Arena Pharmaceuticals, Inc.
ARENA PHARMACEUTICALS INC (Form: 10-K, Received: 03/15/2002 17:12:45)
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K



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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                              to                             

        COMMISSION FILE NUMBER 000-31161


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

Delaware
(State or other jurisdiction of
incorporation or organization)
  23-2908305
(I.R.S. Employer
Identification No.)

6166 Nancy Ridge Drive, San Diego, CA
(Address of principal executive offices)

 

92121
(Zip Code)

(858) 453-7200
(Registrant's telephone number, including area code)


        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

        Yes  ý     No  o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  o

        The approximate aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $226,000,000 as of February 1, 2002, based upon the closing price of the Common Stock as reported on the Nasdaq Stock Market on such date. For purposes of this calculation, shares of Common Stock held by directors and officers and stockholders whose ownership in the registrant is known by the registrant to exceed five percent have been excluded. This number is provided only for purposes of this report and does not represent an admission by either the registrant or any such person as to the status of such person.

        As of February 1, 2002 there were 27,586,173 shares of the registrant's Common Stock outstanding.


DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Arena Pharmaceuticals, Inc. Proxy Statement dated April 23, 2002, for the Annual Meeting of Shareholders to be held June 11, 2002 (the "Proxy Statement"), to be filed no later than 120 days after December 31, 2001, are incorporated by reference into Part III of this Report on Form 10-K.




ARENA PHARMACEUTICALS, INC.

INDEX

No.

   
  Page
PART I        

Item 1.

 

Business

 

1
Item 2.   Properties   24
Item 3.   Legal Proceedings   24
Item 4.   Submissions of Matters to a Vote of Security Holders   24

PART II

 

 

 

 

Item 5.

 

Market for the Registrant's Common Equity and Related Stockholder Matters

 

25
Item 6.   Selected Financial Data   26
Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations   28
Item 7A.   Quantitative and Qualitative Disclosures about Market Risk   37
Item 8.   Financial Statements and Supplementary Data   38
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   61

PART III

 

 

 

 

Item 10.

 

Directors and Executive Officers of the Registrant

 

61
Item 11.   Executive Compensation   61
Item 12.   Security Ownership of Certain Beneficial Owners and Management   61
Item 13.   Certain Relationships and Related Transactions   61

PART IV

 

 

 

 

Item 14.

 

Exhibits, Financial Statement Schedules and Reports on Form 8-K

 

61


INFORMATION RELATING TO FORWARD-LOOKING STATEMENTS

        This Annual Report on Form 10-K includes forward-looking statements. These forward-looking statements involve a number of risks and uncertainties. Such forward looking statements include statements about our strategy and goals referred to in this Annual Report, and other statements that are not historical facts, including statements which are preceded by the words "intends," "will," "plans," "expects," "anticipates," "estimates," "aims," and "believes" or similar words. For such statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Readers of the Annual Report are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements. Actual events or results may differ materially from Arena's expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward looking statements include, but are not limited to, the following: the ability to complete Project Genesis, if at all, within a reasonable time period; future quarterly or annual financial results; the timing, success and cost of preclinical research, out-licensing endeavors and clinical studies; and receipt of additional milestone payments, if any, from collaborators. Additional risk factors that could cause actual results to differ materially from those in Arena's forward looking statements are disclosed in Arena's SEC reports, including, but not limited to, Arena's registration statement filed June 21, 2001 on Form S-1, as amended, its most recent quarterly report on Form 10-Q and its most recent annual report on Form 10-K.

PART I

Item 1. Business.

        We are an emerging biopharmaceutical company focused principally on discovering and developing drugs that target G protein-coupled receptors, called GPCRs. GPCRs are an important part of the pharmaceutical and biotechnology industries' drug discovery and development efforts. Of the leading 100 pharmaceutical products, based on 2000 revenues, 34 wholly or in part act on GPCRs. In 2000, these GPCR-based pharmaceutical products represented over $38.6 billion in sales, and included Claritin® for allergies, Zantac® for gastric ulcers, Imitrex® for migraines and Cozaar® for hypertension.

        We have developed a technology called constitutively activated receptor technology or 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 TaiGen Biotechnology Co., Ltd., that are designed to produce revenues. We also have entered into other research focused collaborative agreements with other companies and academic researchers and universities aimed at expanding our expertise. Since

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inception through December 31, 2001, we have recognized cumulative revenues of $25.7 million from all of our collaborative relationships.

        Early in 2001, we 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, which is a recently acquired screening technology that we believe is highly complementary to CART, a proprietary customized GPCR gene expression microarray developed for us by an outside vendor and other technologies. 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.

        In addition to Project Genesis, we have initiated an effort to screen known drugs and ligands to GPCRs to identify novel mechanisms of action associated with these compounds. Through this effort, we believe that we have identified a GPCR that may be responsible for certain activity of niacin. This discovery is in the early preclinical stage, and the development process is highly uncertain and subject to significant risks. Niacin is a drug used for the reduction of cholesterol and improving lipid profiles. However, one undesirable side effect of niacin is flushing, which is the transient redness of the face and neck caused by dilation of the cutaneous blood vessels. Discovery of the receptor through which niacin acts could make possible the discovery of new drugs that have comparable or better effects than niacin on cholesterol reduction without the undesirable side effect of flushing.

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.

        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 a step that limits the rate at which drugs are discovered at receptor targets.

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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:

        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.

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

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

        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.

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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:

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 continued opportunity to license Melanophore technology to companies in addition to GlaxoSmithKline, Eisai and Tularik 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 strategic 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 therapeutically relevant GPCRs.

        Project Genesis is comprised of the following steps:

        ACQUIRING THERAPEUTICALLY RELEVANT GPCRS.     We expect to acquire these GPCRs through our own internal research efforts as well as from outside sources. We have identified over 1,000 potential GPCR sequences, analyzed over 700 GPCRs and, to date, identified over 500 GPCR sequences, which we believe may be therapeutically relevant because of their tissue expression. We

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continue to employ our proprietary algorithmic approaches to genomic databases in order to complete GPCR identification across the entire human genome.

        DETERMINING THE LOCATION AND RELATIVE EXPRESSION LEVELS OF GPCRS.     Utilizing a proprietary, custom-designed oligonucleotide "GPCR chip," we have identified the relative expression levels of more than 700 GPCRs across 80 human tissues and over 50 human cell lines. The data indicate a large number of previously unidentified GPCRs expressed in tissues of high therapeutic importance, including over 225 receptors within major systems of the central nervous system, approximately 180 GPCRs localized to various cardiovascular tissues and approximately 300 receptors in endocrine/metabolic systems. We are now extending the analysis to examine GPCR expression levels in a variety of human diseased tissues and biopsy samples with the aim of prioritizing GPCRs for small molecule drug discovery.

        PREPARING THE GPCRS FOR SCREENING.     Having identified the GPCR sequences, our scientists CART-activate prioritized GPCRs and prepare large quantities of receptor cDNA for small molecule screening. To date, we have prepared approximately 370 GPCRS for screening and continue to expand this number as receptors are prioritized .

        SCREENING THE THERAPEUTICALLY RELEVANT GPCRS.     We employ high-throughput screening approaches, including CART and Melanophore technologies, to screen GPCRs across our in-house chemical library.

        IDENTIFYING POTENTIAL DRUG CANDIDATES.     Small molecule leads, which have been identified from our chemical library screens are optimized for potency and selectivity by our in-house medicinal chemists.

        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. Alternatively, we may choose to develop the drug candidates ourselves.

OUR STRATEGY

        Our goal is to become a leader in the discovery and development 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 AND DEVELOP DRUG LEADS

        We believe Project Genesis is the best way to use our technologies to rapidly discover novel drug leads that target therapeutically relevant GPCRs. Project Genesis will focus and accelerate our internal research & development efforts to enable us to remain a leader in the discovery of drug candidates that target GPCRs.

ENTER INTO STRATEGIC COLLABORATIONS

        We have entered into revenue-generating collaborations with Eli Lilly, Taisho, Fujisawa, ICI and TaiGen under which we apply our technologies to 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.

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APPLY CART TO OTHER RECEPTORS FOR OLFACTORY AND PLANT APPLICATIONS

        Arena is pursuing the application of CART technology to both olfactory and taste receptors with a view to identifying novel chemicals which may act as regulators of taste and smell. We are also applying CART to non-human receptors for a variety of applications. Arena scientists have discovered that applying CART to the plant GPCR, GCR1, produces phenotypic changes in plants transformed with this receptor. These include cell cycle changes and alterations in seed dormancy and time to flowering. Utilizing CART-activated GCR1 receptors may allow identification of chemical modulators of these important plant functions for potential agricultural application.

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 171 patent applications, including provisional and non-provisional applications, with the United States Patent and Trademark Office and the World Intellectual Property Organization. Four United States patents have been issued to us directed to composition of matter and methods of use claims, 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 GPCRs 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

        In early 2001, we 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.

PURSUE THERAPEUTIC APPLICATIONS

        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 Project Genesis 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 expected to have 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.

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        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. 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. 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, 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 undesired 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. We believe that we have identified a GPCR that may be responsible for certain activity of niacin. Niacin is widely used for cholesterol reduction and improvement of lipid profiles. Using CART, we intend 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 16 million people in the United States. The diabetes program is actively evaluating the following pancreatic orphan receptors as potential targets for improved insulin secretion in Type 2 diabetes mellitus: 19AJ, 20AY, 20YS, 20DJ, 20PH, 19AH and 19BE. The first five of these have been shown to be expressed in pancreatic ß-cells. A number orphan receptors are also under investigation for their possible role as modulators of insulin action. These include 20PO, 19BK, 19CD, 20JO, 19CN, FZD4, 20DP, 19BH and 19X. The first six of these targets appear to be regulated during adipocyte differentiation.

        INFLAMMATION.     We have identified several orphan GPCRs, including the 18AF GPCR, 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. 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 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

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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, receptors for which the natural ligand has been discovered. 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 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. Two such drug leads, which we refer to as AR116081 and AR116082, have displayed activities in tests involving laboratory animals indicating that these compounds could be useful in treating psychiatric disorders such as schizophrenia. Moreover, these compounds possess a higher degree of receptor selectivity than currently marketed anti-psychotics, which suggests that these compounds may have a different efficacy/side effect profile than these other drugs.

        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 by 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 by ourselves.

OTHER APPLICATIONS OF CART

        OLFACTORY AND TASTE GPCRS.     Over the past four years, we have also obtained the full-length gene sequences of over 300 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

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and development. Arena scientists have recently identified a role for a plant GPCR in controlling aspects of seed dormancy, plant flowering and plant growth.

        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 based upon this collaboration have been born and are currently being analyzed for functional information.

        TYROSINE KINASE RECEPTORS.     In addition to applying CART to orphan GPCRs, we are also applying CART to other human receptor classes, including TKRs. A number of 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 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.

        VIRAL GPCRS.     GPCRs are involved in either replication or infection in a number of viruses. For example, the Kaposi's sarcoma-associated virus has GPCRs within its genome which we believe are important for replication, and 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.

OUR PRESENT AND FUTURE 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. 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. 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. There can be no assurance that we will be successful in consummating any such arrangement.

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 also includes GPCRs of potential interest in the cardiovascular and oncology fields.

        During our collaboration, we pursue an agreed upon research plan with Eli Lilly that has several objectives. We mutually review and select GPCRs that will become subject to the collaboration. These GPCRs may be provided either by us or by Eli Lilly. We and Eli Lilly jointly select a number of GPCRs for CART-activation and we provide Eli Lilly with enabled high-throughput screens for

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screening at either party's facilities. We receive research funding from Eli Lilly for our internal resources committed to the collaboration, which are augmented by substantial resources by Eli Lilly. Together, we are responsible for identifying drug leads and Eli Lilly will be responsible 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 has exclusive rights to screen chemical libraries, discover drug leads using that CART-activated GPCR and develop, register and sell any resulting products worldwide.

        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.

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 CART-activated 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.

        In January 2001, we signed an amendment to our original agreement with Taisho whereby Taisho was granted worldwide rights to our 18F program which includes the 18F receptor, a GPCR that we believe is 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.

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

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. If we and Fujisawa 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.

        Our collaborative agreement with Fujisawa will terminate upon the expiration of Fujisawa's obligation, if any, to make royalty payments under the agreement. 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.

ICI

        In June 2001, we entered into an agreement with ICI to apply our CART technology to olfactory and gustatory GPCRs. The initial feasibility period of research under our agreement lasted approximately six months and included applying our CART technology to develop olfactory and/or gustatory GPCR assays for ICI and then screening compounds supplied by ICI businesses. Under the one-year exclusivity period of our agreement that started when the feasibility period ended, ICI has the exclusive right to request us to select additional sensory GPCRs to apply our CART technology. We may also receive royalties on related sales, if any.

TAIGEN

        In July 2001 we entered into an agreement with TaiGen Biotechnology Co., Ltd., a Taiwan-based start-up biopharmaceutical organization focused on the discovery and development of innovative therapeutics. In exchange for equity in TaiGen's Series A preferred financing, TaiGen has the right to select and obtain several GPCRs from us. We will activate, develop a screening assay and transfer selected activated receptors to TaiGen. We may also receive royalty payments based on annual TaiGen licensing revenue, if any. We will not initially receive any cash payments from TaiGen.

EISAI

        In August 2001, we entered into a Melanophore technology agreement with Eisai Co., Ltd., a Japan-based pharmaceutical company. The one-year agreement allows Eisai to use our Melanophore technology for the identification of natural ligands to cell surface receptors. Eisai may extend the agreement for one additional year by payment of an extension fee. We may also receive consulting fees, research and development milestones and royalties on drug sales, if any.

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RESEARCH COLLABORATION

        In April 2001 we signed a binding letter of intent with Axiom Biotechnologies, Inc. for a collaborative research program involving Axiom's proprietary RHACE™ 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. 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. The stock purchase was completed in August 2001.

CHEMNAVIGATOR

        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 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 in exchange for stock. Our carrying value for our investment in ChemNavigator is zero because we have made no financial contribution to ChemNavigator in exchange for our ownership interest. In addition, we are not required to reimburse the outside investors for any losses ChemNavigator incurs. We currently beneficially own approximately 35% of the outstanding common stock of ChemNavigator.

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 171 patent applications, including provisional and non-provisional applications in the United States and with the World International Property Organization regarding:

        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. It

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has also been possible to obtain broad method patents for techniques and procedures for screening and drug-identification technologies. 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.

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        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.

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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 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 may often rely on our collaborators for support of development programs and 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, which may negatively impact the development of drugs that they discover which are subject to our agreements. Generally, our agreements with our collaborators also do not preclude them from pursuing development efforts in one or more therapeutic areas of interest in which we have internal development efforts ongoing.

GOVERNMENT REGULATION

        Ours and our collaborator's 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 collaborator's 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 all of our drug candidates by ourselves. We will use collaborators, internal resources and outside contractors to develop and commercialize drug candidates discovered through the use of our technology. Before marketing in the United States, any pharmaceutical or therapeutic product 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

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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. 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 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 at 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 we or the FDA may decide that clinical trials should be discontinued at any time if any significant safety issues are identified. 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:

        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 a 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.

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        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 $22.9 million for the year ended December 31, 2001, $12.1 million for the year ended December 31, 2000 and $8.3 million for the year ended December 31, 1999.

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,

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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 February 1, 2002, we employed 209 people, including 179 in research and development and 30 in administration. Fifty-seven of our employees hold doctoral degrees and an additional 30 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.

Risk Factors

WE HAVE A HISTORY OF LOSSES AND LIMITED REVENUES.

        We were formed in April 1997. We had losses of $6.9 million for the year ended December 31, 2001. Through December 31, 2001, we had an accumulated deficit of $27.6 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 continue to 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 THE DECISIONS OF OUR COLLABORATORS.

        One of our strategies is to use our technologies to generate meaningful revenues from our collaborative and license agreements. Through December 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,

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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.

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

        The main 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, in particular, CART and Melanophore technologies, 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.

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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.

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. 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.

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        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 to what extent these guidelines will ultimately affect our patent applications on CART, genetically altered GPCRs, GPCRs that we have discovered or chemical compounds that we discover using CART.

        To date, four patents have been issued to us directed to composition of matter and use claims, and we own two issued patents directed to Melanophore technology. There is no assurance that any issued patent will result in a drug product or other commercial opportunity.

        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

21



seeking to enjoin commercial activities relating to the affected products or our methods or processes could:


        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.

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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:

        We are not able to control these factors. 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 analysts' or shareholders' expectations, our stock price may decline and such decline could be significant.

WE WILL NEED ADDITIONAL CAPITAL IN THE FUTURE TO SUFFICIENTLY FUND OUR OPERATIONS AND RESEARCH AND DEVELOPMENT AND 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. In addition, if we are successful in developing drug leads, our capital requirements will be much greater than our current capital. 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.

        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

23



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.

WE MAY ENGAGE IN STRATEGIC TRANSACTIONS THAT 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.

WE USE BIOLOGICAL AND HAZARDOUS MATERIALS.

        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:

Item 2. Properties.

        Our facilities consist of approximately 92,000 square feet of research and office space located at 6138, 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 2001, we purchased the 6138-6150 Nancy Ridge Drive facility whose square footage is approximately 55,000 square feet and consists of 33,000 square feet of laboratory space and 22,000 square feet of office space. In November 2001, we acquired a 13,000 square foot facility at 6114 Nancy Ridge Drive and leased it back to the previous owner. The previous owner terminated the lease in January 2002 and we have started converting the facility into additional laboratory and office space. Also in November 2001, we acquired a 49,000 square foot facility at 6154 Nancy Ridge Drive and leased it back to the previous owner. The term of the lease expires in November 2002 unless we are given notice by the tenant of an earlier termination date. We believe that the facility can be expanded to a 72,000 square foot facility in which we will use primarily for additional laboratory and office space. We believe these facilities will be adequate to meet our near-term space requirements. In addition, we believe that the space needed to accommodate our growth through 2003 is available on commercially reasonable terms.

Item 3. Legal Proceedings.

        None.

Item 4. Submissions Of Matters To A Vote Of Security Holders.

        No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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PART II

Item 5. Market For The Registrant's Common Equity And Related Stockholder Matters.

        Our common stock has traded on the Nasdaq National Market under the symbol "ARNA." The following table sets forth, for the period indicated, the high and low bid quotations for the common stock as reported by the Nasdaq National Market.

 
  High
  Low
Year ended December 31, 2000            
Third Quarter (from July 28, 2000)   $ 47.00   $ 18.00
Fourth Quarter   $ 44.00   $ 13.63
 
  High
  Low
Year ended December 31, 2001            
First Quarter   $ 27.13   $ 11.56
Second Quarter   $ 33.10   $ 17.13
Third Quarter   $ 35.49   $ 8.65
Fourth Quarter   $ 13.02   $ 8.77

        On February 1, 2002, the last reported sale price on the Nasdaq National Market for our common stock was $10.76 per share.

