<PAGE>
 
================================================================================

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC 20549

                                   FORM 10-Q
                                        
(Mark One)
  [X]          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
               FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998

                                      or

  [_]         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
     FOR THE TRANSITION PERIOD FROM ________________ TO __________________

                          Commission File No. 0-19651
                          ---------------------------
                                        

                         MAGAININ PHARMACEUTICALS INC.
                         -----------------------------
             (Exact name of registrant as specified in its charter)


     DELAWARE                                             13-3445668
     --------                                             ----------
     (State or other jurisdiction of                   (IRS Employer
     incorporation or organization)            Identification Number)

     5110 CAMPUS DRIVE
     Plymouth Meeting, Pennsylvania                            19462
     ------------------------------                            -----
     (Address of principal executive offices)              (ZIP Code)


                                 610-941-4020
                                 ------------
             (Registrant's telephone number, including area code)


Indicate by check mark whether the Registrant (1) has filed all reports to be
filed by Section 13 of 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 _____
                                   ----

The number of outstanding shares of the Registrant's Common Stock, par value
$.002 per share, on October 30, 1998 was 22,289,863.

================================================================================
<PAGE>
 
                         MAGAININ PHARMACEUTICALS INC.

                                     INDEX
--------------------------------------------------------------------------------

<TABLE> 
<CAPTION> 
                                                                                    Page
                                                                                    ----
<S>                                                                                 <C> 
Part I -    FINANCIAL INFORMATION
 
  ITEM 1.   Financial Statements
            (unaudited)
 
            Balance Sheets
            as of September 30, 1998 and December 31, 1997                            3
 
            Statements of Operations
            for the three and nine months ended September 30, 1998 and                4
            September 30, 1997
 
            Statements of Cash Flows
            for the nine months ended September 30, 1998 and September 30, 1997       5
 
            Notes to Financial Statements                                             6


  ITEM 2.   Management's Discussion and Analysis
            of Results of Operations and Financial Condition                         10


PART II -   OTHER INFORMATION                                                        15
</TABLE> 

                                       2


                         
<PAGE>
 
                         MAGAININ PHARMACEUTICALS INC.
                                BALANCE SHEETS
                  (In thousands -- except per share amounts)

<TABLE>
<CAPTION>
                                                                          SEPTEMBER 30, 1998        DECEMBER 31, 1997
                                                                          ------------------        -----------------
                                                                                 (Unaudited)
<S>                                                                       <C>                       <C> 
Assets
Current assets:
 Cash and cash equivalents                                                      $     806                $     487
 Short-term investments                                                            24,227
                                                                                                            38,574
 Prepaid expenses and other current assets                                            299                      490
                                                                                ---------                ---------
          Total current assets                                                     25,332                   39,551
 
Fixed assets, net                                                                   3,026                    2,824
Other assets                                                                           98                       69
                                                                                ---------                ---------
          Total assets                                                          $  28,456                $  42,444
                                                                                =========                =========
 
Liabilities and Stockholders' Equity
Current liabilities:
 Accounts payable and accrued expenses                                          $   8,317                $   5,944
 Current portion of note payable                                                        -                      500
 Current portion of capital lease obligations                                           -                       34
                                                                                ---------                ---------
          Total current liabilities                                                 8,317                    6,478
 
Note payable                                                                        2,500                    1,000
Deferred rent                                                                          69                       96
                                                                                ---------                ---------
          Total liabilities                                                        10,886                    7,574
                                                                                ---------                ---------
 
Commitments, contingencies and other matters
 
Stockholders' equity:
 Preferred stock -- $.001 par value; 9,211 shares authorized,
    none issued                                                                         -                        -
 Common stock -- $.002 par value; 45,000 shares authorized,
    22,290 and 21,980 shares issued and outstanding                                    45                       44
 Additional paid-in capital                                                       145,541                  144,444
 Accumulated other comprehensive income                                                 1                        6
 Accumulated deficit                                                             (128,017)                (109,624)
                                                                                ---------                ---------
          Total stockholders' equity                                               17,570                   34,870
                                                                                ---------                ---------
 
          Total liabilities and stockholders' equity                            $  28,456                $  42,444
                                                                                =========                =========
 </TABLE>

                      See Notes to Financial Statements.

