<PAGE>   1
                       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, 1998
                                       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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001
par value

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve (12) months (or for such shorter period that
the registrant was required to file such report(s)), and (2) has been subject
to the filing requirements for the past ninety (90) days.         YES [X] NO

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

The aggregate market value of the voting and non-voting common equity (excluding
preferred stock convertible into and having voting rights on certain matters
equivalent to 622,222 shares of common stock) held by non-affiliates of the
registrant was approximately $69,500,000, based on the last sales price of the
Common Stock as of December 21, 1998. 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 21, 1998, 41,817,017 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,
1998 to be filed pursuant to Regulation 14A under the Securities Exchange Act of
1934 and the Exhibit Index hereto.


<PAGE>   2


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, including the
proposed settlement of the Redux-related product liability 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," "estimate"
or other expressions which are predictions of or indicate future events and
trends and which 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, including the
risk that the proposed settlement of the product liability litigation will be
finally approved; uncertainties relating to clinical trials, regulatory approval
and commercialization of CerAxon; 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; contractual arrangements; 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" refers to Interneuron
Pharmaceuticals, Inc.; the "Company" refers to Interneuron and its Subsidiaries;
the "Subsidiaries" refers to Intercardia, Inc., a majority-owned subsidiary of
the Company ("Intercardia"), and its subsidiaries, including CPEC, Inc. ("CPEC")
and InterNutria, Inc., a majority-owned subsidiary of the Company
("InterNutria"); and "Common Stock" refers to the common stock, $.001 par value,
of Interneuron.

     Redux(TM) is a trademark of Les Laboratoires Servier, licensed to the
Company and American Home Products Corp. ("AHP"). CerAxon(TM), AnatoMark(TM) and
PMS Escape(TM) are trademarks of the Company and BEXTRA(R) is a registered
trademark of Intercardia. LidodexNS(TM) is a trademark of Algos Pharmaceutical
Corp., licensed to the Company. All other trademarks or trade names referred to
in this report are the property of their respective owners.

Item 1. Business.

     (a) General Development of Business

     The Company is a diversified biopharmaceutical company engaged in the
development and commercialization of a portfolio of products and product
candidates primarily for central nervous system and other diseases. The Company
seeks to acquire, develop and commercialize products with international market
experience or that are in clinical or late pre-clinical development. The Company
is currently developing several drugs in clinical trials, including citicoline
for ischemic stroke, pagoclone for panic and anxiety and, through Intercardia,
BEXTRA (bucindolol HCl) for congestive heart failure. In April 1998, the



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Company withdrew its New Drug Application ("NDA") for citicoline which had been
submitted to the Food and Drug Administration (the "FDA") in December 1997,
after negative results from a preliminary analysis of a small Phase 3 clinical
trial. The Company commenced a third large Phase 3 clinical trial in July 1998
testing citicoline in ischemic stroke.

     Intercardia is primarily focused on cardiovascular disease. Its most
advanced drug, BEXTRA, is in a Phase 3 clinical trial among patients with
congestive heart failure. As a result of the merger in May 1998 of Transcell
Technologies, Inc., formerly a majority-owned subsidiary of Interneuron
("Transcell"), into Intercardia, Intercardia is also engaged in
carbohydrate-based drug discovery.

     In September 1998, the Company adopted a plan to discontinue operations of
InterNutria, which was focused on dietary supplement products. In December 1998,
Progenitor, Inc., a minority-owned subsidiary of Interneuron, announced its
intention to terminate its operations effective immediately. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

     On September 15, 1997, the Company announced the 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 779 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 25, 1998, the U.S. District Court for the Eastern District of
Pennsylvania preliminarily approved a formal agreement to settle all product
liability litigation and claims against Interneuron related to Redux. The Court
also conditionally certified a limited fund class action. A fairness hearing on
the settlement has been scheduled for February 25, 1999. The settlement is
subject to certain conditions and will not become final until approved by the
Court and the time for filing appeals has passed or all appeals have been
exhausted.

     The Company has also been named as a defendant in approximately ten
lawsuits filed by alleged purchasers of the Company's common stock, purporting
to be class actions, claiming violation of the federal securities laws. The
Redux-related product liability and securities litigation and claims may
materially adversely affect the Company and its financial condition and results
of operations.

     The Company was incorporated in 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 address is http://www.interneuron.com.

     (b) Financial Information about Industry Segments

       The Company operates in only one business segment.

     (c) Narrative Description of Business




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PRINCIPAL PRODUCTS UNDER DEVELOPMENT


<TABLE>
<CAPTION>

INTERNEURON:
------------
PRODUCT       INDICATION/USE                     STATUS (*)             COMMERCIAL RIGHTS
-------       --------------                     ----------             -----------------
<S>           <C>                                <C>                    <C>
CerAxon       Stroke                             Phase 3                U.S. and Canada
(citicoline)  

Pagoclone     Anxiety/Panic disorders            Phase 2/3 trial        Worldwide, except
                                                 completed August       for France, where
                                                 1998                   Rhone-Poulenc Rorer
                                                                        Pharmaceuticals
                                                                        Inc. ("RPR")
                                                                        retains an option

IP501         Cirrhosis of the liver             Phase 3                Option to acquire
                                                                        rights to North
                                                                        America and Asia
</TABLE>

<TABLE>
<CAPTION>

INTERCARDIA:
------------
PRODUCT OR TECHNOLOGY    INDICATION/USE        STATUS(*)              COMMERCIAL RIGHTS
----------------------  --------------        ---------              -----------------
<S>                        <C>                   <C>                    <C>
BEXTRA (bucindolol)        Congestive heart      Phase 3                Worldwide; licensed
                           failure                                      in Europe and other
                                                                        areas outside the
                                                                        U.S. and Japan to
                                                                        BASF Pharma/Knoll
                                                                        AG ("Knoll")

OP2000                     Inflammatory bowel    Phase 1                Worldwide (except
                           disease                                      for Japan and
                                                                        Korea)
                           
Antioxidant small          Diseases associated   Preclinical            Worldwide           
molecules                  with oxygen free                                                 
                           radicals                                                         

Combinatorial              Drug discovery        Research; Preclinical  Worldwide; Rights    
carbohydrate                                                            to compounds from    
chemistry                                                               two distinct         
                                                                        structural classes   
                                                                        of anti-bacterial    
                                                                        agents licensed to   
                                                                        Merck & Co., Inc.    
                                                                        ("Merck")            

Hepatic stem cell          Liver diseases;       Research               Worldwide
technology                 cell and gene                                       
                           therapy                                             
</TABLE>

_________________
* See "Government Regulation"             




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REDUX

     Product Liability Litigation

     Following the withdrawal of Redux in September 1997, Interneuron has been
named, together with other pharmaceutical companies, as a defendant in
approximately 779 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.

     Proposed Settlement: On September 25, 1998, the U.S. District Court for the
Eastern District of Pennsylvania (the "Court") preliminarily approved an
Agreement of Compromise and Settlement (the "Settlement Agreement") relating to
the proposed settlement of all product liability litigation and claims against
Interneuron related to Redux. The Court also conditionally certified a limited
fund class action. The Court order followed a letter of understanding outlining
terms of the settlement announced on September 3, 1998 and execution of the
formal settlement agreement between the Company and the Plaintiffs' Management
Committee, consisting of attorneys designated by the Court to represent
plaintiffs in the multi-district litigation relating to Redux. A fairness
hearing on the settlement has been scheduled for February 25, 1999.

     On November 3, 1998, the Court issued a stay halting all Redux product
liability litigation against the Company, pending and future, in state courts.
This followed the issuance of a similar stay halting Redux product liability
litigation in federal courts on September 3, 1998. These stays will remain
effective until the February 25, 1999 fairness hearing and may be extended
pending the outcome of this hearing. The settlement is subject to certain
conditions and will not become final until approved by the Court and the time
for filing appeals has passed or all appeals have been exhausted.

     Summary of Settlement Agreement: Under the terms of the proposed settlement
and the Court orders, the limited fund class action established by the
settlement includes all persons in the United States who used Redux, and certain
other persons such as their family members, who would be bound by the terms of
the settlement. Membership in the class is mandatory for all persons included
within the class definition. Class members asserting claims against Interneuron
will be required to seek compensation only from the settlement fund, and their
lawsuits against Interneuron will be dismissed. By agreeing to the proposed
settlement, Interneuron does not admit liability to any plaintiffs or claimants.

     The Settlement Agreement requires Interneuron to deposit a total of
approximately $15,000,000 in three installments into a settlement fund. The
first installment of $2,000,000 was deposited into the settlement fund in
September 1998. A second installment of $3,000,000 is to be made after the
Settlement Agreement is approved by the Court which, if obtained, would follow
the fairness hearing. These installments, less certain expenses, will be
returned to Interneuron if the settlement does not become final. A third
installment of $10,000,000, plus interest, is to be made after the settlement
becomes final.

     In addition, the Settlement Agreement provides 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 becomes final. Royalties will be paid at the rate of 7% of
gross sales of Interneuron products sold by Interneuron,


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15% of cash dividends received by Interneuron from its subsidiaries related to
product sales, and 15% of license revenues (including license fees, royalties or
milestone payments) received by Interneuron from a sublicensee related to
product sales. All Interneuron products will be subject to this royalty during
the applicable term. If, at the end of that seven year period, the amount of
royalty payments made by Interneuron is less than $55,000,000, the settlement
fund will 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. The Company will record initial charges to
operations for the estimated fair value of its obligations under the Settlement
Agreement, exclusive of insurance proceeds, at such time as the Company can
determine that it is probable that the conditions to final settlement have been
or will be met, which is expected to be subsequent to the Fairness Hearing and
to the Supreme Court ruling in Ortiz. See Note H of Notes to Consolidated 
Financial Statements.


     Securities Litigation:  The Company has also been named as a defendant 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.
                                ----------------

     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.
Payments under the Settlement Agreement will adversely affect the Company's
financial condition and results of operations. In the event the proposed
settlement does not become final 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. 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--Risks Relating to Redux
Litigation" and Note H 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 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


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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 Pondimin and phentermine.
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 (commonly
referred to as the "fen-phen" combination). 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 a combination of fenfluramine and
phentermine ("fen-phen"), compared to an untreated group. In general, these
studies have been and are being 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 are 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



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placebo-treated patients and that the incidence of such abnormalities among
Redux patients was less than previously reported estimates. Findings from these
studies differ with regard to the strength and clinical significance of the
association. Differences in trial design preclude precise comparison. A summary
of the results of the study sponsored by the Company follows.

     Interneuron Sponsored Clinical Study: 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
220 patients who took Redux for three months or longer when compared to 192
individuals who had not taken Redux. No severe and very few moderate cardiac
valve abnormalities 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. In addition, findings from the study suggest that
elevated blood pressure at the time that echocardiograms were taken among these
patients, as well as the concomitant use of drugs with monoamine oxidase
inhibitory properties, which were contraindicated with the use of Redux,
increased the incidence of cardiac valve abnormalities. Additional findings
suggest that the greater the time off Redux, the less likely patients were to
show valvular abnormalities. These findings are being further evaluated.

     The average duration of Redux use among all Redux patients in this study
was 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
U.S. FDA. Market research data indicates that more than 80% of patients who were
prescribed Redux received drug therapy for 90 days or less and 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. Cardiac valve disease was defined as mild or
greater aortic valve regurgitation and/or moderate or greater mitral valve
regurgitation. Previous reports had estimated rates of cardiac valve
insufficiencies among anorexigen-treated patients of up to 30%.

     Among all study participants, 1.4% of Redux patients and 0.5% of
non-treated patients (p =.63) met the FDA's definition of mitral valve
regurgitation. Among the core group of matched pairs, 1.7% of Redux patients and
0.6% of non-treated controls (p =.32) met this definition.

     With respect to aortic valve regurgitation, in all patients, 5.9% of Redux
patients and 2.1% of non-treated patients (p =.08) met the FDA's definition.
Among the core group of matched pairs, 6.3% of Redux patients and 2.3% of
non-treated controls (p =.07) met this definition.

     For all patients with either aortic or mitral valve regurgitation meeting
FDA criteria only, the incidence was 2.6% for controls and 7.3% for the Redux
patients (p =.04). When analyzed for valvular insufficiency of any degree
including trace, there was an increased incidence in the Redux group when
compared to the untreated control group for the aortic valve (p =.04) but not
the mitral valve (p =.28).

     When potentially confounding factors were considered, such as use of
concomitant monoamine oxidase inhibitors (such as estrogens and thyroid hormone
replacements), and the patients' blood pressures at the time of their
echocardiograms, the difference in the incidence of valvular insufficiency
between Redux and non Redux treated patients became non-significant. For
example, when patients were exposed to concomitant drugs possessing monamine
oxidase inhibitory properties were excluded from the analysis, 3%



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of control group patients met FDA-criteria for aortic and mitral valve
regurgitation as compared with 4% in the Redux group (p = not significant).

     CITICOLINE (CERAXON)

     General: Citicoline (cytidine-5'-diphosphate choline, sodium) is under
development by the Company 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 (the "infarct") of blood and oxygen. This loss of blood flow
and oxygen causes, among other events, a breakdown of brain cell membranes, and
places the surrounding tissue (the "penumbra") at risk for death, leading to an
extension of the size of infarct believed to result from the release and
oxidation of such compounds as free fatty acids. This release is likely caused
in part by the inappropriate release of glutamate and other neurotransmitters.

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

     Ongoing Phase 3 trial: Following the Company's withdrawal in April 1998 of
the NDA for citicoline, the Company commenced a third Phase 3 clinical trial
with this drug in June 1998. This multi-center trial, which will include an
estimated 900 patients with ischemic stroke at approximately 175 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 improvement in neurological function as measured
by the National Institutes of Health ("NIH") Stroke Scale. Patients will be
treated with citicoline, 2000 milligrams daily, for six weeks, with a six week
follow-up period. The Company anticipates that this study will be completed in
late 1999.

     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 the ongoing trial, the Company will determine whether to re-submit
the NDA for citicoline to the FDA. 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.

     NDA submission and withdrawal: 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 Chemical Industries, Ltd. 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



                                       9
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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.

     In April 1998, the Company announced that a preliminary analysis of a
100-patient Phase 3 trial with citicoline failed to meet its primary and the
principal secondary endpoint. 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. 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. 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.

     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 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, did not achieve statistical significance. However, this primary
analysis was statistically invalid because the patient imbalance and other
statistical factors failed to satisfy the requirements for the correct operation
of the statistical model. Therefore, a protocol-defined responders analysis,
percentage of patients who achieve a Barthel Index greater than or equal to 95,
among patients with moderate to severe strokes, was employed.

     In the responders analysis, 41% of citicoline-treated patients with an NIH
Stroke Scale on entry of greater than or equal to eight (moderate to severe
strokes) achieved a Barthel Index of greater than or equal to 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
or equal to 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 or equal 
to 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



                                       10
<PAGE>   11



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 (18% 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 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 < 0.04).

     Patients in both the 500 milligram and 2000 milligram groups exhibited
significantly greater (p < 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 < 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 < 0.04).

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

     Efficacy outcome measures for the 1000 milligram daily group did not reach
statistical significance in this trial. Patients in the 1,000 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: As a result of the Company's withdrawal of its
citicoline NDA, the related additional time and expense for product development,
and the Company's limited cash resources, the Company is reevaluating its
commercialization strategy for citicoline, for which the Company has selected
the tradename CerAxon. The Company requires additional funds for manufacturing,
distribution, marketing and selling efforts, the amount of which will depend
upon whether the Company markets citicoline itself or enters into a corporate
collaboration and the terms of any such collaboration. The Company has no


                                       11
<PAGE>   12



commitments or arrangements to obtain additional funds and there can be no
assurance such funds can be obtained on terms favorable to the Company or at
all.

     The Company will be dependent upon third party suppliers of citicoline bulk
compound, finished product and packaging for manufacturing in accordance with
the Company's requirements and current U.S. Good Manufacturing Practices
("cGMP") regulations, as well as on third party arrangements for the
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 does not have an agreement with a manufacturer
for supply of commercial quantities of finished product and there can be no
assurance such agreement can be obtained on terms favorable to the Company or at
all, which could adversely affect the Company's ability to commercialize
citicoline on a timely and cost-effective basis. The Company is subject to an
agreement with Ferrer Internacional S.A. ("Ferrer"), a Spanish pharmaceutical
company which licensed certain patent rights relating to citicoline to the
Company, requiring the Company to purchase from Ferrer citicoline bulk compound
for commercial purposes at fixed prices, subject to certain conditions. Any
citicoline manufacturing facilities are subject to FDA inspection. There can be
no assurance the Company 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
such suppliers will be able to meet manufacturing requirements on a timely basis
or at all. See "Risk Factors--Uncertainties Relating to Citicoline" and "--Need
for Additional Funds".

     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 its agreement with Ferrer 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 if such approval has not been obtained for reasons
beyond the Company's control.

     In September and October 1998, two U.S. patents were granted to the Company
relating to the use of citicoline in the protection of brain tissue from
cerebral infarction following ischemic stroke. In June 1998, the Company
licensed worldwide rights (outside the U.S. and Canada) to corresponding foreign
patent applications to Ferrer. In exchange, the Company will be entitled to
royalties from Ferrer on certain exports 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 addition to any proprietary rights provided by these patents, the
Company intends to pursue market exclusivity under the Drug Price Competition
and Patent Term Restoration Act of 1984 (commonly referred to as the
Waxman-Hatch Act) in commercializing citicoline for ischemic stroke. See
"Government Regulation".



                                       12
<PAGE>   13


     PAGOCLONE

     General: Panic disorder is a severe anxiety condition characterized by
panic attacks, acute episodes of anxiety comprised of distressing symptoms, such
as difficulty breathing, sweating, heart palpitations, feeling dizzy or faint,
and fear of losing control. 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).

     Pagoclone is under development by the Company as a drug to treat
panic/anxiety disorders. 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 include
serotonin agonists such as BuSpar, and benzodiazepines, such as Valium and
Xanax, as well as selective serotonin reuptake inhibitors such as Paxil, Zoloft
and Prozac. Although benzodiazepines are effective in relieving anxiety
symptoms, they may cause side effects such as sedation, hangover, dizziness and
tolerance with continuing use, and they have the potential for addiction. In
addition, the sedative/hypnotic effects of benzodiazepines are generally
increased by alcohol intake, which may lead to serious side effects that may
include coma.

     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 syndromes 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.

     This primary analysis, conducted on a last observation carried forward
(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 liability 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


                                       13
<PAGE>   14



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 rights to pagoclone, a patented compound, in exchange for
license fees, milestone payments and royalties based on sales. See "Patents and
Proprietary Rights."

     Further Development: Based on the results of the Company's Phase 2/3
clinical trial on pagoclone, the Company believes it has identified an optimal
dose for Phase 3 clinical testing. However, the Company requires substantial
additional funds to complete development of pagoclone and intends to pursue a
corporate collaboration or seek additional capital to fund development and
commercialization of the drug and to conduct manufacturing and marketing
activities. There can be no assurance the Company will be successful in entering
into any collaboration or obtaining other financing, or as to the terms of any
such arrangements. If the Company is not able to obtain a corporate
collaboration or other financing, the Company does not intend to conduct Phase 3
clinical testing of pagoclone and, accordingly, development of pagoclone would
be significantly delayed or curtailed.

     OTHER INTERNEURON PRODUCTS

     AnatoMark: In July 1998, the Company received FDA authorization for the
marketing in the U.S. of a medical device called the AnatoMark Non-Invasive Head
Reference System ("AnatoMark"). AnatoMark is designed to provide anatomical
reference markers during brain imaging to enable reproducible alignment of
multiple successive images. No invasive procedure is required as is typical with
other devices used in brain imaging. The Company introduced AnatoMark in
December 1998. The product is being manufactured and assembled by third parties
on behalf of the Company. The Company licensed exclusive worldwide rights to
AnatoMark from Brigham and Women's Hospital, Inc., Boston, Massachusetts in
exchange for a license fee and royalties on net sales. Research is ongoing to
develop software to assist in the automatic adjustment of imaging machines using
the AnatoMark System.

     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 license 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 specified
terms, subject to U.S. government uses, 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. 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 expected in mid-2000. The study is designed
to have periodic interim analyses which could lead



                                       14
<PAGE>   15



to earlier termination if a significant positive drug effect is identified. 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 and other
neurodegenerative diseases. The Company is conducting preclinical testing and,
depending upon the results, will determine whether to conduct further studies.
See "Agreements".

     LidodexNS: In December 1996, the Company and Algos entered into an
agreement for the development and commercialization of LidodexNS, a combination
of lidocaine and, dextromethorphan, that 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. The Company has conducted preclinical
toxicity 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 projects or to seek a corporate collaboration in which a third
party assumes responsibility and funding for drug development, manufacturing and
marketing.

     INTERCARDIA, INC.

     Intercardia was formed in 1994 and completed its initial public offering in
February 1996. Intercardia focuses on the discovery and development of products
to treat cardiovascular inflammatory and infectious diseases and disorders. In
May 1998, Intercardia acquired Transcell, formerly a majority-owned subsidiary
of Interneuron.

     BEXTRA (bucindolol)

     General: Intercardia's most advanced product is BEXTRA (bucindolol HCl), a
drug in Phase 3 clinical trials for the treatment of congestive heart failure
("CHF"). CHF is a syndrome of progressive degeneration of cardiac function
generally defined as the inability of the heart to pump sufficient volume of
blood for proper functioning of vital organs. CHF is caused by a number of
conditions that produce a primary injury or stress to the heart muscle.
Regardless of the cause of the primary damage, the body will activate
compensatory mechanisms in an attempt to maintain cardiac output. These
mechanisms include activation of the cardiac adrenergic systems resulting in
stimulation of beta-adrenergic receptors on cells located in the heart and
vascular system. Chronic stimulation of these receptors is believed to
contribute to the continual worsening of cardiac function and high mortality.

     Bucindolol is a non-selective beta-blocker with mild vasodilating
properties. The Company believes that vasodilating beta-blockers such as
bucindolol represent a promising approach to the treatment of CHF.

     Competitive Drugs: One beta-blocker, carvedilol, was approved by the FDA
and launched in the U.S. by SmithKline Beecham PLC, under the trademark Coreg,
for the treatment of CHF. Carvedilol, a non-selective beta-blocker with moderate
vasodilating properties, has also been approved for the treatment of CHF in
Europe and other markets. Other pharmaceutical companies are also developing
beta-blockers as a treatment for CHF.


                                       15
<PAGE>   16


     In March 1998, Germany-based Merck KGaA announced early termination of the
CIBIS II trial which studied bisoprolol, a beta-1 receptor selective
beta-blocker, as a treatment for CHF patients in Europe. Merck KGaA reported
that in the trial, which enrolled 2,647 patients, those receiving bisoprolol had
a significantly higher survival rate than those receiving customary treatment.
Bisoprolol is currently marketed in the U.S. by Wyeth-Ayerst for hypertension.

     In November 1998, Astra Pharmaceuticals announced preliminary results and
early termination of a 4,000 patient mortality study known as MERIT, evaluating
metoprolol succinate, a beta-1 receptor selective beta-blocker. The preliminary
results indicated that metoprolol significantly reduced mortality and improved
survival of patients with CHF. Metoprolol is marketed as Toprol XL and other
trademarks for hypertension and angina.

     As a result, if approved, BEXTRA could be the third or fourth beta-blocker
therapy to enter the U.S. market for CHF. To succeed in a competitive market,
BEXTRA will need to be differentiated from other beta-blocker therapies and
there can be no assurance that the data from BEST will provide the basis for
such differentiation. In addition, the price of the different therapies may
become important as competition increases and the pressure to lower the price of
BEXTRA may increase. In addition to competition from other beta-blockers, the
Company is aware of other types of drugs being developed for CHF. See
"Competition."

     BEST Study: A Phase 3 clinical trial began in June 1995 among patients with
CHF, to test whether the addition of bucindolol to traditional therapy for CHF
will reduce mortality in patients with moderate to severe CHF. The Beta-blocker
Evaluation of Survival Trial, known as BEST, is being conducted by the National
Institutes of Health ("NIH") and the Department of Veterans Affairs ("VA"). The
BEST study is designed to enroll up to 2,800 patients (of which at least 33% are
recommended to be female), having moderate to severe symptoms (NYHA classes III
and IV), at approximately 90 clinical centers throughout the U.S. and Canada.
Approximately 2,640 patients have been enrolled in BEST and enrollment is
scheduled to end December 31, 1998. The protocol for BEST calls for a follow-up
of 18 months or more for each patient.

     An independent Data and Safety Monitoring Board is periodically monitoring
the progress, outcomes, toxicity, safety and other data of BEST on a
confidential basis. The Data and Safety Monitoring Board is authorized to
terminate the study early, either for safety reasons or because the benefit of
the drug has been demonstrated. The Company was informed that the Data and
Safety Monitoring Board most recently met in November 1998 to review interim
study data and recommended that the study continue.

     The NIH and VA have committed up to $15,750,000 primary funding for BEST.
Intercardia has provided additional funding for the study and, as a result of
the termination of the Astra Merck Collaboration, will be solely responsible for
the non-government funded portion of the development costs in the U.S.
Intercardia estimates additional BEST support costs of approximately $6,000,000
during fiscal 1999. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations".

     Because BEST is sponsored by the NIH and the VA, Intercardia does not
control the timing, operation, or analysis of the study. The government sponsors
are not required to give Intercardia the database from the study until a
manuscript has been prepared and accepted for publication by a scientific
journal. There can be no assurance that the results of BEST will be positive,
that bucindolol will receive marketing approval in any country on a timely basis
or at all, or that, if approved, bucindolol will successfully compete in the
market. If bucindolol does not receive regulatory approval, the Company would be
materially adversely affected.



                                       16
<PAGE>   17


     BEAT: In collaboration with Intercardia, Knoll has initiated BEAT, a study
of bucindolol's use in treating patients who have recently suffered an acute
myocardial infarction and as a result have reduced heart function. BEAT is a
randomized double-blind, placebo-controlled study designed to expand the
suitable patient population for BEXTRA. It is scheduled to enroll 2,000 patients
in multiple investigative centers in Denmark and the United Kingdom.
Approximately 75 patients have been enrolled in BEAT.

     BEAT is designed to show whether treating patients with BEXTRA in the
beginning of the downward spiral of heart failure, which often follows a heart
attack, reduces overall mortality. A minimum follow-up period of two years is
required for each patient. There can be no assurance that the study will be
completed at all or in a timely manner, that the results will be positive, or
that any commercial benefit can be obtained from the results.

     BEXTRA Marketing

     U.S. Market:  Intercardia holds development and marketing rights for
bucindolol in the U.S. following the September 1998 termination of a
collaboration agreement among CPEC, Intercardia and Astra Pharmaceuticals, L.P.
(formerly Astra-Merck, Inc.) ("Astra Pharmaceuticals"), in connection with the
restructuring of Astra-Merck, Inc. The original agreement, entered into in
December 1995, related to the development, commercialization and marketing in
the U.S. of a twice-daily formulation of bucindolol for the treatment of CHF.
In connection with the termination of this agreement and resolution of an
earlier dispute relating to responsibility for funding certain costs, Astra
Pharmaceuticals made a $4,000,000 payment to CPEC.  As a result, Intercardia
has assumed responsibility for the U.S. development and commercialization for
BEXTRA.  Intercardia requires a corporate collaboration or additional funds for
the commercialization of BEXTRA and is currently exploring possible
development, commercialization and marketing collaborations.  See
"Agreements--Intercardia Agreements".

