Edgar Filing: ARENA PHARMACEUTICALS INC

FILED PURSUANT TO RULE 424(B)(4)
REGISTRATION STATEMENT NO-333-62268
PROSPECTUS

[THOMAS WEISEL PARTNERS LLC BANNER]

[ARENA PHARMACEUTICALS LOGO]

5,000,000 Shares
Common Stock

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Arena Pharmaceuticals is selling 4,000,000 shares of common stock and the
selling stockholders identified in this prospectus are selling an additional
1,000,000 shares. We will not receive any of the proceeds from the sale of the
shares sold by the selling stockholders. We have granted the underwriters a
30-day option to purchase up to an additional 750,000 shares from us to cover
over-allotments, if any.

Our common stock is listed on the Nasdaq National Market under the symbol
"ARNA." The last reported sale price on June 21, 2001 was $27.50 per share.
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INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 6.
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PER SHARE TOTAL

Public offering price $27.50 $137,500,000
Underwriting discount $ 1.44 $ 7,200,000
Proceeds, before expenses, to us $26.06 $104,240,000
Proceeds, before expenses, to the selling stockholders $26.06 $ 26,060,000

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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THOMAS WEISEL PARTNERS LLC

DAIN RAUSCHER WESSELS

ABN AMRO ROTHSCHILD LLC

LAZARD

The date of this prospectus is June 21, 2001

TABLE OF CONTENTS

PAGE
--------

Prospectus Summary.......................................... 1
Risk Factors................................................ 6
Special Note Regarding Forward Looking Statements........... 15
Use of Proceeds............................................. 16
Price Range of Common Stock................................. 16
Dividend Policy............................................. 16
Capitalization.............................................. 17
Dilution.................................................... 18
Selected Financial Data..................................... 19
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 20
Business.................................................... 26
Management.................................................. 45
Relationships and Related Party Transactions................ 54
Principal and Selling Stockholders.......................... 55
Description of Capital Stock................................ 58
Underwriting................................................ 61
Legal Matters............................................... 64
Experts..................................................... 64
Where You Can Find More Information......................... 64
Index to Consolidated Financial Statements.................. F-1

PROSPECTUS SUMMARY

THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS.
YOU SHOULD READ THIS ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE "RISK FACTORS"
SECTION. UNLESS THE CONTEXT REQUIRES OTHERWISE, THE TERMS "ARENA," "WE," "US"
AND "OUR" AS USED IN THIS PROSPECTUS REFER TO ARENA PHARMACEUTICALS, INC. AND
ITS SUBSIDIARIES.

OUR COMPANY

We are an emerging biopharmaceutical company focused principally on
discovering drugs that act on an important class of drug targets called G
protein-coupled receptors, or GPCRs. We have developed a technology called
Constitutively Activated Receptor Technology, or CART, that can be applied to
GPCRs and other classes of receptors to identify drug leads. We believe that
CART is a more efficient drug discovery technique than traditional drug
discovery techniques. Using CART, we have discovered new drug leads in the areas
of obesity and schizophrenia. In both of these programs, drug leads were
discovered within 18 months, which is substantially less time than might be
required to discover a drug lead using traditional drug discovery techniques.
Based on our success using CART, we have established collaborative drug
discovery programs with a number of pharmaceutical and biotechnology companies,
which in some cases have already resulted in revenues to us related to milestone
payments and research and development fees.

GPCRs are an important part of the pharmaceutical and biotechnology
industries' drug discovery efforts. Of the leading 100 pharmaceutical products,
based on 2000 revenues, 39 wholly or in part act on GPCRs. In 2000, these
GPCR-based pharmaceutical products represented over $42.6 billion in sales and
included Claritin-Registered Trademark- for allergies,
Zantac-Registered Trademark- for gastric ulcers, Imitrex-Registered Trademark-
for migraines and Cozaar-Registered Trademark- for hypertension.

Based upon the recent completion of the mapping of the human genome,
scientists estimate that there are approximately 40,000 genes in the human
genome, and of these, approximately 2%, or 800, are GPCRs with potential
pharmaceutical applications. Because of the limitations associated with
traditional drug discovery techniques, only a fraction of these GPCRs have been
used to discover drugs. We believe that our technologies provide us with a
significant advantage in the market for GPCR based drug development, as well as
a substantial intellectual property position that we expect will establish a
barrier to entry by potential competitors.

THE DRUG DISCOVERY PROBLEM

Scientists are using advances in genomics research to identify new drug
targets. These new drug targets form the basis of drug discovery for the
treatment of disease. Abnormal cell function causes diseases in humans. The
function of a cell changes when a natural substance, which scientists call a
ligand, is released from a cell and binds to the surface of that cell or another
cell through a receptor such as a GPCR. This binding triggers the initiation of
various signals within the cell, resulting in changes in biological activity.
Drugs work by imitating or inhibiting the binding of the ligand to the cell,
thereby affecting cellular function to regulate the disease process.

Traditional drug discovery techniques for drugs that target receptor drug
targets such as GPCRs require scientists to identify the ligand that naturally
binds to the drug target. This identification process is very uncertain and,
even when successful, typically takes four to five years and costs millions of
dollars per drug target. To our knowledge, only a limited number of examples
exist where a ligand for a GPCR has been intentionally discovered. Therefore,
this identification process is usually the major bottleneck in the drug
discovery process, limiting the rate at which drugs are discovered at GPCR drug
targets.

OUR TECHNOLOGY SOLUTIONS

CART provides us and our collaborators with an efficient and cost effective
drug discovery technique that avoids this major bottleneck in receptor drug
discovery efforts. Because of CART, we and our collaborators do not use, and
therefore do not need to identify, the receptor's native ligand for our drug
discovery efforts. Instead, we use CART to genetically alter, or activate, GPCRs
and other receptors to mimic the biological response that occurs when the ligand
binds to the drug target. We use these activated drug targets as screening tools
to identify chemical compounds that alter this biological response. These
chemical compounds, known as drug leads, are the basis for drug discovery.

Our Melanophore Technology is a unique screening technique that we believe
complements CART. Melanophore Technology provides a broadly applicable, simple
and sensitive means to detect biological responses and eliminates the need for
radioactive or fluorescent screening techniques. In combination, we believe that
CART and Melanophore Technology enhance our drug discovery efforts at all of the
estimated 800 GPCR drug targets.

THERAPEUTIC APPLICATIONS OF CART

We have successfully identified drug leads that inhibit or activate the
function of a number of GPCRs. In the past four years, we have obtained the
full-length gene sequences of 407 human GPCRs and made them available for
activation and screening. We have selected and applied CART to a number of GPCR
targets that we believe have high potential value for the discovery of
therapeutics to treat diseases such as obesity, cancer, cardiovascular disease,
diabetes, inflammation and Alzheimer's Disease. Obesity affects approximately
22 million adults in the United States. We have identified a drug lead that we
believe may be the basis for the development of drug candidates, and ultimately
drugs, for use in the treatment of obesity. Schizophrenia affects more than two
million people in the United States in a given year. We have also discovered
drug leads that may be useful in the treatment of diseases resulting from the
overactivity of a GPCR which is associated with psychiatric disorders such as
schizophrenia. We discovered these obesity and schizophrenia drug leads within
approximately 18 months from the initial application of CART to these drug
targets.

OUR COLLABORATORS

In April 2000, we entered into a significant collaborative agreement with
Eli Lilly and Company. This collaboration focuses principally on diseases of the
central nervous system and endocrine system, as well as cardiovascular diseases,
and may be expanded to other diseases, including cancer. In May 2000, we entered
into a collaborative agreement with Taisho Pharmaceutical Co., Ltd. This
collaboration focuses on a specified number of drug targets of interest to
Taisho for its drug discovery efforts. In January 2000, we entered into a
collaborative agreement with Fujisawa Pharmaceutical Co., Ltd. to validate up to
13 drug targets. We have also entered into a collaborative agreement with
Lexicon Genetics, Inc. Under the terms of some of these agreements, we have
received various payments, including payments related to milestones that have
been achieved and assay development fees. Some of our agreements also entitle us
to other milestone payments and royalties based on sales, if any.

PROJECT GENESIS

We recently began Project Genesis, a broad, internal program to discover
drug leads and develop drug candidates that target all of the estimated 800
therapeutically relevant human GPCRs. Key discrete elements of Project Genesis
include:

- obtaining genetic sequence information on the estimated 800 GPCRs from
both public and proprietary sources

- determining the location of all of the estimated 800 GPCRs within the body
and functions associated with these GPCRs

- cloning and demonstrating CART-activation of all of the estimated 800
GPCRs

- using Melanophore Technology and other techniques to screen all of the
GPCRs that demonstrate CART-activation against our library of chemical
compounds

- selecting the most promising drug leads obtained from our screening
efforts for development and optimization as drug candidates

We expect to complete all of the discrete elements of Project Genesis within
the next three to five years. At any stage of Project Genesis, we may enter into
collaborative arrangements for any of the GPCR drug targets, drug leads or drug
candidates that we may discover.

OUR STRATEGY

Our goal is to become a leader in the discovery of novel, proprietary drugs
that target human GPCRs. The major elements of our strategy to achieve this goal
are:

- execute Project Genesis to accelerate drug discovery at all
therapeutically relevant GPCRs

- enter into strategic collaborations

- use CART to identify novel, proprietary drug leads that have unique
mechanisms of action

- continue to protect and expand our intellectual property rights

- invest in or acquire complementary technologies

We are also applying CART to other human receptors and non-human receptors
for human therapeutic, agricultural and other applications.

RECENT DEVELOPMENTS

The following summarizes recent events that have occurred since the
completion of our initial public offering in July 2000. These events are
described in greater detail elsewhere in this prospectus:

- We received our first four milestone payments from Eli Lilly in
September 2000, October 2000, December 2000 and March 2001. The milestone
payments were related to Eli Lilly's acceptance of CART-activated versions
of three GPCRs in August 2000 and September 2000 and its acceptance of six
additional GPCRs in December 2000.

- In October 2000, we received our first milestone payment from Taisho. The
milestone payment was related to Taisho's acceptance of a CART-activated
version of a GPCR selected by Taisho and Taisho's request that we screen
the CART-activated version of this GPCR using our chemical library. In
January 2001, we licensed our 18F program to Taisho, including the 18F
obesity orphan receptor target and drug leads discovered using the 18F
receptor, for a one-time payment and future milestones and royalties. In
March 2001, we entered into a receptor discovery collaboration with Taisho
under which Taisho has paid us a one-time research and development fee for
the first phase of the collaboration.

- In February 2001, we acquired Bunsen Rush Laboratories, Inc. and its
proprietary and patented Melanophore Technology for $15.0 million in cash.

- In April 2001, we entered into a binding letter of intent with Axiom
Biotechnologies Inc. Under the terms of the letter of intent, we will
identify the location and expression of GPCRs contained in Axiom's human
cell lines. In addition, we have paid $2.0 million to Axiom in connection
with the letter of intent, which provides that we will purchase
approximately 570,000 shares of Axiom's preferred stock.

THE OFFERING

Common stock offered by us........................... 4,000,000 shares

Common stock offered by the selling stockholders..... 1,000,000 shares

Common stock to be outstanding after this offering... 26,743,038 shares

Use of proceeds...................................... For general corporate purposes, including
working capital, research and development,
clinical testing, expansion of our facilities
and potentially for acquisitions of
complementary businesses or technologies. You
should read the discussion under the heading
"Use of Proceeds" for more information.

Nasdaq National Market symbol........................ ARNA

The number of shares of common stock to be outstanding after this offering
is based on the number of shares outstanding as of March 31, 2001, including
470,562 shares issued upon exercise of unvested options that are subject to
repurchase by us until vested, and excluding:

- 1,000,000 shares of common stock that are reserved for issuance under our
2001 Arena Employee Stock Purchase Plan

- 850,750 shares of common stock issuable upon the exercise of outstanding
options under our 2000 Equity Compensation Plan at a weighted average
exercise price of $21.60 per share

- 493,500 shares of common stock issuable upon the exercise of outstanding
options under our 1998 Equity Compensation Plan at a weighted average
exercise price of $0.66 per share

You should read the discussion under the heading "Capitalization" for more
information regarding the outstanding shares of our common stock and options to
purchase our common stock.

Generally, the information in this prospectus, unless otherwise noted,
assumes that the over-allotment option granted to the underwriters to purchase
up to 750,000 additional shares of common stock is not exercised.

OTHER INFORMATION

We were incorporated on April 14, 1997 in Delaware and commenced operations
in July 1997. Our corporate headquarters is located at 6166 Nancy Ridge Drive,
San Diego, California 92121. Our telephone number is (858) 453-7200.

CART-TM-, Arena-TM-, Aressa-TM-, ChemNavigator-TM- and BRL Screening-TM- are
our trademarks. Arena Pharmaceuticals-Registered Trademark- and our logo are our
registered trademarks. Trade names and trademarks of other companies appearing
in this prospectus are the property of their respective holders.

SUMMARY FINANCIAL DATA

The following table summarizes our financial data. The summary financial
data for the period from April 14, 1997 (inception) to December 31, 1997 and for
the years ended December 31, 1998, 1999 and 2000 are derived from our audited
financial statements. We have also included data from our unaudited financial
statements for the three months ended March 31, 2000 and 2001 and as of
March 31, 2001. The as adjusted balance sheet data reflects the sale by us of
4,000,000 shares of common stock in this offering at a price of $27.50 per
share, after deducting the estimated underwriting discounts and commissions and
offering expenses payable by us. You should read this data together with our
financial statements and related notes included elsewhere in this prospectus.

PERIOD FROM
APRIL 14, 1997 THREE MONTHS ENDED
(INCEPTION) YEAR ENDED DECEMBER 31, MARCH 31,
THROUGH ----------------------------------------- ---------------------------
DECEMBER 31, 1997 1998 1999 2000 2000 2001
------------------ ----------- ------------ ------------ ------------ ------------

STATEMENT OF OPERATIONS DATA:
Revenues........................... $ -- $ -- $ -- $ 7,683,396 $ -- $ 5,392,335

Operating expenses:
Research and development........... 447,038 2,615,526 8,336,483 12,080,204 2,399,358 3,903,341
General and administrative......... 234,614 728,806 1,814,023 2,678,980 423,828 1,025,983
Amortization of deferred
compensation..................... -- -- 378,109 4,342,896 409,479 1,268,666
Amortization of acquired technology
and other purchased
intangibles...................... -- -- -- -- -- 128,083
--------- ----------- ------------ ------------ ------------ ------------
Total operating expenses......... 681,652 3,344,332 10,528,615 19,102,080 3,232,665 6,326,073
Interest and other, net............ (13,113) (51,986) 290,665 5,056,714 110,465 2,018,732
--------- ----------- ------------ ------------ ------------ ------------
Net income (loss)................ (694,765) (3,396,318) (10,237,950) (6,361,970) (3,122,200) 1,084,994
Non-cash preferred stock charge.... -- -- -- (22,391,068) (14,187,563) --
--------- ----------- ------------ ------------ ------------ ------------
Net income (loss) applicable to
common stockholders............ $(694,765) $(3,396,318) $(10,237,950) $(28,753,038) $(17,309,763) $ 1,084,994
========= =========== ============ ============ ============ ============
Net income (loss) per share:
Basic and diluted................ $ (0.73) $ (3.51) $ (10.05) $ (2.84) $ (15.92) $ 0.05
========= =========== ============ ============ ============ ============
Shares used in calculating net
income (loss) per share:
Basic............................ 955,000 966,799 1,018,359 10,139,755 1,086,988 22,272,476
========= =========== ============ ============ ============ ============
Diluted.......................... 955,000 966,799 1,018,359 10,139,755 1,086,988 23,247,747
========= =========== ============ ============ ============ ============

AS OF MARCH 31, 2001
---------------------------
ACTUAL AS ADJUSTED
------------ ------------

BALANCE SHEET DATA:
Cash and cash equivalents................................... $125,503,323 $229,043,323
Total assets................................................ 156,621,158 260,161,158
Long-term debt, net of current portion...................... 832,314 832,314
Deferred compensation....................................... (6,916,624) (6,916,624)
Accumulated deficit......................................... (19,606,009) (19,606,009)
Total stockholders' equity.................................. 151,177,620 254,717,620

RISK FACTORS

AN INVESTMENT IN OUR COMMON STOCK INVOLVES SIGNIFICANT RISKS. YOU SHOULD
CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE YOU BUY OUR COMMON STOCK.

RISKS RELATED TO OUR BUSINESS

WE HAVE A HISTORY OF LOSSES AND LIMITED REVENUES.

We were formed in April 1997. We had losses of $3.4 million for the year
ended December 31, 1998, $10.2 million for the year ended December 31, 1999 and
$6.4 million for the year ended December 31, 2000. For the three months ended
March 31, 2001, we had revenues of $5.4 million and operating expenses,
excluding non-cash items, of $4.9 million. Through March 31, 2001, we had an
accumulated deficit of $19.6 million. Our losses have resulted in large part
from the significant research and development expenditures required to identify
and validate new drug targets and new drug leads. We rely on our collaboration
and license agreements for our revenues, and we may experience operating losses
even if we or our collaborators successfully identify potential drug targets and
drug leads. If the time required to generate revenues and to achieve sustained
profitability is longer than we anticipate, or if we are unable to obtain
necessary funds, we may never achieve sustained profitability and may have to
discontinue our operations.

MOST OF OUR REVENUES ARE CONTINGENT UPON COLLABORATIVE AND LICENSE AGREEMENTS
AND WE MAY NOT RECEIVE SUFFICIENT REVENUES FROM THESE AGREEMENTS TO SUSTAIN
PROFITABILITY.

Our strategy is to use our technologies to generate meaningful revenues from
our collaborative and license agreements. Through March 31, 2001, substantially
all of our revenues have been derived from two of our collaborators, Eli Lilly
and Taisho. We expect substantially all of our revenues for the near term to be
derived from these collaborators. Our ability to generate revenues depends on
our ability to enter into additional collaborative and license agreements with
third parties and to maintain the agreements we currently have in place. We will
receive little or no revenues under our agreements if we or our collaborators'
research, development or marketing efforts are unsuccessful, or if our
agreements are terminated early. Additionally, if we do not enter into new
collaborative agreements, we will not receive revenues from new sources.

Our receipt of revenues from collaborative arrangements will be
significantly affected by the amount of time and effort expended by our
collaborators, the timing of the identification of useful drug targets and the
timing of the discovery of drug leads and the development of drug candidates.
Under our existing agreements, we may not earn significant milestone payments
until our collaborators have advanced products into clinical testing, which may
not occur for many years, if at all. We do not control the amount and timing of
resources that our collaborators devote to our collaborative programs, potential
products or product rights. Furthermore, we lack sales and marketing experience
and will depend on our collaborators to market any drugs that we develop with
them.

Conflicts may arise between us and our collaborators, such as conflicts
concerning ownership rights to particular drug leads or drug candidates. While
our existing collaborative agreements typically provide that we receive
milestone and royalty payments with respect to drugs developed from our
collaborative programs, disputes may arise over the application of payment
provisions to these drugs and any royalty payments may be at reduced rates. If
any of our collaborators were to breach, terminate or fail to renew their
collaborative agreements with us, the pre-clinical or clinical development or
commercialization of the affected drug candidates or research programs could be
delayed or terminated. Our collaborative agreements generally allow either party
to terminate the agreements with advance written notice of that party's intent
to terminate. In addition, our collaborators have the right to terminate the
collaborative agreements under some circumstances in

which we do not. In some circumstances, our collaborators can continue to use
our technology after our agreements are terminated.

Our collaborators may choose to use alternative technologies or develop
alternative drugs either on their own or with other collaborators, including our
competitors, in order to treat diseases that are targeted by collaborative
arrangements with us. Our collaborative agreements typically do not prohibit
these activities.

Consolidation in the pharmaceutical or biotechnology industry could have an
adverse effect on us by reducing the number of potential collaborators or
jeopardizing our existing relationships. We may not be able to enter into any
new collaborative agreements.

IF PROBLEMS ARISE IN THE TESTING AND APPROVAL PROCESS, OUR TECHNOLOGIES MAY NOT
LEAD TO SUCCESSFUL DRUG DEVELOPMENT EFFORTS AND WE WILL NOT RECEIVE REVENUES.

In order to receive some of the milestone payments under our collaborative
agreements, we or our collaborators must successfully complete pre-clinical and
clinical trials of drug candidates discovered using our technologies. To date,
we have identified only a few drug leads, all of which are in the very early
stages of development and none of which have completed the development process.

Developing drug leads, drug candidates and drugs is highly uncertain and
subject to significant risks. Our access to and use of some human or other
tissue samples in our research and development efforts is subject to government
regulation, both in the United States and abroad. United States and foreign
government agencies may also impose restrictions on the use of data derived from
human or other tissue samples. We or our collaborators will rely on third-party
clinical investigators at medical institutions to conduct our clinical trials,
and may rely on other third-party organizations to perform data collection and
analysis. As a result, we may face delays outside of our control. It may take us
or our collaborators many years to complete any pre-clinical or clinical trials,
and failure can occur at any stage of testing. Interim results of trials do not
necessarily predict final results, and acceptable results in early trials may
not be repeated in later trials. Moreover, if and when our programs reach
clinical trials, we or our collaborators may decide to, or be required to,
discontinue development of any or all of these projects at any time for
commercial, scientific or other reasons.

In order to receive royalty payments from our collaborators, we or our
collaborators must receive approval from regulatory agencies to market drugs
discovered using our technologies. A new drug may not be sold in the United
States until the United States Food and Drug Administration, or FDA, has
approved a new drug application, or an NDA. When a drug receives an approved
NDA, this approval is limited to those disease states and conditions for which
the drug candidate has been demonstrated through clinical trials to be safe and
effective. Drug candidates developed by us or our collaborators may not prove to
be safe and effective in clinical trials and may not meet all of the applicable
regulatory requirements necessary to receive marketing approval. We do not
expect any drugs resulting from our or our collaborators' research to be
commercially available for many years, if at all.

DRUG DISCOVERY AND DEVELOPMENT IS AN INTENSELY COMPETITIVE BUSINESS THAT COULD
RENDER OUR TECHNOLOGIES OBSOLETE OR NONCOMPETITIVE.

An important focus of our efforts is GPCRs. Because GPCRs are an important
target class for drug discovery efforts, we believe that most pharmaceutical
companies, several biotechnology companies, and other organizations have
internal drug discovery programs focused on GPCRs. Another company or
organization may have, or may develop, a technology using GPCRs to discover and
develop drug leads or drug candidates more effectively, more quickly or at a
lower cost than our technologies. Such a technology could render our
technologies, and in particular, CART, obsolete or noncompetitive.

Many of the drugs that we or our collaborators are attempting to discover
and develop would compete with existing therapies. In addition, many companies
are pursuing the development of drugs that target the same diseases and
conditions that we are targeting such as cancer, obesity, cardiovascular
disease, diabetes and Alzheimer's Disease. Our competitors may use discovery
technologies and techniques or partner with collaborators in order to develop
drug leads, drug candidates and drugs more rapidly or successfully, or with less
cost, than we or our collaborators are able to do. Many of our competitors,
particularly large pharmaceutical companies, have substantially greater
development capabilities and greater financial, scientific and human resources
than we do. Companies that complete clinical trials, obtain required regulatory
agency approvals and commence commercial sale of their drugs before we do may
achieve a significant competitive advantage, including certain patent and FDA
marketing exclusivity rights. So far, we have not achieved any of these
competitive advantages. Any results from our research and development efforts,
or from our joint efforts with our existing or any future collaborators, might
not compete successfully with existing products or therapies.

OUR SUCCESS IS DEPENDENT ON INTELLECTUAL PROPERTY RIGHTS HELD BY US AND THIRD
PARTIES AND OUR INTEREST IN THESE RIGHTS IS COMPLEX AND UNCERTAIN.

Our success will depend in large part on our own and, to some extent, on our
collaborators' abilities to obtain, secure and defend patents. We have numerous
United States and international patent applications pending for our
technologies, including patent applications on drug lead discovery techniques
using CART, genetically altered GPCRs, GPCRs that we have discovered, compounds
discovered using CART, and Melanophore Technology. Currently, four patents have
been issued to us and we own two issued patents directed to Melanophore
Technology. The procedures for obtaining an issued patent in the United States
and in most foreign countries are complex. These procedures require an analysis
of the scientific technology related to the invention and many legal issues. We
believe CART represents an entirely new way to discover drug leads. Because of
this, we expect that the analysis of our patent applications will be complex and
time-consuming. Therefore, our patent position is very uncertain and we do not
know when, or if, we will obtain additional issued patents for our technologies.

When we activate a receptor, we change the way that the receptor would
otherwise naturally function. We believe that our activated receptors are
patentable. A third party may obtain an issued patent on a natural version of a
receptor that we activate. We believe that an activated version of the natural
receptor should not infringe a patent on the natural receptor. However, a third
party who owns a patent on a natural version of a receptor may not agree with
our position. We could be sued for patent infringement, and we do not know how a
court would rule in such a case.

No consistent policy regarding the breadth of claims allowed in
biotechnology patents has emerged to date. For example, on January 5, 2001 the
United States Patent and Trademark Office issued finalized Utility Examination
Guidelines to its patent examiners that focus on what can be patented under
United States patent law. These guidelines are expected to primarily impact the
procedures that are used in determining the types of inventions that can be
patented in the fields of biotechnology and chemistry. We do not know how, if at
all, these guidelines may affect our patent applications on CART, genetically
altered GPCRs, GPCRs that we have discovered or chemical compounds that we
discover using CART.

We also rely on trade secrets to protect our technologies. However, trade
secrets are difficult to protect. We require all of our employees to agree not
to improperly use our trade secrets or disclose them to others, but we may be
unable to determine if our employees have conformed or will conform with their
legal obligations under these agreements. We also require collaborators and
consultants to enter into confidentiality agreements, but we may not be able to
adequately protect our trade secrets or other proprietary information in the
event of any unauthorized use or disclosure or the lawful

development by others of this information. Many of our employees and consultants
were, and many of our consultants may currently be, parties to confidentiality
agreements with other pharmaceutical and biotechnology companies, and the use of
our technologies could violate these agreements. In addition, third parties may
independently discover our trade secrets or proprietary information.

Technology licensed to us by others, or in-licensed technology, is important
to some aspects of our business. We generally do not control the patent
prosecution, maintenance or enforcement of in-licensed technology. Accordingly,
we are unable to exercise the same degree of control over this intellectual
property as we do over our internally developed technologies. Moreover, some of
our academic institution licensors, research collaborators and scientific
advisors have rights to publish data and information to which we have rights. If
we cannot maintain the confidentiality of our technologies and other
confidential information in connection with our collaborations, then our ability
to receive patent protection or protect our proprietary information will be
impaired.

A DISPUTE REGARDING THE INFRINGEMENT OR MISAPPROPRIATION OF OUR PROPRIETARY
RIGHTS OR THE PROPRIETARY RIGHTS OF OTHERS COULD BE COSTLY AND RESULT IN DELAYS
IN OUR RESEARCH AND DEVELOPMENT ACTIVITIES.

Our success depends, in part, on our ability to operate without infringing
on or misappropriating the proprietary rights of others. There are many issued
patents and patent applications filed by third parties relating to products or
processes that could be determined to be similar or identical to ours or our
licensors, and others may be filed in the future. Our activities, or those of
our licensors or collaborators, may infringe patents owned by others. Although
the government sponsored project to sequence the human genome has made genomics
information freely available to the public, other organizations and companies
are seeking proprietary positions on genomics information that overlap with the
government sponsored project. Our activities, or those of our licensors or
collaborators, could be affected by conflicting positions that may exist between
any overlapping genomics information made available publicly as a result of the
government sponsored project and genomics information that other organizations
and companies consider to be proprietary.

We believe that there may be significant litigation in our industry
regarding patent and other intellectual property rights. Any legal action
against us, or our collaborators, claiming damages or seeking to enjoin
commercial activities relating to the affected products or our methods or
processes could:

- require us, or our collaborators, to obtain a license to continue to use,
manufacture or market the affected products, methods or processes, which
may not be available on commercially reasonable terms, if at all

- prevent us from making, using or selling the subject matter claimed in
patents held by others and subject us to potential liability for damages

- consume a substantial portion of our managerial and financial resources

- result in litigation or administrative proceedings that may be costly,
whether we win or lose

In addition, third parties may infringe on or misappropriate our proprietary
rights, and we may have to institute costly legal action to protect our
intellectual property rights. We may not be able to afford the costs of
enforcing our intellectual property rights against third parties.

WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OUTSIDE THE
UNITED STATES.

Patent law outside the United States is uncertain and in many countries is
currently undergoing review and revision. The laws of some countries do not
protect our intellectual property rights to the same extent as United States
laws. It may be necessary or useful for us to participate in proceedings to

determine the validity of our, or our competitors', foreign patents, which could
result in substantial cost and divert our efforts and attention from other
aspects of our business.

