<PAGE>
 
                                 UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-K


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

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
                                       or


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


                         Commission file number: 24572

                               GENEMEDICINE, INC.
             (Exact name of registrant as specified in its charter)

                 Delaware                                  76-0355802
   (State or other jurisdiction of            (IRS Employer Identification No.) 
   incorporation or organization)   
 
8301 New Trails Drive, The Woodlands, Texas                77381-4248
  (Address of principal executive office)                  (zip code)

                                  281/364-1150
              (Registrant's telephone number, including area code)



Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:  Common Stock, Par
Value $0.001

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. [X]

The aggregate market value of the Common Stock held by non-affiliates of the
registrant, based upon the last sale price of the Common Stock reported on the
National Association of Securities Dealers Automated Quotation System on March
23, 1998 was $33,758,225*.

The number of shares of registrant's Common Stock outstanding as of March 23,
1998 was 14,513,775.

DOCUMENTS INCORPORATED BY REFERENCE: Registrant's Proxy Statement for the 1998
Annual Meeting of Stockholders is incorporated by reference in Part III, Items
10, 11, 12 and 13 of this Form 10-K.

------------------------
* Excludes 3,490,681 shares of Common Stock held by directors, executive
officers and stockholders whose ownership exceeds ten percent of the shares
outstanding on March 23, 1998.  Exclusion of shares held by any person should
not be construed to indicate that such person possesses the power, direct or
indirect, to direct or cause the direction of the management or policies of the
registrant or that such person is controlled by or under common control with the
registrant.
<PAGE>
 
                               GENEMEDICINE, INC.
              ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED
                               DECEMBER 31, 1997

                               TABLE OF CONTENTS


                                        
<TABLE>
<S>                                                                              <C>  
PART I
Item 1.     Business.............................................................   3
                  Overview.......................................................   3
                  Scientific and Industry Background.............................   4
                  GeneMedicine Non-Viral Gene Therapy Technology.................   5
                  Product Development............................................   7
                  Strategic Alliances............................................   9
                  Licensing and Research Agreements..............................  10
                  Patents and Proprietary Technology.............................  11
                  Commercialization and Manufacturing............................  12
                  Government Regulation..........................................  12
                  Competition....................................................  14
                  Product Liability Insurance....................................  14
                  Risk Factors...................................................  15
                  Human Resources................................................  19
                  Executive Officers of the Registrant...........................  20

Item 2.     Properties...........................................................  21
Item 3.     Legal Proceedings....................................................  21
Item 4.     Submission of Matters to a Vote of Security Holders..................  21


PART II
Item 5.     Market for Registrant's Common Equity and Related Stockholder Matters  22
Item 6.     Selected Financial Information.......................................  23
Item 7.     Management's Discussion and Analysis of Financial Condition
            and Results of Operations............................................  24
Item 8.     Financial Statements and Supplementary Data..........................  25
Item 9.     Changes in and Disagreements with Accountants on Accounting and
            Financial Disclosure.................................................  25

PART III
Item 10.    Directors and Executive Officers.....................................  26
Item 11.    Executive Compensation...............................................  26
Item 12.    Security Ownership of Certain Beneficial Owners and Management.......  26
Item 13.    Certain Relationships and Related Transactions.......................  26

PART IV
Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K........  27
</TABLE> 

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                                     PART I
                                        
ITEM 1.   BUSINESS

  Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties.  Actual results could differ materially from those discussed
here. Factors that could cause or contribute to such differences include, but
are not limited to, the early stage of GeneMedicine, Inc.'s development and
technological uncertainty, future capital needs and uncertainty of additional
funding, dependence on collaborative partners and licenses, the failure of
existing or future partnerships to be successful, uncertainty of patent
protection, uncertainty of government regulatory requirements, level of
competition and rapid technological change, as well as those set forth in "Risk
Factors" and elsewhere in this Form 10-K.


Overview

  GeneMedicine, Inc. ("GeneMedicine" or the "Company") is engaged in the
discovery and development of a new class of pharmaceutical products that
incorporate genes ("gene medicines") for the treatment or prevention of serious
diseases. The Company's gene medicines are designed to be well-characterized
pharmaceutical products that are directly administered to patients.  Gene
medicines are designed to deliver genetic instructions to targeted cells in the
body to produce therapeutic proteins or desired immune responses. Gene therapy
requires the safe and convenient introduction of genes into specific cells of
the body and the achievement of suitably sustained therapeutic levels of the
desired protein or of the intended immune response.  In addition, control of
gene function is necessary so that protein production or immune response can be
modified based on the patient's needs.

  Gene medicines are intended for both acute and chronic use.  They are designed
to be administered through convenient and conventional routes, including
intramuscular injection, inhalation and intravenous injection.  The Company's
initial business focus is the development of gene medicines for treating
cancers, neuromuscular disorders, cardiovascular disease, and pulmonary
diseases, as well as in the development of nucleic acid vaccines for therapeutic
and prophylactic treatment of viral and bacterial infections.  GeneMedicine
intends to develop and commercialize its products through corporate alliances
with major pharmaceutical and biotechnology companies.

  GeneMedicine has established a broad proprietary position in non-viral gene
therapy that includes: several key gene delivery and gene expression
technologies; technology related to the manufacture of gene medicines; and, the
use of certain genes to treat certain disease indications.  The Company's core
gene delivery technology includes lipid-, peptide-, and polymer-based systems,
each of which can be applied to specific clinical targets.  In October 1997,
GeneMedicine announced issuance both in the U.S. and in Europe of a patent that
covers the use for gene therapy of any cationic lipid combined with
deoxyribonucleic acid ("DNA") and administered by injection or inhalation, the
most common routes of administration. GeneMedicine has an exclusive worldwide
license to the technology covered by this patent. Gene medicines also
incorporate novel DNA sequences that may be used to control the tissue-
specificity, duration and level of functioning of administered genes. The
Company has developed patented GeneSwitch(TM) technology that may be used to
turn off or to activate the expression of previously administered therapeutic
genes in specific cells. GeneMedicine has created high-yield, low-cost and
scaleable integrated manufacturing processes for the production of its gene
medicines for clinical use.

  The Company's current efforts in the development of cancer gene medicines are
focused on its Interleukin-2 ("IL-2") Gene Medicine for the treatment of head
and neck cancer.  The IL-2 Gene Medicine is the Company's first product being
developed through a corporate alliance with certain Boehringer Mannheim
subsidiaries ("Boehringer Mannheim") of Corange International Ltd. ("Corange")
which was acquired by Roche Holding Ltd. in March 1998. In August 1997,
GeneMedicine commenced a Phase I clinical trial to study the safety and
tolerability of its IL-2 Gene Medicine. An additional IL-2 Gene Medicine Phase I
clinical trial conducted in Germany in collaboration with Boehringer Mannheim
commenced shortly thereafter.  In January 1998, GeneMedicine announced that it
was re-examining potential target indications for its Insulin-like Growth
Factor-I ("IGF-I") Gene Medicine and would not start a previously scheduled
Phase I clinical trial for this product. GeneMedicine received clearance from
the U.S. Food and Drug Administration ("FDA") late in the fourth quarter of 1996
to commence the Phase I clinical trial to study the safety and tolerability of
the IGF-I Gene Medicine, but no patients had been enrolled in the trial. The
reasons for the Company's decision not to 

                                       3
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proceed with the trial were the restrictive criteria placed on the patients'
qualifications for enrollment in this trial and the Company's assessment of the
relative market opportunities for the product. GeneMedicine is currently
conducting preclinical studies on the IGF-I Gene Medicine as part of the
Company's examination of clinical indications for the product. The IGF-I Gene
Medicine is intended for the treatment of focal motor neuropathy and has further
potential broad application in the treatment of muscle disorders and
neuropathies that afflict large patient populations and are not adequately
addressed by current therapies, if at all.


SCIENTIFIC AND INDUSTRY BACKGROUND

  Gene therapy is a method for the treatment or prevention of disease that uses
genes to provide the patient's cells with the genetic instructions necessary to
produce specific therapeutic proteins needed to correct or to modulate disease.
In comparison, traditional pharmaceutical approaches have focused on the
development of small molecule drugs that work generally by interacting with
certain protein targets that are involved in the disease processes and either
enhance or inhibit the function of those proteins. However, many small molecule
drugs lack selectivity and cause side effects by interactions with unwanted
protein targets.  Often the molecular mechanism of action of a small molecule
drug is unclear. The development of small molecule drugs typically takes a long
time and is costly. With protein-based therapeutics developed by biotechnology
companies, the therapeutic protein is directly administered to the patient, but
protein-based therapeutic products are very inefficient in entering cells and
are difficult to manufacture. The practical use of protein-based therapeutics
has been limited to a small number of "circulating proteins." Drug discovery and
development is increasingly benefiting from the intensive efforts by academic
groups and genomic companies to discover genes and understand their functions.
The human genome contains an estimated 100,000 genes. To date, research has
identified about 40,000 of these genes. Only approximately 5,000 genes have been
characterized as to their full function, however, it is estimated that the
elucidation of the human genome could be completed in the next five years.  It
is expected that this genomic information will expand the opportunities for gene
therapy, provide more selective target proteins for small molecule drugs, and
reveal new candidates for protein-based therapeutic products.

  Each cell in the body has the ability to produce thousands of the different
proteins that are essential for cellular structure, function and growth. Genes
are segments of DNA present in each cell in the body, which provide the
information the cells use to produce proteins. Protein production begins in the
nucleus of the cell when the gene is copied (transcribed) into a precursor
ribonucleic acid (called pre-mRNA) which is processed in the nucleus to
ribonucleic acid ("RNA") known as "messenger RNA." Messenger RNA then moves from
the nucleus of the cell into the cell's cytoplasm, where it is "translated" by
the cell into protein. The process of transcription and translation that results
in protein production by the cell is called gene expression.  Different types of
cells express distinct sets of genes and, therefore, produce different sets of
proteins.  The cells look different and perform different functions. Effective
gene therapy requires the delivery of the therapeutic gene to specific targeted
cells.

  Gene therapy approaches currently in development may be distinguished by the
methods used to transfer or deliver therapeutic genes to the patient. These
methods include the use of (i) cells genetically altered ex vivo (outside the
body) with viruses or other gene-transfer methods, (ii) viruses (such as
retrovirus and adenovirus) which have been genetically modified so that they
cannot reproduce and infect other cells, and (iii) synthetic formulations of
plasmids. The Company believes that ex vivo and virus-based gene therapy
approaches have significant clinical and commercial limitations. Both viral and
non-viral ex vivo approaches involve complex procedures whereby the target cells
must be removed from the patient, modified with the therapeutic gene, expanded
in number, cleansed of contaminants and then reintroduced into the patient. In
addition, most ex vivo and some in vivo gene therapies result in a permanent
genetic alteration of the cell, which generally precludes the ability to
modulate treatment in response to therapeutic needs. While a number of viral
gene therapies currently in development can potentially be suitable for direct
administration, safety issues may limit their further development. These include
adverse immune responses, inflammation and the development of antibodies that
may block the activity of the virus-based gene therapy and prevent repeated
administration.

  Non-viral methods are based on the direct administration to patients of
plasmid-based gene expression systems that contain a therapeutic gene as well as
genetic sequences that direct the cell to transcribe and translate this gene
into a therapeutic protein. Plasmids are closed loops of DNA that can be
produced in bacteria through fermentation. In the majority of cases, plasmid-
based gene therapy requires the use of a synthetic gene delivery system to
deliver the gene 

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expression system to the nucleus of specific target cells within the body. Non-
viral gene therapy systems can be administered by conventional and convenient
methods such as intramuscular injection, inhalation or intravenous injection,
can provide increased safety over viral gene therapy approaches and can be
degraded from the body by natural processes allowing the gene medicine to be
administered repeatedly.


GENEMEDICINE NON-VIRAL GENE THERAPY TECHNOLOGY

  GeneMedicine believes that gene medicines may provide a new quality of
pharmaceutical treatment that is not attainable through the use of small
molecule drugs or protein-based therapeutic products. In addition, the Company
believes that the non-viral plasmid-based gene medicines which it is developing
will have significant clinical and commercial advantages over other gene therapy
methods. These advantages include increased safety and direct administration
benefits; enhanced delivery of the therapeutic gene to specific target cells;
and the ability to control the level and site of therapeutic protein production.
The Company believes its gene medicines can provide cost-effective and
convenient treatments for a wide variety of diseases and disorders without the
safety concerns and practical limitations that accompany certain virus-based or
ex vivo gene therapies as well as small molecule drugs and protein based
therapeutic products.

  A gene medicine contains three components: a therapeutic gene that codes for a
specific therapeutic protein; a gene delivery system that controls the location
of the gene within the body; and a plasmid-based gene expression system that may
serve to control the location, level and duration of expression of the
therapeutic gene as well as the location of the resultant protein.

  Each biological target for gene therapy, such as muscle, solid tumors, the
lungs or the cells of the immune system, has a different structure and
biochemistry. The Company believes that for effective gene therapy each
biological target requires a specific gene delivery and gene expression system.
GeneMedicine is currently developing non-viral technology platforms, each
consisting of a gene delivery system and a gene expression system for several
target tissues including: muscle, solid tumors, tumor endothelium, antigen
presenting cells, lung airways, and liver hepatocyte cells.

  The gene delivery system brings the plasmid into contact with the desired cell
and facilitates internalization of the plasmid across the cellular membrane.
This plasmid gene expression system then moves to the nucleus of the cell, where
gene expression begins, resulting in the production of a therapeutic protein
through the steps of transcription and translation.  The Company can engineer
the gene expression system to control whether the resulting protein will remain
within the cell for an intracellular effect or whether it will be secreted from
the cell for either a local or systemic effect. The gene expression system can
also be adjusted to control the level of protein production, as well as the
location and duration of gene expression. The Company's gene medicines are
designed to produce therapeutic levels of protein over a period of several days
to several months.


  GeneMedicine anticipates that its gene expression systems will remain separate
from the cells' chromosomal DNA and degrade from the body. Use of the Company's
gene medicines is intended to be analogous to conventional pharmaceuticals
because they are designed to be administered repetitively if necessary to a
patient according to a dosing schedule that matches the extent and severity of
the disease and can also be used to treat acute or chronic diseases.


 GENE DELIVERY SYSTEMS

  GeneMedicine is developing gene delivery systems based on three broad classes
of materials-lipids, polymers and peptides. The Company has certain rights to
materials in each of these classes.


  Lipids

  GeneMedicine has exclusive and co-exclusive licenses to in vivo gene therapy
  uses of certain cationic lipid gene delivery technologies.  In October 1997,
  GeneMedicine announced issuance both in the U.S. and in Europe of a patent
  that covers the use for gene therapy of any cationic lipid combined with DNA
  and administered by injection or inhalation, the most common routes of
  administration. GeneMedicine  has an exclusive worldwide license to 

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  the technology covered by this patent. In 1994, GeneMedicine obtained a
  worldwide co-exclusive license, with the right to sublicense, from Syntex
  (U.S.A.) Inc. ("Syntex") its cationic lipid gene delivery technology (DOTMA)
  for in vivo gene therapy uses. The Company has shown that gene delivery
  systems containing cationic lipid combined with neutral lipids enhance the
  cellular uptake of plasmid-based gene expression systems in animals. These
  lipid-based gene delivery systems have been demonstrated to enhance the entry
  of genes into tumor cells after intratumoral administration and also to
  deliver genes to the endothelium and epithelium of the lung after intravenous
  administration and inhalation, respectively. The Company is using one of its
  proprietary cationic lipid gene delivery systems in its IL-2 Gene Medicine
  product intended for the treatment of head and neck cancer. In addition, the
  Company's academic collaborators are employing cationic lipid gene delivery
  systems in three physician-initiated clinical trials: a Phase I clinical trial
  to deliver genes to cells lining the airways; and two Phase II clinical trials
  to deliver genes to endothelium cells lining the blood vessels of muscle
  tissue and of the heart. The Company also is pursuing the discovery and
  development of several novel classes of lipid molecules for enhancing gene
  delivery to a variety of tissues.

  Polymers

   The Company has developed gene delivery systems that employ certain polymers
   which, in certain formulations for conventional drugs, are approved for human
   use. The Company has shown that these polymers interact with plasmids and
   facilitate the delivery of genes into muscle cells in vivo after
   intramuscular administration.   The Company is employing its proprietary
   polymeric PINC (Protective, Interactive, Non-Condensing) gene delivery system
   in its IGF-I Gene Medicine. The Company's scientists have demonstrated in
   animal models that the use of polymeric PINC gene delivery systems can lead
   to a significant increase in both the level and the reproductabilty of
   proteins produced in muscle compared to the administration of plasmids
   formulated in saline (so-called "naked" DNA).

   Peptides
 
   GeneMedicine is creating and developing gene delivery systems made up of
   short synthetic peptides and peptides containing simple sugars
   (glycopeptides). The peptides are designed to bind to gene expression systems
   to form a tightly compacted complex, which the Company believes is important
   for gene expression systems to gain access to certain types of cells. The
   glycopeptides are designed to interact specifically with natural receptors
   present on the surfaces of target cells and to effect the entry of the gene
   expression system through the membrane and into those cells. The Company also
   has developed certain gene delivery systems designed to enhance the movement
   of the gene expression system to the cell nucleus where gene expression
   occurs. The Company is developing glycopeptide gene delivery systems for gene
   medicines targeting the hepatocyte cells in the liver after intravenous
   administration. In addition, the Company's peptides can be utilized in
   combination with other materials such as cationic lipids.

   GENE EXPRESSION SYSTEMS
 
       The proprietary gene expression systems of GeneMedicine are designed to
provide therapeutic levels of protein expression at selected sites within the
body. These systems may incorporate cell-specific regulatory elements to cause
transcription in specific cells. The Company's gene expression systems also can
contain genetic elements that control the processing of the RNA transcripts to
messenger RNA, the stability of messenger RNA and the efficiency of secretion of
the gene product from the cell. Gene expression systems may contain
GeneSwitch(TM) technology to enable the expression of a therapeutic protein to
be regulated by administration of certain low molecular weight drugs.

