<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


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

                                    FORM 10-K

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

                                   (Mark One)
                [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                                       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, 1998 was approximately $26 million,
based upon the closing price of such stock on December 31, 1998.

     As of March 1, 1999, 11,018,242 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 1999
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, 1998.



<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 and fungal
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 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 and fungal
infections, as well as potentiators, to overcome resistance pathways and restore
usefulness to existing agents that have been rendered ineffective. The specific
problematic bacteria being addressed by the Company (staphylococci, enterococci,
Pseudomonas aeruginosa and Streptococcus pnenumoniae) 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 Fungal Efflux
Program is designed to identify inhibitors of efflux pumps and thereby restore
or improve the effectiveness of antifungal agents against such pathogens as
Candida and Aspergillus.

     Microcide's Targeted Genomics programs seek to identify and exploit the
pharmaceutically-relevant portions of bacterial genomes that are essential to:
(1) bacterial viability in vitro (the Bacterial Essential Genes Program and
Animal Health Program), (2) fungal viability in vitro (the Fungal Genomics
Program), or (3) bacterial growth in vivo (the Bacterial In Vivo Survival Genes
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 Animal Health Program, essential bacterial
targets are being identified and prioritized, and those with specificity for
animal health pathogens will be used in screening to discover antibiotics
designed specifically for animal health use. In the Fungal Genomics Program, a
proprietary collection of 160 fungal mutants has been specifically created by
the Company to target over 100 essential genes in six pharmaceutically-relevant
pathways, a subset of which are selectively being incorporated into the
Company's high-throughput, whole-cell assay system to search for novel, small
molecule antifungal agents. In the Bacterial In Vivo Survival Genes 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 genes required for survival in vivo. Microcide also has established,
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.

     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, 1998, the Company's collaborative partners have
provided the Company with $40.6 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, the
Company will be entitled to receive an additional $13.2 million of research
support payments. The Company has retained full rights to products which may
result from its internal, self-funded programs in Bacterial In Vivo Survival
Genes, Fungal Efflux Pumps and Fungal Genomics.



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<PAGE>   3

     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 1999. 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. 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 bacterial in vitro 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 1999, Microcide and Pfizer established a separate
collaboration to utilize bacterial genetic approaches with in vitro essential
genes to discover products for the treatment of bacterial infections in animals.
If specified research and development milestones are achieved, Microcide will be
entitled to receive certain milestone payments for each product developed within
the collaboration; such milestone payments are lower in amount than those
applicable to human health applications.

     ICONIX. In January 1998, Microcide entered into a collaboration with Iconix
Pharmaceuticals, Inc. ("Iconix"), a newly established biotechnology company of
which Microcide is a significant minority shareholder, and to which Microcide
licensed or assigned certain technology related to surrogate genetics
("Surrogate Genetics Technology"). Iconix will apply the Surrogate Genetics
Technology to a number of viral disease targets in a search for novel antiviral
agents. Microcide is obligated to provide Iconix with research support payments
of $2.5 million in each of 1999 and 2000. Microcide has been granted worldwide
development, manufacturing and marketing rights to any 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 approvals, the
continuation of the Company's collaborations with its corporate 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 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 additional 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
successful development of any drugs, or that any drugs, if successfully
developed, will be proven to be safe and effective in clinical trials, meet
applicable regulatory standards, be capable of being manufactured in commercial
quantities at reasonable costs or be successfully commercialized. Product
development of new pharmaceuticals is highly uncertain, and unanticipated
developments, clinical or regulatory delays, unexpected adverse effects or
inadequate therapeutic efficacy would slow or prevent product development
efforts of the Company or its collaborative partners and have a material adverse
effect on the Company's



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<PAGE>   4

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 invasion and colonization by
disease-causing bacteria. These infections may be confined to a single organ or
tissue, or disseminated throughout the body, and can cause many serious clinical
conditions, including pneumonias, endocarditis, osteomyelitis, meningitis,
deep-seated soft tissue infections, complicated urinary tract infections,
bacteremia and septicemia.

      According to estimates by the United States Centers for Disease Control
and Prevention (the "CDC"), approximately 1.9 million hospital-acquired
infections occurred in the United States in 1995, accounting for more than $4.5
billion in additional health care costs and contributing to more than 88,000
deaths. 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.

     Antibiotics work by interfering with a vital bacterial cell function at a
specific cellular target, either killing the bacteria or inhibiting 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
biosynthesis. 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 remain the mainstay of
therapy, since 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

     Invasive infections due to fungi are a continuing problem, particularly
among patient populations with compromised host defenses due to
immunosuppressive drugs (e.g., in organ transplant patients or cancer
chemotherapy) or underlying diseases (e.g., 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.



                                       4
<PAGE>   5

     VIRAL INFECTIONS

     Viral infections continue to be a major medical problem in both
immune-competent and immunosuppressed patients. Over 25 million people are
estimated to be infected with the human immunodeficiency virus (HIV). Newer
combination therapies with HIV-protease inhibitors or newer
reverse-transcriptase inhibitors have markedly improved survival and reduced the
occurrence of opportunistic infections. However, these agents are often poorly
tolerated by patients due to drug-drug interactions and adverse effects, require
frequent administration of multiple pills that makes adherence to prescribed
regimens difficult, and are subject to viral resistance to therapy, resulting in
a need for new agents. There is a vast unmet clinical need for effective and
well-tolerated antiviral therapy in other viral infections with a high
prevalence and morbidity. Hepatitis B (HBV) afflicts a major proportion of the
global population; U.S. Centers for Disease Control and Prevention estimates
that approximately 3.9 million people in the U.S. have hepatitis C infection
(HCV). Both of these forms can cause chronic infections that can lead to the
need for liver transplantation and other complications. Well-tolerated treatment
regimens that produce a durable antiviral response would represent a
considerable advance in the long-term management of chronically-infected
patients. Cytomegalovirus infection remains a complication in transplant
patients as well as in certain pediatric populations, and existing antiviral
therapies are often poorly tolerated.

     ANIMAL HEALTH INFECTIONS

     Bacterial infections represent a major problem for the animal health
industry, particularly with respect to livestock animals but also for companion
animals. Livestock undergo periods of stress-induced suppression of immunity
during which there is increased susceptibility to bacterial infection. Important
bacterial pathogens of livestock include species responsible for bovine and
porcine respiratory diseases, enteric diseases, and mastitis. The Company
estimates that global sales of antiinfective products for use in animal health
applications are in excess of $2.0 billion.

     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 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, pneumococci and pseudomonas.
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) antibiotic
use in 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 may in turn have 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-susceptible 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 various parts of
the United States; 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 therapy is generally more
costly and potentially more toxic to the patient due to additive and sometimes
synergistic side effects. The table below 



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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:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
                         PROBLEMATIC DRUG-RESISTANT BACTERIA
-------------------------------------------------------------------------------------
<S>                           <C>                        <C>
                              Clinically Significant     Remaining
Bacteria                      Resistance Problems        Recommended Treatment
-------------------------------------------------------------------------------------

   Staphylococcus sp.         Beta-lactams               Vancomycin
                              Fluoroquinolones           Combination Therapy
                              Aminoglycosides
                              Macrolides
-------------------------------------------------------------------------------------

   Enterococcus sp.           Beta-lactams               Multiple Antibiotic Therapy
                              Aminoglycosides
                              Glycopeptides
-------------------------------------------------------------------------------------

   Pseudomonas aeruginosa     Beta-lactams               Combination Therapy
                              Fluoroquinolones
                              Aminoglycosides
-------------------------------------------------------------------------------------

   Streptococcus pneumoniae   Beta-lactams               Cephalosporin or Carbapenem
                              Macrolides                 Vancomycin
                              Tetracyclines              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, 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 bacterial genetics technology platform
will enable it to rapidly identify drug candidates within new classes of
antibiotics.

     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 in vivo. The Company believes that inhibitors of such targets
have not been previously systematically sought in antibiotic discovery programs,
and that its In Vivo Survival Genes program utilizes proprietary methods to
discover inhibitors of these genes for development as novel antibiotics.
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 in its proprietary multichannel screening
system for antifungal drug discovery. Through a collaboration with Iconix, the
Company seeks to apply Surrogate Genetics Technology to screen against a number
of viral disease targets in the search for novel inhibitors.

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     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 quality and reduce the costs of development
of these technologies as compared to working independently.

     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 In Vivo Survival Genes, Fungal Genomics and
Fungal Efflux Pump programs, and to generally enter into collaborative
relationships at later stages of product development.

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 and in vitro and in
vivo essential 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 have been available for high-throughput screening
since 1997. The structural diversity of the library and the molecular diversity
needs of Microcide's programs continue to be monitored, and the Company expects
that strategic supplementation of these diversity libraries will occur in 1999
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 and fungal drug resistance,
either by interfering with resistance pathways to potentiate existing
antimicrobials, or by developing novel lead compounds which avoid such
resistance pathways. The Company's Targeted Genomics programs utilize microbial
genetics and genomics approaches to discover inhibitors of novel drug targets
for further development as small molecule therapeutics.



