<PAGE>

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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
                              __________________

                                   FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
     For the Fiscal Year Ended December 31, 1997

                                      OR

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

                        Commission File Number 0-27150
                              __________________

                           PathoGenesis Corporation
            (Exact name of Registrant as specified in its charter)
                  Delaware                           91-1542150
      (State or other jurisdiction of             (I.R.S. Employer
       incorporation or organization)           Identification Number)

              201 Elliott Avenue West, Seattle, Washington 98119
              (Address of Principal Executive Offices) (Zip Code)

      Registrant's telephone number, including area code: (206) 467-8100
                               __________________

       Securities registered pursuant to Section 12(b) of the Act:  None

          Securities registered pursuant to Section 12(g) of the Act:
                   Common Stock, $0.001 par value per share
                             (Title of Each Class)
                              __________________

     Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes  X   No
                                              ---     ---

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

     The aggregate market value of the voting stock of the Registrant held by
stockholders who were not affiliates (as defined by regulations of the
Securities and Exchange Commission) of the Registrant was approximately
$510,536,959 on March 20, 1998 (based on the closing price quoted on the Nasdaq
National Market on March 20, 1998, as reported by The Wall Street Journal). On
March 20, 1998, the Registrant had issued and outstanding an aggregate of
16,245,547 shares of common stock.

                      Documents Incorporated by Reference

     Those portions of the Registrant's proxy statement to be filed pursuant to
Regulation 14A for the annual meeting of stockholders to be held on June 3,
1998, described in Part III hereof, are incorporated by reference in this
report.

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                                    PART I

     This annual report on Form 10-K contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed here. Factors that could cause or contribute to
such differences include, but are not limited to, those discussed in "Item 1.
Business" and "Item 7. Management's Discussion and Analysis" of this Form 10-K,
and in Exhibit 99 to this Form 10-K.

Item 1.  Business

Summary

     PathoGenesis Corporation ("PathoGenesis" or the "Company") is a Delaware
corporation organized in 1991. The Company develops novel drugs to treat
serious, chronic human infectious diseases where there is a significant need for
improved therapy. In December 1997, the United States Food and Drug
Administration ("FDA") approved the Company's first drug, TOBI(TM) (tobramycin
solution for inhalation). The Company began marketing TOBI in 1998. TOBI is a
stable, premixed, proprietary formulation of the antibiotic tobramycin for
delivery by inhalation using a nebulizer. The drug is indicated for the
management of cystic fibrosis ("CF") patients with Pseudomonas aeruginosa ("P.
aeruginosa").

     Based on the potential efficacy of delivering a high concentration of
tobramycin directly to the site of infection in the lungs, the Company initiated
Phase II clinical trials of TOBI in patients with bronchiectasis (a form of
severe chronic bronchitis) and tuberculosis during 1997. In addition, the
Company initiated Phase II clinical trials of a second drug candidate, PA-1648.
This oral drug candidate is being developed as a potential replacement for the
antibiotic rifampin in tuberculosis treatment. The Company is developing
additional inhaled and oral drug candidates for lung infections. The table below
shows the development status and targeted market for each of PathoGenesis' drug
candidates in clinical trials. See "Government Regulation and Product Testing"
for a description of the various phases of product testing. The number of
patients shown refers to the total number of patients with the underlying
disease; not all of such patients have (or will develop) lung infections the
company's drug candidates are designed to treat.
<TABLE>
<CAPTION>
                                                                                  Approximate
        Indication                Drug Candidate       Development Status         Number of Patients
----------------------------------------------------------------------------------------------------
<S>                               <C>                  <C>                        <C>
Cystic fibrosis                   TOBI                 Approved by FDA in         30,000 (U.S.)
                                                       1997; filed for            30,000 (Europe)
                                                       approval in Canada in      10,000 (rest of world)
                                                       March 1998; regulatory
                                                       filings in Europe
                                                       expected in 1998


----------------------------------------------------------------------------------------------------------
Bronchiectasis (a form of         TOBI                 Phase II clinical trials   100,000 (U.S.)
severe chronic bronchitis)                             commenced in 1997          100,000 (Europe)
                                                                                  100,000 (Japan)


----------------------------------------------------------------------------------------------------------
Tuberculosis (adjunct             TOBI                 Phase II clinical          25,000 (U.S. and Canada)
 therapy for patients                                  trials commenced in 1997
 with contagious
 pulmonary tuberculosis)
----------------------------------------------------------------------------------------------------------
Tuberculosis                      PA-1648              Phase II clinical          25,000 (U.S. and Canada)
                                  (rifalazil)          trials commenced in 1997
----------------------------------------------------------------------------------------------------------
</TABLE>
                                       1
<PAGE>

     There can be no assurance that TOBI will achieve market acceptance. In
addition, the results of the clinical trials of TOBI for other indications being
conducted by the Company may not be consistent with results obtained in the
clinical trials for TOBI in cystic fibrosis patients, and such trials may not be
completed within anticipated time frames, if at all. No assurance can be given
that the Company will develop any of its other drug candidates successfully.

Anti-Pseudomonas Drug Development Program

     The goal of PathoGenesis' anti-pseudomonas drug development program is to
develop drug candidates that can provide significant benefit to people with
pseudomonal lung infections. The Company's first drug, TOBI, was developed to
treat people with cystic fibrosis and is currently being tested in patients with
bronchiectasis (a form of severe chronic bronchitis) who have pseudomonal lung
infections.

     PathoGenesis is conducting further research into P. aeruginosa therapy,
including investigation of additional aerosolized antibiotics. In October 1997,
the Company received a Therapeutics Development Grant from the Cystic Fibrosis
Foundation, which will help support the preclinical development of PA-1420
(polymyxin E1), a purified form of the antibiotic colistin. The drug candidate
is a broad-spectrum gram-negative antibiotic designed to be administered by
aerosol. The Company has applied for patents on PA-1420.

     In September 1997, PathoGenesis, the Cystic Fibrosis Foundation and the
University of Washington Genome Center announced a partnership to collaborate on
laboratory research into the genetic makeup of P. aeruginosa. See "Research and
Development."

     TOBI for Cystic Fibrosis Lung Infections

     In December 1997, TOBI became the first FDA-approved antibiotic solution
for inhalation to treat people with CF. The drug is indicated for the management
of CF patients with P. aeruginosa. TOBI is a stable, premixed, proprietary
formulation. It has received orphan drug designation from the FDA, which
provides the Company with seven years of marketing exclusivity in the U.S. from
the time of approval. TOBI also is covered by a U.S. formulation patent that
will expire in 2013. Patent applications are pending in other countries. See
"Patents."

     Tobramycin is a fermentation product isolated from Streptomyces tenebrarius
in 1967. It is a water-soluble compound belonging to the group of antibiotics
called aminoglycosides. Like other aminoglycosides, tobramycin inhibits
bacterial protein synthesis and is most active against gram-negative bacteria.
Compared with other aminoglycosides, tobramycin is more active against P.
aeruginosa by at least two- to four-fold and is generally less toxic.
Intravenous tobramycin has been approved for marketing for more than 20 years.

     Cystic Fibrosis

     Cystic fibrosis is the most common life-shortening inherited disease in the
U.S., affecting about 30,000 Americans. According to the Cystic Fibrosis
Foundation, CF is diagnosed in one of every 3,300 newborns in the U.S. Most
people with CF are diagnosed by age three. The median survival age is 31.3
years.

                                       2
<PAGE>

     Cystic fibrosis is characterized by the production of unusually thick,
sticky mucus that obstructs the airways of the lungs, the bronchial tubes and
bronchioles. Early in life, cystic fibrosis patients typically have bacterial
infections comparable to other children. While the majority of their early lung
infections are treated effectively, the accumulation of mucus in the lungs
usually leads to life-long infections. This results in gradual destruction of
lung tissue, and eventually, respiratory failure. P. aeruginosa is the dominant
type of bacteria, infecting the lungs of about 60 percent of all people with CF
in the U.S. Infection with pseudomonal bacteria is increasingly likely as the
patient ages. Furthermore, P. aeruginosa is rarely if ever permanently
eradicated after antibiotic treatment.

     An estimated 90% of all illnesses associated with CF are related to the
respiratory system. Periodic flare-ups of pseudomonal infection can cause life-
threatening episodes and hospitalization, which increases treatment costs,
exposes the patient to potential hospital-acquired infections, and disrupts
education and family life. For more than 20 years, the standard treatment for
these flare-ups was intravenous tobramycin, typically for periods of 10-14 days.
However, cumulative systemic exposure to intravenous tobramycin increases the
risk of adverse side effects, such as significant kidney damage and hearing
loss. As an antibiotic specifically formulated for inhalation, TOBI is delivered
directly to the lungs where the infection resides. The drug is formulated to
minimize its absorption into the bloodstream through the airway lining, thereby
reducing the risk of adverse effects. On average, 100-fold greater
concentrations of tobramycin can be delivered to the actual site of infection by
directly depositing the antibiotic on the airway lining as compared with
intravenous delivery.

     Treatment of pseudomonal infection using TOBI would be expected to begin at
the first detection of pseudomonal bacteria and may continue throughout the
patient's lifetime. The Company believes that the market for TOBI is significant
and growing. About 60% of the 30,000 CF patients in the U.S. have been diagnosed
with pseudomonal lung infections. Market growth may occur as new patients are
diagnosed and improved therapy extends the lives of patients. Most CF patients
are treated at 113 centers accredited by the Cystic Fibrosis Foundation.

     The Development of TOBI for Cystic Fibrosis

     For the past 20 years, inhaled tobramycin has been used experimentally to
treat pseudomonal infections in CF patients. Various solutions of tobramycin for
inhalation have been compounded by pharmacists and patients from commercially
available sources; however, the use of these formulations for inhalation has not
been approved by the FDA. Because physicians employing inhaled tobramycin used
different formulations and reported conflicting results, the Cystic Fibrosis
Foundation sponsored early research in aerosol administration. Researchers at
Children's Hospital and Medical Center in Seattle found that not all nebulizers
(devices used to produce the aerosol) deliver tobramycin to the affected area of
the lung. In addition, the doses used were frequently insufficient. Higher doses
are required in inhaled therapy than in intravenous therapy, since the inhaled
drug must pass through the sputum (phlegm), which partially binds and
inactivates tobramycin.

     Subsequently, the investigators tested inhaled tobramycin in a multi-center
randomized controlled trial of 71 cystic fibrosis patients with P. aeruginosa.
The results were published in the New England Journal of Medicine in June 1993.
In this study, aerosolized tobramycin appeared safe and held promise for
reducing pseudomonal bacterial counts, thereby improving lung function. However,
the treatment regimen of 600 milligrams three times daily would not have been
practical, given the compounded drug's lack of stability, lengthy treatment
times, and an estimated annual retail cost of about $30,000 per patient at that
time.

                                       3
<PAGE>

     PathoGenesis has obtained exclusive worldwide licenses from each of the
Cystic Fibrosis Foundation and Children's Hospital and Medical Center in Seattle
for patents, research and technology relating to the use of an aerosol
tobramycin solution or any other aerosol aminoglycoside solution for the
treatment of bronchopulmonary infections. See "Licenses and Other Agreements."
In March 1996, the Company was awarded a competitive $470,000 grant by the FDA
Office of Orphan Products Development to support its Phase III clinical trials
of TOBI.

     The Company significantly modified the treatment protocol published in the
New England Journal of Medicine. Its goal was to provide a more economical and
convenient therapy by developing TOBI, a concentrated, preservative-free
formulation of tobramycin solution for inhalation. The Company has obtained a
formulation patent on TOBI in the U.S., and patent applications are pending in
other countries. Each ready-to-use ampule of TOBI contains 300 milligrams of
tobramycin in a 5 milliliter solution. TOBI is aerosolized and administered
using a Pari LC Plus(TM) reusable nebulizer and a DeVilbiss Pulmo-Aide(R) air
compressor. It is inhaled twice daily and requires an average of about 15
minutes per treatment. The TOBI treatment regimen consists of repeated cycles of
28 days on drug, followed by 28 days off drug.

     In January 1997, PathoGenesis announced results from two pivotal double-
blind, placebo-controlled Phase III clinical trials of TOBI in patients with
cystic fibrosis. A total of 520 cystic fibrosis patients aged 6 to 63 with P.
aeruginosa lung infections participated in the studies, which were conducted for
24 weeks at 69 cystic fibrosis centers across the U.S. Patients were divided
into two groups -- those receiving placebo plus standard CF therapy and those
receiving TOBI plus standard CF therapy. Compared with placebo plus standard CF
therapy, the six-month clinical trials of TOBI showed:

(i)   Improved and maintained lung function: TOBI-treated patients demonstrated
      a significant improvement in lung function compared to those receiving
      standard CF therapy. At the end of the six months, the average improvement
      in lung function from baseline was 11% in one trial, and 7% in the other.
      To put this into perspective: A CF patient's pulmonary function declines
      2% to 3% a year on average, with the median age of death currently at 31
      years. Thus, a 10% improvement in lung function typically represents a
      return to what the patient's lung function was three to four years
      earlier.

