NEUROGEN CORP - 10-K Annual Report

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 0-18311

NEUROGEN CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 22-2845714
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

35 NORTHEAST INDUSTRIAL ROAD
BRANFORD, CONNECTICUT 06405
(Address of principal executive offices) (Zip Code)

(203) 488-8201
(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 $.025 per share (the "Common Stock")
(Title of Class)

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
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 definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The approximate aggregate market value of the Common Stock held by
non-affiliates of the registrant was $50,626,033 as of March 1, 2002, based upon
the closing price of the Common Stock as reported on The Nasdaq National Market
on such date. For purposes of determining this number, shares of Common Stock
held by officers, directors and stockholders whose ownership exceeds five
percent were excluded. This number is provided only for purposes of this report
and does not represent an admission by either the registrant or any such person
as to the status of such person.

As of March 1, 2002, the registrant had 17,733,476 shares of Common Stock
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

(1) The Neurogen Corporation Proxy Statement for the Annual Meeting of
Stockholders to be held on July 15, 2002 is incorporated by reference into Items
10, 11, 12 and 13 of Part III of this Form 10-K.

PART I

ITEM 1. BUSINESS

Overview

Neurogen Corporation (NASDAQ: NRGN) is a leading small molecule drug
discovery and development company targeting new drug candidates to improve the
lives of patients suffering from neurological, inflammatory, pain and metabolic
disorders. Neurogen has generated a portfolio of compelling new drug programs
through its fully integrated drug discovery platform, successfully solving
complex issues in the discovery of small molecule drugs for valuable targets.
Neurogen's strategy is to advance a mix of proprietary drugs independently and,
when advantageous, collaborate with world-class pharmaceutical companies during
the drug research and development process to obtain additional resources and to
access complementary expertise. Neurogen's Accelerated Intelligent Drug
Discovery (AIDD) process and its expertise in cellular functional assays enhance
the Company's ability to rapidly and cost effectively identify active compounds
during the drug discovery process.

Neurogen has diversified its drug discovery and development efforts across
a broad number of disease-related targets and has discovered multiple drug
candidates for each target. Throughout the pharmaceutical industry the majority
of all drug candidates fail to overcome all of the obstacles on the way to
commercialization. Because of this high attrition rate, we believe that the true
value of a drug discovery company's pipeline is most accurately measured by the
company's ability to rapidly discover multiple generations of improved
candidates within each of several programs, rather than by the promise of any
single compound in any one program. We believe that this ability to rapidly and
systematically produce multiple generations of incrementally improved drug
candidates in multiple programs is our most valuable asset. Although we are much
smaller than major pharmaceutical companies, we have discovered ten small
molecule drug candidates that we and our pharmaceutical company partners have
taken into human clinical trials. Two of these candidates from our programs for
the treatment of Alzheimer's disease and insomnia are currently being tested in
human trials by our partner in these programs, Pfizer Inc. We are also testing a
third candidate from our program for the treatment of inflammatory disorders in
human trials. We own all commercial rights to this program.

Neurogen is constantly working to gain and maintain a competitive advantage
in the process of discovering and developing new drug candidates. As a result,
we have generated a high-quality collection, or library, of over 1.3 million
potential drug compounds and have created powerful new drug discovery and
refinement technologies. The prime example of these new technologies is our
Accelerated Intelligent Drug Discovery AIDD(TM) system. Our AIDD system is an
engine for the discovery of new drug leads and the optimization of these leads
to create drug candidates for clinical development. We believe that this system
also enables us to generate chemical matter with which to rapidly assess the
functional utility of new gene-based targets. Our AIDD system is a key factor
contributing to our belief that our small molecule drug discovery and
development platform is among the most advanced and efficient in the industry.

Background on the Drug Discovery Industry

The Traditional Drug Discovery Process

Most drugs work by binding to a particular target in the body, thereby
altering communication between cells or otherwise regulating cellular activity.
Therefore, the traditional path to discovering small molecule drugs typically
begins with the identification of a biological target that is believed to
regulate cellular communication or activities which could be modulated to treat
a given disorder. A test, or assay, is then developed in order to discover
compounds with biological activity at this target. Such an assay facilitates the
screening of the target against a library of many compounds that have been
synthesized in the laboratory. Compounds that bind to the target protein and
alter its activity are referred to as "hits." Medicinal chemists then optimize
these hits until they have sufficient potency to become lead candidates and then
improve their "drug-like" properties, such as gastrointestinal absorption,
stability, freedom from unwanted activities, etc., with the goal of producing a
successful drug development candidate.

Chemists typically try to streamline the process by copying chemical
structures from known active compounds. Even taking this approach, however, the
number of possible compounds that could be made is too vast to actually test
against even a single target using any available technology. Generally, the
search is further narrowed only by educated guessing. As a result of the
uncertainty of this approach, traditional methods can take many years or may
fail entirely.

If it were possible to predict in advance which compounds would result in a
hit, and which chemical changes would help optimize hits into drug candidates,
the drug discovery process would be vastly simplified. Unfortunately, the
traditional drug discovery process has had to rely on a trial and error approach
that has proven extremely expensive, inefficient and unreliable. Optimization of
hits to achieve the delicate balance of properties necessary for a successful
drug is still a daunting task. Most hits are never optimized into successful
drugs despite years of effort.

Drug Discovery in the Post-Genomics Era

Private and public groups have announced the full sequencing of the human
genome. The sequencing and deciphering of the human genome provides a useful
piece in the drug discovery puzzle. Genes and, more significantly, the proteins
they code for can be regulators of biological activity and thus represent
potential drug targets. Today all marketed drugs interact at fewer than 500
distinct biological targets. It has been estimated that once we more fully
understand the role and interactions of the 30,000 or more genes comprising the
human genome, the number of valid drug targets will increase to several
thousand.

Today, the pharmaceutical and biotechnology industries are facing an
explosion of newly identified potential targets. However, virtually all of these
potential targets have a very low level of validation and it is believed that
most potential targets will not prove useful. Once identified, a target must be
validated as useful. There are many levels of validation. Early indications of
validity may be little more than educated guesses, derived from similarity to
known targets and the identity of which tissues express a particular gene. Full
validity for a new target is not established until drugs that interact at that
target are tested in large numbers of humans.

The explosion of potential targets coupled with the decreasing level of
validity of those targets presents two significant challenges to pharmaceutical
and biotechnology companies over the next several years. One problem in the
post-genomics world is how to quickly determine which genes might be useful
targets for which diseases. An even more difficult task is to efficiently
exploit the availability of new potential targets by rapidly discovering new
lead compounds and optimizing such leads into drug candidates. Finding superior
methods and technologies to determine if newly isolated genes represent good
targets and devising workable strategies to identify the most promising
compounds for screening and optimization are essential steps in accelerating and
increasing the probability of success of the drug discovery process. We believe
that the greatest value created from genomics efforts will not be in the new
targets they provide, but in the discovery of new drugs, especially small
molecule drugs, which work through these new targets.

The Neurogen Competitive Advantage

At Neurogen, we have developed a drug discovery and development platform
designed to rapidly discover drug candidates for valuable potential targets
where others have failed and to capitalize on the wealth of new potential drug
targets. We believe our proprietary platform enables us to rapidly and
efficiently discover compounds that hit new potential drug targets, evaluate the
utility of those targets and optimize useful leads into new drug candidates.

We focus our efforts on the discovery and development of small molecule
drugs. Small molecule drugs are usually more stable and easily absorbed than
large molecule drugs, and so in most cases may be administered as a pill, a
patch, or an ointment. In addition, small molecule drugs are generally much
easier and less expensive to manufacture, distribute, and store. Protein-based
large molecule drugs typically require refrigeration, while most small molecule
drugs do not. Small molecule drugs can also be safely shipped and stored at
regular temperatures. Small molecule drugs that can be taken orally currently
make up about three quarters of the sales of the top 100 prescription drugs.
Additionally, where there is a choice, patients generally would rather take a
pill than an injection.

Components of Neurogen's Discovery and Development Platform

o Accelerated Intelligent Drug Discovery (AIDD(TM))system

AIDD is an integrated system of hardware, software, and processes
that allows scientists to improve on the trial and error approach
traditionally associated with drug discovery and development. This
system incorporates automated robotics guided by state-of-the-art
computerization, including neural network-based artificial
intelligence, to aid our scientists as we design, model, synthesize
and screen new chemical compounds. Specifically, AIDD enables our
scientists to streamline and accelerate the drug discovery process
through the effective and efficient iterative application of the
screening, computational modeling and synthesis phases of discovery
research.

Our AIDD-based discovery system works in a closed drug discovery
loop of repeated cycles of automated synthesis, testing, and analysis.
During each cycle, which can take as little as two weeks, a
computerized, or virtual, model of the interaction between the
compounds being screened and the target being screened is created.
With each repetition of the cycle, the virtual model is improved and
refined. The neural network system then uses the upgraded model to aid
our scientists in making better predictions about which compounds
should be synthesized and/or screened in the next cycle.

AIDD extends compound modeling, prediction, and design
capabilities beyond that achievable by human perception alone. At the
same time, AIDD is designed to carry out this drug discovery cycle
with the exceptionally efficient use of discovery resources.

o Focused Compound Library and Virtual Library(TM).

Our AIDD-based system works in tandem with our focused compound
library. Instead of randomly generating a compound library as many
other drug discovery companies have done, we have chosen to bias or
"enrich" our compound library in favor of selected families of
compounds. Because the number of small organic compounds that can be
synthesized is virtually infinite, we believe that to be successful in
the drug discovery process, it is not the biggest or most diverse
library that counts, but rather the richest and most intelligently
designed.

AIDD aids our scientists by relating functional molecules not
just by their core structures, but also by their overall posture in
chemical space. By focusing on the overall orientation of active
compounds, rather than solely on their core structures, AIDD helps our
scientists as they seek to identify functionally related groups of
compounds that we call "Islands(TM)." Starting with computer models of
key characteristics both of compounds that work well and of those that
work poorly, AIDD allows us to rapidly evaluate a large number of
promising chemical variants using our automated techniques. This
process allows us to expand identified Islands and to discover new
ones. We add compounds newly synthesized in the process to our
enriched compound library and subsequently test them against multiple
targets via high throughput screening. The results of each of these
cycles of synthesis, analysis and testing are exploited to refine the
AIDD models so as to aid us in the design of better compounds and the
discovery of new Islands of high activity potential.

