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                      SECURITIES AND EXCHANGE COMMISSION
                           Washington, D. C. 20549
                                          
           ---------------------------------------------------------
                                          
                                   FORM 10-K
                                          
                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                                          
For the fiscal year ended March 31, 1998            Commission File No. 1-9613
                                          
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                         PACIFIC PHARMACEUTICALS, INC.
              (Exact Name of Registrant as specified in its charter)
                                          
                Delaware                                36-3258753
     (State or other jurisdiction of                 (I.R.S. Employer
      incorporation or organization)              Identification Number)

                          6730 Mesa Ridge Rd., Suite A
                              San Diego, CA  92121
                                 (619) 550-3900
              (Address, including zip code, and telephone number, 
       including area code, of Registrant's principal executive offices)
                                        
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          Securities registered pursuant to Section 12(b) of the Act:

                                                   Name of each exchange
         Title of each class                        on which registered
         -------------------                        -------------------
     Common Stock, $.02 Par Value                 American Stock Exchange

          Securities registered pursuant to Section 12(g) of the Act:
                                      None
                                (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 is not contained herein, and will not be 
contained, to the best of registrant's knowledge, in definitive proxy or 
information statements incorporated by reference in Part III of this Form 
10-K or any amendment to this Form 10-K.  [  ]

     The aggregate market value of the voting stock held by persons 
considered by the registrant for this purpose to be nonaffiliates of the 
registrant was approximately $8,935,000 on July 8, 1998, when the closing 
price of such stock, as reported in the American Stock Exchange, was $0.50.
     
     *(Market value includes value of Series A Convertible Preferred Stock 
based upon conversion rate into Common Stock). 

     The number of shares outstanding of the registrant's Common Stock, $.02 par
value, as of July 8, 1998 was 11,257,021 shares.
                                          
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                        DOCUMENTS INCORPORATED BY REFERENCE
                                          

1.   Certain portions of the Registrant's Proxy Statement for its Annual Meeting
     of Stockholders held on August  13, 1998, which will be mailed on or about
     July 13, 1998 are incorporated into Part III hereof.

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                                    PART 1
                                          
ITEM 1.   BUSINESS

SUMMARY

     Pacific Pharmaceuticals, Inc. and Subsidiaries (collectively, the 
"Company"), a development stage enterprise, is engaged primarily in the 
development and commercialization of medical products based on 
biotechnological research regarding the treatment and detection of cancer and 
other diseases. 
     
O(6) BENZYLGUANINE 
     
     During the fiscal year ended March 31, 1998, the Company acquired a 
worldwide exclusive license for O(6) Benzylguanine (BG), a series of related 
compounds and a gene therapy which the Company believes to enhance the 
effectiveness of a class of currently used chemotherapeutic agents (O(6) 
alkylators). These technologies are licensed to the Company from Pennsylvania 
State University, the National Institutes of Health (NIH), the University of 
Chicago, and Case Western Reserve University. The Company, in turn, assigned 
the License to its subsidiary, BG Development Corp. ("BGDC"). See--"BG 
Development Corp.; Proprietary Rights; Research and Development".

     BG and related compounds are small molecules for intravenous 
administration in the treatment of cancer. The Company believes BG to be 
capable of destroying the resistance of cancer cells to a class of 
chemotherapeutic agents, O(6)-alkylating agents, which include carmustine 
(BCNU), lomustine (CCNU), dacarbazine (DTIC), streptozotocin, procarbazine, 
fomustine, and temozolomide. The Company believes that the effectiveness of 
alkylating chemotherapeutic agents against various tumors such as brain, 
prostate, colon cancers, melanoma and lymphoma is limited due to the ability 
of tumor cells to repair the DNA damage caused by the alkylating agents, 
because the DNA repair protein, AGT (O(6)-alkylguanine-DNA alkyltransferase), 
protects tumor cells by repairing the tumor cell DNA. The Company believes 
that BG  inactivates the AGT protein in a variety of cancers thereby 
overcoming resistance to the O(6)-alkylating agents.
     
     A Phase I clinical trial of BG has been completed at Duke University 
Medical Center, and two other Phase I trials are currently being conducted at 
the University of Chicago and Case Western Reserve University, respectively.  
A study in brain cancer patients has established the dose of BG at which the 
levels of tumor AGT protein are depleted by more than 90%. The other studies 
are currently examining the safety of a combination of BG and BCNU in a 
variety of tumors.  The Company plans to initiate a Phase II clinical trial 
with a combination of BG and BCNU initially in brain cancer. The Company 
intends to pursue clinical trials with BG in melanoma, lymphoma and colon 
cancer and to pursue the use of BG in combination with alkylating agents in 
cancer patients undergoing bone marrow transplantation.

     O(6)-ALKYLATING CHEMOTHERAPEUTIC AGENTS. The treatments for most cancers 
include surgery, chemotherapy and/or radiation therapy.  O(6)-alkylators are 
chemotherapeutic agents that are primarily used to treat brain cancer, 
melanoma, lymphoma and certain gastrointestinal cancers.  BCNU and DITC 
remain important in the chemotherapeutic treatment of brain cancer and 
advanced melanoma. Procarbazine has become an important agent in the 
treatment of Hodgkin's disease and brain tumors.  Temozolomide has shown 
potential for the treatment of lymphomas, melanoma and brain tumors.  In 
general, although there is a small percentage of patients who have achieved 
long-term remission, the O(6)-alkylators are generally not considered 
curative.  The critical factor contributing to the poor prognosis is the 
resistance of cancers to the chemotherapeutic agents.

     POTENTIAL ROLE OF BG IN ABROGATING CANCER DRUG RESISTANCE. Tumor cells 
display a variety of mechanisms of resistance to many drugs.  Alkylating 
agents act by causing damage to the DNA by binding to the O(6)-position of 
guanine on the DNA strand.  AGT is believed to play a significant role in 
cancer resistance to the O(6)-alkylators by removing this chemical bond. A 
published study in 226 patients with 

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brain cancer (high-grade astrocytoma) receiving BCNU therapy showed that the 
patients with low levels of AGT responded better to treatment and had 
increased survival relative to patients with high levels of AGT. Conversely, 
the patients with high levels of tumor AGT protein had poor disease 
prognosis.  Since it appears that BG temporarily destroys AGT, the Company 
believes that BG may reduce the resistance that is commonly observed in 
cancer cells following treatment with O(6)-alkylating agents.
     
     O(6)-alkylating agents such as BCNU and CCNU are believed to cause a 
number of different damages to the tumor DNA, including an interstrand 
cross-link between guanine and cytosine (building blocks of DNA) on the 
opposite strand. The Company believes that there is a strong correlation 
between the number of strand cross-links and tumor cells killed.  AGT protein 
protects tumor cells from damage by removing the damage from the 
O(6)-position of guanine. The Company believes that there are no other 
proteins involved in the repair process, and that the AGT protein is 
inactivated in the repair process. The Company believes that BG binds to the 
AGT protein, thereby blocking the tumor DNA repair and believes that 
inactivation of the AGT protein in a variety of human tumors by non-toxic 
doses of BG could render these tumors more sensitive to the cytotoxic effects 
of O(6)-alkylating agents. 

     EFFICACY OF BG IN ANIMAL STUDIES. Results of in vitro testing have led 
to an evaluation of O(6)-alkylating agents in animal tumor models.  Upon 
administration of BG to mice carrying two different human brain tumors prior 
to the administration of BCNU, 80% and 100% tumor regression was observed 
compared to 0% and 10% suppression in animals treated with BCNU alone. 
Combinations of BG and BCNU were also found to be effective in mice bearing 
human colon cancers, showing 96% tumor regression compared to 35% tumor 
regression with BCNU alone. Growth inhibition was also observed in a rat 
prostate model after treatment with BG and BCNU, which inhibition was not 
observed in animals treated with BCNU alone.

     HUMAN CLINICAL TRIALS WITH BG. To date BG has been entered into three 
different Phase I dose escalation clinical trials.  The Company believes that 
a completed clinical study at the Duke University Medical Center has shown 
that BG, injected intravenously, crosses the blood-brain barrier and 
effectively blocks the activity of human brain tumor AGT protein. The Company 
believes that the study at Duke University Medical Center has demonstrated BG 
to be nontoxic when administered alone, and to be effective in inhibiting 
over 90% of AGT activity in brain cancer specimens surgically removed from 
patients 18 hours after the intravenous administration of BG.  Clinical 
studies at the University of Chicago and Case Western Reserve University are 
examining the use of BG in combination with BCNU in brain, colon and renal 
cancer.  In these studies, BG is administered over a one-hour period by 
intravenous infusion, followed by an infusion of BCNU one hour after 
completion of the BG infusion.  At the conclusion of these Phase I clinical 
studies, the Company anticipates entering a Phase II efficacy study for BG in 
brain cancer, followed by studies in other cancers. The Company plans to 
pursue the use of BG in combination with the alkylating agents in cancer 
patients undergoing bone marrow transplantation.

     GENE THERAPY.  Standard therapy with O(6)-alkylating chemotherapeutic 
agents commonly results in bone marrow suppression.  Through the BG license, 
the Company has also acquired a proprietary gene therapy that may result in 
the production of an altered AGT protein in bone marrow cells.  A gene for an 
altered AGT protein is introduced to the bone marrow hematopoietic stem cells 
in vitro, followed by the introduction of the modified stem cells to the 
host.  The Company believes that the concomitant use of an O(6)-alkylating 
agent plus BG in the presence of the altered AGT protein may result in 
reduced resistance of the cancer cells with less toxicity to the bone marrow. 

     RELATED TECHNOLOGIES. In addition to BG, a considerable number of 
additional compounds have been tested for AGT protein inactivation. The 
Company believes that a number of next generation compounds have been found 
to be effective in inhibiting the activity of tumor AGT protein. The Company 
also believes that it has a proprietary interest in these compounds. The 
Company believes that it is possible that these compounds will offer 
complementary properties to that of BG in further abrogation of cancer 
resistance to O(6)-alkylating agents.

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     PATENTS AND PROPRIETARY TECHNOLOGIES. Four patents including the 
composition of matter and use for BG and related compounds have been issued. 
Four additional applications provide protection for the next generation 
compounds. A patent application currently under prosecution is intended to 
provide protection for the use of gene therapy to introduce AGT mutant into 
the stem cells. 
     
BG DEVELOPMENT CORP.; PROPRIETARY RIGHTS; RESEARCH AND DEVELOPMENT
     
     The Company and Pennsylvania State University (the "Licensor") entered 
into an exclusive, worldwide, royalty bearing license agreement (the 
"License") with the right to grant sublicenses to certain patents and patent 
applications relating to the manufacture and use of proposed products 
incorporating BG. The Company, in turn, assigned the License to BGDC, 
then a wholly owned subsidiary of the Company, pursuant to an Assignment 
and Assumption Agreement dated April 20, 1998 (the "Assignment").  In 
accordance with the Assignment, BGDC has assumed the obligations of the 
Company under the License, including royalty and other payments more fully 
described below, provided that the Company guarantees such payments. 
     
     The Company and BGDC are pursuing a private placement transaction (the 
"Transaction") to fund the development of BG and to provide capital resources 
for the Company to develop its other products. Any offer and sale of 
securities in the Transaction would be made in reliance on an exemption from 
registration under the Securities Act of 1933, as amended, and the rules and 
regulations promulgated thereunder. Under the terms of the Transaction, the 
Company and BGDC would sell up to $10.0 million of a class of Preferred Stock 
of BGDC (the "BGDC Preferred Stock") convertible into shares of BGDC common 
stock. The Company and BGDC closed on $2.9 million gross proceeds ($2.6 
million net proceeds) on June 22, 1998. Following the closing, BGDC is no 
longer a wholly owned subsidiary of the Company, but remains majority owned 
by the Company. The Company cannot predict when or if any future closing of 
the Transaction will occur.
      
     Under the terms of the License, the Company has a six month evaluation 
period ending on September 17, 1998. The Company may terminate the agreement 
during the evaluation period and pay $75,000 to the Licensor.
     
     The Company has had preliminary discussions with the N.I.H. with respect 
to entering into a Cooperative Research and Development Agreement ("CRADA"). 
Pursuant to the CRADA the N.I.H. would, among other things, make available to 
the Company (a) all N.I.H. clinical data relating to any potential products 
incorporating BG ("Licensed Products") developed or generated by the N.I.H. 
prior to the date of the CRADA and (b) all subsequent data developed under 
such CRADA.  The Company estimates that, pursuant to the CRADA, it would be 
required to pay to the N.I.H. approximately $125,000 per year for four years.
     
     If the Company elects to continue the License after the evaluation 
period, the Company has agreed to pay to the Licensor a percentage of sales 
of Licensed Products as well as certain performance-based milestones. In 
accordance with the terms of such sales, the Company has agreed to pay to the 
Licensor a non-refundable minimum annual royalty (the "Minimum Annual 
Royalty") equal to $75,000 per year creditable against future milestone 
payments and third party payments, subject to certain deferrals. The Company 
must also pay to the Licensor $150,000 as an up-front licensing fee payable 
in cash or equity at the discretion of the Company.  The Company may fulfill 
up to 75% of it's payment obligations resulting from Minimum Annual Royalties 
or performance milestones through the issuance of a number of shares of the 
Company's Common Stock equal to the cash value of such payments. The Company 
is obligated to reimburse the Licensor approximately $200,000 for prior 
patent costs in six monthly installments commencing in September 1998. In 
accordance with the Assignment, BGDC has agreed to assume the above described 
obligations of the Company. To the extent that the Company satisfies any of 
the obligations through the issuance of shares of its Common Stock, BGDC has 
agreed to reimburse the Company for fair market value of the Company's Common 
Stock.

                                       3

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PHOTODYNAMIC THERAPY (PDT) - BINARY THERAPEUTICS, INC.


     PHOTODYNAMIC THERAPY (PDT) OVERVIEW. Photodynamic Therapy is an emerging 
mode of treatment for cancer which uses the combination of light-activated 
drugs and nonthermal light to achieve selective, photochemical destruction of 
cancer cells with minimal effect on surrounding normal tissues.  PDT 
typically has two primary components:

     1.   DRUG ADMINISTRATION:  A light-absorbing dye or other "photosensitizing
          drug" is injected into the patient. (PDT drugs are designed to be
          "selective," i.e., taken up and retained in cancerous cells while,
          conversely, quickly clearing from normal cells.

     2.   ILLUMINATION WITH LIGHT:  After administration of the PDT drug, a
          laser or other source is used to illuminate the area of treatment with
          light at the specific wavelength required for absorption by the drug. 
          The light is non-thermal and, similar to the drug, has no therapeutic
          effect by itself.   
 
     The absorption of light energy by the drug generates biochemical 
reactions which destroy the cancer cells; the reaction is highly controlled 
and will end upon cessation of the light energy.
     
The potential advantages of PDT in the treatment of cancer are expected to be 
as follows:

     -    Selectivity:  Selective to cancer cells with minimal effect on normal
          healthy tissue, a significant benefit over chemotherapy and radiation
          treatment.
     -    More Extensive Eradication:  Facilitates the treatment of not only the
          larger, easily identifiable tumors but also other cancerous cells
          which are in the field of illumination.
     -    Controllable:  The photosensitizing drugs are inactive until excited
          by light within their specific absorption band.  Photodynamic activity
          begins only when the drug-saturated cells are exposed to light and
          ends when the light is terminated.

     Among the clinical applications expected for PDT is as an adjunct to 
surgery;  PDT has the potential of increasing the effectiveness of surgery by 
destroying cancerous cells missed by surgery.  In other instances, PDT might 
serve as an alternative to surgery.  PDT may represent a less invasive 
technique for primary removal of a tumor where surgery is not indicated (for 
example, inoperable tumors located close to nerves, major blood vessels or 
other critical tissue).  PDT may be integrated with the patient's total 
treatment regimen, used in combination with or as an alternative to 
traditional treatment to palliate more advanced disease.  The Company expects 
that the applications will develop as PDT becomes more proven and the range 
of clinical utility is demonstrated.

     A limited number of drug compounds and systems have been approved by the 
applicable regulatory agencies both in the United States and internationally. 
PDT products or systems currently approved for use, however, are limited to 
treatment of superficial or surface tumors due to inherent limitations in the 
technologies.    
          
     BORONATED PROTOPORPHYRIN COMPOUND ("BOPP") FOR TREATMENT OF BRAIN AND 
OTHER CANCERS. BOPP is currently undergoing preparation for human clinical 
trials as a photosensitizing drug for PDT treatment of brain cancer.  The 
Company believes, based upon the results of preclinical studies, that BOPP 
may be useful as a photosensitizing drug for PDT treatment of other tumors.  
BOPP is also suitable for use in another form of cancer treatment, Boron 
Neutron Capture Therapy, in which a neutron radiation beam is used instead of 
light as the activating energy source.  However, in this case, the neutron 
beam causes the disintegration of the boron atoms within BOPP and the release 
of alpha particles which are lethal to the cancer cells. 
     
     OPTION TO ACQUIRE BINARY THERAPEUTICS, INC. On June 4, 1996 the Company 
entered into an agreement with Binary Therapeutics, Inc. ("BTI") under which 
the Company was granted an option to acquire BTI, a development stage company 
and the holder of certain technologies in the area of PDT for cancer.  The 
agreement, as amended,  gives the Company the right to acquire BTI by a 
merger of BTI into a wholly-owned subsidiary of the Company. In February 
1997, the Company and BTI agreed to extend the period during which the 
Company may exercise its option to acquire BTI from April 30, 1997 until such 

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time as BTI has completed human clinical trials of BOPP at an agreed upon 
dose level (the "Option Period"). The Option Period was extended at the 
Company's request to enable BTI to complete pre-clinical studies, to commence 
clinical trials in humans and to demonstrate that a given dose level of BOPP 
in humans would not cause certain adverse events. Accordingly, the Company 
has deferred its election to exercise the option until all of the conditions 
have been satisfied.
 
     The agreement calls for the Company to issue common stock to the BTI 
stockholders with an aggregate acquisition value of $6,000,000. The number of 
shares of the Company's common stock to be issued will be determined based 
upon the market value of the Company's common stock prior to the date of 
exercise, but not less than 1,000,000 nor more than 3,000,000 shares of its 
common stock. The agreement has been approved by a majority of the 
stockholders of BTI. The Board of Directors voted to approve the merger, 
however the merger is also subject to shareholder approval for  the issuance 
of additional shares of common stock. One of the Company directors is also a 
director of BTI.

     Under the agreement, the Company will assist BTI during the option 
period in preparing the PDT products for advancement into human clinical 
trials. The Company pays substantially all of BTI's operating expenses which 
are comprised primarily of product development costs. The Company is also 
required to advance to BTI funds to repay $664,000 in indebtedness, including 
accrued interest as part of the acquisition price of BTI. Certain holders of 
such indebtedness are shareholders of the Company.  In exchange for such 
funding, BTI issues convertible notes to the Company which may be converted 
into BTI equity at the Company's option if the merger is not consummated. The 
Company has advanced $2,458,000 to BTI since the signing of the merger 
agreement. 
     
     PATENTS. Patents encompassing the BOPP technology have been issued to 
the Regents of the University of California in the United States and 
Australia, Ireland and South Africa.  Patent applications are pending in 
Canada, the European Patent Organization, Japan, Norway and Israel.  Rights 
related to the above patents were licensed to BTI under an Exclusive License 
Agreement dated July 1, 1992, as amended August 29, 1995, pursuant to which 
BTI is obligated to make certain payments.

     PRECLINICAL TESTING OF BOPP. Preclinical testing of BOPP in the United 
States and Australia, including testing of the compound with various animal 
models, has indicated that BOPP has the following advantages over certain 
existing PDT agents (including hematoporphyrin derivative, or "HpD") in the 
treatment of certain cancers:

     -    Selective (as much as 200 in tumors to 1 in healthy tissue) retention
          of BOPP in brain tumor models, compared to a 30 to 1 or less for
          existing known compounds. 
     -    Intracellular localization in mitochondria  (the energy center of the
          cell) for more efficient tumor cell killing.
     -    Highly water soluble and stable under physiological conditions.

     BOPP is selectively taken up in rapidly growing tissues and may find 
applications in many hyperproliferative disorders, such as vascular and 
coronary restenosis following angioplasty or bypass surgery, psoriasis and 
rheumatoid arthritis.  PDT therapy is being studied in academic centers for 
conditions as diverse as acute macular degeneration of the retina, removing 
microbial contaminants from blood and cleansing bone marrow of leukemic cells.

     HUMAN CLINICAL STUDIES. BTI and the Company filed an Investigational New 
Drug application ("IND") with the FDA in March 1998. Human clinical trials 
began in May 1998 and BTI and the Company have agreed to target brain cancer 
for the initial human clinical studies, which will be conducted at the Royal 
Melbourne Hospital in Melbourne, Australia, in part because one of the 
world's experts in PTD for the treatment of brain cancer will oversee the 
clinical trials.

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CANCER IMMUNOTHERAPY

     CANCER IMMUNOTHERAPY OVERVIEW. The Company's proprietary cancer 
immunotherapy treatment is in preparation for human clinical trials and may 
initially target breast cancer.  Cancer immunotherapy treatment consists of 
the co-injection of an infrared absorbing dye (photosensitizing drug) and an 
immunoadjuvant directly into a tumor followed by illumination with an 
infrared laser.  The Company believes that the potential of cancer 
immunotherapy therapy to destroy metastatic tumors offers an improved 
methodology for treatment of cancers such as breast, lung and prostate, 
particularly when in the more advanced stages. Cancer immunotherapy therapy 
is intended to produce tumor tissue destruction in the primary area of 
treatment.  An important distinction of cancer immunotherapy treatment, 
however, is that this therapy is also intended to trigger an immune reaction 
in the patient to complete the destruction of the primary tumor and to also 
concomitantly destroy any metastases. 
     
