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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                           ---------------------------
                         FIRST AMENDMENT TO FORM 10-K ON
                                   FORM 10-K/A
    (Mark One)
        [X]         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
                                       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. 0-20111

                          ARONEX PHARMACEUTICALS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                  DELAWARE                                 76-0196535
      (STATE OR OTHER JURISDICTION OF                   (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                  IDENTIFICATION NO.)

        ARONEX PHARMACEUTICALS, INC.
        8707 TECHNOLOGY FOREST PLACE
            THE WOODLANDS, TEXAS                           77381-1191
  (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                 (ZIP CODE)

                                 (281) 367-1666
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
        None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                    Common Stock, par value $.001 per share
                                (TITLE OF CLASS)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                   Yes  X   No
                                      ----     ----

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

         The aggregate market value of the voting stock held by non-affiliates
of the registrant on March 24, 2000 was $83,162,002, based on the closing sales
price of the registrant's common stock on the Nasdaq National Market on such
date of $3.75 per share. For purposes of the preceding sentence only, all
directors, executive officers and beneficial owners of ten percent or more of
the common stock are assumed to be affiliates. As of March 24, 2000, 22,922,078
shares of the registrant's common stock were outstanding.

         Certain sections of the registrant's definitive proxy statement
relating to the registrant's 2000 annual meeting of stockholders, which proxy
statement will be filed under the Securities Exchange Act of 1934 within 120
days of the end of the registrant's fiscal year ended December 31, 1999, are
incorporated by reference into Part III of this Form 10-K.

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                                TABLE OF CONTENTS
<TABLE>

<S>                                                                                            <C>

                                     PART I

Item 1.           Business .....................................................................1
                           General .............................................................1
                           Business Strategy ...................................................1
                           Clinical and Scientific Background ..................................2
                           Products in Clinical Development ....................................3
                           Infectious Diseases .................................................4
                           Cancer ..............................................................6
                           Research Pipeline ...................................................8
                           Collaborative Agreements ............................................9
                           Manufacturing ......................................................10
                           Sales and Marketing ................................................10
                           Patents and Proprietary Rights .....................................11
                           Government Regulation ..............................................12
                           Competition ........................................................15
                           Employees ..........................................................15
                           Additional Business Risks ..........................................15

Item 2.           Properties ..................................................................21

Item 3.           Legal Proceedings ...........................................................21

Item 4.           Submission of Matters to a Vote of Security Holders .........................21

                                     PART II

Item 5.           Market for Registrant's Common Equity and Related Stockholder Matters .......22

Item 6.           Selected Financial Data .....................................................23

Item 7.           Management's Discussion and Analysis of
                           Financial Condition and Results of Operations ......................24
                           Overview ...........................................................24
                           Results of Operations ..............................................24
                           Acquired In-Process Research and Development .......................25
                           Liquidity and Capital Resources ....................................26
Item 7A.          Quantitative and Qualitative Disclosures about Market Risk ..................28

Item 8.           Financial Statements and Supplementary Data .................................28

Item 9.           Changes in and Disagreements with Accountants on
                  Accounting and Financial Disclosure .........................................28
</TABLE>

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<TABLE>

<S>                <C>                                                                         <C>
                                    PART III

Item 10.          Directors and Executive Officers of the Registrant ..........................29

Item 11.          Executive Compensation ......................................................29

Item 12.          Security Ownership of Certain Beneficial Owners and Management ..............29

Item 13.          Certain Relationships and Related Transactions ..............................29

                                     PART IV

Item 14.          Exhibits, Financial Statements Schedules and Reports on Form 8-K ............30


Signatures ....................................................................................34


Index to Financial Statements ................................................................F-1
</TABLE>


                           FORWARD-LOOKING STATEMENTS



         This Annual Report on Form 10-K includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). When used in this document, the words "anticipate," "believe," "expect,"
"estimate," "project" and similar expressions are intended to identify
forward-looking statements. Such statements are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those anticipated, believed, expected,
estimated or projected. For additional discussion of such risks, uncertainties
and assumptions, see "Item 1. Business -- Manufacturing," "-- Sales and
Marketing," "-- Patents and Proprietary Rights," "-- Government Regulation," "--
Competition" and "-- Additional Business Risks" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this report.

                                      -ii-
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                                     PART I

ITEM 1.   BUSINESS

GENERAL

         Aronex Pharmaceuticals (identified herein as "we", "us" or "our") is a
biopharmaceutical company engaged in the identification and development of
proprietary innovative medicines to treat cancer and infectious diseases. Our
strategy is to identify and develop medicines based upon either refinements of
proven therapies or new ways of treating specific diseases. Our focus is on
medicines for cancer and infectious diseases for which current therapy is
inadequate. The effectiveness of the current generation of anti-cancer and
anti-infective drugs is limited because of two significant factors. First,
cancer cells frequently become resistant to commonly used anti-cancer drugs, and
organisms responsible for infectious diseases may also develop resistance to
anti-infective drugs. This resistance results in the ultimate progression of
many cancers and some infections. Second, these current generation drugs,
particularly cancer drugs, are generally toxic because of their lack of
selectivity that results in significant side effects on normal cells. We are
targeting the development of drugs for cancer and infectious diseases that are
selective in their action, with unique or special ways of acting and more
favorable safety profiles.

BUSINESS STRATEGY

         We have implemented a comprehensive strategy to become a commercial
biopharmaceutical company involved in the identification, development and
commercialization of novel medicines for treating cancer and infectious
diseases. Our strategy encompasses five key elements:

o        Therapeutic Focus. We have adopted a clear therapeutic focus aimed at
         identifying and developing novel medicines to satisfy clearly-defined,
         unsatisfied needs in the treatment of cancer and infectious diseases.
         We believe that this focus provides synergies in the development of
         products as a result of common patient populations, and will provide
         synergies in the marketing and commercialization of products as a
         result of the common hospital-based sales and distribution channels and
         concentrated customer base associated with these products. In addition,
         we believe our focus on medicines for cancer and infectious diseases
         for which current therapy is inadequate may facilitate expedited
         commercialization of our products.

o        Balanced Product Portfolio. We have a portfolio of clinical products
         that we believe provides a balanced development and commercialization
         risk profile. Two of our products are liposomal formulations of drugs
         that are currently on the market, designed to improve effectiveness and
         reduce adverse side effects. Liposomal formulations trap the drug
         within a lipid-based environment. We believe that this should
         contribute to a reduction in the development risks associated with our
         products. Two of our products are new compounds with novel mechanisms
         of action against a specific disease target. While these products are
         associated with a greater degree of development risk, we believe that
         these products may have a substantial impact against the diseases they
         are intended to treat. We believe that this balanced development and
         commercialization risk profile limits our dependence on a single
         product.

o        Expedited Drug Development Programs. We believe that we have created an
         effective pharmaceutical development infrastructure. With expertise in
         preclinical development, drug formulation and delivery, quality
         assurance, quality control and analytical chemistry, drug
         manufacturing, regulatory and clinical affairs, we believe that we have
         the ability to effectively advance preclinical and clinical products
         through the development pipeline.

o        Leveraged Research and Technological Resources. We rely on several
         sources to provide potential opportunities to expand our pipeline of
         products for commercialization. Using academic and corporate
         collaborations, we seek late-stage preclinical products for advancement
         into our clinical pipeline as well as early-stage clinical products
         with prospects for rapid clinical development. Additional opportunities
         are available through our existing capabilities in drug formulation and
         delivery.



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o        Marketing and Commercialization Strategy. Our marketing and
         commercialization effort is designed to create a revenue stream
         utilizing two diverse methods. We intend to market products in the
         United States through our own sales and marketing efforts or through
         co-marketing, and to market products overseas through licensing
         arrangements with corporate partners. We also intend to market those
         products requiring broader marketing and distribution efforts through
         licensing arrangements with corporate partners.

CLINICAL AND SCIENTIFIC BACKGROUND

         Our development programs are aimed at the identification and
development of innovative medicines to treat cancer and infectious diseases for
which current therapy is inadequate. The effectiveness of the current generation
of anti-cancer and anti-infective drugs is limited because of two significant
factors. First, cancer cells frequently become resistant to commonly used
anti-cancer drugs, and organisms responsible for infectious diseases may also
acquire resistance to anti-infective drugs. This resistance results in the
ultimate progression of many cancers and some infections, such as HIV. Second,
these drugs, particularly cancer drugs, are generally toxic because their lack
of selectivity results in significant side effects on normal cells. We are
targeting the development of drugs for cancer and infectious diseases that are
selective in their actions, with unique or special ways of acting and more
favorable safety profiles.

         Infectious Diseases

         The immune system, the major line of defense against infection, may be
weakened by diseases, such as HIV and diabetes, or by drugs or agents used for
the treatment of other medical conditions, such as chemotherapy in cancer
patients or immunosuppressive, anti-rejection therapy in patients receiving
organ transplants. A weak immune system predisposes patients to opportunistic
infections caused by otherwise harmless microbes. These opportunistic infections
are caused by microbes, including fungi such as Aspergillus and Candida, viruses
or bacteria. Some of these "opportunistic" microbes can be or become resistant
to existing therapies. Drugs with new mechanisms of action and/or improved
safety profiles are needed to treat fungal, viral and bacterial diseases and to
overcome the toxicity limitations associated with certain existing drugs.

         Cancer

         The American Cancer Society estimates that in the United States alone
more than 1.2 million new cases of cancer will be diagnosed and more than
500,000 people will die of cancer in 2000. According to the American Cancer
Society, major classes of cancer include:

         o        solid tumors, the most common of which are breast cancer,
                  prostate cancer and cancers of the lung;
         o        cancers of the lymphoid system; and
         o        cancers of the blood.

         In the United States there are annually approximately 179,000 new cases
of breast cancer, 171,000 new cases of lung cancer, 62,000 new cases of lymphoma
and 29,000 new cases of leukemia, according to the American Cancer Society.
Chemotherapy, surgery and radiation are the major components in the treatment of
cancer. Chemotherapy is usually the primary treatment for cancers, such as
hematologic malignancies, which cannot be excised by surgery. In addition,
chemotherapy is increasingly being used as an adjunct to radiation and surgery
to improve efficacy and reduce the incidence of metastasis, or spread of cancer,
and as primary therapy for some solid tumors. The standard strategy for
chemotherapy is to destroy the malignant cells by exposing them to as much drug
as the patient can tolerate. Clinicians attempt to design a combination of
drugs, dosing schedule and method of administration that increases the
probability that malignant cells will be destroyed, while minimizing the harm to
healthy cells.



                                      -2-
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         Most current anti-cancer drugs have significant limitations. Certain
cancers, such as colon, lung, kidney and pancreatic cancers, are inherently
unresponsive to chemotherapeutic agents. Certain other cancers may initially
respond to a chemotherapeutic agent, but cease to respond as the cancer cells
acquire resistance to the drug during the course of therapy. As cancer cells
develop resistance to a specific chemotherapeutic agent, they often
simultaneously become resistant to a wide variety of structurally unrelated
agents through a phenomenon known as "multi-drug resistance." Finally, current
anti-cancer drugs are generally highly toxic, with effects including bone marrow
suppression and irreversible cardiotoxicity, which can prevent their
administration in therapeutic doses.

         Our Approach to the Treatment of Cancer and Infectious Diseases

         Our focused effort aims at identifying highly-specific, novel medicines
for the treatment of cancer and infectious diseases. Through our research and
development strategy, we seek to augment our pipeline by partnering with
academic centers such as The University of Texas M.D. Anderson Cancer Center.
These relationships are intended to permit us to identify opportunities which
have already been validated in preclinical and, in some instances, clinical
studies before we allocate resources for further evaluation and development. We
also anticipate expansion of our product pipeline through acquisitions, licenses
and joint ventures with corporate partners. This strategy is further intended to
allow us to bypass the lengthy and uncertain drug discovery and screening
process and to proceed quickly to product development and clinical evaluation.
We believe that utilizing this strategy will allow us to maintain a full
pipeline of innovative products for the treatment of cancer and infectious
diseases. See "-- Collaborative Agreements."

PRODUCTS IN CLINICAL DEVELOPMENT

         The following table lists our clinical products, along with their
initial indications and clinical status:

<TABLE>
<CAPTION>

             PRODUCT                           INDICATIONS                           CLINICAL STATUS
             -------                           -----------                           ---------------

<S>                               <C>                                                <C>
         INFECTIOUS DISEASES
         Nyotran(R) ............  Presumed Fungal Infections                     Phase III completed
                                  Cryptococcal Meningitis                        Phase III completed
                                  Candidemia                                     Phase II completed
                                  Aspergillus Salvage                            Phase II

         CANCER
         ATRAGEN(R) ............  Acute Promyelocytic Leukemia                   NDA amendment pending
                                  Acute Promyelocytic Leukemia Monotherapy       Phase II
                                  Non-Hodgkin's Lymphoma                         Phase II
                                  Prostate Cancer                                Phase II
                                  Renal Cell Carcinoma                           Phase I/II
                                  Acute Myelogenous Leukemia                     Phase II
                                  Kaposi's Sarcoma                               Phase II completed
         Annamycin .............  Breast Cancer                                  Phase II
                                  Leukemia                                       Phase I/II
         Aroplatin(TM) .........  Lung Cancer                                    Phase II
                                  Renal Cell Carcinoma                           Phase II
</TABLE>

         "Phase I" indicates that the first phase of human clinical studies is
being conducted with a small number of subjects in order to gain evidence of
safety, establish the maximum dose of the drug which may be safely administered
to patients and to characterize the distribution of a drug in a human patient.
"Phase I/II" indicates that a product is being tested in humans primarily for
safety and drug distribution, while preliminary measures of efficacy are also
observed. "Phase II" indicates that a product is being tested in humans for
safety and preliminary evidence of efficacy. "Phase III" indicates that a
product is being tested in multi-center studies generally designed to provide
evidence of efficacy and further safety of the product in a large number of
patients.


                                      -3-
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         We can give no assurance that the results of any of our clinical trials
will be favorable or that our products will obtain regulatory approval for
commercialization. See "Additional Business Risks -- Clinical Trial Results May
Result in Failure to Obtain FDA Approval and Inability to Sell Products."

INFECTIOUS DISEASES

         Our infectious disease program centers on the development of new agents
for the treatment of infectious diseases, including those that occur in patients
with weakened immune systems. The clinical program presently focuses on the
development of Nyotran(R) for life-threatening systemic, or internal, fungal
infections.

         Nyotran(R)for Presumed Fungal Infections (Phase III completed),
         Cryptococcal Meningitis (Phase III completed), Candidemia (Phase II
         completed) and Aspergillus Salvage (Phase II)

         Systemic fungal infections are generally serious and may result in
death. Most systemic fungal infections are caused by Candida, or yeasts, and
Aspergillus, or molds, species. These life-threatening infections occur most
often in patients with impaired immune defense mechanisms as a result of an
underlying disease, such as HIV or diabetes, or the effects of treatments for
other medical conditions, such as chemotherapy in cancer patients or
anti-rejection therapy in patients receiving organ transplants. The population
of patients who become candidates for anti-fungal treatment is increasing
because of a number of factors, including more aggressive use of chemotherapy in
cancer patients, increases in organ and bone marrow transplants, increased use
of in-dwelling catheters for prolonged periods and the spread of HIV.

         We believe that the drugs that are currently used to treat systemic
fungal infections, including fluconazole, itraconazole, amphotericin B and
liposomal formulations of amphotericin B, have limitations that present a need
for new therapies. Data from recent in vitro, or test tube, studies as well as
clinical trial data indicate that a number of fungal strains are becoming
increasingly resistant to known therapies. Fluconazole and itraconazole are
relatively safe and are effective in inhibiting fungal growth in Candida, but
are not effective in inhibiting fungal growth in Aspergillus and are generally
not effective in treating fungal infections in patients who are seriously ill
and whose immune systems are compromised and not functioning properly.
Amphotericin B is very active against both Candida and Aspergillus but is highly
toxic. Several companies have developed liposomal versions of amphotericin B
that are designed to reduce the potential toxicity of amphotericin B.

         Nyotran(R) is a lipid-based, intravenous formulation of the drug
nystatin, an established, widely-used topical anti-fungal agent. Although
nystatin has proven to be a potent anti-fungal against a broad spectrum of
fungi, including Candida, Cryptococcus, Histoplasma, Blastomyces and
Aspergillus, its poor solubility and toxicity have previously precluded its
systemic administration as a therapy for these fungal infections. Our
proprietary formulation, Nyotran(R), reduces the toxicity of nystatin. In
addition, we believe that Nyotran(R)'s lipid-based formulation addresses the
solubility problem of nystatin. We believe Nyotran(R) offers potential
advantages over current systemic anti-fungal therapies. Our in vitro studies
indicate that it is active against a range of fungal strains, including Candida,
Aspergillus, Cryptococcus and Fusarium species, some of which are resistant to
currently available anti-fungal therapies. We believe that our clinical trials
suggest that Nyotran(R) can be administered at doses that are effective in
treating Aspergillus, Candida and Cryptococcus infections.

         The strategy for the development of Nyotran(R) has involved several
stages. We have conducted three Phase I clinical studies which demonstrated a
favorable safety profile. We completed a Phase II open label study in patients
with Candidemia evaluating Nyotran(R) at multiple doses. Although this Phase II
study has been completed, it remains open on a compassionate basis to enroll
patients for whom other therapies have not been effective. Results from this
study indicate that a dose of one-third of the maximum tolerated dose
established in Phase I appears to be efficacious. Based upon data from this
study, we initiated Phase III comparative multicenter trials in the United
States, Australia and in Europe of Nyotran(R) against amphotericin B in patients
with presumed fungal infections. Most frequently, in a hospital environment, a
patient with a fever of unknown origin will be treated with an antibiotic. When
this treatment proves ineffective, the physician then presumes that the patient
has a fungal infection, and begins treatment with an anti-fungal agent. The
diagnosis of a confirmed fungal infection may occur several days after
anti-fungal therapy has begun. We completed the clinical trials for presumed
fungal infections in




                                      -4-
<PAGE>   8

late 1998. Data from these trials was presented at the September 1999 39th
Interscience Conference on Antimicrobial Agents and Chemotherapy meeting.

         To expand the potential indications for Nyotran(R), we commenced Phase
III trials for patients with cryptococcal meningitis and Phase II Aspergillus
salvage trials. The Aspergillus salvage trials are designed to treat patients
with Aspergillus who have failed treatment with current products. In late 1999,
we completed the Phase III trials designed to show the equivalency of Nyotran(R)
versus amphotericin B in the treatment of confirmed cryptococcal meningitis. In
February 2000, we announced our preliminary findings from this trial. The data
demonstrated that Nyotran(R) was not equivalent to amphotericin B with respect
to the primary efficacy endpoint but there was no difference with respect to
survival, a secondary endpoint. The data also indicated a favorable renal
toxicity profile when compared to amphotericin B. Having gathered data from four
clinical trials, we are now in a position to meet with the U.S. Food and Drug
Administration "FDA" to determine the regulatory strategy for submission of our
New Drug Application "NDA" in the United States. We will then review the
strategy for filings in Europe and other parts of the world that will be
accomplished by Abbott Laboratories. See "-- Government Regulation," "--
Collaborative Agreements -- Collaborative Agreement with Abbott Laboratories"
and "Additional Business Risks -- Clinical Trial Results May Result in Failure
to Obtain FDA Approval and Inability to Sell Products."

         The active ingredient of Nyotran(R), nystatin, is available
commercially. We have utilized a contract manufacturer for our clinical
requirements of Nyotran(R), who we believe to be capable of satisfying the
quantities required for clinical trials and anticipated quantities for initial
commercial sales. However, we expect Abbott Laboratories to manufacture the
quantities of Nyotran(R) necessary to conduct any remaining clinical trials and,
following regulatory approval, to manufacture Nyotran(R) for commercial sale.

         Current treatment for systemic fungal infection is largely limited to
amphotericin B, several liposomal formulations of amphotericin B and
fluconazole. Amphotericin B has been a common choice for the treatment of
systemic fungal infections. The clinical usefulness of amphotericin B is
limited, however, because serious toxicity can occur at doses that are only
marginally effective. Liposomal formulations of amphotericin B have been
developed by several companies, including The Liposome Company, Inc., Gilead
Sciences and ALZA Corporation. Each of these companies' products have regulatory
approval in the United States and other countries. Each of these liposomal
formulations shows a reduction in toxicity as compared to amphotericin B. Pfizer
Inc.'s fluconazole, the world's largest selling anti-fungal product, is an oral
formulation used for a wide range of less serious Candida indications. We are
aware of other anti-fungal agents currently in clinical development.

         In November 1998, we entered into a license agreement with Abbott
Laboratories for Nyotran(R). The license agreement provides Abbott with
exclusive worldwide rights to market and sell Nyotran(R), subject to rights
previously granted to Grupo Ferrer Internacional, S.A. in Spain and Portugal and
certain co-promotion rights retained by us in the United States and Canada.
Abbott has paid us milestone and up-front payments of $14.7 million under the
license agreement and purchased common stock for $3.0 million under a related
stock purchase agreement. Abbott has provided funding for the continuing
clinical development of Nyotran(R) and will make subsequent milestone payments
if specified sales targets are achieved. Abbott has agreed to pay us royalties
which increase in amount based upon the level of product sales of Nyotran(R) in
each year. See "-- Collaborative Agreements -- Collaborative Agreement with
Abbott Laboratories."

         M.D. Anderson has granted us the worldwide exclusive license under an
issued patent to the use of a liposomal formulation of nystatin in the treatment
of systemic fungal infections. Another issued patent protects a process of
pharmaceutical utility in making Nyotran(R). A continuation of this process
patent is currently being prosecuted seeking additional claims in this area. See
"-- Patents and Proprietary Rights."




                                      -5-
<PAGE>   9



CANCER

         Our programs in cancer focus on developing medicines based upon either
refinements of proven therapies or new approaches to the treatment of specific
disease targets. The clinical program currently focuses on development of
ATRAGEN(R) for hematological malignancies and solid tumors, Annamycin for solid
tumors and hematological malignancies and AroplatinTM for solid tumors.

         ATRAGEN(R) for Acute Promyelocytic Leukemia ("APL") (NDA amendment
         pending), APL monotherapy (Phase II), Non-Hodgkin's Lymphoma (Phase
         II), Prostate Cancer (Phase II), Renal Cell Carcinoma (Phase I/II), AML
         (Phase II) and Kaposi's Sarcoma (Phase II completed)

         In December 1998, we filed an NDA with the FDA for approval of
ATRAGEN(R) for the treatment of patients with acute promyelocytic leukemia,
"APL", for whom therapy with tretinoin is necessary but for whom an intravenous
administration is required. In September 1999, we received a letter from the FDA
notifying us that the application was not approvable in its current form. We
anticipate submitting an amendment to this NDA. This indication represents a
therapeutic area where new therapies are needed. ATRA, or tretinoin, has been
approved as an oral formulation by the FDA as a treatment for APL. ATRA and
other retinoids cause cell differentiation in contrast to most conventional
chemotherapeutic agents. Retinoids are molecules comprising both natural and
synthetic derivatives of retinol, otherwise known as vitamin A. However, we
believe the effectiveness of the oral formulation of ATRA may be reduced by the
rate at which it is metabolized, which lowers the amount of drug that reaches
the cancer target.