AIDD's ability to design new compounds and to discover new
Islands is accomplished not only by the testing of real compounds
already in our enriched library, but by testing computer-designed
molecules in a huge "virtual" library. These compounds exist only as
computer-based compound models, screened against computer-based target
models. The results of this Virtual Screening(TM) of our Virtual
Library(TM), which includes several hundred billion virtual compounds,
are also integrated into each succeeding reiteration of the AIDD-based
discovery process. Promising virtual compounds are synthesized, added
to the enriched compound library, and tested against actual targets
via high throughput screening. In this process we seek to generate new
Islands of high activity potential structures and refine the chemical
leads that we have identified until we reach compounds that we believe
are promising enough to move to the next phases of drug research and
development. In addition, by determining which compounds in which
Islands react with newly identified targets with a lower level of
validity, we believe we can efficiently discover a great deal about
the ultimate utility of such targets.

o Biological Expertise

We have expanded Neurogen's expertise in receptor biology beyond
gamma-aminobutyric acid GABA receptors, the Company's original focus.
Today we believe that we have one of the leading receptor biology
teams in the industry. We utilize this expertise in the design and
construction of screening assays to capitalize on novel biological
targets in our drug discovery efforts. Neurogen does not engage in
so-called "me too" drug discovery, by attempting to change the
chemical structure of an existing drug just enough to create a new
patentable product that may offer little or no improvement over
existing therapies working through the same biological target. Rather,
we focus on discovering novel drugs, and all of the candidates we have
taken into the clinic work by distinctly new target mechanisms
designed to provide significant therapeutic advantages. We believe
that our scientific expertise coupled with our AIDD-based discovery
system and our enriched library will allow us to continue to
efficiently capitalize on valuable drug targets where others have
failed to discover successful drug candidates and to capitalize on the
large number of new potential targets that have resulted from the
sequencing of the human genome.

Neurogen's Business Strategy

Neurogen's vision is to become a continuously profitable company
excelling at the creation of small molecule drugs using a seamless,
integrated discovery, development and medical paradigm to provide maximal
value for the patient and for the shareholder. The following are the key
elements of the business strategy we are employing to achieve the Neurogen
vision:

o Create a risk-balanced drug portfolio. To increase the probability of
successful drug discovery and development efforts, we are pursuing
multiple promising targets with multiple drug candidates for multiple
disorders. Neurogen believes that the robustness of a drug portfolio
should be based on the diversity of the programs in the pipeline,
rather than betting on a single potential blockbuster drug. We are
concentrating our efforts on key therapeutic areas (neuroscience, pain
and inflammation) within which clinical indications may be developed
for a variety of disorders, balancing risk against potential value. We
believe that our ability to produce multiple generations of candidates
in multiple programs using AIDD distinguishes Neurogen as a leading
drug discovery and development company.

O Build our development capability. Neurogen possesses a powerful drug
discovery capability which we are seamlessly linking to pharmaceutical
development and clinical initiatives so that we continuously optimize
drug properties. We believe this integrated medical feedback loop will
speed development of compounds in the clinic, and we are deploying
additional resources to support the early clinical trials of our lead
drug candidates.

o Selectively partner our drug programs. Neurogen's partnering strategy
seeks to retain ownership and control of programs as far downstream as
possible, balancing risk for the Company while maximizing return for
shareholders. We are building capabilities internally to take programs
further in clinical development. These capabilities enable us to
pursue a flexible business model, using partnered programs when we
feel it will be competitively and economically advantageous to do so.
When we partner our programs we seek to collaborate with
pharmaceutical leaders with demonstrated strengths and resources which
complement our own.

Neurogen Drug Programs

Neurogen designs and develops drugs that we believe will offer therapeutic
advantages or reduced side effects over drugs currently available to treat a
particular disease. Most of our programs address novel targets for which
significant scientific evidence exists to suggest that the target mechanism
plays a meaningful role in the disease or disorder we seek to treat. On a select
basis, we have also established discovery programs for targets that have been
newly identified as potential mediators in a disease where less is known about
the role of the target mechanism, but where we feel the risk/reward profile is
particularly compelling. In both cases, we believe that by designing drugs
specifically targeting a receptor, such compounds offer the potential for
equivalent or improved efficacy with fewer side effects than drugs currently on
the market, or may cause markets to grow in areas where few effective
therapeutics currently exist. In addition, drugs active against new targets
offer the possibility of adding to or synergistically improving existing
therapy.

The following table summarizes our most advanced programs in our current
drug pipeline:

Disorder Target Mechanism Program Status Commercial Rights
- ------------------------------ -------------------------- --------------------------- --------------------------
- ------------------------------ -------------------------- --------------------------- --------------------------

- ------------------------------ -------------------------- --------------------------- --------------------------
- ------------------------------ -------------------------- --------------------------- --------------------------
Cognition Disorders GABA -Phase II (NGD 97-1) Pfizer Marketing/
(e.g. Alzheimer's Disease) -Preclinical development Neurogen Royalty
(NGD 97-2)
- ------------------------------ -------------------------- --------------------------- --------------------------
- ------------------------------ -------------------------- --------------------------- --------------------------
Anxiety and Depression GABA -Completed Phase IIa Pfizer Marketing/
(NGD 91-3). Compound did Neurogen Royalty
not reach statistical
significance for efficacy
- ------------------------------ -------------------------- --------------------------- --------------------------
- ------------------------------ -------------------------- --------------------------- --------------------------
Autoimmune and pulmonary C5a Phase I Neurogen
disease (NGD 2000-1)

In the section below, we describe our most significant active drug
development programs in detail.

Cognition Disorders (GABA):

Memory loss is one of the most devastating symptoms of neurodegenerative
diseases such as Alzheimer's disease and Parkinson's disease. Research sponsored
by the National Institute for Mental Health indicates that as many as 5 million
people in the United States suffer from dementia, a condition characterized by
the impairment of learning and recall. Another prominent study indicates that
approximately 10% of people over age 65 suffer from some form of dementia.
Industry analysts estimate the current annual market for drugs to treat
cognitive disorders to be in excess of $1.0 billion worldwide.

We have discovered a number of compounds that exhibit memory enhancing
effects in animal models by modulating GABA activity at receptor subtypes we
believe are involved in the storage and retrieval of memory. Some drugs impair
memory by increasing GABA activity in memory centers of the brain. These drugs
are often used in out-patient surgery to cause the patient to forget the
surgical procedure. Our approach in this program is to modulate the GABA system
in the opposite direction from these drugs which impair memory. Our drug
candidates selectively decrease GABA activity in the memory centers of the
brain, an approach which has the potential to thereby enhance memory. Animal
studies, to date, suggest that compounds with this activity are efficacious in
enhancing memory.

Currently, Pfizer, our collaborative partner in this program, is evaluating
the most advanced of these compounds, NGD 97-1, in Phase II human clinical
studies, which began in the first quarter of 2001.

Inflammation and Autoimmune Disorders (C5a):

Complement component C5a promotes inflammation, attracts white blood cells,
and may trigger the immune system to start attacking the body's own tissues, an
inappropriate reaction central to autoimmune and inflammatory diseases. Industry
estimates value sales of drugs to treat inflammation, autoimmune and pulmonary
disorders at $23 billion worldwide.

Neurogen scientists believe that inhibiting the activation of the C5a
receptor may work to treat inflammation in rheumatoid arthritis, asthma, and
other autoimmune diseases by blocking inflammatory responses . A small molecule
drug inhibiting the C5a receptor could also be effective in treating other
inflammatory diseases with the ease of oral delivery and without many of the
side effects associated with currently available treatments. We have identified
several compounds that potently block the activation of C5a receptors.
Neurogen's leading compound in this program, NGD 2000-1 is currently in Phase I
clinical trials. To date, we have retained all rights to our C5a antagonist
program.

Insomnia (GABA):

Recent studies indicate that as many as 20 million people in the United
States experience chronic insomnia and an additional 20 to 30 million Americans
experience intermittent sleep disorders. Industry analysts estimate that the
annual market for drugs to treat insomnia is more than $1.5 billion worldwide
and over $500 million in the United States. We are developing drugs to treat
sleep disorders, primarily insomnia. While currently marketed drugs to treat
sleep disorders, known as hypnotics, are effective, they may cause numerous side
effects, including "hangovers," rebound insomnia, short-term memory loss and
addiction.

The link between the GABA system and sleep is illustrated by the
benzodiazapine class of drugs such as Valium(R), which cause sleepiness, and by
drugs marketed to treat insomnia such as Ambien(R) and Sonata(R), which work
through the same GABA receptors as the benzodiazapines. We have identified drug
candidates to treat insomnia that have a different GABA receptor binding profile
than currently marketed drugs. Animal studies, to date, suggest that these
compounds are efficacious in inducing sleep with fewer side effects than
existing therapies. Drugs to treat insomnia should not only induce sleep but
they should have pharmacokinetic properties which cause the drug to work quickly
and then be out of the system before morning. Pfizer, our partner in this
program, is currently evaluating our lead compound, NGD 96-3, in Phase I
clinical studies.

Depression and Stress (CRF1):

Depression is one of the most prevalent mental illnesses in the United
States, affecting approximately 17 million people or 9% of the adult population
annually according to the National Institute of Mental Health. While recent
pharmaceutical research has led to improved drugs, such as Prozac(R), for the
treatment of depression, these medications have limitations in their use,
primarily because of their slow onset of therapeutic action (often greater than
10 days from the commencement of dosing), lack of efficacy in some patients, and
side effects such as sexual dysfunction. Industry analysts estimate the current
annual market for antidepressants to be approximately $17 billion worldwide.

Stress is a condition commonly associated with depression. A number of
neuropeptide receptors that appear to be involved in stress responses, including
receptors for CRF1, exhibit altered characteristics in depressed patients.

