<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

                                 _________________


[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarter ended March 31, 1999

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

For the transition period from ___________ to _____________

                          Commission File No. 0-18728

                       INTERNEURON PHARMACEUTICALS, INC.
            (exact name of registrant as specified in its charter)

Delaware                                         04-3047911
(State or other jurisdiction of                  (I.R.S. Employer Identification
incorporation or organization)                   Number)

One Ledgemont Center, 99 Hayden Avenue           02421
Lexington, Massachusetts                         (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code (781) 861-8444

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

Indicate by check 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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

       Yes    X             No ___
             ---               

Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.

Class                                            Outstanding at May 13, 1999:
Common Stock $.001 par value                     41,916,047 shares
<PAGE>
 
                       INTERNEURON PHARMACEUTICALS, INC.

                              INDEX TO FORM 10-Q

<TABLE> 
<CAPTION> 
PART I. FINANCIAL INFORMATION                                                                           PAGE
<S>                                                                                                     <C> 
Item 1. Financial Statements

Consolidated Balance Sheets as of March 31, 1999
  and September 30, 1998...............................................................................   3

Consolidated Statements of Operations for the Three and Six Months
  ended March 31, 1999 and 1998........................................................................   4

Consolidated Statements of Cash Flows for the Six Months
  ended March 31, 1999 and 1998........................................................................   5

Notes to Unaudited Consolidated Financial Statements...................................................   6

Item 2. Management's Discussion and Analysis of Financial
  Condition and Results of Operations..................................................................  12

PART II. OTHER INFORMATION

Item 1.  Legal Proceedings.............................................................................  24

Item 4.  Submission of Matters to a Vote of Security Holders...........................................  28

Item 6.  Exhibits and Reports on Form 8-K..............................................................  29

SIGNATURES.............................................................................................  30
</TABLE> 

                                      -2-
<PAGE>
 
Item 1. Financial Statements

                       INTERNEURON PHARMACEUTICALS, INC.
                          CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)
                   (Amounts in thousands except share data)

<TABLE> 
<CAPTION> 
                                                                                      March 31,     September 30,
                                                                                        1999            1998
                                                                                      ---------     -------------
                                                 ASSETS
<S>                                                                                  <C>            <C>  
Current assets:
      Cash and cash equivalents                                                      $   37,292       $  39,330   
      Marketable securities                                                              10,154          28,877   
      Accounts receivable                                                                   144           1,273   
      Prepaids and other current assets                                                   1,919           1,116   
                                                                                     ----------       ---------   
           Total current assets                                                          49,509          70,596   
                                                                                                                  
Marketable securities                                                                        --           3,825   
Property and equipment, net                                                               3,399           3,691   
Other assets                                                                                 84              85   
                                                                                     ----------       ---------   
                                                                                     $   52,992       $  78,197   
                                                                                     ==========       =========   
                                              LIABILITIES                                                         
Current liabilities:                                                                                              
      Accounts payable                                                               $    1,369       $   1,334   
      Accrued expenses                                                                   26,135          27,008   
      Current portion of notes payable and capital lease obligations                        686             837   
                                                                                     ----------       ---------   
           Total current liabilities                                                     28,190          29,179   
                                                                                                                  
Long-term portion of notes payable and capital lease obligations                          1,526           1,663   
                                                                                                                  
Minority interest                                                                         3,163           7,499   
                                                                                                                  
                                             STOCKHOLDERS' EQUITY                                                 
                                                                                                                  
Preferred stock; $.001 par value, 5,000,000 shares authorized; Series B, 239,425                                  
      shares issued and outstanding at March 31, 1999 and September 30, 1998,                                     
      respectively (liquidation preference at                                                                     
      March 31, 1999 $3,401)                                                              3,000           3,000   
      Series C, 5,000 shares issued and outstanding at March 31, 1999 and                                         
      September 30, 1998, respectively (liquidation preference at March 31,                                       
      1999 $504)                                                                            500             500   
Common stock; $.001 par value, 80,000,000 shares authorized;                                                      
      41,904,357 and 41,817,017 shares issued and outstanding at March 31,                                        
      1999 and September 30, 1998, respectively                                              42              42   
Additional paid-in capital                                                              270,886         268,278   
Accumulated deficit                                                                    (254,315)       (231,996)  
Accumulated other comprehensive income                                                       --              32   
                                                                                     ----------       ---------   
      Total stockholders' equity                                                         20,113          39,856   
                                                                                     ----------       ---------   
                                                                                     $   52,992       $  78,197   
                                                                                     ==========       =========   
</TABLE> 

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

                                      -3-
<PAGE>
 
                       INTERNEURON PHARMACEUTICALS, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
          For the three and six months ended March 31, 1999 and 1998
                                  (Unaudited)
                 (Amounts in thousands except per share data)

<TABLE> 
<CAPTION> 
                                                    Three Months Ended March 31,          Six Months Ended March 31,
                                                    ----------------------------         ---------------------------
                                                      1999              1998                 1999             1998   
                                                    ---------         ---------          ----------        --------- 
<S>                                                 <C>               <C>                <C>               <C> 
Contract and license fee revenues                   $     209         $     673           $     900        $  1,327   
                                                                                                                      
Costs and expenses:                                                                                                   
Research and development                               11,046            11,595              22,699          20,006   
Selling, general and administrative                     3,364             7,278               6,609          14,847   
Purchase of in-process research and                                                                                   
  development                                              --                --                  --             500   
                                                    ---------         ---------           ---------        --------   
    Total costs and expenses                           14,410            18,873              29,308          35,353   
                                                                                                                      
Net loss from operations                              (14,201)          (18,200)            (28,408)        (34,026)  
                                                                                                                      
Investment income, net                                    556             1,432               1,333           3,263   
Equity in net loss of unconsolidated                                                                                  
 subsidiary                                                --              (978)                 --          (1,871)  
Minority interest                                       2,411               929               4,756           1,524   
                                                    ---------         ---------           ---------        --------   
                                                                                                                      
Net loss from continuing operations                   (11,234)          (16,817)            (22,319)        (31,110)  
                                                                                                                      
Discontinued operations:                                                                                              
Loss from operations of InterNutria                        --            (6,550)                 --         (11,391)  
                                                    ---------         ----------          ---------        --------   
                                                                                                                      
Net loss                                            $ (11,234)        $ (23,367)          $ (22,319)       $(42,501)  
                                                    ==========        ==========          =========        ========   
                                                                                                                      
Net  loss per common share - basic and diluted:                                                                       
                                                                                                                      
Net loss from continuing operations                 $   (0.27)        $   (0.41)          $   (0.53)       $  (0.75)  
Net loss from discontinued operations               $      --         $   (0.16)          $      --        $  (0.28)  
Net loss per common share                           $   (0.27)        $   (0.57)          $   (0.53)       $  (1.03)  
                                                                                                                      
Weighted average common shares                                                                                        
      outstanding                                      41,890            41,282              41,853          41,223   
                                                    =========         =========           =========        ========   
</TABLE> 


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

                                      -4-
<PAGE>
 
                        INTERNEURON PHARMACEUTICALS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                For the six months ended March 31, 1999 and 1998
                                   (Unaudited)
                             (Amounts in thousands)

<TABLE> 
<CAPTION> 
                                                                                Six months ended March 31,
                                                                                --------------------------
                                                                                   1999           1998
                                                                                ---------      ----------
<S>                                                                             <C>            <C> 
Cash flows from operating activities:
     Net loss                                                                   $ (22,319)     $(42,501)
     Adjustments to reconcile net loss to net cash
        (used) by operating activities:
        Depreciation and amortization                                                 571           844
        Minority interest in net loss of consolidated subsidiaries                 (4,756)       (1,524)
        Equity interest in net loss of unconsolidated subsidiary                       --         1,871
        Noncash compensation                                                        2,867         8,380
     Change in assets and liabilities:
        Accounts receivable                                                         1,130          (550)
        Prepaid and other assets                                                     (804)          (13)
        Inventory                                                                      --          (283)
        Accounts payable                                                               34         1,913
        Deferred revenue                                                               --          (314)
        Accrued expenses and other liabilities                                       (892)       (9,434)
                                                                                ---------      --------
Net cash (used) by operating activities                                           (24,169)      (41,611)
                                                                                ---------      --------

Cash flows from investing activities:
     Capital expenditures                                                            (278)       (1,230)
     Purchases of marketable securities                                            (2,520)      (19,830)
     Proceeds from maturities and sales of marketable securities                   25,036        34,641
                                                                                ---------      --------
Net cash provided by investing activities                                          22,238        13,581
                                                                                ---------      --------

Cash flows from financing activities:
     Net proceeds from issuance of common and treasury stock                           14           222
     Net proceeds from issuance of stock by subsidiaries                              166           175
     Principal payments of capital lease obligations                                 (194)         (366)
     Principal payments of notes payable                                              (93)          (39)
                                                                                ---------      --------
Net cash (used) by financing activities                                              (107)           (8)
                                                                                ---------      --------

Net change in cash and cash equivalents                                            (2,038)      (28,038)
Cash and cash equivalents at beginning of period                                   39,330        55,820
                                                                                ---------      --------

Cash and cash equivalents at end of periods                                     $  37,292      $ 27,782
                                                                                =========      ========
</TABLE> 

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

                                      -5-
<PAGE>
 
              INTERNEURON PHARMACEUTICALS, INC. AND SUBSIDIARIES

             NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


A.  Basis of Presentation
    ---------------------

    The consolidated financial statements included herein have been prepared by
Interneuron Pharmaceuticals, Inc. ("Interneuron" or the "Company") without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. In the opinion of management, the accompanying unaudited
consolidated financial statements include all adjustments (consisting only of
normal recurring adjustments) necessary to present fairly the consolidated
financial position, results of operations and cash flows of the Company. The
unaudited consolidated financial statements included herein should be read in
conjunction with the audited consolidated financial statements and the notes
thereto included in the Company's Form 10-K for the fiscal year ended September
30, 1998.

    Interneuron is a diversified biopharmaceutical company engaged in the
development and commercialization of a portfolio of products and product
candidates primarily for neurological and behavioral disorders. The Company also
develops products and technologies through Intercardia, Inc. and its
subsidiaries ("Intercardia") , a public company and a consolidated subsidiary,
focused on cardiovascular disease and carbohydrate-based drug discovery. As of
September 30, 1998, InterNutria, Inc. ("InterNutria"), a majority-owned and
consolidated subsidiary, has been classified as a discontinued operation and the
Company's investment in Progenitor, Inc. ("Progenitor") has been reduced to zero
pursuant to Progenitor's December 1998 determination to discontinue operations
(see Note D). All significant intercompany activity has been eliminated.