One of our United States patent applications relating to some aspects of our
technology that we filed internationally was not timely filed in the designated
foreign countries. We have taken remedial actions in an attempt to file the
patent application in a number of these foreign countries. We cannot assure you
that any of these remedial actions will be successful, or that patents based
upon this patent application will be issued to us in any of these foreign
countries. In particular, we failed to timely file this patent application in
Japan and, as a result, no patent will be issued to us in Japan based upon this
particular patent application. Based upon other patent applications that relate
to CART that we have filed in the United States and internationally, we believe
that there will be no material adverse effect on our business or operating
results if we fail to obtain a patent based on the subject matter of this
particular patent application.

OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE AND MAY CAUSE OUR STOCK PRICE TO
DECLINE.

Our revenues and results of operations may fluctuate significantly from
quarter to quarter, depending on a variety of the factors described in this
section, including:

- the timing of and receipt by us of milestone and royalty payments

- the timing of discovery of drug leads and the development of drug
candidates, if any

- changes in the research and development budgets of our existing
collaborators or potential collaborators

- others introducing new drug discovery techniques or new drugs that target
the same diseases and conditions that we and our collaborators target

- regulatory actions

- expenses related to, and the results of, litigation and other proceedings
relating to intellectual property rights or other matters

We are not able to control many of these factors and we believe that
period-to-period comparisons of our financial results are not necessarily
indicative of our future performance. If our revenues in a particular period do
not meet expectations, we may not be able to adjust our expenditures in that
period, which could cause our operating results to suffer.

WE MAY HAVE DIFFICULTY IN COMBINING CART WITH MELANOPHORE TECHNOLOGY.

We have not yet fully incorporated Melanophore Technology into our drug
discovery process. Melanophore Technology may have limited applicability to the
drug discovery process that focuses on CART-activated GPCRs. If this is the
case, our drug discovery programs may be delayed or otherwise impacted and our
business could be harmed.

WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE TO SUFFICIENTLY FUND OUR OPERATIONS
AND RESEARCH, AND IF NEEDED, WE MAY NOT BE ABLE TO OBTAIN ADDITIONAL CAPITAL ON
TERMS FAVORABLE TO US.

We have consumed substantial amounts of capital to date and we expect to
increase our operating expenses over the next several years as we expand our
facilities, infrastructure and research and development activities. We also
expect that Project Genesis will consume significant amounts of our research and
development funds. Based upon our current and our anticipated activities, we
believe that our current funds will be sufficient to support our current
operating plan through at least the next two years. However, if this plan
changes, we may require additional financing sooner. For example, we may use a
portion of our funds to acquire complementary businesses or technologies.
Financing may not be

available or may not be available on terms favorable to us. To the extent that
we raise additional funds through collaboration and licensing arrangements, we
may be required to relinquish some rights to our technologies or drug leads, or
grant licenses on terms that are unfavorable to us. We may also raise additional
funds through the incurrence of debt, and the holders of any debt we may issue
would have rights superior to your rights. If adequate funds are not available,
we will not be able to continue our development.

OUR RESEARCH AND DEVELOPMENT EFFORTS WILL BE SERIOUSLY JEOPARDIZED IF WE ARE
UNABLE TO ATTRACT AND RETAIN KEY EMPLOYEES.

We have less than 160 employees. Our success depends, in part, on the
continued contributions of our principal management and scientific personnel,
and we face intense competition for such personnel. In particular, our research
programs depend on our ability to attract and retain highly skilled scientists.
If we lose the services of any of our key personnel, in particular Jack Lief,
Dominic P. Behan or Derek T. Chalmers, as well as other principal members of our
scientific or management staff, our research and development or management
efforts could be interrupted or significantly delayed. For example, Eli Lilly
has the right to terminate our collaboration agreement if they do not approve
suitable replacements for key employees who leave us. We do not have employment
agreements with any of our key employees and any of our employees could
terminate his or her employment with us at any time. We may also encounter
increasing difficulty in attracting enough qualified personnel as our operations
expand and the demand for these professionals increases, and this difficulty
could impede the attainment of our research and development objectives.

OUR BUSINESS MAY BE HARMED BY HIGHER ENERGY COSTS AND INTERRUPTED POWER SUPPLIES
RESULTING FROM THE ELECTRICAL POWER SHORTAGES CURRENTLY AFFECTING THE STATE OF
CALIFORNIA.

Our corporate headquarters and laboratories are located in San Diego,
California. Electrical power is vital to our operations and we rely on a
continuous power supply to conduct our operations. California is in the midst of
a power crisis and has recently experienced significant power shortages. In the
event of an acute power shortage, the California system operator has on some
occasions implemented, and may in the future continue to implement, rolling
blackouts throughout California.

For this type of contingency, we have acquired a stand-by electrical
generator to provide power to our laboratories and offices. However, there can
be no assurances that our stand-by generator will be able to provide sufficient
power to our laboratories and offices in the event of sustained interruptions to
our power supply. If blackouts interrupt our power supply frequently or for more
than a few days we may have to reduce or temporarily discontinue our normal
operations. In addition, the cost of our research and development efforts may
increase because of the disruption to our operations. Any such reduction or
disruption of our operations at our facilities could harm our business.

IF WE USE BIOLOGICAL AND HAZARDOUS MATERIALS IN A MANNER THAT CAUSES INJURY OR
VIOLATES LAWS, OUR BUSINESS AND OPERATIONS MAY SUFFER.

Our research and development activities involve the controlled use of
potentially harmful biological materials as well as hazardous materials,
chemicals and various radioactive compounds. For example, we use radioactive
phosphorous-32 on a daily basis and sodium cyanide on a regular basis. We cannot
completely eliminate the risk of accidental contamination, which could cause:

- an interruption of our research and development efforts

- injury to our employees resulting in the payment of damages

- liabilities under federal, state and local laws and regulations governing
the use, storage, handling and disposal of these materials and specified
waste products

ANTI-TAKEOVER PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND DELAWARE LAW
COULD PREVENT A POTENTIAL ACQUIROR FROM BUYING US.

Provisions of our certificate of incorporation and Delaware law could make
it more difficult for a third party to acquire us, even if the acquisition would
be beneficial to our stockholders. Our amended and restated certificate of
incorporation gives our board of directors the authority to issue up to
7,500,000 shares of preferred stock and to determine the price, rights,
preferences and privileges and restrictions, including voting rights, of those
shares without any further vote or action by our stockholders. Some of the
rights of the holders of common stock may be subject to, and may be harmed by,
the rights of the holders of any shares of preferred stock that may be issued in
the future. The issuance of preferred stock could potentially prevent us from
consummating a merger, reorganization, sale of substantially all of our assets,
liquidation or other extraordinary corporate transaction without the approval of
the holders of the outstanding shares of preferred stock. These provisions could
prevent the consummation of a transaction in which our stockholders could
receive a substantial premium over the current market price for their shares.

OUR EQUITY INTEREST IN CHEMNAVIGATOR.COM MAY HAVE NO VALUE.

We have licensed certain Internet-related technologies to ChemNavigator.com
in exchange for shares of ChemNavigator.com stock. We currently have a 33%
equity interest in ChemNavigator.com. Since it was formed in May 1999,
ChemNavigator.com has incurred net operating losses and negative cash flows from
operating activities, and we expect ChemNavigator.com to incur increasing net
operating losses and negative cash flows for the foreseeable future.
ChemNavigator.com has received only limited revenues to date, and it may not be
able to generate sufficient revenues or obtain financing to offset its losses.

ChemNavigator.com faces intense competition from established companies that
provide Internet-based products to the same customers as ChemNavigator.com. Some
of these companies have greater financial, technical and human resources than
ChemNavigator.com has, have a longer operating history and are more well-known
to ChemNavigator.com's target customers. If ChemNavigator.com is not able to
compete successfully, it will not achieve profitability and may have to
discontinue operations.

OUR EQUITY INTEREST IN ARESSA PHARMACEUTICALS MAY HAVE NO VALUE.

We currently have an 83% equity interest in Aressa. Since it was formed in
August 1999, Aressa has incurred net operating losses and negative cash flows
from operating activities, and we expect Aressa to incur increasing net
operating losses and negative cash flows for the foreseeable future. Aressa has
not received any revenues to date, and it may never generate any revenues or
obtain financing to offset its losses and may have to discontinue operations.

WE MAY ENGAGE IN STRATEGIC TRANSACTIONS WHICH COULD HARM OUR BUSINESS.

From time to time we consider strategic transactions, such as the
acquisition of Bunsen Rush Laboratories. These additional potential transactions
may include a variety of different business arrangements, including spin-offs,
acquisitions, strategic partnerships, joint ventures, restructurings,
divestitures, business combinations and investments. We cannot assure you that
any such transactions will be consummated on favorable terms or at all or will
not harm our business. Any such transaction may require us to incur
non-recurring or other charges and may pose significant integration challenges
or disrupt our management or business, which could harm our business and
financial results.

RISKS RELATED TO THIS OFFERING

OUR COMMON STOCK HAS BEEN PUBLICLY TRADED FOR LESS THAN ONE YEAR AND DURING THIS
PERIOD THE PRICE OF OUR COMMON STOCK HAS BEEN HIGHLY VOLATILE.

Prior to this offering, our common stock has been publicly traded for less
than one year. During the past 10 months, the market price of our common stock
fluctuated from a low of $11.75 during the first quarter of 2001 and a high of
$46.25 during the third quarter of 2000. We expect the market price of our stock
to continue to fluctuate in response to many factors, including:

- changes in financial estimates or recommendations by securities analysts
regarding us or our common stock

- announcements about the biotechnology or pharmaceutical areas in which we
and our collaborators operate

- the impact of regulatory developments in the United States and foreign
countries on us or our collaborators

- public concern as to safety and effectiveness of research and products
developed by us, our collaborators or our competitors

The market price for securities of biotechnology companies has been
increasingly volatile. In the past, following periods of volatility in the
market price of a particular company's securities, securities class action
litigation has often been brought against the company. We may become involved in
this type of litigation in the future. Litigation of this type is often
extremely expensive and diverts management's attention and resources.

IF OUR STOCKHOLDERS SELL SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK AFTER THIS
OFFERING, THE MARKET PRICE OF OUR COMMON STOCK MAY DECLINE.

If our stockholders sell substantial amounts of our common stock after this
public offering, including shares issued upon the exercise of outstanding
options, the market price of our common stock may decline. These sales also
might make it more difficult for us to sell equity or equity-related securities
in the future at a time and price that we deem appropriate. Upon the closing of
this offering, based upon the number of shares of our common stock outstanding
as of March 31, 2001, we will have outstanding an aggregate of 26,743,038 shares
of common stock. Of these shares, the 5,000,000 shares of common stock to be
sold in this offering, the 6,900,000 shares of common stock sold in our initial
public offering and the shares sold to date by our stockholders pursuant to
Rule 144 and Rule 701 under the Securities Act will be freely tradable without
restriction or further registration under the Securities Act, unless the shares
are held by our "affiliates" as such term is defined in Rule 144 of the
Securities Act. Two of our stockholders, who hold an aggregate of 3,477,332
shares of our common stock, may sell their shares on the public market at any
time, subject to applicable limitations under Rule 144. All remaining shares
held by our existing stockholders were issued and sold by us in private
transactions and are eligible for public sale if registered under the Securities
Act or sold in accordance with Rule 144 or Rule 701 thereunder, except for
shares held by our officers and directors that are subject to lock-up agreements
under which these individuals have agreed not to offer or sell any of these
shares of common stock for a period of 90 days from the date of this prospectus
without the prior written consent of the underwriters. In addition, the
underwriters will require agreements from:

- one of our selling stockholders, who after this offering will beneficially
own 1,915,840 shares of our common stock, not to offer or sell any of the
shares of our common stock that it holds for a period of 90 days after the
date of this prospectus

- the other selling stockholder, who after this offering will beneficially
own 3,112,149 shares of our common stock, not to offer or sell any of the
shares of our common stock that it holds for 60 days, 90 days and
120 days after the date of this prospectus, in each case with respect to
one-third of the shares owned by that stockholder immediately after this
offering

without the prior written consent of the underwriters.

On September 7, 2000, we filed registration statements on Form S-8 to
register all of the shares of common stock which could be purchased upon the
exercise of stock options outstanding on that date, and all of the shares of
common stock reserved for issuance, pursuant to our 1998 Equity Compensation
Plan and 2000 Equity Compensation Plan. On June 13, 2001, we filed a
registration statement on Form S-8 to register all of the shares of common stock
which are reserved for issuance under the 2001 Arena Employee Stock Purchase
Plan. Accordingly, shares issued upon exercise of such options are, and shares
issued under the 2001 Arena Employee Stock Purchase Plan will be, freely
tradable by holders who are not our affiliates and, subject to the volume and
other limitations of Rule 144, by holders who are our affiliates.

THE INTERESTS OF OUR LARGEST STOCKHOLDERS MAY CONFLICT WITH OUR INTERESTS AND
THE INTERESTS OF OUR OTHER STOCKHOLDERS.

Immediately upon the completion of this offering, our current four largest
stockholders will beneficially own approximately 8.5 million shares, or
approximately 31.8% of our outstanding common stock. If these stockholders act
together, they could exert considerable influence over us, including with
respect to the election of directors and the approval of actions submitted to
our stockholders. In addition, without the consent of these stockholders, we may
be prevented from entering into transactions that could be beneficial to us,
such as acquisition proposals from third parties.

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This prospectus contains statements about our future that involve the risks
and uncertainties described above and elsewhere in this prospectus. These
forward looking statements are subject to certain risks and uncertainties, which
could cause actual results to differ materially from such statements. These
statements include, without limitation, statements about market opportunity, our
growth strategy and our expectations, plans and objectives. The words "believe,"
"expect," "anticipate," "estimate," "optimistic," "intend," "plan," "project,"
"target," "aim," "will," and similar expressions identify forward looking
statements. These words and statements may be found in the sections of this
prospectus entitled "Prospectus Summary," "Risk Factors," "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," and in this prospectus generally. Our actual results
will differ, perhaps materially, from those anticipated in these statements as a
result of various factors, including all the risks discussed above in the "Risk
Factors" section and elsewhere in this prospectus. Because of these
uncertainties, you should not place undue reliance on these statements. Except
to the extent required by applicable laws or rules, we do not intend to update
any of these factors or to publicly announce the result of any revisions to any
of these statements, whether as a result of new information, future events or
otherwise.

USE OF PROCEEDS

The net proceeds from the sale of the 4,000,000 shares of common stock we
are offering will be approximately $103.5 million (or approximately $123.1
million if the underwriters' over-allotment option is exercised in full), at a
public offering price of $27.50 per share and after deducting estimated
underwriting discounts and commissions and offering expenses payable by us. We
will not receive any of the proceeds from the sale of shares by the selling
stockholders.

We intend to use the net proceeds from this offering for general corporate
purposes, including working capital, research and development expenses,
discovery, development and clinical testing of drug leads, drug candidates and
drugs derived from GPCR targets, and other research and development and clinical
testing activities. The amounts and timing of our actual expenditures for each
purpose may vary significantly depending upon numerous factors. In addition, we
expect to use a portion of the net proceeds to expand our facilities and may use
a portion of the net proceeds to acquire complementary businesses or
technologies.

As of the date of this offering, we cannot specify with certainty all of the
particular uses for the net proceeds of this offering. Accordingly, we will
retain broad discretion in the allocation of the net proceeds of this offering.
Pending the use of the net proceeds as described above, we intend to invest the
net proceeds of this offering in short-term, investment-grade, interest-bearing
securities.

PRICE RANGE OF COMMON STOCK

Our common stock has traded on the Nasdaq National Market under the symbol
"ARNA" since our initial public offering on July 28, 2000. Prior to that time,
there was no public market for our common stock. The following table sets forth,
for the periods indicated, the high and low closing prices per share of our
common stock as reported on the Nasdaq National Market since July 28, 2000.

PERIOD HIGH LOW
------ -------- --------

July 28, 2000 through September 30, 2000.................... $46.25 $23.63
October 1, 2000 through December 31, 2000................... $42.56 $14.06
January 1, 2001 through March 31, 2001...................... $25.31 $11.75
April 1, 2001 through June 21, 2001......................... $33.00 $17.73

On June 21, 2001, the last reported sale price on the Nasdaq National Market
for our common stock was $27.50 per share.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock and
do not anticipate paying any cash dividends in the foreseeable future. We
currently intend to retain future earnings, if any, to fund the expansion and
growth of our business. Payments of future dividends, if any, will be at the
discretion of our board of directors after taking into account various factors,
including our financial condition, operating results, current and anticipated
cash needs, plans for expansion and other factors that our board deems relevant.

CAPITALIZATION

The following table sets forth our capitalization as of March 31, 2001:

- on an actual basis derived from our unaudited financial statements

- on an as adjusted basis to also give effect to the sale of
4,000,000 shares of common stock offered by us hereby at a public offering
price of $27.50 per share, after deducting underwriting discounts and
commissions and estimated offering expenses payable by us

You should read this table in conjunction with the financial statements and
the notes to those statements and the other financial information included
elsewhere in this prospectus.

AS OF MARCH 31, 2001
---------------------------
ACTUAL AS ADJUSTED
------------ ------------

Long-term debt, net of current portion...................... $ 832,314 $ 832,314
Stockholders' equity:
Common stock, $.0001 par value: 67,500,000 shares
authorized, 22,743,038 shares issued and outstanding,
actual; 67,500,000 shares authorized, 26,743,038 shares
issued and outstanding, as adjusted..................... 2,274 2,674
Additional paid-in capital................................ 177,697,979 281,237,579
Deferred compensation..................................... (6,916,624) (6,916,624)
Accumulated deficit....................................... (19,606,009) (19,606,009)
------------ ------------
Total stockholders' equity.............................. 151,177,620 254,717,620
------------ ------------
Total capitalization.................................. $152,009,934 $255,549,934
============ ============

- 1,000,000 shares of common stock reserved for issuance under our 2001
Arena Employee Stock Purchase Plan

- 850,750 shares of common stock issuable upon the exercise of outstanding
options under our 2000 Equity Compensation Plan at a weighted average
exercise price of $21.60 per share

- 493,500 shares of common stock issuable upon the exercise of outstanding
options under our 1998 Equity Compensation Plan at a weighted average
exercise price of $0.66 per share

DILUTION

The net tangible book value of our common stock at March 31, 2001 was
$135.9 million, or $5.98 per share. Net tangible book value per share represents
the amount of our total tangible assets less total liabilities, divided by the
number of shares of common stock outstanding. After giving effect to the sale of
the 4,000,000 shares of common stock offered by us hereby at a public offering
price of $27.50 per share and after deducting the estimated underwriting
discounts and commissions and offering expenses payable by us, our pro forma net
tangible book value at March 31, 2001 would have been approximately $239.5
million, or $8.95 per share. This represents an immediate increase in net
tangible book value of $2.97 per share to existing stockholders and an immediate
dilution of $18.55 per share to new investors purchasing shares of common stock
in this offering. The following table illustrates this dilution:

Public offering price per share............................. $27.50
Net tangible book value per share as of March 31, 2001...... $5.98
Increase per share attributable to the sale of common stock
in this offering.......................................... 2.97
-----
Pro forma net tangible book value per share after this
offering.................................................. 8.95
------
Dilution in net tangible book value per share to new
investors in this offering................................ $18.55
======

If the underwriters' over-allotment option is exercised in full, the as
adjusted net tangible book value per share after this offering would be $9.42
per share, the increase in net tangible book value per share to existing
stockholders would be $3.44 per share and the dilution in net tangible book
value to new investors would be $18.08 per share.

The previous table includes 470,562 shares of common stock subject to
repurchase by us as of March 31, 2001. The shares that are subject to repurchase
by us were issued upon the exercise of options that were granted under our 1998
Equity Compensation Plan and our 2000 Equity Compensation Plan, but that had not
vested as of March 31, 2001. The exercise of these unvested options was
permitted by the option agreements under which these options were granted. In
the event that an employee leaves our employ prior to full vesting, we have the
right to repurchase any unvested shares at the original purchase price.

The table assumes that none of the stock options outstanding as of
March 31, 2001 are exercised. As of March 31, 2001, there were 1,344,250 shares
of common stock issuable upon exercise of outstanding stock options at a
weighted average exercise price of $13.91 per share.

SELECTED FINANCIAL DATA

Our selected statement of operations data for the period April 14, 1997
(inception) through December 31, 1997 and our balance sheet data as of
December 31, 1997 and 1998 have been derived from our financial statements which
have been audited by Ernst & Young LLP, independent auditors, and are not
included in this prospectus. Our selected statement of operations data for the
years ended December 31, 1998, 1999 and 2000 and our balance sheet data as of
December 31, 1999 and 2000 have been derived from our consolidated financial
statements, which have been audited by Ernst & Young LLP, independent auditors,
and are included elsewhere in this prospectus. We have also included our
statement of operations data from our unaudited consolidated financial
statements for the three months ended March 31, 2000 and 2001 and our balance
sheet data as of March 31, 2001 from our unaudited financial statements included
in this prospectus. The unaudited consolidated financial statements include all
adjustments, consisting of normal recurring accruals, which we consider
necessary for a fair presentation of the financial position and the results of
operations for these periods. You should read the data set forth below together
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes included
elsewhere in this prospectus.

PERIOD FROM
APRIL 14, 1997 THREE MONTHS
(INCEPTION) YEAR ENDED DECEMBER 31, ENDED MARCH 31,
THROUGH ----------------------------------------- -------------------------
DECEMBER 31, 1997 1998 1999 2000 2000 2001
------------------ ----------- ------------ ------------ ------------ ----------

STATEMENT OF OPERATIONS
DATA:
Revenues.................... $ -- $ -- $ -- $ 7,683,396 $ -- $5,392,335
Operating expenses:
Research and development.... 447,038 2,615,526 8,336,483 12,080,204 2,399,358 3,903,341
General and
administrative............ 234,614 728,806 1,814,023 2,678,980 423,828 1,025,983
Amortization of deferred
compensation.............. -- -- 378,109 4,342,896 409,479 1,268,666
Amortization of acquired
technology and other
purchased intangibles..... -- -- -- -- -- 128,083
--------- ----------- ------------ ------------ ------------ ----------
Total operating
expenses................ 681,652 3,344,332 10,528,615 19,102,080 3,232,665 6,326,073
Interest and other, net..... (13,113) (51,986) 290,665 5,056,714 110,465 2,018,732
--------- ----------- ------------ ------------ ------------ ----------
Net income (loss)......... (694,765) (3,396,318) (10,237,950) (6,361,970) (3,122,200) 1,084,994
Non-cash preferred stock
charge.................... -- -- -- (22,391,068) (14,187,563) --
--------- ----------- ------------ ------------ ------------ ----------
Net income (loss)
applicable to common
stockholders............ $(694,765) $(3,396,318) $(10,237,950) $(28,753,038) $(17,309,763) $1,084,994
========= =========== ============ ============ ============ ==========
Net income (loss) per share:
Basic and diluted......... $ (0.73) $ (3.51) $ (10.05) $ (2.84) $ (15.92) $ 0.05
========= =========== ============ ============ ============ ==========
Shares used in calculating
net income (loss) per
share:
Basic..................... 955,000 966,799 1,018,359 10,139,755 1,086,988 22,272,476
========= =========== ============ ============ ============ ==========
Diluted................... 955,000 966,799 1,018,359 10,139,755 1,086,988 23,247,747
========= =========== ============ ============ ============ ==========

AS OF DECEMBER 31, AS OF
---------------------------------------------------- MARCH 31,
1997 1998 1999 2000 2001
---------- ---------- ----------- ------------ ------------

BALANCE SHEET DATA:
Cash and cash equivalents.............. $1,553,422 $ 194,243 $ 5,401,508 $144,413,176 $125,503,323
Total assets........................... 2,421,603 1,653,090 8,525,840 152,711,929 156,621,158
Long-term debt, net of current
portion.............................. 790,863 970,785 2,158,784 960,517 832,314
Redeemable convertible preferred
stock................................ 2,193,356 2,598,643 18,251,949 -- --
Deferred compensation.................. -- -- (625,955) (7,899,970) (6,916,624)
Accumulated deficit.................... (694,765) (4,091,083) (14,329,033) (20,691,003) (19,606,009)
Total stockholders' equity (deficit)... (694,665) (4,068,283) (13,899,549) 148,784,325 151,177,620

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

YOU SHOULD READ THE FOLLOWING DISCUSSION IN CONJUNCTION WITH OUR
CONSOLIDATED FINANCIAL STATEMENTS, THE RELATED NOTES AND OTHER FINANCIAL
INFORMATION APPEARING ELSEWHERE IN THIS PROSPECTUS.

OVERVIEW

We are an emerging biopharmaceutical company focused principally on
discovering drugs that target GPCRs. We use CART, a new technology that we
developed, to identify drug leads more efficiently than traditional drug
discovery techniques.

In April 2000, we entered into a significant collaborative agreement with
Eli Lilly focusing on the application of CART to GPCRs of interest to Eli Lilly.
We have received, and expect to continue to receive, research funding from Eli
Lilly for our internal resources committed to these tasks, which will be
augmented by substantial resource commitments by Eli Lilly. We may receive
milestone payments of up to $1.25 million per receptor for successful
application of CART and up to an additional $6.0 million of clinical development
milestone payments for each drug candidate discovered using CART. We may also
receive additional milestone and royalty payments associated with the
commercialization of drugs discovered using CART, if any. In addition, we have
entered into other collaborative agreements, including with Taisho and Fujisawa,
regarding the application of CART to GPCRs. We have recognized revenues of
approximately $6.3 million from our collaboration with Eli Lilly and
approximately $6.6 million from our collaboration with Taisho.

In February 2001, we acquired Bunsen Rush Laboratories for $15.0 million in
cash. Substantially all of the purchase price has been assigned to acquired
technology, which we currently amortize over ten years.

We plan to pursue several specific objectives during the remainder of 2001,
namely:

- establishing additional collaborations with pharmaceutical and
biotechnology companies

- expanding the number of receptors available for activation by CART through
internal research efforts and, potentially, external licensing agreements

- increasing our internally funded drug discovery efforts, including
expansion of our chemistry and screening efforts

- pursue these and other objectives as part of Project Genesis

We incur significant research and development expenses. As of March 31,
2001, all of our research and development costs have been expensed as incurred.
We believe that continued investment in research and development is critical to
attaining our strategic objectives. We expect that the implementation of Project
Genesis will significantly increase our research and development expenses.

In connection with the grant of stock options to employees, we recorded
deferred stock compensation totaling $226,000 during the three months ended
March 31, 2001 and $11.6 million during the year ended December 31, 2000. The
deferred stock compensation represents the difference on the date such stock
options were granted between the exercise price and the estimated market value
of our common stock as determined by our management, or after July 28, 2000, the
quoted market value. Deferred compensation is included as a reduction of
stockholders' equity and is amortized to

expense over the vesting period of the options in accordance with FASB
Interpretation No. 28, which permits an accelerated amortization methodology. We
recorded amortization of deferred compensation expense of approximately
$1.3 million during the three months ended March 31, 2001 and $409,000 during
the three months ended March 31, 2000. As of March 31, 2001, we anticipate that
total charges to be recognized in future periods from amortization of deferred
stock compensation will be $3.0 million for the remaining nine months of 2001,
$2.7 million for the year ending December 31, 2002, $1.1 million for the year
ending December 31, 2003 and $119,000 for the year ending December 31, 2004.

Our ability to achieve our identified goals or objectives is dependent upon
many factors, some of which are out of our control, and we may not achieve our
identified goals or objectives.

Our quarterly operating results will depend upon many factors, including the
expiration or termination of research contracts with our collaborators, the size
of future collaborations, the success rate of our technology collaborations
leading to milestones and royalties, and general and industry-specific economic
conditions which may affect research and development expenditures. As a
consequence, our revenues in future periods are likely to fluctuate
significantly from period to period.

THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2000

REVENUES. We recorded revenues of $5.4 million during the three months
ended March 31, 2001, compared to no revenue during the three months ended
March 31, 2000. The revenues for the three months ended March 31, 2001 were
primarily attributable to our collaborations with Eli Lilly and Taisho, both
significant customers, which included research funding, milestone payments, and
technology access and development fees. Research funding is recognized as
revenue when the services are rendered. Revenues from technology access and
development fees are recognized over the term of the collaboration. Revenues
from non-refundable research and development fees are recognized as the services
are performed. Revenues from milestone payments are recognized when the
milestone is achieved. Our collaborators often pay us before we recognize the
revenue, and these payments are deferred until earned. As of March 31, 2001, we
had deferred revenues totaling approximately $1.6 million.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased $1.5 million to $3.9 million for the three months ended March 31, 2001
from $2.4 million for the three months ended March 31, 2000. The increase was
due primarily to increased personnel expenses of $784,000, related
infrastructure expenses of $444,000 and lab supply expenses of $272,000 to
support the personnel in order to expand the application of our technology. As
of March 31, 2001, all research and development costs have been expensed as
incurred. We believe that continued investment in research and development is
critical to attaining our strategic objectives and we expect these expenses to
continue and to increase.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $576,000 to $1.0 million for the three months ended March 31, 2001
from $424,000 for the three months ended March 31, 2000. The increase was a
result of increased personnel added to support a growing company as well as
supporting the needs of a public company. General and administrative expenses
consist primarily of salaries and related personnel expenses for executive,
finance and administrative personnel, professional fees, and other general
corporate expenses. We expect that our general and administrative expenses will
increase to support our growth and requirements as a public company.