We believe that an orally available drug candidate that blocks the CRF1
receptor may be efficacious in relieving depression, anxiety and/or stress
related disorders without significant side effects. A number of companies are
seeking to develop CRF1 drug candidates. To date, many companies have
experienced difficulties in identifying CRF1 blockers which have drug properties
appropriate for commercialization. We believe this is due to the fact that the
scope of known chemical structures which block CRF1 is relatively narrow.

We have discovered a number of compounds that block the CRF1 receptor
subtype and have demonstrated efficacy in animal models of depression and
stress. Importantly, the chemical structure of these compounds is significantly
outside of the scope of known CRF1 blockers. We believe these novel chemical
templates hold the potential of avoiding the development issues of known CRF1
structures. In December of 2001, we entered into a collaborative agreement with
Aventis Pharmacuticals (described below) to research and develop compounds to
modulate CRF1 receptors. Neurogen and Aventis are evaluating the most advanced
of these compounds in preclinical tests in preparation for clinical trials.

Pain (VR-1):

Neurogen has established a program to explore the utility of compounds that
modulate the type 1 Vanilloid Receptor (VR-1) so as to develop drugs for the
treatment of chronic pain. Studies in genetically altered mice lacking the VR-1
receptor provide strong evidence for a role of VR-1 in the sensation of noxious
heat as well as thermal hyperalgesia(heightened sensitivity to pain) in models
of inflammatory pain. Neurogen researchers believe that a drug which blocks the
VR-1 receptor could benefit patients suffering from various types of
inflammatory pain states and specific types of nociceptive, or localized, pain.
Through our AIDD program, we have discovered and optimized VR-1 antagonist drug
leads suitable for the further exploration of the utility of this target. To
date, we have retained all commercial rights to our VR-1 program.

Obesity (MCH):

Neurogen has established a program to explore the utility of and develop
drugs that modulate the effects of Melanin Concentrating Hormone (MCH) for the
treatment of obesity. MCH-deficient mice have reduced body weight and leanness
due to reduced feeding and increased metabolic rate, suggesting a role for MCH
in the central regulation of food intake and energy expenditure. Neurogen
researchers believe that a drug that blocks the activity of MCH could decrease
appetite and body weight. We have discovered and optimized MCH antagonist drug
leads suitable for further exploration of the utility of this target. To date,
we have retained all commercial rights to our MCH program.

Neurogen Collaborations

Neurogen's strategy is to advance a mix of proprietary drugs independently
and, when advantageous, collaborate with world-class pharmaceutical companies
during the drug development process to obtain additional resources and to access
complementary expertise. The Company's collaboration agreements offer funding
for drug discovery and development programs as well as clinical, manufacturing,
marketing, and sales expertise. At the same time, Neurogen has retained certain
rights to future royalties or profit-sharing for successful drugs resulting from
collaborative programs. These strategic alliances balance the Company's exposure
to research and development risks inherent in the industry while retaining a
share in the success of future products.

A summary of the material terms of our existing collaborative agreements
follows:

Pfizer Inc.

o The 1992 Pfizer Agreement - covers our GABA-based anxiety,
depression and cognitive disorders program
- Pfizer purchased 1.0 million shares of our common stock for $13.8
million.
- We received funding from 1992 through 2001 for collaborative
research and development under these programs.
- Subject to certain diligence obligations, Pfizer has the right to
determine when to advance compounds in the clinical process.
- We will receive milestone payments if specified development and
regulatory objectives are achieved.
- Pfizer received the exclusive worldwide license to manufacture,
use and sell GABA-based anxiolytics, anti-depressants and
cognition enhancers developed in this collaboration.
- Pfizer is required to pay us royalties based on net sales levels,
if any, for such products.
- In December 2001, our collaborative research program came to its
scheduled conclusion. Pfizer is currently developing candidates
and evaluating other candidates from the program to determine
whether further development is desirable.

o The 1994 Pfizer Agreement - covers our GABA-based sleep disorder
program
- Pfizer purchased approximately 1.1 million shares of our common
stock for approximately $9.9 million.
- We received funding from 1994 through 2001 for research and
development under this program.
- Pfizer has the right to determine when to advance compounds in the
clinical process.
- We will receive milestone payments if specified development and
regulatory objectives are achieved.
- Pfizer received the exclusive worldwide license to manufacture,
use and sell GABA-based sleep disorder products developed in the
collaboration.
- Pfizer is required to pay us royalties based on net sales levels,
if any, for such products.
- In December 2001, our collaborative research program came to its
scheduled conclusion. Pfizer is currently developing candidates
and evaluating other candidates from the program to determine
whether further development is desirable.

o The 1999 Pfizer Technology Transfer Agreement - license for a portion
of our AIDD technology
- Pfizer received a non-exclusive license to a portion of our AIDD
technology.
- We have received as of December 31, 2001 $24 million and may
receive up to an additional $3 million for transfer of this
technology.
- We may receive additional payments based upon Pfizer's success in
using the technology.

o The 2001 Aventis CRF1 Collaboration Agreement
- Aventis paid $10 million for the licensing of Neurogen's CRF1
technology.
- Neurogen will receive committed research payments and be
reimbursed for research expenses for three years from the effective
date.
- Neurogen will receive milestone payments if specified development
and regulatory objectives are achieved.
- Aventis received the exclusive worldwide license to manufacture,
use and sell CRF1 receptor modulatory products developed in the
collaboration.
- Aventis is required to pay us royalties based on net sales levels,
if any, for such products.

Patents and Proprietary Technology

Our success depends, in part, on our ability to obtain and enforce patents,
maintain trade secrets and operate without infringing the intellectual property
rights of third parties. We file patent applications both in the United States
and in foreign countries, as we deem appropriate, for protection of both our
products and our processes. To date, we are the sole assignee of 171 issued
United States patents and numerous foreign patents:

o 66 of our issued United States patents and several pending patent
applications concern the compounds in our GABA-based program to
discover drugs to treat anxiety, sleep disorders and dementia;

o 71 of our issued United States patents and several pending patent
applications concern compounds that modulate activity at receptor
subtypes for the neurotransmitter dopamine, which is thought to play a
role in schizophrenia;

o 23 of our issued United States patents and several pending patent
applications are in our drug discovery program to treat depression
through the CRF1 receptor; and

o Five of our issued United States patents and several pending patent
applications concern NPY receptor-targeted drug discovery candidates
to treat obesity.

We are not currently engaged in any research based on any technology
transfer that we believe would obligate us to pay royalties to any third party.

The patent position of biotechnology and pharmaceutical firms is highly
uncertain and involves many complex legal and technical issues. There is
considerable uncertainty regarding the breadth of claims allowed in such cases
and the degree of protection afforded under such patents. As a result, we cannot
assure you that our patent applications will be successful or that our current
or future patents will afford us protection against our competitors. It is
possible that our patents will be successfully challenged or that patents issued
to others may preclude us from commercializing our products. Litigation to
establish the validity of patents, to defend against infringement claims or to
assert infringement claims against others can be lengthy and expensive, even if
a favorable result is obtained. Moreover, much of our expertise and technology
cannot be patented.

We also rely heavily on trade secrets and confidentiality agreements with
collaborators, advisors, employees, consultants, vendors and other service
providers. We cannot assure you that these agreements will not be breached or
that our trade secrets will not otherwise become known or be independently
discovered by competitors. Our business would be adversely affected if our
competitors were able to learn our secrets or if we were unable to protect our
intellectual property.

Competition

The biopharmaceutical industry is highly competitive and subject to rapid
and substantial technological change. Developments by others may render our
products under development or technologies noncompetitive or obsolete, or we may
be unable to keep pace with technological developments or other market factors.
Technological competition in the industry from pharmaceutical and biotechnology
companies, universities, governmental entities and others diversifying into the
field is intense and is expected to increase. Many of these entities have
significantly greater research and development capabilities than we do, as well
as substantially more marketing, manufacturing, financial and managerial
resources. These entities represent significant competition for us. In addition,
acquisitions of, or investments in, competing development-stage pharmaceutical
or biotechnology companies by large corporations could increase such
competitors' financial, marketing, manufacturing and other resources.

Competitors have developed or are in the process of developing technologies
that are, or in the future may be, the basis for competitive products. Our
competitors may develop products that are safer, more effective or less costly
than any products we may develop or may be able to complete their development
more quickly. If a competitor were to develop and successfully commercialize a
drug similar to one we were working on before us, it would put us at a
significant competitive disadvantage.

Manufacturing

Neurogen is currently relying, in part, on third-party manufacturers to
produce large quantities of development candidate compounds for pre-clinical
development and dosage forms of these candidates to support clinical trials.

Pfizer manufactures or will be responsible for manufacturing, drugs for
clinical trials which are subject to the 1992 Pfizer Agreement and the 1994
Pfizer Agreement and has the right to manufacture future products under these
collaborations, if any, for commercialization.

Aventis Pharmaceuticals will be responsible for manufacturing, or having
manufactured, drugs for clinical trials which are subject to the 2001 Aventis
Agreement, and has the right to manufacture future products under the
collaboration, if any, for commercialization.

With respect to compounds not currently subject to collaborations, we
currently utilize third-party manufacturers for preclinical development and
clinical trials.

Sales and Marketing

Neurogen's strategy is to market our products either directly or through
co-promotion arrangements or other licensing arrangements with large
pharmaceutical or biotechnology companies. We do not expect to establish a
direct sales capability for at least the next several years, though we may
pursue such a capability in the future. Pfizer has the right to market worldwide
future products, if any, resulting from the Pfizer Agreements. Aventis has the
right to market worldwide future products, if any, resulting from the 2001
Aventis CRF1 Collaboration Agreement.

Government Regulation

The production and marketing of our products and our research and
development activities are subject to regulation for safety, efficacy and
quality by numerous governmental authorities in the United States and other
countries. In the United States, drugs are subject to rigorous federal
regulation and, to a lesser extent, state regulation. The Federal Food, Drug and
Cosmetic Act, as amended, and the regulations promulgated thereunder, and other
federal and state statutes and regulations govern, among other things, the
testing, manufacture, safety, efficacy, labeling, storage, record keeping,
approval, advertising and promotion of our products. Product development and
approval within this regulatory framework will take a number of years and
involve the expenditure of substantial resources.

