ARQULE INC, S-1/A, 1997-04-04

ARQULE INC
S-1/A, 1997-04-04
PHARMACEUTICAL PREPARATIONS

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 4, 1997

REGISTRATION NO. 333-22945
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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AMENDMENT NO. 2 TO FORM S-1

REGISTRATION STATEMENT
UNDER THE
SECURITIES ACT OF 1933

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ARQULE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
DELAWARE 2834 04-3221586
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
OF INCORPORATION OR CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
ORGANIZATION)
</TABLE>

200 BOSTON AVENUE
MEDFORD, MASSACHUSETTS 02155
(617) 395-4100
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

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ERIC B. GORDON

PRESIDENT AND CHIEF EXECUTIVE OFFICER
ARQULE, INC.
200 BOSTON AVENUE
MEDFORD, MASSACHUSETTS 02155
(617) 395-4100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

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

COPIES TO:

<TABLE>
<S> <C>
MICHAEL LYTTON, ESQ. GEORGE W. LLOYD, ESQ.
LYNNETTE C. FALLON, ESQ. TESTA, HURWITZ & THIBEAULT, LLP
PALMER & DODGE LLP HIGH STREET TOWER
ONE BEACON STREET 125 HIGH STREET
BOSTON, MASSACHUSETTS 02108 BOSTON, MASSACHUSETTS 02110
(617) 573-0100 (617) 248-7000
</TABLE>

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.

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If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 (the "Securities Act"), check the following box. [ ]

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

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.
================================================================================
<PAGE> 2

PROSPECTUS
- ----------

2,000,000 Shares

ArQule, Inc.

[ArQule, Inc. Logo]

Common Stock

Of the 2,000,000 shares of Common Stock offered hereby, 1,632,500 shares
are being sold by ArQule, Inc. and 367,500 shares are being sold by the Selling
Stockholders. The Company will not receive any of the proceeds from the sale of
shares by the Selling Stockholders. See "Principal and Selling Stockholders."

The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol ARQL. On April 3, 1997, the last reported sale price of the Common
Stock was $13.25 per share. See "Price Range of Common Stock."

------------------
THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
======================================================================================================
PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share................. $12.00 $0.66 $11.34 $11.34
- ------------------------------------------------------------------------------------------------------
Total(3).................. $24,000,000 $1,320,000 $18,512,550 $4,167,450
======================================================================================================
</TABLE>

(1) See "Underwriting" for indemnification arrangements with the several
Underwriters.

(2) Before deducting expenses payable by the Company estimated at $275,000.

(3) The Company has granted to the Underwriters a 30-day option to purchase up
to 300,000 additional shares of Common Stock solely to cover
over-allotments, if any. If all such shares are purchased, the total Price
to Public, Underwriting Discount and Proceeds to Company will be
$27,600,000, $1,518,000 and $21,914,550, respectively. See "Underwriting."

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

The shares of Common Stock are offered by the several Underwriters subject
to prior sale, receipt and acceptance by them and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that certificates for such shares will be available
for delivery on or about April 9, 1997, at the office of the agent of Hambrecht
& Quist LLC in New York, New York.

HAMBRECHT & QUIST

OPPENHEIMER & CO., INC.

VECTOR SECURITIES INTERNATIONAL, INC.

April 4, 1997

<PAGE> 3

[Graphical representation displaying the integration of ArQule's

Combinatorial Drug Design and Development Platform]

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF
THE COMPANY, INCLUDING BY ENTERING STABILIZING BIDS OR EFFECTING SYNDICATE
COVERING TRANSACTIONS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS MAY ENGAGE IN
PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL
MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M UNDER THE SECURITIES EXCHANGE
ACT OF 1934. SEE "UNDERWRITING."

AMAP(TM), Directed Array(TM) and Mapping Array(TM) are trademarks of the
Company for which there are pending applications for registration in the U.S.
Patent and Trademark Office.
<PAGE> 4

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and financial statements, including notes thereto, appearing
elsewhere in this Prospectus.

ArQule, Inc. (the "Company" or "ArQule") has created a new technology
platform for the discovery and production of novel chemical compounds with
commercial potential. The Company has developed proprietary technologies for the
identification and optimization of drug development candidates and
agrichemicals. Using combinatorial chemistry, a modular building block approach
to the development of compounds, structure-guided compound design, high speed
parallel chemical synthesis and information technology, the Company rapidly
develops large, diverse collections of compounds that have the potential to be
biologically active. To date, the Company has entered into collaborative
arrangements with Abbott Laboratories, Monsanto Company, Pharmacia Biotech AB,
Roche Bioscience and Solvay Duphar B.V., and has formed joint discovery programs
with several biotechnology companies.

The Company's goal is to penetrate the product development pipelines of
major pharmaceutical, biotechnology and agrichemical companies and to maximize
the likelihood that active compounds are discovered and successfully developed.
In order to achieve this goal, the Company pursues a strategy designed to
maximize the number of biological targets against which its compounds are
screened. ArQule believes that its technologies will allow its collaborative
partners in the pharmaceutical, biotechnology and agrichemical industries to
accelerate the product development process by several years, permitting them to
realize significant cost reductions and the earlier recovery of research and
development expenditures for successful drugs and agrichemicals. In addition,
the Company believes its technologies will allow researchers to seek solutions
to product development challenges previously deemed too costly or otherwise
impractical because of the inherent limitations of traditional medicinal
chemistry.

Using its proprietary "automated molecular assembly plant" (AMAP(TM))
system and structure-activity relationship ("SAR") data regarding biological
targets and molecular components, ArQule produces significant quantities of pure
small organic compounds in logically structured spatially addressable arrays.
Unlike most current approaches to compound development, ArQule's compound arrays
are created by using structure-guided and rational design tools to
systematically assemble molecular components with properties the Company's
scientists believe are likely to exhibit biological activity. ArQule's compound
arrays are designed around certain core structures or themes. Each compound in
the array is different from the adjacent compounds as a result of a single
structural modification. Each ArQule array omits compounds that are closely
analogous to other compounds in the array, using representative diversity to
create a logical representation of a virtual library of hundreds of times as
many compounds as are in the array. The Company's collaborative partners are
able to realize significant savings by screening the thousands of compounds in
each ArQule array rather than the millions of compounds they represent.

ArQule manufactures and delivers two types of arrays of synthesized
compounds to its pharmaceutical, biotechnology and agrichemical partners: (i)
Mapping Array(TM) compound sets, which are arrays of novel, diverse small
molecule compounds used in screening for lead generation and (ii) Directed
Array(TM) compound sets, which are arrays of compounds that are closely related,
often referred to as "analogs" of a particular lead compound. Both Mapping Array
and Directed Array sets are shipped in industry-standard 96-well microtiter
plates that are compatible with most screening protocols. Under its Mapping
Array Program, ArQule ships a minimum of 100,000 compounds per year in 15 to 20
separate Mapping Array sets, each consisting of 3,000 to 10,000 individual
compounds based on a different theme or core structure chosen by ArQule. Under a
typical Directed Array Program, ArQule provides three to seven Directed Array
sets, each averaging about 1,000 analogs of a particular lead compound chosen by
a collaborator in consultation with ArQule.

ArQule provides its Mapping Array and Directed Array Programs primarily to
partners in the pharmaceutical, biotechnology and agrichemical industries. To
date, ArQule has entered into collabo-

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<PAGE> 5

rative arrangements with Abbott Laboratories, Monsanto Company, Pharmacia
Biotech AB, Roche Bioscience and Solvay Duphar B.V., and has formed joint
discovery programs with several biotechnology companies. In exchange for
non-exclusive access to ArQule's Mapping Array Program, the Company's
pharmaceutical and agrichemical partners pay ArQule a combination of up-front
and annual subscription fees as well as a fixed amount for each Directed Array
Program. In addition, these companies have agreed to make payments upon the
achievement of certain milestones and to pay royalties upon the
commercialization of products based on compounds from either the Mapping Array
or the Directed Array Programs. In exchange for providing the arrays to the
Company's biotechnology partners, the Company receives joint ownership of any
potential drugs identified by the biotechnology partner.

ArQule's integrated technologies also present the Company with
opportunities in a number of biological and non-biological fields outside of
drug discovery and agrichemicals. These opportunities include the development of
industrial catalysts and nano-scale polymeric structures for specialized
mechanical applications.

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<PAGE> 6
- -------------------------------------------------------------------------------
THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company................ 1,632,500 shares
Common Stock offered by the Selling Stockholders... 367,500 shares
Common Stock to be outstanding after the
offering......................................... 11,490,862 shares(1)
Use of proceeds.................................... To fund research and product development
programs and for general corporate and
working capital purposes.
Nasdaq National Market symbol...................... ARQL
</TABLE>

SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(MAY 6, 1993) THROUGH YEAR ENDED
DECEMBER 31, DECEMBER 31,
--------------------- -------------------------------
1993 1994 1995 1996
--------------------- ------- ------- -------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue................................ $ -- $ 85 $ 3,330 $ 7,255
Loss from operations................... (1,456) (4,067) (1,966) (3,410)
Net loss............................... $(1,465) $(4,206) $(2,252) $(2,993)
Unaudited pro forma net loss
per share(2)........................ $ (0.33) $ (0.39)
Shares used in computing unaudited
pro forma net loss per share(2)..... 6,853 7,705
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------
ACTUAL AS ADJUSTED(3)
------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities.................. $37,086 $55,324
Working capital................................................... 31,440 49,678
Total assets...................................................... 43,509 61,747
Capital lease obligations, less current portion................... 1,728 1,728
Total stockholders' equity........................................ 34,621 52,859
</TABLE>

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

(1) Excludes 1,394,920 shares issuable upon the exercise of options outstanding
as of December 31, 1996 with a weighted average exercise price of $3.62 per
share.

(2) Unaudited pro forma net loss per share is determined by dividing Net loss by
Shares used in computing unaudited pro forma net loss per share. For
information regarding Shares used in computing unaudited pro forma net loss
per share, see Note 2 of Notes to Financial Statements.

(3) As adjusted to give effect to the sale of 1,632,500 shares of Common Stock
offered by the Company hereby, after deducting the underwriting discount and
offering expenses, at the public offering price of $12.00 per share and the
application of the estimated net proceeds therefrom as set forth in "Use of
Proceeds."

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

Except as otherwise noted, all information in this Prospectus assumes no
exercise of the Underwriters' over-allotment option. The shares of Common Stock
offered hereby involve a high degree of risk. Investors should carefully
consider the information set forth under "Risk Factors."

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

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<PAGE> 7

RISK FACTORS

This Prospectus contains forward-looking statements that involve risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements as a result of certain factors, including those
set forth below and elsewhere in this Prospectus. The following risk factors
should be considered carefully in addition to the other information in this
Prospectus before purchasing the shares of Common Stock offered hereby.

Limited Operating History; History of Operating Losses; Uncertainty of
Future Profitability. The Company has had a limited operating history. For the
years ended December 31, 1994, 1995 and 1996, the Company had net losses of
approximately $4.2 million, $2.3 million and $3.0 million, respectively. As of
December 31, 1996, the Company had an accumulated deficit of approximately $10.9
million. The Company's expansion of its operations and enhancements to its
technology will result in significant expenses over the next several years that
may not be offset by significant revenues. The Company expects that revenue for
the foreseeable future and the Company's ability to achieve profitability will
be dependent upon the ability of the Company to enter into additional
collaborative arrangements with customers. To date, all revenue received by the
Company has been derived from up-front fees, payments for compound deliveries,
and research and development funding paid pursuant to collaborative agreements
with the Company's collaborative partners. The Company has not realized any
revenue from the achievement of milestones or royalties from the discovery,
development or sale of a commercial product by one of the Company's
collaborative partners, and there can be no assurance that any such revenue will
be realized. The Company is unable to predict when, or if, it will become
profitable. See "Selected Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

Unproven Business Strategy. The Company's modular building block approach
to chemistry has not yet resulted in the commercialization of a product. The
Company uses chemical building blocks for the purpose of rapidly identifying,
optimizing and obtaining proprietary rights to as many compounds with commercial
potential as possible. The pricing and nature of the Company's programs are such
that there may only be a limited number of companies that are potential
customers for such programs. The Company's ability to succeed is dependent upon
the acceptance by potential customers of the Company's approach to chemistry and
compound analysis as an effective tool in the discovery and development of
compounds with commercial potential. Due to the highly proprietary nature of the
activities being conducted, the central importance of these activities to their
product discovery and development efforts, and the desire to obtain maximum
patent and other proprietary protection on the results of their internal
programs, pharmaceutical, biotechnology and agrichemical companies have
historically conducted lead compound identification and optimization within
their own research departments. There can be no assurance that the Company's
present or future collaborators will not pursue existing or alternative
technology, either independently or in collaboration with others, in preference
to that of the Company or that the Company will be able to attract future
collaborators on acceptable terms or develop a sustainable, profitable business.
See "Business."

Competition and the Risk of Obsolescence of Technology. Competition among
the many organizations actively attempting to identify and optimize compounds
for development in the pharmaceutical industry and in other areas is intense.
ArQule competes with the research departments of pharmaceutical companies,
biotechnology companies, agrichemical companies, combinatorial chemistry
companies and research and academic institutions. Many of these competitors have
greater financial and human resources, and more experience in research and
development, than the Company. Historically, pharmaceutical and agrichemical
companies have maintained close control over their research activities,
including the synthesis, screening and optimization of chemical compounds. Many
of these companies, which represent the greatest potential market for ArQule's
products and services, have developed or are developing internal combinatorial
chemistry and other methodologies to improve productivity, including major
investments in robotics technology to permit the automated parallel synthesis of
compounds. In addition, ArQule competes with biotechnology and combinatorial
chemistry companies that offer a range of products and services. Academic
institutions, governmental

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<PAGE> 8

agencies and other research organizations are also conducting research in areas
in which the Company is working, either on their own or in collaboration with
others. The Company anticipates that it will face increased competition in the
future as new companies enter the market and advanced technologies, including
more sophisticated information technologies, become available. The Company's
technological approaches may be rendered obsolete or uneconomical by advances in
existing technological approaches or the development of different approaches by
one or more of the Company's competitors. See "Business--Competition."

Limited Sales and Marketing Experience; Expansion of Sales Activities. To
date, the Company has sold its products to its collaborative partners primarily
through the efforts of its senior management. The Company's senior management
has limited experience in marketing products similar to those of the Company. In
order to achieve significant long-term growth in revenue and its overall
strategic goals, the Company intends to hire several dedicated sales and
marketing personnel. There can be no assurance that the Company will be able to
achieve anticipated expansion of its business, attract a significant number of
new collaborative partners as customers or build an efficient and effective
sales and marketing organization. In the event the Company is unable to achieve
any one or more of the foregoing goals, the Company's business, financial
condition and results of operations could be materially adversely affected. In
addition to the risks inherent in the Company's efforts to market its own
products, the Company's revenue from royalties and milestone payments from its
collaborative partners is substantially dependent upon the marketing efforts of
such collaborative partners as discussed below under "Risk Factors--Dependence
on Third Parties."

Dependence on Third Parties. The Company's strategy for the development
and commercialization of its products and services involves the formation of
collaborative arrangements with third parties, initially pharmaceutical,
biotechnology and agrichemical companies. To date, the Company has entered into
numerous such arrangements. There can be no assurance that the Company's
existing collaborations will not be terminated under certain circumstances by
its collaborators and any such terminations could have a material adverse effect
on the Company. There can be no assurance that the Company will be able to
establish additional collaborative arrangements, that any such arrangements will
be on terms favorable to the Company, or that current or future collaborative
arrangements will ultimately be successful. Further, ArQule's receipt of revenue
from collaborative arrangements is affected by the timing of efforts expended by
third parties. The Company's products and services will result in commercialized
pharmaceutical and agrichemical products generating milestone payments and
royalties only after significant preclinical and clinical development efforts or
the completion of preliminary field trials, the receipt of the requisite
regulatory approvals, and the integration of manufacturing capabilities and
successful marketing efforts. With the exception of certain aspects of
preclinical drug development, the Company does not currently intend to perform
any of these activities. Therefore, the Company will be dependent upon the
expertise of, and dedication of sufficient resources by, third parties to
develop and commercialize products. Should a collaborative partner fail to
develop or commercialize a compound or product to which it has obtained rights
from the Company, the Company may not receive any future milestone payments or
royalties associated with such compound or product. Furthermore, there can be no
assurance that any such development or commercialization would be successful or
that disputes will not arise over the application of payment provisions to such
products. There can be no assurance that current or future collaborative
partners will not pursue alternative technologies or develop alternative
products, either on their own or in collaboration with others, including the
Company's competitors, as a means for developing alternative solutions in the
areas targeted by collaborative arrangements with the Company. See
"Business--ArQule's Product Discovery Programs."

Dependence on Key Employees. The Company is highly dependent on the
principal members of its scientific and management staff, in particular, Dr.
Joseph C. Hogan, Jr. and Dr. David L. Coffen. The loss of one or more members of
its staff could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company does not maintain key
person life insurance on the life of any employee. The Company's future success
will also depend, in part, on its ability to identify, hire and retain
additional qualified personnel, including individuals with doctorates

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<PAGE> 9

in basic sciences. There is intense competition for such personnel in the areas
of the Company's activities, and there can be no assurance that the Company will
be able to continue to attract and retain personnel with the advanced technical
qualifications necessary for the development of the Company's business. Failure
to attract and retain key personnel could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business--Employees" and "Management."

Future Capital Needs; Uncertainty of Additional Funding. There can be no
assurance that the net proceeds from this offering, together with the Company's
existing capital resources and revenue from operations, will be adequate to fund
the Company's operations through March 1999. The Company may be required to
raise additional capital over a period of several years in order to conduct its
operations. Such capital may be raised through additional public or private
equity financings, as well as collaborative arrangements, borrowings and other
available sources. The Company's capital requirements depend on numerous
factors, including entering into additional collaborative arrangements,
competing technological and market developments, changes in the Company's
existing collaborative relationships, the cost of filing, prosecuting, defending
and enforcing patent claims and other intellectual property rights, the purchase
of additional capital equipment, the progress of the Company's drug discovery
programs and the progress of the Company's collaborators' milestone and
royalty-producing activities. The Company does not currently plan to
independently develop, manufacture or market any products it discovers. Should
the Company choose to develop any such products, however, the Company will
require substantial funds to conduct research and development, preclinical
studies, clinical trials and field trials and to market any products that may be
developed. There can be no assurance that additional funding, if necessary, will
be available on favorable terms, if at all. If adequate funds are not available,
the Company may be required to curtail operations significantly or to obtain
funds by entering into arrangements with collaborative partners or others that
may require the Company to relinquish rights to certain of its technologies,
product candidates, products or potential markets. To the extent that additional
capital is raised through the sale of equity or securities convertible into
equity, the issuance of such securities could result in dilution to the
Company's existing stockholders. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

Dependence on Scale Up and Management of Growth. The Company's success
will depend on the expansion of its operations and the management of these
expanded operations. To be cost-effective in its delivery of services and
products, the Company must enhance productivity through further automation of
its processes and improvements to its technology. The Company also must
successfully structure and manage multiple additional collaborative
relationships. There can be no assurance that the Company will be successful in
its engineering efforts to further automate its processes or that the Company
will be successful in managing and meeting the staffing requirements of
additional collaborative relationships. Failure to achieve any of these goals
could have a material adverse effect on the Company's business, financial
condition or results of operations. See "Business--ArQule's Product Discovery
Programs" and "--Employees."

Control By Management and Existing Stockholders. Upon completion of this
offering, the Company's significant stockholders, executive officers, directors
and affiliated entities together will beneficially own approximately 49.5% of
the outstanding shares of Common Stock (48.3% if the Underwriters'
over-allotment option is exercised in full). As a result, these stockholders,
acting together, will be able to control most matters requiring approval by the
stockholders of the Company, including the election of directors. Such a
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company, including transactions in which stockholders
might otherwise receive a premium for their shares over then current market
prices. See "Principal and Selling Stockholders."

Dependence on Patents and Proprietary Rights. ArQule has one issued patent
and has filed a number of patent applications. There can be no assurance that
patent applications filed by ArQule will result in patents being issued, that
the claims of such patents will offer significant protection of the Company's
technology, or that any patents issued to or licensed by ArQule will not be
challenged, narrowed, invalidated or circumvented. The Company believes its
success will depend in large part on

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<PAGE> 10

its ability, and the ability of its licensees and its licensors, to obtain
patents for its technologies and the compounds and other products, if any,
resulting from the application of such technologies, to defend such patents once
obtained and to maintain trade secrets, both in the United States and in foreign
countries. In the absence of such patents, the Company may be unable to prevent
others from utilizing the Company's technology and may need to rely upon
expertise developed during pre-commercial implementation of the technology,
which may not provide the same level of competitive advantages. The commercial
success of the Company will also depend upon avoiding the infringement of
patents issued to others and maintaining the technology licenses upon which
certain of the Company's current products are, or any future products under
development might be, based.

Some of the Company's competitors have, or are affiliated with companies
having, substantially greater resources than the Company, and such competitors
may be able to sustain the costs of complex patent litigation to a greater
degree and for longer periods of time than the Company. Uncertainties resulting
from the initiation and continuation of any patent or related litigation could
have a material adverse effect on the Company's ability to compete in the
marketplace pending resolution of the disputed matters. To date, one patent has
been issued to the Company. There can be no assurance that other patents will
issue to the Company or its licensors as a result of their pending applications
or that, if issued, such patents will contain claims sufficiently broad to
afford protection against competitors with similar technology. Moreover, there
can be no assurance that the Company or its customers will be able to obtain
significant patent protection for compounds or products based upon the Company's
technology. There can be no assurance that any patents issued to the Company or
its collaborative partners, or for which the Company has license rights, will
not be challenged, narrowed, invalidated or circumvented, or that the rights
granted thereunder will provide competitive advantages to the Company.
Litigation, which could result in substantial cost to the Company, may be
necessary to enforce the Company's patent and license rights, to enforce or
defend an infringement claim, or to determine the scope and validity of others'
proprietary rights. If competitors of the Company prepare and file patent
applications in the United States or abroad that claim technology also claimed
by the Company, the Company may have to participate in interference proceedings
declared by the U.S. Patent and Trademark Office to determine the priority of
invention, or opposition proceedings in a foreign patent office, both of which
could result in substantial cost to the Company, even if the outcome is
favorable. An adverse outcome could subject the Company to significant
liabilities to third parties, and require the Company to cease using the
technology or to license disputed rights from third parties, which licenses may
not be available at reasonable cost.

A number of pharmaceutical, biotechnology and agrichemical companies, as
well as research and academic institutions, have developed technologies, filed
patent applications or received patents on various technologies that may be
related to the Company's business. Some of these technologies, applications or
patents may conflict with the Company's technologies or patent applications.
Such conflicts could also limit the scope of the claim of any patents that the
Company may be able to obtain, or result in the rejection of the Company's
patent applications. The Company currently has certain licenses to patents and
patent applications from third parties, and in the future may require additional
licenses from other parties. There can be no assurance that: (i) such licenses
will be obtainable on commercially reasonable terms, if at all; (ii) the patents
underlying such licenses will be valid and enforceable; (iii) patents having
commercially valuable claims will issue from any licensed patent applications;
or (iv) the proprietary nature of any other technology underlying such licenses
will remain proprietary.

The Company relies substantially on certain technologies that are not
patentable or proprietary and are therefore available to the Company's
competitors. The Company also relies on certain proprietary trade secrets and
know-how that are not patentable. Although the Company has taken steps to
protect its unpatented trade secrets and know-how, in part through the use of
confidentiality agreements with its employees, consultants and certain of its
collaborators, there can be no assurance that (i) the agreements will not be
breached; (ii) the Company would have adequate remedies for any

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breach; or (iii) the Company's trade secrets will not otherwise become known or
be independently developed or discovered by competitors. See "Business--Patents
and Proprietary Rights."

Possible Volatility of Stock Price. The market price of the Company's
Common Stock, which is quoted on the Nasdaq National Market, may be subject to
significant fluctuations in response to announcements of technological
innovations or new commercial products by the Company or its competitors,
developments concerning proprietary rights, including patents and litigation
matters, publicity regarding actual or potential results with respect to
products or compounds under development by the Company or its collaborative
partners, regulatory developments in both the United States and foreign
countries, public concern as to the efficacy of new technologies, general market
conditions, as well as quarterly fluctuations in the Company's revenues and
financial results and other factors. In particular, the realization of any of
the risks described in these "Risk Factors" could have a dramatic and adverse
impact on such market price. See "Underwriting."

