<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 December 31, 1998

[ ]  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 February 10, 1999:
Common Stock $.001 par value              41,898,853 shares
<PAGE>
 
                       INTERNEURON PHARMACEUTICALS, INC.

                              INDEX TO FORM 10-Q



<TABLE>
<CAPTION>

PART I.  FINANCIAL INFORMATION                                         PAGE

Item 1. Financial Statements

<S>                                                                     <C>
Consolidated Balance Sheets as of December 31, 1998
  and September 30, 1998..............................................    3

Consolidated Statements of Operations for the Three Months
  ended December 31, 1998 and 1997....................................    4

Consolidated Statements of Cash Flows for the Three Months
  ended December 31,  1998 and 1997...................................    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............................................   23

Item 6.  Exhibits and Reports on Form 8-K.............................   28

SIGNATURES............................................................   29
</TABLE>

                                      -2-
<PAGE>
 
Item 1.  Financial Statements

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

<TABLE>
<CAPTION>
                                                                                December 31,    September 30,
                                                                                    1998             1998
                                                                                -------------   --------------
 
                                                    ASSETS
<S>                                                                             <C>             <C>
Current assets:
     Cash and cash equivalents                                                     $  32,325        $  39,330
     Marketable securities                                                            24,688           28,877
     Accounts receivable                                                                 443            1,273
     Prepaids and other current assets                                                 1,888            1,116
                                                                                   ---------        ---------
             Total current assets                                                     59,344           70,596
 
Marketable securities                                                                  2,042            3,825
Property and equipment, net                                                            3,666            3,691
Other assets                                                                              84               85
                                                                                   ---------        ---------
                                                                                   $  65,136        $  78,197
                                                                                   =========        =========
 
                                                LIABILITIES
Current liabilities:
     Accounts payable                                                              $   1,583        $   1,334
     Accrued expenses                                                                 25,773           27,008
     Current portion of notes payable and capital lease obligations                      662              837
                                                                                   ---------        ---------
             Total current liabilities                                                28,018           29,179
 
Long-term portion of notes payable and capital lease obligations                       1,712            1,663
 
Minority interest                                                                      5,328            7,499
 
 
                                            STOCKHOLDERS' EQUITY
 
Preferred stock; $.001 par value, 5,000,000 shares authorized;
     Series B, 239,425 shares issued and outstanding at December 31
     and September 30, 1998, respectively (liquidation preference at 
     December 31, 1998 $3,034)                                                         3,000            3,000
     Series C, 5,000 shares issued and outstanding at December 31 and
     September 30, 1998, respectivey (liquidation preference at 
     December 31, 1998 $503)                                                             500              500
Common stock; $.001 par value, 80,000,000 shares authorized;
     41,817,017 shares  issued and outstanding at December 31 and
     September 30, 1998, respectively                                                     42               42
Additional paid-in capital                                                           269,606          268,278
Accumulated deficit                                                                 (243,081)        (231,996)
Unrealized net gain on marketable securities                                              11               32
                                                                                   ---------        ---------
     Total stockholders' equity                                                       30,078           39,856
                                                                                   ---------        ---------
                                                                                   $  65,136        $  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 months ended December 31, 1998 and 1997
                                  (Unaudited)
                 (Amounts in thousands except per share data)
<TABLE>
<CAPTION>
 
                                                                Three months ended December 31,
                                                               ---------------------------------
                                                                   1998                   1997
                                                                ---------              ---------
<S>                                                           <C>                      <C>
Contract and license fee revenues                              $    691                 $    654
                                                                                       
Costs and expenses:                                                                    
Research and development                                         11,653                    8,411
Selling, general and administrative                               3,245                    7,569
Purchase of in-process research and development                       -                      500
                                                               --------                 --------
     Total costs and expenses                                    14,898                   16,480
                                                               --------                 --------
                                                                                       
Net loss from operations                                        (14,207)                 (15,826)
                                                                                       
Investment income, net                                              777                    1,831
Equity in net loss of unconsolidated subsidiary                       -                     (893)
Minority interest                                                 2,345                      595
                                                               --------                 --------
                                                                                       
