<PAGE>   1

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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                             ----------------------

                                    FORM 10-K

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

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
                                       OR

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

               FOR THE TRANSITION PERIOD FROM _______ TO ________

                           COMMISSION FILE NO. 0-20111

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

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

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

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

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                     Common Stock, par value $.001 per share
                                (TITLE OF CLASS)

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

                                   Yes  X   No
                                       ---     ---

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

         The aggregate market value of the voting stock held by non-affiliates
of the registrant on March 25 , 1998 was $48,612,036, based on the closing sales
price of the registrant's common stock on the Nasdaq National Market on such
date of $3.69 per share. For purposes of the preceding sentence only, all
directors, executive officers and beneficial owners of ten percent or more of
the common stock are assumed to be affiliates. As of March 25, 1998, 15,467,281
shares of the registrant's common stock were outstanding.

         Certain sections of the registrant's definitive proxy statement
relating to the registrant's 1998 annual meeting of stockholders, which proxy
statement will be filed under the Securities Exchange Act of 1934 within 120
days of the end of the registrant's fiscal year ended December 31, 1997, are
incorporated by reference into Part III of this Form 10-K.



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<PAGE>   2


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

                                     PART I

ITEM 1.   BUSINESS

GENERAL

         Aronex Pharmaceuticals, Inc. ("Aronex Pharmaceuticals" or the
"Company") is an emerging biopharmaceutical company engaged in the
identification and development of proprietary innovative medicines to treat
cancer and infectious diseases. The Company's strategy is to identify and
develop medicines based upon either refinements of proven therapies or novel
mechanisms of action against specific disease targets. The Company has a
portfolio of clinical products that it believes provides a balanced development
and commercialization risk profile. The Company believes its focus on medicines
for cancer and infectious diseases for which current therapy is inadequate will
provide synergies in development and product marketing and will facilitate
expedited commercialization of its products.

         Aronex Pharmaceuticals currently has four products in various stages of
ongoing clinical development. In addition, the Company has proprietary
technologies in drug formulation and drug delivery. The Company's four products
in clinical development are (i) NYOTRAN(TM) for the treatment of systemic fungal
infections, (ii) ATRAGEN(R) for the treatment of cancer, (iii) Annamycin for the
treatment of cancers with multi-drug resistance and (iv) Zintevir(TM) for the
treatment of human immunodeficiency virus ("HIV") infection.

         The Company has strategic alliances and collaboration arrangements with
leading corporations and academic institutions, including alliances with
Boehringer Mannheim GmbH ("Boehringer Mannheim"), Genzyme Corporation
("Genzyme") and Grupo Ferrer Internacional, S.A. ("Ferrer") and a collaboration
with The University of Texas M.D. Anderson Cancer Center ("MD Anderson").

         Aronex Pharmaceuticals was incorporated in 1986 as Argus
Pharmaceuticals, Inc. ("Argus"), and acquired Oncologix, Inc. ("Oncologix") and
Triplex Pharmaceutical Corporation ("Triplex") through a three-way merger (the
"Mergers") in September 1995, at which time Argus changed its name to Aronex
Pharmaceuticals, Inc. The merger of these three complementary companies
established an integrated company with the following characteristics: (i) a
clear therapeutic focus in cancer and infectious diseases; (ii) a well-defined
and diverse portfolio of products at various stages of clinical development;
(iii) technologies in drug formulation and delivery; (iv) a diverse group of
corporate partners and academic affiliations; and (v) an experienced team of
biopharmaceutical personnel who possess the ability to identify and develop
novel products, design and implement complex clinical trials, manage regulatory
issues, develop manufacturing processes and implement the commercialization of
products. Unless the context otherwise requires, references in this report to
"Aronex Pharmaceuticals" and the "Company" refer to Aronex Pharmaceuticals and
its subsidiaries.

         The Company's corporate headquarters is located at 8707 Technology
Forest Place, The Woodlands, Texas 77381-1191, and its telephone number is (281)
367-1666.



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BUSINESS STRATEGY

         Aronex Pharmaceuticals has implemented a comprehensive strategy to
become a commercial biopharmaceutical company involved in the identification,
development and commercialization of novel medicines for treating cancer and
infectious diseases. The Company's strategy encompasses five key elements.

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

         Balanced Product Portfolio. The Company has a portfolio of clinical
products that it believes provides a balanced development and commercialization
risk profile. Two of the Company's products are liposomal formulations of drugs
that are currently on the market, designed to improve effectiveness and reduce
adverse side effects. The Company believes that this should contribute to a
reduction in the development risks associated with such products. Two of the
Company's products are new compounds with novel mechanisms of action against a
specific disease target. While these products are associated with a greater
degree of development risk, the Company believes that these products may have a
substantial impact against the diseases they are intended to treat. The Company
believes that this balanced development and commercialization risk profile
limits its dependence on a single product.

         Expedited Drug Development Programs. The Company believes that it has
created an effective pharmaceutical development infrastructure. With expertise
in preclinical development, drug formulation and delivery, quality assurance,
quality control and analytical chemistry, drug manufacturing, regulatory and
clinical affairs, the Company believes that it has the ability to effectively
advance preclinical and clinical products through the development pipeline.

         Leveraged Research and Technological Resources. The Company relies on
several sources to provide potential opportunities to expand its pipeline of
products for commercialization. Using its academic and corporate collaborations,
the Company seeks late-stage preclinical products for advancement into the
Company's clinical pipeline as well as early-stage clinical products with
prospects for rapid clinical development. Additional opportunities are available
through the Company's existing capabilities in drug formulation and delivery.

         Marketing and Commercialization Strategy. The Company's marketing and
commercialization effort is designed to create a revenue stream utilizing two
diverse methods. The Company intends to market products in the United States
through its own sales and marketing efforts and to market products overseas and
those requiring broader marketing and distribution efforts through licensing
arrangements with corporate partners.

CLINICAL AND SCIENTIFIC BACKGROUND

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






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         Infectious Diseases

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

         Cancer

         The American Cancer Society estimates that more than 1.2 million new
cases of cancer will be diagnosed and more than 500,000 people will die of
cancer in 1998 in the United States. Major classes of cancer include (i) solid
tumors, the most common of which are breast cancer (approximately 179,000 new
cases in the United States annually) and cancers of the lung (approximately
171,000 new cases in the United States annually), (ii) cancers of the lymphoid
system (approximately 62,000 new cases of lymphoma in the United States
annually) and (iii) cancers of the blood (approximately 29,000 new cases of
leukemia in the United States annually). Chemotherapy, surgery and radiation are
the major components in the treatment of cancer. Chemotherapy is usually the
primary treatment for cancers, such as hematologic malignancies, which cannot be
excised by surgery. In addition, chemotherapy is increasingly being used as an
adjunct to radiation and surgery to improve efficacy and reduce the incidence of
metastasis (the spread of cancer), and as primary therapy for some solid tumors.
The standard strategy for chemotherapy is to destroy the malignant cells by
exposing them to as much drug as the patient can tolerate. Clinicians attempt to
design a combination of drugs, dosing schedule and method of administration that
increases the probability that malignant cells will be destroyed, while
minimizing the harm to healthy cells.

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

         Aronex Pharmaceuticals' Approach to the Treatment of Cancer and
         Infectious Diseases

         The Company has a focused effort aimed at identifying highly-specific,
novel medicines for the treatment of cancer and infectious diseases. The
Company's research and development strategy is to augment its pipeline by
partnering with academic centers such as MD Anderson and the National Institutes
of Health ("NIH"). These relationships are intended to permit the Company to
identify opportunities which have already been validated in preclinical and, in
some instances, clinical studies before the Company allocates resources for
further evaluation and development. The Company also anticipates expansion of
its product pipeline through acquisitions, licenses and joint ventures with
corporate partners. This strategy is further intended to allow the Company to
bypass the lengthy and uncertain drug discovery and screening process and to
proceed quickly to product development and clinical evaluation. The Company
believes that utilizing this strategy will allow it to maintain a full pipeline
of innovative products for the treatment of cancer and infectious diseases.
See "-- Collaborative Agreements."




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PRODUCTS IN CLINICAL AND PRECLINICAL DEVELOPMENT

         The following table lists the Company's clinical and preclinical
products, along with their initial indications and clinical status:

<TABLE>
<CAPTION>
                     PRODUCT                      INDICATIONS                               CLINICAL STATUS(1)
                     -------                      -----------                               ------------------
<S>                                     <C>                                                 <C>

          INFECTIOUS DISEASES
          NYOTRAN(TM) ...............   Comparative Presumed Fungal Infections              Phase III
                                        Candidemia                                          Phase II completed(2)
                                        Aspergillus Salvage                                 Phase II
                                        Esophageal Candidiasis                              Phase II
                                        Cryptococcal Meningitis                             Phase II/III

          Zintevir(TM) ..............   HIV Infection                                       Phase I/II

          CANCER
          ATRAGEN(R) ................   Acute Promyelocytic Leukemia                        Phase II  (Pivotal)
                                        Kaposi's Sarcoma                                    Phase II completed
          Annamycin .................   Breast Cancer                                       Phase II
          AR726 .....................   Lung Cancer                                         Phase II(3)
          AR209 .....................   Breast Cancer                                       Preclinical

</TABLE>


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

     "Preclinical" indicates that the compound exhibits in vitro activity and
     that the Company is conducting efficacy, toxicology and drug distribution
     testing of the compound in vitro and in animal models.

(2)  This Phase II clinical trial has been completed. However, the Company will
     continue to enroll patients for whom other therapies have not proven
     effective on a compassionate basis.

(3)  This Phase II clinical trial is being conducted under an institutional
     Investigational New Drug application ("IND") at MD Anderson.

         There can be no assurance that the results of any of the Company's
clinical trials will be favorable or that its products will obtain regulatory
approval for commercialization. See "-- Additional Business Risks
--Uncertainties Related to Clinical Trial Results."




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INFECTIOUS DISEASES

         Aronex Pharmaceuticals' infectious disease program centers on the
development of new agents for the treatment of infectious diseases, including
those that occur in patients with weakened immune systems. The clinical program
presently focuses on the development of NYOTRAN for life-threatening systemic
fungal infections and Zintevir for the treatment of HIV infection.

         NYOTRAN(TM) for Presumed Fungal Infections (Phase III), Candidemia
         (Phase II completed), Aspergillus Salvage (Phase II), Esophageal
         Candidiasis (Phase II) and Cryptococcal Meningitis (Phase II/III)

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

         Available agents for the treatment of systemic fungal infections
include itraconazole, fluconazole, amphotericin B and liposomal formulations of
amphotericin B; however, the Company believes that these drugs have some
limitations. Fluconazole is relatively safe and is effective in inhibiting
fungal growth in Candida, but is not effective in inhibiting fungal growth in
Aspergillus and is generally not effective in treating fungal infections in
patients who are seriously ill and immunocompromised. In addition, resistance to
fluconazole can develop. Amphotericin B is very active against both Candida and
Aspergillus but is highly toxic. Several companies have developed liposomal
versions of amphotericin B that are designed to reduce the potential toxicity of
amphotericin B.

         NYOTRAN is a liposomal, intravenous formulation of nystatin, an
established, widely-used topical antifungal agent. Although nystatin has proven
to be a potent anti-fungal against a broad spectrum of fungi, including Candida,
Cryptococcus, Histoplasma, Blastomyces and Aspergillus, its poor solubility and
toxicity have previously precluded its systemic administration as a therapy for
such fungal infections. Aronex Pharmaceuticals has developed a proprietary
formulation to deliver NYOTRAN to reduce the toxicity of "free" nystatin. The
Company believes NYOTRAN offers potential advantages over current systemic
anti-fungal therapies. The Company's in vitro studies indicate that it is active
against a range of fungal strains, including Candida, Aspergillus, Cryptococcus
and Fusarium species, some of which are resistant to currently available
anti-fungal therapies. While final clinical efficacy trials have not been
completed, the Company believes that its Phase I and Phase II clinical trials
suggest that NYOTRAN can be administered at doses that are effective in treating
Aspergillus, Candida and Cryptococcal infections.

         The strategy for the development of NYOTRAN has involved several
stages. The Company has conducted three Phase I clinical studies which
demonstrated a favorable safety profile. The Company completed a Phase II open
label study in patients with Candidemia evaluating NYOTRAN at multiple doses.
Although this Phase II study has been completed, it remains open on a
compassionate basis to enroll patients for whom other therapies have not been
effective. Results from this study indicate that a dose of one-third the
tolerated dose established in Phase I appears to be efficacious. Based upon data
from this study, the Company initiated Phase III comparative multicenter trials
of NYOTRAN against amphotericin B in patients with presumed fungal infections in
the United States and in Europe. In early 1998, to expand the potential
indications for NYOTRAN, the Company also initiated Phase II trials for the
treatment of patients with Candida infections in the esophagus and Phase II/III
trials for patients with Cryptococcal meningitis. If the Phase III trials are
successful, the Company plans to file a New Drug Application (an "NDA") for
NYOTRAN with the United States Food and Drug Administration (the "FDA") and
appropriate marketing applications worldwide. See "-- Government Regulation" and
"-- Additional Business Risks -- Uncertainties Related to Clinical Trial
Results."

         The active ingredient of NYOTRAN, nystatin, is available commercially.
The Company has contracted for the manufacture of its clinical requirements of
NYOTRAN by a contract manufacturer which provides Good Manufacturing





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Practices ("GMP") facilities capable of satisfying the quantities required for
clinical trials and anticipated quantities for initial commercial sales.

         The Company believes that, if approved by the FDA, NYOTRAN will be
prescribed primarily in large community hospitals and regional medical centers.
The Company may choose to establish marketing arrangements with corporate
partners with broad marketing capabilities for the successful marketing of
NYOTRAN.

         The Company estimates that over 300,000 patients worldwide develop
systemic fungal infections annually. The current systemic anti-fungal market is
estimated at more than $1.5 billion on an annual basis. Further, the incidence
of systemic fungal infections continues to increase because of the aging
population, the more aggressive use of chemotherapy, advances in medical
therapies and the development of resistant fungal strains.

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

         In 1997, Aronex Pharmaceuticals entered into a collaborative agreement
with Ferrer to commercialize and market NYOTRAN in Spain and Portugal. In
December 1997, the Company, in cooperation with Ferrer, filed national Marketing
Authorization Applications in Spain and Portugal seeking approval for NYOTRAN
for the treatment of systemic fungal infections. See "--Collaborative
Agreements--Relationship with Ferrer."

         MD Anderson has granted Aronex Pharmaceuticals the worldwide exclusive
license to an issued patent directed to the use of a liposomal formulation of
nystatin in the treatment of systemic fungal infections. A process which is of
substantial pharmaceutical utility for making NYOTRAN is protected by another
issued patent. A continuation of this process patent is currently being
prosecuted seeking additional claims in this area. See "-- Patents and
Proprietary Rights."

         Zintevir(TM) for HIV Infection (Phase I/II)

         Zintevir is a product under development by Aronex Pharmaceuticals for
the treatment of HIV infection. The drugs currently approved in the United
States for treatment of HIV infection consist of reverse transcriptase
inhibitors (AZT, ddI, ddC, d4T, 3TC, delaviridine and nevirapine) and protease
inhibitors (saquinavir, ritinovir, indinavir and nelfinavir). By contrast, the
Company believes the primary mechanism of action of Zintevir is inhibition of
HIV-1 integrase, a key enzyme in catalyzing the integration of HIV within human
cells.

         Two Phase I trials on Zintevir have been completed. A Phase I single
dose study of Zintevir was initiated at San Francisco General Hospital in
October 1995. The primary objectives of this Phase I study were to determine the
safety and pharmacokinetics profile of escalating single doses of Zintevir in
patients with HIV infection. Single doses as high as 6 mg/kg were given. A Phase
I multiple dose study was initiated at Harris Laboratories, Inc., a clinical
research organization, in May 1996. The primary objectives of the multiple dose
study were to determine the safety and pharmacokinetics profile of multiple
intravenous doses of Zintevir and to evaluate the anti-HIV activity in HIV
infected patients. Multiple doses as high as 3 mg/kg were administered every
other day for a total of seven doses with minimal adverse events. Multiple doses
as high as 6 mg/kg given every day for 14 days will be administered in a Phase
I/II clinical trial begun in November 1997. See "-- Additional Business Risks --
Uncertainties Related to Clinical Trial Results."

         Although treatment with a combination of reverse transcriptase and
protease inhibitors has been shown to reduce the level of HIV ribonucleic acid
("RNA") in the plasma to undetectable levels in many patients, HIV
deoxyribonucleic




                                      -7-
<PAGE>   8

acid ("DNA") continues to persist in the tissues of these patients. In addition,
25% of patients who have received combination therapy with reverse transcriptase
and protease inhibitors do not respond to the treatment, either because of the
patient's inability to withstand the combination therapy due to side effects or
the failure of the combination therapy to produce an anti-viral effect.

         Certain of the currently-approved drugs for treating HIV cause toxicity
in some patients. AZT may cause anemia as a result of bone marrow toxicity, and
ddI, ddC, and d4T may cause painful neuropathy. Although these toxicities are
sometimes reversible, they are considered serious and dose-limiting and may
prevent prolonged use. 3TC and saquinavir have been reported to have few serious
side effects. Some of the new protease inhibitors are known to cause kidney
stones and severe diarrhea. There is a continuing need for improved drugs for
the treatment of HIV infection, particularly for drugs that have novel
mechanisms of action and activity against AZT-resistant HIV strains.

         According to the NIH, between 650,000 and 900,000 people in the United
States and over 30 million people worldwide are infected with HIV. In the United
States alone, over 600,000 AIDS cases had been reported by June 1997. The
Company believes that substantial market potential exists for HIV agents with
novel mechanisms of action, for use in combination with existing therapies.

         The use and composition of a group of compounds including Zintevir are
the subject of one issued patent and four United States patent applications and
six foreign patent applications. These applications are either assigned wholly
to Aronex Pharmaceuticals, or jointly to the Company and Baylor College of
Medicine ("Baylor"), in which latter case the Company has exclusively licensed
Baylor's rights. The issued patent covers the inhibition of HIV production in
cultured cells by a group of compounds including Zintevir. See "-- Patents and
Proprietary Rights."

CANCER

         Aronex Pharmaceuticals' programs in cancer focus on developing
medicines based upon either refinements of proven therapies or novel mechanisms
of action against specific disease targets. The clinical program currently
focuses on development of ATRAGEN(R) for hematological cancers and Annamycin for
breast cancer.

