UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934 (Amendment No.               )

 

 

CUBIST PHARMACEUTICALS, INC.
65 Hayden Avenue
Lexington, MA 02421

NOTICE OF 2007 ANNUAL MEETING OF STOCKHOLDERS

TO THE STOCKHOLDERS OF CUBIST PHARMACEUTICALS, INC.:

NOTICE IS HEREBY GIVEN that the 2007 Annual Meeting of Stockholders of Cubist Pharmaceuticals, Inc., or the 2007 Annual Meeting, will be held at our principal executive office at 65 Hayden Avenue, Lexington, MA 02421, on Thursday, June 7, 2007, at 8:30 A.M., local time, for the following purposes:

1.                 To elect three (3) Class II directors to our Board of Directors, or Board, each to hold office for a three-year term and until his or her successor has been duly elected and qualified.

2.                 To consider and vote upon a proposal to amend our corporate charter to increase the number of authorized shares of common stock from 100,000,000 shares to 150,000,000 shares.

3.                 To consider and vote upon a proposal to amend our Amended and Restated 1997 Employee Stock Purchase Plan, or ESPP, to extend the ESPP for an additional ten years and to increase the number of shares issuable under the ESPP by 250,000.

4.                 To consider and vote upon a proposal to amend our Amended and Restated 2002 Directors’ Equity Incentive Plan, or Directors’ Plan, to allow for the issuance of stock awards and to increase the number of shares issuable under the Directors’ Plan by 300,000.

5                    To ratify the selection of PricewaterhouseCoopers LLP as our independent auditor for the fiscal year ending December 31, 2007.

6.                 To transact such other business as may properly come before the 2007 Annual Meeting or any adjournments or postponements thereof.

The Board of Directors has fixed April 12, 2007 as the record date for the determination of stockholders entitled to notice of, and to vote at, the 2007 Annual Meeting. Accordingly, only stockholders of record at the close of business on April 12, 2007 will be entitled to notice of, and to vote at, the meeting or any adjournments thereof.

To ensure your representation at the 2007 Annual Meeting, you are urged to vote by proxy by following one of these steps as promptly as possible:

(a)             Vote via telephone (toll-free) in the United States or Canada (see instructions on the enclosed proxy card);

(b)            Vote via the Internet (see instructions on the enclosed proxy card); or

(c)             Complete, date, sign and return the enclosed proxy card (a postage-prepaid envelope is enclosed).

The Internet and telephone voting procedures are designed to authenticate stockholders’ identities, to allow stockholders to vote their shares, and to confirm that their instructions have been properly recorded. Specific instructions to be followed by any registered stockholder interested in voting via the Internet or telephone are set forth on the enclosed proxy card and must be completed by 2:00 a.m. Eastern Time on June 7, 2007. Your shares cannot be voted unless you date, sign, and return the enclosed proxy card, vote via the Internet or telephone, or attend the 2007 Annual Meeting in person. Regardless of the number of shares you own, your careful consideration of, and vote on, the matters before the stockholders is important.

 

April 26, 2007

 

CUBIST PHARMACEUTICALS, INC.
65 Hayden Avenue
Lexington, MA 02421

PROXY STATEMENT

GENERAL INFORMATION

Proxy Solicitation

This Proxy Statement is furnished to the holders of the common stock, $.001 par value per share, of Cubist Pharmaceuticals, Inc., which we refer to in this Proxy Statement as “Cubist” or the “Company,” in connection with the solicitation of proxies on behalf of our Board of Directors, or Board, for use at the 2007 Annual Meeting to be held at our principal executive office at 65 Hayden Avenue, Lexington, Massachusetts on Thursday, June 7, 2007 at 8:30 A.M. local time or at any adjournment or postponement of the meeting. The purposes of the 2007 Annual Meeting and the matters to be acted upon are set forth in the accompanying Notice of 2007 Annual Meeting of Stockholders. The Board knows of no other business that will come before the 2007 Annual Meeting.

This Proxy Statement and proxies for use at the 2007 Annual Meeting will be first mailed to stockholders on or about April 30, 2007. We will pay the costs of soliciting proxies, and proxies will be solicited chiefly by mail. Additional solicitations may be made by telephone, email or facsimile by our officers or regular employees. We have retained Computershare Limited, or “Computershare” and The Altman Group, Inc., or “Altman”, to organize the distribution and return of the proxy materials. We pay Computershare approximately $15,000 annually for various services related to the Proxy Statement, including those rendered in connection with our 2007 Annual Meeting. We will pay Altman no more than $2,000 plus expenses to distribute the proxy materials and to solicit the vote of stockholders.

An Annual Report on Form 10-K, containing audited financial statements for our fiscal year ended December 31, 2006, accompanies this Proxy Statement.

Voting and Revocability of Proxy

Registered stockholders can vote their shares (1) via a toll-free telephone call from the U.S. or Canada, (2) via the Internet, or (3) by mailing their signed proxy card. The telephone and Internet voting procedures are designed to authenticate stockholders’ identities, to allow stockholders to vote their shares, and to confirm that their instructions have been properly recorded. Specific instructions to be followed by any registered stockholder interested in voting via telephone or the Internet are set forth on the enclosed proxy card.

Stockholders may revoke the authority granted by their execution of proxies at any time before the effective exercise of such authority by filing with our Secretary a written revocation or a duly executed proxy bearing a later date or by voting in person at the 2007 Annual Meeting. Shares represented by executed and unrevoked proxies will be voted in accordance with the choice or instructions specified thereon. If no specifications are given, the proxies intend to vote the shares represented thereby to

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(i) approve Proposal No. 1 to elect the Class II nominees to the Board, (ii) approve Proposal No. 2 to amend our corporate charter to increase the number of authorized shares of common stock by 50,000,000 shares, (iii) approve Proposal No. 3 to amend our ESPP to extend the ESPP by ten years and to increase the number of shares issuable under the ESPP by 250,000, (iv) approve Proposal No. 4 to amend our Directors’ Plan to allow for the issuance of stock awards and to increase the number of shares issuable under the Directors’ Plan by 300,000, and (v) approve Proposal No. 5 to ratify the selection of PricewaterhouseCoopers LLP as our independent auditor for the fiscal year ending December 31, 2007, each as set forth in the accompanying Notice of 2007 Annual Meeting of Stockholders and in accordance with the proxies’ best judgment on any other matters that may properly come before the 2007 Annual Meeting.

Record Date and Voting Rights

Only stockholders of record at the close of business on April 12, 2007 are entitled to notice of, and to vote at, the 2007 Annual Meeting or any adjournment or postponement of the meeting. On April 12, 2007, we had outstanding 55,286,747 shares of common stock, each of which is entitled to one vote upon each of the matters to be presented at the 2007 Annual Meeting. The presence, in person or by proxy, of a majority of the issued and outstanding shares of common stock on April 12, 2007, will constitute a quorum for the transaction of business at the 2007 Annual Meeting. Votes withheld from any nominee, abstentions, and broker “non-votes” are counted as present or represented for purposes of determining the presence or absence of a quorum for the 2007 Annual Meeting. A broker “non-vote” occurs when a nominee holding shares for a beneficial owner does not vote on one or more proposals because the nominee does not have discretionary voting power and has not received instructions from the beneficial owner.