  Cell-Specific Promoters

  GENEMEDICINE is developing plasmids containing cell-specific promoters that
  allow gene expression to be restricted to certain cells within the body. Cell-
  specific gene expression systems are being developed for several targets
  including certain tumors, muscle cells, the liver and the immune system. The
  Company believes that cell-specific expression can enhance the effectiveness,
  safety and reliability of gene therapy products.

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  RNA Processing

  The Company has demonstrated that certain DNA sequences, when incorporated
  into gene expression systems, can increase the duration and level of gene
  expression in vitro and in vivo.  Such  genetic elements increase the
  efficiency and accuracy of RNA processing, which leads to an increase in the
  amount of messenger RNA produced from the gene expression system.  These
  genetic elements increase the stability of the messenger RNA.  Particular
  genetic elements increase the ability of messenger RNA to direct the synthesis
  of the protein product.  The Company has also shown that other DNA sequences,
  when incorporated into gene expression systems, can control the secretion of a
  gene product from several types of cells.

  Drug-Controlled GeneSwitch(TM)

  The Company is developing gene-switch technology which has the capability to
  turn off or activate the expression of previously administered therapeutic
  genes in specific cells by means of certain low molecule weight drugs that are
  used in humans for various therapeutic applications. Gene expression continues
  for as long as the drug is present within the cell. Using a prototype of the
  GeneSwitch(TM) technology, GeneMedicine has demonstrated drug-controlled
  activation of therapeutic genes in animals in several tissues. The Company has
  developed cell-specific gene switches that have been shown in vivo to provide
  for both drug-activated and cell-specific gene expression.

PRODUCT DEVELOPMENT

  The Company's business focus is the development of gene medicines for treating
cancers, neuromuscular disorders, cardiovascular disease, and pulmonary
diseases, as well as in development of nucleic acid vaccines for the therapeutic
and prophylactic treatment of viral and bacterial infections.  GeneMedicine
intends to develop and commercialize its products through corporate alliances
with major pharmaceutical and biotechnology companies.

  CANCER GENE MEDICINES

  GeneMedicine is developing cancer gene medicines that incorporate plasmids
encoding certain cytokine genes. The gene medicines are designed to provide
localized expression of the cytokines which result in potent anti-tumor effects
with minimal systemic exposure and which promote immune responses against
tumors. A corporate alliance with Boehringer Mannheim provides for research and
development of gene medicines to treat head and neck tumors and melanoma. The
Company's IL-2 Gene Medicine for the treatment of head and neck cancer is the
subject of early human clinical trials, and the Company's other cancer gene
medicines are at research and preclinical development stages.

  In August 1997, GeneMedicine commenced a Phase I clinical trial to study the
safety and tolerability of its IL-2 Gene Medicine for the treatment of head and
neck cancer. An additional IL-2 Gene Medicine Phase I clinical trial conducted
in Germany in collaboration with Boehringer Mannheim commenced shortly
thereafter. There can be no assurance, however, that the Phase I clinical trials
of the IL-2 Gene Medicine will be completed successfully within any specific
time period, if at all. GeneMedicine has demonstrated using animal models of
head and neck cancer that its IL-2 Gene Medicine slows the rate of tumor
progression and increases animal survival. More than 40,000 patients in the
United States and 75,000 patients in Europe are diagnosed with head and neck
cancer each year. While head and neck cancers are slow to metastasize, current
therapies do not provide effective treatment in that recurrence of the tumor is
common and mortality in the first five years after diagnosis is approximately 30
percent. The IL-2 Gene Medicine is intended to be used initially in conjunction
with surgery and radiotherapy to reduce disease recurrence and to extend
survival.

The IL-2 Gene Medicine is comprised of a plasmid encoding the human IL-2 gene
and a proprietary cationic lipid gene delivery system that enhances uptake of
the gene into the target cells after direct intratumoral injection.  This
product is designed to provide sustained, localized expression of the IL-2
protein and to promote an immune response against the tumor.  The use of a
cationic lipid gene delivery system is also intended to enable repeated
administration of the IL-2 gene in a safe and effective manner.  IL-2 is an
important human cytokine that has multiple functions and which plays a major
role in the body's immune response to foreign pathogens and tumors.  A
recombinant IL-2 protein product has 

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FDA approval for the treatment of renal cell carcinoma. In addition, the IL-2
protein has demonstrated clinical responses in several other types of cancer.
The application of the recombinant protein in the treatment of cancer is limited
by its short half-life and by significant toxicity when administered
systemically. In contrast, the IL-2 Gene Medicine is designed to control the
sustained production of the IL-2 protein in the tumor mass, thereby avoiding
potentially harmful systemic levels of the IL-2 protein. The technologies
developed for therapy of solid tumors of the head and neck may be applicable to
a wide range of solid tumors and systemic metastases. Additional candidate gene
medicine products for head and neck cancer are currently in research and
preclinical studies.

  GROWTH FACTOR GENE MEDICINES

The Company believes that the controlled delivery and expression of growth
factor genes can have important benefits for the treatment of disease conditions
arising from inadequate repair and regeneration of tissue.  The localized
delivery of certain gene medicines may cause the sustained production of growth
factor proteins that can induce the growth of local tissue to correct the
underlying condition.  Current identified areas of opportunity for growth factor
gene medicines include: neurotrophic and myotrophic gene medicines for the
treatment of focal neuropathies, and angiogenic genes for the treatment of
critical ischemia in the heart or the peripheral circulation.  Each of these
applications has separate demands with respect to the targeted cell.

  IGF-I Gene Medicine

  The Company believes that several muscle and peripheral nerve disorders can be
  treated effectively with gene medicines that cause the localized production of
  therapeutic proteins after intramuscular administration. Furthermore, delivery
  of certain gene medicines to muscle cells could cause the intended sustained
  production and secretion of therapeutic proteins systemically.  The Company
  has developed proprietary polymer gene delivery systems that have been shown
  to enhance the in vivo level and reproducibility of gene expression
  significantly over naked DNA. The Company's primary focus in this product area
  is the development of its IGF-I Gene Medicine.

  GeneMedicine received clearance from the FDA late in the fourth quarter of
  1996 to commence a Phase I clinical trial to study the safety and tolerability
  of the IGF-I Gene Medicine. In January 1998, GeneMedicine announced that it is
  re-examining potential target indications for its IGF-I Gene Medicine and
  would not start the previously scheduled Phase I clinical trial. No patients
  had been enrolled in the clinical trial. The reasons for the Company's
  decision not to proceed with the trial were the restrictive criteria placed on
  the patients' qualifications for enrollment in this clinical trial and the
  Company's assessment of the relative market opportunities for the product.
  GeneMedicine is currently conducting preclinical studies on the IGF-I Gene
  Medicine as part of the Company's examination of clinical indications for the
  product. The IGF-I Gene Medicine is intended for the treatment of focal motor
  neuropathy and has further potential broad application in the treatment of
  muscle disorders and neuropathies that afflict large patient populations and
  are not adequately addressed by current therapies, if at all.

  GeneMedicine has shown in a series of animal models that its IGF-I Gene
  Medicine promotes nerve and muscle growth and provides sustained expression of
  the IGF-I protein for several weeks after a single administration.  The IGF-I
  Gene Medicine incorporates the human IGF-I gene with one of the Company's
  proprietary gene delivery systems, a polymeric PINC system that enables gene
  delivery to skeletal muscle, and a proprietary muscle-specific gene expression
  system.  This product is designed to provide sustained, localized  expression
  of the IGF-I protein after direct intramuscular injection to repair nerves and
  restore muscle mass and strength.  The product's non-viral gene delivery
  system is intended to reduce the likelihood of an immunogenic response and
  thereby allows for repeat administration over a prolonged period of time.

  Vascular Growth Factor Gene Medicine

  GeneMedicine has provided one of its proprietary lipid gene delivery systems
  to scientists at Kuopio University in Finland for two Phase II, physician-
  initiated clinical trials involving gene therapy following angioplasty.  These
  scientists are using the GeneMedicine delivery system to deliver a vascular
  endothelium growth factor (`VEGF') 

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  gene medicine by catheter to prevent the proliferation of smooth muscle cells
  and reclosure of the vessels in patients who are undergoing either a coronary
  angioplasty or peripheral angioplasty. The coronary angioplasty trial will
  involve up to 90 patients, one third of which will receive a VEGF gene
  medicine using the GeneMedicine proprietary lipid gene delivery system. The
  peripheral angioplasty trial will involve up to 75 patients, one third of
  which will receive a VEGF gene medicine using the GeneMedicine proprietary
  lipid gene delivery system.

  PULMONARY GENE MEDICINES

  GeneMedicine has provided one of its proprietary lipid gene delivery systems
and alpha-1 antitrypsin ("AAT") gene expression systems to scientists at
Vanderbilt University ("Vanderbilt").  Under a physician-initiated
Investigational New Drug Application ("IND"), researchers at Vanderbilt have
incorporated the AAT gene in these systems and are conducting Phase I human
clinical studies of this gene medicine as part of a study on the possible
treatment for AAT deficiency, a significant contributor to the development of
emphysema.  Approximately 160,000 people in the United States have AAT
deficiency and about 23,000 of these people are at risk for hereditary
emphysema. GeneMedicine retains the right to commercialize this product.

  NUCLEIC ACID VACCINES

  GeneMedicine is adapting its expertise in the delivery and control of
expression of genes to opportunities in the field of nucleic acid vaccines.  The
prospective advantages of nucleic acid vaccines include: more precise control of
expression of antigens in the body and greater specificity of the immune
response against the pathogen; the ability to express several antigens for
protection from the same or multiple disease causing organisms; and,
potentiation of long-term antigenic memory and more robust cellular and humoral
immune response.

  In addition, nucleic acid vaccines may be created to provide immunization
against diseases where no vaccine currently exists, and with costs and
compliance potentially better than traditional vaccine approaches.  The Company
has identified disease targets, gene candidates and appropriate animal models
and has begun to conduct its initial research in the field.

STRATEGIC ALLIANCES

   The Company intends to develop and commercialize all of its products in
corporate partnerships with major pharmaceutical and biotechnology companies.
There can be no assurance, however, that the Company's current or future
partnership arrangements will be successful or established on favorable terms.
Should any corporate partner fail to develop or commercialize successfully any
product to which it has rights, or any of the partner's products to which
GeneMedicine has rights, the Company's business may be adversely affected. In
addition, there can be no assurance that any of these collaborations will be
continued or result in successfully commercialized products. Failure of a
corporate partner to continue funding any particular program could delay or halt
the development or commercialization of any product arising out of such program.
The Company's Syntex Alliance (defined below) ended in accordance with its terms
in April 1997. In addition, there can be no assurance that corporate partners
will not pursue alternative technologies or develop alternative products either
on their own or in collaboration with others, including the Company's
competitors, as a means for developing treatments for the diseases targeted by
the Company's programs.

  Effective February 1995, GeneMedicine entered into a corporate partnership
agreement with Corange the parent company of Boehringer Mannheim, providing for
research and development of gene medicines to treat head and neck tumors and
melanoma (the "BM Alliance"). GeneMedicine also granted Boehringer Mannheim an
option, which expires May 3, 1998, to expand the collaboration to include
additional cancer indications. Boehringer Mannheim may exercise its option by
agreeing to fund additional research and development at GeneMedicine
commensurate with the initial BM Alliance. Pursuant to the BM Alliance,
Boehringer Mannheim agreed to fund $25 million of research and development at
GeneMedicine at the rate of $5 million a year and make an aggregate equity
investment in GeneMedicine of $20 million at the rate of $4 million a year. The
prices per share for common equity investments by Boehringer Mannheim for the
years 1996 through 1999 are based upon the average closing price for the 15
consecutive trading days immediately preceding February 1 for each year, with
the purchase in 1996 at a 20 percent premium. In no case are the 

                                       9
<PAGE>
 
purchase prices to be less than $7.50 per share. Research and development
funding of $4.6 million, $5 million and $5 million were received in 1995, 1996,
and 1997, respectively. The first four $4 million equity investments were made
in July 1995, February 1996, February 1997 and February 1998 in which 444,444,
418,629, 533,333 and 533,333 common shares were issued at $9.00, $9.56, $7.50
and $7.50 per share, respectively. All remaining payments to the Company are
subject to the achievement of certain milestones. In February 1997, the Company
received a milestone payment of $500,000 for achievement of FDA clearance to
commence the Phase I clinical trial for the IL-2 Gene Medicine. If GeneMedicine
continues to meet the milestones for the development of a gene medicine to treat
head and neck cancer under the BM Alliance, the Company may be entitled to
additional milestone payments of up to $3.25 million. If GeneMedicine fails to
reach certain milestones after the fifth anniversary of the agreement, it may
have to fund an additional year of research at its own expense, not to exceed $5
million. Under the BM Alliance, upon successful completion of Phase II clinical
testing, GeneMedicine may elect either to receive up to 50 percent of profits by
agreeing to share development and commercialization expenses or to receive
royalty payments based on worldwide product sales.

  In April 1994, the Company and Syntex (U.S.A.) Inc., now a subsidiary of Roche
Holding Ltd., entered into a corporate partnership for the development of gene
medicines for certain inflammatory and immunological disorders (the "Syntex
Alliance") providing for a three-year research program.  This alliance ended in
accordance with its terms in April 1997.  Pursuant to the Syntex Alliance,
GeneMedicine obtained a worldwide co-exclusive license, with the right to
sublicense, from Syntex its cationic lipid gene delivery technology (DOTMA) for
in vivo gene therapy uses. The rights under this agreement continue even though
the Company's Syntex Alliance ended. In connection with the commencement of the
Syntex Alliance, Syntex purchased 3,750,000 shares of the Company's Series B
Preferred Stock. The Series B Preferred Stock is convertible into Common Stock
on a 3.5-to-one basis by the holder at any time and by the Company (i) upon the
Company's Common Stock trading at an average price of $14.00 or more per share
for 30 consecutive trading days, (ii) upon completion of a public offering with
minimum gross proceeds of $10 million at a minimum price of $14.00 per share or
(iii) after April 8, 1998. The 3,750,000 shares of Series B Preferred Stock are
convertible into an aggregate of 1,071,428 shares of Common Stock. The holders
of the Series B Preferred Stock are entitled to receive an aggregate liquidation
preference of $15 million, after which assets would be distributed ratably to
the holders of Common Stock. The liquidation preference also applies in the
event of a merger or sale of all or substantially all of the Company's assets.
In connection with the same transaction, Syntex also acquired a five-year
warrant to purchase 1,071,428 shares of the Company's Common Stock at an
exercise price of $21.00 per share. The Company has the right to accelerate the
termination of the warrant at any time.


LICENSING AND RESEARCH AGREEMENTS

  SYNTEX

  The Company has a worldwide co-exclusive license, with the right to
sublicense, from Syntex to its DOTMA technology for in vivo gene therapy uses.
The rights under this agreement continue even though the Company's Syntex
Alliance ended in accordance with its terms in April 1997.

  BAYLOR COLLEGE OF MEDICINE

  The Company has several agreements with Baylor College of Medicine ("Baylor")
pursuant to which the Company has exclusive rights to certain current and future
gene therapy technologies developed by the Company's founding scientists and
their collaborators, as well as access to certain additional technology as it is
developed by such individuals.

  UNIVERSITY OF CALIFORNIA

  GeneMedicine has an exclusive, worldwide license from the University of
California to certain gene delivery technologies and improvements developed by
Dr. Frank C. Szoka, Jr., one of the Company's founders, at the University of
California, San Francisco ("UCSF"). Dr. Szoka's laboratory at UCSF is developing
gene delivery systems to transport genes across membranes for delivery to their
targeted cells and organs.  GeneMedicine also has an exclusive consulting
relationship with Dr. Szoka in the field of gene therapy.

                                       10
<PAGE>
 
  VANDERBILT UNIVERSITY

  The Company has an exclusive, worldwide license from Vanderbilt University to
certain gene delivery technologies and improvements developed by Dr. Kenneth
Brigham. The license pertains to rights under a patent covering formulations of
cationic lipid and DNA, including those containing additional components such as
neutral lipids, polymers or peptides, used for gene therapeutic products and
gene-based vaccines that are administered to patients by injection or
inhalation.


PATENTS AND PROPRIETARY TECHNOLOGY

  Patents and other proprietary rights are important to the Company's business.
The Company's policy  is to file patent applications and protect technology,
inventions and improvements to inventions that are commercially important to the
development of its business. The Company also relies on trade secrets, know-how,
continuing technology innovations and licensing opportunities to develop and
maintain its competitive position. To date, the Company has filed or
participated as a licensee in the filing of numerous patent applications in the
United States relating to the Company's technology, as well as foreign
counterparts of certain of these applications in many countries. The Company has
licensed from Syntex certain rights under certain United States and foreign
patents claiming the use of DOTMA for in vivo gene delivery. GeneMedicine  has
licensed from Vanderbilt exclusive worldwide rights to certain United States and
European patent rights covering the gene therapy use of any cationic lipid
combined with DNA and administered by injection or inhalation. The Company also
has licensed from Baylor rights under a patent covering all gene therapy
applications of the Company's GeneSwitch(TM) technology and a patent claiming 
the use of a muscle-specific gene expression system.

  The Company presently has proprietary rights to only a limited number of
genes, and the Company may need to obtain licenses to other gene sequences or
technology to which it currently has no proprietary rights. There can be no
assurance that the Company will be able to obtain such licenses on commercially
reasonable terms, or at all. If required licenses are not available to the
Company, the Company may not be able to develop or market certain products.

