10-Q

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

/x/
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarter Ended June 30, 2001  Commission File No. 000-21429

ArQule, Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware
(State of Incorporation) 04-3221586
(I.R.S. Employer Identification Number)

19 Presidential Way, Woburn, Massachusetts 01801
(Address of Principal Executive Offices)

(781) 994-0300
(Registrant's Telephone Number, including Area Code)

    Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/  No / /

    Number of shares outstanding of the registrant's Common Stock as of July 31, 2001:

Common Stock, par value $.01      20,312,155 shares outstanding

ArQule, Inc.

Quarter Ended June 30, 2001

Table of Contents

		Page
PART I—FINANCIAL INFORMATION
Item 1—Unaudited Consolidated Financial Statements
	Consolidated Balance Sheet (Unaudited) June 30, 2001 and December 31, 2000	3
	Consolidated Statement of Operations (Unaudited) Three months ended June 30, 2001 and 2000 and six months ended June 30, 2001 and 2000	4
	Consolidated Statement of Cash Flows (Unaudited) Six months ended June 30, 2001 and 2000	5
	Notes to Unaudited Consolidated Financial Statements	6
Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations		8
Item 3—Quantitative and Qualitative Disclosures About Market Risk		11
PART II—OTHER INFORMATION		12
Item 4—Submission of Matters to a Vote of Security Holders		12
Signatures		14

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ArQule, Inc.

Consolidated Balance Sheet (Unaudited)

(In thousands, except share data)

			June 30, 2001			December 31, 2000
ASSETS
Current Assets:
	Cash and cash equivalents		$	73,609		$	86,079
	Marketable securities			15,851			23,940
	Accounts receivable			5,331			1,564
	Accounts receivable—related parties			364			718
	Inventory			519			400
	Prepaid expenses and other current assets			1,564			1,326
		Total current assets		97,238			114,027
	Property and equipment, net			54,803			33,699
	Non-current marketable securities			4,917			—
	Intangible assets			50,620			—
	Other assets			337			1,750
			$	207,915		$	149,476
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable and accrued expenses		$	5,095		$	4,171
	Current portion of long-term debt			7,500			3,500
	Deferred revenue			10,495			11,976
	Deferred revenue—related parties			144			943
		Total current liabilities		23,234			20,590
Long term debt				15,450			7,200
Deferred revenue				1,133			1,266
		Total liabilities		39,817			29,056
Stockholder's Equity:
	Common stock, $0.01 par value; 50,000,000 shares authorized; 20,307,452 and 17,072,727 shares issued and outstanding at June 30, 2001 and December 31, 2000, respectively			203			171
	Additional paid-in capital			234,084			151,084
	Accumulated deficit			(57,060	)		(30,683	)
	Accumulated other comprehensive income			81			29
	Deferred compensation			(9,210	)		(181	)
		Total stockholders' equity		168,098			120,420
			$	207,915		$	149,476

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

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ArQule, Inc.

Consolidated Statement of Operations (Unaudited)

(In thousands, except per share data)

			Three Months Ended June 30,					Six Months Ended June 30,
			2001			2000		2001			2000
Revenue:
	Compound development revenue		$	12,476		$	9,543	$	24,761		$	17,233
	Compound development revenue—related parties			1,196			2,541		2,852			5,239
		Total revenue		13,672			12,084		27,613			22,472
Costs and expenses:
	Cost of revenue			5,037			4,199		9,230			8,201
	Cost of revenue—related parties			1,644			1,118		3,982			2,522
	Research and development			6,854			4,405		12,742			8,593
	Marketing, general and administrative			3,074			2,091		5,594			4,452
	Stock-based compensation			1,925			—		3,241			—
	Amortization of intangibles			1,921			—		3,202			—
	In-process research and development			—			—		18,000			—
		Total costs and expenses		20,455			11,813		55,991			23,768
		Income (loss) from operations		(6,783	)		271		(28,378	)		(1,296	)
Net investment income				662			338		2,001			563
	Net income (loss)		$	(6,121	)	$	609	$	(26,377	)	$	(733	)
Basic net income (loss) per share			$	(0.31	)	$	0.05	$	(1.35	)	$	(0.05	)
Weighted average common shares outstanding—Basic				20,030			13,520		19,548			13,362
Diluted net income (loss) per share			$	(0.31	)	$	0.04	$	(1.35	)	$	(0.05	)
Weighted average common shares outstanding—Diluted				20,030			14,398		19,548			13,362

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

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ArQule, Inc.

Consolidated Statement of Cash Flows (Unaudited)

(In Thousands)

				Six Months Ended June 30,
				2001			2000
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities:
	Net loss			$	(26,377	)	$	(733	)
Adjustment to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization			4,126			3,663
		Amortization of deferred compensation			3,404			402
		Amortization of intangible assets			3,202			—
		Purchase of in-process research and development			18,000			—
		(Increase) decrease in accounts receivable			(412	)		952
		(Increase) decrease in inventory			(119	)		142
		Increase in prepaid expenses and other current assets			(89	)		(164	)
		Decrease in other assets			1,657			28
		Decrease in accounts payable and accrued expenses			(3,093	)		(2,652	)
		Decrease in deferred revenue			(2,413	)		(1,368	)
Net cash (used in) provided by operating activities					(2,114	)		270
Cash flows from investing activities:
		Purchases of available-for-sale securities			(23,962	)		(38,527	)
		Proceeds from sale or maturity of marketable securities			27,186			40,455
		Proceeds from tenant improvement allowance			—			2,212
		Acquisitions, net of cash acquired			(1,598	)		—
		Additions to property and equipment			(24,035	)		(3,651	)
			Net cash (used in) provided by investing activities		(22,409	)		489
Cash flows from financing activities:
		Principal payments of capital lease obligation			(1,179	)		(244	)
		Borrowings of long term debt			16,000			—
		Principal payments of long-term debt			(3,750	)		(775	)
		Proceeds from issuance of common stock			982			5,120
			Net cash provided by financing activities		12,053			4,101
		Net (decrease) increase in cash and cash equivalents			(12,470	)		4,860
		Cash and cash equivalents, beginning of period			86,079			4,208
Cash and cash equivalents, end of period				$	73,609		$	9,068

Supplemental disclosure of non-cash activity:

Net liabilities assumed in acquisition—see Note 3.

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

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ArQule, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Nature of Operations

    ArQule, Inc. is a chemistry-based drug discovery company engaged in the design, discovery, development and production of novel chemical compounds with commercial potential in the pharmaceutical and biotechnology industries. Our operations are focused on the integration of combinatorial chemistry, structure-guided drug design, computational models of drug-like compound characteristics and other proprietary technologies which facilitate the design of drug-like chemical compounds and automate the process of chemical synthesis. We use these integrated technologies to produce screening libraries and to generate and optimize drug development candidates.

2. Basis of Presentation

    We have prepared the accompanying consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to these rules and regulations. These consolidated financial statements should be read in conjunction with our audited financial statements and footnotes related thereto for the year ended December 31, 2000 included in our annual report on Form 10-K filed with the Securities and Exchange Commission on March 22, 2001 and as amended on May 2, 2001. The unaudited consolidated financial statements include, in the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly our financial position as of June 30, 2001, and the results of our operations for the three and six months ended June 30, 2001 and 2000. The results of operations for such interim periods are not necessarily indicative of the results to be achieved for the full year.

3. Camitro Corporation

    On January 29, 2001, we acquired Camitro Corporation, a privately held predictive modeling company based in Menlo Park, California in a transaction accounted for as a purchase business combination. Pursuant to the terms of the merger agreement, we issued approximately 3.4 million shares of our common stock and $1.7 million in cash in exchange for all of Camitro's outstanding shares and the assumption of all of Camitro's outstanding stock options and warrants. The merger transaction was valued at $84.3 million based on our share price on the measurement date for the merger. The results of operations of Camitro, the estimated fair value of the assets acquired, and liabilities assumed are included in our financial statements from the date of acquisition.

    The purchase price was allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on our estimates of fair value on the acquisition date. The purchase price exceeded the amounts allocated to the identifiable tangible and intangible assets acquired and liabilities assumed by $29.7 million. This excess was classified as goodwill, which is being amortized on a straight-line basis over its estimated useful life of seven years.

    Approximately $18.0 million of the purchase price represents the estimated fair value of the purchased in-process research and development ("IPR&D") that had not yet reached technological feasibility and had no alternative future use. Accordingly, this amount was immediately expensed in the consolidated statement of operations upon the acquisition date. The value assigned to the IPR&D technology was comprised of the initial suite of ADMET (absorption, distribution, metabolism, elimination, toxicity) models and the upgrade suite of ADME models. The valuation of the IPR&D was determined using the discounted cash flow method. Revenue and expense projections, as well as technology assumptions, were prepared through 2008 based on information provided by Camitro's

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management. Revenue projections for each in-process development project were identified as follows: (1) revenue derived from products relying on core technology, and (2) revenue derived from projects relying on a new IPR&D project. The projected cash flows, adjusted based on probability of success, were discounted using a 50% rate for core technology and a 60% rate for in-process technology. The fair value of IPR&D was determined separately from all other acquired assets using the income approach. The in-process development projects are not expected to reach technological feasibility until sometime during 2001. Management is responsible for the assumptions used to determine the estimated fair value of the IPR&D.

4. Derivative Financial Instruments

    We have adopted the provisions of Statements of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). Our use of derivative financial instruments is limited to the utilization of Interest Rate Swap agreements. Settlement accounting is used for these interest rate swaps, whereby amounts to be paid or received under the interest rate swap agreements are accrued as interest rates change and are recognized as an adjustment to interest expense. These swaps are part of a designated hedging arrangement; therefore, a transition adjustment is not necessary.

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

Overview

    We are a chemistry-based drug discovery company engaged in the design, discovery, development and production of novel chemical compounds with commercial potential in the pharmaceutical and biotechnology industries. Our operations are focused on the integration of combinatorial chemistry, structure-guided drug design, computational models of drug-like compound characteristics and other proprietary technologies which facilitate the design of drug-like chemical compounds and automate the process of chemical synthesis. We use these integrated technologies to generate and optimize drug development candidates.

    We primarily generate revenue through our collaborative agreements for production and delivery of compound arrays and other research and development services. Under most of these collaborative agreements, we are also entitled to receive milestone and royalty payments if the customer develops products resulting from the collaboration. To date, we have received two milestone payments and no royalty payments. In addition, we have established a number of joint drug discovery programs with biotechnology companies and academic institutions and are pursuing a limited number of our own internal drug discovery programs. We have not yet realized any significant revenue from our joint discovery programs with biotechnology companies and academic institutions or from our internal drug discovery programs. While we expect our revenue to increase in 2001, our financial performance may vary from expectations, including quarterly variations in performance, because levels of revenue are dependent on expanding or continuing existing collaborations, entering into additional corporate collaborations, receiving future milestones and royalty payments, and realizing value from ongoing drug discovery programs, all of which are difficult to anticipate.

    We will continue to invest in technologies that we believe will enhance and expand our capabilities in drug discovery. These continued investments in technology are intended to enhance the novelty, diversity, and medical relevance of our compound arrays and to augment the power and scope of our chemistry capabilities. In addition to investments in technology, we may invest in internal lead optimization programs with the goal of delivering clinical candidates.

    We have incurred a cumulative net loss of $57.1 million through June 30, 2001. Losses have resulted principally from costs incurred in research and development activities related to our efforts to develop our technologies, the acquisition of complementary technologies and associated administrative costs required to support these efforts. While we were profitable in fiscal year 2000, we will not be profitable in 2001 and our ability to achieve sustained profitability is dependent on a number of factors. Such factors include our ability to perform under our collaborations at the expected cost, our ability to expand or to continue our existing collaborations, the timing and cost of additional investments in technology, and the realization of value from the development and commercialization of products in which we have an economic interest. All of these factors are difficult to anticipate.

    Upon consummation of the Camitro acquisition in January 2001, we immediately charged to income $18.0 million representing the estimated fair value of purchased in-process technology that had not yet reached technological feasibility and had no alternative future use (see note 3 of notes to consolidated financial statements). The value was determined by estimating the costs to develop the purchased in-process research and development into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present values. The discount rate in each project takes into account the uncertainty surrounding the successful development and commercialization of the purchased in-process technology. The resulting net cash flows from such projects were based on our management's best estimates of revenue, cost of sales, research and development costs, selling, general and administrative costs and income taxes from such projects.