(ii)  Fewer days in the hospital: On average, TOBI-treated patients were
      hospitalized three fewer days than patients receiving standard CF therapy
      -- 5.1 days for TOBI patients, compared to 8.1 days for placebo patients
      over the six months.

(iii) Fewer days requiring anti-pseudomonal antibiotics: On average, TOBI-
      treated patients required 4.4 fewer days of intravenous anti-pseudomonal
      therapies than patients receiving standard CF therapies -- 9.7 days for
      TOBI patients, compared to 14.1 days for placebo patients.

(iv)  Safety: TOBI was well-tolerated by patients, although more TOBI-treated
      patients experienced hoarseness (13% versus 7% in placebo patients) and
      ringing in the ears (3% versus none of the placebo patients). All episodes
      of ringing in the ears were temporary and resolved without stopping the
      TOBI treatment regimen.

                                       4
<PAGE>

(v)  Reduction in bacterial counts: TOBI therapy resulted in a significant
     reduction in P. aeruginosa density in sputum during the on-drug periods.
     Sputum bacterial density returned to baseline during the off-drug periods.
     Reductions in sputum bacterial density were smaller in each successive
     cycle.

     One concern with long-term administration of any antibiotic is the
emergence of drug-resistant bacteria. However, intravenous tobramycin therapy
for acute flare-ups of pseudomonal infection in CF patients is usually
efficacious, even though resistant pseudomonal bacteria are frequently found.
Treatment for six months with TOBI in the clinical trials did not affect the
susceptibility of the majority of P. aeruginosa isolates tested. However,
microbiological measures of increased drug resistance were noted in some
patients. The relationship of in vitro (laboratory) susceptibility test results
and clinical outcome with TOBI therapy has not been established.

     All patients who completed the Phase III clinical trials were eligible for
an 18-month follow-on program, allowing them to continue receiving TOBI. More
than 85% of the patients chose to participate, allowing PathoGenesis to gather
longer-term safety and efficacy data. Longer-term results are expected to be
released at scientific meetings in 1998 and 1999. A long-term (180-day) animal
toxicology study completed by the Company in 1996 showed no safety problems at
clinically relevant doses.

     TOBI for Cystic Fibrosis Patients Outside the U.S.

     PathoGenesis filed in March 1998 for approval to market TOBI to cystic
fibrosis patients in Canada. The Company anticipates filing in 1998 for
regulatory approval to market TOBI for cystic fibrosis in the United Kingdom,
and later in other European countries. About 30,000 people in Europe have CF.
PathoGenesis intends to file its U.S. data on TOBI as administered using a Pari
LC Plus jet nebulizer and DeVilbiss Pulmo-Aide compressor. In preparation for
that filing, the Company initiated a study in 1997 to evaluate the drug's
stability according to European standards. In 1998, the Company expects to
initiate a small-scale open-label clinical trial of TOBI in Europe to validate
TOBI's safety and efficacy given the differences in standard therapy between the
U.S. and Europe. The Company currently intends to market TOBI using its own
sales force in northern Europe, where most CF patients are treated in
centralized CF centers, and to seek sales and distribution partners in other
markets.

     The Company began marketing TOBI for cystic fibrosis in the U.S. in January
1998. There can be no assurance that TOBI will achieve market acceptance.
Furthermore, there can be no assurance that the Company will succeed in
obtaining regulatory approvals to enable it to introduce TOBI in other markets
on a timely basis. Even if the Company obtains the necessary foreign regulatory
approvals, no assurance can be given that the Company will be able to market
TOBI successfully in foreign markets.

     TOBI for Bronchiectasis

     Bronchiectasis (a form of severe chronic bronchitis) is a lung disease in
which previous bouts of viral or bacterial infection have damaged the air
passages and compromised the lungs' normal defenses against airway infection. In
bronchiectasis, persistent bacterial infection is present in air passages of the
lungs and causes inflammation, which leads to progressive lung damage. The late-
stage clinical manifestations are similar to cystic fibrosis lung disease,
except that bronchiectasis patients are usually older. Approximately 100,000
people in the U.S. have bronchiectasis, based on hospital admission records.
These patients often require a significant number of hospitalizations to treat
complications of the condition.

                                       5
<PAGE>

     Due to certain clinical similarities between cystic fibrosis and
bronchiectasis, the Company believes TOBI can suppress bacterial growth in the
lungs of bronchiectasis patients and thereby decrease inflammation and
progressive lung damage. In 1997, the Company initiated a double-blind, placebo-
controlled, randomized Phase II clinical trial of TOBI in bronchiectasis
patients. The Company plans to enroll about 50 patients aged 18 or older who
have been diagnosed with bronchiectasis and P. aeruginosa airway infections. The
28-day trial is being conducted in about 12 medical centers in the U.S. The
principal endpoint will be microbiological response as measured by changes in
observed bacterial levels in the sputum. TOBI's potential benefits may include
decreased hospitalizations and a slowing of decline in lung function of
patients. Results are expected to be announced in 1998.

     There can be no assurance that the Company's planned development of TOBI
for this indication will be successful or completed within anticipated time
frames, or at all, or that regulatory approvals will be obtained.

     TOBI for Ventilator Patients

     Accidents, premature birth, and chronic lung diseases are among the reasons
that patients have to be connected to ventilators for long periods of time.
PathoGenesis estimates about 15,000 long-term ventilator patients live in the
U.S., with a similar number in Europe. These patients are susceptible to
infection by P. aeruginosa and other pathogens. As a result, they may be
hospitalized 2-3 times a year. For example, about 75% of U.S. tracheotomy
patients experience pseudomonal lung infections. The Company is evaluating the
market potential, and may initiate a clinical study of TOBI in ventilator
patients.

Tuberculosis Drug Development Program

     For the past 25 years, development of anti-tuberculosis drugs has been
limited. However, tuberculosis ("TB") ranks as one of the most serious
infectious diseases worldwide because of its highly contagious nature, worldwide
prevalence and increasing levels of drug resistance. PathoGenesis' goal is to
develop drug candidates that can provide significant benefit to TB patients,
either as an adjunct (supplemental) therapy or as a replacement for one of the
four drugs in the current standard primary regimen of therapy (isoniazid,
rifampin, pyrazinamide and ethambutol). PathoGenesis' drug candidates include:

(i)   TOBI to treat patients newly diagnosed with tuberculosis. TOBI's potential
      benefits as an addition to oral TB therapies could include shorter
      hospital quarantines. A shorter contagious period also helps safeguard
      healthcare workers and family members. A Phase II trial is currently being
      conducted.

(ii)  PA-1648, an oral drug candidate to replace rifampin in the standard
      regimen of therapy. Potential benefits may include reduced length of
      therapy, less frequent dosing, and fewer or milder side effects than
      current therapies. This could help improve patient compliance with the
      recommended course of therapy. A Phase II trial is currently being
      conducted.

(iii) PA-824, one of a novel class of compounds called the nitroimidazoles that
      were developed by PathoGenesis. PA-824 has demonstrated activity against
      multiple-drug-resistant TB strains in preclinical testing and is being
      investigated as a possible replacement or supplement for isoniazid, one of
      the drugs in the standard treatment regimen for TB.

                                       6
<PAGE>

     Tuberculosis

     Worldwide, more than a billion people are infected with Mycobacterium
tuberculosis ("M. tuberculosis"), the bacterium that causes TB. The vast
majority of these infections are latent (inactive) cases, which may exist for
decades before the lung disease manifests itself. An estimated eight million
active tuberculosis cases are diagnosed and more than two million deaths occur
worldwide each year. In the U.S., the Centers for Disease Control and Prevention
report an average of 25,000 active TB cases per year and more than 10 million
latent cases.

     Initial exposure to M. tuberculosis results in a latent infection of the
lung, which usually can be diagnosed using a tuberculosis skin test. After a
latent phase ranging from months to decades, the bacterium may resume active
growth. If untreated, patients typically develop progressive tuberculosis
pneumonia with loss of lung function, severe weight loss and eventual death.
Patients with active tuberculosis are extremely infectious. Those in close
contact with such patients are at risk of becoming infected by exposure to
airborne droplets produced from coughing. The most effective way to control the
spread of TB is through early identification and thorough treatment of active
cases.

     Patents have expired on all four drugs in the current standard regimen of
therapy to treat tuberculosis. Currently, active TB is treated with a regimen of
at least three different drugs taken daily for a minimum of six months. The goal
of multi-drug therapy is to reduce the emergence of drug-resistant bacteria and
shorten the treatment duration. However, side effects can include severe
gastrointestinal upset and hepatitis, and the mortality rate of drug-related
adverse effects is about one in 2,000. While current therapies are effective if
the patient adheres to and completes the treatment course, up to 30% of patients
relapse due to noncompliance. Lack of compliance also is the primary cause of
drug-resistant TB. As a result, a number of cities have instituted costly
"directly observed therapy programs," in which healthcare workers observe
administration of every oral dose in an effort to improve compliance.
Consequently, the Company believes that a significant market opportunity exists
for drug candidates that can lower overall treatment costs by shortening the
length of therapy, decreasing the frequency of administration and improving
compliance levels.

     TOBI for Tuberculosis

     In vitro, 300 milligrams of TOBI demonstrated activity against TB bacteria,
including multi-drug-resistant strains. As a result, the Company believes TOBI
may be a valuable adjunct to current tuberculosis drug regimens, with the
potential to shorten the period of initial infectivity. A shorter contagious
period may reduce hospital stays and help prevent secondary transmission to
family members and healthcare workers. TB takes about a week to culture and
diagnose. Patients with known or suspected infectious pulmonary tuberculosis are
typically placed in hospital isolation wards for about two weeks until systemic
antibiotics can eliminate tuberculosis in the sputum. Sputum samples are taken
daily. Once three consecutive sputum smears are negative, the patient is
considered non-infectious and may go home to finish the remaining months of
standard TB treatment.

     In 1997, the Company initiated an open-label Phase II clinical trial of
TOBI in patients with contagious pulmonary TB. PathoGenesis plans to enroll 15-
20 patients aged 18 or older who have been newly diagnosed with pulmonary TB.
During the eight-day open-label trial, patients will receive 300 milligrams of
TOBI twice daily for five consecutive days using a nebulizer. The study will
examine whether TOBI decreases bacterial counts in the sputum more rapidly than
standard systemic therapies. At the study's conclusion, all patients will be
treated with a standard multi-drug regimen of tuberculosis therapy. Results are
expected to be announced in 1998.

                                       7
<PAGE>

     In April 1996, the Company filed a provisional patent application with the
U.S. Patent and Trademark Office for use of the TOBI formulation for the
treatment of tuberculosis. There can be no assurance that the Company will be
successful in its efforts to develop TOBI for this indication, or that the
Company's Phase II clinical trials will be completed within the anticipated time
frames, if at all.

     PA-1648

     PA-1648 (rifalazil) is being developed as a candidate for inclusion in the
standard regimen of TB therapy. This oral drug candidate was synthesized, tested
for anti-mycobacterial activity, and patented in the U.S. and major foreign
markets by Kaneka Corporation ("Kaneka") under the name KRM-1648. Kaneka has
granted exclusive rights to the Company for the development, marketing and sale
of PA-1648 in the U.S., Canada and Mexico. See "Manufacturing" and "Licenses and
Other Agreements."

     PA-1648 is a novel derivative of the generic drug rifampin. More than 20
peer-reviewed articles have reported its efficacy in vitro and in vivo (in
animals) against tuberculosis and disseminated Mycobacterium avium complex
("MAC") infections, a tuberculosis-like disease affecting AIDS patients. The
Company has conducted confirmatory studies. In preclinical studies, PA-1648
demonstrated several characteristics suggesting that it could be superior to
rifampin for use in treating TB. In vitro, PA-1648 has been shown to be:

     (i)   eight- to 80-fold more potent than rifampin against M. tuberculosis
           and MAC;

     (ii)  active against multiple strains of M. tuberculosis and MAC; and

     (iii) potent against other intracellular pathogens, particularly Chlamydia
           pneumoniae and Helicobacter pylori.

     Phase I clinical trial data on PA-1648 in healthy volunteers suggest that
PA-1648 has a longer half-life in humans than rifampin -- at least 48 hours on
average, versus two to three hours for rifampin. In addition, PathoGenesis' data
indicate that the ratio of intracellular drug concentrations to extracellular
drug concentrations is much higher for PA-1648 than for other rifampins.
PathoGenesis believes this may allow a 25- or 50-milligram dose to be taken once
or twice a week to treat rifampin-sensitive TB bacteria. In addition, a lower
dose may reduce the risk of side effects. Rifampin is typically dosed at about
300 milligrams once a day, and can cause flu-like side effects and transient
reductions in white blood cell counts in some individuals.

     In 1997, the Company initiated a randomized multiple-dose open-label Phase
II trial of PA-1648 in patients with pulmonary tuberculosis. The trial is being
conducted in Brazil in collaboration with the National Institute of Allergy and
Infectious Diseases Tuberculosis Research Unit at Case Western Reserve
University, Cleveland. The Company plans to enroll 60 patients aged 18-65 who
have been diagnosed with pulmonary TB. Patients will be divided into four
treatment groups, which will receive various combinations of PA-1648 and
isoniazid, isoniazid alone, or isoniazid plus rifampin. The 14-day protocol is
designed to evaluate the early bactericidal activity of PA-1648. After
completion of the 14-day study, the patients will be given standard treatment of
tuberculosis (isoniazid, rifampin, pyrazinamide and ethambutol) under the
supervision of their own physicians. The Company expects to use the trial
results to evaluate whether PA-1648 may be safe and effective when taken less
frequently than rifampin and whether it has the potential to reduce the length
of treatment. Results are expected to be announced in 1998.