                                       3
<PAGE>
 
                         MAGAININ PHARMACEUTICALS INC.
                           STATEMENTS OF OPERATIONS
                                  (unaudited)
                  (In thousands -- except per share amounts)

<TABLE>
<CAPTION>
 
 
                                           THREE MONTHS ENDED                NINE MONTHS ENDED
                                              SEPTEMBER 30,                     SEPTEMBER 30,
                                     ------------------------------     ---------------------------
                                           1998             1997             1998            1997
                                          ------           ------           ------          ------  
<S>                                  <C>                   <C>          <C>                 <C>
Revenues:
     Contract revenues                    $    --          $    13         $     --          $10,088
 
 
Costs and expenses:
     Research and development               5,138            6,327           17,042           16,864
     General and administrative               668              826            2,547            2,475
                                          -------          -------         --------          -------
                                            5,806            7,153           19,589           19,339
                                          -------          -------         --------          -------
 
Loss from operations                       (5,806)          (7,140)         (19,589)          (9,251)
 
Interest income                               393              431            1,336            1,301
Interest expense                              (56)             (29)            (140)             (73)
                                          -------          -------         --------          -------
                                              337              402            1,196            1,228
                                          -------          -------         --------          -------
 
Loss                                      $(5,469)         $(6,738)        $(18,393)         $(8,023)
                                          =======          =======         ========          =======
 
Loss per share - basic                      $(.25)           $(.35)           $(.83)           $(.41)
                                          =======          =======         ========          =======
 
Weighted average shares outstanding        22,287           19,369           22,213           19,366
                                          =======          =======         ========          =======
</TABLE>

                       See Notes to Financial Statements.

                                       4
<PAGE>
 
                         MAGAININ PHARMACEUTICALS INC.
                           STATEMENTS OF CASH FLOWS
                                  (unaudited)
                                (In thousands)
 
<TABLE> 
<CAPTION> 
                                                                                 NINE MONTHS ENDED
                                                                                   September 30,
                                                                           ----------------------------
                                                                             1998                1997
                                                                           --------            --------
<S>                                                                       <C>                 <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:
 Loss                                                                     $(18,393)           $ (8,023)
 Adjustments to reconcile loss to                                         
  net cash used in operating activities:                                  
   Depreciation and amortization                                               842                 709
   Issuance of common stock under manufacturing                           
     agreement                                                                 859                  --
   Compensation expense under stock grants                                     100                  --
   Deferred rent                                                               (27)                (23)
  Changes in operating assets:                                            
   (Increase) decrease in prepaid expenses and                            
    other assets                                                              (421)                 22
   Increase (decrease) in accounts payable and                            
    accrued expenses                                                         2,373                (172)
                                                                          --------            --------
                                                                          
   Net cash used in operating activities                                   (14,667)             (7,487)
                                                                          --------            --------
                                                                          
CASH FLOWS FROM INVESTING ACTIVITIES:                                     
 Purchases of investments                                                  (33,980)            (37,426)
 Proceeds from maturities and sales of investments                          48,900              43,934
 Purchase of fixed assets                                                   (1,044)             (1,206)
                                                                          --------            --------
                                                                          
   Net cash provided by (used in) investing activities                      13,876               5,302
                                                                          --------            --------
                                                                          
CASH FLOWS FROM FINANCING ACTIVITIES:                                     
 Proceeds from borrowings under note payable                                 1,000                 500
 Payments on capital lease obligations                                         (28)                (97)
 Proceeds from exercise of employee stock options and warrants                 138                  75
                                                                          --------            --------
                                                                          
   Net cash provided by (used in) financing activities                       1,110                 478
                                                                          --------            --------
                                                                          
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                           319              (1,707)
                                                                          
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                 487               2,072
                                                                          --------            --------
                                                                          
CASH AND CASH EQUIVALENTS, END OF PERIOD                                  $    806            $    365
                                                                          ========            ========
                                                                          
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                         
Cash paid for interest during the period                                  $    133            $     72
                                                                          ========            ========
</TABLE>

                      See Notes to Financial Statements.