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    If these projects are not successfully developed, our revenue and profitability may be adversely affected in future periods. Additionally, the value of other intangible assets acquired may become impaired. We are continuously monitoring our development projects. Management believes that the assumptions used in the valuation of purchased in-process technology represent a reasonably reliable estimate of the future benefits attributable to the purchased in-process technology. No assurance can be given that actual results will approximate those assumed values in future periods.

    We plan to use a portion of our existing cash to develop the purchased in-process technology related to the acquisition of Camitro into commercially viable products. This development primarily consists of completion of all planning, designing, prototyping, high-volume manufacturing verification and testing activities that are necessary to establish that a product can be produced to meet its design specifications, including functions, features and technical performance requirements. Management's estimate of the costs to be incurred to develop the purchased in-process technology into commercially viable products has not materially changed from the estimates disclosed at the time of the acquisition.

Forward-Looking Statements

    This report, including the Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements reflecting management's current expectations regarding our future performance. These statements can generally be identified by the use of forward-looking words such as "believe," "expect," "plan," "intend," "may," will," "should," "anticipate," or similar words and phrases. Forward-looking statements reflect management's current expectations, which are based on certain assumptions regarding revenue growth and profitability, the progress of product development efforts under collaborative agreements, the executions of new collaborative agreements, our development of technology acquired from Camitro, and other factors relating to our growth. Such expectations may not materialize, and therefore actual results could differ materially from those anticipated, if, among other things, product development efforts are delayed or suspended, negotiations with potential collaborators are delayed or unsuccessful, or if other assumptions prove to be incorrect. For a complete description of risks and uncertainties that may cause actual results to differ materially from management's current expectations, please refer to Exhibit 99.1 to our Annual Report on Form 10-K filed on March 22, 2001 and as amended on May 2, 2001. We will not update any forward-looking statements to reflect events or circumstances that occur after the date of that report, except as may be required by law.

Results of Operations

Three and Six Months Ended June 30, 2001 and 2000

    Revenue.  Our revenue for the three months ended June 30, 2001 increased $1.6 million or approximately 13 percent to $13.7 million from $12.1 million for the same period in 2000. Revenue was $27.6 million and $22.5 million for the six months ended June 30, 2001 and 2000, respectively. These increases are primarily due to incremental fees received for delivery of additional compounds to Pfizer Inc and Bayer AG.

    Cost of revenue.  Our cost of revenue for the three months ended June 30, 2001 increased $1.4 million or approximately 26 percent to $6.7 million from $5.3 million for the same period in 2000. Cost of revenue was $13.2 million and $10.7 million for the six months ended June 30, 2001 and 2000, respectively. These increases are primarily attributable to increased costs for producing Custom Array sets for Pfizer Inc and Bayer AG in concert with our incremental deliverables. Our gross margins were 52 percent for each of the six month periods ended June 30, 2001 and 2000.

    Research and development expenses.  Our research and development expenses for the three months ended June 30, 2001 increased $2.5 million or approximately 56 percent to $6.9 million from

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$4.4 million for the same period in 2000. Research and development expenses were $12.7 million and $8.6 million for the six months ended June 30, 2001 and 2000, respectively. This increase is the result of our ongoing efforts to augment and enhance our chemistry capabilities and proprietary complementary technologies, including increased personnel, as we expand our lead optimization and drug discovery programs.

    Marketing, general and administrative expenses.  Our marketing, general and administrative expenses for the three months ended June 30, 2001 increased $1.0 million or approximately 47 percent to $3.1 million from $2.1 million for the same period in 2000. Marketing, general and administrative expenses were $5.6 million and $4.5 million for the six months ended June 30, 2001 and 2000, respectively. These increases were primarily associated with increased administrative costs to support our growth during 2001, particularly salaries and recruiting expenses related to growth in the number of employees.

    Merger related charges.  Our merger related charges for the three months ended June 30, 2001 were $3.8 million, comprised of $1.9 million for stock-based compensation and $1.9 million for the amortization of goodwill and other intangibles. For the six months ended June 30, 2001, our total merger related charges amounted to $6.4 million, i.e. recognition of $3.2 million for aggregate stock-based compensation and $3.2 million in total amortization of goodwill and other intangibles. In the first quarter of 2001, we recognized a one-time charge of $18.0 million for in-process research and development.

    Net investment income.  Our net investment income for the three months ended June 30, 2001 increased $0.4 million or approximately 96 percent to $0.7 million from $0.3 million for the same period in 2000. Net investment income was $2.0 million and $0.6 million for the six months ended June 30, 2001 and 2000, respectively. Interest income rose in 2001 primarily due to our higher average cash balance as a result of our sale of common stock in the fourth quarter of 2000.

    Net income (loss).  Our net loss for the three months ended June 30, 2001 was $(6.1) million, compared to net income of $0.6 million for the same period in 2000. Our net loss was $(26.4) million and $(0.7) million for the six months ended June 30, 2001 and 2000, respectively. Our net loss in 2001 is primarily attributable to $24.4 million in merger-related amortization and charges from our acquisition of Camitro (approximately $3.8 million in the three months ended June 30, 2001) and our increased investment in research and development as we enhance our drug discovery platform.

Liquidity and Capital Resources

    At June 30, 2001, we held cash, cash equivalents and marketable securities (including non-current marketable securities) with a value of $94.4 million, compared to $110.0 million at December 31, 2000. Our working capital at June 30, 2001 was $74.0 million. We have funded operations through June 30, 2001 with sales of common stock and payments from corporate collaborators.

    For the six months ended June 30, 2001, our net cash flow from operating activities decreased by $2.4 million compared to the same period in 2000. This change reflected the difference between a $2.1 million use of cash (negative flow) in operating activities for the six months ended June 30, 2001 and a $0.3 million source of cash from operating activities (positive flow) for the same period in 2000. The difference is a consequence primarily of the timing of payments from our corporate collaborations.

    For the six months ended June 30, 2001, our net cash flow from investing activities decreased by $22.9 million compared to the same period in 2000. This change reflected the difference between a $22.4 million use of cash (negative flow) in investing activities for the six months ended June 30, 2001 and a $0.5 million cash provided (positive flow) from investing activities for the same period in 2000. The principal reason for this change was our purchase of our facility and the adjacent lot in Woburn, Massachusetts for $20.5 million in March 2001.

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    For the six months ended June 30, 2001, our net cash flow from financing activities increased by $8.0 million compared to the same period in 2000. This change reflected the difference between $12.0 cash provided (positive flow) by investing activities for the six months ended June 30, 2001 and $4.0 cash provided (positive flow) from investing activities for the same period in 2000. The principal reason for this change was that, in March 2001, we amended and extended our term loan agreement with Fleet National Bank to borrow an additional $16.0 million in order to finance our facility and land purchase. Principal amounts are payable in 16 equal quarterly installments beginning on April 1, 2001. Interest payments are made monthly in arrears beginning on the first day of the month following commencement of the amended agreement. Interest accrues at the rate of one month LIBOR plus 1.75%. At June 30, 2001, our average interest rate on this additional debt was approximately 6.01%. This constituted the full utilization of our existing credit facility with Fleet.

    We expect that our available cash and marketable securities, together with operating revenues and investment income will be sufficient to finance our working capital and capital requirements for the foreseeable future. Our cash requirements may vary materially from those now planned depending upon the results of our drug discovery and development strategies, our ability to enter into any additional 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. We cannot guarantee that will be able to obtain additional customers for our products and services, or that such products and services will produce revenues adequate to fund our operating expenses. If we experience increased losses, we may have to seek additional financing from public or private sales of our securities, including equity securities. There can be no assurance that additional funding will be available when needed or on acceptable terms.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    We own financial instruments that are sensitive to market risk as part of our investment portfolio. Our investment portfolio is used to preserve our capital until it is used to fund operations, including our research and development activities. None of these market-risk sensitive instruments are held for trading purposes. We invest our cash primarily in money market mutual funds and U.S. government and other investment grade debt securities. These investments are evaluated quarterly to determine the fair value of the portfolio. Our investment portfolio includes only marketable securities with active secondary or resale markets to help insure liquidity. We have implemented policies regarding the amount and credit ratings of investments. Due to the conservative nature of these policies, we do not believe we have material exposure due to market risk. Additionally, we entered into two interest rate swap agreements with Fleet National Bank primarily to reduce the impact of changes in interest rates on our cash flows. The impact on our financial position and results of operations from likely changes in interest rates should not be material.

    See notes 2 and 7 to the consolidated financial statements in our 2000 Annual Report on Form 10-K filed March 22, 2001, and as amended on May 2, 2001, for a description of our use of derivatives and other financial instruments. The carrying amounts reflected in the consolidated balance sheet of cash and cash equivalents, trade receivables, and trade payables approximates fair value at June 30, 2001 due to the short-term maturities of these instruments.

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ArQule, Inc.

PART II—OTHER INFORMATION

Item 1—Legal Proceedings. None.

Item 2—Changes in Securities and Use of Proceeds. None.

Item 3—Defaults Upon Senior Securities. None.

Item 4—Submission of Matters to a Vote of Security Holders

    At the Annual Meeting of Stockholders held on May 17, 2001, our stockholders voted as follows:

(a)

To elect Laura Avakian, Werner Cautreels, Ph.D. and Tuan Ha-Ngoc as directors:

Total Votes "For" Laura Avakian	14,319,988
Total Votes "Withheld" for Laura Avakian	48,687
Total Votes "For" Werner Cautreels, Ph.D	14,319,988
Total Votes "Withheld" for Werner Cautreels, Ph.D.	48,687
Total Votes "For" Tuan Ha-Ngoc	14,319,988
Total Votes "Withheld" for Tuan Ha-Ngoc	48,687

    The proposal received a plurality of the votes cast by the stockholders entitled to vote thereon and, therefore, Ms. Avakian, Dr. Cautreels, and Dr. Ha-Ngoc were re-elected to the Board of Directors.

    Ariel Elia, L. Patrick Gage, Ph.D., Dr. Stephen A. Hill and Michael Rosenblatt, M.D. all continued their terms in office.

(b)

To approve an amendment to our Amended and Restated Certificate of Incorporation to increase the aggregate number of shares of common stock that may be issued by us by 20,000,000 shares from 30,000,000 to 50,000,000 shares, $0.01 par value per share:

Total Votes "For" the Proposal	14,021,076
Total Votes "Against" the Proposal	335,758
Abstentions	11,841

    The proposal received the affirmative vote of a majority of the shares of common stock outstanding and, therefore, was adopted.

(c)

To approve an amendment to our Amended and Restated 1994 Equity Incentive Plan to increase the aggregate number of shares of common stock that may be issued under the plan by 1,000,000 shares from 5,700,000 to 6,700,000 shares:

Total Votes "For" the Proposal	6,504,423
Total Votes "Against" the Proposal	3,377,311
Abstentions	11,335
Broker Non-Votes	4,475,606

    The proposal received the affirmative vote of a majority of the shares of common stock present or represented at the meeting and entitled to vote thereon and, therefore, was adopted.

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(d)

To approve an amendment to our Amended and Restated 1996 Employee Stock Purchase Plan to increase the aggregate number of shares of common stock that may be issued under the plan by 100,000 shares from 420,000 to 520,000 shares:

Total Votes for the Proposal	9,759,656
Total Votes Against the Proposal	123,998
Abstentions	9,435
Broker Non-Votes	4,475,606

    The proposal received the affirmative vote of a majority of the shares of common stock present or represented at the meeting and entitled to vote thereon and, therefore, was adopted.

Item 5—Other Information. None.

Item 6(a)—Exhibits:

Exhibits	Description
10.1*	Amended and Restated Research and Development Agreement between Sankyo Co., LTD. and ArQule dated April 2, 2001. Filed herewith.

    *Certain confidential material contained in this document has been omitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.

Item 6(b)—Reports on Form 8-K. None.

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ArQule, Inc.

