-----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, KCF/Ws5lm3JMWSY3LkWWRGqlVaa+4WGohaYpFv1nE0FWSBGrb3ORvDK3GKvBC+zv JnjIV8JefNqid40Z3zZPEA== 0000912057-97-011007.txt : 19970401 0000912057-97-011007.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-011007 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ARRIS PHARMACEUTICAL CORP/DE/ CENTRAL INDEX KEY: 0000913056 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 222969941 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-22788 FILM NUMBER: 97568698 BUSINESS ADDRESS: STREET 1: 385 OYSTER POINT BLVD STREET 2: SUITE 3 CITY: SOUTH SAN FRANCISCO STATE: CA ZIP: 94080 BUSINESS PHONE: 4157378600 MAIL ADDRESS: STREET 1: 385 OYSTER POINT BLVD STREET 2: SUITE 3 CITY: SOUTH SAN FRANCISCO STATE: CA ZIP: 94080 10-K405 1 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 Commission File No. 0-22788 ARRIS PHARMACEUTICAL CORPORATION (Exact name of Registrant as specified in its charter) _______________________________ Delaware 22-2969941 (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 385 Oyster Point Boulevard, Suite 3, South San Francisco, California 94080 (Address of principal executive offices, including zip code) Registrant's telephone number, including area code: (415) 829-1000 SECURITIES REGISTERED PURSUANT TO Section 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO Section 12(g) OF THE ACT: COMMON STOCK $.001 PAR VALUE (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 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 (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The approximate aggregate market value of the voting stock held by nonaffiliates of the Registrant as of February 28, 1997, based upon the last trade price of the Common Stock reported on the Nasdaq National Market on February 28, 1997, was $191,642,259*. The number of shares of Common Stock outstanding as of February 28, 1997 was 14,936,497. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants Proxy Statement which will be filed with the Commission pursuant to Section 14a in connection with the 1997 annual meeting of stockholders are incorporated herein by reference in Part III of this report. *Excludes approximately 335,180 shares of Common Stock held by Directors and Officers of the Registrant's outstanding Common Stock at February 28, 1997. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant. PART I. ITEM 1. BUSINESS Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section under "Business Risks" as well as in the remainder of this section and in the section entitled "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Arris Pharmaceutical Corporation ("Arris" or "the Company") uses an integrated drug discovery approach combining structure-based drug design, combinatorial chemistry and its proprietary Delta Technology to discover and develop diverse small molecule therapeutics for existing markets where currently available therapies have significant limitations. Arris' product development includes protease programs targeting the inhibition of enzymes implicated in asthma, inflammatory disease, blood clotting disorders, infectious diseases, osteoporosis, cancer and autoimmune disease. The Company's technology platform also includes receptor-based discovery programs designed to discover small molecule drugs that mimic important therapeutic proteins that are already successful products. BUSINESS RISKS The Company is at an early stage of development. The Company's technologies are, in many cases, new and still under development. All of the Company's potential products are in an early stage of development and will require significant additional research and development efforts prior to any commercial use, including extensive preclinical and clinical testing as well as lengthy regulatory clearance. There can be no assurance that the Company's research and development efforts will be successful, that any of its potential products will prove to be safe and efficacious in clinical trials or that any commercially successful products will ultimately be developed by the Company. In addition, many of the Company's currently proposed products are subject to development and licensing arrangements with the Company's collaborators. Therefore, the Company is dependent on the research and development efforts of these collaborators. Moreover, the Company is entitled only to a portion of the revenues, if any, realized from the commercial sale of any of the potential products covered by the collaborations. The Company has experienced significant operating losses since its inception and expects to incur significant operating losses over at least the next several years. The development of the Company's technology and potential products will require a commitment of substantial funds to conduct these costly and time consuming activities. All of the Company's revenues to date have been received pursuant to the Company's collaborations. Should the Company or its collaborators fail to perform in accordance with the terms of any of their agreements, any consequent loss of revenue under the agreements could have a material adverse effect on the Company's results of operations. The potential products under development by the Company have never been manufactured on a commercial scale and there can be no assurance such products can be manufactured at a cost or in quantities necessary to make them commercially viable. The Company has no sales, marketing or distribution capability. If any of its products subject to collaborative agreements are successfully developed, the Company must rely on its collaborators to market such 2 products. If the Company develops any products which are not subject to collaborative agreements, it must either rely on other large pharmaceutical companies to market such products or must develop a marketing and sales force with technical expertise and supporting distribution capability in order to market such products directly. The foregoing risks reflect the Company's early stage of development and the nature of the Company's industry and products. Also inherent in the Company's stage of development is a range of additional risks, including competition, uncertainties regarding protection of patents and proprietary rights, government regulation and uncertainties regarding pharmaceutical pricing and reimbursement. PROTEASE-BASED PROGRAMS BACKGROUND Proteases are targets for therapeutic intervention because they are believed to play an important role in many disease processes. Arris is developing selective and highly potent inhibitors of serine and cysteine proteases--two large families of regulatory enzymes. The Company has designed multiple chemical classes of both serine and cysteine protease inhibitors, including inhibitors of tryptase, the blood clotting enzymes, chymase and several cathepsins. TRYPTASE Tryptase is a serine protease that has been shown by Arris' scientists to be a mediator of inflammation. Tryptase is released by mast cells as part of an immune response to allergens and contributes to a cascade of biological events which results in inflammation. Inhibition of tryptase is the focus of the Company's most advanced research and development program. Arris' tryptase inhibitors are designed to slow or halt the inflammatory process at an early stage thereby providing safe and effective therapies that treat the underlying cause of disease rather than the symptoms. The initial market opportunity being evaluated by the Company in collaboration with Bayer AG is asthma. Corticosteroids are increasingly used to treat the chronic underlying inflammation associated with asthma. However, they may cause immune system suppression with prolonged use as well as a variety of other side effects, including insomnia, nervousness, irritability and depression. The Company believes that tryptase inhibitors may represent replacements for steroids, the most commonly prescribed anti-inflammatory drugs for asthma. Arris' first clinical compound, APC-366, is currently in Phase IIa clinical studies in the United Kingdom for use in the treatment of asthma. The Company believes that APC-366, in an inhaled aerosol formulation, is the first drug designed and introduced into humans for its properties as a tryptase inhibitor. In October 1996, Arris announced that final data from the Phase IIa study of its tryptase inhibitor, APC-366, in allergen-induced asthma models confirmed preliminary data released earlier in the year. The final data showed that APC-366 provided protection against allergen-induced early and late airway responses as well as protection against histamine-induced bronchial hyperresponsiveness studied in an allergen challenge model. Additional Phase IIa studies were initiated in mid-1996. The results of those studies are expected by the end of the first half of 1997. These studies are also being conducted in the United Kingdom. Although conducted outside of the United States, the studies are designed to meet FDA standards. The clinical trials for APC-366 are being conducted under the 3 Company's control and at its expense. Pursuant to the Company's collaboration agreement with Bayer, research and development expenses related to the Company's first clinical compound, APC-366 will be borne by the Company, at least through Phase IIb clinical trials. Once Phase IIb studies are complete, if the compound meets certain criteria agreed upon by Bayer and Arris, Bayer is obligated to assume further development expense for the compound and to reimburse Arris for clinical expenses through Phase IIb. If the compound fails to meet these criteria, neither Arris nor Bayer will further develop the drug as a therapeutic for asthma. In September 1996, Bayer elected to initiate clinical development of an Arris compound, BAY-17-1998, the development costs of which are borne entirely by Bayer. This compound entered IND-enabling studies in 1996, and it is expected to enter Phase I clinical trials in 1997. THROMBIN, FACTOR XA AND FACTOR VIIA Thrombin, Factor Xa and Factor VIIa are three enzymes involved in the clotting cascade, a series of biochemical events that contributes to the formation of blood clots. All three are serine proteases that have been acknowledged as targets for a host of disorders related to abnormal clotting. Arris is collaborating with Pharmacia & Upjohn to develop oral therapeutics based on the inhibition of these proteases. In 1996, Arris designed and tested a variety of compounds based on the Delta Technology, and with its partner, Pharmacia & Upjohn, identified six families of Delta compounds for thrombosis and pharmacokinetic analysis. Based on the results of that work, Arris and Pharmacia & Upjohn expect to identify a compound for nomination as a clinical candidate to enter IND-enabling studies. See "Delta Technology." CHYMASE Like tryptase, chymase is a mast cell protease which the Company believes plays a significant role in inflammation-related diseases and also may have implications in connective tissue disease and hypertension. The Company's chymase program is being pursued in collaboration with Bayer and is at an earlier stage of discovery research than the Bayer-sponsored tryptase program. A lead compound designed using Arris' proprietary Delta Technology has been identified with a high degree of potency and selectivity for chymase. Pharmacological studies have been initiated using this compound to confirm the therapeutic relevance of chymase in certain inflammatory diseases. CATHEPSINS K AND L Cathepsins K and L are cysteine protease targets that were acquired by Arris as part of their purchase of Khepri Pharmaceuticals in December of 1995, and they are thought to play a role in osteoporosis. In November 1996, Arris announced a research and development collaboration with Merck & Co. to develop small molecule inhibitors of these enzymes as a treatment for osteoporosis. Cathepsin K and cathepsin L belong to a class of proteases called cysteine proteases. Specifically, cathepsin K is known to be secreted in excessive amounts by osteoclasts. In the healthy human body, osteoblast cells are responsible for bone-building while osteoclasts are responsible for bone 4 degradation. By maintaining a careful balance in each type of cell's activity, normal bone remodeling and skeletal integrity is achieved. However, when the rate at which bone is destroyed by the osteoclasts exceeds the rate at which new bone is produced by osteoblasts, the result is excessive bone resorption--a condition that results in brittle bones and is characteristic of osteoporosis. By inhibiting cathepsin K, Arris and its partner believe that a new drug may be able to re-balance the activity of osteoclasts and osteoblasts and arrest the bone-destroying effects of osteoporosis. Herpes Virus Proteases: CMV, HSV, and HHV The infectivity of many viral organisms depends on their ability to replicate within the nucleus of a host cell and "escape" in a special protective coating called the "capsid." In many instances, the cell's ability to manufacture the capsid is controlled by a discrete viral protease. It is believed that if production of the capsid can be inhibited, viral particles would be prevented from escaping from one cell and infecting others. Indeed, this is the mechanism targeted by HIV protease inhibitors currently on the market. The same process is believed to contribute to the spread of infections by the herpes family of viruses, including cytomegalovirus (CMV), herpes simplex virus (HSV), and eight other herpes viruses known collectively as HHV. With its collaborative partner, SmithKline Beecham, in June 1996 Arris began working on its first infectious disease program. The goal of that program is the establishment of proof-of-concept that a herpes virus could be inhibited intracellularly using inhibitors designed using the Delta principle. CATHEPSIN B Cathepsin B may contribute to the growth of tumors in cancer. In IN VITRO studies, a collaborator of Arris demonstrated that several of the Company's inhibitors of cathepsin B prevented cancer cells from invading normal tissues. If this finding proves broadly applicable to a wide range of cancers, the Company believes that it may be able to develop a drug which reduces the rate at which cancers spread throughout the body. Arris has expressed cathepsin B and is currently conducting IN VITRO testing of its inhibitors of the enzyme. CATHEPSIN S Cathepsin S is a cysteine protease found in autoimmune cells. Unlike many other proteases, it is rarely expressed in other types of cells. It is believed that cathepsin S functions in a pathway that causes the body to improperly recognize its own cells as foreign pathogens. As a result, it may be possible to use inhibitors of cathepsin S to block the pathway and as a result, protect the body from autoimmune disorders. Arris has expressed cathepsin S and is conducting in vitro testing of its inhibitors of the enzyme. PROTEASES IN INFECTIOUS DISEASE Arris believes that it may be possible to treat many infectious diseases through the inhibition of proteases that regulate pathogen invasion and pathogen survival. Many infectious organisms, including 5 viral, bacterial and fungal organisms, depend on the activity of proteases for colonizing their host, obtaining key nutrients or sustaining life. Specifically, the Company believes that certain protease inhibitors may provide viable therapeutic alternatives to current anti-infective agents where resistance has become an increasingly serious problem. The Company is currently exploring the role that certain expressed serine and cysteine proteases play in infectious organisms. OTHER PROTEASE TARGETS The Company also has a number of other early research programs aimed at identifying potential biological targets among serine and cysteine proteases, evaluating their biological relevance in various diseases, and designing inhibitors to those protease targets implicated in certain pathological processes. Using sophisticated genetic mapping techniques, the Company believes it is able to gain proprietary knowledge about how proteases contribute to key biological events, in particular, those that play a role in physiological disorders, such as cancer, inflammatory diseases, and bacterial, fungal and viral infections. RECEPTOR-BASED PROGRAMS BACKGROUND The Company's receptor-based programs to date have been focused on developing orally active, synthetic molecules that mimic the action of a group of therapeutically useful proteins called cytokines and growth factors. The Company believes that oral mimetics of the currently approved products could significantly expand the indications for which these drugs are prescribed. RECEPTOR DIMERIZATION Arris and its collaborators have discovered that many cytokines and growth factors activate distinct biological activities via a common mechanism of action: receptor dimerization --the coming together of two receptor subunits on the cell surface. Dimerization is stimulated by the binding of the cytokine or growth factor to its receptor, and the Company believes it may also be triggered by certain small molecule compounds. Arris' has programs in this area focused on two cell surface receptor targets that dimerize prior to signaling: Erythropoietin (EPO) and Human Growth Hormone (HGH). HUMAN GROWTH HORMONE. Human growth hormone is a pituitary-derived hormone that promotes musculoskeletal growth. The first recombinant hGH product was co-developed by Pharmacia & Upjohn and Genentech. Recombinant human growth hormone is currently approved in the United States for the treatment of short stature caused by chronic renal insufficiency, Turner's Syndrome and growth hormone inadequacy in children. Arris' research program in this area is being conducted in collaboration with Pharmacia & Upjohn. The program is actively screening potential compounds through the use of both proprietary assays and cell-based proliferation assays developed by Arris. ERYTHROPOIETIN. EPO is a large glycoprotein hormone that helps regulate the production of red blood cells in the body. The first recombinant EPO product was developed and successfully commercialized by Amgen. Recombinant EPO is currently approved in the United States for the treatment of certain 6 conditions characterized by reduced red blood cell counts, such as anemia related to chronic kidney failure, cancer-associated chemotherapy and the use of drugs in certain HIV patients. Arris' research program in this area is being conducted in collaboration with Amgen and is in the lead optimization phase. Combinatorial chemistry is being used to produce and enhance compounds with the characteristics of drugs. DELTA TECHNOLOGY Among the advanced technologies developed by Arris for the design of protease inhibitors is the Company's proprietary Delta Technology. The Company's Delta Technology represents a novel and broadly applicable method for the design of selective and highly potent inhibitors of serine and cysteine proteases. Arris is leveraging this finding by designing multiple classes of protease inhibitors. Arris has demonstrated that by using the Delta Technology, the potency of certain small molecule reversible inhibitors can be increased as much as 1000+ fold. Protease inhibitor compounds designed by application of the Delta Technology are generally simple organic molecules of low molecular weight. The Company believes that the compounds will prove to be easy to manufacture with correspondingly high yields. Delta Technology provides a scientific foundation upon which the Company's collaborations with Pharmacia & Upjohn in blood clotting disorders, its collaboration with Merck & Co. in osteoporosis, and its collaboration with SmithKline Beecham in infectious disease are based. The Company is exploiting the Delta Technology broadly by applying it to existing and new protease targets and seeking collaborations with pharmaceutical companies for the application of Delta Technology to their protease discovery programs. RESEARCH TECHNOLOGIES The Company has created a platform of general and proprietary discovery technologies to meet the Company's primary goal: the conversion of promising leads into molecules which possess desired drug properties as early as possible in the discovery and development process. Research at Arris encompasses multiple technologies vital for new drug discovery. Medicinal Chemistry. Medicinal chemistry at Arris plays a central role in developing organic compounds as well as in optimizing those identified as potential clinical candidates. Medicinal chemistry is an iterative process used to improve the potency, selectivity, oral bioavailability, metabolic stability and biological half-life of a drug candidate. Combinatorial Chemistry. Arris uses combinatorial chemistry technologies to produce large numbers of molecules that can be screened against biological targets of interest. For example, with its partner Pharmacia & Upjohn, the Company is building a broad diversity screening library of 250,000 individually synthesized compounds, representing approximately 100 different classes of small molecules. Structure-Based Design. X-ray crystallography is a physical method that has been successful in determining the three-dimensional structure of large, complex proteins. Arris has advanced X-ray crystallographic instrumentation on site and has applied this technology to the solution of 7 molecular structures of several proteases--both in its own discovery as well as its partners research programs. In 1996, an Arris paper on the structure of cathepsin K was accepted for publication in Nature/Structural Biology. Computational Sciences. Arris uses a proprietary suite of computer algorithms and computational tools to generate ideas for molecular structures, to direct combinatorial chemical activity and to perform virtual screening. These tools have been used successfully in both the Company's protease and receptor programs. High Throughput Screening. Where the structure of a target protein is not well understood, the screening of libraries of organic compounds provides lead structures for medicinal chemistry. Thousands of compounds can be screened daily at Arris to identify new lead compounds or to optimize existing ones. The Company has adapted commercially available technologies to meet the needs of its product development programs. Protein Biochemistry. In contrast to traditional biotechnology companies, the Company generally employs the tools of recombinant DNA technology, including proprietary systems, to produce proteins, not as drugs but as reagents for screening and for X-ray crystallography. RESEARCH AND DEVELOPMENT COLLABORATIONS Arris currently is pursuing product development both on a proprietary basis and in collaboration with other pharmaceutical companies. All of its collaborations have been focused on discrete targets in order to preserve for the Company ownership of certain core technologies and developments as they apply to expanded programs and new targets. This allows the Company to proliferate its proprietary programs and to seek multiple partnerships based on key developments. Through corporate collaborations, the Company augments its financial resources thereby reducing its dependence on capital markets. Collaborations also allow the Company to broaden its pipeline of programs, access complementary technologies and gain significant development and commercialization expertise. Arris has implemented this strategy by partnering and thereby fully funding all of its major programs with leading pharmaceutical companies. See Note 3 to the Company's consolidated financial statements for the details of the revenue associated with these collaborations. Merck & Co.--Osteoporosis In November 1996, Arris established a collaborative agreement with Merck for the development of small molecule inhibitors of proteases involved in osteoporosis. The agreement provides for an initial commitment fee and research and development funding for a two year term which may be extended at Merck's option or terminated in certain circumstances. The agreement also provides benchmark payments upon the achievement of mutually agreed upon milestones. Arris granted Merck an exclusive license to develop, manufacture and market certain protease inhibitors. Arris is to receive royalties on Merck's sales of any licensed products. SMITHKLINE BEECHAM--VIRAL DISEASES 8 In June 1996, Arris entered into an agreement with SmithKline Beecham to develop inhibitors using Arris' proprietary Delta technology with certain intracellular viral proteases. The agreement incorporates an initial proof-of-concept phase and an optional research phase, if elected by SmithKline. Arris has received a license fee and shall receive research funding and certain milestone payments during the proof-of-concept and research phases. Subject to the initiation of the research phase of the program, Arris granted SmithKline an exclusive license to develop inhibitors of the target proteases using Arris' Delta technology and an exclusive license to manufacture and market any products developed under the agreement. In return, Arris shall receive royalties on any product sales. BAYER AG--TRYPTASE AND CHYMASE In November 1994, Arris established a collaborative agreement with Bayer aimed at developing inhibitors of the regulatory enzymes tryptase and chymase for the treatment of asthma and other inflammatory and auto-immune diseases. The agreement calls for a five-year research collaboration between the parties which Bayer may terminate at its discretion after three years. Arris received an initial commitment fee, is receiving research funding over the research period, and will receive benchmark payments upon the achievement of mutually agreed upon milestones. Arris granted Bayer the exclusive right to develop inhibitors of tryptase and chymase which result from the program, worldwide manufacturing and marketing rights to these compounds, and assigned to Bayer certain rights to patents arising out of the collaboration. Arris is to receive royalties on Bayer's sales of any licensed products. The Bayer collaboration provides that research and development expenses related to the Company's first clinical compound, APC-366, will be borne by the Company through Phase IIb. If the results of the Phase IIb studies meet certain agreed-upon criteria, Bayer will assume development of APC-366. If the results fail to meet the criteria, development of APC-366 will be terminated. In September 1996 Bayer also elected to initiate clinical development of an Arris compound, designated BAY-17-1998, the development costs of which are borne entirely by Bayer. Pharmacia & Upjohn--Combinatorial Chemistry In March 1996, Arris entered into a research agreement with Pharmacia & Upjohn to use combinatorial chemistry to create a probe library consisting of 250,000 small molecule synthetic organic compounds. (This agreement supersedes the December 1994 Pharmacia & Upjohn--Combinatorial Chemistry and High Throughput Screening collaboration.) Arris granted Pharmacia & Upjohn a co-exclusive license to the library being developed along with the technologies used for synthesis and screening. In return for the co-exclusive license, Arris receives upfront nonrefundable license payments and payments upon delivery of the compounds. Pharmacia & Upjohn--Inhibitors of Coagulation In August 1995, Arris entered into a research and development agreement with Pharmacia & Upjohn focused on the development of inhibitors of Thrombin, Factor Xa and Factor VIIa using Arris' Delta Technology, for the treatment of blood clotting disorders. The agreement calls for a five-year research collaboration between the parties, which Pharmacia & Upjohn may terminate at its discretion after three years. Arris received an initial commitment fee, is receiving research funding over the research period, and will receive benchmark payments upon the achievement of mutually agreed upon milestones. Arris granted Pharmacia & Upjohn the exclusive right to develop inhibitors of Thrombin, 9 Factor Xa and Factor VIIa which may result from the program, as well as worldwide manufacturing and marketing rights to these compounds. Arris is to receive royalties on Pharmacia & Upjohn's sales of any licensed products. Pharmacia & Upjohn--Human Growth Hormones In March 1993, Arris entered into a research and development agreement with Pharmacia & Upjohn aimed at developing certain human growth factor mimetics, initially focusing on hGH. Pharmacia & Upjohn is a leading marketer of growth factors, including recombinant hGH. The agreement between Arris and Pharmacia & Upjohn calls for a research collaboration between the parties, the funded research phase of which expires in 1997. Further research may be conducted by Pharmacia & Upjohn pursuant to the agreement. Concurrent with the signing of the initial agreement, Pharmacia & Upjohn made a $5.4 million equity investment in Arris. Arris is receiving research funding during the term of the research collaboration and will receive benchmark payments if mutually agreed upon milestones are reached. Arris granted Pharmacia & Upjohn the exclusive right to develop growth factor mimetics discovered as well as worldwide manufacturing and marketing rights to these compounds. Arris is to receive royalties on Pharmacia & Upjohn's sales of any licensed products. Arris retains the rights to technology developed by the Company and gains licensing rights to certain technology developed by Pharmacia & Upjohn under the research program that may have application to other cytokine targets outside the focus of the collaboration. AMGEN--EPO In May 1993, Arris entered into an agreement with Amgen aimed at the development of synthetic, small molecule mimetics of EPO. The agreement, as amended in 1996, calls for a research collaboration between the parties which ended in February 1997. Further research will be conducted by Amgen. Arris received an initial commitment fee, received research funding over the research period and will receive benchmark payments if certain milestones are achieved by Amgen. Arris granted Amgen the exclusive right to develop any EPO mimetic compounds discovered, as well as worldwide manufacturing and marketing rights to those compounds. Arris is to receive royalties on Amgen's sales of any licensed products and under certain circumstances Arris is required to pay royalties to third parties. Arris has retained the rights to apply all technologies developed solely by the Company to the development of products outside the EPO field. Either Arris or Amgen can independently exploit jointly developed technology that does not pertain to EPO. Amgen is a leading marketer and manufacturer of recombinant EPO. ACQUISITION OF KHEPRI On December 22, 1995, Arris acquired Khepri Pharmaceuticals, Inc. ("Khepri") in a transaction accounted for as a purchase. Prior to the acquisition, Khepri was a privately-held development stage company focused on the discovery and development of cysteine protease-based therapeutics. In connection with the acquisition, in December 1995 and 1996 the Company issued 1,414,759 and 518,701 shares of Common Stock, respectively to shareholders of Khepri. In addition in July 1996, the Company issued 161,418 shares of Common Stock to the minority interest shareholders of the Canadian subsidiary of Khepri, in exchange for their 50% ownership in that entity. 10 PATENTS AND PROPRIETARY RIGHTS Arris holds five U.S. patents relating to compositions of matter, methods of treating disease, combinatorial chemistry and computational technologies expiring through various dates in 2013. Further, Arris has 36 pending patent applications relating to compositions of matter, methods of treatment, combinatorial chemistry, assay techniques, transgenic animal models, computational technologies and novel technology for the discovery of novel protease inhibitors. Arris intends to file additional patent applications, when appropriate, relating to its technology and to specific products it develops. The Company's policy is to strategically file selected patent applications to protect technology, inventions and improvements that are important to the development of its business. The Company also relies upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain its competitive position. The patent positions of pharmaceutical and biotechnology firms, including the Company, are uncertain and involve complex legal and factual questions. In addition, the scope of the claims in a patent application can be significantly modified during prosecution before the issued patent is issued. Consequently, the Company does not know whether any of its applications will result in the issuance of patents, or if any issued patents will provide significant proprietary protection or will be circumvented or invalidated. Since patent applications in the United States are maintained in secrecy until patents issue, and since publication of discoveries in the scientific or patent literature often lag behind actual discoveries, the Company cannot be certain that it was the first creator of inventions covered by its pending patent applications or that it was the first to file patent applications for such inventions. Moreover, the Company may have to participate in interference proceedings declared by the United States Patent and Trademark Office ("PTO") to determine priority of invention, which could result in substantial cost to the Company, even if the eventual outcome is favorable to the Company. There can be no assurance that the Company's pending patent applications, if issued, or its existing patents, would be held valid. An adverse outcome could subject the Company to significant liabilities to third parties, require disputed rights to be licensed from third parties or require the Company to cease or modify its use of such technology. The development of therapeutic products for applications in the Company's product fields is intensely competitive. A number of pharmaceutical companies, biotechnology companies, universities and research institutions have filed patent applications or received patents in the areas of the Company's programs. In addition, patent applications relating to the Company's potential products or technologies may currently be pending. Some of these applications or patents may limit or preclude the Company's applications and could result in a significant reduction of the coverage of the Company's patents, or potential patents. The Company is aware of pending patent applications that have been filed by other companies that may pertain to certain of the Company's technologies. If patents are issued to these or other companies containing preclusive or conflicting claims, and such claims are ultimately determined to be valid, the Company may be required to obtain licenses to these patents or to develop or obtain alternative technology. Furthermore, the Company has in the past been, and may from time to time in the future be, notified of claims that the Company may be infringing patents or other intellectual 11 property rights owned by third parties. The Company has obtained one license under a patent, and if necessary or desirable the Company may seek additional licenses under other patents or intellectual property rights. There can be no assurance, however, that a license will be available on reasonable terms or at all. The Company could decide, in the alternative, to resort to litigation to challenge such claims. Such challenges could be extremely expensive and time consuming and could have a material adverse effect on the Company's business, financial condition or results of operations. The Company also relies on trade secrets and contractual arrangements to protect certain of its proprietary information, processes and products. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known or be independently discovered by competitors. Much of the know-how important to the Company's technology and many of its processes, which may not be patentable, are dependent upon the knowledge, experience and skills of key scientific and technical personnel. To protect its rights to its proprietary know-how and technology, the Company requires all employees, consultants, advisors and collaborators to enter into confidentiality agreements that prohibit the disclosure of confidential information to anyone outside the Company and require disclosure to the Company of ideas, developments, discoveries and inventions made by them. There can be no assurance that these agreements will effectively prevent disclosure of the Company's confidential information or will provide meaningful protection for the Company's confidential information if there is unauthorized use or disclosure. The Company's business may be adversely affected by competitors who develop substantially equivalent technology. In connection with certain research, the Company has entered into sponsored research agreements with various researchers and universities. Generally, under these agreements the Company funds the research of investigators in exchange for the right or an option to a license to any patentable inventions that may result in designated areas. The Company is obligated to make certain payments during the terms of certain of the agreements, to pay royalties on net sales of any licensed products and, in some cases, to negotiate in good faith the business terms of any license executed upon exercise of licensing options. There can be no assurance that these agreements will not be breached or that the Company would have adequate remedies for any breach. COMPETITION The pharmaceutical industry is intensely competitive. Many companies, including biotechnology, chemical and pharmaceutical companies, are actively engaged in the research and development of products in the Company's targeted areas. Many of these companies have substantially greater financial, technical and marketing resources than the Company. In addition, some of these companies have considerable experience in preclinical testing, clinical trials and other regulatory approval procedures. Moreover, certain academic institutions, governmental agencies and other research organizations are conducting research in areas in which the Company is working. These institutions are becoming increasingly aware of the commercial value of their findings and are becoming more active in seeking patent protection and licensing arrangements to collect royalties for the use of technology that they have developed. These institutions also may market competitive commercial products on their own or through joint ventures and will compete with the Company in recruiting highly qualified scientific personnel. 