                                      -6-
<PAGE>
 
B. Basic and Diluted Earnings Per Share
   ------------------------------------

The following table sets forth the computation of basic and diluted earnings per
share:

<TABLE> 
<CAPTION> 
                                              Three Months Ended March 31,              Six Months Ended March 31,       
                                          ------------------------------------    ------------------------------------      
                                               1999                  1998                1999              1998          
                                          ----------------    ----------------    ----------------  ------------------   
<S>                                       <C>                 <C>                 <C>               <C>                  
Numerator for basic and diluted:                                                                                         
   Net loss                                $(11,234,000)        $(23,367,000)        $(22,319,000)    $ (42,501,000)     
                                           =============        =============        =============    ==============     
                                                                                                                         
Denominator for basic and diluted:                                                                                       
   Weighted average shares outstanding       41,890,000           41,282,000           41,853,000        41,223,000      
                                           =============        =============        =============    ==============     
                                                                                                                         
Net loss per common share - basic          $      (0.27)        $      (0.57)        $      (0.53)    $       (1.03)     
                                           =============        =============        =============    ==============     
                                                                                                                         
Net loss per common share - diluted        $      (0.27)        $      (0.57)        $      (0.53)    $       (1.03)     
                                           =============        =============        =============    ==============     
</TABLE> 


     During the three month period ended March 31, 1999, securities not included
in the computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i) options
to purchase 4,400,773 shares of Common Stock at prices ranging from $4.38 to
$20.13 with expiration dates ranging up to December 18, 2006; (ii) warrants to
purchase 812,500 shares of Common Stock with exercise prices ranging from $5.00
to $12.66 and with expiration dates ranging up to July 17, 2006; and (iii) call
options sold by the Company for 2,000,000 shares of Common Stock with an
exercise price of $36.00 and expiration dates ranging up to December 31, 1999.
Additionally, during the three month period ended March 31, 1999, securities not
included in the computation of diluted earnings per share, because they would
have an antidilutive effect due to the net loss for the period, were as follows:
(i) options to purchase 2,735,801 shares of Common Stock at prices ranging from
$0.83 to $4.16 with expiration dates ranging up to March 17, 2009; (ii) Series B
and C preferred stock convertible into 622,222 shares of Common Stock; and (iii)
unvested Restricted Stock Awards of 743,310 shares of Common Stock granted
pursuant to the Company's 1997 Equity Incentive Plan.

     During the three month period ended March 31, 1998, securities not included
in the computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i) options
to purchase 4,878,032 shares of Common Stock at prices ranging from $9.50 to
$32.00 with expiration dates ranging up to January 21, 2008; (ii) warrants to
purchase 667,500 shares of Common Stock with exercise prices ranging from $10.00
to $23.25 and with expiration dates ranging up to July 17, 2006, and (iii) call
options sold by the Company for 2,000,000 shares of Common Stock with an
exercise price of $36.00 and expiration dates ranging up to December 31, 1999.
Additionally, during the three month period ended March 31, 1998, securities not
included in the computation of diluted earnings per share, because they would
have an antidilutive effect due to the net loss for the period, were as follows:
(i) options to purchase 2,296,017 shares of Common Stock at prices ranging from
$0.83 to $8.75 with expiration dates ranging up to March 3, 2008; (ii) warrants
to purchase 186,157 shares of Common Stock with exercise prices ranging from
$2.75 to $9.00 and with expiration dates ranging up to February 3, 2005; (iii)
Series B and C preferred stock convertible into 622,222 shares of Common Stock;
and (iv) unvested Restricted Stock Awards of 1,328,704 shares of Common Stock
granted pursuant to the Company's 1997 Equity Incentive Plan.

     During the six month period ended March 31, 1999, securities not included
in the computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i) options
to purchase 6,995,174 shares of Common Stock at prices ranging from $3.75 

                                      -7-
<PAGE>
 
to $20.13 with expiration dates ranging up to March 3, 2008; (ii) warrants to
purchase 812,500 shares of Common Stock with exercise prices ranging from $5.00
to $12.77 and with expiration dates ranging up to July 17, 2006; and (iii)call
options sold by the company for 2,000,000 shares of Common Stock with an
exercise price of $36.00 and expiration dates ranging up to December 31, 1999.
Additionally, during the six month period ended March 31, 1999, securities not
included in the computation of diluted earnings per share, because they would
have an antidilutive effect due to the net loss for the period, were as follows:
(i) options to purchase 141,400 shares of Common Stock at prices ranging from
$0.83 to $3.63 with expiration dates ranging up to March 17, 2009; (ii) Series B
and C preferred stock convertible into 622,222 shares of Common Stock; and (iii)
unvested Restricted Stock Awards of 743,310 shares of Common Stock granted
pursuant to the Company's 1997 Equity Incentive Plan.

     During the six month period ended March 31, 1998, securities not included
in the computation of diluted earnings per share, because their exercise price
exceeded the average market price during the period were as follows: (i) options
to purchase 4,211,325 shares of Common Stock at prices ranging from $10.50 to
$32.00 with expiration dates ranging up to January 21, 2008; (ii) warrants to
purchase 167,500 shares of Common Stock with exercise prices ranging from $12.77
to $23.25 and with expiration dates ranging up to July 17, 2006; and (iii) call
options sold by the Company for 2,000,000 shares of Common Stock with an
exercise price of $36.00 and expiration dates ranging up to December 31, 1999.
Additionally, during the six month period ended March 31, 1998, securities not
included in the computaiton of diluted earnings per share, because they would
have an antidilutive effect due to the net loss for the period, were as follows:
(i) options to purchase 2,962,724 shares of Common Stock at prices ranging from
$0.83 to $10.00 with expiration dates ranging up to March 3, 2008; (ii) warrants
to purchase 686,157 shares of Common Stock with exercise prices ranging from
$2.75 to $10.00 and with expiration dates ranging up to February 3, 2005; (iii)
Series B and C preferred stock convertible into 622,222 shares of Common Stock;
and (iv) unvested Restricted Stock Awards of 1,328,704 shares of Common Stock
granted pursuant to the Company's 1997 Equity Incentive Plan.

     Certain of the securities listed above contain anti-dilution provisions.

C.   Comprehensive Income (Loss)
--------------------------------
     
     Effective October 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes standards for reporting and displaying comprehensive income
or loss and its components in a set of financial statements. SFAS 130 requires
that all items recognized under accounting standards as components of
comprehensive earnings be reported on one of the following: a statement of
income and comprehensive income or a statement of stockholders' equity.
Components of comprehensive income or loss are net income or loss and all other
nonowner changes in equity such as the change in the unrealized net gain on
marketable securities. Presentation of comprehensive loss for earlier periods is
provided for comparative purposes. Comprehensive loss for the fiscal reporting
periods ended March 31, 1999 and 1998 is as follows:

<TABLE> 
<CAPTION> 
                                             Three Months Ended March 31,               Six Months Ended March 31,
                                         --------------------------------             ------------------------------
                                             1999               1998                      1999             1998
                                         -------------       -------------            -------------    -------------
         <S>                             <C>                 <C>                      <C>              <C> 
         Net loss                        $(11,234,000)       $(23,367,000)            $(22,319,000)    $(42,501,000)
         Change in unrealized net
           gain on marketable
           securities                         (11,000)            (15,000)                 (32,000)         (63,000)
                                         -------------       -------------            -------------    -------------
         Comprehensive loss              $(11,245,000)       $(23,382,000)            $(22,351,000)    $(42,564,000)
                                         =============       =============            =============    =============
</TABLE> 

                                      -8-
<PAGE>
 
D. Subsidiaries
   ------------

Progenitor:

     In December 1998, Progenitor announced its intention to implement an
immediate cessation of operations due to insufficient funds to meet its
obligations. Progenitor's market valuation had been substantially reduced and
the Company could not viably sell any of its holdings of Progenitor securities.
As a result, the Company's investment in Progenitor was reduced to zero as of
September 30, 1998.

InterNutria:

    In September 1998, the Company adopted a plan to discontinue the operations
of InterNutria. Accordingly, the net losses from InterNutria's operations for
all periods prior to September 30, 1998 have been segregated from continuing
operations and condensed and reported on a separate line in on the statements of
operations. The Company is seeking to sell all or part of InterNutria's assets,
which include primarily a line of sports drink products and PMS Escape. There
can be no assurance the Company will be successful and the Company does not
expect to generate significant proceeds from any InterNutria asset sales.

    The Company has reclassified its prior year statements of operations to
reflect the operating results of InterNutria as a discontinued operation.
Operating results of InterNutria, exclusive of interest on intercompany debt
which was eliminated in consolidation, for the three and six month periods ended
March 31, 1998 is as follows:

<TABLE> 
<CAPTION> 
                                                   Three Months Ended        Six Months Ended
                                                     March 31, 1998             March 31, 1998
                                                   ---------------------     -----------------
                  <S>                              <C>                       <C> 
                  Revenues                           $     684,000             $   1,671,000
                  Operating expenses                     7,234,000                13,036,000
                                                     --------------            --------------
                  Net loss from operations              (6,550,000)              (11,365,000)
                  Interest expense                              --                   (26,000)
                                                     --------------            --------------
                  Net loss                           $  (6,550,000)            $ (11,391,000)
                                                     ==============            ==============
</TABLE> 

E. Withdrawal of Redux(TM), Legal Proceedings, and Related Contingencies
   ---------------------------------------------------------------------

     On September 15, 1997, the Company and Wyeth-Ayerst announced a market
withdrawal of the weight loss medication Redux, which was launched in June 1996.
In connection with the market withdrawal of Redux, the Company recorded as of
September 30, 1997 certain charges aggregating approximately $10,800,000. Total
expenses relating to the market withdrawal of Redux may exceed these amounts,
which are estimates and do not include provisions for liability, if any, arising
out of Redux-related litigation or other related costs.

     Interneuron is named, together with other pharmaceutical companies, as a
defendant in approximately 1,049 product liability legal actions, many of which
purport to be class actions, in federal and state courts involving the use of
Redux and other weight loss drugs. On December 10, 1997, the federal Judicial
Panel on Multidistrict Litigation issued an Order allowing for the transfer or
potential transfer of the federal actions to the Eastern District of
Pennsylvania for coordinated pretrial proceedings.


