Ligand Pharma. DEFM14A 01.24.07

SEC Filing Excerpt
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[Ligand Logo]

Ligand Pharmaceuticals Incorporated

10275 Science Center Drive
San Diego, California 92121

January 24, 2007

To our stockholders:

You are cordially invited to attend a special meeting of stockholders of Ligand Pharmaceuticals Incorporated to be held at the La Jolla Marriott located at 4240 La Jolla Village Drive, La Jolla, California 92037 on February 12, 2007 at 9:00 a.m., local time.

We have agreed to sell all of our rights in and to AVINZA (morphine sulfate extended-release capsules), in the United States, its territories and Canada to King Pharmaceuticals, Inc. (King), and its wholly-owned subsidiary King Pharmaceuticals Research and Development, Inc. (King R&D), pursuant to an asset purchase agreement, dated as of September 6, 2006, as amended as of November 30, 2006. In exchange for our rights in and to AVINZA, King and King R&D have agreed to pay us $265 million in cash, subject to specific inventory adjustments, assume a payment obligation of Ligand of approximately $48 million (or reimburse Ligand at closing of the asset sale to the extent any such amounts have been paid ) and specified existing royalty obligations to third parties, and pay Ligand certain royalty payments based on Kings annual net sales of AVINZA through AVINZAs patent expiration in November 2017. The full text of the asset purchase agreement is included as Annex A to the proxy statement that accompanies this letter.

The proposed asset sale will not become effective until such time as we receive not less than the minimum number of votes necessary to approve the sale of all or substantially all of our assets, under Delaware law. We have scheduled a special meeting of our stockholders for this vote on February 12, 2007. YOUR VOTE IS VERY IMPORTANT.

After careful consideration, our board of directors has unanimously determined that the proposed sale of assets is in the best interest of Ligand Pharmaceuticals Incorporated and our stockholders. THE BOARD OF DIRECTORS UNANIMOUSLY APPROVED THE PROPOSED SALE AND THE ASSET PURCHASE AGREEMENT AND RECOMMENDS THAT YOU VOTE FOR THE APPROVAL AND ADOPTION OF THE PROPOSED SALE.

We are also asking for your approval of a proposal to amend Ligands 2002 Stock Incentive Plan (the 2002 Plan) to allow equitable adjustments to be made to options outstanding under the 2002 Plan in the event of a payment of a special cash dividend to our stockholders.

Our board of directors has approved the amendment to the 2002 Plan. THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE APPROVAL AND ADOPTION OF THE AMENDMENTS TO OUR 2002 PLAN.

Please review in detail the attached proxy statement for a more complete statement regarding the proposal to approve the asset sale (proposal 1 in this proxy statement), which includes a description of the asset purchase agreement, the background of the decision to enter into the asset purchase agreement, and the reasons that our board of directors has decided to recommend that you approve the asset sale; and the amendment to the 2002 Plan (proposal 2 in this proxy statement).

Your vote is very important to us regardless of the number of shares you own. Whether or not you are able to attend the special meeting in person, please complete, sign and date the enclosed proxy card and return it in the envelope provided as soon as possible. If you hold shares of our common stock directly in your name, you may also grant a proxy using the Internet or by telephone by following the instructions printed on your proxy card. Granting a

proxy by mail, telephone or the Internet will not limit your right to vote in person if you wish to attend the special meeting and vote in person.

On behalf of our board of directors, I thank you for your support and urge you to vote FOR each of the proposals described in this proxy statement.

By Order of the Board of Directors,

/s/ John L. Higgins

John L. Higgins
Chief Executive Officer
San Diego, California

January 24, 2007

The notice and proxy statement are first being mailed to our stockholders on or about January 29, 2007.

Ligand Pharmaceuticals Incorporated

10275 Science Center Drive
San Diego, California 92121

NOTICE OF SPECIAL MEETING OF STOCKHOLDERS

To Be Held On February 12, 2007

To our stockholders:

A special meeting of stockholders of Ligand Pharmaceuticals Incorporated will be held at the La Jolla Marriott located at 4240 La Jolla Village Drive, La Jolla, California 92037 on February 12, 2007 at 9:00 a.m., local time. At this meeting you will be asked:

1. To consider and to vote on a proposal to approve the sale of all or substantially all of our assets under Delaware law through the sale of our rights in and to AVINZA (morphine sulfate extended-release capsules), in the United States, its territories and Canada, pursuant to the asset purchase agreement attached as Annex A to this proxy statement;

2. To consider and to vote on a proposal to amend Ligands 2002 Stock Incentive Plan to allow equitable adjustments to be made to options outstanding under the plan in the event of the payment of a large non-recurring cash dividend;

3. To approve adjournment of the special meeting, if necessary, to facilitate the approval of the preceding proposals, including to permit the solicitation of additional proxies if there are not sufficient votes at the time of the special meeting to establish a quorum or to approve the preceding proposals; and

4. To transact such other business as may properly be brought before the special meeting or any adjournment or postponement thereof.

