-----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, LLNYw57kuQnlL8ttDzeVxFgLx5jhR0xHEbvTEQp19F8KwUqp/HeiB6CTX2TuI4j7 XWTM2K95lVsxn5OwTMmmgQ== 0000936392-99-000361.txt : 19990402 0000936392-99-000361.hdr.sgml : 19990402 ACCESSION NUMBER: 0000936392-99-000361 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMBICHEM INC CENTRAL INDEX KEY: 0001002276 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 330617379 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-23473 FILM NUMBER: 99582023 BUSINESS ADDRESS: STREET 1: 9050 CAMINO STREET 2: SUITE 200 CITY: SAN DIEGO STATE: CA ZIP: 92121 BUSINESS PHONE: 6195300484 MAIL ADDRESS: STREET 1: 9050 CAMINO SANTA FE CITY: SAN DIEGO STATE: CA ZIP: 92121 10-K405 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) COMMISSION FILE NUMBER: 00-23473 COMBICHEM, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 33-0617379 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OR INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 9050 CAMINO SANTA FE SAN DIEGO, CALIFORNIA 92121 92121 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 619-530-0484 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $0.001 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of 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 the voting stock held by nonaffiliates of the registrant as of February 28, 1999 was approximately $28,048,947. For the purposes of this calculation, shares owned by officers, directors and 10% shareholders known to the registrant have been deemed to be owned by affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the registrant's Common Stock as of February 28, 1999 was 13,440,421. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 6, 1999, to be filed on or about April 6, 1999, referred to herein as the "Proxy Statement", are incorporated as provided in Part III. Certain exhibits filed with the Registrant's prior registration statements and Forms 10-Q are incorporated as provided in Part IV. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS OVERVIEW CombiChem is a computational product discovery company that is applying its proprietary design technology and rapid synthesis capabilities to accelerate the discovery process for new drugs and chemical products. We believe our approach offers pharmaceutical and chemical companies the opportunity to conduct their discovery efforts in a more productive and cost-effective manner. Using our proprietary Discovery Engine(TM) process, we focus on the generation, evolution and optimization of potential new lead candidates for our collaborative partners who will then develop, manufacture, market and sell any resulting products. We believe that our process is widely applicable to a variety of disease targets and therapeutic indications as well as to other industries such as agrochemical, industrial chemical and materials science. To date, we have established collaborative agreements with Athena Neurosciences, Inc., a wholly owned subsidiary of Elan Corporation, plc, ICOS Corporation, ImClone Systems Incorporated, Novartis Crop Protection AG, Ono Pharmaceutical Co., Ltd., Roche Bioscience, a division of Syntex (U.S.A.) Inc., Sumitomo Pharmaceuticals Co., Ltd. and Teijin Limited. In addition, we are using our approach on internal programs to discover new lead candidates that will then be outlicensed to third parties, while retaining a larger economic interest. In December 1998, we further broadened the application of the technology by establishing a joint venture with Chirotech Technology, Ltd., a member of the Chiroscience Group of companies, to commercialize libraries of chiral compounds. The joint venture, ChiroChem Discovery Services, LLC, was established to develop and sell specifically designed chiral compound libraries. Industry Background During the past decade, significant advances in life sciences research and the increasing appreciation of the complexity of biological processes have highlighted the productivity limitations of traditional approaches to drug discovery. These limitations, together with increased competition in the pharmaceutical and biotechnology industries, have created intense pressure on companies involved with drug development to reconsider the allocation of their research budgets and to improve the cost-effectiveness of their drug discovery process. Between 1976 and 1996, the number of new chemical entities approved by the FDA remained relatively constant, ranging between 12 to 30 per year, despite a more than 10-fold increase in research and development spending by pharmaceutical and biotechnology companies. Furthermore, it typically takes 12 to 15 years from the original concept of affecting 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. Frustrated with the inefficiencies of traditional drug discovery approaches, pharmaceutical and biotechnology companies are beginning to embrace new enabling technologies, such as combinatorial chemistry, genomics, structure-based drug design, high-throughput screening and information technologies, in order to gain a competitive advantage by accelerating the time to develop and commercialize new compounds. These technologies also have the potential to reduce significantly the cost associated with drug discovery. The Traditional Drug Discovery Process and its Limitations The traditional path to discovering a new drug typically begins with the identification of one or more biological targets that are believed to affect a disease state. A biological test or assay based on a target is then developed, predicated on the scientific belief that a compound binding with this target may have a therapeutic benefit with respect to the disease under study. Such an assay facilitates the screening (testing to determine which of the compounds have the desired activity against the target) of a collection of hundreds to thousands of candidate compounds, typically contained in a library, that have been synthesized in the laboratory. Compounds that bind to the target protein and modulate its activity are referred to as hits. Medicinal chemists optimize these hits until they have sufficient potency to become lead candidates and then improve their preclinical characteristics (such as potency, specificity and in vivo profile) further with the goal of producing drug development candidates. 1 3 In summary, the traditional drug discovery process consists of the following steps: [CHART] The traditional drug discovery process is extremely expensive, inefficient and unreliable. Failure at any point during this discovery process would typically force the scientist either to abandon the project or to return to the initial starting point and repeat the process. As a result, the discovery of a new drug for a specified target can take years or can fail entirely. In recent years, the advent of robotic high-throughput screening and automated synthesis technologies, such as combinatorial chemistry and parallel synthesis, has begun to relieve one apparent bottleneck involving screening, synthesis and purification of compounds in the library. While these technologies facilitate the mechanics of drug discovery, they address neither the unreliability of the process nor its principal inefficiency: the number of iterations required to find a lead candidate. To address these problems, a novel approach is needed that can provide information to improve the selection of each subsequent library of compounds to synthesize, potentially reducing the number of iterations. Only by improving the processes of data analysis and compound selection can a laborious, iterative procedure be forced to converge on the lead candidates with the most desirable pharmacological profiles. Current Combinatorial Chemistry and Computational Approaches and Their Limitations Combinatorial chemistry involves the rapid creation of large collections of chemical compounds for the purpose of identifying hits through random screening. Combinatorial chemistry has made possible the synthesis of thousands or even millions of molecules in a short period of time. The traditional approach involved synthesizing only one molecule at a time. Over the last decade, the field of combinatorial chemistry has evolved from only companies that design and synthesize molecules to include those that develop software and automation to facilitate design and synthesis. These companies tend to use highly varied approaches, including: focusing on single, pure compounds versus making mixtures; building large versus small, focused libraries; automating part versus all of the process; and using or not using medicinal chemistry as a principal guiding force. Computational methods are also employed in drug discovery. These methods involve the use of computer-based and information technologies to manage large chemical databases, to examine X-ray crystal structures of the target when available (structure-based drug design), to operate the assorted automated devices available for the synthesis of libraries, to determine how changes in the structure affect the activity of a molecule (SAR activity) and to generate "virtual libraries" using chemical building blocks from readily available sources. Currently, the dominant method of pursuing drug discovery focuses on screening large libraries to search for a lead candidate directly in the library, or at least a hit, which can then be optimized by the more traditional techniques of medicinal chemistry to generate a development candidate. We believe this brute-force, trial-and-error approach is flawed because limited or no information is factored into the library design to force the iterative drug discovery process to converge. This limitation in current combinatorial chemistry approaches is underscored by the fact that most compound libraries used for screening have been constructed with the sole objective of isolating a development candidate with the highest binding affinity to a target. In order to achieve this objective against all possible targets, it is believed such libraries would have to contain in excess of 100 million compounds. A library of that size is well beyond current synthesis capabilities. In addition, the challenge of drug discovery is not only to find a lead candidate that exhibits activity against a biological target. It is also important to ensure that the lead candidate will have characteristics that will enable it to overcome the more difficult in vivo hurdles of toxicity, metabolism or problems with oral administration, none of which will become evident until early testing. Unless information can be extracted about which characteristics are most necessary for binding, it is difficult to know how to modify a compound to maintain tight binding affinity 2 4 while overcoming these hurdles. Furthermore, if no hits are found after the screening of a traditional combinatorial library, a scientist has no starting point for the drug discovery process. While both combinatorial chemistry and computational approaches are useful in drug discovery to some degree, they are severely taxed by the complexity of properly using the information available for library design, as evidenced by the following drawbacks: (1) the inability to derive and integrate information both from compounds that are active and those that are inactive against the target; (2) the inability to probe the target in order to compute ways of improving the predictive models or hypotheses; and (3) the inability to handle the dual requirements of speed and quality when large data sets must be analyzed. We believe that these drawbacks constitute fundamental reasons that current discovery approaches have been only moderately successful in generating lead candidates and development candidates, despite the large number of initial hits. CombiChem's Solution and Advantages We believe that we offer a solution to drug discovery by combining our proprietary design technology and rapid synthesis capabilities in a unique way. Our convergent, iterative process for drug discovery -- our Discovery Engine (see the following diagram) -- is based on compound libraries designed for information. The design of libraries for information involves the selection of compounds that collectively probe the biological target in a systematic way to determine the chemical characteristics required for binding to such target. By identifying features that discriminate between active and inactive compounds, predictive models, called hypotheses, are constructed and then used to select a more focused library of compounds. The compounds are chosen from our proprietary Virtual Library, a computational representation of a very large number of potential molecules chosen for ease of laboratory synthesis. We believe that by repeating this process of selecting, synthesizing and screening informative compounds and analyzing the resulting data, the Discovery Engine process quickly converges on the most predictive hypothesis. This hypothesis describes the characteristics a compound must possess to be active against the target and, thus, is used to select a variety of potent lead candidates. Each cycle of the Discovery Engine refines the definition of the best hypothesis for the target in question. After several cycles, the resulting hypothesis can be used to design highly potent compounds from a broad range of chemical classes including those not readily amenable to combinatorial synthesis techniques. By facilitating the design of a variety of potent compounds for preclinical testing, the Discovery Engine has the potential to increase greatly the likelihood that at least one of these compounds passes the significant downstream hurdles and eventually becomes a commercial drug. 3 5 [DIAGRAM] We believe that the advantages of our Discovery Engine include the following: - Generating lead candidates from multiple structural series that exhibit the same biological activity. By using predictive hypotheses to search the Virtual Library, multiple structural series of compounds that have the same effect on the target can be identified. The availability of multiple structural series increases the likelihood that at least one of these molecules will overcome the in vivo hurdles in preclinical development. In addition, this provides an opportunity for us and our collaborators to enhance the intellectual property position that potentially can be developed around these compounds by having more than one patentable structural series. - Generating lead structures against a wide range of targets including those for which little or no information is available. The Universal Informer Library consists of a computer-designed, proprietary collection of approximately 13,000 physical compounds that can be screened against targets where little or no information is available about the molecular structures that may be active against those targets. Once the Universal Informer Library is screened, the information obtained is used to start the Discovery Engine process. In addition, because the Discovery Engine is not dependent on having prior knowledge about the target (for instance, an X-ray crystal structure representative of the target), it can potentially be used to discover drugs against any target. - Achieving rapid generation, evolution and optimization of lead candidates. By combining flexible design technology and rapid synthesis, our Discovery Engine can produce lead candidates for any of the three types of drug discovery programs -- lead generation, lead evolution or lead optimization -- with less than two years of effort. - Reducing synthesis and screening costs. Our design technology facilitates the use of small, informative libraries. Use of these small libraries decreases the costs associated with synthesis and screening. In addition, our Virtual Library of drug-like molecules has been explicitly constructed for ease of laboratory synthesis. STRATEGY Our objective is to be the industry leader in the generation, evolution and optimization of novel lead candidates. We intend to utilize our scientific and technology assets in the discovery 4 6 process through a mix of collaborative and internal programs by applying the following business strategies: - Establish multiple collaborations with large pharmaceutical and biotechnology companies focused on biological targets chosen by the collaborators. We intend to collaborate with large pharmaceutical and biotechnology companies on fully funded programs aimed at biological targets chosen by these collaborators. Our collaborative efforts are exclusively focused on the discovery process, with a particular emphasis on the discovery of novel compounds against biological targets. We believe our technology platform provides us with opportunities to establish multiple collaborations, which may be for the same disease state. We believe this will allow us to build a portfolio of opportunities that may include project initiation fees, research support, milestone payments and royalties. - Conduct internal discovery efforts aimed at selected biological targets, retaining a larger economic interest in the subsequently outlicensed lead candidates. We also intend to conduct our own internally funded discovery programs by choosing biological targets of current scientific interest and working in collaboration with genomics, biotechnology or screening companies. After identifying lead candidates that are ready for development, we intend to outlicense them, retaining a larger economic interest in such candidates as they are developed and commercialized by a third party. - Broaden the scope of our technology through application of our Discovery Engine process in alternative industries such as the agrochemical and materials science field. We recently initiated a collaboration in the agrochemical field with Novartis. We also are considering additional opportunities in alternative industries, including the industrial chemical and materials science field. In December 1998, we established ChiroChem Discovery Services, LLC, to develop and sell specifically designed chiral libraries. - Maintain technology leadership in both software development and rapid synthesis capabilities. We intend to continue to extend our technology leadership through enhancements of existing software, design of future generations of software and continued advancements of our synthesis capabilities. We believe that these developments will allow us to decrease the time required to discover lead candidates and to maintain our technology leadership and competitive advantage. COMBICHEM'S PROCESS: THE DISCOVERY ENGINE The successful implementation of our Discovery Engine process requires the direct involvement of and interaction between our chemists and our software applications team. This process consists of the following steps: Data analysis -- the compilation and analysis of screening data, literature information and available data about the target. The starting point for a drug discovery program varies depending on the amount of prior information that is available. The collaborator may have tested its corporate collection of compounds or some other chemical library. The collaborator may also have information regarding structures of compounds that are initial hits (moderately active compounds), information regarding structures that are inactive against the particular target or prior information about the target structure itself. On the other hand, if little or no prior information or screening data is available on the initial hits or target, we can make available for screening our proprietary Universal Informer Library as a way of generating a relevant set of information with which to initiate the Discovery Engine. See "CombiChem's Proprietary Technologies -- Universal Informer Library." The analysis of the available information is a critical step in the process because it will determine what type of program will be undertaken -- lead generation, lead evolution or lead optimization -- and the resources that will be required. See "CombiChem's Discovery Programs." Hypothesis generation -- the software-based generation of models that predict the biological activity of molecular structures. Once the analysis of the available data is completed by our chemists and software applications team, the information is used as input for hypothesis generation. The steps involved in hypothesis generation are: - Conformational analysis. Conformational analysis is performed on each active and inactive molecule to determine which shapes or conformations such molecules can take. 5 7 Because it is typically not known which of these shapes a particular molecule will assume when it shows its greatest activity against a biological target, all reasonable conformations are computationally described and analyzed. Our proprietary technology allows for the analysis of large data sets and complex molecular structures to be completed quickly and thoroughly. - Hypothesis generator. Using the screening data and the results of conformational analysis, the hypothesis generation software produces computational models, called hypotheses, that attempt to explain the observed differences in biological activity between active and inactive molecules. In the early phases of a discovery program, the hypothesis generator will often generate many hypotheses that are consistent with the data. The repeated application of the Discovery Engine cycle systematically tests the hypotheses, eliminating some while strengthening others by providing supporting data. Repeating this procedure results in predictive hypotheses. We believe that our proprietary design technology differs from others currently in use in that it (1) includes all of the screening data (including inactives) in generating hypotheses, (2) takes into account a much broader characterization of molecule-target interaction and (3) forces convergence to a predictive model of the important binding features by probing the target systematically using rapid synthesis and screening. Virtual Library search -- the computational search of the Virtual Library to find molecular structures that fit the hypotheses. Once the hypotheses are generated, they are used to search our proprietary Virtual Library to identify molecular structures that have the features represented in the hypotheses. The Virtual Library is a computational representation of a very large number of molecules chosen for ease of laboratory synthesis. For each hypothesis that is generated, a more focused library of tens to hundreds of molecules from the Virtual Library is chosen for synthesis in the laboratory. The Virtual Library is generated and searched by proprietary design technology, which can exploit much larger libraries than is possible with commercially available tools. See "CombiChem's Proprietary Technologies -- Virtual Library." Library synthesis -- the laboratory synthesis of molecular structures that are selected from the Virtual Library using a wide range of chemistries. Once the more focused library of compounds is designed using molecules chosen from the Virtual Library, our chemists are responsible for synthesizing the compounds in the laboratory. Unlike many combinatorial chemistry groups, our chemists are not restricted to particular chemical reactions or a limited list of structural templates, thus providing maximum flexibility to synthesize the libraries quickly. See "CombiChem's Proprietary Technologies -- Synthesis and Analytical Chemistry Technology." The above four steps in the Discovery Engine process are completed by our project teams. Once the molecules are synthesized, those libraries are then sent to the partner or a contract group for screening. Data from these assays will be available to us for the next iteration of the cycle. With each iteration, the Discovery Engine provides more information, improving the hypotheses and increasing the likelihood of discovering active molecules with desirable pharmacological characteristics. Eventually, the hypotheses will converge to provide lead compounds that warrant further testing as development candidates. It currently takes our scientists approximately three months to advance through the steps in one Discovery Engine cycle. Depending upon the information available to start a project, it may take two to four iterations of the cycle to generate strongly predictive hypotheses that may eventually yield novel and highly active lead candidates. Our Discovery Engine process is being validated by both our active collaborative programs and retrospective analysis of drug discovery examples taken from the recent scientific literature. In one such example, we applied our design technology to a project where the data provided was a compilation of third-party research into the design of HIV protease inhibitors. The objective was to determine whether our process could be used to discover novel inhibitors for the enzyme given a collection of only weakly active hits from screening. We generated hypotheses with distinct features by collecting information on eight weakly active HIV protease inhibitors and 500 randomly selected inactive molecules with the same drug-like characteristics as the weakly active compounds. Each of these weakly active compounds was found by either an academic or commercial team in the early phases of trying to discover an HIV protease drug. To assess whether the generated hypotheses are, in fact, able to predict the activities of new molecules, several highly potent HIV protease inhibitors, including currently marketed drugs, were added to a virtual library of several hundred inactive compounds. Using the hypotheses, we searched the Virtual Library. 6 8 The search produced a list of highly ranked protease inhibitors with a variety of chemical structures, including some of the highly potent HIV protease inhibitors currently under development or marketed by major pharmaceutical companies. The structures selected from the Virtual Library differ significantly from those used to develop the hypotheses, validating our capabilities in lead evolution. We have similarly validated our technology on over a dozen other literature data sets and on several programs with collaborators. In our lead evolution programs with several collaborators, we have already been successful in evolving from one structural series to multiple, novel structural series while improving biological activity. These results and a variety of equally successful applications of the Discovery Engine demonstrate the viability of our computational drug discovery methods and the strength of our proprietary technology. COMBICHEM'S PROPRIETARY TECHNOLOGIES To implement our Discovery Engine process, we have developed and assembled an integrated set of proprietary technologies. These include the following: Universal Informer Library The use of many traditional drug discovery approaches presupposes the existence of prior information to start the process. However, recent efforts such as the Human Genome Project and others are producing a number of novel targets about which there is limited prior information. In addition, there are many known targets for which no suitable leads have been identified. To address these situations, our scientists developed a Universal Informer Library. Our Universal Informer Library consists of a computer-designed, proprietary collection of approximately 13,000 physical compounds. Unlike other libraries that are used to identify lead structures directly after screening, the Universal Informer Library is used to gather information concerning the relevant binding features that are important to the target. The compounds in the Universal Informer Library are molecules with the potential to bind to many different targets. Screening against the Universal Informer Library is therefore intended to provide a few, weakly active compounds against the background of many, varied inactive compounds. Using this data, hypotheses may be extracted, which allow the Discovery Engine to be initiated. The Universal Informer Library was designed to provide hits for virtually all possible targets. However, if there is some reason to expect certain structural features to be relevant to a particular target, the Universal Informer Library can be augmented with compounds that contain those features. In this way, information gained from prior experience can be incorporated into the Universal Informer Library; this may improve the hypotheses and therefore reduce the number of cycles required to identify a lead candidate. We completed validation of our Universal Informer Library approach by screening a subset of the Universal Informer Library against a wide range of targets and achieving an outcome comparable to that typically seen in the pharmaceutical industry with libraries containing hundreds of thousands of compounds. Virtual Library Our Virtual Library is a computational representation of a very large number of molecules chosen for the ease with which they can be synthesized in the laboratory. To maximize the likelihood that the Virtual Library will contain potent, patentable compounds active against most targets, we populated it with hundreds of novel structural templates derived from a large range of chemical reactions. Each of the templates has two to four sites at which a wide variety of structural changes can be made synthetically using available chemicals. This chemistry can also be scaled up to give ready access to quantities of each lead candidate sufficient to perform early preclinical testing. The Virtual Library is generated and searched by two components of our proprietary software: Virtual Library Cascader(TM) software and Virtual Library Search software. See "-- Design Technology." Synthesis and Analytical Chemistry Technology Once the Virtual Library is searched for collections of molecules that match the hypotheses, our chemists initiate synthesis of these molecules in the laboratory. The challenge for our chemists is to select the technique that will most quickly achieve the synthesis of the library. While there is considerable debate throughout the industry about the relative merits of various methods of 7 9 chemical synthesis (solid versus solution phase, for example), our chemists have the flexibility to use the appropriate approach for each specific synthesis task. We believe we have expertise in most or all of the readily used techniques and, in addition, have access to a number of new proprietary methods. As long as relatively straightforward chemistry is applied to library production, synthesis is generally not the rate-limiting step. The challenge lies in the isolation and purification of the library compounds. We apply several approaches, including a number of proprietary semi-automated techniques, to facilitate these procedures in order to achieve purity standards of greater than 85%. Design Technology We rely on our proprietary design technology in order to complete several of the key steps in our Discovery Engine. The proprietary design technology includes: Conformational analysis software -- a computer program for identifying the distinct three-dimensional shapes of a molecule. Conformational analysis is performed on each active and inactive molecule to determine which shapes or conformations such molecules can take. It is typically unknown which of these shapes a particular molecule will assume when it shows its greatest activity against a biological target. As a result, all reasonable conformations are computationally described and analyzed. We have developed proprietary conformational analysis software, which rapidly determines all the distinct, reasonable shapes each molecule can assume. Both the speed and the thoroughness of the conformational analysis software distinguish it from commercial chemistry software and permit the Discovery Engine to handle large data sets. Hypothesis generation software -- a computer program for analyzing screening data to identify the requirements a potential drug must satisfy to bind to this target. Once conformational analysis has been applied to each of the screened molecules, our proprietary hypothesis generation software produces computational models that can estimate the biological activity of chemical structures. These models, called hypotheses, are generated by applying methods from statistics, information theory, physical chemistry and computer science to the screening data in order to identify the differences between active and inactive compounds. The predictive capabilities of the computational models and the novel algorithms used to produce them distinguish our hypothesis generator from commercial chemistry software. Virtual Library Cascader software -- a computer program for conveniently describing virtual libraries. The Cascader software facilitates the rapid specification of virtual libraries to the computer. By providing databases of reagents and descriptions of reactions to the Cascader, a chemist can quickly describe large libraries of compounds to the computer. The Cascader can use the resulting description to construct explicit subsets of the large virtual library and to present the structures to the chemist and to the Virtual Library Search software. Virtual Library Search software -- a computer program for selecting molecules from the Virtual Library that, when synthesized and screened, will provide the most information about additional binding requirements. The Virtual Library search software uses hypotheses to estimate computationally the potency of prospective compounds. The goal is to increase the likelihood that the chemists devote their synthesis efforts to compounds that fit the hypotheses and are thus most likely to bind to the target. By using the computer to test the compounds in the Virtual Library against the hypotheses, the Discovery Engine can rapidly identify both active compounds which satisfy several different hypotheses and informative compounds which discriminate among hypotheses. Routinely searching virtual libraries with billions of compounds has generally not been possible with commercial chemistry software. Each cycle of the Discovery Engine refines the assessment of the best hypothesis for the target in question. After several cycles, the resulting hypothesis can be used to design highly potent compounds from a broad range of chemical classes including those not easily synthesized by standard techniques. By facilitating the design of a variety of potent compounds for preclinical testing, the Discovery Engine has the potential to increase greatly the likelihood that at least one of these compounds passes the hurdles and eventually becomes a commercial drug. 8 10 COMBICHEM'S DISCOVERY PROGRAMS We are applying our technology to discover lead compounds for biological targets chosen by our collaborators. In addition, we are selecting our own biological targets of interest. In the first instance, where we are working on a target chosen by a collaborator, the commercial terms are negotiated based on a number of factors, including the number of targets to be included in the collaboration and the type of program -- lead generation, lead evolution or lead optimization. Depending upon the type of program, we will work on the program for a period of one to two years. We will assign a dedicated project team, funded by the collaborator, consisting of applications scientists and synthetic, medicinal and analytical chemists. The team composition and size is dependent upon the type of program and its objectives. To ensure confidentiality, we provide target exclusivity to each of our collaborators. Each team works in a dedicated laboratory. At the conclusion of the program, assuming its objectives have been met, the program team will transfer the lead structure(s) to the collaborator. At this point, our work is completed, but the partner will continue to develop the lead candidate. As the collaborator develops the lead candidate and reaches certain agreed-upon objectives, we will receive milestone payments. Eventually, when the lead candidate becomes a marketed drug, we will receive royalties on the sales of the drug. In our internal programs, we pay for all of the work to be completed and will outlicense the lead structures to a partner for the development and commercialization phases. Depending upon the data available, the Discovery Engine can be applied to three types of discovery programs: lead generation, lead evolution and lead optimization. Lead generation uses the Universal Informer Library to generate information for the Discovery Engine in situations where little or no prior information is known about the target. Lead evolution begins with existing information (either from the collaborator or from the scientific literature) regarding a lead candidate with the objective of identifying different structural series that can provide either other development options or an enhanced patent position. The evolution path may be chosen either as an outgrowth of a lead optimization program or directly from a collaborator's established lead candidate series. Lead optimization involves a lead candidate provided by a collaborator that requires improvement prior to being identified as a drug development candidate. Using our computational drug discovery approach, initial libraries are constructed around a given template. Using a convergent, iterative process, subsequent libraries are increasingly focused as increased activity (e.g., affinity, selectivity) is achieved. Collaborative Agreements CombiChem's collaborative agreements are as follow:
- --------------------------------------------------------------------------------------------------- COMPANY NAME TARGET OR THERAPEUTIC AREA OF FOCUS TYPE OF PROGRAM - --------------------------------------------------------------------------------------------------- Elan/Athena Multiple targets in central nervous system Lead generation, lead conditions evolution, and lead optimization ICOS Identified, undisclosed target Lead evolution ImClone Multiple targets in oncology Lead generation, lead evolution Novartis Crop Herbicide, fungicide and insecticide Lead optimization Protection AG Ono Program based on Universal Informer Library Target selection, Lead generation Roche Bioscience Protein-Protein interaction Lead optimization Enzyme Lead evolution Receptor Lead optimization Sumitomo Target implicated in osteoarthritis and Lead evolution rheumatoid arthritis Teijin G-protein coupled receptor Lead evolution(1) - ---------------------------------------------------------------------------------------------------
(1) The Teijin program started as a lead optimization program. 9 11 Internal Discovery Programs We are conducting our own internally funded discovery programs by choosing biological targets of current scientific interest and working in collaboration with genomics, biotechnology or screening companies. After identifying lead candidates that are ready for development, we intend to outlicense them, retaining a larger economic interest in such candidates as they are developed and commercialized by a third party. COMBICHEM'S COLLABORATIVE ARRANGEMENTS Our business model is to enter into collaborative arrangements focused on drug discovery efforts to improve our chances of achieving profitability and to minimize our financing requirements. Commercial terms of a collaborative arrangement are driven by the number and nature of the targets. The key components of the commercial terms typically contained in our collaborations include project initiation fees, research funding, milestone payments and royalties. We have the following completed or active collaborative arrangements: Athena Neurosciences, Inc., a wholly owned subsidiary of Elan Corporation, plc In October 1997, we entered into a multiple project collaborative agreement with Athena Neurosciences, Inc., a wholly owned subsidiary of Elan Corporation, plc. The agreement provides for a three-year research program to discover novel therapeutic compounds for treatment of central nervous system conditions. The first project was initiated upon signing, with a second project initiated in March 1998. The agreement provides for Elan/Athena's access to the Universal Informer Library as deemed necessary by the research management committee composed of Elan/Athena and CombiChem representatives. Under the agreement, Elan/Athena paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of pre-determined objectives. Elan/Athena will also make royalty payments on worldwide sales of any products resulting from the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach or by Elan/Athena after the one-year anniversary upon 90 days prior written notice. In connection with the initial collaborative agreement, Elan International Services Ltd., an affiliate of Elan/Athena, purchased 1,000,000 shares of common stock for $8.0 million. In addition, the same affiliate acquired 250,000 shares of common stock in the initial public offering. ICOS Corporation In March 1998, we entered into a collaborative agreement with ICOS Corporation providing for a lead evolution project on an undisclosed target. Under the agreement, ICOS receives exclusive global rights to develop and market any products resulting from the collaboration. ICOS made an advance payment in April 1998, and agreed to pay research support funding, payments upon achievement of certain clinical milestones and royalty payments on any product sales. The lead evolution project terminates on August 31, 2000. The agreement may be terminated by either party 90 days following an uncured material breach. ImClone Systems Incorporated In October 1997, we entered into a collaborative agreement with ImClone Systems Incorporated providing for a two-year research program to identify and characterize novel small molecule inhibitors to multiple targets for development in oncology. The agreement provides for ImClone's access to our Universal Informer Library and Virtual Library. Under the terms of the agreement, ImClone agreed to provide us with research support payments, milestone payments upon the achievement of certain program objectives and royalties on worldwide product sales of therapeutic products that may arise out of the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach. In connection with the collaborative agreement, ImClone purchased 312,500 shares of common stock for $2.0 million. Novartis Crop Protection AG In May 1998, we entered into a collaborative agreement with Novartis Crop Protection AG providing for a two-year lead optimization project for the herbicide, fungicide and insecticide markets. Under the agreement, Novartis paid a project initiation fee and agreed to provide 10 12 research funding and milestone payments upon the achievement of certain milestones. Novartis has exclusive global rights to develop and market or sub-license products resulting from the collaboration. We will be entitled to royalties on sales of any products resulting from the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach. Ono Pharmaceutical Co., Ltd. In December 1998, we entered into a collaborative agreement with Ono Pharmaceutical Co., Ltd. providing for a two-year lead generation research program on an undisclosed target. Under the agreement, Ono paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Ono will make royalty payments on worldwide sales of any products resulting from the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach. Roche Bioscience, a division of Syntex (U.S.A.) Inc. In October 1996, we entered into a collaborative agreement with Roche Bioscience providing for a broad two-year research program to perform research against three initial targets, including a protein-protein interaction, an enzyme and a receptor, with an option to add additional targets. Roche Bioscience can elect one of the approaches -- lead generation, lead evolution or lead optimization -- for each research program against each collaboration target. A program may be initiated at any time during the term of the collaboration, thereby extending the term to allow for completion of each program. Under the agreement, Roche Bioscience paid a project initiation fee and agreed to provide research funding and to make milestone payments upon the achievement of certain milestones. Roche Bioscience will make royalty payments on worldwide sales of any products resulting from the collaboration. As of January 31, 1999, we had successfully concluded the research phase and delivered lead candidates to Roche for further development. As this development process continues, Roche will make additional payments if certain milestones are met. During 1998, we achieved three research milestones in this collaboration, triggering cash milestone payments in two of the three projects. Sumitomo Pharmaceuticals Co., Ltd. In August 1997, we entered into a collaborative agreement with Sumitomo Pharmaceuticals Co., Ltd. providing for a two-year lead evolution program on a target that is believed to play a fundamental role in osteoarthritis and rheumatoid arthritis. Under the agreement, Sumitomo paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Sumitomo will make royalty payments on worldwide sales of any products resulting from the collaboration. Sumitomo may extend the research period for up to four successive six-month periods upon mutual agreement. The agreement may be terminated by either party 90 days following an uncured material breach. Teijin Limited In March 1996, we entered into a collaborative agreement with Teijin Limited providing for a one-year research program on a G-protein coupled receptor target. In March 1997, we amended our agreement to extend the research phase of the collaborative agreement for an additional year. While the initial focus of the collaboration was lead optimization, the effort was redirected to lead evolution during the course of the research. Under the agreement, Teijin paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Teijin also committed internal resources to the discovery effort. Teijin will make royalty payments on any products resulting from the collaboration. We retain the rights to the compounds arising under this collaboration in North and South America; Teijin has rights to these compounds in Asia and Europe with a right of first negotiation to acquire our rights. Under the original agreement, either party may terminate the agreement in the event of a material breach remaining uncured for 60 days. As of March 31, 1998, we successfully concluded the research phase and delivered lead candidates to Teijin for further development. As this development process continues, Teijin will make additional payments if certain milestones are met. 11 13 RESEARCH AND DEVELOPMENT Our expenses for research and development activities were as follows:
YEAR ENDED DECEMBER 31, -------------------------- 1996 1997 1998 ------ ------ ------ (IN THOUSANDS) Collaborative........................... $ 420 $4,317 $9,209 Proprietary............................. 4,820 4,400 5,849
The increases reflect the additional costs incurred with the expansion of the Company's collaborative agreements and the investments in proprietary technologies. COMPETITION Many organizations are actively attempting to identify, optimize and generate lead compounds for potential pharmaceutical development. We compete with the research departments of pharmaceutical companies, biotechnology companies, combinatorial chemistry companies and research and academic institutions, as well as other computationally based drug discovery companies. Many of these competitors have greater financial and human resources and more experience in research and development than we have. Historically, large pharmaceutical companies have maintained close control over their research activities, including the synthesis, screening and optimization of chemical compounds. Many of these companies, which represent one of the largest potential markets for our products and services, are internally developing combinatorial and computational approaches 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 compounds extracted from natural products, such as plants and microorganisms, and compounds created using rational drug design. Academic institutions, governmental agencies and other research organizations are also conducting research in areas in which we are working, either on their own or through collaborative efforts. We anticipate that we will face increased competition in the future as new companies enter the market and advanced technologies become available. Our processes may be rendered obsolete or uneconomical by technological advances or entirely different approaches developed by one or more of our competitors. The existing approaches of our competitors or new approaches or technology developed by our competitors may be more effective than those developed by us. PATENTS AND PROPRIETARY INFORMATION Our success will depend in large part on our own, our licensees' and our licensors' ability to obtain and defend patents for each party's respective technologies and the compounds and other products, if any, resulting from the application of such technologies. Our success will also depend on our ability to maintain trade secrets and operate without infringing upon the proprietary rights of others, both in the United States and in foreign countries. The patent positions of pharmaceutical and biotechnology companies, including ours, are uncertain and involve complex legal and factual questions for which important legal principles are largely unresolved. We have pending United States and foreign patent applications relating to various aspects of our technology, certain systems, materials and methods used in screening compounds and the libraries or compounds contained in the libraries. These patent applications are either owned or co-owned by us or rights under them are licensed to us. To date, one of our foreign patents has issued and two United States patents have issued. To the extent that any foreign patent application filed in the European Patent Office or the Japanese Patent Office issues as a patent, a challenge to the validity of such patent may be presented in an opposition proceeding. Patents may not issue as a result of any such pending applications. Even if patents are issued, such patents may not be sufficiently broad to afford protection against competitors with similar technologies. We are aware of five United States patents issued to third parties that claim proprietary rights; two of these patents are entitled "System and method for automatically generating chemical compounds with desired properties", the third is entitled "System, method, and computer program for at least partially automatically generating chemical compounds having desired properties" and the fourth and fifth are entitled "Method of generating a plurality of chemical compounds in a spatially arranged array." Although we believe that our current activities do not infringe these patents or the patents of other third 12 14 parties, we continually assess our position with respect to such patents. Our belief about our activities may not be upheld in any litigation over patents. In addition, our future technological developments may not be outside the scope of these patents or the patents of other third parties. Further, third parties may seek to assert such patent rights against us, which would result in significant legal costs and require substantial management resources. We may need a license from a third party to continue practicing our rights. We may not be able to obtain such a license, if required, on commercially reasonable terms, if at all. From time to time, we receive correspondence from third parties to license patents owned or controlled by third parties. Our inability to obtain or maintain patent protection or necessary licenses could have a material adverse effect on our business and results of operations. Our inability either to demonstrate non-infringement of these and other current and future patents, whether issued in the United States or overseas, or to obtain the appropriate licenses, would have a material adverse effect on our business and results of operations. Moreover, there can be no assurance that we or our customers will be able to obtain patent protection for lead compounds or pharmaceutical products based upon our or our customers' technologies. Any patents issued to us or our collaborative partners, or for which we have license rights, may be challenged, invalidated or circumvented. The rights granted under any licenses may not provide competitive advantages to us. To the extent that we or our consultants or collaborators use intellectual property owned by others in their work for us, disputes may also arise as to the rights in related or resulting know-how and inventions. Litigation may be necessary to enforce our patent and license rights or to determine the scope and validity of others' proprietary rights. Any such litigation, whether or not the outcome thereof is favorable to us, could result in substantial cost to and diversion of effort by us. Further, United States patent law does not provide any remedies for infringement that occurred before the patent is issued. Our commercial success will also depend upon successfully avoiding the infringement of current and future patents issued to competitors and upon maintaining the technology licenses upon which certain of our current products are, or any future products under development might be, based. If our competitors prepare and file patent applications in the United States that claim inventions also claimed by us or our collaborators, we may have to participate in interference proceedings declared by the Patent and Trademark Office to determine the priority of invention, which could result in substantial cost to us, even if the outcome is favorable to us. An adverse outcome could subject us to significant liabilities to third parties and require us to license disputed rights from third parties or cease using the technology. A United States patent application is maintained under conditions of confidentiality while the application is pending in the Patent and Trademark Office. As a result, we cannot determine the inventions being claimed in pending patent applications filed by our competitors in the Patent and Trademark Office. A number of pharmaceutical and biotechnology companies and research and academic institutions have developed technologies, filed patent applications or received patents on various technologies that may be related to our business. Some of these technologies, applications or patents may conflict with our technologies or patent applications. Such conflict could limit the scope of the patents, if any, that we may be able to obtain, or result in the denial of our patent applications. We may not be able to obtain licenses to patents held by third parties that may cover our activities at a reasonable cost, if at all. To continue to practice our technology we would have to develop or obtain alternative technologies which we may not be able to do. We currently have certain licenses from third parties and in the future may require additional licenses from other parties. These licenses may be required to refine our Discovery Engine further and to allow our collaborators to develop, manufacture and market commercially viable products effectively. Such licenses may not be obtainable on commercially reasonable terms, if at all. In addition, patents underlying such licenses may not be valid and enforceable. Finally, the proprietary nature of any patented technology underlying such licenses may not remain proprietary. We rely substantially on certain technologies that are not patentable or proprietary and are therefore available to our competitors. We also rely on certain proprietary trade secrets and know-how that are not patentable. Although we believe we have taken steps to protect our unpatented trade secrets and know-how, in part through the use of confidentiality agreements with our employees, consultants and certain of our contractors, there can be no assurance that (1) these agreements will not be breached, (2) we would have adequate remedies for any breach or (3) our trade secrets will not otherwise become known or be independently developed or discovered by competitors. Our failure to protect all or part of our patents, trade secrets and know-how could have a material adverse effect on our business and results of operations. 