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<PAGE>   8

                          MICROCIDE'S RESEARCH PROGRAMS

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
          PROGRAM                             PROGRAM GOAL                    CURRENT STAGE (1)     PARTNER
---------------------------------------------------------------------------------------------------------------
<S>                           <C>                                             <C>                  <C>
                                             TARGETED ANTIBIOTICS
---------------------------------------------------------------------------------------------------------------
                              Antibiotics for treatment of Gram-positive
Gram-Positive Program         bacteria, including resistant strains (MRS,     Pre-Clinical          J&J
                              VRE and beta-lactam-resistant S. pneumoniae)    Candidates
---------------------------------------------------------------------------------------------------------------
Bacterial Efflux Pump         Potentiators principally for use with
Program                       existing quinolones against resistant           Drug Design           Daiichi
                              Gram-negative bacteria, including P. 
                              aeruginosa
---------------------------------------------------------------------------------------------------------------
Fungal Efflux Pump Program    Potentiators to improve the efficacy of
                              existing and new agents against fungal          Screening and Lead    Internal
                              pathogens, including Candida sp. and            Identification
                              Aspergillus
---------------------------------------------------------------------------------------------------------------
                                              TARGETED GENOMICS
---------------------------------------------------------------------------------------------------------------
Bacterial Essential Genes     Novel classes of broad- and narrow-spectrum     Drug Design           Pfizer
Program                       antibiotics
---------------------------------------------------------------------------------------------------------------
Animal Health Program         Novel classes of antibiotics for animal         Target                Pfizer
                              health applications                             Identification
---------------------------------------------------------------------------------------------------------------
Bacterial In Vivo Survival    Novel classes of antibiotics                    Target                Internal
Genes Program                                                                 Identification and
                                                                              Screening
---------------------------------------------------------------------------------------------------------------
Fungal Genomics Program       Novel systemic antifungal agents                Screening and Lead    Internal
                                                                              Identification
---------------------------------------------------------------------------------------------------------------
Viral Genomics Program        Novel  antiviral  therapeutics  for HIV, HCV,   Target                Iconix
                              CMV, HBV, influenza, Human Papilloma Virus      Identification and
                              and RSV                                         Screening
---------------------------------------------------------------------------------------------------------------
</TABLE>

----------

     (1)  The Company's preclinical research programs generally consist of the
          following stages, listed chronologically: "Target 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"). "Lead Identification" -- lead compounds have
          been identified whose in vitro and in vivo characteristics are being
          evaluated in biochemical, microbiological, pharmacological and
          toxicological tests for entry into drug design programs. "Drug Design"
          -- structure-activity relationships of selected compounds are being
          defined and such compounds optimized through medicinal chemistry
          efforts. "Candidate Selection" -- optimized leads are being scaled-up
          and evaluated in key efficacy, toxicological and pharmacological tests
          in advance of selection as pre-clinical development candidates.
          "Pre-clinical Candidate" -- a lead compound is undergoing 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.



                                       8
<PAGE>   9

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, 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,
and Fungal Efflux Pump programs.

     GRAM-POSITIVE PROGRAM

     Microcide's Gram-Positive Program is focused on discovering and developing
novel antibiotics 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, complicated
urinary tract infections, pneumonias, bacteremia and septicemia.

     The Gram-Positive program is being conducted in collaboration with J&J and
consists of the discovery and development of beta-lactam antibiotics with
specific efficacy against resistant Gram-positive bacteria. Traditional
beta-lactam antibiotics work by inhibiting enzymes (penicillin-binding proteins,
or PBPs) that carry out crucial steps in the biosynthesis 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
biosynthesis in the presence of such antibiotics, as well as by the production
of beta-lactamases, which render beta-lactams ineffective.

     Microcide's Gram-Positive program has identified novel beta-lactam
antibiotics which are beta-lactamase-stable and inhibit PBPs, including PBP2a,
thereby gaining efficacy against MRS. Compounds emerging from the Company's
beta-lactam program are active against staphylococci, including MRS,
enterococci, including VRE, and 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
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.

     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 1999. 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 seven patents out of these series
have issued in the United States.

     In December of 1998, the Company, in collaboration with J&J, selected a
second beta-lactam drug candidate for pre-clinical development. 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. The Company expects that these
activities will occur in parallel with the development of the initial
beta-lactam drug candidate.

     BACTERIAL EFFLUX PUMP PROGRAM

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



                                       9
<PAGE>   10

     The Company believes that the combination of bacterial efflux pump
inhibitors with existing antibiotics could restore the activity of antibiotics
against bacteria expressing efflux pump-mediated antibiotic resistance. In
addition, many bacterial species have active efflux pumps that contribute to the
overall intrinsic susceptibility of the species to certain antibiotics; thus the
Company believes that the combination of bacterial efflux pump inhibitors with
existing antibiotics could increase the susceptibility of many Gram-negative and
Gram-positive bacteria to these antibiotics, thereby lowering required
therapeutic doses. The Company has established a genetics and molecular biology
program which focuses on microbial efflux systems, and has developed novel
screening and lead evaluation technologies to permit the identification of lead
compounds for subsequent drug design efforts.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------

                               EFFLUX-MEDIATED ANTIBIOTIC RESISTANCE IN BACTERIA
-----------------------------------------------------------------------------------------------------------
<S>                             <C>                      <C>                      <C>
           Bacteria             Efflux Pump Specificity  Pump - Structural Family   Antibiotic Effluxed

-----------------------------------------------------------------------------------------------------------
Staphylococcus aureus           Broad-spectrum                    MF,             Fluoroquinolones
                                                                  ABC             Macrolides
                                                                                  Streptogramins
-----------------------------------------------------------------------------------------------------------
Staphylococcus                  Specific                          MF              Tetracyclines
Enterococcus 
Streptococcus
-----------------------------------------------------------------------------------------------------------
Streptococcus pyogenes          Specific                          MF              Macrolides
-----------------------------------------------------------------------------------------------------------
Streptococcus pneumoniae        Broad-spectrum                                    Macrolides
                                                                Unknown           Fluoroquinolones
-----------------------------------------------------------------------------------------------------------
Pseudomonas aeruginosa          Broad-spectrum                    RND             Fluoroquinolones
                                                                                  Beta-lactams
-----------------------------------------------------------------------------------------------------------
Neisseria gonorrhoeae           Broad-spectrum                    RND             Erythromycin
-----------------------------------------------------------------------------------------------------------
Proteus vulgaris                Broad-spectrum                  Unknown           Fluoroquinolones
-----------------------------------------------------------------------------------------------------------
Klebsiella pneumoniae           Broad-spectrum                  Unknown           Fluoroquinolones
-----------------------------------------------------------------------------------------------------------
Shigella dysenteria             Broad-spectrum                  Unknown           Fluoroquinolones
-----------------------------------------------------------------------------------------------------------
</TABLE>

     The Company, in collaboration with Daiichi, is designing compounds based on
efflux pump inhibitor leads. The primary objective of this program has been to
develop potentiators which will be combined with Daiichi's oral and parenteral
quinolone antibiotics to overcome efflux pump-mediated resistance in P.
aeruginosa and other bacteria. The Company has filed ten 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. In addition, the Company believes that inhibitors could be
combined with other classes of antibiotics for which efflux pump-mediated
resistance limits clinical utility and is investigating new opportunities in
this area. The company believes that several antibiotic-efflux pump inhibitor
combinations could be usefully developed based on different antibiotics and
different structural families of bacterial efflux pumps.

     FUNGAL EFFLUX PUMP PROGRAM

     The azoles (inhibitors of the ergosterol biosynthesis pathway) are
currently the most widely used class of agents in the treatment of fungal
diseases. Among the azoles, fluconazole is the most extensively used, but there
are increasing reports of fluconazole therapy failures due to resistance
emergence. Recently, multi-drug efflux pumps have been implicated in Candida
resistance to fluconazole (and other azoles). As with bacterial efflux,
intrinsic fungal resistance to fluconazole, such as found in C. glabrata, C.
krusei and 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 intrinsic and acquired
resistance, thereby extending the useful life of existing agents, broadening the
antifungal spectra of existing agents, or allowing newer agents to be clinically
efficacious.

     Microcide has established genetic potentiation assays and used them to
identify a number of leads, both from natural product and synthetic diversity
sources, which are now the subject of drug design programs.

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 focus its gene
discovery efforts on 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, the Animal Health
Program and the 



                                       10
<PAGE>   11

Fungal Genomics Program) or in vivo (the Bacterial In Vivo Survival Genes
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 this approach
to viruses through its collaboration with Iconix. The Company believes that this
approach offers significant advantages over traditional pharmaceutical company,
biochemical assay approaches, as well as the more recent microbial genomic
sequencing approaches.

     Traditional approaches to antibiotic drug discovery have centered on
biochemically-defined targets. In such approaches, screening assays are
developed based on selected enzyme or receptor targets. Appropriately designed
biochemical 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 can only identify 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 drug candidates because sufficient concentrations within
the bacterium are not achieved at the target site.

     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 remains necessary to identify the
pharmaceutically-relevant target genes from this information, and to then
develop screens for potential inhibitors. Such screens will then face many of
the same limitations as traditional biochemical 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 only on
the functionally important portions of the genome and thereby bypassing the task
of sequencing and characterizing irrelevant portions of the genome.