     Other Markets: In December 1996, Intercardia entered into an agreement with
Knoll ("the Knoll Collaboration") relating to the development, manufacture and
marketing of bucindolol for the treatment of CHF in all countries with the
exception of the U.S. and Japan (the "Territory"). Under the terms of the Knoll
Collaboration, Knoll made total payments to CPEC of $3,480,000 in fiscal 1997.
Knoll agreed to make future payments to CPEC upon the achievement of product
approval and net sales milestones.

     Intercardia and Knoll agreed to share the development and marketing costs
of bucindolol in the Territory. In general, Knoll agreed to pay approximately
60% of the development and marketing costs prior to product launch, and
Intercardia agreed to pay approximately 40% of such costs, subject to certain
maximum dollar limitations. If the product is approved, CPEC will be entitled to
a royalty equal to 40% of net profits, as defined in the agreement, and would be
responsible for, and pay to Knoll, 40% of any net loss, as defined. In June
1998, Knoll initiated the BEAT study, a Phase 3 clinical trial in Europe, and
Intercardia is required to fund 40% of the study's costs.

     Once-Daily Formulation: In April 1996, Intercardia entered into an
agreement with SkyePharma AG ("SkyePharma"), formerly Jago Pharma AG, to
determine the feasibility of developing a once-daily formulation of bucindolol
using SkyePharma proprietary technology. Intercardia is funding this activity,
with partial reimbursement from Knoll. If the formulation is successfully
developed, Intercardia is required to pay milestone fees as well as royalties to
SkyePharma on net sales of the once-daily formulation, until the expiration of
the relevant patent on a country-by-country basis. The rights to the once-daily
formulation of bucindolol for the Knoll Territory were exclusively licensed to
Knoll. Current FDA guidelines for approval of a new formulation require at least
one Phase 3 clinical trial using the formulation, which would be expensive and
time consuming. There is no assurance this formulation will be developed,
receive FDA approval or enhance the competitive position of bucindolol.



                                       17
<PAGE>   18


     Licensing; Proprietary Rights:  CPEC, Inc. ("CPEC"), of which 80% is owned
by Intercardia and approximately 20% is owned by Interneuron, licensed from
Bristol-Myers Squibb Company ("BMS") worldwide rights to develop and
commercialize bucindolol for use in treating CHF, in exchange for royalties
based on sales, generally for 15 years after first commercial sale.  The U.S.
composition of matter patent on bucindolol expired in November 1997. Assuming
FDA approval is obtained, Intercardia intends to pursue five years' market
exclusivity under the Waxman-Hatch Act. Intercardia is developing a once-daily
formulation in collaboration with SkyePharma.  See"Risk Factors - Uncertainty
Regarding Waxman Hatch Act."

     Intercardia Research Laboratories

     Overview: Following the merger of Transcell with and into Intercardia, the
operations formerly conducted by Transcell are now conducted by a division of
Intercardia known as Intercardia Research Laboratories, based in Princeton, New
Jersey. Intercardia Research Laboratories is engaged in the discovery and
development of drugs based on synthetic carbohydrate chemistry technology
originating from Princeton University scientists Daniel Kahne, Ph.D., and
Suzanne Walker-Kahne, Ph.D., who are also minority stockholders or optionholders
of Intercardia. This platform technology enables carbohydrate-based
combinatorial libraries of compounds to be generated on a solid support for uses
in drug discovery. Although the Company believes the platform technology has
potential application to a variety of therapeutic areas, Intercardia Research
Laboratories is initially targeting the discovery and development of compounds
that can be used as anti-bacterial or anti-fungal agents. Several projects are
underway to design proprietary analogues of known anti-infective agents to
improve their efficacy, safety or pharmacokinetics profile. Two of these
projects are funded in part by Merck. Intercardia requires substantial
additional funds for the development and commercialization of this technology,
which is in early stages of development.

     Transcell Acquisition: On May 8, 1998, the merger of Transcell with and
into Intercardia and the acquisition by Intercardia of certain related
technology rights owned by Interneuron was completed and, simultaneously,
Interneuron contributed to Transcell's capital all of Transcell's indebtedness
and payables to Interneuron (approximately $18,698,000) (the "Transcell
Acquisition"). Consideration given by Intercardia consisted of (i) Intercardia
common stock payable 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 payable 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 Intercardia 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, Intercardia issued an aggregate of 320,151 shares of common
stock, of which 191,383 shares were issued to Interneuron. In addition,
Intercardia issued 174,672 shares to Interneuron as the Initial
Technology/Guarantee Payment. Intercardia 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 will be
made in August 1999 and February 2000, respectively, and each installment will
consist of the issuance of $3,000,000 of Intercardia common stock, as then
valued. Interneuron owned approximately 61% and 62% of the outstanding capital
stock of Intercardia before and immediately after the Transcell Acquisition,
respectively. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

     Merck Agreement: In July 1997, Transcell, Interneuron and Merck entered
into a Research Collaboration and License Agreement (the "Merck Agreement")
relating to the discovery, development and commercialization of novel
antibacterial agents.


                                       18
<PAGE>   19


     The initial focus of this collaboration is the discovery and biological
evaluation of analogues of anti-bacterial compounds selected from two distinct
structural classes and the license to Merck of any products arising out of the
two research programs.

     Under the Merck Agreement, Merck made an initial licensing payment, agreed
to provide research support over two years, and agreed to provide additional
payments based upon the achievement of defined clinical and regulatory
milestones for each program. To date, Intercardia's costs of conducting the
program have exceeded revenues received under the Merck Agreement and this trend
may continue. Merck agreed to pay royalties on net sales of any products that
may be developed based on the research programs. Certain of the rights licensed
to Merck are based on exclusive licenses held by Intercardia from Princeton
University, which has received and will be entitled to varying percentages of
certain payments and royalties based on sales.

     In connection with the Transcell Acquisition, Intercardia was assigned and
assumed all of Transcell's and Interneuron's rights and obligations under the
Merck Agreement partially in exchange for Intercardia's payment to Interneuron
of the Initial Technology/Guaranty Payment and agreement to pay Interneuron
royalties on sales of products developed under the Merck Agreement.

     Licensing; Proprietary Rights: As a result of the Transcell Acquisition,
Intercardia owns or licenses from Princeton University 11 issued patents in the
United States relating to its combinatorial carbohydrate technology. A number of
patent applications are pending. Intercardia has rights to license inventions
arising out of research sponsored at Princeton University.

     Other Products under Development and Early-Stage Programs

     In July 1998, Intercardia licensed worldwide rights (except for Japan and
South Korea) to a patented compound known as OP2000 from Opocrin S.p.A., a
pharmaceutical company in Modena, Italy. Intercardia intends to investigate the
use of OP2000, an oligosaccharide product derived from heparin, as a drug for
the treatment of inflammatory bowel disease. Intercardia will be responsible for
conducting clinical trials for OP2000 and made a $1,000,000 payment to Opocrin
upon execution of the license agreement.

     Intercardia has established and may establish additional subsidiaries in
specific areas. Intercardia's 66%-owned subsidiary, Aeolus Pharmaceuticals,
Inc., is conducting catalytic antioxidant small molecule research. Intercardia
believes these antioxidants have the potential to address a broad range of
conditions that result from toxicities associated with excess oxygen free
radicals. Certain components of the technology used in this program are licensed
from Duke University.

     Intercardia's approximately 80% owned subsidiary, Renaissance Cell
Technologies, Inc., is conducting research in the area of hepatic stem cells.
Renaissance entered into an agreement with the University of North Carolina at
Chapel Hill ("UNC") to sponsor research on hepatic stem cells in exchange for an
option to an exclusive license to products resulting from the research. As of
September 30, 1998, Renaissance was obligated to pay UNC $338,000 to fund
research.

     Intercardia does not have sufficient funds to develop, commercialize,
manufacture and market its potential products and intends to seek to enter into
collaborative agreements with other companies to do so. There can be no
assurance it will be successful in obtaining or retaining any such
collaborations.

     Clayton I. Duncan is President and Chief Executive Officer of Intercardia,
which had 54 full-time employees as of September 30, 1998. As of September 30,
1998, Interneuron owned approximately 62% of the outstanding common stock of
Intercardia, and approximately 47% on a fully-diluted basis. In certain

                                       19
<PAGE>   20



circumstances, Interneuron has the right to purchase additional shares of
Intercardia common stock at fair market value so that Interneuron's equity
ownership in Intercardia does not fall below 51%.

     INTERNUTRIA, INC.

     In September 1998, Interneuron adopted a plan to discontinue operations at 
its InterNutria, Inc. subsidiary. Although the Company is currently continuing
to fill minimal orders for InterNutria's products, primarily PMS Escape, active
promotion of InterNutria's products has ceased. InterNutria had commenced a
national launch of PMS Escape in September 1997. Although the Company is
currently seeking to sell InterNutria or all or a portion of its assets, there
can be no assurance the Company will be successful in doing so. The Company does
not expect to generate any significant proceeds from any such sale.

     The operations of InterNutria resulted in substantial losses to the Company
and, during fiscal 1998, the Company incurred losses from discontinued
operations relating to InterNutria of approximately $19,500,000, including
charges during the last quarter of fiscal 1998 relating to the plan to
discontinue operations at InterNutria. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note M of Notes to the
Consolidated Financial Statements.

     PROGENITOR, INC.

     Progenitor was formed in February 1992 and completed its initial public
offering in August 1997. Concurrently with the Progenitor IPO, Progenitor
completed the acquisition of Mercator Genetics, Inc., a privately held genomics
company. As a result, Interneuron's percentage ownership of Progenitor was
reduced to approximately 37% and, at September 30, 1998, Interneuron owned
approximately 36% of Progenitor's outstanding common stock.

     Progenitor had 55 full-time employees as of September 30, 1998. In December
1998, Progenitor announced its intention to implement an immediate cessation of
operations. Progenitor did not have sufficient funds to meet its obligations and
cash requirements and was unable to raise additional funds. Progenitor's market
valuation had been substantially reduced and the Company can not viably sell any
of its holdings of Progenitor securities. Beginning in August 1997, the Company
no longer consolidated the financial statements of Progenitor but included
Progenitor in the Company's financial statements using the equity method of
accounting. As of September 30, 1998, the Company had reduced to zero its
investment in Progenitor.

     See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note P of Notes to the Consolidated Financial
Statements.

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 and limited marketing capabilities. In general, the
Company intends to seek to contract with third parties to manufacture and market
products requiring broad marketing capabilities and for overseas marketing.


                                       20
<PAGE>   21


     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. These collaborators are expected to be granted
exclusive or semi-exclusive rights to sell specific products on a disease
application or market-specific basis in exchange for a royalty, equity
investment, co-marketing, joint venture or other financial interest.
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. In the
event the Company is able to obtain additional funds, as to which there can be
no assurance, the Company may seek to market certain products, by developing an
internal sales force or through contract sales representatives, directly to
selected groups of physician specialists likely to prescribe or recommend the
product. In such event, the Company would likely be responsible for all costs
associated with developing, manufacturing and marketing the product.

     Assuming final approval of the Redux Settlement Agreement, the Company will
be required to pay to the settlement fund up to an aggregate of $55,000,000 of
royalties based on sales of Interneuron products and on certain other payments
received by the Company in connection with product sales during the seven year
period following the time when the settlement becomes final. See
"Agreements--Redux Agreements--Settlement Agreement" and "Legal Proceedings".

     Citicoline

     As a result of the Company's withdrawal of the citicoline NDA, the
additional time and expense required for citicoline product development, and the
Company's limited cash resources, the Company is reevaluating its
commercialization strategy for citicoline. The Company requires additional funds
for manufacturing, distribution, marketing and selling efforts, the amount of
which will depend upon whether the Company markets citicoline itself or enters
into a corporate collaboration and the terms of any such collaboration. The
Company has no commitments or arrangements to obtain additional funds and there
can be no assurance such funds can be obtained on terms favorable to the Company
or at all.

     The Company will be dependent upon third party suppliers of citicoline bulk
compound, finished product and packaging for manufacturing in accordance with
the Company's requirements and cGMP regulations, as well as on third party
arrangements for the distribution of citicoline. Supplies of citicoline finished
product used for clinical purposes have been produced on a contract basis by
third party manufacturers. The Company does not have arrangements with a
manufacturer for supply of commercial quantities of finished product and there
can be no assurance such agreement can be obtained on terms favorable to the
Company or at all, which could adversely affect the Company's ability to
commercialize citicoline on a timely and cost-effective basis. The Company is
subject to an agreement with Ferrer requiring the Company to purchase from
Ferrer citicoline bulk compound for commercial purposes at fixed prices, subject
to certain conditions. There can be no assurance the Company 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 such suppliers will be able to meet
manufacturing requirements on a timely basis or at all. See "Risk
Factors--Uncertainties Relating to Citicoline" and "--Need for Additional
Funds".



                                       21
<PAGE>   22


     BEXTRA

     Following the termination of its agreement with Astra Pharmaceuticals,
Intercardia has assumed responsibility for the U.S. development and
commercialization for BEXTRA and is currently exploring possible development,
commercialization and marketing collaborations for BEXTRA, as well as the
selection of a third-party manufacturer for BEXTRA.

     Intercardia has an agreement with Knoll for the development and
commercialization of bucindolol in all countries except the U.S. and Japan.
Intercardia is responsible for 40% of development and marketing costs and is
entitled to receive 40% of net profits, or pay 40% of net losses, as defined in
the agreement. See "Agreements - Intercardia Agreements".

     Redux

     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 Ingelheim Pharmaceuticals, Inc. ("Boehringer") produced on
behalf of Interneuron commercial scale quantities of the finished dosage
formulation of Redux in capsule form.

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 research and
development of technologies and therapies similar to those being pursued by the
Company. Many of the Company's competitors have substantially greater financial
and other resources, larger research and development staffs and significantly
greater experience in conducting clinical trials and other regulatory approval
procedures and manufacturing and marketing pharmaceutical products than the
Company. In the event the Company markets any products directly, it will compete
with companies with well-established distribution networks and market position.
See "Manufacturing and Marketing".

     There can be no assurance that 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 products that compete
with compounds 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.
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


                                       22
<PAGE>   23



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.

     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 of a number of 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 Knoll and Fiblast by AHP. 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 potentially broader, 24-hour post-stroke therapeutic window.

     BEXTRA

     The cardiovascular drug market is highly competitive with many drugs
marketed by major multi-national and integrated pharmaceutical companies having
substantially greater technical, marketing and financial resources than
Intercardia. One competitive beta-blocker has been approved by the FDA for use
in treating CHF and two companies have announced positive results from pivotal
clinical trials of two other beta-blockers in CHF patients. Substantial
educational efforts may be required to convince physicians of the therapeutic
benefits of bucindolol.

     If approved, BEXTRA could be the third or fourth beta-blocker therapy to
enter the U.S. market for CHF. To succeed in a competitive market, Intercardia
believes that BEXTRA will need to be differentiated from other beta-blocker
therapies, and there can be no assurance that the data from BEST will provide
the basis for such differentiation. In addition, the price of the different
therapies may become important, and as competition increases, the pressure to
lower the price of BEXTRA may increase. There can be no assurance that
Intercardia will be able to market BEXTRA on a profitable basis.

     Carvedilol, a non-selective beta-blocker with moderate vasodilating
properties was launched in the United States by SmithKline Beecham as the
product Coreg for the treatment of CHF. Carvedilol also is approved for the
treatment of CHF in Europe and other markets. Coreg is being marketed by
SmithKline Beecham directly and through a co-promotion with Hoffman-LaRoche Inc.

     Other pharmaceutical companies are developing beta-blockers as a treatment
for CHF. In March 1998, Germany-based Merck KGaA announced early termination of
the CIBIS II trial which studied bisoprolol as a treatment for CHF patients in
Europe. Merck KGaA reported that in the trial, which enrolled 2,647 patients,
those receiving bisoprolol had a significantly higher survival rate than those
receiving customary treatment. Bisoprolol is a beta-1 receptor selective
beta-blocker marketed in the United States by Lederle for hypertension. The
Company does not know whether an application for bisoprolol's use in treating
CHF will be filed in the United States or any other country. Even if an
application is not filed, physicians could prescribe bisoprolol for this use on
an "off-label" basis in countries where it has already been approved for a
different indication. "Off-label" use of bisoprolol could reduce the market for
bucindolol, especially if bisoprolol is less expensive than bucindolol.

     Astra Pharmaceuticals announced in November 1998 preliminary results of a
mortality study ("MERIT") evaluating the beta-1 receptor selective beta-blocker
metoprolol succinate. The preliminary results indicated that metoprolol
significantly reduced mortality and improved survival of patients with CHF. The
study was


                                       23
<PAGE>   24



stopped early based on a scheduled interim analysis by the independent safety
monitoring committee. Metoprolol is marketed as Toprol XL for hypertension and
angina. If metoprolol is approved for use in treating CHF, Astra
Pharmaceuticals, the Company's former collaborator for bucindolol, is expected
to market the product. Under FDA "user fee" guidelines, a supplemental NDA for
metoprolol is subject to a six month review by the FDA, compared to the 12 month
review targeted for initial NDAs. Metoprolol therefore could be approved for use
in treating CHF before bucindolol (assuming BEST results are positive).

Pagoclone

     Current therapy for anxiety or panic disorders generally includes
benzodiazepines, such as Valium and Xanax, serotonin agonists such as BuSpar,
and selective serotonin reuptake inhibitors such as Paxil, Zoloft and Prozac. 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. The Company requires substantial additional funds or a
corporate collaboration to develop and commercialize Pagoclone and its failure
to obtain such funds would delay and possibly prevent the drug's development.
Any significant delay in development of pagoclone could adversely affect the
competitive position of the drug, assuming FDA approval were obtained.



                                       24
<PAGE>   25


AGREEMENTS

Redux Agreements

     Settlement Agreement: On September 25, 1998, the U.S. District Court for
the Eastern District of Pennsylvania (the "Court") preliminarily approved an
Agreement of Compromise and Settlement (the "Settlement Agreement") between
Interneuron and the Plaintiffs' Management Committee, consisting of attorneys
designated by the Court to represent plaintiffs in the multi-district litigation
relating to Redux, relating to the settlement of all product liability
litigation and claims against the Company related to Redux. The Court also
conditionally certified a limited fund class action. A fairness hearing on the
settlement has been scheduled for February 25, 1999.

     The limited fund class action established by this settlement includes all
persons in the United States who used Redux, and certain other persons such as
their family members, who would be bound by the terms of the settlement.
Membership in the class is mandatory for all persons included within the class
definition.

     Under the terms of the proposed settlement, class members asserting claims
against Interneuron will be required to seek compensation only from the
settlement fund and their lawsuits against Interneuron will be dismissed. By
agreeing to the proposed settlement, Interneuron does not admit liability to any
plaintiffs or claimants. Under the Settlement Agreement, the released parties
include, among other parties, Interneuron, Boehringer (except for claims arising
from defects in the manufacture or packaging of Redux) and their respective
affiliates and stockholders (in their capacity as stockholders).

     The Settlement Agreement requires Interneuron to deposit a total of
approximately $15,000,000 in three installments into a settlement fund. The
first installment of $2,000,000 was deposited into the settlement fund in
September 1998. A second installment of $3,000,000 is to be made after the
Settlement Agreement is approved by the Court, which would follow the fairness
hearing. These installments will be returned to Interneuron if the settlement
does not become final. A third installment of $10,000,000, plus interest, is to
be made after the settlement becomes final.

     In addition, the proposed settlement provides for Interneuron to cause all
remaining and available product liability insurance proceeds related to Redux to
be deposited into the settlement fund. As part of the Settlement Agreement,
Interneuron and the Plaintiffs' Management Committee also entered into a Royalty
Agreement. Under the Royalty Agreement, Interneuron agreed to make royalty
payments to the settlement fund, in the total amount of $55,000,000, based upon
sales of Interneuron products and other revenues, over a seven year period
beginning after the settlement becomes final. Royalties will be paid at the rate
of 7% of gross sales of Interneuron products sold by Interneuron, 15% of cash
dividends received by Interneuron from its subsidiaries related to product
sales, and 15% of license revenues (including license fees, royalties or
milestone payments) received by Interneuron from a sublicensee related to
product sales. All Interneuron products will be subject to this royalty during
the applicable term.

     If, at the end of that seven year period, the amount of royalty payments
made by Interneuron is less than $55,000,000, the settlement fund will receive
shares of Interneuron stock ("Royalty Shares") in an amount equal to the unpaid
royalty balance divided by $7.49 per share, subject to adjustment under certain
circumstances such as stock dividends or distributions. In the event Interneuron
merges with or sells all or substantially all of its assets to another
corporation prior to payment of the $55,000,000 of royalties, the settlement
fund shall be entitled to receive the kind and amount of shares of stock or
other securities or property to which a holder of the number of shares of Common
Stock (calculated based on the unpaid royalty balance at such time) would have
been entitled to at the time of the transaction.



                                       25
<PAGE>   26


     Interneuron has the right of first refusal to purchase Royalty Shares in
the event of any proposed transfer by the settlement fund and any transfers by
the settlement fund must be in accordance with the volume restrictions contained
in Rule 144(e) of the Securities Act of 1933, as amended. In addition, the
settlement fund agreed to vote any Royalty Shares held by it in the same manner
and proportion as the other holders of outstanding securities of Interneuron
entitled to vote on any matter.

     The Company will record initial charges to operations for the estimated
fair value of the Company's obligations under the Settlement Agreement,
exclusive of insurance proceeds, at such time as the Company can determine that
it is probable that the conditions to final settlement have been or will be met,
which is expected to be subsequent to the Fairness Hearing and to the Supreme
Court ruling in Ortiz. The settlement will not become final until approved by
the Court and the time for filing appeals has passed or all appeals have been
exhausted. See Note H of Notes to Consolidated Financial Statements.

     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 agreements are for a term of 15 years commencing on the date dexfenfluramine
is first commercially introduced by AHP, subject to earlier termination.

     Under the AHP Agreements, AHP purchased preferred stock of the Company for
an aggregate purchase price of $3,500,000. As of September 30, 1998, AHP owned
shares of Interneuron preferred stock convertible into an aggregate of 622,222
shares of Common Stock.

     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.

     AHP has the right to terminate its sublicense upon 12 months notice to the
Company. The AHP Agreements provide that Servier has the right to withdraw its
consent to the sublicense under certain circumstances. Servier consented to the
AHP acquisition of American Cyanamid Company.

     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 provides 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.

     Redux was withdrawn from the market in September 1997. As a result,
Interneuron terminated its sales force and received no revenues from AHP in
fiscal 1998.



                                       26
<PAGE>   27


     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 --
Risks Relating to Redux Litigation".

     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.

     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 for a term of 15 years from the date dexfenfluramine is
first marketed in the U.S. 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 stockholdings (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. See "Risk Factors -- Risks Relating to Redux Litigation" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".

     Boehringer Ingelheim Agreement: In November 1995, the Company entered into
an approximately three-year manufacturing agreement with Boehringer under which
Boehringer supplied, and the Company purchased all of its requirements for Redux
capsules from Boehringer. 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. Boehringer is a released party under the Settlement
Agreement, except for specified claims. See "Legal Proceedings".

Citicoline

     In January 1993, the Company entered into a license and supply agreement
with Ferrer, as amended in June 1998 (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 MIT. The underlying
U.S. patent expires in 2003. The Ferrer Agreement also provides that Ferrer
shall, subject to certain limitations, be the exclusive supplier at a fixed
price of raw materials required for the manufacture of any product developed
under such patent rights. The 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 agreement provides for

                                       27
<PAGE>   28



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 agreement requires Interneuron to use
diligent efforts to obtain regulatory approval.

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

Pagoclone

     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. The trademark will be owned by Interneuron. In exchange,
the Company paid RPR a license fee and agreed to make milestone payments based
on clinical and regulatory developments, and royalties based on net sales. This
license agreement provides that it is terminable 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. Interneuron granted RPR an option to sublicense from Interneuron under
certain conditions rights to market pagoclone in France. 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.

IP 501

     During 1997, the Company obtained an exclusive option to license 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 specified terms, subject
to U.S. government uses, 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.

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). Preclinical data suggests the potential of
PACAP as a treatment for stroke and other neurodegenerative diseases. Under
terms of the license, the Company paid Tulane an upfront 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.

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 fluoxetine to treat disturbances of appetite and mood associated with


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premenstrual syndrome. Prozac (fluoxetine hydrochloride), Lilly's
antidepressant, is not currently 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.

     The patent rights to the use of fluoxetine in treating premenstrual
syndrome are licensed by the Company from MIT. The use of fluoxetine to treat
PMS was discovered by Judith Wurtman, Ph.D., and Richard J. Wurtman, M.D.,
scientific founder of Interneuron, both of MIT.

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, for the treatment of acute migraine headache. 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.

Intercardia Agreements

     Termination of Astra Merck Agreement: In September 1998, Intercardia, CPEC
and Astra Pharmaceuticals terminated the Marketing and Development Collaboration
and License Agreement relating to the U.S. development and commercialization of
the twice-daily formulation of bucindolol for the treatment of CHF, in
connection with the restructuring of Astra Merck, Inc. The original agreement
was entered into in December 1995. In connection with the termination of this
agreement and resolution of an earlier dispute relating to responsibility for
funding certain costs, Astra Pharmaceuticals made a $4,000,000 payment to CPEC.
As a result, Intercardia has assumed responsibility for the U.S. development and
commercialization for BEXTRA. Intercardia requires a corporate collaboration or
additional funds for the commercialization of BEXTRA and is currently exploring
possible development, commercialization and marketing collaborations.

     Pursuant to the Astra Merck Collaboration, Astra Pharmaceuticals made a
$5,000,000 payment to CPEC, assumed responsibility for certain obligations of
CPEC and committed an amount up to $15,000,000 of U.S. development costs for the
twice-daily formulation of bucindolol, including Intercardia's costs related to
the BEST study. Intercardia and CPEC paid Astra Pharmaceuticals an aggregate of
$10,000,000 in December 1997 (of which a portion was paid by Interneuron,
reflecting its percentage ownership interest in CPEC, as a loan to CPEC). See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

     BASF Pharma/Knoll, AG Agreement: In December 1996, Intercardia entered into
an agreement with Knoll (the "Knoll Collaboration") relating to the development,
manufacture and marketing of bucindolol for the treatment of CHF in all
countries with the exception of the U.S. and Japan. The Knoll Collaboration
relates to both the twice-daily bucindolol formulation and the once-daily
bucindolol formulation currently under development. Under the terms of the Knoll
Collaboration, Knoll has made payments totaling approximately $3,628,000 to CPEC
which were recognized as contract and license fee revenue. Knoll agreed to make
future payments to CPEC upon the achievement of product approval and sales
milestones.



                                       29
<PAGE>   30


     Intercardia and Knoll agreed to share the development and marketing costs
of bucindolol in the Territory. In general, Knoll agreed to pay approximately
60% of the development and marketing costs prior to product launch, and
Intercardia agreed to pay approximately 40% of such costs, subject to certain
maximum dollar limitations. CPEC will be entitled to a royalty equal to 40% of
net profits, as defined in the Knoll Collaboration, and would be responsible
for, and pay to Knoll, 40% of any net loss, as defined.

     The Knoll Collaboration is to continue for 15 years after the first
commercial sale with respect to each country in the Knoll Territory, subject to
two additional five-year renewals at Knoll's option. Knoll has the right to
terminate the Knoll Collaboration at any time prior to the termination of BEST
and within 60 days after the BEST primary end-point results are reported to
Knoll. Because a significant portion of Intercardia's development,
commercialization and marketing activities relating to bucindolol in the Knoll
Territory are conducted and funded by Knoll, Intercardia is substantially
dependent upon this arrangement for the success of bucindolol in the Knoll
Territory.

