<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                              ---------------------

                                    FORM 10-K405
                              ---------------------
(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, 1997
                                       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

                         MICROCIDE PHARMACEUTICALS, INC.
             (Exact name of registrant as specified in its charter)

               DELAWARE                                         94-3186021
     (State or other jurisdiction                            (I.R.S. Employer
   of incorporation or organization)                      Identification Number)

  850 MAUDE AVENUE, MOUNTAIN VIEW, CA                             94043
(Address of principal executive office)                         (Zip Code)

       Registrant's telephone number, including area code: (650) 428-1550

        Securities registered pursuant to Section 12(b) of the Act: None

           Securities registered pursuant to Section 12(g) of the Act:

                     COMMON STOCK, $.001 PAR VALUE PER SHARE
                                (Title of Class)

        Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 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. [X]

        The aggregate market value of the voting stock of the issuer held by
non-affiliates of the issuer on December 31, 1997 was approximately $75 million,
based upon the closing price of such stock on December 31, 1997.

        As of March 1, 1998, 10,907,043 shares of Common Stock of the registrant
were outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

        Certain information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated by reference from the Registrant's Proxy Statement for the 1998
Annual Meeting of Stockholders, which will be filed with the Securities and
Exchange Commission within 120 days after the close of the Registrant's fiscal
year ended December 31, 1997.


<PAGE>   2

                                     PART I

ITEM 1. BUSINESS

INTRODUCTION

        Microcide is a biopharmaceutical company whose mission is to discover,
develop and commercialize novel antimicrobials for the improved treatment of
serious bacterial, fungal and viral infections. The Company's discovery and
development programs address the growing problem of bacterial drug resistance
and the need for improved antifungal and antiviral agents through two principal
themes: (i) Targeted Antibiotics, which focuses on developing novel antibiotics
and antibiotic potentiators to directly address existing bacterial resistance
problems, and (ii) Targeted Genomics, which utilizes bacterial, fungal and viral
genetics to discover new classes of antimicrobials and other novel treatments
for infectious diseases.

        The Company believes that the antibiotics market provides an attractive
opportunity for its research and development activities because (i) it is the
third largest pharmaceutical market, with systemic antibiotics in 1997 totaling
$22.4 billion in worldwide sales, including $6.7 billion in the United States;
(ii) there are significant unmet clinical needs, caused by growing bacterial
resistance problems, that require new antibacterial therapies; and (iii) the
preclinical and clinical development process for antibiotics generally follows
an efficient and well-defined path to the market. The Company believes that the
systemic antifungals market, totaling approximately $2.3 billion in 1997, also
represents an attractive opportunity because there currently are relatively few
effective and non-toxic agents to treat the growing population of
immunocompromised patients with systemic fungal infections. Despite recent
progress by industry in introducing new antiviral agents, which have contributed
to the market expanding 33% in 1997 to $3.4 billion, the Company believes that
there is a clear clinical need for additional and improved treatments for viral
infections.

        Microcide's Targeted Antibiotics programs seek to rapidly develop
clinically useful antibiotics tailored to treat specific bacterial infections,
as well as antibiotic potentiators, to overcome resistance pathways and restore
usefulness to existing antibiotics that have been rendered ineffective. The
specific problematic bacteria being addressed by the Company (staphylococci,
enterococci, Pseudomonas aeruginosa and Streptococcus pneumoniae) are
responsible for 44% of the approximately two million hospital-acquired
infections occurring annually in the United States. These infections are
estimated to result in approximately eight million days of extended hospital
stay and account for more than $4.0 billion in additional health care costs each
year.

        Microcide's Targeted Genomics programs seek to identify and exploit the
pharmaceutically relevant portions of bacterial genomes that are essential to
bacterial viability in vitro (the Bacterial Essential Genes Program), to fungal
viability in vitro (the Fungal Genomics Program) or to bacterial growth and
virulence in vivo (the Bacterial Pathogenesis Program). In the Bacterial
Essential Genes Program, Microcide has identified over 100 essential gene
targets, which have been selectively incorporated into the Company's
high-throughput, multi-channel screening system to discover new classes of
antibiotics. In the Fungal Genomics Program, a library of over 1,100 essential
gene mutants has been constructed, a subset of which is selectively being
incorporated into the Company's high-throughput, whole-cell assay system to
search for small molecule antifungal agents. In the Bacterial Pathogenesis
Program, Microcide has developed new molecular genetics technologies in order to
discover and develop novel therapeutic agents based on interference with the
function of bacterial pathogenesis genes. Microcide is establishing, in concert
with Iconix Pharmaceuticals, Inc., a Viral Genomics Program based on applying
surrogate genetic technologies to the creation of drug screens for a number of
viral disease targets in the search for improved antiviral agents.


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        The Company has entered into collaborative agreements with three major
pharmaceutical companies to enhance certain of its discovery and development
programs. As of December 31, 1997, the Company's collaborative partners have
provided the Company with $30.1 million of license fees, milestone payments and
research support payments and $10.0 million in equity investments. Assuming each
of the collaborative agreements continues until its scheduled expiration
(including the Daiichi collaboration for which Daiichi has notified Microcide of
its intention to exercise its option to extend the collaboration for an
additional year beyond the original term), the Company will be entitled to
receive an additional $20.9 million of research support payments. The Company
has retained full rights to products which may result from its internal,
self-funded programs in bacterial cell wall inhibitors, bacterial pathogenesis
genes, fungal efflux pumps and fungal genomics.

        J&J. Microcide established a collaboration in October 1995 with
Ortho-McNeil Pharmaceuticals and the R.W. Johnson Pharmaceutical Research
Institute (each of which are affiliates of Johnson & Johnson and are
collectively referred 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. The Company and J&J selected an initial
beta-lactam drug candidate for pre-clinical development in October 1996 and the
Company expects to enter into clinical trials with respect to such product
candidate in 1998. If specified research and development milestones are
achieved, the Company will be entitled to receive up to $16.5 million for the
initial product and up to $15.5 million for each subsequent product developed
within the collaboration.

        Daiichi. Microcide 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 pseudomonas. The Company expects to select with Daiichi its
first quinolone potentiation candidate in 1998 for subsequent pre-clinical
development. If specified research and development milestones are achieved,
Microcide will be entitled to receive up to $13.0 million for each product
developed within the collaboration.

        Pfizer. Microcide established a collaboration in March 1996 with Pfizer
to implement its essential gene and multi-channel screening system to discover
novel classes of antibiotics. If specified research and development milestones
are achieved, Microcide will be entitled to receive milestone payments of up to
$32.5 million for each product developed within the collaboration.

        In January 1998, Microcide entered into a collaboration with Iconix
Pharmaceuticals, Inc. ("Iconix"), a recently established biotechnology company
of which Microcide is a significant minority shareholder and which has licensed
or been assigned certain technology related to surrogate genetics ("Surrogate
Genetics Technology") from Microcide. Iconix will apply the Surrogate Genetics
Technology of Iconix to a number of viral disease targets to search for novel
antiviral agents. Microcide is obligated to provide Iconix with research support
payments of $6.1 million over the three years of the collaboration. Microcide
has been granted worldwide development, manufacturing and marketing rights to
antiviral products which may emerge from the collaboration and, if specified
research and development milestones are achieved, Iconix will be entitled to
receive milestone payments from Microcide of up to $11.0 million for the first
product and up to $10.5 million for each subsequent product developed within the
collaboration.

        The information set forth in this Business Section contains
forward-looking statements, including but not limited to statements concerning
the use of the Company's discoveries and technology platform to identify
potential product candidates, expectations regarding the anticipated date of
selection of clinical development candidates, the expected date of commencement
of clinical trials, development time lines, the timing and likelihood of
regulatory approval, the continuation of the Company's collaborations with its
net investments partners, the Company's future capital requirements and the
expected time period during which the Company's existing financial resources
will meet such capital requirements, and business conditions and


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growth in the biopharmaceutical industry and general economy. The Company's
actual results could differ materially from those anticipated in these
forward-looking statements as a result of the factors set forth in this Business
Section, as well as those set forth elsewhere in this Form 10-K.

        The Company was founded in December 1992, has not commenced clinical
trials of any drugs and does not expect that any drugs resulting from its and
its collaborative partners' research and development efforts will be
commercially available for a significant number of years, if at all. Since
inception, the Company has focused its activities on the development of a gene
function-based technology platform and other proprietary information to identify
and commercialize novel antimicrobials for the treatment of serious infections.
It is difficult to predict when, if ever, the Company will be able to
successfully discover novel lead compounds for potential development as product
candidates. All compounds discovered by the Company will require extensive
preclinical and clinical testing prior to submission of any regulatory
application for commercial use. Extensive preclinical and clinical testing
required to establish safety and efficacy will take a number of years, and the
time required to commercialize new drugs cannot be predicted with accuracy.
There can be no assurance that the Company's approach to drug discovery, or the
efforts of any collaborative partner of the Company, will result in the
development of any drugs, or that any drugs, if successfully developed, will be
proven to be safe and effective in clinical trials, 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 product development efforts of the Company or its
collaborative partners and have a material adverse effect on the Company's
operations. The Company will not receive revenues or royalties from sales of
drugs for a significant number of years, if at all. Failure to receive
significant revenue or achieve profitable operations could impair the Company's
ability to sustain operations, and there can be no assurance that the Company
will ever receive significant revenues or achieve profitable operations.

INFECTIOUS DISEASE ENVIRONMENT

        BACTERIAL INFECTIONS AND ANTIBIOTICS OVERVIEW

        Bacterial infections are a significant and growing medical problem. They
occur when the body's immune system cannot prevent the invasion and colonization
of the body by disease-causing bacteria. These infections may either be confined
to a single organ or tissue, or disseminated throughout the body, and can cause
many serious diseases, including pneumonias, endocarditis, osteomyelitis,
meningitis, deep-seated soft tissue infections, bacteremia and complicated
urinary tract infections.

        According to estimates from the United States Centers for Disease
Control and Prevention (the "CDC") for the period 1980 to 1992, approximately
two million hospital-acquired infections occurred annually in the United States,
accounting for more than eight million days of extended hospital stay and
causing more than $4.0 billion in additional health care costs each year. While
overall per capita mortality rates declined in the United States from 1980 to
1992, the per capita mortality rate due to infectious diseases increased 58%
over this period, making infectious diseases the third leading cause of death in
the United States. The Company believes that bacterial infections, especially
infections caused by difficult-to-treat, antibiotic-resistant bacteria, cause or
contribute to a substantial majority of these deaths.

        Antibiotics are administered both to prevent bacterial infections and to
treat established bacterial diseases. When administered to prevent an infection,
antibiotics are given prophylactically, before definitive clinical signs or
symptoms of an infection are present. When administered to treat an established
infection, antibiotics are often chosen empirically, before diagnostic testing
has established the causative bacterium and its susceptibility to specific
antibiotics.


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        Antibiotics work by interfering with a vital bacterial cell function at
a specific cellular target, either killing the bacteria or arresting their
multiplication, thereby allowing the patient's immune system to clear the
bacteria from the body. Currently available antibiotics work on relatively few
targets, through mechanisms such as inhibiting protein or cell wall synthesis.
These targets tend to be present in all bacteria and are highly similar in
structure and function, such that certain antibiotics kill or inhibit growth of
a broad range of bacterial species (i.e., broad-spectrum antibiotics).

        Major structural classes of antibiotics include beta-lactams,
fluoroquinolones, macrolides, tetracyclines, aminoglycosides, glycopeptides and
trimethoprim combinations. Penicillin, a member of the beta-lactam class (which
also includes extended-spectrum penicillins, cephalosporins and carbapenems),
was first developed in the 1940s. Nalidixic acid, the earliest member of the
quinolone class, was discovered in the 1960s. The creation of broad-spectrum
antibiotics began in the 1970s and 1980s, with major advances seen in the 1970s
with the development of newer beta-lactams, and in the 1980s with the
development of fluoroquinolones. These antibiotics are still being used
extensively. No major new class of antibiotics has been discovered and
commercialized in the last 20 years.

        According to sales data compiled by IMS International, an independent
pharmaceutical industry research firm, the market for systemic (orally or
parenterally administered) antibiotics constitutes the third largest worldwide
pharmaceutical market, generating $22.4 billion in worldwide sales in 1997,
including $6.7 billion in the United States. The in-hospital antibiotic market,
where bacterial resistance poses the most serious threat, totaled $7.3 billion
worldwide during this period.

        FUNGAL INFECTIONS

        Systemic fungal infections are becoming an increasing medical problem,
especially among patients whose immune systems are compromised due to cancer
chemotherapy, transplantation or AIDS. Despite the limitations of existing
therapeutics, systemic antifungal agents generated worldwide sales of
approximately $2.3 billion in 1997, according to IMS International. The two
major classes of clinically important systemic antifungal agents utilize
essentially only two targets: ergosterol (membrane) and cell wall biosynthesis.
Amphotericin B, while fungicidal, has toxicity limitations in many patients. In
contrast, the azole class of compounds is limited by suboptimal efficacy in the
treatment of deep-seated fungal infections in immunocompromised patients, due to
its fungistatic mode-of-action and emerging drug resistance.

        VIRAL INFECTIONS

        Viral infections are also a major medical problem. The World Health
Organization estimates that over 8 million people have been afflicted with AIDS
and that over 25 million people are currently infected with HIV. It has been
estimated that over 300 million people are carriers of the Hepatitis B virus, an
infection that results in progressive liver damage, cirrhosis and liver cancer.
An estimated 60 million people are infected with Hepatitis C, a viral infection
with similarities to both HIV and Hepatitis B. In addition, viruses are
responsible for the flu and many colds, which while generally less serious from
a health perspective, are widely prevalent. According to IMS International,
worldwide sales in 1997 of antiviral therapeutics, excluding vaccines, were $3.4
billion which represented a 33% increase from 1996.

        ANTIBIOTIC RESISTANCE PROBLEMS

        One of the key contributors to the increase in mortality and morbidity
due to bacterial infections is the increasing prevalence of drug-resistant
bacteria. Evidence of bacterial resistance to penicillin was first seen in the
1940s shortly after its introduction. Methicillin and subsequent
second-generation penicillins were developed to overcome these
penicillin-resistant organisms, but resistance to methicillin


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in turn began to occur in the 1970s shortly after its release, and has continued
to increase. Similar resistance problems are now seen with a number of
clinically important bacteria targeted by the Company's initial products,
including staphylococci, enterococci, pseudomonas and pneumococci. Strains of
these bacteria have become resistant to all but a few antibiotics. According to
estimates based on CDC data, these four groups of bacteria are responsible for
44% of all hospital-acquired infections and for 63% of hospital-acquired blood
stream infections in the United States.

        A number of factors are believed to contribute to the increased rate of
bacterial drug resistance: (i) physician reliance on broad-spectrum antibiotics
for empiric treatment of an infection before it is definitively diagnosed; (ii)
repeated exposure of bacteria to long-term antibiotic therapy, providing a
competitive advantage to bacteria harboring drug resistance; (iii) the
increasing number of immunosuppressed patients (from cancer chemotherapy, AIDS
and organ transplantation); (iv) the growing number of institutionalized, often
elderly, patients receiving multiple courses of antibiotics; (v) the increased
frequency of invasive medical procedures; and (vi) societal and technological
changes, including air travel, that accelerate the spread of drug-resistant
bacteria.

        One example of the seriousness of antibiotic resistance is
methicillin-resistant staphylococci ("MRS"), which has become resistant to
virtually all currently used antibiotics, except vancomycin. The heavy use of
vancomycin to treat MRS infections has probably in turn contributed to the
emergence of new strains of enterococci, the third most prevalent cause of
bacterial infection in hospitals in the United States, which are resistant to
vancomycin. Infections caused by these vancomycin-resistant enterococci ("VRE")
frequently do not respond to any current therapies, and in many cases prove
fatal. The transfer of vancomycin resistance from enterococci to staphylococci
has been demonstrated experimentally. If vancomycin resistance is transferred in
the clinical setting by VRE to staphylococci, the leading cause of
hospital-acquired bacterial infections, no effective antibiotic therapy will
remain to treat MRS infections. The first report of vancomycin intermediate
resistant Staphylococcus aureus in a clinical setting occurred in 1997 in Japan,
followed by subsequent reports of strains with decreased susceptibility in
patients in Michigan and New Jersey; although caused by a different
mechanism-of-action than occurs in VRE, the Company believes that these reports
are suggestive of future resistance problems.

        As a result of increasing bacterial resistance to existing antibiotics,
numerous clinical infections occur that resist first-line therapy. When bacteria
develop resistance to established first-line antibiotics, it is often necessary
to use a combination of two drugs, or multiple antibiotic therapy of three or
more drugs, to treat these resistant infections. Such combination or multiple
antibiotic therapy is generally more costly and potentially more toxic to the
patient due to additive and sometimes synergistic side effects. The table below
outlines some of the major problematic drug-resistant bacteria, the classes of
antibiotics to which they already show clinically significant levels of
resistance, and the remaining recommended treatments:


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<TABLE>
<CAPTION>
        ---------------------------------------------------------------
                     PROBLEMATIC DRUG-RESISTANT BACTERIA
<S>                            <C>               <C>
                               Clinically
                               Significant
                               Resistance        Remaining
        Bacteria               Problems          Recommended Treatment
        ---------------------------------------------------------------
          Staphylococcus sp.   Beta-lactams      Vancomycin
                               Fluoroquinolones  Combination Therapy
                               Aminoglycosides
                               Macrolides
        ---------------------------------------------------------------
          Enterococcus sp.     Beta-lactams      Multiple Antibiotic
                               Aminoglycosides   Therapy
                               Glycopeptides
        ---------------------------------------------------------------
          Pseudomonas          Beta-lactams      Combination Therapy
          aeruginosa           Fluoroquinolones
                               Aminoglycosides
        ---------------------------------------------------------------
          Streptococcus        Beta-lactams      Cephalosporin or
          pneumoniae           Macrolides        Carbapenem
                               Tetracyclines     Vancomycin
                                                 Fluoroquinolones
        ---------------------------------------------------------------
</TABLE>
STRATEGY

        The Company believes that the antibiotics market provides an attractive
opportunity for its research and development activities because (i) there are
significant unmet clinical needs caused by growing bacterial resistance problems
that require new antibacterial therapies and (ii) the preclinical and clinical
development process for antibiotics typically follows an efficient and
well-defined path to the market, with early testing generally predictive of
later stage results. The Company believes these factors will lead to shorter
overall development timelines and higher approval rates for its products than
for products in most other therapeutic categories. Microcide's strategy is to
focus near-term preclinical research activities on drug resistance mechanisms
and to conduct longer-term drug discovery using novel antibacterial targets
identified through its Targeted Genomics programs. In addition, the Company has
extended its genetic discovery technology platform beyond bacteria to include
fungi and viruses. The Company's strategy is comprised of the following five key
elements:

        Develop Novel Antibiotics by Targeting Drug Resistance Mechanisms.
Microcide's near-term research programs focus on rapidly identifying and
optimizing proprietary compounds that are effective against problematic
antibiotic-resistant bacteria, notably MRS, VRE, beta-lactam-resistant
pneumococci and quinolone-resistant pseudomonas. Since antibiotic resistance
problems are often due to a single defined pathway, the Company believes that
targeting those pathways will enable it to rapidly develop novel antibiotics
tailored to specific resistant bacteria, as well as to develop antibiotic
potentiators that overcome resistance mechanisms and restore the usefulness of
established antibiotics that have been rendered ineffective. The Company's
Gram-Positive, Bacterial Efflux Pump, Bacterial Cell Wall and Fungal Efflux Pump
programs are focused in this area.

