<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K

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

For the fiscal year ended September 30, 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. 0-18728

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

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

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

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

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

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

The aggregate market value of the voting and non-voting common equity (excluding
preferred stock convertible into and having voting rights on certain matters
equivalent to 622,222 shares of Common Stock) held by non-affiliates of the
registrant was approximately $109,600,000, based on the last sales price of the
Common Stock as of December 23, 1999. Shares of Common Stock held by each
executive officer and director, by each person who beneficially owns 10% or more
of the outstanding Common Stock, and individuals or entities related to such
persons have been excluded. This determination of affiliate status may not be
conclusive for other purposes.

As of December 23, 1999, 42,076,532 shares of Common Stock, $.001 par value, of
the registrant were issued and outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

See Part III hereof with respect to incorporation by reference from the
registrant's definitive proxy statement for the fiscal year ended September 30,
1999 to be filed pursuant to Regulation 14A under the Securities Exchange Act of
1934 and the Exhibit Index hereto.
<PAGE>

PART I

Note Regarding Forward Looking Statements
-----------------------------------------

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

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

  Redux is a trademark of Les Laboratoires Servier ("Servier"), licensed to the
Company and American Home Products Corp. ("AHP").  CerAxon is a trademark of the
Company and BEXTRA(R) is a registered trademark of Incara Pharmaceuticals Corp.,
previously  Intercardia, Inc. ("Incara").  LidodexNS is a trademark of Algos
Pharmaceutical Corporation ("Algos"), licensed to the Company. All other
trademarks or tradenames referred to in this report are the property of their
respective owners.

Item 1. Business.

      (a) General Development of Business

  The Company is a biopharmaceutical company engaged in the development and
commercialization of a portfolio of products and product candidates for central
nervous system and other disorders, including multiple compounds in late-stage
clinical development. The Company seeks to acquire, develop and commercialize
products with market experience or that are in clinical or late pre-clinical
development. The Company is currently developing or has certain rights to four
drugs: citicoline for ischemic stroke, pagoclone for panic and anxiety disorder,
trospium for overactive bladder and IP 501 for cirrhosis of the liver. Other
products and compounds, in earlier stages of clinical or pre-clinical
development, to which the Company has rights, include PACAP (pituitary adenylate
cyclase activating polypeptide) for stroke, diabetes and other neurodegenerative
diseases, and LidodexNS for migraine headache.

  In August 1999, the Company completed enrollment of 899 patients in a Phase 3
clinical trial with citicoline (current tradename CerAxon).  Preliminary
results of the trial are expected in January 2000.  If the results are

                                      -2-
<PAGE>

positive, the Company expects to re-submit the New Drug Application ("NDA") for
citicoline in the first half of calendar year 2000. The NDA was originally
submitted in December 1997, based on the results of previously conducted
clinical trials in the U.S. and Japan, and was withdrawn in April 1998. In
December 1999, the Company licensed exclusive rights to commercialize
citicoline in the U.S. and Canada to Takeda Chemical Industries, Ltd.
("Takeda").

  The Company is also developing pagoclone, a novel treatment for panic and
generalized anxiety disorders. A Phase 2/3 clinical trial involving 277 patients
showed that treatment with pagoclone statistically significantly reduced the
frequency of panic attacks among patients suffering from panic disorder. In
December 1999, the Company licensed exclusive worldwide rights to commercialize
pagoclone to Warner-Lambert Company ("Warner-Lambert").

  In November 1999, the Company obtained an exclusive U.S. license to trospium,
a prescription drug product currently marketed as a treatment for overactive
bladder in several European countries. The Company intends to file an
Investigational New Drug application ("IND") and initiate a Phase 3 clinical
study with this drug in late 2000.

  The Company has an exclusive option to negotiate a license to a compound known
as IP 501 for the treatment and prevention of liver diseases, including alcohol-
induced cirrhosis and Hepatitis C.  IP 501 is currently being studied in a Phase
3 clinical trial sponsored by the Veterans Administration.

  On September 15, 1997, the Company announced a market withdrawal of its first
prescription product, the weight loss medication Redux (dexfenfluramine
hydrochloride capsules) C-IV, which had been launched by AHP, the Company's
licensee, in June 1996. Simultaneously, Wyeth-Ayerst Laboratories ("Wyeth-
Ayerst"), a division of AHP, announced withdrawal of the weight loss medication
Pondimin (fenfluramine hydrochloride tablets) C-IV. Following the withdrawal,
Interneuron has been named, together with other pharmaceutical companies, as a
defendant in approximately 1,965 product liability legal actions, many of which
purport to be class actions, in federal and state courts involving the use of
Redux and other weight loss drugs.

  On September 27, 1999, the U.S. District Court for the Eastern District of
Pennsylvania (the "District Court") rejected a proposed agreement preliminarily
approved by the District Court in September 1998 to settle all product liability
litigation and claims against Interneuron related to Redux, finding that the
proposed agreement did not meet the requirements for limited fund class actions,
as recently described by the United States Supreme Court in Ortiz v. Fibreboard
                                                            -------------------
Corp. The District Court also vacated the stays of pending and future litigation
-----
that were previously in effect. The Company filed a petition with the U.S. Court
of Appeals for the Third Circuit on October 12, 1999, seeking review of the
District Court's ruling. That petition is still pending.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux and
Pondimin.  The Company is in discussions with AHP and the Plaintiffs' Management
Committee (consisting of attorneys designated to represent plaintiffs in
nationwide multidistrict litigation) regarding avenues for the Company to reach
a comprehensive resolution of its outstanding Redux-related litigation.  The
Company cannot predict whether any settlement will be reached or the terms of
any settlement.

  The Company was incorporated in the State of New York in October 1988 and in
March 1990 was reincorporated in Delaware. The Company's executive offices are
located at One Ledgemont Center, 99 Hayden Avenue, Lexington, Massachusetts
02421-7966. The Company's telephone number is 781-861-8444, its fax number is
781-861-3830, and its Internet website is http://www.interneuron.com.

                                      -3-
<PAGE>

     (b) Financial Information about Industry Segments

The Company operates in only one business segment.

     (c) Narrative Description of Business

PRODUCTS

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

<TABLE>
<CAPTION>
 PRODUCT        INDICATION/USE           REGULATORY STATUS (*)           COMMERCIAL RIGHTS
 -------        --------------           ---------------------           -----------------
<S>             <C>                      <C>                             <C>
Citicoline      Ischemic Stroke          Phase 3                         U.S. and Canada; licensed to
(CerAxon)                                                                Takeda

Pagoclone       Anxiety/Panic disorders  Phase 2/3 trial completed       Worldwide, except for France,
                                                                         where Rhone-Poulenc Rorer
                                                                         Pharmaceuticals Inc. ("RPR")
                                                                         retains an option; licensed
                                                                         to Warner-Lambert

Trospium        Overactive bladder       Phase 3 clinical trial planned  U.S.
                                         to begin late 2000

IP 501          Cirrhosis of the liver   Phase 3                         Option to acquire rights for
                                                                         North America and Asia

PACAP           Stroke, neuro-           Pre-clinical                    Worldwide
                degenerative diseases,
                diabetes

LidodexNS       Migraine headache        Pre-clinical                    Worldwide development,
                                                                         manufacturing and marketing
                                                                         collaboration with Algos
</TABLE>
_____________________________
*See "Government Regulation."

CITICOLINE (CERAXON)

     General: Citicoline (cytidine-5'-diphosphate choline sodium)  is the
     -------
Company's most advanced product under development, currently under the trade
name CerAxon, as a potential treatment for ischemic stroke. An ischemic stroke
occurs when brain tissue dies or is severely damaged as the result of
interrupted blood flow caused by a clogged artery which deprives an area of the
brain of blood and oxygen, commonly known as an infarct. This loss

                                      -4-
<PAGE>

of blood flow and oxygen causes, among other events, a breakdown of brain cell
membranes, and places the surrounding tissue, the penumbra, at risk for death,
leading to an extension of the size of infarct believed to result from the
release and oxidation of such compounds as free fatty acids. This release is
likely caused in part by the inappropriate release of glutamate and other
neurotransmitters.

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

  Takeda Agreement: On December 2, 1999, the Company entered into an agreement
  ----------------
with Takeda under which the Company licensed to Takeda exclusive rights to
commercialize citicoline in the U.S. and Canada (the "Takeda Agreement"). Under
the Takeda Agreement, the Company is entitled to receive $13,000,000 in
licensing and other guaranteed payments, of which approximately $11,500,000 has
been received to date, and up to $60,000,000 in payments contingent upon the
achievement of future regulatory milestones in the U.S. and Canada. Takeda also
agreed to pay Interneuron royalties on net sales. In addition, Takeda agreed to
fulfill the royalty payment obligations of Interneuron to Ferrer Internacional,
S.A. ("Ferrer"), pursuant to Interneuron's agreement with Ferrer. Takeda would
be responsible for funding any future Phase 4 studies of citicoline in stroke
and, in the future, any Phase 3 studies for additional indications. The Takeda
Agreement also grants an exclusive option to Takeda to negotiate a license in
the U.S. and Canada for any one alternative Interneuron compound, excluding
pagoclone, in the event Takeda decides to terminate the Takeda Agreement
following a review of the results of the ongoing Phase 3 clinical trial. See
"Risk Factors - We may not be able to collaborate with third parties to
commercialize certain other products if Takeda terminates the citicoline license
agreement."

  Ongoing Phase 3 Trial: Following the Company's withdrawal in April 1998 of
  ---------------------
the NDA for citicoline, the Company commenced a Phase 3 clinical trial with this
drug in June 1998. Enrollment in this trial, known as ECCO 2000 (Effects of
Citicoline on Clinical Outcome - 2000 mg.), was completed in late August 1999.
This multi-center trial, which includes 899 patients with ischemic stroke at
more than 170 hospitals in the U.S. and Canada, will compare the neurological
function of citicoline-treated patients with that of placebo patients at 12
weeks following stroke. The primary endpoint is the change in neurological
function of patients between the time of enrollment and the end of the follow-up
period (12 weeks), as measured by the National Institutes of Health ("NIH")
Stroke Scale Scores. Patients have been treated with citicoline, 2000 milligrams
daily, for six weeks, with a six week follow-up period. The Company anticipates
that preliminary results of this study will be available in January 2000. A
negative outcome of the citicoline trial could have a material adverse effect on
the Company. See "Risk Factors - A negative outcome of the citicoline trial
would materially harm us."

  The 2000 milligram dose level used in ECCO 2000 is higher than the dose used
in the Company's two most recent citicoline clinical trials but was used in the
Company's first Phase 3 trial in which patients treated with this dose achieved
the primary endpoint of improved neurological function.

  Regulatory Strategy: Depending upon the evaluation of the results from ECCO
  -------------------
2000, the Company will determine whether to re-submit the NDA for citicoline to
the U.S. Food and Drug Administration ("FDA").

                                      -5-
<PAGE>

Assuming a positive outcome, Interneuron plans to re-submit the NDA for
citicoline under Takeda's name. Takeda is responsible for filing the Canadian
regulatory filing counterpart for citicoline under its name. Pursuant to the
Takeda Agreement, Interneuron and Takeda will jointly oversee the development
and regulatory filings of citicoline in the U.S. and Canada.

  The Company had submitted the NDA for citicoline to the FDA in December 1997.
Data in the NDA included the results of two Phase 3 clinical trials conducted by
the Company in the U.S., a Japanese Phase 3 clinical trial conducted by Takeda
and supportive clinical and post-marketing data from more than 30 countries
where citicoline has already been approved.  The NDA was accepted for filing and
was assigned priority and fast-track review status.  A priority review status
reflects the FDA's commitment to review the NDA within six months following
submission, and a fast-track designation indicates the FDA has determined that a
drug is intended to treat a serious or life-threatening condition that currently
has an unmet medical need and that the FDA can take actions to expedite the
development and review of the drug.  Even if the Company does re-submit the NDA,
as to which there is no assurance, the Company is unable to predict whether or
when the FDA would grant authorization to market citicoline in the U.S.  Upon
resubmission of the NDA, a new review period would commence. See "Risk Factors -
A negative outcome of the citicoline trial would materially harm us."

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

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

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

                                      -6-
<PAGE>

  In the responders analysis, 41% of citicoline-treated patients with an NIH
Stroke Scale on entry of greater than or equal to eight (moderate to severe
strokes) achieved a Barthel Index of greater than 95 compared to 25% of placebo-
treated patients (OC (observed cases) analysis, p = 0.02). Thus, patients with
moderate to severe stroke treated with citicoline had a 64% greater chance of
complete or near-complete recovery relative to patients with moderate to severe
stroke treated with placebo. In the LOCF (last observation carried forward)
analysis, 33% of moderate to severe citicoline patients and 21% of moderate to
severe placebo patients achieved a Barthel Index of greater than 95 (p = 0.05),
a 57% increased chance of improvement in recovery.

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

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

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

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

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

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

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

  In addition, global neurologic status, assessed by the Rankin Scale mean
scores, was significantly improved (p less than 0.04) with citicoline
treatment compared to placebo.

                                      -7-
<PAGE>

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

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

  Manufacturing and Marketing: Pursuant to the Takeda Agreement, Takeda is
  ---------------------------
responsible for commercial manufacturing and marketing of citicoline. Takeda has
advised the Company, that assuming FDA approval is obtained, it intends to
commercialize citicoline through Takeda Pharmaceuticals America, Inc.,
established in 1998 as the wholly-owned U.S. marketing subsidiary of Takeda.

  The Company will be dependent upon Takeda or third party suppliers of
citicoline bulk compound, finished product and packaging for manufacturing in
accordance with current U.S. Good Manufacturing Practices ("cGMP") regulations,
and will be dependent on Takeda for the marketing and distribution of
citicoline. Supplies of citicoline finished product used for clinical purposes
have been and are being produced on a contract basis by third party
manufacturers. The Company's license and supply agreement with Ferrer dated
January 1993 as amended in June 1998 (the "Ferrer Agreement"), requires the
purchase from Ferrer of citicoline bulk compound for commercial purposes at
fixed prices, subject to certain conditions. If such conditions permit the
purchase of bulk compound from a third party, the Company entered into an
agreement with a manufacturer to supply citicoline bulk compound for commercial
purposes and has assigned this agreement to Takeda. Any citicoline manufacturing
facilities are subject to FDA inspection. There can be no assurance Takeda or
its suppliers can or will establish on a timely basis, or maintain,
manufacturing capabilities of bulk compound and finished product required to
obtain regulatory approval or that any facilities used to produce citicoline
will have complied, or will be able to maintain compliance, with cGMP or that
Takeda or its suppliers will be able to meet manufacturing requirements on a
timely basis or at all. See "Risk Factors - We will depend on Takeda and other
third parties to manufacture and market citicoline."

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

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

                                      -8-
<PAGE>

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

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

PAGOCLONE

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

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

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

  Warner-Lambert Agreement: Effective as of December 23, 1999, the Company
  ------------------------
entered into an agreement with Warner-Lambert under which the Company licensed
to Warner-Lambert exclusive worldwide rights to commercialize pagoclone (the
"Warner-Lambert Agreement"). Under the Warner-Lambert Agreement, the Company is
entitled to receive $13,750,000 in an up-front payment and up to $60,000,000 in
payments contingent upon the achievement of clinical and regulatory milestones.
Warner-Lambert also agreed to pay Interneuron royalties on net sales. Under the
Warner-Lambert Agreement, Warner-Lambert would be responsible for conducting and
funding all further clinical development, regulatory review, manufacturing and
marketing of pagoclone for all indications on a worldwide basis. Under the
Company's agreement with RPR, RPR is entitled to receive a portion of the
payments to be received by the Company from Warner-Lambert. See "Risk Factors-We
will depend on Warner-Lambert to develop, manufacture and market pagoclone."

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

  The double-blind, placebo-controlled, parallel group study involved 277
patients at six clinical sites in the U.S. Patients were enrolled in the study
following confirmed diagnoses of panic disorder. The number of attacks
experienced by each patient during a two-week screening period prior to
enrollment represented the baseline for subsequent comparison of panic attack
frequency.  Following the screening period, patients were randomized to receive
one of three doses of pagoclone orally (.15 milligrams/day, .30 milligrams/day
or .60 milligrams/day) or placebo for eight weeks.  The primary outcome
measurement was the change from baseline in the number of panic attacks seen at
the eight week time point.

                                      -9-
<PAGE>

  This primary analysis, conducted on an LOCF basis, showed that patients in the
 .15 milligrams/day group experienced a 43% reduction in the number of panic
attacks relative to patients on placebo (p =0.141), that patients in the .30
milligrams/day group experienced a 70% reduction relative to patients on placebo
(p =0.021), and that patients in the .60 milligrams/day group experienced a 52%
reduction (p =0.098) relative to patients on placebo.

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

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

  Licensing and Proprietary Rights:  In 1994, the Company licensed from RPR
  --------------------------------
exclusive worldwide, except for France where RPR retains an option, rights to
pagoclone, a patented compound, in exchange for license fees, milestone payments
and royalties based on net sales. See "Patents and Proprietary Rights-Pagoclone"
and "Agreements."

  Further Development:  Under the Warner-Lambert Agreement, Warner-Lambert
  -------------------
will be responsible for all further development of pagoclone. The Company
anticipates that Warner-Lambert will initiate clinical trials with pagoclone for
panic disorder and generalized anxiety disorder in late 2000.

TROSPIUM

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

  Trospium belongs to a class of compounds known as muscarinic receptor
antagonists.  These compounds relax smooth muscle tissue, such as that found in
the bladder. Pre-clinical data with trospium suggests that it does not enter the
central nervous system and thus may have a side effect profile preferable to
currently available agents.  In addition, clinical data and commercial
experience reflect favorable efficacy and safety profiles.

  Licensing and Proprietary Rights: In November 1999, the Company licensed
  --------------------------------
exclusive U.S. rights from Madaus AG ("Madaus") to market trospium (the "Madaus
Agreement"), an orally administered prescription drug product

                                      -10-
<PAGE>

marketed for approximately 20 years as a treatment for overactive bladder (urge
incontinence) in several European countries, including Germany, Spain, Austria,
and Switzerland. In exchange, the Company agreed to pay Madaus regulatory
milestone, royalty and sales milestone payments. Over 1,200 patients have been
studied in clinical trials evaluating trospium, and over 8000 patients have been
followed in post-marketing trials. Interneuron is responsible for all clinical
development and regulatory activities and costs related to the compound in the
U.S. There are no existing U.S. patents covering the use of orally administered
trospium to treat overactive bladder. The commercialization of trospium by the
Company will not utilize these patents, and the Company intends to attempt to
rely on the provisions of the Waxman-Hatch Act to obtain a period of market
exclusivity in the U.S., if the FDA approves trospium in the U.S. for the
intended indication. The Madaus Agreement includes a license of the know-how
relating to the European clinical trials of trospium. See "Patents and
Proprietary Rights-Trospium."

  Development Strategy: The Company intends to file an IND, and initiate a Phase
  --------------------
3 clinical study with this drug in late 2000. The Madaus Agreement requires
Madaus to commercially manufacture the product, provided certain conditions are
met. The Company requires substantial additional funds to complete development
of trospium and may pursue a corporate collaboration to fund development and
marketing of the drug. There can be no assurance the Company will be successful
in obtaining the funds or entering into any collaboration for the development of
trospium. See "Risk Factors - We will rely on third parties to commercialize our
products."

OTHER PRODUCTS UNDER DEVELOPMENT

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

  IP 501:  During 1997, the Company obtained an exclusive option to negotiate
  ------
a license to a compound (designated by the Company as IP 501) for the treatment
and prevention of liver diseases, including alcohol-induced cirrhosis and
Hepatitis C.  The option grants Interneuron the right to obtain an exclusive
license on certain specified terms, subject to the rights of the U.S. government
in North America, Japan and Korea, to an issued U.S. patent and U.S. and
international patent applications, following Interneuron's review of data from
an ongoing government-sponsored Phase 3 clinical trial. Interneuron's rights to
this compound are subject to the negotiation and execution of a definitive
license agreement on terms to be agreed upon by the parties. This orally-
administered compound is being studied in a Phase 3 clinical study sponsored by
the Veterans Administration. All 800 patients who will be included in the study
have been enrolled. Completion of the study is currently expected in mid-2000.
The study is designed to have periodic interim analyses which could lead to
earlier termination or extension of the trial. The primary endpoint of the study
is improvement in liver histology, or condition, among drug-treated pre-
cirrhotic patients compared with placebo patients, as measured by serial liver
biopsies.

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

  LidodexNS:  In December 1996, the Company entered into an agreement with
  ---------
Algos for the development and commercialization of LidodexNS, a combination of
lidocaine and dextromethorphan, which may offer the potential for relief of
acute migraine headache through intranasal administration. The Company has
conducted certain preclinical  studies and is evaluating additional preclinical
studies.

  The Company does not have sufficient funds to develop and commercialize any of
the foregoing potential products.  Depending upon ongoing preclinical or
clinical test results, the Company may discontinue or defer development of any
or all of these potential products or to seek a corporate collaboration in which
a third party

                                      -11-
<PAGE>

assumes responsibility and funding for drug development, manufacturing and
marketing for any or all of them. See "Risk Factors - We will rely on third
parties to commercialize our products."

SUBSIDIARIES

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

CPEC:  On July 15, 1999, the Company entered into agreements and transactions
----
(the "CPEC Exchange Transactions") that resulted in Interneuron owning 65
percent of (CPEC, which was developing BEXTRA (bucindolol), a non-selective
beta-blocker with mild vasodilating properties, for congestive heart failure. In
exchange, Interneuron returned to Incara approximately 4.2 million of the 4.5
million shares of Incara common stock owned by Interneuron. As a result of the
CPEC Exchange Transactions, the Company and Incara assumed 65 percent and 35
percent, respectively, of CPEC's funding requirements for any future development
of BEXTRA in the U.S. and Japan and would be entitled to 65 percent and 35
percent, respectively, of the profits and available cash of CPEC.

