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                      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 September 30, 2000 or

[_]Transition Report Pursuant to Section 13 or 15(d) of the Securities
   Exchange Act of 1934 for the transition period from     to

                          Commission File No. 0-18728

                       Interneuron Pharmaceuticals, Inc.
            (Exact name of registrant as specified in its charter)

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

               Delaware                              04-3047911
    (State or other jurisdiction of               (I.R.S. Employer
    incorporation or organization)             Identification Number)

         One Ledgemont Center,                          02421
           99 Hayden Avenue,                         (Zip Code)
             Lexington, MA
    (Address of principal executive
               offices)

      Registrant's telephone number, including area code: (781) 861-8444

       Securities registered pursuant to Section 12(b) of the Act: None

  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 voting and non-voting common equity
(excluding preferred stock convertible into and having voting rights on
certain matters equivalent to 622,222 shares of Common Stock) held by non-
affiliates of the registrant was approximately $42,750,000, based on the last
sales price of the Common Stock as of December 14, 2000. Shares of Common
Stock held by each executive officer and director, by each person who
beneficially owns 10% or more of the outstanding Common Stock, and individuals
or entities related to such persons have been excluded. This determination of
affiliate status may not be conclusive for other purposes.

  As of December 14, 2000, 42,780,492 shares of Common Stock, $.001 par value,
of the registrant were issued and outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

  See Part III hereof with respect to incorporation by reference from the
registrant's definitive proxy statement for the fiscal year ended September
30, 2000 to be filed pursuant to Regulation 14A under the Securities Exchange
Act of 1934 and the Exhibit Index hereto.

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                                    PART I

Note Regarding Forward Looking Statements

  Statements in this Form 10-K that are not statements or descriptions of
historical facts are "forward-looking" statements under Section 21E of the
Securities Exchange Act of 1934, as amended, and the Private Securities
Litigation Reform Act of 1995 and are subject to numerous risks and
uncertainties. These forward-looking statements and other forward-looking
statements made by the Company or its representatives include, without
limitation, statements regarding the Redux-related litigation, the Company's
ability to successfully develop, obtain regulatory approval for and
commercialize any products, to enter into corporate collaborations or obtain
sufficient additional capital to fund operations, and are based on a number of
assumptions. The words "believe," "expect," "anticipate," "intend," "plan,"
"estimate" or other expressions which are predictions of or indicate future
events and trends and do not relate to historical matters identify forward-
looking statements. Readers are cautioned not to place undue reliance on these
forward-looking statements as they involve risks and uncertainties, and actual
results could differ materially from those currently anticipated due to a
number of factors, including those set forth under "Risk Factors" and
elsewhere in, or incorporated by reference into, this Form 10-K. These factors
include, but are not limited to, risks relating to the Redux-related
litigation; uncertainties relating to clinical trials, regulatory approval and
commercialization of the Company's products; the early stage of products under
development; need for additional funds and corporate partners; history of
operating losses and expectation of future losses; product liability;
dependence on third parties for manufacturing and marketing; competition;
government regulation; risks associated with contractual arrangements; limited
patents and proprietary rights; dependence on key personnel; uncertainty
regarding pharmaceutical pricing and reimbursement and other risks. The
forward-looking statements represent the Company's judgment and expectations
as of the date of this Report. The Company assumes no obligation to update any
such forward-looking statements. See "Risk Factors."

  Unless the context indicates otherwise, "Interneuron" and the "Company"
refer to Interneuron Pharmaceuticals, Inc. and "Common Stock" refers to the
common stock, $.001 par value per share, of Interneuron.

ITEM 1. Business.

(a) General Description of Business:

  Interneuron is a biopharmaceutical company engaged in the development and
commercialization of a diversified portfolio of product candidates, including
multiple compounds in late stage clinical development. The Company is
currently developing or has certain rights to five compounds in clinical
development: pagoclone for panic and generalized anxiety disorders, trospium
for overactive bladder, IP 501 for cirrhosis of the liver, citicoline for
ischemic stroke, and PRO 2000 for the prevention of sexually transmitted
diseases and human immunodeficiency virus ("HIV") infection. In addition, the
Company has other compounds in earlier stages of development, including PACAP
(pituitary adenylate cyclase activating polypeptide) for respiratory diseases,
diabetes, stroke and other neurodegenerative diseases.

  The Company seeks to acquire, develop and commercialize a portfolio of
pharmaceutical products for a range of therapeutic indications. The key
elements to Interneuron's business strategy include: 1) identifying products
with broad applications and large, unsatisfied markets, 2) acquiring clinical
and late pre-clinical stage compounds with defined pathways to the clinic and
to market, 3) focusing on products with clinical data or market experience
outside the U.S., 4) adding value to acquired products through clinical
testing and regulatory review activities and competencies, and 5)
commercializing products independently or through selective corporate
partnerships that will help ensure the timely penetration of target markets.
The Company's strategy is both systematic and opportunistic across a range of
products arising from a variety of partners including biopharmaceutical,
regional pharmaceutical, and multi-national pharmaceutical firms, as well as
academic and government institutions. Within these relationships, Interneuron
attempts to leverage its capabilities, expertise, resources, and shared
commitment to maximize the potential of each therapeutic product.

                                       2
<PAGE>

  The Company's lead product, pagoclone, is in development for the treatment
of panic and generalized anxiety disorders. In December 1999, the Company
entered into an agreement with the Warner-Lambert Company, now Pfizer Inc.
("Pfizer"), under which it licensed to Pfizer exclusive worldwide rights to
develop and commercialize pagoclone (the "Pfizer Agreement"). The Company has
received $16,750,000 to date under the Pfizer Agreement, and Interneuron is
entitled to receive up to an additional $57,000,000 in payments contingent
upon the achievement of clinical and regulatory milestones, as well as
royalties on net sales. In August 2000, Pfizer began its clinical program for
pagoclone in panic disorder.

  In November 1999, the Company obtained an exclusive U.S. license to
trospium, a prescription drug product currently marketed as a treatment for
overactive bladder in Europe. In May 2000, the Company met with the United
States Food and Drug Administration ("FDA") to discuss the existing European
clinical efficacy trials and safety database for trospium and to seek guidance
on criteria for approvability of the compound. Based on its conversations with
the FDA, the Company intends to conduct a standardized electrocardiograpic
safety study which is recommended by the FDA for drugs in the pharmacological
class of trospium. Additionally, based upon those discussions with the FDA,
the Company believes that, in combination with the existing efficacy and
safety data on trospium, a single, successful 300-400 patient Phase 3 trial
will be necessary and sufficient for submission of an New Drug Application
("NDA"). On December 12, 2000, the Company filed an Investigational New Drug
application ("IND") for trospium and expects to conduct its safety study in
the second quarter of fiscal 2001. Assuming positive results from this study,
the Company expects to begin its Phase 3 trial in fiscal 2001.

  The Company has an option to negotiate an exclusive license to a compound
known as IP 501 for the treatment and prevention of cirrhosis of the liver
caused by alcohol and hepatitis viruses. IP 501 is currently being studied in
a recently completed 800-patient Phase 3 clinical trial sponsored by the
Department of Veterans Affairs (the "Veterans Administration"). The Company
expects the Veterans Administration to complete their analysis of the data in
the first quarter of calendar 2001.

  In December 1999, the Company licensed exclusive rights to commercialize
citicoline, a drug for the treatment of ischemic stroke, in the United States
and Canada to Takeda Chemical Industries, Ltd. ("Takeda") (the "Takeda
Agreement"). In exchange, the Company received $13,000,000 in licensing and
other payments and was entitled to receive an additional $60,000,000 in
payments contingent upon the achievement of regulatory milestones, as well as
royalties on net sales. In January 2000, the Company announced that a
preliminary analysis of the 899-patient Phase 3 clinical trial with citicoline
failed to meet its primary endpoint, a measure of improvement in neurological
function among patients suffering from moderate to severe ischemic stroke,
although a number of secondary endpoints were positive. Takeda recently
notified the Company of its decision not to participate in the further
development of citicoline, thereby terminating the Takeda Agreement.
Therefore, the Company has reacquired all rights to this compound. In
addition, Takeda has indicated that it will exercise its option under the
Takeda Agreement to negotiate a license of another one of the Company's
compounds. The Company does not intend to further develop citicoline unless it
is able to find another partner to participate in such development.

  In June 2000, the Company licensed exclusive, worldwide rights from
HeavenlyDoor.com, Inc., formerly Procept, Inc. ("HDCI"), to develop and market
PRO 2000, a candidate topical microbicide to prevent infection by HIV and
other sexually transmitted pathogens. In October 2000, dosing and follow-up
for a Phase 1/Phase 2 clinical trial of PRO 2000 was completed by the National
Institutes of Health ("NIH") at sites in the U.S. and South Africa. No serious
adverse events were reported and a full analysis of the data by the NIH is
ongoing. Additional government funded clinical testing is planned for 2001.

  In July 2000, the Company and Eli Lilly and Company ("Lilly") announced that
Lilly's drug, Sarafem(TM), was approved in the United States for the treatment
of premenstrual dysphoric disorder ("PMDD"), a severe form of premenstrual
syndrome ("PMS"). In 1997, the Company licensed to Lilly certain patents
covering the use of fluoxetine hydrochloride for the treatment of symptoms
associated with PMS. The Company has received

                                       3
<PAGE>

up front and milestone payments under the Lilly license agreement and expects
to receive royalties on net sales in the United States of fluoxetine for PMDD
during the period of market exclusivity.

  On September 15, 1997, the Company announced a market withdrawal of its
first prescription product, the weight loss medication Redux(TM)
(dexfenfluramine hydrochloride capsules) C-IV, which had been launched by
American Home Products Corporation ("AHP"), the Company's licensee, in June
1996. Since the withdrawal of Redux, Interneuron has been named, together with
other pharmaceutical companies, as a defendant in approximately 3,200 product
liability legal actions, some of which purport to be class actions, in federal
and state courts involving the use of Redux and other weight loss drugs. To
date, there have been no judgments against the Company, nor has Interneuron
paid any amounts in settlement of any of these claims. Following the dismissal
and the anticipated dismissal of Interneuron as a defendant in certain cases,
the Company estimates that there will be approximately 2,300 active cases. In
January 2000, the Company filed suit against AHP for fraud, misrepresentation
and breach of contract, seeking unspecified but substantial damages.

  The Company was incorporated in Delaware in March 1990. The Company's
executive offices are located at One Ledgemont Center, 99 Hayden Avenue,
Lexington, Massachusetts 02421-7966.

(b) Financial Information about Industry Segments

  The Company operates in only one business segment.

                                       4
<PAGE>

(c) Narrative Description of Business

                                   PRODUCTS

  The following table summarizes the products under development by the Company
or to which the Company has certain rights, including product name,
indication/use, regulatory status and commercial rights held by the Company
with respect to each product. For a more detailed description of each product,
see product descriptions following the chart.

<TABLE>
<CAPTION>
Product Name  Indication/Use                  Regulatory Status(*)     Commercial Rights
------------  --------------                  --------------------     -----------------
<S>           <C>                             <C>                      <C>
Pagoclone     Anxiety/Panic disorders         Phase 2/Phase 3 trial    Worldwide; licensed to Pfizer
                                              in panic disorder
                                              completed by
                                              Interneuron;
                                              Pfizer has initiated
                                              clinical trials


Trospium      Overactive bladder              Phase 3 expected to      United States
                                              begin in fiscal 2001



IP 501        Cirrhosis of the liver          Phase 3                  Option to negotiate an
                                                                       exclusive license for the U.S.,
                                                                       Canada, Japan and Korea

Citicoline    Ischemic stroke                 Phase 3                  United States and Canada


PRO 2000      Prevention of HIV and           Phase 1/Phase 2          Worldwide
              sexually transmitted diseases


PACAP         Respiratory diseases, diabetes, Pre-clinical             Worldwide
              stroke and other
              neurodegenerative diseases
</TABLE>
--------
* See "Government Regulation."

                                   PAGOCLONE

  General: Pagoclone is under development as a drug to treat panic and
generalized anxiety disorders. Panic disorder is a severe anxiety condition
characterized by panic attacks, acute episodes of anxiety comprised of
distressing symptoms, such as breathing difficulty, sweating, heart
palpitations, feeling dizzy or faint, and fear of losing control. Generalized
anxiety disorder is a condition characterized by excessive anxiety and worry
most days for at least six months about a variety of events or activities,
such as work or family. Patients with generalized anxiety disorder experience
persistent diffuse anxiety without the specific symptoms that characterize
phobic disorders, panic disorders, or obsessive-compulsive disorders. There
are approximately 2.5 million patients in the U.S. with panic disorder and
over 20 million patients with anxiety disorders. Anxiety disorders, including
panic disorder, are believed to be associated with excessive neuronal activity
resulting from a decrease in the function of the major inhibitory
neurotransmitter called GABA (gamma amino butyric acid).

  The Company believes that pagoclone, a novel GABA modulator and a member of
the cyclopyrrolone class of compounds, increases the action of GABA, thus
reducing excess neuronal activity and alleviating symptoms of panic and
anxiety. Pre-clinical and early clinical data suggest that pagoclone may offer
advantages over traditional benzodiazepine anti-anxiety agents, including
reduced drowsiness, lower addiction and withdrawal potential and less
potential for alcohol interactions.

  Current pharmacological treatments for anxiety and panic disorders generally
include benzodiazepines, serotonin agonists and selective serotonin reuptake
inhibitors. Traditional side effects seen with these classes of anti-anxiety
drugs include sedation, lack of mental acuity, withdrawal and rebound anxiety
related to the benzodiazepine class of drugs, and agitation, insomnia and
sexual dysfunction related to serotonin reuptake inhibitors.

                                       5
<PAGE>

  Pfizer Agreement: In December 1999, the Company entered into the Pfizer
Agreement under which the Company licensed to Pfizer exclusive, worldwide
rights to develop and commercialize pagoclone. To date under the Pfizer
Agreement, the Company has received $16,750,000, including an up-front payment
of $13,750,000, and is entitled to receive up to an additional $57,000,000 in
payments contingent upon the achievement of clinical and regulatory
milestones. Pfizer will also pay Interneuron royalties on net sales if
pagoclone is commercialized. Under the Pfizer Agreement, Pfizer is responsible
for conducting and funding all further clinical development, regulatory
review, manufacturing and marketing of pagoclone on a worldwide basis. See
"Agreements" and "Risk Factors--We will depend on Pfizer to develop,
manufacture and market pagoclone."

  Ongoing Development: In August 2000, Pfizer initiated clinical trials with
pagoclone for panic disorder. The Company received a $3,000,000 milestone
payment upon initiation of the panic disorder trial. Pfizer has advised the
Company that it is preparing to begin its clinical program with pagoclone in
generalized anxiety disorder.

  Phase 2/3 Clinical Trial: In August 1998, the Company announced results of
its Phase 2/3 trial showing that treatment with pagoclone statistically
significantly reduced the frequency of panic attacks among patients suffering
from panic disorder. In addition, pagoclone was well-tolerated by these
patients, with no evidence of sedation and no apparent withdrawal symptoms in
this study, which included a tapering-off period.

  The double-blind, placebo-controlled, parallel group study involved 277
patients at six clinical sites in the United States. Patients were enrolled in
the study following confirmed diagnoses of panic disorder. The number of
attacks experienced by each patient during a two-week screening period prior
to enrollment represented the baseline for subsequent comparison of panic
attack frequency. Following the screening period, patients were randomized to
receive one of three doses of pagoclone orally (.15 milligrams/day, .30
milligrams/day or .60 milligrams/day) or placebo for eight weeks. The primary
outcome measurement was the change from baseline in the number of panic
attacks seen at the eight week time point. This primary analysis, conducted on
an LOCF basis, showed that patients in the .15 milligrams/day group
experienced a 43% reduction in the number of panic attacks relative to
patients on placebo (p=0.141), that patients in the .30 milligrams/day group
experienced a 70% reduction relative to patients on placebo (p=0.021), and
that patients in the .60 milligrams/day group experienced a 52% reduction
(p=0.098) relative to patients on placebo.

  Pagoclone was well tolerated with a low incidence of side effects in all
dosage groups and no clinically significant differences from placebo.
Sedation, a major side effect of benzodiazepine drugs, was evaluated by use of
the Stanford Sleepiness Scale. There were no differences observed between
pagoclone and placebo using this scale. In addition, there were no evident
withdrawal effects seen at the end of the study as determined by the Rickels
Withdrawal Scale. Of note, other common side effects seen with existing
classes of anti-anxiety drugs were not significantly different between
pagoclone patients and patients receiving placebo in this trial. These
traditional side effects include sedation, lack of mental acuity, withdrawal
and rebound anxiety related to the benzodiazepine class of drugs, and
agitation, insomnia and sexual dysfunction related to selective serotonin
reuptake inhibitors.

  Pilot Study: In November 1997, the Company announced that data from a pilot
study among 16 patients suffering from panic attacks showed that those who
were treated with three doses per day, orally, of pagoclone experienced a
marked reduction in the number of their panic attacks compared to those who
received placebo. This double-blind, placebo controlled crossover study was
conducted by a team of researchers in the U.K. Pagoclone produced a
significant reduction (40%, p=0.012) in the total number of panic attacks over
a two week treatment period and a reduction (40%, p=0.006) in the average
number of panic attacks per day compared to the pre-treatment period. No
significant change in the total number of panic attacks was observed during
placebo treatment.

  Licensing and Proprietary Rights: In February 1994, the Company licensed
from Rhone-Poulenc Rorer, S.A., now Aventis, S.A. ("Aventis") exclusive
worldwide rights to pagoclone, subject to Aventis' option to

                                       6
<PAGE>

obtain a sublicense in France, a patented compound, in exchange for license
fees, milestone payments and royalties based on net sales. Aventis is entitled
to receive a portion of the payments to be received by the Company under the
Pfizer Agreement. See "Agreements" and "Patents and Proprietary Rights--
Pagoclone."

                                   TROSPIUM

  General: Trospium is under development as a drug to treat overactive
bladder, the most common cause of urinary incontinence in the elderly.
According to a recent report of the American Urological Association,
approximately 17 million Americans, 85 percent of whom are women, suffer from
bladder control problems, which can lead to overactive bladder. According to
the SCRIP report dated July 10, 1998, approximately 20 percent of overactive
bladder patients are currently treated with pharmacotherapy. Economic costs
related to diagnosis and treatment of overactive bladder are estimated to
exceed $26 billion, as stated in the Journal of the American Medical
Association report on December 16, 1998.

  Trospium belongs to a class of compounds known as muscarinic receptor
antagonists. These compounds relax smooth muscle tissue, such as that found in
the bladder. Pre-clinical data with trospium suggests that it does not enter
the central nervous system and thus may have a side effect profile preferable
to currently available agents. In addition, clinical data and commercial
experience reflect favorable efficacy and safety profiles. Trospium is
currently marketed in several European countries, including Germany, Spain,
Austria, and Switzerland, and was recently approved for sale in Britain,
France, and Italy.

  Development Strategy: In May 2000, the Company met with the FDA to discuss
the existing European clinical efficacy trials and safety database for
trospium and to seek guidance on criteria for approvability of the compound.
Based on its conversations with the FDA, the Company intends to conduct a
standardized electrocardiograpic safety study which is recommended by the FDA
for drugs in the pharmacological class of trospium. Additionally, based upon
those discussions with the FDA, the Company believes that, in combination with
the existing efficacy and safety data on trospium, a single, successful 300-
400 patient Phase 3 trial will be necessary and sufficient for submission of
an NDA. On December 12, 2000, the Company filed an IND for trospium and
expects to conduct its safety study in the second quarter of fiscal 2001.
Assuming positive results from this study, the Company expects to begin its
Phase 3 trial in fiscal 2001.

  Licensing and Proprietary Rights: In November 1999, the Company licensed
exclusive U.S. rights from Madaus AG ("Madaus") to market trospium (the
"Madaus Agreement"). In exchange, the Company agreed to pay Madaus regulatory
milestone, royalty and sales milestone payments. Interneuron is responsible
for all clinical development and regulatory activities and costs related to
the compound in the U.S. There are no existing U.S. patents covering the use
of orally-administered trospium to treat overactive bladder. The Company
expects to rely on the provisions of the Waxman-Hatch Act to obtain a period
of market exclusivity in the U.S., if the FDA approves trospium in the U.S.
for the intended indication. The Madaus Agreement includes a license of the
know-how relating to the European clinical trials of trospium. See "Patents
and Proprietary Rights--Trospium" and "Government Regulation."

  Madaus Development: The current clinical database for trospium includes over
2,200 subjects and patients (over 1,300 treated with active drug). The
database comprises two double-blind, placebo-controlled dose-ranging studies,
five double-blind, placebo-controlled studies, one of which included an
active-controlled treatment arm, and several comparative trials, one of which
was a long-term comparative 52-week study on safety, tolerability, and
efficacy. Many of these studies assessed the relative efficacy of trospium on
urodynamic measurements such as bladder capacity and compliance, maximum
detrusor pressure, and residual urine, in addition to micturition diary data.
In addition to this clinical database, over 8,000 patients have been followed
in post-marketing trials. To supplement the clinical database, Interneuron
will also utilize Madaus' extensive pharmacology, toxicology and
pharmacokinetic studies, including acute, subacute, chronic, carcinogenicity,
genotoxicity, and reproduction studies, as well as numerous pre-clinical and
clinical biopharmaceutic studies.


                                       7
<PAGE>

                                  CITICOLINE

  General: Citicoline is under development as a treatment for ischemic stroke.
An ischemic stroke occurs when brain tissue dies or is severely damaged as the
result of interrupted blood flow caused by a clogged artery which deprives an
area of the brain of blood and oxygen, commonly known as an infarct. This loss
of blood flow and oxygen causes, among other events, a breakdown of brain cell
membranes, and places the surrounding tissue, the penumbra, at risk for death,
leading to an extension of the size of infarct believed to result from the
release and oxidation of such compounds as free fatty acids. This release is
likely caused in part by the inappropriate release of glutamate and other
neurotransmitters.

  Mechanism of Action: Citicoline is believed to have multiple acute and
longer-term mechanisms of action in diminishing the effects of stroke. On an
acute basis, citicoline appears to limit infarct size by preventing the
accumulation of fatty acids, which would otherwise yield toxic oxidation
products, by preventing their release. On a longer-term basis, citicoline is
believed to promote the formation of additional membrane elements needed by
damaged neurons to restore functional activity by raising blood levels of
choline, cytidine and other phospholipid precursors, which are substrates
believed to be essential for the formation of the nerve cell membrane.
Citicoline is thereby believed to help stabilize the cell membrane and, as a
result, decrease edema, or brain swelling, caused when blood flow to brain
cells is stopped, and help to re-establish normal neurochemical function in
the brain. Citicoline also appears to increase levels of acetylcholine, a
neurotransmitter believed to be associated with learning and memory functions.

  Takeda Agreement: In December 1999, the Company entered into the Takeda
Agreement under which the Company licensed to Takeda exclusive rights to
commercialize citicoline in the U.S. and Canada. Under the Takeda Agreement,
the Company received $13,000,000 in licensing and other payments and was
entitled to receive up to $60,000,000 in payments contingent upon the
achievement of regulatory milestones, as well as royalties on net sales.
Takeda recently notified the Company of its decision not to participate in the
further development of citicoline, thereby terminating the Takeda Agreement.
Therefore, the Company has reacquired all rights to this compound. In
addition, Takeda has indicated that it will exercise its option under the
Takeda Agreement to negotiate a license of another one of the Company's
compounds. The Company does not intend to further develop citicoline unless it
is able to find another partner to participate in such development. See
"Agreements" and "Risk Factors--We may not be able to collaborate with third
parties to commercialize certain other products due to the existence of the
Takeda option."

  ECCO 2000 Phase 3 Trial: In June 1998, the Company commenced a Phase 3
clinical trial, known as ECCO 2000 (Effects of Citicoline on Clinical
Outcome--2000 mg.), with citicoline. This multi-center trial, which included
899 patients with ischemic stroke at more than 170 hospitals in the U.S. and
Canada, compared the neurological function of citicoline-treated patients with
that of placebo patients at 12 weeks following stroke. Patients were treated
with citicoline, 2000 milligrams daily, for six weeks, with a six week follow-
up period.

  On January 10, 2000, the Company announced that the ECCO 2000 trial failed
to meet its primary endpoint, a measure of improvement in neurological
function among patients suffering from moderate to severe ischemic stroke. The
pre-specified, primary outcome measurement of the trial was the comparison of
the percentages of patients treated with citicoline or placebo who achieved at
least a 7-point improvement on the National Institutes of Health Stroke Scale
("NIHSS") scores from baseline to endpoint. Secondary outcomes included
additional comparisons of neurological function and infarct volume
measurements among citicoline and placebo patients at the end of the study.

  Although improvement in the primary outcome measurement was not achieved,
other measures were found to be statistically significant in favor of
citicoline. A pre-specified Overall Response Outcome measured by a global test
of multiple outcomes had a significantly (p less than or = 0.03) higher odds
of a favorable outcome in the citicoline-treated patients than in the placebo
group. This statistical test combines correlated outcomes including the
Barthel Index (measure of functional outcome), Modified Rankin Scale (measure
of global outcome) and NIHSS (measure of neurological function) to measure
overall recovery from stroke. While not a pre-specified

                                       8
<PAGE>

endpoint, the standard analyses used in stroke research, using the Modified
Rankin Scale score of 0 or 1 (full recovery) trended in favor of citicoline at
week 1 (p less than or = 0.08) and reached significance (p less than or =
0.03) at Week 12 with 26% of the citicoline-treated patients achieving full
recovery as compared to 20% of the placebo-treated patients. Diffusion-
weighted MR Imaging was collected in a pre-specified substudy to evaluate the
effect of treatment on infarct volume. Citicoline treatment was associated
with a significant 1.3% average increase in lesion volume compared to a 30.1%
average increase in the placebo group. Though not significant, a reduction in
lesion volume from baseline to Week 12 was observed in 67% of citicoline and
54% of placebo-treated patients. In addition, findings from the study indicate
that there were no significant adverse safety issues associated with
citicoline.

  Regulatory Review: The Company had submitted an NDA for citicoline to the
FDA in December 1997. Data in the NDA included the results of two Phase 3
clinical trials conducted by the Company in the U.S., a Japanese Phase 3
clinical trial conducted by Takeda and supportive clinical and post-marketing
data from more than 30 countries where citicoline has already been approved.
The NDA was accepted for filing and was assigned priority and fast-track
review status. However, based on the results of a subsequent 100-patient Phase
3 trial which failed to meet its primary endpoint of reducing infarct size
among patients taking citicoline versus those taking placebo, the Company
withdrew its NDA in April 1998.

  Review of Phase 3 Infarct Trial: In April 1998, the Company announced that a
preliminary analysis of a 100-patient Phase 3 trial with citicoline failed to
meet the primary and the principal secondary endpoints. With respect to the
primary endpoint, no statistically significant difference was detected in the
reduction of infarct size among patients with ischemic stroke who received 500
milligrams per day of citicoline as compared with patients who received
placebo, although there was a trend in favor of the citicoline-treated
patients. With respect to the principal secondary endpoint, the trial did not
show an improvement in neurological function among drug-treated patients as
compared with patients who received placebo. A safety review of the trial
indicated that citicoline was well tolerated and there did not appear to be
any adverse effects that differed significantly in frequency between
citicoline-treated patients and placebo-treated patients. The Company believes
that a placebo response rate unexpectedly higher than that previously reported
in the scientific literature may have accounted for the inability to detect a
difference in infarct size reduction and neurological function among drug-
treated patients, as compared with patients who received placebo.

  Review of Pivotal Phase 3 Trial: In July 1997, the Company announced results
of its second pivotal clinical trial in the U.S. with citicoline to treat
patients suffering from ischemic stroke. In this study, 267 patients received
citicoline and 127 patients received placebo. The primary outcome analysis of
this double-blind, placebo-controlled trial was improvement in the Barthel
Index, a 100 point rating scale of functional capabilities in neurological
patients, at a time point three months after an ischemic stroke. Patients were
considered to have achieved complete or near-complete functional recovery if
they achieved a Barthel score of 95 or 100 at three months. Findings from this
trial were published in Stroke (December 1999).

  There was an unexpected highly significant baseline imbalance in the
percentage of placebo versus citicoline-treated patients who had mild strokes
on study entry (34% for placebo vs. 22% for citicoline (p = 0.006)), due to
chance. The study was influenced by the significant preponderance of mild
cases, who have a much better prognosis, in the placebo group. As a result of
this imbalance and other statistical factors, the primary analysis of the
study, the distribution of Barthel Index scores in citicoline vs. placebo-
treated patients as a function of baseline NIH Stroke Scale scores was
statistically invalid because the patient imbalance and other statistical
factors failed to satisfy the requirements for the correct operation of the
statistical model. Thus the study failed to achieve statistical significance
in the protocol-defined primary outcome measure. Therefore, a protocol-defined
responders analysis, in which the percentage of patients who achieve a Barthel
Index greater than or equal to 95, among patients with moderate to severe
strokes, was employed.

  In the responders analysis, 41% of citicoline-treated patients with an NIH
Stroke Scale on entry of greater than or equal to eight (moderate to severe
strokes) achieved a Barthel Index of greater than 95 compared to 25% of
placebo-treated patients (OC (observed cases) analysis, p = 0.02). Thus,
patients with moderate to severe

                                       9
<PAGE>

stroke treated with citicoline had a 64% greater chance of complete or near-
complete recovery relative to patients with moderate to severe stroke treated
with placebo. In the LOCF (last observation carried forward) analysis, 33% of
moderate to severe citicoline patients and 21% of moderate to severe placebo
patients achieved a Barthel Index of greater than 95 (p = 0.05), a 57%
increased chance of improvement in recovery.

  Overall, patients who had mild strokes on entry into the study (NIH Stroke
Scale 5 through 7) had an excellent clinical outcome regardless of placebo or
citicoline treatment. For example, approximately 80% of patients with mild
strokes who received placebo and a similar percentage of citicoline-treated
patients with mild strokes achieved a Barthel score of greater than 95 at
three months.

  In another protocol-defined measure of functional clinical outcome, the 6-
point Rankin scale of physician-rated global assessment was utilized. A Rankin
score of 0 or 1 at study completion indicated complete or near-complete lack
of disability. Among patients with moderate to severe strokes, 24% of
citicoline-treated patients vs. 11% of placebo treated patients achieved a
Rankin score of 0 or 1 (OC analysis, p = 0.02), a 118% improvement in outcome.
In the LOCF analysis, 19% of moderate to severe citicoline patients and 11% of
moderate to severe placebo patients had a Rankin scale of 0 or 1, a 73%
improvement in outcome (p = 0.08).

  A preliminary safety review indicated that citicoline was well tolerated.
There did not appear to be any adverse events that differed significantly in
frequency from placebo-treated patients. The mortality rates for drug-treated
and placebo-treated patients were identical (17% in each group).

  Review of Pivotal Phase 2/3 Trial: Interneuron's initial pivotal study of
citicoline in stroke was reported in 1996. Findings from that trial were
published in Neurology in July 1997. The Company designates a trial as a Phase
2/3 if it is a well-controlled trial which the Company may utilize, depending
upon results, as either a pivotal or supporting trial in an NDA submission.

  The primary efficacy outcome in this study of 259 patients was improvement
in neurological function, as assessed by the Barthel Index. Among all patients
who received 500 milligrams daily of citicoline, 53% achieved a score of
greater than or equal to 95 on the Barthel Index at 12 weeks, indicative of
complete or near-complete recovery from stroke, compared with 33% of placebo-
treated patients, a 61% improvement in outcome (p less than 0.04).

  Patients in both the 500 milligram and 2000 milligram groups exhibited
significantly greater (p less than 0.05) improvement on the Barthel Index at
week 12 than placebo-treated patients. In addition, more patients in the 500
milligram and 2000 milligram groups exhibited normal or near normal scores in
mental function (p less than 0.04), as measured by the Mini-Mental State Exam,
which grades the cognitive state of patients.

