<PAGE>

                                 UNITED STATES
                      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, 1999

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______

                          Commission File No. 0-12943

                           CYPRESS BIOSCIENCE, INC.
            (Exact name of registrant as specified in its charter)
                                _______________

                   Delaware                                22-2389839
       (State or other jurisdiction of                 (I.R.S. Employer
        incorporation or organization)                Identification No.)


       4350 Executive Drive, Suite 325
            San Diego, California                             92121
       (Address of principal executive                     (Zip Code)
                   offices)

      Registrant's telephone number, including area code:  (858) 452-2323

       SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:  NONE
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                          Common Stock $.02 Par Value
                        Common Stock Purchase Warrants
                    Units Consisting of Three (3) Shares Of
            Common Stock And One (1) Common Stock Purchase Warrant
                               (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 such filing
requirements for the past 90 days.  Yes   X     No __
                                         --

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) 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. [X]

The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of March 1, 2000 was $175,868,304.*

The number of shares outstanding of the Registrant's common stock as of March 1,
2000 was 48,178,062.

DOCUMENTS INCORPORATED BY REFERENCE:  None

______________________

* Calculated based on 37,024,906 shares of common stock held as of March 1, 2000
by nonaffiliates and a per share market price of $4.75. Excludes 11,153,156
shares of common stock held by directors and executive officers and stockholders
whose ownership exceeds five percent of the common stock outstanding at March 1,
2000. Exclusion of such shares should not be construed to indicate that any such
person possesses the power, direct or indirect, to direct or cause the direction
of the management or policies of the Registrant or that such person is
controlled by or under common control with the Registrant.

                                       1
<PAGE>

                           CYPRESS BIOSCIENCE, INC.

                                   FORM 10-K

                                     INDEX

                                    PART I

<TABLE>
<CAPTION>
                                                                                              Page
                                                                                              ----
<S>                                                                                           <C>
ITEM 1    Business............................................................................   1
ITEM 2    Properties..........................................................................  14
ITEM 3    Legal Proceedings...................................................................  14
ITEM 4    Submission Of Matters To a Vote of Security Holders.................................  14

                                                 PART II

ITEM 5     Market For The Company's Common Stock And Related Security Holder Matters..........  15
ITEM 6     Selected Consolidated Financial Data...............................................  16
ITEM 7     Management's Discussion And Analysis Of Financial Condition
           And Results Of Operations..........................................................  17
ITEM 7A    Quantitative and Qualitative Disclosures About Market Risk.........................  20
ITEM 8     Financial Statements And Supplementary Data........................................  20
ITEM 9     Changes In And Disagreements With Accountants On Accounting
           And Financial Disclosure...........................................................  20

                                                 PART III

ITEM 10    Directors And Executive Officers Of The Company....................................  21
ITEM 11    Executive Compensation.............................................................  24
ITEM 12    Security Ownership Of Certain Beneficial Owners And Management.....................  29
ITEM 13    Certain Relationships And Related Transactions.....................................  30

                                                 PART IV

ITEM 14   Exhibits, Financial Statement Schedules And Reports on Form 8-K.....................  31
          Signatures..........................................................................  33
</TABLE>
<PAGE>

                                    PART I

Item 1.  BUSINESS

     Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K contain forward-looking statements
within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act, including, in particular, statements in this Annual Report about
the Company's plans, strategies and prospects.  These statements, which may
include words such as "may," "will," "expect," "believe," "intend," "plan,"
"anticipate," "estimate," or similar words, are based on the Company's current
beliefs, expectations and assumptions and are subject to a number of risks and
uncertainties.  Although the Company believes that its beliefs, expectations and
assumptions reflected in these statements are reasonable, the Company's actual
results and financial performance may prove to be very different from what the
Company might have predicted on the date of this Annual Report.  Some of the
risks and uncertainties that might cause such differences are discussed under
the heading "Risk Factors" beginning on page 11 and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" beginning on page 17.

COMPANY OVERVIEW AND RECENT DEVELOPMENTS

     Cypress Bioscience, Inc. (the "Company") markets the PROSORBA(R) column for
the treatment of types of rheumatoid arthritis ("RA") and idiopathic
thrombocytopenia purpura ("ITP"), which are types of immune disorders, and is
engaged in the development of novel therapeutic agents for the treatment of
blood platelet disorders. The PROSORBA column absorbs antibodies and circulating
immune complexes and modulates the patient's inappropriate immune response to
certain diseases. In March 1999, the Food and Drug Administration ("FDA")
granted Cypress marketing clearance to distribute the PROSORBA column for the
treatment of moderate to severe RA. The Company previously received marketing
clearance from the FDA in December 1987 to distribute the PROSORBA column for
the treatment of ITP, an immune-mediated bleeding disorder.

     In June 1996, the Company commenced a prospective, randomized, multi-
center, double blind, controlled Phase III pivotal trial designed to confirm the
findings of an earlier pilot study evaluating the use of the PROSORBA column in
the treatment of RA. In January 1998, the Company's Phase III clinical trial was
stopped early due to the achievement of favorable safety and statistically
significant efficacy results. Based on such results, the Company filed a Pre-
Market Approval ("PMA") application for the PROSORBA column for the treatment of
RA with the FDA in July 1998.

     The Company appeared at a hearing before the FDA's Gastroenterology and
Urology Device Advisory Panel (the "FDA Panel") on October 29, 1998. The FDA
Panel recommended on that day to the FDA that the PROSORBA column be approved
for the treatment of moderate to severe RA, subject to certain requirements. On
March 16, 1999, the Company received marketing clearance for the PROSORBA column
subject to the requirement that the Company conduct a post-marketing trial for
the treatment of RA with a combination of the PROSORBA column and a disease
modifying anti-rheumatic drug ("DMARD"). In April 1999, the Company and its
partners, Fresenius Aktiengesellschaft and Fresenius Hemotechnology, Inc.
(collectively "Fresenius") commercially launched the PROSORBA column in the
U.S. for the RA indication.

     The Company is also developing Cyplex(TM), a platelet alternative,
previously known as Infusible Platelet Membranes ("IPM"), as an alternative to
traditional platelet transfusions.  Currently the Company does not have a
facility to manufacture Cyplex; however, the Company is working to improve the
Cyplex manufacturing process by investing in process development with third
parties.  Once Cyplex production resumes, the Company expects to initiate a
Phase IIb clinical trial.

     In addition, the Company has in the past evaluated various possible
strategic transactions, including the potential acquisitions of products,
technologies and companies, and expects to continue to do so in the future.

Agreement with Fresenius

     In March 1999, the Company entered into a partnership with Fresenius for
the co-marketing and distribution of the PROSORBA column in the United States
and for the registration and distribution of the PROSORBA column in Europe,
Latin America and subject to certain conditions, Japan and select Asian
countries. The terms of the agreement with Fresenius specify joint efforts to
introduce and market the PROSORBA column in the U.S., with Fresenius having
exclusive distribution rights and responsibility for clinical trials and
registration overseas.  The Company has taken the lead in marketing the PROSORBA
column to rheumatologists in the U.S. who are generally the doctors who
prescribe the PROSORBA column for RA treatment (the Company's present marketing
strategy).  Fresenius will take the lead in marketing the PROSORBA column to
rheumatologists and physicians outside the United States. The agreement includes
a 50/50 profit split in the territories other than the

                                       1
<PAGE>

United States. The profit sharing is 50/50 in the U.S. for both the PROSORBA
column and disposables sold by Fresenius for use with the PROSORBA column, and
for any contract year that PROSORBA column sales exceed $25 million in the U.S.
the Company will receive 60% of the profits for such contract year and Fresenius
will receive 40%. In addition, the Company is entitled to receive up to $54
million in license payments upon the achievement of certain cumulative net sales
of the PROSORBA column (subject to conditions relating to the timing of such
payments). In the United States, the license payments are payable in some cases
in cash and in others in equity investments by Fresenius at market prices, and
in the non-U.S. territory, the license payments are payable in cash.

     Revenues from the Fresenius agreement for the year ended December 31, 1999
consisted of Cypress's pro rata share of sales by Fresenius. Until profits are
generated, Cypress will recognize revenue based on the payments form Fresenius,
which are generally determined as the ratio of allowable expenses incurred for
production, research and development and sales and marketing by Cypress
compared to allowable expenses incurred by Cypress and Fresenius under the
agreement.

     The agreement also included an option for Fresenius to purchase assets used
in Cypress' manufacturing facilities in Redmond, Washington (the "Option").  In
April 1999, Fresenius exercised its option and acquired the asset related to
then PROSORBA column manufacturing function for $5.2 million.  During 1999
Cypress recorded a total gain on the sale of approximately $2.5 million
recognized from inventory and manufacturing assets.

     In addition, in March 1999, Fresenius purchased 297,530 shares of the
Company's common stock for approximately $1.0 million or $3.361 per share and
purchased for $500,000 a three-year warrant to purchase 342,466 shares of common
stock with an exercise price of  $7.50 per share.

The PROSORBA Column

     The Company's PROSORBA column is a therapeutic, extracorporeal
immunoadsorption device which removes circulating immune complexes and
immunoglobulin from a patient's plasma in a procedure that takes place in an
extracorporeal loop (i.e., outside the body) and returns the treated plasma and
red blood cells to the patient. The PROSORBA column treatment uses therapeutic
apheresis, in a process similar to donating platelets, a patient's blood is
removed from an arm and passed through a cell separator machine that separates
the blood cells from the plasma (the liquid portion of the blood). The plasma is
then passed through the PROSORBA column, which is composed of a silica matrix
coated with protein A, a substance which binds to immunoglobulin (commonly known
as antibodies) and other circulating immune complexes. Once these substances are
removed, the plasma is recombined with the red blood cells and reinfused into
the patient's body. This procedure generally lasts two-hours and can be
performed in an outpatient setting. The standard course of treatment for RA
involves 12 weekly outpatient apheresis sessions.

     The PROSORBA column treats a defective immune system by modulating the
immune system to respond more effectively.  The modulation can result in the
clearance of antigens or control of an autoimmune disease.  The Company believes
that the PROSORBA column treats a dysfunctional immune system response rather
than treating the disease itself.  The Company is providing financial support
for an extramural program with leading academic laboratories to study the
mechanisms of action of the PROSORBA column.

     Fresenius, the Company's partner, received CE mark approval on the PROSORBA
column in January 2000, and CE mark clearance on the complete treatment system
is expected in the second quarter of 2000. This approval will allow Fresenius to
begin marketing the PROSORBA column to European Common Market countries in the
second quarter of 2000.

     The agreement the Company entered into with Fresenius did not include
distribution rights for Canada.  In March 2000, the Company entered into an
agreement with Medexus of Toronto, Canada, pursuant to which Medexus was
appointed as the exclusive Canadian distributor.  Medexus received Canadian
approval to market the PROSORBA column in March 2000.  Medexus will be
conducting clinical studies and plans to begin marketing the PROSORBA column in
the second quarter of 2000 to Canadian rheumatologists.

Rheumatoid Arthritis

     Rheumatoid arthritis is an autoimmune disease which occurs when the body's
own immune system attacks the cartilage surrounding the joints. This chronic
immune response causes pain, stiffness, swelling and loss of function in the
joints and eventually leads to inflammation in other body organs. Most patients
exhibit a chronic, fluctuating course of disease that, if left untreated,
results in progressive joint destruction, deformity, disability and premature
death. Because there is no known cure for RA or means of preventing it, optimal
management requires early diagnosis and timely introduction of agents which
reduce the probability of irreversible joint damage. Unfortunately, many of the
most commonly used medications to treat RA are toxic or teratogenic. Some of the
therapies were originally developed as cancer chemotherapy regimens and are only
effective for a limited number of years.

                                       2
<PAGE>

     RA is not the arthritis of aging, known as osteoarthritis, in which
cartilage is destroyed over time. RA is an aggressive, systemic and often
debilitating disease in which the body's immune system mistakes its cells as
foreign and attacks its own tissue, resulting in severe consequences, including
joint destruction. Much like other autoimmune diseases, the onset of RA most
often occurs during the most productive period of one's life, during the 30's
and 40's, though sufferers may range in age from children to elderly. The
disease also shows a 3 to 1 preference for women.

     The American College of Rheumatology estimates that roughly 1% of the U.S.
population, or approximately 2.5 million people, are afflicted with RA.
Worldwide, the incidence is believed to be about seven million people. An
estimated 200,000 patients are newly diagnosed with RA each year in the United
States alone. Currently, there is no cure for RA - only therapies that attempt
to reduce pain and inflammation and retard the disease process.

History of the Development of the PROSORBA Column in Rheumatoid Arthritis

     In September 1995, the Company announced the results of its 15 patient
pilot clinical trial that used the PROSORBA column for therapy in RA. The
results showed a statistically significant 76% reduction in painful joints and a
70% reduction in swollen joints in 11 patients three months after completing
treatment with the PROSORBA column. These results were published in the Journal
of Rheumatology in August 1999. The Company believes that these findings confirm
the potential utility of the PROSORBA column in treating RA reported by an
earlier independent study published in the JOURNAL OF RHEUMATOLOGY in May 1994.

     In 1996, the Company began providing financial support to several leading
research facilities in the form of grants and contractual support to further
efforts in studying the mechanism of action of the PROSORBA column in the
treatment of RA.  For the years ended December 31, 1999 and 1998, the amounts of
financial support provided by the Company were approximately $212,000 and
$152,000, respectively.

     In June 1996, the Company commenced a prospective, randomized, multi-
center, double blind, sham controlled Phase III pivotal trial designed to
confirm the findings of the pilot study in a larger group of patients. The
patients were randomly entered into two treatment groups with approximately half
of the patients treated with the PROSORBA column and the other half of the
patients with a placebo treatment.

     In January 1998, the Company announced that an independent Data Safety and
Monitoring Board ("DSMB") recommended the early cessation of the Company's Phase
III clinical trial evaluating the use of the PROSORBA column in the treatment of
RA. The recommendation to end enrollment in the Phase III trial was based on the
achievement of favorable safety and statistically significant efficacy results.
These results were recently published in Arthritis & Rheumatism in October 1999.
In July 1998, the Company filed a PMA application for submission to the FDA
requesting new labeling for the PROSORBA column to incorporate the RA
indication. The Company appeared at a hearing before the FDA's Panel on October
29, 1998. The FDA Panel recommended on that day to the FDA that the PROSORBA
column be approved for the treatment of moderate to severe RA, subject to
certain requirements. In March 1999, the Company received marketing approval for
the PROSORBA Column for use in the treatment of moderate to severe RA. A
condition of approval of the PROSORBA column by the FDA was that Cypress agree
to conduct a post approval study (device equivalent of Phase IV trial) of the
PROSORBA column used with concomitant methotrexate therapy. Mandatory post
approval trials are post-marketing studies in order to gather additional data
concerning the product's performance after commercial sales begin. In this case,
Cypress will study the safety and effectiveness of the PROSORBA column in
patients who continue to take a common rheumatoid arthritis medication,
methotrexate.

Cyplex(TM) (Infusible Platelet Membranes), A Platelet Alternative

     Cypress is also developing Cyplex, previously known as Infusible Platelet
Membranes, as an alternative to traditional platelet transfusions. Cyplex is
made from small platelet membrane fragments, which can be virally inactivated
similar to other blood-derived products. Cypress provides the following
significant benefits over traditional platelets:

 .    Longer shelf life (greater than one year vs. 3 to 5 days for human
     platelets);
 .    Virally inactivated compared to human platelets, which can transmit viral
     infection; and do not induce an immune response compared to human
     platelets, meaning they may function in settings where the patient is
     "Refractory" to standard platelet transfusions.


                                       3
<PAGE>

     Several extramural projects are currently ongoing at leading institutions
in Europe and North America to improve the Cyplex manufacturing process,
including an agreement with the Dutch Red Cross (CLB) to collaborate on process
development and scale-up of Cyplex.  Further clinical studies await the
conclusion of the manufacturing optimization studies.

Treatment of Thrombocytopenia

     If blood platelet levels become too low (severe thrombocytopenia), the
hemostasis system begins to deteriorate.  Left untreated, thrombocytopenia can
lead to spontaneous bruising and bleeding and may progress to shock, circulatory
collapse, and death.  Thrombocytopenia is a common side effect of the chemo- and
radiation therapies used to treat cancer and can also be caused by liver disease
or by major blood loss from traumatic injuries. Platelet dysfunction that is
similar in consequence to thrombocytopenia is caused by prolonged exposure to
some medical devices, such as heart-lung bypass machines used in open-heart
surgery.

     Thrombocytopenia is currently treated with transfusion of human platelets.
In 1992, sales of platelets to hospitals for this purpose were about $1.3
billion worldwide, including approximately $550 million in the United States.
The Company estimates that associated costs with platelet transfusions,
including filters, HLA cross matching and donor recruitment add another
approximately $200 million in the United States.  Platelet usage in the U.S.
grew at an average annual rate of about 5% to 7% since 1987, and the Company
expects this growth to continue for at least the next several years.  Cyplex has
the potential to replace a major percentage of platelet transfusions for
thrombocytopenia.

     Platelet transfusion is generally an effective therapy, but it has a number
of significant drawbacks. Based on the Phase IIb clinical trial conducted in
1996 to 1998, we believe Cyplex's characteristics will allow it to overcome a
majority of the disadvantages of platelet transfusion, as summarized in the
table below:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
Human Platelets                               Cyplex(TM) Benefits                      Cyplex(TM) Economic Impact
-------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>                                      <C>
Can transmit viruses                  Viral Inactivation                       Increased safety, reduced liability and
                                                                               testing costs

Patients frequently become            Does not induce alloimmunization         Reduced hospitalization, no platelet
alloimmunized*                                                                 typing, improved outcomes

Platelets do not control bleeding     Cyplex(TM) controls bleeding in many     Reduced morbidity and mortality
in some patients                      of these patients

Shelf life of 3 to 5 days             Shelf life greater than one year         Reduced loss from out-dating, emergency
                                                                               availability, improved logistics and
                                                                               reduced infrastructure
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Alloimmunization is the process whereby the body develops antibodies to
platelets that cause later transfusions to be ineffective.

     In addition to safety and toxicity testing in animals and humans, in early
1996, the Company initiated a trial designed to study efficacy in patients with
low platelet counts during active bleeding episodes.  The Phase II trial showed
that Cyplex controlled or halted bleeding in 17 of 26 patients, a 65% response
rate.  Of the 26 patients, 12 had previously not responded to platelet
transfusions, the traditional therapy for uncontrolled bleeding.  In this
subgroup of refractory non-responders, Cyplex was effective in controlling or
halting bleeding in 7 out of 12 patients, or 58% of the time.

     In February 1998, the Company entered into a collaborative agreement with
The Central Laboratory of the Dutch Red Cross, a leading manufacturer and
supplier of blood derivatives, and an organization with a strong tradition of
research. The collaboration is on process development and scale-up of Cyplex.
The collaborative work is intended to accelerate commercialization of Cyplex,
reduce the manufacturing costs, improve the clinical characteristics and to
broaden its potential market beyond patients who are resistant to platelet
transfusions.

MARKETING AND SALES

     In April 1999, the Company and Fresenius launched the sale of the PROSORBA
column for the treatment of moderate to severe RA, this after receiving
clearance to market the PROSORBA column for RA from the FDA in March 1999.
The PROSORBA

                                       4
<PAGE>

column was previously approved by the FDA in 1987 for use in ITP, an immune
bleeding disorder.