     Many experts believe that long-term control or elimination of cancer 
requires the utilization of the patient's own immune surveillance and defense 
systems. An optimal cancer treatment would be one that fully restores and 
stimulates the body's normal immunobiological responses against the growth of 
malignant cells.  For reasons not completely understood, the body's immune 
response in cancer patients is not fully stimulated or developed to the 
extent necessary to halt the proliferation of malignant cells. Attempts have 
been made using stimulants (immunoadjuvants) to activate the immune system to 
activate the immune system.  However, the use of a nonspecific immunoadjuvant 
may only "activate" the body's immune system without specifically targeting 
the cancer cells. Immunotherapy using an immunoadjuvant alone appears to 
achieve only limited success in the treatment of cancer.     

     PRECLINICAL STUDIES OF CANCER IMMUNOTHERAPY TREATMENT. Preclinical 
studies of cancer immunotherapy treatment conducted with animals indicate 
that the therapy induces a specific immune response which appears to destroy 
primary and metastatic tumors, and may provide longer-term protection against 
recurrence of the cancer.  As indicated above, cancer immunotherapy treatment 
is initiated with the injection of a combination of an infrared absorbing dye 
and an immuno-adjuvant directly into a tumor.  The light absorbed by the dye 
raises the temperature within the tumor and produces photothermal destruction 
of tumor tissue.  This photothermal destruction is only the precursor of what 
is believed to be the more significant component of cancer immunotherapy 
therapy, the immune response.  

     The hypothesis of the Company's scientific collaborators is that this 
response proceeds as follows:  The immuno-adjuvant stimulates an immune 
response directed against the specific antigen unmasked by the photothermal 
treatment of the tumor, resulting in an immunological attack against the 
tumor cell population. Even more significantly, a systemic immune response 
can also stimulated, which may destroy tumors distant from the site of 
treatment, namely metastases. The immune response appears to provide 
long-term immunity toward the cancer and the prospect for a "true cure."    

     Preclinical testing of cancer immunotherapy therapy has included 
treatment of rats inflicted with a sub-surface chemically-induced breast 
cancer tumor. The breast cancer model tested, the DMBA-4 cell line, is an 
extremely challenging model which is characterized by rapid proliferation of 
the primary tumor and the formation of metastatic tumors throughout the body. 
Of the untreated rats, 99% die within 30 days of tumor implantation.  The 
model has proven to be unresponsive to traditional treatments including 
surgery, chemotherapy, radiation and laser therapy.  

     With the application of what the principal researchers currently believe 
to be optimal dosing, cancer immunotherapy treatment has generated success 
(measured by both tumor eradication and long-term survival) in a proportion 
of the animals treated.  Importantly, tumor eradication appeared to be 
achieved for both the primary tumor treated, and possibly the metastases 
which were not directly subject to the injection treatment. This supports the 
hypotheses that the regression of the metastases has been caused by 
stimulation of an immune response. Upon rechallenge (reintroduction of  tumor 
cells  to the animals 

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subsequent to the original tumor eradication) the "second generation" tumors 
are also eradicated, indicating the existence of longer-term immunity against 
cancer. 

     HUMAN CLINICAL STUDIES. The Company has targeted breast cancer for the 
initial human clinical studies, in part, because of the preclinical success 
achieved with breast cancer studies in animals.  The Company's current plan 
is to commence a Phase 1 clinical study of breast cancer patients who have 
been nonresponsive to other treatment methodologies.

     EXCLUSIVE LICENSE TO CANCER IMMUNOTHERAPY FROM WOUND HEALING OF OKLAHOMA 
("WHO"). The Company obtained an exclusive worldwide license to the cancer 
immunotherapy technology in May 1996 under an agreement with WHO, a privately 
held company. The agreement calls for the Company to pay WHO royalties based 
on sales of products incorporating the cancer immunotherapy technology, 
including a minimum royalty of $50,000 per year.  The Company has also 
entered into a research agreement (see - "Product Development Strategy") with 
WHO under which the principal developers of the cancer immunotherapy 
technology are assisting with the preparation of the IND application to the 
FDA and performing additional studies to investigate the mechanism of action 
of cancer immunotherapy.
     
     PATENTS. WHO was assigned the rights by the holders thereof to patent 
applications encompassing the cancer immunotherapy technology in the United 
States and the countries covered by the Patent Cooperative Treaty ("PCT") by 
the holders.

AST TECHNOLOGY - PERIODONTAL TISSUE MONITOR (PTM) 

     PERIODONTAL DISEASE. A World Health Organization report estimates that 
the incidence of periodontal disease worldwide averages 33% of the total 
adult population, or approximately 1.5 billion people.  In the United States 
alone, surveys by the American Dental Association indicate that approximately 
16 million "scaling and root planing" sessions (a common treatment for 
periodontitis) are held each year at an average cost of $200 to $800 per 
session.  Prevalence of the disease and expenditures for treatment are also 
significant in many international markets.

     Because of the difficulty in diagnosing active periodontitis, and the 
fact that all current diagnosis methods are retrospective, the dental 
practitioner is often forced to treat the disease relatively late in its 
progression and may treat the entire mouth of a patient even though the 
disease is active in only a few specific sites.  Treating the patient's full 
mouth in such instances results in unnecessary cost and patient discomfort, 
and late treatment may result in the need for more extensive, and costly, 
treatment techniques. 

     PTM PRODUCT. The Company's proprietary PTM is an eye-readable, chairside 
disposable test designed for use within the dental office to assist 
practitioners (dentists and periodontists) in the diagnosis of periodontitis 
and in the monitoring of the effectiveness of their efforts to treat the 
disease. The PTM works by identifying the enzyme aspartate aminotransferase 
("AST") which is found in crevicular fluid when cells die. 

     The PTM is designed to be simple, easy to use, and is performed 
chairside in the dental office.  The dental professional initiates the test 
by touching a small strip of paper to the neck of the tooth to collect a 
fluid sample.  The paper strip is then placed in a solution which changes 
color if the active disease is present.  This process takes approximately 8 
to 12 minutes.  Since the PTM has such a short turn-around time, the test can 
be initiated at the start of an office visit with results available before 
the patient leaves the dental chair.  The PTM requires no special equipment, 
has a long shelf-life and is disposable.  The most important benefits the 
Company expects from use of the PTM are:

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     -    Assistance with early detection of the disease, facilitating earlier
          treatment and less extensive treatment techniques.

     -    Testing for active periodontal disease on a site-by-site basis,
          allowing the clinician to treat only those sites with active disease
          and avoiding unnecessary extensive therapy.  

     -    Evaluation of the effectiveness of treatment within weeks of such
          treatment, facilitating immediate follow-up treatment if necessary.

     Periodontitis is usually chronic, in some patients reappearing from time 
to time, and in others persisting for extended time periods.  It is expected 
that several PTM tests may be used on a patient throughout a year; one PTM 
prior to treatment, and one or more following treatment to determine if the 
treatment has been effective. It is anticipated that PTM will be used to 
monitor patients over an extended period of time.

     PTM PATENTS AND REGULATORY APPROVAL.  The Company licensed certain 
technology from the University of Illinois ("U of I") on the use of AST as an 
adjunct to the diagnosis and monitoring of treatment of periodontal disease. 
Two U.S. patents relating to the licensed technology have been issued; 
international patent protection was only available on one of the 
technologies, and patents have been received in major international markets. 
In addition to the U of I patents, patents encompassing the PTM have been 
issued in the United States, and in Australia, Canada, Hong Kong, Israel, 
Japan, New Zealand, Singapore, South Africa, and with the European Patent 
Organization.  A patent application has been filed pursuant to the PCT.

     On June 23, 1997, the Company received approval from the FDA to begin 
commercial sales and distribution in the United States of the PTM product. 
During the current year, the Company also signed two agreement with 
Steri-Oss, Inc. for the exclusive five-year distribution of PTM worldwide, 
except in Japan. To date, there have been no significant sales under the 
license agreement. The Company's distribution agreement with Hawe Neos for 
distribution of PTM in Europe terminated in November 1997. The company also 
has an agreement with Shofu, Inc. covering distribution of the PTM in Japan. 
The product is currently undergoing clinical trials in Japan and is in the 
regulatory approval process. 

PHOTOCHROMIC TECHNOLOGY ("KEPHRA-TM-")

     KEPHRA TECHNOLOGY AND MARKET APPLICATIONS.  The name "Kephra" 
encompasses the Company's family of dyes which react with sunlight or other 
sources of UV light ("photochromic dyes").  The Kephra dyes are colorless 
when viewed under room fluorescent or incandescent light, but become very 
colorful when exposed to UV light.  The Kephra process is reversible such 
that when the dyes are removed from sun light they return to their original 
colorless appearance.  Kephra dyes have a relatively long lifetime, and the 
colorless to color process can be repeated numerous times depending upon the 
application.  Kephra dyes can be used in numerous printing processes, 
including lithography, flexography, and silk screen.  The dyes can also be 
incorporated into water-based inks. The Company is not actively developing 
opportunities to sell products using Kephra technology. The Company is, 
however, trying to sell or license its photochromatic technology to others in 
order to focus completely on development of its other products. The Company 
is not expecting its Kephra technology to generate significant revenues.

PRODUCT DEVELOPMENT STRATEGY

     The Company conducts its research and other product development efforts 
through a combination of internal and collaborative programs.  The Company 
currently does and will rely upon research arrangements with universities, 
contract research organizations, and similar institutions and persons for a 
significant portion of its product development efforts, particularly for 
preclinical work being for all of it's products under development.  The 
Company expects to increase its internal product development resources as its 
efforts related to the BG, cancer immunotherapy and PDT areas, reflecting the 
Company's refocus toward the development and commercialization of medical 
products based on biopharmaceutical research regarding the treatment of 
cancer. Product development efforts related to the PTM and Kephra 

                                       8

<PAGE>
                                        
technologies have previously been conducted primarily by the Company's 
internal personnel. No further product development work is underway for PTM 
and Kephra products. The Company incurred product development costs of 
$2,196,000, $2,566,000 and $1,854,000 in the years ended March 31, 1998, 
1997 and 1996, respectively.  BTI relies almost exclusively on such 
collaborative research arrangements for its PDT product development efforts.  
The Company has relied upon licensing and other transactions to gain access 
to proprietary technologies. See - "Cancer Immunotherapy", "Photodynamic 
Therapy (PDT)-Binary Therapeutics, Inc.--.," and "AST Technology - 
Periodontal Tissue Monitor"("PTM").    

PATENTS AND PROPRIETARY RIGHTS

     The Company believes that patents and other proprietary rights are 
important to its business.  The Company's policy is to file patent 
applications to protect technology, inventions and improvements to its 
inventions that are considered important to the development of its business.  
The Company also relies upon trade secrets, know-how, continuing 
technological innovations and licensing opportunities to develop and maintain 
its competitive position.

     To date, the Company has received a number of patents, and filed a 
number of other patent applications, relating to the Company's technologies 
in the United States and internationally.  The Company has also benefited 
from such issuances or filings of others as a licensee.  In addition, a 
potential acquisition candidate of the Company, Binary Therapeutics, Inc., 
has also benefited from such patent issuances or filings of others as a 
licensee (see discussions of specific patents throughout this "BUSINESS" 
section).  

     The patent positions of biotechnology firms and other high-tech firms, 
including the Company, are uncertain and involve complex legal and factual 
questions for which important legal principles are largely unresolved.  In 
addition, the coverage claimed in a patent application can be significantly 
reduced before a patent is issued.  Consequently, the Company does not know 
whether any patent applications will result in the issuance of patents. 
Additionally, the Company does not know whether its existing patents (and any 
patents related to its patent applications which subsequently may be issued) 
will provide significant proprietary protection or will be circumvented or 
invalidated.  Since patent applications in the United States are maintained 
in secrecy until foreign counterparts, if any, publish or issue patents and 
since publication of discoveries in the scientific or patent literature often 
lag behind actual discoveries, the Company cannot be certain that it or any 
licenser was the first creator of inventions covered by existing patents or 
pending patent applications or that it or such licenser was the first to file 
patent applications for such inventions.  Moreover, the Company might have to 
participate in interference proceedings declared by the U.S. Patent and 
Trademark Office to determine priority of inventions, which could result in 
substantial cost to the Company, even if the eventual outcome were favorable 
to the Company.  There can be no assurance that the Company's current 
patents, or patents relating to its patent applications, if issued, would be 
held valid by a court or that a competitor's technology or product would be 
found to infringe such patents.

     A number of biotechnology and high-tech companies and research and 
academic institutions have developed technologies, filed patent applications 
or received patents on various technologies that may be related to the 
Company's business. Some of these technologies, applications or patents may 
conflict with the Company's technologies, patents or patent applications.  
Such conflict could limit the scope of the patents (if any) that the Company 
has or may be able to obtain or result in the denial of the Company's patent 
applications.  In addition, if patents that cover the Company's activities 
are issued to other companies, there can be no assurance that the Company 
would be able to obtain licenses to these patents at a reasonable cost or be 
able to develop or obtain alternative technology.

     The Company also relies upon trade secret protection for its 
confidential and proprietary information.  There can be no assurance that 
others will not independently develop substantially equivalent 

                                       9

<PAGE>
                                        
proprietary information and techniques or otherwise gain access to the 
Company's trade secrets or disclose such technology or that the Company can 
meaningfully protect its trade secrets.

     It is the Company's policy to require its employees, consultants, and 
other parties to collaborative agreements to execute confidentiality 
agreements upon the commencement of employment or consulting relationships or 
a collaboration with the Company.  These agreements provide that all 
confidential information developed or made known during the course of the 
relationship with the Company is to be kept confidential and not disclosed to 
third parities except in specific circumstances.  In the case of employees, 
the agreements provide that all inventions resulting from work performed for 
the Company, utilizing property of the Company or relating to the Company's 
business and conceived or completed by the individual during employment shall 
be the exclusive property of the Company to the extent permitted by 
applicable law.  There can be no assurance, however, that these agreements 
will provide meaningful protection of the Company's trade secrets or adequate 
remedies in the event of unauthorized use or disclosure of such information.

MANUFACTURING AND MARKETING

     The Company engages primarily in the development of biotechnological 
products, and intends, through marketing agreements, sublicenses or other 
means, to rely upon relationships with domestic and/or international 
companies for the marketing of such products.  The Company has relied upon 
contract manufacturers for its products under development and for its limited 
commercial production requirements to date, although the Company has retained 
certain quality control and managerial responsibility.  The Company may elect 
to internalize more of the manufacturing and marketing responsibilities at 
such time as such a strategy is determined to be economically advantageous 
and as its financial resources and personnel permit such efforts. The 
commercial success of some of the Company's products (if successfully 
developed) may, to a large extent, depend upon the manufacturing and 
marketing efforts of others.

GOVERNMENT REGULATION AND GOVERNMENT APPROVALS

     The manufacturing and marketing of the Company's medical products are 
subject to regulation for safety and efficacy by governmental authorities in 
the United States and other countries.  In the United States, pharmaceuticals 
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, approval, advertising 
and promotion of the Company's medical products.  Product development and 
approval within this regulatory framework takes a number of years and 
involves the expenditure of substantial resources.

     The steps required before a pharmaceutical agent, such as the proposed 
cancer immunotherapy or PDT products, may be marketed in the United States 
include (i) preclinical laboratory and animal tests, (ii) the submission to 
the FDA of an IND, which must become effective before human clinical trials 
may commence, (iii) adequate and well-controlled human clinical trials to 
establish the safety and efficacy of the drug, (iv) the submission of the New 
Drug Application ("NDA") to the FDA, and (v) the FDA approval of the NDA 
prior to any commercial sale or shipment of the drug. In addition to 
obtaining FDA approval for each product, each domestic drug manufacturing 
establishment must be registered with the FDA.  Domestic manufacturing 
establishments are subject to biennial inspections by the FDA and must comply 
with current Good Manufacturing Practices ("GMP") for drugs.  To supply 
products for use in the United States, foreign manufacturing establishments 
must comply with GMP and are subject to periodic inspection by the FDA or by 
regulatory authorities in such countries under reciprocal agreements with the 
FDA.

     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.

                                       10

<PAGE>
                                        
     Clinical trials involve the administration of the pharmaceutical product 
to healthy volunteers or to patients identified as having the condition for 
which the pharmaceutical is being tested.  The pharmaceutical is administered 
under the supervision of a qualified principal investigator.  Clinical trials 
are conducted in accordance with protocols previously submitted to the FDA as 
part of the IND that detail the objectives of the study, the parameters used 
to monitor safety and the efficacy criteria evaluated.  Each clinical study 
is conducted under the auspices of the independent Institutional Review Board 
("IRB") at the institution at which the study is conducted.  The IRB 
considers, among other things, ethical factors, the safety of the human 
subjects and the possible liability for the institution.

     Clinical trials are typically in three sequential phases that may 
overlap. In Phase I, the initial introduction of the pharmaceutical into 
healthy human volunteers, the emphasis is on testing for safety (adverse 
effects), dosage tolerance, metabolism, distribution, excretion and clinical 
pharmacology.  Phase II involves studies in a limited patient population to 
determine the efficacy of the pharmaceutical for specific targeted 
indications, to determine dosage tolerance and optimal dosage and to identify 
possible adverse side effects and safety risks.  Once a compound is found to 
be effective and to have an acceptable safety profile in Phase II 
evaluations, Phase III trials are undertaken to evaluate clinical efficacy 
further and to further test 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 and clinical trials are submitted to the 
FDA in the form of an NDA for marketing approval.  The testing and approval 
process is likely to require substantial time, effort and cost 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 process and 
may delay marketing approval.  After FDA approval for the initial 
indications, further clinical trials would be necessary to gain approval for 
the use of the product for any additional indications.  The FDA may also 
require post-marketing testing to monitor for adverse effects, which can 
involve significant expense.

     The Company's Periodontal Tissue Monitor is categorized as a medical 
device under the FDA regulations and therefore a Premarket Approval 
application was filed and approved by the FDA. See - PTM PATENTS AND 
REGULATORY APPROVAL - for a description of the status of the FDA approval 
relating to the PTM.

     For both currently marketed and future products, failure to comply with 
applicable regulatory requirements after obtaining regulatory approval can, 
among other things, result in the suspension of regulatory approval, as well 
as possible civil and criminal sanctions.  In addition, changes in 
regulations could have a material adverse effect on the Company.

COMPETITION

     The cancer immunotherapy and PDT drugs and systems which the Company is 
developing will be competing with existing therapies.  In addition, a number 
of companies are pursuing the development of novel pharmaceuticals which 
target the same diseases that the Company is targeting.  A number of 
pharmaceutical and biotechnology companies, academic institutions, government 
 agencies, and other public and private organizations conducting research are 
pursuing PDT-related approaches to cancer therapy.  A number of such 
organizations are also developing potentially competitive products for 
diagnosing periodontal disease. Furthermore, academic institutions, 
government  agencies, and other public and private organizations conducting 
research may seek patent protection with respect to potentially competing 
products or technologies and may establish collaborative arrangements with 
competitors of the Company.

     Many of the Company's existing or potential competitors, particularly 
large pharmaceutical companies, have substantially greater financial, 
technical and human resources than the Company and may 

                                       11

<PAGE>
                                        
be better equipped to develop, manufacture and market products.  In addition, 
many of these companies have extensive experience in preclinical testing and 
human clinical trials.  These companies may develop and introduce products 
and processes competitive with or superior to those of the Company.  The 
development by others of new treatment methods for those indications for 
which the Company is developing products could render these products 
noncompetitive or obsolete.

     The Company's products under development are expected to address a broad 
range of markets.  The Company's competition will be determined in part by 
the potential indications for which the Company's products are developed and 
ultimately approved by regulatory authorities.  For certain of the Company's 
potential products, an important factor in competition may be the timing of 
market introduction of the Company's or competitors' products.  Accordingly, 
the relative speed at which the Company or its existing or its future 
corporate partners can develop products, complete the clinical trials and 
regulatory approval processes, and supply commercial quantities of the 
products to the market are expected to be important competitive factors.  The 
Company expects that competition among products approved for sale will be 
based, among other things, on product efficacy, safety, reliability, 
availability, price and patent position.

     The Company's competitive position also depends upon its ability to 
attract and retain qualified personnel, obtain patent protection or otherwise 
develop proprietary products or processes and secure sufficient capital 
resources for the often substantial period between technological conception 
and commercial sales.

RESEARCH AND DEVELOPMENT

     The Company incurred product development costs of $2,196,000, $2,566,000 
and $1,854,000 in the fiscal years ended March 31, 1998, 1997 and 1996 for 
work on all products under development. 

COMPLIANCE WITH ENVIRONMENTAL LAWS

     The Company believes that it is in compliance with all federal, state 
and local environmental laws and regulations. To the extent that the 
Company's management can determine, there are no federal, state of local 
provisions regulating the discharge of materials into the environment or 
otherwise relating to the protection of the environment, with which 
compliance by the Company has had or is expected to have a material effect 
upon the capital expenditures, earnings or competitive position of the 
Company.

PERSONNEL

     As of March 31, 1998, the Company had 7 full-time employees, none of 
whom were covered by a collective bargaining agreement.

