ARQULE, INC.

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 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 þ No o

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o

The aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant as of June 30, 2003 was: $96,584,484.

There were 28,731,288 shares of the registrant’s Common Stock outstanding as of March 1, 2004.

Portions of the definitive proxy statement for the Registrant’s Annual Meeting of Shareholders to be held on May 19, 2004, which definitive proxy statement will be filed with the Securities and Exchange Commission not later that 120 days after the registrant’s fiscal year end of December 31, 2003, are incorporated by reference into Part III of the Form 10-K.

You should carefully consider the risks described below together with all of the other information included in this Form 10-K before making an investment decision. An investment in our common stock involves a high degree of risk. We operate in a dynamic and rapidly changing industry that involves numerous uncertainties. The risks and uncertainties described below are not the only ones we face. Other risks and uncertainties, including those that we do not currently consider material, may impair our business. If any of the risks discussed below actually occur, our business, financial condition, operating results or cash flows could be materially adversely affected. This could cause the trading price of our common stock to decline, and you may lose all or part of your investment.

This Form 10-K contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. All statements that are not descriptions of historical fact are forward-looking statements, based on estimates, assumptions and projections that are subject to risks and uncertainties. These statements can generally be identified by use of forward looking terminology such as “believes”, “expects”, “intends”, “may”, “will”, “should”, “anticipates” or similar terminology. Although we believe that the expectations reflected in such forward looking statements are reasonable as of the date thereof, such expectations are based on certain assumptions regarding the progress of product development efforts under collaborative agreements, the execution of new collaborative agreements and other factors relating to our growth. Such expectations may not materialize if product development efforts, including any necessary trials of our potential drug candidates, are delayed or suspended, if positive early results are not repeated in later studies or in humans, if planned acquisitions or negotiations with potential collaborators are delayed or unsuccessful, if we are unsuccessful at integrating acquired assets or technologies, if our planned transition to a drug discovery and development company takes longer or is more expensive than we anticipated or if other assumptions prove incorrect. The forward-looking statements contained herein represent the judgment of ArQule as of the date of this Form 10-K. ArQule disclaims any intent or obligation to update any forward-looking statement except to the extent required by law.

We are a biotechnology company engaged in the research and development of small molecule cancer therapeutics based on a novel biological approach to cancer, our Activated Checkpoint Therapy^SM (ACT^SM) platform, and our expertise in small molecule chemistry and intelligent drug design.

Our company was incorporated in Delaware in 1993, and completed a public offering in 1996. Since inception, we have provided fee-based services to pharmaceutical companies and biotechnology companies, using our chemistry based technology and expertise to attract collaborators. We have an experienced and highly qualified scientific and management team that can apply our chemistry technology platform to produce compounds that have medicinal attributes. We continue to provide fee-based services to our collaborators. We also use our chemical technology capabilities in our cancer drug discovery programs.

On September 8, 2003, we acquired Cyclis Pharmaceuticals, Inc. (“Cyclis”), an early stage cancer therapeutics company. This acquisition enabled us to continue our transition to a drug discovery and development company in accordance with our stated strategy. The Cyclis acquisition provided us with the proprietary ACT^SM platform, an oncology discovery pipeline and ARQ 501, which is now in Phase 1 clinical trials. We believe that the ACT^SM approach to anti-cancer therapies offers the potential to deliver clinical candidates with improved activity and reduced toxicity over many other molecular approaches and traditional therapies.

In connection with our acquisition of Cyclis, we issued approximately 4.6 million shares of common stock (valued at $18.8 million), paid cash of $5 million and forgave notes receivable of $0.5 million. We incurred consulting, legal, accounting and other third-party costs of approximately $1.6 million in order to complete the transaction. These costs were accounted for as part of the acquisition, and capitalized, resulting in a total purchase price of $25.9 million.

Our ACT^SM platform is an approach to cancer therapy that is intended to use small molecule drugs to restore and activate cellular checkpoints that are defective in cancer cells, and that, once activated, will cause the cancer cells to undergo programmed cell death.

The cells in the human body usually grow, divide and die so that the body always has the number of each different type of cells necessary to support a healthy existence. Cell division is controlled through a series of molecular events called the cell cycle. The cell cycle is designed to ensure that cell division proceeds accurately, so that each daughter cell receives the appropriate cellular DNA and other subcellular machinery.

The cell cycle has several built in “checkpoints,” during which quality-control mechanisms operate to ensure that each step of the cycle is completed correctly. For example, in a normal cell, checkpoint functions monitor for damage to the cellular DNA. If damage is detected, the cell attempts to repair the damage. If the DNA damage is too severe, the cell undergoes programmed cell death. Thus, a cellular checkpoint is a natural defense mechanism that ensures the genomic integrity of the cells in the body by eliminating damaged cells.

Cancer cells, with multiple abnormalities including DNA damage, survive and proliferate because key checkpoints and pathways that should lead to cell death are often disabled during the development of cancer. As a result, cancer cells undergo cell division in an uncontrolled way.

Our ACT^SM platform is based on our current understanding that a therapeutic agent which reactivates the quality control, or checkpoint functions of a cell, has the potential to re-enable the cell to detect and respond to DNA damage. Because cancer cells contain genes relating to tumor formation (activated oncogenes) and irreparable DNA damage, we believe that restoration of their checkpoint functions will result in such cells

undergoing cell death. In addition to the effect checkpoint activation has in cancer cells, the absence of adverse effect in normal cells is also important. Normal, healthy cells have little DNA damage compared with cancer cells. Consequently, when a checkpoint is activated in a healthy cell, we do not expect to see cell death. In other words, since non-cancer cells are genetically normal, they are more likely to be spared even if exposed to the same checkpoint-activating stimulus as the cancer cell.

We believe therapeutics based on the ACT^SM approach will be more effective and less toxic that traditional cancer therapies due to their ability to selectively cause cancer cells to undergo cell death, while leaving healthy cells unaffected. This is in contrast to conventional chemotherapy which seeks to kill cancer cells by creating further damage to DNA. A well-known side effect of this approach is that some normal cells are indiscriminately damaged, causing toxicity to patients and limiting the effectiveness of chemotherapy. Furthermore, because checkpoint functions are virtually the same in different cell types, and because many cancers have checkpoint defects, we believe that therapeutics developed using the ACT^SM platform will be effective against a broad spectrum of cancers and will counteract the variable genetic makeup of cancer cells.

Our oncology portfolio, based on the ACT^SM platform, consists of four programs that we obtained through our acquisition of Cyclis. The first two seek to target and elevate E2F, a protein related to cellular checkpoint and cell death. The third and fourth involve different targets and mechanisms related to checkpoints and cell death pathways, namely Cancer Survival Proteins (CSPs) and p53.

ARQ 501 entered Phase 1 clinical trials in September 2003 and is our first clinical-stage compound.

Preclinical findings. ARQ 501 is aimed at causing rapid and sustained elevation in the checkpoint regulatory protein E2F1. Based on preclinical findings, we believe that ARQ 501 has the potential for improved activity and reduced toxicity over other molecular approaches and traditional cancer chemotherapy. In preclinical studies, ARQ 501 activated E2F-mediated checkpoints leading to selective cell death of cancer cells. The compound has demonstrated anti-cancer activity in mice when applied as both a single agent and in combination with chemotherapy. In contrast to its selectivity for tumor cells over normal cells, ARQ 501 is active against tumor cells with a broad range of genetic defects. We believe this is particularly advantageous for treatment of solid tumors, where individual tumor masses are comprised of highly heterogeneous cancer cells.

Ongoing Phase 1 study. Our Phase 1 (monotherapy) dose-escalation study in patients with advanced solid tumors is currently underway at the Dana-Farber/ Harvard Cancer Center in three Boston hospitals: Dana-Farber Cancer Institute, Massachusetts General Hospital and Beth Israel Deaconess Medical Center. The objectives of this study are to determine the safety profile (clinical tolerability) of ARQ 501 and a recommended dose to be used in Phase 2 clinical trials. Study subjects receive ARQ 501 as a one-hour intravenous infusion on a weekly schedule. Tumor response is assessed by imaging after eight weeks of therapy. To date, the treatment dose has been safely escalated toward our pre-determined dose limit while treating a single patient at a time. Once we safely reach our pre-determined dose limit in the single patient study, groups (or cohorts) of three patients each will be enrolled for further dose escalation.

Other clinical development plans. Based on the results of our preclinical tests, which have shown ARQ 501 to be active against a large number of solid and hematological (bloodstream) tumors, we intend to investigate ARQ 501 in solid tumors both as a single agent and in combination therapy, and in hematologic tumors initially as a single agent.

Applying our platform in small molecule chemistry and intelligent drug design to our 550 series program, we are developing analogues and derivatives of ARQ 501. These new compounds are also aimed at modulating E2F. We have identified several such compounds and we are currently working to optimize these leads for further development by designing and selecting the version of a given lead compound that has the most advantageous set of drug-like characteristics possible.

In our Cancer Survival Protein (“CSP”) program, we are developing compounds aimed at blocking cellular survival mechanisms that cancer cells possess and, thereby, selectively triggering cell death in such cancer cells. CSPs are certain proteins, including cytosolic and nuclear proteins, that are inappropriately elevated to excessive levels in cancer cells. In an animal model of cancer, our scientists have explored the feasibility of safely and effectively treating cancer by blocking the activity of cancer cell survival proteins with small molecule compounds. We believe we have discovered a mechanism and a proprietary series of compounds. Work is underway to advance this series of compounds to select a clinical candidate. While the potential outcome is expected to be similar (namely selective cell death), the targets, mechanism of action and chemistry involved in the 650 series are all different from those involved in the 501 and 550 programs.

In our p53 Modulation (PUMA) program, we are validating the newly discovered intracellular protein PUMA (“p53-Upregulated Modulator of Apoptosis”) as a target for treating cancer. p53, is a protein that controls several key cell cycle checkpoints. In normal cells, when p53 is present in sufficient amounts, the PUMA protein is produced. When PUMA is produced, it rapidly induces cell death in cancer cells. In human cancer, however, the gene that expresses the p53 protein is a commonly mutated gene. The result of this mutation is that the p53 protein is either not functional, or not produced in sufficient amounts to perform its checkpoint-related functions, including the production of PUMA. In our PUMA program, we are researching a potential way to restore normal function to the p53/ PUMA pathway by inducing the production of PUMA. We are now developing cancer specific PUMA modulators. This program involves a different, but potentially equally important, checkpoint pathway to cell death, which may have application to certain types of cancer.

We have two internal drug discovery programs outside of our cancer focus, each of which were developed using our chemistry based drug discovery technology platform. In order to focus on our cancer programs, we are currently exploring opportunities to out-license both of these programs.

In November 2003, we commenced GLP-toxicity studies with our lead compound, ARQ 101, a p38 MAP Kinase inhibitor for rheumatoid arthritis. Throughout 2003, we had progressed several compounds through advanced lead optimization demonstrating functional oral activity in a rat model of rheumatoid arthritis. In this established animal model, the data indicated that our compounds reduced joint swelling in a dose-dependent manner and were well tolerated at all doses studied.

ArQule’s pain program involves the N-type Calcium channel for neuropathic pain. In the first quarter of 2003, we generated lead compounds with activity against the N-type Calcium channel and identified three families of chemicals. In the second half of 2003, in connection with our shift in resources to our oncology based programs, we held up this program just prior to beginning optimization work on the lead compounds.

Our business strategy aims to balance revenues from our chemistry services with our cancer drug discovery and development. Our specific goals for the near future are as follows:


	•	Complete phase 1 clinical trials of ARQ 501.

	•	Accelerate the preclinical work on our ARQ 550, ARQ 650 and PUMA programs.

	•	Out-license ARQ 101 for rheumatoid arthritis and our series of lead compounds for the N-type Calcium Channel for neuropathic pain.

	•	Continue to execute our chemical technologies contracts efficiently on a cash flow positive basis.

Our strategy for developing compounds into commercial products has the following components:

Focus on Cancer, a market with a large unmet need. Cancer is the second most common cause of death in the Western world. Estimates for 2003 suggest that approximately 1.2 million new cases of invasive cancer will be diagnosed annually in the United States. Medical therapy has evolved as an alternative to or adjunct of surgery including the introduction of cytotoxic chemotherapy and radiation over 50 years ago. While chemotherapies have evolved, they are still harmful to all rapidly dividing cells. More recently, a number of alternative therapies that are target specific have been introduced. We believe that our approach has the potential to be both more selective for cancer cells than traditional chemotherapies and applicable to a broad spectrum of cancers.

Pursue clinical development to take advantage of available accelerated regulatory approval opportunities. Cancer compounds have been eligible for accelerated regulatory approval. On average, three new oncology agents have been approved per year over the past 14 years. Once on the market the agents may be approved for additional indications. In 2002, five oncology products were approved and the FDA granted a total of 23 new indications for cancer products. In 2003, there were seven approvals for oncology products, two of which were approved under an accelerated approval process. In 1992 the FDA implemented Accelerated Approval Procedures, to permit market approval of drugs for life threatening diseases on the basis of evidence predictive of clinical benefit followed by further post-approval study. Two medical areas (HIV and cancer) have stood to benefit from the availability of these procedures. As of December 2003, there were five cancer products in clinical trials on the accelerated approval track. We believe that our drug candidates could qualify for this fast track regulatory approval following demonstration of Phase 2 clinical responses in cancer patients for whom there is no alternative therapy.

Focus on Small molecule drugs, which have a large market. Most prescription medicines are — and we believe will continue to be — small molecules. Approximately 88% of the top 200 prescription drugs, based on worldwide sales in 2001, are compounds described as small molecules. Small molecules can be made into pills that can be readily swallowed. In addition, small molecule drugs have a low production cost as compared to other therapeutic agents because they are easier to make, store and ship. Other therapeutic agents, such as proteins and antibodies, are more difficult to administer — requiring, for example, injections. They are also more costly to manufacture than small molecules.

Benefit from the resources and strengths of collaborators. We intend to develop drug candidates we discover from the preclinical testing phase through human proof of principle. We then expect to out-license, co-develop or sell our drug candidates to pharmaceutical companies for completion of clinical testing and commercialization. We believe that by striking this balance at the proper time, we will be able to obtain the maximum risk-adjusted return on our investment in these potential drugs.

Acquire new technologies as necessary. As we further our transition to oncology-focused biotechnology, we may need to supplement our portfolio and resources by acquisition, in-licensing and/or developing internal

expertise. Such transactions could allow us to move more quickly toward developing additional candidates for clinical trials. We may also continue to invest in technology and personnel to enhance or expand our capabilities in drug discovery.

Obtain the most benefit from our chemistry technology platform. ArQule has developed a chemistry-based drug discovery technology platform designed to create small molecules that possess drug-like characteristics. We believe that identifying drug-like characteristics prior to preclinical development increases the likelihood that small molecules reaching preclinical development will have a greater potential to become medicines. Without such a technology platform, the traditional approach is to develop small molecules that have demonstrated activity toward biological targets, with little regard to whether the molecules otherwise would make good medicines. In our view, a drug that has the best set of drug-like characteristics for its indication (i.e., one that is the most effective and has the fewest side effects) will ultimately generate the most revenue in its category, even if it is not the first to become available on the market. We are using our chemistry technology and expertise in our cancer discovery programs.

Build on the pharmaceutical and biotechnology expertise of our management and scientific teams. Our executive team consists of leaders with experience in drug discovery and development and specific expertise in oncology. Our CEO, Dr. Stephen Hill, formerly led global drug development for F. Hoffmann-La Roche, Ltd. After the Cyclis acquisition, we retained the scientific founder of the ACT^SM platform, Dr. Chiang Li and most of his research team to advance our biology research and research programs based on the ACT^SM platform at ArQule Biomedical Institute. In late December, we hired Dr. Adam Craig to lead our clinical development program and direct our medical affairs. Dr. Craig was previously Senior Director of Clinical Oncology at Ilex Oncology.

We provide chemistry services to collaborators and customers for their discovery programs. In line with our transition to drug discovery, we intend to run our chemistry technologies as a profitable, cash flow positive business, with minimal investment in 2004.

We are an established market leader in the production of diverse collections of chemical compounds using automated high throughput technology and computational design tools. We do not believe that any of our competitors in small molecule chemistry possess the particular combination of technology included in our chemistry technology platform and we believe our capabilities provide a competitive advantage over the industry standard techniques for designing and producing drug-like molecules. We believe it would take any competitor several years, (assuming it would be possible to work around our proprietary technology), to duplicate our technology platform and process.

We are currently providing chemistry technology services under collaborations with Pfizer Inc, Sankyo Company, Ltd. and Novartis Institute for Biomedical Research, Inc. (NIBRI). Our collaboration with Pfizer is our largest collaboration and accounted for 84% of our revenue for 2003. During 2003 we also had active chemistry services-based collaborations with Bayer AG, Solvay Duphar B.V. and Pharmacia Corporation. The active phase under the Bayer, Solvay and Pharmacia collaborations terminated during 2003 and our obligations to Sankyo and NIBRI terminate in June 2004 and September 2004, respectively. We also completed activity under collaborations with GlaxoSmithKline, Wyeth Pharmaceuticals, Searle and Johnson & Johnson in 2002. Under our collaboration agreements, we generally receive fees for the services we provide during the active phase of the agreement. These agreements also impose trailing obligations on our collaborators to, under specified circumstances, make milestone and royalty payments to us based on their further development of compounds we provided to them. In addition, for several of our formerly active collaborators, we have agreed to provide a limited amount of compound production services, as such collaborators seek to optimize promising compounds. Wyeth has filed an IND based upon a compound derived from our Directed Array Program and made milestone payments to us in connection therewith in October 2002 and February 2004.

Pfizer. Since the inception of this relationship in 1999, we have produced collections of chemical compounds exclusively for Pfizer using our automated high throughput system. This agreement expires in 2008. In February 2004, the agreement was amended to maintain compound deliveries at approximately the same level from 2004 through the end of the term, instead of increasing them as previously specified. This will result in a decrease in the total potential contract value of $55 million compared to the terms agreed upon in 2001.

As of March 1, 2004, we have received $191.0 million from Pfizer since inception of this relationship in 1999. If our relationship with Pfizer is successful, we could receive up to an additional $177.7 million over the remaining term of the contract. Pfizer has made equity investments in our company of $10 million in 2001, and $8 million in 2003, based on the achievement of certain delivery milestones. Under the amended agreement, upon notice, Pfizer may terminate the relationship beginning in December, 2005 for any reason, but would not be entitled to receive any refund for amounts paid to ArQule through the date of termination.

Sankyo. In November 1997, we entered into a three-year agreement with Sankyo Company, Ltd. to discover and optimize drug candidates. In April 2001, we extended our agreement with Sankyo through June 2004. The total value of the extended agreement is up to $14.8 million in committed payments of which, as of March 1, 2004, we have received $14.6 million. To date, we have not received any milestone or royalty payments under this agreement.

Novartis Institute for Biomedical Research, Inc. On September 3, 2003, we entered into a one year chemistry services collaboration with NIBRI, an affiliate of Novartis AG. Under this agreement, we are applying our integrated chemistry technology platform to generate and optimize small molecule compounds for NIBRI’s anti-infective drug discovery program. The total contract value of the agreement is $1 million, of which we have received $0.6 million as of March 1, 2004. NIBRI must also make additional payments if we achieve certain developmental milestones. This agreement expires in September 2004.

We believe that patent and trade secret protection is crucial to our business and that our future will depend in part on our ability to obtain patents, maintain trade secret protection and operate without infringing the proprietary rights of others, both in the U.S. and other countries. As of March 1, 2004, we had eighteen issued or allowed U.S. utility patents, one issued U.S. design patent, five granted foreign patents, and numerous patent applications in the U.S. and other countries. While many patent applications have been filed in the U.S. and other countries with respect to our cancer programs, the majority of these have not yet been issued or allowed. The patent positions of companies in the biotechnology industry and the pharmaceutical industry are highly uncertain and involve complex legal and factual questions. Therefore, we cannot predict the breadth of claims, if any, that may be allowed under any of our patent applications, or the enforceability of any of our issued patents.

As needed, we obtain rights under patents owned by other parties through licenses. We have several exclusive and nonexclusive technology licenses from certain institutions in support of our research programs. We anticipate that we will continue to seek licenses from universities and others where applicable technology complements our research and development efforts.

Patents extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends on the type of patent, the scope of its coverage and the availability of legal remedies in the country.

In an effort to maintain the confidentiality and ownership of our trade secrets and proprietary information, we require all of our employees and consultants to sign confidentiality agreements. Employees and consultants involved in scientific and technical endeavors also sign invention assignment agreements. We intend these confidentiality and assignment agreements to protect our proprietary information by controlling the disclosure

“ArQule”, the ArQule logo, “Directed Array”, and “Mapping Array” are trademarks of ArQule that are registered in the U.S. Patent and Trademark Office. The terms “AMAP”, “ArQule Reactor”, “Compass Array”, “Custom Array”, “MapMaker”, “Optimal Chemical Entities”, “OCEs”, “Parallel Track”, and “PrepQule” are trademarks of ArQule. The terms Activated Checkpoint Therapy and ACT are service marks of ArQule.

The pharmaceutical and biotechnology industries are highly competitive. We face intense competition from organizations such as large pharmaceutical companies, biotechnology companies and academic and research organizations. The major pharmaceutical organizations competing with us have greater capital resources, larger overall research and development staff and facilities and considerably more experience in drug development. Biotechnology companies competing with us may have these advantages as well. In addition to competition for collaborators and investors, these companies and institutions also compete with us in recruiting and retaining highly qualified scientific and management personnel.

With respect to our cancer drug discovery and development programs, other companies have potential drugs in preclinical and clinical trials that may result in effective, commercially successful treatments for the same cancers we target. In the area of small molecule anti-cancer therapeutics, we have identified a number of companies that have clinical development programs and focused research and development in small molecule approaches to cancer such as Ariad Pharmaceuticals; Genaera Corporation; Onyx Pharmaceuticals, OSI Pharmaceuticals, Oxigene, Inc.; Telik Inc. and Tularik Inc.

Several organizations are actively attempting to identify and optimize compounds for internal or collaborator programs and, like us, act both as chemistry service providers and as integrated drug discovery companies. These companies include Array^TM BioPharma and Exelixis. Other competitors in the chemistry technology services market are Pharmacopeia, Inc.; Albany Molecular Research, Inc.; Evotec OAI; and Discovery Partners International, Inc.


	•	developing and protecting our novel approach to anti-cancer therapeutics, namely the compounds and science that result from our ACT^SM platform;

	•	advancing a discovery and development portfolio of anti-cancer candidates that are selective for cancer cells and applicable across a broad spectrum of cancer types;

	•	securing partners to co-develop and advance our drug candidates through later-stage clinical trials and beyond;

	•	securing and sustaining business based on our ability to design and produce chemical compound collections for lead generation;

	•	securing and sustaining business based on our ability to identify, optimize and advance lead compounds toward the clinic; and

	•	maintaining our position as an industry leader in chemistry technology innovation.

There can be no assurance that our competitors will not develop more effective or more affordable products or technology, or achieve earlier product development and commercialization than ArQule, thus rendering our technologies and/or products obsolete, uncompetitive or uneconomical.

Virtually all pharmaceutical and biotechnology products that we or our collaborative partners develop will require regulatory approval by governmental agencies prior to commercialization. The nature and the extent to which these regulations apply varies depending on the nature of the products. In particular, human pharmaceutical products are subject to rigorous preclinical and clinical testing and other approval procedures by the FDA. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of these products required by the FDA. The process of obtaining these approvals and the subsequent compliance with appropriate federal statutes and regulations are time consuming and require substantial resources and the outcome is uncertain.

Generally, in order to gain FDA approval, a company first must conduct preclinical studies in the laboratory and in animal models to gain preliminary information on a compound’s activity and to identify any safety problems. Preclinical studies must be conducted in accordance with FDA regulations. The results of these studies are submitted as a part of an IND that the FDA must review before human clinical trials of an investigational drug can start. If the FDA does not respond with any questions, a drug developer can commence clinical trials thirty days after the submission of an IND.

In order to eventually commercialize any products, we or our collaborator first will be required to sponsor and file an IND and will be responsible for initiating and overseeing the clinical studies to demonstrate the safety and efficacy that are necessary to obtain FDA marketing approval. Clinical trials are normally done in three phases and generally take several years, but may take longer to complete. Furthermore, the FDA may suspend clinical trials at any time if the FDA believes that the subjects participating in trials are being exposed to unacceptable risks or if the FDA finds deficiencies in the conduct of the trials or other problems with our product under development.

After completion of clinical trials of a new product, FDA marketing approval must be obtained. If the product is classified as a new pharmaceutical, we or our collaborator will be required to file a New Drug Application (“NDA”), and receive approval before commercial marketing of the drug. The testing and approval processes require substantial time and effort. NDAs submitted to the FDA can take several years to obtain approval and the FDA is not obligated to grant approval at all.

Even if FDA regulatory clearances are obtained, a marketed product is subject to continual review. If and when the FDA approves any of our or our collaborators’ products under development, the manufacture and marketing of these products will be subject to continuing regulation, including compliance with current Good Manufacturing Practices (“GMP”) adverse event reporting requirements and prohibitions on promoting a product for unapproved uses. Later discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions. Various federal and, in some cases, state statutes and regulations also govern or influence the manufacturing, safety, labeling, storage, record keeping and marketing of pharmaceutical products.

For marketing outside the United States, we or our partners will be subject to foreign regulatory requirements governing human clinical trials, marketing approval and post-marketing activities for pharmaceutical products and biologics. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement vary widely from country to country.

Our research and development processes involve the controlled use of hazardous materials and controlled substances. Although we are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and waste products, the license or sale of our chemistry services is not subject to the same degree of government regulations applicable to our drug product candidates.

As of March 1, 2004, we employed 257 people across three sites: Woburn, Medford and Norwood, Mass. Of that total, 89 hold Ph.D.s and 14 hold Masters in the Sciences. As of March 1, 2004, 161 of our employees were engaged in operations, 52 were engaged in research and development and 44 were engaged in marketing and general administration.

We file annual and quarterly reports, proxy statements and other information with the SEC. You may read and copy any document we file at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. We also maintain a web site at http://www.ArQule.com, which provides additional information about our company and links to documents we file with the SEC.

Set forth below is certain information regarding our current executive officers and directors, including their respective ages, as of March 1, 2004:

President and Chief Executive Officer. Dr. Hill has served as ArQule’s President and CEO since April 1999. Before joining ArQule, Dr. Hill was the Head of Global Drug Development at F. Hoffmann-La Roche Ltd. from 1997-1999. Dr. Hill joined Roche in 1989 as Medical Adviser to Roche Products in the United Kingdom. He held several senior positions there that included Medical Director, responsible for clinical trials of compounds across a broad range of therapeutic areas, such as CNS, HIV, cardiovascular, metabolic and oncology products. Subsequently, he served as Head of International Drug Regulatory Affairs at Roche headquarters in Basel, Switzerland, where he led the regulatory submissions for seven major new chemical entities. Dr. Hill also was a member of Roche’s Portfolio Management, Research, Development and Pharmaceutical Division Executive Boards. Prior to Roche, Dr. Hill served seven years with the National Health Service in the United Kingdom in General and Orthopedic Surgery. Dr. Hill is a Fellow of the Royal College of Surgeons of England and holds his scientific and medical degrees from St. Catherine’s College at Oxford University.

Chief Scientific Officer and Vice President, Head of ArQule BioMedical Institute. Dr. Li joined ArQule in September 2003. Prior to joining ArQule, he had served as the scientific founder and Vice President of Research at Cyclis Pharmaceuticals, Inc., a faculty member at Harvard Medical School and an attending physician at Harvard’s Beth Israel Deaconess Medical Center. At Cyclis, Dr. Li directed research

efforts that led to a cancer therapeutic portfolio, which culminated in the successful IND filing of Cyclis’ first drug candidate, CO-501. Dr. Li is the inventor of, and has directed research efforts on, the Activated Checkpoint Therapy^SM (ACT^SM) platform that underscores ArQule’s oncology portfolio. He has published a number of highly cited articles in over 30 publications in leading biomedical journals and holds 15 issued or filed patents. Dr. Li is a member of several professional societies, including a recent induction to the National Register’s Who’s Who in Executives and Professionals. Dr. Li has been a recipient of a number of honors, recognitions and research awards. Most recently his work was recognized by the editorial board of the journal, Cell Cycle, as one of the “Top Ten Most Outstanding Cell Cycle Research Papers” of the past year published in all biomedical journals. Dr. Li graduated from the Harvard-MIT Division of Health Science and Technology and received his M.D. degree Magna Cum Laude from Harvard Medical School.

Vice President, Finance, Chief Financial Officer and Treasurer. Ms. Mawhinney joined the Company in December 2003 as Vice President, Finance and CFO. Ms. Mawhinney has more than 20 years of experience in finance covering audit, accounting, treasury, tax, SEC reporting, investor relations, corporate financing and merger and acquisition responsibilities. For the past three years, Ms. Mawhinney has been Chief Financial Officer, Secretary and Treasurer of Cleanwise, Inc., a Massachusetts-based third-party logistics software start-up company. From 1999 to 2000, she was Chief Financial Officer, Secretary and Treasurer of Veridiem Inc., a Massachusetts-based marketing automation software start-up. From 1993 to 1999, Ms. Mawhinney served in a variety of finance functions, and in 1996 became Chief Financial Officer, Secretary and Treasurer, for The Butcher Company, a chemical process manufacturer with annual sales of $80 million. Prior to that she was with KPMG in Boston, MA. Ms. Mawhinney holds a Masters degree from St. Andrews University in Scotland and has been a C.P.A. in Massachusetts since 1989.

Vice President, Legal, General Counsel and Secretary. Mr. Jacobs joined ArQule in June 2001 as Vice President, Legal, General Counsel and Secretary. Previously, Mr. Jacobs held the position of Senior Counsel in the Biomedical Services division of the American Red Cross where from 1997 to 2001 he was responsible for all matters involving new products, revenue generation, licensing, intellectual property and mergers and acquisitions. Prior to joining the Red Cross, Mr. Jacobs practiced in the fields of tax and international commercial transactions at the law firms of Kramer, Levin et al. in New York City from 1988 to 1994 and Shimron, Molcho in Jerusalem from 1994 to 1996. Mr. Jacobs received his J.D. with honors from Columbia Law School, an M.A. with distinction from the Jewish Theological Seminary and a B.A. from Columbia College.

Ariel Elia was named Chairman of the Board in March 2001 and has been a director since September 2000. Since 1999, Mr. Elia has served as Chairman of the European Advisory Board of E.Med Securities, a private, U.S.-based company providing investment banking services to emerging growth companies in the life sciences industry. Mr. Elia has been a director of Altamir S.A., a French venture capital company, since 1995, and a director of Yissum, the research and development company of the Hebrew University of Jerusalem in Israel, since 1999. Mr. Elia also serves as a Governor of both the Ben Gurion University (since 1992) and the Hebrew University of Jerusalem (since 1998), in Israel. Prior to his current positions, Mr. Elia was the Chief Executive Officer of Jouveinal Laboratories, a privately held, French pharmaceutical company. Mr. Elia also spent 17 years with Merck & Co., serving both in Europe and in the U.S., most recently as Senior Vice President, International Division. Before joining Merck, Mr. Elia spent 12 years with American Home Products Corporation, serving as President of the International Household Products Division prior to his departure. Mr. Elia graduated from Victoria College in Alexandria, Egypt with an Oxford and Cambridge degree as a Bachelor of Arts. His honors include Knight of the Order of the Crown in Belgium and Doctor of Philosophy Honoris Causa of Ben Gurion University, Israel and the Hebrew University of Jerusalem.

Laura Avakian has been a director since March 2000. Since 1999, Ms. Avakian has been Vice President for Human Resources for the Massachusetts Institute of Technology, where she directs all human resource programs and oversees the Institution’s Medical Department. Prior to joining MIT, she was Senior

Vice President, Human Resources, for Beth Israel Deaconess Medical Center and for its parent corporation CareGroup (1996-1999). She previously served as President of The American Society for Healthcare Human Resources Administration, and received the distinguished service award, literature award and chapter leadership award from that society. She received the 1996 Award for Professional Excellence in Human Resources Management from the Society for Human Resource Management. She has also served as editor of the Yearbook of Healthcare Management and authored numerous chapters and articles on human resources management. Ms. Avakian received her B.A. degree from the University of Missouri at Columbia and her M.A. degree from Northwestern University.

Timothy C. Barabe has been a director since November 2001. Mr. Barabe has been employed by Novartis AG since April 1982 in various capacities. Beginning in May 2003, Mr. Barabe has been the Chief Financial Officer of Sandoz Generics, the generic pharmaceutical subsidiary of Novartis. Beginning in February 2002 until April 2003, Mr. Barabe was Group Vice President and President, Specialty Lenses of CIBA Vision. From 1993 through January 2002, Mr. Barabe was the Chief Financial Officer of CIBA Vision Corp., a subsidiary of Novartis. From June 1998 through May 2003, Mr. Barabe served as a director of BioCure, Inc., a majority-owned subsidiary of Novartis. Mr. Barabe received his B.B.A. degree from the University of Massachusetts (Amherst) and his M.B.A. degree from the University of Chicago.

Werner Cautreels, Ph.D. has been a director since September 1999. He has over 20 years of experience in the healthcare industry. Since May 1998, Dr. Cautreels has been the Global Head of Research and Development of Solvay Pharmaceuticals. Prior to that time, Dr. Cautreels served as Senior Vice President of Research and Development at Nycomed Amersham Ltd., held two senior management positions at Sterling Winthrop and served as Vice President of Scientific Affairs at Sanofi Pharmaceuticals, where he conducted clinical trials in various therapeutic areas and researched licensing opportunities. Dr. Cautreels received his Ph.D. in Chemistry from University of Antwerp, Belgium.

Tuan Ha-Ngoc has been a director since 2002. He is the President and CEO of GenPath Pharmaceuticals, Inc., a biopharmaceutical company. He has 26 years of worldwide experience in the healthcare industry, primarily in the biotechnology sector, but also in the pharmaceutical, medical devices and Information Technology areas. From 1999 to 2002, he was co-founder, President and CEO of deNovis, Inc., an enterprise-scale software development company for the automation of healthcare administrative functions. From 1998 to 1999, he served as Corporate Vice President, Strategic Development for American Home Products Corporation. From 1984 to 1998, he was at Genetics Institute, Inc., as its Executive Vice President responsible for Corporate Development, Commercial Operations, European and Japanese Operations. From 1976 to 1984, he was in various marketing and business positions at Baxter Healthcare, Inc. Mr. Ha-Ngoc received his M.B.A. degree from INSEAD and his Master’s degree in Pharmacy from the University of Paris, France. He serves on the Board of Fellows, Harvard School of Dental Medicine and on the Boards of Directors of the International Institute of Boston.

Patrick J. Zenner has been a director since 2002. A 32-year veteran of the pharmaceutical industry, Patrick Zenner retired in 2001 from the position of President and Chief Executive Officer of Hoffmann-La Roche Inc., North America. Hoffmann-La Roche Inc., based in Nutley, N.J., is the prescription drug unit of the Roche Group. Long active in industry, academic and civic affairs, Mr. Zenner is immediate past chairman of the HealthCare Institute of New Jersey and served on the Boards of Directors and Executive Committees of the Pharmaceutical Research & Manufacturers of America (PhRMA) and the Biotechnology Industry Organization (BIO). In addition, Mr. Zenner has been a member of numerous associations, including the American Foundation for Pharmaceutical Education, the Health Care Leadership Council and the National Committee for Quality Health Care. Mr. Zenner is currently on the Boards of Trustees of Creighton University and Fairleigh Dickinson University. In addition, Mr. Zenner is a member on the Boards of Directors of CuraGen Corporation, Dendrite International, Praecis Pharmaceuticals Inc., Geron Corporation, First Horizon Pharmaceutical Corporation, Xoma Ltd., West Pharmaceutical Services, Exact Sciences, Inc. and other private companies.

Development of our products is at an early stage and is uncertain and our approach and technology may never result in a commercial drug.

The discovery and development of drugs is inherently risky and involves a high rate of failure. Discovering and developing commercial drugs is relatively new to us.

Our proposed drug products and drug research programs are in the early stages of development and require significant, time-consuming and costly research and development, testing and regulatory clearances. We do not expect that these product candidates will be commercially available for several years, if ever. We have never identified a drug candidate that has been developed into a commercial drug using this platform. It is uncertain whether our technology platform will achieve these goals at all, or whether it will be competitive with platforms used by our competitors.

We must show the safety and efficacy of our product candidates through expensive, time consuming preclinical and clinical trials, the results of which are uncertain.

Our product candidates are at the preclinical stages of development, with the exception of ARQ 501 which is now in Phase 1 clinical studies. Although several of our product candidates have demonstrated some favorable pharmacological effects in preclinical studies, they may not prove to be effective in humans. We will need to conduct extensive further testing of all of our product candidates, expend significant additional resources and possibly partner with another company to realize commercial value from any of our product candidates.

Before obtaining regulatory approvals for the commercial sale of our products, we must demonstrate, through preclinical studies (animal testing) and clinical trials (human testing), that our proposed products are safe and effective for use in each target indication. This testing is expensive and time-consuming, and failure can occur at any stage. Acceptable results from initial preclinical studies and clinical trials of products under development are not necessarily indicative of results that will be obtained from subsequent or more extensive preclinical studies and clinical testing in humans. Clinical trials may not demonstrate sufficient safety and efficacy to obtain the required regulatory approvals or result in marketable products. The failure to adequately demonstrate the safety and efficacy of a product under development will delay and could prevent its regulatory approval.

A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials.

Though it is our stated strategy to pursue clinical development to take advantage of available accelerated regulatory approval opportunities, there is no guarantee that our product candidates will show the evidence predictive of clinical benefit necessary to qualify for such opportunities.

Clinical trials for the product candidates we are developing may be delayed by many factors, including that potential appropriate patients for testing are limited in number. The failure of any clinical trials to meet applicable regulatory standards could cause such trials to be delayed or terminated, which could further delay the commercialization of any of our product candidates. Any such delays will increase our product development costs, with the possibility that we could run out of funding. Consequently, if such delays are significant they could negatively affect our financial results and the commercial prospects for our products.

We are dependent on third-party providers of preclinical and clinical development services, including GLP synthesis and testing. If we choose to perform such studies ourselves we will be required to incur significant costs and devote significant efforts to establish our own development facilities and capabilities. If we are unable to reach agreement with third-party service providers on acceptable terms, or to establish our own development facilities, ArQule’s preclinical and clinical development of products will be delayed and our financial results will be adversely affected.

We may face challenges in realizing the benefits of the Cyclis acquisition, and future acquisitions.

Having acquired Cyclis Pharmaceuticals, Inc. on September 8, 2003, we have been operating the Cyclis business for less than six months. Integrating the operations and personnel of ArQule and Cyclis has been a complex process of integrating the former Cyclis business, including the ARQ 501 program, and the Cyclis molecular biology expertise into our existing operations. It is too early to be certain that the integration has been successful or that we will achieve the anticipated benefits of the merger. There may be unexpected delays or we may be unable to successfully develop the Cyclis business and technology over the long term. As noted below, we also may effect additional acquisitions, which could pose similar, or greater, risks than the Cyclis acquisition. There is also the risk that we may have greater difficulty integrating more than one acquisition at the same time.

