Bearing Product available for administration to a human subject, PRI shall maintain policies of commercial general liability insurance and product liability insurance in an amount not less than $5 million per occurrence. 14. MISCELLANEOUS. ------------- 14.1. PUBLICITY. Neither party shall reveal the terms of this Agreement or use the name of the other party in connection with any promotional statements to the public about the work performed under this Agreement or the relationship between the parties, whether in a press release, advertisement, promotional sales literature, or other promotional oral or written statements, without the prior written approval of the other party, except for restatements of previously-approved statements and disclosures required by applicable law or regulation. 14.2. RELATIONSHIP OF PARTIES. For the purposes of this Agreement, each party is an independent contractor and not an agent or employee of the other party. Neither party shall have authority to make any statements, representations, or commitments of any kind, or to take any action which shall be binding on the other party, except as may be explicitly provided for herein or authorized in writing. 24 25 14.3. REPRESENTATIONS AND WARRANTIES. Each party represents and warrants to the other party (i) that it has the legal right, power, and authority to enter into this Agreement, to extend the rights and licenses granted to the other party in this Agreement, and to fully perform its obligations under this Agreement, and (ii) 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. In the event that a party becomes aware that any of its representations and warranties under this Section become untrue during the term of this Agreement, such party shall immediately furnish the other party with written notice which describes the facts in reasonable detail. 14.4. 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. 14.5. HEADINGS. All headings in this Agreement are for convenience only and shall not affect the meaning of any provision hereof. 14.6. BINDING EFFECT. This Agreement shall inure to the benefit of and be binding upon the parties and their respective lawful successors and assigns. 14.7. ASSIGNMENT. Neither party may assign this Agreement without the prior written consent of the other party, except that a party may assign this Agreement to an Affiliate or 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. 14.8. 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 national overnight courier, confirmed facsimile transmission, or registered or certified mail, return receipt requested, postage prepaid, to the following addresses or facsimile numbers: If to PRI: The R.W. Johnson Pharmaceutical Research Institute 920 U.S. Route 202 South P.O. Box 300 Raritan, New Jersey 08869-0602 Attention: President Facsimile: 908-707-1895 25 26 With a copy to: Office of General Counsel Johnson & Johnson One Johnson & Johnson Plaza New Brunswick, NJ 08933 Facsimile: 732-524-2788 If to ArQule: ArQule, Inc. 200 Boston Avenue Medford, MA 02155 Attn: President Tel: (781) 395-4100 Fax: (781) 393-8321 With a copy to: ArQule, Inc. 200 Boston Avenue Medford, MA 02155 Attn: Legal Department Tel: (781) 395-4100 Fax: (781) 393-8321 Either party may change its designated address and facsimile number by notice to the other party in the manner provided in this Section. 14.9. AMENDMENT AND WAIVER. This Agreement may be amended, supplemented, or otherwise modified at any time, but 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. 14.10. GOVERNING LAW. This Agreement and the legal relations among the parties shall be governed by and construed in accordance with the laws of the State of Delaware irrespective of any conflict of laws principles. 14.11. HART-SCOTT-RODINO ACT. If required by law, the parties shall, at their own expense, prepare and make appropriate filings under Title II of the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as amended, and the rules and regulations promulgated thereunder (16 C.F.R. 801.1 et. seq.) (the "Act") as soon as reasonably practicable. The parties shall co-operate in the antitrust clearance process and agree to furnish promptly to the FTC and the Antitrust Division of the Department of Justice any additional information reasonably requested by them in connection with such filings. 26 27 14.12. 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 this Agreement shall be construed as if such invalid or unenforceable provision had not been included herein. 14.13. NON-SOLICITATION. During the term of the ArQule compound supply as set forth in Section 11.2. and thereafter for a period of two (2) years, PRI shall not persuade or induce, or attempt to persuade or induce, any ArQule employee to discontinue his or her employment with ArQule in order to become employed by or associated with PRI; its Affiliates; or any other business, enterprise, or effort that is associated with PRI. 14.14. RIGHTS UPON INSOLVENCY. All rights and licenses to Patent Rights granted under or pursuant to this Agreement by ArQule to PRI are, for all purposes of Section 365(n) of Title 11 of the U.S. Code ("Title 11"), licenses of rights to "intellectual property" as defined under Section 101(60) of Title 11. The parties agree that PRI shall retain and may fully exercise all of its rights and elections under Title 11. ArQule agrees during the term of this Agreement to create and maintain current copies or, if not amenable to