     The Company entered into the agreement with Fresenius (see "Agreement with
Fresenius") in March 1999, in which Cypress and Fresenius agreed to jointly
market the PROSORBA column as a treatment for RA.   The Company has taken the
lead in marketing the PROSORBA column to rheumatologists in the U.S. who will
prescribe the PROSORBA column for RA treatment.  As of March 2000 the Company
currently has 19 sales and marketing employees whose primarily goal is marketing
the PROSORBA column for the RA.  Of this group 15 are sales representatives
directly calling on rheumatologists.  Since the PROSORBA column's launch for RA
in April 1999, RA sales have increased from quarter to quarter.  The Company is
concentrating its efforts on marketing the PROSORBA column for use in RA.
However, since the Company has not actively marketed the PROSORBA column for
treatment of ITP, and does not intend to do so in the future, sales for the
treatment of ITP have declined and may continue to do so in the future.

     Successful commercialization of a new medical product, such as the PROSORBA
column for the RA indication, depends on medical coverage and reimbursement by
public and private health insurers to health care providers for use of such
products.  Payers are increasingly challenging the price and cost effectiveness
of medical products and there are constant issues and questions related to
reimbursement of the treatments with the PROSORBA column.  The Company funds a
PROSORBA column reimbursement hotline.  Through the hotline the physician office
can obtain assistance with coverage and reimbursement inquiries, including
direct contact with third-party payers to resolve coverage and reimbursement
questions.

     The PROSORBA column treatment uses a therapeutic apheresis procedure when
administered to patients. The providers of therapeutic apheresis are limited,
and therefore availability of therapeutic apheresis to rheumatologists may also
be limited. As a result, a rheumatologist may not use the PROSORBA column on
patients which would consequently affect sales of the PROSORBA column.

     No customer represented more than 10% of the Company's annual sales during
the years ended 1999, 1998 and 1997, respectively.

PATENTS, TRADEMARKS AND PROPRIETARY TECHNOLOGY

     The Company believes that its success depends primarily on the experience,
capabilities, and skills of its personnel.  However, patents and other
proprietary rights are important and the Company seeks to protect its
intellectual property rights by a variety of means, including patents,
maintaining trade secrets and proprietary know-how, and technological innovation
to develop and maintain its competitive position.  Cypress actively seeks patent
protection both in the U.S. and internationally and has a portfolio of patents
and license rights related to the PROSORBA column and Cyplex.  There is no
assurance that the Company will be able to obtain additional patents either in
the United States or in foreign jurisdictions or that, any existing or future
patents will provide sufficient protection or be of commercial benefit to the
Company.  Insofar as the Company relies on trade secrets and unpatented
proprietary know-how, there is no assurance that others will not independently
develop similar technology or that secrecy will not be breached.  Finally, there
is no assurance that the Company will be able to develop further technological
innovations.

The PROSORBA Column

     The Company presently owns ten issued U.S. patents and two international
patents (excluding patents relating to the area of platelet therapeutics) which
expire during 2004 to 2015. The process used in manufacturing the PROSORBA
column is covered by several of these patents. Pursuant to the License and
Distribution Agreement, the Company has granted to Fresenius an exclusive
license under certain patents related to the PROSORBA column to manufacture, use
and distribute the PROSORBA column in the territory for use in the treatment of
ITP, RA and any other indications that may be cleared by the FDA. See "Company
Overview" and "Marketing and Sales". Certain patents cover the use of the
PROSORBA column in the treatment of ITP and RA. United States and international
applications are pending. The Company also owns the registered trademark
PROSORBA(R) in the U.S. and other jurisdictions. The Company expects that the
value of its trademark will increase with sales of the PROSORBA column for RA.
The Company intends to enforce its trademarks and brand names.

Cyplex(TM) (Infusible Platelet Membranes), A Platelet Alternative

     The Company presently owns seven issued U.S. patents and three pending U.S.
patent applications relating to the area of platelet therapeutics.  Certain
international patent applications corresponding to the issued U.S. patents have
been filed. To date, four foreign patents have been issued while others are
still pending in countries or jurisdictions outside the U.S.  These patents and
those that might be issued on the pending patent applications are scheduled to
expire during 2010 to 2015.

                                       5
<PAGE>

General

     Although patents are enforceable from the date of issuance and presumed to
be valid, future litigation or reexamination proceedings regarding the
enforcement of validity of the Company's existing patents or future patents, if
issued, could result in a ruling adverse to the Company that could invalidate
such patents or substantially reduced the scope of protection afforded by such
patents.  There can be no assurance that the Company's patents will afford
commercially significant protection of its proprietary technology or have
commercial application.  There has been no judicial determination of the
validity or scope of its proprietary rights.  Moreover, the patent laws in
foreign countries may differ from those of the United States, and the degree of
protection afforded by foreign patents may be different.

     Others have filed applications for, or have been issued, patents and may
obtain additional patents and other proprietary rights relating to products or
processes competitive with those of the Company.  The scope and validity of such
patents is presently unknown.  If existing or future patents are upheld as valid
by courts, the Company may be required to obtain licenses to use technology
covered by such patents.

     The Company has nonexclusive licenses to certain third-party patents
relating to the PROSORBA column for which the Company pays royalties based upon
the PROSORBA column sales.  These licenses have been sublicensed to Fresenius.

GOVERNMENT REGULATION

     The Company's research and development activities and the marketing of the
PROSORBA column by the Company are subject to regulation for safety and efficacy
by numerous governmental authorities in the United States and other countries.
In the United States, both biologics and medical devices are subject to rigorous
FDA regulation. The Federal Food, Drug and Cosmetic Act and the Public Health
Service Act govern the testing, manufacture, safety, efficacy, labeling,
storage, record keeping, clearance, advertising and promotion of the Company's
products. In addition to the FDA regulations, the Company is also subject to
other federal and state regulations such as the Occupational Safety and Health
Act and the Environmental Protection Act. Product development and clearance
within this regulatory framework takes a number of years and involves the
expenditure of substantial resources. In addition, there is no assurance that
this regulatory framework will not change or that additional regulation will not
arise at any stage of the Company's product development which may affect
clearance or delay of an application or require additional expenditures by the
Company.

     The Company's regulatory strategy is to pursue clinical development and
marketing clearance of its products worldwide.  The Company intends to seek
input from the FDA at each stage of the clinical process to facilitate
appropriate and timely clinical development, focusing on issues such as trial
design and clinical endpoints.  Where appropriate, the Company intends to pursue
available opportunities, to the extent available, for accelerated approval of
products.  A corporate partner may be helpful to accelerate international
development.  The time required for completing such testing and obtaining such
approvals is uncertain and approval itself may not be obtained.  In addition,
delays or rejections may be encountered based upon changes in FDA policy during
the period of product development and FDA regulatory review of each submitted
Premarket Approval Application, New Drug Application or Product License
Application. Similar delays may also be encountered in foreign countries. There
can be no assurance that even after such time and expenditures, regulatory
approval will be obtained for any products developed by the Company. Moreover,
if regulatory approval of a product is granted, such approval may entail
limitations on the indicated uses for which the product may be marketed.
Further, even if such regulatory approval is obtained, a marketed product, its
manufacturer and the facilities in which the product is manufactured are subject
to continual review and periodic inspections. Late discovery of previously
unknown problems with the product, manufacturer or facility may result in
restrictions on such product or manufacturer, including withdrawal of the
product from the market.

     Whether regulated by the FDA as a medical device, drug or biologic, or
otherwise by any state or foreign authorities, the clearance process for any of
the Company's products is expensive and time consuming and no assurance can be
given that any regulatory agency will grant its clearance.  There is no
assurance that the Company will have sufficient resources to complete the
required testing and regulatory review processes.  Furthermore, the Company is
unable to predict the extent of adverse governmental regulation, which might
arise from future United States, or foreign legislative or administrative
action.

The PROSORBA Column

     The PROSORBA column is regulated by the FDA as a Class III medical device.
The regulatory clearance of a Class III medical device in the United States
intended for therapeutic use in humans involves many steps including pre-
clinical and clinical testing.  Pre-clinical evaluation of a Class III device
includes testing to demonstrate that in clinical studies with human

                                       6
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subjects the product would not present an unreasonable hazard. Pre-clinical and
clinical evaluation of the PROSORBA column was conducted as part of the
clearance process for treatment of patients with ITP.

     Although the Company has no current plans to do so, for each additional
disease that the Company wants to treat with the PROSORBA column, clinical
testing must be conducted. Before such clinical testing can begin, an
Investigational Device Exemption application must be prepared and filed with the
FDA. This application consists of (i) information on the composition of the
product, (ii) manufacturing data, (iii) results of all pre-clinical safety and
effectiveness studies, and (iv) a design of the study and protocol.

     The clinical testing of a device may consist of a preliminary feasibility
study leading to a larger study of safety and effectiveness, or it may consist
of only the larger safety and effectiveness study. Upon completion of the study
and compilation of the data, a PMA application can be filed. The FDA is required
to respond to the PMA submission within 180 days, although the FDA may not and
often does not adhere to this schedule and further review may take additional
time. After the FDA completes its review of the PMA application, the clinical
study data may be reviewed by an advisory panel of medical experts who are not
part of the FDA. The applicant is required to answer questions posed by this
panel. Based upon its review of the data, the advisory panel may make a
recommendation of approval or nonapproval to the FDA. The FDA usually follows
the recommendation of the panel but is not required to. Assuming the advisory
panel recommends approval of the PMA, the FDA may approve the application and
the product may then be commercially distributed. The FDA approval process is
lengthy and expensive and there can be no assurance that FDA approval will be
received for any particular product on a timely basis, if at all. The
manufacture and distribution of medical devices are subject to continuing FDA
regulation. In addition to the requirement that the device be marketed only for
its approved uses, applicable law requires compliance with the FDA's Good
Manufacturing Practices ("GMP") regulations. Failure to comply with the GMP
regulations or with other applicable legal requirements can lead to federal
seizure of violating products, injunctive actions brought by the federal
government, and potential criminal liability on the part of the Company and of
the officers and employees of the Company who are responsible for the activities
that lead to the violations.

     Although the Company has received marketing clearance from the FDA for the
treatment of ITP and RA with the PROSORBA column, there is no assurance that any
marketing clearance for other diseases or products will be granted on a timely
basis, or at all, or that it will be economically feasible to commercialize the
PROSORBA column for these other diseases. The FDA may also require post-
marketing testing and surveillance programs to monitor the effectiveness and
safety of the Company's products. As a condition to the clearance of the PMA for
the treatment of moderate to severe RA, the FDA has required and the Company has
agreed to perform a post-approval clinical trial to determine the safety and
effectiveness of a combination treatment of RA with the PROSORBA column and
methotrexate, a DMARD. A second objective of this study is to assess the
efficacy of retreatment with the column.

     In addition to the mandatory post-approval clinical trial, the Company, may
elect to conduct additional trials on the use of the PROSORBA column following
the failure of other RA drugs or treatments in order to enhance marketability of
the PROSORBA column. While the Company expects that the clinical trial data will
enhance marketability of the PROSORBA column, the results of clinical trials are
unpredictable and could adversely affect FDA approval of the PROSORBA column,
product labeling, potential sales of the PROSORBA column and/or cause the FDA to
withdraw its marketing clearance and thereby adversely affect the financial
results, financial condition and prospects of the Company.

     The PROSORBA column is commercially distributed for use in the treatment of
ITP under a PMA that was approved by the FDA in 1987 and for the treatment of
moderate to severe RA under a PMA that was approved by the FDA in March 1999.
Changes to the product and its manufacturing process, and certain types of
labeling changes must be approved by the FDA prior to implementation.  The
Company completed and received approval for a supplement to the PMA in
connection with the treatment of ITP with the FDA for the consolidation of its
manufacturing facilities into one site in April 1997.  There can be no assurance
that any future supplements will be approved by the FDA in a timely manner.

     Fresenius is responsible for obtaining CE approval for the PROSORBA column
in Europe and obtaining any other registrations or regulatory approvals in the
territory outside the United States. Fresenius obtained the European CE approval
in February 2000.

Cyplex(TM) (Infusible Platelet Membranes), A Platelet Alternative

     Cyplex(TM) is regulated by the FDA as a biologic. The steps required before
a biologic may be marketed in the U.S. include (i) preclinical laboratory and
animal tests, (ii) the submission to the FDA of an application for an
Investigational New Drug Application ("IND"), which must become effective before
human clinical trials may commence in the U.S., (iii) adequate

                                       7
<PAGE>

and well-controlled human clinical trials to establish the safety and efficacy
of the biologic, (iv) the submission of a Product License Application ("PLA") to
the FDA and (v) the FDA approval of the PLA prior to any commercial sale or
shipment of the biologic. In addition to obtaining FDA approval for each
product, each domestic biologic manufacturing establishment must be registered
with, and approved by, the FDA. This establishment clearance process has now
been combined with the PLA process.

     Preclinical tests include laboratory evaluation of product chemistry and
animal studies to assess the safety and efficacy of the product and its
formulation. The results of the preclinical tests are submitted to the FDA as
part of an IND, and unless the FDA objects, the IND will become effective 30
days following its receipt by the FDA.

     Clinical trials involve the administration of the biologic to healthy
volunteers ("Phase I"), or to patients identified as ones with the condition for
which the biologic is being tested ("Phase II & III"), under the supervision of
a qualified principal investigator. Clinical trials are conducted in accordance
with 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
is submitted to the FDA as part of the IND. Each clinical study is conducted
under the auspices of an independent Institutional Review Board ("IRB") at the
institution at which the study will be conducted. The IRB will consider, among
other things, ethical factors, the safety of human subjects and the possible
liability of the institution.

     Clinical trials are typically conducted in three sequential phases, but the
phases may overlap. In Phase I, the initial introduction of the biologic into
healthy human subjects, the product is tested for safety (adverse effects),
dosage tolerance, metabolism, distribution, excretion and clinical pharmacology.
Phase II involves studies in a limited patient population to (i) determine the
efficacy of the drug for specific targeted indications, (ii) determine dosage
tolerance and optimal dosage and (iii) 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 further for safety
within an expanded patient population at multiple clinical study sites. The FDA
reviews both the clinical plans and the results of the trials and may
discontinue the trials at any time if there are significant safety issues.

     The results of the preclinical tests and clinical trials are submitted to
the FDA in the form of a NDA or PLA for marketing approval. The testing and
approval process is likely to require substantial time and effort and there can
be no assurance that any approval will be granted on a timely basis, if at all.
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. Additional animal studies or clinical
trials may be requested during the FDA review period and may delay marketing
approval. After FDA approval for the initial indications, further clinical
trials may be necessary to gain approval for the use of the product for
additional indications. The FDA mandates that adverse effects be reported to the
FDA and may also require post-marketing testing to monitor for adverse effects,
which can involve significant expense.

     Among the conditions for NDA or PLA approval is the requirement that the
prospective manufacturer's quality control and manufacturing facilities are
subject to biennial FDA inspections and foreign manufacturing facilities are
subject to periodic FDA inspections or inspections by the foreign regulatory
authorities with reciprocal inspection agreements with the FDA. The Prescription
Drug Act of 1992 requires companies engaged in pharmaceutical development, such
as the Company, to pay user fees in the amount of at least $100,000 upon
submission of a PLA.

     For marketing outside the United States, the Company also is subject to
foreign regulatory requirements governing human clinical trials and marketing
approval for drugs. The requirements governing the conduct of clinical trials,
product licensing, pricing and reimbursement vary widely from country to
country.

COMPETITION

The PROSORBA Column

     The PROSORBA column competes with conventional methods of treatment for RA
which generally consist of drug therapies which have been accepted by the
medical community as classical treatment methods. In addition, the PROSORBA
column competes with new therapies including

                                   8
<PAGE>

leflunomide (a small molecule new drug available as of fall 1998), and two new
biological drugs designed to block the immune system modulator Tumor Necrosis
Factor-alpha etanercept (available as of fall 1998) and infliximab (available as
of fall 1999). These drugs have all impacted the rate of the PROSORBA column use
by rheumatologists. This impact is attributable to familiarity doctors have with
drugs as compared to therapeutic devices such as the PROSORBA column and the
breadth and depth of clinical information available on them which is relatively
more than the clinical information available on the PROSORBA column.
Consequently, doctors tend to place the new therapies ahead of the PROSORBA
column in the treatment paradigm. Patients who do not experience a positive
clinical response to the new drug therapies, or who are not appropriate for
these drugs, are patients the Company believes should be treated with the
PROSORBA column.

     Many of the Company's current and potential competitors have significantly
greater resources than the Company. The PROSORBA column represents a different
approach to the treatment of immune-related diseases inasmuch as the PROSORBA
column focuses on the removal of circulating immune complexes that are
suppressive to the body's immune system. The Company is aware of a select number
of other companies which are known to be pursuing approaches to disease
treatment similar to the Company's methodology. In addition, it is always
possible that established companies and research institutions with greater
resources may develop other treatment methods for both ITP and RA.

     The Company believes that its success will depend primarily on, among other
things, the market acceptance of its therapeutic approach, its scientific
expertise, the PROSORBA column's performance measured against competing
products, adequate funding, the outcome of mandatory post approval clinical
trials, and on its ability to develop, protect, and market products in the
future. The Company's competitive success will also depend on its continued
ability to attract and retain skilled and experienced personnel, to develop and
secure the rights to advanced proprietary technology, and to commercially
exploit its technology prior to the development of competitive products by
others.

Cyplex(TM) (Infusible Platelet Membranes), A Platelet Alternative

     When and if the Company receives FDA clearance for Cyplex, it will
initially be launched for the control of bleeding in patients who are non-
responsive to platelet transfusions. There are currently no competing therapies
for such platelet-refractory patients. With respect to the remaining platelet
market, Cyplex's additional advantages over traditional platelet therapy support
its usage. These additional advantages include virus inactivation, denaturing or
destruction of surface antigens, and extended shelf life.   Products in
development are attempting to provide one or more of these same advantages;
however, none seem to provide all four advantages over traditional platelet
therapy. There is no assurance, however, that other parties will not develop
competing therapies.

MANUFACTURING AND SUPPLY

     In April 1999 Fresenius exercised its option to acquire from Cypress the
PROSORBA column manufacturing facility and related assets, located in Redmond,
Washington.  The option was a part of the partnering arrangement, which was
completed in March 1999.  Fresenius has contractually agreed to provide an
adequate supply of the PROSORBA column to meet the market demand.  In the event
Fresenius elects to discontinue the production of the PROSORBA column, Fresenius
is required to provide Cypress with the PROSORBA column for up to three years
from the date of Fresenius' notification to Cypress that it intends to
discontinue production of the PROSORBA column.  In the event that the license
agreement between the Company and Fresenius has been terminated for any reason,
other than if Fresenius terminates because of material breach by the Company,
Fresenius has agreed to continue to supply the Company with the PROSORBA column
until the Company has built or acquired a replacement manufacturing facility and
obtained all regulatory clearance necessary in order to manufacture the PROSORBA
column.  If Fresenius elects to discontinue its production of the PROSORBA
column, there is no assurance Fresenius will provide the contractual three years
of continued supply or that the Company would be able to resume manufacturing of
the PROSORBA column in a timely manner.

     The Company believes that raw materials and other components are available
in sufficient quantities to meet production requirements for the PROSORBA column
by Fresenius.

     Currently the Company does not have a facility to manufacture Cyplex,
however the Company is working to improve the Cyplex manufacturing process by
investing in process development with third parties.  The Company may have to
rely on contract manufacturing or purchase or build a new manufacturing facility
in the future to meet its Cyplex supply needs.  There is no assurance that the
Company will resume the production of Cyplex on a timely basis.

