<PAGE>   1
 
================================================================================
 
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                               ------------------
 
   
                                  FORM 10-K/A
    
 
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
                        COMMISSION FILE NUMBER: 0-23736
 
                               ------------------
 
                         GUILFORD PHARMACEUTICALS INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                           <C>
                   DELAWARE                                     52-1841960
       (STATE OR OTHER JURISDICTION OF                        (IRS EMPLOYER
        INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NO.)
</TABLE>
 
                             6611 TRIBUTARY STREET
                           BALTIMORE, MARYLAND 21224
                                 (410) 631-6300
         (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
                                                        
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE              
                                                        
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                          COMMON STOCK, $.01 PAR VALUE 
                                 TITLE OF CLASS
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.  Yes  X      No __
 
   
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [  ]
    
 
   
     As of March 7, 1997, the aggregate value of the 14,803,393 shares of Common
Stock of the Registrant issued and outstanding on such date, excluding 3,003,839
shares held by all affiliates of the Registrant, was approximately $333,337,401.
This figure is based on the closing sales price of $28.25 per share of the
Registrant's Common Stock as reported on the Nasdaq National Market System on
February 27, 1997.
    
 
   
     Number of shares of Common Stock outstanding as of February 28,
1997: 14,803,393
    
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     List hereunder the following documents incorporated by reference and the
Part of the Form 10-K into which the document is incorporated:
 
     None
================================================================================
<PAGE>   2
 
                                     PART I
 
ITEM 1.  BUSINESS.
 
OVERVIEW
 
   
     Guilford Pharmaceuticals Inc. (together with its subsidiaries, "Guilford"
or the "Company") is a biopharmaceutical company engaged in the development and
commercialization of novel products in two principal areas: (i) targeted and
controlled drug delivery systems using proprietary biodegradable polymers for
the treatment of cancer and other diseases; and (ii) therapeutic and diagnostic
products for neurological diseases and conditions.
    
 
     The Company's first product in its drug delivery business is GLIADEL(R)
wafer ("GLIADEL"), a novel treatment for glioblastoma multiforme, the most
common and rapidly fatal form of brain cancer. GLIADEL was cleared for marketing
by the United States Food and Drug Administration ("FDA") in September 1996 for
use as an adjunct to surgery to prolong survival in patients with recurrent
glioblastoma multiforme for whom surgical resection is indicated. GLIADEL was
commercially launched in the United States on February 25, 1997 by the Company's
marketing partner, RPR. Rhone-Poulenc Rorer Pharmaceuticals, Inc. (together with
its parent, Rhone-Poulenc Rorer, Inc., "RPR") is submitting marketing
applications in other countries and the Company and RPR are planning further
clinical trials of GLIADEL to seek to expand its labeling. The Company also
intends to broaden its line of polymer-based oncology products through the use
of other chemotherapeutic agents, different polymer systems and various
formulations, and may also consider developing polymer drug delivery for other
applications.
 
     The Company's lead neurological product candidate is DOPASCAN(R) Injection
("DOPASCAN"), a radiolabeled tropane derivative that is being developed for the
diagnosis and monitoring of Parkinson's disease. The Company has completed
enrollment in a multi-center Phase II clinical trial of DOPASCAN in the United
States and is preparing to commence Phase III clinical trials later this year.
The Company also is developing other neurological product candidates, including:
(i) neurotrophic drugs to promote nerve growth and repair, which may have
applications for spinal cord injuries, peripheral neuropathies and
neurodegenerative diseases, such as Alzheimer's disease and Parkinson's disease;
(ii) neuroprotective drugs to reduce neuronal damage due to stroke or severe
head trauma; and (iii) drugs to treat addictive disorders.
 
   
     Future sales of GLIADEL are subject to certain risks, including the
following. The Company's agreements with RPR do not impose any minimum purchase
requirements on the part of RPR, and there can be no assurance that RPR will be
successful in marketing and selling GLIADEL. GLIADEL represents a novel approach
to the treatment of brain cancer, and there can be no assurance of broad
acceptance by the medical or patient communities. The Company currently relies
on a single supplier for BCNU, the chemotherapeutic agent used in GLIADEL, and
on a single manufacturing facility to produce GLIADEL. Inability to secure
timely, sufficient, or Good Manufacturing Practices ("GMP") quality supply of
BCNU, unforeseen plant shutdowns due to personnel or plant or equipment
problems, risks associated with regulatory compliance (including the need to
manufacture GLIADEL in accordance with the FDA's GMP regulations), and the
potential inability to meet future product demand, among others, could adversely
affect the timing and extent of any future revenues from GLIADEL sales. For
discussion of these and other risks, see the section entitled "Risk Factors" in
the Company's Registration Statement on Form S-3, as amended (File No.
333-23001), initially filed on March 7, 1997 (the "March 1997 Form S-3"),
particularly those paragraphs specifically addressing the aforementioned risks.
    
 
   
     Any statements made by the Company in this annual report that are forward
looking are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Investors are cautioned that these
forward looking statements involve risks and uncertainties that could cause the
actual results to differ from predicted results. Information concerning factors
that could affect such results are set forth herein and in the Company's filings
with the Securities and Exchange Commission, including the March 1997 Form S-3.
    
 
                                       I-1
<PAGE>   3
 
PRODUCT AND DEVELOPMENT PROGRAMS
 
     The following table summarizes the current status of the Company's product,
product candidates and research programs:
 
   
<TABLE>
<CAPTION>
PROGRAM/PRODUCT CANDIDATES    DISEASE INDICATIONS/CONDITIONS            STATUS (1)                   CORPORATE PARTNER
---------------------------   ------------------------------    ---------------------------   -------------------------------
<S>                           <C>                               <C>                           <C>
DRUG DELIVERY BUSINESS
GLIADEL                       Recurrent glioblastoma            Market                        RPR,
  (3.85% BCNU)                multiforme                                                      Orion Farmos (Scandinavia)
                              Initial treatment of malignant    Phase III(2)                  RPR,
                              glioma                                                          Orion Farmos (Scandinavia)
GLIADEL                       Malignant glioma                  Phase I                       RPR,
  (6.5% up to 20% BCNU)                                                                       Orion Farmos (Scandinavia) (3)
Other polymer-based           Various cancers                   Research                      RPR (4)
  products
NEUROLOGICAL PRODUCTS
DOPASCAN                      Imaging agent to diagnose and     Phase II                      DRL (Asia) (5)
                              monitor Parkinson's disease
NEUROTROPHIC DRUGS
Neuroimmunophilin ligands     Nerve growth and repair           Preclinical                   --
                              (Parkinson's disease,
                              Alzheimer's disease, multiple
                              sclerosis, stroke, spinal cord
                              injury and peripheral
                              neuropathies)
NEUROPROTECTIVE DRUGS
Pre-synaptic glutamate        Stroke, severe head trauma,       Research                      --
  inhibitors                  ALS, epilepsy and Parkinson's
                              disease
NOS inhibitor                 Stroke, severe head trauma        Research                      --
PARS inhibitor                Stroke, severe head trauma        Research                      --
ADDICTION THERAPEUTICS
Dopamine transporter ligand   Cocaine addiction                 Research                      --
</TABLE>
    
 
---------------
(1) "Research" includes initial research related to specific molecular targets,
    synthesis of new chemical entities and assay development for the
    identification of lead compounds. "Preclinical" includes testing of lead
    compounds in vitro and in animal models, pharmacology and toxicology
    testing, product formulation and process development prior to the
    commencement of clinical trials.
 
   
(2) A trial is expected to commence in mid-1997.
    
 
   
(3) Orion Farmos has certain rights of first refusal.
    
 
   
(4) RPR has certain rights of first offer.
    
 
   
(5) Japan, Korea and Taiwan.
    
 
   
     Development and commercialization of the Company's product and product
candidates is subject to numerous risks and uncertainties, certain of which are
set forth in this annual report and in the Section entitled "Risk Factors" in
the March 1997 Form S-3.
    
 
DRUG DELIVERY BUSINESS
 
     The Company's drug delivery business currently involves the use of
biodegradable polymers for targeted and controlled drug delivery of
chemotherapeutic drugs to treat cancer. Delivering high drug concentrations
locally for a sustained period of time may increase the efficacy of chemotherapy
in controlling tumor growth
 
                                       I-2
<PAGE>   4
 
and may decrease the side effects associated with systemic drug administration.
Guilford has developed expertise in the discovery, clinical development and
manufacturing of polymer-based drug delivery products.
 
  GLIADEL
 
   
     The Company's first product in its drug delivery business is GLIADEL, a
novel treatment for malignant glioma, the most common and rapidly fatal form of
primary brain cancer. GLIADEL is a white wafer about the size of a dime made of
a proprietary biodegradable polymer which contains the cancer chemotherapeutic
drug BCNU (carmustine). Up to eight GLIADEL wafers are implanted in the cavity
created when a neurosurgeon removes the brain tumor. The wafers gradually
degrade in the cavity and deliver BCNU directly to the tumor site in high
concentrations for an extended period of time without exposing the rest of the
body to the toxic side effects of BCNU. GLIADEL is used to complement standard
therapy with surgery, radiation therapy and systemic chemotherapy in patients
with recurrent glioblastoma multiforme. In a North American Phase III clinical
trial, GLIADEL was shown to increase the six-month survival rate by more than
50% in these patients. The availability of GLIADEL gives physicians a new
treatment option for this rapidly fatal disease.
    
 
   
     On September 23, 1996 the FDA cleared the Company's New Drug Application
("NDA") for GLIADEL for use as an adjunct to surgery to prolong survival in
patients with recurrent glioblastoma multiforme for whom surgery is indicated.
RPR began commercial sale of GLIADEL in the United States on February 25, 1997
through its existing oncology sales force. Prior to launch, GLIADEL was
available to neurosurgeons in the United States through a Treatment
Investigation New Drug application ("Treatment IND") cleared by the FDA. A
Treatment IND protocol is a clinical trial that allows the use of a product
prior to FDA marketing clearance. The Treatment IND protocol was approved in
over 170 hospitals in the United States and more than 450 treatments were
distributed.
    
 
   
     GLIADEL has been studied in trials involving over 650 patients, including
two Phase III multi-center, randomized, double-blind, placebo-controlled
clinical trials. The results of a trial conducted in the United States and
Canada involving 222 patients undergoing surgery for recurrent malignant glioma
were published in the April 22, 1995 issue of The Lancet. Patients received
either GLIADEL or a placebo wafer. This trial examined GLIADEL's additive effect
to survival, adjunctive to the best treatments currently available for brain
cancer, i.e., surgery, radiation therapy and in some cases, systemic
chemotherapy. The survival rate at six months, the primary endpoint, was 47% in
the placebo group and 60% in the GLIADEL group, with an improvement in median
survival of eight weeks (a 35% increase). In this trial which formed the basis
for FDA marketing clearance of the NDA for GLIADEL, the survival rate for 145
patients with recurrent glioblastoma multiforme at six months was 36% in the
placebo group and 56% in the GLIADEL group (a greater than 50% increase) with an
improvement in median survival of eight weeks. These results were statistically
significant after adjustment for prognostic factors, and no clinically important
adverse effects attributable to the drug were reported in either trial.
    
 
   
     In June 1996, the Company entered into a strategic agreement with RPR
granting RPR the worldwide (excluding Scandinavia) rights to market, sell and
distribute GLIADEL. During 1996, RPR paid Guilford $27.5 million in milestone
payments, $7.5 million in an equity investment in Company Common Stock and
extended to the Company a $7.5 million line of credit, which the Company intends
to use to expand its annual manufacturing capacity from 8,000 to 30,000
treatments (each consisting of eight GLIADEL wafers). Under the agreements with
RPR, Guilford receives a combined transfer price and royalty of 35% to 40% of
the net sales of GLIADEL. GLIADEL could earn additional payments totaling up to
$40.0 million (including $7.5 million in the form of an equity investment),
subject to achievement of certain milestone events, including expanded labeling
in the United States to include use of GLIADEL at the time of initial surgery
and international marketing approvals. The Company will be required to pay a
royalty to MIT on sales of GLIADEL pursuant to the license agreement under which
the Company acquired the underlying technology for this product.
    
 
     Guilford and RPR have initiated a series of new clinical trials for the
purpose of seeking to expand the market for GLIADEL. A Phase III randomized,
double-blind, placebo-controlled trial in patients undergoing
 
                                       I-3
<PAGE>   5
 
initial surgery for malignant glioma is planned to commence in mid-1997. In
addition, Guilford has initiated a Phase I clinical trial to test the safety of
escalating the concentration of BCNU in GLIADEL from 3.85% to 20%, following
preclinical studies suggesting that higher concentrations of BCNU in GLIADEL may
be even more effective and appear to be safe.
 
   
     In October 1995, the Company entered into an agreement with Orion Farmos, a
major Scandinavian health care company, for the sales, marketing and
distribution of GLIADEL in Scandinavia. The agreement provides for payments to
Guilford based on GLIADEL sales made by Orion Farmos in Scandinavia. Orion
Farmos has commenced sales of GLIADEL in Scandinavia on a named hospital basis.
    
 
     Other Polymer-Based Drug Delivery Products.  The Company intends to broaden
its line of polymer-based products to include drug delivery products for the
treatment of tumors outside the central nervous system. Other cancers that may
be suitable for this type of targeted therapeutic approach include tumors of the
prostate, ovaries, head and neck, breast, esophagus, liver, pancreas, lung and
colon. In addition, the Company is investigating other polymer systems and
additional configurations such as gels, beads and rods for stereotactic
implantation. As part of this effort, the Company has entered into two research
collaborations with a biomedical engineering laboratory at Johns Hopkins to
discover new polymers and to advise the Company on new product development. In
June 1996, the Company entered into a license agreement with MIT and Johns
Hopkins relating to a patent application claiming certain biodegradable polymers
for use in connection with the controlled local delivery of certain
chemotherapeutic agents (including paclitaxel (Taxol(R)) and camptothecin) for
treating solid tumors. In July 1996, the Company entered into a license
agreement with Johns Hopkins relating to two issued United States patents
relating to polyphosphoesters. In addition, the Company has established a
strategic partnership with RPR to commercialize GLIADEL and evaluate the
opportunity to incorporate RPR's proprietary chemotherapeutics in Guilford's
proprietary polymer systems.
 
NEUROLOGICAL PRODUCTS PROGRAM
 
   
     DOPASCAN.  The Company's lead neurological product candidate is DOPASCAN, a
radiolabeled tropane derivative that is being developed for the diagnosis and
monitoring of Parkinson's disease. DOPASCAN is administered intravenously in
very small quantities and allows physicians to obtain images of dopamine neurons
in the brain. Dopamine neurons are highly concentrated in a specialized area of
the brain that degenerates in Parkinson's disease. Parkinson's disease is a
common neurodegenerative disorder affecting more than 600,000 patients in the
United States. In its early stages, Parkinson's disease can be very difficult to
clinically distinguish from other diseases with similar symptoms but which do
not respond well or at all to specific therapy for Parkinson's disease. In order
to properly treat these patients, it is important to establish an accurate early
diagnosis. Unfortunately there are no diagnostic tests currently available that
can detect the neuronal degeneration in Parkinson's disease and the typical
delay between the onset of symptoms and clinical diagnosis is more than two
years. The only way to establish the diagnosis at present is through repeated
physician visits and the use of therapeutic trials of drugs such as L-Dopa,
which carry with them the risk of unnecessary, sometimes severe, side effects.
    
 
   
     DOPASCAN is administered by a single intravenous injection. The next day,
the patient returns to the hospital and lies under a SPECT camera for about 30
minutes to have images taken. The images obtained with the SPECT camera identify
loss of dopamine neurons in the brain. To date, over 1,000 patients have been
imaged in the United States and Europe using DOPASCAN. In initial United States
Phase II trials DOPASCAN accurately differentiated patients clinically diagnosed
with Parkinson's disease from those without the disease. The Company has
completed enrollment in a multi-center Phase II clinical trial of DOPASCAN in
the United States and expects the study report to be available in the second
quarter of 1997. The Company intends to commence Phase III clinical trials in
North America prior to the end of 1997. In addition, the Company expects to
undertake further clinical trials in Europe to support European regulatory
filings.
    
 
     The Company has entered into an agreement with Daiichi Radioisotope
Laboratories, Ltd. ("DRL"), a leading Japanese radiopharmaceutical company, to
develop and commercialize DOPASCAN in Japan, Korea and Taiwan. DRL has informed
the Company that it has completed Phase I clinical trials, and intends to
 
                                       I-4
<PAGE>   6
 
commence Phase II clinical trials in Japan later this year. The Company intends
to seek partners for distribution of this product in other territories,
including the United States and Europe.
 
  Neurotrophic Drugs
 
     Guilford is developing small molecule, orally bioavailable compounds to
promote nerve growth and repair (neurotrophic agents) for the treatment of
neurological disorders. The degeneration or damage of nerve cells in the brain
and peripheral neurons resulting from certain diseases and conditions causes a
loss of either central nervous system function (e.g., Alzheimer's disease,
Parkinson's disease, multiple sclerosis, spinal cord injury and stroke) or
peripheral nerve function (e.g., diabetic neuropathy and other peripheral
neuropathies). Under normal circumstances, damaged nerves have a very limited
ability to regrow, which poses a major obstacle for the treatment of these
conditions.
 
   
     In 1990, scientists at Johns Hopkins led by Dr. Solomon H. Snyder
discovered that a binding protein for commonly used immunosuppressive agents
such as tacrolimus (FK-506), was concentrated 10 to 50 fold higher in the brain
than in the immune system. The Johns Hopkins scientists went on to discover that
commonly used immunosuppressive drugs can promote nerve growth, and Guilford has
exclusively licensed from Johns Hopkins a United States patent application
claiming these discoveries. Guilford and Johns Hopkins scientists further
discovered that the mechanism of nerve growth promotion is independent of the
mechanism responsible for immunosuppression, and is mediated by binding to the
major neuroimmunophilin in the brain. This binding was discovered to initiate a
previously unknown neurotrophic cascade.
    
 
     Based on these discoveries, the Company has synthesized hundreds of
proprietary small molecule neuroimmunophilin ligands in several distinct
chemical series that promote nerve growth without being immunosuppressive. The
Company has filed numerous patent applications in the United States and
internationally relating to both novel compositions and methods of treating
neurological disorders utilizing these compounds. These compounds induce nerve
growth directly, as well as potentiate nerve growth in the presence of nerve
growth factors. Several of Guilford's lead compounds have exhibited neurotrophic
effects at picomolar and even sub-picomolar concentrations in in vitro nerve
cell cultures.
 
     Experimental results of one of the Company's lead products, GPI-1046, were
reported in 1996 and published in the March 4, 1997 issue of the Proceedings of
the National Academy of Sciences. In two animal models of Parkinson's disease,
GPI-1046 demonstrated neuroprotective and neuroregenerative effects and recovery
of behavioral function. In one experiment where a neurotoxin and GPI-1046 were
administered simultaneously, the compound produced a 90% protection and/or
regeneration of the nigral-striatal dopamine neurons, the dopamine neurons which
are selectively lost in Parkinson's disease. In another experiment where
GPI-1046 was administered up to one month following the administration of the
neurotoxin, a 45% regeneration of functional striatal dopamine neurons and near
complete normalization of behavior in the affected animals was observed. In
addition to animal models of Parkinson's disease, GPI-1046 has been shown to
promote nerve regeneration in a rat model of peripheral nerve injury. In this
model, GPI-1046 increased the size and number of axons and also increased the
degree of myelination of nerve cells in a damaged sciatic nerve, leading to
partial functional improvement in the paralyzed leg. Further, GPI-1046 and other
compounds exhibited systemic activity, oral bioavailability, and the ability to
cross the blood-brain barrier, unlike many naturally occurring nerve growth
factors.
 
   
     GPI-1046 is currently undergoing the necessary preclinical toxicology,
pharmacokinetic and additional testing, including primate studies, to support
clinical trials. In addition, Company scientists have designed and synthesized
additional compounds from several distinct chemical series with improved potency
and efficacy compared to GPI-1046, and several of these compounds are in
preclinical development. One such example, GPI-1216, potently promotes neurite
outgrowth in chick sensory neurons in cell culture in sub-picomolar
concentrations, and is 50% more efficacious than GPI-1046 in an in vivo model of
Parkinson's disease. Additional lead compounds from other patent series, such as
GPI-1152 and GPI-1234, are also more than 50% more efficacious than GP-1046 in
vivo. The Company intends to commence preliminary clinical trials with one of
its lead compounds in late 1997 or early 1998.
    
 
                                       I-5
<PAGE>   7
 
   
     The Company's neuroimmunophilin ligands have produced nerve regeneration
following multiple routes of administration, including oral administration.
Further, neuroimmunophilin ligands are able to cross the blood-brain barrier,
while many naturally-occurring nerve growth factors, proteins and peptides are
not orally bioavailable and do not cross the blood-brain barrier. Guilford
intends to investigate the utility of its compounds in a range of neurological
disorders (Parkinson's disease and Alzheimer's disease), multiple sclerosis,
spinal cord injury and various peripheral neuropathies.
    
 
   
     The Company is currently in discussions with several multinational
pharmaceutical companies regarding a collaboration for this program, however
there can be no assurance that the Company will enter into any such
collaboration.
    
 
  Neuroprotective Drugs
 
   
     Guilford is developing novel compounds to protect brain cells against
damage from ischemia (the lack of oxygen delivery from reduced blood flow) and
other insults and disorders which cause damage due to massive release of
excitatory amino acid neurotransmitters such as glutamate. The Company's
approach is to identify and clinically test compounds that have the ability to
intervene at three distinct steps in a biochemical pathway leading to neuronal
damage: (i) pre-synaptic inhibition of glutamate; (ii) inhibition of NOS; and
(iii) inhibition of PARS.
    
 
   
     In normal brain function, the pre-synaptic release of the neurotransmitter
glutamate, resulting in stimulation of post-synaptic glutamate receptors
(including n-methyl-D-aspartate (NMDA)), plays a critical role in many central
neuronal functions. However, in conditions such as ischemia, epilepsy and
Huntington's disease, there is a massive increase in pre-synaptic glutamate
release, which results in excessive activation of post-synaptic glutamate
receptors. This, in turn, causes excess production of the neurotransmitter
nitric oxide, mediated by the enzyme NOS, which results in damage to cellular
DNA. The nerve cell then attempts to repair such damage, mediated by the enzyme
PARS, which leads to depletion of cell energy and cell death.
    
