-----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, RC8A6eBIlQw6RM/4JCktIu8LK6uqYDfQaFIIWnHvyAMgiYB1XcvVjN7gv+gXHhsZ DZbUCPe6N4SA0DF/9/E2xQ== 0000884939-99-000009.txt : 19990326 0000884939-99-000009.hdr.sgml : 19990326 ACCESSION NUMBER: 0000884939-99-000009 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990325 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SYNAPTIC PHARMACEUTICAL CORP CENTRAL INDEX KEY: 0000884939 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 222859704 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27324 FILM NUMBER: 99572652 BUSINESS ADDRESS: STREET 1: 215 COLLEGE RD CITY: PARAMUS STATE: NJ ZIP: 07652 BUSINESS PHONE: 2012611331 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K Mark One: [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the 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 0-27324 SYNAPTIC PHARMACEUTICAL CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 215 College Road Paramus, NJ (Address of principal executive offices) 22-2859704 (I.R.S. Employer Identification No.) 07652 (201) 261-1331 (Zip Code) (Registrant's telephone number, including area code) 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 $.01 per share Rights to Purchase Series A Junior Convertible Preferred Stock, par value $.01 per share (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The approximate aggregate market value of the voting and non voting common equity held by non-affiliates of the registrant was approximately $123,067,000 as of February 15, 1999, based upon the closing price of the Common Stock as reported on The Nasdaq Stock Market on such date. For purposes of this calculation, shares of Common Stock held by directors, officers and stockholders whose ownership in the registrant is known by the registrant to exceed five percent have been excluded. This number is provided only for purposes of this report and does not represent an admission by either the registrant or any such person as to the status of such person. As of February 15, 1999, there were 10,727,906 shares of the registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Synaptic Pharmaceutical Corporation Proxy Statement, to be filed not later than 120 days after December 31, 1998, in connection with the registrant's 1999 Annual Meeting of Stockholders, referred to herein as the "Proxy Statement," are incorporated by reference into Part III of this Report on Form 10-K. SYNAPTIC PHARMACEUTICAL CORPORATION INDEX TO REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1998 Part I Page ---- Item 1. Business..................................................... 1 Item 2. Properties................................................... 33 Item 3. Legal Proceedings............................................ 33 Item 4. Submission of Matters to a Vote of Securityholders........... 33 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................................ 34 Item 6. Selected Financial Data...................................... 35 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 35 Item 7A. Quantitative and Qualitative Disclosures About Market Risk... 45 Item 8. Financial Statements......................................... 47 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................... 68 Part III Item 10. Directors and Executive Officers of the Registrant........... 68 Item 11. Executive Compensation....................................... 68 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................. 68 Item 13. Certain Relationships and Related Transactions............... 68 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................................ 69 (i) Part I Item 1. Business Overview Synaptic Pharmaceutical Corporation ("Synaptic" or the "Company") is a biotechnology company engaged in the development of a broad platform of enabling technology which it calls "human receptor- targeted drug design technology." The Company is utilizing this technology to discover and clone the genes that code for human receptor subtypes that may be associated with specific disorders. The Company and its collaborative partners and other licensees are in turn utilizing the cloned receptor genes to design compounds that can potentially be developed as drugs for treating these disorders. Synaptic's human receptor-targeted drug design technology is the result of an integrated approach to four life science fields: molecular biology; cell biology; pharmacology; and chemistry, including medicinal, combinatorial and computer-assisted chemistry. This technology allows chemists to focus their drug discovery efforts on a specific human receptor subtype target. The Company believes that its technology provides three distinct advantages over the traditional approach to drug discovery in which compounds are screened against animal tissues containing many different receptor subtypes. First, by having an isolated receptor subtype as a target, chemists are better able to design compounds that interact with only the target of interest and not with other receptors that may be responsible for side effects. Second, the Company believes that using human receptor subtypes as drug design targets will substantially reduce the number of problems that often arise during the drug development process as a result of differences in a compound's activity in humans compared to its activity in animal models. Third, Synaptic believes that its technology may be more cost-effective than traditional drug discovery because the Company and its collaborative partners and other licensees can eliminate or redesign compounds that react poorly with human receptor targets prior to initiating the costly activities related to preclinical testing and clinical trials. Synaptic focuses its receptor and drug discovery efforts on members of a receptor superfamily known as "G protein-coupled receptors" or "GPCRs." The Company selected this receptor superfamily for two principal reasons. First, many GPCRs have been shown to be effective drug targets, as evidenced by the commercial availability of drugs for a wide variety of therapeutic applications that work by means of their interactions with GPCRs. Second, the GPCR superfamily is extremely large and diverse and, based on several estimates, exceeds several thousand receptors, with its members being involved in the mediation of a broad array of physiological functions. Accordingly, the Company believes that there are substantial opportunities to use many receptors within the GPCR superfamily as targets for novel drugs. The Company employs a number of approaches to discover and clone genes that code for GPCRs. Its principal approach, until recently, has been a targeted genomics approach. This approach involves two steps. First, the Company identifies families of receptors within the GPCR superfamily that are, based on available pharmacological information relating to these families suggesting a potential role in physiological disorders, of particular interest to the Company. The Company then devises strategies to enable it to discover and clone receptor genes within the targeted families. After the Company discovers and clones two or more members of a targeted receptor family, its strategy is to seek a collaborative partner with which it can attempt to design and develop drugs that act at one or more of the cloned receptors. 1 While the Company has been successful employing this targeted genomics approach, as evidenced by collaborations with pharmaceutical companies focused on four different families of GPCRs, it has begun to shift the emphasis in its gene discovery efforts from the targeted genomics approach to a nontargeted genomics approach. This shift stems from certain developments in the field of gene discovery over the past several years. First, due in large part to the successful targeted cloning efforts of the Company and other biotechnology companies, pharmaceutical companies and academic institutions, many of the genes that code for members of GPCR families for which there exists a body of pharmacological information suggesting a role in physiological disorders have now been cloned. As a result, most of the genes that remain to be cloned are those that code for members of GPCR families for which there may be little, if any, pharmacological information, and those that code for receptors whose families have not yet been identified and for which there is a lack of biological knowledge. Second, there has been a tremendous increase in interest over the past several years in determining the sequence of the entire human genome. This interest has spurred significant competition and technological advances in the field of genomics. Many of these technological advances involve a "nontargeted" approach to gene discovery in that they facilitate the identification of genes from large collections of DNA sequence information without, in the first instance, requiring the design and implementation of strategies aimed at cloning the members of specific receptor families. While the nontargeted approaches to gene discovery often yield genes about which there is little, if any, existing biological knowledge, they have greatly accelerated the rate at which novel genes are being discovered. Given these developments and the fact that there is a finite number of genes in the human genome, in an effort to remain competitive in the field of gene discovery, the Company has begun to shift the emphasis in its gene discovery efforts from a targeted genomics approach to a nontargeted genomics approach. The Company's nontargeted genomics approach involves the integration of certain proprietary molecular biology technology of the Company with automated gene sequencing technologies and bioinformatics. In formulating this approach, the Company was intent upon addressing a problem commonly experienced by many in industry and in academia who are employing nontargeted genomics technologies to identify novel genes. The problem is one of "redundancy." Many of these technologies are repeatedly yielding the same sequences of genes that are abundantly expressed in the tissues of interest, but are failing to identify genes expressed at low levels. It is the Company's belief that many of the genes that are expressed at low levels may be valuable targets for the design of novel drugs. Accordingly, the molecular biology technology used by Synaptic in its nontargeted genomics approach has been designed to facilitate the discovery of novel genes by significantly reducing the redundancy produced by many other genomics technologies. This approach to gene discovery yields for the Company both genes that code for GPCRs, which continue to be of primary interest to the Company, and genes that code for other proteins, which the Company believes may be valuable targets for drug discovery. The discoveries resulting from the Company's nontargeted genomics approach will, in general, be genes that code for proteins of unknown function and whose potential as valuable drug targets has not been established. Therefore, the Company does not believe that the types of collaborations in which it has engaged with pharmaceutical companies in the past, which collaborations have had as their focus genes whose value as drug targets is known or suspected, will be available to it with respect to such genes. Accordingly, rather than seeking to establish collaborations focused on its nontargeted gene discoveries, the Company will seek to license certain of these discoveries to pharmaceutical companies. Any research necessary for evaluating the licensed discoveries as potential drug targets and any drug discovery and development efforts focused on these discoveries would thus be within the province of the Company's licensees and would be conducted independently of the Company. In addition, the Company intends to retain certain of its nontargeted gene discoveries for internal evaluation and possible subsequent licensing. 2 To date, gene discoveries resulting from the Company's targeted genomics approach have led to collaborations between the Company and five pharmaceutical companies: Eli Lilly and Company ("Lilly"), Merck & Co., Inc. ("Merck"), Novartis Pharma AG ("Novartis"), Warner-Lambert Company ("Warner- Lambert") and Grunenthal GmbH ("Grunenthal"). The collaboration with Lilly and the collaboration with Merck have each yielded one compound that is currently in clinical development. As of the date of this Report, the collaborations with Lilly, Warner- Lambert and Grunenthal were ongoing. Although the Merck collaboration ended in February 1999, and the Novartis collaboration ended in August 1998, Merck and Novartis each continue to have licenses to certain of the Company's technology and patent rights, and the Company will be entitled to payments if certain milestones are achieved and royalties on sales of any drugs that may ultimately be developed through the use of the Company's technology. In addition to the licenses it granted in connection with its collaborative arrangements, the Company has licensed certain patent rights relating to its gene discoveries to Glaxo Group Limited ("Glaxo"). Certain discussions in this Report refer to various phases of preclinical testing and clinical trials. For a description of such phases, see the footnotes in the table entitled "Summary of Certain Drug Discovery Programs" set forth under "--Drug Discovery Programs: Focus on G Protein-Coupled Receptor Superfamily" below. 3 Business Strategy Synaptic's business strategy is to develop, together with its collaborative partners, a broad array of drugs based upon the Company's human receptor-targeted drug design technology, as well as to license certain of its technology to third parties which will use the technology in their drug development efforts. This strategy consists of four principal objectives. To Discover and Clone G Protein-Coupled Receptor Genes The first objective of the Company's business strategy is to aggressively discover and clone G protein- coupled receptor genes, and to aggressively seek patent protection for such discoveries. Historically, the Company has employed a targeted approach to gene discovery in which its molecular biology expertise is used to discover and clone receptor genes within families of GPCRs identified by the Company as being of particular interest based upon their potential role in certain physiological disorders. As of February 15, 1999, Synaptic had successfully cloned a number of receptor genes using this approach and had received United States patents relating to 13 of these receptor genes and related drug discovery systems. In addition, at that date several United States patent applications relating to the Company's receptor gene discoveries were pending, several corresponding patents had been issued in other countries and additional corresponding patent applications had been filed in other countries. The Company has more recently established a nontargeted approach to gene discovery based upon a proprietary molecular biology technology developed by Synaptic. The Company intends to seek patent protection for certain discoveries resulting from its nontargeted genomics approach. See "Patents, Proprietary Technology and Trade Secrets" below. To Discover and Design Potential Drugs with Human Receptor-Targeted Drug Design Technology The Company's second objective is to discover and design, or to have its collaborative partners and other licensees discover and design, potential drugs through the use of the Company's human receptor-targeted drug design technology. The Company and its collaborative partners and other licensees are using this technology to design, synthesize and optimize compounds for further development. The Company's two approaches to designing and synthesizing compounds include medicinal chemistry and combinatorial chemistry, each of which is supported by the Company's expertise in computer-assisted molecular modeling. With both approaches, the Company's chemists and pharmacologists use their knowledge of the structures of ligands and targeted receptor subtypes to design and synthesize initial chemical structures that are then optimized. To Leverage Resources and Generate Royalty-Based Revenues The Company's third objective is to leverage resources and generate royalty-based revenues through collaborations and licensing arrangements with pharmaceutical companies. Towards this objective, the Company has focused most of its scientific resources on the discovery and design phases of the drug development process. To date, the Company has entered into four royalty-based collaborations in which its collaborative partners have participated or participate in the early phases of the drug development process and have assumed principal responsibility for preclinical testing, clinical trials and commercialization. As part of these arrangements, the Company's collaborative partners are required to provide the Company with milestone payments upon the occurrence of certain events and royalties tied to net sales of any drugs resulting from the collaborations. In addition, certain of the Company's collaborative partners have provided the Company with 4 financial support for research. The Company has also licensed certain patent rights to Glaxo. Glaxo is conducting the research and development activities relating to the license independently of Synaptic and is required to pay Synaptic royalties tied to net sales of any drugs covered by the license. By pursuing the objective of leveraging resources and generating royalty-based revenues, Synaptic benefits from the expertise and resources of its partners and other licensees, while simultaneously maintaining relatively low capital requirements. While a principal objective of the Company's business strategy continues to be to leverage resources and generate royalty-based revenues, the Company believes that the terms attendant to future collaborations and arrangements with pharmaceutical companies will be different in certain material respects from the terms of its former and ongoing collaborations. The Company's first three collaborations, those with Lilly, Merck and Novartis, focused on receptor families with respect to which there was, at the time the Company entered into such collaborations, a considerable amount of pharmacological data suggesting that the members of such families were involved in a variety of physiological disorders and that these members were, as a consequence, potentially valuable as drug targets. Each of Lilly, Merck and Novartis provided the Company with research funding from the inception of its collaboration with the Company. The Company's fourth collaboration, the one with Warner-Lambert, is focused on a family of receptors with respect to which the pharmacological data suggesting a role for members of this family in physiological disorders was, at the outset of the collaboration, considerably more speculative. As a result, the Company's agreement with Warner-Lambert provides for a collaboration conducted in two stages. In the first stage, the companies engage in a joint research program designed to identify the role of members of the targeted receptor family in a variety of disorders. During this stage, the companies fund their own research efforts. It is not until the second stage, which will occur only if a certain amount of scientific progress is made during the first stage, that Warner-Lambert may become obligated to provide research funding to Synaptic. The Company believes that many, if not most, of the receptor genes discovered as a result of its nontargeted genomics approach will be members of receptor families about which there is presently little, if any, biological information suggesting a role for such receptors in specific physiological disorders. As a consequence, the Company does not believe that it will be able to exploit most of these gene discoveries in the near future through collaborations in which it receives full financial support for its research efforts. Accordingly, the Company is seeking to license certain of the results of its nontargeted approach to gene discovery to pharmaceutical companies. These licensees would then be responsible for generating the biological information necessary for evaluating the licensed discoveries as potential drug targets and for any drug discovery and development efforts focused on these discoveries. In addition, the Company intends to retain certain of its nontargeted gene discoveries for internal evaluation and possible subsequent licensing. To Retain Ownership of Certain Products The Company's fourth objective is to retain ownership rights to certain products developed through the use of its technology. The Company is seeking to achieve this objective in a variety of manners, including the exploration of and entry into collaborations with pharmaceutical companies in which the Company increases its participation in and funding of drug development activities conducted as part of such collaborations. Through such arrangements, the Company believes that it may be able to gain access to additional chemistry, in vivo pharmacology, preclinical and clinical expertise, as well as to retain a greater portion of the downstream financial benefits associated with the commercialization of any products resulting from such arrangements. In January 1998, the Company entered into a collaboration with Grunenthal in which the Company participates in and may fund a portion of the drug development activities conducted as part of the collaboration. See "Grunenthal Agreement" under "Collaborative and Licensing Arrangements" below. 5 Background The Role of Receptors in Controlling Cellular Function The human body coordinates its activities through communication among its great variety of cells and tissues. One of the principal means of communication occurs through chemical signaling, when one cell releases a chemical messenger, called a "ligand," which ultimately binds to and activates a protein molecule, called a "receptor," on the surface of another cell. The activation of the receptor on the surface of the receiving cell triggers a cascade of events in which the message received by the receptor is, in turn, transmitted to the interior of the cell, thereby causing some aspect of the behavior of the receiving cell to change. The nature of this change depends upon a number of factors, including the specific ligand and receptor involved in the communication. Many different kinds of receptors involved in cellular communication exist in the human body. Receptors are first classified into categories, called "superfamilies," based upon similarities in their biochemical and structural properties. There are four principal superfamilies of receptors: the G protein- coupled receptor superfamily, the receptor protein-tyrosine kinase superfamily, the ligand-gated ion channel superfamily and the intracellular receptor superfamily. The receptors included within each superfamily are then subcategorized into groups, called "families," based upon the specific ligands with which they interact. Examples of receptor families within the GPCR superfamily are the serotonin, adrenergic, neuropeptide Y ("NPY") and galanin families of receptors. Each member of each family is called a "receptor subtype." Historically, it was believed that each family of receptors had only one or two members. Scientists have discovered, however, that many families of receptors have more than two receptor subtypes. The number of receptor subtypes within each family of receptors varies, with some families, such as the serotonin family, comprising at least 14 known receptor subtypes, and other families, such as the alpha adrenergic family, comprising at least six known receptor subtypes. In general, each receptor subtype is distributed differently throughout the body and often controls physiological functions that are different from those controlled by other receptor subtypes within the same family. By interacting with all of its receptor subtypes that are located throughout the body, a single ligand thus plays a role in numerous physiological functions. For example, the ligand for adrenergic receptor subtypes, noradrenaline (also known as norepinephrine), interacts with at least nine different receptor subtypes (six alpha and three beta receptor subtypes), one of which has been shown to contract the muscles surrounding the prostate and another of which has been shown to regulate blood pressure. In some cases, the same receptor subtype is found in different tissues of the human body. A compound designed to bind selectively to a receptor subtype for treating a disorder in one tissue could, therefore, potentially cause an adverse side effect in other tissues that contain the same receptor subtype. The tissue affected by the disorder may, however, have certain other characteristics that can be exploited to guide receptor subtype-targeted compounds to that tissue. Receptor-Based Drug Therapy--The Traditional Approach Many illnesses arise because of abnormalities in intercellular communication, and the concept of receptor-based drug therapy was developed to address this problem. The goal of receptor-based drug therapy is to develop drugs that will interact with the receptor believed to be associated with the targeted abnormality, thereby inhibiting or enhancing the cascade of events that is mediated by the receptor. A number of receptor- based drugs have been developed and are currently being marketed. In general, however, these drugs do not 6 differentiate among receptor subtypes and, while they may indeed interact with the targeted receptor subtypes, thereby having some therapeutic effect, they may also interact with other receptor subtypes within the same family as the targeted receptor subtypes. These other receptor subtypes may be associated with other physiological functions, and interactions of these drugs with them often result in undesirable side effects. In addition, many of these drugs have limited therapeutic utility because they must be used in suboptimal doses in order to minimize these side effects. The reason that many of these currently available drugs do not differentiate among receptor subtypes stems from the fact that they were discovered through traditional drug discovery methods. The traditional approach to drug discovery involves the screening of compounds against animal tissues containing multiple receptor subtypes to determine their relevant biological activity. This approach is limited in its ability to yield optimally effective drugs because of inherent limitations in the use of animal tissues to test drugs intended for humans. First, by using animal tissues containing multiple receptor subtypes, it is usually difficult and often impossible both to measure with precision the effect of a compound on the receptor subtype that is the target of a drug discovery effort and to determine whether the compound is binding to other receptor subtypes in the tissue that are not the intended drug target. Second, due to differences in the receptor systems of various species of animals as compared to humans, there are often significant differences between a drug's activity in animals and the same drug's activity in humans. In fact, there are several examples of drug development candidate failures in human clinical trials that were due to differences in the properties of such candidates in humans as compared to their properties in the animal tissues that were initially used for drug discovery. As a consequence, compounds initially tested against animal tissues often do not have the desired effects when they are ultimately administered to humans in clinical trials. Synaptic's Human Receptor-Targeted Drug Design Technology Synaptic believes that its human receptor-targeted drug design technology can overcome the limitations of the traditional approach to drug discovery. This technology involves three steps: (i) the discovery and cloning of the human genes that code for receptor subtypes; (ii) the use of each of these genes to create a cell line that can be used to measure, or assay, the pharmaceutical properties of compounds that bind to the targeted receptor subtype and that are, therefore, candidates for drug development; and (iii) the design, synthesis and optimization of compounds that are highly selective for the targeted human receptor subtype. In the first step, the Company's molecular biologists employ genetic engineering techniques to clone the gene that codes for the receptor subtype of interest. In the second step, the Company's cell biologists place the gene into a recipient cell which then expresses the human receptor subtype on its surface. This recipient cell, which expresses a single population of the targeted human receptor subtype and is devoid of all other related receptor subtypes, is then propagated by the Company's cell biologists, resulting in the establishment of a cell line. Finally, this cell line is used as a drug discovery system by the Company's pharmacologists to evaluate compounds synthesized by the Company's or its collaborative partners' chemists. Since each of these cell lines expresses a single receptor subtype, it is possible to design compounds with high affinity for the ultimate target of a drug discovery program--the appropriate human receptor subtype--and low affinity for those subtypes suspected of being associated with side effects. The Company's technology makes it possible not only to clone receptor subtypes previously believed or known to exist, but also to discover and clone receptor subtypes which had previously been undetectable in animal tissues because they were present in concentrations too low to detect using traditional pharmacological techniques. Many of these newly discovered receptor subtypes may provide opportunities for the design of novel drugs. In addition, the Company believes that its ability to access and to use individual 7 cloned human receptor subtypes in its drug design efforts will yield safer and more effective drugs than those currently available. Synaptic further believes that its technology may make the drug development process more predictive and cost-effective than the traditional approach because the Company and its collaborative partners and other licensees can eliminate or redesign nonsubtype-selective compounds and compounds that react poorly with human targets at an early stage of the process rather than at the costly later stages of preclinical testing and clinical trials. Finally, drugs developed through the use of the Company's human receptor-targeted drug design technology will be small molecule drugs which offer possibilities of avoiding specialized delivery approaches and which may be delivered orally. The Company also believes that its success in the discovery of receptor subtypes will enable it to further refine the understanding of many disease processes. There is increasing evidence to suggest that some disorders may actually involve the malfunctioning of any one of a variety of receptor subtypes included within different receptor families. For example, in the case of obesity, there are pharmacological data indicating that NPY, galanin and serotonin receptor subtypes are involved in controlling food intake. As a result, more than one drug could be developed to treat obesity, but such drugs would work through different biological mechanisms by exerting their therapeutic effects by interacting with receptor subtypes belonging to different families. The Company believes that its human receptor-targeted drug design technology may make it possible to discover two or more separate drugs that could benefit distinct patient populations whose symptoms (for example, obesity), while identical, stem from different physiological disorders and therefore require different treatments. Consequently, the Company and its licensees have initiated several programs in which different receptor subtypes are being used as drug targets for the same therapeutic application. To date, the Company has not completed development of any drugs and does not expect that drugs developed by it or its collaborative partners or other licensees will be commercially available for a number of years. Receptor Gene Discovery and Cloning The Company's principal receptor cloning projects to date have focused on four families of receptors within the G protein-coupled receptor superfamily: the serotonin, alpha adrenergic, NPY and galanin receptor families. Additional projects directed toward other receptor families are ongoing. The Company employs a number of approaches to discover and clone genes that code for GPCRs. Its principal approach, until recently, has been a targeted genomics approach. This approach involves two steps. First, the Company identifies families of receptors within the GPCR superfamily that are, based on available pharmacological information relating to these families suggesting a potential role in physiological disorders, of particular interest to the Company. The Company then devises strategies to enable it to discover and clone receptor genes within the targeted families. After the Company discovers and clones two or more members of a targeted receptor family, its strategy is to seek a collaborative partner with which it can attempt to design and develop drugs that act at one or more of the cloned receptors. While the Company has been successful employing this targeted genomics approach, as evidenced by collaborations with pharmaceutical companies focused on four different families of GPCRs, it has begun to shift the emphasis in its gene discovery efforts from the targeted genomics approach to a nontargeted genomics approach. This shift stems from certain developments in the field of gene discovery over the past several years. First, due in large part to the successful targeted cloning efforts of the Company and other biotechnology companies, pharmaceutical companies and academic institutions, many of the genes that code for members 8 of GPCR families for which there exists a body of pharmacological information suggesting a role in physiological disorders have now been cloned. As a result, most of the genes that remain to be cloned are those that code for members of GPCR families for which there may be little, if any, pharmacological information, and those that code for receptors whose families have not yet been identified and for which there is a lack of biological knowledge. Second, there has been a tremendous increase in interest over the past several years in determining the sequence of the entire human genome. This interest has spurred significant competition and technological advances in the field of genomics. Many of these technological advances involve a "nontargeted" approach to gene discovery in that they facilitate the identification of genes from large collections of DNA sequence information without, in the first instance, requiring the design and implementation of strategies aimed at cloning the members of specific receptor families. While the nontargeted approaches to gene discovery often yield genes about which there is little, if any, existing biological knowledge, they have greatly accelerated the rate at which novel genes are being discovered. Given these developments and the fact that there is a finite number of genes in the human genome, in an effort to remain competitive in the field of gene discovery, the Company has begun to shift the emphasis in its gene discovery efforts from a targeted genomics approach to a nontargeted genomics approach. The Company's nontargeted genomics approach involves the integration of certain proprietary molecular biology technology of the Company with automated gene sequencing technologies and bioinformatics. In formulating this approach, the Company was intent upon addressing a problem commonly experienced by many in industry and in academia who are employing nontargeted genomics technologies to identify novel genes. The problem is one of "redundancy." Many of these technologies are repeatedly yielding the same sequences of genes that are abundantly expressed in the tissues of interest, but are failing to identify genes expressed at low levels. It is the Company's belief that many of the genes that are expressed at low levels may be valuable targets for the design of novel drugs. Accordingly, the molecular biology technology used by Synaptic in its nontargeted genomics approach has been designed to facilitate the discovery of novel genes by significantly reducing the redundancy produced by many other genomics technologies. This approach to gene discovery yields for the Company both genes that code for GPCRs, which continue to be of primary interest to the Company, and genes that code for other proteins, which the Company believes may be valuable targets for drug discovery. The Company's collection of cloned genes that code for receptors in the GPCR superfamily comprises human genes, as well as genes from various other mammalian species that correspond to the human genes. These receptor genes include genes that were discovered by the Company and genes that were discovered by others about which information is publicly available. In general, the Company seeks to patent those cloned receptor genes and those drug discovery systems that it has discovered or invented. As of February 15, 1999, the Company had received United States patents relating to 13 receptor genes and related drug discovery systems. In addition, at that date, several United States patent applications relating to the Company's receptor gene discoveries were pending, several corresponding patents had been issued in other countries and additional corresponding patent applications had been filed in other countries. There can be no assurance that the Company will be awarded patents in respect of any of its pending patent applications or in respect of patent applications it may file in the future. Drug Discovery Systems Once the Company clones the gene for a receptor subtype, it places the gene into a recipient cell which then expresses the receptor subtype on its surface. This cell, which expresses a single population of the targeted human receptor subtype, is then propagated in the laboratory by the Company's cell biologists, resulting in the 9 establishment of a cell line. This cell line, which constitutes a drug discovery system, is used in two different types of assays: binding assays and functional assays. In Synaptic's binding assays, the Company's pharmacologists measure the affinity of a compound for both the receptor subtype that is the target of a particular drug discovery program and the other receptor subtypes that could be associated with side effects. These measurements help to predict the potency of a compound, as well as the degree of selectivity that the compound has for the targeted receptor subtype over other receptor subtypes. The data obtained from binding assays enable the chemists to design compounds toward or away from one or more of the relevant subtypes, as appropriate, for optimal therapeutic efficacy. In Synaptic's functional assays, the Company's pharmacologists determine the nature of the response of the receptor subtype to the compound. Data from the functional assays show whether the compound is acting to inhibit or enhance the activity of the receptor subtype. By enabling the Company's pharmacologists to evaluate compounds rapidly at their ultimate human receptor subtype targets, the Company's proprietary drug discovery systems serve as tools that the Company's and its partners' or other licensees' chemists can use to design drugs that will be more effective and have fewer or substantially less severe side effects than existing drugs. Although the Company believes that its drug discovery systems accurately measure the properties of a compound's interaction with the human receptor subtypes, there are many additional factors, such as the drug's stability in the body or its ability to be administered orally, that impact the ultimate pharmaceutical success of a compound. In addition to using its binding and functional assays for the design of drugs that act at targeted receptor subtypes, these assays are also used to identify ligands for receptor subtypes resulting from the Company's nontargeted genomics program. Chemistry and Molecular Pharmacology The Company employs two approaches to designing and synthesizing receptor subtype-selective compounds, medicinal chemistry and combinatorial chemistry, both of which are supported by the Company's expertise in computer-assisted molecular modeling. With both approaches, the Company's chemists and pharmacologists use their knowledge of the structures of ligands and the targeted receptor subtypes to design and synthesize initial chemical structures that will have activity at these subtypes. Combinatorial chemistry involves automated synthesis of a variety of novel compounds by assembling them using different combinations of chemical building blocks. The use of combinatorial chemistry greatly accelerates the process of generating compounds. The resulting arrays of compounds are called libraries and are used to screen for compounds ("lead compounds") that demonstrate a sufficient level of activity at receptors of interest. The Company is using combinatorial chemistry to synthesize "focused" libraries of compounds anticipated to be highly biased toward the Company's drug discovery targets. The Company's scientists have successfully generated lead compounds through the use of these combinatorial chemistry techniques. Once lead compounds are identified, whether through the use of combinatorial chemistry or traditional medicinal chemistry, a variety of analogues are prepared to facilitate an understanding of the relationship between chemical structure and biological activity. These studies help define structure activity relationships which can then be used to design drug candidates with improved potency, selectivity and pharmacokinetic properties. Combinatorial chemistry is used to rapidly generate a variety of structures for lead optimization. Traditional medicinal chemistry, which involves the synthesis of compounds one at a time, is also used for further refinement and to generate compounds not accessible by automated techniques. 