        As of February 1, 2002 there were approximately 6,500 stockholders of record of the Company's common stock.

Dividends

        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.

Use of Proceeds from the Sale of Registered Securities

        On July 28, 2000 we completed our initial public offering of 6,000,000 shares of our common stock and on August 10, 2000 the underwriters exercised an over-allotment option for an additional 900,000 shares of our common stock. The shares of common stock sold in the offering were registered under the Securities Act of 1933 in a Registration Statement on Form S-1, as amended (No. 333-35944). The Securities and Exchange Commission declared the Registration Statement effective on July 27, 2000.

        Our total net proceeds from the initial public offering were approximately $113.9 million. Of the net proceeds, through December 31, 2001, we have used approximately $5.4 million to acquire facilities at 6138-6150 Nancy Ridge Drive in San Diego, California, $5.3 million to acquire facilities at 6154 Nancy Ridge Drive in San Diego, California, $1.2 million to acquire facilities at 6114 Nancy Ridge Drive in San Diego, California, $15.0 million to acquire all of the outstanding stock of Bunsen Rush, $2.0 million to acquire stock in Axiom Biotechnologies, Inc. and $10.5 million for lab, equipment and furniture purchases and leasehold improvements. The balance of the net proceeds remains in working capital, held as temporary investments in short-term money funds, asset backed securities, corporate debt securities, federal agency notes and mortgage-backed securities.

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Item 6. Selected Financial Data.

        The following Selected Financial Data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data" included elsewhere in this Annual Report on Form 10-K.

 
   
   
   
   
  Period from April 14, 1997 (inception) through December 31, 1997
 
 
  Year ended December 31,
 
 
  2001
  2000
  1999
  1998
 
Revenues                                
Collaborative agreements   $ 16,643,999   $ 7,683,396   $   $   $  
Collaborative agreements with affiliates     1,416,000                  
   
 
 
 
 
 
  Total revenues     18,059,999     7,683,396              
Expenses                                
Research and development     22,864,250     12,080,204     8,336,483     2,615,526     447,038  
General and administrative     5,390,446     2,678,980     1,814,023     728,806     234,614  
Amortization of deferred compensation     4,239,740     4,342,896     378,109          
Amortization of acquired technology and other purchased intangibles     1,280,830                  
   
 
 
 
 
 
  Total operating expenses     33,775,266     19,102,080     10,528,615     3,344,332     681,652  
Interest and other, net     8,832,543     5,056,714     290,665     (51,986 )   (13,113 )
   
 
 
 
 
 
Net loss     (6,882,724 )   (6,361,970 )   (10,237,950 )   (3,396,318 )   (694,765 )
Non-cash preferred stock charge         (22,391,068 )            
   
 
 
 
 
 
Net loss applicable to common stockholders   $ (6,882,724 ) $ (28,753,038 ) $ (10,237,950 ) $ (3,396,318 ) $ (694,765 )
   
 
 
 
 
 
Net loss per share, basic and diluted   $ (0.28 ) $ (2.84 ) $ (10.05 ) $ (3.51 ) $ (0.73 )
   
 
 
 
 
 
Shares used in calculating net loss per share, basic and diluted     24,989,067     10,139,755     1,018,359     966,799     955,000  
   
 
 
 
 
 

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  As of December 31,
 
 
  2001
  2000
  1999
  1998
  1997
 
Balance Sheet Data:                                
Cash and cash equivalents   $ 176,676,669   $ 144,413,176   $ 5,401,508   $ 194,243   $ 1,553,422  
Short-term investments     50,247,624                  
Total assets     276,973,710     152,711,929     8,525,840     1,653,090     2,421,603  
Long-term obligations, net of current portion     402,092     960,517     2,158,784     970,785     790,863  
Redeemable convertible preferred stock             18,251,949     2,598,643     2,193,356  
Deferred compensation     (3,611,933 )   (7,899,970 )   (625,955 )        
Accumulated deficit     (27,573,727 )   (20,691,003 )   (14,329,033 )   (4,091,083 )   (694,765 )
Total stockholder's equity (deficit)     269,473,678     148,784,325     (13,899,549 )   (4,068,283 )   (694,665 )

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Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations.

        You should read the following discussion and analysis in conjunction with "Item 8. Financial Statements and Supplementary Data" included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth in Arena's registration statement filed June 21, 2001 on Form S-1, as amended, in its most recent quarterly report on Form 10-Q, in this Form 10-K under "Risk Factors" in the Business section and elsewhere in this Form 10-K and in Arena's other SEC filings. All forward-looking statements included in this document are based on information available to us on the date of this document and we assume no obligation to update any forward-looking statements contained in this Form 10-K.

        We are an emerging biopharmaceutical company focused principally on discovering and developing drugs that target GPCRs. We use CART and Melanophore technologies to identify drug leads more efficiently than traditional drug discovery techniques.

Critical Accounting Policies and Management Estimates

        The Securities and Exchange Commission defines critical accounting policies as those that are, in management's view, most important to the portrayal of the company's financial condition and results of operations and most demanding of their judgment. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the US. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies include:

        Revenue Recognition.     Our revenue recognition policies are in accordance with the Securities and Exchange Commission Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements. SAB 101 provides guidance related to revenue recognition based on the interpretations and practices developed by the Securities and Exchange Commission. Many of our agreements contain multiple elements, including downstream milestone and royalty obligations.

        Revenue from milestones is recognized when earned, as evidenced by written acknowledgment from our collaborator, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, and (ii) our performance obligations after the milestone achievement will continue to be funded by our collaborator at a comparable level to before the milestone achievement. If both of these criteria are not met, the milestone payment is recognized over the remaining minimum period of our performance obligations under the agreement. Upfront fees under our 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 revenues as the services are performed.

        Goodwill and Intangibles.     Purchase accounting requires accounting estimates and judgments to allocate the purchase price to the fair market value of the assets and liabilities purchased. In February 2001 we acquired Bunsen Rush for $15.0 million in cash. We allocated $15.4 million to the patented Melanophore technology and assumed approximately $430,000 in current liabilities. The acquired Melanophore technology is being amortized over its useful life of ten years. The estimated

28



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 and the patent life of the technology. As with any intangible asset, we will evaluate the value of the technology and, if necessary, we will have a future write-down of the carrying value of the technology if we determine the technology has become impaired or may accelerate the amortization if we determine the technology life has been shortened.

        Income Taxes.     We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

        The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management's judgment in their application. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto which begin on page F-1 of this Annual Report on Form 10-K which contain accounting policies and other disclosures required by generally accepted accounting principles.

Overview

        In April 2000, we entered into a 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 also includes GPCRs of potential interest in the cardiovascular and oncology fields. During our collaboration, we pursue an agreed upon research plan with Eli Lilly that has several objectives. We mutually review and select GPCRs that will become subject to the collaboration. These GPCRs may be provided either by us or by Eli Lilly. We and Eli Lilly jointly select a number of GPCRs for CART-activation and we provide Eli Lilly with enabled high-throughput screens for screening at either party's facilities. We receive research funding from Eli Lilly for our internal resources committed to the collaboration, which are augmented by substantial resources by Eli Lilly. Together, we are responsible for identifying drug leads and Eli Lilly will be responsible 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. Revenues recognized under the Eli Lilly collaboration were approximately $8.5 million for the year ended December 31, 2001 consisting of research funding of approximately $4.9 million, milestone achievements of approximately $3.5 million, and $100,000 from amortization of the upfront payment. For the year ended December 31, 2000, 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 $75,000 from amortization of the upfront payment.

        In May 2000, we entered into an agreement with Taisho Pharmaceutical Co., Ltd. to initiate a research collaboration focused on several GPCRs selected by Taisho in therapeutic areas of interest to Taisho. Under the terms of the agreement, Taisho will receive exclusive, worldwide rights to the selected CART-activated GPCR targets and to any drug leads discovered using the activated versions of these receptors. We may receive up to a total of $2.3 million in revenues per receptor associated with

29



research, development and screening fees. We may also receive clinical development milestones, regulatory approval milestones and royalties on drug sales, if any. In January 2001, we 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 us for the 18-F Program based upon work completed by the Company 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. 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.

        Revenues recognized under the Taisho collaborations were approximately $6.2 million for the year ended December 31, 2001 consisting of milestone achievements and research and development fees of approximately $4.8 million, research funding of $1.3 million and $120,000 from amortization of the upfront payment. 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 $80,000 from amortization of the upfront payment.

        In January 2000, we entered into a collaborative agreement with Fujisawa Pharmaceutical, Co., Ltd. Under 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. If we and Fujisawa achieve various milestones, we 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. We may also receive clinical development milestones, regulatory approval milestones and royalties on drug sales, if any. Our collaborative agreement with Fujisawa will terminate upon the expiration of Fujisawa's obligation to make royalty payments under the agreement, if any. For the year ended December 31, 2001, we recognized $500,000 in milestone-based revenues under the Fujisawa collaboration.

        In June 2001, we entered into an agreement with ICI to apply our CART technology to olfactory and gustatory GPCRs. The feasibility period of research under our agreement lasted approximately six months and included applying our CART technology to develop olfactory and/or gustatory GPCR assays for ICI and then screening using compounds supplied by ICI businesses. Under the one-year exclusivity period of our agreement that started when the feasibility period ended, ICI has the exclusive right to request us to select additional sensory GPCRs for which we will apply our CART technology. We may also receive royalties on related sales, if any. For the year ended December 31, 2001, we recognized revenues of $600,000 under the ICI agreement.

        In July 2001, we entered into an agreement with TaiGen Biotechnology Co., Ltd., a Taiwan-based start-up biopharmaceutical organization focused on the discovery and development of innovative therapeutics. In exchange for $3.3 million in equity in TaiGen's Series A preferred financing, TaiGen has the right to select and obtain several GPCRs from us. We will activate and develop a screening

30



assay and transfer selected activated receptors to TaiGen. We may also receive royalty payments based on annual TaiGen licensing revenue, if any. We will not initially receive any cash payments from TaiGen. We account for our ownership interest in TaiGen using the equity method of accounting, a method of accounting for an investment, which requires increasing or decreasing the investment for the investor's proportionate share of the investee's earnings or losses. For the year ended December 31, 2001, we recognized revenues of $1.4 million for the transfer of selected receptor screens to TaiGen. This revenue is considered related party revenue because our President and CEO is a member of the board of directors of TaiGen. One of our outside directors is also a member of the board of directors of TaiGen. In addition, based upon our ownership interest in TaiGen of approximately 17%, as well as our representation on TaiGen's board of directors, we shared in TaiGen's losses, increasing our net loss for the year ended December 31, 2001 by approximately $204,000.

        In August 2001, we entered into a Melanophore technology agreement with Eisai Co., Ltd., a Japan-based pharmaceutical company. The one-year agreement allows Eisai to use our Melanophore technology for the identification of natural ligands to cell surface receptors. Eisai may extend the agreement for one additional year by payment of an extension fee. We may also receive consulting fees, research and development milestones and royalties on drug sales, if any. For the year ended December 31, 2001, we recognized $414,000 in license revenues under the Eisai agreement.

        We have entered into a drug research collaboration agreement and a software license agreement with Tripos, a related party, 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 jointly share expenses and any proceeds resulting from the collaboration. In addition, during 2001, we paid Tripos $1,405,000 for compounds purchased outside of the existing agreements with Tripos, and the use of such compounds by us will not involve additional payments to Tripos.

        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, 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.

        In February 2001, we acquired, for $15.0 million in cash, all of the outstanding capital stock of Bunsen Rush Laboratories, Inc., a company that provided receptor screening for the pharmaceutical and biotechnology industries using its proprietary and patented Melanophore technology. Melanophore technology is a functional-based screening technology used to identify compounds that interact with cell surface receptors, including known and orphan GPCRs and receptor tyrosine kinases. The functional nature of Melanophore technology eliminates the need for radioactive or fluorescent screening techniques and provides a simple and sensitive means to detect cellular signals generated by activated GPCRs. Substantially all of the purchase price has been allocated to acquired technology, which we amortize over ten years. For the year ended December 31, 2001, amortization of acquired technology and other purchased intangibles related to the Bunsen Rush acquisition totaled $1.3 million.

        We recently initiated Project Genesis, an internal drug discovery program using a combination of CART, Melanophore 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 strategic 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 therapeutically relevant GPCRs.

        We plan to pursue several specific objectives during the remainder of 2002, namely:

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        We incur significant research and development expenses. As of December 31, 2001, all of our research and development costs have been expensed as incurred. We generally do not track our historical research and development costs by project; rather, we track such costs by the type of cost incurred, primarily personnel expenses and laboratory-related expenses. For this reason, we cannot accurately estimate with any degree of certainty what our historical costs have been for any particular research and development project. We believe that continued investment in research and development is critical to attaining our strategic objectives. We expect that the implementation and continuation 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 and $11.6 million during the years ended December 31, 2001 and 2000, respectively. 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 $4.2 million during the year ended December 31, 2001 and $4.3 million during the year ended December 31, 2000. As of December 31, 2001, we anticipate that total charges to be recognized in future periods from amortization of deferred stock compensation will be $2.5 million for the year ending December 31, 2002, $1.0 million for the year ending December 31, 2003 and $112,000 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 operating results will depend upon many factors, including the expiration or termination of our collaborations, 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.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000

        Revenues.     We recorded revenues of $18.1 million during the year ended December 31, 2001, compared to $7.7 million in revenue during the year ended December 31, 2000. Eighty-one percent and 99% of our revenues during the years ended December 31, 2001 and 2000, respectively, were from our collaborations with Eli Lilly and Taisho, both significant customers, which included research funding, milestone payments, and technology access and development fees. Our collaborators often pay us before we recognize the revenue and these payments are deferred until earned. As of December 31, 2001, we had deferred revenues totaling approximately $2.8 million.

        Research and Development Expenses.     Research and development expenses increased $10.8 million to $22.9 million for the year ended December 31, 2001 from $12.1 million for the year ended December 31, 2000. The increase was due primarily to increases in: personnel expenses of $5.1 million; lab supplies, laboratory equipment rental and depreciation of laboratory equipment totaling $4.0 million; and subscription fees of $750,000 for our subscription to the web-based Celera Discovery System entered into in 2001. As of December 31, 2001, all research and development costs have been

32



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 $2.7 million to $5.4 million for the year ended December 31, 2001 from $2.7 million for the year ended December 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 re-measured as the underlying options vest in accordance with EITF 96-18.

        For the year ended December 31, 2001, we recorded amortization of deferred compensation of approximately $4.2 million, compared to $4.3 million for the year ended December 31, 2000.

        Interest Income.     Interest income increased $3.0 million to $7.6 million for the year ended December 31, 2001 from $4.6 million for the year ended December 31, 2000. The increase was due to higher average cash and investment balances primarily due to our public offering in June 2001 through which we raised net cash proceeds of $123.0 million, offset by declining interest rates in 2001.

        Interest Expense.     Interest expense decreased $108,000 to $112,000 for the year ended December 31, 2001 from $220,000 for the year ended December 31, 2000. This decrease was primarily the result a reduction in average balances of obligations under capital leases during the year ended December 31, 2001 as well as a convertible note to a related party that was converted into common stock in July 2000.

        Gain on Investment.     Gain on investment increased by $608,000 to $1.2 million for the year ended December 31, 2001 from $576,000 for the year ended December 31, 2000 as a result of a larger gain on the sale of liquid short-term investments in 2001.

        Other Income.     Other income increased $297,000 to $354,000 for the year ended December 31, 2001 from $57,000 for the year ended December 31, 2000. This increase was due primarily to the rental income we earned in 2001 when we acquired a facility subject to a lease with a tenant.

        Minority Interest in TaiGen.     Our minority interest in TaiGen accounted for a loss of $204,000 for the year ended December 31, 2001. We account for our ownership interest in TaiGen, which we acquired in July 2001 using the equity method of accounting, a method of accounting for an investment, which requires increasing or decreasing the investment for the investor's proportionate share of the investee's earnings or losses. Based upon our ownership interest in TaiGen, we recorded our share of TaiGen's losses by increasing our net loss for the year ended December 31, 2001.

        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 relates 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

33



stockholders' equity. The amount increased our basic net loss per share for the year ended December 31, 2000.

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. Ninety-nine percent of revenues for the year ended December 31, 2000 were attributable to our collaborations with Eli Lilly and Taisho, which included research funding, milestone achievements and technology access and development fees. If our collaborators pay us before we recognize the revenue, we will defer revenue recognition of these payments until earned. As of December 31, 2000 we had current and non-current 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-related expenses of $3.5 million and lab supplies costing $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.

        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.

        Net Loss.     Net loss decreased $3.8 million to $6.4 million for the year ended December 31, 2000 compared to $10.2 million for the year ended December 31, 1999. The decrease reflects revenues of $7.7 million in the year ended December 31, 2000 reduced by increases in research and development and general and administrative expenses as well as amortization of deferred compensation.

        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 relates to the issuance of our Series E preferred stock in January 2000, our Series F preferred stock in March 2000 and our

34



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 basic net loss per share for the year ended December 31, 2000.

Liquidity and Capital Resources

        Liquidity refers to our ability to generate adequate amounts of cash to meet our needs. We have been generating only a portion of the cash necessary to fund our operations from revenues. We have incurred a loss in each year since inception, and we expect to incur substantial losses for at least the next several years. We expect that losses may fluctuate, and that such fluctuations may be substantial. At December 31, 2001, we had an accumulated deficit of $27.6 million. Our accumulated deficit is the result of expenses incurred in connection with our research and development activities and general and administrative costs. We have funded our operations primarily through public and private equity financings, and to a lesser extent from cash we received from our collaborators, together with our interest income and gains from our investments.

        Potential immediate sources of liquidity for us include cash balances and unused borrowing capacity. Another potential source of liquidity is the sale of additional shares of our stock.

        The maintenance of liquidity is one of the goals of our cash investment policy. Under this policy, we seek to limit our risk in order to preserve the principal.

        As of December 31, 2001, we had $226.9 million in cash and cash equivalents and short-term investments compared to $144.4 million in cash and cash equivalents as of December 31, 2000. The increase of $82.5 million is primarily attributable to the net proceeds from our public offering of common stock in June 2001 where we raised $123.0 million, partially offset by our acquisition of Bunsen Rush Laboratories for $15.0 million in cash in February 2001, the purchase of three of our facilities for a total of $11.9 million in cash in 2001, as well as other equipment purchases totaling $8.7 million. This was also partially offset by cash used in operations of $1.6 million.