If we choose to acquire complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete these acquisitions, to integrate successfully an acquired business or technology in a cost-effective and non-disruptive manner or to complete commercialization of an acquired product.

From time to time, we may choose to acquire complementary businesses, products, or technologies instead of developing them ourselves. We do not know if we will be able to complete any acquisitions, or whether we will be able to successfully integrate any acquired businesses, operate them profitably or retain their key employees. Integrating any business, product or technology we acquire could be expensive and time-consuming, disrupt our ongoing business and distract company management. In addition, in order to finance any acquisition, we might need to raise additional funds through public or private equity or debt financings. In that event, we could be forced to obtain financing on less than favorable terms and, in the case of equity financing, that may result in dilution to our stockholders. In addition, under certain circumstances, amortization of assets or charges resulting from the costs of acquisitions could harm our business and operating results.

We may not be able to find collaborators or successfully form collaborations in furtherance of our drug development efforts.

We plan to seek collaborators for our drug development efforts. We would like to enter into these collaborations to obtain external financing for drug development and to obtain access to commercialization expertise. The availability of partners depends on the willingness of pharmaceutical companies to collaborate in drug discovery activities. There are only a limited number of pharmaceutical companies which would fit our requirements. The number could decline further through consolidation or the number of collaborators with interest in our drugs could decline. If the number of our potential collaborators declines further, collaborators may be able to negotiate terms unfavorable to us.

We face significant competition in seeking collaborators, both from other biotechnology companies and from the internal capabilities and compound pipelines of the pharmaceutical companies themselves. This competition is particularly intense in the oncology field. Our ability to interest such companies in forming co-development and commercialization arrangements with us will be influenced by, among other things:


	•	the compatibility of technologies;

	•	the potential partner’s acceptance of our approach to drug discovery;

	•	the quality and commercial potential of any drug candidate we may succeed in developing; and

	•	our ability, and collaborators’ perceptions of our ability, to achieve intended results in a timely fashion, with acceptable quality and cost.

Even if we are able to gain the interest of potential drug development partners, the negotiation, documentation and implementation of collaborative arrangements are complex and time-consuming. Collaborative opportunities may not be available on commercially acceptable terms and, if formed, may not be commercially successful or, if successful, may not realize sufficient return for us. If we are unable to form

collaborations, we may not gain access to the financial resources and industry expertise necessary to develop drug products or successfully market any products we develop on our own and, therefore, be unable to generate revenue from pharmaceutical products.

Our success depends on the efforts of our collaborators, whom we do not and cannot control.

If we are able to enter into collaborations for the development and commercialization of our drug candidates, we will depend on our partners to develop and commercialize our drug candidates. Similarly, we depend on parties to whom we have provided compounds through chemistry services collaborations to develop and commercialize those compounds. Each of our current chemistry services collaborators has, and we expect that each future collaborator will have, significant discretion in determining the efforts and resources that it will apply to the development and commercialization of compounds and drug candidates covered by its collaboration with us.

Any of our current or future collaboration partners may fail to develop or commercialize a compound or product to which they have obtained rights from us for a variety of reasons, including that our partner:


	•	decides not to devote the necessary resources because of internal constraints or other priorities, or because of a merger with another pharmaceutical company changes those priorities;

	•	decides to pursue a competitive potential drug or compound developed outside of our collaboration;

	•	cannot obtain necessary regulatory approvals; or

	•	exercises a right to terminate our collaboration.

We may not receive any milestone, royalty or license payments under our current or any future collaborations.

Although we have received license and milestone fees to date under our chemistry services collaborations, we may never receive any royalty payments or additional license and milestone fees under such agreements. Likewise, even if we are able to enter into collaboration agreements relating to our drug candidates, we may never receive any milestone, royalty or license payments under such future agreements.

Our receipt of any future milestone, royalty or license payments depends on many factors, including whether our collaborators want or are able to continue to pursue a potential drug candidate and the ultimate commercial success of the drug. Development and commercialization of potential drug candidates depends not only on the achievement of objectives by us and our collaborators, but also on each collaborator’s financial, competitive, marketing and strategic considerations and regulation in the United States and other countries. Pharmaceutical products our collaborators develop will require lengthy and costly testing in animals and humans and regulatory approval by governmental agencies prior to commercialization. These agencies may not approve the products for commercialization despite the substantial time and resources required to seek approvals and comply with appropriate statutes and regulations. If unforeseen complications arise in the development or commercialization of the potential drug candidates by our collaborators, we may not realize milestone, royalty or license payments.

Even if we are successful in bringing a product to market, we face substantial competitive challenges in effectively marketing and distributing our product. Many other companies and research institutions are developing products within the field of oncology, including large pharmaceutical companies with much greater financial resources, and more experience in developing products, running clinical trials, obtaining FDA approval and bringing new drugs to market. We are in a rapidly evolving field of research, and our technology may be rendered non-competitive or obsolete by approaches and methodologies discovered by others, both before and after we have gone to market with our product. We also face competition from existing therapies that are currently accepted in the marketplace, and the impact of adverse events in our field that may affect regulatory approval or public perception.

We may not be able to recruit and retain the scientists and management we need to compete.

To succeed, we must attract, retain and motivate highly skilled scientists and management. We compete intensely with pharmaceutical and biotechnology companies, including our collaborators, medicinal chemistry outsourcing companies, contract research companies, and academic and research institutions to recruit scientists and management. If we cannot hire additional qualified personnel, the workload may increase for both existing and new personnel. The shortage of personnel with experience in drug development could lead to increased recruiting, relocation and compensation costs, which may exceed our expectations and resources. These increased costs also may reduce our profit margins and make hiring new scientists impractical.

We may not be able to balance successfully our primary focus of drug development with the needs of our chemical technologies operation.

While we concentrate on drug development, there is a risk that we will pay less attention to our original, ongoing business. Furthermore, customers, potential collaborators and others may not accept our shift in strategy. Also, we may not implement the shift effectively, which may undermine our results even if the strategy, technology and management team work together effectively.

We may be exposed to potential liability related to the development, testing or manufacturing of compounds developed by ArQule.

We develop, test and manufacture the precursors to drugs generally intended for use in humans. If our drug discovery activities result in clinical trials, or the manufacture and sale of drugs, we could be liable if persons are injured or die while using these drugs. We may have to pay substantial damages and/or incur legal costs to defend claims resulting from injury or death, and we may not receive expected royalty or milestone payments if commercialization of a drug is limited or ended as a result of such claims. We have product liability insurance that contains customary exclusions and provides coverage per occurrence at levels, in the aggregate, which we believe are customary and commercially reasonable in our industry given the stage we have achieved in drug commercialization. However, our product liability insurance does not cover every type of product liability claim that we may face or loss we may incur and may not adequately compensate us for the entire amount of covered claims or losses or for the harm to our business reputation. Also, we may be unable to maintain our current insurance policies or obtain and maintain necessary additional coverage at acceptable costs or at all.

From our inception in 1993 through December 31, 2003, we have incurred cumulative losses of approximately $184 million. These losses have resulted principally from the costs of our research activities and enhancements to our technology. We have derived our revenue primarily from:


	•	license and technology transfer fees for access to our chemical synthesis and production platforms such as transfer of our AMAP technology to Pfizer;

	•	payments for product deliveries;

	•	research and development funding paid under our agreements with our collaboration partners; and

	•	to a limited extent, milestone payments.

To date, these revenues have generated profits only in 1997 and 2000 and our revenue from our chemistry services collaborators is expected to decline in 2004. We have not realized any revenue from royalties from the sale by any of our collaboration partners of a commercial product developed using our technology. We might never become profitable on a sustained basis.

Our revenue from chemistry technologies collaborations is uncertain and not diversified.

Our ability to generate revenue from chemistry services collaborations typically involves significant technical evaluation and/or commitment of capital by our collaborators and is subject to a number of significant risks, including collaborators’ budgetary constraints and internal acceptance reviews.

To maintain our current relationships with chemistry services collaborators and to meet the performance and delivery requirements in our contracts, we must provide drug discovery capabilities and chemistry technology products and services at appropriate levels, with acceptable quality and at acceptable cost. Our ability to deliver the drug discovery capabilities, products and services we want to offer to our collaborators is limited by many factors, including the difficulty of the chemistry, the lack of predictability in the scientific process and the shortage of qualified scientific personnel. In particular, a large portion of our revenue depends on producing collections of high-quality chemical compounds, which requires a high rate of production. If we are unable to maintain the rate of compound synthesis to meet our existing or future contractual commitments, it may result in delayed or lost revenue, loss of collaborations and/or failure to expand our existing relationships.

Also, at present we depend largely on chemistry services collaboration arrangements for our revenue and cannot be sure whether our collaborations will succeed or whether we will realize much of the potential revenue from our collaborations. In addition, 84% of our revenue was generated from our Pfizer collaboration in 2003, pursuant to which Pfizer holds certain termination rights beginning in December, 2005. Significant portions of the revenue from milestones and royalties that we may receive under these collaborations will depend upon our ability and/or our partners’ ability to successfully develop, license, introduce, market and sell new drugs developed using our chemical compounds and/or proprietary technology. We have little control over the efforts of our partners. We may not be able to achieve these milestones and may not be able to develop commercial drugs or other products on which royalties will be payable.

Products developed in collaborations will result in commercialized drugs generating royalties only after, among other things:


	•	significant preclinical and clinical development efforts and expenditures;

	•	regulatory approvals;

	•	development of manufacturing capabilities; and

	•	successful marketing.

Some of our chemistry services collaborators can influence when we deliver products and perform services under their contracts with us. This could cause our operating results to fluctuate significantly. In addition, we expect to continue to experience significant fluctuations in operating results due to factors such as general and industry specific economic conditions that may affect the research and development expenditures of pharmaceutical and biotechnology companies, as well as the timing of compound shipments to our collaborators.

Our collaboration agreements require that covered products or compounds reach significant developmental stages in the drug discovery process before we will receive milestone payments. If these milestones are not achieved as expected, our revenue will be delayed and/or reduced. For planning purposes, we estimate the timing of the accomplishment of various scientific, clinical, regulatory and other milestones, such as the commencement or completion of scientific studies and clinical trials and the submission of regulatory filings. These estimates are based on a variety of assumptions. The actual timing of these milestones can vary compared to our estimates, in many cases for reasons beyond our control.

Revenue is recognized in accordance with generally accepted accounting principles (“GAAP”), which require us to expense certain costs as incurred and defer the related revenue over the life of the contract. This

We thus believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some periods may not meet the expectations of stock market analysts and investors, causing our stock price to decline.

Although we believe that we have sufficient funding in the near term, we will at some point need to obtain additional financing. Such financing could come from the proceeds of public or private debt or equity financings or corporate partnerships. We may not be able to obtain adequate funds for our operations from these sources when needed or on acceptable terms. If we raise additional capital through the sale of equity, or securities convertible into equity, each shareholder’s proportionate ownership in ArQule may be diluted.

If we cannot obtain additional financing, we could be forced to delay or scale back our research and development programs. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds by entering into arrangements with collaboration partners or others that may require that we relinquish rights to certain technologies, product candidates, products or potential markets.

In particular, our plans for clinical development of drug candidates will cause us to incur significant costs. If we are successful in our drug development efforts, we may be involved in multiple clinical trials with cumulative costs escalating greatly over time.

We believe that our cash, cash equivalents and short-term investment securities balances as of December 31, 2003 will be sufficient to meet our operating and capital requirements for the next three years. We have based this estimate on assumptions and estimates that may prove to be wrong. Even if we our estimates are correct, we may need or choose to obtain additional financing during that time.

Delaware law and our Amended and Restated Certificate of Incorporation contain provisions that could prevent or delay a change of control.

Section 203 of the Delaware General Corporation Law contains provisions restricting stockholder action to acquire control of the company. This could discourage third parties from seeking to obtain control. In addition, certain aspects of our charter documents, for example, rights to issue preferred stock without shareholder approval, a board of directors with staggered terms and limits on the ability of stockholders to call special meetings or act by written consent may be considered as hindrances to a change of control.

To be successful and compete, we must obtain and protect patents on our products and technology and protect our trade secrets. Where appropriate, we seek patent protection for certain aspects of our technology, but patent protection may not be available for some of the compounds and drugs, and their use, synthesis, formulations and technologies we are developing. The patent position of biotechnology firms is highly uncertain, involves complex legal and factual questions, and has recently been the subject of much litigation. No consistent policy has emerged from the U.S. Patent and Trademark Office or the courts regarding the breadth of claims allowed or the degree of protection afforded under many biotechnology patents. In addition, there is a substantial backlog of biotechnology patent applications at the U.S. Patent and Trademark Office, and the approval or rejection of patent applications may take several years.

We do not know whether our patent applications will result in issued patents. For example, we may not have developed a method for treating a disease before others have developed similar methods. In addition, the receipt of a patent might not provide much practical protection. If we receive a patent with a narrow scope, then it will be easier for competitors to design products that do not infringe on our patent. We cannot be

certain that we will receive any additional patents, that the claims of our patents will offer significant protection of our technology, or that our patents will not be challenged, narrowed, invalidated or circumvented.

Competitors may interfere with our patent protection in a variety of ways. Competitors may claim that they invented the claimed invention prior to us. Competitors may also claim that we are infringing on their patents and that therefore we cannot practice our technology as claimed under our patents. Competitors may also contest our patents by showing the patent examiner that the invention was not original, was not novel or was obvious. In litigation, a competitor could claim that our issued patents are not valid for a number of reasons. If a court agrees, we would lose that patent. As a company, we have no meaningful experience with competitors interfering with our patents or patent applications.

To protect or enforce our patent rights, we may initiate patent litigation against third parties, such as infringement lawsuits or interference proceedings. Such litigation can be expensive, take significant time and divert management’s attention from other business concerns, which could increase our research and development expense and delay our product programs. Litigation that we initiate may provoke third parties to assert claims against us.

It is also unclear whether our trade secrets will prove to be adequately protected. To protect our trade secrets, we require our employees, consultants and advisors to execute confidentiality agreements. We cannot guarantee, however, that these agreements will provide us with adequate protection against improper use or disclosure of confidential information. Our employees, consultants or advisors may unintentionally or willfully disclose our information to competitors. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants or advisors had or have previous employment or consulting relationships. Like patent litigation, enforcing a claim that a third party illegally obtained and is using our trade secrets is expensive and time-consuming, and the outcome is unpredictable. In addition, courts outside the United States are sometimes less willing than our federal and state courts to protect trade secrets. Furthermore, others may independently develop substantially equivalent knowledge, methods and know-how.

If we must spend significant additional time and money protecting our patents and trade secrets, we will have fewer resources to devote to the development of our technologies, and our business and financial prospects may be harmed.

Our success will depend partly on our ability to operate without infringing on or misappropriating the proprietary rights of others.

There are many patents in our field of technology and we cannot guarantee that we do not infringe on those patents or that we will not infringe on patents granted in the future. If a patent holder believes a product of ours infringes on its patent, the patent holder may sue us even if we have received patent protection for our technology. Intellectual property litigation is costly and, even if we prevail, the cost of such litigation could adversely affect our business, financial condition and results of operations. In addition, litigation is time-consuming and could divert management attention and resources away from our business. If we do not prevail in litigation, we may have to pay substantial damages for past infringement.

Also, if we lose, the court may prohibit us from selling or licensing the product that infringes the patent unless the patent holder licenses the patent to us. The patent holder is not required to grant us a license. If a license is available, it may not be available on acceptable terms. For example, we might have to pay substantial royalties or grant cross-licenses to its patents. In addition, some licenses may be nonexclusive and, accordingly, our competitors may have access to the same technology licensed to us. If we fail to obtain a required license, we could encounter delays in product development while we attempt to design around other patents or we could even be prohibited from developing, manufacturing or selling products requiring these licenses. If we are unable to cost-effectively redesign our products so they do not infringe a patent, we may be unable to sell some of our products. Any of these occurrences will result in lost revenues and profits for us.

We may not be able to acquire any exclusive rights to technology or products derived from our collaborations. There is also a risk that disputes may arise as to the rights to technology or products developed in collaboration with other parties.

The success of our strategy depends, in part, on our ability to apply a growing base of knowledge, technology and data across all of our internal projects and our collaborations. Some of this data has been and will continue to be generated from our work with collaborators. Although we believe that certain of this information is not proprietary to our collaborators, our collaborators may disagree and may succeed in preventing us from using some or all of this information and/or technology ourselves or with others. Without the ability to use this information freely, we may be limited in our ability to improve the efficiency of our drug discovery and development process.

We may not obtain regulatory approval for the sale and manufacture of drug products.

The development and commercialization of drug candidates in the United States, including those drug candidates we develop alone or in collaboration with our partners, are subject to regulation by U.S. regulatory authorities. Pharmaceutical products require lengthy and costly testing in animals and humans and regulatory approval by the appropriate governmental agencies prior to commercialization. Regulatory authorities may suspend clinical trials at any time if they believe that the subjects participating in the trials are being exposed to unacceptable risks or if an agency finds deficiencies in the conduct of the trials or other problems with our product under development. Approval of a drug candidate as safe and effective for use in humans is never certain and these agencies may delay or deny approval of the products for commercialization. Changes in regulatory policy during the period of regulatory review may result in unforeseen delays or denial of approval. Similar delays and denials may be encountered in foreign countries.

As a company, ArQule has never obtained regulatory approval to manufacture and sell a drug. If we and/or our collaborators develop a drug candidate and cannot obtain this approval, we may not realize milestone or royalty payments based on commercialization goals for such drug candidate. Even if regulatory approval is obtained, regulatory authorities may require additional clinical studies after sales of a drug have begun. In addition, the identification of certain side effects after a drug is on the market may result in the subsequent withdrawal of approval, reformulation of the drug, additional preclinical and clinical trials, changes in labeling, recalls, warnings to physicians or the public, and negative publicity.

Any of these events could delay or prevent us from generating revenue from the commercialization of any drug candidates we develop or help to develop.

We have only limited experience in regulatory affairs, and some of our products may be based on new technologies; these factors may affect our ability or the time we require to obtain necessary regulatory approvals.

As we have only recently had our first product candidate in clinical trials, we have only limited experience in filing and prosecuting the applications necessary to gain regulatory approvals. Moreover, certain of the products that are likely to result from our research and development programs may be based on new technologies and new therapeutic approaches that have not been extensively tested in humans. The regulatory requirements governing these types of products may be more rigorous than for conventional products. As a result, we may experience a longer regulatory process in connection with any products that we develop based on these new technologies or new therapeutic approaches.

If our use of chemical and hazardous materials violates applicable laws or causes personal injury, we may be liable for damages.

Our drug discovery activities, including the analysis and synthesis of chemical compounds, involve the controlled use of chemicals, including flammable, combustible, toxic and radioactive materials that are potentially hazardous if misused. Federal, state and local laws and regulations govern our use, storage, handling and disposal of these materials. These laws and regulations include the Resource Conservation and Recovery Act, the Occupational Safety and Health Act and local fire and building codes, and regulations promulgated by the Department of Transportation, the Drug Enforcement Agency, the Department of Energy, the Department of Health and Human Services, and the laws of Massachusetts, where we conduct our operations. We may incur significant costs to comply with these laws and regulations in the future. Notwithstanding our extensive safety procedures for handling and disposing of such materials, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be liable for damages, and any such liability could exceed our resources, disrupt our business and have a negative impact on our financial condition and results of operations.

Because we have limited manufacturing capabilities, if we decide to outsource the manufacturing of chemical compounds, or initiate a drug manufacturing strategy, we will be dependent on third-party manufacturers or will be required to incur significant costs and devote significant efforts to establish our own manufacturing facilities and capabilities.

We have limited experience with the FDA’s good manufacturing practices and no commercial scale manufacturing capabilities. If we expand beyond our current manufacturing activities, or apply for regulatory approvals to commercialize products and services, we will need to develop, contract for, or otherwise arrange for, the necessary manufacturing capabilities.

There are a limited number of manufacturers that operate under the FDA’s good manufacturing practices regulations capable of manufacturing our products. As a result, we may experience difficulty finding manufacturers for our products with adequate capacity for future needs. If we are unable to arrange for outsourced manufacturing of our products, or to do so on commercially reasonable terms, we may not be able to complete development of our products or market them.

Reliance on an outsourced manufacturer entails risks to which we would not be subject if we manufactured products ourselves, including reliance on the manufacturer for regulatory compliance and quality assurance, the possibility of breach of the manufacturing agreement because of factors beyond our control and the possibility of termination or nonrenewal of the agreement by the manufacturer, based on the manufacturer’s own business priorities, at a time that is costly or inconvenient for us.

We may in the future elect to manufacture certain of our products in our own manufacturing facilities. We would need to invest substantial additional funds and recruit qualified personnel in order to build or lease and operate any manufacturing facilities.

In November 1999, we moved our main operations to a new facility in Woburn, Massachusetts, which includes approximately 128,000 square feet of laboratory and office space. This facility was designed to our specific requirements. In March 2001, we purchased this building and the land on which it sits and a developable adjacent parcel of land for $18.2 million and $2.3 million, respectively, in an arms-length transaction with the original developer.

We lease approximately 56,000 square feet of laboratory and office space in Medford, Massachusetts, the majority of which is used for the Pfizer collaboration. We lease these facilities from Cummings Properties, LLC (“Cummings”) under two lease agreements, one of which expires on July 30, 2005 and the other on July 30, 2006. The Company subleases portions of these facilities pursuant to two sublease agreements. See

In March 2002, we entered into an eight year lease with Pacific Shores Development LLC for approximately 34,000 square feet of laboratory and office space in Redwood City, California. We took occupancy in September 2002. Each base lease payment, the first of which was due and paid in September 2002, is $75,823 per month, subject to annual escalation provisions.

In December 2002, we announced a major restructuring of our operations which included closing our facilities in Redwood City, California as of December 31, 2002 and Cambridge, United Kingdom as of March 31, 2003. In October 2003, ArQule completed an agreement with InPharmatica Ltd. to sell certain assets of its former operations in the United Kingdom and to assign its facility lease obligation. We are actively attempting to sub-lease our California facilities. See Note 11, “Restructuring Actions” in notes to Consolidated Financial Statements appearing in Item 8 in this Annual Report on Form 10-K.

On August 1, 2001, Cummings significantly raised ArQule’s rent on the lease that expires July 30, 2006. We believe this increase to be in excess of that which is permissible under the lease agreement. Accordingly, on January 16, 2002, we brought a complaint in the Superior Court of Middlesex County in the Commonwealth of Massachusetts for declaratory relief and damages against Cummings arising, in part, out of Cummings’ attempts to increase the lease rates. Nevertheless, during the pendency of this dispute, we are paying the rental rates proposed by Cummings. The Company seeks recovery of the funds that it has already paid, and is paying, under protest. If we are unsuccessful in our claim against Cummings, and must pay all or a portion of the rental expense increase currently proposed by Cummings, we may be required to record an additional expense of up to approximately $0.8 million to record the difference between our contractual rental payments and contractual sublease rental income over the remaining period of the lease. Conversely, if the contingency is resolved in ArQule’s favor and the Company is entitled to a refund of amounts previously paid, the Company may be required to record a gain in a future period.

ArQule has been named as one of multiple co-defendants, including Wyeth, Inc. and Solvay Pharmaceuticals, Inc., in seven related lawsuits, filed by a number of individual plaintiffs beginning in July 2003 in U.S. District Courts in the Southern and Eastern Districts in Texas and in the District Court, 281st Judicial District, Harris County, Texas. Plaintiffs in these proceedings are seeking damages relating to alleged personal injuries claimed to be the result of taking Hormone Replacement Therapy. The Company was never involved in the manufacture, marketing or sale of Hormone Replacement Therapy drugs and does not believe that it has produced or provided any compounds that have been introduced to humans relating to the products that are the subject of these claims. ArQule has filed or is filing stipulations of dismissal or a motion to dismiss in each of these cases.

Although we cannot predict the outcome of any litigation, as of the date of this annual report, based on the information now available to us, we do not believe that these lawsuits, individually or in the aggregate, are reasonably likely to have, either individually or in the aggregate, a material adverse effect on the Company, its business, prospects, financial condition or operating results.

No matters were submitted to stockholders for a vote during the fourth quarter of 2003.

ArQule’s common stock is traded on the NASDAQ National Market under the symbol “ARQL”.

The following table sets forth, for the periods indicated, the range of the high and low closing sale prices for ArQule’s common stock:

As of March 1, 2004, there were approximately 185 holders of record and approximately 6,799 beneficial shareholders of our common stock.

We have never paid cash dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, for use in our business.

The following table provides information as of December 31, 2003 regarding compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance.

The following data, insofar as it relates to the years 1999, 2000, 2001, 2002 and 2003 have been derived from ArQule’s audited consolidated financial statements, including the consolidated balance sheet as of December 31, 2002 and 2003 and the related consolidated statements of operations and of cash flows for the three years ended December 31, 2003 and notes thereto appearing in Item 8 of this Annual Report on Form 10-K. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Financial Statements and the Notes thereto appearing in Items 7 and 8, respectively of this Annual Report on Form 10-K. The historical results are not necessarily indicative of the results of operations to be expected in the future. This data is in thousands, except per share data.

We are a biotechnology company engaged in the research and development of small molecule cancer therapeutics. We also provide fee-based chemistry services to pharmaceutical and biotechnology companies to produce novel chemical compounds with drug-like characteristics.

We have incurred a cumulative net loss of $184 million from inception through December 31, 2003. Our expenses prior to September 2003 related to development activities associated with our chemistry services, the associated administrative costs required to support those efforts, and the cost of acquisitions. We expect research and development costs to increase in 2004 as we pursue development of our cancer programs. We do not expect to make additional investments in chemistry services during 2004. Although we have generated positive cash flow from operations for the last five years, we have recorded a net loss for each of those years. We expect to record a loss for 2004. Based on our cash position at the end of 2003 we will be able to dedicate approximately $25 million per year over the next three years to our ACT^SM research and development

Our revenue is derived from chemistry services performed for our customers. Revenue, expenses and gross margin fluctuate from quarter to quarter based upon contractual deliverables and the timing of the recognition of revenue under our revenue recognition policy (see the discussion of this under “Critical Accounting Policies and Estimates” below). As we increase our activities in cancer related research and development, the timing and extent of these efforts, together with the length and outcome of our clinical trials will further impact the fluctuation of results from operations. While our focus will be on cancer related research and development, we will continue to pursue revenue opportunities from customers for our chemistry services.

In February 2004, we initiated a restructuring involving a reduction in workforce of 55 people, or 19% of the total workforce. This was undertaken to better align our resources with our new focus on cancer related research and development, and in response to a decrease in chemistry services activities. We plan to aggressively hire expertise in the field of drug discovery during 2004, and anticipate no net headcount decrease by the end of the year.

Cash flow from operating activities. For 2003 the total of $4.1 million was primarily comprised of an operating profit, excluding non-cash charges, of $9.7 million and additional restructuring provisions of $1.2 million not requiring immediate cash outlays in 2003, which were partially offset by restructuring related payments of $3.8 million, and $3.0 million of payments related to liabilities assumed in the acquisition of Cyclis.

Cash and cash equivalents used in investing activities. The total was $10.8 million in 2003, compared to $1.7 million in 2002. The increase in 2003 was due to $7.0 million for the Cyclis acquisition and $4.5 million for capital additions, which was partially offset by net proceeds from the sale and maturity of marketable securities of $0.7 million. The composition and mix of cash, cash equivalents and marketable securities may change frequently as a result of the Company’s constant evaluation of conditions in financial markets and the timing of specific investments.

Cash and cash equivalents used in financing activities. The total was $1.4 million in 2003, compared to $3.7 million in 2002. The 2003 use was comprised of $7.4 million of principal repayments on our term loan to Fleet National Bank and $2.5 million of long-term debt assumed in connection with the acquisition of Cyclis and subsequently repaid. This was partially offset by proceeds from the issuance of common stock of $8.5 million, of which $8.0 million represents an investment by Pfizer.

We have been cash flow positive from operations for five consecutive years. We expect that our available cash and marketable securities of $77 million at December 31, 2003, together with operating revenues and investment income, will be sufficient to finance our working capital and capital requirements for the next three years. In addition, we are currently considering raising additional capital through a follow-on public offering of our securities. We have filed a shelf registration statement on Form S-3 with the SEC covering securities having an aggregate maximum amount of $50 million.

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, results of research and development, the need for currently unanticipated capital expenditures, competitive and technological advances, acquisitions and other factors. We cannot guarantee that we will be able to obtain additional customers for our chemistry services, or that such services will produce revenues adequate to fund our operating expenses. We cannot guarantee that we will be able to develop any of our drug candidates into a commercial product. If we experience increased losses, we may have to seek additional financing from public and private sale of our securities, including equity securities. There can be no assurance that additional funding will be available when needed or on acceptable terms.

Our contractual obligations were comprised of the following as of December 31, 2003 (in thousands):

Included in the total minimum payments for operating leases is approximately $6.7 million related to unoccupied real estate in California which was accrued as a liability, net of assumed sublease income, as a part of the Company’s restructuring charges in 2002 (see Note 11 to the Consolidated Financial Statements in Item 8 of this Form 10K). Purchase obligations are comprised primarily of outsourced preclinical and clinical trial expenses and payments to license certain intellectual property to support the Company’s research efforts.

A “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results and requires management’s most difficult, subjective or complex judgements, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management believes the following are critical accounting policies. Please see the discussion of our significant accounting policies in Note 2 to the Consolidated Financial Statements included in Item 8 of this Form 10-K for additional information.

ArQule has entered into various chemistry-based collaborative agreements with pharmaceutical and biotechnology companies. Revenue from these collaborative agreements is recognized as follows:


	•	Non-refundable technology transfer fees. Under certain circumstances these are recognized as revenue upon completion of performance of a specified deliverable. However, where the effort is relatively constant over the performance period of the contract, the revenue is recognized on a straight-line basis over the performance period of the contract.

	•	Funding of compound development work. Revenue is recognized over the term of the applicable contract using the proportional achievement of deliveries against a compound delivery schedule, or the development labor expended against a total research and development labor plan, as the measure of progress toward completion.

	•	Payments based upon delivery of compounds. Payments based upon delivery of specialized compounds meeting the collaborator’s specified criteria are recognized as revenue once our obligations are complete, the collaborator has accepted the delivery of these compounds and collection is reasonably assured.


	•	Certain milestones and royalties on product sales. If there are no continuing performance obligations, these revenues are recognized upon achievement of the related milestone. Revenues from milestone payments related to continuing performance obligations are recognized as revenue upon achievement of the milestone only if all of a specified list of conditions are met. Otherwise, the milestone payments are deferred and recognized as revenue over the term of the performance obligations.

We follow these guidelines to measure revenue; however, certain judgments affect the application of these policies. For example, in connection with our Pfizer collaboration we have recorded current and long term deferred revenue based on our best estimate of when such revenue will be recognized. The estimate of deferred revenue reflects our estimate of the timing and extent of services that we will provide to Pfizer. Our services to Pfizer, and the timing of those services, are difficult to estimate and are impacted by factors outside of our control. For example, the timing and quantity of compounds we provide is largely dependent on Pfizer’s internal needs. Changes to estimates could impact the timing and amount of revenue we recognize in the future.

Upon consummation of the Cyclis acquisition, we immediately charged to income $30.4 million representing purchased in-process research and development (“IPR&D”) that had not yet reached technical feasibility and had no alternative future use. Approximately $14 million of the charge represents the fair value of the IPR&D; the remaining $16.4 million of the charge represents the allocation to IPR&D of a portion of the excess of purchase price over the fair value of assets acquired.

We believe that this charge represents a reasonably reliable estimate of the future benefits attributed to purchased IPR&D. The value assigned IPR&D (before the step-up adjustment) was composed of the projected value of three Cyclis preclinical drug development projects based on various mechanisms of actions associated with the ACT^SM technology. The valuation was determined using the income approach. Potential revenue and drug development expenses were projected through 2020 based on information obtained from management and from published third-party industry statistics for similar drug development businesses. Specifically, we estimated that the development of our current cancer programs through clinical trials to commercial viability will take approximately nine years and cost in excess of $500 million. The discounted cash flow method was applied to the projected cash flows, adjusted for the probability of success, using a discount rate of 30%. The discount rate takes into consideration the uncertainty surrounding successful development and commercialization of the IPR&D. Since the acquisition, nothing has occurred that would lead us to believe that the original estimates of the cost to develop these compounds, or their revenue potential, is materially different from the estimates used at the time of the acquisition for purposes of purchase accounting.

Accruals for abandoned facilities under lease require significant management judgment and the use of estimates, including assumptions concerning our ability to sublease certain operating leases for abandoned real estate (see Note 11 to the Consolidated Financial Statements in Item 8 of this 10-K). These estimates of the time required to sublease the facilities and sublease rates the Company will receive were based on our analysis of the local real estate markets and general economic conditions in the regions of the abandoned facilities. If it takes longer to sublease these facilities than the Company has estimated, or if the sublease rates are less favorable than estimated, the Company may be required to take an additional charge for abandoned real estate of up to $3.1 million. Conversely, if the space is subleased either earlier than estimated or if the sublease rates actually achieved are more favorable, the Company may be required to reverse a portion of its current accrual for abandoned real estate.

At December 31, 2003, we performed an assessment of the fair value of our investment in a privately held proteomics company. This assessment included analysis of that company’s current financial condition, its

prospects for generating additional cash flow from operating activities, the current market conditions for raising capital funding for companies in this industry and the likelihood that any funding raised would significantly dilute our ownership percentage. As a result of this analysis it was our judgment that an impairment had occurred and that the fair value of our investment was $0.3 million, resulting in a non-cash loss on investment of $4.7 million. If this entity is unsuccessful in its efforts to secure additional financing it may cease operations, rendering our investment worthless and necessitating a further write down. If the value of this investment recovers, we will not write-up the investment until it is sold.

We lease approximately 56,000 square feet of laboratory and office space in Medford, Massachusetts, the majority of which is used for the Pfizer collaboration. We lease these facilities from Cummings Properties, LLC (“Cummings”) under two lease agreements, one of which expires on July 30, 2005 and one of which expires on July 30, 2006. The Company subleases portions of these facilities pursuant to two sublease agreements.

On August 1, 2001, Cummings significantly raised ArQule’s rent, as outlined in Item 3, LEGAL PROCEEDINGS. We made an estimate of the most likely outcome of this contingency and concluded that no provision is required at December 31, 2003. It is our estimation that the most likely settlement at trial would result in no net financial statement loss. Nevertheless, if we are unsuccessful at trial, the Company could be required to record an additional expense of up to $.8 million.

2003 as compared to 2002: Revenue increased by $2.7 million, or 4%. Revenue from our chemistry collaboration with Pfizer increased by $8.5 million due to an increase in the number of compounds developed under the terms of the contract and our receipt of certain contractual milestone payments on an accelerated basis because we met delivery requirements in 2003 ahead of schedule. This increase was offset by reductions in revenue from Bayer of $2.1 million, Solvay of $1.1 million, and Pharmacia of $0.5 million as the Company completed its final contractual obligations with these companies in 2003, and from reductions in revenue from Searle of $1.0 million, Wyeth of $0.7 million and Glaxo-Smith-Kline of $0.6 million whose contracts all ended in 2002. We expect revenue from our chemical services contracts to decrease in 2004 as a result of February 2004 amendments to our Pfizer agreement that will cause our compound deliveries to Pfizer to remain stable at 2004 levels, instead of increasing as previously agreed. In addition, in 2003 we completed the Bayer, Solvay and Pharmacia agreements.

2002 as compared to 2001: Revenue increased by $4.4 million, or 8%, primarily due to a $10.5 million increase in Custom Array library revenues from our agreement with Pfizer. This increase was partially offset by reductions in revenue from Wyeth of $3.1 million, from Johnson & Johnson of $1.7 million, and from Sankyo of $1.3 million as these collaborations wound down.

2003 as compared to 2002: Cost of revenue increased due to increased cost of personnel, materials and facility related expenses, including depreciation, necessary to satisfy the increase in activity under the Pfizer contract during 2003, partially offset by a reduction in material costs associated with the completion of the Bayer contract during the third quarter of 2003. Gross margin as a percentage of revenue increased primarily as a result of the one-time increase in Pfizer revenue due to our receipt of certain contractual milestone payments on an accelerated basis because we met delivery requirements in 2003 ahead of schedule and to the recognition of previously deferred revenue from Bayer as a result of our completing our contractual obligations. the associated costs for which were incurred in earlier years. We expect cost of revenue will decrease in 2004 as a result of lower revenues and the resultant decrease in direct production and material costs due to the absence of activity under the Bayer, Solvay and Pharmacia agreements, which were terminated in 2003. We expect gross margin percentage to decrease in 2004 as a result of the lower revenues available to offset fixed overhead and facility-related expenses.

2002 as compared to 2001: Cost of revenue increased due to increased cost of personnel and materials necessary to satisfy the 2002 expansion of the Pfizer collaboration. Our gross margin as a percentage of revenue decreased by 5.7 percentage points due to the increased labor and material costs necessary to fulfill the Pfizer and Bayer collaborations.

2003 as compared to 2002: The $12.5 million decrease in research and development primarily reflects the cost savings associated with the Company’s decision in December 2002 to cease further development of the Camitro predictive modeling technology, to close the related facilities in Redwood City, California (effective December 31, 2002) and Cambridge, United Kingdom (effective March 31, 2003), and to realign its workforce in order to expedite its transition to a drug discovery and development company. These cost savings were partially offset by the increased cost associated with the acquisition of Cyclis in September 2003, notably the addition of approximately 14 scientists, increased laboratory supply and facility expenses and the cost of preclinical and clinical studies to develop the ACT^SM platform and ARQ 501. We expect research and development expense to increase in 2004 as we expand our oncology discovery pipeline and begin clinical trials.

2002 as compared to 2001: The $2.9 million increase primarily consists of an additional $2.1 million in personnel and related costs and $0.9 million of additional third-party information system technology as the result of our efforts to augment and enhance our chemistry, biology, predictive and computational modeling capabilities and related proprietary technologies. In 2002, the Company devoted additional personnel and resources to the integration and refinement of the respective technologies in order to advance the objective of a fully integrated drug discovery platform.

2003 as compared to 2002: The decrease in marketing, general and administrative expense is primarily due to the cost savings associated with the severance of 31 marketing, general and administrative employees as part of the Company’s restructuring actions in December 2002, and the closing of the Redwood City and Cambridge facilities. The decrease consists primarily of reductions in employee related expenses of $1.8 million, professional fees of $0.6 million and facility related expense of $0.6 million. We expect marketing,

2002 as compared to 2001: Marketing, general and administrative expenses were essentially flat year-over-year.

2003. Acquisition related charges in 2003 relate to the September 8, 2003 acquisition of Cyclis. Upon consummation of the Cyclis acquisition, we immediately charged to income $30.4 million representing purchased in-process research and development (“IPR&D”) that had not yet reached technical feasibility and had no alternative future use. Approximately $14 million of the charge represents the fair value of the IPR&D. The remaining $16.4 million of the charge represents a step-up adjustment resulting from the excess of the purchase price over the identifiable tangible and intangible assets acquired and liabilities assumed which was allocated on a pro rata basis to the carrying value of acquired long-lived assets. See “Critical Accounting Policies and Estimates” above for a discussion of our accounting policies and significant estimates.