     Bristol-Myers Squibb Agreement: Through CPEC, Intercardia has an exclusive
worldwide license from BMS to bucindolol for pharmaceutical therapy for
congestive heart failure and left ventricular function. The license requires
Intercardia to conduct all appropriate clinical trials necessary for the
preparation and filing of an NDA and a comparable application in at least one
Western European country. Intercardia is obligated to pay royalties on net
product sales. Unless earlier terminated, the bucindolol license continues, with
respect to each country, until the later of patent expiration, or 15 years after
first commercial sale of bucindolol (subject to two five-year renewals at
Intercardia's option). CPEC's royalty obligations extend beyond the expiration
date of the underlying patent, which may materially adversely affect BEXTRA's
competitive position in the event a generic version of bucindolol is introduced.

     SkyePharma Development and License Agreement: In April 1996, Intercardia
entered into an agreement with SkyePharma to determine the feasibility of
developing a once-daily formulation of bucindolol using SkyePharma proprietary
technology. If the formulation is successfully developed, Intercardia is
required to pay milestone fees as well as royalties to SkyePharma on net sales
of the once-daily formulation, until the expiration of the relevant patent on a
country-by-country basis (or 15 years, if no patent is issued in that country).
If Intercardia elects not to proceed with development of a formulation that has
been shown to be feasible, SkyePharma may develop the formulation unless
Intercardia makes a $500,000 payment.

     Merck Agreement: In July 1997, Transcell, Interneuron and Merck entered
into a Research Collaboration and License Agreement (the "Merck Agreement")
relating to the discovery, development and commercialization of novel
antibacterial agents. In connection with the Transcell Acquisition, Intercardia
was assigned and assumed all of Transcell's and Interneuron's rights and
obligations under the Merck Agreement, partially in exchange for payment to
Interneuron of the Initial Technology/Guaranty Payment and royalties based on
sales of any products developed under the Merck Agreement. The initial focus of
this collaboration is the discovery and biological evaluation of analogues of
anti-bacterial compounds selected from two distinct structural classes and the
license to Merck of any products arising out of the two research programs.
Intercardia agreed to utilize its combinatorial technologies to prepare
libraries of carbohydrate derivative compounds for biological evaluation and
further development.

     Under the Merck Agreement, Merck made initial option and license payments
aggregating $2,500,000, agreed to provide research support over two years, and
agreed to provide additional payments based upon the achievement of defined
clinical development and regulatory milestones for each program. In addition,
Merck agreed to pay royalties on net sales of any products that may be developed
based on the research programs.



                                       30
<PAGE>   31


     Certain of the rights licensed to Merck are based on exclusive licenses or
rights held by Intercardia from Princeton University, which has received and
will be entitled to varying percentages of certain payments and royalties
received from Merck. In connection with the Transcell Acquisition, Intercardia
also agreed to pay Interneuron a royalty on net sales of products subject to the
Merck Agreement.

     Princeton Licenses: In connection with the Transcell Acquisition,
Intercardia was assigned and assumed license agreements previously entered into
between Princeton and each of Transcell and Interneuron granting exclusive
worldwide licenses to specified patent applications and any patents that issue
therefrom covering a significant portion of Intercardia's carbohydrate chemistry
technology, including any derivative patent applications or patents that issue,
in exchange for a license fee, annual maintenance fees, milestone payments and
royalties based on sales. The license agreements require Intercardia to use its
best efforts to commercialize the licensed products or processes, including in
certain cases satisfying milestones.

PATENTS AND PROPRIETARY RIGHTS

     Citicoline

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

     U.S. patents were issued to Interneuron in September and October 1998
relating to use of citicoline in the protection of brain tissue from cerebral
infarction following ischemic stroke. The Company licensed rights to this patent
to Ferrer worldwide 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.

     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--Uncertainty Regarding Waxman-Hatch Act".

     Pagoclone

     Interneuron licensed from RPR on a worldwide basis patents and patent
applications covering a composition of matter, processes, and metabolites of
pagoclone. A U.S. composition of matter patent was issued in October 1990 and
related U.S. patents were issued in February and March 1996.


                                       31
<PAGE>   32


     Other Interneuron Products

     Interneuron has an option to license a U.S. patent issued on February 8,
1994, relating to a phospholipid found in lecithin, which in turn is obtained
from soya bean oil. Three claims of this patent relate to methods of preventing
or treating liver cirrhosis in mammals by administering an effective amount of
the compound. European and Japanese counterparts are pending.

     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.

     Intercardia

     CPEC has licensed from BMS a compound patent on bucindolol which expired
in November 1997. Intercardia intends to pursue up to five years of market
exclusivity under the Waxman-Hatch Act, although there can be no assurance such
exclusivity will be obtained, and also may develop a once-daily formulation of
the drug. See "Government Regulation."

     As a result of the Transcell Acquisition, Intercardia owns or licenses from
Princeton University 11 issued patents in the United States relating to its
combinatorial carbohydrate technology. A number of patent applications are
pending. Intercardia has rights to license inventions arising out of research
sponsored at Princeton University.

     Redux

     Under the Servier Agreements, the Company has 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 is
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.

     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 designed around or challenged. 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 products by obtaining regulatory clearance, through showing
equivalency to the Company's product, without being required to conduct the
lengthy clinical tests required of the Company.

     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 clinical testing, manufacturing
and marketing of the affected product or process. If any such actions are
successful, in addition to any potential liability for damages, 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


                                       32
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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 and accordingly, if
products based on such technologies are commercialized, they may infringe such
patents or other rights.

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 application is required before human clinical use in the United
States of a new drug compound or biological product can commence. The IND
application 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 establishments, both foreign and domestic,
also are subject to inspections by or under the authority of the FDA and by
other federal, state, local or foreign agencies.

     Even after initial FDA or foreign health authority approval has been
obtained, further studies, including Phase 4 post-marketing studies, may be
required to provide additional data on safety and will be required to gain
approval for the use of a product as a treatment for clinical indications other
than those for which the product was initially tested. Also, the FDA or foreign
regulatory authority will require post-marketing


                                       33
<PAGE>   34



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.

     Patent Term Extension and Market Exclusivity:

     Under the Drug Price Competition and Patent Term Restoration Act of 1984
(commonly referred to as 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 each of citicoline and bucindolol 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.

     Foods and Dietary Supplements:

     Foods with health-related claims are subject to regulation by the FDA as
conventional foods, medical foods, dietary supplements or drugs, and a product's
classification will depend, in part, on its intended use as reflected in the
claims for the product. InterNutria's products were dietary supplements pursuant
to the Dietary Supplement Health Education Act of 1994 for the dietary
management of physiological processes.

     If represented for use in the cure, mitigation, treatment or prevention of
disease, a product will be regulated as a drug. If no such claims are made, the
product may be regulated as a conventional food or as a dietary supplement. No
explicit or implicit claim that "characterizes the relationship" of a nutrient
to a "disease or health-related condition" is permitted in food labeling unless
the FDA has authorized that claim by regulation or unless the claim has been
endorsed by a scientific body of the U.S. Government with official
responsibility for public health protection and the FDA receives prior notice of
the use of such claim.

     Dietary supplements may bear claims describing the role of nutrient or
dietary ingredient intended to affect the structure or function of the body,
provided certain requirements (such as substantiation for the claims) are met.
These claims need not be authorized by the FDA in a regulation.

     The FDA also regulates the substances that may be included in food
products. A substance intended for use as a food or to be added to a food may be
marketed only if it is generally recognized among qualified experts as safe for
its intended use or if it has received FDA approval for such use in the form of
a food additive regulation. If the Company develops a food which is, or which
contains, a substance that is not generally recognized as safe or approved by
the FDA in a food additive regulation for its intended use, then such approval
must be obtained prior to the marketing of the product. Dietary ingredients used
in dietary supplements need not be generally recognized as safe, but they may
not present a significant or unreasonable risk of illness or injury.

     Devices:


                                       34
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     The AnatoMark device manufactured and marketed by the Company is also
subject to regulation by the FDA. The FDA requires manufacturers of medical
devices to comply with applicable laws and regulations governing the testing,
manufacturing, labeling, marketing and distribution of medical devices. Devices
are generally subject to varying levels of regulatory control.

     One process, which was applicable to AnatoMark, applies to any new device
that is substantially equivalent to a device first marketed prior to May 1976
and does not require pre-market approval. In this case, FDA permission to
distribute the device can be accomplished by submission of a pre-market
notification submission (a "510(k) Submission"), and issuance by the FDA of an
order permitting commercial distribution. A 510(k) Submission must provide
information supporting its claim of substantial equivalence. If clinical data
from human experience is required to support a 510(k) Submission, this data must
be gathered in compliance with investigational device exemption regulations for
investigations performed in the United States. The FDA must issue an order
finding substantial equivalence before commercial distribution can occur.
Changes to existing devices which do not significantly affect safety or
effectiveness can generally be made by the Company without additional 510(k)
Submissions. The Company's AnatoMark device received FDA authorization for
marketing in July 1998.

     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.

EMPLOYEES

     As of September 30, 1998, Interneuron and Intercardia had 92 full-time
employees, including 38 at Interneuron and 54 at Intercardia. The Company
adopted a plan to discontinue InterNutria's operations in September 1998.
InterNutria had seven employees at such time. At September 30, 1998, Progenitor
had 55 employees. However, in December 1998, Progenitor announced its intention
to terminate its operations. 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 - Risks Relating to Redux Litigation."

     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 Subsidiaries (excluding Progenitor)
are parties to office and laboratory leases providing for aggregate annual
rental of approximately $1,225,000. The Company has guaranteed certain
Subsidiaries' obligations under lease arrangements.



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<PAGE>   36


Item 3. Legal Proceedings

     Product Liability Litigation

     The Company has been named, together with other pharmaceutical companies,
as a defendant in approximately 779 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. Plaintiff's
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,
primary pulmonary hypertension, 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.

     Proposed Settlement of Product Liability Litigation: On September 25, 1998,
the U.S. District Court for the Eastern District of Pennsylvania (the "Court")
preliminarily approved an Agreement of Compromise and Settlement (the
"Settlement Agreement") between Interneuron and the Plaintiffs' Management
Committee, consisting of attorneys designated by the Court to represent
plaintiffs in the multi-district litigation relating to Redux, relating to the
settlement of all product liability litigation and claims against the Company
related to Redux. The Court also conditionally certified a limited fund class
action. The Court order followed a letter of understanding outlining terms of
the settlement announced on September 3, 1998 and execution of the formal
settlement agreement between the Company and the Plaintiffs' Management
Committee. A fairness hearing on the settlement has been scheduled for February
25, 1999.

     On November 3, 1998, the Court issued a stay halting all product liability
litigation, pending and future, in state courts against the Company related to
Redux. This followed the issuance of a similar stay halting Redux product
liability litigation in federal courts on September 3, 1998. These stays will
remain effective until the fairness hearing scheduled for February 25, 1999 and
may be extended pending the outcome of this hearing.

     The limited fund class action established by this settlement includes all
persons in the United States who used Redux, and certain other persons such as
their family members, who would be bound by the terms of the settlement.
Membership in the class is mandatory for all persons included within the class
definition.

     Under the terms of the proposed settlement, class members asserting claims
against Interneuron will be required to seek compensation only from the
settlement fund and their lawsuits against Interneuron will be dismissed. By
agreeing to the proposed settlement, Interneuron does not admit liability to any
plaintiffs or claimants. Under the Settlement Agreement, the released parties
include, among other parties, Interneuron, Boehringer (except for claims arising
from defects in the manufacture or packaging of Redux) and their respective
affiliates and stockholders (in their capacity as stockholders).

     Summary of Settlement Agreement:  The settlement agreement requires
Interneuron to deposit a total of approximately $15,000,000 in three
installments into a settlement fund.  The first installment of $2,000,000


                                       36
<PAGE>   37



was deposited into the settlement fund in September 1998. A second installment
of $3,000,000 is to be made after the settlement agreement is approved by the
Court, which would follow the fairness hearing. These installments, less certain
expenses, will be returned to Interneuron if the settlement does not become
final. A third installment of $10,000,000, plus interest, is to be made after
the settlement becomes final.

     In addition, the proposed settlement provides for Interneuron to cause all
remaining and available product liability insurance proceeds related to Redux to
be deposited into the settlement fund. As part of the Settlement Agreement,
Interneuron and the Plaintiffs' Management Committee also entered into a Royalty
Agreement. Under the Royalty Agreement, Interneuron agreed to make royalty
payments to the settlement fund, in the total amount of $55,000,000, based upon
sales of Interneuron products and other revenues, over a seven year period
beginning after the settlement becomes final. Royalties will be paid at the rate
of 7% of gross sales of Interneuron products sold by Interneuron, 15% of cash
dividends received by Interneuron from its subsidiaries related to product
sales, and 15% of license revenues (including license fees, royalties or
milestone payments) received by Interneuron from a sublicensee related to
product sales. All Interneuron products will be subject to this royalty during
the applicable term. If, at the end of that seven year period, the amount of
royalty payments made by Interneuron is less than $55,000,000, the settlement
fund will receive shares of Interneuron Common Stock ("Royalty Shares") in an
amount equal to the unpaid royalty balance divided by $7.49 per share, subject
to adjustment under certain circumstances such as stock dividends or
distributions.

     In the event Interneuron merges with or sells all or substantially all of
its assets to another corporation prior to payment of the $55,000,000 of
royalties, the settlement fund shall be entitled to receive the kind and amount
of shares of stock or other securities or property to which a holder of the
number of shares of Common Stock (calculated based on the unpaid royalty balance
at such time) would have been entitled to at the time of the transaction.
Interneuron has the right of first refusal to purchase Royalty Shares in the
event of any proposed transfer by the settlement fund and any transfers by the
settlement fund must be in accordance with the volume restrictions contained in
Rule 144(e) of the Securities Act of 1933, as amended. In addition, the
settlement fund agreed to vote any Royalty Shares held by it in the same manner
and proportion as the other holders of outstanding securities of Interneuron
entitled to vote on any matter.

     Conditions to Final Settlement: The settlement will not become final until
approved by the Court and the time for filing appeals has passed or all appeals
have been exhausted. In this case, in order to approve the settlement, the Court
must make a determination that the proposed settlement is fair and reasonable
and meets each of the prerequisites for a class action generally, and for a
"limited fund" class action in particular, all as required by the Federal Rules
of Civil Procedure. Pursuant to these rules, notice of the proposed settlement
was provided to potential class members in November 1998, and the Court has
scheduled a Fairness Hearing for February 25, 1999 (the "Fairness Hearing"). At
the Fairness Hearing, proponents and opponents of the proposed settlement will
be given an opportunity to present written and oral arguments in favor of or
against the settlement. Following the Fairness Hearing, the Court must determine
if the case is properly certified as a limited fund class action, and if so,
whether the terms of the Settlement Agreement are fair and reasonable.

     The Company may withdraw from the Settlement Agreement, or the Settlement
Agreement may otherwise terminate, under any of the following conditions: (i)
final approval of the Settlement Agreement is not entered by the Court; (ii)
class certification and/or approval of the Settlement Agreement is overturned on
appeal for any reason; (iii) pending and future litigation against the Company
or any other party released by the Settlement Agreement ("Released Parties") is
not permanently enjoined on the final approval date; (iv) the class action and
all pending multi-district lawsuits against the Released Parties are not
dismissed with prejudice on the final approval date; (v) an order is not entered
by the Court permanently barring contribution and indemnity claims by other
defendants in the diet drug litigation; and (vi) Interneuron is unable to compel
tender of its insurance proceeds.


                                       37
<PAGE>   38


     On November 20, 1998, one of the insurers filed an action against Servier
and the Company in the Court, pursuant to the federal interpleader statute. The
insurer alleges that both Servier and the Company have asserted claims against a
commercial excess insurance policy issued by the insurer to Interneuron with
limits of $5,000,000 in excess of $20,000,000. The insurer has deposited the
limits of the policy into the registry of the Court.

     There can be no assurance that after the Fairness Hearing the Court will
approve the settlement, and even if the settlement is approved by the Court,
opponents of the settlement may appeal the Court's opinion to the United States
Court of Appeals for the Third Circuit. In addition, there is a case pending
before the United States Supreme Court (Ortiz v. Fibreboard Corporation et al.)
("Ortiz"), that may influence the Court's decision or the outcome of any appeal
that might be taken. Oral argument in the Ortiz case was heard on December 8,
1998 and the Supreme Court is likely to render its opinion between January and
June 1999. Although factually distinguishable in many respects from the
Company's proposed settlement, Ortiz involves an appeal from a mandatory,
putative "limited fund" class action settlement. There can be no assurance that
the Supreme Court's rulings in Ortiz will not significantly influence, or
potentially result in the overturning of, the Settlement Agreement.

     Future Charges to Operations: The Company will record initial charges to
operations for the estimated fair value of the Company's obligations under the
Settlement Agreement, exclusive of insurance proceeds, at such time as the
Company can determine that it is probable that the conditions to final
settlement have been or will be met, which is expected to be subsequent to the
Fairness Hearing and to the Supreme Court ruling in Ortiz. The amount of the
liability to be recognized by the Company pursuant to the Settlement Agreement
is likely to be significant and to materially adversely affect the Company's net
worth. Additionally, if the Company records such charges prior to the final
settlement date, then on the date the Settlement Agreement becomes final, the
Company will determine if there was any increase in the fair value of the equity
conversion feature of the Royalty Agreement and record any such increase as an
additional charge to operations. From the date the Company records the charge
and related liability for the settlement and through the term of the Royalty
Agreement, the Company will record charges to accrete the liability attributable
to the royalty feature of the Royalty Agreement up to the amount of royalties
the Company expects to pay pursuant to the Royalty Agreement over the time the
Company expects to make such royalty payments. Payments to be made by the
Company pursuant to the Settlement Agreement could have a material adverse
effect on the operations and financial condition of the Company. See Note H of
Notes to Consolidated Financial Statements.

     Securities Litigation

     The Company and certain present or former directors and/or officers of the
Company have been named as defendants in nine lawsuits filed in the United
States District Court for the District of Massachusetts 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 disseminated 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.

     On January 23, 1998, the 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 current officer and director and one current director 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.

     The Court held a Case Management Conference on September 23, 1998, and
issued a procedural order on that same day establishing a schedule for class
certification briefing, fact and expert discovery, dispositive


                                       38
<PAGE>   39



motions briefing and trial.  Trial is scheduled for April 2000. The Company is
vigorously pursuing its defenses to these actions.

     General

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

     Although the Company maintains certain product liability and director and
officer liability insurance and intends to defend the product liability,
securities 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. Payments under the Settlement Agreement will adversely
affect the Company's financial condition and results of operations. If the
Settlement Agreement is overturned or not made final, the ongoing Redux-related
product liability litigation would then proceed against the Company. In this
event, the existence of such litigation may continue to materially adversely
affect the Company's business, including its ability to obtain sufficient
financing to fund operations. In addition, although the Company is unable to
predict the outcome of any such litigation, in the event the proposed settlement
does not become final and in the event of successful uninsured or insufficiently
insured claims, or in the event a successful indemnification claim was made
against the Company, the Company's 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 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, and 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 "Risk Factors" and Note H 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>
Lindsay A. Rosenwald, M.D.     43  Chairman of the Board of Directors
Glenn L. Cooper, M.D.          45  President, Chief Executive Officer and Director
Mark S. Butler                 52  Executive Vice President, Chief Administrative
                                   Officer and General Counsel
Bobby W. Sandage, Jr., Ph.D.   45  Executive Vice President, Research and
                                   Development and Chief Scientific Officer
</TABLE>


                                       39
<PAGE>   40


     Lindsay A. Rosenwald, M.D. was a co-founder and since February 1989 has
been Chairman of the Board of Directors of the Company. Dr. Rosenwald has been
the Chairman and President of The Castle Group Ltd., a biotechnology and
biopharmaceutical venture capital firm, since October 1991, the founder and
Chairman of Paramount Capital Investments, LLC, a biotechnology, biomedical and
biopharmaceutical merchant banking firm, since 1995, the founder and Chairman of
Paramount Capital, Inc., an investment banking firm, since February 1992, and
the founder and Chairman of Paramount Capital Asset Management, Inc. a money
management firm specializing in the life sciences industry since June 1994. Dr.
Rosenwald received his M.D. from Temple University School of Medicine and his
B.S. in Finance from Pennsylvania State University. Dr. Rosenwald is also a
director of the following publicly-traded pharmaceutical or biotechnology
companies: BioCryst Pharmaceuticals, Inc., Neose Technologies, Inc., Sparta
Pharmaceuticals, Inc., VIMRx Pharmaceuticals, Inc. and is a director of a number
of privately held companies in biotechnology or pharmaceutical fields.

     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, is a
director of each of the Subsidiaries. Dr. Cooper is a director of Genta
Incorporated ("Genta"), a publicly-traded biotechnology 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.

     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.

     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 Aeolus, a
subsidiary of Intercardia, and of Genta.

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

     Dale Ritter joined the Company in October 1994 as Corporate Controller and
in December 1996 was named Vice President and Chief Accounting Officer. In July
1998, Mr. Ritter was named Senior Vice President of Finance and as of August 18,
1998 was appointed Acting Chief Financial Officer and Treasurer. Prior to
joining the Company, Mr. Ritter was Director of Finance at Parexel International
Corporation from 1990 to September 1994.

     The Company is actively seeking a permanent Chief Financial Officer.


                                       40
<PAGE>   41


     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 and on representations that no other reports
were required, there were no reports required under Section 16(a) of the
Securities Exchange Act of 1934 which were not timely filed during fiscal 1998.

     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, 1997:
October 1 through December 31, 1996    $  29 3/4    $ 18 1/2
January 1 through March 31, 1997          32 5/8      15 7/8
April 1 through June 30, 1997             21 5/8      12 3/4
July 1 through September 30, 1997         22          10 7/8

Fiscal Year Ended September 30, 1998:
October 1 through December 31, 1997    $  13 3/4    $  9 1/8
January 1 through March 31, 1998        10 15/16     7 11/16
April 1 through June 30, 1998             15 1/2       3 1/8
July 1 through September 30, 1998         5 1/16       2 1/2
</TABLE>

     Approximate Number of Equity Security Holders

     The number of record holders of the Company's Common Stock as of December
21, 1998 was approximately 790.

     Dividends

     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.

     Recent Sales of Unregistered Securities

     In May 1998, in connection with the repricing of certain options and
warrants that had exercise prices of $10 or more, the Company issued warrants
to purchase an aggregate of 105,000 shares of Common Stock at an exercise price
of $6.19 per share, in exchange for the cancellation of warrants to purchase
the same number of shares of Common Stock at exercise prices ranging from
$18.25 to $23.25 per share. In August


                                       41
<PAGE>   42



1998, in connection with the repricing of options that were not subject to the
May 1998 exchange offer, the Company issued options outside the Company's stock
option plans to purchase an aggregate of 50,000 shares of Common Stock at an
exercise price of $4.16 per share, in exchange for the cancellation of options
to purchase the same number of shares of Common Stock at an exercise price of
$7.00 per share. The remaining options issued pursuant to the May 1998 and
August 1998 exchange offers were registered on registration statements on Form
S-8. The issuance of the non-registered options and warrants to an aggregate of
five directors of and consultants to the Company was exempt from registration
under the Securities Act of 1933 pursuant to Section 4(2) thereof.

                                       42


<PAGE>   43
     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,
                                                                  (Amounts in thousands except per share data)     
                                                              1994        1995       1996         1997        1998
                                                          --------    --------    -------     --------    --------
<S>                                                      <C>         <C>        <C>          <C>          <C>      
STATEMENT OF OPERATIONS DATA:                                                                                      
Product revenue ........................................  $     --    $     --    $ 13,779    $ 55,945    $     -- 
Contract and license fee revenue .......................       101       3,463       8,335      11,039       6,488 
Total revenues .........................................       101       3,463      22,114      66,984       6,488 

Cost of product revenue ................................        --          --      11,454      41,144          -- 
Research and development ...............................    17,737      15,070      17,344      50,180      39,762 
Selling, general and administrative ....................     8,341       7,142      13,991      19,581      21,975 
Product withdrawal .....................................        --          --          --       7,528          -- 
Purchase of in-process research and development ........     1,852          --       6,434       3,044         500 

Net loss from operations ...............................   (27,829)    (18,749)    (27,109)    (54,493)    (55,749)
Investment income, net .................................       444         894       4,135       8,944       5,465 
Equity in net loss of unconsolidated subsidiary ........        --          --          --      (9,028)     (4,040)
Net loss from continuing operations ....................   (27,385)    (17,292)    (22,400)    (49,670)    (50,485)
Discontinued operations ................................        --        (689)     (5,586)     (5,586)    (19,477)

Net loss ...............................................  $(27,385)   $(17,981)   $(27,986)   $(55,256)   $(69,962)
Net loss per common share from continuing operations ...  $   (.98)   $   (.57)   $   (.61)   $  (1.21)   $  (1.22)
Net loss per common share from discontinued operations .  $     --    $   (.02)   $   (.15)   $   (.14)   $   (.47)
Net loss per common share - basic and diluted ..........  $     --    $   (.59)   $   (.76)   $  (1.35)   $  (1.69)
Weighted average common shares outstanding .............    27,873      30,604      37,004      41,064      41,468 

<CAPTION>                                                                       September 30,                             
                                                                           (Amounts in thousands)                     
                                                              1994        1995        1996        1997        1998 
                                                          --------    --------   ---------    --------   ---------
<S>                                                        <C>         <C>       <C>          <C>         <C>      
BALANCE SHEET DATA:     
Working capital                                           $  8,577    $ 25,755   $ 155,246   $  82,229   $  41,417 
Total assets                                                18,278      37,516     186,438     152,930      78,197 
Long-term portion of notes payable                                                   
 and capital lease obligations                                                        
Total liabilities                                            8,501      10,486      22,303      43,962      30,842 
Accumulated deficit                                        (60,811)    (78,792)   (106,778)   (162,034)   (231,996)
Stockholders' equity                                         9,777      21,392     144,762      96,009      39,856 
</TABLE> 


                                       43
<PAGE>   44


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

       The following discussion should be read in conjunction with the
  Consolidated Financial Statements and Notes thereto appearing elsewhere in
  this report. See "Note Regarding Forward Looking Statements".

  General

       Redux

       Proposed Settlement of Product Liability Litigation

       Subsequent to the September 15, 1997 market withdrawal of the weight loss
  medication Redux, Interneuron has been named, together with other
  pharmaceutical companies, as a defendant in approximately 779 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 U.S. District Court for the Eastern District
  of Pennsylvania (the "Court") preliminarily approved an Agreement of
  Compromise and Settlement (the "Settlement Agreement") between the Company and
  the Plaintiffs' Management Committee ("PMC") relating to the proposed
  settlement of all product liability litigation and claims against the Company
  relating to Redux. As part of the Settlement Agreement, the Company and the
  PMC entered into a royalty agreement (the "Royalty Agreement") relating to a
  portion of the payments proposed to be made to the settlement fund.

       On November 3, 1998, the 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. These
  stays will remain effective until a fairness hearing scheduled for February
  25, 1999 and may be extended pending the outcome of this hearing.

       Summary of Proposed Settlement: The limited fund class action established
  by the Settlement Agreement includes all persons in the United States who used
  Redux, and certain other persons such as their family members, who would be
  bound by the terms of the settlement. Membership in the class is mandatory for
  all persons included within the class definition. Class members asserting
  claims against Interneuron will be required to seek compensation only from the
  settlement fund, and their lawsuits against Interneuron will be dismissed. By
  agreeing to the proposed settlement, Interneuron does not admit liability to
  any plaintiffs or claimants.