         According to the American Cancer Society, approximately 1,000 new cases
of APL in the United States are diagnosed annually, and each year approximately
500,000 patients in the United States develop the various types of cancer
identified as potential indications for ATRAGEN(R). ATRAGEN(R) also may be
useful in treating a variety of hematological malignancies and solid tumors.

         ATRAGEN(R) is a lipid-based, intravenous formulation of ATRA. Our lipid
formulation has been developed to change certain aspects of the drug's behavior
in the body to overcome the known deficiencies of oral retinoids, such as the
oral formulation of ATRA. ATRAGEN(R) has a different pharmacokinetics and
distribution profile, so that there may be a decrease in the proportion of the
drug metabolized and an increase in the proportion that reaches the cancer
target. Following ATRAGEN(R) treatment, higher plasma concentrations of the drug
are achieved than after oral ATRA therapy. Unlike oral administration, these
drug levels are maintained throughout the course of therapy. These
characteristics may deliver the drug more effectively to the bone marrow, liver
and spleen, where most leukemic cells are found.

         We completed a Phase I clinical trial of ATRAGEN(R) in 1995 in patients
with cancers of the blood. Phase I data presented in the journal Blood during
1996 indicated that ATRAGEN(R) sustains levels in the blood after prolonged
dosing, is well tolerated, and shows evidence of activity against certain
leukemias and lymphomas. We recently completed patient enrollment for the Phase
II clinical evaluation of ATRAGEN(R) for its potential to induce remission and
prevent relapse of APL in patients who have experienced a recurrence of the
cancer. Interim results from one of these trials, presented at the American
Society for Hematology meeting in December 1997, demonstrated that ATRAGEN(R)
has activity against APL. Based on the pivotal Phase II data, we submitted an
NDA for ATRAGEN(R) for the treatment of patients with APL for whom therapy with
the drug tretinoin is necessary but for whom an intravenous administration is
required.

         ATRAGEN(R) is also being assessed in Phase II clinical trials for its
use as a monotherapy in the treatment of newly-diagnosed APL patients. Interim
Phase II data presented in the journal Blood in October 1999 indicated that
ATRAGEN(R) can induce remissions without the use of chemotherapy. Some of the
patients sustained ongoing remissions for as long as 24 months.

         ATRAGEN(R) has also been assessed in Phase II clinical trials for the
treatment of Kaposi's sarcoma. Results from this trial indicated that ATRAGEN(R)
was generally well tolerated, with headaches and dry skin being the primary
reported adverse events. We are not presently pursuing this indication, although
we may do so in the future.



                                      -6-
<PAGE>   10

         In 1998, we initiated a Phase II clinical trial in non-Hodgkin's
lymphoma and a Phase II clinical trial in hormone-refractory prostate cancer. In
early 1999, a Phase I/II clinical trial in combination with interferon alpha in
renal cell carcinoma was initiated at New York Presbyterian Hospital and the
Weill Medical College of Cornell University under an institutional
Investigational New Drug application, or IND. In late 1999, we initiated a Phase
II clinical trial in acute myelogenous leukemia "AML". ATRAGEN(R) has been
designated an orphan drug for the treatment of acute and chronic leukemia by the
FDA. See "-- Government Regulation" and "-- Additional Business Risks --
Clinical Trial Results May Result in Failure to Obtain FDA Approval and
Inability to Sell Products."

         The composition and method of use of ATRAGEN(R) is the subject of a
patent application, assigned to The University of Texas M.D. Anderson Cancer
Center, as to which the rights of M.D. Anderson are exclusively licensed to us.
Claims to the ATRAGEN(R) formulation have been allowed in the European Patent
Office. See "-- Patents and Proprietary Rights."

         Annamycin for Refractory Breast Cancer (Phase II) and Refractory
Leukemia (Phase I/II)

         Annamycin is a new chemical entity belonging to the class of widely
prescribed anti-cancer agents known as anthracyclines. This class of drug, which
includes doxorubicin, daunorubicin and idarubicin, has been shown to be
effective, either alone or in combination, against proliferating cancer cells.
Anthracyclines currently on the market, however, suffer from two primary
limitations:


         o        Cancer cells often develop a resistance to them, rendering the
                  treatment ineffective. This resistance, once developed by
                  cancer cells, generally extends to include resistance to a
                  variety of other chemotherapeutic agents, a phenomenon
                  commonly referred to as multi-drug resistance. The best
                  understood mechanism behind multi-drug resistance involves an
                  increase in the production of P-glycoprotein, a trans-cell
                  membrane pump. This pump transports drugs, including most
                  types of anti-cancer drugs, out of tumor cells.

         o        Currently available anthracyclines also frequently result in
                  severe toxic effects, including irreversible cardiotoxicity.

         Annamycin was designed to overcome these two major limitations. In
contrast to conventional chemotherapeutic agents, Annamycin is structured so
that it avoids the mechanism of operation of the trans-cell membrane pump
believed to be one of the mechanisms responsible for multi-drug resistance. Our
preclinical studies have shown that Annamycin, which is a lipid-based
formulation of a novel anthracycline, may be active against multi-drug resistant
tumor cells that over-express at least two of the pumps that are believed to be,
at least in part, responsible for tumor cells becoming resistant to treatment.
This over-expression implies that the levels of the enzymes present in a
particular person exceed the levels found in a healthy or normal person. Our
preclinical studies of Annamycin in animals bearing human tumors also indicate
that Annamycin may be less cardiotoxic than doxorubicin. A Phase I
dose-escalating clinical trial of Annamycin was completed in August 1997. Data
from this trial were presented at the American Society of Clinical Oncology
meeting in May 1997. Annamycin is currently being evaluated in Phase II
multi-center clinical trials in breast cancer patients whose tumors are
resistant to conventional therapies. In April 1999, we initiated a Phase I/II
clinical trial in refractory leukemia patients. See "-- Additional Business
Risks -- Clinical Trial Results May Result in Failure to Obtain FDA Approval and
Inability to Sell Products."

         We believe that there is a substantial market for an agent which is
active against multi-drug resistance and exhibits an improved safety profile
over doxorubicin. The American Cancer Society estimates that each year there are
approximately 179,000 new cases of breast cancer in the United States. Annamycin
also may be useful in treating other varieties of solid tumors, leukemias and
lymphomas.

         While there are a range of chemotherapeutic agents used alone and in
combination to treat breast cancer and other solid tumors, including
doxorubicin, daunorubicin, liposomal formulations of doxorubicin and
daunorubicin, taxol, platinum and cyclophosphamide, we do not believe that there
are any medicines available that are active against multi-drug resistant tumors.
We are aware of some agents currently in Phase II clinical trials that



                                      -7-
<PAGE>   11

are designed to modify multi-drug resistance, but for which no efficacy data are
yet available. These agents would potentially be used in combination with
chemotherapeutic agents.

         Our liposomal formulation of Annamycin is the subject of an issued
patent, licensed exclusively to us by The University of Texas M.D. Anderson
Cancer Center. In addition, a patent application has been filed with respect to
an improved process for preparing Annamycin. This patent application is also
licensed to us under the exclusive license with M.D. Anderson. Annamycin itself
is the subject of a patent that has been non-exclusively sublicensed to us by
M.D. Anderson, which M.D. Anderson licensed from Ohio State University. See
"--Patents and Proprietary Rights."

         Aroplatin(TM) for Lung Cancer (Phase II) and Renal Cell Carcinoma
(Phase II)

         Together with M.D. Anderson we are developing the novel platinum
analogue, AroplatinTM, for the treatment of solid tumors. AroplatinTM has been
designed to overcome the toxicity and resistance that currently limits the
usefulness of platinum, a chemotherapeutic agent widely used in the treatment of
solid tumors. Phase I clinical trials have been conducted under a physician's
IND at M.D. Anderson.

         Aroplatin(TM) is currently being evaluated in two Phase II clinical
trials, under institutional IND's at M.D. Anderson:

         o        a trial for the treatment of mesothelioma, a type of lung
                  cancer, funded by the Office of Orphan Drug Products at the
                  FDA; and

         o        a trial for the treatment of metastatic renal cell carcinoma
                  funded by us.

         In November 1999, we assumed ownership of the institutional INDs for
AroplatinTM and will begin conducting our own clinical development programs for
this product. AroplatinTM has been designated an orphan drug for the treatment
of malignant mesothelioma by the FDA.

         AroplatinTM is covered by a series of patents and a patent application,
licensed exclusively to us by M.D. Anderson, relating to hydrophobic
cis-platinum complexes and to stable liposomal formulations of the lipophilic
platinum compounds. Hydrophobic or lipophilic means reduced solubility in water,
and refers to cis-platinum complexes which are platinum molecules joined at
different positions. The claims of these patents are drawn to novel cis-platinum
complexes having hydrophobic properties and possessing hydrocarbon substituents.
Hydrocarbon substituents are molecules consisting of hydrogen and carbon.
Formulations containing the novel platinum complexes entrapped in liposomes and
exhibiting improved drug stability are included. The patents also cover
anti-tumor compositions with these stable cis-platinum complexes containing
liposomes and methods of using them to treat tumors. Claims to the product have
been allowed by the European Patent Office. A patent application filed in the
United States that may overlap claims included in the United States patents
licensed to us is the subject of an ongoing interference proceeding in the
United States Patent and Trademark Office challenging the validity of this
patent. We cannot currently predict the outcome of this matter. See "-- Patents
and Proprietary Rights."

RESEARCH PIPELINE

         Our goal is to establish an effective and efficient pharmaceutical
development infrastructure and capability to provide a continuing pipeline of
products for commercialization. Our research and development strategy is to
augment our pipeline by partnering with academic centers such as M.D. Anderson,
as well as with private research foundations. This partnering will allow us to
identify opportunities which have already been validated in preclinical and, in
some instances, clinical studies before allocating resources for further
evaluation and development. This approach will allow us to bypass the lengthy
and uncertain drug discovery and screening process and to proceed quickly to
product development and clinical evaluation. We believe that using this strategy
will allow us to maintain a full pipeline of innovative products for the
treatment of cancer and infectious diseases. See "-- Collaborative Agreements."




                                      -8-
<PAGE>   12

COLLABORATIVE AGREEMENTS

         Our development strategy involves entering into selected development
and licensing agreements with corporate partners to provide working capital as
well as assist in the efficient development and marketing of certain of our
products. See "-- Additional Business Risks -- Our Ability to Enter into
Collaborative Agreements Is Critical to Our Successful Development, Sales and
Licensing of Products and Potential Profitability."

         Collaborative Agreement with Abbott Laboratories

         In November 1998, we entered into a stock purchase agreement and a
license agreement with Abbott Laboratories for Nyotran(R). The license agreement
provides Abbott with exclusive worldwide rights to market and sell Nyotran(R),
subject to rights previously granted to Grupo Ferrer Internacional, S.A. in
Spain and Portugal and co-promotion rights retained by us in the United States
and Canada for an initial two year period. These co-promotion rights will renew
annually thereafter for successive one year periods unless canceled by either
party. To date, Abbott has purchased $3.0 million of our common stock and paid
us up-front and milestone payments of $ 14.7 million under the license
agreement. Abbott's payments to us provided funding for the continuing clinical
development of Nyotran(R), and subsequent milestones are due if specified sales
targets are achieved. However, there can be no assurance that these milestone
payments will be made. Certain milestone payments are subject to reduction if
the completion of the applicable activity is delayed beyond various dates. Once
paid, all payments are non-refundable. Abbott will also pay us royalties that
increase in amount based upon the level of product sales of Nyotran(R) in each
year.

         The licenses granted under the Nyotran(R) agreement terminate on a
country-by-country basis on the expiration of the last patent relating to that
product in that country. The agreement is terminable by Abbott in the event
certain regulatory milestone goals are not met or other specified events occur,
such as adverse safety and efficacy issues, and are terminable by either party
on the occurrence of a breach that is not cured by the breaching party within a
certain time period after notice has been given to that breaching party. In the
event the agreement is terminated by Abbott due to our failure to achieve a
regulatory milestone in a timely manner or other specified cause, no further
payments by Abbott are due.

         Relationship with Grupo Ferrer Internacional, S.A.

         In 1997, we entered into a supply and distribution agreement with Grupo
Ferrer Internacional, S.A. to commercialize and market Nyotran(R), under which
Grupo Ferrer received the exclusive right to distribute and sell Nyotran(R) in
Spain and Portugal. This agreement was subsequently amended to enable Abbott to
pursue an optimal registration and commercialization strategy in all
international markets. The three parties are continuing three-way discussions to
define this strategy.

         Relationship with The University of Texas M.D. Anderson Cancer Center

         We have two license agreements with M.D. Anderson which grant us
exclusive rights to manufacture, use, market and sell products based upon
certain technology developed at M.D. Anderson relating to the development of
human monocyte or murine macrophage-derived cytotoxins which inhibit or destroy
the proliferation of tumor cells, liposomal-encapsulated polyene antibiotics,
except amphotericin B, liposomal-encapsulated anthracyclines,
liposomal-encapsulated platinum derivatives and liposomal-encapsulated
retinoids. Human monocyte or murine macrophage-derived cytotoxins refers to the
source of the cytotoxins, which is either human or mouse-based. Nyotran(R),
ATRAGEN(R), Annamycin and AroplatinTM are products derived from our relationship
with M.D. Anderson.

         The license agreements with M.D. Anderson require us to pay royalties
for licensed technology based on specified percentages of cumulative net sales
and royalties from sublicensees. We are also obligated to pay a milestone
payment of $200,000 upon the approval of an NDA for each licensed product.
Because we have not sold any products or processes to date, we have not paid any
royalties under the license agreements. M.D. Anderson is responsible for the
preparation, filing and prosecution of all patent applications, foreign and
domestic, relating to technology developed at M.D. Anderson, and we reimburse
M.D. Anderson for expenses incurred for these activities.



                                      -9-
<PAGE>   13

         The license agreements generally remain in force until the expiration
of the last patent subject to the agreements. Either party may terminate the
license agreements after 60 days notice to the other party in the event of a
material breach of the terms of that agreement. M.D. Anderson has the right to
terminate either license agreement with 90 days notice for failure to convert
the licensed subject matter to a commercial form; however, we believe our
ongoing and active research and development efforts directed at commercial
marketing of the licensed products currently satisfies this obligation.

         We have entered into research and development contracts with M.D.
Anderson in conjunction with the license agreements which obligate us to fund
research and development expenses incurred by the M.D. Anderson scientists that
relate to the technology licensed by us. These contracts grant us an exclusive
worldwide license to technology under the license agreements and developed as a
result of research funded by us. These contracts also grant us a right of first
refusal to acquire an exclusive worldwide license to certain technology
developed at M.D. Anderson which is not the result of projects funded by us.

MANUFACTURING

         We do not have the facilities necessary to manufacture our products in
accordance with the good manufacturing practices guidelines established by the
FDA for companies manufacturing pharmaceutical products. We do have the
capability to develop formulations, analytical methods, process controls and
manufacturing technology for our products. We generally use contract
manufacturers to produce batches of our products for clinical testing, although
we expect Abbott to supply the quantities of Nyotran(R) necessary to conduct our
remaining clinical trials of that product. We and the manufacturers of our
products, other than Abbott, have not entered into any written agreements other
than periodic purchase orders for the supply of the products they manufacture on
our behalf. Contract manufacturers are closely supervised to ensure adherence to
established production methods and compliance with our rigorous quality control
and quality assurance standards. We do not expect to establish any significant
manufacturing capacity in the near future. We do not operate, and do not
currently plan to operate, manufacturing facilities for the production of our
products in commercial quantities, and intend to contract with third parties for
the manufacture and supply of our products. There can be no assurance that we
will be able to obtain supplies of products from third-party suppliers on terms
or in quantities acceptable to us. Also, we depend on third parties for the
manufacture of our products. This may adversely affect our product profit
margins and ability to develop and deliver products on a timely basis. Any
third-party suppliers of this kind or any manufacturing facility we establish
will be required to meet FDA good manufacturing practices requirements. FDA
inspection and approval of manufacturing facilities and quality procedures for a
drug are a prerequisite to approval of an NDA for that drug. We may encounter
significant delays in obtaining supplies from third-party manufacturers or
experience interruptions in our supplies. If we are unable to obtain adequate
supplies, our business would be materially adversely affected.

         The raw materials required for the majority of our products are
currently available in quantities sufficient to conduct our research,
development, preclinical safety and clinical development activities. Certain of
our products, such as Annamycin and AroplatinTM, are new syntheses and,
therefore, are not yet available in commercial quantities. We cannot give
assurance that the raw materials necessary for the manufacture of our products
will be available in sufficient quantities or at a reasonable cost.
Complications or delays in obtaining raw materials or in product manufacturing
could delay the submission of products for regulatory approval and the
initiation of new development programs, which could materially impair our
competitive position and potential profitability.

SALES AND MARKETING

         We presently intend to market our products in North America through our
own sales and marketing infrastructure or under marketing arrangements with
other companies and will build our sales and marketing infrastructure in
accordance with regulatory submissions. We currently plan to market selected
products directly to oncologists, hematologists and infectious disease
specialists through a niche sales and marketing force in the United States.
Where large market opportunities require large sales forces, we may enter into
co-marketing arrangements with, or license marketing rights to, third parties.
Our international strategy is to negotiate marketing agreements with
pharmaceutical manufacturers and distributors which will entitle us to receive a
percentage of net product sales.




                                      -10-
<PAGE>   14




         We do not have any experience in sales, marketing or distribution. To
market any of our products, we must develop a sales and marketing force with
supporting distribution capability or enter into marketing and distribution
arrangements with a company that has an established capability. Significant
additional expenditures will be required for us to develop these capabilities.
We have entered into agreements with Abbott and Grupo Ferrer with respect to the
marketing and sale of Nyotran(R). In addition, we may enter into marketing
agreements with one or more pharmaceutical companies to market other products
that we may develop. To the extent we rely upon licensing, marketing or
distribution arrangements with others, any revenues we receive will depend upon
the efforts of third parties. We cannot assure that any third party will market
our products successfully or that any third-party collaboration will be on terms
favorable to us. If any marketing partner does not market a product
successfully, our business would be materially adversely affected. We cannot
give assurance that we will be able to establish sales, marketing and
distribution capabilities or that we or our collaborators will be successful in
gaining market acceptance for any products that we may develop. Our failure to
establish marketing capabilities or to enter into marketing arrangements with
third parties would have a material adverse effect on us.

PATENTS AND PROPRIETARY RIGHTS

         Our ability to commercialize any products will depend, in part, upon
our or our licensors' ability to obtain patents, enforce those patents, preserve
trade secrets, and operate without infringing upon the proprietary rights of
third parties. The patent positions of biotechnology and pharmaceutical
companies are highly uncertain and involve complex legal and factual questions.
Some of the United States patents and patent applications owned by or licensed
to us are method-of-use patents that cover the use of certain compounds to treat
specified conditions, and composition-of-matter patents are not available for
some of our product candidates. We cannot assure that:

         o        the patent applications licensed to or owned by us will result
                  in issued patents;
         o        that patent protection will be secured for any particular
                  technology;
         o        that any patents that have been or may be issued to us or our
                  licensors will be valid or enforceable;
         o        that any patents will provide meaningful protection to us;
         o        that others will not be able to design around the patents; or
         o        that our patents will provide a competitive advantage or have
                  commercial application.

         We cannot give assurance that patents owned by or licensed to us will
not be challenged by others. We could incur substantial costs in proceedings
before the United States Patent and Trademark Office and other regulatory
authorities, including interference proceedings. These proceedings could result
in adverse decisions about the patentability of our inventions and products as
well as about the enforceability, validity or scope of protection afforded by
the patents. We are currently involved in an interference proceeding against
Sumitomo Pharmaceuticals before the United States Patent and Trademark Office
regarding the drug NDDP used in the formula of AroplatinTM. AroplatinTM consists
of the liposomal formulation of the NDDP molecule. Both of the parties claim
sole right to the invention. Sumitomo Pharmaceuticals is relying on a Japanese
patent for priority. The interference was declared by an examiner to be between
a currently pending United States patent application owned by Sumitomo
Pharmaceuticals and certain issued patents licensed by us from M.D. Anderson.
Should the Patent Office deem the Sumitomo Pharmaceuticals Japanese patent to be
first in time over the date relating to our issued patents, our patents may be
revoked or alternatively, some of the claims contained in these patents would be
revoked. Under these circumstances, we would need to enter into a license
agreement to obtain rights to NDDP in order to commercialize the product in the
United States. There can be no assurance that we will be able to enter into a
license on acceptable terms, if at all. See "-- Cancer -- AroplatinTM for Lung
Cancer (Phase II) and Renal Cell Carcinoma (Phase II)."

         We cannot give assurance that the manufacture, use or sale of our
product candidates will not infringe patent rights of others. We may be unable
to avoid infringement of those patents and may be required to seek a license,
defend an infringement action, or challenge the validity of the patents in
court. We cannot give assurance that a license will be available to us, if at
all, upon terms and conditions acceptable to us or that we will prevail in any
patent litigation. Patent litigation is costly and time consuming, and we cannot
assure that we will have sufficient resources to bring the litigation to a
successful conclusion. If we do not obtain a license under such patents, are
found liable for infringement, or are not able to have infringing patents
declared invalid, we may be liable for significant money damages, may encounter
significant delays in bringing products to market, or may be precluded from
participating in the manufacture, use or sale of products or methods of
treatment requiring these



                                      -11-
<PAGE>   15

licenses. We do not believe that the commercialization of our products will
infringe upon the patent rights of others. However, we cannot assure that we
have identified all or any United States and foreign patents that pose a risk of
infringement.

         We also rely upon trade secrets and other unpatented proprietary
information in our product development activities. To the extent we rely on
trade secrets and unpatented know-how to maintain our competitive technological
position, we cannot assure that others may not independently develop the same or
similar technologies. We seek to protect trade secrets and proprietary
knowledge, in part through confidentiality agreements with our employees,
consultants, advisors and collaborators. Nevertheless, these agreements may not
effectively prevent disclosure of our confidential information and may not
provide us with an adequate remedy in the event of unauthorized disclosure of
such information. If our employees, scientific consultants or collaborators
develop inventions or processes independently that may be applicable to our
products, disputes may arise about ownership of proprietary rights to those
inventions and processes. These inventions and processes will not necessarily
become our property, but may remain the property of those persons or their
employers. Protracted and costly litigation could be necessary to enforce and
determine the scope of our proprietary rights. Failure to obtain or maintain
patent and trade secret protection, for any reason, would have a material
adverse effect on us.

         We engage in collaborations, sponsored research agreements, licensing
and other arrangements with academic researchers and institutions that have
received and may receive funding from United States government agencies. As a
result of these arrangements, the United States government or certain third
parties have rights in certain inventions developed during the course of the
performance of these collaborations and agreements as required by law or the
agreements. These rights typically allow the government to use the invention for
free on an internal basis and for research and development purposes.