YEAR 2000 COMPLIANCE
     
     The Company recognizes the need to ensure its operations will not be 
adversely impacted by the inability of the Company's systems to process data 
having dates on or after January 1, 2000 ("Year 2000"). Processing errors due 
to software failure arising from calculations using the Year 2000 date are 
recognized as a risk. The Company is currently addressing the risk, with 
respect to the availability and integrity of its financial systems and the 
reliability of its operating systems, and is in the process of communicating 
with suppliers, customers, financial institutions and others with whom it 
conducts business to assess whether they are or will be Year 2000 compliant. 
While the Company believes its planning efforts are adequate to address its 
Year 2000 concerns, there can be no assurance that the systems of other 
companies on which the Company's systems and operations rely will be 
converted on a timely basis and will not have a material effect on the 
Company. In addition, the potential impact of the Year 2000 on others with 
whom the Company does business and any resulting effects on the Company 
cannot be reasonably estimated at this 

                                       12

<PAGE>
                                        
time. The cost of the Company's Year 2000 initiatives is not expected to be 
material to the Company's results of operations or financial position.

ADDITIONAL RISKS AND UNCERTAINTIES

IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS

     Certain of the information provided by the Company in its reports and 
registration statements filed with the Securities and Exchange Commission or 
provided by its spokespersons from time to time, including information set 
forth under the captions "Item 1 - Business" and "Item 7 - Management's 
Discussion and Analysis of Financial Condition and Results of Operations" and 
elsewhere in this Report on Form 10-K for the Fiscal year ended March 31, 
1998 constitute "Forward Looking Statements" within the meaning of Section 
27A of the Securities Act of 1933, as amended, which are intended to be 
covered by the safe harbors from liability created thereby.  All such forward 
looking statements involve risks and uncertainties, including those 
statements regarding risks of new product development; the lengthy and 
uncertain process for FDA and other regulatory approval of the PDT and cancer 
immunotherapy; the dependence on the WHO license agreement; the Company's 
option to acquire BTI pursuant to the BTI Agreement; and the dependence on 
others for marketing and manufacturing.  Many other important factors affect 
the Company's ability to achieve the stated outcomes and to successfully 
develop and commercialize its products, including those statements regarding 
the Company's status as a development stage company; potential need for 
substantial additional funds. and other factors.  As a result, there can be 
no assurance that the forward looking statements in this Report or made from 
time to time will prove to be accurate.  In light of the significant 
uncertainties inherent in the forward looking statements included herein, the 
inclusion of such information should not be regarded as a representation by 
the Company or any other person that the objectives and plans of the Company 
will be achieved.
     
     DEVELOPMENT STAGE COMPANY.  The Company has generated only limited 
revenues from operations to date. As of March 31, 1998, the Company had an 
accumulated deficit of $41,055,000, and expects substantial losses to 
continue for the foreseeable future.  The Company's operations are subject to 
numerous risks associated with the establishment and development of new 
products, particularly those based on innovative or novel technologies.  
These  risks include the possibility that any or all of the Company's 
products will be found to be ineffective or unsafe, that the products, once 
developed, although effective, are uneconomical to market, that third parties 
hold proprietary rights that preclude the Company from marketing such 
products or that third parties market a superior or equivalent product.  The 
Company's ability to generate significant revenues and profitability will 
depend, among other factors, on the successful completion of product 
development, obtaining regulatory approvals, establishing manufacturing and 
marketing capabilities, gaining market acceptance for its products, and 
obtaining adequate funds to finance operations.  There can be no assurance 
that the Company will generate any revenues or achieve profitability.

     LIMITED CASH RESOURCES; POTENTIAL NEED FOR ADDITIONAL FUNDS. As of March 
31, 1998, the Company had cash of approximately $3,290,000. The Company 
estimates that its resources are sufficient through March 1999. The Company 
may undertake to raise additional equity capital beyond the initial closing 
of the Transaction or may generate revenues from product sales or marketing 
and research alliances.

     The Company has expended and intends to continue to expend substantial 
funds to conduct research and development activities, including preclinical 
and clinical testing of its cancer therapy technologies and its funding 
commitments under its agreement with BTI. Accordingly, the Company will 
require significant additional funds, either from marketing partners, product 
sales, or additional equity or debt financing, to complete development and 
commence commercial-scale manufacturing of its products. The actual date 
through which the existing cash resources will be adequate to fund the 
Company's operations, and the timing and magnitude of the need for additional 
funds, may vary significantly based on numerous factors, including (i) 
successful completion of Phase I safety study for the PDT cancer 

                                       13

<PAGE>
                                        
technology (ii) the timing and receipt of U.S. regulatory approval, if any, 
to commence human clinical studies for BG technology (iii) the timing and 
receipt of U.S. regulatory approval, if any, to commence human clinical 
studies for cancer immunotherapy technology (iv) the timing of the 
establishment of any marketing partnership(s) for the PTM and strategic 
partnership(s) for the PDT and PDIT technologies, (v) the timing and the 
amount, if any, of payments received from any such partner(s), (vi) the 
timing and amount, if any, of revenues generated from sales of the PTM, and 
(vii) the timing and the amount, if any, of proceeds available from the 
exercise of the Class A Warrants,  Settlement Warrants and stock options. The 
Company and BGDC are pursuing a $10 million equity private placement 
financing in which there was an initial closing of $2.9 million. The Company 
has no other commitments for any additional funding.

     SUBSTANTIAL DILUTION. The number of shares of common stock issuable upon 
conversion of the preferred stock and upon exercise of outstanding warrants 
and options, though subject to adjustment in certain events, is 25,853,000 
shares of Common Stock, or nearly two and one-half times the 10,777,000 
shares of Common Stock issued and outstanding on March 31, 1998. The 
conversion of the convertible preferred stock and the exercise of the 
warrants and the options, and the sale of the underlying shares of common 
stock (or even the potential of such conversion, exercise or sale) may have a 
depressive effect on the market price of the common stock.  The conversion of 
the convertible preferred stock and the exercise of the warrants and options 
also may have a dilutive effect. Moreover, the ability of the Company to 
obtain any needed capital on terms favorable to the Company may be adversely 
affected.  As a result of the convertible preferred stock, the warrants and 
the options being outstanding, the Company may be deprived of favorable 
opportunities to obtain additional equity capital, if it should then be 
needed.  It is also possible, that as long as the convertible preferred 
stock, the warrants and options remain outstanding, their existence might 
limit increases in the price of the Common Stock.

     In the event the Company issues shares of common stock or otherwise 
obtains any additional funding to complete development and commence 
commercial-scale manufacturing of its products, the terms thereof may have a 
dilutive effect on holders of the Company's securities.

     The Company currently has 4,310,000 shares of Common Stock available for 
issuance, and has granted to date options to purchase 2,032,500 shares of 
common stock at a weighted average price of $2.24, to management, key 
employees, directors, and consultants under various stock option plans or by 
direct grant from the Board of Directors.  Pursuant to such plans, directors, 
key employees and consultants may be eligible to receive stock options 
exercisable for common stock at exercise prices which may be lower than the 
initial conversion price of the convertible preferred stock or the exercise 
price of the Class A Warrants. Future option grants, if any, may dilute the 
value of the common stock.

     IMMINENT POSSIBILITY OF AMEX DELISTING; IMPACT OF POTENTIAL AMEX 
DELISTING ON MARKETABILITY OF SECURITIES. On June 24, 1998, the Company 
received notice from the American Stock Exchange ("AMEX") that Amex intends 
to take action to remove the Company's Common Stock from the AMEX because the 
Company no longer satisfies all of the financial guidelines of the AMEX for 
continued listing. The Company notified the Board of Governors of AMEX that 
it intends to appeal to the decision to remove the Company's Common Stock 
from the AMEX. There can be no assurance that the appeal by the Company will 
be successful, and that the listing will be continued. The Company is taking 
measures to ensure that in the event of an unsuccessful appeal, an orderly 
transition will occur and that its Common Stock will commence trading on the 
NASD Electronic Bulletin Board. If delisting were to occur, it is possible 
that it might be more difficult to dispose of the common stock or to obtain 
as favorable a price for the common stock.  Consequently, the liquidity of 
the common stock could be impaired, not only in the number of shares of 
common stock that could be bought and sold at a given price, but also through 
delays in the timing of transactions and reduction in security analysts' and 
the media's coverage of the Company, which could result in lower prices for 
the common stock than might otherwise be attained and in a larger spread 
between the bid and asked prices for the common stock. Accordingly, an 
investor would find it more 

                                       14

<PAGE>
                                        
difficult to dispose of, or obtain accurate quotations as to the price of, 
the Company's currently listed securities, resulting in a material adverse 
effect on the Company and the prices of its securities.

     RISK OF PENNY STOCK REGULATION. If the Company's Common Stock were 
delisted from the AMEX the common stock would be deemed "penny stock", based 
upon its current price range. The Commission has adopted regulations which 
generally define " penny stock" to be any equity security that has a market 
price ( as defined in the regulation) of less than $5.00 per share, subject 
to certain exceptions.  Such exceptions include any equity security listed on 
AMEX.  If the Common Stock is removed from listing on AMEX, the Common Stock 
may become subject to Rules 15g-1 through 15g-6 promulgated under the 
Exchange Act for non-exchange listed and non-NASDAQ securities.  These rules 
impose additional sales practice requirements on broker-dealers who sell such 
securities to persons other than established customers and accredited 
investors (generally, those persons with assets in excess of $1,000,000 or 
annual incomes exceeding $200,000 individually or $300,000 together with 
their spouse).  For transactions covered by these rules, the broker-dealer 
must make a special suitability determination for the purchase of the common 
stock and have received the purchaser's written consent to the transaction 
prior to the purchase. Additionally, for any transaction involving a penny 
stock, unless exempt, the rules require a broker-dealer, prior to a 
transaction in a penny stock not otherwise exempt from the rules, to (i) 
deliver a standardized risk disclosure document prepared by the Commission 
that provides information about penny stocks and the nature and level of 
risks in the penny stock market and (ii) provide the customer with current 
bid and offer quotations of the penny stock, the compensation of the 
broker-dealer and its salesperson in the transaction, a monthly account 
statement showing the market value of each penny stock held in the customer's 
account, and if the broker-dealer is the sole market-maker, the broker-dealer 
must disclose this fact and the broker-dealer's presumed control over the 
market.  These disclosures may restrict the ability of broker-dealers to sell 
the Common Stock and may have the effect of reducing the level of trading 
activity in the secondary market for a stock that becomes subject to the 
penny stock rules.  If the common stock becomes subject to the penny stock 
rules, the holders thereof may find it difficult to sell their shares.

     LIMITED TRADING VOLUME; POSSIBLE PRICE VOLATILITY. Historically, the 
common stock has generally experienced relatively low daily trading volumes 
in relation to number of shares outstanding.  The market price of the common 
stock also has been volatile and it may continue to be volatile as has been 
the case with the securities of other public medical-technology companies. 
Additionally, if the Company's Common Stock is removed from AMEX, the 
volatility could increase. Factors such as announcements by the Company or 
its competitors concerning technological innovations, results of clinical 
trials, new commercial products or procedures, proposed government 
regulations and developments or disputes relating to patents or proprietary 
rights may have a significant effect on the market price of the Company's 
securities.  Changes in the market price of the common stock may bear no 
relation to the Company's actual operations or financial results. 

     GOVERNMENT REGULATIONS; NEED FOR FDA AND OTHER REGULATORY APPROVAL. 
Prior to marketing, each of the Company's proposed medical products, 
including the BG technology and both the drug and light delivery components 
of the proposed PDT and cancer immunotherapy treatment systems, must undergo 
an extensive regulatory approval process conducted by the FDA and applicable 
agencies in other countries.  The process, which focuses on safety and 
efficacy and includes a review by the FDA of preclinical testing and clinical 
trials and investigation as to whether good laboratory and clinical practices 
were maintained during testing, is likely to take many years and require the 
expenditure of substantial resources.  The Company is and will be dependent 
on the external laboratories and medical institutions conducting its 
preclinical testing and clinical trials to maintain both good laboratory 
practices established by the FDA and good clinical practices.  Data obtained 
from preclinical and clinical testing are subject to varying interpretations 
which could delay, limit or prevent regulatory approval.  In addition, 
delays, limitations or rejections may be encountered based upon changes in 
FDA policy for drug or medical device approval during the period of 
development and by the requirement for regulatory review of each IND and New 
Drug Application ("NDA") relating to any pharmaceutical product proposed to 
be introduced by the Company and an application for PMA relating to any 
medical device proposed to be introduced by the Company.  There can be no 
assurance that, even after significant expenditures, 

                                       15

<PAGE>
                                        
regulatory approval will be obtained for any of the Company's product 
candidates.  Moreover, such approval may entail significant limitations on 
the indicated uses for which a medical product may be marketed.  Any denials 
of or substantial delays in obtaining requisite approvals or limitations on 
such approvals may have a material adverse effect on the Company.  Such 
denials, and delays in obtaining regulatory approvals and limitations on such 
approvals could be experienced both domestically and abroad.  

     Even if such regulatory approval is obtained, a marketed medical product 
and its manufacturer are subject to continual regulatory review, and later 
discovery of previously unknown problems with a product or manufacturer may 
result in restrictions on such product or the manufacturing thereof, 
including withdrawal of such product from the market. Change in the 
manufacturing procedures used by the Company for any of the Company's 
approved medical products are subject to FDA review, which could have an 
adverse effect upon the Company's ability to continue the commercialization 
or sale of a product.  The process of obtaining FDA approval is costly and 
time consuming, and there can be no assurance that any of the Company's 
products will be deemed to be safe and effective by the FDA. The Company will 
not be permitted to market any of its medical products in any jurisdiction in 
which the product does not receive regulatory approval.
     
     UNCERTAINTY OF PRE-CLINICAL AND CLINICAL TRIALS RESULTS. The grant of 
regulatory approvals for the commercial sale of the Company's proposed 
products, if any, will depend in part on the Company or any collaborators 
successfully conducting extensive preclinical and clinical testing to 
demonstrate safety and efficacy in humans.  The results of preclinical and 
clinical testing may prove to be inconclusive.  The results of preclinical 
testing discussed in this report or otherwise presented by the Company for 
its proposed products are subject to varying interpretations and may not be 
indicative of results that will be obtained in humans.  In addition, results 
attained in early clinical trials may not be indicative of results that will 
be obtained in later clinical trials.  As results of particular preclinical 
studies and clinical trials are received, the Company or its collaborators, 
if any, may abandon projects that they might have otherwise believed to be 
promising, some of which may be described in this report.

     There can be no assurance that the Company's interpretation of results 
will be accepted by governmental regulators.  Even if the development of the 
Company's proposed products in the preclinical phase advances to the clinical 
stage, there can be no assurance that they will prove to be safe and 
effective for human use.  The products that are successfully developed, if 
any, will be subject to requisite regulatory approval prior to their 
commercial sale, and the approval, if obtainable, may take several years.  A 
number of companies in the pharmaceutical industry have suffered significant 
setbacks in advanced clinical trials even after promising results in earlier 
trials.  Generally, only a very small percentage of the number of new 
pharmaceutical products initially developed are approved for sale.  Even if a 
new pharmaceutical product is approved for sale, there can be no assurance 
that it will be commercially successful.  The Company may encounter 
unanticipated problems relating to development, manufacturing, distribution 
and marketing, some of which may be beyond the Company's financial and 
technical capacity to resolve.  The failure to address such problems 
adequately could have a material adverse effect on such Company's businesses, 
financial condition or results of operations.  No assurance can be given that 
the Company will succeed in the development and marketing of any new drug 
products, or that such products will not be rendered obsolete by products of 
competitors.

          The rate of completion of clinical trials will depend upon, among 
other factors, obtaining adequate clinical supplies and the rate of patient 
enrollment.  Patient enrollment is a function of many factors including the 
size of patient population, the nature of the protocol, the proximity of 
patients to clinical sites and the eligibility criteria for the study.  
Delays in planned patient enrollment can result in increased costs or delays 
or both, which could have a material adverse effect on the business of the 
Company.

                                       16

<PAGE>
                                        
     DEPENDENCE ON BTI AGREEMENT AND LICENSE AGREEMENTS; RISK OF LOSS OF 
TECHNOLOGY. The Company has the right to acquire rights to the PDT technology 
derived from the option the Company has to acquire BTI pursuant to an 
agreement between the Company and BTI (the "BTI Agreement)  The Company and 
BTI have agreed to extend the period during which the Company may exercise 
its option to acquire BTI from April 30, 1997 until such time as BTI has 
completed human clinical trials of the Boronated Porphyrin (BOPP) at an 
agreed upon dose level (the "Option Period"). The Option Period was extended 
at the Company's request to enable BTI to complete preclinical studies, to 
commence clinical trials in humans and to demonstrate that a given dose level 
of BOPP in humans would not cause certain adverse events. The Company 
believes that the extension of the Option Period will give it greater 
opportunity to access the preliminary data resulting from the BOPP Phase I 
human clinical trials and to evaluate the possibility of adverse events in 
human patients before determining whether to acquire BTI.  Accordingly, the 
Company has elected to defer exercise of the option. Under the terms of the 
license agreement which BTI has with the Regents of the University of 
California at San Francisco ("UCSF"), BTI must pay yearly minimum royalties 
of $25,000 and make certain payments upon the achievement of certain 
milestones in order to retain the license with UCSF.

     In March 1998, the Company signed a license agreement (the "BG License 
Agreement") for the BG compound with the Co-owners of the patents. Under the 
terms of the agreement, the Company has a six month evaluation period ending 
on September 17, 1998. The Company may terminate the agreement during the 
evaluation period and pay $75,000 to the Co-Owners. If the Company elects to 
continue to develop the BG technology, it would be obligated to make 
additional milestone, royalty and patent reimbursement payments to the 
Co-Owners during the term of the License Agreement. The agreement also has a 
provision in which the Company may elect to make payments in common stock of 
the Company.

     The right of the Company to the PDIT technology is derived from the 
Company's license agreement (the "WHO License Agreement") with WHO.  The WHO 
License Agreement requires the Company to pay royalties to WHO based on sales 
of products incorporating the cancer immunotherapy technology, including a 
minimum royalty of $50,000 per year.
     
     If the Company does not meet its obligations under the BTI Agreement, as 
amended, the BG License Agreement, or the WHO Agreement, the Company could 
lose its right to any or all of the underlying technology which could have a 
material adverse effect on the Company.  

     UNCERTAINTY OF PROTECTION OFFERED BY PATENTS AND TRADE SECRETS. The 
medical industry, particularly the pharmaceutical segment, places 
considerable importance on obtaining patent and trade secret protection for 
new technologies, products and processes.  The Company's success will depend, 
in part, on its ability to enjoy or obtain protection for its products and 
technologies under United States and foreign patent laws and other 
intellectual property laws, to preserve its trade secrets and to operate 
without infringing the proprietary rights of third parties.  To date, the 
Company has received a number of patents, and has filed a number of other 
patent applications, relating to the Company's technologies in the United 
States and internationally.  BTI and the Company have each benefited as a 
licensee from such issuances or filings of others. 

     The patent positions of pharmaceutical, medical and biotechnology firms, 
including the Company, are uncertain and involve complex legal and factual 
questions for which important legal principles are largely unresolved.  To 
date, no consistent policy has been developed by the U.S. Patent and 
Trademark Office regarding the breadth of claims allowed in medical device or 
biotechnology patents or the degree of protection afforded under such 
patents.  The coverage claimed in a patent application can be significantly 
reduced before a patent is issued.  Consequently, the Company does not know 
whether any patent applications will result in the issuance of patents.  
Additionally, the Company does not know whether its existing patents (and any 
patents related to its patent applications which subsequently may be issued) 
will provide significant proprietary protection or will be circumvented or 
invalidated.  Since patent applications in the United States are maintained 
in secrecy until foreign counterparts, if any, publish or issue patents and 

                                       17

<PAGE>
                                        
since publication of discoveries in the scientific or patent literature often 
lag behind actual discoveries, the Company cannot be certain that it or any 
licensor was the first creator of inventions covered by existing patents or 
pending patent applications or that it or such licensor was the first to file 
patent applications for such inventions.  Moreover, the Company might have to 
participate in interference proceedings declared by the U.S. Patent and 
Trademark Office to determine priority of inventions, which could result in 
substantial cost to the Company even if the eventual outcome were favorable 
to the Company.  There can be no assurance that the Company's current 
patents, or patents relating to its patent applications, if issued, would be 
held valid by a court or that a competitor's technology or product would be 
found to infringe such patents.

     A number of biotechnology and high-tech companies and research and 
academic institutions have developed technologies, filed patent applications 
or received patents on various technologies that may compete with the 
Company's business. Some of these technologies, applications or patents may 
conflict with the Company's technologies, applications or patents.  Such 
conflict could limit the scope of the patents that the Company has or may be 
able to obtain or result in the denial of the Company's patent applications.  
In addition, if patents that cover the Company's activities are issued to 
other companies, there can be no assurance that the Company would be able to 
obtain licenses to these patents at a reasonable cost or be able to develop 
or obtain alternative technology.

     The Company also relies upon trade secret protection for its unpatented 
confidential and proprietary technology and information.  There can be no 
assurance that others will not independently develop substantially equivalent 
proprietary technology and information, gain access to the Company's trade 
secrets or disclose such technology and information, or, in general, that the 
Company can meaningfully protect its unpatented technology and information.