 
  Pre-Synaptic Glutamate Inhibitors
 
   
     To date, a number of biopharmaceutical companies have attempted to find
compounds which might block the effects of excess glutamate on post-synaptic
glutamate receptors. However, a number of post-synaptic glutamate antagonists
have been associated with toxicities.
    
 
   
     Guilford scientists have succeeded in inhibiting the pre-synaptic release
of glutamate, that is, preventing excessive levels of glutamate from being
produced and released in the first place. The Company has identified compounds
which exhibit nanomolar potency in vitro. The Company has filed both composition
of matter patent applications, relating to several series of novel compounds,
and method of use patent applications, relating to this novel mechanism to
inhibit excess glutamate during conditions of neurodegeneration. GPI-5000, the
Company's prototype pre-synaptic glutamate inhibitor, has demonstrated
significant neuroprotectant activity in several cell culture and animal models
of neurodegeneration. In both in vitro and in vivo models of focal ischemia,
GPI-5000 exhibited approximately 90% neuroprotection of cortical neurons. To the
Company's knowledge, such a magnitude of neuroprotection is significantly
greater than that reported by post-synaptic glutamate receptor antagonists,
calcium channel antagonists or pH modulators tested under similar conditions. In
addition, because GPI-5000, as well as Guilford's other series of proprietary
compounds, do not interact with post-synaptic glutamate receptors, they may not
be associated with the toxicities associated with post-synaptic glutamate
antagonists. "Prototype" as used here and elsewhere in this document designates
a compound which the Company uses to establish proof of principle of the
relevant mechanism of action, but which it does not intend to develop into a
product because of pharmacokinetic characteristics of the compound, the
Company's proprietary position with respect to such compound or for other
reasons. The Company is currently seeking to develop proprietary lead compounds
in this program through medicinal chemistry around GPI-5000 and other compounds.
    
 
     The Company is currently testing compounds in animal models of stroke and
other disorders believed to be associated with glutamate toxicity, such as ALS,
epilepsy, severe head trauma, and Parkinson's disease. Certain of these
compounds have shown significant neuroprotective activity in preclinical models.
 
                                       I-6
<PAGE>   8
 
  NOS Inhibitors
 
   
     The Company is developing drugs to inhibit the formation of nitric oxide, a
neurotransmitter that mediates certain important actions of glutamate. When
excess glutamate is released (e.g., due to stroke or severe head trauma), a
variety of biochemical effects occur, including activation of NOS, an enzyme
that synthesizes nitric oxide from the amino acid arginine. In animal models of
vascular stroke, treatment with nitroarginine, a NOS inhibitor, blocked 70% of
neuronal damage. Further, there are three distinct known forms of NOS: neuronal
NOS (nNOS), inducible NOS (iNOS) and endothelial NOS (eNOS). In animal models of
stroke, there is a 50% reduction of neuronal damage in a "knock-out" mouse
lacking nNOS. In contrast, inhibition of eNOS will reduce blood flow to the
brain during stroke, thus aggravating nerve cell damage. Consequently, there is
considerable interest in identifying compounds which selectively inhibit nNOS.
The Company is currently investigating novel mechanisms to selectively inhibit
nNOS activity. The Company has an exclusive license to an issued United States
patent which relates to the use of NOS inhibitors to prevent or treat disease
conditions caused by glutamate neurotoxicity.
    
 
  PARS Inhibitors
 
   
     The Company is developing compounds which inhibit PARS, an intracellular
enzyme that is involved in the repair of damaged DNA. Nitric oxide has been
shown to damage DNA in nerve cells and to trigger the activation of PARS, which
in turn leads to depletion of energy in the cell, resulting in cell death.
Guilford and Johns Hopkins scientists have shown that inhibitors of PARS can
prevent neurotoxicity in cultures of cerebral cortical neurons, suggesting that
they may be effective in treating stroke and neurodegenerative diseases. Using a
prototype small molecule PARS inhibitor, GPI-6000, Guilford scientists have
demonstrated that administration of that compound significantly decreases nerve
cell loss in a rat model of focal ischemia. The Company is using GPI-6000 to
establish proof of principle of the relevant mechanism of action but does not
intend to further develop this compound into a product. The Company is currently
seeking to develop proprietary lead small molecule PARS inhibitors for the
treatment of neurological disorders through medicinal chemistry around GPI-6000
and other compounds. The Company has an exclusive license to an issued United
States patent which relates to the use of PARS inhibitors to treat disease
conditions caused by NMDA neurotoxicity.
    
 
  Addiction Therapeutics
 
   
     In February 1995, Guilford formed Gell, a corporate joint venture with
Abell focusing on the development of therapeutics for cocaine addiction and
other addictive behaviors. On March 5, 1997, Abell exercised its right to put
its interest in Gell to Guilford for 750,000 shares of Guilford Common Stock.
Thereafter, Gell became a wholly-owned subsidiary of Guilford. See
"-- Technology Licensing Agreements." Gell seeks to identify and develop
selective cocaine antagonists and mixed agonist/antagonists which will have
clinical utility in the treatment of cocaine addiction and overdose and other
addictive behaviors. It is estimated that 2.1 million people (nearly 1% of the
United States population) use cocaine on a weekly basis and that several hundred
thousand use it daily. At present, cocaine treatment options are generally
limited to counseling, psychotherapy and participation in self-help groups.
    
 
     The Company's cocaine addiction therapeutics program focuses on the
development of drugs which prevent cocaine from binding to dopamine transporters
while minimally affecting normal dopamine transport function. Within the past
decade, the mechanism by which cocaine exerts its addictive behaviors has been
elucidated. Scientists have found that cocaine facilitates the action of
dopamine in the brain by inhibiting the function of the dopamine transporter.
Dopamine uptake and cocaine binding occur at distinct sites on the transporter.
Therefore it may be possible to design drugs that specifically inhibit cocaine
binding while permitting the transporter to maintain its normal function.
 
   
     Guilford scientists have identified and synthesized novel compounds with
specificity for the cocaine recognition site in the brain and the Company has
filed patent applications covering several classes of compounds. A prototype
compound, GPI-2138, is 17 times more potent in binding to the cocaine binding
site than in inhibiting dopamine uptake, compared to cocaine. In animal
experiments, GPI-2138 blocked certain
    
 
                                       I-7
<PAGE>   9
 
   
behavioral effects produced by cocaine, including hyperlocomotion and cocaine
self-administration. Company scientists have synthesized other compounds which
exhibit a binding-to-uptake ratio in vitro of as high as 38 times greater than
cocaine. The Company has also entered into a cooperative research and
development agreement with the National Institute of Drug Abuse to identify and
develop cocaine antagonists. In addition to cocaine addiction, other forms of
addiction, including alcohol and heroin addiction, may result from facilitation
of dopaminergic neurotransmission in certain areas of the brain. As a result,
Guilford scientists are currently investigating whether GPI-2138 and related
compounds may block the addictive properties of alcohol and heroin in laboratory
animals. The Company is using GPI-2138 to establish proof of principle of the
relevant mechanism of action but does not intend to further develop this
compound into a product. The Company is currently seeking to develop proprietary
lead compounds in this program through medicinal chemistry around GPI-2138 and
other compounds.
    
 
MANUFACTURING AND RAW MATERIALS
 
   
     The Company manufactures GLIADEL using a proprietary process at its 12,500
square foot manufacturing facility in Baltimore, Maryland. Approximately 5,500
square feet of packaging, quality control, laboratory, and warehouse space were
added in 1996 to support the commercial launch of GLIADEL. The facility has been
in operation since April 1995 and was inspected by the FDA in October 1995. The
Company's current facilities are designed to enable the Company to produce up to
8,000 GLIADEL treatments annually. During 1997 and 1998, the Company expects to
make additional capital expenditures of approximately $3.7 million to expand the
Company's GLIADEL manufacturing plant capacity from 8,000 to 30,000 treatments
annually. The Company expects to draw on the capital available under its $7.5
million loan agreement with RPR to fund the expansion.
    
 
   
     The Company believes that the various materials used in GLIADEL are readily
available and will continue to be available at reasonable prices. Nevertheless,
the active chemotherapeutic ingredient in GLIADEL, the generic drug BCNU, is
currently being supplied by a single vendor. While the Company believes that it
has an adequate supply of BCNU to meet current demand and has entered into an
agreement for process development of BCNU with a potential second source of
BCNU, any interruption in the ability of the current supplier to deliver this
ingredient could prevent the Company from delivering the product on a timely
basis. The Company depends upon the availability of certain single-source raw
materials in its formulations, but is seeking alternate suppliers for most of
these raw materials as well. There can be no assurance that such sources can be
secured successfully on terms acceptable to the Company, or at all. Failure of
any supplier to provide sufficient quantities of raw material in accordance with
GMP could cause delays in clinical trials and commercialization of products.
    
 
   
     In October 1995 and July 1996, the Company entered into development and
contract manufacturing agreements with Nordion International Inc., a leading
supplier of radiolabeled products based in Canada, and its European subsidiary,
Nordion Europe S.A. (collectively, "Nordion"). Pursuant to these agreements, the
Company synthesizes the precursor of DOPASCAN and supplies it to Nordion, which
then radiolabels DOPASCAN with Iodine-123 for distribution to hospitals involved
in the clinical trials in North America and Europe, respectively. During the
term of these agreements, Nordion has agreed not to perform development,
manufacture or supply services for any competing Iodine-123 radiolabeled imaging
diagnostic for Parkinson's disease based on dopamine transporter binding.
Nordion's obligations under the October 1995 agreement terminated as of November
30, 1996 and the obligations under the July 1996 agreement will terminate on
July 31, 1997, or earlier in certain specified circumstances. The Company is
currently negotiating a new agreement respecting the manufacture and supply of
DOPASCAN to support the Company's planned Phase III clinical trials. However,
there can be no assurance that any such agreement will be reached on terms
acceptable to the Company.
    
 
GOVERNMENT REGULATION AND PRODUCT TESTING
 
     All domestic prescription pharmaceutical manufacturers are subject to
extensive regulation by the federal government, principally the FDA and, to a
lesser extent, by state and local and perhaps foreign governments if products
are marketed abroad. Biologics and controlled drug products, such as vaccines
and narcotics, and
 
                                       I-8
<PAGE>   10
 
radiolabeled drugs, are regulated more stringently than are other drugs. The
Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations
govern or influence the development, testing, manufacture, labeling, storage,
approval, advertising, promotion, sale and distribution of prescription
pharmaceutical products. Pharmaceutical manufacturers are also subject to
certain recordkeeping and reporting requirements. Noncompliance with applicable
requirements can result in warning letters, fines, recall or seizure of
products, total or partial suspension of production and/or distribution, refusal
of the government to enter into supply contracts or to approve marketing
applications and criminal prosecution.
 
     Upon FDA approval, a drug may only be marketed for the approved indications
in the approved dosage forms and at the approved dosages. The FDA also may
require post-marketing testing and surveillance to monitor the record of the
approved product. Manufacturers of approved drug products are subject to ongoing
compliance with FDA regulations. For example, the FDA mandates that drugs be
manufactured in conformity with GMP regulations. In complying with the GMP
regulations, manufacturers must continue to expend time, money and effort in
production, recordkeeping and quality control to ensure that the product meets
applicable specifications and other requirements. The FDA periodically inspects
drug manufacturing facilities to ensure compliance with applicable GMP
requirements. Failure to comply subjects the manufacturer to possible FDA
action, such as suspension of manufacturing, seizure of the product or voluntary
recall of a product. Adverse experiences with the product must be reported to
the FDA. The FDA also may require the submission of any lot of the product for
inspection and may restrict the release of any lot that does not comply with FDA
regulations, or may otherwise order the suspension of manufacture, recall or
seizure. Product approvals may be withdrawn if compliance with regulatory
requirements is not maintained or if problems concerning safety or efficacy of
the product occur following approval.
 
FULL CLINICAL TESTING REQUIREMENTS
 
   
     The steps required before a newly marketed drug may be commercially
distributed in the United States include: (i) conducting appropriate preclinical
laboratory and animal tests; (ii) submitting to the FDA an application for an
IND, which must become effective before clinical trials may commence; (iii)
conducting well-controlled human clinical trials that establish the safety and
efficacy of the drug product; (iv) filing with the FDA a NDA for non-biological
drugs; and (v) obtaining FDA approval of the NDA prior to any commercial sale or
shipment of the non-biological drug. In addition to obtaining FDA approval for
each indication to be treated with each product, each domestic drug
manufacturing establishment must register with the FDA, list its drug products
with the FDA, comply with GMP requirements and be subject to inspection by the
FDA. Foreign manufacturing establishments distributing drugs in the United
States also must comply with GMP requirements, list their products, and are
subject to periodic inspection by FDA or by local authorities under agreement
with FDA.
    
 
   
     With respect to a drug product with an active ingredient not previously
approved by the FDA, the manufacturer must usually submit a full NDA, including
complete reports of preclinical, clinical and laboratory studies, to prove that
the product is safe and effective. A full NDA may also need to be submitted for
a drug product with a previously approved active ingredient if studies are
required to demonstrate safety and efficacy, such as when the drug will be used
to treat an indication for which the drug was not previously approved, or where
the method of drug delivery is changed. In addition, the manufacturer of an
approved drug may be required to submit for the FDA's review and approval a
supplemental NDA, including reports of appropriate clinical testing, prior to
marketing the drug with additional indications or making other significant
changes to the product or its manufacture. A manufacturer intending to conduct
clinical trials ordinarily will be required first to submit an IND to the FDA
containing information relating to previously conducted preclinical studies.
    
 
     Preclinical testing includes formulation development, laboratory evaluation
of product chemistry and animal studies to assess the potential safety and
efficacy of the product formulation. Preclinical tests usually must be conducted
in accordance with the FDA regulations concerning Good Laboratory Practices
("GLPs"). The results of the preclinical tests are submitted to the FDA as part
of the IND and are reviewed by the FDA prior to authorizing the sponsor to
conduct clinical trials in human subjects. Unless the FDA objects to an IND, the
IND will become effective 30 days following its receipt by the FDA. There is no
 
                                       I-9
<PAGE>   11
 
certainty that submission of an IND will result in FDA authorization to commence
clinical trials or that authorization of one phase of a clinical trial will
result in authorization of other phases or that the performance of any clinical
trials will result in FDA approval.
 
     Clinical trials for new drugs typically are conducted in three phases and
are subject to detailed protocols. Clinical trials involve the administration of
the investigational drug product to human subjects. Each protocol indicating how
the clinical trial will be conducted must be submitted for review to the FDA as
part of the IND. The FDA's review of a study protocol does not necessarily mean
that, if the study is successful, it will constitute proof of efficacy or
safety. Further, each clinical study must be conducted under the auspices of an
independent institutional review board ("IRB") established pursuant to FDA
regulations. The IRB considers, among other factors, ethical concerns and
informed consent requirements. The FDA or the IRB may require changes in a
protocol both prior to and after the commencement of a trial. There is no
assurance that the IRB or the FDA will permit a study to go forward or, once
started, to be completed. Clinical trials may be placed on hold at any time for
a variety of reasons, particularly if safety concerns arise, or regulatory
requirements are not met.
 
     The three phases of clinical trials are generally conducted sequentially,
but they may overlap. In Phase I, the initial introduction of the drug into
humans, the drug is tested for safety, side effects, dosage tolerance,
metabolism and clinical pharmacology. Phase II involves controlled tests in a
larger but still limited patient population to determine the efficacy of the
drug for specific indications, to determine optimal dosage and to identify
possible side effects and safety risks. Phase II testing for an indication
typically takes at least from one and one-half to two and one-half years to
complete. If preliminary evidence suggesting effectiveness has been obtained
during Phase II evaluations, expanded Phase III trials are undertaken to gather
additional information about effectiveness and safety that is needed to evaluate
the overall benefit-risk relationship of the drug and to provide an adequate
basis for physician labeling. Phase III studies for a specific indication
generally take at least from two and one-half to five years to complete. There
can be no assurance that Phase I, Phase II or Phase III testing will be
completed successfully within any specified time period, if at all, with respect
to any of the Company's product candidates.
 
     Reports of results of the preclinical studies and clinical trials for
non-biological drugs are submitted to the FDA in the form of an NDA for approval
of marketing and commercial shipment. User fee legislation enacted in 1992 now
requires the submission of $240,000 to cover the costs of FDA review of an NDA.
The NDA typically includes information pertaining to the preparation of drug
substances, analytical methods, drug product formulation, details on the
manufacture of finished product as well as proposed product packaging and
labeling. Submission of an NDA does not assure FDA approval for marketing. The
application review process generally takes two to three years to complete,
although reviews of treatments for cancer and other serious or life-threatening
diseases may be accelerated. The approval process may take substantially longer
if, among other things, the FDA has questions or concerns about the safety
and/or efficacy of a product. In general, the FDA requires at least two properly
conducted, adequate and well-controlled clinical studies demonstrating efficacy
with sufficient levels of statistical assurance. The FDA also may request
long-term toxicity studies or other studies relating to product safety or
efficacy. For example, the FDA may require additional clinical tests following
NDA approval to confirm product safety and efficacy (Phase IV clinical tests).
Notwithstanding the submission of such data, the FDA ultimately may decide that
the application does not satisfy its regulatory criteria for approval.
 
     Phase III or other clinical studies may be conducted after, rather than
before, FDA approval under certain circumstances. For example, the FDA may
determine under its expedited or accelerated approval regulations that earlier
studies may establish an adequate basis for drug product approval, provided that
the sponsor agrees to conduct additional studies after approval to verify safety
and effectiveness. Treatment with an experimental drug of patients not in
clinical trials may also be allowed under a Treatment IND before general
marketing begins and pending FDA approval. Charging for an investigational drug
also may be allowed under a Treatment IND to recover certain costs of
development if various requirements are met. These cost-recovery, treatment and
expedited or accelerated approval regulations are limited, for example, to drug
products intended to treat AIDS or other serious or life-threatening diseases
and that provide meaningful therapeutic benefit to patients over existing
treatments or that are for diseases for which no satisfactory
 
                                      I-10
<PAGE>   12
 
alternative therapy exists. No assurances exist that the Company's product
candidates will qualify for cost-recovery, expedited or accelerated approvals or
for treatment use.
 
     The full NDA process for newly marketed non-biological drugs takes a number
of years and involves the expenditure of substantial resources. There can be no
assurance that any approval will be granted on a timely basis, or at all or that
the Company will have sufficient resources to carry such potential products
through the regulatory approval process.
 
ABBREVIATED TESTING REQUIREMENTS
 
     The Drug Price Competition and Patent Term Restoration Act of 1984
("DPC-PTR Act") established abbreviated procedures for obtaining FDA approval
for many non-biological drugs which are off-patent and whose marketing
exclusivity has expired. Applicability of the DPC-PTR Act means that a full NDA
is not required for approval of a competitive product. Abbreviated requirements
are applicable to drugs which are, for example, either bioequivalent to brand
name drugs, or otherwise similar to brand name drugs, such that all the safety
and efficacy studies previously done on the innovator product need not be
repeated for approval. Changes in approved drug products, such as in the
delivery system, dosage form, or strength, can be the subject of abbreviated
application requirements. There can be no assurance that abbreviated
applications will be available or suitable for the Company's non-biological drug
products or that FDA approval of such applications can be obtained.
 
     A five year period of market exclusivity is provided for newly marketed
active ingredients of drug products not previously approved and a three-year
period for certain changes in approved drug products that require for approval
the submission of safety and efficacy information (other than bioequivalence
studies). A period of five years is available for new chemical entities not
previously approved by FDA. A period of three years is available for changes in
approved products, such as in delivery systems of previously approved products.
Both periods of marketing exclusivity mean that abbreviated applications, which
generally rely to some degree on approvals or on some data submitted by previous
applicants for comparable innovator drug products, cannot be approved during the
period of exclusivity. The market exclusivity provisions of the DPC-PTR Act bar
only the marketing of competitive products that are the subject of abbreviated
applications, not products that are the subject of full NDAs. The DPC-PTR Act
also may provide a maximum time of five years to be restored to the life of any
one patent for the period it takes to obtain FDA approval of a drug product,
including biological drugs. No assurances exist that the exclusivity or patent
restoration benefits of the DPC-PTR Act will apply to any product candidates of
the Company.
 
OTHER REGULATION
 
     Products marketed outside the United States which are manufactured in the
United States are subject to certain FDA regulations, as well as regulation by
the country in which the products are to be sold. The Company also would be
subject to foreign regulatory requirements governing clinical trials and
pharmaceutical sales, if products are marketed abroad. Whether or not FDA
approval has been obtained, approval of a product by the comparable regulatory
authorities of foreign countries must usually be obtained prior to the
commencement of marketing of the product in those countries. The approval
process varies from country to country and the time required may be longer or
shorter than that required for FDA approval.
 
     The Company also is governed by other federal, state and local laws of
general applicability. These laws include, but are not limited to, those
regulating working conditions enforced by the Occupational Safety and Health
Administration and regulating environmental hazards under such statutes as the
Toxic Substances Control Act, the Resource Conservation and Recovery Act and
other environmental laws enforced by the United States Environmental Protection
Agency ("USEPA"). The DEA regulates controlled substances, such as narcotics.
Establishments handling controlled substances must, for example, be licensed and
inspected by the DEA, and may be subject to export, import, security and
production quota requirements. Radiolabeled products, including drugs, are also
subject to regulation by the Department of Transportation and to state and
federal licensing requirements. Various states often have comparable health and
environmental laws, such as those governing the use and disposal of controlled
and radiolabeled products.
 
                                      I-11
<PAGE>   13
 
     While the Company is not actively involved in product areas involving
biotechnology and has no current plans to develop products utilizing modern
biotechnology, if the Company were to move in that direction, it would
potentially be subject to extensive regulation. The USEPA, the FDA and other
federal and state regulatory bodies have developed or are in the process of
developing specific requirements concerning products of biotechnology that may
affect research and development programs and product lines. The Company is
unable to predict whether any governmental agency will adopt requirements,
including regulations, which would have a material and adverse effect on any
future product applications involving biotechnology.
 
PATENTS AND PROPRIETARY TECHNOLOGY
 
     Guilford believes that patent and trade secret protection is crucial to its
business and that its future will depend in part on its ability to obtain
patents, maintain trade secret protection and operate without infringing the
proprietary rights of others. As of December 31, 1996, the Company owned or had
licensed rights to 49 United States and 106 foreign patents and 32 United States
and 100 foreign patent applications with claims relating to its biodegradable
polymer, imaging, neurotrophic, neuroprotective and cocaine addiction
therapeutics programs.
 