                                       8
<PAGE>

     There can be no assurance that the Company's planned development of drug
candidates and the necessary clinical trials will be successful or completed
within the anticipated time frames, if at all.

Research and Development

     PathoGenesis focuses its research and development on drug candidates with
potentially unique therapeutic profiles, as well as those it believes it can
develop relatively quickly.  The Company seeks to shorten drug discovery and
development by involving its clinical and regulatory personnel in the early
stages of drug discovery and development.  This allows PathoGenesis to choose
drug candidates that are of significant interest to physicians and regulators
and that have readily measurable effects in clinical trials. PathoGenesis
intends to focus on drug candidates it believes it can develop through its own
resources, although it may also sell, license, joint venture or otherwise
collaborate where it determines such an approach is preferable.

     PathoGenesis' three major technical programs are:  (i) a molecular genetics
program to discover new approaches to the treatment of pathogens; (ii) a
molecular microbiology program that focuses on discovering new approaches to
treating pathogens and using "smart screens" or reporter gene technology to
facilitate drug candidate testing; and (iii) a pharmaceutical chemistry program
that uses combinatorial chemistry to create new drug candidates.  PathoGenesis
also has internal capabilities in functional genomics and molecular target
discovery, assay development for compound screening, the development and
application of technology and informatics to accelerate drug discovery,
medicinal chemistry and Rapid Analog Matrix ("RAM(R)") synthesis, compound
evaluation in animal infection models, and preclinical development capabilities.
In addition, the Company has developed specialized expertise in the drug
mechanisms of action and resistance, aerosol drug delivery, surrogate markers
and assays for clinical trials, and clinical microbiology.  The Company spent
approximately $28.0 million, $20.7 million and $15.7 million on research and
development of proposed drug candidates in 1997, 1996 and 1995, respectively.

     In September 1997, PathoGenesis, the Cystic Fibrosis Foundation and the
University of Washington Genome Center announced a two-year genetic research
project to fund and perform laboratory research to determine the genetic makeup
of P. aeruginosa, a bacterium that affects cystic fibrosis, burn and cancer
patients.  Greater knowledge of the bacterial genome (DNA or genetic code) may
provide new insights into how P. aeruginosa causes infection and defends itself
against antibiotics, which in turn can assist PathoGenesis researchers in
developing new anti-pseudomonal therapies.  In addition, the Company may patent
significant gene sequences.  The genetic data derived from this project are
being published on the Internet at www.pseudomonas.com.  From this site,
researchers can download gene sequences to their own computers or use resident
software to search for similarities between a given gene and the sequences
contained in the growing P. aeruginosa database.

Manufacturing

     The Company currently does not intend to establish internal manufacturing
capabilities.  Instead, it has contracted and intends to contract with third
parties for the production and packaging of its products.  Contract
manufacturing is monitored by PathoGenesis' manufacturing and distribution
support operation in Annandale, New Jersey, which had 12 employees as of year-
end 1997.  All manufacturing facilities used by the Company are subject to
inspection by the FDA.

     The Company sources bulk powdered tobramycin from two of the principal
worldwide suppliers of the drug, and it is anticipated that either one of these
suppliers alone will be able to supply sufficient

                                       9
<PAGE>

quantities to meet the Company's current needs. Formulation and packaging of
TOBI occurs at a facility that also packages other drugs for inhalation for
other pharmaceutical companies. The powdered tobramycin is mixed with water and
excipients, then injected into plastic ampules (vials) using a form-fill-seal
technology in a sterile environment. Each ampule has a snap-top access port,
simplifying the action of delivering TOBI directly into a nebulizer for
inhalation. Another contract manufacturer handles final packaging of the drug.
Four plastic ampules are inserted in an aluminum foil pouch, then 14 pouches are
placed into a single box to comprise a 28-day supply. The contract manufacturer
that performs formulation and packaging for the Company currently does so under
an oral arrangement. The Company has been negotiating a written agreement with
that manufacturer and hopes to finalize such written agreement in the near
future. No assurance can be given that the Company will be able to obtain future
supplies of tobramycin on favorable terms, or that the contract manufacturers
will be able to provide the Company with sufficient supplies of TOBI.

     To deliver TOBI, the Company has designated the Pari LC Plus nebulizer,
manufactured and distributed in the U.S. by Pari Corporation of Germany. The
nebulizer has a useful life of about six months and costs about $15 at retail.
The Company's research shows that this nebulizer efficiently aerosolizes the
TOBI solution and delivers the optimal drug particle size to the lung airways,
minimizing the amount of drug that is absorbed systemically or coughed out.

     The Company obtains bulk powdered PA-1648 from Kaneka. PathoGenesis and
Kaneka are parties to a supply agreement pursuant to which Kaneka is obligated
to supply, and the Company is obligated to purchase at specified prices, all the
bulk powdered drug if and when the Company receives marketing approval of PA-
1648 from the FDA. Such obligations will remain for the duration of the license
agreement with Kaneka, as described under "Licenses and Other Agreements" below.

Sales and Marketing

     Cystic fibrosis is a focused market segment that involves a small group of
physicians and treating institutions in the U.S. and abroad. Currently, more
than 65% of cystic fibrosis patients in the U.S. are treated by institutions or
physicians associated with the 113 cystic fibrosis care centers sponsored by the
Cystic Fibrosis Foundation. Of those centers, 69 sites participated in the
Company's Phase III clinical trials for TOBI. Consequently, the Company believes
a relatively small sales force can provide sufficient coverage for the U.S.
PathoGenesis relies upon 21 full- and part-time dedicated sales personnel
employed by a third party to market TOBI to physicians, hospitals and CF
treatment centers.

     TOBI shipments began on January 2, 1998. PathoGenesis is selling TOBI to
drug wholesalers and mail order pharmacies, including Cystic Fibrosis Services.
Cystic Fibrosis Services is a mail order pharmacy affiliate of the Cystic
Fibrosis Foundation that serves 20% to 25% of people with CF in the U.S. Cystic
Fibrosis Services and other pharmacies accept assignment of benefits and help
patients request reimbursement from third party payors. To assist patients,
pharmacists and caregivers, the Company has established a toll-free hotline.
Other drugs for cystic fibrosis have achieved reimbursement levels of greater
than 98% from third party payors, including private insurance plans and
Medicaid, which covers about 20% of CF patients. The Company expects TOBI to
have a comparable reimbursement level, although no assurance can be given that
such a level will be achieved.

     The Company filed in March 1998 for approval to market TOBI to cystic
fibrosis patients in Canada. In 1997, PathoGenesis established a European office
in Brentford, England, as part of the process of registering TOBI for cystic
fibrosis in the European Union. The Company expects to file in 1998 for approval
of TOBI for CF in England. If and when it obtains approval, the Company plans to
market TOBI using its own sales force in the major northern European countries,
which have centralized cystic fibrosis

                                      10
<PAGE>

centers similar to those in the U.S. PathoGenesis plans to seek sales and
distribution partners in other markets.

Licenses and Other Agreements

     PathoGenesis has licensed from the Cystic Fibrosis Foundation and
Children's Hospital and Medical Center in Seattle exclusive worldwide rights to
patents, research and technology relating to the use of an aerosolized
tobramycin solution or any other aerosolized aminoglycoside solution for the
treatment of bronchopulmonary infections. A $1.5 million milestone payment
became payable by the Company upon the product receiving FDA approval. This
payment is included in accrued clinical development costs at December 31, 1997.
In addition, the Company has agreed to pay a royalty based on net sales. Each
licensing agreement continues in effect until the expiration of any patent
rights under the license, and may be terminated earlier upon a material breach
by either party.

     The Company has licensed from Kaneka exclusive rights for the U.S., Canada
and Mexico to develop, market and sell PA-1648 for use in the treatment of
tuberculosis and other infections.  The license agreement provides that the
Company is responsible for the clinical development, regulatory affairs,
marketing and sales of PA-1648.  The Company has agreed to pay Kaneka certain
clinical and regulatory milestone payments of substantial amounts.  In addition,
the Company has agreed to pay Kaneka a royalty based on net sales for 15 years
from the date of commercial production of PA-1648.  After such 15-year period,
the license is fully paid and remains in effect as a non-exclusive license.
Kaneka has an option to convert the license to a non-exclusive license should
the Company fail to achieve certain milestones.  In addition, the license may
terminate should the Company fail to achieve certain other milestones.  As
partial consideration for the license, the Company paid $500,000 in cash and
issued 50,000 shares of Common Stock to Kaneka.  In addition, in lieu of a cash
milestone payment in 1995, the Company issued to Kaneka an additional 50,000
shares of Common Stock.  Under a related supply agreement, Kaneka is responsible
for providing bulk powdered PA-1648 for the Company's clinical trials.  The
Company believes Kaneka has supplied sufficient quantities of PA-1648 to allow
the completion of Phase II clinical testing of the drug to treat tuberculosis.
See "Tuberculosis Drug Development Program."

     In 1996, PathoGenesis entered into a license and distribution agreement
with Bohdan Automation, Inc.  Under this agreement, Bohdan manufactures and
sells the RAM(R) Synthesizer, a patented combinatorial chemistry system invented
by the Company and Bohdan scientists.

     PathoGenesis engages in research and development collaborations and
licensing arrangements with various academic institutions, government and
commercial research groups, and other companies.  For example, the Company has
entered into a contract with the Cystic Fibrosis Foundation and the University
of Washington to sequence the P. aeruginosa genome as described under "Research
and Development."  The Company believes that none of the licenses under these
arrangements is currently material in relation to the Company's business as a
whole.  The Company expects to pursue additional license agreements and research
collaboration arrangements.

Patents

     PathoGenesis generally applies for patents for its proprietary compounds,
formulations or technologies.  The Company has seven U.S. patents, including a
formulation patent for TOBI.  In addition, the Company is the exclusive licensee
in the U.S., Canada and Mexico of rights under three issued patents relating to
PA-1648.  The Company has seven patent applications pending in the U.S.  In
addition, an international application for a formulation patent for TOBI was
filed in 1995 under the Patent Cooperation

                                       11
<PAGE>

Treaty designating Europe, Canada, Japan and other countries.  There can be no
assurance that these patents or others, if obtained, will provide substantial
protection or commercial benefit to PathoGenesis.  In addition, other companies
may have filed patent applications or have been granted patents in areas of
interest to the Company.  There can be no assurance that any licenses required
under such patents would be available under reasonable terms, if at all.

Government Regulation and Product Testing

     In order to conduct clinical trials, manufacture and market products for
therapeutic use, PathoGenesis must comply with regulation by governmental
authorities in the U.S. and foreign countries. The Company also is subject to
various federal, state and local laws, regulations and recommendations,
including environmental laws and regulations.

     Before a drug may be commercially distributed in the U.S., its developer
must (i) conduct the appropriate preclinical laboratory and animal tests; (ii)
submit an Investigational New Drug application ("IND") that must be approved
before clinical trials may commence; (iii) conduct controlled human clinical
trials that establish the safety and efficacy of the drug candidate; (iv) file a
New Drug Application ("NDA") with the FDA; (v) comply with FDA inspection of
drug manufacturing facilities to ensure compliance with the applicable
requirements; and (vi) obtain FDA approval of the NDA prior to any commercial
sale or shipment of the drug.

     Clinical trials involve the administration of an investigational drug
product to human subjects.  In Phase I, the drug candidate is first tested in
humans for safety, side effects, dosage tolerance, metabolism and clinical
pharmacology.  Phase II trials help determine efficacy, optimal dosage and
possible side effects in specific indications.  Phase III trials are undertaken
to gather additional information about efficacy and safety in order to evaluate
the drug candidate's risks and benefits and to provide an adequate basis for
product labeling.

     Upon approval in the U.S., a drug may be marketed only for the approved
indications in the approved dosage forms and dosages.  The FDA may require post-
marketing testing and surveillance to monitor safety and efficacy history of the
approved product and continued compliance with regulatory requirements.  The FDA
also may require an additional review of manufacturing facilities if a material
change is made to manufacturing equipment, locations or processes.

     To market its products outside the U.S., the Company must comply with the
varying regulations of foreign markets.  In the European Union, foreign
marketing authorizations are approved at the national level, although certain
registration procedures are available to companies wishing to market a product
in more than one country in the Union.  If a regulatory authority is satisfied
that adequate evidence of safety, quality and efficacy has been presented,
marketing authorization is usually granted.  Approval by the FDA does not ensure
approval by other countries.

Competition

     The Company competes with pharmaceutical companies and specialized
biotechnology firms that produce and market products in the United States,
Europe and elsewhere.  Many pharmaceutical companies have focused their
development efforts in the therapeutics areas being pursued by the Company.
Certain of these competitors have secured supply arrangements with other
healthcare companies, which may give them a competitive advantage.  The Company
expects to encounter significant competition for the principal products it plans
to develop.