     RISKS OF NEW PRODUCT DEVELOPMENT; MARKET UNCERTAINTY. The Company's 
technology is new and emerging and only limited preclinical and clinical data 
on its safety and efficacy exits. None of the products underlying these 
technologies that the Company proposes to develop or is developing have been 
approved for marketing by regulatory authorities in the United States or 
elsewhere, and all will require significant research and development, 
including lengthy clinical testing, prior to their commercialization.  The 
results of preclinical testing discussed in this report for the Company's 
drug compounds and technologies are subject to varying interpretations.  
Furthermore, studies conducted with alternative designs or on alternative 
populations could produce results that vary from those discussed in this 
report.  Therefore, there can be no assurance that the results discussed in 
this report or the Company's interpretation of them will be accepted by 
governmental regulators or the medical community.  Even if the development of 
the Company's products in the preclinical phase advances to the clinical 
stage, there can be no assurance that the products will prove to be safe and 
effective.  The products that are successfully developed, if any, will be 
subject to requisite regulatory approval prior to their commercial sale, and 
the approval, if obtainable, is likely to take several years.  Generally, 
only a very small percentage of the number of new pharmaceutical products 
initially developed is approved for sale.  Even if the Company's products are 
approved for sale, there can be no assurance that they will be commercially 
successful.  The Company may encounter unanticipated problems relating to 
development, manufacturing, distribution and marketing, some of which may be 
beyond the Company's financial and technical capacity to solve.  The failure 
to address such problems adequately could have a material adverse effect on 
the Company's business and prospects.  No assurance can be given that the 
Company will succeed in the development and marketing of any new drug 
products, or that the products will not be rendered obsolete by products of 
competitors.

     There can be no assurance of the extent to which any of the Company's 
products, if successfully developed, will actually be used by patients. 
Furthermore, there can be no assurance that the Company's sales of its 
products for such uses will be profitable even if patient use occurs.

     COMPETITION. The biotechnology and medical device industries are 
characterized by rapidly evolving technology and intense competition. Many of 
the companies in these industries have substantially greater financial 
resources and development capabilities than the Company, and many in the 
biotechnology 

                                       18

<PAGE>
                                        
and medical device industries have substantially greater experience in 
undertaking clinical testing of products, obtaining regulatory approvals and 
manufacturing and marketing such products.  There can be no assurance that 
the Company's products will be more effective or achieve greater market 
acceptance than any current or future competitive products, or that 
competitors will not develop products that are more effective than the 
Company's or that would render the Company's products and technologies less 
competitive or obsolete.

     DEPENDENCE ON OTHERS FOR DEVELOPMENT, MARKETING AND MANUFACTURING. The 
Company expects to rely upon marketing partnerships with unaffiliated medical 
product companies and strategic partners to develop and market all of its 
medical products.  Such reliance may limit the Company's ability to control 
the commercialization of such products.  Although the Company believes that 
any such collaborative partners will have an economic motivation to 
commercialize the products which they have the right and responsibility to 
market, the amount and timing of resources devoted to these activities 
generally will be controlled by each individual partner.  There can be no 
assurance that the Company will be successful in establishing any such 
marketing partnerships, or that, if established, such future partners will be 
successful in commercializing the products.  

     The Company also relies upon collaborative agreements with unaffiliated 
companies for the manufacturing and distribution of the PTM product and 
anticipates relying on such companies and partners for the development of its 
drug compounds. The Company expects to continue to rely upon such 
relationships at least in respect to production associated with initial 
commercial sales, and perhaps beyond the initial stages of commercialization. 
 Such reliance may adversely affect profit margins on its products, and there 
are no assurances that the Company can develop or maintain contract 
manufacturing relationships in the future on acceptable terms, if at all. In 
addition, manufacturers of the Company's products will be subject to 
applicable current good manufacturing practices ("GMP") prescribed by the FDA 
or other rules and regulations prescribed by foreign regulatory authorities.  
The Company will be dependent on such manufacturers for continued compliance 
with GMP and applicable foreign standards.  Failure by a manufacturer of the 
Company's products to comply with GMP or applicable foreign standards could 
result in significant time delays or the inability of the Company to 
commercialize a product and could have a material adverse effect on the 
Company.

     DEPENDENCE UPON KEY PERSONNEL. The Company is currently dependent on 
certain executive officers, management and scientific personnel.  The loss of 
these individuals might have a material adverse effect on the research and 
development programs and other operations of the Company.  Competition for 
qualified employees among medical companies is intense, and the loss of any 
of such persons, or an inability to attract, retain and motivate additional 
highly skilled employees, could adversely affect the Company's business and 
prospects. There can be no assurance that the Company will be able to retain 
its existing personnel or to attract additional qualified employees.

     UNCERTAINTY OF PHARMACEUTICAL PRICING, REIMBURSEMENT AND RELATED 
MATTERS. The Company's business, financial condition and results of 
operations may be materially adversely affected by the continuing efforts of 
government and third party payors to contain or reduce the costs of health 
care through various means.  For example, in certain foreign markets pricing 
and profitability of prescription pharmaceuticals are subject to government 
control.  In the United States, the Company expects that there will continue 
to be a number of federal and state proposals to implement similar government 
control.  In addition, increasing emphasis on managed care in the United 
States will continue to put pressure on the pricing of pharmaceutical 
products and diagnostic tests.  Cost control initiatives could decrease the 
price that the Company or any of its strategic partners receives for any 
products in the future and have a material adverse effect on the Company's 
business, financial condition and results of operations.  Further, to the 
extent that cost control initiatives have a material adverse effect on the 
Company's strategic partners, the Company's ability to commercialize its 
products and to realize royalties may be adversely affected.

                                       19

<PAGE>
                                        
     The ability of the Company and any strategic partner to commercialize 
pharmaceutical or diagnostic products may depend in part on the extent to 
which reimbursement for the products will be available from government and 
health administration authorities, private health insurers and other third 
party payors.  Significant uncertainty exists as to the reimbursement status 
of newly approved health care products.  Third party payors, including 
Medicare, increasingly are challenging the prices charged for medical 
products and services.  Government and other third party payors are 
increasingly attempting to contain health care costs by limiting both 
coverage and the level of reimbursement for new therapeutic products and by 
refusing in some cases to provide coverage for uses of approved products for 
disease indications for which the FDA has not granted labeling approval.  
There can be no assurance that any third party insurance coverage will be 
available to patients for any products discovered and developed by the 
Company or its strategic partners.  If adequate coverage and reimbursement 
levels are not provided by government and other third party payors for the 
Company's products, the market acceptance of these products may be reduced, 
which may have a material adverse effect on the Company's business, financial 
condition and results of operations.

     PRODUCT LIABILITY; LIMITED INSURANCE COVERAGE. The Company faces an 
inherent business risk of exposure to product liability claims in the event 
that the use or misuse of its products and proposed products result in 
adverse effects.  The Company currently maintains $5 million of product 
liability insurance coverage and $5 million of clinical trial insurance 
coverage.  There can be no assurance that such coverage is or in the future 
will be adequate or that adequate insurance will be available in the future 
at an acceptable cost, if at all.  In addition, there can be no assurance 
that a product liability claim, even if the Company has insurance coverage, 
would not materially adversely affect the business or financial condition of 
the Company.

ITEM 2.  PROPERTIES

     At March 31, 1998, the Company occupied approximately 3,400 square feet 
of office and laboratory space in San Diego, California under a lease which 
expires in February 1999. When the current lease expires, the Company may 
need to relocate to a larger facility. The Company does not anticipate 
difficulty in locating suitable space to meet its needs.

ITEM 3.  LEGAL PROCEEDINGS

     None.

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

      None.

ADDITIONAL ITEM--EXECUTIVE OFFICERS OF THE REGISTRANT

     The executive officers of the Company, their positions with the Company and
principal occupations and experience are set forth below.

<TABLE>
<CAPTION>
                                                                   YEAR IN
                                                                  WHICH HE
                                                                  BECAME AN
NAME                   POSITION(S)                       AGE       OFFICER
----                   -----------                       ---     ----------
<S>                    <C>                               <C>     <C>
Dr. H. Laurence Shaw   Chairman, President and Chief     52         1996
                       Executive Officer

Anil Singhal, Ph.D.    Vice President-Research and       46         1997
                       Development                       
</TABLE>

                                       20

<PAGE>
                                        
     The officers of the Company hold office at the discretion of the Board 
of Directors of the Company.  During Fiscal 1998, the officers of the Company 
devoted substantially all of their business time to the affairs of the 
Company, and they intend to do so during Fiscal 1999.
     
     From 1995 until joining the Company, Dr. Shaw served as Corporate Vice 
President Research & Development of C.R. Bard.  Prior to that, from 
1993-1995, Dr. Shaw served as Chief Executive Officer, President and Director 
of Atlantic Pharmaceuticals, Inc. and Chief Executive Officer of each of 
Atlantic's operating companies from their inception in 1993.  From 1984-1993, 
he was Vice President, Medical and Regulatory Affairs and Advanced Research 
at Abbott Laboratories.  Previously, from 1981-1984, he was a board member of 
Revlon Health Care, Ltd. (UK) and Director, Medical and Technical Affairs.  
At Revlon, he was responsible for pharmaceutical formulation and development, 
new business development and clinical research for Revlon's major research 
unit outside of the USA.  Prior to Revlon, he served as International Medical 
Director for Meadox Medical Inc.;  Medical Director for Merck in the U.K.; 
and as Associate Director for SmithKline Corporation.  Dr. Shaw is a graduate 
of the University College Hospital Medical School, London, UK and has worked 
in clinical practice in the UK and in the USA.  He is a Fellow of the Faculty 
of Pharmaceutical Medicine of the Royal College of Physicians, a Fellow of 
the American College of Clinical Pharmacology and a member of many 
professional associations. Dr. Shaw also serves on the Board of Directors of 
Endorex Corporation. 
     
     Anil Singhal, Ph.D., was President, BioNexus Pharmaceuticals 1994 to 
1997. From 1986 to 1994 Dr. Singhal was Chief Operating Officer at The 
Biomembrane Institute. From 1979 to 1983, Dr. Singhal was Assistant Professor 
at Mt. Sinai School of Medicine. Dr. Singhal received his Ph.D. from the 
Wakemans Institute of Microbiology from Rutgers University, M. S. Degree from 
St. John's University and an MBA at the University of Washington. Dr. Singhal 
is the author of 40 published papers on oncology and inflammatory disorders.





                                       21


<PAGE>

                           PART II

ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED MATTERS

The following presents the high and low closing prices and trading volumes for
the periods indicated as reported by AMEX. The Company has never paid any cash
dividends and does not contemplate the payment of cash dividends in the
foreseeable future. On June 24, 1998, the Company was notified by AMEX that it
intends to take action to remove the Company's Common Stock from the AMEX
because the Company fails to meet AMEX's financial guidelines for continued
listing. The Company has notified AMEX that intends to appeal AMEX's decision.
There can be no assurance that the Company will be able to maintain its AMEX
listing. If the Company is unable to maintain its AMEX listing, it anticipates
that its Common Stock will initially begin trading on the NASD Electronic
Bulletin Board following removal from AMEX.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                 Year ended March 31, 1997
                                       ----------------------------------------------------------------------------------
                                              First            Second            Third          Fourth             Year
-------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>              <C>              <C>              <C>             <C>
1997 Market price range of common stock
              High                         $     3.69        $   2.50         $     2.06       $    1.75       $     3.69
              Low                          $     1.63        $   1.75         $     1.06       $    1.06             1.06
     Shares traded                          1,810,100         834,300          1,309,100         827,400        4,780,900
</TABLE>

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                 Year ended March 31, 1998
                                       ----------------------------------------------------------------------------------
                                              First            Second            Third          Fourth             Year
-------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>              <C>              <C>              <C>             <C>
1998 Market price range of common stock
              High                          $    1.88        $     2.13       $     1.88       $   1.00        $     2.13
               Low                          $    1.00              1.13             0.75            .56               .56
     Shares traded                            952,600         2,060,700        1,150,100        657,800         4,821,200
</TABLE>

As of June 26, 1998, there were approximately 425 holders of record of the 
Company's Common Stock.

                                                       22

<PAGE>

PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                                                                      Sept. 23,1983
                                                                    Years ended March 31,                            (inception) to
                                        ----------------------------------------------------------------------------    March 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)         1998           1997           1996            1995            1994        1998
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>             <C>             <C>           <C>              <C>          <C>  
                                                         (as restated)(1)
Total revenues                                $    348        $    275        $   379        $ 1,201         $   585      $  6,000
Product development costs                        2,196           2,566          1,854          2,118           1,218        17,161
Net loss                                        (4,371)         (3,897)        (3,256)        (3,755)         (4,613)      (36,562)
Net loss applicable to common stockholders     (11,598)         (5,594)        (3,256)        (3,755)         (4,613)      (45,485)
Net loss per share of common stock--basic     
  and diluted                                 $  (1.25)       $  (0.69)       $ (0.52)       $ (0.74)        $ (1.10)
</TABLE>

<TABLE>
<CAPTION>
                                                                      As of March 31,
                                        ---------------------------------------------------------------------------------
                                                 1998            1997             1996            1995             1994
                                        ---------------------------------------------------------------------------------
<S>                                           <C>             <C>               <C>            <C>               <C>
Cash, cash equivalents, and
   short-term investments                       $3,290          $6,766           $1,698          $1,820           $4,504
Total assets                                     3,591           7,234            2,174           2,305            5,168
Long-term liabilities                               23              13               21              24               70
Stockholders' equity                             2,702           6,331            1,548           1,884            3,942
------------------------------------------------------------------------------------------------------------------------
</TABLE>
*NO DIVIDENDS HAVE BEEN PAID ON THE COMPANY'S COMMON STOCK. CONVERTIBLE 
    PREFERRED STOCK DIVIDENDS ARE NON-CASH. SEE NOTE 2 TO THE CONSOLIDATED
    FINANCIAL STATEMENTS.

(1) These items have been restated for the periods indicated to appropriately 
reflect the value of the warrants issued in connection with the Private 
Placement as described in Note 9 to the consolidated financial statements.



SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>

                                                                   Year ended March 31, 1997
                                                --------------------------------------------------------------------------------
1997                                            First           Second           Third            Fourth            Year
                                                                            (as restated)(1)  (as restated)(1)  (as restated)(1)
--------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>             <C>               <C>             <C>                <C>

Total revenues                                 $   24,832         $31,098          $30,192         $189,058          $275,180
Net loss                                       (1,059,395)       (895,968)        (745,288)      (1,196,715)       (3,897,366)
Convertible preferred dividends                      
  (as previously reported)                           -               -             138,259        1,027,002         1,165,261
Convertible preferred dividends                      
  (as restated)                                      -               -             231,376        1,464,835         1,696,211
Net loss applicable to common stockholders     
  (as previously reported)                     (1,059,395)       (895,968)        (883,547)      (2,223,717)       (5,062,627)
Net loss applicable to common stockholders     
  (as restated)                                (1,059,395)       (895,968)        (976,664)      (2,661,550)       (5,593,577)
Net loss per share of common stock--basic         
  and diluted (as previously reported)           $  (0.13)       $  (0.11)         $ (0.11)     $     (0.27)      $     (0.62)
Net loss per share of common stock--basic
  and diluted (as restated)                      $  (0.13)       $  (0.11)         $ (0.12)     $     (0.33)      $     (0.69)
</TABLE>


<TABLE>
<CAPTION>

1998                                                                   Year ended March 31, 1998
                                             ---------------------------------------------------------------------------------
                                                  First            Second            Third           Fourth         Year
                                             (as restated)(1)  (as restated)(1)  (as restated)(1)
                                             ---------------------------------------------------------------------------------
<S>                                           <C>               <C>              <C>               <C>           <C>
Total revenues                                $   101,283       $    65,263        $   128,130     $    53,784   $   348,460
Net loss                                         (935,449)       (1,330,201)          (883,407)     (1,222,406)   (4,371,463)
Convertible preferred dividends
  (as previously reported)                      1,296,362         1,152,031            665,786       2,866,729     5,980,908
Convertible preferred dividends
  (as restated)                                 1,815,050         1,612,908            932,170       2,866,729     4,360,128
Net loss applicable to common stockholders
  (as previously reported)                     (2,231,811)       (2,482,232)        (1,549,193)           -             -
Net loss applicable to common stockholders
  (as restated)                                (2,750,499)       (2,943,109)        (1,815,577)     (4,089,135)   (7,509,185)
Net loss per share of common stock--basic
  and diluted (as previously reported)        $     (0.27)      $     (0.29)       $     (0.16)           -             -
Net loss per share of common stock--basic
  and diluted (as restated)                   $     (0.34)      $     (0.34)       $     (0.18)    $     (0.39)  $     (1.25)
</TABLE>

(1) These items have been restated for the periods indicated to appropriately 
reflect the value of the warrants issued in connection with the Private 
Placement as described in Note 9 to the consolidated financial statements.

                                      23

<PAGE>

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

RESULTS OF OPERATIONS.

YEAR ENDED MARCH 31, 1998 (FISCAL 1998) COMPARED TO YEAR ENDED MARCH 31, 1997 
(FISCAL 1997)

Total revenue  increased by $73,000, or 27% to $348,000 in Fiscal 1998. The 
majority of the current year revenues  relate to interest and other income.

Sales of the Company's Periodontal Tissue Monitor ("PTM") product were $70,000
in fiscal year 1998. The PTM product was approved during Fiscal 1998 for
commercial sales in the United States, and the Company signed two distribution
agreements during the year. The distributor is presently introducing the product
in various geographic regions around the world. Product sales in the prior year
were comprised primarily of sales of PTM materials. The Company had $5,000 of
Kephra related revenue in Fiscal 1998, compared to $45,000 during Fiscal 1997
for royalties, contract research and marketing rights revenue related to Kephra.

Interest and other revenue for Fiscal 1998 increased by $144,000 to $274,000
compared to Fiscal 1997. This increase was the result of invested cash and
short-term investments during Fiscal 1998 due to the completion of private
equity financing during March 1997.

Cost of product sales for Fiscal 1998 increased by $45,000 or 48% to 
$140,000. The increase was primarily related to the sale of PTM kits under a 
new distribution agreement and the additional cost of product validation 
studies required by the FDA during the year in order to launch the product in 
the United States.

As the Company entered its first human clinical trials, spending on product 
development was concentrated on its Photodynamic Therapy (PDT) cancer 
treatments, Boronated Prophyrin (BOPP) and Cancer Immunotherapy and the new 
compound acquired during Fiscal 1998, O6 Benzlyguanine ("BG"). Product 
development costs for Fiscal 1998 decreased by $369,000 or 14% to $2,196,000 
compared to the prior year. The decrease related to the following areas: (i) 
an increase of $8,000 in funding of product development expenses for BOPP; 
(ii) a decrease of $104,000 in funding of a technology owned by BTI for which 
the Company has suspended additional work; (iii) $18,000 decrease in expenses 
related to Cancer Immunotherapy technology; (iv) acquisition costs of 
$300,000 incurred during Fiscal 1998 for the BG compound; (v) a decrease of 
$256,000 in expenses related to PTM product development, as the PTM product 
was approved by the FDA during the current year and has moved out of the 
product development phase; (vi) a decrease of $299,000 in product development 
expenses related to the Company's Kephra product line and general product 
development costs. The Company is not actively seeking licensing 
opportunities or making product development expenditures for the Kephra 
product line.

General and administrative expenses for Fiscal 1998 were $2,086,000, an 
increase of $931,000 over Fiscal 1997. Such increase is primarily 
attributable to the Company incurring approximately $271,000 in professional 
fees related to the registration of securities issued in the March 1997 
private placement. In addition, the Company recognized $374,000 of expenses 
for financial advisory services performed by Paramount Capital, the Company's 
placement agent. Such expense is recorded in connection with preferred stock 
unit purchase options granted in exchange for financial advisory services. 
The Company also incurred $182,000 in relocation expenses during the year in 
connection with the relocation of its Chairman, President and Chief Executive 
Officer from New Jersey to California. There were no such costs incurred 
during the same period of the prior year.

For Fiscal 1998, business development and marketing expenses were $219,000, a
decline of $72,000 or 25%. The Company focused much effort during the current
fiscal year in securing strategic marketing and 

                                      24

<PAGE>

distribution partners for its various products under development. The Company 
was successful in finding a marketing partner for its PTM product during 
Fiscal 1998.

Interest and other expenses for Fiscal 1998 increased to $78,000 from $66,000.
The Company abandoned several patents relating to the Kephra technology and a
trademark during the year and recognized a loss on abandonment of $68,000.
During Fiscal 1997, the Company incurred $56,000 of interest expense from a
bridge loan prior to completion of its private equity financing in March 1997.

Net loss was $4,371,000 for the year ended March 31, 1998, an increase of 
$474,000 over the prior year. Net loss applicable to common stockholders was 
$11,193,000 for Fiscal 1998. Non-cash convertible preferred stock dividends 
of $7,227,000 were recorded during the current fiscal year compared to 
$1,696,000 in Fiscal 1997 (as restated-See Note 9 to the consolidated 
financial statements), in conjunction with a private equity financing 
completed during the prior year. The transaction is more fully described in 
Note 2 of the Notes to the Consolidated Financial Statements.

YEAR ENDED MARCH 31, 1997 COMPARED TO YEAR ENDED MARCH 31, 1996 (FISCAL 1996)

Total revenue decreased by $104,000, or 27% to $275,000 in Fiscal 1997. The 
majority of the Fiscal 1996 revenues related to marketing rights granted to a 
U.S. soft drink company for the Company's Kephra technology. There were no 
comparable revenues in Fiscal 1997.