   
     The role, validity and value of patents, licenses and proprietary
technology in the business of the Company are subject to various uncertainties
and contingencies. The Company's success will depend in part on its ability to
obtain, maintain and enforce patent protection for its products and processes or
license rights to patents, maintain trade secret protection and operate without
infringing upon the proprietary rights of others. The degree of patent
protection afforded to pharmaceutical and biotechnological inventions is
uncertain, and a number of Guilford's product candidates are subject to this
uncertainty. The Company is aware of a company which has asserted in a public
filing that it has patent applications claiming the use of certain of its
immunosuppressive compounds and multidrug resistance compounds for nerve growth
applications, as well as a patent and patent applications relating to compounds
which it claims are useful in nerve growth applications. While the Company does
not believe that its neurotrophic compounds infringe on such company's patent,
no assurance can be given as to the ability of the Company's patents and patent
applications to adequately protect the Company's neurotrophic product
candidates, including GPI-1046, or that the Company's neurotrophic product
candidates will not infringe or be dominated by this company's patent or patent
applications, if issued. There can be no assurance that any patent applications
filed by, or assigned or licensed to, the Company will be granted, that the
Company will develop additional products or processes that are patentable, or
that any patents issued to, or licensed by, the Company will provide the Company
with any competitive advantages or adequate protection for its products. In
addition, there can be no assurance that any existing or future patents or
intellectual property issued to, or licensed by, the Company will not
subsequently be challenged, invalidated or circumvented by others.
    
 
     It is Guilford's policy to control the disclosure and use of Guilford's
know-how and trade secrets under confidentiality agreements with employees,
consultants and other parties. There can be no assurance, however, that its
confidentiality agreements will be honored, that others will not independently
develop equivalent or competing technology, that disputes will not arise
concerning the ownership of intellectual property or the applicability of
confidentiality obligations, or that disclosure of Guilford's trade secrets will
not occur. To the extent that consultants or other research collaborators use
intellectual property owned by others in their work with the Company, disputes
may also arise as to the rights to related or resulting intellectual property.
 
     Guilford supports and collaborates in research conducted in universities
and in governmental research organizations. There can be no assurance that the
Company will have or be able to acquire exclusive rights to the inventions or
technical information derived from such collaborations or that disputes will not
arise as to rights in derivative or related research programs conducted by the
Company. In addition, in the event of a contractual breach by the Company,
certain of the Company's collaborative research contracts provide for transfer
of technology (including any patents or patent applications) to the contract
sponsors.
 
     If the Company is required to defend against charges of infringement of
patent or proprietary rights of third parties or to protect its own patent or
proprietary rights against third parties, the Company may incur substantial
costs and could lose rights to develop or market certain products or be required
to pay monetary
 
                                      I-12
<PAGE>   14
 
damages or royalties to license proprietary rights from third parties. In
response to actual or threatened litigation, the Company may seek licenses from
third parties or attempt to redesign its products or processes to avoid
infringement; however, there can be no assurance that the Company will be able
to obtain licenses on acceptable terms or at all or redesign its products or
processes. In addition to being a party to patent infringement litigation, the
Company could be required to participate in patent interference proceedings
declared by the United States Patent and Trademark Office, which would be
expensive and time-consuming, even if the Company were to prevail in such a
proceeding. The Company may also be forced to initiate legal proceedings to
protect its patent position or other proprietary rights. These proceedings
typically are costly, protracted, and offer no assurance of success.
 
TECHNOLOGY LICENSING AGREEMENTS
 
   
     In March 1994, the Company entered into an agreement with Scios Inc.
("Scios") (the "GLIADEL Agreement") pursuant to which the Company licensed from
Scios exclusive worldwide rights to 35 United States patents and patent
applications as well as 100 corresponding international patents and patent
applications for polyanhydride biodegradable polymer technology for use in the
field of tumors of the central nervous system and cerebral edema. GLIADEL is
covered by a United States patent which expires in 2010 and certain related
international patents and patent applications. In April 1994, Scios assigned all
of its rights and obligations under the GLIADEL Agreement to MIT. Under the
terms of the GLIADEL Agreement, Guilford is obligated to pay a royalty on all
net sales of products incorporating such technology as well as a percentage of
all royalties received by Guilford from sublicensees and certain advance and
minimum annual royalty payments. In 1996, Guilford paid $1.1 million in royalty
payments to MIT related to payments made to the Company from RPR and Orion
Farmos related to GLIADEL. Guilford has exclusive worldwide rights to the
technology for brain cancer therapeutics, subject to certain conditions,
including a requirement to perform appropriate preclinical tests and file an IND
with the FDA within 24 months of the identification of a drug-polymer product
having greater efficacy than GLIADEL. In addition, Guilford is obligated to
spend a minimum dollar amount in developing products resulting from the
technology through 1997 and to meet certain development milestones. Although the
Company believes that it can comply with such obligations, failure of the
Company to perform these obligations could result in the Company losing its
right to the new polymer-based product.
    
 
   
     In June 1996, the Company entered into a license agreement with MIT and
Johns Hopkins respecting a patent application covering certain biodegradable
polymers for use in connection with the controlled local delivery of certain
chemotherapeutic agents (including paclitaxel (Taxol(R)) and camptothecin) for
treating solid tumors. Under this agreement, the Company is obligated to make
certain annual and milestone payments to MIT and to pay royalties based on any
sales of products incorporating the technology licensed to Guilford.
Furthermore, under the terms of the agreement, the Company has committed to
spend minimum amounts to develop the technology and to meet certain development
milestones. Although the Company believes that it can comply with such
obligations, failure of the Company to perform these obligations could result in
the Company losing its rights to such technology.
    
 
     In July 1996, the Company entered into a license agreement with Johns
Hopkins for two United States patents respecting certain polyphosphoesters
("PPE") polymers developed at Johns Hopkins. This agreement, among other things,
requires Guilford to pay certain processing, maintenance and/or up-front fees,
milestone payments and royalties, a portion of proceeds from sublicenses, and
fees and costs related to patent prosecution and maintenance and to spend
minimum amounts for and meet deadlines regarding development of this technology.
In the event of termination of these licenses, the Company could lose its rights
to use of the licensed technology. The Company has also entered into a sponsored
research agreement with Johns Hopkins with respect to this PPE technology and
has a right of first negotiation regarding inventions that result from this
work.
 
     The Company obtained exclusive worldwide rights to DOPASCAN pursuant to a
March 1994 license agreement (the "RTI Agreement") with Research Triangle
Institute ("RTI"), which grants Guilford rights to various United States and
international patents and patent applications relating to binding ligands for
certain receptors in the brain which are or may be useful as dopamine neuron
imaging agents. DOPASCAN and certain related precursors and analogues are
covered by United States patents which start expiring in
 
                                      I-13
<PAGE>   15
 
2009, as well as certain related international patents and patent applications.
Under the RTI Agreement, the Company reimbursed RTI for certain past
patent-related expenses and agreed to make annual payments to RTI to support
mutually agreed upon research to be conducted at RTI through March 1999. In
addition, the Company is obligated to pay RTI a royalty on gross revenues to
Guilford from products derived from the licensed technology and from sublicensee
proceeds and to make certain minimum royalty payments following the first
commercial sale of such products. In January 1997, the Company paid RTI $32,000
as a result of a payment received from DRL, the Company's DOPASCAN partner in
Japan. Guilford must use commercially reasonable efforts to develop products
related to the licensed technology and to meet certain performance milestones.
Failure of the Company to perform its obligations under the RTI Agreement in the
future could result in termination of the license.
 
     Guilford and Johns Hopkins are parties to two exclusive license agreements
covering the following technologies: (i) neurotrophic use of neuroimmunophilin
ligands, which was jointly discovered by scientists at, and is jointly owned by,
Johns Hopkins and Guilford; and (ii) inhibition of NOS and PARS for
neuroprotective uses. These agreements, among other things, require Guilford to
pay certain processing, maintenance, and/or up-front fees, milestone payments
and royalties, a portion of proceeds from sublicenses, and fees and costs
related to patent prosecution and maintenance and to spend minimum amounts for
and meet deadlines regarding development of the technologies. In the event of
termination of these licenses, the Company could lose its rights to use of the
licensed technology (or in the case of joint inventions, exclusive use of such
technology).
 
   
     Gell, through which the Company conducts its cocaine addiction therapeutics
program, was initially formed in February 1995 as a joint venture owned 80% by
Abell and 20% by Guilford. The $2.5 million in capital invested by Abell in Gell
has funded the cocaine addiction therapeutics program since inception. On March
5, 1997, Abell exercised its right to put its interest in Gell to Guilford for
750,000 shares of Guilford Common Stock. Thereafter Gell became a wholly-owned
subsidiary of the Company.
    
 
  United States Government Rights
 
   
     Aspects of the technology licensed under the Company's license agreements
may be subject to certain Government Rights. These rights include a
non-exclusive, royalty-free worldwide license to practice or have practiced such
inventions for any governmental purpose. In addition, the United States
government has the right to grant licenses which may be exclusive under any of
such inventions to a third-party if it determines that: (i) adequate steps have
not been taken to commercialize such inventions; (ii) such action is necessary
to meet public health or safety needs; or (iii) such action is necessary to meet
requirements for public use under federal regulations. The government also has
the right to take title to a subject invention if there is failure to disclose
the invention and elect title within specified time limits. In addition, the
government may acquire title in any country in which a patent application is not
filed within specified time limits. Federal law requires any licensor of an
invention that was partially funded by the federal government to obtain a
covenant from any exclusive licensee to manufacture products using the invention
substantially in the United States. Further, the Government Rights include the
right to use and disclose without limitation technical data relating to licensed
technology that was developed in whole or in part at government expense.
Provisions recognizing these Government Rights are contained in the Company's
principal technology license agreements.
    
 
SALES, MARKETING AND DISTRIBUTION
 
     In general, the Company's strategy is to seek to establish strategic
alliances with larger pharmaceutical companies to develop and promote products
that require extensive development, sales and marketing resources. Within the
United States, the Company may seek to retain co-promotion rights with respect
to some or all compounds or indications in any such strategic alliances, or the
Company may elect to market and distribute its products directly where the
commercial prospects so warrant.
 
     In June 1996, the Company entered into a marketing, sales and distribution
rights agreement and other related agreements with RPR granting RPR worldwide
(excluding Scandinavia) marketing, sales, promotion and distribution rights for
GLIADEL. Upon execution of these agreements, the Company received $7.5 million
for 281,531 shares of Common Stock. Furthermore, in addition to an aggregate of
$27.5 million in rights payments made by RPR upon execution of the agreements in
June 1996 and FDA clearance of the
 
                                      I-14
<PAGE>   16
 
   
GLIADEL NDA in September 1996, the agreements with RPR provide for up to an
additional $40 million in payments in the event that certain regulatory and
other milestones are achieved, although there can be no assurance that any or
all of such milestones will be attained and certain of these payments are
contingent on international regulatory filings and clearances, the timing and
extent of which are largely within the control of RPR. Moreover, RPR may, under
certain circumstances, fund up to approximately $17 million for the development
of higher dose forms of GLIADEL being developed by the Company and for certain
additional clinical studies related to GLIADEL. Finally, under these agreements,
the Company has the right under certain circumstances to borrow up to an
aggregate of $7.5 million to expand the Company's GLIADEL manufacturing and
related facilities. In addition to the payments outlined above, the Company will
act as the exclusive manufacturer of GLIADEL and will receive transfer price
payments and royalties based on any "net sales" (as defined in the agreements
with RPR) of GLIADEL. RPR's exclusive rights terminate in a particular country
upon the later of the expiration of the last to expire of certain patents
applicable in that country or the last commercial sale of GLIADEL in that
country. Under the Company's agreements with RPR, RPR has an exclusive six-month
period following development of new polymer technology by the Company to make an
offer to license such technology for oncology applications.
    
 
     In October 1995, the Company entered into an agreement appointing Orion
Farmos distributor for GLIADEL in Scandinavia, and in December 1995 the Company
entered into an agreement with DRL for the marketing, sale and distribution of
DOPASCAN in Japan, Korea and Taiwan.
 
COMPETITION
 
   
     The Company is involved in evolving technological fields in which
developments are expected to continue at a rapid pace. Guilford's success
depends upon its ability to effectively compete in the research, development and
commercialization of products and technologies in its areas of focus.
Competition from pharmaceutical, chemical and biotechnology companies,
universities and research institutes is intense and expected to increase. Many
of these competitors have substantially greater research and development
capabilities, experience and manufacturing, marketing, financial and managerial
resources and represent significant competition for the Company. Acquisitions of
competing companies by large pharmaceutical or other companies could enhance the
financial, marketing and other resources available to these competitors. These
competitors may develop products which are superior to those under development
by the Company.
    
 
     The Company is aware of several competing approaches under development for
the treatment of malignant glioma including using radioactive seeds for
interstitial radiotherapy, increasing the permeability of the blood-brain
barrier to chemotherapeutic agents, sensitizing cancer cells to chemotherapeutic
agents using gene therapy and developing chemotherapeutics directed to specific
receptors in brain tumors. To the Company's knowledge, none of these approaches
has resulted in compounds studied in randomized, controlled trials which have
shown them to be superior to conventional therapy.
 
     The Company believes that two other companies are clinically evaluating
imaging agents for dopamine neurons. In addition, a variety of radiolabeled
compounds for use with Positron Emission Tomography ("PET") scanners have been
used to image dopamine neurons successfully in patients with Parkinson's
disease. PET scanning is currently only available in a limited number of
hospitals in the United States and Europe.
 
     A number of companies have shown interest in trying to develop neurotrophic
agents to promote nerve growth and repair in neurodegenerative disorders and
traumatic central nervous system injuries. However much of this activity has
focused on naturally occurring growth factors. Such large molecules generally
cannot cross the blood-brain barrier and thus present problems in administration
and delivery. One company has announced that certain of its neuroimmunophilin
ligands showed positive results in stimulating nerve growth in an animal model
of nerve crush, and has disclosed that it has made patent filings covering
compounds and uses in connection with nerve growth promotion. In addition,
another company announced that IGF-1 showed positive results in clinical trials
of a peripheral neurodegenerative disorder.
 
     There is intense competition to develop an effective and safe
neuroprotective drug or biological agent. Calcium channel antagonists, calpain
inhibitors, adenosine receptor antagonists, free radical scavengers, superoxide
dismutase inducers, proteoloytic enzyme inhibitors, phospholipase inhibitors and
a variety of other
 
                                      I-15
<PAGE>   17
 
agents are under active development by others. Glutamate or NMDA receptor
antagonists are under development by several other companies.
 
     In the field of cocaine addiction, most of the investigated compounds to
date have been studied by academic and government groups. Further, much of this
work has been with known agents, such as carbamazepine, that are commercially
available for other indications. Guilford is aware of another company that is
investigating the use of butylcholinesterase as a treatment for acute cocaine
overdose. The Company is aware of one company that is investigating an
immunological approach in an attempt to develop a cocaine vaccine. The Company
is not aware of other commercial research programs targeting specific cocaine
antagonists, which do not interfere with normal dopamine neuron function.
 
   
     Any product candidate that the Company develops and for which it gains
regulatory approval, including GLIADEL, must then compete for market acceptance
and market share. For certain of the Company's product candidates, an important
factor will be the timing of market introduction of competitive products.
Accordingly, the relative speed with which the Company and competing companies
can develop products, complete the clinical testing and approval processes, and
supply commercial quantities of the products to the market is expected to be an
important determinant of market success. Other competitive factors include
capabilities of the Company's collaborators, product efficacy and safety, timing
and scope of regulatory approval, product availability, marketing and sales
capabilities, reimbursement coverage, the amount of clinical benefit of the
Company's product candidates relative to their cost, method of administration,
price and patent protection. There can be no assurance that the Company's
competitors will not develop more effective or more affordable products or
achieve earlier product development completion, patent protection, regulatory
approval or product commercialization than the Company. The achievement of any
of these goals by the Company's competitors could have a material adverse effect
on the Company's business, financial condition and results of operations.
    
 
PRODUCT LIABILITY AND INSURANCE
 
   
     Product liability risk is inherent in the testing, manufacture, marketing
and sale of the Company's product candidates, and there can be no assurance that
the Company will be able to avoid significant product liability exposure. While
the Company currently maintains $10,000,000 of product liability insurance
covering clinical trials and produced sales, there can be no assurance that such
or any future insurance coverage obtained by the Company will be adequate or
that claims will be covered by the Company's insurance. The Company's insurance
policies provide coverage on a claims-made basis and are subject to annual
renewal. Product liability insurance varies in cost, can be difficult to obtain
and may not be available to the Company in the future on acceptable terms, or at
all.
    
 
EMPLOYEES
 
   
     At December 31, 1996, the Company employed 138 individuals. By February 28,
1997 that number was 156. Of these 156 employees, 130 were employed in the areas
of research and product development and in manufacturing and quality control of
GLIADEL. The remaining 26 employees performed general and administrative
functions, including executive, finance and administration, legal and business
development. To date, the Company has experienced no work stoppages related to
labor issues and believes its relations with its employees are good.
    
 
     All employees are required to enter into a confidentiality agreement with
the Company. Hiring and retaining qualified personnel are important factors for
the Company's future success. The Company is likely to continue to add personnel
particularly in the areas of research, clinical research and operations,
including manufacturing. Intense competition exists for these qualified
personnel from other biotechnology and biopharmaceutical companies, academic,
research and governmental organizations. There can be no assurance that the
Company will be able to continue to hire qualified personnel and, if hired, that
the Company will be able to retain these individuals.
 
SCIENTIFIC ADVISORY BOARD
 
     Guilford's Scientific Advisory Board consists of individuals with
recognized expertise in fields related to Guilford's research and development
programs. The Scientific Advisory Board meets with the Company at
 
                                      I-16
<PAGE>   18
 
   
least twice a year to discuss research priorities and new developments in
neuroscience and consults with and meets informally with the Company on an
as-needed basis.
    
 
     The following persons are members of Guilford's Scientific Advisory Board:
 
     SOLOMON H. SNYDER, M.D. has been a Director of the Company and Chairman of
the Scientific Advisory Board since the Company's inception in July 1993. Dr.
Snyder received his M.D. in 1962 from Georgetown Medical School, trained as a
Research Associate with Julius Axelrod at the National Institute of Mental
Health and completed his Psychiatry Residency at Johns Hopkins Hospital. He is
presently Director of the Department of Neuroscience at Johns Hopkins Medical
School and Distinguished Service Professor of Neuroscience, Pharmacology and
Molecular Sciences, and Psychiatry. Dr. Snyder has received a number of awards
including the Albert Lasker Award in Basic Biomedical Research, the Wolf Prize
and the Bower Award. He is a member of the United States National Academy of
Sciences, the Institute of Medicine and the American Academy of Arts and
Sciences. Dr. Snyder is a director of Scios.
 
     Dr. Snyder has provided consulting services to the Company under consulting
agreements since August 1993. In September 1995, the Company and Dr. Snyder
entered into a new consulting agreement pursuant to which Dr. Snyder will
provide consulting services to the Company through August 1998, unless the
agreement is further extended or earlier terminated. Under the agreement, Dr.
Snyder performs consulting and advisory services as requested by the Company for
a minimum of 24 days and a maximum of 38 days per year, subject to adjustment
under certain circumstances. With certain limited exceptions, Dr. Snyder has
agreed not to engage in any business activity with or provide any consulting or
related services to any organization which directly competes with the Company
during the term of the agreement and for a period of one year thereafter.
 
     JOSEPH COYLE, M.D. is Chairman of the consolidated Department of Psychiatry
and Ebens Draper Professor of Psychiatry and Neuroscience at the Harvard Medical
School. He obtained his M.D. from Johns Hopkins in 1969 and completed his
Psychiatry Residency at Johns Hopkins. His research involves clinical as well as
basic studies of neurotransmitter systems and drug actions in the brain. He has
received numerous honors, including the McAlpin Award of the National Mental
Health Association, the Gold Medal Award of the Society for Biological
Psychiatry and election to the Institute of Medicine of the National Academy of
Sciences.
 
     SAMUEL H. BARONDES, M.D. is the Jeanne and Sanford Robertson Professor of
Neurobiology and Psychiatry and Director of the Center for Neurobiology and
Psychiatry at the University of California, San Francisco. He received his M.D.
from Columbia University in 1958, trained in internal medicine at the Peter Bent
Brigham Hospital, in molecular biology at the National Institutes of Health and
in psychiatry at the McLean and Massachusetts General Hospitals. Dr. Barondes
has received a number of awards including the Royer Award and the Stillmark
Medal, is a member of the Institute of Medicine, and also serves as President of
the McKnight Endowment Fund for Neuroscience.
 
     ROBERT LANGER, PH.D. is presently Germeshausen Professor in the Department
of Chemical Engineering at MIT. Dr. Langer obtained his Ph.D. from MIT in 1974
and since then has been a member of the MIT faculty. Dr. Langer is a leading
authority on polymer drug delivery systems. He has received numerous awards
including election to the United States National Academy of Sciences, the
National Academy of Engineering and the Institute of Medicine.
 
   
     IRA SHOULSON, M.D. obtained his M.D. from the University of Rochester in
1971 where he completed internal medicine and neurology residencies. He is
presently Louis C. Lasagna Professor of Experimental Therapeutics and Professor
of Neurology, Pharmacology and Medicine at the University of Rochester. He is
the recipient of numerous honors including the Modern Medicine Award for
Distinguished Achievement. Dr. Shoulson is a national leader in the design and
execution of major clinical trials evaluating drug actions in Parkinson's
disease, Huntington's disease and other movement disorders. Dr. Shoulson has
served two terms as a member of the Peripheral and Central Nervous System
Advisory Committee of the FDA.
    
 
     ANNE YOUNG, M.D., PH.D. obtained her M.D. and Ph.D. degrees from Johns
Hopkins Medical School in 1973 and 1974, respectively, and completed her
Neurology Residency at the University of California in San Francisco. She served
on the faculty of the Neurology Department at the University of Michigan and
since
 
                                      I-17
<PAGE>   19
 
1991 has been Julieanne Dorn Professor of Neurology at the Harvard Medical
School and Chief of the Neurology Service at the Massachusetts General Hospital.
She has received numerous honors including election to the American Academy of
Arts and Sciences. Her laboratory research focuses on the actions of excitatory
amino acids in the brain, while her clinical research deals with movement
disorders.
 