  Prior to the CPEC Exchange Transactions, Interneuron owned approximately
61 percent of Incara's common stock and approximately 20 percent of CPEC, Inc.,
the predecessor to CPEC. Incara previously owned approximately 80 percent of
CPEC, Inc. Interneuron now owns approximately 5 percent of Incara's outstanding
common stock, representing shares paid to Interneuron as part of the May 1998
merger of Transcell into Incara. Interneuron retains the right to receive
additional shares of Incara common stock, as the final installment of the
Transcell Merger consideration, in February 2000.

  As a result of the CPEC Exchange Transactions, the Company no longer
consolidates Incara's financial statements but instead consolidates CPEC's
financial statements. Interneuron recorded a noncash charge for the purchase of
in-process research and development of approximately $2,400,000 relating to the
CPEC Exchange Transactions in fiscal 1999. Furthermore, as a result of the
termination of the Beta-blocker Evaluation of Survival Trial ("BEST") as
summarized below, and the Company's decision to cease development of BEXTRA, the
Company has accrued additional costs to discontinue the operations of CPEC. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

  On July 29, 1999, BEST terminated at the recommendation of the BEST Data and
Safety Monitoring Board, based upon the absence of significant survival
advantage of treatment with bucindolol. Full results of BEST were presented at
the American Heart Association meeting in November 1999. BEST, a 2,708-patient
Phase 3 clinical trial with bucindolol in the U.S., was co-sponsored by the
National Heart, Lung, and Blood Institute, a division of the NIH, and the
Department of Veterans Affairs.

  According to the BEST Coordinating Center, the decision of the Data and Safety
Monitoring Board to terminate BEST was based upon the totality of evidence
available regarding beta-blocker treatment of heart failure from BEST and other
randomized controlled trials.  There was no significant survival advantage of
treatment with bucindolol for the population as a whole.

                                      -12-
<PAGE>

  On August 5, 1999, Incara and BASF Pharma/Knoll AG terminated their
collaboration for the development of bucindolol in the territory outside the
U.S. and Japan.  The Phase 3 trial of bucindolol in Europe, known as the
Bucindolol Evaluation after Acute Myocardial Infarction Trial ("BEAT"), also
terminated.

MANUFACTURING AND MARKETING

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

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

  Citicoline: Pursuant to the Takeda Agreement, Takeda is responsible for the
  ----------
manufacturing and marketing of citicoline.  Takeda has advised the Company that,
assuming FDA approval is obtained, it intends to directly commercialize
citicoline through Takeda Pharmaceuticals America, Inc., established in 1998 as
the wholly-owned U.S. marketing subsidiary of Takeda.

  The Company will be dependent upon Takeda or third party suppliers of
citicoline bulk compound, finished product and packaging for manufacturing in
accordance cGMP regulations, and will be dependent on Takeda for the marketing
and distribution of citicoline.  Supplies of citicoline finished product used
for clinical purposes have been and are being produced on a contract basis by
third party manufacturers. The Ferrer Agreement requires the purchase from
Ferrer of citicoline bulk compound for commercial purposes at fixed prices,
subject to certain conditions. If such conditions permit the purchase of bulk
compound from a third party, the Company entered into an agreement with a
manufacturer to supply citicoline bulk compound for commercial purposes and has
assigned this agreement to Takeda. Any citicoline manufacturing facilities are
subject to FDA inspection. There can be no assurance Takeda or its suppliers can
or will establish on a timely basis, or maintain, manufacturing capabilities of
bulk compound and finished product required to obtain regulatory approval or
that any facilities used to produce citicoline will have complied, or will be
able to maintain compliance, with cGMP or that Takeda or its suppliers will be
able to meet manufacturing requirements on a timely basis or at all. See "Risk
Factors - We will depend on Takeda and other third parties to manufacture and
market citicoline."

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

COMPETITION

  General: The pharmaceutical industry is characterized by rapidly evolving
  -------
technology and intense competition. Many companies, including major
pharmaceutical companies and specialized biotechnology companies, are engaged in
marketing or development of products and therapies similar to those being
pursued by the Company. Many of the Company's competitors have substantially
greater financial and other resources, larger research and development

                                      -13-
<PAGE>

staffs and significantly greater experience in conducting clinical trials and
other regulatory approval procedures and manufacturing and marketing
pharmaceutical products than the Company. In the event the Company or its
licensees market any products, they will compete with companies with well-
established distribution networks and market position.

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

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

  Citicoline: Activase, marketed by Genentech, Inc. for the treatment of
  ----------
acute ischemic stroke within three hours of symptom onset, is the first therapy
to be indicated for the management of stroke.  Activase is a genetically
engineered version of the naturally occurring tissue plasminogen activator
(t-PA). The Company is aware of certain drugs under development for stroke that
did not achieve positive results in announced clinical trials and other drugs
under development for stroke that are currently in clinical trials, including
clomethiazole by Astra Pharmaceuticals, a glycine antagonist compound by Glaxo
Wellcome plc, antifibrinogen by BASF Pharma/Knoll AG, ReoPro by Lilly Research
Laboratories/Centocor, Inc., a potassium channel-opening compound by Bristol-
Myers Squibb Company, urokinase by Abbott Laboratories and LeukArrest by ICOS
Corp. Based on existing clinical data on citicoline, the Company believes
citicoline may be an attractive post-stroke therapy, particularly in patients
with moderate to severe strokes, due to its potential 24-hour post-stroke
therapeutic window.

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

  Trospium: Current therapy for overactive bladder includes anticholinergics,
  --------
such as Detrol and Ditropan and Ditropan XL.  In addition, the Company is aware
of other companies evaluating in preclinical and clinical

                                      -14-
<PAGE>

development specific antimuscaranics and antispasmodics for overactive bladder.
Pre-clinical data with trospium suggests that it does not enter the central
nervous system and thus may have a side effect profile preferable to currently
available agents. In addition, clinical data and commercial experience reflect
favorable efficacy and safety profiles.

 AGREEMENTS

  Citicoline: In December 1999, the Company entered into the Takeda Agreement
  ----------
under which it licensed to Takeda exclusive rights to commercialize
citicoline in the U.S. and Canada. Under the Takeda
Agreement, Interneuron is entitled to receive $13,000,000 in licensing and other
guaranteed payments, of which approximately $11,500,000 has been received to
date, and up to $60,000,000 in payments contingent upon the achievement of
future regulatory milestones in the U.S. and Canada. Takeda also agreed to pay
Interneuron royalties on net sales. In addition, Takeda agreed to fulfill the
royalty payment obligations of Interneuron to Ferrer pursuant to the Ferrer
Agreement. Takeda would be responsible for funding future Phase 4 studies of
citicoline in stroke and, in the future, Phase 3 studies for additional
indications.

  In the event Takeda decides to terminate the Takeda Agreement following a
review of the results of the ongoing Phase 3 clinical trial, the Takeda
Agreement also grants an exclusive option to Takeda to negotiate a license in
the U.S. and Canada for any one alternative Interneuron compound, excluding
pagoclone. In the event Takeda terminates the Takeda Agreement, Takeda shall
have a period of ten months (the "Negotiation Period") to evaluate and select a
back-up compound and to negotiate the terms of a license agreement with respect
to such compound with the Company. In the event that the parties are unable to
enter into a license agreement upon completion of the Negotiation Period, for a
period of six months following the end of the Negotiation Period the Company may
not offer the compound selected by Takeda to any other party on terms more
favorable than those offered to Takeda without first re-offering such compound
to Takeda on such new terms. Under the Takeda Agreement, Takeda has the right to
terminate the Takeda Agreement at any time on a county-by-country basis prior to
the first NDA approval by the FDA and on not less than ninety days' written
notice to Interneuron after the first NDA has been approved by the FDA. The
parties have also agreed to indemnify one another under certain circumstances.

  The Company granted to Takeda a security interest in its patents relating to
citicoline, and in the event Takeda licenses a back-up compound, the Company
agreed to grant Takeda a security interest in the patents relating to such
back-up compound. Takeda also has the right to require the Company to assign to
Takeda intellectual property related to citicoline following the payment of the
milestone payment relating to the FDA acceptance of the NDA for citicoline. The
security interest and, if applicable, the assignment would be released if the
Company achieves certain financial criteria. Interneuron and Takeda will jointly
oversee the development and regulatory filings of citicoline in the U.S. and
Canada. If citicoline receives marketing approval, Takeda has advised the
Company that it intends to directly commercialize citicoline through Takeda
Pharmaceuticals America, Inc., established in 1998 as the wholly-owned U.S.
marketing subsidiary of Takeda. See "Risk Factors - A negative outcome of the
citicoline trial would materially harm us."

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

                                      -15-
<PAGE>

requires Interneuron to use diligent efforts to obtain regulatory approval. The
Ferrer Agreement requires the purchase from Ferrer of citicoline bulk compound
for commercial purposes at fixed prices, subject to certain conditions. If such
conditions permit the purchase of bulk compound from a third party, the Company
entered into an agreement with a manufacturer to supply citicoline bulk compound
for commercial purposes and has assigned this agreement to Takeda.

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

  Pagoclone: In December 1999, the Company entered into the Warner-Lambert
  ---------
Agreement under which it licensed to Warner-Lambert exclusive worldwide rights
to commercialize pagoclone. Under the Warner-Lambert Agreement, the Company is
entitled to receive $13,750,000 in an up-front payment and up to $60,000,000 in
payments contingent upon the achievement of clinical and regulatory milestones.
Warner-Lambert also agreed to pay Interneuron royalties on net sales. Under the
Warner-Lambert Agreement, Warner-Lambert would be responsible for conducting and
funding all further clinical development, regulatory review, manufacturing and
marketing of pagoclone for all indications on a worldwide basis. Under the
Company's agreement with RPR, RPR is entitled to receive a portion of the
payments to be received by the Company from Warner-Lambert. Subject to RPR's
option to sublicense rights to market pagoclone in France, under certain
conditions, Warner-Lambert has the right to sublicense its rights under the
Warner-Lambert Agreement. Warner-Lambert has the right to terminate the Warner-
Lambert Agreement on not less than six months written notice to Interneuron and
in certain other circumstances. The parties have also agreed to indemnify one
another under certain circumstances.

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

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

    IP 501: During 1997, the Company obtained an exclusive option to negotiate a
    ------
license to a compound (designated by the Company as IP 501) for the treatment
and prevention of liver diseases, including alcohol-induced cirrhosis and
Hepatitis C. The option grants Interneuron the right to obtain an exclusive
license on certain specified terms, subject to the rights of the U.S.
government, in North America, Japan and Korea, to an issued U.S. patent and U.S.
and international patent applications, following Interneuron's review of data
from an ongoing government-sponsored Phase 3 clinical trial. Interneuron's
rights to this compound are subject to the negotiation and execution of a
definitive license agreement on terms to be agreed upon by the parties.

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

                                      -16-
<PAGE>

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

  Lilly License:  In June 1997, the Company entered into an agreement with Eli
  -------------
Lilly and Company and Eli Lilly S.A. ("Lilly") relating to the sublicense by the
Company to Lilly of a U.S. patent and worldwide patent application rights
covering the use of Prozac to treat disturbances of appetite and mood associated
with premenstrual syndrome ("PMS"). The Lilly drug Prozac (fluoxetine
hydrochloride), has not previously been approved to treat this indication. The
Company received an up-front license fee of $1,000,000, and is entitled to
additional payments based upon the achievement of development and regulatory
milestones and royalties based upon net sales.  In January 1999, the Company
received a milestone payment of $500,000 from Lilly marking the completion of a
clinical trial with Prozac for the treatment of PMS, and in October 1999 the
Company received a milestone payment of $500,000 from Lilly based on the
regulatory approval in the U.K. of Prozac to treat premenstrual dysphoric
disorder, a severe form of PMS.  The patent rights to the use of fluoxetine in
treating  PMS  are licensed by the Company from MIT.

 Redux Agreements (See Item 3. Legal Proceedings.)
 ----------------

  Servier Agreements: The Servier Agreements, entered into in February 1990 and
  ------------------
as subsequently amended, grant the Company an exclusive right to market
dexfenfluramine in the U.S. to treat obesity associated with abnormal
carbohydrate craving. The agreements provide for royalties of 11.5% of net
sales, with certain required minimum royalties. The license includes rights to
Servier's Redux trademark.

  Servier has the right to terminate the license agreement upon the occurrence
of certain events, including a sale or transfer of a substantial part of the
Company's assets or a majority of its stock (other than in connection with a
public offering), an acquisition by any party (other than existing stockholders
or their affiliates as of the date of the Servier Agreements) of a 20%
beneficial interest in the Company, or if the Company manifests an intent to
market a substantially similar pharmaceutical product.

  An affiliate of Servier supplied the Company with all of the Company's bulk
chemical requirements for dexfenfluramine for incorporation into the finished
dosage formulation. Interneuron agreed to indemnify Servier under certain
circumstances and Interneuron was required to name Servier as an additional
insured on its product liability insurance policies. See "Risk Factors - The
outcome of the Redux litigation could materially harm us" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

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

  Under the AHP Agreements, AHP purchased preferred stock of the Company for an
aggregate purchase price of $3,500,000. As of September 30, 1999, AHP owned
shares of Interneuron preferred stock convertible into an aggregate of 622,222
shares of Common Stock, subject to certain antidilution adjustments.

                                      -17-
<PAGE>

  The AHP Agreements provide for base royalties to the Company of 11.5% of AHP's
net sales of Redux (equal to the royalty required to be paid by the Company to
Servier) and for "additional" royalties, the applicable rates of which during
fiscal 1997 ranged from 5% of the first $50,000,000 of net sales to 10% of net
sales over $150,000,000.

  The Company also agreed to sell to AHP and AHP agreed to purchase from the
Company for five years from commercial introduction of dexfenfluramine all of
AHP's requirements for dexfenfluramine in bulk chemical form at a purchase price
equal to the price required to be paid by the Company to Servier.

  The AHP Agreements  provide that AHP could continue to market Pondimin but
agreed that so long as Redux remains commercially viable, AHP will differentiate
Redux for promotional and marketing purposes and will not promote or market
Pondimin or any other product for the anti-obesity indication which competes
directly with Redux in a manner which negatively affects the future market for
Redux.

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

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

  During fiscal 1997, the Company entered into agreements with AHP and Servier
for the development and commercialization in the U.S. of a sustained release,
once-a-day form of Redux. Interneuron and AHP each paid Servier $2,000,000 in
connection with the signing of the agreement. Following the withdrawal of Redux,
this program was discontinued.

  Boehringer Ingelheim Agreement: In November 1995, the Company entered into a
  ------------------------------
manufacturing agreement with Boehringer Ingelheim Pharmaceuticals, Inc.
("Boehringer") under which Boehringer supplied, and the Company purchased, all
of its requirements for Redux capsules. The contract contained certain minimum
purchase and insurance commitments by the Company and required conformance by
Boehringer to the FDA's cGMP regulations. Interneuron agreed to indemnify
Boehringer under certain circumstances.

PATENTS AND PROPRIETARY RIGHTS

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

                                      -18-
<PAGE>

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

  In addition to any proprietary rights provided by these patents, the Company
intends to rely on the provisions of the Waxman-Hatch Act to obtain a period of
marketing exclusivity in the U.S., if the FDA approves citicoline for marketing
in the U.S., although there is no assurance market exclusivity will be granted.
The Waxman-Hatch Act establishes a period of time from the date of FDA approval
of certain new drug applications during which the FDA may not accept or approve
short-form applications for generic versions of the drug from other sponsors,
although it may accept or approve long-form applications (that is, other NDAs
supported by pivotal studies) for such drug. The applicable period is five years
in the case of drugs containing an active ingredient not previously approved.
See "Risk Factors - We may depend on market exclusivity for citicoline and other
products."

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

  Trospium: The compound trospium is not covered by a composition of matter
  --------
patent.  Along with know how, Interneuron licensed from Madaus two U.S. patents,
one of which relates to a process for manufacturing trospium and the other
relates to the use of trospium to treat certain asthmatic conditions. These
patents were issued in August 1989 and October 1988, respectively. The
commercialization of trospium by the Company will not utilize these patents, and
the Company intends to attempt to rely on the provisions of the Waxman-Hatch Act
to obtain a period of market exclusivity in the U.S., if the FDA approves
trospium in the U.S. for the intended indication.

  IP501: Interneuron has an exclusive option to negotiate a license to a U.S.
  -----
patent issued on February 8, 1994, relating to a phospholipid found in lecithin
(IP 501). Three claims of this patent relate to methods of preventing or
treating liver cirrhosis in mammals by administering an effective amount of the
compound.  Japanese counterparts are pending.

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

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

                                      -19-
<PAGE>

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

GOVERNMENT REGULATION

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

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

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

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

                                      -20-
<PAGE>

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

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

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

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

REDUX WITHDRAWAL (See Item 3. Legal Proceedings)

  Product Liability Litigation: Following the market withdrawal of Redux in
  ----------------------------
September 1997, Interneuron has been named, together with other pharmaceutical
companies, as a defendant in approximately 1,965 product liability legal
actions, many of which purport to be class actions, in federal and state courts
involving the use of Redux and other weight loss drugs. On December 10, 1997,
the federal Judicial Panel on Multidistrict Litigation issued an Order allowing
for the transfer or potential transfer of the federal actions to the District
Court for coordinated or consolidated pretrial proceedings.

  Rejected Settlement:  On September 25, 1998, the District Court
  -------------------
preliminarily approved an Agreement of Compromise and Settlement (the
"Settlement Agreement"), which was later rejected by the District Court as
described below, relating to a proposed settlement of all product liability
litigation and claims against Interneuron related to Redux.  The District Court
also conditionally certified a limited fund class action and, thereafter, issued
stays halting all Redux product liability litigation against the Company,
pending and future, in federal and state courts. The District Court conducted a
fairness hearing in the second quarter of fiscal 1999 regarding the proposed
Settlement Agreement.

  Following a decision from the U.S. Supreme Court (the "Supreme Court")
overturning a putative "limited fund" class action settlement relating to
asbestos litigation against Fibreboard Corporation, the District Court, on
September 27, 1999, rejected the Settlement Agreement, finding that it did not
meet the requirements for limited fund

                                      -21-
<PAGE>

class actions described by the Supreme Court. The District Court also vacated
the stays of pending and future litigation previously in effect. The Company
filed a petition with the U.S. Court of Appeals for the Third Circuit on
October 12, 1999, seeking review of the District Court's ruling. That petition
is still pending.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux and
Pondimin.  The Company is presently in discussions with AHP and the Plaintiffs'
Management Committee regarding avenues for the Company to reach a comprehensive
resolution of its outstanding Redux-related litigation. The Company cannot
predict whether any settlement will be reached or the terms of any settlement.

  Interpleader Litigation:  On November 20, 1998, December 30, 1998 and
  -----------------------
February 5, 1999, the Company's three product liability insurers filed actions
against Servier and the Company in the District Court, pursuant to the federal
interpleader statute. The aggregate limits of the three commercial excess
insurance policies issued by the insurers to the Company are $40,000,000 in
tiers of $20,000,000, $5,000,000 in excess of $20,000,000, and $15,000,000 in
excess of $25,000,000. The insurers allege that both the Company and Servier
have asserted claims against these policies, a substantial portion of which has
been used in the Company's defense of the litigation. The insurers have
deposited the available proceeds up to the limits of their policies, which is
subject to ongoing claims by the Company and Servier, into the registry of the
District Court.

  Securities Litigation:  The Company and certain present or former directors
  ---------------------
and/or officers of the Company have also been named as defendants in nine
lawsuits filed by alleged purchasers of the Company's Common Stock, purporting
to be class actions, claiming violation of the federal securities laws. On
December 9, 1999, the U.S. District Court for the District of Massachusetts
(the "Massachusetts Federal Court") issued preliminary approval of a proposed
settlement to these lawsuits. If final approval is issued, the proposed terms of
the settlement will be entirely funded by insurance proceeds. See "Item 3-Legal
Proceedings-Securities Litigation."

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

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

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

  Included in the FDA-approved labeling for Redux were references to certain
risks that may be associated with dexfenfluramine and which were highlighted
during the FDA's review of the drug. One issue related to whether there

                                      -22-
<PAGE>

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

  The FDA-approved labeling for Redux also included discussion as to whether
dexfenfluramine is associated with certain neurochemical changes in the brain.
Certain studies conducted by third parties related to this issue purport to show
that very high doses of dexfenfluramine cause prolonged serotonin depletion in
certain animals, which some researchers believe is an indication of
neurotoxicity.  In connection with the approval of Redux, the Company and Wyeth-
Ayerst had agreed with the FDA to conduct a Phase 4, or post-marketing, study
with patients taking Redux. Following the withdrawal of Redux, this study was
terminated.

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

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

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

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

                                      -23-
<PAGE>

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

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

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

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

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

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

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

                                      -24-
<PAGE>

EMPLOYEES

  As of September 30, 1999, Interneuron had 38 full-time employees. None of the
Company's employees is represented by a labor union and Interneuron believes its
employee relations are satisfactory. The Company is highly dependent upon
certain key personnel and believes its future success will depend in large part
on its ability to retain such individuals and attract other highly skilled
management, marketing and scientific personnel. See "Risk Factors - The outcome
of the Redux litigation could materially harm us."

Item 2. Properties

  The Company leases an aggregate of approximately 43,300 square feet of office
space in Lexington, MA. The lease expires in April 2002 and provides for annual
rent of approximately $696,000. The Company has guaranteed certain of Incara's
lease obligations. See Note F of Notes to Consolidated Financial Statements.