         Several bills affecting patent rights have been introduced in the
United States Congress. These bills address various aspects of patent law,
including publication, patent term, reexamination, subject matter and
enforceability. It is not certain whether any of these bills will be enacted
into law or what form new laws may take. Accordingly, the effect of legislative
change on our intellectual property estate is uncertain.

GOVERNMENT REGULATION

         Our research and development activities, preclinical studies and
clinical trials, and ultimately the manufacturing, marketing and labeling of
products, are subject to extensive regulation by the FDA and other regulatory
authorities in the United States and other countries. The United States Federal
Food, Drug and Cosmetic Act and the associated regulations and other federal and
state statutes and regulations govern, among other things, the testing,
manufacture, safety, efficacy, labeling, storage, record keeping, approval,
advertising and promotion of our products. Preclinical study and clinical trial
requirements and the regulatory approval process take years and require the
expenditure of substantial resources. Additional government regulation may be
established that could prevent or delay regulatory approval of our products.
Delays or rejections in obtaining regulatory approvals would adversely affect
our ability to commercialize any product we develop and our ability to receive
product revenues or royalties. If regulatory approval of a product is granted,
the approval may include significant limitations on the indicated uses for which
the product may be marketed.

         The FDA and other regulatory authorities require that the safety and
efficacy of our therapeutic products must be supported through adequate and
well-controlled clinical trials. If the results of these clinical trials do not
establish the safety and efficacy of our products to the satisfaction of the FDA
and other regulatory authorities, we will not receive the approvals necessary to
market our products, which would have a material adverse effect on us.


                                      -12-
<PAGE>   16

         The standard process required by the FDA before a pharmaceutical agent
may be marketed in the United States includes:

         o        preclinical tests;
         o        submission to the FDA of an IND which must become effective
                  before human clinical trials may commence;
         o        adequate and well-controlled human clinical trials to
                  establish the safety and efficacy of the drug in its intended
                  application;
         o        submission of an NDA to the FDA; and
         o        FDA approval of the NDA prior to any commercial sale or
                  shipment of the drug.

         In addition to obtaining FDA approval for each product, each drug
manufacturing establishment must be inspected and approved by the FDA. All
manufacturing establishments are subject to inspections by the FDA and by other
federal, state and local agencies and must comply with current FDA good
manufacturing practices.

         Preclinical tests include laboratory evaluation of product chemistry,
formulation and stability, as well as animal studies to assess the potential
safety and efficacy of each product. Preclinical safety tests must be conducted
by laboratories that comply with the good laboratory practices guidelines
established by the FDA for companies conducting research and development on
proposed pharmaceutical products. The results of the preclinical tests are
submitted to the FDA as part of an IND and are reviewed by the FDA before the
commencement of human clinical trials. Unless the FDA objects to an IND, the IND
will become effective 30 days following its receipt by the FDA. There can be no
assurance that submission of an IND will result in FDA authorization to commence
clinical trials or that the lack of an objection means that the FDA will
ultimately approve an NDA.

         Clinical trials involve the administration of the investigational new
drug to humans under the supervision of a qualified principal investigator.
Clinical trials must be conducted in accordance with Good Clinical Practices
under protocols that detail the objectives of the study, the parameters to be
used to monitor safety, and efficacy criteria to be evaluated. Each protocol
must be submitted to the FDA as part of the IND. Also, each clinical trial must
be approved and conducted under the auspices of an Institutional Review Board.
The Institutional Review Board will consider, among other things, ethical
factors, the safety of human subjects, and the possible liability of the
institution conducting the clinical trials.

         Clinical trials are typically conducted in three sequential phases
which may overlap. In Phase I, the initial introduction of the drug to humans,
the drug is tested for safety, dosage tolerance, metabolism, distribution and
excretion. Phase II involves studies of a limited patient population to gather
evidence about the efficacy of the drug for specific targeted indications,
dosage tolerance and optimal dosage, and to identify possible adverse effects
and safety risks. When a product has shown evidence of efficacy and has an
acceptable safety profile in a Phase II evaluation, Phase III clinical trials
are undertaken to evaluate clinical efficacy and to test for safety in an
expanded patient population at geographically dispersed clinical trial sites.
Phase III clinical trials are not always required, however, where the data
obtained in Phase II trials is determined to be "pivotal." There can be no
assurance that any of our clinical trials will be completed successfully or
within any specified time period. We or the FDA may suspend clinical trials at
any time.

         We have designed the protocols for our pivotal clinical trials based on
analysis of our research, including various parts of our Phase I and Phase II
clinical trials. Although copies of our pivotal clinical trial protocols have
been submitted to the FDA, there can be no assurance that the FDA, after the
results of the pivotal clinical trials have been announced, will not disagree
with the design of the pivotal clinical trial protocols. In addition, the FDA
inspects and reviews clinical trial sites, informed consent forms, data from the
clinical trial sites, including case report forms and record keeping procedures,
and the performance of the protocols by clinical trial personnel to determine
compliance with good clinical practices established by the FDA. The FDA also
looks to determine that there was no bias in the conduct of clinical trials. The
conduct of clinical trials in general and the performance of the pivotal
clinical trial protocols is complex and difficult. There can be no assurance
that the design or the performance of the pivotal clinical trial protocols will
be successful.

         The results of preclinical studies and clinical trials, if successful,
are submitted in an NDA to seek FDA approval to market and commercialize the
drug product for a specified use. The testing and approval process will



                                      -13-
<PAGE>   17

require substantial time and effort, and there can be no assurance that any
approval will be granted for any product or that approval will be granted
according to any schedule. The FDA may deny an NDA if it believes that
applicable regulatory criteria are not satisfied. The FDA may also require
additional testing for safety and efficacy of the drug. Moreover, if regulatory
approval of a drug product is granted, the approval will be limited to specific
indications. There can be no assurance that any of our product candidates will
receive regulatory approvals for commercialization.

         The FDA has implemented an accelerated review process for
pharmaceutical agents that treat serious or life-threatening diseases and
conditions, subject to payment of user fees. When appropriate, we intend to
pursue opportunities for accelerated review of our products. We cannot predict
the ultimate effect of this review process on the timing or likelihood of FDA
review of any of our products.

         Even if regulatory approvals for our products are obtained, our
products and the facilities manufacturing our products are subject to continual
review and periodic inspection. The FDA will require post-marketing reporting to
monitor the safety of our products. Each drug manufacturing establishment must
be inspected and approved by the FDA. All manufacturing establishments are
subject to biennial inspections by the FDA and must comply with the FDA's good
manufacturing practices. To supply drug products for use in the United States,
foreign manufacturing establishments must comply with the FDA's good
manufacturing practices and are subject to periodic inspection by the FDA or by
regulatory authorities in those countries under reciprocal agreements with the
FDA. In complying with good manufacturing practices, manufacturers must expend
funds, time and effort in the area of production and quality control to ensure
full technical compliance. We do not have any drug manufacturing capability and
must rely on outside firms for this capability. See "-- Manufacturing." The FDA
stringently applies regulatory standards for manufacturing. Identification of
previously unknown problems with respect to a product, manufacturer or facility
may result in restrictions on the product, manufacturer or facility, including
warning letters, suspensions of regulatory approvals, operating restrictions,
delays in obtaining new product approvals, withdrawal of the product from the
market, product recalls, fines, injunctions and criminal prosecution.

         Before our products can be marketed outside of the United States, they
are subject to regulatory approval similar to FDA requirements in the United
States, although the requirements governing the conduct of clinical trials,
product licensing, pricing, and reimbursement vary widely from country to
country. No action can be taken to market any drug product in a country until an
appropriate application has been approved by the regulatory authorities in that
country. FDA approval does not assure approval by other regulatory authorities.
The current approval process varies from country to country, and the time spent
in gaining approval varies from that required for FDA approval. In some
countries, the sale price of a drug product must also be approved. The pricing
review period often begins after market approval is granted. Even if a foreign
regulatory authority approves any of our products, no assurance can be given
that it will approve satisfactory prices for the products.

         Our research and development involves the controlled use of hazardous
materials, chemicals, viruses and various radioactive compounds. Although we
believe that our procedures for handling and disposing of those materials comply
with state and federal regulations, the risk of accidental contamination or
injury from these materials cannot be eliminated. If an accident of this type
occurs, we could be held liable for resulting damages, which could be material
to our financial condition and business. We are also subject to numerous
environmental, health and workplace safety laws and regulations, including those
governing laboratory procedures, exposure to blood-borne pathogens, and the
handling of biohazardous materials. Additional federal, state and local laws and
regulations affecting us may be adopted in the future. Any violation of these
laws and regulations, and the cost of compliance, could materially and adversely
affect us.

         Under the Orphan Drug Act, the FDA may grant "orphan drug" status to
therapeutic agents intended to treat a "rare disease or condition," defined as a
disease or condition that affects less than 200,000 persons in the United
States. Orphan drug status grants the sponsor tax credits for the amounts
expended on clinical trials, provided that certain conditions are met, as well
as potential marketing exclusivity for four to seven years following approval of
the pertinent NDA. We received orphan drug status for ATRAGEN(R) in 1993 for the
treatment of acute and chronic leukemia. We received orphan drug status for
AroplatinTM in 1999 for the treatment of malignant mesothelioma. We may request
this status for more of our products as part of our overall regulatory strategy.
There is no assurance, however, that any of our other products will receive
orphan drug status or that the benefits of protection currently afforded by
orphan drug status will remain in effect. In addition, any party may obtain
orphan


                                      -14-
<PAGE>   18

drug status with respect to products for which patent protection has expired or
is otherwise unavailable. The first party granted marketing approval could
prevent other persons from commercializing that product during the period for
which exclusivity was granted to that party. Exclusivity granted under the
Orphan Drug Act is typically for a seven year period.

COMPETITION

         We believe that our products, because of their unique pharmacologic
profiles will become useful new treatments for cancers and infectious diseases,
either as alternatives to or in combination with other pharmaceuticals. We are
engaged in pharmaceutical product development characterized by rapid
technological progress. Many established biotechnology and pharmaceutical
companies, universities and other research institutions with resources
significantly greater than ours may develop products that directly compete with
our products. Those entities may succeed in developing products, including
liposomes and liposomal products, that are safer, more effective or less costly
than our products. Even if our products should prove to be more effective than
those developed by other companies, other companies may be more successful than
us because of greater financial resources, greater experience in conducting
preclinical and clinical trials and obtaining regulatory approval, stronger
sales and marketing efforts, earlier receipt of approval for competing products
and other factors. If we commence significant commercial sales of our products,
we or our collaborators will compete in areas in which we have little or no
experience such as manufacturing and marketing. There can be no assurance that
our products, if commercialized, will be accepted and prescribed by healthcare
professionals.

         Some of our competitors are active in the development of proprietary
liposomes and in liposomal research and product development to treat cancer and
certain fungal infections. Those competitors include The Liposome Company, Inc.,
Gilead Sciences and ALZA Corporation. Each of these companies' products have
regulatory approval in the United States and other countries. Any marketing of
these and other products that treat disease indications targeted by us could
adversely affect the market acceptance of our products as a result of the
established market recognition and physician familiarity with the competing
product. The presence of directly competitive products could also result in more
intense price competition than might otherwise exist, which could have a
material adverse effect on our financial condition and results of operations. We
believe that competition will be intense for all of our product candidates.

EMPLOYEES

         As of December 31, 1999, we had 82 full time employees, 63 of whom were
engaged in research, development, clinical and regulatory affairs and 19 of whom
were engaged in marketing, business development and administration. Our
employees include two M.D.s, eleven Ph.D.s, one Pharm.D and four R.N.s. We have
not experienced any work stoppages and consider relations with our employees to
be good.

ADDITIONAL BUSINESS RISKS

We are In an Early Stage of Development, Have a History of Operating Losses,
Anticipate Future Losses, May Not Generate Revenues From Product Sales and May
Never Become Profitable

         Our business is at an early stage of development. We have not yet
generated any revenues from the commercial sale of our products. We cannot
assure that we will ever generate revenues from product sales.

         We have incurred losses and have had negative cash flows from
operations since inception. We have funded our activities primarily from sales
of stock and, to a lesser extent, from revenues under research and development
agreements and grants. As of December 31, 1999, our accumulated deficit was
$101.5 million. To date, we have dedicated most of our financial resources to
the research and development of products, general and administrative expenses,
and the prosecution of patents and patent applications.

         We expect to incur operating losses for at least the next several
years. This is primarily attributable to our plan to spend substantial amounts
on research and development of products, including preclinical studies and
clinical trials, and, if we obtain necessary regulatory approvals, on sales and
marketing efforts. We cannot assure that we will ever become profitable or that
we will remain profitable if and when we become profitable. See



                                      -15-
<PAGE>   19

"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations" and "-- Liquidity and Capital Resources."

We Will Require Future Capital and Are Uncertain of the Availability or Terms of
Additional Funding, Which May Lead to Bankruptcy if Funding Becomes Unavailable,
or Dilution or other Adverse Effects to the Value of Our Shares or Our
Shareholders' Rights Even if Funding is Available

         We will continue to require substantial additional funds for our
operations. We believe that we can conserve our existing financial resources to
satisfy our capital and operating requirements into mid 2001. In the future, we
may need to raise substantial additional capital to fund operations. It is
possible that changes in research and development plans, acquisitions or other
events will require us to make unexpected large future expenditures. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

         Additional funding may be available in the public or private capital
markets and through collaboration agreements with partners. If, however, the
results of our clinical trials are not favorable, it will be much more difficult
for us to raise additional funds. We do not know if additional funding will be
available at all or on acceptable terms. If we are not able to obtain funding,
it may be necessary to curtail some or all research and development programs or
to obtain funds through arrangements that require us to relinquish rights to
some or all of our products or to declare bankruptcy. If we raise funds by
selling more stock, share ownership by our current stockholders will be diluted.
In addition, we may grant future investors rights which are superior to those of
current stockholders.

Clinical Trial Results May Result in Failure to Obtain FDA Approval and
Inability to Sell Products

         Before approving a drug for commercial sale as a treatment for a
disease, the FDA and other regulatory authorities generally require that the
safety and efficacy of a drug be demonstrated in humans. This is provided by
showing results from adequate and well-controlled clinical trials in which the
drug is used to treat patients suffering from the disease. We cannot predict
whether our clinical trials will adequately demonstrate the drug's safety and
efficacy or whether the FDA or other regulatory authority will agree with the
sufficiency of the trial results. If our clinical trials do not demonstrate the
safety or efficacy of our products, or if we otherwise fail to obtain regulatory
approval for our products, we will not be able to generate revenues from the
commercial sale of our products. See " Business -- Government Regulation."

Delays in Patient Enrollment May Result in Increased Costs, Program Delays, or
Both, to Clinical Trials

         Pivotal clinical trials are very costly and time-consuming. The speed
with which we are able to enroll patients in clinical trials is affected by
several factors, including the size of the patient population, competing trials,
the proximity of patients to clinical sites, and the eligibility criteria for
the study. These delays and complications can affect the cost of our clinical
trials as well as our ability to complete clinical trials on schedule. See
"Business -- Government Regulation."

The FDA Can Impose Other Restrictions On Our Operations that may Increase Costs
or Delay or Prohibit Sales

         The FDA and other regulatory authorities will continue to review our
products and periodically inspect the facilities used to manufacture those
products both before and after the grant of regulatory approvals. If the FDA or
other regulatory authorities identify problems with a product, manufacturer of
our products or its facility, they may impose restrictions that may include
warning letters, suspensions of regulatory approvals, operating restrictions,
delays in obtaining new product approvals, withdrawal of the product from the
market, product recalls, fines, injunctions and criminal prosecution. See
"Business -- Government Regulation."



                                      -16-
<PAGE>   20

Our Products Must Obtain Regulatory Approval In Other Countries Which Delay or
Prohibit Sales

         We and licensees of our products must obtain regulatory approvals in
countries other than the United States before marketing products in those
countries. The requirements governing the conduct of clinical trials, product
licensing, pricing and reimbursement vary widely from country to country. Some
countries require approval of the sale price of a drug before it can be
marketed. In many countries, the pricing review period begins after product
licensing approval is granted. As a result, we or our licensees may obtain
regulatory approval for a product in a particular country, but then be subject
to price regulation that prevents the sale of the product at satisfactory
prices. See " Business -- Government Regulation."

We Experience a Substantial Degree of Uncertainty Relating to Patents that, if
Determined to be Unenforceable, Could Result in the Loss of the Patent or Claims
Against Us

         Our success will depend to a large extent on our ability to:

         o        obtain United States and foreign patent protection for drug
                  candidates and processes,
         o        preserve trade secrets, and
         o        operate without infringing the proprietary rights of third
                  parties.

         Legal standards relating to the validity of patents covering
pharmaceutical and biotechnological inventions and the scope of claims made
under these patents are still developing. As a result, our ability to obtain and
enforce patents that protect our products is uncertain and involves complex
legal and factual questions.

         We also cannot be completely sure that the inventors of subject matter
covered by our patents and patent applications were the first to invent or the
first to file patent applications for such inventions. Furthermore, we cannot
guarantee that any patents will issue from any pending or future patent
applications owned by or licensed to us. Existing or future patents may be
challenged, infringed upon, invalidated, found to be unenforceable or
circumvented by others. We cannot assure that any of our rights under any issued
patents will provide sufficient protection against competitive products or
otherwise cover commercially valuable products or processes. We may not have
identified all United States and foreign patents that pose a risk of
infringement. We are also currently involved in certain interference proceedings
relating to AroplatinTM. See " Business -- Patents and Proprietary Rights."

We May Incur Substantial Costs and Delays As a Result of Proceedings and
Litigation Regarding Patents and Other Proprietary Rights

         Proceedings involving our patents or patent applications could result
in adverse decisions about:

         o        the patentability of our inventions and products; and/or
         o        the enforceability, validity or scope of protection offered by
                  our patents.

         The manufacture, use or sale of our products may infringe on the patent
rights of others. If we are unable to avoid infringement of the patent rights of
others, we may be required to seek a license, defend an infringement action or
challenge the validity of the patents in court. Patent litigation is costly and
time consuming. We may not have sufficient resources to bring these actions to a
successful conclusion. In addition, if we do not obtain a license, and fail
successfully to defend an infringement action or to have infringing patents
declared invalid, we may:

         o        incur substantial money damages;
         o        encounter significant delays in bringing products to market;
                  and/or
         o        be precluded from participating in the manufacture, use or
                  sale of products or methods of treatment requiring licenses.



                                      -17-
<PAGE>   21

Confidentiality Agreements with Employees and Others May Not Adequately Prevent
Disclosure of Trade Secrets and Other Unpatented Proprietary Information, which,
if Disclosed, Could Materially Adversely Affect Our Operations or Financial
Condition

         Because trade secrets and other unpatented proprietary information are
critical to our business, we seek protection through confidentiality agreements
with employees, consultants, advisors and collaborators. These agreements may
not effectively prevent disclosure of confidential information and may not
provide an adequate remedy in the event of unauthorized disclosure of
confidential information. In addition, others may independently discover trade
secrets and proprietary information. Costly and time-consuming litigation could
be necessary to enforce and determine the scope of our proprietary rights, and
failure to obtain or maintain trade secret protection could have a material
adverse effect on our business, results of operations and financial condition.
See "Business -- Patents and Proprietary Rights."

We Do Not Manufacture Our Own Products And May Not Be Able to Obtain Adequate
Supplies, which Could Cause Delays or Reduce Profit Margins

         We do not have the facilities necessary to manufacture products in
accordance with FDA good manufacturing practices. As a result, we use contract
manufacturers to produce quantities for clinical testing. We have not entered
into any agreement with our manufacturers except for (1) periodic purchase
orders and (2) Abbott who holds an option to manufacture Nyotran(R). We do not
expect to establish any significant manufacturing capacity in the near future.
Instead, we intend to rely on corporate partners and contract manufacturers for
the manufacture and supply of our products. Therefore, we may not be able to
obtain supplies of products on acceptable terms or in sufficient quantities, if
at all. Our dependence on third parties for the manufacture of products may also
reduce our profit margins and ability to develop and deliver products with
sufficient speed. See "Business -- Manufacturing."

Our Products Require Materials that May Not Be Readily Available or Cost
Effective, which May Adversely Affect Our Competitive Position or Profitability

         Some of our products, such as Annamycin and AroplatinTM, are new
syntheses and are not yet available in commercial quantities. Raw materials
necessary for the manufacture of these and other of our products may not be
available in sufficient quantities or at a reasonable cost in the future.
Complications or delays in obtaining raw materials or in product manufacturing
could delay the submission of products for regulatory approval and the
initiation of new development programs, which could materially impair our
competitive position and potential profitability. See "Business --
Manufacturing."

We Have No Experience In Sales, Marketing and Distribution and Rely on Third
Parties, which May Result in Lower Sales, Higher Costs or Lower Profit Margins

         We anticipate relying on one or more pharmaceutical companies to market
our products to customers, and, wherever possible, to retain co-marketing rights
in certain markets such as the United States and Canada. Agreements have already
been entered into with Abbott and Grupo Ferrer for distribution of Nyotran(R).
We have retained co-marketing rights under the Abbott agreement for a limited
period of time. See "Business -- Collaborative Agreements." To the extent that
we use distribution arrangements with third parties to market products, our
ability to generate revenues and profits will depend upon the efforts of these
third parties.

         We are developing our own sales and marketing capabilities that will
require us to make significant expenditures. We may not be successful in
establishing sales, marketing and distribution capabilities. In addition, our
ability to generate revenues and profits will be reduced or eliminated:

         o        if we fail to establish sales, marketing and/or distribution
                  capabilities or enter into arrangements with third parties;
         o        if we or new marketing partners fail to market a product
                  successfully;
         o        if physicians do not prescribe our products; or
         o        if patients do not accept our products.


                                      -18-
<PAGE>   22

Our Ability to Enter into Collaborative Arrangements Is Critical to Our
Successful Development, Sales and Licensing of Products and Potential
Profitability

         We are a product development company with limited resources. We do not
conduct research and we are just beginning to create a marketing and sales
department. Therefore, our present strategy involves entering into arrangements
with corporate, government and academic collaborators, licensors, licensees and
others. As a consequence, our success may depend in large part on the success of
these other parties in performing their responsibilities. Also, we may not be
able to establish additional collaborative arrangements or license agreements
that are necessary to develop and commercialize products. Even if established,
these collaborative or license agreements may not be successful. Some of these
collaborative agreements and license agreements provide for milestone payments
to us, and others require us to pay milestone payments to others. We may not be
able to achieve the milestones that trigger payments to us. In addition,
payments by us may not result in the development of marketable products by our
collaborators. See "Business -- Collaborative Agreements."

Competition in The Biotechnology and Pharmaceutical Industries May Result in
Competing Products, Superior Marketing of Other Products and Lower Revenues or
Profits for Us

         We believe that competition will be intense for all of our product
candidates. Our competitors include multinational pharmaceutical and chemical
companies, specialized biotechnology firms, and universities and other research
institutions. Many of these competitors have greater financial and other
resources than we do. These competitors may succeed in developing products that
are safer, more effective or less costly than our products. Even if our products
prove to be more effective than those developed by our competitors, our
competitors may be more successful because of greater financial resources,
greater experience in conducting preclinical and clinical trials and obtaining
regulatory approval, stronger sales and marketing efforts, earlier receipt of
approval for competing products and other factors.