                                       5
<PAGE>
 
                         MAGAININ PHARMACEUTICALS INC.
                         Notes To Financial Statements
                                  (unaudited)

1.   COMPANY BACKGROUND

     Magainin Pharmaceuticals Inc. (the "Company") was incorporated on June 29,
1987.  The Company is a biopharmaceutical company engaged in the development of
medicines for serious diseases.  The Company's development efforts are focused
on anti-infectives, oncology, and pulmonary and allergic disorders.

     The Company has submitted a New Drug Application ("NDA") with the United
States Food and Drug Administration ("FDA") for its lead product development
candidate, pexiganan acetate (formerly called "Cytolex"), a topical cream
antibiotic intended for the treatment of infection in diabetic foot ulcers.  The
Company is also conducting research on an aminosterol class of compounds.  One
such compound, squalamine, is currently being evaluated in Phase I clinical
testing in cancer.  The Company conducts additional research efforts in the
genomics of asthma.

     The Company has not generated any revenues from product sales, and has
funded operations primarily from the proceeds of public and private placements
of securities. Substantial financing will be required by the Company to fund its
continuing research and development activities. There can be no assurance that
such financing will be available when needed or that the Company's research and
development efforts will be successful.

2.   BASIS OF PRESENTATION

     The accompanying financial statements are unaudited and have been prepared
by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC"). The December 31, 1997 balance sheet was derived
from audited financial statements, however, certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to SEC rules and regulations. The Company believes that the financial
statements include all adjustments of a normal and recurring nature necessary to
present fairly the results of operations, financial position, changes in
stockholders' equity and cash flows for the periods presented. Results of
operations for interim periods are not necessarily indicative of those to be
achieved for full fiscal years. These financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997. There
have been no material changes in accounting policies from those stated in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.

3.   NOTE PAYABLE

     The Company has entered into a credit arrangement with a commercial bank.
Borrowings under this credit arrangement bear interest at rates ranging from the
prime rate minus one quarter percent to 8.5%.  As of September 30, 1998, the
Company had borrowed $2,500,000 under this credit arrangement, including
$1,000,000 borrowed during the nine months ended September 30, 1998.  Any
amounts outstanding under this credit arrangement shall become immediately due
and payable under certain circumstances, including the failure by the Company to
maintain certain minimum cash and investment balances, as well as certain
financial ratios.  Under the terms of the credit arrangement, the Company makes
monthly interest-only payments with all principal due in May 1999.

     Although the entire outstanding principal balance is due within one year
from the balance sheet date, the Company has classified the entire $2,500,000
balance as long-term debt under the provisions of Statement of Financial
Accounting Standards No. 6, "Classification of Short Term Obligations Expected
to be Refinanced" ("SFAS 6"). In this regard, the Company has negotiated an
agreement with its commercial bank which permits the Company to refinance the
entire outstanding loan balance on a long-term basis. The terms of the
refinancing agreement are substantially the same as those in the Company's
existing credit arrangement, except that repayment is required on a date which
will be not less than one year and one day from May 1, 1999. The Company intends
to execute this agreement on or before May 31, 1999.

                                       6
<PAGE>
 
4.   STOCKHOLDERS' EQUITY

     The changes in stockholders' equity from December 31, 1997 to September 30,
1998 are summarized as follows:

<TABLE>
<CAPTION>
                                               COMMON STOCK
                                                                    ADDITIONAL                                 OTHER
                                           NUMBER                    PAID-IN           ACCUMULATED         COMPREHENSIVE
                                         OF SHARES       AMOUNT      CAPITAL             DEFICIT              INCOME
                                         ---------       ------     ----------         ------------        ------------- 
<S>                                      <C>             <C>        <C>                <C>                 <C> 
Balance at December 31, 1997                21,980        $  44       $144,444          $  (109,624)        $          6
Fair value of shares issued under                                                                                    
 manufacturing agreement                       125           --            859                   --                   --
Exercise of employee stock                                                                                           
 options and warrants                          177            1            138                   --                   --
Compensation expense under                                                                                           
 stock grants                                    8           --            100                   --                   --
Unrealized loss on short-term                                                                                        
 investments                                    --           --             --                   --                   (5)
Loss                                            --           --             --              (18,393)                  --
                                         ---------       ------     ----------         ------------        ------------- 
                                                                                                                     