        Net cash used in operating activities was approximately $1.6 million during the year ended December 31, 2001. The primary use of cash for the year ended December 31, 2001 was to fund our net loss 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 and $8.7 million during the year ended December 31, 1999. 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 $88.9 million during the year ended December 31, 2001. Net cash used in investing activities for the year ended December 31, 2001 was primarily the result of purchases of short-term investments, the acquisition of Bunsen Rush Laboratories, our purchase of three facilities and the acquisition of laboratory and computer equipment, and furniture and fixtures. Net cash used in investing activities was approximately $2.2 million during the year ended December 31, 2000 and $2.1 million during the year ended December 31, 1999. Net cash used in investing activities was used primarily to purchase laboratory and computer equipment and furniture and fixtures.

        Net cash provided by financing activities was approximately $122.8 million during the year ended December 31, 2001. The net cash provided by financing activities for the year ended December 31, 2001 was primarily attributable to the net proceeds from our public offering of common stock in

35



June 2001 where we raised $123.0 million offset by $540,000 in principal payments on our capital leases. Net cash proceeds from financing activities were approximately $145.3 million during the year ended December 31, 2000 and $16.0 million during the year ended December 31, 1999. The net cash proceeds from financing activities during the year ended December 31, 2000 were 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 year ended December 31, 1999 were primarily from the issuance of preferred stock.

        We occupy 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. 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, 2001, current total minimum annual payments under these capital leases were approximately $574,000 in 2002, $382,000 in 2003 and $44,000 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.

        In February 2001, we acquired all of the outstanding capital stock of Bunsen Rush Laboratories for cash of $15.0 million.

        In November 2001, we acquired a facility at 6154 Nancy Ridge Drive in San Diego for cash of $5.3 million.

        Also in November 2001, we acquired a facility at 6114 Nancy Ridge Drive in San Diego for cash of $1.2 million.

        Based on the research collaborations we already have in place and our current internal business plan, we expect to hire an additional 100 to 120 employees, primarily research scientists and development staff, by the end of 2002. 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 may require additional financing before such time. The estimated length of time current cash and cash equivalents, short-term investments and available borrowings will sustain our operations is based on estimates and assumptions we have made, including the 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, cost associated with securing in-licensing opportunities, if any, and the costs of filing and prosecution of patent applications and enforcing patent claims. These estimates and assumptions are subject to change at any time due to technological advances or competition from other companies. 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, 2001, we had approximately $13.3 million of net operating loss carryforwards and $2.2 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 is 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.

36



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Our exposure to market risk for changes in interest rates relates primarily to our cash equivalents and short-term investments. 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 December 31, 2001, we would expect future interest income from our portfolio to decline by less than $2.3 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.

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Item 8. Financial Statements.


ARENA PHARMACEUTICALS, INC.
INDEX TO FINANCIAL STATEMENTS

 
  Page
Report of Ernst & Young LLP, Independent Auditors   39
Consolidated Balance Sheets   40
Consolidated Statements of Operations   41
Consolidated Statements of Stockholders' Equity (Deficit)   42
Consolidated Statements of Cash Flows   43
Notes to Consolidated Financial Statements   44

38



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, 2001 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, 2001. 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, 2001 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, 2001, in conformity with accounting principles generally accepted in the United States.

San Diego, California
January 11, 2002

39


ARENA PHARMACEUTICALS, INC.

Consolidated Balance Sheets

 
  December 31,
 
 
  2001
  2000
 
ASSETS              
Current assets:              
  Cash and cash equivalents   $ 176,676,669   $ 144,413,176  
  Short-term investments     50,247,624      
  Accounts receivable     3,481,250     2,116,146  
  Prepaid expenses     2,903,281     1,685,122  
   
 
 
    Total current assets     233,308,824     148,214,444  
Land, property and equipment, net     23,268,567     4,265,260  
Acquired technology, net     14,097,204      
Deposits, restricted cash, investments and other assets     6,299,115     232,225  
   
 
 
    Total assets   $ 276,973,710   $ 152,711,929  
   
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY              
Current liabilities:              
  Accounts payable and accrued expenses   $ 2,329,426   $ 615,201  
  Accrued compensation     620,404     300,339  
  Current portion of deferred revenues     2,386,029     220,000  
  Current portion of obligations under capital leases     499,387     480,538  
   
 
 
    Total current liabilities     5,835,246     1,616,078  
Obligations under capital leases, less current portion     402,092     960,517  
Deferred rent     871,867     866,009  
Deferred revenues     390,827     485,000  
Commitments              
  Redeemable convertible preferred stock, $.0001 par value: 7,500,000 shares authorized at December 31, 2001 and 2000; no shares issued and outstanding at December 31, 2001 and 2000          
Stockholders' equity:              
  Common stock, $.0001 par value: 67,500,000 shares authorized at December 31, 2001 and 2000; 27,585,048 and 22,688,313 shares issued and outstanding at December 31, 2001 and December 31, 2000, respectively     2,759     2,268  
  Additional paid-in capital     300,649,789     177,373,030  
  Accumulated other comprehensive gain     6,790      
  Deferred compensation     (3,611,933 )   (7,899,970 )
  Accumulated deficit     (27,573,727 )   (20,691,003 )
   
 
 
    Total stockholders' equity     269,473,678     148,784,325  
   
 
 
    Total liabilities and stockholders' equity   $ 276,973,710   $ 152,711,929  
   
 
 

See accompanying notes.

40


ARENA PHARMACEUTICALS, INC.

Consolidated Statements of Operations

 
  Year Ended December 31,
 
 
  2001
  2000
  1999
 
Revenues                    
  Collaborative agreements   $ 16,643,999   $ 7,683,396   $  
  Collaborative agreements with affiliates     1,416,000          
   
 
 
 
    Total revenues     18,059,999     7,683,396      
Operating expenses:                    
  Research and development     22,864,250     12,080,204     8,336,483  
  General and administrative     5,390,446     2,678,980     1,814,023  
  Amortization of deferred compensation ($2,710,464, $3,018,623 and $264,419 related to research and development expenses and $1,529,276, $1,324,273 and $113,690 related to general and administrative expenses for the years ended December 31, 2001, 2000 and 1999, respectively)     4,239,740     4,342,896     378,109  
  Amortization of acquired intangibles     1,280,830          
   
 
 
 
    Total operating expenses     33,775,266     19,102,080     10,528,615  
  Interest income     7,609,893     4,644,471     446,848  
  Interest expense     (112,188 )   (220,483 )   (165,603 )
  Gain on sale of investments     1,183,977     575,855      
  Other income     354,463     56,871     9,420  
  Minority interest in TaiGen     (203,602 )        
   
 
 
 
  Net loss     (6,882,724 )   (6,361,970 )   (10,237,950 )
  Non-cash preferred stock charge         (22,391,068 )    
   
 
 
 
  Net loss applicable to common stockholders   $ (6,882,724 ) $ (28,753,038 ) $ (10,237,950 )
   
 
 
 
  Net loss per share, basic and diluted   $ (0.28 ) $ (2.84 ) $ (10.05 )
   
 
 
 
  Shares used in calculating net loss per share, basic and diluted     24,989,067     10,139,755     1,018,359  
   
 
 
 

See accompanying notes.

41


ARENA PHARMACEUTICALS, INC.

Consolidated Statements of Stockholders' Equity (Deficit)

 
  Common Stock
   
  Accumulated
Other
Comprehensive
Income

   
   
  Total
Stockholders'
Equity
(Deficit)

 
 
  Additional
Paid-In
Capital

  Deferred
Compensation

  Accumulated
Deficit

 
 
  Shares
  Amount
 
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   123,100     13     81,357                 81,370  
  Issuance of common stock upon exercise of options under the employee stock purchase plan   23,635     3     219,144                 219,147  
  Issuance of common stock in public offering, net of offering costs of $7,599,970   4,750,000     475     123,024,555                 123,025,030  
  Deferred compensation related to stock options           (516,371 )       516,371          
  Amortization of deferred compensation           468,074         3,771,666         4,239,740  
  Net loss                       (6,882,724 )   (6,882,724 )
  Net unrealized gain on available-for-sale securities               6,790             6,790  
  Net comprehensive loss                                       (6,875,934 )
   
 
 
 
 
 
 
 
Balance at December 31, 2001   27,585,048   $ 2,759   $ 300,649,789   $ 6,790   $ (3,611,933 ) $ (27,573,727 ) $ 269,473,678  
   
 
 
 
 
 
 
 

See accompanying notes.

42


ARENA PHARMACEUTICALS, INC.

Consolidated Statements of Cash Flows

 
  Year Ended December 31,
 
 
  2001
  2000
  1999
 
OPERATING ACTIVITIES                    
Net loss   $ (6,882,724 ) $ (6,361,970 ) $ (10,237,950 )
Adjustments to reconcile net loss to net cash used in operating activities:                    
  Depreciation and amortization     1,628,575     787,829     399,278  
  Minority interest     203,602          
  Amortization of acquired technology     1,280,830          
  Amortization of deferred compensation     4,239,740     4,342,896     378,109  
  Amortization /accretion of short-term investment premium/discount     53,374          
  Interest accrued on notes payable to related party         41,262     80,635  
  Deferred rent     5,858     72,886     45,699  
  Deferred financing costs             150,711  
  Change in operating assets and liabilities:                    
    Accounts receivable     (1,365,104 )   (2,116,146 )    
    Prepaid expenses and other assets     (1,218,159 )   (1,657,279 )   (110,071 )
    Deferred revenues     (1,616,582 )   705,000      
    Accounts payable and accrued expenses     2,034,290     49,126     624,195  
   
 
 
 
      Net cash used in operating activities     (1,636,300 )   (4,136,396 )   (8,669,394 )
INVESTING ACTIVITIES                    
  Acquisition of Bunsen Rush     (15,000,000 )        
  Purchases of short-term investments     (51,292,856 )        
  Sales of short-term investments     998,648          
  Purchases of land, property and equipment     (20,631,882 )   (2,279,707 )   (2,007,020 )
  Investment, restricted cash and other assets     (2,960,088 )   90,882     (98,383 )
   
 
 
 
      Net cash used in investing activities     (88,886,178 )   (2,188,825 )   (2,105,403 )
FINANCING ACTIVITIES                    
  Advances under capital lease obligations         377,015     1,562,690  
  Principal payments on capital leases     (539,576 )   (515,551 )   (116,427 )
  Proceeds from issuance of redeemable preferred stock         30,065,334     14,132,224  
  Proceeds from issuance of common stock     123,325,547     115,410,091     28,575  
  Proceeds from convertible note payable to related party             375,000  
   
 
 
 
      Net cash provided by financing activities     122,785,971     145,336,889     15,982,062  
   
 
 
 
  Net increase in cash and cash equivalents     32,263,493     139,011,668     5,207,265  
  Cash and cash equivalents at beginning of period     144,413,176     5,401,508     194,243  
   
 
 
 
  Cash and cash equivalents at end of period   $ 176,676,669   $ 144,413,176   $ 5,401,508  
   
 
 
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                    
  Interest paid   $ 112,189   $ 179,221   $ 84,968  
   
 
 
 
  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  
   
 
 
 
Schedule of non-cash activities:                    
  Deferred revenue assumed in Bunsen Rush acquisition   $ 430,034   $   $  
   
 
 
 
  Equity investment in TaiGen for services to be performed   $ 3,310,404   $   $  
   
 
 
 

See accompanying notes.

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ARENA PHARMACEUTICALS, INC.

Notes to Consolidated Financial Statements

(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 is focused principally on discovering and developing drugs that target G protein-coupled receptors ("GPCRs"), using constitutively activated receptor technology ("CART") and other technologies, to identify drug leads more efficiently than traditional drug discovery techniques.

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") that was formed in August 1999. 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 and has therefore not consolidated Aressa's activity, which has been minimal.

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.

Cash and Cash Equivalents

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

Available-for-Sale Securities

        In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Debt and Equity Securities," short-term investments are classified as available-for-sale. These securities are carried at fair value, with unrealized gains and losses reported as accumulated other comprehensive income. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines judged to be other than temporary, if any, are included in interest income. The cost of securities sold is based on the specific identification method. Interest and dividends on available-for-sale securities are included in interest income. Investments held as of December 31, 2001 consist primarily of Federal Agency obligations, U.S. corporate debt securities and mortgage-backed securities.

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Fair Value of Financial Instruments

        Cash and cash equivalents, accounts payable and accrued liabilities, are carried at cost, which management believes approximates fair value due to the short-term maturity of these instruments. Short-term investments are carried at fair value.

Concentration of Credit Risk and Major Customers

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

        Two collaborative partners individually accounted for 46.9% and 34.6% of total revenues during the year ended December 31, 2001 and 67.6% and 31.0% of total revenues during the year ended December 31, 2000. The same collaborative partners accounted for 97.1% of accounts receivable as of December 31, 2001 and for all accounts receivable as of December 31, 2000.

Property and Equipment

        Property and equipment are stated at cost and depreciated over the estimated useful lives of the assets (3 to 7 years) using the straight-line method. Buildings and building improvements are stated at cost and depreciated over the estimated useful life estimated to be approximately 20 years using the straight-line method. Amortization of leasehold improvements and assets under capital leases are stated at cost and amortized over the shorter of the estimated useful lives of the assets or the lease term.

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.

45



Stock-Based Compensation

        As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's stock option and purchase plans are accounted for under Accounting Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued to Employees." In March 2000, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation—An Interpretation of APB 25." The Company adopted this interpretation in 2000 and its adoption had no significant effect on the Company's consolidated financial statements. In addition, the Company has disclosed the pro forma effect of using the fair value based method to account for its stock-based compensation (Note 9).

        Stock compensation charges for options issued to non-employees have been determined in accordance with SFAS No. 123 and EITF 96-18 "Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services" as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. Stock compensation charges are periodically remeasured as the underlying options vest and are included in deferred compensation in the financial statements.

Revenues

        The Company's revenue recognition policies are in accordance with the Securities and Exchange Commission Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements." SAB 101 provides guidance related to revenue recognition based on the interpretations and practices developed by the Securities and Exchange Commission. Many of the Company's agreements contain multiple elements, including downstream milestone and royalty obligations.

        Revenue from milestones is recognized when earned, as evidenced by written acknowledgment from the collaborator, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, and (ii) the Company's performance obligations after the milestone achievement will continue to be funded by the collaborator at a comparable level to before the milestone achievement. If both of these criteria are not met, the milestone payment is recognized over the remaining minimum period of the Company's performance obligations under the agreement. 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 revenues as the services are performed.

Research and Development Costs

        All research and development expenses are expensed in the year incurred and consist primarily of personnel related expenses and laboratory expenses.

Patent Costs

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

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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 Loss

        In accordance with SFAS No. 130, "Reporting Comprehensive Loss," all components of comprehensive loss, including net loss, are reported in the financial statements in the period in which they are recognized. Comprehensive loss is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. The Company's other comprehensive loss consists of gains and losses on available-for-sale securities and is reported in the consolidated statement of stockholders' equity.

Net Loss Per Share

        Basic and diluted loss per common share are presented in conformity with SFAS No. 128, "Earnings per Share," for all periods presented.

        In accordance with SFAS No. 128, basic and diluted 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.

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

 
  Year Ended December 31,
 
 
  2001
  2000
  1999
 
Net loss applicable to common stockholders   $ (6,882,724 ) $ (28,753,038 ) $ (10,237,950 )
   
 
 
 
Basic and diluted net loss per share   $ (0.28 ) $ (2.84 ) $ (10.05 )
   
 
 
 
Weighted-average shares used in computing net loss per share, basic and diluted     24,989,067     10,139,755     1,018,359  
   
 
 
 

        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 all years presented. 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 291,499, 509,850 and 81,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Such securities, had they been dilutive, would have been included in the computation of diluted net loss per share.

Reclassifications

        Certain prior year amounts have been reclassified to conform with the current year presentation.

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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.

Acquisition

        On February 15, 2001, the Company completed its acquisition of Bunsen Rush Laboratories, Inc. ("Bunsen Rush") pursuant to an Agreement and Plan of Merger dated February 15, 2001. Bunsen Rush was a research-based company that provided 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 allocated as follows:

Existing technology   $ 15,378,000  
Assembled workforce     47,000  
Non-current assets     5,000  
Current liabilities     (430,000 )
   
 
Total   $ 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, 2001 or January 1, 2000, pro forma financial information would not have differed materially from actual results.

Effect of New Accounting Standards

        In July 2001, the Financial Accounting Standards Board issued FASB Statements Nos. 141 and 142, "Business Combinations" and "Goodwill and Other Intangible Assets" ("SFAS 141" and "SFAS 142," respectively). SFAS 141 replaces Accounting Principles Board Opinion No. 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for goodwill. SFAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. SFAS 141 and SFAS 142 are effective for all business combinations completed after June 20, 2001. Upon adoption of SFAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that

48



do not meet the criteria for recognition under SFAS 141 will be reclassified to goodwill. Companies are required to adopt SFAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted under certain circumstances. The adoption of these standards is not expected to have a material impact on the Company's results of operations and financial position.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which establishes one accounting model to be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30. While earlier application is encouraged, SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not believe the adoption of SFAS No. 144 will have a material impact on its financial statements.

(2) INVESTMENT IN CHEMNAVIGATOR

        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 was incorporated and in June 1999, the Company licensed to ChemNavigator 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 valued at approximately $2.6 million based on independent investors' participation in ChemNavigator'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 at zero. As of December 31, 2001 and 2000, the Company's equity ownership represented approximately 35% and 34%, respectively, of the outstanding voting equity securities of ChemNavigator. ChemNavigator has an accumulated deficit and since the Company is under no obligation to reimburse the other ChemNavigator stockholders for its share of ChemNavigator's losses, the Company has not included any of ChemNavigator's loss in the Company's Consolidated Statements of Operations.

        The Company subleases office space to ChemNavigator. The current sublease payment of $5,942 per month can be adjusted monthly based upon changes in the number of ChemNavigator employees.

        Jack Lief, the Company's President and Chief Executive Officer, is also the Chairman of the Board of ChemNavigator. Robert Hoffman, the Company's Vice President, Finance, is also the Chief Financial Officer of ChemNavigator.

(3) INVESTMENT IN ARESSA PHARMACEUTICALS, INC.

        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 an 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 December 31, 2001 Aressa has had limited activity and the amounts of its

49



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. Joyce Williams, the Company's Vice President, Drug Development is also the Vice President, Regulatory and Clinical Affairs of Aressa.