                                      -9-
<PAGE>
 
     On September 25, 1998, the U.S. District Court for the Eastern District of
Pennsylvania (the "Court") preliminarily approved an Agreement of Compromise and
Settlement (the "Settlement Agreement") between the Company and the Plaintiffs'
Management Committee ("PMC") relating to the proposed settlement of all product
liability litigation and claims against the Company relating to Redux. As part
of the Settlement Agreement, the Company and the PMC entered into a royalty
agreement (the "Royalty Agreement") relating to a portion of the payments
proposed to be made to the settlement fund.

     On November 3, 1998, the Court issued a stay halting all Redux product
liability litigation against the Company, pending and future, in state courts,
following the issuance of a similar stay halting Redux product liability
litigation against the Company with federal courts on September 3, 1998. These
stays will remain effective until further order of the Court.

     The limited fund class action established by the Settlement Agreement
includes all persons in the United States who used Redux, and certain other
persons such as their family members, who would be bound by the terms of the
settlement. Membership in the class is mandatory for all persons included within
the class definition. Under the terms of the proposed settlement, class members
asserting claims against Interneuron will be required to seek compensation only
from the settlement fund, and their lawsuits against Interneuron will be
dismissed. By agreeing to the proposed settlement, Interneuron does not admit
liability to any plaintiffs or claimants.

     The Settlement Agreement requires Interneuron to deposit a total of
approximately $15,000,000 in three installments into a settlement fund. The
first installment of $2,000,000 was deposited into the settlement fund in
September 1998. A second installment of $3,000,000 is to be made after the
Settlement Agreement is approved by the Court, which would depend upon the
ruling in the Fairness Hearing, which was conducted between February 25, 1999 
and March 31, 1999 (see below). These installments, less certain expenses, will
be returned to Interneuron if the settlement does not become final. A third
installment of $10,000,000, plus interest, is to be made after the settlement
becomes final.

     In addition, the Settlement Agreement provides for Interneuron to cause all
remaining and available insurance proceeds related to Redux to be deposited into
the settlement fund. Interneuron also agreed to make certain royalty payments to
the settlement fund pursuant to the Royalty Agreement which is part of the
Settlement Agreement, in the total amount of $55,000,000, over a seven year
period commencing when the settlement becomes final. Royalties will be paid at
the rate of 7% of gross sales of Interneuron products sold by Interneuron, 15%
of cash dividends received by Interneuron from its subsidiaries related to
product sales, and 15% of license revenues (including license fees, royalties or
milestone payments) received by Interneuron from a sublicensee related to
product sales. All Interneuron products will be subject to this royalty during
the applicable term. If, at the end of that seven year period, the amount of
royalty payments made by Interneuron is less than $55,000,000, the settlement
fund will receive shares of Interneuron stock in an amount equal to the unpaid
balance divided by $ 7.49 per share, subject to adjustment under certain
circumstances such as stock dividends or distributions. Interneuron could be
required to issue up to 7,343,124 shares of Common Stock if it makes no royalty
payments.

     The Settlement Agreement will not become final until approved by the Court
and the time for filing appeals of the Court's judgment approving the Settlement
Agreement has elapsed without any appeals being filed or all appeals from the
Court's judgment approving the Settlement Agreement have been exhausted and no
further appeal may be taken. In this case, in order to approve the settlement,
the Court must make a determination that the proposed settlement is fair and
reasonable and meets each of the prerequisites for a class action generally, and
for a "limited fund" class action in particular, all as required by the Federal
Rules of Civil Procedure. Pursuant to these rules, notice of the proposed
settlement was 

                                      -10-
<PAGE>
 
provided to potential class members in November 1998. Between February 25, 1999
and March 5, 1999, the Court conducted a Fairness Hearing to determine whether
the case is properly certifiable as a limited fund class action and, if so,
whether the terms of the Settlement Agreement are fair and reasonable. At the
Fairness Hearing, the Court heard testimony from various witnesses, received
documentary evidence, and heard oral arguments from the proponents and opponents
of the settlement. The Court has not yet rendered a decision.

     The Company may withdraw from the Settlement Agreement, or the Settlement
Agreement may otherwise terminate, under any of the following conditions: (i)
final approval of the Settlement Agreement is not entered by the Court; (ii)
class certification and/or approval of the Settlement Agreement is overturned on
appeal for any reason; (iii) pending and future litigation against the Company
or any other party released by the Settlement Agreement ("Released Parties") is
not permanently enjoined on the final approval date; (iv) the class action and
all pending multi-district lawsuits against the Released Parties are not
dismissed with prejudice on the final approval date; (v) an order is not entered
by the Court permanently barring contribution and indemnity claims by other
defendants in the diet drug litigation; or (vi) Interneuron is unable to compel
tender of its insurance proceeds.

     On November 20, 1998, December 30, 1998 and February 5, 1999, the Company's
three product liability insurers filed actions against Les Laboratoires Servier
("Servier") and the Company in the Court, pursuant to the federal interpleader
statute. The insurers allege that both Servier and the Company have asserted
claims against commercial excess insurance policies issued by the insurers to
Interneuron with limits of $20,000,000, $5,000,000 in excess of $20,000,000, and
$15,000,000 in excess of $25,000,000, respectively, a portion of which has been
used in the Company's defense of the litigation. The insurers have deposited the
available proceeds up to the limits of their policies into the registry of the
Court.

     There can be no assurance that the Court will approve the settlement. Even
if the settlement is approved by the Court, opponents of the settlement may
appeal the Court's opinion to the United States Court of Appeals for the Third
Circuit. In addition, there is a case pending before the United States Supreme
Court (Ortiz v. Fibreboard Corporation et al) ("Ortiz"), that may influence the
       -------------------------------------
Court's decision or the outcome of any appeal that might be taken. Oral argument
in the Ortiz case was heard on December 8, 1998 and the Supreme Court is likely
to render its opinion by June 1999, which is the end of the current Supreme
Court term. Although factually distinguishable in many respects from the
Company's proposed settlement, Ortiz involves an appeal from a mandatory,
putative "limited fund" class action settlement. There can be no assurance that
the Supreme Court's rulings in Ortiz will not significantly influence the
approval process for, or potentially result in the overturning of, the
Settlement Agreement.

     The Company will record initial charges to operations for the estimated
fair value of the Company's obligations under the Settlement Agreement,
exclusive of insurance proceeds, at such time as the Company can determine that
it is probable that the conditions to final settlement have been or will be met.
This is expected to be subsequent to the Court's decision regarding approval of 
the Settlement Agreement and the Supreme Court ruling in Ortiz. The amount of
the liability to be recognized in connection with these charges is likely to be
significant and to materially adversely affect the Company's net worth.
Additionally, if the Company records such charges prior to the final settlement
date, then, on the date the Settlement Agreement becomes final, the Company will
determine if there was any increase in the fair value of the equity conversion
feature of the Royalty Agreement and record any such increase as an additional
charge to operations. From the date the Company records the initial charge and
related liability for the settlement and through the term of the Royalty
Agreement, the Company may record additional charges to accrete the liability
attributable to the royalty feature of the Royalty Agreement up to the amount of
royalties the Company expects to pay pursuant to the Royalty Agreement over the
time the Company expects to make such royalty payments.

                                      -11-
<PAGE>
 
Payments to be made by the Company pursuant to the Settlement Agreement could
have a material adverse effect on the results of operations and financial
condition of the Company.

   If the Settlement Agreement is overturned or not made final, the ongoing
Redux-related litigation would then proceed against the Company. In this event,
existence of such litigation, including the time and expenses associated with
the litigation, may materially adversely affect the Company's business,
including its ability to obtain sufficient financing to fund operations.
Although the Company is unable to predict the outcome of any such litigation,
such outcome may materially adversely affect the Company's future business,
results of operations and financial condition.

   The Company has also been named as a defendant in several lawsuits filed by
alleged purchasers of the Company's Common Stock, purporting to be class
actions, claiming violation of the federal securities laws. It is not possible
for the Company to determine its costs related to its defense in these or
potential future legal actions, monetary or other damages which may result from
such legal actions, or the effect on the future operations of the Company.

Item 2.  Management's Discussion and Analysis of Financial Conditions and 
         ----------------------------------------------------------------
               Results of Operations:
               ---------------------

     Statements in this Form 10-Q that are not statements or descriptions of
historical facts are "forward-looking" statements under Section 21E of the
Securities Exchange Act of 1934, as amended, and the Private Securities
Litigation Reform Act of 1995 and are subject to numerous risks and
uncertainties. These forward-looking statements and other forward-looking
statements made by the Company or its representatives include, without
limitation, statements regarding the Redux-related litigation, including the
proposed settlement of the Redux-related product liability litigation; the
Company's ability to successfully develop, obtain regulatory approval for and
commercialize any products, to enter into corporate collaborations or obtain
sufficient additional capital to fund operations, and are based on a number of
assumptions. The words "believe," "expect," "anticipate," "intend," "estimate"
or other expressions which are predictions of or indicate future events and
trends and which do not relate to historical matters identify forward-looking
statements. Readers are cautioned not to place undue reliance on these forward-
looking statements as they involve risks and uncertainties, and actual results
could differ materially from those currently anticipated due to a number of
factors, including those set forth under "Risk Factors" and elsewhere in, or
incorporated by reference into, the Company's Form 10-K for its fiscal year
ended September 30, 1998. These factors include, but are not limited to, risks
relating to the Redux-related litigation, including the risk that the proposed
settlement of the product liability litigation will not be finally approved;
uncertainties relating to clinical trials, regulatory approval and
commercialization of citicoline; need for additional funds and corporate
partners; uncertainties relating to clinical trials, regulatory approval and
commercialization of other products; substantial losses from operations and
expected future losses; minimal revenues; product liability; dependence on third
parties for manufacturing and marketing; competition; government regulation;
contractual arrangements; patents and proprietary rights; dependence on key
personnel; uncertainty regarding pharmaceutical pricing and reimbursement and
other risks. The forward-looking statements represent the Company's judgment and
expectations as of the date of this Report. The Company assumes no obligation to
update any such forward-looking statements.

   The following discussion should be read in conjunction with the Company's
unaudited consolidated financial statements and notes thereto appearing
elsewhere in this report and audited consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1998. Unless the context indicates otherwise, all references
to the Company include Interneuron and its subsidiaries.