         Some of our competitors are active in the development of proprietary
liposomes and in liposomal research and product development to treat cancer and
certain fungal infections. Some of these companies' products have regulatory
approval in the United States and other countries. Any marketing of these and
other products that treat diseases targeted by us could reduce the market
acceptance of our products. The presence of directly competitive products could
also result in intense price competition, which could reduce our revenues and
profits. See "Business -- Competition."

We May Not Be Able to Keep Up With The Rapid Technological Change in the
Biotechnology and Pharmaceutical Industries, Which Could Make Our Products
Obsolete

         Biotechnology and related pharmaceutical technologies have undergone
and continue to be subject to rapid and significant change. We expect that the
technologies associated with biotechnology research and development will
continue to develop rapidly. Our future will depend in large part on our ability
to maintain a competitive position with respect to these technologies. Any
compounds, products or processes that we develop may become obsolete before we
recover expenses incurred in developing those products.

Our Success May Depend on Third-Party Reimbursement of Patients' Costs for Our
Products

         Our ability to commercialize products successfully will depend in part
on the extent to which various third parties are willing to reimburse patients
for the costs of our products and related treatments. These third parties
include government authorities, private health insurers and other organizations,
such as health maintenance organizations. Third-party payors are increasingly
challenging the prices charged for medical products and services. Accordingly,
if less costly drugs are available, third-party payors may not authorize or may
limit reimbursement for our products, even if they are safer or more effective
than the alternatives. In addition, the trend toward managed healthcare and
government insurance programs could result in lower prices and reduced demand
for our products. Cost containment measures instituted by healthcare providers
and any general healthcare reform could affect our ability to sell products and
may have a material adverse effect on us.



                                      -19-
<PAGE>   23

         We cannot predict what additional legislation or regulation relating to
the healthcare industry or third-party coverage and reimbursement may be enacted
in the future, or what effect any legislation or regulation might have on our
business.

Our Activities Involve the Use of Hazardous Materials, which Subject Us to
Regulation, Related Costs and Delays and Potential Liabilities

         Our activities involve the controlled use of hazardous materials,
chemicals, viruses and various radioactive compounds. Although we believe that
our procedures for handling and disposing of these materials comply with state
and federal regulations, the risk of accidental contamination or injury from
these materials cannot be eliminated. If an accident occurs, we could be held
liable for resulting damages, which could be substantial. We are also subject to
numerous environmental, health and workplace safety laws and regulations,
including those governing laboratory procedures, exposure to blood-borne
pathogens and the handling of biohazardous materials. Additional federal, state
and local laws and regulations affecting our operations may be adopted in the
future. We may incur substantial costs to comply with and substantial fines or
penalties if we violate any of these laws or regulations.

Our Business has a Substantial Risk that Product Liability Claims and Insurance
May be Expensive or Unavailable

         We may be subject to product liability claims if the use of our
products is alleged to injure subjects or patients. This risk exists for
products tested in human clinical trials as well as products that are approved
to be sold commercially. Product liability claims could result in a recall of
products or a change in the indications for which they may be used. We presently
have product liability insurance coverage for claims arising from the use of our
products in clinical trials; however, this insurance may not be adequate to
cover all potential claims. Furthermore, product liability insurance is becoming
increasingly expensive. As a result, we may not be able to maintain current
amounts of insurance coverage, obtain additional insurance for clinical trials
or for commercial sales or obtain insurance at a reasonable cost or in
sufficient amounts to protect against losses that could have a material adverse
effect on us.

We Depend on Key Personnel and Competition for Qualified Personnel is Intense,
which Could Result in Delays or Additional Costs

         We believe that our ability to successfully implement our business
strategy is highly dependent on our management and scientific team. The loss of
services of one or more of our executive officers might hinder the achievement
of our development objectives. We are also highly dependent on our ability to
hire and retain qualified scientific and technical personnel. The competition
for these employees is intense. We may not be able to continue to hire and
retain the qualified personnel that we need for our business. Loss of the
services of or failure to recruit key scientific and technical personnel could
substantially hurt us and our product development efforts.

Contingent Stock Rights Could Result in Subsequent Dilution to Net Tangible Book
Value of Shares

         Pursuant to the terms of our 1995 merger with Triplex Pharmaceutical
Corporation, we are obligated to issue shares of our common stock to certain of
their former security holders if our board of directors determines that data
from clinical trials of Zintevir(R) on or before September 11, 2000 is
sufficient to file an NDA with the FDA. If that event occurs, these rights will
result in the issuance of up to an aggregate of $5.0 million of our common
stock. These shares will be valued at the current market value of our common
stock at the time the event requiring issuance of the shares occurs. As a
result, current shareholders could experience further dilution in the net
tangible book value per share.



                                      -20-
<PAGE>   24

ITEM 2.  PROPERTIES

         Our corporate offices and laboratories are located in a 30,000 square
foot leased building located at 8707 Technology Forest Place in The Woodlands, a
suburb of Houston, Texas. The lease for this facility expires in 2008, and we
have renewal options to extend the lease to 2018. Our lease provides an option
to add 40,000 square feet at the then-current market rate. We consider that the
current facilities will be suitable for our needs for the foreseeable future. We
do not intend to develop any internal manufacturing facilities in the near
future.

ITEM 3.  LEGAL PROCEEDINGS

         We are not currently a party to any material legal proceedings.

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

         Not applicable.





                                      -21-
<PAGE>   25




                                     PART II


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

         Our common stock is traded on the Nasdaq National Market under the
symbol "ARNX." The last sale price of the common stock as reported on the Nasdaq
National Market on March 24, 2000, was $3.75 per share. At December 31, 1999,
there were approximately 250 holders of record and approximately 8,500
beneficial owners of our common stock. The following table sets forth the range
of high and low sales prices per share of common stock, as reported on the
Nasdaq National Market, during the periods presented.

<TABLE>
<CAPTION>

YEAR ENDED DECEMBER 31, 1998:                                                           HIGH               LOW
                                                                               ------------------ ------------
<S>                                                                            <C>                <C>
1st Quarter                                                                    $        4 3/4      $        3
2nd Quarter                                                                             4 7/8               3 1/16
3rd Quarter                                                                             4                   2
4th Quarter                                                                             4 3/4               1 11/16

YEAR ENDED DECEMBER 31, 1999:
1st Quarter                                                                    $        3 1/8      $        1 15/16
2nd Quarter                                                                             7 1/8               2 11/16
3rd Quarter                                                                             7 1/16              3 3/8
4th Quarter                                                                             4                   2 9/16

YEAR ENDED DECEMBER 31, 2000:
1st Quarter (Through March 24, 2000)                                           $        5 1/4      $        2 3/4
</TABLE>



DIVIDENDS

         We have never paid cash dividends on our common stock. We currently
intend to retain earnings, if any, to support the development of our business
and do not anticipate paying dividends in the foreseeable future. Payment of
future dividends, if any, will be at the discretion of the board of directors
after taking into account various factors, including our financial condition,
operating results, current and anticipated cash needs and plans for expansion.





                                      -22-
<PAGE>   26







ITEM 6.  SELECTED FINANCIAL DATA

         The selected financial data set forth below are derived from our
financial statements as of and for each of the years in the five-year period
ended December 31, 1999, which have been audited by Arthur Andersen LLP,
independent public accountants. On September 11, 1995, we acquired Triplex
Pharmaceutical Corporation and API Acquisition Company, Inc. or "API", formerly
Oncologix, Inc. This transaction was accounted for under the purchase method of
accounting. The selected financial data prior to September 11, 1995 represent
our operations and balance sheet data, while the selected financial data from
and after September 11, 1995 represent the combined operations and balance sheet
data of the merged companies. The selected financial data set forth below should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our financial statements and notes
thereto included elsewhere in this Annual Report on Form 10-K.

<TABLE>
<CAPTION>

                                                                              YEARS ENDED DECEMBER 31,
                                                             --------------------------------------------------------
                                                               1995        1996       1997        1998        1999
                                                               ----        ----       ----        ----        ----
                                                                        (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                          <C>         <C>         <C>         <C>         <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
  Research and development grants
     and contracts .......................................   $  1,248    $  2,670    $    841    $  6,737    $ 11,052
  Interest income ........................................        452       1,692       2,059       1,265       1,330
                                                             --------    --------    --------    --------    --------
     Total revenues ......................................      1,700       4,362       2,900       8,002      12,382
Expenses:
  Research and development ...............................      8,347      10,357      13,993      22,793      21,494
  Purchase of in-process research
     and development .....................................      8,383         242       3,000          --          --
  Selling, general and administrative ....................      2,215       1,620       2,641       3,354       4,652
  Interest expense and other .............................        184         173         257          86         330
                                                             --------    --------    --------    --------    --------
     Total expenses ......................................     19,129      12,392      19,891      26,233      26,476
                                                             --------    --------    --------    --------    --------
Net loss .................................................   $(17,429)   $ (8,030)   $(16,991)   $(18,231)   $(14,094)
                                                             ========    ========    ========    ========    ========
Basic and diluted loss per share .........................   $  (2.69)   $  (0.62)   $  (1.14)   $  (1.17)   $  (0.65)
                                                             ========    ========    ========    ========    ========
Weighted average shares used in
  computing  basic  and  diluted  loss per
  share ..................................................      6,488      13,048      14,896      15,571      21,727
</TABLE>

<TABLE>
<CAPTION>

                                                                          YEARS ENDED DECEMBER 31,
                                                       --------------------------------------------------------------
                                                         1995         1996          1997        1998         1999
                                                         ----         ----          ----        ----         ----
                                                                               (IN THOUSANDS)
<S>                                                    <C>          <C>          <C>          <C>          <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-
   term and long-term investments ..................   $  12,015    $  41,388    $  29,954    $  20,390    $  20,252
Total assets .......................................      15,530       44,281       32,125       23,045       22,734
Total long-term obligations ........................       1,574          146            6        1,012        3,517
Deficit accumulated during
   development stage ...............................     (44,183)     (52,213)     (69,204)     (87,435)    (101,529)
Total stockholders' equity .........................      11,994       40,477       27,379       13,610       14,731
</TABLE>





                                      -23-
<PAGE>   27




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

         The following discussion and analysis should be read in conjunction
with the Financial Statements and related Notes contained elsewhere herein.

OVERVIEW

         Since our inception in 1986, we have primarily devoted our resources to
fund research, drug discovery and development. We have been unprofitable to date
and expect to incur substantial operating losses for the next several years as
we expend our resources for product research and development, preclinical and
clinical testing and regulatory compliance. We have sustained losses of $101.5
million through December 31, 1999. Our research and development activities and
operations have been financed primarily through public and private offerings of
securities and, to a lesser extent, from revenues under research and development
agreements and grants. Our operating results have fluctuated significantly
during each quarter, and we anticipate that these fluctuations, largely
attributable to varying commitments and expenditures for clinical trials and
research and development, will continue for the next several years.

RESULTS OF OPERATIONS

         Years Ended December 31, 1998 and 1999

         Revenues from research and development grants and contracts increased
66% to $11.1 million in 1999, from $6.7 million in 1998. This increase resulted
from milestone and development revenue under our license agreement for
Nyotran(R).

         Interest income increased by 5% to $1,330,000 in 1999 from $1,265,000
in 1998. This increase resulted from an increase in the average amount of funds
available for investment in 1999.

         Research and development expenses decreased 6% to $21.5 million in
1999, from $22.8 million in 1998. The decrease in research and development
expenses resulted primarily from decreases of $2.3 million and $729,000 in
clinical investigation costs and manufacturing relating to Nyotran(R). These
decreases were partially offset by increases of $640,000 in payroll costs and
$600,000 in regulatory consultants relating mostly to ATRAGEN(R) and Nyotran(R).

         Selling, general and administrative expenses increased 39% to $4.7
million in 1999, from $3.4 million in 1998. The increase in selling, general and
administrative expenses resulted primarily from an increase of $408,000 in
business consultant expense relating mainly to evaluating the market potential
for our product candidates and an increase of $286,000 in marketing expenses
relating mainly to ATRAGEN(R).

         Interest expense and other increased 284% to $330,000 in 1999, from
$86,000 in 1998. The increase in interest expense and other resulted primarily
from an increase in the average amount of capital lease obligations and
indebtedness used to fund the acquisition of laboratory equipment.

         Net loss decreased 23% to $14.1 million in 1999, from $18.2 million in
1998. The decrease in net loss resulted primarily from an increase of $4.3
million in revenues relating to research and development grants and contracts.

         Years Ended December 31, 1997 and 1998

         Revenues from research and development grants and contracts increased
697% to $6.7 million in 1998, from $841,000 in 1997. This increase was due
primarily to $6.2 million in milestone and development payments received from
Abbott in the fourth quarter of 1998.

         Interest income decreased 39% to $1.3 million in 1998, from $2.1
million in 1997. The decrease in interest income resulted from a decrease of
funds available for investment.


                                      -24-
<PAGE>   28

         Research and development expenses increased 63% to $22.8 million in
1998, from $14 million in 1997. The increase in research and development
expenses resulted in an increase of $8.8 million in the medical affairs
department costs in 1998 primarily from:

         o        an increase of $6.1 million in clinical trials for our lead
                  product Nyotran(R);
         o        an increase of $486,000 in clinical trials for ATRAGEN(R); and
         o        an increase of $1.4 million in salaries and payroll costs.

         In 1998, the number of personnel in this department increased
significantly from the same period in 1997. The majority of the personnel added
was attributable to the development of Nyotran(R).

         The $3.0 million in cost incurred for the purchase of in-process
research and development in the third quarter of 1997 related to a non-cash
issuance of common stock under the contingent stock rights issued in the merger
with Triplex. An aggregate of 686,472 shares of common stock with an aggregate
value of $3.0 million were issued under the Triplex contingent stock rights
because equity milestone payments of $5.0 million were not received from Genzyme
relating to ATRAGEN(R) on or before September 11, 1997.

         General and administrative expenses increased 31% to $3.4 million in
1998, from $2.6 million in 1997. The increase in general and administrative
expenses resulted primarily from:

         o        an increase of $290,000 in salaries and payroll costs;
         o        an increase of $110,000 relating to business development
                  activities;
         o        an increase of $78,000 in investor and public relations
                  expenses; and
         o        the addition of $261,000 in marketing expenses, relating
                  primarily to ATRAGEN(R), in 1998.

         Several new administrative positions were added during the second half
of 1997, including a Chief Executive Officer in the fourth quarter of 1997.
Additionally, the former President, who resigned in January 1998, was entitled
to certain severance payments in accordance with his termination and severance
agreement. These severance payments, which continued through January 1999, were
recorded as compensation expenses in 1998.

         Interest expense and other decreased 67% to $86,000 in 1998, from
$257,000 in 1997. The decrease in interest expense and other resulted primarily
from a loss of $200,000 in 1997 from the disposition of equipment and leasehold
improvements that had been used in research activities eliminated in early 1997,
as well as a decrease in interest expense for the first half of 1998 resulting
from a reduction in the average amount of capital lease obligations and
indebtedness used to fund the acquisition of laboratory equipment.

         Net loss increased 7% to $18.2 million in 1998, from $17 million in
1997. The increase in net loss resulted primarily from the increase in research
and development expenses offset by an increase in revenues.

ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT

         On September 11, 1995, we acquired two development-stage companies,
Triplex and API. These acquisitions were accounted for under the purchase method
of accounting in which the aggregate purchase price was allocated to tangible
and intangible assets acquired based on their relative fair values as of the
date of the transaction. We allocated approximately $2.8 million of the purchase
price for Triplex and $5.6 million of the purchase price for API to in-process
research and development. Our valuation of the research and development acquired
considered:

         o        the current scientific and development status of the projects;
         o        the expected amount of time and resources required to complete
                  the projects;
         o        the probability of obtaining collaborators to help finance and
                  develop the projects; and
         o        the potential market for the projects.


                                      -25-
<PAGE>   29

         Our ability to commercialize the products acquired is affected by
several risks. These risks include:

         o        the successful filing and acceptance by the FDA of any IND's;
         o        the completion of all stages of clinical trials;
         o        the submission of data for the approval of any NDA's,
                  including the demonstration of safety and efficacy;
         o        the ability to enter into collaborative arrangements to fund
                  the future development of the acquired products; and
         o        the ability to manufacture the acquired products. See
                  "Business."

         At the time of acquisition, Triplex's major focus was the development
of a new class of drugs to treat serious diseases where currently available
therapy was inadequate or non-existent. Triplex had, at that time, one compound,
Zintevir(R), that was at an advanced preclinical stage of development. Triplex
also had a number of other compounds in early stages of preclinical development.
Zintevir(R) was being developed for the treatment of HIV infection. At the time
of acquisition, laboratory tests had shown that Zintevir(R) inhibited the viral
replication of certain HIV-infected cells and Triplex was performing work to
determine its properties. Additional preclinical and manufacturing work was
required to enter clinical trials.

         In order for Zintevir(R) to become a marketable product, it will be
necessary to conduct several clinical trials and to improve the manufacturing of
the product. We completed two Phase I clinical trials for Zintevir(R). In
October 1997, we began a Phase I/II trial and in 1999 we placed this trial on
hold. Subsequent to the acquisition, we expended approximately $3 million for
the development of Zintevir(R). We will evaluate the results of the Phase I/II
clinical trial and do not intend to progress into additional development of
Zintevir(R) unless another company agrees to fund the additional development
work. If funding is obtained, we estimate it will require an additional $50
million over 3 to 5 years to complete the development of Zintevir(R).

         At the time of acquisition, API was engaged in the research and
development of drugs for the treatment of cancer. We acquired the API projects
to complement our existing product portfolio. The API compounds were licensed by
API from other companies, and were at a preclinical or early clinical stage.
Additional clinical trials and laboratory work were necessary to complete the
development of these compounds. After the acquisition, in order to determine the
best way to complete development, we devoted limited scientific resources to
review the preclinical and clinical data on these projects. The majority of
effort expended by us was to identify other companies who would be interested in
funding these projects. One collaborative agreement was entered into relating to
the projects acquired from API. In 1996, we entered into a license agreement
with Hoffman-LaRoche related to the compound AR209, which was being developed
for breast cancer. Under the agreement, Hoffman-LaRoche was responsible for
funding the costs of all remaining preclinical and clinical development of
AR209. Hoffman-LaRoche paid us a license fee when the agreement was entered into
and an annual license fee in 1997. The agreement was terminated without cause by
Hoffman-LaRoche in September 1998 when they stopped development. Rights to AR209
have returned to us. We have ceased further development of AR209 until funding
from a corporate partner is obtained. We estimate it would require an additional
$25 to $40 million and take 5 to 8 years to complete the development of AR209
for cancer therapies. We have not maintained the license of other compounds from
API.

LIQUIDITY AND CAPITAL RESOURCES

         Since our inception, our primary source of cash has been from financing
activities, which have consisted primarily of sales of equity securities, and to
a lesser extent, from revenues under research and development agreements and
grants. We have raised an aggregate of approximately $90 million from the sale
of equity securities from inception through December 31, 1999. In July 1992, we
raised net proceeds of approximately $10.7 million in the initial public
offering of our common stock. In September 1993, we entered into a collaborative
agreement with Genzyme relating to the development and commercialization of
ATRAGEN(R), in which we received net proceeds of approximately $4.5 million from
the sale of common stock to Genzyme. In November 1993, we raised net proceeds of
approximately $11.5 million and in May 1996, we raised net proceeds of
approximately $32.1 million in public offerings of common stock. From October
1995 through December 31, 1998, we received aggregate net proceeds of
approximately $6.5 million from the exercise of certain warrants issued in our
1995 merger with API. In November 1998, we entered into a license agreement with
Abbott relating to Nyotran(R), in which Abbott purchased 837,989


                                      -26-
<PAGE>   30

shares of common stock for $3.0 million. Through February 29, 2000 we received
an additional $14.7 million in up-front and milestone payments from Abbott, all
of which are non-refundable. In February 1999, we raised net proceeds of
approximately $11.7 million in a public offering of 6.0 million shares of our
common stock.

         The majority of our development activities are committed on a
short-term, as-needed basis through contracts and purchase orders. These
arrangements can be changed based on our needs and development activities. We
have contracted with certain clinical research and other consulting
organizations to assist in conducting our clinical trials. The agreements
provide that we can terminate them at any time, should either our financial
situation, or the results of the studies, require it. Nonetheless, we intend to
continue to engage such services in the future.

         Our primary use of cash to date has been in operating activities to
fund research and development, including preclinical studies and clinical trials
and general and administrative expenses. Cash of $13.1 million and $12.2 million
was used in operating activities during 1999 and 1998. We had cash,
cash-equivalents and short-term and long-term investments of $20.3 million as of
December 31, 1999, consisting primarily of cash and money market accounts, and
United States government securities and investment grade commercial paper.

         We have experienced negative cash flows from operations since inception
and have funded our activities to date primarily from equity financings. We have
expended, and will continue to require, substantial funds to continue our
research and development activities, including preclinical studies and clinical
trials of our products, and to commence sales and marketing efforts if FDA and
other regulatory approvals are obtained.

         We believe that we can conserve our existing financial resources to
satisfy our capital and operating requirements into mid 2001. In the future, we
may need to raise substantial additional capital to fund our operations.

         We have experienced significant increases in accounts payable and
accrued payroll since 1996, primarily as a result of the increased development
activities relating to our two late-stage products. We anticipate that the
amounts expended for these items in the future will continue to correspond with
our development activities. If the volume of development activities decreases,
there will be a decrease in outstanding payables and a decrease in our liquidity
position. We expect that our expenses relating to development activities will
fluctuate from quarter to quarter over the next few years as we have not yet
generated revenues from product sales. Also, we have typically obtained debt
financing when necessary for equipment, furniture and leasehold improvement
requirements. In 1998, our capital requirements increased with the move into new
facilities. As a result, we borrowed $1.4 million in 1998 to finance our
requirements in this new facility. We expect that we will continue to incur
additional debt to meet our capital requirements from time to time in the
future, based on our financial resources and needs.

         Our capital requirements will depend on many factors, including the
risk factors more completely described under "Business -- Additional Business
Risks" above. These factors include:

         o        problems, delays, expenses and complications frequently
                  encountered by development stage companies;
         o        the progress of our research, development and clinical trial
                  programs;
         o        the extent and terms of any future collaborative research,
                  manufacturing, marketing or other funding arrangements;
         o        the costs and timing of seeking regulatory approvals of our
                  products;
         o        our ability to obtain regulatory approvals;
         o        the success of our sales and marketing programs;
         o        the costs of filing, prosecuting and defending and enforcing
                  any patent claims and other intellectual property rights; and
         o        changes in economic, regulatory or competitive conditions of
                  our planned business.