copying, detailed descriptions or other appropriate embodiments, of all such Patent Rights. If a case is commenced by or against ArQule under Title 11, then ArQule (in any capacity, including debtor-in-possession) and its successors and assigns (including, without limitation, a Title 11 trustee) shall either (i) provide PRI access to, or if appropriate provide PRI with a duplicate copy of, all such intellectual property (including all embodiments thereof) held by ArQule and such successors and assigns, as PRI may elect in a written request, immediately upon such request, or (ii) perform all of the obligations provided in this Agreement to be performed by ArQule; provided, however, that ArQule shall fulfill the obligations set forth in clause (i) above in the event that this Agreement is rejected as provided in Title 11 and PRI elects to retain its rights hereunder as provided in Title 11. All rights, powers and remedies of PRI, as a licensee hereunder, provided herein are in addition to and not in substitution for any and all other rights, powers and remedies now or hereafter existing at law or in equity (including, without limitation, Title 11) in the event of the commencement of a Title 11 case by or against ArQule. PRI, in addition to the rights, powers and remedies expressly provided herein, shall be entitled to exercise all other such rights and powers and resort to all other such remedies as may now or hereafter exist at law or in equity (including Title 11) in such event. 14.15. ENTIRE AGREEMENT. This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes any and all prior or contemporaneous oral and prior written agreements and understandings. 14.16. ADVICE OF COUNSEL. PRI and ArQule have each consulted counsel of their choice regarding this Agreement, and each acknowledges and agrees that this Agreement shall not be deemed to have been drafted by one party or another and will be construed accordingly. IN WITNESS WHEREOF, the undersigned have duly executed and delivered this Agreement as a sealed instrument effective as of the date first above written. 27 28 R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE By: /s/ Per A. Peterson ------------------------------------------------ Per A. Peterson President ARQULE, INC. By: /s/ Eric B. Gordon ------------------------ Eric B. Gordon President and Chief Executive Officer 28 29 EXHIBIT A --------- TERMS AND CONDITIONS OF PATENT LICENSE The following terms and conditions supplement the provisions of the Agreement. 1. DEFINITIONS. ----------- 1.1. "COMPOUND ARRAY" means a plurality of chemical compounds arranged in a spatially addressable format. 1.2. "LICENSED ARRAY" means any Compound Array that cannot be developed, manufactured, used, or sold without infringing one or more claims under the Licensed Patents, excluding (i) the specific Compound Array and individual chemical compounds disclosed in the example in the Licensed Patents and (ii) Compound Arrays and individual chemical compounds that incorporate the specific chemistries disclosed in the Licensed Patents (e.g., aminimide- and oxazolone-based chemistries). 1.3. "LICENSED PATENTS" means U.S. Patent Nos. 5,712,171 and 5,736,412 entitled "Method of Generating a Plurality of Chemical Compounds in a Spatially Arranged Array" and any divisional, continuation, reissue, or reexamination of such patents, and any foreign counterparts to such patents. 1.4. "LICENSED PROCESS" means a process used to produce a Compound Array if the process cannot be developed or performed without infringing one or more claims under the Licensed Patents. 2. GRANT OF RIGHTS. --------------- During the term of this Agreement, ArQule hereby grants to PRI and its Affiliates a non-exclusive, worldwide license (without the right to sublicense) under the Licensed Patents to develop, make, and use Licensed Arrays and to develop and perform Licensed Processes for its own internal research and development efforts. This license grant is expressly limited to the Licensed Patents and does not extend to any other current or future issued patents within ArQule Patent Rights. 3. INDEMNIFICATION. --------------- 3.1. INDEMNIFICATION. PRI agrees to defend, indemnify and hold ArQule, its Affiliates and their respective directors, officers, employees, and agents (the "Indemnitees") 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, officers, employees, or agents as a result of: (i) actual or asserted violations by PRI or its Affiliates, sublicensees, or third party manufacturers of any applicable law or regulation that relates to the manufacture, distribution, or sale of any Licensed Array or other product developed 29 30 or discovered using the Licensed Process, including without any alleged or actual claim that such product was adulterated, misbranded, or mislabeled; (ii) claims for bodily injury, death, or property damage attributable to the manufacture, distribution, sale, or use by PRI or its Affiliates, sublicensees, or third party manufacturers of any Licensed Array or other product developed or discovered using the Licensed Process; or (iii) a recall ordered by a governmental agency, or required by a confirmed failure, of any Licensed Array or other product developed or discovered using the Licensed Process that is manufactured, distributed, or sold by PRI, its Affiliates, sublicensees, or third party manufacturers; provided, however, that such indemnification shall not apply to any liability, damage, loss or expense to the