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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(MARK ONE)

x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM            TO            

Commission file number: 0-28006

ESSENTIAL THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 647-5554

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

COMMON STOCK, $0.001 PAR VALUE PER SHARE

PREFERRED SHARE PURCHASE RIGHTS

(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 is not contained herein, and will not be contained, to the best of the 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.    ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x

The aggregate market value of our common stock, $0.001 par value per share, held by non-affiliates as of June 28, 2002 the last business day of our most recently completed second fiscal quarter was approximately $32.0 million, based on shares held by such non-affiliates at the closing price of a share of common stock of $1.71 as reported on the Nasdaq National Market on such date. The number of outstanding shares of common stock of the Company on March 24, 2003 was 18,941,394.

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ESSENTIAL THERAPEUTICS, INC.

FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

INDEX

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PRELIMINARY STATEMENT

We have been notified by the Nasdaq National Market that our common stock may be delisted. If a delisting occurs, holders of our Series B convertible redeemable preferred stock have a right to cause the redemption of their shares of preferred stock which could result in our obligation to pay such holders up to an aggregate of $60.0 million.

We do not have the funds to redeem all outstanding shares of the Series B preferred stock. If we are required to cause such redemption, it may be necessary for us to initiate actions that could result in dissolution, insolvency or seeking protection under bankruptcy laws or other similar actions. Our common stock will have no value if we are required to cease operations or if we seek protection under the bankruptcy laws. Potential investors in our securities should consider the risk that, even if we do not ultimately seek bankruptcy protection, our common stock may nonetheless have no value.

Any person considering an investment in any of our securities is urged to consider both the risk that we will cease operations or seek bankruptcy protection, and the risk that our securities will be worthless. All of the statements set forth in this report are qualified by reference to those facts. Please see “Item 1. Business—Recent Developments”, “Item 1. Business—Risk Factors”, “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Additional Factors That May Affect Future Results” and Note 10 of the Notes to the Consolidated Financial Statements for a discussion of the consequences relating to delisting and the redemption of the Series B Preferred Stock and a discussion of these and other risk factors relating to us and an investment in our securities.

PART I

ITEM 1.     BUSINESS

RECENT DEVELOPMENTS

In December of 2002, we solicited stockholder approval for the transactions contemplated by the several conversion agreements entered into by and between the Company and certain holders of Series B preferred stock owning an aggregate amount of 55,000 shares, or approximately 91% of the outstanding shares of Series B preferred stock. We entered into each of the several conversion agreements as part of our plan, which was submitted to the Nasdaq National Market, to address our failure to comply with Nasdaq’s continued listing requirements. At the time the conversion agreements were executed, we were not in compliance with the Nasdaq continued listing requirement to maintain a minimum stockholders’ equity of $10.0 million. Pursuant to the conversion agreements, we agreed to convene a Special Meeting of Stockholders to approve the conversion of the Series B preferred stock into common stock, increase the authorized capital stock of the Company and approve an amendment to our Restated Certificate of Incorporation to effect any of certain specified reverse stock splits. The special meeting was held on January 23, 2003 and the Company did not receive the affirmative vote of stockholders holding a majority of the outstanding shares of common stock, and therefore the conversion of the Series B preferred stock into common stock and the increase in authorized capital stock were not approved.

In addition to our failure to meet the minimum stockholders’ equity requirement, Nasdaq informed us in February and March 2003 that the Company was not in compliance with other continued listing requirements. On February 7, 2003, we received formal notice that the Company’s request for continued listing would be considered at a hearing to be held before a panel authorized by the Nasdaq National Market on March 20, 2003. The Company presented its appeal at the hearing and as of the date of this annual report we have not been informed of Nasdaq’s determination.

As a result of not acquiring the requisite common stockholder approvals at the special meeting, and if the Company’s appeal to the Nasdaq panel is unsuccessful, the common stock will be delisted. As a result of delisting, the holders of Series B preferred stock have the right to cause the Company to redeem their shares of Series B preferred stock at a price of $1,000 per share in accordance with the terms of the Series B preferred stock. If all of the outstanding preferred stock, that is 60,000 shares, is redeemed, the Company will be obligated to pay the holders of Series B preferred stock an aggregate of $60.0 million. Upon a delisting, we expect that the holders of at least 55,000 shares of Series B preferred stock will exercise their right to cause the Company to redeem their preferred stock and the Company will be obligated to pay to such holders an aggregate of $55.0 million. We currently do not have the funds available to redeem 55,000 or more shares of Series B preferred stock.

As a result of the likely exercise of the redemption rights by the holders of Series B preferred stock upon delisting, it may be necessary for us to initiate actions that could result in our dissolution, insolvency or seeking protection under bankruptcy laws or other similar actions.

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It is our intention to cease operations in California. We previously announced that we began discussions with an entity to acquire a portion of our California operations, including the possible sale of our California facilities, and a selection of pre-clinical infectious disease programs along with the hiring of a portion of our employees in California. It was our desire to identify a buyer for our California operations by March 31, 2003 and we previously announced that we would implement our plan to phase out our California operations if we did not enter into definitive documents by March 31, 2003. We have been unable to date to negotiate mutually agreeable terms with a buyer of our California operations. Consequently, as of March 31, 2003, we expect to eliminate 42 positions. The employees remaining in California will either assist with the closure of certain California facilities or assist in the performance of the Company’s obligations under its collaborative agreement with Fujisawa Pharmaceutical Co., Ltd, which is expected to conclude in the third quarter of 2003. In connection with the phase out of the California operation, we expect to incur restructuring charges of approximately $6.5 million, consisting of $3.5 million in severance, $2.0 million for the write-down of the value of leasehold improvements and equipment and $1.0 million in excess lease costs. We expect to incur the majority of these charges in the first quarter of 2003.

At the conclusion of this phase out period and the gradual elimination of our California operations, we will have approximately 17 employees located in Waltham, Massachusetts. Our remaining employees will focus on the pre-clinical development of our wound healing compound and seek in-licensing opportunities to add to our development efforts.