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

  Product Liability Litigation: Subsequent to the market withdrawal of Redux
  ----------------------------
in September 1997, the Company has been named, together with other
pharmaceutical companies, as a defendant in approximately 1,965 legal actions,
many of which purport to be class actions, in federal and state courts relating
to the use of Redux. The actions generally have been brought by individuals in
their own right or on behalf of putative classes of persons who claim to have
suffered injury or who claim that they may suffer injury in the future due to
use of one or more weight loss drugs including Pondimin (fenfluramine),
phentermine and Redux. Plaintiffs' allegations of liability are based on various
theories of recovery, including, but not limited to, product liability, strict
liability, negligence, various breaches of warranty, conspiracy, fraud,
misrepresentation and deceit. These lawsuits typically allege that the short or
long-term use of Pondimin and/or Redux, independently or in combination
(including the combination of Pondimin and phentermine popularly known as "fen-
phen"), causes, among other things, PPH, valvular heart disease and/or
neurological dysfunction. In addition, some lawsuits allege emotional distress
caused by the purported increased risk of injury in the future. Plaintiffs
typically seek relief in the form of monetary damages (including economic
losses, medical care and monitoring expenses, loss of earnings and earnings
capacity, other compensatory damages and punitive damages), generally in
unspecified amounts, on behalf of the individual or the class. In addition, some
actions seeking class certification ask for certain types of purportedly
equitable relief, including, but not limited to, declaratory judgments and the
establishment of a research program or medical surveillance fund. On December
10, 1997, the federal Judicial Panel on Multidistrict Litigation issued an Order
allowing for the transfer or potential transfer of the federal actions to the
Eastern District of Pennsylvania for coordinated or consolidated pretrial
proceedings.

  On September 25, 1998, the District Court preliminarily approved the
Settlement Agreement relating to a proposed settlement of all product liability
litigation and claims against Interneuron related to Redux, which was later
rejected by the District Court as described below.  The District Court also
conditionally certified a limited fund class action and, thereafter, issued
stays halting all Redux product liability litigation against the Company,
pending and future, in federal and state courts.  The District Court conducted a
fairness hearing in the second quarter of fiscal 1999 regarding the proposed
Settlement Agreement.

  The Settlement Agreement required Interneuron to deposit a total of
approximately $15,000,000 in three installments into a settlement fund.  In
addition, the Settlement Agreement provided for Interneuron to cause all
remaining and available product liability insurance proceeds related to Redux to
be deposited into the settlement fund. Interneuron also agreed to make royalty
payments to the settlement fund, in the total amount of $55,000,000, based upon
revenues related to Interneuron products, over a seven year period commencing
after the settlement would have become final.  If, at the end of that seven-year
period, the amount of royalty payments made by Interneuron were less than
$55,000,000, the settlement fund would be entitled to receive the number of
shares of Interneuron Common Stock equal to the unpaid balance divided by $7.49
per share, subject to adjustment in certain circumstances.

                                      -25-
<PAGE>

  Following a decision from the Supreme Court overturning a putative "limited
fund" class action settlement relating to asbestos litigation against Fibreboard
Corporation, the District Court, on September 27, 1999, rejected the Settlement
Agreement, finding that it did not meet the requirements for limited fund class
actions described by the Supreme Court .  The District Court also vacated the
stays of pending and future litigation that were previously in effect.  The
Company filed a petition with the U.S. Court of Appeals for the Third Circuit on
October 12, 1999, seeking review of the District Court's ruling.  That petition
is still pending.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux and
Pondimin.  The Company is presently in discussions with AHP and the Plaintiffs'
Management Committee regarding avenues for the Company to reach a comprehensive
resolution of its outstanding Redux-related litigation.  The Company cannot
predict whether any settlement will be reached or the terms of any settlement.

  Interpleader Litigation:  On November 20, 1998, December 30, 1998 and
  -----------------------
February 5, 1999, the Company's three product liability insurers filed actions
against Servier and the Company in the District Court, pursuant to the federal
interpleader statute. The aggregate limits of the three commercial excess
insurance policies issued by the insurers to the Company is $40,000,000 in tiers
of $20,000,000, $5,000,000 in excess of $20,000,000, and $15,000,000 in excess
of $25,000,000. The insurers allege that both the Company and Servier have
asserted claims against these policies, a substantial portion of which has been
used in the Company's defense of the litigation. The insurers have deposited the
available proceeds up to the limits of their policies, which is subject to
ongoing claims by the Company and Servier, into the registry of the District
Court.

  Securities Litigation: The Company and certain present or former directors
  ---------------------
and/or officers of the Company were named as defendants in nine lawsuits filed
in the Massachusetts Federal Court by alleged purchasers of the Company's Common
Stock, purporting to be class actions.  The lawsuits claim, among other things,
that the Company violated the federal securities laws by publicly disseminating
materially false and misleading statements concerning the prospects and safety
of Redux, resulting in the artificial inflation of the Company's Common Stock
price during various alleged class periods, the earliest commencing December 16,
1996 through September 17, 1997.

  On January 23, 1998, the Massachusetts Federal Court entered an order
consolidating all of these actions for pretrial purposes.  The plaintiffs
subsequently filed a First Amended And Consolidated Class Action Complaint
[Corrected Version] (the "Complaint") containing substantially similar
substantive allegations against the Company, one officer and director and one
director of the Company and alleging a class period of December 19, 1996 through
September 15, 1997.  The Complaint does not specify the amount of alleged
damages plaintiffs seek to recover.  On May 11, 1998, the defendants moved to
dismiss the Complaint.  On August 14, 1998, the Company received notice that the
defendants' motion to dismiss was denied.

  On September 23, 1998, the Massachusetts Federal Court issued a procedural
order establishing a schedule for class certification briefing, fact and expert
discovery, dispositive motions briefing and trial.  On June 3, 1999, the
Massachusetts Federal Court issued Practice and Procedure Order No. 9 which,
following extensive briefing and oral argument, dismissed plaintiffs' motion for
class certification.

  On July 30, 1999, the Court issued Practice and Procedure Order No. 11, which
stayed all deadlines set by the Massachusetts Federal Court's September 23, 1998
Order pending approval of a proposed settlement.  The parties are negotiating
stipulated settlement papers, settling the lawsuits on a class-wide basis, which
are expected to cover a class period of March 24, 1997 to July 8, 1997.  While
there can be no assurance that the settlement will be approved by the
Massachusetts Federal Court, the proposed settlement received preliminary
approval on December 9, 1999.  If final approval is received, the proposed terms
of the settlement will be entirely funded by insurance proceeds.  The Company
continues to deny all liability.

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

                                      -26-
<PAGE>

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

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

  Not applicable

EXECUTIVE OFFICERS

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

<TABLE>
<CAPTION>
Name                           Age   Position
------                         ---   --------
<S>                            <C>   <C>
Glenn L. Cooper, M.D.          46    President, Chief Executive Officer and
                                     Director

Mark S. Butler                 53    Executive Vice President, Chief
                                     Administrative Officer and General Counsel

Michael W. Rogers              39    Executive Vice President, Chief Financial
                                     Officer and Treasurer

Bobby W. Sandage, Jr., Ph.D.   46    Executive Vice President, Research and
                                     Development and Chief Scientific Officer
</TABLE>

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


                                      -27-
<PAGE>

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

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

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

                               _________________


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

  To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company, there were no reports required under Section
16(a) of the Securities Exchange Act of 1934 which were not timely filed during
fiscal 1999.

                                      -28-
<PAGE>

PART II

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

  Price Range of Securities
  -------------------------

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

<TABLE>
<CAPTION>
                                                   High       Low
                                                   ----       ---
<S>                                              <C>        <C>
Fiscal Year Ended September 30, 1999:

          July 1 through September 30, 1999      $   4 1/2  $ 1 7/32

          April 1 through June 30, 1999              3 1/4   2 13/32

          January 1 through March 31, 1999               6   2 13/16

          October 1 through December 31, 1998        3 7/8     2 1/2


Fiscal Year Ended September 30, 1998:

          July 1 through September 30, 1998      $  5 1/16  $  2 1/2

          April 1 through June 30, 1998             15 1/2     3 1/8

          January 1 through March 31, 1998        10 15/16   7 11/16

          October 1 through December 31, 1997       13 3/4     9 1/8
</TABLE>

  Approximate Number of Equity Security Holders
  ---------------------------------------------

  The number of holders of  record of the Company's Common Stock as of December
16, 1999 was approximately 656.

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

                                      -29-
<PAGE>

Item 6. Selected Financial Data

  The selected financial data presented below summarizes certain financial data
which has been derived from and should be read in conjunction with the more
detailed consolidated financial statements of the Company and the notes thereto
which have been audited by PricewaterhouseCoopers LLP, independent accountants,
whose report thereon is included elsewhere in this Annual Report on Form 10-K
along with said financial statements. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
                                                                            Fiscal Years Ended September 30,
                                                             --------------------------------------------------------------
                                                               1995        1996          1997         1998          1999
                                                             --------    ---------     ---------    ---------     ---------
<S>                                                         <C>          <C>           <C>          <C>           <C>
STATEMENT OF OPERATIONS DATA:
(Amounts in thousands except per share data)

     Product revenue                                         $     --    $  13,779     $  55,945    $      --     $      --
     Contract and license fee revenue                           3,463        8,335        11,039        6,488         1,599
                                                             --------    ---------     ---------    ---------     ---------
     Total revenues                                             3,463       22,114        66,984        6,488         1,599

     Cost of product revenue                                       --       11,454        41,144           --            --
     Research and development                                  15,070       17,344        50,180       39,762        35,710
     Selling, general and administrative                        7,142       13,991        19,581       21,975        11,030
     Product withdrawal                                            --           --         7,528           --            --
     Purchase of in-process research and development               --        6,434         3,044          500         2,421
     Loss from operations                                     (18,749)     (27,109)      (54,493)     (55,749)      (47,562)

     Investment income, net                                       894        4,135         8,944        5,465         2,189
     Equity in unconsolidated subsidiary                           --           --        (9,028)      (4,040)          250
     Loss from continuing operations                          (17,292)     (22,400)      (49,670)     (50,485)      (38,578)

     Discontinued operations                                     (689)      (5,586)       (5,586)     (19,477)          816
     Net loss                                                 (17,981)     (27,986)      (55,256)     (69,962)      (37,762)

     Net loss per common share from continuing operations    $  (0.57)   $   (0.61)    $   (1.21)   $   (1.22)    $   (0.92)
     (Loss)/income per common share from discontinued
        operations                                           $  (0.02)   $   (0.15)    $   (0.14)   $   (0.47)    $    0.02
     Net loss per common share - basic and diluted           $  (0.59)   $   (0.76)    $   (1.35)   $   (1.69)    $   (0.90)
     Weighted average common shares outstanding                30,604       37,004        41,064       41,468        41,898

<CAPTION>
                                                                                     September 30,
                                                             --------------------------------------------------------------
                                                               1995        1996          1997         1998          1999
                                                             --------    ---------     ---------    ---------     ---------
<S>                                                         <C>          <C>           <C>          <C>           <C>
BALANCE SHEET DATA:
(Amounts in thousands)

     Working capital                                         $ 25,755    $ 155,246     $  82,229    $  41,417     $   4,083
     Total assets                                              37,516      186,438       152,930       78,197        26,638
     Long-term portion of notes payable
        and capital lease obligations                             782          542         1,734        1,663             2
     Total liabilities                                         10,486       22,303        43,962       30,842        20,327
     Accumulated deficit                                      (78,792)    (106,778)     (162,034)    (231,996)     (269,758)
     Total stockholders' equity                                21,392      144,762        96,009       39,856         6,122
</TABLE>

                                      -30-
<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and Results
        of Operations:

General
-------

  Redux

    Product Liability Litigation and Rejected Settlement:

  Following the market withdrawal of Redux in September 1997, Interneuron has
been named, together with other pharmaceutical companies, as a defendant in
approximately 1,965 product liability legal actions, many of which purport to be
class actions, in federal and state courts involving the use of Redux and other
weight loss drugs. On December 10, 1997, the federal Judicial Panel on
Multidistrict Litigation issued an Order allowing for the transfer or potential
transfer of the federal actions to the Eastern District of Pennsylvania for
coordinated or consolidated pretrial proceedings.

  Following a decision from the U.S. Supreme Court overturning a putative
"limited fund" class action settlement relating to asbestos litigation against
Fibreboard Corporation, the District Court, on September 27, 1999, rejected the
Settlement Agreement, finding that it did not meet the requirements for limited
fund class actions described by the Supreme Court.  The District Court also
vacated the stays of  pending and future litigation that were previously in
effect.  The Company filed a petition with the U.S. Court of Appeals for the
Third Circuit on October 12, 1999, seeking review of the District Court's
ruling.  That petition is still pending.

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux and
Pondimin. The Company is presently in discussions with AHP and the Plaintiffs'
Management Committee regarding avenues for the Company to reach a comprehensive
resolution of its outstanding Redux-related litigation. The Company cannot
predict whether any settlement will be reached or the terms of any settlement.
Any settlement will likely result in substantial charges to operations, have a
material adverse effect on the Company's net stockholders' equity and require
substantial cash payments and/or equity issuances.

    Interpleader Litigation:

  On November 20, 1998, December 30, 1998 and February 5, 1999, the Company's
three product liability insurers filed actions against Servier and the Company
in the District Court, pursuant to the federal interpleader statute. The
aggregate limits of the three commercial excess insurance policies issued by the
insurers to the Company is $40,000,000 in tiers of $20,000,000, $5,000,000 in
excess of $20,000,000, and $15,000,000 in excess of $25,000,000. The insurers
allege that both the Company and Servier have asserted claims against these
policies, a substantial portion of which has been used in the Company's defense
of the litigation. The insurers have deposited the available proceeds up to the
limits of their policies, which is subject to ongoing claims by the Company and
Servier, into the registry of the District Court.

    Risk Management:

  Although the Company maintains certain product liability and director and
officer liability insurance and intends to defend these and similar actions
vigorously, the Company has been required and may continue to be required to
devote significant management time and resources to these legal actions. In the
absence of a settlement and in the event of successful uninsured or
insufficiently insured claims, or in the event a successful indemnification
claim were made against the Company, the Company's business, financial condition
and results of operations could be materially adversely affected. Even if a
settlement is reached, the terms of such settlement may include cash and/or the
issuance of the Company's securities, which may materially adversely affect the
Company's financial condition and results of operations and result in dilution
to the Company's stockholders. The uncertainties and costs associated with these
legal actions have had, and may continue to have, an adverse effect on the
market price of the Company's Common Stock and on the Company's ability to
obtain corporate collaborations or additional financing to satisfy cash
requirements, to retain and attract qualified personnel,

                                      -31-
<PAGE>

to develop and commercialize products on a timely and adequate basis, to acquire
rights to additional products, or to obtain product liability insurance for
other products at costs acceptable to the Company, or at all, any or all of
which may materially adversely affect the Company's business, financial
condition and results of operations. See Item 3. "Legal Proceedings," "Risk
Factors - The outcome of the Redux litigation could materially harm us" and
Note G of Notes to Consolidated Financial Statements.

  Citicoline

  Citicoline is under development as a potential treatment for ischemic stroke.
The Company is substantially dependent on FDA approval of and, if FDA approval
is obtained, successful marketing of the drug. In December 1999, the Company
entered into the Takeda Agreement under which the Company licensed to Takeda
exclusive rights to commercialize citicoline in the U.S. and Canada. In exchange
Takeda agreed to pay Interneuron $13,000,000 in licensing and other guaranteed
payments, of which approximately $11,500,000 has been received to date, and up
to $60,000,000 in payments contingent upon the achievement of future regulatory
milestones in the U.S. and Canada and royalties on net sales. In addition,
Takeda agreed to fulfill the royalty payment obligations of Interneuron to
Ferrer, pursuant to Interneuron's agreement with Ferrer. Takeda would be
responsible for funding any future Phase 4 studies of citicoline in stroke and,
in the future, any Phase 3 studies for any additional indications. The Takeda
Agreement also grants to Takeda an exclusive option to negotiate a license for
any one alternative Interneuron compound, other than pagoclone, in the event
Takeda terminates the Takeda Agreement following a review of the results of the
ongoing Phase 3 clinical trial. The Company licensed in fiscal 1993 from Ferrer
certain patent and know-how rights in the United States and Canada relating to
the use of citicoline in exchange for a royalty initially equal to 6% of net
sales of citicoline.

  In June 1998, the Company initiated an 899-person Phase 3 clinical trial which
is comparing the change in neurological function at 12 weeks following ischemic
stroke of citicoline-treated patients with that of patients who received
placebo.  Patients were treated with 2000 milligrams of citicoline or placebo
daily for six weeks with a six week follow-up period. The Company anticipates
that preliminary results from this clinical trial will be available in January
2000.  The 2000 milligram dose level is higher than the dose used in the
Company's two most recent citicoline clinical trials but was used in the
Company's first Phase 3 trial in which patients treated with this dose achieved
the primary endpoint of improved neurological function.  Depending upon the
evaluation of the results from this trial, the Company will determine whether to
re-submit the NDA for citicoline to the FDA.  Even if the NDA is re-submitted,
as to which there is no assurance, the Company is unable to predict whether or
when the FDA would grant authorization to market citicoline in the U.S.

  The Company withdrew its NDA for citicoline in April 1998. The Company had
submitted the NDA to the FDA for citicoline in December 1997.  The citicoline
NDA had been accepted for filing and assigned priority and fast-track review
status. A priority review status reflects the FDA's commitment to review the NDA
within six months following submission.  A fast-track designation indicates that
the FDA has determined a drug is intended to treat a serious or life-threatening
condition and that the FDA can take actions to expedite the development and
review of the drug. While there can be no assurance that any resubmission of a
citicoline NDA would be assigned a priority review status, the indication of
stroke presently warrants such NDA review status.

  As of September 30, 1999, the remaining expenditures of all currently planned
clinical trials and related studies and NDA preparation for citicoline, for
which the Company is responsible, were estimated, based upon current trial
protocols, to aggregate approximately $10,000,000. The costs of any related or
additional clinical studies, which will depend upon the results of the on-going
trial, FDA requirements, and Takeda's election to continue the Takeda Agreement
will be the obligation of Takeda. If Takeda terminates the Takeda Agreement and
the Company elects to continue citicoline development, as to which there is no
assurance, the Company would be responsible for any such development costs.

                                      -32-
<PAGE>

  Pursuant to the Takeda Agreement, Takeda is responsible for commercial
manufacturing of citicoline. Takeda has advised the Company that it intends to
commercialize citicoline through Takeda Pharmaceuticals America, Inc.,
established in 1998 as the wholly owned U.S. marketing subsidiary of Takeda. The
Company will be dependent upon Takeda or third party suppliers of citicoline
bulk compound, finished product and packaging for manufacturing in accordance
with cGMP regulations, and will be dependent on Takeda for the marketing and
distribution of citicoline. Supplies of citicoline finished product used for
clinical purposes have been and are being produced on a contract basis by third
party manufacturers. The Ferrer Agreement requires the purchase from Ferrer of
citicoline bulk compound for commercial purposes at fixed prices, subject to
certain conditions. If such conditions permit the purchase of bulk compound from
a third party, the Company entered into an agreement with a manufacturer to
supply citicoline bulk compound for commercial purposes and has assigned this
agreement to Takeda. Any citicoline manufacturing facilities are subject to FDA
inspection. There can be no assurance Takeda or its suppliers can or will
establish on a timely basis, or maintain, manufacturing capabilities of bulk
compound and finished product required to obtain regulatory approval or that any
facilities used to produce citicoline will have complied, or will be able to
maintain compliance, with cGMP or that Takeda or its suppliers will be able to
meet manufacturing requirements on a timely basis or at all. See "Risk Factors -
A negative outcome of the citicoline trial would materially harm us" and "We
will depend on Takeda and other third parties to manufacture and market
citicoline."

  Pagoclone

  The Company is developing pagoclone as a drug to treat panic and generalized
anxiety disorders. The Company licensed from RPR exclusive worldwide rights
(subject to RPR's option to obtain a sublicense in France under certain
conditions) to pagoclone, in exchange for license fees, milestone payments and
royalties based on net sales.

  In August 1998, the Company announced results of its Phase 2/3 trial involving
277 patients showing that treatment with pagoclone statistically significantly
reduced the frequency of panic attacks among patients suffering from panic
disorder. In addition, pagoclone was well-tolerated by these patients, with no
evidence of sedation and no apparent withdrawal symptoms in this study. Based on
the results of this trial, Interneuron believes it has identified an optimal
dose of pagoclone for Phase 3 clinical testing.

  Under the Warner-Lambert Agreement, the Company is entitled to receive
$13,750,000 in an up-front payment and up to $60,000,000 in payments contingent
upon the achievement of clinical and regulatory milestones. Warner-Lambert also
agreed to pay Interneuron royalties on net sales. Under the Warner-Lambert
Agreement, Warner-Lambert would be responsible for conducting and funding all
further clinical development, regulatory review, manufacturing and marketing of
pagoclone for all indications on a worldwide basis. Under the Company's
agreement with RPR, RPR is entitled to receive a portion of the payments to be
received by the Company from Warner-Lambert. See "Risk Factors-We will depend on
Warner-Lambert to develop, manufacture and market pagoclone."

  Trospium

  In November 1999, the Company licensed exclusive U.S. rights from Madaus to
market trospium, an orally

                                      -33-
<PAGE>

administered prescription drug product currently marketed for urge incontinence
(overactive bladder) in several European countries. In exchange, the Company
agreed to pay Madaus regulatory milestone, royalty and sales milestone payments.

The Company intends to file an IND and initiate a Phase 3 clinical study with
this drug, in late 2000. Costs relating to the currently anticipated development
program, including the costs related to an NDA submission, are estimated by the
Company to be approximately $15,000,000.