     As of the end of 1998, 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
biological activity for 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.



                                       11
<PAGE>   12




            [GRAPHIC SHOWING THE COMPANY'S TARGETED GENOMIC APPROACH
                     AND MULTI-CHANNNEL 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 classes. The molecular diversity libraries of the Company and Pfizer
have been extensively applied to these screening efforts. Biological
characterization of screen hits is being followed by exploratory medicinal
chemistry on selected lead compounds. 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 use 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.



                                       12
<PAGE>   13

     ANIMAL HEALTH PROGRAM

      There exists a significant need for new classes of antibacterials
effective against pathogens involved in Animal Health diseases. In collaboration
with Pfizer, Microcide is undertaking molecular genetic approaches to identify
essential gene targets in pathogens important to the animal health market. The
collaboration plans to develop screens for these targets, and undertake
screening of compound libraries to identify specific inhibitors. The Animal
Health Program is based on genetic strategies for gene identification and
screening that have been developed successfully in Microcide's Bacterial
Essential Genes Program.

     BACTERIAL IN VIVO SURVIVAL GENES PROGRAM


     Bacteria possess a set of genes, encoding both metabolic functions and
non-redundant virulence factors and regulators, that are necessary for pathogen
growth in a mammalian environment (in vivo), but which are not required for
bacterial growth in enriched media in a petri dish (in vitro). Microcide refers
to such genes as In Vivo Survival ("ivs") genes. Microcide scientists have
developed a proprietary method (Size-based Marker Identification Technology,
"SMIT") to identify the ivs mutants from among the more than 10,000 gene mutants
which have been evaluated in infection models. Many of these genes constitute
targets not previously directly utilized in drug discovery programs. The Company
has created a library of over 50 ivs genes which are being characterized in
vitro and in animal systems for selection of priority targets for screening.
High throughput whole cell screens are being developed using the mutant strains,
and biochemical assays will be developed for some targets. An extension of the
SMIT technology is expected to be useful as a novel method to enable high
throughput in vivo evaluation of lead compounds. Products that may emerge from
this program are expected to be bactericidal antibiotics which may be applied to
either the human or animal health market.

     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 In Vivo Survival genes.

     FUNGAL GENOMICS PROGRAM

     Microcide's Fungal Genomics Program seeks to identify and utilize for drug
discovery essential fungal gene targets that are functionally conserved among
pathogens and distinct from human genes. The Company has prescreened its
synthetic compound collection against four fungal species and identified a
subset of approximately 5,000 compounds with antifungal activity against one or
more of these organisms. This compound subset has been prioritized according to
a number of pharmacological criteria. In addition, the Company has created a
proprietary collection of 160 conditional growth mutants in over 100 essential
genes of interest in six pharmaceutically-relevant pathways. These mutant
strains provide the basis for hypersensitive, target-directed whole cell
screens, as well as tools for rapid mechanism-of-action studies. The Company is
also using genomic technologies to provide preliminary information on resistance
development. The Company intends to apply these methods, in combination with
more classical pharmacological tests, to provide guidance into the selection of
lead structures to be taken into medicinal chemistry.

     The Company has retained all rights to this program and is self-funding it.
The Company has filed 2 patent applications in the United States covering its
multiplex screening technology.

     VIRAL GENOMICS PROGRAM

     Viruses are obligate intracellular parasites requiring host cell factors
for their replication. Because of this close relationship, traditional drug
discovery via "whole cell-virus" assays has produced only a limited number of
therapeutically efficacious and non-cytotoxic antiviral drugs. The discovery
efforts in the past decade or so have largely been directed to biochemical
screening and, more recently, to structure-based rational drug design. However,
the rate-limiting step of these approaches is that the biochemical, functional,
or structural information of the target proteins must be known prior to assay
development. Nearly all antivirals on the market today target only two protein
families with well-characterized enzymatic activities, namely replicases and
proteases.

     The Microcide-Iconix collaboration in antiviral drug discovery builds on
expertise in microbial genetics and pharmacology and applies proprietary
surrogate assay technology that may provide advantages over other drug discovery
processes. The premise of this technology is based on the concept that an
expression of viral protein in a surrogate microbial organism (e.g. yeast or E.
coli) can produce discreet changes in the cellular physiology that will be
reflective of the native function of that viral 



                                       13
<PAGE>   14

protein. These changes (or phenotypes) can include complementation of a
defective host gene, a reporter-linked activity readout, or simply an inhibition
of cell growth. The most powerful feature of this technology is that the precise
function of a target protein need not be known prior to assay development. For
example, if expression of a viral protein causes growth inhibition in yeast,
then this phenotype can be used to screen for potential inhibitors that reverse
this growth inhibition. During 1998, the program focused on surrogate assay
development and implementation of high-throughput screens for targets in HIV,
HCV, CMV, HBV, influenza, human papillomavirus and RSV.

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
and the Animal Health 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 was three years with J&J
having an option to extend the term for an additional one-year period. J&J has
provided the Company with $3.5 million per year in research support payments
throughout the original term of the J&J Agreements. J&J has extended this
collaboration with respect to beta-lactams through the end of 1999 at a funding
level approximately 40% that of the prior level reflecting the focused scope of
the research effort. J&J made a $3.0 million up-front license payment to the
Company and an affiliate of J&J made a $5.0 million equity investment in the
Company. 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 inhibition
of the efflux pump mechanism, primarily targeted at pseudomonas. The original
term of the research program under the Daiichi Agreement expired March 31, 1998.
Daiichi exercised its option to extend the collaboration for an additional year
(through March 31, 1999) during which Daiichi will provide research support
funding to Microcide of up to $3.5 million. 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."



                                       14
<PAGE>   15

     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."

     PFIZER -- ANIMAL HEALTH PROGRAM

     In January 1999, Microcide and Pfizer entered into agreements (the "Pfizer
Animal Health Agreements") pursuant to which they agreed to expand their
existing antibiotic research collaboration to include a focused effort to
discover and develop new classes of antibiotics specifically designed for animal
health applications. The term of the Pfizer Animal Health Agreements is three
years, subject to Pfizer's right to earlier terminate after January 2001 with
six months' prior written notice. Pfizer is obligated to provide Microcide with
up to $630,000 per year in research support payments during the term of the
Pfizer Animal Health Agreements. Microcide may also receive from Pfizer
milestone payments 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 Pfizer Animal
Health 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 Animal
Health Agreements will be made. See "Targeted Genomics - Animal Health Program."

     Under the Company's Collaborative Agreements, which cover four 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. 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,
Pfizer can terminate its Bacterial Essential Genes collaboration with the
Company at any time after February, 1999 upon six months' prior written notice
and Pfizer can terminate its Animal Health collaboration with the Company at any
time after January, 2001 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



                                       15
<PAGE>   16

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 during 1998. As of December 31, 1998, after giving
effect to the investment and including the stock option pool reserved for
employees and consultants of Iconix, Microcide holds approximately 33% of the
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 a three
year period.

     Pursuant to the Core Technology Development and License Agreement,
Microcide and Iconix expect to work together over a three-year period to jointly
develop and utilize new technology in the areas of molecular diversity,
high-throughput screening, computational sciences and genome sciences. Pursuant
to 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 $5.0 million over the remaining two years of 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. In instances where the Company
relies on partners for the manufacturing, marketing and sales of any products
which result from such collaborations, there can be no assurance that these
partners will satisfactorily perform these functions.

     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.



                                       16
<PAGE>   17

     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 March 20,
1999, the Company had been issued 8 patents in the United States. Further, the
Company has been given three "Notice of Allowances" and one "Notification of
Issuance", which are expected to become issued United States patents within a
few months.

     Patent law as it relates to inventions in the biotechnology field is still
evolving, and involves complex legal and factual questions for which legal
principles are not firmly established. Accordingly, there can be no assurance
that patents will be granted with respect to any of the Company's 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 



                                       17
<PAGE>   18

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 technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with its commercial partners, collaborators,
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



                                       18
<PAGE>   19

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.

     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.

     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 



                                       19
<PAGE>   20

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.

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

EMPLOYEES

     As of December 31, 1998 the Company had 133 full-time, regular employees,
42 of whom hold Ph.D. degrees and 23 of whom hold other advanced degrees.
Approximately 109 of the 133 employees are engaged in scientific activities and
24 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 



                                       20
<PAGE>   21

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 supplements its internal scientific staff with consulting
arrangements with a number of leading academic and industrial scientists and
clinicians. Microcide's Scientific Advisory Board formally meets once or twice
per year to review the Company's programs and provide general scientific
guidance and direction. On a more frequent basis, the Company utilizes
consultants either in small focused groups or as individuals on an ad hoc basis
to provide detailed scientific guidance in such areas as Genetics and Molecular
Biology, Chemistry, Clinical Microbiology/Pharmacology and Molecular
Diversity/Natural Products.

     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 1998, the Company paid its consultants
approximately $407,000 in the aggregate, as compared to approximately $490,000
in 1997 and approximately $340,000 in 1996.