The steps required before a pharmaceutical agent may be marketed in the
United States include:

1. Pre-clinical laboratory tests, in vivo pre-clinical studies and
formulation studies,
2. The submission to the FDA of an Investigational New Drug
Application (IND) for human clinical testing which must become
effective before human clinical trials can commence,
3. Adequate and well-controlled human clinical trials to establish the
safety and efficacy of the drug,
4. The submission of a New Drug Application or Product License
Application to the FDA, and
5. FDA approval of the New Drug Application or Product License
Application prior to any commercial sale or shipment of the drug.

In addition to obtaining FDA approval for each product, each domestic drug
manufacturing establishment must be registered with, and approved by, the FDA.
Domestic manufacturing establishments are subject to biennial inspections by the
FDA and must comply with the FDA's Good Manufacturing Practices for both drugs
and devices. To supply products for use in the United States, foreign
manufacturing establishments must comply with Good Manufacturing Practices and
are subject to periodic inspection by the FDA or by regulatory authorities in
such countries under reciprocal agreements with the FDA.

Pre-clinical testing includes laboratory evaluation of product chemistry
and formulation, as well as animal studies to assess the potential safety and
efficacy of the product. Pre-clinical safety tests must be conducted by
laboratories that comply with FDA regulations regarding Good Laboratory
Practices. The results of the pre-clinical testing are submitted to the FDA as
part of an IND and are reviewed by the FDA prior to the commencement of human
clinical trials. Unless the FDA objects to an IND, the IND will become effective
30 days following its receipt by the FDA.

Clinical trials involve the administration of the new drug to healthy
volunteers or to patients under the supervision of a qualified principal
investigator. Clinical trials must be conducted in accordance with Good Clinical
Practices under protocols that detail the objectives of the study, the
parameters to be used to monitor safety and the efficacy criteria to be
evaluated. Each protocol must be submitted to the FDA as part of the IND.
Further, each clinical study must be conducted under the auspices of an
independent Institutional Review Board at the institution where the study will
be conducted. The Institutional Review Board will consider, among other things,
ethical factors, the safety of human subjects and the possible liability of the
institution. Compounds must be formulated according to Good Manufacturing
Practices.

Clinical trials are typically conducted in three sequential phases, but the
phases may overlap. In Phase I, the initial introduction of the drug into
healthy human subjects, the drug is tested for safety (adverse side effects),
absorption, dosage tolerance, metabolism, bio-distribution, excretion and
pharmacodynamics (clinical pharmacology). Phase II typically involves studies in
a limited patient population

1. to determine the efficacy of the drug for specific, targeted
indications,
2. to determine dosage tolerance and optimal dosage, and
3. to identify possible adverse side effects and safety risks.

When a compound is found to be effective and to have an acceptable safety
profile in Phase II evaluations, Phase III trials are undertaken to further
evaluate clinical efficacy and to test for safety within an expanded patient
population at geographically dispersed clinical study sites. We or the FDA may
suspend clinical trials at any time if it is believed that the individuals
participating in such trials are being exposed to unacceptable health risks.

The results of the pharmaceutical development, pre-clinical studies and
clinical studies are submitted to the FDA in the form of a New Drug Application
for approval of the marketing and commercial shipment of the drug. The testing
and approval process is likely to require substantial time and effort. The
approval process is affected by a number of factors, including the severity of
the disease, the availability of alternative treatments and the risks and
benefits demonstrated in clinical trials. Consequently, there can be no
assurance that any approval will be granted on a timely basis, if at all. The
FDA may deny a New Drug Application if applicable regulatory criteria are not
satisfied, require additional testing or information or require post-marketing
testing and surveillance to monitor the safety of a company's products if it
does not believe the New Drug Application contains adequate evidence of the
safety and efficacy of the drug. Notwithstanding the submission of such data,
the FDA may ultimately decide that a New Drug Application does not satisfy its
regulatory criteria for approval. Moreover, if regulatory approval of a drug is
granted, such approval may entail limitations on the indicated uses for which it
may be marketed. Finally, product approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems occur following initial
marketing.

Among the conditions for New Drug Application approval is the requirement
that any prospective manufacturer's quality control and manufacturing procedures
conform to Good Manufacturing Practices. In complying with standards set forth
in these regulations, manufacturers must continue to expend time, money and
effort in the area of production and quality control to ensure full technical
compliance. Manufacturing establishments, both foreign and domestic, also are
subject to inspections by or under the authority of the FDA and by other
federal, state or local agencies.

Whether or not FDA approval has been obtained, approval of a product by
regulatory authorities in foreign countries must be obtained prior to the
commencement of commercial sales of the product in such countries. The
requirements governing the conduct of clinical trials and product approvals vary
widely from country to country, and the time required for approval may be longer
or shorter than that required for FDA approval. Although there are some
procedures for unified filings for certain European countries, in general, each
country at this time has its own procedures and requirements.

In addition to regulations enforced by the FDA, we are also subject to
regulation under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substances Control Act, the Resource Conservation and
Recovery Act and other present and potential future federal, state or local
regulations. Our research and development involves the controlled use of
hazardous materials, chemicals, and various low-level radioactive compounds.
Although we believe that our safety procedures for handling and disposing of
such materials comply with the standards prescribed by state and federal
regulations, the risk of accidental contamination or injury from these materials
cannot be completely eliminated. In the event of any accident, we could be held
liable for any damages that result and any such liability could exceed our
resources.

Employees

As of December 31, 2001, we had 200 full-time employees, of which 150
persons were scientists and, of these scientists, 64 had Ph.D. degrees. None of
our employees are covered by collective bargaining agreements, and we consider
relations with our employees to be good. Each of our current scientific
personnel has entered into confidentiality and non-competition agreements with
us.

Research and Development Expenses

We incurred research and development expenses of $34,494,000, $28,048,000,
and $23,965,000 in 2001, 2000, and 1999, which exclude non-cash stock
compensation charges of $901,000, $4,637,000 and $77,000, respectively.

ITEM 2. PROPERTIES

We conduct our operations in laboratory and administrative facilities on a
single site located in Branford, Connecticut. The total facilities under our
ownership comprise approximately 148,000 square feet, of which 106,000 square
feet is in use by our personnel. Approximately 27,000 square feet has not yet
been adapted for our research effort.

In 1995, we leased approximately 24,000 square feet of a 39,000 square foot
building under a ten-year agreement, which gave us an option to purchase the
entire facility effective after the fifth year of the original term of the
lease. In January 2001, we elected to purchase the entire facility for $2.4
million. The additional space acquired of approximately 15,000 square feet
continues to be leased through us to the third-party tenants who occupied the
facilities at the time of purchase.

ITEM 3. LEGAL PROCEEDINGS

We know of no material litigation or proceeding pending or threatened to
which we are, or may become, a party.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

CAUTIONARY STATEMENT FOR PURPOSES OF THE
"SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995.

Except for historical matters, the matters discussed in this Form 10-K are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 or any rules, regulations or releases of the
Securities and Exchange Commission with respect thereto. Forward-looking
statements in this Form 10K include, but are not limited to, statements in Item
1 under the caption "Business--Neurogen Drug Programs" with respect to the
Company's various product development programs and statements in Item 7 under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations" with respect to the sufficiency of the Company's cash
balance to fund planned operations. In addition, the Company may from time to
time make forward-looking statements in the future.

Neurogen wishes to caution readers, and others to whom forward-looking
statements are addressed, that any such forward-looking statements are not
guarantees of future performance and that actual results may differ materially
from estimates in the forward looking statements. In addition to the important
factors described elsewhere in this Form 10-K and the Company's other filings
with the Securities and Exchange Commission, the following important factors,
among others, could affect Neurogen's actual future results and could cause such
results to differ materially from estimates expressed in any forward-looking
statements made by, or on behalf of, Neurogen:

o Difficulties or delays in discovery, research, development, testing,
regulatory approval, production and marketing of any of the Company's
drug candidates, including without limitation any unanticipated pre-
clinical or clinical delays, delays in regulatory approvals, the
failure to develop follow-on candidates in a given program, the
failure to attract or retain scientific and management personnel,
adverse side effects or inadequate therapeutic efficacy or inadequate
drug properties which could slow or prevent product development
efforts at any stage of product development by delaying or preventing
clinical trials, delaying or preventing regulatory approval for
commercialization or adversely affecting acceptance by the market.

o Vigorous competition within the Company's anticipated product
markets, including without limitation competition from
fully-integrated pharmaceutical companies, specialty biotechnology
companies and platform technology companies, many or all of which may
have substantially greater capabilities, experience and resources than
the Company.

o Risk that competitors will succeed in developing technologies
(including drug discovery techniques) and products that are more
effective than those of the Company or that are commercialized prior
to similar technologies or products of the Company.

o Neurogen's dependence on its corporate partners with respect to
research and development funding, pre-clinical evaluation of drug
candidates, human clinical trials of drug candidates, regulatory
filings and manufacturing and marketing expertise with respect to most
of its most advanced compounds.

o Risk that Neurogen's interests will not coincide with those of its
collaborators with respect to the timing or conduct of clinical
development of compounds, the future production of developed products
or strategies with respect to development and commercialization of
such products.

o Risk that actual research and development costs and associated
general and administrative costs may exceed budgeted amounts for a
variety of reasons, including the uncertainty of product development
in the pharmaceutical industry.

o Risk that drug targets pursued by the company may prove to be invalid
after substantial investments by the Company.

o Inability to obtain sufficient funds through future collaborative
arrangements, technology transfers, equity or debt financings or other
sources to continue the operation of the Company's business which may
require the Company to reduce substantially or eliminate expenditures
for product development or to relinquish rights to certain of its
technologies or potential products.

o Risk that the Company's patents and trade secrets and confidentiality
agreements with collaborators, employees, consultants or vendors will
be invalidated or not adequately protect the Company's intellectual
property.

o Uncertainty of the scope and enforceability of patents in the
pharmaceutical and biotechnology industries which purport to enable
competitors to restrict others from pursuing certain drug targets.

o Risk that the Company may be prohibited or otherwise restricted from
working on certain targets relevant to the Company's business.

o The Company's dependence upon third parties for the manufacture of its
potential products and the Company's inexperience in manufacturing if
the Company establishes internal manufacturing capabilities, each of
which could adversely affect the Company's future profit margins, if
any, and its ability to develop and manufacture products on a timely
and competitive basis.

o Neurogen's dependence on third parties to market potential products
and Neurogen's lack of sales and marketing capabilities, each of which
could adversely affect the success of any sales and marketing efforts
for the Company's products.

o Unavailability or inadequacy of medical insurance or other third-party
reimbursement for the cost of purchases of the Company's products.

o Inability of the Company to attract and retain qualified management,
employees and consultants.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The common stock of Neurogen is traded on The NASDAQ Stock Market under the
symbol NRGN. As of March 1, 2002, there were approximately 237 holders of record
of the Company's common stock. No dividends have been paid on the common stock
to date, and the Company currently intends to retain any earnings for further
development of the Company's business.