Net loss from continuing operations                             (11,085)                 (14,293)
                  
Discontinued operations:                                                               
Loss from operations of InterNutria                                   -                   (4,841)
                                                               --------                 --------
                                                                                       
Net loss                                                       $(11,085)                $(19,134)
                                                               ========                 ========
                                                                                       
Net loss per common share - basic and diluted:                                         
                                                                                       
Net loss from continuing operations                              ($0.27)                  ($0.35)
Net loss from discontinued operations                                 -                   ($0.12)
Net loss per common share                                        ($0.27)                  ($0.46)
                                                                                       
Weighted average common shares outstanding                       41,817                   41,166
                                                               ========                 ========
</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 three months ended December 31, 1998 and 1997
                                  (Unaudited)
                            (Amounts in thousands)
                                        
<TABLE>
<CAPTION>
                                                                           Three months ended
                                                                              December 31,
                                                                         -----------------------
                                                                            1998         1997
                                                                         ----------   ----------
 
Cash flows from operating activities:
<S>                                                                      <C>          <C>
     Net loss                                                             $(11,085)    $(19,134)
     Adjustments to reconcile net loss to net cash
          (used) by operating activities:
         Depreciation and amortization                                         290          346
         Minority interest in net loss of consolidated subsidiaries         (2,345)        (595)
         Equity interest in net loss of unconsolidated subsidiary                -          893
         Noncash compensation                                                1,463        4,801
     Change in assets and liabilities:
         Accounts receivable                                                   830         (431)
         Prepaid and other assets                                             (772)         531
         Inventory                                                               -         (161)
         Accounts payable                                                      249          293
         Deferred revenue                                                        -         (250)
         Accrued expenses and other liabilities                             (1,246)     (11,544)
                                                                          --------     --------
Net cash (used) by operating activities                                    (12,616)     (25,251)
                                                                          --------     --------
 
Cash flows from investing activities:
     Capital expenditures                                                     (265)        (433)
     Purchase of marketable securities                                      (2,520)     (13,240)
     Proceeds from maturities and sales of marketable securities             8,471       18,704
                                                                          --------     --------
Net cash provided by investing activities                                    5,686        5,031
                                                                          --------     --------
 
Cash flows from financing activities:
     Net proceeds from issuance of common and treasury stock                     -           69
     Net proceeds from issuance of stock by subsidiaries                        49           52
     Principal payments of capital lease obligations                           (91)        (221)
     Principal payments of notes payable                                       (33)          (3)
                                                                          --------     --------
Net cash (used) by financing activities                                        (75)        (103)
                                                                          --------     --------
 
Net change in cash and cash equivalents                                     (7,005)     (20,323)
Cash and cash equivalents at beginning of period                            39,330       55,820
                                                                          --------     --------
 
Cash and cash equivalents at end of period                                $ 32,325     $ 35,497
                                                                          --------     ========
</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 E).  All significant intercompany activity has been
eliminated.

B:  Recent Accounting Pronouncements
    --------------------------------

    The Company will adopt Statement of Financial Accounting Standards ("SFAS")
No.  131, "Disclosures about Segments of an Enterprise and Related  Information"
("SFAS No. 131"), at fiscal year end September 30, 1999. SFAS No. 131
specifies revised guidelines for determining an entity's operating segments and
the type and level of financial  information to be disclosed. Management has not
determined the effect of adopting SFAS No. 131.

    The Company will adopt SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), in the fiscal year ending September 30,
2000.  SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging activities.
SFAS 133 requires companies to recognize all derivatives as either assets or
liabilities, with the instruments measured at fair value.  The accounting for
changes in fair value, gains or losses, depends on the intended use of the
derivative and its resulting designation.  Management has not determined the
effect of adopting SFAS 133.