                                       12
<PAGE>

     The use of antibiotics to treat pseudomonal, mycobacterial and other
bacterial infections is well established.  In cystic fibrosis patients with
pseudomonal lung infections, tobramycin is the most commonly used intravenous
antibiotic.  Medical therapies for patients with CF include antibiotics, anti-
inflammatory drugs, oral replacement enzymes to maintain nutrition, physical
therapy to the chest to loosen lung secretions, and mucolytics to clear
pulmonary secretions, such as Pulmozyme(R) (dornase alpha), manufactured by
Genentech, Inc.  The Company believes those CF therapies complement TOBI.
However, the optimal combination may vary among patients.  In addition, the
potential high cost of combination therapy may limit the use of TOBI in
conjunction with other therapies.  There can be no assurance that alternative
formulations of tobramycin, other antibiotics or different approaches to therapy
will not prove to be more efficacious, safer or more cost-effective than TOBI.

     Antibiotic therapies are currently used to treat tuberculosis.  The Company
believes that PA-1648 could be used in combination with certain existing
therapies as part of multi-drug therapy regimens and that TOBI could be used as
an adjunct therapy for patients with contagious pulmonary TB.  However, optimal
combination therapies may vary among patients.  There can be no assurance that
alternative antibiotics or other therapies will not prove to be more
efficacious, safer or more cost-effective than PA-1648 or TOBI.

Human Resources

     As of December 31, 1997, PathoGenesis had 159 full-time employees, 103 of
whom were engaged in research and development activities at its laboratory
facility in Seattle, Washington.  Since the beginning of 1998, an additional 18
full-time employees of a third party have been selling TOBI on a full-time
basis.  A significant number of the Company's management and professional
employees have had prior experience with pharmaceutical, biotechnology or
medical products companies.  None of the Company's employees is covered by
collective bargaining agreements.

Item 2.  Properties

     The Company's principal facility consists of approximately 70,000 square
feet of leased laboratory and office space in Seattle, Washington.  The lease
expires in March 2003.  A portion of this space has been subleased by the
Company to a third party.  In addition, in 1997 the Company leased about 11,500
square feet of additional office space in Seattle to accommodate its growth into
a commercial enterprise.  The lease expires in March 2003.

     The Company also leases an administrative and marketing office of
approximately 10,500 square feet in Skokie, Illinois.  This lease expires in
March 2003.  A third leased laboratory and office space in Annandale, New Jersey
consists of approximately 18,000 square feet and houses manufacturing support
and distribution support operations. The lease expires in December 2001.

     In addition, in 1997 PathoGenesis leased 1,200 square feet of office space
in Brentford, Middlesex, England, to facilitate its European expansion plans.
PathoGenesis also rents office space in New York City, which is subject to an
oral, month-to-month lease agreement referenced under "Item 13. Certain
Relationships and Related Transactions."

Item 3.  Legal Proceedings

     The Company has no material pending legal proceedings.

                                       13
<PAGE>

Item 4.  Submission of Matters to a Vote of Security Holders

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997.

                                       14
<PAGE>

                                    PART II

Item 5.  Market for the Company's Common Stock and Related Stockholder Matters

     The Company's Common Stock trades on the Nasdaq National Market System
under the symbol PGNS. As of March 20, 1998, there were approximately 183
holders of record of the Company's Common Stock.  However, the Company believes
the actual number of beneficial holders is substantially greater.  No cash
dividends have been paid on the Common Stock to date, and the Company currently
intends to retain any earnings for the development and growth of its business.

     The following table sets forth the range of high and low closing sales
prices of the Common Stock as quoted on the Nasdaq National Market System for
each quarter in 1997 and 1996.  On March 20, 1998, the last reported sale price
for the Company's Common Stock was $34.125.

<TABLE>
<CAPTION>
                                                                           High          Low
     1997:
     <S>                                                                   <C>           <C>
        Fourth Quarter............................................        $40.75       $33.625
        Third Quarter.............................................         38.00         27.50
        Second Quarter............................................         30.50         22.50
        First Quarter.............................................         33.00         20.75
     1996:
        Fourth Quarter............................................         26.13         17.00
        Third Quarter.............................................         17.75         11.50
        Second Quarter............................................         18.75         13.50
        First Quarter.............................................         17.50         10.88
</TABLE>
     The Company issued shares of Common Stock upon cashless exercise of
outstanding warrants as follows:

<TABLE>
<CAPTION>
                                          Number of
                                        Shares Issued      Exercise price
<S>                                     <C>               <C>
1997:
   October                                  8,398              $38.103
   August                                  17,254               30.206
   March                                    1,889               30.344
1996:
   December                                 3,074               24.006
   November                                32,078               24.563
</TABLE>

     Such shares of Common Stock were issued without registration under the
Securities Act of 1933, as amended, in reliance on section 4(2) of such Act and
Rule 506 of Regulation D promulgated under such Act.

                                       15
<PAGE>

Item 6.  Selected Financial Data

     The following selected financial data for the period from December 10, 1991
(date of incorporation) through December 31, 1997 and each of the five years
ended December 31, 1993, 1994, 1995, 1996 and 1997 were derived from the
financial statements of the Company.  The data set forth below should be read in
conjunction with the audited financial statements, related notes and the other
financial information included elsewhere herein.

<TABLE>
<CAPTION>


                                                                                                    Period from
                                                                                                   December 10,
                                                        Years ended December 31,                   1991 through
                                          -----------------------------------------------------    December 31,
(In thousands, except per share data)       1997       1996       1995       1994       1993           1997
                                          ---------  ---------  ---------  ---------  ---------    -------------
<S>                                       <C>        <C>        <C>        <C>        <C>        <C>
Statement of Operations Data:
Revenue -- grants and royalties.........  $    442   $    440   $     --   $     --   $     --         $     882

Operating expenses:
  Research and development..............    28,018     20,673     15,668     12,789      8,213            86,119
  General and administrative............    10,582      4,241      3,609      3,215      3,615            27,960
                                          --------   --------   --------   --------   --------         ---------
     Total operating expenses...........    38,600     24,914     19,277     16,004     11,828           114,079
                                          --------   --------   --------   --------   --------         ---------
     Operating loss.....................   (38,158)   (24,474)   (19,277)   (16,004)   (11,828)         (113,197)
                                          --------   --------   --------   --------   --------         ---------
Other income (expense)
  Investment income, net................     5,278      3,294      1,287      1,285      1,064            12,753
  Other expense.........................      (158)       (84)       (34)       (43)       (41)             (379)
                                          --------   --------   --------   --------   --------         ---------
     Net other income...................     5,120      3,210      1,253      1,242      1,023            12,374
                                          --------   --------   --------   --------   --------         ---------
     Net loss...........................  $(33,038)  $(21,264)  $(18,024)  $(14,762)  $(10,805)        $(100,823)
                                          ========   ========   ========   ========   ========         =========
Net loss per common share --
  basic and diluted.....................  $  (2.10)  $  (1.66)  $  (2.20)  $  (1.95)  $  (1.77)
                                          ========   ========   ========   ========   ========

Weighted average common shares
 outstanding -- basic and diluted.......    15,704     12,829      8,210      7,585      6,111
                                          ========   ========   ========   ========   ========
</TABLE>


<TABLE>
<CAPTION>
                                                                  At December 31,
                                           -------------------------------------------------------------
                                            1997         1996          1995          1994         1993
                                            ----         ----          ----          ----         ----
<S>                                       <C>          <C>           <C>           <C>          <C>
Balance Sheet Data:
Cash, cash equivalents and investment
 securities...........................    $79,041       $60,688       $37,447      $25,994       $20,421
Total current assets..................     87,190        61,809        38,884       26,694        20,862
Total assets..........................     97,596        69,999        46,963       36,086        30,301
Total current liabilities.............      8,107         2,974         3,453        2,925         1,300
Long-term liability...................         --            98           462           --            --
Total stockholders' equity............     89,489        66,926        43,048       33,161        29,001

</TABLE>


                                       16
<PAGE>

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

Overview

     PathoGenesis develops novel drugs to treat serious, chronic human
infectious diseases where there is a significant need for improved therapy. From
its incorporation in December 1991 through the end of 1997, the Company has
engaged primarily in research, development, clinical trials and administrative
activities.

     In December 1997, the FDA approved the Company's first drug, TOBI. In 1998,
PathoGenesis began marketing TOBI for the management of cystic fibrosis patients
with P. aeruginosa. TOBI is the first FDA-approved antibiotic solution for
inhalation for CF patients. An estimated 60% of the 30,000 CF patients in the
U.S. have pseudomonal lung infections. For more than 20 years, the standard of
care was to treat flare-ups of pulmonary symptoms with intravenous tobramycin,
typically for periods of 10-14 days. This generally required hospitalization.

     In order to commercialize TOBI in record time -- just three years from the
time the Company filed an Investigational New Drug application with the
FDA -- PathoGenesis achieved a series of milestones in 1997:

(i)    In January, the Company announced the results of two Phase III clinical
       trials of TOBI in 520 CF patients. The TOBI groups had improved and
       maintained lung function, fewer days in the hospital, and fewer days of
       anti-pseudomonal antibiotic therapy.
(ii)   In May, the Company formed a European subsidiary, PathoGenesis Limited,
       to oversee the process of filing for regulatory approval and bringing
       TOBI to market in Europe. About 30,000 people in Europe have CF.
(iii)  In July, PathoGenesis filed a new drug application with the FDA for TOBI
       in CF patients. The FDA agreed to expedite its review of the data.
(iv)   In November, the Company presented data on TOBI to the FDA's Anti-
       Infective Drugs Advisory Committee, which unanimously recommended that
       TOBI be cleared for marketing.
(v)    TOBI was approved by the FDA on December 22, 1997.

     Also in 1997, the Company initiated two Phase II clinical trials to test
TOBI in patients with bronchiectasis (a form of severe chronic bronchitis) and
tuberculosis. In the U.S., about 100,000 people have bronchiectasis, and an
average of 25,000 active tuberculosis cases are diagnosed annually. In October,
PathoGenesis initiated a Phase II clinical trial of an oral drug, PA-1648, in
people with tuberculosis. The Company intends to report the results of these
clinical trials in 1998. At the preclinical level, PathoGenesis is investigating
additional aerosolized antibiotics as follow-up drug candidates to TOBI, as well
as additional oral antibiotics for treating tuberculosis.

     The Company also has begun collaborating with the Cystic Fibrosis
Foundation and University of Washington Genome Center on a two-year project to
analyze the genetic composition of P. aeruginosa. These data may assist
PathoGenesis researchers in developing new anti-pseudomonal therapies.

     During 1997, PathoGenesis completed its third public offering of stock. The
offering, 2.1 million shares of common stock at $27.00 per share, was completed
in March and resulted in net proceeds of about $53.0 million to the Company.
PathoGenesis became a publicly owned company in November 1995.

                                      17
<PAGE>

     The Company has incurred losses since inception and had an accumulated
deficit through December 31, 1997 of $100.8 million. Such losses resulted
principally from research, development, clinical trial, general and
administrative costs. As of year-end 1997, the Company had not marketed or
generated sales revenues from any drugs. Other than TOBI for cystic fibrosis,
the Company's current drug candidates are not expected to be commercially
available for at least several years. The Company's results may vary
significantly from period to period depending on several factors, such as the
timing of expenses or sales and the progress of research and development
activities.

     In 1998, PathoGenesis began its first year as a commercial enterprise. The
Company's goals for the year include introducing TOBI for cystic fibrosis in the
United States; supporting CF patients' efforts to obtain reimbursement for TOBI
from third party payors; filing for regulatory approval to market TOBI in Canada
(filed in March 1998) and Europe; and further developing drug candidates in the
pipeline for cystic fibrosis, tuberculosis and other lung infections. The
Company expects a net cash outflow of $10.0 million to $15.0 million for the
year, including 1998 capital expenditures of approximately $5.0 million to $7.0
million. This compares with a net cash outflow of $37.0 million in 1997,
including capital expenditures of $4.4 million.

Results of Operations

     Years Ended December 31, 1997 and 1996

     Revenue from grants and royalties was $442,000 in 1997, an increase of
$2,000 from 1996. Revenues were comprised of income received from a two-year
competitive grant from the FDA and royalties from sales of a proprietary
combinatorial chemistry system invented by the Company and Bohdan.

     Research and development expense increased by $7.3 million to $28.0 million
in 1997 from $20.7 million in 1996. This increase was primarily due to increases
in personnel and professional costs relating to clinical development, filing of
a New Drug Application, and costs related to registration of TOBI in Europe.
General and administrative expense increased by $6.4 million to $10.6 million in
1997 from $4.2 million in 1996. Such increase was due to higher personnel and
professional costs relating to marketing and recruiting. The Company implemented
a sales and marketing program in the second half of 1997. In 1998, the launch of
TOBI is expected to generate further increases in sales, marketing, general and
administrative expenditures.

     Investment income, net increased by $2.0 million to $5.3 million in 1997
from $3.3 million in 1996. This increase was due to higher invested balances.