(4) AVAILABLE-FOR-SALE SECURITITES

        Available-for-sale securities at December 31, 2001 consist of the following:

 
  Amortized
Costs

  Gross Unrealized
Gains

  Gross Unrealized
Losses

  Estimated Fair
Value

Mortgage-backed securities   $ 11,394,981   $ 32,249   $ (3,750 ) $ 11,423,480
Corporate debt securities     19,870,831     19,346     (72,037 )   19,818,140
Federal agency notes     18,974,798     31,206         19,006,004
   
 
 
 
Total available-for-sale securities   $ 50,240,610   $ 82,801   $ (75,787 ) $ 50,247,624
   
 
 
 

        The Company also had short-term investments in commercial paper, with maturity dates of three months or less when purchased, as a component of cash and cash equivalents, of $8,245,660 and an associated unrealized loss of $224 at December 31, 2001. The gross realized gains and losses were not material for the period ended December 31, 2001. The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at December 31, 2001 are shown below:

 
  Amortized
Cost

  Estimated
Fair Value

Due in one year or less   $ 5,079,827   $ 5,089,977
Due after one year through four years     45,160,783     45,157,647
   
 
    $ 50,240,610   $ 50,247,624
   
 

(5) PROPERTY AND EQUIPMENT

        Property and equipment consists of the following:

 
  December 31,
 
 
  2001
  2000
 
Laboratory and computer equipment   $ 7,600,627   $ 3,659,632  
Furniture, fixtures and office equipment     428,048     267,841  
Land, building and capital improvements     13,976,420      
Leasehold improvements     4,268,882     1,714,622  
   
 
 
      26,273,977     5,642,095  
   
 
 
Less accumulated depreciation and amortization     (3,005,410 )   (1,376,835 )
   
 
 
Net property and equipment   $ 23,268,567   $ 4,265,260  
   
 
 

50


        Cost and accumulated amortization of equipment under capital leases totaled approximately $2.2 million and $1.2 million, and approximately $2.3 million and $810,000, at December 31, 2001 and 2000, respectively.

(6) CONVERTIBLE NOTES PAYABLE TO RELATED PARTIES

        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, 2000 and 1999 was approximately $41,000 and $72,000, respectively.

        In 1998, the Company issued a convertible note payable to Tripos, for a principal amount of up to $1,500,000 at an annual interest rate of 9.5%. The Company received proceeds of $1,125,000 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 was no beneficial conversion feature associated with the notes.

(7) COMMITMENTS

Leases

        In 1997, the Company leased its facility 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 facility during the first 12 months of the lease term for $2,141,309. 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 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 an additional facility located at 6150 Nancy Ridge Drive in San Diego, California under an operating lease which would have expired in 2013. In January 2001, the Company purchased this facility, along with the adjacent facility at 6138 Nancy Ridge Drive, for approximately $5.4 million in cash.

        Rent expense was $585,252, $728,369 and $598,903 for the years ended December 31, 2001, 2000 and 1999, respectively.

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        Annual future minimum lease obligations as of December 31, 2001 are as follows:

Year Ending December 31,

  Operating Leases
  Capital Leases
 
2002   $ 1,171,037   $ 573,830  
2003     1,186,973     382,442  
2004     772,716     43,646  
2005     645,605      
2006     645,988      
Thereafter     4,522,196      
   
 
 
  Total minimum lease payments   $ 8,944,515     999,918  
   
       
Less amount representing interest           (98,439 )
         
 
Present value of minimum lease obligations           901,479  
Less current portion           (499,387 )
         
 
Long-term portion of capital lease obligations         $ 402,092  
         
 

        Future minimum rentals to be received under non-cancelable leases and subleases which expire within the next 12 months as of December 31, 2001 totaled approximately $120,000.

(8) SIGNIFICANT 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 principally focuses on the central nervous system and also includes GPCRs of potential interest in the cardiovascular and oncology fields.

        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 GPCRs that will become subject to the 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 GPCRs for CART-activation, and the Company will then provide Eli Lilly with enabled high-throughput screens for use at either party's 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 substantial resources by Eli Lilly. The Company and Eli Lilly are jointly responsible for identifying drug leads and Eli Lilly will be responsible 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 achievements 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 development or commercialization milestones.

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        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 $8.5 million for the year ended December 31, 2001, consisting of research funding of approximately $4.9 million, milestone achievements of $3.5 million and $100,000 from the amortization of the upfront payment, 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 $75,000 from the amortization of the upfront payment.

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 therapeutic areas of interest to Taisho. Under the terms of the agreement, Taisho will receive exclusive, worldwide rights to the selected CART-activated GPCR targets and to any drug leads discovered using the CART-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

53



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 $6.2 million for the year ended December 31, 2001, consisting of approximately $4.8 million related to receptor activation selection, screening assay fees and research and development fees, $1.3 million related to research funding and $120,000 from the amortization of the upfront payment, 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 $80,000 from the amortization of the upfront payment.

Collaborative Agreement with Fujisawa

        In January 2000, the Company entered into a collaborative agreement with Fujisawa Pharmaceutical, Co., Ltd. ("Fujisawa"). Under 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 the Company's in-house chemical library. 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. However, there can be no assurance that the Company and Fujisawa will achieve 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. For the year ended December 31, 2001, the Company recognized $500,000 in milestone-based revenues under the Fujisawa collaboration. For the year ended December 31, 2000, no revenue was recorded by the Company from the Fujisawa collaboration.

Collaborative Agreement with ICI

        In June 2001, the Company entered into an agreement with ICI to apply the Company's CART technology to olfactory and gustatory GPCRs. The feasibility period research under the agreement lasted approximately six months and included us using CART technology to develop olfactory and/or gustatory GPCR assays for ICI and then screening using compounds supplied by ICI businesses. Under the one-year exclusivity period of the agreement which started when the feasibility period ended, ICI shall have the exclusive right to request the Company to select additional sensory GPCRs to apply its

54



CART technology and reimburse the Company for costs incurred in applying its technology. The Company may also receive royalties on related sales, if any. For the year ended December 31, 2001, the Company recognized revenues of $600,000 under the ICI agreement.

Collaborative Agreement with TaiGen

        The Company entered into an agreement with TaiGen Biotechnology Co., Ltd. ("TaiGen"), a start-up biopharmaceutical organization focused on the discovery and development of innovative therapeutics, which became effective in July 2001. In exchange for $3.3 million in equity in TaiGen's Series A preferred financing, TaiGen has the right to select and obtain several GPCRs from the Company. The Company will activate and develop a screening assay and transfer selected activated receptors to TaiGen. The Company may also receive royalty payments based on annual TaiGen licensing revenue. The Company will not initially receive any cash payments from TaiGen. The Company's ownership interest in TaiGen is accounted for using the equity method of accounting. For the year ended December 31, 2001, the Company recognized revenue of $1.4 million for the transfer of selected receptor screens to TaiGen. This revenue is considered related party revenue as the Company's President and CEO is a member of the board of directors of TaiGen. One of the Company's outside directors is also a member of the board of directors of TaiGen. In addition, based upon the Company's ownership interest in TaiGen of approximately 17%, as well as the Company's representation on TaiGen's board of directors, the Company recorded its share of TaiGen's losses, increasing the Company's net loss for the year ended December 31, 2001 by approximately $204,000 and reducing its investment in TaiGen to $3.1 million.

Collaborative Agreement with Eisai

        In August 2001, the Company entered into a Melanophore technology agreement with Eisai Co., Ltd. ("Eisai"), a Japan-based pharmaceutical company. The one-year agreement allows Eisai to use the Company's Melanophore technology for the identification of natural ligands to cell surface receptors. Eisai may extend the agreement for one additional year by payment of an extension fee. The Company may also receive consulting fees, research and development milestones and royalties on drug sales, if any. However, there can be no assurance that the Company and Eisai will achieve research and development or commercialization milestones under the agreement. For the year ended December 31, 2001, the Company recognized $414,000 in license revenues under the Eisai agreement.

Collaborative Agreements with Tripos

        The Company has entered into a drug research collaboration agreement and a software license agreement with Tripos, a related party, and the Company may enter into additional agreements with Tripos for the joint development of drug leads using CART-activated receptors and Tripos' chemical library. The Company and Tripos will jointly share expenses and any proceeds resulting from the collaboration. In addition, during 2001, the Company paid Tripos $1,405,000 for compounds purchased outside of the existing agreements with Tripos, and the use of such compounds by the Company will not involve additional payments to Tripos.

55


(9) 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 "Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," 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.

Incentive Stock Plan

        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, 2001, 1,500,000 shares of common stock were authorized for issuance under the 1998 Plan.

        The Amended and Restated 2000 Equity Compensation Plan (the "2000 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, 2001, 2,000,000 shares of common stock were authorized for issuance under the 2000 Plan.

        Unvested shares issued to the Company's 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, 2001, 291,499 shares of common stock, issued pursuant to the exercise of options, were subject to repurchase by the Company. In

56



accordance with SFAS No. 128, the Company has excluded unvested common stock arising from exercised options in its basic loss per share calculations.

        The following tables summarize the Company's stock option activity and related information for the years ended December 31:

 
  2001
  2000
  1999
 
  Options
  Weighted-
Average
Exercise
Price

  Options
  Weighted-
Average
Exercise
Price

  Options
  Weighted-
Average
Exercise
Price

Outstanding at January 1,   1,064,475   $ 12.44   684,600   $ 0.40   407,500   $ 0.20
Granted   895,700     18.89   1,215,175     11.07   373,100     0.60
Exercised   (129,850 )   0.59   (809,425 )   0.46   (90,375 )   0.33
Cancelled   (100,125 )   19.82   (25,875 )   1.66   (5,625 )   0.47
   
 
 
 
 
 
Outstanding at December 31,   1,730,200   $ 16.21   1,064,475   $ 12.44   684,600   $ 0.40
   
 
 
 
 
 

        The following table summarizes information concerning outstanding and exercisable options as of December 31, 2001:

 
  Options Outstanding
  Options Exercisable
Range of
Exercise Price

  Number
Outstanding at
December 31,
2001

  Weighted-
Average
Remaining
Contractual Life

  Weighted-
Average
Exercise Price

  Number
Exercisable at
December 31,
2001

  Weighted-
Average
Exercise Price

$ 0.20 - $2.00   403,000   7.8 Years   $ 0.68   102,825   $ 0.56
$ 9.05 - $16.00   381,500   9.4 Years     13.06   0     0.00
$ 18.12 - $24.23   580,950   8.8 Years     22.65   117,750     23.73
$ 25.58 - $31.34   364,750   9.5 Years     26.41   14,000     30.99
     
 
 
 
 
$ 0.20 - $31.34   1,730,200   8.9 Years   $ 16.21   234,575   $ 14.00
     
 
 
 
 

        At December 31, 2001, 2000 and 1999, 291,499, 509,850 and 63,500 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 $.58, $.51 and $.23, respectively. At December 31, 2001 and 2000, 704,525 and 1,492,233 shares, respectively, were available for future grant. The 1,730,200 options not exercised at December 31, 2001 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-

57



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-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 options granted from January 1, 2001 to December 31, 2001 the fair value of the options was estimated at the date of grant using the Black-Scholes method for option pricing with the following weighted-average assumptions: risk-free interest rate of 2.8%, dividend yield of 0%, expected volatility of 113% 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:

 
  Year Ended December 31,
 
 
  2001
  2000
  1999
 
Adjusted pro forma net loss   $ (11,807,000 ) $ (29,890,000 ) $ (10,250,000 )
Adjusted pro forma basic net loss per share   $ (0.47 ) $ (2.95 ) $ (10.07 )

        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.

        In connection with the grant of stock options to employees, the Company recorded deferred stock compensation totaling $226,000 and $11.6 million during the years ended December 31, 2001 and 2000, respectively. 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 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 amortized to expense over the vesting period of the options in accordance with FASB Interpretation No. 28, which permits an accelerated amortization methodology. The Company recorded amortization of deferred compensation expense of approximately $4.2 million during the year ended December 31, 2001 and $4.3 million during the year ended December 31, 2000. As of December 31, 2001, the Company anticipates that total charges to be recognized in future periods from amortization of deferred stock compensation will be $2.5 million for the year ending December 31, 2002, $1.0 million for the year ending December 31, 2003 and $112,000 for the year ending December 31, 2004.

Employee Stock Purchase Plan

        The 2001 Arena Employee Stock Purchase Plan (the "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 Purchase Plan is 1,000,000. Under the Purchase Plan, employees can choose to have up to fifteen percent of their annual compensation withheld to purchase shares of common stock. The purchase price of the common stock is at 85 percent of the lower of the fair market value of the common stock at the enrollment or purchase date. As of December 31, 2001, 23,635 shares have been issued pursuant to the Purchase Plan.

58



Common Shares Reserved For Future Issuance

        The following shares of Common Stock are reserved for future issuance at December 31, 2001:

Stock option plans   2,434,725
Employee stock purchase plan   976,365
   
Total   3,411,090
   

(10) 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) 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. During 2001, the Company's 401(k) Plan became a multiemployer Plan with its affiliate, ChemNavigator, Inc., in order to provide to its employees a better 401(k) plan with less fees and expenses. The change to the multiemployer plan had no effect on the Company's rate of contribution and the Company believes that there are not any future circumstances that would increase its obligations as a result of such change. The Company's matching portion, which totaled $496,859, $281,595, and $148,784 for the years ended December 31, 2001, 2000 and 1999, respectively, vests over a five-year period.

(11) INCOME TAXES

        Significant components of the Company's deferred tax assets at December 31, 2001 and 2000 are shown below. A valuation allowance of $13.1 million and $7.5 million has been recognized to offset the

59



deferred tax assets as of December 31, 2001 and 2000, respectively, as realization of such assets is uncertain.

 
  December 31,
 
 
  2001
  2000
 
Deferred tax assets:              
  Net operating loss carryforwards   $ 5,440,000   $ 4,991,000  
  Research and development credits     3,176,000     2,089,000  
  Other, net     4,869,000     597,000  
   
 
 
Net deferred tax assets     13,485,000     7,677,000  
Valuation allowance for deferred tax assets     (13,131,000 )   (7,509,000 )
   
 
 
    Total deferred tax assets     354,000     168,000  

Deferred tax liabilities:

 

 

 

 

 

 

 
  Depreciation     (354,000 )   (168,000 )
   
 
 
    Net deferred tax assets   $   $  
   
 
 

        At December 31, 2001, the Company had federal and California tax net operating loss carryforwards of approximately $13.3 million and $13.4 million, respectively. 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 $2.2 million and $1.6 million 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.

(12) QUARTERLY FINANCIAL DATA (UNAUDITED)

2001 for quarter ended

  Dec. 31
  Sept. 30
  June 30
  March 31
  Year
 
Revenues   $ 5,865,071   $ 3,472,338   $ 3,330,255   $ 5,392,335   $ 18,059,999  
Amortization of non-cash deferred compensation     826,690     1,071,653     1,072,731     1,268,666     4,239,740  
Net income (loss)     (2,802,484 )   (2,019,554 )   (3,145,680 )   1,084,994     (6,882,724 )
Basic and diluted earnings (loss) per share   $ (0.10 ) $ (0.07 ) $ (0.14 ) $ 0.05   $ (0.28 )
                                 
2000 for quarter ended

  Dec. 31
  Sept. 30
  June 30
  March 31
  Year
 
Revenues   $ 4,079,999   $ 2,314,126   $ 1,289,271   $   $ 7,683,396  
Amortization of non-cash deferred compensation     1,390,494     1,123,358     1,419,565     409,479     4,342,896  
Net income (loss)     1,064,906     (1,418,594 )   (2,886,082 )   (3,122,200 )   (6,361,970 )
Non-cash preferred stock charge             (8,203,505 )   (14,187,563 )   (22,391,068 )

60


Net income (loss) applicable to common stockholders     1,064,906     (1,418,594 )   (11,089,587 )   (17,309,763 )   (28,753,038 )
Basic and diluted earnings (loss) per share   $ 0.05   $ (0.09 ) $ (8.47 ) $ (15.92 ) $ (2.84 )

61


Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure

        None.

PART III

Item 10. Directors And Executive Officers Of The Registrant.

        The information required by this item is incorporated herein by reference from the information under the caption "Election of Directors" and the caption "Compensation And Other Information Concerning Officers, Directors And Certain Stockholders" and the caption "Section 16(a) Beneficial Ownership Reporting Compliance" contained in the Proxy Statement.

Item 11. Executive Compensation.

        The information required by this item is incorporated herein by reference from the information under the caption "Compensation And Other Information Concerning Officers, Directors And Certain Stockholders" under the caption "Compensation Committee Interlocks and Insider Participation" contained in the Proxy Statement.

Item 12. Security Ownership Of Certain Beneficial Owners And Management.

        The information required by this item is incorporated herein by reference from the information under the caption "Security Ownership Of Certain Beneficial Owners And Management" contained in the Proxy Statement.

Item 13. Certain Relationships And Related Transactions.

        The information required by this item is incorporated herein by reference from the information under the caption "Compensation And Other Information Concerning Officers, Directors And Certain Stockholders" specifically under the subheading "Certain Relationships and Related Transactions" contained in the Proxy Statement.

PART IV

Item 14. Exhibits, Financial Statement Schedules, And Reports On Form 8-K.

(a) 1. Financial Statements.

        Reference is made to the Index to Financial Statements under Item 8, Part II hereof.

2.
Financial Statement Schedules.

        The Financial Statement Schedules have been omitted either because they are not required or because the information has been included in the notes to the Financial Statements included in this Report on Form 10-K.

61


3.
EXHIBITS:

EXHIBIT NO.