Balance at September 30, 1998               22,290        $  45       $145,541          $  (128,017)        $          1
                                         ---------       ------     ----------         ------------        ------------- 
</TABLE>

     Effective January 1, 1998 the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes standards for the reporting of comprehensive income and its
components. Comprehensive income consists of reported net income or loss and
"other comprehensive income" (i.e. other gains and losses affecting
stockholders' equity that, under generally accepted accounting principals, are
excluded from net income or loss as reported on the statement of operations).
With regard to the Company, other comprehensive income consists of unrealized
gains and losses on marketable securities. The adoption of SFAS 130 affects only
the presentation of the Company's balance sheet, and does not affect the
Company's reported results of operations or cash flows.

     The components of the Company's total comprehensive loss for the periods
noted are summarized as follows:

<TABLE>
<CAPTION>
                                                              THREE MONTHS                    NINE MONTHS
                                                                  ENDED                          ENDED
                                                              SEPTEMBER 30,                  SEPTEMBER 30,
                                                       ----------------------------     ------------------------
                                                               1998           1997           1998          1997
                                                            -------        -------       --------       -------
<S>                                                    <C>                 <C>          <C>             <C>
Loss                                                        $(5,469)       $(6,738)      $(18,393)      $(8,023) 
                                                                                                                 
Other comprehensive income:
 Unrealized gain (loss)on securities held for sale              (31)             3             (5)            4
                                                            -------        -------       --------       -------
 
Total comprehensive loss                                    $(5,500)       $(6,735)      $(18,398)      $(8,019)
                                                            -------        -------       --------       -------
</TABLE>

                                       7
<PAGE>
 
5.    MANUFACTURING AGREEMENT

     The Company is working with Abbott Laboratories ("Abbott") with regard to
the manufacture by Abbott of bulk drug substance for pexiganan acetate. The
Company's prior development arrangement with Abbott provides for the issuance by
the Company to Abbott of up to 500,000 shares of the Company's common stock and
the obligation to pay a royalty on any future sales of pexiganan acetate. Stock
issuances by the Company to Abbott will result in a charge to earnings,
representing the fair value of the shares when issued. As of September 30, 1998,
the Company has issued 250,000 shares of common stock to Abbott, including
125,000 shares issued during the nine months ended September 30, 1998. The
issuance of such shares resulted in the recording of an earnings charge of
$859,000 in the nine months ended September 30, 1998. Future stock issuances are
related to the achievement by Abbott of contractual performance milestones.

     The Company expects to finalize an agreement with Abbott initially
providing for the purchase of approximately $10.0 million of bulk drug substance
for pexiganan acetate. As FDA approval of pexiganan acetate has not occurred,
this will result in charges to research and development expense in 1998 and
1999. However, there can be no assurance that such agreement will be
successfully negotiated. The Company is currently dependent upon Abbott for the
production of bulk drug substance for pexiganan acetate. In the event that bulk
drug substance for pexiganan acetate is not manufactured at Abbott, the Company
will need to secure other manufacturing arrangements. This would require
substantial funds and would also result in delays in the introduction of
pexiganan acetate to the market. The process developed by Abbott is proprietary,
and in the event the Company desires to utilize, or have another party utilize,
such proprietary technology the Company would be required to make license
payments to Abbott.

     Further progress in scale-up and manufacturing development efforts will be
required to enable the Company to manufacture and sell pexiganan acetate on a
substantially profitable basis.  This will require substantial additional funds.
The Company has certain efforts under way with respect to alternative
manufacturing sources, including recombinant manufacturing; however, these
programs are at an early stage and significant expenditures over a period of
time will be required to develop a commercially viable process.  No assurance
can be given that a cost-effective manufacturing process can ultimately be
developed, or that any such process would be approved by the FDA, or that the
Company, Abbott or another entity will be able to manufacture pexiganan acetate
on a commercially viable basis.