                                      -12-
<PAGE>
 
General
-------

Redux

         Proposed Settlement of Product Liability Litigation:

    Subsequent to the September 15, 1997 market withdrawal of the weight loss
medication Redux, Interneuron has been named, together with other pharmaceutical
companies, as a defendant in approximately 1,049 legal actions, many of which
purport to be class actions, in federal and state courts involving the use of
Redux and other weight loss drugs. On December 10, 1997, the federal Judicial
Panel on Multidistrict Litigation issued an Order allowing for the transfer or
potential transfer of the federal actions to the Eastern District of
Pennsylvania for coordinated pretrial proceedings.

    On September 25, 1998, the U.S. District Court for the Eastern District of
Pennsylvania (the "Court") preliminarily approved an Agreement of Compromise and
Settlement (the "Settlement Agreement") between the Company and the Plaintiffs'
Management Committee ("PMC") relating to the proposed settlement of all product
liability litigation and claims against the Company relating to Redux. As part
of the Settlement Agreement, the Company and the PMC entered into a royalty
agreement (the "Royalty Agreement") relating to a portion of the payments
proposed to be made to the settlement fund.

    On November 3, 1998, the Court issued a stay halting all Redux product
liability litigation against the Company, pending and future, in state courts,
following the issuance of a similar stay halting Redux product liability
litigation against the Company in federal courts on September 3, 1998. These
stays will remain effective until further order of the Court.

    Summary of Proposed Settlement: The limited fund class action established by
the Settlement Agreement includes all persons in the United States who used
Redux, and certain other persons such as their family members, who would be
bound by the terms of the settlement. Membership in the class is mandatory for
all persons included within the class definition. Under the terms of the
proposed settlement, class members asserting claims against Interneuron will be
required to seek compensation only from the settlement fund, and their lawsuits
against Interneuron will be dismissed. By agreeing to the proposed settlement,
Interneuron does not admit liability to any plaintiffs or claimants.

    The Settlement Agreement requires Interneuron to deposit a total of
approximately $15,000,000 in three installments into a settlement fund. The
first installment of $2,000,000 was deposited into the settlement fund in
September 1998. A second installment of $3,000,000 is to be made after the
Settlement Agreement is approved by the Court, which would depend upon the
ruling in the Fairness Hearing, which was conducted between February 25, 1999 
and March 31, 1999 (see below). These installments, less certain expenses, will
be returned to Interneuron if the settlement does not become final. A third
installment of $10,000,000, plus interest, is to be made after the settlement
becomes final.

    The Settlement Agreement provides for Interneuron to cause all remaining and
available insurance proceeds related to Redux to be deposited into the
settlement fund. Interneuron also agreed to make royalty payments to the
settlement fund in the total amount of $55,000,000, over a seven year period
commencing when the settlement becomes final. Royalties will be paid at the rate
of 7% of gross sales of Interneuron products sold by Interneuron, 15% of cash
dividends received by Interneuron from its subsidiaries related to product
sales, and 15% of license revenues (including license fees, royalties or
milestone payments) received by Interneuron from a sublicensee related to
product sales. All Interneuron products will be subject to this royalty during
the applicable term. If, at the end of that seven year period, the amount of

                                      -13-
<PAGE>
 
royalty payments made by Interneuron is less than $55,000,000, the settlement
fund will receive shares of Interneuron stock in an amount equal to the unpaid
balance divided by $7.49 per share, subject to adjustment under certain
circumstances such as stock dividends or distributions.

    Conditions to Final Settlement: The settlement will not become final until
approved by the Court and the time for appeal of the Court's judgment approving
the Settlement Agreement has elapsed without any appeals being filed or all
appeals from the Court's judgment approving the Settlement Agreement have been
exhausted and no further appeal may be taken. In this case, in order to approve
the settlement, the Court must make a determination that the proposed settlement
is fair and reasonable and meets each of the prerequisites for a class action
generally, and for a "limited fund" class action in particular, all as required
by the Federal Rules of Civil Procedure. Pursuant to these rules, notice of the
proposed settlement was provided to potential class members in November 1998.
Between February 25, 1999 and March 5, 1999, the Court conducted a Fairness
Hearing to determine whether the case is properly certifiable as a limited fund
class action and, if so, whether the terms of the Settlement Agreement are fair
and reasonable. At the hearing, the Court heard testimony from various
witnesses, received documentary evidence, and heard oral arguments from the
proponents and opponents of the settlement. The Court has not yet rendered a
decision.

    The Company may withdraw from the Settlement Agreement, or the Settlement
Agreement may otherwise terminate, under any of the following conditions: (i)
final approval of the Settlement Agreement is not entered by the Court; (ii)
class certification and/or approval of the Settlement Agreement is overturned on
appeal for any reason; (iii) pending and future litigation against the Company
or any other party released by the Settlement Agreement ("Released Parties") is
not permanently enjoined on the final approval date; (iv) the class action and
all pending multi-district lawsuits against the Released Parties are not
dismissed with prejudice on the final approval date; (v) an order is not entered
by the Court permanently barring contribution and indemnity claims by other
defendants in the diet drug litigation; or (vi) Interneuron is unable to compel
tender of its insurance proceeds.

    On November 20, 1998, December 30, 1998 and February 5, 1999, the Company's
three product liability insurers filed actions against Les Laboratoires Servier
("Servier") and the Company in the Court, pursuant to the federal interpleader
statute. The insurers allege that both Servier and the Company have asserted
claims against commercial excess insurance policies issued by the insurers to
Interneuron with limits of $20,000,000, $5,000,000 in excess of $20,000,000, and
$15,000,000 in excess of $25,000,000, respectively a portion of which has been
used in the Company's defense of the litigation. The insurers have deposited the
available proceeds up to the limits of their policies into the registry of the
Court.

    There can be no assurance that the Court will approve the settlement. Even
if the settlement is approved by the Court, opponents of the settlement may
appeal the Court's opinion to the United States Court of Appeals for the Third
Circuit. In addition, there is a case pending before the United States Supreme
Court (Ortiz v. Fibreboard Corporation et al) ("Ortiz"), that may influence the
       -------------------------------------
Court's decision or the outcome of any appeal that might be taken. Oral argument
in the Ortiz case was heard on December 8, 1998 and the Supreme Court is likely
to render its opinion by June 1999, which is the end of the current Supreme
Court term. Although factually distinguishable in many respects from the
Company's proposed settlement, Ortiz involves an appeal from a mandatory,
putative "limited fund" class action settlement. There can be no assurance that
the Supreme Court's rulings in Ortiz will not significantly influence the
approval process for, or potentially result in the overturning of, the
Settlement Agreement.

    Future Charges to Operations: The Company will record initial charges to
operations for the estimated fair value of the Company's obligations under the
Settlement Agreement, exclusive of insurance proceeds, at such time as the
Company can determine that it is probable that the conditions to final
settlement have

                                      -14-
<PAGE>
 
been or will be met. This is expected to be subsequent to the Court's decision
regarding approval of the Settlement Agreement and the Supreme Court ruling in
Ortiz. The amount of the liability to be recognized in connection with these
charges is likely to be significant and to materially adversely affect the
Company's net worth. Additionally, if the Company records such charges prior to
the final settlement date, then, on the date the Settlement Agreement becomes
final, the Company will determine if there was any increase in the fair value
of the equity conversion feature of the Royalty Agreement and record any such
increase as an additional charge to operations. From the date the Company
records the initial charge and related liability for the settlement and through
the term of the Royalty Agreement, the Company may record additional charges to
accrete the liability attributable to the royalty feature of the Royalty
Agreement up to the amount of royalties the Company expects to pay pursuant to
the Royalty Agreement over the time the Company expects to make such royalty
payments. Payments to be made by the Company pursuant to the Settlement
Agreement could have a material adverse effect on the results of operations and
financial condition of the Company.

    If the Settlement Agreement is overturned or not made final, the ongoing
Redux-related litigation would then proceed against the Company. In this event,
the existence of such litigation, including the time and expenses associated
with the litigation, may materially adversely affect the Company's business,
including its ability to obtain additional financing to fund operations.
Although the Company is unable to predict the outcome of any such litigation,
such outcome may materially adversely affect the Company's future business,
results of operations and financial condition.

    Securities Litigation:

    The Company has also been named as a defendant in several lawsuits filed by
alleged purchasers of the Company's Common Stock, purporting to be class
actions, claiming violation of the federal securities laws. It is not possible
for the Company to determine its costs related to its defense in these or
potential future legal actions, monetary or other damages which may result from
such legal actions, or the effect on the future operations of the Company. See
"Legal Proceedings".

    General:

    Although the Company maintains certain product liability and director and
officer liability insurance and intends to defend these and similar actions
vigorously, the Company has been required and may continue to devote significant
management time and resources to these legal actions and, in the event of
successful uninsured or insufficiently insured claims, or in the event a
successful indemnification claim were made against the Company, the Company's
business, financial condition and results of operations could be materially
adversely affected. In addition, the uncertainties and costs associated with
these legal actions have had, and may continue to have, an adverse effect on the
market price of the Company's Common Stock and on the Company's ability to
obtain additional financing to satisfy cash requirements, to retain and attract
qualified personnel, to develop and commercialize products on a timely and
adequate basis, to acquire or obtain rights to additional products, to enter
into certain corporate partnerships, or to obtain product liability insurance
for other products at costs acceptable to the Company, or at all, any or all of
which may adversely affect the Company's business and financial condition.

   Product Withdrawal:

    Redux received clearance in April 1996 by the U.S. Food and Drug
Administration ("FDA") for marketing as a twice-daily prescription therapy to
treat obesity. Until its withdrawal in September 1997, Redux was marketed in the
U.S. by Wyeth-Ayerst and copromoted by Interneuron. A significant portion

                                      -15-
<PAGE>
 
of Interneuron's revenues through fiscal 1997 had been derived from Redux sales
and, accordingly, the Company did not recognize any revenue related to Redux
thereafter and does not expect to realize any future revenues related to Redux.

     Citicoline

    The Company is proceeding with the development of citicoline and commenced
in June 1998 an approximately 900-person Phase 3 clinical trial which will
compare the change in neurological function at 12 weeks following ischemic
stroke of citicoline-treated patients with that of patients who received
placebo. Patients are being treated with 2000 milligrams of citicoline or
placebo daily for six weeks with a six week follow-up period. It is anticipated
that this clinical trial will be completed in late 1999. The 2000 milligram dose
level is higher than the dose used in the Company's two most recent citicoline
clinical trials but was used in the Company's first Phase 3 trial in which
patients treated with this dose achieved the primary endpoint of improved
neurological function. Depending upon the evaluation of the results from this
trial, the Company will determine whether to re-submit the New Drug Application
("NDA") for citicoline to the FDA. Even if the Company does re-submit the NDA,
as to which there is no assurance, the Company is unable to predict whether or
when the FDA would grant authorization to market citicoline in the U.S. Upon
resubmission of the NDA, a new FDA review period would commence.