  DESCRIPTION

3.1   Amended and restated certificate of incorporation of Arena Pharmaceuticals, Inc., (filed as Exhibit 3.1 to Arena's registration statement on Form S-1, as amended, as filed on July 25, 2000, and incorporated by reference herein)
3.2   Amended and restated bylaws of Arena
4.2   Form of common stock certificates (filed as Exhibit 4.2 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000, and incorporated by reference herein)
10.1   1998 Equity Compensation Plan (filed as Exhibit 10.1 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.2   Amended and Restated 2000 Equity Compensation Plan
10.3   Services Agreement, dated May 26, 1999, by and between ChemNavigator.com, Inc., and Jack Lief (filed as Exhibit 10.3 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.4   Services Agreement, dated May 26, 1999, by and between ChemNavigator.com, Inc., and Richard P. Burgoon, Jr. (filed as Exhibit 10.4 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.5   Services Agreement, dated May 26, 1999, by and between ChemNavigator.com, Inc., and Robert Hoffman (filed as Exhibit 10.5 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.6   Lease, dated March 1998, by and between ARE 1666 Nancy Ridge, LLC and Arena, as amended by First Amendment to Lease dated as of June 30, 1998 (filed as Exhibit 10.6 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.7+   Agreement, effective May 29, 2000, by and between Arena and Taisho Pharmaceutical Co., Ltd. (filed as Exhibit 10.7 to Arena's report on Form 10-K for the year ended December 31, 2000, and incorporated by reference herein)
10.8+   First Amendment effective January 24, 2001 by and between Arena and Taisho Pharmaceuticals, Co., Ltd. (filed as Exhibit 10.8 to Arena's report on Form 10-K for the year ended December 31, 2000, and incorporated by reference herein)
10.9+   License Agreement, effective as of January 23, 1998 by and between Arena and SSP Co., Ltd., as amended by Addendum No. 1, dated April 5, 1999 (filed as Exhibit 10.8 to Arena's registration statement on Form S-1 filed on April 28, 2000, and incorporated by reference herein)
10.10+   Research Collaboration and License Agreement, effective as of April 14, 2000, by and between Arena and Eli Lilly and Company (filed as Exhibit 10.9 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000, and incorporated by reference herein)
10.11+   Agreement, dated and effective as of January 24, 2000, by and between Arena and Fujisawa Pharmaceutical Co., Ltd. (filed as Exhibit 10.10 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000 and incorporated by reference herein)

62


10.12   Binding Letter of Intent & Memorandum of Agreement, dated as of April 3, 2000, between Arena and Lexicon Genetics, Inc., (filed as Exhibit 10.11 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.13   Agreement, effective as of September 15, 1999, by and between Arena and Neurocrine Biosciences, Inc. (filed as Exhibit 10.12 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000, and incorporated by reference herein)
10.14   Purchase and Sale Agreement effective December 1, 2000, by and between Arena and Limar Realty Corp. #13 (filed as Exhibit 10.14 to Arena's report on Form 10-K for the year ended December 31, 2000, and incorporated by reference herein)
10.15   Agreement and Plan of Merger, dated February 15, 2001, by and among Arena, BRL Screening, Inc., Bunsen Rush Laboratories, Inc., and Ethan A. Lerner, Michael R. Lerner, Peter M. Lerner, David Unett, and Alison Roby-Shemkovitz (filed as Exhibit 10 to Arena's report on Form 8-K, as filed on February 20, 2001, and incorporated by reference herein)
10.16   Binding letter of Intent & Memorandum of Agreement dated as of April 15, 2001, regarding purchase of preferred stock of Axiom Biotechnologies Inc. by Arena (filed as Exhibit 10.16 to Arena's report on Form 8-K as filed on April 30, 2001, and incorporated by reference herein)
10.17+   Agreement effective as of March 21, 2001 by and between Arena and Taisho Pharmaceutical, Co., Ltd. (filed as Exhibit 10.17 to Arena's report on Form 10-Q for the quarter ended March 31, 2001, and incorporated by reference herein)
10.18   2001 Arena Employee Stock Purchase Plan (incorporated by reference to Exhibit B of Arena's Proxy Statement regarding Arena's May 8, 2001, Annual Stockholders Meeting, filed on March 29, 2001, and incorporated by reference herein)
10.19+   Agreement, executed June 29, 2001 by and between Arena Pharmaceuticals, Inc., and TaiGen Biotechnology Co., Ltd. (filed as Exhibit 10.19 to Arena's report on Form 10-Q for the quarter ended June 30, 2001, and incorporated by reference herein)
10.20+   Agreement, effective June 15, 2001 by and between Imperial Chemical Industries PLC and Arena Pharmaceuticals, Inc. (filed as Exhibit 10.20 to Arena's report on Form 10-Q for the quarter ended June 30, 2001 and incorporated by reference herein)
10.21   Separation Agreement and Release by and between Arena Pharmaceuticals, Inc., and Richard P. Burgoon, Jr. dated September 11, 2001 (filed as Exhibit 10.21 to Arena's report on Form 10-Q for the quarter ended September 30, 2001 and incorporated by reference herein)
10.22   Letter Agreement dated September 13, 2001, by and between Arena Pharmaceuticals, Inc., and Steven W. Spector (filed as Exhibit 10.22 to Arena's report on Form 10-Q for the quarter ended September 30, 2001, and incorporated by reference herein)
21.1   Subsidiaries of the registrant
23.1   Consent of Ernst & Young LLP, independent auditors
24.1   Power of attorney

+
Confidential treatment has been granted for portions of this document.

63


(b) Reports on Form 8-K

On March 11, 2002, the Company filed a current report on Form 8-K under Item 5 announcing that it believes that the Company has identified a G protein-coupled receptor that may be responsible for certain activity of niacin.

(c) Exhibits

See Item 14(a)(3) above.

(d) Financial Statement Schedules

See Item 14(a)(2) above.

64



SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 15, 2002.

Arena Pharmaceuticals, Inc.
A Delaware Corporation

By:

 

/s/  
JACK LIEF       
Jack Lief
Chief Executive Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 15, 2002.

Signatures

  Title

   

 

 

 

 

 

 

 
By:   /s/   JACK LIEF       
Jack Lief
  President, Chief Executive Officer and Director    

By:

 

/s/  
ROBERT HOFFMAN       
Robert Hoffman

 

Vice President, Finance, and Principal Accounting Officer

 

 

By:

 

/s/  
DOMINIC P. BEHAN, PH.D.       
Dominic P. Behan, Ph.D.

 

Director

 

 

By:

 

/s/  
DEREK T. CHALMERS, PH.D.       
Derek T. Chalmers, Ph.D.

 

Director

 

 

By:

 

/s/  
JOHN P. MCALISTER, III, PH.D.       
John P. McAlister, III, Ph.D.

 

Director

 

 

By:

 

/s/  
MICHAEL STEINMETZ, PH.D.       
Michael Steinmetz, Ph.D.

 

Director

 

 

By:

 

/s/  
STEFAN RYSER, PH.D.       
Stefan Ryser, Ph.D.

 

Director

 

 

65


EXHIBIT INDEX

EXHIBIT NO.

  DESCRIPTION

3.1   Amended and restated certificate of incorporation of Arena Pharmaceuticals, Inc., (filed as Exhibit 3.1 to Arena's registration statement on Form S-1, as amended, as filed on July 25, 2000, and incorporated by reference herein)
3.2   Amended and restated bylaws of Arena
4.2   Form of common stock certificates (filed as Exhibit 4.2 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000, and incorporated by reference herein)
10.1   1998 Equity Compensation Plan (filed as Exhibit 10.1 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.2   Amended and Restated 2000 Equity Compensation Plan
10.3   Services Agreement, dated May 26, 1999, by and between ChemNavigator.com, Inc., and Jack Lief (filed as Exhibit 10.3 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.4   Services Agreement, dated May 26, 1999, by and between ChemNavigator.com, Inc., and Richard P. Burgoon, Jr. (filed as Exhibit 10.4 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.5   Services Agreement, dated May 26, 1999, by and between ChemNavigator.com, Inc., and Robert Hoffman (filed as Exhibit 10.5 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.6   Lease, dated March 1998, by and between ARE 1666 Nancy Ridge, LLC and Arena, as amended by First Amendment to Lease dated as of June 30, 1998 (filed as Exhibit 10.6 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.7+   Agreement, effective May 29, 2000, by and between Arena and Taisho Pharmaceutical Co., Ltd. (filed as Exhibit 10.7 to Arena's report on Form 10-K for the year ended December 31, 2000, and incorporated by reference herein)
10.8+   First Amendment effective January 24, 2001 by and between Arena and Taisho Pharmaceuticals, Co., Ltd. (filed as Exhibit 10.8 to Arena's report on Form 10-K for the year ended December 31, 2000, and incorporated by reference herein)
10.9+   License Agreement, effective as of January 23, 1998 by and between Arena and SSP Co., Ltd., as amended by Addendum No. 1, dated April 5, 1999 (filed as Exhibit 10.8 to Arena's registration statement on Form S-1 filed on April 28, 2000, and incorporated by reference herein)
10.10+   Research Collaboration and License Agreement, effective as of April 14, 2000, by and between Arena and Eli Lilly and Company (filed as Exhibit 10.9 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000, and incorporated by reference herein)
10.11+   Agreement, dated and effective as of January 24, 2000, by and between Arena and Fujisawa Pharmaceutical Co., Ltd. (filed as Exhibit 10.10 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000 and incorporated by reference herein)

66


10.12   Binding Letter of Intent & Memorandum of Agreement, dated as of April 3, 2000, between Arena and Lexicon Genetics, Inc., (filed as Exhibit 10.11 to Arena's registration statement on Form S-1, as amended, as filed on June 22, 2000, and incorporated by reference herein)
10.13   Agreement, effective as of September 15, 1999, by and between Arena and Neurocrine Biosciences, Inc. (filed as Exhibit 10.12 to Arena's registration statement on Form S-1, as amended, as filed on July 19, 2000, and incorporated by reference herein)
10.14   Purchase and Sale Agreement effective December 1, 2000, by and between Arena and Limar Realty Corp. #13 (filed as Exhibit 10.14 to Arena's report on Form 10-K for the year ended December 31, 2000, and incorporated by reference herein)
10.15   Agreement and Plan of Merger, dated February 15, 2001, by and among Arena, BRL Screening, Inc., Bunsen Rush Laboratories, Inc., and Ethan A. Lerner, Michael R. Lerner, Peter M. Lerner, David Unett, and Alison Roby-Shemkovitz (filed as Exhibit 10 to Arena's report on Form 8-K, as filed on February 20, 2001, and incorporated by reference herein)
10.16   Binding letter of Intent & Memorandum of Agreement dated as of April 15, 2001, regarding purchase of preferred stock of Axiom Biotechnologies Inc. by Arena (filed as Exhibit 10.16 to Arena's report on Form 8-K as filed on April 30, 2001, and incorporated by reference herein)
10.17+   Agreement effective as of March 21, 2001 by and between Arena and Taisho Pharmaceutical, Co., Ltd. (filed as Exhibit 10.17 to Arena's report on Form 10-Q for the quarter ended March 31, 2001, and incorporated by reference herein)
10.18   2001 Arena Employee Stock Purchase Plan (incorporated by reference to Exhibit B of Arena's Proxy Statement regarding Arena's May 8, 2001, Annual Stockholders Meeting, filed on March 29, 2001, and incorporated by reference herein)
10.19+   Agreement, executed June 29, 2001 by and between Arena Pharmaceuticals, Inc., and TaiGen Biotechnology Co., Ltd. (filed as Exhibit 10.19 to Arena's report on Form 10-Q for the quarter ended June 30, 2001, and incorporated by reference herein)
10.20+   Agreement, effective June 15, 2001 by and between Imperial Chemical Industries PLC and Arena Pharmaceuticals, Inc. (filed as Exhibit 10.20 to Arena's report on Form 10-Q for the quarter ended June 30, 2001 and incorporated by reference herein)
10.21   Separation Agreement and Release by and between Arena Pharmaceuticals, Inc., and Richard P. Burgoon, Jr. dated September 11, 2001 (filed as Exhibit 10.21 to Arena's report on Form 10-Q for the quarter ended September 30, 2001 and incorporated by reference herein)
10.22   Letter Agreement dated September 13, 2001, by and between Arena Pharmaceuticals, Inc., and Steven W. Spector (filed as Exhibit 10.22 to Arena's report on Form 10-Q for the quarter ended September 30, 2001, and incorporated by reference herein)
21.1   Subsidiaries of the registrant
23.1   Consent of Ernst & Young LLP, independent auditors
24.1   Power of attorney

+
Confidential treatment has been granted for portions of this document.

67




QuickLinks

DOCUMENTS INCORPORATED BY REFERENCE
INFORMATION RELATING TO FORWARD-LOOKING STATEMENTS
ARENA PHARMACEUTICALS, INC. INDEX TO FINANCIAL STATEMENTS
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
ARENA PHARMACEUTICALS, INC. Consolidated Balance Sheets
ARENA PHARMACEUTICALS, INC. Consolidated Statements of Operations
ARENA PHARMACEUTICALS, INC. Consolidated Statements of Stockholders' Equity (Deficit)
ARENA PHARMACEUTICALS, INC. Consolidated Statements of Cash Flows
ARENA PHARMACEUTICALS, INC. Notes to Consolidated Financial Statements
SIGNATURES

Exhibit 3.2

AMENDED AND RESTATED BY-LAWS
OF
ARENA PHARMACEUTICALS, INC.

ARTICLE I
Stockholders

SECTION 1. Annual Meeting. The annual meeting of the stockholders of the Corporation shall be held on such date, at such time and at such place within or without the State of Delaware as may be designated by the Board of Directors, for the purpose of electing Directors and for the transaction of such other business as may be properly brought before the meeting. The Board of Directors may determine that an annual meeting shall not be held at any place, but shall instead be held solely by means of remote communication.

SECTION 2. Special Meetings. Except as otherwise provided in the Certificate of Incorporation, a special meeting of the stockholders of the Corporation may be called at any time by the Board of Directors or the President. Any special meeting of the stockholders shall be held on such date, at such time and at such place within or without the State of Delaware as the Board of Directors or the officer calling the meeting may designate. The Board of Directors may determine that any special meeting of stockholders shall not be held at any place, but shall instead be held solely by means of remote communication. At a special meeting of the stockholders, no business shall be transacted and no corporate action shall be taken other than that stated in the notice of the meeting unless all of the stockholders are present in person or by proxy, in which case any and all business may be transacted at the meeting even though the meeting is held without notice.

SECTION 3. Notice of Meetings. Except as otherwise provided in these By-Laws or by law, a written notice of each meeting of the stockholders shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder of the Corporation entitled to vote at such meeting at his or her address as it appears on the records of the Corporation or by a form of electronic transmission to which the stockholder has consented. The notice shall state the place, date and hour of the meeting, the means of remote communication, if any, by which stockholders and proxy holders may be deemed to be present in person and may vote at such meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called.

SECTION 4. Quorum. At any meeting of the stockholders, the holders of a majority in number of the total outstanding shares of stock of the Corporation entitled to vote at such meeting, present in person or represented by proxy, shall constitute a quorum of the stockholders for all purposes, unless the representation of a larger number of shares shall be required by law, by the Certificate of Incorporation or by these By-Laws, in which case the representation of the number of shares so required shall constitute a quorum; provided that at any meeting of the stockholders at which the holders of any class of stock of the Corporation shall be entitled to vote separately as a class, the holders of a

1

majority in number of the total outstanding shares of such class, present in person or represented by proxy, shall constitute a quorum for purposes of such class vote unless the representation of a larger number of shares of such class shall be required by law, by the Certificate of Incorporation or by these By-Laws.

SECTION 5. Adjourned Meetings. Whether or not a quorum shall be present in person or represented at any meeting of the stockholders, the holders of a majority in number of the shares of stock of the Corporation present in person or represented by proxy and entitled to vote at such meeting may adjourn from time to time; provided, however, that if the holders of any class of stock of the Corporation are entitled to vote separately as a class upon any matter at such meeting, any adjournment of the meeting in respect of action by such class upon such matter shall be determined by the holders of a majority of the shares of such class present in person or represented by proxy and entitled to vote at such meeting. When a meeting is adjourned to another time or place, notice need not be given of the adjourned meeting if the time and the place, if any, thereof, or the means of remote communication, if any, by which stockholders and proxy holders may be deemed to be present in person and may vote at such adjourned meeting, are announced at the meeting at which the adjournment is taken. At the adjourned meeting the stockholders or the holder of any class of stock entitled to vote separately as a class, as the case may be, may transact any business which might have been transacted by them at the original meeting. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the adjourned meeting.

SECTION 6. Organization. The Chairman of the Board, or in the absence of the Chairman of the Board, the President, or in the absence of the Chairman of the Board and the President, a Vice President shall call all meetings of the stockholders to order, and shall act as Chairman of such meetings. In the absence of the Chairman of the Board, the President and all of the Vice Presidents, the holders of a majority in number of the shares of stock of the Corporation present in person or represented by proxy and entitled to vote at such meeting shall elect a Chairman.

The Secretary of the Corporation shall act as Secretary of all meetings of the stockholders; but in the absence of the Secretary, the Chairman may appoint any person to act as Secretary of the meeting. It shall be the duty of the Secretary to prepare and make, at least ten days before every meeting of stockholders, a complete list of stockholders entitled to vote at such meeting, arranged in alphabetical order and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting or, if not so specified, at the place where the meeting is to be held, for the ten days next preceding the meeting, to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, and shall be produced and kept at the time and place of the meeting during the whole time thereof and subject to the inspection of any stockholder who may be present.

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SECTION 7. Voting. Except as otherwise provided in the Certificate of Incorporation or by law, each stockholder shall be entitled to one vote for each share of the capital stock of the Corporation registered in the name of such stockholder upon the books of the Corporation. Each stockholder entitled to vote at a meeting of stockholders or to express consent or dissent to corporate action in writing without a meeting may authorize another person or persons to act for him or her by proxy, but no such proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. When directed by the presiding officer or upon the demand of any stockholder, the vote upon any matter before a meeting of stockholders shall be by ballot. Except as otherwise provided by law or by the Certificate of Incorporation, Directors shall be elected by a plurality of the votes cast at a meeting of stockholders by the stockholders entitled to vote in the election and, whenever any corporate action, other than the election of Directors is to be taken, it shall be authorized by a majority of the votes cast at a meeting of stockholders by the stockholders entitled to vote thereon.

Shares of the capital stock of the Corporation belonging to the Corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held, directly or indirectly, by the Corporation, shall neither be entitled to vote nor be counted for quorum purposes.

SECTION 8. Inspectors. When required by law or directed by the presiding officer or upon the demand of any stockholder entitled to vote, but not otherwise, the polls shall be opened and closed, the proxies and ballots shall be received and taken in charge, and all questions touching the qualification of voters, the validity of proxies and the acceptance or rejection of votes shall be decided at any meeting of the stockholders by two or more Inspectors who may be appointed by the Board of Directors before the meeting, or if not so appointed, shall be appointed by the presiding officer at the meeting. If any person so appointed fails to appear or act, the vacancy may be filled by appointment in like manner.

SECTION 9. Consent of Stockholders in Lieu of Meeting. Unless otherwise provided in the Certificate of Incorporation, any action required to be taken or which may be taken at any annual or special meeting of the stockholders of the Corporation, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of any such corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing.

ARTICLE II

Board of Directors

SECTION 1. Number and Term of Office. The business and affairs of the Corporation shall be managed by or under the direction of a Board of Directors, none of whom need be stockholders of the Corporation. The number of Directors constituting the Board

3

of Directors shall be fixed from time to time by resolution passed by a majority of the Board of Directors. The Directors shall, except as hereinafter otherwise provided for filling vacancies, be elected at the annual meeting of stockholders, and shall hold office until their respective successors are elected and qualified or until their earlier resignation or removal.