  The patent positions of pharmaceutical and biotechnology firms are generally
uncertain and involve complex legal and factual questions. To date, there has
emerged no consistent policy regarding the breadth of claims allowed in
biotechnology patents. Consequently, although the Company is currently
prosecuting several patent applications in the United States and worldwide, the
Company does not know whether such applications will result in the issuance of
any patents, or, if issued, whether any such patents will provide sufficient
protection against competitors with similar technology, or whether such patents
will be challenged successfully or circumvented. Patent applications in the
United States are maintained in secrecy until a patent issues, and the Company
cannot be certain that others have not filed patent applications for technology
covered by the Company's or its licensors' pending applications or that the
Company or its licensors were the first to file patent applications for such
technology. Competitors may have filed applications for, or may have received
patents and may obtain additional patents and proprietary rights relating to,
compounds or processes that block or compete with those of the Company. The
Company is aware of patent applications filed or patents issued to third parties
relating to gene therapy technologies. The Company's development efforts are at
an early stage, however, and the Company presently is unable to evaluate whether
any such patent applications or patents will have any effect on its products in
development.

  Patent litigation is becoming more widespread in the biotechnology industry
and it is not possible to predict how any such litigation will affect the
Company. Litigation may be necessary to defend against or assert claims of
infringement, to enforce patents issued to the Company, to protect trade secrets
or know-how owned by the Company or to determine the scope and validity of the
proprietary rights of third parties. Such litigation could result in substantial
costs to and diversion of resources by the Company and may have a material
adverse impact on the Company. There can be no assurance that any of the
Company's issued or licensed patents would be held valid by a court of competent
jurisdiction or that efforts to defend any of such patents by the Company will
be successful.

  The Company also relies on trade secrets, know-how, improvements to
technology, confidentiality agreements and the pursuit of collaborative and
licensing opportunities to develop and maintain its competitive position. There
can be no assurance that third parties will not independently develop equivalent
proprietary information or techniques, will not 

                                       11
<PAGE>
 
gain access to the Company's trade secrets or disclose such technology to the
public, or that the Company can maintain and protect unpatented proprietary
technology. The Company requires its employees, consultants, collaborators and
other advisors to execute confidentiality agreements upon commencement of
employment or other relationships with the Company. There can be no assurance,
however, that these agreements will provide meaningful protection or adequate
remedies for the Company's technology in the event of unauthorized use or
disclosure of such information, or that the parties to such agreements will not
breach such agreements.


COMMERCIALIZATION AND MANUFACTURING

  GeneMedicine currently operates no manufacturing facilities for commercial
production. GeneMedicine intends to develop and commercialize its gene medicines
through alliances with major pharmaceutical and biotechnology companies.
Furthermore, the Company may rely on corporate partners, licensees or other
entities for commercial scale manufacturing and marketing of its products. There
can be no assurance, however, that the Company will be able to reach
satisfactory arrangements with such parties or that such arrangements will
continue and not be terminated.  In addition, there can be no assurance that any
such arrangement will be successful or that its partners will be able to develop
adequate manufacturing capabilities for commercial scale quantities of gene
medicines.  Furthermore, the large scale manufacturing of gene therapy products
has not been demonstrated by any party.

  The Company has developed proprietary manufacturing processes for production
of plasmid and formulated gene medicine for use in early clinical trials. The
Company has manufactured under current Good Manufacturing Practices ("cGMP")
conditions the IL-2 Gene Medicine for Phase I clinical trials and plasmids for a
physician-initiated clinical trial at Vanderbilt. The Company's plasmids are
produced in bacterial cells utilizing traditional fermentation and purification
techniques. The Company believes that certain physical and physicochemical
characteristics of its gene expression systems will enable each of its products
to be produced and purified using consistent methods that will minimize the cost
and risk of the manufacturing process. The processes used by the Company are new
and there can be no assurance that such processes will be effective, accurate or
cost effective.


GOVERNMENT REGULATION

  The production and marketing of the Company's proposed products and its
research and development activities are subject to regulation for safety,
efficacy and quality by numerous governmental authorities in the United States
and other countries. In the United States, pharmaceutical products are subject
to rigorous regulation by the FDA. Such products are regulated under the Federal
Food, Drug, and Cosmetic Act, and biological products, in addition to being
subject to certain provisions of this act, are regulated under the Public Health
Service Act. These laws and the regulations promulgated thereunder govern, among
other things, testing, manufacturing, safety, efficacy, labeling, storage,
record keeping, and advertising and promotional practices involving drugs and
biological products. At the FDA, the Center for Biologics Evaluation and
Research is responsible for the regulation of biological products and has
handled the regulation of most gene therapy products to date. At the present
time, the Company believes that its products will be regulated by the FDA and
comparable foreign regulatory bodies as biologics.

  In addition to the FDA requirements, the National Institutes of Health ("NIH")
has established guidelines for research involving recombinant DNA molecules,
which are utilized by the Company and certain of its collaborators in their
research. These guidelines apply to all recombinant DNA research which is
conducted at or supported by the NIH. Under current guidelines, proposals to
conduct clinical research involving gene therapy which is conducted at
institutions supported by the NIH must be filed with the Recombinant DNA
Advisory Committee and the NIH.

  The steps required before a new pharmaceutical agent may be marketed in the
United States generally include (i) preclinical laboratory tests and in vivo
preclinical studies, (ii) the submission to the FDA of an IND for human clinical
testing, which must become effective before human clinical trials commence,
(iii) adequate and well-controlled human clinical trials to establish the safety
and efficacy of the product, (iv) the submission to the FDA of a New Drug
Application ("NDA") for a drug or a Product License Application and
Establishment License Application ("PLA/ELA") for a biologic and (v) FDA
approval of the NDA or PLA/ELA prior to any commercial sale or shipment of the
drug or biologic, respectively. In the case of drugs, in addition to obtaining
FDA approval for each product, each domestic drug 

                                       12
<PAGE>
 
manufacturing establishment must be registered with the FDA. Domestic
manufacturing establishments are subject to biennial inspections by the FDA and
must comply with GMP regulations enforced by the FDA through its facilities
inspection program for both drugs and biologics. Manufacturers of pharmaceutical
products also may be subject to state regulations.

  Preclinical tests include laboratory evaluation of the product, as well as
animal studies to assess the potential safety and efficacy of the product.
Compounds must be produced according to applicable GMP and preclinical safety
tests must be conducted by laboratories that comply with FDA regulations
regarding Good Laboratory Practices. The results of the preclinical tests,
together with manufacturing information and analytical data, are submitted to
the FDA as part of an IND, which must become effective before human clinical
trials may be commenced. The IND will automatically become effective 30 days
after receipt by the FDA unless the FDA indicates prior to the end of the 30-day
period that it does not wish the trials to proceed as outlined in the IND. In
such a case, the IND sponsor and the FDA must resolve any outstanding concerns
before clinical trials can proceed. There can be no assurance that submission of
an IND will result in FDA authorization to commence clinical trials.

  Clinical trials involve the administration of the investigational product to
healthy volunteers or to patients, under the supervision of a qualified
principal investigator. Clinical trials are conducted in accordance with Good
Clinical Practices under protocols that detail the objectives of the study, the
parameters to be used to monitor safety, and the efficacy criteria to be
evaluated. Each protocol must be submitted to the FDA as part of the IND.
Further, each clinical study must be reviewed and approved by an independent
Institutional Review Board at the institution at which the study will be
conducted. The Institutional Review Board will consider, among other things,
ethical factors and the safety of human subjects.

  Clinical trials typically are conducted in three sequential phases, but the
phases may overlap. In Phase I, the initial introduction of the drug into
generally healthy volunteers, the drug is tested for safety (adverse effects),
dosage tolerance, metabolism, distribution, excretion and pharmacodynamics.
Phase II usually involves studies in a limited patient population to (i)
determine the efficacy of the drug for specific, targeted indications, (ii)
determine dosage tolerance and optimal dosage and (iii) identify possible
adverse effects and safety risks. When a compound is found to be effective and
to have an acceptable safety profile in Phase II evaluations, Phase III trials
are undertaken to evaluate further clinical efficacy and to test further for
safety within an expanded patient population at geographically dispersed
clinical study sites. There can be no assurance that Phase I, Phase II or Phase
III testing will be completed successfully within any specific time period, if
at all, with respect to any of the Company's products subject to such testing.
Furthermore, the FDA may suspend clinical trials at any time on various grounds,
including a finding that the subjects or patients are being exposed to an
unacceptable health risk.

  The results of the pharmaceutical development, preclinical studies and
clinical studies are submitted to the FDA in the form of an NDA or PLA/ELA for
approval of the manufacture, marketing and commercial shipment of the drug or
biologic. The testing and approval process is likely to require substantial time
and effort and there can be no assurance that any approval will be granted on a
timely basis, if at all. The FDA may deny an NDA or PLA/ELA if applicable
regulatory criteria are not satisfied, require additional testing or information
or require postmarketing testing and surveillance to monitor the safety or
efficacy of a product. Moreover, if regulatory approval of a drug is granted,
such approval may entail limitations on the indicated uses for which it may be
marketed. Finally, product approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems occur following initial
marketing. Among the conditions for NDA or PLA/ELA approval is the requirement
that the prospective manufacturer's quality control and manufacturing procedures
conform to GMP, which must be followed at all times. In complying with standards
set forth in these regulations, manufacturers must continue to expend time,
monies and effort in the area of production and quality control to ensure full
compliance.

  For clinical investigation and marketing outside the United States, the
Company is also subject to foreign regulatory requirements governing human
clinical trials and marketing approval for drugs. In Europe, the approval
process for the commencement of clinical trials varies from country to country.
The Company's approach to the European regulatory process involves the
identification of clinical investigators in Europe to conduct clinical studies.
The Company intends to design these studies to meet FDA standards as well as the
standards of such European countries. The foreign regulatory 

                                       13
<PAGE>
 
approval process includes all of the risks associated with FDA approval set
forth above.

  The ability of GeneMedicine to commercialize its products successfully will
depend in part on the extent to which reimbursement for the cost of such
products and related treatments will be available from government health
administration authorities, private health insurers and other organizations.
Third-party payors are increasingly challenging the price of medical products
and services. Significant uncertainty exists as to the reimbursement status of
newly approved health care products.  If the Company succeeds in bringing one or
more products to market, there can be no assurance that these products will be
considered cost effective, that reimbursement will be available, or if
available, that the payor's reimbursement policies will not adversely affect the
Company's ability to sell its products on a profitable basis.

  The Company's research and development processes involve the controlled use of
hazardous and radioactive materials. The Company is subject to federal, state
and local laws and regulations governing the use, manufacture, storage, handling
and disposing of such materials and certain waste products. Although the Company
believes that its safety procedures for handling and disposing of such materials
comply with the standards prescribed by such laws and regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result and any such liability could exceed the resources of
the Company. Although the Company believes that it is in compliance in all
material respects with applicable environmental control facilities in the near-
term, there can be no assurance that the Company will not be required to incur
significant costs to comply with environmental laws and regulations in the
future, or that the operations, business or assets of the Company will not be
materially adversely affected by current or future environmental laws or
regulations.

COMPETITION

  GeneMedicine is pursuing areas of product development in a field that is new
and rapidly evolving and in which significant technological changes are likely.
Rapid technological development could result in the Company's potential products
or technologies becoming obsolete before the Company recovers a significant
portion of its related research, development and capital expenditures. The
Company will experience competition from pharmaceutical and biotechnology
companies that have other forms of treatment for the diseases targeted by the
Company, as well as from other companies in the field of gene therapy. The
Company is aware of a large number of development stage and established
enterprises, including major pharmaceutical and biotechnology firms, that are
exploring the field of human gene therapy or are actively engaged in research
and development in areas related to gene therapy, including non-viral gene
therapy. The Company also may experience competition from companies that have
acquired or may acquire technology from universities and other research
institutions. As these companies develop their technologies, they may develop
proprietary positions in certain aspects of gene therapy that may materially and
adversely affect GeneMedicine. In addition, the Company may face competition
from other companies for limited opportunities to enter into collaborative
arrangements with pharmaceutical and biotechnology companies and academic
institutions and to obtain licenses to proprietary technology, including genes
and methods of gene use, from third parties.

  Many competitors and potential competitors of the Company have substantially
greater product development capabilities and financial, scientific, marketing
and human resources than the Company. Other companies may succeed in developing
products earlier than the Company, in obtaining FDA approvals for such products
more rapidly than the Company, or in developing products that are more effective
than those proposed to be developed by the Company. While the Company will seek
to expand its technological capabilities in order to remain competitive, there
can be no assurance that research and development by others will not render the
Company's technology or products obsolete or non-competitive or result in
treatments or cures superior to any therapy developed by the Company, or that
any therapy developed by the Company will be preferred to any existing or newly
developed technologies.

PRODUCT LIABILITY INSURANCE

  Human therapeutic products involve an inherent risk of product liability
claims and associated adverse publicity. The Company currently carries insurance
against such claims for its clinical trials and for the supply of DNA materials

                                       14
<PAGE>
 
for two other clinical trials. There can be no assurance that it will be able to
maintain product liability insurance on acceptable terms or with adequate
coverage against potential liabilities. Such insurance is expensive, difficult
to obtain and may not be available in the future on acceptable terms, or at all.
An inability to obtain sufficient insurance coverage on reasonable terms or to
otherwise protect against potential product liability claims could prevent or
inhibit the commercialization of the Company's potential products. A product
liability claim brought against the Company or a product withdrawal could have a
material adverse effect upon the Company and its financial condition.


RISK FACTORS

  The following factors, among others, could cause actual results to differ
materially from those contained in forward-looking statements made in this
report and presented elsewhere by management from time to time.

Early Stage of Development; Technological Uncertainty

  Gene therapy is a new and rapidly evolving technology. While many approaches
to gene therapy are being pursued by pharmaceutical and biotechnology companies
and academic institutions, there are currently no marketed gene therapy
products, and existing clinical data on the safety and efficacy of potential
gene therapy products are limited. Clinical and preclinical data relating to the
Company's specific gene therapy approach are also limited. Further, the results
of preclinical studies do not predict safety or efficacy in humans, and results
from such tests or studies are not necessarily indicative of the results that
will be obtained in human clinical trials. All of the potential products under
development by the Company are in research, preclinical or early clinical
development, and revenues from the sale of any such products will not be
realized for at least the next several years, if at all. The potential products
currently under development by the Company will require significant additional
research and development efforts, including extensive preclinical and clinical
testing and the receipt of regulatory approval, prior to commercial use. In
addition, such products are subject to the risks of failure inherent in the
development of products based on innovative technologies. There can be no
assurance that the Company's research and development efforts will be
successful, that any of the potential products developed by the Company will
prove to be safe and effective in clinical trials, or that any commercially
successful products utilizing the Company's technology will be developed by the
Company or its collaborators. Even if successfully developed, these potential
products may not receive regulatory approval or be successfully introduced and
marketed at prices that would permit the Company to operate profitably. Due to
the early stage of development of the Company's potential products and the
extensive testing and regulatory review process required before marketing
approval can be obtained, the Company cannot predict with certainty when it will
be able to commercialize any of its potential products, if at all.

History of Operating Losses; Future Capital Needs; Uncertainty of Additional
Funding

  The Company expects to incur operating losses over at least the next several
years, and there can be no assurance that the Company will ever achieve
profitability. The Company expects to have quarter-to-quarter fluctuations in
any contract revenues, expenses and losses, some of which could be significant.

  The Company has generated no revenues from product sales, nor are any product
revenues expected for at least the next several years. The negative cash flow
from operations is expected to continue for the foreseeable future. The
Company's future capital requirements will depend on many factors, including
continued scientific progress in its research and development programs, the
scope and results of preclinical studies and clinical trials, the time and costs
involved in obtaining regulatory approvals, the costs involved in filing,
prosecuting and enforcing patent claims, competing technological and market
developments, the cost of manufacturing scale-up, effective commercialization
activities and arrangements, and other factors not within the Company's control.
Based on its current plans, the Company believes that its available cash,
including proceeds from projected interest income and anticipated funding from
its corporate alliance with Boehringer Mannheim, will enable the Company to
maintain its current and planned operations into the first quarter of 2000.
There can be no assurance, however, that changes in the Company's research and
development plans or other events affecting the Company's operating expenses
will not result in the expenditure of such resources before such time. The
Company will need to raise substantial additional funds to conduct the research
and development, preclinical studies and clinical trials necessary to bring such
products to market.

                                       15
<PAGE>
 
  The Company intends to seek additional funding through public or private
equity or debt financings or new corporate partnerships. There can be no
assurance that additional financing will be available on acceptable terms, or at
all. Insufficient funds may require the Company to delay, scale back or
eliminate some or all of its research or development programs or to obtain funds
through arrangements with third parties that may require the Company to
relinquish greater or all rights to product candidates at an earlier stage of
development or on less favorable terms than the Company would otherwise seek.
Insufficient funds may also require the Company to relinquish rights to certain
of its technologies that the Company would otherwise develop or commercialize
itself.

