<PAGE>
 
                                                                  CONFORMED COPY
                                                                  --------------



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


                                   FORM 10-Q


(Mark One)

   [X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934 FOR QUARTER ENDED SEPTEMBER 30, 1996

                                      OR

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

Commission File Number:  1-12574

                        TEXAS BIOTECHNOLOGY CORPORATION
-------------------------------------------------------------------------------
            (Exact name of registrant as specified in its charter)


            Delaware                          13-3532643
---------------------------------           ---------------------------
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)

        7000 Fannin, Suite 1920, Houston, Texas               77030
-------------------------------------------------------------------------------
        (Address of principal executive office)            (Zip code)

                                (713) 796-8822
-------------------------------------------------------------------------------
             (Registrant's telephone number, including area code)

                                Not Applicable
-------------------------------------------------------------------------------
                    (Former name, former address and former
                  fiscal year, if changed since last report)

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

Yes   X    No 
    -----     -----    

Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.

               Class                Outstanding at October 15, 1996
               -----                -------------------------------

 Common Stock, $0.005 par value                25,454,434
<PAGE>
 
                        TEXAS BIOTECHNOLOGY CORPORATION

                               TABLE OF CONTENTS
                               -----------------
                                        
<TABLE>
<CAPTION>



                                                                                                                       PAGE NO.
                                                                                                                       --------
PART I.      FINANCIAL INFORMATION
<S>                                                                                                                    <C> 
             ITEM 1:  FINANCIAL STATEMENTS

 
             Consolidated Balance Sheets as of September 30, 1996 and December 31, 1995                                    1
 
             Consolidated Statements of Operations for the three months ended September 30, 1996
             and 1995, the nine months ended September 30, 1996 and 1995, and the period from
             August 2, 1989 (date of incorporation) through September 30, 1996                                             2
 
             Consolidated Statements of Cash Flows the nine months ended
             September 30, 1996 and 1995, and the period from August 2, 1989
             (date of incorporation) through September 30, 1996                                                            3
 
             Notes to Consolidated Financial Statements                                                                    4
 
             ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                      FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                                   14
 
PART II.     OTHER INFORMATION
 
             ITEM 1:  Legal Proceedings                                                                                   19
 
             ITEM 2:  Changes in Securities                                                                               19
 
             ITEM 3:  Defaults Upon Senior Securities                                                                     19
 
             ITEM 4:  Submission of Matters to a Vote of Security Holders                                                 20
 
             ITEM 5:  Other Information                                                                                   20
 
             ITEM 6:  Exhibits and Reports on Form 8-K                                                                    20
 


SIGNATURES                                                                                                                21

INDEX TO EXHIBITS                                                                                                         22
 
</TABLE>
<PAGE>
 
PART I    FINANCIAL INFORMATION
-------------------------------

ITEM 1.   FINANCIAL STATEMENTS
------------------------------

                TEXAS BIOTECHNOLOGY CORPORATION AND SUBSIDIARY
                       (A DEVELOPMENT STAGE ENTERPRISE)

                          CONSOLIDATED BALANCE SHEETS

<TABLE> 
<CAPTION> 

                                                                                             SEPTEMBER 30,     DECEMBER 31,
                                                                                                 1996             1995
                                          ASSETS                                             -------------     ------------
                                          ------                                              (UNAUDITED)

<S>                                                                                          <C>               <C> 

Current assets:                                                                              
        Cash and cash equivalents                                                            $     808,126     $   5,724,264
        Short term investments                                                                  11,738,650         8,195,307
        Short term note receivable                                                                 122,500           122,500
        Prepaids                                                                                   278,072           554,208
        Other current assets                                                                       385,267           547,391
                                                                                             -------------     -------------
                Total current assets                                                            13,332,615        15,143,670

Equipment, furniture and fixtures, and leasehold improvements                                    7,611,538         7,529,415
        Less: Accumulated depreciation and amortization                                         (4,294,237)       (3,746,586)
                                                                                             -------------     -------------
                Net property                                                                     3,317,301         3,782,829
                                                                                             -------------     -------------
                Total assets                                                                 $  16,649,916        18,926,499
                                                                                             =============     =============

                            LIABILITIES AND STOCKHOLDERS' EQUITY
                            ------------------------------------

Current liabilities:
        Accounts payable and accrued expenses                                                $   2,983,544         2,566,264
        Deferred revenue                                                                           250,000           650,110
                                                                                             -------------     -------------
                Total current liabilities                                                        3,233,544         3,216,374

Commitments and contingencies                                                                          ---               ---

Stockholders' equity:
        Preferred stock, par value $.005 per share. At September 30, 1996 and
                December 31, 1995, 5,000,000 shares authorized; none outstanding.                       ---               ---
        Common stock, par value $.005 per share. At September 30, 1996,
                75,000,000 shares authorized; 24,203,600 shares issued and
                outstanding. At December 31, 1995, 40,000,000 shares authorized;
                17,439,365 shares issued and outstanding (notes 2, 3 and 5)                        121,017            87,198
        Additional paid-in capital                                                              73,149,358        59,540,730
        Deferred compensation expense (note 3)                                                         ---           (46,177)
        Deficit accumulated during the development stage                                       (59,854,003)      (43,871,626)
                                                                                             -------------     -------------
                Total stockholders' equity                                                      13,416,372        15,710,125
                                                                                             -------------     -------------
                Total liabilities and stockholders' equity                                   $  16,649,916     $  18,926,499
                                                                                             =============     =============



FORM 10-Q                        See accompanying notes to consolidated financial statements                          Page 1
</TABLE> 


<PAGE>
 
                TEXAS BIOTECHNOLOGY CORPORATION AND SUBSIDIARY
                       (A DEVELOPMENT STAGE ENTERPRISE)

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                                  (UNAUDITED)


<TABLE> 
<CAPTION> 
                                                                                                                 AUGUST 2, 1989
                                                                                                                   (DATE OF
                                                                                                                 INCORPORATION)
                                                        THREE MONTHS ENDED            NINE MONTHS ENDED             THROUGH
                                                          SEPTEMBER 30,                 SEPTEMBER 30,            SEPTEMBER 30,
                                                       1996           1995           1996           1995             1996
                                                    ----------     ----------     ----------     ----------      --------------
<S>                                                 <C>            <C>            <C>            <C>             <C> 
Revenues:
        Research agreements                         $ 1,100,000      3,338,027      4,295,110      5,638,247        15,333,796
        Products and services                             2,500         35,600          6,439        207,801           403,080
        Grant revenue                                       ---         30,391          1,727        206,939           668,951
                                                    -----------     ----------     ----------     ----------       -----------
                Total revenues                        1,102,500      3,404,018      4,303,276      6,052,987        16,405,827
                                                    -----------     ----------     ----------     ----------       -----------

Expenses:
        Research and development                      5,980,096      3,753,107     17,484,641     10,560,959        51,072,296
        Charge for purchase of in-process
          research and development                          ---            ---            ---      1,973,883         9,465,610
        General and administrative                      952,299      1,223,671      3,076,936      3,928,417        18,481,570
        Restructuring and impairment of
          intangible assets (note 9)                        ---            ---        421,165            ---         1,064,915
                                                    -----------     ----------     ----------     ----------       -----------
                Total expenses                        6,932,395      4,976,778     20,982,742     16,463,259        80,084,391
                                                    -----------     ----------     ----------     ----------       -----------

                Operating loss                        5,829,895      1,572,760     16,679,466     10,410,272        63,678,564
                                                    -----------     ----------     ----------     ----------       -----------

Other income (expense):
        Interest income                                 199,811        285,333        697,089        960,540         3,916,208
        Interest expense                                    ---            ---            ---           (969)          (91,647)
                                                    -----------     ----------     ----------     ----------       -----------

                Net loss                            $ 5,630,084      1,287,427     15,982,377      9,450,701        59,854,003
                                                    ===========     ==========     ==========     ==========       ===========

Net loss per share                                  $      0.23           0.07           0.69           0.57              5.96
                                                    ===========     ==========     ==========     ==========       ===========

Weighted average common shares used to
        compute net loss per share                   24,188,708     17,439,365     23,053,607     16,516,343        10,045,776
                                                    ===========     ==========     ==========     ==========       ===========




FORM 10-Q                          See accompanying notes to consolidated financial statements                       Page 2
</TABLE> 

<PAGE>
 
                TEXAS BIOTECHNOLOGY CORPORATION AND SUBSIDIARY
                       (A DEVELOPMENT STAGE ENTERPRISE)

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                  (UNAUDITED)