SIGNATURES

    Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ARQULE, INC.
Date: August 13, 2001		/s/ DAVID C. HASTINGS David C. Hastings (Vice President, Chief Financial Officer and Treasurer)

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ArQule, Inc.
Exhibit Index

Item 6(a)—Exhibits:

Exhibit No.	Description
10.1*	Amended and Restated Research and Development Agreement between Sankyo Co., LTD. and ArQule dated April 2, 2001. Filed herewith.

*Certain confidential material contained in this document has been omitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.

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QuickLinks

ArQule, Inc. Quarter Ended June 30, 2001 Table of Contents
ArQule, Inc. Consolidated Balance Sheet (Unaudited) (In thousands, except share data)
ArQule, Inc. Consolidated Statement of Operations (Unaudited) (In thousands, except per share data)
ArQule, Inc. Consolidated Statement of Cash Flows (Unaudited) (In Thousands)
ArQule, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ArQule, Inc.
ArQule, Inc.
SIGNATURES
ArQule, Inc. Exhibit Index

EX-10.1

                                                                   EXHIBIT 10.1

   CONFIDENTIAL MATERIALS OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND
              EXCHANGE COMMISSION. ASTERISKS DENOTE SUCH OMISSIONS.


                              AMENDED AND RESTATED
                       RESEARCH AND DEVELOPMENT AGREEMENT

         This Agreement, dated as of April 2, 2001, is between Sankyo Co., LTD
("Sankyo"), a Japanese corporation, having a business address at 5-1, Nihonbashi
Honcho 3-chome, Chuo-ku Tokyo 103, Japan, and ArQule, Inc. ("ArQule"), a
Delaware corporation, having a business address at 19 Presidential Way, Woburn,
Massachusetts, U.S.A..

                                 R E C I T A L S

         WHEREAS, Sankyo and ArQule previously entered into a Research and
Development Agreement dated November 1, 1997 (the "Original Agreement");

         WHEREAS, the activities contemplated by the parties under the Original
Agreement are nearly completed; and

         WHEREAS, the parties desire to complete certain activities under the
Original Agreement and then to continue their relationship by undertaking
additional research and development activities;

         NOW, THEREFORE, in consideration of the mutual covenants set forth in
this Agreement, the Parties hereby agree as follows:

1.       DEFINITIONS.

         1.1. "ACTIVE COMPOUND" shall mean an ArQule Compound that exhibits
significant functional activity against a Target, as determined by Sankyo in a
manner consistent with the manner Sankyo uses to evaluate other similarly
situated compounds being developed by Sankyo.

         1.2. "AFFILIATE" shall mean a corporation or other legal entity that
controls, is controlled by, or is under common control with such Party. For
purposes of this definition, "control" means the ownership, directly or
indirectly, of fifty percent (50%) or more of the outstanding equity securities
of a corporation which are entitled to vote in the election of directors or a
fifty percent (50%) or greater interest in the net assets or profits of an
entity which is not a corporation.

         1.3. "AGREEMENT" shall mean this Amended and Restated Research and
Development Agreement, together with EXHIBIT A hereto.




         1.4. "ARQULE COMPOUND" shall mean a chemical compound provided by
ArQule to Sankyo pursuant to this Agreement as part of a screening library,
including without limitation the compounds provided in the Compass Array Library
and Mapping Array Libraries.

         1.5. "ARQULE DERIVATIVE COMPOUND" shall mean a Derivative Compound
developed from a Licensed Compound [*****].

         1.6. "ARRAY" shall mean a set of samples of structurally related
chemical compounds arranged in a format such as a microtiter screening plate.

         1.7. "AVAILABLE COMPOUND" shall mean an Active Compound which ArQule
has determined is not (i) licensed or otherwise committed to a third party or
(ii) committed to an internal ArQule program.

         1.8. "COMPASS ARRAY LIBRARY" shall mean a collection of ArQule
Compounds that is a diverse representative subset of the Mapping Array Libraries
used for initial screening of the Mapping Array Libraries. The description of,
and the specifications for, the Compass Array(TM) Library are set forth in
EXHIBIT A attached hereto.

         1.9. "CONFIDENTIAL INFORMATION" shall mean any technical or business
information furnished by one party (the "DISCLOSING PARTY") to the other party
(the "RECEIVING PARTY") in connection with this Agreement or generated pursuant
to this Agreement. Such Confidential Information may include, without
limitation, the identity or use of a chemical compound, the identity or use of a
biological target, trade secrets, know-how, inventions, technical data or
specifications, testing methods, business or financial information,
collaboration and development activities, Steering Committee and Research
Committee minutes, royalty reports, product and marketing plans, clinical
development plans, and customer and supplier information.

         1.10. "DERIVATIVE COMPOUND" shall mean a chemical compound that was (i)
structurally derived from a parent compound in one or more steps from another by
a process of modification or partial substitution of at least one component
wherein at least one structural feature is retained at each process step or (ii)
actually derived from a parent compound using information obtained from testing
one or more parent compounds. The number of intermediate steps or compounds is
not relevant to the classification of a compound as a Derivative Compound. A
compound need not have structural similarity to the parent compound in order to
be classified as a Derivative Compound.

         1.11. "DIRECTED ARRAY(R) LIBRARY" shall mean an Array comprised of
Derivative Compounds synthesized by ArQule under the Directed Array Program. The
description of, and the specifications for, the Directed Array Libraries are set
forth in EXHIBIT A attached hereto.

         1.12. "DIRECTED ARRAY4 PROGRAM" shall mean a Directed Array
Program conducted by ArQule for Sankyo as set forth in Section 4 and in
accordance with a Research Plan developed by the Research Committee and approved
by the Steering Committee.
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         1.13. "DISCOVERY OPTIMIZATION PROGRAM" means the discovery optimization
program described in Article 5 below.

         1.14. "EFFECTIVE DATE" shall mean the date first written above.

         1.15. "EXTRAORDINARY EXPENSES" shall mean those expenses incurred from
time to time by ArQule in connection with the Directed Array Program and
approved by the Research Committee and Sankyo which are not (i) direct,
out-of-pocket costs provided for in the Research Plan which are directly
attributable to the Directed Array Program or (ii) fixed overhead costs provided
for in the Research Plan which are allocable to the Directed Array Program.

         1.16. "FDA" shall mean the United States Food and Drug Administration
(or its foreign equivalent in Japan or Europe).

         1.17. "FULL-TIME EQUIVALENT" or "FTE" shall mean one (1) or more
qualified full-time employee(s) of ArQule who, alone or collectively, [*****] on
a specific project or task (which is approximately [*****] man-hours reported at
ArQule on the project in one year).

         1.18. "LICENSED COMPOUND" shall mean (i) any ArQule Compound that, as
of the Effective Date, has already been designated as a Licensed Compound under
the Original Agreement and (ii) any Active Compound that the Research Committee
designates as a Licensed Compound in accordance with Section 3.6.

         1.19. "LICENSED COMPOUND SET" shall mean a set of one or more Licensed
Compounds from the same Mapping Array Library that have biological activity for
the same Target, as well as any ArQule Derivative Compounds of such Licensed
Compounds that are synthesized by a party in the course of optimizing those
Licensed Compounds.

         1.20. "MAPPING ARRAY(R) LIBRARY" shall mean an Array of ArQule
Compounds which ArQule makes available to its collaborators for screening on a
non-exclusive basis. The description of, and the specifications for, the Mapping
Array Libraries are set forth in EXHIBIT A attached hereto.

         1.21. "MAPPING ARRAY4 PROGRAM" shall mean the component of the
Research Program under which ArQule has provided and will continue to provide
Sankyo with Mapping Array Libraries and under which ArQule will now provide
Sankyo with the Compass Array Library, as further described in Section 3.

         1.22. "NET SALES" shall mean the aggregate Net Sales Price of
Royalty-Bearing Products in any Royalty Period.

         1.23. "NET SALES PRICE" shall mean the [*****] received on sales by
Sankyo, its Affiliates and Sublicensees of Royalty-Bearing Products, less the
following: [*****]. In any

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transfers of Royalty-Bearing Products between Sankyo and an Affiliate, the Net
Sales Price shall be calculated based on the [*****] of the Royalty-Bearing
Product to an independent third party. In the event that Sankyo receives
non-monetary consideration for any Royalty-Bearing Products, the Net Sales Price
shall be calculated based on the [*****] by Sankyo for such Royalty-Bearing
Products during the [*****] Royalty Period.

         1.24. "PARTY" shall mean ArQule or Sankyo; "PARTIES" means ArQule and
Sankyo, collectively.

         1.25 "PATENT RIGHTS" shall mean any United States and foreign patent
application and any divisional, continuation, or continuation-in-part of such
patent application (to the extent the claims are directed to subject matter
specifically described therein), as well as any patent issued thereon and any
reissue or reexamination of such patent, and any foreign counterparts to such
patents and patent applications. "ARQULE PATENT RIGHTS" means Patent Rights that
are either (i) assigned solely to ArQule, (ii) assigned jointly to ArQule and a
party other than Sankyo, or (iii) licensed to or otherwise controlled by ArQule,
in each case to the extent that ArQule has the ability to license or sublicense
the rights required under this Agreement without payment to a third party.
"SANKYO PATENT RIGHTS" means Patent Rights that are either (i) assigned solely
to Sankyo, (ii) assigned jointly to Sankyo and a party other than ArQule, or
(iii) licensed to or otherwise controlled by Sankyo, in each case to the extent
that Sankyo has the ability to license or sublicense the rights required under
this Agreement without payment to a third party. "JOINT PATENT RIGHTS" means
Patent Rights assigned to both ArQule and Sankyo as joint owners. Joint Patent
Rights will include (i) Patent Rights claiming Joint Technology and (ii) Patent
Rights claiming both ArQule Technology and Sankyo Technology in a single filing.

         1.26. "PHASE I CLINICAL TRIALS" shall mean clinical trials in healthy
adults and/or in a small number of patients commencing upon the filing of a
trial protocol with the appropriate regulatory body and designed to determine
the metabolism and pharmacologic actions of a product in humans, the side
effects associated with increasing doses and to gather evidence on effectiveness
and meeting the requirements established by the FDA or by the equivalent
Japanese agency for Phase I clinical trials. The completion of the Phase I
Clinical Trials will be deemed to have occurred upon the first formal internal
issuance of trial results as measured by trial objectives, or in any event no
later than the commencement of the Phase II Clinical Trials.

         1.27. "PHASE II CLINICAL TRIALS" shall mean clinical trials in a small
sample of the intended patient population commencing upon the filing of a trial
protocol with the appropriate regulatory body and designed to assess the
efficacy for a specific indication of a compound proposed to be used as a
therapeutic or diagnostic pharmaceutical product, to determine dose tolerance
and the optimal dose range as well as to gather additional information relating
to safety and potential adverse effects, and meeting the requirements
established by the FDA or the equivalent Japanese agency for Phase II clinical
trials. The completion of the Phase II Clinical Trials will be deemed to have
occurred upon the first formal internal issuance of trial results as measured by
trial objectives, or in any event no later than the commencement of the Phase
III Clinical Trials.
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         1.28. "PHASE III CLINICAL TRIALS" shall mean clinical trials commencing
upon the filing of a trial protocol with the appropriate regulatory body and
designed to demonstrate safety and efficacy of a compound proposed to be used as
a prophylactic, therapeutic or diagnostic pharmaceutical product in an expanded
patient population at geographically dispersed study sites, meeting the
requirements established by the FDA or the equivalent Japanese agency for Phase
III clinical trials. The completion of the Phase III Clinical Trials will be
deemed to have occurred upon the first formal internal issuance of trial results
as measured by trial objectives, or in any event no later than the filing of an
NDA.

         1.29. "PRECLINICAL DEVELOPMENT" shall mean the commencement of potency
and efficacy testing of a compound in animal models.

         1.30 "PROPRIETARY MATERIALS" shall mean any tangible materials, whether
biological, chemical, physical, or otherwise, that one party (the "PROVIDER")
furnishes to the other party (the "RECIPIENT") under this Agreement and
designates as proprietary or confidential including, without limitation all
ArQule Compounds and Sankyo Compounds.

         1.31. "RESEARCH COMMITTEE" shall mean the research committee
established by the Parties as described in Section 2.1.

         1.32. "RESEARCH PERIOD" shall mean the period commencing on the
Effective Date and continuing until [*****] .