         ATRAGEN(R) for Acute Promyelocytic Leukemia (Pivotal Phase II) and
         Kaposi's Sarcoma (Phase II completed)

         ATRAGEN, the Company's most advanced anti-cancer agent, is presently in
clinical trials for the treatment of acute promyelocytic leukemia ("APL"). This
indication represents a therapeutic area where new therapies are needed.
Established chemotherapeutic agents have been effective in treating some cases
of APL, but have been associated with serious side effects and frequent relapse.
The oral formulation of the retinoid all-trans retinoic acid ("ATRA") has been
approved by the FDA as a treatment for APL. ATRA and other retinoids (a family
of molecules comprising both natural and synthetic derivatives of retinol,
otherwise known as vitamin A) cause cancer cells to re-enter a normal growth
cycle rather than killing them, as conventional chemotherapeutic agents do.
However, the Company believes the effectiveness of the oral formulation of ATRA
may be reduced by the rate at which it is metabolized, which lowers the amount
of drug that reaches the cancer target.

         ATRAGEN is a liposomal, intravenous formulation of all-trans retinoic
acid which has been studied in patients with APL and Kaposi's sarcoma. The
Company's lipid formulation has been developed to change certain aspects of the
drug's behavior in the body to overcome the known deficiencies of oral
retinoids, such as the oral formulation of ATRA. ATRAGEN has a different
pharmacokinetics and distribution profile, so that there may be a decrease in
the proportion of the drug metabolized and an increase in the proportion that
reaches the cancer target. Following ATRAGEN treatment, higher plasma
concentrations of the drug are achieved than after oral ATRA therapy. Unlike
oral administration, these drug levels are maintained throughout the course of
therapy. These characteristics may provide more effective delivery of the drug
to the bone marrow, liver and spleen, where most leukemic cells are found, and a
better safety profile.

         Aronex Pharmaceuticals completed a Phase I clinical trial of ATRAGEN in
1995 in patients with cancers of the blood. Phase I data presented in the
journal Blood during 1996 indicated that ATRAGEN sustains levels in the blood
after prolonged dosing, is well tolerated, and shows evidence of activity
against certain leukemias and lymphomas.





                                      -8-
<PAGE>   9

ATRAGEN is currently in pivotal Phase II clinical evaluation for its potential
to induce remission and prevent relapse of APL in patients that have experienced
a recurrence of the cancer. Interim results from one of these trials, presented
at the American Society for Hematology meeting in December 1997, demonstrated
that ATRAGEN has activity against APL. The Company believes that approximately
2,000 new cases of APL are diagnosed worldwide each year.

         ATRAGEN has also been assessed in Phase II clinical trials in
collaboration with Genzyme for the treatment of Kaposi's sarcoma. Kaposi's
sarcoma is a skin cancer that has been estimated to occur in approximately 15%
of AIDS cases. Results from this trial indicated that ATRAGEN was generally well
tolerated, with headaches and dry skin being the primary reported adverse
events.

         If the results of its current APL clinical trial are successful, the
Company's strategy is to proceed with an initial NDA for ATRAGEN as a treatment
for APL, and subsequently to seek approval for other indications. ATRAGEN has
been designated an orphan drug for the treatment of acute and chronic leukemia
by the FDA. The Company has selected APL as the initial indication for ATRAGEN;
however, as with many cancer treatments, a wider range of potential indications
may be possible. See "-- Government Regulation" and "-- Additional Business
Risks -- Uncertainties Related to Clinical Trial Results."

         The Company believes there is a significant market opportunity for
ATRAGEN. The Company has identified a number of tumor targets for which ATRAGEN
may be an effective therapeutic. Collectively, these targets have an estimated
incidence of 400,000 patients in the United States annually.

         In 1993, Aronex Pharmaceuticals entered into a collaborative agreement
with Genzyme to develop and commercialize ATRAGEN for the treatment of cancer.
This agreement has subsequently been modified, with the result that: (i) the
Company retains responsibility for the further clinical development of ATRAGEN;
and (ii) Genzyme has an option to acquire marketing rights to ATRAGEN, subject
to the right of the Company to retain or reacquire such marketing rights and
subject to certain other rights retained by the Company. See "-- Collaborative
Agreements -- Collaborative Agreement with Genzyme."

         The composition and method of use of ATRAGEN (liposomal Tretinoin) is
the subject of a patent application, assigned to MD Anderson, as to which the
rights of MD Anderson are exclusively licensed to the Company. These rights are
subject to certain options held by Genzyme related to development of ATRAGEN.
Claims to the ATRAGEN formulation have been allowed in the European Patent
Office. See "-- Patents and Proprietary Rights."

         Annamycin for Breast Cancer (Phase II)

         Annamycin is a new chemical entity belonging to the class of widely
prescribed anti-cancer agents known as anthracyclines. This class of drug, which
includes doxorubicin, daunorubicin and idarubicin, has been shown to be
effective, either alone or in combination, against proliferating cancer cells.
Anthracyclines currently on the market, however, suffer from two primary
limitations. Cancer cells often develop a resistance to taxol, doxorubicin and
related anthracyclines, rendering the treatment ineffective. This resistance,
once developed by cancer cells, generally extends to include resistance to a
variety of other chemotherapeutic agents, a phenomenon commonly referred to as
multi-drug resistance. The best understood mechanism behind multi-drug
resistance involves an increase in the production of P-glycoprotein, a
trans-cell membrane pump. This pump transports drugs, including most types of
anti-cancer drugs, out of tumor cells. Currently available anthracyclines also
frequently result in severe toxic effects, including irreversible
cardiotoxicity.

         Annamycin was designed to overcome these two major limitations. In
contrast to conventional chemotherapeutic agents, Annamycin is structured so
that it avoids the mechanism of operation of the trans-cell membrane pump
believed to be one of the mechanisms responsible for multi-drug resistance. The
Company's preclinical studies have shown that Annamycin, which is a liposomal
formulation of a novel anthracycline, may be active against multi-drug resistant
tumor cells. The Company's preclinical studies of Annamycin in animals bearing
human tumors also indicate that Annamycin may be less cardiotoxic than
doxorubicin.



                                      -9-
<PAGE>   10

         A Phase I dose-escalating clinical trial of Annamycin was completed in
August 1997. Data from this trial were presented at the American Society of
Clinical Oncology meeting in May 1997. Annamycin is currently being evaluated in
Phase II multi-center clinical trials in breast cancer patients whose tumors are
resistant to conventional therapies. See "-- Additional Business Risks --
Uncertainties Related to Clinical Trial Results."

         The Company believes that there would be a substantial market for an
agent which is active against multi-drug resistance and exhibits an improved
safety profile over doxorubicin. In the United States, the American Cancer
Society estimates that there are approximately 179,000 new cases of breast
cancer annually. Annamycin also has the potential to be used in treating other
solid tumors in addition to leukemias and lymphomas. In 1998, the Company plans
to initiate Phase II clinical trials to evaluate the activity of Annamycin in
acute myelocytic leukemia.

         While there are a range of chemotherapeutic agents used alone and in
combination to treat breast cancer and other solid tumors, including
doxorubicin, daunorubicin, liposomal formulations of doxorubicin and
daunorubicin, taxol, platinum and cyclophosphamide, the Company does not believe
that there are any medicines available that are active against multi-drug
resistant tumors. Aronex Pharmaceuticals is aware of some agents currently in
Phase II clinical trials that are designed to modulate multi-drug resistance,
but for which no efficacy data are yet available. These agents would potentially
be used in combination with chemotherapeutic agents.

         The Company's liposomal formulation of Annamycin is the subject of an
issued patent, licensed exclusively to the Company by MD Anderson, that claims
liposomal Annamycin and a method using liposomal Annamycin in treating cancer.
In addition, a patent application has been filed with respect to an improved
process for preparing Annamycin. Patent protection is also being sought for a
specific formulation of liposomal Annamycin with improved processing
characteristics. Annamycin itself is the subject of a patent that has been
non-exclusively sublicensed to Aronex Pharmaceuticals by MD Anderson, which was
licensed from Ohio State University. See "-- Patents and Proprietary Rights."

         AR726 for Lung Cancer (Institutional Phase II)

         The Company, in conjunction with MD Anderson, is developing a novel
platinum analogue, AR726, which has been designed to overcome the toxicity and
resistance that currently limits the usefulness of platinum, a chemotherapeutic
agent widely used in the treatment of solid tumors. AR726 was selected as the
Company's lead candidate from a series of platinum anti-cancer compounds.

         Under an institutional IND at MD Anderson, AR726 is currently being
evaluated in a Phase II clinical trial for the treatment of a lung cancer known
as mesothelioma. This trial is sponsored by the Office of Orphan Drug Products
at the FDA. A Phase I clinical trial was previously conducted under a
physician's IND at MD Anderson.

         AR726 is covered by a series of patents and a patent application,
licensed exclusively to the Company by MD Anderson, relating to hydrophobic
cis-platinum complexes and to stable liposomal formulations of the lipophilic
platinum compounds. The claims of these patents are drawn to novel cis-platinum
complexes having hydrophobic properties and possessing branched or
unbranched-chain hydrocarbon substituents. Formulations containing the novel
platinum complexes entrapped in liposomes and exhibiting improved drug stability
are included. Anti-tumor compositions containing these stable cis-platinum
containing liposomes and methods of using them to treat tumors are also covered.
Claims to the product have been allowed by the European Patent Office. A patent
application filed in the United States that may overlap claims included in the
United States patents licensed to the Company is the subject of an ongoing
interference proceeding in the United States Patent and Trademark Office. The
Company cannot currently predict the outcome of this matter. See "-Patents and
Proprietary Rights."

         AR209: erbB-2 Targeted Therapy for Breast Cancer (Preclinical)

         AR209 is an innovative cancer therapy that is being developed initially
for breast cancer, but which Aronex Pharmaceuticals believes has potential for
additional solid tumor indications, including lung, ovarian and stomach cancers.
The Company believes the design of this product improves upon conventional
cancer therapy by targeting specific cancer cells that contain the oncoprotein
erbB-2. The erbB-2 protein occurs at high levels only in tumors and





                                      -10-
<PAGE>   11

not in normal tissues. AR209 is an antibody-toxin complex composed of a
targeting ligand and a fragment of the Pseudomonas exotoxin. This novel product
is designed to bind to cancer cells that contain the erbB-2 oncoprotein and to
be transported inside (internalized) where it kills the cancer cell. Preclinical
studies indicate that AR209 causes regression of solid human tumors and is well
tolerated. The product is currently in preclinical development.

         In 1996, Aronex Pharmaceuticals entered into a collaborative agreement
with Boehringer Mannheim to develop and commercialize AR209 for the treatment of
breast cancer and other solid tumors. See "-- Collaborative Agreements --
Relationship with Boehringer Mannheim."

         Aronex Pharmaceuticals has a worldwide license from the NIH to the
Pseudomonas exotoxin used in the design of AR209. The Company also has an
exclusive license to a United States government patent application covering
antibodies targeting the erbB-2 oncoprotein. Patent applications covering the
sequences of the e23 antibody used in the formulation of AR209 have also been
filed. See "-- Patents and Proprietary Rights."

RESEARCH PIPELINE

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

COLLABORATIVE AGREEMENTS

         The Company's development strategy involves entering into selected
development and licensing agreements with corporate partners to provide working
capital to the Company as well as assist in the efficient development and
marketing of certain of its products. See "-- Additional Business Risks -- Risks
Associated with Collaborative Arrangements."

         Relationship with Boehringer Mannheim

         In 1996, the Company entered into a license agreement with Boehringer
Mannheim to develop and commercialize one of the Company's products, AR209.
Under the agreement, Boehringer Mannheim is responsible for funding the costs of
all remaining preclinical and clinical development of AR209 and for
manufacturing the product. Boehringer Mannheim paid the Company $150,000 in
license fees in connection with this agreement in 1997 and has agreed to pay
minimum annual license fees of $100,000 during the term of the agreement. In
addition, Boehringer Mannheim is required to pay Aronex Pharmaceuticals up to
$2.65 million in milestone payments upon the occurrence of certain events and
will pay Aronex Pharmaceuticals royalties on sales of the product. Aronex
Pharmaceuticals has the option to co-promote the product under terms to be
negotiated by the parties or to co-market the product if the parties are unable
to reach an agreement as to the terms of a co-promotion arrangement. Boehringer
Mannheim has the right to terminate the agreement if the costs of developing
AR209 are materially greater than anticipated and Boehringer Mannheim
determines, in its reasonable discretion, not to proceed with the development of
the product in light of such increased costs. The Company has the right to
terminate the agreement if Boehringer Mannheim fails to achieve certain
milestones.

         Relationship with Ferrer

         In 1997, the Company entered into a supply and distribution agreement
with Ferrer to commercialize and market NYOTRAN, under which Ferrer received the
exclusive right to distribute and sell NYOTRAN(TM) in Spain and Portugal.





                                      -11-
<PAGE>   12

In December 1997, the Company, in cooperation with Ferrer, filed a Marketing
Authorization Application in Spain and Portugal seeking approval for NYOTRAN for
the treatment of systemic fungal infections.

         Collaborative Agreement with Genzyme

         In 1993, the Company entered into a license and development agreement
with Genzyme to develop and commercialize ATRAGEN(R). The initial focus of the
collaboration was the development of ATRAGEN for the treatment of myelogenous
leukemias and certain non-hematologic cancers. The Company and Genzyme shared
clinical development responsibilities and research program funding through the
end of 1996. Under the agreement, Genzyme was required to make up to $1.5
million in milestone payments to the Company upon the occurrence of certain
events and to pay the Company royalties on sales of the product. Genzyme had the
right to terminate the agreement in the event of a third party claim of
infringement by products subject to the agreement. The Company had the right to
terminate the agreement if Genzyme failed to satisfy certain milestones. In
connection with the collaborative agreement, Genzyme made a net $4.5 million
equity investment in the Company and agreed to make an additional $5.0 million
equity investment in the Company if certain developmental goals were achieved.

         In September 1996, Genzyme advanced Aronex Pharmaceuticals $2.0 million
relating to the $5.0 million equity milestone. Early in 1997, the license and
development agreement was amended and Genzyme was released from any further
obligation to perform development work for ATRAGEN, and the license granted to
Genzyme was converted to an option to acquire the right to market and sell
ATRAGEN worldwide (with the Company retaining co-promotion rights in the United
States). This option expires six months after an NDA is filed for ATRAGEN. To
exercise its option, Genzyme is required to pay the Company $3.0 million and
product royalties. If Genzyme exercises its option, Aronex Pharmaceuticals has
six months during which it can reacquire the marketing rights by returning to
Genzyme the $3.0 million received in connection with Genzyme's exercise of the
option and repaying Genzyme the $2.0 million advance. Additionally, the Company
is required to pay Genzyme product royalties, including $500,000 in minimum
royalties in the first year. If Genzyme does not exercise its option, Aronex
Pharmaceuticals is required to repay Genzyme the $2.0 million advance and to pay
product royalties, including $500,000 in minimum royalties in the first year
following the expiration of the option.

         Relationship with MD Anderson

         Aronex Pharmaceuticals has two license agreements with MD Anderson
which grant the Company exclusive rights to manufacture, use, market and sell
products based upon certain technology developed at MD
Anderson relating to the development of human monocyte or murine
macrophage-derived cytotoxins which inhibit or destroy the proliferation of
tumor cells, liposomal-encapsulated polyene antibiotics (except amphotericin B),
liposomal-encapsulated anthracyclines, liposomal-encapsulated platinum
derivatives and liposomal-encapsulated retinoids. NYOTRAN(TM), ATRAGEN(R),
Annamycin and AR726 are products derived from the Company's relationship with MD
Anderson.

         The license agreements with MD Anderson require Aronex Pharmaceuticals
to pay royalties to The University of Texas Board of Regents (the "Board of
Regents") for licensed technology based on specified percentages of cumulative
net sales and royalties from sublicensees. Because it has not sold any products
or processes to date, Aronex Pharmaceuticals has not paid any royalties under
the license agreements. MD Anderson is responsible for the preparation, filing
and prosecution of all patent applications, foreign and domestic, relating to
technology developed at MD Anderson, and the Company reimburses MD Anderson for
expenses incurred in connection with such activities.

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

         Aronex Pharmaceuticals and MD Anderson have entered into research and
development contracts in conjunction with the license agreements which obligate
the Company to fund research and development expenses incurred by the MD




                                      -12-
<PAGE>   13
Anderson scientists that relate to the technology licensed by the Company. Such
contracts grant the Company an exclusive worldwide license to technology related
to the technology licensed under the license agreements and developed as a
result of research funded by the Company. Such contracts also grant the Company
a right of first refusal to acquire an exclusive worldwide license to certain
technology developed at MD Anderson which is not the result of projects funded
by the Company. Aronex Pharmaceuticals and MD Anderson have agreed to the
funding commitments for all research projects under such contracts through
December 31, 1997. Aronex Pharmaceuticals intends to continue funding various
projects after December 31, 1997; however, the continuation of such projects is
dependent on mutually agreed-to funding levels for 1998. The Company and MD
Anderson are currently finalizing the funding arrangements for 1998. If the
Company defaults in the payment of research and development funding commitments
due MD Anderson under such contracts, MD Anderson may suspend the related
research and development projects or, if the Company's default continues for a
period of 60 days, MD Anderson may terminate the related contract upon 60 days
notice to Aronex Pharmaceuticals.

         Relationship with Baylor

         Aronex Pharmaceuticals had collaborative arrangements with Baylor,
under licensing, consulting and research and development arrangements entered
into by Triplex beginning in 1989. The Company has an exclusive, worldwide,
royalty-free license from Baylor to certain technology developed by Baylor. The
collaboration arrangements terminated in 1996. The license agreement terminates
on the expiration of the last patent to expire that is licensed thereunder.