     Years Ended December 31, 1996 and 1995

     Revenue from grants and royalties was $440,000 in 1996. The Company did not
have any revenue in 1995. Revenues in 1996 represented income received from a
two-year competitive grant from the FDA and royalties from sales of a
proprietary combinatorial chemistry system invented by the Company and Bohdan.

     Research and development expense increased by $5.0 million to $20.7 million
in 1996 from $15.7 million in 1995. This was primarily due to increases in
clinical development activity. General and administrative expense increased by
$632,000 to $4.2 million in 1996 from $3.6 million in 1995. This

                                      18
<PAGE>

was due primarily to an increase in costs related to operation as a public
company, such as personnel, investor relations and insurance.

     Investment income, net increased by $2.0 million to $3.3 million in 1996
from $1.3 million in 1995. This increase was due to higher invested balances.

     Liquidity and Capital Resources

     From its inception through December 31, 1997, the Company has financed its
operations primarily by issuing equity securities with aggregate net proceeds of
approximately $185.0 million and investment income of approximately $12.8
million.

     The Company's combined cash, cash equivalents and investment securities
totaled $79.0 million at December 31, 1997, an increase of $18.4 million from
the balance at December 31, 1996. The Company expects that these funds, in
combination with expected revenues from sales of TOBI beginning in 1998, should
be sufficient to meet its operating expenses and capital requirements for the
foreseeable future. The primary uses of cash during the year ended December 31,
1997 were to finance the Company's operations, build inventory of TOBI, upgrade
the Company's communications and computer infrastructure, develop a
manufacturing control and support center, and expand its Chicago-area sales and
marketing office. From its inception through December 31, 1997, the Company
purchased approximately $17.3 million of property and equipment.

     The Company's future capital requirements will depend on many factors,
including the progress of its research and development programs; the progress of
preclinical and clinical testing; the time and cost involved in obtaining
regulatory approvals; the cost of filing, prosecuting, defending and enforcing
any patent claims and other intellectual property rights; competing
technological and market developments; changes and developments in the Company's
existing collaborative, licensing and other relationships and the terms of any
new collaborative, licensing and other arrangements that the Company may
establish; the development of commercialization activities and arrangements; and
the purchase of additional facilities and capital equipment.

     The Company is reviewing its computer systems to ensure that Year 2000
transactions can be processed properly and that modifications and replacements,
where necessary, can be obtained in a timely manner. The cost is not expected to
have a significant impact on the ongoing results of operations.

     The Company plans to continue its policy of investing excess funds in
government securities and investment grade, interest-bearing securities
primarily with expected maturities of one-and-one-half years or less. The
Company does not invest in derivative financial instruments, as defined by
Statement of Financial Accounting Standards No. 119 (SFAS 119), Disclosure about
Derivative Financial Instruments and Fair Value of Financial Instruments.

     At December 31, 1997, the Company had tax net operating loss carryforwards
of approximately $95.0 million and research tax credits of approximately
$970,000, which will begin to expire in 2007. The Company also has Orphan Drug
credits of approximately $5.0 million, which will expire beginning in 2007. The
Company does not anticipate a change in ownership under Section 382 of the
Internal Revenue Code of 1986, as amended, that would result in limitations on
the use of the tax net operating losses, or tax credits. However, there can be
no assurance that future issuances of the Company's securities will not trigger
limitations under Section 382 of the Internal Revenue Code.

                                      19
<PAGE>

Item 8.  Consolidated Financial Statements

     The Consolidated Financial Statements for the fiscal year ended December
31, 1997 may be found beginning on page F-1 of this Annual Report on Form 10-K.

Item 9.  Changes in and Disagreements with Accountants on Accounting and
         Financial Disclosure

     None.

                                   PART III

Item 10.  Directors and Executive Officers of Registrant

     The information appearing under the captions "Election of Directors",
"Executive Officers" and "Executive Compensation" in the Company's proxy
statement for the annual meeting of stockholders to be held on June 3, 1998 (the
"Proxy Statement"), is incorporated in this report by reference.

Item 11.  Executive Compensation

     Information appearing under the caption "Executive Compensation" in the
Proxy Statement is incorporated in this report by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

     The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is incorporated in this
report by reference.

Item 13.  Certain Relationships and Related Transactions

     The information set forth under the caption "Certain Transactions" in the
Proxy Statement is incorporated in this report by reference.

                                      20
<PAGE>

                                    PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)  Documents Filed As a Part of This Report

     (1)  Financial Statements.  The financial statements of PathoGenesis
          Corporation for the year ended December 31, 1997, together with the
          report of the Independent Certified Public Accountants, are set forth
          beginning on page F-1 hereof.

     (3)  Exhibits.  The exhibits to this report are listed in the Exhibit Index
          included elsewhere in this report. Included in the exhibits listed in
          the Index are the following exhibits which constitute management
          contracts or compensatory plans or arrangements:

          10.1  Employment Agreement between the Company and Wilbur H. Gantz,
                dated March 23, 1992

          10.3  Employment Agreement between the Company and A. Bruce
                Montgomery, dated September 19, 1995

          10.4  Employment Agreement between the Company and Marc F.
                Wipperman, effective as of July 1, 1996

          10.26  1992 Stock Option Plan

          10.27  1996 Non-Employee Director Plan

          10.28  1997 Stock Option Plan

(b)  Reports on Form 8-K

     The Company filed a report on Form 8-K on December 30, 1997, relating to
marketing clearance of TOBI by the FDA.

(c)  Exhibits

     The exhibits to this report are listed in the Exhibit Index which appears
after the signature page of this report and is hereby incorporated by reference.

                                      21
<PAGE>

                           PathoGenesis Corporation

                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                             Page No.
                                                                                             --------
<S>                                                                                         <C>
Independent Auditors' Report..............................................................      F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996..............................      F-3
Consolidated Statements of Operations for the years ended
   December 31, 1997, 1996 and 1995, and the period from
   December 10, 1991 (inception) through December 31, 1997................................      F-4
Consolidated Statements of Stockholders' Equity for the years ended
   December 31, 1997, 1996 and 1995, and the period from
   December 10, 1991 (inception) through December 31, 1997................................      F-5
Consolidated Statements of Cash Flows for the years ended
   December 31, 1997, 1996 and 1995, and the period from
   December 10, 1991 (inception) through December 31, 1997................................      F-7
Notes to Consolidated Financial Statements................................................      F-8
</TABLE>

    All financial statement schedules have been omitted, since the information
is not required or because the required information is included in the
consolidated financial statements or the notes thereto.

                                      F-1
<PAGE>

                         Independent Auditors' Report

The Board of Directors and Stockholders
PathoGenesis Corporation:

     We have audited the accompanying consolidated balance sheets of
PathoGenesis Corporation (a development stage enterprise) and subsidiary as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1997 and for the period from December 10,
1991 (inception) through December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

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

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PathoGenesis
Corporation and subsidiary as of December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997 and for the period from December 10, 1991
(inception) through December 31, 1997, in conformity with generally accepted
accounting principles.


                                        KPMG PEAT MARWICK LLP

Seattle, Washington
January 23, 1998



                                      F-2
<PAGE>


                           PATHOGENESIS CORPORATION
                       (A Development Stage Enterprise)
                                AND SUBSIDIARY
                          Consolidated Balance Sheets

<TABLE>
<CAPTION>                                                                                December 31,
                                                                                ------------------------------
                         Assets                                                    1997              1996
                                                                                   ----              ----
<S>                                                                            <C>               <C>
Current assets:
  Cash and cash equivalents                                                    $   5,171,591      $ 14,785,818
  Investment securities                                                           73,869,541        45,901,978
  Interest receivable                                                                656,396           298,437
  Inventories                                                                      4,935,758                --
  Other current assets                                                             2,556,409           823,092
                                                                               -------------      ------------
      Total current assets                                                        87,189,695        61,809,325
                                                                               -------------      ------------
Restricted investment                                                                675,000           675,000

Property and equipment, at cost:
  Leasehold improvements                                                           7,941,149         6,766,935
  Furniture and equipment                                                          8,805,566         5,967,110
                                                                               -------------      -------------
                                                                                  16,746,715        12,734,045
  Less accumulated depreciation and amortization                                   7,138,050         5,320,039
                                                                               -------------      -------------
      Net property and equipment                                                   9,608,665         7,414,006
                                                                               -------------      -------------
Other assets                                                                         122,189           100,370
                                                                               -------------      -------------
                                                                               $  97,595,549      $ 69,998,701
                                                                               ==============     =============

                Liabilities and Stockholders' Equity

Current liabilities:
  Accounts payable                                                             $   1,168,865      $    812,259
  Compensation and benefits                                                        1,461,167           774,258
  Clinical development costs                                                       2,885,107           818,629
  Other accrued expenses                                                           2,591,660           569,068
                                                                               -------------      ------------
      Total current liabilities                                                    8,106,799         2,974,214
                                                                               -------------      ------------

Long-term liability                                                                       --            98,273

Commitments

Stockholders' equity:
  Preferred stock, $0.01 par value.  Authorized 1,000,000 shares;
   none issued and outstanding                                                            --                --
  Common stock, $0.001 par value.  Authorized 60,000,000 shares in 1997 and
   20,000,000 shares in 1996; 16,238,649 shares and 13,930,760 shares issued
   and outstanding at December 31, 1997 and 1996, respectively                        16,239            13,931
  Additional paid-in capital                                                     191,613,454       134,727,920
  Deferred compensation                                                           (1,295,145)               --
  Unrealized loss on investment securities                                           (22,635)          (30,204)
  Deficit accumulated during the development stage                              (100,823,163)      (67,785,433)
                                                                               -------------      ------------
      Total stockholders' equity                                                  89,488,750        66,926,214
                                                                               -------------      ------------
                                                                               $  97,595,549      $ 69,998,701
                                                                               =============      =============

</TABLE>

See accompanying notes to consolidated financial statements.

                                      F-3

<PAGE>

                           PATHOGENESIS CORPORATION
                       (A Development Stage Enterprise)

                                AND SUBSIDIARY

                     Consolidated Statements of Operations

<TABLE>
<CAPTION>                                                                                              December 10,
                                                                                                           1991
                                                                                                       (inception)
                                                            Years ended December 31,                     through
                                                -------------------------------------------------      December 31,
                                                    1997              1996              1995               1997
                                                ------------      ------------      -------------      -------------
<S>                                             <C>               <C>               <C>                  <C>
Revenue - grants and royalties                  $    441,880      $    439,880      $         --       $     881,760
                                                ------------      ------------      ------------       -------------
Operating expenses:
  Research and development                        28,017,738        20,673,049        15,668,417          86,119,276
  General and administrative                      10,582,072         4,241,339         3,609,075          27,959,597
                                                ------------      ------------      ------------       -------------
        Total operating expenses                  38,599,810        24,914,388        19,277,492         114,078,873
                                                ------------      ------------      ------------       -------------
        Operating loss                           (38,157,930)      (24,474,508)      (19,277,492)       (113,197,113)
                                                ------------      ------------      ------------       -------------
Other income (expense):
  Investment income, net                           5,278,098         3,293,782         1,287,457          12,753,145
  Other expense                                     (157,898)          (83,504)          (33,888)           (379,195)
                                                ------------      ------------      ------------       -------------
        Net other income                           5,120,200         3,210,278         1,253,569          12,373,950
                                                ------------      ------------      ------------       -------------
        Net loss                                $(33,037,730)     $(21,264,230)     $(18,023,923)      $(100,823,163)
                                                ============      ============      ============       =============
Net loss per common share - basic and diluted   $      (2.10)     $      (1.66)     $      (2.20)
                                                ============      ============      ============
Weighted average common shares outstanding -
 basic and diluted                                15,704,151        12,829,386         8,209,643
                                                ============      ============      ============
</TABLE>


See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
                           PATHOGENESIS CORPORATION
                       (A Development Stage Enterprise)
                                AND SUBSIDIARY
                Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
                                                                                            Number of
                                                                                             common           Price
                                                                                             shares            per
Date                      Description                                                      outstanding        share
                                                                                           -----------     ------------
<S>                       <C>                                                             <C>              <C>
February to March 1992    Shares issued for cash                                            1,870,000      $    0.08
June to December 1992     Shares issued for cash, net of issue costs of $744,966            4,308,500          10.00
November 1992             Repurchase of common stock through forgiveness of
                              note receivable                                                 (25,000)         10.00
November 1992             Repurchase of common stock for cash                                 (46,875)          0.08
                          Net loss for the period ended December 31, 1992                          --           0.00
                                                                                           ----------      ------------
                          Balances at December 31, 1992                                     6,106,625

October 1993              Shares issued in payment of license fees                             50,000          10.00
                          Net loss for the year ended December 31, 1993                            --           0.00
                                                                                           ----------      ------------
                          Balances at December 31, 1993                                     6,156,625

March 1994                Shares issued for cash, net of issue costs of $1,251,739          1,690,677          12.00
                          Unrealized loss on investment securities                                 --           0.00
                          Net loss for the year ended December 31, 1994                            --           0.00
                                                                                           ----------      ------------
                          Balances at December 31, 1994                                     7,847,302

March 1995                Shares issued in payment of license fees                             50,000          12.00
April to August 1995      Exercise of stock options for cash                                      413          10.00
November 22, 1995         Shares issued for cash, net of issue costs of $2,904,274          3,000,000          10.00
                          Unrealized gain on investment securities                                 --           0.00
                          Net loss for the year ended December 31, 1995                            --           0.00
                                                                                           ----------      ------------
                          Balances at December 31, 1995                                    10,897,715

                          Redemption of fractional shares for cash                                (48)         12.00
February 1996             Shares issued in payment of license fees                              6,250          10.00
February 1996             Repurchase of common stock for cash                                 (45,000)          0.08
May 1996                  Shares issued for cash, net of issue costs of $3,213,410          2,875,000          16.25
                          Exercise of options and warrants for cash and
                              cancellation of warrants                                        196,843       10.00-14.40
                          Unrealized loss on investment securities                                 --           0.00
                          Net loss for the year ended December 31, 1996                            --           0.00
                                                                                           ----------      ------------
                          Balances at December 31, 1996                                    13,930,760

March 1997                Shares issued for cash, net of issue costs of $3,546,639          2,100,000          27.00
                          Exercise of options and warrants for cash and                       207,889       10.00-25.87
                              cancellation of warrants
                          Deferred compensation from granting of stock options                     --                --
                          Compensation expense from stock options                                  --                --
                          Unrealized gain on investment securities                                 --                --
                          Net loss for the year ended December 31, 1997                            --                --
                                                                                           ----------      ------------
                          Balances at December 31, 1997                                    16,238,649      $
                                                                                           ==========      ============
</TABLE>
See accompanying notes to consolidated financial statements.