<TABLE> 
<CAPTION> 
                                                                                                       AUGUST 2, 1989
                                                                                                         (DATE OF
                                                                        NINE MONTHS ENDED              INCORPORATION)
                                                                          SEPTEMBER 30,                   THROUGH
                                                                                                       SEPTEMBER 30,
                                                                     1996               1995               1996
                                                                 ------------       ------------       --------------
<S>                                                              <C>                <C>                <C> 

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                       $  (15,982,377)      (9,450,701)        (59,854,003)
  Adjustments to reconcile net loss to net cash
    used in operating activities:
        Write-off of deferred offering costs related
            to delayed offering                                             ---              ---             324,938
        Depreciation and amortization                                   547,651          607,097           4,400,490
        Interest expense converted on notes payable
            to stockholders                                                 ---              ---              87,755
        Expenses paid with stock                                            ---              ---              24,500
        Non cash acquisition costs expensed                                 ---        1,973,883           9,465,610
        Deferred compensation expense                                    46,177           70,505             287,158
        Impairment of intangible assets                                     ---              ---             643,750
  Change in operating assets and liabilities, net of
    effect of acquisition:
    (Increase) decrease in prepaids                                     276,136              ---            (100,412)
    (Increase) decrease in receivables                                    7,291           87,500             (82,995)
    (Increase) decrease in other current assets                         154,833          (75,833)           (500,450)
    Decrease in inventories                                                 ---              ---              61,245
    Increase in current liabilities                                     417,280          333,295           2,917,426
    (Decrease) in deferred revenue                                     (400,110)      (1,378,620)         (1,422,122)
                                                                 --------------     ------------        ------------
        Net cash used in operating activities                       (14,933,119)      (7,832,874)        (43,747,110)
                                                                 --------------     ------------        ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of equipment and leasehold improvements                     (82,123)        (184,257)         (7,303,078)
  Purchase of short term investments                                (24,007,757)     (20,949,220)        (75,928,978)
  Redemption of short term investments                               20,464,414       25,049,002          64,190,328
  Acquisition of subsidiary, net of cash acquired                           ---              ---            (167,331)
                                                                 --------------     ------------        ------------
        Net cash (used in) provided by investing activities          (3,625,466)       3,915,525         (19,209,059)
                                                                 --------------     ------------        ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from notes payable to stockholders and
    related trusts                                                          ---              ---           1,852,500
  Proceeds from sale of common stock and option and
    warrant exercises, net                                           13,642,447              ---          62,240,483
  Repurchase of common stock                                                ---              ---              (3,750)
  Cost of delayed offering                                                  ---              ---            (324,938)
                                                                 --------------     ------------        ------------
        Net cash provided by financing activities                    13,642,447              ---          63,764,295
                                                                 --------------     ------------        ------------

    Net increase (decrease) in cash and cash equivalents             (4,916,138)      (3,917,349)            808,126

Cash and cash equivalents at beginning of period                      5,724,264        7,199,942                 ---
                                                                 --------------     ------------        ------------

Cash and cash equivalents at end of period                       $      808,126        3,282,593             808,126
                                                                 ==============     ============        ============
Supplemental schedule of noncash financing activities
                                                                 $          ---        2,061,383          11,405,865
                                                                 ==============     ============        ============



FORM 10-Q                    See accompanying notes to consolidated financial statements                           Page 3

</TABLE> 


<PAGE>
 
                TEXAS BIOTECHNOLOGY CORPORATION AND SUBSIDIARY
                       (A DEVELOPMENT STAGE ENTERPRISE)

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

             SEPTEMBER 30, 1996 (UNAUDITED) AND DECEMBER 31, 1995


(1)   ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

      (a)  Organization

           Texas Biotechnology Corporation (the "Company" or "TBC"), a
           biopharmaceutical company, applies innovative drug discovery
           techniques and its specialized knowledge of the role of vascular cell
           biology in cardiovascular disease to the design and development of
           novel pharmaceutical compounds. The Company was incorporated in the
           state of Delaware in 1989.

           During the period from August 2, 1989, (date of incorporation)
           through March 1990, the Company was largely inactive. Since that
           time, the Company has been engaged principally in research and drug
           discovery programs and clinical development of a drug compound. On
           July 25, 1994, the Company acquired all of the outstanding common
           stock of ImmunoPharmaceutics, Inc. ("IPI"), a San Diego, California
           based company, in exchange for common stock of the Company. TBC
           decided to consolidate the IPI operation into TBC in the first half
           of 1996. (See note 9)

           The Company is presently working on a number of long-term development
           projects which involve experimental and unproven technology, which
           may require many years and substantial expenditures to complete, and
           which may be unsuccessful. To date, other than small amounts of
           monoclonal antibody compounds and services produced and sold by IPI
           (now discontinued), the Company has not developed or sold any
           products, and no assurance can be given that the Company will be able
           to develop, manufacture or market any products in the future. In
           addition, no assurance exists that future revenues will be
           significant, that any sales will be profitable, or that the Company
           will have sufficient funds available to complete its research and
           development programs or market any products which it may develop.
           Accordingly, the Company is considered to be in the development stage
           as it has not to date derived significant revenues from its planned
           principal operations.

      (b)  Basis of Consolidation

           The Company's consolidated financial statements include the accounts
           of the Company and its wholly owned subsidiary, IPI. All material
           intercompany transactions have been eliminated. The Company's
           consolidated financial statements include the activity related to IPI
           since August 1, 1994.

      (c)  Cash, Cash Equivalents and Short Term Investments

           Cash equivalents are considered to be those securities or instruments
           with original maturities, when purchased, of three months or less. At
           September 30, 1996, approximately $808,000 was invested in demand and
           money market accounts. Short term investments are those investments
           which have an original maturity of less than one year and greater
           than three months. At September 30, 1996, the Company's short term
           investments consisted of approximately $998,000 in U.S. Treasury
           Bills and $10,741,000 in Corporate Commercial Paper. Cash equivalents
           and short term investments are stated at cost, which approximates
           market value. Interest income is accrued as earned.

           On January 1, 1994, the Company adopted Statement of Financial
           Accounting Standards No. 115 (Statement 115), Accounting for Certain
           Investments in Debt and Equity Securities. Statement 115 provides for
           the use of the amortized cost method for investments in debt
           securities when


FORM 10-Q                                                               Page 4
<PAGE>
 
           management has the positive intent and ability to hold such
           securities to maturity. In connection with the adoption of Statement
           115, the Company classified all short term investments as held to
           maturity.

       (d) Equipment and Leasehold Improvements

           Equipment and leasehold improvements are stated at cost less
           accumulated depreciation and amortization. Depreciation of furniture
           and equipment is provided on the straight-line method over the
           estimated useful lives of the respective assets (3 to 10 years).
           Amortization of leasehold improvements is provided on the straight-
           line method over the remaining minimum lease term.

       (e) Intangible Assets

           Intangible assets are amortized on a straight line basis over ten
           years.

       (f) Research and Development Costs

           All research and development costs are expensed as incurred and
           include salaries of research and development employees. For the three
           months ended September 30, 1996 and 1995, salaries and benefits
           totaled approximately $1,469,000 and $1,797,000, respectively, of
           which approximately $1,179,000 and $1,396,000, respectively, was
           charged to research and development. For the nine months ended
           September 30, 1996 and 1995, salaries and benefits totaled
           approximately $4,936,000 and $5,223,000, respectively, of which
           approximately $3,872,000 and $4,005,000, respectively, was charged to
           research and development. Payments related to the acquisition of in-
           process research and development are expensed.

       (g) Net Loss Per Share

           Net loss per share is calculated using the weighted average shares of
           common stock outstanding during the period. For the three months
           ended September 30, 1996 and 1995, the weighted average common shares
           used to compute net loss per share totaled 24,188,708 and 17,439,365
           respectively. For the nine months ended September 30, 1996 and 1995,
           and the period from August 2, 1989 (date of incorporation) through
           September 30, 1996, the weighted average common shares used to
           compute net loss per share totaled 23,053,607, 16,516,343 and
           10,045,776 respectively. Stock options and stock warrants are
           considered common stock equivalents, however are not included in the
           loss per share computations as their effect is anti-dilutive. Shares
           held in escrow through June 30, 1995, pending satisfaction of certain
           future conditions, and shares related to contingent stock issue
           rights related to the IPI acquisition have been excluded from the net
           loss per share calculation until such shares were released or issued.

       (h) Reclassifications

           Certain reclassifications have been made to prior period financial
           statements to conform with the September 30, 1996 presentation with
           no effect on net loss reported.