Our board of directors has approved the amendment to our 2002 Stock Incentive Plan. THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE APPROVAL AND ADOPTION OF THE AMENDMENT TO THE 2002 STOCK INCENTIVE PLAN.

Only holders of record of our common stock at the close of business on January 23, 2007, will be entitled to notice of and to vote at the special meeting or any adjournment thereof. Each share of our common stock is entitled to one vote on each matter to be voted upon at the special meeting.

Your vote is important, regardless of the number of shares you own. The proposed sale of AVINZA will not be completed unless it is authorized by the affirmative vote of the holders of a majority of the outstanding shares of our common stock entitled to vote at the special meeting. Even if you plan to attend the meeting in person, we request that you complete, sign, date and return the enclosed proxy or grant a proxy by the telephone or using the Internet to ensure that your shares will be represented at the meeting if you are unable to attend. Your prompt cooperation will be greatly appreciated.

You are urged to review carefully the information contained in the enclosed proxy statement prior to deciding how to vote your shares at the special meeting.

The notice and proxy statement are first being mailed to stockholders on or about January 29, 2007.

Please follow the voting instructions on the enclosed proxy card to vote either by mail, telephone or electronically by the Internet.

By Order of the Board of Directors,

/s/ Warner R. Broaddus

Warner R. Broaddus
Secretary
San Diego, California

January 24, 2007

SEC Filing Excerpt
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LIGAND PHARMACEUTICALS INCORPORATED
COMPENSATION DISCUSSION AND ANALYSIS

Philosophy and Overview of Compensation

The Companys executive compensation philosophy is intended to provide compensation opportunities that:

Attract, motivate and retain individuals of superior ability and managerial talent critical to its long-term success;

Align executives interests with the Companys corporate strategies, business objectives and the long-term interests of the Companys stockholders;

Create incentives to achieve key strategic and financial performance measures; and

Enhance the executives incentive to increase the Companys stock price and maximize stockholder value.

Unaudited Financial Information

The 2006 financial information that follows has been derived from the Companys books and records. The Companys 2006 Consolidated Financial Statements are currently being prepared and have not yet been subject to audit. Accordingly, the financial information which follows relating to 2006 is unaudited.

Where applicable, the Company expects that the assumptions used in such financial information (for example, the assumptions used to determine stock compensation expense under SFAS 123(R), Share-Based Payment) will be the same as those used in preparing the Companys 2006 Consolidated Financial Statements.

Total Compensation

The compensation package offered to each executive officer is comprised of four elements:

base salary;

annual variable performance bonus awards payable in cash;

long-term stock-based incentive awards; and

employee benefits and perquisites.

These are described in more detail below.

The Role of the Compensation Committee

The Compensation Committee has the primary authority to determine the Companys compensation philosophy and to establish compensation for the Companys executive officers. In determining each level of compensation and the total package, the Compensation Committee reviewed a variety of sources, to determine and set compensation.

The CEO aids the Compensation Committee by providing annual recommendations regarding the compensation of all executive officers, other than himself. Each named executive officer (NEO) and other senior executive management team members, in turn, participates in an annual performance review with the CEO to provide input about his contributions to the Companys success for the period being assessed. The performance of our CEO and senior executive management team as a group is reviewed annually by the Compensation Committee.

As in prior years, the Compensation Committee and the Companys management consulted several independent compensation surveys to assist them in determining market pay practices for compensating executive officers. These surveys were reviewed to compare the Companys compensation levels to the market compensation levels, taking into consideration the other companies size, the industry, the individual executives level of responsibility and his or her years of experience.

Additionally, each year the Compensation Committee consults surveys of the compensation practices of a peer group of companies in the United States. This is necessary so the Company can offer compensation that is

competitive within that group of companies. This peer group consists of 450-500 leading biopharmaceutical companies (including Ligand Pharmaceuticals), including both public and private firms in a range of sizes, stages of development and geographic locations.

