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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                   FORM 10-K

                                  (Mark One)

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

                For the fiscal year ended December 31, 2000 or

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

              For the transition period from          to

                       Commission File Number 000-30992

                      3-DIMENSIONAL PHARMACEUTICALS, INC.
            (Exact name of registrant as specified in its charter)

     Delaware                                              23-2716487
   (State of incorporation)                              (I.R.S. Employer
                                                      Identification No.)

  Eagleview Corporate Center, Suite 104, 665 Stockton Drive, Exton, PA 19341
               (Address of principal offices including zip code)

                                (610) 458-8959
              (Registrant's telephone number including area code)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

                                     None

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                    Common Stock, par value $.001 per share

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

   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 the definitive proxy statement
incorporated by reference in Part III of this annual report on Form 10-K or
any amendment to this annual report on Form 10-K. [ ]

   As of March 20, 2001, the aggregate market value of the Common Stock held
by non-affiliates of the registrant was $73,369,606. Such aggregate market
value was computed by reference to the closing sale price of the Common Stock
as reported on the Nasdaq National Market on such date.

   As of March 20, 2001, there were 21,479,512 shares of the registrant's
Common Stock outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Portions of the definitive Proxy Statement for the Registrant's 2001 Annual
Meeting of Stockholders to be held on May 14, 2001, to be filed within 120
days after the end of the fiscal year covered by this Annual Report on Form
10-K, are incorporated by reference into Part III of this Report
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                               TABLE OF CONTENTS

                                     PART I

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                                                                          Page
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 Item 1.  Business......................................................    3
 Executive Officers of the Registrant....................................  25
 Item 2.  Properties....................................................   27
 Item 3.  Legal Proceedings.............................................   27
 Item 4.  Submission of Matters to a Vote of Security Holders...........   27

                                    PART II

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          Market for the Registrant's Common Equity and Related
 Item 5.  Stockholder Matters...........................................   27
 Item 6.  Selected Financial Data.......................................   27
          Management's Discussion and Analysis of Financial Condition
 Item 7.  and Results of Operations.....................................   28
 Factors Affecting the Company's Prospects...............................  32
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk....   43
 Item 8.  Financial Statements and Supplementary Data...................   44
          Changes in and Disagreements with Accountants on Accounting
 Item 9.  and Financial Disclosure......................................   64

                                    PART III

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 Item 10. Directors of the Registrant...................................   64
 Item 11. Executive Compensation........................................   64
          Security Ownership of Certain Beneficial Owners and
 Item 12. Management....................................................   64
 Item 13. Certain Relationships and Related Transactions................   64

                                    PART IV

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          Exhibits, Financial Statement Schedules, and Reports on Form
 Item 14. 8-K...........................................................   64
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   This report includes "forward-looking statements" within the meaning of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include, but are not limited to, statements
about our plans, objectives, representations and contentions and are not
historical facts and typically are identified by use of terms such as "may,"
"will," "should," "could," "expect," "plan," "anticipate," "believe,"
"estimate," "predict," "potential," "continue" and similar words, although some
forward-looking statements are expressed differently. You should be aware that
the forward-looking statements included herein represent management's current
judgment and expectations, but our actual results, events and performance could
differ materially from those in the forward-looking statements. The forward-
looking statements are subject to a number of risks and uncertainties,
including, but not limited to, risks associated with our new and uncertain
technologies, clinical trials and product development, the long and arduous
process of obtaining regulatory approval, our dependence on existing strategic
alliances, our dependence on patents and proprietary rights, our ability to
protect and enforce our patents and proprietary rights, the development and
availability of competitive products or technologies and our ability to attract
and retain talented employees and to manage our expansion. These risks and
uncertainties are discussed below in the section entitled "Factors Affecting
the Company's Prospects." We do not intend to update any of these factors or to
publicly announce the results of any revisions to these forward-looking
statements.

                                     PART I

Item 1. Business

Overview

   We are a drug discovery company that discovers and develops its own drug
candidates, which we generally license at the pre-clinical or early clinical
stage. We are also using our technologies to assist collaborators in
discovering drug candidates. To facilitate this process, we have developed an
integrated set of proprietary technologies called DiscoverWorks(TM), which
accelerate and improve the drug discovery process and capitalize on the
opportunities presented by the thousands of new targets for drugs being
revealed from the sequencing of the human genome. Our technologies also
facilitate drug discovery for well-characterized disease targets that have
proven difficult using traditional methods. We believe that our technologies,
which apply to virtually any disease target, produce compounds suitable for
development into drugs in a more timely and cost-effective manner and with a
higher probability of success than that currently achieved using conventional
methods.

Industry Background

   The drug discovery process involves producing a "target protein," which is a
protein that because of its function in the body may underlie a disease
process; identifying "hit" compounds that interact with the particular target
protein; synthesizing and testing structurally similar compounds, or "analogs,"
to produce "lead" compounds with increased suitability as potential drugs; and
chemically modifying, or "optimizing," such lead compounds to produce
candidates for pre-clinical and clinical development. Parallel testing seeks to
confirm, or "validate," the link between the target protein and a specific
disease.

   Drugs are chemical compounds that change the activity of biological target
proteins associated with particular disease states to achieve the desired
therapeutic effect. Using traditional approaches, it has been estimated
generally to take from five to seven years from the initial identification of a
protein as a suitable target for a drug to the production of a drug candidate
ready to go into clinical trials. The major steps in the drug discovery process
following identification of the biological target involve (a) hit
identification, (b) lead generation, (c) lead optimization and (d) target
validation, each of which is described below.

   Hit identification: This involves the screening of large collections of
compounds to identify those compounds that interact with the biological target
(which may be an enzyme, receptor or other protein). A

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compound that interacts with a target protein is referred to as a "hit." In
order to identify hits, the following steps are undertaken:

  .  production ("cloning and expression") of sufficient quantities of the
     target protein to facilitate high- throughput screening;

  .  design and development of a high-throughput screen specific to the
     target protein; and

  .  screening the target protein against collections or "libraries" of
     compounds.

   Lead generation: This involves the chemical modification of hits by repeated
cycles of synthesis and testing of analogs to produce "leads," which are
compounds with improved chemical characteristics, thereby increasing their
suitability as potential drugs.

   Lead optimization: This involves the further optimization of leads by
additional repeated modification to produce drug development candidates with
optimized characteristics for further pre-clinical and clinical development.

   Target validation: In parallel to the above steps in the discovery process,
"target validation" studies seek to establish the link between the target
protein and the particular clinical disease. These tests usually involve
correlating changes in the level of the target protein in cells or animals with
changes in cell biology or animal physiology characteristic of the disease
state. This "biology-driven" target validation, which is generally employed
today in the pharmaceutical industry, is in contrast to "chemistry-driven"
target validation, where the role of the target protein in disease is
determined by testing a target-specific compound in living organism models.

   Drug discovery has traditionally been a costly and time-consuming process in
which the failure rate remains very high. Pharmaceutical companies are facing
growing challenges to rapid and cost efficient drug discovery as continuing
advances are made in genomics research. While there are approximately 500
currently known biological targets for human therapeutics, it is estimated that
genomics research will facilitate the identification of an additional 5,000
potential targets. In order to take advantage of the wealth of opportunities
presented by genomics research, pharmaceutical companies will need to generate
new lead compounds on a scale commensurate with the increase in new targets.
This will require the use of more advanced and integrated technologies to
rapidly and cost efficiently discover and develop lead compounds. We expect
this to become an increasingly severe bottleneck in the discovery process.
Accordingly, we believe that pharmaceutical companies will increasingly use the
resources of drug discovery companies with advanced technology capabilities and
license drug candidates developed by others.

   Although advances in recent years have improved the drug discovery process,
there remain serious bottlenecks, which can include:

  .  an inability to produce in a reasonable time sufficient quantities of
     the target protein for high- throughput screening and concurrent 3-D
     structure analysis of the target protein;

  .  the need to establish a different high-throughput screen for each new
     target, which typically can take from two to six months;

  .  an inability to rapidly generate leads from initial hits, a process
     which typically can take one to two years;

  .  the need for large resources in the lead optimization process;

  .  an inability to incorporate desirable drug-like attributes into leads
     and to validate target proteins sufficiently early in the optimization
     process; and

  .  the time-consuming and resource-intensive nature of the biology-driven
     target validation process.


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Our Integrated DiscoverWorks Solution

   We believe that we provide a unique solution to the problems of efficiency
and productivity in drug discovery in the era following the sequencing of the
human genome by integrating the use of an array of advanced tools with
proprietary information technology to more efficiently discover new drugs and
harness the opportunities presented by genomics. Our DiscoverWorks technologies
include the following technologies and capabilities:

  .  Target Protein Production. Our protein expression technology allows for
     the production of large quantities of a wide-range of target proteins,
     including important proteins embedded in the membrane of cells, such as
     G-protein coupled receptor (GPCR) targets.

  .  3-D Protein Structure. We are able to determine the 3-D structure of
     target proteins by using X-ray crystallography, which is performed by
     forming crystals of the target protein and analyzing how the crystals
     scatter X-rays. The 3-D view of the target protein is useful for
     designing targeted compound libraries or using a computer to screen our
     database of compounds accessible for automated chemical synthesis, to
     examine the way they fit to the 3-D protein structure.

  .  Compound Library. We have a highly diverse Probe Library of over 200,000
     actual compounds pre-designed for pharmaceutical acceptability, and
     available for automated high-throughput screening on demand. Our
     compounds are individually synthesized using combinatorial chemistry
     methods, where a central core structure is modified by the addition of
     different chemical groups connected to the core at different positions.

  .  High-Throughput Screening. Our proprietary ThermoFluor(R) high-
     throughput screening technology provides a direct means to
     quantitatively assess binding of potential drug compounds to virtually
     any target protein, including those derived from genomics. ThermoFluor
     screening does not require knowledge of a target's detailed biochemical
     function, as is required to set-up and use conventional screening
     assays. ThermoFluor screens can be set up for virtually any target
     protein in less than one week. The ThermoFluor screen can also be used
     to rapidly determine whether a target protein is suitable for small
     molecule drug discovery (i.e., whether the target protein is
     "drugable").

  .  Synthetically Accessible Compounds. We have a virtual library stored in
     our computers of approximately 2.5 billion new analogs of the Probe
     Library compounds. We call this virtual library our "Synthetically
     Accessible Library" because each of the compounds in this library can be
     generated in physical form using protocols for the automated synthesis
     of compounds, or "automated chemistry synthesis protocols," developed
     and verified in our laboratories.

  .  Data Analysis. Our DirectedDiversity(R) software allows us to
     comprehensively track and analyze the properties of compounds which have
     binding affinity to a target protein. Each of the compounds in our Probe
     Library and Synthetically Accessible Library has been indexed using a
     comprehensive set of approximately 500 characteristics of each molecule,
     such as bond lengths and angles, facilitating the rapid selection and
     synthesis of compounds with desired properties. In DiscoverWorks, we
     initially screen our Probe Library using the ThermoFluor screen to find
     hits. We then generate leads from these hits by synthesizing in
     succession and testing libraries of up to 1,000 compounds selected from
     our virtual library based on the compounds showing in their chemical
     structure a feature or features of a previous hit.

  .  Structure-based Compound Optimization. We have integrated into our
     DiscoverWorks platform structure-based drug design technology that uses
     X-ray crystallography to directly visualize how compounds bind to a
     target protein. This technology allows the atom-by-atom modification of
     hits to produce leads with improved potency and specificity, and permits
     us to incorporate 3-D structural information into the intelligent
     selection of sub-collections (or "sub-libraries") of the Probe Library
     directed to specific families of target proteins, as well as the
     intelligent design of focused libraries for lead generation. Our
     structure analysis capabilities are enhanced by our ability to make
     large amounts of proteins through our protein production technology.

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  .  Chemistry-driven Target Validation. Our DiscoverWorks technologies
     provide us with two ways to validate new genomics targets early in the
     discovery process:

    .  by using ThermoFluor screening of new, unvalidated target proteins
       against reference compound libraries to ascertain the biochemical or
       physiological properties of the target, a process we refer to as our
       "functional genomics" approach; and

    .  by allowing us to rapidly produce potent and specific leads to
       validate the significance of a new target through assessment of the
       activity of these leads in disease models.

   We believe that our technologies offer an important solution to the resource
and productivity dilemmas facing drug discovery in the era following sequencing
of the human genome by providing the following advantages:

  .  Time Reduction. DiscoverWorks reduces an important segment of the R&D
     process, from the setting up of an assay, which is a test to identify
     compounds that interact with a target protein, to the generation of a
     series of lead compounds with potential efficacy in living organisms,
     from 14 to 30 months at many pharmaceutical companies to as little as
     seven to ten months. We expect that this will reduce resources required
     and development costs per target and accelerate time to market of
     successful drugs.

  .  Improved Compound Characteristics. Owing to the quality of our library
     of compounds and our ability to use structural information about the
     target protein when optimizing lead compounds, our DiscoverWorks
     technologies enhance our ability to include desirable characteristics in
     our compounds to increase the likelihood of their successful development
     as drugs.

   We believe that our technology drives value creation through the reduction
of risk in discovery and early development by facilitating better, more timely
decisions. We expect that our technology, with its broad applicability, will
increase in value as the genomics revolution expands the number of new
molecular targets.

Our Strategy

   Our objective is to be an industry leader in discovery and optimization of
new drug candidates. The main elements of our strategy are to:

  .  Maintain and improve technology position:  We intend to continue to
     pursue technological innovation to enable us to have the most advanced
     and reliable drug discovery processes and tools, both for our
     collaborations and for our internal development programs. To date, we
     have invented the key proprietary technologies used in DiscoverWorks. We
     intend to continue to patent or otherwise protect our technological
     innovations to maintain our strong intellectual property position. We
     also intend to expand our libraries of drug compounds and associated
     drug property databases to facilitate the rapid discovery of new drug
     candidates.

  .  Expand internal drug discovery programs: Our strategy is to license
     internally developed drug candidates at the pre-clinical or early
     clinical stage so that we utilize our resources on the stages of R&D
     where we can add the greatest value. Our current internal drug discovery
     programs are focused on cardiovascular and cancer indications. We intend
     to expand our internal development programs to focus on GPCR targets for
     central nervous system and metabolic diseases and other biological
     targets in high-value therapeutic markets. We intend to form
     collaborations with major genomics and biotechnology companies and
     academic institutions to supply high-quality genomics targets to add to
     our portfolio of target proteins for our pipeline projects.

  .  Pursue additional collaborative R&D agreements: We intend to continue to
     enter into collaborative R&D agreements with leading companies based on
     our DiscoverWorks technologies, which are capable of providing our
     partners with an entire range of drug discovery services from target
     expression through generation of leads, which we can further optimize to
     produce an IND candidate.

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  .  Develop new technologies: We also intend to develop our technology for
     structural analysis of GPCRs that are potential or actual drug targets,
     which we believe represents a significant market opportunity. We believe
     that our scientific expertise applied to the production and 3-D
     structure determination of GPCRs that are drug targets has the potential
     to drive multiple discovery collaborations with pharmaceutical and
     biotechnology companies, as well as expand our internal development
     pipeline.

Evolution of Our Integrated Platform

   Our company was founded in 1993. Originally we focused on connecting
combinatorial chemistry and structure-based drug design to improve the lead
generation and optimization stages of drug discovery. To facilitate this
process, we developed and integrated proprietary chemi-informatic (software for
handling chemistry data) and process control software systems for combinatorial
chemistry, which we call DirectedDiversity. Our first patent for
DirectedDiversity was issued in 1995 and our DirectedDiversity software has
been continually enhanced since then. With the anticipated increase in
previously unknown targets due to the sequencing of the human genome, we also
sought to develop a flexible way to screen the activity of compounds for almost
any type of molecular target, which we call ThermoFluor. Our first patent for
ThermoFluor was issued in February 2000. We integrated the above technologies
as DiscoverWorks in 1998, for use in our internal programs. While we have used
certain of the above technologies in collaborations since 1996, the Bristol-
Myers Squibb Company collaboration, which we entered into in July 2000,
represents the initial collaborative use of the entire set of DiscoverWorks
technologies in a comprehensive drug discovery collaboration.

Our DiscoverWorks Technology Platform

   DiscoverWorks is a highly integrated, multi-dimensional platform for drug
discovery that links our ThermoFluor high-throughput screening technology,
Probe and Synthetically Accessible Libraries, DirectedDiversity chemi-
informatics and combinatorial chemistry capabilities and structure-based drug
design expertise. Starting from the DNA sequence of a new molecular target, we
have developed complete capabilities required to generate high quality chemical
leads (Prototype New Chemical Entity (NCE) Leads) that can be used to test
therapeutic hypotheses in vivo and serve as starting points for the generation
of clinical drug candidates. Our DiscoverWorks technologies can efficiently
assimilate and process vast quantities of data produced from the combination of
combinatorial chemistry and high-throughput screening, and can be rapidly and
efficiently scaled to meet increasing demand. Our DiscoverWorks process
integrates the following technologies:

 Target Protein Production

   We believe that timely large-scale production of target proteins is
essential for effective use of quantitative high-throughput screening
technology. We have extensive experience in cloning, engineering and expressing
target proteins using a wide array of bacterial, insect cell and mammalian cell
expression systems. We believe that we can produce large quantities of target
proteins, including membrane proteins that are difficult to make, in order to
facilitate high-throughput screening and target protein 3-D structure analysis.

 ThermoFluor and Other High-Throughput Screening Technologies

   Our proprietary ThermoFluor high-throughput screening process measures the
binding affinity of a large number of compounds to a target protein.
ThermoFluor is based on a physical effect common to all functionally active
proteins. Proteins, which constitute the vast majority of molecular targets,
are highly organized structures that melt at different defined temperatures. By
measuring the shift in melting temperature of the protein-drug complex caused
by drug binding (how a compound interacts with a protein), it is possible to
estimate the binding affinity of the drug. As a result, ThermoFluor can be
applied with equal effectiveness to virtually all

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varieties of enzymes, receptors, growth factors, antibodies, cell adhesion
molecules (molecules that influence contact between cells) and other target
proteins. We have developed ThermoFluor in an automated computer workstation
format using 384 well assay plates with integrated data processing and database
connectivity. We intend to continue to develop ThermoFluor to incorporate
miniaturization technology and enhance throughput.

   ThermoFluor is able to directly discover leads for target proteins with
unknown biological function, including the thousands of new targets being
identified through genome sequencing. Conventional high-throughput screening
techniques rely on readouts that reflect specific biological activities and
thus are generally time-consuming to set up and difficult to employ in the case
of targets with unknown biological function. We believe that ThermoFluor
significantly shortens the time required for high-throughput screen development
and compound library screening from two to six months for conventional assays
to one month or less. This time saving results from the uniform ThermoFluor
assay approach, as opposed to the need to develop a custom assay for each new
conventional high-throughput screen. The ThermoFluor assay developed and used
for high-throughput screening can also be applied during lead generation and
optimization, thus in many instances avoiding the need to set up subsequent
assays, and offering additional time and cost savings in the discovery process.
The technology is also portable and can be scaled up to screen very large
numbers of compounds at many targets.

   We can also complement ThermoFluor with additional capabilities in high-
throughput screening using conventional robot-assisted receptor binding assays
(measuring the binding affinity of compounds to receptor proteins) or enzyme
assays.

 DirectedDiversity Probe Library

   In order to initiate our DiscoverWorks discovery process, we have
constructed a DirectedDiversity Probe Library incorporating more than 200,000
individually synthesized "drug-like" compounds designed to include the
following desirable properties:

  .  diversity of chemical structures;

  .  representation of 3-D molecular shapes that we believe are useful for
     targeting drug binding sites on proteins; and

  .  possession of the structural and physicochemical characteristics (such
     as shape and molecular weight) commonly found in orally-active, small
     molecule marketed drugs (a small molecule drug is a drug that has a
     molecular weight of about 500 Daltons or less, and is not a protein or a
     peptide).

   As opposed to the compound libraries used by many pharmaceutical companies,
which may include compounds of unknown structure or which may lack certain
desired characteristics for drug candidates, our Probe Library has been
carefully assembled to reflect the parameters above, thereby optimizing its
value as a screening library. Prior to including a compound in our Probe
Library, we extensively analyze and accumulate information on the compound,
including a comprehensive set of approximately 500 molecular descriptors
(physicochemical characteristics of a molecule, such as shape and molecular
weight). The Probe Library includes sub-libraries directed toward classes of
enzyme targets called serine proteases and metalloproteases, receptor tyrosine
kinases, GPCRs and several other receptor classes with broad therapeutic
relevance.

 DirectedDiversity Synthetically Accessible Library

   To complement our Probe Library, we have generated a Synthetically
Accessible Library of approximately 2.5 billion compounds that are analogs of
the compounds in our Probe Library. Each of the compounds in the Synthetically
Accessible Library can be generated in physical form using automated chemistry
synthesis protocols developed and verified in our laboratories. For a typical
optimization cycle, we select a focused library of approximately 1,000
compounds from our Synthetically Accessible Library and synthesize them within
two to three weeks. As with our Probe Library, each of the compounds in our
Synthetically Accessible Library is indexed using a comprehensive set of
approximately 500 molecular characteristics.

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 DirectedDiversity Chemi-informatics Software and Databases

   Using the 500 molecular characteristics referred to above and artificial
intelligence computer procedures, or intelligent algorithms, our patented
DirectedDiversity chemi-informatics software helps assure that properties
important in drug development, such as potency, selectivity, bio-availability,
the extent of uptake of a drug into the body and minimal toxicity, are factored
into compound selection for inclusion in a focused library, and more broadly,
in the Prototype NCE Lead generation and further lead optimization processes.
Starting with hits from the Probe Library, our chemists use our proprietary
software and graphics interfaces to rapidly retrieve thousands of compounds
from our Synthetically Accessible Library which conform to the range of desired
properties. Each selected compound can then be synthesized for future
biological testing. Through our ability to rapidly select and synthesize a
focused library of compounds in each optimization cycle, our chemists can test
many optimization hypotheses in parallel, with all information tracked and
captured by the DirectedDiversity software for use in future compound synthesis
and testing cycles and other discovery programs. The combination of the
detailed chemical description of each of our compounds and the biological
screening data that is generated provides a valuable drug property database for
lead generation and further optimization.

   We believe our DiscoverWorks process is more efficient than traditional
methods due to the quality of both the compounds in our Probe Library and the
compounds from our Synthetically Accessible Library that we synthesize,
combined with the selection and feedback capabilities of our DirectedDiversity
chemi-informatics software and drug property databases. In contrast,
traditional approaches to library generation using combinatorial chemistry are
less directed and information-rich. Moreover, generation of leads derived from
conventional screening hits may require the development of new synthetic
procedures to make analogs, either because synthetic methods for generating
analogs have not previously been developed or the hit has an unknown chemical
structure which must be first determined in order to develop analogs.
Accordingly, an unnecessary expenditure of time and effort may be required in
the discovery process, and the compounds thereby produced may lack required
properties for orally active drugs. We estimate that a Prototype NCE Lead can
typically be generated using our technology in as little as six to nine months,
with five cycles of focused library design, synthesis and biological testing.
This compares to an estimated traditional lead generation process of 12 to 24
months which often requires more synthesis and testing cycles.

 Automated Chemical Synthesis Technologies

   We have a broad range of modern parallel synthetic technologies, which
affords us the capacity to synthesize approximately 20,000 compounds per month.
We believe this compound production is sufficient to support multiple
concurrent discovery programs and can be readily expanded.

 Structure-Based Drug Design Technology

   We have integrated into our DiscoverWorks platform structure-based drug
design technology that uses X-ray crystallography to directly visualize how
lead compounds bind to a target protein. Structure-based drug design allows the
atom-by-atom modification of leads to produce chemically new compounds with
high potency and specificity toward a given target protein. We have established
a state-of-the-art facility for protein production, crystallization, X-ray
crystallography and computational chemistry to carry out 3-D structure
determination of target proteins and their bound complexes with lead compounds.
To date, our scientists have carried out in excess of 100 structure
determinations of protein complexes in our laboratories. The integration of
DirectedDiversity technology with structure-based drug design allows us to
automate and multiplex (automate the synthesis of many compounds in parallel)
the rational design and chemical synthesis of compounds, enabling the
simultaneous investigation and optimization of multiple drug properties.

   Our company is a member of a consortium of pharmaceutical companies that
have formed the Industrial Macromolecular Crystallography Association (IMCA)
and developed a facility for collecting data obtained

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from examining the scattering patterns of X-rays as they interact with a
protein crystal using the unique properties of the Advanced Photon Source at
the Argonne National Laboratory in Argonne, Illinois. The Advanced Photon
Source is among the most brilliant X-ray sources in the world and greatly
extends our capabilities for determining new structures and rapidly carrying
out structure-based design programs. By joining IMCA, 3DP became the only
biotechnology company principally engaged in drug discovery that currently has
direct access to synchrotron X-ray data collection facilities. Other members of
IMCA include Merck & Co., Glaxo SmithKline, Pharmacia, Eli Lilly and Company,
Schering-Plough, Pfizer, Abbott Laboratories, Bristol-Myers Squibb Company, and
Procter & Gamble.