ITEM 2.  PROPERTIES.
 
   
     In August 1994, the Company entered into a master lease for an
approximately 83,000 square foot building in Baltimore, Maryland. The Company
currently occupies 23,000 square feet for office space, 12,500 square feet for
manufacturing space, and 35,000 square feet of research and development
laboratories. The remaining 12,500 square feet is available for additional
laboratories or manufacturing facilities. The master lease expires in July 2005.
Two five-year renewal options are available to the Company or the Company may
exercise a purchase option any time after the ninth year for the then current
fair market value.
    
 
ITEM 3.  LEGAL PROCEEDINGS.
 
     The Company is not a party to any material legal proceedings.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
     None.
 
                                      I-18
<PAGE>   20
 
                                    PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The Company's Common Stock is listed on the Nasdaq National Market under
the symbol "GLFD." The following table sets forth the range of high and low bid
prices for the Common Stock as reported on the Nasdaq National Market for the
periods indicated below.
 
<TABLE>
<CAPTION>
                                                                                 HIGH      LOW
                                                                                ------    -----
<S>                                                                             <C>       <C>
1995
Fourth Quarter...............................................................   $10.67    $7.33
Third Quarter................................................................     9.17     4.08
Second Quarter...............................................................     4.08     3.17
First Quarter................................................................     4.17     2.83
1996
Fourth Quarter...............................................................    22.25    16.00
Third Quarter................................................................    19.67    11.33
Second Quarter...............................................................    23.33    13.33
First Quarter................................................................    16.17    10.17
1997
First Quarter (through March 6, 1997)........................................    29.00    21.25
</TABLE>
 
     As of February 28, 1997, there were approximately 144 holders of record of
the Common Stock.
 
     The Company has never declared or paid any cash dividends and does not
intend to do so for the foreseeable future. The Company currently intends to
retain all earnings, if any, to finance the development of its business. Under
the Company's loan agreements with Signet Bank, during the term of the loans,
the Company may not declare any cash dividends on its Common Stock without the
prior written consent of Signet Bank and the Maryland Industrial Development
Financing Authority.
 
                                      II-1
<PAGE>   21
 
ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA.
 
   
     The following selected consolidated financial data with respect to the
Company for the period from inception on July 14, 1993 through December 31, 1993
and for each of the years in the three year period ended December 31, 1996 have
been derived from the Company's consolidated financial statements which have
been audited by KPMG Peat Marwick LLP, the Company's independent auditors. The
Company's consolidated financial statements as of December 31, 1995 and 1996,
and for each of the years in the three year period ended December 31, 1996,
including the Notes thereto, are included elsewhere in this annual report. The
information set forth below should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere herein.
    
   
<TABLE>
<CAPTION>
                                  JULY 14, 1993
                               (DATE OF INCEPTION)                      YEARS ENDED DECEMBER 31,
                                 TO DECEMBER 31,     ---------------------------------------------------------------
                                      1993                  1994                  1995                  1996
                               -------------------   -------------------   -------------------   -------------------
<S>                            <C>                   <C>                   <C>                   <C>
STATEMENT OF OPERATIONS DATA:
Total revenues...............        $    --               $    --              $     586              $28,020
Expenses:
     Research and
       development...........          1,061                 2,869                  9,688               18,761
     General and
       administrative........            367                 2,369                  4,367                6,736
  Compensation -- warrants...             --                   991                     --                   --
                                     -------               -------              ---------              -------
          Total operating                                                                              
            expenses.........          1,428                 6,229                 14,055               25,497
                                     -------               -------              ---------              -------
     Income (loss) from                                                                                
       operations............         (1,428)               (6,229)               (13,469                2,523
     Other income (expenses),                                                                          
       net...................             15                   332                    832                2,550
                                     -------               -------              ---------              -------
Net income (loss)............        $(1,413)              $(5,897)             $ (12,637)             $ 5,073
                                     =======               =======              =========              =======
Primary earnings (loss) per                                                     
  common share (1)...........        $ (0.50)              $ (1.36)             $   (1.70)             $  0.35
                                     =======               =======              =========              =======
Weighted average common and                                                     
  common equivalent shares                                                      
  used to compute primary                                                       
  earnings (loss) per share                                                     
  (1)........................          2,834                 4,332                  7,436               14,634
Fully diluted earnings (loss)                                                   
  per share (1)..............        $ (0.50)              $ (1.36)             $   (1.70)             $  0.34
                                     =======               =======              =========              =======
Weighted average common and
  common equivalent shares
  used to compute fully
  diluted earnings (loss) per
  share (1)..................          2,834                 4,332                  7,436               15,140
 
<CAPTION>
                                                                   DECEMBER 31,
                               -------------------------------------------------------------------------------------
                                      1993                  1994                  1995                  1996
                               -------------------   -------------------   -------------------   -------------------
<S>                            <C>                   <C>                   <C>                   <C>
BALANCE SHEET DATA:
Cash, cash equivalents and
  investments (2)............        $ 2,562               $11,834              $  19,454              $77,439
Total assets (2).............          3,258                14,562                 26,048               93,659
Long-term debt...............             --                 1,431                  4,696               10,905
Total stockholders' equity...          2,887                11,421                 17,773               75,877
</TABLE>
    
 
---------------
(1) For information concerning the calculation of earnings (loss) per share, see
    Note 2 of Notes to Consolidated Financial Statements.
 
(2) Includes restricted investments of $10.1 million at December 31, 1996. See
    Note 6 of Notes to Consolidated Financial Statements.
 
                                      II-2
<PAGE>   22
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS
 
   
     The following discussion is qualified in its entirety by the more detailed
information and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this annual report. The following discussion contains
forward-looking statements, including but not limited to, those concerning the
commencement and completion of clinical trials, the Company's strategic plans,
anticipated expenditures and the need for additional funds, which involve risks
and uncertainties. The Company's actual results may differ significantly from
the results discussed in the forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed elsewhere in this annual report and in the section entitled "Risk
Factors" in the March 1997 Form S-3.
    
 
GENERAL
 
     Guilford, founded in 1993, is a biopharmaceutical company engaged in the
development and commercialization of novel products in two principal areas: (i)
targeted and controlled drug delivery systems using proprietary biodegradable
polymers for the treatment of cancer and other diseases; and (ii) therapeutic
and diagnostic products for neurological diseases and conditions.
 
   
     In 1996, the Company reported net earnings of $5.1 million. However, prior
to the second quarter of 1996, the Company had incurred net operating losses
from its inception through the first quarter of 1996 and again in the fourth
quarter of 1996. Through December 31, 1996, the Company had an accumulated
deficit of $14.9 million. To date, substantially all of the Company's revenues
have been recognized as research and development or milestone payments under the
Company's collaborations. Except for GLIADEL, the Company's product candidates
are not expected to generate revenues for at least the next several years, if at
all, and the recognition of material revenues for GLIADEL sales is subject to
significant uncertainty. While the Company reported net income for the second
and third quarters of 1996, this was the result of significant and non-recurring
milestone payments from RPR with respect to GLIADEL. The Company does not
anticipate that 1997 will be profitable, and there can be no assurance that the
Company will ever achieve or sustain profitability in the future. Furthermore,
the Company expects to experience quarter-to-quarter and year-to-year
fluctuations in its operating results based upon the timing and amount of sales
of GLIADEL, the timing and realization of milestone and other payments under the
Company's agreements with RPR and other existing and potential collaborations as
well as expenses relating to the Company's research and development, clinical
and manufacturing activities.
    
 
RESULTS OF OPERATIONS
 
  Years Ended December 31, 1996, 1995 and 1994
 
     In 1996, the Company recognized $28.0 million in revenues, primarily
consisting of a total of $27.5 million in non-recurring milestone payments made
by RPR in June and September 1996. In 1995, the Company recognized $0.6 million
in revenues, primarily consisting of a non-refundable license fee payment
pursuant to the Company's agreement with DRL related to DOPASCAN. The Company
recognized no revenues in 1994. The Company will be required to pay a royalty to
MIT on sales of GLIADEL pursuant to the license agreement under which the
Company acquired the underlying technology for this product. The Company
anticipates reporting these amounts upon commencement of GLIADEL sales as cost
of goods sold in future periods.
 
     Research and development expenses increased to $18.8 million in 1996 as
compared to $9.7 million in 1995 and $2.9 million in 1994. The increase in these
costs from 1995 to 1996 of $9.1 million was primarily attributable to expenses
related to increased personnel costs and contracted research, consulting and
laboratory supplies. During 1996, the Company accelerated its neuroimmunophilin,
neurotrophic and addictive therapeutics research and development programs,
initiated and completed enrollment of a multi-center Phase II clinical trial in
the United States for DOPASCAN, finalized preparation of its new drug
application for GLIADEL (submitted in February 1996) and prepared for the
commercial launch of GLIADEL. In 1996, research and development expenses also
included a non-cash charge of $1.2 million as compensation expense relating to
certain consulting agreements intended to enhance the Company's ability to
 
                                      II-3
<PAGE>   23
 
   
develop new polymer technologies and products for the delivery of
chemotherapeutics in indications where local tumor recurrence is likely and
controlled release may to be more effective than current therapies. The Company
expects it will be required to record varying amounts quarterly of up to an
additional $2.2 million in the aggregate of non-cash compensation charges in
research and development expenses through 2001 relating to such agreements. The
increase in research and development costs from 1994 to 1995 of $6.8 million was
primarily attributable to the filing of a Treatment IND for GLIADEL, preparation
for the filing of an NDA for GLIADEL, undertaking and completing certain Phase
II clinical trials for DOPASCAN and research costs primarily related to the
Company's neurotrophic, neuroprotective and cocaine addiction therapeutics
programs as well as continued scale-up of the Company's research and development
programs. The Company anticipates that its research and development expenses
will continue to increase significantly in future periods.
    
 
   
     General and administrative expenses increased to $6.7 million in 1996 as
compared to $4.4 million in 1995 and $2.4 million in 1994. The increases in
general and administrative expenses of $2.3 million from 1995 to 1996 and of
$2.0 million from 1994 to 1995 were attributable to higher personnel costs
related to an increase in the number of employees necessary to support the
Company's research and development and commercialization activities.
Additionally, indirect personnel costs, including recruiting and relocation
costs, have increased as the total number of employees has increased. Increases
in costs related to patenting and other activities related to establishment and
preservation of the Company's intellectual property and costs related to
operations as a public company also contributed to increased general and
administrative expenditures over the periods covered. The Company anticipates
that its general and administrative expenses will continue to increase in future
periods.
    
 
     Other income and expense relates primarily to interest income and interest
expense. Interest income increased to $3.1 million in 1996 compared to $0.8
million in 1995 and $0.3 million in 1994. The increases were primarily
attributable to an increase in the average invested capital resulting from the
Company's equity offerings and in 1996 from revenues from RPR. In 1996 and 1995,
the Company incurred interest expense of $0.5 million and $0.2 million,
respectively, relating to borrowings under its loan agreements with Signet Bank
providing for the construction of manufacturing, administrative and research and
development facilities and the purchase of related equipment. In 1994, interest
expense was negligible.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The Company's cash and investments were $77.4 million at December 31, 1996.
Included in this amount is $10.1 million of restricted cash held as collateral
with respect to certain of the Company's indebtedness. The Company had incurred
an accumulated deficit at December 31, 1996 of $14.9 million and expects to
continue to incur additional operating losses from time to time in the future.
 
     The Company incurred capital expenditures of $9.1 million in 1996 compared
to $3.7 million in 1995 and $2.3 million in 1994. These capital expenditures
were related to the construction of the Company's GLIADEL manufacturing facility
and related tenant improvements for research and development laboratories and
administrative offices. Additionally, other purchases included capital
equipment, including laboratory and manufacturing equipment, and computer
hardware and software to support the Company's activities.
 
   
     The Company had available approximately $1.8 million at December 31, 1996
under its existing loan agreements with Signet Bank to finance the remaining in
process tenant improvements related to the construction of research and
development laboratories and related areas. To finance capital equipment, the
Company in September 1996 finalized a $5.0 million operating lease arrangement
with General Electric Capital Corporation for the financing of certain
equipment. Such financing, along with other sources, is expected to provide for
the Company's equipment needs at least through the second quarter of 1997. At
December 31, 1996, $3.0 million was available under this arrangement to lease
additional equipment.
    
 
     During 1997 and 1998, the Company expects to make additional capital
expenditures of approximately $3.7 million to expand the Company's GLIADEL
manufacturing plant capacity from 8,000 to 30,000 treatments annually. The
Company expects to use the capital available under its loan agreement with RPR
to fund the expansion. Under this loan agreement, the Company has the right to
borrow up to an aggregate of $7.5 million under certain conditions for such
purposes. As of January 2, 1997, $4.0 million was available under the agreement;
the remainder is available no earlier than 12 nor later than 18 months following
funding
 
                                      II-4
<PAGE>   24
 
of the initial tranche. Any principal amounts borrowed under this loan agreement
are due five years from the date borrowed and will carry an interest rate equal
to the lowest rate paid by RPR from time to time on its most senior
indebtedness. Both principal and interest due under this arrangement may, at the
Company's election, be repaid by off-setting certain amounts due to the Company
under the agreements with RPR. No amounts were outstanding under this loan at
December 31, 1996.
 
     The Company will require substantial funds in order to continue its
research and development programs and preclinical and clinical testing and to
manufacture and, where applicable, market its products. The Company's capital
requirements depend on numerous factors, including the progress of its research
and development programs, the progress of preclinical and clinical testing, the
time and costs involved in obtaining regulatory approvals, the cost of filing,
prosecuting, defending and enforcing any patent claims and other intellectual
property rights, competing technological and market developments, changes in the
Company's existing research relationships, the ability of the Company to
establish collaborative arrangements, the development of collaborative and
licensing agreements and other arrangements and the progress of manufacturing
scale-up efforts.
 
     The Company believes that its existing resources will be sufficient to fund
the Company's activities for at least the next twelve months. There can be no
assurance, however, that changes in the Company's research and development and
commercialization plans or other factors affecting the Company's operating
expenses including potential acquisitions will not result in the expenditure of
these proceeds and the Company's other resources before that time.
 
     The Company anticipates that it will fund future capital requirements
through a combination of its existing working capital coupled with the net
proceeds from this offering, revenues generated under its agreements with RPR
relating to GLIADEL, public or private financings (as necessary), additional
collaborative or other research and development agreements, commercialization
and marketing arrangements with corporate partners or other potential sources.
The Company's ability to raise future capital on acceptable terms is dependent
on conditions in the public and private equity markets and the performance of
the Company, as well as the overall performance of other companies in the
biopharmaceutical and biotechnology sectors. There can be no assurance that
required future financing arrangements will be available on acceptable terms, or
at all.
 
                                      II-5
<PAGE>   25
 
ITEM 8.  FINANCIAL STATEMENTS.
 
                         GUILFORD PHARMACEUTICALS INC.
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                         PAGE
                                                                                         ----
<S>                                                                                      <C>
Independent Auditors' Report..........................................................   F-2
Consolidated Balance Sheets...........................................................   F-3
Consolidated Statements of Operations.................................................   F-4
Consolidated Statements of Stockholders' Equity.......................................   F-5
Consolidated Statements of Cash Flows.................................................   F-6
Notes to Consolidated Financial Statements............................................   F-7
</TABLE>
 
                                       F-1
<PAGE>   26
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors and Stockholders of
Guilford Pharmaceuticals Inc.:
 
     We have audited the accompanying consolidated balance sheets of Guilford
Pharmaceuticals Inc. and subsidiaries as of December 31, 1995 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Guilford
Pharmaceuticals Inc. and subsidiaries as of December 31, 1995 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996, in conformity with generally accepted
accounting principles.
 
                                                KPMG Peat Marwick LLP
 
Baltimore, Maryland
February 28, 1997
 
                                       F-2
<PAGE>   27
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)

                                     ASSETS
 
   
<TABLE>
<CAPTION>
                                                                             DECEMBER 31,
                                                                        ----------------------
                                                                          1995          1996
                                                                        --------      --------
<S>                                                                     <C>           <C>
Current assets:
  Cash and cash equivalents..........................................   $  4,260      $ 16,560
  Short-term investments.............................................     11,552        20,097
  Short-term investments -- restricted...............................        250         1,608
  Collaborative research receivable..................................        556           376
  Inventory..........................................................         --         1,533
  Other current assets...............................................        291           435
                                                                        ---------     ---------
          Total current assets.......................................     16,909        40,609
Investments..........................................................         --        30,653
Investments -- restricted............................................      3,392         8,521
Property and equipment, net..........................................      5,456        13,455
Other assets.........................................................        291           421
                                                                        ---------     ---------
          Total assets...............................................   $ 26,048      $ 93,659
                                                                        =========     =========
                     LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable...................................................   $  1,640      $  2,038
  Bond payable -- current portion....................................        293           941
  Term loan payable -- current portion...............................         --           540
  Accrued expenses and other current liabilities.....................      1,646         3,358
                                                                        ---------     ---------
          Total current liabilities..................................      3,579         6,877
Long-term liabilities:
  Bond payable, less current portion.................................      4,696         6,588
  Term loan payable, less current portion............................         --         4,317
                                                                        ---------     ---------
          Total liabilities..........................................      8,275        17,782
Stockholders' equity:
  Preferred stock, par value $.01 per share. Authorized 4,700,000
     shares, none issued.............................................         --            --
  Series A junior participating preferred stock, par value $.01 per
     share. Authorized 300,000 shares, none issued...................         --            --
  Common stock, par value $.01 per share. Authorized 20,000,000
     shares; 10,189,598 (6,793,065 pre-split) and 13,979,490 issued
     and outstanding at December 31, 1995 and 1996...................         68           140
  Additional paid-in capital.........................................     38,121        90,880
  Notes receivable on common stock...................................       (139)         (129)
  Accumulated deficit................................................    (19,947)      (14,874)
  Unrealized gain on available-for-sale securities...................         --            62
  Deferred compensation..............................................       (330)         (202)
                                                                        ---------     ---------
          Total stockholders' equity.................................     17,773        75,877
                                                                        ---------     ---------
          Total liabilities and stockholders' equity.................   $ 26,048      $ 93,659
                                                                        =========     =========
</TABLE>
    
 
          See accompanying notes to consolidated financial statements.
 
                                       F-3
<PAGE>   28
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
   
<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31,
                                                           ---------------------------------------
                                                              1994          1995          1996
                                                           ----------    ----------    -----------
<S>                                                        <C>           <C>           <C>
Revenues:
  Contract and license revenue..........................   $       --    $      556    $    27,600
  Revenues under collaborative agreements...............           --            30            420
                                                           ------------  ------------  ------------
          Total revenues................................           --           586         28,020
Operating expenses:
  Research and development..............................        2,869         9,155         17,850
  Research and development -- Gell Pharmaceuticals
     Inc................................................           --           533            911
  General and administrative............................        2,369         4,367          6,736
  Compensation expense -- warrants......................          991            --             --
                                                           ------------  ------------  ------------
          Total operating expenses......................        6,229        14,055         25,497
                                                           ------------  ------------  ------------
Income (loss) from operations...........................       (6,229)      (13,469)         2,523
Other income (expense):
  Interest income.......................................          336           823          3,070
  Other income..........................................           --           199              8
  Interest expense......................................           (4)         (190)          (528)
                                                           ------------  ------------  ------------
          Net income (loss).............................   $   (5,897)   $  (12,637)   $     5,073
                                                           ============  ============  ============
Primary earnings (loss) per common share:...............   $    (1.36)   $    (1.70)   $      0.35
                                                           ============  ============  ============
 
Weighted average common and common equivalent shares
  outstanding -- primary................................        4,332         7,436         14,634
 
Fully diluted earnings (loss) per common share:.........   $    (1.36)   $    (1.70)   $      0.34
                                                           ============  ============  ============
Weighted average common and common equivalent shares
  outstanding -- fully diluted..........................        4,332         7,436         15,140
</TABLE>
    
 
          See accompanying notes to consolidated financial statements.
 