2002 and 2001. Acquisition related charges in 2002 and 2001 all relate to the January 2001 acquisition of Camitro. Upon consummation of the 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 4 of notes to Consolidated Financial Statements included in Item 8 of this 10-K).

In 2002, we continued to recognize stock-based compensation charges based on the amortization of deferred compensation arising from the issuance of stock options issued below market value and restricted stock to former employees of Camitro, in addition to amortizing core technology. We implemented Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”) in January 2002, and accordingly ceased recording periodic goodwill amortization charges in lieu of performing annual assessments for impairment. At December 31, 2002, we assessed the recoverability of the carrying value of our core technology and goodwill balances and, based on the applicable accounting standards, recorded impairment charges of $17.1 million and $25.9 million, respectively, representing the entire remaining balances of these assets. See “Critical Accounting Policies and Estimates” above for a discussion of our accounting policies and significant estimates.

In December 2002, we announced a restructuring of our operations whereby we ceased further development and commercialization of the Camitro predictive modeling technology and realigned our workforce to expedite the transition towards becoming a drug discovery company.

The restructuring actions included closing our facilities in Redwood City, California and Cambridge, United Kingdom, along with the termination of employees in these facilities and our Massachusetts facilities.

Termination benefits relate to severance and benefit costs associated with the elimination of 128 managerial and staff positions worldwide, comprising approximately 31% of the workforce. Facility-related costs relate to the remaining lease payment obligations associated with the abandonment of our facilities in Redwood City, California and Cambridge and the non-cash write-off of leasehold improvements and equipment no longer expected to provide future economic benefit at the abandoned facilities, less assumed proceeds from sale. Other charges include a $0.5 million non-cash stock compensation charge, contractual obligations which provided no future value to the Company, and other miscellaneous costs associated with closing the California and United Kingdom operations. See Item 11 in the Notes to the Consolidated Financial Statements at Item 2 of this 10K. We believe that these actions resulted in savings of approximately $12 million per year in personnel and facility-related expenses.

Activities against the restructuring accrual (which is included in accrued liabilities in the Consolidated Balance Sheet) in 2002 and 2003 were as follows (in thousands):

The Company eliminated 108 positions in December 2002; the remaining 20 were eliminated by March 31, 2003. As of December 31, 2003 virtually all termination benefits had been paid. California facility costs will be paid out through the remaining lease term of the facility, which extends through 2010, unless we are able to mitigate such costs by subleasing the facility or settling our leasehold position by paying a lump-sum payment to the landlord. In October 2003, ArQule completed an agreement with InPharmatica Ltd. to sell certain assets of its former operations in the United Kingdom. As a result, ArQule reversed $0.3 million of restructuring accrual to reflect a change in its original estimate of the remaining leasehold obligations and assumed sublease income in the United Kingdom. Throughout the latter half of 2003, ArQule was in negotiations with a third-party to sublease its facility in California on favorable terms. Those negotiations were terminated in January 2004. As a result, the adequacy of the accrual relative to the lease obligation and assumed sublease income for the California facility was reassessed, and based on continued deterioration in the local real estate market, an additional provision of $1.5 million was recorded.

Interest income is derived from our portfolio of cash and short-term investments. Interest income decreased in each of the last three years due to decreasing average principal balances and continued decreasing interest rates. Interest expense decreased in each of the last three years due to lower average debt balances and lower interest rates.

The loss on investments relates to an impairment charge taken to write down the Company’s investment in a privately-held proteomics Company to its estimated fair value. See “Critical Accounting Policies and Estimates” above for a discussion of our accounting policies and significant estimates.

In December 2003, the FASB reached a consensus on Emerging Issues Task Force Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). This issue addresses how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. This issue is applicable to agreements entered into after June 15, 2003. The Company is currently assessing the impact EITF No. 00-21 will have on revenue recognition in 2004, in particular as it relates to the updated Pfizer contract which was signed in February 2004.

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.

Our use of derivative financial instruments is limited to the utilization of an interest rate swap agreement. Settlement accounting is used for this interest rate swap, which has a notional amount of $975,000 and expires on June 30, 2004. Any differences paid or received on interest rate swap agreements are recognized as adjustments to interest expense over the life of each swap, thereby adjusting the effective interest rate of the underlying obligations. The fair market value of this swap was an unrecognized loss of $22,000 at December 31, 2003.

See Notes 2 and 12 to the Consolidated Financial Statements 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 December 31, 2003 due to the short-term maturities of these instruments.


	Schedules are not included because they are not applicable or the information is included in the Notes to Consolidated Financial Statements

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of ArQule, Inc. and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Notes 2 and 8 to the consolidated financial statements, the Company changed its method of accounting for goodwill in 2002 .

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

During 2001, 2002, and 2003 the Company paid approximately $1,621, $953 and $536 respectively, for interest expense.

Net assets and liabilities assumed in the Camitro and Cyclis acquisitions — see Note 4.

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

We are a biotechnology company engaged in the discovery and development of novel drugs primarily for the treatment of cancer. We apply our proprietary ACT^SM technology platform to develop small molecule compounds that we believe will selectively kill cancer cells by restoring and activating cellular checkpoints while sparing normal cells. Our oncology portfolio consists of our lead clinical candidate, ARQ 501 and several discovery programs based on the ACT^SM platform.

We also provide chemistry services to collaborators and customers for their discovery programs, which has been a part of our business since our inception. In our chemistry technologies business, we apply our expertise in the design, production, and evaluation of chemical compounds that have the potential to become medicines. For example, we generate libraries, or large collections, of potential drug candidates, assess the drug likeness of candidates and select the most promising candidates, all using high throughput, automated chemistry. Our chemistry services-based collaboration agreements involve several pharmaceutical companies, including Pfizer Inc., Sankyo Company, Ltd and Novartis Biomedical Research Institute.

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

The consolidated financial statements include the accounts of ArQule, Inc. and its wholly-owned subsidiary Camitro Corporation, including Camitro, U.K. Ltd. (subsequently renamed ArQule U.K. Ltd.), which was acquired on January 29, 2001 (collectively, “we”, “us”, “our” and the “Company”). All intercompany transactions and balances have been eliminated. In September 2002, the Camitro Corporation was merged into, and made part of, ArQule, Inc. We acquired Cyclis Pharmaceuticals, Inc. (“Cyclis”) on September 8, 2003, at which time Cyclis was merged into ArQule and ceased to be a separate entity. The results of Cyclis’ operations and the estimated fair value of assets acquired and liabilities assumed are included in the financial statements from the date of acquisition.

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

We consider all highly liquid investments purchased within three months of maturity date to be cash equivalents. We invest our available cash primarily in money market mutual funds and U.S. government and other investment grade debt securities that have strong credit ratings. As a matter of policy, we determine on a quarterly basis the fair market value of our investment portfolio. Our securities are recorded on our balance sheet at fair market value. Unrealized gains and losses on securities are included in shareholders equity, net of related tax effects. If the fair market value of a marketable security declines below its cost basis, and, based upon our consideration of all available evidence, we conclude such decline is “other than temporary”, we mark the investment to market through a charge to current earnings. At December 31, 2002 and 2003, we have classified these investments as available-for-sale.

At December 31, 2002 and 2003, our financial instruments consist of cash, cash equivalents, marketable securities, accounts receivable, accounts payable, accrued expenses, debt and interest rate swaps. The carrying amounts of these instruments approximate their fair values.

Investments in non-marketable equity securities are accounted for under the cost method if ArQule owns less than 20 percent of the outstanding stock of the investee and our management determines we do not exert significant influence over the management of the investee. We assess the fair value of investments in non-marketable equity securities quarterly, or whenever events or changes in circumstances indicate the carrying value may not be recoverable. In the event fair value is determined to be less than the carrying value of an investment, the carrying value is written down to fair value if the decline in value is significant and is deemed to be other than temporary. Since there is no readily available market information concerning the fair value of these investments, such assessments require significant management judgment in analyzing the investee’s financial position and projected future financial results and cash flows. Although the estimates used reflect our best estimates of fair value based upon available information, the use of different estimates could yield different conclusions concerning the recoverability of the carrying value of investments.

Our foreign subsidiary, ArQule, U.K. Ltd., had designated the Great Britain Pound Sterling as its functional currency. Financial statements of this foreign subsidiary are translated to U.S. dollars for consolidation purposes using current rates of exchange for monetary assets and liabilities and historical rates of exchange for non-monetary assets and related elements of expense. Revenue and other expense elements are translated at rates that approximate the rates in effect on the transaction dates. Related cumulative translation adjustments are included as a component of equity in the consolidated balance sheet.

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

Prior to December 2002, the Company’s intangible assets consisted primarily of the value of core technology and goodwill which was recorded in connection with the acquisition of Camitro Corporation. Both balances were amortized in 2001 using the straight-life method over their estimated useful lives of seven years. These technology assets were subject to amortization in 2002.

In January 2002, we adopted Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). As a result, goodwill balances are no longer subject to periodic amortization, but rather assessments for impairment. In conjunction with the adoption of SFAS 142, goodwill is subject in 2002 to both a transitional goodwill impairment test as of January 1, 2002 and an annual assessment for impairment based on fair value. In addition, FAS 142 requires that a goodwill impairment review be performed whenever events or changes in circumstances (“triggering events”) indicate that the carrying value may not be recoverable.

In addition to performing impairment assessments for goodwill, we also assess the recoverability of our core technology intangible asset annually, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If it is determined that the carrying value of an intangible asset might not be recoverable based on one or more indications of impairment, we measure any impairment based on the projected future cash flow of the underlying asset.

ArQule has entered into various chemistry-based collaborative agreements with pharmaceutical and biotechnology companies under which ArQule produces and delivers compound arrays and other research and development services. Revenue from collaborative agreements includes non-refundable technology transfer fees, funding of compound development work, the delivery of compounds, payments based upon delivery of specialized compounds meeting the collaborators specified criteria, and certain milestones and royalties on product sales. Non-refundable technology transfer fees are recognized as revenue when we have the contractual right to receive such payment, provided a contractual arrangement exists, the contract price is fixed or determinable, the collection of the resulting receivable is reasonably assured and we have no further performance obligations under the license agreement. When we have performance obligations under the terms of a contract, non-refundable fees are recognized as revenue as we complete our obligations. Where our level of effort is relatively constant over the performance period, the revenue is recognized on a straight-line basis. Funding of compound development work is recognized over the term of the applicable contract using the proportional achievement of deliveries against a compound delivery schedule or the development labor expended against a total research and development labor plan as the measure of progress toward completion. Any significant changes in the assumptions underlying our estimates to complete a contract (e.g., changes in the number of person hours to develop compounds, or changes in throughput capacity of our machinery and equipment) could impact our revenue recognition. Payments based upon delivery of specialized compounds meeting the collaborator’s specified criteria are recognized as revenue once the collaborator has accepted the delivery of these compounds and collection is reasonably assured.

Revenues from milestone payments related to chemistry-based collaboration arrangements under which we have no continuing performance obligations are recognized upon achievement of the related milestone. Revenues from milestone payments related to arrangements under which the Company has continuing performance obligations are recognized as revenue upon achievement of the milestone only if all of the following conditions are met: the milestone payments are non-refundable; achievement of the milestone was not reasonably assured at the inception of the arrangement; substantive effort is involved in achieving the milestone; and the amount of the milestone is reasonable in relation to the effort expended or the risk associated with achievement of the milestone. If any of these conditions are not met, the milestone payments are deferred and recognized as revenue over the term of the arrangement as we complete our performance obligations. Payments received under these arrangements prior to the completion of the related work are recorded as deferred revenue.

Cost of revenue represents the actual costs incurred in connection with performance pursuant to our chemistry-based collaborative agreements and the costs incurred to develop and produce compounds under these agreements. These costs consist primarily of payroll and payroll-related costs, chemicals, supplies and overhead expenses.

Costs of internal research and development and research and development done pursuant to collaborations are charged to operations as incurred. Development costs incurred in connection with funded development collaborations are included in cost of revenue. We incurred research and development expenses of $46,446, $31,389 and $49,291 in 2001, 2002 and 2003, respectively, including amounts assigned to acquired in-process technology of $18,000 in 2001 and $30,359 in 2003. The value assigned to acquired in-process technology, which was charged to operations upon acquisition, was determined by identifying and valuing those acquired in-process research projects for which (a) technological feasibility had not been established at the acquisition date, (b) there was no alternative future use, and (c) the fair value was estimable with reasonable reliability. See Note 4 for additional information.

Accruals are established for involuntary employee termination benefits in the same period that the appropriate level of management and the Board of Directors approve and commit the Company to a termination plan which: a) specifically identifies the number, location and job level of employees to be terminated; b) specifies the benefits terminated employees are to receive; c) assures that employees will be terminated within one year.

Accruals are established for property and equipment and facility-related costs for facilities to be abandoned which have no future economic benefit to the Company in the same period that the appropriate level of management and Board of Directors approve and commit the Company to an abandonment plan which: a) specifically identifies all significant actions to be taken to complete the abandonment plan; b) will begin as soon as possible after the abandonment plan is approved and; c) the period to complete that abandonment plan indicates that significant changes are not likely.

Accruals for property and equipment and facility related costs of abandoned facilities require significant management judgment and the use of estimates, including assumptions concerning our ability to sublease certain operating leases for abandoned real estate (see Note 11). These estimates of the time required to sublease the facilities and sublease rates the Company will receive were based on management’s analysis of the local real estate markets and general economic conditions in the regions of the abandoned facilities. If it takes longer to sublease these facilities than the Company has estimated, or if the sublease rates are less favorable than estimated, the Company may be required to take an additional charge for abandoned real estate. Conversely, if the space is subleased either earlier than estimated, or if the sublease rate actually achieved are more favorable, the Company may be required to reverse a portion of its current accrual for abandoned real estate.

We utilize an interest rate swap agreement in order to reduce the impact of changes in interest rates on our term loans. Settlement accounting is used for this interest rate swap, which expires on June 30, 2004. Any differences paid or received on interest rate swap agreements are recognized as adjustments to interest expense over the life of each swap, thereby adjusting the effective interest rate of the underlying obligations. The fair market value of this swap was an unrecognized loss of $22 at December 31, 2003.

Management uses consolidated financial information in determining how to allocate resources and assess performance. For this reason, we have determined that we are principally engaged in one industry segment. See Note 17 with respect to significant customers. Substantially all of our revenue since inception has been generated in the United States and substantially all of our long lived assets are located in the United States.

The asset and liability approach is used to account for income taxes by recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized

The computations of basic and diluted earnings (loss) per common share are based upon the weighted average number of common shares outstanding and potentially dilutive securities. Potentially dilutive securities include stock options and warrants. Options to purchase of 3,397,277, 3,690,317 and 3,895,918 shares of common stock were not included in the 2001, 2002 and 2003 computation of diluted net loss per share, respectively, because inclusion of such shares would have an anti-dilutive effect.

Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), requires that companies either recognize compensation expense for grants of stock options and other equity instruments based on fair value, or provide pro forma disclosure of net income (loss) and net income (loss) per share in the notes to the financial statements. At December 31, 2003, we have three stock-based compensation plans, which are described more fully in Note 14. We account for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations. Accordingly, no compensation cost has been recognized under SFAS 123 for our employee stock option plans. Had compensation cost for the awards under those plans been determined based on the grant date fair values, consistent with the method required under SFAS 123, the Company’s net loss and net loss per share would have been reduced to the pro forma amounts indicated below:

For the purposes of pro forma disclosure, the estimated value of each employee and non-employee option grant was calculated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the use of highly subjective assumptions, including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the fair value estimates, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock-based compensation. The model was calculated using the following weighted-average assumptions: no dividend yield for all years; volatility of 95% for 2001, 2002 and 2003; risk-free interest rates of 4.24% in 2001, 3.85% in 2002 and 2.0% in 2003; and expected lives of 4 years in 2001 and 5 years for 2002 and 2003 for options granted.

Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under accounting principles generally accepted in the United States are included in comprehensive income (loss) but are excluded from net income (loss) as these amounts are recorded directly as an adjustment to stockholders’ equity, net of tax. Our other comprehensive income (losses) were $(58), $(170) and $62 in 2001, 2002, and 2003 respectively, and is composed of unrealized gains and losses on marketable securities and interest rate swaps and foreign currency translation adjustments.

Certain reclassifications have been made to the 2001 and 2002 financial statements to conform to the 2003 presentation.

In December 2003, the FASB reached a consensus on Emerging Issues Task Force Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). This issue addresses how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. This is applicable to agreements entered into in after June 15, 2003. The Company is currently assessing the impact EITF No. 00-21 will have on revenue recognition in 2004, in particular as it relates to the updated Pfizer contract which was signed in February 2004.

We have entered into a number of license, research and development agreements (the “Agreements”) with corporate collaborators. Three separate agreements were entered into with Solvay Duphar B.V. (“Solvay”), Wyeth Pharmaceuticals (“Wyeth”) and Novartis Institute for BioMedical Research, Inc, an affiliate of Novartis AG (“Novartis”). Revenue related to these agreements is included in compound development revenue-related parties. Two members of our Board of Directors are currently employed by Solvay and Novartis, respectively, and Wyeth had a representative on our Board of Directors who resigned in January 2002.

On September 8, 2003, ArQule acquired all of the outstanding securities of Cyclis, a privately held, development stage cancer-therapeutics company based in Norwood, Massachusetts, in a transaction accounted for as a purchase business combination. At that time, Cyclis was merged with and into ArQule and Cyclis ceased to exist as a separate entity. Pursuant to the terms of the acquisition agreement, ArQule issued approximately 4.6 million shares of common stock, paid cash of $5,000 and forgave notes receivable of $500. ArQule incurred consulting, legal, accounting and other third-party costs of approximately $1,631 in order to close the transaction. The shares issued were valued at $18,808 based on the Company’s share price on the measurement date of acquisition, resulting in a total purchase price of $25,939. The results of the acquired Cyclis operations and the estimated fair value of the assets acquired and liabilities assumed are included in the 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 the Company’s estimates of fair value at the acquisition date. The purchase price exceeded the amounts allocated to the identifiable tangible and intangible assets acquired and liabilities assumed by approximately $17,057. Since Cyclis was a development stage enterprise it is not considered a business under Emerging Issues Task Force No. 98-3, and therefore the excess purchase price cannot be allocated to goodwill. Consequently, the excess purchase price was allocated on a pro rata basis to the carrying value of the acquired long-lived assets, resulting in a step-up in basis of property and equipment and in-process research and development (“IPR&D”) of $699 and $16,359, respectively.

The following table shows the allocation of the purchase price to acquired assets and liabilities for the acquisition of Cyclis:

Upon consummation of Cyclis acquisition, we immediately charged to income $30,359 representing purchased IPR&D that had not yet reached technical feasibility and had no alternative future use. Approximately $14,000 of the charge represents the fair value of the IPR&D; the remaining $16,359 of the charge represents the aforementioned step-up adjustment. The value assigned IPR&D (before the step-up adjustment) was composed of the projected value of three Cyclis preclinical drug development projects based on various mechanisms of actions associated with the ACT^SM technology. The valuation was determined using the income approach. Potential revenue and drug development expenses were projected through 2020 based on information obtained from management and from published third-party industry statistics for similar drug development businesses. The expenditures that will be necessary to complete the clinical trials are subject to numerous uncertainties. Completion of clinical trials may take several years or more, and the estimate of time and cost to complete can be affected by factors such as the number of patients required to participate in the trials, the number of clinical sites involved in the trials, the length of time required to enroll a suitable number of patients and the type, complexity, novelty and intended use of a product. We estimate that the development of these acquired projects through clinical trials to commercial viability will take approximately nine years and cost in excess of $500,000. The discounted cash flow method was applied to the projected cash flows, adjusted for the probability of success, using a discount rate of 30%. The discount rate takes into consideration the uncertainty surrounding successful development and commercialization of the IPR&D.

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 $1,733 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 $84,268 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 at the acquisition date. Identifiable intangible assets were being amortized over their estimated useful life of seven years. The purchase price exceeded the amounts allocated to the identifiable tangible and intangible assets acquired and liabilities assumed by $29,699. This excess was classified as goodwill, which was being amortized on a straight-line basis over its estimated useful life of seven years through December 2001. Beginning in 2002, goodwill is no longer amortized, but instead tested annually for impairment. Our goodwill and acquired core technology assets were written-off in December 2002. See Note 8 — Intangible Assets.

The following table shows the allocation of the purchase price to acquired assets and liabilities for the acquisition of Camitro:

Approximately $18,000 of the purchase price represents the estimated fair value of the purchased 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 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 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. Management is responsible for the assumptions used to determine the estimated fair value of the IPR&D.

In December 2002, the Company decided to cease all further development the ADMET models and to close its facilities in California and the United Kingdom. As a result of that decision, the unamortized value of the remaining intangible asset were fully written-off at December 31, 2002. (See Note 8 — Intangible Assets for further information.)

Pfizer. Our largest collaboration is with Pfizer Inc. Since the inception of this relationship in 1999, we have managed and staffed a facility that produces collections of chemical compounds exclusively for Pfizer using our automated high-speed compound production system. Pfizer received a non-exclusive license to use this system in its internal production program. We expanded this contract in December 2001 to a seven-year agreement. With this expansion, Pfizer and ArQule scientists work more closely on idea generation and library design. Pfizer has also committed to undertake one lead optimization program with ArQule and has direct access to our library design tools on a non-exclusive basis.

We renegotiated this contract again in early February 2004. Under the amended terms of the contract, ArQule will continue to work with Pfizer’s scientists to more closely match its compound deliveries to those libraries which Pfizer believes have the greatest developmental opportunity. Under this new agreement, ArQule will maintain compound deliveries at approximately the same level to be supplied in 2004 instead of increasing compound deliveries as specified in the previous agreement. This will result in a decrease in the total potential contract value of $55,000 compared to the terms agreed upon in 2001.

If our amended relationship with Pfizer is successful, we could earn up to $291,000 over the term of the contract (2001-2008). As of December 31, 2003, we have received $190,320 from Pfizer since inception of this relationship in 1999. Pfizer has made equity investments in our company of $10,000 in 2001, at the onset of the expanded agreement, plus investments of $8,000 in 2003 based on the achievement of certain delivery milestones. Although Pfizer owns all rights in compounds produced pursuant to the collaboration, the activities we perform on behalf of Pfizer allow us to enhance and validate our high throughput compound production techniques as applied to lead generation. Pfizer may terminate the new agreement, beginning in December 2005, for any reason, but would not be entitled to receive any refund for amounts paid to ArQule through the date of termination.

In addition we have, or in 2003 completed, collaborations with the following companies:

Bayer. In October 1999, we entered into a three-year collaboration with Bayer AG to produce large collections of compounds designed exclusively for Bayer in accordance with its specifications. We refer to such collections as Custom Array^TM libraries. In December 2002, we extended the production period until September 30, 2003. Bayer owns all rights in compounds for an initial period, after which we will co-own rights in compounds that Bayer has not claimed in a patent application. We received a $3,000 upfront payment and an additional $27,000 during the term of the agreement for delivery and success fees. As of December 31, 2003, we have completed our contractual obligations and have received the entire $30,000 due under this agreement. Bayer will pay no milestones or royalties to us on compounds that they develop and market.

Sankyo. In November 1997, we entered into a three-year agreement with Sankyo Company, Ltd. to discover and optimize drug candidates. Under the terms of the agreement, Sankyo received a subscription to our Mapping Array™ Program. The program involved a large collection of compounds provided on a non-exclusive basis to several pharmaceutical companies as a tool to discover new lead compounds. Sankyo also committed to a minimum number of Directed Array™ Programs during the term of the agreement. In April 2001, we extended our agreement with Sankyo through June 2004 to include access to the Compass Array™ libraries, which are a subset of the Mapping Arrays™, in addition to continuing to use our Directed Array™ Program, which involves a target-focused library. The total value of the extended agreement is up to $14,800 million in committed payments of which, as of December 31, 2003, we have received $14,580. To date, we have not received any milestone or royalty payments under this agreement.

Solvay. In November 1995, we entered into a five-year agreement with Solvay Duphar B.V. Under this agreement, Solvay subscribed to our Mapping Array™ and Directed Array™ Programs and received a non-exclusive license to our AMAP Chemistry Operating System. This agreement was superseded by an amended and restated agreement with Solvay Pharmaceuticals, B.V., which became effective on January 1, 2001. The amended agreement extended the collaboration through December 31, 2003. Under the amended agreement, Solvay received our Compass Array™ libraries and continued to access our Directed Array™ Programs. As of December 31, 2003, we have received $20,682 under the original and amended agreements, both of which are complete. Solvay must also make additional payments if we achieve certain development milestones and pay royalties on sales of any drugs that result from the relationship. To date, we have not received any milestone or royalty payments. In connection with the original collaboration in 1995, an affiliate of Solvay, Physica B.V., made a $7,000 equity investment in ArQule.

Novartis Institute for BioMedical Research, Inc. On September 3, 2003, we entered into a one year chemistry services collaboration with Novartis Institute for BioMedical Research, Inc. (NIBRI), an affiliate of Novartis AG. As part of the collaboration we will apply our integrated chemistry technology platform to generate and optimize small molecule compounds for NIBRI’s anti-infective drug discovery program. The total contract value of the agreement is $1,000, of which we have received $328 as of December 31, 2003. NIBRI must also make additional payments if we achieve certain developmental milestones.

Also, we successfully completed major collaborations with GlaxoSmithKline, Pharmacia, Wyeth Pharmaceuticals and Johnson & Johnson. The collaboration agreements contain trailing obligations of our collaborators to, under specified circumstances, make milestone and royalty payments. In addition, for several of our formerly active collaborators, we have agreed to provide a limited amount of compound production services, as such collaborators seek to optimize promising compounds. Wyeth has selected a compound from

GlaxoSmithKline. In November 2000, we entered into a five-year collaboration and license agreement with SmithKline Beecham Corporation (now GlaxoSmithKline). Under the terms of the agreement, GlaxoSmithKline received access to our Compass Array libraries and Mapping Array libraries for screening primarily in the anti-infective field. GlaxoSmithKline elected to terminate the agreement in November 2002, before the end of the five-year term. As of December 31, 2003, we have received $1.5 million under this collaboration. GlaxoSmithKline has agreed to pay us development milestones and royalties on sales of products resulting from the collaboration. To date, we have not received any milestone or royalty payments.

Pharmacia. We entered into a five-year collaboration with Monsanto Company (now Pharmacia Corporation) in December 1996. Under this agreement, we provided Monsanto with access to our Mapping and Directed Array Programs and Compass Array and Mapping Array libraries. Pharmacia has made payments totaling $12.7 million under this agreement. In addition, Monsanto has agreed to pay us development milestones and royalties from the sales of products resulting from the collaboration. In July 1998, we received a milestone payment for a Mapping Array compound selected by Monsanto for entry into field trials. In March 2002, we entered into a one-year technical access agreement with Pharmacia Corporation which granted Pharmacia non-exclusive access to our proprietary ADMET simulation technology. In March 2003, we extended the technical access agreement to June 30, 2003. As of December 31, 2003, we have satisfied our contractual obligations with Pharmacia.

Wyeth Pharmaceuticals. In July 1997, we entered into a four and one half year agreement with Wyeth Pharmaceuticals (“Wyeth”). Under this agreement, Wyeth subscribed to our Mapping Array and Directed Array Programs. We discontinued our Mapping Array Program as of 2002, and as a consequence and in agreement with Wyeth, we did not renew our collaboration. Wyeth has continuing rights to screen the compounds from the Mapping and Directed Array Programs and continuing obligations to pay us development milestones and royalties from the sales of products resulting from compounds we shipped during the collaboration. Wyeth has filed an IND based upon a compound from our Directed Array Program and made milestone payments to us in connection therewith in October 2001 and February 2004. As of December 31, 2003, we have received $27.1 million under this agreement.

Johnson & Johnson. In December 1998, we entered into a three-year collaboration with R.W. Johnson Pharmaceutical Research Institute, a division of Johnson & Johnson, Inc., in which R.W. Johnson subscribed to our Mapping Array Program. We discontinued our Mapping Array Program as of 2002, and, as a consequence and in agreement with R.W. Johnson, we did not renew our collaboration. As of December 31, 2003, we have received $9.0 million under this agreement. In addition, R.W. Johnson has agreed to pay us developmental milestones and royalties from sales of any products resulting from this collaboration. To date, we have not received any milestone or royalty payments.

The following is a summary of the fair market value of available-for-sale marketable securities we held at December 31, 2001 and 2002:

At December 31, 2002 and 2003, marketable securities are carried at fair market value and are classified as current as the funds are highly liquid and are available to meet working capital needs and to fund current operations. The gross unrealized gains (losses) on marketable securities at December 31, 2002 and 2003 were $55 and $(28), respectively.

The following table summarizes our investments with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003:

The securities summarized above represent a total of seven investments purchased by the Company in order to maximize its return on liquid assets in excess of its immediate needs. The temporary impairments relate to unfavorable market interest rate fluctuations which have decreased the fair value of the investments below the original investment cost. The Company believes these fluctuations are temporary and therefore has not realized an impairment loss on these investments at December 31, 2003.

See Note 11 related to restructuring charge for the write-off of leasehold improvements and equipment located in the Company’s abandoned facilities.

In connection with our acquisition of Camitro, we recognized amortization expense in 2001 of $4,013 and $3,091 related to goodwill and core technology, respectively. In January 2002, we adopted SFAS 142, and as a result did not amortize goodwill in 2002 in lieu of performing an annual assessment for impairment. In 2002, we recognized amortization expenses of $3,373 related to core technology.

In conjunction with the adoption of SFAS 142, goodwill is subject in 2002 to both a transitional goodwill impairment test as of January 1, 2002 and an annual assessment for impairment based on fair value. The Company has determined it consists of a single reporting unit. We completed the transitional goodwill impairment test as of January 1, 2002 by comparing the Company’s fair value to its net assets, including goodwill. If the carrying value of the Company’s net assets exceeds the Company’s fair value the goodwill is impaired. Fair value is based on quoted market prices adjusted to provide for a control premium. The fair value of the reporting unit on January 1, 2002 exceeded the net assets of the reporting unit, including goodwill. Accordingly, we concluded that no impairment existed as of the January 1, 2002 transition date. ArQule

performed its annual assessment for 2002 as of July 1, 2002. That analysis also indicated that the fair value of the reporting unit exceeded the Company’s net assets, including goodwill, and therefore we concluded that no impairment existed as of the annual assessment date.

The following table represents the pro forma impact SFAS 142 would have had on our net loss per share had the standard been in effect in 2001:

In addition to requiring transitional and annual assessments of goodwill impairment, SFAS 142 requires that a goodwill impairment review be performed whenever events or changes in circumstances (“triggering event”) indicate that the carrying value may not be recoverable. In December 2002, we announced a restructuring of operations resulting from our decision to cease further development of our ADMET predictive models and to close our facilities in Redwood City, California and Cambridge, United Kingdom. The Company concluded the restructuring charge was a triggering event and that the carrying value of our goodwill asset may be impaired. Accordingly, we conducted an impairment review as required under SFAS 142 as of December 31, 2002 and concluded that an impairment had occurred as of that date. To determine the amount of the impairment charge we calculated our implied goodwill as the difference between fair value of the reporting unit and the fair value of our assets and liabilities. We determined that the fair value of the reporting unit was significantly less than the fair value of our assets and liabilities, which implied goodwill was zero, and therefore recorded a non-cash impairment charge of $25,890 to write-off the entire carrying value as of December 31, 2002. This charge is included in operating costs and expenses within the statement of operations in 2002.

The impairment analyses for the Company’s core technology intangible asset and goodwill asset involved considerable judgment and use of several estimates, including: control premiums and projected cash flows of our ADMET predictive models. We used a control premium of 40% in determining the Company’s fair value was based on an analysis of control premiums involved in acquisitions of companies of similar size and in similar industries. The cash flow assumptions for our ADMET predictive models were based on management’s belief that there is no future potential cash flow associated with ArQule commercializing the ADMET models for third-party use or as the basis for a collaborative agreement. All of these estimates involve significant judgment by the Company’s management. Although the estimates used reflect management’s best estimates based upon all available evidence, the use of different estimates could have yielded different conclusions concerning the impairment of the core technology and goodwill assets.

We also performed an impairment assessment of the carrying value of the core technology in the fourth quarter of 2002 in light of our decision to cease development of the ADMET predictive modeling as a result of our inability to successfully commercialize these models and to generate any future cash flow. Based on this assessment, which included an analysis of management’s estimates that there were no future cash flows resulting from these models, we concluded that the carrying value of the core technology was not recoverable, and accordingly took an impairment charge of $17,137 representing the entire remaining carrying value of our core technology.

In July 2001, we purchased approximately 1.8 million preferred shares of a privately owned proteomics company for $5,000. This represented an approximately 8% ownership interest. We are accounting for this under the cost method as we do not exert significant influence in the company. This investment is included in other assets on the Consolidated Balance Sheet. We assess the fair value of this investment quarterly or whenever events or changes in circumstance indicate that the investment value may not be recoverable. During 2003, this entity attempted to raise additional financing in order to fund its operations, but was unable to secure such financing on acceptable terms. At December 31, 2003, we performed such an assessment based on an analysis of the investment’s current financial condition, its prospects of generating additional cash flow from operating activities, the current market conditions for raising capital funding for companies in this industry and the likelihood that any funding raised would significantly dilute our ownership percentage. As a result of this analysis it was our judgment that a permanent impairment had occurred and that the fair value of our investment was $250, resulting in a non-cash loss on investment of $4,750.

In December 2002, we announced a major restructuring of our operations whereby we ceased further development and commercialization of the ADMET predictive models and realigned our workforce to expedite the transition towards becoming a drug discovery company. The decision was precipitated by our inability to successfully commercialize the ADMET predictive modeling technology to generate incremental cash flow through either direct access fees or a predictive model based collaborative agreement.

Termination benefits relate to severance and benefit costs associated with the elimination of 128 managerial and staff positions worldwide, comprising approximately 31% of the workforce, in the following areas: 97 positions in research and development functions and 31 positions in administrative functions. Facility-related costs relate to the remaining lease payment obligations associated with the abandonment of our facilities in Redwood City, California and Cambridge and the non-cash write-off of leasehold improvements and equipment no longer expected to provide future economic benefit at the abandoned facilities, less assumed proceeds from sale. Other charges include a $477 non-cash stock compensation charge related to ArQule’s contractual obligation to remove all restrictions related to restricted stock of certain employees who were involuntarily terminated, plus contractual obligations which provided no future value to the Company and other miscellaneous costs associated with closing the California and United Kingdom operations. See Note 2 “Significant Accounting Policies” for a discussion of our accounting policy for restructuring charges. We believe that these actions resulted in savings of approximately $12,000 per year in personnel and facility-related expenses.

Activities against the restructuring accrual (which is included in accrued liabilities in the Consolidated Balance Sheet) in 2002 and 2003 were as follows (in thousands):

The Company eliminated 108 positions in December 2002; the remaining were eliminated by March 31, 2003. As of December 31, 2003 virtually all termination benefits had been paid. California facility costs will be paid out through the remaining lease term of the facility, which extends through 2010, unless we are able to mitigate such costs by subleasing the facility or settling our leasehold position by paying a lump-sum payment to the landlord. In October 2003, ArQule completed an agreement with InPharmatica Ltd. to sell certain assets of its former operations in the United Kingdom. As a result, ArQule reversed $290 of restructuring accrual to reflect a change in its original estimate of the remaining leasehold obligations and assumed sublease income in the United Kingdom. Throughout the latter half of 2003, ArQule was in negotiations with a third-party to sublease its facility in California on favorable terms. Those negotiations were unsuccessfully terminated in January 2004. As a result, management reassessed the adequacy of its accrual relative to its lease obligation and assumed sublease income for the California facility, and based on continued deterioration in the local real estate market recorded an additional provision of $1,529.

Accruals for abandoned property and equipment and facilities require significant management judgment and the use of estimates, including assumptions concerning our ability to sublease certain operating leases for abandoned real estate with remaining lease payments of up to $9,029 as of December 31, 2003. These estimates of the time required to sublease the facilities and sublease rates the Company will receive were based on management’s analysis of the local real estate markets and general economic conditions in the regions of the abandoned facilities. If it takes longer to sublease these facilities than the Company has estimated, or if the sublease rates are less favorable than estimated, the Company may be required to take an additional charge for abandoned real estate of up to $3,143. Conversely, if the space is subleased either earlier than estimated or if the sublease rate actually achieved are more favorable, the Company may be required to reverse a portion of its current accrual for abandoned real estate.

In February 2004, the Company announced that it was restructuring its operations to affect a shift in resources from its chemistry technologies to its internal research efforts and would be eliminating approximately 55 staff and managerial positions, representing approximately 19% of its workforce, resulting in a restructuring charge in the first quarter of 2004 of between $1,200 and $1,400. The Company expects to hire approximately the same number of employees with skill-sets which better compliment the drug discovery and development efforts, by the end of 2004.

In March 1999, we entered into a term loan agreement with Fleet National Bank (“Fleet”). The terms of this agreement allow for borrowings up to a maximum of $15,000 based on 80% of qualifying property and equipment purchases, provided that we comply with certain covenants, including the maintenance of specified financial ratios. Borrowings under this facility are classified as either “Tranche A” (term loans entered into before June 30, 1999) or “Tranche B” (term loans entered into between July 1, 1999 and June 30, 2000). Principal amounts due are payable in 16 equal quarterly installments beginning on September 30, 1999 and September 30, 2000 for “Tranche A” and “Tranche B” borrowings, respectively. Interest payments are made monthly in arrears beginning on the first day of the month following commencement of this agreement and accrue at one month LIBOR plus 1.75%. We entered into an interest rate swap agreement with Fleet primarily to reduce the impact of changes in interest rates on our term loan agreement. At December 31, 2003 we have an interest rate swap with a notional amount of $975. Under this agreement, we will pay Fleet at the rate of 8.99%. Settlement accounting is used for this interest rate swap which expires on June 30, 2004. The impact on our financial position and results of operations from likely changes in interest rates is not material, as our hedging of transactions is limited to these specific liabilities. The fair market value of this agreement was an unrecognized loss of $22 at December 31, 2003. In March 2001, we amended and extended our term loan agreement with Fleet National Bank to borrow an additional $16,000 in order to finance our facility and land purchase (“Tranche C”). 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 175 basis points. On December 31, 2003 our interest rate on Tranche C was 3.09%. As of December 31, 2003, the “Tranche A” loan had been fully repaid and we had total outstanding balances of $975 and $4,000, respectively, on our “Tranche B” and “Tranche C” loans. This facility is collateralized by all of our property and equipment.

On September 28, 2002, the Company amended its existing loan agreement with Fleet National Bank to allow for additional borrowing of up to $2,500 to finance the build-out associated with its leased facility in Redwood City, California. The incremental new borrowing is termed the “Facility Three Term Loan.” Principal payments on the Facility Three Term Loan will be made in 36 monthly installments commencing on April 30, 2003. Interest payments will be made monthly in arrears beginning on the first day of the month following commencement of this agreement, and interest accrued at the rate of LIBOR plus 175 basis points, which was 3.13% on December 31, 2003. The Company has borrowed $2,500 against the Facility Three Term Loan.