         1.33. "RESEARCH PROGRAM" shall mean, collectively, each of the Directed
Array Programs and the Mapping Array Program.

         1.34. "RESEARCH PLAN" shall mean a plan of research for the Mapping
Array Program and the Directed Array Programs as developed by the Research
Committee and approved by the Steering Committee.

         1.35. "ROYALTY-BEARING PRODUCT" shall mean a product containing
[*****].

         1.36. "ROYALTY PERIOD" shall mean, with respect to each Royalty-Bearing
Product, every calendar quarter, or partial calendar quarter, commencing with
the first commercial sale of such Royalty-Bearing Product in any country and
thereafter during which Sankyo has the obligation to pay a royalty pursuant to
Section 8.5.

         1.37. "SANKYO COMPOUND" shall mean any chemical compound provided by
Sankyo or its Affiliates to ArQule under the Directed Array Program.

         1.38. "SANKYO DERIVATIVE COMPOUND" shall mean a Derivative Compound
developed from an Sankyo Compound [*****].
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         1.39 "STEERING COMMITTEE" shall mean the steering committee established
by the parties as described in Section 2.2.

         1.40. "SUBLICENSEE" shall mean any non-Affiliate third party licensed
by Sankyo to make, use (except where the right to use accompanies the sale of
any Royalty-Bearing Product by Sankyo or its Affiliates or Sublicensees) or sell
any Royalty-Bearing Product.

         1.41. "TARGET" shall mean any biological target selected by Sankyo for
which Sankyo has certain proprietary technology and/or expertise.

         1.42. "TECHNOLOGY" shall mean any proprietary development, information,
know-how, idea, design, concept, technique, process, invention, compound,
discovery, improvement whether or not patentable or copyrightable. "ARQULE
TECHNOLOGY" means Technology that is either (i) assigned solely to ArQule, (ii)
assigned jointly to ArQule and a party other than Sankyo, or (iii) licensed to
or otherwise controlled by ArQule, in each case to the extent that ArQule has
the ability to license or sublicense the rights required under this Agreement
without payment to a third party. "SANKYO TECHNOLOGY" means Technology that is
either (i) assigned solely to Sankyo, (ii) assigned jointly to Sankyo and a
party other than ArQule, or (iii) licensed to or otherwise controlled by Sankyo,
in each case to the extent that Sankyo has the ability to license or sublicense
the rights required under this Agreement without payment to a third party.
"JOINT TECHNOLOGY" means Technology that is developed or discovered jointly by
one or more employees or consultants of Sankyo and one or more employees or
consultants of ArQule in connection with this Agreement.

         1.43. "U.S. TERRITORY" shall mean the fifty states comprising the
United States of America and all American possessions.

         1.44. "WORLDWIDE TERRITORY" shall mean the world excluding the U.S.
Territory.

         1.45. The above definitions are intended to encompass the defined terms
in both the singular and plural tenses.

2.       MANAGEMENT OF RESEARCH PROGRAM.

         2.1.     RESEARCH COMMITTEE.

                  2.1.1. COMPOSITION OF RESEARCH COMMITTEE. The Parties hereby
establish a Research Committee comprised of six (6) members, with three (3)
representatives appointed by each Party, including one (1) member from each
party who also serves on the Steering Committee. A Party may change one or more
of its representatives to the Research Committee at any time upon notice to the
other Party. Each Party will also designate one of its representatives as its
team leader.

                  2.1.2. DUTIES OF THE RESEARCH COMMITTEE. The Research
Committee shall direct and administer the Research Program. Specifically, the
Research Committee shall develop and revise the Research Plan. In addition, the
Research Committee shall (i) designate Active


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Compounds as Licensed Compounds as described in Section 3.6.; (ii) maintain and
update the list of Licensed Compounds; (iii) determine the allocation of the
funding and personnel resources to be contributed by ArQule for each Directed
Array Program; and (iv) resolve matters involving scientific questions.

                  2.1.3. MEETINGS OF THE RESEARCH COMMITTEE. The Research
Committee shall communicate regularly, but in no event less than monthly, via
written project status reports through written communications means, including,
without limitation, electronic mail. A member of the committee from each Party
will promptly respond to such communications where appropriate within seven (7)
days of its receipt by such member. In the event that questions or issues arise
from such written communications that cannot be, or are not being effectively
addressed by such written communications, or upon request by any member of the
Research Committee, the Research Committee shall promptly conduct one or more
telephone conferences to address such questions or issues and shall prepare and
deliver to each Party a brief written report describing the significant issues
and discussions that take place during such telephone conference(s). A
representative of the Research Committee jointly appointed by its members shall
provide each member with five (5) business days notice of the time of any such
telephone conferences and the proposed agenda with respect thereto, unless
waived by all members. The Research Committee shall meet quarterly with the
location alternating between ArQule and Sankyo, or at such other times and
locations as the Research Committee determines. A representative of the Research
Committee jointly appointed by its members shall provide each member with five
(5) business days notice of the time and location of meetings, unless such
notice is waived by all members. If a designated representative of a Party
cannot attend any meeting of the Research Committee, such Party may designate a
different representative for that meeting without notice to the other Party, and
the substitute member will have full power to vote on behalf of the permanent
member. All actions and decisions of the Research Committee will require the
unanimous consent of all of its members. If the Research Committee fails to
reach agreement upon any matter, the dispute will be referred to the Steering
Committee for resolution. Within ten (10) days following each quarterly meeting
of the Research Committee, the Research Committee shall prepare and deliver, to
both Parties, a written report describing the decisions made, conclusions and
actions agreed upon.

         2.2.     STEERING COMMITTEE.

                  2.2.1. COMPOSITION OF STEERING COMMITTEE. The Parties hereby
establish a Steering Committee with equal membership from each party. A Party
may change one or more of its representatives to the Steering Committee at any
time upon notice to the other Party.

                  2.2.2. DUTIES OF STEERING COMMITTEE. The Steering Committee
will have overall authority to direct the collaboration and [*****] over
financial decisions and other decisions relating to contractual or business
issues. Specifically, the Steering Committee will (i) approve Research Plans and
updates to Research Plans, (ii) resolve disputes and deadlocks within the
Research Committee, and (iii) review and approve resource allocation decisions
for Directed Array Programs.
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                  2.2.3. MEETINGS OF THE STEERING COMMITTEE. The Steering
Committee shall meet at least once every [*****] with the location alternating
between ArQule and Sankyo. A representative of the Steering Committee jointly
appointed by its members shall provide each member with [*****] notice of the
time and location of meetings, unless such notice is waived by all members. If a
designated representative of a Party cannot attend any meeting of the Steering
Committee, such Party may designate a different representative for that meeting
without notice to the other Party, and the substitute member will have full
power to vote on behalf of the permanent member. All actions and decisions of
the Steering Committee will require the unanimous consent of all of its members.
If the Steering Committee fails to reach agreement upon any matter, the dispute
will be referred to the dispute resolution procedures set forth in Section 13.5.
Within [*****] following each meeting of the Steering Committee, the Steering
Committee shall prepare and deliver, to both Parties, a written report
describing the decisions made, conclusions and actions agreed upon.

         2.3. COOPERATION. Each Party agrees to provide the Research Committee
and Steering Committee with information and documentation as reasonably required
for the Research Committee and Steering Committee to fulfill its duties under
this Agreement. In addition, each Party agrees to make available its employees
and consultants as reasonably requested by the Research Committee and Steering
Committee. The Parties anticipate that members of the Research Committee and
Steering Committee will communicate informally with each other and with
employees and consultants of the Parties on matters relating to the Directed
Array Program.

         2.4. VISITS TO FACILITIES. Members of the Research Committee and
Steering Committee shall have reasonable access to the facilities of each Party
where activities under this Agreement are in progress, but only during normal
business hours and with reasonable prior notice. Each Party shall bear its own
expenses in connection with such site visits.

3.       MAPPING ARRAY PROGRAM.

         3.1. PRIOR MAPPING ARRAY PROGRAM. Sankyo acknowledges that, prior to
the Effective Date, ArQule previously delivered to Sankyo, and Sankyo accepted,
approximately [*****] ArQule Compounds within Mapping Array Libraries produced
by ArQule from [*****] through [*****]. Sankyo further acknowledges that such
ArQule Compounds were fully satisfactory to Sankyo. ArQule acknowledges that
Sankyo has fully paid for such ArQule Compounds, except that ArQule remains
eligible to receive milestone and royalty payments on Royalty-Bearing Products
as set forth in Sections 8.3. and 8.5.

         3.2. COMPASS ARRAY LIBRARY. ArQule will supply Sankyo with [*****]of
the Compass Array Library corresponding to Mapping Array Libraries produced in
[*****] within [*****] after the Effective Date and [*****] of the Compass Array
Library corresponding to Mapping Array Libraries produced in[*****]. ArQule will
not disclose the structures of ArQule Compounds in the Compass Array Library and
Sankyo will have no obligation to disclose its Targets. Sankyo will promptly
screen the Compass Array Library against its Targets. When
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Sankyo detects Active Compounds in the Compass Array Library, Sankyo will
promptly inform ArQule through the Research Committee.

         3.3. MAPPING ARRAY LIBRARY. During the period from the [*****] upon the
written request of Sankyo, ArQule will promptly deliver to Sankyo any Mapping
Array Libraries selected by Sankyo. Promptly upon its receipt of any such
Mapping Array Libraries, Sankyo shall test such Mapping Array Libraries for
activity against the relevant Targets. In addition, Sankyo may continue to
screen all Mapping Array Libraries received prior to the Effective Date against
any Targets. Initially, ArQule will identify the Chemical Themes of each Mapping
Array Library in [*****] but not the structures of the individual ArQule
Compounds in the Mapping Array Library, and Sankyo will not disclose the Targets
screened. If Sankyo detects Active Compounds, Sankyo shall promptly provide
ArQule with notice by telefax communication of the spatial location of Active
Compounds in the Mapping Array Libraries, which telefax shall be followed by a
confirmatory letter.

         3.4. MUTUAL DISCLOSURE. ArQule will promptly determine whether the
Active Compounds identified by Sankyo in the Mapping Array Libraries are
Available Compounds, and then promptly notify Sankyo of such determination. If
any Active Compound is not an Available Compound, ArQule shall not disclose the
structure and Sankyo shall have no rights under this Agreement with respect to
that Active Compound. If an Active Compound is an Available Compound, ArQule
shall reserve such Active Compound as an Available Compound to Sankyo under this
Agreement, which means that ArQule [*****]. ArQule then shall disclose to Sankyo
(i) the structure of such Available Compound correlated to its well location and
(ii) upon request of Sankyo, the structures but not the locations of inactive
ArQule Compounds in the same Mapping Array Library, and Sankyo shall disclose to
ArQule (i) the identity of the Target and (ii) the level of activity. All such
disclosed information shall be treated as Confidential Information by both
Parties.

         3.5. RESYNTHESIS. During the period from [*****] ArQule shall
resynthesize and deliver to Sankyo an additional [*****] of any Available
Compound requested by Sankyo to enable Sankyo to conduct confirmatory screening
activities. Sankyo shall provide ArQule with written notice of the Available
Compounds that Sankyo desires to have resynthesized by ArQule, in accordance
with the specifications set forth in EXHIBIT A. In each case the actual amount
of, and delivery schedule for, resynthesized Available Compounds will be
determined by the Research Committee. ArQule will continue to reserve all of the
Available Compounds from the same Mapping Array Library for a period [*****]
after Sankyo receives at least one resynthesized Available Compound from that
Mapping Array Library. The Steering Committee may extend this reservation period
for one or more Available Compounds.

         3.6. DESIGNATION OF LICENSED COMPOUNDS. At the request of Sankyo, the
Research Committee will review and consider the pertinent confirmatory data and,
after consideration, designate confirmed Available Compounds as "Licensed
Compounds" under this Agreement. Sankyo acknowledges that an Active Compound
that Sankyo desires to designate as a Licensed Compound may not retain its
status as an Available Compound if the reservation period expired
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for that Active Compound. Therefore, if an Active Compound is no longer reserved
(i.e., the reservation period expired), ArQule must determine whether that
Active Compound is still an Available Compound before the Research Committee may
designate the Active Compound as a Licensed Compound. Upon the designation of an
ArQule Compound as a Licensed Compound, the licenses set forth in Section 6.2.
shall automatically apply. All Licensed Compounds from a Mapping Array Library
that share activity for the same Target shall form a Licensed Compound Set for
the purposes of this Agreement.