        Accelerate the Discovery of New Antibiotic Classes through Targeted
Genomics. Microcide has developed a technology platform which utilizes bacterial
genetics to discover the genes which are essential for a bacterium's in vitro
survival. Microcide is utilizing these essential bacterial genes discovered in
its Bacterial Essential Genes Program as the basis for identifying and
characterizing novel antibiotic targets. The Company has developed an innovative
methodology for parallel high-throughput screening of these targets against
molecular diversity libraries to identify a large number of active lead
compounds. The Company believes that this genetics technology platform will
enable it to rapidly identify drug candidates within new classes of antibiotics.


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        Extend Targeted Genomics to Additional Gene Targets and Other Important
Infectious Pathogens. Microcide has extended its molecular genetics technologies
in targeted genomics to identify and characterize genes that are critical to
bacterial growth or virulence in vivo. The Company believes that inhibitors of
such targets have not been previously systematically sought in antibiotic
discovery programs, and that its Bacterial Pathogenesis program utilizes novel
methods to discover inhibitors of bacterial pathogenesis genes for development
as new treatment approaches for bacterial disease. Microcide's Fungal Genomics
program seeks to identify essential fungal gene targets which are functionally
conserved among pathogens and distinct from human genes, and then utilize these
genes simultaneously for antifungal drug discovery in its proprietary
multichannel screening system. Through a collaboration with Iconix, the Company
seeks to apply Surrogate Genetics to screen against a number of viral disease
targets in the search for novel inhibitors.

        Enhance Research and Development and Reduce Capital Requirements through
Collaborative Agreements. The Company has entered into collaborations with three
major pharmaceutical companies to develop its initial products. Such
collaborations are expected to provide Microcide with funding, discovery
technologies, research staffing, access to molecular diversity, and development
and commercialization capabilities. By utilizing the resources of its
collaborators, Microcide expects to lower its capital requirements and reduce
the time needed to commercialize its products worldwide. Microcide is developing
certain defined joint technologies in collaboration with Iconix, an arrangement
which it believes will enhance the development of these technologies as compared
to working alone and will do so in a more cost effective manner than if
independently pursued.

        Retain the Ability to Independently Develop and Market Certain Products.
Microcide's longer-term development strategy is to continue to utilize strategic
collaborations selectively to complement internal efforts. Microcide plans to
retain certain rights to products resulting from its unpartnered programs,
including the Company's Bacterial Pathogenesis, Bacterial Cell Wall, Fungal
Genomics and Fungal Efflux Pump programs, and to enter into collaborative
relationships at later stages of product development and where appropriate for
distribution and commercialization.

MICROCIDE'S RESEARCH PROGRAMS

        Microcide's research programs employ an interdisciplinary approach that
incorporates several drug discovery and research technologies, including
targeted genomics, synthetic and natural product diversity, high-throughput and
multi-channel screening, combinatorial and medicinal chemistry,
computer-assisted drug design and bioinformatics. The Company believes that its
interdisciplinary approach more effectively utilizes a broader range of novel
microbial targets for new compound discovery than traditional biochemical
approaches. Microcide believes that drug resistance genes, essential genes and
pathogenisis genes can be developed into screens for selective inhibitors and
that these methods can be widely employed in the lead discovery process. Access
to molecular diversity libraries for screening targets is critical to drug
discovery. In some instances, the Company's collaborative partners are providing
molecular diversity libraries to support the screening process. However, the
Company has also established a stand-alone molecular diversity capability for
its programs, and has built libraries of structurally distinct synthetic
compounds and natural product extracts for this purpose. The Company's natural
products program provides access to broad-based molecular diversity not possible
to achieve by synthetic compound libraries alone. The Company believes that both
of its libraries contain significant structural diversity. More than 250,000
molecular diversity samples were available for high-throughput screening at the
end of 1997. The structural diversity of the library and the molecular diversity
needs of Microcide's programs will be monitored, and the Company expects that
strategic supplementation of these diversity libraries will occur in 1998 and
beyond.

        The Company's discovery and preclinical research activities center on
two themes: Targeted Antibiotics and Targeted Genomics. The Company's Targeted
Antibiotics programs focus on overcoming bacterial drug resistance, either by
interfering with resistance pathways to potentiate existing antibiotics, or by
developing novel lead compounds which avoid such resistance pathways. The


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Company's Targeted Genomics programs utilize bacterial genetics and genomics
approaches to discover inhibitors of novel drug targets for further development
as effective antibiotics or anti-pathogenesis therapeutics. In addition, this
approach is being utilized with fungal pathogens to discover small molecule
systemic antifungal agents.
<TABLE>
<CAPTION>
                             MICROCIDE'S RESEARCH PROGRAMS

     ---------------------------------------------------------------------------------------

                                                                    CURRENT
           PROGRAM                 PROGRAM GOAL                    STAGE (1)    PARTNER
     ---------------------------------------------------------------------------------------
                                 TARGETED ANTIBIOTICS
     ---------------------------------------------------------------------------------------
<S>                           <C>                                 <C>             <C>
     Gram-Positive Program

       Novel                  Antibiotics for treatment of        Pre-Clinical    J&J
       Beta-lactams           Gram-positive bacteria              Candidate
                              including resistant
                              strains (MRS, VRE and
                              beta-lactam-resistant
                              Streptococcus pneumoniae)
     ---------------------------------------------------------------------------------------
       Antibiotic             Potentiators which restore          Drug Design     J&J
       Potentiators           efficacy to existing classes of
                              antibiotics through inhibition
                              of resistance mechanisms
     ---------------------------------------------------------------------------------------
       Signal                 Adjunct to existing antibiotics     Screening       J&J
       Transduction           for treatment of
                              resistant and susceptible
                              staphylococci
     ---------------------------------------------------------------------------------------
     Bacterial Efflux         Potentiators for use with           Drug Design     Daiichi
     Pump Program             existing quinolones against
                              resistant Gram-negative
                              bacteria, including Pseudomonas
                              aeruginosa
     ---------------------------------------------------------------------------------------
     Bacterial Cell
     Wall Program
       First Generation Narrow-spectrum antibiotics               Drug Design     Internal
     ---------------------------------------------------------------------------------------
       Second Generation Broad-spectrum antibiotics               Drug Design     Internal
     ---------------------------------------------------------------------------------------
     Fungal Efflux Pump       Potentiators to improve the         Screening       Internal
     Program                  efficacy of existing and new
                              agents against fungal
                              pathogens, including Candida
                              albicans
     ---------------------------------------------------------------------------------------
     ---------------------------------------------------------------------------------------
                                  TARGETED GENOMICS
     ---------------------------------------------------------------------------------------
     Bacterial                Novel classes of broad- and         Screening       Pfizer
     Essential Genes          narrow-spectrum antibiotics
     Program
     ---------------------------------------------------------------------------------------
     Bacterial                Novel anti-virulence or             Gene            Internal
     Pathogenesis             anti-pathogenesis bacterial         Identification
     Program                  therapeutics
     ---------------------------------------------------------------------------------------
     Fungal Genomics          Novel systemic antifungal agents    Gene            Internal
     Program                                                      Identification/
                                                                  Screening
     ---------------------------------------------------------------------------------------
     Viral Genomics           Novel antiviral therapeutics        Gene            Iconix
     Program                  for HCV, CMV, Human Papilloma       Identification/
                              Virus and others                    Screening
     ---------------------------------------------------------------------------------------
</TABLE>
-----------

(1) The Company's preclinical research programs generally consist of the
    following stages, the goals of which are:

    "Gene Identification" -- development and implementation of methods to
    identify appropriate gene targets to be used in screening.

    "Screening" -- development and implementation of assay technologies to
    identify selective target inhibitors ("leads").

    "Leads Identified" -- identification of lead compounds whose in vitro and in
    vivo characteristics are sufficient to evaluate in biochemical,
    microbiological, pharmacological and toxicological tests for entry into drug
    design programs.

    "Drug Design" -- definition of structure-activity relationships of selected
    compounds and optimization of such compounds through medicinal chemistry
    efforts.

    "Candidate Selection" -- scale-up and evaluation of optimized leads in key
    efficacy, toxicological and pharmacological tests in advance of selection as
    pre-clinical development candidates.

    "Pre-clinical Candidate" -- the extensive preclinical investigation,
    including pharmaceutical characterization, product formulation, process
    scale-up for manufacturing, and animal safety and tolerability studies,
    all of which are requisite to entering into human clinical trials.


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<PAGE>   10

TARGETED ANTIBIOTICS

        Microcide's Targeted Antibiotics programs involve two approaches: (i)
the development of novel antibiotic potentiators which overcome bacterial
resistance by interfering with resistance mechanisms to potentiate existing
antibiotics, and (ii) the development of novel antibiotic compounds which avoid
such resistance mechanisms. The Company's Targeted Antibiotics programs include
the Gram-Positive, Bacterial Efflux Pump, Bacterial Cell Wall and Fungal Efflux
Pump programs.

        GRAM-POSITIVE PROGRAM

        Microcide's Gram-Positive Program is focused on discovering and
developing novel antibiotics and antibiotic potentiators for the treatment of
infections caused by drug-resistant Gram-positive bacteria, including MRS, VRE
and pneumococci. Gram-positive and Gram-negative bacteria have fundamentally
different surface characteristics. These surface properties greatly affect the
ability of an antibiotic to penetrate the bacterium and reach its target site.
As a result, antibiotics that are effective against Gram-positive bacteria are
often less effective against Gram-negative bacteria, and vice versa. The
problematic Gram-positive bacteria targeted by this program cause serious
infections, including endocarditis, osteomyelitis, meningitis, deep-seated soft
tissue infections, bacteremia, complicated urinary tract infections and
pneumonias.

        The Gram-Positive program is being conducted in collaboration with J&J
and consists of the following major areas: (i) discovery of beta-lactam
antibiotics with specific efficacy against resistant Gram-positive bacteria;
(ii) discovery of novel antibiotic potentiators of existing beta-lactams or
vancomycin for use against MRS and VRE, respectively; and (iii) discovery of
inhibitors of signal transduction in bacteria. Among these efforts, the
beta-lactam program is receiving the most resources and is at the most advanced
stage.

        Novel Beta-lactams

        Traditional beta-lactam antibiotics work by inhibiting enzymes
(penicillin-binding proteins, or PBPs) that carry out crucial steps in the
synthesis of the bacterial cell wall. Resistance to beta-lactam antibiotics in
MRS is primarily caused by bacterial production of PBP2a, an enzyme capable of
conducting cell-wall synthesis in the presence of such antibiotics, as well as
by the production of beta-lactamases, which render beta-lactams ineffective.

        Microcide's beta-lactam program seeks initially to develop a novel
beta-lactam antibiotic which is beta-lactamase-stable and inhibits PBPs,
including PBP2a, thereby gaining efficacy against MRS. Compounds emerging from
the Company's beta-lactam program are expected to be active against
staphylococci, including MRS, enterococci, including VRE, and possibly other
Gram-positive bacteria. The Company has prepared hundreds of new synthetic
analogs and has made advances in drug design, resulting in several leads with
desirable in vitro potency, in vivo efficacy, favorable pharmacokinetics and
solubility, and low toxicity.

        Antibiotics developed within this program are expected to be
parenterally administered in the institutional setting to prevent or treat
infections caused by Gram-positive bacteria, including those resistant to other
antibiotics. Such newly developed antibiotics could potentially be clinically
adopted for the following uses: as a single agent following treatment failure in
patients with a documented drug-resistant infection, or empirically as a single
agent or in combination with a broad-spectrum antibiotic to extend coverage to
resistant bacterial strains. The Company believes that the clinical adoption of
such antibiotics could be similar to that of vancomycin as a single agent, or
ceftazidime or an aminoglycoside in combination use for empiric therapy.


                                       10
<PAGE>   11
        The Company, in collaboration with J&J, selected an initial beta-lactam
drug candidate for pre-clinical development in October, 1996. This compound is
currently undergoing pharmaceutical characterization, product formulation and
process scale-up for manufacturing of sufficient bulk drug substance to conduct
requisite animal safety and tolerability studies and to complete Phase I
clinical trials. The Company expects to complete all pre-clinical activities and
to enter into human clinical trials in 1998. However, there can be no assurance
that clinical trials will begin by such date, or ever. The Company has filed
patent applications in the United States and elsewhere on ten series of lead
structures discovered in this program, and five patents out of these series have
issued in the United States.

        Antibiotic Potentiation

        The loss of utility of an antibiotic class in the treatment of bacteria
is often due to a single, defined resistance pathway, as is the case in MRS and
VRE. The goal of the Company's antibiotic potentiation program is to discover
compounds that directly interfere with methicillin or vancomycin resistance
pathways in these organisms, in order to restore the effectiveness of
beta-lactams or glycopeptides in the treatment of MRS or VRE infections.
Microcide has developed novel screening technologies to discover inhibitors of
these pathways, and has discovered leads from these screens which show desirable
in vitro and in vivo characteristics. Several of the methicillin potentiator
leads, tested in combination with a number of currently marketed beta-lactams,
demonstrate control of MRS infection in animal models at doses where the
beta-lactams alone are ineffective. The Company has filed patent applications in
the United States and elsewhere covering two series of lead structures
originating from this program.

        Potentiators resulting from this program may be developed for use with
oral or parenteral antibiotics, with the goal of creating a combination product
which either targets a specific resistance problem (for example, in combination
with an anti-staphylococcal penicillin) or alternatively provides broad-spectrum
empiric coverage (such as in combination with imipenem). The Company believes
that the clinical adoption of such potential products could be similar to that
of vancomycin as a potentiator of beta-lactams against staphylococcal
infections.

        The Company has filed patent applications in the United States and
elsewhere covering two series of lead structures originating from this program.

        Inhibitors of Bacterial Signal Transduction

        Signal transduction is a mechanism by which a cell senses and responds
to changes in its external environment and which occurs when a sensor protein,
usually at the cell surface, receives and transmits a signal that results in the
expression of a specific set of genes. A wide range of bacteria use signal
transduction systems to regulate a variety of cellular functions. For example,
it is generally believed that disease-causing bacteria are able to use such
mechanisms to establish infections in different sites of the body. Signal
transduction systems are also utilized by staphylococci and enterococci to
express methicillin and vancomycin resistance. Elements of these regulatory
systems are conserved within bacteria and across bacterial species, but are
dissimilar to signal transduction mechanisms found in mammalian cells. For that
reason, the Company believes that bacterial-specific signal transduction
inhibitors can be developed into effective therapeutic agents.

        Microcide is initially focused on specific signal-transduction systems
in staphylococci. The Company has developed screening and lead evaluation
technologies and has identified compounds which block these control systems.
These compounds are currently undergoing biochemical and microbiological
testing in vitro.

        The Company believes that products resulting from this program could
either serve as stand-


                                       11
<PAGE>   12

alone bactericidal agents, or could represent a new therapeutic approach, as
anti-pathogenesis or anti-virulence agents. Potential initial products will be
targeted at Gram-positive bacteria, and are expected to be used independently or
in combination with antibiotics to enhance their antibacterial efficacy in
particularly difficult-to-treat clinical situations, such as deep-seated soft
tissue infections, endocarditis, osteomyelitis and meningitis.

        The Company has filed patent applications in the United States and
elsewhere covering screening technologies utilized in this program.

        BACTERIAL EFFLUX PUMP PROGRAM

        The high intrinsic resistance of Pseudomonas aeruginosa to many
antibiotics, including quinolones, has generally been attributed to the
impermeable outer membrane of this Gram-negative bacterium. Recent information,
however, indicates that this intrinsic resistance is due to the combined effects
of low membrane permeability and the production of membrane proteins (efflux
pumps) which bind to antibiotics of many different types as they enter the
bacterial cell and eject (efflux) them from the bacterium.

        The Company believes that the combination of bacterial efflux pump
inhibitors with existing antibiotics could increase the susceptibility of
Gram-negative bacteria like pseudomonas to such antibiotics and could increase
the activity of such antibiotics against bacteria expressing efflux
pump-mediated drug resistance ("EMDR"). The Company has established a genetics
and molecular biology program which focuses on bacterial efflux systems, and has
developed novel screening and lead evaluation technologies which have resulted
in the discovery of lead compounds with the desired potency, specificity for
bacterial efflux pumps, and low toxicity in mammalian cells. Drug design efforts
are being pursued to identify metabolically stable and pharmacologically
suitable efflux pump inhibitors for selection as pre-clinical development
candidates. The Company expects that any products resulting from this effort
will be combined with Daiichi's oral and parenteral quinolone antibiotics to
increase their effectiveness against Gram-negative bacteria and to overcome
EMDR in pseudomonas and other bacteria. The Company believes
that the clinical adoption of such antibiotic/inhibitor combinations could be
similar to that of Daiichi's levofloxacin and other quinolones. Furthermore, the
Company believes that such inhibitors could be combined with other antibiotics
against EMDR resistance.