10 Drug Discovery Programs: Focus on G Protein-Coupled Receptor Superfamily The superfamily of receptors to which the Company has chosen to apply its human receptor-targeted drug design technology is the G protein-coupled receptor superfamily, so called because the cascade of events that ensues within the receiving cell following the occurrence of the ligand-receptor interaction is mediated by a class of proteins called "GTP-binding regulatory proteins," or "G proteins," found within the cell. The Company chose to focus on the GPCR superfamily because it believes that this superfamily provides the optimum opportunity for the exploitation of its human receptor-targeted drug design technology. First, it is known that G protein-coupled receptors play a major role in intercellular communication and that drugs that block ("antagonists") or enhance ("agonists") their activity have therapeutic utility. Examples of such drugs include: Zantac(R), a histamine receptor antagonist for the treatment of ulcers; Claritin(R), a histamine receptor antagonist for the treatment of allergy; Propulsid(R), a serotonin receptor agonist for the treatment of gastric motility disorder; Imitrex(R), a serotonin receptor agonist for the treatment of migraine headache; and Hytrin(R), an adrenergic receptor antagonist for the treatment of hypertension and urinary retention resulting from benign prostatic hyperplasia ("BPH"). Second, there is a large body of knowledge about some of the basic structural elements of drugs that interact with these receptors that has accumulated over the years from which the Company and its collaborative partners and licensees can draw in beginning their drug discovery programs. Third, the GPCR superfamily is extremely large and, based on several estimates, exceeds several thousand receptor subtypes belonging to more than 40 known families and an unknown number of additional families the ligands of which have not yet been identified. The Company's human receptor-targeted drug design technology is being utilized in a variety of different drug discovery programs: by the Company independently; by the Company in joint research programs with its collaborative partners; by the Company's former collaborative partners pursuant to licenses from the Company; and by the Company's other licensees. These drug discovery programs are focused principally on human serotonin, alpha adrenergic, NPY and galanin receptor subtypes. The serotonin programs are being conducted by the Company in collaboration with Lilly. One of the alpha adrenergic programs is being conducted by the Company's licensee and former collaborative partner Merck and another of the alpha adrenergic programs is being conducted by the Company in collaboration with Grunenthal. In addition, Glaxo has a license to use certain of the Company's alpha adrenergic technology in its drug discovery efforts. One of the NPY programs is being conducted by the Company's licensee and former collaborative partner Novartis and another of the NPY programs is being conducted by the Company independently. The galanin program is being conducted by the Company in collaboration with Warner-Lambert. Total operating expenses incurred by the Company for each of the fiscal years 1998, 1997 and 1996 were $19,576,000, $17,853,000 and $14,319,000, respectively, of which approximately $7,182,000, $9,785,000 and $6,943,000, respectively, was funded by the Company's collaborative partners during such years. In 1997, the Company increased its internal research and development spending. The Company again increased internal research and development spending during 1998, in part as a result of the expiration of the Novartis collaboration and the termination of the associated research funding provided by Novartis. The Company intends to further increase its internal research and development spending during 1999. The anticipated increase will be due in part to the July 31, 1999 expiration of the Lilly collaboration and the termination of the associated research funding provided by Lilly and the February 28, 1999 expiration of the Merck collaboration and the termination of the associated research funding provided by Merck. Certain of the drug discovery programs in which the Company's human receptor-targeted drug design technology is being utilized are summarized in the following table: 11 Summary of Certain Drug Discovery Programs - ------------------------------------------------------------------------------------------------------------ Collaborative Program(1) Receptor(s) Primary Indication(s) Status(2) Partner Licensee - ------------------------------------------------------------------------------------------------------------ Serotonin 1F Acute Migraine Early Preclinical(3) Eli Lilly __(4) Depression Phase I Clinical Eli Lilly __(4)(5) Depression Late Preclinical Eli Lilly __(4)(5) Depression Late Preclinical Eli Lilly 1A Smoking Cessation Late Preclinical(6) Eli Lilly 2C Obesity Early Preclinical Eli Lilly Alpha Adrenergic 1a Benign Prostatic Hyperplasia Phase II Clinical Merck 2a, 2b or 2c(4) Pain Leads Identified Grunenthal 1a, 1b or 1d (7) (7) Glaxo Neuropeptide Y Y5 Obesity Early Preclinical Novartis Y2 Pain Discovery (8) Galanin 1, 2, and 3 Obesity, Diabetes, Leads Identified Warner- Alzheimer's Disease, Lambert Depression and Pain
(1) The Company's technology is being utilized by certain of the Company's collaborative partners and/or other licensees in drug discovery programs in addition to those programs referenced in the above table. In general, the drug discovery programs that are specifically referenced in the above table are at more advanced stages of development than those that are not specifically referenced in the table. (2) "Discovery" refers to the stage at which chemists are attempting to identify receptor subtype-selective compounds through the use of the Company's drug discovery systems. "Leads Identified" refers to the stage at which receptor subtype-selective compounds have been identified through the use of the Company's drug discovery systems. "Early Preclinical" refers to the stage at which one or more leads have been identified and are being tested in in vitro or in vivo model systems for one or more indications. In addition, at this stage lead compounds may have been shown to be active in animal models for one or more indications and preliminary toxicology and pharmacokinetics studies may also have been concluded. "Late Preclinical" refers to the stage preceding the Phase I Clinical stage at which a drug candidate has been selected, scale-up of such candidate is underway or completed, and toxicology and pharmacokinetics studies are planned or underway or have been concluded. "Phase I Clinical" refers to the stage preceding the Phase II Clinical stage at which a drug candidate is being or has been administered to a small group of healthy human subjects for the purpose of testing for safety (adverse effects), dose tolerance, absorption, bio-distribution, metabolism, excretion and clinical pharmacology. "Phase II Clinical" refers to the stage following completion of the Phase I Clinical stage at which (i) a drug candidate is being or has been administered to a small sample of the actual intended patient population to seek to assess the efficacy of the drug candidate for the specific targeted indication, to determine dose tolerance and the optimal dose range and to gather additional information relating to safety and potential adverse effects or (ii) a compound which is not necessarily a drug candidate due to certain of its pharmacokinetic properties nevertheless is being or has been administered to a small sample of the actual intended patient population to seek to assess the efficacy of the compound for the specific targeted therapeutic indication. In the "proof of concept" case described in clause (ii), the objective is to assess, prior to the expenditure of additional resources, the correctness of the hypothesis that a certain 12 receptor subtype can be manipulated in a therapeutically beneficial manner for the treatment of the disorder of interest. "Phase III Clinical" refers to the stage at which a drug candidate is being or has been administered to a broader sample of the general patient population to establish further clinical safety and efficacy of the drug candidate in order to determine its overall risk-benefit ratio and to provide an adequate basis for all package labeling. (3) In August 1998, the Company and Lilly announced that LY334370, a selective serotonin 1F receptor agonist (SSOFRA), would advance to the Phase III Clinical stage. The Phase III Clinical trials were scheduled to commence in March 1999. However, in March, Lilly informed the Company that it was discontinuing commercial development of LY334370 as a result of its recent review of data from an animal toxicology study. Lilly continues to maintain that all data to date continue to support the hypothesis that SSOFRAs represent a new class of compounds that may effectively treat migraine pain via neuronal mechanisms without the cardiovascular side effects associated with products currently on the market, and has informed the Company that it will continue its efforts to develop alternative SSOFRAs with an improved safety profile. (4) The specific receptor subtype that is the focus of this program is confidential to the Company and its collaborative partner or other licensee. (5) The serotonin receptor subtype which is the target of this program is different from the serotonin receptor subtype which is the target of the depression program that is in the Phase I Clinical stage and is different from the serotonin receptor subtype which is the target of the other depression program that is in the Late Preclinical stage. Accordingly, the compound which is the focus of this depression program is not a back-up to the compound which is the focus of the depression program that is in the Phase I Clinical stage or which is the focus of the other depression program that is in the Late Preclinical stage. (6) During the third quarter of 1998, Lilly informed the Company that it would not continue to develop this compound but would instead seek a development partner or licensee for the compound that is the focus of this program. (7) The therapeutic indications that are the focus of Glaxo's program and the status of such program are not known by the Company. (8) While Synaptic is currently conducting this program independently, Synaptic has agreed to reserve the Y2 receptor as a potential target for drugs for the alleviation of pain exclusively for its collaboration with Grunenthal. 13 Serotonin Programs Serotonin is one of the major neurotransmitters, a type of ligand, of the body. It affects mood, sleep rhythms, sexual functions, appetite, temperature control, gastro-intestinal movement and the cardiovascular, pulmonary and genito-urinary systems. Drugs that inhibit or enhance the actions of serotonin have proven to be effective in the treatment of an array of disorders, such as migraine headache, depression and anxiety. However, many of the serotonergic drugs currently available were designed without the use of cloned serotonin receptor subtype genes and some of these drugs have unacceptable side effect profiles. It is generally believed that the poor side effect profiles stem from the interaction of these drugs with multiple serotonin receptor subtypes. The serotonin family is extremely large, comprising at least 14 receptor subtypes. While each of these receptor subtypes may be implicated in a physiological function distinct from the other subtypes, all of the receptor subtypes respond to the neurotransmitter serotonin--and may be responding to nonsubtype- selective drugs. As a consequence, a nonsubtype-selective drug intended to exert its effects on one physiological function may in fact have the unintended consequence of exerting its effects on other physiological functions, thereby causing the undesirable side effects. Of the 14 serotonin receptor subtype genes that have been discovered and cloned, the Company believes that it is responsible for the discovery and cloning of seven. The Company has been issued United States patents covering six of these receptor genes and related drug discovery systems. A patent application covering the seventh of these genes and the related drug discovery system and additional patent applications relating to all of these genes have been filed in the United States. In addition, several corresponding patent applications have been filed in other countries. The Company has found, through the use of these cloned receptor genes and related drug discovery systems, that the serotonin system is significantly more complex than had previously been understood and believes that the use of its technology to design serotonin receptor subtype-selective drugs will result in new serotonergic drugs with improved efficacy and side effect profiles, as well as serotonergic drugs for new therapeutic applications. There can be no assurance, however, that the Company will be successful in designing a serotonin receptor subtype-selective drug that will achieve the foregoing desired effect. Pursuant to an exclusive license from the Company, Lilly has the right to use all but two of the Company's existing serotonin drug discovery systems for the development and commercialization of serotonergic drugs. Lilly is currently conducting drug discovery programs focused on a number of serotonin receptor subtypes and therapeutic applications. To date, receptor subtype-selective compounds have been identified for a number of serotonin programs. Certain of the serotonin programs are described below. Migraine Headache Migraine headaches are periodic throbbing headaches often accompanied by nausea and vomiting. During the past six to seven years, several new drugs have become available for the treatment of migraine. These drugs include Imitrex(R), Zomig(R), Amerge(R) and Maxalt(R). All of these agents are agonists at certain serotonin receptor subtypes. Although effective in most patients, these drugs have been associated with the tightening of the coronary blood vessels, or vasoconstriction. As a result, these drugs are contraindicated both in patients with ischemic heart disease and in patients with symptoms of ischemic heart disease. In addition, because of the cardiovascular risks, it is recommended that, in the case of any patient in whom unrecognized coronary disease is comparatively likely, the first dose of these drugs be administered in a physician's office or a similarly medically staffed and equipped facility. As part of their collaboration, the Company and Lilly had engaged in a drug discovery program to identify and develop anti-migraine compounds with increased efficacy and reduced side effects. Through the 14 use of the Company's serotonin receptor subtype drug discovery systems, Synaptic scientists discovered that Imitrex(R) reacted strongly with three serotonin receptor subtypes, serotonin 1B and 1D, both of which were long thought to be the targets for anti-migraine effects, as well as serotonin 1F. Zomig(R) and Amerge(R) also react strongly with serotonin 1B, 1D and 1F receptor subtypes. Maxalt(R) reacts strongly with serotonin 1B and 1D receptor subtypes, but somewhat less potently with the serotonin 1F receptor subtype. Synaptic scientists proposed that agents which interact with the serotonin 1F receptor subtype would be effective in the treatment of migraine. Together with scientists at Lilly, Synaptic scientists identified compounds that are selective agonists of the serotonin 1F receptor subtype. These compounds were tested in animal models at Lilly and shown to be orally active and to have a long duration of action. The compounds were also shown to be potent in an animal model that is thought by many scientists in the field to be predictive of therapeutic utility for the treatment of migraine. Furthermore, these compounds were inactive in vasoconstriction assays at Lilly, thereby suggesting that the contraindications relating to cardiovascular problems included in the labeling for Imitrex(R), Zomig(R), Amerge(R) and Maxalt(R) would not be applicable to a 1F-selective agonist for the treatment of migraine. One of these selective serotonin 1F receptor agonists (SSOFRAs) identified as part of the collaboration, LY334370, was selected by Lilly for clinical trials. In 1998, Lilly completed three Phase II clinical trials with LY334370 and informed the Company that the data from these trials indicated that LY334370 is efficacious in the treatment of migraine without the cardiovascular side effects associated with other migraine treatments currently on the market. In August 1998, the Company and Lilly announced that this compound would advance to the Phase III clinical stage. The Phase III clinical trials were scheduled to commence in March 1999. However, in March, Lilly informed the Company that it was discontinuing commercial development of LY334370 as a result of its recent review of data from an animal toxicology study. Lilly continues to maintain that all data to date continue to support the hypothesis that SSOFRAs represent a new class of compounds that may effectively treat migraine pain via neuronal mechanisms without the cardiovascular side effects associated with products currently on the market, and has informed the Company that it will continue its efforts to develop alternative SSOFRAs with an improved safety profile. Due to the discontinuation of commercial development of LY334370, the program is in the early preclinical stage. Synaptic has been issued a United States patent covering the use of genetically engineered cells expressing the human serotonin 1F receptor subtype to identify compounds that bind to the receptor subtype, as well as a United States patent covering the gene encoding the receptor subtype. In addition, Lilly has been issued a United States patent covering the use of 1F agonists exhibiting minimal vasoconstrictive effects for the treatment of migraine. Smoking Cessation There are more than 150 million smokers in major market countries, more than 30 million of whom attempt each year to quit smoking. Chronic use of tobacco is causally linked to a variety of serious diseases, including coronary heart disease, cancer and emphysema. Nicotine patches, gum and nasal sprays have been used as smoking cessation aids, but have met with limited success. Recently, Wellbutrin(R), which has been available for a number of years as an antidepressant, was approved by the United States Food and Drug Administration (the "FDA") for marketing in a sustained release formulation (Zyban(R)) for use as an aid to smoking cessation. Clinical studies show that Zyban(R), either alone or in combination with transdermal nicotine, increases the rate of smoking cessation. However, the long-term response rate to Zyban(R) as an aid in smoking cessation is low (about 20%). In addition, the active ingredient in Zyban(R) has been reported to cause seizures in about 0.4% of patients, along with dizziness and insomnia. 15 As part of a program to identify and develop serotonin 1A antagonists which ameliorate the withdrawal symptoms frequently suffered in connection with smoking cessation, the Company and Lilly designed novel compounds which are highly selective for and are potent antagonists of the serotonin 1A receptor subtype. These compounds have been shown to be effective in an animal model of nicotine withdrawal and may lead to drugs which are more effective as smoking cessation aids than those currently available. Lilly has informed Synaptic that it intends to seek a development partner or licensee for the compound that is the focus of this program. Obesity Drug treatment for obesity has traditionally been used to reduce appetite as a short-term adjunct to diet and exercise. Most drugs approved for the treatment of obesity act centrally through catecholaminergic and/or serotonergic pathways. Earlier compounds, such as Benzedrine(R) and Dexedrine(R), were plagued by problems of tolerance, abuse and cardiovascular side effects. More recently, Pondimin(R) and Redux(R), which release the neurotransmitter serotonin, were widely used, either alone or in combination with phentermine (Phen-Fen). However, both of these drugs have been withdrawn from the market pursuant to a request by the FDA because they appear to cause heart valve defects and pulmonary hypertension. The mechanism by which Pondimin(R) and Redux(R) cause this cardiac and pulmonary toxicity is unknown, but similar toxicity is not seen with other serotonergic drugs, such as Prozac(R) and Zoloft(R), which are widely used as antidepressants. In 1997, Meridia(R) was approved by the FDA for the management of obesity, including weight loss and maintenance of weight loss. This compound, which acts by inhibiting the uptake of the neurotransmitters norepinephrine (noradrenaline) and dopamine, as well as the neurotransmitter serotonin, has been shown to produce long-term (12-month) weight loss. However, Meridia(R) substantially increases blood pressure in some patients. Accordingly, regular monitoring of blood pressure is required in patients receiving Meridia(R). While it has been proven that serotonergic transmission can regulate food intake, it has not been clear which of the serotonin receptor subtypes is responsible for this action. Studies involving genetically altered mice which lack serotonin 2C receptors indicate that this serotonin receptor subtype may play a role. These mice are normal at birth but become obese as they get older, and their obesity is associated with increases in food intake levels and insulin resistance. A possible correlation in humans is provided by the observation that patients treated with drugs such as clozapine, imipramine, and amitriptyline, all of which have, in addition to their principal actions, substantial blockade of the serotonin 2C receptors, are associated with weight gain. As part of their collaboration, the Company and Lilly are engaged in a drug discovery program to identify and develop compounds which are selective for the serotonin 2C receptor over other serotonin receptor subtypes that may be responsible for undesirable side effects. The Company's serotonin receptor subtype drug discovery systems have made it possible to discover subtype-selective compounds that may be effective treatments for obesity through this serotonin 2C mechanism. Subtype-selective compounds which suppress food intake in animal models were identified by Lilly and Synaptic and Lilly has confirmed that it is continuing to evaluate these compounds for their suitability as drug candidates. Depression A number of different pharmacologic strategies have been developed to treat depression. The early drugs shown to be effective in the treatment of depression, such as the tricyclic antidepressants, lithium and the monoamine oxidase inhibitors, have side effects associated with their use that limit their effectiveness. Selective serotonin reuptake inhibitors (SSRIs), such as Prozac(R), Zoloft(R), Paxil(R) and Celexa(R), have been 16 shown to be highly effective in the treatment of many forms of depression. A number of SSRI compounds are now approved for marketing, and these drugs have captured a significant market share. However, all of these currently available drugs have deleterious side effects in many patients which may limit their use. In addition, these drugs have a lag time before their beneficial clinical effects can be seen. This lag time can be a serious problem, especially in the depressed suicidal patient. Furthermore, there are a significant number of patients who do not adequately respond to any of the currently available drug therapies. As part of their collaboration, the Company and Lilly have engaged in several distinct programs focused on the identification and development of serotonergic drugs for the treatment of depression. The programs are distinct in that they target different serotonin receptor subtypes. In each of these programs, scientists at Synaptic and Lilly identified novel serotonin receptor subtype-selective compounds that may have rapid onset of efficacy in the treatment of depression and that may also have better side effect profiles than drugs currently available. Lilly has confirmed that it is conducting Phase I clinical trials in Europe with a compound identified as part of one of these programs, and has selected two other compounds identified as part of the other depression programs for possible development. These other compounds are undergoing late preclinical testing. Other Serotonin Programs The Company has cloned additional serotonin receptor subtypes that are either not currently being pursued by Lilly as drug targets or are being so pursued but are focused on therapeutic applications which are currently confidential to the Company and Lilly. In addition, there is evidence to suggest that one or more serotonin receptor subtypes that are the targets of the drug discovery programs currently being conducted by Lilly may be relevant as targets for other therapeutic applications. Lilly may establish additional drug discovery programs focused on certain of these other serotonin receptor subtypes or therapeutic applications in the future. There can be no assurance, however, that Lilly will establish additional drug discovery programs. Subject to certain limited exceptions, Lilly will be obligated to pay the Company milestones and royalties in respect of sales of any drugs developed by it through the use of the Company's serotonin technology as part of these existing or future drug discovery programs. Alpha Adrenergic Programs Alpha adrenergic receptors are activated by the neurotransmitter norepinephrine (noradrenaline). The alpha adrenergic receptors serve a critical control function in regulating involuntary physiological functions, such as blood pressure, heart rate and smooth muscle tone, and thus may serve as important tools in the management of many disorders. Until 1982, only two alpha adrenergic receptors (alpha-1 and alpha-2) were believed to exist. Since then, scientists have discovered that the alpha adrenergic receptor family contains at least six subtypes (alpha- 1a, 1b and 1d and alpha-2a, 2b and 2c). The Company believes it was responsible for the discovery of the genes that code for the human alpha-1a, -1b, -1d and -2b receptors and has received United States patents relating to all four of these genes and related drug discovery systems. Additional patent applications relating to certain of these genes have been filed both in the United States and in other countries. There are a number of adrenergic drugs on the market today which are effective in the treatment of a variety of disorders. However, most of these drugs were discovered in the 1970's prior to the discovery of the six alpha adrenergic subtypes and are not selective for any one of these receptor subtypes. The Company believes that many of the side effects associated with these drugs may be traced to a lack of selectivity for the 17 appropriate receptor subtypes. The Company's alpha adrenergic drug discovery systems are being used in multiple drug discovery programs. There can be no assurance that the Company or any collaborative partner or other licensee will be successful in designing an alpha adrenergic receptor subtype-selective drug with improved efficacy and an improved side effect profile. Pursuant to a license granted by the Company in connection with the establishment of its collaboration with Merck, Merck is conducting Phase II clinical trials with an alpha-1a antagonist identified as part of the collaboration for the treatment of BPH. In addition, the Company and Grunenthal are collaborating to develop alpha-2 adrenergic agonists for the alleviation of pain. These programs are described below. Benign Prostatic Hyperplasia BPH is a pathology of the prostate, a walnut-sized gland in men that surrounds the urethra as it exits the bladder. As men age, cells in the prostate proliferate, causing growth in the prostatic tissue which in turn results in pressure on the urethra. Common symptoms of BPH include urinary retention, hesitancy or difficulty initiating the stream of urine, urinary frequency, a sense of urgency and a sensation of incomplete emptying of the bladder. The incomplete emptying of the bladder caused by BPH can also lead to urinary tract infections and bladder damage. In severe cases, the flow of urine can become completely blocked and lead to kidney failure. There are several treatment options available for BPH. Transurethral resection of the prostate (TURP) is performed in an estimated 130,000 to 250,000 men in the United States annually. This surgical procedure results in significant benefit. However, as a major surgical procedure which carries the potential for adverse consequences and complications and generally requires hospitalization and the use of general anesthesia, TURP is an unattractive alternative for many patients, and is not recommended for elderly patients. As a result, a number of additional procedures have been developed over the past decade to treat BPH. These include various microwave procedures (in which heat is used to damage or destroy excess tissue), transurethral needle ablation (in which excess tissue is destroyed using radiowaves), and a number of laser treatments involving a variety of techniques, generators and fibers. These newer procedures are generally less invasive than TURP. In addition, many of these newer procedures can be performed on an out-patient basis under local anesthesia. Patient satisfaction with these newer procedures is generally good, and adverse event rates tend to be lower than those seen with TURP. However, these alternative procedures tend to produce less improvement in symptom scores and urinary flow rates than TURP. In addition, since these procedures have been developed only relatively recently, the long-term response rates compared with those of TURP are unclear. Two different pharmacological alternatives for the treatment of BPH in patients who either are not candidates for or elect not to have surgery are currently available. The first alternative is a type of drug that acts by inhibiting the enzyme 5 alpha reductase, which is responsible for the conversion of testosterone to dihydrotestosterone in the prostate. By reducing levels of dihydrotestosterone, which plays a role in growth of prostatic tissue, this type of drug is intended to shrink the gland. An example of this type of drug is Proscar(R). Although there is a rapid regression of the enlarged gland in most patients, less than 50% of patients experience an increase in urine flow and improvement of symptoms when treated with Proscar(R) for 12 months. A minimum of six months' treatment may be necessary to determine whether an individual will respond to the drug. The second type of drug for the treatment of BPH involves the use of alpha-1 adrenergic antagonists, such as Hytrin(R) and Cardura(R), that act by blocking alpha adrenergic stimulation of the prostate. This blocking activity causes a relaxation of the musculature of the prostate, thereby improving urinary flow and providing other symptomatic relief of BPH. Alpha-1 adrenergic antagonists were initially developed as antihypertensive 18 agents in the mid-1970's prior to the discovery that there existed three distinct subtypes of the alpha-1 receptor, and are not selective for any particular alpha-1 subtype. Recently, another alpha antagonist, Flomax(R), was approved for use in the treatment of BPH. Flomax(R) is claimed to be "uroselective," in that it shows some limited (three to four-fold) selectivity for the alpha-1a receptor, which is predominant in the prostate, over the alpha-1b and the alpha-1d receptor subtypes. Rapid symptomatic improvement in approximately 65% to 85% of patients treated with Hytrin(R), Cardura(R) and Flomax(R) has been observed. However, dose-dependent side effects, including hypotension (which can cause dizziness), headache, weakness, nasal congestion and peripheral edema, are associated with the use of Hytrin(R) and Cardura(R). The side effects limit the recommended dose for these drugs. The most significant side effect, hypotension, is particularly detrimental to elderly patients. Experience to date suggests that Flomax(R) may be associated with a reduced risk of cardiovascular adverse events than either Hytrin(R) or Cardura(R). However, somnolence and respiratory adverse events are also seen in Flomax(R) patients. In addition, Flomax(R) is associated with a high incidence of abnormal ejaculation. Through the use of its alpha adrenergic drug discovery systems and by means of in vivo studies, Synaptic discovered that different receptor subtypes are involved in the control of prostate musculature and blood pressure: the alpha-1a receptor subtype is responsible for contraction of prostate musculature and other alpha-1 receptor subtypes are involved in the regulation of blood pressure. This discovery confirmed the Company's hypothesis that many of the side effects caused by nonselective alpha-1 adrenergic antagonists that were available for the treatment of BPH stemmed from their lack of selectivity for the receptor subtype involved in relaxation of prostate musculature. The Company has been issued United States patents covering the use of alpha-1a antagonists having defined degrees of selectivity for the alpha-1a receptor subtype relative to one or both of the other alpha-1 receptor subtypes for the treatment of BPH (the "BPH use patents"). In addition, Synaptic has been issued a United States patent covering the use of genetically engineered cells expressing the human alpha-1a adrenergic receptor subtype to identify compounds that bind to the receptor subtype, as well as a United States patent covering the gene encoding the receptor subtype. The Company, in collaboration with Merck, used the Company's drug discovery systems to design compounds that block the activity of the alpha-1a receptor subtype, thereby producing the desired effects on the prostate, but that have minimal affinity for alpha-1b and alpha-1d receptor subtypes, thereby substantially reducing the cardiovascular effects seen with currently available nonselective alpha-1 adrenergic antagonists. A compound selected by Merck is currently in Phase II clinical trials. Other leads have also been identified and are in the early preclinical stage of testing. Under the terms of the Merck Agreement, Synaptic granted Merck a nonexclusive worldwide license under certain of its patent rights, including the Company's alpha adrenergic receptor patents and patent applications, to develop and commercialize alpha-1a antagonists. In addition, Synaptic granted Merck an exclusive worldwide license to use Synaptic's alpha-1a selective compounds and know-how, as well as an exclusive worldwide license under certain of the Company's patent rights, including the BPH use patents and related patent applications, for the same purpose. However, in March 1998, Merck granted back to Synaptic such rights as were necessary to enable Synaptic to grant to Glaxo pursuant to the Glaxo Agreement a limited license under the BPH use patents and an option to obtain an additional license under the BPH use patents. Pain Analgesic agents are used to relieve pain. Analgesics most commonly used for severe pain are narcotics. Although very effective, narcotic analgesic agents carry the risk of depressing respiration and causing nausea, vomiting and constipation, and their repeated use may lead to addiction. It is believed that nonnarcotic analgesics would be beneficial to many patient populations suffering from severe pain. 19 Alpha-2 agonists have been broadly used and are highly effective as veterinary analgesics. Animal data indicate that these agents do not cause respiratory depression. In addition, their action can be reversed with appropriate drugs. However, they cause both sedation and hypotension when administered within the analgesic dose range. Synaptic believes that its drug discovery systems for the three human alpha-2 adrenergic receptor subtypes can be used to discover alpha-2 analgesics which have significantly fewer deleterious side effects than currently available analgesics and the effects of which may be rapidly reversed. Synaptic chemists have synthesized a broad array of alpha-2 agonists which are the focus of a drug discovery program being conducted by the Company in collaboration with Grunenthal. The two companies are in the process of assessing these compounds and will select those compounds which satisfy the design criteria for further optimization and testing. Neuropeptide Y Programs Neuropeptides are neurotransmitters. Unlike neurotransmitters that are small molecules, such as norepinephrine and serotonin, neuropeptides are much larger molecules. The mode of action of neuropeptides, however, resembles that of small molecule neurotransmitters in that they function by means of an interaction with specific families of receptors, including families within the G protein-coupled