     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 two facilities consisting of approximately 66,500 square
feet of leased laboratory and office space in Mountain View, California under a
lease agreement expiring in 2005. The Company has also entered into leases
through 2005 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, 1999. The other building has been outfitted principally as office
space to meet the needs of Microcide and Iconix. From the Company's inception
through December 31, 1998, the Company has made capital expenditures aggregating
approximately $9.9 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 2000. 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.



                                       21
<PAGE>   22

                                     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 1998
     4th Quarter................................           $5.75      $3.69
     3rd Quarter................................            6.69       3.81
     2nd Quarter................................            9.63       6.69
     1st Quarter................................           10.38       7.25

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
</TABLE>

     As of March 1, 1999, there were 156 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.



                                       22
<PAGE>   23

 ITEM 6.  SELECTED FINANCIAL DATA



<TABLE>
<CAPTION>
                                                                   FOR THE YEARS ENDED DECEMBER 31,
                                                    ----------------------------------------------------------------
                                                      1998          1997          1996          1995          1994
                                                    --------      --------      --------      --------      --------
                                                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                 <C>           <C>           <C>           <C>           <C>    
     STATEMENT OF OPERATIONS DATA:
     Total revenues ...........................     $ 11,181      $ 14,894      $ 11,273      $  4,985      $    --
     Net loss .................................       (9,758)       (4,602)         (670)       (3,516)       (7,034)
     Basic and diluted net loss per share .....        (0.89)        (0.43)        (0.10)        (4.14)         
     Shares used in computing basic and
      diluted net  loss per share .............       10,962        10,817         7,034           849          
</TABLE>


<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                    ----------------------------------------------------------------
                                                      1998          1997          1996          1995          1994
                                                    --------      --------      --------      --------      --------
                                                                             (IN THOUSANDS)
<S>                                                 <C>           <C>           <C>           <C>           <C>    
     BALANCE SHEET DATA:
     Cash, cash equivalents and short-term
      investments .............................     $ 33,192      $ 40,387      $ 47,508      $  8,517      $  5,810
     Working capital ..........................       30,269        37,235        42,542         6,388         4,845
     Total assets .............................       44,490        51,782        56,826        13,493        11,340
     Long-term obligations ....................        3,039           450           952         2,075         2,530
     Total stockholders' equity ...............       37,938        46,896        50,574         9,151         7,506
</TABLE>



                                       23
<PAGE>   24

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, the Company has 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, 1998, the Company had received in the aggregate $40.6
million in license fees, milestone payments and research support payments under
the Collaborative Agreements. Assuming none of the Collaborative Agreements is
terminated prior to its scheduled expiration and including the Pfizer Animal
Health collaboration entered into in January 1999, the Company will be entitled
to receive an additional $13.2 million in research support payments in the
aggregate from J&J, Daiichi and Pfizer.

     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. The
Pfizer Animal Health collaboration provides for a lower level of milestone
payments than those applicable to human health applications. 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 multiple human diseases. Through a private
placement, Iconix arranged a $12.5 million equity investment from institutional
investors during 1998. As of December 31, 1998, after giving effect to the
investment and including the stock option pool reserved for employees and
consultants of Iconix, Microcide holds approximately 33% of Iconix' outstanding
equity on a fully diluted basis. Microcide accounts for its investment using the
equity method of accounting and since Microcide's investment has a zero book
basis, the losses of Iconix do not impact Microcide's statement of operations.
Pursuant to the Core Technology Development and License Agreement, Microcide and
Iconix expect to work together through January 14, 2001 to jointly develop and
utilize new technology in the areas of molecular diversity, high-throughput
screening, informatics and genome sciences. Pursuant to the Support Services
Agreement, Microcide provides Iconix with facilities and various business
support services for which the Company is 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 during 1998,
1999 and 2000. 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.



                                       24
<PAGE>   25

     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, 1998 and 1997

     Revenues. Total revenues decreased from $14.9 million in 1997 to $11.2
million in 1998. There were no license and milestone revenues earned in 1998 as
compared to $1.0 million in 1997 when a milestone fee was received from Pfizer
related to identifying, validating and sequencing an agreed upon number of
bacterial essential genes. Research revenues decreased from $12.2 million in
1997 to $11.1 million in 1998 principally due to lower revenues recognized under
the Daiichi and J&J collaborations relative to the prior year. Other revenues,
consisting of the sale of molecular diversity samples to other pharmaceutical
and biotechnology companies for use in their research programs, were $40,000 in
1998 as compared to $1.7 million in 1997.

     Research and Development Expenses. The Company's research and development
expenses increased 5% from $17.9 million in 1997 to $18.8 million in 1998. This
increase was due primarily to higher compensation and other 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,
and the initiation of research support to Iconix Pharmaceuticals related to the
Viral Genomics Program, partially offset by decreases in molecular diversity
purchases. The Company expects research and development expenses to be
relatively flat in 1999, as increased research support payments to Iconix in
conjunction with the Viral Genomics Program would be partially or largely offset
by decreases in other expenses within the Company.

     General and Administrative Expenses. General and administrative expenses
decreased approximately 3% from $4.1 million in 1997 to $4.0 million in 1998.
This decrease was primarily due to the sharing of administrative costs with
Iconix. These expenses are expected to remain relatively flat in 1999.

     Interest Income and Expense. Interest income decreased from $2.6 million in
1997 to $1.9 million in 1998 as a result of a decrease in average investment
balances. Interest expense declined from $144,000 to $32,000 as a result of the
repayment of capital lease obligations. Interest income is expected to continue
to decline in 1999 and interest expense is expected to increase in 1999.

     Net Loss. Net loss increased from $4.6 million in 1997 to $9.8 million in
1998 as a result of the items discussed above.

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 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.

     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, 



                                       25
<PAGE>   26

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.

     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.

     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.

LIQUIDITY AND CAPITAL RESOURCES

     The Company has financed its operations since inception primarily through
the sale of equity securities, 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, 1998, the Company
had received $64.6 million from the sale of equity and $40.6 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, 1998 were
$33.2 million compared to $40.4 million at December 31, 1997. This decrease was
due primarily to the net loss during 1998, partially offset by the borrowing in
December 1998 of $4.0 million under a new three-year debt facility. Net cash
used in the Company's operations was $7.5 million in 1998 in contrast to net
cash used by the Company's operations of $2.6 million in 1997.

     During 1998, the Company invested $3.1 million in capital expenditures as
compared to $3.7 million in 1997 largely due to facilities expansion and the
purchase of additional research equipment. The Company expects its capital
expenditures in 1999 to be approximately $1.0 million. The present value of
obligations under equipment financing arrangements at December 31, 1998 was
$41,000 and the Company had other debt of $4.0 million. At December 31, 1998,
the Company has an additional $1.0 million available for its use under this
arrangement. The Company made principal payments under its lease obligations of
$795,000 in 1998; the remaining capital leases of $41,000 were repaid in
February 1999.

     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 2000. 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, 1998, the net operating losses available to offset future taxable
income for federal income tax purposes were approximately $22.6 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 2018 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.

IMPACT OF YEAR 2000

           The "Year 2000" issue generally describes the various problems which
may result from the improper processing of dates and date-sensitive
calculations. Computers and other equipment containing computer-related
components (such as programmable logic controllers and other embedded systems)
using two digits to identify the year in a date may not be able to distinguish
between dates in the 20th century versus the 21st century. This issue could
cause system or equipment malfunctions resulting in material and adverse
interruptions in operations.



                                       26
<PAGE>   27

           The Company has begun to assess the potential impact of the Year 2000
computer problem on its computer systems, research equipment with embedded chips
or software, and on the ability of third parties to supply critical materials
and services. The Company has completed the assessment of its computer systems
and believes them to be Year 2000 compliant. The Company expects to complete the
assessment of its embedded systems and certain third party suppliers by the
second quarter of 1999, and to take necessary remediation action by the end of
1999. Expenditures to date have not been material and have consisted solely of
the time of certain company personnel. Based on the partial assessment completed
through March 1, 1999, the Company does not currently expect the future costs of
completing the assessment and making equipment modifications to be material.
Although the Company believes its key financial, information and operational
systems are Year 2000 compliant, there can be no assurances that other defects
will not be discovered in the future. The Company is unable to control whether
the firms and vendors it does business with currently, and in the future, will
have systems which are Year 2000 compliant. The Company's operations could be
affected to the extent that firms and vendors would be unable to provide
services or ship products. However, management does not believe the Year 2000
changes will have a material impact on its business, financial condition or
results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

           The following discussion about the Company's market risk disclosure
involves forward-looking statements. The Company is exposed to market risk
related mainly to changes in interest rates. The Company does not invest in
derivative financial instruments.

INTEREST RATE SENSITIVITY

           The fair value of the Company's investments in marketable securities
at December 31, 1998 was $29.4 million. The Company's investment policy is to
manage its marketable securities portfolio to preserve principal and liquidity
while maximizing the return on the investment portfolio. The Company's
marketable securities portfolio is primarily invested in corporate debt
securities with an average maturity of under one year and a minimum investment
grade rating of A or A-1 or better to minimize credit risk. Although changes in
interest rates may affect the fair value of the marketable securities portfolio
and cause unrealized gains or losses, such gains or losses would not be realized
unless the investments are sold prior to maturity.