13 15 GOVERNMENT REGULATION 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 one of our customers or collaborators or, in the event we decide to develop a drug beyond the early testing phase, by us. The nature and the extent to which such regulation may apply to our customers will vary depending on the nature of any such drugs. Virtually all drugs developed by our customers will require regulatory approval by governmental agencies prior to commercialization. In particular, drugs to be administered to humans are subject to rigorous testing and other approval procedures established by the FDA and by foreign regulatory authorities. Various federal and, in some cases, state statutes and regulations also govern or influence, among other things, the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of such drugs. Non-compliance with applicable requirements can result in fines, warning letters, recall or seizure of products, clinical study holds or delays, total or partial suspension of production, refusal of the government to grant approvals, and civil and criminal penalties. 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 studies in the laboratory and in animal models to gain preliminary information on a compound's efficacy and to identify any safety problems. Studies must be conducted by laboratories that comply with FDA regulations regarding good laboratory practices. The results of these studies are submitted as a part of an investigational new drug application that the FDA must review before human testing of a potential drug can begin. In order to commercialize any products, we or our customer will be required to sponsor and file an investigational new drug application and will be responsible for initiating and overseeing the human testing to demonstrate the safety and efficacy that are necessary to obtain FDA and foreign regulatory authority approval of any such drugs. Human testing is normally done in three phases and generally takes two to five years but may take longer to complete. After completion of human testing of a new product, FDA and foreign regulatory authority marketing approval must be obtained. If the product is classified as a new drug, we or our customer will be required to file a new drug application and receive approval before commercial marketing of the drug can begin. The testing and approval processes require substantial time and effort. Approvals may not be granted on a timely basis, if at all. New drug applications submitted to the FDA can take, on average, two to five years to obtain approval. If questions arise during the FDA review process, approval can take more than five years. Even if FDA regulatory clearances are obtained, a marketed product is still subject to continual review. 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. Domestic manufacturing facilities used by us or our customers are subject to biannual inspections by the FDA and must comply with the FDA's current good manufacturing practices regulations. To comply with such regulations, a manufacturer must spend funds, time and effort in the areas of production and quality control to ensure full technical compliance. The FDA stringently applies regulatory standards for manufacturing. For marketing outside the United States, we or our customer will also be subject to foreign regulatory requirements governing human testing and marketing approval for drugs. The requirements governing the conduct of human testing, product licensing, pricing and reimbursement vary widely from country to country. Our research and development processes involve the controlled use of hazardous materials. We are 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 we believe that our activities currently comply with the standards prescribed by such laws and regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, we could be held liable for any damages that result, and any such liability could exceed our resources. In addition, we may be required to incur significant costs to comply with environmental laws and regulations in the future. The occurrence of any such event could have a material adverse effect on our business and results of operations. 14 16 SALES AND MARKETING We market our products directly to customers through participation in trade conferences and seminars and publications in scientific and trade journals. To date, we have sold our product offerings to our collaborative partners primarily through the efforts of our senior management and dedicated business development professionals. In addition, we utilize outside consultants to supplement our business development activities in targeted geographies or industries. HUMAN RESOURCES As of February 28, 1999, we had 93 full-time employees, 55 of whom have Ph.D. degrees. Of these employees, 76 were engaged in research and development and 17 were engaged in marketing and general administration. None of our employees are covered by collective bargaining agreements. We consider our relations with our employees to be good. RISKS AND UNCERTAINTIES The following is a summary of some of the many risks we face in our business. You should carefully review these risks in evaluating our business. THE TECHNOLOGY WE USE IN OUR BUSINESS IS NEW AND HAS NOT BEEN SHOWN TO BE SUCCESSFUL IN DISCOVERING NEW DRUGS. Our drug discovery process is new. We have not yet shown that it can successfully be used to discover drug candidates that ultimately become commercial products. Furthermore, our drug discovery efforts are focused on some targets with unknown functions. Development of new drugs is highly uncertain. Our drug discovery process may not result in drug candidates that will be safe or effective or commercially successful as products. If our technology is not validated through the successful discovery of drug candidates, our business will be adversely affected. Our strategy, which is unproven, is to use our proprietary technology to rapidly identify, optimize and obtain rights to as many drug candidates as possible. Our near-term profitability depends entirely on whether we can enter into additional collaborative agreements and maintain our current agreements. The pricing and nature of our collaborative relationships, however, is such that our potential customers may include only a limited number of drug, biotechnology and agrochemical companies. Our strategy also involves conducting our own discovery programs by choosing biological targets of current scientific interest and working in collaboration with screening companies to discover drug candidates. Accordingly, we cannot be certain that our strategy will prove successful. Our success also depends on whether potential customers view our process as an effective drug discovery tool. Historically, drug, biotechnology and agrochemical companies have identified and optimized new drug candidates in their own research departments. They have done so primarily to protect the proprietary nature of their activities. To achieve our business objectives, we must convince these companies that our technology and capabilities justify the outsourcing of their programs to us. We may not, however, be able to attract any future customers on acceptable terms for our products and services or develop a sustainable, profitable business. Any failure to do so would adversely affect our business. We generally structure each of our collaborative agreements to provide us with payments for: - initiating the collaboration, - providing research for a specified period (typically over one or two years), - attaining specifically-negotiated milestones, and - earning royalties from the commercial sale of any successfully developed drug candidate. To date, we have generated most of our revenues from providing research services under our collaborative agreements. We receive these revenues, however, only for a limited period and they are generally offset by corresponding research costs. After we complete the research phase of each collaborative agreement, we will receive additional revenues only if our collaborators achieve the 15 17 specified milestones or sell products on which we earn royalties from commercial sales. Any failure to achieve the milestones or to earn royalties could adversely affect our business. WE MAY NEVER BE PROFITABLE. Our near term profitability depends entirely on whether we can enter into additional collaborative agreements and maintain our current agreements. As a result, we are unable to predict when, or if, we will become profitable. We have not yet received, and may never receive, any revenues from royalties for commercial sales by a customer. In addition, our strategy includes potentially developing and licensing drug candidates that we have identified through our internal programs, at our own expense, to others for further development. To date, we have not entered into any of these licenses. We may never enter into any of these licenses on acceptable terms or at all. THE SUCCESSFUL IMPLEMENTATION OF OUR STRATEGY IS DEPENDENT ON THE ACTIVITIES OF OTHERS, OVER WHICH WE HAVE NO CONTROL. Our strategy depends on our ability to enter into collaborative arrangements with others on a regular basis. We may not be able to continue to establish additional collaborative arrangements. If we are successful in establishing additional arrangements, they may not be on favorable terms. The collaborative arrangements also may not ultimately be successful. Any failure to enter into additional collaborative arrangements on favorable terms would adversely affect our business. The timing of when we receive revenues from collaborative arrangements depends on both our efforts and our collaborators' efforts. Generally, for any prospective drug candidate discovered with our technology each of the following events must occur before the candidate results in a commercialized product that will generate milestone payments and royalties: - the early and human testing of the drug candidate must be successful, - the required regulatory approvals, both in the United States and foreign countries, must be obtained, - manufacturing, sales and marketing capabilities must be established, and - the product must be successfully marketed in commercial quantities and at reasonable costs. We do not currently plan to perform any of these activities. Therefore, we will depend on others' expertise and commitment to develop and commercialize products based on drug candidates we discovered or optimized. The amount and timing of resources that current and future collaborators devote to our collaborations are not within our control, and we cannot be certain that their efforts will be successful. In addition, when we are eligible to earn milestone payments differs for each agreement. For instance, for some collaborations, we may not earn milestone fees until the collaborator has advanced products into human testing, which may be well into the future. Furthermore, our collaborative partners are not obligated to develop or commercialize drug candidates we have discovered. Rather, each collaborative partner may independently move forward with a competing drug candidate that the partner developed either internally or in collaboration with others, including our competitors. The potential drugs a collaborative partner develops also may be derivatives of the drug candidates we provided to the partner. While our existing collaborative agreements allow us to retain milestone and royalty payment rights with respect to drugs developed from certain derivatives, disputes may arise over how the payment provisions in our agreements apply to those types of drugs. Conflicts also may arise between collaborative partners about who has the proprietary rights to particular compounds or drug candidates. Additionally, our collaborators generally may terminate their agreements with us upon short notice and following an uncured material breach. Termination of our existing or future collaborative agreements, would result in a loss of anticipated revenue and could adversely affect our business. Furthermore, even though we use independent teams for each collaborative project, conflicts may arise among our collaborators about which collaborator has rights to any overlapping compounds or drug candidates developed with our technologies. Any failure to manage our collaborative relationships successfully, maintain confidentiality among our relationships or prevent these types of conflicts could lead to costly and time consuming disputes and a loss of 16 18 reputation, capital or current or future collaborators. Any of these events could adversely affect our business. SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY RESULTS COULD MATERIALLY IMPACT OUR STOCK PRICE. Our operating results may vary substantially from quarter to quarter and will not necessarily be indicative of results in later periods. Any quarterly fluctuations in revenue or financial results may materially impact our stock price. To date, we have received revenues from project initiation fees, research funding and milestone fees paid under our collaborative agreements. We expect that most of our revenues for the foreseeable future will continue to consist of these payments. In any one quarter, we may receive multiple or no payments from our collaborators. OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO BUILD AND MAINTAIN A STRONG INTELLECTUAL PROPERTY POSITION; FAILURE TO DO SO WOULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. Our success will depend on our ability and the ability of our licensors to obtain and defend patents and other proprietary rights for our technologies and the compounds and other products resulting from our technologies. In addition, to be successful we must avoid infringing the proprietary rights of others. Our patent position, like that of many drug and biotechnology companies, is uncertain and involves complex legal and factual questions for which important legal principles are unresolved. We may not develop or obtain rights to products or processes that are patentable. Even if we do obtain patents, they may not adequately protect the technology we own or have licensed. In addition, others may challenge, seek to invalidate, infringe or circumvent any patents we own or license, and rights we receive under those patents may not provide competitive advantages to us. Further, our activities may infringe the patent rights of others. We cannot be certain that any patents will issue as a result of any pending applications. In addition, any issued patents still may not provide sufficient protection against competitors with similar technologies. Although we believe that our current activities do not infringe any patents of others, we continually assess our position. We cannot be certain that we would be successful in any litigation over patents or that our future technological developments will be outside the scope of others' patent rights. We may also need to initiate litigation, which could be time consuming and expensive, to enforce our proprietary rights or to determine the scope and validity of others' rights. If litigation results, a court may find our patents or those of our licensors invalid or may find that we have infringed on a competitor's rights. If any of our competitors have filed patent applications in the United States which claim technology we also have invented, the Patent and Trademark Office may require us to participate in expensive interference proceedings to determine who has the right to a patent for the technology. We currently license rights from other parties. In the future we may require additional licenses from other parties to refine our drug discovery process further and to allow our collaborators to develop, manufacture and market commercially viable products effectively. We cannot be certain that: - we will be able to obtain any licenses on commercially reasonable terms, or at all, - any patents underlying such licenses will be valid and enforceable, or - the proprietary nature of any patented technology underlying such licenses will remain proprietary. In addition, if we breach any of our licenses, we may lose important rights. We also rely on unpatented trade secrets and know-how to maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with employees, consultants and others. These parties may breach or terminate these agreements, and we may not have adequate remedies for any breach. In addition, our competitors may independently discover our trade secrets. We also rely substantially on certain technologies that are not patentable or proprietary and are therefore available to our competitors. 17 19 OUR INDUSTRY IS EXTREMELY COMPETITIVE AND WE MAY ULTIMATELY PROVE UNSUCCESSFUL. Many organizations are actively attempting to identify, optimize and generate compounds for potential drug development. We compete with the research departments of drug companies, biotechnology companies, agrochemical companies, combinatorial chemistry companies and research and academic institutions as well as other drug discovery companies. Many of our competitors have greater financial and human resources and more experience in research and development. We anticipate that we will face increased competition in the future as new companies enter the market and advanced technologies become available. Ultimately, our processes may become obsolete or uneconomical as a result of new technologies or approaches our competitors develop. For a more complete description of the competitive nature of our industry, please see "Business -- Competition." FAILURE TO EXPAND OUR OPERATIONS AND MANAGE OUR EXPANDED OPERATIONS WOULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. Our success will depend on whether we can expand our operations to service additional collaborative arrangements and manage our expanded operations. To be cost-effective, we must enhance our productivity by further automating our processes and improving our technology generally. In addition, we must successfully structure and manage additional collaborative relationships, including maintaining the confidentiality of the research being provided to our customers. We may not be able to add the technical personnel needed to meet the staffing requirements of any additional collaborative relationships. In addition, our efforts to automate our processes further or to improve our technology may not be successful. Any failure to achieve these goals could adversely affect our business. THE LOSS OF ONE OR MORE OF THE KEY MEMBERS OF OUR SCIENTIFIC AND MANAGEMENT STAFF COULD ADVERSELY AFFECT OUR BUSINESS. The loss of one or more of the key members of our scientific and management staff could adversely affect our business. Our future success also depends on the continued service of our key design, engineering, scientific, software and management personnel and on our ability to identify, hire and retain any additional personnel. There is intense competition for these qualified personnel. We may not be able to continue to attract and retain the personnel necessary to develop our business. Any failure to attract and retain key personnel could adversely affect our business. FAILURE TO COMPLY WITH REGULATORY REQUIREMENTS WOULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. Any failure to comply with regulatory requirements in the United States and overseas can result in fines, warning letters, recall or seizure of products, clinical study holds or delays, total or partial suspension of production, refusal of the government to grant approvals, and civil and criminal penalties. United States and foreign government regulation will be a significant factor in the production and marketing of any drug products that we, our customers or our collaborators develop. The scope of the regulation will vary depending on the type of products involved. Virtually all drug products our customers develop will require regulatory approval. In particular, the FDA and foreign regulatory authorities require vigorous early state and human testing and other procedures for human drug products. Numerous regulations also govern the manufacturing, safety, labeling, storage, record keeping, reporting and marketing of drug products. The process of obtaining and complying with regulatory approvals is time consuming and expensive. The testing and approval processes require substantial time and we cannot be certain if or when any approval will be granted for any products resulting from our technologies. Even if FDA regulatory clearances are obtained, a marketed product is still subject to continual review. Later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on a product's marketing or withdrawal of the product from the market, as well as possible civil or criminal sanctions. In addition, domestic manufacturing facilities are subject to regular FDA inspections and must comply with the FDA's manufacturing practices regulations. To comply with these regulations, a manufacturer must spend funds, time and effort on production and quality control. For marketing outside the United States, we, our collaborators or customers will also be subject to foreign regulatory requirements governing human clinical trials and marketing approval. 18 20 For a more complete description of regulatory requirements we, our customers and collaborators face, please see "Business -- Government Regulation." OUR FUTURE CAPITAL NEEDS ARE UNCERTAIN AND MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS. Our capital requirements depend on many factors, including: - our ability to enter into additional collaborative arrangements, - competing technological and market developments, - changes in our existing collaborative arrangements, - the cost of filing, prosecuting, defending and enforcing patent claims and other proprietary rights, - the purchase of additional equipment, - the progress in our drug discovery programs, and - our collaborators' ability to commercialize milestone and royalty-bearing compounds. We may be required to raise additional capital over a period of several years to continue our operations. Additional funding, if necessary, may not be available on favorable terms. If adequate funds are not available, we may be required to curtail operations significantly or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies, product candidates, products or potential markets that we would not otherwise relinquish. Any failure to receive additional funding would adversely affect our business. THE EFFORTS OF THE GOVERNMENT AND OTHERS TO REDUCE THE COST OF HEALTH CARE MAY HAVE AN ADVERSE EFFECT ON OUR COLLABORATORS AND OUR BUSINESS. We expect that a substantial portion of our revenue in the foreseeable future will be derived from products and services provided to the drug, biotechnology and agrochemical industries. Accordingly, our success in the foreseeable future depends on the success of the companies within those industries and continued demand for our products and services. The efforts of governments and third party payors to contain or reduce the cost of health care will continue to affect the business and financial condition of these companies. For example, in certain foreign markets, pricing or profitability of prescription pharmaceuticals is subject to governmental control. In the United States, a number of legislative and regulatory proposals to change the health care system have been proposed in recent years. In addition, an increasing emphasis on managed care in the United States has and will continue to increase pressure on drug pricing. We cannot predict whether legislative or regulatory proposals will be adopted. If proposals or reforms are adopted and adversely affect the business of our collaborators or customers, our business may also be adversely affected. OUR USE OF HAZARDOUS MATERIALS MAY SUBJECT US TO SIGNIFICANT ENVIRONMENTAL RISKS WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. We use hazardous materials in our research and development activities. As a result, we are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials. The risk of accidental contamination or injury exists. If an accident occurs, we could be responsible for any damages and the amount of the damages could exceed our resources. In addition, we may incur significant costs to comply with environmental laws and regulations in the future. Any of these events could adversely affect our business. OUR EXECUTIVE OFFICERS, DIRECTORS AND THEIR AFFILIATES MAY INFLUENCE ALL MATTERS REQUIRING STOCKHOLDER APPROVAL. Our executive officers and directors and their affiliates own approximately 30% of our outstanding common stock. As a result, these stockholders may influence all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions. This concentration of ownership could also delay or prevent a change in our ownership that other stockholders may favor. 19 21 THE MARKET PRICE OF OUR COMMON STOCK IS VOLATILE AND YOU MAY NOT BE ABLE TO MAKE A RETURN ON YOUR INVESTMENT. The market price of our common stock is likely to be volatile and could fluctuate widely in response to many factors, including: - announcements of new technologies or products by us or our competitors, - developments concerning patents or other proprietary rights, - publicity regarding the status of compounds we or our collaborators are developing, - regulatory developments, both in the United States and foreign countries, - public concern about the effectiveness of new technologies, - changes in expectations of securities analysts concerning our company or our industry in general; - quarterly fluctuations in our revenues and financial results, and - general market conditions. As a result, our operating results may be below the expectations of market analysts and investors, which could reduce the market price of our common stock. The stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices of the securities of many companies in our industry. Often, these fluctuations have been unrelated or disproportionate to the operating performance of the companies. These market fluctuations, as well as general economic, political and market conditions, may reduce the market price of our common stock. In addition, in the past, securities class action litigation has often been instituted following periods of volatility in the market prices of securities. If we face such litigation in the future, it would be costly and time consuming and could adversely affect our business. OUR CHARTER, DELAWARE LAW AND CERTAIN CONTRACT PROVISIONS MAY PREVENT OR DELAY A CHANGE OF CONTROL WHICH MAY NOT BE IN THE BEST INTERESTS OF OUR STOCKHOLDERS. Certain provisions of our charter and stock options, as well as certain provisions of Delaware law, could delay or impede the removal of incumbent directors and could make more difficult a merger, tender offer or proxy contest involving us, even if the events could be beneficial to our stockholders. These provisions could also limit the price that investors might be willing to pay for our common stock. Our charter also authorizes our Board of Directors to issue shares of undesignated preferred stock without stockholder approval on terms that the Board may determine. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to our other stockholders or otherwise adversely affect the rights and powers, including voting rights, of our other stockholders. Moreover, the issuance of preferred stock may make it more difficult for another party to acquire, or may discourage another party from acquiring, voting control of us. WE MAY NOT BE SUCCESSFUL IN RESOLVING ALL OUR YEAR 2000 ISSUES WHICH COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS. The year 2000 issue refers to the inability of certain date-sensitive computer chips, software, and systems to recognize a two-digit date field as belonging to the 21st century. This is a significant issue for most, if not all companies, with far reaching implications, some of which cannot be anticipated or predicted with any degree of certainty. The year 2000 issue may create unforeseen risks to us from our internal computer systems as well as from computer systems of third parties. Any failure of our and/or others' computer systems could adversely affect our business. For a more complete description of the status of our year 2000 readiness program and contingency plans we have instituted, please see "Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000." ITEM 2. PROPERTIES We currently lease and occupy approximately 40,000 square feet of laboratory and office space in San Diego, California. We also lease and occupy approximately 6,000 square feet of office 20 22 space in Palo Alto, California. Our primary San Diego lease (34,000 sq. ft.) expires in May 2006 and a 6,000 square foot laboratory lease expires in October 1999. The Palo Alto lease expires in October 2002. In February 1999, we entered into a 15-year lease agreement for 75,000 square feet of laboratory and office space in San Diego, California with a target commencement date of November 1, 1999. Upon commencement of the new lease, the existing lease for 34,000 square feet in San Diego, California will terminate. Additionally, upon termination, the landlord will purchase all tenant improvements from us at their projected net book value of $2.5 million. ITEM 3. LEGAL PROCEEDINGS We are not a party to any legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 21 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Shares of our common stock are traded on the Nasdaq National Market under the symbol "CCHM." Prior to our initial public offering in May 1998, there was no established published trading market for our common stock. The following table presents the quarterly high and low sales prices of the common stock as reported by Nasdaq. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions. - ---------------------------------------------------------------------- 1998 - ---------------------------------------------------------------------- High Low - ---------------------------------------------------------------------- First quarter n/a n/a - ---------------------------------------------------------------------- Second quarter $8.75 $6.13 - ---------------------------------------------------------------------- Third quarter $8.63 $3.38 - ---------------------------------------------------------------------- Fourth quarter $5.88 $3.38 - ----------------------------------------------------------------------
We had 191 stockholders of record and approximately 800 beneficial stockholders as of February 28, 1999. DIVIDEND POLICY We have not paid dividends on our common stock and intend to continue this policy to retain earnings for use in our business. USE OF PROCEEDS A Registration Statement on Form S-1 (File No. 333-37981) registering 2,587,500 shares of our common stock was declared effective by the SEC on May 7, 1998. The amount of net offering proceeds from the IPO and over-allotment option was approximately $16.2 million. Such proceeds have been invested in short-term investment-grade securities. The principal purposes of the offering were to: (1) increase our equity capital, (2) create a public market for the our Common Stock in order to facilitate future access to public equity markets and (3) create liquidity for our existing stockholders. We intend to use the net proceeds of this offering, together with our existing cash and cash equivalents and short-term investments, to fund research and development, expand laboratory and office facilities and for general corporate purposes. We may also use a portion of the net proceeds for the acquisition of businesses, technologies or products complementary to us. There are no present arrangements or agreements for any such acquisitions. The amounts actually expended for each purpose may vary significantly depending upon numerous factors, including the amount and timing of additional collaborative agreements, the progress of our development, technological advances, the commercial potential of the our services and the status of the our competitors. We believe that our existing cash, cash equivalents and short-term investments, combined with the net proceeds of this offering, projected funding from equipment leases and interest income will be adequate to satisfy our capital requirements and fund operations for the foreseeable future. 22 24 ITEM 6. SELECTED FINANCIAL DATA
PERIOD FROM MAY 23, 1994 (INCEPTION) TO YEAR ENDED DECEMBER 31, DECEMBER 31, ------------------------------------- 1994 1995 1996 1997 1998 -------------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Total revenue..................... $ -- $ 50 $ 2,967 $ 7,471 $15,074 Total operating expenses.......... 711 6,763 8,085 12,004 19,111 ----- ------- ------- ------- ------- Loss from operations.............. (711) (6,713) (5,118) (4,533) (4,037) Net loss.......................... $(706) $(6,675) $(5,118) $(4,322) $(3,312) ===== ======= ======= ======= ======= Basic net loss per share.......... $(19.18) $(11.30) $ (4.45) $ (0.36) ======= ======= ======= ======= Shares used in computing basic net loss per share................. 348 453 971 9,140 ======= ======= ======= =======
AS OF DECEMBER 31, ------------------------------------------------- 1994 1995 1996 1997 1998 ------ ------- -------- -------- -------- BALANCE SHEET DATA: Cash and cash equivalents........... $1,622 $ 3,136 $ 367 $ 5,867 $ 20,334 Short-term investments.............. -- -- 12,166 11,055 9,025 Working capital..................... 1,420 1,990 8,946 12,896 26,146 Total assets................ 1,796 3,997 16,505 25,376 41,980 Long-term obligations, including current portion.................. -- 584 2,541 4,944 6,214 Redeemable convertible preferred stock............................ 2,250 9,650 23,107 23,130 -- Accumulated deficit................. (706) (7,381) (12,499) (16,821) (20,133) Total stockholders' (deficit) equity.......... (682) (7,414) (12,516) (6,449) 30,177
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This annual report may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, which are discussed above in Item 1 at "Risks and Uncertainties." While this outlook represents our current judgment on the future direction of our business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested below. We undertake no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date of this annual report. OVERVIEW CombiChem is a computational product discovery company that is applying its proprietary design technology and rapid synthesis capabilities to accelerate the discovery process for new drugs and chemical products. We believe our approach offers pharmaceutical and chemical companies the opportunity to conduct their discovery efforts in a more productive and cost-effective manner. Using our proprietary Discovery Engine(TM)process, we focus on the generation, evolution and optimization of potential new lead candidates for our collaborative partners who will then develop, manufacture, market and sell any resulting products. We believe that our process is widely applicable to a variety of disease targets and therapeutic indications as well as to other industries such as agrochemical, industrial chemical and materials science. To date, we have established collaborative agreements with Athena Neurosciences, Inc., a wholly owned subsidiary of Elan Corporation, plc, ICOS Corporation, ImClone Systems Incorporated, Novartis Crop Protection AG, Ono Pharmaceutical Co., Ltd., Roche Bioscience, a division of Syntex (U.S.A.) Inc., Sumitomo Pharmaceuticals Co., Ltd. and Teijin Limited. In addition, we are using our approach on internal programs to discover new lead candidates that will then be outlicensed to third parties, while retaining a larger economic interest. In December 1998, we further broadened the application of the technology by establishing a joint venture with Chirotech Technology, Ltd., a member of the Chiroscience Group of companies, to commercialize libraries of chiral compounds. 23 25 The joint venture, ChiroChem Discovery Services, LLC, was established to develop and sell specifically designed chiral compound libraries. Our revenue to date is primarily attributable to the receipt of project initiation fees, milestone payments and research funding. Project initiation fees are received from our collaborators upon, or shortly following, execution of the collaborative agreement. Milestone payments are received from collaborators upon achievement of certain pre-determined objectives. In connection with the performance of research services, we receive research funding under our collaborative agreements. Research funding typically is received only during the life of the research program under the particular collaboration. In addition, we may receive advance payments from our collaborators or potential collaborators, which require us to complete certain performance obligations. Such payments are recorded as deferred revenue when received and are recognized as revenue when our performance obligations have been met, as evidenced by our collaborator's written approval and acceptance. The collaborative activities for which we receive revenue typically occur over a one- to three-year period, if multiple projects are anticipated, or one to two years for single project collaborations. The agreements provide for earlier termination in certain circumstances. We expect that a significant portion of our revenue for the foreseeable future will be comprised of such payments. The receipt of project initiation fees is dependent on our ability to enter into additional collaborative agreements that provide for such fees; the timing of such payments will be difficult to predict. In addition, the timing of certain revenue in the future will depend upon the completion of certain milestones as provided for in our collaborative agreements, which are contingent and uncertain. Milestone fees may be earned for different events or achievements in different agreements. For certain collaborations, such fees may not be earned until the collaborator has advanced products into human testing. In any one fiscal quarter we may earn multiple or no payments from our collaborators. Operating results may therefore vary substantially from period to period and will not necessarily be indicative of results in subsequent periods. Completion of the research phase of a single project collaboration or a single project within a broad multiple project collaboration is not expected to have a material adverse effect on our business. However, the termination or conclusion of any collaborative agreement could have a material adverse effect on our business. In addition, our failure to enter into additional collaborative agreements on favorable terms would have a material adverse effect on our business. We have not been profitable since inception. We have incurred a cumulative net loss of $20.1 million through December 31, 1998. Losses have resulted principally from costs incurred in research and development activities related to efforts to develop our technologies and from the associated administrative costs of supporting these efforts. Our ability to achieve profitability is dependent on our ability to market our technology and capabilities to pharmaceutical, biotechnology, agrochemical and chemical companies. RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1998 AND 1997 Revenue Our revenue for the year ended December 31, 1998 was $15.1 million, up from $7.5 million for the same period in 1997. The increase in revenue resulted primarily from entering into collaborative agreements with ICOS, Novartis and Ono during 1998, the full-year effect of the Sumitomo, Elan/Athena and ImClone agreements, which were executed in 1997, and the achievement of four milestones in 1998. We received three milestone payments from Roche Bioscience and one from Teijin during 1998. Revenue from collaborators exceeding 10% of total revenue for the year ended December 31, 1998 was 38% from Roche, 17% from Sumitomo, 14% from Elan/Athena and 12% from Ono. Operating Expenses Research and development expenses for the year ended December 31, 1998 totaled $15.1 million compared to $8.7 million for the same period in 1997. Research and development costs incurred on behalf of our collaborators increased $4.9 million due to an increase in the number of projects in the active collaboration phase. Research and development costs incurred to advance our proprietary technologies increased $1.4 million due to increased staffing and the full year effect of operations added during 1997. We expect research and development spending to increase over the 24 26 next several years due to increased activities related to collaborations, internal programs and technology development. General and administrative expenses for the year ended December 31, 1998 totaled $4.1 million compared to $3.3 million for the same period in 1997. This increase reflects increased business development activities and administrative support for our expanded programs. These expenses will likely increase in future periods to support our projected growth. Interest Income/Interest Expense Net interest income for the year ended December 31, 1998 was $0.9 million compared to $0.4 million for the same period in 1997. This change reflects increased cash and investment balances resulting from receipts under collaborative agreements and our initial public offering in May 1998. Interest income was partially offset by interest expense incurred on capital lease obligations. Net Loss Net loss for the year ended December 31, 1998 was $3.3 million compared to $4.3 million for the same period in 1997. The decreased loss is primarily attributable to increased revenue from project initiation fees and milestone achievements. YEARS ENDED DECEMBER 31, 1997 AND 1996 Revenue Revenue for the year ended December 31, 1997 was $7.5 million, up from $3.0 million for the same period in 1996. The increase in revenue resulted primarily from entering into collaborative agreements with Sumitomo and Elan/Athena in 1997 and the full year effect of the Teijin and Roche collaborations, which were executed in 1996. Revenues from collaborators exceeding 10% of total revenues for the year ended December 31, 1997 was 39% from Sumitomo, 30% from Roche, and 18% from Elan/Athena. Operating Expenses Research and development expenses for the year ended December 31, 1997 were $8.7 million, up from $5.2 million for the same period in 1996. This increase reflects increased research and development expenses incurred on behalf of collaborators. Such expenses include salaries for additional chemists and molecular design staff for each project team and the associated depreciation of new laboratory equipment. We have the ability to direct our scientific personnel to work either on our collaborative agreements or on our internal research projects as needs arise. We expect research and development spending to increase over the next several years due to increased activities related to collaborations, internal programs and technology development. General and administrative expenses for the year ended December 31, 1997 were $3.3 million, up from $2.8 million for the same period in 1996. This increase reflects increased business development activities, including outside consulting fees and increased travel costs, and administrative support for our expansion in 1997. These expenses will likely continue to increase in future periods to support our projected growth. Interest Income/Interest Expense Net interest income for the year ended December 31, 1997 was $0.4 million compared to a break-even position for the same period in 1996. This change reflects increased cash and investment balances resulting from receipts under collaborative agreements and the sale of common stock in conjunction with the signing of the Elan/Athena and ImClone agreements. Interest income was partially offset by interest expense incurred on capital lease obligations Net Loss Net loss for the year ended December 31, 1997 was $4.3 million compared to $5.1 million for the same period in 1996. The decrease is primarily attributable to additional revenue generated from corporate collaborations during 1997. 25 27 LIQUIDITY AND CAPITAL RESOURCES From inception through December 31, 1998, we financed our operations through proceeds from our initial public offering and private placements of equity securities, payments from corporate collaborators, and the utilization of capital equipment lease financing. In May 1998, we completed our initial public offering of 2,359,500 shares of our common stock (including partial exercise of the underwriters' over-allotment option), generating net proceeds of approximately $16.2 million. Net cash used in operating activities for the year ended December 31, 1998 was $1.9 million compared to net cash used of $3.5 million for the corresponding period in 1997. The decrease in net cash used in operating activities was primarily attributable to the reduction of our net loss and the collection of advance payments from collaborators. At December 31, 1998, we held cash and cash equivalents and short-term investments with a value of $29.4 million. Our working capital at December 31, 1998 was $26.1 million. We have maintained capital lease arrangements since 1994. Under these arrangements, we have funded certain capital expenditures with lease terms ranging from 36 to 48 months in duration. As of December 31, 1998, we had utilized $9.2 million of an available $11.4 million financing facility. We expect the net proceeds from our initial public offering completed in May 1998 and the interest income on the proceeds, together with the existing cash and cash equivalents, short term investments, operating revenue and lease financing arrangements, will be sufficient to finance our working capital and capital requirements for the foreseeable future. Our capital requirements depend on numerous factors. These factors include: (1) our ability to enter into additional collaborative arrangements, (2) competing technological and market developments, (3) changes in our existing collaborative relationships, (4) the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, (5) the purchase of additional capital equipment, (6) the progress of our drug discovery programs and (7) the progress of the commercialization of milestone-and royalty-bearing compounds by our collaborators. We may be required to raise additional capital over a period of several years in order to continue to conduct our operations. Such capital may be raised through additional public or private financing arrangements, as well as collaborative arrangements, borrowings and other available sources. In addition, we may from time to time earn milestone fees under our collaborations. Milestone fees may be earned for different events or achievements in different agreements. Furthermore, for certain collaborations, such fees may not be earned until the collaborator has advanced products into human testing. Such milestones may not be earned for several years, if at all. Our collaborative arrangements may not produce revenue adequate to fund our operating expenses. Additional funding, if necessary, may not be available on favorable terms, if at all. If adequate funds are not available, we may be required to curtail operations significantly or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies, product candidates, products or potential markets that we would not otherwise relinquish. The failure to receive additional funding would have a material adverse effect on our business and results of operations. YEAR 2000 ISSUE Description of the Issue. The Year 2000 issue refers to the inability of certain date-sensitive computer chips, software, and systems to recognize a two-digit date field as belonging to the 21st century. Mistaking "00" for 1900 or any other incorrect year could result in a system failure or miscalculations causing disruptions to operations, including manufacturing, a temporary inability to process transactions, or send invoices, or engage in other normal business activities. This is a significant issue for most, if not all companies, with far reaching implications, some of which cannot be anticipated or predicted with any degree of certainty. The Y2K issue may create unforeseen risks from our internal computer systems as well as from computer systems of third parties with which we deal. Our failures and/or those of third parties' computer systems could have a material adverse impact on our ability to conduct our business. Year 2000 Readiness. We have formed a committee, including the chief financial officer and the information technology manager, to evaluate Y2K risks and readiness. The committee has addressed both information technology and non-information technology systems. Examples of information technology systems include hardware and software purchased from external sources and internally developed software. Examples of non-information technology systems include 26 28 laboratory equipment and those systems that operate the facilities infrastructure. The committee has also considered the systems of those third parties with which we maintain a material relationship. We have substantially completed an assessment of our information technology and non-information technology systems. The assessment phase is, however, an on-going effort. As part of this effort, we are assessing the potential severity of the impact of Y2K induced failures, conducting an inventory of information systems for each business area, prioritizing systems or components to be converted or replaced, and developing a contingency plan for mission critical systems. Renovation procedures have begun on those systems that we have identified in our assessment as being non-Y2K compliant. This renovation entails installation of commercially-available software and firmware updates and performance of system tests. The renovation phase of our Year 2000 efforts is approximately 90% complete. Although the assessment and renovation phases are not 100% complete, based on the work performed to date, we do not foresee an inherently complex Y2K problem. Accordingly, we will concurrently validate and implement converted or replaced mission-critical systems. Validation will take place in an environment that is representative of the true operating environment. Implementation will address the integration of Y2K compliant systems into our true operating environment and will take into consideration the interdependencies of the systems involved. Finally, we will ensure that the Y2K contingency plan is available for each business area. The validation phase is currently in process and we expect this phase to be competed in the third quarter of 1999. For material third parties, we are obtaining written assurances that their systems and/or products are, or will be, Y2K compliant. However, we are not independently verifying their representations. In addition, while we are not dependent on any sole-source suppliers to conduct our laboratory operations, efforts are ongoing to monitor the progress of the Y2K preparations of our current major suppliers of laboratory materials. Year 2000 Costs. The total cost of our Y2K activities is funded through operating cash flows. We are expensing these costs as they are incurred. As of February 28, 1999, we have not incurred any incremental costs to resolve our Y2K issue and we expect that the total cost to become fully compliant will not exceed $50,000. Year 2000 Risks and Contingencies. In the event that systems of third-party providers or vendors of laboratory supplies fail to resolve Y2K issues that effect services or product deliveries to us, we may have to change providers or vendors. Such changes are not anticipated to have a material adverse effect on our business. As previously indicated, we are preparing a Y2K contingency plan which addresses each of the mission-critical systems of our business areas. This plan will also identify strategies and available resources necessary to restore operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The Company's investment portfolio consists of short-term, high quality debt securities. These securities are subject to interest rate risk, and will decline in value if interest rates increase. An immediate 10% change in interest rates would not have a material impact on our financial condition or results of operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's financial statements and supplemental data required by this item are set forth at the pages indicated in Item 14(a)(1). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 27 29 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Identification of Directors. The information under the caption "Election of Directors," appearing in the Proxy Statement, is incorporated herein by reference. (b) Identification of Executive Officers. The information under the heading "Management," appearing in the Proxy Statement, is incorporated herein by reference. (c) Section 16(a) Beneficial Ownership Regarding Compliance. The information under the heading "Section 16 Beneficial Ownership Reporting Compliance," appearing in the Proxy Statement, is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information under the headings "Executive Compensation and Other Information," appearing in the Proxy Statement, is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information under the heading "Ownership of Securities" appearing in the Proxy Statement, is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information under the heading "Certain Transactions," appearing in the Proxy Statement, is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) FINANCIAL STATEMENTS
PAGE NO. ---- Report of Ernst & Young LLP, Independent Auditors........... F-2 Balance Sheets at December 31, 1997 and 1998................ F-3 Statements of Operations for the years ended December 31, 1996, 1997 and 1998....................................... F-4 Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1996, 1997 and 1998.................... F-5 Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998....................................... F-6 Notes to Financial Statements............................... F-7
(2) FINANCIAL STATEMENT SCHEDULES All schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto. (b) No reports on Form 8-K have been filed during the last quarter of the period covered by this report. 28 30 (c) EXHIBITS
EXHIBIT NUMBER DESCRIPTION -------- ----------- 3.1++ Certificate of Incorporation of the Company, as amended. 3.2++ Form of Amended and Restated Certificate of Incorporation of the Company to become effective immediately prior to the Offering. 3.3++ Bylaws of the Company, as amended. 3.4++ Form of Restated Bylaws of the Company to be effective upon completion of the Offering. 4.1++ Form of Certificate for Common Stock. 10.9++ Amended and Restated Investors' Rights Agreement between the Company and the stockholders listed on Schedule A thereto, dated November 15, 1996. 10.11++ Series J Preferred Stock Purchase Agreement between the Company and Jonathan Greene, dated June 11, 1997. 10.12++ Series J Preferred Stock Purchase Agreement between the Company and Andrew Smellie, dated June 11, 1997. 10.13++ Warrant Agreement to Purchase Shares of the Series Z Preferred Stock, as amended between the Company and Comdisco, Inc., dated December 20, 1994. 10.14++ Common Stock Purchase Warrant between the Company and LJL BioSystems, Inc., dated June 15, 1995. 10.15++ Form of Warrant to Purchase Shares of Series C Preferred Stock between the Company and the purchasers listed on Schedule A thereto, dated August 17, 1995. 10.16++ Form of Warrant Agreement to Purchase Shares of Series C Preferred Stock of the Company, between the Company and Comdisco, Inc. in the amounts listed on Schedule A thereto. 10.17++ Form of Warrant to Purchase Shares of Series Z Preferred Stock between the Company and the purchasers listed on Schedule A thereto, dated May 20, 1996. 10.18++ Master Lease Agreement with the Company and Comdisco Inc., dated November 6, 1994, Schedule VL-1, dated November 11, 1994, Schedule VL-2 dated April 15, 1996 and Schedule VL-3 dated April 15, 1996. 10.19*++ Collaboration Agreement between the Company and Teijin Limited, dated March 29, 1996, as amended. 10.20*++ Collaborative Research and License Agreement between the Company and Roche Bioscience, dated October 25, 1996. 10.21*++ Research and Technology Development Agreement between the Company and Sumitomo Pharmaceuticals Co., Ltd., dated August 18, 1997. 10.22*++ Collaborative Research and License Agreement between the Company and ImClone Systems Incorporated, dated October 10, 1997. 10.23*++ Collaborative Research and License Agreement between the Company and Athena Neurosciences, Inc., dated October 15, 1997, as amended. 10.24++ Full Recourse Secured Promissory Note and Stock Pledge Agreement between the Company and Peter Myers, dated September 5, 1995. 10.28++ Promissory Note Secured by Stock Pledge Agreement between the Company and Vicente Anido, Jr., dated June 6, 1997. 10.29++ Stock Pledge Agreement between the Company and Vicente Anido, Jr., dated June 6, 1997. 10.30++ Employment Agreement with Peter Myers, dated March 1, 1995. 10.33++ Employment Agreement with Vicente Anido, Jr., dated March 14, 1996.