MANUFACTURING

         The Company does not have facilities necessary to manufacture its
products in accordance with FDA GMP, but it does have the capability to develop
formulations, analytical methods, process controls and manufacturing technology
for its products. The Company uses contract manufacturers to produce larger
quantities of its products for clinical testing. Production is done on a
per-purchase order basis, and the Company and the manufacturers of its products
have not entered into any written agreements. Contract manufacturers are closely
supervised to ensure adherence to established production methods and compliance
with the Company's rigorous quality control and quality assurance standards. The
Company does not expect to establish any significant manufacturing capacity in
the near future. The Company does not operate and does not currently plan to
operate manufacturing facilities for the production of its products in
commercial quantities, and it intends to contract with third parties for the
manufacture and supply of its products. There can be no assurance that the
Company will be able to obtain supplies of its products from third-party
suppliers on terms or in quantities acceptable to the Company. Also, the
Company's dependence on third parties for the manufacture of its products may
adversely affect the Company's product margins and its ability to develop and
deliver products on a timely basis. Any such third-party suppliers or any
manufacturing facility the Company establishes will be required to meet FDA GMP
requirements. FDA inspection and approval of manufacturing facilities and
quality procedures for a drug are a prerequisite to approval of an NDA for that
drug. The Company may encounter significant delays in obtaining supplies from
third-party manufacturers or experience interruptions in its supplies. If the
Company is unable to obtain adequate supplies, its business would be materially
adversely affected.

         The raw materials required for the majority of the Company's products
are currently available in quantities sufficient to conduct the Company's
research, development, preclinical safety and clinical development activities.
Certain of the Company's products, such as Annamycin, are new syntheses and,
therefore, are not yet available in commercial quantities. No assurance can be
given that the raw materials necessary for the manufacture of the Company's
products will be available in sufficient quantities or at a reasonable cost.
Complications or delays in obtaining raw materials or in product manufacturing
could delay the submission of products for regulatory approval and the
initiation of new development programs, which could materially impair the
Company's competitive position and potential profitability.

SALES AND MARKETING

         The Company presently intends to market its products and will build its
sales and marketing infrastructure in accordance with regulatory submissions.
The Company currently plans to market selected products directly to oncologists,
hematologists and infectious disease specialists through a niche sales and
marketing force in the United States. Where large market opportunities require
large sales forces, the Company may enter into co-marketing



                                      -13-
<PAGE>   14

arrangements with, or license marketing rights to, third parties. The Company's
international strategy is to negotiate marketing agreements with pharmaceutical
manufacturers and distributors which will entitle the Company to receive a
percentage of net product sales.

         The Company does not have any experience in sales, marketing or
distribution. To market any of its products, the Company must develop a sales
and marketing force with supporting distribution capability or enter into
marketing and distribution arrangements with a company that has an established
capability. Significant additional expenditures will be required for the Company
to develop such capabilities. The Company has entered into agreements with
Ferrer with respect to the marketing and sale of NYOTRAN in certain European
markets and with Boehringer Mannheim with respect to the marketing and sale of
AR209 worldwide. In addition, the Company has entered into an agreement with
Genzyme under which Genzyme may acquire the right to market and sell ATRAGEN,
subject to certain conditions and certain rights of the Company. The Company
plans to enter into additional marketing arrangements with one or more
pharmaceutical companies with respect to NYOTRAN and, to the extent that Genzyme
does not acquire or the Company reacquire marketing rights, with respect to
ATRAGEN. In addition, the Company plans to enter into marketing agreements with
one or more pharmaceutical companies to market other products that it may
develop. To the extent the Company relies upon licensing, marketing or
distribution arrangements with others, any revenues the Company receives will
depend upon the efforts of third parties. There can be no assurance that any
third party will market the Company's products successfully or that any
third-party collaboration will be on terms favorable to the Company. If any
marketing partner does not market a product successfully, the Company's business
would be materially adversely affected. There can be no assurance that the
Company will be able to establish sales, marketing and distribution capabilities
or that it or its collaborators will be successful in gaining market acceptance
for any products that the Company may develop. The Company's failure to
establish marketing capabilities or to enter into marketing arrangements with
third parties would have a material adverse effect on the Company.

PATENTS AND PROPRIETARY RIGHTS

         The Company's ability to commercialize any products will depend, in
part, upon its or its licensors' ability to obtain patents, enforce those
patents, preserve trade secrets, and operate without infringing upon the
proprietary rights of third parties. The patent positions of biotechnology and
pharmaceutical companies are highly uncertain and involve complex legal and
factual questions. Some of the United States patents and patent applications
owned by or licensed to the Company are method-of-use patents that cover the use
of certain compounds to treat specified conditions, and composition-of-matter
patents are not available for some of the Company's product candidates. The
Company does not have any patents or patent applications for one of its
products, AR102. There can be no assurance that the patent applications licensed
to or owned by the Company will result in issued patents, that patent protection
will be secured for any particular technology, that any patents that have been
or may be issued to the Company or its licensors will be valid or enforceable,
that any patents will provide meaningful protection to the Company, that others
will not be able to design around the patents, or that the Company's patents
will provide a competitive advantage or have commercial application.

         There can be no assurance that patents owned by or licensed to the
Company will not be challenged by others. The Company could incur substantial
costs in proceedings before the United States Patent and Trademark Office and
other regulatory authorities, including interference proceedings. These
proceedings could result in adverse decisions about the patentability of the
Company's inventions and products as well as about the enforceability, validity
or scope of protection afforded by the patents. The Company is currently
involved in an interference proceeding before the United States Patent and
Trademark Office regarding AR726. See "-- Cancer --AR726 for Lung Cancer."

         There can be no assurance that the manufacture, use or sale of the
Company's product candidates will not infringe patent rights of others. The
Company may be unable to avoid infringement of those patents and may be required
to seek a license, defend an infringement action, or challenge the validity of
the patents in court. There can be no assurance that a license will be available
to the Company, if at all, upon terms and conditions acceptable to the Company
or that the Company will prevail in any patent litigation. Patent litigation is
costly and time consuming, and there can be no assurance that the Company will
have sufficient resources to bring such litigation to a successful conclusion.
If the Company does not obtain a license under such patents, is found liable for
infringement, or is not able to have such patents declared invalid, the Company
may be liable for significant money damages, may encounter significant delays in
bringing products to market, or may be precluded from participating in the
manufacture, use or sale of products or



                                      -14-
<PAGE>   15

methods of treatment requiring such licenses. The Company does not believe that
the commercialization of its products will infringe upon the patent rights of
others. However, there can be no assurance that the Company has identified
United States and foreign patents that pose a risk of infringement.

         The Company also relies upon trade secrets and other unpatented
proprietary information in its product development activities. To the extent the
Company relies on trade secrets and unpatented know-how to maintain its
competitive technological position, there can be no assurance that others may
not independently develop the same or similar technologies. The Company seeks to
protect trade secrets and proprietary knowledge, in part through confidentiality
agreements with its employees, consultants, advisors and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of the
Company's confidential information and may not provide the Company with an
adequate remedy in the event of unauthorized disclosure of such information. If
the Company's employees, scientific consultants or collaborators develop
inventions or processes independently that may be applicable to the Company's
products, disputes may arise about ownership of proprietary rights to those
inventions and processes. Such inventions and processes will not necessarily
become the Company's property, but may remain the property of those persons or
their employers. Protracted and costly litigation could be necessary to enforce
and determine the scope of the Company's proprietary rights. Failure to obtain
or maintain patent and trade secret protection, for any reason, would have a
material adverse effect on the Company.

         The Company engages in collaborations, sponsored research agreements,
licensing and other arrangements with academic researchers and institutions that
have received and may receive funding from United States government agencies. As
a result of these arrangements, the United States government or certain third
parties have rights in certain inventions developed during the course of the
performance of such collaborations and agreements as required by law or such
agreements.

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

GOVERNMENT REGULATION

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

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

         The standard process required by the FDA before a pharmaceutical agent
may be marketed in the United States includes: (i) preclinical tests; (ii)
submission to the FDA of an IND which must become effective before human
clinical trials may commence; (iii) adequate and well-controlled human clinical
trials to establish the safety and efficacy of the drug in its intended
application; (iv) submission of an NDA to the FDA; and (v) FDA approval of the
NDA prior to any commercial sale or shipment of the drug. In addition to
obtaining FDA approval for each product, each drug




                                      -15-
<PAGE>   16

manufacturing establishment must be inspected and approved by the FDA. All
manufacturing establishments are subject to inspections by the FDA and by other
federal, state and local agencies and must comply with current GMP requirements.

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

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

         Clinical trials are typically conducted in three sequential phases
which may overlap. In Phase I, the initial introduction of the drug to humans,
the drug is tested for safety (adverse effects), dosage tolerance, metabolism,
distribution, excretion and pharmacodynamics (clinical pharmacology). Phase II
involves studies of a limited patient population to gather evidence about the
efficacy of the drug for specific targeted indications, dosage tolerance and
optimal dosage, and to identify possible adverse effects and safety risks. When
a product has shown evidence of efficacy and has an acceptable safety profile in
a Phase II evaluation, Phase III clinical trials are undertaken to evaluate
clinical efficacy and to test for safety in an expanded patient population at
geographically dispersed clinical trial sites. There can be no assurance that
any of the Company's clinical trials will be completed successfully or within
any specified time period. The Company or the FDA may suspend clinical trials at
any time.

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

         The results of preclinical studies and clinical trials, if successful,
are submitted in an NDA to seek FDA approval to market and commercialize the
drug product for a specified use. The testing and approval process will require
substantial time and effort, and there can be no assurance that any approval
will be granted for any product or that approval will be granted according to
any schedule. The FDA may deny an NDA if it believes that applicable regulatory
criteria are not satisfied. The FDA may also require additional testing for
safety and efficacy of the drug. Moreover, if regulatory approval of a drug
product is granted, the approval will be limited to specific indications. There
can be no assurance that any of the Company's product candidates will receive
regulatory approvals for commercialization.

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



                                      -16-
<PAGE>   17

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

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

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

         Under the Orphan Drug Act, the FDA may grant "orphan drug" status to
therapeutic agents intended to treat a "rare disease or condition," defined as a
disease or condition that affects less than 200,000 persons in the United
States. Orphan drug status grants the sponsor tax credits for the amounts
expended on clinical trials, provided that certain conditions are met, as well
as potential marketing exclusivity for four to seven years following approval of
the pertinent NDA. The Company received orphan drug status for ATRAGEN(R) in
1993 for the treatment of acute and chronic leukemia and may request this status
for more of its products as part of its overall regulatory strategy. There is no
assurance, however, that any of its other products will receive orphan drug
status or that the benefits of protection currently afforded by orphan drug
status will remain in effect. In addition, any party may obtain orphan drug
status with respect to products for which patent protection has expired or is
otherwise unavailable. The first party granted marketing approval could prevent
other persons from commercializing that product during the period for which
exclusivity was granted to such party (i.e., four to seven years).

COMPETITION

         The Company believes that its products, because of their unique
pharmacologic profiles and novel mechanisms of action, will become useful new
treatments for cancers and infectious diseases, either as alternatives to or in
combination with other pharmaceuticals. The Company is engaged in pharmaceutical
product development characterized by rapid technological progress. Many
established biotechnology and pharmaceutical companies, universities and other
research institutions with resources significantly greater than those of the
Company may develop products that directly




                                      -17-
<PAGE>   18

compete with the Company's products. Those entities may succeed in developing
products, including liposomes and liposomal products, that are safer, more
effective or less costly than the Company's products. Even if the Company's
products should prove to be more effective than those developed by other
companies, other companies may be more successful than the Company because of
greater financial resources, greater experience in conducting preclinical and
clinical trials and obtaining regulatory approval, stronger sales and marketing
efforts, earlier receipt of approval for competing products and other factors.
If the Company commences significant commercial sales of its products, it or its
collaborators will compete in areas in which the Company has little or no
experience such as manufacturing and marketing. There can be no assurance that
the Company's products, if commercialized, will be accepted and prescribed by
healthcare professionals.

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

EMPLOYEES

         As of December 31, 1997, the Company had 72 full time employees, 57 of
whom were engaged in research, development, clinical and regulatory affairs and
15 of whom were engaged in administration. The Company plans to significantly
expand its clinical, development and regulatory affairs staff in the future to
address its needs relating to the preclinical and clinical development of the
Company's products. Of the Company's employees, there are 10 Ph.Ds, 1 Pharm.D.
and 1 M.D. The Company has not experienced any work stoppages and considers
relations with its employees to be good.

ADDITIONAL BUSINESS RISKS

         Early Stage of Development; History of Operating Losses; Anticipation
of Future Losses

         The Company is a development stage company. It has generated no
revenues from product sales, and it does not expect to generate revenue from
product sales in the immediate future. As of December 31, 1997, the Company's
accumulated deficit was $69.2 million. To date, the Company has dedicated most
of its financial resources to the research and development of products, general
and administrative expenses, and the prosecution of patents and patent
applications. The Company expects to incur operating losses for at least the
next several years, primarily due to the expansion of its research and
development programs, including preclinical studies and clinical trials, and
costs associated with the commercialization of its products if regulatory
approvals are received. The Company's ability to achieve profitability will
depend, among other things, on successfully completing development of its
products, obtaining regulatory approvals, establishing manufacturing, sales and
marketing capabilities or collaborative arrangements, and raising sufficient
funds to finance its activities. There can be no assurance that the Company
will be able to achieve profitability or that profitability, if achieved, can
be sustained. See "Selected Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

         Future Capital Needs; Uncertainty of Additional Funding

         The Company has experienced negative cash flows from operations since
its inception and has funded its activities to date primarily from equity
financings. The Company has expended, and will continue to require, substantial
funds to continue research and development, including preclinical studies and
clinical trials of its products, and to commence sales and marketing efforts if
FDA and other regulatory approvals are obtained. The Company expects that its
existing capital resources will be sufficient to fund its capital requirements
through mid-1999. Thereafter, the Company will need to raise substantial
additional capital to fund its operations. The Company's capital requirements



                                      -18-
<PAGE>   19

will depend on many factors, including the problems, delays, expenses and
complications frequently encountered by development stage companies; the
progress of the Company's research and development and clinical trial programs;
the Company's ability to satisfy the extent and terms of any future
collaborative research, manufacturing, marketing or other funding arrangements;
the costs and timing of seeking regulatory approvals of the Company's products;
the Company's ability to obtain regulatory approvals; the success of the
Company's sales and marketing programs; costs of filing, prosecuting and
defending and enforcing any patent claims and other intellectual property
rights; and changes in economic, regulatory or competitive conditions of the
Company's planned business. Estimates about the adequacy of funding for the
Company's activities are based on certain assumptions, including the assumption
that testing and regulatory procedures relating to the Company's products can be
conducted at projected costs. There can be no assurance that changes in the
Company's research and development plans, acquisitions, or other events will not
result in accelerated or unexpected expenditures. To satisfy its capital
requirements, the Company may seek to raise additional funds in the public or
private capital markets. The Company's ability to raise additional funds in the
public or private markets will be adversely affected if the results of its
current or future clinical trials are not favorable. The Company may seek
additional funding through corporate collaborations and other financing
vehicles. There can be no assurance that any such funding will be available to
the Company on favorable terms or at all. If adequate funds are not available,
the Company may be required to curtail significantly one or more of its research
and development programs, or it may be required to obtain funds through
arrangements with future collaborative partners or others that may require the
Company to relinquish rights to some or all of its technologies or products. If
the Company is successful in obtaining additional financing, the terms of such
financing may have the effect of diluting or adversely affecting the holdings or
the rights of the holders of the Company's Common Stock. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."

         Uncertainties Related to Clinical Trial Results

         The FDA and other regulatory authorities generally require that the
safety and efficacy of a drug be supported by results from adequate and
well-controlled pivotal clinical trials before approval for commercial sale. If
the results of the Company's clinical trials do not demonstrate the safety and
efficacy of its products in the treatment of patients suffering from the
diseases for which such products are being tested, the Company will not be able
to submit an NDA to the FDA. Clinical trials conducted on a fast-track, or
expedited, basis may carry a higher risk that data will not be favorable or that
the FDA will not accept the NDA for submission than do pivotal clinical trials
developed with large populations using similar protocols. Even if the Company
believes the pivotal clinical trials demonstrate the safety and efficacy of a
product in the treatment of disease, the FDA and other regulatory authorities
may not accept the Company's assessment of the results. In either case, the
Company may be required to conduct additional clinical trials in an effort to
demonstrate the safety and efficacy of the product. Without acceptable results
and regulatory approval, the Company would not be able to commercialize its
products, which would have a material adverse effect on the Company. There can
be no assurance that the results of any of the Company's clinical trials will be
favorable or that its products will obtain regulatory approval for
commercialization.

         The results of preclinical studies and initial clinical trials of the
Company's products are not necessarily predictive of the results from
large-scale clinical trials. The Company must demonstrate through preclinical
studies and clinical trials that its products are safe and effective for use in
each target indication before the Company can obtain regulatory approvals for
the commercial sale of those products. These studies and trials may be very
costly and time-consuming. The speed with which the Company is able to enroll
patients in clinical trials is an important factor in determining how quickly
clinical trials may be completed. Many factors affect patient enrollment,
including the size of the patient population, the proximity of patients to
clinical sites, and the eligibility criteria for the study. Delays in patient
enrollment in the trials may result in increased costs, program delays, or both,
which could have a material adverse effect on the Company. Even if the Company
establishes the safety and efficacy of its products and obtains FDA and other
regulatory approvals for its products, physicians may not prescribe the approved
product.

         The administration of any product the Company develops may produce
undesirable side effects in humans. The occurrence of side effects could
interrupt or delay clinical trials of products and could result in the denial of
approval of the Company's products for any or all targeted indications by the
FDA or other regulatory authorities. The Company, the FDA or other regulatory
authorities may suspend or terminate clinical trials at any time. Even if the
Company receives FDA and other regulatory approvals, the Company's products may
later exhibit adverse effects that limit or




                                      -19-
<PAGE>   20

prevent their widespread use or that necessitate their withdrawal from the
market. There can be no assurance that any of the Company's products will be
safe for human use.

         Risks Associated with Collaborative Arrangements

         The Company's product development and commercialization strategy
involves the Company entering into various arrangements with corporate,
government and academic collaborators, licensors, licensees and others. As a
consequence, the Company's success may depend on the success of these other
parties in performing their responsibilities. There can be no assurance that the
Company will be able to establish additional collaborative arrangements or
license agreements that are necessary or desirable for the Company to develop
and commercialize its products or that any such collaborative agreement or
license agreement will be successful. Some of the Company's collaborative
agreements and license agreements provide for milestone payments to the Company,
and others require the Company to pay milestone payments to others. No assurance
can be given that the Company will achieve the milestones that trigger payments
to the Company, nor can assurance be given that payments by the Company will
result in the development of marketable products. No assurance can be given that
any current or future collaborative arrangement will be renewed at the end of
its term or will be renewed on terms as favorable to the Company as its original
terms.