Dependence on Collaborative Partners, Licenses and Others

  The Company's strategy is to enter into various arrangements with corporate
and academic collaborators, licensors, licensees and others for the research,
development, clinical testing, manufacturing, marketing and commercialization of
its products. To date, the Company also has entered into corporate partnerships
for development and commercialization of its potential products with two
pharmaceutical firms, one of which (the Syntex Alliance) ended in accordance
with its terms in April 1997. The Company intends to enter into additional
corporate partnering agreements to develop and commercialize products based upon
its gene therapy technology. There can be no assurance, however, that the
Company will be able to establish such additional collaborations on favorable
terms, if at all, or that its current or future partnership arrangements will be
successful. Should any corporate partner fail to develop or commercialize
successfully any product to which it has rights, or any of the partner's
products to which GeneMedicine has rights, the Company's business may be
adversely affected. In addition, there can be no assurance that any
collaboration will be continued or result in successfully commercialized
products. Failure of a corporate partner to continue funding any particular
program could delay or halt the development or commercialization of any products
arising out of such program. In addition, there can be no assurance that the
corporate partners will not pursue alternative technologies or develop
alternative products either on their own or in collaboration with others,
including the Company's competitors, as a means for developing treatments for
the diseases targeted by the Company's programs. The Company also has licenses
(or options to obtain licenses) to technologies developed by other companies and
academic institutions. Pursuant to the terms of certain license agreements, the
Company is obligated to exercise diligence in bringing potential products to
market and to make certain milestone payments that, in some instances, are
substantial. The Company also is obligated to make royalty payments on the
sales, if any, of products resulting from such licensed technology and, in some
instances, is responsible for the costs of filing and prosecuting patent
applications. To date, the Company has licensed key technology from Syntex,
Baylor College of Medicine, the University of California, the University of
Texas and Vanderbilt University.

Uncertainty of Protection of Patents and Proprietary Rights; Access to
Proprietary Genes

  The patent positions of biotechnology and pharmaceutical companies are highly
uncertain and involve complex legal and factual questions, and the breadth of
claims allowed in biotechnology and pharmaceutical patents cannot be predicted.
In addition, there is a substantial backlog of biotechnology patent applications
at the U.S. Patent and Trademark Office (the "PTO") that may delay the review
and, if issued on the basis of such applications, the issuance of any patents.
The Company's success will depend to a significant degree on its ability to
obtain patents and licenses to patent rights, to maintain trade secrets and to
operate without infringing on the proprietary rights of others, both in the
United States and other countries. To date, the Company has rights to certain
U.S. and foreign issued patents and has filed or participated as a licensee in
the filing of a number of patent applications in the United States relating to
the Company's technology, as well as foreign counterparts of certain of these
applications in many countries. The Company intends to continue to file
applications as appropriate for patents covering both its products and
processes. There can be no assurance that patents will issue from any of these
applications or, that claims allowed under issued patents or patents that may
issue from such applications will be sufficient to protect the Company's
technology. Patent applications in the United States are maintained in secrecy
until a patent issues, and the Company cannot be certain that others have not
filed patent applications for technology covered by the Company or its
licensors' pending applications or that the Company or its licensors' were the
first to file patent applications for such technology. Competitors may have
filed applications for, or may have received patents and may obtain additional
patents and proprietary rights relating to, compounds or processes that block or
compete with those of the Company. The Company is aware of patent applications
filed or patents issued to third parties relating to gene therapy technologies.
The Company's development efforts are at an early stage, however, and the
Company presently is unable to evaluate whether any such patent applications or
patents will have any effect on its products in development. Should any of its
competitors have filed patent applications in the United States that claim
technology also invented by the Company, the Company may have to participate in
interference proceedings 

                                       16
<PAGE>
 
declared by the PTO in order to determine priority of invention and, thus, the
right to a patent for the technology in the United States, all of which could
result in substantial cost to the Company to determine its rights or potential
loss of rights. The commercial success of the Company will depend in part on the
Company not infringing patents issued to competitors and not breaching the
licenses that might cover technology used in the Company's products. It is
uncertain whether any third party patents will require the Company to alter its
products or processes, obtain licenses or cease certain activities. In addition,
litigation, which could result in substantial cost to the Company, also may be
necessary to enforce any patents issued to the Company or to determine the scope
and validity of third party proprietary rights. In addition, there can be no
assurance that any patents issued to the Company or to licensors from whom the
Company has licensed rights to technology will not be challenged, invalidated or
circumvented, or that the rights granted thereunder will provide proprietary
protection or commercial advantage to the Company.

  A number of the genes that the Company uses in its research and development
programs or may use in its gene therapy products are or may become patented by
third parties. As a result, the Company may be required to obtain licenses under
such patents in order to test, use or market products that contain any such
proprietary genes. If such licenses are required, there can be no assurance that
the Company will be able to obtain any such license on commercially reasonable
terms, if at all. Failure by the Company to obtain a license to any technology
that it may require to commercialize its products could have a material adverse
effect on the Company.

  The Company also relies on trade secrets, know-how, improvements to
technology, confidentiality agreements and collaborative and licensing
opportunities to develop and maintain its competitive position. Although the
Company protects its proprietary technology in part by confidentiality
agreements with its licensors, licensees, employees, consultants and certain
contractors, there can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any breach or that
the Company's trade secrets will not otherwise become known or be independently
discovered by its competitors.  See "Business-Patents and Proprietary
Technology"


Uncertainty of Government Regulatory Requirements; Lengthy Approval Process

  Because gene therapy is a new method of treatment that has not been
extensively tested in humans, the regulatory requirements governing gene therapy
products and related clinical procedures are uncertain and are subject to
substantial review by various governmental regulatory authorities. This
uncertainty may result in extensive delay in the regulatory approval process,
adding to the already lengthy review process for human therapeutic products in
general. Regulatory requirements ultimately imposed could adversely affect the
ability of the Company or its collaborative partners to clinically test,
manufacture or market products.

  The commercial uses of any of the Company's products will be regulated by the
FDA and comparable foreign regulatory bodies as either biologics or drugs. Each
therapeutic product containing a particular gene will likely be regulated as
either a separate biologic or a drug, depending on its intended use and FDA
policies in effect at such time. In order to commercialize any products, the
Company must sponsor and file an IND for each proposed product and will be
responsible for initiating and overseeing the clinical studies to demonstrate
the safety, efficacy and potency that are necessary to obtain FDA approval of
any such products. The regulatory process for new therapeutic products,
including the required preclinical studies and clinical testing, is lengthy and
expensive and there can be no assurance that necessary FDA clearances and
approvals will be obtained in a timely manner, if at all. There can be no
assurance as to the length of the clinical trial period or the number of
patients the FDA will require to be enrolled in the clinical trials in order to
establish the safety, efficacy and potency of human gene therapy products. The
Company may encounter significant delays or excessive costs in its efforts to
secure necessary approvals, particularly because gene therapy is a novel method
of treatment, and regulatory requirements are evolving and uncertain. Future
U.S. or foreign legislative or administrative acts could also prevent or delay
regulatory approval of the Company's products. There can be no assurance that
the Company will be able to obtain the necessary clearances for clinical trials
or approvals for the manufacturing or marketing of any of its products under
development. Even if regulatory approvals are obtained, they may include
significant limitations on the indicated uses for which a product may be
marketed. In addition, a marketed product is subject to continual FDA review.
Later discovery of previously unknown problems or failure to comply with the
applicable regulatory requirements may result in restrictions on the marketing
of a product or withdrawal of the product from the market, as well as possible
civil or criminal sanctions. In addition, many academic institutions and
companies conducting research in the gene therapy field are using a variety of
approaches and technologies. Any adverse results 

                                       17
<PAGE>
 
obtained by such researchers in preclinical studies or clinical trials could
adversely affect the regulatory environment for gene therapy products generally,
possibly leading to delays in the approval process for the Company's potential
products or preventing approval altogether.

  To market its products outside of the United States, the Company is also
subject to numerous and varying foreign regulatory requirements, implemented by
foreign health authorities, governing the design and conduct of human clinical
trials and marketing approval. The approval procedure varies among countries and
can involve additional testing, and the time required to obtain approval may
differ from that required to obtain FDA approval. The foreign regulatory
approval process includes all of the risks associated with obtaining FDA
approval set forth above, and approval by the FDA does not ensure approval by
the health authorities of any other country.  See "Business-Government
Regulation".


Intense Competition; Rapid Technological Change

  The gene therapy field is new and rapidly evolving, and it is expected to
continue to undergo significant technological change. Rapid technological
development could result in GeneMedicine's potential products or technologies
becoming obsolete before it recovers its related research, development and
capital expenditures. The Company will experience competition from
pharmaceutical and biotechnology companies that have other forms of treatment
for the diseases targeted by the Company, as well as from other companies in the
field of gene therapy. The Company is aware of a large number of development
stage and established enterprises, including major pharmaceutical and
biotechnology firms, which are exploring the field of human gene therapy or are
actively engaged in research and development in areas related to gene therapy.
GeneMedicine also may experience competition from companies that have acquired
or may acquire technology from universities and other research institutions. As
these companies develop their technologies, they may develop proprietary
positions in certain aspects of gene therapy that may materially and adversely
affect GeneMedicine. In addition, the Company may face competition from other
companies for limited opportunities to enter into collaborative arrangements
with pharmaceutical or biotechnology companies and academic institutions and to
obtain licenses to proprietary technology, including genes and methods of gene
use, from third parties.

  Many of the Company's competitors and potential competitors have substantially
greater product development capabilities and financial, scientific, marketing
and human resources than the Company. Other companies may succeed in developing
products earlier than the Company, obtaining approvals for such products from
the FDA more rapidly than the Company, or developing products that are more
effective than those proposed to be developed by the Company. While GeneMedicine
will seek to expand its technological capabilities in order to remain
competitive, there can be no assurance that research and development by others
will not render its technology or products obsolete or non-competitive or result
in treatments or cures superior to any therapy developed by the Company, or that
any therapy developed by the Company will be preferred to any existing or newly
developed technologies. In addition, there can be no assurance that the
Company's competitors will not develop more effective or more affordable
products, or achieve product development completion, patent protection,
regulatory approval or product commercialization earlier than the Company. See
"Business-Competition."

Need to Attract and Retain Key Employees and Consultants

  GeneMedicine is highly dependent on the principal members of its scientific
and management staff. In addition, the Company relies on consultants and
advisors to assist the Company in formulating its research and development
strategy. Attracting and retaining qualified personnel, consultants and advisors
is critical to the Company's success. In order to pursue its product development
and marketing plans, GeneMedicine will be required to hire additional qualified
scientific personnel to perform research and development, as well as personnel
with expertise in clinical testing, government regulation, manufacturing and
marketing. Expansion in product development also is expected to require the
addition of management personnel and the development of additional expertise by
existing management personnel. The Company faces competition for qualified
individuals from numerous pharmaceutical and biotechnology companies,
universities and other research institutions. There can be no assurance that the
Company will be able to attract and retain such individuals on acceptable terms
or at all. See "Business-Human Resources."

Lack of Commercial Manufacturing or Marketing Capability

  The Company currently does not have the resources or capability to manufacture
or market any of its proposed products by itself on a commercial scale. Large
scale manufacturing of gene therapy products has not been demonstrated 

                                       18
<PAGE>
 
by any third parties. GeneMedicine may be dependent to a significant extent on
collaborators, licensees or other entities for commercial scale manufacturing of
its products. The Company has a pilot manufacturing facility, which will require
ongoing funding and compliance with extensive regulations applicable to such a
facility. There can be no assurance that the Company will be able to develop
adequate commercial manufacturing capabilities either on its own or through
third parties. In addition, the Company does not anticipate establishing its own
sales and marketing capability in the foreseeable future, and will be dependent
on third parties for those functions. There can be no assurance that the Company
will be able to develop adequate marketing capabilities either on its own or
through third parties. See "Business-Commercialization and Manufacturing."

Uncertainty of Product Pricing, Reimbursement and Related Matters

  The ability of GeneMedicine to commercialize its products successfully may
depend in part on the extent to which reimbursement for the cost of such
products and related treatments will be available from government health
administration authorities, private health insurers and other organizations.
Third-party payors are increasingly challenging the price of medical products
and services. Significant uncertainty exists as to the reimbursement status of
newly approved health care products, and if the Company succeeds in bringing one
or more products to market, there can be no assurance that these products will
be considered cost effective, that reimbursement will be available, or if
available, that the payor's reimbursement policies will not adversely affect the
Company's ability to sell its products on a profitable basis.

Hazardous and Radioactive Materials; Environmental Matters

  The Company's research and development processes involve the controlled use of
hazardous and radioactive materials. The Company is subject to federal, state
and local laws and regulations governing the use, manufacture, storage, handling
and disposal of such materials and certain waste products. Although the Company
believes that its safety procedures for handling and disposing of such materials
comply with the standards prescribed by such laws and regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result and any such liability could exceed the resources of
the Company. Although the Company believes that it is in compliance in all
material respects with applicable environmental laws and regulations and
currently does not expect to make material capital expenditures for
environmental control facilities in the near-term, there can be no assurance
that it will not be required to incur significant costs to comply with
environmental laws and regulations in the future, or that the operations,
business or assets of the Company will not be materially adversely affected by
current or future environmental laws or regulations. See "Business-Government
Regulation."


Volatility of Stock Price; Absence of Dividends

  The market price of the shares of Common Stock, like that of the common stock
of many other biotechnology companies, has been and is likely to continue to be
highly volatile. Factors such as developments in the Company's relationships
with collaborative partners, fluctuations in the Company's operating results,
announcements of technological innovations or new commercial therapeutic
products by the Company or its competitors, progress with clinical trials,
governmental regulation, health care legislation, changes in reimbursement
policies, developments in patent or other proprietary rights, developments
affecting the Company's collaborative partners, public concern as to the safety
and efficacy of products developed by the Company and market conditions for
biotechnology stocks in general may have a significant effect on the future
price of the Common Stock. The Company has never paid any cash dividends and
does not anticipate paying cash dividends in the foreseeable future.


HUMAN RESOURCES

  As of March 23, 1998, GeneMedicine employed 109 individuals full-time, 75 of
whom hold advanced degrees in science and business, including 41 who hold Ph.D.
or D.V.M. degrees. Of the Company's total work force, 87 employees are engaged
or directly support research and development activities and 22 are engaged in
business development, finance and administrative activities.  In addition,
GeneMedicine has contracting arrangements with several scientists at research
institutions for provision of full-time services, as well as part-time
consulting arrangements with other scientists. The success of GeneMedicine will
depend in large part upon its ability to retain its current employees and
consultants and to attract and retain future employees and consultants.  A
significant number of the Company's management and scientific 

                                       19
<PAGE>
 
staff have had prior experience with large pharmaceutical, biotechnology or
medical products companies. None of the Company's employees is covered by
collective bargaining agreements and the Company considers its relationships
with its employees and consultants to be good. The Company faces competition for
qualified individuals from numerous pharmaceutical and biotechnology companies,
universities and other research institutions. There can be no assurance that the
Company will be able to attract and retain such individuals on acceptable terms
or at all.


EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
 
NAME                              AGE  POSITION
----                              ---  --------      
<S>                               <C>  <C>
 
Eric Tomlinson, D.Sc., Ph.D.....   50  President, Chief Executive Officer and Director
Norman Hardman, Ph.D............   52  Senior Vice President and Chief Operating Officer
Josef F. Bossart, Ph.D..........   46  Vice President and Chief Business Officer
Richard A. Waldron..............   44  Vice President and Chief Financial Officer and Secretary
Alain Rolland, Pharm.D., Ph.D...   38  Vice President, Research
Kathryn N. Stankis..............   39  Vice President, Human Resources
John M. Dodson..................   36  Director, Finance & Accounting
</TABLE>

  Dr. Tomlinson, one of the Company's founders, has been President, Chief
Executive Officer and a director of the Company since July 1992. Dr. Tomlinson
was President and Chief Executive Officer of Somatix Corporation from February
1990 until 1991, and served as a consultant there from April 1991 until March
1992. From 1984 to 1990, he was worldwide Head of Advanced Drug Delivery
Research for Ciba-Geigy Pharmaceuticals ("Ciba-Geigy", where he led its
multidisciplinary program in site-specific drug delivery. From 1979 to 1984, Dr.
Tomlinson was Professor of Pharmaceutical Chemistry at Amsterdam University. Dr.
Tomlinson received a Ph.D. and a D.Sc. degree from London University and an
honorary D.Sc. degree magna cum laude from the United Kingdom Council for
National Academic Awards. He was a Fulbright-Hays Scholar and has (co)-authored
more than 210 scientific publications. Dr. Tomlinson was the 1995 Sidney
Riegelman Lecturer at the University of California, San Francisco.

  Dr. Hardman has been Senior Vice President and Chief Operating Officer since
January 1998 and prior to that was Senior Vice President, Research & Preclinical
Development and Chief Scientific Officer from April 1997 to January 1998.  From
1996 to 1997, Dr. Hardman was with Novartis Pharmaceuticals UK where he was Head
of (UK) Research and Preclinical Development Operations and a member of the
Novartis Pharma UK Management Committee and of the Novartis Global Pharma R&D
Boards.  From 1993 to 1996, Dr. Hardman was Head of UK Research and Member of
the International Research Management Committee for the Pharma Division of Ciba
Pharmaceuticals Ltd., a division of Ciba-Geigy. From 1990 to 1993, Dr. Hardman
was Head of Molecular Biology at the Biotechnology Section of Ciba-Geigy.  Dr.
Hardman received a Ph.D. degree in Biochemistry from the University of
Manchester and a B.Sc. degree with First Class Honors in Chemistry from the
University of London.

  Dr. Bossart was appointed Vice President and Chief Business Officer in March
1997.  From 1982 to 1997, he held various positions involving marketing,
licensing and general management within the Rhone-Poulenc, and later Rhone-
Poulenc Rorer (RPR), groups.  Most recently he was Vice President of Business
and Marketing development for RPR Gencell, the RPR division focused on the
development of gene therapy products.  In this position, Dr. Bossart negotiated
numerous agreements and developed licensing strategies in the field of gene
therapy.  Dr. Bossart holds a Ph.D. degree from The Ohio State University and a
B.Sc.(Hon.) from Carleton University.

  Mr. Waldron has been Vice President and Chief Financial Officer since July
1995. From 1990 to 1995, he was a managing director and the head of finance for
technology-based companies at Rauscher Pierce Refsnes, Inc., an investment
banking firm. From 1985 to 1990, he was a senior vice president responsible for
health care investment banking at Cowen & Company. Mr. Waldron received his
M.B.A. degree with honors from Harvard University and his A.B. degree magna cum
laude in Economics from Princeton University.