AMORTIZATION OF DEFERRED COMPENSATION. Deferred compensation for options
granted to employees has been determined as the difference between the exercise
price and the fair value of our common stock, as estimated by us for financial
reporting purposes, or quoted market value after July 28, 2000, on the date
options were granted. Deferred compensation for options granted to consultants
was

determined in accordance with Statement of Financial Accounting Standards
No. 123 as the fair value of the equity instruments issued and is periodically
remeasured as the underlying options vest in accordance with EITF 96-18.

For the three months ended March 31, 2001, we recorded amortization of
deferred compensation of approximately $1.3 million, compared to $409,000 for
the three months ended March 31, 2000.

INTEREST INCOME. Interest income increased to $2.0 million for the three
months ended March 31, 2001 from $157,000 for the three months ended March 31,
2000, due to higher average cash balances primarily due to our initial public
offering in July 2000 through which we raised net cash proceeds of
$113.9 million.

INTEREST EXPENSE. Interest expense decreased $20,000 to $40,000 for the
three months ended March 31, 2001 from $60,000 for the three months ended
March 31, 2000. This decrease is due to the convertible note to a related party
that was converted into common stock in July 2000.

OTHER INCOME. Other income increased $84,000 to $97,000 for the three
months ended March 31, 2001 from $13,000 for the three months ended March 31,
2000. This increase is due primarily to the rental income we earned in 2001
related to the lease with a tenant we assumed when we acquired a facility we had
been leasing.

YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31, 1999

REVENUES. We recorded revenues of $7.7 million for the year ended
December 31, 2000, as compared to no revenue for the year ended December 31,
1999. The revenues for the year ended December 31, 2000 were primarily
attributable to our collaborations with Eli Lilly and Taisho, which included
research funding, milestone achievements, and technology access and development
fees. Research funding is recognized as revenue when the services are rendered.
Revenues from technology access and development fees are recognized ratably over
the term of the collaboration. Revenues from milestones are recognized when the
milestone is achieved. If our collaborators pay us before we recognize the
revenues, we defer revenue recognition of these payments until earned. As of
December 31, 2000 we had deferred revenues totaling approximately $705,000.

RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
increased $3.8 million to $12.1 million for the year ended December 31, 2000,
from $8.3 million for the year ended December 31, 1999. This increase was
primarily due to increased personnel expenses of $2.4 million, related
infrastructure costs of $1.1 million and lab supply expenses of $1.4 million in
order to expand the application of our technology. The increase was offset by
reduced expenses of $1.1 million related to the development of T-82 for which we
initiated our first Phase I clinical trial in early 1999, and which was
completed in late 1999.

GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative
expenses increased $900,000 to $2.7 million for the year ended December 31,
2000, from $1.8 million for the year ended December 31, 1999. This increase was
primarily due to increased personnel expenses related to additional personnel
hired in the accounting, legal and general administration departments. This
increased staffing was necessary to manage and support our continued growth as
well as to accommodate the demands associated with operating as a public
company.

AMORTIZATION OF DEFERRED COMPENSATION. We recorded amortization of deferred
compensation of approximately $4.3 million for the year ended December 31, 2000
as compared to $378,000 for the year ended December 31, 1999.

INTEREST INCOME. Interest income increased $4.2 million to $4.6 million for
the year ended December 31, 2000, from $447,000 for the year ended December 31,
1999. The increase was primarily

attributable to higher average levels of cash and cash equivalents in the year
ended December 31, 2000, as a result of our initial public offering in
July 2000.

INTEREST EXPENSE. Interest expense increased $54,000 to $220,000 for the
year ended December 31, 2000 from $166,000 for the year ended December 31, 1999.
This increase represents interest incurred on our equipment leases.

GAIN ON INVESTMENT. For the year ended December 31, 2000 we recorded a gain
on the sale of liquid short-term investments in the amount of $576,000.

OTHER INCOME. Other income increased $48,000 to $57,000 for the year ended
December 31, 2000 from $9,000 for the year ended December 31, 1999. This
increase represents rental income received from subleasing office space.

NON-CASH PREFERRED STOCK CHARGE. We recorded a non-cash preferred stock
charge of $22.4 million for the year ended December 31, 2000. This non-cash
preferred stock charge related to the issuance of our Series E preferred stock
in January 2000, our Series F preferred stock in March 2000 and our Series G
preferred stock in April 2000, which were converted into shares of our common
stock upon the closing of our initial public offering. We recorded the non-cash
preferred stock charge at the dates of issuance by increasing the net loss
applicable to common stockholders, without any effect on total stockholders'
equity. The amount increased our net loss per share applicable to common
stockholders for the year ended December 31, 2000.

YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEAR ENDED DECEMBER 31, 1998

RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
increased $5.7 million to $8.3 million for the year ended December 31, 1999,
from $2.6 million for the year ended December 31, 1998. This increase was
primarily due to increased personnel related expenses of $2.5 million and lab
supply expenses of $1.3 million in order to expand the application of our
technology, expenses of $1.5 million associated with our first Phase I clinical
trial of T-82 which was initiated in early 1999, and facility related expenses
of $358,000 as a result of our facility expansion.

GENERAL AND ADMINISTRATIVE EXPENSES. Our general and administrative
expenses increased $1.1 million to $1.8 million for the year ended December 31,
1999, from $729,000 for the year ended December 31, 1998. This increase was
primarily related to five additional personnel hired during 1999 to help support
the growing responsibilities of the accounting, legal and general administration
departments.

AMORTIZATION OF DEFERRED COMPENSATION. We recorded amortization of deferred
compensation of approximately $378,000 for the year ended December 31, 1999.
There was no amortization of deferred compensation in the year ended
December 31, 1998.

INTEREST INCOME. Interest income increased $405,000 to $447,000 for the
year ended December 31, 1999, from $42,000 for the year ended December 31, 1998.
The increase was primarily attributable to higher levels of cash and cash
equivalents in 1999 from the proceeds of the sale of our Series D convertible
preferred stock in January 1999.

INTEREST EXPENSE. Interest expense increased $72,000 to $166,000 for the
year ended December 31, 1999 from $94,000 for the year ended December 31, 1998.
This increase represents interest incurred on our equipment leases as well as
interest accrued on our other debt.

OTHER INCOME. Other income was $9,000 for the year ended December 31, 1999,
compared to none for the year ended December 31, 1998. The other income reported
in 1999 represents rental income received from subleasing office space.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2001, we had an accumulated deficit of $19.6 million. Our
accumulated deficit is the result of expenses incurred in connection with our
research and development activities and general and administrative expenses.
Although we have historically funded our operations primarily through public and
private equity financings, for the three months ended March 31, 2001, the cash
we received from our collaborators, together with our interest income from our
investments, was sufficient to fund our operations.

As of March 31, 2001, we had $125.5 million in cash and cash equivalents
compared to $144.4 million in cash and cash equivalents as of December 31, 2000.
The decrease of $18.9 million is primarily attributable to our acquisition of
Bunsen Rush Laboratories for $15.0 million in cash in February 2001, the
purchase of our facility for $5.4 million in cash in January 2001 as well as
other equipment purchases totaling $2.8 million. This was partially offset by
cash provided by operations of $4.4 million.

Net cash provided by operating activities was approximately $4.4 million
during the three months ended March 31, 2001. The primary source of cash for the
three months ended March 31, 2001 was net income in the period, adjusted for
non-cash expenses, including amortization of deferred compensation, amortization
of acquired technology and other purchased intangibles, and changes in operating
assets and liabilities. Net cash used in operating activities was approximately
$4.1 million during the year ended December 31, 2000, $8.7 million during the
year ended December 31, 1999 and $2.4 million during the year ended
December 31, 1998. The primary use of cash was to fund our net losses for these
periods, adjusted for non-cash expenses, including $4.3 million in non-cash
amortization of deferred compensation during the year ended December 31, 2000,
and changes in operating assets and liabilities.

Net cash used in investing activities was approximately $23.2 million during
the three months ended March 31, 2001. Net cash used in investing activities for
the three months ended March 31, 2001 was primarily the result of the
acquisition of Bunsen Rush Laboratories, our facility purchase and the
acquisition of laboratory and computer equipment, leasehold improvements and
furniture and fixtures. Net cash used in investing activities was approximately
$2.2 million during the year ended December 31, 2000, $2.1 million during the
year ended December 31, 1999 and $593,000 during the year ended December 31,
1998. Net cash used in investing activities was primarily the result of the
acquisition of laboratory and computer equipment, leasehold improvements and
furniture and fixtures.

Net cash used in financing activities was approximately $75,000 during the
three months ended March 31, 2001. The net cash used in financing activities for
the three months ended March 31, 2001 was primarily from principal payments on
our capital leases offset by proceeds from issuances of our common stock. Net
cash proceeds from financing activities was approximately $145.3 million during
the year ended December 31, 2000, $16.0 million during the year ended
December 31, 1999 and $1.7 million during the year ended December 31, 1998. The
net cash proceeds from financing activities during the year ended December 31,
2000 was primarily from net proceeds of $113.9 million from our initial public
offering in July 2000 as well as $30.1 million from the issuance of preferred
stock. The net cash proceeds from financing activities for the years ended
December 31, 1999 and 1998 were primarily from the issuance of preferred stock.

We lease a corporate research and development facility under a lease which
expires in April 2013. The lease provides us with options to extend for two
additional five-year periods. On June 15, 2001, we entered into a letter of
intent to purchase property located at 6154 Nancy Ridge Drive for approximately
$5.1 million. The completion of the purchase is subject to a number of
conditions, including the negotiation of a purchase agreement satisfactory to us
and the seller and our due diligence of the property. We have also entered into
capital lease agreements for various lab and office equipment. The terms of
these capital lease agreements range from 48 to 60 months. At December 31, 2000
current total minimum annual payments under these capital leases were
approximately $614,000 in 2001, $614,000 in 2002, $480,000 in 2003 and $45,000
in 2004.

In January 2001, we purchased a facility we were previously leasing, as well
as the adjoining building, at 6138-6150 Nancy Ridge Drive in San Diego for cash
of $5.4 million. Of the 52,000 square foot facility, 26,000 square feet is
leased to a tenant until August 2001.

In February 2001, we acquired all of the outstanding capital stock of Bunsen
Rush Laboratories, a privately-held research-based company, for cash of
$15.0 million.

Based on the research collaborations we already have in place and our
current internal business plan, we expect to hire an additional 30 to 50
employees, primarily scientists, by the end of 2001. While we believe that our
current capital resources and anticipated cash flows from collaborations will be
sufficient to meet our capital requirements for at least the next two years, we
cannot assure you that we will not require additional financing before such
time. Our funding requirements may change at any time due to technological
advances or competition from other companies. Our future capital requirements
will also depend on numerous other factors, including scientific progress in our
research and development programs, additional personnel costs, progress in
pre-clinical testing, the time and cost related to proposed regulatory
approvals, if any, and the costs of filing and prosecution of patent
applications and enforcing patent claims. We cannot assure you that adequate
funding will be available to us or, if available, that such funding will be
available on acceptable terms. Any shortfall in funding could result in the
curtailment of our research and development efforts.

INCOME TAXES

As of December 31, 2000, we had approximately $12.2 million of net operating
loss carryforwards and $1.6 million of research and development tax credit
carryforwards for federal income tax purposes. These carryforwards expire on
various dates beginning in 2012. These amounts reflect different treatment of
expenses for tax reporting than are used for financial reporting. United States
tax law contains provisions that may limit our ability to use net operating loss
and tax credit carryforwards in any year, or if there has been a significant
ownership change. Any future significant ownership change may limit the use of
our net operating loss and tax credit carryforwards.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk for changes in interest rates relates primarily
to our cash equivalents. We do not use derivative financial instruments in our
investment portfolio. Our cash and investment policy emphasizes liquidity and
preservation of principal over other portfolio considerations. We select
investments that maximize interest income to the extent possible within these
guidelines. If market interest rates were to decrease by 1% from March 31, 2001,
we would expect future interest income from our portfolio to decline by less
than $1.3 million over the next 12 months. The modeling technique used measures
the change in fair values arising from an immediate hypothetical shift in market
interest rates and assumes ending fair values include principal plus earned
interest.

ACCOUNTING PRONOUNCEMENTS

In December 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue
Recognition. SAB 101 provides guidance in applying generally accepted accounting
principles to various revenue recognition issues and specifically addresses
revenue recognition for upfront, non-refundable fees earned in connection with
research collaboration arrangements. Under SAB 101, these fees should generally
be recognized over the term of the agreement. We believe our revenue recognition
policy is in compliance with SAB 101 and we will continue to apply this
accounting principle to our future collaborations.

BUSINESS

OUR COMPANY

We are an emerging biopharmaceutical company focused principally on
discovering drugs that target G protein-coupled receptors, called GPCRs. GPCRs
are an important part of the pharmaceutical and biotechnology industries' drug
discovery efforts. Of the leading 100 pharmaceutical products, based on 2000
revenues, 39 wholly or in part act on GPCRs. In 2000, these GPCR-based
pharmaceutical products represented over $42.6 billion in sales, and included
Claritin-Registered Trademark- for allergies, Zantac-Registered Trademark- for
gastric ulcers, Imitrex-Registered Trademark- for migraines and
Cozaar-Registered Trademark- for hypertension.

We have developed CART, a new technology that we use to identify drug leads
more efficiently than traditional drug discovery techniques. We use CART to
discover drug leads by genetically altering GPCRs and other receptors to mimic
the biological response that occurs when the native ligand binds to the
receptor. We refer to these genetically altered receptors as CART-activated
receptors. We use CART-activated receptors as a screening tool to identify drug
leads that alter the biological response of the receptor. These drug leads are
optimized and tested to develop drug candidates. Using CART, we have discovered
drug leads that have demonstrated pharmacological activity in pre-clinical, or
animal, studies through our own internal research and drug development efforts,
as well as through those of our collaborators. Additionally, we believe that
CART is applicable to other human receptor classes, such as tyrosine kinase
receptors, or TKRs, as well as to non-human receptors for the discovery of
animal therapeutics and agricultural products.

We enter into drug discovery and development collaborative arrangements with
leading life science industry participants. To date, we have entered into
collaborative relationships with a number of pharmaceutical and biotechnology
companies, including Eli Lilly and Company, Taisho Pharmaceutical Co., Ltd.,
Fujisawa Pharmaceutical Co., Ltd. and Lexicon Genetics, Inc. As of March 31,
2001, we have recognized aggregate revenues totaling $12.9 million from our
collaborative partners.

We recently initiated Project Genesis, an internal drug discovery program
that focuses on all GPCRs of therapeutic interest in the human genome. Project
Genesis will use CART, Melanophore Technology, a recently acquired screening
technology that we believe is highly complementary to CART, and customized gene
expression microarrays developed for us by an outside vendor. We believe Project
Genesis will generate a significant advantage for us in the field of GPCR drug
discovery and will provide us with substantial intellectual property that we
expect will establish a barrier to entry by potential competitors.

THE DRUG DISCOVERY PROBLEM

Diseases in humans are caused by the abnormal function of cells. Both normal
and abnormal cellular function is principally the result of communication
between cells. This cellular communication occurs when a ligand is released from
a cell and binds to a receptor on the surface of that cell or another cell. This
binding triggers the initiation of various signals within that cell, resulting
in changes in cellular function. By interacting with the receptor to mimic or
block ligand-receptor binding, drugs affect abnormal cellular function and
thereby regulate the disease process.

Receptors are classified into categories based upon similarities in their
biochemical and structural properties. They are located in various tissues
throughout the body and affect a variety of cellular functions. There are four
principal classes of human receptors: GPCRs; TKRs; ligand-gated ion channel
receptors; and intracellular receptors. We focus primarily on GPCRs because they
are the predominant class of receptors involved in cellular function.

The ligand that naturally binds to a receptor and activates or inhibits a
biological response is referred to as a receptor's native ligand. A receptor for
which the native ligand has been discovered is called a known receptor, while a
receptor for which the native ligand has not been identified is called

an orphan receptor. With the recent completion of the sequencing of the human
genome, scientists now believe that there are about 40,000 genes within the
human genome. Genomics researchers estimate that approximately 2%, or
approximately 800, of these genes are therapeutically relevant GPCRs, the
majority of which are orphans.

Traditional receptor-based drug discovery techniques seek drug leads that
imitate or inhibit ligand binding to the receptor. These traditional techniques
cannot be applied to orphan GPCRs until the native ligands for these orphan
GPCRs are identified. The process of identifying native ligands is very
uncertain, generally involving many stages of tissue extraction and extensive
purification. To our knowledge, of the hundreds of orphan GPCRs that have been
identified, only a limited number of examples exist where a novel native ligand
has been discovered by intentionally targeting an orphan GPCR. Even when
successful, identifying the native ligand typically requires four to five years
and costs millions of dollars per GPCR. For example, a GPCR called GPR 14 was
discovered in 1995, but its native ligand, urotensin II, was not identified
until 1999. The process of identifying native ligands is typically the step that
limits the rate at which drugs are discovered at receptor targets.

OUR TECHNOLOGY SOLUTIONS

CART

We do not use, and therefore do not need to identify, the receptor's native
ligand for our drug discovery efforts. We use CART to discover drug leads by
CART-activating receptors to mimic the biological response that occurs when the
native ligand binds to the receptor. Therefore, CART avoids a major bottleneck
in drug discovery efforts at orphan receptors.

CART can be applied broadly to GPCRs because all GPCRs have highly similar
structural elements, consisting of:

- three extracellular loops on the outside of the cell

- three intracellular loops on the inside of the cell

- seven regions that cross through the cell surface, or membrane, and
connect the extracellular and intracellular loops

When a ligand binds to the extracellular portion of the GPCR, changes occur
to the intracellular portion of the GPCR that permit a signaling molecule
located within the cell, called a G protein, to bind to the intracellular
portion of the GPCR. This leads to further intracellular changes, resulting in a
biological response within the cell.

[DIAGRAM DEPICTING GPCR-MEDIATED BIOLOGICAL RESPONSE]

Under normal physiological conditions, a GPCR exists in equilibrium between
two different states: an inactive state and an active state. When the GPCR's
equilibrium shifts to an active state, the GPCR is able to link to a G protein,
thus producing a biological response. When the GPCR's equilibrium shifts to an
inactive state, the receptor is typically unable to link to a G protein, and
therefore unable to produce a biological response. When a native ligand binds to
the GPCR, the GPCR's equilibrium shifts and the GPCR is stabilized in the active
state.

[DIAGRAM DEPICTING LIGAND-DEPENDENT GPCR ACTIVATION]

By altering the genetic structure of a GPCR, CART stabilizes the GPCR in the
active state in the absence of the native ligand.

[DIAGRAM DEPICTING CART-ACTIVATED GPCR]

Drug screening and discovery targeting GPCRs using CART is comprised of four
stages:

- altering the molecular structure of an intracellular loop or intracellular
portion of the GPCR to generate a CART-activated form of the GPCR

- introducing the CART-activated form of the receptor into mammalian cells,
which, in turn, manufacture the CART-activated form of these receptors at
the cell surface

- analyzing the cells containing the CART-activated GPCR to detect
biological responses that result from the linking of the CART-activated
GPCR to a G protein

- screening chemical libraries of small molecule compounds against the cell
membranes containing the CART-activated GPCR to identify compounds that
interact with the GPCR

Screening using CART allows us to simultaneously identify drug leads that
act as receptor inhibitors to decrease the detected biological responses, or act
as receptor activators to increase the detected responses. Therefore, CART
allows us to discover drug leads that either inhibit or enhance biological
activity.

CART is also useful for identifying drug leads that reduce cellular
responses resulting from ligand-independent activity of receptors. Drugs that
reduce cellular responses, termed inverse agonists, are the preferred drugs for
treating diseases in which ligand-independent receptor activity may be
important, such as schizophrenia. In general, traditional ligand-based drug
screening techniques can only be used to identify neutral antagonists, which do
not affect the ligand-independent activity of the receptor. We can directly
identify inverse agonists using CART by screening for ligand-independent
receptor activity. We believe the inverse agonists that we identify will possess
improved properties over neutral antagonists because they inhibit both
ligand-induced as well as ligand-independent activity.

In addition, because CART does not require the use of the native ligand, we
are not limited to finding compounds that bind to a receptor at the receptor's
ligand binding site. Instead, CART exposes the entire receptor surface to
potential drug leads, allowing for the detection of drug leads which bind at any
point on the receptor surface. We believe that this feature of CART is important
not only with respect to orphan receptors, but to known receptors as well,
because this feature of CART provides us with the ability to discover new drugs
with unique mechanisms of action.

In summary, we believe that CART offers several key advantages for drug
discovery over other screening techniques. Screening CART-activated receptors:

- does not require prior identification of the native ligand for an orphan
receptor

- enhances the detection of, and simultaneously identifies, both receptor
inhibitor and receptor activator drug leads

- allows for the identification of drug leads that inhibit both
ligand-induced and ligand-independent activity

- provides the ability to discover novel and improved therapeutics at known
receptor targets

MELANOPHORE TECHNOLOGY

Melanophore Technology is a unique screening technique based upon the use of
pigment bearing cells called melanophores. Melanophores undergo a color change
in response to light or stimulation by chemicals. Melanophore Technology can be
used to identify compounds that interact with cell surface receptors, including
known and orphan GPCRs and TKRs. Melanophore Technology provides a broadly
applicable, simple and sensitive means to detect cellular signals and eliminates
the need for radioactive or fluorescent screening techniques. We use Melanophore
Technology to identify both inverse agonists and agonists to CART-activated
GPCRs.

While we currently, and anticipate that we will continue to, primarily use
Melanophore Technology in combination with CART-activated receptors, Melanophore
Technology can also be used independent of CART. We believe that this will
provide us with the opportunity to license Melanophore Technology to other
biotechnology and pharmaceutical companies for use in their drug discovery
efforts.

PROJECT GENESIS

We recently initiated Project Genesis, an internal drug discovery program
using a combination of CART, Melanophore Technology and other technologies that
we believe will allow us to discover a substantial number of unique small
molecule drug leads and drug candidates. With the recent completion of the
sequencing of the human genome, we view Project Genesis as a logical extension
of our scientific and business capabilities. Indeed, to the extent that the
human genome project has identified all of the genes within humans, we believe
that Project Genesis will allow us to discover new drug leads at all of the
estimated 800 therapeutically relevant GPCRs.

Project Genesis is comprised of the following processes:

- ACQUIRING ALL OF THE ESTIMATED 800 THERAPEUTICALLY RELEVANT GPCRS. We
expect to acquire these GPCRs through our own internal research efforts as
well as from outside sources. To date, we have secured more than half of
the estimated 800 therapeutically relevant GPCRs through our own research
efforts. We expect to complete this portion of Project Genesis by the end
of 2001.

- DETERMINING THE LOCATION AND RELATIVE EXPRESSION LEVELS OF GPCRS. An
outside vendor is creating customized GPCR probe microarrays for us using
our proprietary sequence information. We intend to use these probe
microarrays to determine the location of GPCRs and their relative
expression levels in normal and diseased tissues. This will allow us to
prioritize GPCRs of therapeutic interest for drug discovery screening.

- PREPARING THE GPCRS FOR SCREENING. We will build a library of full-length
GPCRs that we will CART-activate and clone in preparation for expression
and high throughput screening.

- SCREENING THE CART-ACTIVATED GPCRS. We will use Melanophore Technology and
other techniques to screen all of the GPCRs that demonstrate
CART-activation using our library of chemical compounds to identify
potential drug leads.

- IDENTIFYING POTENTIAL DRUG CANDIDATES. We will use medicinal chemistry to
develop drug candidates for animal testing and potential clinical
development.

We may enter into collaborative arrangements at any stage of Project Genesis
with respect to any CART-activated receptor, drug leads or drug candidates that
we discover.

OUR STRATEGY

Our goal is to become a leader in the discovery of novel, proprietary drugs
that target human and non-human GPCRs. We also apply CART to other human and
non-human receptors. The major elements of our strategy to achieve this goal
are:

EXECUTE PROJECT GENESIS TO ACCELERATE DRUG DISCOVERY AT ALL THERAPEUTICALLY
RELEVANT GPCRS

We view Project Genesis as the next logical scientific and business
extension of the sequencing of the human genome that will allow us to use our
technologies to rapidly discover novel drug leads that target therapeutically
relevant GPCRs. We believe that Project Genesis will focus and accelerate our
internal research efforts to enable us to become the leader in the discovery of
drug candidates that target GPCRs.

ENTER INTO STRATEGIC COLLABORATIONS

We have entered into collaborations with Eli Lilly, Taisho and Fujisawa
under which we CART-activate a significant number of GPCR targets and may
receive additional revenues in the form of development fees, milestone payments
and royalties on products, if any, developed to target these GPCRs. We intend to
enter into additional strategic collaborations using CART and Melanophore
Technology.

USE CART TO IDENTIFY NOVEL, PROPRIETARY DRUG LEADS THAT HAVE UNIQUE
MECHANISMS OF ACTION

CART allows us to identify drug leads that act as receptor inhibitors to
reduce biological activity, or receptor activators to increase biological
activity. Therefore, CART provides the opportunity to simultaneously discover
multiple drug leads with unique mechanisms of action for each receptor target.

APPLY CART TO OTHER HUMAN RECEPTORS AND NON-HUMAN RECEPTORS FOR HUMAN
THERAPEUTIC, AGRICULTURAL AND OTHER APPLICATIONS

We believe CART can also be applied to other types of human receptors, such
as TKRs, which are often implicated as important factors in various diseases,
such as breast cancer. We are also applying CART to non-human receptors for a
variety of applications including plant receptors to discover chemical growth
factors, insect receptors to discover insect control agents and viral receptors
to discover novel anti-viral drug leads. We have CART-activated a number of
these other types of receptors and intend to pursue opportunities developed from
these receptors.

CONTINUE TO PROTECT AND EXPAND OUR INTELLECTUAL PROPERTY RIGHTS

A substantial byproduct of Project Genesis will be the intellectual property
that results from CART-activation of all therapeutically relevant GPCRs and the
small molecule drug leads that we may discover. We have filed approximately 136
independent patent applications with the United States Patent and Trademark
Office, and are filing some of these patent applications worldwide. Four United
States patents have been issued to us and we also own two issued patents for
Melanophore Technology. We believe that we will be issued additional patents on
CART, chemical compounds that we discover using CART-activated receptors and on
our CART-activated receptors because our technology

genetically modifies these receptors and changes their function. We intend to
continually seek ways to vigorously protect and enforce our rights with respect
to our intellectual property.

INVEST IN OR ACQUIRE COMPLEMENTARY TECHNOLOGIES

We recently acquired Bunsen Rush Laboratories and through it, Melanophore
Technology. We will continue to evaluate investment or acquisition opportunities
in new technologies that complement our existing technology.

THERAPEUTIC APPLICATIONS OF CART

Over the past four years, we have obtained the full-length gene sequences of
407 human GPCRs and made them available for CART-activation and screening.
Through the use of CART, we have successfully identified compounds that inhibit
or activate a number of known and orphan receptor targets.

ORPHAN GPCRS

An important element of CART involves using the gene sequences of orphan
GPCRs to understand and define the tissue and cellular distribution of these
GPCRs. The gene sequences provide us with the necessary tools to locate the
orphan receptors in tissues. Once we have identified the location of an orphan
receptor in tissues, we can determine the normal function of the orphan receptor
and compare that function to the function of the orphan GPCR in diseased
tissues. We then use CART to screen the targeted receptor for compounds that can
be employed to verify the proposed receptor function.

We have prioritized and applied CART to orphan GPCRs as having high
potential value as drug discovery targets against specific diseases or
indications, based upon the distribution of the GPCR in specified tissues.
Examples of some of our more advanced CART programs are summarized below.

OBESITY. National Institutes of Health statistics indicate that
approximately 100 million adults in the United States are overweight and that
22% of these are considered clinically obese. The few currently approved drugs
for the treatment of obesity in the United States act as either appetite
suppressants or blockers of fat absorption. However, cardiovascular or
gastrointestinal side effects may limit the long-term effectiveness of these
drugs. Consequently, more effective therapeutics are urgently needed for this
major health problem.

We have an ongoing program directed towards the development of novel
anti-obesity drugs. We have identified a number of orphan GPCRs on brain cells
related to the control of feeding and metabolism, including the 18F, 19U, 19X
and 19NY GPCRs. For example, we have discovered an over-abundance of the 18F
GPCR in brain metabolism centers of genetically obese rats. We believe that this
discovery indicates that overactivity of this GPCR may be associated with
obesity.

We are using CART to identify drug leads that inhibit the activity of the
18F GPCR. Repeated administration of the drug leads we have identified has
resulted in reduced food intake and sustained weight loss in normal laboratory
animals. Similar results were also obtained in a diet-induced animal model of
human obesity. In this diet-induced animal model, these drug leads also
increased fat metabolism and resulted specifically in a loss of fat mass. We
have found that the 18F GPCR is also located on human fat cells. Therefore, we
believe that these drug leads may provide the basis for a novel approach to the
treatment of human obesity by simultaneously reducing food intake and increasing
fat metabolism.