       (i) Revenue Recognition

           Revenue from grants is recognized as earned under the terms of the
           related grant agreements. Revenue from service contracts is
           recognized as the services are performed and/or as milestones are
           achieved. Revenue from products and services is recognized when the
           products are shipped or the services are performed. Amounts received
           in advance of services to be performed under contracts are recorded
           as deferred revenue.



FORM 10-Q                                                               Page 5
<PAGE>
 
       (j) Patent Application Costs

           Costs incurred in filing for patents are expensed as incurred.

       (k) Use of Estimates

           Management of the Company has made a number of estimates and
           assumptions relating to the reporting of assets and liabilities and
           the disclosure of contingent assets and liabilities to prepare these
           financial statements in conformity with generally accepted accounting
           principles. Actual results could differ from these estimates.
 
       (l) Interim Financial Information

           The Consolidated Balance Sheet as of September 30, 1996, and the
           related Consolidated Statements of Operations for the three and nine
           month periods ended September 30, 1996 and 1995, and the period from
           August 2, 1989 (date of incorporation) through September 30, 1996,
           and Consolidated Statements of Cash Flows for the nine month periods
           ended September 30, 1996 and 1995, and the period from August 2, 1989
           (date of incorporation) through September 30, 1996, are unaudited. In
           the opinion of management, all adjustments necessary for a fair
           presentation of such financial statements have been included. Such
           adjustments consisted of normal recurring items. Interim results are
           not necessarily indicative of results for a full year. The
           consolidated financial statements and notes are presented as
           permitted by Form 10-Q and do not contain certain information
           included in the Company's Annual Consolidated Financial Statements
           and Notes which should be read in conjunction with these consolidated
           financial statements and notes.

       (m) Accounting Pronouncements

           In March 1995, the Financial Accounting Standards Board issued
           Statement No. 121, "Accounting for the Impairment of Long-Lived
           Assets and for Long-Lived Assets to Be Disposed Of" (Statement 121).
           The Company has adopted the statement effective December 31, 1995.
           Statement 121 requires that long-lived assets and certain
           identifiable intangible assets to be held and used by an entity be
           reviewed for impairment whenever events or changes in circumstances
           indicate that the carrying amount of an asset may not be recoverable.
           In addition, Statement 121 requires that certain long-lived assets
           and certain identifiable intangible assets to be disposed of be
           reported at the lower of carrying amount or fair value less costs to
           sell. The Company believes the goodwill associated with IPI,
           $643,750, is impaired due to the decision to cease operations at IPI
           and the sale of the QED business unit and has recorded a charge to
           expense during 1995. (See note 9)

           In October 1995, the Financial Accounting Standards Board issued
           Statement No. 123, "Accounting for Stock-Based Compensation"
           (Statement 123). Statement 123 establishes financial accounting and
           reporting standards for stock-based employee compensation plans using
           a fair value based methodology as an alternative to intrinsic value
           based methodology. In addition, Statement 123 establishes the fair
           value as the measurement basis for transactions in which an entity
           issues its equity instruments to acquire goods or services from non-
           employees. The accounting and reporting requirements of Statement 123
           are effective beginning January 1, 1996. The Company intends to
           continue using the intrinsic value method.

(2)    CAPITAL STOCK

       In February, 1996, the Company completed a private placement of common
       stock. The Company issued 6,550,990 shares of Common Stock at $2 1/8 per
       share with proceeds of approximately $13.0 million, net of selling
       commissions and expenses of approximately $900,000. In accordance with
       the terms of the offering, the Company filed, pursuant to Rule 415 of the
       Securities Act, a Shelf Registration Statement as to the shares of Common
       Stock sold to the purchasers in the private placement which became
       effective on June 4, 1996.



FORM 10-Q                                                               Page 6
<PAGE>
 
       In connection with the private placement, the co-exclusive agent, Harris,
       Webb & Garrison received a $634,630 selling commission, 49,775 warrants
       with an exercise price of $3.05 per share and no registration rights, and
       497,749 warrants with an exercise price of $3.66 per share with the
       underlying common stock being registered, under certain circumstances, on
       a "piggyback" basis in the event of a public offering of common stock by
       the Company. The co-exclusive agent, Aurora Capital Corp., received a
       $124,653 selling commission, 25,587 warrants with an exercise price of
       $3.36 per share, and 149,002 warrants with an exercise price of $4.58 per
       share. The common stock underlying Aurora's warrants will be registered
       with the Common Stock issued in the private placement. The co-exclusive
       agents assigned some of these warrants to others.

       In May 1996, the Board of Directors proposed, and stockholders approved,
       an amendment to the Company's Certificate of Incorporation to increase
       the authorized number of shares of the Company's common stock from 40
       million shares to 75 million shares.

       On October 10, 1996 the Company signed a strategic alliance agreement
       with LG Chemical, Ltd. ("LG Chem"), a Korean corporation. In conjunction
       with the agreement, LG Chem purchased 1,250,000 shares of common stock
       for $4.00 per share for a total of $5 million. In addition, LG Chem has
       the option to purchase up to $5 million of common stock on one of four
       exercise dates ending at December 31, 1997. The minimum purchase amount
       is $1,000,000 and LG Chem and TBC must agree on the purchase price or the
       option cannot be exercised on the given exercise date. These shares were
       issued pursuant to "Regulation S" and may not be sold by LG Chem for a
       period of one year per the agreement. The Company's agents in the
       contract negotiations, Raymond James & Associates, Inc. and Mitani & Co.,
       Inc. received $420,000 in commissions and 113,636 warrants exercisable at
       $4.40 per share with the underlying common stock being subject to certain
       piggyback registration rights.

(3)    STOCK OPTIONS

       The Company has in effect the following stock option plans:

       The Amended and Restated 1990 Incentive Stock Option Plan ("1990 Plan")
       allows for the issuance of incentive and non-qualified options to
       employees, directors, officers, non-employee independent contractors and
       non-employee directors, pursuant to which 230,590 shares of common stock
       are reserved for issuance out of authorized but unissued shares of the
       Company.

       The Amended and Restated 1992 Incentive Stock Option Plan ("1992 Plan")
       allows for the issuance of incentive and non-qualified options to
       employees, directors, officers, non-employee independent contractors and
       non-employee directors, pursuant to which 1,597,843 shares of common
       stock are reserved for issuance out of authorized but unissued shares of
       the Company.

       The Stock Option Plan for Non-Employee Directors ("Director Plan") allows
       for the issuance of non-qualified options to non-employee directors,
       pursuant to which 71,429 shares of common stock are reserved for issuance
       out of authorized but unissued shares of the Company to be issued to non-
       employee members of the Board of Directors of the Company based on a
       formula.

       The 1995 Stock Option Plan ("1995 Plan") allows for the issuance of
       incentive and non-qualified options, shares of restricted stock and stock
       bonuses to employees, officers, and non-employee independent contractors,
       pursuant to which 1,000,000 shares of common stock are reserved for
       issuance out of authorized but unissued shares of the Company.

       The 1995 Amended and Restated Non-Employee Director Stock Option Plan
       ("1995 Director Plan") allows for the issuance of non-qualified options
       to non-employee directors, pursuant to which 200,000 shares of common
       stock are reserved for issuance out of authorized but unissued shares of
       the Company to be issued to non-employee members of the Board of
       Directors of the Company based on a formula. In June 1996,



FORM 10-Q                                                               Page 7
<PAGE>
 
       the 1995 Director Plan was amended with respect to the election date
       requirement for a director to request stock in lieu of cash payment of
       director fees.

       A summary of stock options as of September 30, 1996, follows:



<TABLE>
<CAPTION>
 
 
                      Exercise Price                                       Available
 Stock Option Plans     Per Share     Outstanding  Exercised  Exercisable  for Grant
-------------------   --------------  -----------  ---------  -----------  ---------
<S>                   <C>             <C>          <C>        <C>          <C>
 
 
1990 Plan              $3.50 - $3.56      173,369     55,125      165,369     57,221
1992 Plan              $1.41 - $5.36    1,422,977    102,157      710,391    174,866
Director Plan          $2.40 - $4.54       42,576        ---       33,148     28,853
1995 Plan              $1.31 - $4.53      564,500        ---       37,500    435,500
1995 Director Plan     $1.38 - $5.19       82,806        ---       27,606    117,194
                                      -----------   --------   ----------   --------
            TOTAL                       2,286,228    157,282      974,014    813,634
                                      ===========   ========   ==========   ========

</TABLE>

       The Company has recorded deferred compensation for the difference between
       the grant price and the deemed fair value for financial statement
       presentation purposes related to certain options granted in the period
       subsequent to May 27, 1993 and prior to the initial public offering. Such
       amount totaled $287,158, of which $46,177 has been charged to expense in
       1996.