  IP 501

  During 1997, the Company obtained an exclusive option to negotiate a license
to a compound, designated by the Company as IP 501, for the treatment and
prevention of liver diseases, including alcohol-induced cirrhosis and Hepatitis
C. The option grants the Company the right to obtain an exclusive license on
certain specified terms, subject to the rights of the U.S. government in North
America, Japan and Korea, to an issued U.S. Patent and U.S. and international
patent applications, following Interneuron's review of future clinical data.
Interneuron's rights to this compound are subject to the negotiation and
execution of a definitive license agreement on terms to be agreed upon by the
parties.

  This orally administered compound is currently being studied in a Phase 3
clinical study sponsored by the Veterans Administration.  The 800-patient trial
is fully enrolled.  Completion of the study is currently expected in mid-2000.
The study is designed to have periodic interim analyses, which could lead to
earlier termination or an extension of the trial.  The primary endpoint of the
study is improvement in liver histology, or condition, among drug-treated pre-
cirrhotic patients compared with placebo patients, as measured by serial liver
biopsies.

  BEXTRA

  Through CPEC, its 65% owned subsidiary, the Company intended to develop BEXTRA
(bucindolol) as a drug to treat congestive heart failure. On July 29, 1999, CPEC
received notification that BEST was terminated at the recommendation of the BEST
Data and Safety Monitoring Board, based upon the absence of significant survival
advantage of treatment with bucindolol. The Company has determined not to
proceed with BEXTRA development. See Note M of Notes to Consolidated Financial
Statements.

Results of Operations
---------------------

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

  Total revenues, consisting of contract and license fee revenue, decreased
$4,889,000, or 75%, to $1,599,000 in fiscal 1999 from $6,488,000 in fiscal 1998.
The decrease in contract and license fee revenue was primarily the result of the
absence in fiscal 1999 of revenue generated by Incara from Astra Merck, Inc.
("Astra Merck") due to the termination in September 1998 of the Development and
Marketing Collaboration and License Agreement between Astra Merck, Incara and
CPEC, Inc. (the "Astra Merck Collaboration") and decreased revenue from Merck &
Co., Inc. ("Merck") related to product development at Incara Research
Laboratories ("IRL"), a division of Incara which assumed the operations of
Transcell after the merger of Transcell into Incara. These decreases were
partially offset
                                      -34-
<PAGE>

by milestone fees from Lilly relating to the Company's license to Lilly of
rights to commercialize Lilly's drug, Prozac for the treatment of premenstrual
syndrome in the United Kingdom.

  Research and development expenses decreased $4,052,000, or 10%, to $35,710,000
in fiscal 1999 from $39,762,000 in fiscal 1998. Research and development expense
at Interneuron decreased primarily due to reduced noncash compensation expense
related to Interneuron's 1997 Equity Incentive Plan and the absence of expense
in fiscal 1999 for a Redux-related echocardiogram study and the Phase 2/3
pagoclone study. These decreases were partially offset by increased expenses
related to the 899-person Phase 3 citicoline clinical trial which commenced in
June 1998. As a result of the CPEC Exchange Transactions, the Company's
consolidated results of operations included Incara through July 15, 1999.
Accordingly, expenses relating to Incara decreased in fiscal 1999 because
Incara's operations were included in the Company's results of operations for
only nine and one half months in fiscal 1999. However, fiscal 1999 research and
development expenses include estimated charges of approximately $650,000 related
to the Company's decision to discontinue BEXTRA development.

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

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

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

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

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

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

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

  The Company recognized approximately $3,000,000 of noncash expense in fiscal
1999 as a result of grants of Restricted Stock Awards under the Company's 1997
Equity Incentive Plan and expects to recognize approximately $1,000,000 of
related expense in fiscal 2000.

                                      -35-
<PAGE>

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

Fiscal Year Ended September 30, 1998 Compared to Fiscal Year Ended September 30,
1997

  In September 1998, the Company adopted a plan to discontinue the operations of
InterNutria. As a result, the Company's financial statements have been
reclassified to reflect the results of InterNutria's operations as "discontinued
operations: loss from operations of InterNutria." Additionally, the Company
recorded a charge to operations of $2,326,000 in connection with the plan to
discontinue InterNutria's business operations, which includes a full reserve of
InterNutria's inventory as of September 30, 1998 and costs associated with
certain contractual commitments. InterNutria's operations, including the one-
time charges in fiscal 1998, resulted in significant losses, representing
approximately 28% and 10% of the Company's consolidated net losses during fiscal
1998 and 1997, respectively.

  Total revenues decreased substantially to $6,488,000 in fiscal 1998 from
$66,984,000 in fiscal 1997 primarily reflecting the $55,945,000 decrease in
product revenue. The Company did not recognize any Redux-related product revenue
in fiscal 1998 compared to approximately $55,905,000 of Redux-related product
revenue recognized in fiscal 1997.

  Contract and license fee revenue decreased $4,551,000, or 41%, to $6,488,000
in fiscal 1998 from $11,039,000 in fiscal 1997. This decrease primarily reflects
revenues derived during fiscal 1997 under the Copromotion Agreement with AHP, a
license agreement with Lilly and from Progenitor's license agreements.
Progenitor's results were not included in the Company's consolidated results in
fiscal 1998. The decrease was offset in part by an increase in Incara's contract
revenues resulting from a $4,000,000 payment received in September 1998 in
connection with the termination of the Astra Merck Collaboration.

  Total costs and expenses decreased $59,240,000 or 49%, to $62,237,000 in
fiscal 1998 from $121,477,000 in fiscal 1997. This substantial decrease reflects
a $41,144,000 decrease in cost of product revenue due to the absence of any
Redux-related product revenues in fiscal 1998 and the $7,528,000 fiscal 1997
charge related to the Redux product withdrawal, offset in part by an
approximately $10,000,000 noncash compensation charge relating to the Company's
1997 Equity Plan.

  Research and development expenses decreased $10,418,000, or 21%, to
$39,762,000 in fiscal 1998 from $50,180,000 in fiscal 1997. Decreases were
caused by  Incara's accrual in fiscal 1997 of its $10,000,000 commitment to
Astra Merck, which was paid  in December 1997, reductions in Redux-related
expenditures resulting from the product withdrawal, and the absence of expense
from Progenitor, whose results of operations were not consolidated with the
Company's results of operations in fiscal 1998. These decreases were offset in
part by increases resulting from an allocation to research and development of
the noncash compensation expense associated with the Company's 1997 Equity
Incentive Plan, increased expenses from IRL due to their expanded carbohydrate
technology research and Incara's expansion of its other research and development
programs.

  Selling, general and administrative expenses increased $2,394,000 or 12%, to
$21,975,000 in fiscal 1998 from $19,581,000 in fiscal 1997. This increase
primarily reflects an allocation to selling, general and administrative expenses
of the noncash compensation expense relating to the Company's 1997 Equity
Incentive Plan and pre-marketing activities relating to the potential launch of
citicoline which have ceased since the NDA withdrawal in April 1998. These
incremental fiscal 1998 expenses were partially offset by the absence of expense
from Progenitor, whose results of operations were not consolidated with the
Company's in fiscal 1998, and reduced expense relating to the Company's sales
force which was dismissed in the third quarter of fiscal 1998.

                                      -36-
<PAGE>

  Purchase of in-process research and development decreased $2,544,000, or 84%,
to $500,000 in fiscal 1998 from $3,044,000 in fiscal 1997.  Fiscal 1998 expense
relates to a cash payment made to obtain an option to acquire a private company
engaged in early stage product development.  The Company did not exercise this
option. Fiscal 1997 expenses primarily reflected charges from the Company's
open-market purchases of Incara common stock.

  Investment income, net of interest expense, decreased $3,479,000, or 39%, to
$5,465,000 in fiscal 1998 from $8,944,000 in fiscal 1997 primarily as a result
of a decrease in cash available for investment.

  Equity in net loss of unconsolidated subsidiary of $4,040,000 and $9,028,000
in fiscal 1998 and 1997, respectively, represents the Company's share of
Progenitor's net loss for the respective periods subsequent to Progenitor's IPO
in August 1997. The results of Progenitor's operations were reflected in the
Company's financial statements on a consolidated basis until Progenitor's IPO in
August 1997 after which Progenitor was included in the Company's financial
statements using the equity method of accounting. The fiscal 1997 amount
includes approximately $7,800,000 relating to the Company's equity in
Progenitor's charge for acquired in-process research and development resulting
from Progenitor's acquisition of Mercator Genetics, Inc. As of September 30,
1998, the Company's investment in Progenitor had been reduced to zero. See Note
M of Notes to Consolidated Financial Statements.

  Minority interest reflects the Company's allocation to the Subsidiaries'
minority stockholders of the losses of Incara, Transcell through May 8, 1998,
the date of the merger of Transcell into Incara, and Progenitor through August
1997, the date of the Progenitor IPO.

  Loss from the discontinued InterNutria operations increased $11,565,000, or
207%, to $17,151,000 in fiscal 1998 from $5,586,000 in fiscal 1997. This
increase was due primarily to increased selling, marketing and promotion costs
incurred in fiscal 1998 and resulting from the national launch of PMS Escape.
The Company recorded a loss relating to the plan to discontinue InterNutria's
operations of $2,326,000 in fiscal 1998, which includes an inventory reserve and
costs associated with certain contractual liabilities.

  Net loss increased $14,706,000, or 27%, to ($69,962,000) in fiscal 1998 from
($55,256,000) in fiscal 1997 for the reasons described above. Net loss per share
increased to ($1.69) in fiscal 1998 from ($1.35) in fiscal 1997.  The Company
recognized approximately $10,000,000 of noncash expense in fiscal 1998 as a
result of grants of Restricted Stock Awards under the Company's 1997 Equity
Incentive Plan.

Liquidity and Capital Resources
-------------------------------

  Cash, Cash Equivalents and Marketable Securities

  At September 30, 1999, the Company had consolidated cash, cash equivalents and
marketable securities aggregating  $21,811,000 compared to $48,470,000
(excluding amounts held by Incara) at September 30, 1998. This decrease is
primarily due to funding of operations in fiscal 1999 with only minimal cash
generated from operations and no equity financings during fiscal 1999.

  In December 1999, the Company entered into the Takeda Agreement, pursuant to
which Takeda agreed to pay $13,000,000 in up-front payments to the Company, of
which approximately $11,500,000 has been received to date. Additionally, in
December 1999, the Company entered into the Warner-Lambert Agreement pursuant to
which Warner-Lambert agreed to pay $13,750,000 in an up-front payment, which is
expected to be received in January 2000. Under the Company's agreement with RPR,
RPR is entitled to receive a portion of the payments to be received from
Warner-Lambert. (See Note N of Notes to Consolidated Financial Statements.)

  The Company believes it has sufficient cash for currently planned operations
and known commitments and expenditures through September 2000, based on certain
assumptions relating to operations, excluding the Redux product liability
litigation. The Company is unable to predict whether or when the Redux product
liability litigation will be settled or the terms of any settlement. However,
any Redux product liability settlement agreements or arrangements are expected
to require cash payments and/or equity issuances by Interneuron. Depending on
the timing and amount of any such cash payments, the Company may be required to
obtain additional funds. In addition, the Company's cash requirements and cash
resources vary significantly depending upon the results of the ongoing Phase 3
clinical trial on citicoline, whether Takeda elects

                                      -37-
<PAGE>

to continue or terminate the Takeda Agreement and whether FDA authorization for
marketing citicoline is obtained. If the NDA is not submitted or FDA approval is
not obtained, or the Company does not receive the related milestone payments
from Takeda, it will not have sufficient funds for development and
commercialization of any products under development by the Company. In this
event, Interneuron would reevaluate and prioritize ongoing development programs,
including the status of corporate collaborations and allocate its resources and
personnel accordingly. Under the terms of the Warner-Lambert Agreement, Warner-
Lambert is responsible for funding all further development of pagoclone. In the
event Warner-Lambert elected to terminate the Warner-Lambert Agreement, the
Company would be required to seek a corporate partner or obtain additional funds
to complete the development of pagoclone.

  Product Development

  The Company expects to continue expending substantial amounts for the
development of its products. The Company does not have sufficient capital
resources to complete development of its products other than those resources
currently planned for citicoline. Under the Takeda Agreement, Takeda is
responsible for commercialization of citicoline. Under the Warner-Lambert
Agreement, Warner-Lambert is responsible for development and commercialization
of pagoclone.

  During 1997, the Company obtained an exclusive option to negotiate a license
to IP501, a product for the treatment and prevention of liver diseases. The
option grants Interneuron the right to license, on specified terms, North
American and Asian marketing rights to an issued U.S. patent and U.S. and
international patent applications, following Interneuron's review of future
clinical data. This orally-administered compound is being studied in a large
U.S. government-sponsored Phase 3 clinical trial. Eight hundred patients have
been enrolled in the study, which is expected to be completed in mid-2000,
provided the study's Data Safety Monitoring Board deems sufficient data has been
obtained in the follow-up period.

  In November 1999, the Company acquired the U.S. development and marketing
rights to trospium for overactive bladder from Madaus. The Company expects to
file an IND and commence a Phase 3 clinical trial in late 2000.

  The Company is continuing to conduct preliminary evaluations of PACAP, a
compound licensed from Tulane University that, among other indications, may have
potential as a treatment for stroke, and of LidodexNS, a product for the acute
intra-nasal treatment of migraine headaches being developed pursuant to a
collaborative agreement with Algos.

  There can be no assurance that results of any on-going current or future
preclinical or clinical trials  will be successful, that additional trials will
not be required, that any drug under development will receive FDA approval in a
timely manner or at all, or that such drug could be successfully manufactured in
accordance with cGMP or successfully marketed in a timely manner, or at all, or
that the Company will have sufficient funds to commercialize any of its
products, any of which events could materially adversely affect the Company.

  Analysis of Cash Flows

  Cash used by operating activities during fiscal 1999 of $42,812,000 consisted
primarily of a net loss of $37,762,000.

                                      -38-
<PAGE>

  Cash provided by investing activities of $22,690,000 during fiscal 1999
consisted of net proceeds from maturities and sales of marketable securities of
$27,656,000 less $4,679,000 of cash held by Incara as of the date of Incara's
deconsolidation resulting from the CPEC Exchange Transactions and  purchases of
property and equipment of $287,000.

Other
-----

  Year 2000 Issue

    General:

  The Year 2000 issue is the result of the failure of hardware or software
components to properly handle dates which occur on or after January 1, 2000, the
failure to properly handle all manipulations of time related information and the
failure to store century information in a non-ambiguous format (i.e., storing
years with 2 digits rather than 4 digits).  These failures could result in
system failure or miscalculations causing disruptions in processing transactions
or creating incorrect data used in the operations of the business.

  The Company does not believe it has a risk of loss of significant revenues due
to the Year 2000 issue because no pharmaceutical products will have attained FDA
approval prior to the year 2000 and because the Company currently anticipates
marketing and sales fulfillment to be conducted by a licensee.

    Systems Assessment:

  Interneuron's and CPEC's internal systems are similar and comprised primarily
of purchased or leased software. Neither of the companies develops or maintains
any significant proprietary software or hardware systems.  Interneuron utilizes
numerous operationally-related  non-IT systems.  These include telephone
systems, pagers, and security alarm systems.

  Also, Interneuron and CPEC subcontract a substantial portion of their research
and development activities to external vendors, including contract research
organizations, and rely on the systems of these vendors for data and information
that may be date sensitive.  To the extent that the systems of these
subcontractors produce incorrect information or cause incorrect interpretation
of the information that they produce, Interneuron and CPEC are at risk for
making invalid conclusions about the nature, efficacy, or safety of their
products or technologies which could lead to abandoning potentially lucrative
products or technologies or invalidly continuing development and pursuing FDA
approval of others.

  Interneuron and CPEC have ascertained Year 2000 compliance of their primary
internal software systems, operationally-related systems, equipment with
embedded microprocessors, and subcontractors through vendor inquiry and obtained
written assertions of Year 2000 compliance from each.  Interneuron has obtained
letters from its primary internal software vendors and certain subcontractors
that purport their current belief of Year 2000 compliance and generally indicate
continued efforts to assess Year 2000 issues.

    Costs and Contingencies:

  To date, Interneuron has expended only internal costs to assess the Year 2000
issue.  Letters of Year 2000 compliance from internal software providers tend to
indicate Interneuron and  CPEC will not be exposed to any material costs  for
replacements of such systems, however there can be no assurance of this.  Also,
it is not yet possible to ascertain if any expenditure will be required to
replace systems, subcontractors or the work performed

                                      -39-
<PAGE>

by such subcontractors. While vendor assurances and internal testing are useful
in assessing Year 2000 issues, neither can provide absolute assurance that no
Year 2000 problems will or can occur.

  Other

  In November 1998, pursuant to an agreement with Servier to resolve a
withholding tax issue on Redux-related payments to Servier, the Company paid to
the U.S. Internal Revenue Service approximately $1,700,000 for withholding tax
and interest. Servier agreed to reimburse the Company for a portion of the
withholding taxes upon Servier's receipt of a related tax refund from the French
tax authorities.  The Company is unable to predict with certainty whether or
when this reimbursement will be obtained.

  Subsidiaries

  Interneuron funded the operations of InterNutria through September 30, 1998,
at which time the Company adopted a plan to discontinue the operations of
InterNutria.    Interneuron also funded Transcell until May 8, 1998, the
effective date of the merger of Transcell into Incara.   Since May 8, 1998
operations previously conducted by Transcell have been conducted as a division
of Incara  known as IRL.  Accordingly, through July 15, 1999, such operations
continued to be reflected in the Company's consolidated financial statements
until the CPEC Exchange Transactions.

    Incara and CPEC:

  On July 15, 1999, the Company entered into the CPEC Exchange Transactions
pursuant to which the Company acquired from its previously majority-owned
subsidiary, Incara, a 65% interest in CPEC. In exchange, Incara redeemed
4,229,381 of the 4,511,084 shares of Incara common stock previously owned by the
Company and the Company canceled a promissory note issued by Incara to the
Company in a related transaction.  See Note M of Notes to Consolidated Financial
Statements.

  As a result of the CPEC Exchange Transactions, subsequent to July 15, 1999 the
Company ceased consolidating Incara and instead has consolidated only CPEC.
Consolidated net losses from Incara, net of allocation to minority interest and
including IRL in fiscal 1999 and 1998 and Transcell in fiscal 1998, was
approximately 45% of consolidated net loss in fiscal 1999 and approximately 19%
of consolidated net loss in fiscal 1998.

  Subsequent to the announcement of the communication from the Data Safety
Monitoring Board's notification to CPEC of its decision regarding BEST, the
market value of Incara's common stock significantly declined.  As a result, the
Company recorded a charge of $435,000 at September 30, 1999 relating to its
approximately 5% interest in Incara as the decline in value in the Incara stock
was deemed to be other than temporary.

  The Company has guaranteed the first five years of the performance of Incara
under a lease agreement for IRL. Incara has announced its retention of an
advisor to explore the sale of all or a portion of its assets or the company. If
Incara defaults on such lease agreement, the Company will become obligated to
IRL's lessor. The remaining guaranteed obligation pursuant to such lease is
approximately $2,820,000 from October 1999 through May 2002.

    Progenitor:

  In December 1998, Progenitor announced its intention to implement an immediate
cessation of operations due to insufficient funds to meet its obligations.
Progenitor's market valuation had been substantially reduced and the Company
could not viably sell any of its holdings of Progenitor securities.  As a
result, the Company's investment in Progenitor was reduced to zero as of
September 30, 1998.  In fiscal 1999,  Progenitor sold and is seeking to sell
certain of its assets and the Company has recorded a receivable of $250,000
related to an expected distribution of net cash resulting from such sales.

                                      -40-
<PAGE>

 General

  The Company's business strategy includes evaluation of various technologies,
product or company acquisitions, licensing and/or financing opportunities and
Interneuron engages from time to time in discussions relating to such
opportunities. Interneuron may require additional cash to fund future operations
after fiscal 2000. Any Interneuron initiatives may involve the issuance of
securities of Interneuron, which would dilute existing stockholders, and/or
financial commitments for licensing fees and/or to fund product development, or
debt financing, any of which may adversely affect the Company's consolidated
financial condition or results of operations. The Company's in-licensing
agreements generally require the Company to undertake general or specific
development efforts or risk the loss of the license and/or incur penalties.

                                      -41-
<PAGE>

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 8. Financial Statements and Supplementary Data

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

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

Not applicable.

PART III.

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

RISK FACTORS

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

The outcome of the Redux litigation could materially harm us.
------------------------------------------------------------

On September 15, 1997, we announced a market withdrawal of our first
prescription product, the weight loss medication Redux (dexfenfluramine
hydrochloride capsules) C-IV, which had been launched by AHP, our licensee, in
June 1996. Simultaneously, Wyeth-Ayerst Laboratories ("Wyeth-Ayerst"), a
division of American Home Products Corp. ("AHP"), announced withdrawal of the
weight loss medication Pondimin (fenfluramine hydrochloride tablets) C-IV.
Following the withdrawal, we have been named, together with other pharmaceutical
companies, as a defendant in approximately 1,965 product liability legal
actions, many of which purport to be class actions, in federal and state courts
involving the use of Redux and other weight loss drugs.

On September 27, 1999 the U.S. District Court for the Eastern District of
Pennsylvania (the " District Court") rejected a proposed agreement preliminarily
approved by the District Court in September 1998 to settle all product liability
litigation and claims against us related to Redux. The District Court found that
the proposed agreement did not meet the requirements for limited fund class
actions, as recently described by the United States Supreme Court in Ortiz v.
                                                                     --------
Fibreboard Corp. The District Court also vacated the stays of pending and
----------------
future litigation that were previously in effect against us. We filed a petition
with the U.S. Court of Appeals for the Third Circuit on October 12, 1999,
seeking review of the District Court's ruling. That petition is still pending.