Sales of the Company's PTM product comprised the majority of product sales in 
Fiscal 1997. Product sales increased by $87,000 from Fiscal 1996. The prior 
year sales were comprised primarily of sales of Kephra materials. Marketing 
rights revenues for Fiscal 1997 decreased by $55,000, or 92%, to $5,000. 
Fiscal 1996 marketing rights revenue is attributable to rights related to a 
licensing agreement with a U.S. soft-drink company for the Company's Kephra 
technology. Contract research revenue for Fiscal 1997 decreased by $6,000 
from the prior year. Fiscal 1997 revenues related to work performed under a 
joint venture agreement with an ophthalmic company for the use of the 
Company's photochromatic technology.

Interest and other revenue for the Fiscal 1997 increased by $19,000, or 17%, 
to $129,000 compared to Fiscal 1996. This increase was the result of more 
cash and short-term investments due to the completion of private equity 
financing during the year and a gain on the sale of assets.

Cost of product sales for Fiscal 1997 decreased by $29,000 or 24% to $95,000. 
Such  decrease  was  primarily  related to the change in the nature of  
products sold.

Product development costs for Fiscal 1997 increased substantially by $712,000 
or 38% to $2,566,000 over the prior year. The majority of the increase 
resulted from the initiation of work on two projects in the cancer therapy 
area, including: funding of $1,317,000 in product development expenses for 
BOPP and $323,000 in expenses related to the acquisition of Cancer 
Immunotherapy technology, including expenses incurred in association with a 
related research agreement and expenses incurred related to in-house product 
development of the Cancer Immunotherapy. No such costs were incurred in the 
prior year. The Company also incurred costs in Fiscal 1997 relating to the 
filing of a Premarket Application in September 1996 for the Company's PTM 
product. Product development costs for PTM decreased by $827,000 for the year 
because the product development efforts were concluded during the year which 
culminated with FDA approval for PTM in June 1997.

In Fiscal 1997, general and administrative costs decreased by $102,000 over 
the prior year or 8% to $1,156,000. The decrease is due to continued cost 
reduction measures implemented in the prior year, which includes reduced 
staffing costs and insurance expense, offset by higher professional fees.

                                 25

<PAGE>
                           
For Fiscal 1997 business development and marketing expenses were $291,000, a 
decline of $82,000 or 22%. The decline is due to lower consultant and travel 
expenses offset by higher salary and benefit costs.

Interest and other expenses increased to $66,000 for Fiscal 1997, an increase 
of $39,000. The Company required a bridge loan prior to completion of its 
private equity financing in March 1997. Interest expense incurred on the loan 
accounted for the increase.

Net loss was $3,897,000 in Fiscal 1997, an increase of $641,000 over the 
prior year. The increased loss during the current fiscal year was primarily 
due to increased product development expenses discussed above. Net loss 
applicable to common stockholders was $5,594,000 (as restated-See Note 9 to 
the consolidated financial statements) for Fiscal 1997. Non-cash convertible 
preferred stock dividend were recorded during Fiscal 1997 of $1,696,000 (as 
restated) in conjunction with a private equity financing completed during the 
year and more fully described in Note 2 to the Consolidated Financial 
Statements.

CAPITAL RESOURCES AND LIQUIDITY. As of March 31, 1998, cash, cash 
equivalents, and short-term investments decreased by $3,476,000 to 
$3,290,000, compared to March 31, 1997. Working capital decreased by 
$3,557,000 and total assets decreased by $3,644,000. These decreases are 
primarily a result of cash used in operations during Fiscal 1998. 
Stockholders' equity decreased by $3,630,000 as a result of the 
aforementioned net operating loss offset by additions to equity for 
securities issued in exchange for services performed and exercise of warrants.

Since inception, the Company has experienced negative cash flow from 
operations, and management considers it prudent to anticipate that negative 
cash flow from operations will continue until such time as sales of its 
products under development commence. The Company and its subsidiary, BG 
Development Corp. ("BGDC") initiated a private placement equity financing to 
raise a maximum of $10 million assuming exercise of over-allotment provision 
by the placement agent as described in Note 8 to the consolidated financial 
statements. On June 22, 1998, the Company and BGDC closed on gross proceeds 
of $2.9 million ($2.6 net proceeds) for the aforementioned private placement. 
The Company has also initiated contingency plans to defer certain research 
and development expenditures and other non essential costs until the Company 
has closed a more significant portion of the aforementioned financing. 
Management believes the Company's financial resources will be adequate, based 
on the assumption that no significant revenues are generated through March 
1999.

The Company received notice from the American Stock Exchange ("AMEX") that 
Amex intends to take action to remove the Company's Common Stock from the 
AMEX because the Company no longer satisfies all of the financial guidelines 
of the AMEX for continued listing. The Company notified the Board of 
Governors of AMEX that it will appeal the decision to remove the Company's 
Common Stock from the AMEX. There can be no assurance that the appeal by the 
Company will be successful, and that the listing will be continued. The 
Company is taking measures to ensure that in the event of an unsuccessful 
appeal, an orderly transition will occur and that its Common Stock will 
commence trading on the NASD Electronic Bulletin Board. If the Company were 
to lose it's listing on the AMEX, the Company's ability to raise additional 
capital might be impaired.

During Fiscal 1998, the Company received approval from the FDA for its PTM 
product and signed two distribution agreements with Steri-Oss, Inc. for the 
exclusive five-year distribution of PTM globally, excluding Japan. In the 
event the Company begins selling material quantities of the PTM, the Company 
may need additional working capital, and additional personnel and space, both 
of which may cause an increase in the net utilization of cash. However, there 
can be no assurance the Company will enter into any new distribution 
agreements, or that any of its marketing partners will order the PTM products 
in significant quantities.

                                 26

<PAGE>


In May 1996 the Company entered into an agreement with Wound Healing of 
Oklahoma ("WHO"), a privately held corporation, under which it acquired an 
exclusive license to certain proprietary Cancer Immunotherapy technology. The 
Company incurred $305,000 and $323,000 in product development expenses during 
Fiscal 1998 and 1997, respectively, and expects to continue funding such 
efforts associated with the commercialization of the licensed technology, 
including the commencement of human clinical trials, which will increase the 
Company's net utilization of cash. However, there can be no assurance that 
FDA and other regulatory approval required to commence such trials will be 
forthcoming.

In June 1996 the Company entered into an agreement which granted the Company 
the option to acquire Binary Therapeutics, Inc. ("BTI"). BTI is a privately 
held, development stage enterprise holding certain technologies for the PDT 
treatment of cancer. Under the agreement as amended, the Company is currently 
funding substantially all expenses of BTI, which consist primarily of product 
development expenses. The Company incurred $1,405,000 and $1,501,000 in 
product development expenses during Fiscal Years 1998 and 1997, respectively, 
and expects to continue funding such expenses until the Company determines if 
it will elect to exercise its option to acquire BTI. There can be no 
assurance that the Company will exercise its option to acquire BTI.

In March 1998, the Company signed a license agreement for a drug compound 
called O6 Benzylguanine ("BG") with the owners of the patents: Pennsylvania 
State University, the National Institutes of Health (NIH), the University of 
Chicago, and Case Western Reserve University, (collectively, the 
"Co-Owners"), and in turn, assigned it to its subsidiary BGDC. Under the 
terms of the agreement, the Company has a six month evaluation period ending 
on September 17, 1998. The Company may terminate the agreement during the 
evaluation period and pay $75,000 to the Co-Owners.

The Company may enter into a Cooperative Research and Development Agreement 
("CRADA") with the NIH to fund studies and clinical trials. If the Company 
were to enter into a CRADA with the NIH, it would be obligated to provide 
funding of $125,000 each year for research. If the Company elects to continue 
to develop the BG technology, it would be obligated to make additional 
milestone, royalty and patent reimbursement payments to the Co-Owners during 
the term of the License Agreement. The agreement also has a provision in 
which the Company may make certain portions of the aforementioned payments in 
common stock of the Company.

In connection with the license agreement for BG, the Company entered into an 
introduction agreement with Paramount Capital Investments LLC. The agreement 
provides for cash consideration of $100,000 plus reimbursement of expenses, 
as well as milestone payments in the Company's common stock of up to 
1,000,000 shares if the BG compound successfully reaches certain milestones. 
The Company recorded $225,000 in product development expenses under this 
agreement during Fiscal 1998.

The Company has never paid a cash dividend and does not contemplate the 
payment of cash dividends in the foreseeable future.

IMPACT OF INFLATION.  The impact of inflation on the  operations of the 
Company during Fiscal Years 1998, 1997 and 1996 was not material.

YEAR 2000 COMPLIANCE. The Company recognizes the need to ensure its 
operations will not be adversely impacted by the inability of the Company's 
systems to process data having dates on or after January 1, 2000 ("Year 
2000"). Processing errors due to software failure arising from calculations 
using the Year 2000 date are recognized as a risk. The Company is currently 
addressing the risk, with respect to the availability and integrity of its 
financial systems and the reliability of its operating systems, and is in the 
process of communicating with suppliers, customers, financial institutions 
and others with whom it conducts business to assess whether they are or will 
be Year 2000 compliant. While the Company believes its 

                                 27

<PAGE>

planning efforts are adequate to address its Year 2000 concerns, there can be 
no assurance that the systems of other companies on which the Company's 
systems and operations rely will be converted on a timely basis and will not 
have a material effect on the Company. In addition, the potential impact of 
the Year 2000 on others with whom the Company does business and any resulting 
effects on the Company cannot be reasonably estimated at this time. The cost 
of the Company's Year 2000 initiatives is not expected to be material to the 
Company's results of operations or financial position.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.

         Not applicable


                                 28
<PAGE>


 PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

CONSOLIDATED FINANCIAL STATEMENTS:                                                                PAGE
<S>                                                                                                <C>

Independent  Auditors' Report   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  30

Consolidated Balance Sheets as of March 31, 1998 and 1997 (as restated) . . . . . . . . . . . . .  31

Consolidated Statements of Operations for the years ended March 31, 1998, March 31, 1997
(as restated), March 31, 1996 and September 23, 1983 (inception) to March 31, 1998. . . . . . . .  32

Consolidated Statements of Stockholders' Equity from September 23, 1983 (inception) to
   March 31, 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  33

Consolidated Statements of Cash Flow for the years ended March 31, 1998, March 31, 1997,
   March 31, 1996 and September 23, 1983 (inception) to March 31, 1998. . . . . . . . . . . . . .  35

Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

</TABLE>

                                       29

<PAGE>

INDEPENDENT AUDITORS' REPORT


Pacific Pharmaceuticals, Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of Pacific 
Pharmaceuticals, Inc. and Subsidiaries (collectively, the "Company", a 
development stage enterprise) as of March 31, 1998 and 1997, and the related 
consolidated statements of operations, stockholders' equity, and cash flows 
for each of the three years in the period ended March 31, 1998 and the period 
from September 23, 1983 (date of incorporation of Pacific Pharmaceuticals, 
Inc.) to March 31, 1998. These financial statements are the responsibility of 
the Company's management. Our responsibility is to express an opinion on 
these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing 
standards. 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, such consolidated financial statements present fairly, in all 
material respects, the financial position of Pacific Pharmaceuticals, Inc. 
and Subsidiaries at March 31, 1998 and 1997, and the results of their 
operations and their cash flows for each of the three years in the period 
ended March 31, 1998, and for the period from September 23, 1983 (date of 
incorporation of Pacific Pharmaceuticals, Inc.) to March 31, 1998 in 
conformity with generally accepted accounting principles.

The Company is in the development stage as of March 31, 1998. As discussed in 
Note 1 to the consolidated financial statements, the Company's activities 
since inception have been directed primarily toward the development and 
commercialization of products based on biotechnological research.

As discussed in Note 9, the accompanying fiscal 1997 financial statements 
have been restated.


DELOITTE & TOUCHE LLP
July 8, 1998
San Diego, California

                                       30

<PAGE>


CONSOLIDATED BALANCE SHEETS
PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)

<TABLE>
<CAPTION>

                                                                                              As of March 31,
                                                                             --------------------------------------------
                                                                                        1998                    1997
-------------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>                <C>
ASSETS                                                                                                      (as restated,
CURRENT ASSETS:                                                                                              see Note 9)

Cash and cash equivalents                                                              $3,290,176             $1,784,599
Short-term investments                                                                          -              4,981,435
Accounts receivable, net                                                                        -                 99,066
Inventory                                                                                  38,637                 41,677
Prepaid expenses                                                                           85,053                 87,311
-------------------------------------------------------------------------------------------------------------------------
       Total current assets                                                             3,413,866              6,994,088
-------------------------------------------------------------------------------------------------------------------------


Property and equipment, net                                                                71,840                 82,563
Patent costs, net                                                                         104,981                157,597
-------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS                                                                           $3,590,687             $7,234,248
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:

<S>                                                                                      <C>                    <C>
Accounts payable                                                                         $661,371               $723,523
Accrued expenses                                                                          201,125                161,574
Current portion of capital leases                                                           4,066                  4,670
-------------------------------------------------------------------------------------------------------------------------
       Total current liabilities                                                          866,562                889,767
-------------------------------------------------------------------------------------------------------------------------

Capital leases                                                                             22,584                 13,072
-------------------------------------------------------------------------------------------------------------------------

Commitments and contingencies (Note 4)

STOCKHOLDERS' EQUITY:
Convertible preferred stock, $25 par value, 2,000,000 shares authorized 40,090
       and 50,000 issued and outstanding at March 31, 1998 and 1997,
       respectively
       (liquidating preference $10,423,400)                                             1,002,288              1,250,038
Common stock, $.02 par value, 100,000,000 shares authorized;
       10,777,234 and 8,151,029 shares issued and
       outstanding at March 31, 1998 and 1997, respectively                               215,545                163,021
Capital in excess of par value                                                         46,969,197             38,805,489
Deficit accumulated during the development stage                                      (45,485,489)           (33,887,139)
-------------------------------------------------------------------------------------------------------------------------
       Total stockholders' equity                                                       2,701,541              6,331,409
-------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                             $3,590,687             $7,234,248
-------------------------------------------------------------------------------------------------------------------------


</TABLE>

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

                                       31


<PAGE>


CONSOLIDATED STATEMENTS OF OPERATIONS
PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)

<TABLE>
<CAPTION>



                                                          Years Ended March 31,                     September 23, 1983
                                 --------------------------------------------------------------      (inception) to
                                       1998                 1997                  1996                 March 31, 1998
---------------------------------------------------------------------------------------------------------------------
<S>                                   <C>               <C>                        <C>               <C>
REVENUES                                                (as restated,
                                                          see Note 9)

   Product sales                       $69,510             $100,485                $13,657           $2,019,741
   License fees and royalties            5,405                1,207                150,000              486,612
   Contract research                         -               39,172                 45,000              268,063
   Marketing rights                          -                5,000                 60,000            1,311,500
   Interest and other                  273,545              129,316                110,159            1,913,658
---------------------------------------------------------------------------------------------------------------
Total revenues                         348,460              275,180                378,816            5,999,574
---------------------------------------------------------------------------------------------------------------

COSTS AND EXPENSES
   Cost of product sales               140,460               95,200                124,530            3,138,395
   Product development               2,196,433            2,565,664              1,853,899           17,160,961
   General and administrative        2,086,249            1,155,515              1,257,722           17,851,747
   Business development
     and marketing                     218,603              290,603                372,316            3,776,889
   Interest and other                   78,178               65,564                 26,252              633,973
---------------------------------------------------------------------------------------------------------------
Total costs and expenses             4,719,923            4,172,546              3,634,719           42,561,965
---------------------------------------------------------------------------------------------------------------

Net loss                            (4,371,463)          (3,897,366)            (3,255,903)         (36,562,391)

Convertible preferred stock
   dividends                         7,226,887            1,696,211                      -            8,923,098
---------------------------------------------------------------------------------------------------------------

Net loss applicable to
   common stockholders            $(11,598,350)      $   (5,593,577)       $    (3,255,903)     $   (45,485,489)
---------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------

Net loss per share
   of common stock--basic and
   diluted                              ($1.25)              ($0.69)                ($0.52)
-------------------------------------------------------------------------------------------

Weighted average common
   stock outstanding                 9,273,717            8,115,139              6,222,832
-------------------------------------------------------------------------------------------

</TABLE>

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.


                                       32
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 
PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)

<TABLE>
<CAPTION>
                                                           PREFERRED STOCK                     COMMON STOCK         
---------------------------------------------------------------------------------------------------------------------- 
                                                   SHARES           PAR VALUE           SHARES           PAR VALUE    
----------------------------------------------------------------------------------------------------------------------
<S>                                            <C>               <C>                <C>                <C>
Balance at September 23, 1983                          -           $      -                  -           $        
Original issuance of common stock:
   October 1983 at $.02 per share                                                        597,500             11,950
   October 1983 at $2.00 per share                                                        55,000              1,100   
Issuance for cash, January 1984
   at $4.00 per share                                                                    383,625              7,672   
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1984                              -                  -            1,036,125             20,722   
Purchase of treasury stock                                                                                            
Adjustment to capital in excess
   of par value                                                                                                       
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1985                              -                  -            1,036,125             20,722   
Purchase of treasury stock                                                                                            
Initial public offering, October 1985
   at $6.00 per share                                                                    500,000             10,000   
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1986                              -                  -            1,536,125             30,722   
Purchase of treasury stock                                                                                            
Preferred stock subscribed:
   Series A                                           6,000            150,000                                        
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1987                             6,000            150,000         1,536,125             30,722   
Issuance of 8.5% convertible
   subordinated notes warrants                                                                                        
Retirement of treasury stock                                                             (17,500)              (350)   
Preferred stock subscribed/(returned):
   Series A                                          (3,000)           (75,000)                                        
   Series B                                           1,600             40,000                                        
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1988                             4,600            115,000         1,518,625             30,372   
Conversion of 8.5% convertible
   subordinated notes                                                                     39,999                800   
Consultant's compensation                                                                  1,073                 22   
Preferred stock subscribed/(converted):
   Series A                                          (3,000)           (75,000)           35,002                700   
   Series B                                          27,180            679,500                                        
Dividends accrued - Series B                                                                                          
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1989                            28,780            719,500         1,594,699             31,894   
Private placement, November 1989
   at $8.00 per share                                                                     75,000              1,500   
Exercise of common stock options                                                           3,500                 70   
Preferred stock subscribed/(converted):
   Series B                                         (28,780)          (719,500)          719,500             14,390   
Dividends accrued - Series B                                                                                          
Reverse accrued dividends - Series B                                                                                  
Exercise of Series B warrants                                                            463,088              9,262   
Exercise of other warrants                                                                 2,000                 40   
Net loss                                                                                                              
----------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1990                               -                  -           2,857,787             57,156   

</TABLE>


<TABLE>
<CAPTION>

                                                                       DEFICIT
                                                                     ACCUMULATED
                                                    CAPITAL           DURING THE
                                                   IN EXCESS         DEVELOPMENT
                                                 OF PAR VALUE           STAGE
----------------------------------------------------------------------------------
<S>                                          <C>                    <C>
Balance at September 23, 1983                     $                  $          
Original issuance of common stock:
   October 1983 at $.02 per share          
   October 1983 at $2.00 per share                    108,900
Issuance for cash, January 1984
   at $4.00 per share                               1,325,817
Net loss                                                              (137,937)
----------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1984                           1,434,717         (137,937)
Purchase of treasury stock                               (267)
Adjustment to capital in excess
   of par value                                         5,600
Net loss                                                              (692,070)
----------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1985                           1,440,050         (830,007)
Purchase of treasury stock                                (83)
Initial public offering, October 1985
   at $6.00 per share                               2,392,536
Net loss                                                              (994,767)
----------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1986                           3,832,503       (1,824,774)
Purchase of treasury stock                                 (5)
Preferred stock subscribed:
   Series A                                           450,000
Net loss                                                            (1,445,191)
----------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1987                           4,282,498       (3,269,965)
Issuance of 8.5% convertible
   subordinated notes warrants                         62,500
Retirement of treasury stock                              350
Preferred stock subscribed/(returned):
   Series A                                          (225,000)
   Series B                                           120,000
Net loss                                                            (1,327,934)
-----------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1988                           4,240,348       (4,597,899)
Conversion of 8.5% convertible
   subordinated notes                                 249,193
Consultant's compensation                               6,524
Preferred stock subscribed/(converted):
   Series A                                            74,296
   Series B                                         1,556,444
Dividends accrued - Series B                         (221,955)
Net loss                                                            (1,553,240)
------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1989                           5,904,850       (6,151,139)
Private placement, November 1989
   at $8.00 per share                                 538,500
Exercise of common stock options                       13,930
Preferred stock subscribed/(converted):
   Series B                                           705,111
Dividends accrued - Series B                         (141,158)
Reverse accrued dividends - Series B                  363,113
Exercise of Series B warrants                       1,611,546
Exercise of other warrants                             14,360
Net loss                                                            (1,512,343)
-------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1990                           9,010,252       (7,663,482)

</TABLE>

                                       33

<PAGE>

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES(A DEVELOPMENT STAGE ENTERPRISE)