                                       F-4
<PAGE>   29
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
                       (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
                                         PREFERRED STOCK       COMMON STOCK                   NOTES                   UNREALIZED
                                       -------------------  ------------------  ADDITIONAL  RECEIVABLE                  GAIN ON
                                         NUMBER               NUMBER             PAID-IN    ON COMMON  ACCUMULATED   AVAILABLE FOR
                                       OF SHARES   AMOUNT   OF SHARES   AMOUNT   CAPITAL      STOCK      DEFICIT    SALE SECURITIES
                                       ----------  -------  ----------  ------  ----------  ---------  -----------  ---------------
<S>                                    <C>         <C>      <C>         <C>     <C>         <C>        <C>          <C>
Balance, December 31, 1993............  2,423,333   $  24      582,608   $  6    $  4,378     $(108)    $  (1,413)       $  --
Issuance of common stock in initial
  public offering at $8.00* per share,
  net of offering costs...............                       1,875,000     19      12,848
Issuance of warrants..................                                                 10
Issuance of common stock..............                          39,129      1          89       (90)
Issuance of Series A Convertible
  Preferred Stock.....................     50,000       1                             249
Compensation related to issuance of
  common stock and grant of common
  stock options.......................                                                273
Amortization of deferred
  compensation........................
Conversion of Series A Preferred
  Stock............................... (2,473,333)    (25)   1,075,361     10          15
Exercise of warrants..................                          85,217      1         195
Reduction in notes receivable on
  common stock........................                                                           49
Compensation expense -- warrants......                                                991
Net loss for the year.................                                                                     (5,897)
                                       ------------ -----   -----------  ----    --------     -----     ---------        -----
                                                                                                                              
Balance, December 31, 1994............     --       $  --    3,657,315   $ 37    $ 19,048     $(149)    $  (7,310)       $  --
Issuance of common stock in secondary                                                         
  public offering at $6.50* per share,                                                        
  net of offering costs...............                       3,000,000     30      17,901     
Other issuances of common stock.......                          63,286      1         280     
Exercise of warrants by Scios Nova....                          72,464                166     
Equity proceeds from Gell                                                                     
  Pharmaceuticals relating to the put                                                         
  option..............................                                                726     
Amortization of deferred                                                                      
  compensation........................                                                        
Reduction in notes receivable on                                                              
  common stock........................                                                           10
Net loss for the year.................                                                                    (12,637)
                                       ------------ -----   -----------  ----    --------     -----     ---------        -----
                                                                                                                              
Balance, December 31, 1995............     --       $  --    6,793,065   $ 68    $ 38,121     $(139)    $ (19,947)       $  --
Issuance of common stock in secondary                                                         
  public offering at $20.00* per                                                              
  share, net of offering costs........                       2,300,000     23      42,880     
Other issuances of common stock.......                         226,595      2       7,679     
Three-for-two stock split.............                       4,659,830     47         (47)    
Equity proceeds from Gell                                                                     
  Pharmaceuticals relating to the put                                                         
  option..............................                                              1,076     
Amortization of stock option                                                                  
  compensation........................                                              1,171     
Amortization of deferred                                                                      
  compensation........................                                                        
Reduction in notes receivable on                                                              
  common stock........................                                                           10
Unrealized gain on available for sale                                                         
  securities..........................                                                                                      62
Net income for the year...............                                                                      5,073
                                       ------------ -----   -----------  ----    --------     -----     ---------        -----
                                                                                                                              
Balance, December 31, 1996............     --       $  --   13,979,490   $140    $ 90,880     $(129)    $ (14,874)       $  62
                                       ============ ======  ===========  ====    ========     =====     =========        =====
                                                                        
<CAPTION>
 
                                                          TOTAL
                                          DEFERRED    STOCKHOLDERS'
                                        COMPENSATION     EQUITY
                                        ------------  -------------
<S>                                    <C>            <C>
Balance, December 31, 1993............     $   --       $   2,887
Issuance of common stock in initial
  public offering at $8.00* per share,
  net of offering costs...............                     12,867
Issuance of warrants..................                         10
Issuance of common stock..............                         --
Issuance of Series A Convertible
  Preferred Stock.....................                        250
Compensation related to issuance of
  common stock and grant of common
  stock options.......................       (273)             --
Amortization of deferred
  compensation........................         68              68
Conversion of Series A Preferred
  Stock...............................                         --
Exercise of warrants..................                        196
Reduction in notes receivable on
  common stock........................                         49
Compensation expense -- warrants......                        991
Net loss for the year.................                     (5,897)
                                           ------       ---------
Balance, December 31, 1994............     $ (205)      $  11,421
Issuance of common stock in secondary
  public offering at $6.50* per share,
  net of offering costs...............                     17,931
Other issuances of common stock.......       (237)             44
Exercise of warrants by Scios Nova....                        166
Equity proceeds from Gell
  Pharmaceuticals relating to the put
  option..............................                        726
Amortization of deferred
  compensation........................        112             112
Reduction in notes receivable on
  common stock........................                         10
Net loss for the year.................                    (12,637)
                                           ------       ---------
Balance, December 31, 1995............     $ (330)      $  17,773
Issuance of common stock in secondary
  public offering at $20.00* per
  share, net of offering costs........                     42,903
Other issuances of common stock.......                      7,681
Three-for-two stock split.............                         --
Equity proceeds from Gell
  Pharmaceuticals relating to the put
  option..............................                      1,076
Amortization of stock option
  compensation........................                      1,171
Amortization of deferred
  compensation........................        128             128
Reduction in notes receivable on
  common stock........................                         10
Unrealized gain on available for sale
  securities..........................                         62
Net income for the year...............                      5,073
                                           ------       ---------
Balance, December 31, 1996............     $ (202)      $  75,877
                                           ======       =========
</TABLE>
 
---------------
 
* Per share prices are pre-stock split
 
          See accompanying notes to consolidated financial statements.
 
                                       F-5
<PAGE>   30
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
   
<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                                 --------------------------------
                                                                   1994        1995        1996
                                                                 --------    --------    --------
<S>                                                              <C>         <C>         <C>
Cash Flows From Operating Activities:
  Net income (loss)...........................................   $ (5,897)   $(12,637)   $  5,073
  Adjustments to reconcile net income (loss) to net cash
     provided by (used in) operating activities:
     Depreciation and amortization............................         44         567       1,102
     Noncash compensation expense.............................      1,059         122       1,309
     Provision for loss related to advance to underwriter.....        175          --          --
  Changes in assets and liabilities:
     Collaborative research receivable........................         --        (556)        180
     Inventory................................................         --          --      (1,533)
     Other current assets.....................................       (288)       (177)       (144)
     Other assets.............................................       (120)          4        (130)
     Accounts payable.........................................        964         428         398
     Accrued expenses and other liabilities...................        375       1,177       1,712
                                                                 ---------   ---------   ---------
  Net cash provided by (used in) operating activities.........     (3,688)    (11,072)      7,967
                                                                 ---------   ---------   ---------
Cash Flows From Investing Activities:
  Investment in purchases of property and equipment...........     (2,343)     (3,706)     (9,101)
  Maturities of held-to-maturity investments..................         --      40,071      48,368
  Purchases of held-to-maturity investments...................     (7,544)    (47,470)    (56,557)
  Purchases of available-for-sale investments.................         --          --     (36,076)
  Restricted investments......................................       (250)         --      (1,358)
                                                                 ---------   ---------   ---------
  Net cash used in investing activities.......................    (10,137)    (11,105)    (54,724)
                                                                 ---------   ---------   ---------
Cash Flows From Financing Activities:
  Net proceeds from issuances of common stock.................     13,372      18,113      50,584
  Proceeds from bond and term loan issuances..................      1,431       3,558       7,867
  Equity proceeds from Gell Pharmaceuticals Inc. relating to
     the put option...........................................         --         726       1,076
  Principal payments on bond payable..........................         --          --        (470)
  Proceeds received on subscriptions receivable...............        500          --          --
                                                                 ---------   ---------   ---------
  Net cash provided by financing activities...................     15,303      22,397      59,057
                                                                 ---------   ---------   ---------
Net increase in cash and cash equivalents.....................      1,478         220      12,300
Cash and cash equivalents at the beginning of year............      2,562       4,040       4,260
                                                                 ---------   ---------   ---------
Cash and cash equivalents at the end of year..................   $  4,040    $  4,260    $ 16,560
                                                                 =========   =========   =========
Supplemental disclosures of cash flow information:
  Net interest paid...........................................   $     --    $    165    $    470
  Unrealized gain on available-for-sale securities............         --          --          62
  Issued shares of common stock in lieu of cash bonus.........         --          28          --
  Issuances of common stock to executive officers.............        273         237          --
  Collateral transferred from unrestricted to restricted
     investments, net.........................................   $    902    $  2,490    $  5,129
                                                                 =========   =========   =========
</TABLE>
    
 
          See accompanying notes to consolidated financial statements.
 
                                       F-6
<PAGE>   31
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                        DECEMBER 31, 1994, 1995 AND 1996
 
(1)  ORGANIZATION AND BUSINESS ACTIVITIES
 
     Guilford Pharmaceuticals Inc. along with its subsidiaries, ("Guilford" or
the "Company") is a biopharmaceutical company engaged in the development and
commercialization of novel products in two principal areas: (i) targeted and
controlled drug delivery systems using proprietary biodegradable polymers for
the treatment of cancer and other diseases; and (ii) therapeutic and diagnostic
products for neurological diseases and conditions.
 
(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
   
  Principles of consolidation
    
 
     The consolidated financial statements include the accounts of Guilford
Pharmaceuticals Inc. and subsidiaries, all of which are wholly-owned. All
significant intercompany balances and transactions are eliminated in
consolidation.
 
   
  Development stage company
    
 
     During 1996, the Company received regulatory clearance from the U.S. Food
and Drug Administration ("FDA") to commence sales of GLIADEL(R). In addition,
the Company entered into a major strategic alliance with a corporate partner to
market and sell the product on a worldwide basis (excluding Scandinavia) and
recognized revenue from various corporate partnering activities. The Company
expects to recognize additional revenue from similar sources in the future and
from future sales of GLIADEL commencing in 1997. Accordingly, the Company
believes it is no longer in the development stage and has removed the references
and reporting requirements of SFAS No. 7, "Accounting and Reporting by
Development Stage Companies".
 
  Investment in Gell Pharmaceuticals Inc.
 
   
     The Company has a 20% equity interest in Gell Pharmaceuticals Inc. ("Gell")
and exercises significant influence over both operations and financial matters
of Gell (see Notes 14 and 15). In addition, the 80% stockholder has a currently
exercisable put option to exchange such equity interest for 750,000 shares of
common stock of the Company. The equity contributed to Gell by the 80%
stockholder approximated the fair value of the 750,000 shares of common stock of
the Company at the inception of Gell as determined by an independent investment
banker. Accordingly, the Company records substantially all of the contributions
of Gell by such stockholder as equity relating to the put option, which is
deemed by the Company and its investment banker to be an equity instrument of
the Company. In addition, the Company charges to operations approximately 100%
of the costs incurred from Gell's activities. The Company includes the dilutive
effect of the Company's common shares that would be issued under this currently
exercisable put option (using the treasury stock method) in its calculation of
primary and fully diluted earnings (loss) per share.
    
 
   
  Use of estimates
    
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
  Cash and cash equivalents
 
     The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents.
 
                                       F-7
<PAGE>   32
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)

  Investments
 
     Investments consist primarily of debt securities backed by the U.S.
government and commercial paper of U.S. companies. Investments may include
financial instruments which the Company believes will be held-to-maturity or may
be held available-for-sale. Classification of investments is made at the time
these investments are purchased. Held-to-maturity securities are those
securities in which the Company has the ability and intent to hold until
maturity. All other securities are classified as available-for-sale.
 
     Available-for-sale securities are recorded at fair value. Unrealized gains
and losses on available-for-sale securities are excluded from the results of
operations and are reported as a separate component of stockholders' equity
until realized. Realized gains and losses from the sale of available-for-sale
securities are determined on a specific identification basis. Held-to-maturity
securities are recorded at amortized cost, adjusted for the amortization or
accretion of premiums or discounts.
 
     A decline in the market value of any available-for-sale or held-to-maturity
security below cost that is deemed to be other than temporary would result in a
reduction in the carrying amount of such security to fair value. Such impairment
would be charged to operations in the period in which the decline in value is
deemed to be other than temporary. The Company has not recorded any such
permanent impairments since its inception.
 
  Concentration of credit risk
 
     The Company invests its excess cash in accordance with a policy objective
that seeks to preserve both liquidity and safety of principal. The policy limits
investments to certain instruments issued by institutions with strong investment
grade credit ratings and places restrictions on their terms and concentrations
by type and issuer. The Company has not realized any significant losses on its
investments.
 
   
  Fair value of financial instruments
    
 
     The fair value of financial instruments is determined by reference to
various market data and other valuation techniques, as appropriate. The fair
values of financial instruments approximate their recorded value.
 
  Property and equipment
 
     Property and equipment are recorded at cost, including interest on funds
borrowed to finance the construction of tenant improvements. Depreciation and
amortization are provided using the straight-line method over the estimated
useful lives of the assets, generally three to seven years for furniture and
equipment, and over the shorter of the estimated useful life of improvements or
lease term for such leasehold improvements. Expenditures for repairs and
maintenance are expensed as incurred.
 
  Revenue Recognition -- collaborative research, contract and license agreements
 
   
     Collaborative research revenue from cost-reimbursement agreements is
recorded as the related expenses are incurred, up to the contractual limits and
when the Company meets its performance obligations under the respective
agreements. Contract and licensing revenue is recognized when milestones are met
and the Company's significant performance obligations have been satisfied in
accordance with the terms of the respective agreements. Cash received that is
related to future performance under such contracts is deferred and recognized as
revenue when earned.
    
 
  Research and development, patent and royalty costs
 
     Research and development, patent, and royalty costs are expensed as
incurred.
 
                                       F-8
<PAGE>   33
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)

  Inventories
 
     Inventories are stated at the lower of cost or market, using the first-in,
first-out (FIFO) method.
 
  Accounting for income taxes
 
     Deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax basis of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. The measurement of deferred tax assets is
reduced, if necessary, by a valuation allowance for any tax benefits which are
not expected to be realized. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in the period that such tax rate changes
are enacted.
 
  Stock-based compensation
 
   
     The Company accounts for share option issuances in accordance with the
provisions of APB No. 25, "Accounting for Stock Issued to Employees", and
related interpretations. As such, deferred compensation is recorded to the
extent that the current market price of the underlying stock exceeds the
exercise price on the date of grant. Such deferred compensation is amortized
over the respective vesting periods of such option grants. On January 1, 1996,
the Company adopted the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation" which allows entities to continue to apply the
provisions of APB No. 25 for financial statement reporting purposes and provide
pro forma net income (loss) and pro forma earnings (loss) per share footnote
disclosures for employee stock option grants made in 1995 and 1996 as if the
fair-value based method defined in SFAS No. 123 had been applied. The Company
has elected to continue to apply the financial statement reporting provisions of
APB No. 25 and to provide the pro forma disclosure provisions of SFAS No. 123.
Transactions with non-employees, in which goods or services are the
consideration received for the issuance of equity instruments, are accounted for
under the fair-value based method defined in SFAS No. 123 (see Note 9).
    
 
  Stock split
 
     On October 15, 1996, the Company's Board of Directors declared a
three-for-two stock split of the Company's common stock. Earnings (loss) per
share data has been adjusted to reflect the stock split for all periods
presented.
 
   
  Earnings (loss) per share
    
 
   
     The computation of earnings (loss) per share for 1996 and 1995 was based on
the weighted average common shares outstanding during the year, and includes,
when their effect is dilutive, common stock equivalents consisting of warrants,
stock options and put rights.
    
 
     The computation of loss per share in 1994 was based on the weighted average
common shares outstanding and includes common and common equivalent shares
issued during the 12 month period prior to the Company's June 1994 initial
public offering.
 
  Reclassifications
 
     Certain reclassifications have been made to the 1994 and 1995 consolidated
financial statements to conform with the 1996 financial statement presentation.
 
                                       F-9
<PAGE>   34
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(3)  INVESTMENTS
 
     Investments available-for-sale and held-to-maturity securities by major
security type and class of security at December 31, 1995 and 1996, are as
follows:
 
   
<TABLE>
<CAPTION>
                                                                  GROSS         GROSS
                                                                UNREALIZED    UNREALIZED
                                                                 HOLDING       HOLDING       FAIR
                         1995                         COSTS       GAINS         LOSSES       VALUE
    ----------------------------------------------   -------    ----------    ----------    -------
    <S>                                              <C>        <C>           <C>           <C>
                                                                     (IN THOUSANDS)
    Held-to-maturity:
      U.S. Treasury Securities....................   $ 9,681       $  1         $   --      $ 9,682
      Corporate Debt Securities...................     5,513         --             (2)       5,511
      Other Debt Securities.......................        --         --             --           --
                                                     -------    -------       --------      -------
                                                     $15,194       $  1         $   (2)     $15,193
                                                     =======    =======       ========      =======
    1996                                                                  
    Available-for-sale:                                                   
      U.S. Treasury Securities....................   $33,459       $167         $ (106)     $33,520
      Corporate Debt Securities...................     1,190          4             (1)       1,193
      Other Debt Securities.......................     1,427         13            (15)       1,425
                                                     -------    -------       --------      -------
                                                     $36,076       $184         $ (122)     $36,138
                                                     -------    -------       --------      -------
    Held-to-maturity:                                                     
      U.S. Treasury Securities....................   $23,051       $ 83         $  (88)     $23,046
      Corporate Debt Securities...................     1,690         18             (2)       1,706
      Other Debt Securities.......................        --         --             --           --
                                                     -------    -------       --------      -------
                                                     $24,741       $101         $  (90)     $24,752
                                                     -------    -------       --------      -------
                                                     $60,817       $285         $ (212)     $60,890
                                                     =======    =======       ========      =======
</TABLE>
    
 
     Maturities of debt securities classified as available-for-sale and
held-to-maturity were as follows at December 31, 1996 (maturities of
mortgage-backed securities and collateralized mortgage obligations have
 
                                      F-10
<PAGE>   35
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(3)  INVESTMENTS -- (CONTINUED)

been presented based upon estimated cash flows, assuming no change in the
current interest rate environment):
<TABLE>
<CAPTION>
                                                        HELD-TO-MATURITY       AVAILABLE-FOR-SALE
                                                      --------------------    --------------------
                                                       DECEMBER 31, 1996       DECEMBER 31, 1996
                                                      --------------------    --------------------
                                                      AMORTIZED     FAIR      AMORTIZED     FAIR
                                                        COST        VALUE       COST        VALUE
                                                      ---------    -------    ---------    -------
                                                         (IN THOUSANDS)          (IN THOUSANDS)
    <S>                                               <C>          <C>        <C>          <C>
    Due in 1 year or less (1)......................    $20,935     $20,975     $ 9,177     $ 9,291
    Due in 1-2 years...............................      3,806       3,777      14,945      14,885
    Due in 2-5 years...............................         --          --      11,954      11,962
                                                       -------     -------     -------     -------
                                                       $24,741     $24,752     $36,076     $36,138
                                                       =======     =======     =======     =======
</TABLE>
 
---------------
   
(1) Includes $8,521 of restricted securities (see Note 6) included in
    "Investments -- restricted."
    
 
   
(4)  COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
    
<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                                      --------------------
                                                                       1995         1996
                                                                      -------      -------
    <S>                                                               <C>          <C>
                                                                         (IN THOUSANDS)
 
<CAPTION>
    <S>                                                               <C>          <C>
    Inventory:
      Raw materials................................................   $    --      $   600
      Work in process..............................................        --          432
      Finished goods...............................................        --          501
                                                                      --------     -------
                                                                      $    --      $ 1,533
                                                                      ========     =======
    Property and Equipment:
      Laboratory equipment.........................................   $   978      $ 1,322
      Manufacturing equipment......................................       528        1,677
      Computer and office equipment................................     1,258        2,126
      Leasehold improvements.......................................     2,253        9,767
      Construction in process......................................     1,050          276
                                                                      -------      -------
                                                                      $ 6,067      $15,168
      Less accumulated depreciation and amortization...............      (611)      (1,713)
                                                                      -------      -------
                                                                      $ 5,456      $13,455
                                                                      =======      =======
    Accrued Expenses and Other Current Liabilities:
      Consulting and contracted research...........................   $   401      $   935
      Payroll and related costs....................................       681        1,238
      Other current liabilities....................................       564        1,185
                                                                      -------      -------
                                                                      $ 1,646      $ 3,358
                                                                      =======      =======
</TABLE>
 
(5)  SIGNIFICANT CONTRACTS AND LICENSING AGREEMENTS
 
  Agreements with Rhone-Poulenc Rorer Pharmaceuticals Inc.
 
   
     In June 1996, the Company entered into a Marketing, Sales and Distribution
Rights Agreement (together with related agreements, the "RPR Agreements") with
Rhone-Poulenc Rorer Pharmaceuticals Inc. and its parent corporation
(collectively "RPR") granting RPR worldwide marketing rights (excluding
Scandinavia) for GLIADEL. The Company received $15 million upon the signing of
these agreements ($7.5 million as an equity investment and $7.5 million as a
non-refundable rights payment). On September 23, 1996, the Company obtained
clearance from the FDA for GLIADEL for recurrent glioblastoma multiforme where
surgical tumor removal is indicated and, accordingly, received a $20 million
non-refundable
    
 
                                      F-11
<PAGE>   36
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(5)  SIGNIFICANT CONTRACTS AND LICENSING AGREEMENTS -- (CONTINUED)

milestone payment from RPR. RPR is obligated to make up to $40 million in
additional milestone payments, including $7.5 million in the form of an equity
investment, only if the Company achieves certain regulatory approvals. In
addition, RPR may also fund up to $17 million for the development of a
higher-dose GLIADEL product and to fund certain additional clinical studies
related to GLIADEL. The Company will manufacture and supply GLIADEL to RPR and
receive a transfer price and royalties based on sales.
 
   
     Under the RPR Agreements, the Company has the right to borrow up to an
aggregate of $7.5 million under certain conditions, $4.0 million is available no
earlier than January 2, 1997, and the remainder no earlier than 12 nor later
than 18 months following funding of the initial tranche. The loan proceeds would
be used to provide additional polymer product manufacturing capacity expansion.
Any principal amounts borrowed under this loan agreement are due five years from
the date borrowed and will carry an interest rate equal to the lowest rate paid
by of RPR on its most senior indebtedness. Both the principal and interest due
under this agreement may, at the Company's election, be repaid by offsetting
certain amounts due to the Company under the RPR Agreements.
    
 
   
  Other contracts and agreements
    
 
     In October 1995, the Company entered into a license and distribution
agreement with Orion Corporation Farmos ("Orion Farmos") which provides that
Orion Farmos pay to the Company a licensing fee of $100,000, which amount was
received in 1996, and $100,000 upon Orion Farmos' first submission to a
governmental regulatory authority in Finland, Denmark, Norway or Sweden.
Additionally, the Company will receive both a transfer price on materials
shipped to Orion Farmos and royalties on future product sales, if any.
 
     In December 1995, the Company entered into an agreement with Daiichi
Radioisotope Laboratories, Ltd. ("DRL") which provides that DRL pay to the
Company a non-refundable license fee of $555,500, which amount was earned in
1995, and a milestone payment of $555,500 upon the filing of the first
application for the regulatory approval in certain foreign countries.
Additionally the Company receives both a transfer price on materials shipped to
DRL and royalties on future product sales, if any.
 
   
     The Company has entered into licensing, technology transfer and development
agreements with The Johns Hopkins University under which it is required to make
certain payments for patent maintenance costs, processing fees, license payments
and development payments aggregating approximately $995,000 through 1999. The
Company has agreed to spend $500,000 per year through 2003 with respect to their
internal research and development activities on advancing such technologies and
may be required to make certain payments, as defined, to The Johns Hopkins
University should agreed-upon milestones be attained. In addition, the Company
is required to pay a royalty on the net sales of all licensed products, if any,
as well as a percentage of all royalties received by the Company from
sublicensees, if any.
    
 
     The Company has also entered into various other licensing, research and
development agreements whereby they are committed to fund certain mutually
agreed-upon research and development projects, either on a best efforts basis or
upon attainment of certain performance milestones, as defined, or both, for
various periods unless canceled by the respective parties. Such future amounts
to be paid are approximately $1.4 million through 1998. In addition, the Company
is required to pay a royalty on the net sales of all licensed products, if any,
as well as a percentage of all royalties received by the Company from
sublicensees, if any.
 
     Royalty expenses relating to certain sublicensing agreements aggregated
approximately $32,000 in 1995 and $1.1 million in 1996.
 