         3.7. OPTIMIZATION RIGHTS. During the Research Period, Sankyo may submit
Licensed Compound Sets to ArQule for inclusion in the Directed Array Program. At
any time, Sankyo may conduct optimization of any Licensed Compound Set. In the
event that Sankyo conducts optimization of a Licensed Compound Set, then at the
request of Sankyo, ArQule will provide Sankyo with synthetic protocols to enable
Sankyo to make those Licensed Compounds.

         3.8. EXTENSION RIGHT. If ArQule continues to offer the Mapping Array
Program during the[*****], Sankyo may extend on the same terms the supply of
ArQule Compounds in the form of the Compass Array Library and the Mapping Array
Libraries through [*****] upon written notice to ArQule which is received by
ArQule not later than [*****].

4.       DIRECTED ARRAY PROGRAM.

         4.1. PRIOR DIRECTED ARRAY PROGRAMS. Sankyo acknowledges that ArQule has
satisfactorily completed [*****] of the total of [*****] Directed Array Programs
committed under the Original Agreement. ArQule acknowledges that Sankyo has
fully paid for the completed Directed Array Programs, except that ArQule remains
eligible to receive milestone and royalty payments on Royalty-Bearing Products
as set forth in Sections 8.3. and 8.5. ArQule and Sankyo both agree that the
[*****] uncompleted Directed Array Programs under the Original Agreement shall
be completed not later than [*****] under the terms and conditions of the
Original Agreement.

         4.2. DESCRIPTION OF DIRECTED ARRAY PROGRAM. Under the direction of the
Research Committee and in accordance with the Research Plan, ArQule will
synthesize multiple Directed Array Libraries of ArQule Derivative Compounds or
Sankyo Derivative Compounds that meet the specifications set forth on EXHIBIT A.
The Parties intend that, during each year of the Directed Array Program[*****],
Sankyo will submit to ArQule and ArQule will perform [*****] Directed Array
Program, with each Directed Array Program [*****] and intended to produce
approximately[*****]. However, the actual conduct of the Directed Array
Programs, the actual numbers of compounds produced in each Directed Array
Program, and the specifications of the compounds produced in each Directed Array
will be determined by the Research Committee and documented in the Research
Plan, subject to the authority of the Steering Committee.

         4.3. CONDUCT OF DIRECTED ARRAY PROGRAM. Each Directed Array Program
shall be conducted pursuant to the Research Plan in a good scientific manner and
in compliance with all
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applicable legal requirements. The conduct of each Directed Array Program shall
be the primary responsibility of ArQule with participation by Sankyo. ArQule
shall commit a total [*****] per year [*****] to each Directed Array
Program[*****], subject to adjustment by the Steering Committee; provided,
however that ArQule shall have no obligation to commit more than a total of
[*****] the Directed Array Program unless Sankyo funds such additional FTEs as
described below. Sankyo shall propose projects to the Steering Committee for
inclusion as a Directed Array Program. If the Steering Committee approves the
inclusion of the proposed project, ArQule shall thereupon diligently synthesize
Directed Array Libraries of ArQule Derivative Compounds or Sankyo Derivative
Compounds in accordance with the Research Plan; provided that ArQule shall have
the right to decline to synthesize any compound that (i) was under development
by ArQule (including programs with academic collaborators or corporate partners)
before such compound was specifically proposed to be included in the Directed
Array Program or (ii) was already within a screening library before such
compound was specifically proposed to be included in the Directed Array Program.
Sankyo shall provide ArQule with the requisite amount and purity of Sankyo
Compounds, as directed by the Research Committee, for any Directed Array
Programs based on such Sankyo Compounds. Sankyo shall, in its discretion, test
all compounds in the Directed Array Libraries. If Sankyo desires to increase the
number of Directed Array Programs under this Agreement, Sankyo will notify
ArQule through the Research Committee and the parties will discuss the matter.

         4.4. TERM OF DIRECTED ARRAY PROGRAMS. The Parties shall perform the
Directed Array Programs under this Agreement during the Research Period.

5.       DISCOVERY OPTIMIZATION PROGRAM.

         5.1. DESCRIPTION OF DISCOVERY OPTIMIZATION PROGRAM. In a Discovery
Optimization Program, ArQule and Sankyo produce [*****] compound series for a
particular Target with the goal of generating an IND candidate that is ready for
preclinical GLP toxicology studies. The Discovery Optimization Program has three
stages:

              STAGE 1 - LEAD GENERATION

              The first stage of the Discovery Optimization Program will
              generate Active Compounds from the Compass Array Library as
              described above. The objective of the first stage is to identify
              novel chemotypes within the ArQule Compound repository. The
              ability to prioritize Active Compounds from the Compass Array
              Library[*****].

              STAGE 2 - LEAD QUALIFICATION

              The second stage of the Discovery Optimization Program will seek
              to qualify Active Compounds through [*****]. [*****]will be
              developed by screening selected Mapping Array Libraries that
              represent novel chemotypes identified in the Compass Array
              Library. [*****].
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 Exchange Commission. Asterisks denote such omissions.

                                       11



                  STAGE 3 - LEAD OPTIMIZATION

                  The third stage of the Discovery Optimization Program will
                  progress one of the Targets through lead optimization to
                  identify qualified Active Compounds [*****]. During this stage
                  of the program, [*****] of Derivative Compound synthesis and
                  optimization will be executed[*****].

         5.2. OPTION FOR DISCOVERY OPTIMIZATION PROGRAM. ArQule grants Sankyo
the option to enter into a Discovery Optimization Program for [*****] Licensed
Compound Sets at any time during the Research Period. Sankyo may exercise this
option by furnishing ArQule with written notice to that effect, which notice
must be received by ArQule during the Research Period. If Sankyo elects to
exercise this option, Sankyo and ArQule will negotiate in good faith the terms
and conditions of the program, including without limitation the payments and
deliverables. If the Parties have not entered into a binding letter of agreement
on the terms and conditions of the program within [*****]after ArQule receives
notice from Sankyo, then the option right shall expire and ArQule shall have no
further obligation to enter into a Discovery Optimization Program with Sankyo
for that Licensed Compound Set.

6.       LICENSE GRANTS; REVERSION OF RIGHTS.

         6.1. SCREENING LICENSE. Subject to the terms and conditions of this
Agreement, ArQule hereby grants to Sankyo and its Affiliates under ArQule Patent
Rights and ArQule Technology a [*****].

         6.2 DEVELOPMENT AND COMMERCIALIZATION LICENSE. Subject to the terms and
conditions of this Agreement, ArQule hereby grants to Sankyo and its Affiliates
the following licenses:

         (i)      [*****]

         (ii)     [*****]

         (iii)    [*****]

Sankyo and ArQule acknowledge and agree that the [*****] license granted under
clause (i) of this Section [*****] to develop Derivative Compounds based on
Licensed Compounds, but [*****] of Derivative Compounds. Sankyo further
acknowledges and agrees that the license grant in clause (iii) of this Section
is subject to the terms, conditions, and limitations of any agreement under
which ArQule has acquired rights in a chemical synthesis method from a third
party and, in such event, ArQule may require Sankyo to enter into a separate
sublicense agreement before such license grant shall take effect. In the event
that Sankyo decides to sublicense its rights under this Section to a third
party, Sankyo shall furnish ArQule with written
- -----------------------
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 Exchange Commission. Asterisks denote such omissions.

                                       12



notice of the sublicense grant and shall ensure that all sublicense agreements
conform to this Agreement.

         6.3.     REVERSION OF RIGHTS.

                  6.3.1. STATUS REPORTS. Sankyo will furnish ArQule with a brief
semi-annual statement, within thirty (30) days after June 30 and December 31 of
each calendar year, that describes the status of each Licensed Compound Set
which remains under development by Sankyo as a Royalty-Bearing Product. After
Sankyo completes development of a Royalty-Bearing Product, Sankyo will promptly
notify ArQule of the first commercial sale of that Royalty-Bearing Product in
each country. In addition, Sankyo agrees to inform ArQule at least once each
calendar year regarding the status of any Sankyo Derivative Compounds that
Sankyo develops based on Sankyo Derivative Compounds synthesized by ArQule under
this Agreement.

                  6.3.2. RETURN OF ARQULE COMPOUNDS. In the event that Sankyo
ceases to use diligent efforts to develop, manufacture, market, and sell [*****]
Licensed Compound or Derivative Compound within a Licensed Compound Set as a
Royalty-Bearing Product, including without limitation the cessation of efforts
to optimize or develop such Licensed Compound Set, then (i) rights in any ArQule
Compounds within such Licensed Compound Set shall revert to ArQule, (ii) all
licenses granted to Sankyo under this Agreement with respect to such ArQule
Compounds shall terminate, and (iii) Sankyo shall assign to ArQule the ownership
of such ArQule Compounds.

7.       INTELLECTUAL PROPERTY.

         7.1. RIGHTS IN COMPOUNDS. Sankyo shall have the sole right to prepare,
file, prosecute, and maintain Patent Rights that claim the composition or use of
ArQule Derivative Compounds or Sankyo Derivative Compounds developed by either
Party under this Agreement. ArQule shall assign to Sankyo all right, title, and
interest in any Patent Rights filed by Sankyo that claim the composition or use
of such ArQule Derivative Compounds or Sankyo Derivative Compounds. Therefore,
such Patent Rights are considered Sankyo Patent Rights under this Agreement
rather than Joint Patent Rights.

         7.2. OWNERSHIP OF INTELLECTUAL PROPERTY. Other than as expressly
provided herein, neither Party shall have any rights in Patent Rights and
Technology that is invented, developed or discovered by the other Party prior to
the Effective Date or outside the research performed under this Agreement.
Ownership of Patent Rights and Technology arising from the research performed
under this Agreement shall be allocated in the following manner:

         (i)      ArQule shall have sole ownership of all right, title, and
                  interest in ArQule Patent Rights and ArQule Technology;

         (ii)     Sankyo shall have sole ownership of all right, title, and
                  interest in Sankyo Patent Rights and Sankyo Technology; and

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 Exchange Commission. Asterisks denote such omissions.


                                       13



         (iii)    ArQule and Sankyo shall have joint ownership of all right,
                  title, and interest in Joint Patent Rights and Joint
                  Technology.

         7.3. MANAGEMENT OF PATENT RIGHTS. Sankyo shall have sole responsibility
for, and control over, the management of Sankyo Patent Rights and ArQule shall
have sole responsibility for, and control over, the management of ArQule Patent
Rights. Each Party will bear its own expenses in connection with such Patent
Rights. In the case of Joint Patent Rights, the Parties shall agree on the
allocation of responsibility for, and the expense of, the preparation, filing,
prosecution, and maintenance of any Joint Patent Rights claiming such
inventions. In the event of any disagreement concerning any Joint Patent Rights,
the matter shall be resolved by the Steering Committee or, in the absence
thereof, by the President of ArQule and the Director of the Patent Department of
Sankyo. The Party controlling a Joint Patent Right shall consult with the other
Party as to the preparation, filing, prosecution, and maintenance of such Joint
Patent Right reasonably prior to any deadline or action with the U.S. Patent &
Trademark Office or its foreign equivalent in Japan or Europe, and shall furnish
to the other Party copies of all relevant documents reasonably in advance of
such consultation. In the event that the Party controlling a Joint Patent Right
desires to abandon such Joint Patent Right, or if the Party assuming control of
a Joint Patent Right later declines responsibility for such Joint Patent Right,
the controlling Party shall provide reasonable prior written notice to the other
Party of such intention to abandon or decline responsibility, and such other
Party shall have the right, at its expense, to prepare, file, prosecute, and
maintain such Joint Patent Rights.