Anti-Takeover Effect of Certain Charter and By-Law Provisions and Delaware
Law. The Company's Amended and Restated Certificate of Incorporation (the
"Restated Certificate") authorizes the Board of Directors to issue, without
stockholder approval, up to 1,000,000 shares of preferred stock ("Preferred
Stock") with voting, conversion and other rights and preferences that could
adversely affect the voting power or other rights of the holders of Common
Stock. The issuance of Preferred Stock or of rights to purchase Preferred Stock
could be used to discourage an unsolicited acquisition proposal. In addition,
the possible issuance of Preferred Stock could discourage a proxy contest, make
more difficult the acquisition of a substantial block of the Company's Common
Stock or limit the price that investors might be willing to pay for shares of
the Company's Common Stock. The Restated Certificate provides for staggered
terms for the members of the Board of Directors. A staggered Board of Directors
and certain provisions of the Company's By-laws (the "By-laws") and of Delaware
law applicable to the Company could delay or make more difficult a merger,
tender offer or proxy contest involving the Company. The Company, for example,
is subject to Section 203 of the General Corporate Law of Delaware which,
subject to certain exceptions, restricts certain transactions and business
combinations between a corporation and a stockholder owning 15% or more of the
corporation's outstanding voting stock (an "interested stockholder") for a
period of three years from the date the stockholder becomes an interested
stockholder. These provisions may have the effect of delaying or preventing a
change of control of the Company without action by the stockholders and,
therefore, could adversely affect the price of the Company's Common Stock. See
"Management," "Description of Capital Stock--Preferred Stock" and
"--Anti-Takeover Measures."

Potential Liability Regarding Hazardous Materials. The research and
development processes of the Company involve the controlled use of hazardous
materials. The Company is subject to federal, state and local laws and
regulations governing the use, manufacture, storage, handling and disposal of
such materials and certain waste products. The risk of accidental contamination
or injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could be held liable for any damages that result
and any such liability could exceed the resources of the Company. In addition,
there can be no assurance that the Company will not be required to incur
significant costs to comply with environmental laws and regulations in the
future.

Government Regulation. Although the manufacture, transportation and
storage of the Company's products are subject to the laws and regulations
regarding hazardous materials discussed in the preceding risk factor, the sale
of the Company's products is not subject to significant government regulations.
However, the Company's future profitability is dependent on the sales of
pharmaceuticals and other products developed from the Company's compounds by its
customers and collaborators. Regulation by governmental entities in the United
States and other countries may be a significant factor in the production and
marketing of products that may be developed by a customer or collaborative
partner of the Company. The nature and the extent to which such regulation may
apply to the Company's customers or its collaborative partners will vary
depending on the nature of any such products.

10
<PAGE> 12

Virtually all pharmaceutical products developed by the Company's customers
or its collaborative partners will require regulatory approval by governmental
agencies prior to commercialization. In particular, human pharmaceutical
products are subject to rigorous preclinical and clinical testing and other
approval procedures by the U.S. Food and Drug Administration (the "FDA") and by
foreign regulatory authorities. Various federal and, in some cases, state
statutes and regulations also govern or influence the manufacturing, safety,
labeling, storage, record keeping and marketing of such pharmaceutical products.
The process of obtaining these approvals and the subsequent compliance with
appropriate federal and foreign statutes and regulations are time consuming and
require the expenditure of substantial resources. Generally, in order to gain
FDA approval, a company first must conduct preclinical studies in the laboratory
and in animal models to gain preliminary information on a compound's efficacy
and to identify any safety problems. The results of these studies are submitted
as a part of an Investigational New Drug application ("IND") that the FDA must
review before human clinical trials of an investigational drug can start. In
order to commercialize any products, the Company or its customers or its
collaborative partners will be required to sponsor and file an IND and will be
responsible for initiating and overseeing the clinical studies to demonstrate
the safety and efficacy that are necessary to obtain FDA approval of any such
products. Clinical trials are normally done in three phases and generally take
two to five years, but may take longer, to complete. After completion of
clinical trials of a new product, FDA and foreign regulatory authority marketing
approval must be obtained. If the product is classified as a new drug, a New
Drug Application ("NDA") must be filed and approved before commercial marketing
of the drug. The testing and approval processes require substantial time and
effort and there can be no assurance that any approval will be granted on a
timely basis, if at all. NDAs submitted to the FDA can take several years to
obtain approval. Even if FDA regulatory clearances are obtained, a marketed
product is subject to continual review, and later discovery of previously
unknown problems or failure to comply with the applicable regulatory
requirements may result in restrictions on the marketing of a product or
withdrawal of the product from the market as well as possible civil or criminal
sanctions. For marketing outside the United States, the Company will also be
subject to foreign regulatory requirements governing human clinical trials and
marketing approval for pharmaceutical products. The requirements governing the
conduct of clinical trials, product licensing, pricing and reimbursement vary
widely from country to country.

Fertilizers, pesticides and other agrichemical products sold by the
Company's collaborators will be subject to rigorous testing and approval
processes by the U.S. Environmental Protection Agency ("EPA") and similar
regulatory authorities in certain states and in other countries. The process of
obtaining these approvals can be time consuming and costly. There can be no
assurance that such approvals will be granted on a timely basis. See
"Business--Government Regulation."

Shares Eligible for Future Sale and Potential Adverse Effect on Market
Price. Future sales of Common Stock in the public market following this
offering could adversely affect the market price of the Common Stock. Upon
completion of this offering, the Company will have 11,490,862 shares of Common
Stock outstanding, assuming no exercise of currently outstanding options. Of
these shares, approximately 3,018,647 shares and the 2,000,000 shares sold in
this offering (plus any additional shares sold upon exercise of the
Underwriters' over-allotment option) will be freely tradable without restriction
under the Securities Act of 1933, as amended (the "Securities Act"), unless they
are held by "affiliates" of the Company as that term is used under the
Securities Act and the regulations promulgated thereunder. Of the 6,472,215
remaining shares, approximately 5,564,481 shares of Common Stock (plus
approximately 258,857 shares issuable upon exercise of vested options) are
currently eligible for sale under Rules 144 and 701. The remainder of the
approximately 907,734 shares of Common Stock held by an existing stockholder
will become eligible for sale under Rule 144 on April 29, 1997. Stockholders of
the Company, holding in the aggregate 6,195,295 shares of Common Stock, have
agreed, subject to certain limited exceptions, not to sell or otherwise dispose
of any of the shares held by them as of the date of this Prospectus for a period
of 90 days after the date of this Prospectus (the "lock-up period") without the
prior written consent of Hambrecht & Quist LLC. The holders of 6,219,948 shares
of Common Stock have the right in certain circumstances to require the Company
to

11
<PAGE> 13

register their shares under the Securities Act for resale to the public
beginning at the end of the lock-up period. If such holders, by exercising their
demand registration rights, cause a large number of shares to be registered and
sold in the public market, such sales could have an adverse effect on the market
price of the Company's Common Stock. If the Company were required to include in
a Company-initiated registration shares held by such holders pursuant to the
exercise of their piggyback registration rights, such sales may have an adverse
effect on the Company's ability to raise needed capital. See "Shares Eligible
for Future Sale" and "Underwriting."

Broad Management Discretion in Use of Proceeds. The Company's management
will have broad discretion to allocate proceeds of this offering to uses that it
believes are appropriate. There can be no assurance that the proceeds of this
offering can or will be invested to yield a positive return. See "Use of
Proceeds."

Immediate and Substantial Dilution. Purchasers of the shares of Common
Stock offered hereby will experience immediate and substantial dilution
estimated at $7.40 in the net tangible book value of their investment from the
assumed public offering price. Additional dilution will occur upon exercise of
outstanding options. See "Dilution" and "Shares Eligible for Future Sale."

Absence of Dividends. The Company has never paid dividends on its Common
Stock and does not anticipate paying any cash dividends in the foreseeable
future. The Company currently intends to retain its earnings, if any, for the
development of its business.

12
<PAGE> 14

THE COMPANY

ArQule was incorporated in Delaware in December 1993 and is the successor
to a partnership formed on May 6, 1993. The Company's principal executive
offices are located at 200 Boston Avenue, Medford, Massachusetts 02155, and its
telephone number is (617) 395-4100.

USE OF PROCEEDS

The net proceeds to the Company from the sale of the Common Stock offered
by the Company hereby, after deducting the underwriting discount and offering
expenses, are estimated to be $18.2 million ($21.6 million if the Underwriters'
over-allotment option is exercised in full), at the public offering price of
$12.00 per share.

The Company intends to use the net proceeds of the shares offered by the
Company in the offering, together with the Company's existing cash, cash
equivalents, short-term investments and cash generated from operations, for
research and development, working capital and general corporate purposes. Such
general corporate purposes may include acquisitions of other businesses,
technologies, products or capabilities and the funding of joint development
efforts involving selected compounds identified by the biotechnology
collaborators. The Company is not in any negotiations with respect to any such
acquisitions. The amount and timing of the Company's actual expenditures for the
purposes described above will depend upon a number of factors, including the
Company's ability to enter into additional collaborative or licensing
arrangements, as well as the timing and terms of such arrangements. In addition,
the Company's research and development expenditures will vary as programs are
expanded or abandoned and as a result of variability in funding from its
collaborative partners. The Company's management will have broad discretion to
allocate the net proceeds of this offering to uses that it believes are
appropriate. There can be no assurance that the proceeds of this offering can or
will be invested to yield a positive return.

The Company currently believes the net proceeds of the offering, together
with the Company's existing cash, cash equivalents, short-term investments, cash
generated from operations and research funding from corporate collaborators,
will enable the Company to maintain its current and planned operations at least
through March 1999. However, there can be no assurance that this will be the
case. See "Risk Factors--Future Capital Needs; Uncertainty of Additional
Funding" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."

Pending use as set forth above, the net proceeds of the offering will be
invested primarily in interest-bearing, investment-grade securities.

DIVIDEND POLICY

The Company has never paid cash dividends on its Common Stock and does not
anticipate paying any cash dividends in the foreseeable future. The Company
currently intends to retain future earnings, if any, to fund the development of
its business.

13
<PAGE> 15

PRICE RANGE OF COMMON STOCK

The Company's Common Stock began trading on the Nasdaq National Market on
October 16, 1996 under the symbol "ARQL". Prior to October 16, 1996, there was
no public market for the Common Stock or any other securities of the Company.

The following table sets forth, for the periods indicated, the range of the
high and low closing sale prices for the Company's Common Stock:

<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1996
Fourth Quarter (from October 16, 1996)........................... $15.75 $ 9.25
1997
First Quarter.................................................... 24.00 15.00
Second Quarter (through April 3, 1997)........................... 15.38 13.25
</TABLE>

As of April 3, 1997, there were approximately 60 holders of record of the
Company's Common Stock.

CAPITALIZATION

The following table sets forth, as of December 31, 1996, (i) the actual
capitalization of the Company and (ii) the capitalization of the Company as
adjusted to reflect the sale of the 1,632,500 shares of Common Stock offered by
the Company hereby, after deducting the underwriting discount and offering
expenses, at the public offering price of $12.00 per share and the application
of the estimated net proceeds therefrom as set forth in "Use of Proceeds". This
table should be read in conjunction with the financial statements, related notes
and other financial information included herein.

<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------------
ACTUAL AS ADJUSTED
------- -----------
(IN THOUSANDS)
<S> <C> <C>
Capital lease obligations, less current portion........................ $ 1,728 $ 1,728
-------- --------
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000 shares authorized; no
shares issued or outstanding...................................... -- --
Common stock, $0.01 par value; 30,000,000 shares authorized;
9,851,487 shares issued and outstanding actual, 11,483,987 shares
issued and outstanding as adjusted(1)............................. 99 115
Additional paid-in capital........................................... 46,102 64,324
Accumulated deficit.................................................. (10,934) (10,934)
Deferred compensation................................................ (646) (646)
-------- --------
Total stockholders' equity...................................... 34,621 52,859
-------- --------
Total capitalization......................................... $ 36,349 $ 54,587
======== ========
</TABLE>

- ------------------------------
(1) Excludes 1,394,920 shares issuable upon the exercise of options outstanding
as of December 31, 1996 with a weighted average exercise price of $3.62 per
share.

14
<PAGE> 16

DILUTION

The net tangible book value of the Company as of December 31, 1996 was
$34,621,000 or approximately $3.51 per share. Net tangible book value per share
represents the total tangible assets of the Company, less total liabilities,
divided by 9,851,487 shares of Common Stock outstanding. Assuming the receipt by
the Company of the net proceeds from the sale of the 1,632,500 shares of Common
Stock offered by the Company hereby at the public offering price of $12.00 per
share, the pro forma net tangible book value of the Company as of December 31,
1996 would have been $52,859,000, or $4.60 per share. This represents an
immediate increase in net tangible book value of $1.09 per share to existing
stockholders of the Company and an immediate dilution of $7.40 per share to new
investors purchasing Common Stock in this offering. The following table
illustrates the per share dilution to be incurred by new investors as of
December 31, 1996:

<TABLE>
<S> <C> <C>
Public offering price per share..................................... $12.00
Net tangible book value per share at December 31, 1996............ $3.51
Increase per share attributable to new investors.................. 1.09
-----
Pro forma net tangible book value per share after the offering...... 4.60
------
Dilution per share to new investors............................... $ 7.40
======
</TABLE>

The following table sets forth, as of December 31, 1996, the differences
between the existing stockholders and the new investors with respect to the
number of shares of Common Stock acquired from the Company, the total
consideration paid and the average price per share (at the public offering price
of $12.00 per share):

<TABLE>
<CAPTION>
SHARES TOTAL
PURCHASED CONSIDERATION
---------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
----------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1)......... 9,851,487 85.8% $48,237,000 71.1% $ 4.90
New investors(1)................. 1,632,500 14.2 19,590,000 28.9 12.00
---------- ----- ----------- -----
Total.................. 11,483,987 100.0% $67,827,000 100.0%
========== ===== =========== =====
</TABLE>

- ------------------------------
(1) Sales of 367,500 shares by the Selling Stockholders in this offering will
reduce the number of shares held by existing stockholders as of December 31,
1996 to 9,483,987 or 82.6% of total shares outstanding after this offering,
and will increase the number of shares held by new investors to 2,000,000 or
17.4% of the total shares outstanding after this offering.

The above information excludes an aggregate of 1,394,920 shares of Common
Stock issuable upon the exercise of options outstanding as of December 31, 1996
with a weighted average exercise price of $3.62 per share. To the extent that
such options are exercised, there will be further dilution to new investors.

15
<PAGE> 17

SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The following data, insofar as it relates to the period from inception (May
6, 1993) through December 31, 1993 and for the years 1994, 1995 and 1996, have
been derived from the Company's audited financial statements, including the
balance sheet as of December 31, 1995 and 1996 and the related statements of
operations and of cash flows for the three years ended December 31, 1996 and
notes thereto appearing elsewhere herein. The data should be read in conjunction
with the Financial Statements and the Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" appearing
elsewhere in this Prospectus. The historical results are not necessarily
indicative of the results of operations to be expected in the future.

<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(MAY 6, 1993) THROUGH YEAR ENDED
DECEMBER 31, DECEMBER 31,
--------------------- -----------------------------
1993 1994 1995 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue.................................... $ -- $ 85 $ 3,330 $ 7,255
------- ------- ------- -------
Costs and expenses:
Cost of revenue......................... -- -- 1,644 4,739
Research and development................ 769 2,806 2,095 3,076
Marketing, general and administrative... 687 1,346 1,557 2,850
------- ------- ------- -------
Total costs and expenses........... 1,456 4,152 5,296 10,665
------- ------- ------- -------
Loss from operations....................... (1,456) (4,067) (1,966) (3,410)
Interest income (expense), net............. (9) (139) (286) 417
------- ------- ------- -------
Net loss................................... $(1,465) $(4,206) $(2,252) $(2,993)
======= ======= ======= =======
Unaudited pro forma net loss per
share(1)................................ $ (0.33) $ (0.39)
======= =======
Shares used in computing unaudited pro
forma net loss per share(1)............. 6,853 7,705
======= =======
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, 1996
------------------------------ --------------------------
1993 1994 1995 ACTUAL AS ADJUSTED(2)
------ ------- ------- ------- --------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and
marketable securities............ $ 595 $ 425 $ 7,791 $37,086 $55,324
Working capital (deficit)........... 275 (2,108) 5,074 31,440 49,678
Total assets........................ 1,538 2,321 10,190 43,509 61,747
Capital lease obligations, less
current portion.................. 376 962 911 1,728 1,728
Series B mandatorily redeemable
convertible preferred stock...... -- -- 6,888 -- --
Total stockholders' equity
(deficit)........................ 771 (1,203) (1,000) 34,621 52,859
</TABLE>

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

(1) Unaudited pro forma net loss per share is determined by dividing the Net
loss by Shares used in computing unaudited pro forma net loss per share. For
information regarding Shares used in computing unaudited pro forma net loss
per share, see Note 2 of Notes to Financial Statements.

(2) Reflects the effect of the sale of 1,632,500 shares of Common Stock offered
by the Company hereby, after deducting the underwriting discount and
offering expenses, at the public offering price of $12.00 per share and the
application of the estimated net proceeds therefrom as set forth in "Use of
Proceeds."

16
<PAGE> 18

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

OVERVIEW

ArQule is engaged in the discovery and development of novel chemical
compounds with commercial potential in the pharmaceutical, biotechnology and
agrichemical industries. ArQule manufactures and delivers two types of arrays of
synthesized compounds to its pharmaceutical, biotechnology and agrichemical
partners: (i) Mapping Array compound sets, which are arrays of novel, diverse
small molecule compounds used in screening for lead generation and (ii) Directed
Array compound sets, which are arrays of analogs of a particular lead compound
(identified from a Mapping Array set or otherwise), synthesized for the purpose
of optimizing such lead compounds.

The Company currently generates revenue primarily through compound
development from collaborative agreements, which provide for the development and
delivery of Mapping Array and Directed Array sets. The Company's revenue to date
is primarily attributable to five major corporate collaborations: Pharmacia
Biotech AB, entered into in March 1995; Abbott Laboratories, entered into in
June 1995; Solvay Duphar B.V., entered into in November 1995; Roche Bioscience,
entered into in September 1996; and Monsanto Company, entered into in December
1996. Under these collaborations, the Company has received payments of $15.1
million through December 31, 1996 and has recognized $10.4 million as revenue.
The Company recognizes revenue under its corporate collaborations as related
work is performed and arrays are delivered. Payments received from corporate
partners prior to the completion of the related work are recorded as deferred
revenue. License option fees are recognized as the options are granted because
such fees are nonrefundable and the Company has no further obligations to
fulfill. The Company is also entitled to receive milestone and royalty payments
if products generated under the collaborations are developed. The Company has
not received any milestone or royalty payments to date. The Company has
additionally entered into joint discovery agreements with a number of
biotechnology companies to which it has provided Mapping Array and Directed
Array sets in exchange for joint ownership of resulting drug candidates. These
agreements have not yet yielded any significant revenue for the Company.

The Company has not been profitable since inception and has incurred a
cumulative net loss of $10.9 million through December 31, 1996. Losses have
resulted principally from costs incurred in research and development activities
related to the Company's efforts to develop its technologies and from the
associated administrative costs required to support these efforts. The Company's
ability to achieve profitability is dependent on its ability to market its
Mapping Array and Directed Array Programs to pharmaceutical, biotechnology and
agrichemical companies and the joint development and commercialization of
products in which it has an economic interest.

RESULTS OF OPERATIONS

Years Ended December 31, 1996 and 1995

Revenue. The Company's revenue for the year ended December 31, 1996
increased $4.0 million to $7.3 million from $3.3 million for the same period in
1995. This was attributable to a $5.0 million increase in compound development
revenue related to the performance of work and the delivery of Mapping Array and
Directed Array sets under the Company's collaborative agreements, offset by a
$1.0 million decrease in license option fees during the same period. The Company
began recognizing revenue from the Pharmacia Biotech AB, Abbott Laboratories and
Solvay Duphar B.V. collaborations in March, June and November 1995, respectively
and for Roche Bioscience and Monsanto Company in October and December of 1996,
respectively.

Cost of revenue. The Company's cost of revenue for the year ended December
31, 1996 increased $3.1 million to $4.7 million from $1.6 million for the same
period in 1995. This increase was primarily attributable to the costs of
additional scientific personnel and the necessary supplies and overhead expenses
related to the performance of the work and the delivery of the Mapping Array and
Directed

17
<PAGE> 19

Array sets pursuant to its collaborative agreements. The Company anticipates
that the aggregate cost of revenue will increase over the next several years as
its business expands.

Research and development expenses. The Company's research and development
expenses for the year ended December 31, 1996 increased $1.0 million to $3.1
million from $2.1 million for the same period in 1995. This increase was the
result of the Company's expansion of its chemical libraries and related
proprietary technologies. The Company expects research and development spending
to increase over the next several years as the Company further expands its
chemistry discovery and development programs.

Marketing, general and administrative expenses. The Company's marketing,
general and administrative expenses for the year ended December 31, 1996
increased $1.3 million to $2.9 million from $1.6 million for the same period in
1995. The increase was primarily associated with increased business development
activities, expenses of being a public company, and higher levels of
administrative support for the Company's growth during 1996. These expenses will
likely increase in the aggregate in future periods to support the projected
growth of the Company.

Net interest income (expense). The Company's net interest income for the
year ended December 31, 1996 was $0.4 million, which compared to a net interest
expense of $0.3 million for the same period in 1995. Higher interest income in
1996 resulted primarily from the Company holding higher cash balances following
its initial public offering of Common Stock in October 1996.

Net loss. The Company's net loss for the year ended December 31, 1996
increased $0.7 million to $3.0 million from $2.3 million for 1995. The increase
was primarily attributable to operating and development expenses exceeding the
increase in revenue generated from corporate collaborations during 1996.

Years Ended December 31, 1995 and 1994

Revenue. The Company's revenue for the year ended December 31, 1995
increased to $3.3 million from $0.1 million for the same period in 1994. This
increase was attributable to compound development revenue related to the
performance of work and the delivery of Mapping Array and Directed Array sets
under the Company's collaborative agreements which were entered into during
1995. The Company also recognized a $1.0 million license option fee related to
the Pharmacia Biotech AB collaborative agreement entered into in 1995.

Cost of revenue. The Company's cost of revenue for the year ended December
31, 1995 was $1.6 million, reflecting costs associated with the development,
production and delivery of compounds pursuant to the corporate collaborations
entered into in 1995. There was no cost of revenue in 1994 as there were no
collaborative agreements during this year and as the Company's efforts were
directed toward the research and development of its technology.

Research and development expenses. The Company's research and development
expenses for the year ended December 31, 1995 decreased $0.7 million to $2.1
million from $2.8 million for the same period in 1994. This decrease was the
result of the Company focusing, in 1995, on producing compounds delivered
pursuant to its collaborative agreements.

Marketing, general and administrative expenses. The Company's marketing,
general and administrative expenses for the year ended December 31, 1995
increased $0.3 million to $1.6 million from $1.3 million for the same period in
1994. This increase was primarily due to costs associated with increased
business development activities and administrative support, which accompanied
the Company's expansion during 1995.

Net interest expense. The Company's net interest expense for the year
ended December 31, 1995 was $0.3 million, which compared to $0.1 million for the
same period in 1994. This increase was primarily attributable to increased use
of capital equipment lease financing.

18
<PAGE> 20

Net loss. The Company's net loss for the year ended December 31, 1995
decreased $1.9 million to $2.3 million from $4.2 million for the same period in
1994. The decrease was primarily attributable to the increase in revenue
generated from corporate collaborations.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1996, the Company held cash and cash equivalents and
marketable securities with a value of $37.1 million. The Company's working
capital at December 31, 1996 was $31.4 million. The Company has funded
operations through December 31, 1996 with sales of preferred stock and common
stock totaling $45.3 million, payments from corporate collaborators totaling
$15.1 million, and the utilization of capital equipment lease financing totaling
$4.1 million. The Company has maintained a master lease agreement since February
1994. Under the terms of this agreement, the Company has funded certain capital
expenditures through leases with terms of 42 months in duration. As of December
31, 1996, the Company had utilized $3.6 million of the available $8.5 million
financing facility.

Net cash provided by financing activities for the year ended December 31,
1996 was $30.8 million, primarily reflecting proceeds from the Company's October
1996 initial public offering. Net cash provided by financing activities for the
year ended December 31, 1995 was $7.2 million, largely due to a $7.0 million
equity investment by Solvay Duphar B.V. Net cash provided by financing
activities for the year ended December 31, 1994 was $3.8 million, resulting
mainly from capital contributions and proceeds from bridge financings.