         No Assurance of Adequate Third-Party Reimbursement

         The Company's ability to commercialize its products successfully will
depend in part on the extent to which appropriate reimbursement levels for the
cost of the products and related treatment are obtained from government
authorities, private health insurers and other organizations, such as health
maintenance organizations ("HMOs"). Third-party payers are increasingly
challenging the prices charged for medical products and services. Accordingly,
if less costly drugs are available, third party payers may not authorize
reimbursement for the Company's products even if they offer advantages in safety
or efficacy. Also, the trend toward managed healthcare and government insurance
programs could significantly influence the purchase of healthcare services and
products, resulting in lower prices and reducing demand for the Company's
products. The cost containment measures that healthcare providers are
instituting and any healthcare reform could affect the Company's ability to sell
its products and may have a material adverse effect on the Company.

         There can be no assurance that reimbursement in the United States or
foreign countries will be available for any of the Company's products, that any
reimbursement granted will be maintained, or that limits on reimbursement
available from third-party payers will not reduce the demand for, or negatively
affect the price of, the Company's products. The unavailability or inadequacy of
third-party reimbursement for the Company's products would have a material
adverse effect on the Company. The Company is unable to forecast what additional
legislation or regulation relating to the healthcare industry or third-party
coverage and reimbursement may be enacted in the future, or what effect the
legislation or regulation would have on the Company's business.

         Potential Product Liability; Availability of Insurance

         The Company risks exposure to product liability claims if the use of
its products is alleged to have an adverse effect on subjects or patients. This
risk exists for products tested in human clinical trials as well as products
that are sold commercially. There can be no assurance that product liability
claims, if made, would not result in a recall of the Company's products or a
change in the indications for which they may be used. The Company maintains
product liability insurance coverage for claims arising from the use of its
products in clinical trials. There can be no assurance that this coverage will
be adequate to cover claims. Product liability insurance is becoming
increasingly expensive, and no assurance can be given that the Company will be
able to maintain such insurance, obtain additional insurance, or obtain
insurance at a reasonable cost or in sufficient amounts to protect the Company
against losses that could have a material adverse effect on the Company.



                                      -20-
<PAGE>   21

         Dependence on Key Personnel

         The success of the Company depends in large part on the Company's
ability to attract and retain highly qualified scientific and management
personnel. The Company faces competition for such personnel from other
companies, research and academic institutions, government entities and other
organizations. There can be no assurance that the Company will be successful in
hiring or retaining key personnel.

ITEM 2.  PROPERTIES

         The Company's corporate offices and laboratories are located in a
30,000 square foot leased building located at 8707 Technology Forest Place in
The Woodlands, a suburb of Houston, Texas. The lease for this facility expires
in 2008, and the Company has renewal options to extend the lease to 2018.

ITEM 3.  LEGAL PROCEEDINGS

         The Company is not currently a party to any material legal proceedings.

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

         Not applicable.




                                      -21-
<PAGE>   22


                                     PART II


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

         The Company's Common Stock (symbol: ARNX) is traded on the Nasdaq
National Market. The following table sets forth the range of high and low sales
prices for each calendar quarterly period in the two years ended December 31,
1997 as reported on the Nasdaq National Market. The information provided in the
table gives effect to a one-for-two reverse split of the Company's Common Stock
effected in July 1996.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996:       HIGH         LOW
                                  ---------    -------
<S>                               <C>         <C>
1st Quarter .................     $  13 1/2    $ 6 1/2
2nd Quarter .................        15          7 7/8
3rd Quarter .................        12 3/4      6 1/2
4th Quarter .................        10 1/4      7 1/8

YEAR ENDED DECEMBER 31, 1997:
1st Quarter .................     $  10 1/8    $ 5 1/8
2nd Quarter .................         6 7/8      3
3rd Quarter .................         7 5/8      3 5/8
4th Quarter .................         7 1/4      3 11/16

</TABLE>

         The last sale price of the Common Stock as reported on the Nasdaq
National Market on March 25, 1998 was $3.69 per share. At March 25 1998, there
were approximately 200 holders of record and approximately 4,100 beneficial
owners of the Company's Common Stock.

DIVIDENDS

         The Company has never paid cash dividends on the Common Stock. The
Company currently intends to retain earnings, if any, to support the development
of the Company's business and does not anticipate paying dividends in the
foreseeable future. Payment of future dividends, if any, will be at the
discretion of the Company's Board of Directors after taking into account various
factors, including the Company's financial condition, operating results, current
and anticipated cash needs and plans for expansion.




                                      -22-
<PAGE>   23


ITEM 6.  SELECTED FINANCIAL DATA

         The selected financial data set forth below are derived from the
Company's financial statements as of and for each of the years in the five-year
period ended December 31, 1997, which have been audited by Arthur Andersen LLP,
independent public accountants. On September 11, 1995, Aronex Pharmaceuticals,
Triplex and Oncologix effected the Mergers, which were accounted for under the
purchase method of accounting. The selected financial data prior to September
11, 1995 represent the operations and balance sheet data of Aronex
Pharmaceuticals, while the selected financial data from and after September 11,
1995 represent the combined operations and balance sheet data of the merged
companies. The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's financial statements and notes
thereto included elsewhere in this Annual Report on Form 10-K.

<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                             ------------------------------------------------------------------
                                              1993          1994           1995             1996           1997
                                              ----          ----           ----             ----           ----
                                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                          <C>           <C>           <C>              <C>           <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Research and development grants
and contracts ..........................     $     48      $    197      $  1,248         $  2,670      $    841
Interest income ........................          217           534           452            1,692         2,059
                                             --------      --------      --------         --------      --------
Total revenues .........................          265           731         1,700            4,362         2,900
Expenses:
Research and development ...............        4,491         7,637         8,347(1)        10,357        13,993
In-process research
and development ........................           --            --         8,383(2)           242         3,000(4)
General and administrative .............        1,876         1,950         2,215            1,620         2,641
Interest expense and other .............          123           196           184              173           257
                                             --------      --------      --------         --------      --------
Total expenses .........................        6,490         9,783        19,129           12,392        19,891
                                             --------      --------      --------         --------      --------
Net loss ...............................     $ (6,225)     $ (9,052)     $(17,429)        $ (8,030)     $(16,991)
                                             ========      ========      ========         ========      --------
Basic and diluted loss per share(3) ....     $  (1.72)     $  (1.76)     $  (2.69)        $  (0.62)     $  (1.14)
                                             ========      ========      ========         ========      ========
Weighted average shares used in
computing basic and diluted loss per
share(3) ...............................        3,602         5,153         6,488           13,048        14,896
</TABLE>


<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                             ----------------------------------------------------------------
                                               1993           1994         1995          1996         1997
                                               ----           ----         ----          ----         ----
                                                                      (IN THOUSANDS)
<S>                                          <C>           <C>           <C>           <C>           <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-
term and long-term investments .........     $ 19,642      $ 10,019      $ 12,015      $ 41,388      $ 29,954
Total assets ...........................       21,187        12,958        15,530        44,281        32,125
Total long-term obligations ............          913         1,218         1,574           146             6
Deficit accumulated during
development stage ......................      (17,702)      (26,754)      (44,183)      (52,213)      (69,204)
Total stockholders' equity .............       19,471        10,660        11,994        40,477        27,379
</TABLE>

(1)  The Company's research and development expenses for the year ended December
     31, 1995 do not include the research and development expenses incurred by
     Triplex or Oncologix prior to September 11, 1995, the effective date of the
     Mergers, and accordingly are not indicative of the research and development
     expenses that would have been incurred by the Company for the full year had
     such Mergers been effective at the beginning of the year. The Company's
     research and development expenses for the three months ended December 31,
     1995, the first full quarter following the Mergers, were $2.9 million
     (unaudited).

(2)  The amount shown as purchase of in-process research and development
     reflects a non-cash charge for the excess of the purchase price over the
     fair value of the net assets acquired. See Note 4 of Notes to Financial
     Statements.

(3)  See Note 2 of Notes to Financial Statements for a description of the
     computation of loss per share.

(4)  Represents the fair market value of Common Stock issued under the
     contingent stock rights issued relating to the Mergers. See Note 4 of Notes
     to Financial Statements.


                                      -23-
<PAGE>   24

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

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

OVERVIEW

         Since its inception in 1986, Aronex Pharmaceuticals has primarily
devoted its resources to fund research, drug identification and development.
The Company has been unprofitable to date and expects to incur operating losses
for the next several years as it expends its resources for product research and
development, preclinical and clinical testing and regulatory compliance. The
Company has sustained net losses of approximately $69.2 million from inception
through December 31, 1997. The Company has primarily financed its research and
development activities and operations through public and private offerings of
securities. The Company's operating results have fluctuated significantly
during each quarter, and the Company anticipates that such fluctuations,
largely attributable to varying commitments and expenditures for clinical
trials and research and development, will continue for the next several years.

RESULTS OF OPERATIONS

         Years Ended December 31, 1996 and 1997

         Research and development grants and revenues decreased by $1.9 million
to $0.8 million in 1997 from $2.7 million in 1996. The decrease in 1997 research
and development grants and revenues was due primarily to the following factors:
(i) the Company received no revenues from Hoechst Marion Roussel, Inc.
("Hoechst") in 1997 compared with $1.3 million in revenues from Hoechst in 1996,
as a result of the expiration of the Company's research and development
agreement with Hoechst at the end of 1996; (ii) the Company received no revenues
under its collaborative agreement with Genzyme during 1997 as compared with
$576,000 in revenues under the Genzyme agreement in 1996, as a result of the
termination of Genzyme's funding obligations under the agreement; and (iii) the
Company received $166,000 in revenues under a research and development agreement
with Targeted Genetics Corporation ("Targeted Genetics") in 1997 as compared
with $597,000 in revenues from Targeted Genetics in 1996, as a result of the
expiration of the agreement with Targeted Genetics in the second quarter of
1997. The decrease in research and development grants and revenues in 1997 was
partially offset by the Company's receipt in 1997 of $250,000 under the
Company's license agreement with Boehringer Mannheim and an additional $250,000
under a new license agreement with Genzyme relating to gene therapy.

         Interest income increased by $367,000 to $2.1 million in 1997 from $1.7
million in 1996, due primarily to an increase of funds available for investment
during the first half of 1997 resulting from cash received from a public
offering of Common Stock completed in May 1996.

         Research and development expenses increased by $3.6 million to $14.0
million in 1997 from $10.4 million in 1996. This increase in research and
development expenses was due primarily to: (i) an increase of $1.2 million in
clinical investigation costs relating mostly to NYOTRAN; (ii) an increase of
$1.6 million in salaries and payroll costs, including costs relating to the
hiring of senior pharmaceutical development and medical affairs executives;
(iii) an increase of $687,000 in drug materials and manufacturing costs,
relating mainly to NYOTRAN and Zintevir; and (iv) an increase of $678,000 in
outside pharmacology studies, relating mainly to ATRAGEN. These increases were
partially offset by a decrease of $1.2 million in research expenses resulting
from the elimination of the majority of the Company's internal research efforts
in the second quarter of 1997, relating in part to the termination of research
funding from Hoechst.

         In-process research and development costs of $3.0 million incurred in
1997 related to a non-cash research and development charge incurred in
connection with the issuance of 686,472 shares of Common Stock, with an
aggregate fair market value at the time of issuance of $3.0 million, under the
contingent rights issued in the Triplex merger. The issuance of such shares
under the contingent rights was required because equity milestone payments of
$5.0 million were not received from Genzyme relating to ATRAGEN on or before
September 11, 1997. ( See Note 4 of Notes to Financial Statements). In-process
research and development costs of $242,000 in 1996 represent charges incurred
relating to the




                                      -24-
<PAGE>   25

1995 Mergers including the non-cash settlement of a lawsuit filed by certain
stockholders of Oncologix in connection with the Mergers in September 1995.

         General and administrative expenses increased by $1.0 million to $2.6
million in 1997 from $1.6 million in 1996. The increase in general and
administrative expenses was primarily due to the following: (i) an increase of
$721,000 in salaries and payroll costs, including costs relating to the hiring
of a new Chief Executive Officer and a Vice President of Business Development;
and (ii) an increase of $195,000 in stock and stock option compensation expense.

         The Company's net loss increased by $8.9 million to $16.9 million in
1997 from $8.0 million in 1996. The increase was primarily a result of the
following: (i) an increase of $3.6 million in research and development expenses
due to increased salaries and payroll costs and other expenses relating to
advancing the Company's products; (ii) a $3.0 million charge relating to the
issuance of shares of Common Stock under the contingent stock agreement (see
Note 4 of Notes to the Financial Statements); (iii) an increase of $1.0 million
in general and administrative expenses relating mainly to increased salaries and
payroll costs, including salary and hiring costs for several new positions; and
(iv) a decrease of $1.9 million in research and development grants and revenues,
attributable primarily to the loss of revenues from the Hoechst agreement.

         Years Ended December 31, 1995 and 1996

         Research and development grants and revenues increased by $1.5 million
to $2.7 million in 1996 from $1.2 million in 1995. The increase in research and
development grants and revenues was due primarily to: (i) the Company's
recognition of $576,000 in revenues during the third and fourth quarters of 1996
relating to pharmaceutical development work performed in connection with the
Company's collaborative agreement with Genzyme; and (ii) the Company's
recognition of revenues of $1.3 million from Hoechst. The Company did not
recognize any revenue relating to the Genzyme agreement in 1995, as all such
amounts were being deferred in accordance with the agreement, and recognized
revenues of $350,000 in 1995 under the Hoechst agreement, representing amounts
received after its assumption of Triplex's rights under that agreement in the
Mergers.

         Interest income increased by $1.2 million to $1.7 million in 1996 from
$452,000 in 1995, due primarily to an increase of funds available for investment
resulting from cash received from the exercise of warrants and a public offering
of Common Stock completed in May 1996.

         Research and development expenses increased by $2.0 million to $10.4
million in 1996 from $8.3 million in 1995, due primarily to the addition of
Triplex's research department following the Mergers and increased clinical
investigation costs relating to the Company's NYOTRAN and Zintevir products.

         In-process research and development costs of $242,000 in 1996 and $8.4
million in 1995 represent charges incurred in connection with the Mergers in
September 1995 representing the excess of the purchase price and other costs of
the Mergers over the fair value of the assets acquired in the Mergers. The
charges in 1996 include the non-cash settlement of a lawsuit filed by certain
stockholders of Oncologix.

         General and administrative expenses decreased by $595,000 to $1.6
million in 1996 from $2.2 million in 1995, primarily due to: (i) non-recurring
operating expenses incurred on behalf of Oncologix and paid in 1995 by the
Company pursuant to the terms of the Oncologix merger agreement; and (ii) a
decrease in salary and personnel costs from 1995 due to severance payments made
to the Company's former President in 1995.

         The Company's net loss decreased by $9.4 million to $8.0 million in
1996 from $17.4 million in 1995, due primarily to the $8.4 million charge in
1995 for in-process research and development costs in connection with the
Mergers.



                                      -25-
<PAGE>   26

LIQUIDITY AND CAPITAL RESOURCES

         Since its inception, the Company's primary source of cash has been from
financing activities, which have consisted primarily of sales of equity
securities. The Company has raised an aggregate of approximately $75.0 million
from the sale of equity securities from its inception through December 31, 1997.
In July 1992, the Company raised net proceeds of approximately $10.7 million in
the initial public offering of its Common Stock. In September 1993, the Company
entered into a collaborative agreement with Genzyme relating to the development
and commercialization of ATRAGEN, in connection with which the Company received
net proceeds of approximately $4.5 million from the sale of shares of Common
Stock to Genzyme. In November 1993 and May 1996, the Company raised net proceeds
of approximately $11.5 million and $32.1 million, respectively, in public
offerings of Common Stock. From October 1995 through December 31, 1997, the
Company received aggregate net proceeds of approximately $6.5 million from the
exercise of certain warrants issued in the Oncologix merger. Prior to the
Mergers, Triplex had raised $22.0 million from sales of equity securities and
$7.5 million from collaborative arrangements and SBIR grants, of which $6.7
million remained as cash, cash-equivalents and investments at the effective time
of the Mergers. From its inception through December 31, 1997, the Company also
received an aggregate of $4.8 million in cash from collaborative arrangements
and SBIR grants.

         The Company's primary use of cash to date has been in operating
activities to fund research and development, including preclinical studies and
clinical trials, and general and administrative expenses. Cash of $10.7 million,
$7.6 million and $6.5 million was used in operating activities during 1997, 1996
and 1995, respectively.

         The Company had cash, cash-equivalents and short-term and long-term
investments of $30.0 million, $41.4 million and $12.0 million as of December 31,
1997, 1996, and 1995, respectively, consisting primarily of cash, money market
accounts, United States government securities and investment grade corporate
bonds.

         The Company has experienced negative cash flows from operations since
its inception and has funded its activities to date primarily from equity
financings. The Company has expended, and will continue to require, substantial
funds to continue research and development, including preclinical studies and
clinical trials of its products, and to commence sales and marketing efforts if
FDA and other regulatory approvals are obtained. The Company expects that its
existing capital resources will be sufficient to fund its capital requirements
through mid-1999. Thereafter, the Company will need to raise substantial
additional capital to fund its operations. The Company's capital requirements
will depend on many factors, including the problems, delays, expenses and
complications frequently encountered by development stage companies; the
progress of the Company's research, development and clinical trial programs; the
Company's ability to satisfy the extent and terms of any future collaborative
research, manufacturing, marketing or other funding arrangements; the costs and
timing of seeking regulatory approvals of the Company's products; the Company's
ability to obtain regulatory approvals; the success of the Company's sales and
marketing programs; costs of filing, prosecuting and defending and enforcing any
patent claims and other intellectual property rights; and changes in economic,
regulatory or competitive conditions in the Company's planned business.
Estimates about the adequacy of funding for the Company's activities are based
on certain assumptions, including the assumption that testing and regulatory
procedures relating to the Company's products can be conducted at projected
costs. There can be no assurance that changes in the Company's research and
development plans, acquisitions, or other events will not result in accelerated
or unexpected expenditures. To satisfy its capital requirements, the Company may
seek to raise additional funds in the public or private capital markets. The
Company's ability to raise additional funds in the public or private markets
will be adversely affected if the results of its current or future clinical
trials are not favorable. The Company may seek additional funding through
corporate collaborations and other financing vehicles. There can be no assurance
that any such funding will be available to the Company on favorable terms or at
all. If adequate funds are not available, the Company may be required to curtail
significantly one or more of its research or development programs, or it may be
required to obtain funds through arrangements with future collaborative partners
or others that may require the Company to relinquish rights to some or all of
its technologies or products. If the Company is successful in obtaining
additional financing, the terms of such financing may have the effect of
diluting or adversely affecting the holdings or the rights of the holders of the
Company's Common Stock.