12 The Company is pursuing areas of product development in which there is a potential for extensive technological innovation in relatively short periods of time. The Company's first clinical compound, APC-366, is in clinical trials for the treatment of asthma. Currently, Schering-Plough, Astra and Glaxo-Wellcome, among others, produce therapeutics for the treatment of asthma. The Company's competitors may succeed in developing technologies or products that are more effective than those of the Company. Rapid technological change or developments by others may result in the Company's technology or potential products becoming obsolete or noncompetitive. There can be no assurance that the Company's competitors will not develop more efficacious or more affordable products, or achieve earlier product development completion, patent protection, regulatory approval or product commercialization than the Company, which would have a material adverse affect on the Company's business, financial condition and results of operations. GOVERNMENT REGULATION The manufacturing and marketing of the Company's proposed products and its research and development activities are subject to regulation for safety, efficacy and quality by numerous governmental authorities in the United States and other countries. In the United States, drugs are subject to rigorous United States Food and Drug Administration ("FDA") regulation. The Federal Food, Drug and Cosmetic Act, as amended, and the regulations promulgated thereunder, and other federal and state statutes and regulations, govern, among other things, the testing, manufacture, safety, efficacy, labeling, storage, record keeping, approval, advertising and promotion of the Company's products. Product development and approval within this regulatory framework takes a number of years and involves the expenditure of substantial resources. Failure to comply with applicable regulatory requirements may subject a company to administrative or judicially imposed sanctions, such as warning letters, civil penalties, criminal prosecution, injunctions, product seizure, product recalls, total or partial suspension of production, and FDA refusal to approve pending New Drug Applications ("NDA") or supplements to approved applications. The steps required before a pharmaceutical agent may be marketed in the United States include (i) preclinical laboratory tests, in vivo preclinical studies and formulation studies, (ii) the submission to the FDA of an application for human clinical testing, an Investigational New Drug Application ("IND"), which must become effective before human clinical trials commence, (iii) adequate and well-controlled human clinical trials to establish the safety and efficacy of the drug, (iv) the submission of an NDA to the FDA and (v) the FDA approval of the NDA prior to any commercial sale or shipment of the drug. In addition to obtaining FDA approval for each product, each domestic drug manufacturing establishment must be registered with the FDA. Domestic drug manufacturing establishments are subject to biennial inspections by the FDA and must comply with Good Manufacturing Practices ("GMP"). To supply products for use in the United States, foreign manufacturing establishments must comply with GMP and are subject to periodic inspection by the FDA or by corresponding regulatory agencies in such countries under reciprocal agreements with the FDA. Drug product manufacturing establishments located in California also must be licensed by the State of California in compliance with local regulatory requirements. Preclinical tests include laboratory evaluation of product chemistry and formulation, as well as animal studies to assess the potential safety and efficacy of the product. Preclinical safety tests must be conducted by laboratories that comply with FDA regulations regarding Good Laboratory Practices. The results of the preclinical tests are submitted to FDA as part of an IND and reviewed by the FDA prior to the commencement of human 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 FDA authorization to commence clinical trials. 13 Clinical trials involve the administration of the investigational new drug to healthy volunteers or to patients, under the supervision of a qualified principal investigator. Clinical trials are 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 ("IRB") at the institution at which 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. Clinical trials are typically conducted in three sequential phases, but the phases may overlap. In Phase I, the initial introduction of the drug into healthy subjects or patients, the drug is tested to determine its metabolism, pharmacokinetics and pharmacological actions in humans, the side effects associated with increasing doses and early evidence of efficacy, if possible. Phase II involves studies in a limited patient population to (i) determine the efficacy of the drug for specific, targeted indications, (ii) determine dosage tolerance and optimal dosage and (iii) identify possible adverse effects and safety risks. If a compound is found to be effective and to have an acceptable safety profile in Phase II evaluations, Phase III trials are undertaken to further evaluate clinical efficacy and to further test for safety within an expanded patient population at geographically dispersed clinical study sites. There can be no assurance that Phase I, Phase II or Phase III testing will be completed successfully within any specific time period, if at all, with respect to any of the Company's products subject to such testing. Furthermore, the Company or the FDA may suspend or terminate clinical trials at any time if it is felt that the subjects or patients are being exposed to an unacceptable health risk or the FDA finds deficiencies in the IND or the conduct of the investigation. Further, FDA regulations subject sponsors of clinical investigations to numerous regulatory requirements, including, among other requirements, selection of qualified investigators, proper monitoring of the investigations, recordkeeping and record retention, and ensuring that FDA and all investigators are promptly informed of significant new adverse effects or risks with respect to the drug, as well as other ongoing reporting requirements. The results of the pharmaceutical development, preclinical studies and clinical studies are submitted to the FDA in the form of an NDA for clearance of the marketing and commercial shipment of the drug. The testing and approval process is likely to require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis, if at all. The FDA may deny an NDA if applicable regulatory criteria are not satisfied, may require additional testing or information, or may require post-marketing testing and surveillance to monitor the safety of the Company's products if the FDA does not view the NDA as containing adequate evidence of the safety and efficacy of the drug. Notwithstanding the submission of such data, the FDA may ultimately decide that the application does not satisfy its regulatory criteria for approval. Moreover, if regulatory clearance of a drug is granted, such approval may entail limitations on the indicated uses for which it may be marketed. Finally, product approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems occur following initial marketing. Among the conditions for NDA 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. 14 In addition to regulations enforced by the FDA, the Company also is subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state or local regulations. The Company's research and development involves the controlled use of hazardous materials, chemicals and various radioactive compounds. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of such an accident, the Company could be held liable for any damages that result and any such liability could exceed the resources of the Company. For clinical investigation and marketing outside the United States, the Company also is subject to foreign regulatory requirements governing human clinical trials and marketing approval for drugs. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely for European countries both within, and outside, the European Community ("EC"). The Company's approach to the European regulatory process involves the identification of clinical investigators in the member states of the EC and other European countries to conduct clinical studies. The Company intends to design these studies to meet FDA, EC and other European countries' standards. Within the EC, while marketing authorizations must be supported by clinical trial data of a type and extent set out by EC directives and guidelines, the approval process for the commencement of clinical trials is not currently harmonized by EC law and varies from country to country. As far as possible, the studies will be designed to develop a regulatory package sufficient for multi-country approval in the Company's European target markets without the need to duplicate studies for individual country approvals. Outside the U.S., the Company's ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authority. At present, foreign marketing authorizations are applied for at a national level, although within the EC certain registration procedures are available to companies wishing to market the product in more than one EC member state. If the regulatory authority is satisfied that adequate evidence of safety, quality and efficacy has been presented, a marketing authorization will be granted. The system for obtaining marketing authorizations within the EC changed on January 1, 1995 pursuant to EC legislation recently adopted. The new EC registration system is a dual one in which certain products, such as biotechnology and high technology products and those containing new active substances, will have access to a central regulatory system that provides registration throughout the entire EC. Other products will be registered by national authorities in individual EC member states, operating on a principle of mutual recognition. This foreign regulatory approval process includes all of the risks associated with FDA approval set forth above. MANUFACTURING The Company has no manufacturing facilities. The Company's potential products have never been manufactured on a commercial scale. Furthermore, the Company must rely on its collaborators, such as Bayer AG, Pharmacia & Upjohn, Inc., Amgen, Inc., SmithKline Beecham Corporation and Merck & Co. to manufacture potential products created by the collaborations. Although the Company believes that it, or its collaborators or contract manufacturers, will be able to manufacture its compounds in a commercially viable manner, there can be no assurance that such compounds can be manufactured at a cost or in quantities necessary to make them commercially viable. If the Company and its collaborators are unable to manufacture or 15 contract with others for a sufficient supply of its compounds on acceptable terms, or if they should encounter delays or difficulties in their relationships with third party manufacturers, the Company's preclinical and clinical testing schedule 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 would have a material adverse effect on the Company. Moreover, the Company and its collaborators and contract manufacturers 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. MARKETING The Company currently has no sales, marketing or distribution capability. The Company will rely on its collaborative relationships, such as those with Bayer AG, Pharmacia & Upjohn, Inc., Amgen, Inc., SmithKline Beecham Corporation, and Merck & Co. to market certain of its potential products, may enter into future collaborations by which the Company will come to rely on the collaboration to market its products, and may decide to market other potential products directly. To market any of its potential products directly, the Company must develop a marketing and sales force with technical expertise and with supporting distribution capability. There can be no assurance that the Company will be able to establish in-house sales and distribution capabilities or relationships with third parties, or that it will be successful in gaining market acceptance for its potential products. Under its existing collaborations, and to the extent that the Company enters into future co-promotion or other licensing arrangements, any revenues received by the Company under those collaborations will depend upon the efforts of third parties, and there can be no assurance that such efforts will be successful. HUMAN RESOURCES As of January 1, 1997, Arris employed 160 individuals, of whom 67 hold Ph.D. or M.D. degrees and 32 hold other advanced degrees. Approximately 134 employees are engaged in research and development activities, including a variety of disciplines within the areas of molecular biology and other biological sciences, medicinal chemistry, computer sciences and clinical development. Approximately 26 employees are employed in finance, corporate development and general administrative activities. None of the Company's employees is covered by collective bargaining agreements, and management considers relations with its employees to be good. Additionally, Arris augments its full time staff through part-time consulting arrangements with experienced, professional scientists and managers. 16 ITEM 2. PROPERTIES Arris currently occupies approximately 121,000 square feet of leased laboratory, support and administrative space in South San Francisco, California. Leases expire on these facilities on December 31, 1997 with respect to approximately 2,700 square feet, October 31, 2001 with respect to the approximately 49,000 square feet, and August 4, 2006 for the remainder of the Company's facilities. In addition to the above listed facilities, the Company is subleasing approximately 32,000 square feet to an unrelated third party, with the lease and sublease expiring on July, 31, 2000. The Company's existing and planned facilities are believed to be adequate to meet its present requirements, and the Company currently believes that suitable additional space will be available to it, when needed, on commercially reasonable terms. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 17 PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Common Stock began trading on the Nasdaq National Market under the symbol "ARRS" on November 19, 1993. Prior to that date, there was no public market for the Company's Common Stock. The following table sets forth, for the periods indicated, the high and low sales prices of the Common Stock reported on the Nasdaq National Market. These over-the-counter quotations reflect inter-dealer prices, without retail markup, markdown or commission, and may not necessarily represent the sales prices in actual transactions.
HIGH LOW --------- --------- 1995 First Quarter............................................................ $ 7.63 $ 5.72 Second Quarter........................................................... 11.13 7.00 Third Quarter............................................................ 14.25 8.75 Fourth Quarter........................................................... 15.25 9.25 1996 First Quarter............................................................ $ 19.50 $ 12.50 Second Quarter........................................................... 17.25 11.38 Third Quarter............................................................ 14.50 9.50 Fourth Quarter........................................................... 16.25 12.25
On March 19, 1997, the last sale price reported on the Nasdaq National Market for the Company's Common Stock was $13.50 per share. HOLDERS As of February 28, 1997 there were approximately 283 stockholders of record of the Company's Common Stock. DIVIDENDS The Company has not paid dividends on its Common Stock and currently does not plan to pay any cash dividends in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES On December 30, 1996 the Company issued an aggregate of 518,701 shares of its Common Stock to the former preferred stockholders of Khepri Pharmaceuticals, Inc., in connection with the second payment obligation to such stockholders pursuant to the terms of the stock-for-stock acquisition. See "Item 1. Business -Acquisition of Khepri." Such issuance was made without registration upon reliance of Section 3(a)(10) of the Securities Act of 1933, as amended. 18 ITEM 6. SELECTED FINANCIAL DATA ARRIS PHARMACEUTICAL CORPORATION The data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data" which is included elsewhere in this Annual Report on Form 10-K.
YEARS ENDED DECEMBER 31, ------------------------------------------------------ 1992 1993 1994 1995 (1) 1996 --------- --------- --------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Consolidated Statements of Operations: Contract revenues.......................................... $ -- $ 2,542 $ 8,304 $ 16,727 $ 21,560 Operating expenses: Research and development................................. 6,994 8,910 13,155 14,689 24,319 General and administrative............................... 1,531 2,283 4,010 4,247 5,409 Acquired in-process research and development............. -- -- -- 22,514 230 --------- --------- --------- ---------- --------- Total operating expenses............................... 8,525 11,193 17,165 41,450 29,958 --------- --------- --------- ---------- --------- Operating loss............................................. (8,525) (8,651) (8,861) (24,723) (8,398) Interest income (expense), net............................. (68) 172 522 990 2,470 --------- --------- --------- ---------- --------- Net loss................................................... $ (8,593) $ (8,479) $ (8,339) $ (23,733) $ (5,928) --------- --------- --------- ---------- --------- --------- --------- --------- ---------- --------- Net loss per share......................................... $ (2.15) $ (2.10) $ (0.97) $ (2.71) $ (0.45) Weighted average number of shares outstanding.............. 4,006 4,031 8,570 8,745 13,177
DECEMBER 31, -------------------------------------------------------- 1992 1993 1993 1995 (2) 1996 ------------ --------- --------- --------- --------- (IN THOUSANDS) Consolidated Balance Sheet Data: Cash, cash equivalents and marketable investments...... $ 8,422 $ 25,610 $ 30,070 $ 31,105 $ 66,720 Total assets........................................... 11,934 31,063 34,786 40,293 80,832 Long-term obligations.................................. 26,429 3,352 7,645 16,490 10,676 Accumulated deficit.................................... (16,325) (24,804) (33,298) (56,876) (62,804) Total stockholders' equity............................. (16,288) 21,654 13,425 7,278 52,900
- ------------------------ (1) Includes the results of operations of Khepri from December 22, 1995 through December 31, 1995, including a one-time charge for acquired in-process research and development. Excluding such one-time charge, net loss and net loss per share would have been $1,219,000 and $0.14 per share, respectively. With the acquisition of Khepri, the Company expects net loss from continuing operations to increase significantly. (2) Includes the acquisition of Khepri as of December 22, 1995. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ significantly from the results discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section as well as under "Item 1. Business," including, "Business Risks." OVERVIEW Since its inception in April 1989, the Company has devoted substantially all of its resources to its research and development programs. To date, the Company's only source of revenue has been its corporate collaborations with Pharmacia & Upjohn, Inc. and its predecessors ("PNU"), Amgen, Inc. ("Amgen"), Bayer AG ("Bayer"), SmithKline Beecham Corporation ("SB") and Merck & Co. ("Merck"). Its collaborations have taken a variety of forms including in each case certain of the following elements: payments to the Company of an up-front fee, purchase of the Company's common stock (PNU human growth hormone collaboration only), research funding payments, milestone payments, if and when milestones are achieved, and royalties upon the sale of any resulting products. Where appropriate, the up-front fees have been recorded as deferred revenue until earned. On December 22, 1995 and December 30, 1996 the Company issued an aggregate of 1,933,701 shares of common stock for all of the outstanding capital stock of Khepri Pharmaceuticals, Inc. ("Khepri"), a development stage company focusing on the discovery of therapeutic inhibitors of cysteine proteases. The acquisition was a tax-free reorganization accounted for as a purchase. The purchase price was allocated to acquired assets and assumed liabilities based upon their fair value at the date of acquisition. Approximately $22.5 million of the purchase price was allocated to in-process research and development, and has been charged as an expense in the year ended December 31, 1995. The operating results of Khepri from the date of acquisition to December 31, 1995 have also been included in the Company's consolidated results of operations for the year ended December 31, 1995. See "Item 1. Business--Acquisition of Khepri." In July 1996, the minority interest investors in Arris Canada (formerly Khepri Canada) exercised their option to exchange their holdings into 161,418 shares of the Company's Common Stock. The Company has not been profitable since inception and expects to incur substantial losses for at least the next several years, primarily due to the cost of its research and development programs, including preclinical studies and human clinical trials. The Company expects that losses will fluctuate from quarter to quarter, that such fluctuations may be substantial, and that results from prior quarters may not be indicative of future operating results. As of December 31, 1996, the Company's accumulated deficit was approximately $62.8 million. RESULTS OF OPERATIONS Years Ended December 31, 1996 and 1995 20 CONTRACT REVENUE The Company's contract revenues increased to $21.6 million for the year ended December 31, 1996 from $16.7 million in 1995. The increase was due primarily to (i) the inclusion of a full year of research and development funding support under a collaboration with PNU, which commenced in August 1995, for the treatment of blood clotting disorders, (ii) the commencement of the collaboration with PNU in March 1996, for the use of combinatorial chemistry to create probe libraries consisting of 250,000 small molecule synthetic organic compounds, (iii) the commencement of the collaboration with SB in June 1996, to develop inhibitors using Arris' proprietary Delta technology targeting intracellular viral proteases, (iv) a milestone payment from Bayer in September 1996 for the development of a tryptase inhibitor for the treatment of asthma, and (v) the commencement of the collaboration with Merck in November 1996 to develop small molecule inhibitors of proteases involved in osteoporosis. RESEARCH AND DEVELOPMENT The Company's research and development expenses increased to $24.3 million for the year ended December 31, 1996, from $14.7 million in 1995, primarily due to the expansion of the Company's research efforts in new and existing programs and the expenses of programs and facilities added as part of the December 22, 1995 acquisition of Khepri. Research and development expenses increased as a percentage of total expenses (without the consideration of acquired in-process research and development expenses of $230,000 and $22.5 million in 1996 and 1995, respectively) to 82% in 1996 from 78% in 1995. The Company expects its research and development costs to increase in absolute dollars in 1997 and 1998 due to expansion of its research programs and the conduct of preclinical studies and clinical trials. GENERAL AND ADMINISTRATIVE The Company's general and administrative expenses increased to $5.4 million for the year ended December 31, 1996, from $4.2 million in 1995, primarily due to the addition of programs added as a result of the acquisition of Khepri, the addition of general and administrative personnel in support of the Company's expanded research and development efforts, and the expansion of the Company's facilities as well as business development activities. In spite of the overall increase, general and administrative expenses as a percentage of total expenses (without the consideration of acquired in-process research and development expenses of $230,000 and $22.5 million in 1996 and 1995, respectively) has decreased to 18% in 1996 from 22% in 1995. The Company expects its general and administrative expenditures to increase in absolute dollars in 1997 and 1998 in support of expanded research and development. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT In July 1996, in connection with the Company's acquisition of Khepri, the minority interest investors in Arris Pharmaceuticals Canada, Inc. ("Arris Canada"), exercised their right to exchange their interest in Arris Canada for 161,418 shares of the Company's Common Stock. Upon conversion of their shares in Arris Canada, Arris Canada became a wholly owned subsidiary of the Company. The fair value of the shares issued to those minority interest investors on the date of exercise exceeded the book value of the minority interest in Arris Canada by $230,000. This amount has been expensed as acquired in-process research and development for the year ended December 31, 1996. The Company recorded $22.5 million in 1995 as a one-time expense related to in-process research and development in connection with the acquisition. INTEREST INCOME AND INTEREST EXPENSE 21 Interest income increased to $3.1 million for the year ended December 31, 1996 from $1.3 million in 1995. The increase was largely due to the higher average cash balances in 1996 resulting from receipt of net proceeds of approximately $36.2 million from the follow-on public offering of 3,000,000 shares of the Company's Common Stock which closed on March 27, 1996 and approximately $5.5 million from the exercise on April 24, 1996 by the underwriters of the over allotment option in the follow-on public offering of 450,000 shares, and from the receipt of a milestone fee from an existing collaboration and up-front fees collected under new collaborations. Interest expense increased to $670,000 for the year ended December 31, 1996 from $312,000 in 1995 as a result of higher average debt balances incurred to finance the expansion of the Company's facilities and acquisition of lab equipment. PROVISION FOR INCOME TAX The Company incurred a net operating loss in 1996 and, accordingly, no provision for federal or state income taxes was recorded. As of December 31, 1996, the Company had federal net operating tax loss carryforwards of approximately $22.8 million. The Company's ability to utilize its net operating loss carryforwards may be subject to an annual limitation in future periods pursuant to the "change in ownership rules" under Section 382 of the Internal Revenue Code of 1986, as amended. Years Ended December 31, 1995 and 1994 CONTRACT REVENUE The Company's contract revenues increased to $16.7 million for the year ended December 31, 1995 from $8.3 million in 1994. The increase is due to (i) the inclusion of a full year of research and development funding support under a collaboration with Bayer, which commenced in November 1994, for the development of tryptase and chymase inhibitors, (ii) the commencement of the PNU collaboration regarding inhibitors of clotting factors in August 1995, (iii) the commencement of the PNU combinatorial chemistry collaboration in March 1995 and (iv) the expansion of research, resulting in increased revenues, in accordance with the collaboration with Amgen for the development of small molecule oral mimetics of erythropoietin, originally commenced in 1993. RESEARCH AND DEVELOPMENT The Company's research and development expenses increased to $14.7 million for the year ended December 1995, from $13.2 million in 1994, primarily due to the expansion of the Company's research efforts under the programs described above, increases in personnel and expansion of facilities. GENERAL AND ADMINISTRATIVE The Company's general and administrative expenses increased to $4.2 million for the year ended December 31, 1995 from $4.0 million in 1994. The increase was primarily incurred in support of the extension of the Company's research and development programs, increased business development activities and expansion of the Company's facilities. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT In December 1995, the Company recorded a one-time charge of $22.5 million related to acquired in-process research and development in connection with the acquisition of Khepri. INTEREST INCOME AND INTEREST EXPENSE 22 Interest income increased to $1.3 million for the year ended December 31, 1995 from $869,000 in 1994. The increase was due to higher cash and investment balances from collaboration commitment fees, as well as higher interest rates. Interest expense decreased to $312,000 for the year ended December 31, 1995 from $347,000 in 1994. This decrease was a result of more favorable financing terms, offset by an overall increase in obligations outstanding. LIQUIDITY AND CAPITAL RESOURCES The Company has financed its operations since inception primarily through private and public offerings of its capital stock and through corporate collaborations. As of December 31, 1996, the Company had realized approximately $91 million in net proceeds from offerings of its capital stock. In addition, the Company has realized $62 million since inception from its corporate collaborations (excluding the $5.4 million equity investment in the Company made by PNU). The Company's principal sources of liquidity are its cash and investments, which totaled $66.7 million as of December 31, 1996. In September 1996, the Company arranged for a $12 million line of credit from Bank of America, which is available through December 1997. As of December 31, 1996 the Company had borrowed $6.4 million and had $5.6 million remaining available under this line of credit. During the year ending December 31, 1996, $5.0 million of cash was used in operations, $6.9 million was expended for the purchase of property and equipment and $48.2 million was realized through financing activities, primarily due to the follow-on public offering in March 1996. Additional equipment is expected to be needed as the Company increases its research and development activities. The Company received net debt financing of $4.7 million in 1996, which includes $6.4 million in proceeds from the line of credit, discussed above, and net repayments over proceeds from capital leases and a bank note payable of $1.7 million. The Company's revenues presently are attributable to collaborations with PNU, Amgen, Bayer, SB and Merck. The PNU human growth hormone collaboration extends through mid-1997. The Amgen erythropoietin collaboration concluded in February 1997. The proof-of-concept phase of the SB collaboration ends in June 1997 and can be extended by SB beyond that into a research phase. All of the Company's other collaborations extend 12 months beyond March 1997. If the Company is unable to renew any of these existing collaborations or extend the SB collaboration into the research phase, such events may have a material adverse effect on the Company's results of operation and financial condition. The cash received by the Company under all collaborations for the year ended December 31, 1996 was approximately $20.3 million. This amount includes the up-front payment from PNU in connection with the combinatorial chemistry agreement which commenced in March 1996, the up-front payment from SB in connection with the antiviral collaboration which commenced in June 1996 and the up-front payment from Merck in connection with the small molecule inhibitors of proteases involved in osteoporosis. The aggregate collaboration funding to be received by the Company in 1997 and 1998 is expected to be less than that received in 1996, excluding milestone payments and new collaborations. There can be no assurance that the research support or any milestone payments will be realized on a timely basis or at all. The Company expects that its existing capital resources, including research and development revenues from existing collaborations, will enable the Company to maintain current and planned operations through at least the next 48 months. The Company anticipates that it will need to raise substantial additional capital to fund its operations beyond that time. 23 The Company expects that it will seek such additional funding through new collaborations, through the extension of existing collaborations or through public or private equity or debt financing. There can be no assurance that additional financing will be available on acceptable terms or at all. If all additional funds are raised by issuing equity securities, further dilution to stockholders may result. If adequate funds are not available, the Company may be required to delay, to reduce the scope of or to eliminate one or more of its research or development programs or to obtain funds through arrangements with collaborative partners or others that may require the Company to relinquish rights to certain of its technologies or products that the Company would otherwise seek to develop or commercialize itself, which would have a material adverse affect on the Company's results of operations and financial condition. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE ----- Report of Ernst & Young LLP, Independent Auditors...................................... 25 Consolidated Balance Sheets at December 31, 1996 and 1995.............................. 26 Consolidated Statements of Operations for the three years ended December 31, 1996...... 27 Consolidated Statement of Stockholders' Equity for the three years ended December 31, 1996................................................................................. 28 Consolidated Statements of Cash Flows for the three years ended December 31, 1996...... 29 Notes to Consolidated Financial Statements............................................. 31
24 REPORT OF INDEPENDENT AUDITORS Board of Directors and Stockholders Arris Pharmaceutical Corporation We have audited the accompanying consolidated balance sheets of Arris Pharmaceutical Corporation as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 consolidated financial position of Arris Pharmaceutical Corporation at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Ernst & Young LLP Palo Alto, California February 10, 1997 25 ARRIS PHARMACEUTICAL CORPORATION CONSOLIDATED BALANCE SHEETS
DECEMBER 31, -------------------- 1996 1995 --------- --------- (IN THOUSANDS) Assets Current assets: Cash and cash equivalents.............................................. $ 10,822 $ 21,706 Short-term marketable investments...................................... 37,021 9,399 Prepaid expenses and other current assets.............................. 2,217 798 --------- --------- Total current assets.................................................... 50,060 31,903 Marketable investments.................................................. 11,627 -- Restricted cash and investments......................................... 7,250 -- Property and equipment, net............................................. 10,446 7,423 Note receivable from officer............................................ 750 -- Other assets............................................................ 699 967 --------- --------- $ 80,832 $ 40,293 --------- --------- --------- --------- Liabilities and stockholders' equity Current liabilities: Accounts payable....................................................... $ 1,439 $ 872 Accrued compensation................................................... 1,480 1,718 Accrued merger costs................................................... -- 762 Other accrued liabilities.............................................. 1,570 1,889 Current portion of deferred revenue.................................... 10,783 8,585 Current portion of notes payable and capital lease obligations......... 1,984 2,699 --------- --------- Total current liabilities............................................... 17,256 16,525 Noncurrent portion of deferred revenue.................................. 1,973 5,472 Noncurrent portion of notes payable and capital lease obligations....... 8,703 3,263 Convertible acquisition liability....................................... -- 6,185 Minority interest payable............................................... -- 1,570 Commitments Stockholders' equity: Preferred stock, $0.001 par value, 10,000,000 shares authorized, none issued or outstanding................................................. -- -- Common stock, $0.001 par value; 30,000,000 shares authorized, 14,831,975 shares and 10,169,076 shares issued and outstanding at December 31, 1996 and 1995, respectively........................................... 115,904 64,389 Note receivable from officer........................................... (200) (200) Deferred compensation.................................................. -- (35) Accumulated deficit.................................................... (62,804) (56,876) --------- --------- Total stockholders' equity.............................................. 52,900 7,278 --------- --------- $ 80,832 $ 40,293 --------- --------- --------- ---------
26 ARRIS PHARMACEUTICAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 --------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Contract revenue................................................................ $ 21,560 $ 16,727 $ 8,304 Operating expenses: Research and development....................................................... 24,319 14,689 13,155 General and administrative..................................................... 5,409 4,247 4,010 Acquired in-process research and development................................... 230 22,514 -- --------- ---------- --------- Total operating expenses........................................................ 29,958 41,450 17,165 --------- ---------- --------- Operating loss.................................................................. (8,398) (24,723) (8,861) Interest income................................................................. 3,140 1,302 869 Interest expense................................................................ (670) (312) (347) --------- ---------- --------- Net loss........................................................................ $ (5,928) $ (23,733) $ (8,339) --------- ---------- --------- --------- ---------- --------- Net loss per share.............................................................. $ (0.45) $ (2.71) $ (0.97) --------- ---------- --------- --------- ---------- --------- Shares used in computing net loss per share..................................... 13,177 8,745 8,570 --------- ---------- --------- --------- ---------- ---------
27 ARRIS PHARMACEUTICAL CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (In thousands, except share and per share amounts)
NOTE COMMON STOCK RECEIVABLE TOTAL ------------------------ FROM DEFERRED ACCUMULATED STOCKHOLDERS' SHARES AMOUNT OFFICER COMPENSATION DEFICIT EQUITY ------------ ---------- ----------- --------------- ------------ ------------ Balances at December 31, 1993................ 8,493,321 $ 46,981 $ (200) $ (323) $ (24,804) $ 21,654 Exercise of options and warrants to purchase common stock at $0.07-$5.95 per share...... 114,213 42 -- -- -- 42 Issuance of common stock at $5.46 and $4.89 per share in connection with the Employee Stock Purchase Plan (net of offering costs of $60).................................... 27,384 78 -- -- -- 78 Issuance of a warrant to purchase common stock at $7.00 per share................... -- 1 -- -- -- 1 Amortization of deferred compensation........ -- -- -- 144 -- 144 Unrealized loss on securities held as available-for-sale......................... -- -- -- -- (155) (155) Net loss..................................... -- -- -- -- (8,339) (8,339) ---------- ------- ----- ----- ------- ------- Balances at December 31, 1994................ 8,634,918 47,102 (200) (179) (33,298) 13,425 Exercise of options to purchase common stock at $0.35-$7.00 per share................... 74,484 162 -- -- -- 162 Issuance of common stock at $4.89-$11.50 per share (net of repurchases) for cash and services............................... 44,915 281 -- -- -- 281 Issuance of common stock and value of options and warrants issued in connection with the acquisition of Khepri Pharmaceuticals, Inc....................... 1,414,759 16,844 -- -- -- 16,844 Amortization of deferred compensation........ -- -- -- 144 -- 144 Recovery of unrealized loss on securities held as available-for-sale................. -- -- -- -- 155 155 Net loss..................................... -- -- -- -- (23,733) (23,733) --------- ------- ------ ------ --------- -------- Balances at December 31, 1995................ 10,169,076 64,389 (200) (35) (56,876) 7,278 Exercise of options and a warrant to purchase common stock at $0.32-$13.02 per share.................................. 466,088 1,425 -- -- -- 1,425 Issuance of common stock at $13.00 per share net of issuance costs of $3,138............ 3,450,000 41,712 -- -- -- 41,712 Issuance of common stock at $4.89 to $9.46 per share in connection with the Employee Stock Purchase Plan........................ 66,692 393 -- -- -- 393 Issuance of common stock in connection with the exercise of the Arris Canada minority interest option............................ 161,418 1,800 -- -- -- 1,800 Issuance of common stock in connection with the acquisition of Khepri Pharmaceuticals, Inc....................... 518,701 6,185 -- -- -- 6,185 Amortization of deferred compensation........ -- -- -- 35 -- 35 Net loss..................................... -- -- -- -- (5,928) (5,928) Balances at December 31, 1996................ 14,831,975 $ 115,904 $ (200) $ -- $ (62,804) $ 52,900