Net cash provided by operating activities was $0.8 million and $0.7 million
for each of the years ended December 31, 1996 and December 31, 1995,
respectively. The positive cash flow from operating activities primarily
reflects additional payments received from the five corporate collaborators. Net
cash used in operating activities for the year ended December 31, 1994 was $3.8
million, largely due to the Company's scale-up of research and development
activities prior to generating significant revenue.

Net cash provided by investing activities during the year ended December
31, 1996 was $2.0 million, resulting primarily from the sale of marketable
securities offset by the purchases of property and equipment. Net cash used in
investing activities for the year ended December 31, 1995 was $5.3 million as
compared to $0.2 million for the year ended December 31, 1994. This increase
primarily reflects purchases of marketable securities.

Management estimates that the Company's existing cash equivalents,
short-term investments, cash generated from operations and research funding from
corporate collaborators, will enable the Company to maintain its current and
planned operations at least through March 1999. The Company's cash requirements
may vary materially from those now planned depending upon the results of its
drug discovery and development strategies, the ability of the Company to enter
into any corporate collaborations in the future and the terms of such
collaborations, the results of research and development, the need for currently
unanticipated capital expenditures, competitive and technological advances,
acquisitions, and other factors. There can be no assurance that the Company will
be able to obtain additional customers for the Company's products and services,
or that such products and services will produce revenues adequate to fund the
Company's operating expenses. If the Company experiences increased losses, the
Company may have to seek additional financing from public or private sale of its
securities, including equity securities. There can be no assurance that
additional funding will be available when needed or on acceptable terms.

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<PAGE> 21

BUSINESS

OVERVIEW

ArQule has created a new technology platform for the discovery and
production of novel chemical compounds with commercial potential. The Company
has developed proprietary technologies for the identification and optimization
of drug development candidates and agrichemicals. Using combinatorial chemistry,
a modular building block approach to the development of compounds,
structure-guided compound design, high speed parallel chemical synthesis and
information technology, the Company rapidly develops large, diverse collections
of compounds that have the potential to be biologically active. To date, the
Company has entered into collaborative arrangements with Abbott Laboratories,
Monsanto Company, Pharmacia Biotech AB, Roche Bioscience and Solvay Duphar B.V.,
and has formed joint discovery programs with several biotechnology companies.

The potential market for ArQule's proprietary modular building block
technology is comprised of all consumers of novel chemical compounds, including
developers of drugs, separations media, agrichemical products, industrial
catalysts, specialty materials and other industrial products. The Company's
initial business focus has been on the pharmaceutical, biotechnology and
agrichemical industries.

APPLICATION OF THE COMPANY'S TECHNOLOGIES IN THE DRUG DISCOVERY INDUSTRY

INDUSTRY BACKGROUND

Traditional Drug Discovery and Its Limitations. Drugs are chemical
compounds that modulate the activity of biological targets associated with
particular disease states to achieve a desired therapeutic effect. The discovery
and development of drugs has traditionally been a lengthy, expensive and often
unsuccessful process. Typically, it takes 12 to 15 years from the original
concept of modulating the activity of a particular biological target to the
market introduction of a drug that performs such a function. The average cost of
bringing a new drug to market has been estimated to be in excess of $300
million.

The first major step in the drug discovery process is the identification of
one or more compounds that interact with a biological target, such as an enzyme,
receptor or other protein, that is associated with a disease state. To identify
such a compound, collections of compounds are tested or screened for activity
with respect to the biological target. A compound that interacts with a target
is referred to as a hit, and a hit with characteristics making it suitable as a
potential drug is referred to as a lead compound.

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<PAGE> 22

<TABLE>

TRADITIONAL DRUG DISCOVERY PROCESS
<CAPTION>

<S> <C> <C> <C> <C> <C> <C>
Secondary
Development Assays and
of Assays Other Tests Preclinical
Incorporating Target (6 to 12 months) Development

____________ ___________ __________ ___________ ____________ ____________ ______________
Clinical
Unmet Relevant Lead Drug Trials/
Therapeutic _____ Biological __ Assays ___ Hit ___ Compound ___ Development__ Regulatory
Need Target Candidate Approval
____________ ___________ __________ ___________ ____________ ____________ ______________

_________
Natural/
Synthetic
Product
Cellular Libraries Lead
Molecular __________ Optimization
Biology (average 2 years)

Screening
(6 months to 2 years)

__________________________________ Average Time to Market: 12 to 15 years__________________________________
Average Cost: $300+ million

</TABLE>

Historically, drug developers have obtained collections of chemical
compounds for screening from natural product sources and by synthesis. These
collections are often neither sufficiently diverse to be likely to result in a
hit nor preselected to include compounds with promising structures or desirable
drug characteristics. This random screening approach has yielded a relatively
small percentage of hits and only a relatively small portion of those hits have
resulted in lead compounds.

The second major step in the drug discovery process is the optimization of
a lead compound by the sequential synthesis and testing of variations, or
analogs, of a lead compound to identify promising drug development candidates. A
drug development candidate is a lead compound that in preclinical studies
demonstrates pharmacological efficacy, lack of toxicity, potency, selectivity
and other desirable characteristics such as oral availability, cell penetration
and stability. Using traditional medicinal chemistry, lead optimization has
required an average of two years of synthesizing hundreds of analogs of a lead
compound and has been the most expensive and time consuming part of the drug
development process prior to clinical testing. The synthesis of a single
compound analog takes approximately 7 to 10 days and costs approximately $7,500.
As a result, a chemist is usually able to synthesize only 100 to 200 analogs per
year. On average, as many as 6,000 chemical compounds may be synthesized per
successful drug at a cost of approximately $45 million in chemistry costs.

Drug Development in Transition. Lower profit margins, shorter product
lives, the proliferation of generic drugs, managed care and cost containment
initiatives, combined with scientific and technological advances, have created
powerful incentives for drug developers to explore new technologies to discover
novel drugs more quickly and cost effectively. The growing biotechnology and
gene discovery (genomics) industries are rapidly identifying numerous new
biological targets and developing highly sensitive assays incorporating these
targets. Advances in robotics have led to automated high throughput screening
systems, allowing biologists to assay large numbers of chemical compounds
against novel targets. These developments have resulted in increased demand for
large and diverse collections of novel compounds.

In addition, in recent years, structure-guided and rational drug design
approaches have allowed scientists, using structure-activity relationship
("SAR") data about biological targets, to design compounds that are likely to
show activity with respect to a biological target. These developments,

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<PAGE> 23

together with the developments referred to in the preceding paragraph, have
resulted in a proliferation of hits, generating demand for tools to rapidly
create analogs of hits and optimize lead compounds.

Current Combinatorial Chemistry Technology and Its Limitations.
Combinatorial chemistry is the rapid creation of hundreds of thousands of
chemical compounds, most of which do not exist in nature, for the purpose of
rapidly identifying hits through random screening. Current combinatorial
chemistry has been successful in producing large numbers of compounds and
correspondingly large numbers of hits. However, current combinatorial chemistry
techniques have been less successful in generating lead compounds and,
ultimately, drug development candidates for some or all of the following
reasons:

- Time-Consuming Isolation of Hits. In certain combinatorial chemistry
applications, large numbers of chemical compounds are synthesized and
screened in mixtures. Hits must therefore be isolated from the mixtures,
which is a costly, slow, labor-intensive process.

- Lack of Structural and SAR Information. Once a hit is isolated, many
current combinatorial techniques fail to facilitate the identification of
the structure of the hit or to provide SAR data to guide the lead
optimization process.

- Incompatibility with Drug Developers' Screening Protocols. Many
combinatorial compounds are produced in a format that is incompatible
with standard screening protocols of drug developers. In addition, once a
hit is found and the compound is isolated, significant additional work
must often be performed by the combinatorial chemistry company to
determine the structure of the compound. Drug developers relying on this
format may therefore be required to transfer hits to the combinatorial
chemistry company.

- Limitations of Solid Phase Chemistry. Several combinatorial chemistry
techniques involve the production of compounds using solid phase
chemistry in which compounds are attached to small beads. Because many
compounds with desirable chemistries cannot be synthesized using solid
phase chemistry, collections of compounds based exclusively on solid
phase chemistry may have limited diversity.

- Limited Compound Quantities. Certain current combinatorial chemistry
techniques produce very small quantities of each compound, which limits
further testing once a lead compound is found and precludes archiving of
compounds for future testing against additional targets.

- Scale-Up Limitations. Many current combinatorial chemistry techniques
involve laboratory methods that cannot be easily translated into large
scale manufacturing processes. This creates the possibility that active
compounds will be identified that are difficult or impractical to produce
in quantities necessary for clinical trials or commercial production.

- Unproductive Screening. Because certain combinatorial chemistry
techniques involve the screening of random compounds without preselection
for desirable drug characteristics, suitable lead compounds often can be
identified only after many unproductive screenings. In addition, testing
of mixtures frequently produces equivocal or false positive screening
results because the observed activity with a biological target is caused
by several compounds within the mixture rather than the interaction of an
individual compound with a target, leading to further unproductive
screening.

Although recent developments in combinatorial chemistry have shortened the
time between identifying a biological target and obtaining a hit in the target
assay, the proliferation of hits has not led to a commensurate increase in lead
compounds. In addition, current combinatorial chemistry techniques have not
significantly improved the lead optimization process and, therefore, have not
significantly shortened the time it takes to produce a drug development
candidate from a lead compound.

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<PAGE> 24

THE ARQULE REVOLUTION

ArQule believes its modular building block technology overcomes many of the
limitations of current combinatorial chemistry approaches by achieving targeted
diversity to accelerate the identification and optimization of lead compounds.
Targeted diversity is the design of diverse compound arrays that are biased
toward specific biological targets by selecting molecules from a variety of
chemical classes and constructing compound arrays in a manner believed to
increase the probability of discovering one or more active compounds for those
biological targets.

Many organic molecules, including amino acids, peptides, nucleosides,
carbohydrates, steroids and alkaloids, may be viewed as comprised of structural
components, consisting of a scaffold, or core structure, around which a set of
substituent groups and connectors (bonds) is varied. ArQule's scientists have
developed proprietary methods for selecting and combining molecular components,
or building blocks, to produce arrays of compounds that possess properties they
believe will exhibit activity in biological systems.

Using SAR data regarding biologically active compounds and modular
molecular components, ArQule's synthetic and computational chemists work
together to rapidly design compound arrays that include all combinations of a
set of selected building blocks around a common core structure or theme.
ArQule's arrays are created by using structure-guided and rational drug design
tools to systematically select and assemble molecular building blocks with
properties the Company's scientists believe are likely to exhibit biological
activity. Each compound in the array is different from the adjacent compound as
a result of a single structural modification. Each ArQule array omits compounds
that are closely analogous to other compounds in the array, using representative
diversity to create a logical representation of a virtual library of hundreds of
times as many compounds as are in the array. Drug developers are able to realize
significant savings by screening the thousands of compounds in each ArQule array
rather than the millions of compounds they represent. In addition, the SAR data
of compounds within the array provides a navigational tool for lead optimization
by indicating the most promising investigational direction for analoging.

In order to enhance the effectiveness of this modular building block
technology, ArQule integrates the following tools:

- structure-guided design;

- a proprietary "automated molecular assembly plant" (AMAP) system for high
speed parallel synthesis, purification and structural verification of
chemical compounds; and

- proprietary computer applications that facilitate the integration of all
of the Company's proprietary technologies.

[Graphical representation displaying the integration of ArQule's Combinatorial
Drug Design and Development Platform]

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<PAGE> 25

Structure-Guided Design. ArQule's scientists believe that the likelihood
of generating a drug development candidate can be substantially increased if the
collection of compounds used for screening is created using three-dimensional
structural and SAR data. The Company designs its arrays based on chemical
structures that are believed to be biologically active and also on SAR data
regarding a particular target and a particular lead compound. Using this data,
as well as knowledge of the chemical reactions that are feasible using high
speed parallel synthesis, ArQule's scientists design logically arranged arrays
of diverse compounds that can easily be synthesized. The Company believes that
this approach will accelerate the lead discovery and optimization process by
increasing the probability of identifying a lead compound that will result in a
drug development candidate.

The AMAP High Speed Parallel Synthesis System. Using its "automated
molecular assembly plant" (AMAP) system, ArQule synthesizes, purifies and
verifies structural information for individual compounds through automated high
speed parallel synthesis. The AMAP system is capable of synthesizing thousands
of compounds per day, each in milligram quantities adequate for multiple
screens, analyzing such compounds for structural integrity and purity,
registering the structural data in a relational database, and delivering the
compounds in a 96-well microtiter plate format for high throughput screening.

Integrated Proprietary Computer Applications ("Informatics"). ArQule has
developed a proprietary information system which incorporates (i) databases of
the molecular structures of building blocks and the compounds in its arrays,
(ii) multi-dimensional matrix geometry which provides guidance for the creation
of the Company's spatially addressable arrays of compounds containing systematic
variations of modular building blocks, (iii) instructions for the robotics
involved in the AMAP parallel synthesis production process, (iv) resulting
databases of structural information regarding the compounds produced in any
particular array which can be supplied in a format compatible with customers'
own data registration systems and (v) databases of SAR data regarding particular
compounds and their molecular components contained in an array generated when
these compounds are screened against biological targets. This integrated
information system enables ArQule to gather and apply data on an ongoing basis
to enhance the efficiency of the production process and to design compounds
based on a growing knowledge of the structure and activity of its molecular
components.

ADVANTAGES OF ARQULE'S COMBINATORIAL DRUG DISCOVERY AND DEVELOPMENT PLATFORM

The Company believes the integration of its technological capabilities
offers a unique combinatorial drug discovery and development platform. This
platform offers the following significant advantages over current combinatorial
chemistry approaches:

- Elimination of Isolation Issues. Unlike combinatorial chemistry
processes involving the production of synthesized compounds in mixtures,
ArQule's AMAP system produces one compound per well, with each well
containing a known compound with a high level of purity.

- Enhanced Structural and SAR Data. ArQule produces arrays using
preselected modular building blocks that its scientists believe are
likely to produce lead compounds with desirable characteristics, and, in
the case of Directed Array sets, based upon the SAR data of the target
and/or lead compound. As a result, the Company believes the success rate
for drugs developed using its arrays will be improved and the risk of
downstream clinical failure will be reduced. The wealth of SAR data
available with respect to compounds in its arrays will also facilitate
the development of analogs for the further optimization of active
compounds.

- Compatibility with Drug Developers' Screening Protocols. ArQule's
compounds are delivered to its collaborators in 96-well microtiter plates
containing one known compound per well. This delivery format is
compatible with most existing screening protocols and permits the owner
of the assay to screen compounds in its own laboratories, thereby having
complete control over the screening process.

24
<PAGE> 26

- Solution and Solid Phase Chemistry. ArQule's compounds may be produced
using either solution or solid phase chemistry, permitting the creation
of a broad range of novel chemical compounds.

- Significant Compound Quantities. ArQule's compounds are delivered to its
collaborators in milligram quantities, permitting the collaborator to
engage in extensive testing of a lead compound or to screen compounds
against multiple biological targets without having to obtain additional
samples from the Company.

- Ease of Scale-Up. ArQule's compounds are produced using fully
reproducible and scalable manufacturing processes.

- Reduction in Unproductive Screening. By creating logical arrays of
compounds based on known structural and SAR data and eliminating
compounds that are closely analogous to others in the array, ArQule
believes that fewer compounds will need to be screened prior to
identifying compounds with activity. In addition, because ArQule delivers
single compounds for screening, such compounds do not generate the false
positives and false negatives associated with screening mixtures of
compounds.

ArQule believes these significant advantages will allow its collaborative
partners to accelerate the drug discovery process by several years by shortening
the time required to identify a lead compound and to optimize that compound into
a drug development candidate. This acceleration should permit drug developers to
realize significant cost reductions and the earlier recovery of research and
development expenditures for successful drugs.

APPLICATION OF THE COMPANY'S TECHNOLOGIES IN THE AGRICHEMICAL INDUSTRY

Industry Background. Agrichemicals are chemical products used in the
agricultural industry. Examples of agrichemicals are herbicides, pesticides,
fungicides, bactericides and soil treatment agents. Historically, agrichemical
developers have obtained chemical compounds for screening from natural product
sources and by traditional medicinal synthesis, and then screened those
compounds against whole organisms rather than specific molecular targets. Lead
compounds have traditionally been optimized using medicinal chemistry techniques
similar to those used in the drug industry. Agrichemicals are also expensive and
time-consuming to develop. As an example, the American Crop Protection
Association estimates that development, testing, and regulatory approval of a
pesticide product typically requires eight to ten years and may cost up to $50
million.

As in the case of the pharmaceutical industry, the agrichemical industry is
under pressure to identify lead compounds for the development of new products.
As patents expire on existing products and generic equivalents become available,
developers must introduce improved products to stay competitive and maintain
profit margins. To gain market acceptance of a new product at a premium price,
the product must provide some advantage to the customer as compared with
existing products, such as an improvement in environmental profile, user health
and safety, consumer health and safety, user convenience, or effectiveness at
lower concentrations. Alternatively, a producer can maintain profit margins on a
product sold without a premium if that product can be manufactured at a lower
cost. Therefore, products in the agrichemical industry have historically been
subject to a cost-benefit analysis that only recently has affected the
pharmaceutical industry with the advent of managed care.

Combinatorial Chemistry in the Agrichemical Industry. The agrichemical
industry is now adopting new technologies including high throughput screening
and combinatorial chemistry for many of the same reasons as the pharmaceutical
industry. The limitations of certain combinatorial chemistry techniques, as
described in the context of the pharmaceutical industry, are also applicable to
the agrichemical industry. Indeed, compound quantities and scale-up issues are
perhaps more important to the agrichemical industry than the pharmaceutical
industry.

- Compound Quantities. The agrichemical industry has historically used
whole-organism screening methods and has not completed the transition to
screening for specific molecular targets.

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<PAGE> 27

These whole-organism assays consume quantities of test compounds in
excess of the quantities produced using certain current combinatorial
chemistry techniques.

- Scale-Up. As compared with the pharmaceutical industry, the agrichemical
industry manufactures and sells larger quantities of product at a lower
margin. In addition, these products will not succeed in the marketplace
unless they offer a clear advantage over existing products, with cost-
effectiveness as a major factor. Because of these constraints, the ease
and cost of manufacture for a product is a more important consideration
in the agrichemical industry than in the pharmaceutical industry.

The ArQule Advantage. The advantages of the ArQule approach to
combinatorial chemistry, as described in the context of the pharmaceutical
industry, are also advantages for the agrichemical industry. Indeed, the ArQule
combinatorial compound discovery and development platform satisfies the
important considerations of adequate compound quantities for initial screening
and ease of scale-up for manufacturing. ArQule's compounds are delivered to its
collaborators in milligram quantities sufficient for whole-organism screening
methods, which are traditionally used in agrichemical development. In addition,
ArQule's compounds are produced using fully reproducible and scalable
manufacturing processes.

ARQULE'S PRODUCTS

ArQule's integrated technologies result in the production of significant
quantities of pure small molecule compounds contained in a logically structured
spatially-addressable array. ArQule provides its collaborative partners with two
types of arrays of synthesized compounds: (i) Mapping Array compound sets, which
are arrays of novel, diverse, small molecule compounds used for screening
against biological targets and (ii) Directed Array compound sets, which are
arrays of analogs of a particular lead compound synthesized for the purpose of
optimizing that lead compound.

Mapping Array Program. ArQule's Mapping Array Program is a multi-year
subscription to annual Mapping Array compound sets which are designed around
certain core structures or themes selected by ArQule. Through this program, the
Company provides 15 to 20 Mapping Array compound sets, on an annual basis, each
containing between 3,000 and 10,000 individual compounds for a minimum aggregate
of 100,000 compounds. The Mapping Array Program is provided to subscribers
without limitation as to the targets against which the compounds may be
screened. ArQule believes this approach will maximize the number of targets
against which its Mapping Array sets are tested, thereby maximizing the
potential for identifying activity for each compound in the array. Initially,
the Company provides its Mapping Array sets on a non-exclusive, subscription fee
basis for screening purposes only. If a compound shows activity in a
subscriber's assay, the subscriber may license that compound from the Company
for development purposes on an exclusive basis, unless such compound has already
been licensed to another collaborative partner. The Company does not provide any
structural information regarding the compounds in the Mapping Array sets until a
particular compound is licensed.

Directed Array Programs. Under its Directed Array Programs, the Company
provides Directed Array sets in order to optimize lead compounds. In a Directed
Array set, the Company uses its modular building block technology to create
analogs of a lead compound identified by the collaborator, either independently
or as a result of screening a Mapping Array set. Successive Directed Array sets
are generated in order to identify the analog or analogs having the greatest
biological activity and most desirable development characteristics. When
delivering each Directed Array set, the Company provides the collaborator with
structural information for each compound in the array, and each compound is
owned by the collaborator either individually or jointly with ArQule, subject to
the payment of fixed fees, milestones and royalties to the Company. Under a
typical Directed Array Program, ArQule provides three to seven Directed Array
sets, each averaging about 1,000 analogs of a particular lead compound chosen by
a collaborator in consultation with ArQule.

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<PAGE> 28

BUSINESS STRATEGY

ArQule's goal is to become the leading drug and chemical product discovery
company by using its high throughput molecular technologies to design,
synthesize and test high performance molecules for health care and specialty
chemical applications. The Company seeks to penetrate the product development
pipelines of pharmaceutical, agrichemical and biotechnology companies and to
maximize the likelihood of the discovery of activity and successful development
of commercial compounds. Key elements of the Company's strategy include:

- Collaborations with Pharmaceutical and Agrichemical Companies. The
Company seeks collaborations with those companies that have established
manufacturing, marketing and sales resources and a strong commitment to
the development of pharmaceutical or agrichemical products. ArQule offers
to each of its collaborative partners access to its Mapping Array Program
for an annual subscription fee and provides, if requested, customized
Directed Array Programs for a fixed fee. In addition, the Company is
entitled to payments upon the achievement of certain milestones and
royalties upon the commercialization of products developed by the
collaborator from ArQule compounds. The Company plans to pursue
additional collaborations aggressively to gain access to additional
targets and development expertise, and to generate additional revenue.

- Joint Discovery Programs with Biotechnology Companies. Biotechnology
companies have identified numerous proprietary biological targets and
assays and therefore represent important potential collaborators for
joint discovery and development efforts using ArQule's Mapping Array and
Directed Array sets. ArQule provides Mapping Array and Directed Array
sets to biotechnology companies in exchange for joint ownership of any
lead compounds that exhibit activity in the proprietary assays developed
by the biotechnology company collaborators. ArQule seeks collaborators
with promising drug development programs in a broad range of therapeutic
areas.

- Expansion of Proprietary Drug Discovery Capabilities. The Company
intends to expand its proprietary drug discovery capabilities by
developing or acquiring, either independently or in partnership with
others, proprietary biological targets, proprietary assays and the
capability to screen its compounds against such assays. The Company will
also consider investing in the lead optimization and initial preclinical
and clinical development efforts for selected lead compounds in order to
realize a greater portion of the value created by its technologies.

- Extension of Chemistry Tools to Other Areas. The Company intends to
extend its integrated technologies outside the fields of pharmaceuticals,
agrichemicals and bioseparations to a variety of other applications,
including industrial catalysts and polymeric structures for
non-biological applications.

- Continued Investment in Proprietary Chemistry Technology. ArQule intends
to continue its aggressive investment in proprietary chemistry
technologies through internal development and licensing of third party
technologies. ArQule will also continue to invest in improving the cost-
effectiveness of its products through automation and information
technologies.

ARQULE'S PRODUCT DISCOVERY PROGRAMS

Pharmaceutical and Agrichemical Company Collaborations

To date, the Company has entered into the following major collaborations
with pharmaceutical and agrichemical companies:

Abbott Laboratories. In June 1995, the Company entered into a
collaborative agreement with Abbott Laboratories ("Abbott") pursuant to which
Abbott subscribed to the Company's Mapping Array Program and has the right to
request customized Directed Array sets (the "Abbott Agreement"). To date, the
Company has provided Abbott with several Mapping Array and Directed Array sets.
In

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<PAGE> 29

August 1996, the Abbott Agreement was amended to provide for the Company to
supply Abbott with additional Mapping Array sets and to eliminate restrictions
on the period during which Abbott may screen the Mapping Array sets. In December
1996, the Abbott Agreement was further amended to extend the term of the Abbott
Agreement until March 1999, to provide for the Company to supply Abbott with
additional Mapping Array sets during such extended period and to provide for the
payment by Abbott of additional research and development funding during such
extended period. Abbott may not terminate the Abbott Agreement prior to March
1999 without cause. Absent early termination, Abbott has agreed to pay the
Company $6.8 million through March 1999. Abbott is also obligated under the
Abbott Agreement to make additional payments upon the achievement of certain
milestones and to pay royalties on the sale of drugs that may result from the
relationship. To date, Abbott has paid the Company an aggregate of $5.0 million
under the Abbott Agreement.