                                      -26-
<PAGE>   27

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

           Not applicable.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

           None.



                                      -27-
<PAGE>   28

                                    PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The information required by this Item as to the directors and executive
officers of the Company is hereby incorporated by reference from the information
appearing under the captions "Election of Directors" and "Executive Officers" in
the Company's definitive proxy statement which involves the election of
directors and is to be filed with the Securities and Exchange Commission (the
"Commission") pursuant to the Securities Exchange Act of 1934, as amended (the
"Exchange Act") within 120 days of the end of the Company's fiscal year ended
December 31, 1997.

ITEM 11.   EXECUTIVE COMPENSATION.

         The information required by this Item as to the management of the
Company is hereby incorporated by reference from the information appearing under
the captions "Executive Compensation" and "Election of Directors - Director
Compensation" in the Company's definitive proxy statement which involves the
election of directors and is to be filed with the Commission pursuant to the
Exchange Act within 120 days of the end of the Company's fiscal year ended
December 31, 1997. Notwithstanding the foregoing, in accordance with the
instructions to Item 402 of Regulation S-K, the information contained in the
Company's proxy statement under the sub-heading "Report of the Compensation
Committee of the Board of Directors" and "Performance Graph" shall not be deemed
to be filed as part of or incorporated by reference into this Form 10-K.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information required by this Item as to the ownership by management
and others of securities of the Company is hereby incorporated by reference from
the information appearing under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Company's definitive proxy statement
which involves the election of directors and is to be filed with the Commission
pursuant to the Exchange Act within 120 days of the end of the Company's fiscal
year ended December 31, 1997.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The information required by this Item as to certain business
relationships and transactions with management and other related parties of the
company is hereby incorporated by reference to such information appearing under
the captions "Certain Transactions" and "Compensation Committee Interlocks and
Insider Participation" in the Company's definitive proxy statement which
involves the election of directors and is to be filed with the Commission
pursuant to the Exchange Act within 120 days of the end of the Company's fiscal
year ended December 31, 1997.





                                      -28-
<PAGE>   29



         PART IV

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

     (a)   Documents Filed as Part of This Report

           FINANCIAL STATEMENTS

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

           EXHIBITS

<TABLE>
<CAPTION>
       Exhibit
       Number                           Exhibit
       -------                          -------
<S>               <C>
         3.1      Restated Certificate of Incorporation, as amended. Exhibit 3.1
                  to the Company's Quarterly Report on Form 10-Q for the quarter
                  ended June 30, 1997 (the "June 1997 Form 10-Q") is
                  incorporated herein by reference.

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

         4.1      Specimen certificate for shares of Common Stock, par value
                  $.001 per share. Exhibit 4.1 to the Company's Quarterly Report
                  on Form 10-Q for the fiscal quarter ended June 30, 1996 is
                  incorporated herein by reference.

         10.1     Registration Rights Agreement dated August 2, 1989, by and
                  among the Company and certain of its stockholders. Exhibit
                  10.2 to the 1992 Registration Statement is incorporated herein
                  by reference.

         10.2     First Amendment to Registration Rights Agreement dated April
                  18, 1990, by and among the Company and certain of its
                  stockholders. Exhibit 10.3 to the 1992 Registration Statement
                  is incorporated herein by reference.

         10.3     Second Amendment to Registration Rights Agreement dated
                  October 31, 1991, by and among the Company and certain of its
                  stockholders. Exhibit 10.4 to the 1992 Registration Statement
                  is incorporated herein by reference.

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

         10.5     Fourth Amendment to Registration Rights Agreement dated
                  January 20, 1994, among the Company and certain of its
                  stockholders. Exhibit 10.28 to the Company's Annual Report on
                  Form 10-K for the year ended December 31, 1993 (the "1993 Form
                  10-K") is incorporated herein by reference.

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

         10.7++   Amended and Restated 1993 Non-Employee Director Stock Option
                  Plan. Exhibit 10.2 to the June 1997 Form 10-Q is incorporated
                  herein by reference.
</TABLE>

                                      -29-
<PAGE>   30

<TABLE>
<CAPTION>
       Exhibit
       Number                           Exhibit
       -------                          -------
<S>               <C>
         10.8**   Exclusive License Agreement dated October 15, 1986, between
                  the Company, The University of Texas System Board of Regents
                  and The University of Texas M. D. Anderson Cancer Center.
                  Exhibit 10.8 to the 1992 Registration Statement is
                  incorporated herein by reference.

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

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

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

         10.12    Amendment No. 2 to Exclusive License Agreement dated July 9,
                  1993, among the Company, The University of Texas System Board
                  of Regents and The University of Texas M. D. Anderson Cancer
                  Center. Exhibit 10.20 to the 1993 Registration Statement is
                  incorporated herein by reference.

         10.13    Sponsored Laboratory Study Agreement dated July 9, 1993,
                  between the Company and The University of Texas M. D. Anderson
                  Cancer Center. Exhibit 10.21 to the 1993 Registration
                  Statement is incorporated herein by reference.

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

         10.15    Form of Key Management Proprietary Information and Inventions
                  and Noncompetition Agreement. Exhibit 10.23 to the 1992
                  Registration Statement is incorporated herein by reference.

         10.16    Form of Proprietary Information and Inventions Agreement.
                  Exhibit 10.24 to the 1992 Registration Statement is
                  incorporated herein by reference.

         10.17    Stock Purchase Warrant dated March 29, 1990, from the Company
                  in favor of Pacific Venture Finance, Inc. Exhibit 10.28 to the
                  1992 Registration Statement is incorporated herein by
                  reference.

         10.18    Master Loan and Security Agreement dated March 1, 1993,
                  between the Company and MMC/GATX Partnership No. 1. Exhibit
                  10.21 to the Company's Annual Report on Form 10-K for the
                  fiscal year Ended December 31, 1993 (the "1993 Form 10-K") is
                  incorporated herein by reference.
</TABLE>


                                      -30-
<PAGE>   31


<TABLE>
<CAPTION>
       Exhibit
       Number                           Exhibit
       -------                          -------
<S>               <C>
         10.19    Common Stock Purchase Warrant dated June 28, 1993 from the
                  Company in favor of MMC/GATX Partnership No. 1. Exhibit 10.22
                  to the 1993 Form 10-K is incorporated herein by reference.

         10.20    Common Stock Purchase Warrant dated March 21, 1994 from the
                  Company in favor of MMC/GATX Partnership No. 1. Exhibit 10.4
                  to the Company's Quarterly Report on Form 10-Q for the quarter
                  ended March 31, 1994 (the "March 1994 Form 10-Q") is
                  incorporated herein by reference.

         10.21    Common Stock Purchase Warrant dated January 27, 1994 from the
                  Company in favor of Vector Securities International, Inc.
                  Exhibit 10.29 to the 1993 Form 10-K is incorporated herein by
                  reference.

         10.22    License and Development Agreement dated September 10, 1993,
                  between the Company and Genzyme Corporation. Exhibit 10.22 to
                  the 1993 Registration Statement is incorporated herein by
                  reference.

         10.23**  Common Stock Purchase Agreement dated September 10, 1993,
                  between the Company and Genzyme Corporation. Exhibit 10.23 to
                  the 1993 Registration Statement is incorporated herein by
                  reference.

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

         10.25    Amendment No. 2 to Stock Purchase Agreement dated September
                  10, 1996, between the Company and Genzyme Corporation. Exhibit
                  10.2 to the September 1996 Form 10-Q is incorporated herein by
                  reference.

         10.26**  Amendment No. 3 to license and Development Agrement dated
                  March 25, 1997, between the Company and Genzyme Corporation.
                  Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
                  for the fiscal quarter ended March 30, 1997 (the "March 1997
                  Form 10-Q") is incorporated herein by reference.

         10.27    Amendment No. 3 to Common Stock Purchase Agreement dated March
                  25, 1997, between the Company and Genzyme Corporation. Exhibit
                  10.2 to the March 1997 Form 10-Q is incorporated herein by
                  reference.

         10.28    Licensing Agreement dated December 7, 1996, between the
                  Company and Boehringer Mannheim GmbH. Exhibit 10.51 to the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1996 is incorporated herein by reference.

         10.29*   Plan and Agreement of Merger dated February 22, 1995, among
                  Triplex Pharmaceutical Corporation, Argus Pharmaceuticals,
                  Inc. and API Acquisition Company No. 1. Exhibit 1.1 to the
                  Company's Current Report on Form 8-K dated February 22, 1995
                  (the "February 1995 Form 8-K") is incorporated herein by
                  reference.

         10.30    Form of Certificate of Contingent Interest. Exhibit 1.2 to the
                  February 1995 Form 8-K is incorporated herein by reference.

</TABLE>


                                      -31-
<PAGE>   32

<TABLE>
<CAPTION>
       Exhibit
       Number                           Exhibit
       -------                          -------
<S>               <C>
         10.31*   Agreement and Plan of Merger dated February 22, 1995, among
                  Oncologix, Inc., the Company and API Acquisition Company No.
                  2. Exhibit 1.7 to the February 1995 Form 8-K is incorporated
                  herein by reference.

         10.32    Form of Warrant. Exhibit 1.8 to the February 1995 Form 8-K is
                  incorporated herein by reference.

         10.33*   Agreement between Oncologix and HCV Group. Exhibit 1.9 to the
                  February 1995 Form 8-K is incorporated herein by reference.

         10.34    Exchange Agreement dated December 12, 1995, among the Company,
                  Health Care Ventures I, L.P., Health Care Ventures II, L.P.,
                  Health Care Ventures III, L.P. and Health Care Ventures IV,
                  L.P. Exhibit 1.2 to the Company's Current Report on Form 8-K
                  dated December 12, 1995 is incorporated herein by reference.

         10.35++  Third Amendment to Consulting Agreement dated March 15, 1994,
                  between the Company and Gabriel Lopez-Berestein. Exhibit 10.3
                  to the March 1994 Form 10-Q is incorporated herein by
                  reference.

         10.36++  Employment Agreement dated December 5, 1996, between the
                  Company and Praveen Tyle, Ph.D. Exhibit 10.3 to the March 1997
                  Form 10-Q is incorporated herein by reference.

         10.37++  Employment Agreement dated March 12, 1997, between the
                  Company and David S. Gordon, M.D. Exhibit 10.4 to the March
                  1997 Form 10-Q is incorporated herein by reference.

         10.38++  Employment Agreement dated July 28, 1997, between the
                  Company and Janet Walter. Exhibit 10.1 to the Company's
                  Quarterly Report on Form 10-Q for fiscal quarter ended
                  September 30, 1997 is incorporated herein by reference.

         10.39++ Employment Agreement dated November 3, 1997 between the
              +   Company and Geoffrey Cox, Ph.D.

         10.40++  Form of Employment Agreement with James M. Chubb, Ph.D.
                  Exhibit 10.46 to the Merger Registration Statement is
                  incorporated herein by reference.

         10.41    Lease Agreement dated April 4, 1997, between the Company and
                  The Woodlands Corporation. Exhibit 10.3 to the June 1997 Form
                  10-Q is incorporated herein by reference.

         11.1+    Statement regarding computation of loss per share.

         23.1+    Consent of Arthur Andersen LLP.

         27.1+    Financial Data Schedule.

</TABLE>


---------------
+        Filed herewith.

++       Management contract or compensatory plan or arrangement.

*        These agreements omit certain exhibits and schedules. The Company will
         provide a copy of any omitted exhibit or schedule upon request.

**       The Company has omitted certain portions of these agreements in
         reliance upon Rule 406 under the Securities Act.


         (b)      Reports on Form 8-K filed in the fourth quarter of fiscal 1997
                  None



                                      -32-

<PAGE>   33


                                   SIGNATURES

         PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.

                                              ARONEX PHARMACEUTICALS, INC.


Dated: March 25, 1998                         By:  /s/ GEOFFREY F. COX
                                                 ------------------------------
                                                       Geoffrey F. Cox
                                                       Chief Executive Officer

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

<TABLE>

<S>                                      <C>                                          <C>
/s/ GEOFFREY F. COX                      Chairman of the Board of Directors             March 25, 1998
-------------------------------          Chief Executive Officer
Geoffrey F. Cox                          (Principal executive officer)



/s/ TERANCE A. MURNANE                   Controller   March 25, 1998
-------------------------------          (Principal financial and accounting officer)
Terance A. Murnane



/s/ RONALD J. BRENNER                    Director                                       March 25, 1998
-------------------------------
Ronald J. Brenner


/s/ JAMES R. BUTLER                      Director                                       March 25, 1998
-------------------------------
James R. Butler


/s/ GABRIEL LOPEZ-BERESTEIN              Director                                       March 25, 1998
-------------------------------
Gabriel Lopez-Berestein



/s/ MARTIN P. SUTTER                     Director                                       March 25, 1998
-------------------------------
Martin P. Sutter


/s/ GREGORY F. ZAIC                      Director                                       March 25, 1998
-------------------------------
Gregory F. Zaic

</TABLE>



<PAGE>   34


                          INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                              PAGE
                                                                                              ----
<S>                                                                                           <C>
Report of Independent Public Accountants                                                       F-2

Balance Sheets as of December 31, 1996 and 1997                                                F-3

Statements of Operations for the Years ended December 31, 1995, 1996 and 1997,
    and for the Period from Inception (June 13, 1986) through December 31, 1997                F-4

Statements of Stockholders' Equity for the Period from Inception (June 13, 1986)
    through December 31, 1997                                                                  F-5

Statements of Cash Flows for the Years ended December 31, 1995, 1996 and 1997,
    and for the Period from Inception (June 13, 1986) through December 31, 1997               F-10

Notes to Financial Statements                                                                 F-11

</TABLE>


                                      F-1
<PAGE>   35



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Aronex Pharmaceuticals, Inc.:

         We have audited the accompanying balance sheets of Aronex
Pharmaceuticals, Inc. (a Delaware corporation in the development stage), as of
December 31, 1996 and 1997, and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997 and for the period from inception (June 13, 1986)
through December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Aronex
Pharmaceuticals, Inc. as of December 31, 1996 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997 and for the period from inception (June 13, 1986) through
December 31, 1997, in conformity with generally accepted accounting principles.


ARTHUR ANDERSEN LLP


The Woodlands, Texas
February 17, 1998






                                      F-2
<PAGE>   36



                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)


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

<TABLE>
<CAPTION>
                                                 ASSETS
                                                                                            DECEMBER 31
                                                                                          1996          1997
                                                                                        --------      --------
<S>                                                                                     <C>           <C>
Current assets:
         Cash and cash equivalents ................................................     $  4,179      $  2,029
         Short-term investments ...................................................       30,414        17,783
         Accounts receivable ......................................................           78           100
         Prepaid expenses and other assets ........................................          663           474
                                                                                        --------      --------
                  Total current assets ............................................       35,334        20,386

Long-term investments .............................................................        6,795        10,142
Furniture, equipment and leasehold improvements, net of accumulated
depreciation of $2,869 and $3,660, respectively ...................................        2,152         1,107
Deposits ..........................................................................           --           490
                                                                                        --------      --------
                  Total assets ....................................................     $ 44,281      $ 32,125
                                                                                        ========      ========

                                       LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
         Accounts payable and accrued expenses ....................................     $  1,191      $  1,977
         Accrued payroll ..........................................................          126           554
         Advance from Genzyme .....................................................           --         2,000
         Note Payable to Genzyme ..................................................        2,000            --
         Current portion of notes payable .........................................          325           191
         Current portion of obligations under capital leases ......................           16            18
                                                                                        --------      --------
                  Total current liabilities .......................................        3,658         4,740

Long-term liabilities:
         Notes payable, net of current portion ....................................          121            --
         Obligations under capital leases, net of current portion .................           25             6
                                                                                        --------      --------
                  Total long-term obligations .....................................          146             6

Commitments and Contingencies

Stockholders' equity:
         Preferred stock $.001 par value, 5,000,000 shares authorized,
            none issued and outstanding ...........................................           --            --
         Common stock $.001 par value, 30,000,000 shares authorized, 14,597,247
            and 15,459,166 shares issued and outstanding, respectively ............           15            15
         Additional paid-in capital ...............................................       93,742        96,606
         Common stock warrants ....................................................          968           967
         Treasury stock ...........................................................          (11)          (11)
         Deferred compensation ....................................................       (1,949)         (907)
         Unrealized loss on securities available-for-sale .........................          (75)          (87)
         Deficit accumulated during development stage .............................      (52,213)      (69,204)
                                                                                        --------      --------

                  Total stockholders' equity ......................................       40,477        27,379
                                                                                        --------      --------

         Total liabilities and stockholders' equity ...............................     $ 44,281      $ 32,125
                                                                                        ========      ========

</TABLE>

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






                                      F-3
<PAGE>   37


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)


                            STATEMENTS OF OPERATIONS
             (ALL AMOUNTS IN THOUSANDS, EXCEPT LOSS PER SHARE DATA)



<TABLE>
<CAPTION>
                                                                                      PERIOD FROM
                                                   YEARS ENDED DECEMBER 31,       INCEPTION (JUNE 13,
                                             ------------------------------------    1986) THROUGH
                                               1995           1996         1997    DECEMBER 31, 1997
                                             --------      --------      --------  -----------------
<S>                                          <C>           <C>           <C>           <C>
Revenues:
  Interest income ......................     $    452      $  1,692      $  2,059      $  5,581
  Research and development grants
     and contracts .....................        1,248         2,670           841         5,050
                                             --------      --------      --------      --------
          Total revenues ...............        1,700         4,362         2,900        10,631
                                             --------      --------      --------      --------
Expenses:
  Research and development .............        8,347        10,357        13,993        53,135
  Purchase of in-process research
     and development ...................        8,383           242         3,000        11,625
  General and administrative ...........        2,215         1,620         2,641        13,804
  Interest expense and other ...........          184           173           257         1,271
                                             --------      --------      --------      --------
          Total expenses ...............       19,129        12,392        19,891        79,835
                                             --------      --------      --------      --------
Net loss ...............................     $(17,429)     $ (8,030)     $(16,991)     $(69,204)
                                             ========      ========      ========      ========
Basic and diluted loss per share .......     $  (2.69)     $  (0.62)     $  (1.14)
                                             ========      ========      ========