       The Settlement Agreement requires Interneuron to deposit a total of
  approximately $15,000,000 in three installments into a settlement fund. The
  first installment of $2,000,000 was deposited into the settlement fund in
  September 1998. A second installment of $3,000,000 is to be made after the
  Settlement Agreement is approved by the Court, which approval, if obtained,
  would follow the fairness hearing. These installments, less certain expenses,
  will be returned to Interneuron if the settlement does not become final. A
  third installment of $10,000,000, plus interest, is to be made after the
  settlement becomes final.

       The Settlement Agreement provides for Interneuron to cause all remaining
  and available 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


                                       44
<PAGE>   45



  Interneuron products, over a seven year period commencing when the settlement
  becomes final. Royalties will be paid at the rate of 7% of gross sales of
  Interneuron products sold by Interneuron, 15% of cash dividends received by
  Interneuron from its subsidiaries related to product sales, and 15% of license
  revenues (including license fees, royalties or milestone payments) received by
  Interneuron from a sublicensee related to product sales. All Interneuron
  products will be subject to this royalty during the applicable term. If, at
  the end of that seven year period, the amount of royalty payments made by
  Interneuron is less than $55,000,000, the settlement fund will receive shares
  of Interneuron stock in an amount equal to the unpaid balance divided by $7.49
  per share, subject to adjustment under certain circumstances such as stock
  dividends or distributions.

       Conditions to Final Settlement: The settlement will not become final
  until approved by the Court and the time for appeal of the Court's judgment
  approving the Settlement Agreement has elapsed without any appeals being filed
  or all appeals from the Court's judgment approving the Settlement Agreement
  have been exhausted and no further appeal may be taken. In this case, in order
  to approve the settlement, the Court must make a determination that the
  proposed settlement is fair and reasonable and meets each of the prerequisites
  for a class action generally, and for a "limited fund" class action in
  particular, all as required by the Federal Rules of Civil Procedure. Pursuant
  to these rules, notice of the proposed settlement was provided to potential
  class members in November, 1998, and the Court has scheduled a fairness
  hearing for February 25, 1999 (the "Fairness Hearing"). At the Fairness
  Hearing, proponents and opponents of the proposed settlement will be given an
  opportunity to present written and oral arguments in favor of or against the
  settlement. Following the Fairness Hearing, the Court must determine if the
  case is properly is certified as a limited fund class action, and if so,
  whether the terms of the Settlement Agreement are fair and reasonable.

       The Company may withdraw from the Settlement Agreement, or the Settlement
  Agreement may otherwise terminate, under any of the following conditions: (i)
  final approval of the Settlement Agreement is not entered by the Court; (ii)
  class certification and/or approval of the Settlement Agreement is overturned
  on appeal for any reason; (iii) pending and future litigation against the
  Company or any other party released by the Settlement Agreement ("Released
  Parties") is not permanently enjoined on the final approval date; (iv) the
  class action and all pending multi-district lawsuits against the Released
  Parties are not dismissed with prejudice on the final approval date; (v) an
  order is not entered by the Court permanently barring contribution and
  indemnity claims by other defendants in the diet drug litigation; or (vi)
  Interneuron is unable to compel tender of its insurance proceeds.

       On November 20, 1998, one of the insurers filed an action against Servier
  and the Company in the Court, pursuant to the federal interpleader statute.
  The insurer alleges that both Servier and the Company have asserted claims
  against a commercial excess insurance policy issued by the insurer to
  Interneuron with limits of $5,000,000 in excess of $20,000,000. The insurer
  has deposited the limits of the policy into the registry of the Court.

       There can be no assurance that after the Fairness Hearing the Court will
  approve the settlement. Even if the settlement is approved by the Court,
  opponents of the settlement may appeal the Court's opinion to the United
  States Court of Appeals for the Third Circuit. In addition, there is a case
  pending before the United States Supreme Court (Ortiz v. Fibreboard
  Corporation et al) ("Ortiz"), that may influence the Court's decision or the
  outcome of any appeal that might be taken. Oral argument in the Ortiz case was
  heard on December 8, 1998 and the Supreme Court is likely to render its
  opinion between January and June 1999. Although factually distinguishable in
  many respects from the Company's proposed settlement, Ortiz involves an appeal
  from a mandatory, putative "limited fund" class action settlement. There can
  be no assurance that the Supreme Court's rulings in Ortiz will not
  significantly influence the approval process for, or potentially result in the
  overturning of, the Settlement Agreement.



                                       45
<PAGE>   46


       Future Charges to Operations: The Company will record initial charges to
  operations for the estimated fair value of the Company's obligations under the
  Settlement Agreement, exclusive of insurance proceeds, at such time as the
  Company can determine that it is probable that the conditions to final
  settlement have been or will be met. This is expected to be subsequent to the
  Fairness Hearing and the Supreme Court ruling in Ortiz. The amount of the
  liability to be recognized in connection with these charges is likely to be
  significant and to materially adversely affect the Company's net worth.
  Additionally, if the Company records such charges prior to the final
  settlement date, then on the date the Settlement Agreement becomes final, the
  Company will determine if there was any increase in the fair value of the
  equity conversion feature of the Royalty Agreement and record any such
  increase as an additional charge to operations. From the date the Company
  records the initial charge and related liability for the settlement and
  through the term of the Royalty Agreement, the Company may record additional
  charges to accrete the liability attributable to the royalty feature of the
  Royalty Agreement up to the amount of royalties the Company expects to pay
  pursuant to the Royalty Agreement over the time the Company expects to make
  such royalty payments. Payments to be made by the Company pursuant to the
  Settlement Agreement could have a material adverse effect on the operations
  and financial condition of the Company. See Note H of Notes to Consolidated
  Financial Statements.

       If the Settlement Agreement is overturned or not made final, the ongoing
  Redux-related litigation would then proceed against the Company. In this
  event, 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 additional 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, financial condition and results of operations.

       Securities Litigation

       The Company has also been named as a defendant 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.

       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 devote
  significant management time and resources to these legal actions and, in the
  event of successful uninsured or insufficiently insured claims, or in the
  event a successful indemnification claim were made against the Company, the
  Company's business, financial condition and results of operations could be
  materially adversely affected. In addition, the uncertainties and costs
  associated with these legal actions have had, and may continue to have, an
  adverse effect on the market price of the Company's Common Stock and on the
  Company's ability to obtain additional financing to satisfy cash requirements,
  to retain and attract qualified personnel, to develop and commercialize
  products on a timely and adequate basis, to acquire or obtain rights to
  additional products, or to obtain product liability insurance for other
  products at costs acceptable to the Company, or at all, any or all of which
  may adversely affect the Company's business and financial condition. See
  "Legal Proceedings" and "Risk Factors - Risks Relating to Redux Litigation".

       Product Withdrawal



                                       46
<PAGE>   47


       The Company withdrew Redux from the market in September 1997 based on new
  preliminary information provided by the Food and Drug Administration ("FDA")
  to the Company and Wyeth-Ayerst and manufacturers and marketers of phentermine
  concerning potential abnormal echocardiogram findings in patients using these
  drugs. These patients had been treated with Pondimin or Redux for up to 24
  months, most often in combination with phentermine. Redux was launched in June
  1996.

       These observations presented by the FDA (which have since been updated
  and revised by the FDA) reflected a preliminary analysis of pooled information
  rather than results of a formal clinical investigation, and are difficult to
  evaluate because of the absence of matched controls and pretreatment baseline
  data for these patients. Nevertheless, the Company believes it was prudent, in
  light of this information, to have withdrawn Redux from the market.

       On November 13, 1997, the U.S. Department of Health and Human Services
  ("HHS") issued preliminary recommendations for the medical management of
  people who took Pondimin or Redux. HHS recommended, until more complete
  information is available, that patients who took either drug should see their
  physician to determine whether there are signs or symptoms of heart or lung
  disease and, if such person has signs or symptoms of heart or lung disease,
  such as a new heart murmur or shortness of breath, have an echocardiogram
  performed; and that physicians strongly consider performing an echocardiogram
  before a patient who has taken either drug has any invasive procedure for
  which antibiotic prophylactic treatment is recommended to prevent the
  development of bacterial endocarditis.

       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 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 a combination of fenfluramine
  and phentermine ("fen-phen"), compared to an untreated group. In general,
  these studies have been and are being 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 are selected
  and assigned to these groups randomly. Readings of patient echocardiograms are
  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 analyses. 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 far 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.

       Company Sponsored Redux Study

       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 patients who took Redux for
  three months or longer when compared to individuals who had not taken Redux.
  No severe and very few moderate cardiac valve abnormalities were found in
  either Redux patients or non-Redux subjects.



                                       47
<PAGE>   48


       The incidence of cardiac valve abnormalities among Redux patients
  reported in this study, although statistically significant, was far less than
  some previously reported estimates. In addition, findings from the study
  suggest that elevated blood pressure at the time that echocardiograms were
  taken among these patients, as well as the concomitant use of drugs with
  monoamine oxidase inhibitory properties, which were contraindicated with the
  use of Redux, increased the incidence of cardiac valve abnormalities.
  Additional findings suggest that the greater the time off Redux, the less
  likely patients were to show valvular abnormalities. These findings are being
  further evaluated.

       The average duration of Redux use among all Redux patients in this study
  was seven months. The study, funded by the Company, 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. However, market research indicates that
  approximately 86 percent of patients took Redux for 90 days or less and
  approximately 6.5 percent took Redux for six months or more.

       Analyses were conducted based on echocardiographic data from the total
  patient population entered into the study (412) and also from the core group
  (350), which included only the matched pairs. There were totals of 220
  patients and 192 control group, or matched patients, in the study. Cardiac
  valve disease was defined as mild or greater aortic valve regurgitation and/or
  moderate or greater mitral valve regurgitation. Previous reports had estimated
  rates of cardiac valve insufficiencies among anorexigen-treated patients of up
  to 30 percent.

       Among all study participants, 1.4 percent of Redux patients and 0.5
  percent of non-treated patients (p=.63) met the FDA's definition of mitral
  valve regurgitation. Among the core group of matched pairs, 1.7 percent of
  Redux patients and 0.6 percent of non-treated controls (p=.32) met this
  definition.

       With respect to aortic valve regurgitation, in all patients, 5.9 percent
  of Redux patients and 2.1 percent of non-treated patients (p=.08) met the
  FDA's definition. Among the core group of matched pairs, 6.3 percent of Redux
  patients and 2.3 percent of non-treated controls (p=.07) met this definition.

       For all patients with either aortic or mitral valve regurgitation meeting
  FDA criteria only, the incidence was 2.6 percent for controls and 7.3 percent
  for the Redux patients (p=.04). When analyzed for valvular insufficiency of
  any degree including trace, there was an increased incidence in the Redux
  group when compared to the untreated control group for the aortic valve
  (p=.04) but not the mitral valve (p=.28).

       When potentially confounding factors were considered, such as use of
  concomitant monoamine oxidase inhibitors (such as estrogens and thyroid
  hormone replacements), and the patients' blood pressures at the time of their
  echocardiograms, the difference in the incidence of valvular insufficiency
  between Redux and non-Redux treated patients became non-significant. For
  example, when patients were exposed to concomitant drugs possessing monamine
  oxidase inhibitory properties were excluded from the analysis, 3 percent of
  control group patients met FDA-criteria for aortic and mitral valve
  regurgitation as compared with 4 percent in the Redux group (p=not
  significant).

       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 in April 1996 by the FDA for marketing as a
  twice-daily prescription therapy to treat obesity.  Until its voluntary
  withdrawal, Redux was marketed in the U.S. by Wyeth-Ayerst and


                                       48
<PAGE>   49



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

       The FDA-approved labeling for Redux also includes 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. The Company has presented data relating to the
  lack of neurocognitive effects in patients taking Redux to the FDA and
  believes that, as demonstrated in human trials, these animal studies are
  clinically irrelevant to humans because of pharmacokinetic differences between
  animals and humans and because of the high dosages used in the animal studies.
  In connection with the approval of Redux, the Company and Wyeth-Ayerst 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 Pondimin and
  phentermine. 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.

       Redux Revenues: A significant portion of Interneuron's revenues through
  fiscal 1997 had been derived from Redux sales and, accordingly, did not recur
  after fiscal 1997 as a result of the product's withdrawal. The Company's
  revenues relating to Redux were derived primarily from: (1) royalties paid by
  AHP to the Company based on the net sales of Redux capsules by AHP to
  distributors; (2) profit sharing between the Company and AHP on Redux sales by
  the Company's sales force and financial support of the Company's sales force
  provided by AHP; and (3) sales of Redux capsules to AHP. The Company did not
  recognize any revenue related to Redux in fiscal 1998 and does not expect to
  realize any future revenues related to Redux.

       Under the Company's license agreement with AHP the Company received (i)
  "base" royalties equal to 11.5% of AHP's net sales (an amount equal to the
  royalty required to be paid by the Company to Les Laboratoires Servier, a
  French pharmaceutical company from which the Company obtained U.S. rights to
  Redux to treat abnormal carbohydrate craving and obesity ("Servier"), and (ii)
  "additional" royalties (ranging from 5% to 10% of net sales in fiscal 1997)
  based on net sales of Redux by AHP.

       Under a three-year copromotion agreement entered into in June 1996 with
  Wyeth-Ayerst, and to supplement AHP's marketing efforts, the Company had
  developed an approximately 30- person sales force that promoted Redux to
  selected diabetologists, endocrinologists, bariatricians, nutritionists and
  weight management specialists, subject to certain restrictions, in return for
  a percentage of resulting revenues less



                                       49
<PAGE>   50



  certain expenses. Although a portion of the Company's copromotion costs
  related to the sales force was funded by AHP, the Company incurred substantial
  additional costs relating to its sales force and in connection with the
  promotion of Redux.

       Under a manufacturing agreement with Boehringer Ingelheim
  Pharmaceuticals, Inc. ("Boehringer"), Boehringer had manufactured finished
  dosage formulation of Redux capsules on behalf of the Company for sale to AHP.
  The Company recognized revenue from the sale of these capsules upon acceptance
  by AHP, typically 45 days after shipment.

       Charges to Operations: In connection with the market withdrawal of Redux,
  the Company recorded as of September 30, 1997 certain charges aggregating
  approximately $10,800,000. Of this amount, approximately (i) $3,300,000
  (included in cost of revenues) related to reserves for inventories of
  dexfenfluramine drug substance and finished Redux capsules which were deemed
  to have no net realizable value and (ii) $7,500,000 related to costs or
  commitments associated with product development, the cessation of production
  of Redux capsules and other costs. Total expenses relating to the market
  withdrawal of Redux may exceed these amounts which were current estimates and
  do not include provisions for liability, if any, arising out of Redux-related
  litigation or other related costs. In addition, the Company will record
  charges to operations pursuant to the proposed Settlement Agreement if certain
  conditions are met and may incur future charges to operations if the
  Settlement Agreement does not become final or depending on the outcome of this
  or other litigation. See "Proposed Settlement of Product Liability
  Litigation."

       Citicoline

       In April 1998, the Company announced that based upon a preliminary
  analysis, a 100-patient Phase 3 trial with citicoline (cytidine-5'-diphosphate
  choline, sodium), the Company's product under development to treat ischemic
  stroke, failed to meet its primary and the principal secondary endpoints. As a
  result of the preliminary analysis and considering statutory requirements that
  would have mandated an FDA action by June 1998, the Company withdrew its NDA
  for citicoline in April 1998. The Company had submitted the NDA to the FDA for
  citicoline in December 1997.

       With respect to the primary endpoint in this trial, 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. 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. The Company believes that a placebo response rate
  unexpectedly higher than that previously reported in the 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.

       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 and a
  fast-track designation indicates that the FDA has determined 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.

       The Company is proceeding with the development of citicoline and
  commenced in June 1998 an approximately 900 person Phase 3 clinical trial
  which will compare the neurological function at 12 weeks following ischemic
  stroke of citicoline-treated patients with that of patients who received
  placebo. Patients will be treated with 2000 milligrams of citicoline daily for
  six weeks with a six week follow-up period. It is anticipated that this
  clinical trial will be completed in late 1999. The 2000 milligram dose level
  is


                                       50
<PAGE>   51



  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 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.

       As of September 30, 1998, the remaining expenditures of all currently
  planned clinical trials and related studies and NDA preparation for citicoline
  are estimated, based upon current trial protocols, to aggregate approximately
  $28,000,000. The Company is unable to predict the costs of any related or
  additional clinical studies which will depend upon the results of the on-going
  trial and upon FDA requirements. Significant additional funds will be required
  for development, manufacturing, distribution, marketing and selling efforts,
  the amount of which will depend upon whether the Company markets citicoline
  itself or enters into a corporate collaboration.

       Activase, a genetically engineered version of the naturally occurring
  tissue plasminogen activator (t-PA), is marketed by Genentech, Inc. for the
  treatment of acute ischemic stroke within three hours of symptom onset.
  Activase is the first therapy to be indicated for the management of stroke. A
  number of other drugs in clinical trials are also being developed for this
  indication, including clomethiazole by Astra Pharmaceuticals, a glycine
  antagonist compound by Glaxo Wellcome and Fiblast by AHP. Based on existing
  clinical data on CerAxon, the Company believes CerAxon may be an attractive
  post-stroke therapy, particularly in patients with moderate to severe strokes,
  due to its potentially broader, 24-hour post-stroke therapeutic window.

       The Company licensed from Ferrer Internacional, S.A. ("Ferrer"), a
  Spanish pharmaceutical company, certain patent and know-how rights in the
  United States and Canada relating to the use of citicoline in exchange for a
  royalty equal to 6% of the Company's net sales of citicoline. 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.

       In June 1998, the Company entered into an agreement with Ferrer whereby
  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.

       As a result of the Company's withdrawal of its citicoline NDA, the
  related additional time and expense for product development, and the Company's
  limited cash resources, the Company is reevaluating its commercialization
  strategy for citicoline. The Company requires additional funds for
  manufacturing, distribution, marketing and selling efforts, the amount of
  which will depend upon whether the Company markets citicoline itself or enters
  into a corporate collaboration and the terms of any such collaboration. The
  Company has no commitments or arrangements to obtain additional funds and
  there can be no assurance such funds can be obtained on terms favorable to the
  Company or at all.

       The Company will be dependent upon third party suppliers of citicoline
  bulk compound, finished product and packaging for manufacturing in accordance
  with the Company's requirements and current U.S. Good Manufacturing Practices
  ("cGMP") regulations as well as third party arrangements for the distribution
  of


                                       51
<PAGE>   52



  citicoline. Supplies of citicoline finished product used for clinical purposes
  have been and are produced on a contract basis by third party manufacturers.
  The Company does not have an agreement with a manufacturer for supply of
  commercial quantities of finished product and there can be no assurance such
  agreement can be obtained on terms favorable to the Company or at all, which
  could adversely affect the Company's ability to commercialize citicoline on a
  timely and cost-effective basis. The Company's agreement with Ferrer requires
  the Company to purchase from Ferrer citicoline bulk compound for commercial
  purposes at fixed prices, subject to certain conditions. Any citicoline
  manufacturing facilities are subject to FDA inspection both before and after
  FDA approval to determine compliance with cGMP requirements. There can be no
  assurance the Company can or will establish on a timely basis, or maintain,
  manufacturing capabilities of bulk compound or 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
  such suppliers will be able to meet manufacturing requirements on a timely
  basis or at all.

       Pagoclone

       The Company is developing pagoclone as a drug to treat panic/anxiety
  disorders. Current pharmacological treatments for anxiety and panic disorders
  include serotonin agonists such as BuSpar, and benzodiazepines, such as Valium
  and Xanax, as well as selective serotonin reuptake inhibitors such as Paxil.
  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.

        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 syndromes in
  this study, which included a tapering-off period. The Company designates a
  trial as 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. Based on the results of this trial, Interneuron believes it
  has identified an optimal dose of pagoclone for Phase 3 clinical testing. The
  Company estimates the total costs of currently anticipated clinical
  development relating to pagoclone, including license fees to Rhone-Poulenc
  Rorer Pharmaceuticals, Inc. ("RPR"), and NDA preparation to be approximately
  $44,000,000, which if all of such activities are undertaken, would be incurred
  over approximately the next three years. The Company licensed from RPR
  exclusive worldwide rights to pagoclone, in exchange for licensing, milestone
  and royalty payments to RPR.

        The Company does not have sufficient funds to conduct Phase 3 clinical
  testing or commercialization of pagoclone and intends to seek a corporate
  collaboration or additional funds to proceed with a Phase 3 clinical study.
  There can be no assurance the Company will be successful in obtaining a
  corporate collaboration or additional financing sufficient to fund development
  and commercialization of pagoclone, on terms favorable to the Company or at
  all. In this event, the development of pagoclone would be significantly
  delayed or curtailed. Even if a collaboration or other financing is obtained
  the Company is unable to predict with certainty the costs of any additional
  studies which may be required by the FDA for approval of pagoclone and there
  can be no assurance, assuming such trials are conducted, that any such
  clinical trials will be successful or result in FDA approval of the product.
                

        
                                       52
<PAGE>   53


       Results of Operations

       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" for each fiscal
  year reflected on the Consolidated Statement of Operations. Additionally,
  during the last quarter of fiscal 1998, 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%, 10% and 20% of the Company's consolidated net losses during
  fiscal 1998, 1997 and 1996, 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 (see "Redux" above) 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 Intercardia'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 non-cash compensation charge relating to the
  Company's 1997 Equity Plan. The Company may incur significant charges during
  fiscal 1999 relating to the settlement of the Redux product liability
  litigation, if certain conditions are met. See "Proposed Settlement of Product
  Liability Litigation."

       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 Intercardia'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 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 Intercardia Research Laboratories (a division of
  Intercardia which assumed the operations of Transcell Technologies, Inc. after
  the merger of Transcell into Intercardia) due to their expanded carbohydrate
  technology research and Intercardia's expansion of its other research and
  development programs. Research and development expenses associated with
  citicoline are expected to increase substantially during fiscal 1999
  reflecting the June 1998 commencement of an approximately 900 patient Phase 3
  clinical trial expected to end in late 1999.

       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



                                       53
<PAGE>   54



  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 citcoline 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.

       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 Intercardia 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. As of September 30, 1998,
  the Company's investment in Progenitor had been reduced to zero. See
  "Subsidiaries--Progenitor" and Note P of Notes to Consolidated Financial
  Statements.

       Minority interest reflects the Company's allocation to the Subsidiaries'
  minority stockholders of the losses of Intercardia, Transcell through May 8,
  1998, the date of the merger of Transcell into Intercardia, 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 and expects to recognize approximately
  $4,000,000 of such expense in fiscal 1999.

       Fiscal Year Ended September 30, 1997 Compared to Fiscal Year Ended
  September 30, 1996

       Total revenues increased $44,870,000, or 203%, to $66,984,000 in fiscal
  1997 from $22,114,000 in fiscal 1996 reflecting product revenue of
  $55,945,000, primarily from a full year of Redux sales, and $11,039,000 of
  contract and license fee revenue.



                                       54
<PAGE>   55


       Product revenue increased $42,166,000, or 306%, to $55,945,000 in fiscal
  1997 from $13,779,000 in fiscal 1996. This increase includes a $29,485,000
  increase in Redux royalty revenue to $34,968,000 in fiscal 1997 from
  $5,483,000 in fiscal 1996 and a $12,387,000 increase in sales of Redux
  capsules and dexfenfluramine drug substance to $20,697,000 in fiscal 1997 from
  $8,310,000 in fiscal 1996 reflecting a full year of Redux sales compared to
  approximately one fiscal quarter of Redux sales in fiscal 1996. See Note H of
  Notes to Consolidated Financial Statements.

       Contract and license fee revenue increased $2,704,000, or 32%, to
  $11,039,000 in fiscal 1997 from $8,335,000 in fiscal 1996. This increase
  primarily reflects initial payments received pursuant to the Merck Agreement,
  a full year of revenues derived under the copromotion agreement with AHP
  compared to approximately one fiscal quarter of such revenues in fiscal 1996,
  and the initial license fee received from Lilly, partially offset by reduced
  revenue from Intercardia's bucindolol-related license agreements.

       Total costs and expenses increased $72,083,000, or 146%, to $121,477,000
  in fiscal 1997 from $49,394,000 in fiscal 1996. Cost of product revenue,
  primarily attributable to Redux, increased $29,690,000, or 259%, to
  $41,144,000 in fiscal 1997 from $11,454,000 in fiscal 1996 and constituted 41%
  of the increase in total costs and expenses. Included in cost of product
  revenue is approximately $3,300,000 related to reserves for inventories which
  were deemed to have no net realizable value after the withdrawal of Redux.
  Research and development expenses increased substantially in fiscal 1997 from
  fiscal 1996 primarily reflecting increased costs related to the development
  of, and NDA preparation for, citicoline and a $10,000,000 accrual related to
  Intercardia's contractual obligation to Astra Pharmaceuticals. In addition,
  the Company incurred charges to operations aggregating approximately
  $7,500,000 relating to the market withdrawal of Redux. See Note H of Notes to
  Consolidated Financial Statements. Cost of product revenue during fiscal 1998
  will reflect reduced costs associated with Redux as a result of the market
  withdrawal of Redux.

       Research and development expenses increased $32,836,000, or 189%, to
  $50,180,000 in fiscal 1997 from $17,344,000 in fiscal 1996. Increased research
  and development expenses resulted primarily from the conduct of two phase 3
  clinical trials and NDA preparation for citicoline and Intercardia's accrual
  in fiscal 1997 of its $10,000,000 commitment which was paid to Astra
  Pharmaceuticals in December 1997. In fiscal 1997, the Company and AHP had
  commenced development of a sustained release formulation of Redux and incurred
  related clinical development costs and paid license fees to Servier. This
  development program terminated as a result of the Redux withdrawal. Additional
  expenses were incurred by Transcell pursuant to its increased carbohydrate
  chemistry development activities and by the other Subsidiaries on their
  technologies and products.

       Selling, general and administrative expenses increased $5,419,000, or
  38%, to $19,581,000 in fiscal 1997 from $14,162,000 in fiscal 1996. Increased
  sales and marketing expenses were incurred by Interneuron in fiscal 1997 as a
  result of maintaining an approximately 30 person sales force for the
  copromotion of Redux for the full 1997 fiscal year compared to approximately
  one quarter in fiscal 1996. Increased facilities expenses were incurred by
  Interneuron and Transcell related to their respective moves into expanded
  facilities in late fiscal 1997. Also, the Company's growth resulted in
  increased numbers of employees and additional administrative, consulting,
  insurance and payroll-related costs. Partially offsetting these increased
  expenses is a reduction in Progenitor expenses resulting from a non-recurring
  fiscal 1996 charge for expenses relating to its then-postponed IPO and the
  deconsolidation of Progenitor commencing in August 1997 as a result of the
  Progenitor IPO. See Note P of Notes to Consolidated Financial Statements.

       Purchase of in-process research and development decreased $3,390,000, or
  53%, to $3,044,000 in fiscal 1997 from $6,434,000 in fiscal 1996. Fiscal 1997
  expenses primarily reflected charges from the Company's open-market purchases
  of Intercardia common stock and fiscal 1996 expenses primarily reflected
  charges from the Company's acquisitions of the 20% of CPEC not owned by
  Intercardia. The fiscal 1996 acquisition


                                       55
<PAGE>   56



  that resulted in a charge for in-process research and development was made
  primarily in exchange for Interneuron Common Stock which did not require the
  use of cash.

       Investment income, net of interest expense, increased $4,638,000, or
  108%, to $8,944,000 in fiscal 1997 from $4,306,000 in fiscal 1996 primarily
  due to significantly higher invested balances of cash, cash equivalents and
  marketable securities resulting primarily from funds received from public
  offerings in fiscal 1996 by Interneuron and Intercardia.