                                      -6-
<PAGE>
 
CC: 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 December 31,
                                            ----------------------------------
                                                  1998              1997
                                            ----------------   ---------------
     <S>                                     <C>                <C>
      Numerator for basic and diluted:
      Net loss                                 $(11,085,000)     $(19,134,000)
                                               ============      ============
 
      Denominator for basic and diluted:
      weighted average shares outstanding        41,817,000        41,166,000
                                               ============      ============
 
      Net loss per common share - basic        $      (0.27)     $      (0.46)
                                               ============      ============
 
      Net loss per common share - diluted      $      (0.27)     $      (0.46)
                                               ============      ============
</TABLE>

    During the three month period ended December 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 6,314,508 shares of Common Stock at prices
ranging from $3.56 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 three month period ended December
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 17,400 shares of Common
Stock at prices ranging from $0.83 to $3.13 with expiration dates ranging up to
August 3, 2005; (ii) Series B and C preferred stock convertible into 622,222
shares of Common Stock; and (iii) unvested Restricted Stock Awards to acquire
725,146 shares of Common Stock granted pursuant to the Company's 1997 Equity
Incentive Plan.

    During the three month period ended December 31, 1997, 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 4,874,376 shares of Common Stock at prices
ranging from $9.50 to $32.00 with expiration dates ranging up to October 6,
2007; (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 December
31, 1997, 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 2,172,573 shares of Common
Stock at prices ranging from $0.83 to $8.75 with expiration dates ranging up to
May 24, 2005; (ii) warrants to purchase 203,657 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 to
acquire 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.

                                      -7-
<PAGE>
 
D.  Comprehensive Income
    --------------------

    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
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 are net income and all other nonowner changes in equity
such as the change in the unrealized net gain on marketable securities.
Presentation of comprehensive income for earlier periods is provided for
comparative purposes.  Comprehensive income for the three month periods ended
December 31, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
 
                                              1998            1997
                                          -------------   -------------
    <S>                                   <C>             <C>
 
    Net loss                              $(11,085,000)   $(19,134,000)
    Change in unrealized net gain on
       marketable securities                   (21,000)        (48,000)
                                          ------------    ------------
     Comprehensive income                 $(11,106,000)   $(19,182,000)
                                          ============    ============
</TABLE>

E.  Subsidiaries
    ------------

Progenitor:

    In December 1998, Progenitor announced its intention to implement an
immediate cessation of operations. Prognitor did not have sufficient funds to
meet its obligations and was unable to raise additional funds. 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 on the statement of
operations. The Company is seeking to sell InterNutria or all or part of its
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.

                                      -8-
<PAGE>
 
    The Company has reclassified its prior year statement of operations to
reflect the operating results of InterNutria as discontinued operations.
Operating results of InterNutria, exclusive of interest on intercompany debt
which was eliminated in consolidation, for the three month period ended December
31, 1997 is as follows:

               Revenues                      $    987,000
               Operating expenses               5,802,000
                                             ------------
               Net loss from operations        (4,815,000)
               Interest expense                   (26,000)
                                             ------------
               Net loss                      $ (4,841,000)
                                             ============


F.  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 956 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.

    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 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 a fairness hearing scheduled for February 25,
1999 and may be extended pending the outcome of this hearing.

    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.  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.

                                      -9-
<PAGE>
 
    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 approval, if obtained,
would follow the fairness hearing.  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 a Royalty Agreement (the "Royalty Agreement")
which is part of the Settlement Agreement, in the total amount of $55,000,000,
based upon revenues related to Interneuron products, 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.   The Company 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 provided to potential class members in November 1998, and the
Court has scheduled a Fairness Hearing for February 25, 1999 (the "Fairness
Hearing").  At the Fairness Hearing, proponents and opponents of the proposed
settlement will be given an opportunity to present written and oral arguments in
favor of or against the settlement. Following the Fairness Hearing, the Court
must determine if the case is properly certified as a limited fund class action,
and if so, whether the terms of the Settlement Agreement are fair and
reasonable.

    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 and on December 30, 1998, two of the insurers filed an
action against Les Laboratoires Servier ("Servier") and the Company in the
Court, pursuant to the federal interpleader statute.