         7.4. COOPERATION. Each Party agrees to cooperate fully with the other
in the preparation, filing, and prosecution of any Joint Patent Rights. ArQule
agrees to cooperate fully with Sankyo in the preparation, filing, and
prosecution of any Patent Rights that ArQule has assigned to Sankyo pursuant to
Section 7.1. Such cooperation includes, but is not limited to:

         (i)      executing all papers and instruments, or requiring its
                  employees or agents, to execute such papers and instruments,
                  so as to effectuate the ownership of Patent Rights as
                  established under this Agreement and to enable the other party
                  to apply for and to prosecute patent applications in any
                  country;

         (ii)     promptly informing the other party of any matters coming to
                  such party's attention that may affect the preparation,
                  filing, or prosecution of any such patent applications; and
                  undertaking no actions that are potentially deleterious to the
                  preparation, filing, or prosecution of such patent
                  applications.

         7.5.     INFRINGEMENT.

                  7.5.l. OFFENSIVE ACTIONS. With respect to infringement of any
Sankyo Patent Right claiming the composition or use of a Licensed Compound,
ArQule Derivative Compound, or Royalty-Bearing Product, Sankyo shall have the
primary right, but not the obligation, to enforce such Patent Right under its
sole control and at its sole expense. In such event, Sankyo shall be exclusively
entitled to all proceeds or recoveries resulting therefrom, but from such
proceeds or recoveries Sankyo shall pay ArQule a royalty in accordance with
Section 8.5. on damages recovered for sales lost to the infringer. In the event
that Sankyo declines to enforce

                                       14



such Patent Right with respect to a Royalty-Bearing Product where the sales of
the alleged infringer are at least twenty percent (20%) of the market for said
product, then ArQule shall have the secondary right to enforce such Patent Right
under its sole control and at its sole expense. In such event, ArQule shall be
exclusively entitled to all proceeds or recoveries resulting therefrom.

                  7.5.2. DEFENSIVE ACTIONS. Sankyo will indemnify, defend, and
hold harmless ArQule, its Affiliates, and their respective officers, directors,
employees, and agents from any and all loss, damage, cost, and expense
(including reasonable attorneys fees) and amounts paid in settlement arising
from any actual or alleged infringement claim brought by a third party, in law
or in equity, based on activities undertaken pursuant to this Agreement (except
for claims based solely on the practice of an ArQule Patent Right or the use of
ArQule Technology) or based on the manufacture or sale of a Royalty-Bearing
Product. In the event that ArQule intends to claim indemnification under this
Subsection, ArQule shall promptly notify Sankyo of the infringement action and
Sankyo shall assume the defense of the action under its sole control, including
the right to effect a settlement. A failure by ArQule to deliver notice to
Sankyo within a reasonable time shall relieve Sankyo of its indemnity obligation
under this Section to the extent such failure prejudices the ability of Sankyo
to defend such action. ArQule shall cooperate fully with Sankyo and its legal
representatives in the investigation and defense of the action. In the event of
a settlement, Sankyo shall obtain the consent of ArQule before agreeing to any
settlement that imposes restrictions which are inconsistent with the rights and
obligations of the Parties under this Agreement.

8.       PAYMENTS, REPORTS, AND RECORDS.

         8.1.     MAPPING ARRAY PROGRAM.

                  8.1.1. COMPASS ARRAY LIBRARY DELIVERY FEE. In partial
consideration of the delivery of the calendar year 2000 and 2001 portion of the
Compass Array Library (as described in Section 3.2.), Sankyo agrees to pay
[*****].

                  8.1.2. MAPPING ARRAY LIBRARY DELIVERY FEE. In partial
consideration of the delivery of up [*****] Mapping Array Libraries per calendar
quarter from the Effective Date through March 31, 2003 (as described in Section
3.3.), Sankyo agrees to pay ArQule [*****] until the last payment is made on
[*****]. If Sankyo does not request its full allocation of [*****] Mapping Array
Libraries in a given calendar quarter, ArQule shall have no obligation to
provide Sankyo with the shortfall in any subsequent calendar quarter. If Sankyo
receives more than [*****] Mapping Array Libraries in a given calendar quarter,
as requested by Sankyo, Sankyo agrees to pay ArQule [*****] for each such
additional Mapping Array Library within thirty (30) days of receipt.

                  8.1.3. RESYNTHESIS COMPOUNDS. In partial consideration of the
delivery of [*****] resynthesis compounds (as described in Section 3.5.) per
calendar quarter from the[*****] , Sankyo agrees to pay ArQule [*****] until the
last payment is made on[*****]. If Sankyo does not receive its full allocation
of [*****] compounds in a given calendar quarter,
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 Exchange Commission. Asterisks denote such omissions.

                                       15



ArQule shall have no obligation to provide Sankyo with the shortfall in any
subsequent calendar quarter. If Sankyo receives more than [*****] resynthesis
compounds in a given calendar quarter, as requested by Sankyo, Sankyo agrees to
pay ArQule [*****] thirty (30) days of receipt. In addition, if ArQule produces
more than 5 mg of a resynthesis compound, as directed by the Research Committee
and approved by Sankyo, Sankyo will pay ArQule an additional fee that will be
determined by the Steering Committee on a case-by-case basis.

         8.2. DIRECTED ARRAY PROGRAMS. In partial consideration of the conduct
of the Directed Array Programs by ArQule, Sankyo agrees to pay ArQule a total of
[*****], payable on [*****] and thereafter on the first day of each [*****]
during the Research Period until the last payment is made on [*****]. Sankyo and
ArQule acknowledge that this payment is intended to apply to the [*****]
committed by ArQule to the Directed Array Programs each year[*****]. If Sankyo
desires to access additional ArQule FTEs to support Directed Array Programs, and
ArQule provides the requested FTEs, Sankyo will pay ArQule for these additional
FTEs at the rate of [*****] per year, payable quarterly in advance. In addition
to the amounts payable for the FTEs applied to the Directed Array Programs,
Sankyo shall pay any and all Extraordinary Expenses of ArQule, as requested by
the Research Committee and approved by Sankyo.

         8.3. MILESTONE PAYMENTS. In partial consideration of the activities
undertaken by ArQule and the licenses granted by ArQule under this Agreement,
Sankyo shall pay ArQule the following amounts within [*****] after each
occurrence of the following milestones:




PAYMENT FOR ROYALTY-
 BEARING PRODUCTS                    MILESTONE
                  

    [*****]          First IND Filing (or non-U.S. equivalent) for
                     each Royalty-Bearing Product

    [*****]          Completion of Phase I Clinical Trials (or non-U.S.
                     equivalent) for each Royalty-Bearing Product

    [*****]          Completion of Phase II Clinical Trials (or non-U.S.
                     equivalent) for each Royalty-Bearing Product

    [*****]          Commencement of Phase III Clinical Trials (or non-U.S.
                     equivalent) for each Royalty-Bearing Product

    [*****]          Completion of Phase III Clinical Trials (or non-U.S.
                     equivalent) for each Royalty-Bearing Product

    [*****]          First NDA filing (or non-U.S. equivalent) for each Royalty-
                     Bearing Product

    [*****]          Approval of first NDA (or non-U.S. equivalent) for each
                     Royalty-Bearing Product


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 Confidential materials omitted and filed separately with the Securities and
 Exchange Commission. Asterisks denote such omissions.


                                       16



Such milestone payments shall be [*****] under this Agreement, PROVIDED,
HOWEVER, that [*****] of any such milestone payments made with respect to any
Royalty-Bearing Product consisting of an ArQule Compound provided to Sankyo
pursuant to the Mapping Array Program, and not submitted to a Directed Array
Program, [*****] for such Royalty-Bearing Product pursuant to Section 8.5.
Sankyo shall promptly notify ArQule of each occurrence of any of the foregoing
milestones.

         8.4. [*****] MILESTONE PAYMENTS. If any time on or before [*****] prior
to the filing of an IND application with respect to any Royalty-Bearing Product,
[*****], it shall so notify ArQule in writing. Promptly upon its receipt of such
written notice, ArQule shall enter into good faith negotiations with Sankyo for
[*****] under which either (i) [*****] or (ii) [*****]. In addition, such
[*****] and that ArQule shall indemnify Sankyo with respect to such
Royalty-Bearing Product in substantially the form set forth in Section 11.1. If
the Parties are unable to reach agreement with respect to the foregoing by the
expiration of [*****] from the commencement of such negotiations, Sankyo[*****].

         8.5. ROYALTIES. In partial consideration of the activities undertaken
by ArQule and the licenses granted by ArQule under this Agreement, Sankyo shall
pay to ArQule a royalty for each Royalty-Bearing Product as follows:




  SOURCE OF ROYALTY-BEARING PRODUCT       ROYALTY RATE (PERCENTAGE OF NET SALES)

                                          WORLDWIDE TERRITORY     U.S. TERRITORY
                                                            

    Sankyo Derivative Compound                   [*****]              [*****]
    ArQule Compound or ArQule                    [*****]              [*****]
     Derivative Compound


[*****] for the Worldwide Territory and [*****] for the U.S. Territory shall
apply if a Royalty-Bearing Product is based on (i) [*****] or (ii) [*****]. This
royalty obligation shall commence with the first commercial sale of a
Royalty-Bearing Product in any country and shall continue on a
country-by-country basis until the expiration of the last to expire of any
Patent Rights covering that Royalty-Bearing Product or, in any country in which
the Royalty-Bearing Product is not covered by a Patent Right, for a period of
ten (10) years from the date of first commercial sale of that Royalty-Bearing
Product in that country.

         8.6. REPORTS AND PAYMENTS. Within sixty (60) days after the conclusion
of each Royalty Period, Sankyo shall deliver to ArQule a report containing the
following information:

         (i)      gross sales of Royalty-Bearing Products by Sankyo, its
                  Affiliates and Sublicensees during the applicable Royalty
                  Period in each country of sale;
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 Exchange Commission. Asterisks denote such omissions.

                                       17



         (ii)     adjustments and calculation of Net Sales for the applicable
                  Royalty Period in each country of sale; and

         (iii)    total Net Sales in U.S. dollars, together with the exchange
                  rates used for conversion.

All such reports shall be maintained in confidence by ArQule. If no royalties
are due to ArQule for any reporting period, the report shall so state.
Concurrent with this report, Sankyo shall remit to ArQule any payment due for
the applicable Royalty Period. The method of payment shall be mutually agreed
to. All amounts payable to ArQule under this Section will first be calculated in
the currency of sale and then converted into U.S. dollars in accordance with
Section 8.7., and such amounts shall be paid without deduction of any
withholding taxes, value-added taxes, or other charges applicable to such
payments, except as provided for in Section 8.11.

         8.7. INVOICES; PAYMENTS IN U.S. DOLLARS. With the exception of royalty
payments due under Section 8.5, ArQule shall submit invoices to Sankyo for each
payment due ArQule hereunder, and Sankyo shall pay such invoices within sixty
(60) days of receipt thereof. All payments due under this Agreement shall,
except as provided in Section 8.8. below, be payable in United States dollars.
Conversion of foreign currency to U.S. dollars shall be made at the conversion
rate existing in the United States (as reported in the WALL STREET JOURNAL) on
the last working day of the calendar quarter preceding the applicable calendar
quarter. Such payments shall be without deduction of exchange, collection, or
other charges, except as provided for in Section 8.9.

         8.8. PAYMENTS IN OTHER CURRENCIES. If by law, regulation, or fiscal
policy of a particular country, conversion into United States dollars or
transfer of funds of a convertible currency to the United States is restricted
or forbidden, Sankyo shall give ArQule prompt written notice of such
restriction, which notice shall satisfy the sixty-day payment deadline described
in Section 8.6. Sankyo shall pay any amounts due ArQule through whatever lawful
methods ArQule reasonably designates; provided, however, that if ArQule fails to
designate such payment method within thirty (30) days after ArQule is notified
of the restriction, then Sankyo may deposit such payment in local currency to
the credit of ArQule in a recognized banking institution selected by Sankyo and
identified by written notice to ArQule, and such deposit shall fulfill all
obligations of Sankyo to ArQule with respect to such payment.