SECTION 2. Removal, Vacancies and Additional Directors. The stockholders may, at any special meeting the notice of which shall state that it is called for that purpose, remove, with or without cause, any Director and fill the vacancy; provided that whenever any Director shall have been elected by the holders of any class of stock of the Corporation voting separately as a class under the provisions of the Certificate of Incorporation, such Director may be removed and the vacancy filled only by the holders of that class of stock voting separately as a class. Vacancies caused by any such removal and not filled by the stockholders at the meeting at which such removal shall have been made, or any vacancy caused by the death or resignation of any Director or for any other reason, and any newly created directorship resulting from any increase in the authorized number of Directors, may be filled by the affirmative vote of a majority of the Directors then in office, although less than a quorum, and any Director so elected to fill any such vacancy or newly created directorship shall hold office until his or her successor is elected and qualified or until his or her earlier resignation or removal.

When one or more Directors shall resign effective at a future date, a majority of the Directors then in office, including those who have so resigned, shall have power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall become effective, and each Director so chosen shall hold office as herein provided in connection with the filling of other vacancies.

SECTION 3. Place of Meeting. The Board of Directors may hold its meetings in such place or places in the State of Delaware or outside the State of Delaware as the Board from time to time shall determine.

SECTION 4. Regular Meetings. Regular meetings of the Board of Directors shall be held at such times and places as the Board from time to time by resolution shall determine. No notice shall be required for any regular meeting of the Board of Directors; but a copy of every resolution fixing or changing the time or place of regular meetings shall be sent by mail or by telecopy, telegram, cablegram or other electronic transmission to every Director at least five days before the first meeting held in pursuance thereof.

SECTION 5. Special Meetings. Special meetings of the Board of Directors shall be held whenever called by direction of the President or by any two of the Directors then in office. Notice of the day, hour and place of holding of each special meeting shall be given by mailing the same at least two days before the meeting or by causing the same to be transmitted by telephone, telecopy, telegram, cablegram or other electronic transmission at least one day before the meeting to each Director. Unless otherwise indicated in the notice thereof, any and all business other than an amendment of these By-Laws may be transacted at any special meeting, and an amendment of these By-Laws may be acted upon if the notice of the meeting shall have stated that the amendment of these By-Laws

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is one of the purposes of the meeting. At any meeting at which every Director shall be present, even though without any notice, any business may be transacted, including the amendment of these By-Laws.

SECTION 6. Quorum. Subject to the provisions of Section 2 of this Article II, a majority of the members of the Board of Directors in office (but in no case less than one-third of the total number of Directors nor less than two Directors) shall constitute a quorum for the transaction of business and the vote of the majority of the Directors present at any meeting of the Board of Directors at which a quorum is present shall be the act of the Board of Directors. If at any meeting of the Board there is less than a quorum present, a majority of those present may adjourn the meeting from time to time.

SECTION 7. Organization. The President shall preside at all meetings of the Board of Directors. In the absence of the President, a Chairman shall be elected from the Directors present. The Secretary of the Corporation shall act as Secretary of all meetings of the Directors; but in the absence of the Secretary, the Chairman may appoint any person to act as Secretary of the meeting.

SECTION 8. Committees. The Board of Directors may designate one or more committees, each committee to consist of one or more of the Directors of the Corporation. The Board may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not such member or members constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and the affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to approving or adopting, or recommending to the stockholders, any action or matter expressly required by law to be submitted to stockholders for approval, or adopting, amending or repealing these By-laws.

SECTION 9. Conference Telephone Meetings. Unless otherwise restricted by the Certificate of Incorporation or by these By-Laws, the members of the Board of Directors or any committee designated by the Board, may participate in a meeting of the Board or such committee, as the case may be, by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and such participation shall constitute presence in person at such meeting.

SECTION 10. Consent of Directors or Committee in Lieu of Meeting. Unless otherwise restricted by the Certificate of Incorporation or by these By-Laws, any action required or permitted to be taken at any meeting of the Board Directors, or of any committee thereof, may be taken without a meeting if all members of the Board or committee, as the case may be, consent thereto in writing or by electronic transmission and the writing

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or writings or electronic transmission or transmissions are filed with the minutes of proceedings of the Board or committee, as the case may be.

ARTICLE III

Officers

SECTION 1. Officers. The officers of the Corporation shall be a President, one or more Vice Presidents, a Secretary and Chief Financial Officer or Treasurer, and such additional officers, if any, as shall be elected by the Board of Directors pursuant to the provisions of Section 6 of this Article III. The President, one or more Vice Presidents, the Secretary and the Chief Financial Officer or Treasurer shall be elected by the Board of Directors at its first meeting after each annual meeting of the stockholders. The failure to hold such election shall not of itself terminate the term of office of any officer. All officers shall hold office at the pleasure of the Board of Directors. Any officer may resign at any time upon written notice to the Corporation. Officers may, but need not, be Directors. Any number of offices may be held by the same person.

All officers, agents and employees shall be subject to removal, with or without cause, at any time by the Board of Directors. The removal of an officer without cause shall be without prejudice to his or her contract rights, if any.

The election or appointment of an officer shall not of itself create contract rights. All agents and employees other than officers elected by the Board of Directors shall also be subject to removal, with or without cause, at any time by the officers appointing them.

Any vacancy caused by the death, resignation or removal of any officer, or otherwise, may be filled by the Board of Directors, and any officer so elected shall hold office at the pleasure of the Board of Directors.

In addition to the powers and duties of the officers of the Corporation as set forth in these By-Laws, the officers shall have such authority and shall perform such duties as from time to time may be determined by the Board of Directors.

SECTION 2. Powers and Duties of the President. The President shall be the chief executive officer of the Corporation and, subject to the control of the Board of Directors, shall have general charge and control of all its business and affairs and shall have all powers and shall perform all duties incident to the office of President. The President shall preside at all meetings of the stockholders and at all meetings of the Board of Directors and shall have such other powers and perform such other duties as may from time to time be assigned by these By-Laws or by the Board of Directors.

SECTION 3. Powers and Duties of the Vice Presidents. Each Vice President shall have all powers and shall perform all duties incident to the office of Vice President and shall have such other powers and perform such other duties as may from time to time be assigned by these By-Laws or by the Board of Directors or the President.

6

SECTION 4. Powers and Duties of the Secretary. The Secretary shall keep the minutes of all meetings of the Board of Directors and the minutes of all meetings of the stockholders in books provided for that purpose. The Secretary shall attend to the giving or serving of all notices of the Corporation; shall have custody of the corporate seal of the Corporation and shall affix the same to such documents and other papers as the Board of Directors or the President shall authorize and direct; shall have charge of the stock certificate books, transfer books and stock ledgers and such other books and papers as the Board of Directors or the President shall direct, all of which shall at all reasonable times be open to the examination of any Director, upon application, at the office of the Corporation during business hours. The Secretary shall have all powers and shall perform all duties incident to the office of Secretary and shall also have such other powers and shall perform such other duties as may from time to time be assigned by these By-Laws or by the Board of Directors or the President.

SECTION 5. Powers and Duties of the Chief Financial Officer or Treasurer. The Chief Financial Officer or Treasurer shall have custody of, and when proper shall pay out, disburse or otherwise dispose of, all funds and securities of the Corporation. The Chief Financial Officer or Treasurer may endorse on behalf of the Corporation for collection checks, notes and other obligations and shall deposit the same to the credit of the Corporation in such bank or banks or depositary or depositaries as the Board of Directors may designate; shall sign all receipts and vouchers for payments made to the Corporation; shall enter or cause to be entered regularly in the books of the Corporation kept for the purpose full and accurate accounts of all moneys received or paid or otherwise disposed of and whenever required by the Board of Directors or the President shall render statements of such accounts; the Chief Financial Officer or Treasurer shall, at all reasonable times, exhibit the books and accounts to any Director of the Corporation upon application at the office of the Corporation during business hours; and shall have all powers and shall perform all duties incident of the office of Treasurer and shall also have such other powers and shall perform such other duties as may from time to time be assigned by these By-Laws or by the Board of Directors or the President.

SECTION 6. Additional Officers. The Board of Directors may from time to time elect such other officers (who may but need not be Directors), including a Controller, Assistant Treasurers, Assistant Secretaries and Assistant Controllers, as the Board may deem advisable and such officers shall have such authority and shall perform such duties as may from time to time be assigned by the Board of Directors or the President.

The Board of Directors may from time to time by resolution delegate to any Assistant Treasurer or Assistant Treasurers any of the powers or duties herein assigned to the Chief Financial Officer or Treasurer; and may similarly delegate to any Assistant Secretary or Assistant Secretaries any of the powers or duties herein assigned to the Secretary.

SECTION 7. Giving of Bond by Officers. All officers of the Corporation, if required to do so by the Board of Directors, shall furnish bonds to the Corporation for the faithful performance of their duties, in such penalties and with such conditions and security as the Board shall require.

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SECTION 8. Voting Upon Stocks. Unless otherwise ordered by the Board of Directors, the President or any Vice President shall have full power and authority on behalf of the Corporation to attend and to act and to vote, or in the name of the Corporation to execute proxies to vote, at any meeting of stockholders of any corporation in which the Corporation may hold stock, and at any such meeting shall possess and may exercise, in person or by proxy, any and all rights, powers and privileges incident to the ownership of such stock. The Board of Directors may from time to time, by resolution, confer like powers upon any other person or persons.

SECTION 9. Compensation of Officers. The officers of the Corporation shall be entitled to receive such compensation for their services as shall from time to time be determined by the Board of Directors.

ARTICLE IV

Indemnification of Directors and Officers

SECTION 1. Nature of Indemnity. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he or she is or was or has agreed to become a Director or officer of the Corporation, or is or was serving or has agreed to serve at the request of the Corporation as a Director or officer of another corporation, partnership, joint venture, trust or other enterprise, or by reason of any action alleged to have been taken or omitted in such capacity, and may indemnify any person who was or is a party or is threatened to be made a party to such an action, suit or proceeding by reason of the fact that he or she is or was or has agreed to become an employee or agent of the Corporation, or is or was serving or has agreed to serve at the request of the Corporation as an employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person or on his or her behalf in connection with such action, suit or proceeding and any appeal therefrom, if the person acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful; except that in the case of an action or suit by or in the right of the Corporation to procure a judgment in its favor (1) such indemnification shall be limited to expenses (including attorneys' fees) actually and reasonably incurred by such person in the defense or settlement of such action or suit, and (2) no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Delaware Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court shall deem proper. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a man-

8

ner which he or she reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his or her conduct was unlawful.

SECTION 2. Successful Defense. To the extent that a Director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 1 of this Article IV or in defense of any claim, issue or matter therein, he or she shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him or her in connection therewith.

SECTION 3. Determination that Indemnification is Proper. Any indemnification of a Director or officer of the Corporation under Section 1 of this Article IV (unless ordered by a court) shall be made by the Corporation unless a determination is made that indemnification of the Director or officer is not proper in the circumstances because he or she has not met the applicable standard of conduct set forth in Section 1. Any indemnification of an employee or agent of the Corporation under Section 1 (unless ordered by a court) may be made by the Corporation upon a determination that indemnification of the employee or agent is proper in the circumstances because he or she has met the applicable standard of conduct set forth in Section 1. Any such determination shall be made (1) by a majority vote of the Directors who are not parties to such action, suit or proceeding, even though less than a quorum, or (2) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or (3) by the stockholders.

SECTION 4. Advance Payment of Expenses. Unless the Board of Directors otherwise determines in a specific case, expenses incurred by a Director or officer in defending a civil or criminal action, suit or proceeding shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of the Director or officer to repay such amount if it shall ultimately be determined that he or she is not entitled to be indemnified by the Corporation as authorized in this Article IV. Such expenses incurred by other employees and agents may be so paid upon such terms and conditions, if any, as the Board of Directors deems appropriate. The Board of Directors may authorize the Corporation's legal counsel to represent such Director, officer, employee or agent in any action, suit or proceeding, whether or not the Corporation is a party to such action, suit or proceeding.

SECTION 5. Survival; Preservation of Other Rights. The foregoing indemnification provisions shall be deemed to be a contract between the Corporation and each Director, officer, employee and agent who serves in any such capacity at any time while these provisions as well as the relevant provisions of the Delaware General Corporation Law are in effect and any repeal or modification thereof shall not affect any right or obligation then existing with respect to any state of facts then or previously existing or any action, suit, or proceeding previously or thereafter brought or threatened based in whole or in part upon any such state of facts. Such a contract right may not be modified retroactively without the consent of such Director, officer, employee or agent. The indemnification provided by this Article IV shall not be deemed exclusive of any other rights to which a person indemnified may be entitled under any by-law, agreement, vote of stockholders or disinterested Directors or otherwise, both as to action in his or her official capacity and as to ac-

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tion in another capacity while holding such office, and shall continue as to a person who has ceased to be a Director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. The Corporation may enter into an agreement with any of its Directors, officers, employees or agents providing for indemnification and advancement of expenses, including attorneys fees, that may change, enhance, qualify or limit any right to indemnification or advancement of expenses created by this Article IV.

SECTION 6. Severability. If this Article IV or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Corporation shall nevertheless indemnify each Director or officer and may indemnify each employee or agent of the Corporation as to costs, charges and expenses (including attorneys' fees), judgment, fines and amounts paid in settlement with respect to any action, suit or proceeding, whether civil, criminal, administrative or investigative, including an action by or in the right of the Corporation, to the fullest extent permitted by any applicable portion of this Article IV that shall not have been invalidated and to the fullest extent permitted by applicable law.

SECTION 7. Subrogation. In the event of payment of indemnification to a person described in Section 1 of this Article IV, the Corporation shall be subrogated to the extent of such payment to any right of recovery such person may have and such person, as a condition of receiving indemnification from the Corporation, shall execute all documents and do all things that the Corporation may deem necessary or desirable to perfect such right of recovery, including the execution of such documents necessary to enable the Corporation effectively to enforce any such recovery.

SECTION 8. No Duplication of Payments. The Corporation shall not be liable under this Article IV to make any payment in connection with any claim made against a person described in Section 1 of this Article IV to the extent such person has otherwise received payment (under any insurance policy, by-law or otherwise) of the amounts otherwise payable as indemnity hereunder.

ARTICLE V

Stock-Seal-Fiscal Year

SECTION 1. Certificates For Shares of Stock. The certificates for shares of stock of the Corporation shall be in such form, not inconsistent with the Certificate of Incorporation, as shall be approved by the Board of Directors. All certificates shall be signed by the President or a Vice President and by the Secretary or an Assistant Secretary or the Treasurer or an Assistant Treasurer, and shall not be valid unless so signed. In case any officer or officers who shall have signed any such certificate or certificates shall cease to be such officer or officers of the Corporation, whether because of death, resignation or otherwise, before such certificate or certificates shall have been delivered by the Corporation, such certificate or certificates may nevertheless be issued and delivered as though the person or persons who signed such certificate or certificates had not ceased to be such officer or officers of the Corporation.

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All certificates for shares of stock shall be consecutively numbered as the same are issued. The name of the person owning the shares represented thereby with the number of such shares and the date of issue thereof shall be entered on the books of the Corporation.

Except as hereinafter provided, all certificates surrendered to the Corporation for transfer shall be cancelled, and no new certificates shall be issued until former certificates for the same number of shares have been surrendered and cancelled.

SECTION 2. Lost, Stolen or Destroyed Certificates. Whenever a person owning a certificate for shares of stock of the Corporation alleges that it has been lost, stolen or destroyed, he or she shall file in the office of the Corporation an affidavit setting forth, to the best of his or her knowledge and belief, the time, place and circumstances of the loss, theft or destruction, and, if required by the Board of Directors, a bond of indemnity or other indemnification sufficient in the opinion of the Board of Directors to indemnify the Corporation and its agents against any claim that may be made against it or them on account of the alleged loss, theft or destruction of any such certificate or the issuance of a new certificate in replacement therefor. Thereupon the Corporation may cause to be issued to such person a new certificate in replacement for the certificate alleged to have been lost, stolen or destroyed. Upon the stub of every new certificate so issued shall be noted the fact of such issue and the number, date and the name of the registered owner of the lost, stolen or destroyed certificate in lieu of which the new certificate is issued.

SECTION 3. Transfer of Shares. Shares of stock of the Corporation shall be transferred on the books of the Corporation by the holder thereof, in person or by his or her attorney duly authorized in writing, upon surrender and cancellation of certificates for the number of shares of stock to be transferred, except as provided in Section 2 of this Article IV.

SECTION 4. Regulations. The Board of Directors shall have power and authority to make such rules and regulations as it may deem expedient concerning the issue, transfer and registration of certificates for shares of stock of the Corporation.

SECTION 5. Record Date. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting or to receive payment of any dividend or other distribution or allotment of any rights, or to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, as the case may be, the Board of Directors may fix, in advance, a record date, which shall not be (i) more than sixty (60) nor less than ten (10) days before the date of such meeting, or (ii) in the case of corporate action to be taken by consent in writing without a meeting, prior to, or more than ten (10) days after, the date upon which the resolution fixing the record date is adopted by the Board of Directors, or (iii) more than sixty (60) days prior to any other action.

If no record date is fixed, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day

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next preceding the day on which notice is given or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held; the record date for determining stockholders entitled to express consent to corporate action in writing without a meeting, when no prior action by the Board of Directors is necessary, shall be the day on which the first written consent is delivered to the Corporation; and the record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting.

SECTION 6. Dividends. Subject to the provisions of the Certificate of Incorporation, the Board of Directors shall have power to declare and pay dividends upon shares of stock of the Corporation, but only out of funds available for the payment of dividends as provided by law.

Subject to the provisions of the Certificate of Incorporation, any dividends declared upon the stock of the Corporation shall be payable on such date or dates as the Board of Directors shall determine. If the date fixed for the payment of any dividend shall in any year fall upon a legal holiday, then the dividend payable on such date shall be paid on the next day not a legal holiday.

SECTION 7. Corporate Seal. The Board of Directors shall provide a suitable seal, containing the name of the Corporation, which seal shall be kept in the custody of the Secretary. A duplicate of the seal may be kept and be used by any officer of the Corporation designated by the Board of Directors or the President.

SECTION 8. Fiscal Year. The fiscal year of the Corporation shall be such fiscal year as the Board of Directors from time to time by resolution shall determine.

ARTICLE VI

Miscellaneous Provisions.

SECTION 1. Checks, Notes, Etc. All checks, drafts, bills of exchange, acceptances, notes or other obligations or orders for the payment of money shall be signed and, if so required by the Board of Directors, countersigned by such officers of the Corporation and/or other persons as the Board of Directors from time to time shall designate.

Checks, drafts, bills of exchange, acceptances, notes, obligations and orders for the payment of money made payable to the Corporation may be endorsed for deposit to the credit of the Corporation with a duly authorized depository by the Chief Financial Officer or Treasurer and/or such other officers or persons as the Board of Directors from time to time may designate.