The Compensation Committee benchmarks total compensation, as well as annual cash and long-term performance compensation to the median (i.e. 50^th percentile) of executive officers performing similar job functions at companies in our peer group, adjusted to reflect relative company size and performance. However, we strongly believe in retaining the best talent among our senior executive management team. Therefore, the Compensation Committee may approve total compensation packages for senior executive management that vary from the peer group median based on several principal factors. Specifically, officers with relatively less overall experience, less tenure with the Company and/or lower performance ratings over several years will have total compensation set at or below the peer group median. Conversely, if an officer consistently receives favorable performance ratings over successive years, accumulates years of service and expertise with the Company and/or has significant other experience his or her total compensation will typically be above the peer group median. Overall, the Compensation Committee believes that our compensation programs, as structured, are within the market range of our peer group, based on survey information reviewed each year.

Base Compensation

As discussed above, the Company provides its NEOs with a base salary that is structured around the median of base salaries offered by our peer group, but will vary from such level based on:

industry experience, knowledge and qualifications;

the salary levels in effect for comparable positions within the Companys principal industry marketplace competitors; and

internal comparability considerations.

Increases in base salary from year to year are based upon the performance of the executive officers (other than the CEO) as well as market positioning considerations, as assessed by the CEO and approved by the Compensation Committee. The Compensation Committee assesses these factors with respect to the CEO. The Company estimates that the salary levels of our executive officers range from the 50th percentile to the 90th percentile of the salary levels in effect for comparable executive positions at companies in our peer group.

Performance-Based Compensation

Performance Goals

It is the Compensation Committees objective to have a substantial portion of each officers compensation contingent upon the Companys performance as well as upon his or her own level of performance and contribution towards the Companys performance. This allows executive officers to receive bonus compensation in the event certain specified corporate and individual performance measures are achieved.

As an officers level of responsibility increases, it is our intent to have a greater portion of his or her total compensation be dependent upon the Companys performance and stock price appreciation rather than base salary.

In determining the performance compensation awarded to each executive officer, the Company evaluates the Companys and executives performance in a number of areas. The Companys performance is measured on both a short-term and long-term basis, so performance compensation is linked to specific, measurable corporate and individual goals intended to create value for stockholders. In prior years, general criteria for evaluating the performance of the Company included such measures as commercial and research revenue, product development milestones, net stockholder equity and expense control. Individual performance goals include completion of certain projects and achievement of targets in support of the Company goals, by area of responsibility. These include specific inter- and intra- department projects and timely achievement of milestones within those projects, adherence to budget and financial performance targets, and on-time, high-quality execution of recurring department responsibilities.

However, formal metrics for individual and Company goals were not established in 2006 because of the Companys ongoing strategic alternatives evaluation process. Rather, Company and individual performance was measured in terms of the management teams overall success and efficiency in executing and consummating the strategic evaluation process and the transactions that resulted from that process. The Compensation Committee considered, among other factors, the executives contributions to the business and technical evaluations of alternatives, management of the bid process, support of the negotiations and transaction due diligence across each department, consummation of resulting transactions and transition activities before and after consummation.

Annual Performance-Based Cash Compensation

The annual performance-based bonus program consists of a cash award if certain performance criteria are satisfied. The Company sets annual incentive targets around a baseline, which is the median (i.e. 50^th percentile) of annual incentives offered by our Peer Group. Under the Companys program, the potential performance bonus for the CEO is up to 75% of base salary and for the other NEOs is up to 50% of base salary.

Annual bonuses are determined on the basis of the Companys achievement of the corporate performance targets (discussed above) and individual performance targets established for each executive. For each executive officer 50% of the annual award is based on Company performance against pre-set goals, and 50% is based on individual performance against individual pre-set goals.

For fiscal year 2006, the individual goals were designed to support key corporate objectives related to our strategic alternatives process, and the executives were evaluated in relation to their contribution to the attainment of those targets, as discussed above. Accordingly, this element of executive compensation was earned on the basis of the Companys success in executing the strategic process, and the individuals success in supporting that process through individual contributions. Based on the factors described above, in 2006, we determined that the Company had achieved 50% of its goals. Executive officers achieved a median of 83% of their individual goals.

Long-Term Performance-Based Equity Incentive Program

In accordance with its philosophy, the Companys longer term performance-based compensation is based on equity ownership. The Company believes that equity ownership in the Company is important to tie the ultimate level of an executive officers compensation to the performance of the Companys stock and stockholder gains while creating an incentive for sustained growth. To meet these objectives, the Companys senior executive management team is eligible to receive additional grants of performance-based equity compensation upon achieving the same performance criteria described above.