         Estimates about the adequacy of funding for our activities are based on
certain assumptions, including the assumption that testing and regulatory
procedures relating to our products can be conducted at projected costs. There
can be no assurance that changes in our research and development plans,
acquisitions, or other events will not result in accelerated or unexpected
expenditures.



                                      -27-
<PAGE>   31

         To satisfy our capital requirements, we may seek to raise additional
funds in the public or private capital markets. Our ability to raise additional
funds in the public or private markets will be adversely affected if the results
of our current or future clinical trials are not favorable. We may seek
additional funding through corporate collaborations and other financing
vehicles. There can be no assurance that any funding will be available to us on
favorable terms or at all. If adequate funds are not available, we may be
required to curtail significantly one or more of our research or development
programs, or we may be required to obtain funds through arrangements with future
collaborative partners or other parties that may require us to relinquish rights
to some or all of our technologies or products. If we are successful in
obtaining additional financing for the company, the terms of such financing may
have the effect of diluting or adversely affecting the holdings or the rights of
the holders of our common stock.

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

             Not applicable.

ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

             The financial statements required by this Item are incorporated
             under Item 14 in Part IV of this report.

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

             None.



                                      -28-
<PAGE>   32




                                    PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The information required by this Item as to our directors and executive
officers is hereby incorporated by reference from the information appearing
under the captions "Proposals-Proposal I: Election of Directors" and "Company
Information -- Executive Officers" in our definitive proxy statement which
involves the election of directors and is to be filed with the Securities and
Exchange Commission (the "Commission") pursuant to the Securities Exchange Act
of 1934, as amended (the "Exchange Act") within 120 days of the end of our
fiscal year ended December 31, 1999.

ITEM 11.   EXECUTIVE COMPENSATION

         The information required by this Item as to our management is hereby
incorporated by reference from the information appearing under the captions
"Company Information -- Executive Compensation" and " -- Director Compensation"
in our definitive proxy statement which involves the election of directors and
is to be filed with the Commission pursuant to the Exchange Act within 120 days
of the end of our fiscal year ended December 31, 1999. Notwithstanding the
foregoing, in accordance with the instructions to Item 402 of Regulation S-K,
the information contained in our proxy statement under the sub-heading "Company
Information -- Report of the Compensation Committee" and " -- Performance Graph"
shall not be deemed to be filed as part of or incorporated by reference into
this Form 10-K.

ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this Item as to the ownership by management
and others of securities of Aronex Pharmaceuticals is hereby incorporated by
reference from the information appearing under the caption "Stock Ownership of
the Company's Largest Stockholders and Management" in Aronex Pharmaceuticals'
definitive proxy statement which involves the election of directors and is to be
filed with the Commission pursuant to the Exchange Act within 120 days of the
end of Aronex Pharmaceuticals' fiscal year ended December 31, 1999.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this Item as to certain business
relationships and transactions with management and other related parties of
Aronex Pharmaceuticals is hereby incorporated by reference to such information
appearing under the caption "Transactions with Affiliates" in Aronex
Pharmaceuticals' definitive proxy statement which involves the election of
directors and is to be filed with the Commission pursuant to the Exchange Act
within 120 days of the end of Aronex Pharmaceuticals' fiscal year ended December
31, 1999.





                                      -29-
<PAGE>   33







                                     PART IV

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

   (a)    Documents Filed as Part of This Report

   (a)(1) FINANCIAL STATEMENTS

          See Index to Financial Statements on Page F-1 of this report.

   (a)(3) EXHIBITS

  EXHIBIT
  NUMBER                                                    EXHIBIT
  ------                                                    -------

3.1      Restated Certificate of Incorporation, as amended (incorporated by
         reference to Exhibit 3.1 to Aronex Pharmaceuticals' Quarterly
         Report on Form 10-Q for the quarterly period ending June 30, 1997 (the
         "June 1997 Form 10-Q")).

3.1(i)   Certificate of Amendment of Amended and Restated Certificate of
         Incorporation of the Company (incorporated by reference to Exhibit 3.1
         (i) to the Company's Quarterly Report on Form 10-Q for the quarterly
         period ending June 30, 1999).

3.1(ii)  Certificate of Designation of Series One Junior Participating Preferred
         Stock dated October 6, 1999 (attached as Exhibit A to the Rights
         Agreement files as Exhibit 4.1 incorporated by reference to Exhibit 4.1
         on Form 8-A dated October 7, 1999).

3.2      Restated Bylaws (incorporated by reference to Exhibit 3.2 to Aronex
         Pharmaceuticals' Registration Statement on Form S-1 (No. 33-47418)
         (the "1992 Registration Statement"), as declared effective by the
         Commission on July 10, 1992).

4.1      Specimen certificate for shares of Common Stock, par value $0.001 per
         share (incorporated by reference to Exhibit 4.1 to Aronex
         Pharmaceuticals' Quarterly Report on Form 10-Q for the quarterly period
         ended June 30, 1996).

4.1(i)   Rights Agreement, dated October 6, 1999, between the Company and
         American Stock Transfer & Trust Company, as Rights Agent (incorporated
         by reference to Exhibit 4.1 on Form 8-A dated October 7, 1999).

4.2      Form of Rights Certificate (attached as Exhibit B to the Rights
         Agreement files as Exhibit 4.1 incorporated by reference to Exhibit 4.1
         on Form 8-A dated October 7, 1999).

10.1     Registration Rights Agreement dated August 2, 1989, by and among Aronex
         Pharmaceuticals and certain of its stockholders (incorporated by
         reference to Exhibit 10.2 to the 1992 Registration Statement).

10.2     First Amendment to Registration Rights Agreement dated April 18, 1990,
         by and among Aronex Pharmaceuticals and certain of its stockholders
         (incorporated by reference to Exhibit 10.3 to the 1992 Registration
         Statement).

10.3     Second Amendment to Registration Rights Agreement dated October 31,
         1991, by and among Aronex Pharmaceuticals and certain of its
         stockholders (incorporated by reference to Exhibit 10.4 to the 1992
         Registration Statement).

10.4     Third Amendment to Registration Rights Agreement dated September 10,
         1993, among and certain of its stockholders (incorporated by reference
         to Exhibit 10.24 to Aronex Pharmaceuticals' Registration Statement on
         Form S-1 (No. 33-71166) (the "1993 Registration Statement"), as
         declared effective by the Commission on November 15, 1993).



                                      -30-
<PAGE>   34




  EXHIBIT
  NUMBER                               EXHIBIT
  ------                               -------

10.5*    Fourth Amendment to Registration Rights Agreement dated January 20,
         1994, among Aronex Pharmaceuticals * and certain of its stockholders.

10.6+    Amended and Restated 1989 Stock Option Plan (incorporated by reference
         to Exhibit 10.1 to the June + 1997 Form 10-Q).

10.7+    Amended and Restated 1993 Non-Employee Director Stock Option Plan
         (incorporated by reference to + Exhibit 10.2 to the June 1997 Form
         10-Q).

10.8+    1998 Stock Option Plan (incorporated by reference to Exhibit 10.1 to
         Aronex Pharmaceuticals' Quarterly Report on Form 10-Q for the quarterly
         period ended June 30, 1998 (the "June 1998 Form 10-Q")).

10.9     Exclusive License Agreement dated October 15, 1986, between Aronex
         Pharmaceuticals, The University of Texas System Board of Regents and
         The University of Texas M.D. Anderson Cancer Center (incorporated by
         reference to Exhibit 10.8 to the 1992 Registration Statement).

10.10    Research and Development Contract dated October 1, 1986, between Aronex
         Pharmaceuticals, The University of Texas System Board of Regents and
         The University of Texas M.D. Anderson Cancer Center, together with
         amendments and extensions thereto (incorporated by reference to Exhibit
         10.9 to the 1992 Registration Statement).

10.11    Exclusive License Agreement dated July 1, 1988, between Aronex
         Pharmaceuticals, The University of Texas System Board of Regents and
         The University of Texas M.D. Anderson Cancer Center, together with
         amendments and extensions thereto (incorporated by reference to Exhibit
         10.10 to the 1992 Registration Statement).

10.12    Research and Development Contract dated July 1, 1988, between Aronex
         Pharmaceuticals, The University of Texas System Board of Regents and
         The University of Texas M.D. Anderson Cancer Center, together with
         amendments and extensions thereto (incorporated by reference to Exhibit
         10.11 to the 1992 Registration Statement).

10.13    Amendment No. 2 to Exclusive License Agreement dated July 9, 1993,
         among Aronex Pharmacueticals, The University of Texas System Board of
         Regents and The University of Texas M.D. Anderson Cancer Center
         (incorporated by reference to Exhibit 10.20 to the 1993 Registration
         Statement).

10.14    Sponsored Laboratory Study Agreement dated July 9, 1993, between Aronex
         Pharmaceuticals and The University of Texas M.D. Anderson Cancer Center
         (incorporated by reference to Exhibit 10.21 to the 1993 Registration
         Statement).

10.15    Technology Transfer Agreement dated July 18, 1989, among Triplex
         Pharmaceutical Corporation and Baylor 10.15 College of Medicine, BCM
         Technologies, Inc., Michael Edward Hogan and Donald Joseph Kessler
         (incorporated by reference to Exhibit 10.61 to Aronex Pharmaceuticals'
         Registration Statement on Form S-4 (No. 33-91584) dated July 24, 1995
         (the "Merger Registration Statement")).

10.16    Form of Key Management Proprietary Information and Inventions and
         Noncompetition Agreement (incorporated by reference to Exhibit 10.23 to
         the 1992 Registration Statement).

10.17    Form of Proprietary Information and Inventions Agreement (incorporated
         by reference to Exhibit 10.24 to the 1992 Registration Statement).


10.18*   Common Stock Purchase Warrant dated June 28, 1993 from Aronex
         Pharmaceuticals in favor of GATX Capital Corporation.



                                      -31-
<PAGE>   35




  EXHIBIT
  NUMBER                             EXHIBIT
  ------                             -------

10.19*   Common Stock Purchase Warrant dated March 21, 1994 from Aronex
         Pharmaceuticals in favor of GATX Capital Corporation.

10.20*   Common Stock Purchase Warrant dated June 28, 1993 from Aronex
         Pharmaceuticals in favor of MM Ventures.

10.21*   Common Stock Purchase Warrant dated March 21, 1994 from Aronex
         Pharmaceuticals in favor of MM Ventures.

10.22    Amendment No. 2 to License and Development Agreement dated September
         10, 1996, between Aronex 10.22 Pharmaceuticals and Genzyme Corporation
         (incorporated by reference to Exhibit 10.1 to Aronex Pharmaceuticals'
         Quarterly Report on Form 10-Q for the fiscal quarter ended September
         30, 1996 (the "September 1996 Form 10-Q")).

10.23    Amendment No. 2 to Stock Purchase Agreement dated September 10, 1996,
         between Aronex Pharmaceuticals and Genzyme Corporation (incorporated by
         reference to Exhibit 10.2 to the September 1996 Form 10-Q).

10.24    Amendment No. 3 to License and Development Agreement dated March 25,
         1997, between Aronex Pharmaceuticals and Genzyme Corporation
         (incorporated by reference to Exhibit 10.1 to Aronex Pharmaceuticals'
         Quarterly Report on Form 10-Q for the fiscal quarter ended March 30,
         1997 (the "March 1997 Form 10-Q")).

10.25    Amendment No. 3 to Common Stock Purchase Agreement dated March 25,
         1997, between Aronex Pharmaceuticals and Genzyme Corporation
         (incorporated by reference to Exhibit 10.2 to the March 1997 Form
         10-Q).

10.26*   Form of Certificate of Contingent Interest.

10.27+   Employment Agreement dated November 3, 1997 between Aronex
         Pharmaceuticals' and Geoffrey Cox, Ph.D. (incorporated by reference to
         Exhibit 10.39 to Aronex Pharmaceuticals' Annual Report on Form 10-K for
         the fiscal year ended December 31, 1997 (the "1997 Form 10-K")).

10.28+   Consulting Agreement dated January 1, 1998, between Aronex
         Pharmaceuticals and Gabriel Lopez-Berestein (incorporated by reference
         to Exhibit 10.2 to the March 1998 Form 10-Q).

10.29+   Consulting Agreement dated April 1, 1998, between Aronex
         Pharmaceuticals and Roman Perez-Solar (incorporated by reference to
         Exhibit 10.3 to the March 1998 Form 10-Q).

10.30+   Employment Agreement dated June 12, 1998, between Aronex
         Pharmaceuticals and Paul A. Cossum, Ph.D. (incorporated by reference to
         Exhibit 10.3 to the June 1998 Form 10-Q).

10.31+   Employment Agreement dated June 12, 1998, between Aronex
         Pharmaceuticals and Terance A. Murnane (incorporated by reference to
         Exhibit 10.4 to the June 1998 Form 10-Q).

10.32    Lease Agreement dated April 4, 1997, between Aronex Pharmaceuticals and
         The Woodlands Corporation (incorporated by reference to Exhibit 10.3 to
         the June 1997 Form 10-Q).

10.33++  License Agreement dated November 12, 1998, between Aronex
         Pharmaceuticals and Abbott Laboratories (incorporated by reference to
         Exhibit 10.1 to the December 2, 1998 Form 8-K).

10.34++  Stock Purchase Agreement dated November 12, 1998, between Aronex
         Pharmaceuticals and Abbott Laboratories (incorporated by reference to
         Exhibit 10.2 to the December 2, 1998 Form 8-K).





                                      -32-
<PAGE>   36




  EXHIBIT
   NUMBER                          EXHIBIT
   ------                          -------

10.35    Placement Agency Agreement dated as of November 19, 1998 between Aronex
         Pharmaceuticals, Inc. and Paramount Capital, Inc (incorporated by
         reference to Exhibit 10.46 to the December 1998 10-K).

10.36    Form of Warrant issued on February 23, 1999 for the purchase of an
         aggregate of 600,000 shares of common stock (included herein as Exhibit
         C to Placement Agency Agreement which is filed herewith as Exhibit
         10.46).

10.37*   Employment Agreement dated October 6, 1999 between Aronex
         Pharmaceuticals' and William Schary, Ph.D.

10.38*   Employment Agreement dated December 1, 1999 between Aronex
         Pharmaceuticals' and Anthony Williams, M.D.

10.39    Severance Agreement and Release dated March 26, 1999, between the
         Company and David S. Gordon, M.D (incorporated by reference to Exhibit
         10.1 to the March 1999 Form 10-Q).

10.40    Form of Placement Agency Agreement dated November 19, 1999 between
         Aronex Pharmaceuticals, Inc. and Paramount Capital, Inc., incorporated
         by reference to Exhibit 1.1 to the Company's Registration Statement on
         Form S-1 (Registration Statement No. 333-67599).

10.41    Form of Warrant for the purchase of Common Stock, incorporated by
         reference to Exhibit 1.2 of the Company's Registration Statement on
         Form S-1 (Registration Statement No. 333-67599).

10.42    Amendment No. 4 to License and Development Agreement dated May 21, 1999
         by and between Aronex Pharmaceuticals, Inc. and Genzyme Corporation
         (incorporated by reference to Exhibit 10.1 to the June 4, 1999 8-K).

10.43    10% Convertible Note dated May 21, 1999 by Aronex Pharmaceuticals, Inc.
         made payable to Genzyme Corporation for $2.5 million (incorporated by
         reference to Exhibit 10.2 to the June 4, 1999 8-K).

10.44    Common Stock Purchase Warrant for 50,000 shares of Common Stock of
         Aronex Pharmaceuticals, Inc. issued 10.44 in the name of Genzyme
         Corporation (incorporated by reference to Exhibit 10.3 to the June 4,
         1999 8-K).

10.45    Severance Agreement and Release dated July 30, 1999 between the Company
         and Janet Walter (incorporated by reference to Exhibit 10.1 on the
         September 1999 Form 10-Q).

10.46    Consulting Agreement dated October 1, 1999 between the Company and
         James R. Butler (incorporated by reference to Exhibit 10.2 on the
         September 1999 Form 10-Q).

10.47    Consulting Agreement dated October 1, 1999 between the Company and
         David J. McLachlan (incorporated by reference to Exhibit 10.3 on the
         September 1999 Form 10-Q).

11.1     Statement regarding computation of loss per share.

23.1+++  Consent of Arthur Andersen LLP.

24.1     Power of attorney (included on the signature page of this Registration
         Statement).

----------------------
*   Filed with 10-K.
+   Management Contract or Compensatory Plan.
++  Portions of this exhibit have been omitted based upon a request for
    confidential treatment pursuant to Rule 24b- 2g of the Exchange Act. Such
    omitted portions have been filed separately with the Commission.
+++ Filed herewith.



                                      -33-
<PAGE>   37






                                   SIGNATURES

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

                                            ARONEX PHARMACEUTICALS, INC.

  Dated: April 4, 2000                      By: /s/ GEOFFREY F. COX
                                               ---------------------------------
                                               Geoffrey F. Cox
                                               Chief Executive Officer





                                      -34-
<PAGE>   38




                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

                                                                                                 PAGE
                                                                                                 ----

<S>                                                                                             <C>
Report of Independent Public Accountants .........................................................F-2

Consolidated Balance Sheets as of December 31, 1998 and 1999......................................F-3

Consolidated Statements of Operations for the Years ended December 31, 1997,
          1998 and 1999, and the Period from Inception (June 13, 1986) through
          December 31, 1999.......................................................................F-4

Consolidated Statements of Comprehensive Income for the Years ended December 31, 1997,
          1998 and 1999...........................................................................F-4

Consolidated Statements of Stockholders' Equity for the Period from Inception (June 13, 1986)
          through December 31, 1999...............................................................F-5

Consolidated Statements of Cash Flows for the Years ended December 31, 1997,
          1998 and 1999, and the Period from Inception (June 13, 1986) through
          December 31, 1999.......................................................................F-11

Notes to Consolidated Financial Statements........................................................F-12
</TABLE>




                                      F-1
<PAGE>   39


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Aronex Pharmaceuticals, Inc.:

          We have audited the accompanying consolidated balance sheets of Aronex
Pharmaceuticals, Inc. and subsidiaries (a Delaware corporation in the
development stage), as of December 31, 1998 and 1999, and the related
consolidated statements of operations, comprehensive income, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1999 and for the period from inception (June 13, 1986) through December 31,
1999. These consolidated financial statements are the responsibility of Aronex
Pharmaceuticals' management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.

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

          In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Aronex Pharmaceuticals, Inc. as of December 31, 1998 and 1999, and
the results of its operations and its cash flows for each of the three years in
the period ended December 31, 1999 and for the period from inception (June 13,
1986) through December 31, 1999, in conformity with generally accepted
accounting principles in the United States.


ARTHUR ANDERSEN LLP


Houston, Texas
February 18, 2000, (except for
the matter discussed in Note 14,
as to which the date is April 4,
2000).






                                      F-2
<PAGE>   40







                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

                           CONSOLIDATED BALANCE SHEETS
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>

                                                                                              DECEMBER 31,
                                                                                        ----------------------
                                                                                           1998         1999
                                                                                        ---------    ---------
<S>                                                                                     <C>         <C>
Current assets:
         Cash and cash equivalents ..................................................   $  11,338    $  11,528
         Short-term investments .....................................................       7,757        7,804
         Accounts receivable ........................................................         132           --
         Prepaid expenses and other assets ..........................................         260          453
                                                                                        ---------    ---------
                  Total current assets ..............................................      19,487       19,785
Long-term investments ...............................................................       1,295          920
Furniture, equipment and leasehold improvements, net of accumulated
         depreciation of $2,839 and $3,450, respectively ............................       2,263        2,029
                                                                                        ---------    ---------
                  Total assets ......................................................   $  23,045    $  22,734
                                                                                        =========    =========
                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
         Accounts payable and accrued expenses ......................................   $   5,319    $   3,502
         Accrued payroll ............................................................         885          644
         Advance from Genzyme .......................................................       2,000           --
         Current portion of notes payable ...........................................         219          340
                                                                                        ---------    ---------
                  Total current liabilities .........................................       8,423        4,486
Long-term liabilities:
         Notes payable, net of current portion ......................................       1,012        3,517
                                                                                        ---------    ---------
                  Total long-term obligations .......................................       1,012        3,517
Commitments and contingencies
Stockholders' equity:
         Preferred stock $.001 par value, 5,000,000 shares authorized,
                  none issued and outstanding .......................................          --           --
         Common stock $.001 par value, 40,000,000 shares authorized, 16,379,309
                  and 22,853,782 shares issued and outstanding, respectively ........          16           23
         Additional paid-in capital .................................................     100,654      113,262
         Common stock warrants ......................................................          50          908
         Treasury stock .............................................................         (11)         (11)
         Deferred compensation ......................................................        (380)         (69)
         Unrealized gain on securities available-for-sale ...........................         716        2,147
         Deficit accumulated during development stage ...............................     (87,435)    (101,529)
                                                                                        ---------    ---------
                  Total stockholders' equity ........................................      13,610       14,731
                                                                                        ---------    ---------
         Total liabilities and stockholders' equity .................................   $  23,045    $  22,734
                                                                                        =========    =========
</TABLE>

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






                                      F-3


<PAGE>   41

                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

                           CONSOLIDATED BALANCE SHEETS
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>




                                                                                    PERIOD FROM
                                                   YEARS ENDED DECEMBER 31,      INCEPTION (JUNE 13,
                                            ----------------------------------     1986) THROUGH
                                               1997        1998         1999     DECEMBER 31, 1999
                                            ---------    ---------    ---------  -----------------
<S>                                         <C>          <C>          <C>         <C>
Revenues:
   Interest income ......................   $   2,059    $   1,265    $   1,330    $   8,176
   Research and development grants
       and contracts ....................         841        6,737       11,052       22,839
                                            ---------    ---------    ---------    ---------
           Total revenues ...............       2,900        8,002       12,382       31,015
                                            ---------    ---------    ---------    ---------
Expenses:

   Research and development .............      13,993       22,793       21,494       97,422
   Purchase of in-process research
       and development ..................       3,000           --           --       11,625
   General and administrative ...........       2,641        3,354        4,652       21,810
   Interest expense and other ...........         257           86          330        1,687
                                            ---------    ---------    ---------    ---------
           Total expenses ...............      19,891       26,233       26,476      132,544
                                            ---------    ---------    ---------    ---------
Net loss ................................   $ (16,991)   $ (18,231)   $ (14,094)   $(101,529)
                                            =========    =========    =========    =========
Basic and diluted loss per share ........   $   (1.14)   $   (1.17)   $   (0.65)
                                            =========    =========    =========
Weighted average shares used in
   computing basic and diluted loss per
   share ................................      14,896       15,571       21,727
                                            =========    =========    =========
</TABLE>


                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
             (ALL AMOUNTS IN THOUSANDS, EXCEPT LOSS PER SHARE DATA)

<TABLE>
<CAPTION>

Comprehensive income:
<S>                                          <C>          <C>          <C>          <C>
         Net loss ...........................   $ (16,991)   $ (18,231)   $ (14,094)   $(101,529)
         Unrealized gain (loss) on
            securities available for sale ...         (12)         803        1,431        2,147
                                                ---------    ---------    ---------    ---------
Comprehensive income ........................   $ (17,003)   $ (17,428)   $ (12,663)   $ (99,382)
                                                =========    =========    =========    =========
</TABLE>