29 31
EXHIBIT NUMBER DESCRIPTION -------- ----------- 10.34++ Employment Agreement with Lee R. McCracken, dated May 13, 1996. 10.35++ Employment Letter with Karin Eastham, dated March 14, 1997. 10.36++ Standard Industrial/Commercial Single-Tenant Lease between the Company and Campson Corporation, dated December 22, 1995. 10.38++ Lease Agreement between Harbor Investment Partners and the Company, dated October 6, 1997. 10.44++ 1997 Stock Incentive Plan. 10.45++ 1997 Employee Stock Purchase Plan. 10.46++ Form of Indemnification Agreement between the Company and each of its directors. 10.47++ Form of Indemnification Agreement between the Company and each of its officers. 10.48++ 1997 Stock Incentive Plan Form of Notice of Grant of Stock Option. 10.49++ 1997 Stock Incentive Plan Form of Stock Option Agreement. 10.50++ 1997 Stock Incentive Plan Form of Addendum to Stock Option Agreement (Involuntary Termination Following Corporate Transaction/ Change in Control). 10.51++ 1997 Stock Incentive Plan Form of Addendum to Stock Option Agreement (Limited Stock Appreciation Right). 10.52++ 1997 Stock Incentive Plan Form of Stock Issuance Agreement. 10.53++ 1997 Stock Incentive Plan Form of Addendum to Stock Issuance Agreement (Involuntary Termination Following Corporate Transaction/ Change in Control). 10.54++ 1997 Stock Incentive Plan Form of Notice of Grant of Automatic Stock Option (Initial Grant). 10.55++ 1997 Stock Incentive Plan Form of Notice of Grant of Automatic Stock Option (Annual Grant). 10.56++ 1997 Stock Incentive Plan Form of Automatic Stock Option Agreement. 10.57++ 1997 Employee Stock Purchase Plan Form of Stock Purchase Agreement 10.58*++ Collaborative Research and License Agreement between the Company and ICOS Corporation, dated March 30, 1998. 10.59*+ Collaborative Research and License Agreement by and between the Company and Novartis Crop Protection AG, dated May 26, 1998. 10.60+ Amendment No. 1 to the Promissory Note dated September 5, 1995 between the Company and Peter Myers dated as of June 15, 1998. 10.61*+ Amendment to Collaborative Research and License Agreement by and between the Company and Roche Bioscience a division of Syntex (U.S.A.) Inc., dated as of July 31, 1998. 10.62 Amended Promissory Note dated February 24, 1997 between the Company and Vicente Anido Jr., Ph.D., amended as of November 8, 1998. 10.63 Amendment No. 1 to Pledge Agreement by Vince Anido in favor of the Company dated as of November 8, 1998. 10.64* Limited Liability Company Operating Agreement of ChiroChem Discovery Services LLC between Chirotech Ltd. and CombiChem JVR, Inc., dated as of December 1, 1998. 10.65* Cooperation Agreement between Chirotech Technology Ltd., Chirotech Ltd., CombiChem Inc., CombiChem JVR, Inc., and ChiroChem Discovery Services LLC, dated as of December 1, 1998. 10.66* License Agreement between CombiChem Inc., and ChiroChem Discovery Services LLC, dated as of December 1, 1998.
30 32
EXHIBIT NUMBER DESCRIPTION -------- ----------- 10.67* Services Agreement between CombiChem Inc. and ChiroChem Discovery Services LLC, dated as of December 1, 1998. 10.68* Lead Generation Program Agreement by and between the Company and Ono Pharmaceutical Co., Ltd., dated as of December 30, 1998. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney (see page 32). 27.1 Financial Data Schedule.
- --------------- + Previously filed as an exhibit to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (No. 0-23473) and incorporated herein by reference. ++ Incorporated by reference to the same-numbered exhibit (except as otherwise indicated) to the Company's Registration Statement on Form S-1 (No. 333-37981), as amended. * Certain confidential portions of this Exhibit were omitted by means of redacting a portion of the text (the "Mark"). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company's application requesting confidential treatment under Rule 406 under the Securities Act. SUPPLEMENTAL INFORMATION Copies of the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held May 6, 1999 and copies of the form of proxy to be used for such Annual Meeting will be furnished to the Commission at the same time they are distributed to the shareholders. 31 33 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. COMBICHEM, INC. Date: March 30, 1999 By: /s/ VICENTE ANIDO JR. -------------------------------- Vicente Anido Jr., Ph.D. President and Chief Executive Officer POWER OF ATTORNEY Know all men by these presents, that each person whose signature appears below constitutes and appoints Vicente Anido Jr., Ph.D. or Karin Eastham, his or her attorney-in-fact, with power of substitution in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that the attorney-in-fact or his or her substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ VICENTE ANIDO JR. President, Chief Executive March 30, 1999 - ------------------------------------------------ Officer and Director Vicente Anido, Ph.D. /s/ KARIN EASTHAM Vice President, Finance March 30, 1999 - ------------------------------------------------ and Administration and Karin Eastham Chief Financial Officer /s/ PIERRE LAMOND Director March 30, 1999 - ------------------------------------------------ Pierre Lamond /s/ PHILIPPE CHAMBON Director March 30, 1999 - ------------------------------------------------ Philippe Chambon, Ph.D. /s/ PETER MYERS Chief Scientific Officer, March 30, 1999 - ------------------------------------------------ Chief Operating Officer Peter Myers, Ph.D. and Director /s/ ARTHUR REIDEL Director March 30, 1999 - ------------------------------------------------ Arthur Reidel /s/ WILLIAM SCOTT Director March 30, 1999 - ------------------------------------------------ William Scott, Ph.D. /s/ MICHAEL J. PAZZANI Director March 30, 1999 - ------------------------------------------------ Michael J. Pazzani, Ph.D.
32 34 INDEX TO FINANCIAL STATEMENTS
PAGE ---- COMBICHEM, INC. Report of Ernst & Young LLP, Independent Auditors........... F-2 Balance Sheets at December 31, 1997 and 1998................ F-3 Statements of Operations for the years ended December 31, 1996, 1997 and 1998....................................... F-4 Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1996, 1997 and 1998.................... F-5 Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998....................................... F-6 Notes to Financial Statements............................... F-7
F-1 35 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders CombiChem, Inc. We have audited the accompanying balance sheets of CombiChem, Inc. as of December 31, 1997 and 1998, and the related statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CombiChem, Inc. at December 31, 1997 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP San Diego, California January 18, 1999, except for Note 9, as to which the date is March 5, 1999 F-2 36 COMBICHEM, INC. BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------------- 1997 1998 ------------ ------------ Current assets: Cash and cash equivalents........................... $ 5,866,635 $ 20,334,201 Short-term investments, available-for-sale.......... 11,054,725 9,024,714 Accounts receivable................................. 527,633 2,891,981 Prepaid expenses and other current assets........... 767,594 1,310,180 ------------ ------------ Total current assets.................................. 18,216,587 33,561,076 Property and equipment, net......................... 5,961,177 7,901,545 Restricted cash..................................... 262,143 279,143 Deposits and other assets........................... 879,845 238,247 Notes receivable from employee/stockholders......... 56,303 -- ------------ ------------ Total assets.......................................... $ 25,376,055 $ 41,980,011 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable.................................... $ 881,436 $ 1,101,635 Accrued liabilities................................. 1,394,046 1,295,386 Deferred revenue.................................... 1,475,752 3,192,981 Current portion of obligations under capital leases........................................... 1,569,197 1,825,279 ------------ ------------ Total current liabilities............................. 5,320,431 7,415,281 Obligations under capital leases, less current portion............................................. 3,283,373 4,246,454 Deferred rent......................................... 91,227 141,771 Commitments Redeemable convertible preferred stock, $.001 par value, 63,196,896 shares authorized at December 31, 1997 and 5,000,000 authorized at December 31, 1998; 31,019,635 and no shares issued and outstanding at December 31, 1997 and 1998, respectively............ 23,129,968 -- Stockholders' equity (deficit): Common stock, $.001 par value, 40,000,000 shares authorized; 3,227,005 and 13,399,201 shares issued and outstanding at December 31, 1997 and 1998, respectively........................................ 3,227 13,399 Additional paid-in capital............................ 12,519,952 51,861,673 Deferred compensation................................. (1,582,320) (1,140,684) Notes receivable from stockholders.................... (569,061) (424,830) Accumulated deficit................................... (16,820,742) (20,133,053) ------------ ------------ Total stockholders' equity (deficit).................. (6,448,944) 30,176,505 ------------ ------------ Total liabilities and stockholders' equity (deficit)........................................... $ 25,376,055 $ 41,980,011 ============ ============
See accompanying notes. F-3 37 COMBICHEM, INC. STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ----------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Revenue: Revenue under collaborative agreements: Project initiation fees and milestone payments............................. $ 2,500,000 $ 3,333,331 $ 6,800,000 Research and development funding........ 420,000 4,137,250 8,274,434 Grant revenue............................. 47,400 -- -- ----------- ----------- ----------- Total revenue............................. 2,967,400 7,470,581 15,074,434 Operating expenses: Research and development: Collaborative........................ 420,000 4,316,938 9,208,931 Proprietary.......................... 4,820,253 4,399,620 5,848,672 ----------- ----------- ----------- 5,240,253 8,716,558 15,057,603 General and administrative.............. 2,845,074 3,286,569 4,053,983 ----------- ----------- ----------- Total operating expenses.................. 8,085,327 12,003,127 19,111,586 ----------- ----------- ----------- Loss from operations...................... (5,117,927) (4,532,546) (4,037,152) Interest income........................... 144,639 662,525 1,429,363 Interest expense.......................... (145,139) (251,665) (524,522) Foreign tax expense....................... -- (200,000) (180,000) ----------- ----------- ----------- Net loss.................................. $(5,118,427) $(4,321,686) $(3,312,311) =========== =========== =========== Basic and diluted net loss per share...... $ (11.30) $ (4.45) $ (0.36) =========== =========== =========== Shares used in computing basic net loss per share............................... 453,000 971,000 9,140,000 =========== =========== ===========
See accompanying notes. F-4 38 COMBICHEM, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
NOTES COMMON STOCK ADDITIONAL RECEIVABLE TOTAL -------------------- PAID-IN DEFERRED FROM ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL COMPENSATION STOCKHOLDERS DEFICIT EQUITY (DEFICIT) ---------- ------- ----------- ------------ ------------ ------------ ---------------- Balance at December 31, 1995....................... 660,165 $ 660 $ 119,057 $ -- $(150,000) $ (7,380,629) $ (7,410,912) Sale of common stock....... 74,000 74 22,126 -- -- -- 22,200 Repurchase and cancellation of common stock.......... (22,560) (22) (5,843) -- -- -- (5,865) Net loss................... -- -- -- -- (5,118,427) (5,118,427) ---------- ------- ----------- ----------- --------- ------------ ------------ Balance at December 31, 1996....................... 711,605 712 135,340 -- (150,000) (12,499,056) (12,513,004) Sale of common stock....... 1,305,090 1,305 10,071,414 -- -- -- 10,072,719 Deferred compensation related to stock options.................. -- -- 1,773,973 (1,773,973) -- -- -- Amortization of deferred compensation............. -- -- -- 191,653 -- -- 191,653 Sale of common stock for notes receivable......... 1,210,310 1,210 539,225 -- (540,435) -- -- Repayment of notes receivable............... -- -- -- -- 121,374 -- 121,374 Net loss................... -- -- -- -- (4,321,686) (4,321,686) ---------- ------- ----------- ----------- --------- ------------ ------------ Balance at December 31, 1997....................... 3,227,005 3,227 12,519,952 (1,582,320) (569,061) (16,820,742) (6,448,944) Sale of common stock....... 2,456,275 2,456 16,231,301 -- -- -- 16,233,757 Conversion of redeemable convertible preferred stock to common stock.... 7,754,933 7,755 23,122,213 -- -- -- 23,129,968 Repurchase of common stock.................... (39,012) (39) (11,793) -- -- -- (11,832) Amortization of deferred compensation............. -- -- -- 441,636 -- -- 441,636 Repayment of notes receivable from stockholders............. -- -- -- -- 144,231 -- 156,534 Net loss................... -- -- -- -- (3,312,311) (3,312,311) ---------- ------- ----------- ----------- --------- ------------ ------------ Balance at December 31, 1998....................... 13,399,201 $13,399 $51,861,673 $(1,140,684) $(424,830) $(20,133,053) $ 30,176,505 ========== ======= =========== =========== ========= ============ ============
See accompanying notes. F-5 39 COMBICHEM, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ----------------------------------------- 1996 1997 1998 ------------ ----------- ------------ Cash flows from operating activities: Net loss................................ $ (5,118,427) $(4,321,686) $ (3,312,311) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation of property and equipment.......................... 310,765 849,285 1,671,681 Amortization of premium on short-term investments........................ -- 92,707 149,663 Deferred rent........................ 30,409 60,818 50,544 Deferred revenue..................... 2,130,000 (654,248) 1,717,229 Amortization of deferred compensation....................... -- 191,653 441,636 Interest payable converted to preferred stock.................... 20,913 -- -- Change in operating assets and liabilities: Accounts receivable................ (198,419) (329,214) (2,364,348) Prepaid expenses and other current assets.......................... (154,152) (422,366) (400,708) Accounts payable and accrued liabilities..................... 607,106 1,032,345 121,539 ------------ ----------- ------------ Net cash used in operating activities..... (2,371,805) (3,500,706) (1,925,075) Cash flows from investing activities: Purchases of short-term investments..... (12,166,132) (6,191,204) (11,619,652) Maturities of short-term investments.... -- 7,416,825 13,500,000 Purchases of accrued interest on short-term investments............... -- (206,913) (141,878) Purchases of property and equipment..... (2,575,690) (3,911,307) (3,612,049) Deposits and other assets............... (102,077) (741,750) 641,598 Notes receivable from employees......... (66,125) 12,688 56,303 ------------ ----------- ------------ Net cash used in investing activities..... (14,910,024) (3,621,661) (1,175,678) Cash flows from financing activities: Advances on capital lease obligations... 2,337,375 3,257,645 3,096,873 Principal repayments on capital lease obligations.......................... (410,876) (915,816) (1,877,710) Issuance of common stock................ 22,200 10,072,719 16,233,757 Repurchase of common stock.............. (5,865) -- (11,832) Issuance of redeemable convertible preferred stock, net of issuance costs................................ 12,995,390 23,240 -- Payments on note payable................ (100,000) -- -- Receipt of payment on notes receivable from stockholders.................... -- 121,374 144,231 Restricted cash given as collateral for letter of credit..................... (325,000) 62,857 (17,000) ------------ ----------- ------------ Net cash provided by financing activities.............................. 14,513,224 12,622,019 17,568,319 ------------ ----------- ------------ Net increase (decrease) in cash and cash equivalents............................. (2,768,605) 5,499,652 14,467,566 Cash and cash equivalents at beginning of year.................................... 3,135,588 366,983 5,866,635 ------------ ----------- ------------ Cash and cash equivalents at end of year.................................... $ 366,983 $ 5,866,635 $ 20,334,201 ============ =========== ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid............................. $ 124,266 $ 258,109 $ 522,521 ============ =========== ============ SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Conversion of convertible notes payable and interest payable to redeemable convertible preferred stock............. $ 440,000 $ -- $ -- ============ =========== ============
See accompanying notes. F-6 40 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Business CombiChem, Inc. is a computational product discovery company that is applying its proprietary design technology and rapid synthesis capabilities to accelerate the discovery process for new drugs and chemical products. The Company believes its approach offers pharmaceutical and chemical companies the opportunity to conduct their discovery efforts in a more productive and cost-effective manner. Using its Discovery Engine(TM) process, the Company focuses on the generation, evolution and optimization of potential new lead candidates for its collaborative partners, who will then develop, manufacture, market and sell any resulting products. CombiChem believes that its process is widely applicable to a variety of disease targets and therapeutic indications as well as to other industries such as agrochemical, industrial chemical and materials science. In addition, the Company is using its approach on internal programs to discover new lead candidates that will then be out licensed to third parties, retaining a larger economic interest in such candidates. Cash, Cash Equivalents and Short-term Investments Cash and cash equivalents consist of cash and highly liquid investments with maturities of three months or less when purchased. Short-term investments are recorded at amortized cost which approximates market value. The Company applies Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115), to its investments. Under SFAS No. 115, the Company classifies its short-term investments as "Available-for-Sale" and records such assets at estimated fair value in the balance sheet, with unrealized gains and losses, if any, reported in stockholders' equity. As of December 31, 1998, the cost of cash equivalents and short-term investments approximated fair market value. Concentration of Credit Risk The Company invests its excess cash in debt instruments of financial institutions and corporations with strong credit ratings. The Company has established guidelines relative to diversification and maturities that maintain safety and liquidity. The Company historically has not experienced any material losses on its cash equivalents or short-term investments. Property and Equipment Property and equipment are carried at cost. Depreciation of equipment is computed using the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the remaining term of the lease. Amortization of equipment under capital leases is reported with depreciation of property and equipment. Impairment of Long-Lived Assets Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121), requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS No. 121 also addresses the accounting for long-lived assets that are expected to be disposed. To date there have been no such indicators of impairments. Basic Net Loss Per Share Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128 Earnings Per Share ("SFAS No. 128"). SFAS No. 128 requires the F-7 41 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) presentation of basic earnings (loss) per share and diluted earnings (loss) per share, if more dilutive, for all periods presented. In accordance with SFAS No. 128, Earnings Per Share and Securities and Exchange Commission Staff Accounting Bulletin No. 98, basic net loss per share has been computed using the weighted-average number of shares of Common Stock outstanding during the period. Basic Net Loss Per Share A reconciliation of shares used in the calculation of basic net loss per share follows (in thousands, except per share data):
YEARS ENDED DECEMBER 31, ----------------------------- 1996 1997 1998 ------- ------- ------- Net loss..................................... $(5,118) $(4,322) $(3,312) ======= ======= ======= Weighted average shares of Common Stock outstanding (shares used in computing basic net loss per share)........................ 453 971 9,140 ======= ======= ======= Basic and diluted net loss per share......... $(11.30) $ (4.45) $ (0.36) ======= ======= =======
The diluted EPS computation is the same as basic because all potential common shares are antidilutive. New Accounting Standards In 1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS No. 130) and Statement of Financial Accounting Standards No. 131, Segment Information (SFAS No. 131). SFAS No. 130 requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net income and other comprehensive income, including foreign currency translation adjustments, and unrealized gains and losses on investments, shall be reported, net of their related tax effect, to arrive at comprehensive income. Comprehensive loss was the same as net loss. SFAS No. 131 amended the requirements for public enterprises to report financial and descriptive information about its reportable operating segments. Operating segments, as defined in SFAS No. 131, are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company in deciding how to allocate resources and in assessing performance. The financial information is required to be reported on the basis that is used internally for evaluating the segment performance. The Company believes it operates in one business and operating segment and accordingly, adoption of this standard did not have an impact on the Company's financial statements. Revenues under Collaborative Agreements and Research and Development Costs The Company currently generates revenue primarily through its collaborative agreements. Contract research revenue is recognized as research activities are performed under the terms of the research contracts. Contract payments are generally received in advance of the performance of the related research activities. Such payments received in excess of amounts earned are recorded as deferred revenue. Project initiation fees are recognized as revenue upon contract execution. These fees are nonrefundable and the Company has no future performance obligations related to such fees. Research and development costs are expensed as incurred. Costs of services under the Company's collaborative agreements generally approximate the research revenue under such agreements. Project initiation fees and milestone payments do not have associated cost of services. F-8 42 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company's accounts receivable consist primarily of payments due under these agreements. Substantially all of such receivables are collected within 30 days of the balance sheet date. The Company's revenues are concentrated among a small number of customers, as follows:
YEARS ENDED DECEMBER 31, -------------------- 1996 1997 1998 ---- ---- ---- Novartis...................................... -- -- * Elan/Athena................................... -- 18% 14% ICOS.......................................... -- -- * ImClone....................................... -- * * Roche......................................... 67% 30% 38% Sumitomo...................................... 31% 39% 17% Teijin........................................ -- * * Ono........................................... -- -- 12%
- --------------- * Amount earned represents less than 10% of revenues for the period. Stock-Based Compensation As permitted by Statement of Financial Accounting Standards No. 123 (SFAS No. 123), the Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related Interpretations in accounting for its employee stock options. Under APB 25, when the exercise price of the Company's employee stock options is not less than the market price of the underlying stock on the date of grant, no compensation expense is recognized. Options granted to consultants and non-employees are measured at fair value in accordance with SFAS No. 123 and are expensed over the period the related services are rendered. 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 those estimates. Reclassification Reclassifications have been made to certain prior period amounts to conform to the 1998 presentation. 2. BALANCE SHEET INFORMATION Investments There were no realized gains or losses on the sale of securities during the three years ended December 31, 1998. The Company's short-term investments classified as available-for-sale are as follows:
DECEMBER 31, ------------------------- 1997 1998 ----------- ---------- Corporate bonds.................. $10,555,534 $9,024,714 Tax exempt municipal bonds....... 499,191 -- ----------- ---------- $11,054,725 $9,024,714 =========== ==========
F-9 43 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 2. BALANCE SHEET INFORMATION (CONTINUED) The Company has one debt security, with a value of $3,000,000, with a contractual maturity in the year 2000. All other debt securities held by the Company at December 31, 1998 have a contractual maturity less than one year. The amortized cost of the debt securities approximates fair value. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. Property and Equipment Property and equipment consist of the following:
DECEMBER 31, -------------------------- 1997 1998 ----------- ----------- Laboratory and computer equipment..................... $ 4,131,762 $ 7,299,758 Leasehold improvements.......... 2,524,919 3,042,052 Office furniture, fixtures and equipment..................... 576,255 503,175 ----------- ----------- 7,232,936 10,844,985 Less accumulated depreciation and amortization.............. (1,271,759) (2,943,440) ----------- ----------- $ 5,961,177 $ 7,901,545 =========== ===========
3. COMMITMENTS Leases The Company leases its facilities in San Diego and Palo Alto under two operating lease agreements that expire in May 2006 and October 2002, respectively. Rent expense was approximately $383,000, $613,000 and $713,000 for the years ended December 31, 1996, 1997 and 1998, respectively. Lease payments under both agreements are subject to future increases based upon the terms of the lease agreements. The Company leases certain equipment under capital lease obligations. Cost and accumulated amortization of equipment under capital leases were $6,599,000 and $1,140,000 at December 31, 1997 and $9,697,000 and $2,740,000 at December 31, 1998, respectively. Annual future minimum obligations for operating and capital leases as of December 31, 1998 are as follows:
YEAR ENDING DECEMBER 31: OPERATING LEASES CAPITAL LEASES ------------------------ ---------------- -------------- 1999............................. $ 683,341 $2,759,275 2000............................. 699,778 2,109,571 2001............................. 712,106 1,736,497 2002............................. 682,799 299,998 2003............................. 480,786 -- Thereafter....................... 1,263,944 -- ---------- ---------- Total minimum lease payments.......... $4,522,754 6,905,341 ========== Less amount representing interest..... 833,608 ---------- Present value of obligations under capital leases...................... 6,071,733 Less current portion.................. 1,825,279 ---------- Long-term obligations under capital leases.............................. $4,246,454 ==========
F-10 44 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 4. STOCKHOLDERS' EQUITY (DEFICIT) Initial Public Offering In May 1998, the Company completed the sale of 2,359,500 shares of common stock (including partial exercise of underwriters' over-allotment option) in its initial public offering, for net proceeds of $16.2 million. In conjunction with the offering, the Company reincorporated from California to Delaware, effected a one-for-four reverse stock split of its common stock and all outstanding preferred shares were converted into common stock on a one-for-four basis. All share and per share amounts and stock option data have been restated to retroactively give effect to the reverse stock split and the related change in shares outstanding. 1997 Stock Incentive Plan The Company's 1997 Stock Incentive Plan (the 1997 Plan) serves as the successor equity incentive program to the Company's 1995 Plan. The 1997 Plan was adopted by the Board of Directors and the stockholders on October 7, 1997 and became effective upon completion of the initial public offering. A total of 1,072,170 shares of Common Stock have been authorized for issuance under the 1997 Plan. Under the 1997 Plan, options may be designated as incentive stock options or nonstatutory stock options. Options under the 1997 Plan have a term of up to 10 years from the date of grant. The exercise price of options shall be fixed by the Board of Directors, but shall not be less than 100% of the fair market value per share of common stock on the option grant dates. Under the 1997 Plan, selected employees, directors and consultants may be issued shares of common stock at no less than 100% of the fair market value on the date of grant. The vesting schedule for each option grant is determined by the Board of Directors. 1997 Stock Incentive Plan Information with respect to the 1995/1997 Plans is as follows:
WEIGHTED- AVERAGE SHARES EXERCISE PRICE ---------- -------------- Granted................................ 562,980 $0.30 Exercised.............................. -- -- Cancelled.............................. -- -- ---------- Balance at December 31, 1995............. 562,980 $0.30 Granted................................ 531,479 $0.30 Exercised.............................. (72,589) $0.30 Cancelled.............................. (12,536) $0.30 ---------- Balance at December 31, 1996............. 1,009,334 $0.30 Granted................................ 721,543 $2.79 Exercised.............................. (1,210,310) $0.45 Cancelled.............................. (32,471) $0.34 ---------- Balance at December 31, 1997............. 488,096 $3.56 Granted................................ 284,694 $6.26 Exercised.............................. (16,774) $0.49 Cancelled.............................. (7,360) $0.66 ---------- Balance at December 31, 1998............. 748,656 $4.68 ==========
At December 31, 1998, options to purchase 103,244 shares were vested and 338,464 shares remain available for grant. All options are exercisable when issued, and are subject to repurchase if certain vesting requirements aren't met. F-11 45 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 4. STOCKHOLDERS' EQUITY (DEFICIT) (CONTINUED) Following is a further breakdown of the options outstanding as of December 31, 1998:
WEIGHTED- AVERAGE WEIGHTED- EXERCISE WEIGHTED AVERAGE PRICE OF AVERAGE EXERCISE VESTED VESTED REMAINING PRICE OUTSTANDING OUTSTANDING OPTIONS LIFE IN OF OPTIONS OPTIONS OPTIONS RANGE OF EXERCISE PRICES OUTSTANDING YEARS OUTSTANDING EXERCISABLE EXERCISABLE ------------------------ ----------- ------------- ----------- ----------- ----------- $0.30 - $0.40.................. 66,193 7.18 $0.332 37,347 $0.352 $1.00.......................... 26,485 8.55 $1.000 8,658 $1.000 $2.00 - $3.00.................. 16,875 6.81 $2.741 10,742 $2.864 $4.00 - $5.00.................. 421,653 5.69 $4.152 34,747 $4.449 $6.00 - $8.00.................. 217,450 9.26 $7.623 11,750 $8.000 ------- ------- 748,656 6.99 $4.679 103,244 $2.916 ======= =======
Pro forma information regarding net loss and net loss per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options and stock purchase plan under the fair value method of SFAS No. 123. The fair value for these options was estimated at the date of grant using the "Minimum Value" method for option pricing with the following assumptions for 1996, 1997 and through May 6, 1998: risk-free interest rates of 6.50%, dividend yield of 0%, and a weighted-average expected life of the options of five years; and from May 7, 1998 through December 31, 1998: risk free interest rates of 5.65%, dividend yield of 0%, volatility of .65, and a weighted-average expected life of the options of five years. For purposes of pro forma disclosures, the estimated fair value of the options are amortized to expense over the vesting period. The Company's adjusted pro forma information is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------- 1996 1997 1998 ----------- ----------- ----------- Pro forma net loss................ $(5,137,253) $(4,376,686) $(3,354,245) Pro forma basic net loss per share........................... $ (11.34) $ (4.51) $ (0.37)
The weighted-average fair value of options granted during 1996, 1997 and 1998 was $0.08, $0.72 and $0.79, respectively. The pro forma effect on net loss is not likely to be representative of the pro forma effects on reported net income or loss in future years because these amounts reflect less than four years of vesting. The 1997 Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors and the stockholders on October 7, 1997 and became effective upon completion of the initial public offering. A total of 150,000 shares of Common Stock have been authorized for issuance under the Purchase Plan. The Purchase Plan permits eligible employees of the Company to purchase shares of Common Stock, at semi-annual intervals, through periodic payroll deductions. Payroll deductions may not exceed 10% of the participant's base salary, and the purchase price will not be less than 85% of the lower of the fair market value of the stock at either the beginning or the end of the semi-annual intervals. Warrants As of December 31, 1998, the Company has issued warrants to purchase an aggregate of 130,728 shares of common stock at prices ranging from $2.00 to $2.48 per share. The warrants are exercisable in whole or in part through various dates. The Company also has issued warrants to purchase 8,750 shares of common stock at $0.30 per share. The warrants are exercisable in whole or in part at any time at or prior to June 2000. 5. NOTES RECEIVABLE FROM STOCKHOLDERS During 1995, the Company loaned $150,000 to an employee and stockholder for the purchase of a residence in connection with the individual's employment agreement. The note bears interest F-12 46 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 5. NOTES RECEIVABLE FROM STOCKHOLDERS (CONTINUED) at approximately 5.8% and matures on the earlier of (i) April 30, 2000, (ii) 30 days following cessation of employment, (iii) the date on which more than 50% of the Company's outstanding shares of common stock are acquired by a single purchaser or a group of purchasers (iv) the Company merges with or into another organization, or (v) 10 days following the date on which the Maker sells or transfers the Maker's real property. The note is secured by 87,500 shares of the Company's common stock owned by the employee at the date of the note, plus any capital stock thereafter acquired. In August 1996, the Company loaned $66,125 to an employee for relocation in connection with employment, which is secured by a deed of trust on the employee's residence. The loan was paid in full in December 1998. During 1997, the Company instituted an employee loan program whereby the proceeds of full-recourse employee loans are used to purchase common stock from the exercise of the employee's stock options. Under the program, the employee pays 25% of the total exercise price, and the Company loans the employee the remaining 75% of the purchase price. The loans bear interest at an adjustable rate that is the minimum rate allowable by the Internal Revenue Service, subject to quarterly adjustments by the Company. The loans will be repaid through 3 equal payments on the first three anniversary dates of the loan. The Company has $262,527 in loans outstanding as of December 31, 1998 and $419,061 outstanding at December 31, 1997, respectively. 6. COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS Athena Neurosciences, Inc., a wholly owned subsidiary of Elan Corporation, plc In October 1997, the Company entered into a collaborative agreement with Athena Neurosciences, Inc. (Elan/Athena), a wholly owned subsidiary of Elan Corporation, plc providing for a three-year program to discover novel therapeutic compounds for treatment of central nervous system conditions. The first project was initiated upon signing of this collaboration agreement, with a second project initiated in March 1998. The agreement provides for Elan/Athena's access to the Universal Informer Library as deemed necessary by the research management committee composed of representatives of the Company and Elan/Athena. Under the agreement, Elan/ Athena paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of pre-determined objectives. Elan/Athena will also make royalty payments on worldwide sales of products resulting from the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach or by Elan/Athena after the one-year anniversary upon 90 days prior written notice. In connection with the collaborative agreement, Elan International Services Ltd., an affiliate of Elan/Athena, purchased 1,000,000 shares of Common Stock for $8.0 million in October 1997. In addition, the same affiliate acquired 250,000 shares of common stock in the initial public offering. ICOS Corporation In March 1998, the Company entered into a collaborative agreement with ICOS Corporation (ICOS) providing for a lead evolution project on an undisclosed target. Under the agreement, ICOS received exclusive global rights to develop and market any products resulting from the collaboration. ICOS made an advance payment in April 1998 and agreed to pay research support funding, payments upon achievement of certain clinical milestones and royalty payments on any product sales. The lead evolution project terminates on August 31, 2000. The agreement may be terminated by either party 90 days following an uncured material breach. ImClone Systems Incorporated In October 1997, the Company entered into a collaborative agreement with ImClone Systems Incorporated (ImClone) providing for a two-year program to identify and characterize novel small molecule inhibitors to multiple targets for development in oncology. The agreement provides for F-13 47 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 6. COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS (CONTINUED) ImClone's access to the Company's Universal Informer Library and Virtual Library. Under the terms of the agreement, ImClone agreed to provide the Company research support payments, milestone payments upon the achievement of certain program objectives and royalties on worldwide product sales of therapeutic products that may arise out of the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach. In connection with the collaborative agreement, ImClone purchased 312,500 shares of Common Stock for $2.0 million. Novartis Crop Protection AG In May 1998, the Company entered into a collaborative agreement with Novartis Crop Protection AG (Novartis) providing for a two-year lead optimization project for the herbicide, fungicide and insecticide markets. Under the agreement, Novatris paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Novartis has exclusive global rights to develop and market or sub-license products resulting from the collaboration. The Company will be entitled to royalties on sales of products resulting from the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach. Ono Pharmaceutical Co., Ltd. In December 1998, the Company entered into a collaborative agreement with Ono Pharmaceutical Co., Ltd. (Ono) providing for a two-year lead generation research program on an undisclosed target. Under the agreement, Ono paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Ono will make royalty payments on worldwide sales of products resulting from the collaboration. The agreement may be terminated by either party 90 days following an uncured material breach. Roche Bioscience, a division of Syntex (U.S.A.) Inc. In October 1996, the Company entered into a collaborative agreement with Roche Bioscience providing for a broad two-year program to perform research against three initial targets, including a protein-protein interaction, an enzyme and a receptor, with an option to add additional targets. Roche Bioscience can elect one of the approaches -- lead generation, lead evolution or lead optimization -- for each research program against each collaboration target. A program may be initiated at any time during the term of the collaboration, thereby extending the term to allow for completion of each program. Under the agreement, Roche Bioscience paid a project initiation fee to the Company and agreed to provide research funding and to make milestone payments upon the achievement of certain milestones. Roche Bioscience will make royalty payments on worldwide sales of products resulting from the collaboration. Sumitomo Pharmaceuticals Co., Ltd. In August 1997, the Company entered into a collaborative agreement with Sumitomo Pharmaceuticals Co. Ltd. (Sumitomo) providing for a two-year lead evolution program on a target that is believed to play a fundamental role in osteoarthritis and rheumatoid arthritis. Under the agreement, Sumitomo paid a project initiation fee and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Sumitomo will make royalty payments on worldwide sales of products resulting from the collaboration. Sumitomo may extend the research period for up to four successive six-month periods upon mutual agreement. The agreement may be terminated by either party 90 days following an uncured material breach. Teijin Limited In March 1996, the Company entered into a collaborative agreement with Teijin Limited (Teijin) providing for a one-year program on a G-protein coupled receptor target. In March 1997, the Company and Teijin amended their agreement to extend the collaboration for an additional F-14 48 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 6. COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS (CONTINUED) year. While the initial focus of the collaboration was lead optimization, the effort was redirected to lead evolution during the course of the research. Under the agreement, Teijin paid a project initiation fee to the Company and agreed to provide research funding and milestone payments upon the achievement of certain milestones. Teijin also committed internal resources to the discovery effort. Teijin will make royalty payments on products resulting from the collaboration. The Company retains the rights to the compounds arising under this collaboration in North and South America; Teijin has rights to these compounds in Asia and Europe with a right of first negotiation to acquire the Company rights. Under the original agreement, either party may terminate the agreement in the event of a material breach remaining uncured for 60 days. As of March 1998, the Company has successfully concluded its research phase and delivered lead candidates to Teijin for further development. As this development process continues, Teijin will make additional payments if certain milestones are met. 7. BENEFIT PLAN The Company sponsors a 401(k) plan which covers employees who meet certain age and service requirements. Employees may contribute a portion of their earnings each plan year subject to certain Internal Revenue Service limitations. The Company made no discretionary contributions to the plan for the years ended December 31, 1998 and 1997. 8. INCOME TAXES At December 31, 1998, the Company had federal and California income tax net operating loss carryforwards of approximately $18,319,000 and $17,074,000, respectively. The federal and California tax loss carryforwards will begin to expire in 2009 and 2002, respectively, unless previously utilized. The Company also has federal and California research tax credit carryforwards of approximately $653,000 and $426,000, respectively, which will begin to expire in 2010 unless previously utilized. The Company also has a federal foreign tax credit carryforward of approximately $380,000, which will begin to expire in 2002 unless previously utilized. Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of the Company's net operating loss and credit carryforwards may be limited in the event of cumulative changes in ownership of more than 50%. However, the Company does not believe such limitation will have a material effect upon the utilization of these carryforwards. Significant components of the Company's deferred tax assets are shown below. A valuation allowance, which was increased by $1,602,000 in 1998, has been recognized to offset the deferred tax assets as of December 31, 1998 and 1997 as realization of such assets is uncertain.
