<PAGE>   1
                                                                    EXHIBIT 13.1



                   SELECTED PORTIONS OF THE CYTRX CORPORATION
                       1998 ANNUAL REPORT TO SHAREHOLDERS



<PAGE>   2


FIVE YEAR SELECTED FINANCIAL DATA *
CytRx Corporation and Subsidiaries


<TABLE>
<CAPTION>
                                                      1998             1997             1996             1995             1994
                                                  ----------------------------------------------------------------------------
<S>                                               <C>             <C>             <C>             <C>              <C>
Statement of Operations Data:
Revenues:
  Net product sales                               $   481,495     $   456,029     $   522,385     $    512,528     $   500,814
  Net service revenues                                350,789         422,039         357,517               --              --
  Investment and other income                       1,762,747       1,381,306       1,558,914        1,990,506       2,236,751
                                                  ----------------------------------------------------------------------------
Total revenues                                      2,595,031       2,259,374       2,438,816        2,503,034       2,737,565
                                                  ============================================================================

Loss from continuing operations                    (7,506,060)     (4,426,292)     (2,068,302)      (9,273,777)     (7,100,343)
Income (loss) from discontinued operations          2,712,701      (1,626,700)     (3,723,477)      (1,378,805)       (599,843)
Extraordinary item                                   (325,120)             --              --               --              --
                                                  ----------------------------------------------------------------------------
Net loss                                          $(5,118,479)    $(6,052,992)    $(5,791,779)    $(10,652,582)    $(7,700,186)
                                                  ============================================================================

Basic and diluted loss per common share:
  Loss from continuing operations                 $     (0.99)    $     (0.60)    $     (0.27)    $      (1.17)    $     (0.90)
  Income (loss) from discontinued operations             0.36           (0.22)          (0.48)           (0.18)          (0.08)
  Extraordinary item                                    (0.04)             --              --               --              --
                                                  ----------------------------------------------------------------------------
  Net loss                                        $     (0.67)    $     (0.82)    $     (0.75)    $      (1.35)    $     (0.98)
                                                  ============================================================================

Balance Sheet Data:
Total assets                                      $16,641,568     $24,905,995     $24,299,322     $ 30,959,983     $38,660,567
Convertible debentures                                     --       2,000,000              --               --              --
Total stockholders' equity                         14,688,548      19,248,395      22,337,734       29,770,485      38,026,347
</TABLE>

* Restated for the reclassification of the results of operations of Vaxcel, Inc.
  from continuing operations to discontinued operations for the four years ended
  December 31, 1997



<PAGE>   3


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
CytRx Corporation and Subsidiaries


Liquidity and Capital Resources

         At December 31, 1998, the Company had cash equivalents and investments
of $15.3 million and net assets of $14.7 million, compared to $11.2 million and
$19.2 million, respectively, at December 31, 1997. Working capital totaled $13.7
million at December 31, 1998, compared to $7.1 million at December 31, 1997.

         Management believes that cash and investments on hand, combined with
interest income and operating revenues will be sufficient to satisfy the
Company's projected liquidity and working capital needs through the first
quarter of 2000, but it is likely that additional funding will be required for
the commercialization of any products for human use. Definitive statements as to
the time required and costs involved in reaching certain objectives for the
Company's products are difficult to project due to the uncertainties of the
medical research field. Requirements could vary depending upon the results of
research, competitive and technological developments, and the time and expense
required for governmental approval of products, some of which factors are beyond
management's control. CytRx anticipates that it may raise funds through equity
offerings. Additional funding for research and development expenditures may be
obtained through joint ventures and product licensing arrangements with other
companies.

         During 1996 and 1997, the Company received federal government funding
for certain research and development activities via several Small Business
Innovative Research (SBIR) grants. Most recently, the Company received a grant
from the U.S. Food and Drug Administration's Division of Orphan Drug Development
to support CytRx's Phase III clinical trial of FLOCOR. This grant will provide
approximately $400,000 over two years, $200,000 of which was received during
1998, to help defray the overall costs of the study. The Company intends to
continue to seek government assistance for its product development efforts.

         In February 1998, CytRx's wholly-owned subsidiary, Proceutics, Inc.
("Proceutics") consummated a sale of substantially all of its non-real estate
assets to Oread Laboratories, Inc. ("Oread") for approximately $2.1 million.
(See Note 10 to Financial Statements.) Also, in May 1998, CytRx and Proceutics
consummated a sale of the two buildings owned by them at 150 and 154 Technology
Parkway, Norcross, Georgia to ARE-150/154 Technology Parkway, LLC, an affiliate
of Alexandria Real Estate Equities, Inc. ("Alexandria") for approximately $4.5
million. Alexandria assumed the existing lease with Oread. In addition, CytRx
entered into a 10 year lease with Alexandria for administrative office space at
the 154 Technology Parkway building. (See Notes 11 and 12 to Financial
Statements.)

         In April 1998, the Company and its wholly-owned subsidiary, CytRx
Animal Health, Inc. ("CytRx Animal Health") (formerly VetLife, Inc.) entered
into an Acquisition Agreement (the "Acquisition Agreement") with VetLife L.L.C.,
a Delaware limited liability company ("VL LLC"), pursuant to which VL LLC
acquired substantially all of CytRx Animal Health's assets related to its
business of marketing and distributing products that improve the value of food
animal products to the cattle industry (collectively, the "Assets") for a total
purchase price consisting of: (i) a cash payment of $3,500,000, subject to
certain working capital adjustments, (ii) an unsecured, subordinated promissory
note in the principal amount of $4,000,000 bearing interest at an annual rate of
12%, and (iii) certain contingent payments based on future sales of specified
products of VL LLC and its affiliates that, if made in full, could total up to
$5,500,000. The sale of the Assets closed on the same day. VL LLC repaid the $4
million note to CytRx Animal Health in December 1998.

         The Company has consulting agreements with various individuals and
companies for routine business activities including assistance with regulatory,
marketing, investor relations and research and development activities. As of
December 31, 1998 there were no significant firm commitments pursuant to any of
such agreements, and none of such agreements are with affiliates of the Company.

         At December 31, 1998 the Company and its subsidiaries had net operating
loss carryforwards for income tax purposes of approximately $49.2 million, which
will expire in 2000 through 2018 if not utilized. The Company also has research
and development credits available to reduce income taxes, if any, of
approximately $1.2 million which will expire in 2000 through 2010 if not
utilized. Based on an assessment of all available evidence including, but not
limited to, the Company's limited operating history and lack of profitability,
uncertainties of the commercial viability of the Company's technology, the
impact of government regulation and healthcare reform initiatives, and other
risks normally associated with biotechnology companies, the Company has
concluded that it is more likely than not that these net operating loss


<PAGE>   4


carryforwards and credits will not be realized and, as a result, a 100% deferred
tax valuation allowance has been recorded against these assets.

         The above statements regarding the Company's plans and expectations for
future financing are forward-looking statements that are subject to a number of
risks and uncertainties. The Company's ability to obtain future financings
through joint ventures, product licensing arrangements, equity financings or
otherwise is subject to market conditions and the Company's ability to identify
parties that are willing and able to enter into such arrangements on terms that
are satisfactory to the Company. There can be no assurance that the Company will
be able to obtain future financing from these sources. Additionally, depending
upon the outcome of the Company's fund raising efforts via its subsidiaries
discussed above, the accompanying financial information may not necessarily be
indicative of future operating results or future financial condition.

Results of Operations

         The Company recorded a net loss of $5,118,000 for the year ended
December 31, 1998 as compared to net losses of $6,053,000 for 1997 and
$5,792,000 for 1996. Loss from continuing operations before extraordinary items
was $7,506,000, $4,426,000 and $2,068,000 in 1998, 1997 and 1996, respectively.