On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux and
Pondimin.  We are in discussions with AHP and the

                                      -42-
<PAGE>

Plaintiffs' Management Committee (consisting of attorneys designated to
represent plaintiffs in nationwide multidistrict litigation) regarding avenues
for us to reach a comprehensive resolution of our outstanding Redux-related
litigation. We cannot predict whether any settlement will be reached. Even if a
settlement is reached, the terms of such settlement may include cash and/or the
issuance of our securities, which may materially adversely affect our financial
condition and results of operations and result in dilution to our stockholders.

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

A negative outcome of the citicoline trial would materially harm us.
-------------------------------------------------------------------

We are substantially dependent on FDA approval of citicoline and on the
successful commercialization of citicoline. If the 899-patient Phase 3 clinical
study fails to demonstrate positive results in the treatment of ischemic stroke,
we would be materially adversely affected. Takeda has the right to terminate the
Takeda Agreement after review of the results of this study. If Takeda terminates
the Takeda Agreement and we elected to continue citicoline development, we would
be responsible for funding any further citicoline development activities. Also,
Takeda would then have an option to negotiate a license to any of our other
products, other than pagoclone, and a right of first offer if a license between
us and Takeda is not agreed to, which would materially adversely affect our
ability to collaborate with any third party other than Takeda with respect to
any of these products. In April 1998, we withdrew our NDA for citicoline after
negative results in a 100 patient Phase 3 clinical trial. Even if the results of
the current study are positive, the FDA may not grant authorization to market
citicoline which would materially adversely affect us. In addition, because we
have limited funds, if the ongoing trial does not demonstrate the safety and
efficacy of citicoline and if Takeda terminates the Takeda Agreement, we would
be required to reduce or curtail development activities on our other products,
which would materially adversely affect our ability to commercialize our
products.

We will depend on Takeda and other third parties to manufacture and market
--------------------------------------------------------------------------
citicoline.
-----------

We will be dependent upon Takeda or other third parties to manufacture and
supply citicoline bulk compound, finished product and packaging under current
U.S. Good Manufacturing Practices ("cGMP") regulations. We will also be
dependent on Takeda for the marketing and distribution of citicoline. Our
agreement with Ferrer requires the purchase from Ferrer of citicoline bulk
compound for commercial purposes at fixed prices, subject to certain conditions.
If such conditions permit the purchase of bulk compound from a third party, we
entered into an agreement with a manufacturer to supply citicoline bulk compound
for commercial purposes and have assigned this agreement to Takeda. Takeda or
its suppliers may be unable to establish on a timely basis, or maintain,
manufacturing capabilities of bulk compound and finished product and may not be
able to meet market requirements on a timely basis or at all, which would
materially adversely affect our business.

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

                                      -43-
<PAGE>

We may not be able to collaborate with third parties to commercialize certain
-----------------------------------------------------------------------------
other products if Takeda terminates the citicoline license agreement.
--------------------------------------------------------------------

If Takeda terminates the Takeda Agreement, it will have an exclusive option to
negotiate a license to any of our other products, excluding pagoclone, which
would materially adversely affect our ability to collaborate with any third
parties other than Takeda. The exclusive option license negotiation period
covering all products other than pagoclone extends for ten months, and the right
of first offer for a compound selected by Takeda prior to the end of the ten
month period extends for an additional six months. Our potential inability to
enter into licenses or other collaborations during this period could adversely
affect our ability to fund development of the products subject to Takeda's
option, which could materially affect our operations and financial condition.

We will depend on Warner-Lambert to develop, manufacture and market pagoclone.
-----------------------------------------------------------------------------

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

We will rely on third parties to commercialize our products.
-----------------------------------------------------------

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

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

We need additional funds in the near future.
-------------------------------------------

We may require additional funds after fiscal 2000.  We continue to expend
substantial funds for product development activities. We intend to seek
additional funds during fiscal 2000 through corporate collaborations or equity
or debt financings. We do not have any commitments or arrangements for
additional financing.

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

 .  whether we reach a settlement in the Redux product liability litigation and
   the amount and timing of payments required by any settlement; and

 .  the results of the ongoing Phase 3 citicoline clinical trial, whether Takeda
   elects to terminate or continue the Takeda Agreement and whether the FDA
   authorizes citicoline for marketing in the U.S.

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

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

Through September 30, 1999, we had accumulated net losses since inception of
approximately $270,000,000. We continue to have losses and to use cash in
operating activities. We will be required to conduct significant development and
clinical testing activities for the products we are developing. These activities
are expected to result in continued operating losses for the foreseeable future.
We cannot predict the extent of future losses or the time required to achieve
profitability. In addition, payments made by us under the Redux product
liability litigation or any settlement would result in significant charges to
operations and would materially adversely affect our results of operations and
financial condition.

                                      -44-
<PAGE>

We may never be profitable.
--------------------------

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

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

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

We could be materially harmed if our agreements were terminated.
---------------------------------------------------------------

Our agreements with licensors and licensees generally provide the other party
with rights to terminate the agreement, in whole or in part, under certain
circumstances. Many of our agreements require us to diligently pursue
development of the underlying product or risk loss of the license or incur
penalties. Termination of certain agreements could substantially reduce the
likelihood of successful commercialization of a particular product. Depending
upon the importance to us of the product that is subject to any such agreement,
this could materially adversely affect our business. In particular, termination
of the Takeda Agreement and/or the Warner-Lambert Agreement would materially
adversely affect us. Ferrer has the right to terminate the Ferrer Agreement in
the event FDA approval of citicoline is not obtained by January 2002, subject to
certain extensions, or in the event an unaffiliated party acquires 50% of our
Common Stock.

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

The use of products in clinical trials and the marketing of products may expose
us to substantial product liability claims and adverse publicity. Certain of our
agreements require us to obtain specified levels of insurance coverage, naming
the other party as an additional insured. We may not be able to maintain or
obtain insurance coverage, or to obtain insurance in amounts sufficient to
protect us or other named parties against liability, at a reasonable cost, or at
all. In addition, any insurance obtained may not cover any particular liability
claim. We can't predict the extent to which the Redux-related litigation may
affect our ability to obtain sufficient product liability insurance for other
products at costs acceptable to us.  We have indemnified certain licensors and
licensees and may be required to indemnify additional licensors or licensees
against product liability claims incurred by them as a result of products we
develop or market. If uninsured or insufficiently insured product liability
claims arise, or if a successful indemnification claim was made against us, our
business and financial condition could be materially adversely affected.

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

Our research, development and pre-clinical and clinical trial activities and the
manufacturing and marketing of our products are subject to an extensive
regulatory approval process by the FDA and other regulatory agencies in the U.S.
and other countries. The process of obtaining required regulatory approvals for
drugs, including conducting

                                      -45-
<PAGE>

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

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

We have limited patent protection on our products.
--------------------------------------------------

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

  . obtain and enforce patent protection on our products and technologies;
  . maintain trade secrets; and
  . operate and commercialize products without infringing on the patents or
    proprietary rights of others.

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

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

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

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

  . to enforce any of our patents;
  . to determine the scope and validity of the patent rights of others; or
  . in response to legal action against us claiming damages for infringement of
    patent rights or other proprietary rights or seeking to enjoin commercial
    activities relating to the affected product or process.

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

To the extent that consultants, key employees or other third parties apply
technological information independently developed by them or by others to our
proposed products, disputes may arise as to the proprietary rights to such
information which may not be resolved in our favor. Most of our consultants are
employed by or have consulting

                                      -46-
<PAGE>

agreements with third parties and any inventions discovered by such individuals
generally will not become our property. There is a risk that other parties may
breach confidentiality agreements or that our trade secrets become known or
independently discovered by competitors, which could adversely affect us.

We may depend on market exclusivity for citicoline and other products.
----------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

                                      -47-
<PAGE>

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

Many of our products are early stage and may not be successful.
---------------------------------------------------------------

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

We depend upon key personnel and consultants.
---------------------------------------------

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

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

Our company is controlled by certain stockholders.
--------------------------------------------------

Our executive officers, directors and principal stockholders (including
individuals or entities related to such stockholders) beneficially own
approximately 40% of our outstanding Common Stock. Accordingly, these officers,
directors and stockholders may have the ability to exert significant influence
over the election of our Board of Directors and to determine corporate actions
requiring stockholder approval.

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

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

                                      -48-
<PAGE>

We have never paid any dividends.
---------------------------------

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

Our stock price is volatile.
----------------------------

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

  . litigation developments;
  . results of clinical studies and regulatory reviews;
  . market conditions in the pharmaceutical and biotechnology industries;
  . competitive products;
  . financings or corporate collaborations;
  . sales or the possibility of sales of our Common Stock;
  . our results of operations and financial condition;
  . proprietary rights;
  . public concern as to the safety or commercial value of our products; and
  . general economic conditions.

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

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

As of December 23, 1999, we had 42,076,532 shares of Common Stock outstanding.
Substantially all of these shares are eligible for sale without restriction or
under Rule 144. In general, under Rule 144 as currently in effect, a person (or
persons whose shares are aggregated), including persons who may be deemed to be
"affiliates" of the Company as that term is defined under the Securities Act of
1933, is entitled to sell within any three-month period a number of restricted
shares beneficially owned for at least one year that does not exceed the greater
of:

  (i)   one percent of the then outstanding shares of Common Stock, or
  (ii)  the average weekly trading volume in the Common Stock during the four
        calendar weeks preceding such sale.

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

AHP has registration rights relating to 622,222 shares of Common Stock
issuable upon conversion of preferred stock.

                                      -49-
<PAGE>

We have outstanding registration statements on Form S-3 relating to the resale
of our shares of Common Stock and on Form S-8 relating to shares issuable under
our 1989 Stock Option Plan, 1994 Long-Term Incentive Plan, 1995 Stock Purchase
Plan, 1997 Equity Incentive Plan and 1998 Employee Stock Option Plan.

The recipients of shares of our Common Stock under the 1997 Equity Incentive
Plan can sell these shares immediately when the shares vest. As of December 17,
1999, of the 1,314,332 shares of Common Stock issued or issuable under the 1997
Equity Incentive Plan pursuant to stock awards, 717,966 shares vested and were
issued and the remaining 596,472 shares vest through May 2000. The vesting dates
are subject to extension if they occur during a "Black Out Period." Black Out
Periods generally are periods in which the recipient is unable to sell the
shares subject to the award at the applicable vesting date due to legal or
contractual restrictions. The vesting dates are also subject to acceleration
under certain circumstances, including certain changes in control of the
Company, except under certain conditions. Sales of the shares of Common Stock
subject to restricted stock awards or the possibility of sales of such shares
may adversely affect the market price of our Common Stock.

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

As of December 23, 1999, we had reserved the following shares of Common Stock
for issuance:

  . 7,305,000 shares issuable upon exercise of outstanding options and warrants,
    subject to anti-dilution provisions;

  . 596,472 shares issuable, at nominal consideration, upon vesting of stock
    awards under the Company's 1997 Equity Incentive Plan;

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

  . 2,835,000 shares reserved for grant and issuance under the Company's
    stock option plans, stock purchase plan and equity incentive plan.

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

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

Our business could be materially affected by year 2000 compliance failures.
---------------------------------------------------------------------------

If we fail to implement our Year 2000 compliance plan successfully or in a
timely manner, or if we fail to identify significant two-digit dependencies in
our systems or with key business vendors we could be materially adversely
affected. We cannot fully assess the likelihood of third parties' Year 2000
compliance or the impact any noncompliance may have on our operations at this
time.  If there are significant delays or unanticipated Year 2000 issues with
key business vendors, the Year 2000 issue could have a material adverse effect
on our product development and our future results of operations and financial
condition.
                                      -50-
<PAGE>

PART IV

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

(a)  1. Financial Statements

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

     2. Schedules

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

(b)  Reports on Form 8-K

  On July 29, 1999, the Company filed a Report on Form 8-K reporting information
under "Item 2-Acquisition or Disposition of Assets" with respect to the CPEC
Exchange Transactions.  The Company amended this Report by filing an 8-K/A on
September 27, 1999 which provided pro forma financial statements under Item 7.

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

                                      -51-
<PAGE>

<TABLE>
<C>         <S>
10.37    -   License Agreement dated as of February 15, 1992 between the
             Registrant and Massachusetts Institute of Technology(5)
10.40    -   Patent and Know-How Sublicense and Supply Agreement between
             Registrant and American Cyanamid Company dated November 19,
             1992(2)(6)
10.41    -   Equity Investment Agreement between Registrant and American
             Cyanamid Company dated November 19, 1992(6)
10.42    -   Trademark License Agreement between Registrant and American
             Cyanamid Company dated November 19, 1992(6)
10.4     -   Agreement between Registrant and Servier dated November 19,1992(6)
10.45    -   Agreement between Registrant and Parexel International Corporation
             dated October 22, 1992 (as of July 21, 1992)(2)(7)
10.46    -   License Agreement dated February 9, 1993 between the Registrant and
             Massachusetts Institute of Technology(2)(8)
10.52    -   License Agreement dated February 18, 1994 between
             Registrant and Rhone-Poulenc Rorer, S.A.(11)
10.55    -   Patent License Agreement between Registrant and Massachusetts
             Institute of Technology dated March 1, 1994(11)
10.58    -   Master Equipment Lease including Schedules and Exhibits between
             Phoenix Leasing and Registrant(12)
10.59    -   Exhibit D to Agreement between Registrant and Parexel International
             Corporation dated as of March 15, 1994(2)(12)
10.60(a) -   Acquisition Agreement dated as of May 13, 1994 among the
             Registrant, Intercardia, Inc., Cardiovascular Pharmacology
             Engineering Consultants, Inc. ("CPEC"), Myocor, Inc. and the
             sellers named therein(13)
10.60(b) -   Amendment dated June 15, 1994 to the Acquisition Agreement(13)
10.61    -   License Agreement dated December 6, 1991 between
             Bristol-Myers Squibb and CPEC, as amended(2)(13)
10.61(a) -   Letter Agreement dated November 18, 1994 between CPEC and Bristol-
             Myers Squibb(14)
10.65(a) -   1994 Long-Term Incentive Plan, as amended(23)
10.68(a) -   Interneuron Pharmaceuticals, Inc. 1995 Employee Stock Purchase
             Plan, as amended(19)
10.71    -   Securities Purchase Agreement dated June 2, 1995 between the
             Registrant and Reliance Insurance Company, including Warrant and
             exhibits(15)
10.74    -   Securities Purchase Agreement dated as of August 16, 1995 between
             the Registrant and BT Holdings (New York), Inc., including Warrant
             issued to Momint (nominee of BT Holdings)(16)
10.78    -   Contract Manufacturing Agreement dated November 20, 1995 between
             Registrant and Boehringer Ingelheim Pharmaceuticals, Inc.(2)(17)
10.83    -   Co-promotion Agreement effective June 1, 1996 between Wyeth-Ayerst
             Laboratories and Interneuron Pharmaceuticals, Inc.(2)(18)
10.84    -   Master Consulting Agreement between Interneuron Pharmaceuticals,
             Inc. and Quintiles, Inc. dated July 12, 1996(18)
10.85    -   Amendment No. 1 dated July 3, 1996 to Master Consulting Agreement
             between Interneuron Pharmaceuticals, Inc. and Quintiles, Inc. dated
             July 12, 1996(2)(18)
10.86    -   Lease Agreement between Transcell Technologies, Inc. and Cedar
             Brook Corporate Center, L.P., dated September 19, 1996, with
             Registrant guaranty(20)
10.87    -   Lease dated February 5, 1997 between Registrant and Ledgemont
             Realty Trust(21)
10.89    -   Form of ISDA Master Agreement by and between the Registrant and
             Swiss Bank Corporation, London Branch, together with Schedules
             thereto(23)
</TABLE>

                                      -52-
<PAGE>

<TABLE>
<C>         <S>
10.90(a) -   Form of Confirmation for Contract A entered into pursuant to ISDA
             Master Agreement by and between the Registrant and Swiss Bank
             Corporation, London Branch, together with appendix thereto(23)
10.90(b)     Form of Confirmation for Contract B entered into pursuant to ISDA
             Master Agreement by and between the Registrant and Swiss Bank
             Corporation, London Branch, together with appendix thereto(23)
10.90(c) -   Letter Amendment dated September 18, 1997 to Confirmations filed as
             Exhibits 10.90(a) and 10.90(b)(26)
10.91    -   Form of Agreement regarding Registration Rights and Related
             Obligations to be entered into by and between Registrant and Swiss
             Bank Corporation, London Branch(23)
10.92    -   Research and Collaboration and License Agreement effective as of
             June 30, 1997 by and among Merck & Co., Inc., Transcell
             Technologies, Inc. and the Registrant (assigned to Intercardia as
             of May 8, 1998)(2)(24)
10.93    -   Form of Indemnification Agreement between Registrant and each
             director, executive officer and certain officers of the Registrant
             entered into as of October 6, 1997(26)
10.94    -   1998 Employee Stock Option Plan(27)
10.95    -   Agreement and Plan of Merger dated March 2, 1998 by and among
             Registrant, Intercardia, Inc. and Transcell Technologies, Inc.(28)
10.95(a) -   Waiver and Consent Agreement dated May 8, 1998 by and among
             Registrant, Intercardia and Transcell(28)
10.96    -   Assignment and Assumption and Royalty Agreement between Intercardia
             and Registrant dated May 8, 1998(29)
10.97    -   License Agreement between Registrant and the Administrators of the
             Tulane Educational Fund dated April 29, 1998(29)
10.98    -   Letter of Understanding between the Registrant and the Plaintiffs'
             Management Committee dated September 3, 1998(30)
10.99    -   Agreement of Compromise and Settlement, including Appendices, dated
             September 21, 1998, between the Registrant and the Plaintiffs'
             Management Committee(31)
10.100   -   Royalty Agreement between the Registrant and the Plaintiffs'
             Management Committee effective as of September 21, 1998(32)
10.101   -   Fiscal 1999 Senior Executive Bonus Plan, as adopted by the Board of
             Directors on September 9, 1998(33)
10.102   -   Employment Agreement between Interneuron Pharmaceuticals, Inc. and
             Michael W. Rogers dated and effective as of February 23, 1999(34)
10.103   -   Employment Agreement between Interneuron Pharmaceuticals, Inc. and
             Bobby W. Sandage, Jr. dated and effective as of March 15, 1999(34)
10.104   -   Employment Agreement between Interneuron Pharmaceuticals, Inc. and
             Mark S. Butler dated and effective as of March 15, 1999(34)
10.105   -   Employment Agreement between Interneuron Pharmaceuticals, Inc. and
             Glenn L. Cooper, M.D. dated and effective as of May 1, 1999(34)
10.106   -   Agreement of Sublease between Interneuron Pharmaceuticals, Inc.,
             Sublandlord and Genta, Inc., Subtenant dated March 31, 1999(34)
10.107   -   Consent to Sublease dated March 31, 1999 by and among Ledgemont
             Realty Trust, Interneuron Pharmaceuticals, Inc., and Genta,
             Inc.(34)
10.108   -   Exchange Agreement dated July 15, 1999 between Intercardia, Inc.
             and Interneuron Pharmaceuticals, Inc.(35)
10.109   -   Amended and Restated Limited Liability Company Agreement of CPEC
             LLC dated July 15, 1999 among CPEC LLC, Interneuron
             Pharmaceuticals, Inc. and Intercardia, Inc.(35)
10.110   -   Assignment, Assumption and License Agreement dated July 15, 1999 by
             and between CPEC LLC and Intercardia, Inc.(35)
</TABLE>

                                      -53-
<PAGE>

<TABLE>
<C>         <S>
10.111   -   Extension of Term and Supplemental Agreement made as of July 7,
             1999 by and between Interneuron Pharmaceuticals, Inc., and J.
             Howard & Associates(36)
10.112   -   Consent to Sublease dated as of July 9, 1999 by and between
             Interneuron Pharmaceuticals, Inc., and J. Howard & Associates and
             Ledgemont Realty Trust(36)
10.113   -   License Agreement effective as of November 26, 1999 between Madaus
             AG and Interneuron Pharmaceuticals, Inc.(37)
10.114   -   License Agreement effective as of December 2, 1999 by and between
             Interneuron Pharmaceuticals, Inc. and Takeda Chemical Industries,
             Ltd.(37)
10.115   -   Fiscal 2000 Senior Executive Bonus Plan, as adopted by the Board of
             Directors on September 15, 1999
21       -   List of Subsidiaries
23       -   Consent of PricewaterhouseCoopers LLP
27       -   Financial Data Schedule
</TABLE>
____________________________

(1)  Incorporated by reference to the Registrant's Registration Statement on
     Form S-1 (File No. 33-32408) declared effective on March 8, 1990.
(2)  Confidential Treatment granted for a portion of this Exhibit.
(3)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the year ended September 30, 1990.
(4)  Incorporated by reference to Post-Effective Amendment No. 2 to the
     Registrant's Registration Statement on Form S-1 (File No. 33-32408) filed
     December 18, 1991.
(5)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the three months ended March 31, 1992.
(6)  Incorporated by reference to the Registrant's Form 8-K dated November 30,
     1992.
(6a) Incorporated by reference to Post-Effective Amendment No. 5 to the
     Registrant's Registration Statement on Form S-1 (File No. 33-32408) filed
     on December 21, 1992.
(7)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the fiscal year ended September 30, 1992.
(8)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the three months ended December 31, 1992.
(9)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the six months ended March 31, 1993.
(10) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the nine months ended June 30, 1993.
(11) Incorporated by reference to the Registrant's Registration Statement on
     Form S-3 or Amendment No. 1 (File no. 33-75826).
(12) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the six months ended March 31, 1994.
(13) Incorporated by reference to the Registrant's Form 8-K dated June 20, 1994.
(14) Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the fiscal year ended September 30, 1994.
(15) Incorporated by reference to the Registrant's Quarterly Report on Form 8-K
     dated June 2, 1995.
(16) Incorporated by reference to Registrant's Report on Form 8-K dated August
     16, 1995.
(17) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1995.
(18) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q or
     10-Q/A for the quarter ended June 30, 1996.