        The Company, in collaboration with Daiichi, is designing compounds based
on efflux pump inhibitor leads and expects to select its first product candidate
from this program in 1998 for subsequent pre-clinical development. However,
there can be no assurance that such selection will occur by such date, or ever.
The Company has filed two patent applications in the United States and elsewhere
related to the lead structures originating from this program and is preparing
patent applications relating to other series of lead structures.

        FUNGAL EFFLUX PUMP PROGRAM

        The azoles (inhibitors of the ergosterol-biosynthesis pathway) are
currently the most widely used agents in the treatment of fungal diseases. Among
the azoles, fluconazole is the most extensively used antifungal agent, but there
are increasing reports of therapy failures including fluconazole due to
resistance emergence. Recently, multi-drug efflux pumps have been implicated in
Candida resistance in clinical settings to fluconazole (and other azoles). As
with bacterial efflux, intrinsic resistance to fluconazole, such as found in
Aspergillus, may arise from naturally occurring multi-drug efflux pumps.
Therefore, similar to its approach with regard to bacteria, the Company believes
that by inhibiting the activity of efflux pumps in fungal pathogens, it may be
possible to achieve a significant decrease of both


                                       12
<PAGE>   13

intrinsic and acquired resistance, thereby extending the useful life of existing
agents, broadening the antifungal spectrum of existing agents, or allowing newer
agents to be efficacious.

        Microcide has established a genetic potentiation assay against which the
Company's synthetic and natural product libraries are being tested in the search
for small molecule inhibitors.


        BACTERIAL CELL WALL PROGRAM

        In addition to PBPs, certain other enzymes involved in bacterial cell
wall biosynthesis represent attractive targets for antibiotic development. Many
inhibitors of this process, which is essential and unique to bacteria, have been
identified. However, relatively few of these inhibitors have been developed into
clinically usable antibiotics. Microcide's Bacterial Cell Wall program is based
on: (i) a chemistry effort around a natural product lead which shows potent
activity against Pseudomonas aeruginosa and certain other bacteria, and which is
well tolerated and non-toxic in animal studies, and (ii) a screening effort
against the particular enzyme which is the target of this natural product lead.
No agents which act against this target are currently on the market, and
therefore the products discovered from this program are not expected to be
subject to existing resistance mechanisms.

        Toward the end of 1997, Microcide defined the stereochemistry of the
original natural product lead, and synthesized a core structure having the
expected biological activity. In 1998, the Company intends to employ
combinatorial chemistry methods to modify this synthetic core, in the search
for a compound having a clinically useful profile. It is expected that a first
generation agent to emerge from this program may show a narrow spectrum of
activity. If successful in this effort, the Company would continue to produce
analogs in the search for second generation antibiotics with an expanded
spectrum. However, there can be no assurance that either such agent can be
identified or developed. If chemistry efforts based on this lead series are not
successful, the Company will be dependent on new leads emerging from the
screening program, and there can be no assurance that such leads will be
identified.

        The Company has retained all rights to this program and is self-funding
it. The Company has submitted a patent application in the United States on a
series of natural product structures and is preparing a patent application in
the United States related to another series of lead structures originating from
this program.

TARGETED GENOMICS

        Microcide believes that it has developed a unique approach to
anti-infective research using microbial genetics as a foundation for drug
discovery. The Company believes that this approach will yield a large number of
relevant novel drug targets that in turn are expected to lead to the development
of new classes of antimicrobials. The Company's strategy is to target its gene
discovery efforts to the pharmaceutically relevant portion of bacterial and
fungal genomes, by identifying genes that are essential to a pathogen's
viability in vitro (the Bacterial Essential Genes program) or to bacterial
pathogenicity in vivo (the Bacterial Pathogenesis program). These target genes,
once identified, are incorporated into the Company's high-throughput screening
systems to identify compounds for further development. The Company has applied
its targeted genomics approach to bacterial and fungal cellular systems, and
more recently has begun to apply it to viruses through its collaboration with
Iconix. The Company believes that this approach offers significant advantages
over traditional pharmaceutical company approaches, as well as the more recent
genomic sequencing approaches.

        Traditional approaches to antibiotic drug discovery have centered on
biochemically defined targets. In such approaches, screening assays are
developed based on selectively chosen enzyme or


                                       13
<PAGE>   14

receptor targets. Appropriately designed assays can be highly effective but have
several significant drawbacks. First, such an approach is limited in its
application since it requires pre-existing data with respect to the function or
mechanism of an identified target, and only identifies inhibitors of that
specific target. Since many targets lack such information, the range of targets
that can be employed to find inhibitors is limited. Second, such target-specific
assays have relatively long set-up times and high costs. Third, these techniques
often employ an extracellular biochemical approach which may identify compounds
that are excellent inhibitors of essential biochemical enzymes, but subsequently
prove not to be good antibiotic candidates because sufficient concentrations
within the bacterium are not achieved at the target site, or for other reasons.

        Drug discovery efforts have recently employed whole-genome sequencing
approaches to antibiotic target identification. Although such approaches reveal
all of the genetic information in a bacterium, the Company believes that only an
estimated 5% to 10% of the total bacterial genetic material encodes proteins
that are pharmaceutically relevant as drug targets. Genome sequencing approaches
can only address gene function through sequence analysis and comparison, and do
not adequately address the issue of the relevance of a particular gene as a drug
target. Thus, while numerous microbial genomes have been completely or partially
sequenced, considerable research will be necessary to identify the
pharmaceutically relevant target genes from this information, and to develop
screens for potential inhibitors. Such screens will then face many of the same
limitations as traditional screening approaches.

        BACTERIAL ESSENTIAL GENES PROGRAM

        In contrast, Microcide's Bacterial Essential Genes Program utilizes a
targeted genomics approach to discover the pharmaceutically relevant genes
present in bacterial genomes, and focuses on several important and diverse
pathogenic bacteria. The Company has created unique molecular tools and
approaches in bacterial molecular genetics, which allow it to create and use
gene mutants to quickly and directly clone essential bacterial genes. These same
mutants are then used to characterize and prioritize drug targets. This targeted
genomics approach accelerates the entire discovery process by focusing on the
functionally important portions of the genome and thereby bypasses the task of
sequencing and characterizing irrelevant portions of the genome.

        As of the end of 1997, Microcide has identified over 100 of the
estimated 150 to 200 essential genes in its bacterial genomic systems. Because
essential genes are generally common among different bacteria, the Company
believes that a number of the drug targets identified to date could lead to the
discovery of new classes of broad-spectrum antibiotics. The Company has filed
patent applications covering approximately 82 essential genes and related
screening methods in the United States.

        The Company has also created a multi-channel screening process that it
believes will accelerate antibiotic discovery in several important ways.
Foremost is the ability to move directly and rapidly from gene identification to
drug screening using gene mutants. Using genetic assays, many targets can be
utilized simultaneously to evaluate compounds, as opposed to the traditional
screening approach which utilizes few targets in single assay format. This
multi-channel process creates a multi-dimensional profile or "phenoprint" of
each compound tested. Both multiple targets and multiple biological properties
of compounds can thus be simultaneously evaluated during primary screening.
Using defined testing algorithms and statistical analyses of resulting data,
many compounds are tested in high-throughput mode. Collectively, the resulting
compound phenoprints, along with other data on the properties of the genes and
the compounds, form a database of information correlating biological effects of
compounds and their structures to the various targets early in the development
process. This facilitates and enhances the selection of optimal hits and most
promising leads prior to commitment to drug design efforts.


                                       14
<PAGE>   15

  [GRAPHIC SHOWING THE COMPANY'S TARGETED GENOMIC APPROACH AND MULTI-CHANNEL
                              SCREENING PROCESS]

        The Company's multi-channel screening method has the following benefits:
(i) it is broadly applicable to all of the pharmaceutically relevant essential
genes identified; (ii) it identifies compounds that can enter cells and effect
inhibitory action, given its whole-cell based nature; (iii) it utilizes more
sensitive assays than traditional whole-cell screens, allowing for the
identification of a broader range of potential drug candidates; and (iv) it can
be applied even before the novel genes or biochemical targets are fully
characterized. The database created by the Company's Bacterial Essential Genes
program is expected to grow in information content and ability to discriminate
among compounds as each new gene or compound is evaluated and added to the
database. The Company believes this database represents a significant
competitive advantage in antibiotic discovery and development.

        The Company, in collaboration with Pfizer, has implemented its essential
gene and multi-channel screening systems to discover and develop multiple new
antibiotic drug classes. In addition, Microcide and Pfizer have selected a
number of essential gene targets of high interest for biochemical screening. The
molecular diversity libraries of the Company and Pfizer will be selectively
applied to these screening efforts. Potential products resulting from the drug
design efforts of this program are expected to constitute new classes of
broad-spectrum antibiotics. The Company believes that the clinical adoption of
such compounds could be similar to that of clarithromycin, ciprofloxacin or
imipenem. In addition to patent applications covering essential genes, the
Company has filed patent applications covering its multi-channel screening
technology in the United States and elsewhere.

        PATHOGENESIS PROGRAM

        Bacterial pathogenesis is a complex process by which bacteria enter the
host, locate and establish


                                       15
<PAGE>   16

an appropriate growth niche, evade host defenses, circumvent host clearing
mechanisms, and amplify at the site of infection. Specialized bacterial genes
are required for survival in the host that are not required for growth in the
laboratory environment. Damage to the host arises from bacterial products
produced during growth, and from the bacterium's ability to modify and destroy
host tissue. The bacterial gene products causing this damage contribute to
bacterial virulence. The Company believes that cellular functions underlying
these processes of pathogenicity and virulence are conserved among many
disease-causing bacteria, and inhibitors of these cellular functions may be
broadly acting and detrimental to the bacterium and its disease-causing ability.

        Microcide's Pathogenesis program focuses on the genetic determinants
underlying bacterial pathogenicity and virulence. The genetic basis of bacterial
pathogenicity is largely unknown and unexplored for drug targeting. The Company
is developing novel molecular and genetic methods to identify pathogenesis gene
targets in vitro and in animal models, and to genetically assess the effect of
target inhibition in vivo. These methods are being employed to create a library
of such genes for drug discovery research. As of the end of 1997, the Company
has identified 120 pathogenesis gene mutants. These mutants are being
characterized in vitro and in animal systems for selection of key targets for
drug discovery. In addition, specific screens are being devised and implemented
to identify inhibitors of the most attractive pathogenesis gene targets.
Inhibition of genetic processes underlying pathogenesis is expected to
constitute a novel approach to the treatment of bacterial disease, and
potentially offer therapeutic advantages over traditional antibiotic therapy.

        The Company has retained all rights to this program and is self-funding
it. The Company has filed patent applications in the United States covering
methods for discovery and characterization of pathogenesis genes.

        FUNGAL GENOMICS PROGRAM

        Microcide's Fungal Genomics Program seeks to identify essential fungal
gene targets which are functionally conserved among pathogens and distinct from
human genes. To date, a library of over 1100 mutants has been constructed. A
subset of these mutants, representing pharmaceutically relevant targets, has
been incorporated into drug discovery screens. Initial screening efforts are
focusing on sets of approximately 20 genes within each of two genetic systems
essential for fungal growth and survival. The Company intends to continue to
expand its gene mutant set in order to screen against an even larger number of
pharmaceutically relevant targets. The Fungal Genomics Program is expected to be
the first program to employ the Company's multiplexing screening technology
which is designed to perform multiple cell based assays in a single pool,
thereby achieving a 10-100 fold increase in throughput relative to conventional
high throughput screening techniques; this multiplex screening technology is
under development at the Company and there is no assurance that such technology
will be successfully completed.

        The Company has retained all rights to this program and is self-funding
it. The Company has filed a patent application in the United States covering its
multiplex screening technology.

        VIRAL GENOMICS PROGRAM

        Based upon the size of the antiviral therapeutics market, and
Microcide's experience in applying its genetic techniques to bacteria and fungi,
the Company has elected to pursue a genetics-based program against viral
pathogens. The Company believes that enhancements to its existing technologies
are necessary for a productive viral genomics effort, and Microcide is
collaborating with Iconix in pursuing this new research and development
initiative.


                                       16
<PAGE>   17

        The Viral Genomics Program will make extensive use of Iconix's Surrogate
Genetics technology whereby Iconix plans to create high-throughput genetic
screens for validated and potential antiviral targets from relevant human viral
pathogens. Such pathogens are expected to include Cytomegalovirus (CMV),
Epstein-Barr Virus (EBV), Flavovirus, Hepatitis B (HBV), Hepatitis C (HCV),
Herpes Simplex (HSV), Human Immunodeficiency Virus (HIV), Human Papilloma Virus
(HPV), Influenza, Picornavirus (Rhinovirus), Respiratory Syncytial Virus (RSV)
and Varicella-zoster (VZV). Screens against several targets in two of these
pathogens have been established and pilot screening has begun. Additional assays
are under development.

COLLABORATIVE AGREEMENTS

        The Company's strategy is to enter into collaborations with major
pharmaceutical companies to develop its initial products. Such collaborations
are expected to provide the Company with funding, discovery technologies,
research staffing, access to molecular diversity, and development and
commercialization capabilities. To date the Company has entered into
Collaborative Agreements with three major pharmaceutical companies: J&J with
regard to the Gram-Positive program; Daiichi with regard to the Bacterial Efflux
Pump program; and Pfizer with regard to the Bacterial Essential Genes program.
The Company has certain rights to co-promote in North America products developed
pursuant to these collaborations.

        In addition, the Company has entered into a series of agreements with
Iconix Pharmaceuticals, a company which it formed in January 1998. These
agreements include a Core Technology and License Agreement, an Antiviral and
Surrogate Genetics Research Collaboration, and a Support Services Agreement.

        J&J -- GRAM-POSITIVE PROGRAM

        In October 1995, Microcide and J&J entered into agreements (the "J&J
Agreements") pursuant to which they agreed to collaborate to discover and
develop certain antibiotics and antibiotic potentiators targeted at
Gram-positive bacteria. The term of the J&J Agreements is three years, subject
to J&J's right to earlier terminate the J&J Agreements on six months prior
written notice, and with J&J having an option to extend the term for an
additional one-year period. J&J has made a $3.0 million up-front license payment
to the Company and an affiliate of J&J has made a $5.0 million equity investment
in the Company. J&J is obligated to provide the Company with up to $3.5 million
per year in research support payments throughout the term of the J&J Agreements.
Microcide may also receive from J&J milestone payments of up to $16.5 million
for the first product and up to $15.5 million for each subsequent product upon
the achievement of product development milestones and, in addition, royalties on
the worldwide sale of drugs resulting from the collaboration. The first
milestone payment of $1 million was received in October 1996 upon the selection
of a beta-lactam pre-clinical development candidate. The J&J Agreements provide
J&J with exclusive worldwide rights to products developed during the
collaboration. The development, manufacture and sale of drugs resulting from the
collaboration will be conducted by J&J, provided that Microcide has the right to
undertake certain co-promotion activity in North America subject to J&J's
approval. There can be no assurance that any potential products will be
discovered during the collaboration or that, if discovered, J&J will elect to
proceed with the development of such potential products. As a result, there can
be no assurance that any of the milestone or royalty payments contemplated by
the J&J Agreements will be made. See "Targeted Antibiotics -- Gram-Positive
Program."

        DAIICHI -- EFFLUX PUMP PROGRAM

        In November 1995, Microcide and Daiichi entered into an agreement  (the
"Daiichi Agreement") pursuant to which they agreed to collaborate to discover
and develop antibiotics and antibiotic potentiators, acting through


                                       17
<PAGE>   18

inhibition of the efflux pump mechanism, primarily targeted at pseudomonas. The
term of the research program under the Daiichi Agreement is two years and nine
months commencing as of July 1, 1995 subject to Daiichi's right to earlier
terminate the research program under the Daiichi Agreement after July 1, 1997
upon six months prior notice, and with Daiichi having an option to extend the
term of the research program under the Daiichi Agreement for an additional six
months or one year. Daiichi has notified Microcide of its intention to exercise
its option to extend the collaboration for an additional year (through March 31,
1999). Daiichi is obligated to provide research support funding to Microcide of
$3.0 million for the first nine months and up to $3.5 million for each
subsequent year during the term of the research program. Daiichi has the right
to enter into a license agreement (the "Daiichi License Agreement") for
exclusive worldwide rights to products developed during the collaboration.
Pursuant to the Daiichi License Agreement, Microcide is entitled to receive from
Daiichi milestone payments of up to $13.0 million for each product developed
during the collaboration upon the achievement of certain drug development
milestones and, in addition, royalties on the worldwide sale of drugs resulting
from the collaboration. The development, manufacture and sale of drugs resulting
from the collaboration will be conducted by Daiichi subject to Microcide's right
to co-promote such drugs in North America, for which Microcide shall receive
reasonable compensation. There can be no assurance that any potential products
will be discovered during the collaboration or that, if discovered, Daiichi will
elect to proceed with the development of such potential products. As a result,
there can be no assurance that any of the milestone or royalty payments
contemplated by the Daiichi License Agreement will be made. See "Targeted
Antibiotics -- Bacterial Efflux Pump Program."