Our anti-obesity drug program demonstrates the advantages of CART for rapid
drug lead discovery. The process of discovering promising drug leads took
approximately 18 months beginning from our initial discovery of the
over-abundance of the 18F GPCR in genetically obese animals to the animal
testing of the drug leads that we discovered using CART. In January 2001, we
licensed our 18F program to Taisho. Our 18F program includes the 18F receptor as
well as several drug leads that we discovered using the 18F receptor.

CANCER. We have identified several orphan GPCRs, including the 18AD, 20WW,
20PO and 19Y GPCRs, which we believe represent therapeutic targets for the
treatment of a variety of cancers. These orphan GPCRs are attractive therapeutic
targets because they have been shown to be present in abnormally high levels in
ovarian, colorectal, gastrointestinal and uterine cancer cells and cause
unwanted proliferation of cells in laboratory experiments.

CARDIOVASCULAR DISEASE. We have identified several orphan GPCRs, including
the 19L and 20RH GPCRs, that are located within the cardiovascular system, such
as on heart tissues and blood vessel walls. The 19L receptor has been localized
to the smooth muscle cells of blood vessel walls and is regulated under
conditions associated with vessel damage and artherosclerotic damage. The 20RH
receptor has been localized to heart myocytes and is regulated in both IN VITRO
and IN VIVO models associated with cardiomyopathy. Using CART, we aim to
identify small molecule drug leads which may have potential to treat diseases
related to aberrant cardiovascular function.

DIABETES. One of the orphan GPCRs that we discovered, the 19AJ GPCR, is
specifically located on insulin producing beta cells in the pancreas. Normally,
glucose stimulates the beta cell to produce insulin, but in diabetes the beta
cell often becomes less sensitive to glucose and the ability of the beta cell to
produce insulin is impaired. The 19AJ GPCR appears to make the beta cells more
responsive to glucose concentrations, resulting in enhanced insulin release. By
applying CART to the 19AJ GPCR, we will seek to discover drug candidates to
treat diabetes, which, according to the National Institutes of Health, affected
approximately 15.7 million people in the United States in 1997.

INFLAMMATION. We have identified several orphan GPCRs, including the 18AF
and 19W GPCRs, that may mediate inflammatory responses in various locations of
the body. Our preliminary data suggest that the 18AF GPCR may regulate brain
cells related to inflammation. Based upon its sequence structure, the 18AF GPCR
appears to be related to a group of GPCRs called chemoattractant receptors.
Chemoattractant and chemokine receptors are known to be involved in the
inflammation process, and brain inflammation is involved in a number of
neurodegenerative disorders, including stroke. The number of 19W GPCRs is
increased in dying cells during inflammation, suggesting that the 19W GPCR may
be involved in controlling the process of cell death. We have CART-activated the
19W GPCR and have developed an assay for screening of chemical compounds against
this GPCR. Drug leads that modulate the activity of these GPCRs may provide a
unique therapeutic approach to the treatment or mediation of inflammatory
responses. According to the National Institutes of Health, diseases involving
inflammation afflict over 25 million people in the United States.

ALZHEIMER'S DISEASE. Several of our orphan GPCR targets are located on
cells within the central nervous system, including the 18L GPCR. The 18L GPCR is
located on nerve cells in an area of the brain called the hippocampus, which is
responsible for controlling memory function. In Alzheimer's Disease, normal
memory processes in the hippocampus are severely impaired. We believe drug leads
that modulate the 18L GPCR could be useful for controlling memory function and
for the treatment of symptoms of Alzheimer's Disease, which, according to the
National Institutes of Health, affects four million people in the United States.

KNOWN GPCRS

Although we focus on orphan GPCRs, we also apply CART to known GPCRs. We
believe that the application of CART to known GPCRs will identify novel classes
of drug candidates that may be more effective and may have fewer side effects
than existing drugs that target known GPCRs.

Our principal advantage in applying CART to known GPCRs is our ability to
directly identify drug leads that act as inverse agonists, which cannot be
directly identified using traditional ligand-based screening techniques. Inverse
agonists are particularly relevant in treating diseases in which ligand-
independent GPCR activity, or overactivity, is implicated.

We have identified drug leads that are capable of inhibiting both
ligand-independent and ligand-dependent activity at selected known GPCR targets.
We are currently developing drug leads and drug candidates that target these
overactive known GPCRs to treat the related diseases. Our most advanced program
targets the serotonin 5HT2A GPCR for potential treatment of schizophrenia and
other psychiatric disorders.

According to the National Institutes of Health, approximately 1% of the
population develops schizophrenia during their lifetime. More than two million
Americans suffer from schizophrenia in a given year. We have tested currently
available anti-psychotic drugs and have found that they act as inverse agonists
at a known GPCR, referred to as the 5HT2A GPCR. Using CART, we have discovered
and are developing a number of new drug leads that act as inverse agonists at
the 5HT2A GPCR. One such drug lead, which we refer to as AR116081, is the
subject of several issued United States patents. This drug lead has displayed
activities in tests involving laboratory animals indicating that AR116081 could
be useful in treating psychiatric disorders such as schizophrenia and
depression. Moreover, AR116081 possesses a higher degree of receptor selectivity
than currently marketed anti-psychotics, which suggests that this compound may
be more effective than these other drugs. To date, AR116081 exhibits no evidence
of side effects in laboratory animals. In addition to developing AR116081 as a
single therapy for possible use in the treatment of chronic schizophrenia, we
have been exploring the further utility of this drug lead as a combination
product with presently approved therapeutics to treat acute psychosis. In this
approach, AR116081 is being analyzed to determine if it can impact dopamine
circuits, which are overactive in schizophrenic patients. This could allow lower
dosages of currently approved anti-psychotics to be administered in combination
with AR116081, which may avoid the locomotor side-effects which are frequently
observed with higher, clinically effective, dosages of typical anti-psychotics.
We have already confirmed the ability of AR116081 to act synergistically with
clinically approved anti-psychotics in animal models.

Our anti-psychotic drug program also demonstrates the advantages of CART for
rapid drug lead discovery. The process of discovering promising drug leads took
approximately 18 months beginning from the application of CART to the 5HT2A GPCR
to the animal testing of the candidates that we discovered using CART. We intend
to either enter into a collaboration to further expand our anti-psychotic drug
program with the goal of selecting one or more of our novel anti-psychotic drug
leads that target the 5HT2A GPCR, for future clinical development, or to pursue
the clinical development of these potential anti-psychotic drug leads such as
AR116081 by ourselves.

NON-THERAPEUTIC APPLICATIONS OF CART

Over the past four years, we have also obtained the full-length gene
sequences of 334 olfactory and taste GPCRs. We have also obtained five non-human
receptors, including plant, viral and insect receptors.

OLFACTORY AND TASTE GPCRS. A specialized multigene family of GPCRs has been
identified in the nasal membrane and is responsible for the sense of smell.
Another family of GPCRs has recently been discovered in the tongue and is
believed to be responsible for the perception of taste. We are applying

CART to a number of olfactory and taste GPCRs to identify novel compounds that
we believe will be of potential commercial value in the fragrance and food
additive industries.

PLANT GPCRS. Plants respond to a variety of environmental and internal
signals that regulate their growth and development. GPCRs have recently been
identified in a variety of plants and have been implicated in the action of a
variety of plant hormones. We are presently applying CART to plant GPCRs in an
attempt to identify novel regulators of the life cycle of plants that may affect
crop growth and development.

VIRAL GPCRS. GPCRs are involved in either replication or infection in a
number of viruses. Some herpes viruses, including the Kaposi's
sarcoma-associated virus, have GPCRs within their genome which are important for
replication. Other GPCRs appear necessary for primary infection. For example,
HIV infects cells by binding to a GPCR that transports the virus into cells. A
number of orphan GPCRs have been identified which appear to act in a similar
manner for other viruses. Our goal is to identify novel anti-viral drugs using
CART.

INSECT GPCRS. Insect genomes also include GPCRs, and we have begun the
process of applying CART to insect GPCRs in an attempt to identify compounds
that may offer the potential for improved and environmentally safer insect
control agents. Our goal is to use CART-activated insect GPCRs to find compounds
that selectively reduce pest reproduction and feeding behavior.

TYROSINE KINASE RECEPTORS. In addition to applying CART to orphan GPCRs, we
are also applying CART to other human receptor classes, including orphan TKRs. A
number of orphan TKRs have been located on cancerous tissues and may be involved
in excessive cell proliferation and growth. As with GPCRs, CART allows us to
activate orphan TKRs in the absence of native ligands and screen the activated
TKRs to identify novel inhibitors of TKR activity. We are currently evaluating
orphan TKRs for drug screening.

GENETIC "KNOCK-IN" MODELS. We are collaborating with Lexicon Genetics to
develop mice that produce CART-activated GPCRs, or GPCR knock-ins, by using
state-of-the-art molecular genetic techniques. By producing CART-activated
orphan GPCRs in animals, we believe that we will gain valuable insight into the
functionality of individual GPCRs, as well as indications of human disease for
which drugs that target these GPCRs may be useful. In addition, we expect that
these knock-in animals will provide an animal model that can be used to test the
potency of drug leads discovered using CART-activated GPCRs. The first knock-in
GPCR animals developed based upon this collaboration were born in
February 2001.

OUR GPCR COLLABORATORS

Our success will depend in large part upon our ability to enter into
successful collaborations with other pharmaceutical and biotechnology companies.
We are active in the scientific community and within the industry and regularly
make presentations regarding our research and development programs and the
applications of CART at scientific conferences and industry conventions. We
believe that our participation at these events has led, and will continue to
lead, to contacts with existing and potential collaborators. We have entered
into a number of strategic collaborations in the recent past to discover novel
drug leads using CART, and we expect to enter into additional collaborations and
expand our existing collaborations in the future.

ELI LILLY

In April 2000, we entered into a research collaboration with Eli Lilly, one
of the world's leading pharmaceutical companies. Our collaboration with Eli
Lilly is principally focused on the central nervous system and endocrine
therapeutic fields. We will also focus on the cardiovascular field and may
expand our collaboration to other therapy classes, including cancer.

During our collaboration, we will pursue an agreed upon research plan with
Eli Lilly that has several objectives. During the term of our collaboration, we
will mutually review and select GPCRs that will become subject to the
collaboration. These GPCRs may be provided either by us or by Eli Lilly. All of
our pre-existing CART-activated GPCRs were excluded from the collaboration. We
and Eli Lilly will each share our respective knowledge of the GPCRs that become
subject to the collaboration to validate and CART-activate selected receptors.
We will jointly select a number of proprietary central nervous system, endocrine
and cardiovascular GPCRs for CART-activation, and we will then provide Eli Lilly
with enabled high-throughput screens for use at their screening facilities.
During the term of the agreement, we will continue to receive research funding
from Eli Lilly for our internal resources committed to the collaboration, which
will be augmented by substantial resource commitments by Eli Lilly. Eli Lilly
will be responsible for screening its chemical compound library using selected
CART-activated receptors, for identifying drug leads and for the pre-clinical
and clinical testing and development of drug candidates. We may receive up to
$1.25 million per receptor based upon milestone payments in connection with the
successful application of CART to each receptor, and up to an additional
$6.0 million based upon clinical development milestone payments for each drug
candidate discovered using CART. We may also receive additional milestone and
royalty payments associated with the commercialization of drugs discovered using
CART, if any.

Once the assay development fee has been paid for a CART-activated GPCR, Eli
Lilly will have exclusive rights to screen chemical libraries, discover drug
leads that target that GPCR, and to develop, register and sell any resulting
products worldwide. We retain rights to partner or independently develop GPCRs
that do not become subject to the collaboration.

The term of our collaboration agreement with Eli Lilly is five years. Either
party can terminate the agreement with or without cause effective three years
after the date of the agreement by giving written notice prior to the conclusion
of the 33rd month after the date of the agreement. In addition, either party can
terminate the agreement at any time if the other party commits a material
breach, and Eli Lilly can terminate the agreement at any time if, among other
reasons, Eli Lilly does not approve suitable replacements for key employees who
leave us. The parties will continue to have various rights and obligations under
the agreement after the agreement is terminated. The extent of these continuing
rights and obligations depends on many factors, such as when the agreement is
terminated, by which party and for what reason. These continuing obligations may
include further research and development efforts by us and a variety of payments
by Eli Lilly.

Eli Lilly is a significant customer and the loss of such customer would have
a material adverse effect on our business and future revenue stream.

Revenues recognized under the Eli Lilly collaboration were approximately
$1.2 million for the three months ended March 31, 2001, consisting of research
funding of approximately $1.1 million and amortization of the upfront payment of
$25,000, and $5.2 million for the year ended December 31, 2000 consisting of
research funding of approximately $2.9 million, milestone achievements related
to the activation of nine selected GPCRs for approximately $2.2 million, and
amortization of an upfront payment of $75,000.

TAISHO

In May 2000, we entered into a research collaboration with Taisho focused on
several GPCRs selected by Taisho in therapeutic areas of interest. Under the
terms of the agreement, Taisho will receive exclusive, worldwide rights to the
selected GPCR targets and to any drug leads discovered using the CART-activated
versions of these receptors. We may receive up to a total of $2.3 million in
revenues per receptor associated with research, development and screening fees.
We may also receive clinical development milestones, regulatory approval
milestones and royalties on drug sales, if any.

Taisho is a significant customer and the loss of such customer would have a
material adverse effect on our business and future revenue stream.

Revenues recognized under the Taisho collaboration were approximately
$4.2 million for the three months ended March 31, 2001, consisting of
approximately $3.9 million related to receptor activation selection, screening
assay fees and research and development fees, $286,000 related to research
funding and amortization of the upfront payment of $30,000, and $2.4 million for
the year ended December 31, 2000, consisting of milestone achievements of
approximately $2.3 million related to receptor activation selection and
screening assay fees and amortization of the upfront payment of $80,000.

In January 2001, we signed an amendment to our original agreement with
Taisho whereby Taisho was granted world-wide rights to our 18F program which
includes the 18F receptor, a GPCR that we believe represents an obesity orphan
receptor target, and small molecule modulators discovered using this receptor.
In accordance with the amendment, Taisho made a payment in February 2001 to us
for the 18F program based upon work completed by us through the date of the
amendment. In addition, we may receive additional milestone and research funding
payments and royalties on drug sales, if any.

In March 2001, we entered into a receptor discovery agreement with Taisho.
Under the terms of the agreement, we will identify the receptor that binds with
a ligand that Taisho provided to us. If we are successful in identifying and
cloning this receptor, we will CART-activate this receptor and provide a
screening assay to Taisho. In connection with this agreement, Taisho paid us a
one-time non-refundable research and development fee which is being recognized
as revenue as the services are being performed. In addition, we may receive
additional milestone payments and royalties on drug sales, if any.

FUJISAWA

In January 2000, we entered into a collaborative agreement with Fujisawa, a
leading Japan-based pharmaceutical company with significant drug discovery
research efforts. During the collaboration, we will jointly validate up to 13
orphan GPCRs as drug screening targets. We will be responsible for receptor
identification, location and regulation, and will apply CART to GPCRs selected
by Fujisawa. We will also seek to validate screening assays based on the
selected GPCRs. Fujisawa will be entitled to screen selected assays against its
chemical compound library to identify drug leads. Fujisawa will also be
responsible for the pre-clinical and clinical development of any drug candidates
that we or Fujisawa discover. We may also screen the selected GPCRs using our
in-house chemical library. When Fujisawa selects its first receptor, we will be
entitled to receive a one-time initiation fee of $500,000. If we and Fujisawa
then achieve various milestones, we may receive up to a maximum of $3.5 million
per selected receptor for assay transfer, screening and exclusivity fees, and up
to a maximum of $2.0 million per selected receptor based upon the filing of one
or more investigational new drug applications for each drug candidate discovered
using a CART-activated receptor. We may also receive clinical development
milestones, regulatory approval milestones and royalties on drug sales, if any.
We and Fujisawa may never achieve research, development or commercialization
milestones under the agreement.

Our collaborative agreement with Fujisawa will terminate upon the expiration
of Fujisawa's obligation to make royalty payments under the agreement, if any.
Fujisawa may terminate the agreement at any time by providing us with written
notice of their intention to do so and by returning any proprietary rights they
have acquired under the agreement. Additionally, either party may terminate the
agreement for a material breach of the agreement by the other party. The
termination or expiration of the agreement will not affect any rights that have
accrued to the benefit of either party prior to the termination or expiration.

LEXICON GENETICS

In April 2000, we signed a binding letter of intent and memorandum of
agreement with Lexicon Genetics, a genomics company that uses a proprietary
technology to clone mice, enabling large-scale functional genomics. The
agreement establishes a research collaboration with Lexicon Genetics using their
proprietary technology to clone gene-targeted mice whose genomes have been
altered using specified CART-activated orphan GPCRs. Our collaboration with
Lexicon Genetics consists of a feasibility phase to determine both the utility
of this novel approach and the scope of any resulting licensing alliance. If we
proceed beyond the feasibility stage, the agreement establishes a licensing
alliance in which we and Lexicon Genetics will each contribute up to ten unique
GPCRs to clone mice containing CART-activated GPCRs for use as drug discovery
tools, and to discover drug leads using these GPCRs. We will share equally in
the fees, milestones and royalties generated from any licensing agreement with a
third-party involving GPCRs developed through our licensing alliance.

OTHER AGREEMENTS

Our practice is to meet with pharmaceutical and biotechnology companies on
an on-going basis to discuss the possibility of collaborating with them on
projects of mutual interest. At present, we are in the early stages of
discussing with other companies the possibility of a number of such
arrangements. There can be no assurance that we will be successful in
consummating any such arrangement.

RESEARCH COLLABORATION

On April 15, 2001, we signed a binding letter of intent with Axiom
Biotechnologies, Inc. for a collaborative research program involving Axiom's
proprietary RHACE-TM- Technology and Human Cell Bank, as well as the purchase by
us of $2.0 million of Axiom's preferred stock. Axiom's unique assets include the
Axiom Human Cell Bank, a large pharmacologically and genetically characterized
collection of human cells. We have already initiated the scientific
collaboration, and expect to complete the purchase of Axiom's stock in
July 2001. Under the scientific collaboration, we will jointly develop and share
information related to the localization of known GPCRs within human cell lines
owned by Axiom. Axiom will also profile several thousand of our small molecule
compounds using its technologies and we will have exclusive rights to these
data. We will exclusively own the information related to the localization of
orphan GPCRs within these cell lines.

CHEMNAVIGATOR.COM

In 1999, we developed an Internet-based search engine that allows scientists
to search for chemical compounds based primarily on the similarity of chemical
structures. We believe this is important for drug discovery purposes because
chemical similarity can be used as an indicator of biological activity.
ChemNavigator.com was formed in May 1999 and subsequently obtained independent
third-party financing. We licensed the search engine's underlying technology and
related intellectual property to ChemNavigator.com in exchange for stock. Our
carrying value for our investment in ChemNavigator.com is zero because we have
made no financial contribution to ChemNavigator.com in exchange for our
ownership interest. In addition, we are not required to reimburse the outside
investors for any losses ChemNavigator.com incurs. We currently beneficially own
approximately 33% of the outstanding common stock of ChemNavigator.com.

ARESSA PHARMACEUTICALS

In August 1999, we formed Aressa Pharmaceuticals, Inc. as our wholly-owned
subsidiary to take advantage of opportunities to in-license and develop niche
products from other pharmaceutical or biotechnology companies. In
November 1999, Aressa entered into a licensing agreement with respect to a
patented anti-fungal compound. In October 2000, Aressa received gross proceeds
of $1.0 million from

the sale of its stock to an outside investor. Our carrying value for our
investment in Aressa is zero because we have made no financial contribution to
Aressa in exchange for our ownership interest. In addition, we are not required
to reimburse the outside investor for any losses Aressa incurs. We currently
beneficially own approximately 83% of the outstanding common stock of Aressa.

T-82

We licensed T-82 from SSP Co., Ltd. in 1998 as a novel drug candidate to
treat Alzheimer's Disease. We intended to develop T-82 through completion of
Phase II clinical studies, and, based upon the results of these studies, to seek
a partner to conduct the more expensive Phase III clinical efficacy studies. Our
Phase I safety studies of T-82 began in 1999. We have completed four Phase I
studies of T-82 through 2000 and have been assessing the data in conjunction
with SSP. These four Phase I safety-based studies evidenced results that we
believe establish the safety of T-82 in the tested parameters. However, our
analysis of all of the data for T-82, in conjunction with the extensive costs
associated with conducting Phase II and Phase III clinical studies of T-82, the
types and number of potential new treatments for Alzheimer's Disease that are in
more advanced stages of clinical testing and regulatory review, as well as our
ability to receive regulatory approval for commercialization of T-82 or to
successfully license T-82 to a third party, have prompted us to consider if
continuation of the T-82 program is warranted. Although a final decision has not
yet been made, we cannot assure you that we will continue development of T-82.
In the event that we decide to continue our T-82 development program, we may be
unable to license T-82 to another party as we had originally intended, or we may
be unable to secure regulatory approval for the commercialization of T-82.

INTELLECTUAL PROPERTY

Our success depends in large part on our ability to protect our proprietary
technology and information, and operate without infringing on the proprietary
rights of third parties. We rely on a combination of patent, trade secret,
copyright and trademark laws, as well as confidentiality agreements, licensing
agreements and other agreements, to establish and protect our proprietary
rights. Since our inception, we have filed approximately 136 patent applications
in the United States regarding:

- CART

- orphan receptors and CART-activated orphan receptors

- CART-activated known receptors

- small molecule chemical compounds

- web-based search engine technologies

The term of all of our current and future patents, if any are issued, will
commence on the date of issuance and terminate 20 years from the earliest
effective filing date of the patent application. Because the time from filing to
issuance of biotechnology patent applications is often more than three years,
our patent protection, if any, on our products and technologies may be
substantially less than 20 years.

To date, we have received four issued United States patents, and we also own
two issued United States patents related to Melanophore Technology.

We seek patent protection for all of our key inventions, including CART, new
receptors that we discover, genetically-altered receptors, and drug leads
identified by CART. It has been possible to obtain broad, composition-of-matter
patents on novel chemical compounds, such as the drug leads, if any, that we
identify using CART. It has also been possible to obtain broad method patents
for techniques and procedures for screening and drug-identification
technologies, such as those embodied by CART. It has generally not been possible
to obtain broad composition-of-matter patents for nucleic acid and amino acid
sequences. However, it has been possible to obtain patents that protect specific

sequences and functional equivalents of those sequences. Furthermore,
intellectual property law allows for separate and distinct patents for altered
genetic sequences over previously disclosed sequences. We believe that we can
obtain patents on our CART-activated receptor sequences because they are not
functional equivalents of the natural version of the receptor. We have filed and
will continue to file patent applications on these types of technologies. We
believe that CART does not infringe on third-party claims related to any aspect
of our proprietary technology.

As a general matter, obtaining patents in the biotechnology and
pharmaceutical fields is highly uncertain and involves complex legal, scientific
and factual matters. Obtaining a patent in the United States in the
biotechnology and pharmaceutical fields can be expensive and can, and often
does, require several years to complete. Failure to receive patents pursuant to
the applications referred to herein and any future applications could be harmful
to us. Our patent filings in the United States may be subject to interference or
reexamination proceedings. The defense and prosecution of interference and
reexamination proceedings and related legal and administrative proceedings in
the United States involve complex legal and factual questions. We also file
patent applications outside of the United States. The laws of some foreign
countries may not protect our proprietary rights to the same extent as do the
laws of the United States. Third parties may attempt to oppose the issuance of
our patents in foreign countries by way of opposition proceedings. Additionally,
if an opposition proceeding is initiated against any of our patent filings in a
foreign country, that proceeding could have an adverse effect on the
corresponding patents that are issued or pending in the United States. If we
become involved in any interference, reexamination, opposition or litigation
proceedings in the United States or foreign countries regarding patent or other
proprietary rights, those proceedings may result in substantial cost to us,
regardless of the outcome, and may have a material adverse affect on our ability
to develop, manufacture, market or license our technologies or products, or to
maintain or form strategic alliances.

Although we plan to aggressively prosecute our patent applications and
defend our patents against third-party infringement, we cannot assure you that
any of our patent applications will result in the issuance of patents or that,
if issued, such patents will not be challenged, invalidated or circumvented.
Moreover, we cannot assure you that our patents, to the extent they are or will
be issued, will provide us protection against competitors with other
technologies. Our technologies and potential products may conflict with patents
that have been or may be granted to competitors, universities or others. As the
biotechnology industry expands and more patents are issued, the risk increases
that our technologies and potential products may give rise to claims that they
infringe the patents of others. Third parties claiming infringement of their
proprietary rights could bring legal actions against us claiming damages and
seeking to enjoin our use or commercialization of a product or our use of a
technology. In particular, patent applications or patents for innovative and
broadly applicable technologies, such as CART, are sometimes challenged by third
parties as obvious, or as obvious extensions of technologies previously
developed by those third parties. We cannot assure you that such claims will not
be brought against us in the future. If any actions based on these claims are
successful, in addition to any potential liability for damages, we could be
required to obtain a license in order to continue to use a technology or to
manufacture or market a product, or could be required to cease using those
products or technologies. Any claim, with or without merit, could result in
costly litigation and divert the efforts and attention of our scientific and
management personnel. We cannot assure you that we would prevail in any action
or that any license required under any patent would be made available or would
be made available on acceptable terms.

In addition to patent protection, we rely upon trade secrets, proprietary
know-how and continuing technological advances to develop and maintain our
competitive position. To maintain the confidentiality of our trade secrets and
proprietary information, all of our employees are required to enter into and
adhere to an employment-confidentiality and invention-assignment agreement,
laboratory notebook policy, and invention disclosure protocol, as a condition of
employment. Additionally, our

employment-confidentiality and invention-assignment agreement requires that our
employees do not bring to Arena, or use without proper authorization, any
third-party proprietary technology. We also require all of our consultants and
collaborators that have access to proprietary property to execute
confidentiality and invention rights agreements in our favor before beginning
their relationship with us. While such arrangements are intended to enable us to
better control the use and disclosure of our proprietary property and provide
for our ownership of proprietary technology developed on our behalf, they may
not provide us with meaningful protection for such property and technology in
the event of unauthorized use or disclosure.

We have entered into a research agreement with the University of Glasgow to
jointly develop screening strategies using our CART-activated GPCRs, combined
with techniques claimed in a patent application owned by the University. Under
this agreement, we have an option to take an exclusive license to this patent
application, as well as techniques that are developed during the course of the
research agreement.

COMPETITION

A major focus of our scientific and business strategy involves GPCRs. Most
major pharmaceutical companies, as well as several biotechnology companies, have
drug discovery programs based upon GPCRs, including orphan GPCRs. In addition,
other companies have attempted to overcome the problems associated with
traditional drug screening by embarking upon a variety of alternative
strategies. Although some of these approaches are indicated as being based upon
ligand-independent strategies, like CART, we believe that all of these
approaches have relied upon indirect measures of receptor activity, which we
believe provide a limited possibility of assessing receptor-drug interaction and
increase the possibility of false positive results.

Several of our existing and potential competitors have substantially greater
product development capabilities and financial, scientific and marketing
resources than we do. As a result, they may be able to adapt more readily to
technological advances than we can, or to devote greater resources than we can
to the research, development, marketing and promotion of drug discovery
techniques or therapeutic products. Additionally, the technologies being
developed by these companies may be more readily accepted or widely used than
CART. Our future success will depend in large part on our ability to maintain
our competitive position. The biotechnology industry is undergoing rapid and
significant change and we may not be able to compete successfully with newly
emerging technologies.

We will rely on our collaborators for support of our development programs
for our drug candidates and intend to rely on our collaborators for the
manufacturing and marketing of these products. Our collaborators may be
conducting multiple product development efforts within the same disease areas
that are the subjects of their agreements with us. Generally, our agreements
with our collaborators do not preclude them from pursuing development efforts
using a different approach from that which is the subject of our agreement with
them. Any of our drug candidates therefore, may be subject to competition with a
drug candidate under development by a collaborator.

GOVERNMENT REGULATION

Our and our collaborators' on-going drug development activities are subject
to the laws and regulations of governmental authorities in the United States and
other countries in which these products may be marketed. Specifically, in the
United States, the FDA and comparable regulatory agencies in state and local
jurisdictions impose substantial requirements on new product research and the
clinical development, manufacture and marketing of pharmaceutical products,
including testing and clinical trials to establish the safety and effectiveness
of these products. Our and our collaborators' drug products will require
regulatory approval before commercialization. Governments in other countries
have similar requirements for testing, approval and marketing. In the United
States, in addition to

meeting FDA regulations, we are also subject to other federal, state and local
environmental and safety laws and regulations, including regulation of the use
and care of laboratory animals.