The following table sets forth the high and low closing bid prices for the
common stock as reported by NASDAQ.

HIGH LOW
---- ---
FISCAL 2001:
First Quarter.................................................. $36.9375 $19.4688
Second Quarter................................................. 23.5938 18.3750
Third Quarter.................................................. 23.4375 13.5469
Fourth Quarter................................................. 22.5938 15.6094
FISCAL 2000:
First Quarter.................................................. $47.3750 $15.6250
Second Quarter................................................. 30.8750 21.1250
Third Quarter.................................................. 38.7500 26.5625
Fourth Quarter................................................. 38.4375 25.9375

ITEM 6. SELECTED FINANCIAL DATA

For the Year Ended December 31

(in thousands, except per share data)
-----------------------------------------------------
2001 2000 1999 1998 1997

-------- -------- -------- --------- ---------
Total operating revenues....................... $ 11,514 $ 20,413 $ 10,209 $ 11,081 $ 17,979
Total operating expenses....................... $ 42,577 $ 40,858 $ 28,465 $ 24,834 $ 23,276
Net loss....................................... $(25,362) $(15,471) $(14,618) $ (9,458) $ (257)
Net loss per share-basic and diluted........... $ (1.45) $ (0.94) $ (1.00) $ (.66) $ (.02)
Total assets................................... $145,956 $142,588 $ 92,134 $101,810 $111,869
Long-term debt................................. $ 21,029 $ 1,912 $ 1,912 $ - $ 74
Stockholders' equity........................... $105,383 $126,120 $ 84,710 $ 98,567 $106,918
Weighted average number of shares outstanding-
basic and diluted.............................. 17,441 16,490 14,576 14,419 14,348

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

Since its inception in September 1987, Neurogen has been engaged in the
discovery and development of drugs. The Company has not derived any revenue from
product sales and expects to incur significant losses in most years prior to
deriving any such product revenues. Revenues to date have come from five
collaborative research agreements, one license agreement and one technology
transfer agreement.

The preparation of Neurogen's financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Management makes estimates in the areas of
marketable securities and investments, license and research arrangements, income
taxes, accruals and stock compensation. Actual results could differ from those
estimates.

The Company believes the following critical accounting policies affect
management's more significant judgments and estimates used in the preparation of
Neurogen's financial statements:

Revenue Recognition

Each of our collaborative research, licensing and technology transfer
agreements are significant to us. The terms of such arrangements may cause our
operating results to vary considerably from period to period.

The Company has entered into collaborative research agreements which
provide for the partial funding of specified projects in exchange for the grant
of certain rights related to potential discoveries. Revenue under these
arrangements typically includes upfront non-refundable fees, ongoing payments
for specified levels of staffing for research and milestone payments upon
occurrence of certain events. The upfront fees are generally recognized as
revenue ratably over the period of performance under the research agreement. The
research funding is recognized as revenue as the related research effort is
performed. Revenue derived from the achievement of milestones is recognized when
the milestone event occurs.

Neurogen has also entered into technology transfer agreements under which
revenue is recognized when a contractual arrangement exists, fees are fixed and
determinable, delivery of the technology has occurred and collectibility is
reasonably assured. When customer acceptance is required, revenue is deferred
until acceptance occurs. Where there are on-going services or obligations after
delivery, revenue is recognized over the related term of the service on a
percentage of completion basis, unless such service is maintenance, which is
recognized on a straight line basis. Generally, for a contract with multiple
elements, total contract fees are allocated to the different elements based on
evidence of fair value.

Stock-Based Compensation

Generally, the Company grants qualified stock options for a fixed number of
shares to employees with an exercise price equal to the fair market value of the
shares at the date of grant. The Company has also issued restricted stock to key
executives which vest over specified service periods. The Company accounts for
grants of stock options and restricted stock in accordance with APB Opinion No.
25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no
compensation expense for such grants when the grants have an exercise price
equal to the fair market value at the date of grant.

Marketable Securities

The Company invests in U.S. government and corporate debt securities. The
fair value of these securities are subject to volatility and change. The Company
considers its investment portfolio to be available-for-sale securities as
defined in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." Marketable securities at December 31, 2001 and 2000 consisted of
debt securities with maturities of three months to four years. Securities are
available-for-sale and are carried at fair value with the unrealized
gains/losses reported as other comprehensive income. Realized gains and losses
have been determined by the specific identification method and are included in
investment income.

RESULTS OF OPERATIONS

Results of operations may vary from period to period depending on numerous
factors, including the timing of income earned under existing or future
strategic alliances, technology transfer agreements, joint ventures or
financings, if any, the progress of the Company's research and development and
technology transfer projects, technological advances and determinations as to
the commercial potential of proposed products. Neurogen expects research and
development costs to increase significantly over the next several years as its
drug development programs progress. In addition, general and administrative
expenses necessary to support the expanded research and development activities
are generally expected to increase for the foreseeable future.

YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

The Company's fiscal 2001 operating revenues decreased 44 percent to $11.5
million from 2000 operating revenues of $20.4 million, which was an increase
from 1999 operating revenues of $10.2 million. The decrease in 2001 was
primarily due to a decrease in research and development revenues resulting from
a scheduled reduction in the Company's staffing on collaborative programs with
Pfizer (the GABA and NPY programs described below) and the related reduction in
discovery research funding. The recognition of license fees revenue pursuant to
the Pfizer Technology Transfer Agreement (described below) also decreased in
2001. The increase in 2000 operating revenues was primarily due to the
recognition of $11.2 million in license fees revenue under the Pfizer Technology
Transfer Agreement offset by a slight decrease in research funding.

Research and development expenses, excluding non-cash stock compensation
charges, increased 23 percent to $34.5 million in 2001 as compared to 2000, and
also increased 17 percent to $28.0 million in 2000 as compared to 1999. These
increases are due to further development of potential drug candidates, as well
as the Company's continued expansion of its AIDD (TM)(Accelerated Intelligent
Drug Discovery) program for the discovery of new drug candidates. Research and
development expenses represented 84 percent, 83 percent and 85 percent of total
operating expenses (excluding non-cash stock compensation charges) for the years
ended December 31, 2001, 2000 and 1999, respectively.

General and administrative expenses, excluding non-cash stock compensation
charges, increased 15 percent to $6.6 million in 2001 from $5.7 million in 2000
and 31 percent in 2000 from $4.4 million in 1999. These increases are attributed
to additional administrative and technical services and personnel to support the
protection of Neurogen's growing intellectual property estate and to support
Neurogen's expanding research pipeline.

Stock compensation expense, which is primarily composed of non-cash charges
to income related to the grant of restricted stock and the modification of
certain stock options, was $1.5 million in 2001, $7.1 million in 2000 and $0.1
million in 1999.

Other income, consisting primarily of interest income from invested cash
and marketable securities, was $4.5 million in 2001, $5.5 million in 2000 and
$3.6 million in 1999. The differences in annual income are due primarily to
varying levels of invested funds and available interest rates.

For the year ended December 31, 2001, the Company recorded a Connecticut
income tax benefit of $1.2 million in the Statement of Operations. This benefit
is the result of recent Connecticut legislation, which allows certain companies
to obtain cash refunds from the State of Connecticut at an exchange rate of 65%
of their research and development credits in exchange for foregoing the
carryfoward of these credits into future tax years.

The Company recognized a net loss of $25.4 million for the year ended
December 31, 2001, $15.5 million for the year ended December 31, 2000, and $14.6
million for the year ended December 31, 1999. The increase in the 2001 net loss
is primarily due to the decrease in revenues and the increase in research and
development and general and administrative expenses described above. The
increase in the 2000 net loss from 1999 was to a non-recurring, non-cash $6.5
million charge recognized in the first quarter of 2000 upon the vesting of
137,625 shares of restricted stock granted to certain employees in 1998 and
increases in research and development and general and administrative expenses,
as explained above (net of a $0.5 million cumulative effect of change in
accounting principle, as discussed below). These increases in expenses are
partially offset by the recognition of $10.7 million in revenue under the Pfizer
Technology Transfer Agreement (described below).

In December 1999, the staff of the Securities and Exchange Commission
issued its Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in
Financial Statements. SAB No. 101, as amended by SAB No. 101A and 101B, provides
guidance on the measurement and timing of revenue recognition in financial
statements of public companies. SAB No. 101 permits application of its guidance
to be treated as a change in accounting principle in accordance with APB Opinion
No. 20, Accounting Changes.

The Company adopted the guidance of SAB No. 101 in the fourth quarter of
2000, retroactive to January 1, 2000, and reflected a cumulative effect of
change in accounting principle on prior years of $0.5 million, related to timing
of revenue recognition on certain non-refundable up-front payments previously
recognized on a technology transfer agreement.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2001 and 2000, cash, cash equivalents and marketable
securities were in the aggregate $105.3 and $108.8 million, respectively. The
Company's cash and other short-term investment levels decreased ratably
throughout 2001 due primarily to the increase in research and development
expenses, purchases of property, plant and equipment and the decrease in
discovery research funding and license fees from Pfizer as described above. This
decrease was offset by $17.5 million in proceeds from a commercial term mortgage
loan financing completed in December 2001 and a $10.0 million license fee
received under a collaboration and license agreement entered into with Aventis
Pharmaceuticals Inc. ("Aventis"). A total amount of $42.4 million of the
marketable securities at December 31, 2001 have maturities greater than one
year; however, the Company can and may liquidate such investments prior to
maturity to meet its strategic and/or investment objectives. The levels of cash,
cash equivalents and marketable securities have fluctuated significantly in the
past and are expected to do so in the future as a result of the factors
described below.