(4)    INCOME TAXES

       The Company adopted Statement of Financial Accounting Standards No. 109
       "Accounting for Income Taxes" effective January 1, 1993. As of September
       30, 1996, the Company had a net deferred tax asset of approximately
       $20,934,000, primarily composed of the tax benefit associated with net
       operating loss carry forwards, start-up and other capitalized costs. A
       valuation allowance for the full amount of the deferred tax asset has
       been established as realization of the benefit is uncertain.


(5)    COMMON STOCK RESERVED

       The Company has reserved common stock for issuance as of September 30,
       1996 as follows:

<TABLE>
<CAPTION>
 
<S>                                                         <C>
      Stock option plans                                     3,099,862
      Agreement with Genentech, Inc.                           285,715
      Warrants issuable under the Genentech Agreement          142,858
      Warrants outstanding                                   5,376,905
      Underwriters purchase options and related warrants       710,000
      IPI acquisition (contingent shares)                    1,000,000
                                                            ----------
          Total shares reserved                             10,615,340
                                                            ==========
</TABLE>

       LG Chem has the option to purchase up to $5 million of common stock on
       one of four exercise dates ending at December 31, 1997. The minimum
       purchase amount is $1,000,000 and LG Chem and TBC must agree on the
       purchase price or the option cannot be exercised on the given exercise
       date.



FORM 10-Q                                                               Page 8
<PAGE>
 
(6)  CLINICAL RESEARCH AGREEMENTS

     On February 10, 1995, the Company entered into an agreement with Coromed,
     Inc., a contract research organization, to coordinate the clinical
     evaluation of Novastan/R/ as an adjunct to Streptokinase in acute
     myocardial infarction. Coromed is responsible for managing all aspects of
     the clinical trial and making all financial remuneration to testing sites.
     The term of the agreement is 19 months, subject to extension upon the
     mutual written agreement of both parties. The parties have agreed to a
     total budget of approximately $3,196,000. Of this amount, $106,000 was paid
     upon execution of a letter of intent and approximately $450,000 was paid
     upon execution of the agreement. Subsequent payments will be made monthly
     on a per patient basis, to a maximum total of approximately $2,490,000.
     Three additional payments of $50,000 each will be made upon completion of
     specified tasks by Coromed. If the clinical trial is completed in less than
     19 months, the Company will pay Coromed a bonus calculated as a percentage
     of personnel costs as set forth in the budget, to a maximum bonus amount of
     approximately $327,000. In addition, the Company has engaged Coromed to
     provide various services related to other ongoing Novastan/R/ trials
     being conducted by the Company.

     On May 1, 1996, the Company amended the above agreement with Coromed, Inc.
     The term of the contract was extended to 24 months with an additional cost
     of $1,200,000. The bonus payment, if any, is now based on the completion in
     less than 24 months.

(7)  RESEARCH AGREEMENTS

     On October 11, 1994, the Company signed a collaborative agreement with
     Synthelabo, a French pharmaceutical group, to develop and market compounds
     for vascular proliferation disease derived from the Company's FGF and
     antisense programs. Upon consummation of the transaction, Synthelabo
     purchased 1,428,571 shares of common stock for $3.50 per share for a total
     of $5 million and paid a non-refundable licensing fee of $3 million. In
     addition, Synthelabo has committed to pay $3 million annually in research
     payments (payable in quarterly installments of $750,000) for three years.
     Synthelabo has agreed, upon the achievement of certain milestones, to
     further payments of up to $3 million per year for up to $18 million in
     total. Synthelabo has the right to terminate the agreement any time on or
     after October 15, 1996, for any reason and either party has the right to
     terminate the contract for breach of any material obligation. If Synthelabo
     exercises this termination right, the license granted to Synthelabo shall
     terminate and TBC will pay Synthelabo a royalty on net sales of any
     products sold in a certain territory for a period of time. In addition,
     Synthelabo may, at its option, require that the technology be transferred
     to and the development program be conducted by a joint venture owned by TBC
     and Synthelabo should "net worth" as defined in the agreement be less than
     $5 million as of the end of any calendar quarter during the term of the
     agreement. The first quarterly research payment of $750,000 was received on
     October 31, 1994, of which $500,000 was recognized in 1994. As of September
     30, 1996, $250,000 is included in current deferred revenue. Synthelabo will
     pay royalties to TBC, based on the net sales, in those geographic areas
     covered in the agreement. In exchange for the above consideration,
     Synthelabo will receive an exclusive license to manufacture, use, and sell
     any products generated from the research in Europe, the Middle East, Africa
     and the countries of the former Soviet Union. One of the programs, which
     involves antisense, has been abandoned and may result in a redirection of
     the research into another area.

     During 1995, the Company and Synthelabo mutually agreed to exchange certain
     clinical data. In January 1996, the Company signed two agreements with
     Synthelabo with respect to the supply of information related to certain
     clinical studies. Synthelabo paid TBC $500,000 upon execution of the
     agreement. In addition, over the term of the agreements as certain
     milestones are met, Synthelabo has committed to pay TBC additional payments
     that total $2,400,000. These payments are dependent on rate of enrollment
     in certain clinical studies, the completion of certain clinical studies and
     date of completion of certain clinical studies. As of September 30, 1996,
     TBC has received approximately $1.5 million related to these agreements.
     Synthelabo is the licensee for Novastan/R/ in certain territories other
     than those which were sublicensed to TBC.



FORM 10-Q                                                               Page 9
<PAGE>
 
     On October 10, 1996, the Company signed a strategic alliance agreement with
     LG Chem, a Korean corporation, to develop and market compounds derived from
     the Company's Endothelin Receptor and Selectin Antagonist for certain
     disease indications. Upon consummation of the transaction, LG Chem
     purchased 1,250,000 shares of common stock for $4.00 per share for a total
     of $5 million. In addition, LG Chem has committed to pay $10.7 million in
     research payments. Of this amount, $100,000 will be paid on or before
     December 31, 1996, $1.0 million on each of June 30 and December 31 of 1997,
     1998, 1999 and 2000, and $1.3 million on June 30 and December 31, 2001. LG
     Chem has the right to terminate future research payments if TBC fails to
     meet certain Agreement milestones, which milestones will be established by
     the parties in accordance with the agreement. LG Chem will pay royalties to
     TBC, based on net sales, in those geographic areas covered by the
     agreement, which include Korea, China, India and certain other Asian
     countries, excluding Japan. The Company will pay its agents in the contract
     negotiations, Raymond James & Associates, Inc. and Mitani & Co., Inc., a
     commission on all future research payments as well as a royalty on net
     sales.

(8)  LICENSE AGREEMENT

     In May 1993, TBC entered into an agreement with Genentech to sublicense
     Genentech's rights and technology relating to Novastan/R/ (argatroban)
     originally licensed to Genentech by Mitsubishi Chemical Corporation
     ("Mitsubishi"), and to license Genentech's own proprietary technology
     developed with respect to Novastan/R/ (the "Genentech Agreement"). Under
     the license and sublicense, the Company has an exclusive license to use and
     sell Novastan/R/ in the United States and Canada for specified human
     cardiovascular indications, not including cerebral thromboembolism
     (stroke). The Company is required to pay Genentech and Mitsubishi specified
     royalties on net sales of Novastan/R/ by the Company and its sublicensees
     after its commercial introduction in the United States and Canada.
     Genentech has the right to terminate the agreement or to cause the license
     to become non-exclusive if the Company fails to exercise due diligence in
     performing its obligations under the agreement for a period of 60 days
     after receiving written notice from Genentech or fails to maintain a
     minimum consolidated tangible net worth of $5.0 million. The Genentech
     Agreement, as amended, provides that Mitsubishi may terminate Genentech's
     license with Mitsubishi (which results in the termination of the Genentech
     Agreement as well) if TBC does not file an NDA for Novastan/R/ with the FDA
     no later than June 30, 1997, subject to certain additional goals being met
     by TBC. As of December 31, 1995, TBC had not met certain of those goals.
     However, Mitsubishi has agreed to withhold its rights to terminate the
     license with Genentech if the NDA is filed by June 30, 1997, and if TBC
     accomplishes the following milestones: (i) on or before December 31, 1996,
     TBC shall have met certain enrollment guidelines for certain Novastan/R/
     clinical trials; (ii) on or before March 31, 1997, TBC shall complete,
     report and analyze certain other Novastan/R/ clinical trials; (iii) on or
     before September 30, 1997, TBC shall have agreed to proceed with the Phase
     III trial in AMI, and (iv) TBC shall comply with certain reporting and
     information meeting requirements. If these milestones are not met,
     Mitsubishi will retain the rights to terminate the Genentech license;
     provided, that if such termination results from TBC's violation of the
     milestone described in (iii) above, TBC will receive a license from
     Mitsubishi in the field of HIT/HITTS on the same terms, as presently
     included in the Genentech Agreement. Either party may terminate the
     Genentech Agreement on 60 days notice if the other party defaults in its
     material obligations under the agreement, declares bankruptcy or is
     insolvent, or if a substantial portion of its property is subject to
     attachment. The Genentech Agreement is also subject to the continuation of
     Genentech's license agreement with Mitsubishi, which is only terminable if
     Genentech defaults in its material obligations under the agreement,
     declares bankruptcy or is insolvent, or if a substantial portion of its
     property is subject to attachment. Unless terminated sooner pursuant to the
     above described termination provisions, the Genentech Agreement is expected
     to expire in June 2007. Under the Genentech Agreement, TBC has access to an
     improved formulation patent granted in 1993 which expires in 2010 and a use
     patent which expires in 2009.