  Dr. Rolland has been Vice President, Research since February 1998. Prior to
appointment to his current position, Dr. Rolland was Vice President, Gene
Delivery Sciences at the Company from November 1996 to February 1998 and
Director, Gene Delivery Sciences from June 1993 to November 1996 during which
time he directed the Company's efforts in the creation and development of novel
non-viral gene delivery systems. Prior to joining GeneMedicine in 

                                       20
<PAGE>
 
1993, Dr. Rolland worked in drug delivery research at Ciba-Geigy Pharmaceuticals
and more recently was Head of the Formulation Research Group at the
International Centre for Dermatological Research (CIRD Galderma) in France. Dr.
Rolland has received numerous international and national awards for scholarship.
Dr. Rolland holds a Pharm. D., and a Ph.D. degree in Pharmaceutical Sciences
from Rennes University in France.

  Ms. Stankis has been Vice President, Human Resources since March 1994 and
served as the Company's Director of Administration and Human Resources from July
1993 to March 1994. From 1988 to July 1993, Ms. Stankis was employed at
Korn/Ferry International, an international executive search firm, most recently
as Principal and Health Care Products Consultant. Prior to 1988, Ms. Stankis
held various marketing and sales positions with Baxter International and MetPath
Laboratories. Ms. Stankis holds an M.B.A. degree from the University of Houston.

  Mr. Dodson has been Director of Finance & Accounting since September 1994 and
prior to that was the Company's Controller from the time he joined the Company
in November 1993. From 1990 until 1993, Mr. Dodson was employed by Pepsi-Cola
South initially as Manager of Planning and Analysis and most recently as Manager
of Finance-CFO for the South Texas region. From 1985 until 1990, he was employed
by KPMG Peat Marwick, where his most recent position was Audit Manager. Mr.
Dodson holds a B.B.A. degree in Accounting from The University of Texas and is a
Certified Public Accountant.

ITEM 2.   PROPERTIES

  The Company currently leases a 38,000 square-foot building in The Woodlands,
Texas.  This facility has been built to the Company's specifications to
accommodate the Company's laboratory, support and administrative needs, and
includes a production facility designed to support initial clinical trials.
Monthly rent is approximately $1.90 per square foot. The initial term of the
lease, which began in January 1995, is 10 years, after which time the Company
may renew the lease for an additional period of five years. The Company also has
an option to expand this facility by up to an additional 62,000 square feet
during the first six years of the initial term of the lease.

  GeneMedicine believes that this facility and its available expansion will be
adequate to meet the Company's needs for the foreseeable future. Should the
Company need additional space, management believes it will be able to secure
such space on reasonable terms.

ITEM 3.   LEGAL PROCEEDINGS

  The Company is not party to any material legal proceedings.

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

  Not applicable.

                                       21
<PAGE>
 
                                    PART II


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


       The Company's Common Stock was initially offered to the public on July
12, 1994 at an initial public offering price of $7.50 per share. The Common
Stock is traded on the Nasdaq National Market under the symbol "GMED." The
following table sets forth for the periods indicated the high and low sale
prices for the Common Stock as reported by Nasdaq:

 
                               HIGH      LOW    
1997                           -----    -----
    Fourth Quarter.........  $ 6 5/16  $3 3/4
    Third Quarter..........    7 3/4    3 5/8
    Second Quarter.........    9 1/4    5 3/8
    First Quarter..........    9 1/2    5 3/8
 
1996
    Fourth Quarter.........  $ 5 11/16 $3 1/8
    Third Quarter..........    5  3/4   3 3/8
    Second Quarter.........    7  3/8   5 3/8
    First Quarter..........    9  1/4   5 7/8
 
  On March 23, 1998, the last reported sale price of the Company's Common Stock
on the Nasdaq National Market was $3 1/16 per share. As of March 23, 1998, there
were approximately 198 stockholders of record of the Company's Common Stock with
14,513,775 shares outstanding. The market price of the shares of Common Stock,
like that of the common stock of many other biotechnology companies, has been
and is likely to continue to be highly volatile. The Company has never declared
or paid any dividends and does not expect to pay any dividends in the
foreseeable future. See "Business-Risk Factors."

                                       22
<PAGE>
 
ITEM 6.  SELECTED FINANCIAL INFORMATION

  The selected financial information set forth below with respect to the
Company's statements of operations for each of the years ended December 31,
1993, 1994, 1995, 1996 and 1997, and the balance sheet data at December 31,
1993, 1994, 1995, 1996 and 1997, are derived from the financial statements of
the Company audited by Arthur Andersen LLP, independent public accountants. The
data set forth below should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the financial
statements and related notes included elsewhere herein.

<TABLE> 
<CAPTION> 
                                                                                Years ended December 31,
                                                             --------------------------------------------------------------
                                                                       (in thousands, except share and per share data)
                                                                 1993         1994        1995        1996          1997
                                                             -----------  ----------  ----------  -----------    ----------
<S>                                                           <C>          <C>         <C>        <C>            <C>    
STATEMENTS OF OPERATIONS DATA:
Revenues and other income:
   Contract revenue........................................  $       ---  $      ---  $    3,680  $     4,000    $     4,500
   Research and development grant revenue..................          ---         125         ---          722            679
   Interest income.........................................          105         713       1,384        1,862          1,634
                                                             -----------  ----------  ----------  -----------     ----------
         Total revenues and other income...................          105         838       5,064        6,584          6,813
 
Expenses:
   Research and development................................        2,269       7,042      11,338       13,727         14,125
   General and administrative..............................        1,497       2,881       3,736        3,406          4,380
   Interest expense........................................           82          88         140          104             62
                                                             -----------  ----------  ----------  -----------     ---------- 
         Total expenses....................................        3,848      10,011      15,214       17,237         18,567
                                                             -----------  ----------  ----------  -----------     ----------
Net loss...................................................  $    (3,743) $   (9,173) $  (10,150) $   (10,653)   $   (11,754)
                                                             ===========  ==========  ==========  ===========     ==========
Net loss per share(1)......................................  $     (0.91) $    (1.27) $    (1.10) $     (0.84)   $     (0.86)
 
Shares used in computing net loss per share (1)............    4,118,953   7,237,914   9,195,489   12,753,301     13,702,835

</TABLE> 

<TABLE> 
<CAPTION> 
 
                                                                                    December 31,
                                                             --------------------------------------------------------------
                                                                                   (in thousands)
                                                                 1993         1994        1995        1996          1997
                                                             -----------  ----------  ----------  -----------    ----------
<S>                                                           <C>          <C>         <C>         <C>          <C>  
BALANCE SHEET DATA:
    Cash, cash equivalents and short-term investments......   $    4,410   $  22,173    $ 35,197   $   30,872    $    24,582
    Total assets........................                           5,344      25,004      38,760       34,049         27,987
    Long-term liabilities...............                           1,019         410       1,588        2,179          2,975
    Deficit accumulated during the development stage.......       (5,132)    (14,305)    (24,455)     (35,108)       (46,861)
    Total stockholders' equity..........                           3,561      23,383      35,667       29,929         23,198
</TABLE> 
 


(1) Computed on the basis described in Note 2 of Notes to Financial Statements.

                                       23
<PAGE>
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties.  The Company's actual results could differ materially from those
discussed herein.

  Since its inception in January 1992, GeneMedicine has devoted its resources
primarily to fund its research and development programs. The Company has been
unprofitable since inception and has not received any revenues from the sale of
products. No assurance can be given that the Company will be able to generate
sufficient product revenues to attain profitability on a sustained basis or at
all. The Company expects to incur substantial losses for the next several years
as it continues to invest in product research and development, preclinical
studies, clinical trials and regulatory compliance. At December 31, 1997, the
Company's accumulated deficit was approximately $46.9 million.

RESULTS OF OPERATIONS

  The Company does not anticipate revenues from product sales in the foreseeable
future. GeneMedicine expects its source of revenues and other income for the
next several years to be interest income and revenues under licensing and
collaborative research agreements, to the extent that the Company has such
agreements and meets any requirements for receipt of additional payments under
them.

 Years ended December 31, 1995, 1996 and 1997

  Revenues and other income for the year ended December 31, 1997 were $6.8
million, which consisted of contract revenue of $4.5 million, interest income of
$1.6 million and research and development grant revenue of $0.7 million. This
compares with revenues and other income of $6.6 million in 1996 and $5.1 million
in 1995.  The contract revenues in each period resulted from a corporate
partnership with Boehringer Mannheim effective February 1995 to develop certain
non-viral gene medicines for application in the field of cancer. As a component
of contract revenues, in February 1997 the Company received a milestone payment
of $500,000 from Boehringer Mannheim for achievement of FDA clearance to
commence a Phase I clinical trial for the Company's IL-2 Gene Medicine. Higher
interest income for 1996, as compared to 1995 and 1997, was primarily the result
of higher average cash, cash equivalents and short-term investments balances due
to the Company's follow-on public offering in October 1995.

  Research and development expenses for the year ended December 31, 1997 were
$14.1 million, compared to $13.7 million in 1996 and $11.3 million in 1995. The
year-to-year increases in research and development expense were generally due to
the expansion of the Company's research and development activities, staffing
increases and the related salary and benefit costs as well as additional
laboratory supplies and other support costs. The expansion of research and
development activities resulted primarily from the commencement and continued
expansion of research in the field of cancer, offset in 1997 by decreased
research and development activities in the fields of asthma and arthritis
following termination of the Company's corporate alliance with Syntex, which
ended in accordance with its terms in April 1997. In February 1995, the Company
commenced research and development efforts in the field of cancer, which is the
focus of a multi-year corporate partnership with Boehringer Mannheim. The
Company anticipates that expenditures will increase over the next several years
as it expands its research and product development efforts.

  General and administrative expenses were approximately $4.4 million in 1997,
compared to $3.4 million and $3.7 million in 1996 and 1995, respectively. The
increase from 1996 to 1997 was primarily due to (i) expanded efforts focused on
corporate development to obtain new corporate and strategic alliances, including
costs for additional personnel and related recruiting, relocation and salary and
benefit costs, (ii) legal and consulting costs associated with expanded
corporate development efforts and (iii) enhancement of technology systems and
increased efforts for investor relations. The slight decrease in 1996 from 1995
was due primarily to lower legal costs in 1996. The Company expects that general
and administrative expenses will increase in the future as a result of
additional corporate development activities.

  The Company has had losses since inception and, therefore, has not been
subject to federal income taxes. As of December 31, 1997, the Company has
generated net operating loss (NOL) carryforwards of approximately $39 million

                                       24
<PAGE>
 
and approximately $1.2 million of research and development credits available to
reduce future income taxes. These carryforwards begin to expire in 2007. For
financial reporting purposes, a valuation allowance has been established as of
December 31, 1996 and 1997, to offset fully the Company's net deferred tax
assets, including those relating to its carryforwards.  The Company 's ability
to utilize these carryforwards to reduce future taxable income may be limited
due to ownership changes.


LIQUIDITY AND CAPITAL RESOURCES

  Since its inception, the Company has financed its operations primarily through
private sales of its equity securities, its initial and follow-on public
offerings, interest income on invested funds and revenues from corporate
alliances. Through December 31, 1997, the Company had received approximately
$66.4 million in net proceeds from sales of its equity securities. At December
31, 1997, the Company had working capital of $22.9 million and cash, cash
equivalents and short-term investments of $24.6 million. In addition, in
February 1998 the Company received $5.25 million in scheduled payments from
Corange, the corporate parent of Boehringer Mannheim, representing a $4 million
Common Stock equity investment and a $1.25 million quarterly research and
development payment.

  The Company expects its cash requirements to increase significantly in future
periods. The Company will require substantial funds to conduct research and
development programs, preclinical studies and clinical trials of its potential
products and to market with its partners any products that are developed. In
addition, the Company currently plans to manufacture clinical scale quantities
of its products, which will require the Company to expend substantial additional
capital. The Company's future capital requirements will depend on many factors,
including continued scientific progress in its research and development
programs, the ability to maintain existing and establish additional corporate
partnerships, the scope and results of preclinical testing and clinical trials,
the time and costs involved in obtaining regulatory approvals, the costs
involved in filing, prosecuting and enforcing patent claims, competing
technological developments, the cost of manufacturing, and scale-up and
effective commercialization activities and arrangements. Based on its current
plans, the Company believes that its available cash, including proceeds from
projected interest income and anticipated funding from its corporate alliance
with Boehringer Mannheim, will enable the Company to maintain its current and
planned operations into the first quarter of 2000. There can be no assurance,
however, that changes in the Company's research and development plans or other
changes affecting the Company's operating expenses will not result in the
expenditure of such resources before such time. The Company intends to seek
additional funding through public or private financing, research and development
arrangements with potential corporate partners, or from other sources. There can
be no assurance that additional financing will be available on favorable terms,
if at all. In the event that adequate funding is not available, the Company may
be required to delay, reduce or eliminate one or more of its research or
development programs or obtain funds through arrangements with corporate
collaborators or others that may require the Company to relinquish greater or
all rights to product candidates at an earlier stage of development or on less
favorable terms than the Company would otherwise seek. Insufficient financing
may also require the Company to relinquish rights to certain of its technologies
that the Company would otherwise develop or commercialize itself.

  The Company's business is subject to significant risks, including, without
limitation, uncertainties associated with the length and expense of the
regulatory approval process and with obtaining and enforcing patents.  Although
the Company's products may appear promising at an early stage of development,
they may not be successfully commercialized for a number of reasons, such as the
possibility that the potential products will be determined to be ineffective
during clinical trials, fail to receive necessary approvals, be uneconomical to
manufacture or market, or be precluded from commercialization by proprietary
rights of third parties.  In addition, the failure by the Company to obtain
patent protection for its products may make certain of its products commercially
unattractive.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  The information required by this item is incorporated by reference from the
Financial Statements set forth on pages F-1 through F-16 hereof.

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

  Not applicable

                                       25
<PAGE>
 
                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS

  The information required by this item with respect to Directors is
incorporated by reference from the information under the caption "Election of
Directors" contained in the Company's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Company's 1998 Annual Meeting of Stockholders to be held on June
11, 1998 (the "Proxy Statement").

  The information required by this item with respect to Executive Officers of
the Company is contained in item 1 of Part I of this Form 10-K.

ITEM 11.  EXECUTIVE COMPENSATION

  The information required by this item is incorporated by reference from the
information contained under the caption "Executive Compensation" in the Proxy
Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The information required by this item is incorporated by reference from the
information contained under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information required by this item is incorporated by reference from the
information contained under the caption "Certain Transactions" in the Proxy
Statement.

                                       26
<PAGE>
 
                                    PART IV
                                        

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

(a) 1. Financial Statements

       Financial Statements are set forth on pages F-1 through F-16 hereof. The
       index to the Financial Statements is found on page F-1.

    2. Financial Statement Schedules

       All schedules are omitted because they are not required, are not
       applicable, or the information is included in the financial statements or
       notes thereto.

  3.   Exhibits

       See Exhibit Index in part (c) below.
       Each management contract or compensatory plan or arrangement required to
       be filed is identified.


(b)  Reports on Form 8-K

       No reports on Form 8-K were filed in the fourth quarter of 1997.

 
(c)  Exhibits

EXHIBIT
NUMBER       DESCRIPTION OF DOCUMENT
------       -----------------------


3.1          Amended and Restated Certificate of Incorporation of Registrant.
             Previously filed as Exhibit 4.1 to Registrant's Registration
             Statement Form S-8 (File No. 333-38005) and incorporated herein by
             reference.

3.2          By-laws of Registrant, as amended. Previously filed as Exhibit 4.2
             to Registrant's Registration Statement on Form S-8 (File No. 
             333-38005) and incorporated herein by reference.

3.3**        Certificate of Designation of Series A Junior Participating
             Preferred Stock of Registrant

4.1*         Specimen certificate of Common Stock of Registrant

4.2          Preferred Share Purchase Rights Plan dated January 16, 1996.
             Previously filed with Registrant's Form 8-K with the Commission on
             January 29, 1996 and incorporated herein by reference.

10.1(1)      1993 Stock Option Plan, as amended. Previously filed as Exhibit
             10.1 to the Company's March 31, 1997 Form 10-Q and is incorporated
             herein by reference.

10.2*(1)     Forms of Nonstatutory and Incentive Stock Option Agreements under
             the 1993 Stock Option Plan

10.3*(1)     Employee Stock Purchase Plan

10.4(1)      1994 Non-Employee Directors' Stock Option Plan, as amended.
             Previously filed as Exhibit 10.4 to the Company's March 31, 1997
             Form 10-Q and is incorporated herein by reference.

10.5*        Form of Indemnity Agreement between the Company and its directors
             and executive officers

10.6+*       First Amendment and Restatement of License Agreement between
             Registrant and Baylor College of Medicine dated March 7, 1994

10.7+*       First Amendment and Restatement of License Agreement--Woo between
             Registrant and Baylor College of Medicine dated March 7, 1994

10.8+*       First Amendment and Restatement of License Agreement--Gene Switch
             between Registrant and Baylor College of Medicine dated March 7,
             1994

10.9+*       Limited Exclusive License Agreement between Registrant and the
             Regents of the University of California dated October 26, 1993, as
             amended January 21, 1994

10.11+*      Patent License Agreement between Registrant and the University of
             Texas System dated October 15, 1993
 
10.12*(1)    Employment and Stock Purchase Agreement between Registrant and Eric
             Tomlinson dated July 31, 1992

10.13***(1)  Employment Letter between Registrant and Thomas Rossing, M.D. dated
             June 11, 1996

10.14***(1)  Change of Control Severance Plan
 
10.15*       Lease Agreement between Registrant and The Woodlands Corporation
             dated October 29, 1993

                                       27
<PAGE>
 
EXHIBITS (CONT.)