During 2006, we approved a grant of stock options to each of the executive officers, except Dr. Blissenbach, under the 2002 Stock Incentive Plan, based on 2005 performance. The grants are designed to align their interests with those of the stockholders and provide each individual with a significant incentive to manage the Company from the perspective of an owner with an equity stake in the business. The Compensation Committee views granting options as a retention device and therefore also reviews the status of vesting and number of vested verses unvested options at the time of grant. Guidelines for the number of stock options and restricted stock awards granted to each executive officer are determined using a procedure approved by the Compensation Committee based upon several factors, including the executive officers level of responsibility, salary grade, performance and the value of the stock option at the time of grant. The benchmark for these grants is the median level of annual option grants for similar positions at our peer group companies, adjusted using the above factors and taking into consideration such equivalency factors as our number of shares outstanding and market capitalization, compared to the peer group companies.

Each grant allows the officer to acquire shares of common stock at the market price on the grant date over a specified period of time, up to 10 years. Accordingly, the option will provide a return to the executive officer only if the market price of the shares appreciates over the option term.

Stock option grants and other equity incentives, if any, for performance during 2006 have not been determined.

One-time Retention Incentives

In March and October of 2006 the Company entered into letter agreements with a number of its key employees, including each of the NEOs, except Dr. Blissenbach and Mr. Robinson. The agreements provided for certain retention or stay bonus payments in cash and/or stock options if the employee remained employed, with specified conditions, through December 31, 2006. These agreements were implemented as additional incentives for these key employees to remain employed in good standing with the Company in light of circumstances such as the Companys strategic alternatives evaluation process and subsequent asset sales. Awards made under these agreements to NEOs are noted in the relevant tables below.

Discretionary Long-Term Equity Incentive Awards

The Companys executive officers, along with all other Company employees, are eligible to participate in the Companys periodic awards of stock options. For non-executives, these awards include evergreen awards approximately every two years following date of hire. Evergreen awards range from 20% to 50% of the standard new hire option grant for each employees current salary grade, depending on performance.

For executives, the Compensation Committee determines annual awards of additional stock options, if any, based on performance as described above under Long-Term Performance-Based Equity Incentive Program. Additional grants, other than the annual award to executives or evergreen awards to non-executives, may be made following a significant change in job responsibility or in recognition of a significant achievement.

Stock options granted under the various stock plans generally have a four year vesting schedule designed to provide an incentive for continued employment. The options generally expire ten years from the date of the grant. This provides a reasonable time frame during which executive officers and other employees who receive grants can benefit from the appreciation of the Companys shares. The exercise price of options granted under the 2002 Incentive Plan is 100% of the fair market value of the underlying stock on the date of grant.

Other Elements of Compensation and Perquisites

In order to attract, retain and pay market levels of compensation, we provide our NEOs and other employees the following benefits and perquisites.

Medical Insurance. The Company provides to each NEO, the NEOs spouse and children such health, dental and vision insurance coverage as the Company may from time to time make available to its other executives of the same level of employment. The Company pays a portion of the premiums for this insurance for all employees.

Life and Disability Insurance. The Company provides each NEO such disability and/or life insurance as the Company in its sole discretion may from time to time make available to its other executive employees of the same level of employment.

Housing Allowance & Relocation costs. In order to attract and retain management talent, the Company provides relocation benefits, including a housing allowance, to certain executives upon their employment with the Company. The allowance is intended to partially defray the additional cost of housing in the San Diego area, as compared to the executives prior housing costs. There were no relocation reimbursements in 2006.

Deferred Compensation. The Company maintains a Non-Qualified Deferred Compensation Plan, which is unfunded. Members of the Companys senior executive management team are eligible to defer between 2% and 100% of base salary and annual incentive bonus earned under this Non-Qualified Deferred Compensation Plan. Deferred amounts are credited with interest based on the investment options elected by the participants. Benefits are payable upon a fixed date or separation from service, within the meaning of Section 409A of the Internal Revenue Code. However, no benefits are payable prior to the date that is six months after the participants date of separation from service or, if earlier, his death.

Defined Contribution Plan. The Company and its designated affiliates offer the Section 401(k) Savings/Retirement Plan (the 401(k) Plan), a tax-qualified retirement plan, to their eligible employees. The 401(k) Plan permits eligible employees to defer from 1% to 100% of their annual eligible compensation, subject to certain limitations imposed by the Internal Revenue Code. The employees elective deferrals are immediately vested and

non-forfeitable in the 401(k) Plan. The Company currently does not make matching contributions to the 401(k) Plan.