                                      -54-
<PAGE>

(19) Incorporated by reference to Amendment No. 1 to Registrant's Registration
     Statement on Form S-3 (File No. 333-1273) filed March 15, 1996.
(20) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1996.
(21) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended December 31, 1996.
(22) Incorporated by reference to Exhibit 3.5 of Registrant's Quarterly Report
     on Form 10-Q for the three months ended March 31, 1997.
(23) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended March 31, 1997.
(24) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended June 30, 1997.
(25) Incorporated by reference to Registrant's Form S-8 (File No. 333-40315)
     filed November 14, 1997.
(26) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1997.
(27) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended December 31, 1997.
(28) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended March 31, 1998.
(29) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended June 30, 1998.
(30) Incorporated by reference as Exhibit 99.1 of Registrant's Form 8-K dated
     September 3, 1998.
(31) Incorporated by reference as Exhibit 99.2 of Registrant's Form 8-K dated
     September 28, 1998.
(32) Incorporated by reference as Exhibit 99.3 of Registrant's Form 8-K dated
     September 28, 1998.
(33) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1998.
(34) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended March 31, 1999.
(35) Incorporated by reference to Registrant's Form 8-K dated July 27, 1999.
(36) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q
     for the three months ended June 30, 1999.
(37) Confidential Treatment requested for a portion of this Exhibit.

                                      -55-
<PAGE>

                                  SIGNATURES

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

                                  INTERNEURON PHARMACEUTICALS, INC.

Date: December 28, 1999           By:  /s/ Glenn L. Cooper M.D.
                                      ______________________________________
                                       Glenn L. Cooper, M.D.,
                                       President and Chief Executive Officer

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

Name                        Title                              Date
<S>                        <C>                                <C>
 /s/ Glenn L. Cooper, M.D.
____________________________   President and Chief Executive      December 28, 1999
Glenn L. Cooper, M.D.          Officer and Director (Principal
                               Executive Officer)

 /s/ Lindsay Rosenwald, M.D.
____________________________   Chairman of the                    December 28, 1999
Lindsay Rosenwald, M.D.        Board of Directors


____________________________   Director
Harry Gray

 /s/ Alexander M. Haig, Jr.
____________________________   Director                           December 28, 1999
Alexander M. Haig, Jr.

  /s/ Peter Barton Hutt
____________________________   Director                           December 28, 1999
Peter Barton Hutt

  /s/ Malcolm Morville
____________________________   Director                           December 28, 1999
Malcolm Morville

 /s/ Lee J. Schroeder
____________________________   Director                           December 28, 1999
Lee J. Schroeder

 /s/ David B. Sharrock
____________________________   Director                           December 28, 1999
David B. Sharrock

 /s/ Michael W. Rogers
____________________________   Executive Vice President, Chief    December 28, 1999
Michael W. Rogers              Financial Officer, Treasurer
                               (Principal Financial Officer)
 /s/ Dale Ritter
____________________________   Senior Vice President, Finance,    December 28, 1999
Dale Ritter                    (Principal Accounting Officer)
</TABLE>

                                      -56-
<PAGE>

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
Audited Financial Statements                                                Page
<S>                                                                        <C>
Report of Independent Accountants.........................................   F-2
Consolidated Balance Sheets -- September 30, 1999 and 1998................   F-3
Consolidated Statements of Operations -- For the years ended
  September 30, 1999, 1998 and 1997.......................................   F-4

Consolidated Statements of Stockholders' Equity -- For the years ended
  September 30, 1999, 1998 and 1997.......................................   F-5

Consolidated Statements of Cash Flows -- For the years ended
  September 30, 1999, 1998 and 1997.......................................   F-7

Notes to Consolidated Financial Statements................................   F-8
</TABLE>

                                      F-1
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS



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



In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Interneuron
Pharmaceuticals, Inc. and its subsidiaries at September 30, 1999 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended September 30, 1999 in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.



PricewaterhouseCoopers LLP

Boston, Massachusetts
December 1, 1999,
except as to Note N which is
as of December 23, 1999

                                      F-2
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.
                          CONSOLIDATED BALANCE SHEETS
                   (Amounts in thousands except share data)

<TABLE>
<CAPTION>
                                                    September 30,  September 30,
                                                        1999           1998
                                                    ------------   ------------
<S>                                                <C>            <C>
                  ASSETS

Current assets:
     Cash and cash equivalents                        $19,354        $39,330
     Marketable securities                              2,457         28,877
     Accounts receivable                                  785          1,273
     Prepaids and other current assets                  1,812          1,116
                                                    ------------   ------------
          Total current assets                         24,408         70,596

Marketable securities                                      --          3,825
Investment in Incara                                    1,827             --
Property and equipment, net                               403          3,691
Other assets                                               --             85
                                                    ------------   ------------
                                                      $26,638        $78,197
                                                    ============   ============
                LIABILITIES

Current liabilities:

     Accounts payables                                $   157        $ 1,334
     Accrued expenses                                  20,100         27,008
     Current portion of notes payable
        and capital lease obligations                      68            837
                                                    ------------   ------------
          Total current liabilities                    20,325         29,179

Long-term portion of notes payable and
   capital lease obligations                                2          1,663

Minority interest                                         189          7,499

Commitments and contingencies (See Notes)

            STOCKHOLDERS' EQUITY

Preferred stock; $.001 par value, 5,000,000
   shares authorized;
     Series B, 239,425 shares issued and
        outstanding (liquidation preference at
        September 30, 1999 $3,026)                      3,000          3,000
     Series C, 5,000 shares issued and outstanding
        (liquidation preference at September 30,
        1999 $502)                                        500            500
Common stock; $.001 par value, 80,000,000 shares
   authorized; 42,019,426 and 41,817,017 shares
   issued and outstanding at September 30, 1999
   and 1998, respectively                                  42             42
Additional paid-in capital                            272,337        268,278
Accumulated deficit                                  (269,758)      (231,996)
Accumulated other comprehensive income                      1             32
                                                    ------------   ------------
          Total stockholders' equity                    6,122         39,856
                                                    ------------   ------------
                                                    $  26,638      $  78,197
                                                    ============   ============
</TABLE>
              The accompanying notes are an integral part of the
                      consolidated financial statements.

                                      F-3
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                 (Amounts in thousands except per share data)

<TABLE>
<CAPTION>
                                              For the years ended September 30,
                                              ---------------------------------
                                                 1999       1998       1997
                                              ----------   --------   ---------
<S>                                             <C>        <C>        <C>
Revenues:
     Product revenue                            $     --   $     --   $ 55,945
     Contract and license fee revenue              1,599      6,488     11,039
                                                --------   --------   --------
          Total revenues                           1,599      6,488     66,984

Costs and expenses:
     Cost of product revenue                          --         --     41,144
     Research and development                     35,710     39,762     50,180
     Selling, general and administrative          11,030     21,975     19,581
     Product withdrawal                               --         --      7,528
     Purchase of in-process research and
        development                                2,421        500      3,044
                                                --------   --------   --------
          Total costs and expenses                49,161     62,237    121,477

Loss from operations                             (47,562)   (55,749)   (54,493)

Investment income, net                             2,189      5,465      8,944
Equity in unconsolidated subsidiary                  250     (4,040)    (9,028)
Impairment of investment in Incara                  (435)        --         --
Minority interest                                  6,980      3,839      4,907
                                                --------   --------   --------

Loss from continuing operations                  (38,578)   (50,485)   (49,670)

Discontinued operations (see Note M):
Loss from operations of InterNutria                   --    (17,151)    (5,586)
Discontinuation of InterNutria                       816     (2,326)        --
                                                --------   --------   --------

Net loss                                        $(37,762)  $(69,962)  $(55,256)
                                                ========   ========   ========

Net loss per common share - basic and diluted:
     Loss from continuing operations            $  (0.92)  $  (1.22)  $  (1.21)
     Loss from operations of InterNutria              --      (0.41)     (0.14)
     Discontinuation of InterNutria                 0.02      (0.06)        --
                                                --------   --------   --------
Net loss per common share - basic and diluted   $  (0.90)  $  (1.69)  $  (1.35)
                                                ========   ========   ========

Weighted average common shares outstanding        41,898     41,468     41,064
                                                ========   ========   ========

</TABLE>
              The accompanying notes are an integral part of the
                      consolidated financial statements.

                                      F-4
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                         (Dollar amounts in thousands)
<TABLE>
<CAPTION>


                                                                    Common Stock          Preferred Stock
                                                          ------------------------------  ------------------   Additional
                                                           Number of         Par Value   Number of             Paid-In
                                                            Shares             Amount      Shares     Amount    Capital
                                                          ----------          -------     -------     ------   --------
<S>                                                     <C>                  <C>         <C>         <C>       <C>

Balance at September 30, 1996                             41,015,969          $    41     244,425     $3,500   $247,999

Repurchases of common stock
Proceeds from exercise of stock options and warrants         154,902                                               (163)
Proceeds from offering of Employee Stock Purchase Plan                                                             (109)
Dividends on preferred stock                                                                                        (35)
Proceeds from modification of call options                                                                          500
Issuance of common stock for technology rights                55,422                                                108
Gain on sale of stock by subsidiary                                                                               7,291
Stock-based compensation and other                                                                                  102

Comprehensive loss:
   Unrealized net gain loss on marketable securities
   Net loss

      Total comprehensive loss
                                                          ----------          -------     -------     ------   --------
Balance at September 30, 1997                             41,226,293               41     244,425      3,500    255,693

Proceeds from exercise of stock options and warrants          17,500                                               (125)
Proceeds from offering of Employee Stock Purchase Plan        14,726                                                 85
Dividends on preferred stock                                                                                        (35)
Issuance of common stock for technology rights                57,310                                               (787)
Gain on issuance of stock by subsidiary                                                                           2,212
Stock-based compensation and other                           501,188                1                            11,235

Comprehensive loss:
   Unrealized net loss on marketable securities
   Net loss
      Total comprehensive loss
                                                          ----------          -------     -------     ------   --------
   Balance at September 30, 1998                          41,817,017               42     244,425      3,500    268,278

Proceeds from exercise of stock options and warrants          14,400                                                 12
Proceeds from offering of Employee Stock Purchase Plan        16,647                                                 25
Dividends on preferred stock                                                                                        (35)
Stock-based compensation and other                           171,362                                              4,057

Comprehensive loss:
   Net loss
   Unrealized net loss on marketable securities

      Total comprehensive loss
                                                          ----------          -------     -------     ------   --------

   Balance at September 30, 1999                          42,019,426          $    42     244,425     $3,500   $272,337
                                                          ==========          =======  ==========  =========  =========

</TABLE>
              The accompanying notes are an integral part of the
                      consolidated financial statements.

                                      F-5
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.
            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONT.)
                         (Dollar amounts in thousands)

<TABLE>
<CAPTION>

                                                                 Accumulated       Treasury Stock
                                                                   Other         ------------------       Total
                                               Accumulated     Comprehensive     Number of             Stockholders'   Comprehensive
                                                 Deficit       Income/(Loss)      Shares     Amount       Equity           Loss
                                                 -------       -------------     ---------   ------    -------------   -------------
<S>                                           <C>             <C>               <C>         <C>       <C>             <C>
Balance at September 30, 1996                  $(106,778)                                                $144,762

Repurchases of common stock                                                       217,500   $(3,978)       (3,978)
Proceeds from exercise of stock options and
  warrants                                                                       (120,150)    2,224         2,061
Proceeds from offering of Employee Stock
  Purchase Plan                                                                   (16,152)      291           182
Dividends on preferred stock                                                                                  (35)
Proceeds from modification of call options                                                                    500
Issuance of common stock for technology
  rights                                                                                                      108
Gain on sale of stock by subsidiary                                                                         7,291
Stock-based compensation and other                                                (10,715)      187           289

Comprehensive loss:
 Net loss                                        (55,256)                                                 (55,256)        $(55,256)
 Unrealized net gain on marketable
   securities                                                  $     85                                        85               85
                                                                                                                          --------

   Total comprehensive loss                                                                                               $(55,171)
                                                                                                                          ========
                                               ---------       --------          --------   -------      --------
Balance at September 30, 1997                   (162,034)            85            70,483    (1,276)       96,009

Proceeds from exercise of stock options and
  warrants                                                                        (15,000)      281           156
Proceeds from offering of Employee Stock
  Purchase Plan                                                                                                85
Dividends on preferred stock                                                                                  (35)
Issuance of common stock for technology
  rights                                                                          (55,483)      995           208
Gain on issuance of stock by subsidiary                                                                     2,212
Stock-based compensation and other                                                                         11,236

Comprehensive loss:
 Net loss                                        (69,962)                                                 (69,962)        $(69,962)
 Unrealized net loss on marketable
   securities                                                       (53)                                      (53)             (53)
                                                                                                                          --------

   Total comprehensive loss                                                                                               $(70,015)
                                                                                                                          ========
                                               ---------       --------          --------   -------      --------
Balance at September 30, 1998                   (231,996)            32                --        --        39,856

Proceeds from exercise of stock options and
  warrants                                                                                                     12
Proceeds from offering of Employee Stock
  Purchase Plan                                                                                                25
Dividends on preferred stock                                                                                  (35)
Stock-based compensation and other                                                                          4,057

Comprehensive loss:
 Net loss                                        (37,762)                                                 (37,762)        $(37,762)
 Unrealized net loss on marketable
   securities                                                       (31)                                      (31)             (31)
                                                                                                                         ---------

   Total comprehensive loss                                                                                               $(37,793)
                                                                                                                          ========
                                               ---------       --------          --------   -------      --------
Balance at September 30, 1999                  $(269,758)      $      1                --   $    --      $  6,122
                                               =========       ========          ========   =======      ========
</TABLE>
              The accompanying notes are an integral part of the
                      consolidated financial statements.

                                      F-6
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                            (Amounts in thousands)
<TABLE>
<CAPTION>
                                                                           For the years ended September 30,
                                                                           ---------------------------------
                                                                               1999       1998       1997
                                                                           ----------  ----------  ---------
<S>                                                                         <C>        <C>        <C>
Cash flows from operating activities:
  Net loss                                                                   $(37,762)  $(69,962)  $(55,256)
  Adjustments to reconcile net loss to net cash used by operating
   activities:
    Depreciation and amortization                                                 933      2,409      1,484
    Minority interest in net loss of consolidated subsidiaries                 (6,980)    (3,839)    (4,907)
    Purchase of in-process research and development                             2,421         --      2,234
    Noncash compensation                                                        4,437     11,624        434
    Impairment of investment in Incara                                            435         --         --
    Discontinuation of InterNutria                                               (816)     1,106         --
    Equity in unconsolidated subsidiary                                          (250)     4,040      9,028
    Change in assets and liabilities, net of effects from deconsolidations:
      Accounts receivable                                                         719       (139)     2,787
      Prepaid and other current assets                                           (785)       814     (8,348)
      Inventories and other assets                                                (10)       (50)     7,605
      Accounts payable                                                           (612)      (281)       114
      Deferred revenue                                                             --       (750)    (6,171)
      Accrued expenses and other liabilities                                   (4,542)   (11,970)    31,099
                                                                             --------   --------   --------
Net cash (used) by operating activities                                       (42,812)   (66,998)   (19,897)
                                                                             --------   --------   --------

Cash flows from investing activities:
  Capital expenditures                                                           (287)    (1,308)    (3,273)
  Purchases of marketable securities                                           (4,971)   (28,992)   (85,971)
  Proceeds from maturities and sales of marketable securities                  32,627     80,469     25,531
  Purchases of Incara stock                                                        --         --     (2,951)
  Purchases of Progenitor units and stock                                          --         --     (3,605)
  Cash of deconsolidated subsidiaries                                          (4,679)        --        (12)
                                                                             --------   --------   --------
Net cash provided (used) by investing activities                               22,690     50,169    (70,281)
                                                                             --------   --------   --------

Cash flows from financing activities:
  Net proceeds from issuance of common and treasury stock and other
   financing activities                                                            72        242      2,819
  Net proceeds from issuance of stock by consolidated subsidiaries                677        201        333
  Purchases of treasury stock                                                      --         --     (3,978)
  Proceeds from sale/leaseback transactions                                        --         --      1,636
  Proceeds from notes payable                                                      --        460        156
  Principal payments of notes payable                                            (136)      (122)       (35)
  Principal payments of capital lease obligations                                (467)      (442)      (834)
                                                                             --------   --------   --------
Net cash provided by financing activities                                         146        339         97
                                                                             --------   --------   --------

Net change in cash and cash equivalents                                       (19,976)   (16,490)   (90,081)
Cash and cash equivalents at beginning of period                               39,330     55,820    145,901
                                                                             --------   --------   --------
Cash and cash equivalents at end of period                                   $ 19,354   $ 39,330   $ 55,820
                                                                             ========   ========   ========

Supplemental disclosure of financing and investing activities:
  Cash payments for interest                                                 $    218   $    268   $    311
                                                                             ========   ========   ========
  Property and equipment obtained through financing arrangements             $     --   $    159   $  1,211
                                                                             ========   ========   ========
</TABLE>
              The accompanying notes are an integral part of the
                      consolidated financial statements.

                                      F-7
<PAGE>

                       INTERNEURON PHARMACEUTICALS, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A. Nature of the Business:

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

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

B. Summary of Significant Accounting Policies:

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

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

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

                                      F-8
<PAGE>

Cash, Cash Equivalents and Marketable Securities: The Company invests available
cash primarily in short-term bank deposits, money market funds, U.S. commercial
paper and U.S. and foreign government securities. Cash and cash equivalents
includes investments with maturities of three months or less at date of
purchase. Marketable securities consist of investments purchased with maturities
greater than three months and are classified as noncurrent if they mature one
year or more beyond the balance sheet date. The Company classifies its
investments in debt securities as either held-to-maturity or available-for-sale
based on facts and circumstances present at the time the investments are
purchased. At September 30, 1999 and 1998, all investments held were classified
as "available-for-sale."

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

     Office equipment . . . . . . . . . . . . . . . . . . . . . . . 2 to 5 years

     Laboratory equipment . . . . . . . . . . . . . . . . . . . . .      5 years

     Leasehold improvements . . . Shorter of lease term or estimated useful life

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

Revenue Recognition: Product revenue consists of product sales which are
recognized at the later of shipment or acceptance and royalties from licensed
products which are recognized when the amount of and basis for such royalties
are reported to the Company in accurate and appropriate form and in accordance
with the related license agreements. Contract and license fee revenue consists
of technology license-related payments, contractual research milestone payments,
sales and marketing payments, research and development grants and contractual
research and development funding and is recognized when services are performed
or when contractual obligations are met. Cash received in advance of revenue
recognition is recorded as deferred revenue.

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

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

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

Accounting for Stock-Based Compensation: The Company adopted the disclosure -
only alternative permitted under Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
which changes measurement, recognition and disclosure standards for stock-based
compensation. The Company measures stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25 ("APB Opinion No. 25") and related
interpretations. The Company has disclosed pro forma net loss and pro forma net
loss per share for fiscal 1999, 1998 and 1997 in Note H using the fair value
method.

                                      F-9
<PAGE>

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

Comprehensive Income: Effective October 1, 1998, the Company adopted SFAS 130,
"Reporting Comprehensive Income", which establishes standards for reporting and
displaying comprehensive income and its components in a set of financial
statements.  Components of comprehensive income are net income and all other
non-owner changes in equity such as the change in the cumulative gain or loss on
marketable securities. The Company has changed the format of its consolidated
statements of stockholders' equity to present comprehensive income.

Components of accumulated other comprehensive income consist of the following:
<TABLE>
<CAPTION>

                                                        September 30,
                                                ------------------------------
                                                  1999       1998       1997
                                                --------   --------   --------
<S>                                        <C>             <C>        <C>
     Change in unrealized gains (losses)
      on marketable securities                  $(31,000)  $(53,000)  $ 85,000
                                                --------   --------   --------

     Accumulated other comprehensive
      income (loss)                             $(31,000)  $(53,000)  $ 85,000
                                                ========   ========   ========

</TABLE>
Reclassification: Certain prior year amounts have been reclassified to conform
with fiscal 1999 classifications.

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

                                     F-10
<PAGE>

C. Marketable Securities and Investment in Incara:

Marketable Securities
---------------------

  Investments in marketable securities consisted of the following at
September 30, 1999 and 1998:
<TABLE>
<CAPTION>

                                                                 1999                         1998
                                                      --------------------------    --------------------------
                                                                        Market                        Market
                                                         Cost           Value          Cost           Value
                                                       ----------     ----------    -----------    -----------
<S>                                                   <C>            <C>            <C>            <C>
   U.S. government treasury and agency obligations     $       --     $       --    $14,246,000    $14,275,000
   U.S. corporate notes                                 2,456,000      2,457,000     18,424,000     18,427,000
                                                       ----------     ----------    -----------    -----------
                                                       $2,456,000     $2,457,000    $32,670,000    $32,702,000
                                                       ==========     ==========    ===========    ===========
</TABLE>

At September 30, 1999, gross unrealized gains were approximately $1,000 and
there were no unrealized losses. At September 30, 1998, gross unrealized gains
and losses were $34,000 and $2,000, respectively. The maturities of these
marketable securities as of September 30, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
                                                     1999          1998
                                                  -----------  ------------
<S>                                               <C>          <C>
            Within one year                        $2,457,000   $28,877,000
            After one year through three years             --     3,825,000
                                                   ----------   -----------
            Total maturities                       $2,457,000   $32,702,000
                                                   ==========   ===========
</TABLE>

Investment in Incara
--------------------

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

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

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

See Note M.