    The Company withdrew its NDA for citicoline in April 1998. The Company had
submitted the NDA to the FDA for citicoline in December 1997. The citicoline NDA
had been accepted for filing and assigned priority and fast-track review status.
A priority review status reflects the FDA's commitment to review the NDA within
six months following submission. A fast-track designation indicates that the FDA
has determined a drug is intended to treat a serious or life-threatening
condition with a current unmet medical need and that the FDA can take actions to
expedite the development and review of the drug. While there can be no assurance
that any resubmission of a citicoline NDA would be assigned a priority review
status, the indication of stroke presently warrants such NDA review status.

    As of March 31, 1999 the remaining expenditures of all currently planned
clinical trials and related studies and NDA preparation for citicoline are
estimated, based upon current trial protocols, to aggregate approximately
$23,000,000. The Company is unable to predict the costs of any related or
additional clinical studies which will depend upon the results of the on-going
trial and upon FDA requirements. As a result of the Company's withdrawal of its
citicoline NDA, the related additional time and expense for product development,
and the Company's limited cash resources, the Company is evaluating its
commercialization strategy for citicoline. The Company requires additional funds
for manufacturing, distribution, marketing and selling efforts, the amount of
which will depend upon whether the Company markets citicoline itself or enters
into a corporate collaboration and the terms of any such collaboration. The
Company has no commitments or arrangements to obtain additional funds or
collaborations relating to citicoline and there can be no assurance such funds
or collaborations can be obtained on terms favorable to the Company or at all.

    The Company licensed in fiscal 1993 from Ferrer Internacional, S.A.
("Ferrer"), a Spanish pharmaceutical company, certain patent and know-how rights
in the United States and Canada relating to the use of citicoline in exchange
for a royalty equal to 6% of the Company's net sales of citicoline. In June
1998, the Company amended its agreement with Ferrer to extend to January 31,
2002 the date upon which Ferrer may terminate the citicoline license agreement
if FDA approval of citicoline is not obtained. The agreement provides for such
date to be extended for up to two years if the Company provides information to
Ferrer which tends to establish that the Company has carried out the steps for
obtaining such approval and if such approval has not been obtained for reasons
beyond the Company's control. In fiscal 1999, the

                                      -16-
<PAGE>
 
Company was issued three new citicoline-related patents for several claims
including reduction of cerebral infarct size, effective dose regimens,
combination therapies with other products and the treatment of head trauma.

    The Company will be dependent upon third party suppliers of citicoline bulk
compound, finished product and packaging for manufacturing in accordance with
the Company's requirements and current U.S. Good Manufacturing Practices
("cGMP") regulations as well as third party arrangements for the distribution of
citicoline. Supplies of citicoline finished product used for clinical purposes
have been and are produced on a contract basis by third party manufacturers. The
Company does not have an agreement with a manufacturer for supply of commercial
quantities of finished product and there can be no assurance such agreement can
be obtained on terms favorable to the Company or at all, which could adversely
affect the Company's ability to commercialize citicoline on a timely and cost-
effective basis. The Company's agreement with Ferrer requires the Company to
purchase from Ferrer citicoline bulk compound for commercial purposes at fixed
prices, subject to certain conditions. Any citicoline manufacturing facilities
are subject to FDA inspection both before and after FDA approval to determine
compliance with cGMP requirements. There can be no assurance the Company can or
will establish on a timely basis, or maintain, manufacturing capabilities of
bulk compound or finished product required to obtain regulatory approval or that
any facilities used to produce citicoline will have complied, or will be able to
maintain compliance, with cGMP or that such suppliers will be able to meet
manufacturing requirements on a timely basis or at all.

Pagoclone

    The Company is developing pagoclone as a drug to treat panic/anxiety
disorders. Current pharmacological treatments for anxiety and panic disorders
include serotonin agonists such as BuSpar, and benzodiazepines, such as Valium
and Xanax, as well as selective serotonin reuptake inhibitors such as Paxil. 
Pre-clinical and early clinical data suggest that pagoclone may offer advantages
over traditional benzodiazepine anti-anxiety agents, including reduced
drowsiness, lower addiction and withdrawal potential and less potential for
alcohol interactions.

    In August 1998, the Company announced results of its Phase 2/3 trial
involving 277 patients showing that treatment with pagoclone statistically
significantly reduced the frequency of panic attacks among patients suffering
from panic disorder. In addition, pagoclone was well-tolerated by these
patients, with no evidence of sedation and no apparent withdrawal syndromes in
this study, which included a tapering-off period. The Company designates a trial
as Phase 2/3 if it is a well-controlled trial which the Company may utilize,
depending upon results, as either a pivotal or supporting trial in an NDA
submission. Based on the results of this trial, Interneuron believes it has
identified an optimal dose of pagoclone for Phase 3 clinical testing. The
Company estimates the total costs of currently anticipated clinical development
and NDA preparation relating to pagoclone for panic disorder, including license
fees to Rhone-Poulenc Rorer Pharmaceuticals, Inc. ("RPR"), to be approximately
$43,000,000, which if all of such activities are undertaken, would be incurred
over approximately the next three years. The Company licensed from RPR exclusive
worldwide rights to pagoclone, in exchange for licensing, milestone and royalty
payments to RPR.

    The Company does not have sufficient funds to conduct Phase 3 clinical
testing or commercialization of pagoclone and is seeking a corporate
collaboration to proceed with a Phase 3 clinical study. There can be no
assurance the Company will be successful in obtaining a corporate collaboration
or additional financing sufficient to fund development and commercialization of
pagoclone, on terms favorable to the Company or at all. In this event, the
development of pagoclone would be significantly

                                      -17-
<PAGE>
 
delayed or curtailed. Even if a collaboration or other financing is obtained,
the Company is unable to predict with certainty the costs of any additional
studies which may be required by the FDA for approval of pagoclone. There can be
no assurance, assuming such trials are conducted, that any such clinical trials
will be successful or result in FDA approval of the product. 

Results of Operations

    Revenues, consisting of contract and license fee revenue, decreased
$464,000, or 69%, to $209,000 in the three month period ended March 31, 1999
from $673,000 in the three month period ended March 31, 1998 and decreased
$427,000, or 32%, to $900,000 in the six month period ended March 31, 1999 from
$1,327,000 in the six month period ended March 31, 1998. The decreases in
contract and license fee revenue were primarily the result of the absence in the
fiscal 1999 periods of revenue generated by Interneuron's majority-owned
subsidiary, Intercardia, Inc. ("Intercardia") from Astra Merck, Inc. ("Astra
Merck") due to the termination of the Development and Marketing Collaboration
and License Agreement between Astra Merck, Intercardia and CPEC, Inc. (the
"Astra Merck Collaboration") in September 1998 and decreased revenue from Merck
& Co., Inc. ("Merck") related to product development at Intercardia Research
Laboratories ("IRL"), formerly conducted by Transcell Technologies, Inc.
("Transcell"). In the six month period ended March 31, 1999, the decreases were
partially offset by a milestone payment received by the Company from Eli Lilly
and Company ("Lilly") relating to the development of Lilly's drug, Prozac(R) for
the treatment of premenstrual syndrome.

    Research and development expense decreased $549,000, or 5%, to $11,046,000
in the three month period ended March 31, 1999 from $11,595,000 in the three
month period ended March 31, 1998 and increased $2,693,000, or 13%, to
$22,699,000 in the six month period ended March 31, 1999 from $20,006,000 in the
six month period ended March 31, 1998. Research and development expense at
Interneuron decreased in the three and six month periods due to the absence of
expense in fiscal 1999 for a Redux-related echocardiogram study and the Phase
2/3 pagoclone study and reduced noncash compensation expense related to the
Company's 1997 Equity Incentive Plan, partially offset by increased expenses
related to the 900-person Phase 3 citicoline clinical trial which commenced in
June 1998. Intercardia expenses increased in the three and six month periods
ended March 31, 1999 due to continuing U.S. bucindolol development costs
previously assumed by Astra Merck, Intercardia's contractual share of European
bucindolol development costs incurred by BASF Pharma/Knoll AG ("Knoll"),
Intercardia's collaborative partner, and increased expenses associated with the
carbohydrate chemistry program of IRL. In March 1999, Intercardia reduced its
headcount at IRL by approximately 50% as part of an overall assessment of
Intercardia's research and development expenses in view of its limited cash
resources and increased expenses after termination of the Astra Merck
Collaboration, as well as a refocus of IRL's research programs to concentrate on
projects with lead compounds.

    Selling, general and administrative expense decreased $3,914,000, or 54%, to
$3,364,000 in the three month period ended March 31, 1999 from $7,278,000 in the
three month period ended March 31, 1998 and decreased $8,238,000, or 55%, to
$6,609,000 in the six month period ended March 31, 1999 from $14,847,000 in the
six month period ended March 31, 1998. This decrease resulted primarily from
reduced noncash compensation expense related to the Company's 1997 Equity
Incentive Plan, the absence of citicoline pre-marketing expenses that were
incurred in fiscal 1998, the absence of costs of the Company's sales force
resulting from its May 1998 dismissal, and Intercardia's elimination of
duplicative Transcell-related administrative expenses subsequent to the May 1998
merger of Transcell with and into Intercardia. The fiscal 1999 periods include
costs for the Company's launch of its AnatoMark(TM) head reference system. The
Company does not expect to generate profits from AnatoMark in the near future.

    Investment income, net, decreased $876,000, or 61%, to $556,000 in the three
month period ended March 31, 1999 from $1,432,000 in the three month period
ended March 31, 1998 and decreased $1,930,000, or 

                                      -18-
<PAGE>
 
59%, to $1,333,000 in the six month period ended March 31, 1999 from $3,263,000
in the six month period ended March 31, 1998 primarily due to lower balances of
cash and marketable securities resulting from funds used in Company operations
and increased interest expense from additional capital equipment leases entered
into by Intercardia.