Neurogen's cash requirements to date have been met by the proceeds of its
equity financing activities, amounts received pursuant to collaborative
research, licensing or technology transfer arrangements, certain debt
arrangements and interest earned on invested funds. The Company's equity
financing activities have included underwritten public offerings of common
stock, private placement offerings of common stock and private sales of common
stock in connection with collaborative research and licensing agreements. Total
funding received from these financing activities was approximately $146.6
million. The Company's expenditures have been primarily to fund research and
development and general and administrative expenses and to construct and equip
its research and development facilities.

The debt agreements entered into by the Company to date include the
commercial term mortgage loan financing in December 2001, mentioned above, and a
construction loan entered into in October 1999. Total proceeds received under
these agreements as of December 31, 2001, are $22.5 million. Of these amounts
received, as of December 31, 2001, $22.4 million remained outstanding. An
approximate aggregate amount of $1.4 million is due and payable in each of the
next five years. Thereafter, approximately $15.4 million is payable in regular
installments until the scheduled maturity dates. As of December 31, 2001,
Neurogen is not engaged in any significant lease or capital expenditure
commitments.

The Company plans to use its cash, cash equivalents and marketable
securities for its research and development activities, working capital and
general corporate purposes. Neurogen anticipates that its current cash balance,
as supplemented by research funding pursuant to its collaborative research,
licensing and technology transfer agreements, will be sufficient to fund its
current and planned operations through at least 2004. However, Neurogen's
funding requirements may change and will depend upon numerous factors, including
but not limited to, the progress of the Company's research and development
programs, the timing and results of preclinical testing and clinical studies,
the timing of regulatory approvals, technological advances, determinations as to
the commercial potential of its proposed products, the status of competitive
products and the ability of the Company to establish and maintain collaborative
arrangements with others for the purpose of funding certain research and
development programs, conducting clinical studies, obtaining regulatory
approvals and, if such approvals are obtained, manufacturing and marketing
products. Many of these factors could significantly increase the Company's
expenses and use of cash. The Company anticipates that it may augment its cash
balance through financing transactions, including the issuance of debt or equity
securities and further corporate alliances. No assurances can be given that
adequate levels of additional funding can be obtained on favorable terms, if at
all.

As of December 31, 2001, the Company had approximately $83.6 million and
$6.1 million of net operating loss and research and development credit
carryforwards, respectively, available for federal income tax purposes, which
expire in the years 2004 through 2021. The Company also had approximately $73.3
million and $3.5 million of Connecticut state tax net operating loss and
research and development credit carryforwards, respectively, which expire in the
years 2002 through 2021. The Company has applied to exchange year 2000
Connecticut research and development credits for cash proceeds under new
Connecticut tax law provisions (as mentioned above). Because of "change in
ownership" provisions of the Tax Reform Act of 1986, the Company's utilization
of its net operating loss and research and development credit carryforwards may
be subject to an annual limitation in future periods.

COLLABORATIVE RESEARCH AGREEMENTS

In December 2001, Neurogen entered into a collaboration and license
agreement with Aventis (the "Aventis Agreement") pursuant to which Aventis made
an initial payment of $10 million and agreed, among other things, to fund a
specified level of resources for at least three years for Neurogen's program for
the discovery and research of CRF1 receptor-based drugs for a broad range of
applications, including the therapeutic treatment of depression and anxiety
disorders. Aventis has the option to extend the discovery and research effort
for an additional two years. Neurogen is also eligible to receive milestone
payments if certain compound discovery, product development or regulatory
objectives are achieved subject to the collaboration. In return, Aventis
received the exclusive worldwide rights to develop, manufacture and market
collaboration drugs that act through the CRF1 receptor, with no limitations as
to the therapeutic indications for which the drugs may be used. Aventis will pay
Neurogen royalties based upon net sales levels, if any, for collaboration
products. Also under the agreement, Aventis is responsible for funding the cost
of development, including clinical trials, manufacturing and marketing of
collaboration products, if any.

In June 1999, Neurogen and Pfizer entered into a technology transfer
agreement (the "Pfizer Technology Transfer Agreement"). Under the terms of this
agreement, Pfizer has agreed to pay Neurogen a total of up to $27.0 million over
a three year period for the licensing and transfer to Pfizer of certain of
Neurogen's AIDD technologies for the discovery of new drugs, along with the
installation of an AIDD system. Additional payments are also possible upon
Pfizer's successful utilization of this technology. Pfizer has received a
non-exclusive license for certain AIDD intellectual property and the right to
employ this technology in its own drug development programs. As of December 31,
2001, Pfizer had provided $23.5 million in license fees pursuant to the Pfizer
Technology Transfer Agreement.

In 1992, Neurogen entered into a collaborative research agreement with
Pfizer (the "1992 Pfizer Agreement") pursuant to which Pfizer made a $13.8
million equity investment in the Company and agreed, among other things, to fund
a specified level of resources for up to five years (later extended as described
below) for Neurogen's research programs for the discovery of GABA-based drugs
for the treatment of anxiety and cognitive disorders. In 1994, Neurogen and
Pfizer entered into a second collaborative research agreement (the "1994 Pfizer
Agreement") pursuant to which Pfizer made a $9.9 million equity investment in
the Company and agreed, among other things, to fund a specified level of
resources for up to four years (later extended as described below) for
Neurogen's research program for the development of GABA-based drugs for the
treatment of sleep disorders. As of December 31, 2001, Pfizer had provided $43.2
million and $14.1 million of research funding to the Company and $0.5 million
and $0.3 million for the achievement of certain clinical development and
regulatory milestones pursuant to the 1992 and 1994 Pfizer Agreements and the
extensions of such agreements, respectively. Neurogen is eligible to receive
additional milestone payments of up to $12.0 million and $3.0 million under the
1992 and 1994 Pfizer Agreements, respectively, if certain development and
regulatory objectives are achieved regarding its products subject to the
collaboration. In return, under the two agreements, Pfizer received the
exclusive rights to manufacture and market collaboration drugs that act through
the GABA system for the treatment of anxiety, cognition enhancement, depression
or insomnia. Pfizer will pay Neurogen royalties based upon net sales levels, if
any, for such products. Under the agreements, Pfizer is responsible for funding
the cost of all clinical development and the manufacturing and marketing, if
any, of drugs developed from the collaborations.

On three occasions, Neurogen and Pfizer extended Neurogen's research
efforts under the 1992 and 1994 Pfizer Agreements. Pursuant to the extension
agreements, which terminated in December 2001, Neurogen received $2.9 million in
2001 (which amount is included in the above-described cumulative totals received
for the 1992 and 1994 Pfizer Agreements) for research and development funding of
the Company's GABA-based anxiolytic, cognitive enhancer and sleep disorders
projects.

Recently Issued Accounting Pronouncements

In August 2001, the Financial Accounting Standards Board issued SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS
No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," in that it excludes
goodwill from its impairment scope and allows for different approaches in cash
flow estimation. However, SFAS No. 144 retains the fundamental provisions of
SFAS No. 121 for recognition and measurement of the impairment of (a) long-lived
assets to be held and used and (b) long-lived assets to be disposed of other
than by sale. Neurogen has not adopted the provisions of SFAS No. 144 as of
December 31, 2001. However, the Company believes that the implementation of this
standard will not have a material effect on its results of operations and
financial position, since the impairment assessment under SFAS No. 144 is
largely unchanged from SFAS No. 121 and management is not currently aware of any
significant long-lived assets impaired or planned for disposal.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk. The Company's investment portfolio includes investment
grade debt instruments. These securities are subject to interest rate risk, and
could decline in value if interest rates fluctuate. Due to the short duration
and conservative nature of these instruments, the Company does not believe that
it has a material exposure to interest rate risk. Additionally, funds available
from investment activities are dependent upon available investment rates. These
funds may be higher or lower than anticipated due to interest rate volatility.

Capital market risk. The Company currently has no product revenues and is
dependent on funds raised through other sources. One source of funding is
through further equity offerings. The ability of the Company to raise funds in
this manner is dependent upon capital market forces affecting the stock price of
the Company.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Balance Sheets at December 31, 2001 and 2000

Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999

Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2001, 2000 and 1999

Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999

Notes to Consolidated Financial Statements

Report of Independent Accountants

NEUROGEN CORPORATION

CONSOLIDATED BALANCE SHEETS

December 31
-------------------
2001 2000
--------- ---------
(In thousands)

Assets
Current Assets:
Cash and cash equivalents........................................... $51,062 $48,086
Restricted cash..................................................... 1,500 -
Marketable securities............................................... 54,237 60,670
Receivables from corporate partners................................. 1,554 1,517
Other current assets, net........................................... 3,027 1,364
--------- ---------
Total current assets................................................. 111,380 111,637

Property, plant & equipment:
Land, building and improvements..................................... 30,489 17,949
Equipment and furniture............................................. 16,162 14,213
Construction in progress............................................ 462 6,471
Leasehold improvements.............................................. - 4,026
--------- ---------
47,113 42,659
Less accumulated depreciation and amortization........................ 13,062 12,079
--------- ---------
Net property, plant and equipment..................................... 34,051 30,580
Other assets, net..................................................... 525 371
--------- ---------
Total assets.......................................................... $145,956 $142,588
========= =========

See accompanying notes to consolidated financial statements

NEUROGEN CORPORATION

CONSOLIDATED BALANCE SHEETS--(Continued)
December 31
-------------------
2001 2000
--------- ---------
(In thousands, except
per share data)

Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable and accrued expenses............................... $ 3,595 $ 5,014
Unearned revenue from corporate partners, current portion........... 6,699 9,542
Current portion of loans payable.................................... 1,365 -
--------- ---------
Total current liabilities............................................. 11,659 14,556

Unearned revenue from corporate partners, net of current portion...... 7,885 -
Loans payable, net of current portion................................. 21,029 1,912
--------- ---------
Total liabilities..................................................... 40,573 16,468