         Net product sales from continuing operations, which consist primarily
of sales of TiterMax research adjuvant, were $481,000 in 1998, $456,000 in 1997
and $522,000 in 1996. Cost of product sales was $36,000 in 1998, $40,000 in 1997
and $63,000 in 1996, or 7%, 9% and 12% of net product sales, respectively.
During 1996, the Company began marketing the services of its small group of
human resource professionals to third parties under the name of Spectrum
Recruitment Research ("Spectrum") as a way of offsetting the Company's cost of
maintaining this function. Net service revenues from continuing operations
related to Spectrum were $351,000 in 1998, $422,000 in 1997 and $357,000 in
1996. Cost of service revenues was $187,000 in 1998, $242,000 in 1997 and
$171,000 in 1996, or 53%, 57% and 48% of net service revenues, respectively.
Although the TiterMax and Spectrum operations are profitable, the Company is not
dependent on the cash flow which they generate.

         Interest income from continuing operations was $1,007,000 in 1998 as
compared to $752,000 in 1997 and $1,162,000 in 1996. The variances between years
is directly attributable to fluctuating cash and investment balances.
Collaborative, grant and license fee income was $511,000 in 1998 versus $94,000
in 1997 and $59,000 in 1996. The increase during 1998 is due to a $200,000 grant
from the U.S. Food and Drug Administration's Division of Orphan Drug Development
to support CytRx's Phase III clinical trial of FLOCOR, as well as certain
additional Small Business Innovative Research (SBIR) grants for the Company's
additional research programs. Other income was $244,000, $535,000 and $338,000
in 1998, 1997 and 1996, respectively, and primarily relates to administrative
and facilities costs allocated by CytRx to its discontinued subsidiaries. The
related costs are included in selling, general and administrative expenses. The
decrease from 1997 to 1998 is reflective of the discontinuance of the Proceutics
and CytRx Animal Health operations in early 1998.

         Research and development expenditures from continuing operations during
1998 were $7,306,000 versus $3,605,000 in 1997 and $2,032,000 in 1996. Research
and development expenditures have increased during the three year period
primarily as a result of the Company's development activities for FLOCOR,
including the completion of a Phase II clinical trial in 1997 and initiation of
a pivotal Phase III trial in March 1998. The Company expects patient enrollment
in the Phase III trial to be completed during the second half of 1999, with the
final statistical analysis of the study completed by the end of 1999. During
1997 and 1998, the Company also devoted significant resources toward addressing
manufacturing issues for FLOCOR.

         Selling, general and administrative expenses from continuing operations
during 1998 were $2,527,000 as compared to $2,505,000 in 1997 and $2,240,000 in
1996. The overall increase during the three year period is due to general
corporate activities in support of the Company's FLOCOR development efforts.

         Interest expense was $46,000, $293,000 and $0 in 1998, 1997 and 1996,
respectively. Included in the 1997 amount is $265,000 related to the beneficial
conversion feature of $2,000,000 of convertible notes issued in 1997. (See Note
5 to Financial Statements.)

         The extraordinary loss in 1998 relates to the early extinguishment of
6% convertible notes which resulted in payment of premiums of $150,000 and
expensing of capitalized debt issuance costs of $175,000.


<PAGE>   5


         Discontinued Operations - Net income (loss) from the discontinued
operations of Proceutics, CytRx Animal Health and Vaxcel (net of minority
interest) was $2,713,000, $(1,627,000) and $(3,723,000) in 1998, 1997 and 1996.
As discussed above, the assets of Proceutics and CytRx Animal Health were sold
during 1998, thus the results of their operations have been presented as
discontinued operations. During 1998, the Company adopted a plan to dispose of
the research and development activities of Vaxcel and has also presented its
results of operations as discontinued operations. The following table presents
the breakdown of net income (loss) from discontinued operations (see Notes 11
and 13 to Financial Statements).

<TABLE>
<CAPTION>
                                                                  1998            1997            1996
                                                               -----------     -----------     -----------
         <S>                                                   <C>             <C>             <C>
         Proceutics:
             Gain on sale of business                          $   782,000     $        --     $        --
             Gain on sale of real estate                           434,000              --              --
             Operations                                            171,000        (138,000)     (1,448,000)
                                                               -----------     -----------     -----------
                                                                 1,387,000        (138,000)     (1,448,000)
         CytRx Animal Health:
             Gain on sale of business                            6,230,000              --              --
             Operations                                           (585,000)        868,000      (1,151,000)
                                                               -----------     -----------     -----------
                                                                 5,645,000         868,000      (1,151,000)
         Vaxcel:
             Impairment loss                                    (3,213,000)             --              --
             Operations                                         (1,721,000)     (2,599,000)     (1,124,000)
             Minority interest                                     615,000         242,000              --
                                                               -----------     -----------     -----------
                                                                (4,319,000)     (2,357,000)     (1,124,000)
                                                               -----------     -----------     -----------

         Net income (loss) from discontinued operations        $ 2,713,000     $(1,627,000)    $(3,723,000)
                                                               ===========     ===========     ===========
</TABLE>

         The impairment charge recorded by Vaxcel in 1998 relates to acquired
developed technology and goodwill. See Note 11 to Financial Statements.

         Inflation - Management believes that inflation had no material impact
on the Company's operations during the three year period ended December 31,
1998.

         Market Risk - The Company's financial instruments that are sensitive to
changes in interest rates are its investments. The principal amount of
investments, which are all classified as held-to-maturity, was $14,874,000 at
December 31, 1998. All of the investments are zero coupon notes and mature in
early 1999. The weighted average yield-to-maturity of the investments at
December 31, 1998 was 5.18%. The fair value of investments at December 31, 1998
was $14,839,000. The Company is not subject to any other material market risks.

Year 2000 Issue
Introduction
         The term "Year 2000 issue" is a general term used to describe the
various problems that may result from the improper processing of dates and
date-sensitive calculations by computers and other machinery as the year 2000 is
approached and reached. These problems generally arise from the fact that most
of the world's computer hardware and software have historically used only two
digits to identify the year in a date, often meaning that the computer will fail
to distinguish dates in the "2000's" from dates in the "1900's." These problems
may also arise from other sources as well, such as the use of special codes and
conventions in software that make use of the date field.

State of Readiness
         The Company has developed and is implementing a comprehensive plan (the
"Year 2000 Plan") for the Company to become Year 2000 ready by the middle of the
fourth quarter 1999. The Year 2000 Plan covers the following Company systems
(collectively, the "Systems"):

         -        the Company's business-critical information technology and
         operating systems ("Critical IT Systems") which are comprised
         substantially of commercial off-the-shelf software and other third
         party software and hardware relating primarily to financial operations
         and reporting, including accounts payable,

         -        the Company's non-critical information technology and
         operating systems ("Non-Critical IT Systems") which also are
         substantially comprised of commercial off-the-shelf software and other
         third party software and hardware relating to, among others,
         spreadsheet, word processing, and supporting and related operating
         systems;


<PAGE>   6


         -        the systems of the Company's major vendors and other material
         service providers ("Third Party Systems"); and

         -        the Company's non-information technology systems, including
         embedded technology ("Non-IT Systems") relating to, among others,
         security systems and HVAC.

         The Year 2000 Plan consists of four phases: (i) awareness, (ii)
assessment, (iii) remediation, and (iv) creation of contingency plans in the
event of year 2000 failures. The Company has completed the awareness and
assessment phases of its Year 2000 Plan for all of its Systems, and is well
under way toward completing the remediation phase. As part of the assessment
phase, the Company has polled substantially all of the third parties who provide
material services to the Company regarding each third party's Year 2000
compliance plan and state of readiness. The Company has received responses
regarding Year 2000 compliance from most of such third parties, all of whom have
assured the Company that their hardware and/or software is or will be Year 2000
compliant. The Company is actively seeking responses from the remainder of such
third parties.

         The initial actions in the remediation phase have already commenced in
that the Company, during 1998, replaced a significant portion of its desktop
computer systems. The Company intends to schedule any additional required
upgrades or replacements regarding its Systems beginning in the second quarter
of 1999 and ending during the fourth quarter of 1999.

Costs
         To date, the Company has not incurred significant costs in connection
with the implementation of its Year 2000 Plan. Future costs may include, among
others, the engagement of outside consultants, upgrades or replacements of
hardware and software, and implementation of viable contingency plans. The
Company estimates such future costs will not exceed $25,000. The Company
expenses costs associated with the Year 2000 Plan as they are incurred.