        PFIZER -- BACTERIAL ESSENTIAL GENES PROGRAM

        In March 1996, Microcide and Pfizer entered into agreements (the
"Pfizer Agreements") pursuant to which they agreed to collaborate to implement
genetics-based screening technology to identify and subsequently develop
antibacterial products. The term of the Pfizer Agreements is five years, subject
to Pfizer's right to earlier terminate after February 1999 with six months prior
written notice. Pfizer has made a $1.0 million up-front license payment to the
Company and a $5.0 million equity investment in the Company. Pfizer is obligated
to provide Microcide with up to $4.2 million per year in research support
payments during the term of the Pfizer Agreements. Microcide may also receive
from Pfizer milestone payments of up to $32.5 million for each product developed
during the collaboration upon the achievement of product development milestones
and, in addition, royalties on the worldwide sale of drugs resulting from the
collaboration. The first milestone payment of $1.0 million was received in
February 1997 upon the identification, characterization and sequencing of a
specific number of essential genes. The Pfizer Agreements provide Pfizer with
exclusive worldwide rights to products developed during the collaboration. The
development, manufacture and sale of drugs resulting from the collaboration will
be conducted by Pfizer, subject to Microcide's right to co-promote such products
in North America. There can be no assurance that any potential products will be
discovered during the collaboration or that if discovered, Pfizer will elect to
proceed with the development of such potential product. As a result, there can
be no assurance that any of the milestone or royalty payments contemplated by
the Pfizer Agreements will be made. See "Targeted Genomics -- Bacterial
Essential Genes Program."

        Under the Company's Collaborative Agreements, which cover three of the
Company's programs, each of J&J, Daiichi and Pfizer is responsible for (i)
selecting compounds discovered in its collaboration with the Company for
subsequent development, (ii) conducting preclinical testing, clinical trials and
obtaining required regulatory approvals of such drug candidates, and (iii)
manufacturing and commercializing resulting drugs. As a result, the Company's
receipt of revenues (whether in the form of continued research funding, product
development milestones or royalties on sales) under the Collaborative Agreements
is dependent upon the decisions made and activities undertaken by its
collaborative partners and upon the development, manufacturing and marketing
resources of its collaborative partners. The amount and timing of resources
dedicated by the Company's collaborative partners to their respective
collaborations with the Company is not within the Company's control.


                                       18
<PAGE>   19

Moreover, certain compounds discovered by the Company may be viewed by the
Company's collaborative partners as competitive with such partners' products or
potential products. Accordingly, there can be no assurance that the Company's
collaborators will elect to proceed with the development of compounds which the
Company believes to be promising, or that they will not pursue their existing or
alternative technologies in preference to such compounds. There can be no
assurance that the interests of the Company will continue to coincide with those
of its collaborative partners, that some of the Company's collaborative partners
will not develop independently or with third parties drugs that could compete
with drugs of the types covered by the collaborations, or that disagreements
over rights or technology or other proprietary interests will not occur.

        The Company is dependent on its collaborative partners to fund a
substantial portion of its activities over the next several years. However, J&J
can terminate its collaboration with the Company at any time upon six months'
prior written notice, Daiichi can terminate its collaboration with the Company
at any time after July 1, 1997 upon six months' prior written notice, and Pfizer
can terminate its collaboration with the Company at any time after February,
1999 upon six months' prior written notice. If any of the Company's
collaborative partners terminates or breaches its Collaborative Agreement with
the Company, or fails to devote adequate resources to or to conduct in a timely
manner its collaborative activities, the research program under the applicable
Collaborative Agreement or the development and commercialization of drug
candidates subject to such collaboration would be materially adversely affected.
Further, there can be no assurance that the Company's collaborations with J&J,
Daiichi and Pfizer will be successful. Nor can there be any assurance that the
Company will be able to enter into acceptable collaborative or licensing
arrangements with other pharmaceutical companies in the future, or that, if
negotiated, such arrangements would be successful.

        The Company intends to rely on its major pharmaceutical partners for the
manufacturing and marketing of any products which result from such
collaborations. In addition, as part of its business strategy, the Company plans
to retain rights to certain research programs not currently covered by the
Collaborative Agreements for internal product development. Outside North
America, the Company anticipates entering into collaborations with third parties
for distribution and commercialization of any products developed internally by
the Company. There can be no assurance that the Company will be able either to
successfully commercialize any internally developed products in North America
itself or to enter into any such collaborations for distribution and
commercialization of such products outside North America on acceptable terms, if
at all.

        ICONIX

        In January 1998, Microcide formed Iconix, a biotechnology company which
will seek to develop surrogate genetics and chemical informatics into a
technology platform with broad applicability to multiple human diseases. Through
a private placement, Iconix arranged a $12.5 million equity investment from
institutional investors. After giving effect to the investment and including the
initial stock option pool reserved for employees and consultants of Iconix,
Microcide holds approximately 35% of the pro forma fully diluted outstanding
equity of Iconix. In connection with this transaction, Microcide and Iconix
entered into a series of agreements covering the transfer of certain
technologies from Microcide to Iconix, joint technology development in core drug
discovery areas, an antiviral drug discovery and development program, and
support services to be provided by Microcide to Iconix for the next three years.

        Through the Core Technology Development and License Agreement, Microcide
and Iconix expect to work together over the next three years to jointly develop
and utilize new technology in the areas of molecular diversity, high-throughput
screening, computational sciences and genome sciences. Through the
Antiviral and Surrogate Genetics Research Collaboration, Iconix plans to apply
Surrogate Genetics to a number of viral disease targets in the search for novel
inhibitors. Microcide is obligated to provide Iconix with research support
payments of up to $6.1 million over the three years of


                                       19
<PAGE>   20
the collaboration which is extendible at Microcide's option for two additional
one-year periods. Microcide is entitled to worldwide development, manufacturing
and marketing rights to antiviral products which may emerge from the
collaboration and, if specified research and development milestones are
achieved, will be obligated to pay Iconix milestone payments of up to $11.0
million for the first product and up to $10.5 million for each subsequent
product, in addition to royalties on worldwide sales. Pursuant to the Support
Services Agreement, Microcide will provide Iconix with facilities and various
business support services for which Microcide will be reimbursed.

MANUFACTURING AND MARKETING

        The Company does not have any expertise in the manufacture of commercial
quantities of drugs, and its current facilities and staff are inadequate for the
commercial production or distribution of drugs. The Company intends to rely on
its major pharmaceutical partners for the manufacturing, marketing and sale of
any products which result from such collaborations. The Company will be required
to contract with third parties for the manufacture of other products or to
acquire or build production facilities before it can manufacture any such
products itself. There can be no assurance that the Company will be able to
enter into such contractual manufacturing arrangements with third parties on
acceptable terms, if at all, or acquire or build such production facilities
itself. To date the Company has no experience with sales, marketing or
distribution. Consequently, in order to market any of its products, the Company
will be required to develop marketing and sales capabilities, either on its own
or in conjunction with others. There can be no assurance that the Company will
be able to develop any of these capabilities.

        There can be no assurance that any products successfully developed by
the Company or its collaborative partners, if approved for marketing, will
achieve market acceptance. The antimicrobial products which the Company is
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 the Company will depend on a
number of factors, including the establishment and demonstration in the medical
community of the clinical efficacy and safety of the Company's product
candidates, their potential advantage over existing treatment methods, and
reimbursement policies of government and third-party payors. There is no
assurance that physicians, patients or the medical community in general will
accept and utilize any products that may be developed by the Company or its
collaborative partners.

        The ability of the Company and its collaborative partners to receive
revenues and income with respect to drugs, if any, developed through the use of
the Company's technology will depend, in part, upon the extent to which
reimbursement for the cost of such drugs will be available from third-party
payors, such as government health administration authorities, private health
care insurers, health maintenance organizations, pharmacy benefits management
companies and other organizations. Third-party payors are increasingly
challenging the prices charged for pharmaceutical products. There can be no
assurance that third-party reimbursement will be available or sufficient to
allow profitable price levels to be maintained for drugs developed by the
Company or its collaborative partners. The inability to maintain profitable
price levels for such drugs could adversely affect the Company's business.

PATENTS, PROPRIETARY TECHNOLOGY AND TRADE SECRETS

        Protection of the Company's proprietary compounds and technology is
essential to the Company's business. The Company's policy is to seek, when
appropriate, protection for its lead compounds, gene discoveries, screening
technologies and certain other proprietary technology by filing patent
applications in the United States and other countries. The Company has filed
approximately 53 patent applications in the United States, in addition to
applications filed in other countries, covering its inventions. As of the end of
1997, the Company had been issued 5 patents in the United States.

        Patent law as it relates to inventions in the biotechnology field is
still evolving, and involves


                                       20
<PAGE>   21

complex legal and factual questions for which legal principles are not firmly
established. Accordingly, there can be no assurance that patents will be granted
with respect to any of the Company's pending patent applications or with respect
to any patent applications filed by the Company in the future. The patent
position of biotechnology and pharmaceutical companies is highly uncertain and
involves many complex legal and technical issues. There can be no assurance that
patents will be granted with respect to any of the Company's patent applications
currently pending in the United States or in other countries, or with respect to
applications filed by the Company in the future. The failure by the Company to
obtain patents pursuant to the applications referred to herein and any future
applications could have a material adverse effect on the Company. Furthermore,
no assurance can be given that any patents which may be issued to the Company
will not be infringed, challenged, invalidated or circumvented by others, or
that the rights granted thereunder will provide competitive advantages to the
Company. 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 the Company. If the outcome of patent prosecution or
litigation is not favorable to the Company, the Company could be materially
adversely affected. Moreover, because patent applications in the United States
are maintained in secrecy until patents issue, because patent applications in
certain other countries generally are not published until more than eighteen
months after they are filed, because publication of technological developments
in the scientific or patent literature often lags behind the date of such
developments, and because searches of prior art may not reveal all relevant
prior inventions, the Company cannot be certain that it was the first to invent
the subject matter covered by its patent applications or that it was the first
to file patent applications for such inventions.

        The commercial success of the Company will depend in part on not
infringing patents or proprietary rights of others. There can be no assurance
that the Company will be able to obtain a license to any third-party technology
it may require to conduct its business or that if obtainable, such technology
can be licensed at reasonable cost. Failure by the Company to obtain a license
to technology that it may require to utilize its technologies or commercialize
its products may have a material adverse effect on the Company. In some cases,
litigation or other proceedings may be necessary to defend against or assert
claims of infringement, to enforce patents issued to the Company, to protect
trade secrets, know-how or other intellectual property rights owned by the
Company, or to determine the scope and validity of the proprietary rights of
third parties. Any potential litigation could result in substantial costs to and
diversion of resources by the Company and could have a material adverse impact
on the Company. There can be no assurance that any of the Company's issued or
licensed patents would ultimately be held valid or that efforts to defend any of
its patents, trade secrets, know-how or other intellectual property rights would
be successful. An adverse outcome in any such litigation or proceeding could
subject the Company to significant liabilities, require the Company to cease
using the subject technology or require the Company to license the subject
technology from the third party, all of which could have a material adverse
effect on the Company's business.

        In addition to patent protection, the Company relies upon trade secrets,
proprietary know-how and continuing technological advances to develop and
maintain its competitive position. To maintain the confidentiality of its trade
secrets and proprietary information, the Company requires its employees,
consultants and collaborative partners to execute confidentiality agreements
upon the commencement of their relationships with the Company. In the case of
employees, the agreements also provide that all inventions resulting from work
performed by them while in the employ of the Company will be the exclusive
property of the Company. There can be no assurance, however, that these
agreements will not be breached, that the Company would have adequate remedies
in the event of any such breach or that the Company's trade secrets or
proprietary information will not otherwise become known or developed
independently by others.

        The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing techological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with its commercial partners, collaborators,


                                       21
<PAGE>   22

employees and consultants. The Company also has invention or patent assignment
agreements with its employees and certain, but not all, commercial partners and
consultants. There can be no assurance that relevant inventions will not be
developed by a person not bound by an invention assignment agreement. There can
be no assurance that binding agreements will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known or be independently discovered by competitors.

        As is commonplace in the biotechnology industry, the Company employs
individuals who were previously employed at other biotechnology or
pharmaceutical companies, including competitors or potential competitors of the
Company. To the extent such Company employees are involved in research areas at
the Company which are similar to those areas in which they were involved at
their former employer, the Company may be subject to claims that such employees
and/or the Company 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 such claims, which could result in
substantial costs and be a distraction to management, and which may have a
material adverse effect on the Company, even if the Company were successful in
defending such 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 those of
the Company. Many of these companies may employ in such activities greater
financial and other resources, including larger research and development staffs
and more extensive marketing and manufacturing organizations, than the Company
or its collaborative partners. There are also academic institutions,
governmental agencies and other research organizations that are conducting
research in areas in which the Company is working. Competing technologies may be
developed which would render the Company's technologies obsolete or
non-competitive. The Company is aware of many pharmaceutical and biotechnology
companies that are engaged in efforts to treat each of the infectious diseases
for which the Company is seeking to develop therapeutic products.

        The Company also expects to encounter significant competition with
respect to the drugs that it and its collaborative partners 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, the Company's goal is to obtain patent protection for its
potential products and to make those available selectively to pharmaceutical
companies through collaborative and licensing arrangements. There can be no
assurance that competitors of the Company will not develop competing drugs that
are more effective than those developed by the Company and its collaborative
partners or obtain regulatory approvals of their drugs more rapidly than the
Company and its collaborative partners, thereby rendering the Company's and its
collaborative partners' drugs obsolete or noncompetitive. Moreover, there can be
no assurance that the Company's competitors will not obtain patent protection or
other intellectual property rights that would limit the Company's or its
collaborative partners' ability to use the Company's technology or commercialize
its or their drugs.

GOVERNMENT REGULATION

        The development, manufacture and marketing of drugs developed by the
Company or its 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 ("FDA") and comparable Regulatory Agencies
in other countries impose mandatory procedures and standards for the conduct of
certain preclinical testing and clinical trials and the production and marketing
of drugs for human therapeutic use. Product development and approval of a new
drug are likely to take a number of years and involve the expenditure of
substantial resources.

        Any compound developed by the Company or its collaborative partners must
receive Regulatory Agency approval before it may be marketed as a drug in a
particular country. The regulatory process, which includes preclinical 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: (i) preclinical studies; (ii) the submission to the FDA
of a request for authorization to conduct clinical trials on an investigational
new drug (an "IND"); (iii) adequate and well-controlled clinical trials to
establish the safety and efficacy of the drug for its intended use; (iv)
submission to the FDA of a new drug application (an "NDA"); and (v) review and
approval of the NDA by the FDA before the drug may be shipped or sold
commercially.


                                       22
<PAGE>   23

        In the United States, preclinical testing includes both in vitro and in
vivo laboratory evaluation and characterization of the safety and efficacy of a
drug and its formulation. Laboratories involved in preclinical testing must
comply with FDA regulations regarding Good Laboratory Practices. Preclinical
testing results are submitted to the FDA as part of the IND and are reviewed by
the FDA prior to the commencement of human 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 (the
"IRB") at the institution where the study will be conducted. The IRB will
consider, among other things, ethical factors, the safety of human subjects and
the possible liability of the institution. Compounds must be formulated
according to the FDA's Good Manufacturing Practices ("GMP").

        Phase I clinical trials represent the initial administration of the
investigational drug to a small group of healthy human subjects or, more rarely,
to a group of selected patients with the targeted disease or disorder. The goal
of Phase I clinical trials is typically to test for safety (adverse effects),
dose tolerance, absorption, 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
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, preclinical testing, clinical trials and related information are
submitted to the FDA in the form of an NDA for approval of the marketing and
shipment of the drug.

        Data obtained from preclinical 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 the Company or its collaborative
partners, impose costly procedures upon the Company's and its collaborative
partners' activities, diminish any competitive advantages that the Company or
its collaborative partners may attain and adversely affect the Company's ability
to receive royalties. There can be no assurance that, even after such time and
expenditures, Regulatory Agency approvals will be obtained for any compounds
developed by or in collaboration with the Company. Moreover, if Regulatory
Agency approval for a drug is granted, such approval may entail limitations on
the indicated uses for which it may be marketed that could limit the potential
market for any such 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 such 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 the Company or its
collaborative partners in such countries.


                                       23
<PAGE>   24

        Timetables for the various phases of clinical trials and NDA approval
cannot be predicted with any certainty. The Company, its collaborative partners
or the FDA may suspend clinical trials at any time if it is believed that
individuals participating in such trials are being exposed to unacceptable
health risks. Even assuming that clinical trials are completed and that an NDA
is submitted to the FDA, there can be no assurance that the NDA will be reviewed
by the FDA in a timely manner or that once reviewed, the NDA will be approved.
The approval process is affected by a number of factors, including the severity
of the targeted indications, the availability of alternative treatments and the
risks and benefits demonstrated in clinical trials. The FDA may deny an NDA if
applicable regulatory criteria are not satisfied, or may require additional
testing or information with respect to the investigational drug. 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 such approval
is the requirement that the prospective manufacturer's quality control and
manufacturing procedures conform to GMP, which must be followed at all times. In
complying with standards set forth in these regulations, manufacturers must
continue to expend time, monies and effort in the area of production and quality
control to ensure full technical compliance. Manufacturing establishments, both
foreign and domestic, are also subject to inspections by or under the authority
of the FDA and may be subject to inspections by foreign and other federal, state
or local agencies.

        There can be no assurance that the regulatory framework described above
will not change or that additional regulations will not arise that may affect
approval of or delay an IND or an NDA. Moreover, because the Company's present
collaborative partners are, and it is expected that the Company's future
collaborative partners may be, primarily responsible for preclinical testing,
clinical trials, regulatory approvals, manufacturing and commercialization of
drugs, the ability to obtain and the timing of regulatory approvals are not
within the control of the Company.

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

        The Company is 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
the Company believes that its safety procedures for handling and disposing of
radioactive compounds and other hazardous materials used in its research and
development activities comply with the standards prescribed by federal, state
and local regulations, the risk of accidental contamination or injury from these
materials cannot be completely eliminated. In the event of any such accident,
the Company could be held liable for any damages that result and any such
liability could exceed the resources of the Company.


                                       24
<PAGE>   25

EMPLOYEES

        As of December 31, 1997 the Company had 159 full-time, regular
employees, 54 of whom hold Ph.D. degrees and 27 of whom hold other advanced
degrees. Adjusted for those employees who transferred from the Company to Iconix
upon its formation in January 1998, the Company had 142 employees at December
31, 1997, of whom 43 hold Ph.D. degrees and 26 hold other advanced degrees.
Approximately 119 of the 142 employees are engaged in scientific activities and
23 are engaged in general, managerial and administrative functions. None of the
Company's employees is represented by a collective bargaining agreement, nor has
the Company experienced work stoppages. The Company considers its relations with
its employees to be good.