                                    F-5
<PAGE>

<TABLE>
<CAPTION>
                                                                         Unrealized          Deficit
                                                                         gain (loss)        accumulated
                          Additional                                          on             during the               Total
     Common                paid-in                  Deferred              investment        development           stockholders'
      stock                capital                compensation            securities           stage                  equity
--------------        ------------------        --------------------------------------   ------------------     ------------------
<S>                  <C>                       <C>                    <C>               <C>                    <C>
 $     1,870          $       147,730           $             -        $            -    $             -        $        149,600
       4,309               42,335,725                         -                     -                  -              42,340,034

         (25)                (249,975)                        -                     -                  -                (250,000)
         (47)                  (3,703)                        -                     -                  -                  (3,750)
           -                        -                         -                     -         (2,930,285)             (2,930,285)
--------------        ------------------        -----------------      ----------------  ------------------     ------------------
       6,107               42,229,777                         -                     -         (2,930,285)             39,305,599

          50                  499,950                         -                     -                  -                 500,000
           -                        -                         -                     -        (10,804,878)            (10,804,878)
--------------        ------------------        -----------------      ----------------  ------------------     ------------------
       6,157               42,729,727                         -                     -        (13,735,163)             29,000,721

       1,690               19,093,694                         -                     -                  -              19,095,384
           -                        -                         -              (172,809)                 -                (172,809)
           -                        -                         -                     -        (14,762,117)            (14,762,117)
--------------       ------------------         -----------------      ----------------   -----------------     ------------------
       7,847               61,823,421                         -              (172,809)       (28,497,280)             33,161,179

          50                  599,950                         -                     -                  -                 600,000
           1                    4,124                         -                     -                  -                   4,125
       3,000               27,092,726                         -                     -                  -              27,095,726
           -                        -                         -               211,267                  -                 211,267
           -                        -                         -                     -        (18,023,923)            (18,023,923)
--------------       ------------------         ------------------     ----------------   -----------------     ------------------
      10,898               89,520,221                         -                38,458        (46,521,203)             43,048,374

           -                     (576)                        -                     -                  -                    (576)
           6                   62,494                         -                     -                  -                  62,500
         (45)                  (3,555)                        -                     -                  -                  (3,600)
       2,875               43,502,465                         -                     -                  -              43,505,340

         197                1,646,871                         -                     -                  -               1,647,068
           -                        -                         -               (68,662)                 -                 (68,662)
           -                        -                         -                     -        (21,264,230)            (21,264,230)
--------------       ------------------         ------------------     ----------------   -----------------     ------------------
      13,931              134,727,920                         -               (30,204)       (67,785,433)             66,926,214

       2,100               53,151,262                         -                     -                  -              53,153,362
         208                2,140,248                         -                     -                  -               2,140,456

           -                1,594,024                (1,594,024)                    -                  -                       -
           -                        -                   298,879                     -                  -                 298,879
           -                        -                         -                 7,569                  -                   7,569
           -                        -                         -                     -        (33,037,730)            (33,037,730)
--------------       -------------------        ------------------      ----------------  -----------------     ------------------
$     16,239         $    191,613,454           $    (1,295,145)        $     (22,635)    $ (100,823,163)       $     89,488,750
==============       ===================        ==================      ================  =================     ==================
</TABLE>


                                      F-6

<PAGE>

                           PATHOGENESIS CORPORATION
                       (A Development Stage Enterprise)

                                AND SUBSIDIARY

                     Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                                                    December 10,
                                                                                                                       1991
                                                                                                                    (inception)
                                                                          Years ended December 31,                    through
                                                         -----------------------------------------------------      December 31,
                                                              1997               1996              1995                1997
                                                         ---------------    ---------------    ---------------    ---------------
<S>                                                      <C>                <C>                <C>                <C>
Cash flows from operating activities:
  Net loss                                               $   (33,037,730)   $   (21,264,230)   $  (18,023,923)    $  (100,823,163)
  Adjustments to reconcile net loss to net cash used
   in operating activities:
     Depreciation and amortization                             2,076,900          1,618,982         1,557,195           7,512,463
     Amortization of investment premiums (discounts)              33,082            (33,083)          110,855             372,349
     Compensation expense from stock options                     298,879                 --                --             298,879
     Common stock issued in payment of license fees                   --             62,500           600,000           1,159,000
     Loss on sale of property and equipment                       42,643                315            62,859             105,817
     Changes in certain assets and liabilities:
      Interest receivable                                       (357,959)           466,779          (485,430)           (656,396)
      Inventories                                             (4,935,758)                --                --          (4,935,758)
      Other current assets                                    (1,733,317)          (151,381)         (251,102)         (2,556,409)
      Other assets                                               (21,819)           (92,612)           40,926            (122,189)
      Accounts payable                                           356,606           (823,452)        1,209,078           1,168,865
      Compensation and benefits                                  686,909            (85,204)          160,682           1,461,167
      Clinical development costs                               2,066,478            (57,503)         (737,618)          2,885,107
      Other accrued expenses                                   2,022,592            487,595           (44,519)          2,591,660
      Long-term liability                                        (98,273)          (363,713)          461,986                  --
                                                         ---------------    ---------------    --------------     ---------------
          Net cash used in operating activities              (32,600,767)       (20,235,007)      (15,339,011)        (91,538,608)
                                                         ---------------    ---------------    --------------     ---------------
Cash flows from investing activities:
  Purchases of investment securities                        (177,646,664)      (116,498,821)      (72,862,897)       (428,651,136)
  Sales of investment securities                             149,653,588        106,757,801        59,211,912         353,711,611
  Purchases of property and equipment                         (4,370,202)          (961,784)         (448,350)        (17,323,045)
  Proceeds from sale of property and equipment                    56,000                100            40,000              96,100
  Issuance of note receivable                                         --                 --                --            (250,000)
                                                         ---------------    ---------------    --------------     ---------------
          Net cash used in investing activities              (32,307,278)       (10,702,704)      (14,059,335)        (92,416,470)
                                                         ---------------    ---------------    --------------     ---------------
Cash flows from financing activities:
  Net proceeds from issuance of common stock                  53,153,362         43,505,340        27,095,726         185,339,196
  Repurchase of common stock                                           -             (4,176)                -              (4,176)
  Stock option and warrant exercises                           2,140,456          1,647,068             4,125           3,791,649
                                                         ---------------    ---------------    --------------     ---------------
          Net cash provided by financing activities           55,293,818         45,148,232        27,099,851         189,126,669
                                                         ---------------    ---------------    --------------     ---------------
          Net increase (decrease) in cash and
            cash equivalents                                  (9,614,227)        14,210,521        (2,298,495)          5,171,591
Cash and cash equivalents at beginning of period              14,785,818            575,297         2,873,792                  --
                                                         ---------------    ---------------    --------------     ---------------
Cash and cash equivalents at end of period               $     5,171,591    $    14,785,818    $      575,297     $     5,171,591
                                                         ===============    ===============    ==============     ===============
Supplemental schedule of noncash investing and
  financing activities - repurchase of common stock
  through forgiveness of note receivable                 $            --    $            --    $           --     $       250,000
                                                         ===============    ===============    ==============     ===============
</TABLE>

See accompanying notes to consolidated financial statements.

                                      F-7


<PAGE>

                           PATHOGENESIS CORPORATION
                       (A Development Stage Enterprise)
                                AND SUBSIDIARY
    Notes to Consolidated Financial Statements, December 31, 1997 and 1996

(1) Organization and Summary of Significant Accounting Policies

    Nature of Development Stage Activities

    Through 1997, PathoGenesis was a development stage healthcare company. The
    Company develops drugs to treat serious infectious diseases where there is a
    significant need for improved therapy. The Company was incorporated on
    December 10, 1991. Principal activities to date include conducting human
    clinical trials, defining and conducting research programs, entering into
    collaborative licensing agreements, raising capital, recruiting scientific
    and management personnel, and construction of a research facility. In
    December 1997, the Company received marketing clearance from the FDA for
    TOBI, the Company's first drug. Sales of TOBI commenced in January 1998.

    Basis of Presentation

    The accompanying consolidated financial statements include the accounts of
    the Company and its wholly owned European subsidiary, PathoGenesis Limited.
    All significant intercompany accounts and transactions have been eliminated
    in consolidation.

    Cash Equivalents

    All investments in debt instruments with a maturity of three months or less
    at the date of purchase are considered to be cash equivalents.

    Investment Securities

    The Company's investment securities are classified as available-for-sale and
    carried at market value, with unrealized gains and losses excluded from the
    consolidated statement of operations and reported as a separate component of
    stockholders' equity. Realized gains and losses on the sales of investment
    securities are determined on the specific identification method and included
    in investment income, net.

    Inventories

    Inventories are stated at the lower of cost, as determined by the first-in,
    first-out method, or market.

    Depreciation and Amortization

    Furniture and equipment are depreciated using the straight-line method over
    the assets' estimated useful lives of five to 10 years. Leasehold
    improvements are amortized using the straight-line method over the shorter
    of the assets' estimated useful lives or the remaining term of the lease.

    Research and Development Costs

    Research and development costs are charged to expense as incurred.

                                      F-8
<PAGE>

   Income Taxes

   Deferred income taxes are provided based on the estimated future tax effects
   of temporary differences between financial statement carrying amounts of
   existing assets and liabilities and their respective tax bases.

   Deferred tax assets and liabilities are measured using enacted tax rates that
   are expected to apply to taxable income in the years in which those temporary
   differences are expected to be recovered or settled.  The effect on deferred
   tax assets and liabilities of a change in tax rates is recognized in income
   in the period that includes the enactment date.  A valuation allowance is
   established when necessary to reduce deferred tax assets to the amount
   expected to be realized.

   Fair Value of Financial Instruments

   The Company has financial instruments other than investments consisting of
   cash, interest receivable and accounts payable.  The fair value of these
   financial instruments approximates their carrying amount due to their short-
   term nature.

   Stock-Based Compensation

   The Company accounts for its stock option plans for employees in accordance
   with the provisions of Accounting Principles Board (APB) Opinion No. 25,
   Accounting for Stock Issued to Employees, and related interpretations.  As
   such, compensation expense related to employee stock options is recorded only
   if, on the date of grant, the fair value of the underlying stock exceeds the
   exercise price.  The Company applies the disclosure-only requirements of
   Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
   Stock-Based Compensation, which allows entities to continue to apply the
   provisions of APB Opinion No. 25 for transactions with employees, and to
   provide pro forma results of operations disclosures for employee stock option
   grants made in 1995 and subsequent years as if the fair-value-based method of
   accounting in SFAS No. 123 had been applied to these transactions.

   Net Loss Per Share

   The Company has adopted the provisions of SFAS No. 128, Earnings Per Share,
   in 1997 and, accordingly, has reported both basic and diluted net loss per
   common share for each period presented.  Basic loss per share is computed on
   the basis of the weighted average number of shares outstanding for the year.
   Diluted loss per share is computed on the basis of the weighted average
   number of common shares plus dilutive potential common shares outstanding
   using the treasury stock method.  Potential dilutive common shares consist of
   unexercised employee stock options and warrants outstanding.  Stock options
   and warrants outstanding were not included in the computation of diluted loss
   per share, because the representative share increments would be antidilutive.
   There was no change in previously reported loss per share when calculated in
   accordance with the provisions of SFAS No. 128.