YEAR ENDED DECEMBER 31, -------------------------- 1997 1998 ----------- ----------- Deferred tax assets: Net operating loss carryforwards.............. $ 6,325,000 $ 7,436,000 Research and development credits.............. 558,000 930,000 Foreign tax credit............................ 200,000 380,000 Other, net.................................... 240,000 179,000 ----------- ----------- Total deferred tax assets....................... 7,323,000 8,925,000 Valuation allowance for deferred tax assets..... (7,323,000) (8,925,000) ----------- ----------- Net deferred tax assets......................... $ -- $ -- =========== ===========
The Company recorded foreign tax expense of $200,000 and $180,000 for the years ended December 31, 1997 and 1998, respectively, for taxes payable to the Japanese tax authority resulting from revenues under the Sumitomo and the Ono collaborations, respectively. F-15 49 COMBICHEM, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 9. SUBSEQUENT EVENTS In March 1999, the Company entered into a new lease agreement for its San Diego research and administrative facility with a target commencement date of November 1, 1999. The new lease agreement is for a term of 15 years at $2,295,000 per year subject to annual increases related to the Consumer Price Index. The Company negotiated an agreement with the landlord of its current facility to vacate the facility on terms which did not result in a financial penalty or loss to the Company. F-16 EX-10.62 2 EXHIBIT 10.62 1 EXHIBIT 10.62 AMENDED PROMISSORY NOTE $48,000.00 February 24, 1997 As Amended November 8, 1998 San Diego, California VICENTE ANIDO, JR., an individual resident of the State of California ("Obligor"), for value received, hereby promises to pay to the order of COMBICHEM, INC., a Delaware corporation, or holder ("Payee"), in lawful money of the United States at 9050 Camino Santa Fe, San Diego, California 92121, the principal sum of Forty-Eight Thousand Dollars ($48,000.00). Unpaid principal of this Note shall bear no interest. All unpaid principal under this Note shall be due and payable on the earlier of (a) February 23, 2002; (b) the expiration of the 60-day period following the date the Obligor ceases for any reason to remain in the Service of Payee (as defined in that certain Restricted Stock Purchase Agreement dated February 24, 1997 between Obligor and Payee); or (c) the date on which Payee completes the consummation of any corporate transaction in which (i) more than fifty percent (50%) of the outstanding shares of common stock of Payee are acquired by a single purchaser or by a group of purchasers acting in concert in a merger or any other transaction and Obligor receives cash or publicly traded securities in connection therewith; or (ii) all or substantially all of the assets of Payee are acquired by a single purchaser or a group of purchasers acting in concert and Obligor receives cash or publicly traded securities in connection therewith. Nothing in this Note shall confer upon the Obligor any right to continue in the Service of Payee (or its successors or subsidiaries) for any period of specific duration. Upon payment in full of all principal payable hereunder, this Note shall be surrendered to Obligor for cancellation. This Note may be transferred only upon surrender of the original Note for registration of transfer, duly endorsed, or accompanied by a duly executed written instrument of transfer in form satisfactory to Obligor. Thereupon, a new note for like principal amount and interest will be issued to, and registered in the name of, the transferee. Principal is payable only to the registered holder of this Note. Obligor waives presentment, demand for performance, notice of nonperformance, protest, notice of protest, and notice of dishonor. No delay on the part of Payee in exercising any right hereunder shall operate as a waiver of such right under this Note. This Note is being delivered in and shall be construed in accordance with the laws of the State of California. 2 If the indebtedness represented by this Note or any part thereof is collected at law or in equity or in bankruptcy, receivership or other judicial proceedings or if this Note is placed in the hands of attorneys for collection after default, Obligor agrees to pay, in addition to the principal and interest payable hereon, reasonable attorneys' fees and costs incurred by Payee. Any payment shall be deemed made upon receipt by Payee. This Note is the Note referred to in that certain Pledge Agreement ("Pledge Agreement") dated February 24, 1997 between Obligor and Payee, as amended, and is subject to the terms thereof. The Pledge Agreement, among other things, contains provisions for acceleration of the maturity of this Note upon the happening of any one or more of the stated "Events of Default" set forth therein. OBLIGOR UNDERSTANDS THAT THIS IS A FULL RECOURSE PROMISSORY NOTE AND THAT PAYEE MAY, AT ITS OPTION, PROCEED AGAINST ASSETS OF THE UNDERSIGNED OTHER THAN ANY COLLATERAL UNDER THE PLEDGE AGREEMENT IN THE EVENT OF DEFAULT. OBLIGOR ACKNOWLEDGES AND UNDERSTANDS THAT THE RULE 144 HOLDING PERIOD MAY BE TOLLED WITH RESPECT TO ANY COMMON STOCK PLEDGED PURSUANT TO THE PLEDGE AGREEMENT. Obligor acknowledges and agrees that he has been provided the opportunity and encouraged to consult with counsel of Obligor's own choosing with respect to this Agreement, and that Brobeck, Phleger & Harrison LLP solely represents the interests of the Payee. IN WITNESS WHEREOF, Obligor has duly executed this Note, as of the date first above written. /s/ Vicente Anido, Jr. ------------------------------------- Vicente Anido, Jr. 2 EX-10.63 3 EXHIBIT 10.63 1 EXHIBIT 10.63 AMENDMENT NO. 1 TO PLEDGE AGREEMENT This Amendment No. 1 ("Amendment") to the Pledge Agreement dated February 24, 1997 made by Vicente Anido in favor of CombiChem, Inc. (the "Corporation"), as amended (the "Pledge Agreement"), is made as of this 8th day of November, 1998. RECITALS WHEREAS, Mr. Anido has repaid one-half of the principal amount due under that certain Promissory Note for Ninety-Six Thousand Dollars ($96,000.00) between the Corporation and Mr. Anido dated February 24, 1997 (the "Anido Note"); WHEREAS, Mr. Anido had previously pledged 1,280,000 shares of the Common Stock of the Corporation (the "Pledged Shares") as collateral for the Anido Note pursuant to that certain Pledge Agreement between the Corporation and Mr. Anido dated as of February 24, 1997 (the "Pledge Agreement"); WHEREAS, the Board has decided to release one-half of the Pledged Shares; WHEREAS, the Board has determined the release of one-half of the Pledged Shares upon the repayment of one-half of the Anido Note to be just and reasonable to the Corporation. In consideration of the foregoing and the promises and covenants contained herein and other good and valuable consideration, the receipt of which is hereby acknowledged, the parties hereto agree as follows: 1. AMENDMENT TO THE PLEDGE AGREEMENT. a. Schedule 1 of the Pledge Agreement shall be amended in its entirety to read as follows: PLEDGED SHARES
Shares of CombiChem, Inc. Name and Address Common Stock Date of Issuance - ---------------- ------------ ---------------- Vicente Anido, Jr. 640,000 February 24, 1997 1621 Bayside Drive Corona Del Mar, CA 92625
-1- 2 EXHIBIT 10.63 2. EFFECT OF AMENDMENT. Except as set forth above, the Pledge Agreement shall continue in full force and effect. 3. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each which will be deemed an original, and all of which together shall constitute one instrument. 4. SEVERABILITY. If one or more provisions of this Amendment are held to be unenforceable under applicable law, such provision shall be excluded from this Amendment and the balance of the Amendment shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 5. ENTIRE AGREEMENT. This Amendment, together with the Pledge Agreement, as amended, constitutes the full and entire understanding and agreement between the parties with regard to the subjects hereof and thereof. 6. GOVERNING LAW. This Amendment shall be governed by and construed under the laws of the State of California as applied to agreements among California residents entered into and to be performed entirely within California. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -2- 3 IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. COMBICHEM, INC., a Delaware corporation By: /s/ Karin Eastham -------------------------------------- Karin Eastham, Chief Financial Officer /s/ Vicente Anido ----------------------------------------- Vicente Anido [SIGNATURE PAGE TO AMENDMENT NO. 1 TO THE PLEDGE AGREEMENT] EX-10.64 4 EXHIBIT 10.64 1 EXHIBIT 10.64 ------------------------------------------------------------- LIMITED LIABILITY COMPANY OPERATING AGREEMENT OF CHIROCHEM DISCOVERY SERVICES LLC, A CALIFORNIA LIMITED LIABILITY COMPANY DECEMBER 1, 1998 ------------------------------------------------------------- NEITHER THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE REGULATORY AUTHORITY HAS APPROVED OR DISAPPROVED THIS LIMITED LIABILITY COMPANY OPERATING AGREEMENT OR THE LIMITED LIABILITY COMPANY MEMBERSHIP INTERESTS ("INTERESTS") PROVIDED FOR HEREIN. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. THE INTERESTS HAVE NOT BEEN REGISTERED UNDER THE UNITED STATES SECURITIES ACT OF 1933, AS AMENDED, INCLUDING THE RULES AND REGULATIONS THEREUNDER (THE "SECURITIES ACT"), AND THE COMPANY IS UNDER NO OBLIGATION TO REGISTER THE INTERESTS UNDER THE SECURITIES ACT IN THE FUTURE. AN INTEREST MAY NOT BE SOLD, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION UNDER THE SECURITIES ACT OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED. ADDITIONAL RESTRICTIONS ON THE TRANSFER OF INTERESTS ARE CONTAINED IN ARTICLE XI OF THIS AGREEMENT. BASED UPON THE FOREGOING, EACH ACQUIRER OF AN INTEREST MUST BE PREPARED TO BEAR THE ECONOMIC RISK OF INVESTMENT THEREIN FOR AN INDEFINITE PERIOD OF TIME. *** Certain confidential portions of this Exhibit were omitted by means of blackout of the text (the "Mark"). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company's Application Requesting Confidential Treatment under Rule 24b-2 under the Act. 2 TABLE OF CONTENTS
PAGE ---- ARTICLE I FORMATION OF LIMITED LIABILITY COMPANY...............................1 1.1 Formation.......................................................1 1.2 Name and Principal Place of Business............................1 1.3 Office for Records and Agent for Service of Process.............1 1.4 Agreement.......................................................1 1.5 Purposes........................................................1 1.6 Definitions.....................................................2 1.7 Term............................................................2 ARTICLE II MEMBERSHIP; UNITS...................................................3 2.1 Members.........................................................3 2.2 Representations and Warranties..................................3 2.3 Units...........................................................4 2.4 Substitute Members..............................................4 2.5 Resignation or Withdrawal of a Member...........................4 2.6 Dissociation of a Member........................................5 2.7 Rights of Dissociated Member....................................5 2.8 No Contracts....................................................5 2.9 Other Ventures and Activities...................................5 2.10 Member Expenses.................................................6 2.11 Member Compensation.............................................6 2.12 Tax Matters.....................................................6 ARTICLE III CONTRIBUTIONS TO CAPITAL...........................................7 3.1 Capital Commitments.............................................7 3.2 Capital Contributions...........................................7 3.3 Issuance of Units...............................................7 3.4 Additional Contributions and Loans..............................7 3.5 Interest........................................................8 3.6 Failure To Make Capital Contribution............................8 ARTICLE IV ACTION BY MEMBERS...................................................9 4.1 Meetings of Members.............................................9 4.2 Voting Standard.................................................9
-i- 3 TABLE OF CONTENTS (CONTINUED)
PAGE ---- ARTICLE V MANAGEMENT; RESTRICTIONS; EXPENSES..................................9 5.1 Management by Board of Managers................................9 5.2 Number; Vacancies..............................................10 5.3 Meetings of Managers...........................................10 5.4 Voting Procedures..............................................11 5.5 Action Without Meeting.........................................12 5.6 Normal Functions of Board of Managers..........................12 5.7 Conflict of Interest Matters...................................13 5.8 Loss of Vote...................................................13 5.9 Manager Compensation and Expenses..............................14 ARTICLE VI NOTICES............................................................14 6.1 Notices........................................................14 6.2 Waiver of Notice...............................................14 ARTICLE VII OFFICERS..........................................................15 7.1 Chair..........................................................15 7.2 Other Officers.................................................15 7.3 Contracts......................................................15 ARTICLE VIII ACCOUNTING AND RECORDS...........................................16 8.1 Financial Statements and Records...............................16 8.2 Inspection of Books............................................16 8.3 Annual and Monthly Reports.....................................16 8.4 Tax Returns....................................................16 ARTICLE IX ALLOCATIONS........................................................17 9.1 Allocation of Net Income or Net Loss...........................17 9.2 Partnership Status.............................................17 ARTICLE X DISTRIBUTIONS.......................................................17 10.1 Allocation of Distributions among Holders of Units.............17 10.2 Discretionary Distributions....................................17 10.3 No Other Withdrawals...........................................17
-ii- 4 TABLE OF CONTENTS
PAGE ---- ARTICLE XI TRANSFERS..........................................................18 11.1 Transfer of Units..............................................18 11.2 Transfer Void..................................................18 11.3 Transfer of Control of Member..................................18 11.4 Transfer of Control of Affiliates..............................18 11.5 Acquisition of ***.............................................19 ARTICLE XII BUY-SELL PROVISION................................................19 12.1 Application....................................................19 12.2 Procedures.....................................................19 ARTICLE XIII INDEMNIFICATION AND LIMITATION OF LIABILITY......................20 13.1 Indemnification................................................20 13.2 Limitation of Liability........................................22 ARTICLE XIV TERMINATION.......................................................22 14.1 Termination....................................................22 14.2 Continuance of the Company.....................................22 14.3 Authority to Wind Up...........................................23 14.4 Winding Up and Certificate of Cancellation.....................23 14.5 Distribution of Assets.........................................23 14.6 Effect of Termination..........................................24 ARTICLE XV DEFINITIONS........................................................24 15.1 Definitions....................................................24 ARTICLE XVI DISPUTE RESOLUTION................................................28 16.1 Board of Managers Deadlock.....................................28 16.2 Arbitration....................................................29
- ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -iii- 5 TABLE OF CONTENTS (Continued)
PAGE ---- ARTICLE XVII MISCELLANEOUS....................................................29 17.1 Amendment......................................................29 17.2 Withholding Taxes..............................................29 17.3 Publicity......................................................30 17.4 Further Assurances.............................................30 17.5 Construction...................................................30 17.6 Time...........................................................30 17.7 Headings.......................................................31 17.8 Severability...................................................31 17.9 Variation of Terms.............................................32 17.10 Governing Law..................................................32 17.11 Binding Effect.................................................32 17.12 Entire Agreement...............................................32 17.13 Counterparts...................................................32
-iv- 6 CHIROCHEM DISCOVERY SERVICES LLC LIMITED LIABILITY COMPANY OPERATING AGREEMENT THIS LIMITED LIABILITY COMPANY OPERATING AGREEMENT, dated December 1, 1998, is by and between the persons listed on the signature page hereto as members of ChiroChem Discovery Services LLC, a California limited liability company (the "Company"). ARTICLE I FORMATION OF LIMITED LIABILITY COMPANY 1.1 Formation. The Members have formed the Company pursuant to the Beverly-Killea Limited Liability Company Act (as amended, the "Act") by causing articles of organization ("Articles") for the Company to be filed with the California Secretary of State and entering into this Agreement. By this Agreement the Members intend to establish rules and regulations governing ownership and control of the Company. 1.2 Name and Principal Place of Business. Unless and until changed in accordance with this Agreement and the Act, the name of the Company will be "ChiroChem Discovery Services LLC". The principal place of business of the Company shall be at 9050 Camino Santa Fe, San Diego, California or such other place as the Board of Managers may hereafter designate. 1.3 Office for Records and Agent for Service of Process. The Company shall maintain an office at which shall be maintained the records required by Section 17058 of the Act and an agent for service of process as required by Section 17057 of the Act. The office at which shall be maintained the records required by Section 17058 of the Act shall be the principal office of CombiChem, 9050 Camino Santa Fe, San Diego, California 92121, and the name and address of the agent for service of process shall be Karin Eastham c/o CombiChem, 9050 Camino Santa Fe, San Diego, California 92121, or such other person and place as the Board of Managers may hereafter designate. 1.4 Agreement. For and in consideration of the mutual covenants herein contained and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Members executing this Agreement hereby agree to the terms and conditions of this Agreement, as it may from time to time be amended. 1.5 Purposes. The purposes of the Company are: 7 (a) to use chiral templates made available to it pursuant to the CT License, and the technology licensed to it pursuant to the Combi License, to design, synthesize and market chemical libraries consisting of Chiral Compounds to third parties; (b) to use chiral templates made available to it pursuant to the CT License, and the technology licensed to it pursuant to the Combi License, to design, synthesize and market customized chemical libraries consisting of Chiral Compounds in response to third party purchase orders and specifications; (c) to use chiral templates made available to it pursuant to the CT License, and the technology licensed to it pursuant to the Combi License, to synthesize and market individual quantities of a Chiral Compound selected from chemical libraries sold pursuant to paragraphs (a) or (b) to a maximum quantity of ten (10) grams per lot; and (d) to engage in all other lawful activities helpful, necessary or appropriate to maximize the ability of the Company to accomplish the foregoing purposes. 1.6 Definitions. Terms not otherwise defined in this Agreement shall have the meanings set forth in Article XV. 1.7 Term. The term of the Company shall commence on the Effective Date and, unless the term of the Company is otherwise terminated pursuant to the provisions of this Agreement, shall continue until the third calendar anniversary of the Effective Date (the "Initial Term"). Such term may be extended for additional periods of three (3) years by future amendment of this Agreement signed by all Members prior to the expiration of the then current term. -2- 8 ARTICLE II MEMBERSHIP; UNITS 2.1 Members. The initial Members of the Company are each of the two Persons whose names are set forth on the initial signature page of this Agreement, each of which is admitted as a Member upon execution and delivery of this Agreement. Additional signature pages may hereafter be added by the Board of Managers as appropriate to reflect the admission of Substitute Members in accordance with the provisions of this Agreement but not otherwise. 2.2 Representations and Warranties. Each Member hereby represents and warrants to the Company and the other Member as follows: (a) Authorization. The Member is duly organized, validly existing, and in good standing under the law of its jurisdiction of organization; it has full power and authority to execute and enter into this Agreement and to perform its obligations hereunder; and all actions necessary for the due authorization, execution, delivery and performance by that Member of this Agreement have been duly taken. This Agreement has been duly executed and delivered by the Member and constitutes the legal obligation of the Member enforceable in accordance with its terms. (b) Compliance with Other Instruments. The Member's authorization, execution, delivery, and performance of this Agreement do not conflict with or violate any law applicable to the Member or any other agreement or arrangement to which such Member is a party or by which such Member or such Member's assets is bound. (c) Purchase Entirely for Own Account. The Member is acquiring such Member's interest in the Company for the Member's own account, not as a nominee or agent, for investment purposes only and not with a view to or for the resale, distribution, subdivision or fractionalization thereof. The Member has no contract, present intention, understanding, undertaking, agreement or arrangement of any kind with any Person to sell, transfer or pledge to any Person such Member's interest or any part thereof, nor does such Member have any plans to enter into any such agreement. (d) Investment Experience. The Member has such knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of its investment in the Company, is able to bear the economic risks of an investment in the Company, and is able, without materially impairing its financial condition, to hold the Units (as hereinafter defined) for an indefinite period of time and to suffer a complete loss of such investment. -3- 9 (e) Disclosure of Information. The Member is aware of the Company's business affairs and financial condition and has acquired all of the information about the Company it has requested from the Company and considers necessary to reach an informed and knowledgeable decision to acquire an interest in the Company. (f) Federal and State Securities Laws. The Member acknowledges that the Units have not been registered under the Securities Act of 1933, as amended (the "Securities Act") or any state securities laws, inasmuch as they are being acquired in a transaction not involving a public offering, and under such laws, may not be resold or transferred by the Member without appropriate registration or the availability of an exemption from such requirements. In this connection, the Member represents that he is familiar with Rule 144 promulgated under the Securities Act, as presently in effect, and understands the resale limitations imposed thereby and by the Securities Act. The Member is an "accredited investor" within the meaning of Regulation D promulgated under the Securities Act of 1933, as amended. (g) Brokers and Finders. The Member has not retained any investment banker, broker or finder in connection with his, her or its investment in the Company. 2.3 Units. Ownership of the Company shall be divided into and represented by one class of units of the Company (the "Units"). Each Unit shall be entitled to one vote and to equal participation in the profits, losses, capital and distributions of the Company, unless additional or different classes of Units are established by the Board of Managers and approved by the Members. 2.4 Substitute Members. A Substitute Member shall have all the rights and powers and will be subject to all the restrictions and liabilities of the Member who Transferred the Units. 2.5 Resignation or Withdrawal of a Member. Except as specifically provided below, and subject to the provisions on Transfer contained in Article XI, no Member may resign, retire or withdraw from membership in the Company or withdraw such Member's interest in the capital of the Company prior to the dissolution and winding up of the Company. -4- 10 2.6 Dissociation of a Member. The Bankruptcy or Dissolution of a Member (i) will cause such Member to be dissociated from the Company (a "Dissociated Member"), (ii) will terminate the continued membership of such Member in the Company, and (iii) will constitute a Dissolution Event and cause a dissolution and winding up of the Company pursuant to Article XIV hereof except as expressly provided therein to the contrary. 2.7 Rights of Dissociated Member. In the event any Member becomes a "Dissociated Member", the Dissociated Member (or such Member's legal representative) shall be entitled to participate in the winding up of the Company to the same extent as any other Member. 2.8 No Contracts. Each Member hereby covenants not to use any actual or apparent authority or power to bind the Company to any contract or commitment, or to otherwise incur any liability to which the Company will be subject, without the express authorization of the Board of Managers. Each Member hereby agrees to indemnify and hold the Company and the other Member(s) harmless for any loss, liability, expense, damage or injury suffered or sustained by the Company and/or the other Members in consequence of such Member's exercise of such actual or apparent authority or power to bind the Company in violation of the restrictions set forth herein. Upon any material breach of a Member's obligations under this Section, the Company shall have a right of offset against all distributions under this Agreement payable to such Member (and all amounts thereafter payable to such Member or any Affiliate of such Member under any other contract binding on the Company) for amounts owed to the Company pursuant to the indemnification described in the preceding sentence. 2.9 Other Ventures and Activities. (a) The Members: (i) acknowledge that the Members and their respective Affiliates are or may be involved in other research and development, manufacturing, sales or business activities; and (ii) agree that each Member and its Affiliates may engage for their own accounts and for the accounts of others in any such ventures and activities, provided, however, that such ventures and/or activities shall not violate the limitations on activities found in Section 2.2 (Retained Rights) of the CT License or the CombiChem License (as applicable). Except as otherwise required by fiduciary duties, (i) neither the Company nor any Member shall have any right by virtue of this Agreement or the existence of the Company in and to such ventures or activities or to the income or profits derived therefrom, and (ii) the Members, their Affiliates, and other related Persons shall have no duty or obligation to make any reports to the Members or the Company with respect to any such ventures or activities. -5- 11 (b) Each Member acknowledges that the other Member(s) may be prohibited from taking action for the benefit of the Company: (i) due to confidential information acquired or obligations incurred in connection with an outside activity permitted to such Member or its Affiliates under this Section 2.9; or (ii) in connection with activities undertaken prior to the Effective Date. No Person shall be liable to the Company or any Member for any failure to act for the benefit of the Company in consequence of a prohibition described in the preceding sentence. 2.10 Member Expenses. No Member shall be reimbursed for expenses incurred on behalf of, or otherwise in connection with, the Company except to the extent so provided in any Chiro Ancillary Agreement, Combi Ancillary Agreement or this Section. All expenses reasonably incurred by a Member in connection with the preparation, negotiation, execution and delivery of this Agreement and the aforesaid Ancillary Agreements and otherwise in connection with the formation of the Company shall be reimbursed by the Company upon presentation of evidence of such expenses reasonably satisfactory to the Board of Managers. 2.11 Member Compensation. Except as provided in a Chiro Ancillary Agreement or a Combi Ancillary Agreement, no Member shall be entitled to compensation for services provided by such Member to, or for the benefit of, the Company. 2.12 Tax Matters. (a) CombiSub is hereby designated the "tax matters partner" of the Company within the meaning of Section 6231(a)(7) of the Code. Except to the extent specifically provided in the Code or the Treasury Regulations (or the laws of other relevant taxing jurisdictions), the tax matters partner shall have exclusive authority to act for or on behalf of the Company with regard to tax matters, including the authority to make (or decline to make) any available tax elections. (b) Except to the extent otherwise required by applicable law (disregarding for this purpose any requirement that can be avoided through the filing of an election or similar administrative procedure), the tax matters partner shall cause the Company to take the position that the Company is a "partnership" for federal, state and local income tax purposes and shall cause to be filed with the appropriate tax authorities any elections or other documents necessary to give due legal effect to such position. A Member shall not file (and each Member hereby represents that it has not filed) any income tax election or other document that is inconsistent with the Company's position regarding its classification as a "partnership" for applicable federal, state and local income tax purposes. (c) No Member shall file a notice with the United States Internal Revenue Service under Section 6222(b) of the Code in connection with such Member's -6- 12 intention to treat an item on such Member's federal income tax return in a manner which is inconsistent with the treatment of such item on the Company's federal income tax return unless such Member has, not less than 30 days prior to the filing of such notice, provided all Members with a copy of the notice and thereafter in a timely manner provides such other information related thereto as any such Member shall reasonably request. (d) Any Member entering into a settlement agreement with the United States Department of the Treasury which concerns a Company item shall notify all Members of such settlement agreement and its terms within 60 days after the date thereof. ARTICLE III CONTRIBUTIONS TO CAPITAL 3.1 Capital Commitments. The required contributions to the capital of the Company by each Member shall be those amounts of cash and/or property set forth opposite such Member's name in the Annual Budgets (each such amount being a "Capital Commitment"). Each Member's Capital Commitments represent, in the aggregate, the maximum amount of cash and/or property that such Member has agreed to contribute to the Company in accordance with the terms hereof, and no Member shall be obligated to contribute cash and/or property to the Company in any amount in excess of such Member's aggregated Capital Commitments. The initial Members currently agree that the aggregate of all Capital Commitments for the Initial Term shall not exceed *** for each Member without further written agreement of the Members. 3.2 Capital Contributions. Except to the extent provided to the contrary in any Annual Budget, all Capital Contributions shall be in cash. The obligation of a Member to satisfy each of its Capital Commitments shall be without interest. The Members shall make Capital Contributions equal to 100 percent of their respective Capital Commitments in the amounts and on the dates for Capital Contributions set forth in the Annual Budgets. 3.3 Issuance of Units. Each Member shall be promptly issued one Unit for every One U.S. Dollar ($1.00) of Capital Contribution made by the Member. 3.4 Additional Contributions and Loans. Except as set forth in Section 3.6, and except if the Members mutually agree to fund the activities of the Company through loans rather than Capital Contributions, no Member shall be permitted or required to make any additional contribution to the capital of the Company without the consent of the Board of Managers and the Members. No Member shall lend, or be required to lend, any money to the Company or guaranty any Company indebtedness unless all Members agree - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -7- 13 to participate in such loan or guaranty in proportion to the number of Units held by each. The Annual Budgets for 1998 and 1999 will anticipate a requirement of *** in third-party lease financing, which shall be guaranteed by the Members to the extent required by the lender. Any additional loans or guarantees by Members shall be approved in writing by the Members. 3.5 Interest. Except for interest paid to Members for loans approved in accordance with Section 3.4 above, no Member shall be entitled to any interest with respect to such Member's contributions to or share of the capital of the Company or its share of unallocated Net Income. 3.6 Failure To Make Capital Contribution. In the event a Member fails to make a Capital Contribution when due hereunder to satisfy a Capital Commitment, the other Member (the "Aggrieved Member") may give the noncontributing Member notice of such failure. If such failure continues for thirty (30) days after such notice has been given, the Aggrieved Member may elect to take any of the alternative actions described herein if it has made all of the Capital Contributions theretofore due from it to the Company. Such an election shall remain available to the Aggrieved Member until such time as the noncontributing Member's Capital Commitment has been, or deemed to be, fully satisfied. (a) The Aggrieved Member may initiate the procedures described in Article XII; or (b) The Aggrieved Member may contribute to the Company the cash or property then due to the Company from the noncontributing Member, and the amount of such cash (or the value of such property) shall be deemed to be a loan from the Aggrieved Member to the noncontributing Member (a "Default Loan") and a Capital Contribution by the noncontributing Member to the Company, in which event the noncontributing Member's unsatisfied Capital Commitment shall be deemed satisfied and the Company shall issue in the name of the noncontributing Member that number of Units issuable on account of such a Capital Contribution and deliver such Units (the "Pledged Units") to the Aggrieved Member to hold as collateral for payment of the Default Loan. To secure payment of a Default Loan and all accrued interest thereon for which it may hereafter become liable, each Member hereby pledges to the other Member and grants to the other Member a security interest in any Pledged Units. Any Default Loan shall bear interest at the lesser of the maximum rate permitted by applicable law (if there is such a maximum) or the prime rate of interest from time to time quoted by Bank of America plus six percent (6%) and shall be due and payable in full (including all accrued interest) within ninety (90) days after the Aggrieved Member contributes the cash or property then due to the Company from the noncontributing Member. If not - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -8- 14 sooner repaid, a Default Loan shall be repaid from any cash distributions otherwise to be made by the Company to the noncontributing Member under this Agreement and any payment otherwise to be made by the Company to the noncontributing Member or Affiliate under any other contract binding on the Company. Upon repayment of the Default Loan in full (other than disposal of the Pledged Units), the Aggrieved Member shall deliver the Pledged Units to the noncontributing Member and release its security interest therein. If a Default Loan is not repaid in full when due and payable, the Aggrieved Member may, at its sole election, dispose of the Pledged Units in accordance with the California Uniform Commercial Code, as amended from time to time, as payment in full of the Default Loan. Any unpaid Default Loan (including all accrued interest) may also be offset against any amount to be paid to the noncontributing Member by the Aggrieved Member in purchase of the noncontributing Member's Units pursuant to Article XII. ARTICLE IV ACTION BY MEMBERS 4.1 Meetings of Members. Meetings of Members may be held for any purpose at the request of any Member. Members may participate in a meeting of the Members by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting. 4.2 Voting Standard. At any duly noticed meeting at which a quorum is present, the vote of the Member(s) holding a Supermajority of the Units represented at the meeting shall decide any question brought before the meeting, except to the extent that the express provisions of law or this Agreement require a different vote. ARTICLE V MANAGEMENT; RESTRICTIONS; EXPENSES 5.1 Management by Board of Managers. Except for situations in which the approval of the Members is required by statute or this Agreement, in accordance with Section 17151 of the Act, the Company shall be managed and controlled by the Managers acting as a "Board of Managers." The Board of Managers may exercise all powers of the Company and do all such lawful acts and things that are not by statute, the Articles or this Agreement, directed or required to be exercised or done by the Members themselves. It is intended that the powers and authority of the Board of Managers shall be substantially the same as the powers and authority of a board of directors of a corporation formed under the laws of the State of California. Notwithstanding the foregoing, the Board of Managers may not do or permit to be done any of the following without the approval of the Members: -9- 15 (a) Any act or thing that the Act or this Agreement requires to be approved, consented to or authorized by the Members; (b) Voluntarily cause the dissolution of the Company; (c) Compromise the liability of any Member for improper distributions; or (d) Sell all or a substantial part of the Company's assets, other than in the ordinary course of business. 5.2 Number; Vacancies. The Board of Managers shall be comprised of six (6) Managers, three of whom shall be appointed by ChiroSub (the "Chiro Managers") and three of whom may be appointed by CombiSub (the "Combi Managers"). A Chiro Manager may be removed from office by ChiroSub, and a Combi Manager may be removed from office by CombiSub, at any time for any reason. In the event that any Manager dies, resigns or is removed as a Manager, a substitute manager may be appointed by the Member that appointed the former Manager whose vacancy is being filled. On the Effective Date, the Chiro Managers shall be Christine Soden, Alan Shaw and Ray McCague and the Combi Managers shall be Peter Myers, Karin Eastham and Lee McCracken. 5.3 Meetings of Managers. The Board of Managers may hold meetings, both regular and special, either within or without the State of California. Regular meetings of the Board of Managers shall be held at least once a month and may be held at times and places determined by the Board of Managers. Special meetings of the Board of Managers may be called by any Manager on 48 hours notice to each Manager by any reasonable means, including but not limited to telephone or facsimile transmission. Subject to Sections 5.7 and 5.8, at all meetings of the Board of Managers, a majority of the Managers consisting of at least two Chiro Managers and at least two Combi Managers shall constitute a quorum for the transaction of business. If a quorum is not present at a meeting of the Board of Managers, the Managers present may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. Managers may participate in a meeting of the Board of Managers by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting, except that, for at least one meeting held each calendar quarter (which shall be designated by the Chair as such in advance of the meeting), the Managers must attend in person in order to participate. Meetings will alternate between the offices of the Members or shall be held in New York, New York unless otherwise agreed. The Member hosting any meeting shall appoint a secretary to the meeting to record the minutes of the meeting, which will be circulated to the Managers promptly following the meeting for review and comment and then kept in a minute book for the Company available to all Managers and Members. -10- 16 5.4 Voting Procedures. Subject to Sections 5.7 and 5.8, the Chiro Managers shall have, in the aggregate, one (1) vote and the Combi Managers shall have, in the aggregate, one (1) vote, on each matter coming before the Board of Managers at a meeting. Each such vote shall be cast by a majority of the Chiro Managers or the Combi Managers, as the case may be, in attendance at the meeting. Subject to Sections 5.7 and 5.8, any proposed action of the Board of Managers shall require approval by both votes cast at a duly called meeting of the Board of Managers at which a quorum is present to be effective. -11- 17 5.5 Action Without Meeting. Subject to Sections 5.7 and 5.8, any action required or permitted to be taken at any meeting of the Board of Managers may be taken without a meeting if all Managers consent thereto in writing, by single or counterpart writings, and the writing or writings are filed with the minutes of proceedings of the Board of Managers. 5.6 Normal Functions of Board of Managers. Without limiting the generality of Section 5.1, and subject to the other provisions of this Agreement, the Board of Managers shall perform the functions described herein. (a) Prior to the end of each Fiscal Year, the Board of Managers shall consider and approve an "Annual Budget" for next Fiscal Year consisting of at least *** *** *** *** ; provided, however that the Annual Budgets for the Fiscal Years ending December 31, 1998 and December 31, 1999 shall be adopted at the first meeting of the Board of Managers. The Capital Commitment of each Member in an Annual Budget shall be equal, in aggregate amount and in dates and amounts of required Capital Contributions, to that of every other Member. (b) The Board of Managers shall oversee the business activities of the Company and at all times endeavor to operate the Company in a manner consistent with the Annual Budget. Any Company expenditure(s) in any year that will be more than (i) *** in excess of the line item budget for that expenditure in the Annual Budget or (ii) *** of the aggregate expense budget in the Annual Budget shall require prior approval of the Board of Managers before it may be made. (c) The Board of Managers shall oversee, generally or specifically, the design, production and marketing of chemical libraries of Chiral Compounds to third parties and shall, from time to time, select those Chiral Compounds to be individually synthesized and marketed. (d) The Board of Managers shall determine the best interest of the Company in all dealings and proposed dealing with third parties and shall approve, generally or specifically, the terms of any contract, agreement, deed, lease, promissory note, or other instrument or document to be executed and delivered by the Company. - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -12- 18 (e) The Board of Managers shall take such steps as are reasonably necessary and prudent to protect the proprietary rights of the Company in the data, trade secrets, technical information, know-how, inventions, discoveries and other proprietary or confidential information of the Company. Such steps may include (i) filing for patents, trademarks and copyrights when and as appropriate and (ii) opposing patent, copyright and trademark applications filed by third parties which may have an adverse impact upon the Company's proprietary rights. Any such patents, trademarks or copyrights which are issued during the term of the Company shall be in the name of the Company and shall be the property of the Company. 5.7 Conflict of Interest Matters. If a Member or an Affiliate of a Member is or will be a party to a contract or an arbitration proceeding under Section 16.2 in which the Company also is, or is proposed to be, a party, those Managers designated by that Member shall not participate in the consideration of or vote upon any proposed action by the Company concerning said contract or arbitration proceeding. Notwithstanding Sections 5.3, 5.4 and 5.5, in such an event the quorum for a meeting of the Board of Managers to consider such a proposal shall be any three (3), and the proposal shall be considered approved by the Board of Managers upon the single vote approving the proposal cast by the participating Managers at such a meeting or upon a written consent to the proposal signed by all Managers who were eligible to participate in consideration of the proposal. Without limiting the generality of the foregoing, (a) the Chiro Managers shall not consider or vote upon any proposal by which the Company would rescind, waive, modify, enforce or exercise any remedy under or with respect to the CT License, the ChiroTech, Inc. Services Agreement, the CT Limited Services Agreement or those portions of the Cooperation Agreement by which ChiroSub or CT Limited are bound; (b) the Chiro Managers shall not consider or vote upon any proposal for the Company to initiate or respond to any arbitration proceeding against ChiroSub pursuant to Section 16.2 or concerning the conduct of the Company in such a proceeding; (c) the Combi Managers shall not consider or vote upon any proposal by which the Company would rescind, waive, modify, enforce or exercise any remedy under or with respect to the CombiChem License, the CombiChem Services Agreement, or those portions of the Cooperation Agreement by which CombiSub or CombiChem are bound; and (d) the Combi Managers shall not consider or vote upon any proposal for the Company to initiate or respond to any arbitration proceeding against CombiSub pursuant to Section 16.2 or concerning the conduct of the Company in such a proceeding. 5.8 Loss of Vote. In the event one Member acquires additional Units pursuant to Section 3.6(b) on account of the failure of another Member to make Capital -13- 19 Contributions sufficient to satisfy its Capital Commitments and, as a result, said Member owns not less than a Supermajority of all then-issued and outstanding Units, the voting right of the Managers designated by the noncontributing Member shall be suspended until such time (if ever) as said Member owns less than a Supermajority of all then-issued and outstanding Units. Notwithstanding Section 5.3, 5.4 and 5.5, during any such suspension the quorum for a meeting of the Board of Managers shall be any three (3), and the Board of Managers will act upon the single vote then eligible to be cast or upon a written consent signed by all Managers who were eligible to participate in the casting of that vote. 5.9 Manager Compensation and Expenses. The Board of Managers shall receive no compensation from the Company for their services as Managers, but each Manager shall be reimbursed for his or her reasonable out-of-pocket expenses incurred in attending meetings of the Board of Managers and performing related duties of the office under reasonable reimbursement procedures. ARTICLE VI NOTICES 6.1 Notices. Whenever notice or demand is required to be given to any Member by the Act, the Articles or this Agreement, it shall be given in writing, by mail, addressed to such Member at such Member's address as it appears on the records of the Company with postage thereon prepaid, and shall be deemed given three days after it is deposited in the United States mail. Notice to Members may also be given by facsimile and shall be deemed given upon the sending thereof with electronic confirmation of receipt. 