6.   COLLABORATIVE AGREEMENT

     In February 1997, the Company entered into a development, supply and
distribution agreement (the "SB Agreement") in North America with SmithKline
Beecham ("SB") for pexiganan acetate.  To date, SB has paid the Company $10.0
million under the SB Agreement, all of which was received by the Company in the
nine months ended September 30, 1997. SB may make additional payments to the
Company of up to $22.5 million upon the occurrence of certain product
milestones.  SB will also fund a percentage of any development expenses for any
additional indications for pexiganan acetate.  Upon the commencement of
commercial sales by SB, the Company will be responsible for the supply of
pexiganan acetate and SB will be responsible for the marketing and sale of
pexiganan acetate.  The Company will receive certain percentages of SB sales
revenues under agreed upon terms.  The SB Agreement also gives SB the right to
negotiate for rights to another of the Company's product development candidate
under certain terms and conditions.  The SB Agreement gives SB the right to
terminate on a country-by-country basis if SB determines it is not economical to
distribute pexiganan acetate in such areas.

                                       8
<PAGE>
 
7.   ACCOUNTS PAYABLE AND ACCRUED EXPENSES

     Accounts payable and accrued expenses consist of the following (in
      thousands):

<TABLE>
<CAPTION>
                                                               SEPTEMBER 30,         DECEMBER 31,
                                                                   1998                  1997
                                                            -------------------  ---------------------
<S>                                                         <C>                  <C>
          Accounts payable                                               $  131                 $  215
          Clinical and regulator                                            926                  1,197
          Manufacturing costs                                             5,867                  3,507
          Preclinical costs                                                 284                    338
          Professional fees                                                 195                    258
          Other                                                             914                    429
                                                                         ------                 ------
                                                                         $8,317                 $5,944
                                                                         ======                 ======
</TABLE>

                                       9
<PAGE>
 
ITEM 2.

                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 RESULTS OF OPERATIONS AND FINANCIAL CONDITION


     This report contains, in addition to historical information, statements by
the Company with regard to its expectations as to financial results and other
aspects of its business that involve risks and uncertainties and may constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements reflect management's current
views and are based on certain assumptions. Actual results could differ
materially from those currently anticipated as a result of a number of factors,
including, but not limited to, the risks and uncertainties discussed in this
report, as well as those discussed under "Risk Factors" set forth in Item 1 of
the Company's Annual Report on Form 10-K for the year ended December 31, 1997 as
filed with the Securities and Exchange Commission. Given these uncertainties,
current or prospective investors are cautioned not to place undue reliance on
any such forward-looking statements. Furthermore, the Company disclaims any
obligation or intent to update any such factors or forward-looking statements to
reflect future events or developments.

GENERAL

     Magainin Pharmaceuticals Inc. (the "Company") is a biopharmaceutical
company engaged in the development of medicines for serious diseases. The
Company's development efforts are focused on anti-infectives, oncology, and
pulmonary and allergic disorders.

     The Company has submitted a New Drug Application ("NDA") with the United
States Food and Drug Administration ("FDA") for its lead product development
candidate, pexiganan acetate (formerly called "Cytolex"), a topical cream
antibiotic intended for the treatment of infection in diabetic foot ulcers.  The
Company is also conducting research on an aminosterol class of compounds.  One
such compound, squalamine, is currently being evaluated in Phase I clinical
testing in cancer.  The Company conducts additional research efforts in the
genomics of asthma.

     Since commencing operations in 1988, the Company has not generated any
revenue from product sales. The Company has funded operations primarily from the
proceeds of public and private placements of securities. The Company has
incurred a loss in each year since its inception, and expects to incur
substantial additional losses for at least the next several years. The Company
expects that losses will fluctuate from quarter to quarter, and that such
fluctuations may be substantial. As such, results of operations for interim
periods are not necessarily indicative of those to be achieved for full fiscal
years. At September 30, 1998, the Company's accumulated deficit was
approximately $128,017,000.