     Mitsubishi further agreed to supply the Company with its requirements of
     Novastan/R/ throughout the term of the Genentech Agreement for TBC's
     clinical testing and commercial sales of Novastan/R/ in the United States
     and Canada. In the event Mitsubishi should discontinue the manufacture of
     Novastan/R/, Mitsubishi,



FORM 10-Q                                                               Page 10
<PAGE>
 
     Genentech and TBC have agreed to discuss in good faith the means by which,
     and the party to whom, Novastan/R/ production technology will be
     transferred. The transferee may be a person or entity other than Genentech
     or TBC. At present, Mitsubishi is the only manufacturer of Novastan/R/.
     Should Mitsubishi terminate or default in its supply commitment, there can
     be no assurance that alternate sources of bulk Novastan/R/ will be
     available to the Company at reasonable cost, if at all. If such alternate
     sources of supply are unavailable or uneconomic, the Company's results of
     operations would be materially and adversely affected.

     In exchange for the license to Genentech's Novastan/R/ technology, TBC
     issued Genentech 285,714 shares of Common Stock and agreed to issue (i) an
     additional 214,286 shares of Common Stock to Genentech within 10 days after
     the filing of the first New Drug Application ("NDA") with the FDA for
     Novastan/R/, and (ii) an additional 71,429 shares of Common Stock to
     Genentech within 10 days after the FDA's first approval of an NDA for
     Novastan/R/. The Company has also agreed to grant Genentech a warrant to
     purchase an additional 142,858 shares of Common Stock at an exercise price
     of $14.00 per share, subject to adjustment, within ten days of the filing
     of the first NDA for Novastan/R/ with the FDA. If the Company is unable
     to issue any of the additional shares of Common Stock or the warrant to
     Genentech due to circumstances beyond the Company's control, the Company
     has agreed to pay Genentech, in lieu thereof, an amount equal to the value
     of the securities plus interest from May 27, 1993 at the prime rate plus
     one percent, compounded annually. The value of the Common Stock is deemed
     to be $7.00 per share, which represents the cash consideration the Company
     will be obligated to pay to Genentech as liquidated damages, and the value
     of the warrants is to be determined by appraisal, based on the warrants'
     market value. The Company will not be required to make any cash payment if
     both of the filing and approval of the NDA do not occur. TBC has also
     granted Genentech demand and piggyback registration rights with regard to
     shares of Common Stock issued to Genentech.

     Due to the additional research and development required to commercialize
     the technologies associated with the Sublicense and License Agreement, the
     Company expensed the value associated with the 285,714 shares issued to
     Genentech, charging $1,000,000 to purchase of in-process research and
     development expense in the year ended December 31, 1993.

     In connection with the Genentech Agreement, a consultant involved in
     negotiations related to the Agreement will receive a royalty on net sales
     of licensed products.

(9)  CONSOLIDATION OF IMMUNOPHARMACEUTICS, INC.

     The Company decided to consolidate the IPI operation into TBC's in the
     first half of 1996. The overall financial impact on the Company's
     performance will be positive in 1996 due to expected reduction in general
     and administrative expenses and the elimination of some research and
     development positions associated with IPI. The Company believes the
     goodwill associated with IPI, $643,750, is impaired due to the decision to
     cease operations at IPI and the sale of the QED business unit and has
     charged it to expense in the year ended December 31, 1995. The
     restructuring costs associated with the consolidation of the IPI operation
     were approximately $421,000 and have been expensed in the three months
     ended March 31, 1996. This cost included waste disposal, future lease
     commitments, severance pay and related taxes.

(10) COMMITMENTS AND CONTINGENCIES

     a)  Employment Agreements

         Since inception, the Company has entered into employment agreements
         with certain officers and key employees. As of September 30, 1996,
         remaining commitments total approximately $120,000 in 1996 and $232,000
         in 1997. These amounts include payments due to one former employee
         pursuant to his severance agreement. The employment agreements of
         various officers and key employees provide for salary continuation for
         up to twelve months from date of termination upon dismissal by the
         Company, which would approximate $465,000 currently. In addition to
         salary, the Company has



FORM 10-Q                                                               Page 11
<PAGE>
 
         agreed to reimburse certain officers and other employees for costs of
         relocation and temporary travel and living expenses.

         In addition, the Company has signed agreements with five of its
         officers to provide certain benefits in the event of a "change of
         control" as defined in the agreement and the occurrence of certain
         other events. The agreements provide for a lump-sum payment in cash
         equal to eighteen (18) months to three (3) years of annual base salary
         and annual bonus if any. The base salary portion of the agreements
         would aggregate approximately $1.9 million at current rate of
         compensation. In addition, the agreements provide for gross-up for
         certain taxes on the lump-sum payment, continuation of certain
         insurance and other benefits for periods of eighteen (18) months to
         three (3) years and reimbursement of certain legal expenses in
         conjunction with the agreements. These provisions are intended to
         replace compensation continuation provisions of any other agreement in
         effect for an officer if the specified event occurs.

     b)  Legal Proceedings

         On November 21, 1994, a class action shareholders' suit was filed in
         the United States District Court for the Southern District of Texas,
         Houston Division seeking damages in the amount of $16 million.
         Plaintiffs are two individuals who purchased shares of the Company on
         December 16, 1993 following the Company's initial public offering. In
         their complaint, plaintiffs have sued the Company, and certain members
         of the board of directors and certain officers alleging violations of
         Sections 11, 12 and 15 of the Securities Act of 1933, as amended (the
         "Act"). Plaintiffs have also named David Blech, D. Blech & Co.,
         Incorporated and Isaac Blech as defendants. On January 23, 1995, the
         Company and the members of the board of directors filed a motion to
         dismiss the plaintiffs' complaint pursuant to Rule 9(b) and Rule 12b(6)
         of the Federal Rules of Civil Procedure. In addition, defendant John
         Pietruski, Chairman of the Board of Directors, filed a motion to
         dismiss the plaintiffs' complaint pursuant to Rule 12(b)(2) of the
         Federal Rules of Civil Procedure. On February 7, 1995, the plaintiffs
         filed a motion for class certification. The Court denied the motion by
         the Company and by John Pietruski.

         On March 28, 1995, a second class action shareholders' suit was filed
         in the United States District Court for the Southern District of New
         York seeking unspecified damages. Plaintiffs are eight individuals who
         purchased shares in various companies for which D. Blech & Co. acted as
         an underwriter (or co-underwriter) or marketmaker. In their complaint,
         the plaintiffs have sued the Company alleging violations of Section
         10(b) of the Securities Exchange Act of 1934, as Amended (the "Exchange
         Act") and Rule 10b-5 promulgated thereunder by the Securities and
         Exchange Commission (the "Commission"). Plaintiffs have named a number
         of defendants, including David Blech and D. Blech & Co., four
         individuals, two brokerage firms, one investment management company and
         ten other companies for which D. Blech & Co. acted as underwriter or
         marketmaker.