DESCRIPTION OF CURRENT OPERATIONS

Essential Therapeutics, Inc., is a biopharmaceutical company committed to the development and commercialization of critical products for wound healing and life threatening infectious disease. The Company is presently conducting pre-clinical testing of its wound healing compound. Additionally, the Company continues its focus on the growing problem of antibiotic and antifungal resistance. Our Novel Cephalosporin Program, which has been partnered with Johnson & Johnson, or J&J, as it is known in the industry, targets serious gram-positive multi-drug resistant infections. The Efflux Pump Inhibitor Program, which has been partnered with Daiichi, targets gram-negative infections.

We have collaboration agreements with major pharmaceutical companies that have enhanced our discovery and development programs. As of December 31, 2002, we had received $72.1 million in license fees, milestone payments and research support payments, and $10.0 million in equity investments from these collaborations. If certain milestones are reached, we may receive additional milestone payments, as well as royalties on worldwide sales of products that may result from these collaborations. Our development strategy is to continue our efforts to identify attractive in-licensing opportunities to supplement our existing, self-funded efforts.

J&J.    We established a collaboration in October 1995 with affiliates of Johnson & Johnson Pharmaceutical Research & Development, L.L.C., which we collectively refer to as “J&J,” to discover and develop novel beta-lactam antibiotics, antibiotic potentiators and inhibitors of bacterial signal transduction targeted at problematic gram-positive bacteria, including staphylococci and enterococci. In May 2001, we announced that J&J had selected a prodrug of the initial lead compound for toxicology studies. A prodrug is a modified form of a drug that is readily converted to the active drug in the body. In animal studies, administration of this prodrug form eliminated the irritation seen when the compound itself was administered. In June 2002, we announced that J&J had initiated a Phase I clinical trial of this prodrug formulation. We have been informed that J&J has stayed further conduct of the Phase I trial pending review of the project. In January 1999, in collaboration with J&J, we committed to the pre-clinical development of a second cephalosporin compound. This second parenteral cephalosporin antibiotic was selected for pre-clinical development as a back-up and potential “second generation” compound, which may improve the likelihood of ultimately bringing one or more products to the market. We extended this collaboration in December 2000 to develop a new class of cephalosporins, having similar spectrum and potency to the first compounds, but which would be bioavailable following oral administration. We have received two milestone payments under this collaboration and research support was concluded in 2002. The Company discontinued its efforts to develop a back up parenteral and an orally absorbed product in 2002. If specified research and development milestones are achieved, we will be entitled to receive an additional $13.5 million for either the initial or back-up parenteral product developed within the collaboration. In December 2000, we entered into another collaboration with J&J with a focus on the discovery of products from our natural product extracts. We have provided J&J with access to our natural products library for the purpose of screening for activity in various biological and therapeutic applications. Research work on this was concluded in August 2002. J&J will undertake a program for the development, manufacture and sale of products developed from the collaborative research. Under the terms of the agreement, we received an up-front license fee, a technology-access fee for access to our natural products library and funding for our research to identify the active components of natural product extracts. For each product resulting from the collaboration, we will receive specified milestone payments and royalties on worldwide sales.

Daiichi.    We established a collaboration in November 1995 with Daiichi to discover and develop bacterial efflux pump inhibitors to be used in combination with Daiichi’s quinolone antibiotics to target gram-negative bacteria, including

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pseudomonas. The research phase of this collaboration was extended in May 2000, and at the end of March 2001, the research funding portion of this collaboration came to its natural conclusion.

Pfizer.    We established a collaboration with Pfizer in March 1996, to utilize bacterial genetic approaches with in vitro essential genes to discover products for the treatment of bacterial infections in animals. The funded research portion of this agreement ended in January 2002.

Schering-Plough Animal Health.    In October 2000, we entered into collaboration with Schering-Plough Animal Health, or SPAH, to discover and develop compounds to be used in the treatment of veterinary bacterial infections. In July and December 2001, the agreement was amended, each time increasing the level of research funded by SPAH. By amendment effective September 2002, the terms of the collaboration were modified. In order to meet our needs in phasing out the California operations, the collaboration was terminated effective April 3, 2003.

Iconix.    In January 1998, we entered into collaboration with Iconix, a biotechnology company to which we licensed or assigned technology related to Iconix’s genetic technology. At December 31, 2002, we held approximately a 15.5% ownership interest in Iconix, on a fully diluted basis. Iconix has applied the genetics technology to a number of viral disease targets in a search for novel antiviral agents in collaborative research funded by Essential. We are entitled to worldwide development, manufacturing and marketing rights to antiviral products that may emerge from the antiviral collaboration. If we were to develop a product using technology developed under the collaboration, we would be obligated to pay Iconix royalties on worldwide sales. The assay discovery phase of this collaboration ended in January 2001.

Fujisawa Pharmaceutical Co., Ltd.    In August 2002, Essential entered into a collaborative research and development agreement with Fujisawa Pharmaceutical Co., Ltd., or as we refer to them, Fujisawa, to develop assay systems for the discovery of antibacterial antibiotics and perform high-throughput screening of the compounds in Fujisawa’s library through a subcontractor. Fujisawa will conduct lead generation and optimization and will exclusively develop, manufacture and market the resulting products worldwide. During 2002, we received a $1.0 million upfront fee that was deferred and which is being recognized over the one year performance period of the agreement. In addition, Essential earned $625,000 in research support revenue and $200,000 in milestone revenue under the agreement during 2002. If specified research and development milestones are achieved, we would be entitled to receive specified milestone payments, plus royalties based upon sales of products from the collaboration.