   There was no provision for equity in net loss of unconsolidated subsidiary,
Progenitor, in the three and six month periods ended March 31, 1999, compared to
provisions of $978,000 and $1,871,000 in the three and six month periods ended
March 31, 1998, respectively, as the Company wrote down to zero its investment
in Progenitor as of September 30, 1998 as a result of Progenitor's December 1998
decision to cease operations. (See Note D of Notes to Unaudited Consolidated
Financial Statements.)

   Minority interest increased $1,482,000, or 160%, to $2,411,000 in the three
month period ended March 31, 1999 from $929,000 in the three month period ended
March 31, 1998 and increased $3,232,000, or 212%, to $4,756,000 in the six month
period ended March 31, 1999 from $1,524,000 in the six month period ended March
31, 1998. This increase is due to an increased net loss at Intercardia and
because there is a larger percentage of minority stockholders at Intercardia
than there was at Transcell to whom to allocate the loss generated by IRL.

   Due to the Company's September 1998 decision to discontinue the operations
of InterNutria and reflect InterNutria as a discontinued operation in the
Company's statements of operations, no net loss was reflected in the three and
six month periods ended March 31, 1999 relating to InterNutria compared to net
losses of $6,550,000 and $11,391,000 in the three and six month periods ended
March 31, 1998, respectively. InterNutria losses resulted primarily from the
expenses of the national launch of PMS Escape exceeding the revenue from sales
of PMS Escape. Net operating expenses relating to InterNutria expected to be
incurred during the three and six month periods ended March 31, 1999 were
accrued at September 30,1998. (See Note D of Notes to Unaudited Consolidated
Financial Statements.)

     For the reasons described above, net loss decreased $12,133,000 or 52%, to
$11,234,000 in the three month period ended March 31, 1999 from $23,367,000 in
the three month period ended March 31, 1998 and decreased $20,182,000, or 47%,
to $22,319,000 in the six month period ended March 31, 1999 from $42,501,000 in
the six month period ended March 31, 1998.

   Liquidity and Capital Resources
   -------------------------------

   Cash, Cash Equivalents and Marketable Securities

   At March 31, 1999, the Company had consolidated cash, cash equivalents and
marketable securities aggregating $47,446,000 (of which approximately
$12,749,000 is held by Intercardia and is not generally available to
Interneuron) compared to $72,032,000 at September 30, 1998. This decrease is
primarily due to approximately $24,169,000 used to fund operations in the six
month period ended March 31, 1999 (of which approximately $10,500,000 related to
Intercardia).

    While the Company believes it has sufficient cash for currently planned
expenditures through September 1999, based on certain assumptions relating to
operations, the settlement of the Redux product liability litigation and other
factors, it will require additional funds after such time and intends to seek
additional funds or corporate collaborations prior to such time. The Company
requires additional funds for the development and commercialization of
citicoline, pagoclone and its other compounds and technologies, as well as any
new products acquired in the future. The Company has no commitments or
arrangements to obtain such funds. If such funds or corporate collaborations are
not available, the Company will be required 

                                      -19-
<PAGE>
 
to delay product development and regulatory efforts. As a result of the
uncertainties and costs associated with the Redux-related litigation, including
the risk that the proposed settlement of the Redux product liability litigation
does not become final, market conditions and other factors generally affecting
the Company's ability to raise capital, there can be no assurance that the
Company will be able to obtain additional financing to satisfy future cash
requirements or that any financing will be available on terms favorable or
acceptable to the Company.

    Product Development

    The Company expects to continue expending substantial amounts for the
development of citicoline as described above and for its other products. Because
the Company does not have sufficient capital resources to fund significant
further development of any products other than citicoline, it is seeking a
corporate collaboration to provide for future pagoclone development and
marketing costs, including Phase 3 clinical studies. Although the Company is
engaged in discussions with respect to certain corporate collaborations relating
to pagoclone, there can be no assurance any agreement will be obtained. The
failure to obtain additional funds or a corporate collaboration would adversely
affect development of pagoclone. Also, Intercardia, through its 80% owned
subsidiary CPEC, Inc. ("CPEC", of which Interneuron owns 20%), is developing
BEXTRA for congestive heart failure and requires additional funds to develop and
commercialize this product (see "Intercardia"). The Company does not have
sufficient capital to complete development and commercialization of any products
under development and will be required to obtain additional funds or corporate
collaborations to pursue development and commercialization of its products.

    During 1997, the Company obtained an exclusive option to license a product
for the treatment and prevention of liver diseases. The option grants
Interneuron the right to license, on specified terms, North American and Asian
marketing rights to an issued U.S. patent and U.S. and international patents
applications, following Interneuron's review of future clinical data. This
orally-administered compound is being studied in a large U.S. government-
sponsored Phase 3 clinical trial. Eight hundred patients have been enrolled in
the study, which is expected to be completed in mid-2000, provided the study's
Data Safety Monitoring Board deems sufficient data has been obtained in the
follow-up period.

    The Company is continuing to conduct preliminary evaluations of PACAP, a
compound licensed from Tulane University in April 1998 that, among other
indications, may have potential as a treatment for stroke, and of LidodexNS, a
product for the acute intra-nasal treatment of migraine headaches being
developed pursuant to a collaborative agreement with Algos Pharmaceutical
Corporation.

    There can be no assurance that results of any on-going current or future
preclinical or clinical trials will be successful, that additional trials will
not be required, that any drug under development will receive FDA approval in a
timely manner or at all, or that such drug could be successfully manufactured in
accordance with cGMP or marketed in a timely manner or at all, or that the
Company will have sufficient funds to commercialize any of its products, any of
which events could materially adversely affect the Company.

    Analysis of Cash Flows
    ----------------------  

    Cash used by operating activities during the six months ended March 31, 1999
of $24,169,000 consisted primarily of a net loss of $22,319,000.

    Cash provided by investing activities of $22,238,000 during the six months
ended March 31, 1999 consisted of net proceeds from maturities and sales of
marketable securities of $22,516,000 less purchases of property and equipment of
$278,000.

                                      -20-
<PAGE>
 
     Other
     -----

          Year 2000 Issue:

                    General

     The Year 2000 issue is the result of the failure of hardware or software
components to handle properly dates which occur on or after January 1, 2000
including leap years, the failure to handle properly all manipulations of time
related information and the failure to store century information in a non-
ambiguous format (i.e., storing years with 2 digits rather than 4 digits). These
failures could result in system failure or miscalculations causing disruptions
in processing transactions or creating incorrect data used in the operations of
the business.

     While Interneuron and each of its subsidiaries use certain similar internal
systems, each operates its systems independently from the other. The Company
does not envision a Year 2000 issue at Progenitor or InterNutria because their
respective businesses have been discontinued. To the extent Intercardia
maintains certain systems that are the same or similar to Interneuron's,
Interneuron and Intercardia are collaborating to ascertain their Year 2000
compliance to the extent each company deems necessary. The Company does not
believe it has a risk of loss of significant revenues due to the Year 2000 issue
because no pharmaceutical products will have attained FDA approval prior to the
year 2000 and because the Company currently anticipates marketing and sales
fulfillment to be conducted by a licensee. A factor in the selection of
potential licensees will be their ability to demonstrate Year 2000 compliance.

                           Systems Assessment

     Interneuron's and Intercardia's internal systems are similar and comprised
primarily of purchased or leased software. Neither company develops or maintains
any significant proprietary software or hardware systems. Interneuron and
Intercardia utilize numerous operationally-related non-IT systems. These include
telephone systems, pagers, and security alarm systems. Intercardia, through IRL,
owns laboratory equipment with embedded microprocessors and software.

     Also, Interneuron and Intercardia subcontract a substantial portion of
their research and development activities to external vendors, including
contract research organizations, and rely on the systems of these vendors for
data and information that may be date sensitive. To the extent that the systems
of these subcontractors produce incorrect information or cause incorrect
interpretation of the information that they produce, Interneuron and Intercardia
are at risk for making invalid conclusions about the nature, efficacy, or safety
of their products or technologies which could lead to abandoning potentially
lucrative products or technologies or invalidly continuing development and
pursuing FDA approval of others.

     Interneuron and Intercardia are ascertaining Year 2000 compliance of their
primary internal software systems, operationally - related systems, equipment
with embedded microprocessors, and subcontractors through vendor inquiry and
obtaining written assertions of Year 2000 compliance from each. Interneuron has
obtained letters from its primary internal software vendors and certain
subcontractors that purport their current belief of Year 2000 compliance and
generally indicate continued efforts to assess Year 2000 issues. During 1999,
the Company will continue and complete its review of all significant above-noted
vendors and seek to obtain letters of Year 2000 compliance. If such letters
cannot be obtained on a timely basis, Interneuron and Intercardia will assess
the potential risks in each instance and determine the appropriate actions. Such
action may include the replacement of software, equipment, or the subcontractor.
Interneuron 

                                      -21-
<PAGE>
 
and Intercardia will continue during 1999 to monitor vendors and subcontractors
who have provided letters of Year 2000 compliance for any notices or information
that contradict earlier assertions of Year 2000 compliance.

                           Costs and Contingencies

     To date, Interneuron and Intercardia have expended only internal costs to
assess the Year 2000 issue. Letters of Year 2000 compliance from internal
software providers tend to indicate Interneuron and Intercardia will not be
exposed to any material amounts for replacements of such systems, however there
can be no assurance of this. Also, it is not yet possible to ascertain if any
expenditure will be required to replace systems, subcontractors or the work
performed by such subcontractor. While vendor assurances and internal testing
are useful in assessing Year 2000 issues, neither can provide absolute assurance
that no Year 2000 problems will or can occur. During 1999, Interneuron and
Intercardia will continue to refine their plans in an attempt to assure the Year
2000 issue will not materially adversely affect their business operations or
financial condition.

     Other:

    In November 1998, pursuant to an agreement with Les Laboratoires Servier to
resolve a withholding tax issue on Redux-related payments to Servier, the
Company paid to the U.S. Internal Revenue Service approximately $1,700,000 for
withholding tax and interest. Servier agreed to reimburse the Company for a
portion of the withholding taxes upon Servier's receipt of a related tax refund
from the French tax authorities. The Company is unable to predict with certainty
whether or when this reimbursement will be obtained.