receptor superfamily. Although current knowledge of neuropeptides and their receptors is significantly less extensive than knowledge of small molecule neurotransmitters and their receptors, subtypes have been shown to exist for several families of neuropeptide receptors. One focus of the Company in its receptor and drug discovery efforts in this area has been on the NPY family of receptors. Although the natural ligand for this family, NPY, is a large molecule, the goal of this drug discovery program is, as is the case in all of the Company's other drug discovery programs, to design a small molecule drug. Large peptide-like molecules are not stable in the body and thus would have short durations of action and would not be orally available, thus requiring delivery by injection. To date, there is evidence for the existence in humans of at least five NPY receptor subtypes, named Y1, Y2, Y3, Y4 and Y5. However, the discovery and cloning of the genes for only four of these subtypes have been reported. In 1996 and 1997, the Company was awarded United States patents covering the genes that code for the Y2, Y4 and Y5 receptor subtypes and related drug discovery systems. Synaptic has filed additional patent applications relating to these discoveries in the United States and in other countries. A drug discovery program in which the Company's NPY technology is being utilized is being conducted by the Company's former collaborative partner Novartis pursuant to a license from the Company. This program is focused on the development of NPY receptor subtype-selective compounds for the treatment of obesity. Another NPY drug discovery program currently being conducted by the Company focused on pain is contractually reserved for and may become a joint program as part of the Company's collaboration with Grunenthal. There can be no assurance that the NPY drug discovery program focused on pain will become a joint program as part of the Grunenthal collaboration or that the Company or any collaborative partner or other licensee will be successful in designing safe and effective NPY receptor subtype-selective drugs. Obesity Animal studies have shown that NPY is the most potent stimulator of food intake identified to date. As little as one billionth of a gram of NPY injected directly into the hypothalamus, a key brain area that 20 controls appetite, causes well-fed, satiated rats to overeat. Repeated administration of NPY causes continual overeating and obesity. A Y5 receptor was initially isolated by the Company's scientists from rat hypothalamus. In laboratory tests, the activity of NPY and related peptides on the Y5 receptor correlates with the ability of these peptides to stimulate feeding in animals. As part of its collaboration with the Company, Novartis then showed that several peptides that activated the Y5 receptor preferentially over other known NPY receptors increased food intake in rats. Additional studies by Synaptic and Novartis showed that small molecules that selectively block the Y5 receptor significantly reduce food intake in rats and reduce body weight after chronic administration. Based upon these studies, Synaptic believes that the Y5 receptor is a "feeding" receptor, and that compounds that are selective for this receptor subtype may lead to new approaches to the treatment of obesity. From August of 1994 to August of 1998, the Company and Novartis engaged in a joint research program focused on discovering and developing a potent and selective Y5 antagonist for the treatment of obesity. As part of its collaboration with the Company, Novartis received an exclusive worldwide license to use the Company's NPY receptor subtype drug discovery systems for the development and commercialization of Y5 antagonists, as well as any other NPY drugs, for the treatment of obesity and eating disorders. The license remains exclusive until August 2001, following which time it becomes nonexclusive. Novartis has informed the Company that, as of February 15, 1999, it was continuing its efforts to develop a Y5 antagonist for the treatment of obesity pursuant to its license from the Company and the program was in the early preclinical stage of development. Pain As part of its efforts to discover nonnarcotic drugs for the alleviation of pain, the Company is conducting a program focused on the design and development of analgesics that stimulate the Y2 receptor subtype. Direct injection of NPY into the spinal cord produces a high level of analgesia in laboratory animals. This effect is believed to be related to NPY's ability to stimulate Y2 receptors. These receptors control the release of chemical messengers, such as Substance P, which mediate the transmission of pain responses. Synaptic believes that orally active small molecule agonists which would mimic the effects of NPY at the Y2 receptor may offer a new approach to the alleviation of pain that would not result in the side effects typically associated with narcotic analgesics. Although the Company and Grunenthal have not yet initiated a joint program focused on the design and development of Y2-selective compounds for the alleviation of pain, as part of its collaboration with Grunenthal, Synaptic has agreed to reserve the Y2 receptor subtype as a potential target for such drugs exclusively for the collaboration until the expiration of the collaborative agreement. There can be no assurance, however, that the Company and Grunenthal will establish a joint drug discovery program focused on the Y2 receptor subtype. Galanin Program Galanin is a neurotransmitter which, like NPY, is a neuropeptide. Galanin is widely distributed in the gastrointestinal tract and the brain. Pharmacologic studies suggest the existence of multiple receptor subtypes for this neuropeptide. There are a number of possible therapeutic applications for drugs that modulate galanin receptors, including the treatment of obesity, diabetes, Alzheimer's Disease, depression and pain. Most of the research done to date with galanin has focused on its role in the control of food intake. Injection of galanin into the brain has been shown to produce an increase in food intake in satiated rats. As a result, galanin receptor antagonists might result in a reduction of food intake and may thus be useful in the treatment of obesity. The Company has discovered and cloned genes that code for galanin receptor subtypes and has filed patent applications relating to these discoveries. In July 1997, the Company entered into a collaboration with Warner-Lambert to identify and develop galanin receptor subtype-selective compounds for a variety of 21 therapeutic applications. As part of this program, the Company and Warner-Lambert have identified and are attempting to characterize galanin receptor subtype-selective compounds. There can be no assurance that the Company or Warner-Lambert will be successful in identifying additional galanin receptor subtype-selective compounds or developing any compound identified as part of the collaboration. Other Programs The Company is employing a targeted genomics approach to discover novel genes that code for receptor subtypes within a number of GPCR subfamiles. The identities of these subfamiles have not yet been disclosed. The Company is also dedicating resources to its nontargeted genomics effort. While the Company believes that its gene discovery efforts will yield potentially valuable drug targets, the duration of time between its discovery of genes and the validation of such genes as potentially valuable drug targets is indeterminable since the validation process will require additional pharmacological and chemical discoveries. The Company uses a variety of criteria to establish a priority order for the study of new receptor gene discoveries and to determine the length of time and amount of resources to dedicate to each discovery. The Company is also dedicating resources to its combinatorial chemistry efforts to design small molecule libraries of compounds that interact in the desired manner with G protein-coupled receptors. Collaborative and Licensing Arrangements A key element of the Company's business strategy has been to leverage resources and to attempt to generate royalty-based revenues through collaborative and licensing arrangements with pharmaceutical companies. The Company is currently collaborating with three pharmaceutical companies pursuant to: (i) the Research, Option and License Agreement dated as of January 25, 1991, as amended, with Lilly (the "Lilly Agreement"); (ii) the Collaborative Research and License Agreement dated as of July 28, 1997, with Warner- Lambert (the "Warner-Lambert Agreement"); and (iii) the Cooperation Agreement dated as of January 12, 1998, as amended, with Grunenthal (the "Grunenthal Agreement"). Concurrently with the establishment of these collaborative arrangements, the Company granted licenses to certain of its technology and patent rights to Lilly, Warner-Lambert and Grunenthal. In addition to its ongoing collaborative arrangements, the Company has granted licenses to certain of its technology and patent rights to three other pharmaceutical companies pursuant to: (A) the Research Collaboration and License Agreement dated as of November 30, 1993, as amended, with Merck (the "Merck Agreement"); (B) the Research and License Agreement dated as of August 4, 1994, as amended (the "First Novartis Agreement") and the Research and License Agreement dated as of May 31, 1996 (the "Second Novartis Agreement," and together with the First Novartis Agreement, the "Novartis Agreements"); and (C) the Option and License Agreement dated as of March 2, 1998, with Glaxo (the "Glaxo Agreement"). The Merck and Novartis licenses were granted concurrently with the establishment by Synaptic of collaborative arrangements with such companies. While both the Merck collaboration and the Novartis collaboration ended in February 1999 and August 1998, respectively, the associated licenses continue for the respective periods provided in the Merck and Novartis Agreements. Following is a summary of each of the Company's existing collaborative and licensing arrangements. 22 Lilly Agreement In January 1991, the Company and Lilly entered into the Lilly Agreement to promote the discovery and development of serotonin receptor subtype-selective drugs for the treatment of serotonin-related disorders. The collaboration was extended in January 1995 for an additional four-year period and then again for an additional period expiring July 31, 1999. Under the terms of the Lilly Agreement, Lilly provides the Company with funding to support a specified number of the Company's scientists who conduct research as part of the collaboration. Upon the expiration of the term of the collaboration in July 1999, Lilly will cease to provide research funding to Synaptic and Synaptic will cease to provide research support to Lilly. All development, manufacturing, marketing and sales of drugs resulting from the collaboration will be conducted by Lilly. The Company is entitled to receive from Lilly payments upon the achievement of certain drug development milestones and royalties on sales of all drugs developed through the use of the Company's technology. Such royalties will be payable in respect of sales in any country over the period commencing with the date of the first commercial sale of a drug and ending with the expiration of related patent rights in that country. Lilly's milestone and royalty payment obligations under the Lilly Agreement will continue, notwithstanding the expiration of the term of the collaboration. Under the terms of the Lilly Agreement, Lilly received an exclusive worldwide license to use all but two of the Company's existing serotonin drug discovery systems for the development and commercialization of drugs that affect serotonergic transmission. The Company retains the unlimited right to use two of its existing serotonin drug discovery systems and a limited right to use all of its other serotonin drug discovery systems in furtherance of its collaboration with Lilly and for cross-reactivity screening of compounds in nonserotonin drug discovery programs. Lilly was also granted certain exclusive rights under several of the Company's patents and patent applications. Warner-Lambert Agreement In July 1997, the Company and Warner-Lambert entered into the Warner-Lambert Agreement pursuant to which they agreed to collaborate in the identification and development of galanin drugs for a variety of therapeutic applications. Under the terms of the Warner-Lambert Agreement, Warner-Lambert received an exclusive worldwide license to use the Company's galanin receptor subtype drug discovery systems for the development and commercialization of galanin receptor subtype-selective drugs for all therapeutic applications. The collaboration involves two stages. During the first stage, which commenced in October 1997 and will last up to 18 months, each partner will fund its own research and use Synaptic's galanin receptor subtype drug discovery systems to attempt to identify and characterize drug candidates. The second stage of the collaboration, which will last for three years, will commence at such time as the partners identify galanin compounds that are active in animal models. During this stage, Warner-Lambert and Synaptic will attempt to develop drug candidates identified during the first stage, as well as attempt to identify additional drug candidates. Upon the commencement of the second stage, Synaptic is entitled to receive research funding from Warner-Lambert, as well as to require Warner-Lambert to purchase equity in Synaptic. In addition, Synaptic is entitled to receive drug development milestones and royalties on sales of all drugs identified through the collaboration. There can be no assurance, however, that any suitable galanin compound will be identified which would trigger commencement of the second stage of the collaboration or that, even assuming the commencement of such stage, a product will result from this collaboration. 23 Grunenthal Agreement In January 1998, the Company and Grunenthal entered into the Grunenthal Agreement pursuant to which they agreed to collaborate in the identification and development of drugs for the alleviation of pain. As part of the collaboration, the companies jointly select receptors that may play a role in the alleviation of pain and attempt to identify compounds that are active at the selected receptors for further study in Grunenthal's animal model systems. The selected receptors may be receptors known to be implicated in the transmission or inhibition of pain or receptors whose function has not yet been elucidated but which are cloned from tissues known to be so implicated. The companies are responsible for their own expenses incurred during the research stage of any project undertaken as part of the collaboration but will each be responsible for 50% of all development costs incurred as part of the project with respect to any resulting drug candidates up to the commencement of Phase III clinical trials. Synaptic will retain manufacturing and marketing rights in the United States, Canada and Mexico with respect to any drug candidates resulting from the collaboration, while Grunenthal will retain manufacturing and marketing rights in Europe, Central America (other than Mexico) and South America with respect to any such candidates. The two companies will share these rights in all other countries. With respect to each country in its own territories and in the shared territories in which it desires to market a drug candidate, each of Synaptic and Grunenthal will be responsible for conducting Phase III clinical trials, if required, for obtaining any necessary regulatory approval, and for all associated costs. Under the terms of the Grunenthal Agreement, Synaptic agreed to make available to Grunenthal for evaluation all receptors cloned by Synaptic that may be implicated in pain (to the extent not already licensed exclusively to a third party) and not to pursue such receptors, independently or with any third party, as targets of potential drugs for the alleviation of pain during the evaluation period applicable to the receptors or during the period over which activities involving any such receptor are being jointly conducted with Grunenthal. Merck Agreement In November 1993, the Company and Merck entered into the Merck Agreement pursuant to which they agreed to collaborate in the identification and development of alpha-1a antagonists, principally for the treatment of BPH. The initial term of the collaboration was three years. In October 1996, the term of the collaboration was extended through November 1997 and in November 1997, the term of the collaboration was again extended for an additional year through November 1998. In November 1998, the term of the collaboration was extended for an additional three-month period which expired at the end of February 1999. Under the terms of the Merck Agreement, Synaptic granted Merck a nonexclusive worldwide license under certain of its patent rights, including the Company's alpha adrenergic receptor patents and patent applications, to develop and commercialize alpha-1a antagonists. In addition, Synaptic granted Merck an exclusive worldwide license to use the Company's alpha-1a selective compounds and know-how, as well as an exclusive worldwide license under certain of the Company's patent rights, including its BPH use patents and related patent applications, for the same purpose. However, in March 1998, Merck granted back to Synaptic such rights as were necessary to enable Synaptic to grant to Glaxo pursuant to the Glaxo Agreement a limited license under the BPH use patents and an option to obtain an additional license under the BPH use patents. The Company retained the right to use its alpha adrenergic technology for the development of alpha adrenergic and other agents that are not alpha-1a antagonists. In consideration for the licenses granted to Merck, Merck has provided the Company with research funding and license fees. In addition, Merck has agreed to pay the Company additional amounts upon the occurrence of certain events and royalties on product sales. 24 Novartis Agreements In August 1994, the Company and Novartis entered into the First Novartis Agreement pursuant to which they agreed to collaborate in the identification and development of NPY drugs for the treatment of obesity and eating disorders, as well as cardiovascular disorders. In May 1996, the Company and Novartis entered into the Second Novartis Agreement and an amendment to the First Novartis Agreement pursuant to which the term of the collaboration was extended by one year and the scope of the collaboration was expanded to provide for research on additional targets for the design of drugs for the treatment of obesity and eating disorders. The term of the collaboration under the two Novartis Agreements expired in August 1998. During the term of the collaboration, Novartis provided the Company with funding to support a specified number of the Company's scientists dedicated to work on the collaboration. As a result of the expiration of the term of the collaboration in August 1998, Novartis no longer provides research funding to Synaptic and Synaptic no longer provides research support to Novartis. Under the terms of the Novartis Agreements, Novartis is required to make payments to the Company upon the achievement by Novartis of certain drug development milestones and, subject to certain limitations, to pay the Company royalties on the sale of drugs developed through the use of the Company's technology. These payment obligations continue, notwithstanding the expiration of the term of the collaboration. As of December 31, 1998, Novartis Produkte AG, an affiliate of Novartis, held 695,715 shares of Common Stock representing 6.5% of the outstanding shares of Common Stock of the Company at that date. Under the terms of the Novartis Agreements, Synaptic granted Novartis an exclusive worldwide license to use the Company's NPY receptor subtype drug discovery systems for the development and commercialization of NPY receptor subtype-selective drugs for the treatment of obesity and eating disorders, as well as cardiovascular disorders. Synaptic also granted Novartis an exclusive worldwide license to use any proprietary technology of the Company that relates to the subject matter of the Second Novartis Agreement to design drugs for the treatment of obesity and eating disorders. In addition, the Company granted Novartis certain rights under several of the Company's patents and patent applications. These licenses are exclusive until August 2001, following which time they become nonexclusive. Under the Novartis Agreements, the Company retained the right to use its NPY receptor subtype drug discovery systems and other technology for all other therapeutic applications, although Novartis has a right of first negotiation with respect to new uses for NPY receptors discovered by Synaptic during the course of the collaboration. Novartis has declined its right of first negotiation with respect to the use of the Company's NPY receptor subtype drug discovery systems and other technology for the discovery and development of Y2 receptor subtype-selective drugs for the treatment of central nervous system disorders and, as a result, the Company has the right to use the technology, independently or with third parties, for such purpose. Glaxo Agreement In March 1998, the Company and Glaxo entered into the Glaxo Agreement pursuant to which the Company granted Glaxo (i) a nonexclusive license under the Company's alpha 1 adrenergic receptor patents to develop and sell alpha-1a selective compounds for therapeutic applications other than the treatment of BPH and (ii) until May 22, 1999, a nonexclusive license under its alpha 1 adrenergic receptor patents and its BPH use patents to develop but not to commercialize alpha-1a selective compounds for the treatment of BPH. In addition, the Company granted Glaxo an option to obtain a nonexclusive license under its alpha 1 adrenergic receptor patents and its BPH use patents to develop and commercialize alpha-1a selective compounds for the 25 treatment of BPH. Such option is exercisable by Glaxo only until May 22, 1999, upon the payment to Synaptic of an additional amount. As consideration for the foregoing licenses and option, Glaxo made a $2,000,000 payment to Synaptic. Synaptic is also entitled to receive royalties on sales of all alpha-1a selective drugs sold by Glaxo so long as Synaptic has an issued patent relating to an alpha 1 adrenergic receptor subtype in at least one major market country, as well as royalties on sales of any alpha-1a antagonist for the treatment of BPH in any country in which Synaptic has an issued BPH use patent. Other Agreements The Company's practice is to meet with pharmaceutical and biotechnology companies on an on-going basis to discuss the possibility of collaborating with them on projects of mutual interest and/or out-licensing its technology to them on a noncollaborative basis. At present, the Company is in the early stages of discussing with other companies the possibility of a number of such arrangements. There can be no assurance that the Company will be successful in consummating any such arrangement. Patents, Proprietary Technology and Trade Secrets The Company's success depends, in part, on its ability to establish, protect and enforce its proprietary rights relating to its technology. The Company's policy is to seek, when appropriate, protection for its gene discoveries, compound discoveries and other proprietary technology by filing patent applications in the United States and other countries. The Company has filed numerous patent applications both in the United States and in other countries covering its inventions. As of February 15, 1999, the Company had been issued United States patents relating to the genes that code for the human serotonin 1B, serotonin 1D, serotonin 1E, serotonin 1F, serotonin 2A, serotonin 4, alpha-1a adrenergic, alpha-1b adrenergic, alpha-1d adrenergic, alpha-2b adrenergic, NPY2, NPY4 and NPY5 receptor subtypes and related drug discovery systems. These patents expire at various times from 2008 to 2016. In addition, at such date, several United States patent applications relating to the Company's receptor gene discoveries were pending, several corresponding patents had been issued in other countries and additional corresponding patent applications had been filed in other countries. In April 1995, the Company was issued its first functional use patent in the United States. This patent covers the use of selective alpha-1a antagonists for the treatment of BPH. In addition, in November 1996 and July 1998, the United States Patent and Trademark Office issued the Company additional patents relating to the same subject matter. These patents expire in 2012. Additional related patent applications are on file in the United States. In addition, corresponding patents have been issued in other countries and additional corresponding patent applications have been filed in other countries. The Company has also filed patent applications in the United States and in other countries covering its neurotransmitter transporter discoveries. Whereas receptors are protein molecules which bind to and are activated by certain ligands, transporters are protein molecules which serve to terminate the action of certain ligands by carrying them back into the cells from which they are released. As of February 15, 1999, the Company had been issued United States patents covering four of these transporter discoveries. The Company is no longer actively working on its transporter program. However, the transporter technology, insofar as it may be used to design drugs for the alleviation of pain, has been reserved exclusively for evaluation by Grunenthal as the potential focus of a joint program between the Company and Grunenthal pursuant to the Grunenthal Agreement. In addition, the Company is seeking to license its transporter technology for other uses to one or more other companies. 26 Additional patent applications covering the Company's compound discoveries and other inventions have been filed in the United States and in other countries and the Company intends to file additional patent applications in the future. The Company has granted certain rights under several of its patents and patent applications to Lilly, Merck, Novartis, Warner-Lambert, Grunenthal and Glaxo. Patent law as it relates to inventions in the biotechnology field is still evolving, and involves complex legal and factual questions for which legal principles are not firmly established. Accordingly, there can be no assurance that patents will be granted with respect to any of the Company's patent applications currently pending in the United States or in other countries, or with respect to applications filed by the Company in the future. The failure by the Company to receive patents pursuant to the applications referred to herein and any future applications could have a material adverse effect on the Company. There is no clear policy involving the breadth of claims allowed in patents or the degree of protection afforded thereunder. Accordingly, no firm predictions can be made regarding the breadth or enforceability of claims allowed in the patents that have been issued to the Company or in patents that may be issued to the Company in the future, and there can be no assurance that claims in the Company's patents, either as initially allowed by the United States Patent and Trademark Office or any of its non-United States counterparts or as subsequently interpreted by courts inside or outside the United States, will be sufficiently broad to protect the Company's proprietary rights. Also, there can be no assurance that the Company's patents or patent applications will not be challenged by way of interference proceedings or opposed by third parties or that the Company will not be required to participate in interference proceedings or oppose the patents or patent applications of third parties in order to protect its rights. Interference and opposition proceedings can be expensive to prosecute and defend. In 1998, one of the Company's patent applications on file outside the United States was the subject of an opposition filed by a pharmaceutical company. During the year, a determination favorable to the Company was made in which most of the claims in the Company's patent application were found to be patentable. As of February 15, 1999, the Company was seeking to file an amendment to the patent application pursuant to which certain of the claims that were found not to be patentable would be modified. In addition, as of February 15, 1999, one of the Company's patent applications on file in the United States was the subject of an interference proceeding involving an issued patent of a third party, and the Company was seeking to provoke an interference by the United States Patent and Trademark Office between another of its patent applications and a patent application of a third party. There can be no assurance that the amendment to the patent application that is the subject of the opposition proceeding will be accepted, or that the outcome of the interference proceeding or the anticipated interference proceeding will be favorable to the Company. In the event that the amendment is not accepted, the patent that will be issued to the Company in the country in which the proceeding is taking place will not include the unpatentable or modified claims and the Company will not be able to prevent third parties from practicing the subject matter of such claims in that country. Further, whether or not the amendment is accepted, the opponent may seek to file similar oppositions in other countries. In the event that the outcome of the interference proceedings were unfavorable to the Company, the Company might not be able to practice the subject matter of the relevant patent applications in the United States. Accordingly, an unfavorable outcome in any such proceeding would have an adverse effect on the Company. Even if the ultimate outcome of the pending opposition and interference proceedings is favorable to the Company, the Company's participation in them could result in substantial cost to the Company. Further, no assurance can be given that patents issued to the Company will not be infringed, invalidated or circumvented by others, or that the rights granted thereunder will be commercially valuable or will provide competitive advantages to the Company and its present or future collaborative partners or 27 licensees. Moreover, because patent applications in the United States are maintained in secrecy until patents issue, because patent applications in certain other countries generally are not published until more than eighteen months after they are filed and because publication of technological developments in the scientific or patent literature often lags behind the date of such developments, the Company cannot be certain that it was the first to invent the subject matter covered by its patents or patent applications or that it was the first to file patent applications for such inventions. The field of gene discovery has become intensely competitive. A number of pharmaceutical companies, biotechnology companies, universities and research institutions have significantly expanded their gene discovery efforts in recent years. Many of these groups are employing recent technological advances in gene sequencing technology to rapidly identify partial sequences of expressed genes ("expressed sequence tags" or "ESTs") and complete sequences of genes whose functions have not been characterized. Some of these groups, including Washington University (with funding provided by Merck), are currently identifying ESTs through partial sequencing and depositing these sequences into public databases, while others are filing patent applications covering their discoveries. The public availability of EST and other sequence information prior to the time the Company applies for patent protection on corresponding gene discoveries could adversely affect the Company's ability to obtain patent protection with respect to such discoveries. While the Company routinely conducts searches of publicly available databases to determine whether other parties have previously cloned ESTs or full-length genes discovered by the Company, it is not always possible to determine whether the third party or the Company was the first inventor. Patent applications covering ESTs and full-length genes filed by third parties may be competitive with the Company's applications or conflict in certain respects with claims made under the Company's applications. There can be no assurance that, in the event of any conflict, the Company will be in a priority position with respect to inventorship on any of these applications. To the extent any patents issue to other parties on such partial or full-length genes, the risk increases that the Company will not be able to obtain patents covering certain of its discoveries, that the Company's existing or future patents and patent applications may become the subject of interference or opposition proceedings, that the Company may not be able to use such discoveries and/or that the potential products and processes of the Company or its licensees may give rise to claims of patent infringement. The commercial success of the Company depends in part on the Company's ability to operate without infringing patents and proprietary rights of third parties. The Company is aware of a large number of patents and patent applications of third parties that contain claims to genes that code for G protein-coupled receptors, ESTs of novel GPCRs and/or compounds that interact with GPCRs. Patents issued to others may preclude the Company from using or licensing its technology or may preclude the Company or its collaborative partners and other licensees from commercializing drugs developed with the use of the Company's technology. The Company has acquired a license to use certain technologies covered by a patent owned by Columbia University. The Columbia University license is a worldwide nonexclusive license to manufacture, use, sell and sublicense drugs derived from the use of certain recombinant DNA technology. In consideration for such license, the Company has agreed to pay royalties on sales of drugs developed through the use of such license. The term of the license extends until the expiration of the last to expire of the patent rights covered by the license. The Company may be required to obtain additional licenses to patents or other proprietary rights of other parties in order to pursue its own technologies. No assurance can be given that any such additional licenses would be made available on terms acceptable to the Company, if at all. The failure to obtain such licenses could result in delays in the Company's or its collaborative partners' or licensees' activities, including the development, manufacture or sale of drugs requiring such licenses, or preclude such development, manufacture or sale. In some cases, litigation or other proceedings may be necessary to assert infringement claims against others, to defend against claims of infringement, to enforce patents issued to the Company, to protect trade secrets, know-how or other intellectual property rights owned by the Company, or to determine the scope and 28 validity of the proprietary rights of third parties. Such litigation could result in substantial costs to and diversion of resources by the Company and could have a material adverse effect on the Company. There can be no assurance that any of the Company's patents would ultimately be held valid or that efforts to defend any of its patents, trade secrets, know-how or other intellectual property rights would be successful. An adverse outcome in any such litigation or proceeding could subject the Company to significant liabilities, require the Company to cease using the subject technology or require the Company to license the subject technology from the third party, all of which could have a material adverse effect on the Company's business. In addition to patent protection, the Company relies upon trade secrets, proprietary know-how and continuing technological advances to develop and maintain its competitive position. To maintain the confidentiality of its trade secrets and proprietary information, the Company requires its employees, consultants and collaborative partners to execute confidentiality agreements upon the commencement of their relationships with the Company. In the case of employees, the agreements also provide that all inventions resulting from work performed by them while in the employ of the Company will be the exclusive property of the Company. There can be no assurance, however, that these agreements will not be breached, that the Company would have adequate remedies in the event of any such breach or that the Company's trade secrets or proprietary information will not otherwise become known or developed independently by others. Competition The Company operates in a field in which new developments occur and are expected to continue to occur at a rapid pace. Competition from biotechnology and pharmaceutical companies, joint ventures, academic and other research institutions, including government-financed entities, and others is intense and is expected to increase. Although the Company believes that the elements of its human receptor-targeted drug design technology and the manner in which the Company has integrated these elements are proprietary to the Company, one or more of such elements are currently employed by many other pharmaceutical and biotechnology companies in their drug discovery efforts. Moreover, there are other companies with drug discovery programs at least some of the objectives of which are the same as or similar to those of the Company. The Company is aware of many pharmaceutical and biotechnology companies that are engaged in efforts to develop compounds that interact with G protein-coupled receptor subtypes, including receptor subtypes with which the Company is working. In addition, there are a number of companies and academic and other research institutions engaged in gene sequencing, gene discovery, gene expression analysis and other genomic service businesses. There is a finite number of genes in the human genome, and many competitors are seeking to identify, sequence and determine the biological function of a large number of genes in the shortest time possible in order to obtain a proprietary position with respect to the largest number of novel genes discovered. In addition, the Company is aware that other companies and research institutions have developed genomic databases and are marketing, or have announced their intention to market, their data to competitors. The Company expects that additional competitors will attempt to establish gene sequence, gene expression or other genomic databases in the future. In addition, competitors may discover and establish patent positions with respect to the same gene sequences discovered by the Company. Further, certain entities engaged in gene sequencing have made and are continuing to make the results of their sequencing efforts publicly available. These patent positions or the public availability of gene sequences comprising substantial portions of the human genome could decrease the potential value of the Company's discoveries and adversely affect the Company's ability to realize royalties or other revenue from commercialization of this genetic information and products based upon this genetic information. 