The University of Southern California.    In conjunction with our acquisition of Maret Pharmaceuticals, Inc. in March 2002, we acquired a research and license collaborative agreement with the University of Southern California, or as we refer to them, USC, to discover, develop and commercialize drugs based on angiotensin peptide analogues. The agreement was amended in July 2002 to extend the term of the research agreement through March 31, 2003, and we are negotiating to extend the research agreement into the second or third quarter of 2003. During fiscal year 2002, we paid approximately $400,000 in contract services to USC under this agreement. If we are successful in developing products from this collaboration, we will be obligated to pay royalties based upon worldwide sales to USC. In January 2003, we announced that one of the potential products acquired in the Maret acquisition, ETRX 101, did not show signs of sufficient efficacy to support the continuation of development of ETRX 101 as a single agent and the Company decided not to continue its development. The Company is currently developing a wound healing compound in connection with the USC agreement.

We do not expect that any drugs resulting from our collaborations, our development efforts, or our in-licensing efforts will be commercially available for a number of years, if at all. All compounds discovered by us or in-licensed will require extensive pre-clinical and clinical testing prior to submission of any regulatory application for commercial use. Extensive pre-clinical and clinical testing required to establish safety and efficacy will take a number of years, and the time required to commercialize new drugs cannot be predicted with accuracy. We cannot assure you that our approach to drug discovery, or the efforts of our partners, will result in the successful development of any drugs, or that any drugs, if successfully developed, will be proven to be safe and effective in clinical trials, meet applicable regulatory standards, be capable of being manufactured in commercial quantities at reasonable costs or be successfully commercialized. Product development of new pharmaceuticals is highly uncertain, and unanticipated developments, clinical or regulatory delays, unexpected adverse effects or inadequate therapeutic efficacy would slow or prevent our product development efforts or those of our partners and would have a material adverse effect on our business and results of operations. We will not receive revenues or royalties from sales of drugs for a significant number of years, if at all. Any failure to receive significant revenues or achieve profitable operations could impair our ability to sustain operations, and we cannot assure you that we will ever receive significant revenues or achieve profitable operations.

STRATEGY

We believe that the wound healing and antibiotics markets provide an attractive opportunity for our development and collaborative activities because there are significant unmet clinical needs.

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To this end, we are executing our development strategy, which is to continue to utilize strategic collaborations selectively to complement and balance our internal, self-funded efforts as well as aggressively seeking to in-license new compounds. In general, we plan to take our wound healing compound forward into clinical development stages alone before entering into collaborative relationships for final product development and commercialization. Additionally, we intend to continue to pursue the acquisition of clinical compounds as we continue our transition to a product-focused company.

MANUFACTURING AND MARKETING

We do not have any expertise in the manufacture of commercial quantities of drugs, and our current facilities and staff are inadequate for the commercial production or distribution of drugs. We intend to rely on our major pharmaceutical partners for the manufacturing, marketing and sale of any products that result from our collaborations. We will be required to contract with third parties for the manufacture of other products or to acquire or build production facilities before we can manufacture any products ourselves. We cannot assure you that we will be able to enter into contractual manufacturing arrangements with third parties on acceptable terms, if at all, or acquire or build production facilities ourselves. To date we have had no experience with sales, marketing or distribution. Consequently, in order to market any of our products, we will be required to develop marketing and sales capabilities, either on our own or in conjunction with others. We cannot assure you that we will be able to develop any of these capabilities. In instances where we rely on partners for the manufacturing, marketing and sales of any products that result from our collaborations, we cannot assure you that these partners will satisfactorily perform these functions.

We cannot assure you that any products successfully developed by our collaborative partners, or us if approved for marketing, will achieve market acceptance. The wound healing and antimicrobial products that we or our strategic partners are attempting to develop will compete with a number of well-established drugs manufactured and marketed by major pharmaceutical companies. The degree of market acceptance of any products developed by us will depend on a number of factors, including the establishment and demonstration in the medical community of the clinical efficacy and safety of our product candidates, their potential advantage over existing treatment methods, and reimbursement policies of government and third-party payers. We cannot assure you that physicians, patients or the medical community in general will accept and utilize any products that we may develop or that our collaborative partners may develop.

Our ability and that of our collaborative partners to receive revenues and income with respect to drugs, if any, developed through the use of our technology will depend, in part, upon the extent to which reimbursement for the cost of these drugs will be available from third-party payers, such as government health administration authorities, private health care insurers, health maintenance organizations, pharmacy benefits management companies and other organizations. Third-party payers are increasingly challenging the prices charged for pharmaceutical products. We cannot assure you that third-party reimbursement will be available or sufficient to allow profitable price levels to be maintained for drugs developed by our collaborative partners or us. Any inability to maintain profitable price levels for these drugs could adversely affect our business and results of operations.

PATENTS, PROPRIETARY TECHNOLOGY AND TRADE SECRETS

Protection of our proprietary compounds and technology is vital to our business. Our policy is to seek, when appropriate, protection for our lead compounds, screening technologies and other proprietary technology by filing patent applications in the United States and other countries.

Patent law as it relates to inventions in the biotechnology field is still evolving, and involves complex legal and factual questions for which legal principles are not firmly established.

Accordingly, the patent position of biotechnology and pharmaceutical companies is highly uncertain and involves many complex legal and technical issues. We cannot assure you that patents will be granted with respect to any of our patent applications currently pending in the United States or in other countries, or with respect to applications filed by us in the future. The failure by us to obtain patents pursuant to our applications and any future applications could have a material adverse effect on our business. Furthermore, we cannot assure you that any patents that may be issued to us will not be infringed, challenged, invalidated or circumvented by others, or that the rights granted there under will provide competitive advantages to us. In particular, it is difficult to enforce patents covering methods of use of screening and other similar technologies. Litigation to establish the validity of patents, to defend against patent infringement claims and to assert infringement claims against others can be expensive and time-consuming, even if the outcome is favorable to us. If the outcome of patent prosecution or litigation is not favorable to us, our business could be materially adversely affected. Moreover, because patent applications in the United States are maintained in secrecy until patents issue, because patent

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applications in other countries generally are not published until more than eighteen months after they are filed, because publication of technological developments in the scientific or patent literature often lags behind the date of these developments, and because searches of prior art may not reveal all relevant prior inventions, we cannot be sure that we were the first to invent the subject matter covered by our patent applications or that we were the first to file patent applications for particular inventions.