<TABLE>
<CAPTION>                                                                                                                        
                                                                     PREFERRED STOCK                        COMMON STOCK        
                                                           ----------------------------------------------------------------------
                                                                SHARES           PAR VALUE           SHARES           PAR VALUE  
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>                 <C>             <C>                <C>
Exercise of common stock options                                                                       7,100                142  
Exercise of other warrants                                                                            98,000              1,960  
Consultant's compensation                                                                                338                  7  
Private placement, October 1990
   at $12.00 per share                                                                               257,500              5,150  
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1991                                         -                  -             3,220,725             64,415  
Exercise of common stock options                                                                      10,950                218  
Exercise of other warrants                                                                            10,000                200  
Private placement, April 1991
   at $17.50 per share                                                                               214,188              4,284  
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1992                                         -                  -             3,455,863             69,117  
Exercise of common stock options                                                                       4,300                 86  
Private placement, May 1992
   at $11.625 per share                                                                              277,100              5,542  
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1993                                         -                  -             3,737,263             74,745  
Exercise of common stock options                                                                      70,227              1,405  
Common stock retired as payment
   for common stock options exercised                                                               (12,903)              (258)  
Grant of stock option below fair market value                                                                                    
Private placements:
   July 1993 at $5.50 per share                                                                      317,093              6,342  
   December 1993 at average of $6.12 per share                                                       427,275              8,546  
   January 1994 at average of $6.24 per share                                                        222,100              4,442  
   March 1994 at $5.30 per share                                                                      51,000              1,020  
Common stock issued in payment of offering expenses                                                      974                 19  
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1994                                          -                  -            4,813,029             96,261  
Private placements:
    April 1994 at $4.00 per share                                                                    100,000              2,000  
    August 1994 at $4.485 per share                                                                  100,000              2,000  
    September 1994 at $3.80 per share                                                                250,000              5,000  
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1995                                          -                  -            5,263,029            105,261  
Private placements:
    November 1995 at $1.25 per share                                                               2,788,000             55,760  
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1996                                                                          8,051,029            161,021  
Private placement of convertible preferred stock                 50,000         $1,250,038                                       
Warrants exercised                                                                                   100,000              2,000  
Issuance of warrants for services                                                                                                
Convertible preferred stock dividend (as restated, see Note 9)
Net loss 
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1997 (AS RESTATED)                          50,000          1,250,038         8,151,029            163,021  
---------------------------------------------------------------------------------------------------------------------------------
Warrants exercised                                                                                   423,437              8,469  
Issuance of common stock for services                                                                 13,110                262  
Conversion of preferred stock into common stock                 (9,910)          (247,750)         2,189,658             43,793  
Preferred stock unit purchase options as compensation
  for financial advisory services                                                                                                
Convertible preferred stock dividend                                                                                             
Net loss                                                                                                                         
---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1998                                        40,090         $1,002,288        10,777,234           $215,545  
--------------------------------------------------------------------------------------------------------------------------------- 

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

</TABLE>

<TABLE>
<CAPTION>                                                                     DEFICIT
                                                                            ACCUMULATED
                                                           CAPITAL           DURING THE
                                                          IN EXCESS         DEVELOPMENT
                                                         OF PAR VALUE          STAGE
-------------------------------------------------------------------------------------------
<S>                                                     <C>                 <C>
Exercise of common stock options                                 28,258
Exercise of other warrants                                      743,640
Consultant's compensation                                         2,894
Private placement, October 1990
   at $12.00 per share                                        2,765,446
Net loss                                                                       (2,111,267)
------------------------------------------------------------------------------------------ 
BALANCE AT MARCH 31, 1991                                    12,550,490        (9,774,749)
Exercise of common stock options                                 40,932
Exercise of other warrants                                      104,800
Private placement, April 1991
   at $17.50 per share                                        3,433,816
Net loss                                                                       (3,156,803)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1992                                    16,130,038       (12,931,552)
Exercise of common stock options                                 16,139
Private placement, May 1992
   at $11.625 per share                                       2,889,461
Net loss                                                                       (3,738,097)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1993                                    19,035,638       (16,669,649)
Exercise of common stock options                                292,406
Common stock retired as payment
   for common stock options exercised                           (99,740)
Grant of stock option below fair market value                   468,750
Private placements:
   July 1993 at $5.50 per share                               1,531,879
   December 1993 at average of $6.12 per share                2,386,770
   January 1994 at average of $6.24 per share                 1,259,545
   March 1994 at $5.30 per share                                244,088
Common stock issued in payment of offering expenses               8,868
Net loss                                                                       (4,613,042)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1994                                    25,128,204       (21,282,691)
Private placements:
    April 1994 at $4.00 per share                               378,000
    August 1994 at $4.485 per share                             423,575
    September 1994 at $3.80 per share                           886,428
Net loss                                                                       (3,754,968)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1995                                    26,816,207       (25,037,659)
Private placements:
    November 1995 at $1.25 per share                          2,864,383
Net loss                                                                       (3,255,903)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1996                                    29,680,590       (28,293,562)
Private placement of convertible preferred stock              7,291,688
Warrants exercised                                               92,000
Issuance of warrants for services                                45,000
Convertible preferred stock dividend (as restated,            
see Note 9)                                                   1,696,211        (1,696,211)
Net loss                                                                       (3,897,366)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1997 (AS RESTATED)                      38,805,489       (33,887,139)
-------------------------------------------------------------------------------------------
Warrants exercised                                              389,562
Issuance of common stock for services                            11,737
Conversion of preferred stock into common stock                 203,957
Preferred stock unit purchase options as compensation
  for financial advisory services                               331,565
Convertible preferred stock dividend                          7,226,887        (7,226,887)
Net loss                                                                       (4,371,463)
-------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1998                                   $46,969,197      ($45,485,489)
-------------------------------------------------------------------------------------------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

</TABLE>
                                       34

<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOW
PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)

<TABLE>
<CAPTION>

                                                                           YEARS ENDED MARCH 31,           SEPTEMBER 23, 1983
                                                               -----------------------------------------     (INCEPTION) TO
                                                                   1998          1997          1996          MARCH 31, 1998
--------------------------------------------------------------------------------------------------------  -------------------
<S>                                                            <C>           <C>           <C>             <C>
OPERATING ACTIVITIES
Net loss                                                        ($4,371,463)  ($3,897,366)  ($3,255,903)     ($36,562,391)
Adjustments to reconcile net loss to net cash used by
operating activities:
     Depreciation and amortization                                   81,257       109,731       123,427         1,665,001  
     Non-cash compensation expense upon issuance
        of common stock, stock options and warrants                 331,565        45,000             -           851,861  
     Net book value of asset disposals                               76,376        17,064         5,506           241,692  
     Option income from retirement of stock
        or amounts previously advanced by customer                        -             -             -          (400,000)  
     Changes in assets and liabilities:
        Accounts receivable                                          99,066       (96,398)        6,405              -  
        Inventory                                                     3,040          (770)        7,060           (38,640)  
        Prepaid expenses and other assets                             2,258         8,634         3,349           (96,028)  
        Accounts payable                                            (62,152)      509,214        (2,505)          661,371  
        Accrued expenses                                             39,551      (217,353)      263,486            57,102  
        Customer advances                                                 -             -       (30,888)          140,863  
        Other liabilities                                                 -        (7,842)      (11,895)           (4,866)  
--------------------------------------------------------------------------------------------------------  -------------------
     Net cash used by operating activities                       (3,800,502)   (3,530,086)   (2,891,958)      (33,484,036)
--------------------------------------------------------------------------------------------------------  -------------------
INVESTING ACTIVITIES
Purchases of short-term investments                                       -    (4,981,435)   (1,288,106)      (10,461,867)  
Maturities of short-term investments                              4,981,435     1,288,106       992,326        10,461,867  
Capital expenditures                                                (16,502)       (9,764)      (51,596)         (847,929)  
Patent costs                                                        (64,945)      (31,799)      (61,823)         (977,372)  
Other                                                                     -         8,825             -             7,829  
--------------------------------------------------------------------------------------------------------  -------------------
     Net cash provided by (used in) investing activities          4,899,988    (3,726,067)     (409,199)       (1,817,472)  
--------------------------------------------------------------------------------------------------------  -------------------
FINANCING ACTIVITIES
Issuance of notes payable                                                 -       524,467       325,426         2,183,867  
Repayment of notes payable                                                -      (524,467)     (325,426)       (1,965,124)  
Repayment of capital lease obligations                               (3,940)       (4,625)      (37,087)         (183,547)  
Long-term customer advances                                               -             -             -           100,000  
Issuance of common stock, convertible preferred
     stock and stock warrants                                       410,031     8,635,726     2,920,143        38,456,487  
--------------------------------------------------------------------------------------------------------  -------------------
     Net cash provided by financing activities                      406,091     8,631,101     2,883,056        38,591,684  
--------------------------------------------------------------------------------------------------------  -------------------
Net increase (decrease) in cash
     and cash equivalents                                         1,505,577     1,374,948      (418,101)        3,290,176  
Cash and cash equivalents at beginning of period                  1,784,599       409,651       827,752                 -
--------------------------------------------------------------------------------------------------------  -------------------
Cash and cash equivalents at end of period                       $3,290,176    $1,784,599      $409,651        $3,290,176  
--------------------------------------------------------------------------------------------------------  -------------------
Cash paid for interest                                               $2,682       $36,210       $18,804          $497,742  
--------------------------------------------------------------------------------------------------------  -------------------

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

</TABLE>

                                       35

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

PACIFIC PHARMACEUTICALS, INC. AND SUBSIDIARIES (A DEVELOPMENT STAGE ENTERPRISE)

1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS - The Consolidated Financial Statements include the 
accounts of Pacific Pharmaceuticals, Inc. and its wholly owned subsidiaries, 
Perio Test, Inc., XYX Acquisition Corp. and BG Development Corp. 
(collectively, the "Company"). The Company was incorporated under the laws of 
the State of Delaware on September 23, 1983. For the period of inception to 
date, the Company's activities have been directed primarily toward the 
development and commercialization of products based on biopharmaceutical 
research. On August 7, 1997, the Company's stockholders approved an amendment 
to the Certificate of Incorporation to change the name of the Company to 
Pacific Pharmaceuticals, Inc. The Company was formerly known as Xytronyx, Inc.

PRINCIPLES OF CONSOLIDATION - All significant intercompany balances and 
transactions have been eliminated in consolidation.

DEVELOPMENT STAGE - The Company has not earned significant revenues from 
planned principal operations. Accordingly, the Company's activities have been 
accounted for as those of a "Development Stage Enterprise" as set forth in 
Financial Accounting Standards Board Statement No. 7 ("FAS 7"). Among the 
disclosures required by FAS 7 are that the Company's financial statements be 
identified as those of a development stage enterprise, and that the 
consolidated statements of operations, stockholders' equity and cash flows 
disclose activity since the date of the Company's inception.

Since inception, the Company has experienced negative cash flow from 
operations, and management considers it prudent to anticipate that negative 
cash flow from operations will continue until such time as sales of its 
products under development commence. The Company has initiated a private 
placement equity financing to raise a maximum of $10 million assuming 
exercise of over-allotment provision by the placement agent as described in 
Note 8. On June 22, 1998, the Company closed on gross proceeds of $2.9 
million ($2.6 net proceeds), for the aforementioned private placement. The 
Company has also initiated contingency plans to defer certain research and 
development expenditures and other non essential costs until the Company has 
closed a more significant portion of the aforementioned financing. Management 
believes the Company's financial resources will be adequate, based on the 
assumption that no significant revenues are generated through March 1999.

ACCOUNTING ESTIMATES - The preparation of financial statements in conformity 
with generally accepted accounting principles requires management to make 
estimates and assumptions that affect the reported amount 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 may differ from those estimates.

CASH EQUIVALENTS - Cash equivalents consist of money market instruments 
purchased with an original maturity of three months or less.

SHORT-TERM INVESTMENTS - Short term investments represent marketable debt 
securities and are carried at fair value in accordance with FAS 115. 
Unrealized holding gains or losses have not been material.

                                       36

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

ACCOUNTS RECEIVABLE, NET - Accounts receivable consists of sales of products 
to customers, net of allowances for doubtful accounts.

INVENTORY - Inventory, which consists principally of raw materials and work 
in process, is valued at the lower of cost (determined by the first-in, 
first-out method) or market.

PROPERTY AND EQUIPMENT - Depreciation and amortization of property and 
equipment are provided using the straight-line method over the estimated 
useful lives of the related assets, which are principally five and ten years. 
Property and equipment are summarized as follows:


<TABLE>
<CAPTION>
                                                                                        March 31
                                                                                 1998              1997
                                                                            ---------------    --------------
             <S>                                                                 <C>               <C>
             Laboratory equipment                                                 $118,343          $357,139
             Office furniture and equipment                                        166,860           157,966
             Leasehold improvements                                                  3,799             3,799
                                                                            ---------------    --------------
             Total property and equipment                                          289,002           518,904
             Less accumulated depreciation and amortization                       (217,162)         (436,341)
                                                                            ---------------    --------------
             Total                                                                $ 71,840          $ 82,563
                                                                            ---------------    --------------
                                                                            ---------------    --------------

</TABLE>


PATENT COSTS - Legal expenses incurred in connection with applications for 
patents on research and development projects are capitalized. The costs are 
amortized using the straight-line method over five years. Patent costs which 
have no further economic value are written off in the period in which such 
impairment in value occurs. As a result of the Company's annual evaluation of 
its capitalized patent costs, the Company wrote off patent and trademark 
costs during Fiscal 1998 with a net book value of $68,000 which related 
primarily to the Kephra technology. Patent costs are net of accumulated 
amortization of $335,844 and $360,969 at March 31, 1998 and 1997, 
respectively.

ACCRUED EXPENSES - Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                                                       March 31
                                                                                1998               1997
                                                                           ---------------    ---------------
             <S>                                                                 <C>            <C>
             Accrued compensation                                               $  67,687          $  25,185
             Accrued clinical trial expense                                       133,438            133,438
             Other                                                                      -              2,951
                                                                           ---------------    ---------------
             Total                                                              $ 201,125          $ 161,574
                                                                           ---------------    ---------------
                                                                           ---------------    ---------------
</TABLE>

REVENUE RECOGNITION - Product sales revenue is generally recognized at the 
time of product shipment. License fees and royalties, contract research, and 
marketing rights income are all recognized as earned in accordance with their 
respective agreements. Payments received in advance of shipments or prior to 
the completion of the earnings process are recorded as deferred revenue.

LOSS PER SHARE OF COMMON STOCK - Basic loss per share of common stock is 
computed by dividing the net loss applicable to common stockholders by the 
weighted average number of shares of common stock outstanding during the 
period. 

                                       37

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 
128, EARNINGS PER SHARE (EPS) during the current fiscal year. This statement 
requires the presentation of earnings per share to reflect both "Basic EPS" 
as well as "Diluted EPS" on the face of the statement of operations. In 
general, Basic EPS is a function of weighted average number of common shares 
outstanding for the periods. Diluted EPS does reflect the potential dilution 
created by stock issuable pursuant to outstanding options, warrants, 
convertible debt or equity securities and other contingently issuable shares. 
The requirements of SFAS 128 have been applied retroactively to all periods 
presented. There was no impact on reported net loss per common share as a 
result of the adoption of this SFAS.

CONCENTRATION OF CREDIT RISK - The Company invests its excess cash in money 
market accounts and short-term investments, primarily in U. S. Treasury 
securities. The Company has not experienced any significant losses on its 
cash accounts or short-term investments.

FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's carrying amounts of its 
financial assets and liabilities approximate their fair value due to the 
short-term nature of the assets and liabilities.

MAJOR CUSTOMERS -One customer accounted for 98% and 75% of product sales for 
the years ended March 31, 1998 and 1997, respectively. Three customers 
individually accounted for 21%, 26% and 46%, respectively, of fiscal year 
1996 product sales. Export sales, which accounted for 2% in the current 
fiscal year, were to one customer in Japan, and 81% of product sales for the 
year ended March 31, 1997 were primarily to one customer in Europe. Export 
sales, all of which were to Japan, accounted for 51% of product sales in 
fiscal year 1996.

SUPPLEMENTAL CASH FLOW INFORMATION - The Company had the following noncash 
financing and investing activities for the period September 23, 1983 
(inception) through March 31, 1998: Common Stock issued upon the conversion 
of $720,000 of Series B preferred stock during fiscal year 1990; Common Stock 
issued upon the conversion of long-term debt in the amount of $250,000 in 
fiscal year 1996; option income of $100,000 recognized from an amount 
previously classified as a customer advance during fiscal year 1996; capital 
lease obligations incurred totaling $229,000, of which $24,000 was incurred 
in fiscal year 1996 and $29,000 was incurred in fiscal year 1998, and; 
non-cash convertible preferred stock dividends of $6,822,000 and $1,696,000 
in fiscal years 1998 and 1997, respectively.

RECLASSIFICATIONS - Certain items in prior years' consolidated financial 
statements have been reclassified to conform to the current year's 
presentation.

2.    STOCKHOLDERS' EQUITY

PRIVATE PLACEMENTS OF EQUITY SECURITIES - In fiscal year 1997, the Company 
completed a private equity financing ("1997 Private Placement") in two stages 
with the initial closing completed on December 19, 1996 (the "Initial 
Closing") and the final closing completed on March 7, 1997 (the "Final 
Closing") in which it raised $8,542,000, net of offering expenses.

The Company sold 100 Premium Preferred Units ("Units") at a price per Unit of 
$100,000, each Unit consisting of 500 shares of Convertible Preferred Stock 
("Preferred Stock"), par value $25 per share, and 50,000 Common Stock 
Purchase Warrants ("Warrants"), to accredited individuals and institutional 
investors pursuant to Regulation D under the Securities Act of 1933, as 
amended. Each Warrant entitles the holder to purchase one share of Common 
Stock at a price of $1 per share and may be exercised until March 7, 2007.

                                      38

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The initial conversion ratio for the Preferred Stock was 208.33 shares of 
Common Stock for each share of Preferred Stock. The 1997 Private Placement 
contained an adjustment provision to reset the conversion ratio under certain 
conditions. For Preferred Stock converted after March 7, 1998, the new 
conversion ratio is 290.89 shares of common stock for each share of Preferred 
Stock. 

The subscribers to the Private Placement purchased the Units at a discount 
from the closing prices of the Company's common stock on the Initial Closing 
date of 23% and the Final Closing date of 36%. The detachable stock purchase 
warrants issued as part of the Units and had a fair value at the date of 
issuance of $1,967,000. The aggregate value of the beneficial conversion 
feature and warrants at the date of issuance was $6,721,000 and has been 
recognized as a return to the Preferred Stockholders from the date of 
issuance of the Preferred Stock to the date in which the Preferred Stock was 
eligible for conversion into Common Stock. The reset of the conversion ratio 
during March 1998 generated an additional non-cash dividend of $2,576,000. 
Accordingly, non-cash dividends to preferred stockholders totaled $9,297,000, 
of which $7,227,000 and $1,696,000 were recognized during the years ended 
March 31, 1998 and 1997, respectively.

Holders of the Preferred Stock will be entitled to receive dividends, when 
and if declared by the Board of Directors. The Company does not intend to pay 
cash dividends on the Preferred Stock or the underlying Common Stock for the 
foreseeable future. Liquidating rights for preferred stockholders are $260 
per share plus accrued, but unpaid dividends.

Certain of the subscribers to the Private Placement entered into a Lock-up 
Agreement ("Lock-up") with the Company. In the Lock-up, each subscriber 
agreed not to sell or exercise any of the securities contained in the Units 
until the underlying common stock is registered with the Securities and 
Exchange Commission. The Company filed a registration statement with respect 
to resale of the securities to be offered and the registration statement was 
effective on September 4, 1997. As of March 31, 1998, 25% of the securities 
remain subject to the Lock-up.

The placement agent, Paramount Capital Inc. ("Paramount"), who is affiliated
with certain significant shareholders of the Company, received an aggregate
dollar commission of $900,000 and a non-accountable expense allowance of
$410,753. The Company will also pay a commission to Paramount of 6% of the gross
proceeds received upon any exercise of the Warrants. Additionally, in connection
with the 1997 Private Placement and in connection with its provision of
financial advisory services to the Company, Paramount received a Unit Purchase
Option and an Advisory Option (the "Options") which, in the aggregate, entitle
Paramount to purchase 25 Units at $110,000 per unit. Accordingly, the Options
would entitle the holders thereof, upon exercise, to receive (i) 12,500 shares
of Preferred Stock, convertible into 3,636,125 shares of Common Stock, and (ii)
Warrants to purchase 1,250,000 shares of Common Stock. 

Under the terms of the Placement Agency agreement the Company signed with 
Paramount, Paramount will provide financial advisory services to the Company 
for an 18 month period beginning after the final closing. The Company will 
pay Paramount $2,500 per month and has agreed to sell 2.5 Units at $110,000 
per unit to Paramount. The convertible Preferred Stock contained in the Units 
convert into 363,613 shares of the Company's common stock ("Advisory Stock"). 
There are also warrants ("Advisory Warrants") to purchase 125,000 shares of 
the Company's common stock at $1 per share attached to the Units, which are 
exercisable until March 7, 2007. The Company valued the Advisory Stock at 
approximately $335,000 and the Advisory Warrants at approximately $162,000 
using a valuation program in accordance with SFAS 123. The Company is 
amortizing these advisory services over 18 months beginning in April 1997.