                                      -10-
<PAGE>
 
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 $5,000,000 in excess of $20,000,000 and $15,000,000
in excess of $25,000,000, respectively. The insurers have deposited the 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.  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. 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 Fairness Hearing 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 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,
financial condition and results of operations.
 
    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.

                                      -11-
<PAGE>
 
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.

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 956 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.

                                      -12-
<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 in federal courts on September 3, 1998.  These
stays will remain effective until a fairness hearing scheduled for February 25,
1999 and may be extended pending the outcome of this hearing.

    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.  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 approval, if obtained,
would follow the fairness hearing.  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, based upon revenues related
to Interneuron products, 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.

    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,
and the Court has scheduled a fairness hearing for February 25, 1999 (the

                                      -13-
<PAGE>
 
"Fairness Hearing").  At the Fairness Hearing, proponents and opponents of the
proposed settlement will be given an opportunity to present written and oral
arguments in favor of or against the settlement. Following the Fairness Hearing,
the Court must determine if the case is properly certified as a limited fund
class action, and if so, whether the terms of the Settlement Agreement are fair
and reasonable.

    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 and on December 30, 1998, two of the insurers filed an
action 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
$5,000,000 in excess of $20,000,000 and $15,000,000 in excess of $25,000,000,
respectively.  The insurers have deposited the 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. 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. 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 been or  will be met. This is expected to be subsequent to the
Fairness Hearing 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

                                      -14-
<PAGE>
 
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 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, financial condition and results of operations.

    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 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 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 in fiscal 1998 and does not expect to
realize any future revenues related to Redux.

Citicoline

    In April 1998, the Company announced that based upon a preliminary analysis,
a 100-patient Phase 3 trial with citicoline (cytidine-5'-diphosphate choline,
sodium), the Company's product under development to treat

                                      -15-
<PAGE>
 
ischemic stroke, failed to meet its primary and the principal secondary
endpoints. As a result of the preliminary analysis and considering statutory
requirements that would have mandated an FDA action by June 1998, the Company
withdrew its New Drug Application ("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 and a fast-track
designation indicates that the FDA has determined a drug is intended to treat a
serious or life-threatening condition that currently has an unmet medical need
and that the FDA can take actions to expedite the development and review of the
drug.  There can be no assurance that any resubmission of a citicoline NDA would
be assigned a priority review status.

    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 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 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.

    As of December 31, 1998, 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
$26,000,000. 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 reevaluating 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.

    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

                                      -16-
<PAGE>
 
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
relating to pagoclone, including  license fees to Rhone-Poulenc Rorer
Pharmaceuticals, Inc. ("RPR"), and NDA preparation to be approximately
$44,000,000, 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 intends to seek a corporate
collaboration or additional funds 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 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 and 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.

                                      -17-
<PAGE>
 
Results of Operations
---------------------

    Revenues, consisting of contract and license fee revenue, increased $37,000,
or 6%, to $691,000 in the three month period ended December 31, 1998 from
$654,000 in the three month period ended December 31, 1997. Contract and license
fee revenue in fiscal 1998 consisted primarily of 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 and in
fiscal 1997 related primarily to research support pursuant to an agreement with
Merck and Co., Inc. related to product development at Intercardia Research
Laboratories ("IRL"), formerly conducted by Transcell Technologies, Inc.
("Transcell").

    Research and development expense increased $3,242,000, or 39%, to
$11,653,000 in the three month period ended December 31, 1998 from $8,411,000 in
the three month period ended December 31, 1997. This increase was primarily due
to increased expenses incurred by Intercardia including (i) approximately
$1,800,000 for BEXTRA(R) for European development costs and U.S. clinical
development costs previously assumed by Astra Merck and (ii) approximately
$1,100,000 of increased expenses associated with the carbohydrate chemistry
program of IRL. In addition, the Company incurred increased expenses related to
the 900-person phase 3 clinical trial for citicoline, which commenced in June
1998, which were partially offset by reduced noncash compensation expense
related to the Company's 1997 Equity Incentive Plan and the absence of expense
in fiscal 1999 for the Redux-related echocardiogram study.