SECTION 2. Loans. No loans and no renewals of any loans shall be contracted on behalf of the Corporation except as authorized by the Board of Directors. When authorized to do so, any officer or agent of the Corporation may effect loans and advances for

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the Corporation from any bank, trust company or other institution or from any firm, corporation or individual, and for such loans and advances may make, execute and deliver promissory notes, bonds or other evidences of indebtedness of the Corporation. When authorized so to do, any officer or agent of the Corporation may pledge, hypothecate or transfer, as security for the payment of any and all loans, advances, indebtedness and liabilities of the Corporation, any and all stocks, securities and other personal property at any time held by the Corporation, and to that end may endorse, assign and deliver the same. Such authority may be general or confined to specific instances.

SECTION 3. Contracts. Except as otherwise provided in these By-Laws or by law or as otherwise directed by the Board of Directors, the President or any Vice President shall be authorized to execute and deliver, in the name and on behalf of the Corporation, all agreements, bonds, contracts, deeds, mortgages, and other instruments, either for the Corporation's own account or in a fiduciary or other capacity, and the seal of the Corporation, if appropriate, shall be affixed thereto by any of such officers or the Secretary or an Assistant Secretary. The Board of Directors, the President or any Vice President designated by the Board of Directors may authorize any other officer, employee or agent to execute and deliver, in the name and on behalf of the Corporation, agreements, bonds, contracts, deeds, mortgages, and other instruments, either for the Corporation's own account or in a fiduciary or other capacity, and, if appropriate, to affix the seal of the Corporation thereto. The grant of such authority by the Board or any such officer may be general or confined to specific instances.

SECTION 4. Waivers of Notice. Whenever any notice whatever is required to be given by law, by the Certificate of Incorporation or by these By-Laws to any person or persons, a waiver thereof in writing, signed by the person or persons entitled to the notice, whether before or after the time stated therein, shall be deemed equivalent thereto.

SECTION 5. Offices Outside of Delaware. Except as otherwise required by the laws of the State of Delaware, the Corporation may have an office or offices and keep its books, documents and papers outside of the State of Delaware at such place or places as from time to time may be determined by the Board of Directors or the President.

ARTICLE VII

Amendments

These By-Laws and any amendment thereof may be altered, amended or repealed, or new By-Laws may be adopted, by the Board of Directors at any regular or special meeting by the affirmative vote of a majority of all of the members of the Board, provided in the case of any special meeting at which all of the members of the Board are not present, that the notice of such meeting shall have stated that the amendment of these By-Laws was one of the purposes of the meeting; but these By-Laws and any amendment thereof may be altered, amended or repealed or new By-Laws may be adopted by the holders of a majority of the total outstanding stock of the Corporation entitled to vote at any annual meeting or at any special meeting, provided, in the case of any special meeting, that notice of such proposed alteration, amendment, repeal or adoption is included in the notice of the meeting.

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EXHIBIT 10.2

[ARENA LOGO]

AMENDED AND RESTATED

ARENA PHARMACEUTICALS, INC.

2000 EQUITY COMPENSATION PLAN


TABLE OF CONTENTS

AMENDED AND RESTATED ARENA PHARMACEUTICALS, INC.
2000 EQUITY COMPENSATION PLAN

Introduction .............................................................................................1

Administration............................................................................................1
       Committee..........................................................................................1
       Committee Authority................................................................................1
       Committee Determinations ..........................................................................1

Grants ...................................................................................................2

Shares Subject to the Plan ...............................................................................2
       Shares Authorized .................................................................................2
       Adjustments .......................................................................................2

Eligibility for Participation ............................................................................3
       Eligible Persons ..................................................................................3
       Selection of Grantees .............................................................................3

Granting of Options ......................................................................................3
       Number of Shares ..................................................................................3
       Type of Option and Price ..........................................................................3
       Option Term .......................................................................................4
       Exercisability of Options .........................................................................4
       Termination of Employment, Disability or Death ....................................................4
       Exercise of Options ...............................................................................6
       Limits on Incentive Stock Options .................................................................6

Restricted Stock Grants ..................................................................................7
        General Requirements .............................................................................7
        Number of Shares .................................................................................7
        Requirement of Employment or Service .............................................................7
        Restrictions on Transfer and Legend on Stock Certificate .........................................7
        Right to Vote and to Receive Dividends ...........................................................7
        Lapse of Restrictions ............................................................................8

Withholding of Taxes .....................................................................................8
       Required Withholding ..............................................................................8
       Election to Withhold Shares .......................................................................8

Transferability of Grants ................................................................................8
       No Transferability of Grants ......................................................................8
       Transfer of Nonqualified Stock Options ............................................................8

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Change of Control of the Company .........................................................................9

Consequences of a Change of Control ......................................................................9
       Notice and Acceleration ...........................................................................9
       Assumption of Grants ..............................................................................9
       Other Alternatives ................................................................................9
       Limitations ......................................................................................10

Requirements for Issuance or Transfer of Shares .........................................................10
       Shareholder's Agreement ..........................................................................10
       Limitations on Issuance or Transfer of Shares ....................................................10

Amendment and Termination of the Plan ...................................................................10
       Amendment ........................................................................................10
       Termination of Plan ..............................................................................10
       Termination and Amendment of Outstanding Grants ..................................................11
       Governing Document ...............................................................................11

Funding of the Plan .....................................................................................11

Rights of Participants ..................................................................................11

No Fractional Shares ....................................................................................11

Headings ................................................................................................11

Effective Date of the Plan ..............................................................................12

Miscellaneous ...........................................................................................12
       Grants in Connection With Corporate Transactions and Otherwise ...................................12
       Compliance with Law ..............................................................................12
       Governing Law ....................................................................................12

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AMENDED AND RESTATED

ARENA PHARMACEUTICALS, INC.

2000 EQUITY COMPENSATION PLAN

The purpose of the Amended and Restated Arena Pharmaceuticals, Inc. 2000 Equity Compensation Plan (the "Plan") is to provide (i) designated employees of Arena Pharmaceuticals, Inc. (the "Company") and its subsidiaries, (ii) certain consultants and advisors who perform services for the Company or its subsidiaries and (iii) non-employee members of the Board of Directors of the Company (the "Board") with the opportunity to receive grants of incentive stock options, nonqualified stock options and restricted stock. The Company believes that the Plan will encourage the participants to contribute materially to the growth of the Company, thereby benefiting the Company's shareholders, and will align the economic interests of the participants with those of the shareholders.

1. ADMINISTRATION

(a) COMMITTEE. The Plan shall be administered and interpreted by a committee (the "Committee") appointed by the Board. The Committee shall be comprised of two or more individuals who are "non-employee directors" as defined under Rule 16b-3 under the Securities Exchange Act of 1934, as amended (or its successor), and "outside directors" as defined under section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code") (or its successor), and related Treasury regulations. However, the Board may ratify or approve any grants as it deems appropriate, and the Board shall be authorized to take any action that the Committee is authorized to take under the Plan.

(b) COMMITTEE AUTHORITY. Except as otherwise determined by the Board, the Committee shall have the sole authority to (i) determine the individuals to whom grants shall be made under the Plan, (ii) determine the type, size and terms of the grants to be made to each such individual, (iii) determine the time when the grants will be made and the duration of any applicable exercise or restriction period, including the criteria for exercisability and the acceleration of exercisability and (iv) deal with any other matters arising under the Plan.

(c) COMMITTEE DETERMINATIONS. The Committee shall have full power and authority to administer and interpret the Plan, to make factual determinations and to adopt or amend such rules, regulations, agreements and instruments for implementing the Plan and for the conduct of its business as it deems necessary or advisable, in its sole discretion. The Committee's interpretations of the Plan and all determinations made by the Committee pursuant to the powers vested in it hereunder shall be conclusive and binding on all persons having any interest in the Plan or in any awards granted hereunder. All powers of the Committee shall be executed in its sole discretion, in the best interest of the Company, not as a fiduciary, and in keeping with the objectives of the Plan and need not be uniform as to similarly situated individuals.

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2. GRANTS

Awards under the Plan may consist of grants of incentive stock options as described in Section 5 ("Incentive Stock Options"), nonqualified stock options as described in Section 5 ("Nonqualified Stock Options") (Incentive Stock Options and Nonqualified Stock Options are collectively referred to as "Options") and restricted stock as described in Section 6 ("Restricted Stock") (hereinafter collectively referred to as "Grants"). All Grants shall be subject to the terms and conditions set forth herein and to such other terms and conditions consistent with this Plan as the Committee deems appropriate and as are specified in writing by the Committee to the individual in a grant instrument or an amendment to the grant instrument (the "Grant Instrument"). The Committee shall approve the form and provisions of each Grant Instrument. Grants under a particular Section of the Plan need not be uniform as among the grantees.

3. SHARES SUBJECT TO THE PLAN

(a) SHARES AUTHORIZED. Subject to the adjustment specified below, the aggregate number of shares of common stock of the Company ("Company Stock") that may be issued or transferred under the Plan is Two Million (2,000,000) shares. The maximum aggregate number of shares of Company Stock that shall be subject to Grants made under the Plan to any individual during any calendar year shall be Two Hundred Thousand (200,000) shares. The shares may be authorized but unissued shares of Company Stock or reacquired shares of Company Stock, including shares purchased by the Company on the open market for the purposes of the Plan. If and to the extent Options granted under the Plan terminate, expire, or are canceled, forfeited, exchanged or surrendered without having been exercised or if any shares of Restricted Stock are forfeited, the shares subject to such Grants shall again be available for purposes of the Plan.

(b) ADJUSTMENTS. If there is any change in the number or kind of shares of Company Stock outstanding (i) by reason of a stock dividend, spinoff, recapitalization, stock split, or combination or exchange of shares,
(ii) by reason of a merger, reorganization or consolidation in which the Company is the surviving corporation, (iii) by reason of a reclassification or change in par value, or (iv) by reason of any other extraordinary or unusual event affecting the outstanding Company Stock as a class without the Company's receipt of consideration, or if the value of outstanding shares of Company Stock is substantially reduced as a result of a spinoff or the Company's payment of an extraordinary dividend or distribution, the maximum number of shares of Company Stock available for Grants, the maximum number of shares of Company Stock that any individual participating in the Plan may be granted in any year, the number of shares covered by outstanding Grants, the kind of shares issued under the Plan, and the price per share or the applicable market value of such Grants shall be appropriately adjusted by the Committee to reflect any increase or decrease in the number of, or change in the kind or value of, issued shares of Company Stock to preclude, to the extent practicable, the enlargement or dilution of rights and benefits under such Grants; provided, however, that any fractional shares resulting from such adjustment shall be

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eliminated. Any adjustments determined by the Committee shall be final, binding and conclusive.

4. ELIGIBILITY FOR PARTICIPATION

(a) ELIGIBLE PERSONS. All employees of the Company and its subsidiaries ("Employees"), including Employees who are officers or members of the Board, and members of the Board who are not Employees ("Non-Employee Directors"), shall be eligible to participate in the Plan. Consultants and advisors who perform services to the Company or any of its subsidiaries ("Key Advisors") shall be eligible to participate in the Plan if the Key Advisors render bona fide services and such services are not in connection with the offer or sale of securities in a capital-raising transaction, and the Key Advisors do not directly or indirectly promote or maintaining a market for the Company's securities.

(b) SELECTION OF GRANTEES. The Committee shall select the Employees, Non-Employee Directors and Key Advisors who shall receive Grants and shall determine the number of shares of Company Stock subject to a particular Grant in the manner as the Committee shall determine. Employees, Key Advisors and Non-Employee Directors who receive Grants under this Plan shall hereinafter be referred to as "Grantees."

5. GRANTING OF OPTIONS

(a) NUMBER OF SHARES. The Committee shall determine the number of shares of Company Stock that will be subject to each Grant of Options to Employees, Non-Employee Directors and Key Advisors.

(b) TYPE OF OPTION AND PRICE.

(i) The Committee may grant Incentive Stock Options that are intended to qualify as "incentive stock options" within the meaning of section 422 of the Code or Nonqualified Stock Options that are not intended so to qualify or any combination of Incentive Stock Options and Nonqualified Stock Options, all in accordance with the terms and conditions set forth herein. Incentive Stock Options may be granted only to Employees. Nonqualified Stock Options may be granted to Employees, Non-Employee Directors and Key Advisors.

(ii) The purchase price (the "Exercise Price") of Company Stock subject to an Option shall be determined by the Committee and may be equal to, greater than, or less than the Fair Market Value (as defined below) of a share of Company Stock on the date the Option is granted; provided, however, that (w) the Exercise Price of a Nonqualified Stock Option shall not be less than 85% of the Fair Market Value of a share of Company Stock on the date of grant (unless clause (z) below applies), (x) the Exercise Price of an Incentive Stock Option shall be equal to, or greater than, 100% of the Fair Market Value of a share of Company Stock on the date the Incentive Stock Option is granted, (y) an Incentive Stock Option shall not be granted to an Employee

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who, at the time of grant, owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company or any parent or subsidiary of the Company, unless the Exercise Price per share is not less than 110% of the Fair Market Value of Company Stock on the date of grant, and
(z) to the extent required by applicable law, a Nonqualified Stock Option shall not be granted to a person who, at the time of grant, owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company or any parent or subsidiary of the Company, unless the Exercise Price per share is not less than 110% of the Fair Market Value of Company Stock on the date of grant.

(iii) The Fair Market Value per share shall be determined as follows: (x) if the principal trading market for the Company Stock is a national securities exchange or the Nasdaq National Market, the last reported sale price thereof on the relevant date or (if there were no trades on that date) the latest preceding date upon which a sale was reported, or (y) if the Company Stock is not principally traded on such exchange or market, the mean between the last reported "bid" and "asked" prices of Company Stock on the relevant date, as reported on Nasdaq or, if not so reported, as reported by the National Daily Quotation Bureau, Inc. or as reported in a customary financial reporting service, as applicable and as the Committee determines. If the Company Stock is publicly traded and is not subject to reported transactions or "bid" or "asked" quotations as set forth above, the Fair Market Value per share shall be as determined by the Committee.

(c) OPTION TERM. The Committee shall determine the term of each Option. The term of any Option shall not exceed ten years from the date of grant. However, an Incentive Stock Option that is granted to an Employee who, at the time of grant, owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company, or any parent or subsidiary of the Company, may not have a term that exceeds five years from the date of grant.

(d) EXERCISABILITY OF OPTIONS. Options shall become exercisable in accordance with such terms and conditions, consistent with the Plan, as may be determined by the Committee and specified in the Grant Instrument. Options shall vest over a period of not more than five years and at a rate of not less than 20% per year. The Committee may accelerate the exercisability of any or all outstanding Options at any time for any reason.

(e) TERMINATION OF EMPLOYMENT, DISABILITY OR DEATH.

(i) Except as provided below, an Option may only be exercised while the Grantee is employed by, or providing service to, the Company as an Employee, Key Advisor or member of the Board. In the event that a Grantee ceases to be employed by, or provide service to, the Company for any reason other than "disability," death, or termination for "cause," any Option which is otherwise exercisable by the Grantee shall terminate unless exercised within 90 days after the date on which the Grantee ceases to be employed by, or provide service to, the Company (or within such

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other period of time as may be specified by the Committee), but in any event no later than the date of expiration of the Option term. Except as otherwise provided by the Committee, any of the Grantee's Options that are not otherwise exercisable as of the date on which the Grantee ceases to be employed by, or provide service to, the Company shall terminate as of such date.

(ii) In the event the Grantee ceases to be employed by, or provide service to, the Company on account of a termination for "cause" by the Company, any Option held by the Grantee shall terminate as of the date the Grantee ceases to be employed by, or provide service to, the Company. In addition, notwithstanding any other provisions of this Section 5, if the Committee determines that the Grantee has engaged in conduct that constitutes "cause" at any time while the Grantee is employed by, or providing service to, the Company or after the Grantee's termination of employment or service, any Options held by the Grantee shall immediately terminate, unless otherwise provided by the Committee.

(iii) In the event the Grantee ceases to be employed by, or provide service to, the Company because the Grantee is "disabled," any Option which is otherwise exercisable by the Grantee shall terminate unless exercised within one year after the date on which the Grantee ceases to be employed by, or provide service to, the Company (or within such other period of time as may be specified by the Committee), but in any event no later than the date of expiration of the Option term. Any of the Grantee's Options which are not otherwise exercisable as of the date on which the Grantee ceases to be employed by, or provide service to, the Company shall terminate as of such date.

(iv) If the Grantee dies while employed by, or providing service to, the Company or within 90 days after the date on which the Grantee ceases to be employed or provide service on account of a termination specified in Section 5(e)(i) above (or within such other period of time as may be specified by the Committee), any Option that is otherwise exercisable by the Grantee shall terminate unless exercised within one year after the date on which the Grantee ceases to be employed by, or provide service to, the Company (or within such other period of time as may be specified by the Committee), but in any event no later than the date of expiration of the Option term. Any of the Grantee's Options that are not otherwise exercisable as of the date on which the Grantee ceases to be employed by, or provide service to, the Company shall terminate as of such date.

(v) For purposes of this Section 5(e) and
Section 6:

(A) The term "Company" shall mean the Company and its parent and subsidiary corporations, or other entities, as determined by the Committee.

(B) "Employed by, or provide service to, the Company" shall mean employment or service as an Employee, Key Advisor or member of the Board (so that, for purposes of exercising Options and satisfying conditions with respect to Restricted

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Stock, a Grantee shall not be considered to have terminated employment or service until the Grantee ceases to be an Employee, Key Advisor and member of the Board), unless the Committee determines otherwise.

(C) "Disability" shall mean a Grantee's becoming disabled within the meaning of section 22(e)(3) of the Code, or as otherwise determined by the Committee.

(D) "Cause" shall mean, except to the extent otherwise specified by the Committee, a finding by the Committee that the Grantee has breached his or her employment or service contract with the Company, or has been engaged in disloyalty to the Company, including, without limitation, fraud, embezzlement, theft, commission of a felony or proven dishonesty in the course of his or her employment or service, or has disclosed trade secrets or confidential information of the Company to persons not entitled to receive such information, or has breached any written noncompetition or nonsolicitation agreement between the Grantee and the Company or has engaged in such other behavior detrimental to the interests of the Company as the Committee determines. In the event a Grantee's employment or service is terminated for cause, in addition to the immediate termination of all Grants, the Grantee shall automatically forfeit all shares underlying any exercised portion of an Option for which the Company has not yet delivered the share certificates, upon refund by the Company of the Exercise Price paid by the Grantee for such shares.