FOREIGN CURRENCY EXCHANGE RISK

           At this time, the Company does not participate in any foreign
currency exchange activities, therefore, is not subject to risk of gains or
losses for changes in foreign exchange rates.


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.



                                       27
<PAGE>   28

                                    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 1999 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, 1998. 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, 1998. 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 1999 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, 1998. 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 1999 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, 1998. Such information is incorporated herein by
reference.



                                       28
<PAGE>   29

                                     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, 1998 and 1997
           Statements of Operations for the years ended December 31, 1998, 1997
           and 1996 
           Statement of Stockholders' Equity for the years ended December 31, 
           1998, 1997 and 1996 
           Statements of Cash Flows for the years ended December 31, 1998, 1997
           and 1996 
           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.

           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)
          2.2*           Core Technology Development and License Agreement by
                         and between Microcide Pharmaceuticals, Inc. and Iconix
                         Pharmaceuticals, Inc. (formerly EpiGenix, Inc.) (2)
          2.3*           Antiviral and Surrogate Genetics Research Collaboration
                         Agreement by and between Microcide Pharmaceuticals,
                         Inc. and Iconix Pharmaceuticals, Inc. (formerly
                         EpiGenix, Inc.) (2)
          3.2            Restated Certificate of Incorporation of the
                         Registrant. (1)
          3.5            Bylaws of the Registrant. (1)
          4.2            Form of Common Stock Certificate. (1)
          4.3            Series A Preferred Warrant Purchase Agreement and
                         Warrant between Dominion Ventures, Inc. and the
                         Registrant dated May 10, 1993. (1)
          4.4            Series B Preferred Warrant Purchase Agreement and
                         Warrant between Dominion Ventures, Inc. and the
                         Registrant dated May 10, 1993. (1)
          4.5            Series C Preferred Warrant Purchase Agreement and
                         Warrant between Dominion Ventures, Inc. and the
                         Registrant dated June 10, 1994. (1)
          4.6            Series B Preferred Warrant Agreement between Comdisco,
                         Inc. and the Registrant dated September 1, 1993. (1)
          4.7            Series C Preferred Warrant Agreement between Comdisco,
                         Inc. and the Registrant dated September 1, 1993. (1)
         10.1            Information and Registration Rights Agreement, dated
                         June 29, 1994 as amended. (1)
         10.2            1993 Amended Incentive Stock Plan. (1)
         10.3            1996 Employee Stock Purchase Plan. (1)
         10.4            1996 Director Option Plan. (1)
         10.5            401(k) Plan. (1)
         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. (1)
         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. (1)
         10.8*           Joint Research Agreement between the Registrant and
                         Daiichi Pharmaceutical Co., Ltd. dated November 6,
                         1995. (1)
         10.9*           Collaborative Research Agreement between the Registrant
                         and Pfizer Inc dated March 1, 1996. (1)
         10.10*          License and Royalty Agreement between the Registrant
                         and Pfizer Inc dated March 1, 1996. (1)
         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. (1)
         10.12           Master Lease Agreement between the Registrant and
                         Comdisco, Inc. dated September 1, 1993. (1)
         10.13           Lease Agreement between the Registrant and Portola Land
                         Company dated April 1993. (1)
         10.14           Form of Indemnification Agreement between the
                         Registrant and its Officers and Directors. (1)
</TABLE>

                                       29
<PAGE>   30

<TABLE>
<CAPTION>
        EXHIBITS                              DESCRIPTION
        --------                              -----------
<S>                      <C>
         10.15           Employment Agreement dated January 31, 1994 between the
                         Registrant and James E. Rurka. (1)
         10.16           Employment Agreement dated December 23, 1992 between
                         the Registrant and Keith A. Bostian, Ph.D. (1)
         10.17           Lease Agreement commencing November 1, 1996 between the
                         Registrant and Logue Investments L.P., a California
                         limited partnership. (3)
         10.18*          Synthetic Compound Purchase Agreement between the
                         Registrant and Daiichi Pharmaceutical Co., Ltd. dated
                         June 25, 1997. (4)
         10.19           Sublease agreement between the Registrant, Quickturn
                         Design Systems, Inc. and Portola Land Co. dated
                         September 1997. (5)
         10.20           Sub-sublease agreement between the Registrant, Alpha
                         Blox Corporation, Quickturn Design Systems, Inc. and
                         Portola Land Co. dated September 1997. (5)
         10.21           Consulting Agreement dated January 14, 1998 between the
                         Registrant and Keith Bostian, Ph.D. (6)
         10.22           Lease Agreement between the Registrant and Portola Land
                         Co. dated May 11, 1998. (7)
         10.23           Promissory Note between the Registrant and Heller
                         Financial Leasing, Inc. dated December 22, 1998.
         10.24           Security Agreement between the Registrant and Heller
                         Financial Leasing, Inc. dated December 22, 1998.
         10.25+          Amendment of Research and License Agreement between the
                         Registrant and Ortho Pharmaceutical Corporation and the
                         R.W. Johnson Pharmaceutical Research Institute dated
                         October 23, 1998.
         10.26+          Collaborative Research Agreement between the Registrant
                         and Pfizer Inc dated January 13, 1999.
         10.27+          License and Royalty Agreement between the Registrant
                         and Pfizer Inc dated January 13, 1999.
         10.28           Preferred Shares Rights Agreement dated February 2, 
                         1999 between the Registrant and Chase Mellon 
                         Shareholder Services, L.L.C. (8)
         23.1            Consent of Ernst & Young LLP, Independent Auditors.
         24.1            Power of Attorney (see page 31).
         27.1            Financial Data Schedule.
         
</TABLE>

----------

(1)    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.

(2)    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.

(3)    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.

(4)    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.

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

(6)    Incorporated by reference to the same-numbered exhibit in Registrant's
       Form 10-K for the fiscal year ended December 31, 1997, filed with the
       Securities and Exchange Commission and dated March 31, 1998.

(7)    Incorporated by reference to the same-numbered exhibit in Registrant's
       Form 10-Q for the period ended June 30, 1998, filed with the Securities
       and Exchange Commission and dated August 14, 1998.

(8)    Incorporated by reference to Exhibit 1 in Registrant's Form 8-A filed 
       with the Securities and Exchange Commission and dated February 4, 1999.

*      Confidential Treatment granted

+      Confidential Treatment requested

(b)    Reports on Form 8-K:

       No reports on Form 8-K were filed during the quarter ended December 31, 
       1998.

(c)    See part a(3) above.

(d)    All schedules have been omitted because the information required to be 
       set forth therein is not applicable.
<PAGE>   31

                                   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 29, 1999


                                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 29, 1999
--------------------------------------     and Director (Principal Executive Officer)
             James E. Rurka                

  /s/       MATTHEW J. HOGAN               Chief Financial Officer (Principal                March 29, 1999
--------------------------------------     Financial and Accounting Officer)
            Matthew J. Hogan               

  /s/        JOHN P. WALKER                Chairman of the Board of Directors                March 29, 1999
--------------------------------------
             John P. Walker

  /s/    KEITH A. BOSTIAN, Ph.D.           Director                                          March 29, 1999
--------------------------------------
         Keith A. Bostian, Ph.D.

  /s/    DANIEL L. KISNER, M.D.            Director                                          March 29, 1999
--------------------------------------
         Daniel L. Kisner, M.D.

 /s/   HUGH Y. RIENHOFF, JR., M.D.         Director                                          March 29, 1999
--------------------------------------
       Hugh Y. Rienhoff, Jr., M.D.

  /s/      DAVID SCHNELL, M.D.             Director                                          March 29, 1999
--------------------------------------
           David Schnell, M.D.

  /s/       MARK B. SKALETSKY              Director                                          March 29, 1999
--------------------------------------
            Mark B. Skaletsky

</TABLE>



                                       31
<PAGE>   32

                         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>   33

                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, 1998 and 1997, and the related
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Microcide Pharmaceuticals,
Inc. at December 31, 1998 and 1997 and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.


                                             ERNST & YOUNG LLP


Palo Alto, California
February 9, 1999



                                      F-2
<PAGE>   34

                         MICROCIDE PHARMACEUTICALS, INC.

                                 BALANCE SHEETS
                      (In thousands, except share amounts)



<TABLE>
<CAPTION>
                                                                                DECEMBER 31,
                                                                           ----------------------
                                                                             1998          1997
                                                                           --------      --------
<S>                                                                        <C>           <C>     
ASSETS
Current assets:
    Cash and cash equivalents ........................................     $  7,794      $ 11,763
    Short-term investments ...........................................       25,398        28,624

    Prepaid expenses and other current assets ........................          590         1,284
                                                                           --------      --------
Total current assets .................................................       33,782        41,671

Property and equipment, net ..........................................        9,755         9,540
Other assets .........................................................          953           571
                                                                           --------      --------
                                                                           $ 44,490      $ 51,782
                                                                           ========      ========

LIABILITIES AND STOCKHOLDERS' EQUITY 
Current liabilities:
    Accounts payable .................................................     $    642      $  1,313
    Construction payable .............................................           --           347
    Accrued compensation .............................................          920           831
    Current portion of notes payable .................................        1,129           612
    Deferred revenue .................................................          300           786
    Other accrued liabilities ........................................          522           547
                                                                           --------      --------
Total current liabilities ............................................        3,513         4,436

Long-term portion of notes payable ...................................        2,912           224
Accrued rent .........................................................          127           226
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,
    11,017,429 and 10,907,043 shares issued and outstanding at
    December 31, 1998 and 1997, respectively .........................       66,902        66,930
  Deferred compensation ..............................................         (464)       (1,251)
  Accumulated deficit ................................................      (28,497)      (18,739)
  Accumulated other comprehensive loss ...............................           (3)          (44)
                                                                           --------      --------
Total stockholders' equity ...........................................       37,938        46,896
                                                                           --------      --------
                                                                           $ 44,490      $ 51,782
                                                                           ========      ========
</TABLE>



                             See accompanying notes.