In the election of directors, the affirmative vote of a plurality of the shares of common stock present or represented and entitled to vote at the 2007 Annual Meeting, in person or by proxy, is required for the election of each of the nominees. Abstentions and broker “non-votes” will have no effect on the voting outcome with respect to the election of directors. For each of the proposals to extend the term and increase the number of shares issuable under the ESPP, to allow for the issuance of  stock awards and to increase the number of shares issuable under the Directors’ Plan, and to ratify the selection of PricewaterhouseCoopers LLP as our independent auditor for the fiscal year ending December 31, 2007, the affirmative vote of the holders of a majority of shares present in person or represented by proxy at the 2007 Annual Meeting and entitled to vote on such proposals, is required.  For the proposal to amend our corporate charter to increase our number of authorized shares, the affirmative vote of a majority of our outstanding shares is required. Abstentions have the practical effect of a vote against these proposals. Broker “non-votes” will have no effect on the voting outcome of the proposals other than the proposal to amend our corporate charter, for which a broker “non-vote” is the equivalent of a vote “against” the proposal.

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PRINCIPAL STOCKHOLDERS

The following table sets forth certain information with respect to each person known to us to be the beneficial owner of more than 5% of our issued and outstanding common stock as of April 12, 2007. As of April 12, 2007, there were 55,286,747 shares of Cubist common stock outstanding.

(1)          We calculated the percentage of class based on the number of shares reported as beneficially owned in the Securities and Exchange Commission, or SEC, filings of the beneficial owners divided by the actual number of shares outstanding as of April 12, 2007. The percentages in the table differ in most cases from the percentages reported in the beneficial owners’ filings with the SEC because the beneficial owners may have used different denominators than the actual number of shares outstanding as of April 12, 2007.

(2)          The information reported is based on a Schedule 13G/A filed with the SEC on January 8, 2007 by Mazama Capital Management, Inc., or Mazama. Mazama, an investment adviser, reported that it had sole voting power with respect to 4,781,650 shares and sole dispositive power with respect to 8,115,360 shares as of December 31, 2006.

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(3)          The information reported is based on a Schedule 13G/A filed with the SEC on February 12, 2007 by Federated Investors, Inc., or Federated. Federated reported that it had sole voting and dispositive power with respect to these shares as of December 31, 2006.

(4)          The information reported is based on a Schedule 13G/A filed with the SEC on February 14, 2007 by T. Rowe Price Associates, Inc., or T. Rowe Price. These securities are owned by various individual and institutional investors for which T. Rowe Price serves as investment adviser with power to direct investments and/or sole power to vote the securities. For purposes of the reporting requirements of the Securities Exchange Act of 1934, T. Rowe Price is deemed to be a beneficial owner of such securities; however, T. Rowe Price expressly disclaims that it is, in fact, the beneficial owner of such securities. T. Rowe Price reported that it had sole voting power with respect to 793,800 shares and sole dispositive power with respect to 3,623,500 shares as of December 31, 2006.

(5)          The information reported is based on a Schedule 13G/A filed with the SEC on January 9, 2007 by Unicredito Italiano, S.p.A., or Unicredito. Unicredito reported that it had sole voting and dispositive power with respect to these shares as of December 31, 2006. Unicredito previously made filings with the SEC as Pioneer Global Asset Management S.p.A.

(6)          The information reported is based on a Schedule 13G filed with the SEC on January 9, 2007 by Barclays Global Investors, NA, or Barclays, and certain affiliated entities. According to such Schedule 13G, the shares reported are held by Barclays in trust accounts for the economic benefit of the beneficiaries of those accounts. Barclays reported that it had sole voting and dispositive power with respect to these shares as of December 31, 2006.

(7)          The information reported is based on a Schedule 13G filed with the SEC on February 14, 2007 by Janus Capital Management LLC, or Janus. Janus has an indirect 82.5% ownership stake in Enhanced Investment Technologies LLC, or Enhanced, and an indirect 30% ownership state in Perkins, Wolf, McDonnell and Company LLC, or Perkins. Due to this ownership structure, holdings for Janus, Enhanced and Perkins are aggregated. Each such entity is a registered investment adviser, furnishing investment advice to various registered investment companies and to individual and institutional clients. As a result of its role as investment adviser or sub-adviser, Janus may be deemed to be the beneficial owner of the shares held by such clients and companies. Janus reported that it had sole voting and dispositive power with respect to these shares as of December 31, 2006.

(8)          The information reported is based on a Schedule 13G filed with the SEC on March 13, 2007 by Visium Asset Management LLC, or Visium, and affiliated persons and entities, including Jacob Gottlieb who, by virtue of his position as the principal of Visium the sole management member of Visium Capital Management, may be deemed to beneficially own the 2,969,988 shares of common stock beneficially owned by Visium. Visium and Jacob Gottlieb each reported that they had sole voting and dispositive power with respect to all 2,969,988 shares as of March 13, 2007.

(9)          The information reported is based on a Schedule 13G filed with the SEC on March 26, 2007 by OrbiMed Advisors LLC, or OrbiMed Advisors, OrbiMed Capital LLC, or OrbiMed Capital, and Samuel D. Isaly. OrbiMed Advisors reported that it had shared voting and dispositive power with respect to 2,244,300 shares, and OrbiMed Capital reported that it had shared voting and dispositive power with respect to 647,5000, as of March 26, 2007. As President of OrbiMed Advisors and Managing Member of OrbiMed Capital, Mr. Isaly reported that he had shared voting and dispositive power with respect to all 2,891,800 shares as of March 26, 2007.

(10)   The information reported is based on a Schedule 13G filed with the SEC on January 23, 2007 by Deerfield Capital, L.P., or Deerfield, and affiliated persons and entities, including James E. Flynn. Deerfield reported that it had shared voting and dispositive power with respect to 1,086,466 shares, and James E. Flynn reported that he had shared voting and dispositive power with respect to 2,778,634 shares as of December 31, 2006.

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MANAGEMENT STOCKHOLDERS

The following table sets forth information as of April 12, 2007, as reported to us, with respect to the beneficial ownership of the common stock by each member of our Board of Directors, who we refer to herein as our Directors, and each Named Executive Officer (as that term is defined in the Compensation Discussion and Analysis section of this Proxy Statement), other than Dr. Frank Tally who passed away in 2006, and by all of our Directors and executive officers as a group. Beneficial ownership is determined in accordance with the rules and regulations of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to stock options held by that person that are currently exercisable or exercisable within 60 days of April 12, 2007 are deemed outstanding. These shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as indicated below and pursuant to applicable community property laws, each stockholder named in the table has sole voting and investment power with respect to the shares set forth opposite such stockholder’s name. Shares included below under “Right to Acquire” represent shares subject to outstanding stock options currently exercisable or exercisable within 60 days of April 12, 2007. On April 12, 2007, we had outstanding 55,286,747 shares of common stock.