In connection with the Cyclis acquisition, ArQule assumed total long term debt of $2,572. Of this amount, $2,500 plus accrued interest was repaid at closing. The remaining obligation represents two

We are authorized to issue up to one million shares of preferred stock. As of December 31, 2003 and 2002 there were no outstanding shares of preferred stock. Our Board of Directors will determine the terms of the preferred stock if and when the shares are issued.

Our amended Certificate of Incorporation authorizes the issuance of up to 50 million shares of $0.01 par value common stock.

At December 31, 2003, we have 6,109,583 common shares reserved for future issuance of common stock under the Employee Stock Purchase Plan and for the exercise of common stock options pursuant to the Equity Incentive Plan, the Directors Plan and the options acquired from Camitro’s Stock Plan.

The number of shares authorized for award under the 1994 Amended and Restated Equity Incentive Plan (the “Equity Incentive Plan”) is 7,700,000. All shares are awarded at the discretion of our Board of Directors in a variety of stock based forms including stock options and restricted stock. Pursuant to the Equity Incentive Plan, incentive stock options may not be granted at less than the fair market value of our common stock at the date of the grant, and the option term may not exceed ten years. For holders of 10% or more of our voting stock, options may not be granted at less than 110% of the fair market value of the common stock at the date of the grant, and the option term may not exceed five years. Stock appreciation rights granted in tandem with an option shall have an exercise price not less than the exercise price of the related option. As of December 31, 2003, no stock appreciation rights have been issued. In September 2001, a sub-plan, known as the “2001 Inland Revenue Approved Sub-Plan” was added to the 1994 Amended and Restated Equity Incentive Plan and was approved by our Board of Directors. This plan grants Approved Stock Options to the employees of the United Kingdom from the Equity Incentive Plan available awards pool. No Approved Stock Options were granted during 2003 and the 2001 Inland Revenue Approved Sub-Plan was closed in 2003. At December 31, 2003, there were 1,774,595 shares available for future grant under the Equity Incentive Plan. Subject to the above restrictions, the Board of Directors is authorized to designate the options, awards, and purchases under the Equity Incentive Plan, the number of shares covered by each option, award and purchase, and the related terms, exercise dates, prices and methods of payment.

On January 29, 2001, we assumed Camitro Corporation’s outstanding options under the Camitro Stock Plan. There are no longer any shares available for future grant under this Plan. Compensation expense for 2002 related to the acquired Camitro stock options that were unvested at the time of the acquisition was $3,036. On December 13, 2002, the remaining former employees of Camitro were terminated in connection with the Company’s closing of its Redwood City, California facility. As a result, all unvested Camitro stock

The number of shares available for award under the 1996 Amended and Restated Director Stock Option Plan (“Director Plan”) is 290,500. During 2003, our shareholders approved and amended The Director Plan to: (i) increase the number of shares of our common stock automatically granted to a director upon his or her initial election to our board of directors from 7,500 shares to 10,000 shares and (ii) increase the number of shares of our common stock automatically granted to directors upon their continuation on our board immediately after each annual meeting from 3,500 shares to 5,000 shares. All options granted pursuant to the Director Plan have a term of ten years with exercise prices equal to fair market value on the date of grant. Through December 31, 2003, options to purchase 222,500 shares of common stock have been granted under this plan of which 212,500 shares are currently exercisable. As of December 31, 2003, 68,000 shares are available for future grant.

During 2001 and 2002 we issued 10,000 options each year to certain members of our Scientific Advisory Board under the Equity Incentive Plan. There were no such grants in 2003. Compensation expense in 2001 and 2002 was $129 and $72, respectively. Also during 2001 and 2002 compensation expenses of $69 and $113, respectively, was recorded for employees who received non-qualified stock options at below fair market value on the date of grant. There is no remaining deferred compensation expense related to these grants at December 31, 2003.

Option activity under the Plans for the years ended December 31, 2001, 2002 and 2003 was as follows:

The following table summarizes information about options outstanding at December 31, 2003:

In 1996, the stockholders adopted the 1996 Employee Stock Purchase Plan (the “Purchase Plan”). This plan enables eligible employees to exercise rights to purchase our common stock at 85% of the fair market value of the stock on the date the right was granted or the date the right is exercised, whichever is lower. Rights to purchase shares under the Purchase Plan are granted by the Board of Directors. The rights are exercisable during a period determined by the Board of Directors; however, in no event will the period be longer than twenty-seven months. The Purchase Plan is available to substantially all employees, subject to certain limitations. As of December 31, 2003, 648,900 shares have been purchased pursuant to the Purchase Plan. In May 2003, our shareholders approved an amendment to the Purchase Plan to increase the aggregate number of shares of the Company’s common stock which may be issued from 720,000 shares to 1,020,000 shares. As of December 31, 2003, there were 371,065 shares available for future sale under the Employee Stock Purchase Plan.

The current and deferred tax expenses for the years ended December 31, 2003, 2002 and 2001 are as follows:

The following is a reconciliation between the U.S. federal statutory rate and the effective rate for the years ended December 31, 2003, 2002 and 2001:

The deferred tax consequences of temporary differences in reporting items for financial statement and income tax purposes are recognized, if appropriate. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including our ability to generate taxable income within the net operating loss carry-forward period. Management has considered these factors in reaching its conclusion as to the valuation allowance for financial reporting purposes. The income tax effect of temporary differences comprising the deferred tax assets and deferred tax liabilities on the accompanying balance sheets is a result of the following:

Of the $56,351 valuation allowance at December 31, 2003, $6,283 relating to deductions for nonqualified stock options will be credited to paid-in capital, if realized.

As of December 31, 2003, we had federal net operating loss (“NOL”) and research and development credit carryforwards of approximately $64,556 and $6,612, respectively, which can be used to offset future federal income tax liabilities and expire at various dates through 2023. As required by Statement of Accounting Standards No. 109, we evaluated positive and negative evidence bearing upon the realizability of its deferred tax assets, which are comprised principally of net operating loss and research & development credit carryforwards. We have determined that it is more likely than not that we will not recognize the benefits of federal and state deferred tax assets and, as a result, a valuation allowance of approximately $56,351 has been established at December 31, 2003.

Ownership changes, as defined in the Internal Revenue Code, may have limited the amount of net operating loss carryforwards that can be utilized annually to offset future taxable income. Subsequent ownership changes could further affect the limitation in future years.

We lease facilities and equipment under non-cancelable operating leases and capital lease agreements. Assets under capital lease obligations and accumulated amortization, net of step-up adjustments, amounted to $421 and $144, respectively, at December 31, 2003. At December 31, 2003, the minimum lease commitments for all leased facilities and equipment are as follows:

Included in the total minimum payments for operating leases is approximately $6,685 related to abandoned real estate which was accrued as a liability as a part of the Company’s restructuring charges. (see Note 11).

The current and long-term portions of capital leases are included in current portion of long-term debt and long term debt, respectively, in the Consolidated Balance Sheet.

Rent expense under non-cancelable operating leases was approximately $1,863, $2,503 and $1,150 for the years ended December 31, 2001, 2002 and 2003, respectively.

We lease approximately 56,000 square feet of laboratory and office space in Medford, Massachusetts, the majority of which is used for the Pfizer collaboration. We lease these facilities from Cummings Properties, LLC (“Cummings”) under two lease agreements, one of which expires on July 30, 2005 and one of which expires on July 30, 2006. The Company subleases portions of these facilities pursuant to two sublease agreements.

On August 1, 2001, Cummings significantly raised ArQule’s rent on the lease that expires July 30, 2006. We believe this increase to be in excess of that which is permissible under the lease agreement. Accordingly, on January 16, 2002, we brought a complaint for declaratory relief and damages against Cummings arising, in part, out of Cummings’ attempts to increase the lease rates. Nevertheless, during the pendency of this dispute, we are paying the rental rates proposed by Cummings. The Company seeks recovery of the funds that it has already paid, and is paying, under protest. Management has made an estimate of the most likely outcome of this contingency and has concluded that no provision is required at December 31, 2003. However, if we are unsuccessful in our claim against Cummings, and must pay all or a portion of the rental expense increase currently proposed by Cummings, we may be required to record an additional expense of up to approximately $800 to record the difference between our contractual rental payments and contractual sublease rental income over the remaining period of the lease. Conversely, if the contingency is resolved in ArQule’s favor and the

In November 2002, the FASB issued FIN No. 45 which requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. FIN No. 45 also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees are applicable on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective immediately for all guarantees outstanding, regardless of when they were issued or modified. The adoption of FIN No. 45 did not have a material effect on our consolidated financial statements.

Revenues from two of our customers accounted for 62% and 16% of total revenues during 2001. Revenue from two of our customers accounted for 74% and 14% of total revenue during 2002. Revenue from two of our customers accounted for 84% and 10% of our total revenue during 2003. There were no significant customer accounts receivable balances at December 31, 2002. One customer accounted for 95% of our accounts receivable balance at December 31, 2003. We do not require collateral on accounts receivable balances.

Under the supervision and with the participation of the Company’s President and Chief Executive Officer, and Vice President, Chief Financial Officer and Treasurer (its principal executive officer and principal financial officer), management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on the evaluation, the President and Chief Executive Officer and Vice President, Chief Financial Officer and Treasurer have concluded that these disclosure controls and procedures are effective as of September 30, 2003. During the quarter ended December 31, 2003 there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

Certain information relating to our directors and executive officers is contained under the caption “Executive Officers of the Registrant” in Part I, Item 1A of this Annual Report on Form 10-K. The remainder of the information required by Items 10, 11, 12, 13, and 14 of Form 10-K is incorporated by reference from the discussion responsive thereto under the caption “Election of Directors” in our Proxy Statement relating to our 2004 Annual Meeting of Stockholders scheduled for May 19, 2004.

The financial statement schedules listed under Item 8 of this report are omitted because they are not applicable or required information and are shown in the financial statements of the footnotes thereto.


+	Certain confidential material contained in the document has been omitted and filed separately, with the Securities and Exchange Commission pursuant to Rule 406 of the Securities Act of 1933, as amended or Rule 24b-2 of the Securities and Exchange Act of 1934, as amended.

The Company filed a current report on Form 8-K on December 19, 2003, to furnish its press release announcing the achievement of certain contractual milestones with Pfizer, Inc. and to update its financial guidance for 2003.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Woburn, Commonwealth of Massachusetts, on March 11, 2004.


	By:	/s/ STEPHEN A. HILL



	Stephen A. Hill
	President and Chief Executive Officer

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


+	Certain confidential material contained in the document has been omitted and filed separately, with the Securities and Exchange Commission pursuant to Rule 406 of the Securities Act of 1933, as amended or Rule 24b-2 of the Securities and Exchange Act of 1934, as amended.