Stock Purchase Plan. The Companys Employee Stock Purchase Plan (the ESPP), which qualifies under Section 423 of the Internal Revenue Code, permits participants to purchase Company stock on favorable terms. ESPP participants are granted a purchase right to acquire shares of common stock at a price that is 85% of the stock price on either the first day of the calendar quarter or the stock price on the last day of the calendar quarter, whichever is lower. The purchase dates occur on the last business days of March, June, September and December of each year. To pay for the shares, each participant may authorize periodic payroll deductions from 1% to 10% of his cash compensation, subject to certain limitations imposed by the Internal Revenue Code. All payroll deductions collected from the participant in a calendar quarter are automatically applied to the purchase of common stock on that quarters purchase date provided the participant remains an eligible employee and has not withdrawn from the ESPP prior to that date.

Other. The Company makes available certain other perquisites or fringe benefits to executive officers and other employees, such as tuition reimbursement, airline club dues, professional society dues and food and recreational fees incidental to official company functions, including board meetings. With the exception of Dr. Blissenbach, who received reimbursement for commuting expenses, set forth in the Summary Compensation Table below, the aggregate of these other benefits was less than $10,000 for each executive officer in the last fiscal year.

CEO Compensation.

In July 2006, Dr. Blissenbach was elected Chairman and interim CEO following the resignation of our former CEO, Mr. Robinson. In setting Dr. Blissenbachs compensation, the Compensation Committee sought to tie a significant percentage of his compensation to the Companys near-term goals but still be competitive with other companies in the industry and recognize the interim nature of his appointment. A previously-disclosed employment agreement between the Company and Dr. Blissenbach sets forth the terms and conditions, including compensation, governing Dr. Blissenbachs employment. These terms include a base salary of $40,000 per month.

The remaining components of Dr. Blissenbachs compensation, namely an option to purchase 150,000 shares of common stock and a cash performance bonus of up to $100,000, however, are contingent upon attaining certain goals. For the performance bonus opportunity, these are: (a) recruit and appoint a successor CEO (b) complete strategic transaction(s) approved by the Board (c) before October 31, 2006 attain a positive cash flow net of debt in excess of $30 million by completion of real estate transaction; and (d) retain key personnel. The final award of that cash bonus has not yet been determined. Dr. Blissenbachs option to purchase 150,000 shares of stock vests 100% upon the hiring of a successor CEO or, if later, 50% after 6 months and 50% after 1 year. No cash bonus was paid to Dr. Blissenbach in the 2006 fiscal year. Dr. Blissenbach also receives reimbursement for his commuting expenses, including tax reimbursement or gross up.

Prior to his resignation, the Compensation Committee established Mr. Robinsons base salary upon its evaluation of his personal performance and the Companys intention that his base salary keep pace with salaries being paid to similarly situated chief executive officers. We estimate that his base salary was at the 75th to 90th percentile of the salary levels paid to such other chief executive officers.

No cash bonus was paid to Mr. Robinson for the 2006 fiscal year. Mr. Robinson received severance benefits under the terms of his employment and separation agreements as more fully outlined below.

We announced in January 2007 the appointment of John L. Higgins as President, Chief Executive Officer and director. Mr. Higgins was most recently Chief Financial Officer, Executive Vice President, Finance, Administration and Corporate Development of Connetics Corporation, a public specialty pharmaceutical company. We have entered into an employment agreement with Mr. Higgins that includes the following principal elements of compensation:

base salary of $400,000 per year;

performance bonus opportunity with a target of 50% of salary, up to a maximum of 75%;

restricted stock grant of 150,000 shares, vesting over 2 years;

eligibility for future discretionary, performance-based stock or option grants;

lump-sum relocation benefit of $100,000;

ordinary severance (i.e. involuntary termination for cause or voluntary termination with good cause, without a change of control) of 18 months salary, continuation of health benefits, and acceleration of stock and option vesting;

change of control severance of 2 years salary, plus average annual bonus, continuation of health benefits, and acceleration of stock and option vesting.

Severance Arrangements

In September 1996, the Company entered into an employment agreement with Dr. Negro-Vilar pursuant to which he is employed as Executive Vice President, Research & Development and Chief Scientific Officer for an unspecified term. In the event his employment is terminated without cause, he will be entitled to 12 months of salary continuation payments, and all of his outstanding options will immediately vest and become exercisable for all of the option shares.

The Company has entered into agreements with each of the other NEOs (other than Dr. Blissenbach and Mr. Robinson) providing each of them will be entitled to 6 months salary in the event his employment is terminated without cause.

In May 1996, the Company entered into an employment agreement with Mr. Robinson pursuant to which he was employed as President and Chief Executive Officer. This agreement automatically renewed for three years on May 1, 2005. Under the agreement, in the event his employment was terminated without cause, Mr. Robinson was entitled to a severance payment equal to 24 months of base salary, at the rate in effect for him at the time of such termination, health benefits for 24 months and the accelerated vesting of all of his outstanding options, except under certain limited circumstances.