*                    Less than 1% of the issued and outstanding shares of common stock.

(1)          Mr. Bonney holds a portion of his shares with joint voting and investment power with Mrs. Alison G. Bonney.

(2)          Dr. Martin holds his shares with joint voting and investment power with Mrs. Kathleen M. Martin.

(3)          Mr. Maupay holds a portion of his shares with joint voting and investment power with Ms. Margaret Maupay.

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INFORMATION AS TO DIRECTORS AND NOMINEES FOR DIRECTOR

The names of our Directors (including the nominees for re-election and election as Class II Directors at the 2007 Annual Meeting) and certain information regarding each Director are listed below.

(1)          Member of Compensation Committee

(2)          Member of Audit Committee

(3)          Member of Governance Committee

(4)          Member of Scientific Affairs Committee

*                    Committee Chairman

Dr. Archer has served as one of our Directors since September 2006. Since 2005, he has been Associate Dean for Research at Virginia Commonwealth University (VCU) School of Medicine and since 2003 Director of the school’s M.D./Ph.D. program. Additionally, Dr. Archer has served as Professor of Medicine and Microbiology/Immunology at VCU since 1985 and from 1992 to 2005 served as Chairman of the Division of Infectious Diseases at the school. Since 1975, Dr. Archer has held various faculty roles at VCU and began his career as an Instructor of Medicine in 1974 at the University of Michigan Medical School. He is a previous member and chair of the National Institutes of Health (NIH) Study Section on Bacteriology and Mycology and the NIH Study Section on Drug Discovery and Mechanisms of Resistance to Antimicrobials. Additionally, Dr. Archer was a member of the Food and Drug Administration’s Antiinfective Advisory Board, and he is currently on the Scientific Advisory Board of Micuron Pharmaceuticals. He received a B.A. in Pre-med and German from Washington and Lee University in Virginia and his M.D. from the University of Virginia School of Medicine.

Mr. Bate has served as one of our Directors since June 2003 and became our Lead Director in June 2006. Since January 2007, Mr. Bate has been President and Chief Executive Officer and a director of Nitromed, Inc., or Nitromed, a pharmaceutical company. From March 2006 until January 2007, Mr. Bate was Chief Operating Officer and Chief Financial Officer of Nitromed. From 2002 to January 2005, Mr. Bate was head of commercial operations and Chief Financial Officer at Millennium Pharmaceuticals, Inc. In 1999, Mr. Bate co-founded JSB Partners, an investment banking and transaction advisory firm serving the biopharmaceutical industry. He was a partner at JSB Partners through 2002.

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From 1997 to 1999, Mr. Bate served as Senior Managing Director and Chief Executive Officer of MPM Capital, LP, a venture capital company. He was also an advisor to BB Bioventures, a venture capital fund. Mr. Bate’s life sciences industry experience also includes six years at Biogen, Inc., or Biogen, a biopharmaceutical company; from 1993 to 1996 as the company’s vice president of sales and marketing, and as Chief Financial Officer from 1990 to 1993. Mr. Bate is a director of Coley Pharmaceutical Group, Inc., a biopharmaceutical company. Mr. Bate received his B.A. degree in Chemistry from Williams College, and an M.B.A. from The Wharton School of the University of Pennsylvania.

Mr. Bonney has served as Cubist’s President & Chief Executive Officer and as one of our Directors since June 2003. From January 2002 to June 2003, he served as Cubist’s President & Chief Operating Officer. From 1995 to 2001, he held various positions of increasing responsibility at Biogen, including Vice President, Sales and Marketing from 1999 to 2001. While at Biogen, Mr. Bonney built the commercial infrastructure for the launch of Avonex®. Prior to that, Mr. Bonney held various positions of increasing responsibility in sales, marketing and strategic planning at Zeneca Pharmaceuticals, ending his eleven-year career there serving as National Business Director. Mr. Bonney received a B.A. in Economics from Bates College. Mr. Bonney is a director of NPS Pharmaceuticals, Inc., a biopharmaceutical company, and serves on the Board of Trustees of the Beth Israel Deaconess Medical Center and Bates College.

Dr. Grégoire has served as one of our Directors since June 2006. From 2004 to 2005, Dr. Grégoire served as President and Chief Executive Officer of GlycoFi, Inc., a biotherapeutics company. From 2003 to 2004, Dr. Grégoire was a consultant to the biopharmaceutical industry. From 2001 to 2003, Dr. Grégoire served as Executive Vice President, Technical Operations, of Biogen, which became Biogen Idec Inc. in 2003, and from 1995 to 2001, she held various roles of increasing responsibility with Biogen. Prior to Biogen, Dr. Grégoire held clinical research and regulatory roles with Merck & Co., Inc., or Merck, a pharmaceutical company. She is currently a director of IDM-Pharma, a biopharmaceutical company, and Thallion Pharmaceuticals, Inc., a biotechnology company. She received her Pharm.D. degree from the State University of New York at Buffalo and her pharmacy graduate degree (Bachalaureat en Pharmacie) from the Université Laval, Quebec City.

Dr. Martin has served as one of our Directors since October 1997. He served as our Lead Director from October 2004 until June 2006. Since 2004, he has been the Founder, Chairman, and Chief Executive Officer of AvidBiotics Corporation, a biotechnology company. In 2003, he was Chairman and Chief Executive Officer of GangaGen, Inc., a biotechnology company. From July 1997 until April 2003, Dr. Martin served as President, Chief Executive Officer and a founder of Eos Biotechnology, Inc., a biotechnology company. From 1995 to 1996, Dr. Martin was President and Chief Executive Officer of Lynx Therapeutics, Inc., a biotechnology company. During 1994 and through May 1995, Dr. Martin served as Senior Vice President of Chiron Corporation, a biopharmaceutical company. From 1991 to 1994, Dr. Martin served as Executive Vice President of DuPont Merck Pharmaceutical Company. From 1983 to 1990, Dr. Martin was Vice President and then Senior Vice President of Research and Development at Genentech, Inc., a biopharmaceutical company. Prior to 1983, Dr. Martin was a Professor of Medicine, Professor of Biochemistry and an Investigator of the Howard Hughes Medical Institute at the University of California, San Francisco. Dr. Martin is Lead Director of Varian Medical Systems, Inc., a medical equipment and software supplier. Dr. Martin received an M.D. from Duke University.