F-36 EX-10.6.1 3 b49672aiexv10w6w1.txt AMENDED AND RESTATED R&D LICENSE AGREEMENT Exhibit 10.6.1 AMENDED AND RESTATED RESEARCH, DEVELOPMENT AND LICENSE AGREEMENT This Agreement, effective as of January 1, 2001 (the "Effective Date"), is between ArQule, Inc. ("ArQule"), a Delaware corporation, and Solvay Pharmaceuticals B.V. ("Solvay"), a Dutch corporation. R E C I T A L S WHEREAS, the parties previously entered into that certain Research, Development and License Agreement, effective as of November 2, 1995 (the "Prior Agreement"); WHEREAS, the Prior Agreement will, by its terms, expire on December 31, 2000; and WHEREAS, the parties desire to continue certain activities under the Prior Agreement and to continue their collaboration 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 has exhibited biological activity against a Target and as to which Solvay has provided the required notice to ArQule under the Prior Agreement or under this Agreement pursuant to Sections 3.2. and 3.4 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 Research, Development and License Agreement, together with Exhibits A and B hereto. 1.4. "ArQule Compound" shall mean a chemical compound provided by ArQule to Solvay pursuant to this Agreement or under the Prior 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 by ArQule or by or for Solvay in the course of an optimization program for the molecular Target or other Target (e.g., whole cell screen) against which such Licensed Compound was initially discovered to have biological activity, i.e., a compound is not an ArQule Derivative Compound if that compound is independently developed by Solvay. 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 in the Field or (ii) committed to an internal ArQule program in the Field and is reserved to Solvay on an exclusive basis pursuant to Section 3. 1.8. "Chemical Theme" shall mean the chemical or structural characteristics shared by (i) the ArQule Compounds in a Mapping Array Library or (ii) a group of compounds in a Directed Array Library as determined by the Research Committee pursuant to Section 2.2.1. 1.9. "Compass Array(TM) Library" shall mean a collection of ArQule Compounds that is a diverse representative subset of the Mapping Array Libraries produced in calendar year 2001 and used for initial screening of those Mapping Array Libraries. The description of, and the specifications for, the Compass Array Library are set forth in Exhibit A attached hereto. 1.10. "Confidential Information" shall have the meaning set forth in Section 10.1.1. 1.11. "Derivative Compound" shall mean a chemical compound that was structurally derived from a parent ArQule Compound or Solvay Compound in one or more steps 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. 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 another compound in order to be classified as a Derivative Compound. 1.12. "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. 1.13. "Directed Array(R) Program" or "DA Program" shall mean the Directed Array Library component of the Research Program conducted by ArQule for Solvay in general accordance with the Research Plan, as set forth in Section 4. 1.14. "Field" shall mean applications in the life sciences. 1.15. "Full-Time Equivalent" or "FTE" shall mean one (1) or more employees of ArQule who, collectively, spend time and effort working on a specific project or task equivalent 2 to the time and effort of one (1) full-time employee working on such project or task (approx. 2,000 hours per year). 1.16. "Licensed Compound" shall mean (i) any Available Compound that, as of the Effective Date, has already been designated as a Licensed Compound under the Prior Agreement or (ii) any Available Compound that the Research Committee designates as a Licensed Compound in accordance with Section 3.6. 1.17. "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. 1.18. "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. ArQule previously delivered Mapping Array Libraries to Solvay under the Prior Agreement. The description of, and the specifications for, the Mapping Array Libraries that ArQule will deliver to Solvay under Article 3 of this Agreement are set forth in Exhibit A attached hereto. 1.19. "Mapping Array(R) Program" or "MA Program" shall mean the component of the Research Program under which ArQule previously provided to Solvay under the Prior Agreement with Mapping Array Libraries. Under this Agreement ArQule will provide Solvay with a portion of the Compass Array Library and with selected Mapping Array Libraries, as further described in Section 3. 1.20. "Net Sales" shall mean the aggregate Net Sales Price of Royalty-Bearing Products in any Royalty Period. 1.21. "Net Sales Price" shall mean the gross amount received on sales by Solvay, its Affiliates and sublicensees of Royalty-Bearing Products in the Field, less the following: (i) trade, quantity, and cash discounts or rebates actually allowed, (ii) credits or allowances given for rejections or returns, (iii) freight, shipping, or other costs of transportation including insurance costs charged to a customer, and (iv) to the extent separately stated on purchase orders, invoices, or other documents of sale, any taxes (e.g., excise tax, duties, VAT) levied on the sale of a Royalty-Bearing Product which is paid by Solvay or its Affiliates or sublicensees. In any transfers of Royalty-Bearing Products between Solvay and an Affiliate, the Net Sales Price shall be calculated based on the first sale of the Royalty-Bearing Product to an independent third party. In the event that Solvay receives non-monetary consideration for any Royalty-Bearing Products, the Net Sales Price shall be calculated based on the average price charged by Solvay for such Royalty-Bearing Products during the preceding Royalty Period. 1.22. "Patent Rights" shall mean all issued patents and reissues, reexaminations, extensions and supplementary protection certificates thereof and all patent applications and any divisions, continuations, or continuations-in-part thereof (to the extent directed to the subject matter of the parent application) or patents issuing thereon. "ArQule Patent Rights" means Patent Rights that are either (i) assigned solely to ArQule, (ii) assigned jointly to ArQule and a party other than Solvay, 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 3 Agreement without payment to a third party. "Solvay Patent Rights" means Patent Rights that are either (i) assigned solely to Solvay, (ii) assigned jointly to Solvay and a party other than ArQule, or (iii) licensed to or otherwise controlled by Solvay, in each case to the extent that Solvay 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 Solvay as joint owners in relation to Joint Technology. Explicitly excluded are rights in the compounds specified in Section 6.1. Joint Patent Rights will include (i) Patent Rights claiming Joint Technology and (ii) Patent Rights claiming both ArQule Technology and Solvay Technology in a single filing. 1.23. "Phase II Clinical Trials" shall mean clinical trials in a small sample of the intended patient population commencing on the filing of a trial protocol with the appropriate regulatory authority to assess the efficacy for a specific indication of a compound proposed to be used as a prophylactic, 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 U. S. Food and Drug Administration for Phase II clinical trials. 1.24. "Phase III Clinical Trials" shall mean clinical trials 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 U.S. Food and Drug Administration for Phase III clinical trials. 1.25. "Priority Substance" shall mean a compound under this Agreement selected by Solvay or an Affiliate of Solvay to enter into the preclinical research phase. 1.26. "Project Declaration" shall mean, with respect to a compound under this Agreement, the decision to commence human clinical trials. 1.27. "Proprietary Materials" shall have the meaning set forth in Section 10.2.1. 1.28. "Research Committee" shall mean the Research Committee described in Section 2. 1.29. "Research Period" shall mean the period commencing on the Effective Date and continuing through December 31, 2003. 1.30. "Research Plan" shall mean a plan of research for the DA Program covering a six-month period, which shall be updated quarterly pursuant to Section 2.2 to reflect developments during the previous three (3) months and extended for the subsequent three (3) months. 1.31. "Research Program" shall mean, collectively, the Directed Array Program and the Mapping Array Program. 4 1.32. "Royalty-Bearing Product" shall mean a product containing as one of its constituents (i) any Licensed Compound; (ii) any ArQule Derivative Compound; (iii) any Solvay Derivative Compound; or (iv) any other compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from one or more Licensed Compounds or Derivative Compounds, which information forms the primary basis for such discovery or development and which information was not previously known to Solvay from sources other than ArQule. 1.33. "Royalty Period" shall mean every calendar quarter, or partial calendar quarter, in which a royalty is payable to ArQule pursuant to Section 9.5. commencing with the first commercial sale of a Royalty-Bearing Product in any country. 1.34. "Solvay Compound" shall mean any chemical compound provided by Solvay or its Affiliates to ArQule under the Prior Agreement or in the Directed Array Program under this Agreement. 1.35. "Solvay Derivative Compound" shall mean a Derivative Compound developed from a Solvay Compound by ArQule under the Prior Agreement or in the Directed Array Program under this Agreement, as well as Derivative Compounds thereof developed or by or for Solvay. 1.36. "Target" shall mean the biological target against which activity of an Active Compound was revealed, together with any related biomolecules that (i) (A) exhibit substantial structural homology with the identified biomolecule, as measured by the degree of similarity in the primary structure (i.e., amino acid sequence, nucleotide sequence, monosaccharide linkages) and secondary structure (i.e., three-dimensional structure), or (B) perform a substantially similar function as the identified biomolecule, and (ii) have therapeutic relevance. Biological targets shall not be considered as exhibiting substantial structural homology nor functional similarity if such biological targets are generally recognized by the scientific community as being different. 1.37. "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 Solvay, 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. "Solvay Technology" means Technology that is either (i) assigned solely to Solvay, (ii) assigned jointly to Solvay and a party other than ArQule, or (iii) licensed to or otherwise controlled by Solvay, in each case to the extent that Solvay 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 Solvay and one or more employees or consultants of ArQule pursuant to this Agreement, explicitly excluded are the compounds specified in Section 6.1. 1.38. "Valid Claim" means either (i) a claim of an issued patent that has not been held unenforceable or invalid by an agency or a court of competent jurisdiction in any unappealable 5 or unappealed decision or (ii) a claim of a pending patent application that has not been abandoned or finally rejected without the possibility of appeal or refiling. 1.39. The above definitions are intended to encompass the defined terms in both the singular and plural tenses. 2. Management of Research Programs. 2.1. Composition of Research Committee. The parties hereby establish a Research Committee comprised of six (6) members, with three (3) representatives appointed by each party. A party may change one or more of its representatives to the Research Committee at any time upon notice to the other party. 2.2. Duties of the Research Committee. The Research Committee shall direct and administer the Research Program in general accordance with the following provisions: 2.2.1. DA Program. With respect to the DA Program, the Research Committee has heretofore determined the general specifications for the Directed Array Libraries to be delivered to Solvay during the Research Period. ArQule shall have the right, at the time Solvay seeks to include any compound(s) in the DA Program, to exclude from the DA Program any compound that ArQule has determined is (i) licensed or otherwise committed to a third party in the Field or (ii) committed to an internal ArQule program in the Field. The Solvay representatives on the Research Committee shall, in consultation with the ArQule representatives, determine the identity, scope and priority of each Chemical Theme. The identity and scope of such Chemical Theme will be determined on the basis of the following criteria: (i) the specific reaction or reaction sequence used to combine members of two or more discrete chemical units in which each chemical unit bears the functional group(s) required for the specific reaction(s) that result in the combination of the chemical units; and (ii) the extent to which a class of compounds is related by a recurring structural motif associated with a particular biological activity. 2.2.2. Other Responsibilities. In addition, the Research Committee shall (i) revise and extend the Research Plan each calendar quarter for the subsequent six (6) months based on prior developments, (ii) designate Available Compounds as Licensed Compounds as described in Section 3.6; (ii) maintain and update the list of Licensed Compounds and Licensed Compound Sets; (iii) determine the allocation of the funding and personnel resources to be contributed by ArQule for the Directed Array Program; and (iv) resolve matters involving scientific questions and publication disputes that may arise under Section 10.4. 2.3. Meetings of the Research Committee. The Research Committee shall conduct telephone conferences at least once every six (6) weeks and shall prepare and deliver a brief written report (which may be in the form of confirmed electronic mail) describing the significant issues and discussions that take place during such telephone conferences. 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 telephone conferences, unless such notice is waived by all members. ArQule will prepare and deliver to the members of the Research Committee a brief 6 progress report at least one week in advance of the telephone conference, which report will list the ArQule employees then working on the Research Program. The Research Committee shall meet at least twice each year with the location alternating between the ArQule site and the Solvay site, 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. Except as otherwise provided in this Section 2, 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 resolved in accordance with the procedures set forth in Section 13.5 below. Within fourteen (14) days following each meeting, the Research Committee shall prepare and deliver, to both parties, a written report describing the decisions made, conclusions and actions agreed upon. 2.4. Cooperation. Each party agrees to provide the Research Committee with information and documentation as reasonably required for the Research 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. The parties anticipate that members of the Research Committee will communicate informally with each other and with employees and consultants of the parties on matters relating to the Research Programs. 2.5. Visits to Facilities. Members of the Research 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 Agreement. Solvay acknowledges that ArQule has fully performed and discharged its obligations under Section 3.1. of the Prior Agreement. ArQule acknowledges that Solvay has fully satisfied and discharged its obligations under Section 3.2. of the Prior Agreement. Solvay acknowledges and agrees ArQule remains eligible to receive milestone and royalty payments on Royalty-Bearing Products as set forth in this Agreement. Solvay and ArQule expressly acknowledge and agree that the provisions of this Agreement supersede the provisions of the Prior Agreement with respect to the Mapping Array Program. 3.2. Compass Array Library. ArQule will supply Solvay with one (1) copy of the Compass Array Library corresponding to Mapping Array Libraries produced in calendar year 2001 in four (4) quarterly portions promptly after such ArQule Compounds become available, with the last shipment delivered not later than July 1, 2002. ArQule will not disclose the structures of individual ArQule Compounds in the Compass Array Library and Solvay will have no obligation to disclose its Targets. ArQule will disclose to Solvay the Chemical Themes in the Compass Array Library in Markush format. Solvay will diligently screen the Compass Array 7 Library against its selected Targets. When Solvay detects and confirms Active Compounds in the Compass Array Library, Solvay will inform ArQule through the Research Committee. 3.3. Selection of Mapping Array Libraries. During the Research Period, ArQule will promptly determine whether the Active Compounds identified by Solvay in the Compass Array Library are Available Compounds, and then notify Solvay of such determination. If any Active Compound is not an Available Compound, ArQule shall not disclose the structure and Solvay 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 Available Compound to Solvay under this Agreement. ArQule then shall disclose to Solvay the structure of such Available Compound correlated to its well location and its Mapping Array Library. ArQule shall maintain the reserved status of the Available Compound for a period of up to four (4) weeks after the date upon which the structure was disclosed to Solvay. All such disclosed structures shall be treated as ArQule Confidential Information. During the four-week reservation period, Solvay will confirm its interest in that Available Compound and may request the Mapping Array Library for that Available Compound (if Solvay does not already have that Mapping Array Library in its possession) upon written notice to ArQule (including by electronic mail). If Solvay does not confirm its interest in writing and does not request the Mapping Array Library for that Available Compound (if that Mapping Array Library is not already in the possession of Solvay) during the four-week reservation period, the Available Compound shall automatically lose its reserved status and Solvay shall have no further rights to such compound. ArQule will promptly deliver to Solvay the selected Mapping Array Libraries; provided, however, that ArQule will have no obligation to deliver more than one (1) copy of each Mapping Array Library pursuant to this Agreement. In addition, with each shipment of a Mapping Array Library, or upon confirmation of interest by Solvay in the case of a Mapping Array Library already in the possession of Solvay, ArQule will furnish Solvay with (i) the Chemical Theme of the Mapping Array Library in Markush format, (ii) the location of each Available Compound in the Mapping Array Library, and (iii) at the request of Solvay, the locations (but not the structures) of ArQule Compounds that are the nearest homologues to the Available Compounds (under procedures established by the Research Committee) and which are not licensed or otherwise committed to a third party in the Field or committed to an internal ArQule program in the Field. ArQule shall not identify the structures of the individual ArQule Compounds in the Mapping Array Libraries. 3.4. Mapping Array Library. Upon receipt of each Mapping Array Library, or upon receipt of the relevant information as described in Section 3.3. in the case of Mapping Array Libraries already in the possession of Solvay, Solvay shall diligently screen such Mapping Array Library for activity against the relevant Target(s). ArQule will maintain the reserved status of the Available Compound(s) identified in the Compass Array Library for a period of four (4) months after Solvay receives the relevant Mapping Array Library and accompanying information or, in the case of Mapping Array Libraries already in the possession of Solvay, for a period of four (4) months after Solvay receives the relevant information as described in Section 3.3. In addition, Solvay shall have the right to screen all Mapping Array Libraries in its possession irrespective of the Compass Array Library. If Solvay detects and confirms Active Compounds, Solvay shall inform ArQule through the Research Committee in writing (including by electronic mail) of the spatial location of Active Compounds in the Mapping Array Libraries. ArQule will promptly determine whether the Active Compounds identified by Solvay in the Mapping Array 8 Libraries are Available Compounds, and then notify Solvay of such determination. If any Active Compound is not an Available Compound, ArQule shall not disclose the structure and Solvay 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 Solvay under this Agreement. ArQule then shall disclose to Solvay the structure of such Available Compound correlated to its well location, and Solvay shall disclose to ArQule the class of the Target involved. All such disclosed structures and the target class shall be treated as Confidential Information. ArQule shall maintain the reserved status of every Active Compound that is an Available Compound from the same Mapping Array Library for a period of up to four (4) weeks after the date upon which the last structure of these Available Compounds is disclosed to Solvay. If Solvay requests resynthesis of one or more Available Compounds from the same Mapping Array Library during the four-week reservation period, the Research Committee will determine which of these Available Compounds if not all would become a Licensed Compound Set if the resynthesized compounds are confirmed to be Active Compounds, and ArQule will continue to reserve this group of Available Compounds, all as more fully described below. The Research Committee will resolve any disagreements regarding which Available Compounds constitute the "group" represented by the compound or compounds resynthesized. If the four-week reservation period expires for a group of Available Compounds without any resynthesis request by Solvay or without agreement by the Research Committee as to which Available Compounds should constitute the group pending resynthesis and confirmation, the other Available Compounds (i.e., Available Compounds that are not selected for resynthesis by Solvay) from that Mapping Array Library shall automatically lose their reserved status and Solvay shall have no further rights to such compounds. 3.5. Resynthesis. During the Research Period, ArQule shall resynthesize and deliver to Solvay an additional 25 mg quantity of any Available Compound requested by Solvay to enable Solvay to conduct confirmatory screening activities. Solvay shall provide ArQule with written notice of the Available Compounds that Solvay desires to have resynthesized by ArQule. ArQule shall resynthesize the requested compounds 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 maintain the reservation on each group of Available Compounds (as determined by the Research Committee under Section 3.4.) while ArQule prepares resynthesis quantities of selected Available Compounds from that group and will then continue to reserve that group of Available Compound for a period of up to three (3) months after Solvay receives the resynthesized Available Compounds. 3.6. Designation of Licensed Compounds. At the request of Solvay, the Research Committee will review and consider the pertinent confirmatory data with respect to each group of Available Compounds (as determined by the Research Committee under Section 3.4.) and, if the activity of the resynthesized compound or compounds has been confirmed, designate the Available Compounds within the group as "Licensed Compounds" under this Agreement, whereupon Solvay shall disclose the Target and level of activity for the Licensed Compounds and, at the request of Solvay, ArQule shall disclose the structures but not the locations of the other ArQule Compounds in the same Mapping Array Library as the Licensed Compounds. Upon the designation of an Available Compound as a Licensed Compound and the disclosure by 9 Solvay of the Target and level of activity, the licenses set forth in Section 7.2 shall automatically apply, and ArQule shall confirm such license in writing. If the Research Committee determines that the activity of the resynthesized compound or compounds has not been confirmed, then the Available Compounds within the group shall automatically lose their reserved status and Solvay shall have no further rights to such compounds. 3.7. Changes to Reservation Periods. The Research Committee may extend the reservation periods described in Sections 3.3., 3.4., and 3.5. if requested by Solvay and approved in writing by the Chief Scientific Officer of ArQule. 3.8. Optimization Rights. During the Research Period, Solvay may submit any Licensed Compound Set to ArQule for optimization in the Directed Array Program; however, ArQule has no obligation to increase its commitment to the Directed Array Program as set forth in Section 4.3. At any time, Solvay may conduct optimization of any Licensed Compound Set. In the event that Solvay conducts optimization of a Licensed Compound Set, then at the request of Solvay, ArQule will provide Solvay with synthetic protocols (in American Chemical Society experimental format, not automated protocols) to enable Solvay to make those Licensed Compounds. 3.9. Extension Right. If ArQule continues to offer the Mapping Array Program during the year 2002, Solvay 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 December 31, 2002 upon written notice to ArQule which is received by ArQule not later than October 1, 2001. In addition, ArQule and Solvay agree to negotiate in good faith an arrangement under which Solvay may screen the Mapping Array Compounds and have access to the structures of Active Compounds after the conclusion of the Research Period. 4. Directed Array Program. 4.1. Prior Agreement. Solvay acknowledges that ArQule has fully satisfied and discharged its obligations under Sections 4.1. and 4.2. of the Prior Agreement. ArQule acknowledges that Solvay has fully satisfied and discharged its obligations under Section 4.3. of the Prior Agreement. Solvay acknowledges and agrees ArQule remains eligible to receive milestone and royalty payments on Royalty-Bearing Products as set forth in this Agreement. Solvay and ArQule expressly acknowledge and agree that the provisions of this Agreement supersede the provisions of the Prior Agreement with respect to the Directed Array Program. 4.2. Description of Program. Under the direction of the Research Committee and in accordance with the Research Plan, ArQule will synthesize multiple Directed Array Libraries of compounds derived from (i) Solvay Compounds provided to ArQule by Solvay or (ii) Licensed Compounds requested by Solvay to be included in the DA Program. The parties intend that, during the Research Period, ArQule will produce such Directed Array Libraries based on approximately ten (10) different Chemical Themes each calendar year, which will result in the production of up to 1,000 Derivative Compounds per Chemical Theme per year; provided, however, that the number of Chemical Themes actually submitted to the DA Program and the number of Derivative Compounds actually produced per Chemical Theme will be determined by 10 the Research Committee. The parties also intend that ArQule will produce approximately twenty (20) milligrams of each Derivative Compound in the Directed Array Libraries, subject to the availability of the original Solvay Compounds or Licensed Compounds; the amount of each Derivative Compound that ArQule actually produces, however, will be determined by the Research Committee. ArQule agrees that any Derivative Compounds provided to Solvay under the DA Program will not be (i) licensed or otherwise committed to a third party in the Field or (ii) committed to an internal ArQule program in the Field, and Solvay agrees that ArQule may exclude from the DA Program any Derivative Compounds that ArQule has determined are (i) licensed or otherwise committed to a third party in the Field or (ii) committed to an internal ArQule program in the Field. 4.3. Conduct of Directed Array Program. The DA Program will be conducted in accordance with the Research Plan. ArQule shall commit a total of four (4) FTEs per calendar year to the Directed Array Program (including at least two full-time synthetic organic chemists). ArQule shall furnish Solvay with a quarterly report describing progress and methods used in sufficient detail and that includes the names of the synthetic organic chemists and the time spent in the DA Program in that quarter, as well as the total non-chemist FTE resource applied to the DA Program in that quarter with an approximate breakdown by function. Solvay shall propose projects to the Research Committee for inclusion as a Directed Array Program. If the Research Committee approves the inclusion of the proposed project, ArQule shall thereupon diligently synthesize Directed Array Libraries of ArQule Derivative Compounds or Solvay Derivative Compounds in accordance with the Research Plan; Solvay shall provide ArQule with the requisite amount and purity of Solvay Compounds, as directed by the Research Committee, for any Directed Array Library Programs based on such Solvay Compounds. Solvay shall, in its discretion, test all compounds in the Directed Array Libraries. The parties shall perform the Directed Array Programs under this Agreement during the first two (2) years of the Research Period. ArQule shall have no obligation to expand or extend its commitments to the Directed Array Program, including without limitation the commitment of four (4) FTEs per calendar year and the two-year performance period. 5. Ownership of Physical Compounds. ArQule acknowledges and agrees that all Solvay Compounds, Solvay Derivative Compounds, and ArQule Derivative Compounds are Solvay Proprietary Materials and, as such, are owned by Solvay. Solvay acknowledges and agrees that all ArQule Compounds are ArQule Proprietary Materials and, as such, are owned by ArQule. 6. Intellectual Property Rights. 6.1. Rights in Compounds. Solvay shall have the sole right to prepare, file, prosecute, and maintain Patent Rights that claim the composition or use of (i) ArQule Derivative Compounds or Solvay Derivative Compounds developed by either party under this Agreement and (ii) Licensed Compounds that come within the scope of the claims to ArQule Derivative Compounds under clause (i) above, provided that such Licensed Compounds are not already covered by a claim in an ArQule Patent Right. ArQule shall assign to Solvay all right, title, and interest in any Patent Rights filed by Solvay that claim the composition or use of such ArQule 11 Derivative Compounds, Solvay Derivative Compounds, or Licensed Compounds. Therefore, such Patent Rights are considered Solvay Patent Rights under this Agreement rather than Joint Patent Rights, and Solvay shall be the sole owner of such Patent Rights. ArQule shall not in any way seek to rely on any ArQule Patent Right or other intellectual property right in the ArQule Technology to prevent Solvay from exercising its rights under this Section 6.1. 6.2 Ownership of Patent Rights and Technology. 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 subject to the provisions of the Prior Agreement 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, subject to the licenses granted to Solvay under Section 7.1. and Section 7.2.; (ii) Solvay shall have sole ownership of all right, title, and interest in Solvay Patent Rights and Solvay Technology; and (iii) ArQule and Solvay shall have joint ownership of all right, title, and interest in Joint Patent Rights and Joint Technology. 6.3. Management of Patent Rights. Solvay shall have sole responsibility for, and control over, the management of Solvay 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 as decided by the Research Committee. In the event of any disagreement concerning any Joint Patent Rights, the matter shall be resolved by the CEO of ArQule and the Vice President-Research of Solvay. 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 any foreign patent office, 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. 6.4. Cooperation of the Parties. Each party agrees to cooperate fully in the preparation, filing, and prosecution of any Patent Rights under this Agreement and any potential infringement issues relating to ArQule Technology. Such cooperation includes, but is not limited to: 12 (a) 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 set forth in Section 6.1 above and to enable the other party to apply for and to prosecute patent applications in any country; (b) promptly informing the other party of any matters coming to a party's attention that may affect the preparation, filing, or prosecution of any such patent applications or potential infringement issues relating to the ArQule Technology; and (c) undertaking no actions that are potentially deleterious to the preparation, filing, or prosecution of such patent applications. 6.5 Representation. ArQule represents and warrants to Solvay that, to the best of ArQule's knowledge and belief, no claim of ownership, invalidity or patent infringement has been asserted against ArQule or its Affiliates with respect to ArQule Patent Rights or ArQule Technology as of the Effective Date. In addition, ArQule covenants that, during the Research Period, ArQule will use its best efforts to ensure that the practice of the combinatorial library design, synthesis, and analysis technology within the ArQule Technology (commonly referred to and collectively defined herein as the "AMAP Chemistry Operating System") will not infringe any Valid Claim of any Patent Right of a third party in a manner that would have a material adverse effect on Solvay as a result of the activities undertaken by ArQule under Articles 3 and 4 of this Agreement. Solvay acknowledges and agrees that the representations and warranties set forth in this Section 6.5. have effect only in connection with the activities undertaken by ArQule under Articles 3 and 4 of this Agreement and have no effect with respect to the transfer of AMAP Technology under Article 8 of this Agreement. 6.6. Infringement. 6.6.l. Offensive Actions. With respect to infringement of any Solvay Patent Right or any ArQule Patent Right or Joint Patent Right exclusively licensed to Solvay claiming the composition or use of a Licensed Compound, ArQule Derivative Compound, or Royalty-Bearing Product, Solvay 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, Solvay shall be exclusively entitled to all proceeds or recoveries resulting therefrom, but from such proceeds or recoveries Solvay shall pay ArQule a royalty in accordance with Section 9.5. on sales lost to the infringer after deduction of all costs, including reasonable attorney fees incurred by Solvay in the action to enforce such Patent Rights. In the event that Solvay declines to enforce 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. 6.6.2. Defensive Actions. Solvay 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 13 or in equity, based on activities undertaken by Solvay or by ArQule at the direction of Solvay (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 Solvay of the infringement action and Solvay 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 Solvay within a reasonable time shall relieve Solvay of its indemnity obligation under this Section to the extent such failure prejudices the ability of Solvay to defend such action. ArQule shall cooperate fully with Solvay and its legal representatives in the investigation and defense of the action. In the event of a settlement, Solvay 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. 7. License Grants. 7.1. ArQule Screening License. Subject to the terms and conditions of this Agreement, ArQule hereby grants Solvay and its Affiliates a nonexclusive, worldwide, royalty-free, license (without the right to grant sublicenses) under ArQule Patent Rights and ArQule Technology to use the ArQule Compounds during the Research Period to screen for activity against any biological targets in the Field. 7.2. ArQule Commercial License. Effective upon designation by the Research Committee of an ArQule Compound as a Licensed Compound and the disclosure by Solvay of the Target and level of activity pursuant to Section 3.6, ArQule hereby grants to Solvay and its Affiliates with respect to each such Licensed Compound the following licenses in the Field: (i) an exclusive (even as to ArQule), worldwide license (with the right to sublicense) under the ArQule Patent Rights and other rights in ArQule Technology to conduct development of Licensed Compounds, including the right to develop Derivative Compounds based on Licensed Compounds; (ii) an exclusive (even as to ArQule), worldwide license (with the right to sublicense) under the ArQule Patent Rights and other rights in ArQule Technology to make, have made, use, have used, sell and have sold in the Field Licensed Compounds; and (iii) a non-exclusive, worldwide license (with the right to sublicense) under the ArQule Patent Rights and other rights in ArQule Technology to use chemical synthesis methods within the ArQule Patent Rights and ArQule Technology to make Royalty-Bearing Products. Solvay 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 or will acquire rights in a chemical synthesis method from a third party, which shall be promptly notified by ArQule to Solvay and, in such event, ArQule may require Solvay to enter into a separate sublicense agreement before such license grant shall take effect. ArQule 14 represents and warrants that Solvay will not incur any payment obligation to a third party as a result of the practice of the license grant set forth in clause (iii) above for third-party licenses that ArQule has executed prior to the Effective Date. ArQule covenants that ArQule will seek to obtain such royalty-free manufacturing licenses as part of its chemistry licenses in the future. In the event that Solvay decides to sublicense its rights under this Section to a third party, Solvay shall furnish ArQule with written notice of the sublicense grant and shall ensure that all sublicense agreements conform to this Agreement. 7.3. Diligence. Solvay agrees to use reasonable commercial efforts to develop and market Royalty-Bearing Products based on or incorporating any Licensed Compound, or Derivative Compounds thereof, using a level of effort consistent with that used for other Solvay products having similar commercial potential. The parties hereby acknowledge their understanding that Solvay's obligations under this Section do not apply to each Licensed Compound in itself, but only to at least one Licensed Compound or Derivative Compound thereof that is active against the same Target. Subject to Section 7.5, Solvay shall have the sole and absolute discretion to make all decisions relating to the research, development, marketing and other commercialization activities with respect to any Licensed Compound or its Derivative Compounds or any Royalty-Bearing Product derived therefrom. 7.4. Reports of Development Progress. Solvay agrees to keep ArQule informed of its development progress with respect to each Licensed Compound or Derivative Compound thereof for which it has obtained a license under Section 7.2 as follows: (a) Initial Research Plan. Within 60 days after obtaining a license, Solvay will provide ArQule with a time line of its planned research activities for that Licensed Compound and will keep ArQule periodically informed of its progress under such schedule. (b) Lead Compound. Solvay will notify ArQule of the designation of any Licensed Compound or Derivative Compounds thereof as a lead compound that fulfills Solvay's primary criteria in a particular project (e.g., potency, selectivity, and bioavailability). Within 60 days of such designation, Solvay will provide ArQule with a copy of a revised time line of its research activities for that lead compound and will keep ArQule periodically informed of its progress under such schedule. (c) Priority Substance. Solvay will notify ArQule of the designation of any Licensed Compound or Derivative Compounds thereof as a Priority Substance. Within 60 days of such designation, Solvay will provide ArQule with a copy of a revised time line of its research activities for that Priority Substance and will keep ArQule periodically informed of its progress under such schedule. (d) Project Declaration. Solvay will promptly notify ArQule of a Project Declaration for any Licensed Compound or Derivative Compounds thereof. (e) Discontinuation of Development. Solvay agrees to notify ArQule if it decides to discontinue development or marketing of any Licensed Compound or Derivative Compounds thereof. 15 In addition, throughout the term of this Agreement, Solvay will submit to ArQule annual written reports and semi-annual verbal reports of the activities of Solvay and its Affiliates with respect to all such compounds during the reporting period. These reports will include relevant chemical and biological data and other information sufficient to allow ArQule to determine whether Solvay and/or its Affiliates are engaging in significant activity with respect to each such compound prior to Project Declaration. The information in such reports shall be considered Confidential Information under Section 10.1. hereof. During the Research Period, Solvay shall provide such reports on a schedule such that they can be reviewed at the meetings of the Research Committee. In addition, Solvay agrees to inform ArQule at least once each calendar year regarding the status of any Solvay Derivative Compounds that Solvay develops based on Solvay Derivative Compounds synthesized by ArQule under this Agreement. 7.5. Reversion of Rights. In the event that (i) Solvay notifies ArQule pursuant to Section 7.4(e) above that it has determined to discontinue the development of any Licensed Compound or Derivative Compounds thereof or (ii) Solvay and/or its Affiliates fail, prior to Project Declaration with respect thereto, to engage in significant activities for a continuous period of twelve (12) months with respect to any Licensed Compound, or Derivative Compounds thereof and significant activities are not resumed within six (6) months of notice thereof, ArQule shall have the right, immediately upon notice, to terminate the license granted to Solvay under Section 7.2 with respect to such Licensed Compound, and ArQule will thereafter be free to grant licenses to third parties under ArQule Patent Rights and ArQule Technology to make, use, sell and have sold in the Field products incorporating that Licensed Compound. Any dispute concerning whether Solvay or its Affiliates have engaged in significant activity within the meaning of clause (ii) above shall be resolved under the dispute resolution provisions of Section 13.5. 8. AMAP Technology. Solvay acknowledges that ArQule has fully satisfied and discharged all of its obligations under Section 8 of the Prior Agreement, except for the transfer of certain technology that was developed prior to December 31, 2000 and which the Research Committee has agreed to transfer during calendar year 2001, as described in Exhibit B (the "2000 Technology"). ArQule will transfer the 2000 Technology to the extent, and in the manner, approved by the Research Committee and documented in Exhibit B. Solvay may substitute the FTE resources in the Directed Array Program to this technology transfer activity. For any resource commitments beyond the FTEs that are reallocated from the Directed Array Program Solvay shall reimburse ArQule for such activities at the rate of $250,000 per FTE per year. In all cases Solvay shall reimburse ArQule for out-of - pocket expenses (e.g., travel) in relation to these activities. 9. Payments, Reports, and Records. 9.1. Access Fee Payments. 9.1.1. Compass Array Library. In partial consideration of the delivery of the Compass Array Library in accordance with Section 3.2, Solvay shall pay ArQule the amount of 16 two hundred thousand dollars ($200,000), payable in four installments of $50,000 within thirty (30) days after Solvay receives each quarterly segment of such Compass Array Library. 9.1.2. Mapping Array Libraries. In partial consideration of the delivery of up to ten (10) Mapping Array Libraries during the Research Period in accordance with Section 3.3, Solvay shall pay ArQule an annual fee in the amount of three hundred thousand dollars ($300,000), payable as follows: $150,000 On the Effective Date $150,000 On January 2, 2002 Solvay may obtain access to additional available Mapping Array Libraries during the Research Period at a cost of fifty thousand dollars ($50,000) per Mapping Array Library which amount shall be paid to ArQule within thirty (30) days of shipment. 9.2 Resynthesis Payments. In consideration of the synthesis and delivery of resynthesis compounds during the Research Period in accordance with Section 3.5, Solvay shall pay ArQule two thousand, five hundred dollars ($2,500) per compound within thirty (30) days of receipt ( for requested resynthesis of up to twenty-five (25) mg.). 9.3. Directed Array Program Payments. In partial consideration of the performance by ArQule of the DA Program in accordance with Section 4, Solvay shall pay ArQule at the rate of $250,000 per FTE per year for a total of one million dollars ($1,000,000) per year. Solvay shall make such annual payment in advance in equal quarterly installments. 9.4. Milestone Payments. In partial consideration of the performance of the Research Program by ArQule and of the rights granted Solvay under this Agreement, Solvay shall pay ArQule the following amounts within thirty (30) days after each occurrence of the following milestones: (i) with respect to a Royalty-Bearing Product containing as one of its constituents any Licensed Compound, ArQule Derivative Compound, as well as with respect to the Prior Agreement any Solvay Derivative Compound, or any other compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from one or more Licensed Compounds, ArQule Derivative Compounds, or Solvay Derivative Compounds under the Prior Agreement, which information forms the primary basis for such discovery or development and which information was not previously known to Solvay from sources other than ArQule: $2,000,000 Commencement by Solvay, at its own discretion, of Phase III Clinical Trials required by the United States Food and Drug Administration, or the foreign equivalent, for each Royalty-Bearing Product 17 $3,000,000 First commercial sale of each Royalty-Bearing Product in any of: United States; Japan; or, after obtaining EU registration, Germany, France, or the United Kingdom. This milestone is payable only once on the first sale in the first of these countries, not the first sale in each of these countries. (ii) with respect to a Royalty-Bearing Product containing as one of its constituents any Solvay Derivative Compound under this Agreement and any other compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from one or more Solvay Derivative Compounds under this Agreement, which information forms the primary basis for such discovery or development and which information was not previously known to Solvay from sources other than ArQule: $500,000 Commencement by Solvay, at its own discretion, of Phase II Clinical Trials required by the United States Food and Drug Administration, or the foreign equivalent, for each Royalty-Bearing Product $1,000,000 Commencement by Solvay, at its own discretion, of Phase III Clinical Trials required by the United States Food and Drug Administration, or the foreign equivalent, for each Royalty-Bearing Product $2,000,000 First commercial sale of each Royalty-Bearing Product in any of: United States; Japan; or, after obtaining EU registration, Germany, France, or the United Kingdom. This milestone is payable only once on the first sale in the first of these countries, not the first sale in each of these countries. If a Royalty-Bearing Product contains a compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from (a) one or more Solvay Derivative Compounds under this Agreement and (b) a Licensed Compound, ArQule Derivative Compound, or Solvay Derivative Compound under the Prior Agreement (such that the Royalty-Bearing Product could fall within clause (i) or clause (ii) above), then the higher milestone payments shall apply. Such milestone payments shall be non-refundable and shall not be credited against royalties payable to ArQule under this Agreement. Solvay shall promptly notify ArQule of each occurrence of either of the foregoing milestones. 9.5. Royalties. In partial consideration of the performance of the Research Program by ArQule and the rights granted to Solvay under this Agreement, Solvay shall pay to ArQule the following royalty on Net Sales of Royalty-Bearing Products: (i) two percent (2%) with respect to a Royalty-Bearing Product containing as one of its constituents any Licensed Compound, ArQule Derivative Compound, as well 18 as with respect to the Prior Agreement any Solvay Derivative Compound, or any other compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from one or more Licensed Compounds, ArQule Derivative Compounds, or Solvay Derivative Compounds under the Prior Agreement, which information forms the primary basis for such discovery or development and which information was not previously known to Solvay from sources other than ArQule; or (ii) one percent (1%) with respect to a Royalty-Bearing Product containing as one of its constituents any Solvay Derivative Compound under this Agreement and any other compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from one or more Solvay Derivative Compounds under this Agreement, which information forms the primary basis for such discovery or development and which information was not previously known to Solvay from sources other than ArQule. If a Royalty-Bearing Product contains a compound discovered or designed by Solvay directly as a result of information obtained by Solvay under the MA Program or DA Program from (a) one or more Solvay Derivative Compounds under this Agreement and (b) a Licensed Compound, ArQule Derivative Compound, or Solvay Derivative Compound under the Prior Agreement (such that the Royalty-Bearing Product could fall within clause (i) or clause (ii) above), then the higher royalty rate shall apply. Such royalty shall be payable on a country-by-country basis for as long as a Royalty-Bearing Product is covered by a Valid Claim of a Patent Right. 9.6. Other Milestone and Royalty Payments. The parties shall negotiate in good faith the commercially reasonable financial terms pertaining to payments for achievement of development milestones relating to Royalty-Bearing Products and for a royalty on Royalty-Bearing Products for uses within the Field other than as a human therapeutic, which terms shall be set forth in a separate agreement and shall be no higher than those set forth in Sections 9.4. and 9.5. above. Solvay shall not develop or sell a Royalty-Bearing Product for uses within the Field other than as a human therapeutic until such agreement is executed by both parties. 9.7. Reports and Payments. Within thirty (30) days after the conclusion of each Royalty Period, Solvay shall deliver to ArQule a report containing the following information: (a) gross sales of Royalty-Bearing Products by Solvay and its Affiliates and sublicensees during the applicable Royalty Period in each country of sale; (b) calculation of Net Sales for the applicable Royalty Period in each country of sale; and (c) 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, Solvay shall remit 19 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 9.8. 9.8. Invoices; Payments in U.S. Dollars. With the exception of royalty payments due under Section 9.5, ArQule shall submit invoices to Solvay for each payment due ArQule hereunder, and Solvay shall pay such invoices within thirty (30) days of receipt thereof. All payments due under this Agreement shall, except as provided in Section 9.9 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. 9.9. 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, Solvay shall give ArQule prompt written notice of such restriction, which notice shall satisfy the thirty-day payment deadline described in Section 9.7. Solvay 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 Solvay may deposit such payment in local currency to the credit of ArQule in a recognized banking institution selected by Solvay and identified by written notice to ArQule, and such deposit shall fulfill all obligations of Solvay to ArQule with respect to such payment. 9.10. Records. Solvay 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 9.7. 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. ArQule will maintain complete and accurate records of the activities engaged in by the ArQule FTEs, which records shall contain sufficient information to permit Solvay to confirm the compliance of ArQule with Section 4. 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 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 five percent (5%) in any Royalty Period, the Audited Party shall bear the full cost of such audit. Each party may 20 exercise its rights under this Section only once every year and only with reasonable prior notice to the other party. 9.11. Late Payments. Any payments by Solvay 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 Federal Reserve Bank discount rate on the last day of the month the payments are due, calculated based on the number of days that payment is delinquent. 9.12. Withholding Taxes. Any tax required to be withheld by Solvay or any Affiliate or sublicensee under the laws of any foreign country for the account of ArQule under this Article 9 shall be promptly paid by Solvay or said Affiliate or sublicensee for and on behalf of ArQule to the appropriate governmental authority, and Solvay or the Affiliate or sublicensee shall furnish ArQule with proof of payment of such tax together with official or other appropriate evidence issued by the appropriate governmental authority sufficient to enable ArQule to support a claim for income tax credit in respect of any sum so withheld. 10. Confidential Information and Proprietary Materials. 10.1. Confidential Information. 10.1.1. Definition of Confidential Information. 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 and specifically designated as confidential. Such Confidential Information may include, without limitation, the identity of or other information pertaining to Proprietary Materials, the identity of a chemical compound, the use of a chemical compound, trade secrets, know-how, inventions, technical data or specifications, testing methods, business or financial information, research and development activities, product and marketing plans, and customer and supplier information. The parties expressly agree that the structures of Active Compounds and the identity of the related Target shall be considered Confidential Information until such time as the parties have mutually agreed to disclose such information in patent filings pursuant to Section 6.3. 10.1.2. 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 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. 10.1.3. 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, Solvay sublicensees, and advisors who are obligated to maintain the confidential nature of such 21 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. 10.1.4. Exceptions. The obligations of the Receiving Party under Section 10.1.3 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 United States Food and Drug Administration 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. 10.2. Proprietary Materials. 10.2.1. Definition of Proprietary Materials. Proprietary Materials shall mean any tangible chemical, biological, or physical research materials that are furnished by one party (the "Transferring Party") to the other party (the "Receiving Party") in connection with this Agreement regardless of whether such materials are specifically designated as proprietary to the Transferring Party. Proprietary Materials shall include, without limitation, all ArQule 22 Compounds, ArQule Derivative Compounds, Solvay Compounds and Solvay Derivative Compounds.. 10.2.2. Limited Use. The Receiving Party shall use Proprietary Materials solely for the purposes set forth in this Agreement. The Receiving Party shall use the Proprietary Materials only in compliance with all applicable governmental laws and regulations. 10.2.3. Limited Disposition. The Receiving Party shall not transfer or distribute any Proprietary Materials to any third party, except to its Affiliates, without the prior written consent of the Transferring Party. 10.2.4. Reverse Engineering. Solvay shall not attempt to reverse engineer, or attempt to determine the structure of, any ArQule Compound until the structure of such compound has been disclosed to Solvay by ArQule following notification by Solvay of the location of an Active Compound pursuant to Sections 3.3. and 3.4. 10.3. Return of Confidential Information and Proprietary Materials. 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 counsel (for ArQule) and its Legal and Trademarks Department (for Solvay) solely for the purpose of monitoring its obligations under this Agreement. Upon the termination of this Agreement, the Receiving Party shall at the instruction of the Transferring Party either destroy or return any unused Proprietary Materials. 10.4. Publications. In the event that either party desires to publicly disclose (through journals, lectures, or otherwise) any results relating to the Research Programs, such party (the "Publishing Party") shall furnish the other party (the "Reviewing Party") with (i) a copy of any written publication at least sixty (60) days prior to submission or (ii) a summary or abstract of an oral disclosure at least thirty (30) days prior to the intended disclosure date. The Reviewing Party shall have the right to (i) consent to the disclosure with modifications to protect patentable inventions or prevent disclosure of Confidential Information, (ii) delay the disclosure for a period of ninety (90) days to enable the preparation and filing of a patent application, or (iii) refuse to allow the disclosure in order to maintain certain information as a trade secret, which refusal shall not be unreasonably exercised. Any disagreements arising under this Section shall be referred to the Research Committee. 10.5. Survival of Obligations. The obligations set forth in this Article shall remain in effect for a period of five (5) years after termination of this Agreement, except that the obligations of the Receiving Party to return or destroy Confidential Information to the Disclosing Party and to return or destroy Proprietary Materials received from the Transferring Party shall survive until fulfilled. 23 11. Indemnification and Insurance. 11.1. Indemnification. Each party (the "Indemnitor") shall indemnify, defend, and hold harmless the other party and its Affiliates and their directors, officers, employees, and agents and their respective successors, heirs and assigns (the "Indemnitees"), against any liability, damage, loss, or expense (including reasonable attorneys fees and expenses of litigation) incurred by or imposed upon the Indemnitees or any one of them in connection with any claims, suits, actions, demands, or judgments arising out of any theory of product liability (including, but not limited to, actions in the form of tort, warranty, or strict liability) concerning any product (or any process or service) that is made, used, or sold by such other party pursuant to any right or license granted under this Agreement or arising out of any breach of a representation or warranty under this Agreement; provided, however, that such indemnification right shall not apply to any liability, damage, loss, or expense to the extent directly attributable to the negligent activities, reckless misconduct, or intentional misconduct of the Indemnitees. 11.2. Procedures. Any Indemnitee that intends to claim indemnification under Section 11.1 shall promptly notify the appropriate Indemnitor of any claim in respect of which the Indemnitee intends to claim such indemnification, and the Indemnitor shall assume the defense thereof with counsel selected by the Indemnitor (Indemnitor shall consult with Indemnitee with respect to a possible conflict of interest of such counsel retained by Indemnitor); provided, however, that an Indemnitee shall have the right to retain its own counsel at its cost; provided, further, that if representation of such Indemnitee by the counsel retained by the Indemnitor would be inappropriate due to actual or potential conflict of interest between such Indemnitee and any other party represented by such counsel in such proceedings, the Indemnitor and Indemnitee will each pay an equal share of the costs of the Indemnitee. The indemnity agreement in Section 11.1. shall not apply to amounts paid in settlement of any loss, claim, liability or action if such settlement is effected without the consent of Solvay, which consent shall not be withheld unreasonably. The failure to deliver notice to the Indemnitor within a reasonable time after the commencement of any such action, if prejudicial to its ability to defend such action, shall relieve the Indemnitor of any liability to the Indemnitee under Section 11.1. Each party and its Affiliates and their employees and agents shall cooperate fully with the other party and its legal representatives in the investigation of any action, claim or liability covered by this indemnification. 11.3. Insurance. Each party shall maintain reasonably adequate insurance or self-insurance coverage for its own potential liabilities to the Indemnitees as set forth in this Article. 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 Solvay fails to make timely payment of any amounts due to ArQule under this Agreement, ArQule may terminate this Agreement upon thirty (30) days written notice to Solvay, unless Solvay (i) pays all past-due 24 amounts within such thirty-day notice period or (ii) invokes dispute resolution under Section 13.5. within such thirty-day notice period. 12.3. Material Breach. In the event that either party commits a material breach of any of its obligations under this Agreement and such party fails (i) to remedy that breach within ninety (90) days after receiving written notice thereof from the other party or (ii) to commence dispute resolution pursuant to Section 13.5., within ninety (90) days 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. 12.4. Effect of Termination. The following provisions shall survive the expiration or termination of this Agreement: Articles 5, 10, and 11; Sections 3.9, 6.1 through 6.4, 6.6, 7.2 through 7.5, 9.4 through 9.12, 12.4, 13.3, 13.4, 13.5, and 13.10. 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 two (2) years, 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. The License Agreement shall be governed by and construed in accordance with the laws of England. 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 Vice President-Research of Solvay who are authorized to settle such Disputes on behalf of their respective companies ("Senior Executives"). The Senior Executives will meet for 25 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 binding 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. Any such mediation shall be held in London, England. 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 the Rules of Arbitration of the International Chamber of Commerce. The arbitration shall be conducted in the English language 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 Arbitration of the International Chamber of Commerce. Any such arbitration shall be held in London, England. 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 in accordance with the 1958 Convention on the Recognition and Enforcement of Arbitral Awards. (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 26 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 England 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 Solvay: If to ArQule: Solvay Pharmaceuticals B.V. ArQule, Inc. C.J. van Houtenlaan 36 19 Presidential Way 1381 CP Weesp Woburn, MA 01801 The Netherlands Attention: President Attention: Tel: (781) 994-0300 Manager Technology Development Fax: (781) 503-0009 Tel: +31 294 479696 Fax: +31 294 477148 with a copy to: with a copy to: Same Address Same Address Attention: Head Legal Department Attention: General Counsel Tel: +31 294 477479 Tel: (781) 994-0300 Fax: +31 294 477126 Fax: (781) 503-0009 27 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, including without limitation the Prior Agreement. 13.14. Hardship. The underlying objective of this Agreement is to realize in an economical and reasonable way the mutual interests and requirements of the parties. If at any time this Agreement should no longer meet this objective because of technical developments, economic developments or political changes that could not reasonably be foreseen at the time of signing this Agreement thus causing undue and prolonged hardship, the parties shall meet in order to bring about a mutually agreeable solution according to the economic and reasonable objectives of this Agreement. 13.15. 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, blockage or 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. 28 IN WITNESS WHEREOF, the undersigned have duly executed and delivered this Agreement as a sealed instrument effective as of the date first above written. SOLVAY PHARMACEUTICALS BV ARQULE, INC. By:__________________________ By:__________________________ E.A.A.M. Koopmans Stephen A. Hill, M.D. President, Solvay Pharmaceuticals BV, President and Chief Weesp Executive Officer By:__________________________ Prof. S.G. Schaefer Vice President Global Research Solvay Pharmaceuticals 29 EXHIBIT A Compound Specifications 1. Compass Array Library. The Compass Array Library is a diverse subset of approximately 25,000 compounds that have been computationally selected to represent at least 12.5% of the ArQule Compounds in the Mapping Array Libraries that ArQule produces 2001. ArQule will provide approximately 100 micrograms of each Compass Array Library compound dissolved in 25 microliters of 100% DMSO at a concentration of 10 mM in 96-well plates, with 80 filled wells per plate. Because ArQule performs 25% quality control analysis of each Mapping Array Library corresponding to the Compass Array Library, the purity and confirmation of molecular weight is similar to the Mapping Array Library, as described below. 2. Mapping Array Libraries. A Mapping Array Library is an Array of ArQule Compounds that ArQule generally makes available to its collaborators for screening on a non-exclusive basis. Each Mapping Array Library is based upon a single Chemical Theme. ArQule will provide approximately 1mg of each Mapping Array Library compound dissolved in 250 microliters of 100% DMSO at a concentration of 10 mM. The compounds will be provided in 96-well plates with up to 80 filled wells per plate. ArQule performs 25% quality control analysis of each Mapping Array Library by HPLC/UV/ELSD for purity and flow injection mass spectrometry for confirmation of molecular weight. Each Mapping Array Library is on average more than 85% pure as determined by HPLC analysis. A Markush structure file defining each chemical theme is supplied with every shipment. 3. Confirmation Samples and Resynthesized Compounds. As determined by the Research Committee, ArQule shall resynthesize and deliver to Solvay up to twenty-five (25) mg of any Active Compound. ArQule will provide each resynthesized Compound as a dry, solid power or oil with a purity of 95% based on HPLC/UV, ELSD. Typically, resynthesis compounds consist of preparative HPLC-purified, dry, solid compound supplied with proton NMR and mass spectrometry data. 4. Directed Array Compounds. Unless otherwise agreed to by the Research Committee, all ArQule Compounds delivered as part of the Directed Array Libraries will be provided as 30 mmol of compound in DMSO in 96-well plates with up to 80 filled wells per plate. ArQule performs 100% quality control analysis of each Directed Array compound tested by HPLC/UV/ELSD. The average purity of each Directed 30 Array Library is 85% as determined by HPLC analysis. An SD file is supplied with every shipment. EXHIBIT B AMAP Technology Transfer List of 2000 Technology to be transferred and implemented in 2001 1. CRS-WAD Technology Transfer 2. Implement process for Solvay to allow direct procurement of fine mechanical parts 3. a. Supply of source code for all Instrument Control Application via CD or FTP site (No documentation of source code) b. Make LLE quantitation and APD/LLE quantitation operational 4. New Septum Piercing Technology for OCS 5. Modifications to LLE 32-bit application modifications 6. Update WAD.exe with modified rack sequence 7. Transfer TOCS software 8. AIMS Feasibility Study to be completed by March 15, 2001 9. Transfer Solid Phase Synthesis prototype application 10. Supply electronic documentation for all sections of the binders previously delivered to Solvay. 11. Transfer existing Culling and Reformatting application to Solvay EX-10.16 4 b49672aiexv10w16.txt R&D AGREEMENT DATED 11/11/1997 EXHIBIT 10.16 RESEARCH AND DEVELOPMENT AGREEMENT BETWEEN SANKYO CO., LTD and ARQULE, INC. EXHIBIT 10.16 Table of Contents 1. Definitions 1.1. "Active Homolog" 1.2. "Active ArQule Compound" 1.3. "Active Compound" 1.4. "Active Sankyo Compound" 1.5. "Affiliate" 1.6. "Agreement" 1.7. "ArQule Compound" 1.8. "ArQule Derivative Compound" 1.9. "ArQule Patent Rights" 1,10. "ArQule Technology" 1.11. "Array" 1.12. "Base Rate of Interest" 1.13. "Chemical Theme" 1.14. "Confidential Information" 1.15. "Contract Year" 1.16. "Derivative Compound" 1.17. "Directed Array (tm)" 1.18. "Directed Array (tm) Program" 1.19. "Disclosing Party" 1.20. "Effective Date" 1.21. "Extraordinary Expenses" 1.22. "FDA" 1.23. "Joint Patent Rights" 1.24. "Licensed Compound" 1.25. "Licensed Compound Set" 1.26. "Mapping Array (tm)" 1.27. "Mapping Array (tm) Program" 1.28. "Net Sales" 1.29. "Net Sales Price" 1.30. "Party" 1.31. "Patent Rights" 1.32. "Phase I Clinical Trials" 1.33. "Phase II Clinical Trials" 1.34. "Phase III Clinical Trials" 1.35. "Preclinical Compound" 1.36. "Preclinical Development" 1.37. "Receiving Party" 1.38. "Research Period" 1.39. "Research Program" 1.40. "Research Plan" 1.41. "Royalty-Bearing Product" 1.42. "Royalty Period" EXHIBIT 10.16 1.42. "Sankyo Compound" 1.44. "Sankyo Derivative Compound 1.45. "Sankyo Patent Rights" 1.46. "Steering Committee 1.47. "Sublicensee" 1.48. "Target" 1.49. "U.S. Territory" 1.50 "Valid Claim" 1.51 "Worldwide Territory ` 2. Management of Research Program 2.1. Composition of Steering Committee 2.2. Duties of the Steering Committee 2.3. Compounds Excluded from the Directed Array (tm) Program 2.4. Meetings of the Steering Committee 2.5. Cooperation 2.6. Visits to Facilities 3. Mapping Array" (tm) Program 3.1. Conduct of Mapping Array (tm) Program 3.2. Mutual Disclosure 3.3. Reservation of Active ArQule Compounds 3.4. Mapping Array (tm) Program Payments 3.5. Term of Mapping Array (tm) Program 3.6. Performance of Mapping Array (tm) Program 4. Directed Array (tm) Program 4.1. Description of Directed Array (tm) Program 4.2. Conduct of Directed Array (tm) Program 4.3. Directed Array (tm) Program Payments 4.3.1. Delivery Fee 4.3.2. Expenses 4.4. Term of Directed Array (tm) Program 5. License Grants: Reversion of Rights 5.1. Screening Licenses 5.2. Preclinical and Clinical Licenses 5.3. Commercialization License 5.4. Reversion of Rights: Return of Materials 6. Ownership of Compounds 6.1. Sankyo Compounds; Sankyo Derivative Compounds 6.2. ArQule Compounds: ArQule Derivative Compounds EXHIBIT 10.16 7. Intellectual Property Rights 7.1. Ownership of Patent Rights 7.2. Management of Joint Patent Rights 7.3. Cooperation of the Parties 7.4. Infringement by Third Parties 8. Payments, Reports, and Records 8.1. Milestone Payments 8.2. Alternative to Milestone Payments 8.3. Royalties 8.4. Reports and Payments 8.5. Invoices: Payments in U.S. Dollars 8.6. Payments in Other Currencies 8.7. Records 8.8. Late Payments 8,9. Withholding Tax Payments 8.9.1. Payments 8.9.2. Royalty Payments 9. Confidential Information 9.1. Definition of Confidential Information 9.2. Definition of Confidential Information 9.3. Obligations 9.4. Exceptions 9.5. Return of Confidential Information 9.6. Survival of Obligations 10. Representations and Warranties 10.1. Authorization 11. Indemnifications and Insurance 11.1. Sankyo Indemnity Obligations 11.2. Procedure 11.3. Insurance 12. Term and Termination 12.1. Term 12.2. Breach of Payment Obligations 12.3. Material Breach EXHIBIT 10.16 12.4. Effect of Termination 13. Miscellaneous 13.1 Relationship of Parties 13.2. Publicity 13.3. Non-Solicitation 13.4. Governing Law 13.5. Dispute Resolution Procedures 13.6. Counterparts 13.7. Headings 13.3. Binding Effect 13.9. Assignment 13.10. Notices 13.11. Amendment and Waiver 13.12. Severability 13.13. Entire Agreement 13.14. Force Majeure EXHIBIT A EXHIBIT 10.16 RESEARCH AND DEVELOPMENT AGREEMENT This Agreement, dated as of November 1, 1997, 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 200 Boston Avenue, Medford, Massachusetts, U.S.A. RECITALS WHEREAS, ArQule has developed certain technology that has applications in the discovery and development of pharmaceutical compounds; WHEREAS, Sankyo desires that ArQule apply its technologies to the research and development of pharmaceutical compounds for Sankyo; and WHEREAS, in exchange for payment by Sankyo of research funds, milestone payments and royalties, ArQule is willing to perform certain research and development activities for Sankyo, subject to the terms and conditions of this Agreement; NOW, THEREFORE, in consideration of the mutual covenants set forth in this Agreement, the Parties hereby agree as follows: 1. Definitions. 1.1. "Active Homologs" shall mean any ArQule Derivative Compound or Sankyo Derivative Compound that exhibits substantial homology with an Active Compound as determined by the Steering Committee. 1.2. `Active ArQule Compound" shall mean any ArQule Compound or ArQule Derivative Compound which exhibits confirmed significant functional activity against a Target. The Steering Committee shall establish the criteria for "significant functional activity" at the time of selection of each Target. 1.3. "Active Compound" shall mean any Active ArQule Compound or Active Sankyo Compound. 1.4. "Active Sankyo Compound" shall mean any Sankyo Compound or Sankyo Derivative Compound which exhibits confirmed significant functional activity against a Target. The Steering Committee shall establish the criteria for "significant functional activity" at the time of selection of each Target. 1.5. "Affiliate" shall mean a corporation or other legal entity that controls, is EXHIBIT 10.16 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 1.6. "Agreement" shall mean this Research and Development Agreement, together with Exhibit A hereto. 1.7. "ArQule Compound" shall mean any organic chemical molecule that is synthesized by ArQule using its proprietary technology and provided by ArQule to Sankyo under the Mapping Array (tm) Program. 1.8. "ArQule Derivative Compound" shall mean a Derivative Compound synthesized by ArQule from an ArQule Compound under the Directed Array (tm) Program described in Section 4. 1.9. "ArQule Patent Rights" shall mean Patent Rights controlled or owned by ArQule as of the Effective Date or during the Research Period; all to the extent and only to the extent that ArQule now has or hereafter will have the right to grant licenses, immunities or other rights thereunder. 1.10. "ArQule Technology" shall mean all information and data which is owned by ArQule or licensed by third parties to ArQule prior to or during the Research Program and is necessary or useful to conduct the screening to discover Active ArQule Compounds and Active Homologs thereto or to develop, make, use, sell or seek regulatory approval in any country to market a product containing a Licensed Compound; all to the extent and only to the extent that ArQule now Las or hereafter will have the right to grant licenses, immunities or other rights thereunder. 1.11. "Array" shall mean a set of samples of structurally related chemical compounds arranged in a format such as a microtiter screening plate. 1.12. "Base Rate of Interest" shall mean the base rate of interest declared from time to time by the Bank of Boston. 1.13. "Chemical Theme" shall mean the chemical or structural characteristics shared by a group of compounds as determined by the Steering Committee pursuant to Section 2,2. 1.14. "Confidential Information" shall have the meaning set forth in Section 9.1. 1.15. "Contract Year" shall mean each twelve (12) month period of the Research Period, commencing on the Effective Date. 1.16. "Derivative Compound" shall mean a chemical compound structurally derived in EXHIBIT 10.16 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. 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 another compound in order to be classified as a Derivative Compound. 1.17. "Directed Array (tm) shall mean an Array comprised of ArQule Derivative Compounds synthesized by ArQule under the Directed Array (tm) Program described in Section 4. 1.18. "Directed Array (tm) Program" shall mean a Directed Array (tm) Program conducted by ArQule as set forth in Section 4, with each Directed Array (tm) Program consisting of multiple Arrays derived from one (1) Sankyo Compound or one (1) Active ArQule Compound. 1.19. "Disclosing Party" shall mean that Party disclosing Confidential Information to the other Party under Section 9. 1.20, "Effective Date" shall mean the first business day of the month immediately following the date of execution of this Agreement by the Parties hereto. 1.21. "Extraordinary Expenses" shall mean those expenses incurred from time to time by ArQule in connection with the Directed Array (tm) Program which are not (a) direct, out-of-pocket costs provided for in the Research Plan which are directly attributable to the Directed Array (tm) Program or (b) fixed overhead costs provided for in the Research Plan which are allocable to the Directed Array (tm) Program. 1.22. "FDA" shall mean the United States Food and Drug Administration (or its foreign equivalent in Japan or Europe). 1.23. "Joint Patent Rights" shall mean any Patent Rights that are jointly owned by the Parties, as set forth in Section 7.1(b). 1.24. "License Compound" shall mean any Active Compound or Active Homolog thereto with respect to which the Steering Committee has designated in accordance with Sections 2.2 and 3.2. 1.25. "Licensed Compound Set" shall mean, with respect to a Licensed Compound, such Licensed Compound and any Active Homolog thereto. 1.26. "Mapping Array (tm) " shall mean an Array of ArQule Compounds synthesized by ArQule under the Mapping Array (tm) Program set forth in Section 3. 1.27. "Mapping Array (tm) Program" shall mean the Mapping Array (tm) component of the Research Program as set forth in Section 3. EXHIBIT 10.16 1.28. "Net Sales" shall mean the aggregate Net Sales Price of Royalty-Bearing Products in any Royalty Period. 1.29. "Net Sales Price" shall mean the gross amount received on sales by Sankyo, its Affiliates and Sublicensees of Royalty-Bearing Products, less the following; (i) trade, quantity, and cash discounts or rebates actually allowed, (ii) credits or allowances given for rejections or returns, and (iii) freight, shipping, or other costs of transportation charged to a customer. In any transfers of Royalty-Bearing Products between Sankyo and an Affiliate, the Net Sales Price shall be calculated based on the final sale 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 average price charged by Sankyo for such Royalty-Bearing Products during the preceding Royalty Period. 1.30. "Party" means ArQule or Sankyo or their respective Affiliates; "Parties" means ArQule and Sankyo and theft respective Affiliates, 1.31. "Patent Rights" shall mean all rights arising under issued patents and reissues, reexaminations, extensions and supplementary protection certificates thereof and all patent applications and any divisions, continuations, or continuations-in-part thereof or patents issuing thereon, 1.32, "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. 1.33. "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 arid 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 H 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 UI Clinical Trials. EXHIBIT 10.16 1.34. "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 In clinical trials. The completion of the Phase Ill 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. 1.35. "Preclinical Compound" shall mean any Licensed Compound selected by Sankyo or an Affiliate of Sankyo to enter into Preclinical Development. 1.36. "Preclinical Development" shall mean, with respect to any Preclinical Compound, the commencement of potency and efficacy testing in animal models, 1.37. "Receiving Party" mean that Party receiving Confidential Information under Section 9.1, 1.38. "Research Period" shall mean the period during which the Research Program remains in effect. The duration of the Research Period shall be a minimum of three (3) years, unless extended by the mutual agreement of the Parties. 1.39. "Research Program" shall mean, collectively, each of the Directed Array (tm) Programs and the Mapping Array (tm) Program. 1.40. "Research Plan" shall mean a plan of research for the Directed Array (tm) Program covering a minimum of a six-month period, which shall be updated quarterly pursuant to Section 2.2 to reflect developments during the previous three (3) months and extended for the subsequent three (3) months. The parties will begin development of the initial Research Plan by December 31, 1997. The parties will complete the Research Plan for the first Directed Array (tm) Program by January 31, 1998 and will complete the Research Plan for the second Directed Array (tm) Program by March 31, 1998. The completed Research Plan will be attached to this Agreement as & Exhibit A 1.41. "Royalty Bearing Product" shall mean a product containing as one of its constituents (a) any Active ArQule Compound; (b) any ArQule Derivative Compound; (c) any Sankyo Derivative Compound; or (d) any other Derivative Compound discovered or designed by Sankyo from any ArQule Compound, ArQule Derivative Compound or Sankyo Derivative Compound, or otherwise as a result of information provided by ArQule to Sankyo under the Mapping Array (tm) Program described in Section 3, or the Directed Array (tm) Program described in Section 4 developed. 1.42. "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 EXHIBIT 10.16 such Royalty-Bearing Product in any country and ending on the later to occur of (i) the end of the quarter during which all Valid Claims of all Patent Rights covering such Royalty-Bearing Product expire in the applicable country, or (ii) ten (10) years after such first commercial sale in the applicable country. 1.43. "Sankyo Compound" shall mean any chemical compound provided by Sankyo or its Affiliates to ArQule under the Directed Array (tm) Program described in Section 4. 1.44. "Sankyo Derivative Compound" shall mean a Derivative Compound synthesized by ArQule from a Sankyo Compound under the Directed Array (tm) Program describe in Section 4. 1.45. "Sankyo Patent Rights" shall mean Patent Rights controlled or owned by Sankyo as of the Effective Date or during the Research Period; all to the extent and only to the extent that Sankyo now has or hereafter will have the right to grant licenses, immunities or other rights thereunder. 1.46, "Steering Committee" shall have the meaning set forth in Section 2.1. 1.47. "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. 1.48. "Target" shall mean any biological target selected by Sankyo for which Sankyo has certain proprietary technology and/or expertise. 1.49. "U.S. Territory" shall mean the fifty states comprising the United States of America and all American possessions. 1.50. "Valid Claim" shall mean either (a) a claim of an issued patent that has not been held unenforceable or invalid by an agency or a court of competent jurisdiction in any unappealable or unappealed decision or (b) a claim of a pending patent application that has not been abandoned or finally rejected without the possibility of appeal or refiling. 1.51. "Worldwide Territory" shall mean the world excluding the U.S. Territory. 1.52. The above definitions are intended to encompass the defined terms in both the singular and plural tenses. 2. Management of Research Program, EXHIBIT 10.16 2.1. Composition of Steering Committee. The Parties hereby establish a Steering Committee comprised of six (6) members, with three (3) representatives appointed by each Party. The initial members of the Steering Committee shall be as follows: Sankyo Representative Douglas Burdi, Ph.D. Dayid L Coffen, Ph.D. Kaplan, Ph.D. A Party may change one or more of its representatives to the Steering Committee at any time upon notice to the other Party. Each Party will designate one of its representatives as its team leader. 2.2. Duties of the Steering Committee. The Steering Committee shall direct and administer the Research Program. With respect to each Directed Array (tm) Program, the Steering Committee shall specifically determine the following: (i) the appropriate objectives of each Chemical Theme and/or Active Compound to be submitted to the Directed Array (tm) Program; (ii) the appropriate number and type of Chemical Themes to be submitted to the Directed Array (tm) Program, subject to ArQule's right to exclude certain compounds as set forth in Section 2.3 below; (iii) the appropriate number of compounds that ArQule should generate in a Directed Array (tm) for a particular Chemical Theme; and (iv) the appropriate amount of each compound in a Directed Array (tm) that ArQule should deliver to Sankyo for further research and development. The scope of each Chemical Theme will be determined on the basis of the following criteria: (i) the specific reaction or reaction sequence used to combine members of two or more discrete chemical units in which each chemical unit bears the functional group(s) required for the specific reaction(s) that result in the combination of the chemical units; and (ii) the extent to which a class of compounds is related by a recurring structural motif associated with a particular biological activity. In addition, the Steering Committee shall (i) determine whether any Active Compound should be designated as a Licensed Compound; (ii) determine and update the list of Licensed Compounds; (iii) determine the allocation of the funding and personnel resources to be contributed by ArQule under this Agreement; (iv) revise and extend the Research Plan each calendar quarter for the subsequent six (6) months based on prior developments; and (v) resolve matters involving scientific questions. 2.3. Compounds Excluded from the Directed Array (tm) Program. ArQule shall have the right, at the time Sankyo seeks to include any Active ArQule Compound or Active Homolog thereto in any Directed Array (tm) Program, to exclude from such Directed Array (tm) Program any Active ArQule Compound or Active Homolog thereto that is at that time either (I) included within a Directed Array (tm) Program for a third party(1) (ii) being optimized by a third party from a Mapping Array (tm) Program, (iii) previously licensed or reserved by a third party, or (iv) is EXHIBIT 10.16 included within an existing ArQule internal development program. 2.4. Meetings of the Steering Committee. The Steering 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 Steering Committee, the Steering 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 Steering 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 Steering Committee shall meet at least once each quarter at the facilities of ArQule, or at such other times and locations as the Steering Committee determines. A representative of the Steering 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 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. Except as otherwise provided in this Section 2, 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 resolved in accordance with the procedures set forth in Section 13.5 below. Within ten (10) days following each quarterly 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. 2.5. Cooperation. Each Party agrees to provide the Steering Committee with information and documentation as reasonably required for the 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 Steering Committee, The Parties anticipate that members of the Steering Committee will communicate informally with each other and with employees and consultants of the Parties on matters relating to the Directed Array (tm) Program. 2.6. Visits to Facilities. Members of the 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 (tm) Program. EXHIBIT 10.16 3.1, Conduct of Mapping Array (tm) Program. ArQule will supply Sankyo with Mapping Arrays (tm) containing approximately one (1) milligram each of approximately 100,000 different ArQule Compounds during the first Contract Year- selected by ArQule from the 1996 and 1997 Mapping Arrays (tm) of approximately 200,000 different ArQule Compounds (which includes approximately 100,000 ArQule Compounds from ArQule's 1996 Mapping Array (tm) and approximately 100,000 ArQule Compounds from ArQule's 1997 Mapping Array (tm)) based on no more than fifteen (15) Chemical Themes selected by Sankyo and approved by the Steering Committee. Subject to Section 3.6, ArQule will supply Sankyo with Mapping Arrays (tm) containing approximately one (1) milligram each of approximately 100,000 different ArQule Compounds during each subsequent Contract Year of the term of the Mapping Array (tm) Program provided for in Section 3.5, selected at the start of such subsequent Contract Year from the then available Mapping Array (tm) compounds based on no more than fifteen (15) Chemical Themes selected by Sankyo and approved by the Steering Committee. ArQule agrees to ship such 100,000 Mapping Array (tm) compounds (i) for the first Contract Year by December 31, 1997, (ii) for the second Contract Year on or after the earlier to occur of (a) three (3) months after Sankyo completes initial screening, as determined by the Steering Committee, of the Mapping Array (tm) compounds shipped to Sankyo during the first Contract Year, or (ii) July 1, 1999, or earlier when available if so requested by Sankyo in writing, and (iii) for the third Contract Year by the end of the second Contract Year. Sankyo agrees to accept each such shipment of Mapping Array (tm) compounds unless Sankyo has terminated the Mapping Array (tm) Program pursuant to Section 3.6 prior to the date of such shipment, provided, however, notwithstanding any such termination of the Mapping Array (tm) Program, Sankyo agrees to accept any such shipment requested by Sankyo in writing. Promptly upon its receipt of any such Mapping Arrays (tm), Sankyo shall commence testing of such Mapping Arrays (tm) for activity against Targets. Upon the completion by Sankyo of its testing of any such Mapping Arrays (tm), Sankyo shall promptly provide each member of the Steering Committee with notice by telefax communication detailing the discovery of Active Compounds, together with relevant information concerning the functional activity identified, which telefax shall be followed by a confirmatory letter, 3.2. Mutual Disclosure, Initially, ArQule will identify the Chemical Themes of each Mapping Array (tm) but not the structures of the individual ArQule Compounds in the Mapping Arrays (tm). Sankyo may screen the Mapping Arrays (tm) against any Targets during the term of this Agreement and thereafter, Initially, Sankyo will not disclose the Targets screened. If Sankyo detects any Active ArQule Compound in a Mapping Array (tm), ArQule will disclose (a) the structure of each Active ArQule Compound and (b) the structures, but not the locations in the Mapping Array (tm), of all other ArQule Compounds in the Mapping Array (tm) and Sankyo will disclose (a) the identity of the Target and (b) the level of activity. All such disclosed information shall be treated as Confidential Information by both Parties. Sankyo shall submit each such Active ArQule Compound to the Directed Array (tm) Program pursuant to Section 4. Sankyo, at its discretion, may request that the Steering Committee designate any such Active ArQule EXHIBIT 10.16 Compound and Active Homologs thereto as Licensed Compounds comprising a Licensed Compound Set if such Active ArQule Compound and Active Homologs are still available as Licensed Compounds, ArQule shall have the right, at the time Sankyo seeks to designate any Active ArQule Compound or Active Homolog thereto as a Licensed Compound, to exclude from such Licensed Compound designation any Active ArQule Compound or Active Homolog thereto that is at that time either (1) included within a Directed Array (tm) Program for a third party, (ii) being optimized by a third party from a Mapping Array (tm) Program, (iii) previously licensed or reserved by a third party, or (iv) is included within an existing ArQule internal development program. Subject to the foregoing, (a) ArQule shall notify the Steering Committee that such Active ArQule Compound and Active Homologs thereto are properly designated as Licensed Compounds and (b) provide Sankyo with the confirmed chemical composition structure, purity information and location of all Active ArQule Compounds and Active Homologs thereto so designated as Licensed Compounds belonging to such Licensed Compound Set. 3.3. Reservation of Active ArQule Compounds. Prior to designating any Active ArQule Compounds and Active Homologs thereto as Licensed Compounds pursuant to Section 3.2 hereof, Sankyo, at its discretion, may notify ArQule of its intent to license such Active ArQule Compounds and Active Homologs, and request a reservation of such Active ArQule Compounds and Active Homologs thereto (collectively the "Reserved Compounds"). Upon ArQule receiving from Sankyo (i) a written request to reserve such Reserved Compounds, and (ii) disclosure of the Target and activity information pursuant to Section 3.2 hereof, ArQule shall reserve such Reserved Compounds for subsequent designation by Sankyo as Licensed Compounds for a period ending upon the earlier to occur of (i) Sankyo's notification to ArQule that it no longer has an interest in licensing or developing such Reserved Compounds, or (ii) sixty (60) days. 3.4. In consideration of the performance by ArQule of the Mapping Array (tm) Program, during each Contract Year, Sankyo shall pay ArQule a delivery fee equal to $1,000,000 in the initial Contract Year, payable one-third (1/3) upon the Effective Date and two-thirds (2/3) within thirty (30) days of the delivery of the Mapping Arrays (tm) to be provided by ArQule in such first Contract Year. Thereafter, Sankyo shall make the following annual payment to ArQule during each Contract Year, in the second Contract Year payable in full with thirty (30) days of the delivery of the Mapping Arrays (tm) to be provided by ArQule in such Contract Year, and in the third Contract Yeas payable one-third (1/3) on the first day of such Contract Year and two-thirds (2/3) within thirty (30) days of the delivery of the Mapping Arrays (tm) to be provided by ArQule in such Contract Year: Annual Payment = $1,000,000 x (1 + CPI) Where CPI is a fraction, the numerator of which is the difference between the Consumer Price Index (CPI-U; ITS. City Average for all items; 1982-84 = 100) as of the last month of the immediately preceding Contract Year and the Consumer Price Index as of the month immediately preceding the Effective Date and the denominator of which is the Consumer Price Index as of the month immediately preceding the Effective Date. EXHIBIT 10.16 3.5. The Mapping Array (tm) Program shall commence on the Effective Date, continue for a period of three (3) Contract Years, unless earlier terminated as provided in Section 3.6 or Article 12 below. Termination of the Mapping Array (tm) Program shall have no effect on the continuation of any Directed Array (tm) Program. 3.6. Performance of Mapping Array (tm) Program. Sankyo shall have the right to terminate the Mapping Array (tm) Program on or before the earlier to occur of (i) three (3) months after Sankyo completes initial screening, as determined by the Steering Committee, of the Mapping Array (tm) compounds shipped to Sankyo during the first Contract Year, or (ii) June 30, 1999, upon Written notice to ArQule, in the event that (i) ArQule is unable to deliver to Sankyo Mapping Arrays (tm) containing at least fifteen (15) Chemical Themes (or a lesser number of Chemical Themes pursuant to selection of such Chemical Themes in accordance with Section 3.1), (ii) Sankyo fails to obtain any functional activity, as determined by the Steering Committee, from any Mapping Array (tm) compound against any Target falling within a broad range of representative Target categories selected by Sankyo, approved by the Steering Committee and disclosed by Sankyo to ArQule, (iii) there develops a clear pattern of false positive screening results attributable to the quality of Mapping Array (tm) compounds, or (iv) ArQule is consistently unable to provide Mapping Array (tm) compounds in accordance with purity criteria as determined by the Steering Committee. ArQule shall be under the obligation to deliver Mapping Arrays (tm) for the successive Contract Years unless Sankyo exercises its right to terminate the Mapping Array (tm) Program pursuant to this Section 3.6 by formally declaring such termination right and notifying ArQule in writing. 4. Directed Array (tm) Program, 4.1. Description of Directed Array (tm) Program. Under the direction of the Steering Committee and in accordance with the Research Plan, ArQule will synthesize multiple Directed Arrays (tm) of compounds derived from (i) each Sankyo Compound provided to ArQule by Sankyo and/or (ii) each Active ArQule Compound provided by ArQule to Sankyo under the Mapping Array (tm) Program, subject to Section 2.3 above. The Parties intend that, during the Research Period, ArQule will produce such Directed Arrays (tm) in two (2) separate Directed Array (tm) Programs, each based on a different Chemical Theme and intended to produce approximately 1000 compounds, per Contract Year for a minimum of three (3) Contract Years beginning on the Effective Date. However, the number of closely related Chemical Themes actually submitted to each Directed Array (tm) Program for the same Target pursuant to a given Research Plan and the number of ArQule Derivative Compounds and/or Sankyo Derivative Compounds actually produced per Chemical Theme will be determined by the Steering Committee. The Parties also intend that ArQule will produce approximately twenty (20) milligrams of each ArQule Derivative Compound and/or Sankyo Derivative Compound in the Directed Arrays (tm), subject to the availability of the original Sankyo Compounds and/or the ArQule Compounds; provided, however, that the amount of each ArQule Derivative Compound and/or Sankyo Derivative Compound that ArQule actually produces will ultimately be determined by the Steering Committee. 4.2. Conduct of Directed Array (tm) Program. The Directed Array (tm) Program shall be EXHIBIT 10.16 conducted in a good scientific manner and in compliance with all applicable legal requirements. The conduct of the Directed Array (tm) Program shall be the primary responsibility of ArQule with participation by Sankyo. Sankyo shall propose Chemical Themes to the Steering Committee for inclusion in the Directed Array (tm) Program. If the Steering Committee approves the inclusion of the proposed Chemical Theme(1) Sankyo shall provide ArQule with the requisite amount and purity of Sankyo Compounds for that Chemical Theme, as directed by the Steering Committee. ArQule shall thereupon diligently synthesize Directed Arrays (tm) of ArQule Derivative Compounds and/or Sankyo Derivative Compounds, as the case may be, in accordance with the Research Plan. Sankyo shall, in its discretion, test all compounds in the Directed Arrays (tm). The Parties shall continue the procedure described in this Section 4.2 for each Active Compound until the earliest to occur of (1) the determination by the Steering Committee, in accordance with Section 2.2, to designate any such Active Compound and any Active Homolog thereto as a Licensed Compound Set, (ii) the determination by the Steering Committee to cease further testing of such Active Compound, or (iii) the termination of this Agreement in accordance with Section 4.3. Directed Array (tm) Program Payments. 4.3.1. Delivery Fee. In consideration of the performance by ArQule of the Directed Array (tm) Program, Sankyo shall pay ArQule a delivery fee equal to $1,000,000 per Directed Array (tm) Program during the first Contract Year, payable one-third (1/3) upon commencement of the first Directed Array (tm) Program and two-thirds (2/3) within thirty (30) days of the delivery of the final Directed Array (tm) to be provided by ArQule in the first Contract Year. Thereafter, Sankyo shall make the following annual payment to ArQule during each Contract Year, payable one-third (1/3) on the first day of such Contract Year and two-thirds (2/3) within thirty (30) days of the delivery of the Directed Arrays (tm) to be provided by ArQule in such Contract Year: Annual Payment = $1,000,000 x (1 + CPI) Notwithstanding the foregoing, if the number of Active Compounds submitted to all Directed Array (tm) Programs exceeds six (6) for the first three (3) Contract Years, the Parties shall use their respective best efforts to negotiate a discount for all such additional Active Compounds submitted to the Directed Array (tm) Program. 4.3.2. Expenses. In addition to the amounts payable pursuant to Section 4.3.1 above, Sankyo shall pay any and all Extraordinary Expenses of ArQule, as required and approved by the Steering Committee. 4.4. Term of Directed Array (tm) Program. The term of each Directed Array (tm) Program shall begin upon the commencement of the Research Plan and terminate no later than the first anniversary of such commencement date unless extended by the Steering Committee because of extraordinary circumstances. The period for initiating and completing all Directed Array (tm) Programs commenced pursuant to Section 4.1 hereof shall terminate at the end of the third Contract Year, provided, however, that upon six (6) months prior written notice by Sankyo, EXHIBIT 10.16 such period may be extended for one additional two (2) year period at Sankyo's option on terms and conditions to be mutually agreed upon by the Parties. 5. License Grants; Reversion of Rights. 5.1. Screening Licenses ArQule hereby grants to Sankyo, under ArQule Patent Rights and ArQule Technology (a) a nonexclusive, royalty-free license (without the right to sublicense) to test each Mapping Array (tm) for significant functional activity against Targets; and (b) an exclusive, royalty-free license to test each Directed Array (tm) for significant functional activity against Targets. 5.2. Preclinical and Clinical Licenses. Upon the identification by Sankyo of any Active Compound and the determination by the Steering Committee that such Active Compound and any Active Homolog thereto should properly be designated as a Licensed Compound Set, ArQule shall grant to Sankyo, under any intellectual property rights covering the composition, manufacture or use of such Licensed Compound Set, an exclusive, worldwide license (with the right to grant sublicenses subject to notifying ArQule in advance) to conduct Preclinical Development, Phase I Clinical Trials, Phase U Clinical Trials and Phase III Clinical Trials of such Licensed Compound Set, with Sankyo's specific responsibilities to be determined by the Steering Committee. 5.3. Commercialization License. ArQule hereby grants to Sankyo an exclusive, worldwide royalty-bearing license (with the right to grant sublicenses subject to notifying ArQule in advance) (i) to make or have made Royalty-Bearing Products incorporating Licensed Compound Sets for use, distribution and sale, (ii) to distribute for sale and sell Royalty-Bearing Products incorporating Licensed Compound Sets, and (iii) to make Active Compounds within a Licensed Compound Set and sell such Active Compounds to a Sublicensee that incorporates those compounds in a Royalty-Bearing Product. 5.4. Reversion of Rights Return of Materials. In the event that (i) Sankyo determines not to develop any Active ArQule Compound or Active Homolog related to such Active ArQule Compound within a Licensed Compound Set or to discontinue Preclinical Development of all Active ArQule Compounds and Active Homologs related to such Active ArQule Compound within a Licensed Compound Set; or (ii) no Active ArQule Compound or Active Homolog related to such Active ArQule Compound within a Licensed Compound Set is commercially developed within the timetable specified in the Research Plan, then ArQule shall have the right to terminate the license granted to Sankyo under Section 5.2 with respect to all Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds within such Licensed Compound Set. In such event, ArQule shall thereafter be free to grant licenses covering such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds to third parties. Upon termination of such license by ArQule, Sankyo shall (i) grant to ArQule an exclusive, royalty-free license, with the right to grant sublicenses, to manufacture, use or sell such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds under any patent rights of Sankyo covering the composition or use of such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds and (ii) EXHIBIT 10.16 return to ArQule all Proprietary Materials and Confidential Information supplied by ArQule which relate to such Active ArQule Compounds and Active Homologs related to such Active ArQule Compounds. Notwithstanding the foregoing, the provisions of this Section 5.4 shall not apply to Sankyo Compounds or Sankyo Derivative Compounds. 6. Ownership of Compounds. 6.1. Sankyo Compounds: Sankyo Derivative Compounds. All Sankyo Compounds and Sankyo Derivative Compounds shall be owned by Sankyo or its Affiliates, except, and only to the extent that, with respect to the Directed Array (tm) Program, ArQule can show that any such compound (i) was under development by ArQule (including programs with academic collaborators or corporate partners) before such compound was proposed to be included in the Directed Array (tm) Program or first synthesized, as the case may be; (ii) was independently developed by ArQule employees who had no access to Sankyo Confidential Information regarding the particular compound, or (iii) was already within a screening array before such compound was proposed to be included in the Directed Array (tm) Program or was first synthesized, as the case may be. 6.2. ArQule Compounds; ArQule Derivative Compounds. All ArQule Compounds and ArQule Derivative Compounds shall be owned by ArQule except, and only to the extent that, Sankyo can show that any such compound was in the possession of Sankyo before it was provided by ArQule to Sankyo or its Affiliates. 7. Intellectual Property Rights. 7.1. Ownership of Patent Rights (a) ArQule Patent Rights. Any Patent Rights filed by either Party covering Active ArQule Compounds only will be owned solely by ArQule except as provided in Section 7.1(b). (b) Joint Patent Rights. Any Patent Rights (i) filed by either Party covering both Active ArQule Compounds and Active Sankyo Compounds, (ii) claiming an Active ArQule Compound and uses thereof discovered by Sankyo; and/or (iii) claiming an Active Sankyo Compound and uses thereof discovered by ArQule, shall be owned jointly by ArQule and Sankyo. (c) Sankyo Patent Rights. Any Patent Rights filed by either Party covering solely Active Sankyo Compounds will be owned solely by Sankyo. (d) Patent Rights Generally. Any Patent Rights arising out of or related to this Agreement, the ownership of which cannot be determined from Subsections a), (b) or (c) of this Section 7.1, will be owned by the Party(ies) having inventorship under the patent laws of the United States. EXHIBIT 10.16 7.2. Management of Joint 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. 7.3. Cooperation of the Parties. Each Party agrees to cooperate fully in the preparation, filing, and prosecution of any Patent Rights under this Agreement. Such cooperation includes, but is not limited to: (a) 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 set forth in Section 7.1 above and to enable the other Party to apply for and to prosecute patent applications in any country; (b) 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 (c) undertaking no actions that are potentially deleterious to the preparation, filing, or prosecution of such patent applications. 7.4. Infringement by Third Parties. ArQule and Sankyo shall each promptly notify the other in writing of any alleged or threatened infringement by a third party of any ArQule Patent Right, Sankyo Patent Right or Joint Patent Right of which they become aware. The parties shall consult concerning the action(s) to be taken. 8. Payments. Reports, and Records, 8.1. Milestone Payments. In partial consideration of the rights granted Sankyo under this Agreement, Sankyo shall pay ArQule the following amounts within thirty (30) days after each occurrence of the following milestones; Payment for Royalty EXHIBIT 10.16