EXHIBIT
NUMBER       DESCRIPTION OF DOCUMENT
------       -----------------------
10.16+*      Collaborative Alliance Agreement between Registrant and Syntex
             (U.S.A.) Inc. dated April 8, 1994

10.17+*      License Agreement between Registrant and Syntex (U.S.A.) Inc. dated
             April 8, 1994

10.18*       Stock and Warrant Purchase Agreement between Registrant and Syntex
             Corporation dated April 8, 1994

10.19++      Share Purchase Agreement between GeneMedicine, inc. and Corange
             International Ltd. dated July 17, 1995. Previously filed as Exhibit
             10.21 to the Company's Form 10-Q for the quarter ended September
             30, 1995 and is incorporated herein by reference.

10.20++      Alliance Agreement between GeneMedicine, inc. and Corange
             International Ltd. effective February 3, 1995. Previously filed as
             Exhibit 10.22 to the Company's Form 10-Q for the quarter ended
             September 30, 1995 and is incorporated herein by reference.

10.21**(1)   Employment Agreement between Registrant and Richard A. Waldron
             dated June 30, 1995

11.1         Statement regarding calculation of net income (loss) per share

23.1         Consent of Arthur Andersen LLP

24.1         Power of Attorney, reference is made to page 29

27.1         Financial Data Schedule



*    Previously filed as an exhibit to the Registrant's Registration Statement
     on Form S-1 (No. 33-77126) or amendments thereto and incorporated herein by
     reference.

**   Previously filed as an exhibit to the Registrant's Form 10-K for the fiscal
     year ended December 31, 1995 and is incorporated herein by reference.

***  Previously filed as an exhibit to the Registrant's Form 10-K for the fiscal
     year ended December 31, 1996 and is incorporated herein by reference.

+    Confidential treatment has been afforded to certain portions of this
     Exhibit pursuant to Order Granting Application Under the Securities Act of
     1933 and Rule 406 Thereunder Respecting Confidential Treatment dated July
     12, 1994.

++   Confidential treatment has been afforded to certain portions of this
     Exhibit pursuant to Order Granting Application Under the Securities Act of
     1934 and Rule 24b-2 Thereunder Respecting Confidential Treatment dated
     February 5, 1996.

(1)  Executive compensation plans and arrangements of Registrant.

                                       28
<PAGE>

                                  SIGNATURES
 
  Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of The Woodlands, State
of Texas, on March 26, 1998.

                              GENEMEDICINE, INC.
 

                              By: Eric Tomlinson
                                 ----------------------------------
                              Eric Tomlinson, D.Sc., Ph.D.
                              President and Chief Executive Officer
 

   KNOW ALL MEN BY THESE PRESENTS, that each person whose signatures appears
below constitutes and appoints Eric Tomlinson his attorney-in-fact, with the
full power of substitution, for him and in any and all capacities, to sign any
amendments to this Report, and to file the same, with exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that said attorney-in-fact, or
his substitute or substitutes, may do or cause to be done by virtue hereof.

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

<TABLE> 
<CAPTION> 

           SIGNATURE                TITLE                                             DATE
           ---------                -----                                             ----
<S>                               <C>                                             <C> 
     Eric Tomlinson               President, Chief Executive Officer
--------------------------------  and Director (Principal Executive Officer)      March 26,1998
(Eric Tomlinson, D.Sc., Ph.D.)    


     Richard A. Waldron           Vice President and Chief Financial Officer
--------------------------------- (Principal Financial Officer)                   March 26,1998 
    (Richard A. Waldron)         


         John M. Dodson           Director, Finance & Accounting
--------------------------------- (Principal Accounting Officer)                  March 26,1998                
        (John M. Dodson)         


        Edward L. Cahill          Director
---------------------------------                                                 March 26,1998       
       (Edward L. Cahill) 


      Stanley T. Crooke           Director
---------------------------------                                                 March 26,1998       
(Stanley T. Crooke, M.D., Ph.D.)  


      David F.J. Leathers         Director
---------------------------------                                                 March 26,1998  
     (David F.J. Leathers)        

         Arthur M. Pappas         Director
---------------------------------                                                 March 26,1998 
        (Arthur M. Pappas) 


         W. Leigh Thompson        Director
----------------------------------                                                March 26,1998 
  (W. Leigh Thompson, M.D., Ph.D.) 

</TABLE> 

                                       29
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
 
 
                                                                                                       PAGE
                                                                                                       -----
<S>                                                                                                    <C>
Report of Independent Public Accountants...............................................................  F-2
Balance Sheets at December 31, 1996 and 1997...........................................................  F-3
Statements of Operations for the years ended December 31, 1995, 1996 and 1997 and for the period from
 inception through December 31, 1997...................................................................  F-4
Statements of Stockholders' Equity for the period from inception through December 31, 1997.............  F-5
Statements of Cash Flows for the years ended December 31,1995, 1996 and 1997 and for the period from
 inception through December 31, 1997...................................................................  F-7
Notes to Financial Statements..........................................................................  F-8
</TABLE>

                                      F-1
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To GeneMedicine, Inc.

  We have audited the accompanying balance sheets of GeneMedicine, Inc. (a
Delaware corporation in the development stage) as of December 31, 1996 and 1997,
and the related statements of operations, stockholders' equity and cash flows
for the years ended December 31, 1995, 1996 and 1997, and for the period from
inception (January 2, 1992) through December 31, 1997. 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, the financial statements referred to above present fairly, in
all material respects, the financial position of GeneMedicine, Inc. as of
December 31, 1996 and 1997, and the results of its operations and its cash flows
for the years ended December 31, 1995, 1996 and 1997, and for the period from
inception (January 2, 1992) through December 31, 1997, in conformity with
generally accepted accounting principles.



                                  ARTHUR ANDERSEN LLP

The Woodlands, Texas
February 17, 1998

                                      F-2
<PAGE>
 
                               GENEMEDICINE, INC.
                (A Delaware Corporation in the Development Stage)
                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                           December 31,   December 31,
                                                                               1996          1997  
                                                                          ------------  --------------
<S>                                                                       <C>           <C>    
                                     ASSETS
Current Assets:
      Cash and cash equivalents........................................   $  2,145,404   $    873,180 
      Short-term investments...........................................     28,726,602     23,708,845
      Prepaid expenses and other.......................................        170,453        175,128
                                                                          ------------   ------------
         Total current assets..........................................     31,042,459     24,757,153
                                                                          ------------   ------------

Equipment, furniture and leasehold improvements, net...................      2,998,416      3,220,987
Deposits and other assets..............................................          8,395          9,195
                                                                          ------------   ------------
Total Assets...........................................................   $ 34,049,270   $ 27,987,335                   
                                                                          ============   ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
      Accounts payable and accrued liabilities.........................   $  1,352,762   $  1,454,986 
      Deferred grant revenue...........................................        179,489         89,737
      Current portion of capital lease obligations.....................        408,387        270,166
                                                                          ------------   ------------
         Total current liabilities.....................................      1,940,638      1,814,889
                                                                          ------------   ------------
Long-term Liabilities:
      Deferred contract revenue........................................      1,919,970      2,919,970
      Capital lease obligations, net of current portion................        259,393         54,814
                                                                          ------------   ------------
         Total  long-term liabilities..................................      2,179,363      2,974,784
                                                                          ------------   ------------
Commitments

Stockholders' Equity:
      Convertible preferred stock, $.001 par value; 20,000,000 shares
         authorized; 3,750,000 issued and outstanding..................          3,750          3,750
      Common stock, $.001 par value; 40,000,000 shares authorized;
         13,077,369 and 13,911,422 shares issued and outstanding.......         13,077         13,911
      Additional paid-in capital.......................................     65,485,846     70,097,651
      Deferred compensation............................................       (465,803)       (56,348)
      Deficit accumulated during the development stage.................    (35,107,601)   (46,861,302)
                                                                          ------------   ------------
         Total stockholders' equity....................................     29,929,269     23,197,662
                                                                          ------------   ------------
Total Liabilities and Stockholders' Equity.............................   $ 34,049,270   $ 27,987,335 
                                                                          ============   ============
</TABLE>

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

                                      F-3
<PAGE>
 
                              GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                           STATEMENTS OF OPERATIONS
<TABLE> 
<CAPTION> 

                                                                                  Inception
                                                                              (January 2, 1992)
                                      For the Years Ended  December 31,            through
                                 ------------------------------------------      December 31,
                                     1995           1996          1997              1997
                                 ------------   ------------   ------------   ----------------
<S>                              <C>            <C>            <C>              <C> 
Revenues and other income:                                                    
  Contract revenue.............  $  3,680,000   $  4,000,000   $  4,500,000     $ 12,180,000
  Research and development                                                    
   grant revenue...............            --        722,644        678,753        1,526,397
  Interest income..............     1,383,546      1,861,818      1,634,392        5,698,071
                                 ------------   ------------   ------------     ------------ 
                                    5,063,546      6,584,462      6,813,145       19,404,468
Expenses:
  Research and development.....    11,337,688     13,727,587     14,124,813       49,487,748
  General and administrative...     3,735,918      3,405,660      4,379,730       16,281,966
  Interest expense.............       139,651        104,187         62,303          496,056
                                 ------------   ------------   ------------     ------------                             
Total expenses.................    15,213,257     17,237,434     18,566,846       66,265,770
                                 ------------   ------------   ------------     ------------ 
Net loss.......................  $(10,149,711)  $(10,652,972)  $(11,753,701)    $(46,861,302)
                                 ============   ============   ============     ============
Loss per share.................  $      (1.10)  $      (0.84)  $      (0.86)
Shares used in computing basic
 and diluted loss per share....     9,195,489     12,753,301     13,702,835
</TABLE> 

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

                                      F-4


<PAGE>
 

                               GENEMEDICINE, INC.
                (A Delaware Corporation in the Development Stage)
                      STATEMENTS OF STOCKHOLDERS' EQUITY 
   For the Period from Inception (January 2, 1992) through December 31, 1997

<TABLE>
<CAPTION>
                                                                                                               Deficit    
                                                    Convertible                                             Accumulated   
                                                  Preferred Stock         Common Stock        Additional     During the   
                                                -------------------   --------------------      Paid-in      Development  
                                                 Shares      Amount     Shares      Amount      Capital         Stage     
                                                -------     -------   ---------    -------   ------------   ------------  
<S>                                             <C>         <C>       <C>          <C>       <C>            <C>           
Balance at inception, January 2, 1992........          -   $     -            -    $    -    $         -   $          -  
                                              ----------   -------   ----------    ------    -----------   ------------  
Issuance of stock for cash, January and                                                                                  
   October 1992 ($.04 per share).............          -         -      272,268       273          9,256              -  
Issuance of stock for license agreement                                             
   rights, September 1992 ($.04 per share)...          -         -      600,000       600         20,400              -
Issuance of stock for services rendered,                                                                                  
  September and November 1992                                                       
  ($.04 per share)...........................          -         -        6,471         6            221              -
Net loss.....................................          -         -            -         -              -     (1,389,275)  
                                              ----------   -------   ----------    ------    -----------   ------------  
Balance at December 31, 1992 ................          -         -      878,739       879         29,877     (1,389,275) 
                                              ----------   -------   ----------    ------    -----------   ------------  
Issuance of stock for cash, January through                                                                              
  May 1993 ($.04 per share)..................          -         -    1,334,286     1,334         45,366              -
Issuance of Series A Preferred Stock,                                                                                    
  May 1993, for cash ($2.15 per share),                                                                                  
  net of issuance costs of $65,406...........  3,600,462     3,600            -         -      7,680,988              -  
Issuance of Series  A Preferred Stock,                                                                                   
  May 1993, for conversion of debt                                                                                       
  ($2.15 per share)..........................    409,291       410            -         -        880,590              -  
Issuance of stock, July 1993, for cash                                                                                   
  ($.18 per share)...........................          -         -       11,429        11          1,989              -  
Exercise of stock options, December 1993,                                           
  ($.18 per share)...........................          -         -        4,857         5            845              -
Deferred compensation........................          -         -            -         -        210,600              - 
Amortization of deferred compensation........          -         -            -         -              -              -
Net loss.....................................          -         -            -         -              -     (3,742,700)
                                              ----------   -------   ----------    ------    -----------   ------------  
Balance at December 31, 1993 ................  4,009,753     4,010    2,229,311     2,229      8,850,255     (5,131,975) 
                                              ----------   -------   ----------    ------    -----------   ------------  
Issuance of Series B Preferred Stock, April                                         
  1994, for cash ($4.00 per share), net of                                          
  issuance costs of $420,123.................  3,750,000      3,750           -         -     14,576,127              -
Issuance of stock upon conversion of debt,                                                                               
  April 1994 ($10.56 per share)..............          -          -       85,714       86        904,914              -
Issuance of stock in initial public offering,                                                                            
  July 1994 ($7.50 per share), net of                                                                                    
  offering costs of $1,705,625...............          -         -     1,933,333    1,933     12,792,439              -  
Conversion of Series A Preferred Stock into                                                                              
  common stock upon the closing of the                                        
  initial public offering, July 1994......... (4,012,610)   (4,013)    4,012,610    4,013              -              -  
Exercise of stock options and warrants,                                                                                  
  January through  December 1994                                                    
  ($.18 - $2.15 per share)...................      2,857         3        74,285       74         26,159              -
Issuance of stock under employee stock                                              
  purchase plan, December 1994 ($2.66 per                                           
  share).....................................          -         -         9,426        9         25,129              -
Deferred compensation........................          -         -             -        -      1,755,400 
Amortization of deferred compensation........          -         -             -        -              -              -  
Net loss.....................................          -         -             -        -              -     (9,172,943)  
                                              ----------   -------    ----------   ------    -----------   ------------  
Balance at December 31, 1994 ................  3,750,000   $ 3,750     8,344,679   $8,344    $38,930,423   $(14,304,918) 
                                              ==========   =======    ==========   ======    ===========   ============  

</TABLE>

<TABLE>
<CAPTION>
                                              
                                                                 
                                                                 Total
                                                 Deferred     Stockholder's
                                               Compensation     Equity
                                               ------------   -------------
<S>                                            <C>            <C>  
Balance at inception, January 2, 1992........  $         -     $          -  
                                               -----------     ------------
Issuance of stock for cash, January and       
   October 1992 ($.04 per share).............            -            9,529
Issuance of stock for license agreement                 
   rights, September 1992 ($.04 per share)...            -           21,000
Issuance of stock for services rendered,      
  September and November 1992                                            
  ($.04 per share)...........................            -              227
Net loss.....................................            -       (1,389,275)
                                              ------------     ------------
Balance at December 31, 1992 ................            -       (1,358,519)
                                              ------------     ------------ 
Issuance of stock for cash, January through   
  May 1993 ($.04 per share)..................            -           46,700
Issuance of Series A Preferred Stock,                                            
  May 1993, for cash ($2.15 per share),           
  net of issuance costs of $65,406...........            -        7,684,588 
Issuance of Series A Preferred Stock,                                     
  May 1993, for conversion of debt               
  ($2.15 per share)..........................            -          881,000
Issuance of stock, July 1993, for cash        
  ($.18 per share)...........................            -            2,000
Exercise of stock options, December 1993,               
  ($.18 per share)...........................            -              850
Deferred compensation........................     (210,600)               -
Amortization of deferred compensation........       47,220           47,220
Net loss.....................................            -       (3,742,700)
                                              ------------      -----------                
Balance at December 31, 1993 ................     (163,380)       3,561,139
                                              ------------      -----------                                               
Issuance of Series B Preferred Stock, April                                
  1994, for cash ($4.00 per share), net of        
  issuance costs of $420,123.................            -       14,579,877 
Issuance of stock upon conversion of debt,    
  April 1994 ($10.56 per share)..............            -          905,000
Issuance of stock in initial public offering,                              
  July 1994 ($7.50 per share), net of         
  offering costs of $1,705,625...............            -       12,794,372
Conversion of Series A Preferred Stock into              
  common stock upon the closing of the  
  initial public offering, July 1994.........            -                -
Exercise of stock options and warrants,                                   
  January through  December 1994              
  ($.18 - $2.15 per share)...................            -           26,236 
Issuance of stock under employee stock                  
  purchase plan, December 1994 ($2.66 per     
  share).....................................            -           25,138
Deferred compensation........................   (1,755,400)               -
Amortization of deferred compensation........      664,246          664,246
Net loss.....................................            -       (9,172,943)
                                               -----------      -----------
Balance at December 31, 1994 ................  $(1,254,534)     $23,383,065  
                                               ===========      ===========
</TABLE>

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

                                      F-5

<PAGE>

                               GENEMEDICINE, INC.
                (A Delaware Corporation in the Development Stage)
                STATEMENTS OF STOCKHOLDERS' EQUITY (continued)
   For the Period from Inception (January 2, 1992) through December 31, 1997