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Mr. Maupay has served as one of our Directors since June 1999. From January 1995 to June 1995, Mr. Maupay served as Group Executive of Calgon Vestal Laboratories, a division of Bristol-Myers Squibb Corporation. From 1988 to 1995, Mr. Maupay served as President of Calgon Vestal Laboratories, a subsidiary of Merck. From 1984 to 1988, Mr. Maupay served as Vice President, Healthcare at Calgon Vestal Laboratories. Mr. Maupay is currently a director of SyntheMed, Inc., a biomaterials company, and PolyMedica Corporation, a healthcare distribution company. He is also a director and non-executive chair of Kensey Nash Corporation, a medical device company. Mr. Maupay received his B.S. in Pharmacy from Temple University and an M.B.A. from Lehigh University.

Dr. Rosenberg has served as one of our Directors since March 2005. Since 2003, Dr. Rosenberg has been the Chief Scientific Officer of Promega Corporation, a biotechnology company. From 2001 to 2003, Dr. Rosenberg served as Vice President, Research and Development of Promega Corporation. From 2000 until 2001, Dr. Rosenberg was Senior Vice President, Anti-Infectives, Drug Discovery at GlaxoSmithKline, a pharmaceutical company. From 1996 until 2000, Dr. Rosenberg was Senior Vice President, Anti-Infectives at SmithKline Beecham Corporation, the predecessor company to GlaxoSmithKline. Prior to 2000, Dr. Rosenberg held a variety of roles of increasing responsibility with SmithKline Beecham Corporation. Before joining SmithKline Beecham Corporation, Dr. Rosenberg spent 10 years at the National Institutes of Health and was a Section Chief at the National Cancer Institute. Dr. Rosenberg is a director of Promega Corporation, the Medical College of Wisconsin Research Foundation, Nereus Pharmaceuticals, Inc., a pharmaceutical company, Anacor Pharmaceuticals, a pharmaceutical company, and Scarab Genomics, a biotechnology company. He also serves as a member of the Advisory Council for the National Institutes of Allergy & Infectious Diseases at the National Institute of Health. He participates on a variety of academic and industry Scientific Advisory Boards and holds an adjunct Professorship at the University of Wisconsin, Department of Bacteriology, Madison, WI. Dr. Rosenberg is Editor-in-Chief of Current Opinions in Biotechnology, a Senior Editor of the Journal of Bacteriology and a member of several other journal Editorial Boards. Dr. Rosenberg received a B.A. degree from the University of Rochester and a Ph.D. from Purdue University.

Mr. Singleton has served as one of our Directors since June 2003. From 2000 to the present, he has served as Executive Vice President and Chief Financial Officer of CitationShares, LLC, a joint venture of Cessna Aircraft Company, a division of Textron Inc., and TAG Aviation USA, Inc. From 1994 to 1997, Mr. Singleton served as a Managing Director, Executive Vice President and Chief Administrative Officer of CIBC World Markets, an investment banking firm. Previous to that, he served in a variety of roles from 1974 until 1994 at Arthur Andersen & Co., a public accounting firm, ending his tenure there as Partner-In-Charge of the Metro New York Audit and Business Advisory Practice. During 1980 and 1981, he served as a Practice Fellow at the Financial Accounting Standards Board. From 1998 to 2006, Mr. Singleton served as a director of Salomon Asset Reinvestment Company. He received an A.B. in Economics from Princeton University and an M.B.A. from New York University. Mr. Singleton is a Certified Public Accountant.

Mr. Soeters has served as one of our Directors since September 2006. Since 2000, Mr. Soeters has served as President of Novo Nordisk and Senior Vice President of Novo Nordisk North America, a healthcare company. From 1998 to 2000, he served as Senior Vice President, International Marketing, at Novo Nordisk Denmark, and from 1994 to 1998, he served as Managing Director of Novo Nordisk France. From 1992 to 1995, Mr. Soeters was Managing Director at Novo Nordisk Belgium, and in 1991, he was International Marketing Director at Novo Nordisk Denmark. Between 1980 and 1991, he held various

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sales and marketing positions at Novo Nordisk in the Netherlands. Mr. Soeters is a member of the Board of Overseers of the Joslin Diabetes Center, a Trustee of the HealthCare Institute of New Jersey, and since 2005, a member of the Biotechnology Industry Organization (BIO) Board. From 2004-2006, he served on the Board of Directors of the Pharmaceutical Research and Manufacturers of America (PhRMA) in Washington, D.C. Mr. Soeters studied meteorology, as well as sales, product and marketing management in the Netherlands, and he also attended the Stanford Executive Program.

Dr. Wood has served as one of our Directors since March 2005. Dr. Wood is currently an Orthopedic Surgeon and retired President-emeritus of the Mayo Foundation and Professor of Orthopedic Surgery, Mayo Clinic School of Medicine. He was previously Chief Executive Officer of the Mayo Foundation from 1999 until 2003. Prior to 1999, Dr. Wood held a variety of roles within the Mayo Clinic. Dr. Wood is a director of Steris Corporation, a medical sterilization company, Assistive Technology Group, Inc., a rehabilitation and durable medical equipment company, Visionshare, Inc., a software company, and SingHealth, an integrated health system in Singapore. Dr. Wood is also a member of the board of overseers of the Baldrige National Quality Award. Dr. Wood received a B.A. degree from Franklin and Marshall College, an M.D., C.M. degree from McGill University and an M.S. degree from the University of Minnesota.

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COMPENSATION DISCUSSION AND ANALYSIS

The Company is currently in a growth stage and has recently experienced its first commercial marketplace success. As a result of the Company’s rapid and continuing growth, there is a focus on incentives that encourage behaviors and the delivery of results that support the long-term success of the Company. The Company relies on certain core principles to guide its approach to its customers, employees and stockholders. Many of these core Company principles also apply to how the Company approaches executive compensation. With respect to executive compensation, the Company believes in results-oriented pay as evidenced by the Company’s pay programs that award substantial pay for concrete results. The Compensation Committee and Chief Executive Officer, or CEO, believe in taking a leadership position in executive pay and have consistently demonstrated that leadership over the years by the CEO’s moderate guaranteed pay (base salary) with an increasingly substantial portion of his pay based on performance-based incentives tied to the achievement of aggressive goals.

The Company also believes that its existing compensation programs have been effective in meeting the Company’s goals of attracting, retaining and motivating key talent, which has helped validate the mix between short- and long-term compensation and the mix between at-risk and fixed compensation.  The Company regularly reassesses and reviews its programs for areas of potential improvement, and educates its Board members on executive compensation matters. In addition, the Company focuses not just on what is paid, but on the process for decision-making to ensure it has appropriate input from independent advisors and Board members, with the appropriate checks in place to ensure integrity in the process.

We will use the term “Executive Officers” when referring to all of our executive officers, and we will use the term “Named Executive Officers” when referring to the six individuals named in the Summary Compensation Table on page 21 of this Proxy Statement.  When discussing compensation matters generally, we will provide such information with reference to all of our Executive Officers as a group. When we discuss specific matters with respect to the 2006 compensation figures and percentages described in the compensation tables contained herein, we will provide such information for our Named Executive Officers only.