    Selling, general and administrative expense decreased $4,324,000, or 57%, to
$3,245,000 in the three month period ended December 31, 1998 from $7,569,000 in
the three month period ended December 31, 1997. This decrease resulted primarily
from reduced noncash compensation expense related to the Company's 1997 Equity
Incentive Plan, the absence of costs of the Company's  sales force resulting
from its May 1998 dismissal, the absence of citicoline pre-marketing expenses
that were incurred in fiscal 1998 and Intercardia's elimination of duplicative
Transcell-related administrative expenses subsequent to the May 1998 merger of
Transcell with and into Intercardia.  In the quarter ended December 31, 1998,
the Company launched its AnatoMark head reference system.  The Company does not
expect to generate profits from AnatoMark in the near future.

    Investment income decreased $1,054,000, or 58%, to $777,000 in the three
month period ended December 31, 1998 from $1,831,000 in the three month period
ended December 31, 1997 primarily due to lower balances of cash and marketable
securities resulting from funds used in Company operations.

    There was no provision for equity in net loss of unconsolidated subsidiary,
Progenitor,  in the three month period ended December 31, 1998, compared to a
provision of $893,000 in the three month period ended December 31, 1997, as the
Company wrote-down to zero its investment in Progenitor in the fiscal year ended
September 30, 1998 as a result of Progenitor's December 1998 decision to cease
operations. (See Note E of Notes to Unaudited Consolidated Financial
Statements.)

                                      -18-
<PAGE>
 
    Minority interest increased $1,750,000, or 294%, to $2,345,000 in the three
month period ended December 31, 1998 from $595,000 in the three month period
ended December 31, 1997. 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 first
quarter of fiscal 1999 relating to InterNutria compared to a net loss of
$4,841,000 in the first quarter of fiscal 1998, which 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 month period ended December 31, 1998 were accrued
at September 30,1998.

    For the reasons described above, net loss decreased $8,049,000, or 42%, to
$11,085,000 in the three month period ended December 31, 1998 from $19,134,000
in the three month period ended December 31, 1997.

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

    Cash, Cash Equivalents and Marketable Securities

    At December 31, 1998, the Company had consolidated cash, cash equivalents
and marketable securities aggregating $59,055,000 (of which approximately
$17,973,000 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 $12, 616,000 used to fund operations in the three
month period ended December 31, 1998 (of which approximately $5,600,000 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 prior to such time.  The Company will require 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 are not available, the Company will be required 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,
if at all.

    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 intends to seek 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,

                                      -19-
<PAGE>
 
Intercardia is developing BEXTRA for congestive heart failure and requires
additional funds to 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. The study is designed
to have periodic interim analysis which could lead to earlier termination if a
significant positive drug effect is identified.

    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 three months ended December 31,
1998 of $12,616,000 consisted primarily of  a net loss of $11,085,000.

    Cash provided by investing activities of $5,686,000 during the three months
ended December 31, 1998 consisted of net proceeds from maturities and sales of
marketable securities of $5,951,000 less purchases of property and equipment of
$265,000.

    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 uses certain similar internal
systems, each operates their systems independently from the other.  The Company
does not envision a Year 2000 issue at Progenitor or

                                      -20-
<PAGE>
 
InterNutria because their respective businesses will be discontinued prior to
the year 2000. To the extent Intercardia maintains certain systems that are the
same or similar to Interneuron's, Interneuron and Intercardia intend to
collaborate 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 intend to ascertain 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 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.

                                      -21-
<PAGE>
 
     Recent Accounting Pronouncements:

    The Company will adopt SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", at fiscal year end September 30, 1999.
SFAS No. 131 specifies revised guidelines for determining an entity's operating
segments and the type and level of financial information to be disclosed.
Management has not determined the effect of adopting SFAS No. 131.

    The Company will adopt SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities", in the fiscal year ending September 30, 2000. SFAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities. SFAS 133
requires companies to recognize all derivatives as either assets or liabilities,
with the instruments measured at fair value. The accounting for changes in fair
value, gains or losses, depends on the intended use of the derivative and its
resulting designation. Management has not determined the effect of adopting 
SFAS 133.