 Chemistry-Driven Target Validation

   Our chemistry-driven target validation process, also referred to as chemical
genomics or chemogenomics, relies on the any-target capability of our
ThermoFluor screen, coupled with our ability to generate Prototype NCE Leads
rapidly. We have two methods of chemistry-driven target validation: (1)
ThermoFluor screening of new, unvalidated target proteins with reference
libraries of compounds designed specifically to classify biochemical function
and physiological properties of target proteins and (2) use of DiscoverWorks
technology to rapidly produce potent and specific leads to assess and validate
the significance of a new target protein in disease models. By capitalizing on
our ability, using DiscoverWorks, to produce a Prototype NCE Lead in less time
than with conventional drug discovery, we can perform chemistry-driven
validation of new genomics targets early in the discovery process. This
provides an advantage compared to the more prolonged and resource-intensive
strategies of validating target proteins either by chemistry driven validation
as performed in conventional drug discovery, or by biological means of
validation.

 GPCR Technology Program

   G-protein coupled receptors, or GPCRs, are an important class of target
proteins that exist on the surface membrane of all cells, and are associated
with a wide range of therapeutic categories, including asthma, inflammation,
obesity and cancer and cardiovascular, metabolic, gastrointestinal and central
nervous system diseases. There are estimated to be over 600 GPCRs in the human
genome with potential therapeutic utility. GPCRs have been historically
valuable drug targets, but to date there are less than 200 well-characterized
GPCRs with known ligands (compounds which specifically bind to the GPCR), of
which only half are currently targets of commercial drugs. To date, the
industry has been unable to utilize an important drug discovery tool,
structure-based drug design using X-ray crystallography, to develop drugs
targeting either new or well-characterized GPCRs. This is due to the inability
of the industry to crystallize GPCRs that are actual or potential drug targets
and thereby derive three-dimensional X-ray structures that provide a direct
view of the drug-binding site.

   Currently, it is estimated that the less than 100 GPCRs targeted by
commercial drugs account for over $20 billion in annual worldwide drug sales.
These include major drug classes such as antipsychotics, antihistamines, beta-
blockers, anti-migraine drugs, anti-ulcer drugs and analgesics, including drugs
such as Claritin, Zantac, Cozaar, Zyprexa and Tenormin. Both the characterized
GPCRs with known ligands but for which no commercial drugs have yet been
developed, and the approximately 400 uncharacterized GPCRs with possible
therapeutic utility, represent potentially important drug targets.

   GPCR Drug Discovery: We have not produced crystals or X-ray data to
determine the structure of any drug target GPCR. We believe that, if we succeed
in crystallizing drug target GPCRs, our GPCR technology may present an
opportunity to exploit this broad and important range of drug targets,
benefiting both our internal discovery programs and pharmaceutical and
biotechnology company collaborations. Our objectives as we move forward with
this program for the 3-D molecular structure determination of drug target GPCRs
are to develop:

  .  more precisely designed drugs with fewer side effects than many existing
     GPCR drugs, such as antipsychotics;


                                       10
<PAGE>

  .  drugs with lower addiction risk than existing GPCR drugs for pain, such
     as morphine;

  .  small molecule, orally active drugs for GPCR targets for which the only
     currently known ligands are peptides or proteins that, as drugs, would
     need to be given by injection; and

  .  drugs targeting the approximately 400 identified GPCRs which are
     potentially therapeutically relevant, but for which ligands have not yet
     been discovered.

   To expedite drug discovery using GPCR target proteins, our current Probe
Library contains more than 20,000 synthesized compounds which have been
designed, based upon structural features of commercially successful GPCR drugs,
for utility against GPCR target proteins. In addition, our Synthetically
Accessible Library contains a corresponding collection of approximately 200
million analogs of these compounds.

   Our membership in IMCA provides access to a facility for collecting X-ray
scattering data using the unique properties of the Advanced Photon Source, a
dedicated very high energy X-ray source located at the Argonne National
Laboratory. Access to this facility greatly extends our capabilities for
determining new GPCR structures and rapidly carrying out structure-based design
programs.

Our Drug Discovery Collaborations

   We seek to enter into discovery collaborations and joint discovery programs
with pharmaceutical and biotechnology companies. These arrangements can take
various forms ranging from comprehensive programs to licensing agreements for
portions of our libraries, or specific R&D arrangements that utilize our
technologies for lead identification, lead generation and/or lead optimization
purposes. Our technologies are flexible and have applicability for virtually
any therapeutic area.

   Our collaboration strategy is aimed at capitalizing on the trend within the
pharmaceutical industry to outsource major components of the drug discovery
process that can be more effectively provided by companies that have unique
and/or focused technologies. We also seek collaborations with biotechnology
companies that may lack the chemical screening, synthesis and/or optimization
capabilities that our technology platform offers. These collaborations allow us
to leverage the investment we have made in our technology platform and provide
funding for our internal drug development efforts. A summary of our drug
discovery collaborations is provided below.

 Bristol-Myers Squibb Company

   In July 2000, we entered into a collaboration with Bristol-Myers Squibb
Company, or BMS, under which we are using our DiscoverWorks technologies to
assist BMS in the discovery and development of new human drugs for specific
biological targets. In the initial three-year term of the research
collaboration, BMS will supply at least 30 biological targets and we will
create chemical libraries and screen such libraries against these targets.
Thereafter, the parties will agree upon which organization will conduct
subsequent lead optimization and development activities of active hits toward
creating pre-clinical drug candidates and the terms of any such extension.
Patentable subject matter resulting from this collaboration will be assigned
according to U.S. practice for identifying inventorship. In addition to its
collaboration in this research, BMS will be primarily responsible for pre-
clinical and clinical development, and for marketing and sales of any resulting
products.

   Under the BMS contract, we have received upfront licensing and technology
access fees amounting to $19 million, and, as of December 31, 2000, we had
received research funding of $1.3 million. The contract provides that we will
receive committed additional research funding of approximately $13.1 million
over the remaining initial three-year term of the collaboration. In addition,
the contract provides that we will receive milestone payments through the
clinical development stages, and royalty payments on sales of any resulting
products, with the amount at each level determined based on our involvement in
the related optimization and development activities. For each compound,
depending on whether stipulated pre-clinical and clinical milestones are met
and depending on our level of contribution to the development of the compound,
the

                                       11
<PAGE>

contract provides that we could receive milestone payments aggregating up to
$4.5 million to $15 million. BMS also has the opportunity to purchase from us
ThermoFluor high-throughput workstations, seven of which are scheduled for
delivery during 2001.

   We have also granted BMS non-exclusive perpetual licenses under our
DirectedDiversity patent rights for the duration of the licensed rights and
non-exclusive perpetual licenses under our ThermoFluor technology for use by
BMS in their research and development programs in exchange for licensing fees.

   BMS may terminate research activities under our collaboration with 90 days
notice, without cause, but must pay any remaining research funding during the
initial research term or one-half of the remaining research funding during any
extended term. Following the end of the initial research or any extended
research term, either party may terminate the agreement on 30 days notice if no
compound is being optimized or developed under the collaborative agreement.
Otherwise, the agreement will remain in effect for 10 years from the first
commercial sale of a product identified from the research program or until the
expiration of patent rights relating to such product.

 DuPont Pharmaceuticals Company

   In February 2000, we entered into a collaboration with DuPont
Pharmaceuticals Company, or DuPont Pharmaceuticals, to use our
DirectedDiversity technology to assist DuPont Pharmaceuticals in the discovery
of new human and veterinary pharmaceutical compounds for specific biological
targets. The initial research term of the collaborative discovery and lead
optimization agreement is until December 31, 2001, subject to extension by
DuPont Pharmaceuticals. Under our agreement, we will generate custom
combinatorial chemistry libraries based on molecules and information provided
by DuPont Pharmaceuticals and will optimize those molecules into pre-clinical
drug candidates. DuPont Pharmaceuticals is responsible for pre-clinical and
clinical development, and marketing and sales of the resulting products. As of
December 31, 2000, we had received upfront fees and research funding
aggregating approximately $1.3 million and the contract provides that we will
also receive committed additional research funding of approximately $1.0
million over the initial term of the collaboration. The contract provides that
we could also receive milestone payments of up to $6 million, depending on
whether stipulated milestones are met, for the first product developed and
could receive additional milestones if subsequent products are developed. The
contract also provides that we are entitled to receive royalties on sales of
licensed products. We have agreed not to work with anyone other than DuPont on
compounds acting through the targets of the research program during the term of
the program and for one year thereafter.

   DuPont Pharmaceuticals may terminate the research program upon 90 days
notice, provided they pay the balance of any financial support due for the
remainder of the term of the research program.

   We have also entered into a separate agreement granting DuPont
Pharmaceuticals a nonexclusive site license to operate under our
DirectedDiversity patents in support of their internal and collaborative
research programs.

 Boehringer Ingelheim Pharmaceuticals, Inc.

   Effective December 1999, we entered into a collaboration agreement with
Boehringer Ingelheim Pharmaceuticals, Inc., or BIPI, to use our
DirectedDiversity technology to assist BIPI in the discovery of new drugs for
specific biological targets in humans. The initial research term of our
collaboration is two years, subject to annual extensions by BIPI. In this
collaboration, we have agreed to generate custom combinatorial chemistry
libraries based on molecules and information provided by BIPI and will optimize
those molecules into pre-clinical development candidates. BIPI is responsible
for pre-clinical and clinical development, and marketing and sales of the
resulting products. As of December 31, 2000, we had received upfront fees and
research funding aggregating approximately $2.3 million and the contract
provides that we will also receive committed additional research funding of
approximately $1.0 million over the initial term of the collaboration.

                                       12
<PAGE>

The contract provides that we could also receive milestone payments of up to
$2.4 million, depending on whether stipulated milestones are met, for the first
product developed and are eligible to receive additional milestones if
subsequent products are developed. The contract also provides that we are
entitled to receive royalties on sales of resulting products.

   BIPI may terminate the research program upon 30 days written notice provided
it pays us, in most circumstances, an early termination fee if it terminates
the research program prior to the end of any term.

   Aventis CropScience GmbH

   In October 1999, we entered into a collaboration with Hoechst Schering
AgrEvo GmbH, now Aventis CropScience GmbH ("Aventis") to use our
DirectedDiversity technology to assist Aventis in the discovery of compounds
applicable to plant and pest management and animal health. The initial term of
our agreement is two years. In this collaboration, we have agreed to provide
libraries of diverse compounds to Aventis, and will use our DirectedDiversity
technologies to optimize active compounds identified from Aventis' screening of
the compound libraries. Aventis will receive the exclusive worldwide right to
commercialize products in the fields of plant and pest management and animal
health that are discovered during the course of the collaboration. We will
retain rights for uses of compounds outside of the agrochemical commercial
area. As of December 31, 2000, we had received upfront fees, payment for
delivery of compounds, and research funding aggregating approximately $2.2
million and the contract provides that we will also receive additional fees for
research and development funding and license fees, totaling $1.3 million. The
contract provides that we could also receive milestone payments of up to $1.75
million, depending on whether stipulated milestones are met, for each compound
developed. The contract also provides that we will receive royalties on sales
of resulting products. If we enter into a business collaboration with a company
that has substantial activity in the plant and pest management or animal health
field and is a significant competitor of Aventis, Aventis may either terminate
our agreement or require us to take reasonable actions to ensure that Aventis'
confidential or proprietary information is not disclosed to such company.

 E.I. DuPont de Nemours

   In October 1998, we entered into a collaborative research and license
agreement with the Agricultural Products Division of E.I. DuPont de Nemours, or
DuPont, under which we are using our DirectedDiversity chemi-informatics
software and Synthetically Accessible Library to assist DuPont in the discovery
and development of new agrochemicals. As of December 31, 2000, we had received
technology licensing fees and milestone payments aggregating $0.7 million and
the contract provides that we are eligible to receive additional technology
licensing fees during the term of the collaboration. The contract provides that
we could also receive milestone payments of up to $3.7 million, depending on
whether stipulated milestones are met and on our level of contribution to the
optimization of the compound. In addition, the contract provides that we will
receive royalties on the sale of any products developed through this
collaboration. We have advanced in this collaboration from initial hits to more
potent compounds identified from our libraries.

   The initial research term of the agreement is three years. DuPont may
terminate the research program under the agreement at any time, but such
termination will not affect either DuPont's obligation to pay us license fees
under the agreement or our obligation to provide DuPont with access to
DirectedDiversity computer workstations.

 Heska Corporation

   In December 1997, we entered into a research and license agreement with
Heska Corporation, or Heska, to use our DirectedDiversity technology to assist
in the discovery and development of new veterinary therapeutic agents. Under
our agreement, we also granted Heska the exclusive worldwide right to license
the veterinary therapeutic products developed for sale worldwide. Under our
agreement, we received up-front payments and research funding totaling
approximately $2.7 million. Our agreement originally had a two-year research
term

                                       13
<PAGE>

expiring in December 1999, which was extended until it expired in July 2000.
The contract provides that we could receive milestone payments of up to $10.5
million, depending on whether stipulated milestones are met, for the first
product developed and that we are eligible to receive additional milestones if
subsequent products are developed. The contract provides that we will also
receive royalties on sales of resulting products.

Our Internal Drug Candidate Programs and Commercial Licensing and Development
Collaborations

   We are building a promising pipeline of small molecule, orally active
development candidates in the areas of cardiovascular disease, cancer and other
indications. Our current strategy with respect to our internal pipeline is to
advance compounds to late-stage pre-clinical or early stage clinical trials,
and then to license such compounds to pharmaceutical companies for further
development and commercialization. We believe that by focusing our efforts on
pre-clinical development and the early stages of clinical development, we can
use our resources on the stages of drug research and development where we can
add the greatest value.

   As of March 20, 2001, we had several internal programs dedicated to
developing a pipeline of small molecule, orally active drug candidates in
various stages of discovery and development. Our more advanced programs are
described in the table below.

<TABLE>
<CAPTION>
 Molecular Target   Therapeutic Area         Indication                Status

 <S>                <C>              <C>                         <C>
     Thrombin        Cardiovascular          Thrombosis                Phase 1
                                                                    (Licensed to
                                                                 Centocor/Johnson &
                                                                      Johnson)

     Urokinase           Cancer             Solid Tumors            Pre-clinical
                     Cardiovascular  Restenosis, Atherosclerosis    (Licensed to
                                                                 Berlex/Schering AG)

     AvB3/AvB5           Cancer             Solid Tumors            Pre-clinical
                     Bone Disorders         Osteoporosis
                     Cardiovascular          Restenosis

        C1s           Inflammation   Lupus, Autoimmune Diseases     Pre-clinical
                     Cardiovascular        Bypass Surgery         (In collaboration
                       Pulmonary     Adult Respiratory Distress    with BioCryst)
                                           Syndrome (ARDS)

    Hdm2(mdm2)           Cancer      Adjunct to Chemotherapy and  Lead Optimization
                     Cardiovascular           Radiation
</TABLE>

   To date, our internal program pipeline has been based on biological targets
in high-value therapeutic areas that are well known in the pharmaceutical
industry, and have either been recently validated and/or have proved difficult
targets for the industry to develop into commercially attractive products. The
worldwide market for pharmaceuticals is expected to grow substantially given
expectations of improved therapies which will arise from genomics and other
scientific advances and the demographics of an aging and longer-living global
population. Despite the scale of R&D operations within large pharmaceutical
companies, most will continue to license a significant portion of the drugs
that they eventually sell. The market for pre-clinical/early clinical
candidates from our internal programs is therefore significant and is expected
to continue to grow.

 Cardiovascular Disease and Cancer Discovery Programs

   Our initial cardiovascular disease focus is on the enzymes that act together
to form blood clots. This focus is derived from our expertise in serine
protease enzyme drug targets which are well-suited for structure-based

                                       14
<PAGE>

drug design and our other DiscoverWorks capabilities. We have assembled a
portfolio of molecular targets involved in such cardiovascular conditions as
thrombosis, restenosis (reocclusion of blood vessels), angina and
atherosclerosis, and which are also involved in the vascular remodeling
(changes in blood vessel structure) and angiogenesis (the formation of blood
vessels that are required to feed a growing tumor) which underlie the
progression of cancer.

   Our anticancer efforts are aimed at inhibiting cellular processes that
facilitate tumor progression and angiogenesis for a majority of cancer types,
which we believe may result in broadly useful anticancer agents. These cellular
processes include cell activation, growth and migration, adhesion and focal
proteolysis (the enzymatic digestion of proteins to facilitate cell migration),
which are involved in metastasis (the spread of tumor cells away from the
original tumor) and angiogenesis. In addition, we are initiating programs that
target molecules involved in cell-cycle regulation and apoptosis (cell death).
Many of the agents under development are anticipated to have crossover utility
in cardiovascular disease. Our principal cancer targets include urokinase,
AvB3/AvB5, and a binding protein in cancer cells called hdm2 (mdm2).

 Key Cardiovascular Disease Drug Candidates

   Oral Thrombin Inhibitor: Our most advanced cardiovascular drug discovery
program focuses on the development of potent, selective, and orally active
inhibitors of thrombin for arterial and venous thrombosis, including the lead
anticoagulant compound, 3DP-4815, currently in Phase I clinical development. In
December 2000, we entered into an agreement with Centocor, Inc., a subsidiary
of Johnson & Johnson, under which Centocor acquired worldwide rights to our
orally active direct thrombin inhibitor program, including 3DP-4815. Centocor
is responsible for development and worldwide commercialization of all compounds
under the agreement. For the deep vein thrombosis indication, however, we have
an option to co-develop and co-promote with Centocor in the United States. We
will also collaborate with Centocor on a research program to continue our
effort to design and elucidate back-up and follow-on compounds to 3DP-4815.
Under the agreement, we received an upfront cash payment of $6 million from
Centocor and we could also receive milestone payments of up to $44 million
based on the achievement of certain milestones for the first compound developed
and approved under the agreement. During the initial two-year research term,
the contract provides that we will receive payments for research funding
totaling $1.65 million. In addition, we are entitled to receive royalties on
sales of any products marketed under the agreement.

   The only oral anticoagulant currently marketed is warfarin (Coumadin and
generic versions). We have designed our compounds to work by a different
mechanism of action from warfarin, which we believe will provide an enhanced
safety profile without the need for monitoring.

   3DP-4815 was discovered through the close integration of structure-based
drug design and DirectedDiversity combinatorial chemistry and represents a new
class of orally bioavailable thrombin inhibitors. 3DP-4815 is a low molecular
weight, homogenous compound without any asymmetic center that potently and
reversibly inhibits thrombin with excellent specificity. 3DP-4815 is orally
bioavailable and efficacious in several animal models. We filed an
Investigatory New Drug Application ("IND") with the FDA for 3DP-4815 in
December 1999 and initiated Phase 1 clinical trials in January 2000. Unlike
many agents where the detection of pharmacological activity requires results
from advanced patient studies, the pharmacological activity of anticoagulant
agents can be readily observed in the first human clinical trial experience in
normal volunteers. To date, in Phase 1 clinical trials, 3DP-4815 exhibits good
safety and tolerability characteristics.

   Throughout the pre-clinical development phase for 3DP-4815, we have actively
pursued the discovery of additional compounds in the thrombin inhibitor
program, and have identified new classes of compounds that differ significantly
in their chemical structures and pharmacokinetic properties from 3DP-4815.
These may offer the opportunity for backups to 3DP-4815, or additional
therapeutic types of oral antithrombotic agents differentiated by their
pharmacokinetic and other properties.

                                       15
<PAGE>

 Key Cancer Disease Drug Candidates

   Urokinase Inhibitor for Cancer Therapy: Our most advanced cancer discovery
program targets the inhibition of urokinase plasminogen activator (uPA or
Urokinase). An inhibitor of uPA provides a new therapeutic approach to cancer
treatment following surgical removal of tumors, through its ability to inhibit
angiogenesis and metastasis. An expanding body of evidence supports the
identification of uPA as a target for agents that control the spread and growth
of cancer. In addition, uPA has been identified as a target for agents that
prevent restenosis and atherosclerosis.

   Urokinase is a serine protease enzyme that is related to thrombin, but has a
different site on the enzyme molecule that binds substrate (active site
structure), and a different order of potency of substrates and inhibitors
compared to thrombin. Our urokinase inhibitor discovery program draws
substantially from the knowledge base developed in our thrombin inhibitor
program. We have advanced our urokinase inhibitor program using focused
libraries and structure-based drug design, and have discovered proprietary,
potent, orally active, small molecule inhibitors of urokinase. Our pre-clinical
lead compounds have been shown to inhibit tumor cell invasion associated with
prostate cancer and melanoma, inhibit migration of blood vessel muscle cells
without causing cells to die and have oral bioavailability. We believe that our
urokinase inhibitor has potential application as a stand alone agent or in
combination with other compounds under development or currently marketed as
part of a multi-drug therapy regimen.

   In May 2000, we entered into a license and research agreement with Schering
AG, Germany in which Schering AG, Germany obtained, for human therapeutic uses,
exclusive worldwide rights to our urokinase inhibitor compounds. Under our
agreement, we will be responsible for further research and optimization of the
compounds and Schering AG, Germany will be responsible for development,
marketing and sales of the resulting products. As of December 31, 2000, we have
received research funding aggregating approximately $1.6 million and the
contract provides that we will receive committed additional funding of
approximately $3.4 million over the initial two-year term of the research
program. The contract also provides that we could also receive milestone
payments of up to approximately $23 million, depending on whether stipulated
milestones are met, for the first product developed in a therapeutic area, and
we are eligible to receive further milestones for additional therapeutic areas.
After the initial research term, Schering AG, Germany may terminate the
agreement at any time on 90 days' notice. In connection with the agreement, we
issued shares of our series D preferred stock to an affiliate of Schering AG,
Germany for $5 million. These shares automatically converted into 223,214
shares of common stock upon the closing of our initial public offering.

   Antagonists of AvB3/AvB5 and AvB3/AvB5 Integrins: The integrin adhesion
proteins AvB3/AvB5 and AvB3/AvB5, which are receptors for vitronectin and
osteopontin, important proteins that regulate contact between cells, are
essential modulators or mediators of angiogenesis and of the adhesion of cells
of the inner layer of the walls of blood vessels in tumor angiogenesis,
atherosclerosis, restenosis and osteoporosis. We have applied our proprietary
technology to the discovery of potent and selective small molecule antagonists
of AvB3/AvB5 and AvB3/AvB5 and discovered several independent lead series of
compounds. Our lead compounds have been shown to inhibit cellular processes
that require functioning of AvB3/AvB5 and AvB3/AvB5 integrins, such as cell
adhesion or attachment, and migration of endothelial cells which form blood
vessels and cells that form smooth muscle. In addition, our lead compounds are
not cytotoxic and have been shown not to kill cells.

 BioCryst Pharmaceuticals, Inc.

   In October 1996, we entered into a research collaboration with BioCryst
Pharmaceuticals, Inc., to share resources and technology to develop inhibitors
of key serine protease enzymes, including C1s, that represent promising targets
for inhibiting the activation of "complements" (plasma proteins that work to
eliminate microorganisms and other antigens from tissues and blood). This
pathway plays a major role in mediating a broad range of immunological
diseases. In June 1999, we updated and renewed our original agreement to
concentrate on selected complement enzymes as targets for the design of
inhibitors. Under our agreement, we are each responsible for our own research
costs. If a drug candidate emerges as a result of our joint research,

                                       16
<PAGE>

we will then negotiate the product development and commercialization rights and
responsibilities. Under this collaboration, we have generated Prototype NCE
Leads which are currently being optimized further through evaluation in living
organisms and for which we have filed patent applications. The initial term of
the agreement was one year, subject to automatic annual renewal. Either of us
may terminate the agreement at any time upon 60 days written notice. The
agreement was last renewed in June 2000 for an additional year.

 Other Internal Discovery Programs

   In addition to programs in cardiovascular disease and cancer, we plan to
initiate additional programs for central nervous system and metabolic diseases.

Intellectual Property

   Protection of our intellectual property is a strategic priority for our
business. Our ability to protect and use our intellectual property rights in
the continued development and commercialization of our technologies and drug
candidates, operate without infringing the proprietary rights of others and
prevent others from infringing on our proprietary rights is crucial to our
continued success. We will be able to protect our proprietary rights from
unauthorized use by third parties only to the extent that our proprietary
rights are covered by valid and enforceable patents, trademarks or copyrights,
or are effectively maintained as trade secrets, know-how or other proprietary
information. We currently rely on a combination of patents and pending patent
applications, some of which we license and most of which we own, and on
trademarks, copyrights, trade secrets, know-how and proprietary information, to
protect our interests as we continue to develop and commercialize our
technologies and drug candidates.

   We devote significant resources to obtaining, enforcing and defending
patents, as well as developing and protecting our other proprietary
information. Our comprehensive patent strategy is to augment our broad
proprietary portfolio by continuing to actively seek patents for our
technologies and compounds. We have already obtained patents or filed patent
applications on a number of our technologies and on certain of the compounds we
have developed. We also have certain proprietary trade secrets and know-how
that are not patentable or for which we have chosen to maintain secrecy rather
than file for patent protection.

   We have taken certain security measures to protect our trade secrets,
proprietary know-how, technologies and confidential information and continue to
explore further methods of protection. We have executed confidentiality
agreements with our employees and consultants upon the commencement of an
employment or consulting arrangement with us. These agreements require that all
confidential information developed or made known to the individual by us during
the course of the individual's relationship with us be kept confidential and
not disclosed to third parties. These agreements also provide that inventions
conceived by the individual in the course of rendering services to us shall be
our exclusive property. We also attempt to limit access to, and dissemination
of, our confidential information.

   Our intellectual property estate is as follows:

 Drug Discovery Program Patents

   We have ten issued U.S. patents, five Australian patents, four New Zealand
patents, two South African patents and one Pakistani patent covering our drug
discovery program inventions.