RESULTS OF OPERATIONS
REVENUES

     The Company has received no revenue from product sales. Revenues recorded
to date have consisted principally of revenues recognized under collaborations
with corporate partners. During the nine months ended September 30, 1997 the
Company recorded revenue of $10,000,000 reflecting the receipt of payments under
a development, supply and distribution agreement (the "SB Agreement") entered
into in February, 1997 with SmithKline Beecham ("SB") for pexiganan acetate. The
Company does not expect to realize additional milestone revenues from its
arrangement with SB until FDA approval of pexiganan acetate. However, there can
be no assurance that pexiganan acetate will be approved by the FDA. The Company
has no other currently existing collaborations which could result in the
realization of research and development revenues.

                                       10
<PAGE>
 
RESEARCH AND DEVELOPMENT EXPENSES

     Research and development expenses decreased in the three month period ended
September 30, 1998 as compared to the same period a year ago due principally to
a reduction in clinical and preclinical costs associated with pexiganan acetate
and squalamine.

     Research and development expenses were generally the same in the nine month
period ended September 30, 1998 as compared to the same period a year ago.  The
Company recorded a non-cash charge to earnings of approximately $859,000 related
to the issuance of 125,000 shares of common stock by the Company pursuant to its
manufacturing development arrangement with Abbott Laboratories ("Abbott") in the
nine months ended September 30, 1998.

     The level of research and development expenses in future periods will
depend principally upon the progress of research programs at the Company.
Expenses relating to the development of pexiganan acetate are expected to
continue to be significant in future periods principally as a result of the
Company's ongoing manufacturing programs.


GENERAL AND ADMINISTRATIVE EXPENSES

     General and administrative expenses consist principally of personnel costs
and professional fees and have decreased for the three month period ended
September 30, 1998, as compared to a year ago, due principally to decreases in
personnel expenses. The Company expects general and administrative expenses to
increase in future periods to the extent the Company's level of activity
increases.

INTEREST INCOME AND INTEREST EXPENSE


     During the three months ended September 30, 1998, interest income decreased
as compared to the same period of the prior year, due to lower investment
balances during this period. Interest income increased for the nine month period
ended September 30, 1998 as compared to the same period a year ago principally
due to higher investment balances in 1998. The increase in interest expense for
both the three and nine month periods ended September 30, 1998, as compared to
the same periods in the prior year, is due to higher debt balances.


LOSS

     The Company expects to conduct, over the next several years, significant
research, pre-clinical development, clinical testing and manufacturing
activities which, together with projected general and administrative expenses,
are expected to result in continued and significant losses.

                                       11
<PAGE>
 
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

     Cash and investments were $25,033,000 at September 30, 1998 as compared to
$39,061,000 at December 31, 1997.  The primary use of cash was to finance the
Company's operations.

     Since inception, the Company has funded its operations primarily from the
proceeds of public and private placements of securities, including $17,080,000
raised from its initial public offering in December 1991, $21,469,000 raised
from a public offering completed in February 1993, $18,023,000 raised from a
private placement completed in October 1993, $32,627,000 raised from a public
offering completed in August 1995, $11,932,000 raised from a private placement
completed in August 1996, and $19,172,000 raised from a public offering
completed in December 1997, as well as contract and grant revenues, interest
income and lease and debt financing.

     Capital expenditures amounted to $1,044,000 in the nine months ended
September 30, 1998, principally reflecting the build-out of additional
laboratory space, office and laboratory equipment purchases and construction of
leasehold improvements.

     Accounts payable and accrued expenses increased $2,373,000 to $8,317,000 at
September 30, 1998, due principally to accruals made for certain manufacturing
costs.  The Company expects an increase in accounts payable and accrued expenses
in future periods as costs for the purchase of bulk drug substance for pexiganan
acetate continue to be accrued.

     During the first half of 1998 the Company borrowed an additional $1,000,000
under a credit arrangement with a commercial bank, resulting in an increase in
note payable.  Borrowings under this credit arrangement bear interest at rates
ranging from the prime rate minus one quarter percent to 8.5%.  Any amounts
outstanding under this credit arrangement shall become immediately due and
payable under certain circumstances, including the failure by the Company to
maintain certain minimum cash and investment balances, as well as certain
financial ratios.  Under the terms of the credit arrangement, the Company makes
monthly interest-only payments, with all principal due in May 1999.