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



                                      F-4
<PAGE>   42





                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
         PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1999
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>

                                                                            ADDITIONAL    COMMON
                                                       COMMON STOCK          PAID-IN       STOCK       TREASURY
                                                    SHARES      AMOUNT       CAPITAL      WARRANTS      STOCK
                                                  ----------   ----------   ----------   ----------   ----------


<S>                                               <C>          <C>          <C>          <C>          <C>
Sale of Common Stock for cash, August
    through December 1986
             ($1.6396 per share) ..............      183,334   $       --   $      301   $       --   $       --
Issuance of Common Stock for license
   agreement rights, October 1986 ($.006
   per share) .................................       60,606           --            1           --           --
Net loss ......................................           --           --           --           --           --
                                                  ----------   ----------   ----------   ----------   ----------
Balance at December 31, 1986 ..................      243,940           --          302           --           --
Issuance of Common Stock in exchange for
   8% convertible notes, May 1987 ($3.30
         per share) ...........................       90,909            1          299           --           --
Net loss ......................................           --           --           --           --           --
                                                  ----------   ----------   ----------   ----------   ----------
Balance at December 31, 1987 ..................      334,849            1          601           --           --
Warrants issued to purchase 11,364 shares
      of Common  Stock ........................           --           --           --           --           --
Issuance of Common Stock for cash, September
and December 1988 ($.066 per share) ...........      130,303           --            8           --           --
Net loss ......................................           --           --           --           --           --
                                                  ----------   ----------   ----------   ----------   ----------
Balance at December 31, 1988 ..................      465,152            1          609           --           --
Issuance of Common Stock for cash, July
         and August 1989 ($.066 per share) ....      158,182           --           10           --           --
Issuance of Common Stock for cash, August
         1989 ($3.63 per share) ...............    1,220,386            1        4,429           --           --
Issuance of Common Stock for key man life
insurance policies, December 1989 ($3.63) .....        3,862           --           14           --           --
Net loss ......................................           --           --           --           --           --
                                                  ----------   ----------   ----------   ----------   ----------
Balance at December 31, 1989 ..................    1,847,582   $        2   $    5,062     $     --   $       --


<CAPTION>

                                                               UNREALIZED     DEFICIT
                                                              GAIN (LOSS)   ACCUMULATED
                                                             ON SECURITIES    DURING        TOTAL
                                                   DEFERRED    AVAILABLE    DEVELOPMENT  STOCKHOLDERS'
                                                 COMPENSATION  FOR SALE       STAGE         EQUITY
                                                  ----------   ----------   ----------    ----------
<S>                                               <C>          <C>           <C>          <C>
Sale of Common Stock for cash, August
    through December 1986
             ($1.6396 per share) ..............   $       --   $       --   $       --    $      301
Issuance of Common Stock for license
   agreement rights, October 1986 ($.006
   per share) .................................           --           --           --             1
Net loss ......................................           --           --          (40)          (40)
                                                  ----------   ----------   ----------    ----------
Balance at December 31, 1986 ..................           --           --          (40)          262
Issuance of Common Stock in exchange for
   8% convertible notes, May 1987 ($3.30
         per share) ...........................           --           --           --           300
Net loss ......................................           --           --         (216)         (216)
                                                  ----------   ----------   ----------    ----------
Balance at December 31, 1987 ..................           --           --         (256)          346
Warrants issued to purchase 11,364 shares
      of Common  Stock ........................           --           --           --            --
Issuance of Common Stock for cash, September
and December 1988 ($.066 per share) ...........           --           --           --             8
Net loss ......................................           --           --         (832)         (832)
                                                  ----------   ----------   ----------    ----------
Balance at December 31, 1988 ..................           --           --       (1,088)         (478)
Issuance of Common Stock for cash, July
         and August 1989 ($.066 per share) ....           --           --           --            10
Issuance of Common Stock for cash, August
         1989 ($3.63 per share) ...............           --           --           --         4,430
Issuance of Common Stock for key man life
insurance policies, December 1989 ($3.63) .....           --           --           --            14
Net loss ......................................           --           --         (942)         (942)
                                                  ----------   ----------   ----------    ----------
Balance at December 31, 1989 ..................   $       --   $       --   $   (2,030)   $    3,034
</TABLE>






                                                        (continued on next page)
                                       F-5

<PAGE>   43






                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
         PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1999
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>



                                                                                      ADDITIONAL       COMMON
                                                              COMMON STOCK             PAID-IN         STOCK            TREASURY
                                                         SHARES         AMOUNT         CAPITAL         WARRANTS         STOCK
                                                     -------------   -------------   -------------   -------------   -------------

<S>                                                      <C>         <C>             <C>                   <C>           <C>
Balance at December 31, 1989 .....................       1,847,582   $           2   $       5,062   $         --    $          --
Stock options exercised January 1990 ($.66
          per share) .............................              30              --              --              --              --
Warrants issued to purchase 9,914 shares
         of Common Stock .........................              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1990 .....................       1,847,612               2           5,062              --              --
Stock options exercised, May 1991 ($.66
         per share) ..............................              75              --              --              --              --
Issuance of Common Stock for cash and notes
   payable including accrued interest of
   $96,505, October 1991 ($7.26 per share) .......         596,095              --           4,328              --              --
Deferred compensation relating to certain
         stock options ...........................              --              --             326              --              --
Compensation expense related to stock options ....              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1991 .....................       2,443,782               2           9,716              --              --
Stock options exercised, January, April,
     May, October and December 1992 ($.66 per
     share) ......................................          37,198              --              24              --              --
Stock warrants exercised April, May and
     August 1992 ($3.63 per share) ...............          11,364              --              41              --              --
Issuance of Common Stock for cash in initial
     public offering, July 1992 ($14.00 per
     share) ......................................         850,000               1          10,659              --              --
Deferred compensation relating to certain
         stock options ...........................              --              --           1,644              --              --
Compensation expense related to stock options ....              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1992 .....................       3,342,344   $           3   $      22,084   $          --   $          --

<CAPTION>

                                                                          UNREALIZED       DEFICIT
                                                                         GAIN (LOSS)     ACCUMULATED
                                                                        ON SECURITIES      DURING            TOTAL
                                                          DEFERRED        AVAILABLE      DEVELOPMENT     STOCKHOLDERS'
                                                       COMPENSATION        FOR SALE         STAGE           EQUITY
                                                       -------------    -------------   -------------    -------------

<S>                                                    <C>              <C>          <C>              <C>
Balance at December 31, 1989 .....................     $          --    $          --   $      (2,030)   $       3,034
Stock options exercised January 1990 ($.66
          per share) .............................                --               --              --               --
Warrants issued to purchase 9,914 shares
         of Common Stock .........................                --               --              --               --
Net loss .........................................                --               --          (1,825)          (1,825)
                                                       -------------    -------------   -------------    -------------
Balance at December 31, 1990 .....................                --               --          (3,855)           1,209
Stock options exercised, May 1991 ($.66
         per share) ..............................                --               --              --               --
Issuance of Common Stock for cash and notes
   payable including accrued interest of
   $96,505, October 1991 ($7.26 per share) .......                --               --              --            4,328
Deferred compensation relating to certain
         stock options ...........................              (326)              --              --               --
Compensation expense related to stock options ....               138               --              --              138
Net loss .........................................                --               --          (2,914)          (2,914)
                                                       -------------    -------------   -------------    -------------
Balance at December 31, 1991 .....................              (188)              --          (6,769)           2,761
Stock options exercised, January, April,
     May, October and December 1992 ($.66 per
     share) ......................................                --               --              --               24
Stock warrants exercised April, May and
     August 1992 ($3.63 per share) ...............                --               --              --               41
Issuance of Common Stock for cash in initial
     public offering, July 1992 ($14.00 per
     share) ......................................                --               --              --           10,660
Deferred compensation relating to certain
         stock options ...........................            (1,644)              --              --               --
Compensation expense related to stock options ....               460               --              --              460
Net loss .........................................                --               --          (4,708)          (4,708)
                                                       -------------    -------------   -------------    -------------
Balance at December 31, 1992 .....................     $      (1,372)   $          --   $     (11,477)   $       9,238
</TABLE>




                                                        (continued on next page)

                                       F-6
<PAGE>   44






                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
         PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1999
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>

                                                                                      ADDITIONAL       COMMON
                                                              COMMON STOCK             PAID-IN          STOCK          TREASURY
                                                         SHARES         AMOUNT         CAPITAL         WARRANTS          STOCK
                                                     -------------   -------------   -------------   -------------   -------------
<S>                                                  <C>             <C>             <C>             <C>             <C>
Balance at December 31, 1992 .....................       3,342,344   $           3   $      22,084   $          --   $          --
Issuance of Common Stock for compensation ........           5,000              --              51              --              --
Warrants issued to purchase 50,172 shares
    of Common Stock ..............................              --              --              --              --              --
Stock options exercised, February and
    November 1993 ($.66) per share ...............          14,465              --               9              --              --
Issuance of Common Stock for cash,
    September 1993 ($14.00 per share) ............         357,143              --           4,538              --              --
Issuance of Common Stock for cash in
    secondary public offering November &
    December 1993 ($9.00 per share) ..............       1,402,250               2          11,462              --              --
Compensation expense related to stock options ....              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1993 .....................       5,121,202               5          38,144              --              --
Deferred compensation relating to certain
    stock options ................................              --              --              66              --              --
Stock options exercised, January through
October 1994 ($.66 per share) ....................          15,111              --              10              --              --
Warrants issued to purchase 537 shares of
    Common Stock .................................              --              --              --              --              --
Issuance of additional shares of Common
    Stock pursuant to collaborative
    agreement (see Note 6) .......................          66,163              --              --              --              --
Compensation expense related to stock options ....              --              --              --              --              --
Unrealized loss on available-for-sale
    securities ...................................              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1994 .....................       5,202,476   $           5   $      38,220      $       --      $       --

<CAPTION>

                                                                       UNREALIZED        DEFICIT
                                                                       GAIN (LOSS)     ACCUMULATED
                                                                      ON SECURITIES      DURING            TOTAL
                                                         DEFERRED       AVAILABLE      DEVELOPMENT      STOCKHOLDERS'
                                                       COMPENSATION      FOR SALE         STAGE            EQUITY
                                                      -------------    -------------   -------------    -------------
<S>                                                   <C>              <C>             <C>              <C>
Balance at December 31, 1992 .....................    $      (1,372)   $          --   $     (11,477)   $       9,238
Issuance of Common Stock for compensation ........               --               --              --               51
Warrants issued to purchase 50,172 shares
    of Common Stock ..............................               --               --              --               --
Stock options exercised, February and
    November 1993 ($.66) per share ...............               --               --              --                9
Issuance of Common Stock for cash,
    September 1993 ($14.00 per share) ............               --               --              --            4,538
Issuance of Common Stock for cash in
    secondary public offering November &
    December 1993 ($9.00 per share) ..............               --               --              --           11,464
Compensation expense related to stock options ....              396               --              --              396
Net loss .........................................               --               --          (6,225)          (6,225)
                                                      -------------    -------------   -------------    -------------
Balance at December 31, 1993 .....................             (976)              --         (17,702)          19,471
Deferred compensation relating to certain
    stock options ................................              (66)              --              --               --
Stock options exercised, January through
October 1994 ($.66 per share) ....................               --               --              --               10
Warrants issued to purchase 537 shares of
    Common Stock .................................               --               --              --               --
Issuance of additional shares of Common
    Stock pursuant to collaborative
    agreement (see Note 6) .......................               --               --              --               --
Compensation expense related to stock options ....              546               --              --              546
Unrealized loss on available-for-sale
    securities ...................................               --             (315)             --             (315)
Net loss .........................................               --               --          (9,052)          (9,052)
                                                      -------------    -------------   -------------    -------------
Balance at December 31, 1994 .....................    $        (496)   $        (315)  $     (26,754)   $      10,660
</TABLE>




                                                        (continued on next page)

                                      F-7
<PAGE>   45



                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
         PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1999
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>

                                                                                      ADDITIONAL       COMMON
                                                              COMMON STOCK             PAID-IN         STOCK            TREASURY
                                                         SHARES         AMOUNT         CAPITAL         WARRANTS         STOCK
                                                     -------------   -------------   -------------   -------------   -------------
<S>                                                  <C>             <C>             <C>             <C>            <C>
Balance at December 31, 1994 .....................       5,202,476   $           5   $      38,220       $      --      $       --
Deferred compensation relating to certain
   stock options .................................              --              --           1,380              --              --
Stock options exercised, January through
   December 1995 ($.66 per share) ................          36,958              --              24              --              --
Issuance of Common Stock and warrants
   pursuant to merger agreements
   (see Note 4) ..................................       3,868,436               4          11,111           2,844              --
Warrants exercised ($4.50 per share) .............         705,614               1           3,402            (226)             --

Issuance of Common Stock pursuant to
settlement agreement (see Note 6) ................         531,552              --           2,046          (1,130)             --
Issuance of Common Stock for services
   rendered ......................................          37,500              --             159              --              --
Treasury stock purchased ($4.42 per share) .......          (2,480)             --              --              --             (11)
Compensation expense related to stock
   options .......................................              --              --              --              --              --
Unrealized gain on available-for-sale
   securities ....................................              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------

Balance at December 31, 1995 .....................      10,380,056   $          10   $      56,342   $       1,488   $         (11)
                                                     -------------   -------------   -------------   -------------   -------------
<CAPTION>

                                                                       UNREALIZED        DEFICIT
                                                                       GAIN (LOSS)     ACCUMULATED
                                                                      ON SECURITIES      DURING            TOTAL
                                                       DEFERRED         AVAILABLE      DEVELOPMENT      STOCKHOLDERS'
                                                     COMPENSATION        FOR SALE         STAGE            EQUITY
                                                     -------------    -------------   -------------    -------------
<S>                                                  <C>              <C>             <C>              <C>
Balance at December 31, 1994 .....................   $        (496)   $        (315)  $     (26,754)   $      10,660
Deferred compensation relating to certain
   stock options .................................          (1,380)              --              --               --
Stock options exercised, January through
   December 1995 ($.66 per share) ................              --               --              --               24
Issuance of Common Stock and warrants
   pursuant to merger agreements
   (see Note 4) ..................................              --               --              --           13,959
Warrants exercised ($4.50 per share) .............              --               --              --            3,177
Issuance of Common Stock pursuant to
settlement agreement (see Note 6) ................              --               --              --              916
Issuance of Common Stock for services
   rendered ......................................              --               --              --              159
Treasury stock purchased ($4.42 per share) .......              --               --              --              (11)
Compensation expense related to stock
   options .......................................             340               --              --              340
Unrealized gain on available-for-sale
   securities ....................................              --              199              --              199
Net loss .........................................              --               --   $     (17,429)   $     (17,429)
                                                     -------------    -------------   -------------    -------------
Balance at December 31, 1995 .....................   $      (1,536)   $        (116)  $     (44,183)   $      11,994
                                                     -------------    -------------   -------------    -------------
</TABLE>



                                                        (continued on next page)
                                      F-8





<PAGE>   46


                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
         PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1999
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>

                                                                                      ADDITIONAL       COMMON
                                                              COMMON STOCK             PAID-IN         STOCK            TREASURY
                                                         SHARES         AMOUNT         CAPITAL         WARRANTS         STOCK
                                                     -------------   -------------   -------------   -------------   -------------
<S>                                                  <C>            <C>             <C>             <C>             <C>
Balance at December 31, 1995 .....................      10,380,056   $          10   $      56,342   $       1,488   $         (11)
Warrants redeemed January 1996 ...................              --              --             269            (269)             --
Deferred compensation relating to certain
     stock options ...............................              --              --             966              --              --
Issuance of Common Stock for cash in
     secondary public offering, March &
     April 1996 ($10.00 per share) ...............       3,450,000               4          32,073              --              --
Stock options exercised, January through
     December 1996 ($.04-$9.50 per share) ........         106,041              --             343              --              --
Warrants exercised January through December
     1996 ($4.50-$12.00 per share) ...............         622,428               1           3,528            (194)             --
Issuance of Common Stock pursuant to
     settlement agreements .......................          38,722              --             221             (57)             --
Compensation expense related to stock options ....              --              --              --              --              --
Unrealized gain on available-for-sale
     securities ..................................              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1996 .....................      14,597,247              15          93,742             968             (11)
Warrants exercised February and March 1997
         ($8.00 per share) .......................           3,499              --              28              (1)             --
Reversal of deferred compensation relating
          to forfeited stock options .............              --              --            (578)             --              --
Issuance of Common Stock for services ............          22,278              --             130              --              --
Stock options exercised, January through
         December 1997 ($.04-$5.50 per share) ....         128,278              --             215              --              --
Stock purchased-employee stock purchase
plan, June and December 1997 ($3.31
         and $3.19 per share) ....................          21,392              --              69              --              --
Issuance of Common Stock pursuant to
         contingent stock agreement ..............         686,472              --           3,000              --              --
Compensation expense related to stock options ....              --              --              --              --              --
Unrealized loss on securities ....................              --              --              --              --              --
available-for-sale
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1997 .....................      15,459,166   $          15   $      96,606   $         967   $         (11)


<CAPTION>
                                                                        UNREALIZED       DEFICIT
                                                                        GAIN (LOSS)    ACCUMULATED
                                                                      ON SECURITIES       DURING             TOTAL
                                                        DEFERRED        AVAILABLE       DEVELOPMENT      STOCKHOLDERS'
                                                      COMPENSATION       FOR SALE          STAGE            EQUITY
                                                      -------------    -------------   -------------    -------------
<S>                                                   <C>              <C>             <C>              <C>
Balance at December 31, 1995 .....................    $      (1,536)   $        (116)  $     (44,183)   $     (11,994)
Warrants redeemed January 1996 ...................               --               --              --
Deferred compensation relating to certain
     stock options ...............................             (966)              --              --               --
Issuance of Common Stock for cash in
     secondary public offering, March &
     April 1996 ($10.00 per share) ...............               --               --              --           32,077
Stock options exercised, January through
     December 1996 ($.04-$9.50 per share) ........               --               --              --              343
Warrants exercised January through December
     1996 ($4.50-$12.00 per share) ...............               --               --              --            3,335
Issuance of Common Stock pursuant to
     settlement agreements .......................               --               --              --              164
Compensation expense related to stock options ....              553               --              --              553
Unrealized gain on available-for-sale
     securities ..................................               --               41              --               41
Net loss .........................................               --               --          (8,030)          (8,030)
                                                      -------------    -------------   -------------    -------------
Balance at December 31, 1996 .....................           (1,949)             (75)        (52,213)          40,477
Warrants exercised February and March 1997
         ($8.00 per share) .......................               --               --              --               27
Reversal of deferred compensation relating
          to forfeited stock options .............              578               --              --               --
Issuance of Common Stock for services ............               --               --              --              130
Stock options exercised, January through
         December 1997 ($.04-$5.50 per share) ....               --               --              --              215
Stock purchased-employee stock purchase
plan, June and December 1997 ($3.31
         and $3.19 per share) ....................               --               --              --               69
Issuance of Common Stock pursuant to
         contingent stock agreement ..............               --               --              --            3,000
Compensation expense related to stock options ....              464               --              --              464
Unrealized loss on securities ....................               --              (12)             --              (12)
available-for-sale
Net loss .........................................               --               --         (16,991)         (16,991)
                                                      -------------    -------------   -------------    -------------
Balance at December 31, 1997 .....................    $        (907)   $         (87)  $     (69,204)   $      27,379
</TABLE>



                                                        (continued on next page

                                      F-9
<PAGE>   47




                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE
         PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1999
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                      ADDITIONAL       COMMON
                                                              COMMON STOCK             PAID-IN         STOCK            TREASURY
                                                         SHARES         AMOUNT         CAPITAL         WARRANTS          STOCK
                                                     -------------   -------------   -------------   -------------   -------------
<S>                                                  <C>          <C>             <C>             <C>             <C>
Balance at December 31, 1997 .....................      15,459,166   $          15   $      96,606   $         967   $         (11)
Reversal of deferred compensation relating
   to forfeited stock options ....................              --              --             (28)             --              --
Issuance of Common Stock for services ............          23,494              --              76              --              --
Warrants expired June 1998 .......................              --              --             917            (917)             --
Stock options exercised, January through
   December 1998 ($0.04 - $0.68 per share) .......          19,144              --               7              --              --
Issuance of shares through the employee
   stock purchase plan, June and December
   1998 ($3.35 and $1.70 per share) ..............          39,516              --              99              --              --
Issuance of shares for cash November 1998
   ($3.58 per share) .............................         837,989               1           2,977              --              --
Compensation expense related to stock options ....              --              --              --              --              --
Unrealized gain on securities available-for-sale .              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1998 .....................      16,379,309   $          16   $     100,654   $          50   $         (11)
Reversal of deferred compensation relating
to forfeited stock options .......................              --              --             (30)             --              --
Issuance of Common Stock for cash in
    secondary public offering February 1999
    ($2.1875 per share) ..........................       6,000,000               6          11,683              --              --
Issuance of Common Stock for services ............         162,116              --             475              --              --
Issuance of Warrants to purchase 600,000 .........              --              --            (758)            758              --
    shares of Common Stock
Issuance of Warrants to purchase 50,000 ..........              --              --              --             150              --
    shares of Common Stock
Warrants expired December 1999 ...................              --              --              50             (50)             --
Stock options exercised, January through
    December 1999 ($0.22  - $4.75 per
    share) .......................................         241,339               1             869              --              --
Issuance of shares through the employee
    stock purchase plan, June and December
    1999 ($1.65 and $2.66 per share) .............          71,023              --             141              --              --
Compensation expense related to stock options ....              --              --             178              --              --
Unrealized gain on securities available-for-sale .              --              --              --              --              --
Net loss .........................................              --              --              --              --              --
                                                     -------------   -------------   -------------   -------------   -------------
Balance at December 31, 1999 .....................      22,853,782   $          23   $     113,262   $         908   $         (11)
                                                     =============   =============   =============   =============   =============