         On August 14, 1995, the Judicial Panel on The Multi-District Litigation
         ordered that the action filed in the United States District Court for
         the Southern District of Texas, Houston Division be transferred to the
         United States District Court for the Southern District of New York for
         coordinated or consolidated pretrial proceedings with the action
         pending there. In light of the transfer and consolidation of the Texas
         case with similar cases against other companies for which Blech acted
         as underwriter, the Company requested that the Court in New York
         reconsider the Texas Court's denial of its motion to dismiss as a part
         of the Court's consideration of similar motions to dismiss filed by
         those companies. All of these motions were presented to the Court on
         February 6, 1996. On June 6, 1996, the New York District Court entered
         two memorandum opinions in the consolidated cases. In one of its
         opinions, the Court dismissed all of the Exchange Act and common law
         fraud claims filed against the Company and its officers and directors,
         but afforded those plaintiffs the right to attempt to preserve those
         claims by repleading them. The Court ordered that those claims be
         repleaded no later than July 26, 1996. Plaintiffs did not replead those
         claims by the deadline, resulting in the dismissal of all claims
         against the Company in that litigation. In its opinion in the second
         case, i.e., the case filed on November 21, 1994, the Court granted the
         Company and its officers and directors' motion for



FORM 10-Q                                                               Page 12
<PAGE>
 
         reconsideration, but together with all other similar pending motions,
         denied the requested relief. Pursuant to the court's order, the Company
         therefore filed an answer in that case. The Company also filed a Motion
         seeking leave of court to prosecute an immediate appeal of the Court's
         denial of the Company's Motion to Dismiss. The Court heard argument on
         that Motion on October 10, 1996, and the Company awaits the Court's
         ruling. Given the early stage of that case, which is the only remaining
         litigation against the Company, the Company is unable to evaluate its
         potential outcome at this time. The Company disputes these claims and
         intends to contest them vigorously.





FORM 10-Q                                                               Page 13
<PAGE>
 
ITEM 2.
-------

                TEXAS BIOTECHNOLOGY CORPORATION AND SUBSIDIARY

                       (A DEVELOPMENT STAGE ENTERPRISE)

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

             SEPTEMBER 30, 1996 (UNAUDITED) AND DECEMBER 31, 1995



                                   OVERVIEW
                                   --------  

  The following Management's Discussion and Analysis of Financial Condition and
  Results of Operations contains forward-looking statements that involve risks
  and uncertainties.

  Since its formation in 1989, the Company has primarily devoted its resources
  to fund research, drug discovery and development.  The Company has been
  unprofitable to date and expects to incur substantial losses for the next
  several years as the Company invests in product research and development,
  preclinical and clinical testing and regulatory compliance.  The Company has
  sustained net losses of approximately $59.8 million from inception to
  September 30, 1996.  The Company has primarily financed its operations to date
  through private placements of Common Stock and debt, which have raised an
  aggregate of $34.3 million in net proceeds, an initial public offering ("IPO")
  in December 1993,  which raised an aggregate of $24.2 million in net proceeds
  including the over-allotment, and a collaborative agreement with Synthelabo,
  which has raised an aggregate of approximately $15.5 million from research
  payments, license fees and sale of stock.

  On July 25, 1994, the Company acquired all of the outstanding stock of
  ImmunoPharmaceutics, Inc. ("IPI") in exchange for Common Stock of the Company.
  IPI's results of operations have been included in the consolidated results of
  operations beginning August 1, 1994.  During September 1993, IPI entered into
  an agreement to provide research and development services, over a period of 30
  months, to EISAI Co., LTD ("EISAI").  The agreement, which expired in March
  1996, guaranteed contract research funding and allowed for additional amounts
  to be received upon the attainment of certain milestones.  On August 10, 1995,
  IPI received a $2.0 million milestone payment from EISAI.  The Company decided
  to consolidate the IPI operation into TBC's in the first half of 1996.  The
  overall financial impact on the Company's performance will be positive in 1996
  due to expected reduction in general and administrative expenses and the
  elimination of some research and development positions associated with IPI.
  The Company believes the goodwill associated with IPI of $643,750 was impaired
  due to the decision to cease operations at IPI and the sale of IPI's QED
  business unit and charged it to expense in the year ended December 1995.
  Restructuring costs of $421,165 associated with the consolidation of the IPI
  operation were recorded in the quarter ended March 31, 1996.

  The Company signed a collaborative agreement with Synthelabo, the
  pharmaceutical division of L'Oreal, on October 11, 1994 (the "Synthelabo
  Agreement").  Upon consummation of the transaction, Synthelabo purchased
  1,428,571 shares of Common Stock for a total of $5 million and paid the
  Company a nonrefundable licensing fee of $3 million.  In addition, Synthelabo
  has committed to pay $3 million annually in research payments (payable in
  quarterly installments) through July 31, 1997.  In 1996, TBC has signed two
  agreements with Synthelabo to provide to them copies of certain clinical data
  for Novastan/R/.  Through September 30, 1996, TBC has received approximately
  $1.5 million pursuant to these two clinical data agreements.  Over the life of
  the agreements, TBC may receive as much as $2.9 million, including the $1.5
  million received, from Synthelabo.



FORM 10-Q                                                               Page 14
<PAGE>
 
  On October 10, 1996 the Company signed a strategic alliance agreement with LG
  Chemical, LTD. ("LG Chem"), a Korean corporation.  In conjunction with the
  agreement, LG Chem purchased 1,250,000 shares of common stock for $4.00 per
  share for a total of $5 million.  In addition, LG Chem has the option to
  purchase up to $5 million of common stock on one of four exercise dates ending
  at December 31, 1997.  The minimum purchase amount is $1,000,000 and LG Chem
  and TBC must agree on the exercise price or the stock option cannot be
  exercised on the given exercise date.

  The Company's operating results have fluctuated significantly during each
  quarter, and the Company anticipates that such fluctuations, largely
  attributable to varying research and development commitments and expenditures,
  will continue for the next several years.

                             RESULTS OF OPERATIONS
                             ---------------------

             THREE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1995

  Revenues decreased from $3,404,018 in the three month period ended September
  30, 1995 to $1,102,500 in the same period of 1996, a decrease of 68%.
  Revenues were composed of earned revenues under research agreements, sales of
  products and services, and grant income.  The period ended September 30, 1995,
  included a $2 million milestone payment from EISAI (which agreement terminated
  in March 1996).


  Total operating expenses increased 38% from $4,976,778 in the three month
  period ended September 30, 1995 to $6,932,395 in the same period of 1996.
  Research and development expenses increased 59% from $3,753,107 in the three
  month period ended September 30, 1995 to $5,980,096 in the same period of
  1996.  This increase was primarily attributable to continued increases in
  research and development activity related to the clinical trials on the
  compound Novastan/R/ (argatroban) and development work associated with the
  Selectin and Endothelin programs.  General and administrative expenses
  decreased 26% from $1,223,671 in the three month period ended September 30,
  1995 to $952,299 in the same period of 1996. The decrease was primarily
  attributable to the consolidation of the IPI operation in March 1996.  The
  Company had 99 employees at September 30, 1995, including 25 employees at IPI,
  and 80 employees at September 30, 1996, including 1 employee at IPI.

  Other income and expenses was composed entirely of investment income on
  invested funds and interest expense.  Investment income decreased from
  $285,333 in the three month period ended September 30, 1995 to $199,811 in the
  same period of 1996, a decrease of 30%.  The decrease is due to lower interest
  rates from 1995 to 1996 and a lower investment balance throughout 1996.

  The Company incurred a net loss of $1,287,427 for the three month period ended
  September 30, 1995, compared with a net loss of $5,587,670 for the same period
  of 1996.  The increase was due to a $2.0 million milestone payment from EISAI
  received in 1995 and increased research and development expenses related to
  clinical trials on the compound Novastan/R/  in 1996.

              NINE MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND 1995

  Revenues decreased from $6,052,987 in the nine month period ended September
  30, 1995 to $4,303,276 in the same period of 1996, a decrease of 29%.
  Revenues were composed of earned revenues under research agreements, sales of
  products and services, and grant income. The period ended September 30, 1995,
  included a $2 million milestone payment from EISAI (which agreement terminated
  in March 1996).  The period ended September 30, 1996, included $1,645,000 from
  Synthelabo related to the agreement to supply certain clinical data.

  Total operating expenses increased 27% from $16,463,259 in the nine month
  period ended September 30, 1995 to $20,982,742 in the same period of 1996.
  Included in the 1995 operating expenses was a non-cash



FORM 10-Q                                                               Page 15
<PAGE>
 
  charge for in-process research and development for $1,973,883. Exclusive of
  this charge, operating expenses increased 45% from $14,489,376 in the nine
  month period ended September 30, 1995, to $20,982,742 in the same period of
  1996. Research and development expenses increased 66% from $10,560,959 in the
  nine month period ended September 30, 1995 to $17,484,641 in the same period
  of 1996. General and administrative expenses decreased 22% from $3,928,417 in
  the nine month period ended September 30, 1995 to $3,076,936 in the same
  period of 1996. See comments under the preceding three month period comparison
  for explanation of the changes.

  Other income and expenses was composed entirely of investment income on
  invested funds and interest expense.  Investment income decreased from
  $959,571 in the nine month period ended September 30, 1995 to $697,089 in the
  same period of 1996, a decrease of 27%. See comments under the preceding three
  month period comparison for explanation of the decrease.