Risks and Contingency Plans
         The failure to remediate a material Year 2000 problem or develop and
implement a viable contingency plan could result in an interruption in, or a
failure of, certain normal business activities or operations. Such failures
could materially and adversely affect the Company's business, financial
condition and results of operations. Due to the general uncertainty inherent in
the Year 2000 issue, the Company is currently unable to determine the most
reasonably likely worst case Year 2000 scenarios or whether the Year 2000 issue
will have a material impact on the Company. The Company is creating contingency
plans intended to address perceived risks.


<PAGE>   7


CONSOLIDATED BALANCE SHEETS
CytRx Corporation and Subsidiaries

<TABLE>
<CAPTION>
                                                                                             December 31,
                                                                                    ------------------------------
                                                                                       1998               1997
                                                                                    -----------        -----------
<S>                                                                                 <C>                <C>
ASSETS
Current assets:
     Cash and cash equivalents                                                      $ 8,855,375        $ 5,895,008
     Short-term investments                                                           6,417,066                 --
     Accounts receivable                                                                 83,249          1,917,013
     Note receivable                                                                    300,000                 --
     Inventories                                                                         10,935          2,272,798
     Other current assets                                                                10,377             29,157
                                                                                    -----------        -----------

         Total current assets                                                        15,677,002         10,113,976

Property and equipment, net                                                             195,030          4,713,586

Other assets:
     Long-term investments (restricted)                                                      --          5,326,647
     Notes receivable                                                                        --            400,000
     Acquired developed technology, net                                                 600,000          3,454,356
     Other assets                                                                       169,536            897,430
                                                                                    -----------        -----------

         Total other assets                                                             769,536         10,078,433
                                                                                    -----------        -----------

         Total assets                                                               $16,641,568        $24,905,995
                                                                                    ===========        ===========


LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Accounts payable                                                               $   540,089        $ 1,273,303
     Accrued expenses and other current liabilities                                   1,409,034          1,765,815
                                                                                    -----------        -----------

         Total current liabilities                                                    1,949,123          3,039,118

6% Convertible debentures                                                                    --          2,000,000
Minority interest in Vaxcel, Inc.                                                         3,897            618,482

Commitments

Stockholders' equity:
     Preferred Stock, $.01 par value, 1,000 shares authorized, including 1,000
         shares of Series A Junior Participating Preferred
         Stock; no shares issued and outstanding                                             --                 --
     Common stock, $.001 par value, 18,750,000 shares authorized;
         8,236,926 and 7,986,441 shares issued at December 31, 1998
         and 1997, respectively                                                           8,237              7,986
     Additional paid-in capital                                                      66,423,577         65,793,491
     Treasury stock, at cost (625,816 and 555,154 shares held at
         December 31, 1998 and 1997, respectively)                                   (2,270,238)        (2,198,533)
     Accumulated deficit                                                            (49,473,028)       (44,354,549)
                                                                                    -----------        -----------

         Total stockholders' equity                                                  14,688,548         19,248,395
                                                                                    -----------        -----------

         Total liabilities and stockholders' equity                                 $16,641,568        $24,905,995
                                                                                    ===========        ===========
</TABLE>


                             See accompanying notes.


<PAGE>   8


CONSOLIDATED STATEMENTS OF OPERATIONS
CytRx Corporation and Subsidiaries


<TABLE>
<CAPTION>
                                                                             Year Ended December 31,
                                                               ------------------------------------------------
                                                                   1998               1997             1996
                                                               -----------        -----------       -----------
                                                                                  (restated)         (restated)
<S>                                                            <C>                <C>               <C>
Revenues:
     Net product sales                                         $   481,495        $   456,029       $   522,385
     Net service revenues                                          350,789            422,039           357,517
     Interest income                                             1,007,019            751,526         1,161,513
     Collaborative, grant and license fee income                   511,375             94,477            59,232
     Other                                                         244,353            535,303           338,169
                                                               -----------        -----------       -----------
                                                                 2,595,031          2,259,374         2,438,816

Expenses:
     Cost of product sales                                          35,749             39,941            63,171
     Cost of service revenues                                      187,047            242,343           171,462
     Research and development                                    7,305,835          3,605,408         2,032,101
     Selling, general and administrative                         2,526,572          2,504,926         2,240,384
     Interest                                                       45,888            293,048                --
                                                               -----------        -----------       -----------
                                                                10,101,091          6,685,666         4,507,118
                                                               -----------        -----------       -----------

Loss from continuing operations before extraordinary item       (7,506,060)        (4,426,292)       (2,068,302)

Income (loss) from discontinued operations                       2,098,116         (1,869,187)       (3,723,477)
Minority interest in discontinued operations                      (614,585)          (242,487)               --
                                                               -----------        -----------       -----------

Loss before extraordinary item                                  (4,793,359)        (6,052,992)       (5,791,779)
Extraordinary item:
     Loss on early extinguishment of debt                         (325,120)                --                --
                                                               -----------        -----------       -----------

Net loss                                                       $(5,118,479)       $(6,052,992)      $(5,791,779)
                                                               ===========        ===========       ===========

Basic and diluted income (loss) per common share:
     Continuing operations                                     $     (0.99)       $     (0.60)      $     (0.27)
     Discontinued operations                                          0.36              (0.22)            (0.48)
     Extraordinary item                                              (0.04)                --                --
                                                               -----------        -----------       -----------
     Net loss                                                  $     (0.67)       $     (0.82)      $     (0.75)
                                                               ===========        ===========       ===========

Basic and diluted weighted average shares outstanding            7,625,578          7,424,372         7,737,949
</TABLE>


                            See accompanying notes.
<PAGE>   9


CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CytRx Corporation and Subsidiaries


<TABLE>
<CAPTION>
                                                  Common Stock
                                             ---------------------  Additional
                                               Shares                 Paid-in     Accumulated      Treasury
                                               Issued     Amount      Capital        Deficit         Stock          Total
                                             --------------------------------------------------------------------------------

<S>                                          <C>          <C>       <C>           <C>             <C>             <C>
Balance at December 31, 1995                 7,915,308    $7,915    $62,514,691   $(32,509,778)   $  (242,343)    $29,770,485

     Issuance of common stock                   29,895        30        138,324                                       138,354
     Purchase of treasury stock                                                                    (1,779,326)     (1,779,326)
     Net loss                                                                       (5,791,779)                    (5,791,779)
                                             --------------------------------------------------------------------------------
Balance at December 31, 1996                 7,945,203     7,945     62,653,015    (38,301,557)    (2,021,669)     22,337,734
     Issuance of common stock                   41,238        41        169,373                                       169,414
     Purchase of treasury stock                                                                      (176,864)       (176,864)
     Unrealized gain on sale of shares
         of subsidiary                                                2,706,397                                     2,706,397
     Beneficial conversion feature of
         convertible debentures                                         264,706                                       264,706
     Net loss                                                                       (6,052,992)                    (6,052,992)
                                             --------------------------------------------------------------------------------
Balance at December 31, 1997                 7,986,441     7,986     65,793,491    (44,354,549)    (2,198,533)     19,248,395
     Issuance of common stock                  250,485       251        630,086                                       630,337
     Purchase of treasury stock                                                                       (71,705)        (71,705)
                                                                                                                              
     Net loss                                                                       (5,118,479)                    (5,118,479)
                                             --------------------------------------------------------------------------------
Balance at December 31, 1998                 8,236,926    $8,237    $66,423,577   $(49,473,028)   $(2,270,238)    $14,688,548
                                             ================================================================================
</TABLE>

                             See accompanying notes.