We do not plan to commercialize most of our drug candidates by ourselves,
but intend to rely on our collaborators to develop and commercialize our drug
candidates or those that our collaborators discover through the use of our
technology. Before marketing in the United States, any pharmaceutical or
therapeutic products developed by us or our collaborators must undergo rigorous
pre-clinical testing and clinical trials and an extensive regulatory approval
process implemented by the FDA under the federal Food, Drug and Cosmetic Act.
The FDA regulates, among other things, the development, testing, manufacture,
safety and effectiveness standards, record keeping, labeling, storage, approval,
export, advertising, promotion, sale and distribution of pharmaceutical
products. The regulatory review and approval process, which includes
pre-clinical testing and clinical trials of each product candidate is lengthy,
and uncertain. Securing FDA approval requires the submission of extensive
pre-clinical and clinical data and supporting information to the FDA for each
indication to establish a product candidate's safety and effectiveness.
Additional animal studies, other pre-clinical tests or clinical trials may be
requested by the FDA which may delay marketing approval. The approval process
takes many years, requires the expenditure of substantial resources and may
involve ongoing requirements for post-marketing studies.

Before commencing clinical investigations in humans, we or our collaborators
must submit an investigational new drug, or IND, application to the FDA. We
generally intend to rely on our collaborators to file IND applications and
direct the regulatory approval process for the products they develop using CART.
Clinical trials are typically conducted in three sequential phases, although the
phases may overlap or be combined. Phase I represents the initial administration
of the drug to a small group of humans, either healthy volunteers or patients,
to test for safety, dosage tolerance, absorption, metabolism, excretion and
clinical pharmacology. Phase II involves studies in a relatively small number of
patients to begin to assess the effectiveness of the product, to ascertain dose
tolerance and the optimal dose range and to gather additional data relating to
safety and potential adverse effects. Once a drug is found to have some
effectiveness and an acceptable safety profile in the targeted patient
population, Phase III studies are initiated to establish safety and
effectiveness in an expanded patient population and multiple clinical study
sites. The FDA may require further post-marketing studies, referred to as Phase
IV studies. The FDA reviews both the clinical plans and the results of the
trials and may require that we discontinue the trials at any time if the FDA
identifies any significant safety issues. Clinical testing must meet
requirements for institutional review board oversight, informed consent, good
clinical practices and FDA oversight.

The length of time necessary to complete clinical trials varies
significantly and is difficult to predict. Clinical results are frequently
susceptible to varying interpretations that may delay, limit or prevent
regulatory approvals. Additional factors that can cause delay or termination of
our clinical trials, or those of our collaborators, or may increase the cost of
those trials, include, among other factors:

- lack of effectiveness of the product being tested

- adverse medical effects or side effects in treated patients

- slow patient enrollment in the clinical trial

- inadequately trained or insufficient personnel at the study site to assist
in overseeing and monitoring the clinical trial

- delays in approval from a study site's review board

- longer treatment time required to demonstrate effectiveness or determine
the appropriate product dose

- lack of sufficient supplies of the product candidate

If pre-clinical and clinical studies are successful, the results, together
with other information about the product and its manufacture, are submitted to
the FDA in the form of an New Drug Application, or NDA, to request marketing
approval. Before receiving FDA approval to market a product, we or our
collaborators must demonstrate that the product is safe and effective through
clinical trials on the patient population that will be treated. The approval
process is likely to require substantial time and effort and there can be no
assurance that any approval will be granted on a timely basis, if at all.
Additional animal studies or clinical trials may be requested during the FDA
review period that may delay marketing approval. As part of the approval
process, each manufacturing facility must be inspected by the FDA. Among the
conditions of approval is the requirement that a manufacturer's quality control
and manufacturing procedures conform with federally mandated current good
manufacturing practices, or GMPs. Both before and after approval, manufacturers
must expend time, money and effort to ensure compliance with current GMPs and
the FDA conducts periodic inspections to certify compliance. Violations may
result in restrictions on the product or manufacturer, including costly recalls
or withdrawal of the product from the market, or other enforcement action.

If regulatory approval of a product is granted by the FDA, this approval
will be limited to those specific conditions for which the product is approved,
as demonstrated through clinical studies. After FDA approval for the initial
indications, further clinical trials will be necessary to gain approval for the
use of the product for additional indications. Marketing or promoting a drug for
an unapproved indication is prohibited. The FDA requires that adverse effects be
reported to the FDA and may also require post-marketing testing to monitor for
adverse effects, which can involve significant expense. Even after FDA approvals
are obtained, a marketed product is subject to continual review. Later discovery
of previously unknown problems or failure to comply with the applicable
regulatory requirements may result in restriction on the marketing of a product
or withdrawal of the product from the market as well as possible civil or
criminal sanctions. Furthermore, failure to obtain reimbursement coverage from
governmental or third party insurers may adversely impact successful
commercialization.

Our access to and use of human or other tissue samples in our research and
development efforts are subject to government regulation, both in the United
States and abroad. United States and foreign government agencies may also impose
restrictions on the use of data derived from human or other tissue samples. If
our access to or use of human tissue samples, or our collaborator's use of data
derived from such samples, is restricted, our business could suffer.
Additionally, if we continue to develop our plant or insect programs, we may
become subject to different government regulations relating to agricultural and
industrial biotechnology products.

In addition to regulations enforced by the FDA, we are also subject to
regulation under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substances Control Act, the Resource Conservation and
Recovery Act, the Controlled Substances Act and other present and potential
future federal, state or local regulations. Our research and development
programs involve the controlled use of hazardous materials, chemicals,
biological materials and various radioactive compounds. Although we believe that
our safety procedures for handling and disposing of such materials comply with
the standards prescribed by state and federal regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, we could be held liable for any
damages that result, and the extent of that liability could exceed our
resources.

RESEARCH

Research activities are important to our business. Research expenses related
to the development of our technology and services and the improvement of our
existing technology totaled $12.1 million for the year ended December 31, 2000,
$8.3 million for the year ended December 31, 1999 and $2.6 million for the year
ended December 31, 1998. For the three months ended March 31, 2001, our research
expenses totaled $3.9 million.

COMPLIANCE WITH ENVIRONMENTAL REGULATIONS

We believe that our operations comply in all material respects with the
applicable environmental laws and regulations. Our compliance with these
requirements did not and is not expected to have a material effect upon our
capital expenditures, earnings or competitive position.

SOURCES AND AVAILABILITY OF RAW MATERIALS

In general, we purchase raw materials and supplies on the open market.
Substantially all such materials are obtainable from a number of sources so that
the loss of any one source of supply would not have a material adverse effect
upon us.

OUR DATABASE

We have developed a web-based database that can be used to access relevant
information and data generated from our research and development programs. Our
database has a number of characteristics which we believe are unique. Our
database allows individual users to obtain information on specific GPCR targets,
including gene sequence information, data developed by us from GPCR tissue and
cellular distribution studies, the results of drug screening and the results of
our animal studies. In developing this database, we focused on the magnitude of
data that we would generate based upon the number of GPCRs available to us, and
the number of chemical compounds that would be screened in our assays. Our
database, which is the subject of a pending patent application that we own, has
a number of proprietary features that allow us to efficiently organize, store
and access these data and information. Using this database, we and our
collaborators can search for compounds by structure and assay results, and can
search for genes by sequence and tissue or disease expression. One of our
collaborators is currently using our database, and we believe our database will
be a resource for collaborators who have a specific interest in diseases that
affect certain tissues.

EMPLOYEES

As of May 31, 2001, we employed 151 people, including 131 in research and
development and 20 in administration. Thirty-seven of our employees hold
doctoral degrees and an additional 22 hold other advanced degrees. None of our
employees is covered by any collective bargaining agreement. We consider our
relationship with our employees to be good.

OUR FACILITIES

Our facilities consist of approximately 63,000 square feet of research and
office space located at 6150 and 6166 Nancy Ridge Drive, San Diego, California.
At our 6166 Nancy Ridge Drive facility, we currently lease approximately 37,000
square feet of space, of which 23,000 square feet is laboratory space and 14,000
square feet is office space. In 2000, we began leasing additional facilities
located at 6150 Nancy Ridge Drive consisting of approximately 26,000 square
feet. In January 2001, we purchased the 6150 Nancy Ridge Drive facility as well
as the adjoining facility at 6138 Nancy Ridge Drive. The 6138 Nancy Ridge Drive
facility, consisting of approximately 26,000 square feet, is currently occupied
by a tenant whose lease expires on August 31, 2001. After the lease expires, we
will use the additional space primarily for additional laboratory and office
space. We believe these facilities will be adequate to meet our near-term space
requirements. On June 15, 2001, we entered into a letter of intent to purchase
property located at 6154 Nancy Ridge Drive for approximately $5.1 million. The
building located on the property totals approximately 48,000 square feet of
space suitable for office and laboratory expansion. We intend to complete this
purchase by August 1, 2001, and expect to occupy the building in 2002. However,
the completion of the purchase is subject to a number of conditions, including
the negotiation of a purchase agreement satisfactory to us and the seller and
our due diligence of the property.

LEGAL PROCEEDINGS

We are not currently a party to any material legal proceedings.

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table shows information about our executive officers and
directors as of May 31, 2001.

NAME AGE POSITION
---- -------- ------------------------------------------------------------

Jack Lief.................................... 55 President, Chief Executive Officer and Director

Dominic P. Behan, Ph.D....................... 37 Vice President, Research and Director

Derek T. Chalmers, Ph.D...................... 37 Vice President, Research and Director

Robert Hoffman, CPA.......................... 35 Vice President, Finance

Joyce H. Williams, R.A.C..................... 55 Vice President, Drug Development

Richard P. Burgoon, Jr....................... 40 Senior Vice President, Operations, General Counsel and
Secretary

Nigel R.A. Beeley, Ph.D...................... 50 Vice President, Chief Chemical Officer

Elaine Alexander, M.D., Ph.D................. 48 Vice President, Experimental and Clinical Research

Louis J. Scotti.............................. 45 Vice President, Business Development

Joseph F. Mooney............................. 53 Chief Financial Officer

John P. McAlister, III, Ph.D................. 52 Director

Michael Steinmetz, Ph.D...................... 53 Director

Stefan Ryser, Ph.D........................... 41 Director

JACK LIEF is our co-founder and has served as our director, President and
Chief Executive Officer since April 1997. Mr. Lief is also currently serving as
a director, Chief Executive Officer and President of Aressa
Pharmaceuticals, Inc. and of BRL Screening, Inc. Mr. Lief also serves as a
director of ChemNavigator.com, one of our affiliates. From 1995 until
April 1997, Mr. Lief served as an advisor and consultant to numerous
biopharmaceutical organizations. From 1989 to 1994, he served as Senior Vice
President, Corporate Development and Secretary of Cephalon, Inc. From 1983 to
1989, Mr. Lief served as Director of Business Development and Strategic Planning
for Alpha Therapeutic Corporation. Mr. Lief joined Abbott Laboratories in 1972
where he served until 1983, most recently as the head of International Marketing
Research. Mr. Lief holds a B.A. from Rutgers University and a M.S. in Psychology
(Experimental and Neurobiology) from Lehigh University.

DOMINIC P. BEHAN, PH.D. is our co-founder and has served as our Vice
President, Research since April 1997 and our director since April 2000. From
1993 to January 1997, Dr. Behan directed various research programs at Neurocrine
Biosciences. From 1990 until 1993, he was engaged in research at the Salk
Institute. Dr. Behan holds a Ph.D. in Biochemistry from Reading University,
England.

DEREK T. CHALMERS, PH.D. is our co-founder and has served as our Vice
President, Research since April 1997 and as our director since April 2000. From
1994 to December 1996, Dr. Chalmers directed various research programs at
Neurocrine Biosciences. From 1990 until 1994, he was engaged in research at the
University of Michigan. Dr. Chalmers holds a Ph.D. in Neuroscience and
Neuropharmacology from the University of Glasgow, Scotland.

ROBERT HOFFMAN, CPA has served as our Vice President, Finance since
April 2000 and served as our Controller from August 1997 until April 2000.
Mr. Hoffman also serves as the Chief Financial Officer

of ChemNavigator.com and as Vice President, Finance of BRL Screening, Inc. From
1994 to 1997, he served as Assistant Controller for Document Sciences
Corporation. Mr. Hoffman holds a B.B.A. from St. Bonaventure University in New
York and is licensed as a CPA in the State of California.

JOYCE H. WILLIAMS, R.A.C., has served as our Vice President, Drug
Development since February 1998. Ms. Williams began serving as Vice President,
Regulatory & Clinical Affairs of Aressa Pharmaceuticals, Inc. in October 2000.
From January 1997 to February 1998, Ms. Williams served as Regulatory Consultant
for ProFocus Regulatory Solutions. From 1995 to 1996, she served as Executive
Director, Regulatory Affairs at Advanced Sterilization Products, a division of
Johnson & Johnson. Ms. Williams has over 20 years of experience in regulatory
affairs with pharmaceutical and medical technology firms. Ms. Williams holds a
B.A. from Case Western Reserve University and an M.B.A. from Pepperdine
University. Ms. Williams has earned the designation Regulatory Affairs
Certified, or R.A.C.

RICHARD P. BURGOON, JR. joined us in April 1998 and serves as our Senior
Vice President, Operations, General Counsel and Secretary. Mr. Burgoon is also
currently serving as a director, Chief Operating Officer and Secretary of Aressa
Pharmaceuticals, Inc. and as director and Secretary of ChemNavigator.com and as
a director of BRL Screening, Inc. From 1997 to 1998, Mr. Burgoon was an attorney
for Reed, Smith, Shaw & McClay. From 1994 to 1997, Mr. Burgoon served as Senior
Director and Patent Counsel at Cephalon, Inc. From 1992 to 1994, he served as
Intellectual Property Counsel to IDEC Pharmaceuticals Corporation. From 1990 to
1992, he served as Staff Attorney at Beckman Instruments, Inc. Mr. Burgoon holds
B.S. and B.A. degrees from the University of California, Irvine. He received his
J.D. from the Franklin Pierce Law Center.

NIGEL R.A. BEELEY, PH.D. has served as our Vice President and Chief Chemical
Officer since March 1999. From 1994 to 1998, he was Senior Director of Chemistry
at Amylin Pharmaceuticals, Inc. and from 1988 to 1994, he served as Head of
Oncology-Chemistry for Celltech. From 1980 to 1988, he held positions of
increasing seniority in the cardiovascular group at Synthelabo Recherche, and
from 1978 to 1980 he was a CNS Medicinal Chemist for Reckitt and Coleman. From
1976 to 1978, Dr. Beeley held a Royal Society Overseas Research Fellow at ETH,
Zurich, Switzerland. Dr. Beeley has a B.Sc. Honours (Class 1) degree in
Chemistry from the University of Liverpool, U.K. and a Ph.D. in Chemistry from
the University of Manchester, U.K.

ELAINE ALEXANDER, M.D., PH.D. has served as our Vice President, Experimental
and Clinical Research since May 1999. From 1998 to 1999, she served as a
consultant to biotechnology companies and the National Institutes of Health.
From 1993 to 1997, she served as Director of Experimental and Exploratory
Research for Cephalon, Inc. Dr. Alexander holds a Ph.D. and M.D. from the
University of California, Los Angeles.

LOUIS J. SCOTTI has served as our Vice President, Business Development since
August 1999. From June 1998 until July 1999, Mr. Scotti served as President and
Chief Executive Officer for ProtoMed, Inc. From April 1996 to June 1998, he
served as Executive Director of Licensing for Ligand Pharmaceuticals, Inc. From
1986 to 1995, he served in various positions at Reed & Carnrick Pharmaceuticals,
most recently as Vice President of Marketing and Business Development.
Mr. Scotti holds a B.S.E. in Biomedical Engineering from the University of
Pennsylvania.

JOSEPH F. MOONEY has served as our Chief Financial Officer since
September 2000. Mr. Mooney also serves as a director and as Treasurer of BRL
Screening, Inc. From 1995 to 2000, he was a Managing Principal of Liquidity
Sources LLC. From 1987 to 1993, he was with Tucson Resources, Inc., a subsidiary
of Tucson Electric Power, most recently as the Vice President, Securities and
Treasurer. Mr. Mooney holds an M.B.A. from the Graduate School of Business at
the University of Chicago and an M.Sc. from the London School of Economics and
Political Science, as well as degrees in pure mathematics from Boston College
and Brandeis University.

JOHN P. MCALISTER, III, PH.D. has served as our director since July 1997.
Dr. McAlister joined Tripos, Inc., a provider of discovery research software and
services to the life sciences industry, in 1982, and since 1988, has served as
President and Chief Executive Officer of Tripos. Dr. McAlister holds a Ph.D. in
Biochemistry and X-Ray Crystallography from the University of Wisconsin,
Madison. He currently also serves as a director of Tripos.

MICHAEL STEINMETZ, PH.D. has served as our director since May 1999. Since
1997, he has held the title of General Partner at MPM Capital, a venture capital
firm focusing on investments in the biotechnology industry, and he is a Managing
Director of MPM Asset Management LLC. From 1991 to 1997, he served as Vice
President Preclinical Research and Development of various divisions of
F. Hoffmann-La Roche Ltd. Dr. Steinmetz holds a Ph.D. in Natural Sciences from
the University of Munich, Germany. He currently serves as Chairman at Coelacanth
Corporation. Dr. Steinmetz also currently serves as director of Acorda
Therapeutics, Atugen, Cellular Genomics, Epigenomics, MacroGenics and Xcyte.

STEFAN RYSER, PH.D. has served as our director since January 1999. In
April 2000, Dr. Ryser became a Managing Director of Bear Stearns and founding
Managing Partner of Bear Stearns Health Innoventures Management LLC, a company
that manages venture capital investments in the health care industry. From
January 1998 to April 2000, Dr. Ryser served as Chief Executive Officer of
International Biomedicine Management Partners Inc., a Swiss company that manages
investments in the biotechnology industry. From January 1985 to December 1997,
Dr. Ryser held various positions at Hoffman-La Roche Inc., including Head of
Global Research Staff and Scientific Assistant to the President of Global
Research and Development. Dr. Ryser holds a Ph.D. in Molecular Biology from the
University of Basel, Switzerland. He currently also serves as a director of
Telik, Inc. and Cytokinetics, Inc.

Our executive officers are appointed annually by our board of directors and
serve at the discretion of the board of directors. At our annual stockholders
meeting held on May 8, 2001, all of our directors were nominated and elected to
continue their terms. The term for each of our directors expires upon our next
annual stockholders meeting.

BOARD COMMITTEES

In 2000, we established an audit committee, a compensation committee and a
stock option committee. We do not have a nominating committee or a committee
that performs the functions of a nominating committee.

AUDIT COMMITTEE. The audit committee reviews the financial information to
be provided to stockholders, monitors the integrity of our internal controls and
monitors the independence and performance of our independent auditors. The audit
committee currently consists of the outside directors, Dr. McAlister, Dr. Ryser
and Dr. Steinmetz.

COMPENSATION COMMITTEE. The compensation committee reviews and approves the
compensation and benefits for directors and the executive officers, and makes
recommendations to the board of directors regarding these matters. The
compensation committee currently consists of Mr. Lief, Dr. Ryser and
Dr. Steinmetz.

STOCK OPTION COMMITTEE. The stock option committee authorizes and approves
stock option grants under our 1998 Equity Compensation Plan and 2000 Equity
Compensation Plan. The stock option committee currently consists of the outside
directors, Dr. McAlister, Dr. Ryser and Dr. Steinmetz.

DIRECTOR COMPENSATION

Other than expenses in connection with attendance at meetings and other
customary expenses, we currently do not compensate any non-employee members of
our board of directors. Directors who are also employees do not receive
additional compensation for serving as directors.

Under our 2000 Equity Compensation Plan, non-employee directors are also
eligible to receive option grants to purchase shares of our common stock, as
determined by the stock option committee. Non-employee directors will also be
eligible to receive direct stock issuances.

EXECUTIVE COMPENSATION

The following summary compensation table sets forth information concerning
the compensation paid or accrued by us for services rendered to us in all
capacities for the years ended December 31, 2000 and December 31, 1999 by our
Chief Executive Officer and our four other highest paid executive officers.

LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------ ---------------
OTHER SECURITIES
ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($)(1) COMPENSATION($) OPTIONS/SARS(#) COMPENSATION($)
--------------------------- -------- ------------ --------------- --------------- ---------------

Jack Lief ......................... 2000 $321,667 $ -- 300,000 $ --
President and Chief Executive 1999 197,600 -- 12,500 --(3)
Officer

Dominic P. Behan, Ph.D. ........... 2000 200,000 55,000(2) 200,000 --
Vice President, Research 1999 137,500 -- 12,500 2,404(4)

Derek T. Chalmers, Ph.D. .......... 2000 200,000 55,000(2) 200,000 3,365(4)
Vice President, Research 1999 137,500 -- 12,500 4,807(4)

Richard P. Burgoon, Jr. ........... 2000 209,279 -- 100,000 23,653(4)
Senior Vice President, Operations 1999 156,183 -- 22,500 2,981(3)(4)
& General Counsel

Nigel R.A. Beeley, Ph.D. .......... 2000 175,000 -- 25,000 --
Vice President, Chief Chemical 1999 118,750 -- 25,000 --(3)
Officer

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

(1) In accordance with the rules of the SEC, the compensation described in this
table does not include medical, group life insurance or other benefits
received by the executive officers which are available generally to all of
our salaried employees and certain perquisites and other personal benefits
received by the executive officers which do not exceed the lesser of $50,000
or 10% of any such officer's salary and bonus disclosed in this table.
Amounts earned during the years 1999 and 2000 but deferred at the election
of the executive officer pursuant our 401(k) plan are included in the Salary
column.

(2) During the year 2000, Dr. Behan and Dr. Chalmers each received an advance on
their salary in the amount of $80,000. Dr. Behan and Dr. Chalmers have each
offset their advances by $25,000 in the form of salary reductions through
December 31, 2000. This has resulted in a net advance of $55,000 to each of
Dr. Behan and Dr. Chalmers during 2000.

(3) Pursuant to a four year consulting agreement with ChemNavigator.com,
Mr. Lief was awarded 200,000 shares of common stock of ChemNavigator.com in
May 1999. The shares vest at a rate of 50,000 shares per year beginning in
May 2000, provided that Mr. Lief remains employed by us. Pursuant to a four
year consulting agreement with ChemNavigator.com, Mr. Burgoon was awarded

175,000 shares of common stock of ChemNavigator.com in May 1999. The shares
vest at a rate of 43,750 shares per year beginning in May 2000, provided
that Mr. Burgoon remains employed by us. Dr. Beeley was awarded 3,200
options to purchase shares of common stock of ChemNavigator.com for
consulting services rendered in 1999. The options vest at the rate of 800
options per year beginning in October 2000, provided he continues to provide
services to ChemNavigator.com. Currently, we do not assign any value to the
shares of ChemNavigator.com stock.

(4) After their annual anniversary hire date, each of our employees may elect to
be paid for unused vacation time in the form of additional salary.
Dr. Behan elected to be paid in the form of additional salary for one week
of unused vacation time in the year ended December 31, 1999. Dr. Chalmers
elected to be paid in the form of additional salary for two weeks unused
vacation time in the year ended December 31, 1999 and one week of unused
vacation time in the year ended December 31, 2000. Mr. Burgoon elected to be
paid in the form of additional salary for one week of unused vacation time
in the year ended December 31, 1999 and six weeks of unused vacation time in
the year ended December 31, 2000.

OPTION/SAR GRANTS IN LAST FISCAL YEAR

The following table sets forth certain information regarding options granted
during the year ended December 31, 2000 by us to our Chief Executive Officer and
our four other highest paid executive officers:

INDIVIDUAL GRANTS
-----------------------------------------------------------------
PERCENT
OF TOTAL
NUMBER OF OPTIONS/SARS
SECURITIES GRANTED TO MARKET
UNDERLYING EMPLOYEES IN EXERCISE PRICE ON
OPTIONS/SARS FISCAL PRICE PER DATE OF EXPIRATION
NAME GRANTED(#) YEAR(%) SHARE($/SH) GRANT($) DATE
---- ------------ ------------ ----------- -------- ----------

Jack Lief...................... 100,000 8.3% $ 0.60 $18.00 3/3/10
200,000 16.5 24.23 28.50 8/22/10

Dominic P. Behan, Ph.D......... 100,000 8.3 0.60 18.00 3/3/10
100,000 8.3 24.23 28.50 8/22/10

Derek T. Chalmers, Ph.D........ 100,000 8.3 0.60 18.00 3/3/10
100,000 8.3 24.23 28.50 8/22/10

Richard P. Burgoon, Jr......... 50,000 4.1 0.60 18.00 3/3/10
50,000 4.1 24.23 28.50 8/22/10

Nigel R.A. Beeley, Ph.D........ 6,250 0.5 0.60 18.00 3/1/10
18,750 1.6 0.60 18.00 4/4/10

POTENTIAL REALIZABLE VALUE AT ASSUMED
ANNUAL RATES OF STOCK PRICE
APPRECIATION FOR OPTION TERM(1)
---------------------------------------
NAME 5%($) 10%($) 0%($)
---- ---------- ---------- -------------

Jack Lief...................... $2,872,010 $4,608,736 $ --
4,438,700 9,938,332 854,000
Dominic P. Behan, Ph.D......... 2,872,010 4,608,736 --
2,219,350 4,969,166 427,000
Derek T. Chalmers, Ph.D........ 2,872,010 4,608,736 --
2,219,350 4,969,166 427,000
Richard P. Burgoon, Jr......... 1,436,005 2,304,368 --
1,109,675 2,484,583 213,500
Nigel R.A. Beeley, Ph.D........ 179,501 288,046 --
538,502 864,138 --

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

(1) The potential realizable value is based on the form of the option at its
time of grant. It is calculated by assuming that the stock price on the date
of grant appreciates at the indicated annual rate, compounded annually for
the entire term of the option, and the option is exercised and sold on the
last day of its term for the appreciated stock price. Pursuant to SEC
guidelines, for options granted prior to our initial public offering, the
stock price on the date of grant is deemed to be equal to the initial public
offering price of $18.00 per share. The 5% and 10% assumed rates of
appreciation are mandated by the rules of the SEC and do not represent our
estimate or projection of the future price of our common stock.

We do not provide assurance to any executive officer or any other holder of
our securities that the actual stock price appreciation over the ten year option
term will be at the assumed 5% and 10% levels or at any other defined level.
Unless the market price of the common stock does in fact appreciate over the
option term, no value will be realized from the option grants made to the
executive officers.

Pursuant to stock option agreements between us and our employees, our
employees are entitled to exercise their options prior to vesting. If they
exercise their options prior to vesting, they will receive restricted shares
which will vest in accordance with the normal vesting schedule set forth in
their stock option agreement. These stock options are subject to repurchase by
us if they cease to be employed by us.

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES

The following table sets forth information regarding options exercised by,
and held as of December 31, 2000 by, our Chief Executive Officer and our four
other highest paid executive officers:

NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-
NUMBER OF OPTIONS/SARS AT THE-MONEY OPTIONS/SARS
SHARES DECEMBER 31, 2000(#)(2) AT DECEMBER 31, 2000($)(3)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------------- ----------- ------------- ----------- -------------

Jack Lief....................... 162,500 $20,000 -- 200,000 $ -- $ --

Dominic P. Behan, Ph.D.......... 50,000 20,000 6,250 206,250 93,125 1,583,125

Derek T. Chalmers, Ph.D......... 50,000 20,000 6,250 206,250 93,125 1,583,125

Richard P. Burgoon, Jr.......... 53,750 45,250 -- 98,750 -- 726,375

Nigel R.A. Beeley, Ph.D......... 50,000 -- -- -- -- --

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

(1) Value realized is based on the fair market value of our common stock on the
date of exercise minus the exercise price, without taking into account any
taxes that may be payable in connection with the transaction.

(2) Pursuant to stock option agreements between us and our employees, each of
our employees are entitled to exercise their options prior to vesting.
Therefore, all of the exercisable options are vested, but have not yet been
exercised, and all of the unexercisable options may be exercised, but have
not yet vested and will only vest subject to the terms of the stock option
agreements.

(3) Based on the fair market value of our common stock at December 31, 2000 of
$15.50 per share, minus the exercise price of the options.

EMPLOYMENT AGREEMENTS

We do not have any written employment agreements or any change-of-control
plans or arrangements with any of our executive officers or our other employees.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The compensation committee consists of Jack Lief, Michael Steinmetz, Ph.D.
and Stefan Ryser, Ph.D. None of our executive officers serves as a member of the
board of directors or compensation committee of any other entity that has one or
more executive officers serving as members of our board of directors or
compensation committee.

Mr. Lief, who is a member of our compensation committee, is also our
President and Chief Executive Officer and serves as a director of
ChemNavigator.com and as the President and Chief Executive Officer and a
director of Aressa Pharmaceuticals, Inc. and BRL Screening, Inc. Mr. Lief has
entered into a four-year service agreement with ChemNavigator.com in which he
agrees to provide up to 200 hours of service per year. As compensation for his
services he has received 200,000 shares of common stock of ChemNavigator.com,
which vest over a period of four years, subject to Mr. Lief remaining in our
employ. We own 33% of the outstanding capital stock of ChemNavigator.com.