                                      F-12
<PAGE>   37
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(6)  FINANCING AGREEMENTS
 
   
  Bond agreements
    
 
   
     In December 1994, the Company entered into a bond financing arrangement
with Signet Bank under which the Company could borrow up to $8,000,000 for
capital improvements and for the purchase of certain equipment and furniture.
The bond was issued by the Maryland Economic Development Corporation with a 30%
guaranty of the outstanding borrowings by the Maryland Industrial Development
Financing Authority ("MIDFA"). The bond is to be repaid monthly, together with
interest at the London Interbank Overseas Rate ("LIBOR") plus 75 basis points
adjusted monthly (6.7% at December 31, 1996) over 102 months commencing July
1996. The Company is required to meet certain financial covenants, the most
restrictive of which requires the Company to maintain cash collateral equal to
50% of its outstanding indebtedness under the bond less $100,000. The amount of
the Company's cash collateral under the bond will be reduced quarterly beginning
in October 1996 by an amount equivalent to 50% of the principal repaid during
the prior quarter. The Company may not declare any cash dividends on its capital
stock without the prior written consent of Signet Bank and MIDFA. During 1996,
the Company borrowed the remaining available principal amount under the Signet
Bank bond financing of $8 million. The outstanding principal balance was $5.0
million and $7.5 million at December 31, 1995 and 1996, respectively.
    
 
   
  Term loan agreements
    
 
   
     The Company has entered into a $6.7 million term loan agreement with Signet
Bank for other tenant improvements. Under the terms of the loan agreement,
interest is charged monthly on the outstanding balance using LIBOR plus
five-eighths percent (0.625%) per annum. Principal payments are to be repaid
based on seventy-two (72) monthly installments commencing May, 1997. The Company
is required to maintain cash collateral equal to the outstanding principal
balance over the life of the loan. The Company had outstanding $4.9 million
under this loan at December 31, 1996.
    
 
     Under the bond and term loan agreements, the Company has set aside $3.4
million and $8.5 million at December 31, 1995 and 1996, respectively, as
collateral (together with the Bank's security interest in tenant improvements
and equipment) which is included in the accompanying consolidated balance sheets
as noncurrent assets under "Investments -- restricted".
 
   
  Revolving line of credit
    
 
     The Company has available a $250,000 revolving line of credit agreement
with a bank which requires interest at the bank's internal cost of funds plus 1%
and is payable on demand. The line of credit is fully secured by a U.S. Treasury
Note which is recorded under "Short-term investments -- restricted". There were
no amounts outstanding under the line of credit at December 31, 1995 and 1996.
 
  Master Lease Agreement
 
   
     In September 1996, the Company entered into a $5.0 million Master Lease
Agreement ("Master Agreement") with General Electric Capital Corporation
("GECC"). Each equipment lease the Company executes under the Master Agreement
is for a term of 49 months and requires an irrevocable letter of credit issued
from a banking institution equal to 70% of the equipment cost covered by each
such lease, which percentage decreases upon the annual anniversary of each lease
under the Master Agreement. The Company has leased $2.0 million in equipment
under operating leases as of December 31, 1996 collateralized by U.S. Treasury
notes aggregating approximately $1.4 million which are recorded under
"Short-term investments -- restricted".
    
 
                                      F-13
<PAGE>   38
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(7)  CAPITAL TRANSACTIONS
 
   
     On October 15, 1996, the Board of Directors declared a three-for-two stock
split. All of the following transactions have been adjusted to reflect the stock
split. In June 1996, the Company entered into a stock purchase agreement with
RPR (see Note 5) whereby, RPR purchased 281,531 shares of the Company's common
stock for $7.5 million. In March 1996, the Company completed a public equity
offering of 3,450,000 shares of its common stock, $.01 par value providing net
proceeds of approximately $42.9 million to the Company. In August 1995, the
Company completed an additional public offering of 4,500,000 shares of common
stock, $.01 par value per share, providing net proceeds of approximately $17.9
million to the Company. In June 1994, the Company completed its initial public
offering of 2,812,500 shares of common stock providing approximately $12.9
million in net proceeds. In connection with the offering, the Company granted
warrants to purchase 312,934 shares, as adjusted, of common stock to the
underwriter exercisable at $7.19 per share through June 24, 1999.
    
 
     The Company has awarded or sold 67,500, 58,694 and 39,129 shares of its
common stock to certain officers during 1995, 1994 and 1993, respectively. Such
shares are subject to the terms of the 1993 Employee Share Option and Restricted
Share Plan (see Note 9). As a result, the Company recorded deferred compensation
of approximately $510,000, which amount is being charged ratably to operations
over the various vesting periods.
 
(8)  STOCKHOLDER RIGHTS PLAN
 
     In September 1995, the Board of Directors adopted a Stockholder Rights Plan
("Rights Plan") in which preferred stock purchase rights ("Rights") were granted
at the rate of one Right for each share of common stock. All rights expire on
October 10, 2005. At December 31, 1996, the Rights were neither exercisable nor
traded separately from the Company's common stock, and become exercisable only
if a person or group becomes the beneficial owner of 20% or more of the
Company's common stock or announces a tender or exchange offer which would
result in its ownership of 20% or more of the Company's common stock. Each
holder of a Right, other than the acquiring person, would be entitled to
purchase $120 worth of common stock of the Company for each Right at the
exercise price of $60 per Right, which would effectively enable such Rights
holders to purchase common stock at one-half of the then current price.
 
     If the Company is acquired in a merger, or 50% or more of the Company's
assets are sold in one or more related transactions, each Right would entitle
the holder thereof to purchase $120 worth of common stock of the acquiring
company at the exercise price of $60 per Right. At any time after a person or
group of persons becomes the beneficial owner of 20% or more of the common
stock, the Board of Directors, on behalf of all stockholders, may exchange one
share of common stock for each Right, other than Rights held by the acquiring
person.
 
(9)  SHARE OPTION AND RESTRICTED SHARE PLANS
 
  The 1993 Employee Share Option and Restricted Share Plan
 
     The 1993 Employee Share Option and Restricted Share Plan, (the "1993
Plan"), was established to provide eligible individuals with an opportunity to
acquire or increase an equity interest in the Company and to encourage such
individuals to continue in the employment of the Company. Share options are
granted at the fair market value of the stock on the day immediately preceding
the date of grant or date of initial employment, if later. Share options are
exercisable for a period not to exceed ten years from the date of grant. In
general, share options vest over four years.
 
     Shares awarded under the restricted share provisions of the 1993 Plan are
valued at the fair market value of the stock on the day immediately preceding
the date of award and require a vesting period determined by
 
                                      F-14
<PAGE>   39
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(9)  SHARE OPTION PLANS -- (CONTINUED)

the Board of Directors. Should an individual leave the employment of the Company
for any reason, the award recipient would forfeit their ownership rights for all
shares not otherwise fully vested.
 
     At December 31, 1996, the maximum shares issuable under the 1993 Plan is
2,700,000, of which up to 300,000 may be issuable under the restricted share
provisions.
 
  The Directors' Plan
 
     The Director's Stock Option Plan (the "Directors' Plan") was established to
provide non-employee directors an opportunity to acquire or increase an equity
interest in the Company. Under the Directors' Plan, 300,000 shares of common
stock are reserved for issuance at an exercise price not less than fair value of
the Company's common stock on the day immediately preceding the date of grant.
Such options vest 50% at the end of year one and 100% at the end of year two.
Under the Directors' Plan 60,000 and 37,500 options were granted during 1995 and
1996, of which 30,000 are exercisable as of December 31, 1996. In 1996, the
Company granted 120,000 options outside of the Directors' Plan to two directors
with an exercise price of $13.54 (market value at date of grant). Approximately
90,000 options vested in 1996 and the remaining 30,000 options vest in equal
amounts in 1997 and 1998.
 
  Consultants
 
     In 1996, the Company granted options to each of two consultants to purchase
up to 225,000 (post-split) shares of the Company's common stock, valid for 10
years from issuance, with varying exercise prices. Vesting periods are based on
either the passage of time or based upon the achievement of certain milestones,
which, if ever achieved, would result in accelerated vesting of up to 150,000
(post-split) of the aforementioned options for each consultant. In 1996, the
Company recognized $1.2 million in non-cash compensation expense in accordance
with SFAS 123 relating to the value of such stock options (as established using
the Black Scholes pricing model) and it expects to charge varying amounts (up to
an additional $2.2 million in the aggregate) of non-cash compensation expense to
operations through 2001 relating to such agreements.
 
     Additional information with respect to the Company's option activity is
summarized as follows:
 
   
<TABLE>
<CAPTION>
                                                                                   WEIGHTED-
                                                                      SHARE         AVERAGE
                                                                     OPTIONS     EXERCISE PRICE
                                                                    ---------    --------------
    <S>                                                             <C>          <C>
    Balance, December 31, 1993...................................      42,392        $ 0.77
      Granted....................................................     219,452          3.01
      Exercised..................................................          --            --
      Canceled...................................................     (40,217)         5.69
                                                                    ---------       -------
    Balance, December 31, 1994...................................     221,627          2.09
      Granted....................................................     586,725          5.28
      Exercised..................................................     (19,565)         0.77
      Canceled...................................................      (6,750)         3.75
                                                                    ---------       -------
    Balance, December 31, 1995...................................     782,037          4.50
      Granted....................................................   1,777,740         15.61
      Exercised..................................................     (58,363)         3.02
      Canceled...................................................      (6,658)        10.82
                                                                    ---------       -------
    Balance, December 31, 1996...................................   2,494,756        $12.43
                                                                     ========    ==========
</TABLE>
    
 
                                      F-15
<PAGE>   40
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(9)  SHARE OPTION PLANS -- (CONTINUED)

     Options outstanding and exercisable by price range as of December 31, 1996
are as follows:
 
<TABLE>
<CAPTION>
                           OPTIONS OUTSTANDING                                      OPTIONS EXERCISABLE
-------------------------------------------------------------------------     -------------------------------
                    OUTSTANDING     WEIGHTED-AVERAGE                          EXERCISABLE
    RANGE OF           AS OF           REMAINING         WEIGHTED-AVERAGE       AS OF        WEIGHTED-AVERAGE
EXERCISE PRICES     12/31/1996      CONTRACTUAL LIFE      EXERCISE PRICE      12/31/1996      EXERCISE PRICE
----------------    -----------     ----------------     ----------------     ----------     ----------------
<S>                 <C>             <C>                  <C>                  <C>            <C>
 $  0.0 - $10.00       721,349             8.8                $ 4.62            141,651           $ 4.58
 $10.01 - $20.00     1,712,656             9.5                $15.41            135,000           $13.58
 $20.01 - $30.00        60,751             9.3                $21.34                  0           $    0
                                            --
                     ---------                                ------            -------           ------
                     2,494,756             9.3                $12.43            276,651           $ 8.97
                     =========             ===                ======            =======           ======     
</TABLE>
 
     At December 31, 1996, there were 743,433 additional shares available for
grant under the 1993 Plan and 202,500 shares available for grant under the
Directors' Plan.
 
   
  Pro forma option information
    
 
     The per share weighted-average fair value of all stock options granted
during 1995 and 1996 was $2.35 and $7.16 on the date of grant using the Black
Scholes option-pricing model with the following weighted-average assumptions:
1996 -- expected dividend yield 0%, risk-free interest rate of 6.1%, volatility
of 50% and an expected life of 4 years; 1995 -- expected dividend yield 0%,
risk-free interest rate of 5.3%, volatility of 50% and an expected life of 4
years. The per share weighted-average fair value of stock options granted during
1996 to consultants was $6.12 using similar assumptions.
 
     The Company applies APB No. 25 in accounting for share options granted to
employees and, accordingly, no compensation expense has been recognized related
to such options to the extent that such options were granted at an exercise
price that equaled the fair market value at the grant date. Had the Company
determined compensation cost based on the fair value at the grant date for its
stock options under SFAS No. 123, (using the Black-Scholes option-pricing
model), the Company's net income (loss) would have been reduced (increased) to
the pro forma amounts indicated below:
<TABLE>
<CAPTION>
                                                                            1995        1996
                                                                          --------     ------
                                                                            (IN THOUSANDS)
                                                                          (EXCEPT SHARE DATA)
    <S>                                                   <C>             <C>          <C>
    Net income (loss)..................................   As reported     $(12,637)    $5,073
                                                          Pro forma        (12,740)     4,383
    Primary earnings (loss) per share..................   As reported        (1.70)      0.35
                                                          Pro forma          (1.71)      0.30
    Fully diluted earnings (loss) per share............   As reported        (1.70)      0.34
                                                          Pro forma          (1.71)      0.29
</TABLE>
 
     Pro forma net income (loss) reflects only options granted in 1995 and 1996.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net income (loss) amounts
presented above because compensation cost is reflected over the vesting period
and compensation cost for options granted prior to January 1, 1995 is not
considered.
 
(10)  INCOME TAXES
 
     As of December 31, 1996, the Company had net operating loss ("NOL")
carryforwards available for Federal income tax purposes of approximately $10.3
million which expire at various dates between 2008 to 2010. NOL carryforwards
are subject to ownership change limitations and may also be subject to various
other limitations on the amounts to be utilized. As of December 31, 1996, the
Company had foreign tax credit carryforwards of approximately $61,000 expiring
in 2000 and 2001, and general business tax credit carryforwards of $450,000
expiring between 2008 and 2011.
 
                                      F-16
<PAGE>   41
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(10)  INCOME TAXES -- (CONTINUED)
   
     Current income taxes aggregating $179,000 were offset by a deferred benefit
of $179,000, resulting in no provision for income taxes in 1996 (none in 1995
and 1994).
    
 
     Actual income tax expense differs from the expected income tax expense
computed at the effective federal rate as follows:
   
<TABLE>
<CAPTION>
                                                                 1994       1995       1996
                                                                -------    -------    -------
    <S>                                                         <C>        <C>        <C>
                                                                       (IN THOUSANDS)
 
<CAPTION>
    <S>                                                         <C>        <C>        <C>
    Computed "expected" tax expense at statutory rate........   $(2,004)   $(4,296)   $ 1,725
    State income tax, net of federal benefit.................      (265)      (567)       230
    Research collaboration revenue...........................        --         --        557
    Compensatory stock grants................................       397         --         --
    Change in valuation allowance increase (decrease)........     1,871      4,849     (2,552)
    Other....................................................         1         14         40
                                                                -------    -------    -------
                                                                $    --    $    --    $    --
                                                                =======    =======    =======
</TABLE>
    
 
   
     Realization of net deferred tax assets related to the Company's NOL
carryforwards and other items is dependent on future earnings, which are
uncertain. Accordingly, a valuation allowance has been established equal to net
deferred tax assets which are not likely to be realized in the future, resulting
in net deferred tax assets of approximately $179,000 at December 31, 1996. The
change in the valuation allowance was an increase of approximately $4.8 million
in 1995 and a decrease of approximately $2.6 million in 1996.
    
 
   
     Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1995 and 1996 are shown below.
    
<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                                         ------------------
                                                                          1995       1996
                                                                         -------    -------
    <S>                                                                  <C>        <C>
                                                                           (IN THOUSANDS)
 
<CAPTION>
    <S>                                                                  <C>        <C>
    Deferred tax assets:
         Net operating loss carryforwards.............................   $ 7,261    $ 3,971
         Research and experimentation credits.........................       447        450
         Compensatory stock grants....................................       197        861
         Alternative minimum tax credit carryforward..................        --        179
         Accrued expenses.............................................        67        257
         Contribution carryover and capitalized start-up costs........        48         38
                                                                         -------    -------
                                                                           8,020      5,756
    Deferred tax liabilities:
         Prepaid expenses and depreciation............................        44        153
                                                                         -------    -------
    Net deferred tax assets...........................................     7,976      5,603
         Valuation allowance..........................................    (7,976)    (5,424)
                                                                         -------    -------
    Net deferred tax assets reported..................................   $    --    $   179
                                                                         =======    =======
</TABLE>
 
(11)  RELATED PARTY TRANSACTIONS
 
     In September 1995, the Company entered into a three year consulting
agreement with the Chairman of its Scientific Advisory Board (the "Consultant")
who is also a nonemployee director whereby the Consultant is to provide
consulting and advisory services as requested by the Company. The Company is
obligated to pay an annual consulting fee of $150,000 (1st year), $160,000 (2nd
year), and $170,000 (3rd year) and has
 
                                      F-17
<PAGE>   42
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(11)  RELATED PARTY TRANSACTIONS -- (CONTINUED)

granted the Consultant 90,000 stock options at fair market value. These options
will vest one-third upon each anniversary of the grant date so long as the
individual remains a consultant under the agreement.
 
     Notes receivable on common stock aggregating $139,500 and $129,750 at
December 31, 1995 and 1996, respectively, represent amounts due from officers of
the Company and are reflected as a reduction from stockholders' equity.
 
     Scios, Inc., a significant stockholder, has billed the Company for certain
services and equipment purchases related to the Company's research and
development activities aggregating $173,000, $233,000 and $295,000 in 1994, 1995
and 1996, respectively.
 
(12)  LEASE AGREEMENTS
 
     The Company has a master lease arrangement related to the land and building
which it presently occupies which expires in July 2005 with options to renew for
two five-year periods. The Company has the option to purchase the building after
the ninth year for its then current fair market value. The annual rental
aggregates approximately $306,000 and the Company pays for substantially all
occupancy related costs.
 
     The Company's future minimum lease payments under operating leases for
years subsequent to December 31, 1996 are as follows:
 
<TABLE>
<CAPTION>
                            YEAR ENDING DECEMBER 31                           (IN THOUSANDS)
    -----------------------------------------------------------------------   --------------
    <S>                                                                       <C>
           1997............................................................       $  870
           1998............................................................          797
           1999............................................................          798
           2000............................................................          764
           2001............................................................          331
           2002 and thereafter.............................................        1,123
                                                                                  ------
                                                                                  $4,683
                                                                                  ======
</TABLE>
 
     Facility and equipment rent expense aggregated approximately $37,000,
$452,000, and $680,000 in 1994, 1995 and 1996, respectively.
 
(13)  401(k) PROFIT SHARING PLAN
 
     The Company has a 401(k) Profit Sharing Plan (the "401(k) Plan") available
to all employees meeting certain eligibility criteria which permits participants
to contribute up to 15% of their compensation not to exceed the limits
established by the Internal Revenue Code. The Company may make "matching
contributions" equal to a percentage of a participant's contribution or may
contribute a discretionary amount to the Plan. The Company's contributions to
the 401(k) Plan were approximately $6,000, $9,000 and $11,000 for 1994, 1995,
and 1996 respectively.
 
     Effective January 1, 1997, the Company has elected to make "matching
contributions" in the Company's common stock equal to 50% of the first 6% of an
employee's salary contributed to such employees 401(k) Plan account. Such
amounts vest 25% per year based on a participant's years of service with the
Company.
 
(14)  GELL PHARMACEUTICALS INC.
 
     In February 1995, the Company and The Abell Foundation, Inc., a
Baltimore-based not-for-profit corporation ("Abell"), established Gell. Gell was
formed primarily to track Abell's $2.5 million equity investment that, in
substance, was intended to purchase 750,000 shares of the Company's common stock
at the transaction date, which shares had an approximate fair market value of
$2.4 million. Abell received an
 
                                      F-18
<PAGE>   43
 
                         GUILFORD PHARMACEUTICALS INC.
                                AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(14)  GELL PHARMACEUTICALS INC. -- (CONTINUED)

80% equity interest in Gell for $2,500,000 while Guilford received a 20% equity
interest for nominal cash consideration and technology "know-how," which had a
net carrying value of zero at the transaction date.
 
     Under a master services agreement with Gell (the "Gell Agreement"), the
Company provides all of the personnel, resources and related administration and
research services for appropriate reimbursement of such costs incurred by the
Company on behalf of Gell.
 
   
     Accordingly, as the Company receives the $2.5 million from Gell, it
recognizes as paid-in-capital the cash received attributable to the fair value
of Abell's "put option" (which fair value has been established as approximately
$2.4 million by independent investment bankers). The excess cash of
approximately $100,000 is recorded as a reimbursement of certain costs incurred
by the Company on behalf of Gell. The Company has recorded approximately 100% of
the costs incurred from Gell's operations.
    
 
   
     Abell has a put right, immediately effective upon closing of the Gell
Agreement in 1995, which requires the Company to issue 750,000 shares of the
Company's common stock (which amount was fixed at closing) in exchange for
Abell's shares in Gell (see Note 15).
    
 
   
     The Company has received $1.9 million from Gell through December 31, 1996
and has recorded the derived fair value of the equity instrument (put option) as
paid in capital ($726,000 and $1.8 million at December 31, 1995 and 1996,
respectively). Certain costs incurred by the Company on behalf of Gell ($30,000
in 1995 and $45,000 in 1996) have been reimbursed by Gell and such reimbursement
has been recorded in the accompanying consolidated statement of operations.
Actual cash expenditures (including $422,000 of capitalized equipment) incurred
by the Company on behalf of Gell aggregated $1.9 million through December 31,
1996.
    
 
(15)  SUBSEQUENT EVENT (UNAUDITED)
 
     On March 5, 1997, Abell exercised its put option to receive the 750,000
shares of the Company's common stock to which it was entitled. This number of
shares was fixed and agreed to at the inception of the Gell transaction.
 
                                      F-19
<PAGE>   44
 
                                    PART III
 
ITEM 11.  EXECUTIVE COMPENSATION.
 