extent directly attributable to (i) the negligent activities or intentional misconduct of the Indemnitees or (ii) the settlement of a claim, suit, action, or demand by the Indemnitees without the prior written approval of PRI. 3.2. PROCEDURE. The Indemnitees agree to provide PRI with prompt written notice of any claim, suit, action, demand, or judgment for which indemnification is sought under this Agreement. PRI agrees, at its own expense, to provide attorneys reasonably acceptable to ArQule to defend against any such claim. The Indemnitees shall cooperate fully with PRI in such defense and will permit PRI to conduct and control such defense and the disposition of such claim, suit, or action (including all decisions relative to litigation, appeal, and settlement); provided, however, that any Indemnitee shall have the right to retain its own counsel, at the expense of PRI, if representation of such Indemnitee by the counsel retained by PRI would be inappropriate because of actual or potential differences in the interests of such Indemnitee and any other party represented by such counsel. PRI agrees to keep ArQule informed of the progress in the defense and disposition of such claim and to consult with ArQule with regard to any proposed settlement. 4. MISCELLANEOUS. ------------- 4.1. MARKING OF LICENSED ARRAYS. To the extent commercially feasible and consistent with prevailing business and legal practices, PRI shall mark, and shall cause its Affiliates to mark, all Licensed Arrays that are produced under this Agreement with the number of each issued patent under the Licensed Patents that applies to such Licensed Array. 4.2. COMPLIANCE WITH LAW. PRI shall comply with, and shall ensure that its Affiliates comply with, all local, state, federal, and international laws and regulations relating to the development, manufacture, use, and sale of Licensed Arrays. PRI expressly agrees that PRI and its Affiliates shall comply with all United States laws and regulations controlling the export of certain commodities and technical data, including without limitation all Export Administration Regulations of the United States Department of Commerce. 30 EX-11.1 3 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS 1 EXHIBIT 11.1 ARQULE, INC. STATEMENT RE COMPUTATION OF UNAUDITED PRO FORMA NET INCOME (LOSS) PER SHARE (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, 1996 1997 1998 ---- ---- ---- Net income (loss) $ (2,993) $ 291 $ (6,462) ======== ======== ======== Weighted average shares outstanding: Common Stock 2,272 11,282 12,031 Weighted average common shares outstanding 2,272 11,282 12,031 ======== ======== ======== Basic net income (loss) per share $ (1.32) $ 0.03 $ (0.54) ======== ======== ========
YEAR ENDED DECEMBER 31, ----------------------- 1996 1997 1998 ---- ---- ---- Net income (loss) $(2,993) $ 291 $(6,462) Weighted average shares outstanding: Common Stock 2,272 11,282 12,031 Common Stock equivalents -- 1,112 -- ------- ------- ------- Weighted average common shares and equivalents 2,272 12,394 12,031 outstanding ======= ======= ======= Diluted net income (loss) per share $ (1.32) $ 0.02 $ (0.54) ======= ======= =======
EX-21.1 4 SUBSIDIARIES 1 EXHIBIT 21.1 ARQULE, INC. SUBSIDIARIES OF THE COMPANY ArQule Catalytics, Inc., a majority-owned subsidiary of ArQule, is incorporated in Delaware. EX-23.1 5 CONSENT OF PRICEWATERHOUSECOOPERS 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 January 28, 1999 with respect to the financial statements of ArQule, Inc., included in the Annual Report on Form 10-K for the year ended December 31, 1998. PRICEWATERHOUSECOOPERS LLP Boston, Massachusetts March 29, 1999 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 1 5,780 28,090 5,708 0 526 41,003 26,889 (9,068) 60,480 5,457 0 0 0 122 54,145 60,480 0 22,193 14,036 0 0 0 169 (6,462) 0 (6,462) 0 0 0 (6,462) ($0.54) ($0.54)
EX-99.1 7 IMPORTANT RISK FACTORS 1 EXHIBIT 99.1 ARQULE, INC. IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS MARCH 1999 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 year ended December 31, 1998, the Company had a net loss of $6.5 million. For the year ended December 31, 1997, the Company had net income of $0.3 million. In 1996, the Company had a net loss of $3.0 million. 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, substantially 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 realized one milestone payment to date. The Company has not realized any other 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 become 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 2 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 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. 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 3 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 seven issued utility patents and one issued design patent in the United States, four issued Australian patents, 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, the Company has received seven utility patents and one design patent in the United States, and four patents in Australia. There can be no assurance that other patents will issue to the Company 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 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 4 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 partners 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 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. -----END PRIVACY-ENHANCED MESSAGE-----