Upon his resignation in July 2006 and pursuant to a Separation Agreement with Company, Mr. Robinson received as severance benefits 24 months base salary and continuation of health benefits for 24 months under COBRA, plus accelerated vesting of all outstanding options.

We do not have a severance agreement or other arrangement with Dr. Blissenbach. Each of the severance agreements are intended to be competitive within our industry and company size, and thus to attract highly qualified individuals and encourage them to remain employed by the Company. These agreements were of added importance during 2006, in order to retain our senior executives as we initiated and executed our strategic alternatives evaluation and transactions.

Change of Control Arrangements

In addition to the above agreements, the Company has a change-of-control severance agreement with each of the Named Executive Officers other than Mr. Robinson and Dr. Blissenbach. In the event their employment is involuntarily terminated in connection with a change of control of the Company, these individuals receive a severance benefit equal to

one times the annual rate of base salary in effect for such officer at the time of involuntary termination plus

one times the average of bonuses paid to such officer for services rendered in the two fiscal years immediately preceding the fiscal year of involuntary termination.

The severance amount will be payable in a lump sum following the officers termination of employment. The change-of-control severance agreements also accelerate the vesting of all outstanding options and extend the option exercise period from 3 months to one year post-termination.

The proposed asset sale will be a change of control under these change of control severance agreements. Therefore the NEOs (other than Dr. Blissenbach and Mr. Robinson) would be eligible for severance under these agreements if there is an involuntary termination of their employment in connection with this transaction.

Option agreements under the 2002 Plan, which cover each of the NEOs, provide that such options will automatically vest in the event that any of the following occur and the option is not assumed or replaced by a successor:

a merger, consolidation or reorganization of the Company in which 50% or more of its voting securities change ownership;

the sale, transfer or other disposition of all or substantially all of the Corporations assets in complete liquidation or dissolution of the Corporation, or

a change in control of the Company effected through a successful tender offer for more than 50% of the Companys outstanding common stock or through a change in the majority of the Board as a result of one or more contested elections for Board membership.

The proposed asset sale is not a change of control for purposes of the option agreements or the 2002 Plan.

Compensation Recovery Policy

The Board maintains a policy that it will evaluate in appropriate circumstances whether to seek the reimbursement of certain compensation awards paid to an executive officer if such executive engages in misconduct that caused or partially caused a restatement of financial results, in accordance with section 304 of the Sarbanes-Oxley Act of 2002. If circumstances warrant, we will seek to claw back appropriate portions of the executive officers compensation for the relevant period, as provided by law.

Policies with Respect to Equity Compensation Awards

The Company grants all equity incentive awards based on the fair market value as of the date of grant. The exercise price for stock option grants and similar awards is determined by reference to the last quoted price per share on the NASDAQ Global Market at the close of business on the date of grant.

Option awards under the compensation programs discussed above are made at regular Compensation Committee meetings and at special meetings as needed. For example, a special meeting may be called if a regular meeting is cancelled or following the annual performance review process. The effective date for such grants is the date of such meeting. The Company may also make grants of equity incentive awards at the discretion of the Compensation Committee or the board of directors in connection with the hiring of new NEOs and other employees.

Policies Regarding Tax Deductibility of Compensation

Within its performance-based compensation program, the Company aims to compensate the NEOs in a manner that is tax-effective for the Company. Section 162(m) of the Internal Revenue Code restricts the ability of publicly held companies to take a federal income tax deduction for compensation paid to certain of their executive officers to the extent that compensation exceeds $1.0 million per covered officer in any fiscal year. However, this limitation does not apply to compensation that is performance-based.

The non-performance based compensation paid in cash to the Companys executive officers for the 2006 fiscal year did not exceed the $1.0 million limit per officer, and the Compensation Committee does not anticipate that the non-performance based compensation to be paid in cash to the Companys executive officers for fiscal 2007 will exceed that limit.

In addition, the 2002 Stock Incentive Plan has been structured so that any compensation paid in connection with the exercise of options grants under that plan with an exercise price equal to the fair market value of the option shares on the grant date will qualify as performance-based compensation. Therefore, it will not be subject to the $1.0 million deduction limitation.