<PAGE>   10


CONSOLIDATED STATEMENTS OF CASH FLOWS
CytRx Corporation and Subsidiaries

<TABLE>
<CAPTION>
                                                                                    Year Ended December 31,
                                                                      --------------------------------------------------
                                                                         1998                1997               1996
                                                                      -----------        ------------       ------------
<S>                                                                   <C>                <C>                <C>
Cash flows from operating activities:
     Net loss                                                         $(5,118,479)       $ (6,052,992)      $ (5,791,779)
     Adjustments to reconcile net loss to net
         cash used in operating activities:
         Depreciation                                                     216,811             607,349            655,006
         Amortization                                                     282,732             145,644                 --
         Gain on sales of subsidiary operations                        (7,012,305)                 --                 --
         Gain on sale of real estate                                     (433,786)                 --                 --
         Charge for acquired incomplete research and development               --             951,017                 --
         Charge for beneficial conversion feature of
             convertible debentures                                            --             264,706                 --
         Impairment loss (discontinued operations)                      3,212,615                  --                 --
         Extraordinary loss on early extinguishment of debt               325,120
         Minority interest in net loss of subsidiary                     (614,585)           (242,487)                --
         Changes in assets and liabilities:
             Receivables                                                1,082,390            (979,874)          (552,002)
             Inventories                                                1,037,197          (2,263,290)            (3,190)
             Notes receivable                                             100,000                  --           (975,000)
             Other assets                                                  98,545             537,902           (162,443)
             Accounts payable                                             208,884             640,383            320,795
             Unearned revenue                                             172,380             (85,005)           251,192
             Other liabilities                                           (495,323)            382,053            200,103
                                                                      -----------        ------------       ------------
     Total adjustments                                                 (1,819,325)            (41,602)          (265,539)
                                                                      -----------        ------------       ------------

         Net cash used in operating activities                         (6,937,804)         (6,094,594)        (6,057,318)

Cash flows from investing activities:
     Purchases of held-to-maturity securities                          (6,417,066)        (22,103,140)       (12,024,022)
     Maturities of held-to-maturity securities                                 --          32,399,348          5,036,000
     Decrease in long-term investments                                  5,326,647                  --                 --
     Net proceeds from sales of subsidiary operations                   8,336,985                  --                 --
     Net proceeds from sale of real estate                              4,260,747                  --                 --
     Net cash paid for acquisition                                             --          (1,257,974)                --
     Capital expenditures, net                                            (13,317)           (273,755)          (530,051)
                                                                      -----------        ------------       ------------

         Net cash provided by (used in) investing activities           11,493,996           8,764,479         (7,518,073)

Cash flows from financing activities:
     Net proceeds from issuance of common stock                           125,880             169,414            138,354
     Redemption of debt                                                (1,650,000)                 --                 --
     Purchase of treasury stock                                           (71,705)           (176,864)        (1,779,326)
     Proceeds from issuance of debt, net of issuance costs                     --           1,803,366                 --
                                                                      -----------        ------------       ------------

         Net cash provided by (used in) financing activities           (1,595,825)          1,795,916         (1,640,972)
                                                                      -----------        ------------       ------------

Net increase (decrease) in cash and cash equivalents                    2,960,367           4,465,801        (15,216,363)

Cash and cash equivalents at beginning of year                          5,895,008           1,429,207         16,645,570
                                                                      -----------        ------------       ------------

Cash and cash equivalents at end of year                              $ 8,855,375        $  5,895,008       $  1,429,207
                                                                      ===========        ============       ============

Supplemental disclosure of cash flow information:
     Cash paid during the year for interest                           $    45,888        $     23,342       $         --
                                                                      ===========        ============       ============
</TABLE>


                                                 See accompanying notes


<PAGE>   11


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CytRx Corporation and Subsidiaries


1.       Nature of Business

         CytRx Corporation ("CytRx" or "the Company") is a biopharmaceutical
company focused on the development and commercialization of high-value human
therapeutics. The Company's lead product is FLOCOR, now in pivotal Phase III
clinical trials for the treatment of acute sickle cell crisis. CytRx is also
developing FLOCOR for acute respiratory disorders and plans to expand its
development for other vascular disorders such as shock and stroke. CytRx is also
currently engaged in research in the areas of infectious disease, gene and drug
delivery, vaccines, and animal feed additives.

         The Company's product sales from continuing operations include sales of
TiterMax research adjuvant. Titermax is currently sold worldwide through both
distributor and direct channels. The Company also markets the services of its
small group of human resources professionals under the name of Spectrum
Recruitment Research ("Spectrum") as a way of offsetting the Company's cost of
maintaining this function. Spectrum's services are marketed primarily within
metropolitan Atlanta, Georgia. The Company's operational focus is on the
development and commercialization of pharmaceutical products; the TiterMax and
Spectrum operations were formed as ancillary activities, and, while these
operations are profitable, the Company is not dependent on the cash flows which
they generate.

2.       Summary of Significant Accounting Policies

         Basis of Presentation - The consolidated financial statements include
the accounts of CytRx together with those of its majority-owned subsidiaries.
Certain prior year amounts have been reclassified to conform to the 1998
financial statement presentation. As more thoroughly discussed in Note 11, the
operations of Proceutics, Inc. ("Proceutics") and CytRx Animal Health, Inc.
("CytRx Animal Health") (formerly VetLife, Inc.), and Vaxcel, Inc. ("Vaxcel")
are presented as discontinued operations for all periods presented.

         Reverse Stock Split - All share and per share information in the
accompanying consolidated financial statements and notes thereto has been
retroactively adjusted to reflect a one-for-four reverse stock split effected in
February 1996.

         Cash Equivalents - The Company considers all highly liquid debt
instruments with an original maturity of 90 days or less to be cash equivalents.
Cash equivalents consist primarily of auction-market preferred stock, commercial
paper and amounts invested in money market accounts.

         Restricted Cash - In connection with a marketing and distribution
agreement, CytRx Animal Health was required to obtain a letter of credit in the
amount of $5 million in favor of the other party. Such unused letter of credit
was collateralized by approximately $5.3 million in cash equivalents and
investments at December 31, 1997. Such collateral was presented as long-term
investments in the accompanying consolidated balance sheet. (See Note 11).

         Investments - Management determines the appropriate classification of
debt securities at the time of purchase and reevaluates such designation as of
each balance sheet date. Debt securities are classified as held-to-maturity when
the Company has the positive intent and ability to hold the securities to
maturity. Held-to-maturity securities are stated at amortized cost. Marketable
equity securities and debt securities not classified as held-to-maturity are
classified as available-for-sale. Available-for-sale securities are carried at
fair value, with the unrealized gains and losses reported in a separate
component of stockholders' equity. Realized gains and losses are included in
investment income and are determined on a first-in, first-out basis (see Note
3).

         Fair Value of Financial Instruments - The carrying amounts reported in
the balance sheet for cash and cash equivalents, investments (see Note 3),
accounts receivable, notes receivable, accounts payable and convertible
debentures approximate their fair values. The carrying amount reported in the
balance sheet for long-term debt approximates its fair value. The fair value of
such long-term debt is estimated using discounted cash flow analyses based on
the Company's current incremental borrowing rate for similar types of borrowing
arrangements.

         Inventories - Inventories are valued at the lower of cost or market
using the first-in, first-out (FIFO) method.


<PAGE>   12


         Property and Equipment - Property and equipment are stated at cost and
depreciated using the straight-line method based on the estimated useful lives
(twenty years for buildings and five years for equipment and furniture) of the
related assets.

         Acquired Developed Technology and Other Intangibles - Acquired
developed technology and other intangible assets, primarily goodwill, (see Note
11) are amortized over their estimated useful lives (fifteen years) on a
straight-line basis. Management continuously monitors and evaluates the
realizability of recorded acquired developed technology and other intangible
assets to determine whether their carrying values have been impaired. In
accordance with Financial Accounting Standards Board ("FASB") Statement No. 121,
Accounting for the Impairment of Long-Lived Assets, the Company records
impairment losses on long-lived assets used in operations when events and
circumstances indicate that the assets might be impaired and the undiscounted
cash flows estimated to be generated by those assets are less than the carrying
amount of those assets. Any impairment loss is measured by comparing the fair
value of the asset to its carrying amount. As more fully discussed in Note 11,
management evaluated these assets during 1998 and has recorded a provision for
impairment of such assets.

         Patents and Patent Application Costs - Although the Company believes
that its patents and underlying technology have continuing value, the amount of
future benefits to be derived therefrom is uncertain. Patent costs are therefore
expensed rather than capitalized.