28 ARRIS PHARMACEUTICAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Increase (Decrease) in Cash and Cash Equivalents
YEAR ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 --------- ---------- --------- (IN THOUSANDS) Cash flows from operating activities Net loss......................................................................... $ (5,928) $ (23,733) $ (8,339) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization................................................... 3,859 2,454 2,245 Loss on disposal of fixed assets................................................ 209 -- -- Stock issued and issuable for services.......................................... 35 98 -- Acquired in-process research and development.................................... 230 22,514 -- Changes in assets and liabilities: Prepaid expenses and other current assets...................................... (1,419) 742 (203) Other assets................................................................... 93 (31) (39) Accounts payable............................................................... 567 347 (1,645) Accrued compensation........................................................... (238) 27 460 Accrued merger costs........................................................... (762) -- -- Other accrued liabilities...................................................... (319) 810 222 Deferred revenue............................................................... (1,301) (2,274) 12,053 --------- ---------- --------- Net cash and cash equivalents (used in) provided by operating activities......... (4,974) 954 4,754 --------- ---------- --------- Cash flows from investing activities available for-sale-securities: Purchases....................................................................... (11,628) (8,808) -- Maturities...................................................................... -- 16,853 9,418 Held-to-maturity securities: Purchases....................................................................... (74,458) (7,890) -- Maturities...................................................................... 46,837 3,506 -- Purchase of restricted cash and investments...................................... (7,250) -- -- Acquisition, net of cash balances................................................ -- 2,266 -- Note receivable from officer..................................................... (750) -- -- Expenditures for property and equipment.......................................... (6,881) (3,827) (1,115) --------- ---------- --------- Net cash and cash equivalents (used in) provided by investing activities......... (54,130) 2,100 8,303 --------- ---------- --------- Cash flows from financing activities Net proceeds from issuance of common stock....................................... 43,495 345 121 Proceeds from issuance of note payable and capital lease obligations............. 9,164 2,707 2,377 Principal payments on note payable and capital lease obligations................. (4,439) (1,565) (1,522) --------- ---------- --------- Net cash and cash equivalents provided by financing activities................... 48,220 1,487 976 --------- ---------- --------- Net (decrease) increase in cash and cash equivalents............................. (10,884) 4,541 14,033 Cash and cash equivalents, beginning of year..................................... 21,706 17,165 3,132 --------- ---------- --------- Cash and cash equivalents, end of year........................................... $ 10,822 $ 21,706 $ 17,165 --------- ---------- --------- --------- ---------- ---------
29 ARRIS PHARMACEUTICAL CORPORATION Consolidated Statements of Cash Flows (continued) Increase (Decrease) in Cash and Cash Equivalents
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- (IN THOUSANDS) Supplemental disclosure of cash flows information Cash paid during the year for interest.................................... $ 623 $ 291 $ 347 --------- --------- --------- --------- --------- --------- Supplemental schedule of noncash investing and financing activities Issuance of common stock and value of options and warrants issued in acquisition............................................................. $ 6,185 $ 16,844 $ -- --------- --------- --------- --------- --------- --------- Issuance of common stock to Arris Canada minority interest investors...... $ 1,800 $ -- $ -- --------- --------- --------- --------- --------- --------- Noncash acquisition of equipment under capital lease...................... $ -- $ -- $ 7 --------- --------- --------- --------- --------- ---------
30 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Organization and Summary of Significant Accounting Policies ORGANIZATION Arris Pharmaceutical Corporation ("Arris" or the "Company") uses an integrated drug discovery approach combining structure-based drug design, combinatorial chemistry and its proprietary Delta Technology to discover and develop a number of diverse synthetic small molecule therapeutics for commercially important disease categories where existing therapies have significant limitations. Arris' product development includes protease programs targeting the inhibition of enzymes implicated in asthma, inflammatory disease, blood clotting disorders, infectious diseases, osteoporosis, cancer and autoimmune disease. The Company's technology platform also includes receptor-based discovery programs designed to discover small molecule drugs that mimic important therapeutic proteins that are already successful products. The consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, Arris Protease Corporation, Inc., and Arris Canada (formerly Khepri Pharmaceuticals Canada, Inc.) (see Note 2). All significant intercompany accounts and transactions have been eliminated. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS AND INVESTMENTS The Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Investments with maturities greater than three months and less than one year are classified as short-term investments. Investments with maturities greater than one year are classified as long-term investments. Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. 31 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Organization and Summary of Significant Accounting Policies (continued) CASH AND CASH EQUIVALENTS AND INVESTMENTS (continued) Debt securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are stated at amortized cost which approximated fair value. Amortization of premiums and accretion of discounts to maturity are included in interest income. Realized gains and losses, and declines in value judged to be other than temporary are also included in interest income. The cost of securities sold is based on the specific identification method. DEPRECIATION AND AMORTIZATION Depreciation is provided for using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized over the term of the lease or economic useful life, whichever is shorter. REVENUE RECOGNITION Revenue recognized under the Company's collaborative research agreements is recorded when earned as defined in the respective agreements. Research funding and commitment fees are recognized over the research period. Benchmark payments are recognized as revenue upon achievement of mutually agreed upon milestones. Payments received in advance are recorded as deferred revenue until earned. RESEARCH AND DEVELOPMENT Research and development expenses consist of costs incurred for independent and collaborative research and development. These costs include direct and research-related overhead expenses. Research and development expenses under the collaborative research agreements approximate the revenue recognized under the agreements in 1996, 1995 and 1994 (exclusive of milestone and up-front commitment fees). 32 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Organization and Summary of Significant Accounting Policies (continued) STOCK-BASED COMPENSATION In accordance with the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company has elected to continue to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issue to Employees" ("APB 25") and related interpretations in accounting for its employee stock option and purchase plans. See Note 6 for pro forma disclosures required by SFAS 123. NET LOSS PER SHARE Net loss per share is computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options and warrants are excluded from the computation as their effect is antidilutive. 2. Acquisition of Khepri Pharmaceuticals, Inc. On December 22, 1995, the Company acquired all of the outstanding capital stock of Khepri Pharmaceuticals, Inc. ("Khepri"), a development stage company engaged in research, development and marketing of protease and protease inhibitor compounds for the treatment of human diseases and disorders, by merging Khepri with and into Arris Protease, Inc., a wholly owned subsidiary of Arris. The transaction was accounted for as a purchase. The purchase price of $23,039,000 consisted of, among other items, the initial issuance of 1,415,000 shares of Company Common Stock, valued at $15,421,000, in exchange for all outstanding Khepri capital stock, options and warrants valued at $1,423,000 and an obligation due on December 30, 1996 for the Company, at its option, to either pay $6,185,000 in cash or issue approximately 520,000 common shares based on formulas defined in the merger agreement. The Company fulfilled the December 30, 1996 obligation described above by issuing 518,701 shares of its Common Stock. In connection with the acquisition, the Company renegotiated the stock exchange agreements between Khepri and the other investors in Arris Canada. Under the amended agreements, the Company, acting alone, or the minority interest investors, acting together, had the option to terminate both parties' funding obligations of Arris Canada and allow the minority interest investors to exchange their shares in Arris Canada for shares of the Company. In July 1996, the minority interest investors elected to convert their interest in Arris Canada into 161,418 shares of the Company's Common Stock, at which time Arris Canada became a wholly owned subsidiary. 33 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. Acquisition of Khepri Pharmaceuticals, Inc. (continued) The fair value of the Company's Common Stock at the time of the election by the minority interest investors in excess of the book value of the minority interest in July 1996 was $230,000. This amount was recorded as additional purchase price and charged to in process research and development for the year ended December 31, 1996. 3. COLLABORATIVE AGREEMENTS MERCK In November 1996, the Company signed a collaborative research and development agreement with Merck & Co. ("Merck") for the development of small molecule inhibitors of proteases involved in osteoporosis. Arris received an initial commitment fee (which is being amortized over the initial research period). The agreement also calls for a two-year research term which may be extended at Merck's option, during which Arris receives research funding and benchmark payments upon the achievement of mutually agreed upon milestones. Arris granted Merck an exclusive license to develop, manufacture and market certain proteases inhibitors. Arris is to receive royalties on Merck's sales of licensed products. Approximately $804,000 in contract revenue was recognized under this agreement in 1996. SMITHKLINE BEECHAM In June 1996, Arris entered into an agreement with SmithKline Beecham ("SB") to develop inhibitors using Arris' proprietary Delta technology with certain intracellular viral proteases. The agreement incorporates an initial proof-of concept phase and an optional research phase, if elected by SB. Arris has received a license fee and shall receive research funding and certain milestone payments during the proof-of-concept and research phases. Subject to the initiation of the research phase of the program, Arris granted SB an exclusive license to develop inhibitors of the target proteases using Arris' Delta technology and an exclusive license to manufacture and market products developed under the agreement. In return, Arris shall receive royalties on product sales. Approximately $725,000 in contract revenue was recognized under this agreement in 1996. 34 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. Collaborative Agreements (continued) BAYER In November 1994, Arris established a collaborative agreement with Bayer AG ("Bayer") aimed at developing inhibitors of the regulatory enzymes tryptase and chymase for the treatment of asthma and other inflammatory and auto-immune diseases. The agreement calls for a five-year research collaboration between the parties which Bayer may terminate at its discretion after three years. Arris received an initial commitment fee (which is being amortized over the noncancelable portion of the research period), is receiving research funding over the research period, and will receive benchmark payments upon the achievement of mutually agreed upon milestones. Arris granted Bayer the exclusive right to develop inhibitors of tryptase and chymase which result from the program, worldwide manufacturing and marketing rights to these compounds and assigned to Bayer certain rights to patents arising out of the collaboration. Arris is to receive royalties on Bayer's sales of licensed products. The Bayer collaboration provides that clinical development costs related to the Company's clinical compound, APC-366, will be borne by the Company through Phase IIb. If the results of the Phase IIb studies meet certain agreed-upon criteria, Bayer will assume development of APC-366. If the results fail to meet the criteria, development of APC-366 will be terminated. In September 1996, Bayer elected to initiate clinical development of an Arris compound, designated BAY-17-1998, the development costs of which are borne entirely by Bayer. Approximately $7,917,000, $7,667,000 and $639,000 in contract revenue was recognized under this agreement in 1996, 1995 and 1994, respectively. Pharmacia & Upjohn In March 1996, the Company entered into a research agreement with Pharmacia & Upjohn, Inc. ("Pharmacia & Upjohn") to use combinatorial chemistry to create a probe library consisting of 250,000 small molecule synthetic organic compounds. Arris has granted Pharmacia & Upjohn a co-exclusive license to the library being developed along with the technologies used for synthesis and screening. In return for the co-exclusive license, Arris received an upfront nonrefundable license payment (which is being amortized over the expected term of the agreement) and payments upon the delivery of the compounds. 35 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. Collaborative Agreements (continued) Pharmacia & Upjohn (continued) In August 1995, Arris entered into a research and development agreement with Pharmacia & Upjohn focused on the development of inhibitors of Thrombin, Factor Xa and Factor VIIa for the treatment of blood clotting disorders. The agreement calls for a five-year research collaboration between the parties which Pharmacia & Upjohn may terminate at its discretion after three years. Arris received an initial commitment fee (which is being amortized over the noncancelable portion of the research period), is receiving research funding over the research period, and will receive benchmark payments upon the achievement of mutually agreed upon milestones. Arris granted Pharmacia & Upjohn the exclusive right to develop inhibitors of Thrombin, FactorEXa and Factor VIIa which result from the program, as well as worldwide manufacturing and marketing rights to these compounds. Arris is to receive royalties on Pharmacia & Upjohn's sales of licensed products. In January 1994, the Company entered into an agreement with Pharmacia & Upjohn, which ended in January 1995, to apply the Company's proprietary computational algorithms to one of Pharmacia & Upjohn's in-house drug discovery programs. In March 1993, Arris entered into a research and development agreement with Pharmacia & Upjohn aimed at developing certain human growth factor mimetics, initially focusing on human growth hormone. The agreement, as extended, between Arris and Pharmacia & Upjohn calls for a research collaboration between the parties, the funded research phase of which ends in 1997. Further research may be conducted by Pharmacia & Upjohn pursuant to the agreement. Concurrent with the signing of the initial agreement, Pharmacia & Upjohn made a $5.4 million equity investment in Arris. Arris is receiving research funding during the term of the research collaboration and will receive benchmark payments if mutually agreed upon milestones are reached. Arris granted Pharmacia & Upjohn the exclusive right to develop growth factor mimetics discovered as well as worldwide manufacturing and marketing rights to these compounds. Arris is to receive royalties on Pharmacia & Upjohn's sales of any licensed products. Arris retains the rights to technology developed by the Company and gains licensing rights to certain technology developed by Pharmacia & Upjohn under the research program that may have application to other cytokine targets outside the focus of the collaboration. Arris has recognized a total of $8,585,000, $4,536,000 and $3,440,000 in revenues under these agreements for the years ended December 31, 1996, 1995 and 1994, respectively. 36 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. Collaborative Agreements (continued) Pharmacia & Upjohn (continued) In addition to its activities under these collaborative agreements, the Company purchased approximately $103,000 and $389,000 in supplies and equipment from Pharmacia & Upjohn and its subsidiaries in 1996 and 1995, respectively (none in 1994). Amgen Inc. In May 1993, Arris entered into an agreement with Amgen Inc. ("Amgen") aimed at the development of synthetic, small molecule mimetics of erythropoietin ("EPO"). The agreement, as amended in 1996, calls for a research collaboration between the parties through February 1997. Further research will be conducted by Amgen. Arris received an initial commitment fee (which was amortized over the initial research period), received research funding over the research period and will receive benchmark payments as certain milestones are achieved. Arris granted Amgen the exclusive right to develop any EPO mimetic compounds discovered, as well as worldwide manufacturing and marketing rights to those compounds. Arris is to receive royalties on Amgen's sales of licensed products and under certain circumstances Arris is required to pay royalties to third parties. Arris has retained the rights to apply all technologies developed solely by the Company to the development of products outside the EPO field. Either Arris or Amgen can independently exploit jointly developed technology that does not pertain to EPO. Approximately $3,529,000, $4,523,000 and $4,193,000 of contract revenue was recognized under this agreement in 1996, 1995 and 1994, respectively. 37 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS The following is a summary of held-to-maturity securities at December 31, 1996 and 1995:
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ------------- ----------- ----------- (IN THOUSANDS) At December 31, 1996: U.S. treasury securities......................................... $16,550 $ 1 $ -- $16,551 U.S. agency securities........................................... 5,449 7 -- 5,456 Securities of U.S. corporations.................................. 15,022 1 -- 15,023 --------- ---- ----------- ----------- $37,021 $ 9 $ -- $37,030 --------- ---- ----------- ----------- --------- ---- ----------- ----------- At December 31, 1995: U.S. treasury securities......................................... $ 5,015 $-- $(101) $ 4,914 U.S agency securities............................................ 7,392 -- (23) 7,369 Securities of U.S. corporations.................................. 11,487 -- (14) 11,473 --------- ---- ----------- ----------- $ 23,894 $-- $(138) $23,756 --------- ---- ----------- ----------- --------- ---- ----------- -----------
The following is a summary of available-for-sale securities at December 31, 1996 (none at December 31, 1995):
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ----------- --------------- ----------- (IN THOUSANDS) At December 31, 1996: U.S. treasury securities.............................. $ 9,909 $ -- $ -- $ 9,909 Securities of U.S. corporations....................... 1,718 -- -- 1,718 --------- ----- ---- ----------- $ 11,627 $ -- $ -- $11,627 --------- ----- ---- ----------- --------- ----- ---- -----------
38 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) Balance sheet classification:
GROSS GROSS ESTIMATED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ----------- ----------- ----------- (IN THOUSANDS) At December 31, 1996: Short-term marketable investments.................................. $ 37,021 $ 9 $ -- $ 37,030 Long-term marketable investments................................... 11,627 -- -- 11,627 Restricted investments............................................. 7,250 -- -- 7,250 --------- ----------- ----- ----------- $ 55,898 $ 9 $ -- $ 55,907 --------- ----------- ----- ----------- --------- ----------- ----- ----------- At December 31, 1995: Cash equivalents................................................... $ 14,495 $ -- $ -- $ 14,495 Short-term marketable investments.................................. 9,399 -- (138) 9,261 --------- ----------- ----- ----------- $ 23,894 $ -- $ (138) $ 23,756 --------- ----------- ----- ----------- --------- ----------- ----- -----------
At December 31, 1996, the contractual maturities of available-for-sale securities are due after one year and within two years. The contractual maturities of held-to-maturity securities are due within one year. The fair value of the note payable is estimated based on current interest rates available to the Company for debt instruments with similar terms, degree of risk and remaining maturities. The carrying value of the note payable approximates its fair value, as the interest rate on the note resets when the bank s reference rate changes. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. 39 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. PROPERTY AND EQUIPMENT Property and equipment is recorded at cost and consists of the following:
DECEMBER 31, -------------------- 1996 1995 --------- --------- (IN THOUSANDS) Machinery and equipment................................................. $ 12,345 $ 11,087 Furniture and fixtures.................................................. 487 448 Office equipment........................................................ 274 225 Leasehold improvements.................................................. 5,436 3,743 Construction in progress................................................ 1,234 610 --------- --------- 19,776 16,113 Less accumulated depreciation and amortization.......................... (9,330) (8,690) --------- --------- $ 10,446 $ 7,423 --------- --------- --------- ---------
Property and equipment includes approximately $10,548,000 and $9,363,000 recorded under capital leases at December 31, 1996 and 1995, respectively. Amortization is included with depreciation expense, and accumulated amortization of equipment under capital leases was approximately $6,673,000 and $4,730,000 at December 31, 1996 and 1995, respectively. On January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. The effect of adopting the statement was immaterial. 40 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. STOCKHOLDERS EQUITY WARRANTS In connection with various equipment lease arrangements and equity financings, the Company has issued warrants to purchase a total of 170,172 shares of the Company's common stock at prices ranging from $2.86 to $13.46 per share. These warrants expire at various dates from 1996 through 2002. During 1996, warrants to purchase 179 shares of common stock at $2.46 per share were exercised. Warrants to purchase 67,142 shares of common stock expired in 1996. STOCK OPTIONS In 1989, the Company adopted the 1989 Stock Option Plan, whereby directors, officers, employees, and consultants may be issued restricted stock or granted incentive stock options or nonqualified stock options to purchase the Company's common stock at the discretion of the board of directors. In June 1994, the Company adopted the 1994 Non-Employee Directors Stock Option Plan, whereby 125,000 shares of common stock have been reserved for issuance to nonemployee directors upon the exercise of nonqualified stock options granted pursuant to the Plan. All options granted under these Plans become exercisable pursuant to the applicable terms of the grant. Generally, the exercise price of the options are granted at the average market value of the Company's common stock for the 15 days preceding the grant, vest ratably over four years and expire ten years from the date of grant. 41 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Stockholders Equity (continued) Stock Options (continued) Transactions under all of the above plans are as follows:
OUTSTANDING STOCK OPTIONS ------------------------------- WEIGHTED-AVERAGE SHARES NUMBER OF PRICE PER EXERCISE AVAILABLE SHARES SHARE PRICE ---------- -------------- --------------- ----------------- Balances at December 31, 1993..................... 212,539 837,423 $ 0.07-$7.00 $ 4.50 Shares reserved................................. 425,000 -- -- -- Options granted................................. (228,856) 228,856 $ 4.88-$7.00 $ 5.56 Options canceled................................ 39,394 (39,394) $ 0.35-$6.95 $ 0.53 Options exercised............................... -- (93,119) $ 0.07-$5.95 $ 0.49 ---------- -------------- ---------------- ----------- Balances at December 31, 1994..................... 448,077 933,766 $ 0.07-$7.00 $ 5.33 Shares reserved................................. 478,460 -- -- -- Options granted................................. (626,425) 626,425 $ 6.19-$13.08 $ 8.12 Options assumed................................. (128,460) 128,460 $ 1.23-$2.46 $ 1.90 Options canceled................................ 58,115 (58,115) $ 0.35-$11.60 $ 6.63 Options exercised............................... -- (74,484) $ 0.07-$5.95 $ 2.35 Shares repurchased.............................. 7,142 -- $0.07 $ 0.07 ---------- -------------- ---------------- ----------- Balances at December 31, 1995..................... 236,909 1,556,052 $ 0.07-$13.08 $ 4.65 Shares reserved................................. 550,000 -- -- -- Options granted................................. (857,076) 857,076 $ 10.89-$16.12 $ 13.64 Options exercised............................... -- (431,409) $ 0.70-$13.02 $ 2.11 Options canceled................................ 217,363 (217,363) $ 0.84-$16.12 $ 9.17 ---------- -------------- ---------------- ----------- Balances at December 31, 1996..................... 147,196 1,764,356 $ 0.07-$16.12 $ 9.10 ---------- -------------- ---------------- ----------- ---------- -------------- ---------------- -----------
At December 31, 1996, options to purchase 534,517 shares under the plans were exercisable (655,267 and 371,366 at December 31, 1995 and 1994, respectively). The weighted average fair value of stock options granted were $11.13 and $8.30 in 1996 and 1995, respectively. 42 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Stockholders Equity (continued) Stock Options (continued) Options outstanding and exercisable by price range at December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------------------------------------- WEIGHTED- OPTIONS AVERAGE WEIGHTED- OPTIONS WEIGHTED- RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE PRICES 1996 LIFE PRICE 1996 PRICE - --------------- ------------------ -------------- ---------- --------------- ------------- (IN YEARS) $0.07-$1.26..... 185,569 5.83 $ 0.63 172,137 $ 0.59 $1.85-$5.95..... 214,557 7.17 $ 3.87 142,828 $ 3.91 $5.96-$11.30.... 670,926 8.47 $ 8.69 210,619 $ 8.26 $11.32-$16.12... 693,304 9.45 $14.20 75,284 $14.36 --------- ------- 1,764,356 8.32 $ 9.10 600,868 $ 5.49 --------- ---- ------ ------- ------ --------- ---- ------ ------- ------
In fiscal 1993, the Company recorded $404,000 in deferred compensation expense for the difference between the exercise price and the deemed fair value for financial statement presentation purposes of the Company's Common Stock, as determined by the board of directors, for certain options granted prior to the Company's initial public offering effective date (November 19, 1993). Such options were granted at prices ranging from $0.84 to $5.95 per share with a deemed fair value ranging from $1.08 to $6.80 per share and the deferred compensation is being amortized over a three-year period. Amortization of deferred compensation for 1996, 1995 and 1994 was $35,000, $144,000 and $144,000, respectively. EMPLOYEE STOCK PURCHASE PLAN In October 1993, the Company adopted the 1993 Employee Stock Purchase Plan (the "Purchase Plan") for which employees who meet certain minimum employment criteria are eligible. Under the Purchase Plan, a total of 108,879 shares are reserved for future issuance; 66,692 shares were issued in 1996 (47,045 shares were issued in 1995). Eligible employees may purchase stock at 85% of the lower of the fair market value of the stock at the enrollment or purchase date. 43 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Stockholders Equity (continued) Stock Bonus Plan In December 1993, the Company adopted the 1993 Employee Stock Bonus Plan, whereby the Company would reward employees for contributions to the Company and encourage the alignment of the employees long-term interests with those of the Company by granting stock to certain employees for no consideration. These shares do not vest unless the recipient remains an employee of the Company for two years from the date of grant. Under the plan, 50,000 common shares were reserved for grant. Grants for 10,050 shares were outstanding under this plan at December 31, 1996. Additionally, 34,500 shares had vested as of December 31, 1996. STOCK-BASED COMPENSATION As of December 31, 1996, the Company has four stock-based compensation plans, which are described above. The Company has elected to follow APB 25 and related interpretations in accounting for its employee stock-based awards because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options and employee stock-based awards. Compensation expense with respect to such awards has been immaterial. PRO FORMA DISCLOSURES Pro forma information regarding net loss and net loss per share is required by SFAS 123, and has been determined as if the Company had accounted for its stock-based awards granted subsequent to December 31, 1994 under the fair value method of SFAS 123. The fair value for these stock-based awards was estimated at the date of grant using a Black-Scholes option pricing model for the multiple option approach. Under this approach, the expected life of the option is defined as the period from the vesting date to the expected exercise date. 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 stock-based awards 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 the Company's stock-based awards to its employees. 44 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Stockholders Equity (continued) STOCK-BASED COMPENSATION (CONTINUED) PRO FORMA DISCLOSURES (CONTINUED) The fair value of the Company's stock-based awards to employees was estimated assuming no expected dividends and the following weighted-average assumptions:
EMPLOYEE STOCK OPTIONS PURCHASE PLAN -------------------- -------------------- 1996 1995 1996 1995 --------- --------- --------- --------- Expected life (years)............................................................. 1.0 1.0 0.5 0.5 Expected volatility............................................................... 0.63 0.66 0.56 0.56 Risk-free interest rate........................................................... 5.90% 6.91% 5.30% 5.88%
For purposes of pro forma disclosures, the estimated fair value of the stock-based awards are amortized to pro forma net loss over the options vesting period and the purchase plans six-month purchase period. The Company's as reported and pro forma information follows (in thousands, except for net loss per share information):
YEARS ENDED DECEMBER 31, -------------------------- 1996 1995 ------------ ------------ Net loss As reported........................................................... $ (5,928) $ (23,733) Pro forma............................................................. $ (8,308) $ (24,632) Net loss per share As reported........................................................... $ (0.45) $ (2.71) Pro forma............................................................. $ (0.63) $ (2.82)
Because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully realized until 1998. 45 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. COMMITMENTS LEASES The Company leases office and laboratory facilities and equipment. Rent expense, net of sublease income of $32,000 in 1996 (none in 1995 and 1994), for the years ended December 31, 1996, 1995 and 1994 was approximately $1,155,000, $825,000 and $555,000, respectively. Future minimum lease payments under noncancelable leases, net of noncancelable subleases, are as follows:
CAPITAL OPERATING LEASES LEASES --------- ----------- (IN THOUSANDS) 1997...................................................... $ 2,288 $ 1,063 1998...................................................... 1,262 1,032 1999...................................................... 782 1,061 2000...................................................... 352 1,183 2001...................................................... 270 1,081 Thereafter................................................ -- 3,053 --------- -------- Total minimum lease payments.............................. 4,954 $ 8,473 -------- -------- Less amount representing interest......................... (667) --------- Present value of future lease payments.................... 4,287 Less current portion...................................... (1,984) --------- Noncurrent portion of capital lease obligations........... $ 2,303 --------- ---------
NOTE PAYABLE In September 1996, the Company obtained a line of credit agreement to borrow up to $12 million by December 1997. Interest only payments are due monthly until April 1, 1998, at which time principal and interest is payable in 20 quarterly installments. The interest rate under the agreement varies depending upon the underlying collateral. The interest rate at December 31, 1996 was the LIBOR rate plus 1.5%, which was 7.1%. Borrowings under this agreement is secured by cash and marketable securities held by the financial institution. Accordingly, such marketable securities are classified as noncurrent, restricted cash and investments. 46 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. COMMITMENTS (CONTINUED) NOTE PAYABLE (CONTINUED) Principal maturities of the note payable at December 31, 1996 are as follows: (IN THOUSANDS) --------------- 1997........ $ -- 1998........ 960 1999........ 1,280 2000........ 1,280 2001........ 1,280 Thereafter.. 1,600 8. RELATED PARTY TRANSACTIONS On September 3, 1996, the Company loaned $750,000 to an executive officer for the purpose of assisting in the purchase of a residence in exchange for a note receivable. The note is full-recourse and is secured by 130,236 shares of the Company's common stock owned by the executive. The note is subject to an interest rate of 6.02% per annum. All accrued interest and principal are due September 3, 1998. 9. INCOME TAXES As of December 31, 1996, the Company had federal and state net operating loss carryforwards of approximately $22,800,000. The federal net operating loss carryforwards will expire at various dates beginning in 2004 through 2011. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. 47 ARRIS PHARMACEUTICAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets are as follows:
DECEMBER 31, -------------------- 1996 1995 --------- --------- (IN THOUSANDS) Net operating loss carryforwards........................................ $ 7,900 $ 6,500 Research credits (expiring 2004-2011)................................... 2,300 2,200 Capitalized research and development.................................... 12,800 11,800 Other, net.............................................................. 1,900 2,100 --------- --------- Total deferred tax assets............................................... $ 24,900 $ 22,600 Valuation allowance of deferred tax assets.............................. (24,900) (22,600) --------- --------- Net deferred tax assets................................................. $ -- $ -- --------- --------- --------- ---------
Because of the Company's lack of earnings history, the deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by approximately $3,500,000 and $3,000,000 during 1995 and 1994, respectively. Utilization of the net operating losses and credits may be subject to a substantial annual limitation due to the ownership change provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net operating losses and credits before utilization. 48 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. 49 PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is incorporated by reference from the information under the captions "Election of Directors" and "Executive Officers and Key Employees" contained in the Company's definitive proxy statement to be filed no later than April 30, 1997 in connection with the solicitation of proxies for the Company's Annual Meeting of Stockholders to be held May 21, 1997 (the "Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the information under the caption "Executive Compensation" contained in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the information under the captions "Security Ownership of Certain Beneficial Owners Management" contained in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the information under the caption "Certain Relationships and Related Transactions" contained in the Proxy Statement. 50 PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) Index to Financial Statements The Financial Statements required by this item are submitted in Part II, Item 8 of this report. (2) Index to Financial Statements Schedules All schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or in the notes thereto. (3) Exhibits.