(f) EXERCISE OF OPTIONS. A Grantee may exercise an Option that has become exercisable, in whole or in part, by delivering a notice of exercise to the Company with payment of the Exercise Price. The Grantee shall pay the Exercise Price for an Option as specified by the Committee (x) in cash,
(y) with the approval of the Committee, by delivering shares of Company Stock owned by the Grantee (including Company Stock acquired in connection with the exercise of an Option, subject to such restrictions as the Committee deems appropriate) and having a Fair Market Value on the date of exercise equal to the Exercise Price or (z) by such other method as the Committee may approve, including payment through a broker in accordance with procedures permitted by Regulation T of the Federal Reserve Board. Shares of Company Stock used to exercise an Option shall have been held by the Grantee for the requisite period of time to avoid adverse accounting consequences to the Company with respect to the Option. The Grantee shall pay the Exercise Price and the amount of any withholding tax due (pursuant to Section 7) at the time of exercise.

(g) LIMITS ON INCENTIVE STOCK OPTIONS. Each Incentive Stock Option shall provide that, if the aggregate Fair Market Value of the stock on the date of the grant with respect to which Incentive Stock Options are exercisable for the first time by a Grantee during any calendar year, under the Plan or any other stock option plan of the Company or a parent or subsidiary, exceeds $100,000, then the option, as to the excess, shall be treated as a Nonqualified Stock Option. An Incentive Stock Option shall not be granted to any person who is not an Employee of the Company or a parent or subsidiary (within the meaning of section 424(f) of the Code).

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6. RESTRICTED STOCK GRANTS

The Committee may issue or transfer shares of Company Stock to an Employee, Non-Employee Director or Key Advisor under a Grant of Restricted Stock, upon such terms as the Committee deems appropriate. The following provisions are applicable to Restricted Stock:

(a) GENERAL REQUIREMENTS. Shares of Company Stock issued or transferred pursuant to Restricted Stock Grants may be issued or transferred for consideration or for no consideration, and subject to restrictions or no restrictions, as determined by the Committee. The Committee may establish conditions under which restrictions on shares of Restricted Stock shall lapse over a period of time or according to such other criteria as the Committee deems appropriate. The period of time during which the Restricted Stock will remain subject to restrictions will be designated in the Grant Instrument as the "Restriction Period."

(b) NUMBER OF SHARES. The Committee shall determine the number of shares of Company Stock to be issued or transferred pursuant to a Restricted Stock Grant and the restrictions applicable to such shares.

(c) REQUIREMENT OF EMPLOYMENT OR SERVICE. If the Grantee ceases to be employed by, or provide service to, the Company (as defined in
Section 5(e)) during a period designated in the Grant Instrument as the Restriction Period, or if other specified conditions are not met, the Restricted Stock Grant shall terminate as to all shares covered by the Grant as to which the restrictions have not lapsed, and those shares of Company Stock must be immediately returned to the Company. The Committee may, however, provide for complete or partial exceptions to this requirement as it deems appropriate.

(d) RESTRICTIONS ON TRANSFER AND LEGEND ON STOCK CERTIFICATE. During the Restriction Period, a Grantee may not sell, assign, transfer, pledge or otherwise dispose of the shares of Restricted Stock except to a Successor Grantee under Section 8(a). Each certificate for a share of Restricted Stock shall contain a legend giving appropriate notice of the restrictions in the Grant. The Grantee shall be entitled to have the legend removed from the stock certificate covering the shares subject to restrictions when all restrictions on such shares have lapsed. The Committee may determine that the Company will not issue certificates for shares of Restricted Stock until all restrictions on such shares have lapsed, or that the Company will retain possession of certificates for shares of Restricted Stock until all restrictions on such shares have lapsed.

(e) RIGHT TO VOTE AND TO RECEIVE DIVIDENDS. Unless the Committee determines otherwise, during the Restriction Period, the Grantee shall have the right to vote shares of Restricted Stock and to receive any dividends or other distributions paid on such shares, subject to any restrictions deemed appropriate by the Committee.

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(f) LAPSE OF RESTRICTIONS. All restrictions imposed on Restricted Stock shall lapse upon the expiration of the applicable Restriction Period and the satisfaction of all conditions imposed by the Committee. The Committee may determine, as to any or all Restricted Stock Grants, that the restrictions shall lapse without regard to any Restriction Period.

7. WITHHOLDING OF TAXES

(a) REQUIRED WITHHOLDING. All Grants under the Plan shall be subject to applicable federal (including FICA), state and local tax withholding requirements. The Company shall have the right to deduct from all Grants paid in cash, or from other wages paid to the Grantee, any federal, state or local taxes required by law to be withheld with respect to such Grants. In the case of Options and other Grants paid in Company Stock, the Company may require the Grantee or other person receiving such shares to pay to the Company the amount of any such taxes that the Company is required to withhold with respect to such Grants, or the Company may deduct from other wages paid by the Company the amount of any withholding taxes due with respect to such Grants.

(b) ELECTION TO WITHHOLD SHARES. If the Committee so permits, a Grantee may elect to satisfy the Company's income tax withholding obligation with respect to an Option or Restricted Stock by having shares withheld up to an amount that does not exceed the Grantee's minimum applicable withholding tax rate for federal (including FICA), state and local tax liabilities. The election must be in a form and manner prescribed by the Committee and shall be subject to the prior approval of the Committee.

8. TRANSFERABILITY OF GRANTS

(a) NO TRANSFERABILITY OF GRANTS. Except as provided below, only the Grantee may exercise rights under a Grant during the Grantee's lifetime. A Grantee may not transfer those rights except by will or by the laws of descent and distribution or, with respect to Grants other than Incentive Stock Options, if permitted in any specific case by the Committee, pursuant to a domestic relations order (as defined under the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended, or the regulations thereunder), or otherwise permitted by the Committee. When a Grantee dies, the personal representative or other person entitled to succeed to the rights of the Grantee ("Successor Grantee") may exercise such rights. A Successor Grantee must furnish proof satisfactory to the Company of his or her right to receive the Grant under the Grantee's will or under the applicable laws of descent and distribution.

(b) TRANSFER OF NONQUALIFIED STOCK OPTIONS. Notwithstanding the foregoing, if permitted by applicable law, the Committee may provide, in a Grant Instrument, that a Grantee may transfer Nonqualified Stock Options to family members, one or more trusts for the benefit of family members, or one or more entities for the benefit of family members, consistent with applicable securities laws, according to such terms as the Committee may determine; provided that the Grantee receives no

-8-

consideration for the transfer of an Option and the transferred Option shall continue to be subject to the same terms and conditions as were applicable to the Option immediately before the transfer.

9. CHANGE OF CONTROL OF THE COMPANY

As used herein, a "Change of Control" shall be deemed to have occurred if:

(a) Any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than the those persons who are shareholders of the Company on the effective date of the Plan, becomes a "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing more than 50% of the voting power of the then outstanding securities of the Company, provided that a Change of Control shall not be deemed to occur as a result of a change of ownership resulting from the death of a shareholder; or

(b) The shareholders of the Company approve (or, if shareholder approval is not required, the Committee approves) an agreement providing for (i) the merger or consolidation of the Company with another corporation where the shareholders of the Company, immediately prior to the merger or consolidation, will not beneficially own, immediately after the merger or consolidation, shares entitling such shareholders to more than 50% of all votes to which all shareholders of the surviving corporation would be entitled in the election of directors, (ii) the sale or other disposition of all or substantially all of the assets of the Company, or (iii) a liquidation or dissolution of the Company;

10. CONSEQUENCES OF A CHANGE OF CONTROL

(a) NOTICE AND ACCELERATION. Upon a Change of Control, unless the Committee determines otherwise, (i) the Company shall provide each Grantee with outstanding Grants written notice of such Change of Control, (ii) all outstanding Options shall automatically accelerate and become fully exercisable, and (iii) the restrictions and conditions on all outstanding Restricted Stock shall immediately lapse.

(b) ASSUMPTION OF GRANTS. Upon a Change of Control where the Company is not the surviving corporation (or survives only as a subsidiary of another corporation), unless the Committee determines otherwise, all outstanding Options that are not exercised shall be assumed by, or replaced with comparable options or rights by, the surviving corporation.

(c) OTHER ALTERNATIVES. Notwithstanding the foregoing, subject to subsection (d) below, in the event of a Change of Control, the Committee may take one or both of the following actions: the Committee may (i) require that Grantees surrender their outstanding Options in exchange for a payment by the Company, in cash or Company Stock as determined by the Committee, in an amount equal to the amount by which the then Fair Market Value of the shares of Company Stock subject to the

-9-

Grantee's unexercised Options exceeds the Exercise Price of the Options or (ii) after giving Grantees an opportunity to exercise their outstanding Options, terminate any or all unexercised Options at such time as the Committee deems appropriate. Such surrender or termination shall take place as of the date of the Change of Control or such other date as the Committee may specify.

(d) LIMITATIONS. Notwithstanding anything in the Plan to the contrary, in the event of a Change of Control, the Committee shall not have the right to take any actions described in the Plan (including without limitation actions described in Subsection (c) above) that would make the Change of Control ineligible for pooling of interests accounting treatment or that would make the Change of Control ineligible for desired tax treatment if, in the absence of such right, the Change of Control would qualify for such treatment and the Company intends to use such treatment with respect to the Change of Control.

11. REQUIREMENTS FOR ISSUANCE OR TRANSFER OF SHARES

(a) SHAREHOLDER'S AGREEMENT. The Committee may require that a Grantee execute a shareholder's agreement, with such terms as the Committee deems appropriate, with respect to any Company Stock issued or distributed pursuant to this Plan.

(b) LIMITATIONS ON ISSUANCE OR TRANSFER OF SHARES. No Company Stock shall be issued or transferred in connection with any Grant hereunder unless and until all legal requirements applicable to the issuance or transfer of such Company Stock have been complied with to the satisfaction of the Committee. The Committee shall have the right to condition any Grant made to any Grantee hereunder on such Grantee's undertaking in writing to comply with such restrictions on his or her subsequent disposition of such shares of Company Stock as the Committee shall deem necessary or advisable as a result of any applicable law, regulation or official interpretation thereof, and certificates representing such shares may be legended to reflect any such restrictions. Certificates representing shares of Company Stock issued or transferred under the Plan will be subject to such stop-transfer orders and other restrictions as may be required by applicable laws, regulations and interpretations, including any requirement that a legend be placed thereon.

12. AMENDMENT AND TERMINATION OF THE PLAN

(a) AMENDMENT. The Committee may amend or terminate the Plan at any time; provided, however, that the Committee shall not amend the Plan without shareholder approval if such approval is required by section 422 of the Code or, section 162(m) of the Code.

(b) TERMINATION OF PLAN. The Plan shall terminate on the day immediately preceding the tenth anniversary of its effective date, unless the Plan is

-10-

terminated earlier by the Committee or is extended by the Committee with the approval of the shareholders.

(c) TERMINATION AND AMENDMENT OF OUTSTANDING GRANTS. A termination or amendment of the Plan that occurs after a Grant is made shall not materially impair the rights of a Grantee unless the Grantee consents or unless the Committee acts under Section 18(b). The termination of the Plan shall not impair the power and authority of the Committee with respect to an outstanding Grant. Whether or not the Plan has terminated, an outstanding Grant may be terminated or amended under Section 18(b) or may be amended by agreement of the Company and the Grantee consistent with the Plan.

(d) GOVERNING DOCUMENT. The Plan shall be the controlling document. No other statements, representations, explanatory materials or examples, oral or written, may amend the Plan in any manner. The Plan shall be binding upon and enforceable against the Company and its successors and assigns.

13. FUNDING OF THE PLAN

This Plan shall be unfunded. The Company shall not be required to establish any special or separate fund or to make any other segregation of assets to assure the payment of any Grants under this Plan. In no event shall interest be paid or accrued on any Grant, including unpaid installments of Grants.

14. RIGHTS OF PARTICIPANTS

Nothing in this Plan shall entitle any Employee, Key Advisor, Non-Employee Director or other person to any claim or right to be granted a Grant under this Plan. Neither this Plan nor any action taken hereunder shall be construed as giving any individual any rights to be retained by or in the employ of the Company or any other employment rights.

15. NO FRACTIONAL SHARES

No fractional shares of Company Stock shall be issued or delivered pursuant to the Plan or any Grant. The Committee shall determine whether cash, other awards or other property shall be issued or paid in lieu of such fractional shares or whether such fractional shares or any rights thereto shall be forfeited or otherwise eliminated.

16. HEADINGS

Section headings are for reference only. In the event of a conflict between a title and the content of a Section, the content of the Section shall control.

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17. EFFECTIVE DATE OF THE PLAN.

Subject to approval by the Company's shareholders, the Plan shall be effective on the completion of the Company's Initial Public Offering.

18. MISCELLANEOUS

(a) GRANTS IN CONNECTION WITH CORPORATE TRANSACTIONS AND OTHERWISE. Nothing contained in this Plan shall be construed to (i) limit the right of the Committee to make Grants under this Plan in connection with the acquisition, by purchase, lease, merger, consolidation or otherwise, of the business or assets of any corporation, firm or association, including Grants to employees thereof who become Employees of the Company, or for other proper corporate purposes, or (ii) limit the right of the Company to grant stock options or make other awards outside of this Plan. Without limiting the foregoing, the Committee may make a Grant to an employee of another corporation who becomes an Employee by reason of a corporate merger, consolidation, acquisition of stock or property, reorganization or liquidation involving the Company or any of its subsidiaries in substitution for a stock option or restricted stock grant made by such corporation. The terms and conditions of the substitute grants may vary from the terms and conditions required by the Plan and from those of the substituted stock incentives. The Committee shall prescribe the provisions of the substitute grants.

(b) COMPLIANCE WITH LAW. The Plan, the exercise of Options and the obligations of the Company to issue or transfer shares of Company Stock under Grants shall be subject to all applicable laws and to approvals by any governmental or regulatory agency as may be required. With respect to persons subject to section 16 of the Exchange Act, it is the intent of the Company that the Plan and all transactions under the Plan comply with all applicable provisions of Rule 16b-3 or its successors under the Exchange Act. In addition, it is the intent of the Company that the Plan and applicable Grants under the Plan comply with the applicable provisions of section 162(m) and section 422 of the Code. To the extent that any legal requirement of section 16 of the Exchange Act or section 162(m) or 422 of the Code as set forth in the Plan ceases to be required under section 16 of the Exchange Act or section 162(m) or 422 of the Code, that Plan provision shall cease to apply. The Committee may revoke any Grant if it is contrary to law or modify a Grant to bring it into compliance with any valid and mandatory government regulation. The Committee may also adopt rules regarding the withholding of taxes on payments to Grantees. The Committee may, in its sole discretion, agree to limit its authority under this Section.

(c) GOVERNING LAW. The validity, construction, interpretation and effect of the Plan and Grant Instruments issued under the Plan shall exclusively be governed by and determined in accordance with the law of the State of California.

[END OF PLAN]

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Exhibit 21.1

List of Subsidiaries of Arena Pharmaceuticals, Inc.

1. Aressa Pharmaceuticals, Inc. a Delaware corporation, doing business as Aressa Pharmaceuticals.

2. BRL Screening, Inc., a Delaware corporation, doing business as BRL Screening, Inc.


Exhibit 23.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-45330, 333-45332 and 333-62894) pertaining to the Amended and Restated 1998 Equity Compensation Plan, the 2000 Equity Compensation Plan and the 2001 Employee Stock Purchase Plan of Arena Pharmaceuticals, Inc. of our report dated January 11, 2002, with respect to the consolidated financial statements of Arena Pharmaceuticals, Inc., included in the Annual Report (Form 10-K) or the year ended December 31, 2001.

                                                  /s/ ERNST & YOUNG LLP

                                                  ERNST & YOUNG LLP


San Diego, California
March 13, 2002


EXHIBIT 24.1

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that the persons whose signatures appear below have made, constituted and appointed, and by this instrument do make, constitute and appoint Jack Lief and Steven W. Spector, or either one of them, his true and lawful attorney-in-fact and agent, with full powers of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as they might or could do in person, hereby ratifying and confirming all which said attorneys-in-fact and agent, or any of them, or their substitute or substitutes, may lawfully do, or cause to be done by virtue hereof.

IN WITNESS WHEREOF, this Power of Attorney has been signed at San Diego, California, this 15th day of March, 2002.

SIGNATURE                             TITLE
---------                             -----
/s/ Jack Lief                         President, Chief Executive Officer,
-----------------------------         and Director
Jack Lief

/s/ Robert Hoffman                    Vice President, Finance, and Principal
-----------------------------         Accounting Officer
Robert Hoffman

/s/ Dominic P. Behan                  Director
-----------------------------
Dominic P. Behan, Ph.D

/s/ Derek Chalmers, Ph.D.             Director
-----------------------------
Dominic P. Behan


POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that the persons whose signatures appear below have made, constituted and appointed, and by this instrument do make, constitute and appoint Jack Lief and Steven W. Spector, or either one of them, his true and lawful attorney-in-fact and agent, with full powers of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as they might or could do in person, hereby ratifying and confirming all which said attorneys-in-fact and agent, or any of them, or their substitute or substitutes, may lawfully do, or cause to be done by virtue hereof.

IN WITNESS WHEREOF, this Power of Attorney has been signed at St. Louis, Missouri, this 15th day of March, 2002.

SIGNATURE                             TITLE
---------                             -----

/s/ John P. McAlister, III            Director
------------------------------
John P. McAlister, III, Ph.D.


POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that the persons whose signatures appear below have made, constituted and appointed, and by this instrument do make, constitute and appoint Jack Lief and Steven W. Spector, or either one of them, his true and lawful attorney-in-fact and agent, with full powers of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as they might or could do in person, hereby ratifying and confirming all which said attorneys-in-fact and agent, or any of them, or their substitute or substitutes, may lawfully do, or cause to be done by virtue hereof.

IN WITNESS WHEREOF, this Power of Attorney has been signed at Munich, Germany, this 12th day of March, 2002.

SIGNATURE                             TITLE
---------                             -----

/s/ Michael Steinmetz                 Director
------------------------------
Michael Steinmetz, Ph.D.


POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that the persons whose signatures appear below have made, constituted and appointed, and by this instrument do make, constitute and appoint Jack Lief and Steven W. Spector, or either one of them, his true and lawful attorney-in-fact and agent, with full powers of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as they might or could do in person, hereby ratifying and confirming all which said attorneys-in-fact and agent, or any of them, or their substitute or substitutes, may lawfully do, or cause to be done by virtue hereof.

IN WITNESS WHEREOF, this Power of Attorney has been signed at New York, New York, this 15th day of March, 2002.

SIGNATURE                             TITLE
---------                             -----

/s/ Stefan Ryser                      Director
------------------------
Stefan Ryser, Ph.D.