Monsanto Company. In December 1996, the Company entered into a
collaborative agreement with Monsanto Company ("Monsanto"), pursuant to which
Monsanto subscribed to the Company's Mapping Array Program and the Company
agreed to synthesize Directed Array sets from compounds provided to the Company
by Monsanto and/or developed by the Company under the Mapping Array Program (the
"Monsanto Agreement"). Assuming Monsanto requests the synthesis of at least one
Directed Array per year over the term of the Monsanto Agreement, the Company
will receive a minimum of $12.0 million over five years. Monsanto is also
obligated to make additional payments upon the achievement of certain milestones
and to pay royalties on sales of products that may result from the relationship.
The Monsanto Agreement expires in December 2001, subject to Monsanto's right to
extend the term of the Monsanto Agreement for two additional one-year periods.
Monsanto has the right to terminate the Mapping Array Program and/or the
Directed Array Program on six months' written notice at any time subject to its
payment of a termination fee equal to the aggregate minimum amount that would
have been paid to the Company by Monsanto under the program to be terminated
over the entire five-year term. To date, Monsanto has paid the Company an
aggregate of $0.8 million under the Monsanto Agreement.

Pharmacia Biotech AB. In March 1995, the Company entered into a
collaborative agreement with Pharmacia Biotech AB ("Pharmacia"), a wholly-owned
subsidiary of Pharmacia & Upjohn, Inc., to allow Pharmacia to evaluate the
utility of the Company's technology for the development of products in the
fields of bioseparations, synthesis of biomolecules and cell culture (the
"Pharmacia Agreement"). On the same date, the Company and Pharmacia also signed
an agreement under which Pharmacia has an option to acquire an exclusive,
worldwide license to develop and commercialize specified compounds generated by
the Company in additional fields covered under the Pharmacia Agreement, subject
to the payment by Pharmacia of additional fees and the negotiation and execution
by the parties of a license agreement containing commercially reasonable terms
(the "Option Agreement"). To date, Pharmacia has paid the Company an aggregate
of $2.5 million under the Pharmacia Agreement and the Option Agreement.

Roche Bioscience. In September 1996, the Company entered into a
collaborative agreement with Roche Bioscience ("Roche Bioscience"), a division
of Syntex (U.S.A.) Inc. and indirect subsidiary of Roche Holding Ltd., pursuant
to which the Company will synthesize Directed Array sets from compounds provided
to the Company by Roche Bioscience, developed by the Company internally and/or
developed by the Company as a part of the collaboration (the "Roche Bioscience
Agreement"). Absent early termination, Roche Bioscience will pay the Company
approximately $12.1 million over three years. The parties may jointly agree to
increase the number of Directed Array sets to be provided by the Company under
the Roche Bioscience Agreement, which may result in increased payments to the
Company. Roche Bioscience is also obligated to make additional payments upon the
achievement of certain milestones and to pay royalties on sales of drugs that
may result from the relationship. The Roche Bioscience Agreement expires in
September 1999 and is terminable by Roche Bioscience on or after September 1998
on six months' advance notice. If such termination occurs on September 30, 1998,
the Company will have received payments of approximately $8.4 million from Roche
Bioscience through that date and no further payments, other than milestone
payments and

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royalties, will be due to the Company. To date, Roche Bioscience has paid the
Company an aggregate of $3.6 million under the Roche Bioscience Agreement.

Solvay Duphar B.V. In November 1995, the Company entered into a
collaborative agreement with Solvay Duphar B.V. ("Solvay") pursuant to which
Solvay has subscribed to the Company's Mapping Array Program and has the right
to request customized Directed Array sets (the "Solvay Agreement"). To date, the
Company has provided Solvay with several Mapping Array and Directed Array sets.
Absent early termination, Solvay agreed to pay the Company a minimum of $17.5
million over five years. Solvay is also obligated to make additional payments
upon the achievement of certain milestones and to pay royalties on sales of
drugs that may result from the relationship. The Solvay Agreement expires in
November 2000. Solvay has the right to terminate the Mapping Array Program on
twelve months' written notice at any time subject to its payment of a
termination fee of approximately $1.0 million. Solvay may also terminate the
delivery of Directed Array sets on six months' written notice at any time
subject to its payment of a termination fee equal to a certain percentage of the
aggregate research payments made by Solvay in the year in which notice is given.
If Solvay gave notice to terminate both programs on the date of this Prospectus,
as of the effective termination dates, Solvay would have paid the Company $4.3
million, not including the termination fees. No further payments would be due
from Solvay other than milestone or royalty payments. To date, Solvay has paid
the Company an aggregate of $4.3 million under the Solvay Agreement. In
connection with this collaboration, an affiliate of Solvay, Physica B.V., made a
$7.0 million equity investment in the Company. See "Certain Transactions." Under
the Solvay Agreement, Solvay has the right to license, on an exclusive basis,
lead compounds identified from a Mapping Array set that are active against
specified biological targets and that have not previously been committed to
another of ArQule's collaborative partners or to an internal program of the
Company. Solvay also has the right to use certain of ArQule's technologies
internally.

Joint Discovery Programs with Biotechnology Companies

ArQule has initiated joint programs for lead generation and optimization
with a number of biotechnology companies. Some of ArQule's biotechnology
collaborators and their areas of focus are listed below:

<TABLE>
<CAPTION>
COMPANY AREA OF FOCUS
- ------- -------------
<S> <C>
Aurora Biosciences, Inc. Mammalian Cell-Based Assays
Cadus Pharmaceuticals Corporation Signal Transduction
Cubist Pharmaceuticals, Inc. Infectious Diseases
ICAgen, Inc. Ion Channel Receptors
Scriptgen Pharmaceuticals, Inc. RNA/Protein Interaction
Signal Pharmaceuticals, Inc. Gene Transcription/Transcription Factors
SUGEN, Inc. Signal Transduction
T Cell Sciences, Inc. T Cell Activation/Inhibition
</TABLE>

In the United States, small biotechnology companies have been highly
successful in the discovery of biological targets associated with disease
states. Many of these companies, however, lack both (i) large libraries of
chemical compounds to screen against identified targets and (ii) the
sophisticated chemistry expertise required to optimize compounds once a lead
compound has been identified. Under the Company's typical arrangement with a
biotechnology company, ArQule provides Mapping Array sets for screening without
collecting upfront fees, and the biotechnology company executes a preliminary
material transfer agreement. If the collaborator detects an active compound
within a Mapping Array set, and that compound has not been previously committed
to a third party or to an internal ArQule program, the Company and the
collaborator establish a joint discovery program and execute the research
collaboration agreement that is attached to the material transfer agreement. If
the parties are unable to negotiate the scope of a joint discovery program
within a certain period, ArQule has the right to license such compound to any
third party.

29
<PAGE> 31

Although ArQule's formal research collaboration agreement varies from
transaction to transaction, it typically establishes a joint drug development
program for the lead compound and a particular target, and gives ArQule shared
control over the program.

MARKETING AND SALES

The Company markets its products directly to customers through
participation in trade conferences and seminars and publications in scientific
and trade journals.

To date, the Company has sold its products to its collaborative partners
primarily through the efforts of its senior management. The Company's senior
management has limited experience in marketing products similar to those of the
Company. In order to achieve significant long-term growth in revenues and its
overall strategic goals, the Company intends to hire several dedicated sales and
marketing personnel. There can be no assurance that the Company will be able to
achieve anticipated expansion of its business, attract a significant number of
new collaborative partners as customers or build an efficient and effective
sales and marketing organization. In the event the Company is unable to achieve
any one or more of the foregoing goals, the Company's business, financial
condition and results of operations could be materially adversely affected. In
addition to the risks inherent in the Company's efforts to market its own
products, the Company's revenues from royalties and milestone payments from its
collaborative partners are substantially dependent upon the marketing efforts of
such collaborative partners.

RESEARCH AND DEVELOPMENT

ArQule intends to continue its aggressive investment in its proprietary
technologies through internal development and licensing of third party
technologies in order to increase the diversity and improve other
characteristics of the compounds offered. The Company will also continue to
invest in improving the cost-effectiveness of its products and capabilities
through automation and information technologies. The Company is actively
pursuing research projects aimed at identifying and developing new chemistries
to improve and expand on its Mapping Array and Directed Array Programs. The
Company is also undertaking collaborations with other researchers in order to
pursue the possible acquisition of chemistries and other technologies developed
by academic institutions and other third parties.

PATENTS AND PROPRIETARY RIGHTS

ArQule has one issued patent and has filed a number of patent applications.
There can be no assurance that patent applications filed by ArQule will result
in patents being issued, that the claims of such patents will offer significant
protection of the Company's technology, or that any patents issued to or
licensed by ArQule will not be challenged, narrowed, invalidated or
circumvented. The Company may also be subject to proceedings that result in the
revocation of patent rights previously owned by or licensed to ArQule, as a
result of which the Company may be required to obtain licenses from others to
continue to develop, test or commercialize its products. There can be no
assurance that ArQule will be able to obtain such licenses on acceptable terms,
if at all. In addition, there may be pending or issued patents held by parties
not affiliated with ArQule that relate to the technology utilized by ArQule. As
a result, ArQule may need to acquire licenses, to assert infringement, or
contest the validity, of such patents or other similar patents which may be
issued. ArQule could incur substantial costs in defending itself against patent
infringement claims, interference proceedings, opposition proceedings or other
challenges to its patent rights made by third parties, or in bringing such
proceedings or enforcing any patent rights of its own.

The Company also relies upon trade secrets, know-how and continuing
technological advances to develop and maintain its competitive position. In an
effort to maintain the confidentiality and ownership of trade secrets and
proprietary information, the Company requires employees, consultants and certain
collaborators to execute confidentiality and invention assignment agreements
upon

30
<PAGE> 32

commencement of a relationship with the Company. These agreements are intended
to enable the Company to protect its proprietary information by controlling the
disclosure and use of technology to which it has rights and provide for
ownership by the Company of proprietary technology developed at the Company or
with the Company's resources. There can be no assurance, however, that these
agreements will provide meaningful protection for the Company's trade secrets or
other confidential information in the event of unauthorized use or disclosure of
such information or that adequate remedies would exist in the event of such
unauthorized use or disclosure. The loss or exposure of trade secrets possessed
by ArQule could have a material adverse effect on its business.

COMPETITION

Many organizations are actively attempting to identify and optimize
compounds for potential pharmaceutical or agrichemical development. The
Company's services and products face competition based on a number of factors,
including size, diversity and ease of use of libraries of compounds, speed and
costs of identifying and optimizing potential lead compounds and patent
position. ArQule competes with the research departments of pharmaceutical
companies, biotechnology companies, agrichemical companies, combinatorial
chemistry companies and research and academic institutions. Many of these
competitors have greater financial and human resources and more experience in
research and development than the Company. Smaller companies may also prove to
be significant competitors, particularly through arrangements with large
corporate collaborators. In addition to competition for customers, these
companies and institutions also compete with the Company in recruiting and
retaining highly qualified scientific and management personnel.

Historically, pharmaceutical and agrichemical companies have maintained
close control over their research activities, including the synthesis, screening
and optimization of chemical compounds. Many of these companies, which represent
a significant potential market for ArQule's products and services, are
developing in-house combinatorial chemistry and other methodologies to improve
productivity, including major investments in robotics technology to permit the
automated parallel synthesis of compounds. In addition, these companies may
already have large collections of compounds previously synthesized or ordered
from chemical supply catalogs or other sources against which they may screen new
targets. Other sources of compounds include extracts from natural products such
as plants and microorganisms and compounds created using rational design.
Academic institutions, governmental agencies and other research organizations
are also conducting research in areas in which the Company is working either on
their own or through collaborative efforts.

The Company anticipates that it will face increased competition in the
future as new companies enter the market and advanced technologies become
available. The Company's processes may be rendered obsolete or uneconomical by
technological advances or entirely different approaches developed by one or more
of the Company's competitors. The existing approaches of the Company's
competitors or new approaches or technology developed by the Company's
competitors may be more effective than those developed by the Company.

There can be no assurance that the Company's competitors will not develop
more effective or more affordable technology or products, or achieve earlier
product development and commercialization than the Company, thus rendering the
Company's technologies and/or products obsolete, uncompetitive or uneconomical.
See "Risk Factors--Competition and the Risk of Obsolescence of Technology."

GOVERNMENT REGULATION

Although the manufacture, transportation and storage of the Company's
products are subject to certain laws and regulations discussed in the last
paragraph of this section, the sale of the Company's products is not subject to
significant government regulations. However, the Company's future profitability
is dependent on the sales of pharmaceuticals and other products developed from
the Company's compounds by its customers and collaborators. Regulation by
governmental entities in the

31
<PAGE> 33

United States and other countries will be a significant factor in the production
and marketing of any pharmaceutical products that may be developed by a customer
of the Company, or in the event the Company decides to develop a drug beyond the
preclinical phase. The nature and the extent to which such regulation may apply
to the Company's customers will vary depending on the nature of any such
pharmaceutical products. Virtually all pharmaceutical products developed by the
Company's customers will require regulatory approval by governmental agencies
prior to commercialization. In particular, human pharmaceutical products are
subject to rigorous preclinical and clinical testing and other approval
procedures by the FDA and by foreign regulatory authorities. Various federal
and, in some cases, state statutes and regulations also govern or influence the
manufacturing, safety, labeling, storage, record keeping and marketing of such
pharmaceutical products. The process of obtaining these approvals and the
subsequent compliance with appropriate federal and foreign statutes and
regulations are time consuming and require the expenditure of substantial
resources.

Generally, in order to gain FDA approval, a company first must conduct
preclinical studies in the laboratory and in animal models to gain preliminary
information on a compound's efficacy and to identify any safety problems. The
results of these studies are submitted as a part of an IND that the FDA must
review before human clinical trials of an investigational drug can start. In
order to commercialize any products, the Company or its customer will be
required to sponsor and file an IND and will be responsible for initiating and
overseeing the clinical studies to demonstrate the safety and efficacy that are
necessary to obtain FDA approval of any such products. Clinical trials are
normally done in three phases and generally take two to five years, but may take
longer, to complete. After completion of clinical trials of a new product, FDA
and foreign regulatory authority marketing approval must be obtained. If the
product is classified as a new drug, the Company or its customer will be
required to file an NDA and receive approval before commercial marketing of the
drug. The testing and approval processes require substantial time and effort and
there can be no assurance that any approval will be granted on a timely basis,
if at all. NDAs submitted to the FDA can take several years to obtain approval.
Even if FDA regulatory clearances are obtained, a marketed product is subject to
continual review, and later discovery of previously unknown problems or failure
to comply with the applicable regulatory requirements may result in restrictions
on the marketing of a product or withdrawal of the product from the market as
well as possible civil or criminal sanctions. For marketing outside the United
States, the Company will also be subject to foreign regulatory requirements
governing human clinical trials and marketing approval for pharmaceutical
products. The requirements governing the conduct of clinical trials, product
licensing, pricing and reimbursement vary widely from country to country.

Fertilizers, pesticides and other agrichemicals are heavily regulated in
the United States. The EPA regulates such products under the Federal
Insecticide, Fungicide and Rodenticide Act ("FIFRA"). Agrichemicals are also
regulated by various state agencies. Some states, such as California, have their
own extensive registration requirements. To develop and commercialize a
pesticide product, detailed and complex procedures must be followed and Federal
approvals obtained under FIFRA. Small scale field testing usually can be
conducted prior to product registration to evaluate product efficacy. To conduct
large scale tests, a company must obtain an Experimental Use Permit which
generally requires satisfactory completion of certain toxicology and
environmental studies. Synthetic chemical pesticides require extensive
toxicology and environmental testing to substantiate product safety prior to
obtaining a product registration. Commercial sale of agrichemicals requires a
product registration for each pest and crop for which the product is used.

The research and development processes of the Company involve the
controlled use of hazardous materials. The Company is subject to federal state
and local laws and regulations governing the use, manufacture, storage, handling
and disposal of such materials and certain waste products. Although the Company
believes that its activities currently comply with the standards prescribed by
such laws and regulations, the risk of accidental contamination or injury from
these materials cannot be eliminated. In the event of such an accident, the
Company could be held liable for any damages that result and any liability could
exceed the resources of the Company. In addition, there can be no assurance that
the

32
<PAGE> 34

Company will not be required to incur significant costs to comply with
environmental laws and regulations in the future.

EMPLOYEES

As of February 28, 1997, ArQule employed 66 people of whom 29 have Ph.D.
degrees. Of these, 45 were engaged in operations, 12 were engaged in research
and development and 9 were engaged in marketing and general administration. None
of ArQule's employees are covered by collective bargaining agreements. ArQule
believes its employee relations are good.

FACILITIES

ArQule's research facilities include approximately 51,389 square feet of
laboratory and office space in Medford, Massachusetts pursuant to three lease
agreements. These leases extend through July 30, 2001, at which time the Company
has an option to renew the leases for an additional five year period.

ArQule believes its current facilities are adequate for its current
operations. The Company believes that suitable additional space will be
available to it, when needed, on commercially reasonable terms.

LEGAL PROCEEDINGS

In October 1996, two individuals asserted that they are entitled to
compensation from certain of the Company's stockholders and/or the Company equal
to approximately five percent of the equity interests in the Company for
services in connection with the initial financing of the Partnership in 1993. No
litigation has been commenced and settlement discussions are in progress.
However, no assurance can be given that such individuals will not commence
litigation relating to such claims. The Company intends to vigorously defend any
claim brought by such individuals and believes that it has meritorious defenses
to such claims. No assurances can be given regarding the outcome of any such
litigation.

Except as stated above, ArQule is not a party to any other legal
proceedings.

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<PAGE> 35

MANAGEMENT

EXECUTIVE OFFICERS, KEY EMPLOYEES AND DIRECTORS

The following table sets forth certain information regarding the executive
officers, key employees and directors of the Company as of February 28, 1997:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------- --- ------------------------------------------------------
<S> <C> <C>
Eric B. Gordon....................... 49 President, Chief Executive Officer and Director
Joseph C. Hogan, Jr., Ph.D........... 55 Chairman of the Board, Senior Vice President of
Research and Development, Chief Scientific Officer
David L. Coffen, Ph.D................ 58 Vice President of Chemistry
James R. Fitzgerald, Jr.............. 52 Vice President, Chief Financial Officer and Treasurer
John M. Sorvillo, Ph.D............... 42 Vice President of Business Development
Steven L. Gallion, Ph.D.............. 39 Director, Computational Chemistry
Adrian de Jonge, Ph.D.(1)............ 41 Director
Stephen M. Dow(2).................... 41 Director
Allan R. Ferguson(1)(2).............. 54 Director
</TABLE>

- ------------------------------
(1) Member of the Audit Committee.

(2) Member of the Compensation Committee.

Eric B. Gordon has been the President and Chief Executive Officer of the
Company since January 1996. From 1987 until he joined the Company, Mr. Gordon
served in various capacities in the United States and Europe with Pasteur
Merieux Connaught--U.S., a pharmaceutical company, most recently as Vice
President and Chief Financial Officer. In addition, since 1993 he held the
additional position of Chief Executive Officer of Virogenetics Corporation, a
partially owned joint venture company and since 1994 Vice President and
Treasurer of Pasteur Merieux. Mr. Gordon received his A.M.P. from the Wharton
School of Business of the University of Pennsylvania and his B.S. in Accounting
and Finance from Syracuse University.

Joseph C. Hogan, Jr., Ph.D. is a founder of the Company and has served as
the Chief Scientific Officer and Senior Vice President of Research and
Development since its inception. Dr. Hogan has served as the Chairman of the
Board since January 1996. From 1990 until he founded the Company, Dr. Hogan was
the founder and president of Applied Modular Chemistries, Inc., a chemistry
company. Dr. Hogan received his M.S. and B.S. in Chemistry from Boston College
and his Ph.D. from Boston College and the Max Planck Institut fuer
Kohlenforschung, Muelheim/Ruhr, Germany.

David L. Coffen, Ph.D. has been the Vice President of Chemistry since July
1995. From 1971 until he joined the Company, Dr. Coffen was employed by
Hoffman-LaRoche Inc., a pharmaceutical company, in a variety of positions, most
recently as Vice President of Molecular Sciences. Dr. Coffen received his Ph.D.
in Synthetic Organic Chemistry from the Massachusetts Institute of Technology
and his B.S. in Chemistry from the University of Toronto.

James R. Fitzgerald, Jr. joined the Company in July 1996 as the Vice
President, Chief Financial Officer and Treasurer. From 1988 until he joined the
Company, Mr. Fitzgerald was the Chief Financial Officer of Hoyts Cinemas
Corporation, an owner and operator of cinemas. Mr. Fitzgerald received his
M.B.A. and his B.A. in Economics from Northeastern University.

John M. Sorvillo, Ph.D. joined the Company in December 1995 as Vice
President of Business Development. Prior to joining the Company, Dr. Sorvillo
had provided consulting services to the Company since August 1995. From 1985
until he joined the Company, Dr. Sorvillo was employed by Oncogene Science,
Inc., a biotechnology company, in a variety of positions, most recently as Vice
President and General Manager. Dr. Sorvillo attended the Massachusetts Institute
of Technology

34
<PAGE> 36

Program for Senior Executives. He received his Ph.D. in Immunology from the New
York University Medical Center and his B.A. in Biology from the City University
of New York, Hunter College.

Steven L. Gallion, Ph.D. joined the Company in 1994 as Research Fellow in
Computational Chemistry. In 1995, he became the Company's Director of
Computational Chemistry. Prior to joining the Company, he was employed by Marion
Merrell Dow, Inc., a pharmaceutical company, as Senior Associate Scientist of
Theoretical Chemistry from 1993 to 1994 and Associate Scientist of Theoretical
Chemistry from 1992 to 1993. From 1989 to 1992, he was Director of Product
Development of Amber Systems, Inc., a molecular modeling software company. He
received his Ph.D. in Physical Chemistry from the University of Georgia and his
B.S. in Chemistry from Southhampton College of Long Island University.

Adrian de Jonge, Ph.D. has been a director of the Company since November
1995. Dr. de Jonge is the Vice President of Research of Solvay's Pharmaceuticals
Division and has held such position since 1994. From 1987 through 1993, Dr. de
Jonge was employed by Solvay in a variety of positions, most recently as Sector
Manager of Drug Discovery.

Stephen M. Dow has been a director of the Company since its inception.
Since 1983, he has been a general partner of Sevin Rosen Funds, a venture
capital investment firm. Mr. Dow serves as a director of Citrix Systems, Inc.,
ViroPharma, Inc. and several privately held companies.

Allan R. Ferguson has been a director of the Company since its inception.
He has been a general partner of Atlas Venture since 1993 and managing partner
of Aspen Ventures since 1991, both venture capital firms. From 1986 through
1991, Mr. Ferguson was the President of 3i Ventures, a venture capital firm.
Prior to his venture capital experience, Mr. Ferguson held senior level
positions in operations at Johnson & Johnson and Damon Biotech. Mr. Ferguson
serves as a director of AutoImmune Inc. and several privately held companies.

The Company's Restated Certificate provides for a classified board of
directors consisting of three classes, with each class being as nearly equal in
number as possible. The term of one class expires and their successors are
elected for a term of three years at each annual meeting of the Company's
stockholders. The Company has designated two class I directors (Messrs. Dow and
Gordon), two class II directors (Mr. Ferguson and Dr. Hogan) and one class III
director (Dr. de Jonge). These class I, class II and class III directors will
serve until the annual meetings of stockholders to be held in 1997, 1998 and
1999, respectively, and until their respective successors are duly elected and
qualified, or until their earlier resignation or removal. The Restated
Certificate provides that directors may be removed only for cause by a majority
of stockholders. See "Description of Capital Stock--Anti-Takeover Measures."
There are no family relationships among any of the directors or executive
officers.

BOARD COMMITTEES

The Company has standing Audit and Compensation Committees of the Board of
Directors. The Audit Committee consists of Mr. Ferguson and Dr. de Jonge. The
primary function of the Audit Committee is to assist the Board of Directors in
the discharge of its duties and responsibilities by providing the Board with an
independent review of the financial health of the Company and of the reliability
of the Company's financial controls and financial reporting systems. The Audit
Committee reviews the general scope of the Company's annual audit, the fee
charged by the Company's independent accountants and other matters relating to
internal control systems.

The Compensation Committee of the Board of Directors determines the
compensation to be paid to all executive officers of the Company, including the
Chief Executive Officer. The Compensation Committee's duties include the
administration of the Company's Amended and Restated 1994 Equity Incentive Plan
(the "Equity Plan") and the 1996 Employee Stock Purchase Plan. The Compensation
Committee is currently composed of Messrs. Dow and Ferguson.