Weighted average shares used in
  computing basic and diluted
  loss per share .......................        6,488        13,048        14,896
                                             ========      ========      ========

</TABLE>


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


                                      F-4
<PAGE>   38

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                       STATEMENTS OF STOCKHOLDERS' EQUITY
     FOR THE PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1997
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)



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


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


                                                        (continued on next page)


                                      F-5
<PAGE>   39

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                       STATEMENTS OF STOCKHOLDERS' EQUITY
     FOR THE PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1997
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)



<TABLE>
<CAPTION>


                                                                                        ADDITIONAL     COMMON
                                                                 COMMON STOCK            PAID-IN       STOCK       DEFERRED
                                                             SHARES        AMOUNT        CAPITAL      WARRANTS    COMPENSATION
                                                            ---------     ---------     ---------     ---------   ------------
<S>                                                         <C>           <C>          <C>          <C>            <C>
Balance at December 31, 1989 ..........................     1,847,582     $       2     $   5,062     $      --     $      --
Stock options exercised January 1990 ($.66
          per share) ..................................            30            --            --            --            --
Warrants issued to purchase 9,914 shares
         of Common Stock ..............................            --            --            --            --            --
Net loss ..............................................            --            --            --            --            --
                                                            ---------     ---------     ---------     ---------     ---------
Balance at December 31, 1990 ..........................     1,847,612             2         5,062            --            --
Stock options exercised, May 1991 ($.66
         per share) ...................................            75            --            --            --            --
Issuance of Common Stock for cash and notes
         payable  including accrued interest of
         $96,505, October 1991 ($7.26 per share) ......       596,095            --         4,328            --            --
Deferred compensation relating to certain
         stock options ................................            --            --           326            --          (326)
Compensation expense related to stock options .........            --            --            --            --           138
Net loss ..............................................            --            --            --            --            --
                                                            ---------     ---------     ---------     ---------     ---------
Balance at December 31, 1991 ..........................     2,443,782             2         9,716            --          (188)
Stock options exercised, January, April, May,
October and December 1992 ($.66 per
share) ................................................        37,198            --            24            --            --
Stock warrants exercised April, May and
August 1992 ($3.63 per share) .........................        11,364            --            41            --            --
Issuance of Common Stock for cash in initial
public offering, July 1992 ($14.00 per
share) ................................................       850,000             1        10,659            --            --
Deferred compensation relating to certain
         stock options ................................            --            --         1,644            --        (1,644)
Compensation expense related to stock options .........            --            --            --            --           460
Net loss ..............................................            --            --            --            --            --
                                                            ---------     ---------     ---------     ---------     ---------
Balance at December 31, 1992 ..........................     3,342,344     $       3     $  22,084     $      --     $  (1,372)

<CAPTION>
                                                            UNREALIZED      DEFICIT
                                                              LOSS ON     ACCUMULATED
                                                            SECURITIES       DURING                         TOTAL
                                                            AVAILABLE      DEVELOPMENT     TREASURY      STOCKHOLDERS'
                                                             FOR SALE        STAGE          STOCK          EQUITY
                                                             ---------    ---------      ------------     ---------
<S>                                                         <C>          <C>             <C>             <C>
Balance at December 31, 1989 ..........................     $      --     $  (2,030)     $         --     $   3,034
Stock options exercised January 1990 ($.66
          per share) ..................................            --            --                --            --
Warrants issued to purchase 9,914 shares
         of Common Stock ..............................            --            --                --            --
Net loss ..............................................            --        (1,825)               --        (1,825)
                                                            ---------     ---------      ------------     ---------
Balance at December 31, 1990 ..........................            --        (3,855)               --         1,209
Stock options exercised, May 1991 ($.66
         per share) ...................................            --            --                --            --
Issuance of Common Stock for cash and notes
         payable  including accrued interest of
         $96,505, October 1991 ($7.26 per share) ......            --            --                --         4,328
Deferred compensation relating to certain
         stock options ................................            --            --                --            --
Compensation expense related to stock options .........            --            --                --           138
Net loss ..............................................            --        (2,914)               --        (2,914)
                                                            ---------     ---------      ------------     ---------
Balance at December 31, 1991 ..........................            --        (6,769)               --         2,761
Stock options exercised, January, April, May,
October and December 1992 ($.66 per
share) ................................................            --            --                --            24
Stock warrants exercised April, May and
August 1992 ($3.63 per share) .........................            --            --                --            41
Issuance of Common Stock for cash in initial
public offering, July 1992 ($14.00 per
share) ................................................            --            --                --        10,660
Deferred compensation relating to certain
         stock options ................................            --            --                --            --
Compensation expense related to stock options .........            --            --                --           460
Net loss ..............................................            --        (4,708)               --        (4,708)
                                                            ---------     ---------      ------------     ---------
Balance at December 31, 1992 ..........................     $      --     $ (11,477)     $         --     $   9,238

</TABLE>


                                                        (continued on next page)


                                      F-6


<PAGE>   40


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                       STATEMENTS OF STOCKHOLDERS' EQUITY
     FOR THE PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1997
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)


<TABLE>
<CAPTION>


                                                                                        ADDITIONAL     COMMON
                                                                 COMMON STOCK            PAID-IN       STOCK       DEFERRED
                                                             SHARES        AMOUNT        CAPITAL      WARRANTS    COMPENSATION
                                                            ---------     ---------     ---------     ---------   ------------
<S>                                                         <C>           <C>          <C>          <C>          <C>
Balance at December 31, 1992 ..........................     3,342,344     $       3     $  22,084     $    --     $  (1,372)
Issuance of Common Stock for compensation .............         5,000            --            51          --            --
Warrants issued to purchase 50,172 shares
     of Common Stock ..................................            --            --            --          --            --
Stock options exercised, February and
     November 1993 ($.66) per share ...................        14,465            --             9          --            --
Issuance of Common Stock for cash,
     September 1993 ($14.00 per share) ................       357,143            --         4,538          --            --
Issuance of Common Stock for cash in
     secondary public offering November &
     December 1993 ($9.00 per share) ..................     1,402,250             2        11,462          --            --
Compensation expense related to stock options .........            --            --            --          --           396
Net loss ..............................................            --            --            --          --            --
                                                            ---------     ---------     ---------     -------     ---------
Balance at December 31, 1993 ..........................     5,121,202             5        38,144          --          (976)
Deferred compensation relating to certain
     stock options.....................................            --            --            66          --           (66)
Stock options exercised, January through October
     1994 ($.66 per share) ............................        15,111            --            10          --            --
Warrants issued to purchase 537 shares of common
     stock ............................................            --            --            --          --            --
Issuance of additional shares of Common
     Stock pursuant to collaborative
     agreement (see Note 6) ...........................        66,163            --            --          --            --
Compensation expense related to stock options .........            --            --            --          --           546
Unrealized loss on available-for-sale securities ......            --            --            --          --            --
Net loss ..............................................            --            --            --          --            --
                                                            ---------     ---------     ---------     -------     ---------
 Balance at December 31, 1994 .........................     5,202,476     $       5     $  38,220     $    --     $    (496)

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

</TABLE>


                                                        (continued on next page)


                                      F-7
<PAGE>   41


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                       STATEMENTS OF STOCKHOLDERS' EQUITY
     FOR THE PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1997
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)


<TABLE>
<CAPTION>


                                                                                   ADDITIONAL       COMMON
                                                         COMMON STOCK               PAID-IN         STOCK          DEFERRED
                                                     SHARES        AMOUNT           CAPITAL        WARRANTS       COMPENSATION
                                                    ---------     ---------        ---------       ---------      ------------
<S>                                                <C>           <C>              <C>             <C>             <C>
Balance at December 31, 1994 ................       5,202,476      $         5     $    38,220    $         --      $      (496)
Deferred compensation relating to certain
          stock options .....................              --               --           1,380              --           (1,380)
Stock options exercised, January through
          December 1995 ($.66 per share) ....          36,958               --              24              --               --
Issuance of Common Stock and warrants
          pursuant to merger agreements
         (see Note 4) .......................       3,868,436                4          11,111           2,844               --
Warrants exercised ($4.50 per share) ........         705,614                1           3,402            (226)              --
Issuance of Common Stock pursuant to
     settlement agreement (see Note 6) ......         531,552               --           2,046          (1,130)              --
Issuance of Common Stock for services
     rendered ...............................          37,500               --             159              --               --
Treasury stock purchased ($4.42 per share) ..          (2,480)              --              --              --               --
Compensation expense related to stock
     options ................................              --               --              --              --              340
Unrealized gain on available-for-sale
     securities .............................              --               --              --              --               --
Net loss ....................................              --               --              --              --               --
                                                  -----------      -----------     -----------     -----------      -----------
Balance at December 31, 1995 ................      10,380,056      $        10     $    56,342     $     1,488      $    (1,536)


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

</TABLE>


                                                        (continued on next page)


                                      F-8
<PAGE>   42


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                       STATEMENTS OF STOCKHOLDERS' EQUITY
     FOR THE PERIOD FROM INCEPTION (JUNE 13, 1986) THROUGH DECEMBER 31, 1997
                  (ALL AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)


<TABLE>
<CAPTION>


                                                                                   ADDITIONAL       COMMON
                                                         COMMON STOCK               PAID-IN         STOCK          DEFERRED
                                                     SHARES          AMOUNT         CAPITAL        WARRANTS       COMPENSATION
                                                    ---------      ---------       ---------       ---------      ------------
<S>                                                <C>           <C>              <C>             <C>             <C>
Balance at December 31, 1995 ...................     10,380,056     $       10     $   56,342      $    1,488      $   (1,536)
Warrants redeemed January 1996 .................             --             --            269            (269)             --
Deferred compensation relating to certain
         stock options .........................             --             --            966              --            (966)
Issuance of Common Stock for cash in
         secondary public offering, March &
         April 1996 ($10.00 per share) .........      3,450,000              4         32,073              --              --
Stock options exercised, January through
         December 1996 ($.04-$9.50 per share) ..        106,041             --            343              --              --
Warrants exercised January through December
         1996 ($4.50-$12.00 per share) .........        622,574              1          3,528            (194)             --
Issuance of Common Stock pursuant to
         settlement agreements .................         38,722             --            221             (57)             --
Compensation expense related to stock options ..             --             --             --              --             553
Unrealized gain on available-for-sale securities             --             --             --              --              --
Net loss .......................................             --             --             --              --              --
                                                     ----------     ----------     ----------      ----------      ----------
Balance at December 31, 1996 ...................     14,597,247             15         93,742             968          (1,949)
Warrants exercised February and March 1997
         ($8.00 per share) .....................          3,499             --             28              (1)             --
Reversal of deferred compensation relating to
         forfeited stock options ...............             --             --           (578)             --             578
Issuance of Common Stock for services ..........         22,278             --            130              --              --
Stock options exercised, January through
         December 1997 ($.04-$5.50 per share) ..        128,278             --            215              --              --
Stock purchased - employee stock purchase
         plan, June and December 1997 ($3.31
         and $3.19 per share) ..................         21,392             --             69              --              --
Issuance of Common Stock pursuant to
         contingent stock agreement ............        686,472             --          3,000              --              --
Compensation expense related to stock options ..             --             --             --              --             464
Unrealized loss on securities available-for-sale             --             --             --              --              --
Net loss .......................................             --             --             --              --              --
                                                     ----------     ----------     ----------      ----------      ----------
Balance at December 31, 1997 ...................     15,459,166     $       15     $   96,606      $      967      $     (907)
                                                     ==========     ==========     ==========      ==========      ==========

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

</TABLE>

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


                                      F-9
<PAGE>   43



                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                            STATEMENTS OF CASH FLOWS
                           (ALL AMOUNTS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                           PERIOD FROM
                                                                                                            INCEPTION
                                                                                                             (JUNE 13,
                                                                      YEARS ENDED DECEMBER 31,             1986) THROUGH
                                                                                                            DECEMBER 31,
                                                                   1995          1996          1997            1997
                                                                  --------      --------      --------      --------
<S>                                                               <C>           <C>           <C>           <C>
Cash flows from operating activities:
     Net loss ...............................................     $(17,429)     $ (8,030)     $(16,991)     $(69,204)
     Adjustments to reconcile net loss to net cash used
          in operating activities--
     Depreciation and amortization ..........................          749           936         1,139         4,026
     Loss on disposal of assets .............................           --            --           200           200
     Compensation expense related to stock
          and stock options .................................          499           553           594         3,236
     Charge for purchase of in-process research
          and development ...................................        8,383           164         3,000        11,547
     Unrealized gain (loss) on securities available-for-sale           199            41           (12)          (87)
     Acquisition costs, net of cash received of
          $947,000 in 1995 ..................................         (270)           --            --          (270)
     Loss in affiliate ......................................          300            50            --           500
     Accrued interest payable converted to stock ............           --            --            --            97
     Changes in assets and liabilities--
          Decrease (increase) in prepaid expenses and other
               assets .......................................           (1)         (375)          189          (289)
          Decrease (increase) in accounts receivable ........          (32)          267           (22)         (100)
          Increase (decrease) in accounts payable and accrued
               expenses .....................................          796          (322)        1,214         2,458
          Increase (decrease) in deferred revenue ...........          272          (876)           --          (353)
                                                                  --------      --------      --------      --------
          Net cash used in operating activities .............       (6,534)       (7,592)      (10,689)      (48,239)
Cash flows from investing activities:
     Net sales (purchases) of investments ...................       10,094       (32,975)        9,284       (22,190)
     Purchase of furniture, equipment and leasehold
          improvements ......................................         (137)         (256)         (352)       (4,121)
     Proceeds from sale of assets ...........................           --            --            54            54
     Deposits ...............................................           --            --          (490)         (490)
     Investment in affiliate ................................           --            --            --          (500)
                                                                  --------      --------      --------      --------
          Net cash provided by (used in)
          investing activities ..............................        9,957       (33,231)        8,496       (27,247)
     Cash flows from financing activities:
     Proceeds from notes payable ............................           64         2,000            --         4,672
     Repayment of notes payable and principal payments
          under capital lease obligations ...................         (321)         (534)         (272)       (2,458)
     Purchase of treasury stock .............................          (11)           --            --           (11)
     Proceeds from issuance of stock ........................        3,200        35,755           315        75,312
                                                                  --------      --------      --------      --------
          Net cash provided by
          financing activities ..............................        2,932        37,221            43        77,515
                                                                  --------      --------      --------      --------
Net increase (decrease) in cash and cash equivalents ........        6,355        (3,602)       (2,150)        2,029
Cash and cash equivalents at beginning of period ............        1,426         7,781         4,179            --
                                                                  --------      --------      --------      --------
Cash and cash equivalents at end of period ..................     $  7,781      $  4,179      $  2,029      $  2,029
                                                                  ========      ========      ========      ========

Supplemental disclosures of cash flow information:
     Cash paid during the period for interest ...............     $    184      $    120      $     57      $    785

Supplemental schedule of noncash financing activities:
     Conversion of notes payable and accrued interest
          to Common Stock ...................................     $     --      $     --            --      $  3,043

</TABLE>


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


                                      F-10
<PAGE>   44

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                          NOTES TO FINANCIAL STATEMENTS


1.       ORGANIZATION

         Aronex Pharmaceuticals, Inc. ("Aronex Pharmaceuticals" or the
"Company") was incorporated in Delaware on June 13, 1986 and merged with Triplex
Pharmaceutical Corporation and Oncologix, Inc. effective September 11, 1995 (see
Note 4). Aronex Pharmaceuticals is a development stage company which has devoted
substantially all of its efforts to research and product development and has not
yet generated any significant revenues, nor is there any assurance of future
revenues. In addition, the Company expects to continue to incur losses for the
foreseeable future, and there can be no assurance that the Company will
successfully complete the transition from a development stage company to
successful operations. The research and development activities engaged in by the
Company involve a high degree of risk and uncertainty. The ability of the
Company to successfully develop, manufacture and market its proprietary products
is dependent upon many factors. These factors include, but are not limited to,
the need for additional financing, attracting and retaining key personnel and
consultants, and successfully developing manufacturing, sales and marketing
operations. The Company's ability to develop these operations may be immensely
impacted by uncertainties related to patents and proprietary technologies,
technological change and obsolescence, product development, competition,
government regulations and approvals, health care reform, third-party
reimbursement and product liability exposure. Additionally, the Company is
reliant upon collaborative arrangements for research, contractual agreements
with corporate partners, and its exclusive license agreements with M.D. Anderson
Cancer Center ("MD Anderson"). Further, during the period required to develop
these products, the Company will require additional funds which may not be
available to it. The Company expects that its existing cash resources will be
sufficient to fund its cash requirements through mid-1999. Accordingly, there
can be no assurance of the Company's future success.

2.       ACCOUNTING POLICIES

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

         The Company has adopted Statement of Financial Accounting Standards No.
115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity
Securities". Debt and equity securities that the Company has the intent and
ability to hold to maturity are classified as "held to maturity" and reported at
amortized cost. Debt and equity securities that are held for current resale are
classified as "trading securities" and reported at fair value with unrealized
gains and losses included in earnings. Debt and equity securities not classified
as either "securities-held-to-maturity" or "trading securities" are classified
as "securities-available-for-sale" and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity. The adoption of SFAS 115 did not have a material effect on
the Company's financial position or results of operations.

         Cash and cash equivalents include money market accounts and investments
with an original maturity of less than three months. At December 31, 1997, all
short-term investments are held to maturity securities consisting of high-grade
commercial paper and United States Government backed securities with a carrying
value of $17,783,000, which approximates fair market value and cost. Long-term
investments include: (i) held to maturity securities consisting of high grade
commercial paper that mature over the next few years with a carrying value of
$8,446,000, which approximates fair market value and cost; and (ii) available
for sale securities which are United States mortgage backed securities with
various maturity dates over the next several years that have an amortized cost
of $1,783,000, a fair market value of $1,696,000 and a gross unrealized loss of
$87,000 at December 31, 1997. The Company currently has no trading securities.