D. Property and Equipment:

At September 30, 1999 and 1998, property and equipment consisted of the
following:
<TABLE>
<CAPTION>
                                                       1999          1998
                                                   ------------  ------------
<S>                                                <C>           <C>
Office equipment                                   $ 1,045,000   $ 1,725,000
Laboratory equipment                                        --     1,258,000
Leasehold improvements                                 547,000     2,321,000
                                                   -----------   -----------
                                                     1,592,000     5,304,000
Less: accumulated depreciation and amortization     (1,189,000)   (1,613,000)
                                                   -----------   -----------
                                                   $   403,000   $ 3,691,000
                                                   ===========   ===========
</TABLE>

Included in the above amounts are property and equipment under capital lease and
note obligations of $277,000 and $1,207,000 at September 30, 1999 and 1998,
respectively, and related accumulated amortization of $210,000 and $401,000 at
September 30, 1999 and 1998, respectively.  Depreciation expense related to the
assets under capital lease and note obligations amounted to $335,000, $612,000
and $772,000

                                     F-11
<PAGE>

for the years ended September 30, 1999, 1998 and 1997, respectively. Assets
financed through capital lease and note payable arrangements consist primarily
of office and laboratory equipment. The Company paid $137,000, $173,000 and
$165,000 in interest expense during the years ended September 30, 1999, 1998 and
1997, respectively, related to these capital lease and note payable obligations.

Depreciation and amortization expenses for the three years ended September 30,
1999, 1998 and 1997, were $933,000, $2,409,000 and $1,484,000, respectively.

E. Accrued Expenses:

At September 30, 1999 and 1998, accrued expenses consisted of the following:
<TABLE>
<CAPTION>

                                                 1999         1998
                                                 ----         ----
<S>                                          <C>          <C>
          Clinical and sponsored research    $ 8,956,000  $12,378,000
          Redux withdrawal                     7,641,000    7,982,000
          Compensation related                 1,566,000    3,150,000
          InterNutria discontinuation            276,000    1,719,000
          Other                                1,661,000    1,779,000
                                             -----------  -----------
                                             $20,100,000  $27,008,000
                                             ===========  ===========
</TABLE>
F. Commitments and Obligations:

The Company leases its facilities, as well as certain laboratory equipment and
furniture under non-cancelable operating leases. Rent expense under these leases
was approximately $1,974,000, $2,290,000 and $1,931,000 for the years ended
September 30, 1999, 1998 and 1997, respectively. The Company also leases certain
property and equipment under capital leases.

At September 30, 1999, the Company's future minimum payments under non-
cancelable lease arrangements are as follows:
<TABLE>
<CAPTION>
                                                         Operating    Capital
          Fiscal Year                                      Leases     Leases
          -----------                                      ------     ------
          <S>                                           <C>         <C>
          2000                                          $  730,000   $72,000
          2001                                             706,000     2,000
          2002                                             696,000        --
          2003                                             349,000        --
          2004                                                  --        --
          Thereafter                                            --
                                                        ----------   -------
          Total lease payments                          $2,481,000    74,000
                                                        ==========
          Less: amount representing interest                          (4,000)
                                                                     -------
          Present value of net minimum lease payments                $70,000
                                                                     =======
</TABLE>


At September 30, 1998, the Company's note obligations consisted of approximately
$972,000 in note payable agreements (the "Notes").  The Notes require monthly,
semi-annual or single payments, accrue interest at rates ranging from
approximately 5.8% to approximately 13.4% and expire at various dates through
June 2007. At September 30, 1998, $194,000 of the Notes have been classified as
current.  As a result of the CPEC Exchange Transactions (see Note M), there are
no outstanding Notes at September 30, 1999.

                                     F-12
<PAGE>

The Company has guaranteed the first five years of the performance of Incara
under a lease agreement for Incara Research Laboratory's (formerly Transcell)
("IRL") facilities.  Incara has announced its retention of an advisor to explore
the sale of all or a portion of its assets or the company.  If Incara defaults
on such lease agreement, the Company will become obligated to IRL's lessor. The
remaining guaranteed obligation pursuant to such lease is approximately
$2,820,000 from October 1999 through May 2002.

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

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

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

  Interneuron is named, together with other pharmaceutical companies, as a
defendant in approximately 1,965 product liability legal actions, many of which
purport to be class actions, in federal and state courts involving the use of
Redux and other weight loss drugs. On December 10, 1997, the federal Judicial
Panel on Multidistrict Litigation issued an Order allowing for the transfer or
potential transfer of the federal actions to the Eastern District of
Pennsylvania for coordinated pretrial proceedings.

  On September 25, 1998, the  District Court  preliminarily approved an
Agreement of Compromise and Settlement between the Company and the PMC relating
to a proposed settlement of all product liability litigation and claims against
the Company related to Redux.  On November 3, 1998, the District Court issued a
stay halting all Redux product liability litigation against the Company, pending
and future, in state courts, following the issuance of a similar stay halting
Redux product liability litigation against the Company in federal courts on
September 3, 1998.  As stated above, this proposed settlement was subsequently
rejected by the District Court and the stays have been vacated.

  On November 20, 1998, December 30, 1998 and February 5, 1999, the Company's
three product liability insurers filed actions against Les Laboratoires Servier
("Servier") and the Company in the District Court, pursuant to the federal
interpleader statute. The aggregate limits of the three commercial excess
insurance policies issued by the insurers to the Company is $40,000,000 in tiers
of $20,000,000, $5,000,000 in excess of $20,000,000, and $15,000,000 in excess
of $25,000,000. The insurers allege that both the Company and Servier have
asserted claims against these policies, a substantial portion of which has been
used in the Company's defense of the litigation. The insurers have deposited the
available proceeds up to the limits of their policies, which is subject to
ongoing claims by the Company and Servier, into the registry of the District
Court.

  On June 23, 1999, the United States Supreme Court issued its opinion in Ortiz,
overturning a putative "limited fund" class action settlement relating to
asbestos litigation.  In so doing, the Supreme Court identified certain
guidelines  that should be met for an action to be certified as a limited fund
class action.

                                     F-13



<PAGE>

The Company filed an additional brief with the District Court arguing that the
Company's settlement meets the Ortiz guidelines.

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

  On November 23, 1999, the District Court preliminarily approved a proposed
nationwide settlement of AHP's product liability litigation related to Redux and
Pondimin.  The Company is in discussions with AHP and the PMC regarding avenues
for the Company to reach a comprehensive resolution of its outstanding Redux-
related litigation.  The Company cannot predict whether any settlement can be
reached or the terms of any settlement.

  The Company, and certain present or former directors and/or officers of the
Company, have also been named as defendants in several lawsuits filed by alleged
purchasers of the Company's Common Stock, purporting to be class actions,
claiming violation of the federal securities laws. It is not possible for the
Company to determine its costs related to its defense in these or potential
future legal actions, monetary or other damages which may result from such legal
actions, or the effect on the future operations of the Company.

H. Stockholders' Equity:

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

Common Stock:  During fiscal 1995, certain subsidiaries issued convertible
preferred stock through private placements (the "Subsidiaries' Private
Placements"). In connection with certain of the Subsidiaries' Private
Placements, the Company issued 239,938 warrants to purchase shares of the
Company's Common Stock exercisable at $4.63 per share until June 30, 1998, all
of which were exercised or expired.  Additionally, investors in the private
placements had certain rights to cause the Company to purchase from them certain
amounts of the convertible preferred stock deemed to be illiquid but in no
circumstance for an amount greater than that initially paid by the investor (the
"Put Protection Rights"). As a result of Incara's initial public offering
("IPO") in February 1996 Progenitor's IPO and the Transcell Merger, the
Company's potential obligations under the Put Protection Rights expired.

Stock Options and Warrants: Under the Company's 1989 Stock Option Plan (the
"1989 Plan"), incentive or non-qualified options to purchase 3,000,000 shares of
the Company's Common Stock, and under the Company's 1994 Long-Term Incentive
Plan (the "1994 Plan"), incentive or non-qualified options to purchase 6,000,000
shares of the Company's Common Stock, may be granted to employees and directors
and consultants may be granted non-qualified options. Under the 1989 and 1994
Plans the term of each grant cannot exceed ten years.

In January 1998, the Company's Board of Directors adopted, and in March 1998 the
Company's stockholders approved, the 1998 Employee Stock Option Plan (the "1998
Plan") (along with the 1989 and 1994 Plans, the "Option Plans").  Under the 1998
Plan, options to purchase up to 1,500,000 shares of the

                                     F-14
<PAGE>

Company's Common Stock may be granted to employees, directors and consultants,
except persons who were executive officers or directors of the Company as of the
date of adoption of the 1998 Plan. The duration of the 1998 Plan is ten years
and the term of options granted thereunder cannot exceed seven years.

The Company has also granted, outside of the Option Plans, options to purchase
shares of the Company's Common Stock ("Non-Plan Options"). At September 30,
1999, 100,000 Non-Plan Options were outstanding.

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

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

                                     F-15
<PAGE>

Presented below under the caption "Stock Options" is all Plan and Non-Plan
option activity and under the caption "Warrants" is all warrant activity,
certain of which may also be disclosed in this and other Notes to the
Consolidated Financial Statements:



<TABLE>
<CAPTION>
                                                        Stock Options                 Warrants
                                                 -------------------------   ------------------------
                                                               Weighted
                                                               Average
                                                 Shares     Exercise Price   Shares     Warrant Price
                                                 ------     --------------   ------     -------------
<S>                                            <C>          <C>             <C>        <C>
          Outstanding at September 30, 1996     3,891,720        $ 9.85      804,313   $ 4.63 - $23.25

             Granted                            1,477,000        $21.71       50,000   $18.25 - $20.25

             Exercised                           (271,896)       $ 7.53       (3,156)  $          4.63

             Cancelled                            (14,750)       $19.19      (20,000)  $         23.25
                                               ----------                   --------

          Outstanding at September 30, 1997     5,082,074        $13.39      831,157   $ 4.63 - $23.25

             Granted                            8,555,641        $ 6.97      155,000   $  6.19 - $7.13

             Exercised                             (5,000)       $ 5.88      (27,500)  $          4.63

             Cancelled                         (7,242,392)       $12.72     (146,157)  $ 4.63 - $23.25
                                               ----------                   --------

          Outstanding at September 30, 1998     6,390,323        $ 5.57      812,500   $ 5.00 - $12.77

             Granted                              624,667        $ 3.74           --

             Exercised                            (14,400)       $ 0.83           --

             Cancelled                           (508,009)       $ 6.94           --
                                               ----------                   --------

          Outstanding at September 30, 1999     6,492,581        $ 5.30      812,500   $ 5.00 - $12.77
                                               ==========                   ========
</TABLE>

                                     F-16
<PAGE>

At September 30, 1999, stock options were outstanding and  exercisable as
follows:

<TABLE>
<CAPTION>
                                     Outstanding                                              Exercisable
        ------------------------------------------------------------------------       --------------------------
                                                     Weighted         Weighted                          Weighted
              Range of                               Average          Average                           Average
              Exercise                               Remaining        Exercise                          Exercise
               Price               Number         Contractual Life     Price              Number         Price
               -----               ------         ----------------     -----              ------         -----
<S>                               <C>                 <C>            <C>                <C>            <C>
           $1.53 - $5.00          3,124,468           4.4 years        $ 4.14           1,562,621       $ 4.31
           $6.19 - $10.00         3,320,613           5.6 years        $ 6.23           1,227,413       $ 6.31
           $10.50 - $20.13           47,500           6.4 years        $16.01              46,875       $15.97
                                  ---------                                             ---------
           $1.53 - $20.13         6,492,581           5.0 years        $ 5.30           2,836,909       $ 5.36
                                  =========                                             =========
</TABLE>

All outstanding options vest at various rates over periods up to four years and
expire at various dates from March 8, 2001 to March 17, 2009. At September 30,
1998, 757,772 options were exercisable at a weighted average exercise price of
$6.87.  At September 30, 1997, 2,698,907 options were exercisable at a weighted
average exercise price of $9.02.

At September 30, 1999, warrants were outstanding and exercisable as follows:

<TABLE>
<CAPTION>
              Range of                  Number          Number
           Exercise Prices           Outstanding      Exercisable
           ---------------           -----------      -----------
<S>                                  <C>              <C>
             $5.00-7.88                250,000           180,002
               $10.00                  500,000           500,000
               $12.77                   62,500            62,500
                                       -------           -------
                                       812,500           742,502
                                       =======           =======
</TABLE>


All outstanding warrants expire at various dates from August 16, 2000 to July
17, 2006 and have a weighted average exercise price of $9.14 per share.

Restricted Stock Awards:  As an integral component of a management and employee
retention program designed to motivate, retain and provide incentive to the
Company's management and other employees, the Company's Board of Directors
adopted the 1997 Equity Incentive Plan in October 1997 (the "1997 Plan"). The
1997 Plan provides for the grant of restricted stock awards which entitle the
plan participants to receive up to an aggregate of 1,750,000 shares of the
Company's Common Stock upon satisfaction of specified vesting periods.  As of
September 30, 1999, restricted stock awards to acquire an aggregate of 1,314,332
shares had been granted, net of forfeitures, to employees of the Company
primarily in consideration of services rendered by the employee to the Company
and payment of the par value of the shares. The shares subject to the awards
have been registered under the Securities Act of 1933 on a registration
statement on Form S-8 and, accordingly, may be sold by the 1997 Plan
participants immediately upon vesting of the shares.  In accordance with the
provisions of the 1997 Plan for automatic extension of vesting during Black-Out
Periods, as defined in the 1997 Plan, vesting of the shares commenced in April
1998.  Through September 30, 1999, 660,860 shares have vested and been issued by
the Company under the 1997 Plan. Vesting continues through May 2000 on the
remaining 653,472 shares subject to awards at September 30, 1999.

The Company has incurred and will continue to incur compensation expense from
the date of grant of awards through the vesting period of shares subject to
restricted stock awards. The charges relating to the restricted

                                     F-17
<PAGE>

stock awards to acquire 1,314,332 shares are expected to aggregate approximately
$14,000,000, the fair market value of the shares at the time of grant, of which
approximately $3,000,000 and $10,000,000 was incurred in fiscal 1999 and 1998,
respectively, and the remainder will be incurred through the final scheduled
vesting periods in fiscal 2000. Such expense has been and is being allocated to
research and development and selling, general and administrative expense.

Employee Stock Purchase Plan: The Company's 1995 Employee Stock Purchase Plan
(the "1995 Plan") covers an aggregate of 100,000 shares of Common Stock which is
offered in one-year offerings (an "Offering"), the first of which began April 1,
1995. Each Offering is divided into two six-month Purchase Periods (the
"Purchase Periods"). Stock is purchased at the end of each Purchase Period with
employee contributions at the lower of 85% of the last sale price of the
Company's Common Stock on the first day of an Offering or the last day of the
related Purchase Period.  At September 30, 1999, 26,648 shares remain to be
purchased under the 1995 Plan.

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


                                     F-18
<PAGE>

<TABLE>
<CAPTION>
                                 1999               1998              1997
                                 ----               ----              ----
<S>                         <C>                <C>               <C>
Dividend yield                      0%                 0%                0%
Expected volatility            85%-90%            70%-90%           60%-70%
Risk-free interest rate      4.4%-5.8%          5.3%-5.6%         6.0%-6.9%
Expected option life        1-5 years           2-3 years         5 years
Weighted average grant
 date fair value:
    Interneuron              $2.08               $  3.87           $12.81
    Incara                   $3.89               $  9.57           $11.46
    Transcell                $  --               $    -            $ 0.17

</TABLE>

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

For the purpose of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. The pro forma effect on
net loss for the fiscal years ended September 30, 1999, 1998 and 1997 may not be
representative of the pro forma effect on net income or loss in future years.
The Company's pro forma information is as follows for the fiscal years ended
September 30, 1999, 1998 and 1997:



<TABLE>
<CAPTION>
                                1999                      1998                      1997
                      -----------------------   -----------------------   -----------------------
                      As Reported   Pro Forma   As Reported   Pro Forma   As Reported   Pro Forma
                      -----------   ---------   -----------   ---------   -----------   ---------
<S>                   <C>          <C>          <C>          <C>          <C>          <C>
Net loss              $37,762,000  $49,408,000  $69,962,000  $83,043,000  $55,256,000  $62,773,000
Net loss per share    $      0.90  $      1.18  $      1.69  $      2.00  $      1.35  $      1.53
</TABLE>

Treasury Stock and Stock Repurchases: In March 1997, the Company announced that
its Board of Directors had authorized it to repurchase from time to time through
open-market transactions up to 1,500,000 shares of the Company's Common Stock.
The Company repurchased 217,500 shares, all in fiscal 1997, for an aggregate
purchase price of approximately $3,978,000.  All treasury stock has been re-
issued primarily pursuant to stock option and warrant exercises and the 1995
Plan.

Call Options: In May 1997, the Company purchased in private transactions from
Swiss Bank Corporation, London Branch ("SBC") capped call options, which were
subsequently modified, on Interneuron Common Stock. As modified, these call
options gave Interneuron the right to purchase from SBC up to a total of
1,240,000 shares of Interneuron Common Stock at a strike price of $14.50.  All
call options expired without exercise.

                                     F-19
<PAGE>

In exchange for the purchases of these call options, in lieu of cash purchase
prices, the Company sold to SBC call options entitling SBC to purchase from the
Company at a strike price of $36.00 per share, an aggregate of 2,000,000 shares
of Interneuron Common Stock, 1,000,000 shares on each of December 30 and 31,
1999. Modification to the original options, which consisted of extensions of
maturity dates and reductions of the caps and strike prices, resulted in a
$500,000 cash payment to the Company in fiscal 1997 which was reflected as a
credit to additional paid-in capital. The Company will have the right to settle
these call options with cash or stock, subject to certain conditions. If
exercised, the Company expects to settle the call options that it sold through
issuances by the Company to SBC of up to an aggregate of 2,000,000 shares of
Common Stock, subject to the effectiveness of a registration statement covering
the resale of these shares delivered. Because the Company has the ability to
settle call options through issuance or receipt of Common Stock, the Company has
accounted for the original purchases and sales of these call options as
equivalent and offsetting noncash equity transactions. Any gains realized from
purchased call options will be reflected in additional paid-in capital.

Other: In addition to the 42,019,000 shares of Common Stock outstanding at
September 30, 1999, there were approximately 18,161,000 shares of Common Stock
reserved for issuance ("Reserved Common Shares"). Included in the number of
Reserved Common Shares are the following: (i) 4,756,000 shares of Common Stock
reserved for issuance upon conversion of the Company's authorized but unissued
Preferred Stock; (ii) 622,000 shares of Common Stock issuable upon conversion of
issued and outstanding Preferred Stock; (iii) 1,089,000 shares reserved for
issuance under the 1997 Plan; (iv) 8,781,000 shares reserved for issuance under
the Option Plans and the 1995 Plan, (of which approximately 6,392,000 stock
options were outstanding, not all of which were vested); (v) approximately
913,000 shares reserved for issuance from exercise of outstanding warrants and
Non-Plan Options; and (vi) 2,000,000 shares reserved for issuance pursuant to
call options potentially exercisable by SBC.

I. Income Taxes:

At September 30, 1999 and 1998, the significant components of the Company's
deferred tax asset consisted of the following:
<TABLE>
<CAPTION>
                                                    1999           1998
                                                    ----           ----
<S>                                           <C>             <C>
Federal and state net operating loss
     carryforwards                            $  55,718,000   $ 60,876,000
Federal and state tax credit carryforwards        4,647,000      5,154,000
Capital loss carryforwards                        7,160,000
Accrued expenses                                 10,602,000     15,263,000
Investment in CPEC LLC                            9,480,000
Investment in unconsolidated subsidiaries        12,520,000     11,880,000
                                              -------------   ------------
Total deferred tax asset before valuation
     allowance                                  100,127,000     93,173,000
                                              -------------   ------------
Valuation allowance against total deferred
     tax asset                                 (100,127,000)   (93,173,000)
                                              -------------   ------------
Net deferred tax asset                        $          --   $         --
                                              =============   ============
</TABLE>


At September 30, 1999, the Company had net operating loss carryforwards
available for federal income tax purposes of approximately $150,000,000 which
expire at various dates from 2004 to 2019. In addition, the Company had
approximately $3,200,000 of tax credit carryforwards for federal income tax
purposes expiring at various dates through 2014 and capital loss carryforwards
of approximately $17,900,000 for federal income tax purposes expiring in 2004.
The Company's ability to use the net operating loss carryforwards may

                                     F-20
<PAGE>

be subject to limitations resulting from ownership changes as defined in the
U.S. Internal Revenue Code. Approximately $12,500,000 of the net operating loss
carryforwards available for federal income tax purposes relate to exercises of
non-qualified stock options and disqualifying disposition of incentive stock
options, the tax benefit from which, if realized, will be credited to additional
paid-in capital.