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - --------- -------------------------------------------------------------------------------------------------------- 3.1 Amended and Restated Certificate of Incorporation.(1) 3.2 Amended and Restated Bylaws.(1) 10.1 Registration Rights Agreement, among the Registrant and the other parties therein, dated April 16, 1993.(1) 10.2 1989 Stock Plan, as amended.(2) 10.3 Form of Employee Stock Purchase Plan and Form of Offering Document.(2)(15) 10.4 Letter Agreement between the Company and John P. Walker, dated January 19, 1993.(1)(2) 10.6 Standard Industrial Lease between the Registrant and Shelton Properties, Inc., dated October 15, 1992, with related addenda and amendment.(1) 10.7 Third Amendment to Lease between Registrant and Shelton Properties, Inc., dated March 29, 1994.(5) 10.8 Master Equipment Lease Agreement between the Registrant and Phoenix Leasing Incorporated, dated as of April 12, 1993, with related amendments.(1) 10.9 Re-Lease Agreement No. 6132A between the Registrant and PacifiCorp Credit Inc., dated December 27, 1992, with related agreements.(1) 10.10 Master Equipment Lease Agreement No. 2982 between the Registrant and MMC/GATX Partnership No. I, dated as of January 7, 1992, with related addenda.(1) 10.11 Research and License Agreement between the Registrant and Amgen Inc., dated May 28, 1993.(1)(3) 10.12 Sponsored Research Agreement between the Registrant, the Whitehead Institute for Biomedical Research and Dr. Harvey Lodish, dated May 28, 1993.(1)(3) 10.13 License Agreement between the Registrant, the Whitehead Institute for Biomedical Research and Massachusetts Institute of Technology, dated May 28, 1993.(1)(3) 10.14 Consent and Waiver between the Registrant, Amgen Inc., and the Whitehead Institute for Biomedical Research, dated May 28, 1993.(1) 10.15 Collaboration Agreement between the Registrant and Pharmacia AB, dated March 29, 1993.(1)(3) 51 10.15(a) Collaboration Agreement between the Registrant and Pharmacia AB, dated March 29, 1993, page 42.(1) 10.16 Project Agreement between the Registrant and Pharmacia AB, dated March 29, 1993.(1)(3) 10.17 Form of Restricted Stock Purchase Agreement.(1)(2) 10.18 Form of Indemnity Agreement entered into between the Registrant and its officers and directors.(1)(2) 10.19 Stock Bonus Grant Plan.(2)(4) 10.20 Financing Agreement between Hambrecht and Quist Guaranty Finance, L.P., dated March 29, 1994, including Security Agreement and Warrant Purchase Agreement of even date.(5) 10.21 Loan and Security Agreement between Registrant and Silicon Valley Bank dated April 30, 1994.(5) 10.22 1994 Non-Employee Directors' Stock Option Plan.(2) 10.23 Fourth Amendment to Lease dated October 15, 1992 between the Registrant and Shelton Properties, Inc. dated October 1, 1994.(7) 10.24 Collaborative Research and License Agreement between the Registrant and Bayer AG, a German corporation, dated November 28, 1994.(3)(8) 10.25 Research Agreement between the Registrant and Pharmacia AB, a Swedish corporation, dated December 21, 1994.(3)(7) 10.26 Form of Fifth Amendment to Lease dated October 15, 1992 between the Registrant and Shelton Properties, Inc. dated August 28, 1996.(8) 10.27 Master Equipment Lease Agreement between the Registrant and GE Capital dated August 18, 1995.(8) 10.28 Collaborative Research and License Agreement between the Registrant and Pharmacia AB, a Swedish corporation, dated August 29, 1995.(8)(9) 10.30 Agreement and Plan of Merger and Reorganization among the Registrant, Chapel Acquisition Corp. and Khepri Pharmaceuticals, Inc., dated November 7, 1995.(11) 10.31 Form of Stockholder Agreement between the Registrant and certain former stockholders of Khepri Pharmaceuticals, Inc. (11) 10.32 Form of Agreements among the Registrant, Khepri Pharmaceuticals Canada, Inc. and the holders of Class B Shares of Khepri Pharmaceuticals Canada, Inc. (11) 10.33 Amendment to Agreement dated March 29, 1993 between the Registrant and Kabi Pharmacia AB, dated January 31, 1996. (12) 10.34 First Amendment to Research and License Agreement dated May 28, 1993 between Registrant and Amgen, Inc., dated February 2, 1996. (12) 10.35 Research Agreement between the Registrant and Pharmacia & Upjohn, Inc., a Delaware corporation, dated February 29, 1996. (12) 10.36 Form of Sixth Amendment to Lease dated October 15, 1992 between the Registrant and Shelton Properties, Inc. dated March 29, 1996. (12) 10.37 Financing Agreement between Hambrecht and Quist Guaranty Finance, LLC, dated March 29, 1996, including Security Agreement and Warrant Purchase Agreement of even date. (12) 10.38 Amendment to Lease Schedule under Master Property Lease Agreement dated March 29, 1994 between Hambrecht and Quist Guaranty Finance, L.P., dated March 29, 1996. (12) 10.39 Standard Industrial Lease between the Registrant and The Equitable Life Assurance Society of the United States, dated August 5, 1996. (13) 10.40 Business Loan Agreement between Registrant and Bank of America National Trust and 52 Savings Association, dated September 24, 1996. (13) 10.41 Sublease Agreement between Registrant and Fibrogen, Inc., dated September 30, 1996. (13) 10.42 Promissory Note and Pledge Agreement, dated September 3, 1996, by John P. Walker in favor of Registrant. (13) 10.43 Research Collaboration and License Agreement between Merck & Co., Inc. and the Registrant, dated November 6, 1996.* 10.44 Transitional Services Agreement between Dr. N. Jean Warner and the Registrant, dated November 3, 1995.(2) 10.45 Collaborative Research and License Agreement between SmithKline Beecham Corporation and the Registrant, dated June 27, 1996. (14) 10.46 Loan and Security Agreement between Registrant and Silicon Valley Bank, dated March 29, 1996. (14) 23.1 Consent of Ernst & Young LLP 24.1 Power of Attorney (incorporated in the signature page of this Form 10-K). 27 Financial Data Schedule
- ------------------------ * Confidential treatment requested (1) Incorporated herein by reference to the Registration Statement on Form S-1 filed October 5, 1993, or amendments thereto (file number 33-69972). (2) Compensation plan. (3) Subject to confidential treatment order. (4) Incorporated herein by reference to the Registration Statement on Form S-8 filed January 31, 1994 (file number 33-69972). (5) Incorporated herein by reference to the Registrant's Statement on Form 10-Q for the Quarter ended March 31, 1994. (6) Incorporated herein by reference to the Registration Statement on Form S-8 filed June 22, 1994 (file number 33-69972). (7) Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (8) Incorporated herein by reference to the Registrant's Statement on Form 10-Q for the Quarter ended September 30, 1995. (9) Confidential treatment has been requested for portions of this document. Brackets indicate portions of text that have been omitted. A separate filing of such omitted text has been made with the Commission as part of the Company's application for confidential treatment. (10) Incorporated herein by reference to the Registration Statement on Form S-8 filed June 20, 1995 (file number 33-92900). (11) Incorporated herein by reference to the Registrant's Current Report on Form 8-K, filed November 13, 1995. (12) Incorporated herein by reference to the Registration Statement on Form 10-Q for the Quarter ended March 31, 1996. (13) Incorporated herein by reference to the Registration Statement on Form 10-Q for the Quarter ended September 30, 1996. (14) Incorporated herein by reference to the Registration Statement filed on Form S-3/A filed September 19, 1996 (file number 333-09307). (15) Incorporated by reference to the Registration Statement on Form S-8 filed July 29, 1996 (file number 333-09095). 53 (b)(1) On November 13, 1995 the Registrant filed a report on Form 8-K with the Securities and Exchange Commission disclosing under "Item 5--Other Events" that (i) the Registrant had entered into an agreement with Khepri Pharmaceuticals, Inc. ("Khepri") pursuant to which the Registrant would acquire Khepri in a merger, (ii) that the Registrant had entered into agreements with certain stockholders of Khepri whereby such stockholders agreed to take certain actions to facilitate the merger and (iii) that the Registrant had entered into agreements with the stockholders of a subsidiary of Khepri modifying existing contracts with Khepri, subject to consummation of the merger. (2) On January 5, 1996 the Registrant filed a report on Form 8-K, and amended on February 5, 1996 with the Securities and Exchange Commission, in conjunction with the Company's acquisition of Khepri Pharmaceuticals, Inc., which was completed on December 22, 1995. (c) See Exhibits listed under Item 14(a)(3). (d) All schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or in the noted thereto. 54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 28th day of March, 1997. ARRIS PHARMACEUTICAL CORPORATION BY: ----------------------------------------- John P. Walker PRESIDENT AND CHIEF EXECUTIVE OFFICER POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears on the following page constitutes and appoints John P. Walker and Frederick J. Ruegsegger, or any of them, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that the said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the dates indicated.
SIGNATURE TITLE DATE - ------------------------------ --------------------------- ------------------- - ------------------------------ President, Chief Executive March 28, 1997 John P. Walker Officer and Director (Principal executive officer) - ------------------------------ Vice President March 28, 1997 Frederick J. Ruegsegger and Chief Financial Officer (Principal financial and accounting officer) - ------------------------------ Director March 28, 1997 Brook H. Byers - ------------------------------ Director March 28, 1997 Anthony B. Evnin, Ph.d.
55
SIGNATURE TITLE DATE - ------------------------------ --------------------------- ------------------- - ------------------------------ Director March 28, 1997 Vaughn M. Kailian - ------------------------------ Director March 28, 1997 Donald Kennedy, Ph.d. - ------------------------------ Director March 28, 1997 Hans U. Sievertsson, Ph.d.
56 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT PAGE - --------- ------------------------------------------------------------------------------------------------------------- ----- 3.1 Amended and Restated Certificate of Incorporation.(1) 3.2 Amended and Restated Bylaws.(1) 10.1 Registration Rights Agreement, among the Registrant and the other parties therein, dated April 16, 1993.(1) 10.2 1989 Stock Plan, as amended.(2) 10.3 Form of Employee Stock Purchase Plan and Form of Offering Document.(2)(15) 10.4 Letter Agreement between the Company and John P. Walker, dated January 19, 1993.(1)(2) 10.6 Standard Industrial Lease between the Registrant and Shelton Properties, Inc., dated October 15, 1992, with related addenda and amendment.(1) 10.7 Third Amendment to Lease between Registrant and Shelton Properties, Inc., dated March 29, 1994.(5) 10.8 Master Equipment Lease Agreement between the Registrant and Phoenix Leasing Incorporated, dated as of April 12, 1993, with related amendments.(1) 10.9 Re-Lease Agreement No. 6132A between the Registrant and PacifiCorp Credit Inc., dated December 27, 1992, with related agreements.(1) 10.10 Master Equipment Lease Agreement No. 2982 between the Registrant and MMC/GATX Partnership No. I, dated as of January 7, 1992, with related addenda.(1) 10.11 Research and License Agreement between the Registrant and Amgen Inc., dated May 28, 1993.(1)(3) 10.12 Sponsored Research Agreement between the Registrant, the Whitehead Institute for Biomedical Research and Dr. Harvey Lodish, dated May 28, 1993.(1)(3) 10.13 License Agreement between the Registrant, the Whitehead Institute for Biomedical Research and Massachusetts Institute of Technology, dated May 28, 1993.(1)(3) 10.14 Consent and Waiver between the Registrant, Amgen Inc., and the Whitehead Institute for Biomedical Research, dated May 28, 1993.(1) 10.15 Collaboration Agreement between the Registrant and Pharmacia AB, dated March 29, 1993.(1)(3) 10.15(a) Collaboration Agreement between the Registrant and Pharmacia AB, dated March 29, 1993, page 42.(1) 10.16 Project Agreement between the Registrant and Pharmacia AB, dated March 29, 1993.(1)(3) 10.17 Form of Restricted Stock Purchase Agreement.(1)(2) 10.18 Form of Indemnity Agreement entered into between the Registrant and its officers and directors.(1)(2) 10.19 Stock Bonus Grant Plan.(2)(4) 10.20 Financing Agreement between Hambrecht and Quist Guaranty Finance, L.P., dated March 29, 1994, including Security Agreement and Warrant Purchase Agreement of even date.(5) 10.21 Loan and Security Agreement between Registrant and Silicon Valley Bank dated April 30, 1994.(5) 10.22 1994 Non-Employee Directors' Stock Option Plan.(2) 10.23 Fourth Amendment to Lease dated October 15, 1992 between the Registrant and Shelton Properties, Inc. dated October 1, 1994.(7) 10.24 Collaborative Research and License Agreement between the Registrant and Bayer AG, a German corporation, dated November 28, 1994.(3)(8) 10.25 Research Agreement between the Registrant and Pharmacia AB, a Swedish corporation, dated December 21, 1994.(3)(7) 10.26 Form of Fifth Amendment to Lease dated October 15, 1992 between the Registrant and Shelton Properties, Inc. dated August 28, 1996.(8) 10.27 Master Equipment Lease Agreement between the Registrant and GE Capital dated August 18, 1995.(8) 10.28 Collaborative Research and License Agreement between the Registrant and Pharmacia AB, a Swedish corporation, dated August 29, 1995.(8)(9) 10.30 Agreement and Plan of Merger and Reorganization among the Registrant, Chapel Acquisition Corp. and Khepri Pharmaceuticals, Inc., dated November 7, 1995.(11) 10.31 Form of Stockholder Agreement between the Registrant and certain former stockholders of Khepri Pharmaceuticals, Inc. (11) 10.32 Form of Agreements among the Registrant, Khepri Pharmaceuticals Canada, Inc. and the holders of Class B Shares of Khepri Pharmaceuticals Canada, Inc. (11) 10.33 Amendment to Agreement dated March 29, 1993 between the Registrant and Kabi Pharmacia AB, dated January 31, 1996. (12) 10.34 First Amendment to Research and License Agreement dated May 28, 1993 between Registrant and Amgen, Inc., dated February 2, 1996. (12) 10.35 Research Agreement between the Registrant and Pharmacia & Upjohn, Inc., a Delaware corporation, dated February 29, 1996. (12) 10.36 Form of Sixth Amendment to Lease dated October 15, 1992 between the Registrant and Shelton Properties, Inc. dated March 29, 1996. (12) 10.37 Financing Agreement between Hambrecht and Quist Guaranty Finance, LLC, dated March 29, 1996, including Security Agreement and Warrant Purchase Agreement of even date. (12) 10.38 Amendment to Lease Schedule under Master Property Lease Agreement dated March 29, 1994 between Hambrecht and Quist Guaranty Finance, L.P., dated March 29, 1996. (12) 10.39 Standard Industrial Lease between the Registrant and The Equitable Life Assurance Society of the United States, dated August 5, 1996. (13) 10.40 Business Loan Agreement between Registrant and Bank of America National Trust and Savings Association, dated September 24, 1996. (13) 10.41 Sublease Agreement between Registrant and Fibrogen, Inc., dated September 30, 1996. (13) 10.42 Promissory Note and Pledge Agreement, dated September 3, 1996, by John P. Walker in favor of Registrant. (13) 10.43 Research Collaboration and License Agreement between Merck & Co., Inc. and the Registrant, dated November 6, 1996.* 10.44 Transitional Services Agreement between Dr. N. Jean Warner and the Registrant, dated November 3, 1995.(2) 10.45 Collaborative Research and License Agreement between SmithKline Beecham Corporation and the Registrant, dated June 27, 1996. (14) 10.46 Loan and Security Agreement between Registrant and Silicon Valley Bank, dated March 29, 1996. (14) 23.1 Consent of Ernst & Young LLP 24.1 Power of Attorney (incorporated in the signature page of this Form 10-K). 27 Financial Data Schedule
- ------------------------ * Confidential treatment requested (1) Incorporated herein by reference to the Registration Statement on Form S-1 filed October 5, 1993, or amendments thereto (file number 33-69972). (2) Compensation plan. (3) Subject to confidential treatment order. (4) Incorporated herein by reference to the Registration Statement on Form S-8 filed January 31, 1994 (file number 33-69972). (5) Incorporated herein by reference to the Registrant's Statement on Form 10-Q for the Quarter ended March 31, 1994. (6) Incorporated herein by reference to the Registration Statement on Form S-8 filed June 22, 1994 (file number 33-69972). (7) Incorporated herein by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (8) Incorporated herein by reference to the Registrant's Statement on Form 10-Q for the Quarter ended September 30, 1995. (9) Confidential treatment has been requested for portions of this document. Brackets indicate portions of text that have been omitted. A separate filing of such omitted text has been made with the Commission as part of the Company's application for confidential treatment. (10) Incorporated herein by reference to the Registration Statement on Form S-8 filed June 20, 1995 (file number 33-92900). (11) Incorporated herein by reference to the Registrant's Current Report on Form 8-K, filed November 13, 1995. (12) Incorporated herein by reference to the Registration Statement on Form 10-Q for the Quarter ended March 31, 1996. (13) Incorporated herein by reference to the Registration Statement on Form 10-Q for the Quarter ended September 30, 1996. (14) Incorporated herein by reference to the Registration Statement filed on Form S-3/A filed September 19, 1996 (file number 333-09307). (15) Incorporated by reference to the Registration Statement on Form S-8 filed July 29, 1996 (file number 333-09095). EX-10.2 2 EXHIBIT 10.2 Exhibit 10.2 ARRIS PHARMACEUTICAL CORPORATION 1989 STOCK PLAN Adopted May 16, 1989 As Amended by the Board March 25, 1992 Approved by Stockholders March 25, 1992 As Amended by the Board April 6, 1993 Approved by Stockholders October 5, 1993 As Amended by the Board April 20, 1994 Approved by Stockholders June 7, 1994 As Amended by the Board February 8, 1995 Approved by Stockholders June 7, 1995 As Amended by the Board February 27, 1996 Approved by Stockholders June 5, 1996 As Amended by the Board February 6, 1997 Approved by Stockholders _________, 1997 1. Purposes of the Plan. The purposes of this Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to Employees and Directors of and Consultants to the Company and its Subsidiaries and to promote the success of the Company's business. Options granted under the Plan may be incentive stock options (as defined under Section 422 of the Code) or nonstatutory stock options, as determined by the Administrator at the time of grant of an option and subject to the applicable provisions of Section 422 of the Code, as amended, and the regulations promulgated thereunder. Stock purchase rights may also be granted under the Plan. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" means the Board or any of its Committees appointed pursuant to Section 4 of the Plan. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means the Committee appointed by the Board in accordance with paragraph (a) of Section 4 of the Plan. (e) "Common Stock" means the Common Stock of the Company. (f) "Company" means Arris Pharmaceutical Corporation, a Delaware corporation. 1 (g) "Consultant" means any person, including an advisor, who is engaged by the Company or any Parent or Subsidiary to render consulting services and is compensated for such services, provided that the term Consultant shall not include Directors who are not compensated for their services as a Director or are paid only a director's fee by the Company. (h) "Continuous Status as an Employee, Director or Consultant" means the absence of any interruption or termination of the individual's service relationship with the Company, whether through employment or as a Director or Consultant. Continuous Status as an Employee, Director or Consultant shall not be considered interrupted in the case of: (i) sick leave; (ii) military leave; (iii) any other leave of absence approved by the Board, provided that such leave is for a period of not more than ninety (90) days, unless reemployment upon the expiration of such leave is guaranteed by contract or statute, or unless provided otherwise pursuant to Company policy adopted from time to time; or (iv) in the case of transfers between locations of the Company or between the Company, its Subsidiaries or its successor. (i) "Director" means a member of the Board. (j) "Employee" means any person, including officers and Directors, employed by the Company or any Parent or Subsidiary of the Company. The payment of a director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (l) "Fair Market Value" means the value of the Common Stock of the Company as determined in good faith by the Administrator. (m) "Incentive Stock Option" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code. (n) "Non-Employee Director" means a Director who either (i) is not a current Employee or officer of the Company or its Parent or Subsidiary, does not receive compensation (directly or indirectly) from the Company or its Parent or Subsidiary for services rendered as a Consultant or in any capacity other than as a Director (except for an amount as to which disclosure would not be required under Item 404(a) of Regulation S-K promulgated pursuant to the Securities Act ("Regulation S-K")), does not possess an interest in any other transaction as to which disclosure would be required under Item 404(a) of Regulation S-K, and is not engaged in a business relationship as to which disclosure would be required under Item 404(b) of Regulation S-K; or (ii) is otherwise considered a "non-employee director" for purposes of Rule 16b-3. (o) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (p) "Option" means a stock option granted pursuant to the Plan. 2 (q) "Optioned Stock" means the Common Stock subject to an Option. (r) "Optionee" means an Employee or Consultant who receives an Option. (s) "Outside Director" means a Director who either (i) is not a current employee of the Company or an "affiliated corporation" (within the meaning of Treasury regulations promulgated under Section 162(m) of the Code), is not a former employee of the Company or an "affiliated corporation" receiving compensation for prior services (other than benefits under a tax-qualified pension plan), was not an officer of the Company or an "affiliated corporation" at any time, and is not currently receiving compensation, either directly or indirectly, for personal services in any capacity other than as a Director, or (ii) is otherwise considered an "outside director" for purposes of Section 162(m) of the Code. (t) "Parent" means a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (u) "Plan" means this 1989 Stock Plan, as amended from time to time. (v) "Restricted Stock" means shares of Common Stock acquired pursuant to a grant of Stock Purchase Rights under Section 11 below. (w) "Rule 16b-3" means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3, as in effect when discretion is being exercised with respect to the Plan. (x) "Share" means a share of the Common Stock, as adjusted in accordance with Section 13 of the Plan. (y) "Stock Purchase Right" means the right to purchase Restricted Stock in accordance with the provisions of Section 11 below. (z) "Subsidiary" means a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. 3. Stock Subject to the Plan. Subject to the provisions of Section 13 of the Plan, the maximum aggregate number of shares which may be optioned and sold under the Plan is three million four hundred seven thousand five hundred (3,407,500) of Common Stock. Such share reserve is comprised of (i) the aggregate two million six hundred sixty-seven thousand five hundred (2,667,500) shares reserved under the Plan prior to the February 1997 amendment and restatement plus (ii) an additional seven hundred forty thousand (740,000) shares reserved pursuant to the February 1997 amendment and restatement. The shares may be authorized, but unissued, or reacquired Common Stock. 3 If an Option should expire or become unexercisable (for any reason) without having been exercised in full, the unpurchased Shares which were subject thereto shall, unless the Plan shall have been terminated, become available for future grant under the Plan. 4. Administration of the Plan. (a) Procedure. The Board may delegate administration of the Plan to a committee composed of not fewer than two (2) members (the "Committee"), all of the members of which Committee may (but need not) be, in the discretion of the Board, Non-Employee Directors and/or Outside Directors. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board (and references in this Plan to the Board shall thereafter be to the Committee), subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. Notwithstanding anything in this Section 4 to the contrary, the Board or the Committee may delegate to a committee of one or more members of the Board the authority to grant options to eligible persons who are not then subject to Section 16 of the Exchange Act and to eligible persons with respect to whom the Company does not wish to comply with Section 162(m) of the Code. (b) Powers of the Administrator. Subject to the provisions of the Plan and in the case of a duly authorized committee, the specific duties delegated by the Board to such duly authorized committee, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value of the Common Stock, in accordance with Section 2(l) of the Plan; (ii) to select the persons to whom Options and Stock Purchase Rights may from time to time be granted hereunder; (iii) to determine whether and to what extent Options and Stock Purchase Rights or any combination thereof, are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each such award granted hereunder; (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder (including, but not limited to, the share price and any restriction or limitation, regarding any Option or other award and/or the shares of Common Stock relating thereto, based in each case on such factors as the Administrator shall determine, in its sole discretion); 4 (vii) to determine whether and under what circumstances an Option may be settled in cash under subsection 9(f) instead of Common Stock; (viii) to determine whether, to what extent and under what circumstances Common Stock and other amounts payable with respect to an award under this Plan shall be deferred either automatically or at the election of the participant (including providing for and determining the amount, if any, of any deemed earnings on any deferred amount during any deferral period); and (ix) to determine the terms and restrictions applicable to Stock Purchase Rights and the Restricted Stock purchased by exercising such Stock Purchase Rights. Notwithstanding the foregoing, the Company does not have the ability to reduce the exercise price of any Option to the then current Fair Market Value if the Fair Market Value of the Common Stock covered by such Option shall have declined since the date the Option was granted. (c) Effect of Committee's Decision. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of awards granted under the Plan. 5. Eligibility. (a) Stock Purchase Rights may be granted to Employees, Directors and Consultants. (b) Nonstatutory Stock Options may be granted to Employees, Directors and Consultants. Incentive Stock Options may be granted only to Employees. An Employee or Consultant who has been granted an Option may, if he is otherwise eligible, be granted an additional Option or Options. (c) Each Option shall be designated in the written option agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designations, to the extent that the aggregate Fair Market Value of the Shares with respect to which Options designated as Incentive Stock Options are exercisable for the first time by any Optionees during any calendar year (under all plans of the Company or any Parent or Subsidiary) exceeds $100,000, such excess Options shall be treated as Nonstatutory Stock Options. (d) No person shall be eligible to be granted Options covering more than three hundred thousand (300,000) shares of the Company's Common Stock in any calendar year. (e) For purposes of Section 5(c), Incentive Stock Options shall be taken into account in the order in which they were granted, and the Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted. 5 (f) The Plan shall not confer upon any grantee of an award under the Plan any right with respect to continuation of employment or consulting relationship with the Company, nor shall it interfere in any way with his right or the Company's right to terminate his employment or consulting relationship at any time, with or without cause. 6. Term of Plan. The Plan shall be come effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the Shareholders of the Company as described in Section 19 of the Plan. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 15 of the Plan. 7. Term of Option. The term of each Option shall be the term stated in the Option agreement; provided, however, that the term of an Option shall be no more than ten (10) years from the date of grant thereof or such shorter term as may be provided in the Option agreement. However, in the case of an Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Option shall be five (5) years from the date of grant thereof or such shorter term as may be provided in the Option agreement. 8. Option Exercise Price and Consideration. (a) The per share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Board, but shall be subject to the following: (i) In the case of an Incentive Stock Option (A) granted to an Employee who, at the time of the grant of such Incentive Stock Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant. (B) granted to any Employee, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant. (ii) In the case of a Nonstatutory Stock Option granted to any person, the per Share exercise price shall be no less than 85% of the Fair Market Value per Share on the date of grant. (b) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Administrator (and, in the case of an Incentive Stock Option, shall be determined at the time of grant) and may consist entirely of (1) cash, (2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares acquired upon exercise of an Option either have been owned by the Optionee for more than six months on the date of surrender or were not acquired, directly or indirectly, from the 6 Company, and (y) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which said Option shall be exercised, (5) authorization from the Company to retain from the total number of Shares as to which the Option is exercised that number of Shares having a Fair Market Value on the date of exercise equal to the exercise price for the total number of Shares as to which the Option is exercised, (6) delivery of a properly executed exercise notice together with irrevocable instructions to a broker to promptly deliver to the Company the amount of sale or loan proceeds required to pay the exercise price, (7) by delivering an irrevocable subscription agreement for the Shares which irrevocably obligates the option holder to take and pay for the Shares not more than twelve months after the date of delivery of the subscription agreement, (8) any combination of the foregoing methods of payment, (9) or such other consideration and method of payment for the issuance of Shares to the extent permitted under applicable laws. In making its determination as of the type of consideration to accept, the Board shall consider if acceptance of such consideration may be reasonably expected to benefit the Company (Section 153 of the Delaware Corporation law). 9. Exercise of Option. (a) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Board, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Board, consist of any consideration and method of payment allowable under Section 8(b) of the Plan. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such stock certificate promptly upon exercise of the Option. No adjustment will be made for a divided or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 13 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) Termination of Employment or Relationship as a Director or Consultant. In the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates (other than upon the Optionee's death or disability), such Optionee may, 7 but only within ninety (90) days (or such other period of time as is determined by the Board, with such determination in the case of an Incentive Stock Option being made at the time of grant of the Option and not exceeding ninety (90) days) after the date of such termination (but in no event later than the expiration date of the term of such Option as set forth in the Option agreement), exercise his Option of the extent that Optionee was entitled to exercise it at the date of such termination. To the extent that Optionee was not entitled to exercise the Option at the date of such termination, or if Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. (c) Disability of Optionee. Notwithstanding the provisions of Section 9(b) above, in the event an Optionee's Continuous Status as an Employee, Director or Consultant terminates as a result of his or her total and permanent disability (as defined in Section 22(e)(3) of the Code), the Optionee may, but only within twelve (12) months from the date of such termination (but in no event later than the expiration date of the term of such Option as set forth in the Option agreement), exercise the Option to the extent otherwise entitled to exercise it at the date of such termination. To the extent that Optionee was not entitled to exercise the Option at the date of such termination, or if Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. (d) Death of Optionee. In the event of the death of an Optionee, the Option may be exercised, at any time within twelve (12) months following the date of death (but in no event later than the expiration date of the term of such Option as set forth in the Option agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent the Optionee was entitled to exercise the Option at the date of death. To the extent that Optionee was not entitled to exercise the Option at the date of termination, or if Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. (e) Rule 16b-3. Options granted to persons subject to Section 16(b) of the Exchange Act must comply with Rule 16b-3 and shall contain such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. (f) Buyout Provisions. The Administrator may at any time offer to buy out for a payment in cash or Shares, an Option previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Optionee at the time that such offer is made. 10. Transferability of Options. The Option may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Optionee, only by the Optionee; provided, however, that in the case of a Nonstatutory Stock Option, the Option may be transferable to the extent specified in the Option agreement, in which case the Option may be transferred upon such terms and conditions as are set forth in the Option, as the Board or the 8 Committee shall determine in its discretion, including (without limitation) pursuant to a "domestic relations order" within the meaning of such rules, regulations or interpretations of the Securities and Exchange Commission as are applicable for purposes of Section 16 of the Exchange Act. Notwithstanding the foregoing, the person to whom an Option is granted may, by delivering written notice to the Company, in a form satisfactory to the Company, designate a third party who, in the event of the death of the Optionee, shall thereafter be entitled to exercise the Option. 11. Stock Purchase Rights. (a) Rights to Purchase. Stock Purchase Rights may be issued either alone, in addition to, or in tandem with other awards granted under the Plan and/or cash awards made outside of the Plan. After the Administrator determines that it will offer Stock Purchase Rights under the Plan, it shall advise the offeree in writing of the terms, conditions and restrictions related to the offer, including the number of Shares that such person shall be entitled to purchase, the price to be paid (which price shall not be less than 100% of the Fair Market Value of the Shares as of the date of the offer), and the time within which such person must accept such offer, which shall not exceed thirty (30) days (or such longer time as may be determined by the Administrator) from the date upon which the Administrator made the determination to grant the Stock Purchase Right. The offer shall be accepted by execution of a Restricted Stock purchase agreement in the form determined by the Administrator. Shares purchased pursuant to the grant of a Stock Purchase Right shall be referred to herein as "Restricted Stock." (b) Repurchase Option. Unless the Administrator determines otherwise, the Restricted Stock purchase agreement shall grant the Company a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser's employment with the Company for any reason (including death or disability). The purchase price for Shares repurchased pursuant to the Restricted Stock purchase agreement shall be the original price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to the Company. The repurchase option shall lapse at such rate as the Committee may determine. (c) Other Provisions. The Restricted Stock purchase agreement shall contain such other terms, provisions and conditions not inconsistent with the Plan as may be determined by the Administrator in its sole discretion. In addition, the provisions of Restricted Stock purchase agreements need not be the same with respect to each purchaser. (d) Rights as a Stockholder. Once the Stock Purchase Right is exercised, the purchaser shall have the rights equivalent to those of a stockholder, and shall be a stockholder when his or her purchase is entered upon the records of the duly authorized transfer agent of the Company. No adjustment will be made for a dividend or other right for which the record date is prior to the date the Stock Purchase Right is exercised, except as provided in Section 13 of the Plan. 12. Stock Withholding to Satisfy Withholding Tax Obligations. At the discretion of the Administrator, grantees of an Option or Stock Purchase Right may satisfy 9 withholding obligations as provided in this paragraph. When a grantee incurs tax liability in connection with an Option or Stock Purchase Right, which tax liability is subject to tax withholding under applicable tax laws, and the grantee is obligated to pay the Company an amount required to be withheld under applicable tax laws, the grantee may satisfy such obligation by electing to have the Company withhold from the Shares to be issued upon exercise of the Option, or the Shares to be issued in connection with the Stock Purchase Right, that number of Shares having a Fair Market Value equal to the amount required to be withheld. The Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined (the "Tax Date"). All elections by a grantee to have Shares withheld for this purpose shall be made in writing in a form acceptable to the Administrator and shall be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; (b) once made, the election shall be irrevocable as to the particular Shares of the Option or Right as to which the election is made; (c) all elections shall be subject to the consent or disapproval of the Administrator; (d) if the grantee is subject to Rule 16b-3, the election must comply with the applicable provisions of Rule 16b-3 and shall be subject to such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. In the event the election to have Shares withheld is made by a grantee and the Tax Date is deferred under Section 83 of the Code because no election is filed under Section 83(b) of the Code, the grantee shall receive the full number of Shares with respect to which the Option or Stock Purchase Right is exercised but such grantee shall be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. 13. Adjustments Upon Changes in Capitalization or Merger. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, and the maximum number of shares of Common Stock that may be covered by Options granted to any person pursuant to the limitation in Section 5(d), as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of 10 consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. In the event of the proposed dissolution or liquidation of the Company, the Board shall notify the Optionee at least fifteen (15) days prior to such proposed action. To the extent it has not been previously exercised, the Option will terminate immediately prior to the consummation of such proposed action. In the event of a merger of the Company with or into another corporation, the Option shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation. 14. Time of Granting Options. The date of grant of an Option shall, for all purposes, be the date on which the Administrator makes the determination granting such Option, or such other date as is determined by the Board. Notice of the determination shall be given to each person to whom an Option is so granted within a reasonable time after the date of such grant. 15. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may at any time amend, alter, suspend or discontinue the Plan, but no amendment, alteration, suspension or discontinuation shall be made which would impair the rights of any grantee under any grant theretofore made, without his or her consent. In addition, to the extent necessary and desirable to comply with Rule 16b-3 under the Exchange Act or with Sections 162(m) or 422 of the Code (or any other applicable law or regulation, including the requirements of the Nasdaq National Market or any established stock exchange in which the Shares are then listed), the Company shall obtain stockholder approval of any Plan amendment in such a manner and to such a degree as required. (b) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options or Stock Purchase Rights already granted and such awards shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the grantee and the Board, which agreement must be in writing and signed by the grantee and the Company. 16. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of the Nasdaq National Market or any stock exchange upon which the Shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. 11 As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. 17. Reservation of Shares. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 18. Agreements. Options and Stock Purchase Rights shall be evidenced by written agreements in such form as the Board shall approve from time to time. 19. Stockholder Approval. Continuance of the Plan shall be subject to approval by the stockholders of the Company within twelve (12) months before or after the date the Plan is adopted. Such stockholder approval shall be obtained in the degree and manner required under applicable state and federal law. 20. Information to Optionee. The Company shall provide to each Optionee, during the period for which such Optionee has one or more Options outstanding, copies of all annul reports and other information which are provided to all stockholders of the Company. The Company shall not be required to provide such information if the issuance of Options under the Plan is limited to key employees whose duties in connection with the Company assure their access to equivalent information. 12 EX-10.22 3 EXHIBIT 10.22 Exhibit 10.22 ARRIS PHARMACEUTICAL CORPORATION 1994 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN Adopted on April 20, 1994 Approved by Stockholders on June 7, 1994 Amended on February 6, 1997 Approved by Stockholders on ____________, 1997 1. Purpose. (a) The purpose of the 1994 Non-Employee Directors' Stock Option Plan (the "Plan") is to provide a means by which each new director of Arris Pharmaceutical Corporation (the "Company") who is not otherwise an employee of the Company or of any Affiliate of the Company (each such person being hereafter referred to as a "Non-Employee Director") will be given an opportunity to purchase stock of the Company. (b) The word "Affiliate" as used in the Plan means any parent corporation or subsidiary corporation of the Company as those terms are defined in Sections 424(e) and (f), respectively, of the Internal Revenue Code of 1986, as amended from time to time (the "Code"). (c) The Company, by means of the Plan, seeks to secure and retain the services of persons capable of serving as Non-Employee Directors of the Company, and to provide incentives for such persons to exert maximum efforts for the success of the Company. 2. Administration. (a) The Plan shall be administered by the Board of Directors of the Company (the "Board") unless and until the Board delegates administration to a committee, as provided in subparagraph 2(b). 1 (b) The Board may delegate administration of the Plan to a committee composed of two (2) or more members of the Board (the "Committee"), all of the members of which Committee may (but need not) be, in the discretion of the Board, "non-employee directors" within the meaning of Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") or "outside directors" within the meaning of Section 162(m) of the Code. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board, subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan. 3. Shares Subject To The Plan. (a) Subject to the provisions of paragraph 10 relating to adjustments upon changes in stock, the stock that may be sold pursuant to options granted under the Plan shall not exceed in the aggregate one hundred twenty-five thousand (125,000) shares of the Company's common stock. If any option granted under the Plan shall for any reason expire or otherwise terminate without having been exercised in full, the stock not purchased under such option shall again become available for the Plan. (b) The stock subject to the Plan may be unissued shares or reacquired shares, bought on the market or otherwise. 4. Eligibility. Options shall be granted only to Non-Employee Directors of the Company. 5. Non-Discretionary Grants. 2 (a) Each person who is elected or appointed for the first time to serve as a Non-Employee Director on or after February 6, 1997 shall, upon the date of such initial election or appointment, be granted an option to purchase thirty thousand (30,000) shares of common stock of the Company on the terms and conditions set forth herein. (b) On the date of the Company's annual meeting of its stockholders each year, commencing with the 1997 annual meeting, each person who is then serving as a Non-Employee Director and has continuously served as a Non-Employee Director for at least the preceding three (3) months shall be granted an option to purchase five thousand (5,000) shares of common stock of the Company on the terms and conditions set forth herein. 6. Option Provisions. Each option shall contain the following terms and conditions: (a) The term of each option commences on the date it is granted and, unless sooner terminated as set forth herein, expires on the date ("Expiration Date") ten (10) years from the date of grant. If the optionee's service as a Director or as an employee of or consultant to the Company or any Affiliate of the Company terminates for any reason or for no reason, the option shall terminate on the earlier of the Expiration Date or the date three (3) months following the date of termination of service; provided, however, that if such termination of service is due to the optionee's death, the option shall terminate on the earlier of the Expiration Date or twelve (12) months following the date of the optionee's death. In any and all circumstances, an option may be exercised following termination of the optionee's service as a Director of the Company only as to that number of shares as to which it was exercisable on the date of termination of such service under the provisions of subparagraph 6(e). 3 (b) The exercise price of each option shall be one hundred percent (100%) of the fair market value of the stock subject to such option on the date such option is granted. (c) The optionee may elect to make payment of the exercise price under one of the following alternatives: (i) Payment of the exercise price per share in cash at the time of exercise; or (ii) Provided that at the time of the exercise the Company's common stock is publicly traded and quoted regularly in the Wall Street Journal, payment by delivery of shares of common stock of the Company already owned by the optionee, held for the period required to avoid a charge to the Company's reported earnings, and owned free and clear of any liens, claims, encumbrances or security interest, which common stock shall be valued at fair market value on the date preceding the date of exercise; or (iii) Payment by a combination of the methods of payment specified in subparagraph 6(c)(i) and 6(c)(ii) above. Notwithstanding the foregoing, this option may be exercised pursuant to a program developed under Regulation T as promulgated by the Federal Reserve Board which results in the receipt of cash (or check) by the Company prior to the issuance of shares of the Company's common stock. (d) An option shall not be transferable except by will or by the laws of descent and distribution, and shall be exercisable during the lifetime of the person to whom the option is granted only by such person or by his or her guardian or legal representative, unless otherwise specified in the option, in which case the option may be transferred upon such terms and conditions as are set forth in the option, as the Board or the Committee shall determine in its 4 discretion, including (without limitation) pursuant to a "domestic relations order." Notwithstanding the foregoing, the person to whom an option is granted may, by delivering written notice to the Company, in a form satisfactory to the Company, designate a third party who, in the event of the death of the optionee, shall thereafter be entitled to exercise the option. (e) The option shall become exercisable in installments over a period of four (4) years from the date of grant at the rate of twenty five percent (25%) of the total shares granted under such option in four (4) equal annual installments commencing on the date one year after the date of grant of the option, provided that the optionee has, during the entire period prior to such vesting date, continuously served as a Director or as an employee of or consultant to the Company or any Affiliate of the Company, whereupon such option shall become fully exercisable in accordance with its terms with respect to that portion of the shares represented by that installment. (f) The Company may require any optionee, or any person to whom an option is transferred under subparagraph 6(d), as a condition of exercising any such option: (i) to give written assurances satisfactory to the Company as to the optionee's knowledge and experience in financial and business matters; and (ii) to give written assurances satisfactory to the Company stating that such person is acquiring the stock subject to the option for such person's own account and not with any present intention of selling or otherwise distributing the stock. These requirements, and any assurances given pursuant to such requirements, shall be inoperative if (i) the issuance of the shares upon the exercise of the option has been registered under a then-currently-effective registration statement under the Securities Act of 1933, as amended (the "Securities Act"), or (ii), as to any particular requirement, a determination is made by counsel for the Company that such requirement need not be met in the circumstances under the then-applicable securities laws. 5 (g) Notwithstanding anything to the contrary contained herein, an option may not be exercised unless the shares issuable upon exercise of such option are then registered under the Securities Act or, if such shares are not then so registered, the Company has determined that such exercise and issuance would be exempt from the registration requirements of the Securities Act. 7. Covenants Of The Company. (a) During the terms of the options granted under the Plan, the Company shall keep available at all times the number of shares of stock required to satisfy such options. (b) The Company shall seek to obtain from each regulatory commission or agency having jurisdiction over the Plan such authority as may be required to issue and sell shares of stock upon exercise of the options granted under the Plan; provided, however, that this undertaking shall not require the Company to register under the Securities Act either the Plan, any option granted under the Plan, or any stock issued or issuable pursuant to any such option. If the Company is unable to obtain from any such regulatory commission or agency the authority which counsel for the Company deems necessary for the lawful issuance and sale of stock under the Plan, the Company shall be relieved from any liability for failure to issue and sell stock upon exercise of such options. 8. Use Of Proceeds From Stock. Proceeds from the sale of stock pursuant to options granted under the Plan shall constitute general funds of the Company. 6 9. Miscellaneous. (a) Neither an optionee nor any person to whom an option is transferred under subparagraph 6(d) shall be deemed to be the holder of, or to have any of the rights of a holder with respect to, any shares subject to such option unless and until such person has satisfied all requirements for exercise of the option pursuant to its terms. (b) Nothing in the Plan or in any instrument executed pursuant thereto shall confer upon any Non-Employee Director any right to continue in the service of the Company or any Affiliate or shall affect any right of the Company, its Board or stockholders or any Affiliate to terminate the service of any Non-Employee Director with or without cause. (c) No Non-Employee Director, individually or as a member of a group, and no beneficiary or other person claiming under or through such Non-Employee Director, shall have any right, title or interest in or to any option reserved for the purposes of the Plan except as to such shares of common stock, if any, as shall have been reserved for such Non-Employee Director pursuant to any previous option grant. (d) In connection with each option made pursuant to the Plan, it shall be a condition precedent to the Company's obligation to issue or transfer shares to a Non-Employee Director, or to evidence the removal of any restrictions on transfer, that such Non-Employee Director make arrangements satisfactory to the Company to insure that the amount of any federal or other withholding tax required to be withheld with respect to such sale or transfer, or such removal or lapse, is made available to the Company for timely payment of such tax. 7 10. Adjustments Upon Changes In Stock. (a) If any change is made in the stock subject to the Plan, or subject to any option granted under the Plan, without the receipt of consideration by the Company (through merger, consolidation, reorganization, recapitalization, stock dividend, dividend in property other than cash, stock split, liquidating dividend, combination of shares, exchange of shares, change in corporate structure or other transaction not involving the receipt of consideration by the Company), the Plan will be appropriately adjusted in the class(es) and maximum number of shares subject to the Plan pursuant to subparagraph 3(a), and the outstanding options will be appropriately adjusted in the class(es) and number of shares and price per share of stock subject to such outstanding options. Such adjustments shall be made by the Board or the Committee, the determination of which shall be final, binding and conclusive. (The conversion of any convertible securities of the Company shall not be treated as a "transaction not involving the receipt of consideration by the Company".) (b) In the event of: (1) a merger or consolidation in which the Company is not the surviving corporation; (2) a reverse merger in which the Company is the surviving corporation but the shares of the Company's common stock outstanding immediately preceding the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise; or (3) any other capital reorganization in which more than fifty percent (50%) of the shares of the Company entitled to vote are exchanged, the time during which options outstanding under the Plan may be exercised shall be accelerated and the options terminated if not exercised prior to such event. 8 11. Amendment Of The Plan. (a) The Board at any time, and from time to time, may amend the Plan. Except as provided in paragraph 10 relating to adjustments upon changes in stock, no amendment shall be effective unless approved by the stockholders of the Company to the extent stockholder approval is necessary for the Plan to satisfy the requirements of Rule 16b-3 under the Exchange Act or any Nasdaq or securities exchange listing requirements. (b) Rights and obligations under any option granted before any amendment of the Plan shall not be altered or impaired by such amendment unless (i) the Company requests the consent of the person to whom the option was granted and (ii) such person consents in writing. 12. Termination Or Suspension Of The Plan. (a) The Board may suspend or terminate the Plan at any time. Unless sooner terminated, the Plan shall terminate on April 1, 2004. No options may be granted under the Plan while the Plan is suspended or after it is terminated. (b) Rights and obligations under any option granted while the Plan is in effect shall not be altered or impaired by suspension or termination of the Plan, except with the consent of the person to whom the option was granted. (c) The Plan shall terminate upon the occurrence of any of the events described in Section 10(b) above. 13. Effective Date Of Plan; Conditions Of Exercise. (a) The Plan shall become effective upon adoption by the Board of Directors, subject to the condition subsequent that the Plan is approved by the stockholders of the Company. (b) No option granted under the Plan shall be exercised or exercisable unless and until the condition of subparagraph 13(a) above has been met. 9 EX-10.43 4 EXHIBIT 10.43 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ Exhibit 10.43 RESEARCH COLLABORATION AND LICENSE AGREEMENT between MERCK & CO., INC. and ARRIS PHARMACEUTICAL CORPORATION TABLE OF CONTENTS Article I--Definitions.............................................. 1 Article II--Research Program........................................ 8 Section 2.1--General........................................... 8 Section 2.2--Conduct of Research............................... 8 Section 2.3--Use of Research Funding........................... 8 Section 2.4--Exchange of Information........................... 8 Section 2.5--Joint Research Committee.......................... 8 Section 2.6--Records and Reports............................... 8 Subsection 2.6.1--Records................................. 8 Subsection 2.6.2--Copies and Inspection of Records........ 9 Subsection 2.6.3--Quarterly Reports....................... 9 Section 2.7--Research Program Information and Inventions....... 9 Section 2.8--Research Program Term............................. 9 Section 2.9--ARRIS Delta Technology............................ 10 Section 2.10--Rights to Compounds.............................. 10 Article III--License; Development and Commercialization............. 11 Section 3.1--Research License Grants........................... 11 Section 3.2--Commercialization License......................... 12 Section 3.3--Development and Commercialization................. 12 Section 3.4--Exclusivity in the Field.......................... 12 Article IV--Confidentiality and Publication......................... 12 Section 4.1--Nondisclosure Obligations......................... 12 Section 4.2--Restriction on ARRIS Delta Technology............. 12 Section 4.3--Exceptions........................................ 12 Section 4.4--Permitted Disclosure of Proprietary Information... 13 Section 4.5--Publication....................................... 13 Section 4.6--Press Releases.................................... 14 Article V--Payments; Royalties and Reports.......................... 14 Section 5.1--Commitment Fee.................................... 14 i _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ Section 5.2--Research Program Funding.......................... 14 Section 5.3--Milestone Payments................................ 15 Section 5.4--Royalties......................................... 16 Subsection 5.4.1--Royalties Payable By MERCK.............. 16 Subsection 5.4.2--Managed Pharmaceutical Contracts........ 18 Subsection 5.4.3--Change in Sales Practices............... 18 Subsection 5.4.4--Bulk Compound .......................... 18 Subsection 5.4.5--Compulsory Licenses..................... 18 Subsection 5.4.6--Third Party Licenses.................... 18 Section 5.5--Reports; Payment of Royalties..................... 18 Section 5.6--Audits............................................ 19 Section 5.7--Payment Exchange Rate............................. 20 Section 5.8--Income Tax Withholding............................ 20 Article VI--Representations and Warranties.......................... 20 Section 6.1--ARRIS Representations and Warranties.............. 20 Section 6.2--MERCK Representations and Warranties.............. 21 Article VII--Patent Matters......................................... 21 Section 7.1--Filing, Prosecution and Maintenance of Patents.... 21 Section 7.2--Right to Prosecute and Maintain Patents........... 22 Section 7.3--Interference, Opposition, Reexamination and Reissue........................................... 23 Section 7.4--Enforcement and Defense........................... 23 Section 7.5--Patent Term Restoration........................... 25 Article VIII--Term and Termination.................................. 25 Section 8.1--Term and Expiration............................... 25 Section 8.2--Termination by MERCK.............................. 25 Section 8.3--Termination....................................... 27 Subsection 8.3.1--Termination for Cause................... 27 Subsection 8.3.2--Effect of Termination for Bankruptcy.... 28 Section 8.4--Effect of Expiration or Termination............... 28 Article IX--Miscellaneous........................................... 29 ii _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ RESEARCH COLLABORATION AND LICENSE AGREEMENT THIS AGREEMENT is effective as of November , 1996 (the "Effective Date"), between MERCK & CO., INC., a corporation organized and existing under the laws of New Jersey ("MERCK") and ARRIS PHARMACEUTICAL CORPORATION, a corporation organized and existing under the laws of Delaware ("ARRIS"). WITNESSETH: WHEREAS, ARRIS has developed ARRIS Know-How (as defined below) and has rights to ARRIS Patents (as defined below); WHEREAS, MERCK and ARRIS desire to enter into a research collaboration upon the terms and conditions set forth herein; WHEREAS, MERCK desires to obtain a license under the ARRIS Patents and ARRIS Know-How, upon the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the foregoing and the mutual covenants contained herein, the parties hereby agree as follows: ARTICLE I DEFINITIONS Unless specifically set forth herein to the contrary, the following terms, whether used in the singular or plural, shall have the respective meanings set forth below: 1.1 "Active Compound" shall mean any compound in purified form that (A) (1) is a [ * ] compound characterized by having the ability to inhibit (or, in the case of a prodrug, an active species of which inhibits) human cathepsin K or human cathepsin L [ * ] and having greater than [ * ] and having greater than [ * ] in an [ * ] wherein the concentration of the compound is not greater than [ * ], and (2) satisfies one or more of the following: (a) is discovered, identified or synthesized by or on behalf of ARRIS and/or MERCK, or an Affiliate of either of them, pursuant to work conducted under this Agreement, and is determined by the JRC to 1 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ meet the criteria of Subsection 1.1(A)(1) above either [* ] pursuant to work conducted under [ * ] or (ii) [ * ] pursuant to work deriving directly from or based directly upon the results of the work conducted under the Agreement; or (b) is acquired prior to the end of the Research Program Term (including without limitation acquisition of rights thereto) by ARRIS or MERCK, or an Affiliate of either of them, from a third party, on an absolute or contingent basis (such as rights under an option), and is determined by the JRC to meet the criteria of Subsection 1.1(A)(1) above pursuant to work conducted under this Agreement during the Research Program Term; or (c) is generically described within a claim describing a genus of compounds the utility of which is given as human cathepsin K or human cathepsin L inhibition, as defined in any pending or issued claim of any unexpired ARRIS Patent, MERCK Patent or Collaboration Patent filed in the United States or Japan or as a European Patent Application, or as a Patent Cooperation Treaty ("PCT") application designating the United States and the contracting states of the European Patent Convention, and as to which the JRC determines that at least one member of such genus meets the requirements of either Subsection 1.1(A)(1)(a) or 1.1(A)(1)(b) above, PROVIDED THAT such compound is synthesized and assayed [ * ]; or (B) (1) is (a) identified to the JRC from the ARRIS library by ARRIS or from the MERCK library by MERCK, or (b) discovered or synthesized by or on behalf of ARRIS and/or MERCK, or an Affiliate of either of them pursuant to work conducted under this Agreement [ * ], or (c) acquired by ARRIS or MERCK, or an Affiliate of either of them, pursuant to work conducted under this Agreement prior to [ * ], and (2) is designated an Active Compound by the JRC by [ * ]. Notwithstanding the provisions of Subsections 1.1(A) and (B) above, Active Compounds shall not include: (x) Any compound that meets the requirements for being an Active Compound as set forth above but that has not been determined to be or selected as a Program Compound by the later of: (i) [ 2 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ * ], or (ii) [ * ] by a party hereunder; or (y) Any compound marketed by MERCK or its Affiliates as of the Effective Date; or (z) Any compound for which MERCK as of the Effective Date is conducting human clinical trials or has filed an IND (which has not been abandoned or withdrawn), provided that such compound is not known as of the Effective Date to have human cathepsin K and/or L inhibitory activity. 