                                       9
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EMPLOYEES

     The Company believes it has good relationships with its employees, and none
of its employees are covered by a collective bargaining agreement. As of March
2000, the Company employed approximately 34 full-time employees, including 19
employed in sales and marketing, 6 employed in research and development, and 9
employed as administrative and support staff.

     Each of the Company's employees has entered into a confidentiality
agreement that contains terms requiring disclosure of ideas, developments,
discoveries or inventions conceived during employment, and assignment to the
Company all proprietary rights to these matters.

     The Company's ability to maintain its competitive position will depend, in
part, upon ability to attract and keep qualified scientific and managerial
people, and certain key employees. Competition for these people is intense, and
there is no assurance that the Company will be successful in attracting and
retaining these people.

                                       10
<PAGE>

                                 RISK FACTORS


If Our Sales Of The PROSORBA Column For The Rheumatoid Arthritis Indication Do
Not Increase We May Never Become Profitable

     Together with Fresenius, in April 1999 we launched sale of the PROSORBA
column for the treatment of RA. Pursuant to our agreement with Fresenius, we
have incurred significant sales and marketing expenses and have assumed most of
the risk associated with the market launch and ongoing sales and marketing
activity of the PROSORBA column in the United States. As of March 2000, we had
19 sales and marketing employees whose primarily goal is to market the PROSORBA
column for the RA indication. Of this group 15 are sales representatives
directly calling on rhematologists. The Company's marketing strategy depends, in
part, on gaining medical association support and commitment from leading opinion
leaders in the rheumatology community. Recently, other companies have obtained
FDA clearance of new drugs for the treatment of RA, adding to competition.
Products such as leflunomide (a small molecule new drug available as of fall
1998) and two new biological drugs designed to block immune system modulator
Tumor Necrosis Factor-alpha, etanercept (available as of fall 1998) and
infliximab (available as of fall 1999) have all impacted the rate of PROSORBA
column adoption by rheumatologists. Some of these companies have extensive and
well-funded marketing and sales operations. We are dependant in part on our
marketing partner, Fresenius, and to date, our sales of the PROSORBA column have
not increased at the rate we had expected. Sales of the PROSORBA column will
depend upon, among other things, our continued relationship with Fresenius,
acceptance of the PROSORBA column by leading rheumatologists and medical groups,
availability and convenience of treatment centers, availability of insurance
reimbursement, and competition. The PROSORBA column is our only FDA cleared
product and we cannot assure you that sales of the PROSORBA column will enable
us to become a profitable company in the future. There can be no assurance that
our sales and marketing organization will continue to grow sales and gain
acceptance of the PROSORBA column. Any such failure to successfully market the
PROSORBA column for RA could prevent us from becoming profitable.

The Availability of Therapeutic Apheresis is Limited and May Affect the Sales of
the PROSORBA column.

     The PROSORBA column treatment uses a therapeutic apheresis procedure when
administered to patients. The providers of therapeutic apheresis are limited,
and therefore availability of therapeutic apheresis to rheumatologists may also
be limited. As a result, a rheumatologist may not use the PROSORBA column on
patients which would consequently affect sales of the PROSORBA column.

If We Cannot Maintain Our Current Corporate Collaboration With Fresenius, We May
Never Achieve Profitability

     We rely to a significant extent on our collaboration with Fresenius.
Fresenius has an exclusive license to market and distribute the PROSORBA column
in the U.S., Europe and Latin American and, subject to certain conditions, Japan
and select Asian countries. The agreement specifies that the parties will co-
market the PROSORBA column in the U.S. and includes a profit sharing component
and upon the achievement of certain net sales of the PROSORBA column, we may
receive license payments. Therefore, we expect a substantial portion of our
future revenue to be provided as a result of our collaboration with Fresenius.
In addition, Fresenius manufactures the PROSORBA column. Therefore, we rely on
Fresenius to supply the PROSORBA column. If Fresenius were to breach or
terminate its agreement with us or otherwise fail to continue to manufacture the
PROSORBA column, our greatest revenue source would disappear. In addition, if
Fresenius failed to continue to produce the PROSORBA column, we would be forced
to build a replacement manufacturing facility capable of manufacturing the
PROSORBA column and obtain all regulatory clearances necessary to manufacture
the PROSORBA column. We may not have available cash to secure or build a
replacement facility and may be forced to cease our business operations.

     In addition, it is possible that Fresenius' objectives may not conform to
our business objectives and it could cause them to pursue alternative
technologies or potential products instead of ours.  If conflicts arise between
us and Fresenius, Fresenius may act in its self-interest and not in our
interest.  In any dispute, Fresenius has substantially greater resources with
which to assert its rights and greater bargaining power than we have.

We May Not Be Able to Maintain Insurance Coverage For The PROSORBA Column

     Successful commercialization of the PROSORBA column for the RA indication
depends on medical coverage and reimbursement by public and private health
insurers to health care providers for use of such products.  Payers are
increasingly challenging the price and cost effectiveness of medical products.

     Such coverage and reimbursement is not always available or may be time
intensive to obtain due to a variety of factors, many of which affect us in
marketing the PROSORBA column for RA. Generally, in the U.S. the cost of
treatment for ITP using the PROSORBA column has been reimbursed by third-party
payers. Private payers have been covering treatment for RA on a patient case
basis with prior authorization. Medicare has been covering treatment for RA
based on medical necessity at the local level. The Health Care Financing
Administration has initiated a National Coverage Determination

                                       11
<PAGE>

process to establish a medicare coverage policy at the national level. We cannot
assure you that public and private insurers will continue to agree to provide
coverage for the use of the PROSORBA column for the RA indication or the
apheresis treatment. There are no guarantees that a national coverage decision
will be positive or that current coverage status under Medicare will stay the
same. With respect to our relationship with Fresenius, we have the lead
responsibility in the U.S. for obtaining coverage for the PROSORBA column. We
expect that it may take several years to gain uniform favorable coverage status
from managed care and other private third-party payers. The ability to maintain
coverage and reimbursement for RA may also depend on the data from the mandatory
post approval clinical trials. Third-party payer coverage for the treatment of
any other disease indications approved by the FDA will need to be negotiated in
the future and there is no guarantee that coverage of existing indications will
not impact payer decisions. In addition, we do not know whether health care
providers will reimburse us for the use of Cyplex(TM), platelet alternative.

We are In A Competitive Industry And Our Competitors May Develop Products That
Are More Effective Than The PROSORBA Column, Which Would Reduce Our Commercial
Opportunity

     The health care field in general and the RA indication area in which we
market the PROSORBA column is extremely competitive. We compete with other
products, therapeutic techniques and treatments offered by national and
international healthcare and pharmaceutical companies, many of which have
greater marketing, human and financial resources than we do. Recently, other
companies have obtained FDA clearance of new drugs for the treatment of RA,
adding to competition. Some of these companies have extensive and well-funded
marketing and sales operations. The immunological therapy market is
characterized by rapid technological change and potential introductions of new
products or therapies. To respond to these changes, we may be required to
develop or purchase new products to protect our technology from obsolescence or
discover new applications for our existing products. Further, we may develop,
acquire or in-license other products, not directly related to our core
technologies, in order to expand our presence in the market, expand our product
pipeline, and achieve higher levels of revenue. We may not be able to obtain or
develop such products. Even if we obtain or develop new products, such products
may not be commercially viable. In addition, we cannot assure you that
Cyplex(TM), platelet alternative, if cleared for sale by the FDA, will be an
accepted in the marketplace as an effective alternative to traditional platelet
therapy. If the PROSORBA column fails to be accepted in the marketplace for the
treatment of RA or if Cyplex(TM), platelet alternative, fails to be an effective
alternative to traditional platelet therapy, our entire business will be
materially adversely affected.

We May Need Additional Capital For The Development Of New Products

     If we decide to continue the development of products, other than the
PROSORBA column, including Cyplex(TM), platelet alternative, we will be required
to raise additional capital. The amount of capital we will require is difficult
to predict, and it may not be possible to raise any additional capital from any
source.

We Have a History of Operating Losses And If They Continue We May Never Be
Profitable

     We have incurred substantial losses during our history. As of December 31,
1999, we had an accumulated deficit of approximately $87.8 million.  Our ability
to become profitable depends upon the success of our sales and marketing
organization in marketing the PROSORBA column for RA.  Under the profit sharing
arrangement with Fresenius we expect to continue to invest additional working
capital into sales and marketing during the next twelve months.  Profitability
will also be affected by our expenditures related to the development of Cyplex
and FDA mandated phase IV trials for the PROSORBA column.

Our Mandatory Post Approval Clinical Trials May Not Be Successful And If They
Are Not, We May Be Required To Discontinue Marketing the PROSORBA Column

     As a condition to the FDA's clearance of the PROSORBA column for the
treatment of RA, we are obligated to conduct two mandatory post approval
clinical trials. The Company intends to begin enrollment related to these trials
during the year 2000, and we expect to require a significant number of clinical
trial patients.  It is estimated that it will take approximately 3 to 4 years to
complete the two studies (depending upon the number of patients and enrollment
rates). The mandatory post approval trials costs are shared with Fresenius
through the profit sharing arrangement, but will result in reduced profits for
both Fresenius and us. In addition, outcome of the mandatory post approval
trials could affect our FDA clearance of the PROSORBA column for the RA
indication, including changes to our product labeling, potential sales of the
PROSORBA column and/or withdrawal of FDA clearance.

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<PAGE>

Uncertainty Of Health Care Reform May Affect Third-Party Payers Decision To
Provide Insurance Coverage Which May Prevent Us From Becoming Profitable.

     There are widespread efforts to control health care costs in the U.S. and
worldwide. Various federal and state legislative initiatives regarding health
care reform and similar issues continue to be at the forefront of social and
political discussion. These trends may lead third-party payers to decline or
limit coverage and reimbursement for the PROSORBA column, which could negatively
impact the demand for, or pricing and profitability of, the PROSORBA column. We
believe that government and private efforts to contain or reduce health care
costs are likely to continue. If there is no insurance reimbursement for the use
of the PROSORBA column, our sales would likely decrease which could prevent us
from ever becoming profitable.

Our Ability to Compete May Decrease Or Be Eliminated If We Are Not Able To
Protect Our Proprietary Technology

     As a policy, we seek to protect our proprietary technology and inventions
which are used in the PROSORBA column and Cyplex(TM), platelet alternative,
through patents, trade secret law and other legal protections. However, the
patent positions of pharmaceutical and biotechnology companies can be highly
uncertain and involve complex legal and factual questions. We may incur
significant expense in protecting our intellectual property and defending or
assessing claims with respect to intellectual property owned by others. Any
patent or other infringement litigation by or against us could result in
significant expense to us and diversion of our management resources. The process
used in manufacturing the PROSORBA column is covered by one of various patents
that we hold; however, we cannot assure you that this patent will afford
protection of our proprietary technology. We also could be forced to modify or
abandon the PROSORBA column or Cyplex(TM), platelet alternative, based upon our
assessment of intellectual property risks or actual or threatened claims by
others. Since the PROSORBA column is our only FDA cleared product, our entire
business may cease to exist if we are unable to sell that product.

     Others have filed applications for, or have been issued, patents and may
obtain additional patents and other proprietary rights competing with our
products or processes.  Although we do not presently know the scope and validity
of these patents, if existing or future patents are upheld as valid by courts,
we may be required to obtain licenses to use technology covered by these
patents.

We May Be Subject To Product Liability Claims That Could Cause Us To Incur
Liabilities Beyond Our Insurance Coverage

     The use of the PROSORBA column and, if developed and later cleared by the
FDA, Cyplex(TM), platelet alternative, may result in adverse side effects to the
end-users that could expose us to product liability claims. We currently hold
product liability insurance of $15 million, which we believe is adequate in
light of our business. However, we cannot predict all possible harms or side
effects that may result from treatment of patients with our products. Therefore,
we cannot assure you that the amount of coverage we currently hold will be
adequate to protect us. We also cannot assure you that we will have sufficient
resources to pay any liability resulting from such a claim beyond our insurance
coverage, especially in light our current availability of cash.

Our Contracted Researchers Use Hazardous Material Which Could Subject Us To
Significant Liabilities

     Our contracted research and development programs involve the controlled use
of biohazardous materials such as viruses, and may include the use of the HIV
virus that causes AIDS. The risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of such an
accident, we could be held liable for any damages that result, and any such
liability could exceed our resources.

We May Lose Our Net Operating Loss Carryforwards Which Could Prevent Us From
Offsetting Future Taxable Income

     Our sales of common stock in September 1991 and October 1997 caused the
limitation of Section 382 of the Internal Revenue Code of 1986, as amended, to
be applicable. This limitation will allow us to use only a portion of the net
operating loss carryforwards to offset future taxable income, if any, for
federal income tax purposes. Based upon the limitations of Section 382, we may
be allowed to use no more than a prescribed amount of such losses each year to
reduce taxable income, if any. To the extent not used by us, unused losses will
carry forward subject to the limitations to offset future taxable income, if

                                       13
<PAGE>

any, until such unused losses expire. All unused net operating losses will
expire 15 years after any year in which they were generated. The years in which
such expiration will take place range from 2000 to 2012.

Our Stock Price Will Likely Be Volatile Because Of The Industry We Are In

     The market prices of technology companies, particularly life science
companies, have been highly volatile and our stock price has been volatile.  Our
stock may be affected by this type of market volatility, as well as by our own
performance.  The following factors, among other risk factors, may have a
significant effect on the market price of our common stock:

     .    developments in our relationship with Fresenius, Medexus or any future
          corporate collaborators;
     .    announcements of technological innovations or new products by us or
          our competitors;
     .    developments in patent or other proprietary rights;
     .    fluctuations in our operating results;
     .    litigation initiated by or against us;
     .    future revenues from the PROSORBA column;
     .    developments in domestic and international governmental policy or
          regulation; and
     .    economic and other external factors or other disaster or crisis.

The Concentration Of Ownership Among Our Existing Officers, Directors And
Principal Stockholders May Prevent Other Stockholders From Influencing
Significant Corporate Decisions And Depress Our Stock Price

As of March 1, 2000, our executive officers, directors and stockholders with at
least 5% of our stock control approximately 23% of our outstanding common
stock. In addition, the President of Paramount Capital Investments, a 12.3%
stockholder, is a member of our board. If these officers, directors and
principal stockholders act together, they will be able to influence
significantly and possibly control matters requiring approval by our
stockholders, including approvals of amendments to our certificate of
incorporation, mergers, a sale of all or substantially all of our assets, going
private transactions and other fundamental transactions. They may also be able
to control the election of our board of directors members. This concentration of
ownership could depress our stock price.

Item 2.  PROPERTIES

     The Company currently occupies approximately 5,200 square feet of leased
office space in San Diego, California.  The San Diego facility houses the
Company's executive and administrative offices.  The lease for this facility
expires in 2001. In accordance with the San Diego facility lease, the Company
maintained a $35,000 certificate of deposit through August 1999, which was
classified as restricted cash on December 31, 1998.  In December 1999, the
Company signed a one year lease for a 2,800 square foot facility in Redmond,
Washington, to house the Company's research and medical personnel.

     During 1998 the Company leased a 6,900 square foot facility used primarily
for the manufacturing of the PROSORBA column.  In April of 1999, Fresenius
acquired the manufacturing facility and assumed the lease associated with the
facility.

Item 3.  LEGAL PROCEEDINGS

     The Company is not a party to any material legal proceedings.

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

     The information called for by this Item 4 was published in the Company's
Quarterly Report on Form 10-Q for the period ended September 30, 1999 and is
incorporated herein by reference.

                                       14
<PAGE>

                                    PART II

Item 5.  MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY
         HOLDER MATTERS

     The Company's common stock is traded on the over-the-counter market on the
NASDAQ SmallCap Market under the symbol "CYPB". Prior to May 21, 1996 the
Company's common stock was traded on the NASDAQ SmallCap Market under the symbol
"IMRE". Set forth below are the high and low closing sales prices for the
Company's common stock for the first quarter of 2000 (through March 1, 2000) and
each quarter of 1999 and 1998 as reported by the NASDAQ Stock Market, Inc.

<TABLE>
<CAPTION>
                                                                        Price Range of Common Stock
                                                         --------------------------------------------------------
                                                                      High                        Low
                                                         --------------------------------------------------------
<S>                                                      <C>                                      <C>
Year Ended December 31, 2000
   First Quarter (through March 1, 2000)                              $5.09                       $1.75

Year Ended December 31, 1999:
   First Quarter                                                      $3.93                       $2.75
   Second Quarter                                                      3.93                        3.09
   Third Quarter                                                       3.19                        2.44
   Fourth Quarter                                                      2.78                        1.63

Year Ended December 31, 1998
   First Quarter                                                      $3.81                       $1.28
   Second Quarter                                                      3.69                        2.56
   Third Quarter                                                       3.00                        1.44
   Fourth Quarter                                                      3.25                        2.19
</TABLE>

     The above quotations are inter-dealer prices, without retail mark-up, mark-
down or commission and may not necessarily represent actual transactions.  As of
March 1, 2000, there were approximately 5,706 holders of record of the common
stock of the Company.  The Company has never paid cash dividends on its common
stock and does not anticipate any being paid in the foreseeable future.

     On January 20, 1999 the outstanding Preferred Shares were automatically
converted into an equal number of shares of the Company's common stock.

                                       15
<PAGE>

Item 6.  SELECTED CONSOLIDATED FINANCIAL DATA

     The following table presents selected consolidated financial data of the
Company.  The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this report and the consolidated financial statements
and the related notes thereto included elsewhere herein.

<TABLE>
<CAPTION>
                                                                                    YEARS ENDED DECEMBER 31,
                                                      -------------------------------------------------------------------------
                                                           1999           1998          1997            1996          1995
                                                      -------------  -------------  -------------  -------------  -------------
<S>                                                   <C>            <C>            <C>            <C>            <C>
Consolidated Statement of Operations Data:
Results of Operations:
 Product sales                                         $   588,120   $  2,374,970   $ 2,970,342    $  1,967,976   $ 1,104,224
 Revenue from Fresenius agreement                        1,284,583              -             -               -     3,000,000
 Grant income                                                    -        308,470       325,316               -             -
                                                      -------------  -------------  -------------  -------------  -------------
                                                         1,872,703      2,683,440     3,295,658       1,967,976     4,104,224
Costs and expenses:
 Production costs                                          888,015      2,113,781     1,772,681       1,482,563     2,041,422
 Sales and marketing                                     5,937,463      2,378,443     1,292,942         794,356       819,907
 Research and development                                1,889,933      4,290,727     6,707,557       4,002,968     3,219,324
 General and administrative                              3,689,739      3,345,241     2,803,079       4,649,298     2,626,817
 Acquired in-process research
   and development (1)                                           -              -             -       5,146,943       625,000
 Restructuring expense                                           -              -             -         493,712       644,656
 Debt conversion expense                                         -              -             -         276,688     1,124,386
                                                      -------------  -------------  -------------  -------------  -------------
                                                        12,405,150     12,128,192    12,576,259      16,846,528    11,101,512
Other income (expense):
 Interest income                                           496,740        341,755       425,935         458,070       118,994
 Interest expense                                         (160,766)       (41,953)      (31,737)     (1,119,726)     (261,958)
 Gain on sale of assets                                  2,411,532              -             -               -             -
                                                      -------------  -------------  -------------  -------------  -------------
                                                         2,747,506        299,802       394,198        (661,656)     (142,964)

Net loss before imputed dividend on Preferred stock     (7,784,941)    (9,144,950)   (8,886,403)    (15,540,208)   (7,140,252)

Undeclared, imputed dividend on Preferred stock                  -     (2,078,431)            -               -             -

Net loss applicable to common Stockholders             $(7,784,941)  $(11,223,381)  $(8,886,403)   $(15,540,208)  $(7,140,252)
                                                      =============  =============  =============  =============  =============

Net loss per share applicable to common
 stockholders - basic and diluted                      $     (0.17)  $      (0.29)  $     (0.25)   $      (0.53)  $     (0.41)
                                                      =============  =============  =============  =============  =============

Weighted average number of
 Shares outstanding - basic and diluted                 45,043,962     39,234,741    35,236,579      29,206,470    17,598,735
                                                      =============  =============  =============  =============  =============
</TABLE>

<TABLE>
<CAPTION>
                                                                                      DECEMBER 31,
                                                    -------------------------------------------------------------------------
                                                         1999           1998           1997           1996           1995
                                                    -------------  -------------  -------------  -------------  -------------
<S>                                                 <C>            <C>            <C>            <C>            <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments   $11,569,966    $5,619,568     $ 8,515,653    $10,935,668    $1,009,878
Total assets                                        $12,831,472    $9,316,035     $11,788,766    $14,961,076    $4,563,709
Long-term debt (net of current portion)             $ 2,669,891    $  566,300     $   407,735    $ 412,020      $1,539,722
Total stockholders' equity (deficit)                $ 7,744,853    $6,844,571     $ 9,525,992    $12,134,565    $ (524,762)
Working capital (deficit)                           $10,074,546    $5,567,938     $ 7,916,228    $10,161,170    $ (688,771)
</TABLE>

(1)  Reflects the acquisition of in-process research and development associated
with the acquisition by the Company of PRP, Inc. in 1996 and the acquisition of
the minority interest in one of the Company's subsidiaries in 1995.