Compensation Philosophy

The Company maintains a written compensation philosophy that was developed by the CEO in collaboration with, and ultimately approved by, the Compensation Committee. This philosophy covers compensation objectives, elements of compensation, targeted market levels of compensation, stock ownership goals, and parameters around benchmarking executive compensation.

Compensation Objectives

The objectives of the Company’s Executive Officer compensation programs are as follows:

·       To provide competitive compensation that differentiates and rewards Executive Officers for their overall contribution to the Company.

·       To further the Company’s short- and long-term strategic goals by aligning Executive Officer compensation with the achievement of individual and Company objectives designed to promote the creation and protection of value for stockholders.

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·       To design short- and long-term incentive compensation programs that attract and retain high-quality Executive Officers and motivate high performance at the individual and Company levels.

·       To emphasize the alignment of Executive Officer pay with the financial and stock performance of the Company.

Compensation Elements and Targeted Market Levels of Compensation

The Company’s philosophy provides that Executive Officer compensation can be above or below the identified compensation target for each pay element depending on a number of factors including retention considerations, individual and Company performance, relative value of the position within the Company as compared to peer companies, and internal equity considerations.

The Company provides the following key elements of compensation:

·       Base salaries are targeted at the median of the market for comparable positions at comparable companies, but can exceed the median over time based on performance and an increase in experience. Base salaries also can be set below the median for employees with less experience and above the median for employees with extensive experience.

·       Annual performance bonuses are generally targeted to allow total cash compensation to exceed the median of the market for comparable positions at comparable companies if the individual and the Company meet or exceed pre-agreed goals.

·       Long-term incentive awards (stock options) are generally targeted at or above the median of the market to provide comparable compensation with similar positions at comparable companies if the Company’s stock price performs well.

The Company allocates its compensation between short- and long-term compensation with significant emphasis on long-term incentives due to the Company’s stage of growth and desire to focus on long-term results. For 2006, the CEO’s total compensation was comprised of 19% base salary, 13% bonus and 68% long-term incentives (based on the value of long-term incentives granted in 2006). The other Named Executive Officers’ total compensation was comprised, on average, of 32% base salary, 12% bonus and 56% long-term incentives.

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Stock Ownership

In 2005, the Company adopted the following stock ownership guidelines for Directors and Executive Officers. The guidelines are designed to align the interests of the Company’s Directors and Executive Officers with those of its stockholders by ensuring that the Company’s Directors and Executive Officers have a significant financial stake in the Company’s success.

 

In the event that an Executive Officer fails to meet the ownership guidelines yet elects to dispose of shares of Cubist common stock, after each subsequent sale, he or she must retain stock with a market value of at least 50% of the after tax proceeds from any sale.

Compensation Benchmarking

As part of establishing the total compensation package for Executive Officers, the Compensation Committee reviewed compensation packages for comparable positions at comparable companies. In 2006, the Compensation Committee engaged Pearl Meyer & Partners, or PM&P, a nationally recognized executive compensation consulting firm, to assist with this comparable company analysis. The specific elements of compensation reviewed as part of this comparable company analysis included base salaries, annual performance bonuses and long-term incentives. In 2005, PM&P also analyzed the competitiveness of the Company’s retention and change-in-control agreements versus comparable companies.

PM&P recommended a list of comparable companies for Executive Officer compensation comparisons primarily based on industry, revenue, and market capitalization similarity to the Company. Once the peer companies are selected, the Compensation Committee compares the Company to its peer companies on the basis of other financial factors, including growth, profitability, and stockholder return. The comparable companies are reviewed each year and may change from year-to-year depending on changes in the marketplace, acquisitions, divestitures and business focus of the Company or comparable companies.

PM&P prepared and presented a report to the Compensation Committee summarizing the competitive data and comparisons of the Company’s CEO and Executive Officers to the comparable competitive market data utilizing publicly available data from the comparable companies and broad survey data (reflecting companies of similar size in the pharmaceutical/biotech industry). For 2006, the CEO’s base salary was at about the 25th percentile, as compared to the benchmarking and other data, his combined base salary and bonus was at about the 45th percentile, and his long-term incentive package was at about the 60th percentile. The other Named Executive Officers’ (excluding the CEO) were paid base salaries that were on average at about the 55th percentile, with their combined base salaries and bonuses at about the 55th percentile and long-term incentive compensation between the 65th and 70th percentiles.

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Elements of Compensation

Annual Base Salary

Base salaries are included as part of the Company’s compensation package to provide a competitive compensation package consistent with comparable company and industry practices. The Company targets starting base salaries at the median of the marketplace for the following reasons:

·       The Company has a pay-for-performance philosophy, which emphasizes incentive pay and differentiation amongst employees.

·       Median targeted base salaries ensure that the Company is competitive in paying for the base value of the position, yet still allows the Company to emphasize performance.

In certain circumstances, starting base salaries higher than the median are offered for positions that require more complex work, have critical value to the Company, are in high demand in the marketplace and have fewer qualified candidates, or in situations where candidates enter the position with extraordinary relevant experience. Higher base salaries may also be paid over time to reflect superior individual  performance. Base salaries are considered for increases annually.

Annual Performance Bonus Awards

As part of its pay-for-performance philosophy, the Company provides for an annual cash performance bonus under its written Short-Term Incentive Plan, which is filed with the SEC. The Company targets annual cash bonuses that allow total cash compensation to exceed the median of the marketplace depending upon individual and Company performance for the following reasons:

·       To encourage specific short-term Executive Officer behaviors that create and protect Company and stockholder value.

·       To focus Executive Officers on important short-term business objectives that are expected to have a positive long-term impact on the success of the Company.

·       To provide competitive cash compensation packages if goals are met or exceeded.

The cash bonus program is designed to reward the accomplishment of specific Company and individual goals during the year. Each Executive Officer has a target bonus as a percentage of base salary as follows:

 

The target bonus percentages are designed to provide similar bonus opportunities to the Company’s Executive Officers as the target bonus opportunity for executives at comparable companies.

The Company must achieve at least 70% of its Company goals for any annual performance bonuses to be paid because the Company believes that this minimum level of performance should be achieved to justify the payment of any bonuses. The Company also believes this 70% performance threshold is

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reasonable and consistent with industry practices. The maximum annual performance bonuses that can be paid are 200% of the target percentage. The annual performance bonus goals  change year-to-year, but generally are focused on Company and individual performance. Company goals are drafted by the CEO and the Compensation Committee and subsequently reviewed, modified if necessary, and approved by the full Board. For the other Executive Officers, individual goals are established by their respective managers. The following table summarizes the weighting of goals as between Company and individual goals for the Chief Executive Officer and other Executive Officers:

 

Individual goals are designed to focus Executive Officers on individual behaviors that support the overall performance and success of the Company. The specific target metrics for Company and individual goals are considered by the Compensation Committee to be confidential commercial and financial Company information, disclosure of which would result in competitive harm for the Company. The Company and individual goals are set with a reasonable level of difficulty that requires that the Company and the Executive Officers perform at a high level in order to meet the goals and the likelihood of attaining these goals is not assured.