<CAPTION>

                                                                        UNREALIZED       DEFICIT
                                                                        GAIN (LOSS)    ACCUMULATED
                                                                      ON SECURITIES       DURING             TOTAL
                                                        DEFERRED        AVAILABLE       DEVELOPMENT      STOCKHOLDERS'
                                                      COMPENSATION       FOR SALE          STAGE             EQUITY
                                                      -------------    -------------   -------------    -------------
<S>                                                   <C>              <C>             <C>              <C>
Balance at December 31, 1997 .....................    $        (907)   $         (87)  $     (69,204)   $      27,379
Reversal of deferred compensation relating
   to forfeited stock options ....................               28               --              --               --
Issuance of Common Stock for services ............               --               --              --               76
Warrants expired June 1998 .......................               --               --              --               --
Stock options exercised, January through
   December 1998 ($0.04 - $0.68 per share) .......               --               --              --                7
Issuance of shares through the employee
   stock purchase plan, June and December
   1998 ($3.35 and $1.70 per share) ..............               --               --              --               99
Issuance of shares for cash November 1998
   ($3.58 per share) .............................               --               --              --            2,978
Compensation expense related to stock options ....              499               --              --              499
Unrealized gain on securities available-for-sale .               --              803              --              803
Net loss .........................................               --               --         (18,231)         (18,231)
                                                      -------------    -------------   -------------    -------------
Balance at December 31, 1998 .....................    $        (380)   $         716   $     (87,435)   $      13,610
Reversal of deferred compensation relating
to forfeited stock options .......................               30               --              --               --
Issuance of Common Stock for cash in
    secondary public offering February 1999
    ($2.1875 per share) ..........................               --               --              --           11,689
Issuance of Common Stock for services ............               --               --              --              475
Issuance of Warrants to purchase 600,000 .........               --               --              --               --
    shares of Common Stock
Issuance of Warrants to purchase 50,000 ..........               --               --              --              150
    shares of Common Stock
Warrants expired December 1999 ...................               --               --              --               --
Stock options exercised, January through
    December 1999 ($0.22  - $4.75 per
    share) .......................................               --               --              --              870
Issuance of shares through the employee
    stock purchase plan, June and December
    1999 ($1.65 and $2.66 per share) .............               --               --              --              141
Compensation expense related to stock options ....              281               --              --              459
Unrealized gain on securities available-for-sale .               --            1,431              --            1,431
Net loss .........................................               --               --         (14,094)         (14,094)
                                                      -------------    -------------   -------------    -------------
Balance at December 31, 1999 .....................    $         (69)   $       2,147   $    (101,529)   $      14,731
                                                      =============    =============   =============    =============
</TABLE>

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



                                      F-10
<PAGE>   48
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                           (ALL AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>


                                                                                                PERIOD FROM
                                                                                                 INCEPTION
                                                                                                 (JUNE 13,
                                                               YEARS ENDED DECEMBER 31,        1986) THROUGH
                                                          -----------------------------------    DECEMBER 31,
                                                            1997         1998         1999         1999
                                                          ---------    ---------    ---------    ---------
<S>                                                       <C>          <C>          <C>          <C>
Cash flows from operating activities:
   Net loss ...........................................   $ (16,991)   $ (18,231)   $ (14,094)   $(101,529)
      Adjustments to reconcile net loss to net
        cash provided by (used in) operating
           activities
      Depreciation and amortization ...................       1,139          821          611        5,458
      Loss on disposal of assets ......................         200           --           --          200
   Compensation expense related to stock
      and stock options ...............................         594          547        1,084        4,867
   Charge for purchase of in-process research
      and development .................................       3,000           --           --       11,547
   Unrealized gain (loss) on investment ...............         (12)         803        1,431        2,147
   Acquisition costs, net of cash received ............          --           --           --         (270)
   Loss in affiliate ..................................          --           --           --          500
   Accrued interest payable converted to stock ........          --           --           --           97
Changes in assets and liabilities:
   (Decrease) increase in prepaid expenses and other
      assets ..........................................         189          214         (193)        (268)
   Decrease (increase) in accounts receivable .........         (22)         (32)         132           --
   Increase (decrease) in accounts payable and accrued
      expenses ........................................       1,214        3,673       (2,058)       4,073
   Decrease in deferred revenue .......................          --           --           --         (353)
                                                          ---------    ---------    ---------    ---------
   Net cash used in operating activities ..............     (10,689)     (12,205)     (13,087)     (73,531)

Cash flows from investing activities:
   Purchases of investments ...........................     (71,047)     (42,809)     (11,111)    (261,361)
   Sales of investments ...............................      80,331       61,682       11,439      258,372
   Purchase of furniture, equipment and leasehold
      improvements ....................................        (352)      (1,958)        (377)      (6,456)
   Proceeds from sale of assets .......................          54            9           --           63
   Decrease (increase) in deposits ....................        (490)         490           --           --
   Investment in affiliate ............................          --           --           --         (500)
                                                          ---------    ---------    ---------    ---------
   Net cash provided by (used in) investing activities        8,496       17,414          (49)      (9,882)

Cash flows from financing activities:
   Proceeds from notes payable ........................          --        1,369          927        6,968
   Repayment of notes payable and principal payments(1)
      under capital lease obligations .................        (272)        (353)        (301)      (3,112)
   Purchase of treasury stock .........................          --           --           --          (11)
   Proceeds from issuance of stock ....................         315        3,084       12,700       91,096
                                                          ---------    ---------    ---------    ---------
   Net cash provided by financing activities ..........          43        4,100       13,326       94,941
                                                          ---------    ---------    ---------    ---------
   Net increase (decrease) in cash and cash equivalents      (2,150)       9,309          190       11,528
   Cash and cash equivalents at beginning of period ...       4,179        2,029       11,338           --
                                                          ---------    ---------    ---------    ---------
Cash and cash equivalents at end of period ............   $   2,029    $  11,338    $  11,528    $  11,528
                                                          =========    =========    =========    =========
Supplemental disclosures of cash flow information:
   Cash paid during the period for interest ...........   $      57    $      81    $     273    $   1,139
                                                          ---------    ---------    ---------    ---------
Supplemental schedule of noncash financing activities:
   Conversion of notes payable and accrued interest
      to Common Stock .................................  $       --   $       --   $       --    $   3,043
</TABLE>

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






                                      F-11
<PAGE>   49



                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       ORGANIZATION

         Aronex Pharmaceuticals, Inc. ("the Company", "Aronex Pharmaceuticals",
"we", "us" or "our") was incorporated in Delaware on June 13, 1986 and merged
with Triplex Pharmaceutical Corporation ("Triplex") and API Acquisition Company,
Inc. ("API"), formerly Oncologix, Inc. effective September 11, 1995 (see Note
4). In 1998, we formed a subsidiary, Aronex Europe Limited.

         Aronex Pharmaceuticals is a development-stage company that has devoted
substantially all of its efforts to research and product development and has not
yet generated any significant revenues, nor is there any assurance of future
revenues. In addition, we expect to continue to incur losses for the foreseeable
future, and there can be no assurance that we will successfully complete the
transition from a development-stage company to successful operations. The
research and development activities we engage in involve a high degree of risk
and uncertainty. Our ability to successfully develop, manufacture and market our
proprietary products is dependent upon many factors. These factors include, but
are not limited to, the need for additional financing, attracting and retaining
key personnel and consultants, and successfully developing manufacturing, sales
and marketing operations. Our ability to develop these operations may be
immensely impacted by uncertainties related to patents and proprietary
technologies, technological change and obsolescence, product development,
competition, government regulations and approvals, health care reform,
third-party reimbursement and product liability exposure. Additionally, we are
reliant upon collaborative arrangements for research, contractual agreements
with corporate partners, and our exclusive license agreements with The
University of Texas M.D. Anderson Cancer Center. Further, during the period
required to develop these products, we will require additional funds which may
not be available to us. We believe that we can conserve our current cash
resources to satisfy our funding needs into mid 2001. Accordingly, there can be
no assurance of our future success. See "Business -- Additional Business Risks"
in the Company's Form 10-K for the year ended December 31, 1999.

2.       ACCOUNTING POLICIES

         Principles of Consolidation

         The consolidated financial statements include the accounts of Aronex
Pharmaceuticals, Triplex, API and Aronex Europe Limited. All material
intercompany transactions have been eliminated in consolidation.

         Cash, Cash Equivalents and Short- and Long-Term Investments

         Debt and equity securities that we have the intent and ability to hold
to maturity are classified as "held to maturity" and reported at amortized cost.
Debt and equity securities that are held for current resale are classified as
"trading securities" and reported at fair value with unrealized gains and losses
included in earnings. Debt and equity securities not classified as either
"securities-held-to-maturity" or "trading securities" are classified as
"securities-available-for-sale" and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity.

         Cash and cash equivalents include money market accounts and investments
with an original maturity of less than three months. At December 31, 1999,
short-term investments include held to maturity securities and available for
sale securities. The held to maturity securities consist of high-grade
commercial paper and United States Government backed securities with a carrying
value of $5,658,000 which approximates fair market value and cost. Available for
sale securities consist of Targeted Genetics Corporation ("Targeted Genetics")
common stock (see Note 3) with an amortized cost of zero, a fair market value of
$2,146,000 and a gross unrealized gain of $2,146,000. Long-term investments at
December 31, 1999 are available for sale securities which are United States
mortgage backed securities with maturity dates over the next twenty-three years
that have an amortized cost of $920,000 which approximates fair market value and
cost. We currently have no trading securities.



                                      F-12
<PAGE>   50



                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         Furniture, Equipment and Leasehold Improvements

         Furniture and equipment are carried at cost and depreciation is
calculated on the straight-line method using a five-year estimated useful life.
Leasehold improvements are amortized on the straight-line method over the
shorter of the life of the lease or a five-year estimated useful life.
Maintenance and repairs that do not improve or extend the life of assets are
expensed as incurred. Expenditures which improve or extend the life of assets
are capitalized.

         A summary of furniture, equipment and leasehold improvements is as
follows (in thousands):

<TABLE>
<CAPTION>

                                                                     DECEMBER 31,
                                                               ----------------------
                                                                 1998          1999
                                                               ---------    ---------

<S>                                                            <C>          <C>
 Office furniture and equipment ............................   $   1,034    $   1,136
 Laboratory equipment ......................................       3,285        3,460
 Leasehold improvements ....................................         783          883
                                                               ---------    ---------
                                                                   5,102        5,479
Less accumulated depreciation and amortization .............      (2,839)      (3,450)
                                                               ---------    ---------
Furniture, equipment and leasehold improvements, net .......   $   2,263    $   2,029
                                                               =========    =========
</TABLE>


         At December 31, 1999, the cost of all furniture, equipment and
leasehold improvements pledged as collateral on notes payable totaled
$1,916,000.

         Revenue Recognition

         Research and development grant and contract revenues are recognized as
the related work is performed. Any revenue contingent upon future performance by
us is deferred and recognized as the performance is completed. Any revenues
resulting from the achievement of milestones are recognized when the milestones
are achieved. Research and development grant and contract revenues are received
under best efforts contracts and such revenue is not refundable.

         Research and Development

         Costs incurred in connection with research and development activities
are expensed as incurred. These costs consist of direct and indirect costs
associated with specific projects as well as fees paid to various entities that
perform certain research on our behalf.

         Estimates

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

                                      F-13
<PAGE>   51
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         New Accounting Pronouncements

         In December 1999, the Securities and Exchange commission (SEC) issued
Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements"
(SAB 101) which provides guidance related to revenue recognition based on
interpretations and practices followed by the SEC. SAB 101 is effective the
first fiscal quarter of fiscal years beginning after December 15, 1999 and
requires companies to report any changes in revenue recognition as a cumulative
change in accounting principle at the time of implementation in accordance with
Accounting Principles Board Opinion No. 20, "Accounting Changes." We are
currently in the process of evaluating what impact, if any, SAB 101 will have on
our financial position or our results of operations.

3.       INVESTMENT IN AFFILIATE

         In April 1994, we invested in and entered into a drug development
agreement with RGene Therapeutics, Inc. ("RGene"). We purchased $500,000 of
RGene's preferred stock, which was recorded in the financial statements as
investment in affiliate. The original investment was written off as RGene
incurred losses. This resulted in a zero basis when RGene was acquired by
Targeted Genetics, a publicly traded company, in June 1996.

         We received 440,520 shares of Targeted Genetics common stock from the
acquisition of RGene in June 1996 and an additional 104,496 upon the achievement
of certain milestones in October 1998. These shares are subject to Rule 144(k)
of the Securities Act of 1933, were unregistered and subject to a Lock-Up
Agreement and Stock Pledge. The lock-up period was for thirty months from the
date of the merger. Twenty percent of the shares were released six months after
the merger date and additional increments of twenty percent of the shares are
released for each additional six month period. The Company recorded the shares
at zero in the financial statements until 1998 when they were recorded at their
fair market value of $716,000. As a result, an unrealized gain of $2,147,000 is
reflected on the Company's balance sheet at December 31, 1999. In January 2000,
we sold all of our shares of Targeted Genetics and realized a gain of
$2,653,000.

         Under the drug development agreement with RGene, we performed certain
research and development activities with respect to certain RGene projects for
three years. This agreement expired in April 1997. During 1997, we recorded
$166,000 in revenue relating to this agreement.

4.       MERGER AGREEMENTS WITH TRIPLEX PHARMACEUTICAL CORPORATION AND API
         ACQUISITION COMPANY, INC.

         On September 11, 1995, Aronex Pharmaceuticals merged with Triplex and
API through two newly-formed, wholly-owned subsidiaries pursuant to Agreements
and Plans of Merger (the "Triplex Agreement" and the "API Agreement"). The
results of operations and the cash flow for Triplex and API have been included
in the financial statements from the date of acquisition.

         These acquisitions were accounted for under the purchase method of
accounting in which the aggregate purchase price was allocated to tangible and
intangible assets acquired based on their relative fair values as of the date of
the transaction. We allocated approximately $2.8 million of the purchase price
for Triplex and $5.6 million of the purchase price for API to in-process
research and development. Our valuation of the research and development acquired
considered:


         o        the current scientific and development status of the projects;
         o        the expected amount of time and resources required to complete
                  the projects;
         o        the probability of obtaining collaborators to help finance and
                  develop the projects; and
         o        the potential market for the projects.


                                      F-14
<PAGE>   52



                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         Our ability to commercialize the products acquired is affected by
several risks. These risks include:

         o        the successful filing and acceptance by the FDA of the
                  Investigational New Drug Application;
         o        the completion of all stages of clinical trials;
         o        the submission of data for the approval of a New Drug
                  Application, including the demonstration of safety and
                  efficacy;
         o        the ability to enter into collaborative arrangements to fund
                  the future development of the acquired products; and
         o        the ability to manufacture the acquired products. See
                  "Business."


         At the time of acquisition, Triplex's major focus was the development
of a new class of drugs to treat serious diseases where currently available
therapy was inadequate or non-existent. Triplex had, at that time, one compound,
Zintevir(R), that was at an advanced preclinical stage of development. Triplex
also had a number of other compounds in early stages of preclinical development.
Zintevir(R) was being developed for the treatment of HIV infection. Additional
preclinical and manufacturing work was required to enter clinical trials.

         In order for Zintevir(R) to become a marketable product, it will be
necessary to conduct several clinical trials and to improve the manufacturing of
the product. If funding is obtained, we estimate it will require an additional
$50 million over 3 to 5 years to complete the development of Zintevir(R).

         At the time of acquisition, API was engaged in the research and
development of drugs for the treatment of cancer. We acquired the API projects
to complement our existing product portfolio. The API compounds were licensed by
API from other companies, and were at a preclinical or early clinical stage.
Additional clinical trials and laboratory work were necessary to complete the
development of these compounds. If funding is obtained, we estimate it would
require an additional $25 to $40 million and take 5 to 8 years to complete the
development of AR209 for cancer therapies. We did not maintain the license of
other compounds acquired from API.

         In connection with the Triplex Agreement, we issued the following to
existing Triplex stockholders and option holders: (i) 3,441,436 shares of Common
Stock; (ii) options to purchase 88,912 shares of Common Stock; and (iii)
contingent stock issue rights to receive shares of Common Stock with a fair
market value of up to $8.0 million, the conversion of which is contingent upon
the satisfaction of conditions which relate to the licensing or development of
certain products (the "Triplex Contingent Stock Rights").

         The Triplex Contingent Stock Rights entitle the former Triplex
stockholders and option holders to receive shares of Common Stock with an
aggregate fair market value at the time of issuance of $5.0 million (subject to
certain adjustments) if we either: (i) entered into an agreement on or before
September 11, 1997 with respect to the licensing of a certain product whereby we
received at least $5.0 million in cash or an unconditional binding commitment
for at least $5.0 million (events which did not occur) or (ii) obtains data from
such clinical trials for such product on or before September 11, 2000 that our
Board of Directors determines to be sufficient to file a New Drug Application.
In addition, the Triplex Contingent Stock Rights entitled the former Triplex
stock and option holders to receive shares of Common Stock with an aggregate
fair market value at the time of issuance of $3.0 million if we did not receive
a minimum of $5.0 million in equity milestone payments from Genzyme on or before
September 11, 1997 with respect to the development of its ATRAGEN(R) product. As
a result of its failure to receive such payments from Genzyme, we issued 686,472
shares of Common Stock under the Triplex Contingent Stock Rights with an
aggregate fair market value at the time of issuance of $3.0 million and recorded
a corresponding non-cash charge to in-process research and development of $3.0
million in 1997.

         In connection with the API Agreement, we issued the following: (i)
427,000 shares of Common Stock to certain API debt holders; (ii) warrants (the
"Warrants") to purchase approximately 9.0 million shares of Common Stock to API
preferred stockholders, certain former employees and debt holders; and (iii)


                                      F-15
<PAGE>   53
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


contingent stock issue rights to receive shares of Common Stock with a fair
market value of approximately $2.1 million, the conversion of which was
contingent upon the satisfaction of conditions which relate to the licensing or
development of certain products (the "API Contingent Stock Rights").

         The API Contingent Stock Rights entitled such former API investors to
receive shares of Common Stock if we received at least $5.0 million in cash or
an unconditional binding commitment for at least $5.0 million on or before
September 11, 1997 relating to certain products. Neither such event occurred
and, accordingly, the API Contingent Stock Rights expired in 1997.

         The Warrants issued in connection with the API merger consisted of
three series of warrant rights to purchase approximately 2.4 million, 2.8
million and 3.7 million shares of Common Stock, respectively designated as
Series A, Series B and Series C. Upon the failure to exercise a series of
warrant rights prior to their expiration, the warrant holder forfeits all
remaining rights under the terms of the Warrant. The Series A, B and Series C
components of the Warrants expired in December 1995, June 1998 and December
1999, respectively.

         In October 1995, we were named a defendant in a lawsuit filed by
certain warrant holders challenging the redemption of the Warrants. To resolve
this matter, we entered into an agreement in December 1995 which settled the
lawsuit. In accordance with the settlement agreement, the plaintiffs were issued
531,552 shares of Common Stock in exchange for 3,576,668 Warrants in 1995. In
1996, in accordance with the settlement agreement, an additional 38,722 shares
of Common Stock were issued to the warrant holders' attorneys for related
expenses. The excess of the fair value of the Common Stock over the warrant
value was charged to expense.

         In August 1995, we were a defendant in a lawsuit filed by certain
common stockholders of API challenging the merger with API. To resolve this
matter, we entered into an agreement in July 1996 which settled the lawsuit. In
accordance with the settlement agreement, the plaintiffs were issued 20,000
shares of Common Stock. The fair value of these shares of Common Stock was
charged to expense.

5.       NOTES PAYABLE

         In May 1998, we entered into a master loan agreement for the financing
of furniture, office equipment and laboratory equipment acquisitions. Each loan
is collateralized by the furniture and equipment and is payable in 60 monthly
installments. In June 1998 and February 1999, we borrowed $1,369,000 and
$547,000, respectively, through this agreement bearing interest at 12%. In May
1999, a $2.0 million advance from Genzyme Corporation "Genzyme" and $500,000 in
minimum royalties relating to ATRAGEN(R) due to Genzyme were converted into a
$2.5 million convertible note payable to Genzyme. This note bears interest at
10% per annum with interest payable semi-annually, and the principal is due May
21, 2002. This note can be converted into Common Stock of the Company at $4.35
per share at Genzyme's option (See note 9). Future principal payments under
these loan agreements at December 31, 1999 are as follows:

<TABLE>
<CAPTION>

                                  YEAR ENDING
                                DECEMBER 31, NOTE             PAYABLE
                                -----------------        ---------------
<S>                                                      <C>
                                     2000                $       340,000
                                     2001                        383,000
                                     2002                      2,810,000
                                     2003                        301,000
                                     2004                         23,000
                                                         ---------------
                                     Total               $     3,857,000
                                                         ===============
</TABLE>



                                      F-16
<PAGE>   54
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



6.       STOCKHOLDERS' EQUITY

         Common Stock Warrants

         At December 31, 1999, we had warrants outstanding, relating to certain
financing transactions, to purchase 17,414 shares of Common Stock at exercise
prices of $3.63 per share (9,914 shares) and $12.00 per share (7,500 shares).
The warrants expire at various dates through March 2001.

         In connection with its February 1999 common stock offering, we issued
warrants to purchase 600,000 shares of common stock at a price of $3.28 per
share. These warrants expire in February 2004. The fair value of the warrants,
$758,400, has been recorded in the accompanying financial statements. This
amount has been estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions: a risk free
interest rate of 5.2% with in expected life of 5 years and expected volatility
of 113%.

         In connection with its Genzyme financing, we issued Genzyme warrants to
purchase 50,000 shares of Common Stock at an exercise price of $4.00 per share.
These warrants are exercisable until May 21, 2004. The fair value of the
warrants, $150,000, has been recorded in the accompanying financial statements.
This amount has been estimated on the date of grant using the Black Scholes
option pricing model with the following weighted-average assumptions: a risk
free interest rate of 5.2% with an expected life of five years and expected
volatility of 114%.

         Contingent Stock Rights

         In connection with the Triplex and API mergers, we issued $10.1 million
contingent stock rights. At December 31, 1999, $5.0 million contingent stock
rights remain outstanding, contingent upon the development and licensing of a
certain product (see Note 4).


                                      F-17
<PAGE>   55



                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7.       STOCK OPTION PLANS

         During 1989, our stockholders approved the 1989 Stock Option Plan (the
"Plan"). The Plan, as amended in 1992 and in May 1997, authorizes the issuance
of options covering the greater of (i) 2,490,000 shares of Common Stock or (ii)
17% of the shares of Common Stock outstanding on the last day of the preceding
fiscal quarter. The term of each option ranges from five to seven years from the
date of grant. At December 31, 1999, 1,506,033 shares were available for future
grant under the Plan.

         A summary of stock option activity for the Plan follows:

<TABLE>
<CAPTION>


                                                OPTIONS                          PRICE
                                              OUTSTANDING                       PER SHARE
                                             --------------                 ------------------
<S>                                         <C>                             <C>
Balance at December 31, 1996 .............        1,119,149                 $   0.04 to $14.88
          Granted ........................        1,232,578                 $   4.06 to $ 8.88
          Exercised ......................         (150,556)                $   0.04 to $ 5.50
          Forfeited ......................         (240,454)                $   0.66 to $10.50
                                             --------------                 ------------------
    Balance at December 31, 1997 .........        1,960,717                 $   0.04 to $14.88
          Granted ........................          336,114                 $   2.06 to $ 4.63
          Exercised ......................          (42,638)                $   0.04 to $ 0.68
          Forfeited ......................          228,946)                $   3.88 to $14.88
                                             --------------                 ------------------
    Balance at December 31, 1998 .........        2,025,247                 $   0.04 to $14.88
          Granted ........................          404,605                 $   1.94 to $ 5.81
          Exercised ......................         (317,433)                $   0.22 to $ 4.75
          Forfeited ......................         (396,944)                $   0.04 to $14.88
                                             --------------                 ------------------
    Balance at December 31, 1999 .........        1,715,475                 $   0.16 to $11.50
                                             ==============                 ==================
    Exercisable at December 31, 1999 .....        1,098,352                 $   0.16 to $11.50
                                             ==============                 ==================
</TABLE>


         During June 1998, our stockholders approved the 1998 Stock Option Plan
(the "1998 Plan"). This plan authorizes the issuance of options to purchase up
to 750,000 shares of Common Stock. Shares issued under the 1998 Plan expire 10
years from the date of issuance. In 1998, options to purchase 370,000 shares of
Common Stock were issued to employees, and 320,000 of these shares will vest at
the earlier of various dates based on the achievement of corporate and personal
goals as determined by the Board of Directors' compensation committee and the
achievement of specific Common Stock price targets or nine years and ten months
from the date of grant.