                                      F-11
<PAGE>   45


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

         Furniture, Equipment and Leasehold Improvements

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

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

<TABLE>
<CAPTION>
                                                                   1996         1997
                                                                 -------      -------
<S>                                                              <C>          <C>
 Office furniture and equipment ............................     $   571      $   611

 Laboratory equipment ......................................       2,986        2,802
 Leasehold improvements ....................................       1,464        1,354
                                                                 -------      -------

                                                                   5,021        4,767
Less accumulated depreciation and amortization .............      (2,869)      (3,660)
                                                                 -------      -------
Furniture, equipment and leasehold improvements, net .......     $ 2,152      $ 1,107
                                                                 =======      =======
</TABLE>

         At December 31, 1996 and 1997, the cost of laboratory equipment held
under capital leases aggregated $64,000. All furniture, equipment and leasehold
improvements have been pledged as collateral on notes payable.

         Revenue Recognition

         Research and development grant and contract revenues are recognized as
expenses for development activities as they are incurred and the related work is
performed under the terms of the contracts. Any revenue contingent upon future
performance by the Company is deferred and recognized as the performance is
completed. Any revenues resulting from the achievement of milestones are
recognized when the milestones are achieved.

         Research and Development

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

         Loss Per Share

         In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings
per Share", which establishes standards for computing and presenting earnings
per share. The new standard replaces the presentation of primary earnings per
share prescribed by Accounting Principles Board Opinion No. 15 ("APB 15"),
"Earnings per Share", with a presentation of basic earnings per share and also
requires dual presentation of basic and diluted earnings per share on the face
of the statement of operations for all entities with complex capital structures.
Basic earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share is computed similarly to
fully-diluted earnings per share pursuant to APB 15. The Company adopted SFAS
No. 128 in the fourth quarter of fiscal 1997. Because of the loss for the year,
no shares resulting from the assumed exercise of the options or warrants using
the treasury stock method are added to the denominator because the inclusion of
such shares would be antidilutive due to the losses for all periods included in
the statements of operations. Therefore, the Company's basic and diluted
earnings per share are the same.




                                      F-12
<PAGE>   46

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

         Presentation

          In April 1992, the stockholders approved a 1 for 3.3 reverse stock
split and in July 1996, approved a 1 for 2 reverse stock split. Retroactive
effect has been given to the reverse stock splits in stockholders equity and in
all per share data in the accompanying financial statements.

         Estimates

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

3.       INVESTMENT IN AFFILIATE

         In April 1994, the Company invested in and entered into a drug
development agreement with RGene Therapeutics, Inc. ("RGene"). RGene was
involved in the development of gene therapy. Aronex Pharmaceuticals purchased
$500,000 of RGene's preferred stock. This $500,000 investment was written off
during 1994, 1995 and 1996. In June 1996, RGene was acquired by Targeted
Genetics Corporation ("Targeted Genetics"), a publicly traded company. The
Company received 440,520 shares of Targeted Genetics common stock in the merger.
These shares are subject to certain contractual resale restrictions. Under the
drug development agreement with RGene, Aronex Pharmaceuticals performed certain
research and development with respect to certain RGene projects for three years.
This agreement expired in April 1997. During 1995, 1996 and 1997, Aronex
Pharmaceuticals recorded $668,000, $597,000 and $166,000, respectively, in
revenue relating to this agreement.

4.       MERGER AGREEMENTS WITH TRIPLEX PHARMACEUTICAL CORPORATION AND
         ONCOLOGIX, INC.

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

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

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





                                      F-13
<PAGE>   47

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

an aggregate fair market value at the time of issuance of $3.0 million and
recorded a corresponding non-cash research and development expense of $3.0
million in 1997.

         In connection with the Oncologix Agreement, the Company issued the
following: (i) 427,000 shares of Common Stock to certain Oncologix debt holders;
(ii) warrants (the "Warrants") to purchase approximately 9.0 million shares of
Common Stock to Oncologix preferred stockholders, certain former employees and
debt holders; and (iii) contingent stock issue rights to receive shares of
Common Stock with a fair market value of approximately $2.1 million, the
conversion of which was contingent upon the satisfaction of conditions which
relate to the licensing or development of certain products (the "Oncologix
Contingent Stock Rights").

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

         The Warrants issued in connection with the Oncologix merger consisted
of three series of warrant rights to purchase approximately 2.4 million, 2.8
million and 3.7 million shares of Common Stock, respectively designated as
Series A, Series B and Series C. The Series A component of the Warrants has
expired. The Series B and Series C components have exercise prices of $8.00 and
$12.00 per share, respectively, and expiration dates of June 1998 and December
1999, respectively. Upon the failure to exercise a series of warrant rights
prior to their expiration, the warrant holder forfeits all remaining rights
under the terms of the Warrant. At December 31, 1997, warrants to purchase
approximately 3.2 million shares of Common Stock were outstanding. At December
31, 1997, approximately 1.4 million of the Series B warrant rights and 1.8
million of the Series C warrant rights were outstanding.

5.       NOTES PAYABLE AND OBLIGATIONS UNDER CAPITAL LEASES

         In June 1993, the Company entered into a master loan agreement for the
financing of $1.0 million in furniture, office equipment and laboratory
equipment acquisitions. Each loan is collateralized by the furniture and
equipment and is payable in 48 monthly installments with a final installment at
the end of the loan term not to exceed 20% of the purchase price at inception.
During 1993 and 1994, the Company borrowed $607,000 and $392,000, respectively,
through this agreement. In 1993 and 1994, in connection with the financing, the
Company issued to the lender warrants to purchase 5,093 and 2,944 shares of the
Common Stock at an exercise price of $12.00 per share that expire in March 2000
and March 2001, respectively. No value was assigned to the warrants as the value
of the warrants at the dates of issuance was de minimis. Principal of $191,000
is due in 1998 under the master loan agreement.

         In July 1990 and October 1992, the Company borrowed $108,000 and
$388,000, respectively, from a real estate company related to one of its
stockholders to finance the construction of the Company's laboratory and office
space. The Company executed promissory notes bearing interest at 10.5 and 12.5%
per annum, respectively. The July 1990 note was payable in monthly installments
of principal and interest over a five-year period ending July 1995. The October
1992 note, as amended, provided for payment of interest only through October
1994 and monthly payment of principal and interest from November 1994 through
January 1999. This note was paid in full in 1996.

         At December 31, 1996, the Company had a promissory note payable to
Genzyme bearing interest at nine percent per annum. This note was converted to
an advance in 1997 (see Note 9).





                                      F-14
<PAGE>   48

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

         The Company leases certain office and laboratory equipment under
capital leases. The leases have effective interest rates ranging from
approximately 15 to 18% and mature at various dates through March 1999. Future
payments under capital lease obligations are as follows:

<TABLE>
<CAPTION>
                                    Note Payable
                Year Ending         Master Loan
                December 31,         Agreement
                ------------        ------------
<S>                             <C>
                    1998             $ 21,000
                    1999                6,000
                                     --------
                                       27,000
               Less Interest           (3,000)
                                     --------
               Lease Obligations     $ 24,000
                                     ========
</TABLE>


6.      STOCKHOLDERS' EQUITY

         Common Stock

         In July 1992, the Company, in an initial public offering, issued
850,000 shares of Common Stock for $14 a share, with the Company receiving net
proceeds of approximately $10.7 million. In connection with a collaborative
agreement entered into in September 1993 (described in Note 9), Genzyme
Corporation ("Genzyme") made a $5 million equity investment in the Company which
resulted in Genzyme's ownership of approximately 9 percent of the Company's
outstanding Common Stock at the time the investment was made. In September 1994,
the Company issued to Genzyme 66,162 additional shares which were contingent on
certain stock performance criteria. In November 1993, the Company sold 1,250,000
shares of its Common Stock in a secondary public offering for $9.00 per share
which, together with the over-allotment exercise for 152,250 shares of its
Common Stock, raised net proceeds of approximately $11.5 million. In May 1996,
the Company sold 3,000,000 shares of its Common Stock in a secondary public
offering for $10.00 per share which, together with the over-allotment exercise
for 450,000 shares of its Common Stock, raised net proceeds of approximately
$32.1 million.

         Common Stock Warrants

         At December 31, 1997, the Company had warrants outstanding, relating to
certain financing and leasing transactions, to purchase 60,623 shares of Common
Stock at exercise prices ranging from $3.63 per share to $14.00 per share. The
Warrants expire at various dates through March 2001.

         The Company issued Warrants to purchase approximately 9.0 million
shares of Common Stock in connection with the Oncologix merger in 1995 (see Note
4). At December 31, 1997, Warrants to purchase 3.2 million shares of Common
Stock remained outstanding at exercise prices ranging from $8.00 per share to
$12.00 per share, expiring at various dates through December 1999.

        Contingent Stock Rights

         In connection with the Triplex and Oncologix mergers, the Company
issued $10.1 million contingent stock rights. At December 31, 1997, the $5.0
million contingent stock rights remain outstanding, contingent upon the
development and licensing of a certain product (see Note 4).





                                      F-15
<PAGE>   49

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


7.       STOCK OPTION PLANS

         During 1989, the Company's stockholders approved the 1989 Stock Option
Plan (the "Plan"). The Plan, as amended in 1992 and in May 1997, authorizes the
issuance of options covering the greater of (i) 2,490,000 shares of Common Stock
or (ii) 17% of the shares of Common Stock outstanding on the last day of the
preceding fiscal quarter. The term of each option ranges from five to seven
years from the date of grant. At December 31, 1997, 301,907 shares were
available for future grant under the Plan.

         A summary of stock option activity for the Plan follows:

<TABLE>
<CAPTION>

                                          OPTIONS              PRICE
                                        OUTSTANDING          PER SHARE
                                        ----------      -------------------
<S>                                    <C>             <C>
Balance at December 31, 1994 ......        364,607      $     .66 to $14.88
Granted, including options repriced        578,968      $     .04 to $ 7.00
Options repriced ..................        (10,500)     $    7.00 to $14.88
Exercised .........................        (49,459)     $     .22 to $  .68
Forfeited .........................        (95,079)     $     .66 to $14.88
                                        ----------      -------------------
Balance at December 31, 1995 ......        788,537      $     .04 to $14.88
Granted ...........................        533,200      $    5.50 to $12.00
Exercised .........................        (93,541)     $     .04 to $ 9.50
Forfeited .........................       (109,047)     $    4.24 to $11.00
                                        ----------      -------------------
Balance at December 31, 1996 ......      1,119,149      $     .04 to $14.88
Granted ...........................      1,232,578      $    4.06 to $ 8.88
Exercised .........................       (150,556)     $     .04 to $ 5.50
Forfeited .........................       (240,454)     $     .66 to $10.50
                                        ----------      -------------------
Balance at December 31, 1997 ......      1,960,717      $     .04 to $14.88
                                        ==========      ===================
Exercisable at December 31, 1997 ..        638,628      $     .04 to $14.88
                                        ==========      ===================
</TABLE>

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



                                      F-16
<PAGE>   50

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)



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

<TABLE>
<CAPTION>
                                                                     Options            Price
                                                                   Outstanding         Per Share
                                                                   -----------         ---------
<S>                                                                <C>              <C>
            Balance at December 31, 1994                                30,000       $         11.00
            Granted                                                     87,500       $          5.50
            Forfeited                                                 (15,000)       $         11.00
                                                                    ----------       ---------------
            Balance at December 31, 1995                               102,500       $5.50 to $11.00
            Granted                                                    110,000       $5.50 to  $9.38
            Exercised                                                 (12,500)                 $5.50
                                                                    ----------       ---------------
            Balance at December 31, 1996                               200,000       $5.50  to $9.38
            Granted                                                    167,500       $4.25 to $11.00
            Exercised                                                       --       $            --
                                                                    ----------       ---------------
            Balance at December 31, 1997                               367,500       $4.25 to $11.00
                                                                    ==========       ===============
            Exercisable at December 31, 1997                           276,475       $4.25 to $11.00
                                                                    ==========       ===============
</TABLE>


       The Company records deferred compensation for the difference between the
grant price and the deemed fair value for financial statement presentation
purposes related to options. Such amount totals $907,000 at December 31, 1997.
In 1995, 1996 and 1997, $340,000, $553,000, and $594,000, respectively, in
related expense was recorded. The balance will be amortized to expense over the
remaining vesting periods of the options.

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

<TABLE>
<CAPTION>
                                                                       YEAR ENDED
                                                                       DECEMBER 31,
                                                  -----------------------------------------------------
                                                       1995                1996               1997
                                                  --------------      -------------     ---------------
<S>                                               <C>                 <C>               <C>
     Net Loss:
          As reported .......................     $  (17,429,000)     $  (8,030,000)    $   (16,991,000)
                                                     ============        ===========        ============
          Pro forma .........................     $  (18,240,000)     $  (9,062,000)    $   (19,129,000)
                                                     ============        ===========        ============
     Loss Per Share (basic and diluted):
          As reported .......................     $        (2.69)     $       (0.62)    $         (1.14)
                                                     ============        ===========        ============
          Pro forma .........................     $        (2.81)     $       (0.69)    $         (1.29)
                                                     ============        ===========        ============
</TABLE>


       Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation may not
be representative of that to be expected in future years. The fair value of each
option grant is estimated on the date of grant using the Black Scholes options
pricing model with the following weighted-average assumptions used for grants in
1995, 1996 and 1997, respectively: risk-free interest rates of 5.5% to 7.7%,
5.4% to 6.4% and 5.7% to 6.9%, with no expected dividends; expected lives of 5
years and expected volatility of 116% in 1995 and 1996 and 114% in 1997.





                                      F-17
<PAGE>   51


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

       A summary of the status of the Company's two fixed stock option plans as
of December 31, 1995, 1996 and 1997 and charges during the years ending on those
dates is presented below:

<TABLE>
<CAPTION>
                                                      1995                      1996                      1997
                                            ------------------------  ------------------------- -------------------------
                                                           WEIGHTED-                  WEIGHTED-                 WEIGHTED-
                                                            AVERAGE                    AVERAGE                  AVERAGE
                                                           EXERCISE                   EXERCISE                  EXERCISE
     FIXED OPTIONS                           SHARES          PRICE      SHARES         PRICE      SHARES         PRICE
                                            ---------      ---------  ----------      --------  ----------      ---------
<S>                                           <C>          <C>           <C>          <C>        <C>            <C>
Balance at beginning of year .........        394,607      $    5.37     891,037      $   4.29   1,319,149      $   5.27
Granted ..............................        666,468      $    3.61     643,200      $   6.89   1,400,078      $   4.99
Options repriced .....................        (10,500)     $   11.48          --      $     --          --      $     --
Exercised ............................        (49,459)     $    0.49    (106,041)     $   3.24    (150,556)     $   1.43
Forfeited ............................       (110,079)     $    7.30    (109,047)     $   6.75    (240,454)     $   5.91
                                            ---------                 ----------                ----------
Balance at end of year ...............        891,037      $    4.10   1,319,149      $   5.27   2,328,217      $   5.37
                                            =========                 ==========                ==========
Options exercisable at year end ......        360,657      $    3.24     437,391      $   4.10     915,103      $   5.56
                                            =========                 ==========                ==========
Weighted-average fair value of options
granted during the year ..............       $   6.49                   $   7.99                  $   4.02

</TABLE>

         The following table summarizes information about fixed stock options
outstanding at December 31, 1997:

<TABLE>
<CAPTION>
                                   OPTIONS OUTSTANDING                          OPTIONS EXERCISABLE
                  ----------------------------------------------------   -----------------------------------
                        AMOUNT       WEIGHTED-AVERAGE                        NUMBER
   RANGE OF         OUTSTANDING AT      REMAINING     WEIGHTED-AVERAGE    EXERCISABLE AT    WEIGHTED-AVERAGE
EXERCISE PRICES   DECEMBER 31, 1997  CONTRACTUAL LIFE  EXERCISE PRICE    DECEMBER 31, 1997   EXERCISE PRICE
---------------   -----------------  ----------------  ---------------   -----------------   --------------
<S>                <C>               <C>                 <C>                 <C>               <C>
 $0.04 - $ 3.00           56,894        4.2             $  0.40                56,894          $  0.40
 $3.01 - $ 7.00        1,863,110        6.3             $  4.90               612,880          $  4.92
 $7.01 - $14.88          408,213        6.9             $  8.22               245,329          $  8.37
                    ------------                                            ---------
                       2,328,217                                              915,103
                    ============                                            =========
</TABLE>



8.   FEDERAL INCOME TAXES

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

     A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate for the periods ended December 31, 1995, 1996 and 1997
is as follows:

<TABLE>
<CAPTION>
                                                                     1995               1996                 1997
                                                                    ------             ------               ------
<S>                                                                 <C>                <C>                  <C>
Statutory rate                                                      (34.0)%            (34.0)%              (34.0)%
Purchase of in-process research and development                      16.4%               1.1%                 6.6%
Stock option compensation not deductible (deductible)                 0.7%              (0.3)%               (0.2)%
Other nondeductible expenses                                           --                 --                 (0.7)%
Adjustment to deferred tax valuation allowance                       16.9%              33.2%                28.3%
                                                                    ------             ------               ------
                                                                      0.0%               0.0%                 0.0%
                                                                    ======             ======               ======
</TABLE>



                                      F-18
<PAGE>   52

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Significant components of the Company's net deferred tax asset at December 31,
1996 and 1997 are as follows:

<TABLE>
<CAPTION>
                                                                          1996              1997
                                                                      ------------      ------------
<S>                                                                   <C>               <C>
Deferred tax assets relating to:
     Federal net operating loss carryforwards ...................     $ 22,777,400      $ 27,640,500
     Financial statement depreciation and amortization in
          excess of (less than) amount deductible for income
          tax purposes ..........................................          130,400           132,000
     Accrued liabilities not currently deductible
          for income tax purposes ...............................           42,900           725,100
     Equity in loss of affiliate not currently
          deductible for income tax purposes ....................          170,000           170,000
     Other items, net ...........................................          (24,300)          (19,400)
                                                                      ------------      ------------
Total deferred items, net .......................................       23,096,400        28,648,200
Deferred tax valuation allowance ................................      (23,096,400)      (28,648,200)
                                                                      ------------      ------------
Net deferred tax asset ..........................................     $         --      $         --
                                                                      ============      ============
</TABLE>

          At December 31, 1997, the Company had net operating loss ("NOL")
carryforwards for federal income tax purposes of approximately $79.0 million.
The Tax Reform Act of 1986 provided a limitation on the use of NOL and tax
credit carryforwards following certain ownership changes that could limit the
Company's ability to utilize these NOLs and tax credits. Accordingly, the
Company's ability to utilize the above NOL and tax credit carryforwards to
reduce future taxable income and tax liabilities may be limited. As a result of
the merger (see Note 4) with Triplex and Oncologix, a change in control as
defined by federal income tax law occurred, causing the use of these
carryforwards to be limited and possibly eliminated. Additionally, because
United States tax laws limit the time during which NOLs and the tax credit
carryforwards may be applied against future taxable income and tax liabilities,
the Company may not be able to take full advantage of its NOLs and tax credit
carryforwards for federal income tax purposes. The carryforwards will begin to
expire in 2001 if not otherwise used. Due to the possibility of not reaching a
level of profitability that will allow for the utilization of the Company's
deferred tax assets, a valuation allowance has been established to offset these
tax assets. The valuation allowance increased $10,957,000, $3,504,000, and
$5,551,800 for the years ended December 31, 1995, 1996 and 1997, respectively.
These increases were primarily due to the Company's losses from operations for
such periods and the valuation allowance for the net operating loss
carryforwards acquired in the 1995 mergers with Triplex and Oncologix (See Note
4). The Company has not made any federal income tax payments since inception.