The Compensation Committee retains and in the past has exercised the discretion to adjust any Executive Officer’s annual performance bonus up or down  based on the Executive Officer’s relative contributions to the Company’s overall performance.

Long-Term Incentive Compensation (Performance Stock Option Awards)

Executive Officers are eligible for performance stock option awards twice a year to tie a significant portion of the Executive Officers’ compensation directly to Company performance. The Company targets option awards that are at or above the median of the marketplace for the following reasons:

·       To focus Executive Officers on multi-year results.

·       To provide Executive Officers a financial interest in the appreciation of the value of the Company’s common stock and focus them on long-term financial objectives.

·       To align Executive Officer interests with stockholder interests and to create motivation to increase stockholder value.

·       To provide Executive Officers with a compensation package that is competitive with comparable companies.

·       To retain Executive Officers over the long-term through the use of vesting. Options vest 25% per year (6.25% per quarter) over 4 years and remain in effect for 10 years.

In 2006, the Company reconsidered its use of stock options as its sole long-term incentive vehicle and considered alternative equity instruments including restricted stock, performance shares, stock appreciation rights, and cash long-term incentive plans. To date, the Company has elected to continue to

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grant only stock options for its long-term incentive compensation because the emphasis of the Company’s long-term incentive strategy has been to only reward executives for increasing the value of the Company for stockholders. The Company will continue to review this approach to long-term incentives taking into account the financial statement impact of different long-term incentive instruments, tax considerations, executive retention, market competitiveness and the Company’s overall compensation strategy and philosophy.

Perquisites

The Company did not provide Executive Officers with any perquisites in 2006.

Retention Letters with Executive Officers

The Company has entered into retention letters with all of its Executive Officers, forms of which can be viewed in the Company’s SEC filings. Any benefits afforded to Executive Officers under these retention letters are contingent upon the Company receiving an executed release of claims from the Executive Officer. The objectives of providing Executive Officers with these retention letters are to provide competitive executive security arrangements, to assist the Company in attracting and retaining top executive talent, to encourage the Executive Officers’ honest discourse with the CEO and Board without fear of adverse consequences, and to balance the need for an Executive Officer’s personal financial security with the need to act in the best interest of our stockholders in a situation involving a potential change of control of the Company. To ensure that these agreements remain reasonable and competitive, the Compensation Committee periodically reviews competitive data provided by PM&P, as well as potential costs to the Company of the retention letters under various potential termination scenarios and updates its cost analysis prior to making any changes to the retention letters.

Further detail on the terms of the retention letters and the value of the retention letters under various termination scenarios can be found in the section of this proxy statement entitled “Termination of Employment and Change-in-Control Agreements.”

Compensation Determinations

Company Goal Setting for Compensation Purposes

In December 2005, the CEO proposed 2006 Company goals to the Compensation Committee for use in connection with CEO and Executive Officer annual performance bonuses.  The Compensation Committee discussed the proposed Company goals with the CEO, incorporated appropriate modifications and made a recommendation to the full Board. The full Board discussed the recommendations of the Compensation Committee and approved the proposed Company goals. The CEO discussed the performance of the Company with other Directors on a regular basis throughout 2006.

For 2006, the Company goals were based on product revenue, product pipeline building, earnings, and employee development. The Company has various metrics that are used to measure achievement of the goals. The Company achieved 85% of its corporate goals in 2006, 105% of its corporate goals in 2005, and 95% of its corporate goals in 2004.

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CEO Compensation Determination Process

At the beginning of 2006, the Compensation Committee quantitatively evaluated the CEO’s performance against the corporate goals and objectives set in the prior year. The Compensation Committee also solicited qualitative input on the CEO’s performance from all Directors, many Company executives, and some external sources for use in connection with the CEO’s performance evaluation. The Compensation Committee then made a recommendation to the independent Directors for the CEO’s 2006 base salary merit increase, annual performance bonus amount for 2005, and stock option grant, taking into account the following factors:

·       The Company’s performance against the predetermined goals.

·       The Company’s compensation philosophy.

·       The CEO’s individual performance generally.

·       The CEO’s total cash compensation as compared to the second highest paid Executive Officer and the Company’s lowest paid employee to determine whether the CEO’s relative cash compensation is fair and reasonable in the context of internal equity.

·       A competitive analysis prepared by PM&P on CEO compensation at comparable companies.

In February 2006, the Compensation Committee made its base salary recommendations for the CEO to the independent Directors without the CEO present, and, after discussion and requested adjustments, the independent Directors approved the CEO’s base salary for 2006. The CEO’s base salary for 2006 was set at $415,000, which included an 8% merit increase from his 2005 base salary. The Compensation Committee continues to maintain the CEO’s base salary below the median of the market due to the CEO’s desire to demonstrate leadership in keeping CEO pay reasonable and consistent with other Executive Officers. For 2006, the CEO’s base salary was in the 25th percentile as compared to market data.

A significant portion of the CEO’s compensation is paid upon achieving results. In 2006, 85% of the Company’s predetermined goals were achieved, and since the CEO’s bonus is dependent on the Company’s performance, the CEO was awarded an annual performance bonus of 85% of his target bonus. As such, the CEO’s 2006 annual performance bonus, which was paid in 2007, was $282,200 (85% of his target bonus; or 0.85 [company performance] x 0.80 [target bonus percentage] x $415,000 [2006 base salary]). For 2006, the Board chose not to exercise its discretion to adjust the CEO’s annual performance bonus up or down. After careful consideration of the performance of the CEO, the performance of the Company and the CEO’s contribution to that performance, and comparable company CEO long-term incentive awards, the CEO was granted 150,000 stock options on January 31, 2006, which is competitive with equity grants to other CEOs in the market study prepared by PM&P. For 2006, the CEO’s total compensation was comprised of 19% base salary, 13% bonus and 68% long-term incentives. At his election, the CEO did not receive any other option grants during 2006 even though he was eligible for an option grant together with the other Executive Officers at mid year.

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Executive Officer Compensation Determination Process (other than CEO)

In the beginning of 2006, the CEO quantitatively evaluated each of the other Executive Officer’s performance against the Company and individual goals and objectives set in the prior year. In 2006, Mr. Bonney and Dr. Fetzer were the only Executive Officers who played a role in determining other Executive Officer compensation. Mr. Bonney was involved in all Executive Officer compensation decisions, and Dr. Fetzer was involved in Dr. William Pullman’s compensation decisions. Dr. Pullman is our Senior Vice President and Chief Medical Officer. The CEO recommended to the Compensation Committee a base salary increase and stock option grant for each Executive Officer, taking into account:

·       The Company’s compensation philosophy.

·       Each Executive Officer’s individual performance against pre-determined goals.

·       The Company’s performance against the predetermined goals.

·       The appropriateness of each Executive Officer’s compensation relative to other Executive Officers and the CEO.

·       PM&P’s prepared analysis of competitive compensation of executive officers at comparable companies.