        The Company is highly dependent on its management and scientific staff,
including James E. Rurka, its President and Chief Executive Officer, and George
H. Miller, Ph.D., its Senior Vice President - Research and Development. Loss of
the services of any key individual could have an adverse effect on the Company.
The Company does not carry key-man life insurance on any of its executives. The
Company believes that its future success will depend, in part, on its ability to
attract and retain highly talented managerial and scientific personnel and
consultants. The Company faces intense competition for such personnel from,
among others, biotechnology and pharmaceutical companies, as well as academic
and other research institutions. There can be no assurance that the Company will
be able to attract and retain the personnel it requires on acceptable terms.

SCIENTIFIC CONSULTANTS

        The Company has consulting arrangements with a number of leading
academic and industrial scientists and clinicians. Reflecting the maturation of
the Company from an early stage start-up with a limited number of research
programs to an enterprise with a wide range of programs at various stages of
research and development, Microcide is in the process of reorganizing its
Scientific Advisory Board and various other groups of consultants into more
specialized groups in order to more effectively utilize their
skills and expertise. The Company envisions forming consulting boards comprised
of specialists in the following areas:

        GENETICS AND MOLECULAR BIOLOGY. The Company envisions a group of
approximately six leading geneticists and molecular biologists to assist with
the Company's genetics based discovery efforts including its Bacterial Essential
Genes, Pathogenesis, Bacterial Efflux Pump, Fungal Genomics and Fungal Efflux
Pump programs.

        CHEMISTRY. The Company plans to form a group of two or three highly
experienced chemists to provide specific guidance to each of the Company's
programs in terms of analyzing lead structures which emerge from screening
activities, and in terms of devising strategies for exploratory and medicinal
chemistry efforts around chosen leads.

        CLINICAL MICROBIOLOGY / PHARMACOLOGY. The Company envisions a group of
approximately four leading infectious disease clinicians, microbiologists and
pharmacologists to provide specific guidance in evaluating drug candidates with
respect to pre-clinical microbiology, pharmacodynamics, pharmacokinetics and
toxicology. In addition, through their knowledge of resistance problems in
clinical settings and profiles of competitive products on the market or in
development, these consultants will influence the research directions taken by
the Company in its various programs.

        MOLECULAR DIVERSITY / NATURAL PRODUCTS. The Company envisions a group of
approximately four natural product experts who will assist in assembling the
natural products collection and improving current methods of achieving and
assessing molecular diversity.

        The Company is in the process of discussing these changed roles and
negotiating new consulting agreements with certain of the former members of its
Scientific Advisory, Drug Development and


                                       25
<PAGE>   26

Genetics Consulting Boards. In addition, the Company is recruiting several other
scientific experts to participate in these reconstituted consulting boards.

        Many of the Company's consultants have purchased shares of Common Stock
or have been granted options and have written contracts with the Company
pursuant to which they are required to provide to the Company a minimum number
of days per year of consulting services. In 1997, the Company paid its
consultants approximately $490,000 in the aggregate, as compared to
approximately $340,000 in 1996 and approximately $300,000 in 1995.

        None of the consultants is an employee of the Company. Most of the
consultants have other commitments to, or consulting or advisory contracts with,
their employers and other institutions.

ITEM 2. PROPERTIES

        The Company has one facility consisting of approximately 35,500 square
feet of leased laboratory and office space in Mountain View, California under a
lease agreement with an initial term expiring on September 30, 2000. The Company
presently intends to exercise its option to extend the term of this lease for
five additional years. The Company has a second facility, also in Mountain View,
consisting of approximately 31,000 square feet of leased laboratory and office
space. The lease agreement covering this building has an initial term expiring
in 2005. During 1997, the Company entered into leases through April 30, 2000 on
two additional buildings in Mountain View, comprising a total of approximately
35,500 square feet; one of these buildings, comprising approximately 18,000
square feet, has been sublet to another company through October 30, 1998 with
the tenant having two options to renew for three months each. The Company
intends to outfit the other building, principally for office space, during 1998
to meet the needs of Microcide and Iconix. From the Company's inception through
December 31, 1997, the Company has made capital expenditures aggregating
approximately $8.6 million in constructing and equipping its Mountain View
facilities. The Company believes that its facilities are sufficient to
accommodate the anticipated research and administrative needs of the Company
through 1998. Thereafter, the Company believes that it will be able to secure
adequate additional facilities for its continued operations.

ITEM 3. LEGAL PROCEEDINGS

        Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        Not applicable.


                                       26
<PAGE>   27

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        The Company's Common Stock is traded on the Nasdaq National Market
System under the symbol MCDE. The following table sets forth for the periods
indicated the high and low sale price for the Common Stock. The Company's stock
was first publicly traded on May 15, 1996.

<TABLE>
<CAPTION>
                                                                                    HIGH         LOW
<S>                                                                              <C>           <C>
FISCAL YEAR 1997
     4th Quarter ............................................................    $ 12.50       $  8.63
     3rd Quarter ............................................................      13.88         10.88
     2nd Quarter ............................................................      12.25          9.25
     1st Quarter ............................................................      14.00         10.06

FISCAL YEAR 1996
     4th Quarter ............................................................    $ 12.50       $  9.25
     3rd Quarter ............................................................      13.25          8.75
     2nd Quarter (since May 15, 1996) .......................................      20.50         12.50
</TABLE>

        As of March 1, 1998, there were 157 holders of record of Common Stock

DIVIDEND POLICY

        The Company has not paid any cash dividends on its Common Stock since
its inception and does not anticipate paying cash dividends on its Common Stock
in the foreseeable future.


                                       27
<PAGE>   28

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>


                                                                                        PERIOD FROM
                                                                                         INCEPTION
                                                                                         (DECEMBER
                                                                                         11, 1992)
                                                                                            TO
                                                     YEARS ENDED DECEMBER 31,           DECEMBER 31,
                                           ------------------------------------------   ------------
                                             1997        1996        1995      1994         1993
                                           --------    --------    -------    -------   ------------
                                                    (in thousands, except per share data)
<S>                                        <C>         <C>         <C>        <C>        <C>
STATEMENT OF OPERATIONS DATA:
Total revenues .........................   $ 14,894    $ 11,273    $ 4,985    $    --    $    --
Net loss ...............................     (4,602)       (670)    (3,516)    (7,034)    (2,917)
Basic and diluted net loss per share
(1, 2) .................................      (0.43)
Pro forma basic and diluted net loss per
 share (1, 2) ..........................                  (0.07)     (0.53)
Shares used in computing basic and
 diluted net  loss per share (1, 2) ....     10,817       9,596      6,681
</TABLE>


<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                            --------------------------------------------
                                              1997        1996        1995         1994
                                            -------     -------      -------     -------
                                                          (in thousands)
<S>                                         <C>         <C>          <C>         <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
 investments .........................      $40,387     $47,508      $ 8,517     $ 5,810
Working capital.......................       37,235      42,542        6,388       4,845
Total assets..........................       51,782      56,826       13,493      11,340
Long-term obligations.................          450         952        2,075       2,530
Total stockholders' equity............       46,896      50,574        9,151       7,506
</TABLE>


----------

(1) See Note 1 of Notes to Financial Statements for information concerning the
    calculation of per share information.

(2) Pro forma basic and diluted net loss per share for 1996 and 1995 have been
    retroactively restated to apply the requirements of Staff Accounting
    Bulletin No. 98, issued by the SEC in February 1998 (SAB 98). Under SAB 98,
    certain shares of common stock and options and warrants to purchase shares
    of common stock issued at prices substantially below the per share price of
    shares sold in the Company's initial public offering previously included in
    the computation of shares outstanding in such periods prior to the Company's
    initial public offering are now excluded from the computation.

                                       28
<PAGE>   29

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

OVERVIEW

        Microcide is a biopharmaceutical company whose mission is to discover,
develop and commercialize novel antimicrobials for the improved treatment of
serious bacterial, fungal and viral infections. The Company's discovery and
development programs address the growing problem of bacterial drug resistance
and the need for improved antifungal and antiviral agents through two principal
themes: (i) Targeted Antibiotics, which focuses on developing novel antibiotics
and antibiotic potentiators to overcome bacterial resistance problems, and (ii)
Targeted Genomics, which utilizes bacterial, fungal and viral genetics to
discover new classes of antimicrobials and other novel treatments for infectious
diseases.

        As part of the Company's strategy to enhance its research and
development capabilities and to fund, in part, its capital requirements,
Microcide has entered into collaborative agreements with three major
pharmaceutical companies. Pursuant to the Company's collaborative agreements
with J&J, Daiichi and Pfizer (the "Collaborative Agreements"), the Company has
received license fees, milestone payments and research support payments, and can
potentially receive additional research support payments, milestone payments and
royalty payments. License payments are typically nonrefundable up-front payments
for licenses to develop, manufacture and market products, if any, that are
developed as a result of the collaboration. Research support payments are
typically contractually obligated payments to fund research and development over
the term of the collaboration. Milestone payments are payments contingent upon
the achievement of specified milestones, such as selection of candidates for
drug development, the commencement of clinical trials or receipt of regulatory
approvals. If drugs are successfully developed and commercialized as a result of
the Collaborative Agreements, the Company will receive royalty payments based
upon the net sales of such drugs. In addition, during 1997 the Company derived
other revenues principally through the sale of molecular diversity samples to
other pharmaceutical and biotechnology companies for use in their research
programs.

        Through December 31, 1997, the Company had received in the aggregate
$30.1 million in license fees, milestone payments and research support payments
under the Collaborative Agreements. Daiichi has notified Microcide of its
intention to exercise its option to extend its research collaboration with the
Company for an additional year. Assuming none of the Collaborative Agreements is
terminated prior to its scheduled expiration and that the Daiichi collaboration
continues for a full additional year, the Company will be entitled to receive an
additional $20.9 million in research support payments in the aggregate from J&J,
Daiichi and Pfizer. In addition, in the event that any of the other
Collaborative Agreements are extended beyond their current terms, the Company
will be entitled to receive additional research support payments.

        In the event that the Company achieves the specified research and
product development milestones, it will be entitled to receive milestone
payments as follows: up to $16.5 million for the first product and up to $15.5
million for each additional product developed pursuant to the J&J Agreements, up
to $13.0 million for each product developed pursuant to the Daiichi Agreement,
and up to $32.5 million for each product developed pursuant to the Pfizer
Agreements. Receipt of these milestone payments is contingent upon achieving
specified research and product development milestones, a number of which may not
be achieved for several years, if ever. The Company does not expect to receive
royalties based upon net sales of drugs for a significant number of years, if at
all.

        On January 14, 1998, the Company announced the formation and financing
of Iconix Pharmaceuticals, Inc. Iconix is a biotechnology company which will
seek to develop surrogate genetics and chemical informatics into a
technology platform with broad applicability to


                                       29
<PAGE>   30
multiple human diseases. Through a private placement, Iconix arranged a $12.5
million equity investment from institutional investors. After giving effect to
the investment and including the initial stock option pool reserved for
employees and consultants of Iconix, Microcide holds approximately 35% of the
pro forma fully diluted outstanding equity of Iconix. Microcide will account for
its investment using the equity method of accounting and since Microcide's
investment has a zero book basis, the losses of Iconix will not impact
Microcide's statement of operations. Through the Core Technology Development and
License Agreement, Microcide and Iconix expect to work together over the next
three years to jointly develop and utilize new technology in the areas of
molecular diversity, high-throughput screening, computational sciences and
genome sciences. Pursuant to the Support Services Agreement, Microcide will
provide Iconix with facilities and various business support services for which
the Company will be reimbursed. In addition, through the Antiviral and Surrogate
Genetics Research Agreement, Microcide is obligated to provide Iconix with
research support payments of up to $6.1 million over the next three years.
Microcide is entitled to worldwide development, manufacturing and marketing
rights to antiviral products which may emerge from the collaboration and, if
specified research and development milestones are achieved, will be obligated to
pay Iconix milestone payments of up to $11.0 million for the first product and
up to $10.5 million for each subsequent product, in addition to royalties on
worldwide sales.

        Quarterly results of operations are subject to significant fluctuations
based on the timing and amount of certain revenues earned under the
Collaborative Agreements. The Company expects to continue to incur operating
losses in the future.

        Microcide has assessed the likely impact on its business of the Year
2000 Issue and does not believe that this issue will present a material problem
for the Company's business or will require significant resources to address.

        This Report contains forward-looking statements which involve risks and
uncertainties, including but not limited to statements concerning the
continuation of the Company's collaborative agreements with its strategic
partners and the continued receipt of research support payments and potential
receipt of milestone payments thereunder, the successful development and
commercialization of drugs and the receipt of royalties thereon or sales revenue
therefrom, and the expected period of time the Company's existing financial
resources will enable the Company to maintain its current and planned future
operations. The Company's actual results and timing of certain events may differ
significantly from the results discussed in such forward-looking statements.
Factors that might cause a difference include risks inherent in the Company's
business and the pharmaceutical industry in general, such as uncertainties with
regard to the successful continuation of the research and development activities
under the Collaborative Agreements and in the Company's own programs, the
possible decision of a strategic partner to cancel a collaborative program, the
achievement of research and product milestones, the successful completion of
clinical trials and obtaining of required regulatory approvals, and the
achievement of product commercialization goals, as well as other factors set
forth in this Form 10-K.

RESULTS OF OPERATIONS

Fiscal Years Ended December 31, 1997 and 1996

        Revenues. Total revenues increased from $11.3 million in 1996 to $14.9
million in 1997. License and milestone fees were $2.0 million in 1996 and $1.0
million in 1997. During 1996, a license fee was generated by the signing of the
Pfizer Agreement and a milestone fee was received from J&J triggered by the
selection of a pre-clinical development candidate. During 1997, a milestone fee
was received from Pfizer related to identifying, validating and sequencing an
agreed upon number of bacterial essential genes. Research revenues increased
from $9.3 million in 1996 to $12.2 million in 1997 due to a full year of
activity under the Pfizer collaboration and due to an increase in staffing on
these partnered


                                       30
<PAGE>   31

programs. During 1997, the Company derived other revenues of $1.7 million
principally through the sale of molecular diversity samples to other
pharmaceutical and biotechnology companies for use in their research programs;
there were no such other revenues in 1996. Such revenues are not expected to
comprise a significant portion of total revenues in the future.

        Research and Development Expenses. The Company's research and
development expenses increased 67% from $10.7 million in 1996 to $17.9 million
in 1997. This increase was due primarily to higher compensation and other
employee-related expenses associated with an increase in headcount to support
the Company's corporate collaborations and its internal programs, higher
spending for research supplies and materials, higher expenses related to
assembling the Company's molecular diversity collection, higher costs related to
expanded research and development facilities and higher expenses for outside
consulting services. The Company expects research and development expenses to
increase in 1998, but at a slower rate, due to higher compensation and other
employee-related expenses associated with an increase in research personnel,
further expenditures for research materials, research support payments to Iconix
in conjunction with the Antiviral and Surrogate Genetics Collaboration, and
greater facilities and depreciation costs.

        General and Administrative Expenses. General and administrative expenses
increased approximately 42% from $2.9 million in 1996 to $4.1 million in 1997.
This increase was primarily due to increased compensation expense resulting from
an increase in the number of administrative personnel and higher costs for legal
and other outside services. The Company expects general and administrative
expenses to increase in 1998, but at a slower rate, due to the hiring of
additional administrative personnel to support the expansion of its research
activities, and greater facilities and depreciation costs.

        Interest Income and Expense. Interest income increased from $1.9 million
in 1996 to $2.6 million in 1997 as a result of an increase in average investment
balances principally arising from proceeds received from the sale of equity in
May 1996. Interest expense declined from $236,000 to $144,000 as a result of the
repayment of capital lease obligations.

        Net Loss. Net loss increased from $670,000 in 1996 to $4.6 million in
1997 as a result of the items discussed above.

Fiscal Years Ended December 31, 1996 and 1995

        Revenues. Total revenues increased from $5.0 million in 1995 to $11.3
million in 1996. License and milestone fees were $3.0 million in 1995 and $2.0
million in 1996. During 1995, the Company received license fees upon the
execution of the J&J agreement. During 1996, a license fee was generated by the
signing of the Pfizer Agreement and a milestone fee was received from J&J
triggered by the selection of a pre-clinical development candidate. Research
revenues increased from $2.0 million in 1995 to $9.3 million in 1996 due to a
full year of activity under the J&J and Daiichi collaborations and the inclusion
of the first nine months of activity under the Pfizer collaboration.

        Research and Development Expenses. The Company's research and
development expenses increased 67% from $6.4 million in 1995 to $10.7 million in
1996. This increase was largely due to higher compensation and supplies expenses
resulting from an increase in the number of research personnel hired largely to
support the Company's expanded collaborative arrangements, increased
amortization of deferred compensation and greater purchases of research
materials.

        General and Administrative Expenses. General and administrative expenses
increased approximately 39% from $2.1 million in 1995 to $2.9 million in 1996.
This increase was primarily due to increased compensation expense resulting from
an increase in the number of administrative personnel


                                       31
<PAGE>   32

and the amortization of deferred compensation.

        Interest Income and Expense. Interest income increased from $257,000 in
1995 to $1.9 million in 1996 as a result of an increase in average investment
balances principally arising from proceeds received from the sale of equity in
May 1996. Interest expense declined from $278,000 to $236,000 as a result of the
repayment of capital lease obligations.

        Net Loss. Net loss declined from $3.5 million in 1995 to $670,000 in
1996 as a result of the items discussed above.

LIQUIDITY AND CAPITAL RESOURCES

        The Company has financed its operations since inception primarily
through the sale of equity, through funds provided under the Collaborative
Agreements, through other revenues principally consisting of sales of molecular
diversity and through equipment financing. As of December 31, 1997, the Company
had received $64.4 million from the sale of equity and $30.1 million in cash
from license and milestone fees and research support payments under the
Collaborative Agreements.