  Patients who received 500 milligrams of citicoline daily were more than
twice as likely to manifest minimal or no disability at 12 weeks following
stroke as patients who received placebo, as measured by the NIH Stroke Scale.
The NIH Stroke Scale analysis showed that 34% of all citicoline-treated
patients versus 16% of placebo-treated patients achieved complete or near-
complete normalization of function, as indicated by scores 0 to 1, at 12 weeks
following stroke, a 113% of improvement in outcome (p less than 0.04). In
addition, global neurologic status, assessed by the Rankin Scale mean scores,
was significantly improved (p less than 0.04) with citicoline treatment
compared to placebo.

  Efficacy outcome measures for the 1000 milligram daily group did not reach
statistical significance in this trial. Patients in the 1000 milligram group
had a higher proportion of chronic pre-existing cardiac and pulmonary
disorders. These confounding variables may explain the performance of the 1000
milligram group in the trial.

  There was no significant difference in the incidence of death among the four
treatment groups in the trial. All doses of citicoline were well tolerated, as
indicated by analyses of adverse events and laboratory findings. The only
statistically significant differences among citicoline-treated patients versus
placebo-treated patients were an increase in accidental injuries, e.g.,
falling down. However, the 500 milligram dose citicoline group did not
significantly differ from the placebo group in these parameters.

                                      10
<PAGE>

  Manufacturing and Marketing: As a result of Takeda's termination of the
Takeda Agreement, and in the event citicoline is further developed, the
Company will be dependent upon third party suppliers of citicoline bulk
compound, finished product and packaging for manufacturing in accordance with
current U.S. Good Manufacturing Practices ("cGMP") regulations, and will be
dependent on third parties for the marketing and distribution of citicoline.
Supplies of citicoline finished product used for clinical purposes have been
produced on a contract basis by third party manufacturers. The Company's
license and supply agreement with Ferrer Internacional, S.A. ("Ferrer") dated
January 1993 as amended in June 1998 (the "Ferrer Agreement"), requires the
purchase from Ferrer of citicoline bulk compound for commercial purposes. If
such conditions permit the purchase of bulk compound from a third party, the
Company entered into an agreement with a manufacturer to supply citicoline
bulk compound for commercial purposes. See "Risk Factors--We will depend on
third parties to commercialize our products."

  Licensing and Proprietary Rights: In January 1993, the Company licensed from
Ferrer exclusive marketing and manufacturing rights based on certain patent
rights relating to the use of citicoline, including certain patent and know-
how rights in the U.S. and know-how rights in Canada, in exchange for
royalties based on sales. The compound citicoline is not covered by a
composition of matter patent. The licensed U.S. patent covering the
administration of citicoline to treat patients afflicted with certain
conditions associated with the inadequate release of brain acetylcholine
expires in 2003. As described in the licensed U.S. patent, the inadequate
release of acetylcholine may be associated with several disorders, including
the behavioral and neurological syndromes seen after brain traumas and
peripheral neuro-muscular disorders, and post-stroke rehabilitation. Although
the claim of the licensed patent is broadly directed to the treatment of
inadequate release of brain acetylcholine, there can be no assurance this
patent will afford protection against competitors of citicoline to treat
ischemic stroke.

  In June 1998, the Company amended the Ferrer Agreement to extend to January
31, 2002 the date upon which Ferrer may terminate the Ferrer Agreement if FDA
approval of citicoline is not obtained. The Ferrer Agreement provides for such
date to be extended for up to two years if the Company provides information to
Ferrer which tends to establish that the Company has carried out the steps for
obtaining such approval and that such approval has not been obtained for
reasons beyond the Company's control.

  In September and October 1998, two U.S. patents were granted to the Company
relating to the use of citicoline in the protection of brain tissue from
cerebral infarction following ischemic stroke. In June 1998, the Company
licensed worldwide rights (outside the U.S. and Canada) to corresponding
foreign patent applications to Ferrer. In exchange, the Company will be
entitled to royalties from Ferrer on certain exports and sales of the solid
oral form of citicoline in certain countries upon its approval in each country
in the territory licensed to Ferrer. In February 1999, a third U.S. patent was
granted to the Company relating to the use of citicoline in the protection of
brain tissue.

  In May 2000, the Company was awarded a U.S. patent, including claims
directed to a composition of matter, for a "hyperhydrated" form of citicoline.
It is believed that solid forms of citicoline, including tablets, have greater
stability when this hyperhydrated form of citicoline is present. The normal
term of this patent does not expire until 2018. The Company is also pursuing
foreign counterparts of this patent in Canada, China, all European countries
subscribing to the European Patent Convention, Hungary, Japan, Mexico and
Norway.

  In addition to any proprietary rights provided by such patents, the Company
anticipates that citicoline would be entitled to market exclusivity under the
Drug Price Competition and Patent Term Restoration Act of 1984 (commonly
referred to as the "Waxman-Hatch Act"). See "Agreements" and "Government
Regulation."

                                      11
<PAGE>

                                   PRO 2000

  General: PRO 2000 is under development as a topical microbicide to prevent
the sexual transmission of HIV and certain other disease-causing viruses and
bacteria. HIV infection usually leads to AIDS, a life-threatening impairment
of the immune system. The World Health Organization estimates that 4.7 million
new adult HIV infections were acquired worldwide in 1999, the majority through
heterosexual intercourse. Heterosexual contact has also become the most common
route of HIV infection in U.S. women. Other sexually transmitted diseases
("STDs") such as genital herpes, chlamydia and gonorrhea can lead to serious
complications, especially in women, and can increase the risk of HIV
infection. Based on estimates by The Kaiser Family Foundation and The World
Health Organization, there are 15 million new STD cases each year in the U.S.
and more than 340 million worldwide. Topical microbicides represent a new
class of protective substances that are designed to be applied vaginally
before sexual contact. Topical microbicides have the potential to offer an
appealing, female-controlled alternative to condoms, the only products
currently known to prevent HIV transmission.

  The Company believes that PRO 2000 is ideally suited for use as a topical
microbicide. Laboratory studies have shown that the drug is active against
HIV, herpes simplex virus, chlamydia and the bacteria that cause gonorrhea.
Moreover, in government-sponsored tests, vaginally applied PRO 2000 was shown
to be efficacious in a mouse model for genital herpes infection and a monkey
model for vaginal HIV infection. The product is also highly stable, odorless
and virtually colorless. PRO 2000 differs significantly from nonoxynol-9-
containing spermicides, which have failed to provide protection against HIV
infection in previous human clinical trials.

  Development Program: In October 2000, dosing and follow-up for a Phase
1/Phase 2 clinical trial of PRO 2000 vaginal gel was completed by the NIH at
sites in the U.S. and South Africa. This study was designed to assess safety
and acceptability in healthy, sexually active women and HIV-infected, sexually
abstinent women. No serious adverse events were reported, and a full analysis
of the data is underway. Previous Phase 1 studies conducted in Europe (with
support from the Medical Research Council of the United Kingdom) showed a
promising safety and acceptability profile for the drug in healthy, sexually
abstinent women. Phase 1 studies to evaluate the safety of male exposure are
planned for early 2001, and a European Commission-funded Phase 2 safety trial
in at-risk African women is scheduled to begin later in the year.

  Licensing and Proprietary Rights: In June 2000, the Company licensed
exclusive, worldwide rights from HDCI to develop and market PRO 2000 in
exchange for an up-front payment of $500,000, as well as future milestone
payments and royalties on net sales. The Company is responsible for all
remaining development and commercialization activities for PRO 2000. The
Company holds an exclusive license to all intellectual property relating to
PRO 2000, including four issued U.S. patents: one covering the composition of
matter, two covering the use of PRO 2000 to prevent or treat HIV infection,
and one covering the use of PRO 2000 to prevent pregnancy. A similar
contraception patent has also issued in South Africa. Composition and use
claims are under review in several other territories, including Europe,
Canada, and Japan. See "Agreements" and "Patents and Proprietary Rights--PRO
2000."

                       OTHER PRODUCTS UNDER DEVELOPMENT

  The Company is developing or has rights to a number of other products in
varying stages of development. These include the following:

  IP 501: During 1997, the Company obtained an option to negotiate an
exclusive license to a compound (designated by the Company as IP 501) for the
treatment and prevention of cirrhosis of the liver caused by alcohol and
hepatitis viruses. The option grants Interneuron the right to negotiate an
exclusive license in the United States, Canada, Japan and Korea to an issued
U.S. patent and pending Canadian and Japanese counterparts, following
Interneuron's review of data from a recently completed government-sponsored
Phase 3 clinical trial. Interneuron's rights to this compound are subject to
the negotiation and execution of a definitive

                                      12
<PAGE>

license agreement on terms to be agreed upon by the parties. This orally-
administered compound is being studied in a Phase 3 clinical study sponsored
by the Veterans Administration. The trial is complete and the Company is
expecting results in the first quarter of calendar 2001. The primary endpoint
of the study is improvement in liver histology, or condition, among drug-
treated pre-cirrhotic patients compared with placebo patients, as measured by
serial liver biopsies. If the trial is successful and the Company is able to
conclude a definitive licensing agreement to obtain IP 501, the Company will
be required to complete substantial additional development work prior to
filing an NDA for the compound. See "Agreements."

  PACAP: In April 1998, Interneuron licensed from Tulane University exclusive
worldwide rights to a U.S. patent and U.S. and foreign patent applications
owned by Tulane relating to a novel neuropeptide known as PACAP (pituitary
adenylate cyclase activating polypeptide). Limited pre-clinical data suggests
the potential of PACAP as a treatment for respiratory diseases, diabetes,
stroke and other neurodegenerative diseases. The Company is conducting pre-
clinical testing with PACAP and, depending upon the results, will determine
whether to conduct further studies.

  LidodexNS(TM): In December 1996, the Company entered into an agreement with
Endo Pharmaceuticals Holdings Inc., formerly Algos Pharmaceutical Corporation
("Endo"), for the development and commercialization of LidodexNS, a
combination of lidocaine and dextromethorphan, which may offer the potential
for relief of acute migraine headache through intranasal administration. The
Company has conducted and is evaluating certain pre-clinical studies, and is
determining whether to proceed with further development of LidodexNS.

  The Company does not have sufficient funds to commercialize any of the
foregoing products under development. Depending upon ongoing pre-clinical or
clinical test results, the Company may discontinue or defer development of any
or all of these potential products or seek a corporate collaboration in which
a third party assumes responsibility and funding for drug development,
manufacturing and marketing for any or all of them. See "Risk Factors--We will
rely on third parties to commercialize our products" and "Our failure to
acquire and develop additional product candidates will impair our ability to
grow."

                                 SUBSIDIARIES

  In the past, the Company had four subsidiary companies: Progenitor, Inc.
("Progenitor"), Transcell Technologies, Inc. ("Transcell"), InterNutria, Inc.
("InterNutria") and Incara Pharmaceuticals Corporation ("Incara"), formerly
Intercardia, Inc. Progenitor discontinued operations in December 1998 and
InterNutria discontinued operations in September 1998. Transcell was merged
into Incara in May 1998. In July 1999, the Company reduced its ownership of
Incara and increased its ownership interest in CPEC LLC ("CPEC"), previously a
majority-owned subsidiary of Incara, as described below.

  CPEC: On July 15, 1999, the Company entered into agreements and transactions
(the "CPEC Exchange Transactions") that resulted in Interneuron owning 65
percent of CPEC, which was developing BEXTRA(TM) (bucindolol), a non-selective
beta-blocker with mild vasodilating properties, for congestive heart failure.
In exchange, Interneuron returned to Incara approximately 4.2 million of the
4.5 million shares of Incara common stock owned by Interneuron. As a result of
the CPEC Exchange Transactions, the Company and Incara assumed 65 percent and
35 percent, respectively, of CPEC's funding requirements for any future
development of BEXTRA in the U.S. and Japan and would be entitled to 65
percent and 35 percent, respectively, of the profits and available cash of
CPEC. CPEC does not currently intend to conduct any further development work
on BEXTRA.

                          MANUFACTURING AND MARKETING

  General: The Company's ability to conduct clinical trials on a timely basis,
to obtain regulatory approvals and to commercialize its products will depend
in part upon its ability to manufacture its products, either directly or
through third parties, at a competitive cost and in accordance with applicable
FDA and other regulatory requirements, including cGMP regulations. The Company
has no manufacturing facilities or marketing capabilities. In general, the
Company intends to seek to contract with third parties to manufacture and
market products.

                                      13
<PAGE>

  To the extent the Company enters into collaborative arrangements with
pharmaceutical and other companies for the manufacturing or marketing of
products, these collaborators are generally expected to be responsible for
funding or reimbursing all or a portion of the development costs, including
the costs of clinical testing necessary to obtain regulatory clearances, and
for commercial-scale manufacturing and marketing. These collaborators are
expected to be granted exclusive or semi-exclusive rights to sell specific
products in exchange for license fees, milestone payments, royalties, equity
investments or other financial consideration. Accordingly, the Company will be
dependent on such third parties for the manufacturing and marketing of
products subject to the collaboration. There can be no assurance the Company
will be able to obtain or retain third-party manufacturing and marketing
collaborations on acceptable terms, or at all, which may delay or prevent the
commercialization of products under development. Such collaborative
arrangements could result in lower revenues and profit margins than if the
Company marketed a product itself. In the event the Company determines to
establish its own manufacturing or marketing capabilities, it would require
substantial additional funds. See "Risk Factors--We will rely on third parties
to commercialize our products."

  Citicoline: As a result of Takeda's termination of the Takeda Agreement, and
in the event citicoline is further developed, the Company will be dependent
upon third party suppliers of citicoline bulk compound, finished product and
packaging for manufacturing in accordance with cGMP regulations, and will be
dependent on third parties for the marketing and distribution of citicoline.
Supplies of citicoline finished product used for clinical purposes have been
produced on a contract basis by third party manufacturers. The Ferrer
Agreement requires the purchase from Ferrer of citicoline bulk compound for
commercial purposes. If such conditions permit the purchase of bulk compound
from a third party, the Company entered into an agreement with a manufacturer
to supply citicoline bulk compound for commercial purposes. See "Risk
Factors--We will depend on third parties to commercialize our products."

  Pagoclone: Under the Pfizer Agreement, Pfizer is responsible for the
manufacturing and marketing of pagoclone. The Company will be dependent upon
Pfizer for manufacturing bulk compound and finished product and packaging in
accordance with cGMP regulations, and will be dependent on Pfizer for the
marketing and distribution of pagoclone. Any pagoclone manufacturing
facilities will be subject to FDA inspections. See "Risk Factors--We will
depend on Pfizer to develop, manufacture and market pagoclone."

  Trospium: Under the Madaus Agreement, Interneuron is responsible for all
clinical development and regulatory activities and costs related to trospium
in the U.S. Interneuron anticipates that Madaus will manufacture the product,
provided that it can deliver acceptable product to satisfy the U.S. market
requirements. Interneuron has the option to seek a second source supplier to
satisfy these requirements in the event that Madaus is unable to do so.
Interneuron is responsible for the commercialization and marketing of trospium
in the U.S. either independently or through marketing partners.

  PRO 2000: The Company is responsible for providing adequate amounts of PRO
2000 for use in government-sponsored clinical trials. It will be dependent
upon third-party contractors for the manufacture and delivery of these
supplies in accordance with cGMP regulations. The Company intends to seek a
partner for commercial manufacture, marketing and distribution of the product.

                                  COMPETITION

  General: The pharmaceutical industry is characterized by rapidly evolving
technology and intense competition. Many companies, including major
pharmaceutical companies and specialized biotechnology companies, are engaged
in marketing or development of products and therapies similar to those being
pursued by the Company. Many of the Company's competitors have substantially
greater financial and other resources, larger research and development staffs
and significantly greater experience in conducting clinical trials and other
regulatory approval procedures and manufacturing and marketing pharmaceutical
products than the Company. In the event the Company or its licensees market
any products, they will compete with companies with well-established
distribution networks and market position. Additional mergers and acquisitions
in the pharmaceutical industry may result in even more resources being
concentrated in the Company's competitors.

                                      14
<PAGE>

  There can be no assurance that currently marketed products, or products
under development or introduced by others will not adversely affect sales of
any products developed by the Company, render the Company's products or
potential products obsolete or uneconomical 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 products
or technologies. Other companies may succeed in developing and commercializing
products earlier than the Company or which are safer and more effective than
those under development by the Company. Advances in current treatment methods
may also adversely affect the market for such products. The approval and
introduction of therapeutic or other products that compete with products being
developed by the Company could also adversely affect the Company's ability to
attract and maintain patients in clinical trials for the same indication or
otherwise successfully complete its clinical trials. Further, certain of
Interneuron's agreements provide for reduced royalties in the event of generic
competition.

  Colleges, universities, governmental agencies and other public and private
research organizations continue to conduct research and are becoming more
active in seeking patent protection and licensing arrangements to collect
royalties for use of technology that they have developed, some of which may be
directly competitive with those of the Company. In addition, these
institutions may compete with the Company in recruiting qualified scientific
personnel. The Company expects technological developments in its fields of
product development to occur at a rapid rate and expects competition to
intensify as advances in these fields are made. See "Risk Factors--Our
products may be unable to compete successfully with other products."

  Pagoclone: Current pharmacological treatments for anxiety and panic
disorders generally include benzodiazepines, such as Valium and Xanax,
serotonin agonists such as BuSpar, and selective serotonin reuptake inhibitors
such as Paxil, Zoloft, Prozac, and Effexor. Traditional side effects seen with
these classes of anti-anxiety drugs include sedation, lack of mental acuity,
withdrawal and rebound anxiety related to the benzodiazepine class of drugs,
and agitation, insomnia and sexual dysfunction related to serotonin reuptake
inhibitors. The results of the Company's Phase 2/3 trial including 277
patients indicated that pagoclone was well tolerated, with no evidence of
sedation and no apparent withdrawal symptoms. In addition, the Company is
aware of competitors which market certain prescription drugs for indications
other than anxiety who are planning to seek an expansion of labeling to
include anxiety as an indication. The Company is aware that other companies
are developing compounds for anxiety that are in pre-clinical or clinical
development.

  Trospium: Current therapy for overactive bladder includes anticholinergics,
such as Detrol by Pharmacia & Upjohn Company, Inc. and Ditropan and Ditropan
XL by ALZA Corporation. In addition, the Company is aware of other companies
evaluating in pre-clinical and clinical development specific antimuscaranics
and antispasmodics for overactive bladder. Pre-clinical data with trospium
suggests that it does not enter the central nervous system and thus may have a
side effect profile preferable to currently available agents. In addition,
clinical data and commercial experience reflect favorable efficacy and safety
profiles.

  Citicoline: Activase, marketed by Genentech, Inc. for the treatment of acute
ischemic stroke within three hours of symptom onset, is the first therapy to
be indicated for the management of stroke. Activase is a genetically
engineered version of the naturally occurring tissue plasminogen activator (t-
PA). The Company is aware of certain drugs under development for stroke that
did not achieve positive results in announced clinical trials and other drugs
under development for stroke that are currently in clinical trials, including
clomethiazole by AstraZeneca Pharmaceuticals, Gavestinel by Glaxo Wellcome
plc, Ancrod by BASF Pharma/Knoll AG, ReoPro by Lilly Research
Laboratories/Centocor, Inc., BMS204352 by Bristol-Myers Squibb Company, pro-
urokinase by Abbott Laboratories, Repinotan by Bayer and LeukArrest by ICOS
Corp.

  PRO 2000: No comparable product to prevent sexually transmitted infections
has been approved for use in the U.S., Europe or Japan. Marketed vaginal
spermicides containing the detergent nonoxynol-9 have been found to be
ineffective at reducing HIV transmission, and may actually increase the risk
of infection. Approximately 60 new substances are being evaluated for this
indication, but the Company believes only a few have reached the stage of
development of PRO 2000. These include BufferGel by Reprotect, LLC, Savvy by
Biosyn, Inc., Emmelle by ML Laboratories, PLC, Carraguard by The Population
Council, and cellulose sulfate gel by The CONRAD Program.

                                      15
<PAGE>

                                  AGREEMENTS

  Pagoclone: In December 1999, the Company entered into an agreement with the
Warner-Lambert Company (now Pfizer) under which the Company licensed to Pfizer
exclusive, worldwide rights to develop and commercialize pagoclone. To date
under the Pfizer Agreement, the Company has received $16,750,000, including an
up-front payment of $13,750,000, and is entitled to receive up to an
additional $57,000,000 in payments contingent upon the achievement of clinical
and regulatory milestones, as well as royalties on net sales. Under the Pfizer
Agreement, Pfizer is responsible for conducting and funding all further
clinical development, regulatory review, manufacturing and marketing of
pagoclone on a worldwide basis. Pfizer has the right to terminate the Pfizer
Agreement on not less than six months written notice to Interneuron and in
certain other circumstances. The parties have also agreed to indemnify one
another under certain circumstances.

  In February 1994, the Company licensed from Aventis exclusive, worldwide
rights for the manufacture, use and sale of pagoclone under patent rights and
know-how related to the drug, except that Interneuron granted Aventis an
option to sublicense from Interneuron, under certain conditions, rights to
market pagoclone in France. In exchange, the Company paid Aventis a license
fee and agreed to make milestone payments based on clinical and regulatory
developments, and to pay royalties based on net sales. This license agreement
may be terminated in certain circumstances such as material breach or
insolvency. Unless earlier terminated, the license ends with respect to each
country in the territory upon the expiration of the last to expire applicable
patent in that country. The Company agreed to conduct at its expense and be
responsible for all clinical trials with respect to pagoclone and all related
products for use in clinical trials. The license grants the Company the right
to grant sublicenses on a worldwide basis, subject to Aventis' written
approval of the sublicensee, which approval shall not be unreasonably
withheld. In connection with the Pfizer Agreement, Aventis consented to the
sublicense to Pfizer and Interneuron and Aventis amended certain provisions of
the agreement between Aventis and Interneuron. In connection with Aventis'
consent, Interneuron agreed that in the event Aventis exercises its option to
sublicense pagoclone in France, Interneuron has an obligation to supply
Aventis with all of its requirements for pagoclone, and Pfizer has agreed to
assume such obligation as long as the Pfizer Agreement remains in effect.
Interneuron agreed to indemnify Aventis against claims and other damages
resulting from the testing, manufacture, use and sale of pagoclone and is
required to maintain product liability insurance.

  Trospium: In November 1999, the Company entered into the Madaus Agreement
under which it licensed from Madaus exclusive U.S. rights to develop and
market trospium, an orally-administered prescription drug product currently
marketed as a treatment for overactive bladder in Europe. In exchange, the
Company has agreed to pay Madaus regulatory milestone, royalty and sales
milestone payments. Interneuron is responsible for all clinical development
and regulatory activities and costs related to the compound in the United
States. Pursuant to the Madaus Agreement, Madaus is required to manufacture
the product, provided certain conditions are met.

  Citicoline: In December 1999, the Company entered into the Takeda Agreement
under which the Company licensed to Takeda exclusive rights to commercialize
citicoline in the U.S. and Canada. Under the Takeda Agreement, the Company
received $13,000,000 in licensing and other payments, and was entitled to
receive up to $60,000,000 in payments contingent upon the achievement of
regulatory milestones in the U.S. and Canada, as well as royalties on net
sales.

  Takeda recently notified the Company of its decision not to participate in
the further development of citicoline, thereby terminating the Takeda
Agreement. Therefore, the Company has reacquired all rights to this compound.
Takeda has indicated that it will exercise its option under the Takeda
Agreement to negotiate a license in the U.S. and Canada for a back-up compound
from the Company. The compounds which are currently available for
consideration by Takeda are IP 501, PRO 2000, PACAP, and LidodexNS. Takeda
shall have until April 1, 2001 (the "Negotiation Period") to evaluate and
select a back-up compound and to negotiate the terms of a license agreement
with respect to such compound with the Company. In the event that the parties
are unable to enter into a license agreement upon completion of the
Negotiation Period, for a period of six months following the end of the
Negotiation Period, the Company may not offer the compound selected by Takeda
to any other

                                      16
<PAGE>

party on terms more favorable than those offered to Takeda without first re-
offering such compound to Takeda on such new terms. "See Risk Factors--We may
not be able to collaborate with third parties to commercialize certain other
products due to the existence of the Takeda option."

  The Company granted to Takeda a security interest in its patents relating to
citicoline, and in the event Takeda licenses a back-up compound, the Company
agreed to grant Takeda a security interest in the patents relating to such
back-up compound. The security interest would be released if the Company
achieves certain financial criteria.

  In January 1993, the Company entered into the Ferrer Agreement, granting the
Company the exclusive right to make, use and sell any products or processes
developed under patent rights relating to certain uses of citicoline in
exchange for an up-front license fee and royalties based on sales. The
Company's license includes patent and know-how rights in the U.S. and know-how
rights in Canada, and is for a period co-extensive with Ferrer's license from
the Massachusetts Institute of Technology ("MIT"). The Ferrer Agreement
provides that Ferrer may terminate the agreement under certain circumstances,
including the insolvency or bankruptcy of Interneuron, in the event more than
50% of the ownership of Interneuron is transferred to a non-affiliated third
party or in the event FDA approval of citicoline is not obtained by January
31, 2002. The Ferrer Agreement provides for such date to be extended for up to
two years if the Company provides information to Ferrer which tends to
establish that the Company has carried out the steps for obtaining such
approval and if such approval has not been obtained for reasons beyond the
Company's control. The Ferrer Agreement requires Interneuron to use diligent
efforts to obtain regulatory approval.

  In June 1998, the Company licensed to Ferrer worldwide rights, except in the
U.S. and Canada, to the Company's patent rights relating to the use of
citicoline in the protection of brain tissue from cerebral infarction
following ischemic stroke. In exchange, the Company will be entitled to
royalties from Ferrer on certain exports to, and sales of, the solid oral form
of citicoline in certain countries upon its approval in each country. See
"Patents and Proprietary Rights--Citicoline."

  PRO 2000: In June 2000, the Company licensed exclusive worldwide rights from
HDCI to develop and market PRO 2000, a candidate topical microbicide used to
prevent infection by HIV and other sexually transmitted pathogens, in exchange
for an up front payment of $500,000, future milestone payments, and royalties
on net sales. The Company is responsible for all remaining development and
commercialization activities for PRO 2000.

  IP 501: In March 1997, the Company obtained an option to negotiate an
exclusive license to a compound (designated by the Company as IP 501) for the
treatment and prevention of cirrhosis of the liver caused by alcohol and
hepatitis viruses from Dr. Charles S. Lieber. The option grants Interneuron
the right to negotiate an exclusive license in the United States, Canada,
Japan and Korea, to an issued U.S. patent and pending Canadian and Japanese
counterparts, following Interneuron's review of data from a recently completed
government-sponsored Phase 3 clinical trial. Interneuron's rights to this
compound are subject to the negotiation and execution of a definitive license
agreement on terms to be agreed upon by the parties. Dr. Lieber has the right
to terminate the option agreement on the earlier of March 9, 2001 or 90 days
from the date that final results of the Phase 3 trial are received by
Interneuron.

  PACAP: In April 1998, the Company licensed from Tulane University exclusive,
worldwide rights to a U.S. patent and U.S. and foreign patent applications
owned by Tulane relating to a novel neuropeptide, known as PACAP (pituitary
adenylate cyclase activating polypeptide). Limited pre-clinical data suggests
the potential of PACAP as a treatment for respiratory diseases, diabetes,
stroke and other neurodegenerative diseases. Under terms of the license, the
Company paid Tulane an up-front licensing fee, and agreed to fund research
over a two-year period, make additional payments based on the achievement of
clinical and regulatory review milestones and to pay Tulane royalties on net
sales of any product developed from this program.

                                      17
<PAGE>

  LidodexNS: In December 1996, the Company entered into an agreement with Endo
for the development and commercialization of a combination pharmacological
product known as LidodexNS, which may offer the potential for relief of acute
migraine headache through intranasal administration. The agreement establishes
a multi-stage development collaboration between Endo and Interneuron and
licenses to Interneuron rights, co-exclusive with Endo, to manufacture and
market the combined agent. This collaboration will include certain pre-
clinical studies, clinical trials and regulatory review activities overseen by
a joint steering committee. The companies agreed to share in the marketing and
profits of LidodexNS.

  Sarafem: In June 1997, the Company licensed to Lilly worldwide, exclusive
rights to Interneuron's patents for the use of fluoxetine to treat certain
conditions and symptoms associated with PMS (the "Lilly Agreement"). In July
2000, Lilly received approval for fluoxetine to treat PMDD and has begun
marketing the drug under the trade name Sarafem. The Lilly Agreement provides
for milestone payments and royalties based on net sales in the United States.
The maximum aggregate royalty payments to Interneuron in any calendar year
ranges from approximately three to five million dollars and are conditioned
upon the achievement of net sales in the United States above an annually
escalating baseline. Royalties to the Company will terminate at the end of the
first two consecutive quarters in which 70% or less of total Prozac
prescriptions are "dispensed as written." Based on a recent federal court of
appeals ruling, Lilly's composition of matter patent on fluoxetine will expire
in the summer of 2001. Lilly has announced their intention to appeal the
decision. If Lilly's appeal is not successful, potential royalty payments to
the Company under the Lilly Agreement may expire in early 2002. The patent
rights to the use of fluoxetine in treating PMS are licensed by the Company
from MIT. MIT is entitled to a portion of all payments, including royalties,
made to Interneuron by Lilly.

Redux Agreements (See Item 3. Legal Proceedings.)

  Servier Agreements: In February 1990, the Company and Les Labortoires
Servier ("Servier") entered into agreements, subsequently amended (the
"Servier Agreements"), granting the Company an exclusive right to market
dexfenfluramine in the U.S. to treat obesity associated with abnormal
carbohydrate craving. The agreements provide for royalties on net sales, with
certain required minimum royalties. Servier has the right to terminate the
license agreement upon the occurrence of certain events. Interneuron agreed to
indemnify Servier under certain circumstances and Interneuron was required to
name Servier as an additional insured on its product liability insurance
policies. See "Risk Factors--The outcome of the Redux litigation could
materially harm us" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

  AHP Agreements: In November 1992, the Company entered into a series of
agreements (the "AHP Agreements") which granted American Cyanamid Company the
exclusive right to manufacture and market dexfenfluramine in the U.S. for use
in treating obesity associated with abnormal carbohydrate craving, with the
Company retaining co-promotion rights. In 1994, AHP acquired American Cyanamid
Company. The AHP Agreements are for a term of 15 years commencing on the date
dexfenfluramine is first commercially introduced by AHP, subject to earlier
termination. AHP has the right to terminate the AHP Agreements upon 12 months
notice to the Company.

  Effective June 1996, the Company entered into a three-year copromotion
agreement with Wyeth-Ayerst Laboratories ("Wyeth-Ayerst"), an AHP company (the
"Copromotion Agreement"). The Copromotion Agreement provided for Interneuron
to promote Redux to certain diabetologists, endocrinologists, bariatricians
and weight management specialists, subject to certain restrictions, and
receive payments from AHP for a portion of the Company's actual costs.
Interneuron was also entitled to varying percentages of profit derived from
sales generated by its sales force, after deducting certain costs.

  Under the AHP Agreements, under certain circumstances, the Company is
required to indemnify AHP, and the Company is entitled to indemnification by
AHP against certain claims, damages or liabilities incurred in connection with
Redux. The cross indemnification between the Company and AHP generally relates
to the activities and responsibilities of each company. See "Risk Factors--The
outcome of the Redux litigation could materially harm us."

                                      18
<PAGE>

  Boehringer: In November 1995, the Company entered into a manufacturing
agreement with Boehringer Ingelheim Pharmaceuticals, Inc. ("Boehringer") under
which Boehringer agreed to supply, and the Company agreed to purchase, all of
the Company's requirements for Redux capsules. The contract contained certain
minimum purchase, insurance and indemnification commitments by the Company and
required conformance by Boehringer to the FDA's Good Manufacturing Practices
regulations.