29 Many of the Company's competitors are large biotechnology companies and multinational pharmaceutical companies who may employ in such activities greater financial and other resources, including larger research and development staffs and more extensive marketing and manufacturing organizations, than the Company or its present and future collaborative partners or licensees. The genomics industry is characterized by extensive research efforts and rapid technological progress. To remain competitive in its genomics efforts, the Company will be required to continue to expand its databases and to enhance the functionality of its bioinformatics and database software. New developments are expected to continue and discoveries by others may render the Company's services and potential products noncompetitive. The Company also expects to encounter significant competition with respect to the drugs that it and its collaborative partners and other licensees plan to develop. Companies that complete clinical trials, obtain required regulatory approvals and commence commercial sales of their drugs before their competitors may achieve a significant competitive advantage. In order to compete successfully, the Company's goal is to obtain patent protection for certain of its gene discoveries and drug discovery systems and to make these systems available to pharmaceutical companies through collaborative and licensing arrangements for use in discovering drugs for major markets which have historically been difficult to address using the traditional approach to drug discovery. There can be no assurance, however, that the Company will obtain patents covering its technology that protect it against competitors. Moreover, there can be no assurance that the Company's competitors will not succeed in developing technologies that circumvent the Company's technology or that such competitors will not succeed in developing technologies and drugs that are more effective than those developed by the Company and its collaborative partners and other licensees or that would render technology or drugs of the Company and its collaborators and other licensees less competitive or obsolete. In addition, there can be no assurance that competitors of the Company will not obtain regulatory approvals of their drugs more rapidly than the Company and its collaborative partners and other licensees, thereby rendering the Company's and its collaborative partners' and other licensees' drugs noncompetitive or obsolete. Moreover, there can be no assurance that the Company's competitors will not obtain patent protection or other intellectual property rights that would limit the Company's or its collaborative partners' and other licensees' ability to use the Company's technology or commercialize its or their drugs. Government Regulation The development, manufacturing and marketing of drugs developed through the use of the Company's technology are subject to regulation by numerous Federal, state and local governmental authorities in the United States, the principal one of which is the FDA, and by similar agencies in other countries (each of such Federal, state, local and other authorities and agencies, a "Regulatory Agency"). Regulatory Agencies impose mandatory procedures and standards for the conduct of certain preclinical testing and clinical trials and the production and marketing of drugs for human therapeutic use. Product development and approval of a new drug are likely to take many years and involve the expenditure of substantial resources. The steps required by the FDA before new drugs may be marketed in the United States include: (i) preclinical studies; (ii) the submission to the FDA of a request for authorization to conduct clinical trials on an investigational new drug (an "IND"); (iii) adequate and well-controlled clinical trials to establish the safety and efficacy of the drug for its intended use; (iv) submission to the FDA of a new drug application (an "NDA"); and (v) review and approval of the NDA by the FDA. In the United States, preclinical testing includes both in vitro and in vivo laboratory evaluation and characterization of the safety and efficacy of a drug and its formulation. Laboratories involved in preclinical testing must comply with FDA regulations regarding Good Laboratory Practices. Preclinical testing results are submitted to the FDA as part of the IND and are reviewed by the FDA prior to the commencement of human 30 clinical trials. Unless the FDA objects to an IND, the IND will become effective 30 days following its receipt by the FDA. There can be no assurance that submission of an IND will result in the commencement of human clinical trials. Clinical trials, which involve the administration of the investigational drug to healthy volunteers or to patients under the supervision of a qualified principal investigator, are typically conducted in three sequential phases, although the phases may overlap with one another. Clinical trials must be conducted in accordance with Good Clinical Practices under protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. Each protocol must be submitted to the FDA as part of the IND. Further, each clinical study must be conducted under the auspices of an independent Institutional Review Board (the "IRB") at the institution where the study will be conducted. The IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. Compounds must be formulated according to the FDA's Good Manufacturing Practices ("GMP"). Phase I clinical trials represent the initial administration of the investigational drug to a small group of healthy human subjects or, more rarely, to a group of selected patients with the targeted disease or disorder. The goal of Phase I clinical trials is typically to test for safety (adverse effects), dose tolerance, absorption, bio- distribution, metabolism, excretion and clinical pharmacology and, if possible, to gain early evidence regarding efficacy. Phase II clinical trials involve a small sample of the actual intended patient population and may seek to assess the efficacy of the drug for specific targeted indications, to determine dose tolerance and the optimal dose range and/or to gather additional information relating to safety and potential adverse effects. Once an investigational drug is found to have some efficacy and an acceptable safety profile in the targeted patient population, Phase III clinical trials are initiated to establish further clinical safety and efficacy of the investigational drug in a broader sample of the general patient population at geographically dispersed study sites in order to determine the overall risk-benefit ratio of the drug and to provide an adequate basis for all package labeling. The results of the research and product development, manufacturing, preclinical testing, clinical trials and related information are submitted to the FDA in the form of an NDA for approval of the marketing and shipment of the drug. Timetables for the various phases of clinical trials and NDA approval cannot be predicted with any certainty. The Company, its collaborative partners or other licensees or the FDA may suspend clinical trials at any time if it is believed that individuals participating in such trials are being exposed to unacceptable health risks. Even assuming that clinical trials are completed and that an NDA is submitted to the FDA, there can be no assurance that the NDA will be reviewed by the FDA in a timely manner or that once reviewed, the NDA will be approved. The approval process is affected by a number of factors, including the severity of the targeted indications, the availability of alternative treatments and the risks and benefits demonstrated in clinical trials. The FDA may deny an NDA if applicable regulatory criteria are not satisfied, or may require additional testing or information with respect to the investigational drug. Data obtained from preclinical and clinical activities are susceptible to varying interpretations which could also delay, limit or prevent Regulatory Agency approval. Even if initial FDA approval is obtained, further studies, including post-market studies, may be required in order to provide additional data on safety and will be required in order to gain approval for the use of a product as a treatment for clinical indications other than those for which the product was initially tested. The FDA will also require post-market reporting and may require surveillance programs to monitor the side effects of the drug. Results of post-marketing programs may limit or expand the further marketing of the drug. Further, if there are any modifications to the drug, including changes in indication, manufacturing process or labeling, an NDA supplement may be required to be submitted to the FDA. Finally, delays or rejections may be encountered based upon changes in Regulatory Agency policy during the period of drug development and/or 31 the period of review of any application for Regulatory Agency approval for a compound. Moreover, because most of the Company's collaborative partners and other licensees are generally responsible for preclinical testing, clinical trials, regulatory approvals, manufacturing and commercialization of drugs, the ability to obtain and the timing of regulatory approvals are not within the control of the Company. There can be no assurance that the regulatory framework described above will not change or that additional regulations will not arise that may affect approval of a potential drug. Each manufacturing establishment for new drugs is required to receive some form of approval by the FDA. Among the conditions for such approval is the requirement that the prospective manufacturer's quality control and manufacturing procedures conform to GMP, which must be followed at all times. In complying with standards set forth in these regulations, manufacturers must continue to expend time, monies and effort in the area of production and quality control to ensure full technical compliance. Manufacturing establishments, both foreign and domestic, are also subject to inspections by or under the authority of the FDA and may be subject to inspections by foreign and other Federal, state or local agencies. Prior to the commencement of marketing a product in other countries, approval by the Regulatory Agencies in such countries is required, regardless of whether FDA approval has been obtained for such product. The requirements governing the conduct of clinical trials and product approvals vary widely from country to country, and the time required for approval may be longer or shorter than the time required for FDA approval. Although there are some procedures for unified filings for certain European countries, in general, each country has its own procedures and requirements. Delays in obtaining Regulatory Agency approvals could adversely affect the marketing of any drugs developed by the Company or its collaborative partners or other licensees, impose costly procedures upon the Company's or its collaborative partners' or other licensees' activities, diminish any competitive advantages that the Company or its collaborative partners or other licensees may attain and adversely affect the Company's ability to receive revenues or royalties. There can be no assurance that, even after such time and expenditures, Regulatory Agency approvals will be obtained for any compounds developed by, in collaboration with or pursuant to licenses from the Company. Moreover, even if Regulatory Agency approval for a compound is granted, such approval may entail limitations on the indicated uses for which it may be marketed. Further, approved drugs and their manufacturers are subject to continual review, and discovery of previously unknown problems with a drug or its manufacturer may result in restrictions on such drug or manufacturer, including withdrawal of the drug from the market. Regulatory Agency approval of prices is required in many countries and may be required for the marketing of any drug developed by the Company or its collaborative partners or other licensees. As with many biotechnology and pharmaceutical companies, the Company's activities involve the use of radioactive compounds and hazardous materials. The Company is subject to local, state and Federal laws and regulations relating to occupational safety, laboratory practices, the use, handling and disposition of radioactive materials, environmental protection and hazardous substance control. Although the Company believes that its safety procedures for handling and disposing of radioactive compounds and other hazardous materials used in its research and development activities comply with the standards prescribed by Federal, state and local regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of any such accident, the Company could be held liable for any damages that result and any such liability could exceed the resources of the Company. 32 Employees As of February 15, 1999, the Company had 127 full-time employees, 40 of whom hold Ph.D. or M.D. degrees. Of the Company's full-time employees, 109 were engaged directly in scientific research and 18 were engaged in general and administrative functions. The Company's scientific staff members have diversified experience and expertise in molecular and cell biology, biochemistry, molecular pharmacology, medicinal, structural, combinatorial and computer-assisted chemistry and information systems. All employees have entered into agreements with the Company pursuant to which they are prohibited from disclosing to third parties the Company's proprietary information and assign to the Company all rights to inventions made by them during their employment with the Company. The Company's employees are not covered by a collective bargaining agreement, and the Company believes that its relationship with its employees is good. Item 2. Properties The Company leases laboratory and office space in a facility at 215 College Road in Paramus, New Jersey. The Company recently entered into an amendment to its lease which increased its leased space to up to 84,000 square feet. The term of the lease extends through the year 2015. The Company is currently converting a portion of its space into additional research laboratories and may renovate other portions of its space in 1999 for additional laboratories and offices. The Company believes that the space it currently leases is adequate to accommodate the anticipated administrative and research needs of the Company for the foreseeable future. Item 3. Legal Proceedings Other than as described in Item 1 above under the caption "Patents, Proprietary Technology and Trade Secrets," the Company is not a party to any legal proceedings. Item 4. Submission of Matters to a Vote of Securityholders None. 33 Part II Item 5. Market For Registrant's Common Equity and Related Stockholder Matters The Common Stock of the Company trades on the National Market tier of The Nasdaq Stock Market under the symbol SNAP. As of February 15, 1999, there were approximately 2,324 beneficial shareholders of record of the Company's Common Stock. No dividends have been paid on the Common Stock to date, and the Company does not currently intend to declare or pay dividends for the foreseeable future. The following tables set forth the high and low last trade prices for the Common Stock as reported by The Nasdaq Stock Market for the periods indicated below. 1998 Fiscal Year High Low ---- ---- 1st Quarter 1998 14 10 7/16 2nd Quarter 1998 15 1/8 11 1/8 3rd Quarter 1998 15 1/8 9 3/4 4th Quarter 1998 16 1/8 12 5/8 1997 Fiscal Year High Low ---- ---- 1st Quarter 1997 15 1/2 12 1/4 2nd Quarter 1997 14 10 3/8 3rd Quarter 1997 15 5/8 12 3/8 4th Quarter 1997 16 3/4 10 34 Item 6. Selected Financial Data The following table presents selected information relating to the financial condition and results of operations of the Company for the past five years. The following data should be read in conjunction with the Company's financial statements. (In thousands, except per share information) 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------- Total revenues $ 9,352 $ 10,307 $ 9,481 $ 7,977 $ 5,043 Total expenses $ 19,576 $ 17,853 $ 14,319 $ 12,078 $ 11,221 Other income, net $ 3,731 $ 2,200 $ 2,205 $ 734 $ 651 Net loss $ (6,493) $ (5,346) $ (2,633) $ (3,367) $ (5,527) Basic and diluted net loss per share $ (0.61) $ (0.66) $ (0.35) $ (4.76) -- Total assets $ 64,696 $ 69,402 $ 40,355 $ 40,913 $ 20,024 Long term debt -- -- -- $ 107 $ 259 Convertible redeemable preferred stock -- -- -- -- $ 36,199 Accumulated deficit $(35,809) $(29,316) $(23,970) $(21,337) $(17,970) Stockholders' equity (deficiency) $ 62,676 $ 67,704 $ 39,040 $ 38,668 $(17,592) - -------------------------------------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Synaptic Pharmaceutical Corporation is a biotechnology company engaged in the development of a broad platform of enabling technology which it calls "human receptor-targeted drug design technology." The Company is utilizing this technology to discover and clone the genes that code for human receptor subtypes that may be associated with specific disorders. The Company and its collaborative partners and other licensees are in turn utilizing the cloned receptor genes to design compounds that can potentially be developed as drugs for treating these disorders. The Company is currently collaborating with three pharmaceutical companies, Eli Lilly and Company ("Lilly"), Warner-Lambert Company ("Warner-Lambert") and Grunenthal GmbH ("Grunenthal"), pursuant to: (i) the Research, Option and License Agreement dated as of January 25, 1991, as amended, with Lilly (the "Lilly Agreement"); (ii) the Collaborative Research and License Agreement dated as of July 28, 1997, with Warner-Lambert (the "Warner-Lambert Agreement"); and (iii) the Cooperation Agreement dated as of January 12, 1998, as amended, with Grunenthal (the "Grunenthal Agreement"). Concurrently with the establishment of these collaborative arrangements, the Company granted licenses to certain of its technology and patent rights to Lilly, Warner-Lambert and Grunenthal. In addition to its ongoing collaborative arrangements, the Company has granted licenses to certain of its technology and patent rights to three other pharmaceutical companies, Merck and Company ("Merck"), 35 Novartis Pharma AG ("Novartis") and Glaxo Group Limited ("Glaxo"), pursuant to: (A) the Research Collaboration and License Agreement dated as of November 30, 1993, as amended, with Merck (the "Merck Agreement"); (B) the Research and License Agreement dated as of August 4, 1994, as amended (the "First Novartis Agreement") and the Research and License Agreement dated as of May 31, 1996 (the "Second Novartis Agreement," and together with the First Novartis Agreement, the "Novartis Agreements"); and (C) the Option and License Agreement dated as of March 2, 1998, with Glaxo (the "Glaxo Agreement"). The Merck and Novartis licenses were granted concurrently with the establishment by Synaptic of collaborative arrangements with such companies. While both the Merck collaboration and the Novartis collaboration ended in February 1999 and August 1998, respectively, the associated licenses continue for the respective periods provided in the Merck and Novartis Agreements. For convenience of reference, all of the agreements referred to in this paragraph and the preceding paragraph are collectively referred to in this Item 7 as the "License Agreements." The Company had been receiving research funding to support a specified number of the Company's scientists under its collaborations with Merck and Novartis. On February 28, 1999 and August 4, 1998, respectively, the research funding ended in accordance with the Merck and Novartis Agreements. Since inception, the Company has financed its operations primarily through the sale of its stock, through contract and license revenue under certain of its agreements, and through interest income and capital gains resulting from its investments. The Company also has received revenues from government grants under the Small Business Innovative Research ("SBIR") program of the National Institutes of Health. Under the License Agreements, the Company may receive one or more of the following types of revenue: contract revenue, license revenue, royalty revenue or revenue from the sales of drugs. Contract revenue includes research funding to support a specified number of the Company's scientists and payments upon the achievement of specified research and development milestones. Research funding revenue is recognized ratably over the period of the collaboration to which it relates and is based upon predetermined funding requirements. Research and development milestone payment revenue is recognized when the related research or development milestone is achieved. License revenue represents non-refundable payments for a license to one or more of the Company's patents and/or a license to the Company's technology. Non-refundable payments for licenses are recognized at such time as they are received or, if earlier, become guaranteed. Under each of the License Agreements (other than the Grunenthal Agreement), the Company is entitled to receive royalty payments based upon the sales of drugs that may be developed using the Company's technology or that may be covered by the Company's patents. Under the Grunenthal Agreement, the Company has development and marketing rights in certain territories with respect to drugs, if any, that are jointly identified as part of the collaboration with Grunenthal. Accordingly, the Company may receive revenue from sales in its territories (as defined) of such drugs if it markets them independently or the Company may receive royalty payments if it licenses its marketing rights to a third party. To date, the Company has not received either royalty revenue or revenue from the sales of drugs and the Company does not expect to receive such revenues for a number of years, if at all. To date, the Company's expenditures have been for research and development related expenses, general and administrative related expenses, fixed asset purchases and various patent related expenditures incurred in protecting the Company's technologies. The Company has been historically unprofitable and had an accumulated deficit of $35,809,000 at December 31, 1998. The Company expects to continue to incur operating losses for a number of years and may not become profitable, if at all, unless and until it receives royalty revenue or revenue from sales of drugs that may be developed with the use of its technology or its patent rights. 36 Results of Operations Comparison of Fiscal Years Ended December 31, 1998, 1997 and 1996 Revenues. The Company recognized revenue of $9,352,000, $10,307,000 and $9,481,000 for the fiscal years of 1998, 1997 and 1996, respectively. The decrease of $955,000 from 1998 to 1997 was attributable primarily to the following: a net decrease in contract revenue of $2,583,000 resulting primarily from the contractual termination of the Novartis Agreements on August 3, 1998 as well as the reduction in full-time equivalent scientists being funded under another of the License Agreements and a decrease in grant revenue of $372,000 which were offset by an increase of $2,000,000 of license revenue under the Glaxo Agreement. The increase of $826,000 from 1996 to 1997 was attributable primarily to: an increase in contract revenue of $2,842,000 resulting from the expansion of the Company's collaborative arrangement with Lilly and increases in rates charged per full-time equivalent scientist under those of the License Agreements under which the Company received research funding partially offset by a decrease of $2,000,000 of non-recurring license revenue under the terms of one of the License Agreements during the third quarter of 1996. Research and Development Expenses. The Company incurred research and development expenses of $15,274,000, $13,781,000 and $11,337,000 for the fiscal years of 1998, 1997 and 1996, respectively. The increase of $1,493,000, or 11%, from 1997 to 1998 was attributable primarily to: an increase of $673,000 in compensation and fringe benefit expenses; an increase of $377,000 in facility related costs; and an increase of $231,000 in research supply costs. The increase of $2,444,000, or 22%, from 1996 to 1997 was attributable primarily to: an increase of $1,274,000 in compensation and fringe benefit expenses; an increase of $726,000 in research supply costs; and an increase of $397,000 in facility related costs. General and Administrative Expenses. The Company incurred general and administrative expenses of $4,302,000, $4,072,000 and $2,982,000 for the fiscal years of 1998, 1997 and 1996, respectively. The increase of $230,000, or 6%, from 1997 to 1998 was attributable primarily to: an increase of $215,000 in compensation and fringe benefit expenses. The increase of $1,090,000, or 37%, from 1996 to 1997 was attributable primarily to an increase in patent and patent related expenses resulting from increased patent related activities and the expensing of all patent and patent application costs as incurred, effective October 1, 1996. Other Income, Net. The Company recorded other income of $3,731,000, $2,200,000 and $2,205,000 for the fiscal years of 1998, 1997 and 1996, respectively. The increase of $1,531,000 from 1997 to 1998 in other income was primarily due to higher interest income as a result of higher average cash, cash equivalent and marketable securities balances during 1998 which resulted from the receipt of net proceeds from a public offering of its common stock completed in November 1997. Net Loss and Basic and Diluted Net Loss Per Share. The net loss incurred by the Company was $6,493,000 ($0.61 per share), $5,346,000 ($0.66 per share) and $2,633,000 ($0.35 per share) for the fiscal years of 1998, 1997 and 1996, respectively. The decrease in net loss per share of $0.05 from 1997 to 1998 resulted primarily from higher average outstanding shares during 1998 partially offset by the recognition of higher total expenses. The increase in average outstanding shares primarily relates to the sale of 2,875,000 shares of common stock in a public offering in the fourth quarter of 1997 as well as the sale of 137,648 shares of common stock pursuant to the exercise of stock warrants in January 1998. 37 The increase in net loss and net loss per share $0.31 from 1996 to 1997 was primarily attributable to the recognition during 1996 of higher total expenses. Operating Trends. Revenues may vary from period to period depending on numerous factors including the timing of revenue earned under the License Agreements and revenue that may be earned under future collaborative and/or licensing agreements. During 1998, the Company recognized an aggregate of $7,182,000 in research funding revenue from Lilly, Merck and Novartis and $2,000,000 in license revenue from Glaxo. Based on current commitments by the Company's collaborative partners, the Company expects research funding revenue to amount to $1,759,000 in 1999. Furthermore, under the terms of one or more of the License Agreements, additional revenues may be recognized if: certain milestones are achieved; an option to obtain additional licenses to the Company's patents is exercised; a collaboration advances to a new stage, triggering a research funding obligation on the part of one of the Company's collaborative partners under an existing agreement; or if collaborations are renewed. Management continues to assess the opportunity for obtaining additional funding under new collaborative and/or licensing agreements as well as obtaining financing through equity transactions in order to best determine its future expenditure levels. The Company continues to seek additional funding by leveraging its resources, however, there can be no assurance that such funding will be available on acceptable terms or at all. It is also expected that operating expenses will increase in order to support on-going collaborations and internal research efforts. Operating expenses are expected to continue to grow, at a minimum, consistent with historical trends. Patent related expenditures are expected to grow at a rate that is faster than the historical operating expense growth rate. Other income, net is expected to decline in 1999 and 2000 as existing funds are utilized to support the Company's operations. Property and equipment costs are expected to continue to increase as the Company's currently underutilized space is converted into laboratory space. At December 31, 1998, the Company held marketable securities with an estimated fair value of $39,788,000. The Company's primary interest rate exposure results from changes in short-term interest rates. The Company does not purchase financial instruments for trading or speculative purposes. All of the marketable securities held by the Company are classified as available-for-sale securities. The following table provides information about marketable securities held by the Company at December 31, 1998: Estimated Principal Amount and Weighted Average Stated Rate Fair by Expected Maturity Value - ------------------------------------------------------------ --------- (000's) 1999 2000 2001 2002 2003 Total (000's) - ------------------------------------------------------------ --------- Principal $7,142 $3,987 $13,790 $5,500 $8,500 $38,919 $39,788 Weighted Average Stated Rates 5.89% 6.80% 8.16% 6.24% 5.87% 6.83% -- - ------------------------------------------------------------- --------- The stated rates of interest expressed in the above table may not approximate the actual yield of the securities which the Company currently holds since the Company has purchased some of its marketable securities at other than face value. Additionally, some of the securities represented in the above table may be 38 called or redeemed, at the option of the issuer, prior to their expected due dates. If such early redemptions occur, the Company may reinvest the proceeds realized on such calls or redemptions in marketable securities with stated rates of interest or yields that are lower than those of current holdings affecting both future cash interest streams and future earnings. In addition to investments in marketable securities, the Company places some of its cash in money market funds in order to keep cash available to fund operations and to hold cash pending investments in marketable securities. Fluctuations in short term interest rates will affect the yield on monies invested in such money market funds. Such fluctuations can have an impact on future cash interest streams and future earnings of the Company, but such impacts are not expected to be material. Management believes that it has remedied all of its significant information technology and non- information technology systems that may be affected by the year 2000 issue. Management has made inquiries of its significant vendors as to their readiness for the year 2000 issue. The Company's significant vendors have represented to the Company that there is a high probability that the year 2000 issue will not cause a significant disruption to the delivery of goods and services after 1999, however, the Company gives no assurance as to whether or not this will be the case. To date the Company has spent less than $50,000 to remedy systems that may have been affected by the year 2000 issue and does not expect future expenses, if any, to be material. If it turns out that some of the Company's systems or its vendors' systems are not year 2000 compliant, management believes the most likely worst case scenario would be temporary reduction in the current level of productivity. The Company's contingency plan includes, but may not be limited to, manual workarounds and a temporary increase in the current staffing level. The Company does not believe that inflation has had a material impact on its results of operations. Liquidity and Capital Resources At December 31, 1998 and 1997, cash, cash equivalents and marketable securities aggregated $56,378,000 and $62,100,000, respectively. The decrease in cash, cash equivalents and marketable securities resulted from the use of cash to fund operating activities and purchase property and equipment, both of which were offset by cash provided by the issuance of common stock. To date, the Company has met its cash requirements through the sale of its stock, through contract and license revenue, through SBIR grants and through interest income and gains resulting from its investments. During 1998, aggregate research funding from Lilly, Merck and Novartis amounted to $7,182,000. Research funding under the Merck and Novartis Agreements ended concurrently with the termination of the related collaborations. Warner-Lambert does not currently provide research funding to the Company and the Company does not expect that such funding will be provided, if at all, until mid-1999. In addition, it is anticipated that if the current biotechnology financing environment remains unfavorable, raising additional capital may be difficult. At December 31, 1998, the Company had invested an aggregate of $10,618,000 in property and equipment. The Company leases laboratory and office facilities under an agreement expiring on December 31, 2015. The minimum annual payment under the lease is currently $1,107,000. A standby letter of credit for $580,000 has been issued to the Company's landlord as a security deposit and is secured by investment 39 securities of the Company which are, to the extent of $600,000, recorded in the balance sheet as "Restricted Cash." This standby letter of credit must be renewed annually during the life of the lease. At December 31, 1998, the Company had $56,378,000 in cash, cash equivalents and marketable securities. The Company intends to utilize these funds primarily to conduct its current and future research programs, for patent related expenditures, for general corporate purposes, to make leasehold improvements to its facilities and to purchase property and equipment. The Company expects to continue to incur operating losses for a number of years. The Company believes that its cash on hand, together with the funds that it expects to receive under certain of the License Agreements and interest income, will be sufficient to fund its operations, as well as the Company's share of certain development costs under the Grunenthal Agreement, through the year 2001. As of December 31, 1998, the Company had net operating loss carryforwards of approximately $30,000,000 for Federal income tax purposes that will expire principally in the years 2002 through 2018. In addition, the Company had research and development credit carryforwards of $1,610,000 which will expire principally in 2002 through 2018. For financial reporting purposes, a valuation allowance has been recognized to offset the deferred tax assets related to these carryforwards. Due to limitations imposed by the Tax Reform Act of 1986, and as a result of a significant change in the Company's ownership in 1993 and 1997, the utilization of $25,000,000 of net operating loss carryforwards is subject to annual limitation. The utilization of the research and development credits is similarly limited. Disclosure Regarding Forward-Looking Statements This Report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These forward-looking statements include, but are not limited to, those relating to future cash and spending plans, amounts of future research funding, patent-related plans, additional drug discovery programs, the effectiveness, efficacy, or other results of any of the Company's technology or drugs, any other statements regarding future growth, future cash needs, future operations, business plans and financial results, and any other statements which are not historical facts. When used in this document, the words "anticipate," "estimate," "expect," "may," "project," and similar expressions are intended to be among the statements that identify forward-looking statements. Such statements involve risks and uncertainties, including, but not limited to, those risks and uncertainties relating to those described below, as well as other factors detailed elsewhere in this Report, including in Item 1 of this Report under the captions "Patents, Proprietary Technology and Trade Secrets," "Competition" and "Government Regulation" ("Cautionary Statements"). Such Cautionary Statements qualify the forward-looking statements included in this Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Statements. Early Stage of Product Development; Technological Uncertainty Since its inception in January 1987, the Company has focused its activities on the discovery and cloning of receptor genes and the use of such genes as tools in the design of precisely targeted compounds for a broad range of therapeutic applications. To date, neither the Company nor any of its collaborative partners or other licensees has completed the development of drugs designed with the use of the Company's technology 40 and the Company does not expect that any drugs resulting from its or its collaborative partners' or other licensees' research and development efforts will be commercially available for a number of years, if at all. All compounds discovered by the Company and its collaborative partners and other licensees will require extensive preclinical and clinical testing prior to submission of any regulatory application for commercial use. Extensive preclinical and clinical testing required to establish safety and efficacy will take several years, and the time required to commercialize new drugs cannot be predicted with accuracy. Moreover, potential products that appear to be promising at early stages of development may never reach the market for a number of reasons. Such reasons include the possibilities that potential products are found during preclinical testing or clinical trials to be ineffective or to cause harmful side effects, that they fail to receive necessary regulatory approvals, that they are difficult or uneconomical to manufacture on a large scale, that they fail to achieve market acceptance or that they are precluded from commercialization by proprietary rights of third parties. There can be no assurance that the Company's approach to drug discovery, its research and development efforts or the efforts of Lilly, Merck, Novartis, Warner-Lambert, Grunenthal or Glaxo, or any future collaborative partner or other licensee of the Company, will result in the development of any drugs, or that any drugs, if successfully developed, will be proven to be safe and effective in clinical trials, receive required regulatory approvals, be capable of being manufactured in commercial quantities at reasonable costs or be successfully commercialized. Product development of new pharmaceuticals is highly uncertain, and unanticipated developments, including clinical or regulatory delays, unexpected adverse effects and inadequate therapeutic efficacy, would slow or prevent product development efforts of the Company and its collaborative partners and other licensees and have a material adverse effect on the Company's operations. Dependence on Collaborative Partners and Licensees for Development, Regulatory Approvals, Manufacturing, Marketing and Other Resources A key element of the Company's business strategy is to leverage resources by entering into collaborative and licensing arrangements with pharmaceutical companies. Under the Company's agreements with Lilly, Merck, Novartis and Warner-Lambert, the Company's collaborative partners and licensees are each responsible for conducting preclinical testing and clinical trials of compounds developed through the use of the Company's