                                      -22-
<PAGE>
 
    Subsidiaries

    Interneuron had funded the operations of InterNutria through September 30,
1998, at which time the Company adopted a plan to discontinue the operations of
InterNutria. Loss from the discontinued operations of InterNutria represented
approximately 28% and 27% of the Company's consolidated net loss in the three
and six month periods ended March 31, 1998, respectively. Interneuron had also
funded Transcell until May 8, 1998, when the merger of Transcell with and into
Intercardia was completed (the "Transcell Acquisition"). Since the Transcell
Acquisition, the operations previously conducted by Transcell have been
conducted as a division of Intercardia known as IRL. Accordingly, such
operations continue to be reflected in the Company's consolidated financial
statements. Expenses of Intercardia, including IRL (and, in the fiscal 1998
periods, Transcell), continue to constitute a significant part of the Company's
consolidated expenses and, in the six month periods ended March 31, 1999 and
1998, represented approximately 44% and 24%, respectively, of consolidated
research and development and selling, general, and administrative expenses.

    Intercardia:

     As a result of the termination of the Astra Merck Collaboration,
Intercardia has financial responsibility for the remaining estimated 
$12,000,000 to $16,000,000 of U.S. BEXTRA development and NDA preparation
costs. Intercardia does not have sufficient resources to complete development
and commercialization of BEXTRA. Intercardia's funding requirements include
payments to its other collaborative partners, including 40% of development and
marketing costs of bucindolol in the Knoll Territory pursuant to the Knoll
Collaboration, the development of a once-a-day bucindolol formulation, the
operations of IRL previously conducted by Transcell, which merged into
Intercardia in May 1998, and other new technology and product development.
Interneuron currently owns 20% of CPEC and may fund certain bucindolol costs in
accordance with its ownership interest in CPEC. As of March 31, 1999,
Interneuron had paid approximately $1,600,000 to CPEC to fund bucindolol
development.

    Intercardia will require additional financing to fund its operations after
Fiscal 1999 and intends to seek additional financing and corporate
collaborations during fiscal 1999. There can be no assurance such funds or
corporate collaborations will be available on terms acceptable or favorable to
Intercardia, or at all, and any equity financings by Intercardia would dilute
Interneuron's ownership interest in Intercardia. Interneuron owns approximately
61% of the outstanding Intercardia common stock. Interneuron's voting control
over Intercardia may have the effect of delaying or preventing sales of
additional securities or other financing of Intercardia, a sale of Intercardia
or other dilutive activities of Intercardia.

    Intercardia does not have any commitments to obtain any additional funds and
has not established banking arrangements through which it can obtain additional
debt financing. Subsequent to the termination of the Astra Merck collaboration
in September 1998, financial constraints have caused Intercardia to reassess the
allocation of resources among its research and development programs. If
Intercardia is unable to enter into additional collaborations or raise
additional capital to support its current level of operations, Intercardia would
be required to reduce or discontinue one or more of its research and development
programs, or obtain funds through strategic alliances on terms that are not
favorable to Intercardia or its existing stockholders including Interneuron.
Reduction or discontinuation of research and development programs could result
in additional charges to results of operations which would be reflected in the
period of such reduction or discontinuation.

                                      -23-
<PAGE>
 

    Progenitor:

    In December 1998, Progenitor announced its intention to implement an
immediate cessation of operations. Progenitor did not have sufficient funds to
meet its obligations. Progenitor's market valuation had been substantially
reduced and the Company could not viably sell any of its holdings of Progenitor
securities. As a result, as of September 30, 1998, the Company's investment in
Progenitor was reduced to zero.


    General

    The Company's business strategy includes evaluation of various technologies,
product or company acquisitions, licensing and/or financing opportunities and
Interneuron and Intercardia engage from time to time in discussions relating to
such opportunities. Each of Interneuron and Intercardia require additional cash
to fund operations after fiscal 1999 and intends to seek additional financings
and corporate collaborations during fiscal 1999. There can be no assurance
either company will obtain sufficient cash to fund future operations. Any such
initiatives may involve the issuance of securities of Interneuron or
Intercardia, which would dilute existing stockholders, and/or financial
commitments for licensing fees and/or to fund product development, or debt
financing, any of which may adversely affect the Company's consolidated
financial condition or results of operations. The Company's in-licensing
agreements generally require the Company to undertake general or specific
development efforts or risk the loss of the license and/or incur penalties.

    Although Interneuron may acquire additional equity in Intercardia through
participation in financings, purchases from third parties, including open market
purchases and conversion of intercompany debt, equity financings by Intercardia
will likely reduce Interneuron's percentage ownership of Intercardia and funds
held by Intercardia are not generally available to Interneuron.

    PART II - OTHER INFORMATION

    Item 1.  Legal Proceedings
             -----------------           

    Product Liability Litigation

    The Company has been named, together with other pharmaceutical companies, as
a defendant in approximately 1,049 legal actions, many of which purport to be
class actions, in federal and state courts relating to the use of Redux. The
actions generally have been brought by individuals in their own right or on
behalf of putative classes of persons who claim to have suffered injury or who
claim that they may suffer injury in the future due to use of one or more weight
loss drugs including Pondimin (fenfluramine), phentermine and Redux. Plaintiff's
allegations of liability are based on various theories of recovery, including,
but not limited to, product liability, strict liability, negligence, various
breaches of warranty, conspiracy, fraud, misrepresentation and deceit. These
lawsuits typically allege that the short or long-term use of Pondimin and/or
Redux, independently or in combination (including the combination of Pondimin
and phentermine popularly known as "fen-phen"), causes, among other things,
primary pulmonary hypertension, valvular heart disease and/or neurological
dysfunction. In addition, some 

                                      -24-
<PAGE>
 
lawsuits allege emotional distress caused by the purported increased risk of
injury in the future. Plaintiffs typically seek relief in the form of monetary
damages (including economic losses, medical care and monitoring expenses, loss
of earnings and earnings capacity, other compensatory damages and punitive
damages), generally in unspecified amounts, on behalf of the individual or the
class. In addition, some actions seeking class certification ask for certain
types of purportedly equitable relief, including, but not limited to,
declaratory judgments and the establishment of a research program or medical
surveillance fund. On December 10, 1997, the federal Judicial Panel on
Multidistrict Litigation issued an Order allowing for the transfer or potential
transfer of the federal actions to the Eastern District of Pennsylvania for
coordinated or consolidated pretrial proceedings.

    Proposed Settlement of Product Liability Litigation: On September 25, 1998,
the U.S. District Court for the Eastern District of Pennsylvania (the "Court")
preliminarily approved an Agreement of Compromise and Settlement (the
"Settlement Agreement") between Interneuron and the Plaintiffs' Management
Committee, consisting of attorneys designated by the Court to represent
plaintiffs in the multi-district litigation relating to Redux, relating to the
settlement of all product liability litigation and claims against the Company
related to Redux. The Court also conditionally certified a limited fund class
action. The Court order followed a letter of understanding outlining terms of
the settlement announced on September 3, 1998 and execution of the formal
settlement agreement between the Company and the Plaintiffs' Management
Committee.

    On November 3, 1998, the Court issued a stay halting all product liability
litigation, pending and future, in state courts against the Company related to
Redux. This followed the issuance of a similar stay halting Redux product
liability litigation in federal courts on September 3, 1998. These stays will
remain effective until further order of the Court.

    The limited fund class action established by this settlement includes all
persons in the United States who used Redux, and certain other persons such as
their family members, who would be bound by the terms of the settlement.
Membership in the class is mandatory for all persons included within the class
definition. Under the terms of the proposed settlement, class members asserting
claims against Interneuron will be required to seek compensation only from the
settlement fund and their lawsuits against Interneuron will be dismissed. By
agreeing to the proposed settlement, Interneuron does not admit liability to any
plaintiffs or claimants. Under the Settlement Agreement, the released parties
include, among other parties, Interneuron, Boehringer (except for claims arising
from defects in the manufacture or packaging of Redux) and their respective
affiliates and stockholders (in their capacity as stockholders).

    Summary of Settlement Agreement: The settlement agreement requires
Interneuron to deposit a total of approximately $15,000,000 in three
installments into a settlement fund. The first installment of $2,000,000 was
deposited into the settlement fund in September 1998. A second installment of
$3,000,000 is to be made after the settlement agreement is approved by the
Court, which would depend upon the ruling in the Fairness Hearing, which was 
conducted between February 25, 1999 and March 31, 1999 (see below). These
installments, less certain expenses, will be returned to Interneuron if the
settlement does not become final. A third installment of $10,000,000, plus
interest, is to be made after the settlement becomes final.

    In addition, the Settlement Agreement provides for Interneuron to cause all
remaining and available product liability insurance proceeds related to Redux to
be deposited into the settlement fund. As part of the Settlement Agreement,
Interneuron and the Plaintiffs' Management Committee also entered into a Royalty
Agreement. Under the Royalty Agreement, Interneuron agreed to make royalty
payments to the settlement fund, in the total amount of $55,000,000, over a
seven year period beginning after the 

                                      -25-
<PAGE>
 
settlement becomes final. Royalties will be paid at the rate of 7% of gross
sales of Interneuron products sold by Interneuron, 15% of cash dividends
received by Interneuron from its subsidiaries related to product sales, and 15%
of license revenues (including license fees, royalties or milestone payments)
received by Interneuron from a sublicensee related to product sales. All
Interneuron products will be subject to this royalty during the applicable term.
If, at the end of that seven year period, the amount of royalty payments made by
Interneuron is less than $55,000,000, the settlement fund will receive shares of
Interneuron Common Stock ("Royalty Shares") in an amount equal to the unpaid
royalty balance divided by $7.49 per share, subject to adjustment under certain
circumstances such as stock dividends or distributions.

    In the event Interneuron merges with or sells all or substantially all of
its assets to another corporation prior to payment of the $55,000,000 of
royalties, the settlement fund shall be entitled to receive the kind and amount
of shares of stock or other securities or property to which a holder of the
number of shares of Common Stock (calculated based on the unpaid royalty balance
at such time) would have been entitled to at the time of the transaction.
Interneuron has the right of first refusal to purchase Royalty Shares in the
event of any proposed transfer by the settlement fund and any transfers by the
settlement fund must be in accordance with the volume restrictions contained in
Rule 144(e) of the Securities Act of 1933, as amended. In addition, the
settlement fund agreed to vote any Royalty Shares held by it in the same manner
and proportion as the other holders of outstanding securities of Interneuron
entitled to vote on any matter.