                        PATENTS AND PROPRIETARY RIGHTS

  Pagoclone: Interneuron licensed from Aventis rights under U.S. and foreign
patents and patent applications covering compositions of matter, processes,
and metabolites of pagoclone. A U.S. composition of matter patent was issued
in October 1990 and four related U.S. patents were issued in February and
March 1996 and February and October 1997. Interneuron sublicensed to Pfizer
worldwide rights to these patents.

  Trospium: The compound trospium is not covered by a composition of matter
patent. Along with know how, Interneuron licensed from Madaus two U.S.
patents, one of which relates to a process for manufacturing trospium and the
other relates to the use of trospium to treat certain asthmatic conditions.
These patents were issued in August 1989 and October 1988, respectively. The
commercialization of trospium by the Company will not utilize these patents,
and the Company intends to rely on the provisions of the Waxman-Hatch Act to
obtain a period of market exclusivity in the U.S., if the FDA approves
trospium in the U.S. for the intended indication, although there is no
assurance that market exclusivity will be granted. The Waxman-Hatch Act
establishes a period of time from the date of FDA approval of certain new drug
applications during which the FDA may not accept or approve short-form
applications for generic versions of the drug from other sponsors, although it
may accept or approve long-form applications (that is, another NDA supported
by pivotal studies) for such drug. The applicable period is five years in the
case of drugs containing an active ingredient not previously approved.

  Citicoline: The compound citicoline is not covered by a composition of
matter patent. Pursuant to the Ferrer Agreement, Interneuron licensed from
Ferrer a U.S. patent covering the administration of citicoline to treat
patients afflicted with conditions associated with the inadequate release of
brain acetylcholine, which expires in 2003. As described in the licensed
patent, the inadequate release of acetylcholine may be associated with several
disorders, including the behavioral and neurological syndromes seen after
brain traumas and peripheral neuro-muscular disorders and post-stroke
rehabilitation. Although the claim of the licensed patent is broadly directed
to the treatment of inadequate release of brain acetylcholine, there can be no
assurance this patent will afford protection against competitors of citicoline
to treat ischemic stroke.

  U.S. patents were issued to Interneuron in September and October 1998 and in
February 1999 relating to use of citicoline in the protection of brain tissue
from cerebral infarction following ischemic stroke. The Company licensed
worldwide rights to these patents to Ferrer, except in the U.S. and Canada, in
exchange for which the Company will be entitled to royalties from Ferrer on
certain exports and sales of the solid oral form of citicoline in certain
countries upon its approval in each country. Additional domestic and
international patent applications have been filed by the Company.

  In addition to any proprietary rights provided by these patents, the Company
intends to rely on the provisions of the Waxman-Hatch Act to obtain a period
of marketing exclusivity in the U.S., if the FDA approves citicoline for
marketing in the U.S., although there is no assurance market exclusivity will
be granted. See "Risk Factors--We may depend on market exclusivity for
trospium and other products."

  In May 2000, the Company was awarded a U.S. patent, including claims
directed to a composition of matter, for a "hyperhydrated" form of citicoline.
It is believed that solid forms of citicoline, including tablets, have greater
stability when this hyperhydrated form of citicoline is present. The normal
term of this patent does not expire until 2018. The Company is also pursuing
foreign counterparts of this patent in Canada, China, all European countries
subscribing to the European Patent Convention, Hungary, Japan, Mexico and
Norway.

                                      19
<PAGE>

  PRO 2000: The Company holds an exclusive license to all intellectual
property relating to PRO 2000, including four issued U.S. patents: one
covering the composition of matter, two covering the use of PRO 2000 to
prevent or treat HIV infection, and one covering the use of PRO 2000 to
prevent pregnancy. A similar contraception patent has also issued in South
Africa. Composition and use claims are under review in several other
territories, including Europe, Canada, and Japan.

  IP 501: Interneuron has an option to negotiate an exclusive license to a
U.S. patent issued on February 8, 1994, relating to a phospholipid found in
lecithin (IP 501). Three claims of this patent relate to methods of preventing
or treating liver cirrhosis in mammals by administering an effective amount of
the compound. Japanese and Canadian counterparts are pending.

  PACAP: Under its agreement with Tulane University, the Company has rights
under a U. S. patent and patent applications, owned by Tulane or co-owned by
Tulane and Takeda, which are directed to PACAP polypeptides, their
compositions and methods of use for the treatment or prevention of brain
damage. The Company also has rights under a number of European, Canadian and
Japanese counterparts of these domestic patents and patent applications, which
counterparts were filed generally in 1990.

  General: There can be no assurance that patent applications filed by the
Company or others, in which the Company has an interest as assignee, licensee
or prospective licensee, will result in patents being issued or that, if
issued, any of such patents will afford protection against competitors with
similar technology or products, or could not be circumvented or challenged. In
addition, certain products the Company is developing are not covered by any
patents and, accordingly, the Company will be dependent on obtaining market
exclusively under the Waxman-Hatch Act for such products. If the Company is
unable to obtain strong proprietary rights protection of its products after
obtaining regulatory clearance, competitors may be able to market competing
generic products by obtaining regulatory clearance, by demonstrating
equivalency to the Company's product, without being required to conduct the
lengthy clinical tests required of the Company. Certain of the Company's
agreements provide for reduced royalties in the event of generic competition.
See "Risk Factors--We may depend on market exclusivity for trospium and other
products."

  The products being developed by the Company may conflict with patents which
have been or may be granted to competitors, universities or others. Third
parties could bring legal actions against the Company claiming patent
infringement and seeking damages or to enjoin manufacturing and marketing of
the affected product or the use of a process for the manufacture of such
products. If any such actions are successful, in addition to any potential
liability for damages and attorneys fees in certain cases, the Company could
be required to obtain a license, which may not be available, in order to
continue to manufacture or market the affected product or use the affected
process. The Company also relies upon unpatented proprietary technology and
may determine in some cases that its interest would be better served by
reliance on trade secrets or confidentiality agreements rather than patents.
No assurance can be made that others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to such proprietary technology or disclose such technology or that
the Company can meaningfully protect its rights in such unpatented proprietary
technology. The Company may also conduct research on other pharmaceutical
compounds or technologies, the rights to which may be held by, or be subject
to, patent rights of third parties. Accordingly, if products based on such
technologies are commercialized, such commercial activities may infringe such
patents or other rights which would require the Company to obtain a license to
such patents or other rights. See "Risk Factors--We have limited patent
protection on our products."

                             GOVERNMENT REGULATION

  Therapeutics: The Company's products will require, prior to
commercialization, regulatory clearance by the FDA and by comparable agencies
in most foreign countries. The nature and extent of regulation differs with
respect to different products. In order to test, produce and market certain
therapeutic products in the United States, mandatory procedures and safety
standards, approval processes, and manufacturing and marketing practices
established by the FDA must be satisfied.

                                      20
<PAGE>

  An IND is required before human clinical use in the United States of a new
drug compound or biological product can commence. The IND includes results of
pre-clinical (animal) studies evaluating the safety and efficacy of the drug
and a detailed description of the clinical investigations to be undertaken.

  Clinical trials are normally done in three phases, although the phases may
overlap. Phase 1 trials are concerned primarily with the safety and
preliminary effectiveness of the product. Phase 2 trials are designed
primarily to demonstrate effectiveness in treating the disease or condition
for which the product is limited, although short-term side effects and risks
in people whose health is impaired may also be examined. Phase 3 trials are
expanded clinical trials intended to gather additional information on safety
and effectiveness needed to clarify the product's benefit-risk relationship,
discover less common side effects and adverse reactions, and generate
information for proper labeling of the drug, among other things. The FDA
receives reports on the progress of each phase of clinical testing and may
require the modification, suspension or termination of clinical trials if an
unwarranted risk is presented to patients. When data is required from long-
term use of a drug following its approval and initial marketing, the FDA can
require Phase 4, or post-marketing, studies to be conducted.

  With certain exceptions, once successful clinical testing is completed, the
sponsor can submit an NDA for approval of a drug. The process of completing
clinical trials for a new drug is likely to take a number of years and require
the expenditure of substantial resources. There can be no assurance that the
FDA or any foreign health authority will grant an approval on a timely basis,
or at all. The FDA may deny an NDA, in its sole discretion, if it determines
that its regulatory criteria have not been satisfied or may require additional
testing or information. Among the conditions for marketing approval is the
requirement that the prospective manufacturer's quality control and
manufacturing procedures conform to cGMP regulations. In complying with
standards set forth in these regulations, manufacturers must continue to
expend time, money and effort in the area of production, quality control and
quality assurance to ensure full technical compliance. Manufacturing
facilities, both foreign and domestic, also are subject to inspections by, or
under the authority of, the FDA and by other federal, state, local or foreign
agencies.

  Even after initial FDA or foreign health authority approval has been
obtained, further studies, including Phase 4 post-marketing studies, may be
required to provide additional data on safety and will be required to gain
approval for the use of a product as a treatment for clinical indications
other than those for which the product was initially tested. Also, the FDA or
foreign regulatory authority will require post-marketing reporting to monitor
the side effects of the drug. Results of post-marketing programs may limit or
expand the further marketing of the products. Further, if there are any
modifications to the drug, including any change in indication, manufacturing
process, labeling or manufacturing facility, an application seeking approval
of such changes may be required to be submitted to the FDA or foreign
regulatory authority. See "Risk Factors--If we fail to comply with government
regulations it could negatively affect our business."

  Patent Term Extension and Market Exclusivity: Under the Waxman-Hatch Act, a
patent which claims a product, use or method of manufacture covering drugs and
certain other products may be extended for up to five years to compensate the
patent holder for a portion of the time required for development and FDA
review of the product. The Waxman-Hatch Act also establishes periods of market
exclusivity, which are various periods of time following approval of a drug
during which the FDA may not approve, or in certain cases even accept,
applications for certain similar or identical drugs from other sponsors unless
those sponsors provide their own safety and effectiveness data.

  The Company believes that citicoline may be entitled to patent extension and
that trospium and citicoline may be entitled to five years of market
exclusivity under the Waxman-Hatch Act. However, there can be no assurance
that the Company will be able to take advantage of either the patent term
extension or marketing exclusivity provisions or that other parties will not
challenge the Company's rights to such patent extension or market exclusivity.

                                      21
<PAGE>

  Other: The Federal Food, Drug, and Cosmetic Act, the Public Health Service
Act, the Federal Trade Commission Act, and other federal and state statutes
and regulations govern or influence the research, testing, manufacture,
safety, labeling, storage, record keeping, approval, advertising and promotion
of drug, biological, medical device and food products. Noncompliance with
applicable requirements can result in, among other things, fines, recall or
seizure of products, refusal to permit products to be imported into the U.S.,
refusal of the government to approve product approval applications or to allow
Interneuron to enter into government supply contracts, withdrawal of
previously approved applications and criminal prosecution. The FDA may also
assess civil penalties for violations of the Federal Food, Drug, and Cosmetic
Act involving medical devices. The Federal Trade Commission may assess civil
penalties for violations of the requirement to rely upon a "reasonable basis"
for advertising claims for non-prescription and food products.

               REDUX WITHDRAWAL (See Item 3. Legal Proceedings)

  On September 15, 1997, the Company announced a market withdrawal of its
first prescription product, the weight loss medication Redux (dexfenfluramine
hydrochloride capsules) C-IV, which had been launched by AHP, the Company's
licensee, in June 1996. Since the withdrawal of Redux, Interneuron has been
named, together with other pharmaceutical companies, as a defendant in
approximately 3,200 product liability legal actions, some of which purport to
be class actions, in federal and state courts involving the use of Redux and
other weight loss drugs. To date, there have been no judgments against the
Company, nor has Interneuron paid any amounts in settlement of any of these
claims. Following the dismissal and the anticipated dismissal of Interneuron
as a defendant in certain cases, the Company estimates that there will be
approximately 2,300 active cases. In January 2000, the Company filed suit
against AHP for fraud, misrepresentation and breach of contract seeking
unspecified but substantial damages. For a more detailed description of the
background and current status of the Company's legal proceedings regarding
Redux, see Item 3. Legal Proceedings.

  Background; Regulatory Approval, Labeling and Safety Issues: Redux
(dexfenfluramine) is chemically related to Pondimin (fenfluramine).
Fenfluramine is a drug made up of two mirror-image halves--a "right-handed"
half (d-isomer) and "left-handed" half (l-isomer)--and dexfenfluramine is the
right-handed isomer of fenfluramine (the left-handed half is
"levofenfluramine"). Dexfenfluramine alone is a separate drug from the
combined dexfenfluramine/levofenfluramine molecule that is fenfluramine.

  Redux received clearance on April 29, 1996 by the FDA for marketing as a
twice-daily prescription therapy to treat obesity and was launched in June
1996. Until its withdrawal, under license and copromotion agreements, Redux
was marketed in the U.S. by Wyeth-Ayerst and copromoted by the Company.

  Included in the FDA-approved labeling for Redux were references to certain
risks that may be associated with dexfenfluramine and which were highlighted
during the FDA's review of the drug. One issue related to whether there is an
association between appetite suppressants, including dexfenfluramine, and the
development of primary pulmonary hypertension ("PPH"), a rare but serious lung
disorder estimated to occur in the general population at one to two cases per
million adults per year. An epidemiologic study conducted in Europe known as
IPPHS (International Primary Pulmonary Hypertension Study) examined risk
factors for PPH and showed that among other factors, weight reduction drugs,
including dexfenfluramine, and obesity itself were associated with a higher
risk of PPH. In the final report of IPPHS, published in The New England
Journal of Medicine (August 29, 1996), the authors re-classified and included
certain previously excluded cases of PPH, resulting in an increase in the
estimated yearly occurrence of PPH for patients taking appetite suppressants
for greater than three months' duration to be between 23 and 46 cases per
million patients per year. The revised labeling for Redux disclosed this
revised estimate.

  The FDA-approved labeling for Redux also included discussion as to whether
dexfenfluramine is associated with certain neurochemical changes in the brain.
Certain studies conducted by third parties related to this issue purport to
show that very high doses of dexfenfluramine cause prolonged serotonin
depletion in certain animals, which some researchers believe is an indication
of neurotoxicity. In connection with the approval of Redux, the

                                      22
<PAGE>

Company and Wyeth-Ayerst had agreed with the FDA to conduct a Phase 4, or
post-marketing, study with patients taking Redux. Following the withdrawal of
Redux, this study was terminated.

  In July 1997, the Mayo Clinic reported observations of heart valve
abnormalities in 24 patients taking the combination of fenfluramine and
phentermine (commonly referred to as the "fen-phen" combination). The Mayo
Clinic cases were subsequently reported in an article appearing in the August
28, 1997 issue of The New England Journal of Medicine. This article was
accompanied by a letter to the editor from the FDA reporting additional cases
of heart valve disease in 28 patients taking the combination of phentermine
and fenfluramine, two patients taking fenfluramine alone, four patients taking
Redux alone and two patients taking Redux and phentermine.

  The withdrawal of Redux was based on a preliminary analysis by the FDA of
potential abnormal echocardiogram findings associated with certain patients
taking Redux or the combination of fenfluramine with phentermine. These
observations, presented to the Company in September 1997, indicated an
incidence of approximately 30%. Although these observations reflected a
preliminary analysis of pooled information and were difficult to evaluate
because of the absence of matched controls and pretreatment baseline data for
these patients, the Company believed it was prudent, in light of this
information, to have withdrawn Redux from the market.

  Additional adverse event reports of abnormal heart valve findings in
patients using Redux or fenfluramine alone or in combination with other weight
loss agents continue to be received by Interneuron, Wyeth-Ayerst, and the FDA.
These reports have included symptoms such as shortness of breath, chest pain,
fainting, swelling of the ankles or a new heart murmur.

  Subsequent Clinical Studies: Subsequent to the withdrawal of Redux, a number
of studies have been conducted by third parties, including Wyeth-Ayerst, and
one study was conducted by Interneuron, to assess the differences in
cardiovascular clinical outcomes between patients who had taken Redux or the
fen-phen combination, compared to an untreated group. In general, these
studies were conducted and analyzed by independent panels of cardiologists to
compare the incidence of significant heart valve abnormalities in treated
compared to non-treated groups. Patients were selected and assigned to these
groups randomly. Readings of patient echocardiograms have generally been made
on a blinded basis by cardiologists who do not know from which group
individual echocardiograms were taken. Findings of these studies have been
presented or reported by their respective third party sponsors or researchers.
Based on the results of studies announced to date, the incidence of cardiac
valve abnormalities has been shown to be less than that suggested by the
original FDA preliminary analysis. In general, these studies have shown either
no or relatively small differences, although in some cases statistically
significant, between the incidence of cardiac valve abnormalities, as defined
by the FDA, among patients who took Redux and placebo-treated patients and
that the incidence of such abnormalities among Redux patients was less than
previously reported estimates. Findings from these studies differ with regard
to the strength and clinical significance of the association. Differences in
trial design preclude precise comparison. A summary of the results of the
study sponsored by the Company follows.

  Interneuron Sponsored Clinical Study: Preliminary results of a blinded,
matched control group, multi-center clinical study sponsored by the Company
and presented on November 10, 1998 at the Scientific Sessions of the American
Heart Association showed a low overall incidence of FDA-defined cardiac valve
abnormalities among 223 patients who took Redux for three months or longer
when compared to 189 individuals who had not taken Redux. Final results were
published in the November 23, 1999 issue of Circulation. No severe and very
few moderate cases of valvular regurgitation were found in either Redux
patients or non-Redux subjects. The incidence of cardiac valve abnormalities
among Redux patients reported in this study, although statistically
significant, was far less than some previously reported estimates.

  The average duration of Redux use among all Redux patients in this study was
approximately seven months. The study was designed to evaluate the impact of
long-term use of Redux alone upon the incidence of cardiac valve disease as
defined by the FDA. Market research data indicates that more than 80% of
patients who were prescribed Redux in the U.S. received drug therapy for 90
days or less and only approximately 6.5% of patients took Redux for six months
or more.

                                      23
<PAGE>

  Analyses were conducted based on echocardiographic data from the total
patient population entered into the study and also from the core group, which
included only the matched pairs. The FDA has defined significant cardiac valve
regurgitation as mild or greater aortic valve regurgitation and/or moderate or
greater mitral valve regurgitation. Previous reports had estimated rates of
cardiac valve regurgitation among anorexigen-treated patients of up to 30%.

  Final analyses showed that among all study participants, 1.3% of Redux
patients and 0.5% of non-treated patients (p = not significant) met the FDA's
definition of mitral valve regurgitation. With respect to aortic valve
regurgitation, in all patients, 6.3% of Redux patients and 1.6% of non-treated
patients met the FDA's definition (p = 0.01). Among the core group of matched
pairs, 6.4% of Redux patients and 1.7% of non-treated controls (p = 0.03) met
this definition. Among the core group of matched pairs, there was no
statistically significant difference in mitral valve regurgitation. For all
patients with either aortic or mitral valve regurgitation meeting FDA
criteria, the incidence was 2.1% for controls and 7.6% for the Redux patients
(p = 0.02). In summary, the prevalence of aortic valve regurgitation was
statistically significantly greater in the Redux-treated group than in the
control group.

  When the time from discontinuation of Redux treatment to echocardiogram was
analyzed, there was a statistically significant difference in regurgitation
rates in Redux patients versus controls for the less than 8.3 month group but
not the greater than 8.3 month group, possibly indicating decreased prevalence
over time after discontinuation. There was a significant interaction between
Redux treatment and blood pressure at the time of echocardiogram, resulting in
an increased prevalence of aortic regurgitation with higher blood pressure.
This interaction did not exist for the control group. The Redux patients and
controls had similar blood pressures at baseline, but the Redux patients had
significantly higher post-echocardiogram blood pressures than did the
controls. Finally, concomitant use of a drug with MAO (monoamine oxidase)
inhibitory properties may be a factor contributing to the occurrence of
regurgitation. Such drugs were contraindicated with the use of Redux.

  Marketing and Manufacturing: With respect to the marketing and manufacture
of Redux, the Company sublicensed U.S. marketing rights to AHP, while
retaining copromotion rights. Redux was launched in June 1996 and withdrawn in
September 1997. The Company relied on AHP to target the obesity market and for
distribution and advertising and promotional activities. The Company
copromoted Redux through an approximately 30-person sales force to selected
diabetologists, endocrinologists, bariatricians, nutritionists and weight
management specialists, subject to certain restrictions. Under a contract
manufacturing agreement, Boehringer produced on behalf of Interneuron
commercial scale quantities of the finished dosage formulation of Redux in
capsule form.

  Patents and Proprietary Rights: The Servier Agreements granted the Company
an exclusive license to sell dexfenfluramine in the U.S. under a patent
covering the use of dexfenfluramine to treat abnormal carbohydrate craving,
which was sublicensed by the Company to AHP. Use of dexfenfluramine for the
treatment of abnormal carbohydrate craving was patented by Drs. Richard
Wurtman and Judith Wurtman. Dr. Richard Wurtman was a consultant to and a
director of Interneuron. This use patent was assigned to MIT and licensed by
MIT to Servier, and pursuant to the Servier Agreements, was licensed to the
Company.

                                   EMPLOYEES

  As of September 30, 2000, Interneuron had 18 full-time employees. None of
the Company's employees is represented by a labor union and Interneuron
believes its employee relations are satisfactory. The Company is highly
dependent upon certain key personnel and believes its future success will
depend in large part on its ability to retain such individuals and attract
other highly skilled management, marketing and scientific personnel. See "Risk
Factors--We depend upon key personnel and consultants."

ITEM 2. Properties

  The Company leases an aggregate of approximately 22,800 square feet of
office space in Lexington, MA. The lease expires in April 2002 and provides
for annual rent of approximately $387,000. The Company has guaranteed certain
of Incara's lease obligations. See Note F of Notes to Consolidated Financial
Statements.

                                      24
<PAGE>

ITEM 3. Legal Proceedings (See "Business--Redux Withdrawal")

  Product Liability Litigation: Subsequent to the market withdrawal of Redux
in September 1997, the Company has been named, together with other
pharmaceutical companies, as a defendant in approximately 3,200 legal actions,
many of which purport to be class actions, in federal and state courts
relating to the use of Redux. The actions generally have been brought by
individuals in their own right or on behalf of putative classes of persons who
claim to have suffered injury or who claim that they may suffer injury in the
future due to use of one or more weight loss drugs including Pondimin
(fenfluramine), phentermine and Redux. Plaintiffs' allegations of liability
are based on various theories of recovery, including, but not limited to,
product liability, strict liability, negligence, various breaches of warranty,
conspiracy, fraud, misrepresentation and deceit. These lawsuits typically
allege that the short or long-term use of Pondimin and/or Redux, independently
or in combination (including the combination of Pondimin and phentermine
popularly known as "fen-phen"), causes, among other things, PPH, valvular
heart disease and/or neurological dysfunction. In addition, some lawsuits
allege emotional distress caused by the purported increased risk of injury in
the future. Plaintiffs typically seek relief in the form of monetary damages
(including economic losses, medical care and monitoring expenses, loss of
earnings and earnings capacity, other compensatory damages and punitive
damages), generally in unspecified amounts, on behalf of the individual or the
class. In addition, some actions seeking class certification ask for certain
types of purportedly equitable relief, including, but not limited to,
declaratory judgments and the establishment of a research program or medical
surveillance fund. On December 10, 1997, the federal Judicial Panel on
Multidistrict Litigation issued an Order allowing for the transfer or
potential transfer of the federal actions to the Eastern District of
Pennsylvania for coordinated or consolidated pretrial proceedings. To date,
there have been no judgments against the Company, nor has Interneuron paid any
amounts in settlement of any of these claims. Following the dismissal and the
anticipated dismissal of Interneuron as a defendant in certain cases, the
Company estimates that there will be approximately 2,300 active cases.

  Rejected Settlement: On September 27, 1999, the Company announced that the
U.S. District Court for the Eastern District of Pennsylvania (the "District
Court") rejected a proposed agreement among the Company and the Plaintiffs
Management Committee ("PMC") in the Multidistrict Litigation to settle all
product liability litigation and claims against the Company related to Redux.
The District Court found that the proposed settlement did not meet the
requirements for limited fund class actions, as described by the Supreme Court
in its June 23, 1999 decision in Ortiz v. Fibreboard Corp. ("Ortiz"). The
District Court also vacated the stays of pending and future litigation that
were previously in effect. The Company filed a petition with the U.S. Court of
Appeals for the Third Circuit on October 12, 1999, seeking review of the
District Court's ruling and on April 13, 2000 moved to dismiss such petition.
The motion was granted on April 25, 2000. As a result of the District Court's
rejection of the proposed settlement agreement, the ongoing Redux-related
litigation is proceeding against the Company.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP product liability litigation related to Redux and
Pondimin. The Company is not a released party under this settlement.

  Interpleader Litigation: On November 20, 1998, December 30, 1998 and
February 5, 1999, the Company's three product liability insurers filed
interpleader actions against Servier and the Company in the District Court.
Product liability insurance policies issued in three tiers by the insurers to
the Company have an aggregate limit of $40,000,000. The insurers alleged that
the Company asserted claims against these policies, a substantial portion of
which has been used in the Company's defense of the litigation, and Servier,
as an additional insured under these policies, asserted its right to claim
against these policies. The insurers deposited the available proceeds up to
the limits of their policies (the "Deposited Funds") which are subject to
ongoing claims by the Company and Servier into the registry of the District
Court. In October 2000, the District Court dismissed the interpleader actions
and has issued or is expected to issue orders to return the Deposited Funds to
the insurance companies. In January 2000, the Company commenced paying legal
bills associated with the Redux litigation out of its own funds. It is
expected that the insurance companies will resume paying the Company's
litigation expenses and reimburse the Company for litigation expenses
previously paid by the Company.


                                      25
<PAGE>

  Complaint Against AHP: On January 24, 2000, the Company announced it has
filed a complaint against AHP in the Superior Court of the Commonwealth of
Massachusetts. The complaint seeks unspecified but substantial damages and
attorneys' fees pursuant to common and statutory law for AHP's knowing and
willful deceptive acts and practices, fraud and misrepresentations and breach
of contract. AHP has filed an answer to such complaint. The Company cannot
predict its costs relative to this litigation or the duration or the outcome
of the proceedings.

  Securities Litigation Settlement: The Company and certain present or former
directors and/or officers of the Company were named as defendants in several
lawsuits, purporting to be class actions, filed in the Massachusetts Federal
Court by alleged purchasers of the Company's Common Stock, claiming violation
of the federal securities laws. On February 2, 2000, the Massachusetts Federal
Court entered the Final Judgment, which, among other things, granted final
judgment to and an approval of the settlement of the lawsuits on a class-wide
basis, covering a class period of March 24, 1997 to July 8, 1997. No appeal
was taken from the Final Judgment. The settlement amount was entirely funded
by insurance proceeds.

  General: Pursuant to agreements between the parties, under certain
circumstances, the Company may be required to indemnify Servier, Boehringer
and AHP, and the Company may be entitled to indemnification by AHP, against
certain claims, damages or liabilities incurred in connection with Redux. The
cross indemnification between the Company and AHP generally relates to the
activities and responsibilities of each company.

  Although the Company maintains certain product liability and director and
officer liability insurance and intends to defend these and similar actions
vigorously, the Company has been required and may continue to be required to
devote significant management time and resources to these legal actions. In
the absence of a settlement and in the event of successful uninsured or
insufficiently insured claims, or in the event a successful indemnification
claim were made against the Company, the Company's business, financial
condition and results of operations could be materially adversely affected.
Even if a settlement is reached, the terms of such settlement may include cash
and/or the issuance of the Company's securities, which may materially
adversely affect the Company's financial condition and results of operations
and result in dilution to the Company's stockholders. The uncertainties and
costs associated with these legal actions have had, and may continue to have,
an adverse effect on the market price of the Company's Common Stock and on the
Company's ability to obtain corporate collaborations or additional financing
to satisfy cash requirements, to retain and attract qualified personnel, to
develop and commercialize products on a timely and adequate basis, to acquire
rights to additional products, or to obtain product liability insurance for
other products at costs acceptable to the Company, or at all, any or all of
which may materially adversely affect the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations," "Risk Factors --The outcome
of the Redux litigation could materially harm us" and Note G of Notes to
Consolidated Financial Statements.

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

  Not applicable.

                              EXECUTIVE OFFICERS

  The following table sets forth the names and positions of the executive
officers of the Company:

<TABLE>
<CAPTION>
Name                      Age Position
----                      --- --------
<S>                       <C> <C>
Glenn L. Cooper, M.D. ..   47 President, Chief Executive Officer and Chairman
Mark S. Butler..........   54 Executive Vice President, Chief Administrative Officer
                              and General Counsel
Michael W. Rogers.......   40 Executive Vice President, Chief Financial Officer and Treasurer
Bobby W. Sandage, Jr.,     47 Executive Vice President, Research and Development
 Ph.D. .................      and Chief Scientific Officer
</TABLE>


                                      26
<PAGE>

  Glenn L. Cooper, M.D. has been President, Chief Executive Officer and a
director of the Company since May 1993 and Chairman since January 2000. Dr.
Cooper was also Progenitor's President and Chief Executive Officer from
September 1992 to June 1994. Prior to joining Progenitor, Dr. Cooper was
Executive Vice President and Chief Operating Officer of Sphinx Pharmaceuticals
Corporation from August 1990. Dr. Cooper had been associated with Eli Lilly
since 1985, most recently, from June 1987 to July 1990, as Director, Clinical
Research, Europe, of Lilly Research Center Limited; from October 1986 to May
1987 as International Medical Advisor, International Research Coordination of
Lilly Research Laboratories; and from June 1985 to September 1986 as Medical
Advisor, Regulatory Affairs, Chemotherapy Division at Lilly Research
Laboratories. Dr. Cooper is a director and Vice Chairman of Proneuron
Biotechnologies, Inc., a private Israeli-based biotechnology company. Dr.
Cooper received his M.D. from Tufts University School of Medicine, performed
his postdoctoral training in Internal Medicine and Infectious Diseases at the
New England Deaconess Hospital and Massachusetts General Hospital and received
his A.B. from Harvard College.

  Mark S. Butler joined the Company in December 1993 as Senior Vice President
and, in December 1995, was appointed Executive Vice President, Chief
Administrative Officer and General Counsel. Prior to joining the Company, Mr.
Butler was associated with the Warner-Lambert Company since 1979, serving as
Vice President, Associate General Counsel since 1990, as Associate General
Counsel from 1987 to 1990, Assistant General Counsel from 1985 to 1987 and in
various other legal positions from 1979 to 1985. From 1975 to 1979, Mr. Butler
was an attorney with the law firm of Shearman & Sterling.

  Michael W. Rogers joined the Company in February 1999 as Executive Vice
President, Chief Financial Officer and Treasurer. From February 1998 to
December 1998, Mr. Rogers was Executive Vice President and Chief Financial and
Corporate Development Officer at Advanced Health Corporation, a publicly-
traded health care information technology company. From July 1995 to November
1997, he was Vice President, Chief Financial Officer and Treasurer of
AutoImmune, Inc., a publicly-traded biopharmaceutical company. From July 1994
to July 1995, Mr. Rogers was Vice President, Investment Banking at Lehman
Brothers, Inc. From 1990 to 1994, he was associated with PaineWebber, Inc.,
serving most recently as Vice President, Investment Banking Division.

  Bobby W. Sandage, Jr., Ph.D. joined the Company in November 1991 as Vice
President--Medical and Scientific Affairs and was appointed Vice President--
Research and Development in February 1993, Senior Vice President--Research and
Development in February 1994 and Executive Vice President, Research and
Development and Chief Scientific Officer in December 1995. From February 1989
to November 1991 he was Associate Director, Project Management for the
Cardiovascular Research and Development division of DuPont Merck
Pharmaceutical Company. From May 1985 to February 1989 he was affiliated with
the Medical Department of DuPont Critical Care, most recently as associate
medical director, medical development. Dr. Sandage is an adjunct professor in
the Department of Pharmacology at the Massachusetts College of Pharmacy. Dr.
Sandage received his Ph.D. in Clinical Pharmacy from Purdue University and his
B.S. in Pharmacy from the University of Arkansas.

     COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934.

  To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company, there were no reports required under Section
16(a) of the Securities Exchange Act of 1934 which were not timely filed
during fiscal 2000.

                                      27
<PAGE>

                                 RISK FACTORS

  The following factors should be reviewed carefully, in conjunction with the
other information in this Report and the Company's consolidated financial
statements. These factors, among others, could cause actual results to differ
materially from those currently anticipated and contained in forward-looking
statements made in this Report and presented elsewhere by Company management
from time to time. See "Part I--Note Regarding Forward-Looking Statements."

The outcome of the Redux litigation could materially harm us.

  On September 15, 1997, we announced a market withdrawal of our first
prescription product, the weight loss medication Redux (dexfenfluramine
hydrochloride capsules) C-IV, which had been launched by AHP, our licensee, in
June 1996. Following the withdrawal, we have been named, together with other
pharmaceutical companies, as a defendant in approximately 3,200 product
liability legal actions, many of which purport to be class actions, in federal
and state courts involving the use of Redux and other weight loss drugs.

  The existence of such litigation may continue to materially adversely affect
our business, including our ability to obtain sufficient financing to fund
operations. In addition, although we are unable to predict the outcome of any
such litigation, if successful uninsured or insufficiently insured claims, or
if a successful indemnification claim, were made against us, our business,
financial condition and results of operations could be materially adversely
affected. In addition, the costs and uncertainties associated with these legal
actions have had, and may continue to have, an adverse effect on the market
price of our Common Stock and on our ability to obtain corporate
collaborations or additional financing to satisfy cash requirements, to retain
and attract qualified personnel, to develop and commercialize products on a
timely and adequate basis, to acquire rights to additional products, and to
obtain product liability insurance for other products at costs acceptable to
us, or at all, any or all of which may materially adversely affect our
business, financial condition and results of operations.

We will depend on Pfizer to develop, manufacture and market pagoclone.

  Under the Pfizer Agreement, we do not have control over the development or
commercialization of pagoclone. We would be materially adversely affected if
Pfizer does not successfully develop pagoclone. We will be dependent on Pfizer
to manufacture pagoclone under current cGMP regulations. We will also be
dependent on Pfizer for the marketing and distribution of pagoclone.

We will rely on third parties to commercialize our products.

  We require substantial additional funds to complete development of our
products and anticipate forming partnerships to manufacture and market our
products. We pursue corporate partners to fund development and
commercialization of our products. We may not be successful in finding
corporate partners or obtaining other financing and, if obtained, the terms of
any such arrangements may not be favorable to us. If we are not able to obtain
any such corporate partners or financing, development of our products could be
delayed or curtailed, which could materially adversely affect our operations
and financial condition.

  Any collaborative partners may not be successful in commercializing our
products or may terminate their collaborative agreements with us. If we obtain
any collaborative arrangements, we will depend on the efforts of these
collaborative partners and we will have limited or no control over the
development, manufacture and commercialization of the products subject to the
collaboration. If certain of our collaborative partners terminate the related
agreements or fail to develop, manufacture or commercialize products, we would
be materially adversely affected. Because we will generally retain a royalty
interest in sales of products licensed to third parties, our revenues may be
less than if we marketed products directly.


                                      28
<PAGE>

  Any manufacturing facilities for any of our compounds are subject to FDA
inspection both before and after NDA approval to determine compliance with
cGMP requirements. Facilities used to produce our compounds may not have
complied, or may not be able to maintain compliance, with cGMP. The cGMP
regulations are complex and failure to be in compliance could lead to non-
approval or delayed approval of the NDA. This would delay product launch or,
if approval is obtained, may result in remedial action, penalties and delays
in production of material acceptable to the FDA.

Our products are early stage and may not be successful.

  We are investigating for therapeutic potential a variety of pharmaceutical
compounds, and other products at various stages of development. The products
we are developing are subject to the risk that any or all of them are found to
be ineffective or unsafe, or otherwise fail to receive necessary regulatory
clearances. We are unable to predict whether any of our products will receive
regulatory clearances or be successfully manufactured or marketed. Further,
due to the extended testing and regulatory review process required before
marketing clearance can be obtained, the time frames for commercialization of
any products or procedures are long and uncertain.

We rely on the favorable outcome of clinical trials of our products.

  Before obtaining regulatory approval for the commercial sale of any of the
pharmaceutical products we are developing, we or our licensees must
demonstrate that the product is safe and efficacious for use in each target
indication. If clinical trials do not demonstrate the safety and efficacy of
certain products under development, we will be materially adversely affected.
The results of pre-clinical studies and early clinical trials may not predict
results that will be obtained in large-scale testing or use. Clinical trials
of products we are developing may not demonstrate the safety and efficacy of
such products. Regardless of clinical trial results, the FDA may not approve
marketing of the product. A number of companies in the pharmaceutical
industry, including the Company, have suffered significant setbacks in
advanced clinical trials or have not received FDA approval, even after
promising results in earlier trials. We withdrew our NDA for citicoline to
treat ischemic stroke after the failure to meet our primary objective in a
small Phase 3 clinical study.

We could be materially harmed if our agreements were terminated.

  Our agreements with licensors and licensees generally provide the other
party with rights to terminate the agreement, in whole or in part, under
certain circumstances. Many of our agreements require us to diligently pursue
development of the underlying product or risk loss of the license or incur
penalties. Termination of certain agreements could substantially reduce the
likelihood of successful commercialization of a particular product. Depending
upon the importance to us of the product that is subject to any such
agreement, this could materially adversely affect our business. In particular,
termination of the Pfizer Agreement would materially adversely affect us.
Ferrer has the right to terminate the Ferrer Agreement in the event FDA
approval of citicoline is not obtained by January 2002, subject to certain
extensions.

Our failure to acquire and develop additional product candidates will impair
our ability to grow.

  In order to continue to grow, we must continue to acquire and develop
additional compounds. The success of this strategy depends upon our ability to
continue to identify, select and acquire compounds that meet the criteria we
have established. Indentifying suitable compounds is a lengthy and complex
process. In addition, other companies with substantially greater financial,
marketing and sales resources, may compete with us for the acquisition of
compounds. We may not be able to acquire the rights to additional compounds on
terms we find acceptable or at all.

We may not be able to collaborate with third parties to commercialize certain
other products due to the existence of the Takeda option.

  Takeda exercised its exclusive option to negotiate a license to another one
of our other products, excluding pagoclone and trospium, which may materially
adversely affect our ability to collaborate with any third parties

                                      29
<PAGE>

other than Takeda. The exclusive option license negotiation period covering
all products other than pagoclone and trospium extends until April 1, 2001,
and the right of first offer for a compound selected by Takeda prior to April
1, 2001 extends for an additional six months. Our potential inability to enter
into licenses or other collaborations during this period could adversely
affect our ability to fund development of the products subject to Takeda's
option, which could materially affect our operations and financial condition.

We need additional funds in the near future.

  We continue to expend substantial funds for product development activities.
We will require additional funds after fiscal 2001. In addition, we may seek
additional funds during fiscal 2001 through corporate collaborations or equity
or debt financings. We do not have any commitments or arrangements for
additional financing.

  Our cash requirements and cash resources will vary significantly depending
upon the following principal factors:

  .  whether we are successful in defending against our Redux product
     liability litigation;

  .  the timing and amount of defense and indemnity payments in the
     continuing Redux litigation;

  .  the timing and extent of reimbursement from insurers;

  .  whether the company is successful in either in-licensing or out-
     licensing products; and

  .  whether Pfizer is successful in developing pagoclone and the timing of
     any milestone payments related to the Pfizer Agreement

  As a result of the uncertainties and costs associated with the Redux-related
litigation, business development activities, market conditions, and other
factors generally affecting our ability to raise additional funds, we may not
be able to obtain sufficient additional funds to satisfy cash requirements or
may be required to obtain financing on terms that are not favorable to us.
This may require us to curtail our operations or delay development of our
products.

We have a history of losses and expect losses to continue.

  Through September 30, 2000, we had accumulated net losses since inception of
approximately $250,000,000. We expect to have losses and use cash in operating
activities. We will be required to conduct significant development and
clinical testing activities for the products we are developing. These
activities are expected to result in continued operating losses for the
foreseeable future. We cannot predict the extent of future losses or the time
required to achieve profitability. In addition, payments made by us in
connection with product liability litigation would result in significant
charges to operations and would materially adversely affect our results of
operations and financial condition.

We may not be profitable in the future.

  We may never achieve or sustain profitability in the future. The majority of
our revenues had been derived from Redux, which was withdrawn from the market
in September 1997. We expect to continue to experience fluctuations in revenue
as a result of the timing of regulatory filings or approvals, product
launches, license fees, royalties, product shipments, and milestone payments.

We have product liability exposure and insurance uncertainties related to our
products.

  The use of products in clinical trials and the marketing of products may
expose us to substantial product liability claims and adverse publicity.
Certain of our agreements require us to obtain specified levels of insurance
coverage, naming the other party as an additional insured. We may not be able
to maintain or obtain insurance coverage, or to obtain insurance in amounts
sufficient to protect us or other named parties against liability, at a
reasonable cost, or at all. In addition, any insurance obtained may not cover
any particular liability claim. We can't predict the extent to which the
Redux-related litigation may affect our ability to obtain sufficient product

                                      30
<PAGE>

liability insurance for other products at costs acceptable to us. We have
indemnified certain licensors and licensees and may be required to indemnify
additional licensors or licensees against product liability claims incurred by
them as a result of products we develop or market. If uninsured or
insufficiently insured product liability claims arise, or if a successful
indemnification claim was made against us, our business and financial
condition could be materially adversely affected.

If we fail to comply with government regulations it could negatively affect
our business.

  Our research, development and pre-clinical and clinical trial activities and
the manufacturing and marketing of our products are subject to an extensive
regulatory approval process by the FDA and other regulatory agencies in the
U.S. and other countries. The process of obtaining required regulatory
approvals for drugs, including conducting pre-clinical and clinical testing,
is lengthy, expensive and uncertain. Even after such time and expenditures, we
may not obtain necessary regulatory approvals for clinical testing or for the
manufacturing or marketing of any products. Regulatory approval may entail
limitations on the indicated usage of a drug, which may reduce the drug's
market potential. Even if regulatory clearance is obtained, post-market
evaluation of the products, if required, could result in restrictions on a
product's marketing or withdrawal of the product from the market as well as
possible civil or criminal sanctions. We will depend upon the manufacturers of
our products to comply with cGMP. We also depend on laboratories and medical
institutions conducting pre-clinical studies and clinical trials to maintain
both good laboratory and good clinical practices. We may not be able to obtain
on a timely basis, or at all, cGMP manufacturers capable of producing product
to meet our requirements, which would materially adversely affect our ability
to commercialize these products.

  In addition, we and our collaborative partners may be subject to regulation
under state and federal laws, including requirements regarding occupational
safety, laboratory practices, environmental protection and hazardous substance
control, and may be subject to other local, state, federal and foreign
regulation. We cannot predict the impact of such regulation on us, although it
could be material and adverse.

We have limited patent protection on our products.

  Our future success will depend to a significant extent on our ability to:

  .  obtain and enforce patent protection on our products and technologies;

  .  maintain trade secrets; and

  .  operate and commercialize products without infringing on the patents or
     proprietary rights of others.

  Our patents may not afford any competitive advantages and may be challenged
or circumvented by third parties. Further, patents may not issue on pending
patent applications. Because of the extensive time required for development,
testing and regulatory review of a potential product, it is possible that
before a potential product can be commercialized, any related patent may
expire, or remain in existence for only a short period following
commercialization, reducing any advantage of the patent.

  Our licensed U.S. patent covering the administration of citicoline to treat
patients afflicted with conditions associated with the inadequate release of
brain acetylcholine expires in 2003. This patent, along with the additional
patents issued to us relating to citicoline, may not afford protection against
competitors of citicoline to treat ischemic stroke.

  Our license to trospium does not include any patents expected to be used in
commercializing the product.

  Our business may be materially adversely affected if we fail to obtain and
retain needed patents, licenses or proprietary information. Others may
independently develop similar products. Furthermore, litigation may be
necessary:

  .  to enforce any of our patents;

  .  to determine the scope and validity of the patent rights of others; or

  .  in response to legal action against us claiming damages for infringement
     of patent rights or other proprietary rights or seeking to enjoin
     commercial activities relating to the affected product or process.

                                      31
<PAGE>

  The outcome of any litigation is highly uncertain. Any litigation may also
result in significant use of management and financial resources.

  To the extent that consultants, key employees or other third parties apply
technological information independently developed by them or by others to our
proposed products, disputes may arise as to the proprietary rights to such
information which may not be resolved in our favor. Most of our consultants
are employed by or have consulting agreements with third parties and any
inventions discovered by such individuals generally will not become our
property. There is a risk that other parties may breach confidentiality
agreements or that our trade secrets become known or independently discovered
by competitors, which could adversely affect us.

We may depend on market exclusivity for trospium and other products.

  Assuming regulatory approvals are obtained, our ability to commercialize
successfully certain drugs, including trospium, may depend on the availability
of market exclusivity or patent extension under the Waxman-Hatch Act. The
marketing of trospium could be materially adversely affected if marketing
exclusivity or patent extension provisions are not available to us.

Our products may be unable to compete successfully with other products.

  Competition from other pharmaceutical companies is intense and expected to
increase. We are aware of existing products and of products under development
by our competitors that address diseases we are targeting and competitors have
developed or are developing products or technologies that are, or may be, the
basis for competitive products.

  .  Pagoclone would compete with a number of drugs available and under
     development to treat anxiety or panic disorders, including serotonergic
     drugs such as BuSpar, Paxil, Zoloft, Prozac and Effexor and
     benzodiazepines such as Valium and Xanax.

  .  Trospium would compete with other therapies for overactive bladder,
     including anticholinergics, such as Detrol and Ditropan and Ditropan XL.
     In addition, we are aware of other companies evaluating specific
     antimuscaranic and antispasmodics for overactive bladder in pre-clinical
     and clinical development.

  .  With respect to citicoline, Genentech, Inc. markets Activase, a
     thrombolytic agent, as a treatment for stroke. We are aware that other
     companies are conducting clinical trials on a number of other products
     for stroke which could also compete with citicoline.

  Many of the other companies who market or are expected to market competitive
drugs or other products are large, multinational companies who have
substantially greater marketing and financial resources and experience than
us. We may not be able to develop products that are more effective or achieve
greater market acceptance than competitive products. In addition, our
competitors may develop products that are safer or more effective or less
expensive than those we are developing or that would render our products less
competitive or obsolete. As a result, our products may not be able to compete
successfully. In addition, royalties payable to us under certain agreements
may be reduced if there is generic competition.

  Many companies in the pharmaceutical industry also have substantially
greater experience in undertaking pre-clinical and clinical testing of
products, obtaining regulatory approvals and manufacturing and marketing
products. In addition to competing with universities and other research
institutions in the development of products, technologies and processes, we
may compete with other companies in acquiring rights to products or
technologies.

We may be affected by changes in pharmaceutical pricing and reimbursement.

  Efforts of governmental and third-party payors to contain or reduce the cost
of health care will affect our business. Successful commercialization of many
of our products may depend on the availability of

                                      32
<PAGE>

reimbursement for the cost of such products and related treatment from third-
party health care payors, such as the government, private insurance plans and
managed care organizations. Third- party payors are increasingly challenging
the price of medical products and services. Such reimbursement may not be
available for any of our products at all or for the duration of the
recommended treatment with the drug, which could materially adversely affect
our ability to commercialize the drug. The increasing emphasis on managed care
in the U.S. continues to increase the pressure on pharmaceutical pricing.

  There have been, and we anticipate that there will continue to be, a number
of proposals to implement government control over the pricing or profitability
of prescription pharmaceuticals, as is currently the case in many foreign
markets. The announcement or adoption of such proposals could adversely affect
us. Furthermore, our ability to commercialize our products may be adversely
affected to the extent that such proposals materially adversely affect the
business, financial condition and profitability of companies that are
prospective collaborative partners.

We depend upon key personnel and consultants.

  We are dependent on certain executive officers and scientific personnel and
our business would be adversely affected by the loss of certain of these
individuals. In addition, we rely on independent consultants to design and
supervise clinical trials and assist in preparation of FDA submissions.

  Competition for qualified employees among pharmaceutical and biotechnology
companies is intense, and the loss of any qualified employees, or an inability
to attract, retain and motivate highly skilled employees, could adversely
affect our business and prospects. The uncertainties associated with the
ongoing Redux-related litigation has adversely affected our ability to recruit
and retain qualified personnel. We may not be able to attract additional
qualified employees or retain our existing personnel.

Our company is controlled by certain stockholders.

  Our executive officers, directors and principal stockholders (including
individuals or entities related to such stockholders) beneficially own
approximately 41% of our outstanding Common Stock. Accordingly, these
officers, directors and stockholders may have the ability to exert significant
influence over the election of our Board of Directors and to determine
corporate actions requiring stockholder approval.

We may issue preferred stock with preferential rights that could affect your
rights and prevent a takeover of the business.

  Our Board of Directors has the authority, without further approval of our
stockholders, to fix the rights and preferences of and to issue shares of
preferred stock. The preferred stock held by AHP provides that AHP's consent
is required prior to a merger of the Company, the sale of substantially all of
our assets or certain other transactions. In addition, Ferrer may terminate
its license agreement with us relating to citicoline in the event an
unaffiliated third party acquires 50% of our Common Stock. In addition,
vesting of shares of our Common Stock subject to stock awards under our Equity
Incentive Plan accelerates and outstanding options under our stock option
plans become immediately exercisable upon certain changes in control of the
Company, except under certain conditions. In addition, Delaware corporate law
imposes limitations on certain business combinations. These provisions could,
under certain circumstances, have the effect of delaying or preventing a
change in control of the Company and, accordingly, could adversely affect the
price of our Common Stock.

We have never paid any dividends on our Common Stock.

  We have not paid any cash dividends on our Common Stock since inception and
do not expect to do so in the foreseeable future. Any dividends will be
subject to the preferential cumulative dividend of $0.1253 per share and $1.00
per share payable on the outstanding Series B Preferred Stock and Series C
Preferred Stock, respectively, held by AHP and dividends payable on any other
preferred stock we may issue.


                                      33
<PAGE>

Our stock price is volatile.

  The market prices for our securities and for securities of emerging growth
companies have historically been highly volatile. Future announcements
concerning us or our competitors may have a significant impact on the market
price of our Common Stock. Factors which may affect our market price include:

  .  Redux-related litigation developments;

  .  results of clinical studies and regulatory reviews;

  .  market conditions in the pharmaceutical and biotechnology industries;

  .  competitive products;

  .  financings or corporate collaborations;

  .  sales or the possibility of sales of our Common Stock;

  .  our results of operations and financial condition;

  .  proprietary rights;

  .  public concern as to the safety or commercial value of our products; and

  .  general economic conditions.

  The uncertainties associated with the Redux-related litigation have
adversely affected and may continue to adversely affect the market price of
our Common Stock. Furthermore, the stock market has experienced significant
price and volume fluctuation unrelated to the operating performance of
particular companies. These market fluctuations may also adversely affect the
market price of our Common Stock.

Our stock price could be negatively affected if our shares are sold, if we
issue additional shares or if third parties exercise registration rights.

  As of December 14, 2000, we had 42,780,492 shares of Common Stock
outstanding. Substantially all of these shares are eligible for sale without
restriction or under Rule 144. In general, under Rule 144 as currently in
effect, a person (or persons whose shares are aggregated), including persons
who may be deemed to be "affiliates" of the Company as that term is defined
under the Securities Act of 1933, is entitled to sell within any three-month
period a number of restricted shares beneficially owned for at least one year
that does not exceed the greater of:

  (i)one percent of the then outstanding shares of Common Stock, or

  (ii) the average weekly trading volume in the Common Stock during the four
     calendar weeks preceding such sale.

  Sales under Rule 144 are also subject to certain requirements as to the
manner of sale, notice and the availability of current public information
about the Company. However, a person who is not an affiliate and has
beneficially owned such shares for at least two years is entitled to sell such
shares without regard to the volume or other requirements.

  AHP has registration rights relating to 622,222 shares of Common Stock
issuable upon conversion of issued and outstanding Series B and C Preferred
Stock. We have outstanding registration statements on Form S-3 relating to the
resale of our shares of Common Stock and on Form S-8 relating to shares
issuable under our 1989 Stock Option Plan, 1994 Long-Term Incentive Plan, 1995
Stock Purchase Plan, 1997 Equity Incentive Plan and 1998 Employee Stock Option
Plan and 2000 Stock Option Plan.

  The recipients of shares of our Common Stock under the 1997 Equity Incentive
Plan can sell these shares immediately when the shares vest. As of December
14, 2000, of the 1,736,918 shares of Common Stock issued or issuable under the
1997 Equity Incentive Plan pursuant to stock awards, 1,286,918 shares vested
and were issued and the remaining 450,000 shares vest through April 2002. The
vesting dates are subject to extension if they occur during a "Black Out
Period." Black Out Periods generally are periods in which the recipient is
unable to sell the shares subject to the award at the applicable vesting date
due to legal or contractual restrictions. The

                                      34
<PAGE>

vesting dates are also subject to acceleration under certain circumstances,
including certain changes in control of the Company, except under certain
conditions. Sales of the shares of Common Stock subject to restricted stock
awards or the possibility of sales of such shares may adversely affect the
market price of our Common Stock.

Our stockholders could be diluted if we issue our shares subject to options,
warrants, stock awards or other arrangements.

  As of December 14, 2000, we had reserved the following shares of Common
Stock for issuance:


  .  10,445,000 shares issuable upon exercise of outstanding options and
     warrants, subject to anti-dilution provisions;

  .  450,000 shares issuable, at nominal consideration, upon vesting of stock
     awards under the Company's 1997 Equity Incentive Plan;

  .  622,222 shares upon conversion of Preferred Stock owned by AHP, subject
     to anti-dilution provisions; and

  .  1,574,000 shares reserved for grant and issuance under the Company's
     stock option plans, stock purchase plan and equity incentive plan.

  As a result of anti-dilution provisions, additional shares of Common Stock
may be issued upon exercise of certain warrants or conversion of the Preferred
Stock.

  We may grant additional options, warrants or stock awards. In addition, we
may be required to issue additional shares of Common Stock in connection with
technology acquisitions. To the extent such shares are issued, the interest of
holders of Common Stock will be diluted. In addition, we may issue securities
in connection with any settlement of the Redux litigation which would dilute
our stockholders.

                                    PART II

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

Price Range of Securities

  Interneuron's Common Stock trades on the Nasdaq National Market under the
symbol "IPIC." The table below sets forth the high and low sales prices of
Interneuron's Common Stock as reported by the Nasdaq National Market for the
periods indicated. These prices are based on quotations between dealers, do
not reflect retail mark-up, mark-down or commissions, and do not necessarily
represent actual transactions.

<TABLE>
<CAPTION>
                                                             High      Low
                                                             ----      ---
   <S>                                                       <C>       <C>
   Fiscal Year Ended September 30, 2000:
     July 1 through September 30, 2000...................... $3 13/16  $1 3/4
     April 1 through June 30, 2000..........................  3         1 1/2
     January 1 through March 31, 2000.......................  7 9/16    1 5/8
     October 1 through December 31, 1999....................  8 3/4     1 11/32
   Fiscal Year Ended September 30, 1999:
     July 1 through September 30, 1999...................... $4 13/16  $1 1/8
     April 1 through June 30, 1999..........................  3 3/8     2 5/16
     January 1 through March 31, 1999.......................  6 1/4     2 5/8
     October 1 through December 31, 1998....................  4 5/16    2 1/2
</TABLE>

Approximate Number of Equity Security Holders

  The number of holders of record of the Company's Common Stock as of December
14, 2000 was approximately 618.

  The Company has never paid a cash dividend on its Common Stock and
anticipates that for the foreseeable future any earnings will be retained for
use in its business and, accordingly, does not anticipate the payment of cash
dividends. Any dividends will be subject to the preferential dividend of
$0.1253 per share payable on the outstanding Series B Preferred Stock ($30,000
per annum), $1.00 per share payable on the outstanding Series C Preferred
Stock ($5,000 per annum) and dividends payable on any other preferred stock
issued by the Company.

                                      35
<PAGE>

ITEM 6. Selected Financial Data

  The selected financial data presented below summarizes certain financial
data which has been derived from and should be read in conjunction with the
more detailed consolidated financial statements of the Company and the notes
thereto which have been audited by PricewaterhouseCoopers LLP, independent
accountants, whose report thereon is included elsewhere in this Annual Report
on Form 10-K along with said financial statements. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

<TABLE>
<CAPTION>
                                    Fiscal Years Ended September 30,
                              ------------------------------------------------
                                1996      1997      1998      1999      2000
                              --------  --------  --------  --------  --------
                              (Amounts in thousands except per share data)
<S>                           <C>       <C>       <C>       <C>       <C>
Statement of Operations
 Data:
Product revenue.............  $ 13,779  $ 55,945  $    --   $    --   $    --
Contract and license fee
 revenue....................     8,335    11,039     6,488     1,599    27,754
                              --------  --------  --------  --------  --------
  Total revenues............    22,114    66,984     6,488     1,599    27,754
Cost of revenues............    11,454    41,144       --        200     3,024
Research and development....    17,344    50,180    39,762    35,510     3,158
Selling, general and
 administrative.............    13,991    19,581    21,975    11,030     6,823
Product withdrawal..........       --      7,528       --        --     (1,757)
Purchase of in-process
 research and development...     6,434     3,044       500     2,421       --
Income (loss) from
 operations.................   (27,109)  (54,493)  (55,749)  (47,562)   16,506
Investment income, net......     4,135     8,944     5,465     2,189     1,868
Equity in unconsolidated
 subsidiary.................       --     (9,028)   (4,040)      250       175
Income (loss) from
 continuing operations......   (22,400)  (49,670)  (50,485)  (38,578)   19,956
Discontinued operations.....    (5,586)   (5,586)  (19,477)      816       --
Net income (loss)...........   (27,986)  (55,256)  (69,962)  (37,762)   19,956
Income (loss) per common
 share from continuing
 operations--diluted........  $  (0.61) $  (1.21) $  (1.22) $  (0.92) $   0.46
Income (loss) per common
 share from discontinued
 operations--diluted........  $  (0.15) $  (0.14) $  (0.47) $   0.02  $    --
Net income (loss) per common
 share--diluted.............  $  (0.76) $  (1.35) $  (1.69) $  (0.90) $   0.46
Weighted average common
 shares--diluted............    37,004    41,064    41,468    41,898    43,838
<CAPTION>
                                             September 30,
                              ------------------------------------------------
                                1996      1997      1998      1999      2000
                              --------  --------  --------  --------  --------
                                         (Amounts in thousands)
<S>                           <C>       <C>       <C>       <C>       <C>
Balance Sheet Data:
Working capital.............  $155,246  $ 82,229  $ 41,417  $  4,083  $ 26,325
Total assets................   186,438   152,930    78,197    26,638    46,826
Long-term portion of notes
 payable and capital lease
 obligations................       542     1,734     1,663         2       --
Total liabilities...........    22,303    43,962    30,842    20,327    18,728
Accumulated deficit.........  (106,778) (162,034) (231,996) (269,758) (249,802)
Total stockholders' equity..   144,762    96,009    39,856     6,122    27,766
</TABLE>

                                      36
<PAGE>

ITEM 7.  Management's Discussion and Analysis of Financial Conditions and
Results of Operations:

  The following discussion should be read in conjunction with the Company's
audited, consolidated financial statements and notes thereto appearing
elsewhere in this Form 10-K.

General

 Description of Company

  Interneuron is a biopharmaceutical company engaged in the development and
commercialization of a diversified portfolio of product candidates, including
multiple compounds in late stage clinical development. The Company is
currently developing or has certain rights to five compounds in clinical
development: pagoclone for panic and generalized anxiety disorders, trospium
for overactive bladder, IP 501 for cirrhosis of the liver, citicoline for
ischemic stroke, and PRO 2000 for the prevention of sexually transmitted
diseases and HIV infection. In addition, the Company has other compounds in
earlier stages of development, including PACAP (pituitary adenylate cyclase
activating polypeptide) for respiratory disease, diabetes, stroke and other
neurodegenerative diseases.

 Pagoclone

  In December 1999, the Company entered into the Pfizer Agreement, under which
it licensed to Pfizer exclusive, worldwide rights to develop and commercialize
pagoclone. Pursuant to the Pfizer Agreement, in December 1999 the Company
received an up-front payment of $13,750,000 and in September 2000 a clinical
milestone payment of $3,000,000 which were recognized as contract and license
fee revenue in fiscal 2000. The Company is entitled to receive up to
$57,000,000 in additional payments contingent upon the achievement of clinical
and regulatory milestones. Pfizer also agreed to pay Interneuron royalties on
net sales. Under the Pfizer Agreement, Pfizer is responsible for conducting
and funding all further clinical development, regulatory review, manufacturing
and marketing of pagoclone on a worldwide basis. Under the Company's agreement
with Aventis, Aventis is entitled to receive a portion of certain of the
payments to be received by the Company from Pfizer. In fiscal 2000, the
Company recognized $2,800,000 of the amounts received from Pfizer, and paid or
due to Aventis, as cost of revenues.

 Trospium

  In November 1999, the Company obtained an exclusive U.S. license to
trospium, a prescription drug product currently marketed as a treatment for
overactive bladder in Europe. In May 2000, the Company met with the FDA to
discuss the existing European clinical efficacy trials and safety database for
trospium and to seek guidance on criteria for approvability of the compound.
Based on its conversations with the FDA, the Company intends to conduct a
standardized electrocardiograpic safety study which is recommended by the FDA
for drugs in the pharmacological class of trospium. Additionally, based upon
those discussions with the FDA, the Company believes that, in combination with
the existing efficacy and safety data on trospium, a single, successful 300-
400 patient Phase 3 trial will be necessary and sufficient for submission of
an NDA. On December 12, 2000, the Company filed an IND for trospium and
expects to conduct its safety study in the second quarter of fiscal 2001.
Assuming positive results from this study, the Company expects to begin its
Phase 3 trial in fiscal 2001.

 IP 501

  The Company has an option to negotiate an exclusive license to a compound
known as IP 501 for the treatment and prevention of cirrhosis of the liver
caused by alcohol and hepatitis viruses. IP 501 is currently being studied in
an 800-patient Phase 3 clinical trial sponsored by the Veterans
Administration. The Company expects the Veterans Administration to complete
their analysis of the data in the first quarter of calendar 2001.

 Citicoline

  On January 10, 2000, the Company announced that a preliminary analysis of
the 899-patient Phase 3 clinical trial with citicoline failed to meet its
primary endpoint, a measure of improvement in neurological function

                                      37
<PAGE>

among patients suffering from moderate to severe ischemic stroke. The pre-
specified, primary outcome measurement of the trial was the comparison of the
percentages of patients treated with citicoline or placebo who achieved at
least a 7-point improvement on the National Institutes of Health Stroke Scale
("NIHSS") scores from baseline to endpoint. Secondary outcomes included
additional comparisons of neurological function and infarct volume
measurements among citicoline and placebo patients at the end of the study.

  Although improvement in the primary outcome measurement was not achieved,
certain secondary endpoints were positive. At the end of the 12-week trial
period, a statistically significantly higher proportion of citicoline-treated
patients achieved complete or near-complete recovery of neurological function
compared to placebo-treated patients, as measured by the Rankin Scale.
Likewise, at the same time point, NIHSS scores indicated a positive trend in
the number of citicoline-treated patients who achieved full neurological
recovery. Although not statistically significant, a higher percentage of
citicoline-treated patients achieved reduction in the size of their cerebral
infarct compared to placebo-treated patients. In addition, findings from this
study indicate that there were no significant adverse safety issues associated
with citicoline.