                                       16
<PAGE>

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

OVERVIEW

     Cypress Bioscience, Inc. (the "Company") markets the PROSORBA(R) column for
the treatment of types of rheumatoid arthritis ("RA") and idiopathic
thrombocytopenia purpura ("ITP"), which are types of immune disorders and is
engaged in the development of novel therapeutic agents for the treatment of
blood platelet disorders.  The PROSORBA column treats a patient's defective
immune system so that it can more effectively respond to certain diseases.  In
March 1999, the Food and Drug Administration ("FDA") granted Cypress marketing
clearance to distribute the PROSORBA column for the treatment of moderate to
severe RA.  The Company previously received marketing clearance from the FDA in
December 1987 to distribute the PROSORBA column for the treatment of ITP, an
immune-mediated bleeding disorder.

     In March 1999, the Company entered into a partnership with Fresenius
Aktiengesellschaft and Fresenius Hemotechnology, Inc. (collectively "Fresenius")
for the co-marketing and distribution of the PROSORBA column in the United
States and for the registration and distribution of the PROSORBA column in
Europe, Latin America and subject to certain conditions, Japan and select Asian
countries.

     In the U.S., Cypress and Fresenius jointly market the PROSORBA column.
Cypress and Fresenius share in clinical trials and sales and marketing expenses
in the U.S., subject to certain annual dollar limits. Fresenius will have
exclusive distribution rights and responsibility for clinical trials and
registration of the product overseas.  The profit sharing is 50/50 in the U.S.
for both the PROSORBA column and disposables sold by Fresenius for use with the
PROSORBA, and for any contract year that PROSORBA column sales excess $25
million in the U.S. the Company will receive 60% of the profits for such
contract year and Fresenius will receive 40%.

     Revenue from the Fresenius arrangement for the year end December 31, 1999
consisted of Cypress's pro rata share of sales by Fresenius.  Until profits are
generated, Cypress will recognize revenue based on the payments from Fresenius,
which are generally determined as the ratio of allowable expenses incurred for
production, research and development and sales and marketing by Cypress compared
to allowable expenses incurred by Cypress and Fresenius under the agreement.
Until April 1999, Cypress recorded total PROSORBA column sales. As such, current
year revenues are not directly comparable to revenues recorded in the prior
periods.

     In April 1999, Fresenius exercised its option to acquire the PROSORBA
column manufacturing facility and related assets, located in Redmond,
Washington, for $5.2 million.  In 1999, the Company reported a net loss of
approximately $7.8 million compared to $11.2 million in 1998 and $8.9 million in
1997.  During 1999, Cypress recognized a gain on the sale of assets of
approximately $2.4 million.  Excluding the effect of this gain the net loss
would have been $10.2 million for 1999.  During 1998 the Company recorded a non-
recurring imputed dividend of $2.1 million.  Excluding the effect of the imputed
dividend the loss would have been approximately $9.1 million.  Without
consideration to the non-recurring events in 1999 and 1998, the net loss in 1999
increased by approximately $1.1 million from 1998.  The increase is a direct
result of the sales and marketing expense related to the launch of the PROSORBA
column for the RA indication in April 1999 offset, in part, by a decrease in
research and development expenditures.

RESULTS OF OPERATIONS

Revenues

     Product sales by Cypress for the year ended December 31, 1999 totaled
approximately $588,000 compared to $2.4 million for the year ended December 31,
1998.  As of April 1999, the Company no longer records revenues from the sale of
the PROSORBA column.  Instead, Cypress recognizes revenue based on a pro rata
share of the net sales of the PROSORBA column by Fresenius. Accordingly,
revenues for the year ended December 31, 1999 are not directly comparable to
prior periods.

     Total sales of the PROSORBA column by both Cypress or Fresenius for the
year ended December 31, 1999 totaled $3.1 million compared to $2.4 million for
the same period in 1998. The increase in PROSORBA column sales was attributed to
the launch of the Product for use in RA, offset in part by a decline in sales
for use in the ITP indication.

                                       17
<PAGE>

     Cypress will recognize revenue based on payments due from Fresenius, which
are generally determined as the ratio of allowable expenses incurred for
production, research and development, and sales and marketing by Cypress,
compared to allowable expenses incurred by Cypress and Fresenius under the
agreement. Revenue from the Fresenius arrangement totaled approximately $1.3
million for the year ended December 31, 1999.

     During 1998, the Company had a government grant that generated revenues of
approximately $308,000 for the year. This grant expired at the end of 1998 and
was not renewed.

Operating Expenses

     Consolidated operating expenses for the years ended December 31, 1999,
1998, and 1997 were approximately $12.4 million, $12.1 million and $12.6
million, respectively.  The increase in operating expenses of approximately
$277,000 in 1999 from the same period of 1998 was due to a significant increase
in sales and marketing expenses as the Company began marketing the PROSORBA
column for RA.  This increase was partially offset by a significant decrease in
production costs due to Fresenius assuming the production responsibility and a
decrease in research and development expense.  The decrease of approximately
$500,000 in 1998 from 1997 reflects significant savings in research and
development expenses offset by increased sales and marketing, and general and
administrative expenses.

Production Costs

     Production costs were approximately $888,000, $2.1 million and $1.8 million
for the years ended December 31, 1999, 1998 and 1997, respectively.  In April
1999, Fresenius purchased the PROSORBA column manufacturing facility and related
assets from Cypress.  Therefore, since May 1999, production costs represent
royalties incurred by the Company for PROSORBA column sales payable to third
parties.  The decrease in production costs of approximately $1.2 million for the
year ended December 31, 1999 compared to the same period in 1998 reflects
Fresenius taking over responsibility for manufacturing.

Sales and Marketing

     Sales and marketing costs were approximately $5.9 million, $2.4 million and
$1.3 million for the years ended December 31, 1999, 1998 and 1997, respectively.
The increases in sales and marketing expenses of approximately $3.5 million for
1999 compared to 1998, primarily resulted from the hiring of a sales force and
other activities associated with the launch of the PROSORBA column for the
treatment of RA in April 1999.   In the U.S., Cypress and Fresenius jointly
market the PROSORBA column.  Under the agreement, the Company and Fresenius may
recover a portion of their respective sales and marketing expenses.  The amount
recovered is a function of total PROSORBA column sales.  The increase of
approximately $1.1 million in 1998 from 1997 is a result of the Company hiring
three management level marketing personnel, recruiting efforts to hire
additional sales personnel and pre-market launch activities.

Research and Development

     Research and development expenses were approximately $1.9 million, $4.3
million and $6.7 million in 1999, 1998 and 1997, respectively.  The decrease of
$2.4 million in 1999 from 1998 was primarily attributable to the costs incurred
in 1998 related to the FDA application process for use of the PROSORBA column in
RA.  In addition, expenses associated with the development of Cyplex decreased
with the closing of a facility in Boston in June 1998.

     The Company expects to incur significant ongoing research and development
expenses in connection with mandatory post approval clinical trials for the
treatment of RA using the PROSORBA column. Cypress and Fresenius will share in
the expenses of these mandatory trials. The decrease of approximately $2.4
million in 1998 from 1997 was due to the cessation of the Phase III pivotal
trial in January 1998. Research and development expenses typically increase with
each phase of a product's development as such product advances to FDA approval.
The Company records research and development costs as incurred, including the
costs associated with its clinical trials. The Company enrolls patients in
various clinical trial sites and records the related cost as the work is
performed by the respective research entities. The Company accrues costs related
to clinical trials until such costs are actually paid.

General and Administrative

     General and administrative expenses were approximately $3.7 million, $3.3
million, and $2.8 million for the years ended December 31, 1999, 1998 and 1997,
respectively. The increase of approximately $344,000 in 1999 from 1998 was

                                       18
<PAGE>

primarily the result of business development activities with Fresenius in the
first quarter of 1999.  The increase of approximately $542,000 in 1998 from 1997
is the result of business development efforts such as hiring a Director of
Business Development and increased travel for management.

Interest Income

     Interest income was approximately $497,000, $342,000 and $426,000 for the
years ended December 31, 1999, 1998 and 1997, respectively.  The interest income
increase of approximately $155,000 in 1999 from the comparable period in 1998
was the result of higher cash and cash equivalent balances due to the execution
of the Fresenius agreement, exercise of warrants due to the call for redemption
of outstanding warrants which resulted in proceeds to the Company of
approximately $5.2 million, and proceeds of $3.0 million from a line of credit.
The decrease in interest income of approximately $84,000 in 1998, from the
comparable period in 1997, was a result of a decrease in average cash and cash
equivalents due to cash used in operations during 1998.

Interest Expense

     Interest expense was approximately $161,000, $42,000, and $32,000 for the
years ended December 31, 1999, 1998 and 1997, respectively.  The increase in
interest expense of approximately $119,000 in 1999, when compared to 1998, was
due to the $3.0 million in proceeds received by the Company in 1999 on a line of
credit.  The increase of approximately $10,000 in 1998 from 1997 is related to
activity on the Company's capital leases.

Gain on Sale of Assets

     In March 1999, Fresenius exercised their option to purchase the PROSORBA
manufacturing facility from the Company. The option price for the Company's
manufacturing facility, related assets and product inventory was approximately
$5.2 million. After final adjustments related to the sales price of the facility
were determined in the fourth quarter of 1999, a total gain of approximately
$2.5 million was recognized.

Net Loss

     Net loss applicable to common stockholders was approximately $7.8 million,
$11.2 million and $8.9 million for the years ended December 31, 1999, 1998 and
1997, respectively.  The decrease of $3.4 million from 1998 to 1999 was
primarily attributable to the net gain of $2.4 million from the sale of assets
in 1999 and the one time non-recurring, and undeclared imputed dividend charge
of approximately $2.1 million in 1998. Without consideration to the non-
recurring events in 1999 and 1998, the net loss in 1999 increased by
approximately $1.1 million from 1998. The increase is a direct result of the
increase expenses for the Company's sales force and other activities associated
with the launch of the PROSORBA column for RA indication in April 1999 offset,
in part, by a decrease in research and development expenditures. The increase of
approximately $2.3 million in 1998 from 1997 is primarily the result of the one
time, non-recurring and undeclared imputed dividend charge which amounted to
approximately $2.1 million in 1998.

LIQUIDITY AND CAPITAL RESOURCES

     The Company's principal sources of liquidity are its cash and cash
equivalents.  The Company's cash and cash equivalents totaled $11.6 million and
$5.6 million at December 31, 1999 and 1998, respectively. The increase in cash,
cash equivalents and short-term investments of approximately $6.0 million was
primarily due to cash received through investing and financing activities in the
amount of $15.9 million.  This amount was offset by $9.9 million used
in operating activities, resulting in a net cash increase of $6.0 million for
the year ended 1999. Working capital at December 31, 1999 was approximately
$10.1 million.

     The Company believes its cash balance on December 31, 1999, together with
the revenues that will be received from the Fresenius agreement, are sufficient
to fund operations through the year 2000. To the extent the Company decides to
develop and/or acquire products other than the PROSORBA column, including
Cyplex(TM), it will be required to raise additional capital. The amount of
capital required by the Company is dependent upon many factors, including the
following: the Company's ability to successfully market the PROSORBA column for
the RA indication, results of and the costs associated with the mandatory post
approval clinical trials, results of current research and development efforts,
the FDA regulatory


                                       19
<PAGE>


process, costs of commercialization of products and potential competitive and
technological advances and levels of product sales. Because the Company is
unable to predict the outcome of the foregoing factors, some of which are beyond
the Company's control, the Company is unable to estimate with certainty its mid
to long-term capital needs. Although the Company may seek to raise additional
capital through a combination of additional equity sources, there is no
assurance the Company will be able to raise additional capital through such
sources or the funds raised thereby will allow the Company to maintain its
current and planned operations. If the Company is unable to obtain additional
capital, it will be required to delay, scale back or eliminate some or all of
its planned research and development activities related to additional product
opportunities.

IMPACT OF YEAR 2000

     In prior years, the Company discussed the nature and progress of its plans
to become Year 2000 ready. In late 1999, the Company completed its remediation
and testing of systems. As a result of those planning and implementation
efforts, the Company experienced no significant disruptions in mission critical
information technology and non-information technology systems and believes those
systems successfully responded to the Year 2000 date change. The Company
expensed approximately $22,000 in connection with remediating its systems. The
Company is not aware of any material problems resulting from Year 2000 issues,
either with its internal systems or the products and services of third parties.
The Company will continue to monitor its mission critical computer applications
and those of its suppliers and vendors throughout the year 2000 to ensure that
any latent Year 2000 matters that may arise are addressed promptly.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     The Company invests its excess cash in U.S. government securities and money
market funds with strong credit ratings.  As a result, the Company's interest
income is most sensitive to changes in the general level of U.S. interest rates.
The Company does not use derivative financial instruments, derivative commodity
instruments or other market risk sensitive instruments, positions or
transactions in any material fashion. Accordingly, the Company believes that,
while the investment-grade securities it holds are subject to changes in the
financial standing of the issuer of such securities, the Company is not subject
to any material risks arising from changes in interest rates, foreign currency
exchange rates, commodity prices, equity prices or other market changes that
affect market risk sensitive instruments.

Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Refer to the Index on Page F-1 of the Financial Report included herein.

Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
         ACCOUNTING AND FINANCIAL DISCLOSURE

     None

                                       20
<PAGE>

                                   PART III

Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

     The executive officers and directors of the Company, the positions held by
them and their ages as of March 1, 2000 are as follows:

<TABLE>
<CAPTION>
NAME                                     AGE                                 POSITION
----------------------------           ------     ---------------------------------------------------------------
<S>                                    <C>        <C>
Jay D. Kranzler, M.D., Ph.D. (1)(2)       42      Chief Executive Officer, Chief Financial Officer and Chairman
                                                     of the Board of Directors

Carl F. Bobkoski                          47      President, Chief Operating Officer and Corporate Secretary

R. Michael Gendreau, M.D., Ph.D.          44      Executive Vice President, Research & Development, Chief Medical
                                                     Officer and Chief Scientific Officer

Jack H. Vaughn (3)(5)                     79      Director

Samuel D. Anderson (4)(5)                 64      Director

David W. Golde, M.D. (6)(7)               59      Director

Larry J. Kessel, M.D. (4)(5)(6)(7)        46      Director

Mark C. Rogers, M.D.(3)(6)(7)             57      Director
</TABLE>

(1) Member of the 401(k) Plan Committee
(2) Member of the Non-Executive Officer Stock Option Committee
(3) Member of Audit Committee
(4) Member of Stock Option Committee
(5) Member of Compensation Committee
(6) Member of Medical Affairs Committee
(7) Member of Mergers & Acquisitions Committee

     JAY D. KRANZLER, M.D., PH.D., was appointed Chief Executive Officer and
Vice-Chairman of the Company in December 1995.  In April 1996, Dr. Kranzler also
assumed the position of Chief Scientific Officer of the Company, and in November
1997, also assumed the position of Chief Financial Officer.  In April 1998, Dr.
Kranzler was appointed as Chairman of the Board.  From January 1989 until August
1995, Dr. Kranzler served as President, Chief Executive Officer and a director
of Cytel Corporation, a publicly held biotechnology company.  Dr. Kranzler has
been an adjunct member of the Research Institute of Scripps Clinic since January
1989.  Before joining Cytel, Dr. Kranzler was employed by McKinsey & Company, a
management-consulting firm, from 1985 to January 1989 as a consultant
specializing in the pharmaceutical industry.

     CARL F. BOBKOSKI was appointed President and Chief Operating Officer in
March 1999.  Prior to joining the Company, from May 1995 to February 1999, Mr.
Bobkoski served as Executive Vice President of Signal Pharmaceuticals, Inc., a
biopharmaceutical company.  From 1990 to 1995, Mr. Bobkoski was Executive Vice
President and a director at Gensia, Inc ("Gensia"), a biopharmaceutical company,
where he was responsible for directing all commercialization activities for
proprietary products, overseeing the operations of Gensia Laboratories, Ltd., a
wholly-owned subsidiary of Gensia, and supervising product development, finance,
management information systems and corporate development.

     R. MICHAEL GENDREAU, M.D., PH.D., was appointed Vice President of Research
and Development and Chief Medical Officer of the Company in December 1996 and
was promoted to Executive Vice President of Research and Development and Chief
Scientific Officer in February 1999. Dr. Gendreau joined the Company in 1994 and
held various positions from 1994 through 1996, including Executive Director of
Scientific Affairs. From 1991 to 1994, Dr. Gendreau was Vice President of
Research and Development and Chief Medical Officer for MicroProbe Corporation, a
developer and manufacturer of DNA probe-based diagnostic equipment.

                                       21
<PAGE>

     JACK H. VAUGHN has served as a director of the Company since 1991.
Currently, Mr. Vaughn is Chairman of ECOTRUST, a Portland, Oregon-based
foundation promoting environmentally friendly development in the Pacific
Northwest. From 1988 to 1992, he was the U.S. Government's Senior Environmental
Advisor for Central America. Prior to that, Mr. Vaughn had been the founding
Chairman of Conservation International, a private foundation encouraging
biological diversity. Mr. Vaughn was a director of Allegheny & Western Energy
Corporation from 1981 through 1995 and was a member of its Compensation
Committee.

     SAMUEL D. ANDERSON was elected by the Board to serve as a director of the
Company in April 1998. Currently, Mr. Anderson is an independent consultant.
From 1990 to 1991, he was the President and Chief Executive Officer of Trancel
Corporation, a biotechnology company. From 1984 to 1989 Mr. Anderson was the
Chief Executive Officer of Alpha Therapeutics Corporation, a blood plasma
fractionator, and between 1989 and 1990 served as its Chairman of the Board. Mr.
Anderson is currently Chairman of the Board of Hyco, a publicly traded company,
and is also a Board member of publicly traded SeraCare.