         A summary of stock option activity for the 1998 Plan follows:

<TABLE>
<CAPTION>

                                               OPTIONS          PRICE
                                             OUTSTANDING      PER SHARE
                                             -----------   ----------------
<S>                                          <C>           <C>
     Balance at December 31, 1997 ........            --   $             --
          Granted ........................       370,000   $ 2.44 to $ 3.88
          Exercised ......................            --   $             --
          Forfeited ......................            --   $             --
                                             -----------   ----------------
     Balance at December 31, 1998 ........       370,000   $ 2.44 to $ 3.88
          Granted ........................       230,000   $           3.63
          Exercised ......................       (58,800)  $ 2.44 to $ 3.88
          Forfeited ......................      (143,200)  $           3.88
                                             -----------   ----------------

     Balance at December 31, 1999 ........       398,000   $ 3.63 to $ 3.88
                                             ===========   ================
     Exercisable at December 31, 1999 ....        78,172   $ 3.63 to $ 3.88
                                             ===========   ================
</TABLE>

                                      F-18
<PAGE>   56
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         During 1993, we adopted the 1993 Non-Employee Director Stock Option
Plan (the "Director Plan"). The Director Plan, as amended effective in May 1997,
authorizes the issuance of options to purchase up to 600,000 shares of Common
Stock. Shares issued under the Director Plan expire 10 years from the date of
issuance. The Director Plan allows for the issuance of two types of grants:
Formula Grants and Discretionary Grants. Formula Grants are fully-vested when
issued and are issued at a price equal to the fair market value of our stock at
the date of issuance. Each Non-Employee Director was issued 12,500 Formula
Grants on November 14, 1995. In addition, the following Formula Grants are
issued under the Director Plan: (1) options to purchase 25,000 shares of common
stock to each Non-Employee Director upon first being elected to the Board of
Directors and (2) options to purchase 7,500 shares of Common Stock annually,
beginning on December 31, 1997, to each Non-Employee Director who has served as
a director for at least six months. Additionally, under the Director Plan, as
amended in 1997, on March 17, 1997, each Non-Employee Director received an
option to purchase 16,250 shares of Common Stock. These options were fully
vested when issued and were issued at a price equal to the fair market value of
our stock at the date of issuance. Discretionary Grants may be issued by the
Compensation Committee of the Board of Directors and may be issued at less than
the fair market value of our stock. In 1997, grants to purchase a total of
15,000 shares of Common Stock were issued to one Non-Employee Director. These
options were fully vested when issued and were issued at a price equal to the
fair market value of our stock at the date of issuance. In 1996, Discretionary
Grants to purchase a total of 87,500 shares of Common Stock were issued to two
Non-Employee Directors. These options vest over four years and were issued at
less than the fair market value of our Common Stock at the date of grant.

         A summary of stock option activity for the Director Plan follows:

<TABLE>
<CAPTION>

                                                                        OPTIONS             PRICE
                                                                      OUTSTANDING          PER SHARE
                                                                   ----------------   ------------------
<S>                                                                  <C>              <C>
           Balance at December 31, 1996 .......                             200,000   $  5.50 to $  9.38
           Granted ............................                             167,500   $  4.25 to $ 11.00
           Exercised ..........................                                  --   $               --
                                                                   ----------------   ------------------
           Balance at December 31, 1997 .......                             367,500   $  4.25 to $ 11.00
           Granted                                                           62,500   $  2.00 to $  2.53
           Exercised                                                             --   $               --
                                                                   ----------------   ------------------
           Balance at December 31, 1998 .......                             430,000   $  2.00 to $ 11.00
           Granted ............................                             102,500   $  2.97 to $  3.13
           Exercised ..........................                                  --   $               --
           Forfeited ..........................                             (32,500)  $  5.50 to $  9.38
                                                                   ----------------   ------------------
           Balance at December 31, 1999........                             500,000   $  2.00 to $ 11.00
                                                                   ================   ==================
           Exercisable at December 31, 1999....                             478,125   $  2.00 to $ 11.00
                                                                   ================   ==================
</TABLE>


         We record deferred compensation for the difference between the grant
price and the fair value for financial statement presentation purposes related
to options. The balance at December 31, 1999 was $69,000. In 1997, 1998 and
1999, $464,000, $499,000 and $281,000 respectively, in related expense was
recorded. The balance will be amortized to expense over the remaining vesting
periods of the options.



                                      F-19

<PAGE>   57
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



         We account for these plans under APB Opinion No. 25, under which
compensation expense was recorded. Had compensation cost for these plans been
determined consistent with FASB Statement No. 123 ("SFAS 123"), our net loss per
share would have been increased to the following pro forma amounts:

<TABLE>
<CAPTION>

                                                           YEAR ENDED
                                                           DECEMBER 31,
                                      -----------------------------------------------------
                                           1997                1998                1999
                                      ---------------    ---------------    ---------------
<S>                                  <C>                 <C>               <C>
Net Loss:
  As reported .....................   $   (16,991,000)   $   (18,231,000)   $   (14,094,000)
                                      ===============    ===============    ===============
  Pro forma .......................   $   (19,129,000)   $   (19,598,000)   $   (15,567,000)
                                      ===============    ===============    ===============

Loss Per Share (basic and diluted):
  As reported .....................   $         (1.14)   $         (1.17)   $         (0.65)
                                      ===============    ===============    ===============
  Pro forma .......................   $         (1.28)   $         (1.26)   $         (0.72)
                                      ===============    ===============    ===============
</TABLE>

         Because the SFAS 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
may not be representative of that to be expected in future years. The fair value
of each option grant is estimated on the date of grant using the Black Scholes
options pricing model with the following weighted-average assumptions used for
grants in 1997, 1998 and 1999, respectively: risk-free interest rates of 5.7% to
6.9%, 4.3% to 5.8% and 4.6% to 6.4%, with no expected dividends; expected lives
of 5 years for 1997 and 1998 and 3.5 years for 1999, and expected volatility of
114% in 1997, 113% in 1998 and 92% in 1999.

         A summary of the status of our three stock option plans as of December
31, 1997, 1998 and 1999 and charges during the years ending on those dates is
presented below:

<TABLE>
<CAPTION>
                                            1997                       1998                      1999
------------------------------    ------------------------   ------------------------   ------------------------
                                                  WEIGHTED-                   WEIGHTED-                  WEIGHTED-
                                                  AVERAGE                     AVERAGE                    AVERAGE
                                                  EXERCISE                    EXERCISE                   EXERCISE
      FIXED OPTIONS                SHARES          PRICE       SHARES          PRICE      SHARES          PRICE
------------------------------    ----------    ----------   ----------    ----------   ----------    ----------
<S>                                <C>          <C>           <C>          <C>           <C>          <C>
Balance at beginning of year ..    1,319,149    $     5.27    2,328,217    $     5.37    2,825,247    $     4.96
Granted .......................    1,400,078    $     4.99      768,614    $     3.52      737,105    $     3.30
Exercised .....................     (150,556)   $     1.43      (42,638)   $     0.39     (376,233)   $     3.27
Forfeited .....................     (240,454)   $     5.91     (228,946)   $     5.27     (572,644)   $     5.15
                                  ----------                 ----------                 ----------
Balance at end of year ........    2,328,217    $     5.37    2,825,247    $     4.96    2,613,475    $     4.69
                                  ==========                 ==========                 ==========
Options exercisable at year end      915,103    $     5.56    1,917,151    $     5.40    1,654,649    $     5.08
                                  ==========                 ==========                 ==========
Weighted-average fair value of
options granted during the year   $     4.02                 $     2.68                 $     2.24
</TABLE>



                                      F-20

<PAGE>   58

                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         The following table summarizes information about stock options
outstanding at December 31, 1999:

<TABLE>
<CAPTION>

                                        OPTIONS OUTSTANDING                         OPTIONS EXERCISABLE
                     ------------------------------------------------------ -----------------------------------
                          NUMBER        WEIGHTED-AVERAGE                         NUMBER
   RANGE OF           OUTSTANDING AT       REMAINING      WEIGHTED-AVERAGE    EXERCISABLE AT   WEIGHTED-AVERAGE
EXERCISE PRICES      DECEMBER 31, 1999  CONTRACTUAL LIFE   EXERCISE PRICE   DECEMBER 31, 1999  EXERCISE PRICE
--------------       -----------------  -----------------  --------------   ------------------ ----------------
<S>                  <C>                <C>                <C>              <C>                <C>
$0.16 - $  3.00               214,491          7.2          $        2.35            133,590        $    2.33
$3.01 - $  7.00             2,163,944          5.2          $        4.51          1,302,456        $    4.78
$7.01 - $ 11.50               235,040          4.3          $        8.52            218,603        $    8.53
                     ----------------                                       ----------------
                            2,613,475                                              1,654,649
                     ================                                       ================
</TABLE>


         In addition to the stock option plans, we issued 100,000 stock options
to a former consultant. These options are vested, have an exercise price of
$7.00 per share and expire in May 2002.

         8.       FEDERAL INCOME TAXES

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

         A reconciliation of the statutory federal income tax rate to Aronex
Pharmaceuticals' effective income tax rate for the periods ended December 31,
1997, 1998 and 1999 is as follows:

<TABLE>
<CAPTION>

                                                               1997              1998                1999
                                                            ----------         ----------          ---------
<S>                                                              <C>                <C>                 <C>
Statutory rate                                                   (34.0)%            (34.0)%             (34.0)%
Purchase of in-process research and development                    6.6 %              0.0 %               0.0 %
Equity in loss of foreign subsidiary not deductible                0.0 %              0.0 %               2.2 %
Stock option compensation not deductible (deductible)             (0.2)%              0.0 %              (0.4)%
Other                                                             (0.7)%              0.9 %               0.1 %
Adjustment due to deferred tax valuation allowance                28.3 %             33.1 %              32.1 %
                                                            ----------         ----------          ==========
                                                                   0.0 %              0.0 %               0.0 %
                                                            ==========         ==========          ==========
</TABLE>

         Significant components of our net deferred tax asset at December 31,
1998 and 1999 are as follows:

<TABLE>
<CAPTION>

                                                             1998            1999
                                                          ------------    ------------
<S>                                                       <C>              <C>
Deferred tax assets relating to:
   Federal net operating loss carryforwards ...........   $ 35,760,000    $ 39,023,000
   Financial statement depreciation and amortization in
     excess of (less than) amount deductible for income
     tax purposes .....................................        121,400         240,400
   Accrued liabilities not currently deductible
     for income tax purposes ..........................        739,300         748,000
   Equity in loss of affiliate not currently
     deductible for income tax purposes ...............        170,000         170,000
   Other items, net ...................................        (34,300)        (34,300)
Total deferred items, net .............................     36,756,400      40,147,100
Deferred tax valuation allowance ......................    (36,756,400)    (40,147,100)
                                                          ------------    ------------
Net deferred tax asset ................................   $         --    $         --
                                                          ============    ============
</TABLE>

                                      F-21

<PAGE>   59
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



         At December 31, 1999, we had net operating loss ("NOL") carryforwards
for federal income tax purposes of approximately $114.8 million. The Tax Reform
Act of 1986 provided a limitation on the use of NOL and tax credit carryforwards
following certain ownership changes that could limit our ability to utilize
these NOLs and tax credits. Accordingly, our ability to utilize the above NOL
and tax credit carryforwards to reduce future taxable income and tax liabilities
may be limited. As a result of the merger (see Note 4) with Triplex and API, a
change in control as defined by federal income tax law occurred, causing the use
of these carryforwards to be limited and possibly eliminated. Additionally,
because United States tax laws limit the time during which NOLs and the tax
credit carryforwards may be applied against future taxable income and tax
liabilities, we may not be able to take full advantage of our NOLs and tax
credit carryforwards for federal income tax purposes. The carryforwards will
begin to expire in 2001 if not otherwise used. Due to the possibility of not
reaching a level of profitability that will allow for the utilization of our
deferred tax assets, a valuation allowance has been established to offset these
tax assets. The valuation allowance increased $5,551,800, $8,108,400 and
$3,401,700 for the years ended December 31, 1997, 1998 and 1999, respectively.
These increases were primarily due to our losses from operations for such
periods and the valuation allowance for the net operating loss carryforwards
acquired in the 1995 mergers with Triplex and API (See Note 4). We have not made
any federal income tax payments since inception.

9.       LICENSE, RESEARCH AND DEVELOPMENT AGREEMENTS

         We have two exclusive license agreements with M.D. Anderson that may be
terminated in the event of a material breach of the terms of the agreement or
for failure to convert the licensed subject matter to a commercial form.
However, management believes our ongoing research and development efforts
currently satisfy this obligation to commercialize.

         The license agreements require us to pay royalties for licensed patent
products or processes based on cumulative net sales percentages. We must also
pay M.D. Anderson $200,000 for each FDA-approved product resulting from certain
licensed research tasks. No royalties have been paid to date since we have had
no sales.

         For the years ended December 31, 1997, 1998 and 1999, we paid M.D.
Anderson $108,000, $23,000 and $157,000, respectively, for research performed on
behalf of Aronex Pharmaceuticals.

         In 1993, we entered into a non-exclusive license agreement with a
pharmaceutical company to use a patented process in the manufacture, use and
sale of certain of our products with an initial fee of $30,000. Annual royalty
payments by us are to be computed as a percentage of sales, as defined in the
agreement. The royalty payments shall not exceed $1 million in a calendar year
and expire upon expiration of the licensed patents.

         In 1993, we entered into a license and development agreement with
Genzyme to develop and commercialize ATRAGEN(R). In September 1996, Genzyme
advanced us $2.0 million. Early in 1997, the Company amended the agreement
through which (1) we released Genzyme from any further obligation to perform
development work for ATRAGEN(R) and (2) the license granted to Genzyme under the
agreement was converted to an option to acquire the right to market and sell
ATRAGEN(R) worldwide.

         In March 1999, Genzyme notified us that they did not intend to exercise
their option to acquire the right to market and sell ATRAGEN(R) worldwide. As a
result of the election, we have regained full marketing rights to ATRAGEN(R) on
a worldwide basis and we were obligated to repay Genzyme the $2.0 million
advance by May 21, 1999 and pay product royalties, including $500,000 in minimum
royalties by April 24, 2000. In May 1999, the $2.0 million advance from Genzyme
and the $500,000 in minimum royalties were converted into a $2.5 million
convertible note payable to Genzyme. This note can be converted into our Common
Stock at $4.35 per share at Genzyme's option. In connection with this financing,
we issued Genzyme warrants to purchase 50,000 shares of Common Stock at an
exercise price of $4.00 per share. These warrants are exercisable until May 21,
2004. The fair value of the warrants, $150,000 has been recorded in the
accompanying financial statements. This amount has been estimated on the date of
grant using the Black Scholes option pricing model with the following
weighted-average assumptions: a risk free interest rate of 5.2% with an expected
life of five years and expected volatility of 114%.


                                      F-22
<PAGE>   60
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         In 1996, we entered into a license agreement with Boehringer Mannheim
GmbH (subsequently acquired by F. Hoffman-LaRoche Ltd. ("Roche")) to develop and
commercialize one of our products, AR209. Under the agreement, Roche was
responsible for funding the costs of all remaining preclinical and clinical
development of AR209 and for manufacturing the product. Roche paid us $150,000
in license fees in connection with this agreement in 1997 and agreed to pay
minimum annual license fees of $100,000 during the term of the agreement. In
addition, Roche was required to pay us up to $2.65 million in milestone payments
upon the occurrence of certain events and to pay us royalties on sales of the
product. We had the option to co-promote the product under terms to be
negotiated by the parties or to co-market the product if the parties are unable
to reach an agreement as to the terms of a co-promotion arrangement. Roche had
the right to terminate the agreement if the costs of developing AR209 were
materially greater than anticipated and Roche determined, in its reasonable
discretion, not to proceed with the development of the product in light of such
increased costs. We had the right to terminate the agreement if Roche failed to
achieve certain milestones. Both parties had the right to terminate the
agreement without cause, with all rights to AR209 reverting to the
non-terminating party. The agreement was terminated without cause by Roche in
September 1998, as a result of which all rights to AR209 have reverted to us.

         On November 12, 1998, we entered into a license agreement with Abbott
for Nyotran(R). The license agreement provides Abbott with exclusive worldwide
rights to market and sell Nyotran(R), subject to rights previously granted to
Grupo Ferrer Internacional, S.A. in Spain and Portugal and certain copromotion
rights retained by us in the United States and Canada. Under the license
agreement Abbott has paid us up-front payments, development milestones and
development payments. Such payments are not refundable, do not relate to any
future performance obligations and were recognized as revenue in 1998 and 1999.
Abbott purchased 837,989 shares of our Common Stock for $3.0 million under a
related stock purchase agreement on November 30, 1998. Abbott has provided
funding for the continuing clinical development of Nyotran(R) and will make
subsequent milestone payments if specified sales targets are achieved. Abbott
will also pay to us escalating royalties on all product sales of Nyotran(R).

10.      COMMITMENTS AND CONTINGENCIES

         We lease laboratory and office space under operating leases and certain
office equipment on a short-term basis. In 1997, we entered into a lease for a
building from our existing landlord who was a related party until late in 1997.
Under this lease, we have committed to lease 30,000 square feet for ten years
beginning in January 1998. Rental expense relating to these leases was
approximately $236,000, $667,000, and $756,000 for the years ended December 31,
1997, 1998 and 1999, respectively.

         Future minimum noncancellable payments under operating leases at
December 31, 1999 are as follows:

<TABLE>
<CAPTION>

                                  YEAR ENDING
                                  DECEMBER 31,                 AMOUNT
                                  ------------            ----------------
<S>                                                       <C>
                                      2000                $        713,000
                                      2001                         713,000
                                      2002                         713,000
                                      2003                         710,000
                                      2004                         692,000
                                   Thereafter                    2,055,000
                                                          ----------------
                                      Total               $      5,596,000
                                                          ================
</TABLE>

         We are subject to numerous risks and uncertainties because of the
nature of and status of our operations. We maintain insurance coverage for
events and in amounts that we deem appropriate. Management believes that
uninsured losses, if any, will not be materially adverse to our financial
position or results of operations.

                                      F-23
<PAGE>   61
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



         Litigation

         In the normal course of doing business, we occasionally become a party
to litigation. It the opinion of management, pending or threatened litigation
involving the Company will not have a material adverse material effect on our
financial condition.

11.      RELATED PARTY TRANSACTIONS AND EMPLOYMENT AGREEMENTS

         During 1997, 1998 and 1999, we entered into employment agreements with
our chief executive officer and other officers that have initial termination
dates ranging from 2000 to 2001. The agreements are thereafter automatically
renewed for successive periods of twelve to eighteen months unless terminated by
either party. Such agreements provide that in the case of termination without
cause, the officers are entitled to payments ranging from one hundred to one
hundred and fifty percent of their annual salaries. Additionally, one of these
officers has an outstanding loan with Aronex Pharmaceuticals with a balance of
approximately $13,000 at December 31, 1999. This loan will be repaid over the
next two years. Current annual salaries relating to these agreements total $1.1
million at December 31, 1999.

         In February 1998, we amended a consulting agreement with our chief
scientific advisor for a three-year period ending December 31, 2000, whereby we
are committed to pay consulting fees of $156,000 per year through December 31,
2000. One-half of the amount will be paid in cash and one-half will be paid in
our Common Stock. We paid cash of $156,000, $78,000 and $78,000 for the years
ended December 31, 1997, 1998 and 1999, respectively, and issued 18,352 and
40,248 shares of our common stock in 1998 and 1999, respectively, pursuant to
this agreement.

12.      401(k) PLAN

         We maintain a retirement savings plan, effective as amended on January
1, 1991, in which any of our employees who has completed one month of employment
may elect to participate. The plan is an individual account plan providing for
deferred compensation as described in Section 401(k) of the Code and is subject
to, and intended to comply with, the Employee Retirement Income Security Act of
1974, as amended. Each eligible employee is permitted to contribute up to 20% of
his/her annual salary up to the applicable statutory maximum prescribed in the
Code. We may, in our discretion, contribute an amount equal to the employee's
contribution, but our contribution may not exceed an amount equal to 6% of the
employee's compensation. A participant is 50% vested in the accrued benefits
derived from our contributions after completion of one year of employment
following his/her election to participate in the plan, and 100% vested in such
contributions after completion of two years of employment following such
election. Participants may receive hardship loans under the terms of the plan.
The plan provides for distributions in the event a participant dies, reaches the
age of 65, becomes disabled or terminates his/her employment prior to the age of
65. Aronex Pharmaceuticals made contributions of approximately $45,700, $56,500
and $65,200 under the 401(k) plan for the years ended December 31, 1997, 1998
and 1999, respectively.

13.      EMPLOYEE STOCK PURCHASE PLAN

         In December 1996, the Board of Directors adopted the 1997 Employee
Stock Purchase Plan and reserved 250,000 shares of Common Stock for issuance
thereunder. The plan permits employees to purchase Common Stock through payroll
deductions of up to 15% of their compensation subject to limitations as defined
by the Internal Revenue Service. Purchases of Common Stock are made at the lower
of 85% of fair market value at the beginning or end of each six-month offering
period. In 1997, 21,392 shares were purchased by employees at $3.31 and $3.19
per share. In 1998, 39,516 shares were purchased by employees at $3.35 and $1.70
per share. In 1999, 71,023 shares were purchases by employees at $1.65 and $2.66
per share.

                                      F-24
<PAGE>   62
                  ARONEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          (A DEVELOPMENT STAGE COMPANY)

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



14.      SUBSEQUENT EVENT

         On April 4, 2000, we received approximately $6 million in binding
commitments from investors to purchase Units from us. Each $100,000 Unit is
comprised of (1) shares of our common stock in an amount determined by dividing
$100,000 by $2.75 and (2) a warrant with a five-year term to purchase an amount
of shares of our common stock that is thirty-three percent of the amount of
shares contained in such Unit at an exercise price of $3.00 per share. The
Company retained a finder and will pay the finder 7% of the proceeds from the
sale of the Units and issue warrants with a seven year term to purchase 150,000
shares of our common stock at an exercise price of $3.25 per share.














                                      F-25
<PAGE>   63
                                 EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER         DESCRIPTION
-------        -----------
<S>            <C>
 23.1          Consent of Arthur Andersen LLP
</TABLE>