   Use of Estimates

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

                                      F-9
<PAGE>

 2)  Investment Securities

     The following summarizes the Company's investment securities at December
     31:

<TABLE>
<CAPTION>
                                                                     Gross               Gross
                                             Amortized cost       unrealized           unrealized          Market
                                                                     gains               losses            value
                                            ----------------   -----------------   -----------------    ------------
<S>                                       <C>               <C>                 <C>                  <C>
  1997:
      U.S. Treasury notes                  $      6,165,367  $            5,856  $               --   $   6,171,223
      Federal mortgage notes                      7,255,781              19,958              (4,707)      7,271,032
      Municipal bonds                             1,199,960                 400                  --       1,200,360
      Corporate obligations                      59,271,068              76,132            (120,274)     59,226,926
                                           ----------------   -----------------   -----------------    ------------
                                           $     73,892,176  $          102,346  $         (124,981)  $  73,869,541
                                           ================   =================   =================    ============

  1996:
      U.S. Treasury notes                  $     10,641,041  $            3,823  $          (11,272)  $  10,633,592
      Federal mortgage notes                      6,719,925               7,430              (4,276)      6,723,079
      Corporate obligations                      28,571,216              48,441             (74,350)     28,545,307
                                           ----------------   -----------------   -----------------    ------------
                                           $     45,932,182  $           59,694  $          (89,898)  $  45,901,978
                                           ================   =================   =================    ============
</TABLE>


    Amortized cost and market value of investment securities at December 31,
    1997, by contractual maturity are shown below. Actual maturities may differ
    from contractual maturities because borrowers may have the right to call or
    prepay obligations with or without call or prepayment penalties.

<TABLE>
<CAPTION>
                                                                         Amortized                Market
                         Maturities                                        cost                    value
                                                                   -------------------     -------------------

<S>                                                               <C>                     <C>
          Due in 1 year or less                                    $        12,906,819     $        12,814,289
          Due between 1 year to 5 years                                     34,003,855              34,031,720
          Due between 5 years to 10 years                                   23,160,542              23,197,325
          Due after 10 years                                                 3,820,960               3,826,207
                                                                   -------------------     -------------------
                                                                   $        73,892,176     $        73,869,541
                                                                   ===================     ===================
</TABLE>


    Investment income, net includes interest of $5,216,693, $3,412,097 and
    $1,308,126 earned on investments and gains (losses) of $61,405, $(118,315)
    and $(20,669) realized upon the sale of investments for 1997, 1996 and 1995,
    respectively.

    The Company does not invest in derivative financial instruments, as defined
    by SFAS 119, Disclosure about Derivative Financial Instruments and Fair
    Value of Financial Instruments.

(3) Inventories

    Inventories consist of the following at December 31, 1997:

<TABLE>
<S>                                                              <C>
               Finished goods                                     $        2,096,300
               Work in progress                                              733,068
               Raw materials and supplies                                  2,106,390
                                                                  ------------------

                                                                  $        4,935,758
                                                                  ==================
</TABLE>

                                      F-10
<PAGE>

(4)  Long-Term Liability

     In the second quarter of 1995, the Board of Directors reached an agreement
     with the Company's former chairman of the board which obligated the Company
     to pay $944,958 over three years. The Company recorded a charge against
     operations in 1995 and recorded such amount in general and administrative
     expenses. The remaining balance on this obligation of $98,273 is included
     under compensation and benefits at December 31, 1997.

(5)  Stockholders' Equity

     Common and Preferred Stock

     Effective October 17, 1995, the Company's stockholders approved a one-for-
     eight reverse split of the Company's issued and outstanding common stock, a
     change to the authorized number of shares of the Company's $0.001 par value
     common stock to 20,000,000 shares, and an authorization of 1,000,000 shares
     of preferred stock, par value $0.01. The accompanying consolidated
     financial statements reflect the reverse split for all periods presented.
     Effective June 25, 1997, the Company's stockholders approved a change to
     the authorized number of shares of the Company's $0.001 par value common
     stock to 60,000,000 shares.

     Stock Option Plans

     The Company's 1992 Stock Option Plan (Stock Plan) has 1,500,000 shares of
     common stock which have been authorized to be reserved for grants. At
     December 31, 1997, 9,220 shares remain available for future awards. Options
     granted under this plan may be designated as qualified or nonqualified at
     the discretion of the compensation committee of the Board of Directors.

     In 1997, the Company adopted the 1997 Stock Option Plan, under which
     2,000,000 shares of common stock are reserved for grants. At December 31,
     1997, 1,360,155 shares remain available for future awards. Options granted
     under this plan may be designated as qualified or nonqualified at the
     discretion of the compensation committee of the Board of Directors. A
     number of options were granted under the 1997 plan prior to the plan
     receiving stockholder approval. This resulted in deferred compensation of
     approximately $1,594,000, based on the excess of the fair market value of
     the stock at the time of plan approval (measurement date) over the exercise
     price, which was based on the fair value of the stock at the time of option
     grant. Deferred compensation is being amortized on the straight-line method
     over the four-year vesting period of the options.

     In 1996, the Company adopted the 1996 Directors Stock Option Plan
     (Directors Plan) for nonemployee directors, under which 300,000 shares of
     common stock were reserved for grants. Upon adoption of the 1997 Stock
     Option Plan, the Directors Plan was terminated with no further grants to be
     made.

     Generally, options vest over a four-year period in installments of 25% each
     year beginning one year from the date of grant; however, certain options
     can vest upon granting. Vested options may be exercised at any time before
     their expiration date. All options expire not later than 10 years from the
     date of grant. Qualified stock options are exercisable at not less than the
     fair market value of the stock at the date of grant and nonqualified stock
     options are exercisable at prices determined at the discretion of the Board
     of Directors, but not less than 85% of the fair market value of the stock
     at the date of grant.

                                     F-11
<PAGE>

A summary of stock options follows:
<TABLE>
<CAPTION>
                                                                                                                      Weighted
                                                                                                                      average
                                                         1992               Directors              1997               exercise
                                                      Stock Plan              Plan              Stock Plan             price
                                                      ----------            ---------           ----------            --------
<S>                                                   <C>                   <C>                 <C>                   <C>
     Balances at December 31, 1994                      797,062                   -                    -               $10.33
     Granted                                            303,125                   -                    -                12.00
     Canceled                                           (74,121)                  -                    -                10.00
     Exercised                                             (413)                  -                    -                10.28
                                                      ---------              ------              -------               ------

     Balances at December 31, 1995                    1,025,653                   -                    -                10.83
     Granted                                            438,850              42,000                    -                16.18
     Canceled                                           (69,941)                  -                    -                11.17
     Exercised                                         (169,787)                  -                    -                10.11
                                                      ---------              ------              -------               ------

     Balances at December 31, 1996                    1,224,775              42,000                    -                12.73
     Granted                                            134,205                   -              658,995                26.04
     Canceled                                           (33,108)                  -              (19,150)               18.52
     Exercised                                         (169,543)             (8,000)                   -                12.10
                                                      ---------              ------              -------               ------

     Balances at December 31, 1997                    1,156,329              34,000              639,845               $18.51
                                                      =========              ======              =======               ======
</TABLE>
The weighted average fair value of options granted was $14.06, $8.87, and $4.97
in 1997, 1996 and 1995, respectively.

Had compensation cost for the Company's stock option plans been determined
consistent with FASB Statement No. 123, the Company's net loss and loss per
share would have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
                                                                 1997             1996             1995
                                                              -----------      -----------      -----------
<S>                                                           <C>              <C>              <C>
     Net loss - as reported                                   $33,037,730      $21,264,230      $18,023,923
     Net loss - pro forma                                      38,075,062       23,930,975       19,131,780
     Loss per share - basic and diluted, as
      reported                                                    2.10             1.66             2.20
     Loss per share - basic and diluted,
      pro forma                                                   2.42             1.87             2.33
</TABLE>
The fair value of each option grant is estimated on the date of grant using the
Black-Sholes option-pricing model with the following assumptions used for
grants in 1995, 1996 and 1997: dividend yield of 0.0% for all years; expected
volatility of 46% for 1995, 57% to 67% for 1996 and 58% to 64% for 1997; risk-
free interest rate of 5.46% to 7.15% for 1995, 5.18% to 6.85% for 1996 and 5.72%
to 6.44% for 1997; expected lives from three to six years for all years.

                                     F-12
<PAGE>

     The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
                                         Weighted
                                         average       Weighted                       Weighted
      Range of            Number        remaining      average          Number        average
      exercise         outstanding     contractual     exercise      exercisable      exercise
       prices          at 12/31/97        life          price        at 12/31/97       price
-----------------      -----------     -----------     --------      -----------      --------
<S>                    <C>             <C>             <C>           <C>              <C>
$       10.00            281,200        5.3 years       $10.00          281,200        $10.00
        12.00            369,549        7.2 years        12.00          278,593         12.00
   13.75 to 14.75        131,650        8.5 years        14.52           32,913         14.52
   16.13 to 16.75        247,825        8.2 years        16.25          130,864         16.25
   22.00 to 22.25        350,900        9.0 years        22.22           61,850         22.15
   25.00 to 25.88        231,000        9.2 years        25.53           46,000         25.68
   28.13 to 28.75        120,450        9.5 years        28.37               --            --
   35.00 to 36.81         58,400        9.8 years        35.72               --            --
        38.00             39,200        9.9 years        38.00           10,000         38.00
                       ---------                                        -------
$  10.00 to 38.00      1,830,174        8.0 years       $18.51          841,420        $13.89
                       =========                                        =======
</TABLE>
   Common Stock Warrants

   As of December 31, 1997, the Company had outstanding warrants, with
   expiration terms ranging from April 22, 2000 to February 6, 2001, to purchase
   58,223 shares of common stock which are fully exercisable at the following
   per share prices:
<TABLE>
<CAPTION>
                                         Per share
                         Shares            price
                         ---------------------------
<S>                      <C>            <C>
                          3,375         $      12.00
                         54,848                14.40
                         ---------------------------
                         58,223         $12.00-14.40
                         ===========================
</TABLE>
     Shareholder Rights Plan

     The Board of Directors adopted a Shareholder Rights Plan in 1997 and
     declared a dividend of one right for each outstanding share of common
     stock. Such rights only become exercisable after a person or group, whose
     action has not received prior approval from the Board of Directors,
     acquires beneficial ownership of, or commences a tender or exchange offer
     for, 15% or more of the Company's common stock. Each right then may be
     exercised to acquire one one-thousandth of a share of preferred stock,
     designated as Series A Junior Preferred Stock, at an exercise price of
     $250, subject to adjustment. The rights may be redeemed by the Company at
     $0.01 per right at any time until the 10th day following the public
     announcement that a 15% position has been acquired. The rights expire on
     June 26, 2007.

(6)  Income Taxes

     Federal income taxes reported by the Company differ from the amount
     computed by applying the U.S. Federal income tax rate of 34% to pretax
     losses due to limitations on utilizing net operating losses.

                                      F-13
<PAGE>

     The tax effects of temporary differences and carryforwards that give rise
     to deferred tax assets at December 31 are as follows:
<TABLE>
<CAPTION>
                                                                                         1997            1996
                                                                                     ------------    ------------
<S>                                                                                  <C>             <C>
        Deferred tax assets:
            Start-up costs                                                           $         --    $      5,817
            Orphan drug credit carryforwards                                            5,010,532       2,266,232
            Deferred compensation                                                          14,858         116,080
            License agreements                                                            411,894         446,068
            Research and experimentation credit carryforwards                             970,285         747,456
            Net operating loss carryforwards                                           32,293,864      21,425,678
            Depreciation                                                                  488,064         310,432
            Other                                                                         376,211         212,701
                                                                                     ------------    ------------
                           Total gross deferred tax assets                             39,565,708      25,530,464
            Less valuation allowance                                                   39,565,708      25,530,464
                                                                                     ------------    ------------
                           Net deferred tax assets                                     $       --    $         --
                                                                                    =============    ============
</TABLE>
     The increases in the valuation allowance for deferred tax assets of
     $14,035,244, $7,453,622 and $6,388,860 in 1997, 1996 and 1995,
     respectively, are primarily attributable to increases in net operating loss
     and tax credit carryforwards whose utilization cannot reasonably be
     assured.

     At December 31, 1997, the Company has net operating loss carryforwards of
     approximately $94,980,000, research and experimentation credit
     carryforwards of approximately $970,000 and orphan drug credit
     carryforwards of approximately $5,010,000, which are available to offset
     future Federal taxable income and income taxes, respectively, if any, and
     expire beginning in 2007.

(7)  Commitments

     Leases

     The Company leases various office and research facilities under
     noncancelable operating leases which expire between 1998 and 2003. With
     respect to one of the leases, the Company is required to maintain
     collateral on a letter of credit in the amount of a $675,000 certificate of
     deposit which is recorded as a restricted investment.

     Minimum lease payments under noncancelable operating leases and related
     sublease income as of December 31, 1997 are as follows:
<TABLE>
<CAPTION>
                                                                          Lease           Sublease
                                                                         payments          income
                                                                        ----------         --------
<S>                                                                     <C>                <C>
                                1998                                    $2,090,000         $333,000
                                1999                                     2,125,000          333,000
                                2000                                     2,129,000          333,000
                                2001                                     2,094,000               --
                                2002                                     1,136,000               --
                                Thereafter                                 225,000               --
                                                                        ----------         --------
                                                                        $9,799,000         $999,000
                                                                        ==========         ========
</TABLE>
                                     F-14
<PAGE>

     Rent expense for operating leases was approximately $2,002,000, $1,026,000
     and $746,000 for 1997, 1996 and 1995, respectively, and $5,300,000 for the
     period December 10, 1991 (inception) through December 31, 1997.