Our commercial success will depend in part on not infringing patents or proprietary rights of others. We cannot assure you that we will be able to obtain a license to any third-party technology we may require to conduct our business or that if obtainable, this technology can be licensed at reasonable cost. Failure by us to obtain a license to technology that we may require to utilize our technologies or commercialize our products may have a material adverse effect on our business. In some cases, litigation or other proceedings may be necessary to defend against or assert claims of infringement, to enforce patents issued to us, to protect trade secrets, know-how or other intellectual property rights owned by us, or to determine the scope and validity of the proprietary rights of third parties. Any potential litigation could result in substantial costs to and diversion of resources by us and could have a material adverse impact on our business. We cannot assure you that any of our issued or licensed patents will ultimately be held valid or that any efforts to defend any of our patents, trade secrets, know-how or other intellectual property rights will be successful. An adverse outcome in any litigation or proceeding could subject us to significant liabilities, require us to cease using the subject technology or require us to license the subject technology from the third party, all of which could have a material adverse effect on our business.

In addition to patent protection, we rely upon trade secrets, proprietary know-how and continuing technological advances to develop and maintain our competitive position. To maintain the confidentiality of our trade secrets and proprietary information, we require our employees, consultants and collaborative partners to execute confidentiality agreements upon the commencement of their relationships with us. In the case of employees, the agreements also provide that all inventions resulting from work performed by them while in our employ will be our exclusive property. We cannot assure you, however, that these agreements will not be breached, that we would have adequate remedies in the event of any breach or that our trade secrets or proprietary information will not otherwise become known or developed independently by others.

We also rely upon unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our commercial partners, collaborators, employees and consultants. We also have invention or patent assignment agreements with our employees and some, but not all, commercial partners and consultants. We cannot assure you that a person not bound by an invention assignment agreement will not develop relevant inventions. We cannot assure you that binding agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by competitors.

As is commonplace in the biotechnology industry, we employ individuals who were previously employed at other biotechnology or pharmaceutical companies, including competitors or potential competitors of ours. To the extent these employees are involved in research areas that are similar to those areas in which they were involved at their former employer, we may be subject to claims that these employees and/or that we have inadvertently or otherwise used or disclosed the alleged trade secrets or other proprietary information of the former employers. Litigation may be necessary to defend against these types of claims, which could result in substantial costs and be a distraction to management, and which may have a material adverse effect on our business, even if we were ultimately successful in defending against these claims.

COMPETITION

The biotechnology and pharmaceutical industries are intensely competitive. Many companies, including large, multinational pharmaceutical and biotechnology companies, are actively engaged in activities similar to ours. Many of these companies may employ in these activities greater financial and other resources, including larger research and development staffs and more extensive marketing and manufacturing organizations, than us or our collaborative partners. There are also academic institutions, governmental agencies and other research organizations that are conducting research in areas in which we are working. Competing technologies may be developed that would render our technologies obsolete or non-competitive. We are aware of many pharmaceutical and biotechnology companies that are engaged in efforts to treat wounds and each of the infectious diseases for which we are seeking to develop therapeutic products.

We also expect to encounter significant competition with respect to the drugs that our collaborative partners and we plan to develop. Companies that complete clinical trials, obtain required regulatory agency approvals and commence commercial sale of their drugs before their competitors may achieve a significant competitive advantage. In order to compete successfully, our goal is to obtain patent protection for our potential products and to make those available selectively to pharmaceutical

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companies through collaborative and licensing arrangements. We cannot assure you that our competitors will not develop competing drugs that are more effective than those developed by us and our collaborative partners or obtain regulatory approvals of their drugs more rapidly than we and our collaborative partners do, thereby rendering our and our collaborative partners’ drugs obsolete or noncompetitive. Moreover, we cannot assure you that our competitors will not obtain patent protection or other intellectual property rights that would limit our or our collaborative partners’ ability to use our technology or commercialize our or their drugs.

GOVERNMENT REGULATION

The development, manufacture and marketing of drugs developed by us or our collaborative partners are subject to regulation by numerous governmental agencies in the United States and in other countries. The United States Food and Drug Administration, or FDA, and comparable regulatory agencies in other countries impose mandatory procedures and standards for the conduct of some types of pre-clinical testing and clinical trials and the production and marketing of drugs for human therapeutic use. Product development and approval of a new drug are likely to take a number of years and involve the expenditure of substantial resources.

Any compound developed by our collaborative partners or us must receive regulatory agency approval before it may be marketed as a drug in a particular country. The regulatory process, which includes pre-clinical testing and clinical trials of each compound in order to establish its safety and efficacy, can take many years and requires the expenditure of substantial resources. The steps required by the FDA before new drugs may be marketed in the United States include:

In the United States, pre-clinical testing includes both in vitro and in vivo laboratory evaluation and characterization of the safety and efficacy of a drug and its formulation. Laboratories involved in pre-clinical testing must comply with FDA regulations regarding good laboratory practices. Pre-clinical testing results are submitted to the FDA as part of the IND and are reviewed by the FDA prior to the commencement of human clinical trials. Unless the FDA objects to an IND, the IND becomes effective 30 days following its receipt by the FDA. There can be no assurance that submission of an IND will result in the commencement of human clinical trials.

Clinical trials, which involve the administration of the investigational drug to healthy volunteers or to patients under the supervision of a qualified principal investigator, are typically conducted in three sequential phases, although the phases may overlap with one another. Clinical trials must be conducted in accordance with the FDA’s 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, or IRB, at the institution where the study will be conducted. The IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. Compounds must be formulated according to the FDA’s good manufacturing practices.

Phase I clinical trials represent the initial administration of the investigational drug to a small group of healthy human subjects or, more rarely, to a group of selected patients with the targeted disease or disorder. The goal of Phase I clinical trials is typically to test for safety/adverse effects, dose tolerance, absorption, biodistribution, metabolism, excretion and clinical pharmacology and, if possible, to gain early evidence regarding efficacy.