<TABLE>
<CAPTION>
                                                                                                              Deficit    
                                                   Convertible                                             Accumulated   
                                                 Preferred Stock         Common Stock        Additional     During the   
                                               -------------------   --------------------      Paid-in      Development  
                                                Shares      Amount     Shares      Amount      Capital         Stage     
                                               -------     -------   ---------    -------   ------------   ------------  
<S>                                            <C>         <C>       <C>          <C>       <C>            <C>           
Balance at December 31,1994.................. 3,750,000   $ 3,750    8,344,679    $ 8,344   $ 38,930,423   $(14,304,918) 
                                              ---------   -------   ----------    -------   ------------   ------------  
Exercise of stock options, January                                                                                       
   through December 1995 ($.18 - $7.50 per                                                                               
   share)....................................         -         -      157,588        158        257,286              -  
Issuance of stock under employee stock                                                                                   
  purchase plan, June and December                                                                                       
  1995 ($2.66 - $6.48 per share).............         -         -       69,677         70        218,553              -  
Issuance of stock, July 1995, for cash                                                                                   
   ($9.00 per share), net of issuance                                                                                    
   costs of $411,454.........................         -         -      444,444        444      3,588,102              -  
Exercise of warrants, July 1995                                                                                          
  ($1.73 per share)..........................         -         -       20,027         20         34,573              -  
Issuance of stock, October 1995, for                                                                                     
   cash ($6.50 per share), net of offering                                                                               
   costs of $1,560,325.......................         -         -    3,000,000      3,000     17,936,675              -
Amortization of deferred compensation........         -         -            -          -              -              -  
Net loss.....................................         -         -            -          -              -    (10,149,711) 
                                              ---------   -------   ----------    -------   ------------   ------------  
Balance at December 31, 1995 ................ 3,750,000   $ 3,750   12,036,415     12,036     60,965,612    (24,454,629) 
                                              ---------   -------   ----------    -------   ------------   ------------  
Exercise of stock options, January                                                                                       
  through December 1996                                                                                           
   ($.18 - $5.88 per share)..................         -         -      250,676        251        212,204              -  
Issuance of stock under employee stock                                                                                   
  purchase plan, June and December                                                                                       
  1996 ($2.66 - $6.48 per share).............         -         -      108,751        109        311,379              -  
Issuance of stock, February 1996, for                                                                                    
  cash ($9.56 per share) net of                                                                                          
   issuance costs of  $8,818.................         -         -      418,629        418      3,990,764              -  
Exercise of warrants, March and May                                                                                      
  1996 (Note 6)..............................         -         -      262,898        263          5,887              -  
Amortization of deferred compensation........         -         -            -          -              -              -  
Net loss.....................................         -         -            -          -              -    (10,652,972) 
                                              ---------   -------   ----------    -------   ------------   ------------  
Balance at December 31, 1996 ................ 3,750,000     3,750   13,077,369     13,077     65,485,846    (35,107,601) 
                                              ---------   -------   ----------    -------   ------------   ------------  
Exercise of stock options, January                                                                                       
  through December 1997 ($.18 - $6.63 per                                                                                
  share).....................................         -         -      197,065        197        470,384              -  
Issuance of stock under employee stock                                                                                   
  purchase plan, June and December                                                                                       
  1997 ($3.51 - $4.83 per share).............         -         -       62,259         62        282,036              -  
Issuance of stock, February 1997, for                                                                                    
  cash ($7.50 per share) net of                                                                                          
   issuance costs of  $10,667................         -         -      533,333        534      3,988,799              -  
Exercise of warrants, September                                                                                          
  1997 ($.04 per share) (Note 6).............         -         -       24,291         24            826              -  
Issuance of stock under employee 401(k)                                                                                  
  plan, December 1997 ($5.06 per share)......         -         -       17,105         17         86,577              -  
Amortization of deferred compensation........         -         -            -          -              -              -  
Cancellation of stock options................         -         -            -          -       (216,817)             - 
Net loss.....................................         -         -            -          -              -    (11,753,701) 
                                              ---------   -------   ----------    -------   ------------   ------------  
Balance at December 31, 1997 ................ 3,750,000   $ 3,750   13,911,422    $13,911   $ 70,097,651   $(46,861,302) 
                                              =========   =======   ==========    =======   ============   ============  

</TABLE>

<TABLE>
<CAPTION>
                                              
                                                                 
                                                                 Total
                                                 Deferred     Stockholder's
                                               Compensation     Equity
                                               ------------   -------------
<S>                                            <C>            <C>  
Balance at December 31,1994..................  $(1,254,534)   $ 23,383,065
                                               -----------    ------------
Exercise of stock options, January            
   through December 1995 ($.18 - $7.50 per    
   share)....................................            -         257,444
Issuance of stock under employee stock        
  purchase plan, June and December            
  1995 ($2.66 - $6.48 per share).............            -         218,623
Issuance of stock, July 1995, for cash        
   ($9.00 per share), net of issuance         
   costs of $411,454.........................            -       3,588,546
Exercise of warrants, July 1995               
  ($1.73 per share)..........................            -          34,593
Issuance of stock, October 1995, for          
   cash ($6.50 per share), net of offering    
   costs of $1,560,325.......................            -      17,939,675
Amortization of deferred compensation........      394,977         394,977
Net loss.....................................            -     (10,149,711)
                                               -----------    ------------
Balance at December 31, 1995 ................     (859,557)     35,667,212
                                               -----------    ------------
Exercise of stock options, January            
  through December 1996 ($.18 -               
   $5.88 per share)..........................            -         212,455
Issuance of stock under employee stock        
  purchase plan, June and December            
  1996 ($2.66 - $6.48 per share).............            -         311,488
Issuance of stock, February 1996, for         
  cash ($9.56 per share) net of               
   issuance costs of  $8,818.................            -       3,991,182
Exercise of warrants, March and May           
  1996 (Note 6)..............................            -           6,150
Amortization of deferred compensation........      393,754         393,754
Net loss.....................................            -     (10,652,972)
                                               -----------    ------------
Balance at December 31, 1996 ................     (465,803)     29,929,269
                                               -----------    ------------
Exercise of stock options, January            
  through December 1997      
  ($.18 - $6.63 pershare)....................            -         470,581
Issuance of stock under employee stock        
  purchase plan, June and December            
  1997 ($3.51 - $4.83 per share).............            -         282,098
Issuance of stock, February 1997, for         
  cash ($7.50 per share) net of               
   issuance costs of  $10,667................            -       3,989,333
Exercise of warrants, September               
  1997 ($.04 per share) (Note 6).............            -             850
Issuance of stock under employee 401(k)       
  plan, December 1997 ($5.06 per share)......            -          86,594
Amortization of deferred compensation........      192,638         192,638
Cancellation of stock options................      216,817               - 
Net loss.....................................         -       (11,753,701)
                                               -----------    ------------
Balance at December 31, 1997 ................  $   (56,348)   $ 23,197,662
                                               ===========    ============
</TABLE>

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

                                      F-6
<PAGE>
 
                              GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                           STATEMENTS OF CASH FLOWS


<TABLE> 
<CAPTION> 
                                                                                                    Inception
                                                                                                (January 2, 1992)
                                                         For the Year Ended  December 31,            through
                                                   ------------------------------------------      December 31,
                                                       1995           1996          1997              1997
                                                   ------------   ------------   ------------   ----------------
<S>                                                <C>            <C>            <C>              <C> 
Cash flows used in operating activities:                                                        
  Net loss.......................................  $(10,149,711)  $(10,652,972)  $(11,753,701)    $(46,861,302)
  Adjustments to reconcile net loss to net cash
   used in operating activities:                 
    Depreciation and amortization................       644,544        808,409        962,212        2,777,977
    Issuance of convertible debt for noncash      
     consideration...............................             -              -              -          905,000
    Issuance of stock for noncash consideration..             -              -         86,594          107,644
    Compensation expense related to stock plans..       423,502        393,754        192,638        1,721,360
    Loss on equipment retirements................             -          1,313          2,272            7,565
    Changes in assets and liabilities:
      Decrease (increase) in prepaid expenses
       and other assets..........................        41,290        248,151         (5,474)        (181,195)
      Increase in accounts payable and accrued
       liabilities...............................       254,623        235,519        102,224        1,454,986
      Increase in deferred revenue and deferred
       contract revenue..........................       919,970      1,179,489        910,249        3,009,708
                                                   ------------   ------------   ------------     ------------  
        Net cash used in operating activities....    (7,865,782)    (7,786,337)    (9,502,986)     (37,058,257)
                                                   ------------   ------------   ------------     ------------  
Cash flows used in investment activities:
  Purchase of equipment, furniture and leasehold
   improvements..................................    (1,417,523)      (672,441)    (1,187,057)      (6,009,658)
  Net sales (purchases) of short-term 
   investments...................................   (15,779,552)    (8,949,879)     5,017,757      (23,708,845)
                                                   ------------   ------------   ------------     ------------  
        Net cash (used in) provided by investing
         activities..............................   (17,197,075)    (9,622,320)     3,830,700      (29,718,503)
                                                   ------------   ------------   ------------     ------------  
Cash flows from financing activities:
  Proceeds from notes payable and capital lease
   obligations...................................       723,991              -              -        2,030,823
  Repayment of notes payable and capital lease
   obligations...................................      (426,074)      (387,986)      (342,800)      (1,574,843)
  Advance on line of credit......................             -              -              -          750,000
  Proceeds from issuance of preferred stock, net.             -              -              -       22,264,465
  Proceeds from issuance of common stock, net....    22,010,356      4,521,275      4,742,862       44,179,495
                                                   ------------   ------------   ------------     ------------  
        Net cash provided by financing 
         activities..............................    22,308,273      4,133,289      4,400,062       67,649,940
                                                   ------------   ------------   ------------     ------------  
Net increase (decrease) in cash and cash
 equivalents.....................................    (2,754,584)   (13,275,368)    (1,272,224)         873,180
Cash and cash equivalents, beginning of  period..    18,175,356     15,420,772      2,145,404                -
                                                   ------------   ------------   ------------     ------------  
Cash and cash equivalents, end of period.........  $ 15,420,772   $  2,145,404   $    873,180     $    873,180
                                                   ============   ============   ============     ============
Supplemental disclosure of cash flow 
 information:
  Cash paid during the period for interest.......  $    139,651   $    104,187   $     59,132     $    492,185
Supplemental schedule of noncash financing
 activity:
  Conversion of debt to preferred and common
   stock.........................................  $          -   $          -   $          -     $  1,786,000
</TABLE> 

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

                                      F-7


<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                         NOTES TO FINANCIAL STATEMENTS
                               DECEMBER 31, 1997
                                        
1. ORGANIZATION AND BUSINESS:

   GeneMedicine, Inc. (the "Company") is a Delaware corporation in the
development stage.  The Company is developing non-viral gene therapies that may
provide unique clinical benefits in the treatment of a number of human diseases.
The Company intends to develop its products through alliances with major
pharmaceutical and biotechnology companies.

   The Company has devoted substantially all of its efforts to research and
product development and has not yet generated any revenues from the sale of
products, nor is there any assurance of future product revenues.  In addition,
the Company expects to continue to incur losses for the foreseeable future, and
there can be no assurance that the Company will successfully complete the
transition from a development stage company to successful operations.  The
research and development activities engaged in by the Company involve a high
degree of risk and uncertainty.  The ability of the Company to successfully
develop, manufacture and market its proprietary products is dependent upon many
factors.  These factors include, but are not limited to, technological
uncertainty, the need for additional financing, the reliance on collaborative
arrangements for research and contractual agreements with corporate partners,
and the ability to develop or access manufacturing, sales and marketing
experience.  Additional factors include uncertainties as to patents and
proprietary technologies, technological change and risk of obsolescence,
development of products, competition, government regulations and regulatory
approval, and product liability exposure.  As a result of the aforementioned
factors and the related uncertainties, there can be no assurance of the
Company's future success. See "Risk Factors," elsewhere herein.


2. SIGNIFICANT ACCOUNTING POLICIES:

   Cash Equivalents and Short-term Investments

   The Company considers all highly liquid investments with an original maturity
of less than three months when purchased to be cash equivalents.  Short-term
investments have maturities greater than three months at the date of purchase.
At December 31, 1996 and 1997 cash equivalents and short-term investments
consisted primarily of U.S. Government obligations.  All cash equivalents and
short-term investments have been classified as held-to-maturity at December 31,
1996 and 1997.  Investments in debt securities classified as held-to-maturity at
December 31, 1997, have various maturity dates which do not exceed one year.
These securities are carried at amortized cost which approximates fair value.

   Prepaid Expenses and Other
 
   Prepaid expenses and other are mainly comprised of prepayments for contracted
research, building rent, and insurance.

   Equipment, Furniture and Leasehold Improvements

   Equipment, furniture and leasehold improvements are carried at cost and are
depreciated on a straight-line basis over the estimated useful economic lives of
the assets involved. The estimated useful lives employed in computing
depreciation are 3 years for computer software, 5 years for equipment, 7 years
for furniture and the remaining life of the building lease for leasehold
improvements (refer to Note 11). When property is retired or otherwise disposed
of, the cost and accumulated depreciation are removed from the accounts and any
resulting gain or loss is included in income. Maintenance and repairs that do
not extend the life of assets are charged to expense when incurred.

                                      F-8
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

   Research and Development

   Research and development costs are expensed when incurred. These costs
include personnel costs, materials consumed, depreciation on equipment and the
cost of facilities used for research and development. Payments related to the
acquisition and patenting of technology rights, for which development work is in
process, are expensed and considered a component of research and development
costs. Contract revenue and research and development grant revenue include
payments from a corporate partner and a government agency for research and
development performed by the Company and are recognized ratably as the Company
satisfies its obligation under the related agreements. Payments received in
excess of amounts earned are classified as deferred contract revenue.

   Loss Per Share

   In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share".  The
Company adopted the provisions of SFAS No. 128, changing from its previous
method of accounting for net loss per share as set forth in APB Opinion No. 15.
Adoption of Statement No. 128 required retroactive revision of the presentation
of net loss per share in historical financial statements. Net loss per share
amounts as presented herein have remained unchanged from the adoption of SFAS
No. 128 since the Company's outstanding stock options would not have been
included in the calculation because their effect would have been anti-dilutive.
Net loss per share has been computed by dividing the net loss by the weighted
average number of shares of Common Stock outstanding.

   Use of Estimates

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

3. EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS:

   Equipment, furniture and leasehold improvements consist of the following:

<TABLE>
<CAPTION>
                                                         DECEMBER 31,
                                                  --------------------------
                                                     1996          1997
                                                  -----------   -----------
<S>                                               <C>           <C> 
Laboratory equipment............................  $ 3,292,122   $ 3,915,425
Office equipment................................      338,657       386,107
Furniture.......................................      350,803       383,338
Computer software...............................       29,434        63,072
Leasehold improvements..........................      799,318     1,219,084
                                                  -----------   -----------
                                                    4,810,334     5,967,026
Less accumulated depreciation and amortization..   (1,811,918)   (2,746,039)
                                                  -----------   -----------
                                                   $2,998,416   $ 3,220,987
                                                   ==========   ===========
</TABLE> 

                                      F-9
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:

   Accounts payable and accrued liabilities consist of the following:


<TABLE> 
<CAPTION> 
                                                       DECEMBER 31,
                                                   ---------------------
                                                     1996        1997
                                                  ----------  ----------
<S>                                               <C>         <C>
Professional fees...............................  $  200,920  $  402,511
Research contracts..............................     334,556     282,329
Compensation and benefits.......................     162,677     236,941
Other accounts payable and accrued liabilities..     654,609     533,205
                                                  ----------  ----------
                                                  $1,352,762  $1,454,986
                                                  ==========  ==========
</TABLE>

5. CAPITAL LEASE OBLIGATIONS:


   In March 1994, the Company entered into an equipment leasing arrangement with
a financing company.  Equipment has been financed over forty-two and forty-eight
month periods at implicit interest rates of 8.4 percent and 11.2 percent,
respectively. Equipment purchases financed through this agreement are recorded
as capital leases in the accompanying financial statements.

   Future principal payments under capital lease obligations as of December 31,
1997 are as follows:

<TABLE>
 
<S>                                   <C>
1998.................................  $270,166
1999.................................    54,814
                                       --------
                                       $324,980
                                       ========
</TABLE>


6. STOCKHOLDERS' EQUITY:

   In January 1996, the Board of Directors of GeneMedicine adopted a Preferred
Share Purchase Rights Plan in which preferred share purchase rights ("Rights")
were distributed for each share of common stock held as of the close of business
on February 1, 1996.  The rights will expire on February 1, 2006.  Each Right
will entitle stockholders to buy one one-hundredth of a share of a new series of
Series A Junior Preferred Stock at an exercise price of $60.00 per one one-
hundredth of a Preferred Share.  Upon the occurrence of certain events, each
Right will entitle its holder to purchase, at the Right's then-current exercise
price, shares of the Company's Common Stock having a market value of two times
the exercise price of the Right.

   Common Stock

   In July 1994, the Company completed an initial public offering of 1,933,333
shares of Common Stock at $7.50 per share, with the Company receiving net
proceeds of approximately $13,500,000, before payment of offering expenses.

   In October 1995, the Company completed a follow-on public offering of
3,000,000 shares of Common Stock at $6.50 per share, with the Company receiving
net proceeds of  $18,225,000, before payment of offering expenses.

   Series A Convertible Preferred Stock
 
   On May 17, 1993, the Company issued 3,948,894 shares of Series A Preferred
Stock (the "Series A Preferred"), at a price of $2.1525 per share, for aggregate
consideration of approximately $8,435,000, net of offering costs of

                                      F-10
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

approximately $65,000. The consideration received consisted of cash proceeds of
approximately $7,685,000 and conversion of advances of $750,000.  No dividends
were declared or paid to holders of Series A Convertible Stock. Upon completion
of the Company's initial public offering, in July 1994, all Series A Convertible
Stock was converted, on a one for one basis, into 4,012,610 shares of Common
Stock.

   Series B Convertible Preferred Stock/Syntex Warrants

   Upon execution of the Syntex Collaborative Agreement (refer to Note 9),
Syntex Corporation, the then parent company of Syntex (U.S.A.) Inc., purchased
3,750,000 shares of the Company's Preferred Series B Stock (the "Series B
Preferred") and a warrant to purchase 1,071,428 shares of the Company's Common
Stock (the "Common Warrant") for an aggregate purchase price of $15 million. The
Series B Preferred will convert into 1,071,428 shares of Common Stock at the
Company's option (i) upon the Company's Common Stock trading at an average price
of $14.00 per share or more for 30 consecutive days, (ii) upon completion of a
public offering with minimum aggregate proceeds of $10 million and minimum price
of $14.00 per share or (iii) after April 8, 1998. Syntex Corporation may elect
to convert the Series B Preferred into Common Stock at any time. The holders of
the Series B Preferred are entitled to receive a liquidation preference of $4.00
per share, after which remaining assets would be distributed ratably to the
holders of Common Stock. The Common Warrant is exercisable for five years at
$21.00 per share for an aggregate purchase price of $22.5 million. The warrants
have been recorded at zero in the accompanying financial statements as the value
was de minimus upon issuance. The Company has the right to accelerate the
expiration of the Common Warrant at any time.