       Equity in net loss of unconsolidated subsidiary of $9,028,000 reflects
  the Company's equity in the net loss of Progenitor subsequent to the
  Progenitor IPO in mid August 1997, and 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. Results of Progenitor's operations prior to the Progenitor IPO are
  included in the Company's Consolidated Statements of Operations. See Note P of
  Notes to Consolidated Financial Statements.

       The allocation of losses from certain consolidated subsidiaries to their
  respective minority stockholders increased $4,333,000 to $4,907,000 in fiscal
  1997 from $574,000 in fiscal 1996 substantially due to the increased
  Intercardia loss resulting primarily from the $10,000,000 fiscal 1997 accrual
  pertaining to CPEC's commitment to Astra Pharmaceuticals, which was paid in
  December 1997.

       Net loss increased $27,270,000, or 97%, to ($55,256,000) in fiscal 1997
  from ($27,986,000) in fiscal 1996. Net loss per share increased to ($1.35) in
  fiscal 1997 from ($.76) in fiscal 1996 also reflecting an increase in weighted
  shares outstanding to 41,064,000 in fiscal 1997 from 37,004,000 in fiscal 1996
  resulting from additional equity issuances.

       Liquidity and Capital Resources

       Cash, Cash Equivalents and Marketable Securities

       At September 30, 1998, the Company had consolidated cash, cash
  equivalents and marketable securities aggregating $72,032,000 (of which
  approximately $23,600,000 is held by Intercardia and is not generally
  available to Interneuron) compared to $140,052,000 at September 30, 1997. This
  decrease is primarily due to approximately $67,000,000 used to fund
  operations, including $10,000,000 paid in December 1997 by CPEC, Inc.
  ("CPEC"), a majority-owned subsidiary of Intercardia, to Astra Pharmaceuticals
  (all of which was accrued at September 30, 1997) and $2,000,000 paid in
  September 1998 as the initial installment of the proposed settlement of the
  Redux product liability litigation, offset in part by the $4,000,000 received
  by CPEC in September 1998 in connection with the termination of the Astra
  Merck Collaboration. A portion of the payment to Astra Pharmaceuticals was
  funded by Interneuron, which owns directly approximately 20% of CPEC.

       While the Company believes it has sufficient cash for currently planned
  expenditures through September 1999, based on certain assumptions relating to
  operations, the settlement of the Redux product liability litigation and other
  factors, it will require additional funds after such time and intends to seek
  additional funds prior to such time. The Company will require additional funds
  for the development and commercialization of citicoline, pagoclone and its
  other compounds and technologies, as well as any new products acquired in the
  future. The Company has no commitments or arrangements to obtain such funds.
  If such funds are not available, the Company will be required to delay product
  development and regulatory efforts. As a result of the uncertainties and costs
  associated with the Redux-related litigation including the risk that the
  proposed settlement of the Redux product liability litigation does not become
  final, market conditions and other factors generally affecting the Company's
  ability to raise capital, there can be no


                                       56
<PAGE>   57



assurance that the Company will be able to obtain additional financing to
satisfy future cash requirements or that any financing will be available on
terms favorable or acceptable to the Company, if at all.  See "General -- Redux
-- Legal Actions."

       Interneuron intends to seek a corporate collaboration which provides for 
future pagoclone development and marketing costs, including Phase 3 clinical
studies. Although the Company is engaged in discussions with respect to certain
corporate collaborations relating to pagoclone, there can be no assurance any
agreement will be obtained. The Company does not have sufficient capital to
complete development and commercialization of any products under development and
will be required to obtain additional funds or corporate collaborations to
pursue development and commercialization of its products.

       Product Development

       The Company expects to continue expending substantial amounts for the
development of citicoline as described above and for its other products. Because
Interneuron does not have sufficient capital resources to fund significant
further development of any products other than citicoline, the Company intends
to seek additional funds or a corporate collaboration to conduct a Phase 3
clinical trial on pagoclone. The failure to obtain additional funds or a
corporate collaboration would adversely affect development of pagoclone. See
"Citicoline," "Pagoclone," and "Cash, Cash Equivalents and Marketable
Securities" above.

       During 1997, the Company obtained an exclusive option to license 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 patents
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. The study
is designed to have periodic interim analysis which could lead to earlier
termination if a significant positive drug effect is identified.

       The Company is continuing to conduct preliminary evaluations of PACAP, a
compound licensed from Tulane University in April 1998 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 Pharmaceutical
Corporation.

       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 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 Fiscal 1998 Cash Flows

       Cash used by operating activities during fiscal 1998 of $66,998,000
consisted primarily of (i) a net loss of $69,962,000 (ii) $10,000,000 paid by
CPEC in December 1997 to Astra Merck for CPEC's contractual liability pursuant
to the Astra Merck Collaboration recorded as of September 30, 1997, and (iii)
$2,000,000 paid by the Company in September 1998 as the initial cash installment
of the proposed settlement of the Redux-related product liability litigation,
partially offset by noncash compensation charges of $11,624,000, consisting
primarily of compensation expense relating to grants of restricted stock awards
under the

                                       57
<PAGE>   58



  Company's 1997 Equity Incentive Plan, and $4,040,000 of equity in the net loss
  of the unconsolidated subsidiary, Progenitor.

       Cash provided by investing activities of $50,169,000 during fiscal 1998
  consisted primarily of net proceeds from maturities and sales of marketable
  securities of $51,477,000 less purchases of property and equipment of
  $1,308,000.

       Other

       Treasury Stock and Share 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. As of September 30, 1997, the Company had repurchased
  217,500 shares, for an aggregate purchase price of approximately $3,978,000,
  all of which were re-issued primarily pursuant to stock option and warrant
  exercises and the employee stock purchase plan. No further repurchases were
  made in fiscal 1998 and there was no treasury stock at September 30, 1998.

       Open-Market Purchases of Intercardia Common Stock: 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 Intercardia. As of September 30, 1997, the Company had
  purchased 129,400 shares of Intercardia common stock, 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. These purchases represented approximately 2% of number of outstanding
  shares of Intercardia at September 30, 1997.

       Call Options: In May 1997, the Company purchased in private transactions
  from Swiss Bank Corporation, London Branch ("SBC") capped call options, which
  were modified in September 1997, 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. The call options maturing on December 31, 1997, June 9, 1998, and
  September 21, 1998 expired without exercise. The remaining call option is
  exercisable on January 11, 1999 with respect to 310,000 shares. The call
  options which the Company purchased may be settled, if exercised, with cash or
  Common Stock in an amount equal to the difference between the strike price and
  the market price, determined over a specified valuation period, subject to a
  cap. Under certain circumstances, the Company may delay the expiration date of
  the remaining call option for the payment of additional consideration to SBC.

       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 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 Interneuron 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.


                                       58
<PAGE>   59


       SBC has advised that it has engaged, and may engage, in transactions,
  including buying and selling shares of the Company's Common Stock, to offset
  its risk relating to the options. Purchases and sales could affect the market
  price of the Company's Common Stock.

       Year 2000 Issue

       The Year 2000 issue is the result of the failure of hardware or software
  components to handle properly dates which occur on or after January 1, 2000
  including leap years; the failure to handle properly 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.

       While each of the Company's subsidiaries uses certain similar internal
  systems, each operates their systems independently from the other. The Company
  does not envision a Year 2000 issue at Progenitor or InterNutria because each
  company is being operated pursuant to a plan to discontinue their respective
  businesses prior to the year 2000. As of September 30, 1998, the Company had
  fully reserved its positions in each entity and does not foresee any future
  charges to operations resulting from either entity. To the extent Intercardia
  maintains certain systems that are the same or similar to Interneuron's,
  Interneuron and Intercardia intend to collaborate to ascertain their Year 2000
  compliance to the extent each company deems necessary. 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 conducted by a licensee. A factor in the selection of 
  potential licensees will be their ability to demonstrate Year 2000 compliance.

       Systems Assessment

       Interneuron's and Intercardia's internal systems are similar and
  comprised primarily of purchased or leased software. Neither company develops
  or maintains any significant proprietary software or hardware systems.
  Interneuron and Intercardia utilize numerous operationally-related non-IT
  systems. These include telephone systems, pagers, and security alarm systems.
  Intercardia, through Intercardia Research Laboratories, owns laboratory
  equipment with embedded microprocessors and software.
        
       Also, Interneuron and Intercardia 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
  Intercardia 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 Intercardia intend to ascertain Year 2000 compliance of
  their primary internal software systems, operationally - related systems,
  equipment with embedded microprocessors, and subcontractors through vendor
  inquiry and obtaining 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. During 1999, the Company will continue and complete its review of all
  significant above-noted vendors and seek to obtain letters of Year 2000
  compliance. If such letters cannot be obtained on a timely basis, Interneuron
  and Intercardia will assess the potential risks in each instance and determine
  the appropriate actions. Such action may include the replacement of software,
  equipment, or the subcontractor. Interneuron and Intercardia will continue
  during
        

                                       59
<PAGE>   60



  1999 to monitor vendors and subcontractors who have provided letters of Year
  2000 compliance for any notices or information that contradict earlier
  assertions of Year 2000 compliance.

       Costs and Contingencies

       To date, Interneuron and Intercardia have expended only internal costs to
  assess the Year 2000 issue. Letters of Year 2000 compliance from internal
  software providers tend to indicate Interneuron and Intercardia will not be
  exposed to any material amounts 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 by such subcontractor. 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. During 1999,
  Interneuron and Intercardia will continue to refine their plans in an attempt
  to assure the Year 2000 issue will not materially adversely affect their
  business operations or financial condition.

       Recent Accounting Pronouncements

       The Company will adopt SFAS No. 130, "Reporting Comprehensive Income"
  ("SFAS No. 130"), in the fiscal year ending September 30, 1999. SFAS No. 130
  establishes standards for reporting and display of comprehensive income and
  its components in a full set of general-purpose financial statements.

       The Company will adopt SFAS No. 131, "Disclosures about Segments of an
  Enterprise and Related Information" ("SFAS No. 131"), in the fiscal year
  ending September 30, 1999. SFAS No. 131 specifies revised guidelines for
  determining an entity's operating segments and the type and level of
  financial information to be disclosed. Management has not determined the
  effect of adopting SFAS No. 131.

       The Company will adopt SFAS No. 133, "Accounting for Derivative
  Instruments and Hedging Activities" ("SFAS 133"), during the fiscal year
  ending September 30, 2000. SFAS 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 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 has
  not determined the effect of adopting SFAS 133.

       Other

       In July 1998, the Company received FDA authorization for marketing in the
  U.S. a medical device called the AnatoMark Non-Invasive Head Reference System
  ("AnatoMark") designed to provide reproducible anatomical markers
  non-invasively for brain imaging. The Company introduced AnatoMark in December
  1998 and plans to sell the product directly and promote it through literature,
  meetings, and the efforts of a contract sales representative.

       In November 1998, pursuant to an agreement with Les Laboratoires 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



                                       60
<PAGE>   61


       Interneuron had funded the operations of InterNutria through September
  30, 1998, at which time the Company adopted a plan to discontinue the
  operations of InterNutria. Loss from the discontinued operations of
  InterNutria represented 28% and 10% of the Company's consolidated net loss in
  fiscal 1998 and 1997, respectively. See "InterNutria". Interneuron had also
  funded Transcell until May 8, 1998, when the merger of Transcell into
  Intercardia was completed. See "Intercardia". Since the Transcell Acquisition,
  the operations previously conducted by Transcell have been conducted as a
  division of Intercardia known as Intercardia Research Laboratories.
  Accordingly, such operations continue to be reflected in the Company's
  consolidated financial statements. Expenses of Intercardia, including
  Intercardia Research Laboratories, continue to constitute a significant part
  of the Company's consolidated expenses and, in fiscal 1998 and 1997,
  represented approximately 33% and 35%, respectively, of the consolidated
  research and development and selling, general, and administrative expenses.

       Intercardia

       In September 1998, Intercardia and Astra Pharmaceuticals, L.P. (formerly
  Astra-Merck, Inc.) terminated the Marketing and Development Collaboration and
  License Agreement (the "Astra-Merck Collaboration") relating to the U.S.
  development and commercialization of the twice-daily formulation of bucindolol
  for the treatment of CHF, in connection with the restructuring of Astra-Merck,
  Inc. In connection with the termination of this agreement and resolution of an
  earlier dispute relating to responsibility for funding, Astra Pharmaceuticals
  made a $4,000,000 payment to CPEC. As a result, Intercardia has assumed
  responsibility for the U.S. development and commercialization for BEXTRA.
  Intercardia requires a corporate collaboration or additional funds for the
  commercialization of BEXTRA and is currently exploring possible development,
  commercialization and marketing collaborations.

       Pursuant to the Astra Merck Collaboration, originally entered into in
  December 1995, Astra Pharmaceuticals made a $5,000,000 payment to CPEC,
  assumed responsibility for certain obligations of CPEC and committed an amount
  up to $15,000,000 of U.S. development costs for the twice-daily formulation of
  bucindolol, including Intercardia's costs related to the BEST study.
  Intercardia and CPEC paid Astra Pharmaceuticals an aggregate of $10,000,000 in
  December 1997 (of which a portion was paid by Interneuron, reflecting its
  percentage ownership interest in CPEC, as a loan to CPEC).

       Through September 30, 1998, a substantial portion of the BEXTRA
  development costs have been assumed or paid by the National Institutes of
  Health, the Department of Veterans Affairs, Astra Merck and/or BASF
  Pharma/Knoll AG ("Knoll"), Intercardia's partner for the development and
  commercialization of BEXTRA in Europe. There can be no assurance of the
  success of the Beta-blocker Evaluation of Survival Trial (the "BEST Study") or
  that BEXTRA will be successfully commercialized.

       Pursuant to the Knoll Collaboration, Intercardia is responsible for
  approximately 40% of the development and marketing costs of bucindolol in the
  Knoll Territory, which includes all countries other than the United States and
  Japan, subject to certain maximum dollar limitations. Intercardia's portion of
  development and clinical trial costs for the Knoll Territory is estimated to
  be up to $10,000,000 over the next several years. Intercardia is also
  responsible for approximately 40% of the once-a-day development costs which
  relate to development solely for the Knoll Territory and approximately 67% of
  once-a-day development costs which have a worldwide benefit.

       Intercardia will require additional financing to fund its operations
  after 1999 and intends to seek additional financing and corporate
  collaborations during fiscal 1999. There can be no assurance such funds will
  be available on terms acceptable or favorable to Intercardia, or at all. As a
  result of the termination of the Astra Merck Collaboration, Intercardia has
  resumed financial responsibility for the remaining estimated $15,000,000 to
  $20,000,000 of BEXTRA U.S. development and NDA preparation costs. Interneuron
  may


                                       61
<PAGE>   62



  fund 20% of such costs in order to maintain its approximately 20% ownership
  interest in CPEC. There is no assurance that Intercardia will have sufficient
  resources to complete the U.S. development of BEXTRA. Intercardia's other
  funding requirements include payments to its other collaborative partners,
  including 40% of development and marketing costs of bucindolol in the Knoll
  Territory pursuant to the Knoll Collaboration, the operations of Intercardia
  Research Laboratories previously conducted by Transcell, which merged into
  Intercardia in May 1998, and new technology and product development.

       In July 1998, Intercardia licensed worldwide rights (except for Japan and
  South Korea) to OP2000 from Opocrin S.p.A., of Modena, Italy. Intercardia
  intends to investigate the use of OP2000 as a drug for the treatment of
  inflammatory bowel disease. Intercardia will be responsible for conducting
  clinical trials for OP2000 and made a $1,000,000 payment to Opocrin upon
  execution of the license agreement. Intercardia will make additional payments
  to Opocrin upon achievement of certain milestones.

       On May 8, 1998, the merger of Transcell with and into Intercardia and the
  acquisition by Intercardia of certain related technology rights owned by
  Interneuron was completed and, simultaneously, Interneuron contributed to
  Transcell's capital all of Transcell's indebtedness and payables, aggregating
  $18,698,000, to Interneuron (the "Transcell Acquisition"). Consideration
  given by Intercardia consisted of (i) Intercardia common stock payable 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 payable 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 Intercardia
  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, Intercardia issued an aggregate of 320,151 shares of
  common stock, of which 191,383 shares were issued to Interneuron. In
  addition, Intercardia issued 174,672 shares to Interneuron for the Initial
  Technology/Guarantee Payment. Intercardia 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 will
  be made in August 1999 and February 2000, respectively, and each installment
  will consist of the issuance of $3,000,000 of Intercardia common stock, as
  then valued. Intercardia's acquisition of the minority shareholders' interest
  in Transcell resulted in Intercardia recording a charge to operations in
  fiscal 1998 for the purchase of in-process research and development of
  approximately $5,300,000. This charge is 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
  Acquisition and the book value of the Intercardia shares received by the
  Company for the Initial Technology/Guarantee Payment. Interneuron owned
  approximately 61% and 62% of the outstanding capital stock of Intercardia
  before and immediately after the closing of the Transcell Acquisition,
  respectively.
        
       InterNutria

       InterNutria commenced a national launch of PMS Escape in September 1997
  and a line of sports drinks in spring 1998. InterNutria's operations resulted
  in significant losses and, in September 1998, the Company adopted a plan to
  discontinue the operations of InterNutria. The Company incurred additional
  charges of approximately $2,326,000 in connection with the termination of
  InterNutria's operations including a full reserve against inventory. The
  Company is seeking to sell InterNutria or its assets. However, there can be no
  assurance it will be successful in this regard or that it will generate any
  significant proceeds from any sale.

                                       62
<PAGE>   63


       Progenitor

       Progenitor completed its initial public offering and acquisition of
  Mercator Genetics, Inc. in August 1997, which resulted in Interneuron's
  ownership in Progenitor's outstanding capital stock decreasing to
  approximately 37% (and subsequently to approximately 36% at September 30,
  1998). Consequently, the Company ceased consolidating the financial statements
  of Progenitor. The Company's financial statements include Progenitor on a
  consolidated basis through August 1997 and on an equity method basis
  thereafter. See "Results of Operations".

       In December 1998, Progenitor announced its intention to implement an
  immediate cessation of operations. Progenitor did not have sufficient funds 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, as of
  September 30, 1998, the Company's investment in Progenitor was reduced to
  zero. See Note P of Notes to Consolidated Financial Statements.

       General

       The Company's business strategy includes evaluation of various
  technologies, product or company acquisitions, licensing and/or financing
  opportunities (including private placements and initial and follow-on equity
  offerings), and Interneuron and Intercardia engage from time to time in
  discussions relating to such opportunities. In particular, each of Interneuron
  and Intercardia require additional cash to fund operations after 1999 and
  intend to seek additional financings and corporate collaborations during
  fiscal 1999. There can be no assurance either company will obtain sufficient
  cash to fund future operations. See "Liquidity and Capital Resources" and
  "Subsidiaries - Intercardia." Any such initiatives may involve the issuance of
  securities of Interneuron or Intercardia and/or financial commitments for
  licensing fees and/or to fund product development, either 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.

       Although Interneuron may acquire additional equity in Intercardia through
  participation in financings, purchases from third parties, including open
  market purchases and conversion of intercompany debt, equity financings by
  Intercardia will likely reduce Interneuron's percentage ownership of
  Intercardia and funds held by Intercardia are not generally available to
  Interneuron.

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.



                                       63
<PAGE>   64

PART III

     The information called 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."

     Risks Relating to Redux Litigation

     After the Redux withdrawal in September 1997, we have been named, together
with other pharmaceutical companies, as a defendant in approximately 779 product
liability legal actions in federal and state courts involving the use of Redux
and other weight loss drugs. Many of these actions purport to be class actions.
On September 25, 1998, the U.S. District Court for the Eastern District of
Pennsylvania (the "Court") preliminarily approved a settlement agreement
relating to the proposed settlement of all product liability litigation against
us related to Redux.

     Risks Associated with Proposed Settlement of Product Liability Litigation:
If the settlement agreement becomes final, payments we make could materially
adversely affect our operations and financial condition. The amount of the
liability and related charges we recognize are likely to be significant and to
materially adversely affect our net worth. If the proposed settlement does not
become final, the ongoing Redux-related product liability litigation would then
proceed against us. In this event, this litigation may continue to materially
adversely affect our business, including our ability to obtain sufficient
financing to fund operations. In addition, although we cannot predict the
outcome of this litigation, such outcome may materially adversely affect our
future business, financial condition and results of operations. In addition, the
costs and uncertainties associated with the legal actions related to Redux have
had, and may continue to have, an adverse effect on:

     - the market price of our common stock;

     - our ability to obtain corporate collaborations or additional
       financing to satisfy cash requirements;

     - our ability to retain and attract qualified personnel; 

     - our ability to develop and commercialize products on a timely
       and adequate basis;

     - our ability to acquire rights to additional products; and

     - our ability to obtain product liability insurance for other
       products and officers and directors' liability insurance at acceptable 
       costs, or at all.

     Any or all of these factors may materially adversely affect our business,
financial condition and results of operations. See Note H of Notes to
Consolidated Financial Statements.

     Conditions to Final Settlement:  The settlement will not become final
until:

     - approved by the Court and - the time for filing appeals has passed or all
       appeals have been exhausted.

                                       64
<PAGE>   65


     In this case, in order to approve the settlement, the Court must make a
determination that the proposed settlement:

     - is fair and reasonable;

     - meets each of the prerequisites for a class action generally; and

     - meets the prerequisites for a "limited fund" class action in particular,
       all as required by the Federal Rules of Civil Procedure.

     Pursuant to these rules, notice of the proposed settlement was provided to
potential class members in November 1998. The Court has scheduled a fairness
hearing for February 25, 1999. At the fairness hearing, proponents and opponents
of the proposed settlement will be given an opportunity to present written and
oral arguments in favor of or against the settlement. Following the fairness
hearing, the Court must determine if the case is properly certified as a limited
fund class action, and if so, whether the terms of the settlement agreement are
fair and reasonable.

     We may withdraw from the settlement agreement, or the settlement agreement
may otherwise terminate, under any of the following conditions:

     - final approval of the settlement agreement is not entered by the Court; "
       class certification and/or approval of the settlement agreement is
       overturned on appeal for any reason;

     - pending and future litigation against us or any other party released by
       the settlement agreement is not permanently enjoined on the final
       approval date;

     - the class action and all pending multi-district lawsuits against the
       released parties are not dismissed with prejudice on the final approval
       date;

     - an order is not entered by the Court permanently barring contribution and
       indemnity claims by other defendants in the diet drug litigation; or

     - we are unable to compel tender of our insurance proceeds.

     There is a risk that after the fairness hearing the Court may not approve
the settlement. Even if the Court approves the settlement, opponents of the
settlement may appeal the Court's opinion to the United States Court of Appeals
for the Third Circuit. There is a case pending before the United States Supreme
Court (Ortiz v. Fibreboard Corporation et al.) ("Ortiz"), that may influence the
Court's decision or the outcome of any appeal that might be taken. Oral argument
in the Ortiz case was heard on December 8, 1998 and the Supreme Court is likely
to render its opinion between January and June 1999. Although factually
distinguishable in many respects from our proposed settlement, Ortiz involves an
appeal from a mandatory, putative "limited fund" class action settlement. The
Supreme Court's rulings in Ortiz may significantly influence, or potentially
result in the overturning of, the settlement agreement.

     Summary of Payments Required by Proposed Settlement: The settlement
agreement requires us to deposit approximately $15,000,000 in three installments
into a settlement fund as follows:


     - $2,000,000, which was deposited in September 1998;

     - $3,000,000, payable after the Settlement Agreement is approved by the 
       Court; and 

     - $10,000,000, plus interest, after the settlement becomes final.

     The first two installments, less certain expenses, will be returned to us
if the settlement does not become final.

     In addition, we agreed:


                                       65
<PAGE>   66


     - to cause all remaining and available product liability insurance proceeds
       related to Redux to be deposited into the settlement fund;

     - to pay royalties based on our product revenues to the settlement fund, in
       the total amount of $55,000,000, over a seven year period commencing
       after the settlement becomes final;

     - if, at the end of that seven year period, we pay less than $55,000,000 of
       royalties, to issue to the settlement fund shares of our stock in
       an amount equal to the unpaid balance divided by $7.49 per share.

     In November 1998, one of the insurers filed an action against us and
Servier pursuant to the federal interpleader statute. The insurer alleges that
both we and Servier have asserted claims against an insurance policy issued by
the insurer to us with limits of $5,000,000 in excess of $20,000,000. The
insurer has deposited the limits of the policy into the registry of the Court.

     Future Charges to Operations:  As a result of the settlement, we will
record charges to operations, which may be substantial, expected to be as 
follows:

     - We will record initial charges for the estimated fair value of our
       obligations under the settlement agreement, exclusive of insurance
       proceeds. We will record this charge when we can determine that it is
       probable that the conditions to final settlement have been or will be
       met. We expect this to be subsequent to the fairness hearing and the
       Supreme Court ruling in Ortiz.

     - If we record charges prior to the final settlement date, then on the
       date the settlement agreement becomes final, we will determine if there
       was any increase in the fair value of the equity conversion feature of
       the royalty agreement and record any such increase as an additional
       charge to operations.

     - From the date we record the initial charge and related liability for the
       settlement and through the initial term of the royalty agreement, we may
       record additional charges to accrete the liability attributable to the
       royalty feature of the royalty agreement up to the amount of royalties we
       expect to pay over the time we expect to make such royalty payments.

     Redux Safety Issues: The FDA-approved labeling for Redux included
references to certain risks that may be associated with dexfenfluramine and that
were highlighted during the FDA's review of the drug. One issue relates to
whether there is an association between appetite suppressants, including
dexfenfluramine, and the development of primary pulmonary hypertension ("PPH").
PPH is 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. This study 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 July 1997, the Mayo Clinic reported observations of heart valve
abnormalities in 24 patients taking the combination of Pondimin and phentermine.
The Mayo Clinic cases were subsequently reported in an article


                                       66
<PAGE>   67



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 September 1997 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
(commonly referred to as the "fen-phen" combination). The FDA presented these
observations, indicating an incidence of approximately 30%, to us in September
1997. Subsequent to the withdrawal, we have been named as a defendant in
numerous legal actions relating to Redux, as summarized above.

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

     On November 13, 1997, the U.S. Department of Health and Human Services
("HHS") issued preliminary recommendations for the medical management of people
who took Pondimin or Redux. HHS recommended, until more complete information is
available, that:

  -    patients who took either drug should see their physician to determine
       whether there are signs or symptoms of heart or lung disease;
 
  -    if such person has signs or symptoms of heart or lung disease, such as a
       new heart murmur or shortness of breath, have an echocardiogram
       performed;
  
  -    physicians strongly consider performing an echocardiogram before a
       patient who has taken either drug has any invasive procedure for which
       antibiotic prophylactic treatment is recommended to prevent the
       development of bacterial endocarditis. 

       See "Business--Redux" and "Legal Proceedings".

Uncertainties Relating to Citicoline

     Risk that Ongoing Phase 3 Study Does Not Demonstrate Efficacy or that FDA
Does Not Approve Citicoline: We are substantially dependent on FDA approval of
citicoline and on the successful commercialization of citicoline. In the event
the ongoing Phase 3 clinical study fails to demonstrate the efficacy of
citicoline or the FDA does not grant authorization to market the drug, we would
be materially adversely affected. In April 1998, we withdrew our NDA for
citicoline after receipt of negative results in a 100 patient Phase 3 clinical
trial. We are now devoting a substantial portion of our cash resources to a 900
patient Phase 3 clinical study with citicoline which commenced in June 1998.
However, the results of the ongoing Phase 3 clinical study may not demonstrate
the efficacy of citicoline. Notwithstanding the results of this study, the FDA
may not grant authorization to commercialize citicoline. Our agreement with
Ferrer relating to a license of certain patent rights relating to citicoline
provides that Ferrer may terminate the agreement if FDA approval of citicoline
is not obtained by January 2002, subject to certain extensions.