9.       LICENSE, RESEARCH AND DEVELOPMENT AGREEMENTS

          The Company has two exclusive license agreements with MD Anderson
which may be terminated in the event of a material breach of the terms of the
agreement or for failure to convert the licensed subject matter to a commercial
form. However, the Company believes its ongoing research and development efforts
currently satisfy this obligation to commercialize.

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

         For the years ended December 31, 1995, 1996 and 1997, the Company paid
MD Anderson $392,000, $144,000, and $108,000, respectively, for research
performed on behalf of the Company.

          The Company entered into a non-exclusive license agreement to use a
patented process in the manufacture, use and sale of certain of Aronex
Pharmaceuticals' products in 1993 with an initial fee of $30,000. Annual royalty
payments





                                      F-19
<PAGE>   53

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

by the Company are to be computed as a percentage of sales, as defined in the
agreement. The royalty payments shall not exceed $1 million in a calendar year
and expire upon expiration of the licensed patents.

          In 1993, the Company entered into a license and development agreement
with Genzyme to develop and commercialize ATRAGEN(R). The initial focus of the
collaboration was the development of ATRAGEN for the treatment of myelogenous
leukemias and certain non-hematologic cancers. The Company and Genzyme shared
clinical development responsibilities and research program funding through the
end of 1996. Under the agreement, Genzyme was required to make up to $1.5
million in milestone payments to the Company upon the occurrence of certain
events and to pay the Company royalties on sales of the product. Genzyme had the
right to terminate the agreement in the event of a third party claim of
infringement by products subject to the agreement. The Company had the right to
terminate the agreement if Genzyme failed to satisfy certain milestones. In
connection with the collaborative agreement, Genzyme made a net $4.5 million
equity investment in the Company and agreed to make an additional $5.0 million
equity investment in the Company if certain developmental goals were achieved.

          In September 1996, Genzyme advanced Aronex Pharmaceuticals $2.0
million relating to the $5.0 million equity milestone. In early 1997, the
license and development agreement was amended and Genzyme was released from any
further obligation to perform development work for ATRAGEN. Under the amendment,
the license granted to Genzyme was converted to an option to acquire the right
to market and sell ATRAGEN worldwide (with the Company retaining co-promotion
rights in the United States). Genzyme is required to pay the Company $3.0
million no more than six months after the filing of an NDA for ATRAGEN to
exercise the option, and would thereafter be required to pay royalties on sales
of ATRAGEN. Aronex Pharmaceuticals has the right to re-acquire the marketing
rights at any time within the six months following Genzyme's exercise of the
option by returning Genzyme's $3.0 million option exercise payment, repaying
Genzyme's $2.0 million advance and paying royalties on sales of ATRAGEN,
including $500,000 in minimum royalties in the first year. If Genzyme does not
exercise its option, Aronex Pharmaceuticals is required to repay Genzyme the
$2.0 million advance and to pay royalties on sales of ATRAGEN, including
$500,000 in minimum royalties in the first year following the expiration of the
option.

          In 1996, the Company entered into a license agreement with Boehringer
Mannheim to develop and commercialize one of the Company's products, AR209.
Under the agreement, Boehringer Mannheim is responsible for funding the costs of
all remaining preclinical and clinical development of AR209 and for
manufacturing the product. Boehringer Mannheim paid the Company $150,000 in
license fees in connection with this agreement in 1997 and has agreed to pay
minimum annual license fees of $100,000 during the term of the agreement. In
addition, Boehringer Mannheim is required to pay Aronex Pharmaceuticals up to
$2.65 million in milestone payments upon the occurrence of certain events and
will pay Aronex Pharmaceuticals royalties on sales of the product. Aronex
Pharmaceuticals has the option to co-promote the product under terms to be
negotiated by the parties or to co-market the product if the parties are unable
to reach an agreement as to the terms of a co-promotion arrangement. Boehringer
Mannheim has the right to terminate the agreement if the costs of developing
AR209 are materially greater than anticipated and Boehringer Mannheim
determines, in its reasonable discretion, not to proceed with the development of
the product in light of such increased costs. The Company has the right to
terminate the agreement if Boehringer Mannheim fails to achieve certain
milestones.

10.       COMMITMENTS AND CONTINGENCIES

          The Company leases laboratory and office space under operating leases
and certain office equipment on a short-term basis. In 1997, the Company entered
into a lease for a building from its current landlord who was a related party
until late in 1997. Under this lease, the Company has committed to lease 30,000
square feet for ten years beginning in January 1998. Rental expense was
approximately $208,000, $268,000, and $236,000 for the years ended December 31,
1995, 1996 and 1997, respectively.





                                      F-20
<PAGE>   54

                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


         Future minimum noncancellable payments under operating leases at
December 31, 1997 are as follows:

<TABLE>
<CAPTION>
                  YEAR ENDING
                  DECEMBER 31,           AMOUNT
                  ------------         -----------
<S>                                   <C>
                      1998             $   698,000
                      1999                 714,000
                      2000                 714,000
                      2001                 714,000
                      2002                 712,000
                   Thereafter            3,570,000
                                       -----------
                      Total            $ 7,122,000
                                       ===========
</TABLE>

         The Company is subject to numerous risks and uncertainties because of
the nature of and status of its operations. The Company maintains insurance
coverage for events and in amounts that it deems appropriate. Management
believes that uninsured losses, if any, will not be materially adverse to the
Company's financial position or results of operations.

11.       RELATED PARTY TRANSACTIONS AND EMPLOYMENT AGREEMENTS

         In September 1995, the Company entered into an employment agreement
with an officer of the Company, for an initial term of one year. This officer
terminated his employment on January 15, 1998 and the Company is obligated to
pay his monthly salary of $19,583 and certain benefits for a period of twelve
months after termination.

         During 1995, 1996 and 1997, the Company entered into employment
agreements with its chief executive officer and other officers which have
initial termination dates ranging from 1998 to 2000. The agreements are
thereafter automatically renewed for successive periods of twelve to eighteen
months unless terminated by either party. Such agreements provide that in the
case of termination without cause, the officers are entitled to payments ranging
from one hundred to one hundred and fifty percent of their annual salaries.
Under these agreements the Company is committed to pay certain relocation costs
and an amount equal to the federal income tax liability relating to a portion of
the taxable relocation costs. Additionally, one of these officers has an
outstanding loan with the Company with a balance of approximately $18,000 at
December 31, 1997. This loan will be repaid over the next three years. Current
annual salaries relating to these agreements total $1,017,000 at December 31,
1997.

         In February 1998, the Company amended a consulting agreement with the
Company's chief scientific advisor for a three-year period ending December 31,
2000, whereby the Company is committed to pay consulting fees of $156,000 per
year through December 31, 2000. One-half of the amount to be paid over the next
three years will be paid in cash and one-half will be paid in Company Common
Stock. The Company paid cash of $132,000, $144,000, and $156,000 for the years
ended December 31, 1995, 1996 and 1997, respectively, pursuant to this
agreement.

         During 1995 and 1996, the Company paid $28,500 and $2,500,
respectively, in consulting fees to a consulting firm which is wholly-owned by a
former member of the Board of Directors.

12.       401(K) PLAN

         Under a 401(k) plan, employees can contribute up to 20% of their
compensation subject to limitations as defined by the Internal Revenue Service.
The Company matches 25% of each employee's contributions up to a maximum of
$1,000 per employee per year. The Company contributed approximately $25,800,
$40,000 and $45,700 in matching contributions for the years ended December 31,
1995, 1996 and 1997, respectively.






                                      F-21
<PAGE>   55


                          ARONEX PHARMACEUTICALS, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

13.      EMPLOYEE STOCK PURCHASE PLAN

         In December 1996, the Board of Directors adopted the 1997 Employee
Stock Purchase Plan and reserved 250,000 shares of Common Stock for issuance
thereunder. The plan permits employees to purchase Common Stock through payroll
deductions of up to 15% of their compensation subject to limitations as defined
by the Internal Revenue Service. Purchases of Common Stock are made at the lower
of 85% of fair market value at the beginning or end of each six-month offering
period. In 1997, 21,292 shares were purchased by employees at $3.31 and $3.19
per share.




                                      F-22
<PAGE>   56
                              INDEX TO EXHIBITS

<TABLE>
<CAPTION>
       EXHIBIT
       NUMBER                           DESCRIPTION
       -------                          -----------
<S>               <C>
         3.1      Restated Certificate of Incorporation, as amended. Exhibit 3.1
                  to the Company's Quarterly Report on Form 10-Q for the quarter
                  ended June 30, 1997 (the "June 1997 Form 10-Q") is
                  incorporated herein by reference.

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

         4.1      Specimen certificate for shares of Common Stock, par value
                  $.001 per share. Exhibit 4.1 to the Company's Quarterly Report
                  on Form 10-Q for the fiscal quarter ended June 30, 1996 is
                  incorporated herein by reference.

         10.1     Registration Rights Agreement dated August 2, 1989, by and
                  among the Company and certain of its stockholders. Exhibit
                  10.2 to the 1992 Registration Statement is incorporated herein
                  by reference.

         10.2     First Amendment to Registration Rights Agreement dated April
                  18, 1990, by and among the Company and certain of its
                  stockholders. Exhibit 10.3 to the 1992 Registration Statement
                  is incorporated herein by reference.

         10.3     Second Amendment to Registration Rights Agreement dated
                  October 31, 1991, by and among the Company and certain of its
                  stockholders. Exhibit 10.4 to the 1992 Registration Statement
                  is incorporated herein by reference.

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

         10.5     Fourth Amendment to Registration Rights Agreement dated
                  January 20, 1994, among the Company and certain of its
                  stockholders. Exhibit 10.28 to the Company's Annual Report on
                  Form 10-K for the year ended December 31, 1993 (the "1993 Form
                  10-K") is incorporated herein by reference.

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

         10.7++   Amended and Restated 1993 Non-Employee Director Stock Option
                  Plan. Exhibit 10.2 to the June 1997 Form 10-Q is incorporated
                  herein by reference.
</TABLE>


<PAGE>   57

<TABLE>
<CAPTION>
       EXHIBIT
       NUMBER                           DESCRIPTION
       -------                          -----------
<S>               <C>
         10.8**   Exclusive License Agreement dated October 15, 1986, between
                  the Company, The University of Texas System Board of Regents
                  and The University of Texas M. D. Anderson Cancer Center.
                  Exhibit 10.8 to the 1992 Registration Statement is
                  incorporated herein by reference.

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

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

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

         10.12    Amendment No. 2 to Exclusive License Agreement dated July 9,
                  1993, among the Company, The University of Texas System Board
                  of Regents and The University of Texas M. D. Anderson Cancer
                  Center. Exhibit 10.20 to the 1993 Registration Statement is
                  incorporated herein by reference.

         10.13    Sponsored Laboratory Study Agreement dated July 9, 1993,
                  between the Company and The University of Texas M. D. Anderson
                  Cancer Center. Exhibit 10.21 to the 1993 Registration
                  Statement is incorporated herein by reference.

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

         10.15    Form of Key Management Proprietary Information and Inventions
                  and Noncompetition Agreement. Exhibit 10.23 to the 1992
                  Registration Statement is incorporated herein by reference.

         10.16    Form of Proprietary Information and Inventions Agreement.
                  Exhibit 10.24 to the 1992 Registration Statement is
                  incorporated herein by reference.

         10.17    Stock Purchase Warrant dated March 29, 1990, from the Company
                  in favor of Pacific Venture Finance, Inc. Exhibit 10.28 to the
                  1992 Registration Statement is incorporated herein by
                  reference.

         10.18    Master Loan and Security Agreement dated March 1, 1993,
                  between the Company and MMC/GATX Partnership No. 1. Exhibit
                  10.21 to the Company's Annual Report on Form 10-K for the
                  fiscal year Ended December 31, 1993 (the "1993 Form 10-K") is
                  incorporated herein by reference.
</TABLE>



<PAGE>   58


<TABLE>
<CAPTION>
       EXHIBIT
       NUMBER                           DESCRIPTION
       -------                          -----------
<S>               <C>
         10.19    Common Stock Purchase Warrant dated June 28, 1993 from the
                  Company in favor of MMC/GATX Partnership No. 1. Exhibit 10.22
                  to the 1993 Form 10-K is incorporated herein by reference.

         10.20    Common Stock Purchase Warrant dated March 21, 1994 from the
                  Company in favor of MMC/GATX Partnership No. 1. Exhibit 10.4
                  to the Company's Quarterly Report on Form 10-Q for the quarter
                  ended March 31, 1994 (the "March 1994 Form 10-Q") is
                  incorporated herein by reference.

         10.21    Common Stock Purchase Warrant dated January 27, 1994 from the
                  Company in favor of Vector Securities International, Inc.
                  Exhibit 10.29 to the 1993 Form 10-K is incorporated herein by
                  reference.

         10.22    License and Development Agreement dated September 10, 1993,
                  between the Company and Genzyme Corporation. Exhibit 10.22 to
                  the 1993 Registration Statement is incorporated herein by
                  reference.

         10.23**  Common Stock Purchase Agreement dated September 10, 1993,
                  between the Company and Genzyme Corporation. Exhibit 10.23 to
                  the 1993 Registration Statement is incorporated herein by
                  reference.

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

         10.25    Amendment No. 2 to Stock Purchase Agreement dated September
                  10, 1996, between the Company and Genzyme Corporation. Exhibit
                  10.2 to the September 1996 Form 10-Q is incorporated herein by
                  reference.

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

         10.27    Amendment No. 3 to Common Stock Purchase Agreement dated March
                  25, 1997, between the Company and Genzyme Corporation. Exhibit
                  10.2 to the March 1997 Form 10-Q is incorporated herein by
                  reference.

         10.28    Licensing Agreement dated December 7, 1996, between the
                  Company and Boehringer Mannheim GmbH. Exhibit 10.51 to the
                  Company's Annual Report on Form 10-K for the fiscal year ended
                  December 31, 1996 is incorporated herein by reference.

         10.29*   Plan and Agreement of Merger dated February 22, 1995, among
                  Triplex Pharmaceutical Corporation, Argus Pharmaceuticals,
                  Inc. and API Acquisition Company No. 1. Exhibit 1.1 to the
                  Company's Current Report on Form 8-K dated February 22, 1995
                  (the "February 1995 Form 8-K") is incorporated herein by
                  reference.

         10.30    Form of Certificate of Contingent Interest. Exhibit 1.2 to the
                  February 1995 Form 8-K is incorporated herein by reference.

</TABLE>



<PAGE>   59

<TABLE>
<CAPTION>
       EXHIBIT
       NUMBER                           DESCRIPTION
       -------                          -----------
<S>               <C>
         10.31*   Agreement and Plan of Merger dated February 22, 1995, among
                  Oncologix, Inc., the Company and API Acquisition Company No.
                  2. Exhibit 1.7 to the February 1995 Form 8-K is incorporated
                  herein by reference.

         10.32    Form of Warrant. Exhibit 1.8 to the February 1995 Form 8-K is
                  incorporated herein by reference.

         10.33*   Agreement between Oncologix and HCV Group. Exhibit 1.9 to the
                  February 1995 Form 8-K is incorporated herein by reference.

         10.34    Exchange Agreement dated December 12, 1995, among the Company,
                  Health Care Ventures I, L.P., Health Care Ventures II, L.P.,
                  Health Care Ventures III, L.P. and Health Care Ventures IV,
                  L.P. Exhibit 1.2 to the Company's Current Report on Form 8-K
                  dated December 12, 1995 is incorporated herein by reference.

         10.35++  Third Amendment to Consulting Agreement dated March 15, 1994,
                  between the Company and Gabriel Lopez-Berestein. Exhibit 10.3
                  to the March 1994 Form 10-Q is incorporated herein by
                  reference.

         10.36++  Employment Agreement dated December 5, 1996, between the
                  Company and Praveen Tyle, Ph.D. Exhibit 10.3 to the March
                  1997 Form 10-Q is incorporated herein by reference.

         10.37++  Employment Agreement dated March 12, 1997, between the
                  Company and David S. Gordon, M.D. Exhibit 10.4 to the March
                  1997 Form 10-Q is incorporated herein by reference.

         10.38++  Employment Agreement dated July 28, 1997, between the
                  Company and Janet Walter. Exhibit 10.1 to the Company's
                  Quarterly Report on Form 10-Q for fiscal quarter ended
                  September 30, 1997 is incorporated herein by reference.

         10.39++  Employment Agreement dated November 3, 1997 between the
              +   Company and Geoffrey Cox, Ph.D.

         10.40++  Form of Employment Agreement with James M. Chubb, Ph.D.
                  Exhibit 10.46 to the Merger Registration Statement is
                  incorporated herein by reference.

         10.41    Lease Agreement dated April 4, 1997, between the Company and
                  The Woodlands Corporation. Exhibit 10.3 to the June 1997 Form
                  10-Q is incorporated herein by reference.

         11.1+    Statement regarding computation of loss per share.

         23.1+    Consent of Arthur Andersen LLP.

         27.1+    Financial Data Schedule.

</TABLE>


---------------
+        Filed herewith.

++       Management contract or compensatory plan or arrangement.

*        These agreements omit certain exhibits and schedules. The Company will
         provide a copy of any omitted exhibit or schedule upon request.

**       The Company has omitted certain portions of these agreements in
         reliance upon Rule 406 under the Securities Act.