                                      39

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

During November 1995 the Company completed a private placement of 34.85 units 
at $100,000 per unit to "accredited" investors as defined by federal 
securities regulations. Each unit was comprised of 80,000 shares of the 
Company's common stock and 100,000 warrants to purchase one share of common 
stock per warrant at an exercise price of $1.00 per share for a period of ten 
years. The Company received net proceeds of $2,920,000 after issuance costs 
of $565,000 Included among the issuance costs was the payment of $314,000 in 
commissions and a non-accountable expense allowance of $139,000 to Paramount. 
The Company will also pay a commission to Paramount of 6% of the gross 
proceeds received upon any exercise of the warrants. Additionally, Paramount 
received 4.35625 unit purchase warrants at an exercise price $110,000 per 
unit, to purchase up to 784,125 shares of common stock.

WARRANTS AND PLACEMENT AGENT'S UNIT PURCHASE OPTIONS - The table below 
summarizes the number of the Company's outstanding warrants and unit purchase 
options at March 31, 1998:

<TABLE>
<CAPTION>
                                                                        Placement
                                                                          Agent's               Other
                                          Class A         Class B       Options and         Compensation
Description                              Warrants        Warrants         Warrants             Warrants            Total
------------------------------------   --------------   ------------  ------------------  ------------------  ---------------
<S>                                      <C>              <C>             <C>               <C>                 <C>
Balance at March 31, 1997                  8,385,150        309,734           4,638,408             403,600       13,736,892
     Issued                                                                   1,031,880                            1,031,880
     Exercised                               423,437                                                                 423,437
     Cancelled/Expired                                                                              153,600          153,600
                                       --------------   ------------  ------------------  ------------------  ---------------
Balance at March 31, 1998                  7,961,713        309,734           5,670,288             250,000       14,191,735
                                       --------------   ------------  ------------------  ------------------  ---------------
                                       --------------   ------------  ------------------  ------------------  ---------------

Weighted Average Exercise Price          $      1.00      $   22.00      $         1.06      $         1.48     $       1.49
                                       --------------   ------------  ------------------  ------------------  ---------------

</TABLE>


The Company may redeem the warrants if the market price of the Company's 
Common Stock for the 20-day period exceeds $4 per share. 3,010,000 of the 
Class A Warrants expire in November 2005 and 4,952,000 expire in March 2007.

As described in Note 4, a stipulated settlement agreement was completed in 
June 1994 under which the Company issued Class B warrants to purchase 309,734 
shares of common stock at an exercise price of $22 per share, exercisable for 
a period of five years from date of issuance. The settlement warrants were 
issued on August 11, 1996 and expire in August 2001. The Company valued the 
Class B warrants using a generally accepted valuation program and determined 
that the value was immaterial.

In May 1996, the Company entered into an agreement with Wound Healing of 
Oklahoma ("WHO"), under which the Company acquired an exclusive world-wide 
license to a certain Cancer Immunotherapy technology. Under the agreement, 
the Company granted WHO a ten-year warrant to purchase 100,000 shares of the 
Company's common stock at an exercise price of $2.25 per share valued at 
$50,000, and must pay a minimum royalty of $50,000 per year. The value of the 
warrant was based upon the negotiated terms of the agreement. The first year 
royalty is payable in two stages, 1) $25,000 due upon execution of the 
agreement and 2) $25,000 due upon submission of an Investigational New Drug 
("IND") application to the U. S. Food and Drug Administration ("FDA"). The 
initial $25,000 was recognized as an expense upon execution of the agreement. 
The Company will record the balance of the expense related to the issuance of 
the warrant and pay the contingent portion of the minimum royalty if and when 
an IND is filed with the FDA concerning this technology.

                                       40

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

In September 1996, the Company entered into a line of credit agreement with 
two of its stockholders under which the Company may borrow up to $500,000. 
The agreement called for interest at the rate of 12% per annum. In connection 
with the line of credit agreement, the Company granted the stockholders 
five-year warrants to purchase a total of 150,000 shares of the Company's 
common stock at an exercise price of $0.96. The warrants, which expire in 
October 2001, are valued at $20,000, which was recorded as interest during 
the period the line of credit facility was outstanding. The fair market value 
of the warrants was determined based upon rates for lines of credit with 
similar terms available to the Company at the date of grant. The line of 
credit was subsequently paid back in March 1997.

STOCKHOLDERS' RIGHTS PLAN - In April 1991, the Company's Board of Directors 
adopted a stockholders' rights plan. The plan provides for the distribution 
of preferred stock purchase rights to common stockholders which separate from 
the common stock ten business days following: (a) an announcement of an 
acquisition by a person or group ("Acquiring Party") of 15% or more of the 
outstanding common shares of the Company, (b) the commencement of a tender 
offer or exchange offer for 15% or more of the common shares, or (c) a merger 
or asset sale as defined in the agreement. Under the agreement, certain 
related parties are not considered to be an Acquiring Party. In addition, the 
plan was amended in November 1995 to allow Paramount (and its affiliates) 
associated with the November 1995 private placement to acquire up to 30% of 
the outstanding common shares of the Company without being characterized as 
an Acquiring Party and was additionally amended on December 17, 1996 to 
provide that Paramount (and its affiliates) would not be considered an 
Acquiring Party under the plan. One right attached to each share of common 
stock outstanding as of April 15, 1991 and attaches to all shares issued 
thereafter. Each right entitles the holder to purchase one one-hundredth of 
one share of Series R junior participating cumulative preferred stock, par 
value $25 per share ("unit of preferred stock"), at an exercise price of $120 
per unit of preferred stock. The units of preferred stock are non redeemable, 
voting and are entitled to certain preferential dividend and liquidation 
rights. The exercise price and the number of units of preferred stock 
issuable are subject to adjustment to prevent dilution.

If, after the rights have been distributed, the Company is a party to a 
business combination or other specifically defined transaction, each right 
(other than those held by the Acquiring Party) will entitle the holder to 
receive, upon exercise, units of preferred stock or shares of common stock of 
the surviving company with a value equal to two times the exercise price of 
the right. Alternatively, a majority of the independent Directors of the 
Company may direct the Company to exchange all of the then outstanding rights 
for common stock at an exchange ratio of one common share per right. The 
rights expire April 15, 2001 and are redeemable (at the option of a majority 
of the independent Directors of the Company) at $.01 per right at any time 
until the tenth day following an announcement of the acquisition of 15% or 
more of the Company's Common Stock.

COMMON STOCK OPTIONS - The Company is authorized to issue options of up to 
6,418,000 common shares to directors, consultants and key employees under 
various stock option plans or by direct grant by the Company's Board of 
Directors. Incentive and non-qualified stock options are granted at prices 
not less than the fair market value at the date of grant. There were no 
options granted below fair market value during fiscal years 1998, 1997 and 
1996. However, during fiscal year 1998, two employees were issued 75,000 
shares of restricted stock at a fair market value of $0.875 per share which 
vest over a two year period. Options become exercisable in various increments 
over two through five years. Options expire if not exercised within 5-10 
years from the date of grant.

                                       41

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


The following table summarizes stock option activity for the fiscal years ended
March 31, 1996, 1997 and 1998:

<TABLE>
<CAPTION>
                                                Number            Weighted Average
                                               of Shares           Exercise Price
                                               --------            --------------
      <S>                                      <C>                     <C>
      Outstanding April 1, 1995                1,051,640               $ 8.87
           Granted                               182,000               $ 2.21
           Exercised                                   -                    -
           Canceled                             (320,340)              $11.51
                                                 -------
      Outstanding March 31, 1996                 913,300               $ 6.59
           Granted                             1,054,000               $ 1.15
           Exercised                                   -                    -
           Canceled                            (257,300)               $ 5.10
                                               ---------
      Outstanding March 31, 1997               1,710,000               $ 3.08
           Granted                               920,000               $ 1.17
           Exercised                                   -                    -
           Canceled                            (597,500)               $ 1.48
                                                --------
      Outstanding March 31, 1998               2,032,500               $ 2.24
                                               ---------
                                               ---------

</TABLE>

As of March 31, 1998, 4,310,000 shares remained available for grant under all 
plans. At March 31, 1998, options for 888,225 shares of common stock were 
exercisable at a weighted average exercise price of $3.45 per share and the 
remaining 1,144,275 become exercisable through 2002. At March 31, 1997, 
options for 489,725 common shares were exercisable at a weighted average 
exercise price of $6.78 per share.

The Company has adopted the disclosure only provisions of SFAS 123 and 
continues to account for its stock-based awards using the intrinsic value 
method in accordance with APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO 
EMPLOYEES and its related interpretations. Accordingly, no compensation 
expense has been recognized during fiscal years 1998, 1997 and 1996 for 
employee stock option and purchase plan arrangements. In fiscal year 1998, 
$5,000 of compensation expense was recognized related to restricted stock 
awards.

Under SFAS 123, the fair value of stock-based awards to employees is 
calculated through the use of option pricing models, even though such models 
were developed to estimate the fair value of freely tradable, fully 
transferable options without vesting restrictions, which significantly differ 
from the Company's stock option awards. These models also require subjective 
assumptions, including future stock price volatility and expected life of 
options. A change in those assumptions could result in a significant change 
in the calculated values. Pro forma disclosures as if the Company adopted the 
cost recognition requirements under SFAS 123 in fiscal years 1998 and 1997 
are presented below.

If the computed fair values of the fiscal year 1998, 1997 and 1996 awards had 
been amortized to expense over the vesting period of the awards, the proforma 
effect would have been an increase to compensation expense and net loss of 
$383,000 or ($.04) per share, $113,000 or ($.01) per share and $40,000 or 
($.01) per share for the years ended March 31, 1998, 1997 and 1996, 
respectively. The program effect on net loss for fiscal years 1998, 1997 and 
1996 is not representative of the proforma effect on net income or loss in 
future years because it does not take into consideration proforma 
compensation expense related to grants awarded prior to April 1, 1995.

                                       42

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table summarizes significant ranges of outstanding and exercisable
options at March 31, 1998:

<TABLE>
<CAPTION>
                                               OPTIONS OUTSTANDING            OPTIONS EXERCISABLE
                                               -------------------            -------------------

                                         WEIGHTED AVERAGE      WEIGHTED                    WEIGHTED
                                            REMAINING          AVERAGE                     AVERAGE
    RANGE OF                 NUMBER        CONTRACTUAL         EXERCISE       NUMBER       EXERCISE
  EXERCISES PRICES          OF SHARES       LIFE (YRS)          PRICE       EXERCISABLE     PRICE
  ----------------          --------        ----------          -----       -----------     -----
    <S>                    <C>                 <C>            <C>             <C>          <C>
     $ 0.75-$1.13          1,525,000           8.9            $ 1.05          528,125      $ 1.11

        1.75-2.50            183,500           7.9              2.04           95,200        2.03

        3.50-5.13            197,000           6.4              4.91          137,900        4.91

       6.25-10.00             67,000           5.1              9.09           67,000        9.09

      15.00-16.88             60,000           2.7             16.57           60,000       16.57
                           ---------                                          -------

     $ 0.75-16.88          2,032,500           8.3            $ 2.24          888,225      $ 3.45
                           ---------                                          -------
                           ---------                                          -------

</TABLE>

The weighted average fair value of options granted during fiscal years 1998,
1997 and 1996 was estimated at $0.58, $0.57 and $1.42 respectively. The
Company's calculations were made using the Black Scholes option pricing model
recognizing forfeitures as they occur with the following weighted average
assumptions:

<TABLE>
<CAPTION>

                               1998             1997              1996
                               ----             ----              ----
<S>                            <C>              <C>               <C>
Expected Life                  2.6              2.6               4.0
Interest Rate                  5.8%             6.0%              6.0%
Volatility                      75%              75%               84%
Dividend Yield                   0%               0%                0%

</TABLE>

3.    DISTRIBUTION AND MARKETING AGREEMENTS

In May 1996, the Company entered into a distribution agreement with a 
European dental company for it to become the exclusive European distributor 
for the Company's Periodontal Tissue Monitor ("the PTM") product. The Company 
made an initial shipment to the distributor and recorded revenue of $76,000 
during the year ended March 31, 1997. No revenues were recorded in the 
current fiscal year under this agreement and the agreement terminated in 
November 1997.

On June 23, 1997, the Company received approval from the United States Food 
and Drug Administration ("FDA") to begin commercial sales and distribution in 
the United States of its PTM product. During the current fiscal year, the 
Company signed two agreements with an international dental company for the 
exclusive five-year distribution of PTM worldwide, except in Japan. The 
company recorded $68,000 in revenues under the agreements during the current 
fiscal year.

                                       43

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

During the year ended March 31, 1996 the Company entered into an agreement 
under which it granted exclusive rights relating to its Kephra(TM) 
photochromic technology. The agreement relates to the exclusive use of Kephra 
in the U.S. and Canadian soft-drink markets and expired in June 1997. The 
Company recorded $150,000 of revenues during fiscal 1996 under this agreement.

In January 1996 the Company entered into an agreement under which it licensed 
its Sun Alert technology for exclusive worldwide use. The Sun Alert license 
is renewable each year with a minimum royalty payment of $5,000.

4.   COMMITMENTS AND CONTINGENCIES

TECHNOLOGY LICENSE AGREEMENTS - The Company enters into agreements relating 
to certain technologies which obligate the Company to pay royalties based on 
any sales of products incorporating such technologies and upon achievement of 
certain other milestones.

In March 1998, the Company signed a license agreement for a compound called 
O6 Benzylguanine ("BG") with the owners of the patents: Pennsylvania State 
University, the National Institutes of Health (NIH), the University of 
Chicago, and Case Western Reserve University, (collectively, the 
"Co-Owners"). Under the terms of the agreement, the Company has a six month 
evaluation period ending on September 17, 1998. The Company may terminate the 
agreement during the evaluation period and pay $75,000 to the Co-Owners. 
Accordingly, the Company recorded $75,000 in product development expenses 
under this agreement during Fiscal 1998.

The Company may enter into a Cooperative Research and Development Agreement 
("CRADA") with the NIH to fund studies and clinical trials. If the Company 
were to enter into a CRADA with the NIH, it would be obligated to provide 
funding of $125,000 each year for five years for research. If the Company 
elects to continue to develop the BG technology, it would be obligated to 
make additional milestone, royalty and patent reimbursement payments to the 
Co-Owners during the term of the License Agreement. The agreement also has a 
provision in which the Company may elect to make payments in common stock of 
the Company.

In connection with the license agreement for BG, the Company entered into an 
introduction agreement with Paramount. The agreement provides for cash 
consideration of $100,000 plus reimbursement of expenses, as well as 
milestone payments in the Company's common stock of up to 1,000,000 shares if 
the BG compound successfully reaches certain milestones. The Company recorded 
$225,000 in product development expenses under this agreement during the 
current fiscal year. Paramount is affiliated with certain significant 
shareholders of the Company and a Paramount employee is a member of the 
Company's Board of Directors.

In May 1996 the Company entered into an agreement with Wound Healing of 
Oklahoma ("WHO") under which it acquired an exclusive worldwide license to 
Cancer Immunotherapy technology. The agreement requires the Company to pay 
WHO a royalty ranging from 8% to 10% on any sales of products using the 
licensed technology, or from the sale of marketing rights associated with the 
technology. The Company also entered into a research agreement for one year, 
plus renewal options, with WHO. During fiscal years 1998 and 1997, the 
Company incurred research and deveolopment expense of $305,000 and $322,000, 
on developing this technology.

The Company has an agreement with the Board of Trustees of the University of 
Illinois ("U of I") which grants the Company an exclusive license to certain 
technologies used in the PTM product and requires the Company to pay a 
royalty, subject to reduction under certain circumstances, to U of I equal to 
5% of any sales of PTM. No royalties were recorded under the agreement in 
fiscal year 1998.

                                       44

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


LEASES - The capitalized cost and accumulated depreciation of property under
capital lease obligations included in property and equipment is as follows:

<TABLE>
<CAPTION>
                                                                March 31
                                                             1998        1997
                                                             ----        ----
           <S>                                             <C>         <C>
           Office furniture and equipment                  $28,393     $23,918
           Less accumulated depreciation                    (3,155)     (6,176)
                                                           -------     -------
           Net property under capital lease obligations    $25,238     $17,742
                                                           -------     -------
                                                           -------     -------
</TABLE>


Future minimum lease commitments and rental payments are summarized as follows
for the year ending March 31:

<TABLE>
<CAPTION>
                                                              Capital       Operating
                                                              Leases          Lease
                                                              ------          ------
           <S>                                               <C>             <C>
           1999                                              $ 6,519         $34,078
           2000                                                6,519         -------
           2001                                                6,519         -------
           2002                                                6,519
           2003                                                6,519
           Thereafter                                          1,630
                                                             -------
                                                              34,225
           Less imputed interest                              (7,575)
                                                             -------
           Present value of minimum future lease payments    $26,650
                                                             -------
                                                             -------

</TABLE>

At March 31, 1998, the Company occupied approximately 3,400 square feet of
office and laboratory space in San Diego, California under a lease which expires
in February 1999. The lease has no renewal options. Total rent expense for the
fiscal years ended March 31, 1998, 1997 and 1996, and the period September 23,
1983 to March 31, 1998 was $45,472, $136,831, $132,766 and $1,559,483,
respectively.

EMPLOYMENT AGREEMENT - The Company entered into an employment agreement with 
Dr. H. Laurence Shaw, its Chairman, President and Chief Executive Officer for 
an initial two year period beginning December 17, 1996, subject to renewal 
upon mutual agreement. Pursuant to the agreement, the Company has agreed to 
pay Dr. Shaw an initial base salary, subject to certain annual increases. Dr. 
Shaw will also be entitled to receive a minimum annual bonus with an 
additional annual milestone-based bonus at the discretion of the Board of 
Directors of up to an additional 50% of base salary. In connection with the 
execution of the agreement, Dr. Shaw was paid a signing bonus. Pursuant to 
the terms of agreement, Dr. Shaw was granted qualified incentive stock 
options to purchase 675,000 shares of the common stock of the Company, 
exercisable for a period of ten years, at an exercise price equal to the fair 
market value on the date of issuance, with vesting ratably over a three year 
period from the date of grant.

Under the terms of Dr. Shaw's employment agreement, the Company is required 
to pay all of Dr. Shaw's relocation expenses. The Board of Directors approved 
an interest free bridge loan of $300,000 to Dr. Shaw for the purpose of 
acquiring a new residence in California prior to the sale of his New Jersey 
residence. The loan, which was made on May 1997, was paid back in September 
1997. The Company paid $182,000 in relocation expenses under the employment 
agreement during fiscal year 1998.

CONSULTING AGREEMENTS - As compensation for services rendered, the Company 
paid annual consulting fees to its former Chairman of $37,500 and $87,500 for 
fiscal years 1997 and 1996, respectively.

                                       45

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

In December 1996, Dr. Jerry Weisbach was appointed to the Board of Directors 
of the Company.  The Company also entered into a consulting agreement with 
Dr. Weisbach to provide advisory services to the Company.  Dr. Weisbach was 
paid $30,600 and $9,000 during the fiscal years 1998 and 1997, respectively.  
Dr. Weisbach resigned from the Board of Directors in January 1998 and the 
consulting agreement was terminated.

LITIGATION - During 1992, the Company was the target of a consolidated 
stockholder class action complaint. Although management believed the claim to 
be without merit, the Company concluded that it was in the best interest of 
the Company to settle the matter. Such action was ultimately settled during 
fiscal 1995 with a cash payment of $2,800,000 to the plaintiff class, all of 
which was paid by the Company's insurers. Additionally, in fiscal year 1997, 
the Company issued to the plaintiff class five year Class B Warrants to 
purchase 309,734 shares of Common Stock at an exercise price of $22 per 
share. The Class B Warrants were issued on August 11, 1997 and expire in 
August 2001. The Company valued the Class B warrants using a generally 
accepted valuation model and determined that the value was immaterial.

5.    INCOME TAXES

Significant components of the Company's deferred tax assets and liabilities are
as follows:

<TABLE>
<CAPTION>
                                                                             March 31
                                                                  1998                     1997
                                                           --------------------     --------------------
      <S>                                                      <C>                      <C>
      Deferred tax assets:
              Capitalized research expense                     $       226,000          $       276,000
              Accruals not currently deductible                         53,000                   41,000
              Net operating loss carryforwards                      12,388,000               11,647,000
              Capitalized technology                                   646,000                        -
              Research and development and other credits               577,000                  634,000
                                                           --------------------     --------------------
                     Total deferred tax credits                     13,890,000               12,598,000
      Deferred tax liabilities-patent expense                          (44,000)                 (65,000)
                                                           --------------------     --------------------
                     Total net deferred tax assets                  13,846,000               12,533,000
      Valuation allowance for deferred tax assets                  (13,846,000)             (12,533,000)
                                                           --------------------     --------------------
                     Net deferred tax assets                   $             -          $             -
                                                           --------------------     --------------------
                                                           --------------------     --------------------

</TABLE>

A valuation allowance of $13,846,000 and $12,533,000 at March 31, 1998 and 
1997, respectively, has been recognized as an offset to the deferred tax 
assets as realization of such assets is uncertain. At March 31, 1998, the 
Company has federal and California tax net operating loss carryforwards of 
approximately $33,077,000 and $9,175,000, respectively. The Company also has 
federal and California research and other credit carryforwards of 
approximately $442,000 and $135,000, respectively. The difference between the 
tax loss and credit carryforwards for federal and California purposes is 
attributable to the capitalization of research and development expenses for 
California tax purposes and a required 50% limitation in the utilization of 
California tax loss carryforwards. The federal and California tax loss 
carryforwards and the credit carryforwards expire beginning in Fiscal 1999 
through 2013, unless previously utilized.