   The patents cover various compounds, methods of making compounds,
pharmaceutical compositions, and methods of using the compounds for inhibiting
proteases and for treating particular disease states. The proteases that are
inhibited include, but are not limited to, thrombin, factor Xa, urokinase,
complement and other protease inhibitors, integrins and certain other targets.
Disease states include cardiovascular diseases and cancer as described in the
section entitled "Our Internal Drug Candidate Programs and Commercial Licensing
and Development Collaborations." The U.S. patents are directed to distinct
families of new compounds.


                                       17
<PAGE>

   We also have 28 pending U.S. patent applications, seven of which have
received a notice of allowance from the U.S. patent office, and 133 pending
foreign patent applications and six applications in preparation, covering
compounds, methods of making compounds, pharmaceutical compositions, and
methods of using the compounds for inhibiting proteases and for treating
particular disease states.

   We currently do not have any issued patents for any of our lead compounds in
our internal program, but we have two allowed applications covering lead
compounds, one in our thrombin internal program and one in our urokinase
internal program, respectively. However, we may be unable to obtain any issued
patents for any patent applications we have filed or may file in the future for
such compounds.

 DirectedDiversity Combinatorial Chemistry Process Patents

   Our DirectedDiversity technology is protected by four issued U.S. patents.
Collectively, these patents provide apparatus and process patent coverage for
the automated, semi-automated and/or manual computer directed selection,
synthesis, testing, and refinement of compounds in chemical libraries,
including the computer codes that allow implementation of this process.

   In October 1995, we were issued our first U.S. patent covering our
DirectedDiversity technology. The patent covers the use of semi-automated
feedback control for refining the properties of combinatorial libraries for all
applications in which suitable properties can be measured (e.g., drugs,
herbicides, paints, scents, solvents, advanced materials, etc.). A second U.S.
patent related to our DirectedDiversity technology was issued in November 1996
covering the automatic generation of new drug leads through computer-
controlled, iterative robotic synthesis and analysis of chemical libraries. Our
third U.S. patent, issued in November 1997, covers additional features of our
DirectedDiversity technology, including inventions related to computer software
for semi-automatic and automatic generation of compounds of interest. We
received our fourth U.S. patent for DirectedDiversity in May 1999, covering the
generation of new drug leads through computer-controlled, iterative robotic
synthesis and analysis of chemical libraries.

   We also have three Australian patents and two Israeli patents covering our
DirectedDiversity technology described above.

   Additionally, we have 12 pending U.S. patent applications and 33 pending
foreign patent applications. In addition to our DirectedDiversity technology
described above, these patent applications cover new methods for handling large
multidimensional data sets. Within our DirectedDiversity technology, these
methods are utilized for visualizing chemical compound
similarity/dissimilarity, for lead identification, and for lead optimization.
The methods for handling large multi-dimensional data sets have applications
beyond our DirectedDiversity technology. Two of these pending U.S. patent
applications and one of these pending foreign patent applications cover
apparatuses, processes and software inventions for quickly and efficiently
searching large chemical libraries, as well as other inventions relating to
data mining (searching data for relationships).

 ThermoFluor Patents

   We have two issued U.S. patents covering our ThermoFluor screening and
protein characterization technology, process and instruments. One U.S. patent
covers methods for screening compounds for binding to proteins and nucleic
acids, and the other covers an instrument for implementing our patented methods
for screening compounds.

   We also have ten pending U.S. patent applications, one New Zealand patent
and 19 pending foreign patent applications covering this technology. We have
received notice of allowance on two of these U.S. patent applications. The
pending applications cover methods for screening for biochemical conditions
that stabilize proteins and nucleic acids, methods for screening for
biochemical conditions that facilitate protein crystallization, methods for
screening for biochemical conditions that promote recombinant protein folding,
and methods for screening for lead compounds that bind to a target receptor.
The pending applications also cover "functional genomics," which include
methods for screening proteins of unknown function in order to determine the
function of newly discovered proteins.

                                       18
<PAGE>

   Under the terms of a settlement agreement with Anadys Pharmaceuticals, Inc.
(formerly Scriptgen) relating to an action that Anadys brought against us in
the United States District Court for the District of Delaware on October 13,
1998 for our alleged infringment of two patents, we acquired a limited license
to Anadys' ATLAS (Any Target Ligand Affinity Screen) assay technology and
Anadys was granted a limited license to the method claims of our ThermoFluor
assay technology. Neither of these licenses is exclusive. Under this agreement,
we paid Anadys $1.5 million and Anadys released us from all claims of
infringement with respect to those two patents. The settlement agreement
restricts us, until March 7, 2003, from specified activities in connection with
screening drugs useful for treating "infection" (defined as relating to drugs
whose principal aim is to treat or cure infectious disease in humans). As part
of this settlement agreement, we are precluded from using our ThermoFluor
screening technology in the Hepatitis C Virus "infection" area as part of
collaborative agreements or as part of our internal drug programs until March
7, 2003. In addition, we are precluded from using our ThermoFluor screening
technology as part of more than one collaboration agreement in the area of
"infection" until March 7, 2003, and such collaborative agreement must be
limited to a maximum of three anti-viral targets. Our collaboration with BMS
constitutes the one permitted collaboration agreement in the area of infection.
The settlement with Anadys, however, does not restrict use of our ThermoFluor
screening technology for our internal drug discovery efforts, other than the
limitation with respect to Hepatitis C Virus "infection," or for purposes of
collaborative agreements outside the area of "infection." In addition, if our
use of ThermoFluor facilitates the discovery of a drug used to treat infectious
disease, we are obligated to pay Anadys a royalty based on revenue from the
sale of such a drug.

 Other Technology

   We have made discoveries relating to other technology which may be useful
for drug discovery. Two such patent applications have been filed, one
concerning components of the GPCR technology.

 U.S. Government Grants

   We have been awarded a number of U.S. government grants to fund a variety of
internal scientific programs and undertake exploratory research. Under these
grants, we retain ownership of all intellectual property and commercial rights
generated during these projects, subject to a non-transferable, paid-up license
for the use by or on behalf of the United States of the inventions made with
federal funds. This license is not exclusive and is retained by the U.S.
government as provided by applicable statutes and regulations. We have received
the following award and government grants from the National Institutes of
Health (Small Business Innovative Research "SBIR" grants) and the National
Institute of Standards and Technology (Advanced Technology Program "ATP" award)
during the past several years under which we have received a total of
approximately $3.8 million:

<TABLE>
<CAPTION>
                                                                 Grant/Award
Grant/Award Title                                                    Date
-----------------                                               --------------

<S>                                                             <C>
Automated Receptor Screening by Thermal Physical Assays
 (SBIR)(Phase 1)...............................................       May 1995

Crystallization and Structural Determination of G-Coupled
 Protein Receptors (ATP).......................................    August 1995

Protein Engineering a Receptor Antagonist (SBIR)(Phase 1)...... September 1995

Automated Receptor Screening by Thermal Physical Assays
 (SBIR)(Phase 2)............................................... September 1996

Four Helix Bundle Analog of a G-Protein Coupled Receptor
 (SBIR)(Phase 1)...............................................  February 1999

Expression of G-Protein Coupled Receptors for Structure
 Determination (SBIR)(Phase 1)................................. September 1999

Four Helix Bundle Analog of a G-Protein Coupled Receptor
 (SBIR)(Phase 2)...............................................     March 2000
</TABLE>


                                       19
<PAGE>

   The sponsoring agencies make decisions annually on continuations of multi-
year awards based on the availability of funds from the United States Congress
and our satisfactory performance under each grant or award.

Government Regulation

   The U.S. Food and Drug Administration (FDA) and comparable regulatory
agencies in state and local jurisdictions and in foreign countries impose
substantial requirements on the development, manufacture and marketing of
pharmaceutical candidates. These agencies and other federal, state and local
entities regulate research and development activities and the testing,
manufacture, quality control, safety, effectiveness, labeling, storage, record-
keeping, approval, promotion and advertising and pricing of our drug candidates
and those of our collaborative partners. Obtaining marketing approvals and
later complying with ongoing statutory and regulatory requirements are costly
and time-consuming. Any failure by us or our collaborators, licensors or
licensees to obtain, or any delay in obtaining, regulatory approvals or in
complying with other requirements could adversely affect the commercialization
of drug candidates and our ability to receive upfront payments, milestone
payments or royalty revenues.

   The steps required before a new drug candidate for humans may be distributed
commercially in the U.S. generally include:

  .  conducting appropriate pre-clinical laboratory evaluations of the drug
     candidate's chemistry, formulation and stability, and pre-clinical
     studies to assess the potential safety and efficacy of the product
     candidate;

  .  submitting the results of these evaluations and tests to the FDA, along
     with manufacturing information and analytical data, in an
     investigational new drug application (IND);

  .  making the IND effective after the resolution of any safety or
     regulatory concerns of the FDA;

  .  obtaining approval of Institutional Review Boards, or IRBs, to introduce
     the drug into humans in clinical studies;

  .  conducting adequate and well-controlled human clinical trials that
     establish the safety and efficacy of the drug candidate for the intended
     use, typically in the following sequential, or slightly overlapping,
     stages:

     Phase 1: The drug candidate is initially introduced into healthy human
     subjects or patients and tested for safety, dose tolerance,
     absorption, metabolism, distribution and excretion;

     Phase 2: The drug candidate is studied in patients to identify
     possible adverse effects and safety risks, determine dosage tolerance
     and the optimal dosage, and collect some efficacy data;

     Phase 3: The drug candidate is studied in an expanded patient
     population at multiple clinical study sites to confirm efficacy and
     safety at the optimized dose, by measuring a primary endpoint
     established at the outset of the study; and

     Phase 4: The FDA may in some circumstances require post-marketing
     studies to delineate additional information about a drug's risks,
     benefits and optimal use;

  .  submitting the results of preliminary research, pre-clinical studies,
     and clinical trials as well as chemistry, manufacturing and control and
     labeling information on the drug candidate to the FDA in an New Drug
     Application (NDA) or Biologics License Application (BLA); and

  .  obtaining FDA approval of the NDA or BLA prior to any commercial sale or
     shipment of the drug candidate.

   The steps required before a new animal drug may be distributed commercially
in the U.S. are similar to the foregoing. The major differences are that
additional safety issues need to be addressed if the target

                                       20
<PAGE>

animal(s) will contribute or be part of human food, and the requisite clinical
study requirements for animal drugs are oftentimes less expensive than that for
human drugs. Also, there are no user fees for New Animal Drug Applications
(NADAs).

   Upon approval, a drug candidate may be marketed only in those dosage forms
and for those indications approved in the NDA or BLA/NADA. In addition to
obtaining FDA approval for each indication to be treated with each product
candidate, each foreign and domestic drug candidate manufacturing establishment
must register with the FDA, list its product candidates with the FDA, comply
with cGMPs and permit and pass manufacturing plant inspections by the FDA.
Moreover, the submission of applications for approval may require additional
time to complete manufacturing stability studies. Foreign companies that
manufacture drug candidates for distribution in the United States also must
list their product candidates with the FDA and comply with cGMPs. They are also
subject to periodic inspection by the FDA or by local authorities under
agreement with the FDA. Moreover, approval of drug candidates may be delayed by
certain market exclusivity and patent protections awarded to other parties
concerning similar products or drug candidates.

   Any drug candidates that we or our collaborators manufacture or distribute
under FDA approvals are subject to extensive continuing regulation by the FDA,
including recordkeeping requirements and reporting of adverse experiences with
the product candidate. Additionally, if we or our collaborators propose any
modifications to a product, including changes in indication, manufacturing
process, manufacturing facility or labeling, we or our collaborators may be
required to submit an NDA/NADA supplement to the FDA. The promotion and
advertising for drugs that we or our collaborators market are also subject to
review and can be the subject of possible FDA action.

   Failure to comply subjects the manufacturer to possible FDA action, such as
warning letters, suspension of manufacturing, seizure of the product, voluntary
recall or withdrawal of a product or injunctive action, as well as possible
civil or criminal penalties. We currently rely on, and intend to continue to
rely on, third parties to manufacture our compounds and product candidates.
These third parties will be required to comply with cGMPs.

   Products manufactured in the United States for distribution abroad will be
subject to FDA regulations regarding export, as well as to the requirements of
the country to which they are shipped. These latter requirements are likely to
cover the conduct of clinical trials, the submission of marketing applications,
and all aspects of manufacturing and marketing. Such requirements can vary
significantly from country to country. As part of our strategic relationships,
our collaborators may be responsible for the foreign regulatory approval
process for our product candidates, although we may be legally liable for
noncompliance.

   We and our collaborators are also subject to various federal, state and
local laws, rules, regulations and policies relating to safe working
conditions, laboratory and manufacturing practices, the experimental use of
animals and the use and disposal of hazardous or potentially hazardous
substances used in connection with our research work. Also, the availability
and levels of government or third party payor reimbursement for our products
and those of our collaborators/licensees that involve our technology will have
a considerable impact on our revenues and business. The availability and scope
of government and third party reimbursement for drugs are subject to ongoing
debate and change. For example, the U.S. Congress is actively debating whether
and how to provide prescription drug benefits to Medicare beneficiaries.
Government and third party payors are continuously striving to reduce
reimbursement levels for healthcare products, and these cost control
initiatives may be applied to our products or those of our
collaborators/licensees. Further, changes in government reimbursement are
oftentimes adopted by other payors.

   The extent of government regulation which might result from future
legislation or administrative action cannot be accurately predicted. As a
result, the actual effect of these developments on our business is uncertain
and unpredictable.

                                       21
<PAGE>

Competition

   We compete both in the markets for drug discovery technologies and services
and the markets for pharmaceutical products. Our principal competitors are the
internal drug discovery departments of our pharmaceutical company customers and
potential customers. Many of our customers and potential customers have
developed or acquired or are developing or are acquiring integrated drug
discovery capabilities that use combinatorial chemistry, chemi-informatics
software, structure-based drug design and high-throughput screening. In
addition, many of these companies have large collections of compounds that they
have previously synthesized, purchased from chemical supply catalogs or
obtained from other sources against which they may screen new targets.

   We also compete with biotechnology and drug discovery services companies,
academic and scientific institutions, governmental agencies, and public and
private research organizations. Our technology platform integrates many
technologies, including combinatorial chemistry, chemi-informatics software,
structure-based drug design and high-throughput screening. We face competition
based on numerous factors, including size, diversity and ease of use of
compound libraries, speed and cost of identifying and optimizing potential lead
compounds and patent position from companies offering one or more technology
components of the discovery process. Companies such as Aurora Biosciences
Corporation and Evotec BioSystems AG have developed ultra-high-throughput
screening capabilities. In addition, several competitors, including Anadys
Pharmaceuticals, Inc., Novalon Pharmaceutical Corporation and Cetek Corporation
have developed alternative approaches to screening protein targets of unknown
function that are competitive with our "any target" ThermoFluor technology.
There are many companies that provide combinatorial chemistry services for lead
generation and optimization that compete with our DiscoverWorks technologies
and discovery services. Competitors such as Pharmacopeia, Inc., ArQule, Inc.,
Discovery Partners, Inc. and MediChem, Inc. use computer methods to assist in
the design of large screening libraries and synthesize them using combinatorial
or parallel chemical synthesis methods, which are competitive with our
DirectedDiversity technology. Competitors such as Tripos Inc. and MDL
Information Systems, Inc. are computer software companies that offer chemi-
informatics and other software and database services to support drug discovery,
which are competitive with the software components of our DirectedDiversity
chemi-informatics technology. Competitors such as Vertex Pharmaceuticals, Inc.,
Millenium Pharmaceuticals, Inc. and Axys Pharmaceuticals, Inc. extensively use
structure-based drug design or genomics technologies integrated with
combinatorial chemistry and other drug discovery technologies. These entities
compete with us either on their own or in collaborations. Companies such as
Arena Pharmaceuticals, Inc., Synaptic Pharmaceuticals, Inc. and Evotec
BioSystems AG have developed GPCR screening technologies that offer alternative
approaches to GPCR drug discovery which may be competitive with our structure-
based drug design approach. In addition, both internal drug design units at
major pharmaceutical companies and companies offering protein modeling
services, such as Structural Bioinformatics, Inc., or companies that have
competitive GPCR crystallography, such as MediChem, Inc., may use approaches
similar to the structure-based approaches under development at 3DP.

   While we believe that our integration of proprietary technologies for drug
discovery provides us with a competitive advantage over many of our competitors
and intend to further develop our integrated "target-to-lead" technologies, we
recognize that many of our competitors will seek to integrate and improve their
technologies to provide discovery capabilities similar or superior to those
provided by us.

   For drug candidates that we seek to outlicense from our internal drug
discovery pipeline, we face, and will continue to face, intense competition
from organizations such as large pharmaceutical and biotechnology companies.
Competition with any of the programs in our internal drug discovery pipeline
may arise from current or future drug candidates in the same therapeutic class
or other classes of therapeutic agents or other methods of preventing or
reducing the incidence of disease. In addition, any drug candidate that is
successfully developed may compete with existing therapies that have long
histories of safe and effective use.

   Due to perceived shortcomings of available agents and the large market
potential, competition to develop a safe, orally active antithrombotic agent is
intense, with many discovery programs in process, including programs in

                                       22
<PAGE>

clinical development by AstraZeneca PLC and Knoll GmbH. In addition, we are
aware of several other programs targeting additional proteins in the
coagulation process which could be competitive with our thrombin inhibitor,
including programs of Schering AG, Germany and AstraZeneca PLC. In addition, we
are aware of an oral heparin program of Emisphere Technologies, Inc. believed
to be in Phase 2 which may also compete with our thrombin inhibitor. In
addition, oral agents that effect blood platelet activation could provide
competitive therapeutic approaches to oral inhibitors of the coagulation
process. We are aware of such drug development programs at Merck & Co., Inc.,
GlaxoSmithKline and Schering-Plough Corporation, among others.

   Our orally active urokinase inhibitor for the inhibition of cancer
metastasis and tumor angiogenesis faces competition from a number of agents and
approaches under development. We are aware of competing urokinase inhibitor
programs at Abbott Laboratories, Axys Pharmaceuticals, Inc., Corvas
International, Inc. and Pfizer Inc. We are also aware of programs aimed at
developing compounds that are antagonists of the receptor for urokinase that
could compete with our oral urokinase inhibitor. There are also a number of
alternative approaches to controlling angiogenesis or metastasis including the
use of a) inhibitors of matrix metalloproteases, which are protease enzymes
that destroy the matrix material that binds cells together, including programs
by British Biotech plc (in alliance with Schering-Plough), Bristol-Myers Squibb
Company, Pharmacia Corporation and Pfizer Inc., b) inhibitors of cellular
tyrosine kinases, including programs by Cephalon Inc. and Sugen Inc., and c)
other therapeutic proteins or monoclonal antibodies, which are antibodies that
are produced from a single cell type and target a variety of processes in
cancer cells.

   Our other research programs in small molecule drug discovery are also in
highly competitive areas. Many other companies are working in these areas and
they may achieve earlier or greater success than we may be able to achieve.

   Our current and anticipated future research programs and services that focus
on the discovery of small molecule drugs that target GPCRs are also in a highly
competitive area. Most major pharmaceutical companies have extensive drug
discovery programs that target one or more GPCRs, and many biotechnology
companies have developed proprietary positions for particular GPCR receptors or
screening technologies. We also face competition, and anticipate accelerated
competition, in the area of structural analysis of target proteins identified
as a result of the sequencing of the human genome, where academic laboratories
and possibly companies, either on their own or in collaboration with others,
are seeking to determine the structures of drug target GPCRs, and databases of
drug target GPCR structures are being created in competition with the GPCR
structural and other databases we may develop. Recently, researchers at the
University of Washington at Seattle announced that they had successfully
determined the 3-D structure of bovine rhodopsin, a GPCR that is not a drug
target. Data from this or other research efforts aimed at GPCRs that are not
drug targets may also be used to create databases in competition with the GPCR
structural databases that we may develop.

   Most of our competitors, either alone, or together with their collaborators,
have substantially greater research and development capabilities and financial,
scientific, operational, marketing and sales resources than we do, as well as
significantly more experience in research and development, clinical trials,
regulatory matters, manufacturing, marketing and sales. These competitors and
other companies may have developed or may in the future develop new
technologies or products that compete with ours or which could render our
technologies and products obsolete. In addition, our competitors may succeed in
obtaining broader patent protection, receiving FDA approval for products or
developing and commercializing products or technologies before us. We also
compete with these organizations in recruiting and retaining qualified
scientific and management personnel.

Clinical Testing Strategy

   We do not have the ability to independently conduct clinical studies and
obtain regulatory approvals for our drug candidates. To the extent our
collaborators do not perform these functions, we intend to rely on third party
expert clinical investigators and clinical research organizations to perform
these functions.


                                       23
<PAGE>

Manufacturing Strategy

   We are an early stage drug discovery company and, accordingly, do not at
this stage require commercial scale manufacturing capabilities. We currently
rely, and anticipate continuing to do so for the foreseeable future, on
internal capabilities for synthesis of the small amounts of chemical compounds
required for the discovery phases of our internal programs and external
collaborations.

   Completion of any pre-clinical trials for our drug candidates involving
large quantities of chemical compounds, or any future clinical trials and
commercialization of our drug candidates by us or our collaborators, will
require access to, or development of, facilities to manufacture a sufficient
supply of our drug candidates. We do not have the facilities or experience to
manufacture the quantities of drug candidates necessary for any such trials or
commercial purposes on our own and do not intend to develop or acquire
facilities for the manufacture of such quantities of drug candidates in the
foreseeable future. We currently intend, instead, to rely on our collaborators
and third-party contract manufacturers.

   In addition, because we generally license drug candidates for further
development and commercialization, once a drug candidate is licensed, we must
rely on our collaborators' ability to manufacture, or to have manufactured, the
quantities necessary for further development and commercialization of these
drug candidates.

Marketing and Sales

   We market and sell our DiscoverWorks drug discovery services and
technologies, and license drug candidates from our internal drug discovery
programs, through a direct marketing effort to potential customers in the
pharmaceutical and biotechnology industries. Since we are an early-stage
company, we do not have an established sales and marketing effort, but have
solicited our collaborative partners primarily through the efforts of our
management and business development teams. We also make presentations at trade
shows and have an internet web site that describes our products and services.

   We currently have no sales, marketing or distribution capabilities to
commercialize our drug candidates. In order to commercialize any of our drug
candidates, we must either internally develop sales, marketing and distribution
capabilities or make arrangements with third parties to perform these services.
We intend to rely for the foreseeable future on collaborations with licensees
of our compounds to market any of our drug candidates which receive regulatory
approvals in the future.

Employees

   As of March 20, 2001, we had 140 full-time employees, 68 of whom hold Ph.D.
degrees. Of these employees, 105 were engaged in research and development and
35 were engaged in business development, finance and general administration.
Our scientific staff includes: 20 molecular and cell biologists, 13 structural
biologists, biophysicists and enzymologists, 47 chemists and 25 computer
scientists and engineers. Many of our employees have extensive experience in
drug discovery at major pharmaceutical companies. None of our employees are
represented by labor unions or covered by collective bargaining agreements. We
have not experienced any work stoppages, consider our employee relations to be
good and believe that we enjoy a strong corporate culture built on cooperation
among our various departments, which we view as a key element in our
interdisciplinary approach to research.

                                       24
<PAGE>

Executive Officers of the Registrant

   The following table sets forth certain information concerning the executive
officers, as well as certain other members of senior management, of the
Company:

<TABLE>
<CAPTION>
            NAME            AGE                             POSITION
            ----            ---                             --------
   <S>                      <C> <C>
   David C. U'Prichard,
    Ph.D                     52 Chief Executive Officer
   F. Raymond Salemme,
    Ph.D.                    56 President and Chief Scientific Officer
   Roger F. Bone, Ph.D.      43 Senior Vice President, Research & Development
   Graham R. Brazier         39 Senior Vice President, Corporate Development
   Wendy L. Nagy             58 Senior Vice President, General Counsel
   Scott M. Horvitz          42 Vice President, Finance and Administration, Secretary, Treasurer
   Kevin M. Mullin           38 Vice President, Human Resources
   Richard M. Soll, Ph.D.    44 Vice President, Chemistry
   Paul M.K. Weiss, Ph.D..   42 Vice President, Technology and Product Licensing
</TABLE>

   Dr. David C. U'Prichard joined us in September 1999 as our CEO and a member
of our Board of Directors. From 1997 to 1999, Dr. U'Prichard served as
President of Research and Development at SmithKline Beecham. While at
SmithKline Beecham, Dr. U'Prichard oversaw the entry of approximately ten
compounds into global development, the international registration of the
diabetes drug Avandia(R)* and the entry of four compounds into Phase III trials
and six compounds into early clinical trials; additionally, he instituted
several major restructuring efforts at the company. Prior to SmithKline
Beecham, he worked for ICI/Zeneca from 1986 to 1997, as Executive Vice
President and International Research Director from 1994 to 1997. Previously,
Dr. U'Prichard was instrumental in the launch of Nova Pharmaceuticals in 1983,
following an academic career as the Associate Professor of Pharmacology and
Neurobiology at Northwestern University Medical School (1978-83), and his
postdoctoral fellowship at Johns Hopkins University (1975-78). Dr. U'Prichard
received his Ph.D. in Pharmacology from the University of Kansas, and his B.S.
in Pharmacology with first-class honors from the University of Glasgow,
Scotland. He has held academic appointments at Northwestern University, Johns
Hopkins University and the University of Pennsylvania and is an Honorary
Professor at the University of Glasgow. He is also an author of more than 100
primary and review publications, was a founding co-editor of Molecular
Neurobiology and co-editor of Epinephrine in the Central Nervous System and has
served as a member of various editorial boards. Dr. U'Prichard serves on the
Board of Directors of Lynx Therapeutics, Inc.