technology, obtaining regulatory approvals and manufacturing and commercializing any resulting drugs. Under the Grunenthal Agreement, Grunenthal is responsible for conducting certain preclinical testing and clinical trials of compounds developed through the use of the Company's technology. The Company has no involvement in the research and development activities of Glaxo under the Glaxo Agreement. As a result, the Company's receipt of revenues (whether in the form of drug development milestones, royalties on sales or net sales proceeds) in respect of drugs resulting from its collaborative and licensing arrangements is dependent upon the activities of its collaborative partners and other licensees. The amount and timing of resources dedicated by the Company's collaborative partners and other licensees to the development of drugs that would be subject to royalties payable to the Company are not within the Company's control. Moreover, there can be no assurance that the interests of the Company will continue to coincide with those of its collaborative partners or other licensees, that one or more of the Company's collaborative partners or other licensees will not develop independently or with third parties drugs that could compete with drugs of the types covered by their arrangements with the Company, or that disagreements over rights or technology or other proprietary interests will not occur. If any of the Company's collaborative partners or other licensees breaches its agreement with the Company, or fails to devote adequate resources to or conduct in a timely manner its collaborative or licensed activities, the related research programs or the development and commercialization of drug candidates subject to such arrangement could be materially adversely affected. There can be no assurance that the Company's 41 collaborative or licensing arrangements will be successful. Further, there can be no assurance that the Company will be able to enter into acceptable collaborative or licensing arrangements with other pharmaceutical companies in the future, or that, if negotiated, such arrangements will be successful. History of Operating Losses and Accumulated Deficit The Company has incurred significant operating losses since its inception in January 1987. At December 31, 1998, the Company's accumulated deficit was $35,809,000. Losses have resulted principally from costs incurred in connection with the Company's research and development activities and from general and administrative costs associated with the Company's operations. The Company expects to continue to incur substantial operating losses at least over the next several years and expects losses to increase as research funding under its collaborative arrangements diminish. As of December 31, 1998, the only revenues generated by the Company had resulted from payments under collaborative and license agreements, and government grants under the SBIR program of the National Institutes of Health. The Company's revenues, expenses and losses may fluctuate from quarter to quarter and year to year. Research payments under the Novartis Agreements expired in 1998, and research payments under the Merck Agreement expired in February 1999. In addition, research payments under the Lilly Agreement are scheduled to expire in July 1999, unless the research program is extended by mutual agreement of the Company and Lilly. The Company anticipates that there will initially be little, if any, biological knowledge regarding many of its future gene discoveries and, as a result, it will have fewer opportunities to enter into collaborative arrangements focused on such discoveries. The Company does not expect to achieve revenues or royalties from sales of drugs for a number of years, if at all. The Company will not achieve revenues or royalties from drug sales unless it or one of its collaborative partners or other licensees successfully completes clinical trials with respect to a drug candidate, obtains regulatory approvals for that drug candidate and commercializes the resulting drug. Failure to achieve significant revenue or profitable operations could impair the Company's ability to sustain operations and there can be no assurance that the Company will ever achieve significant revenues or profitable operations. Future Capital Needs; Uncertainty of Additional Funding The operation of the Company's business requires substantial capital resources and such requirements are likely to increase in the future. The Company's future financial requirements will depend on many factors, including the continued progress of its research and development programs, the timing and results of preclinical testing and clinical trials, if any, of its or its collaborative partners' or other licensees' drug candidates, the timing of regulatory approvals, if any, technological advances, determinations as to the commercial potential of its or its collaborative partners' or other licensees' proposed products and the status of competitive products. The Company's capital requirements will also depend on the Company's ability to establish and maintain collaborative or licensing arrangements with others and on whether its future collaborative partners provide research funding to the Company and are responsible for all development activities, preclinical testing and regulatory approvals and, if such approvals are obtained, the manufacturing and marketing of products. In addition, such capital requirements will depend on the time and expense associated with filing and, if necessary, prosecuting and enforcing patent claims. The Company entered into the Grunenthal Agreement in January 1998. Under this agreement, the Company will retain certain ownership rights to products that result from the collaboration. In addition, the Company will be significantly involved in the development of any such potential products but may also be required to contribute substantial financial resources towards such development. Accordingly, the cost to the 42 Company of this arrangement may be significantly greater than the cost to it of participating in a royalty-based collaboration. No assurance can be given that the Company's existing cash on hand and marketable securities and funds it will receive under its collaborative and license agreements, together with interest income, will be sufficient. The Company expects that it will, in the future, seek to raise additional funding from other sources, including other collaborative partners and licensees, and through public or private financings, including sales of equity or debt securities. Any such collaborative or licensing arrangement could result in limitations on the Company's ability to control the research and development of potential drugs and the commercialization of resulting drugs, if any, as well as its profits therefrom. Any such equity financing could result in dilution to the Company's then existing stockholders. There can be no assurance that additional funds will be available on favorable terms or at all, or that such funds, if raised, would be sufficient to permit the Company to continue to conduct its operations. If adequate funds are not available, the Company may be required to curtail significantly or eliminate one or more of its receptor or drug discovery programs. Uncertainties Related to Clinical Trials Before obtaining required regulatory approvals for the commercial sale of each product under development, the Company or its collaborators and other licensees must demonstrate through preclinical studies and clinical trials that such product is safe and efficacious for use. The results of preclinical studies and initial clinical trials are not necessarily predictive of results that will be obtained from large-scale clinical trials, and there can be no assurance that clinical trials of any product under development will demonstrate the safety and efficacy of such product or will result in a marketable product. The safety and efficacy of a therapeutic product under development by the Company or its collaborative partners or other licensees must be supported by extensive data from clinical trials. A number of companies have suffered significant setbacks in advanced clinical trials, despite promising results in earlier trials. The failure to demonstrate adequately the safety and efficacy of a therapeutic drug under development would delay or prevent regulatory approval of the product and could have a material adverse effect on the Company. In addition, the FDA or other Regulatory Agency may require additional clinical trials, which could result in increased costs and significant development delays. The rate of completion of clinical trials of the Company's or its collaborative partners' and other licensees' products is dependent upon, among other factors, obtaining adequate clinical supplies and the rate of patient accrual. Patient accrual is a function of many factors, including the size of the patient population, the proximity of patients to clinical sites and the eligibility criteria for the trial. Delays in planned patient enrollment in clinical trials may result in increased costs, program delays or both, which could have a material adverse effect on the Company. In addition, the Company's collaborative partners and other licensees generally have the right to control the planning and execution of product development and clinical programs, and there can be no assurance that such partners and licensees will conduct such programs in accordance with schedules that are satisfactory to the Company. There can be no assurance that, if clinical trials are completed, the Company or its collaborative partners and other licensees will submit NDAs with respect to any potential products or that any such application will be reviewed and approved by the FDA in a timely manner, if at all. Lack of Manufacturing Experience; Reliance on Contract Manufacturers The Company currently has no manufacturing facilities and relies on its collaborative partners and other licensees or other manufacturers to produce its compounds for research and development, preclinical and 43 clinical purposes. The products under development by the Company and its collaborative partners and other licensees have never been manufactured on a commercial scale and there can be no assurance that such products can be manufactured at a cost or in quantities necessary to make them commercially viable. If the Company were unable to contract for a sufficient supply of its compounds on acceptable terms, or if it should encounter delays or difficulties in its relationships with manufacturers, any preclinical or clinical testing schedule of the Company would be delayed, resulting in delay in the submission of products for regulatory approval or the market introduction and subsequent sales of such products, which could have a material adverse effect on the Company. Moreover, manufacturers that the Company may use must adhere to current GMP regulations enforced by the FDA through its facilities inspection program. If these facilities cannot pass a pre-approval plant inspection, the FDA pre-market approval of the products will not be granted. Lack of Sales and Marketing Capability The creation of infrastructure to commercialize pharmaceutical products is a difficult, expensive and time-consuming process. Synaptic currently has no sales or marketing capability. To market directly any product it may develop, the Company will need to establish a marketing and sales force with technical expertise and distribution capability or contract with other pharmaceutical and/or health care companies with distribution systems and direct sales forces. There can be no assurance that the Company will be able to establish direct or indirect sales and distribution capabilities or be successful in gaining market acceptance for licensing arrangements. To the extent that the Company enters into co-promotion or licensing arrangements, any revenues received by the Company will be dependent on the efforts of third parties, and there can be no assurance that any such efforts will be successful. Dependence on Key Personnel The Company is highly dependent on its management and scientific staff. Loss of the services of any key individual could have an adverse effect on the Company. The Company believes that its future success will depend, in part, on its ability to attract and retain highly talented managerial, scientific, software and bioinformatics personnel and consultants. The Company faces intense competition for such personnel from, among others, biotechnology and pharmaceutical companies, as well as academic and other research institutions. There can be no assurance that it will be able to attract and retain the personnel it requires on acceptable terms. Failure to attract and retain such personnel could have a material adverse effect on the Company. External Environment Over the past several years, there has been a significant reduction in the number of investors who are willing to commit capital to the biotechnology industry. With over 300 public biotechnology companies and over 1,000 private biotechnology companies, the lack of capital is severely impairing the ability of many of these companies to carry out their research. Additionally, many pharmaceutical companies are now routinely performing many of the types of research and services that have historically been performed by biotechnology companies. As a consequence, many pharmaceutical companies are less interested than in the past both in engaging in collaborations with biotechnology companies in a number of areas and in providing them with research funding and other sources of revenue. 44 Over time, the Company could be materially adversely affected by a lack of available capital and/or a lack of interest on the part of the pharmaceutical industry in its services or products. This unfavorable external environment could result in the Company's inability to complete certain of its research projects and/or in the need for the Company to downsize until it begins to receive royalty income pursuant to outstanding licensing arrangements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Quantitative and qualitative disclosures about market risk (i.e., interest rate risk) are included in Item 7 of this Report. 45 (This page intentionally left blank.) 46 Item 8. Financial Statements SYNAPTIC PHARMACEUTICAL CORPORATION INDEX TO FINANCIAL STATEMENTS Page ---- Report of Independent Auditors...............................................48 Balance Sheets at December 31, 1998 and 1997.................................49 Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 1998, 1997 and 1996.......................50 Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996...........................................51 Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996...........................................53 Notes to Financial Statements................................................54 47 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders SYNAPTIC PHARMACEUTICAL CORPORATION We have audited the accompanying balance sheets of Synaptic Pharmaceutical Corporation as of December 31, 1998 and 1997, and the related statements of operations and comprehensive income (loss), stockholders' equity 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 Synaptic Pharmaceutical Corporation at December 31, 1998 and 1997, 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. ERNST & YOUNG LLP Hackensack, New Jersey January 29, 1999, except for Note 11 as to which the date is February 4, 1999 48 SYNAPTIC PHARMACEUTICAL CORPORATION BALANCE SHEETS (in thousands, except share information) December 31, 1998 and 1997 Assets 1998 1997 - ------------------------------------------------------------------------------ Current assets: Cash and cash equivalents $ 16,590 $ 23,113 Restricted cash 600 600 Marketable securities--current maturities 7,133 10,010 Revenue receivable under license agreement -- 40 Other current assets 1,064 674 - ------------------------------------------------------------------------------ Total current assets 25,387 34,437 Property and equipment, net 5,733 4,682 Marketable securities 32,655 28,977 Patent and patent application costs, net of accumulated amortization (1998--$1,454; 1997--$1,069) 921 1,306 - ------------------------------------------------------------------------------ $ 64,696 $ 69,402 ============================================================================== Liabilities and Stockholders' Equity - ------------------------------------------------------------------------------ Current liabilities: Accounts payable $ 966 $ 811 Accrued liabilities 645 547 Accrued compensation 326 340 Deferred revenue 83 -- - ------------------------------------------------------------------------------ Total current liabilities 2,020 1,698 Stockholders' equity: Preferred Stock, $.01 par value; authorized--1,000,000 shares -- -- Common Stock, $.01 par value; authorized--25,000,000 shares; issued and outstanding--10,711,374 shares in 1998 and 10,526,585 shares in 1997 107 105 Additional paid-in capital 98,516 97,049 Accumulated other comprehensive income--net unrealized (losses) gains on securities (77) 26 Deferred compensation (61) (160) Accumulated deficit (35,809) (29,316) - ------------------------------------------------------------------------------ Total stockholders' equity 62,676 67,704 - ------------------------------------------------------------------------------ $ 64,696 $ 69,402 ============================================================================== See notes to financial statements. 49 SYNAPTIC PHARMACEUTICAL CORPORATION STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (in thousands, except share and per share information) For the Years Ended December 31, 1998, 1997 and 1996 1998 1997 1996 - -------------------------------------------------------------------------- Revenues: Contract revenue $ 7,202 $ 9,785 $ 6,943 License revenue 2,000 -- 2,000 Grant revenue 150 522 538 - -------------------------------------------------------------------------- Total revenues 9,352 10,307 9,481 Expenses: Research and development 15,274 13,781 11,337 General and administrative 4,302 4,072 2,982 - -------------------------------------------------------------------------- Total expenses 19,576 17,853 14,319 - -------------------------------------------------------------------------- Loss from operations (10,224) (7,546) (4,838) Other income, net: Interest income 3,603 2,205 2,013 Interest expense -- (5) (20) Gain on sale of securities 128 -- 212 - -------------------------------------------------------------------------- Other income, net 3,731 2,200 2,205 - -------------------------------------------------------------------------- Net loss $(6,493) $(5,346)$ (2,633) =========================================================================== Comprehensive loss: Net loss $(6,493) $(5,346) $(2,633) Unrealized (losses) gains arising during period (82) 27 15 Less: reclassification adjustment for gains included in net income (21) -- (212) - --------------------------------------------------------------------------- Comprehensive loss $(6,596) $(5,319) $(2,830) =========================================================================== Basic and diluted net loss per share $ (0.61) $ (0.66) $ (0.35) =========================================================================== Shares used in computation of net loss per share 10,684,892 8,129,260 7,577,610 =========================================================================== See notes to financial statements. 50 SYNAPTIC PHARMACEUTICAL CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share information) Net Unrealized Notes Gains Receivable Total Additional (Losses) Deferred From Accumu- Stock- Common Stock Paid-In on Compen- Stock- lated Treasury holders' Shares Amount Capital Securities sation holders Deficit Stock Equity ------ ------ ------- ---------- ------ ------- ------- ----- ------------ Balance at December 31, 1996 7,326,368 $ 73 $59,952 $196 $ (208) $ (6) $ (21,337) $ (2) $ 38,668 Purchase of 1,190 shares of treasury stock at cost -- -- -- -- -- -- -- (1) (1) Payments received on notes receivable from stockholders -- -- -- -- -- 6 -- -- 6 Deferred compensation related to stock incentive plan -- -- 388 -- (388) -- -- -- -- Forfeiture of deferred compensation related to stock incentive plan -- -- (121) -- 121 -- -- -- -- Amortization of deferred compensation -- -- -- -- 179 -- -- -- 179 Issuance of 48,126, shares of common stock pursuant to exercise of stock options 46,061 1 81 -- -- -- -- 3 85 Issuance of 48,114 shares of common stock pursuant to exercise of stock warants 48,114 -- 457 -- -- -- -- -- 457 Issuance of 213,000 shares of common stock pursuant to overallotment option 213,000 2 2,474 -- -- -- -- -- 2,476 Adjustment to reflect net unrealized loss on securities -- -- -- (197) -- -- -- -- (197) Net loss for the year ended December 31, 1996 -- -- -- -- -- -- (2,633) -- (2,633) --------- ------- -------- ---------- --------- ------- ------------ ----- ------------ Balance at December 31, 1996 7,633,543 76 63,231 (1) (296) -- (23,970) -- 39,040 Purchase of 438 shares of treasury Stock at cost -- -- -- -- -- -- -- (1) (1) Forfeiture of deferred compensation related to stock incentive plan -- -- (12) -- 12 -- -- -- -- Amortization of Deferred compensation -- -- -- -- 124 -- -- -- 124 Issuance of 18,480, shares of common stock pursuant to exercise of stock options 18,042 1 36 -- -- -- -- 1 38 Issuance of 2,875,000 share of common stock in public offering 2,875,000 28 33,794 -- -- -- -- -- 33,822 Adjustment to reflect net unrealized loss on securities -- -- -- 27 -- -- -- -- 27 Net loss for the year ended December 31, 1997 -- -- -- -- -- -- (5,346) -- (5,346) ---------- ------- -------- ---------- --------- ------- ------------ ----- ------------ Balance at December 31, 1997 10,526,585 $ 105 $ 97,049 $ 26 $ (160) $ -- $ (29,316) $ -- $ 67,704 ========== ======= ======== ========== ========= ======= ============= ===== ============
See notes to financial statements. 51 SYNAPTIC PHARMACEUTICAL CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY -- (Continued) (in thousands, except share information) Net Unrealized Notes Gains Receivable Total Additional (Losses) Deferred From Accumu- Stock- Common Stock Paid-In on Compen- Stock- lated Treasury holders' Shares Amount Capital Securities sation holders Deficit Stock Equity ------ ------ ------- ---------- ------ ------- ------- ----- ------------ Balance at December 31, 1997 10,526,585 $ 105 $ 97,049 $ 26 $ (160) $ -- $ (29,316) $ -- $ 67,704 Purchase of 375 shares of Treasury Stock at cost -- -- -- -- -- -- -- (1) (1) Forfeiture of deferred compensation related to stock incentive plan -- -- (20) -- 20 -- -- -- -- Amortization of deferred compensation -- -- -- -- 79 -- -- -- 79 Issuance of 47,516, shares of common stock pursuant to exercise of stock options 47,141 1 127 -- -- -- -- 1 129 Issuance of 137,648 shares of common stock pursuant to exercise of stock warrants 137,648 1 1,307 -- -- -- -- -- 1,308 Adjustment to reflect net unrealized gain on securities -- -- -- (103) -- -- -- -- (103) Adjustment to reflect recognition of short-swing profits realized on sale of stock by stockholder -- -- 53 -- -- -- -- -- 53 Net loss for the year ended December 31, 1998 -- -- -- -- -- -- (6,493) -- (6,493) ---------- ------- -------- ---------- --------- ------- ------------ ----- ------------ Balance at December 31, 1998 10,711,374 $ 107 $ 98,516 $ (77) $ (61) $ -- $ (35,809) $ -- $ 62,676 ========== ======= ======== ========== ========= ======= ============= ===== ============
See notes to financial statements. 52 SYNAPTIC PHARMACEUTICAL CORPORATION STATEMENTS OF CASH FLOWS (in thousands) For the Years Ended December 31, 1998, 1997 and 1996 1998 1997 1996 - -------------------------------------------------------------------------------- Operating activities: Net loss $ (6,493) $ (5,346) $ (2,633) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and patent amortization 1,505 1,209 960 Amortization of premiums/(discounts) on securities 226 (123) (158) Amortization of deferred compensation 79 124 179 Gain on sales of securities (128) -- (212) Changes in operating assets and liabilities: Increase in other assets (390) (816) (107) Increase in accounts payable, accrued liabilities and accrued compensation 239 490 44 Decrease (increase) in license agreement revenue receivable 40 152 (62) Increase (decrease) in deferred revenue 83 -- (821) - -------------------------------------------------------------------------------- Net cash (used in) operating activities (4,839) (4,310) (2,810) Investing activities: Proceeds from sale or maturity of investments 70,797 27,666 10,710 Purchases of investments (71,799) (35,696) (32,238) Purchases of property and equipment (2,171) (2,888) (1,106) Increase in patent and patent application costs -- -- (518) - -------------------------------------------------------------------------------- Net cash (used in) investing activities (3,173) (10,918) (23,152) Financing activities: Issuance of common stock, net of repurchases 1,436 33,859 3,016 Short-swing profits realized on sale of stock by stockholder 53 -- -- Payments on capital lease -- (107) (152) Payments on notes receivable from stockholders -- -- 6 - -------------------------------------------------------------------------------- Net cash provided by financing activities 1,489 33,752 2,870 - -------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (6,523) 18,524 (23,092) Cash and cash equivalents at beginning of period 23,113 4,589 27,681 - -------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 16,590 $ 23,113 $ 4,589 ================================================================================ Supplemental cash flow disclosure: Cash paid for interest $ -- $ 5 $ 20 ================================================================================ See notes to financial statements. 53 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS December 31, 1998 Note 1 -- Summary of Significant Accounting Policies Organization. Synaptic Pharmaceutical Corporation (the "Company") is engaged in the development of a broad platform of enabling technology which it calls "human receptor-targeted drug design technology". The Company is utilizing this technology to discover and clone the genes that code for human receptor subtypes that may be associated with specific disorders and to design compounds that can potentially be developed as drugs for treating these disorders. The Company makes available this technology to its collaborative partners and other licensees through collaborative and licensing agreements from which the Company derives the principal portion of its revenue. Basic and Diluted Net Loss Per Share. Net loss per share is computed using the weighted average number of shares of common stock outstanding. In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share." Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Since the Company has a history of operating losses, the adoption of the new standard had no effect on the current and prior year net loss per share amounts. Also, as a result of the Company's operating losses and the anti-dilutive effect from stock options and warrants, such instruments are excluded from the computation of basic and diluted net loss per share. Revenue Recognition. Research funding revenue is recognized ratably over the period of the collaboration to which it relates. Payments received in advance under the related contracts are recorded as deferred revenue until the research is performed. Research milestone payment revenue is recognized at the time the related research milestone is achieved. License revenue represents non-refundable payments for licenses to the Company's technology and/or patent rights. Non-refundable payments for licenses are recognized at such time as they are received or, if earlier, become guaranteed. Government grant receipts are recorded as revenue in the period in which the related research is performed. Cash Equivalents. Cash equivalents consist of highly liquid investments with a maturity of three months or less when purchased. Included in cash equivalents at December 31, 1998, is approximately $16,393,000 related to investments in money market funds. At December 31, 1997, this amount totaled $23,109,000. Marketable Securities. All of the Company's marketable securities are classified as available-for-sale securities and are carried at fair value, with the unrealized gains and losses reported as a separate component of stockholders' equity. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other than temporary, if any, are included in other income. The cost of securities sold is based on the specific identification method. Investments held as of December 31, 1998 consist primarily of U.S. Government and Federal Agency obligations, U.S. corporate debt securities and mortgage-backed securities. The maturities range from February 22, 1999, through November 17, 2003. The Company has established guidelines relative to diversification, credit ratings and maturities to maintain safety and liquidity. The guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. 54 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 Property and Equipment. Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Scientific equipment, office equipment and furniture and fixtures are depreciated over a life of 7 years. Leasehold improvements are depreciated principally over the life of the facility lease, which is currently 17 years (see Note 9). Software is depreciated over a life of 3 years. Assets acquired under capital lease arrangements were depreciated over the life of the related leases. Patents. Prior to October 1, 1996, patent and patent application costs were capitalized and amortized over 7 years or the estimated life of the patent, if less, using the straight-line method. Capitalized costs through October 1, 1996 will continue to be amortized over the remaining portions of their seven-year lives. Effective October 1, 1996, patent and patent application costs are expensed as incurred. The effect in 1996 of this change in accounting estimate was to increase expenses and net loss by $171,000, or $0.02 per share. The Company periodically reviews capitalized costs to assess ongoing recoverability. Accrued Liabilities. Included in accrued liabilities at December 31, 1998 and 1997 are accrued professional fees totaling $506,000 and $345,000, respectively. Stock-Based Compensation. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), in accounting for its employee stock options. Under APB No. 25, compensation expense is recognized only when the exercise price of options is below the market price of the underlying stock on the date of grant. Such expense is recognized ratably over the vesting period. 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. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Comprehensive Income (Loss). In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This pronouncement, which was adopted effective January 1, 1998, requires the presentation of a statement of comprehensive income. Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period resulting from transactions and other events and circumstances from nonowner sources. Comprehensive loss for the Company, in addition to net loss, includes unrealized gains and losses on marketable securities held for sale, currently recorded in stockholders' equity. 55 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 Note 2 -- Marketable Securities The following is a summary of all of the Company's marketable securities. All of these securities are classified as available-for-sale securities. Determination of estimated fair value is based on quoted market prices: Gross Gross Unrealized Unrealized Estimated Cost Gains (Losses) Fair Value - -------------------------------------------------------------------------------- December 31, 1998: U.S. Treasury obligations and obligations of U.S. government agencies $12,998,000 -- $(43,000) $12,955,000 U.S. corporate debt securities 25,851,000 $41,000 (79,000) 25,813,000 Mortgage-backed securities 1,016,000 4,000 -- 1,020,000 - -------------------------------------------------------------------------------- $39,865,000 $45,000 $(122,000) $39,788,000 ================================================================================ December 31, 1997: U.S. Treasury obligations and obligations of U.S. government agencies $21,299,000 -- $(22,000) $21,277,000 U.S. corporate debt securities 15,966,000 57,000 (11,000) 16,012,000 Mortgage-backed securities 1,696,000 2,000 -- 1,698,000 - -------------------------------------------------------------------------------- $38,961,000 $59,000 $(33,000) $38,987,000 ================================================================================ The gross realized gains on sale of available-for-sale securities for the years ending December 31, 1998, 1997 and 1996 totaled $128,000, $0 and $212,000, respectively, and the gross realized losses totaled $0, $0 and $0, respectively. The net adjustment to unrealized (losses) gains on available-for-sale securities included as a separate component of stockholders' equity totaled $(103,000) in 1998, $27,000 in 1997 and $(197,000) in 1996. 56 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 Note 3 -- Collaborative and Licensing Arrangements At December 31, 1998, the Company was engaged in collaborations with three pharmaceutical companies. In addition to these collaborative arrangements, the company has granted licenses to certain of its technology and patent rights to three other pharmaceutical companies. Details of these arrangements are set forth below: Eli Lilly and Company. The Company and Eli Lilly and Company ("Lilly") are parties to a collaborative and licensing agreement under which the Company granted Lilly an exclusive license to use all but two of the Company's serotonin drug discovery systems to promote the discovery and development of receptor subtype-selective drugs for the treatment of serotonin-related disorders. Through 1998, Lilly provided funding to the Company to support a specified number of the Company's scientists who conducted research as part of the collaboration. Lilly is required to pay royalties on sales of any products developed through the use of the Company's technology and is required to make payments upon the achievement of certain milestones. During 1998, 1997 and 1996, the Company recognized $4,659,000, $4,748,000, and $2,011,000, respectively, in revenue under this agreement. Revenues that have been recognized are not subject to repayment. Merck & Co., Inc. The Company and Merck & Co., Inc. ("Merck") are parties to a collaborative and licensing agreement to identify and develop alpha-1a antagonists, principally for the treatment of BPH. The Company granted Merck certain licenses and know-how to develop and commercialize alpha-1a antagonists. Under the terms of the agreement, Merck is providing funding to the Company to support a specified number of the Company's scientists who conduct research as part of the collaboration. Under the terms of the agreement, the collaboration and associated research funding is scheduled to end on February 28, 1999. Merck is required to pay royalties on certain product sales and is required to make payments upon the achievement of certain milestones. During 1998, 1997 and 1996, the Company recognized $482,000, $1,631,000 and $3,613,000, respectively, in revenue under this agreement. Revenues that have been recognized are not subject to repayment. At December 31, 1998, the Company had received $83,000 in advance for work to be performed in January and February 1999. At December 31, 1997, the Company had a receivable amounting to $40,000, for certain reimbursable expenditures. Novartis Pharma AG. The Company and Novartis Pharma AG ("Novartis") are parties to two collaborative and licensing agreements under which the Company granted Novartis an exclusive worldwide license to use the Company's neuropeptide Y technology to develop, manufacture and sell compounds that work through neuropeptide Y receptor subtypes for the treatment of obesity and eating disorders. Until August 4, 1998, Novartis provided funding to the Company to support a specified number of the Company's scientists 57 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 who conducted research as part of the collaboration. Under the terms of the agreements, the collaboration and associated research funding ended on August 4, 1998. Novartis is required to pay royalties on certain product sales and is required to make payments upon the achievement of certain milestones. During 1998, 1997 and 1996, the Company recognized $2,041,000, $3,406,000 and $3,319,000, respectively, in revenue under this agreement. Revenues that have been recognized are not subject to repayment. At December 31, 1998, Novartis held 695,715 shares of the Company's common stock which represents 6.5% of the outstanding shares of the Company. Warner-Lambert Company. The Company and Warner-Lambert Company ("Warner-Lambert") are parties to a collaborative and licensing agreement pursuant to which they are collaborating to identify and develop galanin drugs for a variety of therapeutic applications. Warner-Lambert received an exclusive worldwide license to use the Company's galanin receptor subtype drug discovery systems for the development and commercialization of galanin receptor subtype-selective drugs for all therapeutic applications. To date, the Company has not recognized any revenue under this collaboration. Grunenthal GmbH. The Company and Grunenthal GmbH ("Grunenthal") are parties to a collaborative and licensing agreement pursuant to which they are collaborating to discover and develop drugs for the treatment of pain. The Company is using its receptor-targeted drug design technology to identify compounds of interest and Grunenthal is using its expertise to evaluate the compounds in pain model systems and conduct preclinical studies. Grunenthal will conduct clinical studies with promising compounds. The companies will each be responsible for their own research costs and equally share the development costs through Phase IIa clinical trials. The Company will retain manufacturing and marketing rights in the U.S., Canada and Mexico and share these rights in countries outside of Europe, South and Central America where Grunenthal retains such rights. To date, the Company has not recognized any revenue under this collaboration. Glaxo Group Limited. The Company and Glaxo Group Limited of the United Kingdom ("Glaxo") are parties to a licensing agreement under which the Company granted Glaxo (i) a nonexclusive license under the Company's alpha 1 adrenergic receptor patents to develop and sell alpha-1a selective compounds for therapeutic applications other than the treatment of BPH and (ii) until May 22, 1999, a nonexclusive license under its alpha 1 adrenergic receptor patents and its BPH use patents to develop but not to commercialize alpha-1a selective compounds for the treatment of BPH. During 1998, the Company recognized $2,000,000 in revenue under this licensing arrangement. Revenue that has been recognized is not subject to repayment. In addition, the Company granted Glaxo an option to obtain a nonexclusive license under its alpha 1 adrenergic receptor patents and its BPH use patents to develop and commercialize alpha-1a selective compounds for the treatment of BPH. Such option is exercisable by Glaxo only until May 22, 1999, upon the payment to Synaptic of an additional amount. If the option is exercised, Glaxo is required to pay royalties on any benign prostatic hyperplasia drug which reaches the market and is required to make payments upon the achievement of certain milestones. 