     Additional Funds or Corporate Collaboration Required to Market Citicoline:
We require additional funds for manufacturing, distribution, marketing and
selling efforts, assuming FDA approval of citicoline. The amount of funds
required depends upon whether we market citicoline ourselves or enter into a
corporate collaboration and the terms of any such collaboration. We have no
commitments or arrangements to obtain additional funds or a corporate
collaboration. We may not be able to obtain such funds or a corporate
collaboration on favorable terms or at all. If we market citicoline directly, we
will be required to obtain substantial additional funds and to establish,
maintain and manage sufficient sales and marketing capabilities.


                                       67
<PAGE>   68



We have no experience in marketing any pharmaceutical products directly. We may
not be able to recruit and retain required marketing, sales, medical and
administrative support personnel or otherwise successfully market citicoline.
Assuming FDA approval, revenues we generate from citicoline will depend to a
significant extent on the FDA-approved label as well as the availability of
third-party reimbursement for the drug.

     If additional funds are not available, we will be required to delay product
launch, reduce launch and marketing efforts, or enter into a corporate
collaboration for citicoline on terms which may not be favorable to us. Any of
these alternatives may cause us to generate less revenue and, eventually,
reduced profitability from citicoline than if we were able to launch the product
on a timely basis and conduct sole marketing. See "Risks Relating to Redux
Litigation" and "Need for Additional Funds".

     Dependence on Third Parties for Manufacturing Citicoline: We will be
dependent upon third party suppliers of citicoline bulk compound, finished
product and packaging for manufacturing in accordance with our requirements and
current U.S. Good Manufacturing Practices ("cGMP") regulations. We will also be
dependent on third party arrangements for the distribution of citicoline. We do
not have an agreement with a manufacturer for supply of commercial quantities of
citicoline finished product and we may not be able to obtain such an agreement
on favorable terms or at all. Our inability to obtain a supply agreement for
finished product could adversely affect our ability to commercialize citicoline
on a timely and cost-effective basis. Our agreement with Ferrer requires us to
purchase from Ferrer citicoline bulk compound for commercial purposes at fixed
prices, subject to certain conditions. We may be unable to establish on a timely
basis, or maintain, manufacturing capabilities of bulk compound and finished
product. In addition, suppliers may not be able to meet manufacturing
requirements on a timely basis or at all.

     Any citicoline manufacturing facilities are subject to FDA inspection both
before and after NDA approval to determine compliance with cGMP requirements.
Any 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.

     Need for Additional Funds

     Although we believe we have sufficient cash to meet our requirements
through fiscal 1999, we will require additional funds after such time. We
continue to expend substantial funds for product development activities,
primarily clinical testing of citicoline. We intend to seek additional funds
during fiscal 1999 through corporate collaborations or equity or debt
financings. We do not have any commitments or arrangements for additional
financing. As a result of the uncertainties and costs associated with the
Redux-related litigation, market conditions, and other factors generally
affecting the 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 the Company. If we are
unable to enter into a corporate collaboration or obtain additional funds, we
will not have sufficient cash to support our operations beyond 1999. In such
event we would be required to reduce, defer or discontinue our product
development programs. We may be required to obtain funds on terms which are not
favorable to us and our stockholders.

     Our financing requirements are based on certain assumptions primarily
relating to operations and the proposed settlement of the Redux product
liability litigation. The amount of additional funds we require depends on many
factors including:

  -    the timing, costs and outcome of the Redux-related litigation, including
       whether and when the proposed settlement of the product liability
       litigation becomes final and related payments become due;


                                       68
<PAGE>   69




    - the results of the ongoing Phase 3 clinical trial with citicoline; " the
      timing and outcome of the FDA review process for citicoline;

    - if citicoline receives FDA authorization for marketing, the timing
      and extent of citicoline launch and marketing activities we conduct;
    
    - our ability to enter into a corporate collaboration for citicoline or
      pagoclone and the terms of any such collaborations;

    - the nature and extent of clinical trials conducted by us on other 
      products; 
    - whether we acquire and seek to develop new products; and 

    - the extent to which we use cash or securities as consideration for any of
      the foregoing. To the extent that we issue securities, dilution to
      existing stockholders will result.

     See "Risks Relating to Redux Litigation" and "Uncertainties Related to
Citicoline".

     In addition, although Intercardia believes it has sufficient cash resources
through fiscal 1999, it will also require additional funds after such time and
intends to seek additional financing or corporate collaborations during fiscal
1999. If adequate funds are not available to Intercardia on acceptable terms,
Intercardia may be required to delay, scale back or eliminate some or all of its
research and product development programs. Although we may acquire additional
equity in Intercardia, equity financings by Intercardia will likely reduce our
percentage ownership of Intercardia. Funds held by Intercardia are not generally
available to us.

     History of Losses; Accumulated Deficit and Expectation of Future Losses;
Charges to Operations; Uncertainty of Future Profitability

     Through September 30, 1998, we had accumulated net losses since inception
of approximately $232,000,000. We continue to have losses and to use cash in
operating activities. We will be required to conduct significant development and
clinical testing activities and establish marketing, sales, regulatory and
administrative capabilities for many of 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 to be made by us
pursuant to the proposed settlement of the Redux product liability litigation
could materially adversely affect our operations and financial condition.

     We will record charges to operations in connection with the settlement
agreement, commencing when we can determine it is probable that the conditions
to final settlement have been or will be met. The amount of the related
liability to be recognized by us is likely to be significant and to materially
adversely affect our net worth. See "--Risks Relating to Redux Litigation" and
"Legal Proceedings".

     We incurred a $2,326,000 charge during fiscal 1998 relating to our plan to
discontinue InterNutria's operations. InterNutria's operations resulted in
substantial losses, including $17,151,000 in fiscal 1998, prior to this charge.
We have also incurred and will continue to incur noncash compensation expense
over the vesting periods of 1,226,334 shares subject to awards granted under
the Company's 1997 Equity Incentive Plan. These charges are expected to
aggregate approximately $14,000,000, of which we incurred approximately
$10,000,000 in fiscal 1998 and we expect to incur the remainder through fiscal
2000. In connection with Intercardia's acquisition of CPEC, we will incur
charges to operations when and if Intercardia makes two milestone payments to
the former CPEC stockholders. These milestone payments are payable with our
Common Stock. Each additional payment will have a minimum value of $750,000 and
a maximum value of $1,875,000. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

     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


                                       69
<PAGE>   70



to experience, fluctuations in revenues as a result of the Redux withdrawal,
regulatory approvals, product launches, the timing of license fees, royalties,
product shipments, and milestone payments.

     Uncertainties Generally Related to Clinical Trials

     Before obtaining regulatory approval for the commercial sale of any of the
pharmaceutical products we are developing, we 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 after receipt of negative results in a small Phase 3 clinical
study and commenced a third pivotal Phase 3 clinical study. BEXTRA is currently
in a Phase 3 clinical study for which enrollment is scheduled to end December
31, 1998. Because this study is sponsored by the National Institutes of Health
and the VA, Intercardia does not control the timing, operation or analysis of
the study.

Product Liability Exposure and Insurance Uncertainties

     In addition to the claims and risks summarized under "Risks Relating to
Redux Litigation", the use of other products in clinical trials and the
marketing of any 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 thereto as an additional
insured. We may not be able to maintain or obtain such insurance coverage, or to
obtain such insurance in amounts sufficient to protect us or other named parties
against such liability, at a reasonable cost, or at all. In addition, any
insurance obtained may not cover any particular liability claim. We are unable
to 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.
In the event of uninsured or insufficiently insured product liability claims, or
in the event a successful indemnification claim was made against us, our
business and financial condition could be materially adversely affected.

     Dependence on Others for Clinical Development, Regulatory Approvals,
Manufacturing and Marketing

     We depend upon collaborative partners for the development, manufacturing
and marketing of certain of our products. In particular, we do not have
sufficient funds to conduct and do not intend to commence a Phase 3 clinical
study on pagoclone unless we enter into a collaborative arrangement providing
for development, manufacturing and marketing. We may not be successful in
establishing any collaborative arrangements. In addition, any such 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 may have limited control over the manufacture and commercialization of the
products subject to the collaboration. In the event 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.

     Risk of Termination of Contractual Arrangements



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<PAGE>   71


     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. 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. In September 1998, an
agreement among Intercardia, CPEC and Astra Pharmaceuticals relating to the
development and commercialization of BEXTRA in the U.S. terminated. As a result,
Intercardia is now responsible for substantially all remaining U.S. development
and marketing costs associated with BEXTRA. See "Agreements" and "--Need for
Additional Funds".

     Uncertainty of Government Regulation

     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 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. See "Uncertainties Relating to Citicoline."

     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.

     Limited Patent Protection; Failure to Obtain or Retain Patents and
Proprietary Rights

     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.

     The U.S. composition of matter patent on bucindolol expired in November
1997. As a result, assuming FDA approval can be obtained, competitors,
including generic drug manufacturers, may market bucindolol,


                                       71
<PAGE>   72



if market exclusivity is not obtained under the Waxman-Hatch Act and after such
exclusivity expires. Intercardia must pay a royalty on net sales of bucindolol,
which lessens its ability to compete with generic drug manufacturers of
bucindolol. 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, subject to potential extension
under the Waxman-Hatch Act. 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
neuromuscular disorders, and post-stroke rehabilitation. Although the claim of
the licensed patent is broadly directed to the treatment of inadequate release
of brain acetylcholine, this patent may not afford protection against
competitors of citicoline to treat ischemic stroke.

     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 technologies or duplicate any technology we
develop. Furthermore, litigation may be necessary to:

     - enforce any of our patents;

     - 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 such litigation is highly uncertain. Such litigation may
also result in significant use of management and financial resources.

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

     Uncertainty Regarding Waxman-Hatch Act

     Assuming regulatory approvals are obtained, our ability to commercialize
successfully certain drugs, including citicoline and BEXTRA, may depend on the
availability of market exclusivity or patent extension under the Waxman-Hatch
Act. The composition of matter patent for bucindolol expired in November 1997
and the Company's licensed patent relating to citicoline expires in 2003. The
marketing of these products could be materially adversely affected if marketing
exclusivity or patent extension provisions are not available to us.

     The Waxman-Hatch Act establishes a period of time from the date of FDA
approval of certain NDAs 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
complete NDAs) for such drug. The Waxman-Hatch Act also provides that a patent
which claims a product, use or method of manufacture covering certain 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 research and FDA review of
the product. We are unable to predict whether we will obtain market exclusivity
for CerAxon or BEXTRA or patent term extension for citicoline under the
Waxman-Hatch Act or similar foreign laws.



                                       72
<PAGE>   73


Competition

     Competition from other pharmaceutical companies is intense and expected to
increase. We are aware 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.

  -    BEXTRA would compete with Coreg (carvedilol), which is marketed in
       the U.S. for the treatment of congestive heart failure and possibly with
       two other beta-blockers which were the subject of separate Phase 3
       clinical trials that each recently terminated early due to positive
       results.  As a result, bucindolol would be the third or fourth
       beta-blocker to be introduced in the U.S. market to treat CHF. Although
       the patent on bucindolol has expired, Intercardia is required to pay
       royalties on net sales.

  -    Pagoclone would also 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.

     Many of the other companies who market or are expected to market
competitive drugs are large, multinational pharmaceutical 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.

     If the proposed settlement of the Redux product liability litigation
becomes final, we will be required to pay the settlement fund royalties on
product sales, in addition to royalties payable to licensors. These obligations
may adversely affect our ability to compete with certain lower priced
competitive drugs.

     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.

     Uncertainty Regarding 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 such drug. The
increasing emphasis on managed care in the U.S. continues to increase the
pressure on pharmaceutical pricing. There have been, and we anticipate that
there will continue to be, a number of proposals to implement government control
over the pricing or profitability of prescription pharmaceuticals, as is
currently the case in many foreign markets. The announcement or adoption of such
proposals could adversely affect us. Furthermore, our ability to commercialize
our products may be adversely affected to the extent that such proposals
materially adversely


                                       73
<PAGE>   74



affect the business, financial condition and profitability of companies that are
prospective collaborative partners.

     Risks Relating to Managing Growth

     Assuming required additional funds and regulatory approvals are obtained
and additional product launches occur, we may experience a period of rapid
growth. This would place significant demands on our management, operational,
financial and accounting resources. If we market certain products directly, such
as citicoline, we will further strain these resources. In particular, we will be
required to establish and maintain a marketing organization, including a sales
force and related management systems. Our future success will depend in part on
whether we can expand our operational, financial and accounting systems and
expand, train and manage our employee base. Our inability to manage growth
effectively could have a material adverse effect on our business, financial
condition and results of operations.

     Early Stage of Products Under Development

     We are investigating for therapeutic potential a variety of pharmaceutical
compounds, technologies and other products at various stages of development.
Intercardia Research Laboratories is conducting very early stage research and
its technology requires significant further research and development, testing
and regulatory clearances, and is subject to the risks of failure inherent in
the development of products or therapeutic procedures based on innovative
technologies. 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.

     Dependence 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. We have key person life insurance policies on the lives of Glenn L.
Cooper, M.D., Richard Wurtman, M.D. and Lindsay A. Rosenwald, M.D. Drs. Wurtman
and Rosenwald devote only a portion of their time to the Company's business. 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 of such persons, 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 adversely affects our ability to recruit qualified
personnel. We are actively seeking to hire a permanent chief financial officer
and, if regulatory approvals and additional funds are obtained, will be required
to hire significant numbers of marketing and sales personnel, as well as medical
and administrative support personnel, in connection with a launch of citicoline.
We may not be able to attract additional qualified employees or retain our
existing personnel.

     Control by Present Stockholders; Anti-Takeover Provisions

     Our executive officers, directors and principal stockholders (including
individuals or entities related to such stockholders) beneficially own
approximately 44% of our outstanding Common Stock. Accordingly, these officers,


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<PAGE>   75



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.

     The 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 the Company's 1997 Equity
Incentive Plan accelerates and outstanding options under the Company's 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.

     No 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.

     Potential Volatility of Stock Price

     The market prices for our securities and for securities of emerging 
growth companies have historically been highly volatile. Future announcements
concerning us or Intercardia 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 stock;

 - our results of operations and financial condition;

 - proprietary rights; 

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

 - 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. See "Risks Relating to Redux Litigation" and "Shares 
Eligible For Future Sale; Registration Rights."

     Shares Eligible for Future Sale; Registration Rights

     As of December 22, 1998, we had 41,817,017 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:

                                       75
<PAGE>   76



     (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. Swiss Bank Corporation, London
Branch ("SBC"), has registration rights relating to 2,000,000 shares of Common
Stock subject to options held by SBC to purchase such shares in December 1999.
See Note I of Notes to Consolidated Financial Statements.

     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. Of the
1,226,334 shares of Common Stock issued or issuable under the 1997 Equity
Incentive Plan pursuant to stock awards, 501,188 shares vested and were issued
during fiscal 1998, and the remaining 725,146 shares vest from December 1998
through May 2000. The vesting dates are subject to extension if it occurs 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.

     Shares Subject to Options, Warrants, Stock Awards and Royalty Agreement

     As of December 22, 1998, we had reserved the following shares of Common
Stock for issuance:

  -    7,203,000 shares issuable upon exercise of outstanding options and
       warrants, subject to anti-dilution provisions. As a result of such
       provisions, additional shares of Common Stock may be issued upon exercise
       of certain warrants.

  -    725,146 shares issuable, at nominal consideration, upon vesting of stock
       awards under the Company's 1997 Equity Incentive Plan;

  -    7,343,124 shares for potential issuance under the royalty agreement, if
       the proposed settlement of the Redux product liability litigation becomes
       final, based on the total amount of royalties payable ($55,000,000)
       divided by the conversion price ($7.49 per share); and

  -    an additional 3,322,000 shares reserved for issuance under the Company's
       stock option plans, stock purchase plan and equity incentive plan.

     We may grant additional options, warrants or stock awards. In addition, we
are required to issue additional shares of Common Stock in connection with
technology acquisitions and may issue additional shares if certain call options
to purchase 2,000,000 shares are exercised. To the extent such shares are
issued, the interest of holders of Common Stock will be diluted.



                                       76
<PAGE>   77


     Risk Associated  with Year 2000 Compliance

     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 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. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".

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

During the three month period ended September 30, 1998, the Registrant filed
reports on Form 8-K reporting information under "Item 5 - Other Information" on
August 18, 1998 and September 9, 1998. The Company also filed a report on Form
8-K reporting information under "Item 5 - Other Information" on October 2, 1998.

(c) Exhibits


<TABLE>
<S>      <C>  <C>
3.4      -    Restated Certificate of Incorporation of Registrant, as amended(41)
3.5      -    By-Laws of Registrant(1)
4.4      -    Certificate of Designation establishing Series C Preferred Stock(17)
4.8      -    1997 Equity Incentive Plan and Form of Restricted Stock Award Agreement thereunder(44)
10.5 (a) -    Consultant and Non-competition Agreement between the Registrant, Richard Wurtman, M.D.(34)
10.5 (b) -    Consultant and Non-competition Agreement between InterNutria, Inc. and Judith Wurtman,
              Ph.D.(34)
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 (7)
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)
</TABLE>


                                       77
<PAGE>   78


<TABLE>
<S>      <C>  <C>
10.12(c) -    Amendment Agreement between Registrant and Servier, Orsem and Oril,
              Produits Chimiques dated November 19,1992(3)(12)
10.12(d) -    Amendment Agreement dated April 28, 1993 between Registrant and
              Servier(16)
10.12(e) -    Consent and Amendment Agreement among Servier, American Home Products
              Corp. and Registrant(34)
10.13    -    Trademark License Agreement between the Registrant and Orsem dated
              February 7, 1990(1) 10.14 - Supply Agreement between the Registrant and Oril
              Products Chimiques dated February 7, 1990(1)(3) 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(3)(16)
10.22(b) -    Addendum and Second Amendment to License Agreement between the
              Registrant and Ferrer Internacional S.A., dated June 1, 1998 (47)
10.25    -    License Agreement between the Registrant and the Massachusetts Institute of 
              Technology(4)
10.28    -    Letter Agreement between the Registrant and Bobby W. Sandage, Jr., Ph.D.(7)
10.37    -    License Agreement dated as of February 15, 1992 between the Registrant and 
              Massachusetts Institute of Technology(9)
10.40    -    Patent and Know-How Sublicense and Supply Agreement between Registrant and 
              American Cyanamid Company dated November 19, 1992 (3)(12)
10.41    -    Equity Investment Agreement between Registrant and American Cyanamid Company 
              dated November 19, 1992(12)
10.42    -    Trademark License Agreement between Registrant and American Cyanamid Company 
              dated November 19, 1992(12)
10.4     -    Agreement between Registrant and Servier dated November 19,1992(12)
10.45    -    Agreement between Registrant and Parexel International Corporation dated October 
              22, 1992 (as of July 21, 1992)(3)(14)
10.46    -    License Agreement dated February 9, 1993 between the Registrant and Massachusetts
              Institute of Technology(3)(15)
10.51    -    Letter Agreement between the Registrant and Mark Butler(18)
10.52    -    License Agreement dated February 18, 1994 between Registrant and Rhone-Poulenc 
              Rorer, S.A.(20)
10.55    -    Patent License Agreement between Registrant and Massachusetts Institute of 
              Technology dated March 1, 1994(20)
10.58    -    Master Equipment Lease including Schedules and Exhibits between Phoenix Leasing
              and Registrant (agreements for Transcell and Progenitor are substantially identical), 
              with form of continuing guarantee for each of Transcell and Progenitor(22) 
10.59    -    Exhibit D to Agreement between Registrant and Parexel International Corporation 
              dated as of March 15, 1994(3)(22) 
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(23)
10.60(b) -    Amendment dated June 15, 1994 to the Acquisition Agreement(23)
10.61    -    License Agreement dated December 6, 1991 between Bristol-Myers Squibb and CPEC, as amended(3)(23)
10.61(a) -    Letter Agreement dated November 18, 1994 between CPEC and Bristol-Myers Squibb(25) 
10.65(a) -    1994 Long-Term Incentive Plan, as amended(42)
</TABLE>

                                       78
<PAGE>   79



<TABLE>
<S>      <C>  <C>
10.67    -    Employment Agreement between Intercardia and Clayton I. Duncan with Registrant guarantee(25)
10.67(a) -    Amendment to Employment Agreement between Intercardia, Inc. and Clayton I. Duncan(36)
10.68(a) -    Interneuron Pharmaceuticals, Inc. 1995 Employee Stock Purchase Plan, as amended(36)
10.69    -    Office Lease, dated April 24, 1995 between Intercardia, Inc. and Highwoods/Forsyth Limited
              Partnership, with Registrant Guaranty(27)
10.71    -    Securities Purchase Agreement dated June 2, 1995 between the Registrant and Reliance 
              Insurance Company, including Warrant and exhibits(29)
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)(32)
10.78    -    Contract Manufacturing Agreement dated November 20, 1995 between Registrant and 
              Boehringer Ingelheim Pharmaceuticals, Inc.(3)(34)
10.79    -    Development and Marketing Collaboration and License Agreement between Astra Merck, Inc., 
              Intercardia, Inc. and CPEC, Inc., dated December 4, 1995.(3)(33)
10.80    -    Intercompany Services Agreement between Registrant and Intercardia, Inc.(33)
10.82    -    Employment Agreement between Registrant and Glenn L. Cooper, M.D. dated
              April 30, 1996 effective as of May 13, 1996(37) 
10.83    -    Co-promotion Agreement effective June 1, 1996 between Wyeth-Ayerst Laboratories and Interneuron
              Pharmaceuticals, Inc.(3)(38)
10.84    -    Master Consulting Agreement between Interneuron Pharmaceuticals, Inc. and Quintiles, Inc.
              dated July 12, 1996(38)
10.85    -    Amendment No. 1 dated July 3, 1996 to Master Consulting Agreement between Interneuron 
              Pharmaceuticals, Inc. and Quintiles, Inc. dated July 12, 1996(3)(38)
10.86    -    Lease Agreement between Transcell Technologies, Inc. and Cedar Brook Corporate Center, L.P., 
              dated September 19, 1996, with Registrant guaranty(39)
10.87    -    Lease dated February 5, 1997 between Registrant and Ledgemont Realty Trust(40)
10.89    -    Form of ISDA Master Agreement by and between the Registrant and Swiss Bank Corporation, 
              London Branch, together with Schedules thereto(42)
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(42)
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(42)
10.90(c) -    Letter Amendment dated September 18, 1997 to Confirmations filed as
              Exhibits 10.90(a) and 10.90(b)(45)
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(42)
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)(3)(43)
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(45)
10.94    -    1998 Employee Stock Option Plan(46)
10.95    -    Agreement and Plan of Merger dated March 2, 1998 by and among
              Registrant, Intercardia, Inc. and Transcell Technologies, Inc.(47)
10.95(a) -    Waiver and Consent Agreement dated May 8, 1998 by and among
              Registrant, Intercardia and Transcell(47)
</TABLE>

                                       79
<PAGE>   80


<TABLE>
<S>      <C>  <C>
10.96    -    Assignment and Assumption and Royalty Agreement between
              Intercardia and Registrant dated May 8, 1998(48)
10.97    -    License Agreement between Registrant and the Administrators of the
              Tulane Educational Fund dated April 29, 1998(48)
10.98    -    Letter of Understanding between the Registrant and the Plaintiffs'
              Management Committee dated September 3, 1998(49)
10.99    -    Agreement of Compromise and Settlement, including Appendices,
              dated September 21, 1998, between the Registrant and the Plaintiffs'
              Management Committee(50)
10.100   -    Royalty Agreement between the Registrant and the Plaintiffs' Management
              Committee effective as of September 21, 1998(51)
10.101   -    Fiscal 1999 Senior Executive Bonus Plan, as adopted by the Board September 9, 1998
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.
(3)  Confidential Treatment requested for a portion of this Exhibit.
(4)  Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the year ended September 30, 1990.
(7)  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.
(9)  Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the three months ended March 31, 1992.
(12) Incorporated by reference to the Registrant's Form 8-K dated November 30,
     1992. (13) 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. (14) Incorporated by reference to the
     Registrant's Annual Report on Form 10-K for the fiscal year ended September
     30, 1992.
(14) Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the fiscal year ended September 30, 1992
(15) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the three months ended December 31, 1992.
(16) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the six months ended March 31, 1993.
(17) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the nine months ended June 30, 1993.
(18) Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the fiscal year ended September 30, 1993
(20) Incorporated by reference to the Registrant's Registration Statement on
     Form S-3 or Amendment No. 1 (File no. 33-75826).
(22) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the six months ended March 31, 1994.
(23) Incorporated by reference to the Registrant's Form 8-K dated June 20, 1994.
(25) Incorporated by reference to the Registrant's Annual Report on Form 10-K
     for the fiscal year ended September 30, 1994.
(27) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the six months ended March 31, 1995.
(29) Incorporated by reference to the Registrant's Quarterly Report on Form 8-K
     dated June 2, 1995.



                                       80
<PAGE>   81


(32) Incorporated by reference to Registrant's Report on Form 8-K dated August
     16, 1995.
(33) Incorporated by reference to Registration Statement filed on Form S-1 (No.
     33-80219) by Intercardia, Inc. on December 8, 1995.
(34) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1995.
(36) Incorporated by reference to Amendment No. 1 to Registrant's Registration
     Statement on Form S-3 (File No. 333-1273) filed March 15, 1996.
(37) Incorporated by reference to Registrant's Registration Statement on Form
     S-3 (File No. 333-03131) filed May 3, 1996.
(38) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q or
     10-Q/A for the quarter ended June 30, 1996.
(39) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1996
(40) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended December 31, 1996
(41) Incorporated by reference to Exhibit 3.5 of Registrant's Quarterly Report
     on Form 10-Q for the three months ended March 31, 1997
(42) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended March 31, 1997
(43) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended June 30, 1997
(44) Incorporated by reference to Registrant's Form S-8 (File No. 333-40315)
     filed November 14, 1997.
(45) Incorporated by reference to Registrant's Annual Report on Form 10-K for
     the fiscal year ended September 30, 1997.
(46) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended December 31, 1997
(47) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended March 31, 1998
(48) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for
     the three months ended June 30, 1998
(49) Incorporated by reference as Exhibit 99.1 of Registrant's Form 8-K dated
     September 3, 1998
(50) Incorporated by reference as Exhibit 99.2 of Registrant's Form 8-K dated
     September 28, 1998
(51) Incorporated by reference as Exhibit 99.3 of Registrant's Form 8-K dated
     September 28, 1998


                                       81
<PAGE>   82


                                   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, 1998          By:  /s/ Glenn L. Cooper
                                 ---------------------------------------------
                                      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>
Name                           Title                                  Date
<S>                            <C>                                    <C>
/s/ Glenn L. Cooper            President and Chief Executive          December 28, 1998
-----------------------------  Officer and Director (Principal
Glenn L. Cooper, M.D.          Executive Officer)      
                                     
/s/ Lindsay Rosenwald
-----------------------------  Chairman of the                        December 28, 1998
Lindsay Rosenwald, M.D.        Board of Directors

                               Director                               December   , 1998
-----------------------------
Harry Gray

/s/ Alexander M. Haig          Director                               December 28, 1998
-----------------------------
Alexander M. Haig, Jr.