        Cash, cash equivalents and short term investments at December 31, 1997
were $40.4 million compared to $47.5 million at December 31, 1996. This decrease
was due primarily to the net loss during 1997, the timing of payments resulting
in the increase in certain assets (largely receivables related to the sale of
molecular diversity samples late in the year) and a decrease in certain
liabilities including accounts payable and deferred revenues, and due to the
repayment of capital lease obligations.

        Net cash used in the Company's operations was $2.6 million in 1997 in
contrast to net cash provided by the Company's operations of $4.4 million in
1996. This change in cash flow was largely due to an increased net loss, and due
to the timing of payments resulting in the increase in certain assets (largely
receivables related to the sale of molecular diversity samples late in the year)
and a decrease in certain liabilities including accounts payable and deferred
revenues.

        During 1997, the Company invested $3.7 million in capital expenditures
as compared to $5.8 million in 1996 largely due to facilities expansion and the
purchase of additional research equipment. The Company expects its capital
expenditures in 1998 to be approximately $3.0 million. The present value of
obligations under capital leases at December 31, 1997 was $836,000. The Company
made principal payments under its lease obligations of $1.1 million in 1997 and
expects to make principal payments under its lease obligations of $612,000 in
1998.

        The Company expects that its existing capital resources, interest income
and future payments due under the Collaborative Agreements will enable the
Company to maintain current and planned operations at least through 1999. In the
event that the Company requires additional funding at any point in the future,
the Company will seek to raise such additional funding from other sources,
including other collaborative arrangements, and through public or private
financings, including sales of equity or debt securities. Any such collaborative
or licensing arrangement could result in limitations on the Company's ability to
control the commercialization of resulting drugs, if any, and could limit
profits, if any, therefrom. Any such equity financing could result in dilution
to the Company's then-existing stockholders. There can be no assurance that
additional funds will be available on favorable terms or at all, or that such
funds, if raised, would be sufficient to permit the Company to continue to
conduct its operations. If adequate funds are not available, the Company may be
required to curtail significantly or eliminate one or more of its research
programs.

        The Company has not generated significant taxable income to date. At
December 31, 1997, the net operating losses available to offset future taxable
income for federal income tax purposes were


                                       32
<PAGE>   33

approximately $15.6 million. Because the Company has experienced ownership
changes, future utilization of the carryforwards may be limited in any one
fiscal year pursuant to Internal Revenue Code regulations. The carryforwards
expire at various dates beginning in 2008 through 2012 if not utilized. As a
result of the annual limitation, a portion of these carryforwards may expire
before becoming available to reduce the Company's federal income tax
liabilities.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

        See Index to Financial Statements on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

        Not applicable.


                                       33
<PAGE>   34

                                    PART III

ITEM 10.  EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT

        Information required by this item will be contained in the Company's
Notice of 1998 Annual Meeting of Stockholders and Proxy Statement, pursuant to
Regulation 14A, to be filed with the Securities and Exchange Commission within
120 days after December 31, 1997. Such information is incorporated herein by
reference.

ITEM 11.  EXECUTIVE COMPENSATION

        Information required by this item will be contained in the Company's
Notice of 1998 Annual Meeting of Stockholders and Proxy Statement, pursuant to
Regulation 14A, to be filed with the Securities and Exchange Commission within
120 days after December 31, 1997. Such information is incorporated herein by
reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        Information required by this item will be contained in the Company's
Notice of 1998 Annual Meeting of Stockholders and Proxy Statement, pursuant to
Regulation 14A, to be filed with the Securities and Exchange Commission within
120 days after December 31, 1997. Such information is incorporated herein by
reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Information required by this item will be contained in the Company's
Notice of 1998 Annual Meeting of Stockholders and Proxy Statement, pursuant to
Regulation 14A, to be filed with the Securities and Exchange Commission within
120 days after December 31, 1997. Such information is incorporated herein by
reference.

                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)     Documents filed as part of this report:

        1.     List of Financial Statements. The following financial statements
               of Microcide Pharmaceuticals, Inc. and Report of Ernst & Young
               LLP, Independent Auditors, are included in this report:

               Balance Sheets as of December 31, 1997 and 1996.
               Statements of Operations for the years ended December 31, 1997,
                 1996 and 1995
               Statement of Stockholders' Equity for the years ended December
                 31, 1997, 1996 and 1995
               Statements of Cash Flows for the years ended December 31, 1997,
                 1996 and 1995
               Notes to Financial Statements
               Report of Ernst & Young LLP, Independent Auditors

        2.     List of all Financial Statement schedules:

               (i)    All schedules are omitted because they are not applicable
                      or the required information is shown in the Financial
                      Statements or notes thereto.

        3.     List of exhibits required by Item 601 of Regulation S-K.


                                       34
<PAGE>   35
        The following exhibits are filed as part of, or incorporated by
reference into, this report.

<TABLE>
<CAPTION>
        Exhibits                                    Description
<S>                  <C>

          2.1++     Iconix Pharmaceuticals, Inc. (formerly EpiGenix, Inc.) Series
                    A Preferred Stock Purchase Agreement.

          2.2++*    Core Technology Development and License Agreement by and
                    between Microcide Pharmaceuticals, Inc. and Iconix
                    Pharmaceuticals, Inc. (formerly EpiGenix, Inc.)

          2.3++*    Antiviral and Surrogate Genetics Research Collaboration
                    Agreement by and between Microcide Pharmaceuticals, Inc.
                    and Iconix Pharmaceuticals, Inc. (formerly EpiGenix, Inc.)

          3.2+      Restated Certificate of Incorporation of the Registrant.

          3.5+      Bylaws of the Registrant.

          4.2+      Form of Common Stock Certificate.

          4.3+      Series A Preferred Warrant Purchase Agreement and Warrant between Dominion
                    Ventures, Inc. and the Registrant dated May 10, 1993.

          4.4+      Series B Preferred Warrant Purchase Agreement and Warrant between Dominion
                    Ventures, Inc. and the Registrant dated May 10, 1993.

          4.5+      Series C Preferred Warrant Purchase Agreement and Warrant between Dominion
                    Ventures, Inc. and the Registrant dated June 10, 1994.

          4.6+      Series B Preferred Warrant Agreement between Comdisco, Inc. and the Registrant
                    dated September 1, 1993.

          4.7+      Series C Preferred Warrant Agreement between Comdisco, Inc. and the Registrant
                    dated September 1, 1993.

          10.1+     Information and Registration Rights Agreement, dated June 29, 1994 as amended.

          10.2+     1993 Amended Incentive Stock Plan.

          10.3+     1996 Employee Stock Purchase Plan.

          10.4+     1996 Director Option Plan.

          10.5+     401(k) Plan.

          10.6+*    Research and License Agreement between the Registrant and Ortho Pharmaceutical
                    Corporation and the R.W. Johnson Pharmaceutical Research Institute dated October
                    24, 1995.

          10.7+*    Research and License Agreement between the Registrant and Ortho Pharmaceutical
                    Corporation and the R.W. Johnson Pharmaceutical Research Institute dated October
                    24, 1995.

          10.8+*    Joint Research Agreement between the Registrant and Daiichi Pharmaceutical Co.,
                    Ltd. dated November 6, 1995.

          10.9+*    Collaborative Research Agreement between the Registrant and Pfizer Inc dated
                    March 1, 1996.

          10.10+*   License and Royalty Agreement between the Registrant and Pfizer Inc dated March
                    1, 1996.

          10.11+    Master Lease Agreement between Dominion Ventures, Inc. and the Registrant, dated
                    May 10, 1993, as amended on June 10, 1994 and November 22, 1994.

          10.12+    Master Lease Agreement between the Registrant and Comdisco, Inc. dated September
                    1, 1993.

          10.13+    Lease Agreement between the Registrant and Portola Land Company dated April
                    1993.

          10.14+    Form of Indemnification Agreement between the Registrant and its Officers and
                    Directors.

          10.15+    Employment Agreement dated January 31, 1994 between the Registrant and James E.
                    Rurka.
</TABLE>


                                       35
<PAGE>   36
<TABLE>
<CAPTION>
        Exhibits                                    Description
<S>                 <C>
          10.16+    Employment Agreement dated December 23, 1992 between the Registrant and Keith A.
                    Bostian, Ph.D.

          10.17+++  Lease Agreement commencing November 1, 1996 between the
                    Registrant and Logue Investments L.P., a California limited
                    partnership.

          10.18*#   Synthetic Compound Purchase Agreement between the Registrant and Daiichi
                    Pharmaceutical Co., Ltd. dated June 25, 1997.

          10.19##   Sublease agreement between the Registrant, Quickturn Design Systems, Inc. and
                    Portola Land Co. dated September 1997.

          10.20##   Sub-sublease agreement between the Registrant, Alpha Blox Corporation, Quickturn
                    Design Systems, Inc. and Portola Land Co. dated September 1997.

          10.21     Consulting Agreement dated January 14, 1998 between the Registrant and Keith
                    Bostian, Ph.D.

          23.1      Consent of Ernst & Young LLP, Independent Auditors.

          24.1      Power of Attorney (see page 38).

          27.1      Financial Data Schedule.

          27.2      Financial Data Schedule.
</TABLE>

----------

  +  Incorporated by reference to the same-numbered exhibit in Registrant's
  Registration Statement on Form S-1, registration number 333-2400, filed with
  the Securities and Exchange Commission and dated May 14, 1996.

  ++ Incorporated by reference to the same-numbered exhibit in Registrant's Form
  8-K filed with the Securities and Exchange Commission and dated January 29,
  1998.

  +++ Incorporated by reference to the same-numbered exhibit in Registrant's
  Form 10-Q for the period ended September 30, 1996, filed with the Securities
  and Exchange Commission and dated November 8, 1996.

  #   Incorporated by reference to the same-numbered exhibit in Registrant's
  Form 10-Q for the period ended June 30, 1997, filed with the Securities and
  Exchange Commission and dated August 14, 1997.

  ##  Incorporated by reference to the same-numbered exhibit in Registrant's
  Form 10-Q for the period ended September 30, 1997, filed with Securities
  and Exchange Commission and dated November 14, 1997.

*  Confidential Treatment granted

(b)     Reports on Form 8-K:

        No reports on Form 8-K were filed during the quarter ended December 31,
1997. On January 29, 1998, the Company filed a report on Form 8-K, as amended on
January 30, 1998 and March 30, 1998, in connection with its collaboration with
Iconix Pharmaceuticals, Inc. (formerly EpiGenix, Inc.). The Form 8-K/A filed
March 30, 1998 contains financial statements required by Article 11 of Reg S-X.

(c)     See part a(3) above.

(d)     All schedules have been omitted because the information required to be
        set forth therein is not applicable.


                                       36
<PAGE>   37

                                   SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                         MICROCIDE PHARMACEUTICALS, INC.
                                         a Delaware Corporation



                                         By:    /s/ JAMES E. RURKA
                                            -----------------------------------
                                                 James E. Rurka
                                                 President and Chief Executive
                                                 Officer

                                         Date:  March 27, 1998


                                       37
<PAGE>   38

                                POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James E. Rurka and Matthew J. Hogan,
jointly and severally his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendment to this
Report on Form 10-K, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
            Signature                                   Title                           Date

<S>                                     <C>                                             <C>
  /s/ JAMES E. RURKA                    President, Chief Executive Officer              March 27, 1998
----------------------------------      and Director (Principal Executive
James E. Rurka                          Officer)


  /s/ MATTHEW J. HOGAN                  Chief Financial Officer (Principal              March 27, 1998
----------------------------------      Financial and Accounting Officer)
Matthew J. Hogan


  /s/ JOSEPH S. LACOB                   Chairman of the Board of Directors              March 27, 1998
----------------------------------
Joseph S. Lacob


  /s/ KEITH A. BOSTIAN, PH.D.           Director                                        March 27, 1998
----------------------------------
Keith A. Bostian, Ph.D.


 /s/ HUGH Y. RIENHOFF, JR., M.D.        Director                                        March 27, 1998
----------------------------------
Hugh Y. Rienhoff, Jr., M.D.


  /s/ DAVID SCHNELL, M.D.               Director                                        March 27, 1998
----------------------------------
David Schnell, M.D.


  /s/ L. JAMES STRAND, M.D.             Director                                        March 27, 1998
----------------------------------
L. James Strand, M.D.


  /s/ JOHN P. WALKER                    Director                                        March 27, 1998
----------------------------------
John P. Walker



</TABLE>


                                       38
<PAGE>   39
                         MICROCIDE PHARMACEUTICALS, INC.

                          INDEX TO FINANCIAL STATEMENTS


<TABLE>
<S>                                                                           <C>
      Report of Ernst & Young LLP, Independent Auditors................     F-2

      Financial Statements:
        Balance Sheets.................................................     F-3
        Statements of Operations.......................................     F-4
        Statement of Stockholders' Equity..............................     F-5
        Statements of Cash Flows.......................................     F-6
        Notes to Financial Statements..................................     F-7
</TABLE>


                                      F-1
<PAGE>   40

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Microcide Pharmaceuticals, Inc.

   We have audited the accompanying balance sheets of Microcide Pharmaceuticals,
Inc. as of December 31, 1997 and 1996, and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

   We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

   In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Microcide Pharmaceuticals, Inc.
at December 31, 1997 and 1996 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.

                                                 ERNST & YOUNG LLP

Palo Alto, California
February 9, 1998


                                      F-2
<PAGE>   41

                         MICROCIDE PHARMACEUTICALS, INC.

                                 BALANCE SHEETS
                      (In thousands, except share amounts)



<TABLE>
<CAPTION>
                                                                         DECEMBER 31,
                                                                      1997          1996
                                                                    --------      --------
<S>                                                                 <C>           <C>
ASSETS
Current assets:
   Cash and cash equivalents ..................................     $ 11,763      $  8,317
   Short-term investments .....................................       28,624        39,191
   Prepaid expenses and other current assets ..................        1,284           334
                                                                    --------      --------
Total current assets ..........................................       41,671        47,842

Property and equipment, net ...................................        9,540         8,825
Other assets ..................................................          571           159
                                                                    --------      --------
                                                                    $ 51,782      $ 56,826
                                                                    ========      ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable ...........................................     $  1,313      $  1,523
   Construction payable .......................................          347           745
   Accrued compensation .......................................          746           496
   Current portion of capital lease obligations ...............          612         1,110
   Deferred revenue ...........................................          786         1,189
   Other accrued liabilities ..................................          632           237
                                                                    --------      --------
Total current liabilities .....................................        4,436         5,300

Long-term portion of capital lease obligations ................          224           811
Accrued rent ..................................................          226           141
Commitments
Stockholders' equity:
  Preferred stock, par value $0.001; 5,000,000 shares
   authorized; no shares issued and outstanding................           --            --
  Common stock, par value $0.001; 50,000,000 shares authorized,
   10,907,043 and 10,741,668 shares issued and outstanding at
   December 31, 1997 and 1996, respectively....................       66,930        66,279
  Deferred compensation .......................................       (1,251)       (1,577)
  Net unrealized gain (loss) on securities
    available-for-sale ........................................          (44)            9
  Accumulated deficit .........................................      (18,739)      (14,137)
                                                                    --------      --------
Total stockholders' equity ....................................       46,896        50,574
                                                                    --------      --------
                                                                    $ 51,782      $ 56,826
                                                                    ========      ========
</TABLE>





                             See accompanying notes.


                                      F-3
<PAGE>   42

                         MICROCIDE PHARMACEUTICALS, INC.

                            STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                              YEARS ENDED DECEMBER 31,
                                                        ------------------------------------
                                                          1997          1996          1995
                                                        --------      --------      --------
<S>                                                        <C>        <C>              <C>
Revenues:
  License and milestone revenues ..................     $  1,000      $  2,000      $  3,000
  Research revenue ................................       12,183         9,273         1,985
  Other revenues ..................................        1,711            --            --
                                                        --------      --------      --------
Total revenues ....................................       14,894        11,273         4,985

Operating expenses:
  Research and development ........................       17,877        10,717         6,400
  General and administrative ......................        4,091         2,889         2,080
                                                        --------      --------      --------
Total operating expenses ..........................       21,968        13,606         8,480
                                                        --------      --------      --------

Loss from operations ..............................       (7,074)       (2,333)       (3,495)

Interest income ...................................        2,616         1,899           257
Interest expense ..................................         (144)         (236)         (278)
                                                        --------      --------      --------

Net loss ..........................................     $ (4,602)     $   (670)     $ (3,516)
                                                        ========      ========      ========


Basic and diluted net loss per share ..............     $  (0.43)
                                                        ========
Pro forma basic and diluted net loss per share ....                   $  (0.07)     $  (0.53)
                                                                      ========      ========

Shares used in computing basic and diluted net loss
  per share .......................................       10,817         9,596         6,681
</TABLE>







                             See accompanying notes.


                                      F-4
<PAGE>   43
                         MICROCIDE PHARMACEUTICALS, INC.