1.2 "ARRIS Delta Technology" shall mean that specific technology, methods, techniques, materials, know-how, inventions, information and data described generally in a letter from ARRIS to MERCK of even date with this Agreement, all improvements to and inventions incorporating the ARRIS Delta Technology (but excluding (i) Active Compounds, (ii) any improved or modified Active Compounds which are themselves Active Compounds and (iii) those inventions which arise from the use by MERCK or its Affiliates or sublicensees of ARRIS Delta Technology to the extent permitted under Section 4.3 of this Agreement) made prior to [ * ], and the Patents owned or Controlled by ARRIS at any time covering the foregoing. 1.3 "Affiliate" shall mean (i) any corporation or business entity of which more than 50% of the securities or other ownership interests representing the equity, the voting stock or general partnership interest are owned, controlled or held, directly or indirectly, by MERCK or ARRIS; or (ii) any corporation or business entity which, directly or indirectly, owns, controls or holds 50% (or the maximum ownership interest permitted by law) or more of the securities or other ownership interests representing the equity, the voting stock or, if applicable, the general partnership interest, of MERCK or ARRIS. 1.4 "ARRIS Know-How" shall mean all information, materials and technology, including without limitation methods, techniques, know-how, inventions, data, ARRIS Research Information, Technology and Improvements, to the extent (a) owned or Controlled by ARRIS or an ARRIS Affiliate at any time prior to [ * ], and (b) necessary or useful to the work MERCK shall perform in the Field pursuant to the Agreement, but excluding ARRIS Patents, Collaboration Patents, and ARRIS Delta Technology. 1.5 "ARRIS Patents" shall mean all Patents owned or Controlled by ARRIS that claim (a) Active Compounds, the manufacture or use of Active Compounds, or methods or materials used for discovering, identifying, or assaying for Active Compounds, or (b) to the extent not covered in subsection (a), any ARRIS Know-How or ARRIS Research Information, where such Patents cover inventions made prior to [ * ], but excluding the ARRIS Delta Technology. 3 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ 1.6 "ARRIS Research Information" shall mean all Research Program Information and Inventions developed or invented solely by ARRIS (including by its employees, agents or consultants). 1.7 "Calendar Quarter" shall mean the respective periods of three consecutive calendar months ending on March 31, June 30, September 30 and December 31. 1.8 "Calendar Year" shall mean each successive period of 12 months commencing on January 1 and ending on December 31. 1.9 "Combination Product" shall mean a Licensed Product which includes one or more active ingredients other than a Program Compound in combination with one or more Program Compounds. 1.10 "Collaboration Patents" shall mean all Patents that claim inventions in Research Program Information and Inventions that are invented jointly by ARRIS and MERCK (including by their respective employees, agents or consultants). 1.11 "Collaboration Research Information" shall mean all Research Program Information and Inventions developed or invented jointly by ARRIS and MERCK (including by their respective employees, agents or consultants). 1.12 "Control" shall mean, with respect to a compound, material, information or intellectual property right, possession by a party of a license with the right to sublicense existing as of the Effective Date or that is acquired during the term of this Agreement. 1.13 "Field" shall mean the discovery, identification, synthesis, assaying, manufacture, and research use of Active Compounds and the clinical development of Program Compounds and the manufacture, use, sale or importation of Licensed Products. 1.14 "First Commercial Sale" shall mean, with respect to any Licensed Product, the first sale by MERCK or its Affiliates or sublicensees to a third party intended for end use or consumption of such Licensed Product in a country after all required approvals, including marketing and pricing approvals, have been granted by the governing health authority of such country. 1.15 "Improvement" shall mean any enhancement in the manufacture, formulation, ingredients, preparation, presentation, means of delivery, dosage or packaging of Program Compound or Licensed Product. 1.16 "JRC" shall mean the Joint Research Committee described in Section 2.5 of this Agreement. 4 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ 1.17 "Licensed Product" shall mean a preparation in final form for sale by prescription, over-the-counter or any other method for any and all uses, including, without limitation, in humans and/or animals and/or agriculture, and all other uses, which contains a Program Compound, including, without limitation, any Combination Product. 1.18 "MERCK Know-How" shall mean all information, materials, and technology, including without limitation methods, techniques, know-how, inventions, data, MERCK Research Information, Technology or Improvements, to the extent (a) owned or Controlled by MERCK or a MERCK Affiliate at any time prior to [ * ], and (b) in the reasonable opinion of MERCK necessary or useful to the work ARRIS shall perform in the Field pursuant to the Agreement, but excluding MERCK Patents, and Collaboration Patents. 1.19 "MERCK Research Information" shall mean all Research Program Information and Inventions developed or invented solely by MERCK (including by its employees, agents or consultants). 1.20 "MERCK Patents" shall mean all Patents owned or Controlled by MERCK that claim (a) Active Compounds, the manufacture or use of Active Compounds, or methods or materials used for discovering, identifying, or assaying for Active Compounds, or (b) to the extent not covered in subsection (a), any MERCK Know-How or MERCK Research Information, where such Patents cover inventions made prior to [ * ]. 1.21 "Net Sales" shall mean [ * ] Licensed Product sold by MERCK, its Affiliates or sublicensees (which term does not include distributors) to the first independent third party after deducting, if not previously deducted, from the amount invoiced: (a) trade and quantity discounts; (b) credits and allowances on account of returned or rejected products; (c) rebates, chargebacks and other amounts paid on sale or dispensing of Licensed Product; (d) [ * ]; (e) [ * ]; and 5 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. (f) [ * ] used for [ * ] Licensed Product as it is sold, to the extent included within the gross invoice price of Licensed Product. With respect to sales of Combination Products, Net Sales shall be calculated on the basis of the invoice price of Licensed Product(s) containing the same weight of Program Compound sold without other active ingredients. If such Licensed Product is not sold without other active ingredients, Net Sales shall be calculated on the basis of [ * ] which shall be the [ * ] which shall be the [ * ], but in no event shall such [ * ] shall be determined [ * ] in accordance with [ * ]. 1.22 "Patents" shall mean any and all issued patents and patent applications (which shall be deemed to include certificates of invention and applications for certificates of invention) and including all divisions, continuations, continuations-in-part, reissues, renewals, extensions, supplementary protection certificates or the like of any of the foregoing patents and patent applications and foreign equivalents thereof. 1.23 "Program Compound" shall mean (a) an Active Compound that: (i) has [ * ] against human cathepsin K or L; (ii) [ * ]; (iii) if a human cathepsin K inhibitor, has greater than [ * ]; or, if a human cathepsin L inhibitor, has greater than [ * ]; and (iv) [ * ]; or 6 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ (b) any other Active Compound designated as a Program Compound by the JRC by the [ * ]; or (c) any compound deemed to be a Program Compound as provided in Section 2.10(d) of this Agreement. 1.24 "Proprietary Information" shall mean all scientific, clinical, regulatory, marketing, financial and commercial information or data, whether communicated in writing, orally or by any other means, that is provided by one party to the other party in connection with this Agreement. Proprietary Information shall include, without limitation, MERCK Know-How, ARRIS Know-How and ARRIS Delta Technology. 1.25 "Research Program Information and Inventions" shall mean all discoveries, Improvements, processes, formulas, data, inventions, know-how and trade secrets, patentable or otherwise, developed or discovered under or arising from the parties' work, alone or jointly, under the Research Program. 1.26 "Research Program" shall mean the collaborative research effort between the parties as set forth in Article II of this Agreement and Attachment 2.1 hereto. 1.27 "Technology" shall mean all polynucleotides encoding human cathepsins, the expression vectors and systems containing the coding regions of the polynucleotides encoding the human cathepsins, various organisms (including, but not limited to, [ * ]) transformed with the polynucleotides encoding the human cathepsins and required for the production of recombinant human cathepsin polypeptides, protocols and biochemical expertise involved in the activation and purification of human cathepsins, [ * ], substrates, assays, non-reversible and reversible inhibitors of human cathepsins, and all additional know-how involved in the design of cathepsin inhibitors. 1.28 "Territory" shall mean all of the countries in the world. 1.29 "Valid Patent Claim" shall mean a claim of an issued and unexpired patent included within the ARRIS Patents, MERCK Patents or Collaboration Patents, which has not been revoked or held unenforceable or invalid by a decision of a court or other governmental agency of competent jurisdiction, unappealable or unappealed within the time allowed for appeal, and which has not been disclaimed, denied or admitted to be invalid or unenforceable through reissue or disclaimer or otherwise. 7 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ ARTICLE II RESEARCH PROGRAM 2.1 General. ARRIS and MERCK shall engage in the Research Program upon the terms and conditions set forth in this Agreement. The activities to be undertaken during the Research Program are set forth in Attachment 2.1 which may be amended from time to time upon the mutual written agreement of the authorized representatives of the parties. 2.2 Conduct of Research. ARRIS and MERCK each shall conduct the Research Program in good scientific manner, and in compliance in all material respects with all requirements of applicable laws, rules and regulations and all applicable good laboratory practices to attempt to achieve their objectives efficiently and expeditiously. 2.3 Use of Research Funding. ARRIS shall apply the research funding it receives from MERCK under this Agreement in accordance with the Research Program attached hereto as Attachment 2.1, as such may be amended from time to time upon the mutual written agreement of authorized representatives of the parties. 2.4 Exchange of Information. Upon execution of this Agreement, ARRIS shall disclose to MERCK in English and in writing all ARRIS Know-How not previously disclosed. During the term of this Agreement, ARRIS shall also promptly disclose to MERCK in English and in writing on an ongoing basis all ARRIS Know-How. MERCK shall promptly disclose to ARRIS during the term of this Agreement MERCK Know-How which MERCK determines, in its discretion, may be necessary or useful to ARRIS in the performance of the Research Program. 2.5 Joint Research Committee. The parties shall form a Joint Research Committee ("JRC") which shall be composed of three scientists from each party and chaired by MERCK. The JRC shall meet at least monthly during the Research Program Term to monitor and evaluate the progress of and direct the Research Program. The JRC may designate compounds as Active Compounds in accordance with Subsection 1.1(B) or Program Compounds in accordance with Subsection 1.23(b) during the period ending on [ * ]. Such meetings may be face-to-face or by teleconference or videoconference, except that there must be one face-to-face meeting approximately every three months at alternating sites. In the event of any unresolved differences between the parties with respect to issues that come before the JRC, [ * ]. 2.6 Records and Reports. 2.6.1 Records. ARRIS and MERCK each shall maintain records which shall be complete and accurate and shall 8 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ fully and properly reflect all work done and results achieved in the performance of the Research Program in sufficient detail and in good scientific manner appropriate for patent and regulatory purposes. 2.6.2 Copies and Inspection of Records. MERCK shall have the right, during normal business hours and upon reasonable notice no more than [ * ], to inspect and copy all of the records of ARRIS referenced in Section 2.6.1, except that ARRIS need not disclose any data or information relating to compounds in ARRIS's library as of the Effective Date that do not meet the criteria in Subsection 1.1(A)(1). MERCK shall maintain such records and the information disclosed therein in confidence in accordance with Section 4.1. MERCK shall have the right to arrange for a reasonable number of its employees, agents and outside consultants to visit ARRIS at its offices and laboratories during normal business hours and upon reasonable notice, and to discuss the Research Program and its results in detail with the technical personnel and consultants of ARRIS. All inspections, copying and visits hereunder shall be conducted in a manner so as not to disrupt ARRIS's business or cause any disclosure of any other ARRIS confidential information. 2.6.3 Quarterly Reports. Within 30 days following the end of each Calendar Quarter during the term of this Agreement, ARRIS shall provide to MERCK a written progress report which shall describe the work performed to date on the Research Program, evaluate the work performed in relation to the goals of the Research Program and provide such other information required by the Research Program or reasonably requested by MERCK relating to the progress of the goals or performance of the Research Program. Upon request, ARRIS shall provide copies of the records described in Section 2.6.1. above (excluding the data and information excluded as set forth in Section 2.6.2). 2.7 Research Program Information and Inventions. The Research Program Information and Inventions developed or invented under this Agreement shall be owned as follows: (a) ARRIS Research Information shall be owned [ * ]; (b) MERCK Research Information shall be owned [ * ]; and (c) Collaboration Research Information shall be owned [ * ]. Each party shall promptly disclose to the other the development, making, conception and reduction to practice of all Research Program Information and Inventions. ARRIS shall not be required to disclose to MERCK the invention or development of ARRIS Delta Technology except to the extent such inventions or developments relate directly to the Field. 2.8 Research Program Term. Except as otherwise provided herein, the term of the Research Program shall commence on the Effective Date and continue for a 9 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ period of two years (or three years if extended as provided below in this Section 2.8) (the "Research Program Term"), except that MERCK may terminate the Research Program and this Agreement in accordance with Section 8.2. The parties by mutual written agreement executed by authorized representatives may extend the Research Program Term for one additional year. Upon extension of the Research Program Term, if applicable, Attachment 2.1 setting forth the Research Program shall be amended in writing by mutual agreement. 2.9 ARRIS Delta Technology. As part of its efforts under the Research Program, ARRIS shall use all reasonable efforts to apply the ARRIS Delta Technology to the identification, discovery and synthesis of Active Compounds. The ARRIS Delta Technology shall remain proprietary to ARRIS. MERCK agrees not to make any use of the Delta Technology, except as may be permitted under Section 4.3 of this Agreement. The parties understand and agree, however, that incident to MERCK's research and development activities in collaboration with ARRIS under the Research Program, MERCK and/or its Affiliates (including their respective employees or agents) may make inventions or developments relating to or based upon the ARRIS Delta Technology. MERCK hereby assigns to ARRIS all improvements to and inventions incorporating the ARRIS Delta Technology (excluding (i) Active Compounds, (ii) any improved or modified Active Compounds which are themselves Active Compounds and (iii) those inventions which arise from the use of ARRIS Delta Technology by MERCK or its Affiliates or sublicensees as may be permitted under Section 4.3 of this Agreement) made during the Agreement. 2.10 Rights to Compounds. The parties contemplate that each of them will make compounds from its library available for testing for purposes of this Agreement and that additional compounds may be invented and/or synthesized in the course of the Research Program. In respect of such compounds, the parties agree as follows: (a) Pre-existing compounds which are tested in the Research Program and are determined, under the provisions of Section 1.1, not to be Active Compounds shall revert to the party which made such compound available, without any restriction under this Agreement. (b) Compounds which are invented in the course of the Research Program shall be owned [ * ] each such compound, with compounds which are invented jointly by the parties [ * ], and all such compounds that are determined under the provisions of Section 1.1 not to be Active Compounds shall [ * ] such compounds, [ * ] under this Agreement. (c) Active Compounds shall not be subject to clinical development (but shall be available for pre-clinical investigation) by either party except pursuant to the terms of this Agreement unless and until such Active 10 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ Compound is released from this Agreement. Active Compounds shall be released from this Agreement if such Active Compound is not determined to be or designated as a Program Compound under the provisions of Section 1.23 by the later of: (i) [ * ], or (ii) [ * ] such Active Compound was first synthesized by a party hereunder. Rights in Active Compounds which are released from this Agreement shall be determined in accordance with subsections (a) and (b) above. (d) Neither party shall develop or market any compound that at any time during the periods specified in Section 1.1 met the definition of Active Compound under Section 1.1, even if such compound later was released from the terms of this Agreement as provided in subsection (c) above and subsection (x) of Section 1.1, except pursuant to the terms of this Agreement if such compound is developed for its inhibition of cathepsin K or L. Any such compound developed shall be deemed a Program Compound for all purposes hereunder. (e) Program Compounds shall be developed and marketed only in accordance with the terms of this Agreement. (f) No implied license under patent rights is granted under this Section 2.10. ARTICLE III LICENSE; DEVELOPMENT AND COMMERCIALIZATION 3.1 Research License Grants. (a) Upon the terms and conditions set forth herein, ARRIS hereby grants MERCK the sole license under the ARRIS Know-How and the ARRIS Patents solely as necessary to conduct the discovery, research and development of Active Compounds under this Agreement. The foregoing license may be sublicensed to MERCK Affiliates and, with the consent of the parties, to third party sublicensees. (b) Upon the terms and conditions set forth herein, MERCK hereby grants ARRIS the sole license under the MERCK Know-How and the MERCK Patents solely as necessary to conduct the discovery, research and development of Active Compounds under this Agreement. (c) As used in Subsections 3.1(a) and (b) above, the phrase "sole license" shall mean that the licensor has not granted and shall not grant to any third party during the term of this Agreement the license rights granted to the licensee in the applicable Subsection. 11 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ 3.2 Commercialization License. Upon the terms and conditions set forth herein, ARRIS hereby grants MERCK the exclusive license under the ARRIS Know-How and the ARRIS Patents and ARRIS' interest in the Collaboration Research Information and the Collaboration Patents solely to develop, make, have made, use, import and sell Program Compounds and Licensed Products in the Territory. The foregoing license may be sublicensed to MERCK Affiliates and third party sublicensees. 3.3 Development and Commercialization. MERCK shall use [ * ] in developing and commercializing [ * ] pharmaceutical products, at its own expense, to develop and commercialize a Licensed Product in such countries in the Territory [ * ]. 3.4 Exclusivity in Field. ARRIS and MERCK each covenant to the other that during the period commencing on the Effective Date and continuing until [ * ], it will conduct no activity concerning discovering, identifying, researching or developing compounds which meet the criteria of Subsection 1.1(A)(1) except pursuant to this Agreement (provided that the foregoing shall not prevent a party or its Affiliates from conducting pre-clinical investigations on such compounds for uses outside of their inhibition of cathepsin K or cathepsin L). The foregoing shall not be interpreted to limit the other obligations under this Agreement, including without limitation those under Sections 2.9 and 2.10 and Article IV. ARTICLE IV CONFIDENTIALITY AND PUBLICATION 4.1 Nondisclosure Obligations. All Proprietary Information disclosed by one party to the other hereunder shall be maintained in confidence by the receiving party and shall not be disclosed to any non-party or used for any purpose except as expressly permitted herein without the prior written consent of the other party to this Agreement, except that the foregoing shall not apply to the extent provided in Section 4.3 below. 4.2 Restriction on ARRIS Delta Technology. MERCK agrees [ * ] not to disclose ARRIS Delta Technology to any of its employees except to those MERCK employees who reasonably require same for the purposes of this Agreement and who have been apprised of the confidential nature of such disclosure. 4.3 Exceptions. The non-use and non-disclosure obligations of Sections 4.1 and 4.2 shall not apply to the extent that the Proprietary Information: (a) is known by the receiving party at the time of its receipt, and not through a prior disclosure by the disclosing party, as documented by business records; 12 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ (b) is properly in the public domain; (c) is subsequently disclosed to the receiving party by a third party who may lawfully do so and is not under an obligation of confidentiality to the disclosing party; or (d) is developed by the receiving party independently of Proprietary Information received from the disclosing party. 4.4 Permitted Disclosure of Proprietary Information. Notwithstanding Section 4.1, a party receiving Proprietary Information of the other party may disclose such Proprietary Information: (a) to governmental or other regulatory agencies in order to gain approval to conduct clinical trials or to market Licensed Product, but such disclosure may be only to the extent reasonably necessary to obtain such authorizations; (b) by MERCK to its permitted sublicensees, agents, consultants, Affiliates and/or other third parties to the extent necessary for the research and development, manufacturing and/or marketing of the Licensed Product (or for such parties to determine their interest in performing such activities) in accordance with this Agreement on the condition that such third parties agree to be bound by the confidentiality obligations contained within this Agreement, PROVIDED the term of confidentiality for such third parties shall be no less than[ * ], or (c) if required to be disclosed by law or court order, provided that notice is promptly delivered to the other party in order to provide an opportunity to challenge or limit the disclosure obligations. (d) Notwithstanding the foregoing, [ * ]. 4.5 Publication. MERCK and ARRIS each acknowledge the other's interest in publishing its results to obtain recognition within the scientific community and to advance the state of scientific knowledge. Each party also recognizes the mutual interest in obtaining valid patent protection and in protecting business interests and trade secret information. Consequently, either party, its employees, agents or consultants wishing to make such a publication shall deliver to the other party a copy of the proposed written publication or an outline of an oral disclosure at least [ * ] prior to submission for publication or presentation. The reviewing party shall have the right (a) to propose modifications to the publication for patent reasons, trade secret reasons or business reasons or (b) to request a reasonable delay in publication or presentation in order to protect know-how and patentable information. 13 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ If the reviewing party requests a delay, the publishing party shall delay submission or presentation for [ * ] after the filing of the initial patent application to enable patent applications protecting each party's rights in such information to be filed in accordance with Article VII below. Upon expiration of such [ * ], the publishing party shall be free to proceed with the publication or presentation. If the reviewing party requests modifications to the publication, the publishing party shall edit such publication to prevent disclosure of trade secret or proprietary business information prior to submission of the publication or presentation. 4.6 Press Releases. Each party shall have the right to make public announcements concerning this Agreement or the subject matter hereof, provided that the other party shall have reasonable opportunity and the right to approve the content of such announcement prior to its being made, which approval shall not be delayed or unreasonably withheld. MERCK shall have reasonable opportunity and the right to review all filings describing the terms of this Agreement, prior to their submittal by ARRIS to the SEC, including all proposed redacted copies of this Agreement. ARRIS shall give due respect to any reasonable and timely request by MERCK with respect thereto, including confidential treatment of selected portions of this Agreement. ARTICLE V PAYMENTS; ROYALTIES AND REPORTS 5.1 Commitment Fee. In consideration of ARRIS's commitment to perform its obligations under the Research Program and for access to the ARRIS Know-How granted hereunder, MERCK shall pay ARRIS a non-refundable commitment fee of [ * ] upon execution of this Agreement by both parties. 5.2 Research Program Funding. In consideration for ARRIS's performance of its obligations under the Research Program, and subject to the terms and conditions contained herein, MERCK shall pay ARRIS: (a) For the First Year of the Research Program Term: an amount equal to [ * ] (representing [ * ] per Full Time Equivalent ("FTE") for [ * ]), payable in four equal quarterly installments of [ * ] each. The first such quarterly installment of [ * ] shall be due upon execution of this Agreement by both parties. The remaining three such quarterly installments of [ * ] each shall be due on the first day of the respective three month period, i.e., on February 1, 1997, May 1, 1997 and August 1, 1997. Should the parties agree to amend the Research Program to require [ * ] additional FTEs during the First Year, the additional payment for such FTE(s) shall equal [ * ] per FTE. 14 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ (b) For the Second Year of the Research Program Term: an amount equal to [ * ] (representing [ * ] per FTE for [ * ]), payable in four quarterly installments of [ * ] each. Such quarterly installments shall be due on the first day of the respective three month period, i.e., on November 1, 1997, February 1, 1998, May 1, 1998 and August 1, 1998. If the JRC determines to accelerate the Research Program during the Second Year by requiring up to as many as [ * ] during the Second Year, the parties shall amend the Research Program accordingly and the additional payment for such FTE(s) shall equal [ * ] per FTE. (c) For any Third Year of the Research Program Term: If the Research Program Term is extended for a Third Year as set forth in Section 2.8 above, payments for such Third Year shall equal [ * ] per required FTE. 5.3 Milestone Payments. Subject to the terms and conditions of this Agreement, MERCK shall pay to ARRIS the following milestone payments: (a) [ * ] upon [ * ] set forth in Section [ * ] of this Agreement; (b) [ * ] upon [ * ]of a [ * ]; (c) [ * ] upon [ * ] of a Program Compound for [ * ] as defined by MERCK; (d) [ * ] upon [ * ] of [ * ] using a Program Compound; (e) [ * ] upon [ * ] of [ * ] using a Program Compound; (f) [ * ] upon [ * ] a Licensed Product for [ * ]; (g) [ * ] upon [ * ] a Licensed Product in the [ * ]. ARRIS shall notify MERCK in writing within [ * ] upon the achievement of the milestone described in (b) above, and MERCK shall pay ARRIS the appropriate milestone payment within [ * ] of its receipt of such notice. MERCK shall notify ARRIS in writing within [ * ] upon the achievement of 15 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ each milestone described in (a) and (c) through (g) above, and upon such notice shall pay ARRIS the appropriate milestone payment. The milestone payments described in (a) through (c) above shall be payable only upon the initial achievement of such milestone and no amounts shall be due hereunder for subsequent or repeated achievement of such milestone. The milestone payments described in (d) through (g) above shall be payable only upon the achievement of each such milestone for the [ * ] a particular milestone event. Notwithstanding the foregoing, if a Program Compound is approved and marketed as a Licensed Product, and MERCK elects to develop or to continue developing, e.g., as a second generation product, another Program Compound (which does not contain the same Program Compound or any salt form, different formulation, or stereo-isomer thereof as such Licensed Product) as a Licensed Product, MERCK shall make the required payment for [ * ] described in [ * ] any such [ * ], which shall include payment of all milestone payments described in [ * ] that were [ * ] of such Licensed Product. [ * ] of each milestone payment made for the achievement of a milestone described in (f) and (g) as set forth above [ * ] for the Program Compound for which such milestone was paid; PROVIDED, HOWEVER, that the [ * ] for such Program Compound [ * ] in such year. 5.4 Royalties. 