     In February 1997, the Company entered into a development, supply and
distribution agreement (the "SB Agreement") in North America with SmithKline
Beecham ("SB") for pexiganan acetate.  Through September 30, 1998, SB has paid
the Company $10,000,000 under the SB Agreement, all of which was received by the
Company during the nine months ended September 30 1997.  SB may make additional
payments to the Company of up to $22,500,000 upon the occurrence of certain
product milestones.  SB will also fund a percentage of any development expenses
for any additional indications for pexiganan acetate.  Upon the commencement of
commercial sales by SB, the Company will be responsible for the supply of
pexiganan acetate and SB will be responsible for the marketing and sales of
pexiganan acetate.  The Company will receive certain percentages of SB sales
revenues under agreed upon terms.  The SB Agreement also gives SB the right to
negotiate for rights to another of the Company's product development candidate,
under certain terms and conditions.  The SB Agreement gives SB the right to
terminate on a country-by-country basis if SB determines it is not economical to
distribute pexiganan acetate in such areas.

                                       12
<PAGE>
 
     The Company has submitted a New Drug Application ("NDA") with the FDA for
pexiganan acetate.  The NDA submission includes the results of two multi-center,
randomized, Phase III clinical equivalence trials comparing 1% pexiganan acetate
cream to ofloxacin, an oral antibiotic indicated for skin and soft tissue
infections.  The NDA, as submitted, includes data analyses for a number of
primary endpoints.  These include clinical response of infection, overall
microbiological response of infection, and therapeutic cure (a combination of
clinical and overall microbiological cures), which were analyzed over a number
of patient cohorts and timepoints.  The Company's analyses of the data showed
statistical equivalence between pexiganan acetate and ofloxacin in the majority
of such endpoints.  Although the Company believes the two pivotal trials of
pexiganan acetate yielded successful results, there can be no assurance that the
FDA will concur with the Company's analysis in this regard.  There can be no
assurance that pexiganan acetate will receive FDA approval on a timely basis, if
at all.  The failure of the Company to obtain FDA approval for pexiganan
acetate, any significant delay in obtaining such approval, or the imposition of
highly restrictive conditions on such approval, would have a material adverse
effect on the Company.

     The Company believes that its existing capital resources should be
sufficient to finance its operations into 1999. However, the Company's capital
requirements may change due to numerous factors, including the progress of the
Company's research and development programs, regulatory approvals, competitive
and technological advances, the commercial viability of the Company's products,
the terms of collaborative arrangements, if any, entered into by the Company,
and other factors, many of which are beyond the Company's control. The Company
will require substantial additional funds to continue its research and
development programs and to commercialize potential products. The Company
intends to seek such funds through a combination of future offerings of
securities and collaborative arrangements with third parties, and regularly
explores alternatives in this regard. The Company does not have any commitments
to obtain any additional funds and has no established banking arrangements
through which it can obtain additional debt financing. There can be no assurance
that future funding will be available to the Company, or if available, will be
obtainable on terms favorable to the Company. The receipt of funding, if any,
from corporate partners, including SB, will depend largely on the progress of
research and development programs. Under collaborative arrangements the Company
may convey marketing, distribution, manufacturing, development or other rights
to its proposed products to pharmaceutical companies in order to receive
financial or other assistance. This will result in lower consideration to the
Company upon commercialization of such products than if no arrangements were
entered into, or if such arrangements were entered into at later stages in the
product development process. There can be no assurance that the Company will be
able to enter into such arrangements on favorable terms, if at all.

     If the Company does not enter into appropriate collaborations, receive
additional funds from SB under its current agreement, or raise sufficient funds
from the periodic sale of securities, the Company will be required to delay or
eliminate expenditures for potential products, including pexiganan acetate, or
to enter into collaborations with third parties to commercialize potential
products or technologies that the Company would otherwise seek to develop
itself, or seek other arrangements.