                                      F-3
<PAGE>   35

                         MICROCIDE PHARMACEUTICALS, INC.

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


<TABLE>
<CAPTION>
                                                                            YEARS ENDED DECEMBER 31,
                                                                       ------------------------------------
                                                                         1998          1997          1996
                                                                       --------      --------      --------
<S>                                                                    <C>           <C>           <C>     
Revenues:
  Research revenues ..............................................     $ 11,141      $ 12,183      $  9,273
  License and milestone revenues .................................           --         1,000         2,000
  Other revenues .................................................           40         1,711            --
                                                                       --------      --------      --------
Total revenues ...................................................       11,181        14,894        11,273

Operating expenses:
  Research and development .......................................       18,806        17,877        10,717
  General and administrative .....................................        3,971         4,091         2,889
                                                                       --------      --------      --------
Total operating expenses .........................................       22,777        21,968        13,606
                                                                       --------      --------      --------

Loss from operations .............................................      (11,596)       (7,074)       (2,333)

Interest income ..................................................        1,870         2,616         1,899
Interest expense .................................................          (32)         (144)         (236)
                                                                       --------      --------      --------

Net loss .........................................................     $ (9,758)     $ (4,602)     $   (670)
                                                                       ========      ========      ========

Basic and diluted net loss per share .............................     $  (0.89)     $  (0.43)     $  (0.10)
                                                                       ========      ========      ========

Shares used in computing basic and diluted net loss per share ....       10,962        10,817         7,034
</TABLE>



                             See accompanying notes.



                                      F-4
<PAGE>   36

                         MICROCIDE PHARMACEUTICALS, INC.

                        STATEMENT OF STOCKHOLDERS' EQUITY

                   FOR THE THREE YEARS ENDED DECEMBER 31, 1998
               (In thousands, except share and per share amounts)


<TABLE>
<CAPTION>
                                                                                                       ACCUMULATED
                                                                                                          OTHER            TOTAL
                                                 PREFERRED      COMMON       DEFERRED     ACCUMULATED  COMPREHENSIVE   STOCKHOLDERS'
                                                   STOCK         STOCK      COMPENSATION    DEFICIT    INCOME (LOSS)      EQUITY
                                                 ---------      --------    ------------  -----------  -------------   -------------
<S>                                              <C>            <C>         <C>           <C>          <C>             <C>     
Balances at December 31, 1995 ...............     $ 22,435      $    597      $   (412)     $(13,467)     $     (2)     $  9,151
Net loss ....................................           --            --            --          (670)           --          (670)
Net unrealized gain on securities
   available-for-sale .......................           --            --            --            --            11            11
                                                                                                                        --------
Comprehensive loss ..........................                                                                               (659)
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
                                                  --------      --------      --------      --------      --------      --------
Balances at December 31, 1996 ...............           --        66,279        (1,577)      (14,137)            9        50,574
Net loss ....................................           --            --            --        (4,602)           --        (4,602)
Net unrealized loss on securities
   available-for-sale .......................           --            --            --            --           (53)          (53)
                                                                                                                        --------
Comprehensive loss ..........................                                                                             (4,655)
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
                                                  --------      --------      --------      --------      --------      --------
Balances at December 31, 1997 ...............           --        66,930        (1,251)      (18,739)          (44)       46,896
Net loss ....................................           --            --            --        (9,758)           --        (9,758)
Net unrealized gain on securities
   available-for-sale .......................           --            --            --            --            41            41
                                                                                                                        --------
Comprehensive loss ..........................                                                                             (9,717)
Issuance of 38,773 shares of
   common stock under the employee
   stock purchase plan ......................           --           202            --            --            --           202
Issuance of 71,613 shares of common
   stock due to options
   exercised by employees and consultants ...           --            34            --            --            --            34
Deferred compensation .......................           --            --            --            --            --            --
Reversal of deferred compensation
   for terminated employees .................           --          (264)          264            --            --            --
Amortization of deferred compensation .......           --            --           523            --            --           523
                                                  --------      --------      --------      --------      --------      --------
Balances at December 31, 1998 ...............     $     --      $ 66,902      $   (464)     $(28,497)     $     (3)     $ 37,938
                                                  ========      ========      ========      ========      ========      ========
</TABLE>



                             See accompanying notes.



                                      F-5
<PAGE>   37

                         MICROCIDE PHARMACEUTICALS, INC.

                            STATEMENTS OF CASH FLOWS
                                 (In thousands)

                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

<TABLE>
<CAPTION>
                                                                                     YEARS ENDED DECEMBER 31,
                                                                               ---------------------------------------
                                                                                 1998           1997           1996
                                                                               ---------      ---------      ---------
<S>                                                                            <C>            <C>            <C>       
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss .................................................................     $  (9,758)     $  (4,602)     $    (670)
Adjustments to reconcile net loss to net cash provided by (used in)
 operating activities:
 Depreciation and amortization ...........................................         2,874          2,988          1,560
 Amortization of deferred compensation ...................................           523            672            490
 Accrued rent ............................................................           (99)           103            (14)
 Issuance of common stock for services (included in issuance costs).......            --             --            103

 Changes in assets and liabilities:
     Prepaid expenses and other current assets ...........................           694           (950)          (196)
     Other assets ........................................................          (382)          (412)            73
     Accounts payable ....................................................        (1,018)          (210)         1,092
     Construction payable ................................................            --           (398)           713
     Accrued compensation and other liabilities ..........................            64            626            460
     Deferred revenue ....................................................          (486)          (403)           776
                                                                               ---------      ---------      ---------
Net cash provided by (used in) operating activities ......................        (7,588)        (2,586)         4,387
                                                                               ---------      ---------      ---------

CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of short-term investments .......................................       (85,790)      (102,264)       (39,180)
Maturities of short-term investments .....................................        89,057        112,778             --
Capital expenditures .....................................................        (3,089)        (3,702)        (5,779)
                                                                               ---------      ---------      ---------
Net cash provided by (used in) investing activities ......................           178          6,812        (44,959)
                                                                               ---------      ---------      ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations ..........................          (795)        (1,085)        (1,117)
Proceeds from debt financing .............................................         4,000             --             --
Proceeds from issuances of common stock ..................................           236            270         36,499
Repayment of shareholder note ............................................            --             35             --
Net proceeds from issuance of convertible preferred stock ................            --             --          4,990
                                                                               ---------      ---------      ---------
Net cash provided by (used in) financing activities ......................         3,441           (780)        40,372
                                                                               ---------      ---------      ---------

Net increase (decrease) in cash and cash equivalents .....................        (3,969)         3,446           (200)
Cash and cash equivalents at beginning of period .........................        11,763          8,317          8,517
                                                                               ---------      ---------      ---------
Cash and cash equivalents at end of period ...............................     $   7,794      $  11,763      $   8,317
                                                                               =========      =========      =========


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid ........................................................     $       2      $      23      $      --
                                                                               =========      =========      =========
Interest paid ............................................................     $      32      $     144      $     236
                                                                               =========      =========      =========
</TABLE>



                             See accompanying notes.



                                      F-6
<PAGE>   38

                         MICROCIDE PHARMACEUTICALS, INC.

                          NOTES TO FINANCIAL STATEMENTS

                                DECEMBER 31, 1998

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 and fungal 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 anticipates working on a number of long-term development
projects which involve experimental and unproven technology. The projects
require many years and substantial expenditures to complete, and may ultimately
be unsuccessful. Therefore, the Company will need to obtain additional funds
from outside sources to continue its research and development activities, fund
operating expenses, pursue regulatory approvals and build production, sales and
marketing capabilities, as necessary.

     In January 1998, Microcide formed Iconix Pharmaceuticals, Inc. ("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. After giving effect to the investment and including the
stock option pool reserved for employees and consultants of Iconix, Microcide
holds approximately 33% of Iconix' outstanding equity on a fully diluted basis.
Microcide accounts for its investment using the equity method of accounting and
since Microcide's investment has a zero book basis, the losses of Iconix do not
impact Microcide's statement of operations.

   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, 1998 and 1997, 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.



                                      F-7
<PAGE>   39

   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 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 1998 and 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. Diluted net loss per share has not been presented; given the
Company's net loss position, the result would be anti-dilutive.

           Had the Company been in a net income position, diluted earnings per
share for 1998, 1997 and 1996 would have included the shares used in the
computation of pro forma basic net loss per share as well as an additional
349,000, 567,000 and 664,000 shares, respectively, related to outstanding
options and warrants not included above (as determined using the treasury stock
method).