  In December 1999, the Company entered into, and subsequently amended, the
Takeda Agreement under which the Company licensed to Takeda exclusive U.S. and
Canadian commercialization rights to citicoline. Under the Takeda Agreement,
the Company received $13,000,000 in licensing and other payments and was
entitled to receive up to $60,000,000 in payments contingent upon the
achievement of regulatory milestones, as well as royalties on net sales.
Takeda recently notified the Company of its decision not to participate in the
further development of citicoline, thereby terminating the Takeda Agreement.
Therefore, the Company has reacquired all rights to this compound. The Company
does not intend to further develop citicoline unless it is able to find
another partner to participate in such development. Takeda has also indicated
that it will exercise its option under the Takeda Agreement to negotiate a
license of another one of the Company's compounds. Takeda has the right until
April 1, 2001 to negotiate a license for a chosen compound and an additional
six month period during which the Company may not offer the compound selected
by Takeda to any other party on terms more favorable than those offered to
Takeda without first re-offering such compound to Takeda on such new terms.

  In fiscal 2000, the Company recognized $10,000,000 as license fee revenue
from Takeda and $3,000,000 related to the product option as deferred revenue.

 PRO 2000

  In June 2000, the Company licensed exclusive, worldwide rights from HDCI to
develop and market PRO 2000, a candidate topical microbicide used to prevent
infection by HIV and other sexually transmitted pathogens, in exchange for an
up front payment of $500,000, which was paid and charged to research and
development expense, as well as future milestone payments and royalties on net
sales. The Company is responsible for all remaining development and
commercialization activities for PRO 2000.

  In October 2000, dosing and follow-up for a Phase 1/Phase 2 clinical trial
of PRO 2000 was completed by the NIH at sites in the U.S. and South Africa. No
serious adverse events were reported, and a full analysis of the data is
ongoing. Additional government funded clinical testing is planned for 2001.

 Sarafem

  In June 1997, the Company licensed to Lilly worldwide, exclusive rights to
Interneuron's patent covering the use of fluoxetine to treat certain
conditions and symptoms associated with PMS. Lilly has received approval for
fluoxetine to treat PMDD and has begun marketing the drug under the trade name
Sarafem. The agreement provides for milestone payments and royalties based on
net sales in the United States. The Company expects to receive royalties on
future net sales of Sarafem. The maximum aggregate royalty payments to
Interneuron in any calendar year ranges from three to five million dollars and
are conditioned upon the achievement of net sales in the United States above
an annually escalating baseline. Royalties to the Company will terminate at
the end of the first two consecutive quarters in which 70% or less of total
Prozac prescriptions are "dispensed as written."

                                      38
<PAGE>

Based on a recent federal court of appeals ruling, Lilly's composition of
matter patent on fluoxetine will expire in the summer of 2001. Lilly has
announced their intention to appeal the decision. If Lilly's appeal is not
successful, potential royalty payments to the Company under this agreement may
expire in early 2002.

 Redux

  Product Liability Litigation and Rejected Settlement: On September 15, 1997,
the Company announced a market withdrawal of its first prescription product,
the weight loss medication Redux (dexfenfluramine hydrochloride capsules) C-
IV, which had been launched by AHP, the Company's licensee, in June 1996.
Since the withdrawal of Redux, Interneuron has been named, together with other
pharmaceutical companies, as a defendant in approximately 3,200 product
liability legal actions, some of which purport to be class actions, in federal
and state courts involving the use of Redux and other weight loss drugs. To
date, there have been no judgments against the Company, nor has Interneuron
paid any amounts in settlement of any of these claims. Following the dismissal
and the anticipated dismissal of Interneuron as a defendant in certain cases,
the Company estimates that there will be approximately 2,300 active cases.

  On September 27, 1999, the Company announced that the District Court
rejected a proposed agreement among the Company and the PMC to settle all
product liability litigation and claims against the Company related to Redux.
The District Court found that the proposed settlement did not meet the
requirements for limited fund class actions, as described by the Supreme Court
in its June 23, 1999 decision in Ortiz. The District Court also vacated the
stays of pending and future litigation that were previously in effect. The
Company filed a petition with the U.S. Court of Appeals for the Third Circuit
on October 12, 1999, seeking review of the District Court's ruling and on
April 13, 2000 moved to dismiss such petition. Such motion was granted on
April 25, 2000. As a result of the District Court's rejection of the proposed
settlement agreement, the ongoing Redux-related litigation is proceeding
against the Company. In October 2000, the District Court returned $1,757,000
to the Company from the initial payment the Company made to the District Court
pursuant to the proposed settlement. The Company reflected this amount at
September 30, 2000 as a receivable and as a credit to costs and expenses under
the caption product withdrawal.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP product liability litigation related to Redux and
Pondimin. The Company is not a released party under this settlement.

  Interpleader Litigation and Funding of Product Liability Litigation
Costs: On November 20, 1998, December 30, 1998 and February 5, 1999, the
Company's three product liability insurers filed interpleader actions against
Servier and the Company in the District Court. Product liability insurance
policies issued in three tiers by the insurers to the Company have an
aggregate limit of $40,000,000. The insurers alleged that the Company asserted
claims against these policies, a substantial portion of which has been used in
the Company's defense of the litigation, and Servier, as an additional insured
under these policies, asserted its right to claim against these policies. The
insurers deposited the Deposited Funds which are subject to ongoing claims by
the Company and Servier into the registry of the District Court. In October
2000, the District Court dismissed the interpleader actions and has issued or
is expected to issue orders to return the Deposited Funds to the insurance
companies. In January 2000, the Company commenced paying legal bills
associated with the Redux litigation out of its own funds. It is expected that
the insurance companies will resume paying the Company's litigation expenses
and reimburse the Company for litigation expenses previously paid by the
Company. See "Liquidity and Capital Resources--Analysis of Cash Flows."

  Complaint Against AHP: In January 2000, the Company announced it has filed a
complaint against AHP in the Superior Court of the Commonwealth of
Massachusetts. The complaint seeks unspecified but substantial damages and
attorneys' fees pursuant to common and statutory law for AHP's knowing and
willful deceptive acts and practices, fraud and misrepresentations and breach
of contract. AHP has filed an answer to such complaint. The Company cannot
predict its costs relative to this litigation or the duration or outcome of
the proceedings.

                                      39
<PAGE>

  Risk Management: Although the Company maintains certain product liability
and director and officer liability insurance and intends to defend these and
similar actions vigorously, the Company has and may continue to devote
significant management time and resources to these legal actions and, in the
event of successful uninsured or insufficiently insured claims, or in the
event a successful indemnification claim were made against the Company, the
Company's business, financial condition and results of operations could be
materially adversely affected. In addition, the uncertainties and costs
associated with these legal actions have had, and may continue to have, an
adverse effect on the market price of the Company's Common Stock and on the
Company's ability to obtain additional financing to satisfy cash requirements,
to retain and attract qualified personnel, to develop and commercialize
products on a timely and adequate basis, to acquire or obtain rights to
additional products, to enter into certain corporate partnerships, or to
obtain product liability insurance for other products at costs acceptable to
the Company, or at all, any or all of which may materially adversely affect
the Company's business and financial condition. The Company cannot predict the
outcome of any litigation.

Results of Operations

 Fiscal Year Ended September 30, 2000 Compared to Fiscal Year Ended September
30, 1999

  The Company had net income of $19,956,000, or $0.46 per share, diluted, in
fiscal 2000 compared to a net loss of ($37,762,000), or ($0.90) per share,
diluted, in fiscal 1999. This substantial change to net income from net loss
is primarily the result of $26,750,000 of contract and license fee revenue
from the Takeda and Pfizer Agreements entered into in December 1999, the
substantial reduction of costs in fiscal 2000 related to the Phase 3
citicoline clinical trial that ended in January 2000 and the absence in fiscal
2000 of the results of operations of Incara which resulted in a net loss in
fiscal 1999. In July 1999, the Company exchanged its majority position in
Incara for a majority position in CPEC LLC, after which the Company no longer
consolidates the results of Incara's operations. Additionally, in fiscal 2000,
the Company recorded a gain on sales of Incara stock, a credit for the return
of funds from the District Court paid in September 1998 pursuant to the terms
of a proposed settlement agreement relating to the Redux product liability
litigation, and a credit to research and development expenses for costs
previously accrued relative to the Phase 3 citicoline clinical trial which
were determined to be unnecessary. The Company expects to report losses for
its consolidated operations in fiscal 2001.

  Contract and license fee revenue increased to $27,754,000 in fiscal 2000
from $1,599,000 in fiscal 1999. Contract and license fee revenue in fiscal
2000 included $16,750,000 received from Pfizer pursuant to the Pfizer
Agreement, including $3,000,000 received from Pfizer in September 2000
relating to Pfizer's achievement of a clinical trial milestone, $10,000,000
received from Takeda pursuant to the Takeda Agreement and $1,000,000 received
from Lilly relating to Lilly's approval from the FDA to market Sarafem to
treat PMDD in the U.S. Contract and license fee revenue in fiscal 1999
consisted primarily of $1,000,000 of milestone payments received from Lilly
relating to the development of Sarafem and contract revenue at Incara.

  Cost of revenues of $3,024,000 in fiscal 2000 consists primarily of
$2,800,000 related to the amount due or paid to Aventis for their portion of
the contractual and milestone payments received by the Company from Pfizer and
$200,000 due to MIT for their portion of the milestone payment received by the
Company from Lilly. Cost of revenues of $200,000 in fiscal 1999 relates to the
amount paid to MIT for their portion of the milestone payment received by the
Company from Lilly in fiscal 1999.

  Research and development expense decreased $32,352,000, or 91%, to
$3,158,000 in fiscal 2000 from $35,510,000 in fiscal 1999. This decrease was
substantially due to the absence in fiscal 2000 of Incara expenses, less
expense related to citicoline due to the completion of the 899-person Phase 3
citicoline clinical trial in January 2000 and reduced expenses related to
pagoclone. Contributing to the decrease in research and development expense in
fiscal 2000 were credits recorded in fiscal 2000 reflecting the reversal of
costs accrued relative to the Phase 3 citicoline clinical trial which were
determined to be unnecessary, a reversal of costs accrued and related to
pagoclone development which was determined to be unnecessary subsequent to the
Pfizer Agreement, and a reversal of costs accrued relative to the
discontinuation of bucindolol development.

                                      40
<PAGE>

  Selling, general and administrative expense decreased $4,207,000, or 38%, to
$6,823,000 in fiscal 2000 from $11,030,000 in fiscal 1999. This decrease was
primarily due to the absence in fiscal 2000 of Incara expenses and diminished
charges for restricted stock awards granted pursuant to the Company's 1997
Equity Incentive Plan partially offset by increased legal and consulting
costs. Additionally, personnel-related costs decreased in fiscal 2000 as a
result of workforce reductions and attrition in fiscal 2000.

  Investment income, net decreased $321,000, or 15%, to $1,868,000 in fiscal
2000 from $2,189,000 in fiscal 1999. This decrease is primarily due to the
absence in fiscal 2000 of Incara investment income, net while Interneuron's
average invested cash balances were slightly higher.

  Gain on sales of investment securities of $1,550,000 in fiscal 2000 resulted
from the Company's sale of 288,000 shares of Incara common stock.

  Minority interest in fiscal 2000 is attributable to the consolidation of
CPEC LLC and in fiscal 1999 was primarily attributable to the consolidation of
Incara. As described above, Incara's results of operations are not
consolidated with the Company's in fiscal 2000.

  The Company may incur significant future charges to operations relating to
Redux product liability litigation or any settlement thereof.

 Fiscal Year Ended September 30, 1999 Compared to Fiscal Year Ended September
30, 1998

  Contract and license fee revenues decreased $4,889,000, or 75%, to
$1,599,000 in fiscal 1999 from $6,488,000 in fiscal 1998. The decrease in
contract and license fee revenue was primarily the result of the absence in
fiscal 1999 of revenue generated by Incara from Astra Merck, Inc. ("Astra
Merck") due to the termination in September 1998 of the Development and
Marketing Collaboration and License Agreement between Astra Merck, Incara and
CPEC, Inc. (the "Astra Merck Collaboration") and decreased revenue from Merck
& Co., Inc. ("Merck") related to product development at Incara Research
Laboratories ("IRL"), a division of Incara which assumed the operations of
Transcell after the merger of Transcell into Incara. These decreases were
partially offset by milestone fees from Lilly relating to the Company's
license to Lilly of rights to commercialize fluoxetine for the treatment of
PMS in the United Kingdom.

  Research and development expenses decreased $4,252,000, or 11%, to
$35,510,000 in fiscal 1999 from $39,762,000 in fiscal 1998. Research and
development expense at Interneuron decreased primarily due to reduced noncash
compensation expense related to Interneuron's 1997 Equity Incentive Plan and
the absence of expense in fiscal 1999 for a Redux-related echocardiogram study
and the Phase 2/3 pagoclone study. These decreases were partially offset by
increased expenses related to the 899-person Phase 3 citicoline clinical trial
which commenced in June 1998. As a result of the CPEC Exchange Transactions,
the Company's consolidated results of operations included Incara through July
15, 1999. Accordingly, expenses relating to Incara decreased in fiscal 1999
because Incara's operations were included in the Company's results of
operations for only nine and one half months in fiscal 1999. However, fiscal
1999 research and development expenses include estimated charges of
approximately $650,000 related to the Company's decision to discontinue BEXTRA
development.

  Selling, general and administrative expenses decreased $10,945,000, or 50%,
to $11,030,000 in fiscal 1999 from $21,975,000 in fiscal 1998. These decreases
resulted primarily from reduced noncash compensation expense related to the
Company's 1997 Equity Incentive Plan, the absence of costs of the Company's
sales force resulting from its May 1998 dismissal and the absence of
citicoline pre-marketing expenses that were incurred in fiscal 1998.

  Purchase of in-process research and development increased $1,921,000 to
$2,421,000 in fiscal 1999 from $500,000 in fiscal 1998. Fiscal 1999 expense
relates to the Company's acquisition of an increased ownership interest in
CPEC. Fiscal 1998 expense relates to a cash payment to obtain an option, which
was not exercised, to acquire a private company engaged in early stage product
development.

                                      41
<PAGE>

  Investment income, net decreased $3,276,000, or 60%, to $2,189,000 in fiscal
1999 from $5,465,000 in fiscal 1998 primarily as a result of a decrease in
cash available for investment.

  The Company fully reserved its investment in Progenitor at September 30,
1998 due to Progenitor's December 1998 decision to close its business and
included such charge in equity in unconsolidated subsidiary in fiscal 1998. In
fiscal 1999, as a result of net proceeds expected from Progenitor's sales of
assets and payment of liabilities, the Company recorded a receivable from
Progenitor of $250,000 and reflected this amount as equity in net income of
unconsolidated subsidiary. See Note M of Notes to Consolidated Financial
Statements.

  Minority interest increased $3,141,000, or 82%, to $6,980,000 in fiscal 1999
from $3,839,000 in fiscal 1998 because there was a larger percentage of
minority stockholders at Incara than there was at IRL to whom to allocate the
loss generated by IRL, and from the inclusion in fiscal 1999 of a loss
allocation to the minority stockholders of CPEC LLC.

  There was no loss from operations of InterNutria in fiscal 1999 because
costs to discontinue InterNutria operations were accrued in fiscal 1998 and
reflected in discontinuation of InterNutria in fiscal 1998. In fiscal 1999,
the Company determined certain costs for the discontinuation of InterNutria
would not be incurred and recorded an $816,000 reduction in such accrued costs
which was recorded as a credit to discontinuation of InterNutria in 1999.

  Net loss decreased $32,200,000, or 46%, to ($37,762,000) in fiscal 1999 from
($69,962,000) in fiscal 1998 for the reasons described above. Net loss per
share decreased to ($0.90) in fiscal 1999 from ($1.69) in fiscal 1998.

  The Company recognized approximately $3,000,000 of noncash expense in fiscal
1999 as a result of grants of Restricted Stock Awards under the Company's 1997
Equity Incentive Plan.

Liquidity and Capital Resources

 Cash, Cash Equivalents and Marketable Securities

  At September 30, 2000, the Company had consolidated cash, cash equivalents
and marketable securities of $33,751,000 compared to $21,811,000 at September
30, 1999. This increase of $11,940,000 is primarily due to approximately
$30,750,000 received from Takeda, Pfizer and Lilly pursuant to the Takeda,
Pfizer and Lilly Agreements less costs and expenses and net amounts used to
fund operations in fiscal 2000, including approximately $6,218,000 paid to the
group of law firms defending the Company in the Redux-related product
liability litigation for which the Company expects to be reimbursed in fiscal
2001 by its product liability insurers. See "Analysis of Cash Flows" and "Part
I, Item 3. Legal Proceedings".

  While the Company believes it has sufficient cash for currently planned
expenditures through fiscal 2001 based on certain assumptions relating to
operations and other factors, excluding any settlements of the Redux-related
litigation by and against the Company, it will require additional funds after
such time. The Company has reduced its overhead and expenditures. In February
2000, the Company reduced its workforce by 11 people. This reduction and
additional attrition has brought the Company's workforce to 18 employees as of
September 30, 2000. The Company does not currently have sufficient funds to
fully-develop and commercialize any of its current products and product
candidates and will require additional funds or corporate collaborations for
the development and commercialization of trospium, PRO 2000 and its other
compounds and technologies, as well as any new businesses, products or
technologies acquired or developed in the future. The Company has no
commitments or arrangements to obtain such funds. If such funds are not
available, the Company will be required to further reduce its operations and
delay development and regulatory efforts. As a result of the uncertainties and
costs associated with the Redux-related litigation, including the fact that no
settlement agreements exist or are pending and the stays of pending and future
product liability litigation and claims against the Company have

                                      42
<PAGE>

been vacated by the court, market conditions and other factors generally
affecting the Company's ability to raise capital, there can be no assurance
that the Company will be able to obtain additional financing to satisfy future
cash requirements or that any financing will be available on terms favorable
or acceptable, or at all.

 Product Development

  The Company expects to continue to expend substantial additional amounts for
the development of its products. There can be no assurance that results of any
on-going current or future pre-clinical or clinical trials will be successful,
that additional trials will not be required, that any drug or product under
development will receive FDA approval in a timely manner or at all, or that
such drug or product could be successfully manufactured in accordance with
cGMP or successfully marketed in a timely manner, or at all, or that the
Company will have sufficient funds to commercialize any of its products.

 Analysis of Cash Flows

  Cash provided from operating activities during fiscal 2000 of $9,729,000
consisted primarily of net income and an increase in deferred revenue offset
by payments relating to the Company's temporary funding of Redux-related
product liability defense costs (discussed below) and a reduction of accrued
expenses and other liabilities from payments of and adjustments to clinical
development costs.

  Reflected in insurance claim receivable at September 30, 2000 of $8,435,000
is $6,218,000 which the Company paid through September 30, 2000 to the group
of law firms defending the Company in the Redux-related product liability
litigation and an additional $2,217,000 which the Company owes to such law
firms for services rendered through September 30, 2000 (see Part I, Item 3.
Legal Proceedings). The Company is currently paying these law firms' fees at
the rate of approximately $2,200,000 per quarter. The Company currently
intends to pay such fees until the Company can be reimbursed out of the
Deposited Funds. In October 2000, the District Court dismissed the
interpleader actions and has issued or is expected to issue orders to return
the Deposited Funds to the insurance companies. It is expected that the
insurance companies will resume paying the Company's litigation expenses and
reimburse the Company in fiscal 2001 for litigation expenses previously paid
by the Company. If the Company is unable to obtain reimbursement for this
claim, the Company may incur charges to write-off all or a portion of the
$8,435,000 insurance claim receivable.

  Cash used by investing activities in fiscal 2000 of $4,635,000 consisted
primarily of net outflows from purchases of marketable securities and
partially offset by proceeds from the sale of Incara stock.

Other

  Investment in Incara: In March 2000, the Company received from Incara
approximately 488,000 shares of Incara common stock valued at approximately
$1,627,000 as the third and final installment for the sale of Transcell to
Incara in May 1998. As of September 30, 2000, the Company owned 482,000 shares
of Incara common stock. The Company's investment in Incara at September 30,
2000 is valued at $1,627,000 using Incara's fair market value as of the close
of business on September 30, 2000 of approximately $3.38 per share. As of the
close of business on December 14, 2000, the fair market value of Incara's
common stock was approximately $2.63 per share.

  Recent Accounting Pronouncements: In June 1998, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. SFAS No. 133 requires companies to
recognize all derivatives as either assets or liabilities, with the
instruments measured at fair value. The accounting for changes in fair value,
gains or losses, depends on the intended use of the derivative and its
resulting designation. In June 1999,

                                      43
<PAGE>

the FASB issued SFAS No. 137 which defers the effective date of adoption of
SFAS No. 133 to fiscal years beginning after June 15, 2000. The Company
believes the adoption of SFAS No. 133 will not have a material impact on its
financial statements.

  In December 1999, the U.S. Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), which clarifies the SEC's views related to revenue
recognition and disclosure. In June 2000, the SEC issued SAB 101B which delays
the implementation date of SAB 101. The Company will adopt SAB 101 in the
fourth quarter of fiscal 2001 and is presently determining the effect it will
have on its financial statements.

  Other: In November 1998, pursuant to an agreement with Servier to resolve a
withholding tax issue on Redux-related payments to Servier, the Company paid
to the U.S. Internal Revenue Service approximately $1,700,000 for withholding
tax and interest. Servier agreed to reimburse the Company for a portion of the
withholding taxes upon Servier's receipt of a related tax refund from the
French tax authorities. In May 2000, the Company received reimbursement for
the withholding taxes it sought from Servier.

  Call options held by Swiss Bank Corporation, London Branch for the purchase
of 1,000,000 shares of the Company's Common Stock at an exercise price of
$36.00 per share on each of December 30 and 31, 1999 expired without exercise.

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk

  Not applicable.

ITEM 8. Financial Statements and Supplementary Data

  The response to this item is included in a separate section of this Report.
See "Index to Consolidated Financial Statements" on Page F-1.

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

  Not applicable.

                                   PART III

  The information required by Item 10: Directors and Executive Officers of the
Registrant; Item 11: Executive Compensation; Item 12: Security Ownership of
Certain Beneficial Owners and Management; and Item 13: Certain Relationships
and Related Transactions will be included in and is incorporated by reference
from the Company's definitive proxy statement to be filed pursuant to
Regulation 14A within 120 days after the close of its fiscal year.

                                    PART IV

ITEM 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K

  (a) 1. Financial Statements

      An index to Consolidated Financial Statements appears on page F-1.

    2. Schedules

      All financial statement schedules are omitted because they are not
    applicable, not required under the instructions or all the information
    required is set forth in the financial statements or notes thereto.

                                      44
<PAGE>

    (b) Reports on Form 8-K

      No reports on Form 8-K were filed during the three month period ended
    September 30, 2000.

    (c) Exhibits

<TABLE>
 <C>      <S>
 3.4      --Restated Certificate of Incorporation of Registrant, as amended(22)
 3.5      --By-Laws of Registrant(1)
 4.4      --Certificate of Designation establishing Series C Preferred Stock(10)
 4.8      --1997 Equity Incentive Plan and Form of Restricted Stock Award
           Agreement thereunder(25)
 10.5     --Consultant and Non-competition Agreement between the Registrant,
           Richard Wurtman, M.D.(17)
 10.6     --Assignment of Invention and Agreement between Richard Wurtman,
           M.D., Judith Wurtman and the Registrant(1)
 10.7     --Management Agreement between the Registrant and Lindsay Rosenwald,
           M.D.(1)
 10.9(a)  --Restated and Amended 1989 Stock Option Plan(4)
 10.11    --Restated Amendment to MIT Option Agreement(1)
 10.12(a) --Patent and Know-How License Agreement between the Registrant and
           Les Laboratoires Servier ("Servier") dated February 7, 1990
           ("License Agreement")(1)
 10.12(b) --Revised Appendix A to License Agreement(1)
 10.12(c) --Amendment Agreement between Registrant and Servier, Orsem and Oril
           Produits Chimiques dated November 19, 1992(2)(6)
 10.12(d) --Amendment Agreement dated April 28, 1993 between Registrant and
           Servier(19)
 10.12(e) --Consent and Amendment Agreement among Servier, American Home
           Products Corp. and Registrant(17)
 10.13    --Trademark License Agreement between the Registrant and Orsem dated
           February 7, 1990(1)
 10.14    --Supply Agreement between the Registrant and Oril Produits Chimiques
           dated February 7, 1990(1)(2)
 10.16    --Assignment of Invention by Richard Wurtman, M.D. (1)
 10.22(a) --License Agreement dated January 15, 1993, as amended, between the
           Registrant and Grupo Ferrer(2)(9)
 10.22(b) --Addendum and Second Amendment to License Agreement between the
           Registrant and Ferrer Internacional S.A., dated June 1, 1998(28)
 10.25    --License Agreement between the Registrant and the Massachusetts
           Institute of Technology(3)
 10.37    --License Agreement dated as of February 15, 1992 between the
           Registrant and Massachusetts Institute of Technology(5)
 10.40    --Patent and Know-How Sublicense and Supply Agreement between
           Registrant and American Cyanamid Company dated November 19,
           1992(2)(6)
 10.41    --Equity Investment Agreement between Registrant and American
           Cyanamid Company dated November 19, 1992(6)
 10.42    --Trademark License Agreement between Registrant and American
           Cyanamid Company dated November 19, 1992(6)
 10.44    --Consent Agreement between Registrant and Servier dated November
           19,1992(12)
 10.45    --Agreement between Registrant and PAREXEL International Corporation
           dated October 22, 1992 (as of July 21, 1992)(2)(7)
 10.46    --License Agreement dated February 9, 1993 between the Registrant and
           Massachusetts Institute of Technology(2)(8)
 10.52    --License Agreement dated February 18, 1994 between Registrant and
           Rhone-Poulenc Rorer, S.A.(11)
 10.55    --Patent License Agreement between Registrant and Massachusetts
           Institute of Technology dated March 1, 1994(11)
</TABLE>

                                       45
<PAGE>

<TABLE>
 <C>      <S>
 10.58    --Master Equipment Lease including Schedules and Exhibits between
           Phoenix Leasing and Registrant (agreements for Transcell and
           Progenitor are substantially identical), with form of continuing
           guarantee for each of Transcell and Progenitor(12)
 10.59    --Exhibit D to Agreement between Registrant and Parexel International
           Corporation dated as of March 15, 1994(2)(12)
 10.60(a) --Acquisition Agreement dated as of May 13, 1994 among the
           Registrant, Intercardia, Inc., Cardiovascular Pharmacology
           Engineering Consultants, Inc. (CPEC), Myocor, Inc. and the sellers
           named therein(13)
 10.60(b) --Amendment dated June 15, 1994 to the Acquisition Agreement(23)
 10.61    --License Agreement dated December 6, 1991 between Bristol-Myers
           Squibb and CPEC, as amended(2)(13)
 10.61(a) --Letter Agreement dated November 18, 1994 between CPEC and Bristol-
           Myers Squibb(14)
 10.65(a) --1994 Long-Term Incentive Plan, as amended(23)
 10.67    --Employment Agreement between Intercardia and Clayton I. Duncan with
           Registrant guarantee(25)
 10.68(a) --Interneuron Pharmaceuticals, Inc. 1995 Employee Stock Purchase
           Plan, as amended(19)
 10.71    --Securities Purchase Agreement dated June 2, 1995 between the
           Registrant and Reliance Insurance Company, including Warrant and
           exhibits(15)
 10.74    --Securities Purchase Agreement dated as of August 16, 1995 between
           the Registrant and BT Holdings (New York), Inc., including Warrant
           issued to Momint (nominee of BT Holdings)(16)
 10.78    --Contract Manufacturing Agreement dated November 20, 1995 between
           Registrant and Boehringer Ingelheim Pharmaceuticals, Inc.(2)(17)
 10.83    --Co-promotion Agreement effective June 1, 1996 between Wyeth-Ayerst
           Laboratories and Interneuron Pharmaceuticals, Inc.(2)(18)
 10.84    --Master Consulting Agreement between Interneuron Pharmaceuticals,
           Inc. and Quintiles, Inc. dated July 12, 1996(18)
 10.85    --Amendment No. 1 dated July 3, 1996 to Master Consulting Agreement
           between Interneuron Pharmaceuticals, Inc. and Quintiles, Inc. dated
           July 12, 1996(2)(18)
 10.86    --Lease Agreement between Transcell Technologies, Inc. and Cedar
           Brook Corporate Center, L.P., dated September 19, 1996, with
           Registrant guaranty(20)
 10.87    --Lease dated February 5, 1997 between Registrant and Ledgemont
           Realty Trust(21)
 10.89    --Form of ISDA Master Agreement by and between the Registrant and
           Swiss Bank Corporation, London Branch, together with Schedules
           thereto(23)
 10.90(a) --Form of Confirmation for Contract A entered into pursuant to ISDA
           Master Agreement by and between the Registrant and Swiss Bank
           Corporation, London Branch, together with appendix thereto(23)
 10.90(b) --Form of Confirmation for Contract B entered into pursuant to ISDA
           Master Agreement by and between the Registrant and Swiss Bank
           Corporation, London Branch, together with appendix thereto(23)
 10.90(c) --Letter Amendment dated September 18, 1997 to Confirmations filed as
           Exhibits 10.90(a) and 10.90(b)(26)
 10.91    --Form of Agreement regarding Registration Rights and Related
           Obligations to be entered into by and between Registrant and Swiss
           Bank Corporation, London Branch(23)
 10.92    --Research and Collaboration and License Agreement effective as of
           June 30, 1997 by and among Merck & Co., Inc., Transcell
           Technologies, Inc. and the Registrant (assigned to Intercardia as of
           May 8, 1998)(2)(24)
 10.93    --Form of Indemnification Agreement between Registrant and each
           director, executive officer and certain officers of the Registrant
           entered into as of October 6, 1997(26)
 10.94    --1998 Employee Stock Option Plan(27)
 10.95    --Agreement and Plan of Merger dated March 2, 1998 by and among
           Registrant, Intercardia, Inc. and Transcell Technologies, Inc.(28)
 10.95(a) --Waiver and Consent Agreement dated May 8, 1998 by and among
           Registrant, Intercardia and Transcell(28)
</TABLE>

                                       46
<PAGE>

<TABLE>
 <C>    <S>
 10.96  --Assignment and Assumption and Royalty Agreement between Intercardia
         and Registrant dated May 8, 1998(29)
 10.97  --License Agreement between Registrant and the Administrators of the
         Tulane Educational Fund dated April 29, 1998(29)
 10.98  --Letter of Understanding between the Registrant and the Plaintiffs'
         Management Committee dated September 3, 1998(30)
 10.99  --Agreement of Compromise and Settlement, including Appendices, dated
         September 21, 1998, between the Registrant and the Plaintiffs'
         Management Committee(31)
 10.100 --Royalty Agreement between the Registrant and the Plaintiffs'
         Management Committee effective as of September 21, 1998(32)
 10.102 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Michael W. Rogers dated and effective as of February 23, 1999(34)
 10.103 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Bobby W. Sandage, Jr. dated and effective as of March 15, 1999(34)
 10.104 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Mark S. Butler dated and effective as of March 15, 1999(34)
 10.105 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Glenn L. Cooper, M.D. dated and effective as of May 1, 1999(34)
 10.106 --Agreement of Sublease between Interneruon Pharmaceuticals, Inc.,
         Sublandlord and Genta, Inc., Subtenant dated March 31, 1999(34)
 10.107 --Consent to Sublease dated March 31, 1999 by and among Ledgemont
         Realty Trust, Interneuron Pharmaceuticals, Inc., and Genta, Inc. (34)
 10.108 --Exchange Agreement dated July 15, 1999 between Intercardia, Inc. and
         Interneuron Pharmaceuticals, Inc. (35)
 10.109 --Amended and Restated Limited Liability Company Agreement of CPEC LLC
         dated July 15, 1999 among CPEC LLC, Interneuron Pharmaceuticals, Inc.
         and Intercardia, Inc.(35)
 10.110 --Assignment, Assumption and License Agreement dated July 15, 1999 by
         and between CPEC LLC and Intercardia, Inc.(35)
 10.111 --Extension of Term and Supplemental Agreement made as of July 7, 1999
         by and between Interneuron Pharmaceuticals, Inc., and J. Howard &
         Associates(36)
 10.112 --Consent to Sublease dated as of July 9, 1999 by and between
         Interneuron Pharmaceuticals, Inc., and J. Howard & Associates and
         Ledgemont Realty Trust(36)
 10.113 --License Agreement effective as of November 26, 1999 between Madaus AG
         and Interneuron Pharmaceuticals, Inc.(37) (2)
 10.114 --License Agreement effective as of December 2, 1999 by and between
         Interneuron Pharmaceuticals, Inc. and Takeda Chemical Industries,
         Ltd.(37) (2)
 10.116 --License Agreement between Interneuron Pharmaceuticals, Inc. and
         Warner-Lambert Company effective as of December 23, 1999(38) (2)
 10.117 --License Agreement by and between HeavenlyDoor.com, Inc. and
         Interneuron Pharmaceuticals, Inc. dated June 14, 2000(39) (2)
 10.118 --Fiscal 2001 Senior Executive Bonus Plan, as adopted by the Board of
         Directors on September 13, 2000
 21     --List of Subsidiaries
 23     --Consent of PricewaterhouseCoopers LLP
 27     --Financial Data Schedule
</TABLE>
--------
(1)   Incorporated by reference to the Registrant's Registration Statement on
      Form S-1 (File No. 33-32408) declared effective on March 8, 1990.
(2)   Confidential Treatment granted for a portion of this Exhibit.
(3)   Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the year ended September 30, 1990.