·       Retention considerations.

·       The Executive Officer’s potential future contributions to the success of the Company.

The Compensation Committee reviewed and discussed with the CEO the performance of each Executive Officer and the reason for the CEO’s recommendations for such Executive Officer. After incorporating the Compensation Committee’s requested adjustments to the CEO’s recommendations, the Compensation Committee approved the 2006 base salary and option awards for each Executive Officer (the 2005 annual performance bonuses disclosed in last year’s Proxy Statement were also determined at that time).

Named Executive Officer 2006 base salaries ranged from $180,000 to $415,000, and included increases over 2005 base salaries ranging from approximately 3% to 12%, with an average increase of 7%. In 2006, the Compensation Committee increased salaries for two Named Executive Officers by 10% and 12%, respectively which included an adjustment to ensure competitive alignment with their peers at comparable companies. Details of Named Executive Officer base salaries for 2006 can be found in the Summary Compensation Table contained in this Proxy Statement.

With the exception of the CEO, each Executive Officer’s bonus target is weighted 60% on achievement of predetermined Company goals and 40% on achievement of predetermined individual goals. For 2006, the Company achieved 85% of the predetermined Company goals. The other Named Executive Officers achieved between 83% and 95% of their individual goals. As a result of the Company’s goal achievement and individual goal achievement, Named Executive Officer annual performance bonuses ranged from 84% to 89% of each Named Executive Officer’s target bonus, with an average of 87%, and a total payout for the Named Executive Officers of $450,480 (excluding the CEO and Dr. Frank Tally). For 2006, the Compensation Committee chose not to exercise its discretion to adjust Named Executive Officer annual performance bonuses up or down, other than for Dr. Frank Tally. For 2006, Dr. Frank Tally received a performance bonus of $100,080, which represented 56% of his base salary, in recognition of

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Dr. Tally’s extraordinary contributions in 2006.  Details of the 2006 annual performance bonuses (which were paid in February 2007) can be found in the Summary Compensation Table and the Grants of Plan-Based Awards Table in this Proxy Statement.

The Company divides its annual grant of performance stock options into two grants per year (the value of both grants combined are compared to the market for an annual grant size). In 2006, the Named Executive Officers received annual performance stock option grants at the beginning of the year that ranged from 25,000 to 40,000 performance stock options, with an average of 30,000 and total option grants for the Named Executive Officer’s of 150,000 options (excluding the CEO). In addition, the Named Executive Officers, (other than the CEO) also received mid-year grants that ranged from 10,000 to 20,000 stock options, with an average of 16,000, with total mid-year option grants for the five Named Executive Officers of 79,000 options (excluding the CEO). Individual option grant determinations were made after careful consideration of the performance of each Executive Officer, the performance of the Company and the Named Executive Officer’s contribution to that performance, retention, and comparable company executive officer long-term incentive awards. For the year, total combined Named Executive Officer annual stock option grants ranged from 34,000 to 60,000 stock options, with an average of 45,800 and total option grants for the Named Executive Officer’s of 229,000 options (excluding the CEO). Details of the performance stock option grants made in 2006 can be found in Grants of Plan-Based Awards Table in this proxy statement.

Role of the Company’s Management in the Compensation Determination Process

Our Executive Officers play a very limited role in the determination of Executive Officer compensation. During 2006, Mr. Bonney and Dr. Fetzer were the only Executive Officers who played a role in the Executive Officer compensation process. The process was, as follows:

·       The CEO presents Executive Officer performance ratings to the Compensation Committee and makes recommendations relating to Executive Officer compensation, and in the case of Dr. Pullman with input from Dr. Fetzer.

·       The CEO develops proposed Company goals for review by the Compensation Committee and approval by the Board.

·       The CEO, in consultation with the Vice President, Human Resources, develops proposals relating to potential changes in compensation programs for review and approval by the Compensation Committee.

·       The CEO, Vice President, Human Resources, and other employees, as appropriate, provide the Compensation Committee and other advisors with Company data necessary to evaluate and implement compensation proposals and programs.

Role of the Compensation Consultant

For 2006, the Compensation Committee retained PM&P as its compensation consultant. PM&P served as an independent advisor to the Compensation Committee on topics primarily related to Board and executive compensation. The PM&P consultant was selected in 2005 by the Compensation Committee, reported to the Compensation Committee Chair, took direction from the Committee, and did not provide

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any services to the Company other than the services provided at the request of the Compensation Committee.

PM&P’s general responsibilities to the Compensation Committee include working with management to acquire Company data necessary to complete work requested by the Compensation Committee, working with the Compensation Committee to help it understand compensation concepts, issues and the changing requirements of regulatory authorities, and assisting the Compensation Committee with reviews of management proposals relating to changes in compensation and related programs.

Specific PM&P activities completed for the Compensation Committee in 2006 included the following:

·       Provided the Compensation Committee with a recommended updated list of comparable companies based on the criteria described above.

·       Provided the Compensation Committee with a competitive assessment of compensation for Executive Officers using PM&P’s recommended (and Compensation Committee approved) comparable company compensation data, and size- and industry-appropriate broad survey data.

·       Prepared a dilution analysis of overall Company equity use compared to overall equity use by comparable companies.

·       Prepared a financial performance analysis comparing the Company’s financial performance to the comparable companies.

·       Provided the Compensation Committee with a competitive assessment of compensation for members of the Board of Directors by comparing the Company’s Director compensation programs to director compensation programs at comparable companies.

·       Assisted the Company with preparation of this compensation discussion and analysis and related compensation tables.

·       Attended all Compensation Committee meetings and executive sessions at the request of the Compensation Committee.

·       Provided the Compensation Committee with market-based compensation recommendations.

Impact of Accounting and Tax on the Form of Compensation

The Compensation Committee has considered the impact of the Statement of Financial Accounting Standard No. 123, or SFAS 123(R), as revised by the FASB in 2004, on the Company’s use of equity incentives as a key retention tool. The Compensation Committee has determined that the current estimated costs to the Company of continuing to use equity incentives relative to the benefits the Company believes these programs provide does not warrant any change to the Company’s current equity incentive framework.

Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”), limits the tax deduction for compensation paid to Named Executive Officers to $1,000,000. This deduction limitation does not apply to compensation that constitutes “qualified performance-based compensation” within the meaning of Section 162(m) of the Code and regulations promulgated thereunder, including certain performance-based compensation that has been approved by the stockholders. Our stockholders have approved our employee stock option plan, which is designed to allow the deduction of income recognized

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in connection with stock options granted under such plan. We have in the past and may in the future award compensation that is not fully deductible under the Code when we view such compensation as consistent with our compensation policies and in the best interests of the Company and its stockholders. For 2006, Executive Officers at the Company did not receive compensation that exceeded the deductibility limits of Section 162(m).

Under our retention agreements, we do not compensate executives for any excise tax liability they may incur by reason of payments made under the agreement. As a result, if a Named Executive Officer would be assessed any excise tax liability under Section 280G of the Code as a result of payments made and benefits received under his retention agreement, he would be responsible for the payment of such excise tax.