         8.9. RECORDS. Sankyo and its Affiliates shall maintain complete and
accurate records of Royalty-Bearing Products made, used or sold by them or their
Sublicensees under this Agreement, and any amounts payable to ArQule in relation
to such Royalty-Bearing Products, which records shall contain sufficient
information to permit ArQule to confirm the accuracy of any reports delivered to
ArQule in accordance with Section 8.6. The relevant Party shall retain such
records relating to a given Royalty Period for at least three (3) years after
the conclusion of that Royalty Period. During the Royalty Period and thereafter
for a period of three (3) years, each Party (acting as the "Auditing Party")
shall have the right, at its own expense, to cause an independent certified
public accountant to inspect such records of the other Party (the "Audited
Party") during normal business hours for the sole purpose of verifying any
reports and payments delivered under this Agreement. Such accountant shall not
disclose to the Auditing Party any

                                       18



information other than information relating to accuracy of reports and payments
delivered under this Agreement and shall provide the Audited Party with a copy
of any report given to the Auditing Party. The Parties shall reconcile any
underpayment or overpayment within thirty (30) days after the accountant
delivers the results of the audit. In the event that any audit performed under
this Section reveals an underpayment in excess of [*****] in any Royalty Period,
the Audited Party shall bear the full cost of such audit. Each party may
exercise its rights under this Section only once every year and only with
reasonable prior notice to the other Party.

         8.10. LATE PAYMENTS. Any payments by Sankyo that are not paid on or
before the date such payments are due under this Agreement shall bear interest,
to the extent permitted by law, at two percentage points above the prime rate of
interest as reported in the WALL STREET JOURNAL on the date payment is due,
calculated based on the number of days that payment is delinquent.

         8.11.    WITHHOLDING TAX PAYMENTS.

                  8.11.1. PAYMENTS. All amounts payable under this Section 8
except royalties payable under Section 8.5. shall represent the actual proceeds
to be received by ArQule after any applicable deductions have been made,
including without limitation any withholding taxes. ArQule agrees to reasonably
cooperate with Sankyo in obtaining a refund of any withholding taxes paid by
Sankyo with respect to any payments to ArQule hereunder. In the event that
ArQule is successful in obtaining exemption therefrom, a full allowance of such
withholding tax or a foreign tax credit paid by Sankyo under this Agreement,
ArQule agrees to promptly remit such refund amount received by ArQule to Sankyo.

                  8.11.2. ROYALTY PAYMENTS. Sankyo may only withhold from
royalties due to ArQule under Section 8.5. amounts for payment of Japanese
withholding tax that is required by law to be paid to the Japanese taxing
authority with respect to such royalty amounts due to ArQule; PROVIDED,
HOWEVER, that such amount withheld shall not exceed [*****] of such royalties
due to ArQule; and FURTHER PROVIDED, HOWEVER, that in regard to any such tax
withholding Sankyo shall give ArQule such documents, and provide any other
cooperation or assistance on a reasonable basis, as may be necessary to
enable ArQule to claim exemption therefrom, to receive a full allowance of
such withholding tax or claim a foreign tax credit, and Sankyo shall upon
ArQule's request give proper evidence as to the payment of such tax. In the
event that Sankyo is successful in obtaining any refund of tax withholding
amounts paid by Sankyo under Sections 8.5. of this Agreement, Sankyo agrees
to promptly remit such refund amount received by Sankyo to ArQule.

9.       CONFIDENTIAL INFORMATION AND PROPRIETARY MATERIALS.

         9.1.     CONFIDENTIAL INFORMATION.

                  9.1.1. DESIGNATION OF CONFIDENTIAL INFORMATION. Confidential
Information that is disclosed in writing shall be marked with a legend
indicating its confidential status. Confidential Information that is disclosed
orally or visually shall be documented in a written
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 Confidential materials omitted and filed separately with the Securities and
 Exchange Commission. Asterisks denote such omissions.

                                       19



notice prepared by the Disclosing Party and delivered to the Receiving Party
within thirty (30) days of the date of disclosure; such notice shall summarize
the Confidential Information disclosed to the Receiving Party and reference the
time and place of disclosure.

                  9.1.2.   OBLIGATIONS.  The Receiving Party agrees that it
shall:

                           (a) maintain all Confidential Information in strict
         confidence, except that the Receiving Party may disclose or permit the
         disclosure of any Confidential Information to its, and its Affiliates,
         directors, officers, employees, consultants, and advisors who are
         obligated to maintain the confidential nature of such Confidential
         Information and who need to know such Confidential Information for the
         purposes set forth in this Agreement;

                           (b) use all Confidential Information solely for the
         purposes set forth in, or as permitted by, this Agreement; and

                           (c) allow its directors, officers, employees,
         consultants, and advisors to reproduce the Confidential Information
         only to the extent necessary to effect the purposes set forth in this
         Agreement, with all such reproductions being considered Confidential
         Information.

                  9.1.3. EXCEPTIONS. The obligations of the Receiving Party
under Section 9.1.2. above shall not apply to the extent that the Receiving
Party can demonstrate that certain Confidential Information:

                           (a) was in the public domain prior to the time of its
         disclosure under this Agreement;

                           (b) entered the public domain after the time of its
         disclosure under this Agreement through means other than an
         unauthorized disclosure resulting from an act or omission by the
         Receiving Party;

                           (c) was independently developed or discovered by the
         Receiving Party without use of the Confidential Information;

                           (d) is or was disclosed to the Receiving Party at any
         time, whether prior to or after the time of its disclosure under this
         Agreement, by a third party having no fiduciary relationship with the
         Disclosing Party and having no obligation of confidentiality to the
         Disclosing Party with respect to such Confidential Information; or

                           (e) is required to be disclosed to comply with
         applicable laws or regulations (such as disclosure to the FDA or the
         United States Patent and Trademark Office or to their foreign
         equivalents), or to comply with a court or administrative order,
         provided that the Disclosing Party receives prior written notice of
         such disclosure and that the Receiving Party takes all reasonable and
         lawful actions to obtain confidential treatment for such disclosure
         and, if possible, to minimize the extent of such disclosure.


                                       20



                  9.1.4. RETURN OF CONFIDENTIAL INFORMATION. Upon the
termination of this Agreement, at the request of the Disclosing Party, the
Receiving Party shall destroy or return to the Disclosing Party all originals,
copies, and summaries of documents, materials, and other tangible manifestations
of Confidential Information in the possession or control of the Receiving Party,
except that the Receiving Party may retain one copy of the Confidential
Information in the possession of its Legal Department solely for the purpose of
monitoring its obligations under this Agreement.

         9.2.     PROPRIETARY MATERIALS.

                  9.2.1. OWNERSHIP. Sankyo acknowledges and agrees that the
ArQule Compounds and any other Proprietary Materials provided to Sankyo and its
Affiliates under this Agreement are and shall remain the property of ArQule.
ArQule acknowledges and agrees that any Sankyo Compounds and any other
Proprietary Materials provided to ArQule under this Agreement are and shall
remain the property of Sankyo. The foregoing notwithstanding, the Parties agree
that ownership of any intellectual property rights in ArQule Derivative
Compounds shall be determined in accordance with Section 6.

                  9.2.2. RESTRICTIONS ON USE AND TRANSFER. Sankyo shall use the
ArQule Compounds only for the purposes contemplated by this Agreement, and shall
not transfer the ArQule Compounds to any third party without the prior written
consent of ArQule. Except as expressly permitted herein, Sankyo shall not
attempt to identify the ArQule Compounds in the Mapping Array Libraries or
Compass Array Libraries. In the case of Proprietary Materials other than ArQule
Compounds, the Recipient agrees to use such Proprietary Materials only for the
purposes indicated by the Provider, and shall not transfer the Proprietary
Materials to any third party without the prior written consent of the Provider.
The Recipient further agrees to inform its employees and consultants about the
proprietary nature of the Proprietary Materials and to take reasonable
precautions, at least as stringent as those observed by the Recipient to protect
its own Proprietary Materials, to ensure that such employees and consultants
observe the obligations of the Recipient under this Section 9.2.2.

                  9.2.3. DISPOSITION OF UNUSED MATERIALS. At the request of the
Provider, the Recipient will return or destroy any unused Proprietary Materials
furnished by the Provider; provided, however, that the disposition of unused
ArQule Compounds shall be made in accordance with Section 12.4.

                  9.2.4. COMPLIANCE WITH LAW. The Recipient agrees to comply
with all international, national, state, and local laws and regulations
applicable to the use, storage, disposal, and transfer of Proprietary Materials
furnished by the Provider, including without limitation the Toxic Substances
Control Act (15 USC 2601 et seq.) and implementing regulations (in particular,
40 CFR 720.36 [Steering and Development Exemption]), the Food, Drug, and
Cosmetic Act (21 USC 301 et seq.) and implementing regulations, and all Export
Administration Regulations of the Department of Commerce. The Recipient assumes
sole responsibility for any violation of such laws or regulations by the
Recipient or any of its Affiliates.

                                       21


                  9.2.5. LIMITATION OF LIABILITY. Any Proprietary Materials
delivered pursuant to this Agreement are understood to be experimental in nature
and may have hazardous properties. The Recipient should assume that the
materials are dangerous and should use appropriate precautions. THE PROVIDER
MAKES NO REPRESENTATIONS, AND EXTENDS NO WARRANTIES OF ANY KIND, EITHER EXPRESS
OR IMPLIED, WITH RESPECT TO THE PROPRIETARY MATERIALS FURNISHED TO THE
RECIPIENT. THERE ARE NO EXPRESS OR IMPLIED WARRANTIES OF MERCHANTABILITY OR
FITNESS FOR A PARTICULAR PURPOSE. THE PROVIDER DISCLAIMS ANY WARRANTY, EXPRESS
OR IMPLIED, THAT THE USE OF ANY PROPRIETARY MATERIALS WILL NOT INFRINGE ANY
PATENT OR OTHER INTELLECTUAL PROPERTY RIGHTS OF A THIRD PARTY, AND THE PROVIDER
SHALL HAVE NO LIABILITY RELATING THERETO.

         9.3. SURVIVAL OF OBLIGATIONS. The obligations set forth in this Section
9 shall remain in effect for a period of [*****] after termination of this
Agreement, except that the obligations of the Receiving Party to destroy or
return Confidential Information and Proprietary Materials to the Disclosing
Party shall survive until fulfilled.

10.      REPRESENTATIONS AND WARRANTIES.

         Each Party represents and warrants to the other that it has the legal
right and power to enter into this Agreement, to extend the rights and licenses
granted to the other in this Agreement, and to fully perform its obligations
hereunder, and that the performance of such obligations will not conflict with
its charter documents or any agreements, contracts, or other arrangements to
which it is a Party.

11.      INDEMNIFICATION AND INSURANCE.

         11.1. SANKYO INDEMNITY OBLIGATIONS. Sankyo agrees to defend, indemnify
and hold ArQule, its Affiliates and their respective directors, officers,
employees and agents harmless from all costs, judgments, liabilities and damages
assessed by a court of competent jurisdiction arising from claims asserted by a
third party against ArQule, its Affiliates or their respective directors,
employees or agents as a result of: (a) actual or asserted violations of any
applicable law or regulation by Sankyo, its Affiliates, sublicensees or third
party manufacturers by virtue of which the Royalty-Bearing Products
manufactured, distributed or sold shall be alleged or determined to be
adulterated, misbranded, mislabeled or otherwise not in compliance with such
applicable law or regulation; (b) claims for bodily injury, death or property
damage attributable to the manufacture, distribution, sale or use of the
Royalty-Bearing Products by Sankyo, its Affiliates, sublicensees or third party
manufacturers; or (c) a recall ordered by a governmental agency, or required by
a confirmed failure, of Royalty-Bearing Products manufactured, distributed, or
sold by Sankyo, its Affiliates, sublicensees or third party manufacturers as
reasonably determined by the Parties hereto.
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                                       22



         11.2. PROCEDURE. In the event that ArQule or any of its Affiliates or
their respective employees or agents (the "Indemnitee") intends to claim
indemnification under this Section 11, such Party shall promptly notify Sankyo
of any loss, claim, damage, liability or action in respect of which the
Indemnitee intends to claim such indemnification, and Sankyo shall assume the
defense thereof with counsel mutually satisfactory to the Parties; provided,
however, that an Indemnitee shall have the right to retain its own counsel, with
the fees and expenses to be paid by Sankyo, if representation of such Indemnitee
by the counsel retained by Sankyo would be inappropriate due to actual or
potential differing interests between such Indemnitee and any other Party
represented by such counsel in such proceedings. The indemnity agreement in this
Section 11 shall not apply to amounts paid in settlement of any loss, claim,
damage, liability or action if such settlement is effected without the consent
of Sankyo, which consent shall not be withheld unreasonably. The failure to
deliver notice to Sankyo within a reasonable time after the commencement of any
such action, if prejudicial to its ability to defend such action, shall relieve
Sankyo of any liability to the Indemnitee under this Section 11, but the
omission so to deliver notice to Sankyo will not relieve it of any liability
that it may have to any Indemnitee otherwise than under this Section 11. The
Indemnitee under this Section 11, its employees and agents, shall cooperate
fully with Sankyo and its legal representatives in the investigation of any
action, claim or liability covered by this indemnification.