Such milestone payments shall be non-refundable and shall not be credited against royalties payable to ArQule under this Agreement, provided, however, that twenty-five percent (25%) 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 (tm) Program, and not submitted to a Directed Array (tm) Program, shall be creditable up to $1,000,000 per year against royalties due ArQule for such Royalty-Bearing Product pursuant to Section 8.3. Sankyo shall promptly notify ArQule of each occurrence of any of die foregoing milestones. 8.2. Alternative to Milestone Payments. If any time on or before sixty (60) days prior to the filing of an IND application with respect to any Royalty-Bearing Product, Sankyo elects, in lieu of paying the foregoing milestone payments for such Royalty-Bearing Product, to share with ArQule the proceeds of the commercial exploitation of such 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 an appropriate amendment to this Agreement under which either (i) the Parties would share equally in the aggregate revenues from such Royalty-Bearing Product on a worldwide basis or (ii) ArQule would be granted the exclusive right to commercially exploit such Royalty-Bearing Product in certain agreed-upon territories. If the Parties are unable to reach agreement with respect to the EXHIBIT 10.16 foregoing by the expiration of sixty (60) days from the commencement of such negotiations, Sankyo shall remain obligated to pay the full amount of milestone payments set forth in Section 8.1 above for such Royalty-Bearing Product. 8.3. Royalties. In consideration of the licenses granted to Sankyo hereunder, for each Royalty Period, Sankyo shall pay to ArQule a royalty for each Royalty-Bearing Product as follows:

8.4. Reports and Payments. Within thirty (30) days after the conclusion of each Royalty Period, Sankyo shall deliver to ArQule a report containing the following information: (a) gross sales of Royalty-Bearing Products by Sankyo, its Affiliates and Sublicensees during the applicable Royalty Period in each country of sale; (b) adjustments and calculation of Net Sales for the applicable Royalty Period in each country of sale; and (c) 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 8.6, 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 8.9. 8.5. Invoices; Payments in U.S. Dollars. With the exception of royalty payments due under Section 8.3, ArQule shall submit invoices to Sankyo for each payment due ArQule hereunder (including without limitation all payments due pursuant to Section 3.4, and Sankyo shall pay such invoices within thirty (30) days of receipt thereof. All payments due under this Agreement shall, except as provided in Section 8.6 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. EXHIBIT 10.16 8.6. 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 thirty-day payment deadline described in Section 8.4. Sankyo shall pay any amounts due ArQule through whatever lawful methods ArQule reasonably designates; provided, however, that if ArQule falls 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. 8.7. 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 8.4. 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, 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 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 five percent (5%) 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. 8.8. 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 Base Rate of Interest calculated based on the number of days that payment is delinquent. 8.9. Withholding Tax Payments, 8.9.1. Payments. All amounts payable under Section 3.4, 4.3 and 8.1 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 any refund of tax withholding amounts paid by Sankyo under Sections 3.4, 4.3 and 8.1. of this Agreement, ArQule agrees to promptly remit such refund amount received by ArQule to Sankyo. EXHIBIT 10.16 8.9.2. Royalty Payments, Sankyo may only withhold from royalties due to ArQule under Section 8.3 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 the lesser of (i) ten percent (10%) of such royalties due to ArQule, or (ii) such amount actually creditable by ArQule as a foreign tax credit against taxes currently payable by ArQule to the United States government; 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 8.3 of this Agreement, Sankyo agrees to promptly remit such refund amount received by Sankyo to ArQule, 9. Confidential Information. 9.1. Definition of Confidential Information Confidential Information shall mean any technical or business information furnished by the Disclosing Party to the Receiving Party in connection with this Agreement and specifically designated as confidential. Such Confidential Information may include, without limitation, the identity of a chemical compound, the use of a chemical compound, trade secrets, know-how, inventions, technical data or specifications, testing methods, business or financial information, research and development activities, product and marketing plans, and customer and supplier information, 9.2. Definition 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 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. 9.3. 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 EXHIBIT 10.16 (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. 9.4. Exceptions. The obligations of the Receiving Party under Section 9.3 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 theft 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. 9.5. 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 counsel (for ArQule) and its Legal Department (for Sankyo) solely for the purpose of monitoring its obligations under this Agreement. 9.6. Survival of Obligations. The obligations set forth in this Article shall remain in effect for a period of five (5) years after termination of this Agreement, except that the obligations of the Receiving Party to destroy or return Confidential Information to the Disclosing Party shall survive until fulfilled. EXHIBIT 10.16 10. Representations and Warranties. 10.1. Authorization. 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 arid 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. 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 Article 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 Indernnitee and any other Party represented by such counsel in such proceedings. The indemnity agreement in this Article 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 Article 11, but the Omission so to deliver notice to Sankyo will not relieve it of any liability that it may have to any Indeninitee otherwise than under this Article 11. The Indemnitee under this Article 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. EXHIBIT 10.16 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 last Royalty Period covering any Royalty-Bearing Product, 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 thirty (30) days written notice to Sankyo, unless Sankyo pays all past-due amounts within such thirty-day notice period. 12.3. Material Breach. In the event that either Party continues 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 ninety (90) days after receiving written notice thereof from the other Party or (ii) to commence dispute resolution pursuant to Section 13.5, within ninety (90) days 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. 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 5, Article .6, Article 7 and Article S (with respect only to milestone payments and royalties accrued at the time of termination but not yet paid), Article 9, Article 11 and Article 13 shall survive the expiration or termination of this Agreement. 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 EXHIBIT 10.16 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 two (2) years, 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. 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. 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). EXHIBIT 10.16 (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 theft appointment, then the third arbitrator shall be appointed by the Court of 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. 119. 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 200 Boston Avenue, Suite 3600 Shinagawa-ku Medford, MA 02155 Tokyo 140 Japan Attention: Eric B. Gordon EXHIBIT 10.16 Attention: Hiroshi Fukunai Tel: 03 3492 3131 Tel: (617) 395-4100 Fax: 03 5436 856/ Fax: (617) 395-1225 with a copy to: Palmer & Dodge One Beacon Street Boston, MA 02108 Attention: Michael Lytton, Esquire Tel: (617) 573-0327 Fax: (617) 227-4420 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 EXHIBIT 10.16 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. [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] IN WITNESS WHEREOF, the undersigned have duty 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: Tetsun Hiraoka. Ph.D. Name: Eric B. Gordon --------------------- Title: Member of the Board and Title: President and Chief Executive ------------------------ Director of Research Institute EXHIBIT 10.16 27 EXHIBIT A Research Plan [THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK] EX-10.31 5 b49672aiexv10w31.txt TERMINATION AGREEMENT DATED 6/30/2000 EXHIBIT 10.31 TERMINATION OF AGREEMENT This Termination of Agreement, dated as of June 30, 2000, is between ArQule, Inc. ("ArQule"), a Delaware corporation, and Pharmacia Corporation, formerly known as Monsanto Company ("Pharmacia"), a Delaware corporation. RECITALS WHEREAS, ArQule and Pharmacia have previously entered into an Array Delivery and Testing Agreement dated December 23, 1996, as subsequently amended and restated on January 11, 2000 (the "Prior Agreement"), with respect to which ArQule provides certain compound arrays for testing by Pharmacia and its Affiliates and performs certain other compound development activities in exchange for payment by Pharmacia of research thuds, milestone payments and royalties; and WHEREAS, Pharmacia has decided, and ArQule is willing to, terminate the Prior Agreement. NOW, THEREFORE, in consideration of the mutual covenants set forth in this Agreement, the parties hereby agree as follows: 1. Termination. The Prior Agreement previously executed and delivered by and between ArQule and Pharmacia entitled "Amended and Restated Array Delivery and Testing Agreement" dated January 2000 (including its predecessor agreement entitled "Array Delivery and Testing Agreement" dated December 23, 1996, and any other understandings and agreements relating to the subject matter thereon, and the obligations and rights of the parties with respect thereto, except as set forth below, are hereby terminated in theft entirety. 2. Termination Payment. In consideration of the termination of the Prior Agreement, and the satisfaction and discharge of any and all of Pharmacia's obligations to make research and development and array delivery payments thereunder, including without limitation all payments pursuant to Subsections 3.2.5 and 3.3.2, Pharmacia shall pay to ArQule, within sixty (60) days following the date hereof, the sum of Four Million One Hundred Thirty Two Thousand and Five Hundred Ninety Five Dollars (US$4,132,595). ArQule represents that, upon payment of the foregoing amount, there are no amounts outstanding or due from Pharmacia as of the date hereof under the Prior Agreement of which ArQule is aware or should have been aware. 3. Survival of Provisions. Notwithstanding the foregoing or anything to the contrary in Section 11.4 of the Prior Agreement, the following provisions of the Prior Agreement shall survive termination: Articles 8, 10, and 12 (except for Section 12.15 which shall not survive). IN WITNESS WHEREOF, the undersigned have duly executed and delivered this Agreement as a sealed instrument effective as of the date first above written. EXHIBIT 10.31 PHARMACIA CORPORATION ARQULE, INC. By: _________ By: _____ Name: Name: Title: Title: EX-10.45 6 b49672aiexv10w45.txt EMPLOYMENT AGREEMENT/ STEPHEN A. HILL/ 1/1/2004 EXHIBIT 10.45 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") dated as of January 1, 2004 (the "Execution Date") is made by and between ArQule, Inc., a Delaware corporation (the "Company") with its principal offices at 19 Presidential Way, Woburn, Massachusetts 01801, and Stephen A. Hill, M. D. ("Executive") whose current principal residential address is 26 Dole Hill Lane, Boxford, MA 01921. WHEREAS, the Company desires to continue to employ and retain Executive in a senior executive capacity and to enter into an agreement embodying the terms of such employment; and WHEREAS, Executive desires to accept such continued employment and enter into such an agreement; NOW, THEREFORE, in consideration of the premises, and the mutual covenants and agreements contained herein and for other good and valuable consideration, the receipt, adequacy and sufficiency of which are hereby acknowledged, the Company and Executive (the "Parties") hereby agree as follows: 1. Term of Employment. The Company hereby agrees to continue to employ Executive, and Executive hereby accepts such continued employment with the Company, upon the terms and subject to the conditions set forth in this Agreement, for a period commencing on January 1, 2004 (the "Effective Date") and continuing until terminated in accordance with the provisions of Section 5 (the "Employment Term"). 2. Title; Duties. During the Employment Term, Executive shall serve as President and Chief Executive Officer of the Company reporting directly to the Board of Directors of the Company or its designee (the "Board"). Executive hereby agrees to undertake the duties and responsibilities inherent in such position and such other duties and responsibilities consistent with such position as the Board shall from time to time reasonably assign to Executive. 3. No Conflict. During the Employment Term, Executive shall devote substantially all of Executive's business time and efforts to the performance of Executive's duties hereunder and shall not, directly or indirectly, engage in any other business, profession or occupation for compensation or otherwise which would conflict with the rendition of such duties without the prior written consent of the Board, which consent shall not be unreasonably withheld, delayed or conditioned. Executive represents and warrants that Exhibit A attached hereto states all current business relationships, including, but not limited to, consulting agreements, confidentiality agreements and non-competition agreements to which Executive is a party as of the Execution Date. 4. Compensation and Benefits. 4.1. Base Salary and Bonus. During the Employment Term, the Company shall pay Executive for Executive's services hereunder a base salary at the initial annual rate of $412,000, payable in regular installments in accordance with the Company's usual payment practices and subject to annual review and upward adjustment by the Board in its sole discretion. Such amount (as it may be raised (but not decreased) from time to time in accordance with this Section 4.1) shall be referred to herein as the "Base Salary." Executive shall also be eligible to receive a discretionary annual cash bonus based on a target amount (either as a percentage or a fixed dollar amount) established by the Board and on Company and individual performance. Executive shall also be eligible to participate in any and all other bonus plans and packages that are made available to the Company's executives, on a basis consistent with Executive's position and then-current Base Salary and in accordance with the policies and practices of the Company and the Company's Board of Directors (the "Board"). 4.2. Stock Option Grant. As further compensation for Executive's services hereunder, the Company shall grant to Executive, on the Effective Date, a stock option (the "Execution Stock Option") to purchase zero (0) shares of the Company's Common Stock, $0.01 par value per share (the "Common Stock"), pursuant to the Company's Amended and Restated 1994 Equity Incentive Plan (the "Plan") and in accordance with the terms, and subject to a vesting schedule pursuant to which twenty-five percent of the shares shall vest annually commencing on the first anniversary of the Effective Date, and other conditions, set forth in the form of Option Certificate (attached hereto as Exhibit B in the event the Execution Stock Option grants an option to purchase more than zero shares of Common Stock). The method of determining the exercise price of the Execution Stock Option is set forth in the attached Exhibit C. Subject to the discretion of the Board, the Company may grant to Executive from time to time other stock options to purchase additional shares of Common Stock, also pursuant to the Plan and such other terms and conditions set forth at the time of such grant (the Execution Stock Option and such other stock options, together with any stock options to purchase Common Stock which the Company has previously granted to Executive, collectively, the "Stock Options"). 4.3. Executive Benefits. During the Employment Term and subject to any contributions therefor generally required of senior executives of the Company, Executive shall be entitled to receive such employee benefits (including fringe benefits, 401(k) plan participation, and life, health, dental, accident and short and long term disability insurance) which the Company may, in its sole and absolute discretion, make available generally to its senior executives or personnel similarly situated; provided, however, that it is hereby acknowledged and agreed that any such employee benefit plans may be altered, modified or terminated by the Company at any time in its sole discretion without recourse by Executive. 4.4. Paid Time Off. Executive shall be entitled to four weeks (20 working days) of paid time off ("PTO") per annum during the Employment Term, to be taken at such time or times as shall be mutually convenient for the Company and Executive; provided, however, that the Company may elect to increase the annual time to which Executive shall be entitled to PTO. Unused PTO shall be allocated pursuant to the Company's existing policies and practices. 2 4.5. Business Expenses and Perquisites. Upon delivery of adequate documentation of expenses incurred in accordance with the policies and practices of the Company, Executive shall be entitled to reimbursement by the Company during the Employment Term for reasonable travel, entertainment and other business expenses incurred by Executive in the performance of Executive's duties hereunder in accordance with such policies as the Company may from time to time have in effect. 5. Termination. 5.1. Without Cause by the Company. 5.1.1. The Severance Package. The Company may terminate Executive's employment hereunder at any time without Cause (as defined in Section 5.2) upon not less than fourteen (14) days prior written notice from the Company to Executive. The effective date of Executive's termination shall be referred to herein as the "Termination Date." If Executive's employment is terminated by the Company pursuant to this Section 5.1, the Company shall pay Executive all amounts owed to Executive for work performed prior to the Termination Date plus the following amounts and consideration (the "Severance Package"), subject to standard payroll deductions and withholdings: (i) two times the Base Salary through the end of the twelve (12) month period commencing on the Termination Date to be paid in a lump sum; (ii) a lump sum payment equal to two times the average bonus, if any, paid by the Company to Executive with respect to the two (2) years preceding the year in which the Termination Date occurs; (iii) the costs associated with continuing the benefits which Executive is entitled to receive pursuant to Section 4.3 of this Agreement at the level in effect as of the Termination Date (subject to any employee contribution requirements applicable to Executive on the Termination Date) through the twelve (12) month period commencing on the Termination Date; and (iv) the cash value of any accrued but unused PTO, as of the Termination Date. The payment to Executive of any benefits or consideration other than the Severance Package following the termination of Executive's employment pursuant to this Section 5.1 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws, including that the Board, in its sole discretion, may accelerate the vesting of any Stock Option held by Executive as of the Termination Date. 5.1.2. Deemed Termination. For purposes of this Section 5.1, a "termination without cause" shall be deemed to occur, and Executive shall be entitled to the Severance Package, in the event any of the following occurs and Executive provides to the Company Notice of Termination (as defined in Section 5.6) within forty-five (45) days thereafter: (a) the Company substantially reduces or diminishes Executive's responsibilities or title without Cause; (b) the Company reduces Executive's Base Salary or bonus target (other than in connection with a Company-wide decrease in salary or bonus, respectively); (c) the Company materially breaches any of its obligations to Executive pursuant to this Agreement, and fails to cure such breach within 30 days of receipt of notice thereof; (d) the Company relocates Executive's place of employment without Executive's written consent by a distance of more than fifty (50) miles, excluding any relocation to the Company's existing offices in Medford or Woburn, MA which would not constitute a deemed termination; or (e) a successor in interest to the Company fails to assume the obligations of this Agreement. 3 5.1.3. Accelerated Vesting in Change of Control. In the event that the Company terminates or is deemed to terminate Executive's employment pursuant to this Section 5.1 within one year of the latest possible date of a Change of Control, in addition to the Severance Package, any Stock Option held as of the Termination Date shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the applicable Option Certificate. For purposes of this Agreement, any one of the following events shall be considered a "Change of Control" of the Company: (a) the acquisition by any "person" (as such term is defined in Section 3(a)(9) of the Securities Exchange Act of 1934) of any amount of the Company's Common Stock so that such person holds or controls fifty percent (50%) or more of the Company's Common Stock; (b) the merger or consolidation of the Company with or into any other entity in which the holders of the Company's outstanding shares of capital stock immediately before such merger or consolidation do not, immediately after such merger or consolidation, retain capital stock representing a majority of the voting power of the surviving entity of such merger or consolidation; (c) a sale of all or substantially all of the assets of the Company to a third party; (d) within any twenty-four (24) month period, the election by the stockholders of the Company of twenty percent (20%) or more of the directors of the Company other than pursuant to nomination by the Company's management; or (e) the execution of a legally binding, definitive agreement approved by the Board of Directors providing for any of the events set forth in (a), (b), (c) or (d) above. 5.2. For Cause by the Company. Notwithstanding any other provision of this Agreement, Executive's employment hereunder may be terminated by the Company at any time for Cause. For purposes of this Agreement, "Cause" shall mean: (i) Executive's arbitrary, unreasonable, or willful failure to follow the reasonable instructions of the Board or otherwise perform Executive's duties hereunder (other than as a result of a Disability (as defined in Section 5.3)) for thirty (30) days after a written demand for performance is delivered to Executive on behalf of the Company which demand specifically identifies the manner in which the Company alleges that Executive has not substantially followed such instructions or otherwise performed Executive's duties; (ii) Executive's willful misconduct that is materially injurious to the Company (whether from a monetary perspective or otherwise); (iii) Executive's willful commission of an act constituting fraud with respect to the Company; (iv) conviction of Executive for a felony under the laws of the United States or any state thereof; or (v) Executive's material breach of Executive's obligations under Section 6 hereof. If Executive's employment is 4 terminated by the Company for Cause, the Company shall pay Executive all amounts owed to Executive for work performed prior to the Termination Date, plus the cash value of any accrued but unused PTO, as of the Termination Date. The payment to Executive of any other benefits following the termination of Executive's employment pursuant to this Section 5.2 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws. 5.3. Disability. Subject to the requirements of the Americans with Disabilities Act, Massachusetts General Laws Chapter 151B and any other applicable laws, Executive's employment hereunder may be terminated by the Company at any time in the event of the Disability of Executive. For purposes of this Agreement, "Disability" shall mean the inability of Executive to perform substantially Executive's duties hereunder due to physical or mental disablement which continues for a period of four (4) consecutive months during the Employment Term, as determined by an independent qualified physician mutually acceptable to the Company and Executive (or Executive's personal representative) or, if the Company and Executive (or such representative) are unable to agree on an independent qualified physician, as determined by a panel of three physicians, one designated by the Company, one designated by Executive (or such representative) and one designated by the two physicians so designated. If Executive's employment is terminated by the Company for Disability, (a) the Company shall pay Executive all amounts owed to Executive for work performed prior to the Termination Date, plus the Severance Package, except that the Base Salary paid as a part of the Severance Package shall be reduced by the amount of Base Salary, salary continuation (short-term disability), and cash disability benefits (long-term disability) paid to Executive for the corresponding period under the Company's employee benefit plans as then in effect, and (b) any Stock Option held as of the Termination Date shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the applicable Option Certificate. The payment to Executive of any benefits other than as described in the immediately preceding sentence following the termination of Executive's employment pursuant to this Section 5.3 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws. 5.4. Death. Executive's employment hereunder shall automatically terminate in the event of Executive's death. If Executive's employment is terminated by the death of Executive, (a) the Company shall pay to Executive's estate or legal representative all amounts owed to Executive for work performed through the last day of Executive's actual employment by the Company plus the Severance Package, and (b) any Stock Option held as of the Termination Date shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the applicable Option Certificate. The payment to Executive of any benefits other than as described in the immediately preceding sentence following the termination of Executive's employment pursuant to this Section 5.4 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws. 5.5. Termination by Executive. Executive's employment hereunder may be terminated by Executive at any time upon not less than thirty (30) days prior written notice from Executive to the Company. Executive agrees that such notice period is reasonable and necessary in light of the duties assumed by Executive pursuant to this Agreement and fair in light of the 5 consideration Executive is receiving pursuant to this Agreement. If Executive terminates Executive's employment with the Company pursuant to this Section 5.5, the Company shall pay Executive only an amount equal to the Base Salary through the Termination Date, plus the cash value of any accrued but unused PTO as of the Termination Date. 5.6. Notice of Termination. Any purported termination of employment by the Company or by Executive shall be communicated by written Notice of Termination to the other Party in accordance with Section 8 hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of employment under the provision so indicated. 5.7 Excise Tax. Notwithstanding any other provision of this Agreement, in the event that any portion of the Severance Package or any other payment or benefit received or to be received by Executive (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement) (collectively, the "Package") would be subject to the excise tax imposed under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Excise Tax"), then the Package shall be reduced to the extent necessary so that no portion of the Package is subject to the Excise Tax. All determinations required to be made under this Section 5.7 shall be made by tax counsel selected by the Company and reasonably acceptable to Executive ("Tax Counsel"), which determinations shall be conclusive and binding on Executive and the Company absent manifest error. All fees and expenses of Tax Counsel shall be borne solely by the Company. Prior to any reduction in Executive's Package pursuant to this Section 5.7, (a) Tax Counsel shall provide Executive and the Company with a report setting forth its calculations and containing related supporting information, and (b) Executive shall be entitled to specify which component(s) of the Package shall be reduced in order to comply with the terms of this Section 5.7. 5.8. Survival. The provisions of Section 6 shall survive the termination of this Agreement. 6. Confidentiality. 6.1 Definitions. As used herein, the term "Confidential Information" shall mean any and all ideas, inventions information, know-how, compounds, materials and other items (whether patentable or not) that are confidential or proprietary to the Company (or to its affiliates, collaborators, consultants, suppliers, or customers) whether disclosed in written, oral, tangible or other form and whether or not labeled or otherwise identified as confidential or proprietary. Confidential Information shall include, without limitation, the following to the extent proprietary to the Company (or to its affiliates, collaborators, consultants, suppliers or customers) and not publicly available: (a) inventions, trade secrets, discoveries and computer programs, and any improvements or modifications thereto; 6 (b) engineering, research, development and design projects, data, designs, drawings and specifications; (c) manufacturing, development and other technical processes, applications, methods, apparatus and equipment; (d) business information such as lists of approved components and sources, price lists, product costs, production schedules, business plans, sales information, profit and loss information, and customer and collaborator lists; (e) any and all reagents, substances, chemical compounds, subcellular constituents, cells or cell lines, organisms and progeny, and mutants, as well as any and all derivatives or replications derived from or relating to such materials; and (f) any and all information, materials and other items supplied by third parties to the Company (or generated by the Company for third parties) under an obligation of confidentiality. 6.2 Non-Disclosure. Executive shall not at any time (whether during or after Executive's employment with the Company) disclose or use any Confidential Information for Executive's own benefit or purposes or the benefit or purposes of any other person, firm, partnership, joint venture, association, corporation or other organization, entity or enterprise (a "Person") other than the Company. 6.3 Exceptions. Notwithstanding any other provision in the Agreement, Confidential Information shall not include any information or material which: (a) is or becomes generally available to the public other than as a result of disclosure thereof by Executive: (b) is lawfully received by Executive on a non-confidential basis from a third party that is not itself under an obligation of confidentiality or non-disclosure to the Company with respect to such information; (c) can be shown by Executive to have been independently developed by Executive; (d) Executive establishes by competent proof was in Executive's possession at the time of disclosure by the Company and was not acquired, directly or indirectly from the Company; or (e) is required to be publicly disclosed by law or by regulation; provided, however, that in such event Executive shall provide the Company with prompt advance notice of such disclosure so that 7 the Company has the opportunity if it so desires to seek a protective order or other appropriate remedy. 6.4 Return of Company Property. Executive agrees that upon termination of Executive's employment hereunder, Executive shall return immediately to the Company any proprietary materials, any materials containing Confidential Information and any other Company property then in Executive's possession or under Executive's control, including, without limitation all notes, drawings, lists, memoranda, magnetic disks or tapes, or other recording media containing such Confidential Information, whether alone or together with non-confidential information, all documents, reports, files, memoranda, records, software, credit cards, door and file keys, telephones, PDAs, computers, computer access codes, disks and instructional manuals, or any other physical property that Executive received, prepared, or helped prepare in connection with Executive's employment under this Agreement. Upon termination, Executive shall not retain any copies, duplicates, reproductions, or excerpts of Confidential Information, nor shall Executive show or give any of the above to any third party. Executive further agrees that Executive shall not retain or use for Executive's account at any time any trade name, trademark, service mark, logo or other proprietary business designation used or owned in connection with the business of the Company. 7. Specific Performance. Executive acknowledges and agrees that the Company's remedies at law for a breach or threatened breach of any of the provisions of Section 6 would be inadequate and, in recognition of this fact, Executive agrees that, in the event of such a breach or threatened breach, in addition to any remedies at law, the Company, without posting any bond, shall be entitled to obtain equitable relief in the form of specific performance, temporary restraining orders, temporary or permanent injunctions or any other equitable remedy which may then be available. 8. Notices. Any notice hereunder by either Party to the other shall be given in writing by personal delivery, telex, facsimile, overnight courier or certified mail, return receipt requested, addressed, if to the Company, to the attention of the Board with a copy to the General Counsel at the Company's executive offices or to such other address as the Company may designate in writing at any time or from time to time to Executive, and if to Executive, to Executive's most recent address on file with the Company. Notice shall be deemed given, if by personal delivery or by overnight courier, on the date of such delivery or, if by telex or facsimile, on the business day following receipt of answer back or facsimile information or, if by certified mail, on the date shown on the applicable return receipt. 9. Assignment. This Agreement may not be assigned by either Party without the prior written consent of the other Party, provided however that the Company may assign this Agreement without Executive's consent in the event of a merger, acquisition, or transfer of all or substantially all of the assets of the Company with or to a third party (a "Merger"). In the event of a Merger, the Company shall require any successor Person to assume and agree to perform this Agreement; failure to so assume and agree shall constitute a deemed termination for purposes of Section 5.1.2(e). 8 10. Entire Agreement. This Agreement constitutes the entire agreement between the Parties with respect to the subject matter hereof and there have been no oral or other agreements of any kind whatsoever as a condition precedent or inducement to the signing of this Agreement or otherwise concerning this Agreement or the subject matter hereof. As of the Effective Date, this Agreement shall supercede and replace in its entirety the Employment Agreement by and between the Parties dated as of December 8, 1998 (the "Original Agreement") and the Original Agreement shall be of no further force or effect. 11. Expenses. The Parties shall each pay their own respective expenses incident to the enforcement or interpretation of, or dispute resolution with respect to, this Agreement, including all fees and expenses of their counsel for all activities of such counsel undertaken pursuant to this Agreement, provided, however, that in the event Executive is the prevailing Party in any judicial or arbitral proceeding relating to this Agreement, the Company shall reimburse Executive for all reasonable costs, fees and expenses (including reasonable attorneys' fees) incurred by Executive in connection with such proceeding. 12. Arbitration. In the event any dispute should arise between the Parties with respect to any of the terms and conditions of this Agreement, then, at the initiation of either Party, such dispute shall be submitted and finally settled by arbitration in Boston, Massachusetts under the rules of the Employment Disputes Rules of the American Arbitration Association by an arbitrator selected by the American Arbitration Association. The dispute shall be determined in accordance with Section 18 of this Agreement, except with respect to issues of arbitrability, which shall be governed by the Federal Arbitration Act, 9 U.S.C. Secs. 1-16, and not state law. The arbitrator shall allow such discovery as is appropriate to the purposes of arbitration in accomplishing a fair, speedy and cost-effective resolution of the dispute. If any Party fails to participate in the arbitration proceedings, the arbitrators may proceed to decision based on expedited written submissions by the participating Party. The award rendered by the arbitrator shall be nonappealable, final and binding upon the Parties, and judgment upon the award rendered may be entered by either Party in any court of competent jurisdiction. The Parties agree not to institute any litigation or proceedings against each other in connection with this Agreement except as provided in this Section 12, provided, however, that either Party shall have the right to seek injunctive relief or other provisional remedies in any federal or state court of competent jurisdiction in the Commonwealth of Massachusetts. 13. Waivers and Further Agreements. Any waiver of any terms or conditions of this Agreement shall not operate as a waiver of any other breach of such terms or conditions or any other term or condition, nor shall any failure to enforce any provision hereof operate as a waiver of such provision or of any other provision hereof; provided, however, that no such written waiver, unless it, by its own terms, explicitly provides to the contrary, shall be construed to effect a continuing waiver of the provision being waived and no such waiver in any instance shall constitute a waiver in any other instance or for any other purpose or impair the right of the Party against whom such waiver is claimed in all other instances or for all other purposes to require full compliance with such provision. Each of the Parties agrees to execute all such further instruments and documents and to take all such further action as the other Party may reasonably require in order to effectuate the terms and purposes of this Agreement. 9 14. Amendments. This Agreement may not be amended, nor shall any waiver, change, modification, consent or discharge be effected except by an instrument in writing executed by both Parties. 15. Severability. If any provision of this Agreement shall be held or deemed to be, or shall in fact be, invalid, inoperative or unenforceable as applied to any particular case in any jurisdiction or jurisdictions, or in all jurisdictions or in all cases, because of the conflict of any provision with any constitution or statute or rule of public policy or for any other reason, such circumstance shall not have the effect of rendering the provision or provisions in question invalid, inoperative or unenforceable in any other jurisdiction or in any other case or circumstance or of rendering any other provision or provisions herein contained invalid, inoperative or unenforceable to the extent that such other provisions are not themselves actually in conflict with such constitution, statute or rule of public policy, but this Agreement shall be reformed and construed in any such jurisdiction or case as if such invalid, inoperative or unenforceable provision had never been contained herein and such provision reformed so that it would be valid, operative and enforceable to the maximum extent permitted in such jurisdiction or in such case. 16. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 17. Section Headings. The headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 18. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the law (other than the law governing conflict of law questions) of the Commonwealth of Massachusetts. IN WITNESS WHEREOF, the Parties have executed or caused to be executed this Agreement as of the Execution Date. ARQULE, INC. By:_________________________________ Name: Title: EXECUTIVE By:_________________________________ Name: Stephen A. Hill Title: President and Chief Executive Office 10 EXHIBIT A Business Relationships 11 EXHIBIT B Option Certificate Not applicable. 12 EXHIBIT C Determination of Option Price The exercise price of the Execution Stock Option is the Fair Market Value of ArQule's Common Stock (as defined below) as of the date of the commencement of Executive's employment with the Company. The Fair Market Value of ArQule's Common Stock shall be the closing price of the Common Stock as reported by the Nasdaq National Market on the trading day immediately prior to the date of the commencement of Executive's employment with the Company. 13 EX-10.46 7 b49672aiexv10w46.txt EMPLOYMENT AGREEMENT/ J. DAVID JACOBS/ 1/1/2004 EXHIBIT 10.46 EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") dated as of January 1, 2004 (the "Execution Date") is made by and between ArQule, Inc., a Delaware corporation (the "Company") with its principal offices at 19 Presidential Way, Woburn, Massachusetts 01801, and J. David Jacobs ("Executive") whose current principal residential address is 38 Kenwood Avenue, Newton, MA 02459. WHEREAS, the Company desires to continue to employ and retain Executive in a senior executive capacity and to enter into an agreement embodying the terms of such employment; and WHEREAS, Executive desires to accept such continued employment and enter into such an agreement; NOW, THEREFORE, in consideration of the premises, and the mutual covenants and agreements contained herein and for other good and valuable consideration, the receipt, adequacy and sufficiency of which are hereby acknowledged, the Company and Executive (the "Parties") hereby agree as follows: 1. Term of Employment. The Company hereby agrees to continue to employ Executive, and Executive hereby accepts such continued employment with the Company, upon the terms and subject to the conditions set forth in this Agreement, for a period commencing on January 1, 2004 (the "Effective Date") and continuing until terminated in accordance with the provisions of Section 5 (the "Employment Term"). 2. Title; Duties. During the Employment Term, Executive shall serve as Vice President, Legal, General Counsel and Secretary of the Company reporting directly to the Chief Executive Officer. Executive hereby agrees to undertake the duties and responsibilities inherent in such position and such other duties and responsibilities consistent with such position as the Chief Executive Officer shall from time to time reasonably assign to Executive. 3. No Conflict. During the Employment Term, Executive shall devote substantially all of Executive's business time and efforts to the performance of Executive's duties hereunder and shall not, directly or indirectly, engage in any other business, profession or occupation for compensation or otherwise which would conflict with the rendition of such duties without the prior written consent of the Chief Executive Officer, which consent shall not be unreasonably withheld, delayed or conditioned. Executive represents and warrants that Exhibit A attached hereto states all current business relationships, including, but not limited to, consulting agreements, confidentiality agreements and non-competition agreements to which Executive is a party as of the Execution Date. 4. Compensation and Benefits. 4.1. Base Salary and Bonus. During the Employment Term, the Company shall pay Executive for Executive's services hereunder a base salary at the initial annual rate of $222,480, payable in regular installments in accordance with the Company's usual payment practices and subject to annual review and upward adjustment by the Chief Executive Officer or the Chief Executive Officer's designee in his or her sole discretion. Such amount (as it may be raised (but not decreased) from time to time in accordance with this Section 4.1) shall be referred to herein as the "Base Salary." Executive shall also be eligible to receive a discretionary annual cash bonus based on a target amount (either as a percentage or a fixed dollar amount) established by the Chief Executive Officer and on Company and individual performance. Executive shall also be eligible to participate in any and all other bonus plans and packages that are made available to the Company's executives, on a basis consistent with Executive's position and then-current Base Salary and in accordance with the policies and practices of the Company and the Company's Board of Directors (the "Board"). 4.2. Stock Option Grant. As further compensation for Executive's services hereunder, the Company shall grant to Executive, on the Effective Date, a stock option (the "Execution Stock Option") to purchase zero (0) shares of the Company's Common Stock, $0.01 par value per share (the "Common Stock"), pursuant to the Company's Amended and Restated 1994 Equity Incentive Plan (the "Plan") and in accordance with the terms, and subject to a vesting schedule pursuant to which twenty-five percent of the shares shall vest annually commencing on the first anniversary of the Effective Date, and other conditions, set forth in the form of Option Certificate (attached hereto as Exhibit B in the event the Execution Stock Option grants an option to purchase more than zero shares of Common Stock). The method of determining the exercise price of the Execution Stock Option is set forth in the attached Exhibit C. Subject to the discretion of the Chief Executive Officer and the Board, the Company may grant to Executive from time to time other stock options to purchase additional shares of Common Stock, also pursuant to the Plan and such other terms and conditions set forth at the time of such grant (the Execution Stock Option and such other stock options, together with any stock options to purchase Common Stock which the Company has previously granted to Executive, collectively, the "Stock Options"). 4.3. Executive Benefits. During the Employment Term and subject to any contributions therefor generally required of senior executives of the Company, Executive shall be entitled to receive such employee benefits (including fringe benefits, 401(k) plan participation, and life, health, dental, accident and short and long term disability insurance) which the Company may, in its sole and absolute discretion, make available generally to its senior executives or personnel similarly situated; provided, however, that it is hereby acknowledged and agreed that any such employee benefit plans may be altered, modified or terminated by the Company at any time in its sole discretion without recourse by Executive. 4.4. Paid Time Off. Executive shall be entitled to four weeks (20 working days) of paid time off ("PTO") per annum during the Employment Term, to be taken at such time or times as shall be mutually convenient for the Company and Executive; provided, however, 2 that the Company may elect to increase the annual time to which Executive shall be entitled to PTO. Unused PTO shall be allocated pursuant to the Company's existing policies and practices. 4.5. Business Expenses and Perquisites. Upon delivery of adequate documentation of expenses incurred in accordance with the policies and practices of the Company, Executive shall be entitled to reimbursement by the Company during the Employment Term for reasonable travel, entertainment and other business expenses incurred by Executive in the performance of Executive's duties hereunder in accordance with such policies as the Company may from time to time have in effect. 5. Termination. 5.1. Without Cause by the Company. 5.1.1. The Severance Package. The Company may terminate Executive's employment hereunder at any time without Cause (as defined in Section 5.2) upon not less than fourteen (14) days prior written notice from the Company to Executive. The effective date of Executive's termination shall be referred to herein as the "Termination Date." If Executive's employment is terminated by the Company pursuant to this Section 5.1, the Company shall pay Executive all amounts owed to Executive for work performed prior to the Termination Date plus the following amounts and consideration (the "Severance Package"), subject to standard payroll deductions and withholdings: (i) the Base Salary through the end of the twelve (12) month period commencing on the Termination Date to be paid in a lump sum; (ii) a lump sum payment of the average bonus, if any, paid by the Company to Executive with respect to the two (2) years preceding the year in which the Termination Date occurs; (iii) the costs associated with continuing the benefits which Executive is entitled to receive pursuant to Section 4.3 of this Agreement at the level in effect as of the Termination Date (subject to any employee contribution requirements applicable to Executive on the Termination Date) through the twelve (12) month period commencing on the Termination Date; and (iv) the cash value of any accrued but unused PTO, as of the Termination Date. The payment to Executive of any benefits or consideration other than the Severance Package following the termination of Executive's employment pursuant to this Section 5.1 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws, provided, however, that the Chief Executive Officer, in his sole discretion, may accelerate the vesting of any Stock Option held by Executive as of the Termination Date. 5.1.2. Deemed Termination. For purposes of this Section 5.1, a "termination without cause" shall be deemed to occur, and Executive shall be entitled to the Severance Package, in the event any of the following occurs and Executive provides to the Company Notice of Termination (as defined in Section 5.6) within forty-five (45) days thereafter: (a) the Company substantially reduces or diminishes Executive's responsibilities or title without Cause; (b) the Company reduces Executive's Base Salary or bonus target (other than in connection with a Company-wide decrease in salary or bonus, respectively); (c) the Company materially breaches any of its obligations to Executive pursuant to this Agreement, and fails to cure such breach within 30 days of receipt of notice thereof; (d) the Company relocates Executive's place of employment without Executive's written consent by a distance of more than 3 fifty (50) miles, excluding any relocation to the Company's existing offices in Medford or Woburn, MA which would not constitute a deemed termination; or (e) a successor in interest to the Company fails to assume the obligations of this Agreement. 5.1.3. Accelerated Vesting in Change of Control. In the event that the Company terminates or is deemed to terminate Executive's employment pursuant to this Section 5.1 within one year of the latest possible date of a Change of Control, in addition to the Severance Package, any Stock Option held as of the Termination Date shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the applicable Option Certificate. For purposes of this Agreement, any one of the following events shall be considered a "Change of Control" of the Company: (a) the acquisition by any "person" (as such term is defined in Section 3(a)(9) of the Securities Exchange Act of 1934) of any amount of the Company's Common Stock so that such person holds or controls fifty percent (50%) or more of the Company's Common Stock; (b) the merger or consolidation of the Company with or into any other entity in which the holders of the Company's outstanding shares of capital stock immediately before such merger or consolidation do not, immediately after such merger or consolidation, retain capital stock representing a majority of the voting power of the surviving entity of such merger or consolidation; (c) a sale of all or substantially all of the assets of the Company to a third party; (d) within any twenty-four (24) month period, the election by the stockholders of the Company of twenty percent (20%) or more of the directors of the Company other than pursuant to nomination by the Company's management; or (e) the execution of a legally binding, definitive agreement approved by the Board of Directors providing for any of the events set forth in (a), (b), (c) or (d) above. 5.2. For Cause by the Company. Notwithstanding any other provision of this Agreement, Executive's employment hereunder may be terminated by the Company at any time for Cause. For purposes of this Agreement, "Cause" shall mean: (i) Executive's arbitrary, unreasonable, or willful failure to follow the reasonable instructions of the Chief Executive Officer or otherwise perform Executive's duties hereunder (other than as a result of a Disability (as defined in Section 5.3)) for thirty (30) days after a written demand for performance is delivered to Executive on behalf of the Company which demand specifically identifies the manner in which the Company alleges that Executive has not substantially followed such instructions or otherwise performed Executive's duties; (ii) Executive's willful misconduct that 4 is materially injurious to the Company (whether from a monetary perspective or otherwise); (iii) Executive's willful commission of an act constituting fraud with respect to the Company; (iv) conviction of Executive for a felony under the laws of the United States or any state thereof; or (v) Executive's material breach of Executive's obligations under Section 6 hereof. If Executive's employment is terminated by the Company for Cause, the Company shall pay Executive all amounts owed to Executive for work performed prior to the Termination Date, plus the cash value of any accrued but unused PTO, as of the Termination Date. The payment to Executive of any other benefits following the termination of Executive's employment pursuant to this Section 5.2 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws. 5.3. Disability. Subject to the requirements of the Americans with Disabilities Act, Massachusetts General Laws Chapter 151B and any other applicable laws, Executive's employment hereunder may be terminated by the Company at any time in the event of the Disability of Executive. For purposes of this Agreement, "Disability" shall mean the inability of Executive to perform substantially Executive's duties hereunder due to physical or mental disablement which continues for a period of four (4) consecutive months during the Employment Term, as determined by an independent qualified physician mutually acceptable to the Company and Executive (or Executive's personal representative) or, if the Company and Executive (or such representative) are unable to agree on an independent qualified physician, as determined by a panel of three physicians, one designated by the Company, one designated by Executive (or such representative) and one designated by the two physicians so designated. If Executive's employment is terminated by the Company for Disability, (a) the Company shall pay Executive all amounts owed to Executive for work performed prior to the Termination Date, plus the Severance Package, except that the Base Salary paid as a part of the Severance Package shall be reduced by the amount of Base Salary, salary continuation (short-term disability), and cash disability benefits (long-term disability) paid to Executive for the corresponding period under the Company's employee benefit plans as then in effect, and (b) any Stock Option held as of the Termination Date shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the applicable Option Certificate. The payment to Executive of any benefits other than as described in the immediately preceding sentence following the termination of Executive's employment pursuant to this Section 5.3 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws. 5.4. Death. Executive's employment hereunder shall automatically terminate in the event of Executive's death. If Executive's employment is terminated by the death of Executive, (a) the Company shall pay to Executive's estate or legal representative all amounts owed to Executive for work performed through the last day of Executive's actual employment by the Company plus the Severance Package, and (b) any Stock Option held as of the Termination Date shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the applicable Option Certificate. The payment to Executive of any benefits other than as described in the immediately preceding sentence following the termination of Executive's employment pursuant to this Section 5.4 shall be determined by the Board in its sole discretion in accordance with the policies and practices of the Company and applicable laws. 5 5.5. Termination by Executive. Executive's employment hereunder may be terminated by Executive at any time upon not less than thirty (30) days prior written notice from Executive to the Company. Executive agrees that such notice period is reasonable and necessary in light of the duties assumed by Executive pursuant to this Agreement and fair in light of the consideration Executive is receiving pursuant to this Agreement. If Executive terminates Executive's employment with the Company pursuant to this Section 5.5, the Company shall pay Executive only an amount equal to the Base Salary through the Termination Date, plus the cash value of any accrued but unused PTO as of the Termination Date. 5.6. Notice of Termination. Any purported termination of employment by the Company or by Executive shall be communicated by written Notice of Termination to the other Party in accordance with Section 8 hereof. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of employment under the provision so indicated. 5.7. Survival. The provisions of Section 6 shall survive the termination of this Agreement. 6. Confidentiality. 6.1 Definitions. As used herein, the term "Confidential Information" shall mean any and all ideas, inventions information, know-how, compounds, materials and other items (whether patentable or not) that are confidential or proprietary to the Company (or to its affiliates, collaborators, consultants, suppliers, or customers) whether disclosed in written, oral, tangible or other form and whether or not labeled or otherwise identified as confidential or proprietary. Confidential Information shall include, without limitation, the following to the extent proprietary to the Company (or to its affiliates, collaborators, consultants, suppliers or customers) and not publicly available: (a) inventions, trade secrets, discoveries and computer programs, and any improvements or modifications thereto; (b) engineering, research, development and design projects, data, designs, drawings and specifications; (c) manufacturing, development and other technical processes, applications, methods, apparatus and equipment; (d) business information such as lists of approved components and sources, price lists, product costs, production schedules, business plans, sales information, profit and loss information, and customer and collaborator lists; (e) any and all reagents, substances, chemical compounds, subcellular constituents, cells or cell lines, organisms and progeny, and 6 mutants, as well as any and all derivatives or replications derived from or relating to such materials; and (f) any and all information, materials and other items supplied by third parties to the Company (or generated by the Company for third parties) under an obligation of confidentiality. 6.2 Non-Disclosure. Executive shall not at any time (whether during or after Executive's employment with the Company) disclose or use any Confidential Information for Executive's own benefit or purposes or the benefit or purposes of any other person, firm, partnership, joint venture, association, corporation or other organization, entity or enterprise (a "Person") other than the Company. 6.3 Exceptions. Notwithstanding any other provision in the Agreement, Confidential Information shall not include any information or material which: (a) is or becomes generally available to the public other than as a result of disclosure thereof by Executive: (b) is lawfully received by Executive on a non-confidential basis from a third party that is not itself under an obligation of confidentiality or non-disclosure to the Company with respect to such information; (c) can be shown by Executive to have been independently developed by Executive; (d) Executive establishes by competent proof was in Executive's possession at the time of disclosure by the Company and was not acquired, directly or indirectly from the Company; or (e) is required to be publicly disclosed by law or by regulation; provided, however, that in such event Executive shall provide the Company with prompt advance notice of such disclosure so that the Company has the opportunity if it so desires to seek a protective order or other appropriate remedy. 6.4 Return of Company Property. Executive agrees that upon termination of Executive's employment hereunder, Executive shall return immediately to the Company any proprietary materials, any materials containing Confidential Information and any other Company property then in Executive's possession or under Executive's control, including, without limitation all notes, drawings, lists, memoranda, magnetic disks or tapes, or other recording media containing such Confidential Information, whether alone or together with non-confidential information, all documents, reports, files, memoranda, records, software, credit cards, door and file keys, telephones, PDAs, computers, computer access codes, disks and instructional manuals, or any other physical property that Executive received, prepared, or helped prepare in connection with Executive's employment under this Agreement. Upon termination, Executive shall not 7 retain any copies, duplicates, reproductions, or excerpts of Confidential Information, nor shall Executive show or give any of the above to any third party. Executive further agrees that Executive shall not retain or use for Executive's account at any time any trade name, trademark, service mark, logo or other proprietary business designation used or owned in connection with the business of the Company. 7. Specific Performance. Executive acknowledges and agrees that the Company's remedies at law for a breach or threatened breach of any of the provisions of Section 6 would be inadequate and, in recognition of this fact, Executive agrees that, in the event of such a breach or threatened breach, in addition to any remedies at law, the Company, without posting any bond, shall be entitled to obtain equitable relief in the form of specific performance, temporary restraining orders, temporary or permanent injunctions or any other equitable remedy which may then be available. 8. Notices. Any notice hereunder by either Party to the other shall be given in writing by personal delivery, telex, facsimile, overnight courier or certified mail, return receipt requested, addressed, if to the Company, to the attention of the Chief Executive Officer with a copy to the General Counsel at the Company's executive offices or to such other address as the Company may designate in writing at any time or from time to time to Executive, and if to Executive, to Executive's most recent address on file with the Company. Notice shall be deemed given, if by personal delivery or by overnight courier, on the date of such delivery or, if by telex or facsimile, on the business day following receipt of answer back or facsimile information or, if by certified mail, on the date shown on the applicable return receipt. 9. Assignment. This Agreement may not be assigned by either Party without the prior written consent of the other Party, provided however that the Company may assign this Agreement without Executive's consent in the event of a merger, acquisition, or transfer of all or substantially all of the assets of the Company with or to a third party (a "Merger"). In the event of a Merger, the Company shall require any successor Person to assume and agree to perform this Agreement; failure to so assume and agree shall constitute a deemed termination for purposes of Section 5.1.2(e). 10. Entire Agreement. This Agreement constitutes the entire agreement between the Parties with respect to the subject matter hereof and there have been no oral or other agreements of any kind whatsoever as a condition precedent or inducement to the signing of this Agreement or otherwise concerning this Agreement or the subject matter hereof. As of the Effective Date, this Agreement shall supercede and replace in its entirety the letter agreement by and between the Parties dated April 3, 2001 (the "Letter Agreement") and the Employment Agreement by and between the Parties dated as of June 4, 2001 (the "Original Agreement") and the Letter Agreement and the Original Agreement shall be of no further force or effect. 11. Expenses. The Parties shall each pay their own respective expenses incident to the enforcement or interpretation of, or dispute resolution with respect to, this Agreement, including all fees and expenses of their counsel for all activities of such counsel undertaken pursuant to this Agreement, provided, however, that in the event Executive is the prevailing Party in any judicial or arbitral proceeding relating to this Agreement, the Company shall reimburse 8 Executive for all reasonable costs, fees and expenses (including reasonable attorneys' fees) incurred by Executive in connection with such proceeding. 12. Arbitration. In the event any dispute should arise between the Parties with respect to any of the terms and conditions of this Agreement, then, at the initiation of either Party, such dispute shall be submitted and finally settled by arbitration in Boston, Massachusetts under the rules of the Employment Disputes Rules of the American Arbitration Association by an arbitrator selected by the American Arbitration Association. The dispute shall be determined in accordance with Section 18 of this Agreement, except with respect to issues of arbitrability, which shall be governed by the Federal Arbitration Act, 9 U.S.C. Secs. 1-16, and not state law. The arbitrator shall allow such discovery as is appropriate to the purposes of arbitration in accomplishing a fair, speedy and cost-effective resolution of the dispute. If any Party fails to participate in the arbitration proceedings, the arbitrators may proceed to decision based on expedited written submissions by the participating Party. The award rendered by the arbitrator shall be nonappealable, final and binding upon the Parties, and judgment upon the award rendered may be entered by either Party in any court of competent jurisdiction. The Parties agree not to institute any litigation or proceedings against each other in connection with this Agreement except as provided in this Section 12, provided, however, that either Party shall have the right to seek injunctive relief or other provisional remedies in any federal or state court of competent jurisdiction in the Commonwealth of Massachusetts. 13. Waivers and Further Agreements. Any waiver of any terms or conditions of this Agreement shall not operate as a waiver of any other breach of such terms or conditions or any other term or condition, nor shall any failure to enforce any provision hereof operate as a waiver of such provision or of any other provision hereof; provided, however, that no such written waiver, unless it, by its own terms, explicitly provides to the contrary, shall be construed to effect a continuing waiver of the provision being waived and no such waiver in any instance shall constitute a waiver in any other instance or for any other purpose or impair the right of the Party against whom such waiver is claimed in all other instances or for all other purposes to require full compliance with such provision. Each of the Parties agrees to execute all such further instruments and documents and to take all such further action as the other Party may reasonably require in order to effectuate the terms and purposes of this Agreement. 14. Amendments. This Agreement may not be amended, nor shall any waiver, change, modification, consent or discharge be effected except by an instrument in writing executed by both Parties. 15. Severability. If any provision of this Agreement shall be held or deemed to be, or shall in fact be, invalid, inoperative or unenforceable as applied to any particular case in any jurisdiction or jurisdictions, or in all jurisdictions or in all cases, because of the conflict of any provision with any constitution or statute or rule of public policy or for any other reason, such circumstance shall not have the effect of rendering the provision or provisions in question invalid, inoperative or unenforceable in any other jurisdiction or in any other case or circumstance or of rendering any other provision or provisions herein contained invalid, inoperative or unenforceable to the extent that such other provisions are not themselves actually in conflict with such constitution, statute or rule of public policy, but this Agreement shall be 9 reformed and construed in any such jurisdiction or case as if such invalid, inoperative or unenforceable provision had never been contained herein and such provision reformed so that it would be valid, operative and enforceable to the maximum extent permitted in such jurisdiction or in such case. 16. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 17. Section Headings. The headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. 18. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the law (other than the law governing conflict of law questions) of the Commonwealth of Massachusetts. IN WITNESS WHEREOF, the Parties have executed or caused to be executed this Agreement as of the Execution Date. ARQULE, INC. By:________________________________ Name: Stephen A. Hill Title: President and Chief Executive Officer EXECUTIVE By:________________________________ Name: J. David Jacobs Title: Vice President, Legal, General Counsel and Secretary 10 EXHIBIT A Business Relationships Director of and Counsel to the Volpi Foundation for the Performing Arts, Inc. 11 EXHIBIT B Option Certificate Not applicable. 12 EXHIBIT C Determination of Option Price The exercise price of the Execution Stock Option is the Fair Market Value of ArQule's Common Stock (as defined below) as of the date of the commencement of Executive's employment with the Company. The Fair Market Value of ArQule's Common Stock shall be the closing price of the Common Stock as reported by the Nasdaq National Market on the trading day immediately prior to the date of the commencement of Executive's employment with the Company. 13 EX-10.47 8 b49672aiexv10w47.txt EMPLOYMENT AGREEMENT/ LOUISE MAWHINNEY/ 1/1/2004 Exhibit 10.47 December 1st, 2003 Louise A. Mawhinney 22 Frost Lane Sudbury, MA 01776 Dear Louise, I am pleased to offer you a position at ArQule as Chief Financial Officer at a bi-weekly rate of $7692.31, which annualizes to $200,000 per year. The position will report to the Chief Executive Officer and is on an employment-at-will basis. Compensation is reviewed in the first Quarter (January though March) for all employees and is subject to performance-based increases. At that time, you will also be eligible for stock options and a 25% cash bonus subject to being an employee in good standing. These bonuses are discretionary, subject to pro-ration and are based on Company results as well as individual performance. Subject to the approval of the ArQule Board of Directors, you would also receive 75,000 options to purchase common stock of ArQule, Inc. as part of this offer. The exercise price per share will be equal to the ArQule common stock closing price (4:00 p.m. Eastern Standard Time) reported by the NASDAQ National Market on the last trading date preceding your first date of employment. These options would vest at a rate of twenty-five percent annually commencing on the first anniversary of your employment start date with ArQule. You and your dependents are entitled to ArQule's comprehensive health package including medical and dental coverage. You are also provided life insurance at two times your annual salary up to $300,000 and long and short-term disability insurance. In addition, you will receive four weeks of paid personal time, which will be accrued on a monthly basis. You will also be eligible to enroll in our Company sponsored 401K Plan on the first day of any quarter. You will be eligible as well to participate in the Employee Stock Purchase Plan, pursuant to which you will be able to purchase limited amounts of ArQule stock at a discount to the market price. Your eligibility for benefits will be subject to the requirements, conditions, terms and restrictions in our Plan documents. If the Company terminates your employment without cause (as defined below) due to a change of control of the Company (as defined below), the Company shall pay you an amount over the twelve month period following such termination equal to twelve months of your annual base salary and benefits. For purposes of this letter, "cause" shall mean: (i) your arbitrary, unreasonable, or willful failure to follow the reasonable instructions of the Chief Executive Officer or otherwise perform your duties hereunder (other than as a result of a total or partial incapacity due to physical or mental illness) for thirty (30) days after a written demand for performance is delivered to you on behalf of the Company which demand specifically identifies the manner in which the Company alleges that you have not substantially followed such instructions or otherwise performed your duties; (ii) your willful misconduct that is materially injurious to the Company (whether from a monetary perspective or otherwise); (iii) your willful commission of an act constituting fraud with respect to the Company; (iv) your conviction for a felony under the laws of the United States or any state thereof; or (v) your material breach of your employment obligations (including compliance with the Company's Code of Conduct) or your obligations under the Employee Non-Disclosure and Inventions Agreement. If your employment is terminated by the Company for cause, the Company shall pay you all amounts owed to you for work performed prior to the termination date. For purposes of this letter, any one of the following events shall be considered a change of control: (i) the acquisition by any person (as such term is defined in Section 3(a)(9) of the Securities Exchange Act of 1934) of any amount of the Company's common stock so that it holds or controls fifty percent (50%) or more of the Company's Common Stock; or (ii) a merger or consolidation after which fifty percent (50%) or more of the voting stock of the surviving corporation is held by persons who were not stockholders of the Company immediately prior to such merger or combination. In addition, in the event that your employment is terminated by the Company without cause (as defined above) within one year following a change of control of the Company, the stock options referenced herein shall become immediately exercisable as to all option shares without regard to the vesting schedule set forth on the form of the option certificate. Employment is contingent upon the satisfactory completion of references and background screening, execution of the Company's Employee Non-Disclosure and Inventions Agreement (which shall govern where more specific than this letter) and verification of authorization to work in the United States. While you render services to the Company and for one year following termination or separation, you will not, directly or indirectly, alone or through or with any person, entity or organization: (a) compete with the Company in any of its activities; (b) solicit, divert or take away, or attempt to solicit, divert or take away, the business or patronage of any of the actual or prospective clients, customers or accounts, of the Company; (c) recruit, solicit or hire any person who is, or within six months preceding such termination or separation was, an employee, officer or director of or consultant to the Company (collectively, a "Company Person"); or (d) induce or attempt to induce any Company Person to discontinue his or her relationship with the Company or to commence an employment or other business relationship with another entity. As an employee of ArQule, you are expected to make or participate in business decisions and actions in the course of your employment based solely on the best interests of the Company as a whole, and without consideration of personal relationships or benefits. While you render services to the Company, you will not engage in any other gainful employment, business or activity without written consent of the Company. You may, with consent, participate in financial, business and other activities outside the scope of your employment so long as the activities do not conflict with your responsibilities to the Company. Please refer to the Company's Code of Conduct and Conflict of Interest Policy (posted on the ArQule Intranet), to which you will be subject as an employee of the Company. Kindly confirm your start date below. Please return a signed copy of this letter to Elaine Palome, Director of Employment, within one week. Please plan on reporting to work at 8:30 on your first day for Orientation. This offer letter and any documents referenced herein contain all the terms and conditions of employment and supersede any other written documents or conversations about such items. If you need further information regarding this offer or any other aspect of employment at ArQule feel free to reach me either by phone (781) 994-0311 or email, shill@arqule.com. ArQule is an organization that is building an outstanding reputation for innovation in Drug Discovery and Development. Our employees are responsible for our success. We look forward to you accepting our offer and to your becoming part of the ArQule Team. With best regards, Accepted and agreed to by: Stephen Hill ____________________________ Chief Executive Officer Louise Mawhinney ____________________________ Start Date EX-10.48 9 b49672aiexv10w48.htm AMENDMENT TO COLLABORATION AGREEMENT/ 2/12/2004 AMENDMENT TO COLLABORATION AGREEMENT/ 2/12/2004

This refers to the agreement between ArQule, Inc. (“ArQule”) and Pfizer Inc and its Affiliates (“Pfizer”) dated December 18, 2001 (the “Agreement”). ArQule and Pfizer hereby agree to amend the Agreement as follows:

Section 1.11 of the Agreement shall be deleted in its entirety and replaced by the following:

“1.11 “Pfizer Compounds” means 1) the compounds designed and produced by ArQule (hereby “File Enrichment Compounds”), 2) those compounds designed and produced by ArQule that are of greater than * compounds per library (hereby “Large Libraries”), and 3) those compounds designed by Pfizer and produced by ArQule that are of * compounds per library (hereby “Hit Follow-up Compounds”), their intermediates, and the protocols used to produce those compounds, pursuant to the Collaboration Program, and all Positional Isomers related to such compounds.”