     DAVID W. GOLDE, M.D., was elected by the Board to serve as a director of
the Company in April 1998.  Dr. Golde has been the Physician-in-Chief of
Memorial Sloan-Kettering Cancer Center since 1991.  He has been a Professor of
Medicine at Cornell University Medical College since 1991 and at UCLA School of
Medicine since 1979. Dr. Golde is also a director of Eron, Inc.  Dr. Golde is a
consultant to numerous medical and research institutions.

     MARK C. ROGERS, M.D., was elected by the Board to serve as a director of
the Company in October 1999. Currently, Dr. Rogers is the President of Paramount
Capital Investments, which is a company specializing in investments in the
pharmaceutical, medical and biotechnology industries. Dr. Rogers is also a
director of Genta Incorporated, a biopharmaceutical company. From 1992 to 1996
he served as the Vice Chancellor for Health Affairs at the Duke University
Medical Center. From 1990 to 1992 was an Associate Dean of the John's Hopkins
University. Dr. Rogers was also a founding member of ENTREMED, a biotechnology
company.

     LARRY J. KESSEL, M.D., was elected by the Board to serve as a director of
the Company in October 1999.  Currently, Dr. Kessel is in private practice in
internal and geriatric medicine, since 1985 he has served a medical director at
Integrated Health Services, a conglomerate involved in geriatric care.  He has
been a clinical instructor at Jefferson Medical College since 1984.  Dr. Kessel
holds a position on the Board of Directors of Genta, Inc. since September 1997.

     Each officer serves at the discretion of the Board of Directors.  The
Company's Bylaws permit the Board of Directors to establish by resolution the
authorized number of directors, and the Company currently has six directors
authorized.  Pursuant to the Fresenius agreement, the Company has agreed, if
Fresenius so requests, to increase the number of directors by one member and
to appoint a Fresenius designee to the new seat. The Company's Restated
Certificate of Incorporation and Bylaws provide that the Board of Directors
shall be divided into three classes, each class consisting, as nearly as
possible, of one-third of the total number of directors, with each class having
a three-year term. Each director holds office until the annual meeting of
stockholders of the Company which coincides with the end of such director's
three-year term and until such director's successors have been elected and duly
qualified. There are no family relationships among any of the directors or
officers of the Company.

BOARD COMMITTEES

     On January 20, 2000, the Board of Directors reorganized the composition of
the board committees due to the resignations of Richard M. Crooks and Philip J.
O'Reilly and the additions of Mark C. Rogers, M.D. and Larry Kessel, M.D.  The
Board of Directors has designated certain committees, including, but not limited
to an Audit Committee, Compensation Committee, Stock Option Committee which has
a Non-Executive Stock Option Committee, Medical Affairs Committee, and Mergers
and Acquisitions Committee.

     The Audit Committee meets with the Company's independent auditors at least
annually to review the results of the annual audit and discuss the financial
statements; recommends to the Board the independent auditors to be retained; and
receives and considers the auditors' comments (out of the presence of
management) as to controls, adequacy of staff and management performance and
procedures in connection with audit and financial controls.  The Audit Committee
is composed of two directors: Mr. Vaughn (Chairman) and Dr. Mark Rogers.

     The Compensation Committee makes recommendations based on management's
inputs concerning salaries and incentive compensation, awards stock options to
executives under the Company's stock option plans and otherwise determines

                                       22
<PAGE>

compensation levels and performs such other functions regarding compensation as
the Board may delegate.  The Compensation Committee is composed of three
directors: Messrs. Anderson (Chairman), Vaughn, and Dr. Kessel.

     The Stock Option Committee considers and recommends to the Board of
Directors the number and terms of stock options to be granted to officers and
employees of the Company.  The Stock Option Committee is composed of two
directors: Mr. Anderson and Dr. Kessel.  The Non-Executive Officer Stock Option
Committee was created by the Stock Option Committee in February 1996.  It has
the authority to grant certain numbers of options to employees who are not
executive officers of the Company; provided, however, that the number of options
granted to employee by the Non-Executive Officer Stock Option Committee is
limited to 200,000 each period between Board meetings.  The Non-Executive
Officer Stock Option Committee is comprised of one director: Dr. Kranzler.

     The Medical Affairs Committee reviews and recommends actions associated
with the Company's efforts on marketing the PROSORBA column to the medical
community.  The Committee provides guidance, and assists with the contact of
prominent doctors in the appropriate fields.  The Medical Affairs Committee is
composed of three directors: Drs. Rogers, Kessel and Golde.

     The Mergers and Acquisitions Committee reviews, researches and makes
recommendations on the Company's potential abilities to merger or acquire with
appropriate companies.  In addition, the Committee may make recommendations
related to the negotiations of a merger and/or acquisition, and perform due
diligence procedures on behalf of the Company.  The Mergers and Acquisitions
Committee is composed of three directors: Drs. Rogers, Kessel and Golde.

SCIENTIFIC ADVISORY BOARDS

     The Company has established four scientific advisory boards to provide
scientific and clinical support and guidance related to the Company's products.
The areas of focus of the scientific advisory boards are immunology,
rheumatology, hematology, and platelet therapy.

     The Immunology Advisory Board  (the "IAB") is currently composed of Gerald
T. Nepom (appointed July 1996), M.D., Ph.D., Scientific Director of the Virginia
Mason Research Center in Seattle, Washington; Eng Tan (appointed June 1996),
M.D., Director, W.M. Keck Autoimmune Disease Center, The Scripps Clinic and
Research Institute, San Diego, California; and Richard Lerner, M.D., President,
The Scripps Research Institute.  The focus of the IAB will be to provide
guidance to the extramural research investigating the PROSORBA column's
immunologic mechanism of action.

     The Rheumatology Advisory Board (the "RAB") is composed of David Felson
(appointed June 1996), M.D., M.P.H. Professor of Medicine and Public Health,
Director, Boston University Arthritis Health Services Center; Richard Panush
(appointed June 1996), M.D., Professor and Chairman, Department of Medicine, St.
Barnabas Medical Center, Livingston, New Jersey; George Ehrlich (appointed June
1996), M.D., University of Pennsylvania Medical School, Member, Expert Advisory
Panel on Chronic Degenerative Disease, World Health Organization; Sanford H.
Roth, M.D., Medical Director, Arizona Research and Education, Phoenix, Arizona;
Gary S. Firestein, M.D., University of California at San Diego, School of
Medicine, La Jolla, California; and Roy Fleischmann, M.D., Chief Executive
Officer, Rheumatology Research International, Dallas, Texas.  The RAB will
oversee and guide the Company's programs in RA.  The RAB members are all serving
as advisors to the FDA in the Drug Division which reviews New Drug Applications
for rheumatology pharmaceutical product.

     The Hematology Advisory Board (the "HAB") is composed of  David J. Kuter
(appointed June 1996), M.D., D.Phil., Chairman, Department of Hematology,
Massachusetts General Hospital.  The HAB will oversee and guide the Company's
programs in ITP.

     The Platelet Advisory Board (the "PAB") is composed of Richard H. Aster
(appointed November 1996), M.D., former President, Blood Center of Southeast
Wisconsin; and Scott N. Swisher (appointed November 1997), M.D., Chairman, FDA
Blood Products Advisory Committee; Professor of Medicine (emeritus), University
of Michigan.  The PAB will oversee the Company's programs as they relate to
platelet therapy.

     There are no material consulting or other agreements between the Company
and any member of the Company's various scientific advisory boards.

                                       23
<PAGE>

Item 11.  EXECUTIVE COMPENSATION

COMPENSATION OF DIRECTORS

     Each non-employee director of the Company is entitled to receive between
$12,000 and $24,000 per year for such person's service as a director.  Messrs.
O'Reilly and Vaughn each received $12,000 in cash compensation for service as a
director during fiscal year 1999.   Messrs. Golde and Anderson each received
$24,000 in cash compensation for service as a director during fiscal year 1999.
Mr. Kessel received $2,000 in cash compensation for service as a director during
fiscal year 1999.  In addition, Mr. Vaughn is entitled to receive an option to
purchase 10,000 shares of common stock of the Company upon each annual meeting
of such non-employee director to the Board. Messrs. Anderson, Golde, and Drs.
Kessel and Rogers received an option to purchase 100,000 shares of common stock
of the Company upon their initial election to the Board and are not entitled to
receive additional option grants upon any annual meeting.  Directors who are
employees of the Company do not receive any fee for their service as directors.
None of the Company's directors receive any fees for their service on any
committee of the Board.  All of the Company's directors are reimbursed for their
out-of-pocket travel and accommodation expenses incurred in connection with
their service as directors of the Company.

COMPENSATION OF EXECUTIVE OFFICERS

     The following table sets forth all compensation awarded or paid to and
earned by, the Chief Executive Officer of the Company during the fiscal years
ended December 31, 1999, 1998 and 1997 as well as those executive officers whose
salary and bonus were in excess of $100,000 for services rendered to the Company
during the years ended December 31, 1999, 1998 and 1997, and one former
executive officer who departed from the Company in March 1999 (collectively, the
"Named Executive Officers"):

                          SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                                Long-Term
                                                   Annual Compensation                       Compensation (1)
                                           ----------------------------------------------------------------------------
                                                                                      Shares               All Other
                                   Fiscal         Base                              Underlying            Compensation
  Name and Principal Position       Year        Salary($)        Bonus($)           Options(#)                ($)
-----------------------------------------------------------------------------------------------------------------------
<S>                               <C>        <C>              <C>              <C>                   <C>
Jay D. Kranzler, M.D., Ph.D.,          1999        $305,500         $150,000                     -              $12,800(2)
   Chief Executive Officer,            1998         277,000                -                     -               11,300(3)
    Chief Financial Officer and        1997         245,000          125,000               277,440               10,800(4)
    Chairman of the Board

Carl Bobkoski                          1999         189,500                -               500,000               15,250(5)
    President, Chief Operating         1998               -                -                     -                    -
    Officer and Corporate              1997               -                -                     -                    -
    Secretary

Debby Jo Blank, M.D.(6),               1999          94,600                -                     -                9,460(7)
   President, Chief Operating          1998         244,000                -                     -               52,000(8)
    Officer and Director               1997         215,500          101,500               101,415                9,500(9)

R. Michael Gendreau, M.D.              1999         191,500           75,000                     -               10,000(10)
   Executive Vice President,           1998         167,400                -               150,000               10,000(11)
    Research and Development,          1997         149,000              262                     -                4,472(12)
    Chief Medical Officer; and
    Chief Scientific Officer
</TABLE>

1.  The Company's 1996 Equity Incentive Plan (the "1996 Plan"), is intended to
    further the interests of the Company by providing for the grant of stock
    awards to directors, officers and employees of and consultants to the
    Company.
2.  Includes $2,800 paid by the Company on behalf of Dr. Kranzler for life
    insurance premiums during 1999, and $10,000 of contributions made by the
    Company under its 401(k) plan.
3.  Includes $1,300 paid by the Company on behalf of Dr. Kranzler for life
    insurance premiums during 1998, and $10,000 of contributions made by the
    Company under its 401(k) plan.

                                       24
<PAGE>

4.  Includes $1,300 paid by the Company on behalf of Dr. Kranzler for life
    insurance premiums during 1997, and $9,500 of contributions made by the
    Company under its 401(k) plan.
5.  Includes $5,250 paid by the Company on behalf of Mr. Bobkoski for long-term
    disability premiums during 1999, and $10,000 of contributions made by the
    Company under its 401(k) plan.
6.  Dr. Blank resigned from the Company effective March 1999.
7.  Represents $9,460 of contributions made by the Company under its 401(k) plan
    during 1999.
8.  Includes $42,000 paid to Dr. Blank for relocation costs associated with Dr.
    Blank's relocation to San Diego, California upon joining the Company. Also
    includes $10,000 of contributions made by the Company under its 401(k) plan.
9.  Represents $9,500 in contributions made by the Company under its 401(k)
    plan.
10. Represents $10,000 in contributions made by the Company under its 401(k)
    plan.
11. Represents $10,000 in contributions made by the Company under its 401(k)
    plan.
12. Represents $4,472 in contributions made by the Company under its 401(k)
    plan.

             STOCK OPTION GRANTS AND EXERCISES IN LAST FISCAL YEAR

     The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 1999 to the Named Executive
Officers:

<TABLE>
<CAPTION>
                                      Individual Grants
                          -------------------------------------------
                                          % of Total                               Potential Realizable
                                           Options                                   Value at Assumed
                             Shares       Granted to                               Annual Rates of Stock
                           Underlying    Employees in      Exercise                   Appreciation for
                             Options         Fiscal        Price Per   Expiration     Option Term($)(2)
                                                                                   ------------------------
         Name               Granted (#)    Year(%)(1)      Share($)       Date          5%          10%
------------------------- ------------- ---------------- ------------ ------------ ----------- ------------
Carl Bobkoski               500,000 (3)      36.4%           $2.75       2/17/09      864,730    2,191,396
<S>                       <C>           <C>              <C>          <C>          <C>         <C>
</TABLE>

1.  Based upon options to purchase a total of 1,373,000 shares of common stock
    of the Company granted during the fiscal year 1999.
2.  The potential realizable value is based upon the assumption that the fair
    market value of the common stock appreciates at the annual rate shown
    (compounded annually) from the date of grant until the end of the option
    term. Actual realizable value, if any, on stock option exercises is
    dependent on the future performance of the common stock and overall market
    conditions, as well as the option holder's continued employment through the
    vesting period.
3.  Such options vest 25% on the one-year anniversary of the date of grant with
    the remainder vesting ratably and daily over the following three-year
    period.

                AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                       AND FISCAL YEAR-END OPTION VALUES

     The following table sets forth certain information as of December 31, 1999,
regarding options held by the Named Executive Officers.  None of such
individuals exercised any options during the fiscal year ended December 31,
1999.  There were no stock appreciation rights outstanding at December 31, 1999.

<TABLE>
<CAPTION>
                                             Number of Shares
                                          Underlying Unexercised                 Value of Unexercised
                                                   Options                       In-The-Money Options
                                                at FY-End (#)                     as of FY-End ($)(1)
                                   --------------------------------------------------------------------------
                 Name                  Exercisable      Unexercisable       Exercisable      Unexercisable
-------------------------------------------------------------------------------------------------------------
<S>                                <C>                  <C>                 <C>              <C>
Jay Kranzler, M.D., Ph.D.                2,992,342             60,427         $907,980             $11,330

Carl Bobkoski                                    -            500,000         $      -             $     -

R. Michael Gendreau, M.D.                  344,385             71,615         $ 19,773             $ 7,039
</TABLE>

1.   Calculation based upon $1.8125, the closing sales price of the underlying
shares of common stock as reported on the Nasdaq SmallCap Market on December 31,
1999, less exercise price.

                                       25
<PAGE>

EMPLOYMENT AND CHANGE OF CONTROL AGREEMENTS

     Jay D. Kranzler, M.D., Ph.D., the Company's Chairman of the Board, Chief
Executive Officer, and Chief Financial Officer had a base salary in 1999 of
$305,500, and received a performance based bonus of $150,000. In addition to his
base salary and bonus, under his employment agreement, Dr. Kranzler was granted
an option to purchase 3,025,327 shares of common stock of the Company (which
amount represented eight percent (8%) of the Company's common stock on a fully
diluted basis on the date of grant) at an exercise price equal to $1.50 per
share. The options vest twenty-five percent (25%) immediately upon grant and
thereafter ratably and daily over a four year period subject to board approved
company-wide stock option accelerations. In August 1997, Dr. Kranzler was
granted an option to purchase 277,440 shares of the Company's common stock at an
exercise price of $1.625 per share and vest twenty-five percent (25%) one year
from the date of grant and thereafter ratably and daily over a three (3) year
period. On January 27, 2000 Dr. Kranzler was granted an option to purchase
1,000,000 shares of the Company's common stock at an exercise price of $2.8125
per share and vest ratably and daily over a four (4) year period. As of March 1,
2000, options to purchase 3,024,327 shares of common stock had vested.

     In April 1996, the Company entered into an employment agreement with Dr. R.
Michael Gendreau, the Company's Executive Vice President, Research and
Development, Chief Scientific Officer and Chief Medical Officer, whereby Dr.
Gendreau's annual compensation consisted of a base salary of $149.000.  During
1999, Dr. Michael Gendreau received a base salary of $191,500 and a performance
bonus of $75,000.  In April 1996 the Company also granted Dr. Gendreau options
to purchase up to 125,000 shares of the Company's common stock at an exercise
price of $2.019 per share. On January 1, 1998, Dr. Gendreau was granted an
option to purchase 50,000 shares of common stock of the Company at an exercise
price of $1.4375 per share and on August 10, 1998 he was granted an additional
option to purchase 100,000 shares of the Company's common stock at an exercise
price of $2.3438 per share which vest twenty-five (25%) after one year upon
grant and thereafter ratably and daily over a three (3) year period.  On January
27, 2000 Dr. Gendreau was granted an option to purchase 125,000 shares of the
Company's common stock at an exercise price of $2.8125 per share which vest
ratably and daily over a four (4) year period.  As of March 1, 2000, options to
purchase a total of 353,560 shares of common stock had vested. In the event that
Dr. Gendreau's employment with the Company is terminated by the Company without
cause due to a corporate merger or acquisition, Dr. Gendreau will receive a six
month salary severance.

     In February 18, 1999, the Company entered into an employment agreement with
Carl F. Bobkoski, the Company's President, Chief Operating Officer and Corporate
Secretary, whereby Mr. Bobkoski's annual compensation consists of base salary of
$215,000 and he is eligible at the sole discretion of the Board for an annual
bonus equal to 25% of his base salary. During 1999 Mr. Bobkoski was paid
$189,500 in base salary. In February 1999, the Company also granted Mr. Bobkoski
options to purchase up to 500,000 shares of the Company's common stock at an
exercise price of $2.75 per share. If the Company terminated Mr. Bobkoski's
employment without cause, he is entitled to his base salary for six months;
provided that the payments shall increase by one month for every full year of
continuous service with the Company. In addition, in the event that Mr.
Bobkoski's employment with the Company is terminated by the Company without
cause due to a corporate merger or acquisition, Mr. Bobkoski's options shall
become fully exercisable.

REPORT OF COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION

     The Compensation Committee (the "Committee") is comprised of directors who
are not employees of the Company.  The Committee is responsible for establishing
and administering the Company's executive compensation arrangements.

     The Company believes that a competitive, goal-oriented compensation policy
is critically important to the creation of value for stockholders.  To that end,
the Company has created an incentive compensation program intended to reward
outstanding individual performance.  Under the Omnibus Budget Reconciliation Act
of 1993, beginning in 1994, the federal income tax deduction for certain types
of compensation paid to the Chief Executive Officer and four other most highly
compensated officers of publicly held companies is limited to $1,000,000 per
officer per fiscal year unless such compensation meets certain requirements. The
Committee is aware of this limitation and believes that the deductibility of
compensation payable in 1999 will not be affected by this limitation.

Compensation Philosophy

     The Company's compensation program is intended to implement the following
principles:

     .  Compensation should be related to the value created for stockholders.
     .  Compensation programs should support the short-term and long-term
        strategic goals and objectives of the Company.
     .  Compensation programs should reflect and promote the Company's values
        and reward individuals for outstanding contributions to the Company's
        success.

                                       26
<PAGE>

Short-term and long-term compensation programs play a critical role in
attracting and retaining well-qualified executives.