35
<PAGE> 37

SCIENTIFIC ADVISORY BOARD

The Company's Scientific Advisory Board consists of individuals with
demonstrated expertise in various fields who advise the Company concerning
long-term scientific planning, research and development. Members also evaluate
the Company's research program, recommend personnel to the Company and advise
the Company on technology matters. The Scientific Advisory Board has met
collectively and in smaller groups, and its members have also been available
individually to advise the Company on specific scientific and technical issues.
Scientific Advisory Board members are compensated on a time and expenses basis
and have received shares of Common Stock of the Company. In the future,
Scientific Advisory Board members also receive options to purchase shares of
Common Stock of the Company. The Company has entered into consulting agreements
with a number of the Scientific Advisory Board members.

No member of the Scientific Advisory Board is employed by the Company, and
members may have other commitments to or consulting or advisory contracts with
their employers or other entities that may conflict or compete with their
obligations to the Company. Accordingly, such persons are expected to devote
only a small portion of their time to the Company. The members of the Company's
Scientific Advisory Board are:

Amin Arnaout, M.D. is Associate Professor of Medicine at Harvard Medical
School and the Director of the Inflammation and Leukocyte Biology Program at
Massachusetts General Hospital where he is also an Associate Physician. He is an
internationally recognized figure in the field of leukocyte adhesion. He is a
graduate of the American University of Beirut School of Medicine and did his
postgraduate work in internal medicine and nephrology at The Johns Hopkins
University Medical Center, Children's Hospital and the Brigham and Women's
Hospital.

William D. Carlson, M.D., Ph.D. is the Director of Cardiovascular Research
for Harvard Community Health Plan, Associate Physician at Brigham and Women's
Hospital and Assistant Professor of Medicine at Harvard University Medical
School. He is widely known for his work in drug development and structural
biology including the renin-angiotensin and osteogenic growth factor systems. He
received his Ph.D. in Molecular Biophysics and Biochemistry from Yale University
and his M.D. from Yale Medical School.

George L. Kenyon, Ph.D. is the Dean of the School of Pharmacy and Professor
of Chemistry and Pharmaceutical Chemistry at the University of California, San
Francisco. He is widely known for his work in the mechanisms of enzymatic
action, and synthetic and mechanistic chemistry and the development of
structure-based approaches to the rational design of enzymatic inhibitions. He
received his Ph.D. in Organic Chemistry from Harvard University.

Irwin D. Kuntz, Ph.D. is the Acting Director of the Molecular Design
Institute, Chairman of the Graduate Group in Biophysics, and Professor in the
Department of Pharmaceutical Chemistry at the University of California, San
Francisco. He is widely known for his pioneering work in computational
chemistry. He received his Ph.D. in Physical Chemistry from the University of
California, Berkley.

Gregory Petsko, Ph.D. is the Lucille P. Markey Professor of Biochemistry
and Chemistry, and Director of the Rosenteil Basic Medical Sciences Research
Center at Brandeis University. He is widely known for his work in the
development of protein crystallography and its application to exploring
fundamental aspects of protein folding. He received his Ph.D. in Molecular
Biology from Oxford University.

Dagmar Ringe, Ph.D. is the Lucille P. Markey Associate Professor and Chair
of the Graduate Program in Biophysics at Brandeis University. She is
internationally recognized for her contributions to the use of x-ray
crystallography to explore fundamental aspects of drug binding behavior. She
received her Ph.D. in Organic Chemistry from Boston University.

36
<PAGE> 38

William R. Roush, Ph.D. is a Distinguished Professor of Chemistry at
Indiana University. He is widely known for his basic studies and applications
for a wide variety of synthetic chemical reactions. He received his Ph.D. in
Chemistry from Harvard University.

K. Barry Sharpless, Ph.D. is the William M. Keck Professor of Chemistry at
The Scripps Research Institute. He is widely known for his pioneering work in
asymmetric chemical synthesis. He received his Ph.D. in Organic Chemistry from
Stanford University.

Harry H. Wasserman, Ph.D. is the Eugene Higgins Professor Emeritus of
Chemistry. He is widely known for his work in the development of new methods in
synthetic organic chemistry. He received his Ph.D. in Organic Chemistry from
Harvard University.

1996 DIRECTOR STOCK OPTION PLAN

All of the directors who are not employees of the Company (the "Eligible
Directors") are currently eligible to participate in the Company's 1996 Director
Stock Option Plan (the "Director Plan"). At the time the Director Plan was
adopted and upon the election of a director who was not an Eligible Director at
the time of adoption, such director or directors were or will be, as applicable,
automatically granted an option to purchase 7,500 shares of Common Stock (the
"Initial Options"). The Initial Options become exercisable with respect to 2,500
shares on the date of the Company's next annual meeting of stockholders
following the date of grant and on the date of each annual meeting of
stockholders thereafter. In addition, options under the Director Plan are
automatically granted once a year, at the annual meeting of stockholders of the
Company, to Eligible Directors elected or reelected at the meeting. Each such
Eligible Director receives an option to purchase 3,500 shares of Common Stock
(the "Annual Options") for each year of the term of office to which the director
is elected (normally, 10,500 shares for election to a three-year term of
office). The Annual Options become exercisable with respect to 3,500 shares on
the date on which the Annual Option was granted and on the date of each annual
meeting of stockholders thereafter, so long as the optionee is then an Eligible
Director of the Company. The Initial Options and Annual Options have a term of
ten years, and an exercise price payable in cash or shares of Common Stock. The
Director Plan was adopted by the Board of Directors in August 1996 and,
therefore, Initial Options for 7,500 shares were issued to each of Mr. Dow, Mr.
Ferguson and Dr. de Jonge. The exercise price for the Initial Options granted on
the date of the adoption of the Plan was $11.00, the fair market value on such
date as determined by the Board of Directors. The exercise price for the Initial
Options and the Annual Options will equal the last sale price for the Common
Stock on the business day immediately preceding the date of grant, as reported
on the Nasdaq National Market. As of April 3, 1997, options to purchase a total
of 22,500 shares of Common Stock were outstanding under the Director Plan, and
102,500 shares of Common Stock were reserved for future option grants under the
Director Plan.

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<PAGE> 39

EXECUTIVE COMPENSATION

The following table sets forth certain information with respect to the
annual and long-term compensation paid or accrued by the Company for services
rendered to the Company in all capacities for the fiscal years ended December
31, 1995 and 1996 by its Chief Executive Officer, its Chief Financial Officer
and another executive officer of the Company whose total salary exceeded
$100,000 (collectively, the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
---------------------------------- ------------
OTHER ANNUAL SECURITIES
COMPENSATION UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) ($) OPTIONS(#) COMPENSATION($)
- ------------------------------------------- ----- -------- -------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Eric B. Gordon(1).......................... 1996 $219,808 -- $126,195(2) 464,920 --
President and Chief Executive Officer 1995 -- -- -- -- --

Joseph C. Hogan, Jr., Ph.D. ............... 1996 171,308 -- 435(3) -- 30,000(4)
Chairman of the Board, Senior Vice 1995 150,000 -- -- -- --
President of Research and Development
and Chief Scientific Officer

James R. Fitzgerald, Jr.(5)................ 1996 51,346 -- -- 50,000 --
Vice President, Chief Financial 1995 -- -- -- -- --
Officer and Treasurer
</TABLE>

- ------------------------------
(1) Mr. Gordon commenced employment with the Company in January 1996. Terms of
his employment are described under "--Executive Employment Agreements."

(2) Consists of reimbursement of relocation expenses incurred by Mr. Gordon
during the fiscal year ended December 31, 1996 in connection with his
becoming an employee of the Company.

(3) Consists of Medicare taxes owed by Dr. Hogan that were paid by the Company.

(4) Consists of amount of indebtedness owed by Dr. Hogan to the Company that was
forgiven by the Company during the fiscal year ended December 31, 1996.

(5) Mr. Fitzgerald commenced employment with the Company in July 1996. Terms of
his employment are described under "--Executive Employment Agreements."

The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 1996 by the Company to the
Named Executive Officers:

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
------------------------------------------------------- ANNUAL RATES OF
NUMBER OF PERCENT OF STOCK PRICE
SECURITIES TOTAL EXERCISE APPRECIATION
UNDERLYING OPTIONS GRANTED OR FOR OPTION TERM(1)
OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION -----------------------
NAME GRANTED(#) FISCAL YEAR ($/SHARE)(2) DATE 5%($) 10%($)
- --------------------------------- ---------- --------------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Eric B. Gordon................... 77,486(3) 8.3% $ 0.80 1/23/06 $ 38,984 $ 98,794
387,434(4) 41.5 0.80 1/23/06 194,924 493,976
Joseph C. Hogan, Jr., Ph.D....... -- -- -- -- -- --
James R. Fitzgerald, Jr.......... 50,000(4) 5.4 6.00 7/09/06 188,668 478,123
</TABLE>

- ------------------------------
(1) The dollar amounts under these columns are the result of calculations at the
5% and 10% rates set by the Securities and Exchange Commission and,
therefore, are not intended to forecast possible future appreciation, if
any, in the price of the underlying Common Stock. No gain to the optionees
is possible without an increase in price of the underlying Common Stock,
which will benefit all stockholders proportionately.

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<PAGE> 40

(2) The exercise price of these options is equal to the fair market value of the
Company's Common Stock on the date of grant, as determined by the Company's
Board of Directors.

(3) Options granted under the Company's Amended and Restated 1994 Equity
Incentive Plan. The shares subject to this option have fully vested.

(4) Options granted under the Company's Amended and Restated 1994 Equity
Incentive Plan. These options become exercisable as to 25% of the shares on
each of the first four anniversaries of January 23, 1996 for Mr. Gordon and
of July 9, 1996 for Mr. Fitzgerald.

The following table sets forth certain information concerning exercisable
and unexercisable stock options held by the Named Executive Officers as of
December 31, 1996:

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES(1)

<TABLE>
<CAPTION>
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FISCAL YEAR-END AT FISCAL YEAR-END(2)
------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Eric B. Gordon.................... 77,486 387,434 $ 1,158,416 $ 5,792,138
Joseph C. Hogan, Jr., Ph.D........ -- -- -- --
James R. Fitzgerald, Jr........... -- 50,000 -- 487,500
</TABLE>

- ------------------------
(1) No options were exercised during the fiscal year ended December 31, 1996 by
the Named Executive Officers.

(2) Based on the difference between closing price of the underlying shares of
Common Stock on December 31, 1996 as reported by the Nasdaq National Market
($15.75) and the option exercise
price.

STOCK PLANS

Amended and Restated 1994 Equity Incentive Plan. The Company's Equity Plan
authorizes the grant of incentive stock options within the meaning of Section
422 of the Internal Revenue Code of 1986, as amended (the "Code"), and
nonqualified stock options for the purchase of an aggregate of 3,200,000 shares
(subject to adjustment for stock splits and similar capital changes) of Common
Stock to employees of the Company and, in the case of non-qualified stock
options, to consultants of the Company or any Affiliate (as defined in the
Equity Plan) capable of contributing to the Company's performance. The Board of
Directors has appointed the Compensation Committee to administer the Equity
Plan. As of December 31, 1996, 1,372,420 shares of Common Stock were subject to
outstanding options granted under the Equity Plan, leaving 1,306,033 shares
available for issuance upon future grants under the Equity Plan.

1996 Employee Stock Purchase Plan. The Company has also adopted an
employee stock purchase plan (the "Purchase Plan") under which employees may
purchase shares of Common Stock at a discount from fair market value. There are
120,000 shares of Common Stock reserved for issuance under the Purchase Plan.
The Purchase Plan is intended to qualify as an employee stock purchase plan
within the meaning of Section 423 of the Code. Rights to purchase Common Stock
under the Purchase Plan are granted at the discretion of the Compensation
Committee, which determines the frequency and duration of individual offerings
under the Plan and the dates when stock may be purchased. Eligible employees
participate voluntarily and may withdraw from any offering at any time before
stock is purchased. Participation terminates automatically upon termination of
employment. The purchase price per share of Common Stock in an offering is 85%
of the lesser of its fair market value at the beginning of the offering period
or on the applicable exercise date and may be paid through payroll deductions,
periodic lump sum payments or a combination of both. The Purchase Plan
terminates on

39
<PAGE> 41

August 14, 2006. As of December 31, 1996, no shares of Common Stock had been
issued under the Purchase Plan.

401(K) PLAN

The Company has a 401(k) savings and retirement plan (the "401(k) Plan")
which covers substantially all employees of the Company. The 401(k) Plan allows
participants to agree to certain salary deferrals which the Company allocates to
the participant's plan account. These amounts may not exceed statutorily
mandated annual limits set forth in the Code. The Company currently does not
match employee contributions to the 401(k) Plan but may do so in the future.

EXECUTIVE EMPLOYMENT AGREEMENTS

The Company has entered into employment agreements with Mr. Gordon and Mr.
Fitzgerald. The Company agreed to employ Mr. Gordon as President and Chief
Executive Officer of the Company, effective January 2, 1996, at an annual salary
of $225,000. In connection with this agreement, Mr. Gordon was granted options
to acquire 387,434 shares of Common Stock at $0.80 per share, which vest over
four years, and options to acquire 77,486 shares of Common Stock at $0.80 per
share, which vested upon the achievement of certain milestones. Mr. Gordon has
also been provided with moving and relocation allowances. The agreement provides
for continued employment until termination by either party. If Mr. Gordon is
terminated by the Company without cause, the agreement provides that he will be
entitled to receive his base salary, plus any benefits to which he is entitled
and any options granted to Mr. Gordon which would have otherwise vested, for a
period of up to six months following such termination of employment. In July
1996, the Company also made a loan in the principal amount of $250,000 to Mr.
Gordon. The principal amount of the loan will be repaid in three equal annual
installments beginning in October 1997 and bears interest at the lowest
applicable federal rate of interest as published by the Internal Revenue
Service. See "Certain Transactions."

Under Mr. Fitzgerald's Agreement, the Company has agreed to employ Mr.
Fitzgerald as Vice President and Chief Financial Officer of the Company,
effective July 9, 1996, at an annual salary of $150,000. In connection with the
agreement, Mr. Fitzgerald was granted options, which vest over four years, to
acquire 50,000 shares of Common Stock at $6.00 per share. The agreement provides
for continued employment until termination by either party. If Mr. Fitzgerald is
terminated without cause by the Company during the first year of the agreement,
he will be entitled to receive his base salary, plus any benefits to which he is
entitled and any options granted to Mr. Fitzgerald which would have otherwise
vested, for a period of up to six months.

CERTAIN TRANSACTIONS

In December 1993, in exchange for the transfer to the Company of
substantially all of the assets and liabilities of ArQule Partners, L.P., a
Delaware limited partnership (the "Partnership"), the Company issued 1,500
shares of its Common Stock to the Partnership, at which time the Partnership
became the sole stockholder of the Company. In November 1994, the Company
declared a stock dividend of 3,332.33 shares of its Common Stock on each
outstanding share of Common Stock held by the Partnership as of October 17,
1994. After certain transfers of Common Stock by the Partnership, in November
1994 all the remaining outstanding shares of Common Stock then held by the
Partnership were surrendered to the Company in exchange for shares of Series A
Convertible Preferred Stock, $0.01 par value per share (the "Series A Preferred
Stock"), which were converted into 4,295,500 shares of Common Stock concurrently
with the closing of the Company's initial public offering.

In November 1993, the Company made a loan in the amount of $63,000 to
Joseph C. Hogan, Jr., Ph.D., Chairman and Chief Scientific Officer of the
Company, which loan is represented by a promissory note due and payable in
November 1996, and was extended to November 1997. The promissory note bears
interest at the lowest applicable federal rate of interest as published by the
Internal Revenue Service. The entire principal and accrued interest is currently
outstanding.

40
<PAGE> 42

During the period from August 1994 through February 1995, Sevin Rosen Fund
IV L.P., Atlas Venture Fund, II, L.P. and Atlas Venture Europe Fund B.V. made a
series of bridge loans to the Company in the aggregate amount of $2,400,000 (the
"Bridge Loans") in exchange for promissory notes and warrants to purchase an
aggregate of 155,300, 58,229 and 26,471 shares of Common Stock, respectively,
exercisable at $0.25 per share until the earlier of the effective date of an
initial public offering or various dates through December 31, 1999 (the "Bridge
Warrants"). In November 1995, the principal amount of the promissory notes
representing the Bridge Loans was converted into shares of Series A Preferred
Stock, which were converted into an aggregate of 960,000 shares of Common Stock
concurrently with the closing of the Company's initial public offering. The
Bridge Warrants were exercised on a cashless basis for 234,992 shares of Common
Stock prior to the closing of the Company's initial public offering.

In November 1995, the Company issued 1,800,000 shares of Series B
Convertible Preferred Stock, $.01 par value per share (the "Series B Preferred
Stock"), to Physica B.V. for cash at a purchase price of $3.89 per share. Such
shares of Series B Preferred Stock were converted into 900,000 shares of Common
Stock concurrently with the closing of the Company's initial public offering.
Physica B.V. is an affiliate of Solvay Duphar B.V., with whom the Company has a
major corporate collaboration. See "Business--ArQule's Product Discovery
Programs."

Also in November 1995, the Company made a loan in the amount of $120,000 to
Dr. Hogan. The loan is represented by a promissory note and is secured by shares
of Common Stock issuable to Dr. Hogan upon dissolution of the Partnership. The
loan bears interest at the lowest applicable federal rate of interest as
published by the Internal Revenue Service. The original principal amount of the
loan is forgiven at a rate of 25% per year on each anniversary date of the note
as long as Dr. Hogan is employed by the Company. In November 1996, $30,000 of
the principal amount of the loan was forgiven by the Company. The remaining
principal and accrued interest is currently outstanding.

In April 1996, all accrued interest outstanding on the Bridge Loans through
November 1995 in the aggregate amount of $142,000 was converted into shares of
Series A Preferred Stock, which were converted into an aggregate of 56,714
shares of Common Stock concurrently with the closing of the Company's initial
public offering. In addition, in consideration of the waiver by Physica B.V. of
its anti-dilution rights under the Company's Amended and Restated Certificate of
Incorporation and its right of first refusal with respect to such shares of
Series A Preferred Stock, the Company issued to Physica B.V. additional shares
of Series B Preferred Stock, which were converted into 7,734 shares of Common
Stock concurrently with the closing of the Company's initial public offering.

In July 1996, the Company made a loan in the amount of $250,000 to Eric B.
Gordon, the President, Chief Executive Officer and a director of the Company,
which loan is secured by shares of Common Stock issuable to Mr. Gordon upon the
exercise of stock options. The loan is represented by a promissory note which is
due and payable in three equal annual installments beginning in October 1997 and
which bears interest at the lowest applicable federal rate of interest as
published by the Internal Revenue Service. The entire principal and accrued
interest is currently outstanding.

In February 1997, the Partnership was dissolved and all shares of Common
Stock of the Company held by the Partnership were distributed to its partners.
Sevin Rosen Fund IV L.P., Atlas Venture Fund II, L.P. and Atlas Venture Europe
B.V., which are direct significant stockholders of the Company (collectively,
the "Venture Fund Investors"), Legomer Investors, Inc. ("LII"), Legomer
Technologies, Inc. ("LTI"), The Hogan Family Limited Partnership, of which Dr.
Hogan is a general partner, and certain other persons were partners of the
Partnership and received shares of Common Stock of the Company upon such
Partnership distribution. The Venture Fund Investors hold all of the outstanding
shares of LII. Dr. Hogan holds 50% of the outstanding stock of LTI. See
"Principal and Selling Stockholders."

41
<PAGE> 43

PRINCIPAL AND SELLING STOCKHOLDERS

The following table and footnotes set forth certain information regarding
the beneficial ownership of the Company's Common Stock as of April 3, 1997, by
(i) persons known by the Company to be beneficial owners of more than 5% of the
Common Stock, (ii) the Named Executive Officers, (iii) each director of the
Company, (iv) all other Selling Stockholders and (iv) all current executive
officers and directors as a group. Unless otherwise indicated, each of the
Company's stockholders has an address in care of the Company's principal
executive offices.

<TABLE>
<CAPTION>
SHARES
SHARES BENEFICIALLY BENEFICIALLY
OWNED PRIOR TO OWNED AFTER
OFFERING(1) OFFERING(1)
------------------- SHARES -------------------
5% STOCKHOLDERS NUMBER PERCENT OFFERED NUMBER PERCENT
- --------------- --------- ------- ------- --------- -------
<S> <C> <C> <C> <C> <C>
Atlas Venture(2)......................... 1,366,250 13.86% -- 1,366,250 11.89%
222 Berkeley Street
Boston, MA 02116
Physica B.V.(3).......................... 907,734 9.20% -- 907,734 7.90%
C.J. van Houtenlaan, 36
1381 CD Weiss
The Netherlands
Sevin Rosen Fund IV L.P.(4).............. 2,368,832 24.03% -- 2,368,832 20.62%
13455 Noel Road, Suite 1670
Dallas, TX 75240

EXECUTIVE OFFICERS AND DIRECTORS
- --------------------------------
Adrian de Jonge, Ph.D.(5)................ 910,234 9.23% -- 910,234 7.92%
Stephen M. Dow(6)........................ 2,371,332 24.05% -- 2,371,332 20.63%
Allan R. Ferguson(7)..................... 1,368,750 13.88% -- 1,368,750 11.91%
Eric B. Gordon(8)........................ 175,844 1.75% -- 175,844 1.51%
Joseph C. Hogan, Jr., Ph.D.(9)........... 1,237,412 12.54% 180,000(11) 1,057,412 9.19%
James R. Fitzgerald, Jr.(10)............. 4,750 * -- 4,750 *
All current executive officers and
directors as a group (6 persons)(12)... 6,068,322 60.34% 180,000 5,888,322 50.38%

OTHER SELLING STOCKHOLDERS
- --------------------------
Robert Dishman(13)....................... 542,567 5.50% 135,000(14) 407,567 3.55%
Gregory Petsko, Ph.D..................... 50,000 * 25,000 25,000 *
Dagmar Ringe, Ph.D....................... 50,000 * 25,000 25,000 *
William R. Roush, Ph.D................... 50,000 * 2,500 47,500 *
</TABLE>

- ------------------------------
* Indicates less than 1%.

(1) Assumes no exercise of the over-allotment option. The persons and entities
named in the table have sole voting and investment power with respect to
the shares beneficially owned by them, except as noted below. Share numbers
include shares of Common Stock issuable pursuant to the outstanding options
that may be exercised within 60 days after April 3, 1997.

(2) Consists of (i) 938,766 shares owned by Atlas Venture Fund II, L.P. and
(ii) 427,484 shares owned by Atlas Venture Europe Fund B. V. (collectively,
"Atlas Venture"). The voting and investment discretion over the shares
owned by Atlas Venture Fund II, L.P. is exercised by the general partners
of Atlas Venture Associates II, L.P., its general partner. The general
partners of Atlas Venture Associates II, L.P. are Allan R. Ferguson, Barry
J. Fidelman, Jean-Francois Formela and Christopher J. Spray. Because of
this relationship, Allan R. Ferguson, a director of the Company, shares
voting and investment discretion over such shares. Atlas Venture Europe
Fund B.V. is a corporation wholly-owned by Atlas InvesteringsGroep N.V.
("AIG"). The voting and investment discretion over the shares owned by
Atlas Venture Europe Fund B.V. is exercised by the managing directors of
AIG, Michiel A. de Haan and Evert H. Smid. Three officers of AIG, Gerard H.
Montanus, Hans Bosman and Jaap van Hellemond, share voting and investment
discretion

42
<PAGE> 44

with these two managing directors over the shares held by Atlas Venture
Europe Fund B.V. The numbers of shares of Common Stock attributed to Atlas
Venture assumes a pro rata distribution of the shares currently owned by
LII to its stockholders (which include Atlas Venture). See "Certain
Transactions."

(3) The voting and investment discretion over the shares owned by Physica B.V.
is exercised by the sole director of Physica B.V., J.W.F. van Ingen.

(4) Consists of 2,368,832 shares owned by Sevin Rosen Fund IV L.P. ("Sevin
Rosen"). The voting and investment discretion over the shares owned by
Sevin Rosen is exercised by the general partner of SRB Associates IV L.P.,
its general partner. The general partners of SRB Associates L.P. are
Stephen M. Dow, Jon W. Bayless, Charles H. Phipps, Dennis J. Gorman, and
John V. Jaggers. Because of this relationship, Stephen M. Dow, a director
of the Company, shares voting and investment discretion over such shares.
The number of shares of Common Stock attributed to Sevin Rosen assumes a
pro rata distribution of the shares currently owned by LII to its
stockholders (which include Sevin Rosen). See "Certain Transactions."