                                       13
<PAGE>
 
     The Company expects to finalize an agreement with Abbott initially
providing for the purchase of approximately $10.0 million of bulk drug substance
for pexiganan acetate. As FDA approval of pexiganan acetate has not occurred,
this will result in charges to research and development expense in 1998 and
1999. However, there can be no assurance that such agreement will be
successfully negotiated. The Company is currently dependent upon Abbott for the
production of bulk drug substance for pexiganan acetate. In the event that bulk
drug substance for pexiganan acetate is not manufactured at Abbott, the Company
will need to secure other manufacturing arrangements. This would require
substantial funds and would also result in delays in the introduction of
pexiganan acetate to the market. The process developed by Abbott is proprietary,
and in the event the Company desires to utilize, or have another party utilize,
such proprietary technology the Company would be required to make license
payments to Abbott.

     Further progress in scale-up and manufacturing development efforts will be
required to enable the Company to manufacture and sell pexiganan acetate on a
substantially profitable basis.  This will require substantial additional funds.
The Company has certain efforts under way with respect to alternative
manufacturing sources, including recombinant manufacturing; however, these
programs are at an early stage and significant expenditures over a period of
time will be required to develop a commercially viable process.  No assurance
can be given that a cost-effective manufacturing process can ultimately be
developed, or that any such process would be approved by the FDA, or that the
Company, Abbott or another entity will be able to manufacture pexiganan acetate
on a commercially viable basis.

     The Company's prior development arrangement with Abbott provides for the
issuance by the Company to Abbott of up to 500,000 shares of its Common Stock
and the obligation to pay a royalty on any future sales of pexiganan acetate.
Stock issuances by the Company to Abbott will result in a charge to earnings,
representing the fair value of the shares when issued.  As of September 30,
1998, the Company has issued 250,000 shares of common stock to Abbott, including
125,000 shares issued during the nine months ended September 30, 1998. The
issuance of such shares resulted in the recording of an earnings charge of
$859,000 in the nine months ended September 30, 1998.  Future stock issuances
are related to the achievement by Abbott of contractual performance milestones.

     The Company also expects to conduct significant manufacturing development
activities for its other products under development.  The Company is currently
working with outside contractors for the chemical production of squalamine.  The
Company expects to expend significant resources in the chemical synthesis of
squalamine and other compounds under development, however, there can be no
assurance that these efforts will be successful.

     The Company's capital expenditure requirements will depend upon numerous
factors, including the success of pexiganan acetate and the progress of the
Company's other research and development programs, the time and cost required to
obtain regulatory approvals, the ability of the Company to enter into additional
collaborative arrangements, the demand for products based on the Company's
technology, if and when such products are approved, and possible acquisitions of
products, technologies and companies.  The Company had no significant capital
commitments as of September 30, 1998.

     The Company is working to resolve the potential impact of the year 2000
issue on the ability of the Company's computerized information systems to
accurately process information that may be date-sensitive. Computer programs
that recognize a date using "00" as the year 1900 rather than the year 2000
could result in errors or system failures. The Company utilizes a number of
computer programs across its entire operation. The Company has not completed its
assessment, but currently believes that costs of addressing this issue will not
have a material adverse impact on the Company's financial position. However, if
the Company and third parties upon which it relies are unable to address this
issue in a timely manner, it could result in a material financial risk to the
Company. In order to assure that this does not occur, the Company plans to
devote all resources required to resolve any significant year 2000 issues in a
timely manner.

                                       14
<PAGE>
 
PART II - OTHER INFORMATION

  ITEM 1.  LEGAL PROCEEDINGS

  None

  ITEM 2.  CHANGES IN SECURITIES

  None

  ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

  None

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

  None

  ITEM 5.  OTHER INFORMATION

  None

  ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

     27    Financial Data Schedule

                                       15
<PAGE>
 
SIGNATURES

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


                                              Magainin Pharmaceuticals Inc.
                                                      (Registrant)



                 Date: October 30, 1998       /s/ Michael R. Dougherty
                                              ------------------------
                                              Michael R. Dougherty
                                              President, Chief Executive Officer
                                              and Chief Financial Officer

                                       16