     While compensation opportunities should be based in part upon individual
contribution, the actual amounts earned by executives in variable compensation
programs should also be based upon how the Company performs.

     The Company's executive compensation for the Chief Executive Officer and
all other executives is based upon three components, each of which is intended
to serve the Company's compensation principles.

Base Salary

     Base salary is targeted at the competitive median for similar companies in
the biotechnology industry.  For the purpose of establishing these levels, the
Committee compares the Company's compensation structure from time to time with
the companies covered in a compensation survey of the biotechnology industry
entitled, Biotechnology Compensation and Benefits Survey, which is prepared by
Radford Associates and sponsored by the Biotechnology Industry Organization.
Many of the Companies covered in that survey are also included in the published
industry line-of-business index included in the Company's Stock Price
Performance Graph, included elsewhere in this document.

     Based upon its reviews of industry data, the Compensation Committee
determined that the base salaries of the Chief Executive Officer and all other
executive officers were appropriate and necessary to attract individuals of such
high caliber within the biotechnology industry.  The Committee reviews the
salaries of the Chief Executive Officer and other executive officers each year
and such salaries may be increased based upon (i) the individual's performance
and contribution to the Company and (ii) increases in median competitive pay
levels.

Annual Incentives

     The Company has a cash bonus program whereby bonus amounts are determined
based upon the achievement of corporate goals and individual performance. Any
bonus is based, in part, upon Company performance and in part on individual
performance.  The Committee believes bonus amounts are similar to those paid by
other companies in the biotechnology industry.

Long-Term Incentives

     Long-term incentive compensation is provided through grants of options to
purchase shares of the Company's common stock to the Chief Executive Officer,
other executive officers and other employees.  The stock options are intended to
retain and motivate all employees to improve long-term performance of the
Company.  It is common in the biotechnology industry to grant stock options to
all employees.  As of 1997, stock options had been granted to all full-time
employees of the Company.  The Committee believes the amount and value of such
grants are based upon levels similar to other companies in the biotechnology
industry.  Generally, stock options are granted with an exercise price equal to
prevailing market value.  The stock options generally vest in increments over a
period of years.

COMPENSATION OF THE CHIEF EXECUTIVE OFFICER

     Dr. Kranzler, the Company's Chief Executive Officer, assisted the Company
in achieving certain of its goals in 1999.  In 1999, the Company entered into an
exclusive distribution agreement with Fresenius with respect to the PROSORBA
column, obtained FDA clearance of the sale of the PROSORBA column for RA and
launched the sales of the PROSORBA column for the treatment of RA.  In
accordance with the policies noted above, and in consideration of Dr. Kranzler's
contributions to the Company, the Committee set Dr. Kranzler's base salary at
$305,500 a 10.3% increase over 1998, and the committee also awarded Dr. Kranzler
a $150,000 bonus in 1999.

                    Compensation Committee
                      Sam Anderson, Chairman
                      Larry Kessel, M.D.
                      Jack Vaughn

                                       27
<PAGE>

                         STOCK PRICE PERFORMANCE GRAPH

Comparison of Cumulative Return on Investment

     The following Stock Price Performance Graph compares the Company's
cumulative total stockholder return on the Company's common stock for the
periods indicated with the cumulative total return of the NASDAQ OTC Index and
the NASDAQ Pharmaceuticals Stock Index. The Company has not declared any
dividends since its inception.  The Board and the Committee recognize that the
market price of the Company's common stock is influenced by many factors, only
one of which is Company performance.  The historical stock price performance
shown on the Stock Price Performance Graph is not necessarily indicative of
future stock price performance.

                               94      95       96       97      98       99
                          --------------------------------------------------
NASDAQ OTC                    100   125.0     86.7     63.2   132.0     79.7
CYPRESS BIOSCIENCE, INC.      100   141.3    173.9    213.1   300.0    556.0
NASDAQ PHARMACEUTICAL         100   183.4    184.0    190.0   241.7    449.8

The above comparison assumes $100 was invested in the Company's common stock and
each index on December 31, 1994.

                                       28
<PAGE>

Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
           MANAGEMENT

     The following table sets forth information as of March 1, 2000 with respect
to (i) each stockholder known to the Company to be the beneficial owner of more
than five percent (5%) of the outstanding common stock of the Company, (ii) each
director, (iii) each Named Executive Officer and (iv) all directors and Named
Executive Officers of the Company as a group.  Except as set forth below, each
of the named persons and members of the group has sole voting and investment
power with respect to the shares shown.

<TABLE>
<CAPTION>
                                                              Amount and Nature of
                                                            -----------------------
                                                            Beneficial Ownership of      Percent of Class of
                                                            -----------------------      -------------------
Beneficial Owner of Common Stock (1)                            Common Stock (2)           Common Stock (2)
                                                                ----------------           ----------------
<S>                                                         <C>                          <C>
Allen & Company Incorporated..............................       4,999,158(3)                      10.4%
  711 Fifth Avenue
  New York, New York 10022
Paramount Capital Asset Management, Inc...................       5,934,000(4)                      12.3%
  787 Seventh Avenue, 44th Floor
  New York, NY 10019
Jay D. Kranzler...........................................       3,520,724(5)                       6.9%
Carl Bobkoski.............................................         270,721(6)                         *
R. Michael Gendreau.......................................         344,856(7)                         *
Jack H. Vaughn............................................          75,000(8)                         *
Samuel D. Anderson........................................          78,603(9)                         *
David Golde...............................................          52,098(10)                        *
Larry J. Kessel...........................................          72,890(11)                        *
Mark C. Rogers............................................          65,890(12)                        *
All Directors and Named Executive Officers as a
  Group (8 persons)                                              4,229,022                          8.1%
</TABLE>

*Less than one percent

(1)  This table is based upon information supplied by officers, directors and
     principal stockholders and Schedule 13Ds filed with the Securities and
     Exchange Commission (the "Commission"). Except as shown otherwise in the
     table, the address of each stockholder listed is in care of the Company at
     4350 Executive Drive, Suite 325, San Diego, California, 92121.
(2)  Except as otherwise indicated in the footnotes of this table and pursuant
     to applicable community property laws, the persons named in the table have
     sole voting and investment power with respect to all shares of common
     stock. Beneficial ownership is determined in accordance with the rules of
     the Commission and generally includes voting or investment power with
     respect to securities. Shares of common stock subject to options or
     warrants exercisable within 60 days of March 1, 2000 are deemed outstanding
     for computing the percentage of the person or entity holding such options
     or warrants but are not deemed outstanding for computing the percentage of
     any other person. Percentage of beneficial ownership is based upon
     48,175,562 shares of the Company's common stock outstanding as of March 1,
     2000.
(3)  This information was derived from information provided to the Company by
     Allen & Company Incorporated. Includes 1,005,119 shares of common
     stock held in the name of Susan Allen. Also includes 599,359 shares
     of common stock held in the name of Herb Allen.
(4)  Dr. Lindsay A. Rosenwald is the sole shareholder of Paramount Capital Asset
     Management, Inc. ("Paramount Capital"). Paramount Capital is the general
     partner of Aries Domestic Fund, L.P., a limited partnership incorporated in
     Delaware ("Aries Domestic") and the investment manager of The Aries Master
     Fund, a Cayman Islands trust ("The Aries Master Fund"). Of the 5,934,000
     shares of common stock indicated as beneficially held, Paramount Capital
     shares voting and dispositive power with the following persons or entities:
     Dr. Rosenwald with respect to 3,000,000 of the shares; Aries Domestic with
     respect to 846,600 of the shares; and The Aries Master Fund with respect to
     2,087,400 of the shares.
(5)  Includes 3,073,966 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000.  Also includes 194,998 shares
     of common stock held in Dr. Kranzler's name. Also includes 251,760 shares
     of common stock held by the Company's 401(k) plan for which Dr. Kranzler,
     as co-trustee of the 401(k) plan, has voting rights to such shares.
(6)  Includes 18,661 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000. Also includes 251,760 shares
     of common stock held by the Company's 401(k) plan for which Mr. Bobkoski,
     as co-trustee of the 401(k) plan, has voting rights to such shares. Also
     Includes 100 shares held by Alexander Bobkoski, Mr. Bobkoski's son, 100
     shares held by Elizabeth Bobkoski, Mr. Bobkoski's daughter and 100 shares
     held by Catherine Bobkoski, Mr. Bobkoski's daughter.
(7)  Includes 344,856 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000.
(8)  Includes 75,000 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000.
(9)  Includes 53,603 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000.  Also Includes 25,000 shares
     of common stock held by Samuel D. and Mary Ann H. Anderson as trustees of
     the Samuel and Mary Ann Anderson trust dated March 22, 1979.
(10) Includes 52,098 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000.
(11) Includes 70,890 shares of common stock issuable pursuant to options or
     other rights exercisable within 60 days of March 1, 2000.
(12) Includes 65,890 shares of common stock issuable pursuant to options
     exercisable within 60 days of March 1, 2000.

                                       29
<PAGE>

Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Mr. Mark Rogers, M.D., appointed as director of the Company in January
2000, is the President of Paramount Capital Investments.  As of March 1, 2000,
Paramount Capital Investments held approximately 12.3% of the Company's common
stock.

     Mr. Richard Crooks, Jr., a former director of the Company, is a director of
and consultant to Allen & Company Incorporated, a principal stockholder of the
Company.  Effective November 1999, Mr. Crooks resigned his Board of Director's
position with the Company.

     The Company has also entered into an employment agreement with its three
executive officers, as described under the caption "Management - Employment
Agreements." The Company has granted stock options to certain directors and
executive officers of the Company.  See "Management - Executive Compensation."

     The Company's Bylaws provide that the company will indemnify its directors
and executive officers and may indemnify its other officers, employees and other
agents to the fullest extent permitted by Delaware law.  The Company is also
empowered under it bylaws to enter into indemnification contracts with its
directors and officers and to purchase insurance on behalf of any person who it
is required or permitted to indemnify.  Pursuant to this provision, the Company
has entered into indemnity agreements with each of its directors and officers
and currently maintains directors and officers insurance coverage.

                                       30
<PAGE>

                                    PART IV

Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
          8-K

(1)  Financial Statements

The financial statements of the Company are included herein as required under
Item 8 of this Annual Report on Form 10-K. See Index on page F-1.

(2)  Financial Statement Schedules

Financial statement schedules have been omitted since they are either not
required, not applicable, or the information is otherwise included.

(3)  EXHIBITS

<TABLE>
<CAPTION>
     Exhibit No.        Description                                  Incorporated by Reference to
    ----------------------------------------------------------------------------------------------------------------------
<S>                     <C>                                          <C>
     3.1                Amended and Restated Certificate of          Exhibit 3.1 to Form 10-Q for the quarter ended March
     3.2                Incorporation                                30, 1996
     4.1                By-Laws, as amended                          Exhibit 3.2 to 1995 Form 10-K
                        Form of Stock Certificate                    Exhibit 4.1 to Form S-1 Registration Statement No.
                                                                     33-41225
     10.3               Agreement and Plan of Merger and             Exhibit 2.1 to Form 10-Q for quarter ended September
                        Reorganization dated October 10, 1996, by    30, 1996
                        and among Registrant, Cypress Acquisition
                        Sub, Inc. and PRP, Inc.
     10.4               Warrant Agreement dated September 18,        Exhibit 4.1 to Form 10-Q for quarter ended September
                        1996, between Registrant and American        30, 1996
                        Stock Transfer & Trust Company
     10.5               Exchange of Bridge Debt and Warrant          Exhibit 4.2 to Form 10-Q for quarter ended September
                        Termination Agreement between Registrant     30, 1996
                        and certain holders of indebtedness of
                        PRP, Inc.
     10.6               Incentive Stock Option                       Exhibit 28.2 to Form S-8 Registration Statement No.
                                                                     33-20188
     10.7               Form of Nonqualified Stock Option            Exhibit 4.5 to Form 10-K for the year ended December
                                                                     31, 1993
     10.8               Form of 7% Convertible Debentures            Exhibit 10.1 to Form 10-Q for the quarter ended
                                                                     March 31, 1994
     10.10              Form 7% Convertible Debenture Purchase       Exhibit 10.4 to Form 10-Q for the quarter ended
                        Agreement                                    March 31, 1994
     10.11              Form of Senior Convertible Debenture         Exhibit 4.10 to 1995 From 10-K
     10.12              Form of Senior Convertible Debenture         Exhibit 4.11 to 1995 Form 10-K
                        Purchase Agreement
     10.14              Form of Warrant to Purchase Common Stock     Exhibit 99.1 to Form S-8 Registration Statement No.
                                                                     333-19465
     10.15              1996 Equity Incentive Plan (the "1996        Exhibit 99.1 to Form S-8 Registration Statement No.
                        Plan")                                       333-06771
     10.20              Form of Incentive Stock Option Agreement     Exhibit 3.1 to Form 10-Q for the quarter ended March
                        under the 1996 Plan                          30, 1996
     10.21              1996 Equity Incentive Plan Form of           Exhibit 3.1 to Form 10-Q for the quarter ended March
                        Non-Statutory Stock Option Agreement         30, 1996
     10.22              Incentive Stock Option and Appreciation      Exhibit 99.4 to Form S-8 Registration Statement No.
                        Plan, as amended June 29, 1992               333-06771
     10.24              Amended and Restated 1988 Nonqualified       Exhibit 99.6 to Form S-8 Registration Statement No.
                        Stock Option Plan                            333-06771
</TABLE>

                                       31
<PAGE>

<TABLE>
     <S>                <C>                                          <C>
     10.25              Form of Nonqualified Stock Option            Exhibit 99.7 to Form S-8 Registration Statement No.
                        Agreement under the 1988 Plan                333-06771
     10.26              Form of Stock Option Agreement for           Exhibit 99.8 to Form S-8 Registration Statement No.
                        issuance's of all non-plan options           333-06771
     10.27              Form of Nonstatutory Stock Option            Exhibit 99.3 to Form S-8 Registration Statement No.
                        Agreement under the 1996 Plan                333-06771
     10.28              Stock Option and Stock Appreciation Plan     Exhibit 28.1 to Form S-8 Registration Statement No.
                                                                     333-06771
     10.29              Warrant Agreement dated September 19, 1996   Exhibit 10.1 to Form S-3 Registration Statement No.
                        between the Registrant and American Stock    333-15483
                        Transfer & Trust company
     10.30              1988 Nonqualified Stock Option Plan          Exhibit 28.3 to Form S-8 Registration Statement No.
                                                                     333-06771
     10.33              Warrant Agreement dated as of August 29,     Exhibit 99.1 to Form S-3 Registration Statement No.
                        1991 between IMRE Corporation and            33-71278
                        Manufacturers Hanover Trust Company of
                        California (now known as Chemical Trust
                        Company of California)
     10.35              Employment Agreement with Jay D. Kranzler    Exhibit 10.8 to 1995 Form 10-K
     10.38              Employment Offer Letter dated as of          Exhibit 10.38 to 1998 Form 10-K
                        February 18, 1999 between the Registrant
                        and Carl F. Bobkoski
     10.39              Separation Agreement dated March 15, 1999    Exhibit 10.39 to 1998 Form 10-K
                        between the Registrant and Debby Jo Blank
     10.41              Sublease dated February 1, 1999 between      Exhibit 10.41 to 1998 Form 10-K
                        the Company and Cardia Pacemakers, Inc.
                        and related lease dated August 1991
                        between Michael R. Mastro and Redmond East
                        Associates and Incontrol, Inc. and
                        Amendments One through Ten
     10.42              License and Distribution agreement with      Exhibit 10.1 to Form 10-Q from the quarter ended
                        Fresenius dated March 26, 1999               March 31, 1999
     10.43              Asset Purchase Agreement with Fresenius      Exhibit 10.2 to Form 10-Q from the quarter ended
                        dated March 26, 1999                         March 31, 1999
     10.44              Registration Agreement with Fresenius        Exhibit 10.3 to Form 10-Q from the quarter ended
                        dated March 26, 1999                         March 31, 1999
     10.45              Securities Purchase Agreement with           Exhibit 10.4 to Form 10-Q from the quarter ended
                        Fresenius dated March 26, 1999               March 31, 1999
     10.46              Fresenius Common Stock Purchase Warrant      Exhibit 10.5 to Form 10-Q from the quarter ended
                        dated March 26, 1999                         March 31, 1999
     10.47              Loan and Securities Agreement between        Exhibit 10.1 to Form 10-Q from the quarter ended
                        Cypress Bioscience, Inc., PRP, Inc. and      September 30, 1999
                        Transamerica Business Credit Corporation
     10.48              Stock Subscription Warrant to Purchase       Exhibit 10.2 to Form 10-Q from the quarter ended
                        Common Stock of Cypress Bioscience, Inc.     September 30, 1999
                        between the Company and TBCC Funding Turst
                        II or its registered assigns
     11.1               Statement regarding computation of per       Item 8 of 1995 Form 10-K
                        share loss
     23.1               Consent of Ernst & Young LLP, Independent
                        Auditors
     24.1               Power of Attorney                            Reference is made to page [37]
     27.1               Financial Data Schedule
</TABLE>


     (b)    Reports on Form 8-K
            None

                                       32
<PAGE>

                                  SIGNATURES

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



                                         Cypress Bioscience, Inc.
                                         By:  /s/ Jay D. Kranzler
                                              -------------------------------
                                              Jay D. Kranzler, M.D., Ph. D.
                                              Chief Executive Officer,
                                              Chief Financial Officer, and
                                              Chairman of the Board
                                              (Principal Executive Officer and
                                              Principal Financial and Accounting
                                              Officer)

Date:  March 30, 2000

                               POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Jay D. Kranzler, M.D., Ph.D., as his true
and lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sing any and all amendments to this Annual Report on Form 10-K,
and to file the same with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent, and full power and authority to do and
performance each and every act and thing requisite and necessary to be done in
connection therewith, as fully to intents and purposes as he might or could do
in person, hereby ratifying and confirming that all said attorney-in-fact and
agent, or any of them or their or his substitute or resubstitute, may lawfully
do or cause to be done by virtue hereof.

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


<TABLE>
<CAPTION>
Signature                                     Title                                                   Date
---------                                     -----                                                   ----
<S>                                           <C>                                                     <C>
/s/ Jay D. Kranzler                           Chief Executive Officer, Chief Financial Officer and    March 30, 2000
-----------------------------------------
Jay D. Kranzler, M.D., Ph.D.                  Chairman of the Board (Principal Executive Officer
                                              and Principal Financial and Accounting Officer)

/s/ Larry J. Kessel, M.D.                     Director                                                March 30, 2000
-----------------------------------------
Larry J. Kessel, M.D.

/s/ Mark C. Rogers, M.D.                      Director                                                March 30, 2000
-----------------------------------------
Mark C. Rogers, M.D.

/s/ Jack H. Vaughn                            Director                                                March 30, 2000
-----------------------------------------
Jack H. Vaughn

/s/ Samuel D. Anderson                        Director                                                March 30, 2000
-----------------------------------------
Samuel D. Anderson

/s/ David Golde, M.D.                         Director                                                March 30, 2000
-----------------------------------------
David Golde, M.D.
</TABLE>

                                       33
<PAGE>

                           CYPRESS BIOSCIENCE, INC.
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S>                                                                                                          <C>
Report of Ernst & Young LLP, Independent Auditors..........................................................  F-2
Consolidated Balance Sheets as of December 31, 1999 and 1998...............................................  F-3
Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997.................  F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997.......  F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997.................  F-6
Notes to Consolidated Financial Statements.................................................................  F-7
</TABLE>

                                      F-1
<PAGE>

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


The Board of Directors and Stockholders

Cypress Bioscience, Inc.