COMPENSATION PLANS

The purpose of our equity compensation plans is to provide our designated
employees, certain consultants and advisors who perform services for us, and
non-employee members of our board of directors, with the opportunity to receive
grants of incentive stock options, non-qualified stock options and restricted
stock. Our plans permit the compensation committee to select eligible persons to
receive awards and to determine the terms and conditions of such awards. The
compensation committee will also set the vesting schedule and exercise price of
the options, provided that the option exercise price may not be less than 85% of
the fair market value per share of our common stock on the date of grant. In
addition, no participant may be granted incentive stock options that are first
exercisable in any one calendar year with a fair market value in excess of
$100,000. The options and restricted stock granted under our equity compensation
plans generally vest ratably over a four-year vesting period from the date of
grant and are exercisable up to ten years from the date of grant.

1998 EQUITY COMPENSATION PLAN

Our 1998 Equity Compensation Plan was adopted by our board of directors in
June 1998 and later approved by our stockholders. We have reserved 1,500,000
shares of our common stock for issuance under the plan. As of March 31, 2001, we
had granted incentive stock options and non-qualified stock options to purchase
1,523,025 shares of common stock at a weighted average price of $0.54 per share
under this plan, of which options for 998,025 shares of our common stock had
been exercised, 31,500 had been canceled and 106,200 were vested. Pursuant to
stock option agreements between us and some option holders for option grants
under this plan, some of our option holders are entitled to exercise their
options prior to vesting. All of the unexercisable options granted under this
plan may be exercised immediately, but will vest subject to the terms of the
particular stock option agreement.

2000 EQUITY COMPENSATION PLAN

Our 2000 Equity Compensation Plan was adopted by our board of directors in
April 2000 and was approved by our stockholders in May 2000. We have reserved
2,000,000 shares of our common stock for issuance pursuant to this plan. As of
March 31, 2001, we had granted incentive stock options and non-qualified stock
options to purchase 850,750 shares of our common stock at a weighted average
price of $21.60 per share under this plan, none of which have been exercised,
canceled or vested. Pursuant to stock option agreements between us and some
option holders for option grants under this plan, some of our option holders are
entitled to exercise their options prior to vesting. All of the unexercisable
options granted under this plan may be exercised immediately, but will vest
subject to the terms of the particular stock option agreement.

401(K) PLAN

We have established a tax-qualified employee savings and retirement plan, or
401(k) plan, which our full-time employees may participate in if they choose to
do so. Pursuant to the plan, eligible employees may elect to reduce their
current compensation by up to the lesser of 14% of their annual compensation and
the statutorily prescribed limit, which is $10,500 in 2000, and have the amount
of such reduction contributed to the plan. The trustees of the plan, at the
direction of each participant, invest the contributions to the plan in
designated investment options. The plan is intended to qualify under
Section 401 of the Internal Revenue Code, so that contributions to the plan and
income earned on the plan contributions are not taxable until withdrawn, and so
that the contributions we make will be deductible when made. Employees are
eligible to participate in the plan on the first day of their employment. Our
matching contributions, which totaled approximately $282,000 for the year ended
December 31, 2000, $149,000 for the year ended December 31, 1999 and $27,000 for
the year ended December 31, 1998, vest over a five year period.

2001 ARENA EMPLOYEE STOCK PURCHASE PLAN

Our 2001 Arena Employee Stock Purchase Plan, which will become effective on
July 1, 2001, was adopted by our board of directors in March 2001 and approved
by our stockholders in May 2001. The aggregate number of shares of our common
stock that may be issued pursuant to this plan is 1,000,000 shares.

The plan provides our employees with an opportunity to purchase our common
stock through accumulated payroll deductions. Participation in the plan is
voluntary and is dependent on each eligible employee's election to participate
and his or her determination as to the level of payroll deductions. The plan is
administered by our board of directors or a committee appointed by our board of
directors. Each of our employees, including our officers and the officers and
employees of our subsidiaries, whose customary employment with us is at least
20 hours per week, is eligible to participate in an offering period.

Each participant in the plan is automatically granted options to purchase
shares of our common stock. The number of shares subject to the option may not
exceed 625 shares of our common stock in each purchase period. The option
expires at the end of the offering period or upon termination of employment,
whichever is earlier. The option granted to each participant will be exercised
at the end of each purchase period to the extent that the payroll deductions
accumulated during a purchase period permit a participant to purchase shares.

Shares of common stock may be purchased under the plan at a price not less
than 85% of the lesser of the fair market value of the common stock on the first
trading day of each offering period or the last trading day of each purchase
period. The fair market value of our common stock on any relevant date will
generally be the closing price per share as reported on the Nasdaq National
Market, or the mean of the closing bid and asked prices, if no sales were
reported, as quoted on the Nasdaq National Market or reported in THE WALL STREET
JOURNAL. If the fair market value of our common stock on any exercise date in an
offering period is lower than the fair market value of our common stock on the
first day of that offering period, all participants in that offering period will
be automatically withdrawn from that offering period immediately after the
exercise of their options and automatically re-enrolled on the first day of the
new offering period.

An employee may not participate in the plan if, immediately after the grant
to be made under the plan, that employee would own sufficient shares of our
capital stock or hold outstanding options to purchase shares of our capital
stock representing five percent or more of the voting power or value of our
outstanding shares of capital stock, or if his or her rights to purchase stock
under all of our employee stock purchase plans accrue at a rate exceeding
$25,000 worth of stock for each calendar year, based on the fair market value of
the shares at the time the option is granted.

LIMITATION ON LIABILITY AND INDEMNIFICATION

LIMITATION ON LIABILITY

Our certificate of incorporation provides that the liability of our
directors will be limited to the fullest extent permitted by Delaware law. Our
directors will not be personally liable to us or our stockholders for monetary
damages resulting from a breach of fiduciary duty except for:

- any breach of the duty of loyalty to us or our stockholders

- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law

- liability under Section 174 of the Delaware General Corporation Law

- any transaction from which the director derived an improper personal
benefit

This limitation of liability does not apply to the responsibility or
liability of our directors pursuant to any criminal statute nor does it relieve
our directors from payment of taxes pursuant to federal, state or local law.

INDEMNIFICATION

Our by-laws provide that we will indemnify our directors and executive
officers and may indemnify our other corporate agents, to the fullest extent
permitted by Delaware law. Section 145 of the Delaware corporate laws provides a
corporation with the power to indemnify any officer or director acting in his
capacity as the corporation's representative who was, is or is threatened to be
made, a party to any action or proceeding for expenses, judgments, fines and
amounts paid in settlement actually and reasonably incurred in connection with
such action or proceeding. The indemnity provisions apply whether the action was
instituted by a third-party or arose by or in our right. Generally, the only
limitation on our ability to indemnify our officers and directors is if their
actions violate a criminal statute or if their actions or failures to act are
finally determined by a court to have constituted willful misconduct or
recklessness.

We currently have directors' and officers' liability insurance to provide
our directors and officers with insurance coverage for losses arising from
claims based on breaches of duty, negligence, errors and other wrongful acts.

RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

Dr. McAlister, a member of our board of directors, is also the Chief
Executive Officer and President of Tripos, Inc. Prior to this offering, Tripos
was the beneficial owner of approximately 8.9% of our common stock. We have
entered into a drug research collaboration agreement and a software license
agreement with Tripos, and we may enter into additional agreements with Tripos
for the joint development of drug leads using CART-activated receptors and
Tripos' chemical library. We will share expenses and any proceeds resulting from
the collaboration with Tripos and will pay Tripos a fee for services they
provide outside of the collaboration.

Dr. Steinmetz, a member of our board of directors, is also a Managing
Director of MPM Asset Management LLC, an affiliate of MPM Capital L.P. Prior to
this offering, MPM Capital L.P. was the beneficial owner of approximately 17.7%
of our common stock. In January 2000, entities controlled by MPM Capital L.P.
purchased 1,141,033 shares of our Series E preferred stock for an aggregate
purchase price of $4,564,132. In March 2000, entities controlled by MPM Capital
L.P. purchased 865,385 shares of our Series F preferred stock for an aggregate
purchase price of $4,500,002. Dr. Steinmetz is the holder of record of 50,000
shares of ChemNavigator.com's Series A preferred stock, 13,296 shares of its
Series B preferred stock and holds a warrant to purchase 3,324 shares of the
common stock of ChemNavigator.com for which he paid an aggregate purchase price
of $80,315.

Prior to this offering, International BM Biomedicine Holdings, Inc. was the
beneficial owner of approximately 8.5% of our common stock. In January 2000,
International BM Biomedicine Holdings purchased 500,000 shares of our Series E
preferred stock for an aggregate purchase price of $2,000,000.

Dr. Michael E. Lewis, one of our co-founders, served as our director until
April 2000. Dr. Lewis is a principal in BioDiligence Partners, Inc. We paid
BioDiligence Partners, Inc. $150,000 during the year ended December 31, 2000,
for consulting services rendered to us.

Mr. Lief, our President and Chief Executive Officer, is also the President
and Chief Executive Officer of Aressa Pharmaceuticals, Inc. and BRL
Screening, Inc. and a member of the board of directors of Aressa
Pharmaceuticals, Inc., ChemNavigator.com and BRL Screening, Inc.

Mr. Burgoon, our Senior Vice President, Operations, General Counsel and
Secretary, is also the Secretary of Aressa Pharmaceuticals, Inc. and
ChemNavigator.com, and is a member of the board of directors of Aressa
Pharmaceuticals, Inc., ChemNavigator.com and of BRL Screening, Inc. Mr. Burgoon
has entered into a four-year service agreement with ChemNavigator.com in which
he agrees to provide up to 200 hours of service per year. As compensation for
his services he has received 175,000 shares of common stock of
ChemNavigator.com, which vest over a period of four years, subject to
Mr. Burgoon remaining in our employ.

Mr. Hoffman, our Vice President, Finance, is also the Vice President,
Finance of BRL Screening, Inc. Mr. Hoffman has entered into a four-year service
agreement with ChemNavigator.com in which he agrees to provide up to 200 hours
of service per year. As compensation for his services he has received 100,000
shares of common stock of ChemNavigator.com, which vest over a period of four
years, subject to Mr. Hoffman remaining in our employ.

In April 2000, Mr. Scotti, our Vice President, Business Development,
purchased 10,000 shares of our Series G preferred stock for an aggregate
purchase price of $73,000.

Dr. Beeley, our Vice President and Chief Chemical Officer has provided
consulting services to ChemNavigator.com and has received 3,200 options to
purchase shares of common stock of ChemNavigator.com as compensation for
services rendered. The options vest over a period of four years, provided he
continues to provide services to ChemNavigator.com.

We also sublease office space to ChemNavigator.com at a fair market rate. We
believe that all of the transactions described above were made and are on terms
no less favorable to us than those that could be obtained from independent third
parties in arms-length negotiations.

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of April 30, 2001 and as adjusted to
give effect to the sale of 4,000,000 shares of common stock in this offering by
us and the sale of 1,000,000 shares of common stock in this offering by the
selling stockholders, by:

- each person, group or entity who is the beneficial owner of 5% or more of
our common stock

- each selling stockholder

- each director and nominee for director

- our Chief Executive Officer and our four other highest paid executive
officers

- all of our current directors and executive officers as a group

The following table is based on information supplied by our officers,
directors, principal stockholders, and Schedules 13D and 13G filed with the SEC.
The number of shares beneficially owned by each 5% stockholder, director or
executive officer is determined under the rules of the SEC. Under the SEC rules,
beneficial ownership includes any shares as to which the individual or entity
has sole or shared voting power or investment power and also includes any shares
which the individual or entity has the right to acquire on or before June 29,
2001 through the exercise of stock options, and any reference in the footnotes
to this table to shares subject to stock options refers only to stock options
that are so exercisable. For purposes of computing the percentage of outstanding
shares of common stock held by each person or entity, any shares which that
person or entity has the right to acquire on or before June 29, 2001 are deemed
to be outstanding, but are not deemed to be outstanding for the purpose of
computing the percentage ownership of any other person. Unless otherwise
indicated in the footnotes to this table and subject to community property laws
where applicable, we believe that the stockholders named in this table have sole
voting and investment power with respect to the shares indicated as beneficially
owned. The inclusion in the table of any shares deemed beneficially owned does
not constitute an admission of beneficial ownership of those shares. Unless
otherwise indicated in the footnotes below, the address for the beneficial
owners listed in this table is care of Arena Pharmaceuticals, Inc., 6166 Nancy
Ridge Drive, San Diego CA 92121.

BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
PRIOR TO OFFERING AFTER THE OFFERING
---------------------- SHARES ----------------------
TO BE
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES PERCENTAGE SOLD SHARES PERCENTAGE
------------------------------------ --------- ---------- -------- --------- ----------

MPM Capital L.P.(1).......................... 4,012,149 17.6% 900,000 3,112,149 11.6%
International BM Biomedicine Holdings,
Inc.(2).................................... 1,932,665 8.5 -- 1,932,665 7.2
Tripos, Inc.(3).............................. 2,015,840 8.8 100,000 1,915,840 7.2
The TCW Group, Inc.(4)....................... 1,544,667 6.8 -- 1,544,667 5.8
Jack Lief(5)................................. 715,500 3.1 -- 715,500 2.6
Dominic P. Behan, Ph.D.(6)................... 447,500 1.9 -- 447,500 1.7
Derek T. Chalmers, Ph.D.(7).................. 452,500 2.0 -- 452,500 1.7
Richard P. Burgoon, Jr.(8)................... 153,000 * -- 153,000 *
Nigel R.A. Beeley, Ph.D.(9).................. 50,000 * -- 50,000 *
Michael Steinmetz, Ph.D.(1).................. 10,942 * -- 10,942 *
Stefan Ryser, Ph.D.(10)...................... 17,000 * -- 17,000 *
John P. McAlister, III, Ph.D.(3)............. 2,032,840 8.9 -- 1,932,840 7.2
All directors and executive officers as a
group (13 persons)(11)..................... 4,109,282 17.4 -- 4,009,282 14.5

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

* Less than one percent

(1) In the case of MPM Capital L.P., includes shares held through interests in
MPM Capital L.P. and in entities directly or indirectly controlled by it.
MPM Capital L.P. is a direct and indirect parent or a control person of MPM
Asset Management LLC and funds managed and advised by it, and the general
partners of such funds. Such shares also include shares held through
interests in Medical Portfolio Management, LLC, the general partner of MPM
Capital L.P. and reflect 3,473,112 shares held of record prior to this
offering by BB BioVentures LP, 497,310 shares held of record prior to this
offering by MPM BioVentures Parallel Fund, L.P., and 41,727 shares held of
record prior to this offering by MPM Asset Management Investors 1999 LLC,
according to a Schedule 13G filed in February 2001. MPM Capital L.P. and
each of the entities controlled by it disclaims beneficial ownership of
shares not directly held by it. According to Schedule 13Gs filed in
February 2001, Drs. Ansbert S. Gadicke and Luke B. Evnin each hold sole
voting and dispositive power over the shares beneficially owned by MPM
Capital L.P. Drs. Gadicke and Evnin each disclaims beneficial ownership of
shares not held directly by him. Dr. Steinmetz is a Managing Director of
MPM Asset Management LLC, which is the advisor of BB BioVentures LP and MPM
BioVentures Parallel Fund L.P. Dr. Steinmetz owns 10,942 shares of our
common stock directly and may be deemed to beneficially own the shares
owned by BB BioVentures LP, MPM BioVentures Parallel Fund L.P., and MPM
Asset Management Investors 1999 LLC, but disclaims beneficial ownership of
shares that he does not hold directly. Dr. Steinmetz is also the holder of
record of 50,000 shares of ChemNavigator.com's Series A preferred stock,
13,296 shares of its Series B preferred stock and holds a warrant to
purchase 3,324 shares of the common stock of ChemNavigator.com. The address
of MPM Capital L.P., the entities controlled by it and Drs. Gadicke, Evnin
and Steinmetz is One Cambridge Center, 9th Floor, Cambridge, Massachusetts
02142.

(2) Represents shares beneficially owned by International BM Biomedicine
Holdings, Inc. according to a Schedule 13G dated December 31, 2000. The
address for International BM Biomedicine Holdings is House of Commerce,
Nauenstrasse 41, P.O. Box 136, CH-4002, Basel, Switzerland.

(3) Represents 2,015,840 shares beneficially owned by Tripos, Inc.
Dr. McAlister is the President, Chief Executive Officer and director of
Tripos. Dr. McAlister owns 2,000 shares of our common stock directly and is
not selling any shares in this offering. Shares beneficially owned by
Dr. McAlister also include 15,000 shares issuable upon the exercise of
stock options. The address for Tripos is 1699 South Hanley Road, St. Louis,
Missouri 63144. Dr. McAlister disclaims beneficial ownership of shares in
which he does not have a pecuniary interest.

(4) Represents shares benefically owned by The TCW Group, Inc. according to a
Schedule 13F-HR filed by The TCW Group for the quarter ended March 31,
2001. Reflects 809,840 shares held of record by TCW Asset Management
Company, 64,550 shares held of record by Trust Company of the West and
670,277 shares held of record by TCW Investment Management Company for the
benefit of their clients and affiliated advisors. Based upon the
Schedule 13F-HR, The TCW Group and Robert Day share voting and dispositive
power with respect to these shares. The address for The TCW Group, Inc. is
865 South Figueroa Street, Los Angeles, California 90017.

(5) Includes 300,000 shares issuable upon the exercise of stock options. Also
includes 93,750 shares that were issued to Mr. Lief upon the exercise of
unvested stock options. Shares issued upon the exercise of unvested stock
options will vest over the four-year term of the underlying stock option
agreement, subject to repurchase by us if Mr. Lief leaves our employ.
Mr. Lief also owns 200,000 shares of the common stock of ChemNavigator.com,
subject to repurchase by ChemNavigator.com if Mr. Lief is no longer
employed by us.

(6) Includes 212,500 shares issuable upon the exercise of stock options. Also
includes 12,500 shares that were issued to Dr. Behan upon the exercise of
unvested stock options. Shares issued upon the exercise of unvested stock
options will vest over the four-year term of the underlying stock option
agreement, subject to repurchase by us if Dr. Behan is no longer employed
by us.

(7) Includes 181,250 shares issuable upon the exercise of stock options. Also
includes 12,500 shares that were issued to Dr. Chalmers upon the exercise
of unvested stock options. Shares issued upon the exercise of unvested
stock options will vest over the four-year term of the underlying stock
option agreement, subject to repurchase by us if Dr. Chalmers is no longer
employed by us.

(8) Includes 62,500 shares issuable upon the exercise of stock options. Also
includes 46,250 shares that were issued to Mr. Burgoon upon the exercise of
unvested stock options. Shares issued upon the exercise of unvested stock
options will vest over the four-year term of the underlying stock option
agreement, subject to repurchase by us if Mr. Burgoon is no longer employed
by us. Mr. Burgoon also owns 175,000 shares of the common stock of
ChemNavigator.com subject to repurchase by ChemNavigator.com if
Mr. Burgoon is no longer employed by us.

(9) Includes 31,250 shares that were issued to Dr. Beeley upon the exercise of
unvested stock options. Shares issued upon the exercise of unvested stock
options will vest over the four-year term of the underlying stock option
agreement, subject to repurchase by us if Dr. Beeley is no longer employed
by us.

(10) Includes 15,000 shares issuable upon the exercise of stock options.

(11) Includes 801,250 shares issuable upon the exercise of stock options held by
our directors and executive officers. None of our directors or executive
officers are selling shares in this offering.

DESCRIPTION OF CAPITAL STOCK

AUTHORIZED AND OUTSTANDING CAPITAL STOCK

Our authorized capital stock as of March 31, 2001 consisted of 67,500,000
shares of common stock and 7,500,000 shares of preferred stock, and as of this
date there were 22,743,038 shares of common stock and no shares of preferred
stock outstanding.

As of March 31, 2001, an aggregate of 1,157,725 shares of our common stock
were available for grant under our 1998 Equity Compensation Plan and our 2000
Equity Compensation Plan. As of that date, we had outstanding options to
purchase 1,344,250 shares of our common stock. In addition, we have reserved
1,000,000 shares of our common stock for issuance under our 2001 Arena Employee
Stock Purchase Plan.

After giving effect to the sale of the common stock in this offering, we
will have a total of 26,743,038 shares of common stock and no shares of
preferred stock outstanding, assuming that the underwriters do not exercise
their over-allotment option.

COMMON STOCK

Our common stock has the following characteristics and rights:

VOTING:

- one vote for each share held of record on all matters submitted to a vote
of our stockholders

- no cumulative voting rights

- election of directors by plurality of votes cast

- all other matters by majority of votes cast

DIVIDENDS:

- subject to preferential dividend rights of outstanding preferred stock, if
any

- common stockholders are entitled to receive ratably declared dividends

- our board of directors may only declare dividends out of legally available
funds

ADDITIONAL RIGHTS:

- subject to the preferential liquidation rights of outstanding shares of
preferred stock, if any, common stockholders are entitled to receive
ratably net assets, available after the payment of all debts and
liabilities, upon our liquidation, dissolution or winding up

- no preemptive rights

- no subscription rights

- no redemption rights

- no sinking fund rights

- no conversion rights

The rights and preferences of our common stockholders, including the right
to elect directors, are subject to the rights of any series of preferred stock
we may issue in the future.

PREFERRED STOCK

Our amended and restated certificate of incorporation provides that we may,
by resolution of our board of directors, and without any further vote or action
by our stockholders, authorize and issue, subject to limitations prescribed by
law, up to an aggregate of 7,500,000 shares of preferred stock. The preferred
stock may be issued in one or more series. With respect to any series, our board
of directors may determine the designation and the number of shares,
preferences, limitations and special rights, including dividend rights,
conversion rights, voting rights, redemption rights and liquidation preferences.
Because of the rights that may be granted, the issuance of preferred stock may
delay, defer or prevent a change of control.

REGISTRATION RIGHTS

Following completion of this offering, three holders who beneficially own an
aggregate of 6,960,654 shares of our common stock will have the right to have
their shares registered under the Securities Act of 1933. These rights are
provided under the terms of agreements between us and the holders of these
shares. Under these agreements, the holders of these shares have the right,
subject to specific conditions, to require us to file up to four registration
statements on their behalf and, when we become eligible to use Form S-3 under
the Securities Act, to require us to file up to six additional registration
statements on Form S-3 on their behalf. The holders of these securities are also
entitled to require us to include their common stock in future registration
statements we file under the Securities Act. Under these agreements, we are also
required to pay the expenses associated with the registration of these holders'
shares.

Once a holder can sell all of its shares under Rule 144 of the Securities
Act during any 90 day period, the holder cannot require us to register his
shares under these agreements. Additionally, any remaining registration rights
will terminate on July 28, 2006. Registration of shares of common stock pursuant
to the exercise of these registration rights would result in such shares
becoming freely tradable without restriction under the Securities Act
immediately upon the effectiveness of such registration and may adversely affect
our stock price.

ANTI-TAKEOVER EFFECTS OF PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW

Our certificate of incorporation provides that our board of directors may
establish the rights of, and cause us to issue, substantial amounts of preferred
stock without the need for stockholder approval. Further, our board may
determine the terms, conditions, rights, privileges and preferences of the
preferred stock. Our board is required to exercise its business judgment when
making such determinations. Our board's use of its discretion to issue preferred
stock may inhibit the ability of third parties to acquire us. Additionally, our
board may issue the preferred stock in an attempt to dilute the common stock
held by entities seeking to obtain control of us. Some of the rights of the
holders of common stock will be subject to, and may be adversely affected by,
any preferred stock that may be issued in the future. Our preferred stock
provides desirable flexibility in connection with possible acquisitions,
financings and other corporate transactions. However, it may also have the
effect of discouraging, delaying or making it more difficult for third parties
to acquire or attempt to acquire control of us or substantial amounts of our
common stock.

Section 203 of the Delaware General Corporation Law, which applies to us,
generally prohibits certain business combinations between a Delaware corporation
and an interested stockholder. An interested stockholder is generally defined as
a person who beneficially owns, or within three years of the date of the
business combination did own, directly or indirectly, 15% or more of the
outstanding

voting shares of a Delaware corporation, or is an affiliate or associate of a
person who meets these criteria. The statute broadly defines business
combinations to include:

- mergers

- consolidations

- sales or other dispositions of assets having an aggregate value equal to,
or in excess of 10% of the aggregate market value of, the consolidated
assets of the corporation or aggregate market value of all outstanding
stock of the corporation

- certain transactions that would increase the interested stockholder's
proportionate share ownership in the corporation

The statute prohibits any such business combination for a period of three
years commencing on the date the interested stockholder becomes an interested
stockholder, unless one of the following occurs:

- the business combination is approved by the corporation's board of
directors prior to the date the interested stockholder becomes an
interested stockholder

- the interested stockholder acquired at least 85% of the voting stock of
the corporation (other than stock held by directors who are also officers
or by certain employee stock plans) in the transaction in which it becomes
an interested stockholder

- the business combination is approved by the board of directors and by the
affirmative vote of at least two-thirds of the outstanding voting stock
that is not owned by the interested stockholder

The Delaware General Corporation Law contains provisions enabling a
corporation to avoid Section 203's restrictions if the corporation's
stockholders vote to approve an amendment to the corporation's certificate of
incorporation or by-laws to avoid the restrictions. In addition, the
restrictions contained in Section 203 are not applicable to any of our existing
stockholders. We have not and do not currently intend to "elect out" of the
application of Section 203 of the Delaware General Corporation Law.

TRANSFER AGENT

The transfer agent and registrar for our common stock is Computershare Trust
Company, Inc.

UNDERWRITING

GENERAL

Subject to the terms and conditions set forth in an underwriting agreement,
each of the underwriters named below has severally agreed to purchase from us
the aggregate number of shares of common stock set forth opposite its name
below:

UNDERWRITERS NUMBER OF SHARES
------------ ----------------

Thomas Weisel Partners LLC.................................. 2,500,000
Dain Rauscher Incorporated.................................. 1,250,000
ABN AMRO Rothschild LLC..................................... 625,000
Lazard Freres & Co. LLC..................................... 625,000
---------
Total..................................................... 5,000,000
=========

Of the 5,000,000 shares to be purchased by the underwriters, 4,000,000
shares will be purchased from us and 1,000,000 shares will be purchased from the
selling stockholders.

The underwriting agreement provides that the obligations of the several
underwriters are subject to various conditions, including approval of legal
matters by counsel. The nature of the underwriters' obligations commits them to
purchase and pay for all of the shares of common stock listed above if any are
purchased.

The underwriting agreement provides that we and the selling stockholders
will indemnify the underwriters against liabilities specified in the
underwriting agreement under the Securities Act or will contribute to payments
that the underwriters may be required to make relating to these liabilities.

Thomas Weisel Partners LLC expects to deliver the shares of common stock to
purchasers on June 27, 2001.

OVER-ALLOTMENT OPTION

We have granted a 30-day over-allotment option to the underwriters to
purchase up to a total of 750,000 additional shares of our common stock from us
at the public offering price, less the underwriting discounts and commissions
payable by us, as set forth on the cover page of this prospectus. If the
underwriters exercise this option in whole or in part, then each of the
underwriters will be separately committed, subject to conditions described in
the underwriting agreement, to purchase the additional shares of our common
stock in proportion to their respective commitments set forth in the table
above.

COMMISSIONS AND DISCOUNTS

The underwriters propose to offer the shares of common stock directly to the
public at the public offering price set forth on the cover page of this
prospectus, and at this price less a concession not in excess of $0.86 per share
of common stock to other dealers specified in a master agreement among
underwriters who are members of the National Association of Securities
Dealers, Inc. The underwriters may allow, and the other dealers specified may
reallow, concessions, not in excess of $0.10 per share of common stock to these
other dealers. After this offering, the offering price, concessions and other
selling terms may be changed by the underwriters. Our common stock is offered
subject to receipt and acceptance by the underwriters and to other conditions,
including the right to reject orders in whole or in part.

The following table summarizes the compensation to be paid to the
underwriters by us and the expenses payable by us:

TOTAL
----------------------------
WITHOUT OVER- WITH OVER-
PER SHARE ALLOTMENT ALLOTMENT
--------- ------------- ------------

Public offering price................................... $27.50 $137,500,000 $158,125,000
Underwriting discount................................... 1.44 7,200,000 8,280,000
Proceeds, before expenses, to us........................ 26.06 104,240,000 123,785,000
Proceeds, before expenses, to the selling
stockholders.......................................... 26.06 26,060,000 26,060,000

INDEMNIFICATION OF UNDERWRITERS

We and the selling stockholders will indemnify the underwriters against some
civil liabilities, including liabilities under the Securities Act and
liabilities arising from breaches of our representations and warranties
contained in the underwriting agreement. If we are unable to provide this
indemnification, we will contribute to payments the underwriters may be required
to make in respect of those liabilities.

NO SALES OF SIMILAR SECURITIES

The underwriters will require our directors, officers and selling
stockholders to agree, subject to specified exceptions, not to offer, sell,
agree to sell, directly or indirectly, or otherwise dispose of any shares of
common stock or any securities convertible into or exchangeable for shares of
common stock without the prior written consent of Thomas Weisel Partners LLC for
a period of 90 days after the date of this prospectus, except that, in the case
of shares beneficially owned by MPM Capital L.P., such period will be 60 days,
90 days and 120 days after the date of this prospectus, in each case with
respect to one-third of the shares owned by that stockholder immediately after
this offering.