                        STATEMENT OF STOCKHOLDERS' EQUITY

                   FOR THE THREE YEARS ENDED DECEMBER 31, 1997
               (In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
                                                                                           NET
                                                                                        UNREALIZED                     TOTAL
                                                    PREFERRED   COMMON     DEFERRED   GAIN (LOSS) ON  ACCUMULATED  STOCKHOLDERS'
                                                      STOCK      STOCK   COMPENSATION   SECURITIES      DEFICIT        EQUITY
                                                    ---------  --------  ------------ --------------  -----------  -------------
<S>                                                  <C>       <C>       <C>           <C>            <C>          <C>
Balances at December 31, 1994 .....................  $ 17,443  $     14      $    --      $     --        $ (9,951)      $  7,506
Issuance of 573,429 shares of Series D
  preferred stock, net ............................     4,992        --           --            --              --          4,992
Issuance of  18,907 shares of common
  stock  due to options exercised by
  employees and common stock for services .........        --         5           --            --              --              5
Net unrealized loss on securities
  available-for-sale ..............................        --        --           --            (2)             --             (2)
Deferred compensation .............................        --       578         (578)           --              --             --
Amortization of deferred compensation .............        --        --          166            --              --            166
Net loss ..........................................        --        --           --            --          (3,516)        (3,516)
                                                     --------   -------     --------      --------        --------       --------
Balances at December 31, 1995 .....................    22,435       597         (412)           (2)        (13,467)         9,151
Issuance of 571,429 shares of Series E
  preferred stock, net ............................     4,990        --           --            --              --          4,990
Issuance of 2,875,000 shares of common
  stock at $14.00 per share in the
  initial public offering, net ....................        --    36,387           --            --              --         36,387
Conversion of 6,880,791 preferred shares
  to 6,880,791 common shares of stock .............   (27,425)   27,422           --            --              --             (3)
Issuance of 8,405 shares of common stock under the
  employee stock purchase plan ....................        --        84           --            --              --             84
Issuance of  122,032 shares of common
  stock  due to options exercised by
  employees and common stock for services .........        --       134           --            --              --            134
Deferred compensation .............................        --     1,655       (1,655)           --              --             --
Amortization of deferred compensation .............        --        --          490            --              --            490
Net unrealized gain on securities
  available-for-sale ..............................        --        --           --            11              --             11
Net loss ..........................................        --        --           --            --            (670)          (670)
                                                     --------   -------     --------      --------        --------       --------
Balances at December 31, 1996 .....................        --    66,279       (1,577)            9         (14,137)        50,574
Issuance of 24,749 shares of common stock under the
  employee stock purchase plan ....................        --       210           --            --              --            210
Issuance of  140,626 shares of common
  stock  due to options exercised by
  employees and consultants .......................        --        60           --            --              --             60
Deferred compensation .............................        --       378         (378)           --              --             --
Reversal of deferred compensation for
  terminated employees ............................        --       (32)          32            --              --             --
Amortization of deferred compensation .............        --        --          672            --              --            672
Repayment of note receivable ......................        --        35           --            --              --             35
Net unrealized loss on securities
  available-for-sale ..............................        --        --           --           (53)             --            (53)
Net loss ..........................................        --        --           --            --          (4,602)        (4,602)
                                                     --------   -------     --------      --------        --------       --------
Balances at December 31, 1997 .....................  $     --   $66,930     $ (1,251)     $    (44)       $(18,739)      $ 46,896
                                                     ========   =======     ========      ========        ========       ========
</TABLE>



                             See accompanying notes.


                                      F-5
<PAGE>   44
                         MICROCIDE PHARMACEUTICALS, INC.

                            STATEMENTS OF CASH FLOWS
                                 (In thousands)

                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS


<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                           -------------------------------------------
                                                              1997            1996             1995
                                                           ---------        ---------        ---------
<S>                                                        <C>              <C>              <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss ................................................  $  (4,602)       $    (670)       $  (3,516)
Adjustments to reconcile net loss to net cash
 provided by (used in) operating activities:
 Depreciation and amortization ..........................      2,988            1,560            1,247
 Amortization of deferred compensation ..................        672              490              166
 Accrued rent ...........................................        103              (14)              38
 Issuance of common stock for services (included in
  issuance costs) .......................................         --              103               --
 Net unrealized gain (loss) on securities ...............        (53)              11               (2)
 Changes in assets and liabilities:
    Prepaid expenses and other current assets ...........       (950)            (196)             201
    Other assets ........................................       (412)              73               --
    Accounts payable ....................................       (210)           1,092              165
    Construction payable ................................       (398)             713               32
    Accrued compensation and other liabilities ..........        626              460               41
    Deferred revenue ....................................       (403)             776              413
                                                           ---------        ---------        ---------
Net cash provided by (used in) operating activities .....     (2,639)           4,398           (1,215)
                                                           ---------        ---------        ---------

CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of short-term investments ......................   (102,211)         (39,191)              --
Maturities of short-term investments ....................    112,778               --               --
Capital expenditures ....................................     (3,702)          (5,779)            (148)
                                                           ---------        ---------        ---------
Net cash provided by (used in) investing activities .....      6,865          (44,970)            (148)
                                                           ---------        ---------        ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations .........     (1,085)          (1,117)            (927)
Proceeds from issuances of common stock .................        270           36,499                5
Repayment of shareholder note ...........................         35               --               --
Net proceeds from issuance of convertible preferred .....         --            4,990            4,992
                                                           ---------        ---------        ---------
Net cash provided by (used in) financing activities .....       (780)          40,372            4,070
                                                           ---------        ---------        ---------

Net increase (decrease) in cash and cash equivalents ....      3,446             (200)           2,707
Cash and cash equivalents at beginning of period ........      8,317            8,517            5,810
                                                           ---------        ---------        ---------
Cash and cash equivalents at end of period ..............  $  11,763        $   8,317        $   8,517
                                                           =========        =========        =========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:
Income taxes paid .......................................  $      23        $      --        $      --
                                                           =========        =========        =========
Interest paid ...........................................  $     144        $     236        $     274
                                                           =========        =========        =========

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
 FINANCING ACTIVITIES:
Equipment purchased under capital leases ................  $      --        $      --        $     746
                                                           =========        =========        =========
</TABLE>

                            See accompanying notes.


                                      F-6
<PAGE>   45

                         MICROCIDE PHARMACEUTICALS, INC.

                          NOTES TO FINANCIAL STATEMENTS

                                DECEMBER 31, 1997

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  Organization and Basis of Presentation

   Microcide Pharmaceuticals, Inc. (the "Company") is a biopharmaceutical
company whose mission is to discover, develop and commercialize novel
antimicrobials for the improved treatment of serious bacterial, fungal and viral
infections. The Company's discovery and development programs address the growing
problem of bacterial drug resistance and the need for improved antifungal and
antiviral agents through two principal themes: (i) Targeted Antibiotics, which
focuses on developing novel antibiotics and antibiotic potentiators to directly
address existing bacterial resistance problems, and (ii) Targeted Genomics,
which utilizes bacterial, fungal and viral genetics to discover new classes of
antimicrobials and other novel treatments for infectious diseases.

  Use of Estimates

   The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

  Cash, Cash Equivalents and Investments

   The Company considers all highly liquid investments with a maturity from date
of purchase of three months or less to be cash equivalents. The Company
maintains deposits with financial institutions in the United States and invests
its excess cash in commercial paper and corporate debt securities which bear
minimal risk.

   Management determines the appropriate classification of securities at the
time of purchase and reevaluates such designation as of each balance sheet date.
At December 31, 1997 and 1996, respectively, all securities were designated as
available-for-sale. These securities are stated at fair value based upon market
quotes, with the unrealized gains and losses reported in stockholders' equity.
Amortization of premiums and discounts are included in interest income. Realized
gains and losses and declines in value judged to be other than temporary, if
any, are included in other income. The cost of securities sold is based on the
specific identification method.

  Property and Equipment

   Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over the estimated useful lives of the assets, which
varies between three, five and seven years. Equipment under capital lease and
leasehold improvements are amortized using the straight-line method over the
estimated useful lives of the assets or the term of the lease, whichever is
shorter.

  Revenue Recognition

   Revenues related to research contracts are recognized ratably over the
related funding periods for each contract. The Company is required to perform
research activities as specified in each respective agreement on a best efforts
basis and the Company is reimbursed based on the costs associated with the
number of full time equivalent employees working on each specific contract,
which is generally on a ratable basis over the term of the agreement. Deferred
revenue may result when the Company does not incur the required level of effort
during a specific period in comparison to funds received under the respective
contracts. Revenues related to license agreements with noncancelable,
nonrefundable terms and no significant future obligations are recognized upon
execution of the agreements. Milestone payments will be recognized pursuant to
collaborative agreements upon


                                      F-7
<PAGE>   46

the achievement of specified milestones, such as selection of candidates for
drug development, the commencement of clinical trials or receipt of regulatory
approvals. For collaborative arrangements which include both revenue received on
a cost reimbursement basis and funds received associated with the purchase of
the Company's equity, the Company accounts for the equity component based on the
estimated fair value of the Company's securities issued at the date that the
terms of the respective agreements were agreed upon. During 1997, the Company
reported other revenues which principally related to the sale of molecular
diversity samples to pharmaceutical or biotechnology companies for use in their
drug discovery programs.

  Stock-Based Compensation

   In accordance with the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the
Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations, and to adopt the "disclosure only" alternative described in
SFAS 123. Under APB 25, if the exercise price of the Company's employee stock
options equals or exceeds the fair market value on the date of the grant or the
fair value of the underlying stock on the date of the grant as determined by the
Company's Board of Directors, no compensation expense is recognized.

  Net Loss Per Share

   Effective December 31, 1997, the Company adopted statement of Financial
Accounting Standards No. 128 "Earnings per Share" ("SFAS 128"). SFAS 128
requires the presentation of basic earnings (loss) per share and diluted
earnings (loss) per share, if more dilutive, for all periods presented.

   In accordance with SFAS 128, basic net loss per share has been computed using
the weighted-average number of shares of Common Stock outstanding during the
period. Basic net loss per share for 1996 and 1995 have been retroactively
restated to apply the requirements of Staff Accounting Bulletin No. 98 ("SAB
98"), issued by the SEC in February 1998. Under SAB 98, certain shares of common
stock and options and warrants to purchase shares of common stock issued at
prices substantially below the per share price of shares sold in the Company's
initial public offering previously included in the computation of shares
outstanding in periods prior to the Company's initial public offering are now
excluded from the computation in such periods. Diluted net loss per share has
not been presented; given the Company's net loss position, the result would be
anti-dilutive.

   Basic pro forma net loss per share as presented in the statement of
operations has been computed as described above and also gives effect to the
conversion of the convertible Preferred Stock that automatically converted upon
completion of the Company's initial public offering (using the as-if converted
method) from the original date of issuance.

   A reconciliation of shares used in the calculation of basic and pro forma
basic net loss per share follows (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                                         YEARS ENDED DECEMBER 31,
                                                                ------------------------------------------
                                                                  1997             1996             1995
                                                                --------         --------         --------
<S>                                                             <C>              <C>              <C>
Net loss ...................................................    $ (4,602)        $   (670)        $ (3,516)
                                                                ========         ========         ========
Basic and Diluted:
Weighted average shares of common stock outstanding ........      10,817            7,034              849
                                                                --------         --------         --------
Basic and diluted net loss per share .......................    $  (0.43)        $  (0.10)        $  (4.14)
                                                                ========         ========         ========

Pro Forma:
Shares used above ..........................................                        7,034              849
Adjusted to reflect the effect of the assumed conversion
of preferred stock..........................................                        2,562            5,832
                                                                                 --------         --------
Shares used in computing pro forma basic and diluted net
loss per share  ............................................                        9,596            6,681
                                                                                 ========         ========
Pro forma basic and diluted net loss per share .............                     $  (0.07)        $  (0.53)
                                                                                 ========         ========
</TABLE>


                                      F-8
<PAGE>   47

        Had the Company been in a net income position, diluted earnings per
share for 1997, 1996 and 1995 would have included the shares used in the
computation of pro forma basic net loss per share as well as an additional
567,000, 664,000 and 522,000 shares, respectively, related to outstanding
options and warrants not included above (as determined using the treasury stock
method).

  Impact of Recently Issued Accounting Standards

   In 1997, Statement of Financial Accounting Standards No. 130 ("SFAS 130"),
"Reporting Comprehensive Income," was issued and is required to be adopted by
the Company in 1998. In 1997, Statement of Financial Accounting Standards No.
131 ("SFAS 131"), "Disclosure About Segments of an Enterprise and Related
Information," was issued and is required to be adopted by the Company in 1998.
The Company expects the adoption of these statements will not impact results of
operations or financial position.

2. COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS

  Johnson & Johnson

   In October 1995, the Company entered into a research and development
agreement with Ortho Pharmaceutical Corporation and the R.W. Johnson
Pharmaceutical Research Institute, both Johnson & Johnson companies ("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. The agreement
provides for certain revenue payments, including payments for research and
development costs for three years and for reaching certain research and
development goals. J&J received exclusive worldwide rights to products developed
during the collaboration in the field of use as defined in the agreement. The
development, manufacturing, marketing and sale of drugs resulting from the
collaboration will be conducted by J&J, provided that the Company has the right
to undertake certain co-promotion activities in North America, subject to J&J
approval. Should the development efforts result in a marketable product, the
Company will receive royalty payments based on product sales. In connection with
the agreement, J&J made a nonrefundable $3,000,000 up-front license payment to
the Company, and an affiliate of J&J made an equity investment of $5,000,000 in
return for 571,429 shares of Series D convertible preferred stock which
subsequently converted to common stock upon the Company's initial public
offering (see Note 6). Total revenue recognized under the agreement for the
years ended December 31, 1997, 1996 and 1995 was $3,500,000, $4,500,000 and
$3,647,000, respectively.

  Daiichi Pharmaceutical Co., Ltd.

   In November 1995, the Company entered into a research and development
agreement with Daiichi Pharmaceutical Co., Ltd. ("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
pseudomonas. The agreement provides for certain revenue payments, including
payments for research and development costs for two years and nine months
commencing July 1, 1995 and for reaching certain research and development goals.
Daiichi has notified Microcide that it intends to exercise its option to extend
the research collaboration for an additional year. Daiichi has the right to
enter into a license agreement for exclusive worldwide rights to products
developed during the collaboration in the field of use as defined in the
agreement. The development, manufacturing, marketing and sale of drugs resulting
from the collaboration will be conducted by Daiichi, subject to the Company's
right to co-promote such drugs in North America. Should the development efforts
result in a marketable product, the Company will receive royalty payments based
on product sales. Total research revenue recognized under the agreement for the
years ended December 31, 1997, 1996 and 1995 was $4,364,000, $3,175,000 and
$1,338,000, respectively.


                                      F-9
<PAGE>   48

  Pfizer Inc.

   In March 1996, Microcide entered into a research and development agreement
with Pfizer Inc. ("Pfizer") to implement the Company's essential gene and
multi-channel screening system to discover novel classes of antibiotics. The
agreement provides for certain revenue payments, including payments for research
and development costs for five years and for reaching certain research and
development goals. Pfizer received exclusive worldwide rights to products
developed during the collaboration. The development, manufacturing, marketing
and sale of drugs resulting from the collaboration will be conducted by Pfizer,
subject to the Company's right to co-promote such products in North America.
Should the development efforts result in a marketable product, the Company will
receive royalty payments based on product sales. In connection with the
agreement, Pfizer made a $1,000,000 up-front license payment and a $5,000,000
equity investment in return for 571,429 shares of Series E convertible preferred
stock which subsequently converted to common stock upon the Company's initial
public offering (see Note 6). Revenue recognized under the agreement for the
years ended December 31, 1997 and 1996 was $5,319,000 and $3,598,000,
respectively.

   Costs related to research revenues under the above agreements for the years
ended December 31, 1997, 1996 and 1995 approximated the related research revenue
recognized (exclusive of license and milestone fees).

3. PROPERTY AND EQUIPMENT

   Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                     -----------------------
                                                        1997          1996
                                                     ---------     ---------
                                                         (In thousands)
<S>                                                  <C>           <C>
        Laboratory and office equipment........      $   7,678     $   5,286
        Leasehold improvements.................          8,578         7,268
                                                     ---------     ---------
                                                        16,256        12,554
        Less accumulated depreciation and
          amortization.........................         (6,716)       (3,729)
                                                     ----------    ----------
        Property and equipment, net............      $   9,540     $   8,825
                                                     =========     =========
</TABLE>

   Properties leased under capital leases are included above with a cost of
approximately $4,538,000 at December 31, 1997 and 1996, with accumulated
amortization of approximately $3,576,000 and $2,634,000 at December 31, 1997 and
1996, respectively.

4. INVESTMENTS

   The following is a summary of available-for-sale securities as of:

<TABLE>
<CAPTION>
                                                       AVAILABLE-FOR-SALE SECURITIES
                                       ----------------------------------------------------------
                                                        GROSS            GROSS          ESTIMATED
                                       AMORTIZED      UNREALIZED       UNREALIZED         FAIR
                                         COST           GAINS            LOSSES           VALUE
                                       ----------------------------------------------------------
                                                            (In thousands)
<S>                                    <C>             <C>              <C>              <C>
December 31, 1997
Cash equivalents and short-term
investments:
Money market funds ............        $  2,133        $     --         $     --         $  2,133
Corporate debt securities .....          37,461              --              (44)          37,417
                                       --------        --------         --------         --------
                                       $ 39,594        $     --         $    (44)        $ 39,550
                                       ========        ========         ========         ========

December 31, 1996
Cash equivalents and short-term
investments:
Money market funds ............        $    420        $     --         $     --         $    420
Corporate debt securities .....          44,165              15               (6)          44,174
                                       --------        --------         --------         --------
                                       $ 44,585        $     15         $     (6)        $ 44,594
                                       ========        ========         ========         ========
</TABLE>


                                      F-10
<PAGE>   49

   Maturities of securities available-for-sale were as follows:

<TABLE>
<CAPTION>
                                                       AS OF DECEMBER 31,
                                     --------------------------------------------------------
                                              1997                          1996
                                     ---------------------------   --------------------------
                                     AMORTIZED    ESTIMATED FAIR   AMORTIZED   ESTIMATED FAIR
                                        COST          VALUE          COST          VALUE
                                     ---------------------------   --------------------------
                                                         (In thousands)
<S>                                   <C>            <C>            <C>            <C>
Due in 90 days or less ............   $10,937        $10,927        $ 5,425        $ 5,403

Due in 90 days through 2 years ....    28,657         28,623         39,160         39,191
                                      -------        -------        -------        -------
                                      $39,594        $39,550        $44,585        $44,594
                                      =======        =======        =======        =======
</TABLE>

5. LEASES

   The Company is making payments under capital lease lines of credit with
leasing companies which financed certain equipment purchases.