   Dr. F. Raymond Salemme founded our company in 1993 and currently serves as
President and Chief Scientific Officer. Dr. Salemme is a co-inventor of our
DirectedDiversity chemi-informatics process control technology and our
ThermoFluor assay technology. Prior to founding our company, Dr. Salemme
supervised groups specializing in structure-based drug design, biophysics and
computational chemistry at Sterling Winthrop Pharmaceuticals and DuPont Merck
Pharmaceuticals, Inc. Dr. Salemme also worked in Central Research and
Development at DuPont, where he led research in protein X-ray crystallography
and engineering, developed computational methods for crystallography and drug
design, and conducted molecular dynamics simulations of proteins and polymers.
In 1983, Dr. Salemme founded the Protein Engineering Division of Genex
Corporation, among the first companies to use X-ray crystallography and
molecular modeling for genetically engineering proteins. From 1973 to 1983, Dr.
Salemme was Professor of Biochemistry at the University of Arizona and
published extensively in the areas of molecular structures of redox proteins
and theory of biological electron transfer and protein architecture. Dr.
Salemme received a B.A. in Molecular Biophysics from Yale University (with
exceptional distinction) and a Ph.D. in Chemistry from the University of
California, San Diego, where his Ph.D. thesis solved one of the first high-
resolution 3-D protein structures by X-ray crystallography. Dr. Salemme is a
member of several professional societies, and serves on national scientific
review committees including the Visiting Committee for Advanced Technology of
the National Institutes for Standards and Technology (NIST) and the National
Institutes of Health (NIH) Structural Genomics Initiative Review Panel.

--------
  *Avandia is a registered trademark of SmithKline Beecham.

                                       25
<PAGE>

   Dr. Roger F. Bone joined us in 1993 and currently serves as Senior Vice
President, Research and Development. Dr. Bone began his career with Merck & Co.
in 1990 as Senior Research Biophysicist and was named Research Fellow in 1992.
He was a Postdoctoral Fellow at the University of California from 1985 to 1990,
and he was an associate with Howard Hughes Medical Institute from 1988 to 1990.
Dr. Bone is a recipient of the U.S. Public Health Service Individual National
Research Award, is widely published in scientific journals, and is a co-
inventor on several patents, including patents covering our DirectedDiversity
technology. Dr. Bone received his Ph.D. in Biochemistry from the University of
North Carolina at Chapel Hill and his B.S. in Chemistry from Purdue University.

   Mr. Graham R. Brazier joined us in September 2000 as Senior Vice President,
Corporate Development. Most recently, Mr. Brazier served as Vice President
Worldwide Business Development, Pharmaceuticals at SmithKline Beecham, where he
spent ten years in various business development roles, based in both the U.K.
and U.S. From 1986 to 1990, Mr. Brazier was with Squibb Pharmaceuticals in
various headquarter and operating finance roles in the U.K., Holland and
Belgium. Mr. Brazier is a Fellow of the Chartered Association of Certified
Accountants (U.K.).

   Wendy L. Nagy, Esq. joined us in December 2000 as Senior Vice President,
General Counsel. From 1996 until she joined us, Ms. Nagy held positions at
MedImmune Oncology, Inc. (formerly U.S. Bioscience, Inc.), where she served as
Vice President and General Counsel from December 1999 until December 2000.
Prior to joining U.S. Bioscience, she served in legal positions with Cephalon,
Inc. and Unisys Corporation, and she was an associate with Morgan, Lewis &
Bockius LLP from 1986 until 1994. Ms. Nagy received her J.D. cum laude in 1986
from Villanova University School of Law, where she served as a member and
managing editor of the Villanova Law Review. She received a Ph.D. in Sociology
from the Australian National University (Canberra) in 1979, a B.A. (Hons.) in
Sociology from the University of New England (N.S.W., Australia), and a B.A. in
Anthropology from Macquarie University (Sydney) in 1974.

   Mr. Scott M. Horvitz has served as our Vice President, Finance and
Administration since our inception. From 1991 to 1993, Mr. Horvitz held various
positions at Magainin Pharmaceuticals Inc. and most recently served as
Executive Director, Finance and Human Resources. From 1983 to 1991, Mr. Horvitz
was with the firm of Richard A. Eisner and Company, LLP, Certified Public
Accountants, where he most recently served as a Senior Audit Manager,
specializing in venture-financed, technology start-up companies. Mr. Horvitz
holds a B.S. in Accounting from the State University of New York at Albany and
is a Certified Public Accountant.

   Mr. Kevin M. Mullin joined us in June 2000 as Vice President, Human
Resources. From 1999 to June 2000, Mr. Mullin was Vice President, Global Human
Resources at PR Newswire. From 1997 to 1999, Mr. Mullin served as Executive
Director, Strategic Planning at Covance, Inc. From 1991 to 1997, Mr. Mullin was
Director, Human Resources and Operations, Merck Vaccine Business at Merck & Co.
Prior thereto, Mr. Mullin served as Vice President, Human Resources & Community
Relations at Taylor Health System and was Director, Management Consulting
Services at Coopers & Lybrand. Mr. Mullin earned his M.S. in Human Resources
Management from Villanova University and his B.A. in Business and Economics
from Princeton University.

   Dr. Richard M. Soll joined us in 1994 and currently serves as Vice
President, Chemistry. From 1983 to 1994, Dr. Soll held various positions at
Wyeth-Ayerst Research and Ayerst Laboratories, most recently serving as a
Principal Scientist, Medicinal Chemistry. Dr. Soll conducted his postdoctoral
fellowship at Harvard University, and he received his Ph.D. in Synthetic
Organic Chemistry from Dartmouth College and his B.S. in Chemistry from the
University of Massachusetts. Dr. Soll is widely published in scientific
journals and is a co-inventor on numerous patents covering our
DirectedDiversity technology.

   Dr. Paul M. K. Weiss joined us in December 1997 and currently serves as Vice
President, Technology and Product Licensing. From 1993 to 1997, Dr. Weiss held
various positions at American Home Products Corporation and Wyeth-Ayerst
Laboratories, including Director-Licensing, Director-Business Development and
Research, and Manager-Business Development. Prior thereto, Dr. Weiss was
employed by Columbia Research

                                       26
<PAGE>

Laboratories as International Director of Product Development and R&D
Coordinator. Dr. Weiss received his Ph.D. in Biochemistry and his M.B.A. from
the University of Wisconsin-Madison, and his B.S. in Biochemistry from Carleton
University Institute of Biochemistry in Ottawa, Ontario.

Item 2. Properties

   We lease approximately 41,000 square feet of space in Exton, Pennslvania
which includes our executive offices and one of our research and development
facilities, including approximately 10,000 square feet, adjacent to our
existing space, that we occupied in December of 2000. The initial 31,000 square
feet of our Exton facility is leased through June 2008 and the additional
10,000 square feet is subject to options allowing us to extend that portion of
the lease term through June 2008. In December of 2000 we leased approximately
32,500 square feet of additional research and development space in Cranbury,
New Jersey. Our Cranbury facility is leased through March 2007. To meet our
expected growth needs we are also negotiating for additional space for use in
expansion of our research capabilities.

Item 3. Legal Proceedings

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

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

   No matters were submitted to stockholders during the fourth quarter of 2000.

                                    PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

   Our common stock has been traded on the Nasdaq National Market under the
symbol "DDDP" since August 4, 2000.

   The following table sets forth the high and low closing prices for our
common stock for the quarters indicated as reported on the Nasdaq National
Market.

<TABLE>
<CAPTION>
                                                                  HIGH     LOW
     2000                                                         ----     ---
     <S>                                                         <C>     <C>
     Third Quarter.............................................. $38.875 $15.000
     Fourth Quarter............................................. $35.000 $11.375
</TABLE>

   As of March 20, 2001, there were approximately 90 holders of record and
approximately 1,700 beneficial stockholders of our common stock.

   We do not intend to pay any cash dividends on our common stock in the
foreseeable future. We currently intend to retain any future earnings for use
in our business.

Item 6. Selected Financial Data

   The selected financial data set forth below are derived from our financial
statements. Our statements of operations data for the years ended December 31,
2000, 1999 and 1998 and our balance sheet data at December 31, 2000 and 1999,
are derived from our financial statements that have been audited by Richard A.
Eisner & Company, LLP, which are included elsewhere in this annual report, and
are qualified by reference to such financial statements. The statement of
operations data for the years ended December 31, 1997 and 1996 and the balance
sheet data as of December 31, 1998, 1997 and 1996 are derived from our audited
financial statements, which are not included in this annual report. The
selected financial information set forth below should be read together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and related notes appearing elsewhere
in this annual report.

                                       27
<PAGE>

<TABLE>
<CAPTION>
                                           Year ended December 31,
                                  ---------------------------------------------
                                    2000      1999     1998     1997     1996
                                  --------  --------  -------  -------  -------
                                    (in thousands, except per share data)
<S>                               <C>       <C>       <C>      <C>      <C>
Statements of Operations Data:
Grant and research revenue......  $ 12,409  $  4,489  $ 5,095  $ 3,580  $   967
                                  --------  --------  -------  -------  -------
Costs and expenses
 Research and development.......    14,562    12,136   10,984    6,517    4,556
 General and administrative.....     8,652     6,525    4,458    3,000    1,708
 Litigation settlement..........        --     1,500       --       --       --
                                  --------  --------  -------  -------  -------
 Total costs and expenses.......    23,214    20,161   15,442    9,517    6,264
                                  --------  --------  -------  -------  -------
Loss from operations............   (10,805)  (15,672) (10,347)  (5,937)  (5,297)
Interest income.................     3,458       328      868      521       14
Interest expense................      (646)     (625)    (232)    (149)    (580)
                                  --------  --------  -------  -------  -------
Loss before income taxes........  $ (7,993) $(15,969) $(9,711) $(5,565) $(5,863)
Provision for income taxes......       159        --       --       --       --
                                  --------  --------  -------  -------  -------
Net loss........................  $ (8,152) $(15,969) $(9,711) $(5,565) $(5,863)
Declared and accrued cumulative
 dividends on preferred stock...      (396)     (669)    (144)      --       --
                                  --------  --------  -------  -------  -------
Net loss applicable to common
 stock..........................  $ (8,548) $(16,638) $(9,855) $(5,565) $(5,863)
                                  ========  ========  =======  =======  =======
Basic and diluted net loss per
 common share--historical.......  $   (.97) $ (27.37) $(22.20) $(27.55) $(58.04)
                                  ========  ========  =======  =======  =======
Weighted average common shares
 outstanding--historical........     8,778       608      444      202      101
                                  ========  ========  =======  =======  =======
Basic and diluted net loss per
 common share--pro forma........  $   (.52) $  (1.57)
                                  ========  ========
Weighted average common shares
 outstanding--pro forma.........    15,663    10,198
                                  ========  ========
<CAPTION>
                                             As of December 31,
                                  ---------------------------------------------
                                    2000      1999     1998     1997     1996
                                  --------  --------  -------  -------  -------
                                               (in thousands)
<S>                               <C>       <C>       <C>      <C>      <C>
Balance Sheet Data:
Cash, cash equivalents and
 marketable securities..........  $114,557  $  7,645  $ 9,726  $ 8,953  $ 1,312
Total assets....................   123,244    12,480   15,712   12,646    3,401
Notes payable--dividends and
 accrued interest...............        --       685      144       --       --
Deferred income, less current
 portion........................     9,619        --       --       --       --
Long-term debt, less current
 portion........................     1,315     2,330    3,270      820      575
Convertible notes and accrued
 interest.......................        --    10,115       --       --       --
Settlement accrual, less current
 portion........................        --       500       --       --       --
Redeemable convertible preferred
 stock..........................        --    34,834   34,834   24,461   12,015
Accumulated deficit.............   (53,261)  (45,109) (29,140) (19,429) (13,864)
Total stockholders' equity
 (deficiency)...................   100,023   (41,748) (25,384) (15,702) (11,198)
</TABLE>

   See our financial statements for a description of the computation of the
historical and pro forma net loss per share and the number of shares used in
the historical and pro forma per share calculations in "Statements of
Operations Data" above.

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

Overview

   We are a drug discovery company that has developed an integrated set of
proprietary technologies called DiscoverWorks which accelerate and improve the
drug discovery process and capitalize on the opportunities for drug discovery
presented by the thousands of new targets for drugs being revealed from the
sequencing of the human genome. Our technologies also facilitate drug discovery
for well-characterized disease targets that have proven difficult using
traditional methods. We believe that our technologies, which apply to virtually
any disease target, produce compounds suitable for development into drugs in a
more timely and cost-effective manner and with a higher probability of success
than that currently achieved using conventional methods. We

                                       28
<PAGE>

are using our technologies both to assist collaborators in discovering drug
candidates and to discover and develop our own drug candidates, which we
currently intend to license at the pre-clinical or early clinical stage.

   To date, substantially all of our revenue has been from corporate
collaborations, license agreements and government grants. Revenue from our
corporate collaborations and our licensing agreements consists of up-front
fees, ongoing research and development funding, milestone payments and
royalties upon the sale of designated products. Royalties from sales of
products are not expected for at least several years, if at all. We recognize
revenue from corporate collaborations, including periodic payments for research
and development activities and related nonrefundable technology access fees
and/or technology or software licensing fees, over the period that we perform
research and development activities under the terms of these agreements.
Revenue from nonrefundable up-front fees for the licensing of technology,
products or software under agreements that do not require us to perform
research or development activities or other significant future performance
obligations is recognized at the time that the agreement is executed or the
software is delivered. Revenue resulting from the achievement of milestone
events stipulated in the agreements is recognized when the milestone is
achieved. With respect to license agreements where we have future performance
obligations, up-front fees and other amounts received in excess of revenue
recognized are recorded as deferred income.

   We have incurred substantial operating losses since our inception in 1993.
As of December 31, 2000, our accumulated deficit was $53.3 million. We have
funded our operations primarily through public and private placements of equity
securities totaling $153.0 million and cash received under collaborative
agreements of $40.2 million. Our losses have resulted principally from costs
incurred in research and development activities related to our efforts to
develop our technologies and our internal drug discovery programs and from the
associated administrative costs required to support these efforts. We currently
expect to recognize revenue for 2001 of approximately $22.9 million including
the recognition of up-front fees previously received, research funding
payments, license fees and proceeds from equipment sales. Not included in the
expected revenue in 2001 are any potential milestone payments we may receive
under existing agreements or any amounts that we may receive from new
collaborations. We expect to incur additional operating losses over the next
several years as we continue to develop our technologies and fund internal
product research and development. Our ability to achieve profitability is
dependent on the progress and commercialization of drug candidates from
existing internal programs and collaborations and our ability to initiate and
develop new internal programs and enter into additional collaborations with
favorable economic terms. Payments either under collaborative agreements or
related to the licensing of drug candidates we develop internally will be
subject to significant fluctuation in both timing and amount and therefore our
results of operations for any period may not be comparable to the results of
operations for any other period.

Results of Operations

 Years Ended December 31, 2000 and 1999

   Revenue. Our revenue for 2000 was $12.4 million as compared to $4.5 million
for 1999. Revenues in 2000 included $11.7 million from corporate
collaborations, including revenue from new agreements with Bristol-Myers
Squibb, DuPont Pharmaceuticals Company, Boehringer Ingelheim Pharmaceuticals,
Inc., and Schering AG, Germany and continued funding from Aventis CropScience
GmbH and Heska Corporation and $0.7 million from government grants. The 2000
revenue amount is net of a charge of approximately $0.4 million in connection
with a modification of the Bristol-Myers Squibb agreement made during the
fourth quarter of 2000. The modification resulted from an agreement with
Bristol-Myers Squibb to terminate both Bristol-Myers Squibb's subscription to a
planned GPCR structure database and its non-exclusive license to related
technologies. Revenues in 1999 included $4.3 million from corporate
collaborations, including revenues from a new agreement with Aventis, continued
funding from Wyeth-Ayerst, Merck KGaA, and Heska Corporation and $0.2 million
from government grants. Funding from the Heska agreement ended in 2000 and our
agreements with Wyeth-Ayerst and Merck KGaA ended in 1999. In December of 2000,
we entered into a license agreement with Centocor, Inc., a wholly owned
subsidiary of Johnson & Johnson, under which

                                       29
<PAGE>

Centocor acquired worldwide rights to our orally active direct thrombin
inhibitor program. We will begin to recognize revenue from this agreement in
2001.

   Research and Development Expenses. Our research and development expenses
increased by $2.5 million, to $14.6 million for 2000 from $12.1 million for
1999. This increase was related to the expansion of research efforts in our
internal programs, including clinical testing of our lead thrombin compound,
the commencement of collaborative discovery programs and investment in our core
technologies. The expansion of research efforts required the hiring of
additional personnel, resulting in increased expenses for personnel and
increased expenses for equipment and lab supplies for all of these activities.

   General and Administrative Expenses. Our general and administrative expenses
increased by $2.2 million to $8.7 million for 2000 from $6.5 million for 1999.
The increase was primarily related to increased management and administrative
personnel expenses resulting from the hiring of additional personnel, expansion
of our operations and business development efforts and other expenses relating
to our operations as a public company.

   Other Income (Expenses). Interest income increased by $3.2 million to $3.5
million for 2000 from $0.3 million in 1999. The increase in interest income is
attributable to the investment of the proceeds from our initial public offering
and private placements of securities completed during this period, as well as
investment of the upfront fees we have received from our collaborators.
Interest expense was $0.6 million for 2000 and $0.6 million for 1999.

   Provision for Income Taxes As of December 31, 2000, we had net operating
loss carryforwards for federal income taxes of $35.1 million. We also have
federal research and development tax credit carryforwards. Our utilization of
the net operating loss and tax credit carryforwards may be subject to annual
limitations pursuant to Section 382 of the Internal Revenue Code, and similar
state provisions, as a result of changes in our ownership structure. The annual
limitations may result in the expiration of net operating losses and credits
prior to utilization.

   At December 31, 2000 and 1999, the Company had deferred tax assets
representing the benefit of net operating loss carryforwards, certain start up
costs capitalized for tax purposes, upfront payments from collaborators taxable
in the year received, and research and development tax credits. During the year
ended December 31, 2000, we recorded a provision for federal and state income
taxes of $0.2 million. The federal tax provision was based on the alternative
minimum tax under which net operating loss carryforwards are available to
offset 90% of our current tax liability. The Company did not record a benefit
for the deferred tax asset because realization of the benefit was uncertain
and, accordingly, a valuation allowance is provided to offset the deferred tax
asset.

 Years Ended December 31, 1999 and 1998

   Revenue. Our revenue for 1999 was $4.5 million as compared to $5.1 million
in 1998. Revenues in 1999 included $4.3 million from corporate collaborations,
including revenue from a new agreement with Aventis, continued funding from
Wyeth-Ayerst, Merck KGaA, Heska Corporation and E.I. DuPont de Nemours and $0.2
million from government grants. Revenues in 1998 included $4.5 million from
corporate collaborations, including funding from Wyeth-Ayerst, Merck KGaA, and
Heska Corporation, and $0.6 million from government grants. The decrease in
revenue for 1999 is primarily connected to the completion in August 1998 of
funding from an Advanced Technology Program (ATP) award sponsored by the
National Institute of Standards and Technology, which commenced in August of
1995, and a reduction in revenues from Wyeth-Ayerst. Revenues from the ATP and
Wyeth-Ayerst programs decreased from 1998 to 1999 by $0.3 million and $0.7
million, respectively. Our agreements with Wyeth-Ayerst and Merck KGaA ended in
1999.

   Research and Development Expenses. Our research and development expenses
increased by $1.1 million, to $12.1 million for 1999 from $11.0 million for
1998. This increase related to the expansion of research efforts

                                       30
<PAGE>

in our internal programs, including pre-clinical testing of our lead thrombin
compound, the commencement of collaborative discovery programs, investment in
our core technologies and associated increases in expenses for personnel,
facility expansion, equipment and lab supplies.

   General and Administrative Expenses. Our general and administrative expenses
increased by $2.0 million, to $6.5 million for 1999 from $4.5 million for 1998.
The increase was primarily related to increased management and administrative
personnel expenses arising in connection with increased hiring and to legal and
professional fees incurred in connection with litigation involving our
ThermoFluor technology, which we settled in March 2000, the expansion of our
operations and business development efforts. In connection with the settlement
of litigation, we accrued an expense of $1.5 million in 1999. Under the terms
of a settlement agreement with Anadys Pharmaceuticals, Inc. relating to an
action that Anadys brought against us in the United States District Court for
the District of Delaware on October 13, 1998 for our alleged infringment of two
patents, we acquired a limited license to Anadys' ATLAS (Any Target Ligand
Affinity Screen) assay technology and Anadys was granted a limited license to
the method claims of our ThermoFluor assay technology. Neither of these
licenses is exclusive. Under this agreement, we paid Anadys $1.0 million in
2000 and made an additional payment of $0.5 million in March 2001. In exchange
for these payments, Anadys has released us from all claims of infringement with
respect to those two patents. The settlement agreement restricts us, for a
period of three years, from specified activities in connection with screening
drugs useful for treating "infection" (defined as relating to drugs whose
principal aim is to treat or cure infectious disease in humans). As part of
this settlement agreement, until March 7, 2003, we are precluded from using our
ThermoFluor screening technology in the Hepatitis C Virus "infection" area as
part of collaborative agreements or as part of our internal drug programs. In
addition, we are precluded from using our ThermoFluor screening technology as
part of more than one collaboration agreement in the area of "infection" until
March 7, 2003, and such collaborative agreement must be limited to a maximum of
three anti-viral targets. Our collaboration with Bristol-Myers Squibb Company
constitutes the one permitted collaboration agreement in the area of infection.
The settlement with Anadys, however, does not restrict use of our ThermoFluor
screening technology for our internal drug discovery efforts, or for purposes
of collaborative agreements outside the area of "infection," other than the
limitation with respect to Hepatitis C Virus "infection." In addition, if our
use of ThermoFluor facilitates the discovery of a drug used to treat infectious
disease, we are obligated to pay Anadys a royalty based on revenue from the
sale of such a drug.

   Other Income (Expenses). Interest income decreased by $0.6 million, to $0.3
million for 1999 from $0.9 million for 1998. This was related to lower average
cash balances during 1999. Interest expense increased by $0.4 million, to $0.6
million in 1999 from $0.2 million in 1998. The increase in interest expense was
primarily attributable to an increase in short-term borrowings from certain of
our investors.

   Provision for Income Taxes. We incurred net operating losses for the years
ended December 31, 1999 and 1998, and, accordingly, we did not pay any federal
income taxes.

Liquidity and Capital Resources

   At December 31, 2000, we had cash and cash equivalents of $114.6 million and
working capital of $103.2 million. We have funded our operations to date
primarily through public and private placements of equity securities with
aggregate proceeds of approximately $153.0 million, and cash received under
corporate collaborations totaling $40.2 million, government grants totaling
$3.8 million, capital equipment and leasehold improvement financing totaling
$7.8 million and interest earned on our cash balances. Our operating activities
generated funds of $8.7 million in 2000. Our operating activities used funds
totaling $10.6 million and $8.4 million in 1999 and 1998, respectively.

   To date, substantially all of our revenue has been from corporate
collaborations, license agreements and government grants. We expect that
substantially all of our revenue for the foreseeable future will come from
similar sources as well as from interest income. In addition, our ability to
achieve profitability will be

                                       31
<PAGE>

dependent upon our ability to enter into additional corporate collaborations
and license internally developed products. We believe that our available cash
and cash equivalents, expected revenue from collaborations and license
arrangements, existing capital resources and interest income should be
sufficient to fund anticipated levels of operations for at least the next two
years.

Recently Issued Accounting Standards

   In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Financial
Instruments and for Hedging Activities," which will be effective for our fiscal
year 2001. This statement establishes accounting and reporting standards
requiring that every derivative instrument, including derivative instruments
embedded in other contracts, be recorded in the balance sheet as either an
asset or liability measured at its fair value. The statement also requires that
changes in the derivative's fair value be recognized in earnings unless
specific hedge accounting criteria are met. SFAS 133 is not anticipated to have
a significant impact on our operating results or financial condition when
adopted, since we currently do not engage in hedging activities.

Factors Affecting the Company's Prospects

 We have a history of net losses and may never achieve or maintain
 profitability.

   We have incurred net losses since our inception, including net losses of
approximately $16.0 million for the year ended December 31, 1999 and
approximately $8.2 million for the year ended December 31, 2000. As of December
31, 2000, we had an accumulated deficit of approximately $53.3 million. We may
incur additional losses for at least the next several years. The extent of our
future losses will depend on the rate of growth, if any, of our revenue and on
the level of our expenses. To date, we have derived substantially all of our
revenue from corporate collaborations, license agreements and government
grants. We expect that substantially all of our revenue for the foreseeable
future will result from payments from these sources and from the licensing of
our technologies and of our internally developed pre-clinical and clinical drug
candidates. We also expect to spend significant amounts to enhance our drug
discovery technologies and to fund research and development of drug candidates
we develop internally. Because our operating expenses will increase
significantly in the near term, we will need to generate significant additional
revenue to achieve profitability. In order to generate revenue, we must
continue to develop products and technologies from which we can derive revenue
either ourselves or through existing and future collaborations. Accordingly, we
may never achieve profitability. Even if we do achieve profitability, we may
not be able to sustain or increase profitability on a quarterly or annual
basis.