     Included in rent expense are payments to a partnership in which a member of
     the Board of Directors and the Secretary are partners of approximately
     $37,500, $36,200 and $35,500 for 1997, 1996 and 1995, respectively.

     Employment and Consulting Agreements

     The Company has employment and consulting agreements with certain key
     executives, research scientists and advisors. The terms of these agreements
     range from two to five years, provide for discretionary bonuses, as
     determined by the Company's Board of Directors, and provide for annual
     increases in compensation to be determined at the discretion of the Board
     of Directors.

     Approximate minimum compensation payments due pursuant to these employment
     and consulting agreements are as follows:
<TABLE>
<CAPTION>
<C>                   <S>                       <C>
                      1998                      $517,000
                      1999                       294,000
                      2000                       151,000
                                                --------
                                                $962,000
                                                ========
</TABLE>

(8)  Collaboration Agreements

     In 1997, the Company entered into a two-year research agreement with the
     Cystic Fibrosis Foundation and the University of Washington to sequence the
     Pseudomonas aeruginosa genome to assist in the drug discovery process.
     Under this agreement, the Company is required to pay $1.0 million over the
     two-year period. As of December 31, 1997, the Company has made payments
     totaling $412,421.

     In May 1996, the Company entered into a distribution agreement with Bohdan
     Automation, Inc. (Bohdan), pursuant to which Bohdan has agreed to
     manufacture and sell a proprietary combinatorial chemistry system invented
     by the Company and Bohdan scientists. Royalties of $206,000 and $238,000
     were earned from this arrangement during 1997 and 1996, respectively.

     In 1994, the Company entered into a license agreement with the Cystic
     Fibrosis Foundation and Children's Hospital and Medical Center in Seattle
     to obtain worldwide rights to TOBI. A $1.5 million milestone payment is
     payable by the Company pursuant to the product receiving approval for
     marketing by the FDA, and is included in accrued clinical development costs
     at December 31, 1997. The Company is responsible for sales, marketing,
     manufacturing and regulatory affairs related to the product. The Company
     will pay a royalty on net product sales.

     In 1993, the Company entered into a license agreement with Kaneka
     Corporation (Kaneka) to obtain North American rights to PA-1648, a product
     then in preclinical trials. The initial payment for these rights was
     $500,000 cash and 50,000 shares of common stock. A second milestone payment
     of 50,000 shares of common stock was paid in 1995 when the Investigational
     New Drug application was filed. Subsequent payments will be made upon
     accomplishment of certain milestones. The Company is responsible for
     clinical trials, sales, marketing and regulatory affairs related to PA-
     1648. Kaneka is responsible for manufacturing the bulk form of the product.
     The Company will pay a royalty on net product sales.

                                     F-15
<PAGE>

     In 1993, the Company entered into a collaborative research agreement with
     Public Health Research Institute (PHRI). The agreement calls for payments
     to the research institution of up to $1.5 million over three years, not to
     exceed $500,000 in any one year. In addition, the Company was committed to
     spend $1.0 million per year in research and development to support this
     collaborative research. As of December 31, 1997, the Company has fulfilled
     its obligation under this commitment to PHRI.

     In 1993, the Company entered into a license and manufacturing agreement
     with a then significant shareholder to obtain worldwide rights to a product
     in clinical trials. Under the agreement, the Company was to make certain
     fixed payments to the licensor upon accomplishment of certain milestones.
     Initial payment for these rights was $550,000 and the Company was
     responsible for clinical trials, sales, marketing and regulatory affairs
     related to the product. In 1994, the Company decided to cease development
     of this product and has fulfilled its obligation under this agreement.

     Also in 1993, the Company entered into a development agreement with a then
     significant shareholder pursuant to which the Company was assisted with its
     research and development activities relating to a product currently in
     clinical trials. The Company paid research and development fees of $923,100
     related to this agreement. The Company entered into an additional
     development agreement dated August 15, 1994 with this shareholder, pursuant
     to which the Company continues to receive assistance in developing this
     product. The Company has made payments under this agreement of
     approximately $289,000, $1,055,000 and $210,000 in 1997, 1996 and 1995,
     respectively.

                                     F-16
<PAGE>

                                  SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Seattle, State of Washington, on March 30, 1998.

                                 PATHOGENESIS CORPORATION

                                 By:  /s/ Wilbur H. Gantz
                                      -------------------
                                          Wilbur H. Gantz
                                          Chairman

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

<TABLE>
<CAPTION>


         Signature                              Title
         ---------                              -----
<S>                                 <C>                                  <C>

    /s/ Wilbur H. Gantz              Chairman, Chief Executive             )
-------------------------------       Officer, President and               )
        Wilbur H. Gantz               Director                             )
                                      (Principal Executive Officer)        )
                                                                           )
    /s/ Alan R. Meyer                Executive Vice President,             )
-------------------------------       Chief Financial Officer and          )
        Alan R. Meyer                 Director (Principal Financial        )
                                      and Accounting Officer)              )
                                                                           )
    /s/ John L. Gordon               Director                              )
-------------------------------                                            )
        John L. Gordon                                                     )
                                                                           )
                                                                           )
    /s/ Elizabeth M. Greetham        Director                              )
-------------------------------                                            )
        Elizabeth M. Greetham                                              )  March 30, 1998
                                                                           )
                                                                           )
    /s/ Michael J. Montgomery        Director                              )
-------------------------------                                            )
        Michael J. Montgomery                                              )
                                                                           )
                                                                           )
    /s/ Talat M. Othman              Director                              )
-------------------------------                                            )
        Talat M. Othman                                                    )
                                                                           )
                                                                           )
    /s/ Eugene L. Step               Director                              )
-------------------------------                                            )
        Eugene L. Step                                                     )
                                                                           )
                                                                           )
    /s/ Fred Wilpon                  Director                              )
-------------------------------                                            )
        Fred Wilpon                                                        )
</TABLE>
<PAGE>

                                 EXHIBIT INDEX

<TABLE>
<CAPTION>

  No.                             Description of Exhibit
  ---                             ----------------------
<S>            <C>
3.1(a)         Amended and Restated Certificate of Incorporation, as amended
               (incorporated by reference to Exhibit 3.1 to the Company's
               Registration Statement on Form S-1, Registration No. 333-22297).

3.1(b)         Certificate of Amendment of Amended and Restated Certificate of
               Incorporation (incorporated by reference to Exhibit 4.1(b) to the
               Company's Registration Statement on Form S-8, Registration No.
               333-45571).

3.1(c)         Certificate of Designations (incorporated by reference to Exhibit
               4.3 to the Company's Registration Statement on Form S-8,
               Registration No. 333-45571).

3.2            By-Laws, as amended through January 30, 1998.

4.1(a)         Form of Stock Certificate (incorporated by reference to Exhibit
               4.1 to the Company's Registration Statement on Form S-1,
               Registration No. 33-97070).

4.1(b)         Rights Agreement dated as of June 25, 1997 between the Company
               and Harris Trust and Savings Bank, as Rights Agent, including the
               form of Right Certificate as Exhibit B (incorporated by reference
               to Exhibit 1 to the Company's Current Report on Form 8-K filed on
               July 10, 1997, File No. 0-27150).

4.1(bb)        First Amendment, dated as of March 8, 1998, to Rights Agreement
               between the Company and Harris Trust and Savings Bank, as Rights
               Agent.

4.1(c)         Form of Right (included in Exhibit 4.1(b)).

4.2            PathoGenesis Corporation 1992 Stock Option Plan (incorporated by
               reference to Exhibit 4.2 to the Company's Registration Statement
               on Form S-1, Registration No. 33-97070).

4.3            1996 Non-Employee Director Plan (incorporated by reference to
               Exhibit 4.3 to the Company's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1995, File No. 0-27150).

4.4            PathoGenesis Corporation 1997 Stock Option Plan (incorporated by
               reference to Annex A to the Company's proxy statement dated April
               29, 1997, File No. 0-27150).

10.1           Employment Agreement between the Company and Wilbur H. Gantz,
               dated March 23, 1992 (incorporated by reference to Exhibit 10.2
               to the Company's Registration Statement on Form S-1, Registration
               No. 33-97070).

10.3           Form of Employment Agreement between the Company and A. Bruce
               Montgomery, dated September 19, 1995 (incorporated by reference
               to Exhibit 10.2 to the Company's Registration Statement on
               Form S-1, Registration No. 33-97070).

10.4           Employment Agreement between the Company and Marc F. Wipperman,
               effective as of July 1, 1996 (incorporated by reference to
               Exhibit 10.4 to the Company's Registration Statement on Form S-1,
               Registration No. 333-22297).

10.6           Consulting Agreement between the Company and Sidney Altman, dated
               March 10, 1992 (incorporated by reference to Exhibit 10.4 to the
               Company's Registration Statement on Form S-1, Registration No.
               333-2956).
</TABLE>

                                       1
<PAGE>

<TABLE>
<CAPTION>

  No.                               Description of Exhibit
  ---                               ----------------------
<C>            <S>
10.7           Consulting Agreement between the Company and Stephen Benkovic,
               dated March 26, 1992 (incorporated by reference to Exhibit 10.5
               to the Company's Registration Statement on Form S-1, Registration
               No. 33-97070).

10.8           Consulting Agreement between the Company and Lucy Shapiro, dated
               as of August 1, 1995 (incorporated by reference to Exhibit 10.6
               to the Company's Registration Statement on Form S-1, Registration
               No. 33-97070).

10.10          Consulting Agreement between the Company and Arnold Smith, dated
               October 1, 1996 (incorporated by reference to Exhibit 10.10 to
               the Company's Registration Statement on Form S-1, Registration
               No. 333-22297).

10.11          Licensing Agreement between the Company and Kaneka Corporation,
               dated October 25, 1993 and amendment thereto, dated March 3, 1995
               (incorporated by reference to Exhibit 10.9 to the Company's
               Registration Statement on Form S-1, Registration No. 33-97070).*

10.12          Supply Agreement between the Company and Kaneka Corporation,
               dated as of October 25, 1993 (incorporated by reference to
               Exhibit 10.10 to the Company's Registration Statement on Form
               S-1, Registration No. 33-97070).*

10.16          License Agreement between the Company and Children's Hospital and
               Medical Center, dated January 1, 1994 (incorporated by reference
               to Exhibit 10.14 to the Company's Registration Statement on Form
               S-1, Registration No. 33-97070).*

10.17          License Agreement between the Company and the Cystic Fibrosis
               Foundation, dated January 1, 1994 (incorporated by reference to
               Exhibit 10.15 to the Company's Registration Statement on Form
               S-1, Registration No. 33-97070).*

10.21(a)       Lease for laboratory in Seattle, Washington, between David A.
               Sabey and Sandra L. Sabey and the Company, dated June 8, 1992
               (the "Laboratory Lease"), as amended by the Second Amendment,
               dated November 16, 1992 (incorporated by reference to Exhibit
               10.18 to the Company's Registration Statement on Form S-1,
               Registration No. 33-97070).

10.21(b)       Third Amendment to the Laboratory Lease, dated August 1, 1996
               (incorporated by reference to Exhibit 10.21 to the Company's
               Registration Statement on Form S-1, Registration No. 333-22297).

10.23(a)       Lease for the Skokie, Illinois facility, between The Equitable
               Life Assurance Society of the United States and the Company,
               dated October 1992 (the "Skokie Lease"), as amended, dated March
               31, 1995 (incorporated by reference to Exhibit 10.20 to the
               Company's Registration Statement on Form S-1, Registration No.
               33-97070).

10.23(b)       Amendment to Skokie Lease, dated April 30, 1996 (incorporated by
               reference to Exhibit 10.23 to the Company's Registration
               Statement on Form S-1, Registration No. 333-22297).

10.24          Lease for Annandale, New Jersey Facility, between Exxon Research
               and Engineering Company and the Company, dated November 25, 1996
               (incorporated by reference to Exhibit 10.24 to the Company's
               Registration Statement on Form S-1, Registration No. 333-22297).
</TABLE>

                                       2
<PAGE>

<TABLE>
<CAPTION>

  No.                               Description of Exhibit
  ---                               ----------------------
<C>            <S>
10.25          Rights Agreement dated as of June 25, 1997 between PathoGenesis
               Corporation and Harris Trust and Savings Bank, as Rights Agent,
               including the form of Right Certificate as Exhibit B, and the
               First Amendment to Rights Agreement, dated as of March 8, 1998
               (included in Exhibits 4.1(b) and 4.1 (bb)).

10.26          1992 Stock Option Plan (included in Exhibit 4.2).

10.27          1996 Non-Employee Director Plan (included in Exhibit 4.3).

10.28          1997 Stock Option Plan (included in Exhibit 4.4).

23.1           Consent of KPMG Peat Marwick LLP.

27.1           Financial Data Schedule.

99             Important Information on Forward-Looking Statements.
</TABLE>

* Contains confidential material omitted and filed separately with the
  Securities and Exchange Commission.  Brackets denote such omissions.

                                       3