                                      F-8
<PAGE>   40

   Comprehensive Loss

     The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standard No. 130, ("SFAS 130"), "Reporting Comprehensive
Income," in June 1997. SFAS 130 establishes standards for reporting and display
of comprehensive income (loss) and its components as part of the Company's full
set of financial statements and is effective for fiscal years beginning after
December 31, 1997. The Company adopted SFAS 130 in the fiscal year ended
December 31, 1998.

   Segment Information

     Effective January 1, 1998, the Company adopted Statement No. 131,
"Disclosure about Segments of an Enterprise and Related Information" (Statement
131). Statement 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports. Statement 131 also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. The adoption of Statement 131 had no significant effect on
results of operations or the financial position of the Company.

   Other Recent Accounting Pronouncements

     In June 1998, the FASB issued Statement of Financial Accounting Standard
No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
133"). The Company is required to adopt SFAS 133 for the year ending December
31, 2000. SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments. Microcide does
not currently engage in hedging activities; adoption of SFAS 133 is expected to
have no material impact on Microcide's financial condition and results of
operations.

   Reclassifications

     Certain reclassifications of prior year amounts have been made to conform
to current year presentation.

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. This collaboration was subsequently extended with respect to
beta-lactam antibiotics through the end of 1999. 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, 1998,
1997 and 1996 was $3,206,000, $3,500,000 and $4,500,000, 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 subsequently exercised its option to extend the research collaboration
for an additional 



                                      F-9
<PAGE>   41

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, 1998, 1997 and 1996 was
$3,749,000, $4,364,000 and $3,175,000, respectively.

   Pfizer Inc.

     In March 1996, the Company 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, 1998, 1997 and 1996 was $4,186,000, $5,319,000 and
$3,598,000, respectively.

     In January 1999, the Company expanded its existing antibiotic research
collaboration with Pfizer to include a focused effort to discover and develop
new classes of antibiotics specifically designed for animal health applications.
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. 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.

     Costs related to research revenues under the above agreements for the years
ended December 31, 1998, 1997 and 1996 approximated the related research revenue
recognized (exclusive of license and milestone fees).

   Iconix Pharmaceuticals, Inc.

     In January 1998, Microcide and Iconix entered into several collaborative
agreements. Through the Core Technology Development and License Agreement,
Microcide and Iconix expect to work together over the following three years to
jointly develop and utilize new technology in the areas of molecular diversity,
high-throughput screening, computational sciences and genome sciences. During
1998, projects jointly undertaken pursuant to this agreement resulted in a net
expense to Microcide of approximately $274,000. 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. During 1998, Microcide incurred research expense pursuant to the
antiviral collaboration of approximately $823,000. Microcide is obligated to
provide Iconix with research support payments of up to $5.0 million over the
remaining years of 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 provides Iconix with facilities and
various business support services for which Microcide is reimbursed. During
1998, Microcide received approximately $763,000 from Iconix pursuant to the
Support Services Agreement which it treated as a reduction of expenses.



                                      F-10

<PAGE>   42


3. PROPERTY AND EQUIPMENT

     Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                        DECEMBER 31,
                                                                  ----------------------
                                                                    1998          1997
                                                                  --------      --------
                                                                      (In thousands)
<S>                                                               <C>           <C>     
        Laboratory and office equipment ....................      $  9,547      $  7,678
        Leasehold improvements .............................         9,798         8,578
                                                                  --------      --------
                                                                    19,345        16,256
        Less accumulated depreciation and amortization......        (9,590)       (6,716)
                                                                  --------      --------
        Property and equipment, net ........................      $  9,755      $  9,540
                                                                  ========      ========
</TABLE>

     Properties leased under capital leases are included above with a cost of
approximately $655,000 and $4,538,000 at December 31, 1998 and 1997, with
accumulated amortization of approximately $609,000 and $3,576,000 at December
31, 1998 and 1997, respectively. Under an equipment financing arrangement with a
lender, a security agreement was executed, granting a lien and security interest
to specific property of the Company (see Note 5).

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, 1998
     Cash equivalents and short-term investments:
     Money market funds ...............................        $  2,520        $     --         $     --         $  2,520
     Corporate debt securities ........................          26,908              33              (36)          26,905
                                                               --------        --------         --------         --------
                                                               $ 29,428        $     33         $    (36)        $ 29,425
                                                               ========        ========         ========         ========
     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
                                                               ========        ========         ========         ========
</TABLE>

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

<TABLE>
<CAPTION>
                                                             AS OF DECEMBER 31,
                                          ---------------------------------------------------------
                                                    1998                         1997
                                          ---------------------------    --------------------------
                                          AMORTIZED    ESTIMATED FAIR    AMORTIZED   ESTIMATED FAIR
                                            COST           VALUE           COST          VALUE
                                          ---------------------------    --------------------------
                                                                (In thousands)
<S>                                       <C>          <C>               <C>         <C>    
     Due in less than 1 year ......        $28,428        $28,425        $32,979        $32,938
     Due in 1 to 2 years ..........             --             --          6,615          6,612
     Due in 2 to 3 years ..........          1,000          1,000             --             --
                                           -------        -------        -------        -------
                                           $29,428        $29,425        $39,594        $39,550
                                           =======        =======        =======        =======
</TABLE>

5.  LEASES AND DEBT FINANCING

     In fiscal years 1998 and prior, the Company was making payments under
capital equipment lease lines of credit. In December 1998 and February 1999,
Microcide exercised its option to buy out equipment under the outstanding leases
whose terms were due to expire during 1998 and 1999. In December 1998, Microcide
borrowed $4.0 million under an equipment financing arrangement



                                      F-11
<PAGE>   43

whose terms include a fixed interest rate of 9.55% per annum with a repayment
term of 36 months. Under this arrangement, Microcide can borrow up to an
additional $1.0 million during 1999. This loan is collaterized by property and
equipment.

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

<TABLE>
<CAPTION>
                                                            EQUIPMENT        OPERATING
                                                            FINANCING          LEASES
                                                           -----------      -----------
          Year ended December 31,                                 (In thousands)
<S>                                                        <C>              <C>    
          1999 ......................................        $ 1,437         $ 1,613
          2000 ......................................          1,544           1,748
          2001 ......................................          1,544           2,064
          2002 ......................................            133           2,142
          2003 ......................................              4           2,221
          Thereafter ................................             --           4,069
                                                             -------         -------
          Total minimum payment required ............          4,662         $13,857
                                                                             =======
          Less amount representing interest .........           (621)
                                                             -------
          Present value of future lease payments ....          4,041
          Less current portion ......................         (1,129)
                                                             -------
                                                             $ 2,912
                                                             =======
</TABLE>

     Rent expense for operating leases was approximately $1,215,000, $947,000
and $454,000 in 1998, 1997 and 1996, respectively.

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, 1998, 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).

   1996 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, 1998, 48,073 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 16,000 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 



                                      F-12
<PAGE>   44

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 June 18, 1998, 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
400,000. The total number of shares of common stock now reserved for issuance
under the Plan is 2,280,000.

     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.

    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, 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
            Options granted .................           683,845          $3.81-$12.12        $   6.58
            Options exercised ...............           (71,613)          $0.20-$2.50        $   0.42
            Options canceled ................          (286,472)         $0.38-$12.50        $  10.99
                                                     ---------- 
          Balance at December 31, 1998 ......         1,431,346          $0.20-$14.00        $   6.71
                                                     ========== 
</TABLE>

     Under the Amended Incentive Stock Option Plan, options to purchase 515,433
and 392,821 shares of common stock were exercisable at December 31, 1998 and
1997, respectively. At December 31, 1998, 397,183 shares remained available for
grant under the Amended Incentive Stock Option Plan. Through December 31, 1998,
200,000 shares of common stock have been issued pursuant to stock purchase
rights granted under the Plan which are subject to repurchase by the Company
upon termination of employment. The Company's repurchase right generally lapses
over four years. At December 31, 1998, 7,917 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 $3,000.

    Under the Director Plan, of the 56,000 shares outstanding, 23,334 shares
were exercisable at December 31, 1998. At December 31, 1998, 24,000 shares
remained available for grant under the Director Plan.



                                      F-13
<PAGE>   45

    The options outstanding at December 31, 1998 have been segregated into three
ranges for additional disclosures as follows:

<TABLE>
<CAPTION>
                                       OPTIONS OUTSTANDING                               EXERCISABLE OPTIONS
                                   --------------------------       WEIGHTED-         --------------------------
                                                    WEIGHTED-         AVERAGE                          WEIGHTED-
                 RANGE OF                           AVERAGE         REMAINING                          AVERAGE
                 EXERCISE                           EXERCISE      CONTRACTUAL LIFE                     EXERCISE
                  PRICES             NUMBER          PRICES          (IN YEARS)        NUMBER           PRICES
               ------------        ---------        ---------     ----------------    ---------        ---------
<S>                                <C>              <C>           <C>                 <C>              <C>      
               $0.20-$0.375          159,129        $    0.33             6.08          156,476        $    0.33
               $2.50-$4.625          195,037             2.58             7.31          126,288             2.50
               $5.00-$8.875          533,295             5.91             9.71           27,269             7.19
               $9.00-$14.00          543,885            10.84             8.29          228,734            11.13
                                   ---------                                          ---------
                                   1,431,346             6.71             8.44          538,767             5.77
                                   =========                                          =========
</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 was not fully
reflected until 1999 since the options granted by Microcide generally vest over
four years.