/s/ Peter Barton Hutt          Director                               December 28, 1998
-----------------------------
Peter Barton Hutt

/s/ Malcolm Morville           Director                               December 28, 1998
-----------------------------
Malcolm Morville

/s/ Robert K. Mueller          Director                               December 28, 1998
-----------------------------
Robert K. Mueller

/s/ Lee J. Schroeder           Director                               December 28, 1998
-----------------------------
Lee J. Schroeder

/s/ David B. Sharrock          Director                               December 28, 1998
-----------------------------
David B. Sharrock

/s/ Richard Wurtman            Director                               December 28, 1998
-----------------------------
Richard Wurtman, M.D.

/s/ Dale Ritter                Senior Vice President, Finance,        December 28, 1998
-----------------------------  Acting Chief Financial Officer 
Dale Ritter                    and Treasurer (Principal 
                               Financial and Accounting Officer)      
</TABLE>




                                       82
<PAGE>   83
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS






Audited Financial Statements                                                Page

Report of Independent Accountants.........................................  F-2
Consolidated Balance Sheets -- September 30, 1998 and 1997................  F-3
Consolidated Statements of Operations -- For the years ended 
September 30, 1998, 1997 and 1996.........................................  F-4
Consolidated Statements of Stockholders' Equity -- For the years ended 
September 30, 1998, 1997 and 1996.........................................  F-5
Consolidated Statements of Cash Flows -- For the years ended 
September 30, 1998, 1997 and 1996.........................................  F-7
Notes to Consolidated Financial Statements................................  F-8





                                       F-1

<PAGE>   84





                        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, 1998 and 1997, and
the results of their operations and their cash flows for each of the three years
in the period ended  September 30, 1998, in conformity  with generally  accepted
accounting principles.  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  generally  accepted  auditing  standards  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 8, 1998





                                       F-2

<PAGE>   85



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

<TABLE>
<CAPTION>
                                                                                      September 30,     September 30, 
                                                                                           1998              1997
                                                                                          ------            -----
                                     ASSETS
Current assets:                                                                                         
<S>                                                                                 <C>               <C>        
      Cash and cash equivalents                                                     $    39,330       $    55,820
      Marketable securities                                                              28,877            64,549
      Accounts receivable                                                                 1,273             1,297
      Inventories                                                                            -                735
      Prepaids and other current assets                                                   1,116             2,056
                                                                                     ----------         ---------
                                                                                         70,596           124,457

Marketable securities                                                                     3,825            19,683
Investment in unconsolidated subsidiary                                                      -              4,040
Property and equipment, net                                                               3,691             4,669
Other assets                                                                                 85                81
                                                                                     ----------         ---------
                                                                                     $   78,197     $     152,930
                                                                                     ==========         =========
                                                                                     
                                   LIABILITIES
Current liabilities:                                                                                    
      Accounts payable                                                               $    1,334        $    1,615
      Accrued expenses                                                                   27,008            39,153
      Deferred revenue                                                                        -               750
      Current portion of notes payable and capital lease obligations                        837               710
                                                                                     ----------         ---------
             Total current liabilities                                                   29,179            42,228

Long-term portion of notes payable and capital lease obligations                          1,663             1,734

Minority interest                                                                         7,499            12,959


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 at September 30, 1998                             
      and 1997, respectively  (liquidation preference at September 30, 1998 $3,026)       3,000             3,000
      Series C, 5,000 shares issued and outstanding at September 30, 1998 and                           
      1997, respectively  (liquidation preference at September 30, 1998 $502)               500               500
Common stock; $.001 par value, 80,000,000 shares authorized; 41,817,017 shares                          
      issued and outstanding and  41,226,293 shares issued at September 30, 1998                    
      and 1997, respectively                                                                 42                41
Additional paid-in capital                                                              268,278           255,693
Accumulated deficit                                                                    (231,996)         (162,034)
Unrealized net gain on marketable securities                                                 32                85
Treasury stock, at cost, no shares and  70,483 shares at  September 30, 1998
      and  1997, respectively                                                                 -            (1,276)
                                                                                     ----------         ---------
                  Total stockholders' equity                                             39,856            96,009
                                                                                      =========         ---------
                                                                                     $   78,197        $  152,930
                                                                                     ==========         =========


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


                                      F-3

<PAGE>   86







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



<TABLE>
<CAPTION>
                                                                  For the years ended September 30,
                                                                 --------------------------------- 
                                                        
                                                                  1998           1997            1996
                                                                  ----           ----            ----
Revenues:                                                                                  
<S>                                                          <C>            <C>            <C>      
     Product revenue                                         $        -     $  55,945      $  13,779
     Contract and license fee revenue                             6,488        11,039          8,335
                                                             ----------    ----------     ----------
         Total revenues                                           6,488        66,984         22,114

Costs and expenses:                                                                        
     Cost of product revenue                                          -        41,144         11,454
     Research and development                                    39,762        50,180         17,344
     Selling, general and administrative                         21,975        19,581         14,162
     Product withdrawal                                               -         7,528             -
     Purchase of in-process research and development                500         3,044          6,434
                                                             ----------    ----------     ----------
         Total costs and expenses                                62,237       121,477         49,394

Net loss from operations                                        (55,749)      (54,493)       (27,280)

Investment income, net                                            5,465         8,944          4,306
Equity in net loss of unconsolidated subsidiary                  (4,040)       (9,028)             -
Minority interest                                                 3,839         4,907            574
                                                             ----------    ----------     ----------

Net loss from continuing operations                             (50,485)      (49,670)       (22,400)

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

Net loss                                                    $   (69,962)   $ (55,256)     $  (27,986)
                                                             ==========    ==========     ==========

Net loss per common share - basic and diluted:
  Net loss from continuing operations                       $     (1.22)   $    (1.21)    $    (0.61)
  Net loss from operations of InterNutria                         (0.41)        (0.14)         (0.15)
  Net loss from discontinuation of InterNutria                    (0.06)            -             -
                                                             ----------    ----------     ----------
Net loss per common share - basic and diluted                $    (1.69)   $    (1.35)    $    (0.76)
                                                             ==========    ==========     ==========

Weighted average common shares outstanding                       41,468        41,064         37,004
                                                             ==========    ==========     ==========





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



                                       F-4

<PAGE>   87



                        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, 1995                                         33,284,006      $ 33         244,425  $3,500     $  96,651

Proceeds from exercise of Class B Warrants and other warrants          3,524,897         4                                13,124
Proceeds from exercise of stock options                                  740,022         1                                 3,141
Public offering of common stock, net of issuance costs of $850         3,000,000         3                               109,127
Proceeds from offering of Employee Stock Purchase Plan                    16,672                                             146
Dividends on preferred stock                                                                                                 (35)
Shares issued in payment of dividends                                      9,935                                             105
Issuance of common stock for technology rights                           342,792                                           8,827
Shares and payments pursuant to private placement agreements              97,645                                             (35)
Gain on sale of stock by subsidiary                                                                                       16,348
Stock-based compensation                                                                                                     600
Net loss                                                                                                                    
                                                                      ----------       ---         -------  ------      --------
     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
Unrealized net gain on marketable securities                                                                                    
Net 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
Unrealized net loss on marketable securities                                                                                    
Net loss                                                                                                                       
                                                                      ----------       ---         -------   ------     --------
     Balance at September 30, 1998                                    41,817,017       $42         244,425   $3,500     $268,278
                                                                      ==========       ===         =======   ======     ========
</TABLE>


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



                                       F-5

<PAGE>   88



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

                                                                                              
                                                                                                 Treasury Stock
                                                                                              ---------------------        
                                                                                 Unrealized                              Total
                                                                   Accumulated   Net Gain on   Number                 Stockholders' 
                                                                     Deficit     Securities   of Shares     Amount      Equity      
                                                                   ----------    -----------  ---------    --------   ------------
<S>                                                                <C>          <C>          <C>            <C>       <C>   
Balance at September 30, 1995                                         ($78,792)                                        $  21,392

Proceeds from exercise of Class B and other warrants                                                                      13,128
Proceeds from exercise of stock options                                                                                    3,142
Public offering of  common stock, net of issuance costs of $850                                                          109,130
Proceeds from offering of Employee Stock Purchase Plan                                                                       146
Dividends on preferred stock                                                                                                 (35)
Shares issued in payment of dividends                                                                                        105
Issuance of common stock for technology rights                                                                             8,827
Shares and payments pursuant to private placement agreements                                                                 (35)
Gain on sale of stock by subsidiary                                                                                       16,348
Stock-based compensation                                                                                                     600
Net loss                                                               (27,986)                                          (27,986)
                                                                    ----------                                          --------
     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
Unrealized net gain on marketable securities                                      $    85                                     85
Net loss                                                               (55,256)                                          (55,256)
                                                                    ----------   --------  ----------    ------------   --------
    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
Unrealized net loss on marketable securities                                          (53)                                   (53)
Net loss                                                               (69,962)                                          (69,962)
                                                                    ----------   --------  ----------    ------------   --------
     Balance at September 30, 1998                                  ($231,996)   $     32          --     $        --   $ 39,856
                                                                    ==========   ========  ==========    ============   ========
</TABLE>

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

                                       F-6

<PAGE>   89




                        INTERNEURON PHARMACEUTICALS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                                        For the years ended September 30,
                                                                                      --------------------------------------
                                                                                       1998           1997            1996
                                                                                      ------         ------          -------

Cash flows from operating activities:                                                                             
<S>                                                                                   <C>          <C>             <C>
    Net loss                                                                          ($69,962)      ($55,256)        ($27,986)
    Adjustments to reconcile net loss to net cash                                                                 
      used by operating activities:                                                                               
        Depreciation and amortization                                                    2,409          1,484              927
        Minority interest in net loss of consolidated subsidiaries                      (3,839)        (4,907)            (574)
        Purchase of in-process research and development                                      -          2,234            8,098
        Noncash compensation                                                            11,624            434            1,422
        InterNutria discontinuation                                                      1,106              -                -
        Equity in net loss of unconsolidated subsidiary                                  4,040          9,028                -
        Change in assets and liabilities, net of effects from deconsolidation:                                    
           Accounts receivable                                                            (139)         2,787           (4,101)
           Prepaid and other current assets                                                814         (8,348)          (1,135)
           Inventories and other assets                                                    (50)         7,605           (8,049)
           Accounts payable                                                               (281)           114            1,414
           Deferred revenue                                                               (750)        (6,171)           6,921
           Accrued expenses and other liabilities                                      (11,970)        31,099            3,633
                                                                                     =========     ==========        =========

Net cash (used) by operating activities:                                               (66,998)       (19,897)         (19,430)
                                                                                     =========     ==========        =========

Cash flows from investing activities:                                                                             
    Capital expenditures                                                                (1,308)        (3,273)          (1,850)
    Purchases of marketable securities                                                 (28,992)       (85,971)         (56,641)
    Proceeds from maturities and sales of marketable securities                         80,469         25,531           51,141
    Purchases of Intercardia stock                                                           -         (2,951)               -
    Purchases of Progenitor units and stock                                                  -         (3,605)               -
    Other                                                                                    -            (12)              63
                                                                                     =========     ==========        =========
Net cash provided (used) by investing activities                                        50,169        (70,281)          (7,287)
                                                                                     =========     ==========        =========

Cash flows from financing activities:                                                                             
    Net proceeds from issuance of common and treasury stock and other
           financing activities                                                            242          2,819          125,510
    Net proceeds from issuance of stock by subsidiaries                                    201            333           30,569
    Purchases of treasury stock                                                              -         (3,978)               -
    Proceeds from sale/leaseback transactions                                                -          1,636              313
    Proceeds from notes payable                                                            460            156               16
    Principal payments of notes payable                                                   (122)           (35)               -
    Principal payments of capital lease obligations                                       (442)          (834)            (571)
                                                                                     =========     ==========        =========
Net cash provided by financing activities                                                  339             97          155,837
                                                                                     =========     ==========        =========

Net change in cash and cash equivalents                                                (16,490)       (90,081)         129,120
Cash and cash equivalents at beginning of period                                        55,820        145,901           16,781
                                                                                     =========     ==========        =========
Cash and cash equivalents at end of period                                           $  39,330       $ 55,820        $ 145,901
                                                                                     =========     ==========        =========

Supplemental disclosure of financing and investing activities:                                                    
    Cash payments for interest                                                       $     268     $      311        $     330
                                                                                     =========     ==========        =========
    Property and equipment obtained through financing arrangements                   $     159     $    1,211        $     157
                                                                                     =========     ==========        =========



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




                                       F-7

<PAGE>   90




                        INTERNEURON PHARMACEUTICALS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A. Nature of the Business:

Interneuron  Pharmaceuticals,   Inc.  ("Interneuron"  or  the  "Company")  is  a
diversified   biopharmaceutical   company   engaged  in  the   development   and
commercialization  of a portfolio of products and product  candidates  primarily
for neurological and behavioral  disorders.  The Company also develops  products
and technologies,  through two consolidated  subsidiaries and one unconsolidated
subsidiary (the  "Subsidiaries"):  Intercardia,  Inc.  ("Intercardia")  a public
company and a consolidated  subsidiary,  focuses on  cardiovascular  disease and
carbohydrate-based  drug  discovery;   InterNutria,   Inc.  ("InterNutria"),   a
consolidated subsidiary, focuses on dietary supplement products; and Progenitor,
Inc. ("Progenitor") a public company and an unconsolidated  subsidiary,  focuses
on functional  genomics using  developmental  biology. As of September 30, 1998,
InterNutria has been classified as a discontinued operation (see Note M) and the
Company's   investment  in  Progenitor  has  been  fully  reserved  pursuant  to
Progenitor's December 1998 determination to discontinue operations (see Note P).

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.  This action was taken based on new,  preliminary
and summary information regarding potential abnormal  echocardiogram findings in
patients using these medications. 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 H.)

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  Intercardia (see Note P). 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.

Cash, Cash Equivalents and Marketable Securities:  The Company invests available
cash primarily in short-term bank deposits, money market funds, U.S. and foreign
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, 1998 and 1997, all

                                       F-8

<PAGE>   91



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.

Inventories:  Inventories are valued at the lower of cost  (first-in,  first-out
method) or market.  For products  requiring  regulatory  approval or  compliance
prior to marketing, inventory costs are capitalized commencing from the time the
Company  determines it is probable the pertinent  product will be approved by or
comply with requirements of the relevant  regulatory  authorities  including the
U.S. Food and Drug Administration ("FDA").

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. (See Note J.)

Accounting for Stock-Based Compensation: The Company adopted the disclosure - 
only alternative permitted under Statement of Financial Accounting Standards 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 interpreta-
tions.  The Company has disclosed proforma net loss and proforma net loss per 
share for fiscal 1998, 1997 and 1996 in Note I using the fair value method.  As 
such, the adoption of SFAS No. 123 did not impact the financial position or the 
results from operations of the Company.



                                       F-9

<PAGE>   92



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.

Earnings per Share: During the fiscal year ended September 30, 1998, the Company
adopted Statement of Financial Accounting Standards No. 128, "Earnings Per
Share" ("SFAS No. 128").  SFAS No. 128 replaced the previously reported primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities.  All earnings
per share amounts for all periods have been presented to conform to SFAS No. 128
requirements.  There was no effect on the earnings per share disclosures as a
result of adoption of SFAS No. 128 due to the antidilutive effect of the
Company's outstanding options, warrants and convertible securities. (See Note
K.)

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  liability,   need  for  additional  funds,   competition,
dependence on third parties for manufacturing  and marketing,  dependence on key
personnel,  protection  of  proprietary  technology,  and  compliance  with  FDA
government regulations.

Reclassification: Certain prior year amounts have been reclassified to conform
with fiscal 1998 classifications.

Recent Accounting Pronouncements: The Company will adopt SFAS No. 130,
"Reporting Comprehensive Income" ("SFAS No. 130"), in the fiscal year ending
September 30, 1999. SFAS No. 130 establishes standards for reporting and display
of comprehensive income and its components in a full set of general-purpose
financial statements.

The Company will adopt SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"), in the fiscal year ending
September 30, 1999. SFAS No. 131 specifies revised guidelines for determining an
entity's operating segments and the type and level of financial information to
be disclosed. Management has not determined the effect of adopting SFAS No. 131.

The Company will adopt SFAS No. 133, "Accounting for Derivative  Instruments and
Hedging  Activities" ("SFAS 133"), in the fiscal year ending September 30, 2000.
SFAS  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 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 has not determined the
effect of adopting SFAS 133.




                                      F-10

<PAGE>   93



C. Marketable Securities:

<TABLE>
<CAPTION>

Investments in marketable securities consisted of the following at September 30, 1998 and 1997:

                                                                  1998                                  1997
                                                   --------------------------------     ---------------------------------
                                                                         Market                                 Market
                                                        Cost              Value              Cost               Value
                                                   --------------    --------------     --------------       ------------
<S>                                                   <C>               <C>                <C>                <C>        
U.S. government treasury and agency obligations       $14,246,000       $14,275,000        $12,768,000        $12,789,000
Foreign government and  corporate obligations                 --                --          13,904,000         13,903,000
U.S. corporate notes                                   18,424,000        18,427,000         57,475,000         57,540,000
                                                   ==============    ==============     ==============         ==========
                                                      $32,670,000       $32,702,000        $84,147,000        $84,232,000
                                                   ==============    ==============     ==============        ===========
</TABLE>

<TABLE>
<CAPTION>

At  September  30,  1998,  gross  unrealized  gains and losses were  $34,000 and $2,000,  respectively.  At September 30, 1997,
gross unrealized gains and losses were  $89,000  and  $4,000  respectively.  The  maturities  of these  marketable securities
as of September 30, 1998 and 1997 were as follows: 

                                                                          1998                1997
                                                                      -------------      -------------
<S>                                                                     <C>                <C>        
Within one year                                                         $28,877,000        $64,549,000
After one year through three years                                        3,825,000         19,683,000
                                                                      =============      =============
Total maturities                                                        $32,702,000        $84,232,000
                                                                      =============      =============
</TABLE>


D. Inventories:

<TABLE>
<CAPTION>

At September 30, 1997, inventories consisted of the following:

                                                                                              1997
                                                                                         =============
<S>                                                                                          <C>      
Raw materials                                                                                $ 221,000
Finished goods                                                                                 514,000
                                                                                         =============
                                                                                             $ 735,000
                                                                                         =============
</TABLE>


At September 30, 1998, the Company has fully  reserved all inventory  related to
PMS  Escape  in  connection  with the  Company's  decision  to  discontinue  the
operations  of  InterNutria  (see Note M). At September  30,  1997,  inventories
related  primarily  to PMS Escape as all  Redux-related  inventories  were fully
reserved in connection with the market withdrawal of Redux (see Note H).


                                      F-11

<PAGE>   94



E. Property and Equipment:

<TABLE>
<CAPTION>

At  September  30,  1998 and  1997,  property  and  equipment  consisted  of the
following:

                                                             1998                1997
                                                            ======              =====
<S>                                                        <C>               <C>       
Office equipment                                           $1,725,000        $2,131,000
Laboratory equipment                                        1,258,000         2,093,000
Leasehold improvements                                      2,321,000         2,362,000
                                                          -----------       -----------
                                                            5,304,000         6,586,000
Less: accumulated depreciation  and amortization           (1,613,000)       (1,917,000)
                                                          -----------     -------------
                                                           $3,691,000        $4,669,000
                                                          ===========     =============
</TABLE>


Included in the above amounts is property and equipment  under capital lease and
note  obligations  of $1,207,000  and $2,713,000 at September 30, 1998 and 1997,
respectively, and related accumulated depreciation of $401,000 and $1,149,000 at
September 30, 1998 and 1997, respectively. Assets financed through capital lease
and note  payable  arrangements  consist  primarily  of  office  and  laboratory
equipment. The Company paid $173,000 and $165,000 in interest expense during the
years ended September 30, 1998 and 1997, respectively,  related to these capital
lease and note payable obligations.

F. Accrued Expenses:

<TABLE>
<CAPTION>

At September 30, 1998 and 1997, accrued expenses consisted of the following:

                                                            1998               1997
                                                           ======             -----
<S>                                                      <C>               <C>         
Clinical and sponsored research                          $ 12,378,000      $ 21,077,000
Redux withdrawal                                            7,982,000        11,620,000
Compensation related                                        3,150,000         3,949,000
InterNutria discontinuation                                 1,719,000                 -
Other                                                       1,779,000         2,507,000
                                                        -------------         ---------
                                                         $ 27,008,000      $ 39,153,000
                                                         ============      ============
</TABLE>


G. 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  $2,290,000,  $1,931,000  and  $1,195,000 for the years ended
September 30, 1998, 1997 and 1996, respectively. The Company also leases certain
property and equipment under capital leases.


                                      F-12

<PAGE>   95

<TABLE>
<CAPTION>

At  September  30,  1998,   the  Company's   future   minimum   payments   under
non-cancelable lease arrangements are as follows:

                                                 Operating          Capital
Fiscal Year                                       Leases            Leases
                                             ------------     -------------
<C>                                           <C>                <C>       
1999                                          $ 1,964,000        $  742,000
2000                                            1,841,000           622,000
2001                                            1,740,000           268,000
2002                                            1,288,000            27,000
2003                                              957,000            20,000
Thereafter                                      4,479,000                --
                                             ------------     -------------
Total lease payments                         $ 12,269,000         1,679,000
                                             ============

Less: amount representing interest                                 (151,000)
                                                              -------------
Present value of net minimum lease                              
payments                                                         $1,528,000
                                                                 ==========
</TABLE>


At September 30, 1998 and 1997,  the  Company's  note  obligations  consisted of
approximately  $972,000 and $633,000 in note payable  agreements  (the  "Notes")
respectively.  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 and 1997,
$194,000  and  $73,000,  respectively,  of  the  Notes  have  been classified as
current.

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

On  September  15,  1997,  the  Company  and  Wyeth-Ayerst  announced  a  market
withdrawal of the weight loss medication Redux, which was launched in June 1996.
In connection with the market  withdrawal of Redux,  the Company  recorded as of
September 30, 1997 certain charges  aggregating  approximately  $10,800,000.  Of
this amount, approximately (i) $3,300,000 (included in cost of revenues) related
to reserves for inventories of dexfenfluramine drug substance and finished Redux
capsules which were deemed to have no net realizable  value and (ii)  $7,500,000
related  to  costs or  commitments  associated  with  product  development,  the
cessation  of  production  of Redux  capsules and other  costs.  Total  expenses
relating to the market  withdrawal  of Redux may exceed these  amounts which are
current 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  779 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 U.S.  District  Court for the Eastern  District of
Pennsylvania (the "Court") preliminarily approved an Agreement of Compromise and
Settlement (the "Settlement  Agreement") between the Company and the Plaintiffs'
Management  Committee ("PMC") relating to the proposed settlement of all product
liability  litigation and claims against the Company  relating to Redux. As part
of the  Settlement  Agreement,  the Company  and the PMC entered  into a royalty
agreement  relating  to a portion  of the  payments  proposed  to be made to the
settlement fund.

On November 3, 1998, the Court issued a stay halting all Redux product liability
litigation against the Company,

                                      F-13

<PAGE>   96



pending and future,  in state  courts,  following the issuance of a similar stay
halting  Redux  product  liability  litigation  against the Company with federal
courts on September 3, 1998.  These stays will remain effective until a fairness
hearing  scheduled for February 25, 1999 and may be extended pending the outcome
of this hearing.

The limited fund class action  established by the Settlement  Agreement includes
all persons in the United States who used Redux,  and certain other persons such
as their  family  members,  who would be bound by the  terms of the  settlement.
Membership in the class is mandatory for all persons  included  within the class
definition.  Class members asserting claims against Interneuron will be required
to seek  compensation  only from the settlement fund, and their lawsuits against
Interneuron  will  be  dismissed.   By  agreeing  to  the  proposed  settlement,
Interneuron does not admit liability to any plaintiffs or claimants.

The   Settlement   Agreement   requires   Interneuron  to  deposit  a  total  of
approximately  $15,000,000  in three  installments  into a settlement  fund. The
first  installment  of $2,000,000  was  deposited  into the  settlement  fund in
September  1998.  A second  installment  of  $3,000,000  is to be made after the
Settlement  Agreement  is approved by the Court,  which  approval,  if obtained,
would follow the fairness hearing.  These  installments,  less certain expenses,
will be returned to Interneuron if the settlement does not become final. A third
installment of  $10,000,000,  plus interest,  is to be made after the settlement
becomes final.

In addition,  the  Settlement  Agreement  provides for  Interneuron to cause all
remaining and available insurance proceeds related to Redux to be deposited into
the settlement fund. Interneuron also agreed to make certain royalty payments to
the settlement  fund pursuant to a Royalty  Agreement (the "Royalty  Agreement")
which is part of the Settlement  Agreement,  in the total amount of $55,000,000,
based upon revenues  related to Interneuron  products,  over a seven year period
commencing when the settlement becomes final. Royalties will be paid at the rate
of 7% of gross sales of Interneuron  products sold by  Interneuron,  15% of cash
dividends  received  by  Interneuron  from its  subsidiaries  related to product
sales,  and 15% of  license  revenues  (including  license  fees,  royalties  or
milestone  payments)  received  by  Interneuron  from a  sublicensee  related to
product sales.  All Interneuron  products will be subject to this royalty during
the  applicable  term.  If, at the end of that seven year period,  the amount of
royalty  payments made by Interneuron is less than  $55,000,000,  the settlement
fund will receive shares of  Interneuron  stock in an amount equal to the unpaid
balance  divided  by $ 7.49 per  share,  subject  to  adjustment  under  certain
circumstances  such as stock  dividends or  distributions.  The Company could be
required  to issue up to  7,343,124  shares  of  Common  Stock if it is makes no
royalty payments.

The  Settlement  Agreement will not become final until approved by the Court and
the time for filing  appeals of the Court's  judgement  approving the Settlement
Agreement  has elapsed  without any appeals  being filed or all appeals from the
Court's judgement approving the Settlement  Agreement have been exhausted and no
further appeal may be taken.  In this case, in order to approve the  settlement,
the Court must make a  determination  that the proposed  settlement  is fair and
reasonable and meets each of the prerequisites for a class action generally, and
for a "limited fund" class action in particular,  all as required by the Federal
Rules of Civil  Procedure.  Pursuant  to these  rules,  notice  of the  proposed
settlement  was provided to potential  class members in November  1998,  and the
Court has  scheduled a Fairness  Hearing for  February  25, 1999 (the  "Fairness
Hearing").  At the Fairness  Hearing,  proponents  and opponents of the proposed
settlement will be given an opportunity to present written and oral arguments in
favor of or against the settlement.  Following the Fairness  Hearing,  the Court
must determine if the case is properly certified as a limited fund class action,
and  if so,  whether  the  terms  of  the  Settlement  Agreement  are  fair  and
reasonable.

The  Company may  withdraw  from the  Settlement  Agreement,  or the  Settlement
Agreement may otherwise terminate,  under any of the following  conditions:  (i)
final  approval of the  Settlement  Agreement is not entered by the Court;  (ii)
class certification and/or approval of the Settlement Agreement is overturned on
appeal for

                                      F-14

<PAGE>   97



any reason; (iii) pending and future litigation against the Company or any other
party  released  by  the  Settlement   Agreement  ("Released  Parties")  is  not
permanently  enjoined on the final approval date;  (iv) the class action and all
pending  multi-district  lawsuits against the Released Parties are not dismissed
with  prejudice on the final  approval  date; (v) an order is not entered by the
Court permanently barring  contribution and indemnity claims by other defendants
in the diet drug  litigation;  or (vi) Interneuron is unable to compel tender of
its insurance proceeds.