   The Company leases its office and research facilities under various operating
leases whose terms expire between the years 2000 and 2005. The Company has
options to extend certain leases for an additional five years. Future minimum
lease payments under all noncancelable leases are as follows:

<TABLE>
<CAPTION>
                                           CAPITAL      OPERATING
                                           LEASES         LEASES
                                           ------         ------
<S>                                        <C>            <C>
Year ended December 31,                         (In thousands)
1998 ...................................   $  765         $1,568
1999 ...................................      197          1,615
2000 ...................................       --            970
2001 ...................................       --            468
2002 ...................................       --            487
Thereafter .............................       --          1,434
                                           ------         ------
Total minimum payment required .........      962         $6,542
                                                          ======
Less amount representing interest ......     (126)
                                           ------
Present value of future lease
payments ...............................      836
Less current portion ...................     (612)
                                           ------
                                           $  224
                                           ======
</TABLE>

   Rent expense for operating leases was approximately $947,000, $454,000 and
$377,000 in 1997, 1996 and 1995, respectively.

   The Company has commitments with certain manufacturers to purchase equipment
for a total cost of $606,000. At December 31, 1997, the Company estimates that
its remaining obligation under these commitments is approximately $180,000.

6. STOCKHOLDERS' EQUITY

  Preferred Stock

   The Company is authorized to issue 5,000,000 shares of preferred stock. The
Company's Board of Directors may set rights and privileges of any preferred
stock issued.

  Warrants

   At December 31, 1997, warrants to purchase 160,187 shares of common stock at
a weighted average price of $2.85 were outstanding. The warrants expire three
years after the initial public offering (May 15, 1999).


                                      F-11
<PAGE>   50

  1996 Employee Stock Purchase Plan

   During 1996, the shareholders ratified the adoption of the 1996 Employee
Stock Purchase Plan (the "Purchase Plan"). The Company has reserved 120,000
shares of common stock for issuance to employees. Under the Purchase Plan,
employees may purchase common stock through payroll deductions in semi-annual
offerings at a price equal to the lower of 85% of the closing price on the
applicable offering commencement date or 85% of the closing price on the
applicable offering termination date. At December 31, 1997, 86,846 shares of
stock remained available for future purchase under the Purchase Plan.

  1996 Director Option Plan

   During 1996, the shareholders approved the 1996 Directors' Stock Option Plan
(the "Director Plan"). The Company has reserved 80,000 shares of common stock
for issuance to non-employee directors pursuant to options granted under this
Plan. The Director Plan provides for the automatic grant of an option (the
"First Option") to purchase 12,000 shares of common stock to each non-employee
director provided that such director was not an employee director of the Company
immediately prior to becoming a non-employee director. Each non-employee
director, whether or not eligible to receive a First Option, is automatically
granted an option to purchase 4,000 shares of common stock (a "Subsequent
Option") each year on the date of the Company's annual stockholders meeting, if
on such date he or she has served on the Board for at least six months. First
Options and Subsequent Options have terms of ten years. First Options vest and
become exercisable as to 1/6th of the shares subject to the option six months
after the date of grant, and as to 1/36th of the shares each month thereafter.
Subsequent Options vest as to 1/12th of the shares subject to the option each
month after the date of grant. The exercise prices of First Options and
Subsequent Options are 100% of the fair market value per share of the common
stock, generally determined with reference to the closing price of the common
stock as reported on the Nasdaq National Market on the date of grant.

  1993 Amended Incentive Stock Plan

   At the Annual Shareholders' Meeting held on May 13, 1997, the shareholders
approved the amendment of the 1993 Amended Incentive Stock Plan (the "Plan"),
thereby increasing the number of shares of common stock reserved for issuance by
500,000. The total number of shares of common stock now reserved for issuance
under the Plan is 1,880,000.

   Under the Plan, options and stock purchase rights may be granted by the board
of directors to employees and consultants. Options granted may be either
incentive stock options or nonstatutory stock options. Incentive stock options
may be granted to employees with exercise prices of no less than the fair value
and nonstatutory options may be granted to employees or consultants at exercise
prices of no less than 85% of the fair value of the common stock on the grant
date as determined by the board of directors. Initial options, usually granted
with an initial vesting date of the employee's date of hire, generally vest at
the rate of 25% at the end of the first year with the remaining balance vesting
ratably over the next three years. Stock award options are granted as determined
by the board of directors, with a vesting schedule in which 1/48 of the total
number of shares granted becomes exercisable one month from the date of grant
and each subsequent 1/48 becomes exercisable each full month thereafter. Common
stock issued pursuant to exercise of either stock option or stock purchase
rights are subject to repurchase by the Company upon termination of employment.
The Company's repurchase right generally lapses over four years.


                                      F-12
<PAGE>   51

   Combined activity under the Director Option Plan and Amended Incentive Stock
Option Plan was as follows:

<TABLE>
<CAPTION>
                                        NUMBER OF          RANGE OF EXERCISE   WEIGHTED AVERAGE
                                          SHARES                PRICES          EXERCISE PRICE
                                        ---------          -----------------   ----------------
<S>                                       <C>                 <C>                   <C>
Balance at December 31, 1994 ...          384,400            $0.20-$ 0.38           $ 0.27
  Options granted ..............          144,800                  $ 0.38           $ 0.38
  Options exercised ............          (13,867)           $0.25-$ 0.38           $ 0.25
  Options canceled .............          (18,833)           $0.20-$ 0.38           $ 0.27
                                        ---------
Balance at December 31, 1995 ...          496,500            $0.20-$ 0.38           $ 0.30
  Options granted ..............          417,100            $0.38-$12.50           $ 6.33
  Options exercised ............         (112,032)           $0.20-$ 2.50           $ 0.30
  Options canceled .............          (27,868)           $0.20-$10.75           $ 1.13
                                        ---------
Balance at December 31, 1996 ...          773,700            $0.20-$12.50           $ 3.52
  Options granted ..............          533,100            $9.44-$14.00           $11.53
  Options exercised ............         (140,626)           $0.20-$ 2.50           $ 0.44
  Options canceled .............          (60,588)           $0.20-$13.75           $ 8.01
                                        ---------
Balance at December 31, 1997 ...        1,105,586            $0.20-$14.00           $ 7.50
                                        =========
</TABLE>

   Under the Amended Incentive Stock Option Plan, options to purchase 392,821
and 273,634 shares of common stock were exercisable at December 31, 1997 and
1996, respectively. At December 31, 1997, 358,556 shares remained available for
grant under the Amended Incentive Stock Option Plan. Through December 31, 1997,
200,000 shares of common stock have been issued pursuant to stock purchase
rights granted under the Plan, of which 47,917 shares were subject to the
Company's repurchase provision (at the original purchase prices from $0.25 to
$0.375 per share) for an aggregate value of $13,000.

   Under the Director Plan, of the 20,000 shares that had been granted, 11,665
shares were exercisable at December 31, 1997. At December 31, 1997, 60,000
shares remained available for grant under the Director Plan.

   The options outstanding at December 31, 1997 have been segregated into three
ranges for additional disclosures as follows:

<TABLE>
<CAPTION>
                             OPTIONS OUTSTANDING          WEIGHTED-        EXERCISABLE OPTIONS
                         ---------------------------       AVERAGE     ---------------------------
                                          WEIGHTED-       REMAINING                      WEIGHTED-
             RANGE OF                      AVERAGE       CONTRACTUAL                      AVERAGE
             EXERCISE                     EXERCISE          LIFE                         EXERCISE
              PRICES         NUMBER        PRICES        (IN YEARS)        NUMBER         PRICES
          ------------   ------------   ------------   --------------- ------------   -----------
<S>                         <C>          <C>                <C>           <C>          <C>
           $0.20-$0.375     232,702      $   0.32           6.94          197,513      $   0.31
              $2.50         190,434          2.50           8.17           81,148          2.50
           $9.44-$14.00     682,450         11.34           9.19          125,825         11.20
                         ----------                                    ----------
                          1,105,586          7.50           8.54          404,486          4.14
                         ==========                                    ==========
</TABLE>

   Stock Compensation

   The Company has elected to follow APB 25 and related interpretations in
accounting for its stock options because, as discussed below, the alternative
fair value accounting provided for under SFAS 123 requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of the
grant, no compensation expense is recognized. Because SFAS 123 is applicable
only to options granted subsequent to 1994, its pro forma effect will not be
fully reflected until 1998 since the options granted by Microcide generally vest
over four years.

   The Company recorded $2,233,000 in deferred compensation pursuant to APB 25
for the difference between the grant price and the deemed fair value of the
Company's common stock for certain options in the 12-month period prior to the
initial public offering. The Company also recorded deferred compensation for
stock options granted to consultants. The deferred compensation is being
amortized to expense over the vesting period of the options, generally three to
four years.


                                      F-13
<PAGE>   52

   Pro forma information regarding the net income (loss) and earnings (loss) per
share is required by SFAS 123, and has been determined as if the Company had
accounted for its employee stock options granted subsequent to 1994 under the
fair value method of that Statement. The fair value for these options was
estimated at the date of grant using the Black-Scholes option pricing model for
the multiple option approach with the following assumptions for 1997, 1996 and
1995: weighted-average volatility factor of 0.57, 0.6 and 0.6, respectively; no
expected dividend payments; weighted-average risk-free interest rates in effect
of 6.10%, 5.62% and 5.99%, respectively; and a weighted-average expected life of
3.42 years, 3.64 years and 2.67 years, respectively.

   The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a single measure of the
fair value of the Company's employee stock options.

   Based upon the above methodology, the weighted-average fair value of options
granted during the years ended December 31, 1997, 1996 and 1995 was $5.21, $6.69
and $4.04, respectively.

   For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to pro forma net income (loss) over the options' vesting
period. The Company's pro forma information is as follows:

<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                           ----------------------------------------
                                                                1997          1996          1995
                                                           -----------    -----------   -----------
<S>                                                        <C>            <C>           <C>
                Pro forma net loss..................       $(5,789,000)   $(1,407,000)  $(3,629,000)
                Pro forma loss per share............         $   (0.54)     $   (0.15)    $   (0.54)
</TABLE>

7. NOTES RECEIVABLE FROM RELATED PARTIES

   At December 31, 1997, the Company had notes receivable due from employees in
the amount of $354,000. These notes generally bear interest at 6%, are secured
by property and are due within one year following termination of employment.

8. INCOME TAXES

   As of December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $15,600,000 and $3,900,000, respectively. The
Company also had federal research and development tax credit carryforwards of
approximately $300,000. The federal net operating loss carryforward will expire
at various dates beginning in 2008 through 2012, if not utilized. The state net
operating loss carryforward will expire at various dates beginning in 1998
through 2002, if not utilized.

   Utilization of the net operating losses and credits may be subject to an
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986.

   Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets are as follows:


                                      F-14
<PAGE>   53

<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              ---------------------
                                                                1997          1996
                                                              -------       -------
                                                                (In thousands)
<S>                                                           <C>           <C>
                       Deferred tax assets:
                         Net operating loss carryforwards..   $ 5,500       $ 4,000
                         Research credit carryforwards.....       500           700
                         Other.............................     1,300         1,100
                                                              -------       -------
                       Total deferred tax assets...........     7,300         5,800
                       Valuation allowance.................    (7,300)       (5,800)
                                                              --------      --------
                       Net deferred tax assets.............   $    --       $    --
                                                              =======       =======
</TABLE>

   Due to the lack of earnings history of the Company, the total net deferred
tax asset has been fully offset by a valuation allowance. The valuation
allowance increased by $200,000 and $1,600,000 during the years ended December
31, 1996 and 1995.

9. SUBSEQUENT EVENTS

   On January 14, 1998, the Company announced the formation and financing of
Iconix Pharmaceuticals, Inc. Iconix is a chemical genetics company which will
seek to extend Microcide's microbial genomics research into a technology
platform with broad applicability to multiple human diseases. Through a private
placement, Iconix arranged a $12.5 million equity investment from institutional
investors. After giving effect to the investment and including the initial stock
option pool reserved for employees and consultants of Iconix, Microcide holds
approximately 35% of the pro forma fully diluted outstanding equity of Iconix.
Microcide will account for its investment using the equity method of accounting
and since Microcide's investment has a zero book basis, the losses of Iconix
will not impact Microcide's statement of operations.

   Through the Core Technology Development and License Agreement, Microcide and
Iconix expect to work together over the next three years to jointly develop and
utilize new technology in the areas of molecular diversity, high-throughput
screening, computational sciences and genome sciences. Pursuant to the Support
Services Agreement, Microcide is obligated to provide Iconix with facilities and
various business support services for which the Company will be reimbursed. In
addition, through the Antiviral and Surrogate Genetics Research Agreement,
Microcide is obligated to provide Iconix with research support payments of $6.1
million over the next three years. Microcide is entitled to worldwide
development, manufacturing and marketing rights to antiviral products which may
emerge from the collaboration and, if specified research and development
milestones are achieved, will be obligated to pay Iconix milestone payments of
up to $11.0 million for the first product and up to $10.5 million for each
subsequent product, in addition to royalties on worldwide sales.

                                      F-15
<PAGE>   54
                                 EXHIBIT INDEX
<TABLE>
<CAPTION>
        Exhibits                                    Description
<S>                 <C>
          2.1++     Iconix Pharmaceuticals, Inc. (formerly EpiGenix, Inc.) Series
                    A Preferred Stock Purchase Agreement.

          2.2++*    Core Technology Development and License Agreement by and
                    between Microcide Pharmaceuticals, Inc. and Iconix
                    Pharmaceuticals, Inc. (formerly EpiGenix, Inc.)

          2.3++*    Antiviral and Surrogate Genetics Research Collaboration
                    Agreement by and between Microcide Pharmaceuticals, Inc.
                    and Iconix Pharmaceuticals, Inc. (formerly EpiGenix, Inc.)

          3.2+      Restated Certificate of Incorporation of the Registrant.

          3.5+      Bylaws of the Registrant.

          4.2+      Form of Common Stock Certificate.

          4.3+      Series A Preferred Warrant Purchase Agreement and Warrant between Dominion
                    Ventures, Inc. and the Registrant dated May 10, 1993.

          4.4+      Series B Preferred Warrant Purchase Agreement and Warrant between Dominion
                    Ventures, Inc. and the Registrant dated May 10, 1993.

          4.5+      Series C Preferred Warrant Purchase Agreement and Warrant between Dominion
                    Ventures, Inc. and the Registrant dated June 10, 1994.

          4.6+      Series B Preferred Warrant Agreement between Comdisco, Inc. and the Registrant
                    dated September 1, 1993.

          4.7+      Series C Preferred Warrant Agreement between Comdisco, Inc. and the Registrant
                    dated September 1, 1993.

          10.1+     Information and Registration Rights Agreement, dated June 29, 1994 as amended.

          10.2+     1993 Amended Incentive Stock Plan.

          10.3+     1996 Employee Stock Purchase Plan.

          10.4+     1996 Director Option Plan.

          10.5+     401(k) Plan.

          10.6+*    Research and License Agreement between the Registrant and Ortho Pharmaceutical
                    Corporation and the R.W. Johnson Pharmaceutical Research Institute dated October
                    24, 1995.

          10.7+*    Research and License Agreement between the Registrant and Ortho Pharmaceutical
                    Corporation and the R.W. Johnson Pharmaceutical Research Institute dated October
                    24, 1995.

          10.8+*    Joint Research Agreement between the Registrant and Daiichi Pharmaceutical Co.,
                    Ltd. dated November 6, 1995.

          10.9+*    Collaborative Research Agreement between the Registrant and Pfizer Inc dated
                    March 1, 1996.

          10.10+*   License and Royalty Agreement between the Registrant and Pfizer Inc dated March
                    1, 1996.

          10.11+    Master Lease Agreement between Dominion Ventures, Inc. and the Registrant, dated
                    May 10, 1993, as amended on June 10, 1994 and November 22, 1994.

          10.12+    Master Lease Agreement between the Registrant and Comdisco, Inc. dated September
                    1, 1993.

          10.13+    Lease Agreement between the Registrant and Portola Land Company dated April
                    1993.

          10.14+    Form of Indemnification Agreement between the Registrant and its Officers and
                    Directors.

          10.15+    Employment Agreement dated January 31, 1994 between the Registrant and James E.
                    Rurka.
</TABLE>


<PAGE>   55
<TABLE>
<CAPTION>
        Exhibits                                    Description
<S>                 <C>
          10.16+    Employment Agreement dated December 23, 1992 between the Registrant and Keith A.
                    Bostian, Ph.D.

          10.17+++  Lease agreement commencing November 1, 1996 between the
                    Registrant and Logue Investments L.P., a California limited
                    partnership.

          10.18*#   Synthetic Compound Purchase Agreement between the Registrant and Daiichi
                    Pharmaceutical Co., Ltd. dated June 25, 1997.

          10.19##   Sublease agreement between the Registrant, Quickturn Design Systems, Inc. and
                    Portola Land Co. dated September 1997.

          10.20##    Sub-sublease agreement between the Registrant, Alpha Blox Corporation, Quickturn
                    Design Systems, Inc. and Portola Land Co. dated September 1997.

          10.21     Consulting Agreement dated January 14, 1998 between the Registrant and Keith
                    Bostian, Ph.D.

          23.1      Consent of Ernst & Young LLP, Independent Auditors.

          24.1      Power of Attorney (see page 38).

          27.1      Financial Data Schedule.

          27.2      Financial Data Schedule.
</TABLE>

----------

  +  Incorporated by reference to the same-numbered exhibit in Registrant's
  Registration Statement on Form S-1, registration number 333-2400, filed with
  the Securities and Exchange Commission and dated May 14, 1996.

  ++ Incorporated by reference to the same-numbered exhibit in Registrant's Form
  8-K filed with the Securities and Exchange Commission and dated January 29,
  1998.

  +++ Incorporated by reference to the same-numbered exhibit in Registrant's
  Form 10-Q for the period ended September 30, 1996, filed with the Securities
  and Exchange Commission and dated November 8, 1996.


  #   Incorporated by reference to the same-numbered exhibit in Registrant's
  Form 10-Q for the period ended June 30, 1997, filed with the Securities and
  Exchange Commission and dated August 14, 1997.

  ##  Incorporated by reference to the same-numbered exhibit in Registrant's
  Form 10-Q for the period ended September 30, 1997, filed with Securities
  and Exchange Commission and dated November 14, 1997.


*  Confidential Treatment granted