     The following table sets forth the annual and long-term compensation for
services in all capacities awarded to, earned by or paid to the Company's Chief
Executive Officer and the Company's four other most highly compensated executive
officers (the "Named Executive Officers") whose total annual salary and bonus
exceeded $100,000 during the fiscal year ended December 31, 1996:
 
                           SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                                                             LONG-TERM
                                                                                            COMPENSATION
                                                                                               AWARDS
                                                    ANNUAL COMPENSATION                ----------------------
                                       ---------------------------------------------   RESTRICTED  SECURITIES
                                                                      OTHER ANNUAL       STOCK     UNDERLYING      ALL OTHER
     NAME AND PRINCIPAL POSITION       YEAR   SALARY($)   BONUS($)   COMPENSATION($)   AWARDS(1)   OPTIONS(#)   COMPENSATIONS($)
-------------------------------------  ----   ---------   --------   ---------------   ---------   ----------   ----------------
<S>                                    <C>    <C>         <C>        <C>               <C>         <C>          <C>
Craig R. Smith, M.D. ................  1996   $ 260,417   $150,000(2)          --            --      100,000        $ 61,890(3)
  President and Chief                  1995     248,334     75,000             --            --      150,000        $ 11,306
  Executive Officer                    1994     213,333     50,000             --            --           --          42,920(3)
Andrew R. Jordan.....................  1996     170,981     40,000(2)          --            --       40,000              --
  Senior Vice President, Chief         1995     164,583     35,000             --            --       71,250              --
  Financial Officer                    1994     153,125     30,000             --            --           --          89,324(4)
  and Treasurer                                                                  
John P. Brennan......................  1996     169,223     45,000(2)          --            --       40,000              --
  Senior Vice President,               1995     160,000     37,000             --            --       82,500          31,421
  Operations                           1994     135,273(5)   42,250(6)         --            --       39,131          50,780(4)
Earl W. Henry........................  1996     205,833     35,000(2)      48,647(7)         --       25,000              --
  Vice President,                      1995     197,693(5)   40,000            --        18,750       52,500         136,967(4)
  Clinical Research
Nicholas Landekic....................  1996     150,037     50,000(2)      47,422(7)         --       45,000              --
  Vice President,                      1995     114,327(5)   61,000            --        15,000       61,250              --
  Business Development
</TABLE>
 
---------------
 
(1) Pursuant to Stock Purchase Agreements with the Company, Dr. Smith and
    Messrs. Jordan and Brennan purchased 254,348 shares, 39,129 shares and
    39,129 shares of Common Stock, respectively, for purchase prices equal to
    $.15, $.77 and $1.53 per share, the fair value of the Common Stock on the
    dates of the purchases as determined by the Board of Directors. The shares
    purchased by each of these individuals, until vested as described below (the
    "Unvested Shares"), are subject to the Company's right to repurchase for 90
    days at the original price per share plus interest at the applicable federal
    rate following termination of each individual's employment with the Company,
    except in the case of Dr. Smith where such repurchase right is triggered (a)
    in the event that Dr. Smith's employment is terminated for cause, other than
    for "Good Reason" (as defined in his stock purchase agreement), or (b) as a
    result of Dr. Smith's death or disability. The Unvested Shares are released
    from such repurchase options and become vested (the "Vested Shares") at a
    rate of 1/48 per month on the last calendar day of each month beginning on
    the last calendar day of each month following August 20, 1993 in the case of
    Dr. Smith, October 31, 1993 in the case of Mr. Jordan and February 28, 1994
    with respect to Mr. Brennan. As of December 31, 1996, the aggregate value of
    the Vested Shares and Unvested Shares held by Dr. Smith and Messrs. Jordan
    and Brennan were $4,927,983 and $985,597; $739,171 and $170,578; and
    $665,359 and $246,390, respectively, based on the closing price for the
    Company's Common Stock of $23.25 per share as reported on the NASDAQ
    National Market on December 31, 1996. Each of Dr. Henry and Mr. Landekic was
    granted 18,750 shares and 15,000 shares of restricted Common Stock upon his
    respective employment with the Company which under the original terms of the
    grants were to be released from the Company's repurchase option annually as
    to 25% of the shares over a four year period beginning in January and March
    1995, respectively. At December 31, 1996 the aggregate value of the Vested
    Shares and Unvested Shares held by Dr. Henry and Mr. Landekic was $108,984
    and $326,953 and $87,188 and $261,563, respectively. In January 1997, the
    Compensation Committee of the Board voted to accelerate the vesting of all
    of the remaining unvested shares issued to Dr. Henry and Mr. Landekic
    effective as of January 15, 1997.
 
                                      III-1
<PAGE>   45
 
(2) Cash bonuses in the amounts set forth above relating to performance for 1996
    were paid in January 1997.
 
(3) 1994 payments consist of certain expenses related to Dr. Smith's relocation
    to Baltimore amounting to $31,095 and $11,825 related to forgiveness of
    debt; the 1996 payment consist of forgiveness of debt and amounts paid to
    cover anticipated tax liabilities related to a portion of the debt forgiven.
 
(4) Consists of relocation costs.
 
(5) Mr. Brennan began his employment with the Company in February 1994. Each of
    Dr. Henry and Mr. Landekic began his employment with the Company in January
    and March 1995, respectively.
 
(6) Of the total bonus amounts paid to Mr. Brennan in fiscal 1994, $23,750
    represents the aggregate fair market value as of the date of grant of shares
    of the Company's Common Stock issued to Mr. Brennan as a bonus under the
    Company's 1993 Employee Shares Option and Restricted Share Plan, as amended
    (the "1993 Employee Plan").
 
(7) Consists of non-cash compensation related to the vesting in 1996 of a
    portion of the restricted share awards granted to Dr. Henry and Mr. Landekic
    upon his respective employment with the Company.
 
     Option Grants
 
     The following table sets forth certain information concerning the grant of
stock options under the 1993 Employee Plan to the Company's Chief Executive
Officer and the Named Executive Officers for the fiscal year ended December 31,
1996:
 
                       OPTION GRANTS IN LAST FISCAL YEAR
 
<TABLE>
<CAPTION>
                                                                                                          POTENTIAL REALIZABLE
                                                           PERCENTAGE                                       VALUE AT ASSUMED
                                                            OF TOTAL                                        ANNUAL RATES OF
                                            NUMBER OF       OPTIONS                                           STOCK PRICE
                                            SECURITIES     GRANTED TO                                       APPRECIATION FOR
                                            UNDERLYING    EMPLOYEES IN    EXERCISE OR                        OPTION TERM(1)
                                             OPTIONS      FISCAL YEAR     BASE PRICE     EXPIRATION    --------------------------
            NAME AND POSITION               GRANTED(#)      1996(%)        ($/SHARE)        DATE         5%($)           10%($)
-----------------------------------------   ----------    ------------    -----------    ----------    ----------      ----------
<S>                                         <C>           <C>             <C>            <C>           <C>             <C>
Craig R. Smith, M.D......................     100,000         15.1%         $17.625        12/06       $1,108,427      $2,808,971
  President and Chief Executive Officer        75,000(2)                    $14.917        02/06          703,577       1,783,003
Andrew R. Jordan.........................      40,000          7.0%         $17.625        12/06          443,371       1,123,588
  Senior Vice President, Chief                 41,250(2)                    $14.917        02/06          386,968         980,652
  Financial Officer and Treasurer
John P. Brennan..........................      40,000          7.3%         $17.625        12/06          443,371       1,123,588
  Senior Vice President, Operations            45,000(2)                    $14.917        02/96          422,146       1,069,802
Earl W. Henry............................      25,000          3.4%         $17.625        12/06          277,107         702,243
  Vice President, Clinical Research            15,000(2)                    $14.917        02/06          140,715         356,601
Nicholas Landekic........................      45,000          5.9%         $17.625        12/06          498,792       1,264,037
  Vice President, Business Development         23,750(2)                    $14.917        02/06          222,795         564,606
</TABLE>
 
---------------
 
(1) Amounts represent hypothetical gains that could be achieved for the
    respective options at the end of the ten year option term. The assumed 5%
    and 10% rates of stock appreciation are mandated by the rules of the
    Securities and Exchange Commission and may not accurately reflect the
    appreciation of the price of the Common Stock from the date of grant until
    the end of the option term. These assumptions are not intended to forecast
    future price appreciation of the Common Stock.
 
(2) Represents options granted in February 1996 to the Named Executive Officers
    in respect of fiscal year 1995.
 
                                      III-2
<PAGE>   46
 
Option Exercises and Holdings
 
     Options with respect to 58,363 shares were exercised during the fiscal year
ended December 31, 1996. The following table sets forth information with respect
to the Company's Chief Executive Officer and the Named Executive Officers
concerning the exercise of options during the fiscal year ended December 31,
1996 and unexercised options held as of the end of that fiscal year:
 
       AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED DECEMBER 31, 1996
                       AND FISCAL YEAR-END OPTION VALUES
 
<TABLE>
<CAPTION>
                                                                NUMBER OF SECURITIES                                     
                                                               UNDERLYING UNEXERCISED             VALUE OF UNEXERCISED   
                                                                   OPTIONS HELD AT                IN-THE-MONEY OPTIONS   
                                                                DECEMBER 31, 1996 (#)         AT DECEMBER 31, 1996 ($)(1)
                                                           -------------------------------    ----------------------------
                          NAME                             EXERCISABLE     UNEXERCISABLE      EXERCISABLE    UNEXERCISABLE
--------------------------------------------------------   -----------    ----------------    -----------    -------------
<S>                                                        <C>            <C>                 <C>            <C>
Craig R. Smith, M.D.....................................         --            250,000         $      --      $ 2,468,745
Andrew R. Jordan........................................      9,783            121,033           219,954        1,301,202
John P. Brennan.........................................         --            142,066                --        1,665,529
Earl W. Henry...........................................         --             77,500                --          995,513
Nicholas Landekic.......................................         --            106,250                --        1,181,439
</TABLE>
 
---------------
 
(1) Total value of unexercised in-the-money options is based on the closing
    price of the Common Stock of $23.25 per share on December 31, 1996 minus the
    exercise price of the options.
 
DIRECTOR COMPENSATION
 
   
     In 1996, Directors received no compensation for their attendance at Board
meetings but received reimbursement for expenses related to attendance at
meetings. In February 1997, the Compensation Committee of the Board adopted a
policy effective as of the date of the Company's 1997 Annual Meeting of
Stockholders, currently scheduled for May 21, 1997, to pay non-employee
directors an annual retainer of $10,000, payable quarterly in advance, plus
$1,500 for each regular meeting of the Board attended either in person or by
telephone and $1,500 for each special meeting of the Board attended in person.
    
 
     In 1994, the Company initiated a Directors' Stock Option Plan, as amended
(the "Director Plan") to attract outside directors with an increased incentive
to make significant contributions to the long-term performance and growth of the
Company and to directly align their interests with those of the Company's
stockholders. Board members who are not officers or employees (i) of the
Company, (ii) of any subsidiary of the Company, or (iii) of any entity which
owns twenty percent or more of the capital stock of the Company are eligible to
receive options under the Director Plan.
 
   
     The Company has reserved 300,000 shares of the Company's Common Stock for
issuance under the Director Plan and 97,500 options to purchase shares have been
granted to date. Options issued under the Director Plan are nonqualified stock
options for tax purposes. The exercise price of options granted under the
Director Plan are not less than the closing price of a share of Common Stock on
the date immediately prior to the date the option is granted. Options are
exercisable one year from the date of grant and remain exercisable for a period
of ten years from the date the option is granted. Options vest 50% on the first
anniversary of the date of grant and the remainder on the second anniversary
date. Each eligible director who begins serving on the Board of Directors
receives an option to purchase 30,000 shares of stock on the date such service
commences and also is entitled to an option to purchase 7,500 shares of stock
immediately following each of the next four annual elections of directors,
provided such Director has served for at least one year and continues to be a
director at the time of such issuance. The Director Plan is intended to qualify
for the exemption provided by Rule 16b-3 under the Securities Exchange Act of
1934, as amended (the "Exchange Act").
    
 
     Solomon H. Snyder, M.D., a director of the Company, has provided consulting
services to the Company under consulting agreements since August 1993. Under the
terms thereof, Dr. Snyder receives no other compensation outside those provided
therein (other than reimbursement of expenses), and thus does not participate in
the Director Plan. For a description of the Company's current consulting
arrangement with Dr. Snyder, see "Certain Transactions -- Snyder Consulting
Agreement".
 
                                      III-3
<PAGE>   47
 
     Richard L. Casey, who has served on the Board of Directors since the
inception of the Company, has never received any compensation from the Company
for his services as a director. In March 1996, the Compensation Committee
granted Mr. Casey a non-qualified stock option outside the Director Plan to
purchase 75,000 shares of Company Common Stock at $13.54 per share. This option
became exercisable as to 60% of the shares subject to the option on September
27, 1996 and will become exercisable with respect to an additional 20% on March
27, 1997. The remaining 20% will become exercisable on March 27, 1998 so long as
Mr. Casey remains a director of the Company.
 
     John H. Newman served on the Board of Directors from the Company's
inception until May 21, 1996. In March 1996, the Compensation Committee granted
Mr. Newman a non-qualified stock option outside the Director Plan to purchase
45,000 shares of Company Common Stock at $13.54 per share. This option became
fully exercisable on September 27, 1996.
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
     Until May 1995, Messrs. Casey and Newman comprised the Compensation
Committee of the Board of Directors. In May 1995, Dr. Thompson replaced Mr.
Casey as a member of the Compensation Committee. Effective May 21, 1996, Mr.
Newman resigned from the Compensation Committee. Mr. Casey is the Chairman,
President and Chief Executive Officer of Scios, a principal stockholder of the
Company. Mr. Newman is Vice President of Legal Affairs, General Counsel and
Secretary of Scios. In January 1995, Scios exercised a warrant issued to it to
acquire 108,696 shares of Common Stock for an aggregate exercise price of
$166,667.
 
     In fiscal years 1994, 1995 and 1996, Guilford paid approximately $173,000,
$233,000 and $295,000, respectively, for services and equipment purchases from,
and lease payments to, Scios.
 
     In March 1994, the Company entered into an agreement with Scios to license
certain technologies related to the Company's lead product, GLIADEL. The terms
of this agreement require the Company to pay to Scios a royalty on all net sales
of licensed products covered by the agreement as well as a percentage of
royalties received by the Company from sublicensees in each country until the
later of (i) the last to expire of the relevant patents in each country or (ii)
15 years after market introduction of GLIADEL. The agreement also contains
provisions requiring payment of minimum annual royalties following commercial
sale of GLIADEL. Scios assigned this agreement to the Massachusetts Institute of
Technology in 1994.
 
EMPLOYMENT AGREEMENTS
 
     The Company entered into employment agreements with Dr. Smith, Mr. Jordan,
Mr. Brennan, Mr. Laderman, Dr. Henry, Dr. Suzdak, Mr. Landekic, and Mr. Seoh
shortly before each of these individuals joined the Company. Under the original
terms of these agreements in the event one or more of these individuals were
required to leave the Company's employment at the Company's request, other than
for cause, the Company would be required to continue paying a salary to such
individual(s) until the earlier of commencement of other suitable employment or
three months (six months in the case of Messrs. Landekic and Seoh), if
terminated within the first twelve months of employment, or six months (nine
months in the case of Messrs. Landekic and Seoh), if terminated thereafter. In
1996, these agreements were amended to provide for such severance payments for
12 months following termination of employment except in the case of Dr. Smith
where the severance payment period was set at 36 months following employment
termination.
 
401(k) PROFIT SHARING PLAN
 
     The Company adopted a defined contribution plan (the "401(k) Plan")
effective January 1, 1994 which is intended to satisfy the tax qualification
requirements of Sections 401(a), 401(k) and 401(m) of the Internal Revenue Code
of 1986, as amended (the "Code"). All employees of the Company hired on or
before the effective date of the 401(k) Plan are eligible to participate as of
January 1, 1994. Employees hired after January 1, 1994 will be eligible to
participate as of the first day of the calendar quarter following completion of
three months of service and attainment of age 21. The 401(k) Plan permits
participants to contribute up to 15% of compensation, excluding fringe benefits,
not to exceed the limits of Section 402g(1) of the Code (i.e., $9,500 in 1996).
All amounts deferred under the 401(k) Plan's salary reduction feature by a
participant vest immediately in the participant's account while contributions
made by the Company vest over a four year
 
                                      III-4
<PAGE>   48
 
period in the participant's account based on the participant's term of service
with the Company. Effective January 1, 1997, the Company has elected to make
"matching contributions" in newly issued shares of Common Stock equal in value
to fifty percent (50%) of the first six percent (6%) of an employee's salary
contributed to such employee's 401(k) Plan account. In addition, discretionary
payments of approximately $6,000, $9,000 and $11,000 were made in 1994, 1995 and
1996, respectively.
 
1993 EMPLOYEE SHARE OPTION AND RESTRICTED SHARE PLAN
 
   
     In September 1993, the Company's Board of Directors adopted the 1993
Employee Plan. The Stockholders of the Company approved the 1993 Employee Plan
in March 1994. In December 1994, the Company's Board of Directors approved
amending the 1993 Employee Plan to increase the number of shares of Common Stock
issuable under the plan from 430,434 to 900,000 shares, which amendment was
approved by the Company's stockholders in May 1995. In February 1996, the Board
approved amending the 1993 Employee Plan to increase the number of shares of
Common Stock issuable under the plan from 900,000 to 2,700,000 shares, which
amendment was approved by the Company's stockholders in May 1996. As of December
31, 1996, options to purchase 1,729,756 shares were outstanding under the 1993
Employee Plan, and options to purchase an additional 102,700 shares were
approved for grant by the Compensation Committee of the Board in February 1997.
The purposes of the 1993 Employee Plan is to improve business results by
providing eligible individuals with an opportunity to acquire an increased
financial interest in the Company. Payment of the exercise price for options
granted under the 1993 Employee Plan may be made in cash, shares of Common Stock
or a combination of the two.
    
 
     All full-time employees of the Company or any subsidiary, or other
individuals whose participation the Board of Directors shall determine is in the
best interests of the Company, are eligible to receive options or restricted
shares of Common Stock ("Restricted Shares") under the 1993 Employee Plan
(collectively, "Incentive Awards"). The 1993 Employee Plan is currently
administered by the Compensation Committee. The 1993 Employee Plan is intended
to qualify for the exemption provided by Rule 16b-3 under the Exchange Act. The
Compensation Committee selects recipients for Incentive Awards and determines
the nature of the Incentive Award granted, the number of shares granted or
subject to each option, the option vesting schedule and other terms and
conditions of each Option or Restricted Share award. The Board of Directors may
modify, amended, suspend or terminate the 1993 Employee Plan, provided that such
action may not affect outstanding options, and stockholder approval is required
to amend the 1993 Employee Plan if such amendment would cause the 1993 Employee
Plan not to comply with the Code.
 
     The number of shares that may be issued pursuant to Incentive Awards under
the 1993 Employee Plan shall not exceed in the aggregate 2,700,000 shares of
Common Stock, of which number 300,000 shares may be awarded as Restricted
Shares, and the maximum number of shares subject to options that can be granted
under the 1993 Employee Plan to any executive officer or other employee of the
Company is 215,217 shares. All options granted pursuant to the 1993 Employee
Plan are exercisable in accordance with a vesting schedule which is set at the
time of the issuance of the Option and, except as indicated below, may not be
exercised more than ten years from the date of grant. Options granted under the
1993 Employee Plan may be incentive stock options intended to qualify under
Section 422 of the Code (an "Incentive Option") or options not intended to so
qualify (a "Nonqualified Option"). The 1993 Employee Plan generally requires the
exercise price of Incentive Options to be at least equal to the closing price of
a share of the Company's Common Stock on the date immediately prior to the date
of the grant. In the case of Nonqualified Options, applicable provisions of the
Code provide that the exercise price may not be less than 85% of the closing
price of the Company's Common Stock on the date immediately prior to the date of
the grant. In the case of Incentive Options granted to a stockholder, either
directly or indirectly, holding in excess of 10% of the Company's outstanding
Common Stock, the option exercise price must be at least equal to 110% of the
fair market value of the Company's Common Stock on the date of grant and such
option may not be exercised more than five years from the date of grant.
 
     Generally, all unexercised options terminate three months following the
date an optionee ceases to be employed by the Company or any affiliate or
subsidiary of the Company other than by reason of disability or death (but not
later than the expiration date) whether or not such termination is voluntary.
Generally, any option held by an employee who dies or who ceases to be employed
because of disability must be exercised by
 
                                      III-5
<PAGE>   49
 
the employee or his representative within one year after the employee dies or
ceases to be an employee (but not later than the expiration date). The Board
may, however, provide that an option may be exercised over a longer period of
time following termination of employment (but not later than the option
expiration date). Options and Restricted Shares are not transferable, except in
the event of death to the decedent's estate or during the lifetime of an
optionee to (i) the spouse, children or grandchildren of the optionee
("Immediate Family Members"), (ii) a trust or trusts for the exclusive benefit
of such Immediate Family Members, or (iii) a partnership in which such Immediate
Family members are the only partners, provided that there may be no
consideration for any such transfer. In addition, Restricted Shares may be
transferred or assigned after the applicable restriction on the shares has
terminated. The 1993 Employee Plan has no termination date, provided however
that no Incentive Option may be granted on or after the tenth anniversary of the
effective date of the 1993 Employee Plan (i.e., September 2003).
 
KEY PERSON LIFE INSURANCE
 
     The Company is the owner and beneficiary of, term life insurance policies
in the amount of $1,000,000 covering Dr. Smith. Similar policies have been
issued with respect to Messrs. Jordan and Brennan.
 
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's officers, directors and certain
beneficial holders of common stock to file reports about their ownership of the
Company's Common Stock. Based solely on its review of the copies of such reports
furnished to the Company by its directors and officers during and with respect
to the year 1996, the Company believes that all reports required by Section
16(a) of the Exchange Act were timely filed, except (a) that Forms 4 reporting
the grant of certain stock options under the Company's 1993 Employee Plan to Dr.
Smith and Messrs. Brennan, Jordan and Laderman in August 1995 were inadvertently
not filed in a timely manner and (b) a Form 4 related to an open market purchase
of shares of Common Stock of the Company by certain funds over which Ms.
Greetham may be deemed to have voting or investment control was filed one month
late.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     The following table sets forth certain information regarding the principal
stockholders of Common Stock as of March 6, 1997, including each person known by
the Company to be the beneficial owner of more than five percent of the
outstanding Common Stock, the Company's Chief Executive Officer and the four
other
 
                                      III-6
<PAGE>   50
 
most highly compensated executive officers of the Company for the fiscal year
ended December 31, 1996, each of the directors of the Company, certain other
holders and all officers and directors of the Company as a group.
 