                                      47
<PAGE>

(4)   Incorporated by reference to Post-Effective Amendment No. 2 to the
      Registrant's Registration Statement on Form S-1 (File No. 33-32408)
      filed December 18, 1991.
(5)   Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1992.
(6)   Incorporated by reference to the Registrant's Form 8-K dated November
      30, 1992.
(6a)  Incorporated by reference to Post-Effective Amendment No. 5 to the
      Registrant's Registration Statement on Form S-1 (File No. 33-32408)
      filed on December 21, 1992.
(7)   Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1992.
(8)   Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended December 31, 1992
(9)   Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1993.
(10)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended June 30, 1993.
(11)  Incorporated by reference to the Registrant's Registration Statement on
      Form S-3 or Amendment No. 1 (File no. 33-75826).
(12)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1994.
(13)  Incorporated by reference to the Registrant's Form 8-K dated June 20,
      1994.
(14)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1994.
(15)  Incorporated by reference to the Registrant's Report on Form 8-K dated
      June 2, 1995.
(16)  Incorporated by reference to the Registrant's Report on Form 8-K dated
      August 16, 1995.
(17)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1995.
(18)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q or 10-Q/A for the period ended June 30, 1996.
(19)  Incorporated by reference to Amendment No. 1 to Registrant's
      Registration Statement on Form S-3 (File No. 333-1273) filed March 15,
      1996.
(20)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1996.
(21)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended December 31, 1996.
(22)  Incorporated by reference to Exhibit 3.5 of the Registrant's Quarterly
      Report on Form 10-Q for the period ended March 31, 1997.
(23)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1997.
(24)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended June 30, 1997.
(25)  Incorporated by reference to the Registrant's Form S-8 (File No. 333-
      40315) filed November 14, 1997.
(26)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1997.
(27)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended December 31, 1997.
(28)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1998.
(29)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended June 30, 1998.
(30)  Incorporated by reference as to Exhibit 99.1 of Registrant's Form 8-K
      dated September 3, 1998.
(31)  Incorporated by reference as to Exhibit 99.2 of Registrant's From 8-K
      dated September 28, 1998.
(32)  Incorporated by reference as to Exhibit 99.3 of Registrant's Form 8-K
      dated September 28, 1998.

                                      48
<PAGE>

(34)  Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended March 31, 1999.
(35)  Incorporated by reference to Registrant's Form 8-K dated July 27, 1999.
(36)  Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended June 30, 1999.
(37)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1999.
(38)  Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended December 31, 1999.
(39)  Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended June 30, 2000.

                                      49
<PAGE>

                                  SIGNATURES

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

                                          INTERNEURON PHARMACEUTICALS, INC.

                                                  /s/ Glenn L. Cooper M.D.
Date: December 21, 2000                   By: _________________________________
                                                   Glenn L. Cooper, M.D.
                                                 President, Chief Executive
                                                    Officer and Chairman

  Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons in the capacity and
as of the date indicated.

<TABLE>
<CAPTION>
                 Name                            Title                   Date
                 ----                            -----                   ----

<S>                                    <C>                        <C>
       /s/ Glenn L. Cooper M.D.        President, Chief Executive  December 21, 2000
______________________________________  Officer and Chairman
        Glenn L. Cooper, M.D.           (Principal Executive
                                        Officer)

            /s/ Harry Gray             Director                    December 21, 2000
______________________________________
              Harry Gray

      /s/ Alexander M. Haig, Jr.       Director                    December 21, 2000
______________________________________
        Alexander M. Haig, Jr.

         /s/ Malcom Morville           Director                    December 21, 2000
______________________________________
           Malcolm Morville

                                       Director                    December  , 2000
______________________________________
       Lindsay Rosenwald, M.D.

         /s/Lee J. Schroeder           Director                    December 21, 2000
______________________________________
           Lee J. Schroeder

        /s/ David B. Sharrock          Director                    December 21, 2000
______________________________________
          David B. Sharrock

        /s/ Michael W. Rogers          Executive Vice President,   December 21, 2000
______________________________________  Chief Financial Officer,
          Michael W. Rogers             and Treasurer (Principal
                                        Financial Officer)

           /s/ Dale Ritter             Senior Vice President,      December 21, 2000
______________________________________  Finance, (Principal
             Dale Ritter                Accounting Officer)
</TABLE>

                                      50
<PAGE>

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
                      Audited Financial Statements
Report of Independent Accountants........................................  F-2
Consolidated Balance Sheets--September 30, 2000 and 1999.................  F-3
Consolidated Statements of Operations--For the years ended September 30,
 2000, 1999 and 1998.....................................................  F-4
Consolidated Statements of Stockholders' Equity--For the years ended Sep-
 tember 30, 2000, 1999, and 1998.........................................  F-5
Consolidated Statements of Cash Flows--For the years ended September 30,
 2000, 1999, and 1998 ...................................................  F-7
Notes to Consolidated Financial Statements...............................  F-8
</TABLE>

                                      F-1
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of Interneuron Pharmaceuticals,
Inc.:

  In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of
Interneuron Pharmaceuticals, Inc. and its subsidiaries at September 30, 2000
and 1999, and the results of their operations and their cash flows for each of
the three years in the period ended September 30, 2000 in conformity with
accounting principles generally accepted in the United States of America.
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 of these statements in accordance
with auditing standards generally accepted in the United States of America,
which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.

                                          /s/ PricewaterhouseCoopers LLP

Boston, Massachusetts
November 14, 2000, except as to the
information in Note N for which
the date is December 14, 2000

                                      F-2
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

                          CONSOLIDATED BALANCE SHEETS

                    (Amounts in thousands except share data)

<TABLE>
<CAPTION>
                                                    September 30, September 30,
                                                        2000          1999
                                                    ------------- -------------
<S>                                                 <C>           <C>
                      ASSETS
Current assets:
  Cash and cash equivalents........................   $  24,871     $  19,354
  Marketable securities............................       8,880         2,457
  Accounts receivable..............................         433           785
  Insurance claim receivable.......................       8,435           --
  Settlement deposit receivable....................       1,757           --
  Prepaids and other current assets................         677         1,812
                                                      ---------     ---------
    Total current assets...........................      45,053        24,408
Investment in Incara...............................       1,627         1,827
Property and equipment, net........................         146           403
                                                      ---------     ---------
                                                      $  46,826     $  26,638
                                                      =========     =========
                    LIABILITIES
Current liabilities:
  Accounts payables................................   $     122     $     157
  Accrued expenses.................................      15,604        20,100
  Deferred revenue.................................       3,000           --
  Current portion of capital lease obligations.....           2            68
                                                      ---------     ---------
    Total current liabilities......................      18,728        20,325
Long-term portion of capital lease obligations.....         --              2
Minority interest..................................         332           189

Commitments and obligations (Notes F and G)

               STOCKHOLDERS' EQUITY

Preferred stock; $.001 par value, 5,000,000 shares
 authorized:
  Series B, 239,425 shares issued and outstanding
   (liquidation preference at September 30, 2000
   $3,026) ........................................       3,000         3,000
  Series C, 5,000 shares issued and outstanding
   (liquidation preference at September 30, 2000
   $502)...........................................         500           500
Common stock; $.001 par value, 80,000,000 shares
 authorized:
  42,780,492 and 42,019,426 shares issued and
   outstanding at September 30, 2000 and 1999,
   respectively....................................          43            42
Additional paid-in capital.........................     274,011       272,337
Accumulated deficit................................    (249,802)     (269,758)
Accumulated other comprehensive income.............          14             1
                                                      ---------     ---------
    Total stockholders' equity.....................      27,766         6,122
                                                      ---------     ---------
                                                      $  46,826     $  26,638
                                                      =========     =========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                   statements

                                      F-3
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                  (Amounts in thousands except per share data)

<TABLE>
<CAPTION>
                                                     For the years ended
                                                        September 30,
                                                  ---------------------------
                                                   2000      1999      1998
                                                  -------  --------  --------
<S>                                               <C>      <C>       <C>
Contract and license fee revenues................ $27,754  $  1,599  $  6,488
Costs and expenses:
  Cost of revenues...............................   3,024       200       --
  Research and development.......................   3,158    35,510    39,762
  Selling, general and administrative............   6,823    11,030    21,975
  Product withdrawal.............................  (1,757)      --        --
  Purchase of in-process research and
   development...................................     --      2,421       500
                                                  -------  --------  --------
  Total costs and expenses.......................  11,248    49,161    62,237
Income (loss) from operations....................  16,506   (47,562)  (55,749)
Investment income, net...........................   1,868     2,189     5,465
Equity in net income (loss) of unconsolidated
 subsidiary......................................     175       250    (4,040)
Gain on sale of equity securities................   1,550       --        --
Impairment of equity securities..................     --       (435)      --
Minority interest................................    (143)    6,980     3,839
                                                  -------  --------  --------
Income (loss) from continuing operations.........  19,956   (38,578)  (50,485)
Discontinued operations (see Note M):
  Loss from operations of InterNutria............     --        --    (17,151)
  Discontinuation of InterNutria.................     --        816    (2,326)
                                                  -------  --------  --------
Net Income (loss)................................ $19,956  $(37,762) $(69,962)
                                                  =======  ========  ========
Income (loss) per common share--basic and
 diluted:
  Income (loss) from continuing operations:
    Basic........................................ $  0.47  $  (0.92) $  (1.22)
    Diluted...................................... $  0.46  $  (0.92) $  (1.22)
  Loss from operations of InterNutria--basic and
   diluted.......................................     --        --   $  (0.41)
  Discontinuation of InterNutria--basic and
   diluted.......................................     --   $   0.02  $  (0.06)
  Net income (loss):
    Basic........................................ $  0.47  $  (0.90) $  (1.69)
    Diluted...................................... $  0.46  $  (0.90) $  (1.69)
  Weighted average common shares:
    Basic........................................  42,487    41,898    41,468
                                                  =======  ========  ========
    Diluted......................................  43,838    41,898    41,468
                                                  =======  ========  ========
</TABLE>


   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-4
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                         (Dollar amounts in thousands)

<TABLE>
<CAPTION>
                                                        Preferred
                                     Common Stock         Stock
                                 -------------------- --------------
                                                      Number         Additional
                                 Number of  Par Value   of            Paid-In
                                   Shares    Amount   Shares  Amount  Capital
                                 ---------- --------- ------- ------ ----------
<S>                              <C>        <C>       <C>     <C>    <C>
Balance at September 30, 1997..  41,226,293    $41    244,425 $3,500  $255,693
Proceeds from exercise of stock
 options and warrants..........      17,500                               (125)
Proceeds from offering of
 Employee Stock
 Purchase Plan.................      14,726                                 85
Dividends on preferred stock...                                            (35)
Issuance of common stock for
 technology rights.............      57,310                               (787)
Gain on issuance of stock by
 subsidiary....................                                          2,212
Stock-based compensation and
 other.........................     501,188      1                      11,235
Comprehensive loss:
  Net loss.....................
  Unrealized net loss on
   marketable
   securities..................
  Total comprehensive loss.....
                                 ----------    ---    ------- ------  --------
Balance at September 30, 1998..  41,817,017     42    244,425  3,500   268,278
Proceeds from exercise of stock
 options.......................      14,400                                 12
Proceeds from offering of
 Employee
 Stock Purchase Plan...........      16,647                                 25
Dividends on preferred stock...                                            (35)
Stock-based compensation and
 other.........................     171,362                              4,057
Comprehensive loss:
  Net loss.....................
  Unrealized net loss on
   marketable
   securities..................
  Total comprehensive loss.....
                                 ----------    ---    ------- ------  --------
Balance at September 30, 1999..  42,019,426     42    244,425  3,500   272,337
Proceeds from exercise of stock
 options.......................     112,014                                462
Proceeds from offering of
 Employee
 Stock Purchase Plan...........      13,197                                 28
Dividends on preferred stock...                                            (35)
Stock-based compensation and
 other.........................     635,855      1                       1,219
Comprehensive income:
  Net income...................
  Unrealized net gain on
   marketable
   and equity securities.......
  Total comprehensive income...
                                 ----------    ---    ------- ------  --------
Balance at September 30, 2000..  42,780,492    $43    244,425 $3,500  $274,011
                                 ==========    ===    ======= ======  ========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-5
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (cont.)

                         (Dollar amounts in thousands)

<TABLE>
<CAPTION>
                                        Accumulated      Treasury Stock
                                           Other     -----------------------
                          Accumulated  Comprehensive Number of Stockholders'  Total   Comprehensive
                            Deficit    Income (Loss)  Shares      Amount     Equity   Income (Loss)
                          -----------  ------------- --------- ------------- -------  -------------
<S>                       <C>          <C>           <C>       <C>           <C>      <C>
Balance at September 30,
 1997...................  $ (162,034)       $85        70,483     $(1,276)   $96,009
Proceeds from exercise
 of stock options and
 warrants...............                              (15,000)        281        156
Proceeds from offering
 of Employee Stock
 Purchase Plan..........                                                          85
Dividends on preferred
 stock..................                                                         (35)
Issuance of common stock
 for technology rights..                              (55,483)        995        208
Gain on issuance of
 stock by subsidiary....                                                       2,212
Stock-based compensation
 and other..............                                                      11,236
Comprehensive loss:
  Net loss..............     (69,962)                                        (69,962)   $(69,962)
  Unrealized net loss on
   marketable
   securities...........                    (53)                                 (53)        (53)
                                                                                        --------
  Total comprehensive
   loss.................                                                                $(70,015)
                          ----------        ---       -------     -------    -------    ========
Balance at September 30,
 1998...................    (231,996)        32           --          --      39,856
Proceeds from exercise
 of stock options.......                                                          12
Proceeds from offering
 of Employee Stock
 Purchase Plan..........                                                          25
Dividends on preferred
 stock..................                                                         (35)
Stock-based compensation
 and other..............                                                       4,057
Comprehensive loss:
  Net loss..............     (37,762)                                        (37,762)   $(37,762)
  Unrealized net loss on
   marketable
   securities...........                    (31)                                 (31)        (31)
                                                                                        --------
  Total comprehensive
   loss.................                                                                $(37,793)
                          ----------        ---       -------     -------    -------    ========
Balance at September 30,
 1999...................    (269,758)         1           --          --       6,122
Proceeds from exercise
 of stock options.......                                                         462
Proceeds from offering
 of Employee Stock
 Purchase Plan..........                                                          28
Dividends on preferred
 stock..................                                                         (35)
Stock-based compensation
 and other..............                                                       1,220
Comprehensive income:
  Net income............      19,956                                          19,956    $ 19,956
  Unrealized net gain on
   marketable and equity
   securities...........                     13                                   13          13
                                                                                        --------
  Total comprehensive
   income...............                                                                $ 19,969
                          ----------        ---       -------     -------    -------    ========
Balance at September 30,
 2000...................  $(249,802)        $14           --      $    --    $27,766
                          ==========        ===       =======     =======    =======
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-6
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                       For the years ended
                                                          September 30,
                                                    ---------------------------
                                                     2000      1999      1998
                                                    -------  --------  --------
<S>                                                 <C>      <C>       <C>
Cash flows from operating activities:
  Net income (loss)...............................  $19,956  $(37,762) $(69,962)
  Adjustments to reconcile net income (loss) to
   net cash provided by (used in) operating
   activities:
  Depreciation and amortization...................      206       933     2,409
  Minority interest in net income (loss) of
   consolidated subsidiaries......................      143    (6,980)   (3,839)
  Equity in (income) loss of unconsolidated
   subsidiary.....................................     (175)     (250)    4,040
  Purchase of in-process research and
   development....................................      --      2,421       --
  Loss on disposal of property and equipment......       25       --        --
  Gain on sale of equity securities...............   (1,550)      --        --
  Noncash compensation............................    1,184     4,437    11,624
  Impairment of equity securities.................      --        435       --
  Discontinuation of InterNutria .................      --       (816)    1,106
  Change in assets and liabilities, net of effects
   from deconsolidation:
   Accounts receivable............................      352       719      (139)
   Insurance claim receivable.....................   (8,435)      --        --
   Settlement deposit receivable..................   (1,757)      --        --
   Prepaid and other assets.......................    1,310      (795)      763
   Accounts payable...............................      (35)     (612)     (281)
   Deferred revenue...............................    3,000       --       (750)
   Accrued expenses and other liabilities.........   (4,495)   (4,507)  (11,969)
                                                    -------  --------  --------
Net cash provided by (used in) operating
 activities.......................................    9,729   (42,777)  (66,998)
                                                    -------  --------  --------
Cash flows from investing activities:
  Capital expenditures............................      (16)     (287)   (1,308)
  Proceeds from sales of property and equipment...       42       --        --
  Purchases of marketable securities..............  (13,773)   (4,971)  (28,992)
  Proceeds from maturities and sales of marketable
   securities.....................................    7,357    32,627    80,469
  Proceeds from sale of equity securities.........    1,755       --        --
  Cash of deconsolidated subsidiary...............      --     (4,679)      --
                                                    -------  --------  --------
Net cash (used in) provided by investing
 activities.......................................   (4,635)   22,690    50,169
                                                    -------  --------  --------
Cash flows from financing activities:
  Net proceeds from issuance of common and
   treasury stock.................................      491        37       242
  Net proceeds from issuance of stock by
   consolidated subsidiaries......................      --        677       201
  Proceeds from notes payable.....................      --        --        460
  Principal payments of notes payable.............      --       (136)     (122)
  Principal payments of capital lease
   obligations....................................      (68)     (467)     (442)
                                                    -------  --------  --------
Net cash provided by financing activities.........      423       111       339
                                                    -------  --------  --------
Net change in cash and cash equivalents...........    5,517   (19,976)  (16,490)
Cash and cash equivalents at beginning of period..   19,354    39,330    55,820
                                                    -------  --------  --------
Cash and cash equivalents at end of period........  $24,871  $ 19,354  $ 39,330
                                                    =======  ========  ========
Supplemental discolosure of financing and
 investing activities:
  Cash payments for interest......................  $     4  $    218  $    268
                                                    =======  ========  ========
  Property and equipment obtained through
   financing arrangements.........................  $    --  $     --  $    159
                                                    =======  ========  ========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                      F-7
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A. Nature of the Business

  Interneuron Pharmaceuticals, Inc. ("Interneuron" or the "Company") is a
biopharmaceutical company engaged in the development and commercialization of
a diversified portfolio of product candidates, including multiple compounds in
late stage clinical development. The Company is currently developing or has
certain rights to five compounds in clinical development: pagoclone for panic
and generalized anxiety disorders, trospium for overactive bladder, IP 501 for
cirrhosis of the liver, citicoline for ischemic stroke, and PRO 2000 for the
prevention of sexually transmitted diseases and human immunodeficiency virus
("HIV") infection. In addition, the Company has other compounds in earlier
stages of development, including PACAP (pituitary adenylate cyclase activating
polypeptide) for respiratory diseases, diabetes, stroke and other
neurodegenerative diseases.

  The Company has also engaged in the development of products and technologies
through subsidiaries: CPEC LLC, a consolidated subsidiary, focused on the
development of BEXTRA for congestive heart failure; Incara Pharmaceuticals
Corporation ("Incara", formerly Intercardia, Inc.), a public company and a
consolidated subsidiary through July 15, 1999, focused on cardiovascular
disease and carbohydrate-based drug discovery; InterNutria, Inc.
("InterNutria"), a consolidated subsidiary, focused on dietary supplement
products and Progenitor, Inc. ("Progenitor"), a consolidated subsidiary
through August 11, 1997, focused on functional genomics using developmental
biology. As of September 30, 1998, InterNutria was classified as a
discontinued operation. Progenitor is being liquidated pursuant to
Progenitor's December 1998 determination to discontinue operations. As of
September 30, 1999, the Company determined to discontinue BEXTRA development
and the operations of CPEC LLC. (See Note M.)

  On September 15, 1997, the Company and Wyeth-Ayerst Laboratories ("Wyeth-
Ayerst"), a division of American Home Products Corp. ("AHP") announced a
withdrawal of the weight loss medication Redux(TM) (dexfenfluramine
hydrochloride capsules) C-IV. The market withdrawal of Redux resulted in the
recognition of certain charges to operations and accrued liabilities in fiscal
1997. In addition, the Company has been named in, and has initiated, certain
legal actions. (See Note G.)

  The Company is subject to a number of risks, including those common to
companies in the pharmaceutical and biotechnology industries, such as
litigation, product development and regulatory approval, product liability,
need for additional funds, competition, dependence on third parties for
manufacturing and marketing, dependence on key personnel, protection of
proprietary technology, compliance with FDA government regulations and
uncertainties regarding the outcome of Redux-related litigation and/or
settlements of such litigation.

B. Summary of Significant Accounting Policies

  Basis of Presentation: The consolidated financial statements include the
accounts of the Company and its majority-owned subsidiaries. Transcell
Technologies, Inc. ("Transcell") was a majority-owned subsidiary through May
8, 1998 at which time it was merged into Incara (see Note M). Incara was a
majority-owned subsidiary until July 15, 1999, after which, pursuant to the
CPEC Exchange Transactions (see Note M), it was no longer consolidated. All
significant intercompany accounts and transactions have been eliminated.
Investments in subsidiary companies which are less than majority but greater
than 20% owned are reflected using the equity method of accounting.

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

                                      F-8
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Cash, Cash Equivalents and Marketable Securities: The Company invests
available cash primarily in short-term bank deposits, money market funds, U.S.
commercial paper and domestic and foreign government securities. Cash and cash
equivalents includes investments with maturities of three months or less at
date of purchase. Marketable securities consist of investments purchased with
maturities greater than three months and are classified as noncurrent if they
mature one year or more beyond the balance sheet date. The Company classifies
its investments in debt securities as either held-to-maturity or available-
for-sale based on facts and circumstances present at the time the investments
are purchased. At September 30, 2000 and 1999, all investments held were
classified as "available-for-sale." Investments are stated at fair value with
unrealized gains and losses included as a component of accumulated other
comprehensive income until realized. The fair value of these securities is
based on quoted market prices.

  Property and Equipment: Property and equipment are stated at cost. The
Company provides for depreciation using the straight-line method based upon
the following estimated useful lives:

<TABLE>
   <S>                           <C>
   Office equipment............. 2 to 5 years
   Laboratory equipment......... 5 years
   Leasehold improvements....... Shorter of lease term or estimated useful life
</TABLE>

  Expenses for repairs and maintenance are charged to operations as incurred.
Upon retirement or sale, the cost of the assets disposed and the related
accumulated depreciation are removed from the accounts and any resulting gain
or loss is credited or charged, respectively, to operations.

  Revenue Recognition: Contract and license fee revenue consists of technology
license-related payments, contractual research milestone payments, sales and
marketing payments, research and development grants and contractual research
and development funding and is recognized when services are performed or when
contractual obligations are met. Cash received in advance of revenue
recognition is recorded as deferred revenue.

  Research and Development: Research and development costs are expensed in the
period incurred.

  Advertising Costs: Advertising costs are expensed in the period incurred.

  Income Taxes: Deferred tax liabilities and assets are recognized based on
temporary differences between the financial statement basis and tax basis of
assets and liabilities using current statutory tax rates. A valuation
allowance against net deferred tax assets is established if, based on the
available evidence, it is more likely than not that some or all of the
deferred tax assets will not be realized.

  Accounting for Stock-Based Compensation: The Company adopted the disclosure-
only alternative permitted under Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
which changed measurement, recognition and disclosure standards for stock-
based compensation. The Company measures stock-based compensation in
accordance with Accounting Principles Board Opinion No. 25 ("APB Opinion No.
25") and related interpretations, including FASB Interpretation No. 44. The
Company has disclosed pro forma net income and loss and pro forma net income
and loss per share for fiscal 2000, 1999 and 1998 in Note H using the fair
value method.

  Issuance of Stock by a Subsidiary: Gains on the issuance of common stock by
a subsidiary are included in net income unless the subsidiary is a research
and development, start-up or development stage company or an entity whose
viability as a going concern is uncertain. In those situations the Company
accounts for the change in its proportionate share of the subsidiary's net
assets resulting from the additional equity raised by the subsidiary as an
equity transaction and credits any resulting gain to additional paid-in
capital.

                                      F-9
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Comprehensive Income: Components of comprehensive income or loss are net
income or loss and all other non-owner changes in equity such as the change in
the cumulative gain or loss on marketable securities. The Company presents
comprehensive income (loss) in its consolidated statements of stockholders'
equity.

  Components of accumulated other comprehensive income or loss consist of the
following:

<TABLE>
<CAPTION>
                                                        September 30,
                                                  --------------------------
                                                   2000     1999      1998
                                                  ------- --------  --------
   <S>                                            <C>     <C>       <C>
   Change in unrealized gains (losses) on
    marketable and equity securities............. $13,000 $(31,000) $(53,000)
                                                  ------- --------  --------
   Accumulated other comprehensive income
    (loss)....................................... $13,000 $(31,000) $(53,000)
                                                  ======= ========  ========
</TABLE>

  Segment Information: The Company operates in one business segment, drug
development and commercialization. The Company follows the requirements of
SFAS No.131, "Disclosures about Segments of an Enterprise and Related
Information."

  Reclassification: Certain prior year amounts have been reclassified to
conform with fiscal 2000 classifications.

  Recent Accounting Pronouncements: In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts (collectively
referred to as derivatives), and for hedging activities. SFAS No. 133 requires
companies to recognize all derivatives as either assets or liabilities, with
the instruments measured at fair value. The accounting for changes in fair
value, gains or losses, depends on the intended use of the derivative and its
resulting designation. Management believes the effect of adoption SFAS No. 133
will not have a significant impact on its financial statements. In June 1999,
the FASB issued SFAS No. 137 which defers the effective date of adoption of
SFAS No. 133 to fiscal years beginning after June 15, 2000. The Company
believes the adoption of SFAS No. 133 will not have a material impact on its
financial statements.

  In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial
Statements" ("SAB 101"), which clarifies the SEC's views related to revenue
recognition and disclosure. In June 2000, the SEC issued SAB 101B which delays
the implementation date of SAB 101. The Company will adopt SAB 101 in the
fourth quarter of fiscal 2001 and is presently determining the effect it will
have on its financial statements.

C. Marketable Securities and Investment in Incara

 Marketable Securities

  Investments in marketable securities consisted of the following at September
30, 2000 and 1999:

<TABLE>
<CAPTION>
                                           2000                  1999
                                   --------------------- ---------------------
                                                Market                Market
                                      Cost      Value       Cost      Value
                                   ---------- ---------- ---------- ----------
   <S>                             <C>        <C>        <C>        <C>
   State government obligations... $1,000,000 $1,000,000 $      --  $      --
   U.S. corporate notes...........  7,876,000  7,880,000  2,456,000  2,457,000
                                   ---------- ---------- ---------- ----------
                                   $8,876,000 $8,880,000 $2,456,000 $2,457,000
                                   ========== ========== ========== ==========
</TABLE>

                                     F-10
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  At September 30, 2000, gross unrealized gains and losses on marketable
securities were $6,000 and $2,000, respectively. At September 30, 1999, gross
unrealized gains were $1,000 and there were no gross unrealized losses. All
marketable securities mature within one year of the balance sheet date on
which they are reported.

 Investment in Incara

  At September 30, 2000, Investment in Incara was comprised of 482,011 shares
of Incara common stock valued at $1,627,000.

  At September 30, 1999, Investment in Incara was comprised of the following:

    (i) 281,703 shares of Incara common stock valued at $185,000. In fiscal
  1999, the Company recorded a charge to operations of $435,000 to write down
  its investment in Incara as the decline in value was deemed other than
  temporary.

    (ii) a receivable of $1,642,000 due from Incara, payable in Incara common
  stock, in February 2000 relating to the third payment for the May 8, 1998
  sale of Transcell to Incara.

  See Note M.

D. Property and Equipment

  At September 30, 2000 and 1999, property and equipment consisted of the
following:

<TABLE>
<CAPTION>
                                                         2000         1999
                                                      -----------  -----------
   <S>                                                <C>          <C>
   Office equipment.................................. $   976,000  $ 1,045,000
   Leasehold improvements............................     362,000      547,000
                                                      -----------  -----------
                                                        1,338,000    1,592,000
   Less: accumulated depreciation and amortization...  (1,192,000)  (1,189,000)
                                                      -----------  -----------
                                                      $   146,000  $   403,000
                                                      ===========  ===========
</TABLE>

  Included in the above amounts are property and equipment under capital
leases of $261,000 and $277,000 at September 30, 2000 and 1999, respectively,
and related accumulated amortization of $257,000 and $201,000 at September 30,
2000 and 1999, respectively. Depreciation expense related to the assets under
capital leases amounted to $60,000, $335,000, and $612,000 for the years ended
September 30, 2000, 1999 and 1998, respectively. Assets financed through
capital leases consist primarily of office and laboratory equipment. The
Company paid $4,000, $137,000, and $173,000 in interest expense during the
years ended September 30, 2000, 1999 and 1998, respectively, related to these
capital leases.

  Depreciation and amortization expenses for the three years ended September
30, 2000, 1999 and 1998, were $206,000, $933,000, and $2,409,000,
respectively.

                                     F-11
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


E. Accrued Expenses

  At September 30, 2000 and 1999, accrued expenses consisted of the following:

<TABLE>
<CAPTION>
                                                           2000        1999
                                                        ----------- -----------
   <S>                                                  <C>         <C>
   Clinical and sponsored research..................... $ 2,499,000 $ 8,956,000
   Redux withdrawal....................................   7,604,000   7,641,000
   Compensation related................................   1,160,000   1,566,000
   Product license fees................................     950,000     100,000
   Redux product liability litigation legal fees.......   2,217,000         --
   Other...............................................   1,174,000   1,837,000
                                                        ----------- -----------
                                                        $15,604,000 $20,100,000
                                                        =========== ===========
</TABLE>

F. Commitments and Obligations

  The Company leases its facilities, as well as certain laboratory equipment
and furniture under non-cancelable operating leases. Rent expense under these
leases was approximately $738,000, $1,974,000, and $2,290,000 for the years
ended September 30, 2000, 1999 and 1998, respectively. The Company also leases
certain property and equipment under capital leases.

  At September 30, 2000, the Company's future minimum payments under non-
cancelable lease arrangements are as follows:

<TABLE>
<CAPTION>
                                                              Operating  Capital
   Fiscal Year                                                  Leases   Leases
   -----------                                                ---------- -------
   <S>                                                        <C>        <C>
   2001...................................................... $  692,000 $2,000
   2002......................................................    687,000    --
   2003......................................................    376,000    --
   Thereafter................................................        --     --
                                                              ---------- ------
     Total lease payments.................................... $1,755,000  2,000
                                                              ==========
     Less: amount representing interest......................               --
                                                                         ------
     Present value of net minimum lease payments.............            $2,000
                                                                         ======
</TABLE>

  The Company has guaranteed the first five years of the performance of Incara
under a lease agreement for Incara Research Laboratory's (formerly Transcell)
("IRL") facilities. If Incara defaults on such lease agreement, the Company
will become obligated to IRL's lessor. The remaining guaranteed obligation
pursuant to such lease is approximately $1,551,000 from October 2000 through
May 2002.