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

J.  Earnings Per Share:

The following table sets forth the computation of basic and diluted earnings per
share for the years ended September 30, 1999, 1998 and 1997:

<TABLE>
<CAPTION>
                                                 1999            1998          1997
                                                 ----            ----          ----
<S>                                         <C>             <C>
Numerator for basic and diluted:
     Net loss                                $(37,762,000)   $(69,962,000)  $(55,256,000)
                                             ============    ============   ============
Denominator for basic and diluted:
     Weighted average shares outstanding       41,898,000      41,468,000     41,064,000
                                             ============    ============   ============
Net loss per common share - basic            $     (0.90)    $      (1.69)  $      (1.35)
                                             ============    ============   ============
Net loss per common share - diluted          $     (0.90)    $      (1.69)  $      (1.35)
                                             ============    ============   ============
</TABLE>


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

During the year ended September  30, 1998, securities not included in the
computation of diluted earnings per share, because their exercise price exceeded
the average market price during the period were as follows: (i) options to
purchase 301,625 shares of Common Stock at prices ranging from $7.88 to $28.13
with expiration dates ranging up to May 5, 2007; (ii) warrants to purchase
612,500 shares of Common Stock with exercise prices ranging from $7.88 to $12.77
and with expiration dates ranging up to June 1, 2002; and (iii) call options
sold by the Company for 2,000,000 shares of Common Stock with an exercise price
of $36.00 and expiration dates ranging up to December 31, 1999. Additionally,
during the year ended September 30, 1998, securities not included in the
computation of diluted earnings per share, because they would have an
antidilutive effect due to the net loss for the period, were as follows:
(i) options to purchase 6,088,698 shares of Common Stock at prices ranging from
$0.83 to $7.25 with expiration dates ranging up to March 3, 2008; (ii) warrants
to purchase 200,000 shares of Common Stock with exercise prices ranging from
$5.00 to $7.13

                                     F-21
<PAGE>

and with expiration dates ranging up to July 17, 2006; (iii) Series B and C
preferred stock convertible into 622,222 shares of Common Stock; and
(iv) unvested Restricted Stock Awards to acquire 725,146 shares of Common Stock
granted pursuant to the Company's 1997 Equity Incentive Plan.

During the year ended September 30, 1997, securities not included in the
computation of diluted earnings per share, because their exercise price exceeded
the average market price during the period were as follows: (i) options to
purchase 581,550 shares of Common Stock at prices ranging from $21.50 to $32.00
with expiration dates ranging up to July 23, 2007; (ii) warrants to purchase
55,000 shares of Common Stock with exercise prices of $23.25 and with expiration
dates ranging up to July 17, 2006; and (iii) call options sold by the Company
for 2,000,000 shares of Common Stock with an exercise price of $36.00 and
expiration dates ranging up to December 31, 1999. Additionally, during the year
ended September 30, 1997, securities not included in the computation of diluted
earnings per share, because they would have an antidilutive effect due to the
net loss for the period, were as follows: (i) options to purchase 4,500,524
shares of Common Stock at prices ranging from $0.83 to $20.25 with expiration
dates ranging up to September 23, 2007; (ii) warrants to purchase 826,157 shares
of Common Stock with exercise prices ranging from $4.63 to $20.13 and with
expiration dates ranging up to July 6, 2004; and (iii) Series B and C preferred
stock convertible into 622,222 shares of Common Stock.

K. Related Party Transactions:

The Company and certain of its subsidiaries have agreements with certain
directors and former directors of the Company and parties related to directors
to provide technical and other consulting services. The total of such payments
were approximately $277,000, $414,000, and $417,000 in fiscal 1999, 1998 and
1997, respectively. In addition to the above, (i) one related party was a
principal investigator in a clinical trial and received approximately $34,000
and $296,000 in fiscal 1998 and 1997, respectively, for services performed in
that capacity and (ii) one director is the chairman and chief executive officer
of an entity that provided product distribution services for certain InterNutria
products to which InterNutria paid approximately $12,000, $58,000, and $117,000
in fiscal 1999, 1998 and 1997, respectively.

The Company made contributions of $55,000, $147,000, and $147,000,  in the years
ended September 30, 1999, 1998, and 1997, respectively,  to The Center for Brain
Science and Metabolism Charitable Trust of which one of the Company's former
directors is the scientific director.

L. Agreements:

Servier: In February 1990, as amended, the Company entered into a series of
agreements with Les Laboratoires Servier (" Servier") under which the Company
licensed U.S. marketing rights to Redux, in exchange for royalty payments of
11.5% of net product sales.  Additionally, the agreements required the Company
to purchase the bulk compound from an affiliate of Servier.  (See Note G.)

American Home Products: In November 1992, the Company entered into an agreement
with American Cyanamid Company (which subsequently was acquired by AHP) for the
development and marketing in the U.S. of  Redux.   In connection with this
agreement, AHP made certain milestone payments to the Company and purchased from
the Company the Series B and C Preferred Stock which is outstanding at September
30, 1999 and 1998. Holders of Series B and C Preferred Stock are entitled to
receive mandatory dividends of $.13 and $1.00 per share, respectively,  payable
at the election of the Company in cash or Common Stock. Such dividends are
payable annually on April 1 of each year, accrue on a daily basis and are
cumulative. Holders of Series B  and C Preferred Stock are also entitled to a
liquidation preference of $12.53 and $100.00 per share, respectively,  plus
accumulated and unpaid dividends. Holders of Series B and C Preferred Stock are
entitled to convert such shares into an aggregate of 622,222 shares of Common
Stock (a conversion price of $5.63 per share) subject to anti-dilution
adjustments.  Holders of the Series B and C Preferred Stock are entitled to vote
on all matters submitted to a vote of stockholders other than the election of
directors, generally holding the number of votes equal to the number of shares
of Common Stock into which such shares of Preferred Stock are convertible.
Additionally, the agreement with AHP provides for royalty payments to the
Company based upon net sales of Redux and for AHP to share equally with the
Company certain research and development expenses. AHP has the right to
terminate its sublicense upon twelve months notice to the Company.


On April 29, 1996, Redux received FDA clearance for marketing. The Company's
License Agreement with AHP required AHP to pay base royalties equal to 11.5% of
AHP's net sales and additional royalties ranging from 5% of the first
$50,000,000 of AHP's annual net sales if Redux is a scheduled drug to 10% of
AHP's annual net sales over $150,000,000.  On September 15, 1997, the Company
and AHP announced a market withdrawal of Redux. (See Note G.)

                                     F-22
<PAGE>

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

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

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

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

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

Eli Lilly: In June 1997, the Company entered into an agreement with Eli Lilly
and Co. and Eli Lilly S.A. ("Lilly") relating to the licensing by Lilly from the
Company of a use patent for Lilly's antidepressant Prozac to treat disturbances
of appetite and mood associated with premenstrual syndrome. Lilly paid the
Company an up-front license fee of $1,000,000, which was recorded as license fee
revenue in fiscal 1997, and is required to make additional payments based upon
achievement of development and regulatory related milestones and to pay
royalties based upon net sales.  In fiscal 1999, the Company recorded a total of
$1,000,000 in milestone fees from Lilly relating to filing and receipt of
approval for marketing Prozac in the United Kingdom for the above indication.

Merck: In July 1997, Transcell (subsequently merged into Incara; see Note M) and
Interneuron entered into a Research Collaboration and Licensing Agreement with
Merck & Co., Inc. ("Merck") (the "Merck Collaboration") to discover and
commercialize certain novel antibacterial agents.  Interneuron assigned its
rights and obligations under the Merck Collaboration in connection with the
Transcell Merger. Merck made initial payments totaling $2,500,000 of which
$1,500,000 was recognized as license fee revenue in fiscal

                                     F-23
<PAGE>

1997 and $1,000,000 was recognized as license fee revenue ratably over the
twelve month option period commencing in July 1997. Additionally, Merck provided
research support for the first two years of the agreement, made payments based
upon achievement of certain defined clinical development and regulatory
milestones and will pay royalties based upon net sales of products resulting
from the Merck Collaboration. A portion of any royalties from Merck are payable
to Interneuron. (See Note M.)

M. Subsidiaries:

Incara
------

General:

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

The Astra Merck Collaboration was terminated in September 1998.  Incara received
$5,000,000 upon execution of the Astra Merck Collaboration, and paid Astra
Pharmaceuticals LP $10,000,000 in December 1997, which had been accrued as a
liability at September 30, 1997.  During the fiscal years ended September 30,
1998 and 1997, the Company recognized contract revenue of approximately
$4,833,000 (including a $4,000,000 termination fee), and $553,000, respectively,
from payments made by Astra Pharmaceuticals LP  to Incara. During the fiscal
years ended September 30, 1998 and 1997, Astra Merck assumed additional
liabilities of approximately $6,065,000 and  $5,505,000  respectively, on
Incara's behalf. These additional amounts did not impact the Company's
Consolidated Statements of Operations, as they were offset against related
expenses. At September 30, 1998, the Company's Consolidated Balance Sheet
included approximately $944,000 of accounts receivable due from Astra
Pharmaceuticals  and approximately $941,000 of accrued expenses related to
obligations assumed by Astra Pharmaceuticals LP.

The Knoll Collaboration related to both the twice-daily bucindolol formulation
and a once-a-day bucindolol formulation. Under the terms of the Knoll
Collaboration, Knoll made up-front payments to CPEC, Inc. totaling $3,143,000
which were recognized as contract and license fee revenue in fiscal 1997. Knoll
and Incara agreed to share the development and marketing costs of bucindolol in
the Knoll Territory. In general, Knoll agreed to pay approximately 60% of
certain development and marketing costs prior to product launch and Incara
agreed to pay approximately 40% of such costs, subject to certain maximum dollar
limitations. Knoll also agreed to pay approximately 60% of once-a-day
formulation development costs that related solely to the Knoll Territory and
approximately one-third that would have had worldwide benefit. Knoll and Incara
were sponsoring a 2000 patient clinical trial in Europe known as BEAT
(Bucindolol Evaluation after Acute

                                     F-24
<PAGE>

myocardial infarction Trial). In August 1999 Knoll notified Incara that BEAT has
been stopped and it is canceling the Knoll Agreement.

In February 1997, the Company announced that its Board of Directors had
authorized it to purchase from time to time through open-market transactions up
to 200,000 shares of the common stock of Incara. As of September 30, 1998, the
Company had purchased 129,400 shares of Incara common stock, all in fiscal 1997,
for an aggregate purchase price of approximately $2,951,000, of which
approximately $2,234,000 was recorded as purchase of in-process research and
development in fiscal 1997.

Transcell Merger:

On May 8, 1998, the merger of Transcell with and into Incara and the acquisition
by Incara of certain related technology rights owned by Interneuron was
completed. Simultaneously, Interneuron contributed to Transcell's capital all of
Transcell's indebtedness and payables, aggregating $18,698,000, to Interneuron
(the "Transcell Merger").  Consideration given by Incara consisted of (i) Incara
common stock issuable to the former Transcell stockholders, including
Interneuron, in three installments with an aggregate market value at closing of
approximately $14,200,000, of which $3,000,000 was paid at closing as an initial
payment to Interneuron for certain of its technology rights and continued
guarantees of certain Transcell leases (the "Initial Technology/Guarantee
Payment"), and (ii) the issuance of options and warrants to purchase 259,488
shares of Incara common stock to Transcell employees and consultants in exchange
for their options and warrants to purchase Transcell capital stock.
Accordingly, in connection with the first installment of the merger
consideration due at the closing of the merger, Incara issued an aggregate of
320,151 shares of common stock, of which 191,383 shares were issued to
Interneuron.  In addition, Incara issued 174,672 shares to Interneuron for the
Initial Technology/Guarantee Payment.   Incara also agreed to pay Interneuron a
royalty on sales of certain products that may be developed under the Merck
Agreement.  The second and third installments of the merger consideration were
to be made in August 1999 and February 2000, respectively, and each installment
was to consist of the issuance of approximately $3,000,000 of Incara common
stock, as then valued.  Pursuant to the CPEC Exchange Transactions (see below),
the Company waived its right to receive the second installment of the merger
consideration in August 1999 and instead retained a number of Incara shares at a
price determined as of July 15, 1999.  Incara's acquisition of the minority
shareholders' interest in Transcell resulted in Incara recording a charge to
operations in fiscal 1998 for the purchase of in-process research and
development of approximately $5,300,000.  This charge was eliminated in
consolidation and is not reflected in the Company's results of operations
because the Company did not acquire any incremental interest in Transcell's net
assets as a result of the transaction.  In connection with this transaction, the
Company also recorded a credit to additional paid-in capital of approximately
$2,212,000 to reflect adjustments to minority interest resulting from the
Transcell Merger and the book value of the Incara shares received by the Company
for the Initial Technology/Guarantee Payment.  Interneuron owned approximately
61% of the outstanding capital stock of Incara before the closing of the
Transcell Merger and approximately 62% immediately after the closing of the
Transcell Merger.

CPEC Exchange Transactions:

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

                                     F-25
<PAGE>

Company (the "Redeemed Shares") and the Company cancelled a promissory note
issued by Incara to the Company in a related transaction, as described below.

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

Pursuant to the Assignment and License Agreement CPEC LLC (i) assigned to Incara
all its rights, and Incara assumed all of CPEC LLC's liabilities, under the
Knoll Agreement, except for the Company's 19.9% portion of CPEC LLC's pre-CPEC
Exchange Transactions liability to Knoll (approximately $250,000), and (ii)
licensed to Incara development and marketing rights in the Knoll Territory,
subject to the Knoll Agreement. In exchange, Incara agreed to pay CPEC a royalty
based on net sales of bucindolol in the Knoll Territory and 65% of a milestone
payment payable by Knoll if net sales in the Knoll Territory exceed a specified
amount. Under the LLC Agreement, any payments that would have been received by
CPEC under the Assignment and License Agreement would be distributed to the
Company.

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

The Company and Incara also entered into a registration rights agreement.  Under
this agreement, Incara granted the Company certain registration rights under the
Securities Act of 1933 relating to the Retained Shares as well as other shares
of Incara common stock the Company has the right to receive in the future,
including those issuable in February 2000 as the third installment of the
Transcell Merger consideration.

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

The Company has  reflected the CPEC Exchange Transactions in its consolidated
financial statements as of July 15, 1999 by removing from them the consolidated
financial statements of Incara and commencing

                                     F-26
<PAGE>

consolidation of only CPEC LLC. Interneuron used the purchase method of
accounting for the acquisition of a majority and controlling interest in CPEC
LLC and incurred a noncash charge of $2,421,000 for in-process research and
development related to the CPEC Exchange Transactions in fiscal 1999. As of
September 1999, the Company has determined not to continue BEXTRA development
and has reflected a liability of approximately $640,000 related to such decision
at September 30, 1999.

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

Progenitor:
-----------

In August 1997, Progenitor completed an initial public offering (the "Progenitor
IPO") of  2,875,000 units, at $7.00 per unit, each unit consisting of one share
of Progenitor common stock and one five-year warrant to purchase one share of
Progenitor common stock at $10.50 per share. The Progenitor IPO resulted in
proceeds to Progenitor, net of offering-related costs, of approximately
$17,200,000. Interneuron purchased 500,000 units of the Progenitor IPO for a
total of $3,500,000. Concurrent with the Progenitor IPO, Progenitor sold
1,023,256 shares of Progenitor common stock to Amgen pursuant to a stock
purchase agreement for a purchase price of $4,500,000 in cash and a $1,000,000
promissory note. Concurrent with the closing of the Progenitor IPO, Progenitor
acquired Mercator Genetics, Inc. ("Mercator") (the "Mercator Acquisition") for
an aggregate purchase price of approximately $24,000,000, including related
transaction costs, paid with the issuance of approximately 3,443,000 shares of
Progenitor common stock, plus the assumption of Mercator liabilities,
forgiveness of debt relating to advances made by Progenitor to Mercator and the
issuance of stock options and warrants.  Interneuron's ownership in Progenitor's
outstanding capital stock decreased from approximately 76% at September 30, 1996
to approximately 37% at September 30, 1997 principally due to the Progenitor IPO
and the Mercator Acquisition. As a result of the Company's decreased percentage
of ownership in Progenitor, as of the date of the Progenitor IPO and Mercator
Acquisition, the Company ceased consolidating the financial statements of
Progenitor and commenced including Progenitor in the Company's financial
statements using the equity method of accounting.  At September 30, 1999 and
1998, Interneuron's ownership in Progenitors's outstanding capital stock was
approximately 36%.

In connection with the Mercator Acquisition, Progenitor incurred non-recurring
charges to operations in fiscal 1997 related to the purchase of in-process
research and development. Interneuron included approximately $7,800,000 of these
charges in equity in net loss of unconsolidated subsidiary based on the
Company's ownership interest in Progenitor. As a result of the Progenitor IPO,
Interneuron recognized a gain on its investment in Progenitor of approximately
$7,291,000 which was recorded as an increase in the Company's additional paid-in
capital.  In fiscal 1997, the Company reported equity in Progenitor's net losses
of approximately $9,028,000 for the period from the Progenitor IPO to September
30, 1997.

In December 1998, Progenitor announced its intention to implement an immediate
cessation of operations. Progenitor did not have sufficient funds at that time
to meet its obligations and was unable to raise additional funds.  Progenitor's
market valuation had been substantially reduced and the Company could not viably
sell any of its holdings of Progenitor securities. As a result, the Company's
investment  in Progenitor was reduced to zero as of September 30, 1998.  During
the year ended September 30, 1998, the Company reported equity in Progenitor's
net losses of approximately $4,040,000.  At September 30, 1999, the Company has
reflected a receivable from Progenitor of $250,000 related to an expected
distribution of  net cash resulting from Progenitor's sales of assets and
payments of liabilities.  This estimated dividend was recorded in income as

                                     F-27
<PAGE>

equity in unconsolidated subsidiary in fiscal 1999. Following are condensed
statements of operations and balance sheet data of Progenitor for which fiscal
1998 information is unaudited:

<TABLE>
<CAPTION>
                                     Fiscal Year ended September 30,
                                     -------------------------------
                                           1998             1997
                                           ----             ----
<S>                                 <C>              <C>
Statement of Operations:
Revenues                             $    485,000     $  1,142,000
Charge for acquired in-process
     research and development                  --       21,092,000
Net loss                              (13,916,000)     (30,283,000)

<CAPTION>
                                            September 30, 1998
                                     -------------------------------
<S>                                         <C>
Balance Sheet:
Current assets                                 $7,239,000
Noncurrent assets                               3,062,000
Current liabilities                             4,513,000
Noncurrent liabilities                          2,849,000
</TABLE>

Transcell:
---------

Until May 8, 1998, the date of the Transcell Merger (see "Incara" above),
the Company consolidated the financial statements of Transcell.  After May 8,
1998, Transcell was merged into Incara and operated as an Incara division called
Incara Research Laboratories.  Therefore, the results of Transcell continued to
be included in the Company's Consolidated Results of Operations until the CPEC
Exchange Transactions.  The Company's ownership of Transcell was approximately
79% at September 30, 1997 and immediately prior to the Transcell Merger.

InterNutria:
-----------

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

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

                                     F-28
<PAGE>

In September 1998, the Company adopted a plan to discontinue the operations of
InterNutria. Accordingly, the net losses from InterNutria's operations have been
segregated from continuing operations and condensed and reported on a separate
line on the statement of operations. In fiscal 1998, the Company recorded a
charge of $2,326,000 for the discontinuation of InterNutria's operation. In
fiscal 1999, the Company determined certain costs relating to the
discontinuation of InterNutria would not be incurred and recorded a credit of
$816,000 to discontinuation of InterNutria. At September 30, 1998 the assets of
InterNutria were $571,000 and the liabilities were $35,543,000, including
indebtedness to Interneuron of $33,019,000. At September 30, 1999, the assets of
InterNutria were $2,000 and the liabilities were $37,326,000, including
indebtedness to Interneuron of $37,054,000. All inventories have been fully
reserved at September 30, 1999 and 1998. All indebtedness to Interneuron is
eliminated in the consolidated financial statements. The Company has sought to
sell InterNutria or all or part of its assets. InterNutria's sports drink
product line was sold in fiscal 1999 for future royalties on sales commencing in
2001; PMS Escape has not been sold. The Company does not expect to generate
significant proceeds from any sales of InterNutria or its assets.

Operating results of InterNutria, exclusive of charges relating to the
discontinuation of operations and interest on intercompany debt, for the fiscal
years ended September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
                                                 1998           1997
                                                 ----           ----
<S>                                          <C>            <C>

        Revenues                             $  2,567,000   $   879,000
        Operating expenses                     19,701,000     6,345,000
                                             ------------   -----------
        Net income/(loss) from operations     (17,134,000)   (5,466,000)

        Interest (expense) income net             (17,000)     (120,000)
                                             ------------   -----------

        Net income/(loss)                    $(17,151,000)  $(5,586,000)
                                             ============   ===========
</TABLE>

N.  Subsequent Events

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

In December 1999, the Company entered into an agreement with Takeda Chemical
Industries, Ltd. ("Takeda") under which the Company licensed to Takeda exclusive
U.S. and Canadian commercialization rights to citicoline (the "Takeda
Agreement") in exchange for $13,000,000 in licensing and other guaranteed
payments, of which approximately $11,500,000 has been received to date, up to
$60,000,000 in payments contingent upon the achievement of future regulatory
milestones in the U.S. and Canada, and royalties on net sales. Takeda also
agreed to fulfill the royalty payment obligations of Interneuron to Ferrer,
pursuant to Interneuron's agreement with Ferrer, and to fund any future Phase 4
studies of citicoline in stroke and Phase 3 studies for additional indications.
The Takeda Agreement also provides an option to Takeda to negotiate a license
for any one alternative Interneuron compound, excluding pagoclone, in the event
Takeda decides to terminate the citicoline license following a review of the
results of the ongoing 899-person Phase 3 clinical trial.

In December 1999, the Company entered into an agreement with Warner-Lambert
Company ("Warner-Lambert"), under which it licensed to Warner-Lambert exclusive
worldwide rights to commercialize pagoclone (the "Warner-Lambert Agreement").
Under the Warner-Lambert Agreement, the Company is entitled to receive
$13,750,000 in an up-front payment and up to $60,000,000 in payments contingent
upon the achievement of clinical and regulatory milestones. Warner-Lambert also
agreed to pay Interneuron royalties on net sales. Under the Warner-Lambert
Agreement, Warner-Lambert would be responsible for conducting and funding all
further clinical development, regulatory review, manufacturing and marketing of
pagoclone for all indications on a worldwide basis. Under the Company's
agreement with RPR, RPR is entitled to receive a portion of the payments to be
received by the Company from Warner-Lambert.

                                     F-29