 If we fail to obtain necessary funds for our operations, we will be unable to
 maintain and improve our technology position and will be unable to develop and
 commercialize our drug candidates.

   To date, we have funded our operations primarily through public and private
placements of equity securities and revenues from corporate collaborations,
with additional revenue from government grants, capital equipment and leasehold
financing, and interest earned on net proceeds of our initial public offering
and private placements. We believe that our cash and cash equivalents, expected
revenue from collaborations and license arrangements, existing capital
resources and interest income should be sufficient to meet our operating and
capital requirements for at least the next two years. However, our present and
future capital requirements depend on many factors, including:

  .  the level of research and development investment required to maintain
     and improve our technology position;

  .  our ability to enter into new agreements with collaborators or to extend
     the terms of our existing collaborations, and the terms of any agreement
     of this type;

  .  our success rate or that of our collaborators in discovery efforts
     associated with milestones and royalties;

                                       32
<PAGE>

  .  the timing, willingness and success of our collaborators to
     commercialize our products, which would result in milestone payments and
     in royalties;

  .  costs of recruiting and retaining qualified personnel;

  .  costs of filing, prosecuting, defending and enforcing patent claims and
     other intellectual property rights;

  .  our need or decision to acquire or license complementary technologies or
     new targets, or acquire complementary businesses; and

  .  changes in drug candidate development plans needed to address any
     difficulties in clinical studies or in commercialization.

   Should we require additional capital in the future, we do not know whether
additional financing will be available on acceptable terms when needed. We may
raise these funds through public or private equity offerings or debt financings
or through corporate collaborations and licensing arrangements.

   If we raise additional capital by issuing equity securities, our existing
stockholders' percentage ownership will be reduced and they may experience
substantial dilution. Any equity securities issued may also provide for rights,
preferences or privileges senior to holders of our common stock. If we raise
additional funds by issuing debt securities, these debt securities would have
rights, preferences and privileges senior to holders of our common stock and
the terms of the debt securities issued could impose significant restrictions
on our operations. If we raise additional funds through collaborations and
licensing arrangements, we may be required to relinquish some rights to our
technologies or drug candidates, or grant licenses on terms that are not
favorable to us. If adequate funds are not available, we may have to delay or
may not be able to continue developing our drug candidates.

   If additional funds are required to operate our business, these funds may
not be available on terms that we find favorable, if at all. If adequate funds
are not available or are not available on acceptable terms, our ability to fund
our operations, take advantage of opportunities, develop products or
technologies or otherwise respond to competitive pressures could be
significantly delayed or limited and we may need to downsize or halt our
operations.

 The drug candidates we are developing internally, including those we have
 licensed for commercial development, are at an early stage of development, and
 they may fail in later development or commercialization.

   Our most advanced compound, which is licensed to Centocor, is currently in
Phase 1 clinical trials. All of the compounds that we are currently developing
will require significant additional research, formulation and manufacturing
process development, and pre-clinical and extensive clinical testing prior to
regulatory approval and commercialization. Pre-clinical and clinical studies of
our products under development may not display the safety and efficacy
necessary to obtain regulatory approvals. Pharmaceutical and biotechnology
companies have suffered significant setbacks in advanced clinical trials, even
after experiencing promising results in earlier trials. Products that appear to
be promising at early stages of development may not reach the market or be
marketed successfully for a number of reasons, including the following:

  .  researchers may find that the product is ineffective or has harmful side
     effects during later pre-clinical testing or clinical trials;

  .  the product may fail to receive necessary regulatory approval or
     clearance;

  .  the product may be too difficult to manufacture on a large scale;

  .  the product may be too expensive to manufacture or market;

  .  the product may not achieve broad market acceptance;


                                       33
<PAGE>

  .  others may hold proprietary rights that will prevent the product from
     being marketed; or

  .  others may market equivalent or superior products.

   We do not expect that we will make commercially available any products we
are developing internally or in association with our collaborators for at least
several years, if at all. We and our collaborators may not succeed in our
research and product development efforts and we may not be able to launch any
successfully commercialized products. Further, after commercial introduction of
a new product, discovery of problems through adverse event reporting could
result in restrictions on the product, including recall or withdrawal from the
market and, in certain cases, civil or criminal penalties resulting from
actions by regulatory authorities or damage from product liability judgments.

 We are developing and using new technologies, and if we are unable to
 successfully commercialize these technologies, we will not achieve
 profitability.

   Our DiscoverWorks technologies, in particular our DirectedDiversity and
ThermoFluor technologies, represent a new and unproven approach to the
identification and optimization of lead compounds with therapeutic potential.
We have not used these technologies in the development of any compound that has
reached the point of commercialization. The collaboration with Bristol-Myers
Squibb Company represents the initial collaborative use of the entire
DiscoverWorks set of technologies. In addition, although we began using the
entire DiscoverWorks set of technologies in our internal programs in 1998, we
did not use our ThermoFluor technology in our most advanced internal programs.
Our technologies may not result in the successful identification, optimization
or development of compounds that are safe or efficacious. Because the
development of new pharmaceutical products is highly uncertain, our drug
discovery technologies may not produce any commercially successful compounds.
Failure to validate our technologies through the successful discovery of
compounds that become commercialized would hinder our ability to license drug
candidates developed by us internally and to market successfully our
technologies and services.

   Historically, due to the highly proprietary nature of drug discovery and
development efforts, and the desire to obtain maximum patent and other
proprietary protection for their programs, other pharmaceutical and
biotechnology companies have conducted molecular target screening and lead
compound identification and optimization within their own internal research
departments. To succeed, we must convince these companies that our technologies
and capabilities justify retaining us to work on drug discovery programs on
their behalf or the licensing by them of our technologies. Under the terms of a
settlement agreement with Anadys Pharmaceuticals, Inc., formerly known as
Scriptgen Pharmaceuticals, Inc., we acquired a limited license to Anadys' ATLAS
(Any Target Liquid Affinity Screen) assay technology and Anadys was granted a
limited license to the method claims of our ThermoFluor screening technology.
Neither of these licenses was exclusive. The settlement agreement precludes us,
until March 7, 2003, from using our ThermoFluor screening technology in the
Hepatitis C Virus "infection" area as part of collaborative agreements or as
part of our internal drug programs. In addition, the settlement agreement
precludes us from using our ThermoFluor screening technology as part of more
than one collaboration agreement in the area of "infection" until March 7,
2003, and such collaborative agreement must be limited to a maximum of three
anti-viral targets. Our collaboration agreement with Bristol-Myers Squibb
Company constitutes the one permitted collaboration agreement in the area of
infection. The settlement with Anadys does not restrict use of our ThermoFluor
screening technology for our internal drug discovery efforts, other than the
limitation with respect to the Hepatitis C Virus "infection," or for purposes
of collaborative agreements outside the area of "infection." Only two of our
existing collaborations involve the use of our ThermoFluor screening
technology. Our ability to succeed will depend upon the acceptance by potential
collaborators of our systems, services and technologies as effective discovery
tools.

   In addition, we may not be successful in our efforts to develop certain
aspects of our technologies and, as a result, we may not be able to
successfully commercialize these technologies. For example, if we are not
successful in crystallizing or determining the 3-D structure of a drug-target
GPCR, this would significantly limit the usefulness of our GPCR technology and
might result in the commercial failure of this technology.

                                       34
<PAGE>

 If we do not update and enhance our technologies, they will become obsolete.

   Technological change occurs rapidly in the pharmaceutical market, and our
future success will depend on our ability to update and enhance our
technologies. Because DiscoverWorks integrates many technologies, we may find
it difficult to stay abreast of the rapid changes in each of the areas that
DiscoverWorks encompasses. If we fail to stay at the forefront of technological
change we will be unable to compete effectively. In particular, our
DirectedDiversity technology for optimizing the properties of lead compounds
and our ThermoFluor technology for high-throughput screening involve areas
where many companies are actively developing new technologies. Because the
pharmaceutical and biotechnology industries currently perceive high-throughput
screening and optimizing of lead compounds to represent critical bottlenecks in
the discovery process, our competitors are using substantial resources to
develop new technologies to reduce these bottlenecks. Accordingly, advances in
existing technological approaches or our current or future competitors'
development of different approaches may render our technologies obsolete.

 We are dependent on our collaborators, and our failure to successfully manage
 our existing and future collaborations and license arrangements could prevent
 us or our collaborators from developing and commercializing our products.

   Our strategy depends upon the maintenance of our existing collaborations and
licensing arrangements as well as the formation of new collaborations and
licensing arrangements, principally with pharmaceutical and biotechnology
companies. We may fail to maintain our existing collaborations or licensing
arrangements, or establish additional collaborative or licensing arrangements,
on terms favorable to us. In addition, our current or future collaborations or
licensing arrangements may not be successful or we may be unable to
successfully manage these collaborations or licensing arrangements. As a
result, we could become involved in disputes that might result in, among other
things, a significant strain on our management resources, legal claims
involving significant time and expense, a loss of capital and a loss of current
or future collaborators. Several other factors could harm our present or future
collaborations or licensing arrangements:

  .  our failure to achieve our research and development objectives under our
     collaborative agreements;

  .  the development of conflicts with our collaborators as to rights to
     intellectual property to technologies or product candidates either we or
     they develop;

  .  our entry into additional collaboration agreements that potentially
     conflict with the business objectives of our collaborators;

  .  the decision by our collaborators to become competitors of ours or enter
     into agreements with our competitors; or

  .  the limit on the number of potential collaborators that results from
     further consolidation in our target markets.

   In addition, if we exclusively license any aspect of our technologies to one
or more collaborators, we will limit our ability to license this technology to
other parties. This may limit our ability to enter into future collaborations
or licensing arrangements.

   Since we do not currently possess the resources necessary to complete
development and commercialization of our internal drug candidates, we expect to
rely on and continue to enter into licensing arrangements for the further
development and commercialization of our drug candidates. These drug candidates
will require significant pre-clinical and/or clinical development efforts, the
receipt of the requisite regulatory approvals and the successful manufacturing
and marketing of the drugs. With the exception of certain aspects of pre-
clinical and early clinical development, we do not intend to perform any of
these activities. A party to whom we license a drug candidate may not devote
sufficient resources to the development, manufacture, marketing or sale of
these products. We will have limited or no control over the resources that any
third party may devote to our projects.


                                       35
<PAGE>

   Any of our present or future collaborators may breach or terminate their
agreements with us or otherwise fail to conduct their collaborative activities
successfully and in a timely manner. In addition, we may dispute the
application of payment provisions under any of our collaboration agreements. If
we fail to enter into or maintain collaborative agreements, or if any of these
events occur, we may not be able to commercialize our technologies or develop
and commercialize our drug candidates.

 If our collaborators fail to advance compounds arising from the use of our
 technologies to develop and commercialize pharmaceutical products, our
 business will suffer.

   Our future revenue will depend in part on the realization of milestone
payments and royalties, if any, triggered by our collaborators' successful
development and commercialization of lead compounds identified through the use
of our technologies or of lead compounds that we develop internally and
license. The agreements with our collaborators do not obligate them to develop
or commercialize lead compounds identified through the use of our technologies.
Our development and commercialization of lead compounds will therefore depend
not only on our and our collaborators' achievement of development objectives,
but also on each collaborator's own financial, competitive, marketing and
strategic considerations, such as the relative advantages of other companies'
products, including relevant patent and proprietary positions. If a
collaborator fails to develop or commercialize a lead compound identified
through the use of our technologies, or if a compound that a collaborator
develops is determined to be unsafe or of no therapeutic benefit, we will not
receive any future milestone payments or royalties for that compound, and we
may have only limited or no rights to independently develop and commercialize
that compound.

 If the third-party expert clinical investigators and clinical research
 organizations we intend to rely on to conduct any of our future clinical
 trials do not perform in an acceptable or timely manner, our clinical trials
 could be delayed or unsuccessful.

   We do not have the ability to independently conduct clinical studies and
obtain regulatory approvals for our drug candidates and, to the extent our
collaborators do not perform these functions, we intend to rely on third-party
expert clinical investigators and clinical research organizations to perform
these functions. If we cannot locate, and enter into favorable agreements with,
acceptable third parties, or if these third parties do not successfully carry
out their contractual duties, meet expected deadlines and enrollment objectives
and follow regulatory guidelines, including clinical laboratory and
manufacturing guidelines, then we will not obtain required approvals and will
be unable to commercialize our drug candidates on a timely basis, if at all.

 If we or our collaborators are unable to manufacture or contract with third
 parties to manufacture drug candidates in sufficient quantities and at an
 acceptable cost, we or our collaborators may be unable to complete clinical
 trials and commercialize these drug candidates.

   Our or our collaborators' completion of any pre-clinical trials for our drug
candidates involving large quantities of chemical compounds, or any future
clinical trials and commercialization of drug candidates, will require access
to, or development of, facilities to manufacture a sufficient supply of our
investigational drug candidates. We do not have the facilities or experience to
manufacture the quantities of drug candidates necessary for any such trials or
commercial purposes on our own and do not intend to develop or acquire
facilities for the manufacture of such quantities of drug candidates in the
foreseeable future. We currently intend, instead, to rely on third-party
contract manufacturers.

   In addition, because we intend to license drug candidates for further
development and commercialization, once a drug candidate is licensed, we must
rely on our collaborators' abilities to manufacture, or have manufactured, the
quantities necessary for further development and commercialization of these
drug candidates.

   Our manufacturing strategy presents the following risks:

  .  we, or our collaborators, may not be able to locate acceptable
     manufacturers or enter into favorable long-term agreements with them;

                                       36
<PAGE>

  .  third parties may fail to successfully manufacture our drug candidates
     or to manufacture them in a cost effective and/or timely manner;

  .  we have not tested the manufacturing processes for our drug candidates
     in quantities needed for clinical trials or commercial sales;

  .  delays in scale-up to commercial quantities could delay clinical
     studies, regulatory submissions and commercialization of drug
     candidates;

  .  we may not have intellectual property rights, or may have to share
     intellectual property rights, to many improvements in the manufacturing
     processes or new manufacturing processes for our drug candidates;

  .  our drug candidates require a long lead time to manufacture and the
     manufacturing process is complex; and

  .  manufacturers of our drug candidates are subject to the FDA's current
     Good Manufacturing Practices regulations, or cGMPs, and similar foreign
     standards and we and our collaborators do not have control over
     compliance with these regulations by third-party manufacturers.

   Any of these factors could delay clinical trials or commercialization of
drug candidates developed and commercialized by us or by our collaborators,
entail higher costs and result in us or our collaborators being unable to
effectively sell any products.

 If we, or our collaborators, do not obtain and maintain required regulatory
 approvals, we will be unable to commercialize our product candidates.

   Regulation by governmental entities in the United States and other
countries could impact the development, production and marketing of any
pharmaceutical products that we or our collaborators develop. The nature and
the extent to which such regulation may apply will vary depending on the
nature of any such pharmaceutical products. In particular, the United States
Food and Drug Administration, or FDA, and foreign regulatory authorities apply
rigorous pre-clinical and clinical testing and other approval requirements to
pharmaceutical products for use in humans and animals. Various federal and, in
some cases, state statutes and regulations and similar statutes and
regulations of foreign jurisdictions also govern or influence the
manufacturing, safety, labeling, storage, recordkeeping, confidential patient
information exchange, promotion, advertising, marketing and pricing relating
to such pharmaceutical products. Companies spend a large amount of time and
resources obtaining these approvals and complying with appropriate federal and
foreign statutes and regulations. Both we and our collaborators may be unable
to successfully complete the pre-clinical and clinical development of, and
file new drug applications, or NDAs or BLAs, with the FDA for any drug
candidate. In addition the FDA may not grant approval on a timely basis, if at
all, for any drug candidate. Any failure by our collaborators or licensees to
obtain, or any delay in obtaining, regulatory approval or non-patent market
exclusivity could adversely affect our ability to receive milestone payments
or royalty revenues. Even if our collaborators or licensees obtain FDA
regulatory approvals, material changes to an approved product, such as
manufacturing changes or additional labeling claims, require further FDA
review and approval. Once obtained, the FDA may withdraw any approval.
Further, if we, our collaborators, our contract research organizations or our
contract manufacturers fail to comply with applicable FDA and other regulatory
requirements at any stage during the regulatory process, the FDA may impose
sanctions, including delays, warning letters, fines, product recalls or
seizures, injunctions, refusal of the FDA to review pending market approval
applications or supplements to approval applications, total or partial
suspension of production, civil penalties, withdrawals of previously approved
marketing applications, or criminal prosecutions. In addition, foreign
regulatory requirements governing human and animal clinical trials and
marketing approval for pharmaceutical products govern our and our
collaborators' marketing outside the United States. The requirements governing
the conduct of clinical trials, product licensing, pricing and reimbursement
may vary from country to country, adding to the overall expense of drug
development.


                                      37
<PAGE>

 If we, or our collaborators, do not obtain adequate reimbursement, we will be
 unable to commercialize our product candidates.

   In both domestic and foreign markets, sales of our product candidates will
depend in part upon the availability of reimbursement from third-party payors.
Such third-party payors include government health administration authorities,
managed care providers, private health insurers and other organizations. These
third-party payors are increasingly challenging the price and examining the
cost effectiveness of medical products and services. In addition, significant
uncertainty exists as to the reimbursement status of newly approved healthcare
products. We, or our collaborators, may need to conduct post-marketing studies
in order to demonstrate the cost-effectiveness of our products. Such studies
may require us to provide a significant amount of resources. Our product
candidates may not be considered cost-effective. Adequate third-party
reimbursement may not be available to enable us to maintain price levels
sufficient to realize an appropriate return on our investment in product
development. Domestic and foreign governments continue to propose and pass
legislation designed to reduce the cost of healthcare. Accordingly,
legislation and regulations affecting the pricing of pharmaceuticals may
change before our proposed products are approved for marketing. Adoption of
such legislation could further limit reimbursement for pharmaceuticals. If the
government and third-party payors fail to provide adequate coverage and
reimbursement rates for our product candidates, the market acceptance of our
products may be adversely affected. If our products do not receive market
acceptance, our business, financial condition and results of operations will
be materially adversely affected.

 If we are unable to build sales, marketing and distribution capabilities or
 enter into agreements with third parties to perform these functions, we will
 not be able to commercialize any of our drug candidates.

   We currently have no sales, marketing or distribution capabilities to
commercialize our drug candidates. In order to commercialize any of our drug
candidates, we must either internally develop sales, marketing and
distribution capabilities or make arrangements with third parties to perform
these services. We intend to rely for the foreseeable future on collaborations
with licensees of our compounds to market any of our drug candidates which
receive regulatory approvals in the future.

   To market any of our drug products directly, we would have to develop a
marketing and sales force with technical expertise and supporting distribution
capabilities and we may not be able to do so. To promote any of our drug
products through third parties, we would have to locate acceptable third
parties for these functions and enter into agreements with them on acceptable
terms and we may not be able to do so. If we enter into co-promotion or other
licensing arrangements, any product revenues would likely be lower than if we
directly marketed and sold our products, and any revenues that we may receive
would depend upon the efforts of third parties, which efforts may not be
successful. If these third parties do not succeed in carrying out their
contractual duties or do not meet expected deadlines, our sales would suffer
and we might not be profitable.

 Our ability to compete in the market may decline if we do not adequately
 protect our proprietary technologies, or if we lose some of our intellectual
 property rights as a result of, or otherwise become involved in, expensive
 lawsuits or administrative proceedings.

   Our intellectual property consists of patents, copyrights, trade secrets,
and trademarks. Our success depends in part on our ability to obtain patents
and maintain adequate protection of our intellectual property for our
technologies and products in the United States and other countries. We
currently do not have any issued patents for any of our lead compounds for any
of our internal programs and we may be unable to obtain any issued patents for
any patent applications we have filed or may file in the future for such
compounds.

   Our commercial success depends in part on avoiding infringing patents and
proprietary rights of third parties and developing and maintaining a
proprietary position with regard to our own technologies, products and
business. The patent positions of pharmaceutical companies, including our
patent position, involve complex legal and factual questions, and whether a
company will be able to enforce its patent cannot always be predicted with
certainty. Even if we obtain patents, we may lose them in part or in whole as
a result of lawsuits

                                      38
<PAGE>

or administrative proceedings, or competitors may otherwise challenge or
circumvent them. We cannot be sure that relevant patents have not been issued,
or that relevant publications or actions by others have not occurred, that
could block our ability to obtain patents or to operate as we would like.
Others may develop similar technologies or duplicate technologies to those
that we have developed. We are aware of the existence of claims in a granted
patent and published patent applications in some countries that, if valid and
broadly construed, may block our ability to commercialize products or
processes in those countries if we are unable to circumvent or license them.
As to those patents that we have licensed, our rights depend on maintaining
our obligations to the licensor under the applicable license agreement and we
may be unable to do so.

   Extensive litigation regarding patents and other intellectual property
rights characterizes our industry. Many companies have employed intellectual
property litigation as a way to gain a competitive advantage. If we became
involved in litigation or interference proceedings declared by the United
States Patent and Trademark Office, or oppositions or other intellectual
property proceedings outside of the United States, to defend our intellectual
property rights or as a result of alleged infringement of the rights of
others, we might have to spend significant amounts of time and money. We are
aware of a significant number of patents and patent applications relating to
our technologies filed by, or issued to, third parties. Should any of our
competitors have filed patent applications or obtained patents that claim
inventions that we also claim, we may have to participate in an interference
proceeding to determine priority of invention and, thus, the right to a patent
for these inventions or discoveries in the United States. We could incur
substantial costs from such a proceeding even if the outcome is favorable.
Even if successful on priority grounds, an interference may result in loss of
claims based on patentability grounds raised in the interference. The
litigation or proceedings could divert our management time and efforts. Even
unsuccessful claims could result in significant legal fees and other expenses,
diversion of management time and disruption in our business. Uncertainties
resulting from initiation and continuation of any patent or related litigation
could harm our ability to compete.

   An adverse ruling arising out of any intellectual property dispute,
including but not limited to an adverse decision as to the priority of our
inventions, would undercut or invalidate our intellectual property position.
An adverse ruling could also subject us to significant liability for damages,
prevent us from using processes or products, or require us to license disputed
rights from third parties. Although patent and intellectual property disputes
in the biotechnology area are often settled through licensing or similar
arrangements, costs associated with these arrangements may be substantial and
could include ongoing royalties. We may not be able to obtain any necessary
licenses on satisfactory terms, if at all.

   From time to time we have received letters from third parties suggesting
that we may want to consider licensing patents held by such third parties. We
believe that we have defenses to any infringement claim with respect to such
patents. However, we cannot be certain that one or more of the third parties
will not initiate litigation alleging that our technologies infringe claims of
such patents or that a court would not find such claims valid and infringed.

   We have funded specific technologies with U.S. government grants. For
instance, we developed our ThermoFluor screening technology using funds from a
grant awarded by the National Institute for General Medical Sciences at the
National Institutes of Health, and portions of our GPCR technology using funds
from grants awarded by the National Institute for General Medical Sciences at
the National Institutes of Health. We elected to retain title in these
technologies, subject to a nonexclusive, nontransferable, irrevocable, paid-up
license to the U.S. government to practice or have practiced for or on behalf
of the government any technology developed with these funds.

 Confidentiality agreements with employees and others may not adequately
 prevent disclosure of trade secrets and other proprietary information.

   In order to protect our proprietary technology and processes, we also rely
in part on trade secret protection for our confidential and proprietary
information. Our policy is to execute confidentiality agreements with our
employees and consultants upon the commencement of an employment or consulting
arrangement with us.

                                      39
<PAGE>

These agreements require that all confidential information that the individual
develops or that we make known to the individual during the course of the
individual's relationship with us be kept confidential and not disclosed to
third parties. These agreements also provide that inventions that the
individual conceives in the course of rendering services to us shall be our
exclusive property. Such individual may, nonetheless, disclose proprietary
information, others may independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to our trade
secrets and we may be unable to meaningfully protect our trade secrets. Costly
and time-consuming litigation could be necessary to enforce and determine the
scope of our proprietary rights, and failure to obtain or maintain trade
secret protection could adversely affect our competitive business position.

 If our competitors develop and market drug discovery technologies or drug
 candidates faster than we do or that are superior to our drug discovery
 technologies or drug candidates, our commercial opportunities will be reduced
 or eliminated.

   We compete both in the markets for drug discovery technologies and services
and the markets for pharmaceutical products. Our principal competitors are the
internal drug discovery departments of our pharmaceutical company customers
and potential customers. Many of our customers and potential customers have
developed or acquired or are developing or are acquiring integrated drug
discovery capabilities that use combinatorial chemistry (the science of
modifying a central core structure by adding different chemical groups
connected to the core at different positions), chemi-informatics software
(software for handling chemistry data), structure-based drug design (the
science of creating drug molecules from knowledge of the structural features
of the site on the target protein at which drugs bind) and high-throughput
screening. In addition, many of these companies have large collections of
compounds that they have previously synthesized, purchased from chemical
supply catalogs or obtained from other sources against which they may screen
new targets.