6.2 Waiver of Notice. A Member may waive notice, provided that the waiver is in writing signed by the Member whether before or after the notice is required to be given. -14- 20 ARTICLE VII OFFICERS 7.1 Chair. The initial Chair of the Board of Managers shall be Alan Shaw, and he shall serve in such capacity until the end of Fiscal Year 1999. Then CombiSub shall designate one Manager from among the CombiSub Managers to serve as Chair of the Board of Managers for a term of one (1) year concurrent with the next Fiscal Year. Thereafter the Chair shall be a Chiro Manager designated by ChiroSub, then a Combi Manager designated by CombiSub, and so forth for successive one year terms. In the event a Chair ceases to be a Manager during his or her term of office as the Chair, the Member which appointed the former Chair shall designate another Manager to serve as the Chair for the balance of the former Chair's term. The Chair shall preside at all meetings of the Board of Managers. 7.2 Other Officers. The Board of Managers may create such other offices and elect such other officers as it deems appropriate. Any number of offices may be held by the same person. The duties of such officers shall be established from time to time by the Board of Managers. 7.3 Contracts. After the Effective Date, the Board of Managers shall expressly designate one or more Managers or officers to execute and deliver, on behalf of the Company, any contract, agreement, deed, lease or other document or instrument approved generally or specifically by it, and any such document or instrument executed and delivered by such an authorized Person or Persons shall be deemed to have been duly executed and delivered by the Company. No Member's signature shall be required in connection with execution and delivery on such documents and instruments by the Company, and third parties to such documents and instruments shall be entitled to rely upon the Board of Manager's general or specific approval and delegation of authority to the signatory or signatories on behalf of the Company without otherwise ascertaining whether the requirements of this Agreement have been satisfied. -15- 21 ARTICLE VIII ACCOUNTING AND RECORDS 8.1 Financial Statements and Records. The Company shall prepare its financial statements and tax returns using such methods of accounting as the Board of Managers deems necessary or appropriate. The Company shall maintain proper and complete books of account and records of the business of the Company, under the supervision of the Board of Managers, at the Company's principal office or at such other place or places as may be designated by the Board of Managers. The Board of Managers shall give notice to each Member of any change in the location of the books and records. The Company has initially contracted with CombiChem for preparation of such statements, books and records pursuant to the CombiChem Services Agreement. 8.2 Inspection of Books. The Company's books and records shall be open to inspection, audit and copying by any Member, or such Member's designated representative, upon reasonable notice at any time during business hours for any purpose reasonably related to the Member's interest in the Company. Any information so obtained shall be kept confidential by the Member except as required by law. 8.3 Annual and Monthly Reports. Financial statements of the Company shall be prepared as of the end of each Fiscal Year and audited by a firm of independent certified public accountants selected by the Board of Managers, provided, however, that the Board of Managers may waive the audit requirement at any time and for any reason. A copy of the annual financial statements shall be transmitted to the Members within 45 days after the end of each Fiscal Year. In addition, the Company shall cause unaudited monthly financial statements, including a comparison of actual results to the projections found in the Annual Budget applicable for the reporting period, to be prepared and distributed to the Members within 30 days after the end of each month beginning with December 1998. 8.4 Tax Returns. Within 90 days after the end of each Fiscal Year, the Board of Managers shall file a federal income tax information return and transmit to each Member a schedule showing such Member's distributive share of the Company's income, deductions and credits, and all other information necessary for such Member to timely file its own federal income tax return for the Fiscal Year. The Board of Managers similarly shall file, and provide information to the Members regarding, all appropriate state and local income tax returns. ARTICLE IX ALLOCATIONS -16- 22 9.1 Allocation of Net Income or Net Loss. For each Accounting Period , Net Income or Net Loss of the Company, or items thereof, shall be allocated to the Members in proportion to the number of Units held by each. 9.2 Partnership Status. The Members agree that the Company shall be treated as a partnership for all U.S. federal income tax purposes. ARTICLE X DISTRIBUTIONS 10.1 Allocation of Distributions among Holders of Units. All distributions by the Company to holders of Units shall be made in proportion to the holders' ownership of such Units at the time of the distribution. 10.2 Discretionary Distributions. The Board of Managers may cause the Company to make distributions to the holders of Units in accordance with Section 10.1 in such amounts and at such times as they shall from time to time determine to be in the best interests of the Company and its Members; provided, however, that distribution of an amount equal to any estimated distribution amount set forth in the Annual Budget for a Fiscal Year shall be presumptively valid if the Company realized excess cash flow in at least that amount from operations during that Fiscal Year. If any assets are distributed in kind, then they shall be distributed on the basis of the fair market value thereof as determined by the Members, and shall be deemed to have been sold at such fair market value for purposes of the allocations under Article IX. 10.3 No Other Withdrawals. Except as otherwise expressly provided for in this Agreement, no withdrawals or distributions shall be required or permitted. -17- 23 ARTICLE XI TRANSFERS 11.1 Transfer of Units. A Member may Transfer one or more Units to another Member. A Member may also Transfer one or more Units to a Substitute Member, in whole or in part, and the Substitute Member will be admitted to the Company as a member, only if: (i) the Substitute Member shall have agreed in writing to assume all of the obligations of the Member with respect to the Units being so Transferred (including the obligations imposed hereunder as a condition to any transfer); (ii) the Board of Managers shall have concluded (which conclusion may be based upon an opinion of counsel satisfactory to it) that the Transfer will not result in a termination of the Company for federal or state income tax purposes, result in (or materially increase the risk of) the Company being taxable as a corporation for federal income tax purposes, or result in a violation of any law, rule or regulation by the Member, the Substitute Member, the Company or the other Member(s); and (iii) all other Member(s) shall have consented to the Transfer, such consent not to be unreasonably withheld. 11.2 Transfer Void. Any purported Transfer of Units in contravention of this Article XI shall be void and of no effect to, on or against the Company, any Member, any creditor of the Company or any claimant against the Company. 11.3 Transfer of Control of Member. Any Transfer of legal or beneficial ownership or control of a Member, whether by sale or issuance of the Member's equity securities, voting trust agreement, irrevocable proxy or otherwise, shall be deemed an attempted Transfer of the Units owned by that Member for purposes of this Article XI in contravention of Section 11.1. 11.4 Transfer of Control of Affiliates. (a) If there is any Transfer of legal or beneficial ownership or control of *** , whether by sale or issuance of equity securities, voting trust agreement, irrevocable proxy or otherwise, and *** continues to be an *** after such Transfer, *** may, in its sole discretion, institute the buy-sell provisions described in Article XII. (b) If there is any Transfer of legal or beneficial ownership or control of *** , whether by sale or issuance of equity securities, voting trust agreement, irrevocable proxy or otherwise, and *** continues to be an - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -18- 24 *** after such Transfer, *** may, in its sole discretion, institute the buy-sell provisions described in Article XII. (c) As used herein, a *** is a Person for whom at least *** of its consolidated revenues during its most recently completed fiscal year were earned from the sale of goods or services that *** (i) in the case of *** , with those *** by any *** that accounted for at least *** of the consolidated revenues of *** during the same period, and (ii) in the case of *** , with those *** by any *** that accounted for at least *** of the consolidated revenues of *** during the same period. 11.5 Acquisition of *** . (a) If *** or its Affiliates acquire legal or beneficial ownership or control of a *** , whether by purchase of equity securities, a voting trust agreement, irrevocable proxy or otherwise, *** may, in its sole discretion, institute the buy-sell provisions described in Article XII. (b) If *** or its Affiliates acquire legal or beneficial ownership or control of a *** , whether by purchase of equity securities, a voting trust agreement, irrevocable proxy or otherwise, *** may, in its sole discretion, institute the buy-sell provisions described in Article XII. ARTICLE XII BUY-SELL PROVISION 12.1 Application. The procedures described in this Article XII are available only so long as there are only two Members admitted to the Company. Either Member may initiate the procedures, by giving the other Member notice pursuant to Section 12.2(a), during the ninety (90) days following (i) dissolution of the Company pursuant to Section 14.1 or (ii) declaration of a Board Deadlock pursuant to Section 16.1. In addition, an Aggrieved Member under Section 3.6(a) may initiate the procedures, by giving the other Member notice pursuant to Section 12.2(a), as provided therein. 12.2 Procedures (a) The Member initiating these procedures shall give the other Member a notice (the "Price Notice") of its election to do so, together with a statement of a - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -19- 25 hypothetical sale price for all the Company's assets, free and clear of the Company's secured and unsecured liabilities, and a calculation of the net proceeds per Unit (the "Per Unit Price") that each Member would receive if the Company sells all of its assets for cash in the amount of the hypothetical sale price, satisfies all of its liabilities, and distributes the net proceeds to the Members in accordance with this Agreement on the date the Price Notice is given. (b) The other Member shall have thirty (30) days after the Price Notice is given in which to elect to purchase the Units of the initiating Member, or to sell its Units to the initiating Member, for a price per Unit equal to the Per Unit Price. Such an election shall be made by notice given to the initiating Member, in the absence of which the other Member shall be deemed to have elected to sell its Units to the initiating Member. The price shall be payable in cash at closing, which will occur on the tenth (10th) business day after the other Member has elected (or is deemed to have elected) to sell its Units to the initiating Member or purchase the Units of the initiating Member. At the closing, each Member shall execute and deliver such documents and take such other actions as may be necessary or customary to lawfully effect the sale and transfer of Units from one Member or the other. ARTICLE XIII INDEMNIFICATION AND LIMITATION OF LIABILITY 13.1 Indemnification. (a)To the extent permitted by the Act and by law, the Managers, the Members as such, and the directors, officers, employees and agents of any of the foregoing (herein collectively referred to as "Indemnitees") shall, in accordance with this Section, be indemnified and held harmless by the Company from and against any and all loss, claims, damages, liabilities joint and several, expenses, judgments, fines, settlements and other amounts arising from any and all claims (including reasonable legal expenses and reasonable attorneys' fees), demands, actions, suits or proceedings (civil, criminal, administrative or investigative) in which the Indemnitee may be involved, as a party or otherwise, by reason of management of, or involvement in, the affairs of the Company, or rendering of advice or consultation with respect thereto, or which relate to the Company, its properties, business or affairs, if (i) such Indemnitee acted in good faith and in a manner such Indemnitee reasonably believed to be in, or not opposed to, the best interests of the Company, and (ii) with respect to any criminal proceeding, such Indemnitee had no reasonable cause to believe the conduct of such Indemnitee was unlawful. The termination of a proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere, or its equivalent, shall not, of itself, create a presumption that the Indemnitee did not act in good faith and in a manner which the Indemnitee reasonably believed to be in, or not opposed to, the best interests of the Company or that the Indemnitee had reasonable cause to believe that the Indemnitee's conduct was unlawful (unless there has been a final adjudication in the proceeding that the Indemnitee -20- 26 did not act in good faith and in a manner which the Indemnitee reasonably believed to be in or not opposed to the best interests of the Company; or that the Indemnitee did have reasonable cause to believe that the Indemnitee's conduct was unlawful). (b) The Company may also indemnify any Person who was or is a party or is threatened to be made a party to any threatened, pending, or completed action by or in the right of the Company to procure a judgment in its favor by reason of the fact that such Person is or was an officer, employee or agent of the Company, against expenses reasonably incurred by such Person in connection with the defense or settlement of such action, if such Person acted in good faith and in a manner such Person reasonably believed to be in, or not opposed to, the best interests of the Company, except that indemnification shall be made in respect of any claim, issue or matter as to which such Person shall have been adjudged to be liable for misconduct in the performance of the Person's duty to the Company only to the extent that the court in which such action or suit was brought, or another court of appropriate jurisdiction, determines upon application that, despite the adjudication of liability, but in view of all circumstances of the case, such Person is fairly and reasonably entitled to indemnity for such expenses which such court shall deem proper. To the extent that the Person has been successful on the merits or otherwise in defense of any proceedings referred to herein, or in defense of any claim, issue or matter therein, the Person shall be indemnified by the Company against expenses actually and reasonably incurred by the Person in connection therewith. Notwithstanding the foregoing, no Person shall be entitled to indemnification hereunder for any conduct arising from the gross negligence or willful misconduct or reckless disregard in the performance of the Person's duties under this Agreement. (c) Expenses (including attorneys' fees) incurred in defending any proceeding under Sections 13.1 (a) or (b) shall be paid by the Company in advance of the final disposition of such proceeding upon receipt of an undertaking by or on behalf of the Indemnitee or Person to repay such amount if it shall ultimately be determined that the Indemnitee or Person is not entitled to be indemnified by the Company as authorized hereunder. (d) The indemnification provided by this Section 13.1 shall not be deemed to be exclusive of any other rights to which any Person may be entitled under any agreement, or as a matter of law, or otherwise, both as to action in a Person's official capacity and to action in another capacity. (e) The Board of Managers shall have power to purchase and maintain insurance on behalf of the Company, the Managers, Members, officers, employees or agents of the Company and any other Indemnitees at the expense of the Company, against any liability asserted against or incurred by them in any such capacity whether or not the Company would have the power to indemnify such Persons against such liability under the provisions of this Agreement. -21- 27 13.2 Limitation of Liability. Notwithstanding anything to the contrary herein contained, the debts, obligations and liabilities of the Company shall be solely the debts, obligations and liabilities of the Company; and no Manager or Member shall be obligated personally for any such debt, obligation or liability of the Company solely by reason of being a Manager or Member of the Company. ARTICLE XIV TERMINATION 14.1 Termination. The Company shall be dissolved, its assets disposed of, and its affairs wound up upon the first to occur of the following: (a) the expiration of its stated term; (b) the affirmative vote of Member(s) holding not less than a Supermajority of the Units; (c) the entry of a decree of judicial dissolution under the Act; or (d) 90 days following the occurrence of a Dissolution Event. 14.2 Continuance of the Company. Notwithstanding Section 14.1(d), upon the occurrence of a Dissolution Event, if there are at least two remaining Members, all remaining Members may avoid dissolution of the Company by electing, within 90 days after a Dissolution Event, to continue the business of the Company on the same terms as this Agreement. Expenses incurred in the continuance of the Company shall be deemed expenses of the Company -22- 28 14.3 Authority to Wind Up. The Board of Managers shall have all necessary power and authority required to marshal the assets of the Company, to pay its creditors and liabilities, to distribute assets and otherwise wind up the business and affairs of the Company. The Board of Managers shall continue to conduct the business and affairs of the Company for such period as may be necessary to allow an exercise of purchase rights under Article XII ( and consummation of any purchase and sale resulting from the exercise of such rights) and shall thereafter continue to conduct the business and affairs of the Company only insofar as such continued operation remains consistent, in the judgment of the Board of Managers, with an orderly winding up of the Company. 14.4 Winding Up and Certificate of Cancellation.The winding up of the Company shall be completed when all debts, liabilities and obligations of the Company have been paid and discharged or reasonably adequate provision therefor has been made, and all of the remaining property and assets of the Company have been distributed to the Members. Upon the completion of winding up of the Company, a Certificate of Cancellation shall be filed with the Office of the Secretary of State of California. 14.5 Distribution of Assets. Upon dissolution and winding up of the Company, the affairs of the Company shall be wound up and the Company liquidated by the Board of Managers. Pursuant to such liquidation, the assets of the Company in the form of intellectual property owned by the Company (other than rights under the CT License and the Combi License which shall terminate upon the winding up of the Company except as provided in Section 6.2 of each such license agreements) shall be distributed in kind, and the other assets of the Company shall be sold unless the Members shall consent to a distribution in kind of such other assets. If the Members do not consent to a distribution in kind but the Board of Managers determines that an immediate sale would be financially inadvisable, they may defer sale of the Company assets for a reasonable time. If any assets are distributed in kind, then they shall be distributed on the basis of the fair market value thereof as determined by appraisal, and shall be deemed to have been sold at such fair market value for purposes of the allocations under Article IX. Unless the Members otherwise agree, if any assets are to be distributed in kind, they shall be distributed to the Members, as tenants-in-common, in undivided interests in proportion to distributions to which the Members are entitled under this Section 14.5. The assets of the Company, whether cash or in kind, shall be distributed as follows in accordance with the Act: (a) to creditors of the Company in the order of priority provided by law; and (b) the Members in proportion to the number of Units held by each. -23- 29 14.6 Effect of Termination. The Company shall terminate and cease to exist when all of its assets have been sold and/or distributed and all of its affairs have been wound up. ARTICLE XV DEFINITIONS 15.1 Definitions. The following terms shall have the meanings set forth herein for purposes of this Agreement: (a) "Accounting Period" shall mean, for each Fiscal Year, the period beginning January 1 and ending December 31, provided however, that the first Accounting Period shall commence on the date of formation of the Company, the last Accounting Period shall end on the date of the final winding up of the affairs of the Company, and a new Accounting Period shall commence on any date on which the Company terminates for tax purposes. (b) "Act" shall have the meaning set forth in Section 1.1. (c) "Affiliate" shall mean, with respect to a specified Person, (other than a natural person), a Person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the specified Person. (d) "Agreement" shall mean this Limited Liability Company Operating Agreement as the same may be amended from time to time. (e) "Annual Budget" shall mean the budget of income and expenses for the Company for each Fiscal Year, and related financial information, approved by the Board of Managers pursuant to Section 5.6 (a). (f) "Articles" shall have the meaning set forth in Section 1.1. (g) "Bankruptcy" shall mean, with respect to any Person, that a petition shall have been filed by or against such Person as a "debtor" and the adjudication of such Person as a bankrupt under the provisions of the bankruptcy laws of the United States of America shall have commenced, or that such Person shall have made an assignment for the benefit of its creditors generally or a receiver shall have been appointed for substantially all of the property and assets of such Person. (h) "Board of Managers" shall have the meaning set forth in Section 5.1. (i) "Capital Commitment" shall mean, for each Member, the amount of money and/or property required to be contributed by that Member to the capital of the Company pursuant to Article III. -24- 30 (j) "Capital Contribution" shall mean, for each Member, that amount of money and/or property actually contributed by that Member to the capital of the Company pursuant to Article III . (k) "Carrying Value" means, with respect to any asset, the asset's adjusted basis for federal income tax purposes, except as follows: (1) The initial Carrying Value of any asset contributed by a Member to the Company shall be the agreed-upon fair market value of the asset upon contribution, as determined by the contributing Member and the Company. The initial Carrying Value of any asset contributed to the Company as a Capital Contribution shall be set forth in the Annual Budget calling for that Capital Contribution. (2) In the discretion of the Board of Managers, the Carrying Values of all assets may be adjusted to equal their respective fair market values, as determined by the Board of Managers, and the resulting unrecognized gain or loss allocated to each Member as though such assets had been sold for their respective fair market values as of the following times: (A) the acquisition of any additional Units in the Company by any new or existing Member in exchange for more than a de minimis Capital Contribution; and (B) the distribution by the Company to a Member of more than a de minimis amount of assets, unless all Members receive simultaneous distributions of either undivided interests in the distributed property or identical assets in proportion to their ownership of Units in the Company. (3) The Carrying Values of all assets shall be adjusted to equal their respective fair market values, as determined by the Board of Managers, and the resulting unrecognized gain or loss allocated to each Member as though such assets had been sold for their respective fair market values as of the following times: (A) the date the Company is liquidated within the meaning of Treasury Regulation Section 1.704-1 (b)(2)(ii)(g); and (B) the termination of the Company pursuant to the provisions of this Agreement. (4) The Carrying Values of assets shall be increased or decreased to the extent required under Treasury Regulation Section 1.704-1(b)(2)(iv)(m) in the event that the adjusted tax basis of assets is adjusted pursuant to Code Sections 732, 734 or 743. (5) The Carrying Value of an asset that is distributed (whether in liquidation of the Company or otherwise) to one or more Members shall be adjusted to equal its fair market value, as determined by the Board of Managers, and the resulting unrecognized gain or loss allocated to each Member as though such asset had been sold for such fair market value. -25- 31 (6) The Carrying Value of an asset shall be adjusted by the depreciation, amortization or other cost recovery deductions, if any, taken into account by the Company with respect to such asset in computing Net Profit or Net Loss. (l) "Chiral Compound" shall mean a chemical compound manufactured by or on behalf of the Company pursuant to rights granted in the License Agreements. (m) "Chiro Ancillary Agreements" shall mean the Cooperation Agreement, the CT License, the Chirotech Services Agreement and the CT Limited Services Agreement. (n) "ChiroSub" shall mean Chirotech Limited, a company organized and existing under the laws of England and Wales. (o) "Chirotech, Inc." shall mean Chirotech, Inc., a Delaware corporation. (p) "Chirotech Services Agreement" shall mean that certain Services Agreement of even date herewith between Chirotech, Inc. and the Company. (q) "Code" shall mean the Internal Revenue Code of 1986, as amended. (r) "Combi Ancillary Agreements" shall mean the Cooperation Agreement, the CombiChem License and the CombiChem Services Agreement. (s) "CombiChem" shall mean CombiChem, Inc., a Delaware corporation. (t) "CombiChem License" shall mean that certain License Agreement of even date herewith between CombiChem and the Company. (u) "CombiChem Services Agreement" shall mean that certain Services Agreement of even date herewith between CombiChem and the Company. (v) "CombiSub" shall mean CombiChem JVR, Inc., a Delaware corporation. (w) "Cooperation Agreement" shall mean that certain Cooperation Agreement of even date herewith between CT Limited, Chirosub, CombiChem, CombiSub and the Company. (x) "CT License" shall mean that certain License Agreement of even date herewith between CT Limited and the Company. (y) "CT Limited" shall mean Chirotech Technology Limited, a company organized and existing under the laws of England and Wales. -26- 32 (z) "CT Limited Services Agreement" shall mean that certain Services Agreement of even date herewith between CT Limited and the Company. (aa) "Dissociated Member" shall have the meaning set forth in Section 2.6. (bb) "Dissolution" of a Member that is not a natural person shall mean that such Member has terminated its existence, whether partnership, corporate or limited liability company, wound up its affairs and dissolved; provided, however, that a change in the membership of any Member that is a general partnership shall not constitute "Dissolution" hereunder, whether or not the Member is deemed technically dissolved for partnership law purposes, so long as the business of the Member is continued. (cc) "Dissolution Event" shall mean the Bankruptcy or Dissolution of a Member, the occurrence of which terminates the Member's continued membership in the Company and results in the dissolution and winding up of the Company under the Act unless the remaining Members (if more than one) unanimously agree otherwise pursuant to Section 14.2. (dd) "Effective Date" shall mean the later of (i) the date on which the Articles are filed in the office of the Secretary of State of California, or (ii) the date on which this Agreement is executed and delivered by the initial Members, the Chiro Ancillary Agreements are executed and delivered by the parties thereto, and the Combi Ancillary Agreements are executed and delivered by the parties thereto. (ee) "Fiscal Year" shall mean the period from January 1 to December 31 of each year, or as otherwise required by law. (ff) "Initial Term" shall have the meaning set forth in Section 1.7. (gg) " *** " shall have the meaning set forth in Section 11.4. (hh) "Manager" shall mean a natural person appointed to the Board of Managers under Article V and who has not resigned or been removed as a manager pursuant to this Agreement. (ii) "Members" shall mean the initial Members of the Company and all Substitute Members, but does not include Dissociated Members. (jj) "Net Income or Net Loss" shall mean the net book income or loss of the Company for any relevant period. The net book income or loss of the Company shall be computed in accordance with federal income tax principles (i) under the method of - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -27- 33 accounting elected by the Company for federal income tax purposes, (ii) as applied without regard to any recharacterization of transactions or relationship that might otherwise be required under such tax principles and (iii) as otherwise adjusted by: (1) including as income or deductions, as appropriate, any tax-exempt income and related expenses that are neither properly included in the computation of taxable income nor capitalized for federal income tax purposes; (2) including as a deduction when paid or incurred (depending on the Company's method of accounting) any amounts utilized to organize the Company or to promote the sale of (or to sell) an interest in the Company, except that amounts for which an election is properly made by the Company under Section 709(b) of the Code shall be accounted for as provided therein; and (3) calculating the gain or loss on disposition of assets and the depreciation, amortization or other cost-recovery deductions, if any, with respect to assets by reference to their Carrying Values rather than their adjusted tax basis. (kk) "Person" shall mean a natural person, partnership (whether general or limited), limited liability company, trust, estate, association, corporation, custodian, nominee, or any other individual or entity in its own or representative capacity, whether domestic or foreign. (ll) "Substitute Member" shall mean only an Affiliate of an initial Member. (mm) "Supermajority" shall mean, when referring to Units, greater than seventy-five percent (75%) of all outstanding Units. (nn) "Transfer" shall mean any transfer, sale, exchange, encumbrance, pledge, mortgage, assignment or other disposition, whether voluntary or involuntary. (oo) "Treasury Regulation" shall mean any regulation issued by the United States Department of the Treasury pursuant or relating to the Code. ARTICLE XVI DISPUTE RESOLUTION 16.1 Board of Managers Deadlock. In the event the Board of Managers fails to approve an Annual Budget for a Fiscal Year pursuant to Section 5.6 (a) before the commencement of that Fiscal Year, the Annual Budget for the preceding Fiscal Year shall be deemed approved for the Fiscal Year until such time as the Board of Managers approves a new one for that Fiscal Year. In the event of any other deadlock in voting at a meeting of the Board of Managers regarding any material decision relating to the Company, any Manager may declare the existence of a deadlocked vote, in which event -28- 34 the proposal or other subject matter of the deadlocked vote shall be referred by the Company to the chief executive officer of CombiChem and the chairman of CT Limited, who shall confer in good faith in an effort to eliminate the deadlock and otherwise consider the matter for a period of thirty (30) days following referral. If the deadlock is not so broken by that date, either Member may declare that a Board Deadlock exists, and exercise the rights provided in Section 12.1, at any time during the next ninety (90) days. 16.2 Arbitration. Except as hereinabove provided, any controversy between the Members and any claim by one Member against the Company or another Member arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in San Francisco, California in accordance with the then-applicable commercial arbitration rules of the American Arbitration Association. Judgment upon the award rendered may be entered into any court having jurisdiction thereof. The losing party shall bear the costs and expenses of such arbitration. ARTICLE XVII MISCELLANEOUS 17.1 Amendment. Except as provided herein, this Agreement may be amended only with the written consent of a majority of the Board of Managers and of Member(s) holding a Supermajority of Units. 17.2 Withholding Taxes. (a)The Company shall at all times be entitled to make payments with respect to any Member in amounts required to discharge any obligation of the Company to withhold or make payments to any governmental authority with respect to any federal, state, local or other jurisdictional tax liability of such Member arising as a result of such Member's interest in the Company. To the extent each such payment satisfies an obligation of the Company to withhold with respect to any distribution to a Member on which the Company did not withhold or with respect to any Member's allocable share of the income of the Company, each such payment shall be deemed to be a loan by the Company to such Member (which loan shall be deemed to be immediately due and payable) and shall not be deemed a distribution to such Member. The amount of such payments made with respect to such Member, plus interest on each such amount from the date of each such payment until such amount is repaid to the Company accruing at an interest rate per annum equal to the Bank of America prime rate from time to time in effect, shall be repaid to the Company by (i) deduction from any cash distributions made to such Member pursuant to this Agreement; (ii) deduction from any non-cash distributions made to such Member, or (iii) earlier payment by such Member to the Company, in each case as determined by the Board of Managers in its sole discretion. The Board of Managers may, in its discretion, defer making distributions to any Member owing amounts to the Company pursuant to this Section until such amounts are paid to -29- 35 the Company and shall in addition exercise any other rights of a creditor with respect to such amounts. (b) Each Member agrees to indemnify and hold harmless the Company, the Managers and the Members, from and against any liability for taxes, interest or penalties that may be asserted by reason of the failure to deduct and withhold tax on amounts distributable or allocable to said Member. Any amount payable as indemnity hereunder by a Member shall be paid promptly to the Company upon request for such payment from the Board of Managers, and if not so paid, the Board of Managers and the Company shall be entitled to claim against and deduct all such amounts from the allocated portion of Net Profits of, or from any distribution due to, the affected Member. 17.3 Publicity. The Company will consult each of the Members and with Chiroscience Group plc ("Chiroscience"), currently the holder of 70% of the outstanding equity of CT Limited, prior to any public announcement relating to the Company and transactions and/or activities contemplated by this Agreement, the Chiro Ancillary Agreements or the Combi Ancillary Agreements and the terms hereof and thereof; provided, however, that if the percentage of the equity ownership of CT Limited held by Chiroscience becomes less than 50%, the Company will no longer be required to consult with Chiroscience prior to any such public announcement. The Members and Chiroscience, if applicable, will mutually and reasonably approve the timing, content and dissemination of any public announcement, except to the extent that any such party is not reasonably able to consult in a timely manner with or obtain the approval of the other parties when disclosures are required by applicable law; and, provided further, that either party may disclose the transactions contemplated by this Agreement, the Chiro Ancillary Agreements or the Combi Ancillary Agreements and the terms hereof and thereof in connection with any bona fide corporate finance transaction (including ongoing credit facilities), the merger or consolidation of a party or any other transaction effecting a significant change in the ownership or control of a Member or an Affiliate or all or substantially all of a Member's or an Affiliate's business, assets or stock, or other similar corporate transaction or purpose not related to pricing strategies or marketing plans. 17.4 Further Assurances. The parties agree to execute and deliver any further instruments or documents and perform any additional acts that are or may become necessary to effectuate and carry on the Company created by this Agreement. 17.5 Construction. Every covenant, term and provision of this Agreement shall be construed simply according to its fair meaning and not strictly for or against any Member. 17.6 Time. In computing any period of time pursuant to this Agreement, the day of the act, event or default from which the designated period of time begins to run shall not be included, but the time shall begin to run on the next succeeding day. The last day -30- 36 of the period so computed shall be included, unless it is not a business day, in which event the period shall run until the end of the next business day. 17.7 Headings. Section and other headings contained in this Agreement are for reference purposes only and are not intended to describe, interpret, define, or limit the scope, extent, or intent of this Agreement or any provision hereof. 17.8 Severability. Except as otherwise provided in the succeeding sentence, every provision of this Agreement is intended to be severable, and, if any term or provision of this Agreement is illegal or invalid for any reason whatsoever, such illegality or invalidity shall not affect the validity or legality of the remainder of this Agreement. The preceding sentence of this Section shall be of no force or effect if the consequence of enforcing the remainder of this Agreement without such illegal or invalid term or provision would be to cause Member to lose the material benefit of its economic bargain. -31- 37 17.9 Variation of Terms. All terms and any variations thereof shall be deemed to refer to masculine, feminine, or neuter, singular or plural, as the identity of the Person or Persons may require. 17.10 Governing Law. The laws of the State of California shall govern the validity of this Agreement, the construction of its terms, and the interpretation of the rights and duties arising hereunder. 17.11 Binding Effect. Subject to the restrictions on Transfer set forth in Article XI, this Agreement shall be binding on and inures to the benefit of the Members and their respective transferees, successors, assigns and legal representatives. 17.12 Entire Agreement. This Agreement constitutes the entire agreement among the parties with respect to the subject matter herein. 17.13 Counterparts.This Agreement may be executed in one or more counterparts with the same force and effect as if each of the signatories had executed the same instrument. -32- 38 IN WITNESS WHEREOF, all of the Members of ChiroChem Discovery Services LLC, a California limited liability company, have executed this Limited Liability Company Operating Agreement as of the day and year first above written. MEMBERS: CHIROTECH LIMITED, a company organized and existing under the laws of England and Wales By: /s/ Christine H. Soden --------------------------------------- Name: Christine H. Soden -------------------------------------- Title: Director -------------------------------------- Address: Cambridge Science Park Milton Road Cambridge CB4 4WE England COMBICHEM JVR, INC., a Delaware corporation By: /s/ Vicente Anido, Jr. --------------------------------------- Name: Vicente Anido, Jr. -------------------------------------- Title: President & CEO -------------------------------------- Address: 9050 Camino Santa Fe San Diego, CA 92121 [SIGNATURE PAGE TO LLC AGREEMENT] EX-10.65 5 EXHIBIT 10.65 1 EXHIBIT 10.65 COOPERATION AGREEMENT THIS COOPERATION AGREEMENT (this "Agreement") dated as of December 1, 1998, is by and among CHIROTECH TECHNOLOGY LIMITED (Registration No. 2667953), a company organized and existing under the laws of England and Wales ("CT Limited"); CHIROTECH LIMITED (Registration No. 3580272), a company organized and existing under the laws of England and Wales and a wholly owned subsidiary of CT Limited ("ChiroSub"); COMBICHEM, INC., a Delaware corporation ("CombiChem"); COMBICHEM JVR, INC., a Delaware corporation and wholly owned subsidiary of CombiChem ("CombiSub"); AND CHIROCHEM DISCOVERY SERVICES LLC, a California limited liability company ("ChiroChem"). RECITALS WHEREAS, ChiroSub and CombiSub are the two members of ChiroChem, which was formed pursuant to that certain Limited Liability Company Operating Agreement dated as of December 1, 1998 (the "LLC Agreement"); WHEREAS, as such, each of ChiroSub and CombiSub will from time to time be obligated to make Capital Contributions to ChiroChem pursuant to the LLC Agreement; WHEREAS, each of the parent companies of the members of ChiroChem wishes, by this Agreement, to guarantee the prompt payment in full of said Capital Contributions and the timely performance of the other obligations of its wholly-owned subsidiary under the LLC Agreement; WHEREAS, because of the nature of ChiroChem's businesses, any of the parties hereto may become aware of or receive information concerning business opportunities that are derived directly from but outside of the stated purposes of ChiroChem as set forth in the LLC Agreement; WHEREAS, the parties hereto wish to establish procedures and terms by which each such business opportunity will be made available to one of the parent companies in consideration for compensation to the other parent company; WHEREAS, CT Limited and CombiChem are sometimes referred to individually as a "Parent" and collectively as the "Parents," and ChiroSub and CombiSub are sometimes referred to individually as a "Member" and collectively as the "Members;" and WHEREAS, terms not defined herein shall have the meanings given them in the LLC Agreement. AGREEMENT NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: *** Certain confidential portions of this Exhibit were omitted by means of blackout of the text (the "Mark"). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company's Application Requesting Confidential Treatment under Rule 24b-2 under the Act. 2 1. GUARANTEES. 1.1 DEFINITIONS. As used herein, the term "Guaranteed Obligations" shall mean every debt, duty, undertaking, obligation, covenant and condition to be paid or performed by a Member pursuant to the LLC Agreement, including the obligation to make Capital Contributions from time to time. 1.2 GUARANTIES. Each Parent unconditionally guarantees and promises (each a "Guarantee") to and for the benefit of ChiroChem the full, prompt and complete payment and performance by the Member that is its wholly owned subsidiary, as and when due, of that Member's Guaranteed Obligations. 1.3 NATURE OF GUARANTY. Each Guaranty is an original and independent obligation of the Parent making it, separate and distinct from the Guaranteed Obligations. A separate action may be brought or prosecuted against the Parent, regardless of whether such an action is brought or prosecuted against the corresponding Member or any other guarantor and regardless of whether the Member or any other guarantor is joined in the action. Each Parent acknowledges and agrees that its guaranty is a direct and absolute guarantee of payment and performance and not merely a guarantee of collection. Each Parent hereby waives any and all rights or legal requirements that ChiroChem institute any action or proceeding, or exhaust any remedies, against the corresponding Member or any collateral hereafter obtained by ChiroChem for the Guaranteed Obligations or anyone else in respect of the Guaranteed Obligations as a condition precedent to bringing an action against the Parent pursuant to this Agreement. 1.4 BANKRUPTCY NO DISCHARGE. Notwithstanding anything to the contrary herein contained, this Agreement shall continue to be effective or shall be reinstated, as the case may be, if at any time payment or performance of all or any part of the Guaranteed Obligations is avoided or must otherwise be restored or returned by ChiroChem upon the insolvency, bankruptcy or reorganization of a Member or otherwise, all as though such payment or performance had not been made. Notwithstanding any modification, discharge or extension of the Guaranteed Obligations or any amendment, modification, stay or cure of ChiroChem's rights which may occur in any bankruptcy or reorganization case or proceeding concerning the Member, whether permanent or temporary, and whether or not assented to by ChiroChem, the corresponding Parent shall be obligated hereunder to pay all sums payable under the LLC Agreement and this Agreement in performance of all duties now or hereafter arising. 1.5 WAIVER OF DEFENSES. Each Parent hereby waives any defense arising by reason of any disability of the corresponding Member or by reason of the cessation from any cause whatsoever (other than full payment) of the liability of the Member for any of the Guaranteed Obligations. Each Parent shall be liable and remain liable for the payment and performance of the Guaranteed Obligations to the full extent provided herein notwithstanding (a) any previous discharge (partial or total) of the Member from any further liability; (b) any bar (temporary, partial or total) to the pursuit by the Parent of any right or claim for indemnification from the Member; (c) loss of any right or claim by the Parent to be subrogated to the rights or claims of ChiroChem against the Member; (d) any action or inaction or delay in acting by ChiroChem; or (e) ChiroChem's failure to enforce, or delay in enforcing, any of its rights under the LLC Agreement or otherwise. 2 3 1.6 AMENDMENTS TO DOCUMENTS. Each Parent authorizes ChiroChem, without notice, demand or consideration and without affecting the Parent's liability hereunder, from time to time, to: (a) amend, change, release or cancel any of the provisions of the LLC Agreement, by further agreement among ChiroChem and the Members at any time, or by operation of law, without the consent of or notice to the Parent; (b) extend the maturity, grant any indulgence or forbearance or postpone the time of payment of any of the Guaranteed Obligations; and (c) take and hold additional guarantees or collateral as security for the performance and payment of the Guaranteed Obligations, and apply, enforce, exchange, waive and release any guaranty now or hereafter held by ChiroChem. 1.7 WAIVER OF ACCEPTANCE, PRESENTMENTS AND NOTICES. Each Parent waives notice of acceptance of this guaranty and all grace, demands for performance, presentments, notices of default, protests, notices of protest, and notices of dishonor. 