Summary Compensation Table

The total compensation paid to the Companys Chief Executive Officer, Chief Financial Officer, each of the three most highest compensated executive officers other than the Chief Executive Officer and Chief Financial Officer and for Mr. Robinson, the former CEO and Chairman for services rendered to the Company in 2006 is summarized as follows:


									Non-Equity
							Option		Incentive Plan		All Other
			Salary		Bonus		Awards		Compensation		Compensation
Name and Principal Position	Year		($)		($)(3)		($)(4)		($)(5)		($)(6)		Total ($)

Dr. Blissenbach,		2006	$	200,000	$	0	$	453,729	$	0	$	55,422	$	709,151
Chairman and interim CEO(1)
Mr. Maier		2006	$	347,000	$	111,667	$	180,725	$	107,353	$	11,911	$	758,656
Senior Vice President and Chief Financial Officer
Mr. Robinson		2006	$	401,250	$	0	$	871,842	$	0	$	1,508,698	$	2,781,790
Former Chairman and Chief Executive Officer(2)
Dr. Negro-Vilar		2006	$	471,000	$	150,000	$	188,945	$	145,716	$	16,447	$	972,108
Senior Vice President & CSO
Dr. Meglasson		2006	$	292,000	$	91,000	$	183,057	$	90,338	$	27,742	$	684,137
Vice President, Research
Mr. Broaddus		2006	$	309,000	$	95,333	$	139,724	$	95,597	$	4,000	$	643,654
Vice President & General Counsel

Footnotes to Summary Compensation Table

(1) Dr. Blissenbach was appointed Chairman and interim CEO effective August 1, 2006, following the resignation of Mr. Robinson. Option Award includes $72,509 of compensation related to stock options granted to Dr. Blissenbach for his service as a non-employee director prior to his appointment as interim CEO. Dr. Blissenbach received $22,746 in reimbursement of commuting expenses, $10,926 for gross-up of taxes, and $21,750 in non-employee director fees earned prior to his appointment as interim CEO, which amounts are reflected in the All Other Compensation column. In August 2006, Mr. Blissenbach was also awarded a performance bonus opportunity of up to $100,000 payable upon the completion of certain milestones: (a) recruit and appoint a successor CEO; (b) complete strategic transaction(s) approved by the Board; (c) before October 31, 2006 attain a positive cash flow net of debt in excess of $30 million by completion of real estate transaction; and (d) retain key personnel. The final award of that bonus has not yet been determined, however, subject to compensation committee approval, we believe Dr. Blissenbach achieved milestones (c) and (d) in 2006 and milestone (a) in January 2007.

(2) Mr. Robinson served as Chairman, President and CEO until his resignation on July 31, 2006. Pursuant to his Separation Agreement, Mr. Robinson received a lump sum severance payment of $1,410,000, plus $81,343 for accrued vacation, which amounts are included in the All Other Compensation column. The balance of the amount shown as All Other Compensation represents $1,355 in life insurance and $16,000 in medical insurance premiums.

(3) Represents bonus awards for 2006 under the Companys retention bonus plan.

(4) Represents the stock option expense for each NEO for fiscal 2006, determined under Statement of Financial Accounting Standards (SFAS) 123 (revised 2004), Share-Based Payment (SFAS 123(R)). Effective January 1, 2006, we adopted SFAS 123(R) using the modified prospective transition method. No stock-based employee

compensation cost was recognized prior to January 1, 2006, as all options granted prior to 2006 had an exercise price equal to the market value of the underlying common stock on the date of the grant. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R). Under the transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted in 2006, based on grant-date fair value estimated in accordance with the provisions of SFAS 123(R).

There were no stock awards made or outstanding for any NEO in 2006.

The fair value for options that were awarded to the directors and officers was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:


	2006	2005	2004	2003

Risk-free interest rates	4.76%	4.35%	3.61%	3.25%
Dividend Yield
Expected Volatility	70%	72%	74%	74%
Expected Term	5.90 years	5 years	5 years	5 years

In connection with Mr. Robinsons resignation on July 31, 2006, each of his unvested options was immediately vested and the exercise period for all of his outstanding options was extended to January 15, 2007. For purposes of valuing these modifications, we used an expected term of 5.5 months and an expected volatility of 50%.

The expected term of the options is the estimated weighted-average period until exercise or cancellation of vested options (forfeited unvested options were not considered). SAB 107 guidance permits companies to use a safe harbor expected term assumption for grants up to December 31, 2007 based on the mid-point of the period between vesting date and contractual term, averaged on a tranche-by-tranche basis. We used the safe harbor in selecting the expected term assumption for 2006.

Volatility is a measure of the expected amount of variability in the stock price over the expected life of an option expressed as a standard deviation. SFAS 123(R) requires an estimate of future volatility. In selecting this assumption, we used the historical volatility of the Companys stock price over a period equal to the expected term.