Phase II clinical trials involve a small sample of the actual intended patient population and seek to assess the efficacy of the drug for specific targeted indications, to determine dose tolerance and the optimal dose range and to gather additional information relating to safety and potential adverse effects.

Once an investigational drug is found to have some efficacy and an acceptable safety profile in the targeted patient population, Phase III clinical trials are initiated to establish further clinical safety and efficacy of the investigational drug in a broader sample of the general patient population at geographically dispersed study sites in order to determine the overall

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risk-benefit ratio of the drug and to provide an adequate basis for all physician labeling. The results of the research and product development, manufacturing, pre-clinical testing, clinical trials and related information are submitted to the FDA in the form of an NDA for approval of the marketing and shipment of the drug.

Data obtained from pre-clinical and clinical activities are susceptible to varying interpretations, which could delay, limit or prevent regulatory agency approval. In addition, delays or rejections may be encountered based upon changes in regulatory agency policy during the period of drug development and/or the period of review of any application for regulatory agency approval for a compound. Delays in obtaining regulatory agency approvals could adversely affect the marketing of any drugs developed by us or our collaborative partners, impose costly procedures upon our and our collaborative partners’ activities, diminish any competitive advantages that we or our collaborative partners may attain and adversely affect our ability to receive royalties. We cannot assure you that, even after significant time and expenditures, regulatory agency approvals will be obtained for any compounds developed by or in collaboration with us. Moreover, if regulatory agency approval for a drug is granted, this approval may entail limitations on the indicated uses for which it may be marketed that could limit the potential market for this drug. Furthermore, approved drugs and their manufacturers are subject to continual review, and discovery of previously unknown problems with a drug, or its manufacturer, may result in restrictions on the drug or manufacturer, including withdrawal of the drug from the market. In addition, regulatory agency approval of prices is required in many countries and may be required for the marketing of any drug developed by us or our collaborative partners in these countries.

Timetables for the various phases of clinical trials and NDA approval cannot be predicted with any certainty. We, our collaborative partners or the FDA may suspend clinical trials at any time if it is believed that individuals participating in the trials are being exposed to unacceptable health risks. Even assuming that clinical trials are completed and that an NDA is submitted to the FDA, we cannot assure you that the NDA will be reviewed by the FDA in a timely manner or that once reviewed, the NDA will be approved. The approval process is affected by a number of factors, including the severity of the targeted indications, the availability of alternative treatments and the risks and benefits demonstrated in clinical trials. The FDA may deny an NDA if applicable regulatory criteria are not satisfied, or may require additional testing or information with respect to the investigational drug. Even if initial FDA approval is obtained, further studies, including post-market studies, may be required in order to provide additional data on safety and will be required in order to gain approval for the use of a product as a treatment for clinical indications other than those for which the product was initially tested. The FDA will also require post-market reporting and may require surveillance programs to monitor the side effects of the drug. Results of post-marketing programs may limit or expand the further marketing of the drug. Further, if there are any modifications to the drug, including changes in indication, manufacturing process or labeling, an NDA supplement may be required to be submitted to the FDA.

Each manufacturing establishment for new drugs is also required to receive some form of approval by the FDA. Among the conditions for approval is the requirement that the prospective manufacturer’s quality control and manufacturing procedures conform to the FDA’s good manufacturing practices, which must be followed at all times. In complying with standards set forth in these regulations, manufacturers must continue to expend time, monies and effort in the area of production and quality control to ensure full technical compliance. Manufacturing establishments, both foreign and domestic, are also subject to inspections by or under the authority of the FDA and may be subject to inspections by foreign and other federal, state or local agencies.

We cannot assure you that the regulatory framework described above will not change or that additional regulations will not arise that may affect approval of or delay an IND or an NDA. Moreover, because our present collaborative partners are, and it is expected that our future collaborative partners may be, primarily responsible for pre-clinical testing, clinical trials, regulatory approvals, manufacturing and commercialization of drugs, the ability to obtain and the timing of regulatory approvals are not within our control.

Prior to the commencement of marketing a product in other countries, approval by the regulatory agencies in these countries is required, whether or not FDA approval has been obtained for a particular product. The requirements governing the conduct of clinical trials and product approvals vary widely from country to country, and the time required for approval may be longer or shorter than the time required for FDA approval. Although there are some procedures for unified filings for some European countries, in general, each country has its own procedures and requirements.

We are also subject to regulation under other federal laws and regulation under state and local laws, including laws relating to occupational safety, laboratory practices, the use, handling and disposition of radioactive materials, environmental protection and hazardous substance control. Although we believe that our safety procedures for handling and disposing of radioactive compounds and other hazardous materials used in our research and development activities comply with the standards prescribed by federal, state and local regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages that result and any liability could exceed our financial resources.

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The drug development process and regulatory framework for animal drugs are similar in many respects to that for human therapeutics. In the United States, the Center for Veterinary Medicine of the FDA is charged with assuring that a new animal drug will not be introduced into interstate commerce unless it is the subject of an approved new animal drug application, or NADA. Like an NDA, an NADA must be supported by proof that the drug is safe and effective. An NADA application must include reports of adequate and well-controlled investigations. Procedures for the initiation of studies on an investigational new animal drug are similar to those for an IND. Compliance with good laboratory practices and good clinical practices is required.

EMPLOYEES

As of December 31, 2002, we had 70 full-time, regular employees, 24 of whom held Ph.D. degrees and 16 of whom held other advanced degrees. Approximately 49 of the 70 employees are engaged in scientific activities and 21 are engaged in general, managerial and administrative functions. None of our employees is represented by a collective bargaining agreement, nor have we experienced work stoppages.