(5) Consists of (i) 2,500 shares of Common Stock subject to options that will
become exercisable within 60 days of April 3, 1997 and (ii) 907,734 shares
of Common Stock owned by Physica B.V. Dr. de Jonge is Vice President of
Research of Solvay's Pharmaceuticals Division, an affiliate of Physica B.V.
Dr. de Jonge disclaims beneficial ownership of the shares held by Physica
B.V.

(6) Consists of (i) 2,500 shares of Common Stock subject to options that will
become exercisable within 60 days of April 3, 1997 and (ii) 2,368,832
shares owned by or attributed to Sevin Rosen. Mr. Dow is a general partner
of SRB Associates IV L.P. which is the general partner of Sevin Rosen. Mr.
Dow disclaims beneficial ownership of the shares owned by or attributed to
Sevin Rosen, except to the extent of his pecuniary interest therein. See
footnote (4).

(7) Consists of (i) 2,500 shares of Common Stock subject to options that will
become exercisable within 60 days of April 3, 1997 and (ii) 1,366,250
shares owned by Atlas Venture. Mr. Ferguson is a general partner of Atlas
Venture Associates II, L.P., which is the general partner of Atlas Venture
Fund II, L.P. Mr. Ferguson disclaims beneficial ownership of the shares
owned by Atlas Venture, except to the extent of his pecuniary interest
therein. See footnote (2).

(8) Consists of (i) 174,344 shares of Common Stock subject to options that are
presently exercisable and (ii) 1,500 shares of Common Stock held in trust
for the benefit of his children.

(9) Consists of (i) 1,107,514 shares held by The Hogan Family Limited
Partnership, of which Dr. Hogan and his wife are the general partners, (ii)
117,398 shares that represent Dr. Hogan's pro rata ownership interest in
the shares currently owned by LTI and (iii) 12,500 shares of Common Stock
subject to options that are presently exercisable.

(10) Includes 3,750 shares of Common Stock subject to options that are presently
exercisable.

(11) All of the 180,000 shares are being offered by The Hogan Family Limited
Partnership. The Hogan Family Limited Partnership may elect not to sell all
or any of these shares. See footnote (1).

(12) Includes 198,094 shares of Common Stock subject to options that are
presently exercisable or will become exercisable within 60 days of April 3,
1997. See footnotes (5), (6), (7), (8), (9) and (10).

(13) Includes (i) 192,210 shares held by Peptide Limited Partnership and (ii)
117,398 shares that represent Mr. Dishman's pro rata ownership interest in
the shares currently owned by LTI. Mr. Dishman is the President of Peptide,
Inc., the general partner of Peptide Limited Partnership.

(14) Consists of (i) 25,000 shares being offered by Peptide Limited Partnership
and (ii) 110,000 shares being offered by Mr. Dishman. Peptide Limited
Partnership and Mr. Dishman may elect not to sell all or any of such
shares. See footnote (1).

43
<PAGE> 45

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 30,000,000 shares
of Common Stock, $0.01 par value per share, and 1,000,000 shares of Preferred
Stock, $0.01 par value per share. As of the date of this Prospectus, the Company
had approximately 60 shareholders of record. Upon the closing of this offering,
the Company will have 11,490,862 shares of Common Stock outstanding.

The following summary of certain provisions of the Common Stock and
Preferred Stock does not purport to be complete and is subject to, and qualified
in its entirety by, the provisions of the Company's Restated Certificate, which
is included as an exhibit to the Registration Statement, and by the provisions
of applicable law.

COMMON STOCK

Holders of Common Stock are entitled to one vote per share on matters to be
voted upon by the stockholders. There are no cumulative voting rights. Holders
of Common Stock are entitled to receive dividends when, as and if declared by
the Board of Directors out of funds legally available therefor. Upon the
liquidation, dissolution or winding up of the Company, holders of Common Stock
share ratably in the assets of the Company available for distribution to its
stockholders, subject to the preferential rights of any then outstanding shares
of Preferred Stock. The Common Stock outstanding upon the effective date of the
Registration Statement, and the shares offered by the Company hereby, upon
issuance and sale, will be fully paid and nonassessable.

PREFERRED STOCK

The Company's Board of Directors has the authority to issue up to 1,000,000
shares of Preferred Stock in one or more series and to fix the relative rights,
preferences, privileges, qualifications, limitations and restrictions thereof,
including dividend rights, dividend rates, conversion rights, voting rights,
terms of redemption, redemption prices, liquidation preferences and the number
of shares constituting any series or the designation of such series, without
further vote or action by the stockholders. The Board of Directors could,
without the approval of the stockholders, issue Preferred Stock having voting or
conversion rights that could adversely affect the voting power of the holders of
Common Stock and the issuance of Preferred Stock could be used, under certain
circumstances, to render more difficult or discourage a hostile takeover of the
Company. No shares of Preferred Stock are currently outstanding and the Company
has no present plans to issue any shares of Preferred Stock.

ANTI-TAKEOVER MEASURES

In addition to the Board of Directors' ability to issue shares of Preferred
Stock, the Restated Certificate and the By-laws of the Company contain several
other provisions that are commonly considered to discourage unsolicited takeover
bids. The Restated Certificate includes provisions classifying the Board of
Directors into three classes with staggered three-year terms and prohibiting
stockholder action by written consent. Under the Restated Certificate and
By-laws, the Board of Directors may enlarge the size of the Board and fill any
vacancies on the Board. The By-laws provide that nominations for directors may
not be made by stockholders at any annual or special meeting unless the
stockholder intending to make a nomination notifies the Company of its intention
a specified period in advance and furnishes certain information. The By-laws
also provide that special meetings of the Company's stockholders may be called
only by the President or the Board of Directors and require advance notice of
business to be brought by a stockholder before the annual meeting.

In February 1988, a law regulating corporate takeovers (the "Anti-Takeover
Law") took effect in Delaware. In certain circumstances, the Anti-Takeover Law
prevents certain Delaware corporations, including those whose securities are
listed on the Nasdaq National Market, from engaging in a "business combination"
(which includes a merger or sale of more than 10% of the corporation's assets)
with an "interested stockholder" (a stockholder who owns 15% or more of the
corporation's

44
<PAGE> 46

outstanding voting stock) for three years following the date on which such
stockholder became an "interested stockholder" subject to certain exceptions,
unless the transaction is approved by the Board of Directors and the holders of
at least 66 2/3% of the outstanding voting stock of the corporation (excluding
shares held by the interested stockholder). The statutory ban does not apply if,
upon consummation of the transaction in which any person becomes an interested
stockholder, the interested stockholder owns at least 85% of the outstanding
voting stock of the corporation (excluding shares held by persons who are both
directors and officers or by certain employee stock plans). A Delaware
corporation subject to the Anti-Takeover Law may "opt out" of the Anti-Takeover
Law with an express provision either in its certificate of incorporation or
by-laws resulting from a stockholders' amendment approved by at least a majority
of the outstanding voting shares; such an amendment is effective following
expiration of twelve months from adoption. The Company is a Delaware corporation
that is subject to the Anti-Takeover Law and has not "opted out" of its
provisions.

The foregoing provisions of Delaware law and the Restated Certificate and
By-laws could have the effect of discouraging others from attempting a hostile
takeover of the Company and, as a consequence, they may also inhibit temporary
fluctuations in the market price of the Common Stock that might result from
actual or rumored hostile takeover attempts. Such provisions may also have the
effect of preventing changes in the management of the Company. It is possible
that such provisions could make it more difficult to accomplish transactions
which stockholders may otherwise deem to be in their best interests.

TRANSFER AGENT

The transfer agent and registrar for the Common Stock is American Stock
Transfer & Trust Company.

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, the Company will have 11,490,862 shares
of Common Stock outstanding, assuming no exercise of the Underwriters'
over-allotment option or of any other outstanding options. Of these shares,
approximately 3,018,647 shares and the 2,000,000 shares sold in this offering
will be freely tradable, without restriction or further registration under the
Securities Act, except for shares purchased or held by "affiliates" of the
Company as that term is defined in Rule 144 under the Securities Act.

The remaining 6,472,215 outstanding shares of Common Stock are owned by
existing stockholders and are currently deemed "Restricted Shares" under Rule
144. These may not be resold, except pursuant to an effective registration
statement or an applicable exemption from registration. Of these remaining
shares, approximately 5,564,481 shares of Common Stock are currently eligible
for sale under Rules 144 and 701. The Securities and Exchange Commission has
recently amended Ruled 144 to reduce the required holding periods for Restricted
Shares. As a result of such amendment, which becomes effective in April 29,
1997, an additional 907,734 shares will be eligible for sale under Rules 144 and
701.

In connection with the Company's initial public offering, which was
completed in October 1996, stockholders of the Company holding an aggregate of
6,824,515 shares entered into an 180-day lock-up agreement that will expire on
April 14, 1997. In connection with this offering, stockholders of the Company,
holding in the aggregate 6,195,295 shares of Common Stock, have agreed to enter
into the 90-day lock-up agreements described below.

In general, under the recently amended Rule 144, which becomes effective on
April 29, 1997, a person (or persons whose shares are aggregated), including an
affiliate, who has beneficially owned Restricted Shares for at least one year
from the later of the date such Restricted Shares were acquired from the Company
and (if applicable) the date they were acquired from an affiliate, is entitled
to sell, within any three-month period, a number of shares that does not exceed
the greater of 1% of the then outstanding shares of Common Stock or the average
weekly trading volume in the public market

45
<PAGE> 47

during the four calendar weeks preceding such sale. Sales under Rule 144 are
also subject to certain requirements as to the manner and notice of sale and the
availability of public information concerning the Company. All sales of shares
of the Company's Common Stock, including Restricted Shares, held by affiliates
of the Company must be sold under Rule 144, subject to the foregoing volume
limitations and other restrictions.

The Company's directors and executive officers and certain of its
stockholders have agreed that they will not, without the prior consent of the
representatives of the Underwriters, offer to sell, sell, contract to sell,
grant any option to sell or otherwise dispose of or require the Company to file
with the Commission a registration statement under the Act to register any
shares of Common Stock or securities convertible or exchangeable for shares of
Common Stock or warrants or other rights to acquire shares of Common Stock
during the 90-day period following the effective date of the Registration
Statement.

The Company has filed a registration statement under the Securities Act
registering 120,000 shares of Common Stock issuable under the Stock Purchase
Plan. The Company plans to file registration statements under the Securities Act
to register 3,200,000 and 125,000 shares of Common Stock issuable under the
Equity Plan and the Director Plan, respectively, on or about April 14, 1997.
Upon registration, such shares will be eligible for immediate resale upon
exercise, subject, in the case of affiliates, to the volume, manner of sale and
notice requirements of Rule 144.

No prediction can be made as to the effect, if any, that market sales of
additional shares or the availability of such additional shares for sale will
have an impact on the market price of the Common Stock. Nevertheless, sales of
substantial amounts of Common Stock in the public market may have an adverse
impact on the market price of the Common Stock. See "Risk Factors--Shares
Eligible for Future Sale and Potential Adverse Effect on Market Price."

REGISTRATION RIGHTS

The holders of the 6,219,948 shares of Common Stock (the "Registrable
Shares") are entitled to certain rights with respect to registration under the
Securities Act of the Registrable Shares. If the Company proposes to register
any of its securities under the Securities Act, either for its own account or
for the account of other security holders, such holders are entitled to notice
of such registration and are entitled to include such Registrable Shares in the
registration. The rights are subject to certain conditions and limitations,
among them, the right of the underwriters of a registered offering to limit the
number of shares included in such registration. Holders of Registrable Shares
benefiting from these rights may also require the Company to file at its expense
a registration statement under the Securities Act with respect to their shares
of Common Stock and, subject to certain conditions and limitations, the Company
is required to use its best efforts to effect such registration. Furthermore,
such holders may, subject to certain conditions and limitations, require the
Company to file additional registration statements on Form S-3 with respect to
such Registrable Shares. In connection with this offering, such holders waived
their right to have shares of Common Stock registered under the Securities Act
as part of this offering.

46
<PAGE> 48

UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below, through their Representatives, Hambrecht & Quist LLC,
Oppenheimer & Co., Inc. and Vector Securities International, Inc., have
severally agreed to purchase from the Company and the Selling Stockholders the
following respective numbers of shares of Common Stock:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
------------ ---------
<S> <C>
Hambrecht & Quist LLC........................................... 666,668
Oppenheimer & Co., Inc. ........................................ 666,666
Vector Securities International, Inc. .......................... 666,666
---------
Total...................................................... 2,000,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent, including the absence
of any material adverse change in the Company's business and the receipt of
certain certificates, opinions and letters from the Company, its counsel and its
independent auditors and the Selling Stockholders and their counsel. The nature
of the Underwriters' obligation is such that they are committed to purchase all
shares of Common Stock offered hereby if any such shares are purchased.

The Underwriters propose to offer the shares of Common Stock directly to
the public at the public offering price set forth on the cover page of this
Prospectus and to certain dealers at such price less a concession not in excess
of $0.36 per share. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $0.10 per share to certain other dealers. The
Representatives of the Underwriters have advised the Company and the Selling
Stockholders that the Underwriters do not intend to confirm any shares to any
accounts over which they exercise discretionary authority. After the public
offering of the shares, the offering price and other selling terms may be
changed by the Representatives of the Underwriters.

The Company has granted to the Underwriters an option, exercisable no later
than 30 days after the date of this Prospectus, to purchase up to 300,000
additional shares of Common Stock at the public offering price, less the
underwriting discount, set forth on the cover page of this Prospectus. To the
extent that the Underwriters exercise this option, each of the Underwriters will
have a firm commitment to purchase approximately the same proportion thereof
which the number of shares of Common Stock to be purchased by it shown in the
above table bears to the total number of shares of Common Stock offered hereby.
The Company will be obligated, pursuant to the option, to sell shares to the
Underwriters to the extent the option is exercised. The Underwriters may
exercise such option only to cover over-allotments made in connection with the
sale of shares of Common Stock offered hereby.

The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.

The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.

Certain existing stockholders of the Company, including the Company's
executive officers and directors, who will own in the aggregate 6,195,295 shares
of Common Stock after the offering, have agreed that they will not, without the
prior written consent of Hambrecht & Quist LLC, offer, sell or otherwise dispose
of any shares of Common Stock, options or warrants to acquire shares of Common
Stock or securities exchangeable for or convertible into shares of Common Stock
owned by them

47
<PAGE> 49

during the 90-day period following the date of this Prospectus. The Company has
agreed that, subject to limited exceptions, it will not, without the prior
written consent of Hambrecht & Quist LLC, offer, sell or otherwise dispose of
any shares of Common Stock, options or warrants to acquire shares of Common
Stock or securities exchangeable for or convertible into shares of Common Stock
during the 90-day period following the date of this Prospectus.

Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Company's Common Stock at levels above those which might otherwise prevail
in the open market, including by entering stabilizing bids or effecting
syndicate covering transactions. A stabilizing bid means the placing of any bid
or effecting of any purchase, for the purpose of pegging, fixing or maintaining
the price of the Company's Common Stock. A syndicate covering transaction means
the placing of any bid on behalf of the underwriting syndicate or the effecting
of any purchase to reduce a short position created in connection with the
offering. Such transactions may be effected on the Nasdaq National Market, in
the over-the-counter market, or otherwise. Such stabilizing, if commenced, may
be discontinued at any time.

LEGAL MATTERS

The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Palmer & Dodge LLP, Boston, Massachusetts. Michael
Lytton, a partner of Palmer & Dodge LLP, is the Secretary of the Company and
Lynnette C. Fallon, also a partner of Palmer & Dodge LLP, is the Assistant
Secretary of the Company. Certain legal matters in connection with this offering
will be passed upon for the Underwriters by Testa, Hurwitz & Thibeault, LLP,
Boston, Massachusetts.

EXPERTS

The financial statements as of December 31, 1995 and 1996 and for each of
the three years in the period ended December 31, 1996 included in this
Prospectus have been so included in reliance on the report of Price Waterhouse
LLP, independent accountants, given on the authority of said firm as experts in
auditing and accounting.

AVAILABLE INFORMATION

The Company is subject to the informational reporting requirements of the
Exchange Act and in accordance therewith files reports, proxy statements and
other information with the Securities and Exchange Commission (the
"Commission"). Such reports, proxy statements and other information can be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington,
D.C. 20549, and at the Commission's following Regional Offices: Chicago Regional
Office, Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511; and New York Regional Office, 7 World Trade Center, Suite 1300, New
York, New York 10048. Copies of such material can be obtained at prescribed
rates from the Public Reference Section of the Commission at 450 Fifth Street,
N.W., Judiciary Plaza, Washington, D.C. 20549. Such reports and other
information can also be reviewed through the Commission's Web site
(http://www.sec.gov).

Additional information regarding the Company and the shares offered hereby
is contained in the Registration Statement on Form S-1 and the exhibits thereto
filed with the Commission under the Securities Act. This Prospectus does not
contain all of the information contained in such Registration Statement and the
exhibits and schedules thereto. Statements contained in this Prospectus
regarding the contents of any document or contract are qualified in their
entirety by reference to the copy of such contract or document filed as an
exhibit to the Registration Statement. For further information pertaining to the
Company and the shares, reference is made to the Registration Statement and the
exhibits thereto, which may be inspected without charge at, and copies thereof
may be obtained at prescribed rates from, the office of the Commission of 450
Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549.

48
<PAGE> 50

ARQULE, INC.

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants..................................................... F-2
Balance Sheet at December 31, 1995 and 1996........................................... F-3
Statement of Operations for the three years ended December 31, 1996................... F-4
Statement of Redeemable Preferred Stock and Stockholders' Equity (Deficit) for the
three years ended December 31, 1996................................................. F-5
Statement of Cash Flows for the three years ended December 31, 1996................... F-6
Notes to Financial Statements......................................................... F-7
</TABLE>

F-1
<PAGE> 51

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Stockholders of ArQule, Inc.

In our opinion, the accompanying balance sheet and the related statements of
operations, of redeemable preferred stock and stockholders' equity (deficit) and
of cash flows present fairly, in all material respects, the financial position
of ArQule, Inc. at December 31, 1996 and 1995, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1996, in conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

/s/ Price Waterhouse LLP

PRICE WATERHOUSE LLP

Boston, Massachusetts
February 25, 1997

F-2
<PAGE> 52

ARQULE, INC.

BALANCE SHEET

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1995 1996
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents...................................... $ 2,989,000 $ 36,586,000
Marketable securities.......................................... 4,802,000 500,000
Accounts receivable............................................ -- 250,000
Prepaid expenses and other current assets...................... 123,000 338,000
Notes receivable from related parties.......................... 93,000 176,000
----------- ------------
Total current assets................................... 8,007,000 37,850,000
Property and equipment, net...................................... 1,994,000 5,293,000
Other assets..................................................... 99,000 139,000
Notes receivable from related parties............................ 90,000 227,000
----------- ------------
$10,190,000 $ 43,509,000
=========== ============

LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of capital lease obligations................... $ 514,000 $ 1,138,000
Accounts payable and accrued expenses.......................... 769,000 1,109,000
Deferred revenue............................................... 1,650,000 4,163,000
----------- ------------
Total current liabilities.............................. 2,933,000 6,410,000
----------- ------------
Capital lease obligations........................................ 911,000 1,728,000
----------- ------------
Deferred revenue................................................. 458,000 750,000
----------- ------------

Series B mandatorily redeemable convertible preferred stock...... 6,888,000 --
----------- ------------

Stockholders' equity (deficit):
Preferred stock, $0.01 par value; 1,000,000 shares authorized;
no shares issued or outstanding at December 31, 1996 -- --
Series A convertible preferred stock; 10,511,000 shares issued
and outstanding at December 31, 1995........................ 2,486,000 --
Common stock, $0.01 par value; 30,000,000 shares authorized;
522,797 and 9,851,487 shares issued and outstanding at
December 31, 1995 and 1996, respectively.................... 5,000 99,000
Additional paid-in capital..................................... 4,435,000 46,102,000
Accumulated deficit............................................ (7,926,000) (10,934,000)
----------- ------------
(1,000,000) 35,267,000
Deferred compensation.......................................... -- (646,000)
----------- ------------
Total stockholders' equity (deficit)................... (1,000,000) 34,621,000
----------- ------------
Commitments and contingency (Note 13)............................ -- --
----------- ------------
$10,190,000 $ 43,509,000
=========== ============
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-3
<PAGE> 53

ARQULE, INC.

STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
Compound development revenue...................... $ 85,000 $ 1,830,000 $ 4,255,000
Compound development revenue--related party....... -- 500,000 3,000,000
License option fees............................... -- 1,000,000 --
----------- ----------- -----------
85,000 3,330,000 7,255,000
----------- ----------- -----------
Costs and expenses:
Cost of revenue................................... -- 1,367,000 2,683,000
Cost of revenue--related party.................... -- 277,000 2,056,000
Research and development.......................... 2,806,000 2,095,000 3,076,000
Marketing, general and administrative............. 1,346,000 1,557,000 2,850,000
----------- ----------- -----------
4,152,000 5,296,000 10,665,000
----------- ----------- -----------
Loss from operations........................... (4,067,000) (1,966,000) (3,410,000)
Interest income..................................... -- 133,000 607,000
Interest expense.................................... (139,000) (419,000) (190,000)
----------- ----------- -----------
Net loss....................................... $(4,206,000) $(2,252,000) $(2,993,000)
=========== =========== ===========
Unaudited proforma net loss per share assuming
conversion of convertible preferred stock (Note
9):
Net loss per share............................. $ (0.33) $ (0.39)
=========== ===========
Shares used in computing net loss per share.... 6,853,000 7,705,000
=========== ===========
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-4
<PAGE> 54

ARQULE, INC.