58 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 Note 4 -- Property and Equipment Property and equipment consists of the following as of December 31, 1998 and 1997: 1998 1997 - ---------------------------------------------------------------------------- Scientific equipment $ 6,332,000 $ 4,921,000 Furniture and fixtures 188,000 188,000 Office equipment 514,000 454,000 Leasehold improvements 2,003,000 1,557,000 Software 923,000 669,000 Equipment under capitalized leases 658,000 658,000 - ---------------------------------------------------------------------------- 10,618,000 8,447,000 Accumulated depreciation and amortization (4,885,000) (3,765,000) - ---------------------------------------------------------------------------- $ 5,733,000 $ 4,682,000 ============================================================================ Note 5 -- Capital Leases The Company and a bank were parties to a master lease agreement under which the Company leased laboratory and computer equipment with a cost basis of $658,000. The effective interest rate on the leases approximated 10.5%. The assets were depreciated over the related lease terms. Accumulated amortization on leased equipment as of December 31, 1998 and 1997 was $658,000. 59 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 Note 6 -- Stockholders' Equity Common Stock. In December 1995, the Company completed an initial public offering of 2,000,000 shares of its common stock. In January 1996, the underwriters of the initial public offering exercised their over-allotment option to purchase an additional 213,000 shares of common stock. As part of the initial public offering, the then existing convertible redeemable preferred stock automatically converted into 4,928,382 shares of common stock. In October 1997, the Company completed a public offering of 2,500,000 shares of its common stock. In November 1997, the underwriters of the public offering exercised their over-allotment option to purchase an additional 375,000 shares of common stock. In connection with the sale of certain convertible redeemable preferred stock which was converted into common stock upon completion of the Company's initial public offering, the placement agents of certain convertible redeemable preferred stock received warrants to purchase 192,458 shares of the Company's common stock at an exercise price of $9.50 per share. In May 1996, 48,114 of these warrants were exercised. In January 1998, 137,648 of these warrants were exercised and the remaining warrants expired. Stockholders' Rights Plan. In November 1995, the Company's Board of Directors approved the adoption of a stockholders' rights plan (the "Rights Plan"). The Rights Plan provides for the distribution of one right (a "Right") with respect to each share of outstanding common stock and any new issuances of common stock. Upon completion of the initial public offering in December 1995, the Board of Directors designated Series A Junior Participating Preferred Stock and declared a dividend of one Right with respect to each share of common stock outstanding. Each Right will become exercisable to purchase from the Company, at an exercise price of $160.00, 1/1000th of a share of Series A Junior Participating Preferred Stock or that number of shares of common stock having a market value equal to two times the exercise price of the Right. The Rights generally become exercisable for the Series A Junior Participating Preferred Stock ten days following the announcement by any person or group of an intention to make a tender offer or exchange offer, the consummation of which would cause any person or group to become the owner of 15% or more of the outstanding common stock, and generally become exercisable for common stock ten days following the acquisition by any person or group of more than 15% of the outstanding common stock. The Rights will expire in the year 2005. The Rights Plan may discourage certain types of transactions involving an actual or potential change in control of the Company. Each 1/1000th of a share of Series A Junior Participating Preferred Stock will have one vote. Each share of Series A Junior Participating Preferred Stock will be entitled to a preferential quarterly dividend per share equal to the larger of (i) an amount equal to any dividend declared on the common stock and (ii) $.00025. Additionally, in the event of a liquidation, each 1/1000th of a share of the Series A Junior Participating Preferred Stock would be entitled to a preferential liquidation payment equal to $0.01 plus an amount equal to the amount that would be distributed with respect to each share of common stock. Preferred Stock. The Company is authorized to issue up to 1,000,000 shares of preferred stock, 200,000 of which is designated as Series A Junior Participating and 800,000 of which is undesignated. The Board of Directors is authorized to provide for the issuance of preferred stock in one or more classes or series and to fix the number of shares constituting any such class or series, and the voting powers, designations, 60 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions thereof, including the dividend rights, dividend rate, terms of redemption, redemption price or prices, conversion rights and liquidation preferences of the shares constituting any class or series, without any further vote or action by the shareholders of the Company. Note 7 -- Incentive/Stock Plans The Company currently has three stock incentive plans: the 1996 Incentive Plan (the "1996 Plan"), the 1988 Amended and Restated Incentive Plan (the "1988 Plan" and, together with the 1996 Plan, the "Incentive Plans") and the 1996 Nonemployee Director Stock Option Plan (the "Director Plan"). The Company has elected to follow APB No. 25 in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Financial Accounting Standards Board Statement No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB No. 25, compensation expense is required to be recognized when the exercise price of the Company's employee stock options is at a price below the market price of the underlying stock on the date of grant. Incentive Plans. The 1996 Plan and the 1988 Plan were adopted in October 1995 and June 1988, respectively. In May 1998, the Company's stockholders approved an amendment to the 1996 Plan which increased the maximum number of shares available for awards under the 1996 Plan from 1,100,000 to 2,100,000. Effective as of January 1, 1996, the 1996 Plan replaced the 1988 Plan with respect to all future stock and option awards by the Company to its employees and consultants. A committee of the Company's Board of Directors (the "Committee") approves the sale of shares and the granting of nonstatutory or incentive stock options. In addition, under the 1996 Plan, the Committee may grant stock appreciation rights to employees and consultants of the Company. The purchase price for shares and the exercise price of options are determined by the Committee (although, the exercise price of incentive stock options may be no less than the fair market value of the common stock on the date of grant). In general, options granted under the Incentive Plans vest over a four-year period. Unvested options are forfeited upon termination of the employee or consulting relationship. Vested options, if not exercised within a specified period of time following the termination of the employment or consulting relationship, are also forfeited. Options generally expire 10 years from the date of grant. Shares of common stock sold under the Incentive Plans are also generally subject to vesting. Unvested shares of common stock which are sold under the Incentive Plans may be repurchased by the Company, at its option, at the original sale price upon termination of the employment or consulting relationship of the holder with the Company. Options granted and shares sold to employees under the Incentive Plans generally become fully vested upon the occurrence of a change in control of the Company (as defined) if the holders thereof are terminated in connection with such change in control other than for cause (as defined). At December 31, 1998, 967,187 shares remain available for future awards under the 1996 Plan. As of December 31, 1998, no stock appreciation rights had been awarded under the 1996 Plan. Director Plan. The Director Plan was adopted by the Board of Directors in March 1996 and approved by the stockholders in June 1996. In general, under the Director Plan, each nonemployee director of the 61 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 Company is automatically granted an option on the date that he or she first becomes a member of the Board of Directors. In addition, on June 1 of each year, commencing in 1997, each nonemployee director is granted an additional option to purchase 2,500 shares of common stock at an exercise price equal to the fair market value on the date of grant. The maximum number of shares subject to the Director Plan is 250,000. In general, options granted under the Director Plan become exercisable as to 1/24th of the total number of shares subject to the option for each calendar month elapsed after the date of the option grant. In the event of a change in control of the Company (as defined) or the death or disability of the optionee, any unvested portion of the options will become exercisable in full. Options granted under the Director Plan will expire upon the earliest to occur of the following: (a) the expiration of ten years from the date of grant of the option, (b) one year after the optionee ceases to be a director of the Company by reason of death or disability of the optionee, or (c) three months after the date the optionee ceases to be a director of the Company for any reason other than death or disability. Option activities under the Incentive Plans and the Director Plan are detailed in the following table: Weighted Average Option 1996 1988 Director Price Plan Plan Plan Per Share - ------------------------------------------------------------------------------ Outstanding at January 1, 1996 -- 339,775 -- $ 1.79 Granted 443,762 -- 17,500 $13.24 Exercised (2,500) (45,626) -- $ 1.77 Forfeited (25,500) (2,638) -- $11.26 - ------------------------------------------------------------------------------ Outstanding at December 31, 1996 415,762 291,511 17,500 $ 8.55 Granted 503,751 -- 15,000 $12.99 Exercised (625) (17,855) -- $ 2.01 Forfeited (67,825) (8,354) (2,500) $12.88 - ------------------------------------------------------------------------------ Outstanding at December 31, 1997 851,063 265,302 30,000 $10.47 Granted 339,543 -- 15,000 $13.36 Exercised (4,453) (43,063) -- $ 2.70 Forfeited (60,918) (4,375) -- $12.36 - ------------------------------------------------------------------------------ Outstanding at December 31, 1998 1,125,235 217,864 45,000 $11.39 ============================================================================== Exercisable at December 31, 1998 202,195 211,276 30,000 $ 8.10 ============================================================================== Exercisable at December 31, 1997 71,511 221,212 15,000 $ 5.27 ============================================================================== Exercisable at December 31, 1996 8,375 189,549 5,034 $ 2.72 ============================================================================== 62 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 The following table discloses at December 31, 1998, for each of the following classes of options as determined by range of exercise price, the information regarding weighted-average exercise price and weighted-average remaining contractual life of each said class: Weighted Weighted Weighted Average Average Average Remaining Exercise Exercise Contractual Number Of Price of Number Of Price of Life Of Options Options Options Outstanding Outstanding Currently Currently Option Class Outstanding Options Options Exercisable Exercisable ------------ ----------- ------- ------- ----------- ----------- Prices ranging from $1.76 - $2.00 232,864 $ 1.80 3.8 years 218,776 $ 1.79 Prices ranging from $10.125 - $15.25 1,013,235 $12.86 9.0 years 137,945 $12.76 Prices ranging from $16.50 - $16.75 142,000 $16.58 7.3 years 86,750 $16.61 The following table discloses for each of the years ending December 31, 1998, 1997 and 1996, the number of options granted, the weighted-average fair values and the weighted-average exercise prices for those options with exercise prices that equaled or were less than the market price of the common stock on the date of grant. There were no options granted with an exercise price above the market price of the common stock on the date of grant. 1998 1997 1996 ----------------------------------- -------------------------------------- ---------------------------------- Number Number Number of Fair Exercise of Fair Exercise of Fair Exercise Options Value Price Options Value Price Options Value Price - --------------- ----------- ---------- ----------- ------------ ----------- ------------ ----------- ---------- ---------- Exercise price equals market price 354,543 $7.66 $13.36 518,751 $7.59 $12.99 433,262 $ 5.75 $13.92 Exercise price less than market price -- -- -- -- -- -- 28,000 $14.44 $ 2.98
At December 31, 1998, 125 of the shares sold under the 1988 Plan remain subject to repurchase at an aggregate price of $250. Other Disclosures. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had been accounting for its employee stock options under the fair value method of SFAS No. 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for 1998, 1997 and 1996, respectively: weighted average risk-free interest rates of 4.70%, 5.92% and 6.34%; no dividends; and a weighted-average expected life of the options of 5 years. Weighted average volatility factors of the expected 63 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 market price of the Company's common stock of .628, .623 and .352, were used for 1998, 1997 and 1996, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma net loss disclosures, the estimated fair value of options granted subsequent to 1994 is amortized to expense over the options' vesting period. The Company's pro forma net loss information is as follows: 1998 1997 1996 - -------------------------------------------------------------------------------- Pro forma net loss $ (7,863,000) $ (6,113,000) $ (2,847,000) Pro forma net loss per share $ (0.74) $ (0.75) $ (0.38) - -------------------------------------------------------------------------------- The pro forma information above is not likely to be representative of the effects on reported net loss for future years as options are generally granted each year and vest over several years and only include grants subsequent to 1994. For certain options granted during 1996, the Company has recorded pursuant to APB No. 25 approximately $388,000 of deferred compensation expense representing the difference between the exercise price thereof and the market value of the common stock as of the date of grant. This compensation expense is amortized over the vesting period of each option granted. Amortization of deferred compensation under the Incentive Plans amounted to approximately $79,000, $124,000 and $179,000 during 1998, 1997 and 1996, respectively. In addition, approximately $20,000, $12,000 and $121,000 of deferred compensation as it relates to the Incentive Plans was reversed during 1998, 1997 and 1996, respectively, due to the forfeiture of the unvested options. Note 8 -- Income Taxes The liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. At December 31, 1998 and 1997, the Company had net operating loss ("NOL") carryforwards of approximately $30,000,000 and $25,000,000, respectively, for Federal income tax purposes that will expire principally in the years 2002 through 2018. In addition, the Company had research and development credit 64 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 carryforwards of approximately $1,610,000 which will expire principally in 2002 through 2018. For financial reporting purposes, a valuation allowance has been recognized to offset the deferred tax assets related to these carryforwards. Due to the limitations imposed by the Tax Reform Act of 1986, and as a result of significant changes in the Company's ownership in 1993 and 1997, the utilization of approximately $25,000,000 of net operating loss carryforwards is subject to annual limitation. The utilization of the research and development credits is similarly limited. A reconciliation of the Company's income tax expense (benefit) at U.S. federal statutory tax rates to recorded income tax expense (benefit) is as follows: 1998 1997 1996 - -------------------------------------------------------------------------------- Tax at U.S. statutory rates $(2,208,000) $(1,818,000) $ (895,000) State income taxes (386,000) (318,000) (156,000) Research and development credit (110,000) -- -- Expiration of state NOL's 2,000 356,000 -- Other 50,000 108,000 8,000 Valuation allowance recorded 2,652,000 1,672,000 1,043,000 - -------------------------------------------------------------------------------- Recorded tax provision -- -- -- ================================================================================ Significant components of the Company's deferred tax assets as of December 31, 1998 and 1997, are as follows: 1998 1997 - -------------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforwards $ 11,782,000 $ 9,752,000 Research and development credit carryforwards 1,610,000 1,500,000 Book over tax amortization 1,282,000 770,000 - -------------------------------------------------------------------------------- Total deferred tax assets 14,674,000 12,022,000 Valuation allowance (14,674,000) (12,022,000) - -------------------------------------------------------------------------------- Net deferred tax assets -- -- ================================================================================ Note 9 -- Commitments The Company leases facilities under an agreement expiring on December 31, 2015. Rent expense for the years ended December 31, 1998, 1997 and 1996 approximated $693,000, $703,000, and $674,000, respectively, and included executory costs of $126,000, $120,000 and $93,000, respectively. In November 1996, a standby letter of credit for $580,000 was issued to the landlord as a security deposit (expires February 1999). The Company is to renew the letter of credit annually during the duration of the lease. As of December 31, 1998, a bank imposed restriction has been placed on $600,000 in cash held in the Company's investment account to secure the letter of credit. 65 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 As of December 31, 1998, future minimum annual payments under the lease are as follows: 1999 $ 1,107,000 2000 1,251,000 2001 1,309,000 2002 1,309,000 2003 1,309,000 Thereafter 20,482,000 ------------ Total $ 26,767,000 ============ The Company is party to a license agreement with a major research university. Under the terms of this agreement, the Company received a worldwide nonexclusive license under a patent issued in January 1991, which patent expires in 2008. The Company is committed under this agreement to pay royalties on future net sales of products employing the technology or falling under claims of the patents covered by this agreement. The Company has an employment agreement with its Chairman, President and Chief Executive Officer which provides for severance payments of up to one year of base salary upon the occurrence of certain events, including early termination and termination upon a change in control, as defined. In addition to severance payments, under certain circumstances, the agreement calls for immediate vesting of any unvested shares of common stock and stock options. At December 31, 1998, the Company had entered into agreements with each of its Senior Vice President and Chief Financial Officer, Vice President for Research, Vice President and General Counsel and Vice President of Business Development which provide for severance payments in amounts equal to 50% of annual base salary, on substantially the same terms as stated above. In addition to severance, under certain circumstances, the agreements call for immediate vesting of any unvested shares of common stock and stock options. Note 10 -- Employee Benefit Plans The Company established a defined contribution employee retirement plan (the "Plan") effective January 1, 1990, conforming to Section 401(k) of the Internal Revenue Code ("IRC"). All eligible employees with six months service may elect to have a portion of their salary deducted and contributed to the Plan up to the maximum allowable limitations of the IRC. The Company matches 50% of each participant's contribution up to the first 5% of annual compensation (as defined) with a maximum employer contribution of 2.5% of a participant's compensation. The Company's matching portion, which amounted to approximately $117,000, $107,000 and $103,000 for the years ended December 31, 1998, 1997 and 1996, respectively, vests over a six-year period. 66 SYNAPTIC PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS--(Continued) December 31, 1998 The Company currently provides medical, dental, long-term disability and life insurance benefits for its full-time employees. The Company does not presently provide any post-retirement health benefits. Note 11 -- Subsequent Event On February 4, 1999, the Company and Lilly entered into an amendment to the collaborative and license agreement dated as of January 25, 1991. Under the terms of the amendment the parties extended the terms of the collaboration from December 31, 1998, to July, 31, 1999. The amendment requires Lilly to provide research funding to the Company in consideration for research support provided by the Company to Lilly. The amount of such research funding has been reduced from that level which existed at December 31, 1998. 67 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Part III Item 10. Directors and Executive Officers of the Registrant The information required by this item is incorporated herein by reference from the information under the captions "ELECTION OF DIRECTORS" and "COMPENSATION AND OTHER INFORMATION CONCERNING OFFICERS, DIRECTORS AND CERTAIN STOCKHOLDERS" contained in the Proxy Statement. Item 11. Executive Compensation The information required by this item is incorporated herein by reference from the information under the caption "COMPENSATION AND OTHER INFORMATION CONCERNING OFFICERS, DIRECTORS AND CERTAIN STOCKHOLDERS" contained in the Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this item is incorporated herein by reference from the information under the caption "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" contained in the Proxy Statement. Item 13. Certain Relationships and Related Transactions The information required by this item is incorporated herein by reference from the information under the caption "COMPENSATION AND OTHER INFORMATION CONCERNING OFFICERS, DIRECTORS AND CERTAIN STOCKHOLDERS" contained in the Proxy Statement. 68 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) (1) Financial Statements Reference is made to the Index to Financial Statements under Item 8, Part II hereof. (2) Financial Statement Schedules The Financial Statement Schedules have been intentionally omitted either because they are not required or because the information has been included in the notes to the Financial Statements included in this Report on Form 10-K. (3) Exhibits Exhibit No. Description - ---------- -------------------------------------------------------------- 3.1(a) Amended and Restated Certificate of Incorporation of the Company, filed December 19, 1995 (incorporated by reference to Exhibit 3.1(a) to the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1996, Commission File Number 0-27324) 3.1(b) Certificate of Designations of Series A Junior Participating Preferred Stock filed December 19, 1995 (incorporated by reference to Exhibit 3.1(b) to the Company's Quarterly Report on Form 10-Q filed for the quarter ended December 31, 1995, Commission File Number 0-27324) 3.1(c) Certificate of Amendment of the Amended and Restated Certificate of Incorporation of the Company, filed June 5, 1996 (incorporated by reference to Exhibit 3.1(c) to the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1996, Commission File Number 0-27324) 3.2 Amended and Restated By-Laws of the Company, as amended on February 6, 1998 (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File Number 0-27324) 4.1 Specimen of Certificate of Common Stock of the Company (incorporated by reference to Exhibit 4 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) 69 4.2 Rights Agreement dated as of December 11, 1995, between the Company and Chase Mellon Shareholder Services, as Rights Agent (incorporated by reference to Exhibit 4.2 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1995, Commission File Number 0-27324) *10.1 Research, Option and License Agreement dated as of January 25, 1991, between the Company and Eli Lilly and Company, as amended by Addendum dated as of January 1, 1995 (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) *10.2 Research Collaboration and License Agreement dated as of November 30, 1993, between the Company and Merck & Co., Inc., as amended by Amendment No. 1 dated as of February 15, 1995, and as modified by the Letter Agreement dated August 25, 1995 (incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) *10.3 Research and License Agreement dated as of August 4, 1994, between the Company and Ciba-Geigy Limited (predecessor-in-interest of Novartis AG, the parent of Novartis Pharma AG) (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.4 1988 Amended and Restated Incentive Plan of the Company (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.5 Form of Restricted Stock Purchase Agreement under the 1988 Amended and Restated Incentive Plan of the Company (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.6 Form of Incentive Stock Option Agreement under the 1988 Amended and Restated Incentive Plan of the Company (incorporated by reference to Exhibit 10.11 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.7 Form of Nonqualified Stock Option Agreement under the 1988 Amended and Restated Incentive Plan of the Company (incorporated by reference to Exhibit 10.12 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) 10.8 Third Amended and Restated Registration Rights Agreement dated as of January 19, 1993, as amended by Amendment No. 1 dated as of August 4, 1994 (incorporated by reference to Exhibit 10.13 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) 70 10.9 Form of Common Stock Purchase Warrant dated as of January 1993 (incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) 10.10 License Agreement dated June 3, 1991, between the Company and the Trustees of Columbia University in the City of New York (incorporated by reference to Exhibit 10.16 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.11 Employment Agreement dated as of February 14, 1994, between the Company and Robert I. Taber (incorporated by reference to Exhibit 10.21 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.12 Employment Agreement dated as of April 6, 1995, between the Company and Richard L. Weinshank (incorporated by reference to Exhibit 10.24 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) 10.13 Form of Indemnification Agreement between the Company and each of its executive officers and directors (incorporated by reference to Exhibit 10.25 to the Company's Registration Statement on Form S-1,as amended (File Number 33-98366), which became effective on December 13, 1995) +10.14 1996 Incentive Plan of the Company, as amended on May 12, 1998 (filed herewith) +10.15 Incentive Stock Option Agreement dated October 1, 1993, between the Company and Kathleen P. Mullinix (incorporated by reference to Exhibit 10.28 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.16 Incentive Stock Option Agreement dated February 14, 1994, between the Company and Robert I. Taber (incorporated by reference to Exhibit 10.29 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.17 Incentive Stock Option Agreement dated February 7, 1994, between the Company and Lisa L. Reiter (incorporated by reference to Exhibit 10.30 to the Company's Registration Statement on Form S-1, as amended (File Number 33-98366), which became effective on December 13, 1995) +10.18 Incentive Stock Option Agreement dated as of March 21, 1996, between the Company and Kathleen P. Mullinix (incorporated by reference to Exhibit 10.25 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1996, Commission File Number 0-27324) 71 +10.19 Incentive Stock Option Agreement dated as of March 21, 1996, between the Company and Robert L. Spence (incorporated by reference to Exhibit 10.26 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1996, Commission File Number 0-27324) +10.20 Incentive Stock Option Agreement dated as of March 21, 1996, between the Company and Lisa L. Reiter (incorporated by reference to Exhibit 10.27 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1996, Commission File Number 0-27324) +10.21 Nonqualified Stock Option Agreement dated as of March 21, 1996, between the Company and Richard L. Weinshank (incorporated by reference to Exhibit 10.28 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1996, Commission File Number 0-27324) +10.22 Form of Incentive Stock Option Agreement under the 1996 Incentive Plan (incorporated by reference to Exhibit 10.29 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1996, Commission File Number 0-27324) +10.23 Form of Nonqualified Stock Option Agreement under the 1996 Incentive Plan (incorporated by reference to Exhibit 10.30 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1996, Commission File Number 0-27324) ***10.24 Research and License Agreement dated as of May 31, 1996, between the Company and Ciba-Geigy Limited (predecessor-in-interest of Novartis AG, parent of Novartis Pharma AG) (incorporated by reference to Exhibit 10.31 to the Company's Quarterly Report on Form 10-Q/A filed for the quarter ended June 30, 1996, Commission File Number 0-27324) ***10.25 Supplement No. 1 to Research and License Agreement dated as of August 4, 1994, between the Company and Ciba-Geigy Limited (predecessor-in-interest of Novartis AG, parent of Novartis Pharma AG) (incorporated by reference to Exhibit 10.32 to the Company's Quarterly Report on Form 10-Q/A filed for the quarter ended June 30, 1996, Commission File Number 0-27324) 10.26 1996 Nonemployee Director Stock Option Plan of the Company (incorporated by reference to Exhibit 10.33 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1996, Commission File Number 0- 27324) 10.27 Form of Stock Option Agreement under the 1996 Nonemployee Director Stock Option Plan of the Company (incorporated by reference to Exhibit A attached to Exhibit 10.33 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1996, Commission File Number 0-27324) **10.28 Addendum No. 2 to Research, Option and License Agreement dated as of October 31, 1996, between the Company and Eli Lilly and Company (incorporated by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1996, Commission File No. 0-27324) 72 ***10.29 Amendment No.2 to Research Collaboration and License Agreement dated as of October 9, 1996, between the Company and Merck & Co., Inc. (incorporated by reference to Exhibit 10.36 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1996, Commission File No. 0-27324) +10.30 Incentive Stock Option Agreement dated as of December 13, 1996, between the Company and Kathleen P. Mullinix (incorporated by reference to Exhibit 10.37 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1996, Commission File No. 0-27324) +10.31 Form of Incentive Stock Option Agreement dated as of December 13, 1996, entered into between the Company and each of Robert L. Spence, Robert I. Taber, Lisa L. Reiter and Richard L. Weinshank (incorporated by reference to Exhibit 10.38 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1996, Commission File No. 0-27324) ***10.32 Collaborative Research and License Agreement dated as of July 28, 1997, between the Company and the Warner-Lambert Company (incorporated by reference to Exhibit 10.39 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended September 30, 1997, Commission File Number 0- 27324) +10.33 Executive Employment Agreement effective as of October 1,1997, between the Company and Dr. Kathleen P. Mullinix (incorporated by reference to Exhibit 10.34 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) 10.34 Lease Agreement dated November 19, 1997, between the Company and Century Associates, which becomes effective January 1, 1998 (incorporated by reference to Exhibit 10.35 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0- 27324) 10.35 Amendment No. 3 to Research Collaboration and License Agreement dated as of December 1, 1997, between the Company and Merck & Co., Inc. (incorporated by reference to Exhibit 10.36 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) +10.36 Amended and Restated Employment Agreement dated as of January 1, 1998, between the Company and Robert L. Spence (incorporated by reference to Exhibit 10.37 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) ***10.37 Cooperation Agreement dated as of January 12, 1998, between the Company and Grunenthal GmbH (incorporated by reference to Exhibit 10.38 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) 73 +10.38 Amended and Restated Employment Agreement dated as of February 7, 1998, between the Company and Lisa L. Reiter (incorporated by reference to Exhibit 10.39 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) 10.39 Amendment No.4 to Research Collaboration and License Agreement dated as of March 2, 1998, between the Company and Merck & Co., Inc. (incorporated by reference to Exhibit 10.40 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) ***10.40 Option and License Agreement dated as of March 2, 1998, between the Company and Glaxo Group Limited (incorporated by reference to Exhibit 10.41 to the Company's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1997, Commission File No. 0-27324) +10.41 Employment Agreement dated as of April 1, 1998, between the Company and Theresa A. Branchek (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended March 31, 1998, Commission File Number 0-27324) +10.42 Incentive Stock Option Agreement dated as of May 12, 1998, between the Company and Theresa A. Branchek (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1998, Commission File Number 0-27324) +10.43 Nonqualified Stock Option Agreement dated as of May 12, 1998, between the Company and Theresa A. Branchek (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1998, Commission File Number 0-27324) 10.44 Amendment No. 1 to Cooperation Agreement between the Company and Grunenthal GmbH (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended September 30, 1998, Commission File Number 0-27324) 10.45 First Amendment to Lease dated as of November 25, 1998, between ARE-215 College Road, LLC, and the Company (filed herewith) 10.46 Amendment No.5 to Research Collaboration and License Agreement dated as of December 1, 1998, between the Company and Merck & Co., Inc. (filed herewith) 10.47 Addendum No. 3 to Research, Option and License Agreement effective as of January 1, 1999, between the Company and Eli Lilly and Company (filed herewith) 23.1 Consent of Independent Auditors, Ernst & Young LLP 24 Powers of Attorney 27 Financial Data Schedule - ----------------- 74 * Portions of this Exhibit were omitted and confidential treatment thereof has been granted by the Secretary of the Securities and Exchange Commission in response to the Registrant's Application Requesting Confidential Treatment under Rule 406 under the Securities Act of 1933, as amended. ** Portions of this Exhibit have been omitted and filed separately with the Secretary of the Securities and Exchange Commission pursuant to the Registrant's Application Requesting Confidential Treatment under Rule 24b-2 under the Securities Exchange Act of 1934, as amended. *** Portions of this Exhibit were omitted and confidential treatment thereof has been granted by the Secretary of the Securities and Exchange Commission in response to the Registrant's Application Requesting Confidential Treatment under Rule 246-2 under the Securities Act of 1933, as amended. + Management contracts and compensatory plans or arrangements (b) Reports on Form 8-K There were no reports on Form 8-K filed by the Registrant during the fourth quarter of the fiscal year ended December 31, 1998. Supplemental Information Copies of the Registrant's Proxy Statement and copies of the form of proxy to be used at the Annual Meeting of Stockholders to be held on May 6, 1999, will be furnished to the Securities and Exchange Commission at the time they are distributed to the Registrant's stockholders. Amerge(R), Imitrex(R), Wellbutrin(R), Zantac(R) and Zyban(R) are registered trademarks of Glaxo Wellcome Inc. Benzedrine(R), Dexedrine(R) and Paxil(R) are registered trademarks of SmithKline Beecham Pharmaceuticals. Hytrin(R) is the registered trademark of Abbott Laboratories. Prozac(R) is the registered trademark of Lilly and Dista Products. Maxalt(R) and Proscar(R) are registered trademarks of Merck. Pondimin(R) is the registered trademark of A.H. Robins Company, Inc. Redux(R) is the registered trademark of Wyeth Ayerst Laboratories. Zoloft(R) and Cardura(R) are registered trademarks of Pfizer Inc. Flomax(R) is the registered trademark of Boehringer Ingelheim Pharmaceuticals Inc. Claritin(R) is the registered trademark of Schering Corporation. Propulsid(R) is the registered trademark of Johnson & Johnson. Zomig(R) is the registered trademark of Zeneca Inc. Meridia(R) is the registered trademark of Knoll Pharmaceutical Co. Celexa(R) is the registered trademark of Forest Laboratories. All other brand names or trademarks appearing in this Report are the property of their respective owners. 75 SIGNATURE PAGE 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. SYNAPTIC PHARMACEUTICAL CORPORATION Date: March 23, 1999 By: /s/ Kathleen P. Mullinix --------------------------- Name: Kathleen P. Mullinix Title: Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated. Signature Title Date - --------------------------- -------------------------------- -------------- /s/ Kathleen P. Mullinix Chairman, President and - --------------------------- Chief Executive Officer March 23, 1999 Kathleen P. Mullinix, Ph.D. /s/ Robert L. Spence Senior Vice President and - --------------------------- Chief Financial Officer Robert L. Spence (Principal Accounting Officer) March 23, 1999 * Director March 23, 1999 - --------------------------- Jonathan J. Fleming * Director March 23, 1999 - --------------------------- Zola P. Horovitz, Ph.D. * Director March 23, 1999 - --------------------------- Eric R. Kandel, M.D. * Director March 23, 1999 - --------------------------- John E. Lyons * Director March 23, 1999 - --------------------------- Sandra Panem * Director March 23, 1999 - --------------------------- Alison Taunton-Rigby, Ph.D. * By: /s/ Kathleen P. Mullinix Name: Kathleen P. Mullinix, Ph.D. Title: Attorney-in-Fact EX-10.14 2 EXHIBIT 10.14 ------------- SYNAPTIC PHARMACEUTICAL CORPORATION 1996 INCENTIVE PLAN ARTICLE 1 ESTABLISHMENT AND PURPOSE 1.1 Establishment and Effective Date. Synaptic Pharmaceutical Corporation, a Delaware corporation (the "Corporation"), hereby establishes a stock incentive plan to be known as the "Synaptic Pharmaceutical Corporation 1996 Incentive Plan" (the "Plan"). The Plan shall become effective as of January 1, 1996, subject to the approval of the stockholders of the Corporation. In the event that such stockholder approval is not obtained, any awards made hereunder shall be cancelled and all rights of employees and consultants with respect to such awards shall thereupon cease. Upon approval of the Plan by the Board of Directors of the Corporation (the "Board"), awards may be made by the Board's Compensation Committee (the "Committee"), as provided herein. 