         11.3. INSURANCE. Sankyo shall maintain appropriate product liability
insurance with respect to development, manufacture and sales of the
Royalty-Bearing Products by Sankyo in such amount as Sankyo customarily
maintains with respect to sales of its other products. Sankyo shall each
maintain such insurance for so long as it continues to manufacture or sell the
Royalty-Bearing Products, and thereafter for so long as Sankyo maintains
insurance for itself covering such manufacture or sales.

12.      TERM AND TERMINATION.

         12.1. TERM. This Agreement shall commence on the Effective Date and
shall remain in effect until the expiration of the Research Period, unless
earlier terminated as provided in this Article 12.

         12.2. BREACH OF PAYMENT OBLIGATIONS. In the event that Sankyo fails to
make timely payment of any amounts due to ArQule under this Agreement, ArQule
may terminate this Agreement upon [*****] written notice to Sankyo, unless
Sankyo pays all past-due amounts within such [*****] notice period.

         12.3. MATERIAL BREACH. In the event that either Party commits a
material breach of any of its obligations under this Agreement (other than as
provided in Section 12.2) and such Party fails (i) to remedy that breach within
[*****] after receiving written notice thereof from the other Party or (ii) to
commence dispute resolution pursuant to Section 13.5, within [*****] after
receiving written notice of that breach from the other Party, the other Party
may immediately terminate this Agreement upon written notice to the breaching
Party.
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 Exchange Commission. Asterisks denote such omissions.

                                       23



         12.4. EFFECT OF TERMINATION. Termination of this Agreement shall not
relieve the Parties of any obligation accruing prior to such termination. The
provisions of Article 7, Article 8 (with respect only to research-related
payments accrued at the time of termination but not yet paid and with respect to
milestone and royalty payments), Article 9, and Article 11, and Sections 6.2.,
6.3., 12.4., 13.3., 13.4., 13.5., and 13.10., shall survive the expiration or
termination of this Agreement. In addition, if ArQule terminates this Agreement
pursuant to Section 12.3., the provisions of Section 9.3.2. shall immediately
apply to all ArQule Compounds.

13.      MISCELLANEOUS.

         13.1. RELATIONSHIP OF PARTIES. Nothing in this Agreement is intended or
shall be deemed to constitute a partnership, agency, employer-employee or joint
venture relationship between the Parties. No Party shall incur any debts or make
any commitments for the other, except to the extent, if at all, specifically
provided therein.

         13.2. PUBLICITY. Neither Party shall use the name of the other Party or
reveal the terms of this Agreement in any publicity or advertising without the
prior written approval of the other Party, except that (i) either Party may use
the text of a written statement approved in advance by both Parties without
further approval, (ii) either Party shall have the right to identify the other
Party and to disclose the terms of this Agreement as required by applicable
securities laws or other applicable law or regulation, and (iii) either Party
may use the name of the other Party and reveal the existence of this Agreement.

         13.3. NON-SOLICITATION. During the term of this Agreement and
thereafter for a period of [*****] , each Party agrees not to seek to persuade
or induce any employee of the other Party to discontinue his or her employment
with that Party in order to become employed by or associated with any business,
enterprise, or effort that is associated with its own business.

         13.4. GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the Commonwealth of Massachusetts.







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                                       24



         13.5. DISPUTE RESOLUTION PROCEDURES.

                           (a) The Parties hereby agree that they will attempt
         in good faith to resolve any controversy, claim or dispute ("Dispute")
         arising out of or relating to this Agreement promptly by negotiations.
         Any such Dispute which is not settled by the Parties within fifteen
         (15) days after notice of such Dispute is given by one Party to the
         other in writing shall be referred to a senior executive of ArQule and
         the Director of the Research Institute of Sankyo who are authorized to
         settle such Disputes on behalf of their respective companies ("Senior
         Executives"). The Senior Executives will meet for negotiations within
         fifteen (15) days of the end of the 15 day negotiation period referred
         to above, at a time and place mutually acceptable to both Senior
         Executives. If the Dispute has not been resolved within thirty (30)
         days after the end of the 15 day negotiation period referred to above
         (which period may be extended by mutual agreement), subject to any
         rights to injunctive relief and unless otherwise specifically provided
         for herein, any Dispute will be settled first by non-binding mediation
         and thereafter by arbitration as described in subsections (b) and (c)
         below.

                           (b) Any Dispute which is not resolved by the Parties
         within the time period described in subsection (a) shall be submitted
         to an alternative dispute resolution process ("ADR"). Within five (5)
         business days after the expiration of the thirty (30) day period set
         forth in subsection (a), each Party shall select for itself a
         representative with the authority to bind such Party and shall notify
         the other Party in writing of the name and title of such
         representative. Within ten (10) business days after the date of
         delivery of such notice, the representatives shall schedule a date for
         engaging in non-binding ADR with a neutral mediator or dispute
         resolution firm mutually acceptable to both representatives, but in the
         absence agreement the firm shall be the Center for Public Resources
         Institute for Dispute Resolution. Any such mediation shall be held in
         Boston, Massachusetts. Thereafter, the representatives of the Parties
         shall engage in good faith in an ADR process under the auspices of such
         individual or firm. If the representatives of the Parties have not been
         able to resolve the Dispute within thirty (30) business days after the
         conclusion of the ADR process, or if the representatives of the Parties
         fail to schedule a date for engaging in non-binding ADR within the ten
         (10) day period set forth above, the Dispute shall be settled by
         binding arbitration as set forth in subsection (c) below. If the
         representatives of the Parties resolve the dispute within the thirty
         (30) day period set forth above, then such resolution shall be binding
         upon the Parties. If either Party fails to abide by such resolution,
         the other Party can immediately refer the matter to arbitration under
         Section 13.5(c).

         (c) If the Parties have not been able to resolve the Dispute as
         provided in subsections (a) and (b) above, the Dispute shall be finally
         settled by binding arbitration. Any arbitration hereunder shall be
         conducted under rules of the American Arbitration Association. The
         arbitration shall be conducted before three arbitrators chosen
         according to the following procedure: each of the Parties shall appoint
         one arbitrator and the two so nominated shall choose the third. If the
         arbitrators chosen by the Parties cannot agree on the choice of the
         third arbitrator within a period of thirty (30) days after their
         appointment, then the third arbitrator shall be appointed by the Court
         of

                                       25


         Arbitration of the American Arbitration Association. Any such
         arbitration shall be held in Boston, Massachusetts. The arbitrators
         shall have the authority to grant specific performance, and to allocate
         between the Parties the costs of arbitration in such equitable manner
         as they determine. The arbitral award (i) shall be final and binding
         upon the Parties; and (ii) may be entered in any court of competent
         jurisdiction.

                           (d) Nothing contained in this Section or any other
         provisions of this Agreement shall be construed to limit or preclude a
         Party from bringing any action in any court of competent jurisdiction
         for injunctive or other provisional relief to compel the other Party to
         comply with its obligations hereunder before or during the pendency of
         mediation or arbitration proceedings. The Parties hereby irrevocably
         consent to submit to the jurisdiction of the courts of the Commonwealth
         of Massachusetts and/or any other court having jurisdiction for this
         purpose.

         13.6. COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original, and all of which
together shall be deemed to be one and the same instrument.

         13.7. HEADINGS. All headings in this Agreement are for convenience only
and shall not affect the meaning of any provision hereof.

         13.8. BINDING EFFECT. This Agreement shall inure to the benefit of and
be binding upon the Parties, their Affiliates, and their respective lawful
successors and assigns.

         13.9. ASSIGNMENT. This Agreement may not be assigned by either Party
without the prior written consent of the other Party, except that either Party
may assign this Agreement to a successor in connection with the merger,
consolidation, or sale of all or substantially all of its assets or that portion
of its business pertaining to the subject matter of this Agreement.

         13.10. NOTICES. All notices, requests, demands and other communications
required or permitted to be given pursuant to this Agreement shall be in writing
and shall be deemed to have been duly given upon the date of receipt if
delivered by hand, recognized international overnight courier, confirmed
facsimile transmission, or registered or certified mail, return receipt
requested, postage prepaid to the following addresses or facsimile numbers:

If to Sankyo:                               If to ArQule:

Sankyo Co., LTD                             ArQule, Inc.
2-58, Hiromachi 1-Chome                     19 Presidential Way
Shinagawa-ku                                Woburn, MA  01801
Tokyo 140 Japan                             Attention:  President
Attention:  Junichi Ryokai
Tel: 03 3492 3131                           Tel: (781) 994-0300
Fax: 03 5436 8561                           Fax: (781) 503-0009

                                            with a copy to:


                                       26


                                            Same Address
                                            Attention:  General Counsel
                                            Tel: (781) 994-0300
                                            Fax: (781) 503-0009


Either Party may change its designated address and facsimile number by notice to
the other Party in the manner provided in this Section.

         13.11. AMENDMENT AND WAIVER. This Agreement may be amended,
supplemented, or otherwise modified only by means of a written instrument signed
by both Parties. Any waiver of any rights or failure to act in a specific
instance shall relate only to such instance and shall not be construed as an
agreement to waive any rights or fail to act in any other instance, whether or
not similar.

         13.12. SEVERABILITY. In the event that any provision of this Agreement
shall, for any reason, be held to be invalid or unenforceable in any respect,
such invalidity or unenforceability shall not affect any other provision hereof,
and the Parties shall negotiate in good faith to modify the Agreement to
preserve (to the extent possible) their original intent.

         13.13. ENTIRE AGREEMENT. This Agreement constitutes the entire
agreement between the Parties with respect to the subject matter hereof and
supersedes all prior agreements or understandings between the Parties relating
to the subject matter hereof.

         13.14. FORCE MAJEURE. Neither Party shall be held liable or responsible
to the other Party, nor be deemed to be in breach of this Agreement, for failure
or delay in fulfilling or performing any provisions of this Agreement when such
failure or delay is caused by or results from any cause whatsoever outside the
reasonable control of the Party concerned including, but not limited to, fire,
explosion, breakdown of plant, strike, lock-out, labor disputes, casualty or
accident, lack or failure of transportation facilities, flood, lack or failure
of sources of supply or of labor, raw materials or energy, civil commotion,
embargo, any law, regulation, decision, demand or requirement of any national or
local government or authority. The Party claiming relief shall, without delay,
notify the other Party by registered airmail or by telefax of the interruption
and cessation thereof and shall use its best efforts to remedy the effects of
such hindrance with all reasonable dispatch. The onus of proving that any such
Force Majeure event exists shall rest upon the Party so asserting. During the
period that one Party is prevented from performing its obligations under this
Agreement due to a Force Majeure event, the other Party may, in its sole
discretion, suspend any obligations that relate thereto. Upon cessation of such
Force Majeure event the Parties hereto shall use their best efforts to make up
for any suspended obligations. If such Force Majeure event is anticipated to
continue, or has existed for nine (9) consecutive months or more, this Agreement
may be forthwith terminated by either Party by registered airmail or by telefax.
In case of such termination the terminating Party will not be required to pay to
the other Party any indemnity whatsoever.

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                                       27



IN WITNESS WHEREOF, the undersigned have duly executed and delivered this
Agreement as a sealed instrument effective as of the date first above written.


SANKYO CO., LTD                        ARQULE, INC.



By:                                    By:
   ---------------------------------      --------------------------------------
Name:  Tetsuo Hiraoka                     Name:  Stephen A. Hill, M.D.
Title: Executive Managing Director        Title: President and Chief
       General Manager, Research                 Executive Officer
       Institute













                                       28






                                    EXHIBIT A

                             COMPOUND SPECIFICATIONS

[*****]


























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 Confidential materials omitted and filed separately with the Securities and
 Exchange Commission. Asterisks denote such omissions.



                                       29