         Accrued Expenses and Other Current Liabilities - Accrued expenses and
other current liabilities at December 31 are summarized as follows (in
thousands):

<TABLE>
<CAPTION>
                                                 1998                 1997
                                                ------               ------
         <S>                                    <C>                  <C>
         Clinical research grants               $  370               $   --
         Deferred revenue                          261                  166
         Employee incentives                        87                  350
         Distributor incentives                     --                  641
         Other                                     691                  609
                                                ------               ------
                                                $1,409               $1,766
                                                ======               ======
</TABLE>

         Basic and Diluted Loss per Common Share - Basic and diluted loss per
share are computed based on the weighted average number of common shares
outstanding. Common share equivalents (which may consist of options, warrants
and convertible debentures) are excluded from the computation of diluted loss
per share since the effect would be antidilutive.

         Shares Reserved for Future Issuance - The Company has reserved
approximately 2,453,000 of its authorized but unissued shares of common stock
for future issuance pursuant to stock options and warrants and employee benefit
plans.

         Revenue Recognition - Sales are recognized at the time products are
shipped or services rendered. The Company does not require collateral or other
securities for sales made on credit. Revenues from collaborative research
arrangements and grants are generally recorded as the related costs are
incurred. The costs incurred under such arrangements approximated the revenues
reported in the accompanying statements of operations. License fees reported in
the accompanying statements of operations consist of nonrefundable fees received
upon the signing of certain technology license and option agreements. These fees
were recognized as income when they were received. Such agreements generally
contain provisions for additional fees upon the achievement of certain
development milestones by the licensee and upon approval of the related
products, followed by a royalty based upon net sales. Such fees, if any, will be
recognized as income when they become receivable under the terms of the related
contracts.

         Sale of Stock by a Subsidiary - The Company does not recognize gains on
the sale of previously unissued stock of subsidiaries when there are significant
uncertainties regarding the Company's ability to ultimately realize its
investment in the subsidiary. Such gains are reflected as additional paid-in
capital in the Company's consolidated financial statements.

         Stock-based Compensation - The Company grants stock options and
warrants for a fixed number of shares to key employees and directors with an
exercise price equal to the fair market value of the shares at the date of
grant. The Company accounts for stock option grants and warrants in accordance
with APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"),
and, accordingly, recognizes no compensation expense for the stock option grants
and warrants for which the terms are fixed. For stock option grants and warrants
which vest based on certain corporate performance criteria, compensation expense
is recognized to the extent that the quoted market price per share exceeds the
exercise price on the date such criteria are achieved or are probable. The
Company has also granted a limited number of stock options to consultants and
certain third parties. These stock options generally expire after ten years from
the date of grant and have exercise prices equal to the fair market value of the
underlying common stock at the date of grant. Stock


<PAGE>   13


options granted to consultants and certain third parties are valued at their
fair market value on the date the options vest and have been immaterial to date.
In October 1995, the FASB issued Statement of Financial Accounting Standards No.
123, Accounting for Stock-based Compensation ("Statement 123"), which provides
an alternative to APB 25 in accounting for stock-based compensation issued to
employees. However, the Company has continued to account for stock-based
compensation in accordance with APB 25.

         Concentrations of Credit Risk - Financial instruments that potentially
subject the Company to significant concentrations of credit risk consist
principally of cash investments. The Company maintains cash equivalents and
investments in large well-capitalized financial institutions and the Company's
investment policy disallows investment in any debt securities rated less than
"investment-grade" by national ratings services.

         Use of Estimates - The preparation of the financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.

         Segment Information - Effective January 1, 1998, the Company adopted
FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related
Information ("Statement 131"). Statement 131 superceded FASB Statement No. 14,
Financial Reporting for Segments of a Business Enterprise. Statement 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports. Statement 131 also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The adoption of Statement 131 did not affect results of operations or financial
position, but did affect the disclosure of segment information. See Note 13.

3.       Investments

         At December 31, 1998 $8,457,000 and $6,417,000 of investments were
included in cash and cash equivalents and short-term investments, respectively,
in the accompanying consolidated balance sheets. At December 31, 1997,
$5,214,000 and $5,327,000 of investments were included in cash and cash
equivalents and long-term investments, respectively. The contractual maturities
of securities held at December 31, 1998 are one year or less. Actual maturities
may differ from contractual maturities because the issuers of the securities may
have the right to prepay obligations with or without prepayment penalties. At
December 31, 1998 and 1997, the Company has classified all of its investments
(consisting entirely of corporate debt securities) as held-to-maturity, as
summarized below (in thousands):

<TABLE>
<CAPTION>
                                                 1998                    1997
                                               -------                 -------
         <S>                                   <C>                     <C>
         Cost                                  $14,874                 $10,541
         Gross Unrealized Gains                      3                       1
         Gross Unrealized Losses                   (38)                     --
                                               -------                 -------
         Fair Market Value                     $14,839                 $10,542
                                               =======                 =======
</TABLE>

4.       Property and Equipment

         Property and equipment at December 31 consist of the following (in
         thousands):

<TABLE>
<CAPTION>
                                                      1998                    1997
                                                     -----                  -------
         <S>                                         <C>                    <C>
         Land                                        $  --                  $   220
         Buildings and improvements                     --                    4,184
         Equipment and furnishings                     799                    2,963
                                                     -----                  -------
                                                       799                    7,367
         Less accumulated depreciation                (604)                  (2,653)
                                                     -----                  -------
                                                     $ 195                  $ 4,714
                                                     =====                  =======
</TABLE>

5.       6% Convertible Debentures

         In October 1997, the Company privately placed with certain investors
$2,000,000 of convertible notes (the "Debentures") maturing in October, 2001.
The Debentures were convertible on and after December 31, 1997 into shares of
CytRx Common Stock at a price of the lesser of (a) 85% of the average closing
bid price for the 10 days preceding the conversion, or (b) $5.68 per share. Such
beneficial conversion feature was determined to have a fair value of $265,000 at
the date of issuance and was amortized to interest expense from the date of
issuance through the date the Debentures first became convertible. The
Debentures were sold at par and bore interest at a rate of 6% per annum. The
provisions for


<PAGE>   14


conversion of the Debentures allowed the Company, at its discretion, to disallow
conversions below $4.00 per share by redeeming the amount attempted to be
converted at a 10% premium. Also in connection with the issuance of the
Debentures, the investors were issued two year warrants to purchase 40,000
shares of CytRx common stock at an exercise price of $5.68. The fair value of
such warrants was determined to be insignificant.

         In February and March 1998, $500,000 of the Debentures were converted
into 204,104 shares of common stock. In February and May 1998, $1,500,000 of the
Debentures were redeemed by the Company and total redemption premiums of
$150,000 were paid. In addition, $175,000 of previously capitalized debt issue
costs were expensed. The redemption premiums and debt issue costs are reflected
as an extraordinary item in the statement of operations as loss on early
extinguishment of debt. At December 31, 1998 there were no remaining outstanding
Debentures.

6.       Commitments and Contingencies

          Rental expense from continuing operations under operating leases
during 1998, 1997 and 1996 approximated $154,000, $13,000 and $14,000,
respectively. Minimum annual future obligations for operating leases are
$164,000, $163,000, $167,000, $171,000, $178,000 and $863,000 in 1999, 2000,
2001, 2002, 2003, and 2004 and beyond, respectively. Aggregate minimum future
subrentals the Company expects to receive under noncancellable subleases total
approximately $38,000 at December 31, 1998.

7.       Stock Options and Warrants

         CytRx and Vaxcel have stock option plans pursuant to which certain key
employees and directors are eligible to receive incentive and/or nonqualified
stock options to purchase shares of CytRx's or Vaxcel's common stock. The
options granted under the plans generally become exercisable over a three year
period from the dates of grant and have lives of ten years. Certain options
granted to the Company's executive officers and others contain alternative or
additional vesting provisions based on the achievement of corporate objectives.
Additionally, the Company has granted warrants to purchase shares of the
Company's common stock to its President and Chief Executive Officer subject to
vesting criteria as set forth in his warrant agreements; such warrants have
lives of ten years from the dates of grant. Exercise prices of all options and
warrants are set at the fair market values of the common stock on the dates of
grant. During 1998, the Company repriced all outstanding options and warrants
held by current employees to the then current market value. No compensation
expense was recorded for the three years ended December 31, 1998; however, as of
March 9, 1999, the vesting criteria for 680,238 options and warrants had been
achieved, resulting in $735,500 of compensation expense which will be recorded
in the first quarter of 1999.