Commitments and Contingencies

Stockholders' Equity:
Preferred stock, par value $.025 per share; authorized 2,000 shares;
none issued......................................................... - -
Common stock, par value $.025 per share; authorized 30,000 shares;
issued and outstanding 17,733 shares in 2001 and 17,386 shares in
2000............................................................... 443 434
Additional paid-in capital.......................................... 174,709 169,440
Accumulated deficit................................................. (67,685) (42,323)
Deferred compensation............................................... (2,750) (1,706)
Accumulated other comprehensive income.............................. 666 275
--------- ---------
Total stockholders' equity............................................ 105,383 126,120
--------- ---------
Total liabilities and stockholders' equity............................ $145,956 $142,588
========= =========

See accompanying notes to consolidated financial statements

NEUROGEN CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Years Ended December 31
---------------------------------
2001 2000 1999
----------- ---------- ----------

(In thousands, except per share data)
Operating revenues:
License fees............................................ $ 8,458 $11,208 $ 500
Research and development................................ 3,056 9,205 9,709
----------- --------- ---------
Total operating revenues................................ 11,514 20,413 10,209

Operating expenses:
Research and development:
Stock compensation.................................... 901 4,637 77
Other research and development........................ 34,494 28,048 23,965
----------- --------- ---------
Total research and development......................... 35,395 32,685 24,042

General and administrative:
Stock compensation ................................... 601 2,456 51
Other general and administrative...................... 6,581 5,717 4,372
---------- ---------- ---------
Total general and administrative....................... 7,182 8,173 4,423
---------- ---------- ---------
Total operating expenses................................ 42,577 40,858 28,465
---------- ---------- ---------
Operating loss.......................................... (31,063) (20,445) (18,256)

Other income (expense):
Investment income....................................... 4,604 5,474 3,639
Interest expense........................................ (114) - (1)
---------- ---------- ---------
Total other income, net................................. 4,490 5,474 3,638

Net loss before income taxes............................ (26,573) (14,971) (14,618)

Income tax benefit...................................... 1,211 - -
---------- ---------- ---------
Net loss before cumulative effect of change in
accounting principle ................................... (25,362) (14,971) (14,618)
---------- ---------- ---------
Cumulative effect on prior years of the application of
SAB No.101, "Revenue Recognition in Financial Statements" - (500) -
---------- ---------- ---------
Net loss ............................................... $(25,362) $(15,471) $(14,618)
========== ========== =========
Basic and diluted loss per share:
Before cumulative effect of change in accounting
principle ............................................ $ (1.45) $ (0.91) $ (1.00)
Change in accounting principle ....................... - (0.03) -
---------- ---------- ---------
Basic and diluted loss per share ....................... $ (1.45) $ (0.94) $ (1.00)
========== ========== =========
Shares used in calculation of loss per share:
Basic and diluted....................................... 17,441 16,490 14,576
========== ========== =========

See accompanying notes to consolidated financial statements

NEUROGEN CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

For the Years Ended December 31, 2001, 2000 and 1999
(in thousands)
--------------------------------------------------------------------------

Accumulated
Additional Other
Common Stock Paid-in Accumulated Deferred Comprehensive
Shares Amount Capital Deficit Compensation Income Total

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

Balance at December 31, 1998.................... 14,656 $366 $113,901 $(12,234) $(3,540) $74 $98,567
Forfeiture of restricted stock.................. (7) - (131) - 131 - -
Deferred compensation .......................... - - (204) - 333 - 129
Exercise of stock options....................... 126 3 600 - - - 603
Stock issued in 401(k) match.................... 25 1 353 - - - 354
Comprehensive income:
Net loss...................................... - - - (14,618) - - (14,618)
Unrealized loss on marketable securities...... - - - - - (325) (325)
------- ------ ---------- ----------- ------------ ------------- --------
Balance at December 31, 1999.................... 14,800 370 114,519 (26,852) (3,076) (251) 84,710
Stock issued in private placements, net of
offering expenses............................. 1,638 41 38,657 - - - 38,698
Deferred compensation .......................... - - 5,523 - 1,370 - 6,893
Issuance of stock options....................... - - 200 - - - 200
Exercise of stock options ...................... 899 22 10,010 - - - 10,032
Stock issued in 401(k) match ................... 13 - 436 - - - 436
Exercise of warrants............................ 36 1 95 - - - 96
Comprehensive income:
Net loss...................................... - - - (15,471) - - (15,471)
Unrealized gain on marketable securities ..... - - - - - 526 526
------- ------ ---------- ---------- ------------ ------------- ---------
Balance at December 31, 2000.................... 17,386 434 169,440 (42,323) (1,706) 275 126,120
Issuance of restricted stock.................... 150 4 2,905 - (2,909) - 0
Deferred compensation........................... - - (1,392) - 1,865 - 473
Modification to and issuance of stock options... - - 1,029 - - - 1,029
Exercise of stock options....................... 171 4 1,439 - - - 1,443
Income tax benefits from stock option exercises. - - 765 - - - 765
Stock issued in 401(k) match ................... 26 1 523 - - - 524
Comprehensive income:
Net loss...................................... - - - (25,362) - - (25,362)
Unrealized gain on marketable securities...... - - - - - 391 391
------- ------ ---------- ---------- ------------ ------------- ---------
Balance at December 31, 2001.................... 17,733 $443 $174,709 $(67,685) $(2,750) $666 $105,383
======= ====== ========== ========== ============ ============= =========

See accompanying notes to consolidated financial statements

NEUROGEN CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years ended December 31
--------------------------------
2001 2000 1999
---------- ---------- ----------
(In thousands)
Cash flows from operating activities:
Net loss........................................................ $(25,362) $(15,471) $(14,618)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization expense........................... 2,735 2,762 2,608
Stock compensation expense ..................................... 1,502 7,093 129
Noncash compensation and other expense.......................... 898 517 459
Loss on disposal of assets...................................... 21 141 33
Changes in operating assets and liabilities:
(Decrease) increase in accounts payable and accrued expenses... (1,418) 2,309 (155)
Increase in unearned revenue from corporate partners........... 5,042 6,782 2,500
(Increase) decrease in receivables from corporate partners..... (36) (1,231) 369
(Increase) decrease in other assets, net....................... (1,999) (664) 331
Income tax benefits from exercise of stock options.............. 765 - -
---------- ---------- ----------
Net cash (used in)provided by operating activities.............. (17,852) 2,238 (8,344)
---------- ---------- ----------
Cash flows from investing activities:
Purchases of plant and equipment................................ (6,257) (7,899) (3,753)
Purchases of marketable securities.............................. (74,623) (56,230) (35,629)
Maturities and sales of marketable securities................... 81,253 29,580 50,806
Proceeds from sales of assets................................... 30 31 -
---------- ---------- ----------
Net cash provided by (used in)investing activities.............. 403 (34,518) 11,424
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of debt.................................. 20,588 - 1,912
Change in restricted cash....................................... (1,500) - -
Principal payments under loans payable.......................... (106) - (73)
Exercise of warrants and employee stock options................. 1,443 10,080 603
Proceeds from private placement of common stock ................ - 38,698 -
---------- ---------- ----------
Net cash provided by financing activities....................... 20,425 48,778 2,442
---------- ---------- ----------
Net increase in cash and cash equivalents....................... 2,976 16,498 5,522
Cash and cash equivalents at beginning of year.................. 48,086 31,588 26,066
---------- ---------- ----------
Cash and cash equivalents at end of year........................ $51,062 $48,086 $31,588
========== ========== ==========

See accompanying notes to consolidated financial statements

NEUROGEN CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS--Neurogen Corporation ("Neurogen" or the "Company") is a company
engaged in the discovery and development of new drugs for a broad range of
pharmaceutical uses. Neurogen is focused on discovering new small molecule drugs
(i.e. drugs which can be taken as a pill) for large market disorders where
existing therapies achieve limited therapeutic effects or produce unsatisfactory
side effects. The Company has not derived any revenue from product sales to
date.

USE OF ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Management makes estimates in the areas of
investments, license and research arrangements, income taxes, accruals and stock
compensation. Actual results could differ from those estimates.

CASH EQUIVALENTS AND MARKETABLE SECURITIES--The Company considers cash
equivalents to be only those investments which are highly liquid, readily
convertible to cash and which mature within three months from date of purchase.
The carrying values of cash equivalents at December 31, 2001 and 2000 were
approximately $50,774,000 and $47,121,000, respectively.

The Company considers its investment portfolio to be available-for-sale
securities as defined in SFAS No. 115. Marketable securities at December 31,
2001 and 2000 consist of debt securities with maturities of three months to four
years. Securities are available for sale and are carried at fair value with the
unrealized gains/losses reported as other comprehensive income. Realized gains
and losses have been determined by the specific identification method and are
included in investment income. The Company recognized gross realized gains of
$103,000, $84,000 and $15,000 in 2001, 2000 and 1999, respectively. Gross
realized losses were $6,000, $69,000, and $108,000 in 2001, 2000 and 1999,
respectively.

PROPERTY, PLANT AND EQUIPMENT--Property, plant and equipment are stated at
cost. Depreciation is provided using the straight-line method over the estimated
useful lives of the assets, which are as follows:

Equipment and furniture............3 to 7 years
Leasehold improvements.............Shorter of life of
lease or 10 years
Building, building improvements,
building renovations and land
improvements.......................7 to 40 years

REVENUE RECOGNITION--The Company has entered into collaborative research
agreements which provide for the partial funding of specified projects in
exchange for the grant of certain rights related to discoveries. Revenue under
these arrangements typically includes upfront non-refundable fees, ongoing
payments for specified levels of staffing for research and milestone payments
upon the occurrence of certain events. Since the adoption of SAB No. 101, the
upfront fees are generally recognized as revenue ratably over the period of
performance under the research agreement. The research funding is recognized as
revenue as the related research effort is performed. Revenue derived from the
achievement of milestones is recognized when the milestone event occurs.

Neurogen has also entered into technology transfer agreements under which
revenue is recognized when a contractual arrangement exists, fees are fixed and
determinable, delivery of the technology has occurred and collectibility is
reasonably assured. When customer acceptance is required, revenue is deferred
until acceptance occurs. Where there are on-going services or obligations after
delivery, revenue is recognized over the related term of the service on a
percentage of completion basis, unless such obligation is maintenance, which is
recognized on a straight line basis. Generally, for a contract with multiple
elements, total contract fees are allocated to the different elements based on
evidence of fair value.