1.2 Purpose. The purpose of the Plan is to encourage and enable key employees and consultants (subject to such requirements as may be prescribed by the Committee) of the Corporation and its subsidiaries to acquire a proprietary interest in the Corporation through the ownership of the Corporation's common stock, par value $0.01 per share ("Common Stock"), and other rights with respect to the Common Stock. Such ownership will provide such employees and consultants with a more direct stake in the future welfare of the Corporation and encourage them to remain with the Corporation and its subsidiaries. It is also expected that the Plan will encourage qualified persons to seek and accept employment with the Corporation and its subsidiaries. ARTICLE 2 AWARDS 2.1 Form of Awards. Awards under the Plan may be granted in any one or all of the following forms: (i) incentive stock options ("Incentive Stock Options") meeting the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"); (ii) non-qualified stock options ("Non-qualified Stock Options") (unless otherwise indicated, references in the Plan to "Options" shall include both Incentive Stock Options and Non-qualified Stock Options); (iii) stock appreciation rights ("Stock Appreciation Rights"), as described in Article 6 hereof, which may be awarded either in tandem with Options ("Tandem Stock Appreciation Rights") or on a stand-alone basis ("Nontandem Stock Appreciation Rights"); (iv) shares of Common Stock which are subject to vesting requirements as provided in Article 9 hereof ("Restricted Shares"); (v) shares of 1 Common Stock that are not subject to any vesting requirements ("Unrestricted Shares"); and (vi) tax offset payments ("Tax Offset Payments"), as described in Article 11 hereof. 2.2 Maximum Shares Available. The maximum aggregate number of shares of Common Stock available for award under the Plan is 2,100,000 (as constituted on March 6, 1998), subject to adjustment pursuant to Article 12 hereof. Shares of Common Stock issued pursuant to the Plan may be either authorized but unissued shares or issued shares reacquired by the Corporation. In the event that prior to the end of the period during which Options may be granted under the Plan, any Option or any Nontandem Stock Appreciation Rights under the Plan expires unexercised or is terminated, surrendered or cancelled (other than in connection with the exercise of Stock Appreciation Rights) without being exercised in whole or in part for any reason, or any Restricted Shares are forfeited, or if such awards are settled in cash in lieu of shares of Common Stock, then such shares shall be available for subsequent awards under the Plan, upon such terms as the Committee may determine. The aggregate number of shares of Common Stock that may be represented by grants of Options or Stock Appreciation Rights made to any individual during any two-year period may not exceed 250,000 shares, subject to adjustment pursuant to Article 12 hereof. 2.3 Return of Prior Awards. As a condition to any subsequent award, the Committee shall have the right, in its sole discretion, to require employees to return to the Corporation awards previously granted under the Plan. Subject to the provisions of the Plan, such new award shall be upon such terms and conditions as are specified by the Committee at the time the new award is granted. ARTICLE 3 ADMINISTRATION 3.1 Committee. Awards shall be determined, and the Plan shall be administered, by the Committee as appointed from time to time by the Board, which Committee shall consist of not less than two (2) members of the Board; provided, however, that from and after the consummation of the initial public offering of the Common Stock and so long as the Plan shall be required to comply with Rule 16b-3 ("Rule 16b-3") promulgated by the Securities and Exchange Commission (the "SEC") under the Securities Exchange Act of 1934, as amended (the "1934 Act"), in order to permit transactions pursuant to the Plan by employees of the Corporation to be exempt from the provisions of Section 16(b) of the 1934 Act, each member of the Committee, at the effective date of his appointment to the Committee, shall be a "disinterested person," as that term is defined in subparagraph (c)(2)(i) of Rule 16b-3, as in effect from time to time, under the 1934 Act. 3.2 Powers of the Committee. Subject to the express provisions of the Plan, the Committee shall have the power and authority (i) to grant Options and to determine the purchase price of the Common Stock covered by each Option, the term of each Option, the number of shares of Common Stock to be covered by each Option, the time or times at which each Option shall become exercisable and the duration of the exercise period applicable to each Option; (ii) to designate Options as Incentive Stock Options or Non-qualified Stock Options and to determine 2 which Options, if any, shall be accompanied by Tandem Stock Appreciation Rights, (iii) to grant Tandem Stock Appreciation Rights and Nontandem Stock Appreciation Rights and to determine the terms and conditions of such rights; (iv) to grant or cause to be sold Restricted Shares and to determine the purchase price, if any, of such shares and the vesting period and other conditions and restrictions applicable to such shares; (v) to grant or cause to be sold Unrestricted Shares and to determine the purchase price, if any, of such shares; (vi) to determine the amount of, and to make, Tax Offset Payments; (vii) to determine the employees and the consultants to whom, and the time or times at which, Options, Stock Appreciation Rights, Restricted Shares, Unrestricted Shares and Tax Offset Payments shall be granted or made and (viii) to take all other actions contemplated to be taken by the Committee under the Plan, including, but not limited to, authorizing the amendment of any written agreement relating to any award made hereunder. Without limiting the foregoing, in the event of a merger, consolidation, combination, exchange of shares, separation, spin-off, reorganization, liquidation or other similar transaction, the Committee may, in its sole discretion, accelerate the lapse of Restricted Periods and other vesting periods and waiting periods and extend the exercise periods applicable to any award made under the Plan. 3.3 Delegation. The Committee may delegate to one or more of its members or to any other person or persons such ministerial duties as it may deem advisable; provided, however, that the Committee may not delegate any of its responsibilities hereunder if such delegation would cause the Plan to fail to comply with the "disinterested administration" rules under Section 16 of the Act. The Committee may also employ attorneys, consultants, accountants or other professional advisors and shall be entitled to rely upon the advice, opinions or valuations of any such advisors. 3.4 Interpretations. The Committee shall have sole discretionary authority to interpret the terms of the Plan, to adopt and revise rules, regulations and policies to administer the Plan and to make any other factual determinations which it believes to be necessary or advisable for the administration of the Plan. All actions taken and interpretations and determinations made by the Committee in good faith shall be final and binding upon the Corporation, all employees and consultants who have received awards under the Plan and all other interested persons. 3.5 Liability; Indemnification. No member of the Committee, nor any person to whom ministerial duties have been delegated, shall be personally liable for any action, interpretation or determination made with respect to the Plan or awards made thereunder, and each member of the Committee shall be fully indemnified and protected by the Corporation with respect to any liability he or she may incur with respect to any such action, interpretation or determination, to the extent permitted by applicable law and to the extent provided in the Corporation's Certificate of Incorporation and Bylaws, as amended from time to time, or under any agreement between any such member and the Corporation. 3 ARTICLE 4 ELIGIBILITY Awards may be made to all employees and consultants of the Corporation or any of its subsidiaries (subject to such requirements as may be prescribed by the Committee). Awards may be made to a director of the Corporation who is not also a member of the Committee, provided that the director is also an employee. In determining the employees and consultants to whom awards shall be granted and the number of shares to be covered by each award, the Committee shall take into account the nature of the services rendered by such employees and consultants, their present and potential contributions to the success of the Corporation and its subsidiaries and such other factors as the Committee in its sole discretion shall deem relevant. Notwithstanding the foregoing, only employees of the Corporation and any present or future corporation which is or may be a "subsidiary corporation" of the Corporation (as such term is defined in Section 424 (f) of the Code) shall be eligible to receive Incentive Stock Options. ARTICLE 5 STOCK OPTIONS 5.1 Grant of Options. Options may be granted under the Plan for the purchase of shares of Common Stock. Options shall be granted in such form and upon such terms and conditions, including the satisfaction of corporate or individual performance objectives and other vesting standards, as the Committee shall from time to time determine. 5.2 Designation as Non-qualified Stock Option or Incentive Stock Option. In connection with any grant of Options, the Committee shall designate in the written agreement required pursuant to Article 14 hereof whether the Options granted shall be Incentive Stock Options or Non-qualified Stock Options, or in the case both are granted, the number of shares of each. 5.3 Option Price. The purchase price per share under each Incentive Stock Option shall be the Market Price (as hereinafter defined) of the Common Stock on the date the Incentive Stock Option is granted. The purchase price per share under each Non-qualified Stock Option shall be determined by the Committee. In no case, however, shall the purchase price per share of either an Incentive Stock Option or Non-qualified Stock Option be less than the par value of the Common Stock ($0.01). In the case of an Incentive Stock Option granted to an employee owning (actually or constructively under Section 424(d) of the Code), more than 10% of the total combined voting power of all classes of stock of the Corporation or of a subsidiary (a "10% Stockholder"), the option price shall not be less than 110% of the Market Price of the Common Stock on the date of grant. The "Market Price" of the Common Stock on any day shall be determined as follows: (i) if the Common Stock is listed on a national securities exchange or quoted through the NASDAQ National Market System, the Market Price on any day shall be, in the sole discretion of the 4 Committee, either (x) the average of the high and low reported Consolidated Trading sales prices, or if no such sale is made on such day, the average of the closing bid and asked prices reported on the Consolidated Trading listing for such day or (y) the closing price reported on the Consolidated Trading listing for such day; (ii) if the Common Stock is quoted on the NASDAQ interdealer quotation system, the Market Price on any day shall be the average of the representative bid and asked prices at the close of business for such day; or (iii) if the Common Stock is not listed on a national stock exchange or quoted on NASDAQ, the Market Price on any day shall be the average of the high bid and low asked prices reported by the National Quotation Bureau, Inc. for such day. In no event shall the Market Price of a share of Common Stock subject to an Incentive Stock Option be less than the fair market value as determined for purposes of Section 422(b)(4) of the Code. The Option price so determined shall also be applicable in connection with the exercise of any Tandem Stock Appreciation Rights granted with respect to such Option. 5.4 Limitation on Amount of Incentive Stock Options. In the case of Incentive Stock Options, the aggregate Market Price (determined at the time the Incentive Stock Option is granted) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by any optionee during any calendar year (under all plans of the Corporation and any subsidiary) shall not exceed $100,000. 5.5 Limitation on Time of Grant. No grant of an Incentive Stock Option shall be made under the Plan more than ten (10) years after the date the Plan is approved by the stockholders of the Corporation. 5.6 Exercise and Payment. Options may be exercised in whole or in part. Common Stock purchased upon the exercise of Options shall be paid for at the time of purchase. Such payment shall be made in cash or, in the sole discretion of the Committee, through delivery of shares of Common Stock, installment payments under the optionee's promissory note or a combination of cash, Common Stock and/or installment payments, in accordance with procedures to be established by the Committee. Any shares so delivered shall be valued at their Market Price on the date of exercise. Upon receipt of a notice of exercise and payment in accordance with procedures to be established by the Committee, the Corporation or its agent shall deliver to the person exercising the Option (or his or her designee) a certificate for such shares. The Committee in its sole discretion may, on an individual basis or pursuant to a general program established by the Committee in connection with the Plan, lend money to an optionee to exercise all or a portion of an Option granted hereunder. If the exercise price is paid in whole or part with an optionee's promissory note, such note shall (i) provide for full recourse to the maker, (ii) be collateralized by the pledge of the shares of Common Stock that the optionee purchases upon exercise of such Option, (iii) bear interest at a rate no less than the applicable Federal rate (within the meaning of Section 1274 of the Code), and (iv) contain such other terms as the Committee in its sole discretion shall require. In the event that payment for exercised Options is made through the delivery of shares of Common Stock, the Committee, in accordance with procedures established by the Committee, may grant Non-qualified Stock Options ("Restoration Options") to the person exercising the Option for the purchase of a number of shares equal to the 5 number of shares of Common Stock delivered to the Corporation in connection with the payment of the exercise price of the Option and the payment of or surrender of shares for any withholding taxes due upon such exercise. The purchase price per share under each Restoration Option shall be the Market Price of the Common Stock on the date the Restoration Option is granted. 5.7 Term. The term of each Option granted hereunder shall be determined by the Committee; provided, however, that, notwithstanding any other provision of the Plan, in no event shall an Incentive Stock Option be exercisable after ten (10) years from the date it is granted, or in the case of an Incentive Stock Option granted to a 10% Stockholder, five (5) years from the date it is granted. 5.8 Rights as a Stockholder. A recipient of Options shall have no rights as a stockholder with respect to any shares issuable or transferable upon exercise thereof until the date a stock certificate representing such shares is issued to such recipient. Except as otherwise expressly provided in the Plan or by the Committee, no adjustment shall be made for cash dividends or other rights for which the record date is prior to the date such stock certificate is issued. 5.9 General Restrictions. Each Option granted under the Plan shall be subject to the requirement that, if at any time the Board shall determine, in its sole discretion, that the listing, registration or qualification of the shares issuable or transferable upon exercise thereof upon any securities exchange or under any state or Federal law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the granting of such Option or the issue, transfer, or purchase of shares thereunder, such Option may not be exercised in whole or in part unless such listing, registration, qualification, consent, or approval shall have been effected or obtained free of any conditions not acceptable to the Board. The Board or the Committee may, in connection with the granting of any Option, require the individual to whom the Option is to be granted to enter into an agreement with the Corporation stating that as a condition precedent to each exercise of the Option, in whole or in part, such individual shall if then required by the Corporation represent to the Corporation in writing that such exercise is for investment only and not with a view to distribution, and also setting forth such other terms and conditions as the Board or the Committee may prescribe. 5.10 Cancellation of Stock Appreciation Rights. Upon exercise of all or a portion of an Option, the related Tandem Stock Appreciation Rights shall be cancelled with respect to an equal number of shares of Common Stock. ARTICLE 6 STOCK APPRECIATION RIGHTS 6.1 Grants of Stock Appreciation Rights. Tandem Stock Appreciation Rights may be awarded by the Committee in connection with any Option granted under the Plan, either at the time the Option is granted or thereafter at any time prior to the exercise, termination or expiration of the 6 Option. Nontandem Stock Appreciation Rights may also be granted by the Committee at any time. At the time of grant of Nontandem Stock Appreciation Rights, the Committee shall specify the number of shares of Common Stock covered by such right and the base price of shares of Common Stock to be used in connection with the calculation described in Section 6.4 below. The base price of any Nontandem Stock Appreciation Rights shall be not less than 100% of the Market Price of a share of Common Stock on the date of grant. Stock Appreciation Rights shall be subject to such terms and conditions not inconsistent with the other provisions of the Plan as the Committee shall determine. 6.2 Limitations on Exercise. Tandem Stock Appreciation Rights shall be exercisable only to the extent that the related Option is exercisable and shall be exercisable only for such period as the Committee may determine (which period may expire prior to the expiration date of the related Option). Upon the exercise of all or a portion of Tandem Stock Appreciation Rights, the related Option shall be cancelled with respect to an equal number of shares of Common Stock. Shares of Common Stock subject to Options, or portions thereof, surrendered upon exercise of Tandem Stock Appreciation Rights shall not be available for subsequent awards under the Plan. Nontandem Stock Appreciation Rights shall be exercisable during such period as the Committee shall determine. 6.3 Surrender or Exchange of Tandem Stock Appreciation Rights. Tandem Stock Appreciation Rights shall entitle the recipient to surrender to the Corporation unexercised the related Option, or any portion thereof, and to receive from the Corporation in exchange therefor that number of shares of Common Stock having an aggregate Market Price equal to (A) the excess of (i) the Market Price of one (1) share of Common Stock as of the date the Tandem Stock Appreciation Rights are exercised over (ii) the option price per share specified in such Option, multiplied by (B) the number of shares of Common Stock subject to the Option, or portion thereof, which is surrendered. Cash shall be delivered in lieu of any fractional shares. 6.4 Exercise of Nontandem Stock Appreciation Rights. The exercise of Nontandem Stock Appreciation Rights shall entitle the recipient to receive from the Corporation that number of shares of Common Stock having an aggregate Market Price equal to (A) the excess of (i) the Market Price of one (1) share of Common Stock as of the date on which the Nontandem Stock Appreciation Rights are exercised over (ii) the base price of the shares covered by the Nontandem Stock Appreciation Rights, multiplied by (B) the number of shares of Common Stock covered by the Nontandem Stock Appreciation Rights, or the portion thereof being exercised. Cash shall be delivered in lieu of any fractional shares. 6.5 Settlement of Stock Appreciation Rights. As soon as is reasonably practicable after the exercise of any Stock Appreciation Rights, the Corporation shall (i) issue, in the name of the recipient, stock certificates representing the total number of full shares of Common Stock to which the recipient is entitled pursuant to Section 6.3 or 6.4 hereof and cash in an amount equal to the Market Price, as of the date of exercise, of any resulting fractional shares, and (ii) if the Committee causes the Corporation to elect to settle all or part of its obligations arising out of the exercise of the Stock Appreciation Rights in cash pursuant to Section 6.6 hereof, deliver to the recipient an amount in cash equal to the Market Price, as of the date of exercise, of the shares of Common Stock it would otherwise be obligated to deliver. 7 6.6 Cash Settlement. The Committee, in its sole discretion, may cause the Corporation to settle all or any part of its obligation arising out of the exercise of Stock Appreciation Rights by the payment of cash in lieu of all or part of the shares of Common Stock it would otherwise be obligated to deliver in an amount equal to the Market Price of such shares on the date of exercise. ARTICLE 7 NONTRANSFERABILITY OF OPTIONS AND STOCK APPRECIATION RIGHTS No Option or Stock Appreciation Rights may be transferred, assigned, pledged or hypothecated (whether by operation of law or otherwise), except as provided by will or the applicable laws of descent and distribution, and no Option or Stock Appreciation Rights shall be subject to execution, attachment or similar process. Any attempted assignment, transfer, pledge, hypothecation or other disposition of an Option or Stock Appreciation Rights not specifically permitted herein shall be null and void and without effect. An Option or Stock Appreciation Rights may be exercised by the recipient only during his or her lifetime, or following his or her death pursuant to Section 8.3 hereof. Notwithstanding anything to the contrary in the preceding paragraph, the Committee may, in its sole discretion, cause the written agreement relating to any Non-qualified Stock Options or Stock Appreciation Rights granted hereunder to provide that the recipient of such Non-qualified Stock Options or Stock Appreciation Rights may transfer any of such Non-qualified Stock Options or Stock Appreciation Rights other than by will or the laws of descent and distribution in any manner authorized under applicable law; provided, however, that in no event may the Committee permit any transfers which would cause the Plan to fail to satisfy the applicable requirements of Rule 16b-3 under the 1934 Act or which would cause any recipient of awards hereunder to fail to be entitled to the benefits Rule 16b-3 or other exemptive rules under Section 16 of the 1934 Act or be subject to liability thereunder. ARTICLE 8 EFFECT OF TERMINATION OF EMPLOYMENT, DISABILITY, RETIREMENT, OR DEATH 8.1 General Rule. Except as expressly provided in the written agreement relating to any Option or Stock Appreciation Rights or as otherwise expressly determined by the Committee in its sole discretion, in the event that a recipient of Options or Stock Appreciation Rights ceases to be an employee or consultant of the Corporation and its subsidiaries (a "Terminated Person") for any reason other than Disability or Retirement (as hereinafter defined) or death, any Options or Stock Appreciation Rights which were held by such Person on the date on which he or she ceased to be an employee or consultant (the "Termination Date") and which were otherwise exercisable on such Date shall expire unless exercised within the period of 30 days following the Termination Date, but in no event after the expiration of the exercise period of such Options or Stock Appreciation Rights. 8 Except as expressly provided in the written agreement relating to the Options or Stock Appreciation Rights or as otherwise expressly determined by the Committee in its sole discretion, the Committee may, in its sole discretion, cause any Option or Stock Appreciation Rights to be forfeited upon an employee's termination of employment or the termination of a consultant's consulting arrangement if the employee or consultant was terminated for one (or more) of the following reasons: (i) the employee's or consultant's conviction, or plea of guilty or nolo contendere to the commission, of a felony, (ii) the employee's or consultant's commission of any fraud, misappropriation or misconduct which causes demonstrable injury to the Corporation or a subsidiary, (iii) an act of dishonesty by the employee or consultant resulting or intended to result, directly or indirectly, in gain or personal enrichment at the expense of the Corporation or a subsidiary, (iv) any breach of the employee's or consultant's fiduciary duties to the Corporation, (v) the employee's or consultant's willful failure to perform those duties which the employee or consultant is required to perform as an employee or consultant of the Corporation or a subsidiary, (vi) in the case of an employee, a failure to devote his full time and attention exclusively to the business and affairs of the Corporation or a subsidiary; provided, however, that "cause," in the case of an employee or consultant who has an employment or consulting agreement with the Corporation or a subsidiary thereof, shall have the meaning, if any, set forth in such employment or consulting agreement. It shall be within the sole discretion of the Committee to determine whether an employee's or consultant's termination was for one of the foregoing reasons, and the decision of the Committee shall be final and conclusive. 8.2 Disability or Retirement. Except as expressly provided otherwise in the written agreement relating to any Option or Stock Appreciation Rights granted under the Plan or as otherwise determined by the Committee in its sole discretion, in the event of a termination of employment or consulting arrangement of a Terminated Person due to the Disability or Retirement of such Person, any Options or Stock Appreciation Rights which were held by such Person on the Termination Date and which were otherwise exercisable on such Date shall expire unless exercised within the period of 180 days following such Date, but in no event after the expiration date of the exercise period of such Options or Stock Appreciation Rights; provided, however, that any Incentive Stock Option of such Terminated Person shall no longer be treated as an Incentive Stock Option unless exercised within three (3) months of the Termination Date (or within one (1) year in the case of an employee who is "disabled" within the meaning of Section 22(e)(3) of the Code). "Disability" shall mean any termination of employment or consulting arrangement with the Corporation or a subsidiary because of a long-term or total disability, as determined by the Committee in its sole discretion. "Retirement" shall mean a termination of employment or consulting arrangement with the Corporation or a subsidiary with the written consent of the Committee in its sole discretion. The decision of the Committee shall be final and conclusive. 8.3 Death. Except as expressly provided in the written agreement relating to the Options or Stock Appreciation Rights or as otherwise expressly determined by the Committee in its sole discretion, in the event of the death of a recipient of Options or Stock Appreciation Rights while an employee or consultant of the Corporation or any subsidiary, any Options or Stock Appreciation Rights which were held by such Person at the date of death and which were otherwise exercisable on such date shall be exercisable by the beneficiary designated by the employee or consultant for 9 such purpose (the "Designated Beneficiary") or if no Designated Beneficiary shall be appointed or if the Designated Beneficiary shall predecease the employee, by the employee's personal representatives, heirs or legatees for a period of one (1) year from the date of death, but in no event later than the expiration date of the exercise period of such Options or Stock Appreciation Rights, at which time such Options or Stock Appreciation Rights shall expire; provided, however, that any Incentive Stock Option of such recipient shall no longer be treated as an Incentive Stock Option unless exercised within three (3) months of the date of the recipient's death. In the event of the death of a Terminated Person following a termination of employment due to Disability or Retirement, any Options or Stock Appreciation Rights which were held by such Person on the Termination Date and which were exercisable on such Date shall be exercisable by such recipient's Designated Beneficiary, or if no Designated Beneficiary shall be appointed or if the Designated Beneficiary shall predecease such recipient, by such recipient's personal representatives, heirs or legatees for a period of one (1) year from the date of death but in no event later than the expiration date of the exercise period of such Options or Stock Appreciation Rights, at which time such Options or Stock Appreciation Rights shall expire; provided, however, that any Incentive Stock Option of such Terminated Person shall no longer be treated as an Incentive Stock Option within three (3) months of the date of such Termination Date (or within one (1) year in the case of an employee who is "disabled" within the meaning of Section 22(e)(3) of the Code). 8.4 Termination of Unvested Options. All Options and Stock Appreciation Rights which were not exercisable by a Terminated Person as of the Termination Date of such Terminated Person shall terminate as of such Date, except as expressly provided in the written agreement relating to the Options or Stock Appreciation Rights or as otherwise expressly determined by the Committee in its sole discretion. Options and Stock Appreciation Rights shall not be affected by any change of employment so long as the recipient continues to be employed by either the Corporation or a subsidiary. ARTICLE 9 RESTRICTED SHARES 9.1 Grant or Sale of Restricted Shares. The Committee may from time to time cause the Corporation to grant or to sell Restricted Shares under the Plan to employees and consultants, subject to such restrictions, conditions and other terms as the Committee may determine. The purchase price, if any, for Restricted Shares shall be determined by the Committee in its sole discretion. 9.2 Restrictions. At the time a grant of Restricted Shares is made, the Committee shall establish a period over which such Restricted Shares will vest (the "Restricted Period"). Each grant of Restricted Shares may be subject to a different Restricted Period. The Committee may, in its sole discretion, at the time a grant is made prescribe restrictions in addition to or other than the expiration of the Restricted Period, including the satisfaction of corporate or individual performance objectives, which shall be applicable to all or any portion of the Restricted Shares. The Committee may also, 10 in its sole discretion, at any time shorten or terminate the Restricted Period or waive any other restrictions applicable to all or a portion of such Restricted Shares. None of the Restricted Shares may be sold, transferred, assigned, pledged or otherwise encumbered or disposed of during the Restricted Period or prior to the satisfaction of any other restrictions prescribed by the Committee with respect to such Restricted Shares. 9.3 Restricted Stock Certificates. The Corporation shall issue, in the name of each employee or consultant to whom Restricted Shares have been granted or sold, stock certificates representing the total number of Restricted Shares granted or sold to the employee or consultant, as soon as reasonably practicable after the grant or sale. The Corporation, at the direction of the Committee, shall hold such certificates, properly endorsed for transfer, for the employee's or consultant's benefit until such time as the Restricted Shares are forfeited to or repurchased by the Corporation or the restrictions lapse. 9.4 Rights of Holders of Restricted Shares. Holders of Restricted Shares shall have the right to vote such shares and the right to receive any cash dividends with respect to such shares. All distributions, if any, received by an employee or consultant with respect to Restricted Shares as a result of any stock split, stock distribution, a combination of shares, or other similar transaction shall be subject to the restrictions of this Article 9. 9.5 Forfeiture; Repurchase. Except as expressly provided in the written agreement relating to the Options or Stock Appreciation Rights or as otherwise expressly determined by the Committee in its sole discretion, any Restricted Shares held by an employee or consultant pursuant to the Plan shall be forfeited or subject to repurchase by the Corporation at a price equal to the original price paid therefor by the employee or consultant upon the termination of his or her employment or consulting arrangement with the Corporation or its subsidiaries, as the case may be, prior to the expiration or termination of the Restricted Period and the satisfaction of any other conditions applicable to such Restricted Shares. Upon any such forfeiture or repurchase, the Restricted Shares shall be retained in the treasury of the Corporation and available for subsequent awards under the Plan, unless the Committee directs that such Restricted Shares be cancelled. 9.6 Delivery of Restricted Shares. Upon the expiration or termination of the Restricted Period applicable to any Restricted Shares and the satisfaction of any other conditions prescribed by the Committee that are applicable to such Shares, the restrictions applicable to the Restricted Shares shall lapse and a stock certificate for the number of Restricted Shares with respect to which the restrictions have lapsed shall be delivered, free of all such restrictions, to the employee, consultant, beneficiary or estate, as the case may be. ARTICLE 10 UNRESTRICTED SHARES 10.1 Grant or Sale of Unrestricted Shares. The Committee may cause the Corporation to grant or to sell Unrestricted Shares to employees and consultants at such time or times, in such 11 amounts and for such reasons as the Committee, in its sole discretion, shall determine. The purchase price, if any, for Unrestricted Shares shall be determined by the Committee in its sole discretion. 10.2 Delivery of Unrestricted Shares. The Corporation shall issue, in the name of each employee or consultant to whom Unrestricted Shares have been granted or sold, stock certificates representing the total number of Unrestricted Shares granted or sold to the employee or consultant, and shall deliver such certificates to the employee or consultant as soon as reasonably practicable after the date of grant or sale or on such later date as the Committee shall determine at the time of grant or sale. ARTICLE 11 TAX OFFSET PAYMENTS The Committee shall have the authority at the time of any award under the Plan or anytime thereafter to make Tax Offset Payments to assist employees in paying income taxes incurred as a result of their participation in the Plan. The Tax Offset Payments shall be determined by applying a percentage established by the Committee to all or a portion (as the Committee shall determine) of the taxable income recognizable by an employee upon (i) the exercise of Non-qualified Stock Options or Stock Appreciation Rights, (ii) the disposition of shares received upon exercise of Incentive Stock Options, (iii) the lapse of restrictions on Restricted Shares or (iv) the award or sale of Unrestricted Shares. The percentage shall be established, from time to time, by the Committee at that rate which the Committee, in its sole discretion, determines to be appropriate and in the best interests of the Corporation to assist employees in paying income taxes incurred as a result of the events described in the preceding sentence. Tax Offset Payments shall be subject to the restrictions on transferability applicable to Options and Stock Appreciation Rights under Article 7. ARTICLE 12 ADJUSTMENT UPON CHANGES IN CAPITALIZATION Notwithstanding any other provision of the Plan, the Committee may: (i) at any time, make or provide for such adjustments to the Plan or to the number and class of shares available thereunder or (ii) at the time of grant of any Options, Stock Appreciation Rights or Restricted Shares, provide for such adjustments to such Options, Stock Appreciation Rights or Restricted Shares, in each case as the Committee shall deem appropriate to prevent dilution or enlargement of rights, including, without limitation, adjustments in the event of stock dividends, stock splits, recapitalizations, mergers, consolidations, combinations or exchanges of shares, separations, spin-offs, reorganizations, liquidations and the like. 12 ARTICLE 13 AMENDMENT AND TERMINATION The Board may suspend, terminate, modify or amend the Plan, provided that any amendment that would (i) materially increase the aggregate number of shares which may be issued under the Plan, (ii) materially increase the benefits accruing to employees under the Plan, or (iii) materially modify the requirements as to eligibility for participation in the Plan, shall be subject to the approval of the Corporation's stockholders, except that any such increase or modification that may result from adjustments authorized by Article 12 hereof shall not require such stockholder approval. If the Plan is terminated, the terms of the Plan shall, notwithstanding such termination, continue to apply to awards granted prior to such termination. No suspension, termination, modification or amendment of the Plan may, without the consent of the employee or consultant to whom an award shall theretofore have been granted, adversely affect the rights of such employee or consultant under such award. ARTICLE 14 WRITTEN AGREEMENT Each award of Options, Stock Appreciation Rights, Restricted Shares, Unrestricted Shares and Tax Offset Payments shall be evidenced by a written agreement containing such restrictions, terms and conditions, if any, as the Committee may require. In the event of any conflict between a written agreement and the Plan, the terms of the Plan shall govern. ARTICLE 15 MISCELLANEOUS PROVISIONS 15.1 Tax Withholding. The Corporation shall have the right to require employees or their beneficiaries or legal representatives to remit to the Corporation an amount sufficient to satisfy Federal, state and local withholding tax requirements, or to deduct from all payments under the Plan, including Tax Offset Payments, amounts sufficient to satisfy all withholding tax requirements. Whenever payments under the Plan are to be made to an employee in cash, such payments shall be net of any amounts sufficient to satisfy all Federal, state and local withholding tax requirements. The Committee may, in its sole discretion, permit an employee to satisfy his or her tax withholding obligation either by (i) surrendering shares owned by the employee or (ii) having the Corporation withhold from shares otherwise deliverable to the employee. Shares surrendered or withheld shall be valued at their Market Price as of the date on which income is required to be recognized for income tax purposes. 