There can be no  assurance  that  after the  Fairness  Hearing,  the Court  will
approve  the  settlement.  Even if the  settlement  is  approved  by the  Court,
opponents of the settlement may appeal the Court's  opinion to the United States
Court of Appeals for the Third  Circuit.  In  addition,  there is a case pending
before the United States Supreme Court (Ortiz v.  Fibreboard  Corporation et al)
("Ortiz"),  that may influence the Court's decision or the outcome of any appeal
that might be taken.  Oral  argument  in the Ortiz case was heard on December 8,
1998 and the Supreme Court is likely to render its opinion  between  January and
June  1999.  Although  factually  distinguishable  in  many  respects  from  the
Company's  proposed  settlement,  Ortiz  involves  an appeal  from a  mandatory,
putative "limited fund" class action settlement.  There can be no assurance that
the  Supreme  Court's  rulings in Ortiz  will not  significantly  influence  the
approval  process  for,  or  potentially  result  in  the  overturning  of,  the
Settlement Agreement.

The Company will record  initial  charges to operations  for the estimated  fair
value of the Company's obligations under the Settlement Agreement,  exclusive of
insurance  proceeds,  at  such  time as the  Company  can  determine  that it is
probable that the conditions to final  settlement have been or will be met. This
is expected  to be  subsequent  to the  Fairness  Hearing and the Supreme  Court
ruling in Ortiz. The amount of the liability to be recognized in connection with
these charges is likely to be significant and to materially adversely affect the
Company's net worth. Additionally,  if the Company records such charges prior to
the final  settlement  date, then on the date the Settlement  Agreement  becomes
final, the Company will determine if there was any increase in the fair value of
the equity  conversion  feature  of the  Royalty  Agreement  and record any such
increase  as an  additional  charge  to  operations.  From the date the  Company
records the initial charge and related  liability for the settlement and through
the term of the Royalty Agreement,  the Company may record additional charges to
accrete  the  liability  attributable  to the  royalty  feature  of the  Royalty
Agreement up to the amount of royalties  the Company  expects to pay pursuant to
the Royalty  Agreement  over the time the Company  expects to make such  royalty
payments.  Payments  to be  made  by the  Company  pursuant  to  the  Settlement
Agreement  could have a material  adverse effect on the operations and financial
condition  of  the  Company.

If the  Settlement  Agreement  is  overturned  or not made  final,  the  ongoing
Redux-related  litigation would then proceed against the Company. In this event,
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,
financial condition and results of operations.

The  Company  has also been named as a defendant  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.


                                      F-15

<PAGE>   98



I. 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 N.)

Common Stock and  Warrants:  Class B Warrants,  which were issued in  connection
with the  Company's  initial  public  offering in 1990,  entitled  the holder to
purchase one share of Common Stock at $4.75 per share, from the date of issuance
through March 15, 1996.  During  fiscal 1996,  approximately  2,402,000  Class B
Warrants were  exercised  (including  165,000 that were  exercised on a cashless
basis by an affiliate of the Company resulting in the issuance of 138,432 shares
of Common  Stock of the  Company)  resulting  in net  proceeds to the Company of
approximately  $10,612,000 and the issuance of approximately 2,375,000 shares of
Common Stock.

In  connection  with private  placements  of 3,009,045  shares of the  Company's
Common Stock in fiscal 1995,  the Company  issued  warrants to purchase  653,500
shares of its Common  Stock.  At September 30, 1998,  632,500 of these  warrants
were  outstanding  at prices  ranging  from $5.00 to $13.08 per share and expire
from August 16, 2000 to February 3, 2005.

In January 1996, the Company issued 342,792 shares of Common Stock for the pur-
chase of the 20% of outstanding capital stock of CPEC, Inc. ("CPEC") not owned 
by Intercardia. (See Note O.)

In June 1996,  the Company  completed a public  offering of 3,000,000  shares of
Common Stock at $39.00 per share and received  proceeds,  net of issuance costs,
of approximately $109,130,000.

In March 1997, the Company's  stockholders approved an increase to the number of
authorized shares of Common Stock from 60,000,000 to 80,000,000.

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  Intercardia's   IPO,   Progenitor's  IPO  and  the  Transcell
Acquisition, 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

                                      F-16

<PAGE>   99



"Plans"). Under the 1998 Plan, options to purchase up to 1,500,000 shares of the
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 Plans options to purchase shares of
the Company's Common Stock ("Non-Plan Options").  At September 30, 1998, 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 Interneuron's  stock 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 have been 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  Interneuron's  stock  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 have been
exchanged.

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


                                      F-17

<PAGE>   100



<TABLE>
<CAPTION>

                                                  Stock Options                          Warrants
                                            ---------------------------       ------------------------------
                                                            Weighted                                            
                                                             Average                                            
                                            Shares       Exercise Price       Shares          Warrant Price
                                            ----------   --------------       ----------     ---------------
<S>                                          <C>              <C>              <C>           <C>     <C>   
Outstanding at  September 30, 1995           4,081,441        $7.25            2,038,438     $4.00 - $14.00

  Granted                                      848,300       $23.56               75,000     $23.25

  Exercised                                   (740,021)       $4.24           (1,309,125)    $4.00- $14.00

  Canceled                                    (298,000)      $27.22                    -
                                             ---------                          --------

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

  Canceled                                     (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

  Canceled                                  (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
                                             =========                           =======
</TABLE>


<TABLE>
<CAPTION>

At September  30,  1998,  stock  options were  outstanding  and  exercisable  as
follows:

                                     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>    
      $ 0.83-$ 5.00    2,581,801      4.9 years          $ 4.22       356,150     $  4.72
      $ 6.00-$10.00    3,753,747      6.2 years          $ 6.33       351,847     $  7.73
      $10.50-$28.13       54,775      7.5 years          $17.04        49,775     $ 16.15
                       ---------                                      -------
      $ 0.83-$28.13    6,390,323      5.7 years          $ 5.57       757,772     $  6.87
                       =========                                      =======
</TABLE>


All outstanding  options vest at various rates over periods up to four years and
expire at various  dates from  February 18, 1999 to March 3, 2008.  At September
30, 1997,  2,698,907  options were  exercisable at a weighted  average  exercise
price of $9.02. At September 30, 1996,  2,210,998  options were exercisable at a
weighted average exercise price of $7.95.

At September 30, 1998, warrants were outstanding and exercisable as follows:


                                      F-18

<PAGE>   101


<TABLE>
<CAPTION>

          Range of                             
          Exercise        Number             Number
           Prices       Outstanding        Exercisable
          --------      -----------        -----------
        <S>              <C>                 <C>    
        $ 5.00-$7.88     250,000             145,000
           $10.00        500,000             500,000
           $12.77         62,500              62,500
                         -------             -------
                         812,500             707,500
                         =======             =======
</TABLE>


At September 30, 1998,  all  outstanding  warrants  expire at various dates from
August 16, 2000 to September 16, 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, 1998, restricted stock awards to acquire an aggregate of 1,226,334
shares had been granted, net of forfeitures,  to all employees of the Company 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 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 and through  September 30,
1998,  501,188  shares have vested and been issued by the Company under the 1997
Plan. Vesting continues through May 2000 on the remaining 725,146 shares subject
to awards at September 30, 1998.

The Company has incurred and will  continue to incur  compensation  expense from
the date of grant of awards  through  the  vesting  period of shares  subject to
restricted stock awards.  The charges relating to the restricted stock awards to
acquire  1,226,334 shares are expected to aggregate  approximately  $14,000,000,
the fair market value of the shares at the time of grant, of which approximately
$10,000,000  was  incurred  in fiscal  1998 and the  remainder  will be incurred
through the final 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, 1998,  43,295  shares remain to be
purchased under the 1995 Plan.


                                      F-19

<PAGE>   102



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:

<TABLE>
<CAPTION>

                                             1998               1997
                                             ----               ----
<S>                                           <C>                <C>
Dividend yield                                0%                 0%
Expected volatility                         70%-90%            60%-70%
Risk-free interest rate                    5.3%-5.6%          6.0%-6.9%
Expected option life                       2-3 years           5 years
Weighted average grant date fair value:
        Interneuron                          $3.87             $12.81
        Intercardia                          $9.57             $11.46
        Transcell                              -                $ .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 below pro forma net
loss and net loss per share  amounts only include  option grants within the last
two years. The pro forma effect on net loss for the fiscal years ended September
30,  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, 1998 and 1997:

                                                                              
<TABLE>
<CAPTION>
                                
                                 1998                           1997
                      --------------------------     -------------------------
                      As Reported     Pro Forma      As Reported    Pro Forma
                      -----------    -----------     -----------   -----------
<S>                   <C>            <C>             <C>           <C>        
Net loss              $69,962,000    $83,043,000     $55,256,000   $62,773,000
Net loss per share          $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.
As of September 30, 1998, the Company had  repurchased  217,500  shares,  all in
fiscal 1997, for an aggregate purchase price of approximately $3,978,000, all of
which  shares were  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.  The
call options maturing on December 31, 1997, June 9, 1998, and September 21, 1998
expired  without  exercise.  The remaining call option is exercisable on January
11, 1999, with respect to 310,000 shares, and is subject to a cap of $34.50. The
call options which the Company purchased may be settled, if exercised, with cash
or Common  Stock in an amount equal to the  difference  between the strike price
and the market price,  determined over a specified valuation period,  subject to
the cap. Under certain circumstances,  the Company may delay the expiration date
of the remaining call option for the payment of additional consideration to SBC.

                                      F-20

<PAGE>   103



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.  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.  The
additional  $500,000  received in cash for the  subsequent  modification  to the
original  options is  reflected  as a credit to  additional  paid-in  capital in
fiscal 1997.

Other:  In addition to the  41,817,000  shares of Common  Stock  outstanding  at
September 30, 1998, there were  approximately  18,778,000  potentially  issuable
shares of Common Stock  ("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)  1,249,000  shares reserved for
issuance under the 1997 Plan (iv) 9,088,000  shares  reserved for issuance under
the Plans and the 1995 Plan,  (of which  approximately  6,290,000  stock options
were outstanding not all of which were vested);  (v) an estimated 150,000 shares
issuable in connection with certain  acquisitions;  (vi)  approximately  913,000
shares reserved for issuance from exercise of outstanding  warrants and Non-Plan
Options;  and (vii)  2,000,000  shares  reserved for  issuance  pursuant to call
options  potentially  exercisable by SBC. In addition,  the Company had reserved
7,343,124  shares for  issuance  pursuant to the Royalty  Agreement,  subject to
final approval of the Settlement Agreement (see Note H).



                                      F-21

<PAGE>   104



J. Income Taxes:

<TABLE>
<CAPTION>

At September  30, 1998 and 1997,  the  significant  components  of the Company's
deferred tax asset consisted of the following:

                                                           1998                1997
                                                    -----------         -----------

<S>                                                 <C>                <C>
Federal and state net operating loss                                    
         carryforwards                              $60,876,000         $36,728,000
Federal and state tax credit carryforwards            5,154,000           3,922,000
Accrued expenses                                     15,263,000          16,076,000
Investment in unconsolidated subsidiary              11,880,000          10,000,000
                                                    -----------         -----------
Total deferred tax asset before                                         
         valuation allowance                         93,173,000          66,726,000
Valuation allowance against total                                       
         deferred tax asset                         (93,173,000)        (66,726,000)
                                                    -----------         -----------
Net deferred tax asset                              $         -         $         -
                                                    ===========         ===========
</TABLE>



At  September  30,  1998,  the  Company  had net  operating  loss  carryforwards
available for federal income tax purposes of  approximately  $165,000,000  which
expire at  various  dates  from  2004 to 2018.  In  addition,  the  Company  had
approximately  $5,200,000  of tax credit  carryforwards  for federal  income tax
purposes  expiring  at  various  dates  through 2013.  The Company's  ability to
use  the  carryforwards may be  subject to  limitations resulting from ownership
changes as defined in the U.S. Internal Revenue Code.  Approximately $12,500,000
of  the  net operating  loss  carryforwards  available  for  federal  income tax
purposes  relate to  exercises of  non-qualified stock options and disqualifying
dispositions  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.

K.  Earnings Per Share:

<TABLE>
<CAPTION>

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


                                                     1998               1997
                                              ------------------  --------------
<S>                                           <C>                 <C>
Numerator for basic and diluted:
     Net loss                                    $(69,962,000)      $(55,256,000)
                                            =================   ================

Denominator for basic and diluted:
     weighted average shares outstanding           41,468,000         41,064,000
                                            =================   ================

Net loss per common share - basic           $           (1.69)  $          (1.35)
                                            =================   ================

Net loss per common share - diluted         $          (1.69)   $          (1.35)
                                            ================    ================
</TABLE>



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)

                                      F-22
<PAGE>   105



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 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.

L. Related Party Transactions:

The  Company  and  certain of its  subsidiaries  have  agreements  with  certain
directors of the Company and parties  related to directors to provide  technical
and other  consulting  services.  The total of such payments were  approximately
$414,000,  $417,000  and  $357,000  in fiscal 1998, 1997 and 1996, respectively.
Included in the fiscal 1996 payments  was  approximately  $103,000  of  payments
to a director regarding  certain patent  matters and the April 1996 FDA approval
of  Redux.  In  addition  to  the  above,  (i) one related party was a principal
investigator in clinical trials  and received  approximately  $34,000,  $296,000
and $45,000 in fiscal 1998, 1997 and 1996, respectively, for services  performed
in  that capacity and (ii) one  director  is the  Chairman  and Chief  Executive
Officer  of  an  entity  that provides product distribution services for certain
InterNutria products to which InterNutria paid approximately  $58,000,  $117,000
and $47,000 in fiscal 1998,  1997 and 1996, respectively.

In fiscal 1996, InterNutria acquired certain technology from AVAX Technologies, 
Inc. (formerly Walden Laboratories, Inc.) ("AVAX") of which certain of the 
Company's directors are or were stockholders (see Note O).

The Company made contributions of $147,000, $147,000, and $182,000, in the years
ended September 30, 1998, 1997, and 1996, respectively,  to The Center for Brain
Science and Metabolism  Charitable Trust of which one of the Company's directors
is the scientific director.


                                      F-23

<PAGE>   106



M. Discontinued Operations

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.  Additionally,  the fiscal 1998  results
include a separate charge of $2,326,000 for the discontinuation of InterNutria's
operations.  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,  which is eliminated in the consolidated financial statements.  All
inventories  have been fully  reserved at September  30, 1998.  At September 30,
1997,  the  assets of  InterNutria  were  $1,771,000  and the  liabilities  were
$14,884,000,  including indebtedness to Interneuron of $13,754,000.  The Company
is seeking  to sell  InterNutria  or all or part of its  assets,  which  include
primarily  a line of  sports  drink  products  and PMS  Escape.  There can be no
assurance  it will be  successful  and the  Company  does not expect to generate
significant proceeds.

The Company has reclassified its prior year financial  statements to reflect the
operating results of InterNutria as a discontinued operation.  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, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>

                                        1998              1997              1996
                                       =====            ======             =====

<S>                              <C>                <C>              <C>
Revenues                         $ 2,567,000        $  879,000       $   383,000
Operating Expenses                19,701,000         6,345,000         5,799,000
                                  ----------         ---------        ----------
   Net loss from operations       17,134,000         5,466,000         5,416,000
Interest (expense) income, net       (17,000)         (120,000)         (170,000)
                               -------------        ----------        ----------

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



N. Agreements:

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

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 stock which is outstanding at September 30, 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 in the event of
future dilution. Additionally, the agreement with AHP provides for

                                      F-24

<PAGE>   107



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.
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.  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 provides for 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,  providing Redux is supplied to AHP by
the  Company.  The  Company  manufactured  Redux  through  an  arrangement  with
Boehringer Ingelheim Pharmaceuticals,  Inc. ("Boehringer") and was the exclusive
supplier of Redux to AHP. On September 15, 1997, the Company and AHP announced a
market withdrawal of Redux. (See Note H.)

Boehringer:   In  November   1995,   the  Company   entered  into  an  exclusive
manufacturing agreement with Boehringer under which Boehringer agreed to supply,
and the  Company  agreed  to  purchase  from  Boehringer,  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 H.)

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 also entered into an agreement with Ferrer whereby 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 worldwide
exclusive  rights to an anti-panic  and anxiety  compound  (pagoclone).  License
fees,  milestone  payments and future royalties on net sales were  consideration
provided to RPR.

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(R)  (fluoxetine
hydrochloride)  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 pay royalties based upon net sales.



                                      F-25

<PAGE>   108
PACAP: In April 1998, the Company licensed from Tulane University the 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 polypepide). Preclinical data suggests the potential of PACAP
as a treatment for stroke and other neurodegenerative diseases.  Under terms of
the  license,  Interneuron  paid Tulane an upfront licensing  fee and will fund
research over a two-year period. Interneuron will make additional payments based
on the  achievement of clinical and regulatory review  milestones.  Tulane will
receive royalties on net sales of any product developed from this program.

Bristol-Myers Squibb: CPEC (see Note O) holds an exclusive worldwide license to
bucindolol, for use in the treatment of congestive heart failure, which CPEC
acquired from Bristol-Myers Squibb Company ("BMS"). Royalties will be due to BMS
based upon net sales of the product.

Merck: In July 1997, Transcell  (subsequently merged into Intercardia;  see Note
P)  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 to Intercardia
in connection with the  Transcell Acquisition (see  Note P). Merck  made initial
payments totaling $2,500,000 of which $1,500,000 was recognized as  license  fee
revenue in fiscal  1997 and  $1,000,000  was   recognized as license fee revenue
ratably   over the   twelve   month   option   period   commencing in July 1997.
Additionally, Merck will provide  research  support  for the first two  years of
the  agreement  and make payments  based upon   achievement of  certain  defined
clinical  development  and regulatory  milestones  and pay royalties based  upon
net  sales  of  products resulting from the Merck Collaboration.  Certain of the
rights licensed to  Merck are  based  on exclusive  licenses  or rights  held by
Intercardia  from  Princeton  University,   which will  be  entitled  to varying
percentages of certain  payments and royalties  received from Merck.   A portion
of any royalties  from Merck will also be payable to Interneuron.

Astra Merck: In December 1995, Intercardia executed a Development and  Marketing
Collaboration and License Agreement (the "Astra Merck Collaboration") with Astra
Pharmaceuticals  LP,  formerly  Astra  Merck, Inc. ("Astra Pharmaceuticals")  to
provide  for  the development, commercialization and marketing in the U.S. of  a
twice-daily  formulation  of  bucindolol  for the treatment of congestive  heart
failure.  This agreement was terminated in September 1998. Intercardia  received
$5,000,000 upon execution of the Astra Merck Collaboration, which was recognized
as  contract  and  license  fee  revenue  in  the first quarter of fiscal  1996.
Intercardia  paid  Astra  Pharmaceuticals  $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, 1997, and 1996, the Company recognized  contract
revenue  of  approximately $4,833,000 (including a $4,000,000 termination  fee),
$553,000,   and   $5,000,000,   respectively,   from  payments  made  by   Astra
Pharmaceuticals  to  Intercardia.  During  the fiscal years ended September  30,
1998,   1997   and   1996,   Astra  Merck  assumed  additional  liabilities   of
approximately   $6,065,000,   $5,505,000   and   $4,301,000,  respectively,   on
Intercardia's  behalf.  These  additional  amounts did not impact the  Company's
Consolidated  Statements  of  Operations,  as  they were offset against  related
expenses.  As  of  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.

In  connection  with the  termination  of this  agreement  and  resolution of an
earlier dispute  relating to  responsibility  for funding  certain costs,  Astra
Pharmaceuticals made a $4,000,000 payment to CPEC. As a result,  Intercardia has
assumed  responsibility  for the  U.S.  development  and  commercialization  for
BEXTRA.  Intercardia requires a corporate  collaboration or additional funds for
the commercialization of BEXTRA and is currently exploring possible development,
commercialization and marketing collaborations.



                                      F-26

<PAGE>   109



Knoll:  In  December  1996,  Intercardia  entered  into an  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  "Territory").   The  Knoll
Collaboration  relates to both the  twice-daily  bucindolol  formulation and the
once-a-day bucindolol  formulation currently under development.  Under the terms
of the Knoll  Collaboration,  Knoll made up-front  payments to CPEC (see Note O)
totaling $3,143,000 which were recognized as contract and license fee revenue in
fiscal  1997.  Knoll  will make  future  payments  to CPEC  contingent  upon the
achievement of product approval and sales milestones.

Knoll and  Intercardia  agreed to share the  development  and marketing costs of
bucindolol in the Territory.  In general,  Knoll agreed to pay approximately 60%
of  certain  development  and  marketing  costs  prior  to  product  launch  and
Intercardia  agreed to pay approximately  40% of such costs,  subject to certain
maximum dollar  limitations.  CPEC will be entitled to a royalty equal to 40% of
net profits,  as defined in the Knoll  Collaboration,  and would be  responsible
for 40% of any net loss, as defined.  Knoll also agreed to pay approximately 60%
of once-a-day formulation  development costs that relate solely to the Territory
and approximately one-third that have worldwide benefit.

O. Acquisitions:

In September 1994,  Intercardia  acquired 80% of the outstanding common stock of
CPEC which has 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 (the "BEST Study"),  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 have
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
is  obligated  to  fund   other   costs of the  study  including drug supply and
clinical monitoring.

The  purchase  price of CPEC  included  170,000  shares of  Common  Stock of the
Company,  payments to stockholders of CPEC, assumed  liabilities,  other related
expenses and  additional  future  issuances of  Interneuron's  Common Stock upon
achieving  bucindolol-related  milestones  of  filing  an NDA and  receiving  an
approval  letter  from the FDA.  The  value of these  additional  shares  is not
included  in the  purchase  price  because  their  issuance is  contingent  upon
achieving these milestones. Future issuances of Common Stock of the Company will
result in additional charges.

In January 1996, the Company acquired the 20% outstanding  capital stock of CPEC
not owned by  Intercardia  by issuing an aggregate  of 342,792  shares of Common
Stock to the former CPEC  minority  stockholders  and  recorded a charge for the
purchase of in-process  research and development of approximately  $6,084,000 in
fiscal 1996.

In December 1995, InterNutria acquired from 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 consisted of
55,422  shares and was made in fiscal 1997 and the second  payment  consisted of
112,793  shares and 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.
The  Company  recorded a charge of  approximately  $2,150,000  in fiscal 1996 in
connection  with this  transaction  for the purchase of in-process  research and
development  as the  future  benefits  from this  technology  depended  upon the
successful completion of certain clinical trials.


                                      F-27

<PAGE>   110



P. Subsidiaries:

Intercardia:

In February 1996,  Intercardia completed an initial public offering of 2,530,000
shares of  Intercardia  common stock at $15.00 per share  resulting in proceeds,
net of offering costs, of approximately $35,000,000 (the "Intercardia IPO"). The
Company  purchased  333,333  shares  of the  Intercardia  IPO for  approximately
$5,000,000.  The Company's ownership of Intercardia's  outstanding capital stock
decreased from approximately 88% at September 30, 1995 to approximately 60% as a
result of the Intercardia  IPO, without giving effect to exercise of options and
warrants.  In  certain  circumstances,  the  Company  has the right to  purchase
additional  shares of  Intercardia  common stock at fair market value to provide
that the Company's equity ownership in Intercardia does not fall below 51%. As a
result of the Intercardia  IPO, the Company  recognized a gain on its investment
in  Intercardia  of  approximately  $16,350,000  which has been  recorded  as an
increase to the Company's additional paid-in capital.

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 Intercardia.  As of September 30, 1998,
the Company had purchased  129,400  shares of Intercardia  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.

On May 8,  1998,  the  merger of  Transcell  with and into  Intercardia  and the
acquisition  by  Intercardia  of  certain  related  technology  rights  owned by
Interneuron  was  completed  and,  simultaneously,  Interneuron  contributed  to
Transcell's  capital all of Transcell's  indebtedness and payables,  aggregating
$18,698,000,  to Interneuron (the "Transcell Acquisition").  Consideration given
by Intercardia  consisted of (i) Intercardia 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  payable 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 Intercardia 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,
Intercardia issued an aggregate of 320,151  shares  of  common  stock,  of which
191,383  shares  were   issued   to   Interneuron.   In   addition,  Intercardia
issued  174,672  shares  to  Interneuron  for  the  Initial Technology/Guarantee
Payment.  Intercardia  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 will be made in
August  1999  and  February  2000,   respectively,   and each  installment  will
consist  of  the   issuance  of   $3,000,000  of  Intercardia common  stock,  as
then   valued.   Intercardia's   acquisition   of   the   minority shareholders'
interest in Transcell resulted in Intercardia  recording a charge to  operations
in  fiscal  1998  for  the  purchase  of in-process research and development  of
approximately $5,300,000. This charge is 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 Acquisition  and
the  book  value  of  the  Intercardia  shares  received by the Company for  the
Initial  Technology/Guarantee  Payment.  Interneuron  owned  approximately   61%
of  the  outstanding  capital  stock  of  Intercardia before the closing of  the
Transcell  Acquisition  and  approximately  62% immediately after the  Transcell
Acquisition  and at September 30, 1998.



                                      F-28

<PAGE>   111



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,  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 has been recorded as an increase in the  Company's  additional
paid-in  capital.  In  fiscal  1997  the  Company  purchased  20,000  shares  of
Progenitor  common stock for approximately  $105,000.  At September 30, 1997 the
Company's  investment in Progenitor is reflected in investment in unconsolidated
subsidiary  at  $4,040,000.  Such  securities  are  subject  to  regulatory  and
contractual  restrictions  on resale  and on the  liquidity  of the  market  for
Progenitor's securities and, accordingly, the market value of such securities as
of a given  date is not  necessarily  indicative  of  their  ultimate  value  to
Interneuron. 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 July 1997,  the Company  relinquished  certain  conversion  price  adjustment
rights  relating to Progenitor  Series A Preferred  Stock held by the Company in
exchange  for  an  option  to  acquire  an  exclusive,   worldwide   license  to
manufacture, use and sell certain aspects of Del-1, a novel cell surface protein
encoded by the del-1 gene which was discovered by Progenitor.

In December  1998,  Progenitor  announced  its  intention to implement an
immediate  cessation of operations.  Progenitor did not have sufficient funds 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.  Following are condensed  statements of
operations   and  balance  sheet  data  of  Progenitor  for  which  fiscal  1998
information is unaudited:


                                      F-29

<PAGE>   112


<TABLE>
<CAPTION>

                                       Fiscal Year ended September 30,
                                ----------------------------------------------
                                       1998            1997            1996
                                ===========     ===========     ==============
Statement of Operations:                                         
<S>                               <C>           <C>             <C>        
Revenues                          $ 485,000     $ 1,142,000     $ 1,332,000
Charge for acquired in-process                                   
   research and development              --      21,092,000               --
Net loss                        (13,916,000)    (30,283,000)     (5,484,000)
</TABLE>

<TABLE>
<CAPTION>


                                        September 30,
                                ---------------------------
                                        1998          1997
                                ============   ============
Balance Sheet:                                   
<S>                             <C>            <C>         
Current assets                  $ 7,239,000    $ 20,224,000
Noncurrent assets                 3,062,000       3,361,000
Current liabilities               4,513,000       6,703,000
Noncurrent liabilities            2,849,000         942,000
</TABLE>



Transcell:

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

InterNutria:

In January 1998,  Interneuron  sold,  subject to repurchase  rights  expiring 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, 1998,  the Company  owned  approximately  76% of
InterNutria's outstanding stock. (Also, see Note M.)


                                      F-30