STATEMENT OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
STOCKHOLDERS' EQUITY (DEFICIT)
--------------------------------------------------
SERIES B MANDATORILY
REDEEMABLE CONVERTIBLE SERIES A CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
------------------------ ------------------------- ----------------------
SHARES AMOUNT SHARES AMOUNT SHARES PAR VALUE
---------- ----------- ----------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993................ 1,500 $ --
Capital contribution from ArQule Partners,
L.P. (Note 1).............................
3,333.33 for 1 stock split effected in the
form of a stock dividend.................. 4,998,500 50,000
Cancellation of common stock................ (140,528) (1,000)
Issuance of Series A convertible preferred
stock in exchange for common stock........ 8,591,000 $ 86,000 (4,295,500) (43,000)
Cancellation of unvested portion of
restricted stock upon employee
termination............................... (9,375) --
Issuance of common stock purchase warrants
under bridge financing....................
Net loss....................................
----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1994................ 8,591,000 86,000 554,597 6,000
Employee restricted stock purchases......... 68,200 --
Issuance of common stock purchase warrants
under bridge financing....................
Cancellation of unvested portion of
restricted stock upon employee
termination............................... (100,000) (1,000)
Conversion of bridge notes into Series A
convertible preferred stock............... 1,920,000 2,400,000
Issuance of Series B mandatorily redeemable
convertible preferred stock, net of
issuance costs of $115,000................ 1,800,000 $ 6,885,000
Accretion of Series B mandatorily redeemable
preferred stock to redemption value....... 3,000
Net loss....................................
---------- ----------- ----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1995................ 1,800,000 6,888,000 10,511,000 2,486,000 522,797 5,000
Conversion of interest on bridge notes to
Series A convertible preferred stock...... 113,429 142,000
Issuance of Series B mandatorily redeemable
preferred stock to maintain ownership
percentage (Note 9)....................... 15,468
Cancellation of unvested portion of
restricted stock upon employee
termination............................... (1,875) --
Employee option exercise.................... 625 --
Accretion of Series B mandatorily redeemable
preferred stock to redemption value....... 15,000
Conversion of Series B mandatorily
redeemable preferred stock to common
stock..................................... (1,815,468) (6,903,000) 907,734 9,000
Conversion of Series A convertible preferred
stock to common stock..................... (10,624,429) (2,628,000) 5,312,214 54,000
Exercise of warrants pursuant to a cashless
exercise provision........................ 234,992 2,000
Issuance of common stock in connection with
initial public offering, net of issuance
costs of $2,979,000....................... 2,875,000 29,000
Compensation related to the grant of common
stock options.............................
Amortization of deferred compensation.......
Net loss....................................
---------- ----------- ----------- ----------- ---------- ---------
BALANCE AT DECEMBER 31, 1996................ -- $ -- -- $ -- 9,851,487 $ 99,000
========== =========== =========== =========== ========== =========

ADDITIONAL TOTAL
PAID-IN ACCUMULATED DEFERRED STOCKHOLDERS'
CAPITAL DEFICIT COMPENSATION EQUITY (DEFICIT)
----------- ------------ ------------ ----------------
<S> <<C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993................ $ 2,236,000 $ (1,465,000) $ 771,000
Capital contribution from ArQule Partners,
L.P. (Note 1)............................. 2,100,000 2,100,000
3,333.33 for 1 stock split effected in the
form of a stock dividend.................. (50,000) --
Cancellation of common stock................ 1,000 --
Issuance of Series A convertible preferred
stock in exchange for common stock........ (43,000) --
Cancellation of unvested portion of
restricted stock upon employee
termination............................... --
Issuance of common stock purchase warrants
under bridge financing.................... 132,000 132,000
Net loss.................................... (4,206,000) (4,206,000)
----------- ------------ ------------
BALANCE AT DECEMBER 31, 1994................ 4,376,000 (5,671,000) (1,203,000)
Employee restricted stock purchases......... 1,000 1,000
Issuance of common stock purchase warrants
under bridge financing.................... 57,000 57,000
Cancellation of unvested portion of
restricted stock upon employee
termination............................... 1,000 --
Conversion of bridge notes into Series A
convertible preferred stock............... 2,400,000
Issuance of Series B mandatorily redeemable
convertible preferred stock, net of
issuance costs of $115,000................
Accretion of Series B mandatorily redeemable
preferred stock to redemption value....... (3,000) (3,000)
Net loss.................................... (2,252,000) (2,252,000)
----------- ------------ ------------
BALANCE AT DECEMBER 31, 1995................ 4,435,000 (7,926,000) (1,000,000)
Conversion of interest on bridge notes to
Series A convertible preferred stock...... 142,000
Issuance of Series B mandatorily redeemable
preferred stock to maintain ownership
percentage (Note 9).......................
Cancellation of unvested portion of
restricted stock upon employee
termination............................... --
Employee option exercise.................... --
Accretion of Series B mandatorily redeemable
preferred stock to redemption value....... (15,000) (15,000)
Conversion of Series B mandatorily
redeemable preferred stock to common
stock..................................... 6,894,000 6,903,000
Conversion of Series A convertible preferred
stock to common stock..................... 2,574,000 --
Exercise of warrants pursuant to a cashless
exercise provision........................ (2,000) --
Issuance of common stock in connection with
initial public offering, net of issuance
costs of $2,979,000....................... 31,492,000 31,521,000
Compensation related to the grant of common
stock options............................. 709,000 $ (709,000) --
Amortization of deferred compensation....... 63,000 63,000
Net loss.................................... (2,993,000) (2,993,000)
----------- ------------ ---------- ------------
BALANCE AT DECEMBER 31, 1996................ $46,102,000 $(10,934,000) $ (646,000) $ 34,621,000
=========== ============ ========== ============
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-5
<PAGE> 55

ARQULE, INC.

STATEMENT OF CASH FLOWS

Increase (Decrease) in Cash and Cash Equivalents

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss..................................................... $(4,206,000) $(2,252,000) $(2,993,000)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization........................... 189,000 506,000 1,171,000
Amortization of debt discount........................... 25,000 164,000 --
Amortization of deferred compensation................... -- -- 63,000
Increase in accounts receivable......................... -- -- (250,000)
(Increase) decrease in prepaid expenses and other
current assets....................................... 41,000 (94,000) (215,000)
(Increase) decrease in other assets..................... (188,000) 203,000 (40,000)
Increase in notes receivable from related parties....... -- (120,000) (220,000)
Increase in accounts payable and accrued expenses....... 340,000 141,000 482,000
Increase in deferred revenue............................ -- 2,108,000 2,805,000
----------- ----------- -----------
Net cash (used in) provided by operating
activities......................................... (3,799,000) 656,000 803,000
----------- ----------- -----------
Cash flows from investing activities:
Purchases of marketable securities........................... -- (9,052,000) --
Proceeds from sale or maturity of marketable securities...... -- 4,250,000 4,302,000
Additions to property and equipment.......................... (168,000) (495,000) (2,292,000)
----------- ----------- -----------
Net cash (used in) provided by investing
activities......................................... (168,000) (5,297,000) 2,010,000
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from bridge financing--related party................ 1,700,000 700,000 --
Principal payments of capital lease obligations.............. (110,000) (381,000) (737,000)
Proceeds from issuance of mandatorily redeemable convertible
preferred stock, net...................................... -- 6,885,000 --
Proceeds from issuance of common stock....................... -- 1,000 31,521,000
Capital contribution from ArQule Partners, L.P. ............. 2,100,000 -- --
Proceeds from sale-leaseback transactions.................... 107,000 -- --
----------- ----------- -----------
Net cash provided by financing activities............ 3,797,000 7,205,000 30,784,000
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents........... (170,000) 2,564,000 33,597,000
Cash and cash equivalents, beginning of period................. 595,000 425,000 2,989,000
----------- ----------- -----------
Cash and cash equivalents, end of period....................... $ 425,000 $ 2,989,000 $36,586,000
=========== =========== ===========
</TABLE>

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

Capital lease obligations of $935,000, $503,000 and $2,178,000, were
incurred in 1994, 1995 and 1996, respectively, when the Company entered into
leases for various machinery and equipment, furniture and fixtures, and
leasehold improvements.

During 1995, the Company converted $2,400,000 of bridge loans into
1,920,000 shares of Series A convertible preferred stock (Note 8). In addition,
during 1996, the Company converted $142,000 of interest relating to the bridge
loans into 113,429 shares of Series A convertible preferred stock.

During 1996, 12,439,897 shares of Series A and Series B preferred stock
were converted into 6,219,948 shares of common stock, in connection with the
Company's initial public offering of common stock (Note 9). In addition, 234,992
shares of common stock were issued in connection with the cashless exercise of
outstanding warrants.

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

During 1994, 1995 and 1996, the Company paid approximately $98,000,
$254,000 and $190,000, respectively, for interest.

The accompanying notes are an integral part of these financial statements.

F-6
<PAGE> 56

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND NATURE OF OPERATIONS

ArQule, Inc. (the "Company") is engaged in the discovery, development and
production of novel chemical compounds for the pharmaceutical, biotechnology and
agrichemical industries. Its operations are focused on the integration of
combinatorial chemistry, structure-guided rational drug design and other
proprietary technologies which automate the process of chemical synthesis to
produce arrays of small organic chemical compounds used to generate and optimize
drug development candidates.

In May 1993 and in connection with the formation of ArQule Partners L.P.
(the "Partnership"), Legomer Technologies, Inc. ("LTI"), formerly Molecular
Recognition Technologies, Inc., a company owned by the two founding limited
partners in the Partnership, contributed to the Partnership all rights and
interests in certain LTI patented technology (the "Technology") in exchange for
a 0.5% general partner ownership position. The Company was legally incorporated
on December 30, 1993 to carry on the operations of the Partnership. Immediately
following the incorporation of the Company, the Partnership transferred
substantially all of its assets, liabilities and patented technology (the
"Operating Assets"), having an aggregate net book value of $771,000, to the
Company in exchange for 1,500 shares of the Company's $0.01 par value common
stock, representing all of the Company's then outstanding common stock. Because
of the related party nature of these transactions, the Operating Assets and
Technology transfers have been accounted for as transfers of assets between
entities under common control. Accordingly, the accompanying financial
statements include the assets, liabilities and results of operations of the
Company at historical amounts as if the transfers occurred at the inception of
the Partnership.

Amounts which reflect the funding of the Partnership's operations prior to
the conversion of certain shares of the Company's common stock into Series A
preferred stock (Note 9) are reflected as paid-in capital in the accompanying
balance sheet and as capital contributed by ArQule Partners L.P. in the
statements of changes in redeemable preferred stock and stockholders' equity
(deficit) and of cash flows. Such funding totaled $2,100,000 of cash for the
year ended December 31, 1994, and was comprised of aggregate investments in
general partnership interests of $20,000 and limited partnership interests of
$2,080,000.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Significant accounting policies followed in the preparation of these
financial statements are as follows:

Cash Equivalents and Marketable Securities

The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. The Company
invests its available cash primarily in money market mutual funds and U.S.
government and other investment grade debt securities which have strong credit
ratings. These investments are subject to minimal credit and market risks. The
Company specifically identifies securities for purposes of determining gains and
losses on the sale of cash equivalents and short-term investments. At December
31, 1996 and 1995, the Company has classified its investments as
available-for-sale as defined in Statement of Financial Accounting Standards
("SFAS") No. 115.

Fair Value of Financial Instruments

At December 31, 1995 and 1996, the Company's financial instruments consist
of cash, cash equivalents, marketable securities, accounts receivable, notes
receivable from related party, accounts

F-7
<PAGE> 57

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

payable and accrued expenses and mandatorily redeemable convertible preferred
stock. The carrying amount of these instruments approximate their fair values.

Property and Equipment

Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives. Assets under capital
leases and leasehold improvements are amortized over the shorter of their
estimated useful lives or the term of the respective leases by use of the
straight-line method. Maintenance and repair costs are expensed as incurred.

Revenue Recognition

Compound development revenue relates to revenue from significant
collaborative agreements (Note 3) and from licensing of compound arrays. Revenue
from collaborative agreements relates to the delivery of compounds and to
compound development work and is recognized using the percentage of completion
method. The application of this revenue recognition method is dependent on the
contractual arrangement of either compound delivery or development. Accordingly,
revenue is recognized on the proportional achievement of deliveries against a
compound delivery schedule or as development labor is expended against a total
research and development labor plan. Payments received under these arrangements
prior to the completion of the related work are recorded as deferred revenue.
Revenue from licensing of compound arrays with no additional obligations is
recognized upon delivery of the compound array. License option fees represent
payments made to the Company for a right to evaluate and negotiate the terms of
potential licensing arrangements and are recognized as revenue as the options
are granted, as the Company has no further obligations and as payments are
nonrefundable.

Cost of Revenue

Cost of revenue represents the actual costs incurred in connection with
performance pursuant to collaborative agreements and the costs incurred to
produce compound arrays. These costs consist primarily of payroll and
payroll-related costs, supplies and overhead expenses.

Stock Compensation

Options granted to employees and directors are accounted for in accordance
with Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to
Employees". The Company has adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock Based Compensation." Options granted to nonemployees are
accounted for using the fair value method and are recognized as compensation
expense over their respective vesting periods.

Unaudited Pro Forma Net Loss Per Share

Pro forma net loss per share is determined by dividing the net loss by the
weighted average number of common stock and common stock equivalents outstanding
during the period, assuming the conversion of all convertible preferred stock
which occurred upon the closing of the Company's initial public offering as
described in Note 9.

Common stock equivalents, although anti-dilutive, issued at prices below
the offering price per share during the twelve month period preceding the
initial filing of the Registration Statement have been included in the
calculation of unaudited pro forma net loss per share using the treasury stock
method and the initial public offering price of $12.00 per share as if
outstanding for all periods presented through June 30, 1996.

F-8
<PAGE> 58

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Historical net loss per share has not been presented as the Series A
convertible preferred stock would have been omitted from the weighted average
shares outstanding as it is anti-dilutive and was issued more than twelve months
prior to the initial public offering.

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 these estimates.

Reclassifications

Certain reclassifications have been made to the 1994 and 1995 financial
statements to conform to the 1996 presentation. These reclassifications had no
effect on the net loss for 1994 and 1995.

3. SIGNIFICANT AGREEMENTS

The Company has entered into a number of license, research and development
agreements (the "Agreements") with certain corporate collaborators. One
Agreement was entered into with Solvay Duphar B.V. ("Solvay"), a related party
(Note 9). Revenue related to the Solvay Agreement is included in compound
development revenue--related party. Under the terms of these Agreements, the
Company will provide a certain number of compounds per year and has granted the
right to screen these compounds against targets to identify biological activity
(an "Active Compound") and will provide research and development services. The
collaborators have the right to enter into an exclusive, worldwide license (the
"License") for any Active Compound identified. The initial terms of these
Agreements generally range from two to five years during which period the
collaborators make payments to the Company for technology access, delivery of
compounds and for its research and development services. In exchange for a
License, the Company will receive milestone payments during product development
and royalty payments based on the sales of the product. Solvay also has a right
which expires on December 31, 1997 to license certain of the Company's
technologies on a nonexclusive basis for internal use only. Deferred revenue
represents payments made to the Company in advance for technology access,
delivery of compounds and research and development pursuant to these Agreements.
At December 31, 1995, $100,000 of the deferred revenue amount is from a related
party.

Under the terms of material transfer agreements with biotechnology
companies (the "biotech collaborators"), the Company has granted the biotech
collaborator the nonexclusive, royalty-free license to test certain compound
arrays supplied by the Company. Upon identification of an active compound, the
Company will negotiate a joint drug development program with the biotech
collaborator to develop the compound, provided the Company has not previously
licensed the compound. Under the collaboration agreements with these joint drug
development programs, the Company and the biotech collaborator will each bear
the costs and expenses of their respective activities. Proceeds received on
sales or a third party license of the jointly developed compound will first
reimburse development costs incurred by each party on a pro rata basis. After
all such reimbursements have been made, the remaining proceeds will be split
evenly between the parties.

F-9
<PAGE> 59

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

4. CASH EQUIVALENTS AND MARKETABLE SECURITIES

The fair market value of cash equivalents was $2,688,000 and $36,126,000 at
December 31, 1995 and 1996, respectively. At December 31, 1995 and 1996, all of
the Company's cash equivalents were held in money market funds.

The following is a summary of the fair market value of available-for-sale
marketable securities held by the Company at December 31, 1995 and 1996:

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
MATURITY 1995 1996
----------- ---------- --------
<S> <C> <C> <C>
U.S. Government obligations..................... 1-5 years $3,786,000 $500,000
U.S. Government obligations..................... 5-10 years 1,016,000 --
---------- --------
$4,802,000 $500,000
========== ========
</TABLE>

At December 31, 1995 and 1996, marketable securities are carried at fair
market value, which approximates amortized cost. All of the Company's marketable
securities are classified as current at December 31, 1996 as these funds are
highly liquid and are available to meet working capital needs and to fund
current operations. Gross unrealized gains and losses at December 31, 1995 and
1996 and realized gains and losses on sales of securities for the years ended
December 31, 1995 and 1996 were not significant.

5. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<TABLE>
<CAPTION>
ESTIMATED
USEFUL DECEMBER 31,
LIFE -------------------------
(YEARS) 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Machinery and equipment.......................... 3-7 $1,839,000 $4,350,000
Leasehold improvements........................... 5 656,000 2,628,000
Furniture and fixtures........................... 7 72,000 178,000
Construction-in-progress......................... -- 124,000 5,000
---------- ----------
2,691,000 7,161,000
Less--Accumulated depreciation and amortization.............. 697,000 1,868,000
---------- ----------
$1,994,000 $5,293,000
========== ==========
</TABLE>

Assets held under capital leases at December 31, 1995 consisted of
$1,438,000 of machinery and equipment and $485,000 of leasehold improvements. At
December 31, 1996, assets held under capital leases consisted of $3,162,000 of
machinery and equipment, $832,000 of leasehold improvements and $107,000 of
furniture and fixtures. Accumulated amortization of these assets totaled
$554,000 and $1,305,000 at December 31, 1995 and 1996, respectively. For the
years ended December 31, 1994, 1995 and 1996, amortization expense related to
assets held under capital lease obligations was $163,000, $300,000 and $751,000,
respectively.

F-10
<PAGE> 60

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

6. NOTES RECEIVABLE FROM RELATED PARTIES

Notes receivable from related parties consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1996
-------- --------
<S> <C> <C>
Note receivable due from an officer of the Company, due in full
on November 3, 1997.......................................... $ 63,000 $ 63,000
Note receivable due from the same officer of the Company,
payable in four equal annual installments commencing on
November 2, 1996, principal due on each installment date will
be forgiven so long as the officer is employed by the Company
on the installment date, secured by the officer's beneficial
interest in 48,000 shares of common stock of the Company..... 120,000 90,000
Note receivable due from another officer of the Company,
payable in three equal annual installments commencing on
October 16, 1997, secured by shares of common stock of the
Company issuable to the officer upon the exercise of
options...................................................... -- 250,000
-------- --------
183,000 403,000
Less--Current portion.......................................... 93,000 176,000
-------- --------
$ 90,000 $227,000
======== ========
</TABLE>

Interest on the notes receivable from related parties accrues on the unpaid
principal and interest at the lowest applicable federal rate of interest as
published by the Internal Revenue Service (6.3% at December 31, 1996). Interest
due on the notes at December 31, 1995 and 1996 totaling $15,000 and $6,000,
respectively, is included in prepaid expenses and other current assets.

7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses include the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1995 1996
-------- ----------
<S> <C> <C>
Accounts payable............................................. $369,000 $ 485,000
Accrued professional fees.................................... 176,000 469,000
Other accrued expenses....................................... 224,000 155,000
-------- ----------
$769,000 $1,109,000
======== ==========
</TABLE>

8. BRIDGE FINANCING--RELATED PARTY

During 1994 and 1995, the Company received $1,700,000 and $700,000,
respectively under bridge financing arrangements with certain stockholders. In
connection with this financing, the Company issued unsecured promissory notes
and on November 2, 1995, the Company and the stockholders agreed to convert the
principal of these notes into 1,960,000 shares of Series A convertible preferred
stock. At December 31, 1995, interest payable relating to these bridge
financings was $142,000. In April 1996, the Company and the stockholders
converted the interest payable into an additional 113,429 shares of Series A
convertible preferred stock. In 1996, all outstanding shares of Series A
convertible preferred stock were converted into shares of common stock upon the
closing of the Company's initial public offering (Note 9).

As partial consideration for the promissory notes, the Company issued
warrants to purchase 240,000 shares of the Company's common stock. In connection
with the Company's initial public

F-11
<PAGE> 61

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

offering, the Company issued 234,992 shares of common stock upon the cashless
exercise of these warrants.

The proceeds from the bridge financings were allocated to the notes and to
the warrants based on management's estimate of their relative fair values and of
the then-current market interest rate of 12%. This resulted in $132,000 and
$57,000 being ascribed to the warrants in 1994 and 1995, respectively, which was
recorded as additional paid-in-capital and as a discount to the face value of
the notes. The discount was amortized over the period from issuance to
conversion into Series A convertible preferred stock. The amortization of debt
discount totaled $25,000 and $164,000 for the years ended December 31, 1994 and
1995, respectively, and is included in interest expense.

9. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND CONVERTIBLE PREFERRED
STOCK

On November 18, 1994, the Partnership (the sole stockholder of the Company
as of that date) exchanged 563,972 shares of common stock of the Company for
Partnership interests held by certain employees and consultants. The Partnership
also contributed 140,528 shares of common stock to the Company for future
issuance pursuant to the Equity Incentive Plan (Note 11). The Company
immediately retired these contributed shares and reserved 140,528 shares of
common stock for issuance pursuant to the Equity Incentive Plan. The
stockholders of the Company approved the issuance of 8,591,000 shares of Series
A convertible preferred stock to the Partnership in exchange for the remaining
4,295,500 shares of common stock held by the Partnership. Upon the exchange of
preferred stock, the Company retired the related shares of common stock.

On November 5, 1995, as part of a collaborative agreement (Note 3), the
Company sold to Solvay Duphar B.V. ("Solvay") 1,800,000 shares of Series B
preferred stock which resulted in net proceeds to the Company of $6,885,000. In
April 1996, the Company issued to Solvay an additional 15,468 shares of Series B
preferred stock in connection with the conversion of the bridge financing
interest into Series A preferred stock (Note 8) to maintain the original,
agreed-upon ownership percentage.

At December 31, 1995, the Company had 15,000,000 shares of convertible
preferred stock authorized. Upon the closing of the Company's initial public
offering on October 16, 1996 (Note 10), all outstanding shares of Series A and
Series B preferred stock automatically converted into 6,219,948 shares of common
stock, and the number of authorized shares of preferred stock was reduced to
1,000,000 shares.

10. COMMON STOCK

On October 4, 1996, the Company effected a 1-for-2 reverse stock split on
the common stock of the Company. Accordingly, all common share and per share
data have been restated to give retroactive effect to the stock split for all
periods presented.

In October and November 1996, the Company completed its initial public
offering of 2,875,000 shares of common stock. Proceeds to the Company, net of
issuance costs, amounted to $31,521,000. In connection with its initial public
offering, the stockholders approved an amendment to the Company's Certificate of
Incorporation to increase the number of authorized common shares to 30,000,000.

At December 31, 1996, the Company has 2,203,453 shares of its common stock
reserved for issuance upon the exercise of options.

Stock Restriction Agreements

At December 31, 1996, the Company had outstanding 520,922 shares of common
stock issued pursuant to the Equity Incentive Plan (Note 11) which are subject
to stock restriction agreements

F-12
<PAGE> 62

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

whereby the stockholder automatically forfeits to the Company the unvested
portion of shares of common stock in the event of termination of their
employment with the Company. All such forfeited shares shall immediately be
retired by the Company. Shares subject to this agreement vest over a four year
period, either monthly or annually. At December 31, 1996, the aggregate number
of unvested common shares is 277,903. Each stock restriction agreement may be
terminated at the election of the Company.

11. EQUITY INCENTIVE AND STOCK PURCHASE PLANS

During 1994, the stockholders approved the 1994 Amended and Restated Equity
Incentive Plan (the "Equity Incentive Plan"). During 1996, the stockholders
approved an amendment to increase the number of shares of common stock available
for awards under the Equity Incentive Plan to 3,200,000. All shares will be
awarded at the discretion of a Committee of the Board of Directors (the
"Committee") in a variety of stock-based forms including stock options and
restricted stock. Pursuant to the Equity Incentive Plan, incentive stock options
may not be granted at less than the fair market value of the Company's common
stock at the date of the grant, and the option term may not exceed ten years.
For holders of 10% or more of the Company's voting stock, options may not be
granted at less than 110% of the fair market value of the common stock at the
date of the grant, and the option term may not exceed five years. Stock
appreciation rights granted in tandem with an option shall have an exercise
price not less than the exercise price of the related option.

Subject to the restrictions above, the Committee is authorized to designate
the options, awards, and purchases under the Equity Incentive Plan, the number
of shares covered by each option, award and purchase, and the related terms,
exercise dates, prices and methods of payment.

In 1996, the stockholders approved, the 1996 Director Stock Option Plan
(the "1996 Director Plan") for nonemployee directors. Under this plan, eligible
directors are automatically granted once a year, at the annual meeting of
stockholders of the Company, options to purchase 3,500 shares of common stock
which are exercisable on the date of grant. Upon initial election of an eligible
director, options to purchase 7,500 shares of common stock will be granted which
will become exercisable in three equal annual installments commencing on the
date of the Company's next annual stockholders' meeting held after the date of
grant. All options granted pursuant to the 1996 Director Plan have a term of ten
years with exercise prices equal to fair market value on the date of grant.
Through December 31, 1996, options to purchase 22,500 shares of common stock
have been granted under this plan. A maximum of 125,000 shares of common stock
of the Company is reserved for issuance in accordance with the terms of this
plan, of which 102,500 are available for future grant.

The Company applies APB No. 25 and related interpretations in accounting
for employee grants under the Equity Incentive Plan and the 1996 Director Plan
(collectively the "Plans"). For the three years ended December 31, 1996, no
compensation expense has been recognized under the Plans for employee grants.
Had compensation cost been determined based on the estimated value of options at
the grant date consistent with the provisions of SFAS No. 123, the Company's pro
forma net loss and pro forma net loss per share would have been as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------------
1995 1996
----------- -----------
<S> <C> <C>
Pro forma net loss......................................... $(2,254,000) $(3,186,000)
Pro forma net loss per share............................... (0.33) (0.41)
</TABLE>

During 1996, the Company issued 140,000 options to certain consultants and
members of its scientific advisory board under the Equity Incentive Plan. The
estimated value of these options totaled

F-13
<PAGE> 63

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

$709,000, was recorded as deferred compensation and is being amortized as
compensation expense over the vesting period of the options.

For the purposes of pro forma disclosure, the estimated value of each
employee and nonemployee option grant was calculated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions: no
dividend yield for both years; 45% volatility for nonemployee grants in both
years and employee grants subsequent to the initial filing of the Registration
Statement in connection with the Company's initial public offering; no
volatility for employee grants prior to the initial public offering; risk-free
interest rates ranging from 5.20% to 7.10% and expected lives ranging from 3 to
6 years for options granted during both years.