   We also compete with biotechnology and drug discovery services companies,
academic and scientific institutions, governmental agencies, and public and
private research organizations. Our technology platform integrates many
technologies, including combinatorial chemistry, chemi-informatics software,
structure-based drug design and high-throughput screening. We face competition
based on numerous factors, including size, diversity and ease of use of
compound libraries, speed and cost of identifying and optimizing potential
lead compounds and patent position, from companies offering one or more
technology components of the discovery process. These entities compete with us
either on their own or in collaborations.

   While we believe that our integration of proprietary technologies for drug
discovery provides us with a competitive advantage over many of our
competitors, we expect that many of our competitors will seek to integrate and
improve their technologies to provide discovery capabilities similar or
superior to those provided by us.

   For drug candidates developed internally which we seek to license, we face,
and will continue to face, intense competition from organizations such as
large pharmaceutical and biotechnology companies. Competition with any of the
programs in our internal drug discovery pipeline may arise from current or
future drug candidates in the same therapeutic class or other classes of
therapeutic agents or other methods of preventing or reducing the incidence of
disease. Any drug candidate that is successfully developed may compete with
existing therapies that have long histories of safe and effective use.

   Due to perceived shortcomings of available agents and the large market
potential, competition to develop a safe, orally active antithrombotic agent
(an agent which inhibits the formation of blood clots) is intense, with many
discovery programs in process. In addition, our orally active urokinase
inhibitor for the inhibition of cancer metastasis (development of secondary
tumors in other organs of the body during the spread of cancer) and tumor
angiogenesis (development of new blood vessels that allow the further growth
of tumors) and for cardiovascular indications faces competition from a number
of agents and approaches currently under development.


                                      40
<PAGE>

   Our other research programs in small molecule drug discovery also face
strong competition. Many other companies are working in these areas and they
may achieve earlier or greater success than we may be able to achieve.

   Our current and anticipated future research programs that focus on the
discovery of small molecule drugs that target GPCRs are also in a highly
competitive area. Most major pharmaceutical companies have extensive drug
discovery programs that target one or more GPCRs, and many biotechnology
companies have developed proprietary positions for particular GPCR receptors or
screening technologies.

   Most of our competitors, either alone, or together with their collaborators,
have substantially greater research and development capabilities and financial,
scientific, operational, marketing and sales resources than we do, as well as
significantly more experience in research and development, clinical trials,
regulatory matters, manufacturing, marketing and sales. These competitors and
other companies may have already developed or may in the future develop new
technologies or products that compete with ours or which could render our
technologies and products obsolete. In addition, our competitors may succeed in
obtaining broader patent protection, receiving FDA approval for products or
developing and commercializing products or technologies before us. We also
compete with these organizations in recruiting and retaining qualified
scientific and management personnel.

 If we lose our key personnel or are unable to attract and retain qualified
 personnel as necessary, it could delay our product development programs and
 harm our research and development efforts.

   We are highly dependent on the principal members of our scientific and
management staff, including David C. U'Prichard, our Chief Executive Officer,
and F. Raymond Salemme, our President and Chief Scientific Officer. If we lose
the services of one or more of these persons, we may be unable to achieve our
business objectives. Our future success also will depend in part on the
continued service of our other key scientific, software, engineering and
management personnel and our ability to identify, hire and retain additional
personnel. We have maintained key area life insurance on Dr. Salemme since the
Company's inception in 1993, but we do not maintain key area life insurance on
any of our other employees. Intense competition exists for qualified personnel
in the areas of our activities, and we may not be able to continue to attract
and retain such personnel necessary for the development of our business. All of
our key employees are required to sign non-competition agreements with us.
Failure to attract and retain key personnel could have a material adverse
effect on our business, financial condition and results of operations.

 We are experiencing a period of significant expansion of personnel and space
 demands which could delay our product development programs and harm our
 research and development efforts.

   We are increasing the size of our staff at a significant rate, with the
addition of approximately 100 employees planned during the remainder of 2001.
As a result, we will face increasing needs for space and the challenge of
managing the business in multiple locations. These needs and challenges will
place demands on our management, information technology and other support
functions, which may, from time to time, cause delays in our product
development programs and diminish the results of our research and development
efforts.

 We expect that our quarterly results of operations will fluctuate, and this
 fluctuation could cause our stock price to decline, causing investor losses.

   To date, substantially all of our revenue has been from corporate
collaborations, license agreements and government grants. We expect that a
significant portion of our revenues for the foreseeable future will be
comprised of this funding as well as milestone payments. The timing of revenue
in the future will depend largely upon the signing and terms of collaborative
research and development or technology licensing agreements or the licensing of
drug candidates for further development and the recognition of fees, milestone
payments and royalty revenues from these agreements. In any one fiscal quarter
we may receive multiple or no

                                       41
<PAGE>

payments from our collaborators. Although we recognize certain revenue under
our collaborations and some licenses over the life of the contract, operating
results may vary from quarter to quarter. Revenue for any given period may be
greater or less than revenue in the immediately preceding period or in the
comparable period of the prior year. Our operating results may also fluctuate
due to other factors, including the following:

  .  termination of collaborations and licensing arrangements;

  .  the ability and willingness of collaborators to develop and
     commercialize milestone and royalty-bearing products within expected
     timelines and the resulting demand for any commercialized products;

  .  our ability to enter into new collaborative agreements, or to extend the
     terms of our existing collaborative agreements, and the terms of any
     agreement of this type;

  .  our ability or that of our collaborators to successfully satisfy all
     pertinent regulatory requirements;

  .  the level of our expenditures on research and development and the level
     of other operating expenses; and

  .  general and industry specific economic conditions, which may affect our
     collaborators' research and development expenditures.

   If revenue declines or does not grow as anticipated due to the expiration of
collaborative agreements, failure to obtain new agreements or grants, lower-
than-expected milestone or royalty payments or other factors, we may not be
able to correspondingly reduce our operating expenses. A large portion of our
expenses, including expenses for facilities, equipment and personnel, are
committed and growing. Failure to achieve anticipated levels of revenue could
therefore significantly harm our operating results for a particular fiscal
period.

   Due to the possibility of fluctuations in our revenue and our anticipated
increasing expenses, we believe that quarter-to-quarter comparisons of our
operating results are not a good indication of our future performance. Our
operating results in some quarters may not meet the expectations of stock
market analysts and investors. In that case, our stock price may decline.

 If we use or our collaborators use biological and hazardous materials in a
 manner that causes injury, we may be liable for damages.

   Both we and our collaborators conduct research and development activities
which involve the controlled use of potentially harmful biological materials as
well as hazardous materials, chemicals and various radioactive compounds. We
use a wide range of solvents and other chemicals in order to discover new drug
candidates. We also generate biological waste products such as bacterial cells
and analyzed blood products during drug discovery programs. In addition,
several of our biological studies use small quantities of radioactive isotopes
of hydrogen, iodine, carbon, sulfur and phosphorus. We cannot completely
eliminate the risk of accidental contamination or injury from the use, storage,
handling or disposal of these materials. In the event of contamination or
injury, we could be held liable for damages that result, and any liability
could exceed our resources. We do not have liability insurance coverage for
contamination or injury. We also do not have mass tort insurance coverage or
environmental insurance coverage. The cost of compliance with Federal and local
regulatory requirements with respect to the use, monitoring and disposal of
chemical and biological waste products could be significant.

 We may be sued for product liability.

   Because we are involved in the drug discovery process, our business exposes
us to potential product liability risks, when and if drug candidates are
commercialized. We may not be able to avoid product liability

                                       42
<PAGE>

claims. Product liability insurance for the pharmaceutical industry is
generally expensive, if it is available at all. If we are unable to obtain
sufficient insurance coverage on reasonable terms or to otherwise protect
against potential product liability claims, we may be unable to commercialize
our product candidates. We currently maintain products/professional liability
insurance with coverage which we believe is customary and appropriate for
businesses such as that of the Company. If a plaintiff brings a successful
product liability claim against us in excess of our insurance coverage, if
any, we may incur substantial liabilities and our business may fail.

 If we engage in any acquisition or business combination, we will incur a
 variety of risks that could adversely affect our business operations.

   We generally consider and will continue to consider strategic business
initiatives intended to further the development of our business, including
acquiring businesses, technologies and products and entering into business
combinations with other companies. If we do pursue one or more of these
strategic initiatives, we could, among other things:

  .  issue equity securities that would dilute current stockholders'
     percentage ownership, incur substantial debt, or both;

  .  spend substantial operational, financial and management resources in
     integrating new businesses, technologies and products;

  .  assume substantial actual or contingent liabilities; or

  .  merge, or otherwise enter into a business combination with, another
     company in which our stockholders would receive cash or shares of the
     other company, or a combination of both. In such case, many stockholders
     may disagree with the terms of such business combination or may view the
     sufficiency of the consideration to be received to be inadequate, or
     both.

   In addition, any future acquisitions or business combinations might
negatively impact our business relations with a collaborator and could lead to
a termination of our agreement with that collaborator.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

   Our exposure to market risk for changes in interest rates relates primarily
to the increase or decrease in the amount of interest income we can earn on
our investment portfolio and on the increase or decrease in the amount of
interest expense we must pay with respect to our various outstanding debt
instruments. Our risk associated with fluctuating interest expense is limited
to our capital lease obligations, the underlying interest rates of which are
closely tied to market rates, and our investments in interest rate sensitive
financial instruments. Under our current policies, we do not use interest rate
derivative instruments to manage exposure to interest rate changes. We seek to
ensure the safety and preservation of our invested principal funds by limiting
default risk, market risk and reinvestment risk. We seek to minimize the risk
of default by investing in investment grade securities. A hypothetical 100
basis point adverse move in interest rates along the entire interest rate
yield curve would not materially affect the fair value of our interest rate
sensitive financial instruments at December 31, 1998, December 31, 1999 or
December 31, 2000. Declines in interest rates over time will, however, reduce
our interest income while increases in interest rates over time will increase
our interest expense.

                                      43
<PAGE>

Item 8. Financial Statements and Supplementary Data

                         INDEX TO FINANCIAL STATEMENTS

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                                    CONTENTS

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Financial Statements

  Independent auditors' report............................................  45

  Balance sheets as of December 31, 2000 and 1999.........................  46

  Statements of operations for the years ended December 31, 2000, 1999 and
   1998...................................................................  47

  Statements of changes in stockholders' equity (deficiency) for the years
   ended December 31, 2000, 1999 and 1998.................................  48

  Statements of cash flows for the years ended December 31, 2000, 1999 and
   1998...................................................................  49

  Notes to financial statements...........................................  50
</TABLE>

                                       44
<PAGE>

                          INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
3-Dimensional Pharmaceuticals, Inc.
Exton, Pennsylvania

   We have audited the accompanying balance sheets of 3-Dimensional
Pharmaceuticals, Inc. as of December 31, 2000 and 1999, and the related
statements of operations, changes in stockholders' equity (deficiency) and cash
flows for each of the years in the three-year period ended December 31, 2000.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

   We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

   In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of 3-Dimensional
Pharmaceuticals, Inc. as of December 31, 2000 and 1999, and the results of its
operations and its cash flows for each of the years in the three-year period
ended December 31, 2000 in conformity with accounting principles generally
accepted in the United States of America.

                                          Richard A. Eisner & Company, LLP

New York, New York
February 7, 2001

                                       45
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                          December 31,
                                                    --------------------------
                                                        2000          1999
                                                    ------------  ------------
<S>                                                 <C>           <C>
                      ASSETS
                      ------
Current assets:
  Cash and cash equivalents........................ $114,557,000  $  7,645,000
  Prepaid expenses and other current assets........      977,000       337,000
                                                    ------------  ------------
    Total current assets...........................  115,534,000     7,982,000
Property and equipment, net........................    5,508,000     4,314,000
Other assets.......................................    2,202,000       184,000
                                                    ------------  ------------
                                                    $123,244,000  $ 12,480,000
                                                    ============  ============
 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
  Accounts payable and accrued expenses............ $  3,193,000  $  2,737,000
  Current portion of deferred income...............    7,385,000       888,000
  Current portion of long-term debt................    1,209,000     1,139,000
  Current portion of settlement accrual............      500,000     1,000,000
                                                    ------------  ------------
    Total current liabilities......................   12,287,000     5,764,000
Notes payable-dividends and accrued interest.......                    685,000
Deferred income, less current portion..............    9,619,000
Long-term debt, less current portion...............    1,315,000     2,330,000
Convertible notes payable and accrued interest.....                 10,115,000
Settlement accrual, less current portion...........                    500,000
                                                    ------------  ------------
                                                      23,221,000    19,394,000
                                                    ------------  ------------
Commitments
Redeemable convertible Series A preferred stock-
 $.001 par value; 35,136,963 shares authorized and
 25,325,240 outstanding at December 31, 1999
 (aggregate liquidating preference of
 $35,004,474)......................................                 34,834,000
                                                                  ------------
Stockholders' equity (deficiency):
  Convertible preferred stock-$.001 par value:
   5,000,000 and 6,000,000 shares authorized in
   aggregate, none and 1,400,000 outstanding at
   December 31, 2000 and 1999, respectively
   (aggregate liquidating preference of $3,250,000
   at December 31, 1999)...........................                      1,000
  Common stock-$.001 par value; 45,000,000 and
   15,994,613 shares authorized, 21,385,798 and
   745,418 shares outstanding at December 31, 2000
   and 1999, respectively..........................       21,000         1,000
  Additional paid-in capital.......................  157,223,000     3,429,000
  Notes receivable from officers...................     (390,000)      (70,000)
  Deferred compensation............................   (3,570,000)
  Accumulated deficit..............................  (53,261,000)  (45,109,000)
                                                    ------------  ------------
    Total stockholders' equity (deficiency)........  100,023,000   (41,748,000)
                                                    ------------  ------------
                                                    $123,244,000  $ 12,480,000
                                                    ============  ============
</TABLE>

                       See notes to financial statements

                                       46
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                            Year Ended December 31,
                                     ----------------------------------------
                                         2000          1999          1998
                                     ------------  ------------  ------------
<S>                                  <C>           <C>           <C>
Grant and research revenue.......... $ 12,409,000  $  4,489,000  $  5,095,000
                                     ------------  ------------  ------------
Costs and expenses:
  Research and development..........   14,562,000    12,136,000    10,984,000
  General and administrative........    8,652,000     6,525,000     4,458,000
  Litigation settlement.............                  1,500,000
                                     ------------  ------------  ------------
                                       23,214,000    20,161,000    15,442,000
                                     ------------  ------------  ------------
Loss from operations................  (10,805,000)  (15,672,000)  (10,347,000)
Interest income.....................    3,458,000       328,000       868,000
Interest expense....................     (646,000)     (625,000)     (232,000)
                                     ------------  ------------  ------------
Loss before income taxes............   (7,993,000)  (15,969,000)   (9,711,000)
Provision for income taxes..........      159,000
                                     ------------  ------------  ------------
Net loss............................   (8,152,000)  (15,969,000)   (9,711,000)
Declared and accrued cumulative
 dividends on
 preferred stock....................     (396,000)     (669,000)     (144,000)
                                     ------------  ------------  ------------
Net loss applicable to common
 stock.............................. $ (8,548,000) $(16,638,000) $ (9,855,000)
                                     ============  ============  ============
Basic and diluted net loss per
 common share-historical............ $      (0.97) $     (27.37) $     (22.20)
                                     ============  ============  ============
Weighted average common shares
 outstanding-historical.............    8,778,000       608,000       444,000
                                     ============  ============  ============
Basic and diluted net loss per
 common share-proforma.............. $      (0.52) $      (1.57)
                                     ============  ============
Weighted average common shares
 outstanding-proforma...............   15,663,000    10,198,000
                                     ============  ============
</TABLE>


                       See notes to financial statements

                                       47
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC

          STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)

<TABLE>
<CAPTION>
                   Preferred Stock       Common Stock                     Notes                                     Total
                  ------------------  -------------------  Additional   Receivable                              Stockholders'
                               Par                  Par     Paid-in        From       Deferred    Accumulated       Equity
                    Shares    Value     Shares     Value    Capital      Officers   Compensation    Deficit      (Deficiency)
                  ----------  ------  ----------  ------- ------------  ----------  ------------  ------------  -------------
<S>               <C>         <C>     <C>         <C>     <C>           <C>         <C>           <C>           <C>
Balance-December
31, 1997........   1,400,000  $1,000     811,284  $ 1,000 $  3,976,000  $(251,000)                $(19,429,000) $(15,702,000)
Common stock
issued pursuant
to exercise of
stock options
and stock
grants..........                         105,790                93,000                                                93,000
Common stock
reacquired......                        (183,095)             (116,000)    67,000                                    (49,000)
Dividend
declared on
Series A-1
preferred.......                                              (144,000)                                             (144,000)
Compensation
charge in
connection with
acceleration of
vesting terms on
restricted
shares and
options.........                                                66,000                                                66,000
Forgiveness of
loans made to
officers........                                                           63,000                                     63,000
Net loss for the
year............                                                                                    (9,711,000)   (9,711,000)
                  ----------  ------  ----------  ------- ------------  ---------   -----------   ------------  ------------
Balance-December
31, 1998........   1,400,000   1,000     733,979    1,000    3,875,000   (121,000)                 (29,140,000)  (25,384,000)
Common stock
issued pursuant
to exercise of
stock options...                          11,439                11,000                                                11,000
Value of options
issued to
consultants.....                                                18,000                                                18,000
Value of
warrants issued
in connection
with bridge
loan............                                                26,000                                                26,000
Dividend
declared on
Series A-1
preferred.......                                              (501,000)                                             (501,000)
Forgiveness of
loans made to
officers........                                                           51,000                                     51,000
Net loss for the
year............                                                                                   (15,969,000)  (15,969,000)
                  ----------  ------  ----------  ------- ------------  ---------   -----------   ------------  ------------
Balance-December
31, 1999........   1,400,000   1,000     745,418    1,000    3,429,000    (70,000)                 (45,109,000)  (41,748,000)
Common stock
issued pursuant
to exercise of
stock options,
warrants and
stock grants....                         622,010             1,605,000   (521,000)                                 1,084,000
Common stock
issued pursuant
to cashless
exercise of
warrants........                       1,017,230    1,000       (1,000)
Issuance of
Series D
preferred stock,
net of offering
costs of
$24,000.........     625,000   1,000                         4,976,000                                             4,977,000
Common stock
issued pursuant
to initial
public offering,
net of offering
costs of
$7,362,500......                       5,750,000    6,000   78,882,000                                            78,888,000
Conversion of
convertible
preferred
stock...........  (2,025,000) (2,000)    723,214    1,000        1,000
Conversion of
redeemable
preferred
stock...........                      12,463,389   12,000   63,523,000                                            63,535,000
Conversion of
notes payable--
dividends and
accrued
interest........                          71,234             1,068,000                                             1,068,000
Dividends
declared on
Series A-1
preferred.......                                              (563,000)                                             (563,000)
Value of options
issued to
consultants.....                                               392,000                                               392,000
Deferred
compensation
charge in
connection with
option grants...                                             3,983,000              $(3,983,000)
Forfeiture of
options subject
to deferred
compensation....                                               (53,000)                  53,000
Deferred
compensation
expense.........                                                                        360,000                      360,000
Common stock
reacquired......                          (6,697)              (19,000)    19,000
Forgiveness of
loans made to
officers........                                                          182,000                                    182,000
Net loss for the
year............                                                                                    (8,152,000)   (8,152,000)
                  ----------  ------  ----------  ------- ------------  ---------   -----------   ------------  ------------
Balance-December
31, 2000........           0  $    0  21,385,798  $21,000 $157,223,000  $(390,000)  $(3,570,000)  $(53,261,000) $100,023,000
                  ==========  ======  ==========  ======= ============  =========   ===========   ============  ============
</TABLE>

                       See notes to financial statements

                                       48
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                              Year Ended December 31,
                                       ---------------------------------------
                                           2000          1999         1998
                                       ------------  ------------  -----------
<S>                                    <C>           <C>           <C>
Cash flows from operating activities:
Net loss.............................  $ (8,152,000) $(15,969,000) $(9,711,000)
Adjustments to reconcile net loss to
 net cash provided by (used in)
 operating activities:
  Depreciation and amortization......     1,922,000     1,565,000    1,486,000
  Amortization of premium of short-
   term investments..................                      19,000       62,000
  Accretion of interest on discounted
   note payable......................        26,000
  Compensation charge in connection
   with acceleration of vesting of
   options and stock and other.......       201,000        51,000      129,000
  Compensation paid with options and
   warrants..........................       752,000        44,000
Interest paid with common stock......        49,000
Interest paid with preferred stock...       239,000
Changes in:
  Other assets.......................    (1,899,000)      260,000      195,000
  Accounts payable and accrued
   expenses..........................       454,000     1,620,000      106,000
  Settlement accrual.................    (1,000,000)    1,500,000
  Deferred income....................    16,116,000       345,000     (675,000)
                                       ------------  ------------  -----------
     Net cash provided by (used in)
      operating activities...........     8,708,000   (10,565,000)  (8,408,000)
                                       ------------  ------------  -----------
Cash flows from investing activities:
  Purchase of investment securities..                               (8,334,000)
  Sale and maturities of investment
   securities........................                   7,267,000    7,500,000
  Acquisition of subsidiary, net of
   $25,000 cash acquired.............                      (5,000)
  Capital expenditures...............    (3,469,000)     (278,000)  (3,999,000)
                                       ------------  ------------  -----------
     Net cash provided by (used in)
      investing activities...........    (3,469,000)    6,984,000   (4,833,000)
                                       ------------  ------------  -----------
Cash flows from financing activities:
  Proceeds from sale of stock........   102,212,000                 10,372,000
  Proceeds from exercise of options
   and warrants......................     1,068,000        11,000      118,000
  Dividends paid on Series A-1
   preferred stock...................      (229,000)
  Payment for stock repurchased......                                  (49,000)
  Proceeds from issuance of long-term
   debt and notes payable............                                3,924,000
  Proceeds from issuance of short-
   term debt.........................                  10,000,000
  Reduction of long-term debt and
   notes payable.....................    (1,378,000)   (1,224,000)  (1,123,000)
                                       ------------  ------------  -----------
     Net cash provided by financing
      activities.....................   101,673,000     8,787,000   13,242,000
                                       ------------  ------------  -----------
Net increase in cash and cash
 equivalents.........................   106,912,000     5,206,000        1,000
Cash and cash equivalents-beginning
 of year.............................     7,645,000     2,439,000    2,438,000
                                       ------------  ------------  -----------
Cash and cash equivalents-end of
 year................................  $114,557,000  $  7,645,000  $ 2,439,000
                                       ============  ============  ===========
Supplemental disclosures of cash flow
 information:
  Cash paid for interest.............  $    331,000  $    446,000  $   232,000
  Noncash investing and financing
   activities:
   Equipment purchased under capital
    leases...........................                $    390,000
   Dividend declared, paid through
    issuance of notes ...............                $    501,000  $   144,000
   Note receivable exchanged for
    common stock.....................  $    521,000
   Notes payable (including interest
    due of $89,000) exchanged for
    common stock.....................  $  1,068,000
   Notes payable (including interest
    due of $353,000) exchanged for
    redeemable preferred stock.......  $ 10,353,000
   Conversion of redeemable and
    convertible preferred stock to
    common stock.....................  $ 71,751,000
</TABLE>

                       See notes to financial statements

                                       49
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                         NOTES TO FINANCIAL STATEMENTS

                           December 31, 2000 and 1999

NOTE A--DESCRIPTION OF BUSINESS

   3-Dimensional Pharmaceuticals, Inc. (the "Company") is a drug discovery
company that has developed an integrated set of proprietary technologies for
the cost-effective discovery of small molecule pharmaceuticals. The Company is
using its technologies both to assist collaborators in discovering drug
candidates, and to discover and develop its own drug candidates, which it
intends to license at the pre-clinical or early-clinical stage.

   The Company has incurred net losses since inception in 1993 and may incur
additional losses for at least the next several years. Through December 31,
2000, substantially all of the Company's revenue has been derived from
corporate collaborations, license agreements and government grants. The Company
expects that substantially all of its revenue for the foreseeable future will
result from payments from these sources, from the outlicensing of technologies
and of internally developed pre-clinical and clinical drug candidates and from
interest income. The Company expects to spend significant amounts to enhance
its drug discovery technologies and to fund research and development of its
internal pipeline of drug candidates. Through December 31, 2000, the Company's
technologies have not been used in the development of any compound that has
reached the point of commercialization. In order to achieve profitability the
Company must continue to develop products and technologies from which it can
derive revenue, including through existing and future collaborations.

NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 [1] Principles of consolidation

   The financial statements at December 31, 2000 and 1999 include the accounts
of the Company and its wholly-owned subsidiary which was acquired in 1999 for
approximately $30,000 (including cost of acquisition). The subsidiary is an
inactive entity incorporated in Germany, which had cash of $25,000 and no
liabilities at the date of acquisition. All intercompany balances have been
eliminated in consolidation. Financial statements for 1998 include only the
accounts of the Company as it had no subsidiaries during such year.

 [2] Cash and cash equivalents:

   The Company considers all highly liquid investment instruments purchased
with a maturity of three months or less to be cash equivalents. As of December
31, 2000, cash equivalents amounted to $113,713,000 in a money market account,
which is invested principally in U.S. and U.S. Government agency securities.
The Company has established guidelines regarding diversification of its
investments and their maturities, which should maintain safety and liquidity.
The Company has not experienced any losses on its investments.