1.8 ATTORNEYS FEES. Each Parent agrees to pay all expenses, including without limitation reasonable attorneys fees and costs, paid or incurred by ChiroChem in any action to enforce, interpret or defend Section 1 or any subsection thereof of this Agreement. 2. REFERRALS OF BUSINESS OPPORTUNITIES. 2.1 DEFINITIONS. As used herein, the following terms shall have the following meanings: "Production Gross Profits" means all revenues received from the *** resulting from a Production Opportunity less all expenses directly associated with (as determined by U.S. Generally Accepted Accounting Procedures ("GAAP")) the generation of such revenues including, but not limited to, withholding taxes that are not recoverable in the foreseeable future. "Production Opportunity" means an expression of interest from a potential customer or other apparent opportunity to *** to one or more third party customers, *** (in *** ) derived directly from the activities of ChiroChem. "Research Gross Profits" means all revenue received from *** resulting from a Research Opportunity less all expenses directly associated with (as determined by GAAP) the generation of such revenues including, but not limited to, withholding taxes that are not recoverable in the foreseeable future. *** received from collaborators *** and all expenses associated with the *** are specifically excluded from the definition of Research Gross Profits for such collaborative agreements structured to *** on such service. - -------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 3 4 "Research Opportunity" means *** from a potential customer or other apparent opportunity to *** for the account of one or more third party customers for compensation, *** activities to facilitate *** using *** derived directly from the activities of ChiroChem. 2.2 REFERRALS. In the event any party to this Agreement, *** a Production Opportunity or a Research Opportunity which arises directly from the activities of ChiroChem, it shall maintain the confidentiality of such information and make it available to third parties only as provided herein. All such information concerning a Production Opportunity shall be promptly provided by the holder thereof to CT Limited, and all such information regarding a Research Opportunity shall be promptly provided by the holder thereof to CombiChem. The party receiving such information hereunder may consider whether it wishes to pursue the described opportunity, which it may accept or reject in its sole discretion, and it is under no obligation to any other party to do so. If the opportunity is pursued, the receiving party shall periodically keep the other parties reasonably informed of its business activities in pursuit of the opportunity. 2.3 COMPENSATION FOR PRODUCTION OPPORTUNITIES. If CT Limited pursues a Production Opportunity and, as a result thereof, it earns Production Gross Profits from the *** of *** in *** *** , it shall pay to CombiChem, as consideration hereunder, a fee equal to *** of all such Production Gross Profits. Said fee shall be paid in quarterly installments, made not later than the 30th day after the close of each calendar quarter with respect to Production Gross Profits earned during that calendar quarter. Each such payment shall be made in U.S. dollars to the addresses or bank accounts designated by CombiChem. If any currency conversion is required in connection with the payment of such fees hereunder, such conversion shall be made by using the exchange rate as quoted in the Wall Street Journal (U.S.A. edition) on the last business day of the calendar quarter to which such payments relate. Such payments shall be subject to any applicable legally required withholding or other taxes. 2.4 COMPENSATION FOR RESEARCH OPPORTUNITIES. If CombiChem pursues a Research Opportunity and, as a result thereof, it earns Research Gross Profits from the conduct of *** using *** to facilitate *** , it shall pay to CT Limited, as consideration hereunder, a fee equal to *** of all such Research Gross Profits. Said fee shall be paid in quarterly installments, made not later than the 30th day after the close of each calendar quarter with respect to Research Gross Profits earned during that calendar quarter. Each such payment shall be made in pounds sterling to the addresses or bank accounts designated by CT Limited. If any currency conversion is required in connection with the payment of such fees hereunder, such conversion shall be made by using the exchange rate as quoted in the Wall Street Journal (U.S.A. edition) on the last business day of the calendar quarter to which such payments relate. Such payments shall be subject to any applicable legally required withholding or other taxes. - -------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 4 5 2.5 CT LIMITED REPORTS. Within thirty (30) days after the end of each whole or partial calendar quarter during the term of this Agreement in which CT Limited earns Production Gross Profits from the pursuit of a Production Opportunity, CT Limited shall deliver to CombiChem a true and accurate report giving such particulars of the businesses conducted by CT Limited during the preceding whole or partial calendar quarter as the result of Production Opportunities under this Agreement as are pertinent to a fee accounting under this Agreement. Each such report shall include, for the reporting period, at least the following: a. For each Production Opportunity, the *** of each *** in *** during the report period; b. For each customer (identified by name) the Production Gross Profits earned from such *** c. Total fees due to CombiChem hereunder for such period; and d. The aggregate amount of any withholding taxes deducted from the payment made in satisfaction of the fees stated pursuant to (c) above. 2.6 COMBICHEM REPORTS. Within thirty (30) days after the end of each whole or partial calendar quarter during the terms of this Agreement in which CombiChem earns Research Gross Profits from the pursuit of a Research Opportunity, CombiChem shall deliver to CT Limited a true and accurate report giving such particulars of the businesses conducted by CombiChem during the preceding whole or partial calendar quarter as the result of Research Opportunities under this Agreement as are pertinent to a fee accounting under this Agreement. Each such report shall include at least the following: a. For each Research Opportunity, the *** of the *** activities conducted; b. For each customer (identified by name), the Research Gross Profits earned on account of such activities (however denominated); c. Total fees due to CT Limited hereunder for such period; and d. The aggregate amount of any withholding taxes deducted from the payment made in satisfaction of the fees stated pursuant to (c) above. 2.7 RECORDS. Each Parent shall keep (for at least six (6) years after the making of a fee payment hereunder) complete and accurate books of account containing all particulars which may be reasonably necessary for the other Parent to confirm the accuracy of all payments of fees and reports due hereunder. At the written request of the other Parent, each Parent shall make such books and particulars available during normal business hours, upon reasonable notice, for inspection by an independent certified public accountant retained by the - -------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 5 6 other Parent for the purpose of verifying payments of fees and reports related thereto. Such inspections shall be limited solely to those matters directly related to fee and referral obligations under this Agreement. 2.8 INSPECTION COSTS. If an inspection conducted by either CombiChem or CT Limited pursuant to Section 2.7 reveals that CT Limited or CombiChem, as the case may be, has made an error of seven percent (7%) or more in favor of CT Limited or CombiChem, respectively, in the payment due either CombiChem or CT Limited for the year to which the inspection pertains, CT Limited shall reimburse CombiChem, and CombiChem shall reimburse CT Limited, as the case may be, for the cost of the inspection. 3. CORPORATE OPPORTUNITIES. Allocation and pursuit of business opportunities as hereinabove described shall not constitute a misappropriation of the corporate opportunities available to or belonging to ChiroChem. CT Limited shall make available to CombiChem such of its own intellectual property as may be necessary or convenient for CombiChem to pursue a Research Opportunity, by technology license or otherwise, on commercially reasonable terms. CombiChem shall make available to CT Limited such of its own intellectual property as may be necessary or convenient for CT Limited to pursue a Production Opportunity, by technology license or otherwise, on commercially reasonable terms. 4. TERM. The term of this Agreement shall commence on the date hereof and end on the earlier of (i) the date on which ChiroChem terminates and (ii) the date on which it is no longer the case that both ChiroSub (or an Affiliate) and CombiSub (or an Affiliate) are members in ChiroChem. Notwithstanding the foregoing, each Parent's guaranty obligations under Section 1 shall survive beyond the end of the term of this Agreement to the extent that Guaranteed Obligations of the corresponding Member survive beyond said date, and the obligations of Section 2 shall survive indefinitely beyond the end of the term of this Agreement with respect to all Production Gross Profits or Research Gross Profits earned at any time from Production Opportunities or Research Opportunities. 5. CONFIDENTIALITY. Except as provided herein, and except as reasonably necessary to pursue a Production Opportunity or a Research Opportunity, during the term of this Agreement all parties shall hold, and each party shall require its Affiliates to hold, in confidence and not use for any purpose, or disclose to any third party, information involving a Production Opportunity or a Research Opportunity. The obligations of confidentiality set forth in this Section 5 shall not apply to the extent that (a) a disclosing party can demonstrate that the information disclosed to a third party was in the public domain at the time of disclosure, or thereafter became part of the public domain, other than as a result of actions of the disclosing party or (b) the disclosure is required by law, regulation or government or judicial order. 6. MISCELLANEOUS 6.1 AMENDMENT. Except as provided herein, this Agreement may be amended only with the written consent of all parties. 6.2 NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by facsimile transmission (receipt 6 7 verified), or upon receipt if mailed by registered or certified mail (return receipt requested), postage prepaid, or sent by express courier service (receipt verified), to the parties at the following addresses (or at such other address for a party as shall be specified by like notice; provided, that notices of a change of address shall be effective only upon receipt thereof): If to CombiChem, addressed to: CombiChem, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attn: President With a copy to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. If to CombiSub, addressed to: CombiChem JVR, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attn: President With a copy to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. If to CT Limited, addressed to: Chirotech Technology Limited Cambridge Science Park Milton Road Cambridge CB4 4WE England Attention: Secretary 7 8 With a copy to: CombiChem JVR, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attn: President And to: Chiroscience R&D, Inc. 1631 220th Street SE Bothell, WA 98021 USA Attention: Vice President and General Counsel If to ChiroSub, addressed to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE England Attention: Secretary With a copy to: CombiChem JVR, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attn: President And to: Chiroscience R&D, Inc. 1631 220th Street SE Bothell, WA 98021 USA Attention: Vice President and General Counsel If to ChiroChem, addressed to: ChiroChem Discovery Services LLC 9050 Camino Santa Fe San Diego, CA 92121 Attention: Board of Managers With a copy to: CombiChem JVR, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attention: President And to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary 8 9 And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. Any copy of a notice shall be sent at the same time as the original notice. 6.3 FURTHER ASSURANCES. The parties agree to execute and deliver any further instruments or documents and perform any additional acts that are or may become necessary to effectuate and carry out the obligations created by this Agreement. 6.4 CONSTRUCTION. Every covenant, term and provision of this Agreement shall be construed simply according to its fair meaning and not strictly for or against any party. 6.5 TIME. In computing any period of time pursuant to this Agreement, the day of the act, event or default from which the designated period of time begins to run shall not be included, but the time shall begin to run on the next succeeding day. The last day of the period so computed shall be included, unless it is not a business day, in which event the period shall run until the end of the next business day. 6.6 HEADINGS. Section and other headings contained in this Agreement are for reference purposes only and are not intended to describe, interpret, define, or limit the scope, extent, or intent of this Agreement or any provision hereof. 6.7 SEVERABILITY. Except as otherwise provided in the succeeding sentence, every provision of this Agreement is intended to be severable, and, if any term or provision of this Agreement is illegal or invalid for any reason whatsoever, such illegality or invalidity shall not affect the validity or legality of the remainder of this Agreement. The preceding sentence of this Section shall be of no force or effect if the consequence of enforcing the remainder of this Agreement without such illegal or invalid term or provision would be to cause any party to lose the material benefit of its economic bargain. 6.8 VARIATION OF TERMS. All terms and any variations thereof shall be deemed to refer to masculine, feminine, or neuter, singular or plural, as the identity of the Person or Persons may require. 6.9 GOVERNING LAW. The laws of the State of California shall govern the validity of this Agreement, the construction of its terms, and the interpretation of the rights and duties arising hereunder. 6.10 ARBITRATION. Any controversy between the parties hereto arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in San Francisco, California in accordance with the then-applicable commercial arbitration rules of the American Arbitration Association. Judgment upon the award rendered may be entered into any court having jurisdiction thereof. The losing party shall bear the costs and expenses of such arbitration. 9 10 6.11 BINDING EFFECT. This Agreement shall be binding on and inures to the benefit of the parties and their respective transferees, successors, assigns and legal representatives. 6.12 ENTIRE AGREEMENT. Without limiting the effect of the LLC Agreement, the CT License, the CombiChem License, the CombiChem Services Agreement, the CT Limited Services Agreement or the Chirotech Services Agreement, this Agreement constitutes the entire agreement among the parties with respect to the subject MATTER HEREIN. 6.13 COUNTERPARTS.This Agreement may be executed in one or more counterparts with the same force and effect as if each of the signatories had executed the same instrument. [Remainder of This Page Intentionally Left Blank] 10 11 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date set forth above. CHIROTECH TECHNOLOGY CHIROTECH LIMITED, a company LIMITED, a company organized organized and existing under the and existing under the laws of England laws of England and Wales and Wales By: /s/ Christine H. Soden By: /s/ Christine H. Soden -------------------------------- -------------------------------- Name: Christine H. Soden Name: Christine H. Soden -------------------------------- ------------------------------ Title: Director Title: Director -------------------------------- ----------------------------- [SIGNATURE PAGE TO COOPERATION AGREEMENT] 12 COMBICHEM, INC., a Delaware COMBICHEM JVR, INC., a Delaware corporation corporation By: /s/ Vicente Anido, Jr. By: /s/ Vicente Anido, Jr. -------------------------------- ----------------------------------- Name: Vicente Anido, Jr. Name: Vicente Anido, Jr. ------------------------------ ---------------------------------- Title: President & CEO Title: President & CEO ----------------------------- --------------------------------- CHIROCHEM DISCOVERY SERVICES LLC, a California limited liability company By CHIROTECH LIMITED, a company organized and existing under the laws of England and Wales, Member By: /s/ Christine H. Soden -------------------------------- Name: Christine H. Soden ------------------------------ Title: Director ------------------------------ And by COMBICHEM JVR, INC., a Delaware corporation, Member By: /s/ Vicente Anido, Jr. -------------------------------- Name: Vicente Anido, Jr. ------------------------------ Title: President & CEO ------------------------------ [CONTINUED SIGNATURE PAGE TO COOPERATION AGREEMENT] EX-10.66 6 EXHIBIT 10.66 1 EXHIBIT 10.66 LICENSE AGREEMENT BETWEEN COMBICHEM, INC. AND CHIROCHEM DISCOVERY SERVICES LLC *** Certain confidential portions of this Exhibit were omitted by means of blackout of the text (the "Mark"). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company's Application Requesting Confidential Treatment under Rule 24b-2 under the Act. 2 TABLE OF CONTENTS
PAGE 1. DEFINITIONS...................................................................1 1.1 Defined Terms.....................................................1 1.2 "Chiral Compound".................................................2 1.3 "ChiroChem Technology"............................................2 1.4 "Chirotech Technology"............................................2 1.5 "CombiChem Technology"............................................2 1.6 "CT License ".....................................................2 1.7 "Field"...........................................................2 1.8 "Licensed Product"................................................2 1.9 "Net Sales".......................................................2 1.10 "Patent Rights"...................................................2 1.11 "Technology"......................................................3 2. GRANT OF LICENSES.............................................................3 2.1 Grant to ChiroChem................................................3 2.2 Retained Rights...................................................3 2.3 Access............................................................3 2.4 Third-Party Obligations...........................................3 2.5 Grant to CombiChem................................................4 3. ROYALTIES.....................................................................4 3.1 Royalties to CombiChem............................................4 3.2 Payments..........................................................4 4. REPORTS AND RECORDS...........................................................4 4.1 Records...........................................................4 4.2 Reports...........................................................5 4.3 Inspection Costs..................................................5 5. INFRINGEMENT..................................................................5 5.1 Notice............................................................5 5.2 Avoiding Infringement.............................................6 6. TERMINATION OR SOLE CONTROL OF CHIROCHEM......................................6 6.1 Termination or Sole Control of ChiroChem and Effects Thereof......6 6.2 Prior Rights and Obligations......................................7 7. CONFIDENTIALITY...............................................................7 7.1 Confidentiality...................................................7 7.2 Exceptions........................................................8 7.3 Return of Confidential Information................................8
i 3 8. REPRESENTATIONS AND WARRANTIES................................................8 8.1 CombiChem Representations and Warranties..........................8 8.2 ChiroChem Representations and Warranties..........................9 9. INDEMNIFICATION...............................................................9 9.1 Indemnification...................................................9 9.2 Notice of Claims.................................................10 10. EXPORT CONTROLS.............................................................10 10.1 Compliance With Laws.............................................10 11. MISCELLANEOUS PROVISIONS....................................................10 11.1 Agency...........................................................10 11.2 Assignment.......................................................10 11.3 Further Actions..................................................11 11.4 Notices..........................................................11 11.5 Amendment; Approval..............................................12 11.6 Waiver...........................................................12 11.7 Counterparts.....................................................12 11.8 Descriptive Headings.............................................12 11.9 Governing Law; Venue; Dispute Resolution, Arbitration............12 11.10 Severability.....................................................12 11.11 Entire Agreement of the Parties..................................13
ii 4 LICENSE AGREEMENT THIS LICENSE AGREEMENT (this "Agreement") dated as of December 1, 1998, the ("Effective Date"), is by and between COMBICHEM, INC. ("CombiChem"), a Delaware corporation, and CHIROCHEM DISCOVERY SERVICES LLC ("ChiroChem"), a California limited liability company. WHEREAS, CombiChem JVR, Inc. ("CombiSub"), a wholly-owned subsidiary of CombiChem, and Chirotech Limited ("ChiroSub"), a wholly-owned subsidiary of Chirotech Technology Limited ("CT Limited"), are the two members of ChiroChem, which was formed pursuant to that certain Limited Liability Company Operating Agreement of ChiroChem Discovery Services LLC dated as of December 1, 1998 (the "LLC Agreement"); WHEREAS, CombiChem has developed, been licensed from a third party and/or owns certain drug discovery technology and intellectual property rights, including chemical library design software, multi-parallel synthesis and purification methods, chemical libraries suitable for high throughput biological screening assays and medicinal chemistry (collectively, the "CombiChem Technology") useful for the design and production of single compound chemical libraries; WHEREAS, CombiChem desires to license the CombiChem Technology to ChiroChem on the terms set forth in this Agreement; WHEREAS, ChiroChem desires to obtain a license to the CombiChem Technology on the terms set forth in this Agreement; WHEREAS, ChiroChem desires to license certain technology created by ChiroChem resulting from the CombiChem Technology or the Chirotech Technology to CombiChem on the terms set forth in this Agreement; and WHEREAS, CombiChem desires to obtain a license to certain technology created by ChiroChem from the CombiChem Technology or the Chirotech Technology on the terms set forth in this Agreement. NOW, THEREFORE, CombiChem and ChiroChem (the "parties") agree as follows: 1. DEFINITIONS 1.1 Defined Terms. When used in this Agreement each of the following terms shall have the meaning set forth in this Article 1. Capitalized terms not otherwise defined herein shall have the meanings set forth in the LLC Agreement. Unless the context otherwise requires, words importing the singular only shall include the plural and vice versa and references to natural persons shall include bodies corporate. 5 1.2 "CHIRAL COMPOUND" shall mean a chemical compound manufactured by or on behalf of ChiroChem pursuant to rights granted in this Agreement and the CT License. 1.3 "CHIROCHEM TECHNOLOGY" shall mean the technology created by ChiroChem during the Initial Term or any extension thereof which includes, and is derivative of, the CombiChem Technology or the Chirotech Technology. 1.4 "CHIROTECH TECHNOLOGY" shall mean the technology licensed by CT Limited to ChiroChem under the CT License. 1.5 "COMBICHEM TECHNOLOGY" shall mean the Technology described in greater detail in Exhibit 1 hereto. 1.6 "CT LICENSE " shall mean that certain License Agreement between CT Limited and ChiroChem, executed on or about the Effective Date of this Agreement. 1.7 "FIELD" shall mean the use of Chirotech Technology and CombiChem Technology to create libraries of Chiral Compounds for use in the pharmaceutical, *** . 1.8 "LICENSED PRODUCT" shall mean any product that is covered in whole or in part by a claim in Patent Rights (as the case may be) included in the CombiChem Technology or the Chirotech Technology; or any product manufactured by or using a process that is covered in whole or in part by a claim in Patent Rights (as the case may be) included in the CombiChem Technology or the Chirotech Technology; or any product based on, developed or synthesized with or which makes use of all or a portion of the Technology (as the case may be) included in the CombiChem Technology or the Chirotech Technology, or any services rendered by ChiroChem that relate to the CombiChem Technology, or the Chirotech Technology. 1.9 "NET SALES" shall mean the gross amount invoiced by or on behalf of ChiroChem and its Affiliates and distributors for the sale of Licensed Products, less (to the extent included in gross invoiced sales) the amount of: (a) customary trade, cash and quantity discounts actually allowed and taken; (b) allowances actually given for returned or rejected products; (c) actual charges for bad debts; (d) freight and insurance if included in the price; (e) government mandated and other rebates; and (f) value added tax, sales, use or turnover taxes, excise taxes and customs duties included in the invoiced price. 1.10 "PATENT RIGHTS" shall mean any of the patents and patent applications applicable to Technology identified in Exhibit 1, and in respect of such patents and patent applications, all corresponding Patent Co-operation Treaty applications, European Patent Convention applications or applications under similar administrative international conventions, and corresponding national patents and patent applications, together with any divisional, continuation (but not a - -------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 2. 6 continuation-in-part), substitution, reissue, extension, supplementary protection certificate or other application based thereon. 1.11 "TECHNOLOGY" shall mean the technology described in Exhibit 1 hereto (as such Exhibit may be modified or supplemented from time to time by mutual written agreement of parties), and all ideas, know-how, trade secrets, data, inventions, discoveries and other proprietary rights in and to such technology, including Patent Rights applicable to such technology, that CombiChem elects to provide to ChiroChem under this Agreement. 2. GRANT OF LICENSES 2.1 Grant to ChiroChem. Subject to such use being provided under the direction of a CombiChem employee pursuant to the CombiChem Services Agreement or some other similar agreement, CombiChem hereby grants to ChiroChem, and ChiroChem hereby accepts from CombiChem, a royalty-bearing, worldwide, co-exclusive license (exclusive to ChiroChem and to CombiChem and CombiChem's Affiliates), with no right to sublicense, to use the CombiChem Technology to make, have made, use, import and sell Licensed Products solely in the Field. 2.2 Retained Rights. CombiChem and its Affiliates retain the worldwide right under the CombiChem Technology to make, have made, use, import, sell and license products, including libraries of chemical compounds, for any use and any indication in any field; provided that, until the termination of this Agreement pursuant to Section 6 hereof, CombiChem and its Affiliates shall not use the Technology described in Exhibit 1 (as amended from time to time) to design, synthesize and market libraries of chiral chemical compounds for sale or license to third parties, though CombiChem and its Affiliates retain the right to use such Technology for their internal use and to satisfy any obligations they may have under any of their collaboration agreements with third parties (whether currently existing or entered into in the future) with respect to libraries of chemical compounds other than libraries of chiral chemical compounds. 2.3 Access. Promptly after the Effective Date, and thereafter during the term of this Agreement, the FTEs provided to ChiroChem by CombiChem (or some other party), pursuant to the CombiChem Services Agreement (or some other agreement) shall have complete access to the CombiChem Technology provided that such access is under the direction of a CombiChem employee. 2.4 Third-Party Obligations. If any components of the CombiChem Technology are subject to restrictions or obligations imposed on CombiChem by third-party licensors, CombiChem shall disclose such restrictions or obligations to ChiroChem in writing, in Exhibit 1 or thereafter in timely fashion, if such restrictions or obligations restrict the use to which ChiroChem can put such components of the CombiChem Technology (e.g., restrict the field of use) or if they entail royalty or payment obligations to a third-party licensor, whether or not ChiroChem shall be obligated to pay such royalty or payment obligations. ChiroChem shall 3. 7 abide by any such disclosed field-of-use restrictions or similar restrictions; provided that, as to royalty or payment obligations to third-party licensors, CombiChem, not ChiroChem, shall be liable for, and shall pay, such obligations to such third parties when due (subject to the provisions in Section 6.1) unless otherwise agreed in writing. 2.5 Grant to CombiChem. ChiroChem hereby grants to CombiChem, and CombiChem hereby accepts from ChiroChem, a royalty-free, worldwide, non-exclusive license, with no right to sublicense, to use the ChiroChem Technology in connection with any Research Opportunity (as defined in that certain Cooperation Agreement between the parties, among others, dated as of the date hereof). 3. ROYALTIES 3.1 Royalties to CombiChem. In consideration for the rights granted under this Agreement, ChiroChem shall pay to CombiChem an amount equal to *** of Net Sales until the cumulative Net Sales exceed *** and thereafter an amount equal to *** of Net Sales. The parties agree that this represents a commercially reasonable royalty rate for the license of the CombiChem Technology under this Agreement. 3.2 Payments. ChiroChem's payments of royalties to CombiChem in accordance with Section 3.1 will be due and payable within thirty (30) days after the end of each calendar quarter (March 31, June 30, September 30, and December 31) commencing with the first calendar quarter in which Net Sales shall occur, if and to the extent ChiroChem has sufficient cash on hand at the time such payments are due to pay such royalties and any royalties due at such time to CT Limited under the CT License. If in the reasonable judgment of the Board of Managers, ChiroChem lacks sufficient cash at such time to pay such royalties in full, ChiroChem's unpaid royalty obligations shall accrue, together with interest thereon in the amount of twelve percent (12%) per annum (or such lesser amount if required by law) from the date such royalties were initially due and payable until they are paid, and ChiroChem shall pay such royalties and accrued interest as soon as such cash becomes available. Such payments shall be made in United States Dollars to the address or bank account designated by CombiChem. If any currency conversion is required in connection with the payment of amounts hereunder, such conversion shall be made by using the exchange rate as quoted by the Wall Street Journal (U.S.A. Edition) on the last business day of the calendar quarter to which such payments relate. Payments hereunder shall be subject to any applicable, legally required withholding or other taxes. - -------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 4. 8 4. REPORTS AND RECORDS 4.1 Records. ChiroChem shall keep (for at least six (6) years after the making of a royalty payment hereunder) complete and accurate books of account containing all particulars which may be reasonably necessary for CombiChem to confirm the accuracy of all payments of royalties due hereunder. At the written request of CombiChem, ChiroChem shall make such books and particulars available during normal business hours, upon reasonable notice, for inspection by an independent certified public accountant retained by CombiChem for the purpose of verifying ChiroChem's payments of royalties and the accuracy of ChiroChem's reports related thereto. Such inspections shall be limited solely to those matters directly related to royalty obligations under this Agreement. 4.2 Reports. Within thirty (30) days after December 31 of each year in which Net Sales occur, ChiroChem shall deliver to CombiChem true and accurate reports giving such particulars of the business conducted by ChiroChem during the preceding twelve (12) month period under this Agreement as are pertinent to a royalty accounting under this Agreement. These reports shall include at least the following: (a) All Licensed Products manufactured and sold, by country; (b) Total billings for Licensed Products sold by or on behalf of ChiroChem and its Affiliates and any distributors; (c) Deductions applicable and calculations leading to Net Sales; (d) Total royalties due to CombiChem for such year; and (e) The aggregate amount of any withholding taxes deducted from the payment made in satisfaction of the royalties stated pursuant to (d) above. In addition to the above-described annual report, within thirty (30) days after the end of the three other calendar quarters (March 31, June 30, and September 30) commencing with the first calendar quarter in which Net Sales occur, ChiroChem shall deliver to CombiChem a true and accurate report describing at least total billings for Licensed Products in the quarter to which such report pertains, Net Sales, and total royalties due CombiChem for such quarter (whether or not ChiroChem actually pays such royalties at such time). 4.3 Inspection Costs. If an inspection conducted on behalf of CombiChem pursuant to Section 4.1 reveals that ChiroChem has made an error of seven percent (7%) or more in ChiroChem's favor in the payment due CombiChem for the year to which the inspection pertains, ChiroChem shall reimburse CombiChem for the cost of the inspection. 5. 9 5. INFRINGEMENT 5.1 Notice. CombiChem and ChiroChem shall promptly notify the other of any potential infringement of or misappropriation by a third party of the CombiChem Technology. CombiChem shall have the right, but not the obligation, at its expense, to bring, defend and maintain any proceeding it deems advisable involving any such infringement or misappropriation and shall retain all recovery from any infringer. ChiroChem shall have the right, but not the obligation, at its expense, to bring, defend and maintain any proceeding it deems advisable involving any such infringement or misappropriation if CombiChem does not bring, defend or maintain any such proceeding; ChiroChem shall retain all recovery from any infringer if it brings any such proceeding. 5.2 Avoiding Infringement. ChiroChem shall use reasonable efforts to avoid infringement of patent rights and other intellectual property rights of any third party in the research, development and commercialization of the CombiChem Technology and Licensed Products. 6. TERMINATION OR SOLE CONTROL OF CHIROCHEM 6.1 Termination or Sole Control of ChiroChem and Effects Thereof. This Agreement shall terminate upon the termination of ChiroChem or when it is no longer the case that both ChiroSub (or an Affiliate) and CombiSub (or an Affiliate) are members in ChiroChem ("Sole Control"); provided, however, that the license granted in Section 2.1 above shall survive termination of this Agreement insofar as, and only to the extent that, such license relates to and enables the continued manufacture and sale of libraries of Chiral Compounds developed by or on behalf of ChiroChem prior to the termination of this Agreement ("ChiroChem Libraries"). The rights to such ChiroChem Libraries following the termination of ChiroChem shall be determined in accordance with the provisions of the LLC Agreement. The entity(ies) retaining or receiving rights to commercialize such ChiroChem Libraries following Sole Control or the termination of ChiroChem shall succeed to the license rights granted to ChiroChem in Section 2.1 of this Agreement solely to the extent necessary to commercialize such ChiroChem Libraries developed under the LLC Agreement, but such entity(ies) shall have no further obligations to pay royalties to CombiChem under Section 3.1 of this Agreement in connection with the sale of such ChiroChem Libraries; provided, however, that, as a condition of such limited continuation of the license granted herein, (i) such successor entity(ies) shall pay and account for any royalty or payment obligations due to any third-party licensors (excluding Affiliates of CombiChem) in connection with any third-party licenses to CombiChem of any component of CombiChem Technology ("Third-Party Obligations") to the extent such Third-Party Obligations pertain to sales of ChiroChem Libraries by such successor entity(ies), if but only if CombiChem had previously disclosed such royalty or payment obligations in writing to ChiroChem as provided in 6. 10 Section 2.4; and (ii) such successor entity(ies) shall succeed to, be bound by and perform the obligations of ChiroChem under Articles 7, 9, 10 and 11 of this Agreement. The successor entity(ies) shall make any such payments and accountings directly to such third-party licensor(s) at the address(es) to be provided by CombiChem, with copies of such payments and accountings to CombiChem. As one of the conditions of the survival of the licenses granted in Section 2.1, CombiChem shall retain the right to enforce against the successor entity(ies) (a) the payment of and accounting for such Third-Party Obligations, and (b) the obligations under Articles 7, 9, 10 and 11, in accordance with the terms of this Agreement. If CombiChem fails to disclose applicable Third-Party Obligations to ChiroChem as provided in Section 2.4, CombiChem, but not the successor entity(ies), shall be liable for and shall pay such Third-Party Obligations. As a hypothetical example of the above-described effects of Sole Control or the termination of ChiroChem on the license granted in this Agreement (solely for the sake of clarification), if ChiroSub were to acquire the interest of CombiSub in ChiroChem in accordance with the LLC Agreement, ChiroChem would thereafter have a license under the CombiChem Technology to make, use and sell copies of ChiroChem Libraries developed by or on behalf of ChiroChem prior to the termination of this Agreement, but ChiroChem would have no other rights or license under the CombiChem Technology to make, use or sell new libraries of compounds not previously developed by or on behalf of ChiroChem. If ChiroChem were then to terminate, ChiroSub would thereafter have a license (succeeding to the interest of ChiroChem) under the CombiChem Technology to make, use and sell copies of ChiroChem Libraries developed by or on behalf of ChiroChem prior to the termination of ChiroChem, but ChiroSub would have no other rights or license under the CombiChem Technology, including (without limitation) no right or license under the CombiChem Technology to make, use or sell new libraries of compounds not previously developed by or on behalf of ChiroChem. ChiroSub would have no obligation to pay royalties to CombiChem under Section 3.1 in connection with the sale of ChiroChem Libraries, but it would be required, as a condition of its limited license under the CombiChem Technology, to pay any Third-Party Obligations incurred in connection with such sales (directly to the third party) if CombiChem had previously disclosed such Third-Party Obligations to ChiroChem as provided in Section 2.4. ChiroSub's limited license under the CombiChem Technology would automatically terminate upon its cessation of the sale of ChiroChem Libraries (or sooner in the event of its unremedied breach of obligations hereunder). All rights in the Licensed Technology would then automatically revert to CombiChem. Upon termination or Sole Control of ChiroChem, (i) CT Limited and CombiChem shall cooperate to prepare and execute such instruments as are reasonably necessary to give effect to the above and (ii) only to the extent reasonably necessary for the successor entity(ies) to execute the limited license rights described above, CombiChem shall provide, at its direct cost, at least one (1) FTE skilled in the use of the CombiChem Technology to assist and enable the successor entity(ies), as necessary, to continue the manufacture of ChiroChem Libraries as provided above. 6.2 Prior Rights and Obligations. Termination of this Agreement shall not affect any rights or obligations accrued prior to the effective date of such termination. 7. 11 7. CONFIDENTIALITY 7.1 Confidentiality. During the term of this Agreement and for a period of five (5) years thereafter (and longer to the extent license rights continue under Section 6.1), ChiroChem shall hold, and it shall require ChiroSub and ChiroSub's Affiliates to hold, in confidence and not use for any purpose, except as expressly permitted in writing by CombiChem, or disclose to any third party (except as necessary to reliable employees and to ChiroSub, CombiSub and their Affiliates and their employees under similar secrecy obligations) all CombiChem Technology (whether disclosed in written or oral form) and other confidential or proprietary information provided by CombiChem to ChiroChem. ChiroChem, ChiroSub and ChiroSub's Affiliates shall make no research or commercial use of the CombiChem Technology except for the purpose of this Agreement and the LLC Agreement; provided, however, that these obligations shall not apply under the circumstances described in Section 6.1. 7.2 Exceptions. The obligations of confidentiality set forth in Section 7.1 shall not apply to the extent that ChiroChem can demonstrate: (a) that the disclosed information was in the public domain at the time of disclosure, or thereafter became part of the public domain, other than as a result of actions of ChiroChem, ChiroSub, ChiroSub's Affiliates or anyone (other than CombiSub) to whom they disclosed such information; (b) by its written records, that the disclosed information was rightfully known by ChiroChem (excluding CombiChem and its Affiliates), ChiroSub or its Affiliates prior to the date of disclosure; (c) the disclosed information was received by ChiroChem, ChiroSub or any of its Affiliates from a third party not under a duty of confidentiality to CombiChem or any of its Affiliates; (d) by its written records, that the disclosed information was independently developed by ChiroChem, ChiroSub or any of its Affiliates without use of the disclosed information; or (e) the disclosure is required by law, regulation or government or judicial order, provided, however, that CombiChem is given notice prior to any such disclosure sufficient to enable it to try to obtain confidential treatment of such information; provided further that information disclosed under this exception (e) shall continue otherwise to be subject to Section 7.1 following such disclosure unless exception (a) thereafter applies. 7.3 Return of Confidential Information. Upon termination of this Agreement, and subject to Section 7.2 above, at the written request of CombiChem, ChiroChem will return, destroy or delete all confidential or proprietary information received from CombiChem and its Affiliates, all documents and electronic databases to the extent incorporating such confidential or proprietary information, and all copies thereof, provided that ChiroChem may retain (in hard copy and on-line) one (1) copy of such confidential or proprietary information solely for archival purposes and for no other use. 8. 12 8. REPRESENTATIONS AND WARRANTIES 8.1 CombiChem Representations and Warranties. CombiChem hereby represents and warrants as follows: (a) CombiChem has the legal power, authority and right to enter into this Agreement and to perform all of its respective obligations set forth herein. (b) CombiChem is not a party to any agreement with any third party which prevents CombiChem from fulfilling any of its material obligations under the terms of this Agreement. (c) CombiChem has sufficient right, title or interest in the CombiChem Technology to grant the rights granted herein. To the present knowledge of the Chief Executive Officer of CombiChem (as of the Effective Date of this Agreement), no third party has claimed to CombiChem that the CombiChem Technology infringes any third-party patent rights or other intellectual property rights. The CombiChem Technology may, however, be subject to certain obligations to third parties to be disclosed by CombiChem in accordance with Section 2.4. (d) COMBICHEM HEREBY DISCLAIMS ANY AND ALL OTHER WARRANTIES AND REPRESENTATIONS, WHETHER EXPRESS OR IMPLIED, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OF THE COMBICHEM TECHNOLOGY OR ANY LICENSED PRODUCT BASED THEREON, OR ANY REPRESENTATION OR WARRANTY THAT THE COMBICHEM TECHNOLOGY OR ANY LICENSED PRODUCT ENCOMPASSING THE COMBICHEM TECHNOLOGY WILL NOT INFRINGE ANY THIRD PARTY'S PATENT RIGHTS OR OTHER INTELLECTUAL PROPERTY RIGHTS. 8.2 ChiroChem Representations and Warranties. ChiroChem hereby represents and warrants as follows: (a) ChiroChem has the legal power, authority and right to enter into this Agreement and to perform all of its respective obligations set forth herein. (b) ChiroChem is not a party to any agreement with any third party which prevents ChiroChem from fulfilling any of its material obligations under the terms of this Agreement. (c) ChiroChem will comply in all material respects with the terms of the license granted to it under this Agreement and with all federal, state and local laws, rules and regulations applicable to the development, manufacture, distribution, import and export and sale of Licensed Products. 9. 13 9. INDEMNIFICATION 9.1 Indemnification. ChiroChem shall defend, indemnify and hold CombiChem and its directors, officers, employees, and agents (the "Indemnitees") harmless from and against any and all loss, claims, damages, liabilities joint and several, expenses, judgments, fines, settlements and other amounts arising from any and all claims (including reasonable legal expenses and reasonable attorneys' fees), demands, actions, suits or proceedings (civil, criminal, administrative or investigative) of any kind, on any theory, in which an Indemnitee may be involved, as a party or otherwise, based on or arising out of actions undertaken in the exercise of rights granted under this Agreement, including, without limitation, the research, development, commercialization, sale or use of Licensed Products; provided that ChiroChem shall not be obligated to Indemnitees under this Section 9.1 to the extent such claims, demands, actions, suits or proceedings are based on or arise out of CombiChem's breach of its representations or warranties in Section 8.1 above. The indemnification of CombiChem by ChiroChem under this Section shall in no way be construed to grant any indemnification rights which are otherwise excepted from indemnification in any of the Combi Ancillary Agreements. Expenses (including attorneys' fees) incurred by an Indemnitee in defending any proceeding described above shall be paid by ChiroChem in advance of the final disposition of such proceeding upon receipt of an undertaking by or on behalf of the Indemnitee to repay such amount if it shall ultimately be determined that the Indemnitee is not entitled to be indemnified by ChiroChem as authorized hereunder. The indemnification and other obligations described above in this Section 9.1 shall not be deemed to be exclusive of any other rights to which any Indemnitee may be entitled under any agreement, or as a matter of law, or otherwise. 