         A summary of the Company's stock option and warrant activity and
related information for the years ended December 31 is shown below.

<TABLE>
<CAPTION>
                                                       Options and Warrants        Weighted Average Exercise Price
                                              ------------------------------------ -------------------------------
                                                 1998         1997         1996       1998      1997       1996
                                              ----------   ----------   ----------   -----      ----       ----
         <S>                                  <C>          <C>          <C>          <C>       <C>        <C>
         Outstanding - beginning of year       1,439,297    1,237,031    1,018,289   $4.87     $5.00      $ 6.08
         Granted                                 902,488      221,700      275,688    2.65      4.35        3.72
         Exercised                                    --           --           --      --        --          --
         Forfeited                               (83,477)     (19,434)     (56,946)   4.37      6.64       20.44
         Expired                                      --           --           --      --        --          --
                                              ----------   ----------   ----------   -----     -----      ------
         Outstanding - end of year             2,258,308    1,439,297    1,237,031   $1.17     $4.87      $ 5.00
                                              ==========   ==========   ==========

         Exercisable at end of year            1,104,620      940,541      874,946   $1.33     $5.22      $ 5.22

         Weighted average fair value
           of options and warrants
           granted during the year:           $     2.30   $     3.97   $     3.39
</TABLE>

         The following table summarizes additional information concerning
options and warrants outstanding and exercisable at December 31, 1998:

<TABLE>
<CAPTION>
                                       Options Outstanding                                  Options Exercisable
               --------------------------------------------------------------------     -----------------------------
                                                       Weighted
                                                        Average
                                                       Remaining        Weighted                          Weighted
                  Range of                            Contractual        Average          Number           Average
               Exercise Prices   Number of Shares    Life (years)    Exercise Price     Exercisable    Exercise Price
               ---------------   ----------------    ------------    --------------     -----------    --------------
               <S>               <C>                 <C>             <C>                 <C>           <C>
                  $ .75 -  1.00      2,189,206            7.3           $   .99          1,045,518        $  1.00
                   2.75 -  5.00         23,750            4.8              3.96             16,750           4.25
                   6.50 -  7.75         34,414            5.2              7.27             29,414           7.19
                  9.125 - 31.00         10,938            5.7             12.01             10,938          12.01
                                     ---------                                           ---------
                                     2,258,308            7.3              1.17          1,104,620           1.33
                                     =========                                           =========
</TABLE>


<PAGE>   15


         A summary of Vaxcel's stock option activity and the related information
for the years ended December 31 is shown below.

<TABLE>
<CAPTION>
                                                                Options                       Weighted Average Exercise Price
                                               ---------------------------------------       ---------------------------------
                                                  1998            1997           1996         1998          1997          1996
                                                  ----            ----           ----         ----          ----          ----
         <S>                                  <C>              <C>            <C>            <C>           <C>           <C>
         Outstanding - beginning of year         847,000        794,453        735,000       $1.63         $1.50         $1.50
         Granted                                 510,000         63,000         73,620         .63          3.18          1.50
         Exercised                                    --         (5,333)            --          --          1.50            --
         Forfeited                              (281,500)        (5,120)       (14,167)       1.73          1.50          1.50
                                               ---------        -------       --------
         Outstanding - end of year             1,075,500        847,000        794,453       $1.12         $1.63         $1.50
                                               =========        =======       ========

         Exercisable at end of year              160,661        293,663        184,332       $1.68         $1.57         $1.50

         Weighted average fair value of
         options granted during the year      $      .42       $   1.82       $   0.83
</TABLE>

         The exercise prices for Vaxcel's options outstanding as of December 31,
1998 ranged from $.63 to $3.25. The weighted average remaining contractual life
of those options is 6.2 years.

         The Company and Vaxcel have elected to follow APB 25 and related
Interpretations in accounting for their employee stock options and warrants
because, as discussed below, the alternative fair value accounting provided for
under Statement 123 requires use of option valuation models that were not
developed for use in valuing employee stock options.

         Pro forma information regarding net loss and loss per share is required
by Statement 123, which also requires that the information be determined as if
the Company and Vaxcel had accounted for their employee stock options granted
and warrants issued subsequent to December 31, 1994 under the fair value method
of that Statement. The fair value for the Company's options and warrants was
estimated at the date of grant using a Black-Scholes option pricing model with
the following assumptions:

<TABLE>
<CAPTION>
                                                      1998           1997           1996
                                                     -----          -----           ----
         <S>                                         <C>            <C>            <C>
         Weighted average risk free interest rate    5.64%          6.22%          6.30%
         Dividend yields                                 0%             0%             0%
         Volatility factors of the expected market
         price of the Company's common stock         1.026          1.055           1.12
         Weighted average life of the option             8              8              8
         (years)
</TABLE>

         The fair value for Vaxcel's options was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions:

<TABLE>
<CAPTION>
                                                     1998       1997       1996
                                                     ----       ----       ----
         <S>                                         <C>        <C>        <C>
         Weighted average risk free interest rate    5.83%      6.53%      6.34%
         Dividend yields                                0%         0%         0%
         Volatility factors of the expected market
         price of the subsidiary's common stock      .563       .585       .378
         Weighted average life of the option            8          8          8
         (years)
</TABLE>

         The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's and its subsidiary's employee stock options
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.

         For purposes of pro forma disclosures, the estimated fair value of the
options and warrants is amortized to expense over the options' vesting periods.
The Company's pro forma information is as follows (in thousands, except per
share data):

<TABLE>
<CAPTION>
                                             1998           1997           1996
                                           -------        -------        -------
         <S>                               <C>            <C>            <C>
         Pro forma net loss                $(6,521)       $(6,969)       $(6,343)
         Pro forma net loss per share
         (basic and diluted)               $  (.86)       $  (.94)       $  (.82)
</TABLE>
<PAGE>   16

8.       Shareholder Protection Rights Plan

         Effective April 16, 1997, the Company's Board of Directors declared a
distribution of one Right for each outstanding share of the Company's common
stock to stockholders of record at the close of business on May 15, 1997 and for
each share of common stock issued by the Company thereafter and prior to a
Flip-in Date (as defined below). Each Right entitles the registered holder to
purchase from the Company one-ten thousandth (1/10,000th) of a share of Series A
Junior Participating Preferred Stock, at an exercise price of $30. The Rights
are generally not exercisable until 10 business days after an announcement by
the Company that a person or group of affiliated persons (an "Acquiring Person")
has acquired beneficial ownership of 15% or more of the Company's then
outstanding shares of common stock (a "Flip-in Date").

         In the event the Rights become exercisable as a result of the
acquisition of shares, each Right will enable the owner, other than the
Acquiring Person, to purchase at the Right's then current exercise price a
number of shares of common stock with a market value equal to twice the exercise
price. In addition, unless the Acquiring Person owns more than 50% of the
outstanding shares of common stock, the Board of Directors may elect to exchange
all outstanding Rights (other than those owned by such Acquiring Person) at an
exchange ratio of one share of common stock per Right. All Rights that are owned
by any person on or after the date such person becomes an Acquiring Person will
be null and void.

         The Rights have been distributed to protect the Company's stockholders
from coercive or abusive takeover tactics and to give the Board of Directors
more negotiating leverage in dealing with prospective acquirors.

9.       Retirement Plan

         The Company maintains a defined contribution retirement plan (the
"Plan") covering employees of the Company. Historically, at the Board of
Directors' discretion, the Company has matched 50% of the participant's
contribution with common stock. The Company's matching contribution vests over 3
years. Total expense for the Plan for the years ended December 31, 1998, 1997
and 1996 was approximately $110,000, $176,000 and $156,000, respectively, of
which $44,000, $120,000 and $95,000 related to discontinued operations for the
years ended December 31, 1998, 1997 and 1996, respectively.

10.      Income Taxes

         For income tax purposes, CytRx and its subsidiaries have an aggregate
of approximately $49.2 million of net operating losses available to offset
against future taxable income, subject to certain limitations. Included in this
amount is $3,360,000 of net operating losses generated by Zynaxis prior to the
merger. See discussion below. Such losses expire in 2000 through 2018. They also
have an aggregate of approximately $1.2 million of research and development
credits available for offset against future income taxes which expire in 2000
through 2010.