We have agreed that for a period of 90 days after the date of this
prospectus we will not, without the prior written consent of Thomas Weisel
Partners LLC, offer, sell or otherwise dispose of any shares of common stock,
except for the shares of common stock offered in this offering, the shares of
common stock issuable upon exercise of outstanding options and warrants on the
date of this prospectus and the shares of our common stock that are issued under
our 2001 Arena Employee Stock Purchase Plan.

INFORMATION REGARDING THOMAS WEISEL PARTNERS LLC

Due to the fact that Thomas Weisel Partners LLC, one of the underwriters,
was organized within the last three years, we are providing you the following
information. Thomas Weisel Partners LLC was organized and registered as a
broker-dealer in December 1998. Since December 1998, Thomas Weisel Partners LLC
has been named as a lead or co-manager of, or as a syndicate member in, numerous
public offerings of equity securities. Thomas Weisel Partners LLC does not have
any material relationship with us or any of our officers, directors or other
controlling persons, except with respect to its contractual relationship with us
pursuant to the underwriting agreement entered into in connection with this
offering.

NASDAQ NATIONAL MARKET LISTING

Our common stock is quoted on the Nasdaq National Market under the symbol
"ARNA."

DISCRETIONARY ACCOUNTS

The underwriters do not expect sales of shares of common stock offered by
this prospectus to any accounts over which they exercise discretionary authority
to exceed five percent of the shares offered.

SHORT SALES, STABILIZING TRANSACTIONS AND PENALTY BIDS

In order to facilitate this offering, persons participating in this offering
may engage in transactions that stabilize, maintain or otherwise affect the
price of our common stock during and after this offering. Specifically, the
underwriters may engage in the following activities in accordance with the rules
of the SEC.

SHORT SALES. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Covered
short sales are sales made in an amount not greater than the underwriters'
option to purchase additional shares from us in this offering. The underwriters
may close out any covered short position by either exercising their option to
purchase shares or purchasing shares in the open market. In determining the
source of shares to close out the covered short position, the underwriters will
consider, among other things, the price of shares available for purchase in the
open market as compared to the price at which they may purchase shares through
the over-allotment option. Naked short sales are any sales in excess of such
over-allotment option. The underwriters must close out any naked short position
by purchasing shares in the open market. A naked short position is more likely
to be created if the underwriters are concerned that there may be downward
pressure on the price of the common stock in the open market after pricing that
could adversely affect investors who purchase in this offering.

STABILIZING TRANSACTIONS. The underwriters may make bids for or purchases
of the shares for the purpose of pegging, fixing or maintaining the price of the
shares, so long as stabilizing bids do not exceed a specified maximum.

PENALTY BIDS. If the underwriters purchase shares in the open market in a
stabilizing transaction or syndicate covering transaction, they may reclaim a
selling concession from the underwriters and selling group members who sold
those shares as part of this offering. Stabilization and syndicate covering
transactions may cause the price of the shares to be higher than it would be in
the absence of these transactions. The imposition of a penalty bid might also
have an effect on the price of the shares if it discourages resales of the
shares.

The transactions above may occur on the Nasdaq National Market or otherwise.
Neither we nor the underwriters make any representation or prediction as to the
effect that the transactions described above may have on the price of the
shares. If these transactions are commenced, they may be discontinued without
notice at any time.

LEGAL MATTERS

Morgan, Lewis & Bockius LLP, Los Angeles, California will provide us with an
opinion relating to the validity of the common stock issued in this offering.
The validity of the shares of common stock issued in this offering will be
passed upon for the underwriters by Pillsbury Winthrop LLP, New York, New York.

EXPERTS

Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements as of December 31, 1999 and 2000, and for each of the three
years in the period ended December 31, 2000, as set forth in their report. We
have included our financial statements in the prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on their
authority as experts in accounting and auditing.

WHERE YOU CAN FIND MORE INFORMATION

We file reports, proxy statements and other documents with the SEC. You may
read and copy any document we file at the SEC's public reference room at
Judiciary Plaza Building, 450 Fifth Street, N.W., Room 1024, Washington, D.C.
20549. You should call 1-800-SEC-0330 for more information on the public
reference room. Our SEC filings are also available to you on the SEC's internet
site at http://www.sec.gov.

This prospectus is part of a registration statement that we filed with the
SEC. The registration statement contains more information than this prospectus
regarding us and our common stock, including exhibits and schedules which are
part of the registration statement. You should read the registration statement
and the related exhibits and schedules for further information regarding us and
our common stock. You can obtain a copy of the registration statement from the
SEC at the address listed above or from the SEC's internet site.

ARENA PHARMACEUTICALS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE
--------

Report of Ernst & Young LLP, Independent Auditors........... F-2

Consolidated Balance Sheets................................. F-3

Consolidated Statements of Operations....................... F-4

Consolidated Statements of Stockholders' Equity (Deficit)... F-5

Consolidated Statements of Cash Flows....................... F-6

Notes to Consolidated Financial Statements.................. F-7

F-1

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Arena Pharmaceuticals, Inc.

We have audited the accompanying consolidated balance sheets of Arena
Pharmaceuticals, Inc. as of December 31, 1999 and 2000, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. 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 consolidated financial position of Arena
Pharmaceuticals, Inc. at December 31, 1999 and 2000 and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States.

/s/ ERNST & YOUNG LLP

San Diego, California
January 15, 2001 except for the seventh

and eighth paragraphs of Note 7 and Note 12

as to which the date is March 23, 2001

F-2

ARENA PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, MARCH 31,
--------------------------- ------------
1999 2000 2001
------------ ------------ ------------
(UNAUDITED)

ASSETS
Current assets:
Cash and cash equivalents................................. $ 5,401,508 $144,413,176 $125,503,323
Accounts receivable....................................... -- 2,116,146 2,411,000
Prepaid expenses.......................................... 172,052 1,685,122 1,066,584
------------ ------------ ------------
Total current assets.................................... 5,573,560 148,214,444 128,980,907

Property and equipment, net................................. 2,773,382 4,265,260 12,219,879
Acquired technology and other purchased intangibles, net.... -- -- 15,249,951
Deposits and restricted cash................................ 178,898 88,016 88,016
Other assets................................................ -- 144,209 82,405
------------ ------------ ------------
Total assets............................................ $ 8,525,840 $152,711,929 $156,621,158
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses..................... $ 700,383 $ 615,201 $ 1,288,578
Accrued compensation...................................... 166,031 300,339 371,106
Current portion of deferred revenues...................... -- 220,000 1,030,866
Current portion of obligations under capital leases....... 355,119 480,538 493,832
------------ ------------ ------------
Total current liabilities............................... 1,221,533 1,616,078 3,184,382

Convertible note payable to related party, less current
portion................................................... 934,312 -- --
Obligations under capital leases, less current portion...... 1,224,472 960,517 832,314
Deferred rent............................................... 793,123 866,009 859,009
Deferred revenues, less current portion..................... -- 485,000 567,833

Commitments
Redeemable convertible preferred stock, $.0001 par value:
7,792,533 shares authorized at December 31, 1999,
no shares authorized at December 31, 2000 and at
March 31, 2001; 6,908,593 shares issued and outstanding at
December 31, 1999; no shares issued and outstanding at
December 31, 2000 and at March 31, 2001................... 18,251,949 -- --
Stockholders' equity (deficit):
Preferred stock, $.0001 par value: no shares authorized at
December 31, 1999, 7,500,000 shares authorized at
December 31, 2000 and March 31, 2001; no shares issued
and outstanding at December 31, 1999 and 2000 and at
March 31, 2001.......................................... -- -- --
Common stock, $.0001 par value: 25,000,000, 67,500,000 and
67,500,000 shares authorized at December 31, 1999 and
2000 and at March 31, 2001, respectively; 1,116,375,
22,688,313 and 22,743,038 shares issued and outstanding
at December 31, 1999 and 2000 and at March 31, 2001,
respectively............................................ 111 2,268 2,274
Additional paid-in capital................................ 1,055,328 177,373,030 177,697,979
Deferred compensation..................................... (625,955) (7,899,970) (6,916,624)
Accumulated deficit....................................... (14,329,033) (20,691,003) (19,606,009)
------------ ------------ ------------
Total stockholders' equity (deficit).................... (13,899,549) 148,784,325 151,177,620
------------ ------------ ------------
Total liabilities and stockholders' equity (deficit).... $ 8,525,840 $152,711,929 $156,621,158
============ ============ ============

See accompanying notes.

F-3

ARENA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------- --------------------------
1998 1999 2000 2000 2001
----------- ------------ ------------ ------------ -----------
(UNAUDITED) (UNAUDITED)

Revenues........................... $ -- $ -- $ 7,683,396 $ -- $ 5,392,335

Operating expenses:
Research and development......... 2,615,526 8,336,483 12,080,204 2,399,358 3,903,341
General and administrative....... 728,806 1,814,023 2,678,980 423,828 1,025,983
Amortization of deferred
compensation ($264,419,
$3,018,623, $285,398 and
$851,081 related to research
and development expenses and
$113,690, $1,324,273, $124,081,
and $417,585 related to general
and administrative expenses for
the years ended December 31,
1999 and 2000 and for the three
months ended March 31, 2000 and
2001, respectively)............ -- 378,109 4,342,896 409,479 1,268,666
Amortization of acquired technology
and other purchased
intangibles...................... -- -- -- -- 128,083
----------- ------------ ------------ ------------ -----------
Total operating expenses....... 3,344,332 10,528,615 19,102,080 3,232,665 6,326,073
Interest income.................... 42,266 446,848 4,644,471 157,461 1,961,743
Interest expense................... (94,252) (165,603) (220,483) (59,579) (40,259)
Gain on sale of investment......... -- -- 575,855 -- --
Other income....................... -- 9,420 56,871 12,583 97,248
----------- ------------ ------------ ------------ -----------
Net income (loss)................ (3,396,318) (10,237,950) (6,361,970) (3,122,200) 1,084,994
Non-cash preferred stock charge.... -- -- (22,391,068) (14,187,563) --
----------- ------------ ------------ ------------ -----------
Net income (loss) applicable to
common stockholders............ $(3,396,318) $(10,237,950) $(28,753,038) $(17,309,763) $ 1,084,994
=========== ============ ============ ============ ===========
Net income (loss) per share:
Basic and diluted................ $ (3.51) $ (10.05) $ (2.84) $ (15.92) $ 0.05
=========== ============ ============ ============ ===========
Shares used in calculating net
income (loss) per share:
Basic............................ 966,799 1,018,359 10,139,755 1,086,988 22,272,476
=========== ============ ============ ============ ===========
Diluted.......................... 966,799 1,018,359 10,139,755 1,086,988 23,247,747
=========== ============ ============ ============ ===========

See accompanying notes.

F-4

ARENA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

TOTAL
COMMON STOCK ADDITIONAL STOCKHOLDERS'
--------------------- PAID-IN DEFERRED ACCUMULATED EQUITY
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT (DEFICIT)
---------- -------- ------------ ------------- ------------ -------------

Balance at December 31, 1997............... 1,000,000 $ 100 $ -- $ -- $ (694,765) $ (694,665)
Issuance of common stock warrants in
connection with technology agreement... -- -- 14,000 -- -- 14,000
Issuance of common stock upon exercise of
options................................ 43,500 4 8,696 -- -- 8,700
Net loss................................. -- -- -- -- (3,396,318) (3,396,318)
---------- ------ ------------ ------------ ------------ ------------
Balance at December 31, 1998............... 1,043,500 104 22,696 -- (4,091,083) (4,068,283)
Issuance of common stock upon exercise of
options................................ 72,875 7 28,568 -- -- 28,575
Deferred compensation related to stock
options................................ -- -- 1,004,064 (1,004,064) -- --
Amortization of deferred compensation.... -- -- -- 378,109 -- 378,109
Net loss................................. -- -- -- -- (10,237,950) (10,237,950)
---------- ------ ------------ ------------ ------------ ------------
Balance at December 31, 1999............... 1,116,375 111 1,055,328 (625,955) (14,329,033) (13,899,549)
Issuance of common stock upon exercise of
options, net of repurchases............ 808,300 81 360,044 -- -- 360,125
Issuance of common stock upon exercise of
warrants............................... 410,060 41 1,123,925 -- -- 1,123,966
Conversion of convertible note into
common stock........................... 755,000 75 975,499 -- -- 975,574
Issuance of common stock in initial
public offering, net of offering costs
of
$10,274,000............................ 6,900,000 690 113,925,310 -- -- 113,926,000
Conversion of preferred stock to common
stock upon closing of initial public
offering............................... 12,698,578 1,270 48,316,013 -- -- 48,317,283
Deferred compensation related to stock
options................................ -- -- 11,616,911 (11,616,911) -- --
Amortization of deferred compensation.... -- -- -- 4,342,896 -- 4,342,896
Net loss................................. -- -- -- -- (6,361,970) (6,361,970)
---------- ------ ------------ ------------ ------------ ------------
Balance at December 31, 2000............... 22,688,313 2,268 177,373,030 (7,899,970) (20,691,003) 148,784,325
Issuance of common stock upon exercise of
options, net of repurchases
(unaudited)............................ 54,725 6 39,629 -- -- 39,635
Deferred compensation related to stock
options (unaudited).................... -- -- 285,320 (285,320) -- --
Amortization of deferred compensation
(unaudited)............................ -- -- -- 1,268,666 -- 1,268,666
Net income (unaudited)................... -- -- -- -- 1,084,994 1,084,994
---------- ------ ------------ ------------ ------------ ------------
Balance at March 31, 2001 (unaudited)...... 22,743,038 $2,274 $177,697,979 $ (6,916,624) $(19,606,009) $151,177,620
========== ====== ============ ============ ============ ============

See accompanying notes.

F-5

ARENA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------ --------------------------
1998 1999 2000 2000 2001
------------ ------------ ------------ ----------- ------------
(UNAUDITED) (UNAUDITED)

OPERATING ACTIVITIES
Net income (loss).................................... $ (3,396,318) $(10,237,950) $ (6,361,970) $(3,122,200) $ 1,084,994
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization...................... 171,942 399,278 787,829 165,963 291,907
Amortization of acquired technology and other
purchased intangibles............................ -- -- -- -- 128,083
Amortization of deferred compensation.............. -- 378,109 4,342,896 409,479 1,268,666
Interest accrued on notes payable to related
party............................................ 83,896 80,635 41,262 17,932 --
Warrants issued in connection with technology
agreement........................................ 14,000 -- -- -- --
Deferred rent...................................... 747,424 45,699 72,886 13,173 (7,000)
Deferred financing costs........................... (150,711) 150,711 -- (57,984) --
Change in operating assets and liabilities:
Accounts receivable.............................. -- -- (2,116,146) -- (294,854)
Prepaid expenses................................. (18,793) (110,071) (1,657,279) 13,126 618,538
Deferred revenues................................ -- -- 705,000 -- 463,665
Accounts payable, accrued expenses and
compensation................................... 110,170 624,195 49,126 (354,518) 796,144
------------ ------------ ------------ ----------- ------------
Net cash provided by (used in) operating
activities..................................... (2,438,390) (8,669,394) (4,136,396) (2,915,029) 4,350,143

INVESTING ACTIVITIES
Acquisition of Bunsen Rush......................... -- -- -- -- (15,000,000)
Purchases of property and equipment................ (558,933) (2,007,020) (2,279,707) (241,248) (8,246,526)
Deposits, restricted cash and other assets......... (34,171) (98,383) 90,882 90,882 61,804
------------ ------------ ------------ ----------- ------------
Net cash used in investing activities............ (593,104) (2,105,403) (2,188,825) (150,366) (23,184,722)

FINANCING ACTIVITIES
Advances under capital lease obligations........... 148,299 1,562,690 377,015 129,207 --
Principal payments on capital leases............... (14,971) (116,427) (515,551) (195,462) (114,909)
Prepaid financing proceeds......................... -- -- -- 4,514,260 --
Proceeds from issuance of redeemable preferred
stock............................................ 405,287 14,132,224 30,065,334 20,545,461 --
Proceeds from issuance of common stock............. 8,700 28,575 115,410,091 217,760 39,635
Proceeds from convertible note payable to related
party............................................ 1,125,000 375,000 -- -- --
------------ ------------ ------------ ----------- ------------
Net cash provided by (used in) financing
activities....................................... 1,672,315 15,982,062 145,336,889 25,211,226 (75,274)
------------ ------------ ------------ ----------- ------------
Net increase (decrease) in cash and cash
equivalents...................................... (1,359,179) 5,207,265 139,011,668 22,145,831 (18,909,853)
Cash and cash equivalents at beginning of period... 1,553,422 194,243 5,401,508 5,401,508 144,413,176
------------ ------------ ------------ ----------- ------------
Cash and cash equivalents at end of period......... $ 194,243 $ 5,401,508 $144,413,176 $27,547,339 $125,503,323
============ ============ ============ =========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid...................................... $ 10,356 $ 84,968 $ 179,221 $ 41,648 $ 40,259
============ ============ ============ =========== ============
Conversion of convertible note to related party
into common stock................................ $ -- $ -- $ 975,574 $ -- $ --
============ ============ ============ =========== ============
Conversion of convertible note to related party
into redeemable preferred stock.................. $ -- $ 1,521,082 $ -- $ -- $ --
============ ============ ============ =========== ============

See accompanying notes.

F-6

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

THE COMPANY

Arena Pharmaceuticals, Inc. (the "Company") was incorporated on April 14,
1997 and commenced operations in July 1997. The Company operates in one business
segment and has developed a broadly applicable technology that is used to
identify drug candidates in a more efficient manner than traditional drug
discovery approaches.

PRINCIPLES OF CONSOLIDATION

The Company's financial statements include the activity of its wholly-owned
subsidiary, BRL Screening, Inc. since its formation in February 2001. The
financial statements do not include the accounts of its majority-owned
subsidiary, Aressa Pharmaceuticals, Inc. ("Aressa") which was formed in August
1999. Management believes that majority ownership and control of Aressa is
temporary in accordance with Statement of Financial Accounting Standard ("SFAS")
No. 94 "Consolidation of All Majority Owned Subsidiaries," and has therefore not
consolidated Aressa's activity, which has been minimal. The Company's carrying
value for its investment in Aressa is zero because it made no financial
contribution to Aressa in exchange for its ownership interest.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

INTERIM FINANCIAL INFORMATION

The financial information as of March 31, 2001 and for the three months
ended March 31, 2000 and 2001, is unaudited and includes all adjustments,
consisting only of normal recurring adjustments, that the Company's management
considers necessary for a fair presentation of the Company's operating results
and cash flows for such periods. Results for the three month period ended
March 31, 2001 are not necessarily indicative of results to be expected for the
full fiscal year of 2001 or any future period.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of cash and investments with original
maturities of less than three months when purchased.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of cash and cash equivalents, accounts payable, accrued
expenses and obligations under capital leases approximates fair value, unless
the fair value is not practicably determinable.

F-7

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS

Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash and cash equivalents.
The Company limits its exposure to credit loss by placing its cash with high
credit quality financial institutions.

Two collaborative partners individually accounted for 67.6% and 31.0% of
total revenues during the year ended December 31, 2000 and 21.3% and 78.1% of
total revenues during the three months ended March 31, 2001. The same
collaborative partners accounted for all accounts receivables as of
December 31, 2000 and March 31, 2001.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost and depreciated over the estimated
useful lives of the assets (generally three to seven years) using the
straight-line method. Amortization of leasehold improvements is computed over
the shorter of the lease term or the estimated useful life of the related
assets.

INTANGIBLE ASSETS

Acquired technology and other purchased intangibles from the Company's
acquisition of Bunsen Rush Laboratories, Inc. ("Bunsen Rush") is being amortized
over the estimated useful life of 10 years using the straight-line method.

LONG-LIVED ASSETS

In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," if indicators of
impairment exist, the Company assesses the recoverability of the affected
long-lived assets by determining whether the carrying value of such assets can
be recovered through the undiscounted future operating cash flows. If impairment
is indicated, the Company measures the amount of such impairment by comparing
the carrying value of the asset to the present value of the expected future cash
flows associated with the use of the asset. While the Company's current and
historical operating and cash flow losses are indicators of impairment, the
Company believes the future cash flows to be received from the long-lived assets
will exceed the carrying value of the assets. To date, no such impairments have
occurred.

DEFERRED RENT

Rent expense is recorded on a straight-line basis over the term of the
lease. The difference between rent expense and amounts paid under the lease
agreements is recorded as deferred rent in the accompanying balance sheets.

STOCK OPTIONS

SFAS No. 123, "Accounting for Stock-Based Compensation," establishes the use
of the fair value based method of accounting for stock-based compensation
arrangements, under which compensation cost is determined using the fair value
of stock-based compensation determined as of the grant date, and is recognized
over the periods in which the related services are rendered. SFAS No. 123 also

F-8

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
permits companies to elect to continue using the current intrinsic value
accounting method specified in Accounting Principles Board ("APB") Opinion
No. 25 to account for stock-based compensation. The Company has elected to
retain the intrinsic value based method, and has disclosed the pro forma effect
of using the fair value based method to account for its stock-based compensation
(Note 8).

Options and warrants issued to non-employees are recorded at fair value as
prescribed by SFAS No. 123 and EITF 96-18 and periodically remeasured and
expensed over the period services are provided.

REVENUES

Upfront fees under the Company's collaborations are deferred and recognized
over the period the related services are provided. Amounts received for research
funding for a specified number of full time researchers are recognized as
revenue as the services are provided, as long as the amounts received are not
refundable regardless of the results of the research project. Amounts received
for research funding are recognized as revenue as the services are performed.
Assay development fees are recognized upon completion of the screen and
acceptance by the collaborators. Milestone and royalty payments will be
recognized upon completion of specified milestones pursuant to the collaborative
agreements.

RESEARCH AND DEVELOPMENT COSTS

Costs incurred in connection with the development of new products and
changes to existing products are charged to operations as incurred.

PATENT COSTS

Costs related to filing and pursuing patent applications are expensed as
incurred as recoverability of such expenditures is uncertain.

INCOME TAXES

In accordance with SFAS No. 109, "Accounting for Income Taxes," a deferred
tax asset or liability is determined based on the difference between the
financial statement and tax basis of assets and liabilities as measured by the
enacted tax rates which will be in effect when these differences reverse. The
Company provides a valuation allowance against net deferred tax assets unless,
based upon the available evidence, it is more likely than not that the deferred
tax assets will be realized.

COMPREHENSIVE INCOME (LOSS)

In accordance with SFAS No. 130, "Reporting Comprehensive Income," all
components of comprehensive income (loss), including net income (loss), are
reported in the financial statements in the period in which they are recognized.
Comprehensive income (loss) is defined as the change in equity during a period
from transactions and other events and circumstances from non-owner sources. Net
income (loss) and other comprehensive income (loss), including unrealized gains
and losses on investments, is reported net of their related tax effect, to
arrive at comprehensive income (loss). For the years ended December 31, 1998,
1999 and 2000 and for the three months ended March 31, 2000 and 2001,
comprehensive income (loss) equals the net income (loss) as reported.

F-9

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS (LOSS) PER SHARE

Basic and diluted earnings (loss) per common share are presented in
conformity with SFAS No. 128, "Earnings per Share" for all periods presented.
Under the provisions of SAB 98, common stock and convertible preferred stock
that has been issued or granted for nominal consideration prior to the
anticipated effective date of the initial public offering must be included in
the calculation of basic and diluted net earnings (loss) per common share as if
these shares had been outstanding for all periods presented. To date, the
Company has not issued or granted shares for nominal consideration.

In accordance with SFAS No. 128, basic and diluted earnings (loss) per share
has been computed using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. Pro forma
basic and diluted net loss per common share, as presented below, has been
computed for the years ended December 31, 1999 and 2000 and for the three months
ended March 31, 2001 as described above, and also gives effect to the assumed
conversion of preferred stock which automatically converted to common stock
immediately prior to the completion of the initial public offering of the
Company's common stock (using the "as if converted" method) from the original
date of issuance.

The following table presents the calculation of net loss per share:

Net income (loss)................. $(3,396,318) $(10,237,950) $(28,753,038) $(17,309,763) $ 1,084,994
=========== ============ ============ ============ ===========
Basic and diluted net income
(loss) per share................ $ (3.51) $ (10.05) $ (2.84) $ (15.92) $ 0.05
=========== ============ ============ ============ ===========
Weighted-average shares used in
computing net income (loss) per
share, basic.................... 966,799 1,018,359 10,139,755 1,086,988 22,272,476
=========== ============ ============ ============ ===========
Weighted-average shares used in
computing net income (loss) per
share, diluted.................. 966,799 1,018,359 10,139,755 1,086,988 23,247,747
=========== ============ ============ ============ ===========
Pro forma net loss per share,
basic and diluted............... $ (1.29) $ (1.65) $ (1.76)
============ ============ ============
Shares used above................. 1,018,359 10,139,755 1,086,988
Pro forma adjustment to reflect
assumed weighted-average
effect of conversion of
preferred stock............... 6,908,593 7,271,273 8,740,114
------------ ------------ ------------
Shares used in computing pro
forma net loss per share,
basic and diluted............. 7,926,952 17,411,028 9,827,102
============ ============ ============

F-10

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company has excluded all outstanding stock options and warrants, and
shares subject to repurchase from the calculation of diluted loss per common
share because all such securities are antidilutive for the years ended
December 31, 1998, 1999 and 2000. The total number of shares excluded from the
calculation of diluted net loss per share, prior to application of the treasury
stock method for stock options, was 61,625, 81,000 and 509,850 for the years
ended December 31, 1998, 1999 and 2000, respectively. Such securities, had they
been dilutive, would have been included in the computation of diluted net loss
per share.

SEGMENT REPORTING

SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," requires the use of a management approach in identifying segments
of an enterprise. Management has determined that the Company operates in one
business segment.

EFFECT OF NEW ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which was
effective January 1, 2001. SFAS No. 133 establishes accounting and reporting
standards requiring that every derivative instrument, including certain
derivative instruments imbedded in other contracts, be recorded in the balance
sheet as either an asset or liability measured at its fair value. The statement
also requires that changes in the derivative's fair value be recognized in
earnings unless specified hedge accounting criteria are met. Management believes
the adoption of SFAS No. 133 will not have an effect on the financial
statements, as the Company does not engage in the activities covered by SFAS
No. 133.

In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, Revenue Recognition ("SAB 101"). SAB 101
provides the SEC Staff's views in applying generally accepted accounting
principles to various revenue recognition issues and specifically addresses
revenue recognition for upfront, non-refundable fees earned in connection with
research collaboration arrangements. It is the SEC's position that such fees
should generally be recognized over the term of the agreement. The Company
expects to apply this accounting to its future collaborations. The Company
believes its revenue recognition policy is in compliance with SAB 101.

(2) INVESTMENT IN CHEMNAVIGATOR.COM

In January 1999, the Company began development of an Internet-based search
engine that allows scientists to search for compounds based primarily on the
similarity of chemical structures. In May 1999, ChemNavigator.com was
incorporated and in June 1999, the Company licensed to ChemNavigator.com a
website, the trademark ChemNavigator and goodwill associated with the trademark,
intellectual property related to the search engine, as well as technology needed
to perform chemical similarity searches. In return, the Company received
2,625,000 shares of preferred stock in ChemNavigator.com valued at approximately
$2.6 million based on independent investors' participation in
ChemNavigator.com's Series A preferred round of financing. However, the
Company's historical cost basis in the licensed technology was zero and the
Company therefore recorded its investment in ChemNavigator.com at zero. As of
December 31, 2000 and March 31, 2001, the Company's equity ownership represented
approximately 34% and 33%, (unaudited), respectively, of the outstanding

F-11

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(2) INVESTMENT IN CHEMNAVIGATOR.COM (CONTINUED)
voting equity securities of ChemNavigator.com. ChemNavigator.com has an
accumulated deficit and since the Company is under no obligation to reimburse
the other ChemNavigator.com stockholders for its share of ChemNavigator.com's
losses, the Company has not included any equity in the net loss of
ChemNavigator.com in the Company's Consolidated Statements of Operations.

The Company subleases office space to ChemNavigator.com. The current
sublease payment of $5,592 per month can be adjusted monthly based upon changes
in the number of ChemNavigator.com employees.

Jack Lief, the Company's President and Chief Executive Officer, is also the
Chairman of the Board of ChemNavigator.com. Richard P. Burgoon, Jr., the
Company's Senior Vice President, Operations, General Counsel and Secretary, is
also the Secretary of ChemNavigator.com and a member of its board of directors.

(3) INVESTMENT IN ARESSA PHARMACEUTICALS, INC.

In August 1999, the Company formed Aressa Pharmaceuticals, Inc. to take
advantage of opportunities to use the knowledge and skills of its personnel and
funding to be obtained from unaffiliated third parties to in-license and develop
niche products from other pharmaceutical or biotechnology companies. In October
2000, the Company received shares of preferred stock in Aressa that constitute
approximately 83% of the presently outstanding voting equity securities of
Aressa, valued at $5.0 million based on the participation of a independent
investor in Aressa's Series A preferred round of financing raising gross
proceeds of $1.0 million. The Company's carrying value for its investment in
Aressa is zero because it made no financial contribution to Aressa in exchange
for its ownership interest. In addition, the Company is not required to
reimburse the outside investor for any losses Aressa incurs. Through March 31,
2001 Aressa has had minimal activity and the amounts of its assets and
liabilities are currently immaterial to the Company's consolidated financial
statements. Therefore, the Company has not included the accounts of Aressa in
its consolidated financial statements.