   
<TABLE>
<CAPTION>
                    NAME AND ADDRESS                        SHARES BENEFICIALLY
                OF PRINCIPAL STOCKHOLDERS                        OWNED (1)         PERCENTAGE OF OWNERSHIP
---------------------------------------------------------   -------------------    -----------------------
<S>                                                         <C>                    <C>
Scios....................................................        1,450,000                   9.8%
     2450 Bayshore Parkway
     Mountain View, CA 94043
The Abell Foundation, Inc. ..............................          937,500                   6.3%
     111 South Calvert Street
     Baltimore, MD 21202
FMR Corp. ...............................................          738,250(2)                5.0%
     82 Devonshire Street
     Boston, Massachusetts 02109
Arnold H. Snider
     Deerfield Capital, L.P. ............................          703,575(3)                4.8%
     Deerfield Management Company........................           46,425(3)                0.3%
     450 Lexington Avenue, Suite 1930
     New York, NY 10017
T. Rowe Price Associates, Inc. ..........................          813,450(4)                5.5%
     100 East Pratt Street
     Baltimore, Maryland 21202
Rhone-Poulenc Rorer Pharmaceuticals, Inc. ...............          281,531                   1.9%
     500 Arcola Road
     Collegeville, Pennsylvania 19426
Craig R. Smith, M.D. ....................................          460,897(5)                3.1%
Andrew R. Jordan.........................................          187,359(6)                1.3%
John P. Brennan..........................................          120,234(7)                 *
Nicholas Landekic........................................           33,603(8)                 *
Earl W. Henry............................................           45,170(9)                 *
Solomon H. Snyder, M.D. .................................          605,217(10)               4.1%
Richard L. Casey.........................................        1,519,900(11)              10.2%
     c/o Scios
     2450 Bayshore Parkway
     Mountain View, CA 94043
George L. Bunting, Jr. ..................................               --                     --
Elizabeth M. Greetham....................................          225,950(12)               1.5%
W. Leigh Thompson, M.D., Ph.D. ..........................           15,000(13)                *
All directors and officers as a group (13 persons).......        3,338,878                  22.1%
</TABLE>
    
 
---------------
   * Less than one percent.
 
 (1) Beneficial ownership is determined in accordance with the rules of the
     Commission and generally includes voting or investment power with respect
     to securities. Shares of the Company's Common Stock subject to options or
     warrants currently exercisable within 60 days of March 6, 1997 are deemed
     outstanding for purposes of computing the percentage ownership of the
     person holding such option or warrant but are not deemed outstanding for
     purposes of computing the percentage ownership of any other person. Except
     where indicated otherwise, and subject to community property laws where
     applicable, the persons named in the table above have sole voting and
     investment power with respect to all shares of the Company's Common Stock
     shown as beneficially owned by them.
 
 (2) Based on a Schedule 13G filed by this holder on February 14, 1997 which
     disclosed that various persons have the right to receive or the power to
     direct the receipt of dividends from, or the proceeds from the sale of, the
     Common Stock.
 
                                      III-7
<PAGE>   51
 
 (3) Based on a Schedule 13D dated July 16, 1996, Mr. Snider has reported
     beneficial ownership of 750,000 shares of Common Stock, 703,575 of which
     are held by Deerfield Capital, L.P. ("DCLP"), and 46,425 of which are held
     by Deerfield Management Company ("DMC"). According to the Schedule 13D, Mr.
     Snider is the President, Director and sole shareholder of Snider Capital
     Corp., which is the general partner of DCLP, and the President, Director
     and sole shareholder of Snider Management Corporation, which is the general
     partner of DMC.
 
   
 (4) Based on a Schedule 13G filed on February 14, 1997 disclosing that these
     securities are owned by various individual and institutional investors
     including the T. Rowe Price New Horizons Fund, Inc. (which owns 700,500
     shares of Common Stock representing 5.0% of the shares outstanding as of
     February 14, 1997), for which T. Rowe Price Associates, Inc. ("Price
     Associates") serves as investment advisor with the power to direct
     investments and/or sole power to vote securities. For purposes of the
     reporting requirements of the Exchange Act, Price Associates is deemed to
     be a beneficial owner of such securities, however, Price Associates
     expressly disclaims that it is in fact, the beneficial owner of such
     securities.
    
 
   
 (5) Includes options to acquire 40,034 shares of Common Stock exercisable
     within 60 days of March 6, 1997, and 1,578 shares of Common Stock and
     options to acquire 3,583 shares of Common Stock exercisable within 60 days
     of March 6, 1997 held by Dr. Smith's spouse, an employee of the Company.
     Dr. Smith disclaims beneficial ownership of the securities held by his
     spouse.
    
 
   
 (6) Includes 150 shares owned by a child sharing Mr. Jordan's household, of
     which Mr. Jordan disclaims beneficial ownership, and options to acquire
     35,095 shares of Common Stock exercisable within 60 days of March 6, 1997.
     Does not include 750 shares owned by another child of Mr. Jordan who does
     not share Mr. Jordan's household, as to which shares Mr. Jordan disclaims
     beneficial ownership.
    
 
   
 (7) Includes options to acquire 39,783 shares of Common Stock exercisable
     within 60 days of March 6, 1997.
    
 
   
 (8) Includes options to acquire 24,688 shares of Common Stock exercisable
     within 60 days of March 6, 1997.
    
 
   
 (9) Includes options to acquire 3,750 shares of Common Stock exercisable within
     60 days of March 6, 1997, and 9,375 shares of Common Stock and options to
     acquire 719 shares of Common Stock exercisable within 60 days of March 6,
     1997 held by Dr. Henry's wife, an employee of the Company. Dr. Henry
     disclaims beneficial ownership of the securities held by his spouse.
    
 
   
(10) Includes options to acquire 30,000 shares of Common Stock exercisable
     within 60 days of March 6, 1997. Does not include 1,450,000 shares owned by
     Scios. Dr. Snyder is a member of the Board of Directors of Scios and may be
     deemed to have shared voting and investment power over these shares. Dr.
     Snyder disclaims beneficial ownership of the shares owned by Scios.
    
 
   
(11) Mr. Casey is an executive officer and Chairman of the Board of Directors of
     Scios. He may be deemed to have voting and investment power over the shares
     held by Scios. Mr. Casey disclaims beneficial ownership of these shares.
     Mr. Casey has direct ownership over an additional 9,900 shares and options
     to acquire 60,000 shares exercisable within 60 days of March 6, 1997.
    
 
   
(12) Represents shares held by WPG-Life Sciences Fund, L.P. (the "Fund") and
     WPG-Institutional Life Sciences Fund, L.P. (the "Institutional Fund"). Ms.
     Greetham serves as Portfolio Manager of both the Fund and the Institutional
     Fund. Ms. Greetham is a controlling person of Libracorn Financial
     Consultants ("Libracorn"), a limited partner of the Fund which, through its
     interest in the Fund, has a 1.55% interest in the shares held by the Fund.
     Ms. Greetham disclaims beneficial ownership of the shares held by the Fund
     and the Institutional Fund except to the extent of her beneficial interest
     through Libracorn.
    
 
   
(13) Includes options to acquire 15,000 shares of Common Stock exercisable
     within 60 days of March 6, 1997.
    
 
                                      III-8
<PAGE>   52
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
 
     Snyder Consulting Agreement
 
   
     In September 1995, the Company entered into a consulting agreement with Dr.
Snyder (the "Consulting Agreement"), pursuant to which Dr. Snyder provides
certain consulting services to the Company, including, but not limited to,
serving as Chairman of the Company's scientific advisory board ("SAB"),
recommending candidates for SAB membership, assisting the Company in preparing
its business plan and in the recruitment of scientific staff, advising the
Company with respect to the purchase of laboratory equipment and acquisition of
new technologies and participating in such business meetings as the President of
the Company may reasonably request. Dr. Snyder has agreed to make himself
available to render such services for a minimum of 24 and a maximum of 38 days
per year. Under certain very limited circumstances, the Company has rights to
inventions that may be developed by Dr. Snyder. As consideration for these
services, the Company is obligated to pay Dr. Snyder annual fees during each of
the 12 month periods beginning on September 1, 1995, 1996 and 1997 of $150,000,
$160,000 and $170,000, respectively, payable in equal monthly installments. Dr.
Snyder (i) is also entitled to a one-time bonus of $25,000 upon identification
of a lead compound in the Company's nitric oxide synthase research program and
(ii) received non-qualified stock options to purchase 90,000 shares of Common
Stock at an exercise price of $5.917 per share which vest at a rate of one-third
each year beginning on the first anniversary of the date of the Consulting
Agreement.
    
 
     Loans to Officers and Directors
 
     Under the terms of its employment agreement with Dr. Smith, the Company
granted an interest free bridge loan in the principal amount of $175,000 to Dr.
Smith (the "Bridge Loan") shortly after he began his employment with the Company
in July 1993 to assist Dr. Smith in relocating to the Baltimore area. Dr. Smith
repaid the Bridge Loan in October 1994. In August 1994, the Company granted to
Mr. Jordan an interest free bridge loan of $110,000 for use in connection with
the purchase of a residence in Maryland. Mr. Jordan repaid this loan in full in
September 1994. In October 1994, Dr. Smith was granted an interest free loan
related to the sale of his former residence in the amount of $47,733. In 1996,
the Company forgave the balance of this loan and paid to Dr. Smith $23,370 to
cover the anticipated income taxes due related to the loan forgiveness. A note
from Dr. Snyder in the amount of $39,000, related to his purchase of founders
stock in August 1993, was paid in full during 1994.
 
     In connection with the sale of 34,129 shares and 19,565 shares of Common
Stock to Messrs. Brennan and Laderman, respectively, in February 1994,
full-recourse notes bearing interest of 5.32% annually in the amounts of $60,000
and $30,000, respectively, were delivered to the Company by these individuals.
These notes are due in February 1999. In addition, in connection with his
subscription to purchase of 32,609 shares of the Common Stock in December 1993,
Mr. Jordan delivered to the Company a full-recourse note in the amount of
$50,000, bearing interest at the rate of 5.32% annually. Mr. Jordan paid this
note in full in March 1994.
 
     Exercise of Warrants
 
     In December 1994, Drs. Smith and Snyder and Mr. Jordan exercised certain
warrants to purchase 30,000 shares, 65,217 shares and 32,609 shares,
respectively of the Company's Common Stock. The unexercised portions of these
warrants expired on December 31, 1994.
 
     Tax Indemnity Agreements
 
     In March 1994, the Company entered into tax indemnity agreements (the "Tax
Agreements") with Drs. Snyder and Smith and Messrs. Jordan, Brennan and Laderman
(the "Indemnitees") with respect to their purchases of Common Stock, warrants
and/or grants of stock options in August, November and December 1993 and January
and February 1994, respectively. Under the terms of these agreements, the
Company has agreed to indemnify the Indemnities against any tax deficiency
(including any interest, additions to tax or penalties attributable thereto)
they may incur as the result of a challenge by the Internal Revenue Service, or
any state or local authority, to the valuation of the Common Stock purchased by
the Indemnitees or the amount of the exercise price of the options granted to
the Indemnitees.
 
                                      III-9
<PAGE>   53
 
     Gell Pharmaceuticals Inc.
 
     In February 1995, the Company and The Abell Foundation, Inc., a Maryland
philanthropy, formed Gell Pharmaceuticals, Inc. ("Gell"), a new company
dedicated to the development of compounds to treat cocaine and other addictions.
Abell purchased an 80% interest in Gell for $2.5 million, and the Company owns
the remaining 20%. On March 5, 1997, Abell exercised its rights to exchange its
interest in Gell for 750,000 shares of Common Stock of the Company. Prior to the
exchange, the Company conducted all of Gell's research and development under a
services agreement.
 
     Certain Transactions with Scios Inc.
 
     For a description of certain transactions with Scios, see "Compensation
Committee Interlocks and Insider Participation" above.
 
     Option Grants to Mr. Casey and Mr. Newman
 
     On March 27, 1996, the Corporation granted to Messrs. Casey and Newman
non-qualified stock options to purchase 75,000 and 45,000 shares of Common
Stock, respectively. See "Director Compensation" above for a description of the
terms of these option grants.
 
     Employment of Certain Spouses of Executive Officers
 
     The spouses of Drs. Smith and Henry are employees of the Company.
 
                                     III-10
<PAGE>   54
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
 
     (a)(1) Financial Statements
 
     All required financial statements of the registrant as set forth under Item
8 of this report on Form 10-K.
 
     (a)(2) Financial Statement Schedules
 
     All schedules are omitted because they are not applicable or the required
information is included in the Financial Statements or notes thereto.
 
     (a)(3) Exhibits
 
     The following exhibits are filed with this Form 10-K or incorporated herein
by reference to the document set forth next to the exhibit listed below:
 
   
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER                                      DESCRIPTION
   ------------   ----------------------------------------------------------------------------
   <S>            <C>
    3.01(1)       Amended and Restated Certificate of Incorporation of the Company.
    3.02A(1)      Amended and Restated By-laws of the Company.
    3.02B(2)      Amendments to Amended and Restated By-laws of the Company.
    4.01(1)       Specimen Stock Certificate.
    4.02(5)       Stockholder Rights Agreement dated September 26, 1995.
   10.01A(1)      1993 Employee Share Option and Restricted Share Plan ("Option Plan").
   10.01B(6)      Amendment to Option Plan, adopted by the Board of Directors Effective May
                  16, 1995.
   10.01C(7)      Amendment to Option Plan, adopted by the Board of Directors Effective May
                  21, 1996.
   10.01D*        Amendment to Option Plan, adopted by the Board of Directors Effective
                  February 18, 1997.
   10.02(1)       Series A Preferred Stock Purchase Agreement, dated September 30, 1993, as
                  amended between the Company and holders of its Series A Preferred Stock
                  ("Series A Agreement").
   10.02A(4)      Amendment, dated August 25, 1994, to Series A Agreement.
   10.02B(3)      Amendment, dated February 15, 1995, to Series A Agreement.
   10.02(1)+      License Agreement, effective March 18, 1994, between the Company and
                  Research Triangle Institute, a not-for-profit corporation existing under the
                  laws of North Carolina.
   10.02A(1)      Appendix A to Exhibit 10.04.
   10.03(1)+      License Agreement, dated March 15, 1994, between the Company and Scios Nova.
   10.04(1)       Employment Agreement between the Company and Craig R. Smith, M.D.
   10.05(1)       Employment Agreement between the Company and Andrew R. Jordan.
   10.06(1)       Employment Agreement between the Company and John P. Brennan.
   10.07(1)       Employment Agreement between the Company and Ross S. Laderman.
   10.08(3)       Employment Agreement between the Company and Earl W. Henry, M.D.
   10.09(3)       Employment Agreement between the Company and Peter D. Suzdak.
   10.10(3)       Employment Agreement between the Company and Nicholas Landekic.
   10.11(6)       Employment Agreement between the Company and Thomas C. Seoh.
   10.12(7)       Amendments to executive officer employment letter agreements
   10.13(1)       Stock Purchase Agreement, dated August 20, 1993, between the Company and
                  Solomon H. Snyder, M.D.
   10.14(1)       Stock Purchase Agreement, dated August 20, 1993, between the Company and
                  Craig R. Smith, M.D.
</TABLE>
    
 
                                      IV-1
<PAGE>   55
 
   
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER                                      DESCRIPTION
   ------------   ----------------------------------------------------------------------------
   <S>            <C>
   10.15(1)       Stock Purchase Agreement, dated November 15, 1993, between the Company and
                  Andrew R. Jordan.
   10.16(1)       Restricted Share Agreement, dated February 14, 1994, between the Company and
                  John P. Brennan.
   10.17(1)       Restricted Share Agreement, dated February 21, 1994, between the Company and
                  Ross S. Laderman.
   10.18A(1)      Consulting Agreement, dated August 1, 1993, as amended on February 28, 1994,
                  between the Company and Solomon H. Snyder, M.D (the "Snyder Consulting
                  Agreement").
   10.18B(8)      September 1, 1995 amendment to Snyder Consulting Agreement.
   10.19A(1)+     License Agreement, dated December 20, 1993, between the Company and The
                  Johns Hopkins University ("JHU Agreement").
   10.19B(1)      Appendix B to JHU Agreement.
   10.20(1)       Form of Director and Officer Indemnification Agreement.
   10.21(1)       Form of Tax Indemnity Agreement.
   10.22A(1)      Guilford Pharmaceuticals Inc. Directors' Stock Option Plan.
   10.22B(7)      Amendment, Effective May 21, 1996, to Directors' Stock Option Plan
   10.23(1)       License Agreement, effective April 6, 1994, between the Company and Yale
                  University.
   10.24(4)       Lease Agreement, dated August 30, 1994, between Crown Royal, L.P. and the
                  Company.
   10.25(6)       Subscription and Stockholders Agreement, dated February 17, 1995, among Gell
                  Pharmaceuticals Inc., the Company and the Abell Foundation, Inc.
   10.26(3)       Exchange and Registration Rights Agreement, dated February 17, 1995, among
                  the Company and the Abell Foundation, Inc., and the several holders named in
                  Appendix I.
   10.27(3)       Master Services Agreement, dated February 17, 1995, between the Company and
                  Gell Pharmaceuticals Inc.
   10.28(3)       Standard Form of Agreement (AIA Document A111), dated September 28, 1994,
                  between the Company and Riparius Construction, Inc.
   10.29(3)       Loan and Financing Agreement between the Maryland Economic Development
                  Corporation ("MEDCO"), the Company and Signet Bank/Maryland ("Signet").
   10.30(3)       Leasehold Deed of Trust by and between the Company and Janice E. Godwin and
                  Ross Chaffin (as trustees) for the benefit of MEDCO and Signet.
   10.31A(3)      Insurance Agreement between the Maryland Industrial Development Financing
                  Authority and Signet.
   10.31B*        Letter, dated April 2, 1996, amending Insurance Agreement.
   10.32(8)+      License Agreement, dated December 9, 1995, by and between the Company and
                  Daiichi Radioisotope Laboratories, Ltd.
   10.33(9)+      License and Distribution Agreement, dated October 13, 1995, by and between
                  the Company and Orion Corporation Farmos.
   10.33(10)+     DOPASCAN Supply Agreement, dated July 10, 1996, by and among the Company and
                  Nordion International Inc. and Nordion Europe S.A.
   10.34(10)+     Bulk Pharmaceutical Sales Contract, dated September 23, 1994, between the
                  Company and Aerojet-General Corporation.
   10.35(10)      Equipment Lease, dated September 18, 1996, between the Company and General
                  Electric Capital Corporation
   10.36*         Term Loan, dated April 30, 1996, as amended on December 6, 1996, by and
                  between the Company and Signet Bank.
</TABLE>
    
 
                                      IV-2
<PAGE>   56
 
   
<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER                                      DESCRIPTION
   ------------   ----------------------------------------------------------------------------
   <S>            <C>
   10.37(7)       Marketing, Sales and Distribution Rights Agreement between Rhone-Poulenc
                  Rorer Pharmaceuticals Inc. ("RPR"), the Company and GPI Holdings, Inc.,
                  dated June 13, 1996.
   10.38(7)       Manufacturing and Supply Agreement between RPR and the Company, dated June
                  13, 1996.
   10.39(7)       Stock Purchase Agreement between the Company and Rhone-Poulenc Rorer Inc.
                  ("RPR Inc."), dated June 13, 1996.
   10.40(7)       Loan Agreement between the Company and RPR Inc., dated June 13, 1996
   11.01*         Statement re: Computation of Per Share Earnings
   21.01*         Subsidiaries of Registrant
   23.01          Consent of KPMG Peat Marwick LLP.
   24.01*         Power of Attorney (contained in signature page).
   27.01          Financial Data Schedule
</TABLE>
    
 
---------------
 (1) Incorporated by reference from the Registrant's Registration Statement on
     Form S-1 (No. 33-76938) declared effective June 16, 1994.
 
 (2) Incorporated by reference from the Registrant's Registration Statement on
     Form S-8 (No. 333-17833) declared effective December 13, 1996.
 
 (3) Incorporated by reference from the Registrant's Annual Report on Form 10-K
     for the year ended December 31, 1994.
 
 (4) Incorporated by reference from the Registrant's Quarterly Report on Form
     10-Q for the quarter ended September 30, 1994.
 
 (5) Incorporated by reference from the Registrant's Form 8-K filed October 10,
     1995.
 
 (6) Incorporated by reference from the Registrant's Registration Statement on
     Form S-1 (No. 33-94530) declared effective August 16, 1995.
 
 (7) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
     for the quarter ended June 30, 1996.
 
 (8) Incorporated by reference from the Registrant's Form 10-K, filed February
     23, 1996.
 
 (9) Incorporated by reference from the Registrant's Form 10-KA, filed March 4,
     1996.
 
(10) Incorporated by reference from the Registrant's Quarterly Report on Form
     10-Q for the quarter ended September 30, 1996.
 
   
  +  Confidential treatment of certain portions of these agreements has been
     granted by the Securities and Exchange Commission.
    
 
   
  *  Incorporated by reference from the Registrant's Form 10-K, filed March 7,
     1997.
    
 
     (b) Report on 8-K:
 
     The Company filed a current report on Form 8-K on October 16, 1996
announcing the Company's 3-for-2 stock split.
 
                                      IV-3
<PAGE>   57
 
                        SIGNATURES AND POWER OF ATTORNEY
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                          GUILFORD PHARMACEUTICALS INC.
 
   
<TABLE>
<S>                                            <C>
Date: March 14, 1997                                        By:/s/ CRAIG R. SMITH
                                               -----------------------------------------------
                                                            CRAIG R. SMITH, M.D.
                                                    PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
    
 
   
     PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATE INDICATED.
    
 
   
<TABLE>
<CAPTION>
                  SIGNATURE                               TITLE                   DATE
---------------------------------------------  ------------------------------------------------
 
<S>                                            <C>                        <C>
          /s/ CRAIG R. SMITH, M.D.              Chief Executive Officer,         March 14, 1997
---------------------------------------------    President and Director
            CRAIG R. SMITH, M.D.                  (Principal Executive
                                                        Officer)
 
            /s/ ANDREW R. JORDAN                Sr. Vice President, Chief        March 14, 1997
---------------------------------------------    Financial Officer, and
              ANDREW R. JORDAN                    Treasurer (Principal
                                                  Financial Officer and
                                                  Principal Accounting
                                                        Officer)
 
                      *                                 Director                 March 14, 1997
---------------------------------------------
           SOLOMON H. SNYDER, M.D.
 
                      *                                 Director                 March 14, 1997
---------------------------------------------
              RICHARD L. CASEY
 
                      *                                 Director                 March 14, 1997
---------------------------------------------
           GEORGE L. BUNTING, JR.
 
                      *                                 Director                 March 14, 1997
---------------------------------------------
       W. LEIGH THOMPSON, M.D., PH.D.
 
                      *                                 Director                 March 14, 1997
---------------------------------------------
            ELIZABETH M. GREETHAM
 
        *By /s/ CRAIG R. SMITH, M.D.
---------------------------------------------
            CRAIG R. SMITH, M.D.
              ATTORNEY-IN-FACT
</TABLE>
    
 
                                      IV-4