Option Granting Practices

The Company issues stock option awards at various times throughout the year. All options are priced at the closing market price of the Company’s shares on the date of the grant. In the fourth quarter of 2006, we implemented certain new processes regarding stock option grants. Generally, new employees receive a stock option grant that is issued and priced on the 15th day of the month (or, if no trades were reported on such date, the closing price on the most recent trading day preceding the date of grant on which a trade occurred) following the month in which they join the company. In addition, the Company issues stock options to employees who are promoted during the year. Such grants are also issued and priced as of the 15th day of the month following the month in which the employee’s promotion is authorized (or, if no trades were reported on such date, the closing price on the most recent trading day preceding the date of grant on which a trade occurred). The Company also issues performance-related stock options awards at two times during each year, shortly after the beginning of the year, and shortly after mid-year, to employees who demonstrate superior performance and high potential.

The Compensation Committee has authorized a pool of options which may be issued by the CEO from time to time during the year in recognition of extraordinary results. Following the release of the Company’s financial results each quarter, the CEO and Vice President of Human Resources evaluate whether any grants should be made against this additional pool. Any grants then authorized are made on the 15th day of the month following the release of the financial results (or, if no trades were reported on such date, the closing price on the most recent trading day preceding the date of grant on which a trade occurred).

At the end of each calendar year, the Compensation Committee approves guidelines for both new hire stock option awards as well as for stock option awards issued in connection with promotions. In addition, at the beginning of the year and at mid year, the Compensation Committee approves a pool of stock options for the performance-related grants described above. The CEO is required to further approve all individual grants issued in accordance with the foregoing pools and guidelines.  The Compensation Committee must approve all stock option grants to Executive Officers.

We have never had a program or policy in place to coordinate option grants with the release of material, non-public information. During 2006, we conducted a comprehensive internal review of our stock option granting practices from the time of our initial public offering in 1996 through the present. This review uncovered no evidence of any inappropriate granting activity.

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EXECUTIVE COMPENSATION

The following table summarizes aggregate amounts of compensation paid or accrued by the Company for the year ended December 31, 2006 for services rendered in all capacities by our Named Executive Officers

Summary Compensation Table for Fiscal Year 2006

(1)             Represents the proportionate amount of the total fair value of  option awards recognized by the Company as an expense in 2006 for financial accounting purposes, disregarding for this purpose the estimate of forfeitures related to service-based vesting conditions. The fair values of these awards and the amounts expensed in 2006 were determined using the Black-Scholes option pricing model in accordance with SFAS 123(R). The awards for which expense is shown in this table include the awards described in the Grants of Plan-Based Awards in this Proxy Statement, as well as awards granted in 2002, 2003, 2004 and 2005 for which we continued to recognize expense in 2006. The assumptions used in determining the grant date fair values of these awards are set forth in the notes to the Company’s consolidated financial statements, which are included in our Annual Reports on Form 10-K and our Quarterly Reports on Form 10-Q filed with the SEC for the years 2002 through 2006.

(2)             Reflects the actual payouts for fiscal year 2006 under the plan-based non-equity incentive plan. Payments for bonuses earned in 2006 were made in February 2007.

(3)             The Company does not have either a pension or a non-qualified deferred compensation plan.

(4)             All Other compensation constitutes the 401(K) matching contributions for all Named Executive Officers. For Dr. Fetzer, it also includes $142 incurred for annual insurance premiums for supplemental life insurance. For Dr. Tally, who passed away on October 1, 2006, it also includes a one-time $751,000 payment made to his estate on December 18, 2006 that approximated the fair market value gain that his estate would have received had it been able to exercise Dr. Tally’s unexercised options around the time of the payment.

(5)             Dr. Tally’s salary in this table represents the amount he was paid through the time of his death, based on a part-time schedule. His comparable annual full-time equivalent salary would have been $320,000.

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Grants of Plan-Based Awards in 2006 Fiscal Year

The following table sets forth information concerning grants of awards pursuant to plans made to the Named Executive Officers during the year ended December 31, 2006.

(1)                This column indicates the date of the grant under SFAS 123(R) for all non-qualified stock options granted in 2006. The full Board  approved the award to Mr. Bonney on 1/31/06. The awards for the other Named Executive Officers listed above were approved by the Compensation Committee on 1/25/06 and 6/16/06. The Compensation Committee approved the grant date to be 1/31/06 on 1/25/06 and the grant date to be the date of the Compensation Committee meeting for the 6/16/06 grant. The grant prices for both sets of awards reflect the closing price on the NASDAQ as of the grant date (1/31/06 and 6/16/06). These awards have a term of 10 years and become vested in equal quarterly installments over a 4 year period.

(2)                For Mr. Bonney, target reflects 80% of base salary. For all other Named Executive Officers, target reflects 40% of base salary. Maximum awards are capped at 200% of the target award opportunity for all executives and threshold awards are contingent upon the Company achieving 70% of the Company goals.

(3)                The Company must achieve at least 70% of its Annual Goals for employees to be eligible to receive any Plan Awards.

(4)                Mr. Bonney’s award was based 100% on Company performance. All other Named Executive Officere awards were based 60% on company performance and 40% on individual performance performance.

(5)                The exercise prices of the option grants listed correspond with the end-of-day fair market value of the stock on the date of grant.

(6)                For stock option awards, these values reflect the grant date fair value using the Black-Scholes model.  Assumptions used in the Black-Scholes model are as follows:  (1) Mr. Bonney - for stock options awarded on 1/31/06, the Black-Scholes value is $10.1029 per share (using a volatility of 52.0%, a risk-free rate of 4.50%, a dividend yield of 0%, and an expected term of 4.30 years). (2) Mr. Perez, Dr. Fetzer, Mr. McGirr, Mr. Guiffre, and Dr. Tally - for stock options awarded on 1/31/06, the Black-Scholes value is $10.1029 per share (using a volatility of 52.0%, a risk-free rate of 4.50%, a dividend yield of 0%, and an expected term of 4.30 years) and for stock options awarded on 6/16/06, the Black-Scholes value is $10.5199 per share (using a volatility of 52.0%, a risk-free rate of 5.10%, a dividend yield of 0%, and an expected term of 4.30 years).

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Outstanding Equity Awards at 2006 Fiscal Year-End

The following table sets forth information concerning outstanding equity awards held by each Named Executive Officer as of December 31, 2006.

(1)             All stock option grants have a 4-year vesting schedule and vest equally over 16 calendar quarters.

(2)             All stock option grants have a 10-year term.

(3)             Dr. Tally passed away on  October 1, 2006. Dr. Tally’s estate has until the earlier of the expiration of the applicable option and 12 months following the date of his death to exercise any vested options.

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(1)             All stock option grants have a 4-year vesting schedule and vest equally over 16 calendar quarters.

(2)             All stock option grants have a 10-year term.

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