     We have audited the accompanying consolidated balance sheets of Cypress
Bioscience, Inc. as of December 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1999.  These financial statements
are the responsibility of the Company's management.  Our responsibility is to
express an opinion on these financial statements based upon our audits.

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

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Cypress Bioscience, Inc. as of December 31, 1999 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States.


                                                      /s/ Ernst & Young LLP

San Diego, California
February 18, 2000

                                      F-2
<PAGE>

                           CYPRESS BIOSCIENCE, INC.
                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                           December 31,
                                                                                    1999                   1998
                                                                               ------------            ------------
<S>                                                                            <C>                     <C>
ASSETS
Current assets:
  Cash and cash equivalents                                                    $ 11,569,966            $  5,619,568
  Accounts receivable:
    Trade and other, net of allowance for doubtful accounts of
     $32,645 in 1998                                                                      -                 584,200
    From agreement with Fresenius                                                   387,474                       -
  Inventories                                                                             -               1,014,443
  Prepaid expenses                                                                  389,180                 254,891
  Debt acquisition cost - current                                                   144,654                       -
                                                                               ------------            ------------
    Total current assets                                                         12,491,274               7,473,102

Property and equipment, net                                                         226,042               1,789,976
Restricted cash                                                                           -                  35,000
Other assets                                                                         20,360                       -
Deferred financing costs                                                             93,796                  17,957
                                                                               ------------            ------------
    Total assets                                                               $ 12,831,472            $  9,316,035
                                                                               ============            ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                                             $    952,932            $    778,061
  Accrued compensation                                                              135,211                 164,832
  Accrued liabilities                                                               478,477                 952,448
  Current portion of long-term obligations                                          843,941                       -
  Current portion of capital leases                                                   6,167                   9,823
                                                                               ------------            ------------
    Total current liabilities                                                     2,416,728               1,905,164

Convertible debentures                                                              400,000                 400,000
Long-term obligations, net of current portion                                     2,260,570                 144,804
Capital leases, net of current portion                                                9,321                  21,496

Commitments and contingencies (Note 5)

Stockholders' equity:
  Series A convertible preferred stock, $.02 par value; authorized
          3,333,333 shares; issued and outstanding, no shares at
          December 31, 1999 and 1,156,832 shares at December 31, 1998                     -                  23,136
  Common stock, $.02 par value; authorized 75,000,000 shares;
          issued and outstanding, 46,314,110 and 41,402,045 shares at
          December 31, 1999 and 1998, respectively                                  926,282                 828,041
  Additional paid-in capital                                                     94,609,138              86,238,466
  Deferred compensation                                                                   -                (239,446)
  Accumulated deficit                                                           (87,790,567)            (80,005,626)
                                                                               ------------            ------------
    Total stockholders' equity                                                    7,744,853               6,844,571
                                                                               ------------            ------------
    Total liabilities and stockholders' equity                                 $ 12,831,472            $  9,316,035
                                                                               ============            ============
</TABLE>

See accompanying notes.

                                      F-3
<PAGE>

                           CYPRESS BIOSCIENCE, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                   Years Ended December 31,
                                                         1999                1998              1997
                                                      -----------        ------------       -----------
<S>                                                   <C>                <C>                <C>
Revenues:
   Product sales                                      $   588,120        $  2,374,970       $ 2,970,342
   Revenue from Fresenius agreement                     1,284,583                   -                 -
   Grant income                                                 -             308,470           325,316
                                                      -----------        ------------       -----------
                                                        1,872,703           2,683,440         3,295,658
Costs and expenses:
   Production costs                                       888,015           2,113,781         1,772,681
   Sales and marketing                                  5,937,463           2,378,443         1,292,942
   Research and development                             1,889,933           4,290,727         6,707,557
   General and administrative                           3,689,739           3,345,241         2,803,079
                                                      -----------        ------------       -----------
                                                       12,405,150          12,128,192        12,576,259

Other income (expense):
   Interest income                                        496,740             341,755           425,935
   Interest expense                                      (160,766)            (41,953)          (31,737)
   Gain on sale of assets, net                          2,411,532                   -                 -
                                                      -----------        ------------       -----------
                                                        2,747,506             299,802           394,198

Net loss before imputed dividend on
   Series A convertible preferred stock                (7,784,941)         (9,144,950)       (8,886,403)

Undeclared, imputed dividend on Series A
   convertible preferred stock                                  -          (2,078,431)                -
                                                      -----------        ------------       -----------

Net loss applicable to common
   stockholders                                       $(7,784,941)       $(11,223,381)      $(8,886,403)
                                                      ===========        ============       ===========

Net loss per share applicable to common
   stockholders - basic and diluted                   $     (0.17)       $      (0.29)      $     (0.25)
                                                      ===========        ============       ===========

Shares used in computing net loss
   per share applicable to common
   stockholders - basic and diluted                    45,043,962          39,234,741        35,236,579
                                                      ===========        ============       ===========
</TABLE>

See accompanying notes.

                                      F-4
<PAGE>

                           CYPRESS BIOSCIENCE, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                     Preferred Stock            Common Stock        Additional
                                                               ---------------------------------------------------
                                                                 Shares         Par Value     Shares    Par Value  Paid-in Capital
                                                               -------------------------------------------------------------------
<S>                                                            <C>              <C>        <C>          <C>        <C>
Balance December 31, 1996                                                -             -   34,573,111   $691,462       $72,354,683
 Stock options exercised                                                 -             -       20,000        400            37,100
 Deferred compensation related to stock options                          -             -            -          -           (10,284)
 Stock issued to match 401(k) contributions                              -             -      101,668      2,033           163,623
 Stock issued in October 1997 private placement                          -             -    3,851,029     77,021         5,496,514
 Amortization of deferred compensation                                   -             -            -          -                 -
 Net loss                                                                -             -            -          -                 -
                                                               -------------------------------------------------------------------
Balance December 31, 1997                                                -             -   38,545,808    770,916        78,041,636
 Stock options and warrants exercised                                    -             -      876,681     17,534         1,448,435
 Deferred compensation related to stock options and warrants             -             -            -          -           194,870
 Stock issued to match 401(k) contributions                              -             -       72,827      1,456           205,898
 Series A convertible preferred stock issued in
      September 1998 private placement                           3,063,561      $ 61,271            -          -         4,269,196
 Imputed dividend on Series A convertible preferred stock                -             -            -          -         2,078,431
 Preferred stock conversions                                    (1,906,729)      (38,135)   1,906,729     38,135                 -
 Amortization of deferred compensation                                   -             -            -          -                 -
 Net loss                                                                -             -            -          -                 -
                                                               -------------------------------------------------------------------
Balance December 31, 1998                                        1,156,832        23,136   41,402,045    828,041        86,238,466
 Stock options and warrants exercised                                    -             -    3,370,518     67,410         6,432,869
 Deferred compensation related to stock options                          -             -            -          -                 -
 Stock issued to match 401(k) contributions                              -             -       87,185      1,744           204,400
 Sale of common stock to Fresenius                                       -             -      297,530      5,951           994,049
 Sale of warrants to Fresenius                                           -             -            -          -           500,000
 Preferred stock conversions                                    (1,156,832)      (23,136)   1,156,832     23,136                 -
 Stock issued for services                                               -             -            -          -            13,750
 Warrants issued to lendor                                               -             -            -          -           225,604
 Net loss                                                                -             -            -          -                 -
                                                               -------------------------------------------------------------------
Balance December 31, 1999                                                -      $      -   46,314,110   $926,282       $94,609,138
                                                               ===================================================================

<CAPTION>
                                                                            Deferred        Accumulated
                                                                          Compensation        Deficit        Total
                                                                          --------------------------------------------
<S>                                                                       <C>             <C>              <C>
Balance December 31, 1996                                                 $(1,015,738)    $(59,895,842)    $12,134,565
 Stock options exercised                                                            -                -          37,500
 Deferred compensation related to stock options                                10,284                -               -
 Stock issued to match 401(k) contributions                                         -                -         165,656
 Stock issued in October 1997 private placement                                     -                -       5,573,535
 Amortization of deferred compensation                                        501,139                -         501,139
 Net loss                                                                           -       (8,886,403)     (8,886,403)
                                                                          --------------------------------------------
Balance December 31, 1997                                                    (504,315)     (68,782,245)      9,525,992
 Stock options and warrants exercised                                               -                -       1,465,969
 Deferred compensation related to stock options and warrants                 (194,870)               -               -
 Stock issued to match 401(k) contributions                                         -                -         207,354
 Series A convertible preferred stock issued in                                     -                -       4,330,467
     September 1998 private placement                                               -       (2,078,431)              -
 Imputed dividend on Series A convertible preferred stock                           -                -               -
 Preferred stock conversions                                                        -                -               -
 Amortization of deferred compensation                                        459,739                -         459,739
 Net loss                                                                           -       (9,144,950)     (9,144,950)
                                                                          --------------------------------------------
Balance December 31, 1998                                                    (239,446)     (80,005,626)      6,844,571
 Stock options and warrants exercised                                               -                -       6,500,279
 Deferred compensation related to stock options                               239,446                -         239,446
 Stock issued to match 401(k) contributions                                         -                -         206,144
 Sale of common stock to Fresenius                                                  -                -       1,000,000
 Sale of warrants to Fresenius                                                      -                -         500,000
 Preferred stock conversions                                                        -                -               -
 Stock issued for services                                                          -                -          13,750
 Warrants issued to lendor                                                          -                -         225,604
     Net loss                                                                       -       (7,784,941)     (7,784,941)
                                                                          --------------------------------------------
Balance December 31, 1999                                                 $         -     $(87,790,567)    $ 7,744,853
                                                                          ============================================
</TABLE>

See accompanying notes.

                                      F-5
<PAGE>

                           CYPRESS BIOSCIENCE, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                       Years Ended December 31,
                                                                            1999               1998                1997
                                                                        -----------         -----------         -----------
<S>                                                                     <C>                 <C>                 <C>
Operating Activities
Net loss                                                                $(7,784,941)        $(9,144,950)        $(8,886,403)
Adjustments to reconcile net loss to net cash used
 in operating activities:
   Depreciation and amortization                                            253,627             549,953             481,567
   Amortization of deferred compensation                                    239,446             459,739             501,139
   Stock and warrants issued for services                                   239,354                   -                   -
   Common stock issued for employee services                                206,144             207,354             165,656
   Gain on sale of facility and inventory to Fresenius                   (2,497,127)                  -                   -
   Loss (Gain) on disposal of property and equipment                         85,595              (6,610)             (3,298)
   Changes in operating assets and liabilities:
     Accounts receivable, net                                               584,200             (36,161)            (28,700)
     Receivables from Fresenius                                            (387,474)            (34,811)             10,467
     Inventories                                                           (235,437)           (386,439)            345,763
     Prepaid expenses                                                      (134,289)           (140,509)             56,849
     Other assets                                                           (20,360)                  -                   -
     Accounts payable and other accrued liabilities                        (468,211)             44,588            (536,530)
                                                                        -----------         -----------         -----------
Net cash used in operating activities                                    (9,919,473)         (8,487,846)         (7,893,490)

Investing Activities
   Proceeds from sale of facility and inventory to Fresenius              5,245,517                   -                   -
   Purchase of property and equipment                                      (149,358)           (345,636)           (118,038)
   Proceeds from sale of property and equipment                              15,050              11,859               7,685
   Purchase of short-term investments                                             -          (1,000,900)         (2,006,773)
   Sale of short-term investments                                                 -           1,975,233           3,922,600
   Release (deposit) of restricted cash                                      35,000             (35,000)                  -
                                                                        -----------         -----------         -----------
Net cash provided by investing activities                                 5,146,209             605,556           1,805,474

Financing Activities
   Net proceeds from issuance of common stock and warrants                1,500,000                   -           5,573,535
   Net proceeds from issuance of preferred stock                                  -           4,330,467                   -
   Net proceeds from exercise of stock options and warrants               6,500,279           1,465,969              37,500
   Proceeds from term loan                                                3,000,000                   -                   -
   Proceeds (payments) of capital lease obligation                          (15,831)             19,298             (27,207)
   Proceeds from note payable                                                     -             144,804                   -
   Payments on notes payable                                                (40,293)                  -                   -
   Deferred financing costs                                                (220,493)                  -                   -
                                                                        ------------        -----------         -----------
Net cash provided by financing activities                                10,723,662           5,960,538           5,583,828

Increase (decrease) in cash and cash equivalents                          5,950,398          (1,921,752)           (504,188)
   Cash and cash equivalents at beginning of the year                     5,619,568           7,541,320           8,045,508
                                                                        -----------         -----------         -----------
   Cash and cash equivalents at end of the year                         $11,569,966         $ 5,619,568         $ 7,541,320
                                                                        ===========         ===========         ===========

Supplemental disclosure of cash flow information
   Interest paid                                                        $   131,116         $    40,873         $    31,661
                                                                        ===========         ===========         ===========
</TABLE>

See accompanying notes.

                                      F-6
<PAGE>

                        CYPRESS BIOSCIENCE, INC.NOTES
                     TO CONSOLIDATED FINANCIAL STATEMENTS

1.   FORMATION AND BUSINESS OF THE COMPANY

     Cypress Bioscience, Inc. (the "Company") markets the PROSORBA(R) column for
the treatment of types of rheumatoid arthritis ("RA") and idiopathic
thrombocytopenia purpura ("ITP"), which are types of immune disorders and is
engaged in the development of novel therapeutic agents for the treatment of
blood platelet disorders. The PROSORBA column absorbs antibodies and circulating
immune complexes and modulates the patient's inappropriate immune response to
certain diseases. In March 1999, the Food and Drug Administration ("FDA")
granted Cypress marketing clearance to distribute the PROSORBA column for the
treatment of moderate to severe RA. The Company previously received marketing
clearance from the FDA in December 1987 to distribute the PROSORBA column for
the treatment of ITP, an immune-mediated bleeding disorder. The Company is also
developing Cyplex(TM), a platelet alternative, previously known as Infusible
Platelet Membranes, as an alternative to traditional platelet transfusions.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries.  All material intercompany accounts and
transactions have been eliminated in consolidation.

Accounting Estimates in the Preparation of Financial Statements

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

Cash, Cash Equivalents and Short-term Investments

     Cash and cash equivalents consist of cash, money market funds and other
highly liquid investments with a maturity of three months or less from the date
of purchase. The Company applies Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS
115), to its short-term investments. Under SFAS No. 115, the Company classifies
its short-term investments as "available-for-sale" and records such assets at
estimated fair value in the balance sheets with unrealized gains and losses, if
any, reported in stockholders' equity. As of December 31, 1999, the cost of
short-term investments approximated fair value and all of the Company's short-
term investments were in money market accounts that invest in short-term
securities with average maturities of less than one year. The Company has not
experienced any losses on its cash, cash equivalents, or short-term investments.

Inventories

     In April 1999, Fresenius AG purchased the PROSORBA column inventory and
manufacturing facility from Cypress (see note 3).  As a result the Company has
no inventory as of December 31, 1999.  Inventories reported at December 31, 1998
are stated at the lower of cost (using the weighted average method based on the
first-in, first-out method) or market.

Property and Equipment

     Property and equipment, including assets acquired under capital leases, are
recorded at cost and depreciated or amortized over the estimated useful lives of
the assets (three to five years) or the lease term using the straight-line
method.

Accrued Clinical Trial Costs

     The Company enrolls patients in various clinical trial sites which are
conducted primarily in the United States.  The Company records the cost of such
studies as the clinical work is performed by the respective research entities.
The Company accrues costs related to clinical trials in the period incurred.

                                      F-7
<PAGE>

Debt Acquisition Costs

     Debt acquisition costs are being amortized over the life of the related
debt.

Stock and Warrants Issued for Services

     Common stock, common stock warrants and common stock options issued for
services rendered to the Company are recorded at the fair market value of the
equity instrument issued or the value of the services rendered, whichever is
more clearly determinable.

Revenue Recognition

     Revenue from the Fresenius agreement (Note 3) is recognized based on the
agreement and Fresenius' sale to independent third-parties. Revenue from product
sales is recognized when products are shipped. Revenues from government grants
are recognized based on performance requirements of the grant or as the grant
expenditures are incurred.

Research and Development

     Research and development costs are expensed as incurred.

Employee Stock Options

     The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Employees" ("APB 25") and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options.  Under
APB 25, when the exercise price of the Company's employee stock options equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized.

Net Loss Per Share

     In accordance with Statement of Financial Accounting Standards No. 128,
Earnings per Share, the computation of net loss per share is based upon the
weighted average number of shares of common stock issued and outstanding for
each period.  Common stock equivalents related to options, warrants and
convertible securities are excluded from the computation, as their effect is
antidilutive.

Long-Lived Assets

     In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of" ("SFAS 121"), impairment losses are recorded on long-lived assets
used in operations when indicators of impairment are present and the estimated
undiscounted cash flows estimated to be generated by those assets are less than
the assets' carrying amount.  To date, the Company has not identified any
indicators of impairment or recorded any impairments of long-lived assets.

Comprehensive Loss

     Effective January 1, 1998, the Company adopted "Reporting Comprehensive
Income" ("SFAS 130").  SFAS 130 establishes new rules for the reporting and
display of comprehensive income (loss) and its components.  The Company's
comprehensive loss is the same as its net loss for all periods presented.

Recent Accounting Pronouncements

     In June 1998, the FASB issued "Accounting for Derivatives and Hedging
Activities" ("SFAS No. 133"), which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities.  In May 1999, the FASB voted to delay the effective date of
SFAS 133 by one year, meaning that the Company will be required to adopt this
standard in 2001.  The Company has not used any derivative instruments to date.
Management does not anticipate that the adoption of this new standard will have
a significant effect on the financial position on results of operations of the
Company.

3.   FRESENIUS AGREEMENTS

     In March 1999, Cypress entered into an agreement with Fresenius AG
("Fresenius") of Bad Homburg, Germany, and its U.S. subsidiary, Fresenius
Hemotechnology, Inc. ("FHI"). The agreement provides Fresenius with an exclusive
license to distribute the PROSORBA column in the U.S., Europe, Latin America,
and subject to certain conditions, Japan and select Asian countries. Upon
signing of the agreement, Cypress received a total of $1.5 million from
Fresenius consisting of the purchase of  297,530 shares of Cypress common stock
for $1.0 million, and $500,000 for the purchase of three-year warrants to buy
342,466 shares of Cypress common stock at $7.50 per share.


                                      F-8


<PAGE>

     In the U.S., Cypress and FHI will jointly market the PROSORBA column.
Cypress and FHI will share in clinical trials and sales and marketing expenses
in the U.S., subject to certain annual dollar limits. Fresenius will have
exclusive distribution rights and responsibility for clinical trials and
registration of the product overseas.  In the U.S., net profit will be split
50/50 until PROSORBA column revenue reaches a pre-determined sales threshold,
after which time Cypress will receive 60% of the profits and Fresenius will
receive 40%.  Net profits will be split 50/50 outside the U.S.

     Revenue from the Fresenius agreement for the year ended December 31, 1999
consisted of Cypress's pro rata share of sales by FHI.  Until profits are
generated, Cypress will recognize revenue based on the payments from Fresenius,
which are generally determined as the ratio of allowable expenses incurred for
production, research and development and sales and marketing by Cypress compared
to allowable expenses incurred by Cypress and Fresenius under the agreement.
Prior to the Agreement with Fresenius, Cypress recorded PROSORBA column sales as
product sales in the statement of operations. As such, current year revenues are
not directly comparable to revenues recorded in the prior periods.