    Conditions to Final Settlement: The settlement will not become final until
approved by the Court and the time for filing appeals has passed or all appeals
have been exhausted. In this case, in order to approve the settlement, the Court
must make a determination that the proposed settlement is fair and reasonable
and meets each of the prerequisites for a class action generally, and for a
"limited fund" class action in particular, all as required by the Federal Rules
of Civil Procedure. Pursuant to these rules, notice of the proposed settlement
was provided to potential class members in November, 1998. Between February 25,
1999 and March 5, 1999, the Court conducted a Fairness Hearing to determine
whether the case is properly certifiable as a limited fund class action and, if
so, whether the terms of the Settlement Agreement are fair and reasonable. At
the hearing, the Court heard testimony from various witnesses, received
documentary evidence, and heard oral arguments from the proponents and opponents
of the settlement. The Court has not yet rendered a decision.

    The Company may withdraw from the Settlement Agreement, or the Settlement
Agreement may otherwise terminate, under any of the following conditions: (i)
final approval of the Settlement Agreement is not entered by the Court; (ii)
class certification and/or approval of the Settlement Agreement is overturned on
appeal for any reason; (iii) pending and future litigation against the Company
or any other party released by the Settlement Agreement ("Released Parties") is
not permanently enjoined on the final approval date; (iv) the class action and
all pending multi-district lawsuits against the Released Parties are not
dismissed with prejudice on the final approval date; (v) an order is not entered
by the Court permanently barring contribution and indemnity claims by other
defendants in the diet drug litigation; and (vi) Interneuron is unable to compel
tender of its insurance proceeds.

    On November 20, 1998, December 30, 1998 and February 5, 1999, the Company's
three product liability insurers filed actions against Les Laboratoires Servier
("Servier") and the Company in the Court, pursuant to the federal interpleader
statute. The insurers allege that both Servier and the Company have asserted
claims against commercial excess insurance policies issued by the insurers to
Interneuron with limits of $20,000,000, $5,000,000 in excess of $20,000,000, and
$15,000,000 in excess of $25,000,000, 

                                      -26-
<PAGE>
 
respectively, a portion of which has been used in the Company's defense of the
litigation . The insurers have deposited the available proceeds up to limits of
their policies into the registry of the Court.

    There can be no assurance that after the Fairness Hearing the Court will
approve the settlement, and even if the settlement is approved by the Court,
opponents of the settlement may appeal the Court's opinion to the United States
Court of Appeals for the Third Circuit. In addition, there is a case pending
before the United States Supreme Court (Ortiz v. Fibreboard Corporation et al.)
                                        --------------------------------------
("Ortiz"), that may influence the Court's decision or the outcome of any appeal
that might be taken. Oral argument in the Ortiz case was heard on December 8,
1998 and the Supreme Court is likely to render its opinion between February and
June 1999, which is the end of the current Supreme Court term . Although
factually distinguishable in many respects from the Company's proposed
settlement, Ortiz involves an appeal from a mandatory, putative "limited fund"
class action settlement. There can be no assurance that the Supreme Court's
rulings in Ortiz will not significantly influence, or potentially result in the
overturning of, the Settlement Agreement.

    Future Charges to Operations: The Company will record initial charges to
operations for the estimated fair value of the Company's obligations under the
Settlement Agreement, exclusive of insurance proceeds, at such time as the
Company can determine that it is probable that the conditions to final
settlement have been or will be met, which is expected to be subsequent to the
Court's decision regarding approval of the Settlement Agreement and to the
Supreme Court ruling in Ortiz. The amount of the liability to be recognized by
the Company pursuant to the Settlement Agreement is likely to be significant and
to materially adversely affect the Company's net worth. Additionally, if the
Company records such charges prior to the final settlement date, then on the
date the Settlement Agreement becomes final, the Company will determine if there
was any increase in the fair value of the equity conversion feature of the
Royalty Agreement and record any such increase as an additional charge to
operations. From the date the Company records the charge and related liability
for the settlement and through the term of the Royalty Agreement, the Company
will record charges to accrete the liability attributable to the royalty feature
of the Royalty Agreement up to the amount of royalties the Company expects to
pay pursuant to the Royalty Agreement over the time the Company expects to make
such royalty payments. Payments to be made by the Company pursuant to the
Settlement Agreement could have a material adverse effect on the operations and
financial condition of the Company. See Note E of Notes to Unaudited
Consolidated Financial Statements.

    Securities Litigation

    The Company and certain present or former directors and/or officers of the
Company have been named as defendants in nine lawsuits filed in the United
States District Court for the District of Massachusetts by alleged purchasers of
the Company's Common Stock, purporting to be class actions. The lawsuits claim
among other things, that the Company violated the federal securities laws by
publicly disseminating materially false and misleading statements concerning the
prospects and safety of Redux, resulting in the artificial inflation of the
Company's Common Stock price during various alleged class periods.

    On January 23, 1998, the Court entered an order consolidating all of these
actions for pretrial purposes. The plaintiffs subsequently filed a First Amended
And Consolidated Class Action Complaint [Corrected Version] (the "Complaint")
containing substantially similar substantive allegations against the Company,
one current officer and director and one current director and alleging a class
period of December 16, 1996 through September 15, 1997. The Complaint does not
specify the amount of alleged damages plaintiffs seek to recover. On May 11,
1998, the defendants moved to dismiss the Complaint. On August 14, 1998, the
Company received notice that the defendants' motion to dismiss was denied.

                                      -27-
<PAGE>
 
    The Court has issued procedural orders on that same day establishing
schedules for class certification briefing, fact and expert discovery,
dispositive motions briefing and trial. No class has yet been certified. A case
management conference with the Court is scheduled for late May 1999. Trial is
scheduled for April 2000. The Company is vigorously pursuing its defenses to
these actions.

    General

    Under certain circumstances, the Company may be required to indemnify
Servier, Boehringer Ingelheim Pharmaceuticals, Inc. and American Home Products
Corp., and the Company may be entitled to indemnification by AHP, against
certain claims, damages or liabilities incurred in connection with Redux. The
cross indemnification between the Company and AHP generally relates to the
activities and responsibilities of each company.

    Although the Company maintains certain product liability and director and
officer liability insurance and intends to defend the product liability,
securities and similar actions vigorously, the Company has been required and may
continue to be required to devote significant management time and resources to
these legal actions. Payments under the Settlement Agreement will adversely
affect the Company's financial condition and results of operations. If the
Settlement Agreement is overturned or not made final, the ongoing Redux-related
product liability litigation would then proceed against the Company. In this
event, the existence of such litigation may continue to materially adversely
affect the Company's business, including its ability to obtain sufficient
financing to fund operations. In addition, although the Company is unable to
predict the outcome of any such litigation, in the event the proposed settlement
does not become final and in the event of successful uninsured or insufficiently
insured claims, or in the event a successful indemnification claim was made
against the Company, the Company's business, financial condition and results of
operations could be materially adversely affected. In addition, the costs and
uncertainties associated with these legal actions have had, and may continue to
have, an adverse effect on the market price of the Company's common stock and on
the Company's ability to obtain corporate collaborations or additional financing
to satisfy cash requirements, to retain and attract qualified personnel, to
develop and commercialize products on a timely and adequate basis, to acquire
rights to additional products, and to obtain product liability insurance for
other products at costs acceptable to the Company, or at all, any or all of
which may materially adversely affect the Company's business, financial
condition and results of operations.

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

    The Company's annual meeting of stockholders was held on March 16, 1999. At
the meeting (i) all ten director nominees were elected; and (ii) the appointment
of PricewaterhouseCoopers LLP as the independent auditors was ratified.

    (i)  The following Directors were elected for a one-year term by the votes
indicated:

    Lindsay A. Rosenwald, M.D., 32,575,236 for, 357,301 against; Glenn L.
Cooper, M.D., 32,577,249 for, 355,288 against; Harry J. Gray, 32,576,749 for,
355,788 against; Alexander M. Haig, Jr., 32,561,874 for, 370,663 against; Peter
Barton Hutt, 32,263,349 for, 669,188 against; Malcolm Morville, Ph.D.,
32,578,249 for, 354,288 against; Robert K. Mueller, 32,576,849 for, 355,688
against; Lee J. Schroeder, 32,577,349 for, 355,688 against; David B. Sharrock,
32,264,349 for, 668,188 against; Richard Wurtman, M.D., 32,264,549 for, 667,988
against.

                                      -28-
<PAGE>
 
    (ii) The appointment of PricewaterhouseCoopers LLP was ratified by a vote of
32,816,921 for, 73,921 against, and 41,695 abstaining.

    Item 6. Exhibits and Reports on Form 8-K
            --------------------------------
    (a)  Exhibits

         10.102  -   Employment Agreement between Interneuron Pharmaceuticals,
                     Inc. and Michael W. Rogers dated and effective as of
                     February 23, 1999.
         10.103  -   Employment Agreement between Interneuron Pharmaceuticals,
                     Inc. and Bobby W. Sandage, Jr. dated and effective as of
                     March 15, 1999.
         10.104  -   Employment Agreement between Interneuron Pharmaceuticals,
                     Inc. and Mark S. Butler dated and effective as of March 15,
                     1999.
         10.105  -   Employment Agreement between Interneuron Pharmaceuticals,
                     Inc. and Glenn L. Cooper, M.D. dated and effective as of
                     May 1, 1999.
         10.106  -   Agreement of Sublease between Interneuron Pharmaceuticals,
                     Inc., Sublandlord and Genta, Inc., Subtenant dated March
                     31, 1999.
         10.107  -   Consent to Sublease dated March 31, 1999 by and among
                     Ledgemont Realty Trust, Interneuron Pharmaceuticals, Inc.,
                     and Genta, Inc.
            27   -   Financial Data Schedule

    (b)  Reports on Form 8-K

                 The Company did not file any reports on Form 8-K during the
                 three month period ended March 31, 1999.

                                      -29-
<PAGE>
 
                                  SIGNATURES


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


                                    INTERNEURON PHARMACEUTICALS, INC.


    Date: May 13, 1999              By: /s/ Glenn L. Cooper
                                       ----------------------------------------
                                    Glenn L. Cooper, M.D., President
                                    and Chief Executive Officer
                                    (Principal Executive Officer)


    Date: May 13, 1999              By: /s/ Michael W. Rogers
                                       ----------------------------------------
                                    Michael W. Rogers, Executive Vice President,
                                    Chief  Financial Officer, and Treasurer
                                    (Principal Financial Officer)


    Date: May 13, 1999              By: /s/ Dale Ritter
                                       ----------------------------------------
                                    Dale Ritter, Senior Vice President, Finance
                                    (Principal Accounting Officer)

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