   Warrants

   In connection with the Company's initial public offering in July 1994, the
Company issued a warrant to the underwriter and stockholder to purchase 133,333
shares of Common Stock at an exercise price of $13.50 per share. The warrant
became exercisable for four years beginning July 12, 1995, and has been recorded
at zero in the accompanying financial statements as the value was de minimus
upon issuance.

   In connection with the issuance of the Series A Preferred, the Company issued
warrants to acquire 413,705 shares at $2.1525 per share. These warrants have
been recorded at zero in the accompanying financial statements as the value was
de minimus upon issuance. The warrants were exercisable over an 18-month period
beginning May 17, 1993, however, in November 1994, in return for the pro rata
expiration of a cashless exercise provision of the warrants, the exercise
provision was extended to November 17, 1995. In July 1995, 21,428 warrants were
exercised of which 16,071 shares were issued for cash and 5,357 warrants were
exercised under a cashless provision, netting to an issuance of 3,956 shares.
On July 11, 1995, in return for an agreement to not sell or otherwise dispose of
any shares of the Company's Common Stock held by the remaining warrant holders,
the exercise provision was extended to May 17, 1996 and the pro rata expiration
of the cashless exercise provision was rescinded.  In March and May 1996, the
remaining 392,277 warrants were exercised under a cashless provision, netting to
an issuance of 260,041 shares.

   In connection with the advances from D. Blech & Company Incorporated ("D.
Blech"), the Company issued D. Blech and a related party warrants to purchase
28,571 shares of the Company's Common Stock at $.035 per share, exercisable over
a five year period beginning January 1993. The warrants have been recorded at
zero in the accompanying financial statements as the value was de minimus upon
issuance. In September 1997, 24,291 warrants were exercised for cash and the
remaining warrants expired in December 1997.

  In connection with loans from two directors of BCM Technologies, Inc., the
Company issued warrants to purchase 5,714 shares of Series A Preferred Stock at
$2.1525 per share. The warrants have been recorded at zero in the accompanying
financial statements as the value was de minimus upon issuance. One warrant for
2,857 shares was exercised in 1994 and the remaining warrant for 2,857 shares
was exercised in May 1996.

                                      F-11
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

7. 401(K) PLAN, STOCK OPTION PLANS, AND EMPLOYEE STOCK PURCHASE PLAN:


   The Company adopted a 401(k) plan in 1994.  Under the plan, employees can
contribute up to 15 percent of their compensation subject to limitations as
defined by the Internal Revenue Service.  The Company has the option to match an
employee's contribution as determined each year by the Company.  An employee
vests in the Company's matching contribution based on years of service.  No
matching contribution had been made through December 31, 1996. In 1997, the
Company implemented a 25% match of employee contributions to be made with shares
of the Company's Common Stock at year end based on the year end closing price
per share.

   In March 1994, the Board of Directors adopted, and the stockholders
subsequently approved, the 1994 Non-Employee Directors' Stock Option Plan (the
"Directors' Plan"). The Directors' Plan, as amended in 1997, reserved 390,000
shares of common stock for issuance thereunder. The plan permits each director
of the Company who is not otherwise employed by the Company who (i) was a
director on July 12, 1994 or (ii) is first elected as a director after the date
of adoption of the Directors' Plan, automatically will be granted an option to
purchase 10,000 and 30,000 shares of common stock, respectively. In addition,
annually on April 26th , each non-employee director who has been a non-employee
director for at least six months shall be granted an option to purchase 5,000
shares of Common Stock of the Company. All options under this plan vest in four
equal annual installments commencing on the date of grant.

   In April 1993, the Board of Directors approved the 1993 Stock Option Plan
(the "Option Plan"). The Option Plan, as amended in 1997, provides for the grant
of up to 3,945,714 incentive and nonstatutory options to acquire the Company's
common stock. The option prices for the incentive and nonstatutory options shall
be not less than 100 percent and 85 percent, respectively, of the fair market
value of the stock as determined by the Company's Board of Directors.

   In March 1994, the Board of Directors adopted the Employee Stock Purchase
Plan and reserved 857,142 shares of Common Stock for issuance thereunder. The
plan permits full-time employees to purchase Common Stock through payroll
deductions (which cannot exceed 15 percent of each employee's compensation) at
the lower of 85 percent of fair market value at the beginning of each offering
period, as defined, or the fair market value at the end of each six-month
purchase period. In 1996 and 1997, 108,751 and 62,259 shares, respectively, were
purchased by employees under this plan at $2.66 to $6.48 per share.

   The Company accounts for its stock based compensation plans under Accounting
Principles Board Opinion No. 25 and the related Interpretations.  Accordingly,
deferred compensation is recorded for stock options based on the excess of the
deemed value of the common stock on the date the options were granted over the
aggregate exercise price of the options.  This deferred compensation is
amortized over the vesting period of each option.  For certain stock options
granted prior to its initial public offering, the Company recorded deferred
compensation.  Such deferred compensation totals approximately $2 million, of
which  $394,977, $393,754 and $192,638 was recognized as expense during the
years ended December 31, 1995, 1996 and 1997, respectively, and the remaining
amount at December 31, 1997, $56,348, will be amortized to expense in 1998.  As
the exercise price of all options issued since the Company's initial public
offering in July 1994 has been equal to or greater than the market price of the
Company's stock on the date of grant, no further deferred compensation was
recorded.  In 1997, $216,817 of previously recorded deferred compensation was
reversed due to the cancellation of certain options upon termination of the
employees. No compensation cost has been recognized under the Company's stock
purchase plan.

   In October 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based
Compensation" which, if fully adopted, requires the Company to record stock
based compensation at fair value.  The Company has adopted the disclosure
requirements of SFAS No. 123 and has elected not to record related compensation
expense in accordance with this statement.  Had compensation expense for its
stock option and stock purchase plans been determined consistent with 

                                      F-12
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

SFAS No. 123, the Company's net loss and net loss per share would have been
increased to the pro forma amounts indicated below. The compensation costs
disclosed here may not be representative of the effects of pro forma net income
in future years.

<TABLE>
<CAPTION>

                                        1995         1996        1997
                                     -----------  -----------  ----------
<S>                                  <C>          <C>          <C>   
Net loss:               As reported  $10,149,711  $10,652,972  $11,753,701
                        Pro forma    $11,028,844  $12,449,641  $14,218,819
 
Basic and diluted
 net loss per share:    As reported  $      1.10  $      0.84  $      0.86
                        Pro forma    $      1.20  $      0.98  $      1.04
</TABLE>

   The following is a summary of stock option activity:

<TABLE>
<CAPTION>
                                                  1993 STOCK OPTION PLAN            DIRECTORS PLAN
                                                --------------------------   ------------------------------
                                                              WEIGHTED-AVG.                   WEIGHTED-AVG.  
                                                 OPTIONS        PRICE ($)        OPTIONS        PRICE ($)
                                                ---------     ------------    ------------    -------------
<S>                                             <C>           <C>             <C>              <C>  
Balance at December 31, 1994..............      1,230,612            1.76           50,000       7.50
                                                ---------                          -------
  Granted.................................        477,250            6.54          140,000       4.91
  Exercised...............................       (155,088)           1.54           (2,500)      7.50
  Canceled................................        (74,978)           3.66          (37,500)      7.07
                                                ---------                          -------
Balance at December 31, 1995..............      1,477,796            3.23          150,000       5.19
                                                ---------                          -------
  Granted.................................        784,349            4.92           20,000       6.25
  Exercised...............................       (250,676)           0.85              --          --
  Canceled................................       (278,204)           5.80          (30,000)      3.63
                                                ---------                          -------
Balance at December 31, 1996..............      1,733,265            3.94          140,000       5.68
                                                ---------                          -------
  Granted.................................        755,943            6.55           25,000       6.88
  Exercised...............................       (197,065)           2.39               --         -- 
  Canceled................................       (192,237)           5.08               --         --
                                                ---------                          -------
Balance at December 31, 1997..............      2,099,906            4.91          165,000       5.86
                                                =========                          =======
Exercisable at December 31, 1995..........        645,065            2.15            5,000       7.50
Exercisable at December 31, 1996..........        774,465            2.94           35,000       5.86
Exercisable at December 31, 1997..........      1,059,727            4.02           70,000       5.77
 
</TABLE>

   At December 31, 1997, 1,163,837 and 222,500 options were available for future
grant under the 1993 Stock Option Plan and Directors Plan, respectively.  The
exercise price of options outstanding under the 1993 Stock Option Plan and
Directors' Plan at December 31, 1997 range from $0.18 to $9.88 and $3.63 to
$7.50, respectively.  The weighted average contractual life of options
outstanding at December 31, 1997 was nine years for both the 1993 Stock Option
Plan and Directors Plan.

   The weighted average fair value of options granted in 1995, 1996 and 1997 was
$4.78, $3.45 and $4.90, respectively, under the 1993 Stock Option Plan.  The
weighted average fair value of options granted in 1995, 1996 and 1997 was $3.70,
$4.30 and $5.28, respectively, under the Directors' Plan. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants in
1995, 1996 and 1997, respectively:  risk-free interest rates of 6.5 percent for
all years; no expected dividend yields for all years; expected lives of 6 years
for all years and expected volatility of 82, 72 and 85 percent.

                                      F-13
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

   The weighted average fair value of purchase rights granted in 1995, 1996 and
1997 was $1.33, $1.37 and $3.20, respectively, under the Employee Stock Purchase
Plan.  The fair value of employee purchase rights was estimated using the Black-
Scholes option pricing model with the following weighted average assumptions for
1995, 1996 and 1997, respectively: risk-free interest rates of 5.8, 5.6 and 5.8
percent; no expected dividend yields for all years; expected lives of 1.5 years
for all years and expected volatility of 77, 72 and 72 percent.

8. FEDERAL INCOME TAXES:

   The Company recognizes deferred tax liabilities and assets for the expected
future tax consequences of events that have been recognized differently in the
financial statements or tax returns.  Under this method, deferred tax
liabilities and assets are determined based on the difference between the
financial statement carrying amounts and tax bases of liabilities and assets
using exacted tax rates and laws in effect in the years in which the differences
are expected to reverse.  Deferred tax assets are evaluated for realization
based on a more-likely-than-not criteria in determining if a valuation should be
provided.

   As of December 31, 1997, the Company has generated net operating loss ("NOL")
carryforwards of approximately $39 million and research and development credits
of approximately $1.2 million available to reduce future income taxes. These
carryforwards begin to expire in 2007.  A change in ownership, as defined by
federal income tax regulations, could significantly limit the Company's ability
to utilize its carryforwards.  The Company's ability to utilize its current and
future NOLs to reduce future taxable income and tax liabilities may be limited.
Additionally, because Federal tax regulations limit the time during which these
carryforwards may be applied against future taxes, the Company may not be able
to take full advantage of these attributes for federal income tax purposes.  As
the Company has had cumulative losses and there is no assurance of future
taxable income, a valuation allowance has been established to fully offset the
deferred tax asset at December 31, 1997 and 1996.  The valuation allowance
increased $4,443,779 and $3,834,402 for the years ended December 31, 1997 and
1996, respectively, primarily due to the Company's losses.  The components of
the Company's deferred tax assets are as follows:

<TABLE> 
<CAPTION> 
                                                                       DECEMBER 31,
                                                                ---------------------------
                                                                     1996           1997
                                                                -----------    ------------
<S>                                                             <C>            <C>
Net operating loss carryforwards..............................  $  9,714,245   $ 13,487,189
Research and development tax credits..........................       645,000      1,172,825
Capitalized start-up costs....................................       363,735        205,014
Technology license............................................       298,168        278,223
Tax basis of equipment, furniture and leasehold improvements..        97,498        123,720
Contract revenue..............................................       652,790        975,734
Other.........................................................        27,490             --
                                                                ------------   ------------
    Total deferred tax assets.................................    11,798,926     16,242,705
Less valuation allowance......................................   (11,798,926)   (16,242,705)
                                                                ------------   ------------
    Net deferred tax assets...................................  $         --   $         --
                                                                ============   ============
</TABLE> 

                                      F-14
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

9. COLLABORATIVE, LICENSE AND RESEARCH AGREEMENTS:

   Effective February 1995, the Company and Corange International Ltd., the
parent company of the Boehringer Mannheim entered into a multi-year alliance
agreement to develop gene therapy products to treat selected cancer indications.
Under the terms of the agreement, Boehringer Mannheim has agreed to fund $25
million, plus certain amounts for achievement of milestones, for research and
development at the Company, with payments to the Company of $5 million per year,
plus milestones, for five years. Research and development funding of $4.6, $5.0
and $5.5 million, including a $0.5 million milestone payment in 1997,  were
received in 1995, 1996 and 1997, respectively. Because the Company may be
obligated, upon certain circumstances, to conduct research and development in an
amount not to exceed $5 million at the end of the five-year agreement, the
Company has recognized contract revenue at 80 percent of research funding. In
addition, Boehringer Mannheim has agreed to invest $20 million in the common
equity of the Company at $4 million per year. The first four $4 million equity
investments were made in July 1995, February 1996, February 1997 and February
1998 in which 444,444, 418,629, 533,333 and 533,333 common shares were issued at
$9.00, $9.56, $7.50 and $7.50  per share, respectively. The price per share for
common equity investments by Boehringer Mannheim for the years 1996 through 1999
is based upon the 15 consecutive trading days immediately preceding February 1
for each year, with the purchase in 1996 at a 20 percent premium. In no case
shall the purchase price be less than $7.50 per share. All payments to the
Company beginning in 1997 are subject to the achievement of certain milestones.
The Company also granted Boehringer Mannheim a three-year option to expand the
collaboration to include additional cancer indications.

   In April 1994, the Company entered into a collaborative agreement with Syntex
(U.S.A.) Inc., now a subsidiary of Roche Holding Ltd. to develop gene medicines
for certain inflammatory and immunological disorders. The collaborative
agreement ended in accordance with its terms in April 1997. Upon execution of
the collaborative agreement, Syntex Corporation purchased 3,750,000 shares of
the Company's Preferred Series B Stock and a warrant to purchase 1,071,428
shares of the Company's Common Stock. Refer to Note 6.

   In 1992, the Company entered into license agreements with Baylor whereby the
Company has exclusive noncancelable worldwide licenses to use certain
technology. In exchange for the grant of this exclusive license, the Company
issued 600,000 shares of its common stock to Baylor. Pursuant to the license
agreement, the Company will pay Baylor, for the longer of 10 years or the life
of the patent, beginning with the first commercial sale of a product
incorporating the licensed technologies, a royalty on net sales by the Company
of products incorporating any of the such technologies.

   Effective May 7, 1993, the Company obtained a worldwide, exclusive license
for the gene-switch technology initially developed by Baylor in exchange for
14,286 shares of common stock and future royalty payments on net sales by the
Company of any products incorporating the licensed technologies.

   The Company has entered into several sponsored research agreements with a
number of research institutes.  During 1995, 1996 and 1997, the Company paid
$1,340,000, $1,442,100 and $1,055,000 respectively, pursuant to these agreements
and has committed to pay an additional $446,000 and $148,000 in 1998 and 1999,
respectively  under these research agreements.

   In addition, the Company has entered into other licensing agreements with
various universities and research organizations. Under the terms of these
agreements, the Company has received exclusive and nonexclusive licenses to
technology or technology claimed, in certain patents or patent applications. The
Company is required to make payments of nonrefundable license fees and royalties
on future sales of products employing the technology. In 1995, 1996 and 1997,
the Company paid license fees of  $250,000, $362,000 and $238,000, respectively,
under these agreements, which have been recorded as a research and development
expense. To retain these licenses in future years the Company has 

                                      F-15
<PAGE>
 
                               GENEMEDICINE, INC.
               (A Delaware Corporation in the Development Stage)
                   NOTES TO FINANCIAL STATEMENTS-(Continued)

committed to pay approximately $120,000 through 1998.

10. CONSULTING AND RELATED AGREEMENTS:

    In 1995, in connection with the execution of the Boehringer Mannheim
alliance agreement, the Company paid a fee of $350,000 to a former chairman and
stockholder of the Company pursuant to a finder's agreement.

    The Company has entered into consulting agreements with certain individuals
to assist its clinical and research and development efforts. Pursuant to these
agreements, the Company paid $494,000, $447,000 and $384,000 in 1995, 1996 and
1997, respectively. The fees are recorded as research and development expense as
incurred. In 1996, the Company paid a director of the Company $20,300 under a
consulting agreement.

11. COMMITMENTS:

    The Company has entered into employment agreements with its chief executive
and other key employees which have initial expiration dates ranging from 1996 to
1999. The agreements are thereafter automatically renewed for successive twelve-
month terms, unless terminated by the Company or employee. Such agreements
provide that, in the case of termination without cause, the employees are
entitled to payments ranging from 25 percent to 85 percent of their annual
salaries. The aggregate amount charged to expense during 1995, 1996 and 1997
pursuant to these agreements totaled $848,000, $872,000 and $821,000,
respectively.

    On October 29, 1993, the Company entered into an agreement to lease building
facilities from a real estate company. This operating lease commenced in January
1995 and continues for a lease term of 10 years. The obligations under this
lease along with other operating leases are as follows:

<TABLE>
<S>                              <C>
1998...........................  $855,000
1999...........................   854,000
2000...........................   906,000
2001...........................   906,000
2002...........................   906,000
2003...........................   906,000
2004...........................   906,000
 
</TABLE>

                                      F-16