9.2 Notice of Claims. The Indemnitee shall notify ChiroChem promptly in writing of any claims, demands, actions or suits against it of the sort described above and shall cooperate reasonably with ChiroChem, at ChiroChem's expense, in the defense of any such claims, demands, actions and suits, which defense shall be controlled by ChiroChem; provided that the Indemnitee shall at all times have the right to participate in such defense at its own expense (or at ChiroChem's expense should ChiroChem fail to perform its obligations under Section 9.1). 10. EXPORT CONTROLS 10.1 Compliance With Laws. ChiroChem shall not sell, transfer, export or reexport any technology licensed hereunder, except in compliance with all applicable laws, including the export laws of any government agency of the United States or the United Kingdom and any regulations thereunder, and will not sell, transfer, export or reexport any of the technology 10. 14 licensed hereunder to any persons with regard to which there exist grounds to suspect or believe that they are violating such laws or regulations. ChiroChem shall be solely responsible for obtaining all licenses, permits and authorizations required from any other government agency for the export or reexport of such technology or Licensed Products. 11. MISCELLANEOUS PROVISIONS 11.1 Agency. Neither party is, nor shall be deemed to be, an employee, agent, co-venturer or legal representative of the other party for any purpose. Neither party shall be entitled to enter into any contracts in the name of, or on behalf of the other party, nor shall either party be entitled to pledge the credit of the other party in any way or hold itself out as having the authority to do so. 11.2 Assignment. Subject only to Section 6.1 of this Agreement (and on the terms and conditions set forth therein), ChiroChem may not assign or otherwise transfer this Agreement or any rights or obligations set forth herein without the prior written approval of CombiChem, which CombiChem may grant or withhold in its discretion. CombiChem can assign this Agreement at any time to any Affiliate or to any successor by merger or sale of substantially all of its business unit to which this Agreement relates. This Agreement shall be binding upon the successors and permitted assignees of the parties, and the name of a party appearing herein shall be deemed to include the names of such party's successors and permitted assignees to the extent necessary to carry out the intent of this Agreement. Any assignment not in accordance with this Section shall be void. 11.3 Further Actions. Each party agrees to execute, acknowledge and deliver such further instruments, and to do all such other acts, as may be necessary or appropriate in order to carry out the purposes and intent of this Agreement. 11.4 Notices. All notices and other communications required or permitted hereunder shall be in writing and shall be deemed effectively given and received (a) upon personal delivery; (b) upon receipt if mailed by registered or certified mail, return receipt requested, postage prepaid, addressed to the recipients at their addresses as listed below (or at such other address for a recipient as a party shall specify by notice in accordance with this Section); or (c) upon confirmed delivery by express commercial courier service (receipt verified) to the recipients at their addresses as listed below (or at such other address for a recipient as a party shall specify by notice in accordance with this Section): If to ChiroChem, addressed to: ChiroChem Discovery Services LLC 9050 Camino Santa Fe San Diego, CA 92121 Attention: Board of Managers 11. 15 With a copy to: CombiChem JVR, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attention: President And to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. If to CombiChem, addressed to: CombiChem, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attn: President With a copy to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. Any copy of a notice shall be sent at the same time as the original notice. 11.5 Amendment; Approval. No amendment, modification or supplement of any provision of the Agreement shall be valid or effective unless made in writing and signed by a duly authorized officer of each party. No approval provided for in this Agreement shall be valid or effective unless confirmed in writing. 11.6 Waiver. No provision of the Agreement shall be waived by any act, omission or knowledge of a party or its agents or employees except by an instrument in writing expressly waiving such provision and signed by a duly authorized officer of the waiving party. 11.7 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one instrument. 12. 16 11.8 Descriptive Headings. The descriptive headings of this Agreement are for convenience only, and shall be of no force or effect in construing or interpreting any of the provisions of this Agreement. 11.9 Governing Law; Venue; Dispute Resolution, Arbitration. This Agreement shall be governed by and interpreted in accordance with the substantive laws of the State of California. The parties shall attempt to resolve any dispute or controversy that should arise between them quickly and amicably. Any unresolved dispute or controversy between them arising out of or relating to this Agreement, or the breach thereof, shall be settled by binding arbitration in accordance with the then-applicable commercial arbitration rules of the American Arbitration Association. Exclusive venue of any arbitration proceeding commenced by either party to enforce its rights hereunder shall be and remain in San Francisco, California, unless the parties mutually agree otherwise in writing. Judgment upon an arbitration award may be entered into, and enforced by, any court in any venue having jurisdiction thereof. The party substantially losing the arbitration proceeding shall bear the costs and expense of such arbitration and shall reimburse the other party for its reasonable expenses incurred in connection with the arbitration, including reasonable attorney's fees. 11.10 Severability. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be prohibited by or invalid under applicable law, such provision will be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of the Agreement. In the event of such invalidity, the parties shall seek to agree on an alternative enforceable provision that preserves the original purpose of this Agreement. 11.11 Entire Agreement of the Parties. Without limiting the effect of the LLC Agreement, the Cooperation Agreement, the CT License, the CombiChem Services Agreement, the CT Limited Services Agreement or the Chirotech Services Agreement, this Agreement, including Exhibit 1 attached hereto, constitutes and contains the complete, final and exclusive understanding and agreement of the parties hereto with respect to the subject matter hereof, and cancels and supersedes any and all prior negotiations, correspondence, understandings and agreements, whether oral or written, between the parties respecting the subject matter hereof. [Remainder of This Page Intentionally Left Blank] 13. 17 IN WITNESS WHEREOF, CombiChem and ChiroChem have caused this Agreement to be duly executed as of the Effective Date set forth above. CHIROCHEM DISCOVERY COMBICHEM, INC., a Delaware SERVICES LLC, a California limited corporation liability company By CHIROTECH LIMITED, a company By: /s/ Vicente Anido, Jr. organized and existing under the ---------------------------------- laws of England and Wales, Name: Vicente Anido, Jr. Member --------------------------------- Title: President & CEO --------------------------------- By: /s/ Christine H. Soden ---------------------------------- Name: Christine H. Soden -------------------------------- Title: Director ------------------------------- And by COMBICHEM JVR, INC., a Delaware corporation, Member By: /s/ Vicente Anido, Jr. ---------------------------------- Name: Vicente Anido, Jr. ------------------------------- Title: President & CEO ------------------------------- [SIGNATURE PAGE TO COMBICHEM LICENSE AGREEMENT] 18 EXHIBIT 1 COMBICHEM TECHNOLOGY CombiChem hereby provides the following *** technology to ChiroChem under this License Agreement. *** - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 19 *** TECHNOLOGY *** - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. EX-10.67 7 EXHIBIT 10.67 1 EXHIBIT 10.67 SERVICES AGREEMENT THIS SERVICES AGREEMENT (this "Agreement") is made as of December 1, 1998 (the "Effective Date") by and among COMBICHEM, INC., a Delaware corporation ("CombiChem"), and CHIROCHEM DISCOVERY SERVICES LLC, a limited liability company organized under the laws of California ("ChiroChem"). RECITALS WHEREAS, CombiChem JVR, Inc. a Delaware corporation and wholly owned subsidiary of CombiChem ("CombiSub"), has entered into a Limited Liability Company Operating Agreement dated the date hereof (the "LLC Agreement") with Chirotech Limited (Registration No. 3580272), a company organized and existing under the laws of England and Wales ("ChiroSub"). Capitalized terms not defined herein shall have the meanings given them in the LLC Agreement. WHEREAS, ChiroChem desires that CombiChem provide certain services to ChiroChem, and CombiChem desires to provide such services, on the terms set forth herein. NOW, THEREFORE, in consideration of the mutual covenants set forth herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, CombiChem and ChiroChem hereby agree as follows: 1. SERVICES. CombiChem shall supply ChiroChem with the services set forth on Schedule 1 hereto. Such services shall be provided by CombiChem , as agreed by the parties, at reasonable times and upon reasonable notice. The list of services set forth on Schedule 1 may be amended by mutual agreement of the parties from time to time to include such other services as shall be agreed to by CombiChem and the Board of Managers of ChiroChem (as defined in the LLC Agreement). In performing the services hereunder, CombiChem will use the same degree of care and skill that it uses in connection with performance of the same or similar services for its own account. 2. COMPENSATION; INVOICES. 2.1 INTERNAL SERVICES. ChiroChem shall pay to CombiChem an amount equal to *** ***. 2.2 THIRD-PARTY SERVICES. For third-party services arranged by CombiChem and provided to ChiroChem, such third parties shall invoice ChiroChem directly, and ChiroChem shall pay such third parties directly. 2.3 CALCULATION OF COSTS. CombiChem's costs of providing the services hereunder shall be determined using CombiChem's internal cost accounting system. *** Certain confidential portions of this Exhibit were omitted by means of blackout of the text (the "Mark"). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company's Application Requesting Confidential Treatment under Rule 24b-2 under the Act. 2 2.4 SERVICE FEE. The parties *** amount payable under Sections 2.1 or 2.2 of this Agreement. Such fees shall *** *** . 2.5 INVOICES. CombiChem shall invoice ChiroChem no later than the last day of each calendar quarter for the services to be provided by CombiChem to ChiroChem for the following quarter. Such quarterly invoices shall conform to the quarterly amounts, including allowed variances set forth in the LLC Agreement, specified in the Annual Budget (as defined in the LLC Agreement) and, if applicable, shall also include any credits for overpayment or deductions for underpayment for the second immediately preceding quarter, e.g., an invoice for the third quarter would include a credit for an overpayment, if any, made for the services performed in the first quarter. ChiroChem shall remit to CombiChem the full amount of such quarterly invoices within 15 days after receipt. 3. TERM AND TERMINATION. 3.1 TERM. This Agreement shall terminate on the earlier of (a) three (3) years after the Effective Date or (b) the termination of ChiroChem. This Agreement shall be extended for a additional three-year terms coincident with any extension of the LLC Agreement, subject to termination prior to the end of the extended term upon the termination of ChiroChem. 3.2 TERMINATION BY CHIROCHEM. ChiroChem shall have the right to terminate this Agreement, by notice to CombiChem, effective at any time, if CombiChem fails to perform or observe or otherwise breaches any of its material obligations under this Agreement and such failure or breach continues unremedied for a period of sixty (60) days after receipt by CombiChem of written notice thereof, subject to Section 5. 3.3 TERMINATION BY COMBICHEM. CombiChem shall have the right to terminate this Agreement at any time and effective as set forth below: 3.3.1 BANKRUPTCY PROCEEDINGS. At any time, effective as set forth in a written notice to ChiroChem, if ChiroChem shall (i) seek the liquidation, reorganization, dissolution or winding-up of itself or the composition or readjustment of its debts, (ii) apply for or consent to the appointment of, or the taking possession by, a receiver, custodian, trustee or liquidator for itself or of all or a substantial part of its assets, (iii) make a general assignment for the benefit of its creditors, (iv) commence a voluntary case under the Bankruptcy Code, (v) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, winding-up or composition or readjustment of debts or (vi) adopt any resolution of its members for the purpose of effecting any of the foregoing; or 3.3.2 INVOLUNTARY BANKRUPTCY PROCEEDINGS. At any time, effective as set forth in a written notice to ChiroChem if a proceeding or case shall be commenced without the application or consent of ChiroChem and such proceeding or case shall continue undismissed, or an order, judgment or decrees approving or ordering any of the following shall - -------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. 2 3 be entered and continued unstayed and in effect, for a period of forty-five (45) days from and after the date service of process is effected upon ChiroChem seeking (i) ChiroChem's liquidation, reorganization, dissolution or winding-up, or the composition or readjustment of its debts, (ii) the appointment of a trustee, receiver, custodian, liquidator or the like of ChiroChem or of all or any substantial part of its assets or (iii) similar relief in respect of ChiroChem under any law relating to bankruptcy, insolvency, reorganization, winding-up or the composition or readjustment of debts; or 3.3.3 FAILURE TO PAY. If any invoice from CombiChem (which is not disputed on any reasonable grounds) remains outstanding and unpaid for more than sixty (60) days. 3.3.4 SOLE CONTROL OF CHIROCHEM. When it is no longer the case that both ChiroSub (or an Affiliate) and CombiSub (or an Affiliate) are members in ChiroChem. 4. INDEMNIFICATION. ChiroChem hereby agrees to indemnify and hold CombiChem and its directors, officers, employees and agents (the "Indemnitees") harmless from and against any and all loss, claims, damages, liabilities joint and several, expenses, judgments, fines, settlements and other amounts arising from any and all claims (including reasonable legal expenses and reasonable attorneys' fees), demands, actions, suits or proceedings (civil, criminal, administrative or investigative) of any kind, on any theory, in which an Indemnitee may be involved, as a party or otherwise, as a result of services rendered by CombiChem under this Agreement, except for liabilities, costs or expenses resulting from CombiChem's breach of this Agreement or its negligence or intentional misconduct. 5. FORCE MAJEURE. No party shall lose any rights hereunder or be liable to any other party for damages or losses on account of failure of performance by the defaulting party if the failure is occasioned by an act of God, any accident, explosion, fire, storm, earthquake, flood, drought, peril of the sea, riot, embargo, war or foreign, federal, state or municipal order of general application, seizure, requisition or allocation, any failure or delay of transportation, shortage of or inability to obtain supplies, equipment, fuel or labor or any other circumstances or event beyond the reasonable control of the party relying upon such circumstance or event ("Force Majeure"); provided that the party claiming Force Majeure has exerted all reasonable efforts to avoid or remedy such Force Majeure; provided, however, that in no event shall a party be required to settle any labor dispute or disturbance. 6. FURTHER ACTIONS. Each party agrees to execute, acknowledge and deliver such further instruments, and to do all such other acts, as may be necessary or appropriate in order to carry out the purposes and intent of this Agreement. 7. NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by facsimile transmission (receipt verified), or upon receipt if mailed by registered or certified mail (return receipt requested), postage prepaid, or sent by express courier service (receipt verified), to the parties at the following addresses (or at such other address for a party as shall be specified by like notice; provided, that notices of a change of address shall be effective only upon receipt thereof): 3 4 If to ChiroChem, addressed to: ChiroChem Discovery Services LLC 9050 Camino Santa Fe San Diego, CA 92121 Attention: Board of Managers With a copy to: CombiChem JVR, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attention: President And to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. If to CombiChem, addressed to: CombiChem, Inc. 9050 Camino Santa Fe San Diego, CA 92121 Attn: President With a copy to: Chirotech Limited Cambridge Science Park Milton Road Cambridge CB4 4WE Attn: Secretary And to: Brobeck Phleger & Harrison LLP 550 West C Street, Suite 1300 San Diego, CA 92101-3532 Attn: Faye H. Russell, Esq. Any copy of a notice shall be sent at the same time as the original notice. 8. GOVERNING LAW. The laws of the State of California shall govern the validity of this Agreement, the construction of its terms, and the interpretation of the rights and duties arising hereunder. 9. ARBITRATION. Any controversy between the parties hereto arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in San Francisco, California in accordance with the then-applicable commercial arbitration rules of the American Arbitration Association. Judgment upon the award rendered may be entered into any court 4 5 having jurisdiction thereof. The losing party shall bear the costs and expenses of such arbitration. 10. WAIVER. Except as specifically provided for herein, the waiver from time to time by any of the parties of any of their respective rights or their respective failure to exercise any remedy shall not operate or be construed as a continuing waiver of same or of any other of such party's rights or remedies provided in this Agreement. 11. SEVERABILITY. If any term, covenant or condition of this Agreement or the application thereof to any party or circumstance shall, to any extent, be held to be invalid or unenforceable, then (i) the remainder of this Agreement, or the application of such term, covenant or condition to parties or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby and each term, covenant or condition of this Agreement shall be valid and be enforced to the fullest extent permitted by law; and (ii) the parties hereto covenant and agree to renegotiate any such term, covenant or application thereof in good faith in order to provide a reasonably acceptable alternative to the term, covenant or condition of this Agreement or the application thereof that is invalid or unenforceable, it being the intent of the parties that the basic purposes of this Agreement are to be effectuated. 12. HEADINGS; AMBIGUITIES. The section and paragraph headings contained herein are for the purposes of convenience only and are not intended to define or limit the content of said sections or paragraphs. Ambiguities, if any, in this Agreement shall not be construed against any party, irrespective of which party may be deemed to have authorized the ambiguous provision. 13. NO EFFECT ON OTHER AGREEMENTS. No provision of this Agreement shall be construed so as to negate, modify or affect in any way the provisions of any other agreement between the parties unless specifically referred to, and solely to the extent provided, in any such other agreement. 14. RELATIONSHIP OF THE PARTIES. Nothing contained in this Agreement is intended or is to be construed to constitute CombiChem as an employee of ChiroChem. Except as expressly provided herein, no party hereto shall have any express or implied right or authority to assume or create any obligations on behalf of or in the name of another party or to bind the other party to any contract, agreement or undertaking with any third party. 15. SUCCESSORS AND ASSIGNS. Except as otherwise provided herein, no party may assign its rights or obligations under this Agreement to any other person without the prior written consent of the other parties, provided, however, that CombiChem may subcontract the performance of any obligations hereunder, but shall not be relieved from any liability therefor. Subject to the foregoing any reference to CombiChem and ChiroChem hereunder shall be deemed to include the successors thereto and assigns hereof. 16. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which counterparts, when so executed and delivered, shall be deemed to be an original, and all of which counterparts, taken together, shall constitute one and the same instrument. [Remainder of This Page Intentionally Left Blank] 5 6 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first set forth above. CHIROCHEM DISCOVERY SERVICES LLC, COMBICHEM, INC., a Delaware a California limited liability corporation company By CHIROTECH LIMITED, a company By: /s/ Vicente Anido, Jr. organized and existing under the ----------------------------------- laws of England and Wales, Name: Vicente Anido, Jr. Member --------------------------------- Title: President & CEO --------------------------------- By: /s/ Christine H. Soden --------------------------------- Name: Christine H. Soden ------------------------------ Title: Director ------------------------------ And by COMBICHEM JVR, INC., a Delaware corporation, Member By: /s/ Vicente Anido, Jr. --------------------------------- Name: Vicente Anido, Jr. ------------------------------ Title: President & CEO ------------------------------ [SIGNATURE PAGE TO COMBICHEM SERVICES AGREEMENT] 7 SCHEDULE 1 COMBICHEM SERVICES Pursuant to the terms and conditions of this Agreement and this Schedule 1, CombiChem shall provide the following services to ChiroChem: TECHNICAL SERVICES. CombiChem shall provide that number of FTEs approved in the Annual Budget, as amended from time to time, to work for ChiroChem designing and producing libraries of chiral templates. The cost of providing such employees *** ***. ADMINISTRATIVE AND GENERAL SERVICES. CombiChem shall provide that number of FTEs approved in the Annual Budget, as amended from time to time, to provide the accounting services and coordinate audit, legal and general administrative services to ChiroChem. The cost of providing such FTEs *** ***. OTHER SERVICES. The parties currently contemplate that CombiChem shall be responsible for sales efforts in Japan, through third parties, of ChiroChem chiral template libraries and that CombiChem shall be responsible for shipping the chiral template libraries to all ChiroChem customers. The level of these and any additional services (and payment therefor) shall be as agreed upon by ChiroChem and CombiChem from time to time. - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. EX-10.68 8 EXHIBIT 10.68 1 EXHIBIT 10.68 LEAD GENERATION PROGRAM AGREEMENT BETWEEN COMBICHEM, INC. AND ONO PHARMACEUTICAL CO., INC. DECEMBER 30, 1998 *** Certain confidential portions of this Exhibit were omitted by means of blackout of the text (the "Mark"). This Exhibit has been filed separately with the Secretary of the Commission without the Mark pursuant to the Company's Application Requesting Confidential Treatment under Rule 24b-2 under the Act. 2 LEAD GENERATION PROGRAM AGREEMENT THIS LEAD GENERATION PROGRAM AGREEMENT (this "Agreement") is entered into and made effective as of December 30, 1998 (the "Effective Date"), by and between COMBICHEM, INC., a Delaware corporation having its principal offices at 9050 Camino Santa Fe, San Diego, California 92121 ("CombiChem") and ONO PHARMACEUTICAL CO., LTD., a Japanese corporation having its principal offices located at 1-5 Doshomachi, 2-Chome, Chuo-Ku, Osaka 541-8526 Japan ("ONO"). WHEREAS, CombiChem has developed, been licensed from a Third Party and/or owns certain drug discovery technology and intellectual property rights, including chemical library design software, multi-parallel synthesis and purification methods, chemical libraries suitable for high throughput biological screening assays and medicinal chemistry (collectively, the "CombiChem Technology"); WHEREAS, as of the Effective Date, ONO and its Affiliates have developed and own certain drug discovery and intellectual property rights, including certain assays, methods and know-how regarding the Research Target, among other things (collectively, the "ONO Technology"); WHEREAS, CombiChem and ONO have entered into the UIL (as defined herein) Screening Agreement dated March 31, 1998 (the "Screening Agreement") under which CombiChem supplied its proprietary UIL to ONO for the screening of targets in which ONO has an interest for drug discovery. As a result of CombiChem's analysis of ONO's screening data of the UIL on such targets, the Research Target was identified as suitable for the initiation of a lead generation program as set forth in this Agreement; and WHEREAS, CombiChem and ONO desire to conduct research under a lead generation program focusing on such Research Target ("Lead Generation Program" or "LGP") and ONO desires to develop therapeutic drugs in the Field with compounds and information which result from such LGP. NOW, THEREFORE, the Parties agree as follows: 1. DEFINITIONS 1.1 "Active Compound(s)" means a Research Compound (or Research Compounds) which: (a) is synthesized by CombiChem in connection with the Lead Generation Program; (b) is selected by the RMC in connection with the Lead Generation Program based on the criteria for classification of an Active Compound or Inactive Compound as set forth in the Research Plan; and 3 (c) is covered under claims of any Research Patent. 1.2 "Affiliate" of a Party means any corporation or other business entity controlled by, controlling or under common control with, such Party. For this purpose "control" shall mean direct or indirect beneficial ownership of more than fifty percent (50%) of the voting securities or income interest in such corporation or other business, or if not meeting the preceding requirements, any company owned or controlled by or owning or controlling such Party at the maximum control or ownership right permitted in the country where such company exists. 1.3 "Assigned Hit Compound(s)" means a compound (or compounds) which: (a) is included in the UIL and is identified from the screening of the UIL against the Research Target; (b) is confirmed to be satisfactory for the First Year Benchmarks and the Second Year Benchmarks; and (c) CombiChem affirmatively assigns its property rights to ONO under the Screening Agreement. 1.4 "CombiChem Compound" means a chemical compound that is proprietary to CombiChem, or whose use or manufacture is proprietary to CombiChem or its Affiliates excluding any and all compounds in which all rights and intellectual property are assigned to ONO. 1.5 "CombiChem Technology" has the meaning set forth in the preamble. 1.6 "Confidential Information" means all non-public, proprietary or otherwise confidential information, now owned, licensed or controlled or hereafter acquired, developed, owned or licensed or controlled by a disclosing Party prior to or during the term of this Agreement. Confidential Information shall include, but is not limited to, (a) all information and materials received by either Party from the other Party pursuant to this Agreement which is confidential under Article 10 hereof; (b) all information and materials generated by either Party arising out of the Lead Generation Program during the Research Period; and (c) the terms and conditions of this Agreement. 1.7 "Cycle" means, following the initiation of the Research Period, the period of time between CombiChem's taking and starting to process data received from ONO or CombiChem and ONO's screening of compounds resulting from CombiChem's processing of such data. -2- 4 1.8 "Derivative" means a compound (or compounds) which: (a) has not been synthesized by CombiChem; (b) has resulted from chemical synthesis by ONO to generate a Preclinical Lead Compound or a Development Compound after the end of the Research Period; and (c) is covered under claims of any Research Patent. 1.9 "Development Compound(s)" means a compound (or compounds) which: (a) (i) is an Active Compound or (ii) is a Derivative or an Improved Derivative; (b) is designated by ONO to be appropriate for preclinical studies for the purpose of IND (as defined herein) filing by ONO; and (c) is intended by ONO to be developed or commercialized for use within the Field. 1.10 "Due Diligence" means the use of by a Party of its resources for the purposes of this Agreement in a manner which is consistent with the exercise of reasonable and prudent scientific and business judgment as applied to other programs of ONO or CombiChem, as the case may be, as more fully set forth in the Research Plan. 1.11 "Exclusivity Period" means the Research Period *** , as may be extended or reduced pursuant to Article 3 hereof. 1.12 "Field" means all therapeutic indications in humans for the Research Target against which a Development Compound or Products may be directed. 1.13 "First Commercial Sale" of a Product means the first sale for use or consumption of such Product in a country after required marketing and pricing approval has been granted by the governing health regulatory authority of such country. Sale to an Affiliate shall not constitute a First Commercial Sale unless the Affiliate is the end user of the Product. 1.14 "First Year Benchmark" shall have the meaning set forth in Schedule A attached hereto. 1.15 "FTE" means a full-time equivalent employee of CombiChem having the requisite skills to fulfill CombiChem's obligations under this Agreement. For purposes of this Agreement, the FTEs shall include synthetic and analytical chemists, compound control scientists and computational scientists. - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -3- 5 1.16 "Improved Derivative" means a Derivative (or Derivatives) which is included in the claims of a Selection Patent. No compound (or compounds) proposed by CombiChem for synthesis by CombiChem during the Research Period, and subsequently rejected by the RMC, shall be an Improved Derivative under this Agreement, and if such is later pursued by ONO with respect to the Research Target, such shall be treated as a Derivative under this Agreement. ONO shall use commercially reasonable efforts to demonstrate that a compound is an Improved Derivative to CombiChem's reasonable satisfaction prior to any milestone or royalty *** pursuant to Sections 8.3 or 8.4 hereof. 1.17 "Inactive Compound(s)" means a Research Compound (or Research Compounds) which: (a) is synthesized by CombiChem in connection with the Lead Generation Program but is not selected as an Active Compound by the RMC; and (b) is not covered under the claims of any *** . 1.18 "IND" means an Investigational New Drug notification or equivalent application filed with the governing health regulatory authority in the United States or any foreign equivalent in any country in the Territory. 1.19 "Lead Generation Program" or "LGP" means the research activities generically described in the preamble and to be conducted in accordance with the Research Plan and provisions set forth in Sections 2.1 and 2.2 of this Agreement during the Research Period. 1.20 "NDA" means a New Drug Application or equivalent filed with the governing health regulatory authority in the United States or any foreign equivalent in any country in the Territory. 1.21 Net Sales" means, with respect to any Product, the invoiced sales price of such Product billed by ONO, its licensees or its assignees to independent customers (other than sales to Affiliates of ONO, unless such Affiliate is the end user), less to the extent included in the invoiced sales price, (a) actual credits, allowances, discounts and rebates to, and chargebacks from the account of, such independent customers (b) any actual deductions for spoiled, damaged, out-dated, and returned but not replaced Product; (c) actual contributions made by ONO to the Japanese Fund for Sufferers for Adverse Drug Events, but not to exceed 1% of what would be Net Sales without giving effect to this subsection (c); (d) actual freight and insurance costs incurred in transporting such Product in final form to such customers; (e) actual cash, quantity and trade discounts and other price reduction programs; (f) actual sales, use, value-added and other direct taxes incurred; and (g) actual customs duties, surcharges and other governmental charges incurred in connection with the exportation or importation of such Product in final form. - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -4- 6 1.22 "ONO Compound" means any and all compounds covered under the claims of a Research Patent including, but not limited to, any Assigned Hit Compound, Active Compound, Derivative, Improved Derivative, Preclinical Lead Compound and/or Development Compound. 1.23 "ONO Technology" shall have the meaning set forth in the preamble of this Agreement. 1.24 "Party" means CombiChem or ONO, as the case may be, including their respective Affiliates, permitted successors and assigns. 1.25 "Patent" means (a) valid and enforceable U.S. or non-U.S. Patent, and any non-U.S. equivalent, including any extension (including Supplemental Protection Certificates), registration, confirmation, reissue, continuation, divisionals, continuation-in-part, reexamination or renewal thereof, or (b) pending applications for any of the foregoing, whether filed or issued before or after the Effective Date. 1.26 "Preclinical Lead Compound" means an Active Compound (or Active Compounds), a Derivative (or Derivatives) or an Improved Derivative (or Improved Derivatives) which satisfies the Second Year Benchmarks as set forth in Schedule A attached hereto. 1.27 "Product(s)" means any product containing a Development Compound as the active ingredient or one of the active ingredients and which is granted regulatory approval by the governing health regulatory authority of the applicable country for marketing in the Field. 1.28 "Research Compound(s)" means a compound (or compounds) which (a) is synthesized following the Effective Date by CombiChem and provided a sample of such to ONO for screening against the Research Target under the Lead Generation Program, (b) is a pre-existing or hereafter acquired CombiChem Compound which CombiChem desires to designate as a Research Compound, (c) is a pre-existing or hereafter acquired chemical compound that is proprietary to ONO, or whose use or manufacture is proprietary to ONO or its Affiliates, which ONO desires to designate as a Research Compound or (d) is *** . 1.29 "Research Libraries" means any and all compounds (including, but not limited to, the Research Compounds) included in libraries which are designed and synthesized for ONO by CombiChem following the Effective Date as part of the Lead Generation Program. 1.30 "Research Management Committee" or "RMC" has the meaning set forth in Article 5 below. 1.31 "Research Patent" means a Patent with composition of matter claims and/or treating method claims relating to the Research Target which is filed, maintained and/or prosecuted by ONO based on ONO's rights and intellectual property assigned to ONO pursuant - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -5- 7 to Section 4.2 hereof and which covers the results arising out of the Lead Generation Program during the Research Period. 1.32 "Research Period" means that part of the Lead Generation Program commencing on the Effective Date, and ending *** thereafter, unless earlier terminated, and which can be extended in accordance with Article 6 or Section 8.5(a) hereof. 1.33 "Research Plan" means the research plan to be agreed in writing between the Parties and to be attached hereto as Schedule D, which describes in mutually agreed upon detail the research activities to be performed during the Research Period for the Research Target. 1.34 "Research Target" means *** . 1.35 "Returned Compounds" shall have the meaning set forth in Section 7.3. 1.36 "Royalty Term" means, in the case of any Product, in any country, the period of time commencing on the First Commercial Sale and ending *** from the date of First Commercial Sale in such country. 1.37 "Second Year Benchmark" shall have the meaning set forth in Schedule A attached hereto. 1.38 "Selection Patent" means a Patent with claims covering a compound (or compounds) which (i) is filed, maintained and/or prosecuted by ONO, (ii) is included in a prior Research Patent but not specifically disclosed therein and (iii) has superior effect which is unexpected from a prior Research Patent. 1.39 "Target Exclusivity Obligations" shall have that meaning set forth in Section 3.1 hereof. 1.40 "Territory" means the entire world. 1.41 "Third Party" means an entity other than CombiChem or ONO or their respective Affiliates, or permitted successors or assigns. 1.42 "UIL" means CombiChem's proprietary Universal Informer Library(TM). 2. RESEARCH ACTIVITY 2.1 CombiChem Responsibilities. CombiChem shall, with Due Diligence, provide the following resources to ONO and conduct the following activities under the Lead Generation Program, as more fully described in the Research Plan: - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -6- 8 (a) Prior to the Effective Date, (i) CombiChem has reviewed data and information regarding the Research Target provided by ONO and derived from the UIL by CombiChem and (ii) both Parties have agreed upon the Research Plan under the Screening Agreement. During the Research Period, based on the data and information described above and such additional data and information as may be provided by ONO after the Effective Date and using the CombiChem Technology, CombiChem shall design Research Libraries as a part of the LGP and supply all lead chemestries and synthesize Research Compounds as provided in Section 4.4 hereof. CombiChem shall make commercially reasonable efforts to identify Research Compounds which satisfy the First Year Benchmarks on or before the first anniversary of the commencement of the Research Period and to identify Preclinical Lead Compounds on or before the expiration of the Research Period. (b) During the Research Period, CombiChem shall keep ONO informed of its activities performed in connection with the Lead Generation Program, including, without limitation, providing ONO with data and information (and, upon ONO's request, reasonable quantities of samples pursuant to Section 4.4 hereof) regarding the status of all Research Compounds prior to the meetings of the RMC. CombiChem shall also establish a method of synthesis as provided in Section 4.5 hereof. (c) Subject to Section 2.3 and 8.2 hereof and Article 3 hereof, CombiChem shall provide one (1) project team ("Project Team") to conduct CombiChem's activities in connection with the Lead Generation Program at a per annum rate of *** *** to be paid by ONO pursuant to subsections 8.2 (a), (b) and (c) hereof. The initial Project Team shall consist of a minimum of *** CombiChem FTEs, unless both Parties determine otherwise pursuant to subsection 8.2(c) hereof. (d) CombiChem shall maintain research records in reasonably sufficient detail comparable to the way they are maintained for CombiChem's own research programs and in good scientific manner appropriate for ONO's Patent purposes, which shall reflect all work done and results achieved in accordance with the LGP. Upon ONO's request, CombiChem shall provide ONO with copies of all such records. 2.2 ONO Responsibilities. ONO shall, with Due Diligence, provide the following resources to CombiChem and conduct the following activities under the Lead Generation Program, as more fully described in the Research Plan: (a) During the Research Period, ONO shall make payment to CombiChem for the Lead Generation Program as set forth in Sections 8.1 and 8.2 hereof and shall provide screening, biological and structural data and information to CombiChem necessary for CombiChem to perform its duties under this Agreement. ONO will further assume scientific, financial and administrative responsibility for screening and biological support activities, drug - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -7- 9 development and regulatory filings during and after the term of the Lead Generation Program on the terms set forth below. (b) During the Research Period, ONO shall screen Research Compounds for in vitro activity and, where appropriate, in vivo activity against the Research Target. ONO shall provide CombiChem with data and information which ONO develops pursuant to subsections 2.2(a) and (b) regarding Research Compounds under the Lead Generation Program prior to the meetings of the RMC. (c) Following the Research Period, ONO shall select the Development Compound from the Preclinical Lead Compounds, and if so selected, ONO shall make reasonable commercial efforts to conduct preclinical and clinical studies of the Development Compound for the purpose of filing an NDA and thereafter to progress Products through to the marketplace as expeditiously as possible. The Parties understand that there are inevitable delays in the development process which lie outside ONO's direct accountability. (d) Notwithstanding the provisions of subsection 2.2(c) above, in the event that ONO reasonably determined that the Preclinical Lead Compounds are not satisfactory for development and commercialization, following the Research Period ONO may conduct chemistry work to generate and synthesize the Derivatives and screen such Derivatives for in vitro and in vivo activities against the Research Target only after ONO has thoroughly reviewed and conducted biological testing on all Research Compounds synthesized by CombiChem and provided to ONO. ONO will assume scientific, financial and administrative responsibility for the medicinal chemistry, screening and biological support activities. (e) Following the Research Period through First Commercial Sale, ONO shall use commercially reasonable efforts to prepare and provide CombiChem with each of the reports related to ONO's activities under this Agreement as specified in Schedule C attached hereto. (f) During the Research Period and providing that ONO is not in arrears on any payment specified in Sections 8.1, 8.2 and 8.3 hereof, ONO shall, at its option, send one (1) research chemist to conduct ONO' activities at CombiChem's facilities under the Lead Generation Program. ONO shall have sole responsibility for the expenses associated with its visiting chemists, including, without limitation, salary, travel, living and other associated expenses of such chemist. 2.3 Conduct of Lead Generation Program. The Parties hereby agree that the Lead Generation Program shall be carried out with Due Diligence in accordance with the Research Plan and this Agreement, as each may be amended from time to time. The RMC shall review the Research Plan on a regular and ongoing basis and may make written changes to the Research Plan so long as such changes are mutually agreed to in writing by CombiChem and ONO. 2.4 Third Party Licenses. Each Party shall be solely responsible for acquiring any Third Party license and its associated fees required to perform its obligations under this Agreement. -8- 10 3. EXCLUSIVITY 3.1 Research Target Exclusivity. Following the Effective Date, so long as ONO or its Affiliates are proceeding with Due Diligence for the Research Target, CombiChem shall not work on, or provide services, or advise, either independently, or with any Third Parties (except where CombiChem is providing its UIL to Third Parties without knowledge of such Third Parties' target) with respect to the Research Target (the "Target Exclusivity Obligations"), except (a) with respect to any Third Parties who are collaborators or proposed collaborators of CombiChem, CombiChem shall have the right, consistent with its corporate policy (but without identifying any Research Target), to notify any such Third Party of its decision not to work on and/or inability to work on such Research Target with that Third Party or (b) ONO has provided CombiChem with a notice and release of Target Exclusivity Obligations. 3.2 Compound *** . Any Active Compound, Derivative or Improved Derivative shall be *** available to ONO for research or application within or outside the Lead Generation Program, during the Exclusivity Period, and CombiChem shall not work on or provide information regarding such Active Compound, Derivative or Improved Derivative to any Third Party, except to take any steps necessary to protect ONO's exclusivity hereunder. Following the expiration of the Research Period, Active Compounds, Derivatives or Improved Derivatives for which a Research Patent has not been filed by the end of the Exclusivity Period shall be deemed to be Inactive Compounds for all purposes hereunder; provided, that any such Inactive Compound which is the subject of claim(s) under a pending Research Patent shall continue to be *** available to ONO until a Research Patent is issued with respect to one or more of such claims or until all of such Research Patent claims have been denied and all appeals and refiling procedures have been exhausted, at which time the compounds which are the subject of those claims shall be Inactive Compounds hereunder. 3.3 Inactive Compounds. (a) Except as otherwise provided in this Section 3.3, any Inactive Compounds shall be available to CombiChem and ONO for any purpose. (b) Research Compounds that are classified by the RMC as an Inactive Compound during the *** in the Lead Generation Program or any subsequent Cycle in the Lead Generation Program thereafter (each, a " *** "), shall be exclusively available to ONO for research or application within or outside the Lead Generation Program from the time of classification as an Inactive Compound until the end of the Exclusivity Period. At the end of the Exclusivity Period for any *** , if ONO has filed a *** with claims covering such *** , such *** shall be treated as an Active Compound and shall continue to be exclusively available to ONO as provided herein. If, however, ONO has not filed a Research Patent with claims covering such *** by - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -9- 11 the end of the Exclusivity Period for such *** , such *** shall thereafter become available to CombiChem and ONO for research or application for any purpose. With respect to each *** , during the Exclusivity Period, CombiChem shall not work on or provide information regarding such *** to any Third Party, except to take any steps necessary to protect ONO's exclusivity hereunder. (c) Each Party shall promptly notify the other Party of the filing of a Patent or Research Patent with claims covering an Inactive Compound. 4. COLLABORATION COMPOUNDS 4.1 Pre-Existing Compounds or Other Pre-Existing Rights. Neither Party shall have any rights with respect to any pre-existing compound of the other Party unless and until such compound is designated as a Research Compound by such other Party. Additionally, CombiChem may decline (after informing ONO) to synthesize a particular compound or library of compounds by written notice to ONO of existing Patents and/or contractual obligations with Third Parties restricting CombiChem's performance of such activities. 