Jack Lief, the Company's President and Chief Executive Officer, is also the
Chief Executive Officer and President of Aressa. Richard P. Burgoon, Jr., the
Company's Senior Vice President, Operations, General Counsel and Secretary, is
also the Chief Operating Officer and Secretary of Aressa. Joyce Williams, the
Company's Vice President, Drug Development is also the Vice President,
Regulatory and Clinical Affairs of Aressa.

F-12

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(4) PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

DECEMBER 31, MARCH 31
----------------------- -----------
1999 2000 2001
---------- ---------- -----------
(UNAUDITED)

Laboratory and computer equipment....... $2,641,072 $3,659,632 $ 4,661,142
Furniture and fixtures.................. 185,220 267,841 301,873
Land, building and capital
improvements.......................... -- -- 7,542,499
Leasehold improvements.................. 536,096 1,714,622 1,383,107
---------- ---------- -----------
3,362,388 5,642,095 13,888,621
Less accumulated depreciation and
amortization.......................... (589,006) (1,376,835) (1,668,742)
---------- ---------- -----------
$2,773,382 $4,265,260 $12,219,879
========== ========== ===========

Cost and accumulated amortization of equipment under capital leases totaled
approximately $1.9 million and $331,000, and approximately $2.3 million and
$810,000 at December 31, 1999 and 2000, respectively.

(5) CONVERTIBLE NOTES PAYABLE TO RELATED PARTY

In 1997, the Company issued a convertible note payable to Tripos, Inc.
("Tripos"), a significant stockholder, for the principal amount of $755,000 at
an annual interest rate of 9.5%. In 2000, upon the closing of the Company's
initial public offering, all outstanding principal and accrued interest under
this convertible note was converted into 755,000 shares of common stock.
Interest expense for the years ended December 31, 1998, 1999 and 2000 was
approximately $72,000, $72,000 and $41,000, respectively.

In 1998, the Company issued a convertible note payable to Tripos, for a
principal amount of up to $1.5 million at an annual interest rate of 9.5%. The
Company received proceeds of approximately $1.1 million on this note payable in
1998, and $375,000 in 1999. In 1999, all outstanding principal and accrued
interest under this convertible note payable was converted into 435,840 shares
of Series D redeemable convertible preferred stock. Upon the closing of the
Company's initial public offering, these shares converted into common stock of
the Company.

At the date each note was entered into, the note was convertible into stock
at the then-current fair value of such stock, and therefore there is no
beneficial conversion feature associated with the notes.

(6) COMMITMENTS

LEASES

In 1997, the Company leased its facilities located at 6166 Nancy Ridge Drive
in San Diego, California under an operating lease that had an expiration date in
2004. The Company had an option to buy the facilities during the first
12 months of the lease term for approximately $2.1 million. In 1998, the Company
assigned the option to a publicly traded Real Estate Investment Trust ("REIT")
in exchange for $733,322 in cash. The $733,322 in cash is being recognized on a
straight-line basis as a reduction in the rent expense on the underlying lease.
In addition, the Company signed a new lease

F-13

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(6) COMMITMENTS (CONTINUED)
with the REIT, which expires in 2013. The lease provides the Company with an
option to extend the lease term via two five-year options. Under the terms of
the new lease, effective April 30, 1998, monthly rental payments will be
increased on April 30, 2000 and annually thereafter by 2.75%. In accordance with
the terms of the new lease, the Company is required to maintain restricted cash
balances totaling $79,955 on behalf of the landlord as rent deposits throughout
the term of the lease.

In 2000, the Company leased additional facilities located at 6150 Nancy
Ridge Drive in San Diego, California under an operating lease which expires in
2013. In January 2001, the Company purchased this facility for approximately
$5.4 million in cash.

Rent expense was $366,505, $598,903, $728,369, $147,939 and $136,889 for the
years ended December 31, 1998, 1999 and 2000 and for the three months ended
March 31, 2000 and 2001, respectively.

Annual future minimum lease obligations as of December 31, 2000 are as
follows:

YEAR ENDING DECEMBER 31, OPERATING LEASES CAPITAL LEASES
------------------------ ---------------- --------------

2001............................................ $ 663,017 $ 613,883
2002............................................ 678,528 613,883
2003............................................ 694,465 480,289
2004............................................ 611,866 44,875
2005............................................ 628,691 --
Thereafter...................................... 5,693,571 --
---------- ----------
Total minimum lease payments................ $8,970,138 1,752,930
----------
Less amount representing interest............... (311,875)
----------
Present value of minimum lease obligations...... 1,441,055
Less current portion............................ (480,538)
----------
Long-term portion of capital lease
obligations................................... $ 960,517
==========

The table above representing annual future minimum operating lease
obligations is exclusive of the 6150 Nancy Ridge Drive facility which the
Company purchased in January 2001.

Future minimum rentals to be received under non-cancelable subleases as of
December 31, 2000 totaled approximately $36,000.

(7) COLLABORATIONS

COLLABORATIVE AGREEMENT WITH ELI LILLY

In April 2000, the Company entered into a research alliance with Eli Lilly
and Company ("Eli Lilly"). The collaboration with Eli Lilly will principally
focus on the central nervous system and endocrine therapeutic fields. The
collaboration will also focus on the cardiovascular field and may expand into
other therapy classes, including cancer.

During the collaboration, the Company will pursue an agreed upon research
plan with Eli Lilly that has several objectives. During the term of the
collaboration, the Company and Eli Lilly will mutually review and select
G-protein coupled receptors ("GPCRs") that will become subject to the

F-14

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(7) COLLABORATIONS (CONTINUED)
collaboration. These GPCRs may be provided either by the Company or by Eli
Lilly. All of the Company's CART-activated GPCRs existing as of the effective
date of the agreement are excluded from the collaboration. The Company and Eli
Lilly will each share their respective knowledge of the GPCRs that become
subject to the collaboration to validate and CART-activate selected receptors.
The Company and Eli Lilly will jointly select a number of proprietary central
nervous system, endocrine and cardiovascular GPCRs for CART-activation, and the
Company will then provide Eli Lilly with enabled high-throughput screens for use
at their screening facilities. During the term of the agreement, the Company
will continue to receive research funding from Eli Lilly for internal resources
committed to the collaboration, which will be augmented by resource commitments
by Eli Lilly. Eli Lilly will be responsible for screening its chemical compound
library using selected CART-activated receptors, for identifying drug candidates
and for the pre-clinical and clinical testing and development of drug
candidates. The Company may receive $1.25 million per receptor based upon
milestone payments in connection with the successful application of CART to each
receptor, and up to an additional $6.0 million based upon clinical development
milestone payments for each drug candidate discovered using CART. The Company
may also receive additional milestone and royalty payments associated with the
commercialization of drugs discovered using CART, if any. The Company and Eli
Lilly may never achieve the discovery, development or commercialization
milestones.

Once the assay development fee has been paid for a CART-activated GPCR, Eli
Lilly will have exclusive rights to screen chemical libraries, discover drug
candidates that target that GPCR, and to develop, register and sell any
resulting products worldwide. The Company retains rights to partner or
independently develop GPCRs that do not become subject to the collaboration.

The term of the collaboration agreement with Eli Lilly is five years. Either
Eli Lilly or the Company can terminate the agreement with or without cause
effective three years after the date of the agreement by giving written notice
prior to the conclusion of the 33rd month after the date of the agreement. In
addition, either party can terminate the agreement at any time if the other
party commits a material breach, and Eli Lilly can terminate the agreement at
any time if, among other reasons, Eli Lilly does not approve suitable
replacements for key employees who leave the Company. The parties will continue
to have various rights and obligations under the agreement after the agreement
is terminated. The extent of these continuing rights and obligations depends on
many factors, such as when the agreement is terminated, by which party and for
what reason. These continuing obligations may include further research and
development efforts by the Company and a variety of payments by Eli Lilly.

Revenues recognized under the Eli Lilly collaboration were approximately
$5.2 million for the year ended December 31, 2000 consisting of research funding
of approximately $2.9 million, milestone achievements of approximately
$2.2 million, and amortization of the upfront payment of $75,000. For the three
month period ended March 31, 2001, the Company recognized approximately
$1.2 million in revenues under the Eli Lilly collaboration consisting of
research funding of approximately $1.1 million and amortization of the upfront
payment of $25,000.

COLLABORATIVE AGREEMENTS WITH TAISHO

In May 2000, the Company entered into an agreement with Taisho
Pharmaceutical Co., Ltd. ("Taisho") to initiate a research collaboration focused
on several GPCRs selected by Taisho in

F-15

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(7) COLLABORATIONS (CONTINUED)
therapeutic areas of interest to Taisho. Under the terms of the agreement,
Taisho will receive exclusive, worldwide rights to the selected GPCR targets and
to any drug candidates discovered using the activated versions of these
receptors. The Company may receive up to a total of $2.3 million in revenues per
receptor associated with research, development and screening fees. The Company
may also receive clinical development milestones, regulatory approval milestones
and royalties on drug sales, if any.

In January 2001, the Company signed an amendment to the May 2000 agreement
whereby Taisho was granted world-wide rights to the Company's 18-F Program, an
obesity orphan receptor target and small molecule modulators. In accordance with
the amendment, Taisho made a payment in April 2001 to the Company for the 18-F
Program based upon work completed by the Company through the date of the
amendment. In addition, the Company may receive additional milestone and
research funding payments and royalties on drug sales, if any.

In March 2001, the Company entered into a receptor discovery agreement with
Taisho. Under the terms of the agreement, the Company will identify the receptor
that binds with a ligand that Taisho provided. If the Company is successful in
identifying and cloning this receptor, the Company will CART-activate this
receptor and provide a screening assay to Taisho. In connection with this
agreement, Taisho paid the Company a one-time non-refundable research and
development fee which is being recognized as revenue as the services are being
performed. In addition, the Company may receive additional milestone payments
and royalties on drug sales, if any.

Revenues recognized under the Taisho collaborations were approximately
$2.4 million for the year ended December 31, 2000 consisting of milestone
achievements of approximately $2.3 million and amortization of the upfront
payment of $80,000. Revenues recognized under the Taisho collaborations were
approximately $4.2 million for the three months ended March 31, 2001 consisting
of milestone achievements and research and development fees of approximately
$3.9 million, research funding of $286,000 and amortization of the upfront
payment of $30,000.

COLLABORATIVE AGREEMENT WITH FUJISAWA

In January 2000, the Company entered into a collaborative agreement with
Fujisawa Pharmaceutical, Co., Ltd. ("Fujisawa"). During the collaboration, the
Company will jointly validate up to 13 orphan GPCRs as drug screening targets.
The Company will be responsible for receptor identification, location and
regulation, and will apply CART to GPCRs selected by Fujisawa. The Company will
also seek to validate screening assays based on the selected GPCRs. Fujisawa
will be entitled to screen selected assays against its chemical compound library
to identify drug candidates. Fujisawa will also be responsible for the
pre-clinical and clinical development of any drug candidates that the Company or
Fujisawa discover. The Company may also screen the selected GPCRs using its
in-house chemical library. When Fujisawa selects its first receptor, the Company
will be entitled to receive a one-time initiation fee of $500,000. If the
Company and Fujisawa then achieve various milestones, the Company may receive up
to a maximum of $3.5 million per selected receptor in assay transfer, screening
and exclusivity fees, and up to a maximum of $2.0 million per selected receptor
based upon the filing of one or more investigational new drug applications for
each drug candidate discovered using a CART-activated receptor. The Company may
also receive clinical development milestones, regulatory approval milestones and
royalties on drug sales, if any. The Company and

F-16

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(7) COLLABORATIONS (CONTINUED)
Fujisawa may never achieve research, development or commercialization milestones
under the agreement. The Company's collaborative agreement with Fujisawa will
terminate upon the expiration of Fujisawa's obligation to make royalty payments
under the agreement, if any. Fujisawa may terminate the agreement at any time by
providing the Company with written notice of their intention to do so and by
returning any proprietary rights they have acquired under the agreement.
Additionally, either party may terminate the agreement for a material breach of
the agreement by the other party. The termination or expiration of the agreement
will not affect any rights that have accrued to the benefit of either party
prior to the termination or expiration. To date, the Company has not recognized
any revenue under the Fujisawa collaboration.

(8) STOCKHOLDERS' EQUITY

PREFERRED STOCK

In January 2000, March 2000 and April 2000, the Company sold Shares of
Series E Convertible Redeemable Preferred Stock, Series F Convertible Redeemable
Preferred Stock and Series G Convertible Redeemable Preferred Stock,
respectively at what management believed was fair value. Subsequent to the
commencement of the initial public offering process, the Company re-evaluated
the fair value of its common stock as of January 2000, March 2000 and April 2000
and determined it to be $4.68, $13.50 and $13.50, respectively. In accordance
with EITF 98-5, the Company recorded a non-cash preferred stock charge of
$22.4 million for the year ended December 31, 2000. The Company recorded the
charge at the date of issuance by offsetting charges and credits to preferred
stock, without any effect on total stockholders' equity. The non-cash preferred
stock charge increases the loss applicable to common stockholders in the
calculation of basic net loss per share for the year ended December 31, 2000.

Concurrent with the closing of the Company's initial public offering in
July 2000, all outstanding shares of the Company's preferred stock converted
into 12,698,578 shares of common stock. Following the conversion, the Company's
certificate of incorporation was amended and restated. Under the restated
certificate, the Board has the authority, without further vote or action by
stockholders, to issue up to 7,500,000 shares of preferred stock in one or more
series and to fix the rights, preferences, privileges, qualifications and
restrictions granted to or imposed upon such preferred stock, including dividend
rights, conversion rights, voting rights, rights and terms of redemption,
liquidation preference, any or all of which may be greater than the rights of
the common stock.

COMMON STOCK

In June 1997, a total of 1,000,000 shares of common stock were issued to the
founders of the Company at a price of $.0001 per share under founder stock
purchase agreements. The Company issued 50,000 of these shares to an outside
founder, which vest ratably over 50 months. Unvested shares are subject to
repurchase by the Company, at the original purchase price, if the relationship
between the Company and the outside founder terminates. In 1999, 17,500 shares
were repurchased.

WARRANTS

During the year ended December 31, 2000, all outstanding warrants were
converted into 410,060 shares of common stock of the Company. At December 31,
2000, no warrants are outstanding.

F-17

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(8) STOCKHOLDERS' EQUITY (CONTINUED)
INCENTIVE STOCK PLANS

The Company's Amended and Restated 1998 Equity Compensation Plan (the "1998
Plan") provides designated employees of the Company, certain consultants and
advisors who perform services for the Company, and non-employee members of the
Company's Board of Directors with the opportunity to receive grants of incentive
stock options, nonqualified stock options and restricted stock. The options and
restricted stock generally vest 25% a year for four years and are immediately
exercisable up to ten years from the date of grant. At December 31, 2000 and
March 31, 2001, 1,500,000 shares of common stock were authorized for issuance
under the 1998 Plan.

In 2000, the Board of Directors adopted and stockholders approved the 2000
Equity Compensation Plan (the "2000 Plan") which provides designated employees
of the Company, certain consultants and advisors who perform services for the
Company, and non-employee members of the Company's Board of Directors with the
opportunity to receive grants of incentive stock options, nonqualified stock
options and restricted stock. The options and restricted stock generally vest
25% a year for four years and are immediately exercisable up to ten years from
the date of grant. At December 31, 2000 and March 31, 2001, 2,000,000 shares of
common stock were authorized for issuance under the 2000 Plan.

Unvested shares issued to our employees, consultants, advisors and
non-employee members of the Company's Board of Directors pursuant to the
exercise of options are subject to repurchase, at the original purchase price,
in the event of termination of employment or engagement. In the event the
Company elects not to buy back any such unvested shares, the unvested options
will be expensed at their fair value at that point in time. At December 31, 2000
and March 31, 2001, 509,850 and 470,562 shares of common stock, respectively,
issued pursuant to the exercise of options were subject to repurchase by the
Company. In accordance with FAS 128, the Company has excluded unvested common
stock arising from exercised options in its basic loss per share calculations.

F-18

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(8) STOCKHOLDERS' EQUITY (CONTINUED)
Following is a summary of stock option activity:

WEIGHTED-
AVERAGE
OPTIONS EXERCISE PRICE
--------- --------------

Balance at December 31, 1997......................... 91,000 $ 0.20
Granted............................................ 360,000 $ 0.20
Exercised.......................................... (43,500) $ 0.20
---------
Balance at December 31, 1998......................... 407,500 $ 0.20
Granted............................................ 373,100 $ 0.60
Exercised.......................................... (90,375) $ 0.33
Canceled........................................... (5,625) $ 0.47
---------
Balance at December 31, 1999......................... 684,600 $ 0.40
Granted............................................ 1,215,175 $11.07
Exercised.......................................... (809,425) $ 0.46
Canceled........................................... (25,875) $ 1.66
---------
Balance at December 31, 2000......................... 1,064,475 $12.44
Granted (unaudited)................................ 334,500 $16.41
Exercised (unaudited).............................. (54,725) $ 0.58
---------
Balance at March 31, 2001 (unaudited)................ 1,344,250 $13.91
=========

At December 31, 1998, 1999, and 2000 and at March 31, 2001, options to
purchase 67,000, 159,500, 53,625, and 106,200 shares were vested. The
weighted-average remaining contractual life of options outstanding at
December 31, 1998, 1999 and 2000 was 8.75, 8.50 and 9.22 years, respectively. At
December 31, 1998, 1999 and 2000, 32,625, 63,500 and 509,850 shares of common
stock issued upon the exercise of options were subject to repurchase at the
original purchase price at a weighted-average price of $.20, $.23 and $.51,
respectively. At December 31, 2000 and March 31, 2001, 1,492,233 and 1,157,725
shares, respectively, were available for future grant. The 1,064,475 options not
exercised at December 31, 2000 have exercise prices ranging from $.20 to $36.88
and can be exercised at any time; however, unvested shares are subject to
repurchase at the original purchase price if a grantee terminates prior to
vesting.

In 2000, the Company granted 516,250 stock options to employees at less than
the market price of the stock on the date of grant. These options had a weighted
average exercise price of $24.95 and a weighted average grant date fair value of
$22.12. For options granted at the market value, the weighted average exercise
price and weighted average grant date fair value were $0.72 and $0.23,
respectively.

Pro forma information regarding net income is required by SFAS No. 123 and
has been determined as if the Company had accounted for its employee stock
options under the fair value method of that Statement. For options granted
through July 27, 2000, the fair value of options granted were estimated at the
date of grant using the minimum value pricing model with the following
weighted-average assumptions: risk free interest rate of 6.5%, dividend yield of
0%, and weighted-average expected life of the option of five years. For options
granted from July 28, 2000 to December 31, 2000 the fair value of the options
was estimated at the date of grant using the Black-

F-19

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(8) STOCKHOLDERS' EQUITY (CONTINUED)
Scholes method for option pricing with the following weighted-average
assumptions: risk free interest rate of 6.5%, dividend yield of 0%, expected
volatility of 90% and weighted-average expected life of the option of five
years.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
adjusted pro forma information is as follows:

THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------- ---------------
1998 1999 2000 2001
----------- ------------ ------------ ---------------

Adjusted pro forma net income
(loss)............................ $(3,398,000) $(10,250,000) $(29,889,840) $162,250
Adjusted pro forma basic net income
(loss) per share.................. $ (3.51) $ (10.07) $ (2.95) $ 0.01

The effects of applying SFAS No. 123 for providing pro forma disclosures are
not likely to be representative of the effect on reported net income (loss) for
future years.

During the years ended December 31, 1999 and 2000 and the three months ended
March 31, 2001, in connection with the grant of various stock options to
employees, the Company recorded deferred stock compensation totaling
approximately $1.0 million, $11.6 million and $226,000, respectively,
representing the difference on the date such stock options were granted between
the exercise price and the estimated market value of the Company's common stock
as determined by the Company's management, or after July 28, 2000, the quoted
market value. Deferred compensation is included as a reduction of stockholders'
equity and is being amortized to expense over the vesting period of the options
in accordance with FASB Interpretation No. 28, which permits an accelerated
amortization methodology. During the years ended December 31, 1999 and 2000 and
the three months ended March 31, 2001, the Company recorded amortization of
deferred compensation expense of approximately $378,000, $4.3 million and
$1.3 million, respectively. At March 31, 2001, total charges to be recognized in
future periods from amortization of deferred stock compensation are anticipated
to be approximately $3.0 million, $2.7 million, $1.1 million and $119,000 for
the remaining nine months of 2001 and for the years ending December 31, 2002,
2003 and 2004, respectively.

For the year ended December 31, 2000 and for the three months ended
March 31, 2001 the Company recorded expenses related to the options granted to
our consultants of approximately $323,000 and $70,000, respectively,

COMMON SHARES RESERVED FOR ISSUANCE

At December 31, 2000 and March 31, 2001, 2,556,708 and 2,501,975,
respectively, shares of common stock are reserved for issuance upon exercise of
common stock options and future option grants.

(9) EMPLOYEE BENEFIT PLAN

The Company established a defined contribution employee retirement plan (the
"401(k) Plan") effective January 1, 1998, conforming to Section 401(k) of the
Internal Revenue Code ("IRC"). All eligible employees may elect to have a
portion of their salary deducted and contributed to the 401(k)

F-20

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(9) EMPLOYEE BENEFIT PLAN (CONTINUED)
Plan up to the maximum allowable limitations of the IRC. Through March 31, 1999,
the Company matched 50% of each participant's contribution up to the first 6% of
annual compensation.

Effective April 1, 1999, the Company amended the 401(k) Plan, increasing the
Company match to 100% of each participant's contribution up to the first 6% of
annual compensation for all contributions made after April 1, 1999. The
Company's matching portion, which totaled $27,065, $148,784, $281,595, $61,723
and $107,198 for the years ended December 31, 1998, 1999 and 2000 and for the
three months ended March 31, 2000 and 2001, respectively, vests over a five-year
period.

(10) INCOME TAXES

At December 31, 2000, the Company had federal and California tax net
operating loss carryforwards of approximately $12.2 million and approximately
$12.8 million, respectively.

Significant components of the Company's deferred tax assets at December 31,
1999 and 2000 are shown below. A valuation allowance of $5.7 million and
$7.5 million has been recognized to offset the deferred tax assets as of
December 31, 1999 and 2000, respectively, as realization of such assets is
uncertain.

DECEMBER 31,
-------------------------
1999 2000
----------- -----------

Deferred tax assets:
Net operating loss carryforwards................. $ 4,787,000 $ 4,991,000
Research and development credits................. 928,000 2,089,000
Other, net....................................... 129,000 597,000
----------- -----------
Net deferred tax assets............................ 5,844,000 7,677,000
Valuation allowance for deferred tax assets........ (5,713,000) (7,509,000)
----------- -----------
Total deferred tax assets...................... 131,000 168,000
Deferred tax liabilities:
Depreciation..................................... (131,000) (168,000)
----------- -----------
Net deferred tax assets.......................... $ -- $ --
=========== ===========

The federal and California tax net operating loss carryforwards will begin
to expire in 2012 and 2005, respectively, unless previously utilized. The
Company also has federal and California research tax credit carryforwards of
approximately $1.6 million and $529,000, respectively, which will begin to
expire in 2012 unless previously utilized.

Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of
the Company's net operating loss and credit carryforwards could be limited in
the event of cumulative changes in ownership of more than 50%. Such a change
occurred in prior years. However, the Company does not believe such limitation
will have a material effect upon the Company's ability to utilize the
carryforwards.

F-21

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(11) QUARTERLY FINANCIAL DATA (UNAUDITED)

2000 FOR QUARTER ENDED MARCH 31 JUNE 30 SEPT 30 DEC. 31 YEAR
---------------------- ------------ ------------ ----------- ----------- ------------

Revenues.................... $ -- $ 1,289,271 $ 2,314,126 $ 4,079,999 $ 7,683,396
Amortization of non-cash
deferred compensation..... 409,479 1,419,565 1,123,358 1,390,494 4,342,896
Net income (loss)........... (3,122,200) (2,886,082) (1,418,594) 1,064,906 (6,361,970)
Non-cash preferred stock
charge.................... (14,187,563) (8,203,505) -- -- (22,391,068)
Net income (loss) applicable
to common stockholders.... (17,309,763) (11,089,587) (1,418,594) 1,064,906 (28,753,038)
Basic and diluted earnings
(loss) per share.......... (15.92) (8.47) (0.09) 0.05 (2.84)
Pro forma earnings (loss)
per share................. (1.76) (0.81) (0.07) -- (1.65)

1999 FOR QUARTER ENDED MARCH 31 JUNE 30 SEPT 30 DEC. 31 YEAR
---------------------- ------------ ------------ ----------- ----------- ------------

Revenues.................... $ -- $ -- $ -- $ -- $ --
Amortization of non-cash
deferred compensation..... -- 179,386 97,628 101,095 378,109
Net loss.................... (1,998,235) (2,526,550) (2,734,105) (2,979,060) (10,237,950)
Non-cash preferred stock
charge.................... -- -- -- -- --
Net loss applicable to
costockholders............ (1,998,235) (2,526,550) (2,734,105) (2,979,060) (10,237,950)
Basic and diluted loss per
share..................... (2.03) (2.48) (2.65) (2.84) (10.05)
Pro forma loss per share.... (0.31) (0.32) (0.34) (0.37) (1.29)

(12) RECENT EVENTS

2001 EMPLOYEE STOCK PURCHASE PLAN

The 2001 Arena Employee Stock Purchase Plan was adopted by the Company's
Board of Directors in March 2001. The aggregate number of shares of the
Company's common stock that may be issued pursuant to the 2001 Arena Employee
Stock Purchase Plan is 1,000,000 shares. The 2001 Arena Employee Stock Purchase
Plan will become effective on July 1, 2001.

BUILDING PURCHASE

In January 2001, the Company purchased a facility it was leasing along with
an adjoining building that is currently leased to a tenant at 6138-6150 Nancy
Ridge Drive in San Diego, California. The Company paid cash of $5.4 million and
will amortize the cost over the building's useful life, estimated to be
20 years. The Company assumed the lease with the tenant, the term of which runs
through August 31, 2001. The tenant has paid all rents through the expiration of
the lease.

F-22

ARENA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AS OF MARCH 31, 2001 AND FOR THE THREE MONTHS ENDED

MARCH 31, 2000 AND 2001 IS UNAUDITED)

(12) RECENT EVENTS (CONTINUED)
ACQUISITION

On February 15, 2001 the Company completed its acquisition of Bunsen Rush
pursuant to an Agreement and Plan of Merger dated February 15, 2001. Bunsen Rush
was a privately held research-based company that provides receptor screening for
the pharmaceutical and biotechnology industries using its proprietary and
patented melanophore technology. The purchase price was $15.0 million in cash.

The acquisition was accounted for as a purchase. Costs related to the
acquisition, which were nominal, have been expensed. The purchase price was
preliminarily allocated as follows:

Existing technology......................................... $15,378,000
Assembled workforce......................................... 47,000
Non-current assets.......................................... 5,000
Current liabilities......................................... (430,000)
-----------
$15,000,000
===========

The acquired technology is being amortized over its estimated useful life of
ten years. The estimated useful life of ten years was determined based on an
analysis, as of the acquisition date, of conditions in, and the economic outlook
for the pharmaceutical and biotechnology industries, the patent life of the
technology and the history, current state and planned future operations of
Bunsen Rush.

The acquisition was effected in the form of a merger of Bunsen Rush into BRL
Screening, Inc., ("BRL") a newly formed wholly-owned subsidiary of the Company.
BRL's results from operations have been included in the Company's results from
operations since February 15, 2001. If the acquisition would have occurred on
January 1, 2000, pro forma unaudited financial information would have been as
follows:

THREE MONTHS ENDED
YEAR ENDED MARCH 31,
DECEMBER 31, -------------------------
2000 2000 2001
------------ ----------- -----------

Revenues............................... $ 8,027,301 $ 85,976 $ 5,392,335
Net (loss) income...................... $(8,673,198) $(3,725,007) $ 799,019
Basic net (loss) income per share...... $ (3.06) $ (16.48) $ 0.04
Diluted net (loss) income per share.... $ (3.06) $ (16.48) $ 0.03

F-23

PROSPECTUS JUNE 21, 2001
[THOMAS WEISEL PARTNERS LLC BANNER]

[ARENA PHARMACEUTICALS LOGO]

5,000,000 SHARES
COMMON STOCK

THOMAS WEISEL PARTNERS LLC

DAIN RAUSCHER WESSELS

ABN AMRO ROTHSCHILD LLC

LAZARD

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

Neither we nor any of the underwriters have authorized anyone to provide
information different from that contained in this prospectus. When you make a
decision about whether to invest in our common stock, you should not rely upon
any information other than the information in this prospectus. Neither the
delivery of this prospectus nor the sale of our common stock means that
information contained in this prospectus is correct after the date of this
prospectus. This prospectus is not an offer to sell or solicitation of an offer
to buy these shares of common stock in any circumstances under which the offer
or solicitation is unlawful.