  The Company incurred a net loss of $9,450,701 for the nine month period ended
  September 30, 1995, compared with a net loss of $15,982,377 for the same
  period of 1996.  See comments under the preceding three month period
  comparison for explanation of the changes.

                        LIQUIDITY AND CAPITAL RESOURCES
                        -------------------------------

  The Company has financed its research and development activities to date
  principally through (i) private sales of common stock and an initial public
  offering of a unit security, (ii) issuance of common stock in conjunction with
  assumption of liabilities and assets to acquire IPI and the Novastan/R/
  license, (iii) revenues and proceeds from sales of common stock in connection
  with corporate partner collaboration and research agreements and (iv)
  investment income, net of interest expense.  During the first nine months of
  1996, the Company utilized $14,933,119 net cash in operating activities and
  $13,642,447 was provided by financing activities.  The use of cash in
  operations was caused by the Company's net loss of $15,982,377.  Financing
  activities produced approximately $13,640,000 in net proceeds for the Company
  resulting from the 1996 private placement and the remaining was from exercise
  of stock options and warrants.

  The Company expects to incur substantial research and development expenditures
  as it designs and develops biopharmaceutical products for the prevention and
  treatment of cardiovascular diseases.  The Company anticipates that operating
  expenses will continue to increase during 1996 and subsequent years.  These
  costs to develop Novastan/R/ have increased and will continue to increase
  during 1996 due to the continuation of clinical trials and will continue to be
  significant through the FDA approval process.  These costs include, among
  other things, hiring personnel to direct and carry out all operations related
  to the clinical trials, paying for hospital and procedural costs, services of
  a contract research organization, and purchasing and manufacturing large
  quantities of the compound to be used in such trials.  In addition, the
  Company anticipates that the administrative costs associated with this effort
  will continue to be significant.  The amounts and timing of expenditures will
  depend on the progress of ongoing research and clinical development and
  product launch costs.

  At September 30, 1996, the Company had cash, cash equivalents and short-term
  investments of approximately $12.5 million.  Subsequent to September 30, 1996
  the Company received $5 million from LG Chem, a Korean corporation, related to
  a strategic alliance agreement.  The Company anticipates that its existing
  capital resources and its other revenue sources should be sufficient to fund
  its cash requirements into the third quarter of 1997.  The Company's existing
  capital resources may not be sufficient to fund the Company's operations
  through commercialization of its first product.  Moreover, the Genentech
  Agreement and Synthelabo Agreement require the Company to maintain a tangible
  net worth of at least $5.0 million during the term of these agreements. For
  failure to maintain at least $5.0 million of net worth, Synthelabo may require
  that the technology be transferred to, and the development program be
  conducted by, a joint venture owned by TBC and Synthelabo.  As of September
  30, 1996, the Company's tangible net worth significantly exceeded $5.0
  million.  The Genentech Agreement and Synthelabo Agreement are also terminable
  for other reasons.  Termination of either of these agreements will have a
  material adverse effect on the Company.




FORM 10-Q                                                               Page 16
<PAGE>
 
  The Company will need to raise substantial funds for future operations and is
  actively seeking such funding through collaborative arrangements, public or
  private financing, including equity financing, and other arrangements.  The
  Company expects that significant additional expenditures will be required to
  complete the clinical trials related to Novastan/R/ and to it other product
  candidates which are not yet in clinical trials.  If the Company's current (or
  any additional) product candidates enter clinical trials, further significant
  expenditures will be necessary for laboratory space, scientific and
  administrative personnel, and services of contract research organizations.
  There can be no assurance that the Company will be able to obtain additional
  financing on acceptable terms or in time to fund any necessary or desirable
  expenditures.  In the event such financing is not obtained, the Company's drug
  discovery or development and programs regarding Novastan/R/ and its other
  product candidates may  be delayed, scaled back or eliminated; or it may be
  required to obtain funds through arrangements with collaborative partners or
  others that may require the Company to relinquish rights to certain of its
  technologies, product candidates or products that the Company would not
  otherwise relinquish.

                               PENDING LITIGATION

  As of September 30, 1996, one class action shareholder lawsuit remains pending
  against the Company and includes certain directors and officers as defendants.
  The Company disputes all claims set forth in this lawsuit and intends to
  contest it vigorously.  However, the Company is unable to evaluate the
  potential outcome at this time.

                 HAZARDOUS MATERIALS AND ENVIRONMENTAL MATTERS

  The Company's research and development activities involve the controlled use
  of hazardous and radioactive materials.  The Company is subject to federal,
  state, and local laws and regulations governing the use, manufacture, storage,
  handling and disposal of such materials and certain waste products.
  Management believes that the Company is in compliance with all such laws,
  regulations and standards currently in effect and that the cost of compliance
  with such laws, regulation, and standards will not have a material adverse
  effect on the Company.  The Company does not expect to incur any capital
  expenditures for environmental control in the foreseeable future.

                    IMPACT OF INFLATION AND CHANGING PRICES
                                        
  The pharmaceutical research industry is labor intensive, and wages and related
  expenses increase in inflationary periods.  The lease of space and related
  building services for the Houston facility contains a clause that escalates
  rent and related services each year based on the increase in building
  operating costs and the increase in the Houston Consumer Price Index,
  respectively.  To date, inflation has not had a significant impact on
  operations.

                           ACCOUNTING PRONOUNCEMENTS

   In March 1995, the Financial Accounting Standards Board issued Statement No.
   121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
   Assets to Be Disposed Of" (Statement 121).  The Company has adopted the
   statement effective December 31, 1995.  Statement 121 requires that long-
   lived assets and certain identifiable intangible assets to be held and used
   by an entity be reviewed for impairment whenever events or changes in
   circumstances indicate that the carrying amount of an asset may not be
   recoverable.  In addition, Statement 121 requires that certain long-lived
   assets and certain identifiable intangible assets to be disposed of be
   reported at the lower of carrying amount or fair value less costs to sell.
   The Company believes the goodwill associated with IPI, $643,750, was impaired
   due to the decision to cease operations at IPI and the sale of the QED
   business unit and has recorded a charge to expense.

   In October 1995, the Financial  Accounting Standards Board issued Statement
   No. 123, "Accounting for Stock-Based Compensation" (Statement 123).
   Statement 123 establishes financial accounting and reporting



FORM 10-Q                                                               Page 17
<PAGE>
 
   standards for stock-based employee compensation plans using a fair value
   based methodology as an alternative to intrinsic value based methodology. In
   addition, Statement 123 established the fair value as the measurement basis
   for transactions in which an entity issues its equity instruments to acquire
   goods or services from non-employees. The accounting and reporting
   requirements of Statement 123 were effective beginning January 1, 1996. The
   adaptation of Statement 123 is not expected to have a material impact on
   TBC's 1996 financial position or results of operations as the Company intends
   to continue using the intrinsic value method.

                DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

    This Report includes "forward looking statements" within the meaning of
    Section 27A of the Securities Act of 1933, as amended, and Section 21E of
    the Securities Exchange Act of 1934, as amended.  All statements other than
    statements of historical fact included in this Report are forward looking
    statements.  Such forward looking statements include, without limitation,
    statements under (a) "Organization and Significant Accounting Policies --
    Organization" regarding TBC's expectations for future drug discovery and
    development and related expenditures and (b) "Management's Discussion and
    Analysis of Financial Condition and Results of Operations - Liquidity and
    Capital Resources" - regarding TBC's estimate of sufficiency of existing
    capital resources and ability to raise additional capital to fund cash
    requirements for future operations.  Although TBC believes that the
    expectations reflected in such forward looking statements are reasonable, it
    can give no assurance that such expectations reflected in such forward
    looking statements will prove to have been correct.  The ability to achieve
    TBC's expectations is contingent upon a number of factors which include (i)
    ongoing cost of research and development activities, (ii) cost of clinical
    development of product candidates, (iii) attainment of research and clinical
    goals of product candidates, (iv) timely approval of TBC's product
    candidates by appropriate governmental and regulatory agencies, (v) effect
    of any current or future competitive products, (vi) ability to manufacture
    and market products commercially,  (vii) retention of key personnel and
    (viii) obtaining and timing of sufficient financing through capital raising
    or collaborative agreements to fund operations.