4.2 Intellectual Property Rights; License to ONO. Subject to Section 7.3 hereof, and except as set forth in this Section 4.2, the ownership rights in all Research Patents and intellectual property (whether or not patentable) (including the right to file the Patent) relating to ONO Compound(s) and the subject matter contained therein and resulting from the Lead Generation Program shall be solely vested in ONO. Such ownership rights shall be achieved by CombiChem assigning its right, title and interest in such Research Patents and intellectual property relating to such ONO Compounds to ONO on (i)in the case of Active Compounds, the date of the approved determination by the RMC that a Research Compound is an Active Compound, (ii) in the case of Derivatives or Improved Derivatives, upon notification by ONO to CombiChem of the synthesis by ONO of such Derivative or Improved Derivative or (iii) in the case of any ONO Compounds other than Active Compounds, Derivatives or Improved Derivatives, when a Research Patent is filed by ONO and where such assignment is not possible, ONO shall receive a worldwide, exclusive license under CombiChem's rights, with a right to sublicense for all purposes *** to CombiChem other than those proposed in Article 8. ONO shall be responsible for filing, maintaining and prosecuting all Research Patents at its sole expense in those countries set forth on Schedule E (individually, a "Major Country", and collectively, "Major Countries") and CombiChem shall use commercially reasonable efforts to assist ONO in filing such Research Patent; provided under no circumstances does CombiChem warrant to ONO that its rights in any ONO Compounds are exclusive to the extent such ONO Compounds may be covered under the patent claims of Third Parties wherein such claims are not the direct result of a collaboration between the Third Party and CombiChem. If ONO fails to so file, maintain or prosecute all Research Patents in any Major Country, - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -10- 12 CombiChem shall have the right to request ONO to do so. If ONO elects not to file, maintain or prosecute all Research Patents in any Major Country ONO shall promptly notify CombiChem of such election and provide CombiChem with a fully-paid up license so that CombiChem can take over such filing, maintenance or prosecution of those Research Patents for which ONO has elected not to file, maintain or prosecute in such Major Country, at CombiChem's sole expense. 4.3 Structural Information. Neither Party shall disclose the structure of the other Party's compound, any Active Compound, Derivative, Improved Derivative and Late Stage Inactive Compound to any Third Party without the other Party's written permission, unless required to do so by law, in which case such Party shall promptly notify the other Party of such required disclosure; provided, however, that ONO is entitled to file a Research Patent at its sole discretion and to disclose the structure of compounds covered by such Research Patent to any Third Party following filing of such Research Patent. 4.4 Supply of Research Compounds. Aliquots of any Research Compound that has been synthesized will be prepared and given to ONO for in vitro screening under the Research Plan. CombiChem shall replenish any amounts provided to ONO as set forth in the Research Plan upon ONO's reasonable request. CombiChem shall maintain aliquots of any Research Compound that has been synthesized by CombiChem under the Research Plan. With respect to any Research Compound which ONO intends to test in vivo under the Research Plan, CombiChem shall also provide ONO with additional requirements of samples requested by ONO at CombiChem's expense. To the extent the Research Compounds are not available in a timely and sufficient quantity to allow the earliest start of necessary large scale preclinical or other studies such unavailability of Research Compounds shall not be cited as a lack of Due Diligence provided that CombiChem has made commercially reasonable attempts, and continue such attempts, to provide such unavailable Research Compounds in required quantities in the most expedient manner. 4.5 Method of Synthesis. In order to assist ONO in synthesizing and manufacturing Preclinical Lead Compounds for clinical and commercial supply, CombiChem shall use reasonable efforts to establish, and to provide any reasonable information related to, a method of synthesis for Preclinical Lead Compounds selected by ONO. 5. RESEARCH MANAGEMENT COMMITTEE There shall be established a Research Management Committee (the "RMC") comprised of four (4) core representatives, two (2) of whom shall be chosen from time to time by ONO and two (2) of whom shall be chosen from time to time by CombiChem to discuss between the Parties the progress, direction and/or modification of the Research Plan, or determine whether a Research Compound is an Active Compound or Inactive Compound. RMC meetings shall (i) be convened in person once each quarter during the Research Period, or as otherwise reasonably requested by either Party, (ii) take place alternating between San Diego or Osaka, (iii) be chaired by a representative of a Party hosting the meeting and (iv) be participated in by the members of the RMC, provided, however, that each Party may have such other of its employees and consultants participate in the meeting as may be required to adequately address the specific topics of the meeting. The agenda of the meeting shall be coordinated between the Parties and -11- 13 established at least two (2) weeks prior to the meeting. In the event that a Party wishes to present to the other Party its data and information relating to the LGP, such Party shall furnish the other with such data and information to the extent available, at least two (2) weeks prior to the meeting. A draft of the meeting minutes reflecting matters addressed at such meeting shall be prepared by the Party hosting the meeting and provided to the other for its review and comment. Such minutes shall be considered accurate only upon signing by representatives of both Parties. The Parties acknowledge that the RMC is not authorized to amend or alter the terms of this Agreement; however, the RMC may make appropriate scientific changes to the Research Plan and determination of Active Compound or Inactive Compound which shall only be authorized by minutes of the meeting executed by both Parties or any other written form. A Party may authorize alternate members to act in the place of members of the RMC due to their absence or other unavailability. 6. RESEARCH PERIOD The initial term of the Lead Generation Program shall commence on the Effective Date and conclude at the end of the Research Period, subject to extension upon mutual agreement. To extend the Research Period, either Party must notify the other Party no later than ninety (90) days prior to the then-current expiration date and the Parties shall negotiate in good faith the terms and conditions of any such extension based on a per annum rate of *** ***. Notwithstanding the foregoing, in the event that ONO requests CombiChem to maintain FTEs pursuant to Section 8.5(a) of this Agreement, the Research Period shall automatically be extended for an additional three (3)-month period on the terms set forth in Section 8.5(a). 7. LICENSE GRANTS; SUBLICENSE 7.1 CombiChem License Grant to ONO. Subject to the terms and conditions hereof, CombiChem hereby grants to ONO an exclusive, royalty bearing (as set forth in Section 8.4 of this Agreement), worldwide license, with the right to sublicense to use such CombiChem Technology as is necessary to make, have made, use, have used, sell, have sold, import and export ONO Compounds and/or Products in the Territory. 7.2 ONO License. ONO shall have the right to transfer, assign or license and sublicense to a Third Party ONO Compounds and/or the Products or associated rights under the Research Patents covering ONO Compounds and/or the Products, subject to CombiChem's right to receive all royalties and milestone payments as provided in Sections 8.3, 8.4 and 8.5 hereof. 7.3 ONO *** to CombiChem. Following the decision of ONO or its licensee not to develop and commercialize nor to seek a Third Party to license for commercialization in the Territory with Due Diligence any and all ONO Compounds and/or - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -12- 14 Products (collectively, "Returned Compounds"), ONO shall *** to CombiChem a *** *** , under the Research Patents and know-how which result from the Lead Generation Program and related exclusively to the Returned Compounds, to make, have made, use, have used, sell, have sold, import and export such Returned Compounds in the Territory. Prior to the *** under this Section 7.3 to CombiChem, ONO and CombiChem shall negotiate in good faith the terms and conditions of such *** regarding any Returned Compound. 7.4 Rights to Inactive Compounds. Except as otherwise provided in Section 3.3 hereof with respect to *** , each Party shall be free to screen Inactive Compounds against any target other than a Research Target. In the event that either ONO or CombiChem shall develop, market and/or sell, or enter into a binding agreement with a Third Party to develop, market and/or sell, any product containing the Inactive Compound as an active ingredient, then except to the extent that such Inactive Compound is subject to a valid claim in a Patent owned or controlled by the other Party, the other Party hereto shall not be entitled to any payments, milestones, royalties, fees or compensation of any kind. 8. CONSIDERATION 8.1 Initiation Fee. As of the Effective Date, ONO shall be obligated to pay CombiChem a non-refundable, noncontingent project initiation fee of *** , by registered check or wire transfer, to initiate the Lead Generation Program for the Research Target within thirty (30) days of the Effective Date. 8.2 Lead Generation Program Funding. (a) First Year Research Support. Subject to subsection 8.2(c) below and Sections 9.2 and 9.3 hereof, as of the Effective Date, ONO shall be obligated to pay CombiChem a non-refundable, non-contingent fee in support of CombiChem's research activities to be conducted pursuant to this Agreement during the first year of the Lead Generation Program on the Research Target of *** by registered check or wire transfer within thirty (30) days of the Effective Date. (b) Second Year Research Support. ONO shall pay to CombiChem on or before thirty (30) days prior to the first anniversary of the execution of this Agreement (the "First Anniversary"), *** which is equal to the fee necessary to support CombiChem's research activities to be conducted pursuant to this Agreement during the initial three (3)-month period of the second year of this Agreement . If ONO terminates this Agreement by delivering written notice to CombiChem within two (2) months following the First Anniversary pursuant to Section 9.3 hereof, *** *** during the second year of this Agreement calculated on a - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -13- 15 *** basis: i.e., in case ONO delivers such notice of termination within one (1) month following the First Anniversary, *** shall be the amount equal to *** *** and shall be made to ONO within fifteen (15) business days after CombiChem's receipt of such notice, or is delivered within two (2) months after the First Anniversary, *** shall be the amount equal to *** *** and shall be made to ONO within fifteen (15) business days after CombiChem's receipt of such notice. If ONO notifies CombiChem of its desire to continue this Agreement or fails to notify CombiChem of its termination of this Agreement within two (2) months following the First Anniversary, then *** of the second year research support shall be due on or before the end of three (3) months following the First Anniversary. (c) Expansion or Contraction of Project Team. Notwithstanding subsection 2.1(c) hereof, either Party may request that CombiChem expand or contract its Project Team during the Research Period in order to properly regulate the work-flow on the Research Target. In such event, subject to the mutual agreement of both Parties, the RMC shall promptly confer as to the appropriate number of FTEs to be added to or eliminated from the Project Team. The current annual research support payments set forth in subsections 8.2(a) and (b) above assume *** in both years at an annual cost to ONO of *** . (i) If the Project Team is expanded in the first year of the Research Period, then within thirty (30) days of such expansion, ONO shall pay to CombiChem a payment (for each additional FTE) equal to *** times a fraction with the numerator equal to the number of days in the period of addition of such FTE to the Project Team (which is agreed to by the RMC) and the denominator equal to 365. (ii) If the Project Team is expanded in the second year of the Research Period (or if an expansion which occurred in the first year of the Research Period continues into the second year of the Research Period), then within thirty (30) days of such expansion (or if the expansion occurred in the first year, within thirty (30) days of the First Anniversary), ONO shall pay to CombiChem a payment (for each additional FTE) equal to *** times a fraction with the numerator equal to the number of days in the period of addition of such FTE to the Project Team and the denominator equal to 365. (iii) If an FTE is eliminated from the Project Team in the first year of the Research Period, then within thirty (30) days of such elimination, CombiChem shall pay to ONO a payment (for each eliminated FTE) equal to *** times a fraction with the numerator equal to the number of days in the period of elimination of such FTE from the Project Team and the denominator equal to 365. (iv) If an FTE is eliminated from the Project Team in the second year of the Research Period (or if an elimination which occurred in the first year of the Research Period continues into the second year of the Research Period), then within thirty (30) - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -14- 16 days of such elimination (or if the elimination occurred in the first year, within thirty (30) days of the First Anniversary), CombiChem shall pay to ONO a payment (for each eliminated FTE) equal to *** times a fraction with the numerator equal to the number of days in the period of elimination of such FTE from the Project Team and the denominator equal to 365. (d) During the Research Period, within forty-five (45) days following the end of each six (6) month period (or the early termination), CombiChem shall provide ONO with a *** *** . The amount of the *** shall not effect ONO's obligation to make any payments set forth in this Article 8 or the timing of such payments. 8.3 Milestone Payments. (a) Within thirty (30) days of the occurrence of a milestone triggered by the activities of ONO or its Affiliates as shown on Schedule B attached hereto, ONO shall pay CombiChem the related milestone payment in U.S. dollars as set forth on Schedule B attached hereto by registered check or wire transfer, provided, however, that in the event that the characteristics of a Development Compound or Product that ONO intends to develop, or is developing, for commercialization requires the review of commercial value of such Development Compound and Product, then the Parties shall *** of the *** . Each of such payments shall be a *** or Product (except for payments with respect to *** where the payments shall be made for each Product as provided in Schedule B attached hereto) for use within the Field. ONO shall have no obligation to make any milestone payment pursuant to this Agreement in the event that ONO develops and commercializes an ONO Compound *** . (b) In the circumstance where ONO has milestone payment obligations to CombiChem pursuant to subsection 8.3(a) above with respect to a Product whose primary active ingredient is an *** that was *** and before the end of the Exclusivity Period, *** with respect to such Product shall be *** . For each *** which has elapsed from the end of the Research Period to the *** , the milestone payment will be *** by *** and reaching a *** at the end of the twelfth month following the *** . By way of example, if the *** in the *** after the end of the *** , each *** would be *** *** . (c) In the circumstances where ONO has milestone payment obligations to CombiChem pursuant to subsection 8.3(a) above with respect to a Product whose primary active ingredient is an *** by ONO *** *** with respect to such Product shall be *** . - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -15- 17 8.4 Royalties. (a) During the Royalty Term, ONO will pay CombiChem an earned royalty of *** of Net Sales of Products for use within the Field. Each payment of royalties shall be accompanied by a report of Net Sales of Products in sufficient detail to permit confirmation of the accuracy of the royalty payment made. ONO shall have no obligation to make any royalty payment pursuant to this Agreement in the event that ONO develops and commercializes an ONO Compound outside of the Field. (b) In the circumstance where ONO has royalty obligations to CombiChem pursuant to subsection 8.4(a) above with respect to a Product whose primary active ingredient is an *** and before the end of the Exclusivity Period, such royalty obligations with respect to such Product ***. For each *** which has elapsed from the *** to the ***, the *** and reaching a *** at the end of the twelfth month following the *** . By way of example, if the *** in the *** after the *** ***, the *** would be *** to *** of such Products. (c) In the circumstances where ONO has royalty obligations to CombiChem pursuant to subsection 8.4(a) above with respect to a Product whose primary active ingredient is an *** by ONO after the end of the *** , such royalty obligations shall be *** of Net Sales of such Products. 8.5 *** of the Second Year Benchmarks. (a) *** in its reasonable judgment that the Second Year Benchmarks are not met by the second anniversary of this Agreement ("Second Anniversary"), upon the request of ONO on or prior to the Second Anniversary, CombiChem *** *** as of the Second Anniversary for a period of *** following the Second Anniversary at *** and shall continue to conduct the research activities pursuant to Section 2.1 hereof. If the Second Year Benchmarks are met on or before such *** period ends, CombiChem shall be eligible for the Second Year Benchmark *** under subsection 8.3(a) hereof as if such *** as if the Second Anniversary. (b) If ONO determines in its reasonable judgment that the Second Year Benchmarks are not met by the Second Anniversary due solely to delay *** of its research activities in each Cycle as set forth in the Research Plan, and *** *** after the end of the Research Period, for each *** from the end of the Research Period to the synthesis of the Derivative or Improved Derivative, *** during the *** - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -16- 18 and *** pursuant to Sections *** and reaching a *** at the end of the twelve (12) month period following the *** , whether the Product contains a Derivative or an Improved Derivative; provided however, if ONO finally determines to develop an Active Compound as a Development Compound, *** . (c) *** shall have no obligation *** in the event that *** has caused *** which has a material adverse affect on CombiChem's ability to achieve the Second Year Benchmarks. 8.6 *** of the Second Year Benchmarks. In the event that CombiChem synthesizes an Active Compound within or before the *** *** which meets the Second Year Benchmarks, ONO shall pay to CombiChem an *** within fifteen (15) business days of ONO's confirmation of such achievement in addition to the milestone payment payable upon the achievement of the Second Year Benchmarks set forth in Schedule B attached hereto. 8.7 *** . Notwithstanding the provisions of Sections 8.3(b), 8.3(c), 8.4 (b), 8.4 (c) and 8.5(b), under no circumstances shall the *** *** provided in such sections *** *** provided in this Agreement. 8.8 Manner and Place of Payment. Royalty payments and reports for Net Sales of Products shall be calculated in local currencies and reported for each calendar quarter. All royalty payments owed under this Agreement shall be made by wire transfer to the bank account to be designated by CombiChem within sixty (60) days following the end of each such calendar quarter in case of Products sold by ONO or its Affiliates and within ninety (90) days following the end of each such calendar quarter in the case of Products sold by its licenses or sublicensees. The amount of such sales in foreign currencies shall be converted into United States dollars at the exchange rate in effect on the last business day for each calendar quarter as reported in The Wall Street Journal. However, CombiChem acknowledges that ONO's fiscal term is on a semi-annual basis and any royalty payments for the Net Sales of the second or fourth calendar quarters are tentative and shall be calculated based on the conditions used for the previous quarter. If any overpayment or underpayment is identified in the calculation of the royalty using the conditions of such current term at the end of ONO's official semi-annual term (the first and third calendar quarter), then such overpayment or underpayment shall be deducted or added to the royalty payments of the first or third calendar quarter, as the case may be. 8.9 Target Substitution. In the event that ONO and CombiChem mutually agree in writing that the Research Target is unsuitable for further research, the Parties shall meet to discuss the substitution of another Target. If the Parties mutually agree in writing to such a - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -17- 19 Target, ONO shall not be obligated to pay a second project initiation fee to CombiChem as provided in Section 8.1 hereof. 8.10 Records and Audit. ONO shall keep complete and accurate records pertaining to the sale or other disposition of Products in sufficient detail for a period of three (3) years following each royalty payment to permit CombiChem to confirm the accuracy of all payments due hereunder. CombiChem shall have the right to cause an independent certified public accounting firm reasonably acceptable to ONO to audit such records to confirm ONO's Net Sales for the preceding year. Any information obtained during such audit shall be treated as Confidential Information. Such audits may be exercised after reasonable notice during normal business hours of ONO no more than once each year. CombiChem shall bear the full cost of such audit unless such audit discloses a deficiency of the greater of *** or more than *** from the amount of the Net Sales reported by ONO for such audited period. In such case, ONO shall bear the reasonable cost of such audit. 8.11 Taxes. All income and other taxes levied on account of the royalties and other payments accruing to CombiChem under this Agreement shall be paid by CombiChem, including taxes levied thereon as income to CombiChem. If provision is made in law or regulation for withholding, such tax shall be deducted from the royalty or other payment made by ONO to the proper taxing authority and a receipt of payment of the tax secured and promptly delivered to CombiChem. Each Party agrees to assist the other Party reasonably in claiming exemption from such deductions or withholdings under any double taxation or similar agreement or treaty from time to time in force. 9. TERM AND TERMINATION OF THE AGREEMENT 9.1 Term. The term of this Agreement shall commence upon the Effective Date and unless earlier terminated as provided in this Agreement, shall expire at the end of the Research Period. 9.2 Termination by ONO or CombiChem Due to Breach. If either Party materially breaches this Agreement and fails to remedy that breach within ninety (90) days of receiving written notice thereof from the other Party, or enters into any arrangement of compromise with its creditors or goes into liquidation, insolvency, bankruptcy, receivership or reorganization proceedings, whether voluntarily or compulsorily which is not dismissed by a court of competent jurisdiction within ninety (90) days, then the other Party may at any time, by notice in writing or by facsimile transmission, terminate this Agreement. If ONO terminates this Agreement during the Research Period due to CombiChem's material breach, CombiChem shall repay to ONO within fifteen (15) business days following such termination any unused portion of ONO's research support payment which has been paid pursuant to Section 8.2 hereof calculated on a monthly basis. Within ninety (90) days following termination for any Lead Generation Program and/or research related to the Research Target under this Agreement, the - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission -18- 20 RMC shall prepare a detailed, final written report to each Party, and provide any remaining supply of compounds in synthesis to date, for the Research Target or Lead Generation Program being terminated. 9.3 Other Termination by ONO or CombiChem. (a) In the event that ONO reasonably determines that CombiChem has failed to achieve the "First Year Benchmarks" during the initial twelve (12) months of the Research Period, ONO shall be entitled to immediately terminate this Agreement by delivering written notice of such termination to CombiChem within two (2) months after the First Anniversary and ONO shall not be required to make any further payments thereafter. (b) This Agreement shall be terminable by either Party (the "Notifying Party") giving the other Party (the "Notified Party") written notice of a situation that is thought to materially affect the performance of the Notified Party's obligations under this Agreement (the "First Notice"). Within four (4) weeks of the Notified Party's receipt of the First Notice, the Parties shall meet together in a face-to-face meeting in a place to be mutually agreed. The Parties shall work together to address the issues raised in the First Notice for ninety (90) days following the Notified Party's receipt of the First Notice. If such issues are not resolved to the Notifying Party's reasonable satisfaction within such ninety (90)-day period, the Notifying Party may then provide additional written notice (the "Second Notice") to the Notified Party of the termination of this Agreement, effective immediately following the Notified Party's receipt of the Second Notice. Upon any termination of this Agreement pursuant to this Section 9.3, CombiChem shall repay to ONO within fifteen (15) business days following such termination any unused portion of a ONO research support payment which has been paid pursuant to Section 8.2 hereof calculated on a monthly basis. 9.4 After Termination. Any termination of this Agreement or the Lead Generation Program shall be without prejudice to the accrued rights of either Party prior to the termination. In case of termination of this Agreement or the Lead Generation Program pursuant to Sections 9.2 or 9.3 above, all royalty, milestone and other payment obligations set forth in Sections 8.3, 8.4, 8.5, 8.6 and 8.7 hereof shall survive any such termination. Moreover, unless otherwise specified, ONO shall not be entitled to any refund of any payments made to CombiChem hereunder upon the expiration of the term of this Agreement or earlier termination pursuant to this Article 9. 10. CONFIDENTIAL INFORMATION 10.1 Nondisclosure. During the term of this Agreement and for a period of five (5) years after termination or expiration thereof, each Party shall maintain all Confidential Information in trust and confidence and shall not disclose any Confidential Information to any third party or use any Confidential Information for any purpose except (i) as expressly authorized by this Agreement, (ii) as required by law or court order, after as much advance notice as is practical to the other Party, (iii) to its consultants, subcontractors, licensees or potential licensees, clinical investigators, affiliates, employees or agents who need to know to accomplish the purposes of this Agreement and who are bound by equivalent written confidentiality obligations. -19- 21 Each Party may use the other Party's Confidential Information only to the extent required to accomplish the purposes of this Agreement. Each Party will use at least the same standard of care as it uses to protect proprietary or confidential information of its own to ensure that its Affiliates, employees, agents, consultants and other representatives do not disclose or make any unauthorized use of the Confidential Information. Each Party will promptly notify the other upon discovery of any unauthorized use or disclosure of the Confidential Information. Notwithstanding the foregoing, CombiChem shall maintain all Confidential Information in trust and confidence and shall not disclose any Confidential Information to any Third Party or use any Confidential Information for any purpose with regard to Confidential Information disclosed by ONO to CombiChem pursuant to Sections 1 and 2 of Schedule C until the expiration of the Research Patent covering the Product. 10.2 Exceptions. Confidential Information shall not include any information which the receiving Party can prove by competent evidence: (a) is now, or hereafter becomes, through no act or failure to act on the part of the receiving Party, generally known or available; (b) is known by the receiving Party at the time of receiving such information, as evidenced by its written records; (c) is hereafter disclosed to the receiving Party by a Third Party, as a matter of right and without restriction on disclosure; (d) is independently developed by the receiving Party without the aid, application or use of Confidential Information; or (e) is the subject of a written permission to disclose provided by the disclosing Party. 11. PUBLICATIONS AND PUBLIC STATEMENTS 11.1 Publications. (a) Without affecting obligations under Article 10 above, neither Party shall publish any information with respect to any Research Compound, Active Compound, Derivative, Improved Derivative, Preclinical Lead Compound or Development Compound during the Exclusivity Period without the prior written permission of the other Party. If the proposing Party wishes to obtain such permission, it shall provide the other Party with the manuscript for publication or presentation for the other Party's review prior to the submission of such manuscript for publication or presentation. The other Party shall notify the proposing Party of the disapproval or approval of such publication or presentation within thirty (30) days after receipt of such manuscript by such other Party. Such permission not to be unreasonably withheld. Such thirty (30) day period shall not be extended unless the other Party requests additional time until the submission of a Patent to the competent authorities for the purpose of protecting its intellectual property position; provided, however, ONO may publish scientific information with regard to pharmacology, pharmacy and chemistry, toxicology, metabolism, pharmaceutical, clinical studies of the Development Compound and Product without the prior written consent of CombiChem. (b) Following the Exclusivity Period, ONO may publish any information or material concerning an Active Compound, Derivative, Improved Derivative, Preclinical Lead Compound, Development Compound or Product arising out of the Lead Generation Program or generated solely by ONO after the Research Period without the prior written consent of CombiChem. -20- 22 11.2 Public Statements. Neither Party shall use the name of the other Party in any public statement, prospectus, annual report or press release or other public communication (collectively "Public Statements") (except to the extent that use of the name is required for disclosure by the Securities and Exchange Commission or other governmental rules or regulations (with notice to be provided by CombiChem to ONO in such circumstances)) without the prior written approval of the other Party, which may not be unreasonably withheld or delayed; provided, however, that both Parties shall endeavor in good faith to give the other Party a minimum of five (5) business days to review such Public Statements; provided, further, that, upon approval of any such Public Statement, both Parties may disclose to Third Parties the information contained in such Public Statement without the further approval of the other; and provided, further, that if a Party does not approve such Public Statement, either Party may still use the name of the other Party in any Public Statement, if such Party is advised by counsel that such disclosure is required to comply with applicable law so long as prior written notice of such counsel's view is provided to the other Party. 12. INDEMNIFICATION 12.1 EACH PARTY HEREBY AGREES TO SAVE, DEFEND AND HOLD THE OTHER PARTY, ITS AFFILIATES, OFFICERS, DIRECTORS, EMPLOYEES, CONSULTANTS, AGENTS, LICENSEES AND STOCKHOLDERS HARMLESS FROM AND AGAINST ANY AND ALL SUITS, CLAIMS, ACTIONS, DEMANDS, LIABILITIES, EXPENSES AND LOSSES, INCLUDING REASONABLE LEGAL EXPENSES AND ATTORNEYS' FEES ("LOSSES") RESULTING DIRECTLY OR INDIRECTLY FROM (A) ANY BREACH OF THE INDEMNIFYING PARTY'S OBLIGATION HEREUNDER, OR (B) THE NEGLIGENCE, OR RECKLESSNESS OR INTENTIONAL ACTS OR OMISSIONS IN CONNECTION WITH THE WORK PERFORMED BY OR ON BEHALF OF THE INDEMNIFYING PARTY HEREUNDER. 12.2 SUBJECT TO THE PROVISIONS ABOVE, EACH PARTY HEREBY AGREES TO SAVE, DEFEND AND HOLD THE OTHER PARTY, ITS AFFILIATES, OFFICERS, DIRECTORS, EMPLOYEES, CONSULTANTS, AGENTS, LICENSEES AND STOCKHOLDERS HARMLESS FROM AND AGAINST THE LOSSES RESULTING DIRECTLY OR INDIRECTLY FROM (A) THE USE BY OR ON BEHALF OF THE INDEMNIFYING PARTY, ITS AFFILIATES OR LICENSEES OF RESULTS ACHIEVED BY INDEMNIFYING PARTY HEREUNDER OR (B) THE MANUFACTURE, DEVELOPMENT, USE, HANDLING, STORAGE, SALE OR OTHER DISPOSITION OF CHEMICAL AGENTS, RESEARCH COMPOUNDS, ACTIVE COMPOUNDS PRECLINICAL LEAD COMPOUNDS, DERIVATIVES, IMPROVED DERIVATIVES, DEVELOPMENT COMPOUNDS OR PRODUCTS BY SUCH INDEMNIFYING PARTY, ITS AFFILIATES OR LICENSEES, EXCEPT TO THE EXTENT SUCH LOSSES RESULT FROM THE NEGLIGENCE (WHETHER ACTIVE, PASSIVE OR IMPUTED), BREACH OF THIS AGREEMENT OR WILLFUL MISCONDUCT OF THE PARTY CLAIMING A RIGHT OF INDEMNIFICATION UNDER THIS ARTICLE 12. 12.3 Infringement. -21- 23 (a) Subject to subsection 12.3(c) below, ONO shall hold CombiChem and its officers, directors, employees, consultants, and agents harmless from and against any and all losses resulting from the infringement of any Third Party's Patent issued as of the Effective Date due to the performance by ONO or its Affiliates of any activity contemplated hereunder, including, but not necessarily limited to, ONO's responsibilities under Section 2.2 above, developing Products, and selling Products. (b) Subject to subsection 12.3(c) below, CombiChem shall hold ONO and its officers, directors, employees, consultants, and agents harmless from and against any and all losses resulting from the infringement of any Third Party's Patent issued as of the Effective Date due to the performance by CombiChem of any activity contemplated hereunder, including, but not necessarily limited to, CombiChem's responsibilities under Section 2.1 above. (c) The indemnity provided in subsections 12.3(a) and 12.3(b) above shall not apply where the loss is due to the breach by the indemnified Party of a warranty made in Article 18. 12.4 Procedures. If either Party (the "Indemnified Party") seeks indemnification under this Article 12, it shall inform the other Party (the "Indemnifying Party") of a claim as soon as reasonably practicable after it receives notice of the claim, shall permit the Indemnifying Party to assume direction and control of the defense of the claim (including the right to settle any claim brought against the Indemnified Party upon prior written consent of the Indemnified Party, which shall not be unreasonably withheld), and shall give reasonable cooperation (at the expense of the Indemnifying Party) in the defense of such claim. 12.5 Insurance. CombiChem and ONO each shall maintain, through self insurance or otherwise, insurance with respect to their respective activities contemplated by this Agreement, in such amount and for such term as CombiChem or ONO, respectively, customarily maintains covering its similar activities. 13. ASSIGNABILITY This Agreement may not be assigned by either Party without the prior written consent of the other Party, not to be unreasonably withheld; provided, however, that either Party may assign this Agreement, in whole or in part, to an Affiliate or in whole to a successor of a Party in connection with the merger, consolidation or sale of all or substantially all of such Party's assets or that portion of its business pertaining to the subject matter of this Agreement (and upon doing so will promptly notify the other Party in writing); provided that the assigning Party remains fully liable as obligated hereunder. 14. DISPUTE RESOLUTION PROCEDURES 14.1 Senior Executive's Discussions. If a dispute arises between CombiChem and ONO out of the performance of the obligations of either Party hereunder during the term of this Agreement, such dispute will be referred to the appropriate senior management in the area of the dispute. If such senior management are unable to resolve such dispute within thirty (30) days -22- 24 following the initiation of discussions between them, such dispute shall be settled by arbitration as described in Section 14.2 below. 14.2 Binding Arbitration. If the Parties have not been able to resolve the dispute as provided in Section 14.1 above, the dispute shall be finally settled by binding arbitration. Any arbitration hereunder shall be conducted under the arbitration rules of the *** . If arbitration is demanded by *** , such arbitration shall take place in *** , and it demanded by *** , it shall take place in *** . The arbitration shall be conducted before three arbitrators (at lease one of which shall be an independent expert in pharmaceutical product development, including clinical development and regulatory affairs), chosen according to the following procedure: each of the parties shall appoint one arbitrator and the two (2) so nominated shall choose the third. If the arbitrators chosen by the Parties cannot agree on the choice of the third arbitrator within a period of thirty (30) days after their appointment, then the third arbitrator shall be appointed by arbitration association in the place where arbitration shall take place. The arbitrators shall have the authority to grant specific performance, and to allocate between the Parties the costs of arbitration, including but not limited to the reasonable attorneys' fees, in such equitable manner as they determine. The arbitral award (i) shall be final and binding upon the Parties; and (ii) may be entered into any court of competent jurisdiction. 14.3 Confidentiality. All arbitration proceedings under this Article 14 shall be confidential and the arbitrators may issue appropriate protective orders to safeguard the Parties' Confidential Information. Except as required by law, neither Party shall make (or instruct any arbitrator to make) and public announcement with respect to the proceedings or decisions of any arbitration without the prior written consent of the other Party. The existence of any unresolved dispute, the submission of an unresolved dispute to arbitration pursuant to this Article 14, and any award by arbitrators, shall be kept in confidence by the Parties and the arbitrators, except as required in connection with the enforcement of such award or implementation of such decisions, as mutually agreed by the Parties or as required by law. 14.4 Injunctive and Other Relief. Nothing contained in this Article 14 or any other provisions of this Agreement shall be construed to limit or preclude a Party from bringing any action in any court of competent jurisdiction for injunctive or other provisional relief to compel the other Party to comply with its obligations hereunder before or during the pendency of arbitration proceedings. 15. NOTICES Any notice required or permitted to be given hereunder shall be deemed sufficient if sent by facsimile letter or overnight courier, or delivered by hand to ONO or CombiChem at the respective addresses and facsimile numbers as set forth below or at such other address and facsimile number as either Party hereto may designate. If sent by facsimile letter, notice shall be - -------------------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission. -23- 25 deemed given when the transmission is completed if the sender has a confirmed transmission report. If a confirmed transmission report does not exist, then the notice will be deemed given when the notice is actually received by the person to whom it is sent. If delivered by overnight courier, notice shall be deemed given when it has been signed for. If delivered by hand, notice shall be deemed given when received. if to CombiChem, to: CombiChem, Inc. 9050 Camino Santa Fe San Diego, California 92121 Attention: President Fax number: (619) 530-9998 with a copy to: Brobeck, Phleger & Harrison LLP 550 West C Street, Suite 1200 San Diego, California 92101 Attention: Faye H. Russell, Esq. Fax number: (619) 234-1966 if to ONO to: ONO Pharmaceutical Co., Ltd. 1-5 Doshomachi, 2-Chome, Chuo-Ku Osaka 541-8526 Japan Attention: Director, International Business Fax Number: (06) 6222-2381 with a copy to: ONO Pharmaceutical Co., Ltd. Minase Research Institute 3-7-1 Sakurai Shimamoto Mishima Okasa 618-8585 Japan Attention: Director, Discovery Planning Fax Number: (075) 962-9314 16. SURVIVAL Without prejudice to the provisions of Section 9.4 hereof, the provisions of Sections 2.4, 4.1, 4.2, 4.3 and Articles 3, 7, 8, 10, 11, 12, 14, 15, 17 and this Article 16 shall survive expiration of this Agreement pursuant to Section 9.1 or termination of this Agreement in addition to those provisions which by their terms survive. -24- 26 17. ADDITIONAL TERMS 17.1 Entire Agreement. This Agreement, including all Schedules attached to this Agreement, constitutes the entire understanding between the Parties with respect to the subject matter hereto and supersedes and replaces all previous negotiations, understandings, representations, writings and contract provisions and rights relating hereof. 17.2 Amendment; No Waiver. No provision of this Agreement may be amended, revoked or waived except by a writing signed and delivered by an authorized officer of each Party. Any waiver on the part of either Party of any breach or any fight or interest hereunder shall not imply the waiver of any subsequent breach or waiver of any other right or interest. 17.3 Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, each of which shall remain in full force and effect. 17.4 English Language. This Agreement is entered into in the English language. All meetings and correspondence between the Parties are to be in English. In the event of any dispute concerning the construction or meaning of this Agreement, reference shall be made only to this Agreement as written in English and not to any translation into any other language. 17.5 Headings. The descriptive headings are inserted for convenience of reference only and are not intended to be part of or to affect the meaning of or interpretation of this Agreement. 17.6 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, and all of which together shall be deemed to be one and the same instrument. 17.7 Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of California, without regard to conflicts of laws principles. 17.8 Further Assurances. At any time and from time to time after the Effective Date, the Parties shall each do, execute, acknowledge and deliver, and cause to be done, executed, acknowledged or delivered, all such further acts, transfers, conveyances, or assignments as may be reasonably required to carry out the transactions contemplated by this Agreement. 18. REPRESENTATIONS AND WARRANTIES 18.1 Authorization. All action on the part of each of CombiChem, ONO and their respective officers, and directors necessary for the authorization, execution and delivery of this Agreement and the performance of all obligations of CombiChem, ONO and ONO, respectively, hereunder has been taken. -25- 27 18.2 Rights to Intellectual Property. Each Party warrants that it has the power to grant all of the rights granted and make such required assignments, and to assume all of the obligations required, under this Agreement. Under no circumstances does CombiChem warrant to ONO that ONO's rights in any ONO Compound and/or Products are exclusive to the extent such ONO Compound and/or Products may be covered under the patent claims of Third Parties wherein such claims are not the direct result of a collaboration between the Third Party and CombiChem. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -26- 28 IN WITNESS WHEREOF, the parties have executed this Agreement to be effective as of the Effective Date. COMBICHEM, INC. ONO PHARMACEUTICAL CO., INC. By: /s/ Vicente Anido By: /s/ Illegible -------------------------------- -------------------------------------- Vicente Anido Its: President & CEO Its: President ------------------------------- ------------------------------------- Date: December 28, 1998 Date: December 28th, 1998 ------------------------------ ------------------------------------ [SIGNATURE PAGE TO LEAD GENERATION PROGRAM AGREEMENT] 29 SCHEDULE A First and Second Year Benchmarks First Year Benchmarks *** Second Year Benchmarks *** - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission 30 SCHEDULE B Milestones and Payments(1) *** (1) Paid in U.S. Dollars (2) Paid for each compound which achieves the stated milestone. - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission 31 SCHEDULE C Reporting Requirements The reports with respect to Products to be delivered pursuant to this Agreement will be submitted by ONO to CombiChem as follows and will include the following: 1. When filed and annually thereafter, if not previously provided: (a) Copies of the preclinical pharmacology and toxicology summaries prepared for the IND and NDA (or foreign equivalents) for each Product. (b) Copies of the Integrated Summary of Efficacy and Integrated Summary of Safety prepared for the NDA (or foreign equivalent) for each Product. 2. During the month of July and January of each year: (a) Any projected and actual initiation dates and completion dates and the phase, i.e., Phase I, Phase II and Phase III, of clinical trials for each Product in the Field. (b) The projected and actual completion dates of each trial for each Product in the Field. (c) Any projected and actual dates of NDA (or foreign equivalent) submissions for each Product. (d) Status of Patents and Patent applications both within and outside the United States. (e) Occurrence of any milestone events. (f) Any permitted licensing under this Agreement. 3. Promptly following publication, copies of any publications (preclinical and clinical) by ONO or its investigators or ONO's third party collaborators/investigators concerning a Product. Notwithstanding the provisions of Section 17.4 of the Agreement, ONO shall not be obligated to translate such copies into English for this provision. 4. Promptly following presentation, use good faith efforts to provide copies of materials presented to financial analysts in significant presentations which involved new information concerning a Product. Notwithstanding the provisions of Section 17.4 of the Agreement, ONO shall not be obligated to translate such copies into English for this provision. ONO will notify CombiChem of any delays in the development of any Product as outlined above and will summarize the cause(s) of such delay. 32 SCHEDULE D Research Plan *** - ---------- *** Portions of this page have been omitted pursuant to a request for Confidential Treatment and filed separately with the Commission 33 SCHEDULE E Major Countries Japan South Korea United States Any country included in the European Patent Convention (currently consisting of the United Kingdom, France, Germany, Italy, Switzerland, Netherlands, Belgium, Luxembourg, Denmark, Spain, Portugal, Greece, Sweden, Finland, Austria and Ireland) EX-21.1 9 EXHIBIT 21.1 1 EXHIBIT 21.1 CombiChem Inc. Subsidiaries of Registrant CombiChem JVR, Inc., a Delaware Corporation EX-23.1 10 EXHIBIT 23.1 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8) pertaining to the 1997 Stock Incentive Plan and 1997 Employee Stock Purchase Plan of CombiChem, Inc. of our report dated January 18, 1999, except for Note 9, as to which the date is March 5, 1999, with respect to the financial statements of CombiChem, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1998, filed with the Securities and Exchange Commission. ERNST & YOUNG LLP San Diego, California March 26, 1999 EX-27.1 11 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AT DECEMBER 31, 1998 (AUDITED) AND THE STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 (AUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998. 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 29,359 0 2,892 0 0 33,561 10,844 2,943 41,980 7,415 0 0 0 13 30,163 41,980 0 15,074 0 19,112 (180) 0 905 (3,312) 0 (3,312) 0 0 0 (3,312) (0.36) (0.36)
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