Option activity under the Plans for the three years ended December 31, 1996
was as follows:

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER EXERCISE
STOCK OPTIONS OF SHARES PRICE
--------------------------------------------------------------- --------- --------
<S> <C> <C>
Granted........................................................ 2,500 $ 0.02
----------
Outstanding at December 31, 1994............................... 2,500 $ 0.02
Granted........................................................ 298,500 $ 0.17
----------
Outstanding at December 31, 1995............................... 301,000 $ 0.17
Granted........................................................ 1,096,420 $ 4.55
Exercised...................................................... (625) $ 0.02
Cancelled...................................................... (1,875) $ 0.02
----------
Outstanding at December 31, 1996............................... 1,394,920 $ 3.62
==========
Exercisable at December 31, 1996............................... 149,611 $ 0.50
==========
Weighted average estimated value of options granted during the
year ended December 31, 1996................................. $ 1.49
==========
</TABLE>

The following table summarizes information about options outstanding at
December 31, 1996:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
-------------------------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED
OUTSTANDING AT REMAINING AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES 1996 LIFE PRICE
------------------------------------------------ -------------- ----------- --------
<S> <C> <C> <C>
$0.02..................................... 50,000 8.3 years.. $ 0.02
0.20..................................... 248,500 8.6 years.. 0.20
0.80 - 1.20.................................... 477,420 9.1 years.. 0.81
2.40..................................... 27,500 9.4 years.. 2.40
6.00..................................... 395,000 9.5 years.. 6.00
10.25 - 12.00................................... 196,500 9.8 years.. 11.04
---------
1,394,920
=========
</TABLE>

F-14
<PAGE> 64

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
-------------------------
NUMBER
EXERCISABLE WEIGHTED
AT AVERAGE
DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1996 PRICE
------------------------------------------------------------- ------------ --------
<S> <C> <C>
$0.02................................................... 12,500 $ 0.02
0.20................................................... 59,625 0.20
0.80................................................... 77,486 0.80
-------
149,611
=======
</TABLE>

At December 31, 1996, restricted common stock purchased pursuant to the
Equity Incentive Plan totaled 520,922 shares (Note 10), and there were 1,306,033
shares available for future grant under the Equity Incentive Plan.

Stock Purchase Plan

In 1996, the stockholders adopted the 1996 Employee Stock Purchase Plan
(the "Purchase Plan"). This plan enables eligible employees to exercise rights
to purchase the Company's common stock at 85% of the fair market value of the
stock on the date the right was granted or the date the right is exercised,
whichever is lower. Rights to purchase shares under the Purchase Plan are
granted by the Board of Directors. The rights are exercisable during a period
determined by the Board of Directors; however, in no event will the period be
longer than twenty-seven months. The Purchase Plan is available to substantially
all employees, subject to certain limitations. The Company has reserved 120,000
shares of common stock for purchases under the Purchase Plan. At December 31,
1996, no shares have been purchased pursuant to the Purchase Plan.

12. INCOME TAXES

The benefit (provision) for income taxes was as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Deferred tax benefit:
Federal................................... $ 1,420,000 $ 794,000 $ 886,000
State..................................... 338,000 246,000 347,000
----------- ----------- -----------
1,758,000 1,040,000 1,233,000
Deferred tax asset valuation allowance...... (1,758,000) (1,040,000) (1,233,000)
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
</TABLE>

The Company's deferred tax assets consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
Preoperating costs capitalized for tax purposes........... $ 416,000 $ 370,000
Net operating loss carryforwards.......................... 2,590,000 3,906,000
Tax credit carryforwards.................................. 272,000 311,000
Book depreciation in excess of tax........................ 106,000 30,000
----------- -----------
Gross deferred tax assets................................. 3,384,000 4,617,000
Deferred tax asset valuation allowance.................... (3,384,000) (4,617,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>

F-15
<PAGE> 65

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The Company has provided a full valuation allowance for the deferred tax
assets as the realization of these future benefits is not sufficiently assured
as of the end of each related year. If the Company achieves profitability, the
deferred tax assets will be available to offset future income tax liabilities
and expense.

At December 31, 1996, the Company has federal net operating loss
carryforwards and tax credit carryforwards available to reduce future taxable
income and tax liabilities, respectively, which expire as follows:

<TABLE>
<CAPTION>
NET RESEARCH AND
OPERATING DEVELOPMENT
YEAR OF LOSS TAX CREDIT
EXPIRATION CARRYFORWARDS CARRYFORWARDS
---------- ------------- -------------
<S> <C> <C>
2009.................................................... $4,320,000 $ 84,000
2010.................................................... 2,181,000 52,000
2011.................................................... 3,319,000 16,000
---------- --------
$9,820,000 $152,000
========== ========
</TABLE>

Under the Internal Revenue Code, certain substantial changes in the
Company's ownership could result in an annual limitation on the amount of net
operating loss and tax credit carryforwards which can be utilized in future
years.

A reconciliation between the amounts of reported income tax benefit and the
amount determined by applying the U.S. federal statutory rate of 35% for 1994,
1995 and 1996 to pre-tax loss is as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Income tax benefit at statutory rate........ $ 1,472,000 $ 788,000 $ 1,048,000
State tax benefit, net of federal benefit... 252,000 135,000 180,000
Research and investment tax credits......... 139,000 133,000 53,000
Other....................................... (105,000) (16,000) (48,000)
----------- ----------- -----------
1,758,000 1,040,000 1,233,000
Increase in valuation allowance............. (1,758,000) (1,040,000) (1,233,000)
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
</TABLE>

F-16
<PAGE> 66

ARQULE, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

13. COMMITMENTS AND CONTINGENCY

Leases

The Company leases facilities and equipment under noncancelable operating
and capital leases. The future minimum lease commitments under these leases are
as follows:

<TABLE>
<CAPTION>
YEAR ENDING OPERATING CAPITAL
DECEMBER 31, LEASES LEASES
------------------------------------------------------------ ---------- ----------
<S> <C> <C>
1997..................................................... $ 541,000 $1,343,000
1998..................................................... 520,000 1,058,000
1999..................................................... 458,000 697,000
2000..................................................... 373,000 102,000
2001..................................................... 148,000 --
---------- ----------
Total minimum lease payments................................ $2,040,000 3,200,000
==========
Less--Amount representing interest.......................... 334,000
----------
Present value of minimum lease payments..................... $2,866,000
==========
</TABLE>

The Company has a lease line agreement with a financial institution (the
"Lessor") for $8,500,000 of which approximately $4,884,000 was available for
future leases at December 31, 1996. The term for each lease under the agreement
is forty-two months, commencing on the purchase date of the asset, and the lease
bears interest at a rate determined by the Lessor at the transaction date.
During 1994, the Company sold and leased back approximately $107,000 in
machinery and equipment, furniture and fixtures and office equipment from the
Lessor.

Rent expense under noncancelable operating leases was approximately
$91,000, $163,000 and $283,000 for the years ended December 31, 1994, 1995 and
1996, respectively.

Employment Agreements

The Company entered into an employment agreement with an officer who is
also a member of the board of directors. This agreement provides that if his
employment is terminated without cause, the officer is entitled to receive up to
six months' salary. The Company also entered into an employment agreement with
another officer. This agreement provides that if his employment is terminated
without cause during the first year of the agreement, the officer is entitled to
receive up to six months' salary.

Contingency

In October 1996, the Company received a letter from two individuals who
have asserted that they are entitled to compensation from certain of the
Company's stockholders and/or the Company equal to approximately five percent of
the equity interest in the Company. The Company believes that there are
meritorious defenses against such claims and intends to contest them vigorously;
however, they are currently unable to estimate the outcome of this matter,
including the range of potential loss, if any.

F-17
<PAGE> 67

============================================================

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY THE COMMON STOCK TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM IT IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................... 3
Risk Factors............................... 6
The Company................................ 13
Use of Proceeds............................ 13
Dividend Policy............................ 13
Price Range of Common Stock................ 14
Capitalization............................. 14
Dilution................................... 15
Selected Financial Data.................... 16
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 17
Business................................... 20
Management................................. 34
Certain Transactions....................... 40
Principal and Selling Stockholders......... 42
Description of Capital Stock............... 44
Shares Eligible for Future Sale............ 45
Underwriting............................... 47
Legal Matters.............................. 48
Experts.................................... 48
Available Information...................... 48
Index to Financial Statements.............. F-1
</TABLE>

============================================================

2,000,000 SHARES

ARQULE, INC.
[ARQULE LOGO]
COMMON STOCK

------------------------
PROSPECTUS
------------------------

HAMBRECHT & QUIST

OPPENHEIMER & CO., INC.

VECTOR SECURITIES INTERNATIONAL,
INC.

APRIL 4, 1997

============================================================
<PAGE> 68

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The expenses to be borne by the Company in connection with this offering
are as follows:

<TABLE>
<S> <C>
SEC registration fee...................................... $ 13,330
Nasdaq listing fee........................................ 17,500
NASD filing fee........................................... 4,899
Blue Sky fees and expenses................................ 10,000
Printing and engraving expenses........................... 80,000
Accounting fees and expenses.............................. 40,000
Legal fees and expenses................................... 100,000
Transfer agent and registrar fees......................... 3,500
Miscellaneous expenses.................................... 5,771
--------
Total........................................... $275,000
========
</TABLE>

All of the above figures, except the SEC registration fee and NASD filing
fee, are estimates.

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law grants the Company the
power to indemnify each 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 is or was a director, officer, employee or agent of the Company, or is
or was serving at the request of the Company as a director, officer, employee or
agent of another corporation, partnership, joint venture, trust or other
enterprise, against expenses (including attorneys' fees), judgements, fines and
amounts paid in settlement actually and reasonably incurred by him in connection
with such action, suit or proceeding if he acted in good faith and in a manner
he reasonably believed to be in or not opposed to the best interests of the
Company, and with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful, provided, however, no
indemnification shall be made in connection with any proceeding brought by or in
the right of the Company where the person involved is adjudged to be liable to
the Company except to the extent approved by a court. Article V of the Company's
Amended and Restated By-laws provides that the Company shall, to extent legally
permitted, indemnify each 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
by reason of the fact that he is or was, or has agreed to become, a director or
officer of the Company, or is or was serving, or has agreed to serve, at the
request of the Company, as a director, officer or trustee of, or in a similar
capacity with, another corporation, partnership, joint venture, trust or other
enterprise. The indemnification provided for in Article V is expressly not
exclusive of any other rights to which those seeking indemnification may be
entitled under any law, agreement or vote of stockholders or disinterested
directors or otherwise, and shall inure to the benefit of the heirs, executors
and administrators of such persons. Article V also provides that the Company
shall have the power to purchase and maintain insurance on behalf of any person
who is or was a director, officer, employee or agent of the Company, or is or
was serving at the request of the Company, as a director, officer or trustee of,
or in a similar capacity with, another corporation, partnership, joint venture,
trust or other enterprise, against any liability asserted against and incurred
by such person in any such capacity.

Pursuant to Section 102(b)(7) of the Delaware General Corporation Laws,
Section 7 of Article FIFTH of the Company's Restated Certificate eliminates a
director's personal liability for monetary damages to the Company and its
stockholders for breaches of fiduciary duty as a director, except in
circumstances involving a breach of a director's duty of loyalty to the Company
or its stockholders,

II-1
<PAGE> 69

acts or omissions not in good faith, intentional misconduct, knowing violations
of the law, self-dealing or the unlawful payment of dividends or repurchase of
stock.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Since June 1, 1993, the Company has issued and sold the following
securities, in each case in reliance on an exemption from required registration
pursuant to Section 4(2) of the Securities Act:

In December 1993, in exchange for the transfer to the Company of
substantially all of the assets and liabilities of the Partnership, the Company
issued 1,500 shares of its Common Stock to the Partnership.

Commencing in March 1995, the Company has granted employees and consultants
options under its Amended and Restated 1994 Equity Incentive Plan, which options
have a ten-year term and are exercisable at a price equal to fair market value
on the date of grant, as determined in good faith by the Board of Directors. As
of December 31, 1996, options for 1,372,420 shares of the Company's Common Stock
were outstanding. As of such date, an option for 625 shares of Common Stock had
been exercised at $0.02 per share.

In addition, from inception through December 31, 1996, the Company made
grants of an aggregate of 520,922 shares of Common Stock to certain employees
and consultants of the Company. Such shares are subject to repurchase rights
held by the Company and were sold at fair market value on the date of grant.

In November 1994, the Company declared and paid a stock dividend of
3,332.33 shares of its Common Stock on each outstanding share of Common Stock
held as of October 17, 1994. Pursuant to a Plan of Recapitalization, the
Partnership surrendered an aggregate of 4,295,500 outstanding shares of Common
Stock (after giving effect to such stock dividend) for shares of Series A
Convertible Preferred Stock of the Company which were converted into an equal
number of shares of Common Stock concurrently with the Company's initial public
offering.

During the period from August 1994 through February 1995, certain
stockholders of the Company made a series of Bridge Loans to the Company for an
aggregate of $2,400,000 in exchange for promissory notes and warrants to
purchase an aggregate of 240,000 shares of Common Stock, which warrants were
exercised concurrently with the effective date of the Company's initial public
offering. In November 1995, the Bridge Loans were converted to shares of Series
A Preferred Stock, which were converted into 960,000 shares of Common Stock
concurrently with the closing of the Company's initial public offering.

In November 1995, the Company issued 1,800,000 shares of Series B Preferred
Stock to Physica B.V., which were converted into 900,000 shares of Common Stock
concurrently with the closing of the Company's initial public offering, for cash
at the purchase price of $3.89 per share.

In April 1996, all accrued interest outstanding on the Bridge Loans through
November 1995 was converted into shares of Series A Preferred Stock, which were
converted into 56,714 shares of Common Stock concurrently with the closing of
the Company's initial public offering. In April 1996, the Company also issued
shares of Series B Preferred Stock to Physica B.V., which converted into 7,734
shares of Common Stock concurrently with the closing of the Company's initial
public offering, in consideration of Physica B.V.'s waiver of its anti-dilution
rights under the Company's Amended and Restated Certificate of Incorporation and
its right of first refusal with respect to such shares of Series A Preferred
Stock.

II-2
<PAGE> 70

ITEM 16.

(a) EXHIBITS

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------
<S> <C>
1.1++ Form of Underwriting Agreement.
3.1++ Amended and Restated Certificate of Incorporation of the Company.
3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.5 to the
Company's Registration Statement on Form S-1 (File No. 333-11105) and
incorporated herein by reference.
4.1 Specimen Common Stock Certificate. Filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.
5.1++ Opinion of Palmer & Dodge LLP.
10.1* Amended and Restated 1994 Equity Incentive Plan, as amended through October 17,
1994. Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1
(File No. 333-11105) and incorporated herein by reference.
10.2* 1996 Employee Stock Purchase Plan. Filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.
10.3* 1996 Director Stock Option Plan. Filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.
10.4 Form of Indemnification Agreement between the Company and its directors. Such
agreements are materially different only as to the signing directors and the
dates of execution. Filed as Exhibit 10.4 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.5 Investors' Rights Agreement among the Company and certain stockholders of the
Company dated November 2, 1995. Filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.
10.6 Lease Agreement dated September 29, 1993 between the Company and Beautyrest
Property, Inc. and WRB, Inc. Filed as Exhibit 10.6 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.7 Lease Agreement, dated July 27, 1995, between the Company and Cummings Properties
Management, Inc. as amended. Filed as Exhibit 10.7 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.8* Employment Agreement effective as of January 2, 1996, between the Company and
Eric B. Gordon. Filed as Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.9* Employment Agreement effective as of July 9, 1996, between the Company and James
R. Fitzgerald, Jr. Filed as Exhibit 10.9 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.10* Promissory Note dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the
Company. Filed as Exhibit 10.10 to the Company's Registration Statement on Form
S-1 (File No. 333-11105) and incorporated herein by reference.
10.11* Pledge Agreement dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the
Company. Filed as Exhibit 10.11 to the Company's Registration Statement on Form
S-1 (File No. 333-11105) and incorporated herein by reference.
10.12* Promissory Note and Pledge Agreement dated July 9, 1996 between Eric B. Gordon
and the Company. Filed as Exhibit 10.12 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.
10.13* Promissory Note dated November 4, 1993 between Dr. Joseph C. Hogan, Jr. and the
Company. Filed as Exhibit 10.13 to the Company's Registration Statement on Form
S-1 (File No. 333-11105) and incorporated herein by reference.
10.14+ Research, Development and License Agreement between the Company and Solvay Duphar
B.V. dated November 2, 1995. Filed as Exhibit 10.14 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.
</TABLE>

II-3
<PAGE> 71

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
10.15+ Research & Development and License Agreement between the Company and Abbott
Laboratories dated June 15, 1995, as amended. Filed as Exhibit 10.15 to the
Company's Registration Statement on Form S-1 (file No. 333-11105) and
incorporated herein by reference.

10.16+ Research & Development Agreement between the Company and Pharmacia Biotech AB
dated March 10, 1995, as amended. Filed as Exhibit 10.16 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.

10.17+ Option Agreement between the Company and Pharmacia Biotech AB dated March 10,
1995, as amended. Filed as Exhibit 10.17 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.18* Adoption Agreement for Fidelity Management and Research Company (the Company's
401(k) plan). Filed as Exhibit 10.18 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.19 Research and License Agreement between the Company and Roche Bioscience dated
September 13, 1996. Filed as Exhibit 10.19 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.20+++ Array Delivery and Testing Agreement between the Company and Monsanto Company
dated as of December 23, 1996.

10.21+++ Amendment No. 2 to Research & Development License Agreement between the Company
and Abbot Laboratories dated as of December 24, 1996.

10.22++ Lease Agreement, dated December 20, 1996 between the Company and Cummings
Property Management, Inc.

11.1++ Statement re computation of unaudited pro forma net loss per share.

23.1 Consent of Price Waterhouse LLP. Filed herewith.

23.2++ Consent of Palmer & Dodge LLP.

24.1++ Power of attorney.

27.1++ Financial Data Schedule.
</TABLE>

- ---------------
* Indicates a management contract or compensatory plan.

+ Certain confidential material contained in the document has been omitted and
filed separately, with the Securities and Exchange Commission pursuant to Rule
406 of the Securities Act of 1933, as amended.

++ Previously filed.

(b) FINANCIAL STATEMENT SCHEDULE

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
II Valuation and Qualifying Accounts and Reserves..................................... S-1
</TABLE>

ITEM 17. UNDERTAKINGS

(a) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the provisions described under "Item
14--Indemnification of Directors and Officers" above, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

II-4
<PAGE> 72

(b) The undersigned Registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.

(c) The undersigned Registrant hereby undertakes to provide to the
Underwriters at the closing specified in the underwriting agreement,
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.

II-5
<PAGE> 73

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has duly caused this Amendment to be signed on its behalf by
the undersigned, thereunto duly authorized, in the Town of Medford, Commonwealth
of Massachusetts, on April 4, 1997.

ARQULE, INC.

By: *
------------------------------------
Eric B. Gordon
President, and Chief Executive
Officer

Pursuant to the requirements of the Securities Act of 1933, this Amendment
has been signed below by the following persons in the capacities and on the
dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>

* President, Chief Executive Officer April 4, 1997
- ----------------------------------- and Director (Principal Executive
Eric B. Gordon Officer)

* Vice President, Chief Financial April 4, 1997
- ----------------------------------- Officer and Treasurer (Principal
James R. Fitzgerald, Jr. Financial Officer and Principal
Accounting Officer)

* Director April 4, 1997
- -----------------------------------
Stephen M. Dow

* Chairman of the Board, Senior Vice April 4, 1997
- ----------------------------------- President of Research and
Joseph C. Hogan, Jr. Development, Chief Scientific
Officer and Director

* Director April 4, 1997
- -----------------------------------
Adrian de Jonge

* Director April 4, 1997
- -----------------------------------
Allan R. Ferguson

*By: /s/ MICHAEL LYTTON
-----------------------------
Michael Lytton
Attorney-in-fact
</TABLE>

II-6
<PAGE> 74

SCHEDULE II

ARQULE, INC.

VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

<TABLE>
<CAPTION>
CHARGED
BALANCE AT TO COSTS CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING OF AND OTHER AND END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS WRITE-OFFS PERIOD
- ---------------------------------------------- ------------ --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Deferred tax asset valuation allowance
Year ended December 31, 1994.............. $ 586,000 1,758,000 -- -- $2,344,000
Year ended December 31, 1995.............. 2,344,000 1,040,000 -- -- 3,384,000
Year ended December 31, 1996.............. 3,384,000 1,233,000 -- -- 4,617,000
</TABLE>

S-1
<PAGE> 75

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
1.1++ Form of Underwriting Agreement.

3.1++ Amended and Restated Certificate of Incorporation of the Company.

3.2 Amended and Restated By-laws of the Company. Filed as Exhibit 3.5 to the
Company's Registration Statement on Form S-1 (File No. 333-11105) and
incorporated herein by reference.

4.1 Specimen Common Stock Certificate. Filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.

5.1++ Opinion of Palmer & Dodge LLP.

10.1* Amended and Restated 1994 Equity Incentive Plan, as amended through October 17,
1994. Filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1
(File No. 333-11105) and incorporated herein by reference.

10.2* 1996 Employee Stock Purchase Plan. Filed as Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.

10.3* 1996 Director Stock Option Plan. Filed as Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.

10.4 Form of Indemnification Agreement between the Company and its directors. Such
agreements are materially different only as to the signing directors and the
dates of execution. Filed as Exhibit 10.4 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.5 Investors' Rights Agreement among the Company and certain stockholders of the
Company dated November 2, 1995. Filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (File No. 333-11105) and incorporated herein
by reference.

10.6 Lease Agreement dated September 29, 1993 between the Company and Beautyrest
Property, Inc. and WRB, Inc. Filed as Exhibit 10.6 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.7 Lease Agreement, dated July 27, 1995, between the Company and Cummings Properties
Management, Inc. as amended. Filed as Exhibit 10.7 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.8* Employment Agreement effective as of January 2, 1996, between the Company and
Eric B. Gordon. Filed as Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.9* Employment Agreement effective as of July 9, 1996, between the Company and James
R. Fitzgerald, Jr. Filed as Exhibit 10.9 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.10* Promissory Note dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the
Company. Filed as Exhibit 10.10 to the Company's Registration Statement on Form
S-1 (File No. 333-11105) and incorporated herein by reference.

10.11* Pledge Agreement dated November 2, 1995 between Dr. Joseph C. Hogan, Jr. and the
Company. Filed as Exhibit 10.11 to the Company's Registration Statement on Form
S-1 (File No. 333-11105) and incorporated herein by reference.

10.12* Promissory Note and Pledge Agreement dated July 9, 1996 between Eric B. Gordon
and the Company. Filed as Exhibit 10.12 to the Company's Registration Statement
on Form S-1 (File No. 333-11105) and incorporated herein by reference.

10.13* Promissory Note dated November 4, 1993 between Dr. Joseph C. Hogan, Jr. and the
Company. Filed as Exhibit 10.13 to the Company's Registration Statement on Form
S-1 (File No. 333-11105) and incorporated herein by reference.

10.14+ Research, Development and License Agreement between the Company and Solvay Duphar
B.V. dated November 2, 1995. Filed as Exhibit 10.14 to the Company's Registration
Statement on Form S-1 (File No. 333-11105) and incorporated herein by reference.
</TABLE>

<PAGE> 76

10.20+++ Array Delivery and Testing Agreement between the Company and Monsanto Company
dated as of December 23, 1996.

10.21+++ Amendment No. 2 to Research & Development License Agreement between the Company
and Abbot Laboratories dated as of December 24, 1996.

10.22++ Lease Agreement, dated December 20, 1996 between the Company and Cummings
Property Management, Inc.

11.1++ Statement re computation of unaudited pro forma net loss per share.

23.1 Consent of Price Waterhouse LLP. Filed herewith.

23.2++ Consent of Palmer & Dodge LLP.

24.1++ Power of attorney.

27.1++ Financial Data Schedule.
</TABLE>

- ---------------
* Indicates a management contract or compensatory plan.

+ Certain confidential material contained in the document has been omitted and
filed separately, with the Securities and Exchange Commission pursuant to
Rule 406 of the Securities Act of 1933, as amended.

++ Previously filed.

<PAGE> 1

EXHIBIT 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-1 of our report dated February 25, 1997
relating to the financial statements of ArQule, Inc., which appears in such
Prospectus. We also consent to the application of such report to the Financial
Statement Schedule for the three years ended December 31, 1996 listed under item
16(b) of this Registration Statement when such schedule is read in conjunction
with the financial statements referred to in our report. The audits referred to
in such report also included this schedule. We also consent to the reference to
us under the heading "Experts" in such Prospectus.

PRICE WATERHOUSE LLP

Boston, Massachusetts
April 3, 1997