FORM 10-Q                                                               Page 18
<PAGE>
 
PART II OTHER INFORMATION
-------------------------

ITEM 1.  LEGAL PROCEEDINGS
--------------------------

   On November 21, 1994, a class action shareholders' suit was filed in the
   United States District Court for the Southern District of Texas, Houston
   Division seeking damages in the amount of $16 million.  Plaintiffs are two
   individuals who purchased shares of the Company on December 16, 1993
   following the Company's initial public offering.  In their complaint,
   plaintiffs have sued the Company, and certain members of the board of
   directors and certain officers alleging violations of Sections 11, 12 and 15
   of the Securities Act of 1933, as amended (the "Act").  Plaintiffs have also
   named David Blech, D. Blech & Co., Incorporated and Isaac Blech as
   defendants. On January 23, 1995, the Company and the members of the board of
   directors filed a motion to dismiss the plaintiffs' complaint pursuant to
   Rule 9(b) and Rule 12b(6) of the Federal Rules of Civil Procedure.  In
   addition, defendant John Pietruski, Chairman of the Board of Directors, filed
   a motion to dismiss the plaintiffs' complaint pursuant to Rule 12(b)(2) of
   the Federal Rules of Civil Procedure.  On February 7, 1995, the plaintiffs
   filed a motion for class certification.  The Court denied the motion by the
   Company and by John Pietruski.

   On March 28, 1995, a second class action shareholders' suit was filed in the
   United States District Court for the Southern District of New York seeking
   unspecified damages.  Plaintiffs are eight individuals who purchased shares
   in various companies for which D. Blech & Co. acted as an underwriter (or co-
   underwriter) or marketmaker. In their complaint, the plaintiffs have sued the
   Company alleging violations of Section 10(b) of the Securities Exchange Act
   of 1934, as Amended (the "Exchange Act") and Rule 10b-5 promulgated
   thereunder by the Securities and Exchange Commission (the "Commission").
   Plaintiffs have named a number of defendants, including David Blech and D.
   Blech & Co., four individuals, two brokerage firms, one investment management
   company and ten other companies for which D. Blech & Co. acted as underwriter
   or marketmaker.

   On August 14, 1995, the Judicial Panel on The Multi-District Litigation
   ordered that the action filed in the United States District Court for the
   Southern District of Texas, Houston Division be transferred to the United
   States District Court for the Southern District of New York for coordinated
   or consolidated pretrial proceedings with the action pending there.   In
   light of the transfer and consolidation of the Texas case with similar cases
   against other companies for which Blech acted as underwriter, the Company
   requested that the Court in New York reconsider the Texas Court's denial of
   its motion to dismiss as a part of the Court's consideration of similar
   motions to dismiss filed by those companies.  All of these motions were
   presented to the Court on February 6, 1996.  On June 6, 1996, the New York
   District Court entered two memorandum opinions in the consolidated cases.  In
   one of its opinions, the Court dismissed all of the Exchange Act and common
   law fraud claims filed against the Company and its officers and directors,
   but afforded those plaintiffs the right to attempt to preserve those claims
   by repleading them.  The Court ordered that those claims be repleaded no
   later than July 26, 1996.  Plaintiffs did not replead those claims by the
   deadline, resulting in the dismissal of all claims against the Company in
   that litigation.  In its opinion in the second case, i.e., the case filed on
   November 21, 1994, the Court granted the Company and its officers and
   directors' motion for reconsideration, but together with all other similar
   pending motions, denied the requested relief.  Pursuant to the court's order,
   the Company therefore filed an answer in that case.  The Company also filed a
   Motion seeking leave of court to prosecute an immediate appeal of the Court's
   denial of the Company's Motion to Dismiss.  The Court heard argument on that
   Motion on October 10, 1996, and the Company awaits the Court's ruling.  Given
   the early stage of that case, which is the only remaining litigation against
   the Company, the Company is unable to evaluate its potential outcome at this
   time. The Company disputes these claims and intends to contest them
   vigorously.

ITEM 2.  CHANGES IN SECURITIES
------------------------------
   None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
----------------------------------------
   None




FORM 10-Q                                                               Page 19
<PAGE>
 
ITEM 4.   SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
-------   ----------------------------------------------------
   None

ITEM 5.  OTHER INFORMATION
--------------------------
   None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K
-----------------------------------------
<TABLE>
<CAPTION>
 
      EXHIBIT NO.            DESCRIPTION                                  
      -----------            -----------                                                               
<S>                          <C>
 
       3.6(2)                Certificate of Amendment of Certificate of Incorporation
 
       3.7                   Amended and Restated Bylaws of Texas Biotechnology Corporation
 
      10.51(1)*              Letter Agreement regarding Argatroban Studies Information
                             dated December 14, 1995, between the Company and Synthelabo
                             Recherche
 
      10.52(1)               Amendment B to Clinical Trial Research Agreement dated
                             February 10, 1995 between Texas Biotechnology Corporation
                             and Coromed Inc.
 
      10.53(2)               Letter of Understanding between Texas Biotechnology Corporation and
                              Mitsubishi Chemical Corporation dated July 10, 1996
 
      10.54(2)               Form of Indemnification Agreement between Texas Biotechnology
                             Corporation and its officers and directors dated May 3, 1996
 
      10.55(2)               Amended and Restated 1995 Non-Employee Director Stock Option Plan
                             (as amended by the Board of Directors on June 30, 1996)

      10.56*                 Strategic Alliance Agreement between Texas Biotechnology
                             Corporation and LG Chemical, Ltd. dated October 10, 1996

      10.57                  Common Stock Purchase Agreement between Texas Biotechnology
                             Corporation and LG Chemical, Ltd. dated October 10, 1996

      27.1                   Financial Data Schedule

</TABLE> 

 
*     The Company has omitted certain portions of this agreement in reliance on 
      Rule 24b-2 under the Securities and Exchange Act of 1934, as amended.

(1)   Filed as an exhibit to the Company's Form 10-Q (File No. 1-12574) for the 
      quarter ended March 31, 1996 and incorporated herein by reference.

(2)   Filed as an exhibit to the Company's Form 10-Q (File No. 1-12574) for the 
      quarter ended June 30, 1996 and incorporated herein by reference.


REPORTS ON FORM 8-K
--------------------
None



FORM 10-Q                                                               Page 20
<PAGE>
 
                        TEXAS BIOTECHNOLOGY CORPORATION

                              SEPTEMBER 30, 1996

                                  SIGNATURES



Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on the 13th day of November, 1996.



                              TEXAS BIOTECHNOLOGY CORPORATION


                              By:  /s/ David B. McWilliams
                                   ------------------------
                                   David B. McWilliams
                                   President and Chief Executive Officer



                              By:  /s/ Stephen L. Mueller
                                   -----------------------
                                   Stephen L. Mueller
                                   Vice President of Administration
                                   Secretary and Treasurer
                                   (Principal Financial and Accounting Officer)




FORM 10-Q                                                               Page 21
<PAGE>
 
                               INDEX TO EXHIBITS

 
<TABLE> 
<CAPTION> 

Exhibit No.     Description of Exhibit                                                                 Page No.
-----------     ----------------------                                                                 --------
<S>             <C>                                                                                    <C> 

   3.6 (2)      Certificate of Amendment of Certificate of Incorporation

   3.7          Amended and Restated Bylaws of Texas Biotechnology Corporation

 10.51 (1)*     Letter Agreement regarding Argatroban Studies Information
                dated December 14, 1995, between the Company and Synthelabo
                Recherche

 10.52 (1)      Amendment B to Clinical Trial Research Agreement dated
                February 10, 1995 between Texas Biotechnology Corporation
                and Coromed Inc.

 10.53 (2)      Letter of Understanding between Texas Biotechnology Corporation and 
                Mitsubishi Chemical Corporation dated July 10, 1996

 10.54 (2)      Form of Indemnification Agreement between Texas Biotechnology
                Corporation and its officers and directors dated May 3, 1996
 
 10.55 (2)      Amended and Restated 1995 Non-Employee Director Stock Option Plan
                (as amended by the Board of Directors on June 30, 1996)

 10.56*         Strategic Alliance Agreement between Texas Biotechnology Corporation and LG
                Chemical, Ltd. dated October 10, 1996

 10.57          Common Stock Purchase Agreement between Texas Biotechnology Corporation and
                LG Chemical, Ltd. dated October 10, 1996

 27.1           Financial Data Schedule

--------------
</TABLE> 

*       The Company has omitted certain portions of this agreement in reliance 
        on Rule 24b-2 under the Securities and Exchange Act of 1934, as amended.

(1)     Filed as an exhibit to the Company's Form 10-Q (File No. 1-12574) for 
        the quarter ended March 31, 1996 and incorporated herein by reference.

(2)     Filed as an exhibit to the Company's Form 10-Q (File No. 1-12574) for 
        the quarter ended June 30, 1996 and incorporated herein by reference.





FORM 10-Q                                                               Page 22