15.2 Compliance With Section 16(b). In the case of employees who are or may be subject to Section 16 of the 1934 Act,it is the intent of the Corporation that the Plan and any award 13 granted hereunder satisfy and be interpreted in a manner that satisfies the applicable requirements of Rule 16b-3 so that such persons will be entitled to the benefits of Rule 16b-3 or other exemptive rules under Section 16 of the 1934 Act and will not be subjected to liability thereunder. If any provision of the Plan or any award would otherwise conflict with the intent expressed herein, that provision, to the extent possible, shall be interpreted and deemed amended so as to avoid such conflict. To the extent of any remaining irreconcilable conflict with such intent, such provision shall be deemed void as applicable to employees who are or may be subject to Section 16 of the 1934 Act. 15.3 Successors. The obligations of the Corporation under the Plan shall be binding upon any successor corporation or organization resulting from the merger, consolidation or other reorganization of the Corporation, or upon any successor corporation or organization succeeding to all or substantially all of the assets and business of the Corporation. In the event of any of the foregoing, the Committee may, in its discretion prior to the consummation of the transaction and subject to Article 13 hereof, cancel, offer to purchase, exchange, adjust or modify any outstanding awards, at such time and in such manner as the Committee deems appropriate and in accordance with applicable law. 15.4 General Creditor Status. Employees and consultants shall have no right, title, or interest whatsoever in or to any investments which the Corporation may make to aid it in meeting its obligations under the Plan. Nothing contained in the Plan, and no action taken pursuant to its provisions, shall create or be construed to create a trust of any kind, or a fiduciary relationship between the Corporation and any employee, consultant, beneficiary or legal representative of such employee or consultant. To the extent that any person acquires a right to receive payments from the Corporation under the Plan, such right shall be no greater than the right of an unsecured general creditor of the Corporation. All payments to be made hereunder shall be paid from the general funds of the Corporation and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such amounts except as expressly set forth in the Plan. 15.5 No Right to Employment. Nothing in the Plan or in any written agreement entered into pursuant to Article 14 hereof, nor the grant of any award, shall confer upon any employee any right to continue in the employ of the Corporation or a subsidiary or to be entitled to any remuneration or benefits not set forth in the Plan or such written agreement or interfere with or limit the right of the Corporation or a subsidiary to modify the terms of or terminate such employee's employment at any time. The preceding sentence shall be equally applicable with respect to consultants of the Corporation or a subsidiary. 15.6 Other Plans. Effective upon the adoption of the Plan by the stockholders, no further awards shall be made under the Synaptic Pharmaceutical Corporation Amended and Restated Incentive Plan, originally adopted on June 3, 1988, and last amended and restated on June 16, 1992 (the "Prior Plan"). Thereafter, all awards made under the Prior Plan prior to the adoption of the Plan by the stockholders shall continue in accordance with the terms of the Prior Plan. 15.7 Notices. Notices required or permitted to be made under the Plan shall be sufficiently made if personally delivered to the employee or sent by regular mail addressed (a) to the employee at the employee's address as set forth in the books and records of the Corporation or its subsidiaries, 14 or (b) to the Corporation or the Committee at the principal office of the Corporation clearly marked "Attention: Compensation Committee." 15.8 Severability. In the event that any provision of the Plan shall be held illegal or invalid for any reason, such illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. 15.9 Governing Law. To the extent not preempted by Federal law, the Plan, and all agreements hereunder, shall be construed in accordance with and governed by the laws of the State of New Jersey. 15 EX-10.45 3 EXHIBIT 10.45 ------------- FIRST AMENDMENT TO LEASE THIS FIRST AMENDMENT TO LEASE (this "Amendment") is entered into as of November 25, 1998, by and between AREB215 COLLEGE ROAD, LLC, a Delaware limited liability company ("Landlord"), and SYNAPTIC PHARMACEUTICAL CORPORATION, a Delaware corporation ("Tenant"). WHEREAS, Century Associates, a New Jersey partnership ("Century"), as landlord, previously entered into those certain lease agreements and amendments set forth on, and attached to, Schedule 1 attached hereto (collectively, the "Overlease"), pursuant to which Playtex Apparel, Inc., as successor-in-interest to International Playtex Corporation and International Playtex Company ("Apparel"), as tenant, leased and hired from Century the land, the approximately 110,666 rentable square foot building and the other improvements thereon located at 215 College Road, Paramus, New Jersey (collectively, the "Paramus Facility"); WHEREAS, Tenant, as successor-in-interest to Neurogenetic Corporation under that certain Sublease dated October 31, 1991 (as amended, the "Sublease") attached hereto as Schedule 2, by and between Apparel, as sublessor, and Neurogenetic Corporation, as sublessee, occupies as of the date hereof approximately 41,274 rentable square feet (the "Current Space") in the Paramus Facility as depicted on Exhibit "A" hereto; WHEREAS, Century and Tenant previously entered into that certain Agreement dated November 11, 1997 (the "Agreement"), with respect to Tenant's possession and occupancy of space at the Paramus Facility, a copy of which Agreement is attached hereto as Schedule 3. Any capitalized term used but not otherwise defined herein shall have the meaning given such term in the Agreement; WHEREAS, Playtex Products, Inc., an entity unrelated to Apparel ("Playtex"), currently occupies certain portions of the Paramus Facility pursuant to certain agreements by and among Apparel, Playtex and Century; WHEREAS, Century succeeded to Apparel's interest in the Overlease and the Overlease has been terminated; 1 WHEREAS, the Agreement provides that, in the event the Overlease is terminated, the Agreement, together with the Sublease and the terms of the Overlease incorporated by reference in the Sublease (collectively, the "Lease"), create and constitute a direct lease between Century or its successor, as lessor, and Tenant, as lessee; WHEREAS, Landlord previously acquired Century's fee simple ownership of the Paramus Facility and has succeeded to all of Century's rights, interests and obligations as landlord under the Lease; WHEREAS, the Lease obligates Tenant to lease and hire from Landlord approximately 32,644(A) rentable square feet at the Paramus Facility currently occupied by Playtex as depicted on Exhibit "B" attached hereto ("Expansion Space A") immediately after the date on which Playtex vacates the Paramus Facility (the "Playtex Vacation Date"); WHEREAS, Landlord and Tenant have agreed that, upon the terms and conditions set forth herein, Tenant shall lease and hire from Landlord space in the Paramus Facility in addition to Expansion Space A comprised of (i) an area totaling approximately 6,235 rentable square feet as depicted on Exhibit "C" attached hereto ("Expansion Space B"), and (ii) an area totaling approximately 3,690 rentable square feet as depicted on Exhibit "D" attached hereto("Expansion Space C"); WHEREAS, Landlord and Tenant wish to amend the Lease on the terms and conditions hereinafter set forth; NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Landlord and Tenant hereby agree as follows: 1. Acknowledgment of Direct Lease. Landlord and Tenant hereby acknowledge and agree that the Lease, as modified by this Amendment, constitutes a direct lease between Landlord and Tenant, and that Tenant is and shall be bound by all of the terms of (i) the Overlease which were applicable to Apparel as tenant under the Overlease, notwithstanding the termination of the Overlease, (ii) the Agreement, and (iii) the Sublease. _____________________________ (A)Calculated by subtracting the Current Space (41,274 sq. ft.) from the Minimum Rentable Square Feet defined in paragraph 5(a) of the Agreement (73,918 sq.ft ). 2 2. Delivery of Expansion Space. a. Expansion Space A and B. Landlord shall deliver possession of Expansion Space A and Expansion Space B to Tenant, and Tenant shall accept delivery and possession of such space, on the date (the "Space A/B Delivery Date") which is the first Business Day (as hereinafter defined) following the Playtex Vacation Date; provided, however, that Landlord shall not be liable for any delay in the Space A/B Delivery Date caused by Playtex's failure to timely vacate such space. From and after the date Expansion Space A and Expansion Space B are actually delivered by Landlord to Tenant (the "Actual Space A/B Delivery Date"), both of Expansion Space A and Expansion Space B shall become a part of (and be included in) the Demised Premises and all references in the Lease to the Demised Premises shall thereafter be deemed to include the Current Space, Expansion Space A and Expansion Space B. From and after the Actual Space A/B Delivery Date, Tenant shall be deemed to have complied with its obligations to lease the Minimum Rentable Square Feet, and all references in the Lease to Minimum Rentable Square Feet shall be deemed to mean the aggregate rentable square feet of the Current Space, Expansion Space A and Expansion Space B. b. Expansion Space C. Landlord shall deliver possession of Expansion Space C to Tenant with Landlord's Space C Work (as hereinafter defined) substantially complete, and Tenant shall accept delivery and possession of such space, on the earlier to occur of (i) the first Business Day which is 18 months after the Playtex Vacation Date (the "Primary Space C Delivery Date"), or (ii) the first Business Day which is 120 days after Tenant delivers to Landlord written notice of Tenant's desire to occupy Expansion Space C, which in no event shall be earlier than the Playtex Vacation Date (the "Requested Space C Delivery Date"); provided, however, that Landlord shall not be liable to Tenant for any delay in delivering Expansion Space C on the Requested Space C Delivery Date if Landlord is not reasonably able to substantially complete Landlord's Space C Work prior to the Requested Space C Delivery Date, and so long as Landlord continues to diligently proceed with Landlord's Space C Work, Tenant shall remain obligated to lease and hire from Landlord Expansion C Space upon the date Landlord's Space C Work is substantially complete; and further provided, that Landlord shall in no event be liable for any delay in the Primary Space C Delivery Date or the Requested Space C Delivery Date caused by Playtex's failure to timely vacate Expansion Space C. From and after the date Expansion Space C is actually delivered by Landlord to Tenant (the "Actual Space C Delivery Date"), Expansion Space C shall become a part of 3 (and be included in) the Demised Premises and all references in the Lease to the Demised Premises shall thereafter be deemed to include the Current Space, Expansion Space A, Expansion Space B and Expansion Space C. As used herein, "Landlord's Space C Work" shall mean (i) the removal or legal encapsulation of any friable asbestos present in Expansion Space C, (ii) demolition and removal of all alterations, including all lab benches and fixtures, in Expansion Space C other than the cinder block walls, and (iii) the construction of demising walls necessary to separate Expansion Space C from other space in the Paramus Facility not then occupied by Tenant. 3. Rent. That portion of Paragraph 4 A of the Sublease which was added thereto by Paragraph 6(a) of the Agreement, is deleted in its entirety and replaced with the following: "Tenant shall be liable for, and shall pay to Landlord, annual rent for the Demised Premises in equal monthly installments on the first day of each month, without set-off, deduction or counterclaim, absolutely net, calculated as follows: (i) for the period from and after the date hereof, through and including the Playtex Vacation Date with respect to the Current Space, the annual rate of $13.73 per rentable square foot on the rentable square footage of the Current Space. (i) for the period from the day immediately following the Playtex Vacation Date through and including December 31, 2004: (I) with respect to the Current Space, the annual rate of $13.00 per rentable square foot on the rentable square footage of the Current Space; plus (II) with respect to Expansion Space A and Expansion Space B, from and after the Actual Space A/B Delivery Date, the annual rate of $13.00 per rentable square foot on the aggregate of the rentable square footage of Expansion Space A and Expansion Space B; plus (III) with respect to Expansion Space C, from and after the date which is 18 months after the Primary Space C Delivery Date, 4 irrespective of the Actual Space C Delivery Date, the annual rate of $13.00 per rentable square foot on the rentable square footage of Expansion Space C. (ii) for the period from and including January 1, 2005, through and including December 31, 2009, the annual rate of $16.00 per rentable square foot on the then total rentable square feet of the Demised Premises; and (iii) for the period from and including January 1, 2010, through and including December 31, 2015, the annual rate of $20.00 per rentable square foot on the then total rentable square feet of the Demised Premises." 4. Operating Costs for Expansion Space C. Notwithstanding anything to the contrary set forth herein or in the Lease, including, without limitation, the provisions of Paragraph 5 of the Sublease as amended by the Agreement, Tenant shall not be responsible for any Operating Costs (as defined in Paragraph 7 of the Agreement) with respect to Expansion Space C until the Actual Space C Delivery Date. From and after the Actual Space C Delivery Date, the rentable square footage of Expansion Space C shall be included in the Demised Premises for purposes of calculating Tenant's pro rata share of Operating Costs pursuant to the Lease. 5. Alterations. Paragraph 6 of the Sublease, as amended by the Agreement, is hereby further amended as follows: a. The second to the last sentence of Paragraph 6A(b) which reads "Sublessor consents to Gerald Fantel as a contractor" is hereby deleted. Landlord will not unreasonably withhold its consent to any contractor proposed by Tenant. b. Regardless of whether Landlord's consent shall be required for any alteration pursuant to the terms of Paragraph 6,Tenant shall give Landlord prior written notice of any alteration not less than 10 Business Days prior to commencing work on such alteration. c. Tenant shall deliver to Landlord as-built plans for any and all alterations promptly upon completion of such alteration. 5 6. Tenant Improvements. Tenant acknowledges that neither Landlord nor any agent of Landlord has made any representation or warranty with respect to the condition of all or any part of the Paramus Facility, or with respect to the suitability of all or any part of the Paramus Facility for the conduct of Tenant's business, and Tenant's taking possession of each of Expansion Space A, Expansion Space B and Expansion Space C shall be conclusive evidence that Tenant accepts each such expansion space in the condition in which each exists at the time possession is taken. All work to be performed to or in connection with the Demised Premises, including Expansion Space A, Expansion Space B and Expansion Space C, other than Landlord's Space C Work, shall be performed by Tenant in accordance with the terms and conditions of the Lease, including, without limitation, Paragraph 6 of the Sublease as amended by the Agreement and this Amendment. 7. Tenant Improvement Allowance. Landlord shall provide to Tenant an allowance in the amount of $129,116 (the "Tenant Improvement Allowance"), which may only be used by Tenant to make improvements and alterations to the Demised Premises (exclusive of Landlord's Space C Work). The Tenant Improvement Allowance shall be payable to Tenant by Landlord on the Actual Space A/B Delivery Date. 8. Parking. Paragraph 23 of the Sublease is hereby amended to provide that Tenant shall be entitled to use parking spaces in the parking lot on the Paramus Facility on a pro rata basis based on the aggregate rentable square footage of the Current Space, Expansion Space A, Expansion Space B and Expansion Space C, notwithstanding the Actual Space A/B Delivery Date or the Actual Space C Delivery Date, to the total rentable square footage of the Paramus Facility. Three of such parking spaces shall be the reserved spaces currently marked for Tenant. Landlord and Tenant acknowledge and agree that the parking facilities at the Paramus Facility include a total of 301 parking spaces. All parking shall be in accordance with the terms and conditions of the Lease. 6 9. Notice Provisions. Paragraph 26 H of the Sublease, as amended by Paragraph 17 of the Agreement, is hereby modified to replace the addresses and telephone numbers therein specified with the following: "As to Landlord: ARE-215 College Road, LLC c/o Alexandria Real Estate Equities, Inc. 135 N. Los Robles Avenue, Suite 250 Pasadena, California 91101 Attn: General Counsel Telephone: (626) 578-0777 Facsimile: (626) 578-0770 As to Tenant: Synaptic Pharmaceutical Corporation 215 College Road Paramus, New Jersey 07652 Attn: Mr. Robert L. Spence Telephone: (201) 261-1331 Facsimile: (201) 261-0623" 10. Ratification of Agreement. Except as specifically modified and amended pursuant to this Amendment, the terms and conditions of the Lease are hereby ratified and confirmed by each of Landlord and Tenant. 11. Brokers. Landlord and Tenant each hereby represent, warrant to and agree with each other that it has not had, and shall not have, any dealings with any third party to whom the payment of any broker's fee, finder's fee, commission or other similar compensation ("Commissions") shall or may become due or payable other than with Insignia/ESG, Inc. and Cushman & Wakefield of New Jersey, Inc. (collectively, the "Brokers"). Landlord shall pay all Commissions due to the Brokers in connection with the transaction contemplated hereby in accordance with the terms and conditions of a separate agreement. Landlord hereby indemnifies and agrees to protect, defend and hold Tenant harmless from and against any and all claims, losses, damages, costs and expenses (including, without limitation, reasonable attorneys' fees) incurred by Tenant by reason of any breach or inaccuracy of the representation, warranty and agreement of Landlord contained in this Paragraph. Tenant hereby 7 indemnifies and agrees to protect, defend and hold Landlord harmless from and against any and all claims, losses, damages, costs and expenses (including, without limitation, reasonable attorneys' fees) incurred by Landlord by reason of any breach or inaccuracy of the representation, warranty and agreement of Tenant contained in this Paragraph. 12. Headings. The Paragraph headings of this Amendment are for convenience of reference only and shall not be deemed to modify, explain, restrict, alter or affect the meaning or interpretation of any provision hereof. 13. Counterparts. This Amendment may be executed in as many counterparts as may be deemed necessary and convenient, and by the different parties hereto on separate counterparts, each of which, when so executed, shall be deemed an original, but all such counterparts shall constitute one and the same instrument. 14. Severability. Any provision or part of this Amendment which is invalid or unenforceable in any situation in any jurisdiction shall, as to such situation and such jurisdiction, be ineffective only to the extent of such invalidity and shall not affect the enforceability of the remaining provisions hereof or the validity or enforceability of any such provision in any other situation or in any other jurisdiction. 15. Attorneys' Fees. In the event that any party hereto brings an action or proceeding against any other party to enforce or interpret any of the terms, agreements or provisions of the Lease, as amended by this Amendment, the prevailing party in such action shall be entitled to recover all reasonable costs and expenses of such action or proceeding, including, without limitation, attorneys' fees, charges, disbursements and the fees and costs of expert witnesses. 16. Construction. This Amendment shall not be construed more strictly against one party hereto than against any other party hereto merely by virtue of the fact that it may have been prepared by counsel for one of the parties. 8 17. Business Day. As used herein, the term "Business Day" shall mean a day that is not a Saturday, Sunday or legal holiday. In the event that the date for the performance of any obligation under this Amendment shall fall on a Saturday, Sunday, or legal holiday, the date for performance thereof shall be extended to the next Business Day. All references in the Amendment to "days" other than "Business Days" shall mean calendar days. IN WITNESS WHEREOF, the parties have executed and delivered this Amendment as of the day and year first above written. LANDLORD ARE-215 COLLEGE ROAD, LLC, a Delaware limited liability company By: ALEXANDRIA REAL ESTATE EQUITIES, L.P., a Delaware limited partnership, its managing member By: ARE-QRS CORP., a Maryland corporation, its general partner By:/s/Lynn Anne Shapiro -------------------- Lynn Anne Shapiro General Counsel TENANT SYNAPTIC PHARMACEUTICAL CORPORATION, a Delaware corporation By:/s/Robert L. Spence ------------------- Robert L. Spence 9 Schedule 1 OVERLEASE 1. Lease Agreement dated February 4, 1969, by and between Century Associates ("Century"), as landlord, and International Playtex Corporation ("IPC"), as tenant (copy attached). 2. Land Lease Agreement dated June 21, 1973, by and between Century, as landlord, and IPC, as tenant (copy attached). 3. Lease Agreement dated October 7, 1974, by and between Century, as landlord, and International Playtex Company a Division of Rapid-America Corporation ("IPC-Rapid"), as tenant (copy attached). 4. Amendment to Lease dated August 7, 1973, by and between Century, as landlord, and IPC, as tenant (copy attached). 5. Amendment to Lease dated August 30, 1973, by and between Century, as landlord, and IPC, as tenant (copy attached). 6. Amendment to Lease Agreement dated October 7, 1974, by and between Century, as landlord, and IPC-Rapid, as tenant [Landlord has no copy]. 7. Letter Agreement dated May 30, 1974, by and between Century, as landlord, and IPC-Rapid, as tenant [Landlord has no copy]. 10 Schedule 2 SUBLEASE Sublease dated October 31, 1991, by and between Playtex Apparel, Inc., as sublessor, and Neurogenetic Corporation, as sublessee, as amended by that certain First Sublease Amendment dated August, 1994, by and between Playtex Apparel, Inc., as sublessor, and Synaptic Pharmaceutical Corporation, as sublessee. (copy attached) Schedule 3 AGREEMENT Agreement dated November 11, 1997, by and between Century Associates, as sublessor, and Synaptic Pharmaceutical Corporation, as sublessee. (copy attached) Exhibit "A" CURRENT SPACE Attached. Exhibit "B" EXPANSION SPACE A Attached. Exhibit "C" EXPANSION SPACE B Attached. Exhibit "D" EXPANSION SPACE C Attached. EX-10.46 4 EXHIBIT 10.46 ------------- AMENDMENT NO. 5 AND SUPPLEMENT TO RESEARCH COLLABORATION AND LICENSE AGREEMENT Amendment No. 5 and Supplement dated and effective as of December 1, 1998, between SYNAPTIC PHARMACEUTICAL CORPORATION, a Delaware corporation ("Synaptic"), and MERCK & CO., INC., a New Jersey corporation ("Merck"). Recitals WHEREAS, Merck and Synaptic are parties to a Research Collaboration and License Agreement dated as of November 30, 1993, as amended (the "Agreement"); and WHEREAS, Merck and Synaptic desire to extend the term of the Research Program (capitalized terms used and not defined herein having the meanings set forth in the Agreement) under the Agreement as set forth herein in order to continue to work towards the identification of back-up safety assessment candidates; NOW THEREFORE, in consideration of the premises and covenants set forth herein, the parties agree as follows: 1. The term of the Research Program is hereby extended for an additional three-month period expiring on February 28, 1999 (the "Third Extension Period"). The term may be further extended only upon the mutual agreement of the parties in writing. 2. During the Third Extension Period, as part of the Research Program, Synaptic shall devote the efforts of two full time equivalents in support of the continuing pharmacological characterization of Merck compounds. 3. Merck shall pay to Synaptic, within 30 days of the effective date of this Amendment No. 5, an amount equal to $125,000 (one hundred twenty-five thousand dollars) in consideration of the support set forth in Article 2. 4. From and after the date first written above, all references in the Agreement to "this Agreement," "hereunder," "hereof," "herein," or words of similar import, shall be a reference to the Agreement, as amended by this Amendment No. 5 and Supplement. 5. From and after the date first written above, all references in the Agreement to "the Research Program" shall be a reference to the Research Program conducted during the period beginning on November 30, 1993, and ending on February 28, 1999, in accordance with the Agreement, as amended and supplemented by this Amendment No. 5 and Supplement. 6. Except as expressly amended and supplemented by this Amendment No. 5 and Supplement, the Agreement shall remain in full force and effect and unchanged. IN WITNESS WHEREOF, the parties have caused this Amendment No. 5 and Supplement to be executed and delivered as of the date first written above. SYNAPTIC PHARMACEUTICAL CORPORATION By:/s/Kathleen P. Mullinix ------------------------------ Kathleen P. Mullinix Chairman, President and Chief Executive Officer MERCK & CO., INC. By:/s/Bennett M. Shapiro ---------------------------------- Bennett M. Shapiro Executive Vice President, Worldwide Basic Research EX-10.47 5 EXHIBIT 10.47 ------------- ADDENDUM NO. 3 TO RESEARCH, OPTION AND LICENSE AGREEMENT This Addendum No. 3, effective as of January 1, 1999 (the "Addendum Effective Date"), between ELI LILLY AND COMPANY, a corporation organized under the laws of the State of Indiana, having its principal place of business at Lilly Corporate Center, Indianapolis, Indiana 46285, and its Affiliates (hereinafter collectively called "LILLY"), AND SYNAPTIC PHARMACEUTICAL CORPORATION (formerly known as Neurogenetic Corporation), a corporation organized under the laws of the State of Delaware, having its principal place of business at 215 College Road, Paramus, New Jersey 07652, and its Affiliates (hereinafter collectively called "SYNAPTIC"). Recitals 1. LILLY and SYNAPTIC are parties to a Research, Option and License Agreement dated as of January 25, 1991(the "Original Agreement"), as amended by the Addendum to Research, Option and License Agreement, effective as of January 1, 1995 ("Addendum No. 1"), and Addendum No. 2 to Research, Option and License Agreement, effective as of October 31, 1996 ("Addendum No. 2"; and, together with the Original Agreement and Addendum No. 1, the "Current Agreement"), pursuant to which they have collaborated in a research effort directed at certain serotonin (5- hydroxytryptamine or 5-HT) receptors and 5-HT-related disorders. Capitalized terms used and not defined in this Addendum No. 3 have the meanings ascribed to them in the Current Agreement. 1 2. The Agreement provides that the Project shall terminate on December 31, 1998, but may be extended for additional periods which contemplate additional funding by LILLY and continuing studies by SYNAPTIC and LILLY. The parties desire to extend the term of the Project until July 31, 1999, on the terms and conditions set forth herein. 3. In addition, the parties desire to expressly state that LILLY's right to submit compounds under a certain provision contained in the March 13, 1996 letter agreement, as amended (the "March 1996 Letter Agreement"), between them is not, by virtue of the extension of the term of the Project, being extended. NOW, THEREFORE, in consideration of the premises and the mutual covenants hereinafter recited, the parties agree as follows: Section 1. Definitions. (a) Modification of Definition. The definition of "Project" contained in Section 1.05 of the Current Agreement is hereby amended to read in its entirety as follows: '"Project" means (i) with respect to the period beginning on January 25, 1991, and ending on December 31, 1994, the research and development program conducted by SYNAPTIC in the Field in collaboration with LILLY during such period and (ii) with respect to the period beginning on January 1, 1995, the continuation of such program; provided, however, that from January 1, 1995, until December 31, 1998, such program shall be limited to the continued provision by SYNAPTIC to LILLY of support in (A) the evaluation by SYNAPTIC of LILLY Compounds at Project Receptors and at the 5-HT4 Receptors in binding and functional assays, (B) tissue localization studies involving Project Receptors, (C) the conduct of neurotransmitter release studies involving Project Receptors and 5-HT4 Receptors and (D) the identification of new species homologues of Project Receptors, all in accordance with Sections 2.00, 2.01 and 5.00 and to the extent that LILLY's license shall not have terminated pursuant to Section 6.02; provided further, however, that from January 1, 1999, until July 31, 1999, such program shall be limited to the activities described in the foregoing clause (A)."' 2 Section 2. Staffing, Planning and Execution of Project. (a) SYNAPTIC Effort on Project. Section 2.00 of the Current Agreement is hereby amended by deleting the second sentence thereof in its entirety and by inserting in lieu thereof the following new sentences: "During the period from January 1, 1997, through December 31, 1998, SYNAPTIC shall devote a minimum of twenty-two Scientific Man Years per year to the Project, at least four of which shall be provided by scientists with Ph.D. degrees. During the period from January 1, 1999, through July 31, 1999, SYNAPTIC shall devote an aggregate of 14,570 Scientific Man Hours to the Project. As used herein, the term "Scientific Man Hour" shall mean one man hour of scientific work, on or directly related to the Project, carried out by a SYNAPTIC employee. Of all the SYNAPTIC employees assigned to the Project during the period from January 1, 1999, through July 31, 1999, at least two shall be scientists with Ph.D. degrees and the balance shall be scientists with at least Bachelors degrees in a science. SYNAPTIC desires to provide LILLY with a reasonable level of continuity in terms of personnel assigned to the Project during the period from January 1, 1999, through July 31, 1999. Accordingly, SYNAPTIC will assign to the Project during this period as many of the scientists who were assigned to the Project during the calendar quarter ended December 31, 1998, as is reasonably practicable." Section 3. Funding of the Project. (a) Duration and Amount of Funding. Section 3.00 of the Current Agreement is hereby amended to read in its entirety as follows: "Section 3.00. Duration and Amount of Funding. LILLY has provided SYNAPTIC with financial support over the period from January 1, 1991, to December 31, 1998. LILLY shall provide SYNAPTIC with further financial support for the Project for the period from January 1, 1999, through July 31, 1999. SYNAPTIC shall use the funds supplied by LILLY solely for purposes of the Project. During the period from January 1, 1999, through July 31, 1999, the financial support provided to SYNAPTIC by LILLY shall be $115 per Scientific Man Hour for 14,570 Scientific Man Hours, or $1,675,550 in the aggregate. The amount per Scientific Man Hour shall be the total amount paid to SYNAPTIC by LILLY for SYNAPTIC's effort on the Project, with SYNAPTIC being responsible for all wages, supplies, facilities, utilities and all other expenses in connection with the performance by it of its services for the Project." 3 (b) Section 3.01 of the Current Agreement sets forth the manner in which funding payments are to be made by LILLY to SYNAPTIC, as well as the required timing of such payments, but provides that the parties may agree in writing to other terms. SYNAPTIC and LILLY hereby agree that, notwithstanding the provisions of Section 3.01 of the Current Agreement, the $1,675,550 of funding required to be paid by LILLY to SYNAPTIC in respect of research support during the period from January 1, 1999, through July 31, 1999, shall be payable in two equal installments, the first of which shall be due no later than February 15, 1999, and the second of which shall be due no later than May 1, 1999. Such payments shall be made in the same manner provided in Section 3.01 of the Current Agreement. Section 4. Commercial Terms. Under Section 6.00 of the Current Agreement, Lilly is required to pay Synaptic a running royalty of three percent (3%) or six percent (6%) of the Net Sales of each Product comprising any Existing Lilly Compound or New Compound, respectively, and to make certain milestone payments to Synaptic for each such Compound, subject to the other terms and conditions contained in the Current Agreement. Under Section 3 of the March 1996 Letter Agreement, Lilly and Synaptic agreed to make certain modifications to their economic arrangement with respect to a limited number of Lilly Compounds that met all of the requirements set forth in Section 3(b) of such Letter Agreement and that were submitted by Lilly to Synaptic for testing after December 31, 1995, and before the expiration or termination of the Project. The parties have agreed that effective as of January 1, 1999, Lilly may not submit any additional Lilly Compounds to Synaptic for testing pursuant to Section 3(b) of the March 1996 Letter Agreement. Accordingly, Section 3(a) of the 4 Letter Agreement is hereby amended (a) by deleting therefrom "and before the expiration or termination of the Project" and (b) by inserting in lieu thereof "until December 31, 1998". Section 5. Term and Termination. Pursuant to Section 9.01 of the Current Agreement, the parties hereby agree to extend the Project for an additional seven-month period beginning as of January 1, 1999. Accordingly, the reference in Section 9.01 of the Current Agreement to "December 31, 1998" is hereby replaced with a reference to "July 31, 1999." Section 6. Counterparts. This Addendum may be executed in two counterparts, each of which shall be an original instrument, but both of which together shall constitute one agreement. Section 7. Effect of Addendum. From and after the Addendum Effective Date, (a) all references in the Current Agreement, as amended or supplemented by this Addendum No. 3, to "this Agreement," "hereunder," "hereof," "herein," or words of similar import, shall be a reference to the Current Agreement, as so amended or supplemented and (b) all references in the March 1996 Letter Agreement, as amended by this Addendum No. 3, to "this letter," "hereunder," "hereof," "herein," or words of similar import, shall be a reference to the March 1996 Letter Agreement, as so amended. Except as expressly amended or supplemented by this Addendum No. 3, each of the Current Agreement and the March 1996 Letter Agreement shall remain in full force and effect and unchanged. 5 IN WITNESS WHEREOF, the parties have caused this Addendum to be executed and delivered as of the Addendum No. 3 Effective Date by their proper and duly authorized representatives. ELI LILLY AND COMPANY By: /s/August M. Watanabe ------------------------------- Name: August M. Watanabe Title: Executive Vice President, Science and Technology SYNAPTIC PHARMACEUTICAL CORPORATION By: /s/Robert L. Spence ------------------------------- Name: Robert L. Spence Title: Senior Vice President and Chief Financial Officer 6 EX-23.1 6 EXHIBIT 23.1 ------------ Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333- 05793) pertaining to the 1988 Amended and Restated Incentive Plan, 1996 Incentive Plan and the 1996 Nonemployee Director Stock Option Plan of Synaptic Pharmaceutical Corporation of our report dated January 29, 1999 (except for Note 11 as to which the date is February 4, 1999), with respect to the financial statements of Synaptic Pharmaceutical Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 1998. /s/ ERNST & YOUNG LLP Hackensack, NJ March 23, 1999 EX-24 7 EXHIBIT 24 ---------- POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Kathleen P. Mullinix and Lisa L. Reiter, or either of them, such person's true and lawful attorney-in-fact and agent with full power of substitution and re- substitution for such person and in his or her name, place and stead, in any and all capacities, to sign this Annual Report on Form 10-K and any or all amendments thereto and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission and the National Association of Securities Dealers, granting unto said attorney-in-fact and agent full power and authority, to do and perform each and every act and thing requisite or necessary to be done in and about the premises, to all intents and purposes and as fully as he or she might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent or her substitutes may lawfully do or cause to be done by virtue hereof. Signature Title Date - ------------------------------ ---------------------- -------------- /s/ Kathleen P. Mullinix Chairman of the Board, March 9, 1999 - ------------------------------ President, and Chief Kathleen P. Mullinix Executive Officer /s/ Robert L. Spence Senior Vice President, March 9, 1999 - ------------------------------ Chief Financial Officer, Robert L. Spence and Treasurer /s/ Jonathan J. Fleming Director March 9, 1999 - ------------------------------ Jonathan J. Fleming /s/ Zola P. Horovitz, Ph.D Director March 9, 1999 - ------------------------------ Zola P. Horovitz, Ph.D /s/ Eric R. Kandel, M.D Director March 9, 1999 - ------------------------------ Eric R. Kandel, M.D /s/ John E. Lyons Director March 9, 1999 - ------------------------------ John E. Lyons /s/ Sandra Panem, Ph.D Director March 9, 1999 - ------------------------------ Sandra Panem, Ph.D /s/ Alison Taunton-Rigby, Ph.D Director March 9, 1999 - ------------------------------ Alison Taunton-Rigby, Ph.D EX-27 8
5 YEAR DEC-31-1998 DEC-31-1998 16,590,000 39,788,000 0 0 0 25,387,000 10,618,000 4,885,000 64,696,000 2,020,000 0 0 0 107,000 62,569,000 64,696,000 0 9,352,000 0 19,576,000 0 0 0 (6,493,000) 0 (6,493,000) 0 0 0 (6,493,000) (0.61) (0.61)
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