 [3] Property and equipment:

   Property and equipment are recorded at cost and depreciated using the
straight-line method over estimated useful lives of two to five years.
Equipment acquired under capital lease agreements is amortized over the term of
the lease. Leasehold improvements are amortized over the lesser of the economic
useful life of the improvement or the term of the lease.


 [4] Revenue recognition:

   Revenue from corporate collaborations is recognized over the period that the
Company performs research and development activities under the terms of the
agreements. Such revenue includes periodic payments for research and
development activities and related nonrefundable up-front technology access
fees and/or

                                       50
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

technology or software licensing fees. Revenue from nonrefundable up-front fees
for the licensing of technology, products or software under agreements which do
not require the Company to perform research or development activities or other
significant future performance obligations is recognized at the time the
agreement is executed or the software is delivered. Revenue resulting from the
achievement of milestone events stipulated in the agreements is recognized when
the milestone is achieved. Up-front fees and other amounts received in excess
of revenue recognized are recorded as deferred income.

   In the year ended December 31, 1999, the Company, in connection with its
initial public offering, changed its method of recognizing revenue with respect
to nonrefundable up-front fees received under corporate collaboration research
agreements to the method described above to conform with the requirements of an
accounting bulletin on revenue recognition issued by the staff of the
Securities and Exchange Commission in December 1999 and retroactively restated
its prior years financial statements to reflect the application of the new
method. Prior to the change, the Company recognized revenue from such fees upon
the execution of the agreement.

 [5] Research and development:

   Research and development costs are expensed as incurred.

 [6] Accounting for stock-based compensation:

   The Company accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). In October 1995, the Financial Accounting Standards Board issued
Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
which establishes a fair value-based method of accounting for stock-based
compensation plans. The Company has adopted the disclosure-only alternative
under SFAS No. 123, which requires disclosure of the pro forma effects on net
loss and net loss per share as if stock-based employee compensation was
measured under SFAS No. 123, as well as certain other information. The Company
accounts for stock-based compensation to non-employees using the fair value
method in accordance with SFAS No. 123. The Company has recognized deferred
stock compensation related to certain stock option grants (see Note J).

 [7] Use of estimates:

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

 [8] Per share data:

   Historical basic and diluted net loss per common share is computed by
dividing the net loss increased by declared and accrued cumulative dividends on
the Series A-1 preferred stock for the period by the weighted average number of
common shares outstanding during the period after giving retroactive effect to
the 1 for 2.8 reverse stock split effective in July 2000, exclusive of
outstanding shares of common stock which are subject to repurchase and are
nonvested. As their effects would be anti-dilutive, shares of common stock
issuable upon conversion of preferred stock (for the periods prior to
conversion) and exercise of outstanding options and warrants as well as
outstanding common shares which are nonvested during the periods were not
included in

                                       51
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

computing diluted net loss per common share. Securities and the related number
of common shares not included in the diluted computation for the year ended
December 31, 2000 that could potentially dilute basic earnings per share, if
any, in the future are as follows:

<TABLE>
<CAPTION>
                                                              Dilutive Potential
                                                               Common Shares *
                                                              ------------------
   <S>                                                        <C>
   Preferred stock (see below)...............................      6,858,000
   Options...................................................      2,115,000
   Warrants..................................................      1,531,000
   Common stock--subject to repurchase.......................        179,000
                                                                  ----------
                                                                  10,683,000
                                                                  ==========
</TABLE>
--------
*  Includes weighted average shares for period prior to conversion and
   exercise.

   The preferred stock automatically converted into common stock on a 1 for .36
basis and certain nonvested common stock automatically became vested upon
completion of the initial public offering of the Company's common stock in
August 2000. Accordingly, pro forma basic and diluted net loss per common share
has been calculated by dividing net loss by the weighted average outstanding
common shares as if the preferred stock were converted into common stock, and
certain nonvested common stock was vested, as of the original date of issuance.

 [9] Comprehensive loss:

   Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" requires the reporting of all changes in equity of an
enterprise that result from recognized transactions and other economic events
of the period other than transactions with owners in their capacity as owners.
The Company had no such other comprehensive items to report.

NOTE C--CERTAIN RESEARCH AND COLLABORATION AGREEMENTS

   In December 1997, the Company entered into a research collaboration with
Heska Corporation to assist in the discovery and development of new veterinary
therapeutic agents. The agreement originally had a two year research term which
was extended until it terminated in July 2000. The Company received up-front
payments and research funding aggregating approximately $2.7 million. In
addition, the Company could receive milestone payments of up to $10.5 million,
depending on whether stipulated milestones are met, for the first product
developed and could receive additional milestone payments if subsequent
products are developed. In addition, the Company will receive royalties on
sales of resulting products.

   In October 1998, the Company entered into a collaborative research and
license agreement with the Agricultural Products Division of E.I. DuPont de
Nemours ("DuPont"), which allows DuPont to utilize the Company's
DirectedDiversity technology to develop and refine agrochemicals. As of
December 31, 2000, the Company has received up-front license fees and milestone
payments of $0.7 million and is eligible to receive additional technology
licensing fees during the term of the collaboration. The Company could also
receive milestone payments aggregating up to $3.7 million depending on whether
stipulated milestones are met and depending on the Company's level of
contribution to the optimization of the compound. In addition, the Company will
receive royalties on the sales of any resulting products.

   In October 1999, the Company entered into a research collaboration and
license agreement with AgrEvo GmbH, now part of Aventis CropScience GmbH under
which the Company will utilize its DirectedDiversity technology in the
discovery of compounds applicable to plant and pest management and animal
health. The

                                       52
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

initial term of the agreement is for two years. As of December 31, 2000, the
Company has received upfront payments, payment for delivery of compounds and
research funding of approximately $2.2 million and is eligible to receive
additional fees for research and development funding and license fees totaling
$1.3 million. The Company could receive milestone payments of up to $1.75
million, depending on whether stipulated milestones are met, for each compound
developed. The Company will also receive royalties on sales of resulting
products.

   In December 1999, the Company entered into a collaboration with Boehringer
Ingelheim Pharmaceuticals, Inc. ("BIPI") to use its DirectedDiversity
technology to assist BIPI in the discovery of new drugs for specific biological
targets in humans. The initial term of the collaboration is two years. As of
December 31, 2000, the Company has received upfront fees and research funding
aggregating approximately $2.3 million and will receive additional committed
research funding of approximately $1.0 million over the initial term of the
collaboration. The Company could also receive milestone payments of up to $2.4
million, depending on whether stipulated milestones are met, for the first
product developed and is eligible to receive additional milestone payments if
subsequent products are developed. The Company is also entitled to receive
royalties on the sales of resulting products.

   In February 2000, the Company entered into a collaboration with DuPont
Pharmaceuticals Company ("DuPont Pharmaceuticals") under which the Company
would utilize its DirectedDiversity technology to develop new drugs for
specific biological targets. As of December 31, 2000, the Company has received
upfront fees and research funding aggregating approximately $1.3 million and
will receive additional committed research funding of approximately $1.0
million through December 31, 2001, the end of the initial research term of the
collaboration. The Company could also receive milestone payments of up to $6
million, depending on whether stipulated milestones are met, for the first
product developed and could receive additional milestone payments if subsequent
products are developed. The Company is also entitled to royalty payments on any
resulting products. The Company also granted DuPont Pharmaceuticals a non-
exclusive site license under the Company's DirectedDiversity patents in support
of their internal and collaborative research programs.

   In March 2000, the Company was awarded and commenced a research project in
which it was the recipient of a two-year Small Business Innovative Research
("SBIR") Award totaling up to $1 million. The SBIR is sponsored by the National
Institutes of Health.

   In May 2000, the Company entered into a license and research agreement with
Schering AG, Germany, in which Schering AG obtained, for human therapeutic
uses, exclusive worldwide rights to the Company's urokinase inhibitor
compounds. During the initial two-year research and development term, the
Company is to receive payments for research funding totaling $5 million, of
which $1.6 million was received by December 31, 2000. In addition, the Company
is eligible to receive milestone payments of up to approximately $23 million,
depending on whether stipulated milestones are met, for the first product
developed in a therapeutic area and future milestone payments for additional
therapeutic areas and royalties on the sales of resulting products. In
connection with the agreement, an affiliate of Schering AG made a $5 million
equity investment consisting of 625,000 shares of Series D preferred stock at
$8.00 per share.

   In July 2000, the Company entered into a collaboration with Bristol-Myers
Squibb Company ("BMS") under which the Company will use its DiscoverWorks
technologies to assist BMS in the discovery and development of new human drugs
for specific biological targets. In the initial three-year term of the research
collaboration, BMS will supply at least 30 biological targets and the Company
will create chemical libraries and screen such libraries against these targets.
BMS may terminate research activities with 90 days notice, without cause, but
must pay any remaining research funding during the initial research term or
one-half of the remaining research funding during any extended term. Following
the end of the initial research or any extended

                                       53
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

research term, either party may terminate the agreement on 30 days notice if no
compound is being optimized or developed under the collaborative agreement.
Otherwise, the agreement will remain in effect for ten years from the first
commercial sale of a product identified from the research program or until the
expiration of patent rights relating to such product. The Company received
upfront licensing and technology access fees amounting to $19.0 million through
December 31, 2000, net of a $4.5 million refund resulting from a modification
of the agreement, and research funding of $14.4 million has been committed over
the first three years of the collaboration of which $1.3 million was received
by December 31, 2000. In addition, the Company will receive milestone payments
through the clinical development stages, and royalty payments on sales of any
resulting products, with the amount at each level determined based on the
Company's involvement in the related optimization and development activities.
For each compound, depending on whether all pre-clinical and clinical
milestones are met and depending on the Company's contribution to the
development of the compound, the Company could receive milestone payments
aggregating up to between $4.5 million and $15 million. In addition, BMS also
has committed to purchase seven ThermoFluor instruments, which are scheduled
for delivery in 2001.

   In December 2000, the Company entered into an agreement with Centocor, Inc.,
a subsidiary of Johnson & Johnson, under which Centocor acquired worldwide
rights to the Company's orally active direct thrombin inhibitor program.
Centocor is responsible for development and worldwide commercialization of all
compounds under the agreement. For the deep vein thrombosis indication, the
Company has an option to co-develop and co-promote with Centocor in the United
States. Under the agreement, the Company received an upfront cash payment of $6
million from Centocor in January 2001 and could also receive milestone payments
of up to $44 million based on the achievement of certain milestones for the
first compound developed and approved under the agreement. During the initial
two-year research term the contract provides that the Company will receive
payments for research funding totaling $1.65 million. In addition, the Company
is entitled to receive royalties on sales of any products marketed under the
agreement.

   All revenue from research and collaboration agreements is earned from
activities performed in the United States. Revenue from foreign corporate
collaborators (based on the location of the collaborator) comprised 30%, 23%
and 17% of total collaboration revenues for the years ended December 31, 2000,
1999 and 1998, respectively.

   For the year ended December 31, 2000, four research and development
collaborators accounted for 82% of collaboration revenues. For the years ended
December 31, 1999 and 1998, three research and development collaborators
accounted for 88% and 94% of collaboration revenues, respectively.

NOTE D--PROPERTY AND EQUIPMENT

   Property and equipment, all of which are located in the United States, is
summarized as follows:

<TABLE>
<CAPTION>
                                                            December 31,
                                                        ---------------------
                                                           2000       1999
                                                        ---------- ----------
   <S>                                                  <C>        <C>
   Laboratory equipment, computer software and office
    equipment.......................................... $6,720,000 $4,857,000
   Leasehold improvements..............................  2,655,000  2,310,000
                                                        ---------- ----------
                                                         9,375,000  7,167,000
   Less accumulated depreciation and amortization......  3,867,000  2,853,000
                                                        ---------- ----------
                                                        $5,508,000 $4,314,000
                                                        ========== ==========
</TABLE>

                                       54
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


NOTE E--ACCOUNTS PAYABLE AND ACCRUED EXPENSES

   Accounts payable and accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                              December 31,
                                                          ---------------------
                                                             2000       1999
                                                          ---------- ----------
   <S>                                                    <C>        <C>
   Professional fees..................................... $  289,000 $1,454,000
   Equipment.............................................    685,000    120,000
   Payroll and related expenses..........................  1,280,000    739,000
   Trade.................................................    939,000    424,000
                                                          ---------- ----------
                                                          $3,193,000 $2,737,000
                                                          ========== ==========
</TABLE>

NOTE F--DEBT

 [1] Convertible notes payable:

   On November 18, 1999, the Company completed a convertible note financing for
$10 million. The notes bore interest at the rate of prime + 1% per annum (9.5%
through December 31, 1999). Principal and interest was due on the first
anniversary of the closing date (the "Maturity Date"). The notes provided that,
if prior to the Maturity Date the Company raised an additional $10 million
through the sale of preferred stock, the notes and any unpaid accrued interest
would convert into the preferred stock on the same terms and conditions as
given to the new investors. On March 31, 2000, the Company raised $18.4 million
through the sale of 6,121,083 shares of Series A-5 preferred stock at $3.00 per
share. In connection therewith, the $10 million of convertible notes and
$353,000 of accrued interest were converted into 3,451,165 shares of Series A-5
preferred stock. Accordingly, the convertible notes and accrued interest of
$115,000 have been reclassified to noncurrent liabilities as of December 31,
1999.

   In connection with the sale of the notes, the Company issued warrants to
purchase 1,250,000 shares of common stock exercisable at $3.50 per share for a
period of one year. The Company recorded a noncash interest charge in
connection with these warrants of $26,000 for the year ended December 31, 1999.

 [2] Long-term debt:

   Long-term debt, including capital lease obligations, was as follows:

<TABLE>
<CAPTION>
                                                              December 31,
                                                          ---------------------
                                                             2000       1999
                                                          ---------- ----------
   <S>                                                    <C>        <C>
   Loans payable(1)...................................... $2,091,000 $2,889,000
   Note payable(2).......................................    309,000
   Capital lease obligations (Note H)....................    214,000    580,000
                                                          ---------- ----------
                                                           2,524,000  3,469,000
   Current portion of long-term debt.....................  1,209,000  1,139,000
                                                          ---------- ----------
   Long-term debt........................................ $1,315,000 $2,330,000
                                                          ========== ==========
</TABLE>
--------
(1) During 1998 and 1999, the Company entered into a series of 48-month loans
    to finance laboratory equipment, office equipment and certain tenant
    improvements at interest rates varying between 10.68% and 11.65%. The loans
    are payable in monthly installments of principal and interest aggregating
    $98,000 with final payments in 2002 and 2003 aggregating $362,000 and
    $39,000, respectively. Borrowings related to the purchase of laboratory and
    office equipment are collateralized by the equipment.

                                       55
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

(2) The note is payable in annual installments of $125,000 through December
    2003. Interest on the note payable has been imputed at 10.0% per annum. As
    at December 31, 2000, the discounted amount of the note is $309,000 (face
    value $375,000).

   Long-term debt at December 31, 2000 is payable as follows:

<TABLE>
   <S>                                                                <C>
   2001.............................................................. $1,209,000
   2002..............................................................  1,154,000
   2003..............................................................    161,000
                                                                      ----------
   Total............................................................. $2,524,000
                                                                      ==========
</TABLE>

NOTE G--FAIR VALUE OF FINANCIAL INSTRUMENTS

   Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments," requires the Company to disclose estimated
fair value for its financial instruments. The carrying amounts reported in the
balance sheets for cash and cash equivalents, accounts payable and accrued
expenses approximate fair value because of the short-term duration of those
items. The carrying amounts of convertible notes, debt and notes payable--
dividends approximate fair value because the interest rates on such debt
approximate the market rate.

NOTE H--CAPITAL LEASE OBLIGATIONS

   The Company has entered into a series of 48-month lease agreements to
finance laboratory and office equipment purchases. All of the equipment leased
under these agreements are accounted for as capital leases. The net book value
of the equipment held under capital leases was $207,000 and $555,000 at
December 31, 2000 and 1999, respectively.

   Future lease payments as of December 31, 2000 are as follows:

<TABLE>
<CAPTION>
                                                                        Amount
                                                                       --------
   <S>                                                                 <C>
   Total minimum lease payments, year ending December 31, 2001........ $223,000
   Less amounts representing interest.................................    9,000
                                                                       --------
   Present value of future lease payments at end of year.............. $214,000
                                                                       ========
</TABLE>

   Under these agreements, the Company granted its leasing companies warrants
expiring in 2004 to purchase 187,625 shares of Series A-1 preferred stock at an
exercise price of $1.00 per share and 4,500 shares of common stock at an
exercise price of $7.00 per share. The value of these warrants was not
considered significant at the dates of grant.

NOTE I--REDEEMABLE PREFERRED STOCK AND EQUITY SECURITIES

 [1] Preferred stock:

   At December 31, 1999, convertible preferred stock consisted of convertible
Series B--$.001 par value, 1,000,000 shares authorized, issued and outstanding,
liquidating preference of $2,250,000 and convertible Series C--$.001 par value,
5,000,000 shares authorized, 400,000 shares issued and outstanding, liquidating
preference of $1,000,000. In May 2000, the Company issued 625,000 shares of
convertible Series-D preferred stock at $8.00 per share.


                                       56
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

   In January 1998, the Company issued 4,000,000 shares of Series A-4 preferred
stock for $2.60 per share for aggregate proceeds of $10,372,000, net of
expenses.

   At December 31, 1999, redeemable convertible preferred Series A consisted
of:

<TABLE>
   <S>                                                            <C>
   Series A-1--$.001 par value; 6,926,461 shares authorized,
    6,686,986 shares issued and outstanding, (liquidating
    preference of $6,686,986)....................................  $ 6,611,000
   Series A-2--$.001 par value; 4,333,990 shares authorized,
    issued and outstanding, (liquidating preference of
    $5,417,488)..................................................    5,405,000
   Series A-3--$.001 par value; 10,304,264 shares authorized,
    issued and outstanding, (liquidating preference of
    $12,500,000).................................................   12,446,000
   Series A-4--$.001 par value; 4,000,000 shares authorized,
    issued and outstanding, (liquidating preference of
    $10,400,000).................................................   10,372,000
                                                                  ------------
                                                                  $ 34,834,000
                                                                  ============
</TABLE>

   As set forth in Note F, on March 31, 2000, the Company issued 6,121,083
shares of Series A-5 preferred stock for $3.00 per share for aggregate proceeds
of $18,348,000, net of expenses. In addition, an additional 3,451,165 shares
were issued upon the conversion of $10,000,000 of notes plus $353,000 of
accrued interest. The Series A-5 preferred stock had a liquidating preference
of $28,716,744.

   The Series A shares were redeemable at the option of the stockholder in 25%
annual increments commencing on March 12, 2002 at their original purchase
price, plus an amount equal to any accrued but unpaid cumulative dividends and
any declared but unpaid dividends. The shares of all series of preferred stock
were convertible into common shares of the Company on a 1 to .36 basis, after
giving effect to the reverse common stock split in July 2000 and subject to
certain adjustments based on future issuances of common stock. The shares of
all series were entitled to one vote per share. The Series A shares provided
for cumulative dividends of 10% per share per annum (based on the original
issue price), first commencing for the Series A-1 shares on October 14, 1998.
The Series A-2 through A-5 shares, which were issued from 1996 through 2000,
provided for 10% annual cumulative dividends from and after the fifth
anniversary of the date on which each such series was originally issued.

   In December 1998, the Company declared a 10% per share dividend (based on
the original issue price) payable on January 1, 1999 for the Series A-1 shares
for the portion of the quarterly period beginning on October 14, 1998 and
ending on December 31, 1998. Thereafter, the Company declared dividends at each
calendar quarter through September 30, 1999. The Company's board did not
declare a dividend at December 31, 1999, therefore dividends of $167,000 were
in arrears at year-end 1999. On April 20, 2000, the Company's board declared a
dividend of $334,000 covering the period beginning on October 1, 1999 and
ending on March 31, 2000 and issued a note payable for such dividend. All
dividends declared during 1999 were paid during 1999 by issuing to each holder
of Series A-1 stock a note payable for the amount of the declared dividend. The
notes bore interest at 10% per annum and principal and interest were due no
later than five years from the date of issuance. Additionally, the Company paid
cash dividends to the Series A-1 shareholders in the amount of $167,000 and
$62,000 for the quarter ended June 30, 2000 and for the period through the
Company's IPO on August 4, 2000, respectively.

   In August 2000, all outstanding Series A, B, C and D preferred shares and
the notes payable were automatically converted into common shares of the
Company on a 1 to .36 basis upon completion of the initial public offering of
the Company's common stock.

                                       57
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


 [2] Common Stock:

   Effective July 31, 2000, the Company received the consent of the board of
directors and stockholders for a 1 for 2.8 reverse stock split of the Company's
common stock. All common share data have been retroactively restated to reflect
the reverse stock split. In addition, in July 2000, the Company's certificate
of incorporation was amended to authorize 45,000,000 shares of common stock and
5,000,000 shares of preferred stock.

   In August 2000, the Company completed an initial public offering ("IPO") of
its common stock. The offering consisted of 5,000,000 shares, which were priced
at $15 per share. The Company also granted its underwriters an option to
purchase 750,000 shares to cover over allotments, which was exercised
concurrently with the IPO. Net proceeds to the Company after subtracting
underwriting discounts and expenses was $78,888,000.

 [3] Warrants:

   At December 31, 2000, the Company has outstanding warrants to purchase
common shares, all of which are exercisable, as follows:

<TABLE>
<CAPTION>
      Exercise                    Expiration                                   Number of Common
       Price                         Date                                      Shares Reserved
      --------                    ----------                                   ----------------
      <S>                         <C>                                          <C>
      $0.03                          2005                                            93,948
      $0.03                          2006                                           329,624
      $0.03                          2007                                            34,562
      $7.00                          2004                                             4,500
                                                                                  ---------
                                                                                  * 462,634
                                                                                  =========
</TABLE>
--------
* Weighted average exercise price was $.10 and weighted average remaining
  contractual life was 5.25 years.

 [4] Common stock subject to repurchase:

   As of December 31, 2000 and 1999, respectively, 139,796 and 114,955 shares
of common stock are subject to repurchase by the Company. The shares are
subject to repurchase at the Company's option at the original purchase prices,
ranging from $2.94 to $6.30, in the event that the purchaser's relationship
with the Company is terminated. The number of shares subject to repurchase by
the Company decreases by 25% on the one-year anniversary of the sale, and
further reduces upon later anniversary dates. During 2000, 45,982 shares
subject to repurchase vested with the purchasers at the completion of the
Company's initial public offering.

 [5] Note receivable from officer

   At December 31, 2000, the Company has a note receivable from an officer with
an unpaid balance of $390,000 in connection with a loan made in March 2000 to
purchase 176,871 restricted shares of the Company's common stock. The loan is
collateralized by the officer's beneficial interest in the stock. Under the
terms of the note, interest accrues on the unpaid principal at approximately 7%
per annum. Principal and accrued interest is to be paid in four equal
installments with the first payment due six months from the loan date and the
remaining payments due annually thereafter. The Company has forgiven
installments of principal and interest due on loans to this officer and to
other officers. These amounts have been recorded as compensation expense
totaling $182,000, $58,000 and $77,000 for the years ended December 31, 2000,
1999 and 1998, respectively.

                                       58
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


NOTE J--EQUITY COMPENSATION PLANS

   The Company has maintained two equity compensation plans (together "the
Plans") for the issuance of stock options and other stock grants to its
employees, non-employee directors, advisors and consultants.

   The Company's Equity Compensation Plan adopted in 1993, as amended, provides
for the issuance of restricted stock and the granting of both incentive stock
options and nonqualified stock options to purchase a total of 3,022,095 shares
of common stock. The options vest over various periods, not exceeding five
years, and expire no later than ten years from date of grant. Upon the close of
the Company's initial public offering in August 2000, the Company stopped
making grants under the 1993 Plan.

   During 2000, the board of directors and stockholders approved the 2000
Equity Compensation Plan, which became effective upon the close of the
Company's IPO in August 2000 and provides for the granting of up to 2,200,000
shares of common stock. The 2000 Plan provides for grants of incentive stock
options, nonqualified stock options, stock awards and performance units.

   The Plans are administered by a committee of the board of directors. The
committee has the authority to determine the term during which an option may be
exercised (provided that no option may have a term of more than ten years), the
exercise price of an option and the rate at which options may be exercised.
Incentive stock options may be granted only to employees of the Company.
Nonqualified stock options may be granted to employees, directors or
consultants of the Company. For incentive stock options, the exercise price may
not be less than the fair value of the stock on the date of grant.

   The Company applies APB 25 in accounting for its employee stock option
awards, which requires the recognition of compensation expense for the
difference between the market value of the underlying common stock and the
exercise price of the option at the grant date.