5.4.1 Royalties Payable By MERCK. Subject to the terms and conditions of this Agreement, MERCK shall pay to ARRIS royalties during each Calendar Year on a country-by-country basis: (a) if the Licensed Product is covered by a Valid Patent Claim in the country of sale, then: (i) an amount equal to [ * ] of the Net Sales of such Licensed Products in such countries, until the total annual Net Sales of Licensed Products by MERCK, its Affiliates or sublicensees equals [ * ]; (ii) for that amount of annual Net Sales of Licensed Products by MERCK, its Affiliates or sublicensees greater than [ * ] and less than or equal to [ * ], an amount equal to [ * ] 16 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ of such Net Sales in such countries; and (iii) for that amount of annual Net Sales of Licensed Products by MERCK, its Affiliates or sublicensees greater than [ * ], an amount equal to [ * ] of such Net Sales in such countries; or (b) for sales in countries other than those covered in Subsection 5.4.1(a) above: (i) an amount equal to [ * ] of the Net Sales of such Licensed Products in such countries, until the total annual Net Sales of Licensed Products by MERCK, its Affiliates or sublicensees equals [ * ]; (ii) for that amount of annual Net Sales of Licensed Products by MERCK, its Affiliates or sublicensees greater than [ * ] and less than or equal to [ * ], an amount equal to [ * ] of such Net Sales in such countries; and (iii) for that amount of annual Net Sales of Licensed Products by MERCK, its Affiliates or sublicensees greater than [ * ], an amount equal to [ * ] of such Net Sales in such countries. Royalties on each Licensed Product at the rates set forth above shall be effective as of the date of First Commercial Sale of Licensed Product in a country and shall continue until either (i) the expiration of the last applicable patent on such Licensed Product in such country in the case of sales under Subsection 5.4.1(a) above or (ii) until the [ * ] in such country in the case of sales of Licensed Product under Subsection 5.4.1(b) above, in each case subject to the following conditions: (x) that only one royalty shall be due with respect to the same unit of Licensed Product; (y) that no royalties shall be due upon the sale or other transfer among MERCK, its Affiliates or sublicensees, but in such cases the royalty shall be due and calculated upon MERCK's or its Affiliate's or its sublicensee's Net Sales to the first independent third party; and (z) no royalties shall accrue on the disposition without charge of Licensed Product in reasonable quantities by MERCK, its Affiliates or its sublicensees as samples (promotion or otherwise) or as donations (for 17 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ example, to non-profit institutions or government agencies for a non-commercial purpose). 5.4.2 Managed Pharmaceutical Contracts. MERCK may sell Licensed Products to an independent third party (such as a retailer or wholesaler) and may subsequently perform services relating to Licensed Products and other products under a managed pharmaceutical benefits contract or other similar contract. In such cases, Net Sales shall be based [ * ] in Section 1.21, [ * ] receive compensation arising from the performance of such services. 5.4.3 Change in Sales Practices. The parties acknowledge that during the term of this Agreement, MERCK's sales practices for the marketing and distribution of Licensed Product may change to the extent to which the calculation of the payment for royalties on Net Sales may become impractical or even impossible. In such event the parties agree to meet and discuss in good faith new ways of compensating ARRIS to the extent currently contemplated under Section 5.4.1. 5.4.4 Bulk Compound. In a country other than a Major Market Country (which shall be for purposes of this Section the United States, the United Kingdom, France, Canada, Germany, Japan, Italy and Spain) in those cases where MERCK sells bulk Program Compound to a third party other than a sublicensee rather than Licensed Product in packaged form, and is unable to determine Net Sales, the royalty obligations of this Article V shall be [ * ]. 5.4.5 Compulsory Licenses. If a compulsory license is granted with respect to Licensed Product in any country in the Territory with a royalty rate lower than the royalty rate provided by Section 5.4.1., then the royalty rate to be paid by MERCK on Net Sales in that country under Section 5.4.1 shall be [ * ]. 5.4.6 Third Party Licenses. If one or more patent licenses from a third party or parties are required by MERCK, its Affiliates and/or sublicensees to develop, make, have made, use, sell or import Compound or Licensed Product in a particular country ("Third Party Patent License(s)"), any royalties actually paid by MERCK under such Third Party Patent License(s) with respect to sale of such Licensed Product in such country based on rates [ * ] the rates to be paid ARRIS under Section 5.4.1(a) with respect to such sales, shall be credited against the royalty payments to be paid ARRIS by MERCK with respect to the sale of such Licensed Products in such country; PROVIDED, HOWEVER, that the royalties payable to ARRIS in any given year shall not be reduced by more than [ * ] in such year. 5.5 Reports; Payment of Royalty. Following the First Commercial Sale of a Licensed Product and during the term of the Agreement, MERCK shall furnish 18 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ to ARRIS a quarterly written report for the Calendar Quarter showing the sales of all Licensed Products subject to royalty payments sold by MERCK, its Affiliates and its sublicensees in the Territory during the reporting period and the royalties payable under this Agreement. Reports shall be due on the [ * ] following the close of each Calendar Quarter. Royalties that have accrued in a particular Calendar Quarter shall be due and payable on the date such royalty report is due. MERCK shall keep complete and accurate records in sufficient detail to enable the royalties payable hereunder to be determined. 5.6 Audits. (a) Upon the written request of ARRIS and not more than once in each Calendar Year, MERCK shall permit an independent certified public accounting firm of nationally recognized standing selected by ARRIS and reasonably acceptable to MERCK, at ARRIS's expense, to have access during normal business hours to such of the records of MERCK as may be reasonably necessary to verify the accuracy of the royalty reports hereunder for any Calendar Year ending not more than [ * ] prior to the date of such request. The accounting firm shall disclose to ARRIS only whether the royalty reports are correct or incorrect and the specific details concerning any discrepancies. No other information shall be provided to ARRIS. (b) If such accounting firm correctly concludes that additional royalties were owed during such period, MERCK shall pay [ * ] of the date ARRIS delivers to MERCK such accounting firm's written report so correctly concluding. (c) MERCK shall include in each sublicense granted by it pursuant to this Agreement a provision requiring the sublicensee to make reports to MERCK, to keep and maintain records of sales made pursuant to such sublicense and to grant access to such records by ARRIS's independent accountant to the same extent required of MERCK under this Agreement. Upon the expiration of [ * ] following the end of any Calendar Year, the calculation of royalties payable with respect to such Calendar Year shall be binding and conclusive upon ARRIS, and MERCK and its sublicensees shall be released from any liability or accountability with respect to royalties for such Calendar Year. (d) ARRIS shall treat all information subject to review under this Section 5.6 or under any sublicense agreement in accordance with the confidentiality provisions of Article IV of this Agreement, and shall cause its accounting firm to enter into an acceptable confidentiality agreement with MERCK obligating such firm to retain all such financial information in confidence pursuant to such confidentiality agreement. 19 _______________________________________________________________________________ * Certain confidential information contained in this document, marked by brackets, has been ommitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exhange Act of 1934, as amended. _______________________________________________________________________________ 5.7 Payment Exchange Rate. All payments to be made by MERCK to ARRIS under this Agreement shall be made in United States dollars and may be paid by check made to the order of ARRIS or bank wire transfer in immediately available funds to such bank account in the United States designated in writing by ARRIS from time to time. In the case of sales outside the United States, the rate of exchange to be used in computing the amount of currency equivalent in United States dollars due ARRIS shall be the rate of exchange used by MERCK in its worldwide accounting system, prevailing on the fourth to the last MERCK business day of the Calendar Quarter during which such sales were made, which shall be generally reflective of then prevailing actual currency exchange rates. 5.8 Income Tax Withholding. If laws, rules or regulations require withholding of income taxes or other taxes imposed upon payments set forth in this Article V, MERCK shall make such withholding payments as required and subtract such withholding payments from the payments set forth in this Article V. MERCK shall submit appropriate proof of payment of the withholding taxes to ARRIS within a reasonable period of time. ARTICLE VI REPRESENTATIONS AND WARRANTIES 6.1 Arris Representations and Warranties. ARRIS represents and warrants to MERCK that as of the date of this Agreement: (a) to the best of ARRIS's knowledge, the ARRIS Patents and ARRIS Know-How existing as of the Effective Date are subsisting and are not invalid or unenforceable, in whole or in part; (b) it has the full right, power and authority to enter into this Agreement, to perform the Research Program and to grant the licenses granted under Article III hereof; (c) to the best of ARRIS's knowledge, the ARRIS Patents, ARRIS Know-How and ARRIS Delta Technology practiced as permitted herein do not infringe on any intellectual property rights owned by any third party, and do not result from a misappropriation by ARRIS of any property owned by any third party; (d) there are no claims, judgments or settlements against or owed by ARRIS or pending or threatened claims or litigation relating to the ARRIS Patents, ARRIS Know-How and ARRIS Delta Technology; (e) it has disclosed to MERCK all relevant information regarding the ARRIS Patents and ARRIS Know-How reasonably relating to activities under this Agreement; 20 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. (f) that during the course of the Research Program, ARRIS will not knowingly infringe any valid patents; and (g) [ * ] of the Effective Date of this Agreement and [ * ] hereunder was [ * ]. 6.2 Merck Representations and Warranties. MERCK represents and warrants to ARRIS that as of the date of this Agreement it has the full right, power and authority to enter into this Agreement, to perform the Research Program and to grant the licenses granted under Section 3.1(b) hereof. ARTICLE VII PATENT MATTERS 7.1 Filing, Prosecution and Maintenance of Patents. (a) Each party agrees at its expense to file, prosecute and maintain in the Territory, upon appropriate consultation with the other party, United States patent applications relating to the Research Program Information and Inventions owned in whole or in part by such party, and, with respect to ARRIS, the inventions in the ARRIS Patents licensed to MERCK under this Agreement; PROVIDED, HOWEVER, with respect to Collaboration Research Information, [ * ] obligation to file, prosecute, and maintain at its expense the United States patent applications for such inventions and [ * ] fully and shall cause its employees to cooperate fully on the filing and prosecution of such patents. In each case, the filing party shall give the non-filing party an opportunity to review the text of the application before filing, shall consult with the non-filing party with respect thereto, and shall supply the non-filing party with a copy of the application as filed, together with notice of its filing date and serial number. Each party shall keep the other advised of the status of the actual and prospective patent filings and upon the request of the other party, provide advance copies of any papers related to the filing, prosecution and maintenance of such patent filings. Each party promptly shall give notice to the other of the grant, lapse, revocation, surrender, invalidation or abandonment of any Patents for which the party is responsible hereunder for the filing, prosecution and maintenance. (b) Each party agrees to file, within one year of the filing date of any patent application it files pursuant to Subsection 7.1(a), a counterpart International Application under the PCT designating all member countries and any additional counterpart national patent applications in non-PCT member states so requested by the other party and to maintain and/or prosecute such applications. [ * ] for the [ * ] pursuant to this Subsection 7.1(b). The costs and expenses relating to filing, prosecuting and/or maintaining all national patent applications in non-PCT member countries and all national patent applications arising from the National 21 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. Stage of any PCT patent applications filed pursuant to this Subsection 7.1(b) [ * ]. For Collaboration Patents, MERCK shall file any United States non-provisional and PCT patent applications and bear all costs and expenses related to such filings. (c) Each party agrees to be responsible for maintaining through the end of its term each patent issuing from any patent application it files pursuant to Subsections 7.1(a) and (b). [ * ] for the [ * ] of each United States patent issuing from any patent application it files pursuant to Subsection 7.1(a). The costs and expenses relating to the maintenance of each patent issuing from any patent application filed pursuant to Subsection 7.1(b) shall be [ * ]. (d) Notwithstanding the foregoing, ARRIS shall have the first right to file and prosecute all patent applications claiming Active Compounds identified, designed or developed using or based upon the ARRIS Delta Technology. Such applications shall be reviewed by MERCK prior to filing. All such patent prosecution efforts shall be paid for as provided in Subsections 7.1(a) through (c) above. 7.2 Right to Prosecute and Maintain Patents. (a) Each party shall give timely notice to the other of its decision to forego filing of any patent application required under Section 7.1 or to cease prosecution and/or maintenance of such applications or patents and, in such case, shall permit the other party, [ * ], to continue prosecution or maintenance [ * ]. If the other party elects to continue prosecution or maintenance, or to file based on such party's election not to file pursuant to Section 7.1 above, such notifying party shall execute such documents and perform such acts [ * ] as may be reasonably necessary to permit the other party to continue such prosecution or maintenance. Any patents or patent applications so prosecuted or maintained shall be assigned to such other party. (b) Notwithstanding any provisions of this Agreement, either party, upon appropriate consultation with and assent by the other party, may forego or postpone the filing of any patent applications required under Section 7.1 of this Agreement or may terminate the prosecution and/or maintenance or have the other party take responsibility for filing, prosecuting and/or maintaining any patent applications or other Patents 22 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. required, filed or perfected under or pursuant to Section 7.1 without any loss of rights granted or provided for under this Agreement. 7.3 Interference, Opposition, Reexamination and Reissue. (a) Each party, within ten days of learning of such event, shall inform the other party of any request for, or filing or declaration of, any interference, opposition, or reexamination relating to the ARRIS Patents or Collaboration Patents. MERCK and ARRIS thereafter shall consult and cooperate fully to determine a course of action with respect to any such proceeding. MERCK shall have the right to review and approve any submission to be made in connection with such proceeding. (b) ARRIS shall not institute any opposition, reexamination, or reissue proceeding relating to the ARRIS Patents or Collaboration Patents without the prior written consent of MERCK, which consent shall not unreasonably be withheld. (c) In connection with any interference, opposition, reissue, or reexamination proceeding relating to the ARRIS Patents or Collaboration Patents, MERCK and ARRIS will cooperate fully and will provide each other with any information or assistance that either reasonably may request. ARRIS shall keep MERCK informed of developments in any such action or proceeding, including, to the extent permissible, the status of any settlement negotiations and the terms of any offer related thereto. (d) Each party [ * ] proceeding relating to any patent application it files pursuant to Subsection 7.1(a) or patent issuing therefrom. The parties shall [ * ] any interference, opposition, reexamination or reissue proceeding relating to any patent application filed under Subsection 7.1(b) or patent issuing therefrom. 7.4 Enforcement and Defense. (a) Each party shall give the other notice of either (x) any infringement of ARRIS Patents or Collaboration Patents in the Field, or (y) any misappropriation or misuse of ARRIS Know-How, that may come to ARRIS's attention. MERCK and ARRIS thereafter shall consult and cooperate fully to determine a course of action including, without limitation, the commencement of legal action by either or both of MERCK and ARRIS, to terminate any infringement of such patent rights in the Field or any misappropriation or misuse of ARRIS Know-How in the Field. However, ARRIS, upon notice to MERCK, shall have the first right to initiate and prosecute such legal action [ * ] in the name of ARRIS (and, if appropriate, MERCK), or to control the defense of 23 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. any declaratory judgment action relating to ARRIS Patents, Collaboration Patents or ARRIS Know-How. ARRIS promptly shall inform MERCK if it elects not to exercise such first right, and if such infringement or misuse materially adversely affects MERCK's efforts under this Agreement, MERCK thereafter shall have the right either to initiate and prosecute such action or to control the defense of such declaratory judgment action in the name of MERCK and, if necessary, ARRIS. (b) If ARRIS elects not to initiate and prosecute an action as provided in Subsection 7.4(a), and, due to material adverse effect on MERCK, MERCK has the right and chose to prosecute an action, the cost of any agreed-upon course of action to terminate infringement of ARRIS Patents or Collaboration Patents, misappropriation or misuse of ARRIS Know-How, including the costs of any legal action commenced or the defense of any declaratory judgment, [ * ]. Any proceeds from such action [ * ] will be [ * ]. (c) For any action to terminate any infringement of ARRIS Patents or Collaboration Patents or any misappropriation or misuse of ARRIS Know-How, in the event that either MERCK or ARRIS is unable to initiate or prosecute such action solely in its own name as provided herein, the other party will join such action voluntarily and will execute and cause its Affiliates under its control to execute all documents necessary for the party seeking to initiate litigation to prosecute and maintain such action. In connection with any such action, MERCK and ARRIS will cooperate fully and will provide each other with any information or assistance that either reasonably may request. Each party shall keep the other informed of developments in any such action or proceeding, including, to the extent permissible by law, the status of any settlement negotiations and the terms of any offer related thereto. (d) Any recovery obtained by either or both MERCK and ARRIS, in connection with or as a result of any action contemplated by this Section 7.4 to terminate an infringement or misuse where such infringement or misuse materially adversely affects MERCK's efforts under the Agreement, whether by settlement or otherwise, shall be shared in order as follows: (i) [ * ] for such action, then [ * ]; (ii) if [ * ], then any proceeds shall be [ * ]. 24 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. (e) ARRIS shall inform MERCK of any certification regarding any ARRIS Patents it has received pursuant to either 21 U.S.C. Sections 355(b)(2)(A)(iv) or (j)(2)(A)(vii)(IV) or under [ * ] and shall provide MERCK with a copy of such certification within five days of receipt. ARRIS's and MERCK's rights with respect to the initiation and prosecution of any legal action as a result of such certification or any recovery obtained as a result of such legal action shall be as defined in Subsections 7.4(a) through (d) hereof; PROVIDED, HOWEVER, that ARRIS shall exercise its first right to initiate and prosecute any action and shall inform MERCK of such decision within ten days of receipt of the certification, after which time MERCK shall have the right to initiate and prosecute such action. (f) For any action for which the parties are [ * ] which is [ * ] shall control the action. If the parties are [ * ] shall control the action. 7.5 Patent Term Restoration. The parties shall cooperate in obtaining patent term restoration or supplemental protection certificates or their equivalents in any country in the Territory where applicable to ARRIS Patents. If elections with respect to obtaining such patent term restoration are to be made, [ * ] shall have the right to make the election and [ * ] shall abide by such election. ARTICLE VIII TERM AND TERMINATION 8.1 Term and Expiration. This Agreement shall be effective as of the Effective Date and, unless terminated earlier under Sections 8.2 or 8.3 below, shall continue in effect until expiration of all royalty obligations hereunder. Upon expiration of this Agreement due to expiration of all royalty obligations hereunder, MERCK's licenses pursuant to Section 3.1 shall become fully paid-up, perpetual licenses. 8.2 Termination by MERCK. Notwithstanding anything to the -------------------- contrary herein, MERCK shall have the right to terminate this Agreement (a) at any time after the end of the Research Program Term for any reason by giving [ * ] advance written notice to ARRIS; or (b) during the Research Program Term, upon [ * ] written notice, solely in the event that MERCK in its reasonable judgment exercised in good faith determines that (i) the parties have demonstrated, [ * ] 25 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. , or (ii) [ * ]. [ * ] under Subsection 8.2 (b)(i) above is one that would demonstrate that [ * ]. In the event of termination under this Section 8.2, (i) the rights and obligations hereunder, including any payment obligations not due or accrued as of the termination date, shall terminate, and (ii) MERCK shall have [ * ] for all internal research purposes excluding inhibition of cathepsin K or L, and (iii) To the extent not previously disclosed under Section 2.7, upon termination of this Agreement pursuant to this Section 8.2, MERCK shall disclose to ARRIS the development, making, conception and reduction to practice of all Research Program Information and Inventions as of the effective date of such termination. ARRIS shall have the option to obtain an exclusive license under MERCK's interest in the Research Program Information and Inventions and the Collaboration Patents solely for use in discovering, developing, making, using, importing and selling inhibitors of cathepsin K and L, and an exclusive license under the MERCK Patents solely for use in discovering, developing, making, using, importing and selling inhibitors of cathepsin K and L pursuant to a license agreement to be negotiated in good faith by the parties promptly after the exercise of such option. ARRIS shall have the right to exercise such option within a [ * ] of the effective date of termination of this Agreement under this Section 8.2, after which period such option shall expire if unexercised. Such license agreement shall contain at least the following terms: (a) that ARRIS [ * ] to be [ * ] (b) that ARRIS shall not [ * ]; (c) that ARRIS shall not [ * ] 26 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. [ * ]; (d) that ARRIS shall not [ * ]; (e) that ARRIS shall [ * ] with respect to [ * ] having [ * ]; (f) that ARRIS shall [ * ] of the license agreement; (g) that ARRIS shall [ * ] of the [ * ] with respect to [ * ] under the license; (h) that ARRIS shall [ * ] as follows: (i) with respect to [ * ] and are [ * ] of this Agreement on the terms set forth in [ * ], and (ii) [ * ] with respect to [ * ] which are commercialized by ARRIS under the license; and (i) [ * ] to any [ * ] as of the Effective Date. Such license agreement also shall contain such other commercially reasonable terms as typically are in license agreements. Upon exercise by ARRIS of such option, MERCK and ARRIS promptly thereafter shall negotiate in good faith and enter into such license agreement. 8.3 Termination. 8.3.1 Termination for Cause. This Agreement may be terminated by notice by either party at any time during the term of this Agreement: (a) if the other party is in breach of its material obligations hereunder by causes and reasons within its control and has not cured such breach within [ * ] after receipt of a letter requesting such cure; or (b) in the event ARRIS materially breaches its obligations during the Research Program Term, and fails to cure such breach within [ * ] after notice of such breach, then MERCK may, in lieu of termination under Subsection 8.3.1(a) above, terminate the Research Program, the research license granted to ARRIS under Subsection 3.1(b) and all of MERCK's obligations to fund any further research hereunder, PROVIDED, HOWEVER that all other rights and obligations of MERCK and ARRIS hereunder shall be preserved, including without limitation, the licenses 27 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. retained by MERCK under Subsection 3.1(a) and Section 3.2 of this Agreement. (c) In the event ARRIS materially breaches its obligations at any time during the term of this Agreement and MERCK either notifies ARRIS of the termination of this Agreement under Section 8.3.1(a) or initiates arbitration against ARRIS for breach of this Agreement, or both, any [ * ] may be [ * ] of this Agreement [ * ]. 8.3.2 Effect of Termination for Bankruptcy. If this Agreement is terminated by ARRIS or its appointed trustee based on bankruptcy, all rights and licenses granted under or pursuant to this Agreement by ARRIS to MERCK are, and shall otherwise be deemed to be, for purposes of Section 365(n) of the Bankruptcy Code, licenses of rights to "intellectual property" as defined under Section 101(52) of the Bankruptcy Code. The parties agree that MERCK, as a licensee of such rights under this Agreement, shall retain and may fully exercise all of its rights and elections under the Bankruptcy Code. The parties further agree that, in the event of the commencement of a bankruptcy proceeding by or against ARRIS under the Bankruptcy Code, MERCK shall be entitled to a complete duplicate of (or complete access to, as appropriate) any such intellectual property and all embodiments of such intellectual property upon written request therefore by MERCK. Such intellectual property and all embodiments thereof promptly shall be delivered to MERCK (i) upon any such commencement of a bankruptcy proceeding upon written request therefore by MERCK, unless ARRIS elects to continue to perform all of its obligations under this Agreement or (ii) if not delivered under (i) above, upon the rejection of this Agreement by or on behalf of ARRIS upon written request therefore by MERCK. 8.4 Effect of Expiration or Termination. Expiration or termination of this Agreement shall not relieve the parties of any obligation accruing prior to such expiration or termination, and the provisions of Sections 2.6, 2.7, 2.9, 2.10, Sections 3.1 and 3.2 to the extent provided in Article VIII, 5.6, and Articles I, IV, VII, VIII and IX shall survive the termination or expiration of the Agreement, with Article IV continuing in effect for [ * ] thereafter. Any expiration or early termination of this Agreement shall be without prejudice to the rights of either party against the other accrued or accruing under this Agreement prior to termination, including, without limitation, the obligation to pay royalties for Licensed Products or Program Compound sold prior to such termination. 28 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. ARTICLE IX MISCELLANEOUS 9.1 Force Majeure. Neither party shall be held liable or responsible to the other party nor be deemed to have defaulted under or breached this Agreement for failure or delay in fulfilling or performing any term of this Agreement when such failure or delay is caused by or results from causes beyond the reasonable control of the affected party including, but not limited to, fire, floods, mudslides, earthquakes, embargoes, war, acts of war (whether war be declared or not), insurrections, riots, civil commotions, strikes, lockouts or other labor disturbances, acts of God or acts, omissions or delays in acting by any governmental authority or the other party. The affected party shall notify the other party of such force majeure circumstances as soon as reasonably practical. 9.2 Excused Performance. The obligation of MERCK with respect to any Licensed Product under Section 3.3 is expressly conditioned upon [ * ] relating to the [ * ]. The obligation of MERCK to develop or market any such Licensed Product shall be delayed or suspended so long as [ * ]. All judgments as to [ * ] shall be made by [ * ]. 9.3 Binding Effect; Assignment. This Agreement shall inure to the benefit of and be binding upon each party and its successors and permitted assigns. Except as otherwise provided in Subsections 9.3(a) and (b), neither party shall, directly or indirectly, assign this Agreement or any of its rights or obligations hereunder without the prior written consent of the other party. Without limiting the generality of the foregoing, a merger, acquisition or change of control of a party hereto shall be deemed to be an assignment. As used in this Section 9.3, change of control shall mean a transaction pursuant to which a person or group acting in concert, other than the currently controlling person or group, immediately after such transaction shall effectively control election of directors, but shall not include changes in the identity of owners of a party's publicly held stock not involving any stock owner achieving ownership of more than [ * ] of a party's publicly held stock entitled to vote for the election of directors. (a) Notwithstanding the foregoing, MERCK may, without consent, assign this Agreement and its rights and obligations hereunder to an Affiliate or in connection with the transfer or sale of all or substantially all of its assets related to the Licensed Product or the business, or in the event of its merger or consolidation or change of control or similar transaction. Any such assignee shall assume all obligations of its assignor under the Agreement. (b) Notwithstanding the foregoing, ARRIS may assign this Agreement without consent in connection with a merger of, acquisition of, or sale of 29 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. all or substantially all of the assets of ARRIS, PROVIDED, HOWEVER, that such assignment shall be [ * ] of the obligations of ARRIS hereunder, and further that if such merger, acquisition or sale of assets [ * ], where ARRIS is not the surviving entity, then such assignment shall be subject to Section 9.4 below. In the event of any such assignment by ARRIS hereunder, the licenses granted MERCK hereunder shall not cover any intellectual property of such assignee not previously Controlled by ARRIS existing prior to the date of such assignment. 