The Internal Revenue Code ("the Code") includes provisions which 
significantly limit potential use of net operating losses in situations where 
there is a change in ownership of more than 50% during a three-year

                                       46

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

period. Accordingly, if a change in ownership occurs, the ultimate benefit 
realized from these carryovers may be significantly reduced in total, and the 
amount that may be utilized in any given year may be significantly limited. 
The State of California has enacted similar legislation. The common stock 
issuance of November 27, 1995 in combination with other stock issuances 
completed by the Company during the past three years have resulted in a 
change in ownership as of November 27, 1995 as defined in the Code. 
Accordingly, the Company has federal and California net operating losses in 
the amount of $25,175,000 and $6,526,000 respectively that are currently 
subject to the annual limitation. Approximately $605,000 of these net 
operating losses become available for use each year. The remaining federal 
and California net operating losses of approximately $7,902,000 and 
$2,649,000, respectively, are not subject to the annual limitation since 
these losses occurred after the ownership changes.

6.  OPTION TO ACQUIRE BINARY THERAPEUTICS, INC.

On June 4, 1996 the Company entered into an agreement with Binary 
Therapeutics, Inc. ("BTI") under which the Company was granted an option to 
acquire BTI, a development stage company with certain technologies in the 
area of Photodynamic Therapy ("PDT") for cancer. The agreement, as amended, 
gives the Company the right to acquire BTI by a merger of BTI into a 
wholly-owned subsidiary of the Company. In February 1997, the Company and BTI 
agreed to extend the period during which the Company may exercise its option 
to acquire BTI from April 30, 1997 until such time as BTI has completed human 
clinical trials of Boronated Porphyrin Compound ("BOPP") at an agreed upon 
dose level (the "Option Period"). The Option Period was extended at the 
Company's request to enable BTI to complete preclinical studies, to commence 
clinical trials in humans and to demonstrate that a given dose level of BOPP 
in humans would not cause certain adverse events. Accordingly, the Company 
has deferred its election to exercise the option.

The agreement calls for the Company to issue common stock to the BTI 
stockholders with an aggregate acquisition value of $6,000,000. The number of 
shares of the Company's common stock to be issued ranges from 1,000,000 to 
3,000,000 shares, and is to be determined based upon the market price of the 
Company's common stock prior to the date of exercise. The agreement has been 
approved by a majority of the stockholders of BTI. The Company's Board of 
Directors voted to approve the merger, however the merger is also subject to 
shareholder approval for the issuance of additional shares of common stock. 
One of the Company directors is also a director of BTI.

Under the agreement, the Company will assist BTI during the option period in 
preparing the PDT products for advancement into human clinical trials. The 
Company pays substantially all of BTI's operating expenses which are 
comprised primarily of product development costs. The Company is also 
required to advance to BTI funds to repay $664,000 of indebtedness, including 
accrued interest as part of the acquisition price of BTI. Certain holders of 
such indebtedness are shareholders of the Company. In exchange for such 
funding, BTI will issue convertible notes to the Company which may be 
converted into BTI equity at the Company's option or if the merger is not 
consummated. The Company has elected to record all advances to BTI as product 
development expense in the period incurred due to uncertainties regarding the 
ultimate value to be realized from the convertible notes. During the fiscal 
years ended March 31, 1998 and 1997, the Company advanced $1,176,000 and 
$1,282,000, respectively to BTI.

7.  OTHER RELATED PARTY TRANSACTIONS

For the period September 23, 1983 to March 31, 1995, the Company incurred 
expenses, principally for financial consulting services inclusive of finder's 
fees on Company financing of $861,928 to related entities.

                                       47

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8.     SUBSEQUENT EVENTS

POTENTIAL DELISTING FROM THE AMERICAN STOCK EXCHANGE

On June 24, 1998, the Company received notice from the American Stock 
Exchange ("AMEX") that Amex intends to take action to remove the Company's 
Common Stock from the AMEX because the Company no longer satisfies all of the 
financial guidelines of the AMEX for continued listing. The Company notified 
the Board of Governors of AMEX that intends to appeal the decision to remove 
the Company's Common Stock from the AMEX. There can be no assurance that the 
appeal by the Company will be successful, and that the listing will be 
continued. The Company is taking measures to ensure that in the event of an 
unsuccessful appeal, an orderly transition will occur and that its Common 
Stock will commence trading on the NASD Electronic Bulletin Board.

SECURITY PRIVATE PLACEMENT FINANCING

The Company entered into a Placement Agency agreement with Paramount to do an 
additional private placement financing ("Private Placement"). Under the terms 
of the agreement, the placement agent will use its best efforts to sell 60 
Units for $100,000 each, which consist of 50,000 shares of Series A 
Convertible Preferred Stock ("Units"), valued at $2.00 per share of BG 
Development Corp. ("BGDC"), a wholly-owned subsidiary of the Company. The 
Units are redeemable in cash or common stock of the Company under certain 
circumstances. The Private Placement, as presently structured, would raise 
minimum gross proceeds of $1,000,000 and maximum gross proceeds of $6,000,000 
with a provision for the placement agent to sell an additional 40 Units as an 
over-allotment of up to $4,000,000. Seventy-five percent of the net proceeds 
of the Private Placement will be used by BGDC for development costs 
associated with BG technology acquired during fiscal 1998 (Note 4). 
Twenty-five percent of the net proceeds of the Private Placement will go to 
the Company to be used for general purposes.

At all times while the Units remain outstanding, the preferred stock shall 
accrue dividends as follows:

<TABLE>
<CAPTION>

               Dividend Date                                     Dividend Amount
               -------------                                     ---------------
        <S>                                                     <C>
        From final closing to 30 months                         $1.99 per share
        30-36 months after closing                              $0.82 per share
        36-42 months after closing                              $0.82 per share
        42-48 months after closing                              $1.16 per share
        42-60 months after closing                              $1.16 per share
        After 60 months                                         Compounded rate of 35%

</TABLE>

On June 22, 1998, the Company did an initial closing on 29 Units of the 
private placement described above for gross proceeds of $2,900,000 (net 
proceeds of $2,600,000).

                                       48

<PAGE>

          NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9.     1997 RESTATEMENT 

Subsequent to the issuance of the Company's 1997 financial statements, the 
Company's management determined that the accounting for the convertible 
preferred stock issued, as originally reported in the fiscal 1997, did not 
reflect the value of the detachable stock purchase warrants issued in 
connection with the 1997 Private Placement described in Note 2. The fair 
value of such warrants, as calculated by an independent valuation consulting 
firm was $1,967,000 and is being recorded as a return to the preferred 
stockholders from the date of issue of the Preferred Stock to the date in 
which the Preferred Stock was eligible for conversion into Common Stock. As a 
result, net loss applicable to common shareholders and net loss per share for 
Fiscal 1997 have been restated from the amounts previously reported. Such 
restatement also resulted in a $530,950 increase in both capital in excess of 
par value and the deficit accumulated in development stage.

A summary of the effect of the restatement is as follows:

<TABLE>
<CAPTION>

                                                                            September 23,
                                                                          1983 (inception)              September 23,
                               Fiscal 1997         Fiscal 1997            To March 31, 1997            1983 (inception)
                              As Previously             As                  As Previously              to March 31, 1997
                                 Reported           Restated                  Reported                    As Restated
                             ----------------  -------------------  ----------------------------   -------------------------
<S>                           <C>                  <C>                    <C>                       <C>
Convertible
  preferred stock
  dividends                   $   1,165,261        $   1,696,211          $    1,165,261             $         1,696,211
                             ----------------  -------------------  ----------------------------   -------------------------
Net loss applicable
  to common
  shareholders                $  (5,062,627)       $  (5,593,577)         $  (33,356,189)            $       (33,887,139)
                             ----------------  -------------------  ----------------------------   -------------------------
Net loss per share of
  common stock--basic 
  and diluted                 $       (0.62)       $       (0.69)
                             ----------------  ------------------- 

</TABLE>

                                       49

<PAGE>


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURES

        None.

                                        PART III

ITEM 10.  DIRECTORS AND OFFICERS OF THE REGISTRANT

ITEM 11.  EXECUTIVE COMPENSATION

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

           Information required by Items 10, 11, 12 and 13 is incorporated 
herein by reference to the information under the captions "Election of 
Directors" and "Executive Compensation" and "Beneficial and Record Ownership 
of Securities", respectively, set forth in the Company's definitive Proxy 
Statement to be filed with the Securities and Exchange Commission within 120 
days after March 31, 1998, for its Annual Meeting of Stockholders to be held 
on August 13, 1998. Information concerning executive officers is incorporated 
herein by reference to the information included in Part I, Item 4A of this 
report under the caption "Executive Officers of the Registrant."


                                       50

<PAGE>


                                       PART IV

ITEM 14.     EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES
             AND REPORTS ON FORM 8-K

           (a) (1) The following documents are filed as a part of this Report:
                   Financial Statements--See Index to Consolidated Financial
                   Statements as Item 8 on page 28 of this Report.

                     Exhibits
                     --------

EXHIBIT
NUMBER         DESCRIPTION OF EXHIBIT

2.1           Agreement and Plan of Merger between the Registrant,  XYX 
              Acquisition Corp., and Binary Therapeutics, Inc. dated June 4, 
              1996. (20)

2.2           Letter Agreement dated February 27, 1997 amending the Agreement 
              and Plan of Merger. (25)

3.1           Certificate of Incorporation of the Registrant. (1)

3.2           Certificate of Amendment of Certificate of Incorporation of the
              Registrant. (2)

3.3           Certificate of Amendment of Certificate of Incorporation of the 
              Registrant. (3)

3.4           Certificate of Elimination with respect to the Registrant's Series
              A Convertible Preferred Stock. (4)

3.5           Certificate of Designations of Convertible Preferred Stock,
              Revised Series A of the Registrant. (4)

3.6           Certificate of Designations of Convertible Preferred Stock, Series
              B of the Registrant. (4)

3.7           Form of Certificate of Designations of Series R Junior 
              Participating Cumulative Preferred Stock of the Registrant, as 
              filed with the Delaware Secretary of State on April 16, 1991. (6)

3.8           Certificate of Amendment of Certificate of Designations of 
              Preference of Convertible Preferred Stock, Series B filed with
              the Delaware Secretary of State on September 14, 1989. (13)

3.9           Bylaws of the Registrant amended and restated as of November 6, 
              1992. (16)

3.10          Certificate of Amendment of Certificate of Incorporation filed 
              with the Delaware Secretary of State on April 8, 1996. (20)

*Management contract, compensatory plan or arrangement

                                       51

<PAGE>


EXHIBIT
NUMBER        DESCRIPTION OF EXHIBIT

3.11          Certificate of Amendment to Certificate of Designations of Series
              R Junior Participating Cumulative Preferred Stock, $25.00 par 
              value, filed with the Delaware Secretary of State on November 17,
              1995. (19)

4.1           Description of the Registrant's Common Stock, $.02 par value. (7)

4.2           Rights Agreement, dated as of April 2, 1991, by and between the 
              Registrant and First Chicago Trust Company of New York. (6)

4.3           Form of Right Certificate pertaining to the Preferred Stock 
              Purchase Rights of the Registrant. (6)

4.4           Amendment No. 1 to Rights Agreement between Xytronyx, Inc. and 
              First Chicago Trust Company of New York as Rights Agent dated 
              November 10, 1995. (19)

4.5           Warrant Agreement for "Class B Warrants." (22)

4.6           Certificate of Designations of Series A Convertible Preferred 
              Stock of Xytronyx, Inc. (23)

4.7           Warrant Agreement for "Class B" Warrants including Form of Class
              B Warrant. (24)

4.8           Amendment  No. 2 to Rights Agreement among Xytronyx, Inc., First
              Chicago Trust Company of New York and American Stock Transfer &
              Trust Company dated August 15, 1996. (25)

4.9           Amendment No. 3 To Rights Agreement between Xytronyx, Inc. and
              American Stock Transfer & Trust Company dated December 17, 1996.
              (25)

10.1          Agreement for Cooperative Investigation dated September 6, 1984 
              between the Registrant and the Board of Trustees of the University
              of Illinois. (1)

10.2          Agreement for Cooperative Investigation dated October 8, 1984 
              between the Registrant and the Board of Trustees of the University
              of Illinois. (1)

10.3          Amendment dated October 3, 1985 to the Agreement for Cooperative 
              Investigation dated October 8, 1984 between the Registrant and the
              Board of Trustees of the University of Illinois. (8)

10.4          Agreement dated September 6, 1984 between the Registrant and 
              University Patents, Inc. (1)

10.5          Advice to Holders of the Company Common Stock Issued January 31,
              1984. (1)

10.6          Research Agreement dated January 28, 1986 between the Company and
              the University of Washington. (8)

*Management contract, compensatory plan or arrangement

                                       52

<PAGE>

EXHIBIT
NUMBER          DESCRIPTION OF EXHIBIT

10.7            Research Agreement dated March 4, 1987 between the Registrant 
                and the University of Washington. (3)

10.8*           Nonqualified Stock Option Plan of the Registrant, as amended.
                (8)

10.9*           Incentive Stock Option Plan of the Registrant, as amended. (8)

10.10*          Stock Option Plan for Nonemployee and Non-Consultant Directors 
                of the Registrant. (8)

10.11*          Stock Option Agreement between the Registrant and Morris Weeden.
                (8)

10.12*          Stock Option Agreement between the Registrant and William 
                Jorgenson. (8)

10.13           Form of Indemnity Agreement between the Registrant and its 
                directors and executive officers. (8)

10.14*          Amendment dated May 8, 1987 to the Incentive Stock Option Plan
                of the Registrant. (4)

10.15*          1988 Stock Option Plan of the Registrant. (11)

10.16*          Key Executive Stock Option Plan of the Registrant. (10)

10.17*          1991 Stock Option Plan for Employees and Consultants of the 
                Registrant. (14)

10.18*          1991 Stock Option Plan for Non-Employee and Non-Consultant
                Directors of the Registrant. (14)

10.19           April 29, 1992, Unit Purchase Agreement. (15)

10.20           Ladenburg, Thalmann & Co., Inc. Warrant. (15)

10.21           Payne Financial Group, Inc. Stock Subscription Warrant. (15)


10.22*          Stock Option Agreement between the Registrant and Dr. Peter 
                Baram. (17)

10.23*          Stock Option Agreement between the Registrant and Larry O. 
                Bymaster. (18)

10.24*          Stock Option Agreement between the Registrant and Rand P. 
                Mulford. (18)

10.25           License Agreement Between the Registrant and Wound Healing of
                Oklahoma dated May 8, 1996. (20)

10.26*          Xytronyx, Inc. Equity Incentive Plan. (23)

10.27*          Xytronyx, Inc. Stock Option Plan for Non-Employee 
                Directors. (23)

*Management contract, compensatory plan or arrangement

                                       53

<PAGE>

EXHIBIT
NUMBER          DESCRIPTION OF EXHIBIT

10.28*          Employment Agreement between Xytronyx, Inc. and H. Laurence Shaw
                dated December 16, 1996. (23)

10.29           Form of Placement Agency Agreement between Company and Paramount
                Capital, Inc. (24)

10.30           Form of Amendment No. 1 to Placement Agency Agreement between
                Company and Paramount Capital, Inc. (24)

10.31           Form of Subscription Agreement between Company and certain 
                Selling Stockholders. (24)

10.32*          Employment Agreement dated January 1, 1997 between the Company
                and Larry O. Bymaster. (25)

10.33*          Consulting Agreement dated June 1, 1997 between the Company and
                Donna Shaw, Ph.D. (25)

10.34*          Employment Agreement dated April 18, 1997 between the Company
                and Anil Singhal, Ph.D. (25)

10.35*          Promissory Note dated May 9, 1997 between the Company and Dr. H.
                Laurence Shaw. (25)

10.36*          Exclusive Distribution Agreement dated August 12, 1997 between 
                Pacific Pharmaceuticals, Inc. and Steri-Oss, Inc.(26)

10.37*          Exclusive Distribution Agreement for European  Territory dated
                December 1, 1997 between Pacific Pharmaceuticals, Inc. and 
                Steri-Oss, Inc. Portions of this exhibit have been omitted 
                pursuant to request for confidential treatment. (27)

10.38*          Consulting Agreement dated November 14, 1997 between Pacific 
                Pharmaceuticals, Inc. and Frank Barnes. (27)

10.39*          License Agreement dated March 17, 1998 between the Company and 
                Pennsylvania State University. Portions of the Exhibit have been
                omitted pursuant to a request for confidential treatment. (28)

10.40*          Introduction Agreement dated February 12, 1998 between Paramount
                Capital Investments LLC the Company. Portions of the Exhibit 
                have been omitted pursuant to a request for confidential
                treatment. (28)

10.41*          Form of Placement Agency Agreement dated as of April 1, 1998,
                among the Company, BG Development Corp. and Paramount Capital,
                Inc. (5)

10.42*          Form of Subscription Agreement among the Company, BG Development
                Corp. and Paramount Capital, Inc. (5)

*Management contract, compensatory plan or arrangement

                                       54

<PAGE>

EXHIBIT
NUMBER          DESCRIPTION OF EXHIBIT

23.             Independent Auditors' Consent. (5)

27.             Financial Data Schedule. (5)

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

(1)        Previously filed together with the Registrant's Registration 
           Statement on Form S-18 dated May 30, 1985.

(2)        Previously filed together with Amendment No. 1 to the Registrant's
           Registration Statement on Form S-18 dated July 29, 1985.

(3)        Previously filed together with the Registrant's Annual Report on 
           Form 10-K filed June 29, 1987.

(4)        Previously filed together with the Registrant's Annual Report on
           Form 10-K filed June 17, 1988.

(5)        Filed herewith.

(6)        Previously filed together with the Registrant's Current Report on 
           Form 8-K on April 3, 1991.

(7)        Incorporated by reference to the Registrants Registration Statement 
           on Form 8-A declared effective Sept. 23, 1986.

(8)        Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1986.

(9)        Previously filed together with Amendment No. 2 to the Registrant's
           Registration Statement on Form S-18 dated July 29, 1985.

(10)       Previously filed together with the Registrant's Annual Report on Form
           10-K on June 29, 1989.

(11)       Previously filed together with the Registrant's Proxy Statement dated
           August 15, 1988, for the Annual Meeting of Stockholders held on 
           September 23, 1988.

(12)       Previously filed together with the Registrant's Annual Report on 
           Form 10-K dated March 31, 1990.

(13)       Previously filed together with Registrant's Annual Report on Form 
           10-K dated March 31, 1991.

(14)       Previously filed together with the Registrant's Registration 
           Statement on Form S-8 dated January 13, 1992.

(15)       Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1992.

(16)       Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1993.

                                       55

<PAGE>

(17)       Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1994.

(18)       Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1995.

(19)       Previously filed together with the Registrant's Current Report on
           Form 8-K on November 10, 1995.

(20)       Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1996.

(21)       Previously filed together with the Registrant's Current Report on 
           Form 8-K) on April 1, 1996.

(22)       Previously filed together with the Registrant's Quarterly Report on
           Form 10-Q for the quarter ended September 30, 1996.

(23)       Previously filed together with the Registrant's Quarterly Report
           on Form 10-Q for the quarter ended December 31, 1996.

(24)       Previously filed together with the Registrant's Registration 
           Statement on Form S-3 dated April 28, 1997.

(25)       Previously filed together with the Registrant's Annual Report on Form
           10-K dated March 31, 1997.

(26)       Previously filed together with the Registrant's Current Report on 
           Form 8-K on September 24, 1997.

(27)       Previously filed together with the Registrant's Quarterly Report on
           Form 10-Q for the quarter ended December 31, 1997.

(28)       Previously filed together with the Registrant's Current Report on 
           Form 8-K on March 23, 1998.

           (b)   Reports on Form 8-K.

           A report on Form 8-K, dated June 26, 1998 was filed under item 5 
of Form 8-K with respect to the announcement that the Company received notice 
from the American Stock Exchange ("AMEX") that Amex intends to take action to 
remove the Company's Common Stock from the AMEX because the Company no longer 
satisfies all of the financial guidelines of the AMEX for continued listing. 
The Company will exercise its right to appeal to the Board of Governors of 
AMEX the decision to remove the Company's Common Stock from the AMEX. The 
Company is taking measures to ensure that in the event of an unsuccessful 
appeal, an orderly transition will occur and that its Common Stock will 
commence trading on the NASD Electronic Bulletin Board.

                                       56

<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.


                                          PACIFIC PHARMACEUTICALS, INC.


                                          By:  /s/ JAMES HERTZOG
                                               -----------------
                                               James Hertzog,
                                               Controller and
                                               Principal Financial Officer

                                          Date:  July 13, 1998

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


Signature                 Title                                    Date


/s/ H. LAURENCE SHAW      Chairman of the Board                    July 13, 1998
---------------------     Director, President and
H. Laurence Shaw          Chief Executive Officer
                          (Principal Executive Officer)


/s/ JAMES HERTZOG         Controller                               July 13, 1998
---------------------     (Principal Accounting Officer and
James Hertzog             Principal Financial Officer)


/s/ JACK H. HALPERIN      Director                                 July 13, 1998
---------------------
Jack H. Halperin


/s/ JOHN G. KRINGEL       Director                                 July 13, 1998
---------------------
John G. Kringel


/s/ ELLIOTT H. VERNON     Director                                 July 13, 1998
---------------------
Elliott H. Vernon


/s/ ROBERT A. VUKOVICH    Director                                 July 13, 1998
---------------------
Robert A. Vukovich


/s/ MICHAEL S. WEISS      Director                                 July 13, 1998
---------------------
Michael S. Weiss

                                       57