   Pro forma information regarding net loss and loss per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that statement. The
weighted average fair value of options granted during the years ended December
31, 2000, 1999 and 1998 is estimated to be $13.83, $.35 and $.30, respectively.
The fair value of these options was estimated at the date of grant using the
Black-Scholes option-pricing model with the following assumptions:

<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                                      -------------------------
                                                       2000     1999     1998
                                                      -------  -------  -------
   <S>                                                <C>      <C>      <C>
   Risk-free interest rate...........................     5.9%     6.6%     5.5%
   Expected life..................................... 6 years  6 years  6 years
   Expected volatility...............................     120%      10%      10%
   Dividend yield....................................       0%       0%       0%
</TABLE>

   Had compensation cost for the Company's stock options been determined based
upon the fair value at the grant date for awards under the Plans consistent
with the methodology prescribed under SFAS No. 123, the Company's net loss and
net loss per share would be as follows:

<TABLE>
<CAPTION>
                                               Year Ended December 31,
                                          ------------------------------------
                                             2000         1999         1998
                                          -----------  -----------  ----------
   <S>                                    <C>          <C>          <C>
   Net loss:
     Historical.......................... $ 8,152,000  $15,969,000  $9,711,000
     Pro forma...........................  10,388,000   16,398,000   9,880,000
   Basic and diluted net loss per share:
     Historical.......................... $      (.97) $    (27.37) $   (22.20)
     Pro forma........................... $     (1.23) $    (28.07) $   (22.58)
</TABLE>


                                       59
<PAGE>

                      3-DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)

   The following table summarizes information about stock option activity under
the Plans during the periods indicated:

<TABLE>
<CAPTION>
                               Incentive Options        Nonqualified Options
                            ------------------------- -------------------------
                                          Weighted                  Weighted
                                          Average                   Average
                             Shares    Exercise Price  Shares    Exercise Price
                            ---------  -------------- ---------  --------------
   <S>                      <C>        <C>            <C>        <C>
   Balance--December 31,
    1997...................   827,538      $ 1.54        83,000      $ 0.59
   Granted.................   406,639        2.94        88,808        2.94
   Exercised...............   (85,540)       0.75       (11,321)       0.22
   Terminated..............  (128,488)       2.25
                            ---------                 ---------
   Balance--December 31,
    1998................... 1,020,149        2.08       160,487        1.92
   Granted.................   157,585        2.94       727,619        3.67
   Exercised...............   (11,439)       0.97
   Terminated..............   (31,541)       2.65
                            ---------                 ---------
   Balance--December 31,
    1999................... 1,134,754        2.20       888,106        3.35
   Granted.................   455,170       11.07       431,090       15.17
   Exercised...............  (200,569)       1.80      (191,421)       2.59
   Terminated..............  (133,832)       3.44
                            ---------                 ---------
   Balance--December 31,
    2000................... 1,255,523        5.34     1,127,763        8.00
                            =========                 =========
</TABLE>

   The following table presents information relating to stock options
outstanding and exercisable at December 31, 2000:

<TABLE>
<CAPTION>
                                  Options Outstanding       Options Exercisable
                             ------------------------------ --------------------
                                         Weighted
                                          Average  Weighted             Weighted
                                         Remaining Average              Average
                               Number     Life in  Exercise   Number    Exercise
   Range of Exercise Price   Outstanding   Years    Price   Exercisable  Price
   -----------------------   ----------- --------- -------- ----------- --------
   <S>                       <C>         <C>       <C>      <C>         <C>
   Incentive stock options:
     $0.03 to $ 6.29.......     830,713    6.80     $ 2.23    511,457    $2.10
     $6.30 to $30.00.......     424,810    9.49      11.43          0        0
                              ---------             ------    -------    -----
                              1,255,523    7.71     $ 5.34    511,457    $2.10
                              =========             ======    =======    =====
   Nonqualified stock
    options:
     $0.03 to $ 6.29.......     573,816    8.20     $ 2.77    222,580    $2.52
     $6.30 to $30.00.......     553,947    9.47      13.42     30,714     7.28
                              ---------             ------    -------    -----
                              1,127,763    8.83     $ 8.00    253,294    $3.10
                              =========             ======    =======    =====
</TABLE>

   In addition to the stock option activity, the Company issued 7,143 and 8,929
shares of restricted stock at weighted average purchase prices per share of
$6.30 and $2.94 under the Plans during the years ended December 31, 2000 and
1998, respectively. The Company reacquired 6,697 and 183,095 unvested,
restricted shares at purchase prices of $19,000 and $116,000 during 2000 and
1998, respectively.

   As of December 31, 2000, options and restricted stock for 1,837,870 common
shares were available for future grant under the 2000 Plan.

                                       60
<PAGE>

                      3 DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


   During the year ended December 31, 1998, the Company accelerated vesting on
32,425 shares of restricted stock and incentive stock options in connection
with the termination of an officer. In connection with this modification of
terms to the original grants, the Company recorded a charge to compensation
expense of $66,000 as of the date of termination. During the year ended
December 31, 2000, in connection with the grant of options to employees and
directors and the change in status of an option holder from a consultant to an
employee, the Company recorded deferred stock compensation of $3,983,000,
representing the difference between the exercise price and the market value of
the Company's common stock on the dates such stock options were granted or
status was changed. Deferred compensation is included as a component of
stockholders' equity (deficiency) and is being amortized to expense over the
vesting period of the stock options.

NOTE K--401(K) PLAN

   The Company maintains a defined contribution 401(k) plan available to
eligible employees. Employee contributions are voluntary and are determined on
an individual basis, limited to the maximum amount allowable under federal tax
regulations. The Company at its discretion may make certain contributions to
the plan. For the year ended December 31, 2000, the Company contributed
$226,000 to the plan. The Company made no contributions during 1999 and 1998.

NOTE L--LEASES

   The Company leases its Exton, Pennsylvania executive offices and laboratory
facilities under an operating lease, which expires in June 2008. The Company
also leases laboratory space in Cranbury, New Jersey under an operating lease,
which expires in March 2007. At December 31, 2000, minimum annual rentals under
the leases are as follows:

<TABLE>
<CAPTION>
        Year Ending December 31,                                     Amount
        ------------------------                                   -----------
        <S>                                                        <C>
        2001...................................................... $ 1,697,000
        2002......................................................   1,728,000
        2003......................................................   1,600,000
        2004......................................................   1,632,000
        2005......................................................   1,588,000
        Thereafter................................................   2,596,000
                                                                   -----------
                                                                   $10,841,000
                                                                   ===========
</TABLE>

   The leases provide for escalations for increases in real estate taxes and
certain operating expenses.

   Rent expense was $547,000, $516,000 and $401,000 for the years ended
December 31, 2000, 1999 and 1998, respectively.

NOTE M--INCOME TAXES

   At December 31, 2000, the Company has a net operating loss carryforward and
a research and development credit carryforward for federal income tax purposes
of approximately $35,143,000 and $1,321,000 respectively, which expire through
2019. In addition, the Company has an alternative minimum tax credit
carryforward of $117,000.

                                       61
<PAGE>

                      3 DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


   Deferred tax assets, which represent the tax effects of loss and credit
carryforwards and temporary differences between the financial statement amounts
and the tax basis of assets and liabilities consist of:

<TABLE>
<CAPTION>
                                                          December 31,
                                                    --------------------------
                                                        2000          1999
                                                    ------------  ------------
   <S>                                              <C>           <C>
   Net operating loss carryforwards...............  $ 14,760,000  $ 16,955,000
   Research and development credit carryforwards..     1,321,000       831,000
   Alternative minimum tax credit carryforward....       117,000
   Income deferred for statement purposes, taxable
    when received for tax purposes................     6,652,000       625,000
   Operating expenses, capitalized and amortized
    as start up costs for tax purposes............       247,000       576,000
   Other--depreciation and expenses not currently
    deductible....................................       376,000       181,000
                                                    ------------  ------------
   Total deferred tax asset.......................    23,473,000    19,168,000
   Valuation allowance............................   (23,473,000)  (19,168,000)
                                                    ------------  ------------
   Net deferred tax asset.........................  $          0  $          0
                                                    ============  ============
</TABLE>

   The Company has not recorded a benefit from its carryforwards or deductible
temporary differences because realization of the benefit is uncertain and,
therefore, a valuation allowance has been provided for the deferred tax asset
at December 31, 2000 and 1999, respectively. The provision for income taxes for
the year ended December 31, 2000 represents a current provision for the federal
alternative minimum tax and state income tax. The difference between the tax
benefit computed at the statutory tax rate of 34% and the Company's effective
tax rate is due to the increase in the valuation allowance of $4,305,000,
$6,805,000 and $4,040,000 for the years ended December 31, 2000, 1999 and 1998,
respectively, and the provision for the federal alternative minimum tax and
state income tax of $159,000 for the year ended December 31, 2000.

   In subsequent years, the Company may be subject to an annual limitation on
the utilization of its net operating loss and research and development tax
credit carryforwards under Section 382 of the Internal Revenue Code.

NOTE N--SETTLEMENT OF LITIGATION

   In October 1998, a complaint was filed in the United States District Court
for the District of Delaware, by Anadys Pharmaceuticals, Inc. alleging that the
Company infringed two Anadys U.S. Patents. On March 7, 2000, the Company and
Anadys entered into a Settlement Agreement for a total of $1.5 million which
was paid by the Company for settlement of the litigation. The amount payable
was accrued as of December 31, 1999.

                                       62
<PAGE>

                      3 DIMENSIONAL PHARMACEUTICALS, INC.

                   NOTES TO FINANCIAL STATEMENTS--(Continued)


NOTE O--QUARTERLY RESULTS (unaudited):

<TABLE>
<CAPTION>
                                           Quarter ended
                          ---------------------------------------------------    ------------
                           March 31      June 30    September 30  December 31     Total Year
                          -----------  -----------  ------------  -----------    ------------
<S>                       <C>          <C>          <C>           <C>            <C>
2000
Revenues................  $ 1,484,000  $ 2,131,000  $ 4,994,000   $ 3,800,000(1) $ 12,409,000
Net income (loss).......   (3,742,000)  (2,477,000)     409,000    (2,342,000)     (8,152,000)
Basic net earnings
 (loss) per common
 share--historical *....  $     (5.92) $     (3.76) $      0.03   $     (0.11)   $      (0.97)
Diluted net earnings
 (loss) per common
 share--historical *....  $     (5.92) $     (3.76) $      0.02   $     (0.11)   $      (0.97)
Basic net earnings
 (loss) per common
 share--pro forma.......  $     (0.36) $     (0.18) $      0.02   $     (0.11)   $      (0.52)
Diluted net earnings
 (loss) per common
 share--pro forma.......  $     (0.36) $     (0.18) $      0.02   $     (0.11)   $      (0.52)
                          ===========  ===========  ===========   ===========    ============
1999
Revenues................  $ 1,379,000  $ 1,882,000  $   718,000   $   510,000    $  4,489,000
Net (loss)..............   (2,740,000)  (2,693,000)  (3,633,000)   (6,903,000)    (15,969,000)
Basic and diluted net
 loss per common share--
 historical *...........  $     (5.01) $     (4.73) $     (6.16)  $    (11.25)   $     (27.37)
Basic and diluted net
 loss per common share--
 pro forma..............  $     (0.27) $     (0.26) $     (0.36)  $     (0.68)   $      (1.57)
                          ===========  ===========  ===========   ===========    ============
</TABLE>
--------
*  Per common share amounts for the quarters and full years have been
   calculated separately. Accordingly, quarterly amounts do not add to the
   annual amounts because of differences in the weighted average common shares
   outstanding during each period principally due to the effect of the
   Company's issuing shares of its common stock during the year.
(1) During the quarter ended December 31, 2000, revenues included a $0.4
    million adjustment resulting from a modification of the agreement with BMS.

                                       63
<PAGE>

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

   None.

                                    PART III

Item 10. Directors and Executive Officers of the Registrant

   The response to this item is contained in part under the caption "Executive
Officers of the Registrant" in Part I of this Annual Report on Form 10-K and
the remainder is incorporated by reference from the discussion under the
caption "Nomination and Election of Directors" from our Proxy Statement
relating to our Annual Meeting of Stockholders scheduled for May 14, 2001,
which will be filed within 120 days after the close of the Company's fiscal
year covered by this Report.

Item 11. Executive Compensation

   This information will be included in our Proxy Statement relating to our
Annual Meeting of Stockholders scheduled for May 14, 2001, which will be filed
within 120 days after the close of our fiscal year covered by this Report, and
is incorporated herein by reference to such Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management

   This information will be included in our Proxy Statement relating to our
Annual Meeting of Stockholders scheduled for May 14, 2001, which will be filed
within 120 days after the close of our fiscal year covered by this Report, and
is incorporated herein by reference to such Proxy Statement.

Item 13. Certain Relationships and Related Transactions

   This information will be included in our Proxy Statement relating to our
Annual Meeting of Stockholders scheduled for May 14, 2001, which will be filed
within 120 days after the close of our fiscal year covered by this Report, and
is incorporated herein by reference to such Proxy Statement.

                                    PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 (a) Documents filed as part of this report:

  (1) Financial Statements

   The financial statements are included under Item 8 of this Report.

  (2) Financial Statement Schedules

   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 or the notes thereto.

  (3) List of Exhibits.

   The following is a list of exhibits filed as part of this annual report on
Form 10-K. Where so indicated in parentheses, exhibits which were previously
filed are incorporated herein by reference.

                                       64
<PAGE>

<TABLE>
<CAPTION>
 Exhibit                               Description
 Number  ----------------------------------------------------------------------

 <C>     <S>
 3(i)    Ninth Restated Certificate of Incorporation of the Company
         (incorporated by reference to Exhibit 3.4 to the Company's
         Registration Statement on Form S-1 (File No. 333-37606)).

 3(ii)   Amended and Restated Bylaws of the Company (incorporated by reference
         to Exhibit 3.5 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 4.1     Form of Common Stock Certificate of Company (incorporated by reference
         to Exhibit 4.1 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 10.1    3-Dimensional Pharmaceuticals, Inc. Equity Compensation Plan, as
         amended (incorporated by reference to Exhibit 10.1 to the Company's
         Registration Statement on Form S-1 (File No. 333-37606)).

 10.2    Third Amended and Restated Stockholders' Agreement by and among the
         Company and the Stockholders identified therein, dated March 31, 2000
         (incorporated by reference to Exhibit 10.2 to the Company's
         Registration Statement on Form S-1 (File No. 333-37606)).

 10.3    Series B Preferred Stock Purchase Agreement between the Company and
         Merck KGaA, dated October 11, 1996 (incorporated by reference to
         Exhibit 10.3 to the Company's Registration Statement on Form S-1 (File
         No. 333-37606)).

 10.4    Series C Preferred Stock Purchase Agreement between the Company and
         American Home Products Corporation, dated June 13, 1997 (incorporated
         by reference to Exhibit 10.4 to the Company's Registration Statement
         on Form S-1 (File No. 333-37606)).

 10.5    Series D Preferred Stock Purchase Agreement between the Company and
         Schering Berlin Venture Corporation, dated May 17, 2000 (incorporated
         by reference to Exhibit 10.5 to the Company's Registration Statement
         on Form S-1 (File No. 333-37606)).

 10.6    Warrant to Purchase Common Stock of the Company issued to HealthCare
         Ventures III, L.P., dated November 18, 1999 (incorporated by reference
         to Exhibit 10.6 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 10.7    Warrant to Purchase Common Stock of the Company issued to HealthCare
         Ventures IV, L.P., dated November 18, 1999 (incorporated by reference
         to Exhibit 10.7 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 10.8    Warrant to Purchase Common Stock of the Company issued to Rho
         Management Trust II, dated November 18, 1999 (incorporated by
         reference to Exhibit 10.8 to the Company's Registration Statement on
         Form S-1 (File No. 333-37606)).

 10.9    Warrant to Purchase Common Stock of the Company issued to Aetna Life
         Insurance Company, dated November 18, 1999 (incorporated by reference
         to Exhibit 10.9 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 10.10   Warrant to Purchase Common Stock of the Company issued to Henry
         Rothman, dated November 18, 1999 (incorporated by reference to Exhibit
         10.10 to the Company's Registration Statement on Form S-1 (File No.
         333-37606)).

 10.11   Warrant to Purchase Common Stock of the Company issued to Abingworth
         Bioventures SICAV, dated November 18, 1999 (incorporated by reference
         to Exhibit 10.11 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 10.12   Warrant to Purchase Common Stock of the Company issued to Sentron
         Medical, Inc., dated November 18, 1999 (incorporated by reference to
         Exhibit 10.12 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).

 10.13   Warrant to Purchase Common Stock of the Company issued to Biotech
         Growth S.A., dated November 18, 1999 (incorporated by reference to
         Exhibit 10.13 to the Company's Registration Statement on Form S-1
         (File No. 333-37606)).
</TABLE>

                                       65
<PAGE>


<TABLE>
 <C>   <S>
 10.14 Employment Offer Letter to David C. U'Prichard, dated September 1, 1999
       (incorporated by reference to Exhibit 10.14 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)).

 10.15 Settlement Agreement between the Company and Anadys Pharmaceuticals,
       Inc., dated March 7, 2000 (incorporated by reference to Exhibit 10.15 to
       the Company's Registration Statement on Form S-1 (File No. 333-37606)).
       @

 10.16 Research Collaboration Agreement between the Company and BioCryst
       Pharmaceuticals, Inc., dated October 18, 1996, and Amendment No.1
       thereto, dated October 18, 1996 (incorporated by reference to Exhibit
       10.16 to the Company's Registration Statement on Form S-1 (File No. 333-
       37606)). @

 10.17 Collaborative Discovery and Lead Optimization Agreement between the
       Company and Boehringer Ingelheim Pharmaceuticals, Inc., dated December
       17, 1999 (incorporated by reference to Exhibit 10.17 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)). @

 10.18 Collaborative Research and License Agreement between the Company and
       Hoechst Schering AgrEvo GmbH, now Aventis CropScience GmbH, dated
       October 18, 1999 (incorporated by reference to Exhibit 10.18 to the
       Company's Registration Statement on Form S-1 (File No. 333-37606)). @

 10.19 Collaborative Research and License Agreement between the Company and
       E.I. DuPont de Nemours & Co., dated October 12, 1998 (incorporated by
       reference to Exhibit 10.19 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)). @

 10.20 Collaborative Discovery and Lead Optimization Agreement between the
       Company and DuPont Pharmaceuticals Company, dated February 11, 2000
       (incorporated by reference to Exhibit 10.20 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)). @

 10.21 Nonexclusive Patent License Agreement between the Company and DuPont
       Pharmaceuticals Company, dated February 11, 2000 (incorporated by
       reference to Exhibit 10.21 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)). @

 10.22 Research and License Agreement between the Company and the Heska
       Corporation, dated December 18, 1997, and Amendment No.1 thereto, dated
       December 18, 1997 (incorporated by reference to Exhibit 10.22 to the
       Company's Registration Statement on Form S-1 (File No. 333-37606)). @

 10.23 License and Research Agreement between the Company and Schering AG,
       Germany, dated May 17, 2000 (incorporated by reference to Exhibit 10.23
       to the Company's Registration Statement on Form S-1 (File No. 333-
       37606)). @

 10.24 Master Loan and Security Agreement between the Company and Phoenixcor,
       Inc., dated June 18, 1998 (incorporated by reference to Exhibit 10.24 to
       the Company's Registration Statement on Form S-1 (File No. 333-37606)).

 10.25 Amended and Restated Lease for Combination Office/Laboratory/Light
       Manufacturing Space at Eagleview Corporate Center Lot 28 between the
       Company and Eagleview Technology Partners, dated December 12, 1997
       (incorporated by reference to Exhibit 10.25 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)).

 10.26 Master Lease Agreement between the Company and Transamerica Business
       Credit Corporation, dated June 12, 1997 (incorporated by reference to
       Exhibit 10.26 to the Company's Registration Statement on Form S-1 (File
       No. 333-37606)).

 10.27 Warrant to Purchase Common Stock of the Company issued to Transamerica
       Business Credit Corporation, dated June 12, 1997 (incorporated by
       reference to Exhibit 10.27 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)).

 10.28 Master Lease Agreement, Loan Agreement and Subordination Agreement
       between the Company and Comdisco, Inc., dated March 7, 1994
       (incorporated by reference to Exhibit 10.28 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)).

 10.29 Warrant to Purchase Series A Preferred Stock, originally dated March 7,
       1994 and reissued to CDC Realty, Inc., dated July 21, 1998 (incorporated
       by reference to Exhibit 10.29 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)).
</TABLE>

                                       66
<PAGE>


<TABLE>
 <C>   <S>
 10.30 Warrant to Purchase Series A Preferred Stock, originally dated March 7,
       1994 and reissued to Gregory Stento, dated July 21, 1998 (incorporated
       by reference to Exhibit 10.30 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)).

 10.31 Warrant to Purchase Series A Preferred Stock, originally dated April 25,
       1995 and reissued to Comdisco, Inc., dated July 21, 1998 (incorporated
       by reference to Exhibit 10.31 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)).

 10.32 Warrant to Purchase Series A Preferred Stock, originally dated April 25,
       1995 and reissued to Gregory Stento, dated July 21, 1998 (incorporated
       by reference to Exhibit 10.32 to the Company's Registration Statement on
       Form S-1 (File No. 333-37606)).

 10.33 Form of Warrant to Purchase Common Stock (along with Schedule of Holders
       of Certain Warrants to Purchase Common Stock)(incorporated by reference
       to Exhibit 10.33 to the Company's Registration Statement on Form S-1
       (File No. 333-37606)).

 10.34 3-Dimensional Pharmaceuticals, Inc. 2000 Equity Compensation Plan
       (incorporated by reference to Exhibit 10.34 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)).

 10.35 DiscoverWorks(TM) Drug Discovery Collaboration Agreement between the
       Company and Bristol-Myers Squibb Company, dated July 7, 2000
       (incorporated by reference to Exhibit 10.35 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)).@

 10.36 DiscoverWorks(TM) Nonexclusive License and Purchase Agreement between
       the Company and Bristol-Myers Squibb Company, dated July 7, 2000
       (incorporated by reference to Exhibit 10.36 to the Company's
       Registration Statement on Form S-1 (File No. 333-37606)).@

 10.37 Letter agreement between the Company and Bristol-Myers Squibb Company,
       dated December 18, 2000*

 10.38 Research, Development and Commercialization Agreement between the
       Company and Centocor, Inc., dated as of December 29, 2000.*#

 10.39 First Amendment to Lease between the Company and Eagleview Technology
       Partners dated October 24, 2000.*+

 10.40 Agreement of Sublease between Advanced Medicine, Inc. and the Company,
       dated December 13, 2000.*+

 21.1  Subsidiaries of the Registrant. *

 23.1  Consent of Richard A. Eisner & Company, LLP. *

 24.1  Power of Attorney (included on signature page). *
</TABLE>
--------
*  Filed herewith.
@  Confidential treatment granted with respect to portions of this exhibit.
   Omitted portions were filed separately with the Securities and Exchange
   Commission.
#  Confidential treatment will be requested with respect to portions of this
   exhibit. Omitted portions will be filed separately with the Securities and
   Exchange Commission.
+  The Company will furnish supplementally to the Commission any of the omitted
   exhibits to Exhibit 10.39 upon the request of the Commission.

  (b) Reports on Form 8-K:

   On November 9, 2000, the Company filed a report on Form 8-K, dated November
3, 2000, relating to a press release addressing certain recent developments.

   On December 18, 2000, the Company filed a report on Form 8-K, dated December
18, 2000, relating to a press release addressing certain recent developments.

                                       67
<PAGE>

                                   SIGNATURES

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

                                          3-Dimensional Pharmaceuticals, Inc.

Date: March 30, 2001
                                                /s/ David C. U'Prichard
                                          By: _________________________________
                                                 David C. U'Prichard, Ph.D.
                                                Chief Executive Officer and
                                                          Director

   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. Each person whose
signature appears below in so signing also makes, constitutes and appoints
David C. U'Prichard, F. Raymond Salemme and Scott M. Horvitz, and each of them
acting alone, his true and lawful attorney-in-fact and agent, with full power
of substitution and resubstitution, for him and in his name, place and stead,
in any and all capacities, to execute and cause to be filed with the Securities
and Exchange Commission any and all amendments to this Annual Report on Form
10-K for the fiscal year ended December 31, 2000, and to file the same, with
all exhibits thereto and other documents in connection therewith, and hereby
ratifies and confirms all that said attorney-in-fact or his substitute or
substitutes may do or cause to be done by virtue thereof.

<TABLE>
<CAPTION>
                 NAME                            TITLE                   DATE
                 ----                            -----                   ----

<S>                                    <C>                        <C>
     /s/ David C. U'Prichard           Chief Executive Officer      March 30, 2001
______________________________________  and Director (Principal
      David C. U'Prichard, Ph.D.        Executive Officer)

       /s/ Scott M. Horvitz            Vice President, Finance      March 30, 2001
______________________________________  and Administration
           Scott M. Horvitz             (Principal Financial and
                                        Accounting Officer)

      /s/ F. Raymond Salemme           President, Chief             March 30, 2001
______________________________________  Scientific Officer and
      F. Raymond Salemme, Ph.D.         Director

       /s/ Stephen Bunting             Director                     March 30, 2001
______________________________________
        Stephen Bunting, Ph.D.

       /s/ Bernard Canavan             Director                     March 30, 2001
______________________________________
        Bernard Canavan, M.D.

      /s/ James H. Cavanaugh           Director                     March 30, 2001
______________________________________
      James H. Cavanaugh, Ph.D.

       /s/ Zola P. Horovitz            Director                     March 30, 2001
______________________________________
       Zola P. Horovitz, Ph.D.
</TABLE>


                                       68
<PAGE>

<TABLE>
<S>                                    <C>                        <C>
        /s/ David R. King              Director                     March 30, 2001
______________________________________
            David R. King

         /s/ Joshua Ruch               Director                     March 30, 2001
______________________________________
             Joshua Ruch

       /s/ Harold R. Werner            Director                     March 30, 2001
______________________________________
           Harold R. Werner
</TABLE>


                                       69