G. Withdrawal of Redux, Legal Proceedings, and Related Contingencies

  On September 15, 1997, the Company and Wyeth-Ayerst announced a market
withdrawal of the weight loss medication Redux, which was launched in June
1996. In connection with the market withdrawal of Redux, the Company recorded
as of September 30, 1997 certain charges aggregating approximately
$10,800,000. Total expenses relating to the market withdrawal of Redux may
exceed these amounts, which are estimates and do not include provisions for
liability, if any, arising out of Redux-related litigation or other related
costs.

  Interneuron has been named, together with other pharmaceutical companies, as
a defendant in approximately 3,200 product liability legal actions, many of
which purport to be class actions, in federal and state courts

                                     F-12
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

involving the use of Redux and other weight loss drugs. As a result of the
rejection by the District Court (as defined below) of the proposed settlement
agreement, the ongoing Redux-related litigation is proceeding against the
company. The existence of such litigation, including the time and expenses
associated with the litigation, may materially adversely affect the Company's
business, including its ability to obtain sufficient financing to fund
operations. Although the Company is unable to predict its expense, or the
outcome of, any such litigation, such outcome may materially adversely affect
the Company's future business, results of operations and financial condition.

  On September 27, 1999, the Company announced that the U.S. District Court
for the Eastern District of Pennsylvania (the "District Court") rejected a
proposed agreement among the Company and the Plaintiffs' Management Committee
("PMC") to settle all product liability litigation and claims against the
Company related to Redux. The District Court found that the proposed
settlement did not meet the requirements for limited fund class actions, as
described by the Supreme Court in its June 23, 1999 decision in Ortiz v.
Fibreboard Corp. ("Ortiz"). The District Court also vacated the stays of
pending and future litigation that were previously in effect. The Company
filed a petition with the U.S. Court of Appeals for the Third Circuit on
October 12, 1999, seeking review of the District Court's ruling and on April
3, 2000 the Company moved to dismiss such petition. Such motion was granted on
April 25, 2000. In October 2000, the District Court returned $1,757,000 to the
Company from the initial payment the Company made to the District Court
pursuant to the proposed settlement. The Company reflected this amount at
September 30, 2000 as a receivable and as a credit to costs and expenses under
the caption product withdrawal.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux
and Pondimin. The Company is not a released party under this settlement.

  On November 20, 1998, December 30, 1998 and February 5, 1999, the Company's
three product liability insurers filed actions against Les Laboratoires
Servier ("Servier") and the Company in the District Court, pursuant to the
federal interpleader statute. The aggregate limits of the three commercial
excess insurance policies issued by the insurers to the Company is $40,000,000
in tiers of $20,000,000, $5,000,000 in excess of $20,000,000, and $15,000,000
in excess of $25,000,000. The insurers alleged that the Company asserted
claims against these policies, a substantial portion of which has been used in
the Company's defense of the litigation, and Servier, as an additional insured
under these policies, asserted its right to claim against these policies. The
insurers deposited the available proceeds up to the limits of their policies
(the "Deposited Funds"), which are subject to ongoing claims by the Company
and Servier, into the registry of the District Court. On May 3, 2000, the
Company moved to dismiss such actions as moot in light of the District Court's
rejection of the Company's proposed settlement and the dismissal of the
Company's petition to appeal from such order. In October 2000, the District
Court dismissed the interpleader actions and has issued or is expected to
issue orders to return the Deposited Funds to the insurance companies. It is
expected that the insurance companies will resume paying the Company's
litigation expenses and reimburse the Company for litigation expenses
previously paid by the Company.

  Reflected in the insurance claim receivable at September 30, 2000 of
$8,435,000 is $6,218,000 which the Company paid through September 30, 2000 to
the group of law firms defending the Company in the Redux-related product
liability litigation and an additional $2,217,000 which the Company has
accrued for services rendered by such law firms through September 30, 2000
(see "Part I, Item 3. Legal Proceedings"). The Company currently intends to
pay such fees until the Company can be reimbursed out of the Deposited Funds.
If the Company is unable to obtain reimbursement for this claim, the Company
may incur charges to write-off all or a portion of the $8,435,000 insurance
claim receivable.

                                     F-13
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  On January 24, 2000, the Company announced it has filed a complaint against
AHP in the Superior Court of the Commonwealth of Massachusetts. The complaint
seeks unspecified but substantial damages and attorneys' fees pursuant to
common and statutory law for AHP's knowing and willful deceptive acts and
practices, fraud and misrepresentations and breach of contract. AHP has filed
an answer to such complaint. The Company cannot predict its costs relative to
this litigation or the duration or the outcome of the proceedings.

  The Company and certain present or former directors and/or officers of the
Company were named as defendants in several lawsuits, purporting to be class
actions, filed in the Massachusetts Federal Court by alleged purchasers of the
Company's Common Stock, claiming violation of the federal securities laws. On
February 2, 2000, the Massachusetts Federal Court entered the Final Judgment,
which, among other things, granted final judgment to and an approval of the
settlement of the lawsuits on a class-wide basis, covering a class period of
March 24, 1997 to July 8, 1997. No appeal was taken from the final judgment.
The settlement amount was entirely funded by insurance proceeds.

H. Stockholders' Equity

  Preferred Stock: The Certificate of Incorporation of the Company authorizes
the issuance of 5,000,000 shares of preferred stock. The Board of Directors
has the authority to issue preferred stock in one or more series and to fix
the rights, preferences, privileges and restrictions, including the dividend,
conversion, voting, redemption (including sinking fund provisions), and other
rights, liquidation preferences, and the number of shares constituting any
series and the designations of such series, without any further vote or action
by the stockholders of the Company. In fiscal 1993, the Company issued shares
of Series B and Series C Preferred Stock in connection with an agreement with
AHP. (See Note L.)

  Common Stock: During fiscal 1995, certain subsidiaries issued convertible
preferred stock through private placements (the "Subsidiaries' Private
Placements"). In connection with certain of the Subsidiaries' Private
Placements, the Company issued 239,938 warrants to purchase shares of the
Company's Common Stock exercisable at $4.63 per share until June 30, 1998, all
of which were exercised or expired. Additionally, investors in the private
placements had certain rights to cause the Company to purchase from them
certain amounts of the convertible preferred stock deemed to be illiquid but
in no circumstance for an amount greater than that initially paid by the
investor (the "Put Protection Rights"). All of the Company's potential
obligations under the Put Protection Rights expired without exercise.

  Stock Options and Warrants: The Company's 1989 Stock Option Plan (the "1989
Plan") expired in 1999, however incentive and non-qualified options granted to
employees, officers, directors and consultants pursuant to the 1989 Plan which
were outstanding as of the date of the 1989 Plan's expiration may be exercised
until cancelled. Under the Company's 1994 Long-Term Incentive Plan (the "1994
Plan"), incentive and non-qualified options to purchase 6,000,000 shares may
be granted. Under the 1998 Stock Option Plan (the "1998 Plan"), incentive and
non-qualified options to purchase 1,500,000 shares may be granted. Under the
Company's 2000 Stock Option Plan (the "2000 Plan"), incentive and non-
qualified options to purchase 2,500,000 shares may be granted. Under the 1994
Plan, the 1998 Plan, and the 2000 Plan, and under the 1989 Plan prior to its
expiration (collectively the "Option Plans"), employees and officers may be
granted incentive and non-qualified options and directors and consultants may
be granted non-qualified options. Persons who were executive officers or
directors of the Company as of the date of adoption of the 1998 Plan are not
eligible to receive grants under the 1998 Plan. The duration of each Plan is
ten years. The term of each grant under the 1989, 1994, and 2000 Plans cannot
exceed ten years and the term of each grant under the 1998 Plan cannot exceed
seven years.

                                     F-14
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  The Company has also granted outside of the Option Plans options to purchase
shares of the Company's Common Stock ("Non-Plan Options"). At September 30,
2000, 100,000 Non-Plan Options were outstanding.

  In May 1998, the Company's Board of Directors authorized the Company to
offer (the "May 1998 Exchange Offer") holders of outstanding options, issued
primarily pursuant to the Option Plans, and certain warrants to purchase the
Company's Common Stock which had exercise prices of $10.00 per share or
greater, the right to exchange such options and warrants for new options and
warrants (the "May 1998 New Options and Warrants") to purchase the same number
of shares represented by the outstanding original options and warrants at an
exercise price of $6.19 per share, the fair market value of the Company's
Common Stock determined as of May 5, 1998 (the "May 1998 Exchange Date"). The
May 1998 New Options and Warrants generally vest in six equal installments
every six months commencing November 1998. The term of each May 1998 New
Option or Warrant is the same as the remaining term of the respective original
option or warrant. Pursuant to the May 1998 Exchange Offer, 3,992,040 options
and 105,000 warrants were exchanged.

  In August 1998, the Company's Board of Directors authorized the Company to
offer (the "August 1998 Exchange Offer") holders of outstanding options,
issued primarily pursuant to the Option Plans and which were not subject to
the terms of the May 1998 Exchange Offer, the right to exchange such options
for new options (the "August 1998 New Options") to purchase the same number of
shares represented by the outstanding original options at an exercise price of
$4.16 per share, the fair market value of the Company's Common Stock
determined as of August 17, 1998 (the "August 1998 Exchange Date"). The August
1998 New Options generally vest in four installments: 30% in six months from
the August 1998 Exchange Date, 30% in twelve months from the August 1998
Exchange Date, 20% in eighteen months from the August 1998 Exchange Date, and
20% in twenty four months from the August 1998 Exchange Date. The term of each
August 1998 New Option is the same as the remaining term of the respective
original option. Pursuant to the August 1998 Exchange Offer, 2,144,401 options
were exchanged.

  Presented below under the caption "Stock Options" is all Plan and Non-Plan
option activity and under the caption "Warrants" is all warrant activity:

<TABLE>
<CAPTION>
                                  Stock Options               Warrants
                           ---------------------------- ----------------------
                                       Weighted Average             Warrant
                             Shares     Exercise Price   Shares      Price
                           ----------  ---------------- --------  ------------
<S>                        <C>         <C>              <C>       <C>
Outstanding at
 September 30, 1997.......  5,082,074       $13.39       831,157  $4.63-$23.25
Granted...................  8,555,641       $ 6.97       155,000  $6.19-$ 7.13
Exercised.................     (5,000)      $ 5.88       (27,500)       $ 4.63
Cancelled................. (7,242,392)      $12.72      (146,157) $4.63-$23.25
                           ----------                   --------
Outstanding at
 September 30, 1998.......  6,390,323       $ 5.57       812,500  $5.00-$12.77
Granted...................    624,667       $ 3.74           --
Exercised.................    (14,400)      $ 0.83           --
Cancelled.................   (364,813)      $ 7.29           --
                           ----------                   --------
Outstanding at
 September 30, 1999.......  6,635,777       $ 5.31       812,500  $5.00-$12.77
Granted...................  4,406,750       $ 2.68           --
Exercised.................   (112,014)      $ 5.03           --
Cancelled................. (1,235,596)      $ 5.39       (62,500)       $12.77
                           ----------                   --------
Outstanding at
 September 30, 2000.......  9,694,917       $ 4.12       750,000  $5.00-$10.00
                           ==========                   ========
</TABLE>

                                     F-15
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  At September 30, 2000, stock options were outstanding and exercisable as
follows:

<TABLE>
<CAPTION>
                           Outstanding                         Exercisable
                ----------------------------------------   ------------------------
                               Weighted
                                Average       Weighted                   Weighted
  Range of                     Remaining      Average                    Average
  Exercise                    Contractual     Exercise                   Exercise
   Price         Number          Life          Price        Number        Price
  --------      ---------     -----------     --------     ---------     --------
<S>             <C>           <C>             <C>          <C>           <C>
 $1.53-$2.06      526,250      8.8 years        $1.92         50,000      $1.53
 $2.38-$3.56    3,292,125      9.4 years        $2.39        472,925      $2.46
 $3.63-$5.00    2,944,168      3.8 years        $4.21      2,275,668      $4.25
 $6.00-$8.75    2,877,374      4.9 years        $6.20      1,851,738      $6.22
$9.87-$20.12       55,000      5.3 years       $15.18         55,000      $5.18
                ---------                                  ---------
$1.53-$20.12    9,694,917      6.3 years        $4.12      4,705,331      $4.95
                =========                                  =========
</TABLE>

  All outstanding options vest at various rates over periods up to four years
and expire at various dates from April 26, 2001 to August 14, 2010. At
September 30, 1999, 2,836,909 options were exercisable at a weighted average
exercise price of $5.36. At September 30, 1998, 757,772 options were
exercisable at a weighted average exercise price of $6.87.

  At September 30, 2000, warrants were outstanding and exercisable as follows:

<TABLE>
<CAPTION>
         Range of                        Number                                    Number
      Exercise Prices                  Outstanding                               Exercisable
      ---------------                  -----------                               -----------
      <S>                              <C>                                       <C>
      $5.00-7.88                         250,000                                   215,004
          $10.00                         500,000                                   500,000
                                         -------                                   -------
                                         750,000                                   715,004
                                         =======                                   =======
</TABLE>

  All outstanding warrants expire at various dates from September 16, 2001 to
July 17, 2006 and have a weighted average exercise price of $8.84 per share.

  Restricted Stock Awards: As an integral component of a management and
employee retention program designed to motivate, retain and provide incentive
to the Company's management and other employees, the Company's Board of
Directors adopted the 1997 Equity Incentive Plan in October 1997 (the "1997
Plan"). The 1997 Plan provides for the grant of restricted stock awards which
entitle the plan participants to receive up to an aggregate of 1,750,000
shares of the Company's Common Stock upon satisfaction of specified vesting
periods. As of September 30, 2000, restricted stock awards to acquire an
aggregate of 1,736,918 shares had been granted, net of forfeitures, to
employees of the Company primarily in consideration of services rendered by
the employee to the Company and payment of the par value of the shares. The
shares subject to the awards have been registered under the Securities Act of
1933 on a registration statement on Form S-8 and, accordingly, may be sold by
the 1997 Plan participants immediately upon vesting of the shares. In
accordance with the provisions of the 1997 Plan for automatic extension of
vesting during Black-Out Periods, as defined in the 1997 Plan, vesting of the
shares commenced in April 1998. Through September 30, 2000, 1,286,918 shares
have vested and been issued by the Company under the 1997 Plan. Vesting
continues through April 2002 on the 450,000 shares subject to awards at
September 30, 2000.

  The Company has incurred and will continue to incur compensation expense
from the date of grant of awards through the vesting period of shares subject
to restricted stock awards. The charges relating to the restricted stock
awards to acquire 1,736,918 shares are expected to aggregate approximately
$15,000,000, the
fair market value of the shares at the time of grant, of which approximately
$14,000,000 was incurred in aggregate through fiscal 2000, and the remainder
will be incurred through the final scheduled vesting periods in

                                     F-16
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

fiscal 2002. Such expense has been and is being allocated to research and
development and selling, general and administrative expense.

  Employee Stock Purchase Plan: The Company's 1995 Employee Stock Purchase
Plan (the "1995 Plan") covers an aggregate of 250,000 shares of Common Stock
which is offered in one-year offerings (an "Offering"). Each Offering is
divided into two six-month Purchase Periods (the "Purchase Periods"). Stock is
purchased at the end of each Purchase Period with employee contributions at
the lower of 85% of the last sale price of the Company's Common Stock on the
first day of an Offering or the last day of the related Purchase Period. At
September 30, 2000, 163,451 shares remain to be purchased under the 1995 Plan.

  Pro Forma Net Income (Loss) Information: Pro forma information regarding net
income (loss) shown below was determined as if the Company and its
consolidated subsidiaries had accounted for employee stock options and shares
purchased under stock purchase plans under the fair value method of SFAS No.
123. The fair value of each option grant is estimated on the date of the grant
using a Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants:

<TABLE>
<CAPTION>
                                                    2000      1999      1998
                                                  --------- --------- ---------
<S>                                               <C>       <C>       <C>
Dividend yield...................................        0%        0%        0%
Expected volatility..............................       90%       90%       90%
Risk-free interest rate.......................... 5.8%-6.6% 4.4%-5.8% 5.3%-5.6%
Expected option life.............................   3 years   4 years   4 years
  Weighted average grant date fair value:
  Interneuron:
    Options granted at fair market value.........     $1.38     $2.08     $3.87
    Options granted at greater than fair market
     value.......................................     $0.13       --        --
  Incara options granted at fair market value....       --      $3.89     $9.57
</TABLE>

  The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options. The Company's and its consolidated
subsidiaries' employee stock options have characteristics significantly
different from those of traded options such as vesting restrictions and
extremely limited transferability. In addition, the assumptions used in option
valuation models are highly subjective, particularly the assumption of
expected stock price volatility of the underlying stock. Changes in these
subjective assumptions can materially affect the fair value estimate.

  For the purpose of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. The pro forma effect
on net income (loss) for the fiscal years ended September 30, 2000, 1999, and
1998 may not be representative of the pro forma effect on net income or loss
in future years. The Company's pro forma information is as follows for the
fiscal years ended September 30, 2000, 1999, and 1998:

<TABLE>
<CAPTION>
                                  2000                    1999                        1998
                         ---------------------- --------------------------  --------------------------
                         As Reported Pro Forma  As Reported    Pro Forma    As Reported    Pro Forma
                         ----------- ---------- ------------  ------------  ------------  ------------
<S>                      <C>         <C>        <C>           <C>           <C>           <C>
Net income (loss)....... $19,956,000 $9,742,000 $(37,762,000) $(49,408,000) $(69,962,000) $(83,043,000)
Net income (loss) per
 share--basic...........       $0.47      $0.23       $(0.90)       $(1.18)       $(1.69)       $(2.00)
Net income (loss) per
 share--diluted.........       $0.46      $0.22       $(0.90)       $(1.18)       $(1.69)       $(2.00)
</TABLE>

  Call Options: In May 1997, the Company purchased in private transactions
from Swiss Bank Corporation, London Branch ("SBC") capped call options, which
were subsequently modified, on Interneuron Common Stock. As modified, these
call options gave Interneuron the right to purchase from SBC up to a total of
1,240,000

                                     F-17
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

shares of Interneuron Common Stock at a strike price of $14.50. In exchange
for the purchases of these call options, in lieu of cash purchase prices, the
Company sold to SBC call options entitling SBC to purchase from the Company at
a strike price of $36.00 per share, an aggregate of 2,000,000 shares of
Interneuron Common Stock, 1,000,000 shares on each of December 30 and 31,
1999. All call options expired without exercise.

  Other: In addition to the 42,780,000 shares of Common Stock outstanding at
September 30, 2000, there were approximately 17,850,000 shares of Common Stock
reserved for issuance ("Reserved Common Shares"). Included in the number of
Reserved Common Shares are the following: (i) 4,756,000 shares of Common Stock
reserved for issuance upon conversion of the Company's authorized but unissued
Preferred Stock; (ii) 622,000 shares of Common Stock issuable upon conversion
of issued and outstanding Preferred Stock; (iii) 463,000 shares reserved for
issuance under the 1997 Plan; (iv) 11,159,000 shares reserved for issuance
under the Option Plans and the 1995 Plan, (of which approximately 9,595,000
stock options were outstanding, not all of which were vested); and (v)
approximately 850,000 shares reserved for issuance from exercise of
outstanding warrants and Non-Plan Options.

I. Income Taxes

  At September 30, 2000 and 1999, the significant components of the Company's
deferred tax asset consisted of the following:

<TABLE>
<CAPTION>
                                                       2000          1999
                                                   ------------  -------------
   <S>                                             <C>           <C>
   Federal and state net operating loss
    carryforwards................................  $ 53,404,000  $  55,718,000
   Federal and state tax credit carryforwards....     4,802,000      4,647,000
   Capital loss carryforwards....................     8,338,000      7,160,000
   Accrued expenses..............................     8,620,000     10,602,000
   Investment in CPEC LLC........................     9,651,000      9,480,000
   Investment in unconsolidated subsidiaries.....    11,880,000     12,520,000
                                                   ------------  -------------
   Total deferred tax asset before valuation
    allowance....................................    96,695,000    100,127,000
   Valuation allowance against total deferred tax
    asset........................................   (96,695,000)  (100,127,000)
                                                   ------------  -------------
   Net deferred tax asset........................  $        --   $         --
                                                   ============  =============
</TABLE>

  At September 30, 2000, the Company had net operating loss carryforwards
available for federal income tax purposes of approximately $137,000,000 which
expire at various dates from 2004 to 2020. In addition, the Company had
approximately $3,300,000 of tax credit carryforwards for federal income tax
purposes expiring at various dates through 2015 and capital loss carryforwards
of approximately $21,000,000 for federal income tax purposes expiring at
various dates though 2005. The Company's ability to use the net operating loss
carryforwards may be subject to limitations resulting from ownership changes
as defined in the U.S. Internal Revenue Code. Approximately $12,500,000 of the
net operating loss carryforwards available for federal income tax purposes
relate to exercises of non-qualified stock options and disqualifying
disposition of incentive stock options, the tax benefit from which, if
realized, will be credited to additional paid-in capital.

  Due to the uncertainty surrounding the realization of favorable tax
attributes in future tax returns, all of the deferred tax assets have been
fully offset by a valuation allowance.


                                     F-18
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


J. Earnings Per Share

  The following table sets forth the computation of basic and diluted earnings
per share for the years ended September 30, 2000, 1999, and 1998:

<TABLE>
<CAPTION>
                                          2000         1999          1998
                                       ----------- ------------  ------------
   <S>                                 <C>         <C>           <C>
   Numerator for basic and diluted:
     Net income (loss)................ $19,956,000 $(37,762,000) $(69,962,000)
                                       =========== ============  ============
   Denominator for basic:
     Weighted average shares
      outstanding.....................  42,487,000   41,898,000    41,468,000
                                       =========== ============  ============
   Denominator for diluted:
     Weighted average shares
      outstanding.....................  42,487,000   41,898,000    41,468,000
     Stock options and stock issuable
      under employee compensation
      plans...........................     729,000          --            --
     Common stock issuable under
      outstanding convertible
      preferred stock.................     622,000          --            --
                                       ----------- ------------  ------------
                                        43,838,000   41,898,000    41,468,000
                                       =========== ============  ============
   Net income (loss) per common
    share--basic...................... $      0.47 $      (0.90) $      (1.69)
                                       =========== ============  ============
   Net income (loss) per common
    share--diluted.................... $      0.46 $      (0.90) $      (1.69)
                                       =========== ============  ============
</TABLE>

  During the year ended September 30, 2000, securities not included in the
computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i)
options to purchase 9,312,648 shares of Common Stock at prices ranging from
$2.38 to $20.13 with expiration dates ranging up to August 5, 2010; (ii)
warrants to purchase 750,000 shares of Common Stock with exercise prices
ranging from $5.00 to $10.00 and with expiration dates ranging up to July 17,
2006; and (iii) call options sold by the Company for 2,000,000 shares of
Common Stock with an exercise price of $36.00 and expiration dates ranging up
to December 31, 1999.

  During the year ended September 30, 1999, securities not included in the
computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i)
options to purchase 6,409,581 shares of Common Stock at prices ranging from
$5.88 to $20.13 with expiration dates ranging up to March 17, 2009; (ii)
warrants to purchase 812,500 shares of Common Stock with exercise prices
ranging from $5.00 to $12.77 and with expiration dates ranging up to July 17,
2006; and (iii) call options sold by the Company for 2,000,000 shares of
Common Stock with an exercise price of $36.00 and expiration dates ranging up
to December 31, 1999. Additionally, during the year ended September 30, 1999,
securities not included in the computation of diluted earnings per share,
because they would have an antidilutive effect due to the net loss for the
period, were as follows: (i) options to purchase 83,000 shares of Common Stock
at prices ranging from $1.53 to $3.13 with expiration dates ranging up to
September 15, 2006; (ii) Series B and C preferred stock convertible into
622,222 shares of Common Stock and (iii) unvested Restricted Stock Awards to
acquire 653,472 shares of Common Stock granted pursuant to the Company's 1997
Equity Incentive Plan.

  During the year ended September 30, 1998, securities not included in the
computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i)
options to purchase 301,625 shares of Common Stock at prices ranging from
$7.88 to $28.13 with expiration dates ranging up to May 5, 2007; (ii) warrants
to purchase 612,500 shares of Common Stock with exercise prices ranging from
$7.88 to $12.77 and with expiration dates ranging up to June 1, 2002; and
(iii) call options sold by the Company for 2,000,000 shares of Common Stock
with an exercise price of $36.00 and expiration dates

                                     F-19
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

ranging up to December 31, 1999. Additionally, during the year ended September
30, 1998, securities not included in the computation of diluted earnings per
share, because they would have an antidilutive effect due to the net loss for
the period, were as follows: (i) options to purchase 6,088,698 shares of
Common Stock at prices ranging from $0.83 to $7.25 with expiration dates
ranging up to March 3, 2008; (ii) warrants to purchase 200,000 shares of
Common Stock with exercise prices ranging from $5.00 to $7.13 and with
expiration dates ranging up to July 17, 2006; (iii) Series B and C preferred
stock convertible into 622,222 shares of Common Stock; and (iv) unvested
Restricted Stock Awards to acquire 725,146 shares of Common Stock granted
pursuant to the Company's 1997 Equity Incentive Plan.

K. Related Party Transactions

  The Company and certain of its subsidiaries have or had agreements with
certain directors, former directors and an officer who is not an employee of
the Company and parties related to directors to provide technical and other
consulting services. The total of such payments were approximately $225,000,
$315,000, and $414,000 in fiscal 2000, 1999, and 1998, respectively. In
addition to the above, (i) one related party was a principal investigator in a
clinical trial and received approximately $34,000 in fiscal 1998 for services
performed in that capacity and (ii) one director is the chairman and chief
executive officer of an entity that provided product distribution services for
certain InterNutria products to which InterNutria paid approximately $12,000
and $58,000 in fiscal 1999 and 1998, respectively.

  The Company made contributions of $55,000 and $147,000 in fiscal 1999 and
1998, respectively, to The Center for Brain Science and Metabolism Charitable
Trust of which one of the Company's former directors was the scientific
director.

L. Agreements

  Servier: In February 1990, the Company entered into a series of agreements,
subsequently amended, with Les Laboratoires Servier ("Servier") under which
the Company licensed U.S. marketing rights to Redux, in exchange for royalty
payments of 11.5% of net product sales. Additionally, these agreements
required the Company to purchase the bulk compound from an affiliate of
Servier. Interneuron agreed to indemnify Servier under certain circumstances
and Interneuron was required to name Servier as an additional insured on its
product liability insurance policies. (See Note G.)

  American Home Products: In November 1992, the Company entered into an
agreement with American Cyanamid Company (which subsequently was acquired by
AHP) for the development and marketing in the U.S. of Redux. In connection
with this agreement, AHP made certain milestone payments to the Company and
purchased from the Company the Series B and C Preferred Stock which is
outstanding at September 30, 2000 and 1999. Holders of Series B and C
Preferred Stock are entitled to receive mandatory dividends of $.13 and $1.00
per share, respectively, payable at the election of the Company in cash or
Common Stock. Such dividends are payable annually on April 1 of each year,
accrue on a daily basis and are cumulative. Holders of Series B and C
Preferred Stock are also entitled to a liquidation preference of $12.53 and
$100.00 per share, respectively, plus accumulated and unpaid dividends.
Holders of Series B and C Preferred Stock are entitled to convert such shares
into an aggregate of 622,222 shares of Common Stock (a conversion price of
$5.63 per share) subject to anti-dilution adjustments. Holders of the Series B
and C Preferred Stock are entitled to vote on all matters submitted to a vote
of stockholders other than the election of directors, generally holding the
number of votes equal to the number of shares of Common Stock into which such
shares of Preferred Stock are convertible. Additionally, the agreement with
AHP provides for royalty payments to the Company based upon net sales of Redux
and for AHP to share equally with the Company certain research and development
expenses. AHP has the right to terminate its sublicense upon twelve months
notice to the Company.

  On April 29, 1996, Redux received FDA clearance for marketing. The Company's
license agreement with AHP required AHP to pay base royalties equal to 11.5%
of AHP's net sales and additional royalties ranging

                                     F-20
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

from 5% of the first $50,000,000 of AHP's annual net sales if Redux is a
scheduled drug to 10% of AHP's annual net sales over $150,000,000. On
September 15, 1997, the Company and AHP announced a market withdrawal of
Redux. (See Note G.)

  Boehringer: In November 1995, the Company entered into a manufacturing
agreement with Boehringer Ingelheim Pharmaceuticals, Inc. ("Boehringer") under
which Boehringer agreed to supply, and the Company agreed to purchase, all of
the Company's requirements for Redux capsules. The contract contained certain
minimum purchase, insurance and indemnification commitments by the Company and
required conformance by Boehringer to the FDA's Good Manufacturing Practices
regulations. (See Note G.)

  Ferrer: In January 1993, the Company licensed from Ferrer Internacional,
S.A. ("Ferrer") exclusive rights in the U.S., Puerto Rico and Canada to
certain uses of citicoline, a drug under development for potential treatment
for ischemic stroke (the "Ferrer Agreement"). In June 1998, the Company
amended its agreement with Ferrer to extend to January 31, 2002 the date upon
which Ferrer may terminate the citicoline license agreement if FDA approval of
citicoline is not obtained. The agreement provides for such date to be
extended for up to two years if the Company provides information to Ferrer
which tends to establish that the Company has carried out the steps for
obtaining such approval and if such approval has not been obtained for reasons
beyond the Company's control. A license fee and future royalties on net sales
of citicoline were consideration provided to Ferrer.

  In June 1998, the Company licensed to Ferrer, on a worldwide basis except
for the U.S. and Canada, the use of Interneuron's patent rights relating to
the use of citicoline in the protection of brain tissue from cerebral
infarction following ischemic stroke. In exchange for the license to Ferrer,
Interneuron will be entitled to royalties from Ferrer on certain exports and
sales of the solid form of citicoline in certain countries upon its approval
in each relevant country.

  Takeda: In December 1999, the Company entered into an agreement with Takeda
Chemical Industries, Ltd. ("Takeda"), subsequently amended, under which the
Company licensed to Takeda exclusive U.S. and Canadian commercialization
rights to citicoline (the "Takeda Agreement"). Under the Takeda Agreement, the
Company received $13,000,000 in licensing and other payments, and was entitled
to receive up to $60,000,000 in payments contingent upon the achievement of
regulatory milestones, as well as royalties on net sales.

  The Takeda Agreement also provides an exclusive option to Takeda to
negotiate a license for any one alternative Interneuron compound, excluding
pagoclone and trospium, in the event Takeda decides to terminate the
citicoline license following a review of the 899-person Phase 3 clinical
trial. If Takeda exercises such exclusive option, Takeda has the right until
April 1, 2001 to negotiate a license for the chosen compound and an additional
six month period during which the Company may not offer the compound selected
by Takeda to any other party on terms more favorable than those offered to
Takeda without first re-offering such compound to Takeda on such new terms. If
Takeda exercises its option, all rights to citicoline will be returned to the
Company. In fiscal 2000, the Company recognized $10,000,000 of the Takeda
payments as license fee revenue and $3,000,000 related to the product option
as deferred revenue.

  The Company granted to Takeda a security interest in its patents relating to
citicoline, and in the event Takeda licenses a back-up compound, the Company
agreed to grant Takeda a security interest in the patents relating to such
back-up compound. Takeda also has the right to require the Company to assign
to Takeda intellectual property related to citicoline following the payment of
the milestone payment relating to the FDA acceptance of the NDA for
citicoline. The security interest and, if applicable, the assignment would be
released if the Company achieves certain financial criteria.