     The Company has recorded $2,315,000 in deferred compensation (net of
reversals for stock option cancellations) 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.

    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 1998, 1997 and
1996: weighted-average volatility factor of 0.75, 0.57 and 0.6, respectively; no
expected dividend payments; weighted-average risk-free interest rates in effect
of 4.76%, 6.10% and 5.62%, respectively; and a weighted-average expected life of
3.63, 3.42 and 3.64 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, 1998, 1997 and 1996 was $3.51, $5.21
and $6.69, 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,
                                                ---------------------------------------------------------
                                                    1998                  1997                  1996
                                                -------------         -------------         -------------
<S>                                             <C>                   <C>                   <C>           
          Pro forma net loss ...........        $ (10,601,000)        $  (5,789,000)        $  (1,407,000)
          Pro forma loss per share .....        $       (0.97)        $       (0.54)        $       (0.15)
</TABLE>



                                      F-14
<PAGE>   46

7. NOTES RECEIVABLE FROM RELATED PARTIES

     At December 31, 1998, the Company had notes receivables due from employees
in the amount of $647,000. 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, 1998, the Company had federal and state net operating
loss carryforwards of approximately $22,600,000 and $7,500,000, 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 2018, if not utilized. The
state net operating loss carryforward will expire at various dates beginning in
1999 through 2004, if not utilized.

     Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change of ownership" provisions of the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.

     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:

<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                          -------------------------
                                                           1998              1997
                                                          --------         --------
                                                                (In thousands)
<S>                                                       <C>              <C>     
          Deferred tax assets:
            Net operating loss carryforwards .....        $  8,100         $  5,500
            Research credit carryforwards ........             500              500
            Other ................................           2,300            1,300
                                                          --------         --------
          Total deferred tax assets ..............          10,900            7,300
          Valuation allowance ....................         (10,900)          (7,300)
                                                          --------         --------
          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 $1,500,000 and $200,000 during the years ended December
31, 1997 and 1996, respectively.

9. SUBSEQUENT EVENTS

    Preferred Shares Purchase Rights

     In February 1999, the Company's Board of Directors declared a dividend
distribution of one Preferred Share Purchase Right (a "Right") for each
outstanding share of Common Stock. Each Right entitles stockholders to buy
1/1000th of a share of the Company's Series A Participating Preferred Stock at
an exercise price of $30, subject to adjustment. The Rights will separate from
the Common Stock and become exercisable following the tenth day after a person
or group (a) acquires beneficial ownership of 20% or more of the Common Stock,
or (b) announces commencement of a tender or exchange offer, the consummation of
which would result in ownership by a person or group of 20% or more of the
Common Stock (in either case, the "Distribution Date"). The Company will be
entitled to redeem the Rights at $0.001 per Right at any time prior to the
Distribution Date. The Rights expire on the earliest of (a) February 2, 2009, or
(b) exchange or redemption of the Rights. The Rights are designed to protect
stockholders from unsolicited attempts to acquire the Company on terms that do
not maximize stockholder value, while not preventing a fair acquisition offer
for the Company.



                                      F-15
<PAGE>   47
                                 EXHIBIT INDEX
<TABLE>
<CAPTION>
        EXHIBITS                              DESCRIPTION
        --------                              -----------
<S>                      <C>
          2.1            Iconix Pharmaceuticals, Inc. (formerly EpiGenix, Inc.)
                         Series A Preferred Stock Purchase Agreement. (2)
          2.2*           Core Technology Development and License Agreement by
                         and between Microcide Pharmaceuticals, Inc. and Iconix
                         Pharmaceuticals, Inc. (formerly EpiGenix, Inc.) (2)
          2.3*           Antiviral and Surrogate Genetics Research Collaboration
                         Agreement by and between Microcide Pharmaceuticals,
                         Inc. and Iconix Pharmaceuticals, Inc. (formerly
                         EpiGenix, Inc.) (2)
          3.2            Restated Certificate of Incorporation of the
                         Registrant. (1)
          3.5            Bylaws of the Registrant. (1)
          4.2            Form of Common Stock Certificate. (1)
          4.3            Series A Preferred Warrant Purchase Agreement and
                         Warrant between Dominion Ventures, Inc. and the
                         Registrant dated May 10, 1993. (1)
          4.4            Series B Preferred Warrant Purchase Agreement and
                         Warrant between Dominion Ventures, Inc. and the
                         Registrant dated May 10, 1993. (1)
          4.5            Series C Preferred Warrant Purchase Agreement and
                         Warrant between Dominion Ventures, Inc. and the
                         Registrant dated June 10, 1994. (1)
          4.6            Series B Preferred Warrant Agreement between Comdisco,
                         Inc. and the Registrant dated September 1, 1993. (1)
          4.7            Series C Preferred Warrant Agreement between Comdisco,
                         Inc. and the Registrant dated September 1, 1993. (1)
         10.1            Information and Registration Rights Agreement, dated
                         June 29, 1994 as amended. (1)
         10.2            1993 Amended Incentive Stock Plan. (1)
         10.3            1996 Employee Stock Purchase Plan. (1)
         10.4            1996 Director Option Plan. (1)
         10.5            401(k) Plan. (1)
         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. (1)
         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. (1)
         10.8*           Joint Research Agreement between the Registrant and
                         Daiichi Pharmaceutical Co., Ltd. dated November 6,
                         1995. (1)
         10.9*           Collaborative Research Agreement between the Registrant
                         and Pfizer Inc dated March 1, 1996. (1)
         10.10*          License and Royalty Agreement between the Registrant
                         and Pfizer Inc dated March 1, 1996. (1)
         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. (1)
         10.12           Master Lease Agreement between the Registrant and
                         Comdisco, Inc. dated September 1, 1993. (1)
         10.13           Lease Agreement between the Registrant and Portola Land
                         Company dated April 1993. (1)
         10.14           Form of Indemnification Agreement between the
                         Registrant and its Officers and Directors. (1)
</TABLE>



<PAGE>   48
<TABLE>
<CAPTION>
        EXHIBITS                              DESCRIPTION
        --------                              -----------
<S>                      <C>
         10.15           Employment Agreement dated January 31, 1994 between the
                         Registrant and James E. Rurka. (1)
         10.16           Employment Agreement dated December 23, 1992 between
                         the Registrant and Keith A. Bostian, Ph.D. (1)
         10.17           Lease Agreement commencing November 1, 1996 between the
                         Registrant and Logue Investments L.P., a California
                         limited partnership. (3)
         10.18*          Synthetic Compound Purchase Agreement between the
                         Registrant and Daiichi Pharmaceutical Co., Ltd. dated
                         June 25, 1997. (4)
         10.19           Sublease agreement between the Registrant, Quickturn
                         Design Systems, Inc. and Portola Land Co. dated
                         September 1997. (5)
         10.20           Sub-sublease agreement between the Registrant, Alpha
                         Blox Corporation, Quickturn Design Systems, Inc. and
                         Portola Land Co. dated September 1997. (6)
         10.21           Consulting Agreement dated January 14, 1998 between the
                         Registrant and Keith Bostian, Ph.D. (6)
         10.22           Lease Agreement between the Registrant and Portola Land
                         Co. dated May 11, 1998. (7)
         10.23           Promissory Note between the Registrant and Heller
                         Financial Leasing, Inc. dated December 22, 1998.
         10.24           Security Agreement between the Registrant and Heller
                         Financial Leasing, Inc. dated December 22, 1998.
         10.25+          Amendment of Research and License Agreement between the
                         Registrant and Ortho Pharmaceutical Corporation and the
                         R.W. Johnson Pharmaceutical Research Institute dated
                         October 23, 1998.
         10.26+          Collaborative Research Agreement between the Registrant
                         and Pfizer Inc dated January 13, 1999.
         10.27+          License and Royalty Agreement between the Registrant
                         and Pfizer Inc dated January 13, 1999.
         10.28           Preferred Shares Rights Agreement dated February 2, 
                         1999 between the Registrant and Chase Mellon  
                         Shareholder Services, L.L.C. (8)
         23.1            Consent of Ernst & Young LLP, Independent Auditors.
         24.1            Power of Attorney (see page 31).
         27.1            Financial Data Schedule.
         
</TABLE>

----------

(1)    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.

(2)    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.

(3)    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.

(4)    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.

(5)    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.

(6)    Incorporated by reference to the same-numbered exhibit in Registrant's
       Form 10-K for the fiscal year ended December 31, 1997, filed with
       Securities and Exchange Commission and dated March 31, 1998.

(7)    Incorporated by reference to the same-numbered exhibit in Registrant's
       Form 10-Q for the period ended June 30, 1998, filed with Securities and
       Exchange Commission and dated August 14, 1998.

(8)    Incorporated by reference to Exhibit 1 in Registrant's Form 8-A filed 
       with the Securities and Exchange Commission and dated February 4, 1999.

*      Confidential Treatment granted

+      Confidential Treatment requested