         Deferred income taxes reflect the net effect of temporary differences
between the financial reporting carrying amounts of assets and liabilities and
income tax carrying amounts of assets and liabilities. The components of the
Company's deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                                 December 31,
                                                        -------------------------------
                                                            1998               1997
                                                        ------------       ------------
         <S>                                            <C>                <C>
         Deferred tax assets:
           Net operating loss carryforward              $ 18,677,000       $ 16,942,000
           Tax credit carryforward                         1,245,000          1,096,000
           Other                                           1,218,000          1,396,000
                                                        ------------       ------------
         Total deferred tax assets                        21,140,000         19,434,000
         Deferred tax liabilities:
           Acquired developed technology and other          (228,000)        (1,556,000)
             intangibles
           Depreciation and other                           (143,000)          (194,000)
                                                        ------------       ------------
         Total deferred tax liabilities                     (371,000)        (1,750,000)
                                                        ------------       ------------
         Net deferred tax assets                          20,769,000         17,684,000
         Valuation allowance                             (20,769,000)       (17,684,000)
                                                        ------------       ------------
                                                        $         --       $         --
                                                        ============       ============
</TABLE>

         Based on assessments of all available evidence as of December 31, 1998
and 1997, management has concluded that the respective deferred income tax
assets should be reduced by valuation allowances equal to the amounts of the
deferred income tax assets.


<PAGE>   17


         The total amount of net operating loss carryforwards generated by
Zynaxis, Inc. prior to its merger with Vaxcel (see Note 11) was $31,000,000. The
use of pre-acquisition operating loss carryforwards is subject to limitations
imposed by the Internal Revenue Code. The Company anticipates that these
limitations will affect utilization of the carryforwards prior to expiration.
Therefore, for financial reporting purposes the Company has recorded a deferred
tax asset of $1,277,000 related only to $3,360,000 of net operating losses not
anticipated to be affected by these limitations. A corresponding valuation
allowance of $1,277,000 has been recorded. When realized, the tax benefit of
these loss carryforwards will be applied to reduce acquired developed technology
and other intangibles related to the acquisition of Zynaxis.

11.      Discontinued Operations

Vaxcel, Inc.
         Acquisition of Zynaxis, Inc. - In December 1996 CytRx, Vaxcel, Inc.
("Vaxcel") and Zynaxis, Inc. ("Zynaxis") signed an agreement whereby Zynaxis
would be merged with a wholly-owned subsidiary of Vaxcel. At that time Zynaxis
was a publicly-held biotechnology company engaged in the development of certain
vaccine technologies. The transaction was approved by the Zynaxis stockholders
at a meeting held on May 21, 1997 and was consummated as of that date.

         Under the terms of the agreement all of the outstanding shares of
Zynaxis were converted into shares of Vaxcel based upon certain exchange ratios
defined in the agreement, resulting in the issuance of an aggregate of 1.4
million (12.5%) of the outstanding (post-merger) shares of Vaxcel common stock
(at $2.91 per share) to former Zynaxis stockholders at the date of closing. The
merger was treated as a purchase by Vaxcel and constituted a tax-free
reorganization for Zynaxis stockholders. The results of operations of Zynaxis
are included in the statement of operations since May 21, 1997.

         Pursuant to the agreement, CytRx was to provide up to $2 million to
Zynaxis under a secured credit facility during the period prior to closing of
the merger, at which time the outstanding principal and interest was to be
contributed to the capital of Vaxcel, together with additional equity in the
amount of $4 million less the outstanding principal and interest of the secured
note. At the time of closing the outstanding principal and interest of the
secured note to Zynaxis was approximately $1.7 million, resulting in a net cash
infusion from CytRx to Vaxcel of approximately $2.3 million. In addition, at the
date of closing, Vaxcel issued to CytRx a one-year warrant entitling CytRx to
purchase a number of shares of Vaxcel common stock equal to the amount of
capital which may be necessary for Vaxcel to satisfy requirements for inclusion
in the Nasdaq SmallCap Market, divided by one-half of the $2.91 per share
transaction price at the date of closing. The warrant expired unexercised.

         As a result of this transaction, CytRx owns 87.5% of the outstanding
Vaxcel common stock and former Zynaxis stockholders own the remaining 12.5%. An
unrealized gain of $2,706,000 relating to the sale of 12.5% of Vaxcel common
stock is reflected in stockholders' equity. The change to equity reflecting
CytRx's proportionate share of the increase in Vaxcel's equity related to the
shares issued in connection with the acquisition of Zynaxis was recorded as an
equity transaction since realization of the gain was not assured.

         In accordance with the provisions of APB Nos. 16 and 17, all
identifiable assets acquired, including identified intangible assets and
liabilities assumed, were assigned a portion of the purchase price based on
their respective fair values. The fair values of the acquired developed
technology and incomplete research and development were determined based on an
independent appraisal. A summary of the allocation of the purchase price is as
follows (in thousands):

<TABLE>
         <S>                                                               <C>
         Net tangible assets, less outstanding liabilities                 $ (830)
         Acquired developed technology and other intangibles                4,241
         Acquired incomplete research and development                         951
                                                                           ------
                                                                           $4,362
                                                                           ======
</TABLE>

         Presentation as Discontinued Operations - During 1998, Vaxcel's Board
of Directors retained an investment banking firm to introduce Vaxcel and its
technology licenses to the trade with the purpose of concluding a strategic
transaction for the benefit of the Vaxcel shareholders. The Company was
considering all available options for the disposition of Vaxcel, including
license or sale of specific technologies and possible merger with another
organization. Based on the results of the investment banking firm's efforts and
management's reevaluation of CytRx's strategic direction, in the fourth quarter
of 1998 the Company adopted a plan to dispose of the research and development
activities in which Vaxcel is engaged. The Company intends to complete the plan
during 1999. As a result of adopting such a plan, the operations of Vaxcel are
presented as discontinued operations in the accompanying consolidated statements
of operations. The results of operations


<PAGE>   18


of Vaxcel have been reclassified from income (loss) from continuing operations
to discontinued operations for the two years ended December 31, 1997.

         Net losses (net of minority interest) associated with Vaxcel included
in income (loss) from discontinued operations were approximately $(4,319,000),
$(2,357,000) and $(1,124,000) for the years ended December 31, 1998, 1997 and
1996, respectively. See discussion below regarding the 1998 impairment loss. A
summary of the assets and liabilities of Vaxcel which are included in the
consolidated balance sheets at December 31, 1998 and 1997 is as follows (in
thousands):

<TABLE>
<CAPTION>
                                                   1998                 1997
         <S>                                       <C>                <C>
         Current assets                            $314               $  833
         Property and equipment, net                  7                   74
         Other assets                               655                4,551
                                                   ----               ------
         Total assets                              $976               $5,458
                                                   ====               ======
         Total liabilities                         $618               $  167
                                                   ====               ======
</TABLE>

Impairment Loss - In its efforts to raise additional capital, Vaxcel has been
soliciting bids for the sublicense or purchase of Vaxcel's acquired developed
technology, either together with or separately from Vaxcel's other technologies.
During the fourth quarter, the results of the investment firms's efforts
indicated to management that the acquired developed technology might be
impaired. As a result of this indication, Vaxcel performed an evaluation to
determine, in accordance with Statement 121, whether future cash flows
(undiscounted and without interest charges) expected to result from the use and
eventual disposition of the acquired developed technology would be less than its
aggregate carrying amount and an allocation of goodwill resulting from the
Zynaxis merger. Statement 121 requires that when a group of assets being tested
for impairment was acquired as part of a business combination accounted for
using the purchase method of accounting, any goodwill that arose as part of the
transaction must be included as part of the asset grouping. As a result of the
evaluation, management determined that the estimated future cash flows expected
to be generated by the acquired developed technology would be less than its
carrying amount and allocated goodwill, and therefore the asset is impaired as
defined by Statement 121. Consequently, the original cost basis of the acquired
developed technology and allocated goodwill were reduced to reflect the fair
market value at the date the evaluation was made, resulting in a $3,213,000
impairment loss. In determining the fair market value of the asset, management
considered the transaction described below, among other factors.