                                     F-21
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  Aventis: In February 1994, the Company entered into a license agreement with
Rhone-Poulenc Rorer, S.A. now Aventis S.A. ("Aventis"), granting the Company
an exclusive worldwide license (subject to Aventis' option to obtain a
sublicense in France) under Aventis' patent rights and know-how to
manufacture, use and sell pagoclone. In exchange, the Company paid a license
fee and agreed to pay Aventis' milestone payments and royalties based on net
sales. Interneuron also assumed responsibility for all clinical trials and
regulatory submissions relating to pagoclone.

  The license grants Interneuron the right to grant sublicenses on a worldwide
basis, subject to Aventis' written approval of the sublicensee, which approval
shall not be unreasonably withheld. The Company agreed to indemnify Aventis
under certain conditions and to maintain product liability insurance. Either
party may terminate the license agreement under certain conditions, including
material breach, insolvency or bankruptcy of the other.

  Pfizer: In December 1999, the Company entered into an agreement with the
Warner-Lambert Company, now Pfizer Inc. ("Pfizer"), under which it licensed to
Pfizer exclusive worldwide rights to develop and commercialize pagoclone (the
"Pfizer Agreement"). Under the Pfizer Agreement, in December 1999 the Company
received from Pfizer an initial payment of $13,750,000 and in September 2000 a
clinical milestone payment of $3,000,000 which were recognized as license fee
revenues in fiscal 2000, and the Company is entitled to receive up to
$57,000,000 in additional payments contingent upon the achievement of clinical
and regulatory milestones. Pfizer also agreed to pay Interneuron royalties on
net sales. Under the Pfizer Agreement, Pfizer is responsible for conducting
and funding all further clinical development, regulatory review, manufacturing
and marketing of pagoclone on a worldwide basis. Pursuant to the Aventis
Agreement, Aventis is entitled to receive a portion of certain of the payments
to be received by the Company from Pfizer. In fiscal 2000, the Company
recognized $2,800,000 of the amounts received from Pfizer, and paid or due to
Aventis, as cost of revenues.

  Madaus: In November 1999, the Company licensed exclusive U.S. rights from
Madaus AG ("Madaus") to trospium chloride, an orally-administered prescription
drug product for treatment for overactive bladder (urinary incontinence) in
Europe. In exchange, the Company has agreed to pay Madaus regulatory
milestone, royalty and sales milestone payments. The Company is responsible
for all clinical development and regulatory activities and costs related to
the compound in the U.S.

  HeavenlyDoor.com: In June 2000, the Company licensed exclusive worldwide
rights from HeavenlyDoor.com, Inc., formerly Procept, Inc. ("HDCI") to develop
and market PRO 2000, a candidate topical microbicide used to prevent infection
by HIV and other sexually transmitted pathogens, in exchange for an up front
payment of $500,000, which was paid and charged to research and development
expense in fiscal 2000, as well as future milestone payments and royalties on
net sales. The Company is responsible for all remaining development and
commercialization activities for PRO 2000.

  Lilly: In June 1997, the Company licensed to Eli Lilly & Company ("Lilly")
worldwide, exclusive rights to Interneuron's patent covering the use of
fluoxetine to treat certain conditions and symptoms associated with
premenstrual syndrome ("PMS"). Lilly has received approval for fluoxetine to
treat premenstrual dysphoric disorder ("PMDD"), a severe form of PMS, and has
begun marketing the drug under the trade name Sarafem. The agreement provides
for milestone payments and royalties based on net sales in the United States.
The maximum aggregate royalty payments to Interneuron in any calendar year
ranges from three to five million dollars and are conditioned upon the
achievement of net sales above an annually escalating baseline. Royalties to
the Company will terminate at the end of the first two consecutive quarters in
which 70% or less of total Prozac prescriptions are "dispensed as written."
The Company recognized in each of fiscal 2000 and fiscal 1999 $1,000,000 of
milestone payments relating to the marketing approval of Sarafem in the United
States and the United Kingdom as contract and license fee revenue.

                                     F-22
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


M. Subsidiaries

 Incara

  General

  Prior to fiscal 1997, Incara and Interneuron owned approximately 80% and
20%, respectively, of the outstanding common stock of CPEC, Inc. which had an
exclusive, worldwide license to bucindolol, a non-selective beta-blocker
currently under development for congestive heart failure. Bucindolol began a
Phase 3 clinical trial, the Beta-blocker Evaluation of Survival Trial
("BEST"), for treatment of congestive heart failure in cooperation with the
National Institutes of Health (the "NIH") and the Department of Veteran
Affairs (the "VA") in April 1995. The NIH and VA agreed to provide up to
$15,750,000 throughout the study and CPEC, Inc. was obligated to, and did, pay
an additional $2,000,000, through September 30, 1998, and was obligated to
fund other costs of the study including drug supply and clinical monitoring.
CPEC, Inc. was party to two development agreements relating to bucindolol: (i)
a December 1995 Development and Marketing Collaboration and License Agreement
(the "Astra Merck Collaboration") with Astra Pharmaceuticals LP, formerly
Astra Merck, Inc. ("Astra Merck") to provide for the development,
commercialization and marketing in the U.S. of a twice-daily formulation of
bucindolol; and (ii) a December 1996 agreement with BASF Pharma/Knoll AG
("Knoll") (the "Knoll Collaboration") to provide for the development,
manufacture and marketing of bucindolol in all countries with the exception of
the United States and Japan (the "Knoll Territory").

  The Astra Merck Collaboration was terminated in September 1998. Incara
received $5,000,000 upon execution of the Astra Merck Collaboration, and paid
Astra Pharmaceuticals LP $10,000,000 in December 1997, which had been accrued
as a liability at September 30, 1997. During the fiscal year ended September
30, 1998 the Company recognized contract revenue of approximately $4,833,000
(including a $4,000,000 termination fee) from payments made by Astra
Pharmaceuticals LP to Incara. During the fiscal year ended September 30, 1998
Astra Merck assumed additional liabilities of approximately $6,065,000 on
Incara's behalf. These additional amounts did not impact the Company's
Consolidated Statements of Operations, as they were offset against related
expenses.

  The Knoll Collaboration related to both the twice-daily bucindolol
formulation and a once-a-day bucindolol formulation. Knoll and Incara agreed
to share the development and marketing costs of bucindolol in the Knoll
Territory. In general, Knoll agreed to pay approximately 60% of certain
development and marketing costs prior to product launch and Incara agreed to
pay approximately 40% of such costs, subject to certain maximum dollar
limitations. Knoll also agreed to pay approximately 60% of once-a-day
formulation development costs that related solely to the Knoll Territory and
approximately one-third that would have had worldwide benefit. Knoll and
Incara were sponsoring a 2000 patient clinical trial in Europe known as BEAT
(Bucindolol Evaluation after Acute myocardial infarction Trial). In August
1999 Knoll notified Incara that BEAT has been stopped and cancelled the Knoll
Agreement.

  Transcell Merger

  On May 8, 1998, the merger of Transcell with and into Incara and the
acquisition by Incara of certain related technology rights owned by
Interneuron was completed. Simultaneously, Interneuron contributed to
Transcell's capital all of Transcell's indebtedness and payables, aggregating
$18,698,000, to Interneuron (the "Transcell Merger"). Consideration given by
Incara consisted of (i) Incara common stock issuable to the former Transcell
stockholders, including Interneuron, in three installments with an aggregate
market value at closing of approximately $14,200,000, of which $3,000,000 was
paid at closing as an initial payment to Interneuron for certain of its
technology rights and continued guarantees of certain Transcell leases (the
"Initial Technology/Guarantee Payment"), and (ii) the issuance of options and
warrants to purchase 259,488 shares of

                                     F-23
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Incara common stock to Transcell employees and consultants in exchange for
their options and warrants to purchase Transcell capital stock. Accordingly,
in connection with the first installment of the merger consideration due at
the closing of the merger, Incara issued an aggregate of 320,151 shares of
common stock, of which 191,383 shares were issued to Interneuron. In addition,
Incara issued 174,672 shares to Interneuron for the Initial
Technology/Guarantee Payment. Incara also agreed to pay Interneuron a royalty
on sales of certain products that may be developed under the Merck Agreement.
The second and third installments of the merger consideration were to be made
in August 1999 and February 2000, respectively, and each installment was to
consist of the issuance of approximately $3,000,000 of Incara common stock, as
then valued. Pursuant to the CPEC Exchange Transactions (see below), the
Company waived its right to receive the second installment of the merger
consideration in August 1999 and instead retained a number of Incara shares at
a price determined as of July 15, 1999. Incara's acquisition of the minority
shareholders' interest in Transcell resulted in Incara recording a charge to
operations in fiscal 1998 for the purchase of in-process research and
development of approximately $5,300,000. This charge was eliminated in
consolidation and is not reflected in the Company's results of operations
because the Company did not acquire any incremental interest in Transcell's
net assets as a result of the transaction. In connection with this
transaction, the Company also recorded a credit to additional paid-in capital
of approximately $2,212,000 to reflect adjustments to minority interest
resulting from the Transcell Merger and the book value of the Incara shares
received by the Company for the Initial Technology/Guarantee Payment.
Interneuron owned approximately 61% of the outstanding capital stock of Incara
before the closing of the Transcell Merger and approximately 62% immediately
after the closing of the Transcell Merger.

  CPEC Exchange Transactions

  On July 15, 1999, the Company entered into agreements and transactions (the
"CPEC Exchange Transactions") which included (i) the Amended and Restated
Limited Liability Company Agreement among the Company, CPEC LLC and Incara
(the "LLC Agreement"); (ii) the Assignment and Assumption and License
Agreement between CPEC and Incara (the "Assignment and License Agreement");
and (iii) the Exchange Agreement between the Company and Incara (the "Exchange
Agreement"). Pursuant to the CPEC Exchange Transactions, the Company acquired
from Incara a 65% interest in CPEC LLC. In exchange, Incara redeemed 4,229,381
of the 4,511,084 shares of Incara common stock previously owned by the Company
(the "Redeemed Shares") and the Company cancelled a promissory note issued by
Incara to the Company in a related transaction, as described below.

  CPEC LLC is a Delaware limited liability company that is a successor to
CPEC, Inc., a Nevada corporation. Immediately prior to the CPEC Exchange
Transactions, the common stock of CPEC, Inc. was owned 19.9% by the Company
and 80.1% by Incara. As a result of the CPEC Exchange Transactions, the
limited liability company interests in CPEC LLC are owned 65% by the Company
and 35% by Incara. The Company's percentage ownership of Incara's outstanding
common stock has been reduced from approximately 61% prior to the CPEC
Exchange Transactions to approximately 5% at September 30, 1999. The LLC
Agreement generally provides for the Company and Incara to fund and share
development costs of bucindolol in the United States and Japan (the "CPEC
Territory") and to share profits and losses of CPEC LLC in the same percentage
as their respective ownership of CPEC LLC, subject to adjustment in certain
circumstances. Both the Company and Incara agreed to perform certain services
on behalf of CPEC but will not generally be entitled to reimbursement of
internal costs.

  Pursuant to the Assignment and License Agreement CPEC LLC (i) assigned to
Incara all its rights, and Incara assumed all of CPEC LLC's liabilities, under
the Knoll Agreement, except for the Company's 19.9% portion of CPEC LLC's pre-
CPEC Exchange Transactions liability to Knoll (approximately $270,000), and
(ii) licensed to Incara development and marketing rights in the Knoll
Territory, subject to the Knoll Agreement. In exchange, Incara agreed to pay
CPEC a royalty based on net sales of bucindolol in the Knoll Territory and 65%

                                     F-24
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

of a milestone payment payable by Knoll if net sales in the Knoll Territory
exceed a specified amount. Under the LLC Agreement, any payments that would
have been received by CPEC under the Assignment and License Agreement would be
distributed to the Company.

  Pursuant to the Exchange Agreement, the Company obtained 65% of the limited
liability company interests in CPEC LLC in exchange for the Redeemed Shares
and cancellation by the Company of a note received by the Company from Incara
for Incara's purchase of the Company's CPEC, Inc. common stock. The 281,703
shares of Incara common stock (the "Retained Shares") retained by the Company
were in lieu of the shares of Incara common stock the Company would have been
entitled to receive from Incara as the second installment of the merger
consideration payable in August 1999 in connection with the Transcell Merger.
The Exchange Agreement also provides for the Company to assume 45% of Incara's
obligations under the acquisition agreement dated as of May 13, 1994 (the
agreement under which Incara initially acquired CPEC) for Additional Purchase
Price (as defined in that agreement) payable in Interneuron Common Stock. The
Company's maximum potential liability under this provision is approximately
$1,700,000. The Exchange Agreement also provides for the Company and Incara to
indemnify each other for certain liabilities relating to CPEC.

  On July 29, 1999, CPEC LLC received notification that BEST has been
terminated at the recommendation of the BEST Data and Safety Monitoring Board,
based upon the absence of significant survival advantage of treatment with
bucindolol for the population as a whole. According to the BEST Coordinating
Center, the decision to terminate BEST was based upon the totality of evidence
available regarding beta-blocker treatment of heart failure from BEST and
other randomized controlled trials.

  The Company has reflected the CPEC Exchange Transactions in its consolidated
financial statements as of July 15, 1999 by removing from them the
consolidated financial statements of Incara and commencing consolidation of
only CPEC LLC. Interneuron used the purchase method of accounting for the
acquisition of a majority and controlling interest in CPEC LLC and incurred a
noncash charge of $2,421,000 for in-process research and development related
to the CPEC Exchange Transactions in fiscal 1999. As of September 1999, the
Company determined not to continue BEXTRA development and has reflected a
liability of approximately $138,000 and $640,000 related to such decision at
September 30, 2000 and 1999, respectively.

  The Company accounts for its approximately 5% equity investment in Incara
using the cost method and any increases or temporary decreases in market value
from the book value is reflected in accumulated other comprehensive income and
any permanent decreases in market value from the book value is reflected as a
charge to operations. (See Note C.)

 Progenitor

  Since August 1997, the Company has owned approximately 36% of Progenitor. In
December 1998, Progenitor announced its intention to implement an immediate
cessation of its operations. Progenitor did not have sufficient funds at that
time to meet its obligations and was unable to raise additional funds.
Progenitor's market valuation had been substantially reduced and the Company
could not viably sell any of its holdings of Progenitor securities. As a
result, the Company's investment in Progenitor was reduced to zero as of
September 30, 1998. During the year ended September 30, 1998, the Company
reported equity in Progenitor's net losses of approximately $4,040,000. The
Company reflected a receivable from Progenitor of $250,000 at September 30,
1999 and increased this to $425,000 at September 30, 2000 reflecting estimated
distributions to be made to from Progenitor's net cash resulting from
Progenitor's sales of assets and payments of and provisions for estimated
liabilities. These estimated dividends were recorded in income as equity in
unconsolidated subsidiary in fiscal 1999 and 2000. For the fiscal year ended
September 30, 1998, Progenitor's unaudited revenues and net loss were $485,000
and $13,916,000, respectively.


                                     F-25
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


 Transcell

  Until May 8, 1998, the date of the Transcell Merger (see "Incara" above),
the Company consolidated the financial statements of Transcell. After May 8,
1998, Transcell was merged into Incara and operated as an Incara division
called Incara Research Laboratories. Therefore, the results of Transcell
continued to be included in the Company's Consolidated Results of Operations
until the CPEC Exchange Transactions. The Company's ownership of Transcell was
approximately 79% immediately prior to the Transcell Merger.

 InterNutria

  In December 1995, InterNutria acquired from AVAX Technologies, Inc.
("AVAX"), the technology and know-how to produce a specially-formulated
dietary supplement for women's use during their pre-menstrual period, later
named PMS Escape, in exchange for $2,400,000 payable in two installments of
Interneuron Common Stock. The first payment consisting of 55,422 shares was
made in fiscal 1997 and the second payment consisting of 112,793 shares was
made in fiscal 1998. Certain affiliates of the Company are or were
stockholders of AVAX but did not receive any of the purchase price.

  In January 1998, Interneuron sold, subject to repurchase rights which
expired in April 1999, an aggregate of 10% of its InterNutria common stock to
the executive officers of Interneuron for the par value of the InterNutria
shares ($.0001 per share) which approximated fair market value of these shares
at the time of the transaction. At September 30, 2000 and 1999, the Company
owned approximately 76% of InterNutria's outstanding stock.

  In September 1998, the Company adopted a plan to discontinue the operations
of InterNutria. Accordingly, the net losses from InterNutria's operations have
been segregated from continuing operations and condensed and reported on a
separate line on the statement of operations. In fiscal 1998, the Company
recorded a charge of $2,326,000 for the discontinuation of InterNutria's
operation. In fiscal 1999, the Company determined certain costs relating to
the discontinuation of InterNutria would not be incurred and recorded a credit
of $816,000 to discontinuation of InterNutria. At September 30, 1999, the
assets of InterNutria were $2,000 and the liabilities were $37,326,000,
including indebtedness to Interneuron of $37,054,000. At September 30, 2000,
the assets of InterNutria were $1,000 and the liabilities were $147,000;
indebtedness to Interneuron was deemed unpayable. All indebtedness to
Interneuron is eliminated in the consolidated financial statements.
InterNutria's intellectual assets have been sold and are not expected to
generate any significant future revenues.

  Operating results of InterNutria, exclusive of charges relating to the
discontinuation of operations and interest on intercompany debt, for the
fiscal year ended September 30, 1998 are as follows:

<TABLE>
<CAPTION>
                                                                      1998
                                                                  ------------
      <S>                                                         <C>
      Revenues................................................... $  2,567,000
      Operating expenses.........................................   19,701,000
                                                                  ------------
      Net loss from operations...................................  (17,134,000)
      Interest expense, net......................................      (17,000)
                                                                  ------------
      Net loss................................................... $(17,151,000)
                                                                  ============
</TABLE>

N. Subsequent Event

  Takeda notified the Company of its decision not to participate in the
further development of citicoline, thereby terminating the Takeda Agreement.
Therefore, the Company has reacquired all rights to this compound. Takeda has
indicated that it will exercise its option under the Takeda Agreement to
negotiate a license in the U.S. and Canada for a back-up compound from the
Company.

                                     F-26
<PAGE>

                                 EXHIBIT INDEX

<TABLE>
 <C>      <S>
 3.4      --Restated Certificate of Incorporation of Registrant, as amended(22)
 3.5      --By-Laws of Registrant(1)
 4.4      --Certificate of Designation establishing Series C Preferred Stock(10)
 4.8      --1997 Equity Incentive Plan and Form of Restricted Stock Award
           Agreement thereunder(25)
 10.5     --Consultant and Non-competition Agreement between the Registrant,
           Richard Wurtman, M.D.(17)
 10.6     --Assignment of Invention and Agreement between Richard Wurtman,
           M.D., Judith Wurtman and the Registrant(1)
 10.7     --Management Agreement between the Registrant and Lindsay Rosenwald,
           M.D.(1)
 10.9(a)  --Restated and Amended 1989 Stock Option Plan(4)
 10.11    --Restated Amendment to MIT Option Agreement(1)
 10.12(a) --Patent and Know-How License Agreement between the Registrant and
           Les Laboratoires Servier ("Servier") dated February 7, 1990
           ("License Agreement")(1)
 10.12(b) --Revised Appendix A to License Agreement(1)
 10.12(c) --Amendment Agreement between Registrant and Servier, Orsem and Oril
           Produits Chimiques dated November 19, 1992(2)(6)
 10.12(d) --Amendment Agreement dated April 28, 1993 between Registrant and
           Servier(19)
 10.12(e) --Consent and Amendment Agreement among Servier, American Home
           Products Corp. and Registrant(17)
 10.13    --Trademark License Agreement between the Registrant and Orsem dated
           February 7, 1990(1)
 10.14    --Supply Agreement between the Registrant and Oril Produits Chimiques
           dated February 7, 1990(1)(2)
 10.16    --Assignment of Invention by Richard Wurtman, M.D. (1)
 10.22(a) --License Agreement dated January 15, 1993, as amended, between the
           Registrant and Grupo Ferrer(2)(9)
 10.22(b) --Addendum and Second Amendment to License Agreement between the
           Registrant and Ferrer Internacional S.A., dated June 1, 1998(28)
 10.25    --License Agreement between the Registrant and the Massachusetts
           Institute of Technology(3)
 10.37    --License Agreement dated as of February 15, 1992 between the
           Registrant and Massachusetts Institute of Technology(5)
 10.40    --Patent and Know-How Sublicense and Supply Agreement between
           Registrant and American Cyanamid Company dated November 19,
           1992(2)(6)
 10.41    --Equity Investment Agreement between Registrant and American
           Cyanamid Company dated November 19, 1992(6)
 10.42    --Trademark License Agreement between Registrant and American
           Cyanamid Company dated November 19, 1992(6)
 10.44    --Consent Agreement between Registrant and Servier dated November 19,
           1992(12)
 10.45    --Agreement between Registrant and PAREXEL International Corporation
           dated October 22, 1992 (as of July 21, 1992)(2)(7)
 10.46    --License Agreement dated February 9, 1993 between the Registrant and
           Massachusetts Institute of Technology(2)(8)
 10.52    --License Agreement dated February 18, 1994 between Registrant and
           Rhone-Poulenc Rorer, S.A.(11)
 10.55    --Patent License Agreement between Registrant and Massachusetts
           Institute of Technology dated March 1, 1994(11)
 10.58    --Master Equipment Lease including Schedules and Exhibits between
           Phoenix Leasing and Registrant (agreements for Transcell and
           Progenitor are substantially identical), with form of continuing
           guarantee for each of Transcell and Progenitor(12)
 10.59    --Exhibit D to Agreement between Registrant and Parexel International
           Corporation dated as of March 15, 1994(2)(12)
</TABLE>
<PAGE>

<TABLE>
 <C>      <S>
 10.60(a) --Acquisition Agreement dated as of May 13, 1994 among the
           Registrant, Intercardia, Inc., Cardiovascular Pharmacology
           Engineering Consultants, Inc. (CPEC), Myocor, Inc. and the sellers
           named therein(13)
 10.60(b) --Amendment dated June 15, 1994 to the Acquisition Agreement(23)
 10.61    --License Agreement dated December 6, 1991 between Bristol-Myers
           Squibb and CPEC, as amended(2)(13)
 10.61(a) --Letter Agreement dated November 18, 1994 between CPEC and Bristol-
           Myers Squibb(14)
 10.65(a) --1994 Long-Term Incentive Plan, as amended(23)
 10.67    --Employment Agreement between Intercardia and Clayton I. Duncan with
           Registrant guarantee(25)
 10.68(a) --Interneuron Pharmaceuticals, Inc. 1995 Employee Stock Purchase
           Plan, as amended(19)
 10.71    --Securities Purchase Agreement dated June 2, 1995 between the
           Registrant and Reliance Insurance Company, including Warrant and
           exhibits(15)
 10.74    --Securities Purchase Agreement dated as of August 16, 1995 between
           the Registrant and BT Holdings (New York), Inc., including Warrant
           issued to Momint (nominee of BT Holdings)(16)
 10.78    --Contract Manufacturing Agreement dated November 20, 1995 between
           Registrant and Boehringer Ingelheim Pharmaceuticals, Inc.(2)(17)
 10.83    --Co-promotion Agreement effective June 1, 1996 between Wyeth-Ayerst
           Laboratories and Interneuron Pharmaceuticals, Inc.(2)(18)
 10.84    --Master Consulting Agreement between Interneuron Pharmaceuticals,
           Inc. and Quintiles, Inc. dated July 12, 1996(18)
 10.85    --Amendment No. 1 dated July 3, 1996 to Master Consulting Agreement
           between Interneuron Pharmaceuticals, Inc. and Quintiles, Inc. dated
           July 12, 1996(2)(18)
 10.86    --Lease Agreement between Transcell Technologies, Inc. and Cedar
           Brook Corporate Center, L.P., dated September 19, 1996, with
           Registrant guaranty(20)
 10.87    --Lease dated February 5, 1997 between Registrant and Ledgemont
           Realty Trust(21)
 10.89    --Form of ISDA Master Agreement by and between the Registrant and
           Swiss Bank Corporation, London Branch, together with Schedules
           thereto(23)
 10.90(a) --Form of Confirmation for Contract A entered into pursuant to ISDA
           Master Agreement by and between the Registrant and Swiss Bank
           Corporation, London Branch, together with appendix thereto(23)
 10.90(b) --Form of Confirmation for Contract B entered into pursuant to ISDA
           Master Agreement by and between the Registrant and Swiss Bank
           Corporation, London Branch, together with appendix thereto(23)
 10.90(c) --Letter Amendment dated September 18, 1997 to Confirmations filed as
           Exhibits 10.90(a) and 10.90(b)(26)
 10.91    --Form of Agreement regarding Registration Rights and Related
           Obligations to be entered into by and between Registrant and Swiss
           Bank Corporation, London Branch(23)
 10.92    --Research and Collaboration and License Agreement effective as of
           June 30, 1997 by and among Merck & Co., Inc., Transcell
           Technologies, Inc. and the Registrant (assigned to Intercardia as of
           May 8, 1998)(2)(24)
 10.93    --Form of Indemnification Agreement between Registrant and each
           director, executive officer and certain officers of the Registrant
           entered into as of October 6, 1997(26)
 10.94    --1998 Employee Stock Option Plan(27)
 10.95    --Agreement and Plan of Merger dated March 2, 1998 by and among
           Registrant, Intercardia, Inc. and Transcell Technologies, Inc.(28)
 10.95(a) --Waiver and Consent Agreement dated May 8, 1998 by and among
           Registrant, Intercardia and Transcell(28)
 10.96    --Assignment and Assumption and Royalty Agreement between Intercardia
           and Registrant dated May 8, 1998(29)
 10.97    --License Agreement between Registrant and the Administrators of the
           Tulane Educational Fund dated April 29, 1998(29)
</TABLE>
<PAGE>

<TABLE>
 <C>    <S>
 10.98  --Letter of Understanding between the Registrant and the Plaintiffs'
         Management Committee dated September 3, 1998(30)
 10.99  --Agreement of Compromise and Settlement, including Appendices, dated
         September 21, 1998, between the Registrant and the Plaintiffs'
         Management Committee(31)
 10.100 --Royalty Agreement between the Registrant and the Plaintiffs'
         Management Committee effective as of September 21, 1998(32)
 10.102 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Michael W. Rogers dated and effective as of February 23, 1999(34)
 10.103 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Bobby W. Sandage, Jr. dated and effective as of March 15, 1999(34)
 10.104 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Mark S. Butler dated and effective as of March 15, 1999(34)
 10.105 --Employment Agreement between Interneuron Pharmaceuticals, Inc. and
         Glenn L. Cooper, M.D. dated and effective as of May 1, 1999(34)
 10.106 --Agreement of Sublease between Interneruon Pharmaceuticals, Inc.,
         Sublandlord and Genta, Inc., Subtenant dated March 31, 1999(34)
 10.107 --Consent to Sublease dated March 31, 1999 by and among Ledgemont
         Realty Trust, Interneuron Pharmaceuticals, Inc., and Genta, Inc.(34)
 10.108 --Exchange Agreement dated July 15, 1999 between Intercardia, Inc. and
         Interneuron Pharmaceuticals, Inc.(35)
 10.109 --Amended and Restated Limited Liability Company Agreement of CPEC LLC
         dated July 15, 1999 among CPEC LLC, Interneuron Pharmaceuticals, Inc.
         and Intercardia, Inc.(35)
 10.110 --Assignment, Assumption and License Agreement dated July 15, 1999 by
         and between CPEC LLC and Intercardia, Inc.(35)
 10.111 --Extension of Term and Supplemental Agreement made as of July 7, 1999
         by and between Interneuron Pharmaceuticals, Inc., and J. Howard &
         Associates(36)
 10.112 --Consent to Sublease dated as of July 9, 1999 by and between
         Interneuron Pharmaceuticals, Inc., and J. Howard & Associates and
         Ledgemont Realty Trust(36)
 10.113 --License Agreement effective as of November 26, 1999 between Madaus AG
         and Interneuron Pharmaceuticals, Inc.(37)(2)
 10.114 --License Agreement effective as of December 2, 1999 by and between
         Interneuron Pharmaceuticals, Inc. and Takeda Chemical Industries,
         Ltd.(37)(2)
 10.116 --License Agreement between Interneuron Pharmaceuticals, Inc. and
         Warner-Lambert Company effective as of December 23, 1999(38)(2)
 10.117 --License Agreement by and between HeavenlyDoor.com, Inc. and
         Interneuron Pharmaceuticals, Inc. dated June 14, 2000(39)(2)
 10.118 --Fiscal 2001 Senior Executive Bonus Plan, as adopted by the Board of
         Directors on September 13, 2000
 21     --List of Subsidiaries
 23     --Consent of PricewaterhouseCoopers LLP
 27     --Financial Data Schedule
</TABLE>
--------
<TABLE>
 <C>  <S>
 (1)  Incorporated by reference to the Registrant's Registration Statement on
      Form S-1 (File No. 33-32408) declared effective on March 8, 1990.
 (2)  Confidential Treatment granted for a portion of this Exhibit.
 (3)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the year ended
      September 30, 1990.
 (4)  Incorporated by reference to Post-Effective Amendment No. 2 to the
      Registrant's Registration Statement on Form S-1 (File No. 33-32408) filed
      December 18, 1991.
 (5)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended
      March 31, 1992.
 (6)  Incorporated by reference to the Registrant's Form 8-K dated November 30,
      1992.
</TABLE>
<PAGE>

<TABLE>
 <C>  <S>
 (6a) Incorporated by reference to Post-Effective Amendment No. 5 to the
      Registrant's Registration Statement on Form S-1 (File No. 33-32408) filed
      on December 21, 1992.
 (7)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1992.
 (8)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended December 31, 1992.
 (9)  Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1993.
 (10) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended June 30, 1993.
 (11) Incorporated by reference to the Registrant's Registration Statement on
      Form S-3 or Amendment No. 1 (File no. 33-75826).
 (12) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1994.
 (13) Incorporated by reference to the Registrant's Form 8-K dated June 20,
      1994.
 (14) Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1994.
 (15) Incorporated by reference to the Registrant's Report on Form 8-K dated
      June 2, 1995.
 (16) Incorporated by reference to the Registrant's Report on Form 8-K dated
      August 16, 1995.
 (17) Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1995.
 (18) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q or 10-Q/A for the period ended June 30, 1996.
 (19) Incorporated by reference to Amendment No. 1 to Registrant's Registration
      Statement on Form S-3 (File No. 333-1273) filed March 15, 1996.
 (20) Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1996.
 (21) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended December 31, 1996.
 (22) Incorporated by reference to Exhibit 3.5 of the Registrant's Quarterly
      Report on Form 10-Q for the period ended March 31, 1997.
 (23) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1997.
 (24) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended June 30, 1997.
 (25) Incorporated by reference to the Registrant's Form S-8 (File No. 333-
      40315) filed November 14, 1997.
 (26) Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1997.
 (27) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended December 31, 1997.
 (28) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended March 31, 1998.
 (29) Incorporated by reference to the Registrant's Quarterly Report on Form
      10-Q for the period ended June 30, 1998.
 (30) Incorporated by reference as to Exhibit 99.1 of Registrant's Form 8-K
      dated September 3, 1998.
 (31) Incorporated by reference as to Exhibit 99.2 of Registrant's From 8-K
      dated September 28, 1998.
 (32) Incorporated by reference as to Exhibit 99.3 of Registrant's Form 8-K
      dated September 28, 1998.
 (34) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended March 31, 1999.
 (35) Incorporated by reference to Registrant's Form 8-K dated July 27, 1999.
 (36) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended June 30, 1999.
</TABLE>
<PAGE>

<TABLE>
 <C>  <S>
 (37) Incorporated by reference to the Registrant's Annual Report on Form 10-K
      for the fiscal year ended September 30, 1999.
 (38) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended December 31, 1999.
 (39) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
      for the period ended June 30, 2000.
</TABLE>