2.		Section 2.3(c) of the Agreement shall be deleted in its entirety.

3.		Section 2.5 of the Agreement shall be amended to delete * from the Pfizer Appointees and replaced by . shall also be removed from the ArQule Appointees.

4.		Section 3.1 of the Agreement shall be deleted in its entirety.

5.		Section 4.3(b) of the Agreement shall be deleted in its entirety.

6.		Section 8.3(a) of the Agreement shall be deleted in its entirety and replaced by the following;

Notwithstanding any rights granted under this Section 8, either Party shall have the right to terminate this Agreement, without cause, anytime on or after December 21, 2005 upon six months prior written notice. If Pfizer terminates this Agreement pursuant to this Section 8.3(a), Pfizer will pay to ArQule contemporaneously with delivery of such notice 100% of the Compound

[*]=CERTAIN INFORMATION IN THIS EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS.

Costs (based on the amount of Pfizer Compounds to be produced or designed in the immediately preceding Calendar Quarter as set forth in the Project Plan) for the two full Calendar Quarters following such notice. The Steering Committee will determine a new Project Plan for such two final Calendar Quarters. If ArQule terminates this Agreement pursuant to this Section 8.3(a), ArQule will complete the Production plan until the effective date of termination and Pfizer will pay to ArQule the corresponding Compound Costs.

Exhibits C and F of the Agreement shall be replaced with the Exhibits C and F attached to this letter agreement.

Except for the above changes, all other terms and conditions of the Agreement shall remain in full force and effect for the remainder of the Term.

The Pfizer-ArQule collaboration has generated over * file enrichment (FE) compounds in the previous four years that have augmented Pfizer’s repository and contributed to available High Throughput Screening (HTS) hits. As a result, the FE strategy has shifted the emphasis more to hit follow up (HF) and less on FE. A new research plan has been prepared in order to accommodate the new priorities. The new collaboration will continue with developing and producing FE compounds at a reduced rate and include rapid turnaround of smaller HF libraries. In anticipation of the potential uneven workload during the necessary ramp up in HF, there will also be a small number of “large libraries” (LL) available that are planned to be produced in the next two years of the collaboration in order to manage the overall collaboration output. The quarterly output of each type of deliverable will continue to be managed by the Steering Committee to deliver approximately * compounds annually.

* will be ArQule’s responsibility, whereas * will be Pfizer’s responsibility. FE and LL compounds produced will consist of * and have structures confirmed by mass spectrometry. HF compounds will consist of at least * and have structures confirmed by mass spectrometry. Purity for all compounds will be determined by HPLC *.

All data for these compounds, including physical, analytical, and quality control data, will be stored in an SD file or other format agreed upon by the Steering Committee. The data will be * with the physical samples. If there are samples that do not meet the yield or purity requirement and Pfizer has no interest in them, they will be destroyed and *. In order to ensure full value from the collaboration, Pfizer will provide managerial and scientific staff.

ArQule Inc., located in Woburn MA, is a 300 person oncology drug discovery company focused on improving the discovery process by integrating high throughput chemical synthesis, intelligent library design and high throughput predictive and experimental ADME. Since its inception in 1993, ArQule has established a track record of producing high quality compounds using its industry recognized high throughput parallel synthesis AMAP™ system, which was the basis for establishing the first ArQule/Pfizer collaboration in 1999 followed by the expansion in 2001.

ArQule’s capacity to generate large numbers of compounds fits well with Pfizer’s expertise in the area of high throughput screening. A great portion of all discovery programs are working on leads discovered through HTS, and increasing knowledge of the human genome may well place an even greater reliance on HTS as a pre-requisite for project initiation. The ArQule collaboration will continue to augment Pfizer’s Gene-to-Candidate process in three ways. First, by increasing the size of the screening file, it is likely to increase the proportion of screens that are successful. Second, compounds with a high-speed synthesis heritage will improve the entire efficiency of the hit to candidate process. Third, the early ADME and physical property measures should reduce candidate attrition. Thus, project teams will have more lead compounds available to them, these leads should more closely embody the

desirable properties of a candidate, and they have the potential to be incorporated into an automated closed loop optimization cycle.

There are multiple components to the annual production of approximately * FE compounds in the form of approximately * libraries per year and these are very well established and understood by the collaboration team based on the previous four years. The key components in the FE process can be segmented into the following categories: * and *. These same steps are also similar for HF and LL production, however, the range of available parameters and responsibility may be different from FE.

For FE and LL, Pfizer will provide * and * while ArQule will be responsible for * and *. For HF, Pfizer will be responsible for * as well as provide *. ArQule will be responsible for the * and *.

Library ideas for FE development will be provided *, to insure that the ideas * (Section 9.1). If the proposed library idea is cleared, it will be registered as * and *. If the idea is encumbered and does not clear, then it will be *.

HF and LL request will be cleared through a similar process as FE before they are accepted as part of the production plan.

Bulk template provided for protocol development and production will, be obtained through * and provided to ArQule in a timely manner to meet the development and production plan defined by the Steering Committee.

Library design for FE libraries will continue to be *, as performed currently. A similar approach will be adopted for LL and also be the responsibility of *. Library design criteria may be modified or specific criteria or monomers may be applied to designated libraries as determined by *. Library design for HF will be * and designed libraries with monomer combinations will be *.

Protocol development and the reduction of an idea to a synthetic procedure capable of making *, will be the responsibility of *. The number of automated synthetic and workup steps per protocol is anticipated to average no more than * and *, respectively.

Execution of the developed protocols for FE, HF and LL to produce the * compounds in parallel using the *. The reaction scale for FE will average *. Due to the limited amount of individual templates for LL, the reaction scale will be managed at *. For HF the reaction scale will be adjusted based on the number of steps in the protocol. A one-step protocol will be at approximately *, whereas protocols with two and three steps will be run at * and *, respectively. The reaction scale has a direct impact on the final compound quantity as well as the overall cost, thus it will be appropriately managed by the Steering Committee for cost-effective success. All available technology will be used as necessary to make the compounds of interest.

HPLC purification will be conducted using the developed purification methods on *. HF and LL protocols that do not have developed purification methods will be reviewed by the analytical staff and a * will be *. Limited purification development will be done for HF and LL libraries and this effort will be reserved for those where little information is available or major difficulties are anticipated.

The primary analytical QC method to assess compound * for all compounds produced will be *. * will be the primary sample quantification method. The passing criteria for HPLC purified samples are: *

As analytical and purification technologies evolve, the criteria to best establish the most accurate nature of the final products may be modified by the Steering Committee.

All compounds that meet the acceptance criteria identified in Section 3.7 will be consolidated into full arrays using Pfizer microtiter plates and screening format.

For FE and LL compounds there will be * and the remaining material in a third plate. Compounds * plus the remaining compound in a second microtiter plate and they will be *.

For HF compounds there will be 1 plate (A-plate) with * plus a second plate (B-plate) with *, depending on the requested microtiter plate. Any additional material will be discarded. Compounds * will be * plus the * and they will be *. Compounds * will be * but they will not be *.

The quarterly success payments for FE, LL and HF compounds will be recognized for each compound type independent of the others. All compounds will be delivered * with the associated pertinent information in a SD file. Compounds with unacceptable purity will be removed, discarded and not count towards the annual production goal.

Protocol development information will be recorded in the * following *. Production information will be recorded in the * as well as maintaining * as necessary. All electronic in-process information will be maintained in the *. Analytical data that supports compound production will be maintained in the * and transmitted to *. All appropriate data supporting compound production * and the requisite information will be included in an SD file that will *.

Approximately * protocols, inclusive of *%), must be *. Presently, there are a significant number of protocols in the various stages of development as well as in the backlog section, and therefore new ideas are not immediately necessary to support the program. New ideas can be incorporated into the development plan as necessary to support *, however, the number of new ideas that would be initiated need to * in early development.

Compound production, purification, analysis and shipment will continue as presently defined.

Although a steady state of * HF compounds * are desired to support the new Pfizer strategy, it is recognized that a *. The goal for the * is to *, deliver a * and prepare to *.

•		% average passing rate for all HF libraries but that the range for any particular library could be % passing

•		Eventually, the collaboration should reach a steady state of approximately * libraries designed to * and *

•		* responsible for % of the library design. Approximately % of the library designs will *

•		* will eventually *

•		* will provide all * protocols

•		* will provide * with *.

•		* will provide * with all necessary *

•		Approximately % of the libraries will .

•		* will proceed as *.

•		Average cycle time of * from receipt of monomers and templates to delivery by , assuming . Compounds that take longer than * to deliver would be *, as agreed to, unless otherwise modified by the Steering Committee.

•		Approximately * will require * prior to * and thus *

Large library compounds are generated by * of * provided by *. The average number of steps will be *, which accounts for approximately *% of the transformations being *. The same * will be provided by * and will be *.

•		* will be available *

•		* will be available in * and the *

•		An average of * per template will be *

•		Library design will be * and *

•		Passing rate is expected at *%

•		No development resource *.

•		* will proceed as *.

Based on the speed of HF ramp up, the Steering Committee will manage the blend of the * within the * in order to set the * and *.

The goal of the collaboration’s second year is to * and * for 2005. The LL compounds will * to manage the *.

The goal for the last year is to *. The goal for protocol development and total number of HF libraries will be decided by the Steering Committee at that time.

The Steering Committee for this collaboration will have representatives from ArQule, and Pfizer. The committee will meet each year on a quarterly basis, and the Steering Committee members will establish the dates and locations of these meetings annually. These meetings will serve both to review overall progress, and to establish *. Key issues will include progress towards production goals, ensuring that the development pipeline is maintained, approve changes to plans, verify Pfizer compound delivery and manage conflict resolution. Most importantly, the Steering Committee may choose to change the priorities as a result of their assessment.

• will be responsible for providing the appropriate staffing in order to meet the collaboration goals and deliverables. Chemistry development staff will be a combination of Ph.D. and MS/BS staff with a variety of experience in library design and development. Production, purification and analytical staff will also be a combination of Ph.D., MS/BS and technician level as appropriate for each function. All * employees assigned to this collaboration will have had the appropriate level of safety training.

The present operations workgroups — chemistry workgroup, library production workgroup, library design workgroup, template workgroup and analytical workgroup (CWG, LPWG, LDWG, TWG and AWG, respectively) will continue to meet *. However, since the deliverables and expectations will be different for the modified collaborations, the remit of these groups is expected to change and will be managed by the strategic workgroup as necessary.

All operational costs for * will be *. The annual expected expenses for * are approximated at $* per year and any excess expenses beyond the approximated amount will be approved by the Steering Committee and paid quarterly *. * will supply any necessary * that are * for FE and LL compounds and all monomersin vials for HF compounds.

Routine maintenance of the equipment to keep them operational would be the responsibility of *. * will also be responsible for any maintenance beyond routine and handled, at * expense by service contracts or for custom components by the *.

Appropriate documentation regarding protocol development, library production and analysis will be maintained according to Pfizer’s and ArQule’s documentation procedures. Pertinent data regarding the physical compounds * will be transferred by SD file and *.

The following definitions are provided to clarify terms used in the Collaboration Plan and they relate directly to the activities described in such Plan. They are not intended, necessarily to correspond directly to definitions in Section 1 of the Agreement, unless there is a direct correlation between the term used in the Collaboration Plan, its definition below and its definition in Section 1 of the Agreement. For avoidance of doubt, the definition in Section 1 of the Agreement supercedes the definition of any term used herein:

ADME – Absorption Distribution Metabolism and Excretion are important pharmacokinetic parameters that contribute in part to determining the potential of a compound being a drug.

AIMS – Array Information Management System is the integrated software that tracks the array through the production, purification, analytical and reformatting process.

AMAP™ - Automated Molecular Assembly Plant parallel synthesis system that functions as a combinatorial chemistry synthesis platform comprising library protocols, automated transformations, robotic chemical process workstations, workflow procedures, compound purification systems, analytical QC systems, user interface software, library design software and information management software.

Analytical Workgroup – The group of Pfizer and ArQule scientists that meet biweekly to discuss the analytical issues associated with the development and production.

Array – The subset of library compounds that move through the production, purification, analytical and reformatting process as a related unit.

ASPECT – The ArQule integrated analytical LIMS software that tracks all of the information regarding the ArQule specific analytical process.

CGN – Computer Generated Notebooks are three ring binders that have a computer-generated identifier that tracks loose-leaf information associated with a particular array synthesis.

Chemistry Workgroup – The group of Pfizer and ArQule scientists that meet biweekly to discuss the progress of the file enrichment protocol development effort.

Culling – The process of removing the compounds of a library that do not conform to the acceptance criteria.

Development - The process of performing the necessary chemistry and monomer validation to produce a protocol that will go into Production

Development Goal - The work product that is to be achieved by Development in a given year.

Development Staff - The staff that is responsible for carrying out the necessary chemistry and monomer validation to produce a protocol for Production.

*

Hit Follow Up – The process of rapidly synthesizing additional analogs related to hits that have a high throughput heritage.

HPLC – High performance liquid chromatography is an analytical separation method that separates a mixture into its components in order to determine sample purity and/or component quantity

HPLC Purification – The process of separating the components of a mixture into discrete segments separated by time on a column and collecting only the fraction(s) that contain(s) the compound(s) of interest.

Large Libraries – Producing libraries of related compounds by one-step diversification of template analogs obtained through outsourcing relationships.

Library – The anticipated compounds to be made in production that are related by a common protocol.

Library Design - The process by which a set of compounds are constructed virtually and selected to give the most useful set of compounds with acceptable physical properties.

Library Design Workgroup – The group of Pfizer and ArQule scientists that * the library designs.

Library Idea - The idea, scheme, template(s), around which a set of compounds will be made. This could also include literature precedent for the reaction(s) involved in constructing the library, and an analysis of necessary commercially available monomers to validate that an acceptable library could be made.

Library Production Workgroup – The group of Pfizer and ArQule scientists that meet biweekly to prioritize and manage the quarterly production plans

Library Synthesis – Producing related compounds using a common development protocol.

LIMS – Laboratory Information Management System is a software package dedicated to tracking the development and production samples through the analytical process.

Monomer – Chemical reagents that couple to a core structure to provide diversity to the analogs of a library.

Monomer Selection - The process whereby the monomers that are to be used in a library are selected.

Production – The process of performing the unit operations to synthesize library compounds, submit QC samples for analysis, then cull, reformat, package and ship the compound library with the associated data.

Production Goal - The work product that is to be achieved by Production in a given year.

Production Staff - The staff that is responsible for carrying out the production process.

Protocol - The set of instructions that include, monomers (passed and failed), reagents, solvents, reaction conditions, equipment, and process by which a library is synthesized.

Protocol Validation - After the reaction and monomers have been optimized, a subset of the library is run at the production facility.

QC Analysis – Quality Control analysis of the products from a library, assuring that only products that meet the acceptance criteria are packaged and shipped.

Reformatting – The process of redistributing the compounds that conform to the acceptance criteria into full microtiter plates.

Registration – The process of transferring the structural information as well as the associated pertinent production and analytical data to a database *.

SD File – Structure data file associates the compound structure with the pertinent information regarding that structure in a user defined format that can be used to transfer information between two registration databases easily, efficiently and effectively.

Steering Committee – The group of Pfizer and ArQule staff that manage the collaboration.

Strategic Workgroup – The scientific core team of the Steering Committee that makes and implements decisions on an interim basis as necessary.

Template – The structural component(s) of library members on which diversity elements are introduced by monomer attachment.

Template Workgroup – The group of Pfizer and ArQule scientists that meet biweekly to discuss the status and issues of outsourced template and identify expected template receipt timelines to coordinate associated development and production activities

*

EX-21.1 10 b49672aiexv21w1.txt SUBSIDIARIES OF THE COMPANY EXHIBIT 21.1 ARQULE, INC. SUBSIDIARIES OF THE COMPANY ArQule U.K., Ltd., a company organized under the laws of the United Kingdom EX-23.1 11 b49672aiexv23w1.txt CONSENT OF PRICEWATERHOUSE COOPERS LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Forms S-8 (File Nos. 333-106035, 333-105299, 333-105298, 333-105297, 333-68058, 333-55705, 333-43046, 333-43044, 333-25369, 333-25371, and 333-25369) and Form S-3 (File Nos. 333-111181 and 333-109564) of ArQule, Inc., of our report dated February 13, 2004 relating to the financial statements, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP - --------------------------------- Boston, Massachusetts March 11, 2004 EX-31.1 12 b49672aiexv31w1.txt SEC 302 CERTIFICATION OF CEO EXHIBIT 31.1 CERTIFICATE OF CHIEF EXECUTIVE OFFICER I, Stephen A. Hill, certify that: 1. I have reviewed this annual report on Form 10-K of ArQule, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [Omitted pursuant to the guidance of Release No. 33-8238 (June 5, 2003).] c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 11, 2004 /s/ Stephen A. Hill -------------------------- Stephen A. Hill President and Chief Executive Officer EX-31.2 13 b49672aiexv31w2.txt SEC 302 CERTIFICATION OF CFO EXHIBIT 31.2 CERTIFICATE OF CHIEF FINANCIAL OFFICER I, Louise A. Mawhinney, certify that: 1. I have reviewed this annual report on Form 10-K of ArQule, Inc. 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) [Omitted pursuant to the guidance of Release No. 33-8238 (June 5, 2003).] c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 11, 2004 /s/ Louise A. Mawhinney ---------------------------------- Louise A. Mawhinney Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) EX-32 14 b49672aiexv32.txt SEC 906 CERTIFICATION OF CEO AND CFO EXHIBIT 32 ARQULE, INC. CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER The undersigned, Stephen A. Hill, President and Chief Executive Officer of ArQule, Inc. (the "Company") Louise A. Mawhinney, Principal Financial and Accounting Officer of the Company, both duly elected currently serving, do each hereby certify that, to the best of his/her knowledge: 1. The annual report on Form 10-K for the period ending December 31, 2003, filed on behalf of the Company pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") and containing the financial statements of the Company, fully complies with the requirements of section 13(a) of the Exchange Act; and 2. the information contained in such annual report fairly presents, in all material respects, the financial condition and results of operations of the Company for the dates and periods covered by such annual report. This certification accompanies the Company's Annual Report on Form 10-K for the year ended December 31, 2003 pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (the "2002 Act") and shall not be deemed filed by the Company for purposes of Section 18 of the Exchange Act. This certification is being made for the exclusive purpose of compliance by the Chief Executive Officer and Acting Principal Accounting and Financial Officer of the Company with the requirements of Section 906 of the 2002 Act, and may not be disclosed, distributed or used by any person for any reason other than as specifically required by law. IN WITNESS WHEREOF, the undersigned have executed this Certificate as of the 11th day of March 2004. /s/ Stephen A. Hill - ------------------- Name: Stephen A. Hill Title: President and Chief Executive Officer /s/ Louise A. Mawhinney - ----------------------- Louise A. Mawhinney Title: Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----


Delaware		04-3221586
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


PART I
	Item 1. Business
	Item 1A. Executive Officers and Directors of the Registrant
	Item 2. Properties
	Item 3. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
PART II
	Item 5. Market for the Registrant’s Common Stock and Related Stockholder Matters
	Item 6. Selected Financial Data
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A. Quantitative and Qualitative Disclosures About Market Risk
	Item 8. Consolidated Financial Statements and Supplementary Data
	Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosures
	Item 9A. Controls and Procedures
PART III
PART IV
	Item 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
AMENDED AND RESTATED R&D LICENSE AGREEMENT
R&D AGREEMENT DATED 11/11/1997
TERMINATION AGREEMENT DATED 6/30/2000
EMPLOYMENT AGREEMENT/ STEPHEN A. HILL/ 1/1/2004
EMPLOYMENT AGREEMENT/ J. DAVID JACOBS/ 1/1/2004
EMPLOYMENT AGREEMENT/ LOUISE MAWHINNEY/ 1/1/2004
AMENDMENT TO COLLABORATION AGREEMENT/ 2/12/2004
SUBSIDIARIES OF THE COMPANY
CONSENT OF PRICEWATERHOUSE COOPERS LLP
SEC 302 CERTIFICATION OF CEO
SEC 302 CERTIFICATION OF CFO
SEC 906 CERTIFICATION OF CEO AND CFO


	High		Low

2002
First Quarter	$	16.90	$	10.75
Second Quarter		12.40		5.43
Third Quarter		7.14		5.02
Fourth Quarter		6.37		3.04
2003
First Quarter		3.13		2.04
Second Quarter		5.23		2.42
Third Quarter		4.82		3.74
Fourth Quarter		5.55		4.45
2004
First Quarter (through March 9, 2004)		6.60		5.01



			Year Ended December 31,

			2003			2002			2001			2000		1999

Statement of operations data:
Revenue			$	65,539		$	62,812		$	58,396		$	50,296	$	18,582
Cost and expenses:
	Cost of revenue			36,060			35,231			29,441			21,343		17,457
	Research and development			18,932			31,389			28,446			17,699		13,774
	Marketing, general and administrative			9,560			12,876			12,353			8,293		6,022
	Stock-based compensation			—			3,221			6,949			880		486
	Amortization of core technologies(a)			—			3,373			3,091			—		—
	Amortization of goodwill(a)(b)			—			—			4,013			—		—
	Impairment of core technology(c)			—			17,137			—			—		—
	Impairment of goodwill(c)			—			25,890			—			—		—
	Restructuring charges(d)(f)			1,239			12,695			—			—		—
	Acquired in-process research and development(a)(e)			30,359			—			18,000			—		—

		Total costs and expenses		96,150			141,812			102,293			48,215		37,739

Income (loss) from operations				(30,611	)		(79,000	)		(43,897	)		2,081		(19,157	)
Interest income, net				610			1,125			2,870			1,774		1,724
Loss on investment(g)				(4,750	)		—			—			—		—

Net income (loss)			$	(34,751	)	$	(77,875	)	$	(41,027	)	$	3,855	$	(17,433	)

Basic net income (loss) per share			$	(1.43	)	$	(3.67	)	$	(2.06	)	$	0.28	$	(1.38	)

Weighted average common shares outstanding — basic				24,333			21,215			19,905			13,911		12,606

	Diluted net income (loss) per share		$	(1.43	)	$	(3.67	)	$	(2.06	)	$	0.25	$	(1.38	)

Weighted average common shares outstanding — diluted				24,333			21,215			19,905			15,208		12,606



	December 31,

	2003		2002		2001		2000		1999

Balance sheet data:
Cash, cash equivalents and marketable securities	$	76,724	$	85,626	$	98,002	$	110,019	$	36,421
Working capital		54,698		54,176		69,365		93,437		17,371
Total assets		128,424		145,079		208,475		149,476		77,346
Long-term debt		1,218		6,850		11,700		7,200		10,700
Total stockholders’ equity		86,477		93,715		166,739		120,420		38,753


(Title of Each Class)		Name of Each Exchange on Which Registered

None		None


	*Inflammation — ARQ 101, a p38 MAP Kinase inhibitor for Rheumatoid Arthritis*


Item 1A.	*Executive Officers and Directors of the Registrant*


Name	Age		Position

Dr. Stephen A. Hill		45	President, Chief Executive Officer and a Director
Dr. Chiang J. Li		39	Vice President, Chief Scientific Officer, Head of ArQule BioMedical Institute
Louise A. Mawhinney		48	Vice President, Chief Financial Officer and Treasurer
J. David Jacobs, J.D.		42	Vice President, Legal, General Counsel and Secretary
Ariel Elia		69	Director (Chairman of the Board)
Laura Avakian		58	Director
Timothy C. Barabe		50	Director
Werner Cautreels, Ph.D.		51	Director
Tuan Ha-Ngoc		51	Director
Patrick J. Zenner		57	Director


Item 4.	*Submission of Matters to a Vote of Security Holders*


Item 5.	*Market for the Registrant’s Common Stock and Related Stockholder Matters*


(a)		In January 2001, ArQule acquired Camitro Corporation for $84.3 million in a stock purchase transaction. In conjunction with the transaction, we recorded intangible assets for core technology and goodwill of $23.6 million and $29.7 million, respectively, each of which was being amortized over their estimated useful lives of seven years. We also immediately charged to income the estimated fair value of purchased in-process technology that had not yet reached technological feasibility and had no future alternative use.

(b)		Effective January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, and accordingly ceased recording periodic goodwill amortization charges in lieu of performance of annual assessments for impairment.

(c)		In the fourth quarter of 2002, we performed impairment assessments of the carrying value of the Company’s core technology and goodwill balances. These assessments indicated that the value of the assets were fully impaired and, accordingly, we took impairment charges for the full remaining carrying value.

(d)		In December 2002, ArQule announced a major restructuring of its operations whereby it eliminated 31% of its workforce and closed its operations in Redwood City, California and Cambridge, United Kingdom.

(e)		In September 2003, ArQule acquired Cyclis Pharmaceuticals, Inc. for $25.9 million in a stock purchase transaction. In connection with the transaction, we immediately charged to income $30.4 million representing purchased in-process research and development that had not yet reached technological feasibility and had no future alternative use.

(f)		In October 2003, ArQule completed an agreement with InPharmatica Ltd. to sell certain assets of its former operations in the United Kingdom and to assign its facility obligation. As a result ArQule reversed $0.3 million of restructuring accrual to reflect a change in its original estimate of the remaining leasehold obligations and assumed sublease income in the United Kingdom. In December 2003, the adequacy of the restructuring accrual and assumed sublease income relative to the lease commitment in Redwood City, California was reassessed and, based on deteriorating market conditions, an additional provision of $1.5 million was recorded.

(g)		In the fourth quarter of 2003, the carrying value of an investment in a privately-held proteomic company was written down by $4.8 million to reflect the estimated fair value of the investment.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*



											% increase (decrease)

		2003			2002			2001			2002 to 2003			2001 to 2002


		(In millions)
Cash, cash equivalents and marketable securities		$	76.7		$	85.6		$	98.0			(10	)%		(13	)%
Working capital			54.7			54.2			69.4			1	%		(22	)%
Cash flow from:
	Operating activities		4.1			2.5			4.4			65	%		(44	)%
	Investing activities		(10.8	)		(1.7	)		(65.7	)		(543	)%		97	%
	Financing activities		(1.4	)		(3.7	)		18.4			62	%		(120	)%


				Within		Within		Within		After
		Total		1 Year		1-4 Years		4-7 Years		7 Years

Long-term debt obligations		$	6,912	$	5,840	$	1,072	$	—	$	—
Capital lease obligations			289		141		148		—		—
Operating lease obligations			10,951		2,821		5,597		2,533		—
Purchase obligations			2,965		1,253		797		533		382

	Total	$	21,117	$	10,055	$	7,614	$	3,066	$	382


Item 1.	*Business*


	*p53 Modulation (PUMA)*


	*Pain — Ion Channels*


Item 2.	*Properties*


	*Purchase Accounting and In-process Research and Development*


Termination benefits	$	2,140
Facilities related		9,607
Other charges		948

Total restructuring charges	$	12,695


	Restructuring				2003			Restructuring
	Accrual at		2003		Cash			Accrual at
	December 21, 2002		Provisions		Payments			December 31, 2003

Termination benefits	$	2,029	$	—	$	(2,019	)	$	10
Facilities related		6,285		1,239		(1,364	)		6,160
Other charges		436		—		(367	)		69

Total restructuring accrual	$	8,750	$	1,239	$	(3,750	)	$	6,239



										% (decrease)

	2003			2002			2001			2002 to 2003		2001 to 2002


	(In millions)
Interest income	$	1.1		$	2.1		$	4.5			(45)%		(54)%
Interest expense		(0.5	)		(1.0	)		(1.6	)		(44)%		(41)%

Interest income, net	$	0.6		$	1.1		$	2.9			(46)%		(61)%


Item 7A.	*Quantitative and Qualitative Disclosures About Market Risk*


Item 8.	*Consolidated Financial Statements and Supplementary Data*


	Page

Report of Independent Accountants		F-2
Consolidated Balance Sheet at December 31, 2003 and 2002		F-3
Consolidated Statement of Operations for the years ended December 31, 2003, 2002 and 2001		F-4
Consolidated Statement of Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001		F-5
Consolidated Statement of Cash Flows for the years ended December 31, 2003, 2002 and 2001		F-6
Notes to Consolidated Financial Statements		F-8


								Accumulated
	Common Stock				Additional			Other									Total
					Paid-In			Comprehensive			Deferred			Accumulated			Stockholders’
	Shares		Par Value		Capital			Income			Compensation			Deficit			Equity


	(In thousands, except share data)
Balance at December 31, 2000		17,072,727	$	171	$	151,084		$	29		$	(181	)	$	(30,683	)	$	120,420
Stock option exercises		90,310		1		753												754
Employee stock purchase plan		93,958		1		827												828
Issuance of common stock in connection with the Camitro acquisition		3,103,567		31		81,871						(12,552	)					69,350
Issuance of common stock to Pfizer		755,857		7		9,516												9,523
Forfeiture of deferred compensation						(1,404	)					1,404						—
Compensation related to the grant of common stock options						129						(129	)					—
Amortization of deferred compensation												6,949						6,949
Change in unrealized gain on marketable securities									49									49
Cumulative translation adjustment									(107	)								(107	)
Net loss															(41,027	)		(41,027	)

Balance at December 31, 2001		21,116,419		211		242,776			(29	)		(4,509	)		(71,710	)		166,739
Stock option exercises		130,739		2		534												536
Employee stock purchase plan		126,690		1		786												787
Forfeiture of deferred compensation						(883	)					883						—
Compensation related to the grant of common stock options						72						(72	)					—
Amortization of deferred compensation												3,221						3,221
Restructuring charge related to restricted stock												477						477
Change in unrealized loss on marketable securities and derivatives									(221	)								(221	)
Cumulative translation adjustment									51									51
Net loss															(77,875	)		(77,875	)

Balance at December 31, 2002		21,373,848		214		243,285			(199	)		—			(149,585	)		93,715
Stock option exercises		144,791		1		135												136
Employee stock purchase plan		116,984		1		384												385
Issuance of common stock in connection with Cyclis acquisition		4,571,327		46		18,884												18,930
Issuance of common stock to Pfizer		2,517,821		25		7,975												8,000
Change in unrealized loss on marketable securities and derivatives									94									94
Cumulative translation adjustment									(32	)								(32	)
Net loss															(34,751	)		(34,751	)

Balance at December 31, 2003		28,724,771	$	287	$	270,663		$	(137	)	$	—		$	(184,336	)	$	86,477


Current assets	$	52
Property, plant and equipment		1,297
IPR&D		30,359
Other assets		46
Current liabilities		(3,081	)
Long-term debt, excluding current portion		(2,540	)
Long-term capital leases, excluding current portion		(194	)

	$	25,939


Current assets		$	980
Property, plant and equipment			1,195
Intangible assets:
	Acquired core technology		23,600
	Assembled workforce		200
	In-process research and development		18,000
	Deferred compensation		12,552
	Goodwill		29,699
Other assets			244
Short term liabilities			(1,442	)
Long term liabilities			(760	)

		$	84,268



			December 31,

	Maturity		2003		2002

U.S. Government obligations		Within 1 year	$	4,040	$	1,000
Corporate bonds		Within 18 months		40,545		44,343

			$	44,585	$	45,343



	Less than 12 Months				12 months or more				Total

	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses

U.S. Government obligations	$	—	$	—	$	1,000	$	1	$	1,000	$	1
Corporate bonds		6,908		31		—		—		6,908		31

Total temporarily impaired securities	$	6,908	$	31	$	1,000	$	1	$	7,908	$	32



	Useful Life		December 31,
	Estimated
	(Years)		2003		2002

Land		—	$	6,487	$	6,487
Buildings		30		14,230		14,230
Machinery and equipment		5		28,938		26,110
Leasehold improvements		3-20		28,008		27,788
Furniture and fixtures		7		1,703		1,736
Computer equipment		3		12,928		12,251
Construction-in-progress		—		934		138

				93,228		88,740
Less-accumulated depreciation and amortization				45,286		37,224

			$	47,942	$	51,516



	Year Ended December 31, 2001

				Goodwill
	As			Amortization
	Reported			Adjustment		Pro Forma

Net loss	$	(41,027	)	$	4,013	$	(37,014	)
Basic and diluted net loss per share	$	(2.06	)	$	0.20	$	(1.86	)


						Facility
						Three Term		Promissory
Year Ending December 31,		Tranche B		Tranche C		Loan		Notes

2004		$	975	$	4,000	$	833	$	33
2005			—		—		833		29
2006			—		—		209		—

	Total payments due	$	975	$	4,000	$	1,875	$	62


	Number			Weighted Average
Stock Options	of Shares			Exercise Price

Outstanding as of December 31, 2000		2,407,075		$	9.50
Granted		1,112,875			13.83
Assumed in acquisition		150,718			1.27
Exercised		(122,112	)		6.16
Cancelled		(151,279	)		12.11

Outstanding as of December 31, 2001		3,397,277			10.18
Granted		1,011,092			11.84
Exercised		(130,739	)		4.10
Cancelled		(587,313	)		12.13

Outstanding as of December 31, 2002		3,690,317			10.54
Granted		960,115			3.76
Exercised		(144,791	)		.91
Cancelled		(609,723	)		10.44

Outstanding as of December 31, 2003		3,895,918		$	9.24

Exercisable as of December 31, 2003		2,379,867		$	9.98

Weighted average estimated value of options granted during the year ended December 31, 2003				$	2.73



	Options Outstanding						Options Exercisable

			Weighted
	Number		Average		Weighted		Exercisable		Weighted
	Outstanding at		Remaining		Average		as of		Average
	December 31,		Contractual		Exercise		December 31,		Exercise
Range of Exercise Prices	2003		Life		Price		2003		Price

$ 0.00 — 2.80		33,625		2.4	$	1.00		33,625	$	1.00
2.80 — 5.60		1,877,671		6.7		4.28		1,067,106		4.65
5.60 — 8.40		286,888		4.7		6.89		214,388		6.81
8.40 — 11.20		450,340		6.4		9.98		264,289		9.99
11.20 — 14.00		509,366		7.3		13.37		176,496		13.33
14.00 — 16.80		48,600		4.6		15.25		41,661		15.25
16.80 — 19.60		382,553		5.3		17.95		325,178		17.94
19.60 — 22.40		178,750		3.6		20.02		160,687		20.02
22.40 — 25.20		27,000		6.3		23.13		20,812		23.13
25.20 — 28.00		101,125		4.0		28.00		75,625		28.00

		3,895,918		6.2	$	9.24		2,379,867	$	9.98


	Operating		Capital
Year Ending December 31,	Leases		Leases

2004	$	2,821	$	141
2005		2,654		131
2006		1,844		17
2007		1,099		—
2008		1,144		—
Thereafter		1,389		—

Total minimum lease payments	$	10,951		289

Less: portion representing interest				(3	)

Present value of remaining lease payments				286
Less: current portion				(139	)

			$	147


	First			Second			Third			Fourth
	Quarter			Quarter			Quarter			Quarter

2003
Net revenues	$	15,653		$	15,482		$	15,961		$	18,443
Gross profit		6,320			6,625			7,083			9,452
Net income (loss)		(750	)		1,038			(29,909	)		(5,129	)
Net income (loss) per share, (basic and diluted)	$	(0.03	)	$	0.04		$	(1.22	)	$	(0.18	)
2002
Net revenues	$	13,968		$	16,231		$	16,459		$	16,154
Gross profit		5,694			7,432			7,095			7,360
Net loss		(8,375	)		(4,928	)		(5,468	)		(59,104	)
Net loss per share, (basic and diluted)	$	(0.40	)	$	(0.23	)	$	(0.26	)	$	(2.78	)


Item 9.	*Changes In and Disagreements with Accountants on Accounting and Financial Disclosures*