Potential Sale of Technology - In January 1999, Vaxcel entered into an agreement
with a third party giving the third party the option to purchase the rights to
certain of its technologies for an aggregate purchase price of $600,000. The
third party paid a nonrefundable option fee of $200,000, with an additional
$400,000 due upon the exercise of the option. The initial option period expires
on March 22, 1999, subject to extension upon payment of additional fees by the
third party.

Proceutics, Inc.
         In February 1998, CytRx's wholly-owned subsidiary, Proceutics
consummated a sale of substantially all of its non-real estate assets to Oread
Laboratories, Inc. ("Oread") for approximately $2.1 million. Proceutics retained
its real estate assets consisting of a laboratory building which it leased to
Oread. The laboratory building was subsequently sold in May 1998 (see Note 12).
Prior to consummation of this transaction, Proceutics provided preclinical
development services to the pharmaceutical industry.

         Net income (loss) associated with Proceutics included in income (loss)
from discontinued operations was approximately $1,387,000, $(138,000) and
$(1,448,000) for the years ended December 31, 1998, 1997 and 1996, respectively
(see Note 13). A $782,000 gain related to the sale of non-real estate assets is
included in income from discontinued operations for 1998, as well as a $434,000
gain on the sale of Proceutics' real estate assets (see Note 12). A summary of
the assets and liabilities of Proceutics which were sold and which are included
in the consolidated balance sheet at December 31, 1997 is as follows (in
thousands):

<TABLE>
         <S>                                       <C>
         Current assets                            $  721
         Property and equipment, net                  696
                                                   ------
         Total assets                              $1,417
                                                   ------
         Total liabilities                         $  228
                                                   ======
</TABLE>

CytRx Animal Health, Inc.
         In April 1998, CytRx's wholly-owned subsidiary, CytRx Animal Health,
consummated the sale of substantially all of its assets related to its cattle
marketing operations to VetLife, LLC ("VL LLC") (an unaffiliated company) for a
total
<PAGE>   19


purchase price of $7,500,000, subject to certain working capital adjustments,
plus contingent payments based on certain events and future sales of specified
products of VL LLC and its affiliates that, if made in full, could total up to
$5,500,000. CytRx Animal Health retained $5.3 million in investments that were
pledged to secure a letter-of-credit, as well as the rights to certain
technologies licensed from CytRx. Prior to consummation of this transaction,
CytRx Animal Health was engaged in marketing and distributing products to
enhance North American beef cattle productivity.

         Net income (loss) associated with CytRx Animal Health included in
income (loss) from discontinued operations was approximately $5,645,000,
$868,000 and $(1,151,000) for the years ended December 31, 1998, 1997 and 1996,
respectively (see Note 13). A gain related to the sale of $6,230,000 is included
in income from discontinued operations for 1998. A summary of the assets and
liabilities of CytRx Animal Health which were sold and which are included in the
consolidated balance sheet at December 31, 1997 is as follows (in thousands):

<TABLE>
         <S>                                       <C>
         Current assets                            $3,695
         Property and equipment, net                  100
                                                   ------
         Total assets                              $3,795
                                                   ======
         Total liabilities                         $2,048
                                                   ======
</TABLE>

12.      Sale of Real Estate

         In May 1998, CytRx and Proceutics consummated the sale of the two
buildings owned by them at 150 and 154 Technology Parkway, Norcross, Georgia, to
Alexandria Real Estate Equities, Inc. ("Alexandria") for $4.5 million.
Proceutics' rights and obligations under the lease to Oread (See Note 11) were
assigned to Alexandria, and CytRx leases the building at 154 Technology Parkway
from Alexandria. CytRx will also be responsible for all operating expenses for
the property. Proceutics recorded a gain of $434,000 for the sale of the its
building. A gain of $279,000 on the sale/leaseback of the CytRx building was
deferred and will be amortized over the ten year lease period.

13.      Segment Reporting

         The Company has six reportable segments: Research Products (TiterMax),
Recruiting Services (Spectrum), Product Development (core business of
development and commercialization of pharmaceutical-related products), Cattle
Marketing Operations (CytRx Animal Health), Vaccine Development (Vaxcel) and
Pharmaceutical Services (Proceutics). See Notes 1 and 11 for a description of
these operations.

         The Company adopted FASB Statement No. 131, Disclosures About Segments
of an Enterprise and Related Information, in 1998 which changes the way the
Company reports information about its operating segments. The information for
1997 and 1996 has been restated from the prior year's presentation in order to
conform to the 1998 presentation. The accounting policies of the reportable
segments are the same as those described in the summary of significant
accounting policies (see Note 1). The Company evaluates performance of its
operating segments based primarily on profit or loss from operations before
income taxes. Summarized financial information concerning the Company's
reportable segments is shown in the following table.

<TABLE>
<CAPTION>
                                              Continuing Operations                            Discontinued Operations
                                  ----------------------------------------------- -------------------------------------------------
                                                                       Total       Cattle      Pharma-                    Total
                                  Research   Recruiting   Product    Continuing  Marketing     ceutical      Vaccine   Discontinued
       (in thousands)             Products   Services   Development  Operations  Operations    Services    Development  Operations
---------------------------       --------   --------   -----------  ----------  ----------    --------    -----------  ----------
<S>                               <C>        <C>        <C>          <C>         <C>           <C>         <C>          <C>
1998:
Sales to external customers         $481       $351      $    --      $   832     $ 4,383      $   419      $    --       $ 4,802
Intersegment sales                    --         --           --           --          --          131           --           131
Collaborative, grant & other          --         --          756          756          --           --          167           167
revenue
Interest income                       --         --        1,007        1,007          --           22           13            35
Interest expense                      --         --           46           46          --            3            7            10
Depreciation and amortization         --         --          120          120           8           78          294           380
Unusual Items:
  Gain on sale of business            --         --           --           --       6,230          782           --         7,012
  Gain on sale of real estate         --         --           --           --          --          434           --           434
  Provision for asset impairment      --         --           --           --          --           --        3,213         3,213
  Loss on early debt
    extinguishment                    --         --          325          325          --           --           --            --
Segment profit (loss)                231        114       (8,176)      (7,831)      5,645        1,387       (4,319)        2,713
Total assets                          --         --       15,666       15,666          --           --          976           976
Capital expenditures                  --         --          112          112          --           12            4            16

1997:
Sales to external customers          456        422           --          878      13,469        1,984           --        15,453
Intersegment sales                    --         --           --           --          --          853           --           853
Collaborative, grant & other
  revenue                             --         --          630          630          --           --          243           243
Interest income                       --         --          752          752          --            2           46            48
Interest expense                      --         --          293          293          --           36            1            37
Depreciation and amortization         --         --          171          171          16          365          201           582
Segment profit (loss)                193         77       (4,696)      (4,426)        868         (138)      (2,357)       (1,627)
Total assets                          --         --       11,477       11,477       3,795        4,176        5,458        13,429
Capital expenditures                  --         --           98           98          11          165           --           176

1996:
Sales to external customers          522        358           --          880         711        1,004           --         1,715
Intersegment sales                    --         --           --           --          --          627           --           627
Collaborative, grant & other
  revenue                             --         --          397          397          --           --          128           128
Interest income                       --         --        1,162        1,162          --            2            7             9
Interest expense                      --         --           --           --          --           25           --            25
Depreciation and amortization         --         --          151          151          15          437           52           504
Segment profit (loss)                173         28       (2,269)      (2,068)     (1,151)      (1,448)      (1,124)       (3,723)
Total assets                          --         --       18,869       18,869         735        4,317          378         5,430
Capital expenditures                  --         --           76           76         115          336            3           454
</TABLE>


<PAGE>   20


Report of Independent Auditors

The Board of Directors and Stockholders
CytRx Corporation

         We have audited the accompanying consolidated balance sheets of CytRx
Corporation as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
CytRx Corporation at December 31, 1998 and 1997 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.


/s/ Ernst & Young LLP


Atlanta, Georgia
March 9, 1999