(5) Represents performance bonus awards under the Management Bonus Plan earned in 2006, but paid in 2007.

(6) For each named executive officer other than Dr. Blissenbach, Mr. Robinson and Dr. Meglasson, represents life insurance and medical insurance premiums paid by the Company. The amounts for Dr. Blissenbach and Mr. Robinson are described in the footnotes above. For Dr. Meglasson, the amount represents $11,750 of housing allowance, $13,670 in medical insurance premiums and $2,322 in life insurance premiums.

Narrative to Summary Compensation Table

See Compensation Discussion and Analysis above for complete description of compensation plans pursuant to which the amounts listed under the Summary Compensation Table and Grants of Plan Based Awards Table were paid or awarded and the criteria for such payment.

All options vest and become exercisable upon a change in control, as defined in the 2002 Stock Incentive Plan.

Grants of Plan-Based Awards in Fiscal Year 2006


																	Option
																	Awards:
																	Number				Grant
					Estimated Future Payouts												of		Exercise or		Date Fair
			Compen-		Under Non-Equity Incentive						Estimated Future Payouts Under						Securities		Base Price		Value of
			sation		Plan Awards						Equity Incentive Plan Awards						Under-		of Option		Option
	Grant		Committee		Threshold		Target				Threshold				Maximum		lying		Awards		Award
Name	Date		Action		($)		($)		Maximum ($)		(#)		Target (#)		(#)		Options (#)		($/Sh)		($)

Dr. Blissenbach(1)		1/31/06		1/31/06														10,000	$	12.40	$	77,440
		8/3/06		7/31/06								0		150,000		0			$	9.20	$	876,300
		9/27/06		9/27/06														10,000	$	10.10	$	64,380
		8/1/06		8/1/06	$	0	$	100,000	$	100,000
Mr. Maier		3/10/06		3/10/06														20,000	$	11.90	$	157,820
Mr. Robinson		3/10/06		3/10/06														50,000	$	11.90	$	394,500
Dr. Negro-Vilar		3/10/06		3/10/06														25,000	$	11.90	$	197,275
Dr. Meglasson		3/10/06		3/10/06														25,000	$	11.90	$	197,275
Mr. Broaddus		3/10/06		3/10/06														25,000	$	11.90	$	197,275

Footnotes to Grants of Plan Based Awards Table

(1) Option awards to Dr. Blissenbach on 1/31/06 and 9/27/06 were in connection with his service as a non-employee director. In August 2006, Mr. Blissenbach was awarded a performance bonus opportunity of up to $100,000 payable upon the completion of certain milestones: (a) recruit and appoint a successor CEO; (b) complete strategic transaction(s) approved by the Board; (c) before October 31st attain a positive cash flow net of debt in excess of $30 million by completion of real estate transaction; and (d) retain key personnel. The final award of that bonus has not yet been determined. On August 3, 2006, Dr. Blissenbach was awarded an option to purchase 150,000 shares of stock which vests 100% upon the hiring of a successor CEO or, if later, 50% after 6 months and 50% after 1 year.

Narrative to Grants of Plan Based Awards Table

See Compensation Discussion and Analysis above for complete description of the targets for payment of annual incentives, as well as performance criteria on which such payments were based. The Compensation Discussion and Analysis also describes the options and restricted stock grants.

Except as otherwise noted, all stock options vest over four years beginning on the grant date, with the first vesting occurring 6 months after the grant date.

Outstanding Equity Awards at Fiscal Year-End

The following table provides information on all restricted stock, stock option and SAR awards (if any) held by the named executive officers of the Company as of December 31, 2006. All outstanding equity awards are in shares of the Companys Common Stock.

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END


	Option Awards (1)(2)
					Equity Incentive
					Plan Awards:
	Number of		Number of		Number of
	Securities		Securities		Securities
	Underlying		Underlying		Underlying
	Unexercised		Unexercised		Unexercised		Option		Option
	Options (#)		Options (#)		Unearned Options		Exercise		Expiration
Name	Exercisable		Unexercisable		(#)		Price ($)		Date

Dr. Blissenbach(3)		0		10,000				10.10		9/27/16
		0		0		150,000		9.20		8/03/16
		0		10,000				12.4000		1/31/16
		2,009		0				3.7330		1/03/15
		10,000		0				17.1600		6/11/14
		1,507		0				4.9762		1/2/14
		10,000		0				13.3900		6/20/13
		4,113		0				1.8232		1/2/13
		10,000		0				16.6900		5/15/12
		857		0