We plan to phase out our operations in California. Consequently, as of March 31, 2003, we expect to eliminate 42 positions in California. The remaining employees will either assist with the closure of certain California facilities or assist in the performance of the Company’s obligations under its collaborative agreement with Fujisawa Pharmaceutical Co., Ltd, which is expected to conclude in the third quarter of 2003. Please see “Item 1. Business—Recent Developments.”

SCIENTIFIC CONSULTANTS

We supplement our internal scientific staff with consulting arrangements with a number of leading academic and industrial scientists and clinicians. Our Scientific Advisory Board formally meets once or twice per year to review our programs and provide general scientific guidance and direction. On a more frequent basis, we use consultants either in small focused groups or as individuals on an ad hoc basis to provide detailed scientific guidance. In 2002, we paid consulting fees of approximately $699,000 in the aggregate, as compared to approximately $161,000 in 2001. The increase is due primarily to the Company’s use of consultants for key development roles prior to hiring these key development personnel. None of the consultants is an employee of ours. Most of the consultants have other commitments to, or consulting or advisory contracts with, their employers and other institutions.

RISK FACTORS THAT MAY AFFECT RESULTS

OUR COMMON STOCK MAY BE DELISTED AND OUR SERIES B PREFERRED STOCKHOLDERS MAY CAUSE A REDEMPTION OF THE SERIES B PREFERRED STOCK.

Our common stock is presently listed on the Nasdaq National Market System under the symbol “ETRX.” All companies listed on Nasdaq are required to comply with certain continued listing standards, including maintaining stockholders’ equity of at least $10,000,000, maintaining a minimum bid price of at least $1.00 and maintaining a minimum market value of publicly held shares of $5,000,000. We are not in compliance with these three listing criteria. On January 31, 2003, we received a determination letter from Nasdaq that indicated that the Company’s securities would be delisted. The Company appealed this decision and our appeal was presented at a hearing before the Nasdaq Listing Qualifications Panel on March 20, 2003. If we are unable to resolve listing standard noncompliance with Nasdaq our common stock will be delisted from the Nasdaq National Market System. In the event that Essential’s common stock is delisted from Nasdaq, its market value and liquidity would be materially adversely affected. Moreover, any delisting of our common stock from the Nasdaq National Market would constitute a holder optional repurchase event under the terms of our outstanding Series B preferred stock, giving our Series B preferred stockholders the right to cause Essential to redeem the shares of preferred stock. We do not have the funds to redeem all outstanding shares of Series B preferred stock. If we are required to cause such redemption, it may be necessary for us to initiate actions that could result in dissolution, insolvency or seeking protection under bankruptcy laws or similar actions. Our common stock will have no value if we are required to cease operations or if we seek protection under bankruptcy laws. For a description of the holder optional repurchase event and the rights of the Series B preferred stockholders associated therewith, please see Note 10 to our consolidated financial statements filed with our Form 10-K for the year ended December 31, 2002.

WE NEED TO CONTINUE AS A GOING CONCERN IF OUR BUSINESS IS TO SUCCEED.

Our Independent Auditor’s report to our audited financial statements for the period ended December 31, 2002 indicates that there is substantial doubt about our ability to continue as a going concern. We have been notified by the Nasdaq National

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Market that our common stock may be delisted. If a delisting occurs, holders of our Series B convertible redeemable preferred stock have a right to cause the redemption of their shares of preferred stock, resulting in our obligation to pay such holders up to an aggregate of $60.0 million. We do not have the funds to cause redemption of the Series B preferred stock. If we are required to cause such redemption we may initiate actions that could result in dissolution, insolvency or seeking protection under bankruptcy laws or other similar actions. Our common stock will have no value if we are required to cease operations or if we seek protection under the bankruptcy laws. Potential investors in our securities should consider the risk that, even if we do not ultimately seek bankruptcy protection, our common stock may nonetheless have no value.

IF OUR RESEARCH AND DEVELOPMENT EFFORTS DO NOT RESULT IN POTENTIAL DRUG CANDIDATES AND/OR WE CANNOT ADVANCE POTENTIAL PRODUCTS THROUGH CLINICAL TRIALS, WE MAY FAIL TO DEVELOP PHARMACEUTICAL PRODUCTS.

In July 2002, J&J initiated Phase I clinical trials with RWJ-442831, an Essential-developed prodrug form of the collaboration’s lead parenteral cephalosporin product, known as RWJ-54428. We have been informed that J&J has stayed further conduct of the Phase I trial pending review of the project. There can be no assurance that J&J will move forward with the Phase I clinical trials for this cephalosporin compound, or that even if such trials are reinstated, they will be completed. We have one other cephalosporin compound in the J&J collaboration that is in pre-clinical development. Our other potential products are in the pre-clinical or research stage. All of our potential products will require significant additional research and development efforts before we can sell them. These efforts include extensive pre-clinical and clinical testing prior to submission to the Food and Drug Administration, or FDA, or other regulatory authority. Pre-clinical and clinical testing will likely take several years. After submission, these potential products will be subject to lengthy regulatory review. We cannot predict with accuracy the time required to commercialize new pharmaceutical products.

The development of new pharmaceutical products is highly uncertain and subject to a number of significant risks. We do not expect any of our potential products to be commercially available for a number of years, if at all. Pharmaceutical products that appear to be promising at early stages of development may not reach the market for a number of reasons including the following:

IF WE ARE UNABLE TO ENTER INTO NEW COLLABORATIONS, OR MAINTAIN OUR CURRENT COLLABORATIONS WITH OUR PARTNERS, DEVELOPMENT OF OUR POTENTIAL PRODUCTS COULD BE DELAYED.

Our strategy for enhancing our research and development capability, building our pipeline and funding, in part, our capital requirements involves in-licensing new compounds for development and entering into collaboration agreements with major pharmaceutical companies, which we refer to as our partners. We are actively seeking in-licensing opportunities, but have not yet entered into advanced negotiations with any potential licensors. We cannot be sure that we will be successful in identifying potential candidates to in-license, or that we will be successful in negotiating agreements with the owners of such technology. The failure to do so could have a material adverse effect on our ability to enhance our development pipeline.