9.4 Consequences of Certain Assignments by ARRIS. In the event that ARRIS, during the Research Program Term, assigns this Agreement as permitted in Section 9.3(b) [ * ], ARRIS, immediately upon its ability [ * ] such merger, acquisition or sale, shall [ * ] merger, acquisition or sale and MERCK may, at its choice, on written notice to such assignee given at any time within 30 days of such assignment, [ * ] shall be [ * ] the assignment of this Agreement: (a) [ * ] and any further obligation [ * ] research efforts under the Research Program. After such [ * ], PROVIDED HOWEVER, that the [ * ] as specified under Section [ * ] shall be [ * ] shall be equal to the number of days in the Research Program Term from the Effective Date to the [ * ]; (b) [ * ], and immediately thereafter such assignee shall [ * ] hereunder; (c) possession, during the Research Program Term, of the [ * ] and under [ * ] and the [ * ] under this Agreement. The [ * ] during the Research Program Term to MERCK Affiliates and to third party sublicensees; and 30 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. (d) possession of a [ * ] at the end of the Research Program Term. (e) For purposes of Subsections 9.4 (a), (c) and (d) above and Article I, the "Research Program Term" shall have the period of time such term had under the provisions of Section 2.8 just prior to the assignment of the Agreement by ARRIS. Upon any such assignment, and whether or not [ * ] in Subsections 9.4(a) through (d) above, MERCK shall retain all of its rights under this Agreement, including without limitation the licenses granted to MERCK in Sections 3.1(a) and 3.2 of this Agreement. 9.5 Severability. If one or more of the provisions contained in this Agreement are held invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions shall not be affected or impaired thereby, unless the absence of the invalidated provision(s) adversely affects the substantive rights of the parties. The parties shall in such case use their best efforts to replace the invalid, illegal or unenforceable provision(s) with valid, legal and enforceable provision(s) which, insofar as practical, implement the purposes of this Agreement. 9.6 Use of Names. Neither party may use the names of the other party or those of its Affiliates, sublicensees, employees, agents or consultants or any of their trademarks, names, logotypes or symbols without the prior written consent of the other party. 9.7 Notices. All notices or other communications which are required or permitted hereunder shall be in writing and sufficient if delivered personally, sent by telecopier (and promptly confirmed by personal delivery, registered or certified mail or overnight courier), sent by nationally-recognized overnight courier or sent by registered or certified mail, postage prepaid, return receipt requested, addressed as follows: if to ARRIS, to: Arris Pharmaceutical Corporation 385 Oyster Point Boulevard, Suite 3 South San Francisco, California 94080 Attention: President, Chief Executive Officer Telecopier No.: 415/829-1067 31 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. with a copy to: Cooley Godward LLP 3000 El Camino Real Palo Alto, California 94306 Attention: Robert L. Jones, Esq. Telecopier No.: 415/857-0603 if to MERCK, to: Merck & Co., Inc. One Merck Drive P.O. Box 100 Whitehouse Station, NJ 08889-0100 Attention: Office of Secretary Telecopier No.: 908/735-1246 with a copy to: Attention: Office of Assistant General Counsel Telecopier No.: 908/735-1226 or to such other address as the party to whom notice is to be given may have furnished to the other party in writing in accordance herewith. Any such communication shall be deemed to have been given when delivered if personally delivered or sent by telecopier on a business day, on the business day after dispatch if sent by nationally-recognized overnight courier and on the third business day following the date of mailing if sent by mail. 9.8 Applicable Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey and the United States without reference to any rules of conflict of laws or renvoi. 9.9 Arbitration. Any disputes arising between the parties relating to, arising out of or in any way connected with this Agreement or any term or condition hereof, or the performance by either party of its obligations hereunder, whether before or after termination of the Agreement, shall be finally resolved by binding arbitration. Whenever a party shall decide to institute arbitration proceedings, it shall give written notice to that effect to the other party. The party giving such notice shall refrain from instituting the arbitration proceedings for a period of [ * ] following such notice. During such period, the parties shall make good faith efforts to amicably resolve the dispute without arbitration. Any arbitration hereunder shall be conducted under the rules of the American Arbitration Association. Each such arbitration shall be conducted by a panel of three arbitrators: one arbitrator shall be appointed by each of MERCK and the ARRIS and the third shall be appointed by the American Arbitration Association. Any such arbitration shall be held in New York, New York. The arbitrators shall have the authority to grant specific performance. Judgment upon the award so rendered may be entered in any court having jurisdiction or application may be made to such court for judicial acceptance of any award and an order of enforcement, as the case may be. In no event shall a demand for arbitration be made after the date when institution 32 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. of a legal or equitable proceeding based on such claim, dispute or other matter in question would be barred by the applicable statute of limitations. 9.10 Entire Agreement. This Agreement contains the entire understanding of the parties with respect to the subject matter hereof. All express or implied agreements and understandings, either oral or written, heretofore made are expressly merged in and made a part of this Agreement. This Agreement may be amended, or any term hereof modified, only by a written instrument duly executed by both parties hereto. 9.11 Headings. The captions to the Articles, Sections and Subsections of this Agreement are not a part of the Agreement, but are merely guides or labels to assist in locating and reading the Articles, Sections and Subsections. 9.12 Independent Contractors. ARRIS and MERCK shall be independent contractors and the relationship between them shall not constitute a partnership, joint venture or agency. Neither party shall have the authority to make any statements, representations or commitments of any kind, or to take any action, which shall be binding on the other, without the prior written consent of the other party. 9.13 Waiver. The waiver by a party of any right under this Agreement or of the other party's failure to perform or breach shall not be a waiver of any other right, failure or breach whether of a similar nature or otherwise. 9.14 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement as of its Effective Date. MERCK & CO., INC. ARRIS PHARMACEUTICAL CORPORATION BY: ________/s/______________ BY: ____/s/_____________________ Raymond V. Gilmartin John P. Walker TITLE: Chairman, President TITLE: President & and Chief Executive Chief Executive Officer Officer DATE: November 6, 1996 DATE: November 6, 1996 33 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. ATTACHMENT 2.1 RESEARCH PROGRAM 1. [ * ] [ * ] 2. [ * ] [ * ] 34 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. 3. [ * ] 4. [ * ] 5. [ * ] 35 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. 6. [ * ] 7. [ * ] a. [ * ] b. [ * ] c. [ * ] 36 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. APPENDIX A-1 [ * ] 37 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. APPENDIX A-2 [ * ] 38 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. APPENDIX B [ * ] [ * ] 39 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. APPENDIX C [ * ] 40 CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24b-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. EX-10.44 5 EXHIBIT 10.44 Exhibit 10.44 [Arris Pharmaceutical Corporation Letterhead] November 3, 1995 N. Jean Warner, M.D. 1823 Van Buren Circle Mountain View, CA 94040 Re: Transition Services Dear Jean: Arris Pharmaceutical Corporation (the "Company") is pleased to offer you the position of Vice-President of Medical Affairs of the Company on the terms set forth in this letter agreement (the "Agreement"). As Vice-President of Medical Affairs of the Company, you will perform such duties relating to the integration of the Khepri Pharmaceuticals, Inc. ("Subsidiary") and the Company following consummation of the merger (the "Merger") contemplated by the Agreement and Plan of Reorganization among them and a subsidiary of the Company dated as of November 3, 1995 (the "Reorganization Agreement") as may be assigned by the Company as well as the duties customarily associated with this position, and such duties as may be assigned to you by the Company. You will report to John Walker. Your initial base salary will be two hundred thousand dollars ($200,000) per year, payable in accordance with the Company's regular payroll practices, less payroll deductions and withholdings. In addition, you will receive an increase in your base salary effective January 1, 1996 in the amount equal to the percentage increase determined by the Compensation Committee of the Board of Directors to be awarded to outstanding "1" employees effective on the same date. Management will also recommend to the Company's Board of Directors that, upon the consummation of the Merger, you be granted a stock option to purchase 10,000 shares of the Company's Common Stock with an exercise price and vesting provisions in accordance with Company policies. In addition to your salary, stock option grant and the lump sum bonus contemplated below, the Company will also provide you with sick and vacation leave, and medical, dental and life insurance coverage and participation in the Company's 401(k) plan, employee stock purchase plans, new stock options and management bonus program consistent with Company policy for other Company Vice-Presidents. Details about these benefits are provided in the employee handbook and summary plan descriptions available for your review. Of course, the Company reserves the right to modify your job duties, compensation and benefits from time to time, as it deems necessary, subject to your rights described below. N. Jean Warner, M.D. Page 2 You will be expected to abide by all of the Company's policies and procedures, and acknowledge in writing that you have received and read the Company's employee handbook. As a condition of your employment, you also agree to sign and comply with the Company's Proprietary Information and Inventions Agreement (attached hereto as Exhibit A). By accepting this offer, you represent and warrant that your employment with the Company will not violate any agreements, obligations or understandings that you may have with any third party or prior employer. You agree not to make any unauthorized disclosure to the Company or use on behalf of the Company any confidential information belonging to any of your former employers (except in accordance with agreements between the Company and any such former employer). Of course, during your employment with the Company, you may make use of information generally known and used by persons with training and experience comparable to your own, and information which is common knowledge in the industry or is otherwise legally available in the public domain. If you still are employed on a date one year from the date on which the Merger becomes effective (the "First Anniversary"), you will receive a one-time lump sum Bonus payment of fifty percent (50%) of your then base annual salary (the "Lump Sum Bonus"). Either you or the Company may terminate your employment relationship at any time for any reason whatsoever, with or without cause or advance notice. This at-will employment relationship cannot be changed except in a writing signed by a duly authorized officer of the Company. If the Company terminates your employment without cause during the term of this Agreement (i) you will receive, as severance, twelve (12) months salary and (ii) all stock options held by you on the date of severance shall continue to vest during such severance period and for twelve months thereafter in accordance with their vesting schedule. In the event of such termination, you will not be entitled to any additional compensation or benefits beyond what is provided in this paragraph. If you resign unless you have resigned for "Good Reason" or if your employment is terminated for cause, all compensation and benefits will cease immediately, and you will receive no severance benefits. For purposes of this Agreement, "cause" shall mean misconduct, including: (i) conviction of any felony or any crime involving moral turpitude or dishonesty; (ii) participation in a fraud or act of dishonesty against the Company; (iii) willful breach of the Company's policies; (iv) intentional damage to the Company's property; (v) material breach of this Agreement or your Proprietary Information and Inventions Agreement; or (vi) conduct by you which in the good faith and reasonable determination of the Company's Board of Directors demonstrates gross unfitness to serve. Physical or mental disability shall not constitute "cause." "Good Reason" shall mean (i) a material diminution in your compensation, (ii) a material diminution in your duties or (iii) a reassignment to any location outside of the San Francisco Bay Area. You agree that, for one year following the termination of your employment with the Company, you will not, either directly or through others, solicit or attempt to solicit any employee, consultant N. Jean Warner, M.D. Page 3 or independent contractor of the Company to terminate his or her relationship with the Company in order to become an employee, consultant or independent contractor to or for any other person or business entity. You understand that your existing agreements relating to Subsidiary stock options or restricted stock will be assumed by, or assigned to, the Company pursuant to the terms of the Reorganization Agreement and that your existing vesting schedule will continue in full force and effect. In addition, you hereby agree to not sell, otherwise dispose of or reduce your risk relating to any Company Common Stock you own for a period of up to 90 days following the effectiveness of any underwritten registered offering of securities by the Company (an "Offering") pursuant to any underwriter's "lock up agreement" required by the underwriters of the Offering so long as all executive officers of the Company agree to such lock up agreement. To ensure rapid and economical resolution of any disputes which may arise under this Agreement, you and the Company agree that any and all disputes or controversies, whether of law or fact of any nature whatsoever (including, but not limited to, all state and federal statutory and discrimination claims), with the sole exception of those disputes which may arise from your Proprietary Information and Inventions Agreement, arising from or regarding the interpretation, performance, enforcement or breach of this Agreement shall be resolved by final and binding arbitration (rather than trial by jury or court or resolution in some other forum) under the then existing Rules of Practice and Procedure of Judicial Arbitration and Mediation Services Inc. This Agreement, including Exhibit A, represents the complete, final and exclusive embodiment of the entire agreement between you and the Company with respect to the terms and conditions of your employment. This Agreement is entered into without reliance upon any promise, warranty or representation, written or oral, other than those expressly contained herein, and it supersedes any other such promises, warranties, representations or agreements. It may not be amended or modified except by a written instrument signed by you and a duly authorized officer of the Company. If any provision of this Agreement is determined to be invalid or unenforceable, in whole or in part, this determination will not affect any other provision of this Agreement. This Agreement shall be construed and interpreted in accordance with the laws of the State of California. As required by law, this offer of employment is subject to satisfactory proof of your right to work in the United States. This Agreement will become effective upon the closing of the Merger and shall be void and have no legal effect if the Merger is not consummated. This Agreement shall terminate on the First Anniversary. N. Jean Warner, M.D. Page 4 We look forward to your favorable reply, and to a productive and enjoyable work relationship. Very truly yours, ARRIS PHARMACEUTICAL CORPORATION By: /s/ John P. Walker ------------------------------------- John P. Walker President and Chief Executive Officer Accepted by: /s/ N. Jean Warner, M.D. ------------------------ N. Jean Warner, M.D. Date: 11/3/95 ---------- Exhibit A Proprietary Information and Inventions Agreement ARRIS PHARMACEUTICAL CORPORATION ---------------------------------------------------- EMPLOYMENT, CONFIDENTIAL INFORMATION AND INVENTION ASSIGNMENT AGREEMENT As a condition of my employment with ARRIS Pharmaceutical Corporation ("ARRIS"), and in consideration of my employment with ARRIS and my receipt of the compensation now and hereafter paid to me by ARRIS, I agree to the following: 1. AT-WILL EMPLOYMENT. I understand and acknowledge that my employment with ARRIS is for an unspecified duration and constitutes "at-will" employment. I acknowledge that this employment relationship may be terminated at any time, with or without cause, at the option of either ARRIS or myself, with or without notice. 2. CONFIDENTIAL INFORMATION. (a) ARRIS AND THIRD PARTY INFORMATION. I agree at all times during the term of my employment and thereafter, to hold in strictest confidence, and not to use, except for the benefit of ARRIS, or to disclose to any person, firm or corporation without written authorization of an officer of ARRIS, any Confidential Information of ARRIS. I understand that "Confidential Information" means any ARRIS proprietary information, technical data, trade secrets or know- how, including, but not limited to, research and product plans, products, services, customer lists and customers (including, but not limited to, customers of ARRIS on whom I called or with whom I became acquainted during the term of my employment), markets, developments, inventions, processes, formulas, technology, marketing, finances or other business information disclosed to me by ARRIS either directly or indirectly in writing, orally or otherwise. I recognize that ARRIS has received and in the future will receive from third parties their confidential or proprietary information subject to a duty on ARRIS's part to maintain the confidentiality of such information and to use it only for certain limited purposes, and I understand that such information is also Confidential Information. I further understand that Confidential Information does not include any of the foregoing items that has become publicly known and made generally available through no wrongful act of mine or of others who were under confidentiality obligations as to the item or items involved. (b) FORMER EMPLOYER INFORMATION. I agree that I will not, during my employment with ARRIS, improperly use of disclose any proprietary information or trade secrets of any former or concurrent employer or other person or entity and that I will not bring onto the premises of ARRIS any unpublished document or proprietary information belonging to any such employer, person or entity unless consented to in writing by such employer, person or entity. 3. INVENTIONS. (a) INVENTIONS RETAINED AND LICENSED. I have attached hereto, as Exhibit A, a list describing all inventions, original works of authorship, developments, improvements, and trade secrets that were made by me prior to my employment with ARRIS (collectively referred to as "Prior Inventions"), that belong to me, that relate to ARRIS's proposed business, products or research and development, and that are not assigned to ARRIS hereunder; or, if no such list is attached, I represent that there are no such Prior Inventions. If in the course of my employment with ARRIS, I incorporate into an ARRIS product, process or machine a Prior Invention owned by me or in which I have an interest, ARRIS is hereby granted and will have a non-exclusive, royalty-free, irrevocable, perpetual, worldwide license, with the right to grant sublicenses, to make, have made, modify, use and sell such Prior Invention as part of or in connection with such product, process or machine. (b) ASSIGNMENT OF INVENTIONS. I agree that I will promptly make full written disclosure to ARRIS, and will hold in trust for the sole right and benefit of ARRIS, and hereby assign to ARRIS, or its designee, all my right, title and interest in and to any and all inventions, original works of authorship, developments, concepts, improvements or trade secrets, whether or not patentable or registrable under patent, copyright or similar laws, that I may solely or jointly conceive or develop or reduce to practice, or cause to be conceived or developed or reduced to practice, during the period of time I am in the employ of ARRIS (collectively referred to as "Inventions"), except as provided in Section 3(e) below. I further acknowledge that all original works of authorship that are made by me (solely or jointly with others) within the scope of and during the period of my employment with ARRIS and that are protectable by copyright are works made for hire, as that term is defined in the United States Copyright Act. (c) MAINTENANCE OF RECORDS. I agree to keep and maintain adequate and current written records of all Inventions made by me (solely or jointly with others) during the term of my employment with ARRIS. The records will be in the form of notes, sketches, drawings, and any other format that may be specified by ARRIS. The records will be available to and remain the sole property of ARRIS at all times. (d) PATENT AND COPYRIGHT REGISTRATIONS. I agree to assist ARRIS, or its designee, at ARRIS's expense, in every way to secure ARRIS's rights in the Inventions and any copyrights, patents, mask work rights or other intellectual property rights relating thereto in any and all countries, including disclosing to ARRIS all pertinent information and data with respect thereto, and executing all applications, specifications, oaths, assignments and all other instruments that ARRIS shall deem necessary in order to apply for and obtain such rights and in order to assign and convey to ARRIS, its successors, assigns and nominees the sole and exclusive rights, title and interest in and to such Inventions, and any copyrights, patents, mask work rights or other intellectual property rights relating thereto. I further agree that my obligation to execute or cause to be executed, when it is in my power to do so, any such instrument or papers will continue after the termination of this Agreement. If ARRIS is unable because of my mental or physical incapacity or for any other reason to secure my signature to apply for or to pursue any application for any United States or foreign patents or copyright registrations covering Inventions or original works of authorship assigned to ARRIS as above, then I hereby irrevocably designate and appoint ARRIS and its duly authorized officers and agents as my agent and attorney in fact, to act for and in my behalf and stead to execute and file any such applications and to do all other lawfully permitted acts to further the prosecution and issuance of letters patent or copyright registrations thereon with the same legal force and effect as if executed by me. (e) EXCEPTION TO ASSIGNMENTS. I understand that the provisions of this Agreement requiring assignment of Inventions to ARRIS do not apply to any invention that qualifies fully under the provisions of California Labor Code Section 2870 (attached hereto as Exhibit B). I will advise ARRIS promptly in writing of any inventions that I believe meet the criteria in California Labor Code Section 2870 and that are not otherwise disclosed on Exhibit A. 4. CONFLICTING EMPLOYMENT. I agree that, during the term of my employment with ARRIS, I will not engage in any other employment, occupation, consulting or other business activity directly related to the business in which ARRIS is now involved or becomes involved during the term of my employment, nor will I engage in any other activities that conflict with my obligations to ARRIS. 5. RETURNING ARRIS DOCUMENTS. I agree that, at the time of leaving the employ of ARRIS, I will deliver to ARRIS (and will not keep in my possession, recreate or deliver to anyone else) any and all documents or property, or reproductions of any such documents or property, developed by me pursuant to my employment with ARRIS or otherwise belonging to ARRIS, its successors or assigns. 6. SOLICITATION OF EMPLOYEES. I agree that for a period of twelve (12) months immediately following the termination of my relationship with ARRIS for any reason, whether with or without cause, I will not either directly or indirectly solicit, induce, recruit or encourage any of ARRIS's employees to leave their employment, or take away such employees, or attempt to solicit, induce, recruit, encourage or take away employees of ARRIS, either for myself or for any other person or entity. 7. REPRESENTATIONS. I agree to execute any proper oath or verify any proper document requested by ARRIS to carry out the terms of this Agreement. I represent that my performance of all the terms of this Agreement will not breach any agreement to keep in confidence proprietary information acquired by me in confidence or in trust prior to my employment by ARRIS. I have not entered into, and I agree I will not enter into, any oral or written agreement in conflict with the terms of this Agreement. 8. ARBITRATION AND EQUITABLE RELIEF. (a) ARBITRATION. Except as provided in Section 8(b) below, I agree that any dispute or controversy arising out of or relating to any interpretation, construction, performance or breach of this Agreement, will be settled by arbitration to be held in San Mateo County, California, in accordance with the rules then in effect of the American Arbitration Association. The arbitrator may grant injunctions or other relief in such dispute or controversy. The decision of the arbitrator will be final, conclusive and binding on the parties to the arbitration. Judgment may be entered on the arbitrator's decision in any court having jurisdiction. ARRIS and I will each pay one-half of the costs and expenses of such arbitration, and each of us will separately pay our counsel fees and expenses. (b) EQUITABLE REMEDIES. I agree that it would be impossible or inadequate to measure and calculate ARRIS's damages from any breach of the covenants set forth in Sections 2, 3, and 5 herein. Accordingly, I agree that if I breach my obligations under any of such Sections, ARRIS will have, in addition to any other right or remedy available, the right to obtain an injunction from a court of competent jurisdiction restraining such breach or threatened breach and to specific performance of any such provision of this Agreement. I further agree that no bond or other security will be required in obtaining such equitable relief and I hereby consent to the issuance of such injunction and to the ordering of specific performance. I hereby further consent to the personal jurisdiction of the state and federal courts located in California for any lawsuit filed there against me by ARRIS arising from or relating to this Agreement. 9. GENERAL PROVISIONS (a) GOVERNING LAW. This Agreement will be governed by the laws of the State of California without reference to conflicts of laws principles. (b) ENTIRE AGREEMENT. This Agreement sets forth the entire agreement and understanding between ARRIS and me relating to the subject matter hereof and merges all prior discussions between us. No modification of or amendment to this Agreement, or any waiver of any rights under this Agreement, will be effective unless in writing signed by the party to be charged. Any subsequent change or changes in my duties, salary or compensation will not affect the validity or scope of this Agreement. (c) SEVERABILITY. If one or more of the provisions in this Agreement are deemed void by law, then the remaining provisions will continue in full force and effect. (d) SUCCESSORS AND ASSIGNS. This Agreement will be binding upon my heirs, executors, administrators and other legal representatives and will be for the benefit of ARRIS, its successors, and its assigns. Date: 3 November 1995 Signature: --------------------- --------------------- Nathalie J. Warner ------------------------------- Name of Employee (typed) ARRIS Pharmaceutical Corporation Name: --------------------------- Print Name: Daniel H. Petree --------------------- Title: VP., CFO -------------------------- EXHIBIT A LIST OF PRIOR INVENTIONS AND ORIGINAL WORKS OF AUTHORSHIP Identifying Number Name Date or Brief Description - ---------------------------------------------------------------------- No inventions or improvements - ------- X Additional Sheets Attached - ------- Signature of Employee: --------------------- Print Name of Employee: Nathalie J. Warner ----------------------- Date: 3 November 1995 Signature of Supervisor: --------------------- Print Name of Supervisor: ---------------------- Date: ------------------- EXHIBIT B CALIFORNIA LABOR CODE SECTION 2870 EMPLOYMENT AGREEMENTS; ASSIGNMENT OF RIGHTS "(a) Any provision in an employment agreement which provides that an employee shall assign, or offer to assign, any of his or her rights in an invention to his or her employer shall not apply to any invention that the employee developed entirely on his or her own time without using the employer's equipment, supplies, facilities, or trade secret information except for those inventions that either: (1) Relate at the time of conception or reduction to practice of the invention to the employer's business, or actual or demonstrably anticipated research or development of the employer. (2) Result from any work performed by the employee for the employer. (b) To the extent a provision in an employment agreement purports to require an employee to assign an invention otherwise excluded from being required to be assigned under subdivision (a), the provision is against the public policy of this state and is unenforceable." EX-23.1 6 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos., 33-74720 and 33-80852) pertaining to the 1989 Stock Plan, 1993 Employee Stock Purchase Plan, 1994 Employee Stock Bonus Plan and 1994 Non-Employee Directors' Stock Option Plan and the Registration Statement (Form S-8, No.333-09095) pertaining to the 1989 Stock Plan and Employee Stock Purchase Plan of Arris Pharmaceutical Corporation, of our report dated February 10, 1997 with respect to the consolidated financial statements of Arris Pharmaceutical Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 1996, filed with the Securities and Exchange Commission. ERNST & YOUNG LLP Palo Alto, California March 28, 1997 EX-27 7 EXHIBIT 27 (FDS)
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS, STATEMENTS OF OPERATIONS, STOCKHOLDERS' EQUITY AND CASH FLOWS INCLUDED IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND NOTES THERETO. 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 10,822 55,898 0 0 0 50,060 19,776 (9,330) 80,832 17,256 0 0 0 14,832 52,900 80,832 0 21,560 0 24,319 5,409 0 670 (5,928) 0 (5,928) 0 0 0 (5,928) (.45) (.45)
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