          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.

    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 25% of the Company's consolidated net loss in the three month 
period ended December 31, 1997. 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 1997 period, Transcell), continue to constitute a
significant part of the Company's consolidated expenses and, in the three month
periods ended December 31, 1998 and 1997, represented approximately 43% 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 resumed financial responsibility for the remaining estimated $12,000,000 to
$17,000,000 of BEXTRA U.S. development and NDA preparation costs. There is no
assurance that Intercardia will have sufficient resources to complete
development of BEXTRA. Intercardia's other 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 may fund up to 20%
of certain bucindolol costs in order to maintain its approximately 20% ownership
interest in CPEC.

    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 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 62% of the outstanding
Intercardia common stock. Interneuron's voting control over Intercardia may have
the effect of delaying or preventing sales of additional securities of
Intercardia or a sale of Intercardia or other change of control supported by the
other stockholders of Intercardia.


                                      -22-
 
 

<PAGE>
 
          InterNutria:

    In September 1998, the Company adopted a plan to discontinue the operations
of InterNutria. The Company is seeking to sell InterNutria or its assets.
However, there can be no assurance the Company will be successful or that the
Company will generate any significant proceeds from any sale.

          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 and was unable to raise additional funds. 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
(including private placements and initial and follow-on equity offerings), and
Interneuron and Intercardia engage from time to time in discussions relating to
such opportunities. In particular, each of Interneuron and Intercardia require
additional cash to fund operations after fiscal 1999 and intend 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,
either 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 956 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,

                                      -23-
<PAGE>
 
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 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.  A fairness hearing on the settlement has been scheduled for February
25, 1999.

    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 the fairness hearing scheduled for February 25, 1999 and
may be extended pending the outcome of this hearing.

    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 follow the fairness hearing. These installments, less certain
expenses, will be returned to Interneuron if the

                                      -24-
<PAGE>
 
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 proposed settlement 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, based upon
sales of Interneuron products and other revenues, over a seven year period
beginning after 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 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, and the Court has
scheduled a Fairness Hearing for February 25, 1999 (the "Fairness Hearing").  At
the Fairness Hearing, proponents and opponents of the proposed settlement will
be given an opportunity to present written and oral arguments in favor of or
against the settlement.  Following the Fairness Hearing, the Court must
determine if the case is properly certified as a limited fund class action, and
if so, whether the terms of the Settlement Agreement are fair and reasonable.

    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

                                      -25-
<PAGE>
 
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 and on December 30, 1998, two of the insurers filed an
action against 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 a commercial excess insurance policies issued by the
insurers to Interneuron with limits of $5,000,000 in excess of $20,000,000 and
$15,000,000 in excess of $25,000,000, respectively. The insurers have deposited
the 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. 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
Fairness Hearing 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 F 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 disseminated 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.

                                      -26-
<PAGE>
 
    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.

    The Court held a Case Management Conference on September 23, 1998, and
issued a procedural order on that same day establishing a schedule for class
certification briefing, fact and expert discovery, dispositive motions briefing
and trial. 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.

                                      -27-
<PAGE>
 
  Item 6.      Exhibits and Reports on Form 8-K
               ---------------------------------

          (a)  Exhibits

                 27 Financial Data Schedule

          (b)  Reports on Form 8-K
 
                 On October 2, 1998, the Company filed a report on Form 8-K
                 reporting information under "Item 5 - Other Events" relating to
                 preliminary approval of the Settlement Agreement.



                                      -28-
<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: February 10, 1999
                                  By: /s/ Glenn L. Cooper
                                     ---------------------------------
                                     Glenn L. Cooper, M.D., President
                                     and Chief Executive Officer
                                     (Principal Executive Officer)



Date: February 10, 1999
                                  By: /s/ Dale Ritter
                                     ---------------------------------
                                     Dale Ritter, Senior Vice President, Finance
                                     (Principal Accounting Officer)

                                      -29-