We have entered into collaboration agreements with J&J, Daiichi and Fujisawa. Under these agreements, our partners are responsible for:

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We cannot control the timing of these actions or the amount of resources devoted to these activities by our partners. In addition, these agreements are subject to cancellation or the election not to extend by our partners. As a result, our receipt of revenue, whether in the form of continued research funding, product development milestone payments, or royalties on sales, depends upon the decisions made and the actions taken by our partners. Our partners may view compounds that we may discover as competitive with their own products or potential products, and, therefore, any partner may elect not to proceed with the development of our potential products. Our partners are free to pursue their own existing or alternative technologies to develop products in preference to our potential products. We cannot be certain that our interests will continue to coincide with those of our partners, or that disagreements concerning our rights, technology, or other proprietary interests will not arise with our partners.

Substantially all of our revenues to date have resulted from our collaborations. We intend to continue to rely on our collaborations to fund a substantial portion of our research and development activities over the next several years. If we are unable to enter into new collaborations, the development and commercialization of our potential products may be delayed. In addition, we may be forced to seek alternative sources of financing for product development and commercialization activities.

WE HAVE INCURRED SUBSTANTIAL LOSSES IN THE PAST, EXPECT TO CONTINUE TO INCUR LOSSES FOR THE NEXT SEVERAL YEARS AND MAY NEVER ACHIEVE PROFITABILITY.

We have incurred substantial net losses in every year since our inception in December 1992. We had net losses allocable to common stockholders of $13.9 million in 2000, $28.2 million in 2001 and $42.9 million in 2002. We had an accumulated deficit of $122.3 million through December 31, 2002. We expect to continue to incur operating losses over the next several years.

Substantially all of our revenues to date have resulted from license fees, research support and milestone payments under our collaboration agreements. We will not receive revenues or royalties from drug sales until we or our partners successfully complete clinical trials with regard to a drug candidate, obtain regulatory approval for this drug candidate, and successfully commercialize the drug. We do not expect to receive revenues or royalties from sales of drugs for a number of years, if at all. If we fail to achieve sufficient revenues to become profitable or sustain profitability, we may be unable to continue operations.

IF WE FAIL TO SATISFY SAFETY AND EFFICACY REQUIREMENTS OR MEET REGULATORY REQUIREMENTS IN OUR CLINICAL TRIALS, WE WILL NOT BE ABLE TO COMMERCIALIZE OUR DRUG CANDIDATES.

Either we or our collaborators must show through pre-clinical studies and clinical trials that each of our pharmaceutical products is safe and effective in humans for each indication before obtaining regulatory clearance from the FDA for the commercial sale of that pharmaceutical product. If we fail to adequately show the safety and effectiveness of a pharmaceutical product, regulatory approval could be delayed or denied. The results from pre-clinical studies and early clinical trials are often different than the results that are obtained in large-scale testing. We cannot be certain that we will show sufficient safety and effectiveness in our clinical trials that would allow us to obtain regulatory approval. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials.

Any drug is likely to produce some level of toxicity or undesirable side effects in animals and in humans when administered at sufficiently high doses and/or for a long period of time. Unacceptable toxicities or side effects may occur in the course of toxicity studies or clinical trials. If we observe unacceptable toxicities or other side effects, we, our partner or regulatory authorities may interrupt, limit, delay or halt the development of the drug. In addition, unacceptable toxicities or side effects could prevent approval by the FDA or foreign regulatory authorities for any or all indications.

We must obtain regulatory approval before marketing or selling our future drug products. In the United States, we must obtain FDA approval for each drug that we intend to commercialize. The FDA approval process is lengthy and expensive, and approval is never certain. Products distributed abroad are also subject to foreign government regulation. The process of obtaining FDA and other required regulatory approvals could vary a great deal based upon the type, complexity and novelty of the products involved. Delays or rejections may be caused by additional government regulation from future legislation or administrative action or changes in FDA policy during the period of clinical trials and FDA regulatory review. Similar delays also may be experienced in foreign countries.

None of our drug candidates has received regulatory approval. If we fail to obtain this approval, we will be unable to manufacture and sell our drug products commercially.

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IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY LOSE THE COMPETITIVE ADVANTAGE INHERENT IN OUR PROPRIETARY TECHNOLOGIES.

Our success depends in part on our ability to establish, protect and enforce our proprietary rights relating to our lead compounds, screening technology and other proprietary technology. We have numerous patent applications in the United States, in addition to applications filed in other countries, in order to protect clinical and lead compounds and screening technology, and a number of United States patents have been issued to date on these applications. We cannot be certain that patents will be granted with respect to any of our patent applications currently pending in the United States or in other countries, or with respect to applications filed in the future. For example, although in 2000 a patent was granted in the United States covering our cephalosporin compounds now in development, prosecution has not yet begun on more recently filed patent applications related to prodrugs of our earlier inventions, as well as on our new compounds having potential for oral administration. Our failure to obtain patents pursuant to our current or future applications could have a material adverse effect on our business. Furthermore, we cannot be certain that any patents issued to us will not be infringed, challenged, invalidated or circumvented by others, or that the rights granted there under will provide competitive advantages to us. In particular, it is difficult to enforce patents covering methods of use of screening and other similar technologies. Litigation to establish the validity of patents, to defend against copatent infringement claims and to assert infringement claims against others can be expensive and time-consuming, even if the outcome is favorable to us. If the outcome of patent prosecution or litigation is not favorable to us, our business could be materially adversely affected.

Our commercial success also depends on our ability to operate without infringing patents and proprietary rights of third parties. We cannot assure you that our products will not infringe on the patents or proprietary rights of others. While we are not currently aware of any patents encumbering our ability to practice the technologies we have discovered, it is possible that a patent of this nature may issue in the future. We may be required to obtain licenses to patents or other proprietary rights of others. Any licenses may not be available on terms acceptable to us, if at all. The failure to obtain these licenses could delay or prevent our partners’ activities, including the development, manufacture or sale of drugs requiring such licenses.