Revenue resulting from up-front non-refundable fees under collaborative
research agreements and all fees under technology transfer agreements is
recorded as License Fees revenue for purposes of the financial statements.
Research funding for the Company's staffing on projects and milestone payments
under collaborative agreements are recorded as Research and Development
revenues. Deferred revenue arises from the payments received for research and
development to be conducted in future periods or for licenses of Neurogen's
rights or technology where Neurogen has continuing involvement.

In December 1999, the staff of the Securities and Exchange Commission
issued SAB No. 101, Revenue Recognition in Financial Statements. SAB No. 101, as
amended by SAB No. 101A and 101B, provides guidance on the measurement and
timing of revenue recognition in financial statements of public companies. SAB
No. 101 permits application of its guidance to be treated as a change in
accounting principle in accordance with APB Opinion No. 20, Accounting Changes.
The Company adopted the guidance of SAB No. 101 in the fourth quarter of 2000,
retroactive to January 1, 2000 and reflected a cumulative effect of the change
in accounting principle on prior years of $500,000, related to timing of revenue
recognition on certain non-refundable up-front payments previously recognized on
a technology transfer agreement.

PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include
the accounts of the parent company and a subsidiary, Neurogen Properties LLC,
after elimination of intercompany transactions.

SEGMENT INFORMATION--Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information (SFAS No.
131), requires that an enterprise report financial and descriptive information
about each of its reportable operating segments. The management approach
designates the internal organization that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. The Company operates in one segment: drug discovery and
pharmaceutical development.

STOCK-BASED COMPENSATION--Generally, the Company grants qualified stock
options for a fixed number of shares to employees with an exercise price equal
to the fair market value of the shares at the date of grant. The Company has
also issued restricted stock to key executives which vest over specified service
periods. The Company accounts for grants of stock options and restricted stock
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and, accordingly, recognizes no compensation expense for such grants
when the grants have an exercise price equal to the fair market value at date of
grant. The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation".

RECENT PRONOUNCEMENTS--In July 2001, the Financial Accounting Standards
Board issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill
and Other Intangible Assets." SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated or completed after
June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets
acquired in a purchase business combination must meet to be recognized and
reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead be
tested for impairment at least annually. SFAS No. 142 also requires that
intangible assets with definite useful lives be amortized over their respective
useful lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," which is superceded by SFAS
No. 144 as discussed below. The Company has not been a party to any business
combinations to date and no intangible assets exist as of December 31, 2001.
Therefore, the adoptions of SFAS No. 141 and SFAS No. 142 did not have any
impact on the Company's 2001 financial statements.

INCOME TAXES--The liability method is used to account for income taxes.
Deferred tax assets and liabilities are determined based on differences between
financial reporting and income tax bases of assets and liabilities as well as
net operating loss carryforwards and are measured using the enacted tax rates
and laws that are expected to be in effect when the differences reverse.
Deferred tax assets may be reduced by a valuation allowance to reflect the
uncertainty associated with their ultimate realization.

EARNINGS (LOSS) PER SHARE--Basic EPS is calculated by dividing income or
loss attributable to common stockholders by the weighted average common shares
outstanding. Diluted EPS is calculated by adjusting weighted average common
shares outstanding by assuming conversion of all potentially dilutive shares. In
periods where a net loss is recorded, no effect is given to potentially dilutive
securities, since the effect would be antidilutive.

FAIR VALUE OF FINANCIAL INSTRUMENTS--The carrying value of long-term debt
approximates its fair value based upon currently available debt instruments
having similar interest rates and maturities. The carrying amounts of the
Company's other financial instruments approximate their fair value.

RECLASSIFICATIONS--Certain reclassifications have been made to the 1999 and
2000 financial statements in order to conform to the 2001 presentation.

2. CORPORATE PARTNER AGREEMENTS

AVENTIS
- -------

In December 2001, Neurogen entered into a collaboration and license
agreement with Aventis (the "Aventis Agreement") pursuant to which Aventis made
an initial payment of $10 million and agreed, among other things, to fund a
specified level of resources for at least three years for Neurogen's program for
the discovery and research of CRF1 receptor-based drugs for a broad range of
applications, including the therapeutic treatment and prevention of anxiety and
depression disorders. Aventis has the option to extend the discovery and
research effort for an additional two years. Neurogen is also eligible to
receive milestone payments if certain compound discovery or product development
or regulatory objectives are achieved subject to the collaboration. In return,
Aventis received the exclusive worldwide rights to develop, manufacture and
market collaboration drugs that act through the CRF1 receptor, with no
limitations as to the indications for which the drugs may be used. Aventis will
pay Neurogen royalties based upon net sales levels, if any, for collaboration
products. Also under the agreement, Aventis is responsible for funding the cost
of development, including clinical trials, manufacturing and marketing of
collaboration products, if any. For the year ended December 31, 2001, the
Company recognized $291,000 in revenue under the Aventis Agreement.

PFIZER
- ------

In June of 1999, Neurogen and Pfizer entered into a technology transfer
agreement (the "Pfizer Technology Transfer Agreement"). Under the terms of this
agreement, Pfizer has agreed to pay Neurogen up to a total of $27,000,000 over a
three year period for the licensing and transfer to Pfizer of certain of
Neurogen's AIDD (Accelerated Intelligent Drug Discovery) technologies for the
discovery of new drugs, along with the installation of an AIDD(TM) system.
Additional payments are also possible upon Pfizer's successful utilization of
this technology. Pfizer has received a non-exclusive license to certain AIDD
intellectual property, and the right to employ this technology in its own drug
development programs. As of December 31, 2001, the company had received
$23,500,000 in license fees pursuant to the Pfizer AIDD agreement of which
$8,343,000 and $11,208,000 has been recognized as revenue in 2001 and 2000,
respectively. Remaining revenues associated with amounts received under the
Pfizer Technology Transfer Agreement will be recognized in future periods and
may fluctuate significantly depending on the timing and completion of the
Company's transfer of technology and systems pursuant to the agreement.

In 1995, Neurogen and Pfizer entered into a collaborative agreement (the
"1995 Pfizer Agreement") pursuant to which Pfizer made an equity investment of
$16,500,000 in the Company, paid a license fee of $3,500,000 and agreed, among
other things, to fund a specified level of resources for Neurogen's research
program for the discovery of drugs which work through the neuropeptide Y (NPY)
mechanism for the treatment of obesity and other disorders. In October 2000,
Neurogen and Pfizer concluded the research phase of their NPY-based
collaboration according to schedule and the annual research funding received
from Pfizer came to its scheduled conclusion on October 31, 2000. Pursuant to
the 1995 Pfizer Agreement, Neurogen received total research funding of
$13,740,000, of which approximately $2,340,000 and $3,120,000 was received in
2000 and 1999, respectively, and $2,600,000 and $3,120,000 was recognized in
revenue in 2000 and 1999, respectively. Should Pfizer in the future elect to
continue the development of any drug candidates subject to collaboration,
Neurogen could also receive development and regulatory milestone payments and
would be entitled to royalty, profit sharing and manufacturing rights.

In 1992, Neurogen entered into a collaborative research agreement with
Pfizer (the "1992 Pfizer Agreement") pursuant to which Pfizer made an equity
investment of $13,750,000 in the Company and agreed, among other things, to fund
a specified level of resources for up to five years (later extended as described
below) for Neurogen's research programs for the discovery of GABA-based drugs
for the treatment of anxiety and cognitive disorders. In 1994, Neurogen and
Pfizer entered into a second collaborative research agreement (the "1994 Pfizer
Agreement") pursuant to which Pfizer made an additional equity investment of
$9,864,000 in the Company and agreed, among other things, to fund a specified
level of resources for up to four years (later extended as described below) for
Neurogen's research program for the development of GABA-based drugs for the
treatment of sleep disorders. As of December 31, 2001, Pfizer had provided total
research funding of $43,165,000 and $14,108,000 to the Company and payments of
$500,000 and $250,000 for the achievement of certain clinical development and
regulatory milestones pursuant to the 1992 and 1994 Pfizer Agreements and the
extensions of such agreements, respectively, all of which has been recognized as
revenue. Neurogen is eligible to receive additional milestone payments of up to
$12,000,000 and $3,000,000 under the 1992 and 1994 Pfizer Agreements,
respectively, if certain development and regulatory objectives are achieved
regarding its products subject to the collaboration. In return, under the two
agreements, Pfizer received the exclusive rights to manufacture and market
collaboration drugs that act through the GABA system for the treatment of
anxiety, cognition enhancement, depression or insomnia. Pfizer will pay Neurogen
royalties based upon net sales levels, if any, for such products. Under the
agreements, Pfizer is responsible for funding the cost of all clinical
development and the manufacturing and marketing, if any, of drugs developed from
the collaborations.

On three occasions, Neurogen and Pfizer extended Neurogen's research
efforts under the 1992 and 1994 Pfizer Agreements. Pursuant to the extension
agreements, which terminated in December 2001, Neurogen has received and
recognized in revenue $2,880,000, $6,240,000 and $6,240,000 in each of 2001,
2000 and 1999, respectively (which amount is included in the above-described
cumulative totals received for the 1992 and 1994 Pfizer Agreements) for research
and development funding of the Company's GABA-based anxiolytic, cognitive
enhancer and sleep disorders projects.

3. MARKETABLE SECURITIES

The following tables summarize the company's marketable securities (in
thousands).

December 31, 2001
Gross Gross
Amortized Unrealized Unrealized Fair Value
Cost Gains Loss
----------- ---------- ---------- -----------
U.S. Government
notes................ $22,322 $466 $ (9) $22,779
Corporate notes
and bonds............ 31,249 218 (9) 31,458
----------- ---------- ---------- -----------
Total $53,571 $684 $(18) $54,237
=========== ========== ========== ===========

December 31, 2000
Gross Gross
Amortized Unrealized Unrealized Fair Value
Cost Gains Loss
---------- ---------- ---------- -----------
U.S. Government
notes................ $23,586 $126 $(42) $23,670
Corporate notes
and bonds....