     In April 1999, Fresenius exercised its option to acquire the PROSORBA
column manufacturing facility and related assets, located in Redmond,
Washington, for $5.2 million.  The purchase price paid to Cypress consisted of
cash of $1.2 million and an offset of $4.0 million from the previous drawdown of
an interest-free line of credit provided by Fresenius in March 1999. In
connection with this transaction, Fresenius purchased from the company inventory
for approximately $2.0 million that resulted in a gain to Cypress of $779,000.
After final adjustments related to the sales price of the facility were
determined in the fourth quarter, an additional gain of approximately $1.7
million was recognized.

4.   FINANCIAL STATEMENT DETAILS

Inventories

     In April 1999, Fresenius AG acquired the PROSORBA column manufacturing
facility.  As a result the Company has no inventory as of December 31, 1999.
Inventories are comprised of the following as of December 31, 1998:

                                              1998
                                        ---------------
     Raw materials and components         $  536,513
     Work in progress                        288,930
     Finished goods                          189,000
                                        ---------------
                                          $1,014,443
                                        ===============

Property and Equipment

     Property and equipment are comprised of the following as of December 31:

<TABLE>
<CAPTION>
                                                         1999            1998
                                                   --------------   --------------
     <S>                                           <C>              <C>
     Laboratory and production equipment                $  98,572      $ 2,551,468
     Office equipment                                     465,918          628,928
     Vehicles                                                   -           20,924
     Leasehold improvements                                20,261           73,407
                                                   --------------   --------------
                                                          584,751        3,274,727
     Accumulated depreciation and amortization           (358,709)      (1,484,751)
                                                   --------------   --------------
                                                        $ 226,042      $ 1,789,976
                                                   ==============   ==============
</TABLE>

     Depreciation expense for the years ended December 31, 1999, 1998 and 1997
was $245,000, $542,000 and $474,000, respectively, including an asset under
capital lease.  The cost and accumulated depreciation for assets acquired under
capital leases totaled approximately $25,000 and $9,000, respectively, at
December 31, 1999 and $120,000 and $51,000, respectively, at December 31, 1998.

                                      F-9
<PAGE>

Accrued Liabilities

     Accrued liabilities are comprised of the following as of December 31:

<TABLE>
<CAPTION>
                                                  1999            1998
                                            --------------   --------------
     <S>                                    <C>              <C>
     Accrued clinical trial costs               $209,815         $576,690
     Other                                       268,662          375,758
                                            --------------   --------------
                                                $478,477         $952,448
                                            ==============   ==============
</TABLE>

5.   COMMITMENTS AND CONTINGENCIES

Operating Leases

     The Company currently occupies approximately 5,200 square feet of leased
office space in San Diego, California.  The San Diego facility houses the
Company's executive and administrative offices.  The lease for this facility
expires in 2001. In accordance with the San Diego facility lease, the Company
maintained a $35,000 certificate of deposit through August 1999, which was
classified as restricted cash on December 31, 1998.  In December 1999, the
Company signed a lease for a 2,800 square foot facility in Redmond, Washington,
to house the Company's research and medical personnel.  This lease expires in
November 2000.

     During 1998, the Company leased a 6,900 square foot facility used primarily
for the manufacturing of the PROSORBA column.  In April 1999, Fresenius acquired
the manufacturing facility and assumed the lease associated with the facility.

     The table below indicates future minimum lease obligations under the
operating leases as of December 31, 1999:

                    2000                  $148,693
                    2001                    62,751
                                --------------------------
                                          $211,444
                                ==========================

     Total rent expense was approximately $305,000, $367,000, and $501,000 for
the years ended December 31, 1999, 1998 and 1997, respectively.  Sublease income
was approximately $117,000 for the year ended December 31, 1997.  No sublease
income was received in 1999 or 1998.

Capital Leases

     The Company entered into a capital lease for office equipment in December
1998. The lease expires in April 2002. The following are the minimum lease
payments for the years ended December 31:

              2000                                           $ 9,736
              2001                                             9,736
              2002                                             3,246
                                                        -------------------
              Total minimum lease payments                    22,718
              Less amounts representing interest              (7,230)
                                                        -------------------
              Present value of capital lease payments         15,488
              Less current portion                            (6,167)
                                                        -------------------
              Capital lease obligations, noncurrent          $ 9,321
                                                        ===================

Deferred Compensation

      In connection with an employment agreement entered into in 1995, the
Company granted an aggregate of 4,159,824 options to purchase the Company's
common stock. On the date the options were granted, the closing bid price of the
Company's stock was $1.875 per share. The exercise

                                      F-10
<PAGE>

price of the options was $1.50 per share, reflecting the price per share of
stock sold in the private placement of approximately 8,500,000 shares on the
same date. The Company recorded $1,559,934 of deferred compensation expense on
such date, and such amount has been fully amortized as of December 31, 1999.

6.   LONG-TERM OBLIGATIONS

7% Convertible Debentures

     At December 31, 1999 and 1998, the Company had $400,000 of 7% Convertible
Debentures outstanding which are due March 2001.  The 7% Convertible Debentures
were originally issued in April 1994.  Interest is payable in cash or shares of
common stock at the option of the Company.  During the years ended December 31,
1999 and 1998, the Company recorded related interest expense of $28,000 which
has been paid in cash.  The conversion price for the principal amount is $2.88
per share of registered common stock, the fair market value on the date of
closing.  The conversion price for the interest is the lower of $4.00 per share
of common stock or the average closing price for the 10 days prior to the annual
April 30th interest payment date.  The debentures are redeemable by the Company
at a redemption price of 104% of the principal amount which reduces to 102% in
April 2000.

Note Payable

     In March 1998, the Company received a loan totaling $440,000 to finance the
purchase of fixed assets of which approximately $105,000 is outstanding at
December 31, 1999. In accordance with the terms, the line matures in March 2002
and interest is accrued at the bank's prime rate plus 0.5% (9.0% at December 31,
1999). The loan is fully collateralized by the fixed assets financed with the
line of credit with a net book value of approximately $83,000 at December 31,
1999.

Term Loan

     In September 1999, Cypress signed a $5.0 million term loan agreement with a
financing company of which $2.0 million was drawn down immediately.  An
additional $1.0 million was drawn in December 1999.  The remaining $2.0 million
may be drawn down at the option of the Company subject to Cypress meeting
certain financial criteria.  The initial loan is repayable in six monthly
installments of interest only at 13.29% per annum.  Thereafter, the loan is
payable in twenty-four equal monthly payments of principal and interest.
Repayment terms for the remaining loan tranches are similar to the initial loan.
The loan is secured by certain assets of the Company.  In connection with this
agreement, Cypress granted the lender a five-year warrant to purchase 168,851
shares of the Company's common stock at an exercise price of $2.96 per share.
The warrant was valued in accordance with SFAS No. 123 and is being amortized as
additional interest expense over the term of the loan.

<TABLE>
<CAPTION>
                                                                                 December 31
                                                                        1999                         1998
                                                             -----------------------      ------------------------
          <S>                                                <C>                          <C>
          7% Convertible Debentures due March 2001                    $  400,000                      $400,000
          Term loan, payable through July 2002                         3,000,000                             -
          Note Payable, payable through February 2001                    104,511                       144,804
                                                             -----------------------      ------------------------
                                                                       3,504,511                       544,804
          Less current portion                                          (843,941)                            -
                                                             -----------------------      ------------------------
                                                                      $2,660,570                      $544,804
                                                             =======================      ========================
</TABLE>

          Maturities of long-term obligations at December 31, 1999 are as
follows:

                  2000                                  $  843,941
                  2001                                   1,961,698
                  2002                                     698,872
                                             --------------------------
                                                        $3,504,511
                                             ==========================


                                      F-11
<PAGE>

7.  STOCKHOLDERS' EQUITY

Authorized Shares

     The Company is authorized to issue up to 15,000,000 shares of preferred
stock.

Private Placements

     In September 1998, the Company completed a private placement of 3,063,561
shares of the Company's Series A convertible preferred stock at a price of $1.50
per share for net proceeds of approximately $4.3 million. The Company recorded a
non-cash imputed dividend of approximately $2.1 million related to the sales of
Series A convertible preferred stock.

Series A Convertible Preferred Stock

     The Series A convertible preferred stock was converted into common stock on
January 20, 1999.

Warrants

     In 1991, the Company granted warrants to purchase 749,900 shares of common
stock to certain officers, directors and employees, which are exercisable
through June 2001 at $1.875 per share.  In April 1994, the Company issued Allen
& Company a five-year warrant to purchase 300,000 shares of common stock at
$2.875 for its services as a placement agent for the 7% Convertible Debentures
(see Note 6).

     In conjunction with transactions completed in October 1996, the Company
granted warrants to purchase 2,880,399 shares of common stock.  The warrants
entitle the holders to purchase common stock for $2.00 per share.  In March
1999, the Company called for redemption of the remaining warrants outstanding of
2,724,149.  In April 1999, the Company received net proceeds from the redemption
of $5.2 million.

     In 1998, the Company granted warrants to purchase 250,800 shares of common
stock to consultants, which are exercisable through November 2001, at prices
ranging from $1.88 to $2.40.

     In 1999 the Company issued warrants to purchase 168,651 shares of common
stock at $2.95 per share to a lessor. The warrants are exercisable through
September 2004. The Warrants were valued at $225,604 and are being amortized as
additional interest expense over the life of the loan.

Stock Options

     1996 EQUITY INCENTIVE PLAN.  In April 1996, the Company adopted the 1996
Equity Incentive Plan authorizing the issuance of both incentive and non-
qualified options to purchase the Company's common stock, as well as the
granting of stock appreciation rights, stock bonuses and rights to purchase
restricted stock.  Under the plan, 10,000,000 shares of the Company's common
stock are reserved for issuance to directors, officers, key employees,
consultants and certain advisors.

     INCENTIVE STOCK OPTIONS.  In June 1985, the Company adopted an Incentive
Stock Option and Appreciation Plan.  The plan authorizes options to purchase,
and appreciation rights with respect to, the Company's common stock, which may
be granted to such officers and key employees as may be selected by the Board of
Directors or a committee appointed by the Board to administer the plan. The plan
was amended in June 1992 to increase the number of shares reserved for issuance
to 750,000.  The plan expired in 1995; however, options previously granted under
the plan remain outstanding according to their respective terms and conditions.

     NON-QUALIFIED STOCK OPTIONS.  The Company has reserved 572,000 shares of
common stock for issuance under its 1988 Non-qualified Stock Option Plan, as
amended in 1992 and 1995.  The plan expired February 1998; however, options
previously granted under the plan remain outstanding according to their
respective terms and conditions.

     STOCK OPTIONS-OTHER.  Prior to 1997 the Company granted to employees and
others options to purchase common stock, other than pursuant to a formal option
plan.

     Options granted pursuant to each of the plans above have a term of up to
ten years and generally vest over four years.



     The following table summarizes the activity of the Company's stock options
and warrants:

                                      F-12
<PAGE>

<TABLE>
<CAPTION>
                                                                     Number of Warrants/Options
                               ---------------------------------------------------------------------------------------------------

                                                             1996              Incentive
                                                       Equity Incentive          Stock          Non-Qualified           Other
                                     Warrants            Plan Options           Options         Stock Options          Options
                               ------------------  ---------------------  ----------------  -------------------  -----------------
<S>                            <C>                 <C>                    <C>               <C>                  <C>
Balance December 31, 1996               5,365,199              5,587,157            61,000              472,000          1,150,835
     Granted                                    -                789,522                 -               30,000                  -
     Exercised                                  -                (20,000)                -                    -                  -
     Canceled                            (180,800)              (322,479)          (33,250)             (32,000)            (6,000)
     Expired                           (1,850,000)                     -            (1,500)                   -           (192,730)
                               ---------------------------------------------------------------------------------------------------
Balance December 31, 1997               3,334,399              6,034,200            26,250              470,000            952,105
     Granted                              250,800              1,311,625                 -                    -                  -
     Exercised                           (125,250)              (664,650)                -              (10,000)          (118,000)
     Canceled                                   -               (260,346)                -                    -                  -
     Expired                               (6,800)               (17,951)                -                    -            (33,105)
                               ------------------  ---------------------  ----------------  -------------------  -----------------
Balance December 31, 1998               3,453,149              6,402,878            26,250              460,000            801,000
     Granted                              511,117              1,373,000                 -                    -                  -
     Exercised                         (2,681,423)              (542,845)           (6,250)             (60,000)           (80,000)
     Canceled                            (479,726)              (473,374)                -                    -                  -
     Expired                             (142,000)               (33,476)          (13,000)                   -            (38,000)
                               ------------------  ---------------------  ----------------  -------------------  -----------------
Balance December 31, 1999                 661,117              6,726,183             7,000              400,000            683,000
                               ===================================================================================================
</TABLE>

     All warrants are exercisable at December 31, 1999 at exercise prices
ranging from $2.00 to $7.50, and 661,117 shares of common stock were reserved
for future issuance.

     With respect to stock options, at December 31, 1999, 2,041,322 options were
available for future grant and 9,857,505 shares of common stock were reserved
for future issuance.

     Following is a further breakdown of the options outstanding as of December
31, 1999:

<TABLE>
<CAPTION>
                                     Weighted Average                                          Weighted Average
                                         Remaining                                              Exercise Price
                                     Contractual Life        Weighted                             of Options
     Range of           Options          in Years            Average            Options           Exercisable
 Exercise Prices      Outstanding                         Exercise Price      Exercisable
----------------------------------------------------------------------------------------------------------------
<S>                 <C>              <C>                  <C>                <C>               <C>
$1.00 - $1.50           3,988,031           5.0                $1.50           3,904,401             $1.50
$1.51 - $2.25           2,214,152           4.2                $2.01           1,947,389             $2.02
$2.26 - $3.25           1,506,000           7.9                $2.65             455,397             $2.56
$3.26 - $4.00             108,000           7.3                $3.71              19,000             $3.61
                    ---------------                                       ----------------
                        7,816,183                                              6,326,187
                    ===============                                       ================
</TABLE>

     The weighted average exercise prices and fair values for options granted in
1999 are as follows:

<TABLE>
<CAPTION>
                                                        Weighted Average
                                             ------------------------------------
                 Exercise Price on                  Fair              Exercise
                   Date of Grant                    Value               Price
          -------------------------------    -----------------    ---------------
          <S>                                <C>                  <C>
          Equal to market price of stock              $1.95              $2.81
</TABLE>

                                      F-13
<PAGE>

     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period.  The Company's
pro forma information follows:

<TABLE>
<CAPTION>
                                                               1999                      1998                      1997
                                                      --------------------      ---------------------------------------------
<S>                                                   <C>                       <C>                             <C>
Pro forma net loss (in thousands)                       $    (9,348)                  $ (13,079)                $ (11,302)
Pro forma net loss per share - basic and diluted        $     (0.21)                  $   (0.33)                $   (0.32)
</TABLE>

     The proforma results above for 1999, 1998 and 1997 are not likely to be
representative of the effects of applying FAS 123 on reported net income or loss
for future years as these amounts reflect the expense for less than four years
of vesting.

     Pro forma information regarding net loss and net loss per share is required
by Statement 123, and has been determined as if the Company had accounted for
its employee stock options under the fair-value method of that Statement.  The
fair value for these options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted-average assumptions for
1999: a risk-free interest rate of 6%; a dividend yield of 0%; a volatility
factor of 86.9% and an option life of 4.6 years; 1998: a risk-free interest rate
of 4.8%; a dividend yield of 0%; a volatility factor of 92.5%; and an option
life of 7 years; for 1997: a risk-free interest rate of 6.49%; a dividend yield
of 0%; a volatility factor of 93.9%; and an option life of 7 years.

     The weighted average exercise prices for stock option activity are as
follows:

<TABLE>
<CAPTION>
                                              Number of Stock Options            Weighted Average
                                                  Under All Plans                Exercise Prices
                                          ----------------------------      ------------------------
<S>                                       <C>                               <C>
Balance December 31, 1996                            7,270,992                         $1.74
     Granted                                           819,522                         $1.72
     Exercised                                         (20,000)                        $1.88
     Canceled                                         (393,729)                        $2.08
     Expired                                          (194,230)                        $2.26
                                          ----------------------------
Balance December 31, 1997                            7,482,555                         $1.71
     Granted                                         1,311,625                         $2.36
     Exercised                                        (792,650)                        $1.68
     Canceled                                         (260,346)                        $2.26
     Expired                                           (51,056)                        $2.73
                                          ----------------------------
Balance December 31, 1998                            7,690,128                         $1.80
     Granted                                         1,373,000                         $2.81
     Exercised                                        (689,095)                        $1.86
     Canceled                                         (473,374)                        $2.84
     Expired                                           (84,476)                        $3.25
                                          ----------------------------
Balance December 31, 1999                            7,816,183                         $1.88
                                          ============================
</TABLE>

Defined Contribution Plan

     The Company sponsors a defined contribution plan pursuant to Section 401(k)
of the Internal Revenue Code of 1986.  This plan covers substantially all
employees who provide more than 1,000 hours of service during the year.

     The Plan provides for matching contributions whereby the Company
contributes common stock to the Plan on behalf of participants in an amount
equal to 100% of the participants' contributions during the six-month periods
ending on the last day of June and December.  The Company's contributions will
vest six months after the amount of the contribution is determined if the
employee is still employed by the Company at the end of the vesting period,
except for employees who have been with the Company more than five years for
whom contributions will vest immediately.  The expense recognized for shares
contributed on behalf of employees was approximately $206,000, $207,000, and
$166,000 for the years ended December 31, 1999, 1998 and 1997, respectively,
based upon the market value of the Company's common stock on the date of the
contribution.


                                      F-14
<PAGE>

8.   INCOME TAXES


     Significant components of the Company's deferred income tax assets as of
December 31 are as follows:

<TABLE>
<CAPTION>
                                                        1999                         1998
                                              -----------------------     ------------------------
     <S>                                      <C>                         <C>
     Net operating loss carryforwards             $   24,956,000                $ 21,416,000
     Capitalized research & development                3,683,000                   5,563,000
     Other                                             1,251,000                   1,418,000
                                              -----------------------     ------------------------
                                                      29,890,000                  28,397,000
     Valuation allowance                             (29,890,000)                (28,397,000)
                                              -----------------------     ------------------------
                                                  $            -                $          -
                                              =======================     ========================
</TABLE>

     As of December 31, 1999, the Company has accumulated federal and California
net operating loss carryforwards of approximately $70,398,000 and $5,509,000,
respectively. Approximately $2,300,000 of the federal net operating loss expired
in 1999. The federal tax loss carryforwards will continue to expire in 2000. The
California tax loss carryforward will begin to expire in 2001 unless previously
utilized. Additionally, the Company has federal and California research and
development tax credit carryforwards of approximately $1,120,000 and $94,000,
respectively, which will begin expiring in 2004 unless previously utilized.

     In accordance with certain provision of the Internal Revenue Code, a change
in ownership of greater than 50% within a three-year period will place an annual
limitation on the Company's ability to utilize its existing net operating loss
and tax credit carryforwards.  As a result of the Company's sales of common
stock, ownership changes occurred in September 1991 and October 1997.
Accordingly, the utilization of net operating loss carryforwards which had
accumulated as of September 1991 and October 1997 will be limited to a
prescribed amount in each successive year.  However, the Company believes that
this limitation will not have a material effect on the financial statements.

                                      F-15