In addition to patent protection, we rely on trade secrets, proprietary know-how and technological advances that we seek to protect, in part, by confidentiality agreements with our partners, employees and consultants. We cannot assure you that these agreements will not be breached, that we would have adequate remedies for any breach that might occur, or that our trade secrets, proprietary know-how and technological advances will not otherwise become known or be independently discovered by others.

IF OTHER COMPANIES DEVELOP BETTER PRODUCTS THAN OURS OR MARKET SIMILAR PRODUCTS SOONER, OUR PRODUCTS MAY BE RENDERED OBSOLETE OR NONCOMPETITIVE.

We operate in a field in which new developments are occurring at an increasing pace. Competition from biotechnology and pharmaceutical companies, joint ventures, academic and other research institutions and others is intense and is expected to increase. Many of our competitors have substantially greater financial, technical and personnel resources than we have. Although we believe that we have identified new and distinct approaches to drug discovery, there are other companies with drug discovery programs, at least some of the objectives of which are the same as or similar to ours. For example, there are other companies that have recently described cephalosporins in early stages of development that are designed for treatment of resistant gram-positive infections in hospitals, the same objective as our lead cephalosporin compound. Similarly, several other companies are seeking to capitalize on the expanding body of knowledge of efflux pumps in microorganisms.

Competing technologies may be developed that would render our technologies obsolete or noncompetitive. We are aware of many pharmaceutical and biotechnology companies that are engaged in efforts to treat wound healing and each of the infectious diseases for which we are seeking to develop therapeutic products. We cannot assure you that our competitors will not develop competing drugs that are more effective than those developed by us and our partners or obtain regulatory approvals of their drugs more rapidly than we and our partners, thereby rendering our and our partners’ drugs obsolete or noncompetitive. Moreover, we cannot assure you that our competitors will not obtain patent protection or other intellectual property rights that would limit our and our partners’ ability to use our technology or commercialize our or their drugs.

WE HAVE NO MANUFACTURING, MARKETING OR SALES EXPERIENCE, AND IF WE ARE UNABLE TO ENTER INTO MANUFACTURING AGREEMENTS OR MAINTAIN COLLABORATIONS WITH MARKETING PARTNERS OR IF WE ARE UNABLE TO DEVELOP OUR OWN MANUFACTURING, SALES AND MARKETING CAPABILITY, WE MAY NOT BE SUCCESSFUL IN COMMERCIALIZING OUR PRODUCTS.

We do not have any experience in the manufacture of commercial quantities of drugs, and our current facilities and staff are inadequate for the commercial production or distribution of drugs. We intend to rely on our partners for the manufacturing,

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marketing and sales of any products that result from these collaborations. Manufacturers often encounter difficulties in scaling up to manufacture commercial quantities of pharmaceutical products. We cannot be certain that our current or any other manufacturer will not encounter similar delays in the scale-up to manufacture this or any other compound in commercial quantities in the future.

We will be required to contract with third parties for the manufacture of our products or to acquire or build production facilities before we can manufacture any of our products. We cannot assure you that we will be able to enter into contractual manufacturing arrangements with third parties on acceptable terms, if at all, or acquire or build production facilities ourselves.

To date we have no experience with sales, marketing or distribution. In order to market any of our products, we will be required to develop marketing and sales capabilities, either on our own or in conjunction with others. We cannot assure you that we will be able to develop any of these capabilities.

HEALTH CARE REFORM MEASURES OR COST CONTROL INITIATIVES MAY NEGATIVELY IMPACT PHARMACEUTICAL PRICING, THEREBY HARMING OUR ABILITY TO COMMERCIALIZE OUR POTENTIAL PRODUCTS.

The levels of revenue and profitability of pharmaceutical companies may be affected by continuing governmental efforts to contain or reduce the costs of health care through various means. For example, in some foreign markets pricing or profitability of prescription pharmaceuticals is already subject to governmental control. In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental control. Cost control initiatives could decrease the price that we or our partners receive for any products that we or they may develop in the future which would adversely affect our business. Further, to the extent that these types of proposals or initiatives have a material adverse effect on our partners or potential partners, our ability to commercialize our potential products may be materially adversely affected.

IF OUR PRODUCTS HARM PEOPLE, WE MAY EXPERIENCE PRODUCT LIABILITY CLAIMS THAT MAY NOT BE COVERED BY INSURANCE.

We face an inherent business risk of exposure to potential product liability claims in the event that drugs, if any, developed through the use of our technology are alleged to have caused adverse effects on patients. This risk exists for products being tested in human clinical trials, as well as products that receive regulatory approval for commercial sale. We will, if appropriate, seek to obtain product liability insurance with respect to drugs developed by us and our partners. We may not, however, be able to obtain insurance. Even if insurance is obtainable, it may not be available at a reasonable cost or in a sufficient amount to protect us against liability. Any successful product liability claims may exceed our financial resources. Further, costs of defending against product liability claims, even if we were to prevail ultimately, may have a material adverse effect on our business and results of operations.

IF WE CANNOT ATTRACT AND RETAIN MANAGEMENT AND SCIENTIFIC STAFF, WE MAY NOT BE ABLE TO PROCEED WITH OUR DRUG DISCOVERY AND DEVELOPMENT PROGRAMS.

We are highly dependent on management and scientific staff, including Mark Skaletsky, our President and Chief Executive Officer, Tim Noyes, our Chief Operating Officer, Paul Mellett, our Senior Vice President and Chief Financial Officer and on our other officers. Considering the time necessary to recruit replacements, if we lose the services of any of the named individuals or other senior management and key scientific staff, we may incur delays in our product development and commercialization efforts or experience difficulties in raising additional funds. We may also lose a significant amount of revenues without the senior staff necessary to adequately maintain existing corporate collaborations or to enter into new collaborations. We do not carry key-man life insurance on any of our executives. We believe that our future success will depend, in part, on our ability to attract and retain highly talented managerial and scientifi